National Pension Scheme: Modification Is Crucial, Not Abandonment

National Pension Scheme: Recent protests by Government of India (GoI) employees demanding the revival of the old pension scheme (OPS) have sparked a national debate. OPS was replaced by the National Pension System (NPS) in 2004, which is a defined-contribution scheme that pools contributions from the government employee and concerned government at 10% of the base salary along with dearness allowance (DA). However, government employees maintain that NPS yields only 15% of the amount they would have secured as a pension under OPS, and inflation would erode the meager pension post-retirement.

Advocates of NPS argue that as the pension corpus is invested, market returns will fetch a superior bargain relative to OPS. The recent stock market performance may make NPS seem like a winner. But with only about 20-24% of base salary flowing into the corpus and varied pay grades of government employees, the individual payout will likely be a mixed bag.

In March 2021, Grade C employees constituted 87% of all civilian GoI employees, and Grade A employees made up only 3.6% of the total number. Grade C and B employees want OPS back. This sizeable vote bank is being wooed with gusto across states. The average growth rate in the NPS subscriber base during the last five years has been highest for the corporate sector, followed by the state and central governments. But this sector also shows the greatest volatility in employment, reinforcing the perception that government jobs are synonymous with stability.

Perennial state elections build pressure to make announcements regarding jobs and OPS. For instance, in Gujarat, the maximum number of government jobs promised was 20 lakh, and the minimum 10 lakh. Political parties, of course, ignore the overwhelming majority of the workforce: unorganized labour. Assuming the average government employee works for 30 years, the true cost of OPS (in states that repeal NPS) will be revealed in 2034 when the first batch of NPS employees retire. As OPS is an unfunded, ‘pay-as-you-go’ scheme, pensions will be paid by future taxpayers. When promises pour forth from election to election, the government treasury will see no matching inflow.

The reintroduction of OPS in Rajasthan and Chhattisgarh in the past year only invigorated the debate. The scheme is set to return in Punjab. However, OPS was scrapped in 2004 with bipartisan support from major political parties, owing to the formidable economic logic that OPS, defined-benefit scheme that ran solely on government funds, was unsustainable. OPS required the government to pay 50% of the base salary in the last year of employment, and had a dearness relief component as a buffer against inflation.

Pensions constituted the fifth-largest component of government expenditure, 4% of GDP last year. Burgeoning revenue expenditures without provisioning for these will spell fiscal disaster. Hard-fought gains to rein in the fiscal deficit will be sacrificed at the altar of populism. Adding OPS to the list of government priorities would be dangerously fiscally unsustainable. To give NPS the boot would be like throwing the baby out with the bathwater.

If NPS is not ideal, let its best features be retained. Annuity payments can be inflation-indexed, differential rates of government contribution introduced for different pay grades, and employees incentivised to contribute at higher rates. India’s aim should be adequate and timely pension, and to enhance pension coverage. NPS and the Atal Pension Yojana have made strides towards the latter. To address the former, NPS must be modified, not shelved.

The recent protests by GoI employees demanding the restoration of OPS, along with the reintroduction of OPS in