A] Prelude*
* For more information about pension systems, feel free to visit our dedicated webpages:
https://expatpensionholland.nl/global-pillars-systems
https://expatpensionholland.nl/global-investments-risks-0
Pension reform is again a hot topic, but this time, bureaucrats will make it appear as if it is intended to benefit top officials. The reforms go beyond just raising the retirement age or taxing pensions. Instead, a series of actions, similar to those that were done in Khyber Pakhtunkhwa (KP), should be seriously considered to reduce the cost of pensions to the government exchequer.
The Pakistan government said on Tuesday it was vital to reform the country’s pension system, including by raising the retirement age, to mitigate expenditure as Islamabad aims to save the system billions of dollars per year, with a committee formed to propose recommendations.
B] National Pension Costs
The national pension cost will reach nearly Rs2 trillion in FY24, and it is predicted to rise to Rs10tr in the next decade if no reforms are implemented. In 2002-03, the pension cost stood at Rs25 billion, but in a span of just 20 years, it skyrocketed to over Rs1.5tr.
Pension reforms have previously been tested in KP and generated the expected cost-saving results. It is high time to rationalize the existing pension program and transition to more modern schemes available in developing and developed countries.
Last week, Finance Minister Muhammad Aurangzeb proposed to raise the retirement age from 60 to 65 years. It has sparked controversy over whether the government intends to benefit only a select few individuals. This decision has both advantages and disadvantages.
In KP, the age restriction was raised to 63 years in 2019 with a projected annual savings of Rs20bn. However, the decision was reversed due to strong protest from bureaucrats, and the court also overturned the decision. However, KP’s other pension reforms remained in effect.
KP Advisor on Finance Muzzammil Aslam has a different take on raising the age restriction than his predecessor, who implemented a series of reforms. Mr. Aslam believes that the lump sum payment of pension payments will be delayed for the next five years, providing some much needed breathing room for the time being. This will allow the government to show a lower budget deficit.
The net impact will increase when the five-year allowances are added to the basic salary, which will be used to pay the pension. The age extension will postpone payments, but total payouts to employees will climb over the following five years. While these efforts provide some relief in the short term, crucial steps must be implemented to address the increasing pension liabilities.
There is another idea to tax pensions. It may also face political challenges. However, the KP government has imposed a 5pc pension tax on grades 17 and above on their executive allowance. It is estimated that this measure alone will generate Rs150bn in contributions to a pay-as-you-go pension system.
This was not an easy decision, but it was made in KP to obtain some contribution from existing employees. The federal government can look into this step in response to opposition to taxing pensions.
C] KP Reforms
In 2004, based on recommendations from a World Bank project, India implemented a national pension scheme wherein employee contributions are matched by the government.
Pakistan did not choose to adopt it since it was not anticipated that the cost would rise so dramatically over the next 20 years. Taimur Khan Jhagra, former finance minister of KP, took the lead in implementing a series of pension reforms, including the introduction of a contributory pension scheme for new employees beginning July 1, 2022.
Few substantial changes were made to the existing pension program. A well-known 13-tier pension system was in place, covering the pensioner’s widow, children, parents, siblings, sisters, and grandchildren. KP confined it to direct dependents. The federal government did the same last year, but other provinces have not followed suit. The previous PTI government raised KP and Punjab’s minimum retirement age to 55 from 45, reducing KP’s pension bill by Rs20bn alone.
KP consolidated various pensions into a single one. Previously, individuals could receive two pensions simultaneously, with an active employee receiving both a salary and a pension.
The major reform is the implementation of a contributing pension scheme for new employees. Under this program, the KP government contributes 12pc and employees contribute 10pc. So far, 40,000 staff have been hired under this system starting July 1, 2022.
There are additional critical reforms that the KP and federal governments should implement, such as revisiting the single Universal Pay Scale between Grades 1 and 22. Pay in provinces is decoupled from the Centre and between departments, allowing each department to develop a pay scale appropriate for their budget and the market value of their professions.
Pension reforms are greatly needed. The question is whether the state will be able to sustain pension payments for the next 10 to 15 years.
D] IMF Influence
The belt tightening moves come as Islamabad — which is facing a balance of payment crisis — is in talks with the International Monetary Fund (IMF) to secure a new long-term bailout deal. In the past, Pakistan has faced the challenges of revenue generation and government expenditure and struggled with high levels of debt, a large fiscal deficit and an ongoing need for structural reforms to improve its fiscal sustainability.
Under the last $3 billion bailout, Pakistan implemented several IMF-mandated reforms, such as budget adjustments, increasing interest rates, and higher energy prices. Among expected reforms under a new program are strengthening public finances through gradual fiscal consolidation, broadening the existing tax base and improving tax administration, and debt sustainability, all while protecting the vulnerable.
An IMF mission is expected in Pakistan in the next ten days to discuss a new loan program that the finance minister has said would be “larger and longer.” “Age is just a number,” Finance Minister Muhammad Aurangzeb said at a press conference in Islamabad, calling for reforms in the pension system and saying pension payments were a “huge liability.”
E] ‘60 is the new 40’
“Sixty is the new 40. In the private sector institution I left before coming here as finance minister, we raised the retirement age from 60 to 65. These are your most productive years when you have maximum experience.” He recognized that changes to the service structure could not be carried out overnight but said Pakistan would need to move in this direction to control the pension costs.
Law Minister Azam Nazir Tarar said pension reforms would be held across the board, for which legislation was required. “A large chunk of yearly revenue is utilized on paying retirement benefits and pensions,” Tarar said at the press conference with Aurangzeb. “Legislation is required for this as civil servants, armed forces, judicial organs, and executive organs are included.”
The law minister said a committee had been formed under the chair of the finance minister to propose recommendations pertaining to pension reforms. In March this year, Pakistan’s media widely reported that the finance ministry had shared a pension reform program with the IMF to contain growing pension liabilities, with the consolidated federal and provincial pension expenditure projected to increase by over 20 percent from Rs1.252 trillion last year to Rs1.513tn this year.
The reforms scheme shared with the lender reportedly seeks to cut the annual federal pension expense on existing employees by changing the formula for pension calculation, slashing the commutation rate, discouraging early retirement through the imposition of a penalty, restricting the list of beneficiaries of the deceased employees, and ending the current practice of multiple pensions.
In a 2021 report, the State Bank of Pakistan said the federal pension expenditure was increasingly becoming unsustainable: “When we look at the federal pension bill, there has been a significant rise. Pension bill has increased at a Compounded Annual Growth Rate (CAGR) of almost 14pc during 2012-23.”
F] Finally
According to the bank, overall pension spending as a percentage of total budgeted expenditure for FY20 exceeded the federal and provincial health and education spending and was almost half the level of consolidated development expenditures.
The World Bank in 2020 warned that salary and pension costs in Pakistan would persistently grow and crowd out other public expenditures in the coming years.