RBI Warns Against Reintroduction of Old Pension Scheme (OPS) in Indian States

As several Indian states recently reintroduced the old pension scheme (OPS), and others contemplate a similar move, the Reserve Bank of India (RBI) has sounded a warning. The RBI states that the decision to revert to OPS poses significant fiscal risks for states and could negatively impact India’s medium-term macroeconomic outlook.

Five states have already reintroduced OPS: Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh. Additionally, Haryana witnessed a series of employee union protests in February advocating for the reintroduction of OPS. Rajasthan was the first state to reintroduce the old pension scheme in April 2022, followed by Chhattisgarh in December 2022, Jharkhand and Punjab in October 2022, and Himachal Pradesh in April 2023.

The central government had introduced the National Pension System (NPS) in 2004, replacing the Old Pension Scheme (OPS). The NPS is a defined contribution (DC) scheme, while OPS was a defined benefit plan. The RBI’s bulletin for September 2023 states, “While pension reforms during the first decade of this century were necessary for fiscal consolidation and flexibility, recent decisions to revert to OPS pose significant fiscal risks. These risks could distort the labor market, impact savings and investments, and hinder capital market development, ultimately dampening the country’s medium-term macroeconomic outlook.”

Types of Government Pension Plans

Government pension plans are generally classified into three categories: defined benefit (DB), defined contribution (DC), and hybrid pension arrangements.

• Defined Benefit (DB): In DB plans, benefits are predetermined based on the employee’s final or average salary, and these benefits are guaranteed by the government as the sponsor.
• Defined Contribution (DC): DC plans do not come with a guarantee. Pension benefits depend on the market performance of the pension fund, and the government’s cost is limited to a predefined rate of contribution.
• Hybrid Pension Arrangements: These plans offer a minimum return or benefit guarantee and may also provide a variable (DC-like) benefit on top of the minimum return or benefit guarantee.

The RBI observes, “Recently, states like Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh have announced a reversal to OPS from NPS. While they gain immediate relief from not having to spend on NPS contributions for current employees, unfunded OPS could exert severe financial pressure in the future, especially with increasing longevity.”

Six large states, namely Uttar Pradesh, Rajasthan, Madhya Pradesh, Maharashtra, Chhattisgarh, and Karnataka, account for around half of all NPS subscribers. Uttar Pradesh and Rajasthan are the only two states with more than five lakh subscribers as of November 30, 2022.

NPS vs. OPS

The National Pension Scheme requires employees to contribute 10% of their basic salary, while the government contributes 14%. The eventual payout depends on market returns, primarily invested in debt. In contrast, the old pension system guarantees a fixed pension of 50% of an employee’s last-drawn salary without requiring them to contribute during their working years. OPS is referred to as the Defined Benefit Pension System (DBPS), based on the last pay drawn.

The NPS is referred to as the Defined Contribution Pension System (DCPS), where both the employer and employee contribute to build a pension wealth payable at retirement via annuity or lump sum withdrawal as per norms.

Under OPS, the employee can withdraw 50% of the last-drawn salary as a pension after retirement. Under NPS, a person can withdraw 60% of the accumulated corpus contributed during their working years at retirement, tax-free. The remaining 40% is converted into an annuity, potentially providing a pension of 35% of their last-drawn pay.

NPS applies to all central government employees joining on or after January 1, 2004, including central autonomous bodies (except the Armed Forces). Many state governments have also adopted NPS architecture and made it mandatory for employees joining after a specified date.