Column: Old-age security is finally here

Written by GAUTAM BHARDWAJ | Updated: Sep 10 2013, 00:47am hrs
Approval of the PFRDA Bill by parliament is a historic victory in Indias battle against its looming old-age poverty crisis. The social and fiscal cost of a tax-funded social security would have been far more than India can imagine or afford. The current 100 million elderly, most of whom were excluded from formal pension arrangements while they were young, today face the grim prospect of living for another 20 years in poverty. They are a stark reflection of the huge cost of sustained policy inertia on pension reforms in the past.

The National Pension System (NPS) on the other hand, can produce a dramatically different outcome for the next generation of Indias elderly by providing millions of young citizens with a simple, secure and affordable mechanism to accumulate savings for their old age. Armed with a legislation, the PFRDA can also provide greater business-level confidence to both existing and future market participants eyeing Indias huge latent retirement savings demand. Equally, the rapidly-growing NPS subscriber base can now march towards retirement with greater confidence and a sense of security regarding old age savings.

First Dhirendra Swarup and then Yogesh Agarwal, at the helm of the Pension Fund Regulation and Development Authority, have already spent the last few years in carefully putting together most of the critical pieces of the NPS architecture. With a team of credible pension fund managers, a robust central record-keeping and administration platform, pan-India outreach and access through banks and other third-party distributions, well-regulated annuity providers, modest fees and charges and a track-record of impressive investment returns, we are well placed to jumpstart the next stage of NPS expansion.

However, considering the size and heterogeneity of Indias pension coverage gap, the task ahead will be daunting at best. Nowhere in the world has any country succeeded in achieving the scale of voluntary pension coverage that the PFRDA will need to attempt within a remarkably short window of Indias demographic transition. The challenge before the regulator will be even greater as it targets millions of individuals with modest intermittent incomes, negligible financial literacy and limited banking-access spread across urban and rural locations. The regulatory and business response using NPS will therefore need to be well-planned and coordinated to best meet its core policy objective.

The version of the legislation approved by parliament has two important deviations from the original OASIS proposalsguaranteed returns and pre-retirement withdrawals. Although some tradeoffs in achieving political consensus were expected and are perhaps understandable, these two specific changes appear retrograde at first glance. Both guarantees and early withdrawals have been vehemently opposed by most pension experts over the years and could well constitute a giant step in the wrong directionespecially against the backdrop of our experience with the EPFO.

Forcing fund managers to provide guarantees will prompt conservative portfolio choices and depress returns. This will most adversely impact the retirement outcomes of lower-income individuals who may well be attracted by the concept of a guarantee. Ironically, it is this very population that would most desperately need high real returns to convert modest savings into a meaningful retirement corpus. Indias poor will be unable to afford such guarantees. They should instead be able to harness the equity premium in order to have a serious shot at escaping old-age poverty.

On the other hand, guaranteed returns could be a powerful tool to attract early mass-scale voluntary uptake of the NPSespecially among low-income households. Once a person joins the NPS and becomes comfortable with the idea of regular savings for old age, she/he could be encouraged to migrate her/his accumulations and future contributions to a more suitable portfolio such as the auto-choice option developed by PFRDA. Though its not necessary, greater visibility of portfolio choices and returns may prompt people to take more appropriate decisions over timeespecially since the NPS allows portability across fund managers and products.

Similarly, allowing pre-retirement withdrawals need not cause us to stray from our goals. Obviously, one does not need to be a pension expert to realise that consuming retirement savings while one is still young will have a large adverse impact on terminal accumulations. We have already seen millions of EPFO customers misusing withdrawals and drawing down most of their PF savings before they are old. Not surprisingly therefore, EPF subscribers on average retire with less than R50,000 in their PF accounts-not a very useful corpus for a 20-year retirement.

However, the political compulsions of addressing the liquidity needs of NPS subscribers are perhaps justified to an extentespecially when this will probably be the first (and perhaps the only) regulated savings instrument for most low-income, informal sector individuals for the foreseeable future. Many of them may shy away from the prospect of locking away their savings for 20 years or more. This could make the NPS less attractive to the poor and thus limit voluntary enrollments by a population that is most vulnerable to the risk of old-age poverty.

Here also, the gap between policy intent and outcomes will depend largely on how this feature is implemented. For example, we could set up for (say) 20% of all NPS contributions to automatically flow to a tier-two (savings) account that is already available to each NPS subscriber. These savings would be managed by the same pension fund managers and earn identical returns as the savings in a subscribers tier-one (pension) account. The person would be free to withdraw savings from her tier-two account at any time without the need to specify a reason. To further enhance the liquidity attraction, an NPS subscriber could be issued a debit card linked to her tier-two savings account. She could then simply walk up to an ATM and withdraw a part or all of her savings from her tier-two NPS account at will.

In all this, the importance of broad-based public awareness cannot be overemphasized. Achieving mass-scale coverage and sustained savings discipline will be even more challenging as the majority of the NPS target population will be informal sector working poor who are unable to easily relate to the concepts of retirement or pensions and are also not exposed to long-term market-linked products. The regulator will therefore need a huge publicity budget to proactively promote the concept of old age savings to the roughly 300 million individuals whose present retirement portfolio is a fuzzy mix of children, god and kismet.

Going forward, and as the policy and regulatory efforts with building a mass-market for the NPS gather further momentum and begin succeeding at scale, millions of everyday Indians will need a portable and affordable mechanism to channel potentially tiny pension contributions, month after month over multiple decades, to pension fund managers. Secure, convenient and low cost technology-based payment solutions, of the kind recently proposed by the new RBI governor, will therefore be a key ingredient for Indias success with its pension reform programme.

Clearly, we are treading a difficult and uncharted path with the NPS. But this need not deter our resolve and efforts. Pension reform after all, unlike the PFRDA Bill, is not an event. Its a process. And while we have won the legislative battle, winning the war against old-age poverty will depend almost entirely on implementation. In this process, the PFRDA will need to carefully balance political compulsions, policy goals and sound pension principles. This will not be easy. But it will be paramount.

The author is co-founder, Invest India Micro Pension Services. Views are personal