T C A Srinivasa-Raghavan: How to pay for the old

OKONOMOS

India needs pension funds. The Left should not oppose them.

Ajay Shah used to be a columnist for this paper before he chose the low road and joined the finance ministry as a consulting advisor or advising consultant. The movement is usually the other way.

If Shah has one flaw, it is that he brings an embarrassing amount of passion to economic analysis. In a recent paper* "" although he is still a bit young to get passionate about pensions "" he has put forth a plan that seeks to reform our pension system.

The key problem is to have an efficient mechanism for transferring a portion of current income to the future. The trick lies in maximising the future stream while minimising the draft on current income.

Most people seek to do so by investing in two houses: one to live in and one to rent out. That also results in something tangible for the descendents.

Often, the capital appreciation, especially in the metros, can obviate the need for the descendents to work for a living.

As Shah shows, this preference for physical assents is because our pension system simply doesn't work. Like so may other things in India it covers too few people.

"The system," says Shah "covers just 13 per cent of the workforce. Hence, the dominant fraction of the workforce "" that is 87 per cent "" lies in the 'unorganised sector' and has no formal pension system."

He also shows that, thanks to one thing or another, pensions have tended to grow faster than nominal GDP.

Thus, "over a 17-year period, while nominal GDP grew by a compound rate of 14.5 per cent, the central pension outgo grew at a compound rate of 17.8 per cent and the state pension outgo grew at a compound rate of 21 per cent.

Through this, the combined outgo went from 0.76 per cent of GDP to 1.64 per cent of GDP over this period."

And all this only for a handful of people? If ever there was something crying to be reformed, it is the Indian pension system.

Shah tells us how it can be done. What we need, he says, is a bunch of financial intermediaries who will devote themselves to pensions.

It is called unbundling or allowing different agencies to specialise, under strong supervision because, after all, you are playing with other peoples' money and the temptations can be very great.

The current lot like the provident fund and insurance types are not pension fund-walas. Their charter is different. And, as he is careful to point out, they can get in the way.

"In terms of political economy, this is an unequal battle. The insurance industry in India already exists, and has a sustained capacity for lobbying. In contrast, a comparable pension fund industry does not (at present) exist. There is a challenge for public policy."

The main elements of Shah's scheme are not new. The more important amongst them are:

An individual account, defined contribution system;

Separation between the pension sector (that is, accumulation) and benefits that are purchased from annuity providers;

A separate pensions regulator;

Portability of pension accounts across job changes, and portability of pension assets across multiple fund managers and investment products;

Rules that deter premature withdrawal but do not completely prohibit it.

The importance of devising a better system of pensions can hardly be over-emphasised because a lot of Indians are going to grow a lot older.

They are all going to live for almost as long after they retire as their working lives. They are going to need incomes.

The question is: should they pay for hanging on and on or should their children, either directly or through the taxes they pay.

Shah has suggested an important way of relieving the working classes. The Left which treats all new ideas like a lamp-post needs to recognise this.

*A sustainable and scalable approach in Indian pension reform, http://www.mayin.org/ajayshah/PDFDOCS/Shah2005_pensions.pdf, presented at the inaugural conference of the Lee Kuan Yew School of Public Policy at the National University of Singapore