bne -

Crucial pension reforms are off to a bad start after the Russian government decided on November 23 to duck the tough choice and go for cash now over strong pension funds later.

Faced with either taking more of the cash going into the state pension fund now, to close the gap in its pension liabilities, or finding the money elsewhere and allowing assets in the system to build in order to deal with bigger obligations later, Moscow chose to take the money.

The technicalities of the decision follow from a proposal by the Labour Ministry to reduce the level of contributions employers pay into mandatory retirement saving accounts on behalf of employees. The move proposes to slash those flows from 6% of salary to 2%, beginning in 2014.

The change will reduce the burden on companies, and also free more money in the federal budget. However, private pension fund managers are up in arms at the suggestion, saying that cutting the contributions will slow the growth of assets under management (AUM) dramatically. Parliament made one concession to Russia's nascent asset-management industry, retaining a higher levy for workers who opt to keep their retirement account with a private asset manager.

Russia is in desperate need of effective pension reform. Currently, the volume of AUM in the whole system is equivalent to no more than 3% of GDP. Further west, including some CEE countries like Poland, that level is 65% to 100% plus. In other words, despite a first stab at pension reform in 2004, no progress whatsoever has been made in the intervening years in Russia.

That sets up a big problem for the future. In the run up to the most recent election, President Vladimir Putin increased pensions by 50%, and as much as 25% of the budget is now spent on plugging a widening gap in the system. That gap will only grow, with the population aging rapidly thanks to the demographic catastrophe caused by the collapse of the Soviet Union in 1991.

However, with the federal budget expected to barely scrape a surplus this year, and then set to probably go into deficit as soon as 2014, the government is hungry for revenue.

The problem could be alleviated if non-state pension funds can be developed and then encourage the population to invest in private savings. However, the reform process remains stuck at the very earliest stage and private pension funds, while optimistic about the future, remain small players.

The only glimmer of hope is the government in general, and Putin in particular, say that they see the need to build up a proper pension industry, with the bonus being that it such a goal is integral to the state's plans for developing Russia's capital markets. Putin noted during the VTB Capital forum in September that pension funds are needed not only to pay pensioners, but as an important source of investment capital - for infrastructure projects in particular.