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Pillars of Eastern Europe’s Private Pension System Are Crumbling

Seeking to close budget gaps, governments from Hungary to the Baltic states find private pensions an easy target — and undermine local capital markets in the process.

Across Central and Eastern Europe, the retreat from so-called Pillar II pensions — compulsory private pension funds intended to supplement overburdened state social security — has turned into a rout. At one extreme is Hungary, which has closed down its private pension funds and expropriated their assets. At the milder end of the spectrum, the Baltic states have temporarily reduced the amount of pension contributions funneled into privately managed funds, using the money to plug budget gaps created by the global financial crisis (see “Can Poland’s Private Pension Funds Survive Government’s Bond Grab?”).

For international agencies like the World Bank and the European Bank for Reconstruction and Development, which lobbied hard for the introduction of private pensions in the 1990s, the blame lies with the financial crisis. “They faced the most severe economic downturn since they introduced their Pillar II systems in the 1990s, and had to find ways to bring deficits and growing debts under control,” says Mamta Murthi, the World Bank country director for Central Europe and the Baltics.

The first cannonade against private pensions came from Hungary in 2011. To reduce a swelling budget deficit, the right-wing, populist Fidesz government of Prime Minister Viktor Orbán effectively shut down the country’s private pension funds and seized their money, about $13 billion in total, divided between bonds and equities. Contributors could choose to remain in their Pillar II funds, but they would have their payroll taxes increased by 2 percentage points, to 10 percent, and they would lose all benefits from the state social security system, to which they would continue to contribute, from 2011 onward. Not surprisingly, only 3 percent of contributors decided to keep their private pension funds.

Although the government move set off howls of protest from the private sector and international agencies, the short-term gains for Hungary were undeniable: The public-debt-to-GDP ratio dropped from 83 percent to 77 percent, and the budget moved from a deficit to a large surplus in 2012. The government was able to retire its bonds and sell the equity portion of the pension holdings. This meant a huge cash windfall for the government, helping to reduce its borrowing costs and improve its credit profile. “So in the short term, the move was positive,” says Timothy Ash, London-based head of emerging-markets research at Standard Bank. “The problems are over the longer term because the state assumes all the liabilities of pensioners.”

Other countries in Central and Eastern Europe embraced less radical changes to their pension policies. In Slovakia, which pursued a course similar to Poland’s, contributions to private pension funds were cut from 9 percent of gross salary to 4 percent; they are scheduled to rise to 6 percent by 2018. Meanwhile, the Czech Republic backtracked from a commitment to set up a compulsory private pension system. Instead, it continues to levy a hefty 28 percent payroll tax to finance its pay-as-you-go social security system.

The Baltic nations — Estonia, Latvia and Lithuania — were hit the hardest by the global financial crisis. Their economic output plunged by about 20 percent, on average — a decline comparable to that suffered by Greece. Yet these countries have remained among the staunchest devotees of structural reform, and they made the most-­moderate changes to their Pillar II systems. Estonia, for example, suspended contributions to compulsory private pension plans in 2009. With the return of growth, the government resumed contributions at a rate of 2 percent of gross salary in 2012. It intends to raise contributions gradually over the next few years to make up for the payroll tax holiday.

Some observers hope other CEE countries will follow the strategy of the Baltic states. “With economic growth resuming and governments getting their balance sheets back in order, they will again need to think about making pensions more fiscally sustainable and adequate for people in their old age,” says the World Bank’s Murthi.

Others aren’t as optimistic. “Outside the Baltics there is a worrying picture of reversals,” says the EBRD’s chief economist, Erik Berglof.

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