Social Security System in India: Policy Making Processes and the Policymakers

Social Security System in India: Policy Making Processes and the Policymakers Mukul Asher Professor, Lee Kuan Yew School of Public Policy National University of Singapore Presented at International Conference on Research, Public Policy and Asian Public Policy Schools 14-15 March 2005, Bandung

Organization • Introduction • India’s Social Security System: An Overview • Policy Framework and Processes • Reforms and Prospects

Introduction/1 • This presentation analyzes policymaking processes and policymakers in India which have led to the evolution of the current social security system • It also describes how recent years witnessed initiation of reforms in this sector and prospects for further reform

Introduction/2 • There are indications that recent initiatives have set in motion a process whose dynamics will be determined to a great extent by evidence-based policy processes, which also rely more on institutions and less on individual policymakers

India’s Social Security System Public Sector Occupational Voluntary Tax - EPFO Civil Service Schemes for Enterprises Pension Advantaged Schemes Schemes Unorganized Sector (Usually DB Schemes Schemes ( traditionally Schemes) DB but significant shift to DC) DB DC unity - - EDLI EPF EPS State Government Central Government Local Bodies National Assistance Schemes NGOs, Family, and Comm State Assistance Schemes Group Insurance Welfare Bodies Pension products of Life Insurance Companies DB DB - DB - Small saving s schemes - NCPS DC DC NCPS DC NCPS - - - GPF GPF GPF GS GS GS India’s Social Security System: An Overview/1

India’s Social Security System: An Overview/2 Abbreviations Used DB Defined Benefit DC Defined Contribution EDLI Employees’ Deposit Linked Insurance Scheme EPF Employees’ Provident Fund EPS Employees’ Pension Scheme GPF Government Provident Fund GS Gratuity Scheme NCPS New Civil service Pension Scheme NGO Non-Government Organizations

Policy Framework and Processes/1 I. How Was it Set? • Post Independence, India adopted democratic polity and socialistic pattern of economy and society. This was the common practice during the late 1940s and 1950s • Social security came under the category of labor welfare. Media also covered social security issues from the narrow perspective of benefits to those employed in the formal sector

Policy Framework and Processes/2 • The EPFO was set up in 1952 under the Ministry of Labor to provide a DC Scheme (EPF) for private sector employees • EPF covers employees in a specified set of industries • Reflects a static economic framework • Civil Servants had a DB Pension Scheme, based on the British System • With nationalization of the insurance sector, there was no competition in the market for pension products, such as annuities. As a result, expertise in this area did not develop to the detriment of professionalism in this sector

Policy Framework and Processes/3 • Each component of the social security system developed independently and different agencies were created to be responsible for their functioning. There was little or no coordination among them • Until very recently, little effective attention was paid to administrative and civil service reform. So modernization and professionalism in aligning various components with international developments and with national needs was very limited • Overall policy framework and clear identification of problems or issues were lacking. So policy responses were ad-hoc

Policy Framework and Processes/4 II. Who were the Key Policy Makers? • Due to a lack of co-ordination, there were multiple centers of decision-making for the system • Private Sector Employees: While the EPFO has a tripartite board (with representation from the government, labor unions and employers); the labor minister has a predominant influence and appoints all members

Policy Framework and Processes/5 • Ministers of Labor around the world are usually not heavyweights in the political arena; and could easily be “captured” by organized labor • Unions in India represent very small proportion (less than 5 percent) of the labor force, but exercise disproportionate influence. Their leadership has traditionally had low economics literacy

Policy Framework and Processes/6 • Civil Servants are the beneficiaries of the civil service pension scheme; but also in charge of the evolution and provisions of the scheme. This creates a significant Principal-Agent and moral hazard problem • Occupational pension plans: Employers are the key decision makers. Guidelines are provided by the Income Tax Department that does not have the capacity for effective supervision

Policy Framework and Processes/7 III. How have Policy Processes evolved over time? • Each component of the Indian Social Security System has evolved differently over time. • In particular, EPFO schemes do not reflect the changing economic paradigm

Policy Framework and Processes/8 • Because of variety of economic and demographic factors (such as urgent need for fiscal consolidation and flexibility); individual and population ageing, a growing need for civil service pension reform was felt, particularly at the centre. States usually follow the Centre’s lead

Policy Framework and Processes/9 • It was in the later half of the 1990s that senior officials in the Ministry of Finance began to sense that civil service pension reforms were needed (Given impetus by the 5th Pay Commission Report which increased salaries and pension of even the already retired civil servants substantially, but predictably its calls for 30% reduction in civil service size had limited success) • Concrete action on pension reform was initiated by a group of committed individuals under the leadership of S.A.Dave, and an entrepreneurial Minister in the Ministry of Social Justice and Empowerment, Ms.Maneka Gandhi

Policy Framework and Processes/10 • The result was the Old Age Social and Income Security Report (OASIS) which perhaps for the first time provided a framework for thinking about old age security in India • The Report had recommended a radical change in the pension philosophy to a fully-funded DC scheme, with consequent transfer of risks to individuals. It evoked considerable debate, but the Ministry of Labor remained unconvinced

Policy Framework and Processes/11 • In January 2004, a new Civil Service Pension Scheme, which resembled key philosophy and design features of the OASIS report, was introduced. It is a portable DC scheme designed to eliminate pre-retirement withdrawals with mandated purchase of annuities at retirement • The scheme is initially applicable to new entrants to the Central Government but in an encouraging development, several states have expressed an interest in implementing it for their civil servants

Policy Framework and Processes/12 • This will imply transition to the new Scheme will be a long one (around 40 years) and in the meantime, pension expenditure will increase • The pool of long-term contractual savings will increase rapidly

Policy Framework and Processes/13 • In December 2004, the Pension Fund Regulatory and Development Agency (PFRDA) was set up as a regulator for the provident fund and pension sector • India is one of very few countries that have established a separate regulator for this sector

Policy Framework and Processes/14 • The PFRDA has been given the mandate of promoting old-age income security by establishing, developing and regulating pension funds. So professionalism and system-wide perspective are likely to receive an impetus • The PFRDA is expected to balance the interests of all stakeholders by ensuring that pension funds remain in a secure and separate account; funds are invested according to investment guidelines; appropriate record keeping and disclosure takes place; Provident and Pension Plan administrators provide timely information; and shortfalls are identified on a timely basis and appropriate action is taken

Policy Framework and Processes/15 • Only a fifth of the labor force is covered by pension and provident fund schemes; workers who are not employed in the formal private or government sector thus need to be provided with market-based but well-regulated pension schemes. New civil service pension scheme has a provision for voluntary contributions • Informal and/or unorganized sector is very heterogeneous. There is great diversity in terms of size and regularity of income, savings potential and overall awareness of the need for and ability to save for retirement

Policy Framework and Processes/16 • The challenge of structuring a pension scheme for the unorganized sector has been taken up by the government of India. A group of pension experts, representatives from non-government organizations, micro-finance professionals, policy makers and industry practitioners are currently in the process of designing a retirement financing scheme for workers in the unorganized sector • A critical task will be to educate potential subscribers in this sector and market pension products to the group

Reforms and Prospects/1 • Pension reforms have commenced at the tail-end of India’s reform; and after substantial progress has been made in liberalizing financial and capital markets • The recently announced central budget 2005-06 has taken modest but essential steps towards the rationalization of provident and pension funds sector

Reforms and Prospects/2 • Rationalization of tax structure for long-term savings, simplification of income tax structure, opening up pensions sector to foreign direct investment, prioritizing job creation and an initiative to develop Mumbai as a regional “hub” are some measures proposed in the budget that will have a positive impact on pension coverage and quality and professionalism of service providers • While budget measures have set up reform of the provident and pension funds sector in the appropriate direction, some issues need to be tackled on a priority basis

Reforms and Prospects/3 • The Ministry of Labor and EPFO will have to be brought into the reform process. The policy environment facing EPFO is moving in the right direction, policy entrepreneur and political will are needed for substantial reform • It is critical that PFRDA be made fully functional as soon as possible, and vested with appropriate human capital and regulatory powers to enable it to successfully develop a dynamic pensions sector

Reforms and Prospects/4 • Financial and investment education has assumed greater urgency in India as demographic and economic factors force workers to plan, design and finance their retirement needs • Thus it is not sufficient for PFRDA to regulate pension fund operators and their information dissemination; there will also be a need to provide investor education

Reforms and Prospects/5 • A beginning in this direction has been made by the Indian Pensions Research Foundation, which has put together a pensions policy toolkit to assist members in analyzing the impact of a variety of variables on terminal accumulations • In addition, an online encyclopedia on India's pension sector which provides information on civil service pensions, occupational pension and PF schemes, gratuity, excluded trusts and superannuation plans, private pensions, etc. has been created by Invest India Economic Foundation. The toolkit and the encyclopedia are hosted on http://www.iief.com

Reforms and Prospects/6 • Gradually, expertise is building up in the pensions sector, particularly in the private and non-profit sectors. This is also having an impact on those in the government, academic and media sectors. But greater interaction among them is needed

Reforms and Prospects/7 • The prospects for pension reform appear good. However, there needs to be sustained focus on this sector and greater urgency if the potential of the provident and pension funds sector towards providing economic security to members and towards India’s overall growth objectives is to be realized • Specifically, the emphasis should be on adopting sound governance norms, with accountability and transparency in pension service providers being given highest priority • It is hoped that policymaking processes will be more purposeful and effective, and that policy makers will have a lot more conducive policy and political environment in which policies in this sector can be made consistent with India’s overarching objectives

Reforms and Prospects/8 • The following quote from the Finance Minister in a column in the Wall Street Journal, March 4, 2005, Page A14, suggests possibilities for substantial improvement in the policy making processes within a coherent policy framework. The Finance Ministry is the heavy-weight ministry and will set the tone for developments in the pensions sector, which in turn could create a positive policy environment for the Ministry of Labor and the EPFO. It is also encouraging that UPA government is continuing to build on NDA government’s initiatives in this sector

Reforms and Prospects/9 • “A major ongoing structural reform is the move to a defined-contribution pension system with fully funded individual accounts. The transition to this new system, after a bipartisan process of discussion and policy analysis from 1997, has been fairly smooth. A specialized regulator has been set up for the new pension system. We will attempt institutional innovations to contain administrative costs and improve portability of pensions”

Social Security System in India: Policy Making Processes and the Policymakers