Russian funds enter the pension reform fight

By bne IntelliNews October 25, 2012

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A band of Russian pension funds has united in an attempt to block a Labour Ministry plan to divert pension fund flows back to state coffers, claiming it would destroy the private pillar and wreck Moscow's ambitions to drive infrastructure investment and develop the country's capital markets.

Facing budget deficits, the revenue-hungry Kremlin has proposed a plan that would divert taxes from pension funds and use them instead to plug a hole in the state's pension obligations to current retirees. The fund managers, which earn fees from managing the investable part of these state-generated funds, are appealing to the government to find another way to close the gap, arguing the Kremlin's proposals will stymie development of the pension system.

A debate has broken out in government over how best to develop the pension system and it is a crucial reform. President Vladimir Putin said in September that pension funds are needed not only to support Russia's retirees but also as a source of long-term investment capital, which will be used to invest into the infrastructure development that the country so badly needs.

Under the worst case scenario, the liquidation of existing retirement funds could trigger a RUB1 trillion ($32bn) sell-off in government bonds and drive yields higher, according to VTB Capital Asset Management.

This year the State Pension Fund, which holds the vast majority of pension assets - currently equivalent to around 3% of GDP - faces a deficit of RUB1.3 trillion. That is equivalent to 2.2% of GDP, and represents a huge hike from the RUB30bn imbalance in 2005, former Finance Minister Alexei Kudrin estimates. This gap already drains money out of the state budget, accounting for around 10% of its spending, and is set to expand rapidly, so fixing the system now is imperative.

The Labor Ministry plan, spearheaded by Deputy Prime Minister Olga Golodets, would cut the share of payroll tax that goes into individual accounts for future retirees - the so-called funded part of the system - from 6% to just 2%. That would increase the share of assets that the funded part pays to current retirees from 16% to 20%, reports Bloomberg.

A short-term fix, this plan would reduce the pressure on the budget for now, but as more Russians retire and the share of elderly in the population grows, this plan also reduces the amount salted away in the second pillar, making pension payments an even greater challenge in the future. The number of pensioners will rise to 52% of the working population by 2030 from 33% now, according to the Organization for Economic Cooperation and Development.

It will also reduce the amount of capital in the pension funds available for investment, a point that is becoming increasingly important for the government.

The pension reforms are intimately tied up with the government's attempts to reform the capital market and a key lacuna is the complete lack of domestic institutional investors, without which capital market reforms are fairly meaningless.

The funded element "should retain an important role in financing investment into the Russian economy," Russia's Finance Minister Siluanov said in an October 12 interview, according to the newswire. "We're going to defend that position, and we hope that ultimately we're able to make the case for saving this part."

Private pension funds still play a small role in the business, accounting for just 20% of assets under management in the funded part of the system, which will reach RUB2.3 trillion by year-end, the government estimates. However, of this, funds had invested RUB1.3 trillion into domestic debt by end-2011, according to Vladimir Potapov, global head of portfolio management at VTB Capital Asset Management. If the Labour Ministry plan is adopted then this may trigger a sell off of these investments, the fund manager warns, pushing yields higher as funds need to earn more from less.

Putin has made the task more difficult by committing himself to holding retirement ages at current levels - 55 years for women, 60 for men - during the presidential campaign. Hiking retirement ages would go along way towards solving the funding problem. The president is not blind to the problems with the Labour ministry's plan however. This month he ordered Prime Minister Dmitry Medvedev to send it for public discussion, and a new draft bill is supposed to be submitted for debate by December 15.

More than 74m people had pension savings invested either with state or private funds at the end of 2011, up from 55m in 2005, according to a Finance Ministry report, reports Bloomberg. The value of Russia's retirement savings surged 92% last year to RUB1.76 trillion, from RUB914bn in 2010 and RUB286bn in 2006, the report showed.

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