RBI cautions states against reverting to the old pension scheme (OPS)

The Reserve Bank of India (RBI) has cautioned states against reverting to the old pension scheme (OPS), which was in vogue till 2004, stating that it will add to the fiscal burden of States in the coming years. The central bank says OPS – instead of the National Pension Scheme (NPS) — will lead to the accumulation of liabilities which can become a major risk in the future.

What did RBI say about the old pension scheme?

According to the RBI, a significant risk looming large on the subnational fiscal horizon is the likely reversion to the old pension scheme by some states.

“The annual saving in fiscal resources that this move entails is short-lived. By postponing the current expenses, states risk the accumulation of unfunded pension liabilities in the coming years,” the RBI said in its ‘Report on state finances’ on Monday.

As per the Budget estimates for 2022-23, states are expected to incur a 16 per cent rise in pension expenditure at Rs 463,436 crore in 2022-23 as against Rs 399,813 crore in the previous year, the RBI said. The compounded annual growth rate (CAGR) in pension liabilities for the 12 years ended FY22 was 34 per cent for all the state governments, according to an SBI Research report.

Why are more states going for OPS?

The RBI warning has come after more states joined the queue to bring back OPS instead of the National Pension Scheme (NPS). After Rajasthan, Chhattisgarh, Jharkhand and Punjab, Himachal Pradesh has announced its intention to opt for OPS.States have found it convenient to pay old pensioners with the money collected from the serving employees.

Under the OPS, retired employees received 50 per cent of their last drawn salary as monthly pensions. OPS is considered fiscally unsustainable, and state governments do not have the money to fund it. OPS had no accumulated funds or stock of savings for pension obligations and hence was a clear fiscal burden.

Interestingly, the scheme is always an attractive dispensation for political parties as the current aged people can benefit from it even though they may not have contributed to the pension kitty, according to the SBI Research report.

Old pension scheme vs NPS

An old pension scheme (OPS), commonly known as the PAYG scheme, is defined as an unfunded pension scheme where current revenues fund pension benefits. Under this scheme, the contribution of the current generation of workers was explicitly used to pay the pensions of existing pensioners. OPS involved a direct transfer of resources from the current generation of taxpayers to fund the pensioners.While the PAYG scheme was in vogue in most countries before the 1990s, it was discontinued given the problem of pension debt sustainability, an ageing population, an explicit burden on future generations and the incentive for early retirement (as the pension is fixed at the last drawn salary), the SBI Research report said.

NPS is a defined contribution pension scheme. NPS enables an individual to undertake retirement planning while in employment. With systematic savings and investments,

NPS facilitates the accumulation of a pension corpus during their working life. NPS is designed to deliver a sustainable solution of having adequate retirement income in old age or upon superannuation.

NPS is mandatory for central government employees joining services on or after January 1, 2004, and almost all state governments have adopted it for their employees. NPS, regulated by the Pension Fund Regulatory and Development Authority (PFRDA), is a contributory pension scheme under which employees contribute 10 per cent of their salary (Basic + Dearness Allowance).

The government contributes 14 per cent towards the employees’ NPS accounts. As of December 2022, 59.78 lakh state government employees are part of NPS, with total assets under management of Rs 4.27 lakh crore.