Bigger than UTI

In the flurry of mini-Budget announcements, the one that got the least critical attention, the pension scheme for the unorganised sector, is the one most likely to cause the biggest hole in the Budget in the years to come.

For, while the government says the scheme is fully-funded, it is not. Indeed, while the government itself is moving away from deemed-benefit schemes for bureaucrats to a deemed-contribution one, a deemed-benefit scheme (where the benefits are specified even though they are to accrue 20-30 years later) for the unorganised sector is nothing but populism. Running the scheme also requires organisational skills that the government just does not have.

While there is a 30 per cent leakage in the pension scheme run for 4 million government employees, the new scheme requires collecting Rs 200, month after month, for 30 years, from 370 million unorganised sector workers across the country.

On the face of it, the scheme is financially sound. It requires a monthly contribution of Rs 200 from each unorganised sector employee/employer, and from the age of 60 the employee gets Rs 500 per month till he/she dies.

Assuming a 6 per cent rate interest, and 4 per cent inflation, if an employee starts contributing at the age of 30, this means a corpus of around Rs 95,000 after 30 years, and this is roughly what an annuity scheme would cost for a 60-year old if bought today.

The problems come when you factor in other costs and benefits, apart from the chilling fact that there is no guarantee that interest rates will remain at 6 per cent for the next 30-40 years.

The scheme, for instance, has a 1 per cent cost for administration "" factor this in, and the corpus falls to Rs 80,000.

It also promises an insurance cover of Rs 1 lakh. Throw in the cost of a policy, and the value of the corpus falls even further.

The problems worsen when you begin inflation-proofing the Rs 500 annuity. While the scheme is silent on it, it clearly has to be inflation-indexed since Rs 500 after 30 years is meaningless.

Yet, today, even LIC does not offer inflation-indexed annuities since they are an invitation to disaster. So, the only way to figure out the true cost of the scheme is to assume a no-inflation scenario "" that is, Rs 500 will always be worth Rs 500, irrespective of when it is paid.

But interest rates will then fall from 6 per cent to around 1.5 per cent. Apply this, and the corpus accumulated will be around Rs 90,000. But at a 1.5 per cent interest, the cost of a Rs 500 monthly annuity will be around Rs 400,000!

No matter how you calculate it, the scheme has a gaping hole in it, despite it saying 'the scheme (is) a fully funded pension plan'.

Perhaps that is why the scheme has a clause which says the government may at any point alter the rate of contribution or the scale of benefits!

Whether it will be allowed to reduce benefits once they've been announced, however, is a moot point. The poor taxpayer will then have to shell out the thousands of crores.