The Reserve Bank of India has warned states against returning to the old pension scheme, calling such a move to be "short-lived" that poses a "major risk" to the country's economy.

In its report titled, 'Capital Formation in India - The Role of States,' the central bank says, "A major risk looming large on the sub-national fiscal horizon is the likely reversion to the old pension scheme by some states. The annual saving in fiscal resources that this move entails is short-lived. By postponing the current expenses to the future, States risk the accumulation of unfunded pension liabilities in the coming years."

The development comes at a time when Congress-ruled states like Himachal Pradesh, Chhattisgarh and Rajasthan have opted to roll out the old pension scheme. Punjab, where the Aam Aadmi Party is in power, has also made a similar promise.

"Going forward, increased allocations of capital expenditure for sectors like health, education, infrastructure, and green energy transition can help expand productive capacities and create a broad-based developmental agenda for the states. Outlays on social services and physical infrastructure can enhance productivity; hence, States must mainstream capital planning rather than treating them as residuals and first stops for cutbacks in order to meet budgetary targets," the report says.

"In this context, it is worthwhile to consider creating a capex buffer fund during good times when revenue flows are strong so as to smoothen and maintain expenditure quality and flows through the economic cycle," it adds.

Pension expenditure alone accounts for 12.4% (average of 2017-18 to 2021-22) of total revenue expenditure of the 10 most indebted states, according to the RBI.

A report by the State Bank of India (SBI) had earlier estimated the present value of future liabilities at 13% of gross domestic product (GDP) if all states opt to roll out the old pension scheme.

The Compound Annual Growth Rate (CAGR) in pension liabilities for the 12-year period ended FY22 was at 34% for all the state governments, according to SBI. As of FY21, the pension outgo as a percent of revenue receipts is around 13.2% for all states combined, and 29.7% of own tax revenue. In fact 56% of expenditure of the states that is committed (interest payments, salary, and pension payments) is met out of state revenue receipts.

According to the Comptroller and Auditor General of India (CAG), the state governments' expenditure on subsidies grew at 12.9% and 11.2% during 2020-21 and 2021-22, respectively, after contracting in 2019-20. The share of subsidies in total revenue expenditure by states also surged from 7.8% in 2019-20 to 8.2% in 2021-22.

The old pension scheme also known as pay-as-you-go scheme was discontinued in 2004 and was replaced by the national pension scheme (NPS). Under the old pension scheme, the beneficiary was provided with a monthly pension till the last day of his/her employed life. The monthly pension was 50% of the beneficiary’s last drawn salary.

While the old pension scheme provided no tax benefits, under NPS the beneficiary can claim tax deduction of ₹1.5 lakh under Sections 80C and 80CCD of income tax. Under the NPS, the beneficiary can withdraw 60% sum after retirement.

Follow us on Facebook, X, YouTube, Instagram and WhatsApp to never miss an update from Fortune India. To buy a copy, visit Amazon.