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The challenge for India
Do new initiatives go far enough?

 

By: Robert Palacios
Insights 42, June 2002

 

In the past 50 years, policymakers in India have made precious little progress towards providing a viable alternative to the family as the main source of income security for the elderly. Will recent government initiatives help India navigate its demographic transition in the 21st Century?

Although India's population is young, in the last three decades life expectancy upon reaching age 60 has risen by 15% and fertility rates have halved. The ratio of elderly to working-age people is expected to double in the next 30 years. Yet, as noted in a recent World Bank report entitled, 'India: The Challenge of Old Age Income Security', only 1 in 10 Indian workers participates in a pension scheme. There are two main types of pension schemes - a defined benefit pension scheme for civil servants and those administered by the Employees' Provident Fund Organization (EPFO). Both appear to be unsustainable in their current form

 

Cost of security
The civil servants' scheme operates much as it did prior to independence and continues to be financed directly from the budget. Because there are many more pensioners today and they are living longer, the government's pension bill in 2000 was more than 1% of the GDP, or 15% of revenues.

Established in 1952, the Employees' Provident Fund was gradually extended from 5 to 179 industries. Nevertheless, labour force coverage has barely risen - from 1% to 5%. High rates of withdrawal from account balances, a fixed retirement age and investment returns below income growth combine to produce inadequate balances at retirement. Since 1995, part of the provident fund has been converted to a defined benefit scheme, but projections show that unless the real value of benefits is cut, the scheme is not sustainable.

A social assistance scheme that provides cash transfers to the poor elderly was introduced at the state level in the 1960s and 1970s and at the national level in 1996. There is almost no information available on poverty among the elderly and little evidence of the impact of these meagre cash transfers. However, several studies have raised concerns about targeting, administrative efficiency and even corruption.

 

Growing deficit
The World Bank study highlighted the adverse effects of the pension system on the rest of the economy. The growing fiscal burden of the civil service scheme threatens to 'crowd out' financing of other programmes and to add to India's burgeoning deficit. The EPFO helps to finance this deficit by investing exclusively in government-guaranteed debt but, as a result, deprives the economy of an important source of long-term finance. The perception that mandated contributions are largely a tax on labour encourages informal sector activity.

In March 2001 the Indian Government announced changes, including the introduction of a contributory scheme for civil servants and a new scheme to cover informal sector workers. Progress has been slow, however, and specific plans have not been formulated. In the meantime, there are no plans to reform the EPFO schemes and voluntary, private pensions continue to develop in a regulatory vacuum.

The World Bank study views these distinct areas as interrelated. Old age support should be based on programmes that provide secure income-smoothing mechanisms for workers who can save for old age, and poverty alleviation programmes for those who cannot. Achieving these objectives implies, among other things:  rationalising the defined benefit elements of the formal sector schemes through changes to benefit formulae and retirement ages shifting defined contribution plans to private management investing in a diversified portfolio with appropriate supervision increasing funding of social assistance schemes targeted to the elderly subject to verifiable effectiveness.

 


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