Benjamin Cunningham in Prague -
During an April 7 session of parliament, Czech Finance Minister Andrej Babis pledged to table a new plan for reforming the country’s pension system by June. This would be the latest pension policy shift in Central Europe but hardly the first in recent years: it comes amid a general rolling back by governments of plans to divert pension savings into private funds, in an attempt shore up state finances.
It was Hungary that launched the trend, when it first moved to seize private pension fund savings back in 2010. That came amid more generally populist rhetoric that spooked international investors. “Initially the profits were high and pension funds made money,” says an economist at one major Hungarian bank. “The government played a game that made them out to be some kind of vampires.”
But what was once controversial is now seen as commonplace, and Poland took similar steps last year. Unwieldy EU budgetary rules are at least part of the explanation for this change of course as governments look to meet tighter rules set in Brussels, but regional investors are left wondering what comes next as demographic trends make additional reforms inevitable. The most obvious manifestation of the resulting investment lull is the stagnation of Warsaw Stock Exchange – the WIG index ended flat over the course of 2014, even as Frankfurt’s DAX reached an all-time high and continues to rise. As recently as last year the WSE still stood as a legitimate hope for Central Europe to develop a robust equities market. The only explanation for the huge difference is pension reform,” says Adam Czerniak, chief economist with Polityka Insight, a Warsaw based think-tank.
Second pillar reforms across the region were meant to allow savers to divert a portion of their savings into private pension funds. This is a step away from the existing pay-as-you-go systems where today’s workers finance today’s pensioners. Instead, second pillar accounts become directly tied to savers. In Poland, pension funds overseen by Allianz, Aviva, Axa, Generali and ING were required to invest domestically, a welcome source of capital for the WSE.
Now, not only has the WSE lost its so-called “pension premium” as pension funds shrank by some PLN2.1bn between February 2014 and February 2015, but they have also grown more conservative in their investing, even as requirements that they invest domestically will be gradually eased. There is further blowback, as foreign investors are also hesitant to invest in the WSE until some sort of “new equilibrium is achieved,” Czerniak says. This could take years, he adds.
In the Czech case, the 2013 launch of the second pillar never got off the ground and is set to close by January 2016. Just 83,000 people opted to divert their savings into the Czech second pillar, about one-tenth the number that was originally anticipated, says Pavel Racocha, CEO of Komercni banka’s pension arm, one of the five firms licensed to offer a second pillar fund.
Under the policy, workers contributed 28% of their income to social security payments, but had the option of diverting 3% to the second pillar, which they then matched with an additional 2% contribution of their own. Now savers can recoup the money they invested in the pension funds directly into bank accounts or simply divert it to other savings plans, but the pension funds face considerable losses after investing tens of millions of crowns in creating the funds themselves and the infrastructure for interacting with clients. A legal battle looks possible, even likely. “We will wait for the final wording of the law and then we will try to get some compensation from the government,” Racocha says.
Burnt in Bratislava
Slovakia is in the midst of changes too. Slovaks that diverted savings to the second pillar have until June 15 to pull money out. About 1.5mn Slovaks have money in the private funds and the government hopes to recoup about €400mn.
Contrary to the Czech case, about five-times more Slovaks than predicted actually opted into the second pillar. This left bigger-than-expected holes in the state budget and as a result governments have repeatedly sought to push savers back into the public pension system. This is the fourth time the state has opened up the second pillar since 2005 – hardly a stable investment environment. Slovakia’s three licensed pension fund providers, Allianz-Slovenska Poisovna, Generali and Union, look set to suffer further.
Like elsewhere, Bratislava hopes to use the cash to balance the books and avoid the EU’s excessive deficit procedure, while dodging cuts to popular social or stimulus spending programmes – especially as a general election looms in spring 2016. A recent International Monetary Fund (IMF) report highlighted loopholes that allow for such sleight of hand and noted that “further reforms to the EU’s fiscal framework are warranted to remove disincentives for setting up and maintaining second pension pillars and, more generally, for structural reforms.”
Notably, the EU only began characterising second pension pillars as belonging to the private sector in 2004 – the very year all four countries joined – thus discounting it as state revenue when in budgetary calculations. Though there are some exemptions in EU policy that mitigate part of the balance sheet deficit, they do not apply to debt criteria – this is the so-called transition cost. The IMF recommends changes at the EU level that make it easier to implement second pillar reforms. Still, others are making do with the current regime: after raiding the funds for cash during the crisis years, the Baltic states have begun to bolster second pillar policies once again.
While much of the developed world confronts aging populations and rising pension costs, in Central Europe the problem is compounded by a generation of pensioners who were unable to accumulate private wealth during the communist era. “Close to 100% of the income for today’s retired people comes from the state,” Racocha says of the Czech system.
The Czech state pension system ran a CZK43bn (€1.58bn) deficit in 2014, and about CZK49bn deficits for each of the two years before that. Demographics continue to skew older, workers no longer contribute enough to finance retirees and the gap is set to grow. The share of the population that is older than 65 is expected to nearly triple by 2050. “The first step is that government acknowledges there is a problem,” Racocha says. “They spent all this effort to kill the smallest part of the pension savings instead of fixing the state pillar.”
“Things will only get worse,” he sighs.
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