India - Pension Tension

The decision by the Employees’ Provident Fund Organisation (EPFO) last week has unequivocally and irreversibly opened the gates for pension reforms. While the decision to open fund management to three private sector fund managers — HSBC AMC (Asset Management Company), ICICI Prudential and Reliance — and to the State Bank of India is rather simple, the fact that the EPFO’s powerful Central Board of Trustees felt the need for better fund management — and found private firms worthy of shouldering that responsibility — is a step that shows a new thinking in tune with changing times.

I am enthusiastic about this move not merely from the political or public policy perspective. The numbers thrown up as a result of this decision show a high level of economic efficiency, unseen so far. The charges bid by the three firms to manage about Rs 30,000 crore per annum are the lowest we’ve seen in independent India. At less than one basis point (100 basis points make a percentage point), HSBC, ICICI and Reliance are offering economies of fund management that scale allows them.

At 2.97 basis points, Tata Mutual Fund missed getting part of this pie by a huge margin while Principal, at 7.5-8.0 basis points, was completely out of the reckoning. But what surprised me was Unit Trust of India’s 6.5 basis-point bid. After showing its pro-poor leadership by offering pension plans at Rs 500 per month, the lowest that has since been overtaken by Reliance at Rs 50 per month, seeing its new numbers so out of sync with the industry was unexpected.

But beyond the private management of EPFO funds lies another opening. The new ruling coalition (as well as the presently listless opposition in the BJP) now has a unique opportunity as well as duty to pass the Pension Fund Regulatory and Development Authority (PFRDA) Bill that is needlessly pending in Parliament for the past three years. The Bill was authored by the BJP, pondered over and accepted in principle by the Congress and held back by the Left parties. If the Congress is indeed interested in getting this Bill passed, it needs to break bread with the BJP. Finance Minister P. Chidambaram said as much in a recent press conference. “We can return to the legislative agenda when we re-assemble in Parliament next,” he said, adding that he could canvass the support of 400 MPs on three key bills — on pensions, banking and insurance.

Of these, the pensions bill is the most important, as it puts the poor on India’s legislative agenda. For, more than any other section of society, it is the poor, unorganised labour that will benefit from pension reforms as they get to subscribe to PFRDA’s new pension system (NPS). This sliver of society has no permanent income, no permanent residence. But through an NPS subscription, they can get a permanent account number where they can accumulate their small savings and derive some income from it, however small it may be, once they stop working.

It is important from the public policy perspective as well. Pension liability is one of the fastest-growing expenses of the central and state governments. Between 1994 and 2005, when the Bill was proposed, these liabilities grew at the rate of 21 per cent per annum for the central government and 27 per cent per annum for state governments. Which means that in 11 years the pension liability of the Centre jumped eight-fold, while that of state governments multiplied almost 14 times. With the Sixth Finance Commission on its way, this liability will shoot up once again. Hence the urgency in this opportunity.

The low bids to manage provident fund money raises another question: what stops asset management companies (AMC) from offering these low charges to us investors in mutual funds? A charge of one basis point means that on an investment of Rs 1 lakh EPFO subscribers will pay the AMC Rs 10. For investors in debt funds, the charges are between 25 and 100 basis points. That means an AMC gets Rs 250 to Rs 1,000 for the same investment. Why?

The answer is two-fold. One, the mutual funds industry right now is of the distributor and for the distributor because it is often built by the distributor. Hence, ‘customer acquisition’ costs, which add up to as much as 6 per cent, raise the total cost of servicing an investor. In this case, they will get around Rs 4,000-10,000 crore per annum at zero cost. Two, in EPFO subscribers they get a portfolio stability — the investors are here to stay for long, so products are bought till maturity. In a mutual fund, investors have the option to leave any time and so the fund needs to keep some money in low-return, high-liquidity securities. And for those who think mutual fund costs are high, try and run the numbers of insurance products — you will get a financial heart attack.

Now put these three together. One, low charges by private firms. Two, a changed, reforms-friendly political environment. Three, an acute need for old-age security for the poor. And the only synthesis we get: our elected representatives should pass the PFRDA Bill before jumping into election mode.