Duma approves changes to Russia pension system

By bne IntelliNews December 3, 2012

Bank of Finland -

--The changes were motivated by the persistent deficit of the Pension Fund.

--Nearly a quarter of public sector spending currently goes to funding pensions.

Reform of the pension system has been the major topic of public discussion in Russia this autumn. The labour ministry in October presented a long-term strategy for development of the pension scheme that included measures to improve funding. The cabinet failed to agree on the changes, however, as they pit economic and social ministries against each other.

In accordance with instructions from President Vladimir Putin, the Duma last week approved partial reforms to the current pension system as presented by the labour ministry.

Russia's pension system was fundamentally reformed in 2002 according to internationally accepted practices recommended by various expert agencies, with the Swedish pension system taken as a model. The reformed system introduced a partial shift from a pay-as-you-go arrangement to a funded scheme that allocates part of current contributions to funding of pensions of younger generations. Older workers and current pensioners are paid out by the pay-as-you-go system, i.e. pensions are paid out of the contributions of working people. The employer's mandatory pension contribution is 26% of the wage bill. Of that 6 percentage points goes to the funded scheme and the rest to cover running pension costs.

The change approved by the Duma rolls back the 2002 reforms by reducing the funded share of the 26% from 6 percentage points to 2 points, while shifting the other 4 percentage points to covering current pension costs. The change, which goes into force in 2014, is a short-term fix to finance current pension costs, but doesn't help in creating a long-term sustainable footing for the pension system.

The move has received sharp criticism from the finance and economy ministries, as well as expert agencies that see no justification in butchering the funded component of the pension system. To resolve long-term underfunding of the pension system, Russia must consider eg. raising retirement ages, increasing the length of time a person has to be in the workforce to earn a full pension and elimination of the early pensions offered in many branches.

Reform of the pension system will remain topical as Putin has tasked the government with drafting more amendments to pension laws in the first half of next year.

An aim of the shift to a self-funded pension system has been to support growth of Russia's capital-starved securities markets and boost the functioning of pension funds so that they can engage in long-term financing activities. In the view of capital market proponents, the roll-back implies weaker development of the sector and postponement of making Moscow a major hub of global finance. On the other hand, pension funds have not been very successful at preserving the value of paid-in contributions; the average return on invested contributions has failed to even keep up with inflation over the past ten years.

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