While the country’s new pension system, which is currently under construction, is broadly in line with the best international practices, a lot more needs to be done on the regulatory front in order to convert savings into retirement wealth. A recent study on the financial market implications of India’s pension reforms, conducted by Helene K Poirson of the International Monetary Fund (IMF), concluded that India’s pension system needs five major changes before it can make any meaningful contribution.

These include allowing the private sector to manage pension funds and improving capital market regulations, laws and infrastructure. The study also points out that in the absence of a “first pillar” (minimum guaranteed pension) and mandatory participation, the pension portfolio may get concentrated in government securities and a situation of higher than expected management fees may arise, since economies of scale may not be realised early on due to lack of sufficient critical mass to stimulate financial market development.

As far as asset allocation goes, the study pointed out that investment practices in emerging markets are conservative with a focus on minimum returns. Further, most markets are illiquid and lack depth, which restrict the investment options — in India, not a single paisa of the government’s pension corpus is invested in corporate debt.

Developed markets like the US and the UK have relatively low allocation to fixed-income and hold about 60 per cent in equities.

On regulations, the study observed that the emerging markets adopt a more rigid approach through quantitative investment limits compared to the “prudent person rule” or a self regulatory framework adopted by countries with longer exposure to pension funds, like the UK, the US, Italy and Singapore. With the notable exception of Chile, most emerging economies don’t allow investment in derivative products.

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