It?s the race that would decide the way India?s pension reform pendulum will swing in the next couple of years. Funds under the New Pension Scheme run by the PFRDA were handed over to PSU fund managers in April 2008 after a four year delay, while the entity it seeks to replace in the long run?the EPFO?appointed three new private fund managers from September.
The first set of returns filed by fund managers for both schemes reveal the race to deliver better returns in the first year of operation is going to be neck-and-neck. The NPS allows equity investments up to 15% and was expected to outperform the prevailing EPF rate of 8.5% (2007-08), thus creating a compelling argument for the EPFO board to adopt the equity idea.
Though PFRDA chairman Dhirendra Swarup had earlier stated that the NPS would fully utilise the equity window, only about 1% of the Rs 1,700 crore corpus has been invested.
This has helped the fund managers minimise the impact of the meltdown on Dalal Street in the second half of 2008. When the NPS managers?UTI, SBI and LIC?took charge of the funds in April, the BSE Sensex was at about 16,000 levels.
But while the market fell to 12,860 points by September 30, the three managed to deliver 8.7-9.1% returns in the first six months of this fiscal. If they had, in fact, invested in equities as much as their pattern allows, there was a real risk that they could have actually lost capital instead of delivering super normal returns.
On the other hand, EPFO?s new managers?Reliance Capital AMC, ICICI Prudential AMC and HSBC AMC?who have to deal with more restrictive investment guidelines with no equity exposure, took charge on September 17, two days after the Lehmann Brothers collapse which wreaked havoc on global bond and stock markets.
In the first month, the spurt in bond yields actually worked to their advantage as they delivered astounding 9.5-11% returns. However, the subsequent volatility in bond markets thanks to the liquidity squeeze that was at its worst in India during October and November 2008, took its toll. Returns by November 16 were in the range of 8.21% to 10.37%.
While a few months? returns shouldn?t be considered as an indicator of returns in a long term saving vehicle like pensions, the race will be extremely important in determining the pace and direction of pension reforms. India?s pension reform process is the most important one in the world, according to World Bank?s top social security economist Robert Palacios as it can set an important precedent for other developing countries to follow. This is more so, since the much-touted Chilean pension reform programme has attracted criticism for the way it has played out over the years.
Former central Provident Fund commissioner A Viswanathan, who was instrumental in breaking the 56-year old monopoly of its sole fund manager SBI, told FE a day before he retired on December 31: ?It?s not a race between EPFO and NPS as we don?t directly compete. But it?s an important race between public sector fund managers and private sector fund managers, between EPFO?s conservative risk-free investment strategy and (NPS?) liberalised investment pattern with reasonable risk.?
Though EPFO and NPS may not be directly competing as of now, if returns between the two vary widely, it could create pressure from stakeholders of both systems. Moreover, since the PFRDA intends to open up the New Pension system to private citizens on a voluntary basis from April 1, if it delivers higher returns than EPFO, workers could choose to renegotiate their employment contracts in order to opt out of the mandatory EPF contributions.
?This could only happen if NPS outperforms the EPF rate very significantly. Then EPFO would have to either match the rate or give people a choice to exit. However, one must remember the NPS doesn?t give the sort of assurances to workers that the EPFO does,? Viswanathan said.
Indeed, if employers don?t deposit workers? PF contributions, EPFO still pays the workers their dues from a Special Reserve Fund. In the Employees? Pension Scheme, where the Centre gives a 1.16% subsidy, the pension amount is guaranteed. There are other benefits like disability and dependent pension that are absent from the NPS.
HDFC Bank chief economist Abheek Barua said, ?The first year returns of both schemes will be interesting to watch. It could trigger a serious rethink about giving flexibility in investment pattern.
?In an ideal world with an informed polity, maybe a few years down the line after both the new systems stabilise, a marriage between the EPFO and NPS is not unthinkable. EPFO could be the first pillar pension system whereby everyone, including government employees contributes to it up to a certain mandated salary level. For workers earning higher salaries or wanting to make higher provisions for their retirement, the NPS could be the second pillar voluntary option,? said Viswanathan.