The Unified Pension Scheme: A Double-Edged Sword?

— Akshay Fadnis and Paras Jasrai

Two decades ago the country had taken a big progressive fiscal step ahead given the sustainability concerns regarding the public finances, only to turn the clock back today. In 2004, the union government initiated the National Pensions Scheme (NPS) putting major emphasis on the magic of “markets”¹. This was a major step back from the government being the sole provider of pensions. The idea was that by defining the contribution up front for the pension, the government’s responsibility of serving an ever-increasing pension bill would be controlled for, with the help of markets. However, after two decades, it appears that markets have not found their resonance with government employees as much as it did when the NPS was first introduced.

There was a rising demand for guaranteed benefits like the OPS among the central government employees and various state governments for quite some time. To quell such concerns regarding their retirement and worry that they will not have a sufficient corpus to rely on during their golden age, the Union Government recently introduced a new pension scheme called the Unified Pension Scheme (UPS). UPS assures the employees the combined benefits of both the Old Pension Scheme (OPS) and the NPS. It guarantees a pension equivalent to 50% of the average basic pay over the last 12 months for employees with at least 25 years of service. For shorter service periods, the pension is proportionately reduced, with a minimum pension set at INR10,000 per month for those with at least 10 years of service. Furthermore, it includes assured family pensions, inflation indexation, and a lump sum payment at superannuation, reflecting a hybrid approach that merges the security of OPS with the contributory nature of NPS.

While on the surface the UPS might look like a home run covering all bases, including financial security, linking pensions to markets and an assured income, one needs to be aware of the unintended consequences from the angle of public policy which might arise because of these assurances. We have tried to identify some of the potential ones.

Is it fiscally sustainable in the long run?

One of the most significant unintended consequences of the UPS could be its impact on fiscal sustainability. The scheme promises an assured pension of 50% of the average basic pay drawn over the last 12 months prior to retirement for employees with a minimum of 25 years of service. It also includes provisions for a minimum pension, inflation protection, and increased government contributions. While these features provide greater financial security for retirees, they also represent a substantial long-term financial commitment for the government.

India’s demographic dividend will last till 2040. After that, the country will begin to age and with the increase in government contribution from 14% to 18.5%, while beneficial to employees, could lead to a substantial increase in pension liabilities over time. The guaranteed nature of these benefits, coupled with inflation indexing, means that the government’s pension liabilities could expand significantly if inflation rates increase or if economic growth slows down. The opportunity costs in such a scenario will be high for future governments leading to either spending cuts in essential areas such as health, education, or increase in taxes, potentially leading to economic and political challenges.

Intergenerational Equity Concerns

The UPS, while providing immediate benefits to current employees and retirees, could raise concerns about intergenerational equity. By committing to a defined benefit model with guaranteed pensions and inflation protection, the scheme may place a disproportionate financial burden on future generations of taxpayers. This burden could be exacerbated if the scheme becomes unsustainable due to economic downturns or demographic shifts. Future direct taxpayers and the poor, who pay disproportionately higher indirect taxes, to fund the pensions of such a tiny fraction of the country, without receiving equivalent benefits themselves.

Giving Ammunition to Legally Guaranteed MSPs

The bringing back of the assured benefits via UPS could raise public expectations in various areas, one such being agriculture. The farmers' protest had ended in late 2021 after the union government had repealed the contentious farm laws. However, the farmers had pressed for various demands, one of them being a legalised guarantee for minimum support prices (MSPs). It is an ubiquitous fact that farmers are vulnerable to market fluctuations and who often face volatile market prices for their produce. Through the UPS, the government employees have indicated that they do not want to be at the vagaries of the market. Farmers might see the legal guarantee of MSPs as a parallel to the UPS, a necessary step to ensure their economic stability in a similar way that the UPS ensures pension stability for government employees.

Other Potential Unintended Consequences

There are some other unintended consequences which might come up. This scheme could potentially be used to score brownie points with the public servants and their families as potential voters ahead of elections. With already peak levels of unemployment (especially at the youth level) prevalent in the country, such a scheme might make the public sector jobs seem more lucrative, potentially leading to labour market distortions. India also has a problem of state capacity and with such schemes being optional for current employees and retirees to join it, it might become difficult to manage the administration of NPS and UPS simultaneously. Apart from this if some states do not wish to adopt the UPS, the resultant pension disparity would then perhaps lead to discontentment among public servants across different states. If the states do adopt it, then it might lead to similar opportunity cost issues mentioned above.

Conclusion

The introduction of the UPS marks a significant shift in India's approach to public sector pensions, combining elements of the OPS and the NPS. While the UPS aims to provide greater financial security and address employee concerns, it also raises critical challenges. Government employees form a small chunk of the labour force², yet they are amongst the bigger drains on public finances through expenditures on salaries and pensions³. The guaranteed benefits could strain fiscal sustainability, leading to increased government liabilities and potential cuts in essential services or higher taxes in the future. Additionally, the UPS may distort the labor market by making public sector jobs more attractive, potentially crowding out talent from the private sector and reducing overall productivity. Furthermore, the scheme may inadvertently set a precedent for other sectors, such as agriculture, to demand similar guarantees, complicating public policy. Ideally an annual report on the savings/excesses of the UPS can be released so that there is an accountability built into the system. The release of the detailed committee report which recommended the UPS, can be a beginning for transparency and more analyses. Ultimately, while the UPS seeks to enhance security for government employees, its broader implications could create significant economic and political challenges for India. 

1. The final pension amount was not guaranteed and depended on the accumulated corpus and its growth over time.

2.  2.3 million central government employees form 0.40% of India’s labour force in 2022 (Source: ILO 2024, media reports).

3.  Out of every INR100 expended by the union government, INR12 is spent on salaries and pensions as per FY25 budget (Source: Union Budget FY25).