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Beyond EPFO and NPS Scheme: Tackling India's Looming Pension Crisis

Feb 14, 2018 9:24 AM 6 min read

To meet the future pension liabilities of the workforce, the government needs to urgently set up a sovereign pension fund (SPF) to augment its underfunded pension system, writes Anirudh Menon.


Narendra Modi has sent out signals to global investors indicating that the country will become a manufacturing powerhouse by 2030, especially by investing in its young workforce. But there is an issue that remains unnoticed – India’s population is also ageing rapidly and the current pension system is not adequately primed to handle this issue. This was highlighted by the annual report published recently by the Melbourne Mercer Global Pension Index, which placed India 28th out of the 30 countries reviewed.


As India experiences sustained periods of growth, life expectancy will rise. As a consequence, more people will depend on the national pension system for a longer period after they exit the labour market. According to a report published by PwC, 12% of India’s population will be over 60 by 2030 and the UN Population Fund, expects this to climb to 21% by 2050.


The Indian government is currently sitting on a pension corpus of approximately $120-140 billion which remains idle. To meet the future pension liabilities of the workforce, the government needs to urgently set up a sovereign pension fund (SPF) to augment its underfunded pension system.


Pension Architecture


India follows a traditional pension policy which depends on employer and employee participation. The pension system is available only to the organised sector and denied to the unorganised sector (informal workers). The International Labour Organisation (ILO) states 92% of India’s estimated 510 million workforce is informal with 9% unemployed and the majority underemployed and underpaid.


India’s pension architecture has gone through several reforms and is now broadly structured around two programmes: the Employees’ Provident Fund (EPF) regime, managed by Employees’ Provident Fund Organisation (EPFO); and the National Pension Scheme (NPS). The EPF depends on employer-employee participation and generates annual interests payable to the beneficiary at the time of retirement. The NPS, on the other hand, is a voluntary retirement savings scheme, where the subscriber contributes and earns market-linked interest on the accumulated wealth. It was created in 2004, and has a smaller asset under management of $450 million. The NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), the chief regulator that protects the interests of various subscribers within the system.


Beyond EPFO and NPS Scheme: Tackling India's Looming Pension Crisis
Image Credit: © Jorge Royan /, via Wikimedia Commons


EPFO is the conservative and risk averse fund manager which looks after the pensions of approximately 44 million subscribers. It is well-known for its lack of transparency in declaring its portfolio investments. EPFO uses funds from the common pool and makes investments based on the guidelines set by the central government and the central board of trustees (CBoT). It has been mandated to park 55% of its funds in government securities and bonds, of which 5% can be invested in low-risk securities like mutual funds. Approximately 40% of the fund is set aside for term deposits in banks which have low and stable returns or corporate bonds of which 75% has to be investment grade.


Recently, it was announced that EPFO has been permitted to invest up to 15% in safe stocks and equity-linked mutual funds through exchange traded funds. However, this too has been capped at $800 million which is less than 1% of the entire fund. This sort of passive and reactionary investment culture has been deeply embedded within EPFO – although it has served well in the past in protecting pensioner savings.


The EPFO needs to urgently modernise operations. It can draw lessons from other successful countries, notably, Canada. The Canadian Pension Plan Investment Board (CPPIB) is the chief fund manager that looks after the pension for the Canadian Pension Plan on behalf of 20 million contributors and beneficiaries – estimated to be $328 billion. The portfolio has produced impressive results and achieved a ten-year and five-year annualised net returns of 6.8% and 11.8% respectively. CPPIB’s pension contributions are expected to exceed the pension liabilities until 2022. This gives them the flexibility to reinvest their earnings in order to pay the benefits in subsequent years and also set aside sufficient amount for a rainy day.


Beyond EPFO and NPS Scheme: Tackling India's Looming Pension Crisis
Image Credit: © Jorge Royan /, via Wikimedia Commons


How did CPPIB achieve this level of sophistication in managing its funds? CPPIB has two broad functions: effective accumulation, administration and management of the fund; and the payment of future liabilities. CPPIB achieved its mandate by creating a well-functioning team of investment bankers and economists who understand the risk and reward of managing the country’s pension funds. The in-house capabilities help them save cost by not paying exorbitant fees to external fund managers. It is an independent and depoliticised organisation and is directly accountable to the parliament through the Federal Finance Ministry. The governance structure of CPPIB is well regulated and the financial statements are regularly audited by an external agency.


There are other advantages to the Canadian model. CPPIB is mandated by law to have a long-term horizon and make investments publicly available. CPPIB invests in over 3000 companies globally, and close to 80% of the portfolio is parked in non-Canadian investments – the majority of which are overseas investments. Such portfolio diversity helps reduce the dependence of the fund on the Canadian economy, protecting it from any unforeseen and adverse phenomenon in the economy. The asset mix of CPPIB’s portfolio comprises of public equity, private equity, public fixed income, credit investments, and real assets like real estate, infrastructure and agricultural land.


EPFO can draw important lessons from CPPIB, but the reforms need to be home grown. At present, reports of gross negligence, fraud and mismanagement of EPFO’s funds are common. There are also several cases of delays in payments, double payments, no payments or even cases where payments continue to be made to deceased beneficiaries without legal heirs. EPFO should urgently address the break down in the governance processes by hiring a team of investment professionals with proven track records and led by a Chief Investment Officer, preferably from the private sector.


The second step is for the government to empower EPFO. Much like CPPIB, EPFO should be made an independent body that draws authority from a statute or legislation. The government, which is the ultimate owner of the fund, should set the mandate and investment objective for EPFO as well as the risk tolerance level. The objective here should be to allow EPFO to develop its own asset allocation policy with minimal interference from the government of the day.


The next step is to design a robust performance measurement and evaluation system that monitors the performance of EPFO. The organisation currently follows a cash-basis of accounting for calculating investments and calculates interest liability and payout on the basis of simple accruals. CPPIB use sophisticated methods like Multi-Factor model, which take into account market risk, size risk, value risk, momentum risk, newness of stocks etc.


Other SPFs, like the French Solidarity Investment Fund (SIF) in France and HESTA in Australia are already active in the space of social impact investing. These invest in social enterprises that provide innovative solutions for social problems through the market economy while providing both a social and capital return. They primarily work with lower income groups across financial inclusion, priority sector lending, healthcare, education, technology etc. SPFs by definition have a built-in social element which should ideally make them less averse to social impact investing.


The Finance Minister recently announced a series of incentives to employers to attract more workforce from the informal sector into the formal sector and allocated $158 million from the budget towards this effort. However, a better option would be to create an SPF and use the earnings from the investments to fund national level schemes aimed at formalising the labour market. Moreover, the returns from the SPF can also be used to increase the benefits of EPFO’s subscribers and reduce the need for higher contributions in the future.


Discussions on pension funds are seemingly dry and uninteresting, but it is an important debate that we cannot avoid any longer. India’s pension system is alarmingly ill-equipped to take care of the ageing population as well as future subscribers. In order for India to become a pensioned society, the government should coordinate its efforts to protect its entire workforce against the risk of poverty at old age and also aim to safeguard their retirement savings. An empowered EPFO with a strong team of professionals and a clear set of investment mandate can help achieve its fiduciary duties towards the workforce in India.


About the Author

Anirudh Menon is completing a Master’s in Public Administration at University College London where he is a Chevening Scholar. Prior to this he worked as a risk consultant at KPMG in India. He completed his Masters degree in International Political Economy at LSE’s Department of International Relations in 2012.  


This article was first published on South Asia @ LSE, and is republished with permission. Click here for the original article. These are views of the author, and not the position of the South Asia @ LSE blog, nor of the London School of Economics.