Mounting Pension Burden of States

(Gautam Bhardwaj)

Policy debates about government borrowing normally focus on the explicit borrowing of the Government of India. The government restrains its spending so that it does not borrow too much, because borrowing today means committing future taxes to servicing debt. There is, however, another kind of payment obligation that is made by the government, which is usually ignored while discussing government debt. This is on account of the pension promises the government makes. In India this burden, unlike the explicit government debt, has not been measured, and is certainly not disclosed to the public.

In a recent study, based on the Indian Retirement, Earnings and Savings (IRES) survey, S.A. Dave of CMIE (Centre for Monitoring Indian Economy, Pvt. Ltd.), and my colleagues and I, at the Invest India Economic Foundation, measured a part of the pension burden, or the Implicit Pension Debt of the Centre and states, and found it to be a whopping Rs. 17 lakh crore, or more than 55 per cent of GDP.

The total IPD is the present value of all future pension promises. For India, this includes the value of pension promises to employees and pensioners of Central and state governments and armed forces. This also includes any other implicit (or explicit) pension liability of the government, for example, on meeting the growing shortfall of the employees’ pension scheme (EPS). Importantly, these future pension promises are as real as the government’s promises on repaying its bonds.

The only difference is that while the current public debt is explicit, India has never measured or disclosed its IPD.

The IPD estimate of Rs 17 lakh crore is the present value of purchasing an annuity at retirement for each current employee of the Central and state governments. For example, suppose that a government employee is to be paid a monthly pension of Rs 5,000 on retirement. The government would pay LIC a lump sum of Rs 8 lakh and purchase an annuity for the employee. Thereafter, the employee would receive a monthly pension of Rs 5,000 for life from LIC.

Before this estimate, we only knew that the GOI had an explicit internal public debt of Rs 26.35 lakh crore that would have to be repaid using future taxes. Now we know that in addition, the GOI has unfunded pension promises worth at least Rs 17.35 lakh crore, which will also require future taxation. For an average Indian, this means that in future years, GOI will have to first expend its tax revenues on repaying existing government bonds and meeting pension obligations. Only after these payments have been made, future taxes would be used to perform the actual tasks of government in the areas of health, education and public infrastructure.

While it appears a big number, the IPD of 55.88 per cent of GDP is only a part of the total IPD for India, and is generated by only 5.6 per cent of the workforce. This estimate excludes the IPD for a large of part of the government. For instance, this IPD does not cover the roughly one million defence employees, two million defence pensioners, and the nearly two million pensioners and family pensioners of central ministries including railways and post. Also, this IPD does not consider the current state government pensioners or the 28 million EPS members.

All these are substantial numbers and therefore the total IPD of GOI will be much more than the current estimate.

It is equally important to know that this IPD is understated as it is based on several conservative assumptions. For instance, the estimate assumes only a 2 per cent real annual increase in wages and pensions on account of future pay commissions. Secondly, this estimate is based on the cost of buying a nominal annuity from LIC while government employees would receive an inflation-indexed pension, which increases over time in pace with inflation. Though inflation-indexed annuities are not readily available in India, the cost of such an annuity would be much higher than that for a nominal annuity and hence the IPD would also be larger.

A modest, and perhaps optimistic assumption used for this IPD is that all new state and central government recruits (except defence) will be covered by the New Pension System (NPS) from 1 January 2005. This would freeze the flow of new employees into the current unfunded civil service pension and in turn freeze the IPD. However, if India’s pension reform fails to take off, these apparently large IPD estimates may appear very modest to our children.