The growing interest in Old Pension Scheme ahead of 2024 poll

The Government pension scheme has recently come into the limelight ahead of the five state assembly elections this month and the Lok Sabha elections next year.

The topic of pensions has become a politically contentious matter. Many states governed by the Opposition have reverted to the traditional pension scheme (OPS) which ensures that retirees receive monthly payments equal to 50 per cent of their last-drawn salary.

States governed by opposition parties, such as Rajasthan, Chhattisgarh, Jharkhand, Himachal Pradesh, and Punjab, have switched back to the old pension system (OPS). Economists warn that this move could potentially lead these state governments towards financial insolvency.

In contrast, the market-linked pension plan introduced in 2004 by the NDA when Atal Bihari Vajpayee was the Prime Minister doesn't guarantee a fixed base amount. Another key difference lies in the contribution structure: under the New Pension Scheme (NPS), about 8.7 million employees contribute 10 per cent of their salary, with a 14 per cent match from the government, whereas in the OPS, there is no requirement for employee contributions.

The ultimate pension amount that beneficiaries receive is contingent on this fund's investment returns, primarily invested in government debt instruments. This investment strategy contrasts with the OPS, where pension payments are a fixed portion of the retiree's final salary, regardless of fund performance.

OPS – ‘unfunded’ retirement scheme

Under the old pension system (OPS), employees are guaranteed a fixed pension equal to 50 per cent of their last drawn salary without any contribution from the employees themselves. This is why it is labelled as an "unfunded" retirement scheme.

An official indicated that the government will only partially revert to this old, unfunded scheme. Instead, they are considering a revised model to provide a guaranteed basic amount adjusted for inflation.

The current central government, led by the Bharatiya Janata Party and facing elections next year, established a committee headed by TV Somanathan to evaluate the existing pension system in April.

The proposed changes to the pension scheme would maintain its link to market returns. However, the government is exploring a method to guarantee a minimum pension, potentially around 40 per cent of an employee’s last-drawn salary. The government would cover any shortfall if the market-linked payouts fall below this base amount.

Such a modification aims to balance the need for a sustainable pension system with the assurance of a minimum income for retirees, addressing some concerns about the variability of market-linked returns.

Fiscal risks associated with OPS

Soumya Kanti Ghosh, the Group Chief Economic Adviser at State Bank of India (India's largest bank) has highlighted the fiscal risks associated with the old pension scheme (OPS). He points out that this system could significantly worsen the debt situation of state governments. For context, in the fiscal year 2023-24, India's federal pension budget was ₹2.34 lakh crore.

However, Ghosh's research shows a concerning trend in the financial impact of this scheme on state governments. Over 12 years ending in 2021-22, the compounded annual growth rate of pension liabilities for all state governments was 34 per cent. By the fiscal year 2020-21, the pension outgo as a percentage of revenue receipts had reached 13.2 per cent, indicating a significant financial burden.

These findings suggest that while the OPS is politically favourable due to its assured benefits and inflation-linked increases, it poses a substantial and growing fiscal challenge for state governments in India. The high growth rate in pension liabilities and the significant portion of state revenues dedicated to these pensions underscore the need to consider the scheme's long-term sustainability carefully.

Pensions is 40% of states’ salary bill

The critical issue is whether state budgets can sustain such high pension expenditures. Reserve Bank of India (RBI) data from 2021-22 shows that all states had a combined salary bill of ₹900,000 crore and a pension bill of about ₹400,000 crore. This means pensions constitute approximately 40 per cent of the salary bill, a proportion expected to increase due to two factors: the growing number of retirees each year and the bi-annual indexing of pensions to the dearness allowance, leading to higher payouts for each pensioner. Consequently, as pension obligations rise, states might allocate more funds to pensions, reducing their capacity for capital and development expenditures. This financial strain seems indisputable.

However, from a Rawlsian justice perspective, which advocates equal rights for all citizens, the move away from the old pension scheme (OPS) appears discriminatory between older and newer government employees. In the same organisation, it's unfair for employees performing identical roles to have differing pay and benefits based solely on their date of joining.

This issue becomes more pronounced in government sectors, where salary and perks are tied to one's rank, but post-retirement benefits vary. The OPS supporters have a point here, as seen in the military's adoption of the one-rank, one-pension (OROP) system. Why not extend this to all government employees?

Balanced approach needed

Critics argue that a high pension burden could compromise public finances if the OPS is reinstated. Here, it's essential to understand the compensation ethos in the public versus private sectors. The government sector offers lower salaries but includes perks like generous pensions. The private sector typically provides higher wages with fewer perks encompassed within the cost-to-company (CTC) model.

Adopting a CTC approach in government would inflate salary expenses, drawing criticism. These compensation structures stem from historical decisions, and altering them disrupts other areas. Like the government issuing long-term debt, pensions offer old-age security and manage immediate fiscal expenditures.

To address these issues, a balanced approach is needed. The government could consider increasing salaries under the NPS for parity, reworking perquisites, and ensuring a uniform compensation structure within departments. Acknowledging pensions' significant economic impact, as they stimulate spending across age groups, is also vital.

The Pay Commission of India could explore these ideas, aiming to harmonise compensation structures in its forthcoming recommendations.