Does Indian States' Revival Of Old Pension Scheme Make For A Financial Disaster?

NPS is a fiscally responsible and fair pension scheme. Why are states running away from it and adopting the OPS?

Image: Kamran Akhtar/ The Quint

Four states— Chhattisgarh, Rajasthan, Jharkhand, and Punjab have abandoned the New Pension Scheme (NPS) and resuscitated the Old Pension Scheme (OPS). Himachal Pradesh is expected to issue similar orders soon. It seems the remaining non-BJP-ruled states might also make this switch sooner or later.

The Centre and the BJP-ruled states are holding out for the present. There is, however, a strong build-up of employee sentiment in these states. It might not be surprising if, like farm loan waiver schemes, their resistance also starts weakening and the BJP states also make an about-turn.

NPS is a fiscally responsible and fair pension scheme. Why are the states running away from it and adopting the OPS? What needs to be done to stop this?

How Old Pension Scheme(OPS) Is Employees’ Darling

For government employees, OPS offers an undeserving pension bonanza. They get 50% of the last pay as a pension for their entire post-retirement life (the spouses also get if employees pre-decease). In addition, governments pay Dearness Allowance (DA) on pensions.

The employees don’t make any contribution in their service life to earn this pension and DA. The employees contribute to their tax-exempt General Provident Fund (GPF) account, which is paid back to them with interest on retirement or before, in addition to the pension.

Whereas, benefits are more defined and spartan in NPS. An employee has to make contributions equal to the government’s which builds up a pension corpus in individual pension account. Her pension depends on these contributions and returns earned from the investment of this corpus. He/she can get a pension by annuitising her pension corpus at retirement.

Various calculations suggest that this corpus does not earn a pension annuity equal to 50% of the last pay as pension. The Government of India increased its contribution from 10% to 14% of pay a few years back in an effort to improve pension annuities equal to 50% of their last pay. No DA is paid on NPS pension annuity.

It is no brainer why all the government staff wants OPS.

A Big Fiscal Bugbear for Governments

Pension bonanza for employees comes at a big fiscal cost to the government.

In NPS, the government makes only an upfront contribution every month towards the pension of a government servant while s(he) is in service. Government provides no pension. The government’s fiscal obligations are quite specific and current only. There are no lumpy, uncertain and life-long pension payment obligations.

No doubt NPS is fiscally responsible and OPS fiscally disastrous for the states.

India was in a massively fiscally challenged environment from 1990s. States' fiscal position had become terribly bad by the year 2003-04 when the NPS germinated. Almost all states were living on ways and means advances (WMA) and overdrafts from the RBI. Employees were hardly ever paid their DA instalments on time. Even their retirement dues were routinely delayed.

States had to suspend payments of their bills time and again. Their treasuries were closed many times and for extended periods. Assam treasury remained closed for about 240 days in one year. Governments had no choice but to be fiscally responsible in those dire times.

New Pension Schemes & Govt’s Fiscal Responsibility

The NPS system was introduced in the country in 2004 after considerable studies and discussions by the BJP-led National Democratic Alliance (NDA). This was a significant plank of the larger Fiscal Responsibility and Budget Management (FRBM) package brought in those challenging times.

The NPS system got implemented in almost all the states during 2004-2008 under the leadership of the Congress-led United Progressive Alliance (UPA). Prime Minister Manmohan Singh took enormous personal interest to make this pivot happen.

States' finances became healthier as a consequence.

The NPS system made the government’s pension liabilities determinate and much lower in longer-term assessed actuarially.

FRBM laws brought in by all the states in the same period ensured that the state governments started living within prudential fiscal limits. States could claw back from the brink of bankruptcy.

States, despite the shocks of the global financial crisis in 2008-2010 and Covid-19 epidemic in 2020-22, have managed to live within their fiscal deficit limits of 3% of GSDP for almost 15 years.

The New OPS model surrenders all fiscal gains

The orders issued by the Governments of Chhattisgarh and Rajasthan have following principal features:

• NPS stands repealed from the date specified in the order. OPS gets restored retrospectively with effect from the date when NPS was implemented in the state.

• Employees will no longer make any pension contributions. Employees' contributions will go to their individual GPF accounts. No stake in employees in their pensions.

• The government will either not make any pension contribution or make a very small contribution.

Pensions will become completely unfunded in the OPS system from completely funded in the NPS system.

It has been further announced that the state governments will work to get back from the NPS authorities total accumulated corpus of their NPS employees. Employees’ contribution in the corpus, has been promised to be paid back to them at the time of retirement, along with further interest earned thereon.

Additional Resources Attracted States To Go for OPS

Governments in India tend to regress to short term political economy considerations every now and then. This tendency becomes more prominent when their finances are not in dire straits. Decision to revert to OPS has been further motivated by the prospects of improvement in their finances in the short term.

• First, these governments will not have to contributing their share as contribution. Illustratively, if the Government of Rajasthan pays 14% of the pay and DA as a contribution for its over 3 lakh employees under NPS, its’ expenditure on salaries will go down by about Rs. 1250 crore a year if we take monthly average salary as Rs. 25,000.

• Second, the states might get the accumulated NPS corpus belonging to their employees. The assets under management (AUM) of state employees under NPS exceeds Rs. 4.5 lakh crore. Continuing with Rajasthan example, its share in the NPS corpus should be in excess of Rs. 25,000 crore. When it becomes available, this will be a big one-time windfall.

These are valuable and handy resources for the fiscally strapped Rajasthan government to spend on its pet development schemes and freebies. Ditto for other states.

OPS Will Make States’ Liabilities Unsustainable

Unfunded pensions are a big fiscal debt/liability for the governments.

Pension obligations for employees brought under OPS will be about three times the governments’ contribution to their pensions in the NPS.

Many employees covered under NPS are the pre-2004 regularised employees who are in their fifties now. After a few years’ the state governments will have to shell out pension payments to them.

Government’s debt and liabilities will rise massively when actuarially assessed unfunded pension liabilities are included therein.

The governments making shift to OPS may, in a few years, get overwhelmed by burgeoning pension liabilities.

Govt Has To Take Leadership To Stop This Mess

State governments are still bound by the FRBM laws. Their borrowing limits are fixed by the central government as all states are indebted to the central government.

Unfortunately, the central government has, in the last few years, adopted an excessively centralisation attitude and administered states’ borrowing limits with a sledgehammer (though its own fiscal deficits have more than doubled the FRBM limits).

This has made the states, especially the opposition ruled states, lose trust in the leadership of central government. This explains partly at least these states taking adventurous measures like rebooting the OPS.

NPS is a fair pension system while OPS is excessively liberal. NPS is a fiscally determinate system defining states’ obligations in precise and clear terms; OPS is all uncertainty and fiscal fog. States’ race to revert to fiscally suicidal OPS must be stopped in the national interest.

For this to happen, the Government of India will have to display the kind of leadership which Prime Minister Manmohan Singh had shown in mainstreaming NPS and Arun Jaitley had exhibited in getting states adopt GST.

Government of India should offer a fair fiscal consolidation package with fair and reasonable borrowing limits and NPS as a necessary component. It will require a lot of hard work and persuasion.

Some states may not still agree to walk back completely from OPS. Perhaps, for them, an NPS-oriented model of OPS may have to be evolved. In this model, the states may be allowed to guarantee 50% of last pay as pension keeping the current contributions of both employees and government as in the present NPS account with the corpus managed by the way it is currently managed. This will require these states to only top-up for the shortfall.

Reasonable and fiscally responsible solutions will surely emerge if the central government and states sit together and talk.

(The Author is the Chief Policy Advisor, SUBHANJALI, Author: The $10 Trillion Dream and Former Finance and Economic Affairs Secretary, Government of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)