The cumulative pension burden for the states over the period from 2023 to 2084 will be 4.5 times higher if the states switch back to the Old Pension Scheme (OPS) from the New Pension Scheme (NPS), as revealed by the RBI's monthly bulletin.
It will amount to an additional burden of 0.9 per cent on GDP annually by 2060. These results are in line with the findings of the Vaidyanathan Committee (2022), which estimated that the pension burden of the states maybe four to five times higher in OPS than in NPS.
The Old Pension Scheme, which was in place until 2004, is based on the principle of the defined benefit (DB) system, where the pensions were paid out from the current revenue of the government rather than accumulated funds.
As a result, DB schemes led to rising public expenditure. The changing demographic profile and rising fiscal costs compelled several economies, including India, to re-examine their pension schemes and undertake pension reforms to preserve the sustainability of their security and pension systems. This led to the emergence of a New Pension System (NPS), which will be based on the principle of a defined contribution (DC) plan. As a part of pension reforms initiated in India during the first decade of this century, most of the state governments adopted the National Pension System (NPS).
Since subscription to the NPS started in 2009, the current pension outgo of the State governments includes both pension payments to the retirees who joined under the OPS and pension contributions to the employees covered under the NPS. This has contributed to an increase in the annual pension outgo, whereas the benefits of the NPS would start accruing only when the employees who joined under the NPS begin to retire, as per the bulletin findings.
Recently, a few states, including Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh, announced a reversal of the OPS from the NPS. The immediate gain is that they will not have to spend on the NPS contributions of the current employees. In the future, however, the unfunded OPS is likely to exert severe pressure on their finances, especially with increasing longevity.
The state's recent decisions and announcements to return to the OPS (with a few others considering the same) pose significant fiscal risks for the states, which could have distorting effects on the labor market.
RBI highlights that for the states, while reverting to OPS may look lucrative in the short run, the future burden of OPS outgo will eclipse the short-run gains. By reverting to OPS, the states will only save 0.1 per cent of GDP on an average in yearly pension outgo till 2040 but would be required to incur an average additional increase in pension expenditure by 0.5 per cent of yearly GDP post 2040.
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