[The Dave Committee on pensions reported on 11 January 2000; I read its report carefully because I have much respect for Ajay Shah, who was its economist member. I had considerable reservations about the report, as shown by this column in Business Standard of 14 February 2000.]
A better deal for pensioners
The Dave
Committee on Pensions Reforms has worked assiduously for a long period; it has
also, unlike a typical government commission, held most extensive
consultations. There is much in its report to ponder over. Let me take up three
important issues.
First, the pension industry is currently bound hand and
foot by the government. Most of the savings go into the government’s provident
fund. Employers’ provident funds have to be entirely invested in government
securities or cash. And no one is allowed to choose between provident funds.
The Dave Committee wants to introduce competition in the system, but not too
much. It proposes that six private asset management companies be allowed to
offer three pension funds each. The figure of six AMCs is picked out of a hat;
the idea is probably not to confuse the saver with too many choices. Mr Dave
said that the assets of poorly performing AMCs should be transferred to better
performing ones. But provided that there is complete and easy transferability
of savings from one fund into others, without an exit load, savers’ choices
themselves will achieve such transfers.
The basic issue is that failure of a financial business
has always held a particular horror for governments. Financial intermediaries
are under a temptation to run away with the money of investors in them, and
governments take it as their duty to prevent them from doing so. To this end,
they license financial firms. And some governments ensure that intermediaries
make better profits by limiting competition. This is why Reserve Bank licenses
banks.
SEBI, however, does not believe in limiting competition;
so the number of mutual funds has kept on expanding. The Dave Committee is
uncomfortable with this; it does not want any pension fund to go bankrupt. So
it wants the government to license no more than six pension funds. In my view,
however, the government is not competent to choose. There will in any case be
severe restrictions on what the pension funds can invest in; those restrictions,
plus compulsory audit that SEBI insists on, are the best guarantees of their
viability.
Second, the Committee is intent that some of the savings
must go into equity. The idea is that equity yields more than debt in the long
run, and that Indian savers should get some practice in investing in equity.
The question is, how long a run is necessary to make sure that the investor
will get a superior return? Taking the pitfalls of investing at the peak and
liquidating at the trough, the period would have to be at least ten years, and
quite possibly much longer. Hence if the saver is to be attracted to equity
without burning his fingers, it is necessary that he should be forced to invest
his savings for a long enough period. The Dave Committee’s proposal that withdrawals
should bear a tax of 10 per cent is not enough; in fact, since this rate is
lower than the marginal income tax rate of so many taxpayers, they will be
tempted to use pension funds as short-term tax shelters. Hence, as in other
countries, withdrawals of pension fund savings before the saver reaches the
retirement age should be taxed at his relevant marginal income tax rate. So
should the funds accumulated in the pension fund which, at the attainment of
the age of retirement, are not converted into an annuity. The annuity does not
have to be for the life of the pensioner alone; it can cover the joint lives of
the pensioner and his or her spouse. But the money must not be left for heirs
if it is to go taxfree.
The question needs to be asked here: should the savings
in Dave-style pension funds be allowed to be used for daughters’ dowry, sons’
weddings and purchase of houses? This is how pension savings are currently
being dissipated. The answer to this question must depend on whether these uses
of savings must have the same priority in the eyes of the state as provision
for old age; and the answer, to my mind, is no. It is in national interest that
people should save for their old age, but it does not matter in the least
whether parents spend on their childrens’ weddings or buy houses.
Finally, the Dave Committee would exempt the savings from
any tax provided they are converted into an annuity at the retirement age; but
it wants annuities to be sold only by insurance companies. However, if an insurance
company is going to sell annuities, there is no reason why it should also not
offer mutual funds that on retirement are to be converted into those annuities.
Also, the conversion of a lump sum into an annuity does not require much
sophistication. The Dave Committee is befuddled by the mysteries of actuarial
science, and would like to confine the annuity business to insurance companies
that command actuarial hocus-pocus. But actuarial science is simply calculus of
integral numbers; it is actually simpler than calculus. So in my view, there is
no reason to prevent pension funds from offering annuities as well. The
Committee’s hermetic separation of the savings and annuity businesses is
misplaced. We have got a fuddy-duddy insurance commissioner in Mr Rangachari,
and I would not like him to mess up the pension industry in the way he is going
to mess up the insurance industry. Pension funds are best kept out of his
clutches.
What the Dave Committee does not take into account and
worries me is the fact that however liberal the investment regulations may be,
savers’ preferences will force pension funds to invest most of the savings
in debt; the volume of private marketable debt available in India is too
limited, and pension funds will be forced to investment in government debt.
This would be bad for them as well as the government. The best solution to this
problem would be to permit them to invest in foreign debt.
