India’s saving grace

New Delhi's decision to shift newly recruited civil servants to a new defined-contribution plan is enough to warm the hearts of pension reformers around the world. But even better is the introduction of India's "New Pension System," or NPS, which tackles the all too familiar traditional pension problems, both practical and political, says Indian economist Ajay Shah in the Wall Street Journal.

Transaction fees were at the top of the first list, says Shah. These fees would eat up the pension savings of many who can afford only meagre contributions and maintain small balances. To solve this, the NPS creates a Central Recordkeeping Agency (CRA):

All contributions flow to the CRA, which holds a single database about all participants, enabling small investors to aggregate their transactions to capture economies of scale.

Participants give instructions to the CRA for switching between asset classes and/or pension-fund managers.

The CRA nets these flows and executes a single bulk transaction with each fund manager every day.

The CRA enables a competitive environment in which participants can easily switch between fund managers without the fear of transaction costs eating their savings.

Other elements of the NPS have been designed to combat high transaction costs, as well. Standardised fund-management products, a small number of fund managers and government auctions that will grant the program to the lowest bidder, will help keep costs down.

In addition to breaking ground in pension-plan design, India is also charting new territory in encouraging broad participation, says Shah. The new system will use groups like occupational associations and microfinance organisations to provide informal-sector workers with access to the pension system. These groups will spread the word about the program, pool members' savings and personal data, and then plug that money and information into the CRA on behalf of the small investors.

Source: Ajay Shah, India's Saving Grace, Wall Street Journal, April 17, 2007.

For text: http://online.wsj.com/article/SB117676451732071892.html

For more on International Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=26

FMF Policy Bulletin/ 24 April 2007