If the new PFRDA head's current ideas take shape, NPS may need to be bailed out some day like UTI was

Yogesh Agarwal, the new regulator of the Pension Fund Regulatory and Development Authority (PFRDA), is hell-bent on making the New Pension Scheme (NPS) work.

Mr Agarwal, who took over as the PFRDA chairman on 7th June, is talking about changing the incentive structure of the scheme and making significant other changes. However, if he puts all this articulation into action, he could end up messing the NPS. It will not only destroy the very thoughtful DNA of the scheme, but, in the long run, create a situation of forced government bailouts at the cost of taxpayers. 

Mr Agarwal is setting up a committee under former SEBI (Securities and Exchange Board of India) chairman GN Bajpai to revamp the NPS. But even before that, he has articulated his thoughts on how to energise the scheme. In an interview published by Business Standard today, he says that his idea is to incentivise fund managers, who have been whining that they are losing money on the NPS and an increased corpus only increases their losses. Mr Agarwal's idea is to free the fund managers' fees and make pension fund management open to all fund companies in the silly belief that the best fund manager will attract all the assets.

This deep belief that free-market ideas work well for the financial sector would be touching if only the memories of what happened in the US in 2008 were not so fresh. The US suffered a financial crisis mainly because free-market ideas in housing finance and derivatives did not lead to competition and increased efficiency but only a one-way increase in greed and a nationwide breakdown of risk assessment among the savviest market experts.

If Mr Agarwal plans to change the scheme, won't the existing NPS have to be disbanded and the money returned to investors and fresh bids called? After all, the fund companies are contract-bound to manage the current money at the current fees. Savvy fund managers, who ought to have understood the costs and who were perfectly aware that there was no incentive to sell the NPS, had made considered bids to bag the contracts. If there is a dramatic change in the structure of the scheme, it cannot happen by merely giving investors an exit route. If Mr Agarwal is allowed to do that, it is nothing but a government-backed sleight of hand, which will take advantage of the poor financial literacy in the country.

Worse, it will also sow the seeds for moral hazard over the long term. Like it or not, the NPS is seen as a government-backed scheme. Finance minister Pranab Mukherjee has only underlined this by promising to put Rs1,000 into each new pension account under the Swavalamban in the Union Budget of February 2010. This means that any losses or mess will ultimately have to be borne by the exchequer and will come out of the taxpayers' pockets.

What we need on the NPS is not a new committee and some tinkering, but an end to the turmoil in the incentive structure of all financial products that are sold to ordinary investors with no financial knowledge - this would include mutual funds, insurance or now, the NPS.

Each regulator has tinkered with products under its domain and in every case, it has led to a huge outflow of funds. Mutual funds are reeling under quick-fire changes forced by SEBI; IRDA has recently unleashed changes, whose impact is still to be assessed and now PFRDA is planning to change a scheme that is sold as a long-term investment to ordinary people.