Jan Cienski in Warsaw -

Stocks listed on Poland's stock market have long enjoyed a "pension premium", the higher share price that results from Polish pension funds pumping cash into local shares. But that premium is now in danger as the government contemplates reforms to part of the pension system, trying to rejig the mandatory private pension scheme - the so-called second pillar - that it blames for driving up public debt.

"Over the past 14 years, the pension funds have helped to shape the Polish capital market, increasing its liquidity and attractiveness for foreign investors, and IPO-ing those companies looking for higher valuations," note Mateusz Zawada and Carsten Hesse of Wood & Company, a central European investment bank, who find that any dramatic changes to the current pension system could have negative consequences for Polish equities.

The current government, and particularly Finance Minister Jacek Rostowski - who has called the second pillar system a "trap" - have long had a very negative opinion about the pension reforms that were conducted in 1999. The goal then was to remove the long-term danger to Polish public finances caused by an ageing and shrinking population. The reforms partly switched from a pay-as-you-go system, in which today's workers finance today's pensioners, to one in which today's workers build up savings for their own pensions.

The reform was a model in its time, and was copied by other countries like Sweden. However, the onset of the financial crisis has forced a rethink in Warsaw, as the finance ministry gazes longingly at the billions transferred every year to the pension funds.

Broken promises

In 2011, the government slashed the amount of money flowing to the second pillar, falling from 7.3% of workers' salaries to only 2.3% - although a promise was made to eventually start increasing the flow of money and to allow the funds to invest more aggressively on the stock exchange, potentially boosting their returns.

The problem was that over the decade following the initial reforms, subsequent governments did not follow through on promises to reform the pension system, ending special privileges for farmers, miners and uniformed services, as well as increasing the retirement age. As a result, the second pillar has needed additional financing to keep it solvent.

Over the years, the second pillar funds have become increasingly important to Polish capital markets. They have assets of PLN280bn (€67bn) and are significant investors on the Warsaw Stock Exchange (WSE), often buying and holding stocks issued in IPOs, which makes them a stabilising influence. The funds are allowed to invest 47.5% of their assets in equities (currently amounting to about PLN112bn, a fifth of the WSE's market capitalisation), although that is supposed to rise to 62%. "Without [the funds] the Polish stock exchange would certainly not be the largest in the region," Witold Stepien, head of the Citi Handlowy brokerage, told a recent conference on the impact of pension funds on the capital market.

Warsaw's initial step in 2011 was less radical than the action of Hungary, which completely scrapped their second pillar. It also allowed for a temporary easing of public finances because EU accounting rules do not give an offset for state contributions to private pensions; by keeping the money in the public system, it allowed the government to keep public debt from growing to dangerous levels.

However, the pressure is on the government again as the economy slows much more sharply than had been expected and public debt again rises. According to the government's calculations, debt is a smidgeon below the legal threshold of 55% of GDP, although according to stricter Eurostat definitions debt is already higher than that.

A preliminary report on the scheme leaked to the Polish press states that the second pillar is now less needed because the government's programme of selling off state companies is winding down. The government has also attacked the funds for charging high management fees and for generating lacklustre returns.

The government also calculates that if the funds did not exist, Poland's public debt would drop to only 38% of GDP, far below danger levels. "The higher the level of the [funds] in the pension system, the higher the probability of a future increase in taxes because of the higher costs of servicing the debt," said the preliminary report.

The drum-beat of negative propaganda coming from the government has markets convinced that the second pillar funds are in for a shake-up. The likeliest outcome is for second pillar funds to be forced to transfer the assets of a pensioner to the government system 10 years before a worker retires, as well as allowing workers to opt out of the privatised system altogether. "We are very concerned," says a comment from Citi Handlowy bank.