Sucheta Dalal :Why has the FM guaranteed a pension subsidy? (3 March 2003)
Sucheta Dalal

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Why has the FM guaranteed a pension subsidy? (3 March 2003)  

Justifying the guaranteed return pension scheme announced in the Budget, the Finance Minister’s Chief Economic Advisor said in a television debate that there is a difference between Unit Trust of India’s assured return schemes and the LIC pension scheme because the maximum pension per individual would not be more than Rs 2,000 per month. In fact, the LIC pension scheme is probably worse. It offers a 9 per cent guaranteed return, which is probably the highest yield on fixed return investments today, that too when the minister himself expects interest rates to soften further. Moreover, it comes with an explicit government guarantee.

The FM said that LIC would “launch a special pension policy, guaranteeing an annual return of 9 per cent, in the form of a monthly pension scheme”. The scheme is called the Varishtha Pension Bima Yojana and the FM assured that “the difference between the actual yield earned by the LIC, on the funds invested under the scheme, and the assured return of 9 per cent, will be reimbursed to the LIC annually, by the Government”.

What makes this preposterous is that the Finance Minister has ignored a decade old debate on the evils of ‘assured returns’ and announced a new one even before the third and largest bailout of Unit Trust of India is complete. The Sebi had first frowned on ‘assured’ return schemes almost a decade ago, but the finance ministry supported the demand of banks and insurance companies to float such schemes in order to attract investors.

The reckless guarantees ended in disaster as detailed on Sebi’s website ( It lists numerous instances where the ‘sponsor’ institutions paid up a total of Rs 1,302 crore to make good the returns assured by their mutual fund subsidiaries prior to 1998. The first mention on the list is LIC, which paid nearly Rs 200 crore for the various Dhanavarsha Schemes. The others are Indian Bank, Canara Bank, State Bank of India, Bank of India, General Insurance Corporation and Punjab National Bank. Sebi later barred mutual funds from floating assured return schemes, but UTI remained largely outside its regulatory jurisdiction. The Finance Minister himself has acknowledged that ‘assured returns’ are a problem.

Replying to the debate on the collapse of UTI in the Rajya Sabha, Jaswant Singh had traced UTI’s problems to ‘unsustainable returns’ promised by its assured return schemes. But that realisation was forgotten with respect to the pension scheme. The decision is even more curious because Singh probably had good financial advice right inside his Ministry on how to avoid a ‘guarantee’ that would bind the exchequer.

Dr Ajay Shah, a consultant at the MoF had written an article in the 1990s, titled ‘Making sense of assured-return schemes’ in which he identified ‘mutual fund schemes with assured returns as a source of much controversy’. Long before the UTI debacle he wrote: ‘A special complication in this situation is that the entities involved in selling assured return products are ultimately backed by the Indian government. It is hard to imagine UTI ever being allowed to default on its obligations. If matters at UTI did come to such a pass, we can expect tremendous political pressure upon government to cobble together a bailout. In this sense, an entity like UTI is ‘too big to fail’ (TBTF). If UTI is TBTF, the guarantees that it makes can generate claims upon the taxpayers of India. This is surely an unfair subsidy to UTI which is not being made available to other MFs, and this is surely an inappropriate liability for the government of India to be adopting’.

Interestingly, Dr Shah’s argument was not against ‘assured returns’. In fact he argued, ‘assured returns schemes should exist because India’s investors want them’ and that ‘the financial market volatility of the last decade has generate a large pool of investors who are unwilling to take down—side risk’. His solution was that policy-makers should find a way of make assured returns safer, so that the burden does not devolve on the exchequer. The solution: ‘The risk of assuring returns should be hedged by purchasing put options on a secondary market. If the policy establishment puts its act together, index options can be a reality in India by December 1998. Once this is done, it would become possible to sensibly have assured returns schemes’.

Well, Dr Shah is part of policy establishment today. The question is, why was his expertise structuring an appropriate hedging mechanism and avoiding a burden on the exchequer ignored? And why did the Finance Minister prefer a mindless guaranteed return scheme underwritten by the taxpayer? Maybe it is because our policy makers merely pay lip service to the concept of liberalisation and free markets. At the core, they remain deeply entrenched in a socialistic system which squanders taxpayers money on unviable infrastructure projects or unsustainable financial guarantees.

In this context, the decision to cut the definition of ‘senior citizen’ by another five years to 55 is another stunner. There was a time when people over 65 were defined at senior citizens, later the bar was brought down to 60 and is now further reduced to 55. At the same time, the age bar for holding high political offices is increasing every year. So much so that a 55-year-old politician is considered too young to be Prime Minister but a senior citizen when it comes to claiming a government guaranteed pension. By the FM’s own admission, India’s population is rapidly growing older. Can the government simply go ahead and create a backdoor social security scheme, underwritten by the exchequer, by dipping into tax contributions by the younger generations?

-- Sucheta Dalal