Delia Velculescu, IMF April 1, 2011
Several CEE countries have reduced pre-funding of future liabilities since 2009: Lithuania, Latvia, Romania, and Estonia: temporary measures and fiscal consolidation during crisis. Hungary : eliminated the private pillar pension system at end-2010, taking over assets, with expansionary fiscal measures. Poland: permanent reduction in contributions as of May 2011, with other consolidation measures.
This paper aims to: take stock of the pension reforms undertaken in the CEE, including on long-run fiscal sustainability ; analyze the fiscal implications of pre-funding of pension liabilities (Poland as a case study); discuss the increasing tension between pre-funding pension liabilities and SGP rules in the context of the recent reform reversals; conclude with some policy implications.
Population aging has been looming over CEE: Poland Slovak Rep. Lithuania Romania Latvia Bulgaria EU10 Slovenia Czech Rep. Hungary Old-Age Dep endency Ratio (In percent of working age population) Estonia Euro area 2060 1990 0 20 40 60 80
(in percent of GDP) Country Public debt Pension Spending Implicit Pension Debt Slovenia 25 11 298 Poland 43 12 261 Romania 18 6 256 Slovakia 31 8 210 Hungary 59 9 203 Croatia 33 11 201 Estonia 7 9 189 Lithuania 28 7 15 Source: Holzmann, Palacios, and Zviniene (2004)
As a result, CEE countries adopted multi-pillar pension systems including a private, (in most cases) mandatory, pre-funded DC pillar II Hungary Poland Latvia Bulgaria Estonia Lithuania Slovakia Romania Pension reform date 1998 1999 2001 2002 2002 2004 2005 2008 DB, PAYG NDC, PAYG NDC, PAYG Pension points DB, PAYG DB, PAYG Pension Pension points Public pillar I points Prefunded Prefunded Prefunded Prefunded Prefunded Prefunded Prefunded Prefunded Private pillar II Mandatory/optional Mandatory for new entrants Mandatory up to age 42 Optional Mandatory for new entrants Individual Contribution Rate Contributors as share of employed Assets in percent of GDP, end-2006 Source: Muller (2008) Mandatory up to age 29, optional ages 30-49 Mandatory up to age 29, optional ages 30-49 8 7.3 to increase to 10 to increase to 5 (incl. Mandatory up to age 18, optional for others 2 (employer's contribution 5 9 employers' contribution 69 95 82 77 80 52 72 N/A 6.3 11.1 3.9 1.8 3.6 4.0 1.7 N/A Mandatory up to age 35, optional ages 35-44 to increase to 6
The reforms were expected to have many benefits: Improvement in LR sustainability; Increased labor participation; Better risk diversification; Higher private and national saving; Development of capital markets.
EU27 Intertemporal Net Worth Derived from the Balance Sheet Approach (In percent of GDP) Cyprus Greece Luxembourg Spain Slovenia Czech Rep. Romania Lithuania Slovak Rep. Netherlands Ireland Estonia Malta Austria UK Belgium EU27 Germany France Finland Italy Portugal Poland Latvia Denmark Bulgaria Hungary Sweden Finite Horizon Intertemporal Net Worth -500-400 -300-200 -100 0 100 Cyprus Luxembourg Greece Slovenia Romania Czech Rep. Spain Slovak Rep. Lithuania Ireland Malta Netherlands Estonia UK Finland Austria Germany EU27 Belgium France Portugal Bulgaria Poland Italy Latvia Sweden Hungary Denmark In fin ite Ho rizon Intertemporal Net Worth -2000-1500 -1000-500 0 500
in large part because of reforms of the pillar I that reduced aging costs: Select CEE Countries: Contributions to Finite-Horizon Intertemporal Net Worth (In percent of GDP) Finite Horizon Intertemporal Net Worth Current Net Worth Contribution MT Primary Adjustment Contribution LT Aging Costs Contribution Hungary 43 59 153 51 Bulgaria 0 8 54 62 Latvia 20 7 38 50 Poland 72 22 44 5 Estonia 200 29 226 3 Slovak Rep. 243 1 109 133 Lithuania 250 0 156 94 Romania 252 11 51 190 Euro Area avg. 233 33 57 143 Source: Velculescu (2010), and IMF staff estimates. Data from Spring 2010 IMF WEO
But other benefits have yet to materialize: 7 6 5 4 3 2 1 0 1 2 3 Change in Labor Force pariticpation Rate from Reform Introduction to end 2008 (in percent of GDP) Poland Lithuania Slovakia Hungary Bulgaria Estonia 2 Change in Gross Saving Rate from Reform Introduction to end 2008 (in percent of GDP) 1 0 1 2 3 4 5 6 7
1. We should not expect any benefits. But case-studies (Chile) show large positive effects, and some evidence on capital market effects. 2. Benefits hindered by other reasons: recent reform track record; limited size of the pillar II; Debt financing of transition costs; Regulatory aspects in pillar II.
Initially, costs were expected to be significant but manageable.
Ex post, costs turned out larger and long-lasting. Poland: Deficit and Debt due to Pre-Funding 1.0 Deficit of the Pillar I Pension System (Revenues Minus Contributions, percent of GDP) 20.0 15.0 0.5 10.0 0.0 0.5 1.0 1.5 2.0 19992000200120022003200420052006200720082009 5.0 0.0 5.0 10.0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2.5 15.0 3.0 3.5 4.0 deficit due to reform other deficit 20.0 Pension Fund assets (%GDP) Public debt financinf pre funding (%GDP)
Looking forward, debt-financed pre-funding is expected to further add to fiscal costs. 6 5 eliminating pre funding 8 7 6 eliminating pre funding 4 5 3 2 1 maintaining the current system Pillar I Contributions (%GDP) 4 3 2 1 maintaining the current system Pillar I Benefits (%GDP) 0 0 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2053 2056 2059 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2053 2056 2059
70 60 50 40 30 20 10 0 Deficit and Debt Cost of Pre Funding (%GDP) deficit cost (right scale) debt cost 2.5 2.0 1.5 1.0 0.5 0.0 0.5 1.0 1.5 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2053 2056 2059
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Poland (no pre funding) Poland Germany Fiscal Deficit (percent of GDP) Source: Sept. 2010 IMF WEO and staff calculations.
More flexibility in defining MTOs to take into account long-run aging costs; Regressive deductions of net reform costs from debt and deficit levels, over a limited period of 5 years.
But past temporary fixes were not sufficient: Maastricht debt and deficit limits applied uniformly; MTOs are not closely aligned with aging costs and not binding. New strengthened rules would punish reformers once in the Euro area.
Hungary Poland Recent Measures Affecting the Private Pillar II Pension System Diverted contributions to pillar I and made pillar II system voluntary. Provided incentives for contributors to switch accumulated assets to the first pillar. Plans to implement a reduction in contributions to 2.5 percent starting in April 2011, to be gradually raised to 3.8 percent by 2017. Latvia Reduced contribution rates to 2 percent temporarily. Bulgaria N/A Estonia Suspended contribution rates temporarily. Lithuania Reduced contribution rates to 2 percent temporarily. Slovakia N/A Romania Froze contribution rates to pillar II at 2%.
Assessment: Temporary measures: pragmatic crisis solution, but issues on intertemporal cost sharing; Permanent changes could be risky: if they postpone fiscal adjustment (or encourage extra spending) and weaken credibility.
1. Individual country policies: Preserve private pension systems, supporting them with policies limiting costs and enhancing benefits: Pre-funding through fiscal consolidation and debt, depending on available fiscal space. Improve regulation and supervision of pension funds.
Place more emphasis on forward-looking indicators: 1. Current limits focus exclusively on backward looking indicators of deficits and debt. Myopic, incomplete picture. Modifying these to exclude pension costs is straightforward, but further limits transparency.
2. Need to complement with forward-looking indicators: S1, S2, measures of intertemporal net worth; More compete, transparent picture; Theoretically grounded; However, more complex to compute.
Build on the existing framework: Maintain the Maastricht deficit and debt limits as triggers for entry into and exit from the EDP; Keep MTOs country specific but align them more closely with long-term fiscal indicators (S1 and S2, or sub-components, such as LTC); When in EDP, base CPs on plans to attain the strengthened MTOs.
LTCs and MTOs are currently not aligned: 10 LTC (60 years) 8 EL LU SI 6 CY 4 NL IE RO MT ES FI BE CZ DE 2 DK UK AT LT IT FR SK MTOs LV PT HU BG SE 0 EE 2 1.5 1 0.5 0 0.5 1 1.5 PL 2
Additional considerations: Need to establish a clear and common methodology to calculate aging-costs Create independent body to perform these calculations Update calculations of forward-looking indicators on a more frequent basis.