The government is putting the financial sector reforms, particularly in areas of banking, insurance and pension, on fast track. With the Left out of the way, the initial roadblocks for reforms it would seem have gone away. But the common man may still be far from getting the taste of reform.
Let's take the example of pension sector reforms. So far, the availability of pension product was limited. It was largely limited to the government employees, only 22 million out of the 320 million workforce. In January 2004, the government took the first step towards pension reforms when it moved from defined benefits to defined contribution.
Earlier, a retiring government staff received pension on the basis of last-drawn salary. That changed from 2004, from when pension will get decided depending on the contribution one has made during the work-life. So far 19 states and the central government have joined this scheme.
If the pension reforms go through, the product will be available to anyone who can contribute regularly during one’s working life. If successful, this will be the largest voluntary pension coverage for any country in the world. But this will not be easy despite it being a big business opportunity for companies. Estimates indicate that the voluntary pension market could touch $300 billion in the next 10 years. As the government gets ready to get the bill passed in Parliament, it will be just the first step in a long process that could lead to the potential of this market being realised.
That could just be the beginning of the arduous journey, since there are many issues to be addressed. One, nearly 50% of the population with no access to banking services understandably cannot become a part of a voluntary pension scheme. Second, a majority of those who do have access to banking services have not been attractive customer segment for companies. Low value, large volume and high operational costs of selling financial products makes it commercially unattractive proposition for banks and institutions to target them.
Public Provident Fund (PPF) is a good example. Sold through some 10,000-odd State Bank of India branches and 1,54,000 post offices all over the country, the plain vanilla product has been in existence for four decades. Yet, it has managed to get barely 35 lakh subscribers so far. This is when PPF gets all the tax exemptions a financial product could possibly get. Under the exempt-exempt-exempt scheme, PPF is not taxed at any stages—deposit, interest accrued and the total sum accumulated at the time of withdrawal.
Mutual Funds, in comparison, reach out to a little over 5 million people.
But the potential of pension products are enormous. There is a huge mass of people waiting for the opportunity to save money that gives them reasonable returns for their old age. Of the 430 million people who form the workforce in the country, nearly 320 million are estimated to be in the working age between 15 and 59, according to the 2001 census. Nearly 40 million people are already covered under various schemes.
So that leaves a mass of 280 million people. It is this mass that companies are hoping will turn in to a $300 billion opportunity in the next 10 years. To put the size of that market in context, India's goods exports are currently a little over $150 billion.
The journey from the potential to reality will not be easy. A vast majority of this 280 million, with barely enough income to survive, will find it difficult. Studies indicate that nearly 80-90 million people from the lower middle class have the interest and the capacity to save for retirement. The government would, for obvious reasons, like to address the needs of these people since they have little or no social security system. Most of this mass of 80-90 million people are traders, shopkeepers and workers in the unorganised sector. They may have regular income but rarely pay taxes. So, can tax breaks work to get these 80-90 million people to park money into voluntary savings? It seems a debatable issue.
From the companies' point of view, pension is certainly not the most profitable business, compared to other financial products. Companies can get 20-30% commission, depending on the policy, in the first year for selling life insurance products. For pension products, the commission is fixed at 7.5% in the first year. Mutual fund products can get up to 4%, if targets are exceeded. So, will companies be interested in hawking pension products, since it is not as lucrative as a life insurance product?
More importantly, will companies like to reach out to a segment that may not be most profitable but will only make money if they have the volumes?
But considering the demographic and income profile, the biggest question is whether the young workforce, with largely not enough income cushion, will be interested in buying a product that gives benefits only after their working life?
With the history of failures that voluntary pension funds have seen—Indians not finding it enticing enough, companies not finding it profitable enough, and incentives for lower middle class not yet clear—what could make the product succeed?
That is a big question which Finance Minister P Chidambaram has to answer. That will be the difference between just another plan and the success of the new pension plan.