Tuesday, December 4, 2018

Waiting for the pay-off: Contribution-based social security scheme in Nepal

It was published in The Kathmandu Post, 03 December 2018. Related blog post here.

Prime Minister KP Sharma Oli launched a new contribution-based social security scheme for private sector employees amidst much fanfare and self-congratulation. The opposition bloc cautiously welcomed the initiative, asserting their share of contribution too but censuring the government’s flamboyance.

The new social security scheme, a product of groundwork that began almost a decade ago, is a landmark initiative. It is a win-win for private sector employees and employers (at least on paper) as it offers financial and income certainty for the former and a possibility of investor-friendly workplace environment for the latter. However, the success of the scheme now depends on how effectively and efficiently the government implements it by prioritising institutional set up, and operational and management independence of the fund.

Setting new precedents

The new scheme is in line with contribution-based social security regulation, which reflects the contribution-based social security law passed by the parliament last year. All formal sector firms are required to join the scheme and deposit 31 percent of an employee’s basic monthly salary in the Social Security Fund (SSF), of which 11 percent needs to come directly from worker’s basic salary and the remaining 20 percent must be contributed by the employer. Workers will get a unique social security number that will not change even if their jobs do. 

The SSF offers a number of schemes for workers. First, the health and maternity policy is restricted to medical coverage up to Rs. 100,000  and maternity allowance is equivalent to one month’s salary. If workers need to be absent from work beyond the 12 days of annual leave, then the SSF will provide them 60 percent of minimum salary. Pregnant workers who need to take leave in excess of 60 days (at the maternity level) will also be offered similar facilities. Second, workers will receive financial support in the case of workplace and non-workplace accidents and injuries. Third, workers who have contributed to the fund for at least 15 years are eligible for a monthly pension. Those working less than 15 years can withdraw the contributed money after termination of their employment. Fourth, in cases of deaths of workers, their family members can receive monthly pension equivalent to 60 percent of the worker’s basic salary in the last job. Similarly, children will receive 40 percent of parent’s monthly salary to cover educational expenses up to the age of 18 years.

Compared to existing schemes for workers’ welfare and financial security, these are generous offers. Employees have an incentive to be more disciplined, punctual and productive at workplace- something the private sector wanted since trade unions became unruly, leading to a deterioration of the investment climate - given the promises of not only their own financial and health securities, but also of their dependents. Employers are hoping for an end to labor strikes, often instigated by politically affiliated trade unions, over workers’ welfare and financial allowance. It should help to raise labour productivity (per worker output) if disruptive union politics and dishonest employers do not game the system in their favor. There will also be pressure on informal sector firms to enroll their employees into the program, leading to the formalisation of businesses (and potentially more tax revenue for the government).

The trade unions, which act as sister organisation of political parties, are happy because it is easier for them to make a deal with the government than the private sector (remember that the contribution rates could be changed). The private sector is also happy because now, issues such as planned and ad hoc welfare are now the government’s headache.

Key lies in implementation

The success of the new scheme depends on how effectively and efficiently it is implemented. First, the fund should be operated by an independent agency free from political and trade union pressure. An independent and transparent mechanism to manage fund is quintessential to its operational success and for it to earn higher return on investments. The law allows the government to direct the SSF on issues it thinks are pertinent and of national interest. This provision should not be used by the government to indirectly advance its agenda, especially on matters related to personnel management, daily operation of SSF, and investment decisions. Moreover, the SSF should desist from funding the government’s fiscal deficit—especially if it is due to drastic increase in recurrent expenditure—by purchasing treasury bills and bonds if the returns are not higher than in alternative scenarios.

Previously, the Ministry of Finance indirectly instructed Employees Provident Fund (EPF) and Citizen Investment Trust (CIT) to extend loans to projects it deemed were important and necessary to support the government’s agenda. A recent example includes the loans extended by these semi-autonomous pension funds to Nepal Airlines to purchase aircrafts, whose full operation is uncertain as the company is mired in a controversy over foul play in their procurement processes. This kind of investment, even with sovereign guarantee, increases the odds of incurring losses, which would mean lower than expected payment for employees enrolled in the scheme. Remember that final payment is based on the contribution of employees and the returns earned by the SSF on investments.

Second, a professionally run SSF without political and union interference is paramount to its success. If all formal and informal sector employees enroll, it could easily have over one billion dollars in deposit each year. Acquiring the human resources, and operational and management expertise required to manage such a large fund is quite a behemoth challenge. Furthermore, the failure to invest deposited funds will have an impact on banking sector liquidity unless the SSF adopts the pension fund’s strategy to park deposits in banks offering the highest interest rate.

Third, the government’s liabilities are going to increase drastically because it guarantees payment to workers even if money contributed by the SSF is insufficient. Some of the SSF’s policies, including issues pertaining to workplace accidents and the eligible age for pension schemes, are open ended and therefore, could significantly increase liabilities vis-à-vis its accumulated assets.

Furthermore, if SSF’s investment goes sour, then the liabilities will be even higher. The government is already alarmed by the ballooning retirement payment to public sector employees. Contingent and unfunded liabilities are ever increasing. This calls for a unified social protection scheme that covers public and private sector employees, old age allowance, medical insurance, and unemployment allowance, among others.

Fourth, workers, with their own and familial financial and health securities guaranteed, need to be more disciplined and productive at workplace. This, along with improvements to the investment climate, could result in higher production and investment. Currently, labor productivity of Nepali workers is one of the lowest in South Asia.