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Suresh Krishnamurthy

The proposed pension plan has run into controversy, though the criticisms levelled against it seem misplaced. However, the Government needs to enhance the plan's credibility to ensure its widespread acceptance.

THE new pension system for new government employees that received Cabinet assent last week has predictably run into controversy. It has been criticised for adopting the mutual fund framework, for asking employees to contribute 10 per cent of their emoluments, and also criticised for allowing investments in equities. However, such criticism appears misplaced. The system does have the potential to secure the old-age security of today's youngsters.

Understandable apprehensions: There have earlier been several recommendations to divert employee savings to the equity market. However, several episodes in the past decade are testament to the potential for misuse. So, any attempt to raise moneys from employees and deploy them in the equity market would be viewed with suspicion.

Another reason why the system would be viewed with scepticism is that the plans are primarily an attempt by the Union Government to reduce the budgetary impact of pension payments.

Therefore, there would always be the apprehension that the Government is cutting down on the emoluments. Besides, equity mutual funds have led to loss of investor wealth in certain cases. In this context, the fears appear understandable.

Misplaced fears: But there are reasons why some apprehensions could be misplaced. Take the case of emoluments. Yes, when the Government is asking employees to contribute to take care of their retirement, it means the Government is reducing its contribution. However, that is not exactly unfair, as it is applicable only to fresh recruits.

With respect to equity, contributors need to understand that the lack of exposure to equities could itself turn out to be risky. The right amount of equities could reduce the fluctuations in asset values. So, investors will not have to pay for adverse fluctuations in interest rates in the year of their retirement. Equities are also necessary to combat inflation over the longer-term.

Similarly, the mutual fund framework is required to build credibility. This system (here we are focussing on the structure and not on performance) has been an unvarnished success in India. Its transparency is unmatched. Its costs, while not exactly low, are regulated. Besides, they are lower than those charged by the insurance companies.

If the mutual fund industry has thrown up nasty surprises in the past, it is primarily because regulation has been poor. Besides, whenever greed rather than prudence guides investors, investments are likely to turn bad. Mutual funds are no exception.

In this context, the only way to address the concerns of the public is to enhance the credibility of the new system and the proposed regulator. Credibility would emerge only if laws that stress maximum disclosure, transparent rule-making and effective deterrents for errant behaviour govern the system. The Government needs to act swiftly in this regard.

Not without flaws: The proposed system is not without flaws. It is possible that the number of fund managers would be restricted as, initially, the plans were to let only six fund managers to operate. That could lead to lack of choice.

However, the press note circulated last week suggested that several fund managers would be in operation. Hopefully, that will be the case.

The most important flaw, however, is that the asset allocation plans are inflexible. The plans require a specific proportion to be invested in equities, investment grade corporate securities and government securities.

It would be better if the specific proportion were changed to maximum permissible exposures.

The Government could also specify minimum exposures. The fund manager would decide the appropriate allocation. Such an approach could provide the fund manager enough leeway to minimise risk.

In addition, there should be a provision for investors to migrate to plans with lower proportion of equities, as they grow older. In fact, the proportion of equities in an investor's portfolio should be relative to his age. Such provisions are essential to safeguard investor wealth.

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