Macedonia’s cash-strapped pension system needs thorough reforms as the financial hole in the state pension fund has been constantly rising over the years, reaching 4.5% of the country’s GDP. 

The state-run Pension and Disability Insurance Fund (PIOM) is now in critical financial condition, mainly due to the populist measures taken by the previous government of the conservative VMRO-DPMNE party, which lowered contributions and constantly hiked pensions to secure the support of older Macedonians.

VMRO was eventually forced out of power following mass protests and unrest culminating in a violent invasion of the parliament by its supporters in April 2017. The new government led by the Social Democratic Union of Macedonia (SDSM) now faces the challenge of replenishing the fund and ensuring that pensions payments — PIOM needs an estimated €880mn to pay pensions in 2018 — can be covered. 

According to the latest data from the finance ministry, spending on pensions, which account for the largest share of social transfers from the budget, increased 9% in the third quarter of 2017 to reach 30.9% of total costs.

“The deficit in PIOM reached MKD26.4bn [€428.6mn] in 2016, from only MKD4.2bn in 2000, with the gap resulting from the faster increase of expenditures for pensions than revenues from contributions,” Blagica Petreski, an analyst and CEO of Skopje-based think tank Finance Think, told bne IntelliNews.

The sharp deepening of PIOM’s deficit isn’t entirely due to populist measures taken under the former government, as there were a number of factors responsible. One of them was the introduction of the second pillar of the pension system in 2006, which involves transfer of funds from the first to the second pillar. These expenditures accounted for 25% of PIOM’s total deficit in 2016, Petreski said.

However, according to an official from NLB Nov Penziski Fond, one of the two mandatory funds in Macedonia, the transfers to mandatory pension funds from PIOM account for less than a quarter of the total deficit and are not the primary reason for the gap.

More than 75% of the deficit is attributable to the lowering of the contribution rate for pensions to 18%, a continuation of negative demographic trends, as well as the subsidising of employment without payment of pension contributions, all of which had a negative effect on the level of contributions collected, the NLB Nov Penziski Fond official said in an emailed statement.

Petreski also points to various factors behind PIOM’s deficit, including increasing pensions in the past on several occasions, and most often by more than the planned alignment with inflation, under conditions of low inflation and above the rate of economic growth.

The VMRO-DPMNE government, which ruled from 2006 to May 2017, repeatedly hiked pensions as a populist measure to win pensioners’ votes during frequent elections.

“This mismatching tendency started in 2008, when despite the one-off increase, almost all regular adjustments of pensions were higher than the economic growth and wage increases,” Petreski said.

Until 2008, the Macedonian economy grew by an average of 3.1% and pensions rose by 2.9%. After 2008, however, the economy expanded by an average 2.4% while pensions were 6.5% higher, she explained. Currently, the average pension is around MKD13,900 (€226).

At the same time, PIOM’s revenues increased more slowly due to the reduction of pension contributions from 21.2% to 19% in 2009, and further to 18% in 2010.

This contributed to the deficit even though, as Petreski pointed out, the number of people who are paying contributions has been growing in line with economic growth. As expenditures rose faster than revenues, 43% of PIOM’s total expenditures are now covered from the state budget.

Advance warning

There have been many warnings over the past years that the pension fund faces a shortfall without sufficient funds to pay pensions to its beneficiaries.

Somewhat surprisingly, this hasn’t led to action by pensioners, who seem confident that the government should and will ensure their payments are made regularly. Pensioners do not fear that the lack of funds will put their future pensions in danger.

Speaking to bne IntelliNews one pensioner did, however, criticise mistakes made in the past leading to PIOM’s deficit, such as the previous government’s “soft-hard” policy towards private firms, which on the one hand tolerated the grey economy by allowing firms to hire people without paying pension contributions for them. But on the other hand, the previous government imposed a heavy burden on businesses in terms of many taxes, strict controls, punishments and even closures when irregularities were detected.

Marjan Nikolov, an analyst and CEO of Macedonia’s Center for Economic Analysis (CEA), told bne IntelliNews that the measures of the previous government to lower labour costs did not yield any results, even when they were part of legitimate policies to stimulate business activity.

“The wider atmosphere in terms of the rule of law, the control of corruption, the fiscal transparency and accountability was not secured, but on the contrary it worsened,” Nikolov said.

As the extent of the deficit at PIOM emerged, there have been numerous often heated debates between the main conservative and centre-left parties over the underfunded state pension fund. 

“PIOM faces bankruptcy and to pay pensions Prime Minister Nikola Gruevski and Finance Minister Zoran Stavreski are constantly adding new debts to the burden of citizens,” the SDSM said in a statement back in 2016, slamming the actions of the then government. The party also underlined that at the time half of the pensions were being paid for from the state budget.

“In addition to that, there is unprecedented stealing of the private pension funds with the knowledge of Gruevski and Stavreski, which is a criminal act,” the SDSM accused. The party was referring to the lack of transfers from PIOM to the mandatory pension funds (second pillar).

VMRO-DPMNE reacted by saying that the SDSM did not care about the situation at PIOM, but was unhappy that elderly Macedonians were receiving the highest pensions in the region.

The International Monetary Fund (IMF) has also warned the Macedonian authorities to address this issue. In September 2017, the IMF recommended that untargeted subsidies should be reduced and large and widening pension deficits at PIOM should be reined in through raising the statutory retirement age to the EU average, tightening options for early retirement, indexing pension to CPI inflation only, and refraining from ad-hoc increases.

Carrying the can

Now that VMRO-DPMNE is out of power and the SDSM’s leader Zoran Zaev is prime minister, the centre-left party is responsible for sorting out the mess left by its predecessor. 

Zaev said recently that his Social Democrat-led government may have to take unpopular measures to address the problems in the pension system, but this will happen only after the economy recovers following the political crisis. The first measure, according to Zaev, is raising the statutory retirement age both for men and women and the other is increasing the rate of social contributions.

Macedonia’s GDP contracted in Q2 this year, but now appears to be recovering, with the economy posting growth of 0.2% y/y in Q3, rising to 1.2% in Q4. This means the time for the government to make the next decisions is approaching. 

Indeed, Macedonia’s labour and social policy ministry says it is already working to secure stable payment of pensions. “The payment of pensions will continue and will be on a regular basis and according to realistic projections,” the ministry’s press office told bne IntelliNews.

It also confirmed that together with the finance ministry it is working to prepare a mid-term and long-term plan for PIOM. “An expert analysis is being drafted to prepare a series of solutions aimed to provide the sustainability of the pension system, which is a priority of the government,” the press office said.

For the ministry, raising the retirement age will be the last step that would be taken in the long-run and only if other economic and social measures do not bring the desired results.

At the same time, the analysis of the situation of the state pension system is at the final stage and is being prepared by an expert engaged with the support of the World Bank office in Skopje. “After receiving the recommendations from the analysis, the government will present the draft decisions,” the ministry said. The ministry is also assessing possibilities for the introduction of a state social pension, looking at possible models and ways of financing. The government announced earlier that the size of the planned social pension would be around €100.

Slow and steady 

Analysts and pension fund officials consulted by bne IntelliNews believe reforms aimed at stabilising the situation at PIOM and ensuring stable pensions payments going forward should be implemented gradually through soft rather than sudden changes.

Regarding the situation at PIOM, the NLB Nov Penziski Fond official said that the financing from the central budget cannot be simply eliminated in the short-run, adding that developed European economies are also financing state pension systems from their central budgets.

Petreski underlined that gradual reforms are needed so that the burden of reforms can be shared between stakeholders, to open space for adjustments, and to be in line with social and labour market conditions. The ultimate goal is to avoid any negative effects on the still high poverty and unemployment rate. The at risk of poverty rate in Macedonia was 21.8% in 2016, up from 21.5% a year earlier. Meanwhile, the jobless rate has been constantly falling in recent years, reaching 21.9% in the fourth quarter of 2017, but is still among highest in Europe.

Petreski suggested that reform measures should include an increase in contributions to 20%, meaning a moderate 2pp increase, in combination with additional measures that could be taken immediately or in the next five to ten years.

The first prerequisite, according to the analyst, before any serious reforms are undertaken, is for pension hikes to be made only within the legally set maximum. Measures that will further burden the state pension fund must be avoided, she stressed. 

Speaking of the government’s plans to introduce a so-called social pension, according to Petreski, this should be taken as part of the labour ministry’s social protection measures, and in no case should the payments be drawn from PIOM.

Nikolov suggested that the authorities need to make an assessment of the net costs of the previous policies and based on this draft future measures to restore the sustainability of all public finances. A set of possible measures may include increasing pension contributions, re-examining the role and functions of PIOM in the context of the wider insurance business in Macedonia, as well as evaluating the effect of receiving pensions from the second pension pillar, Nikolov explained.

For Nikolov, increasing the retirement age is not a good option, even though it was suggested by the IMF, as it will have knock-on effects such as higher healthcare costs that will increase the burden on the health system. He argued that the model used in other countries that increased the retirement age cannot be simply implemented in Macedonia due to differences in the quality of life, and therefore the difference of maintaining productivity among older people.

Pension system overhaul 

It’s not all bad news, however. Macedonia initiated pension reforms as early as 2005, and the pension system has been overhauled according to the World Bank model, with well thought out reforms. Today Macedonia has a three-pillar pension system, with a public pay-as-you-go pillar, and two mandatory and two voluntary private pension funds.

The private companies that manage the second pillar funds were set up back in 2005, and mandatory funds have been in operation since the beginning of 2006, while the voluntary funds (the third pillar) have been operating since 2009.

The two mandatory funds are NLB Penziski Fond (NLBm) and KB Prv Otvoren Zadolzitelen Penziski Fond (KBPm). There are also two the private voluntary pension funds – NLB Penzija Plus (NLBv) and KB Prv Otvoren Dobrovolen Penziski Fond (KBPv).

KBPm and KBPv are managed by KB Prvo Drustvo za Upravuvanje so Penziski Fondovi, which is co-owned by Slovenia’s Skupina Prva and Macedonia's largest bank Komercijalna Banka. NLBm and NLBv are managed by NLB Nov Penziski Fond, co-owned by Slovenia’s Nova Ljubljanska Banka and its Macedonian unit, NLB Tutunska Banka.

Past financial statements from these pension funds indicate that the results of the investments are very solid and they have achieved the primary goal of preserving and increasing the value of the paid contributions for its members, the statement from NLB Nov Penziski Fond said bne IntelliNews. 

The multi-pillar system has had some problems, namely difficulties experienced by the private (mandatory) pension funds in getting transfers of funds from PIOM. Now, it seems the problem is close to being solved. “In the past year, the cooperation with the PIOM has significantly improved. The transfer of funds from paid contributions to our members has been made without any major delays and the average level of receivables towards PIOM has fallen,” the statement from the pension fund added. 

However, it noted that, “the problem with the regular transfer of money is not yet fully overcome, but the time of delay and the amounts do not have a significant impact on the balances of our members' accounts.”

Demographic time bomb 

But Macedonia, like other countries across Central, Southeast and Eastern Europe, faces the challenge of a dwindling and ageing population, meaning measures need to be taken to prepare for pensions being more difficult to finance in future. 

According to PIOM data, there were 311,500 pensioners in Macedonia as of January 2018, which is 14.8% of the population. The €880mn needed to pay pensions in 2018 is expected to increase in the coming years.

In-depth analyses were carried out before the start of the initial reforms. They indicated that the pension system as it was then (namely PIOM, the first pillar) would not be sustainable in the long-term due to the continuing decline of the ratio between actively employed people who pay contributions, and the number of pensioners, whose pensions are financed by current employees.

The NLB Nov Penziski Fond official underlined that demographic changes are reflected in ageing of the population and shrinking fertility rates. The size of the active population, in the age band of 15 to 65, in relation to the population aged over 65, is constantly decreasing, thus making further reforms essential. “This tendency is generally observed in all countries,” he said.

Thus while Skopje looks at ways to address the current crisis at PIOM, in the longer term, the sustainability of the state pension funds is jeopardised by demographic trends. Macedonia, along with other countries in the region, will have to face this more fundamental challenge too.