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New pension scheme taps into India's vast market

May 27, 2009 18:24 IST

Kishan Negi, a 54-year-old office manager in Delhi, is just a few years away from retirement. But like the vast majority of Indians, Mr Negi has no pension.

He tries to save but with three sons and a wife to support there is not much left over each month. His plan for retirement, he says, is to move back to his village in northern India where the cost of living is far lower than in Delhi. "Milk is cheap because everyone has a cow," he says.

In the years to come, tens of millions of ageing Indians like Mr Negi will head into retirement with tenuous social safety nets of family support and meagre savings -- if they are lucky.

The number of people aged 60 and older will have more than doubled to 113m between 1991 and 2016, according to a report from the Old Age Social and Income Security (Oasis) project, an expert committee in India.

There is growing concern that more Indians could sink below the poverty line in old age because they have not accumulated enough savings, says Oasis.

To tackle this looming problem, India has designed a voluntary National Pension Scheme open to all. After a decade of discussion, design and political wrangling, the scheme was fully launched this month.

"This is the most significant step in pension reform since Independence," says Ashish Aggarwal, executive director of Invest India Micro Pension Services, a consultancy near Delhi. "It is path breaking."

The potential market for pensions in India is enormous. Some 284m working age people in India lack formal pensions. Pensions are limited to government workers and, to a lesser extent, companies that employ more than 20 people. However, nearly 90 per cent of India's working population is in the "unorganised sector" without the regular salary and benefits of formal employers.

Given that gap, assets under management in NPS could grow to more than Rs12,000bn (Pound 160bn, Euro 183bn, $254bn) by 2019-20 and the scheme could cover at least 80m people, according to a report last year from Delhi research company IIMS Dataworks.

There is also the larger economic impact of a modern pension system in India relieving an over-burdened budget.

"A vital pension system has the potential to boost stock market liquidity, extend the yield curve, lower borrowing costs and improve corporate governance," wrote Robert Palacios, senior pension economist at the World Bank, in 2001.

"Reducing pension liabilities in the public sector reduces future budgetary pressures, allowing more spending in other needed social areas."

In an interview in Delhi, Dhirendra Swarup, chairman of the Pension Fund Regulatory Development Authority outlined the defining features of the NPS.

"It is market based. There is pure defined contribution. The individual chooses the fund manager and investment option. The account is fully portable. Costs are low," says Mr Swarup.

India is a youthful country; nearly half of its 1.1bn population is less than 18 years old. But investing in pensions now will head off future problems of caring for a vast ageing population.

"India is one of the youngest countries in the world. This is the right time for people to start to save," says Mr Swarup.

The NPS allows any Indian between 18 and 54 years old to open an account at designated outlets including major banks, mutual funds and insurers. Post offices should eventually join the list. The scheme requires a minimum contribution of Rs 6,000 each year that cannot be withdrawn until age 60.

Account holders choose from a simple menu of low-, medium- and high-risk investment options.

The first category focuses on government bonds, the latter predominantly on stocks and the middle option on fixed income excluding government bonds.

Savers can put no more than half their contributions into the equity option. If they do not make an active choice, the default is a life cycle fund that gradually reduces the equity component (from the maximum 50 per cent) from age 36.

On exit at age 60 they must use at least 40 per cent of their pension pot to buy an annuity.

The customer chooses from six pension fund managers; ICICI Prudential, IDFC, Kotak Mahindra, Reliance Capital, SBI and UTI. This is part of a new trend in India that allows customers to opt for private sector fund managers instead of being limited to government entities such as State Bank of India.

Mr Swarup says the PFRDA went through an open bidding process among all prospective fund managers. This competitive process translates into low investment management fees of 0.0009 per cent a year. These fees are among the lowest in the world but fund managers are still attracted to the potential of India's large, untapped pensions market.

Annual asset servicing charges also apply (0.0075 per cent or 0.005 per cent) and there are fixed fee service charges.

Pensions in India do exist. India's civil servants and employees of companies with more than 20 people can access fund schemes. However, these are more like long-term savings accounts because funds can be cashed out after seven to 15 years. Returns are also too low to generate much of a safety net when the fund matures.

Although the NPS was ready to launch several years ago, political opposition blocked reforms in pensions and other financial services. That barrier was removed late last year when the opponents withdrew their support from India's ruling coalition government, opening the way for speedy finalisation of the scheme.

Yet the launch of the NPS is still a work in progress. It will be a "long haul," cautions Mr Swarup, who retired from India's Ministry of Finance in 2005.

The biggest challenge ahead is raising awareness about the NPS and the benefits of long-term savings rather than investing in property or gold. "We have to wean people away from traditional means of savings," he adds.

The NPS also lacks tax exemption upon withdrawal and therefore an added incentive for consumers. This is a major shortcoming, says Mr Swarup, though the PFRDA is pressing the government for preferential tax treatment.

Other incentives -- such as state matching contributions -- would help attract the large number of lower-income Indians who do not pay income tax, adds Mr Palacios.

Bureaucratic delays also mean that a bill to officially recognise the PFRDA as the industry regulator has been pending in parliament for four years. Yet this is no serious handicap and the PFRDA essentially acts as a regulator anyway, says Mr Swarup. The landslide victory of the ruling Congress party in India's elections could help move the bill forward in the next session of parliament this summer.

The most pressing challenge is still getting people to enrol in NPS.

"The start will be slow but it will gather steam," says Mr Swarup. "We've just begun on the road to our destination."

Copyright: The Financial Times Limited 2009

Amy Yee, FT.com
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