Ben Aris in Berlin -
Borat may portray Kazakhstan as a bucolic basket-case, but at least he can look forward to a comfortable retirement.
Kazakhstan is the acknowledged leader in structural reform in the CIS and its pension system is far ahead of those of the other major powers in the region. While Ukraine will not even make the first reforms until 2009 and Russia is in the middle of them now (though its pension system has yet to accumulate any real money), Kazakhstan's pension industry is about to celebrate a decade of life and is savouring the first fruits.
"The results of the first 10 years of pension reform have been not just really good, but amazingly good. Nearly 8% of GDP is currently under management of private pension funds," says ING's Julia Tsepliaeva. "These funds are strong and transparent. In fact, it is not just a question of pension reform, but also of the banking reform that took place at the same time. The whole financial system is strong."
Kazakhstan's pension reform began on January 1, 1998 with a relatively high social tax on wages of 21%, allowing the government to pay the current pensioners. Employees pay 10% of their wage as an obligatory contribution to the accumulative pension fund (to their personal account), which is spurring the very rapid growth of pension fund assets and will make this part of the pension system the most important in future.
"The crucial factor in the pension reform has been that employees are obliged to pay 10% of their wages into private pension funds, compared to Russia where the figure is only 2%. It is rare for Russia to look to other CIS states for reform ideas, but they are definitely now envious of the Kazakh pension system," says Tsepliaeva.
A system of tax exemptions was designed to encourage voluntary contributions. As a result, Kazakhstan has developed a solid system of 14 pension funds in the country, with assets of $7.7bn as of February 1, or 10% of GDP, including the currently tiny $5.6m of voluntary pension savings.
This makes institutional investors very important for the country's financial markets - and their lobby strong - pushing the government to offer them more instruments for investment.
Analysts are optimistic on the future accumulation of deposits in non-state pension funds, and after another decade they are likely to have dramatically expanded and strengthened their role in the financial markets, opening new avenues for institutional investors in the region and stimulating long-term investment. Kazakh funds are likely to increase 10-fold to $72bn by 2016, according to ING's estimates.
However, the pension fund managers face many headaches, the main one being how to make money.
"The biggest problem the Kazakh pension funds are faced with is a shortage of instruments to invest in," says Tsepliaeva. "This is why the banking reform was initially important because it provided pension funds with investment alternatives in the form of bank deposits."
While Kazakhstan's economy is coming on nicely, its equity capital market remains thin and shallow. The average return for the state pension fund portfolio in 2006 was 1.2% in real terms, whereas Russia's Vnesheconombank, which manages the Russian state pension fund, reported a 5.5% yield for its portfolio in 2006, though inflation was substantially higher at 9%.
In both Russia and Kazakhstan, the local currencies are currently under strong appreciation pressure, which is keeping local private pension funds more oriented towards ruble or tenge instruments. For example, according to Kazakh pension law, although pension funds are allowed to invest up to 40% of their portfolio in foreign securities (with credit ratings not less than 'BBB'), the actual share is tiny. Yields of 'BBB'-rated bonds are usually low, while continuing appreciation makes returns negative in tenge terms.
As a result, the development of the local financial markets may impose some constraints. Kazakhstan definitely faces limitations, with markets failing to meet increasing demand from institutional investors. There are 32 stocks listed in the A-category of the KASE permitted for pension fund investment, which has a market capitalisation of some $7.4bn, while pension funds have accumulated $7.7bn. Average trading volumes are a paltry $10-15m a day and trading is concentrated in three or four stocks, usually banks.
The domestic debt market is also illiquid. Pension funds buy mostly government bonds and hold them in their portfolios, waiting for redemption, hindering the development of the secondary market.
Fortunately, the National Bank of Kazakhstan has decided to increase its placements and lengthen bond maturities - up to one year. In 2007, the bank is planning to increase the existing volume of notes to $16.8bn, which is good news for the further development of the local debt market.
Low or negative real returns plague most of the countries of the CIS, including Russia and Kazakhstan, where yields, in particular government bond yields, are likely to remain low while oil prices are high. This is likely to push pension funds towards the stock market in the medium to long term.
Analysts expect this to be the main driver in the equity markets for both Russia and Kazakhstan in the coming decade. As Kazakh funds are allowed to invest up to 55% of their assets in equities (50% in A-listed stocks), they will likely aim for the maximum limit. In 10 years, Kazakh pension fund investments in the equity market could reach $32-35bn.
In Kazakhstan, bank deposits remain a very popular option for pension funds, although this option is expected to become less popular in the coming years as deposit rates are likely to continue falling (currently average tenge deposit rates for 1-5 year maturities were 6.3% as of February 1 - lower than the NBK's one-year yield of 6.5%).
Consequently, the share of deposits should drop, while the share of mortgage bonds is very likely to substantially expand to $7-10bn in the coming decade. The corporate bond market too is expected to take a large share of the pension fund portfolio, possibly reaching an inflow of $8-9bn t in 10 years.
Tsepliaeva is optimistic. "10-20 years are needed for the Kazakh pension system to mature into a fully-fledged Western-style private pension system," she says.
As to the exposure of the pension funds to a fall in the price of oil, she says: "A drop in the price of oil would paradoxically help pension funds, because government budget deficit financing would provide more investment instruments for the pension funds."
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