The finance ministry is understood to have shared a pension reform programme with the IMF to contain the growing pension liability as the consolidated federal and provincial pension expenditure is projected to increase by over 20pc from Rs1.252 trillion last year to Rs1.513tn this year.

The pension reform plan, which the government proposed to roll out from July, is a mirror image of the measures that ex-finance minister Ishaq Dar had introduced in his last budget for the current fiscal of 2023-24. The decisions, however, could not be implemented this year because of opposition from the Establishment Division that insisted it would put the civil servants at a disadvantage.

The reforms scheme shared with the lender seeks to cut the annual federal pension expense on its existing employees by changing the formula for pension calculation, slashing the commutation rate, discouraging early retirement through imposition of a penalty, restricting the list of beneficiaries of the deceased employees, and ending the current practice of multiple pensions.

In case, the spouse of the deceased employee is also a government employee, the spouse would not get the pension. Likewise, if a retired employee is rehired they will be given the option to choose either pension or salary. The plan also proposes to index any increase in pension with the Consumer Price Index, with a maximum allowable increase of 10pc per year.

Experts say current system unsustainable, short-term measures can’t be substitute for reform, move towards contributory schemes

The ‘reforms’ are being revived as the country seeks a new medium-term bailout from the lender to reduce its growing external vulnerabilities, and shore up its foreign exchange reserves. Finance Minister Muhammad Aurangzeb said that “the matter of an Extended Fund Facility (EFF) with the IMF would be discussed in Washington next month”.

The government and the IMF have already reached an agreement regarding the disbursal of the last tranche of $1.1bn under the present $3bn short-term standby arrangement (SBA) facility, which expires next month.

Earlier, a statement issued by the IMF on the conclusion of the final SBA review had indicated that fiscal consolidation through cuts in public sector expenditure and improvements in revenue collection, restoration of the energy sector’s viability, reduction in inflation, foreign exchange market reforms, and private sector facilitation would be the key goals of the successor programme.

‘Parametric reforms’

While the suggested changes in the pension rules — described as “parametric” reforms by Hasaan Khawar, an Islamabad-based development consultant, are important short-term measures to contain the pension expenditure, they cannot be a substitute for contributory pension schemes.

“The proposed reforms to reduce retirement age and cut pension benefits are imperative. But both the federal government and provinces will have to ultimately move towards contributory pension models because the present pension system has become unsustainable…,” argued Sajid Amin Javed, an economist associated with the Pakistan Institute of Development Economics.

“The annual public-sector pension liability is now bigger or equal to what the government spends on development projects. This is unsustainable and must change.”

While most countries have already moved from unfunded to funded pensions or introduced “defined contributory” pension programmes, Pakistan continues with the unfunded “non-contributory, defined benefit pay-as-you-go” system for providing financial security to retired public sector employees.

Taimur Khan Jhagra, a former Khyber Pakhtunkhwa finance minister who introduced a contributory pension scheme for the provincial employees hired since July 1, 2022, the first ever such scheme implemented in the country, wrote in an article last July that India has done this in 2004 under a World Bank project. “The same project in Pakistan failed; the result is that the Rs1.5tr pension bill (a third of which is military pensions) for FY24 must be funded through the budget.”

“Our pension bill is guaranteed to grow at 22-25pc per year for the next 35 years,” he wrote, adding the cost of inaction could be calculated from the fact that the national pension bill had risen 50 times during the last 20 years. “They double roughly every four years. Without reforms, within a decade, most pensioners will not be getting a pension. We simply won’t have the money.”

Pensions payments

The federal allocation for pension payments this year stands at Rs801bn compared to Rs171bn in FY14.

The State Bank in its 2021 report commented that 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.”

According to the bank, the overall pension spending as percent of total budgeted expenditure for FY20 exceeded the federal and provincial health and education spending and is almost half the level of consolidated development expenditures.

Likewise, the World Bank in 2020 warned that salary and pension costs will persistently grow and crowd out other public expenditures in the coming years.

Mr Khawar maintains that the total pension payments for the ongoing financial year, if the pension costs of the autonomous and semi-autonomous public entities are also taken into account, would be to the tune of Rs1.7-1.8tr.

Retrospective increments alongside generous commutation and restoration facilities are said to be fueling the trend of early retirement of the civil servants, the SBP had pointed out. This, coupled with the improved life expectancy, higher replacement rate, a growing headcount of the government employees and the unfunded nature of pension payments, is making the current structure unsustainable in Pakistan and burdening the already tight fiscal situation.

Country’s debt sustainability

Both the IMF and the World Bank have been flagging the rising pension expenditure as a pressing concern for the country’s debt sustainability for the last several years. In the 2000s, Punjab led other provinces to set up a pension fund as part of public finance reforms to reduce the burden of pension payments on its budget. However, the pension fund continues to be financed through the provincial budget.

The next ‘pension reform’ it has rolled out ever since pertains to raising the age limit for the early retirements. “The reality is that successive governments have been pushing the issue down the road in the name of reforms to avoid political costs,” a former Punjab finance secretary maintained.

Mr Khawar was of the view that the existing pension model was burdening the national and provincial budgets, eating into revenues that must be spent on social sector and development.

“Growing pension costs, therefore, demand a quick transition from the present unfunded, non-contributory pension scheme to a contributory programme to create fiscal space for essential expenditure. This can be achieved in three-five years, or never, depending on the political will (of government),” he added.

Mr Javed said the government would need to first implement pension policy reforms, defining the retirement rules, pension eligibility criteria, etc, before replacing the existing programme with a contributory pension model.

“At the same time, the authorities would have to strengthen the capacity to invest pension funds profitably. In the initial phases, global investment companies may be hired to explore international investment opportunities. Last but not the least the federal and provincial governments must move in sync to implement the contributory pension model.”

Nevertheless, according to Mr Khawar, the real challenge is how to finance the unfunded pensions of the existing employees on the old defined benefit pension plan. “Even with the defined contributory programme for the new government recruits in place, the public sector pension bill will continue to grow,” he said, putting the current accrued public sector pension liability (to be paid to the government employees retiring in future) in the range of Rs18-19tr.

Published in Dawn, March 27th, 2024