Wednesday, September 04, 2013

Implications of the Pensions Act

In 1998, the Ministry of Social Justice and Empowerment setup `Project OASIS', led by Surendra Dave, to engage in deep thinking about pension reforms. The report, which was submitted on 11 January 2000, envisaged an individual account defined-contribution system with central recordkeeping, and recruitment of fund managers by an auction which asked for the lowest fees+expenses.

This was a futuristic vision at the time, as a lot of the surrounding infrastructure had not fallen into place. In socialist India, it was quite novel to propose that households would build their own assets to take care of themselves in old age. However, the idea rapidly got widespread acceptance. More and more people started looking at the maladies around them and said that if only we had the NPS, these problems would not arise.

NPS was ahead of its time in being mistrustful of mutual funds and insurance companies. The great scandals of mutual funds and ULIPs lay in the future. Issues of consumer protection were not widely understood in 1998. But the key calls made in the NPS have proved to be the right ones: of delivering a solution that is good for the lifetime financial planning of households while giving financial firms wafer-thin margins. Apart from index funds, the NPS is essentially the only piece of Indian finance that is accessible to the average household that I trust. Thinking on consumer protection has progressed enormously in the following years, first at IFMR and then in FSLRC. Yet, the NPS designed in 2000 fares well in satisfying the consumer protection principles of the draft Indian Financial Code of 2013.

In December 2002, NPS was adopted by the NDA government as the mandatory pension system for all new recruits after 1 January 2004. All this was re-opened by the UPA government when it took charge in May 2004, and they chose to stay on course.

From May 2004 to September 2013, we were unable to make progress on the proper legal foundations. But the NPS was built and executed through a network of contracts and rules, planned out by one of India's best lawyers (P. Chidambaram), which is legally sound. All civil servants recruited after 1/1/2004 have been placed into the NPS, and by now this is shaping up to be substantial numbers. NPS has also started gradually going into the unorganised sector, with the assistance of co-contribution.

The wheels grind slow, but they grind true. I wish all this had happened faster, but it is good that it happened. The key implication of this decision by Parliament is that the NPS cannot be shut down by a future administration. To find out more, I suggest :
This story is interesting not just from the immensely important problem of ageing, but also as a case study in how we achieve far-reaching change in India. I disagree with the pessimists who limit their ambitions to minor tinkering changes. We in India must constantly question the foundations; almost everything about the Indian State is broken and needs to be redone from scratch.

There has been a sea change in thinking about financial law in India thanks to the work of the Financial Sector Legislative Reforms Commission.  In 2001 and 2002 we did not know how to draft law. The PFRDA Act reflects the old ways of drafting law and will not look good to modern eyes.

Looking into the future, the story now runs on five tracks:
  1. Making the civil servants NPS work properly as originally envisaged. At present it does not.
  2. NPS has forked into two systems: one for the unorganised sector and another for civil servants. These need to be merged into one single system with full portability.
  3. Achieving large-scale participation and sustained contribution for the unorganised sector -- while not sacrificing the heart of the NPS which is wafer thin charges. All too often, we get an urge to do to the NPS what was done to mutual funds and insurance companies.
  4. Using this institutional capacity to solve the problems of EPFO.
  5. We will need to adapt the PFRDA Act and the draft Indian Financial Code so as to achieve the following framework: (a) NPS would become a pension system run at the instance of the government, (b) It would be regulated by the machinery of the Indian Financial Code, (c) PFRDA would get merged into the proposed Unified Financial Authority (UFA). It is more important to be correct than to be consistent.


  1. Great Perspective on PFRDA. You have rightly identified 5 different tracks for future action. In my opinion the major challenge will remain track 3 which is popularizing it in unorganized sector at lower cost. It is the only track out of five, which can not be achieved with simple executive actions.

    I feel that key will be bundling with various other financial products/services with indirect financial incentives. Some thoughts in this direction are (1) All the commercial bank shall offer mandatory savings and pension account and AUM collected can be used as set off against their priority sector lending obligations (2) Bundle with pure term life insurance cover where insurance covers taper off as pension amount increases. (3) Each milestone there is some reward to the contributor e.g. for completing 60 monthly installment without interruption there is free health check up at ESIC hospitals etc.

  2. The core issue for retirement savings is not how less is the charge ( PPF has none) but on how regularly are the contributions flowing in and the corpus is not touched for anything else. To that extent dont the insurance company pension plans look better?


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