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Can Russia Defuse Its Pension Time Bomb?


Starting next month, millions of Russians will find a big surprise in their mailboxes. Letters from the State Pension Fund will tell them that they are now the guardians of part of their own financial future, and that money has been deposited for them in new individual retirement accounts. The creation of the accounts -- Russia's answer to 401(k) plans in the U.S. -- is a crucial plank in President Vladimir V. Putin's economic reform agenda.

The Kremlin's goal is threefold: to give poverty-strapped retirees a decent income, head off a looming pension crisis for the Russian state, and create an asset-management industry that will invest its funds in the securities of Rus-sian companies and help spur economic growth. Similar programs in Poland, Chile, and Sweden over the past two decades have all paid off. If Russia can make its own plan work, the pension scheme will be one of the largest reforms ever attempted. "It's the last great privatization in Russia," says Elizabeth Hebert, CEO of Moscow-based Pallada Asset Management.

The program will be launched amid growing concern about the viability of Russia's pay-as-you-go pension system. Workers have little incentive to save for retirement themselves: Mother Russia is obligated to provide for them in their dotage. But it's done a poor job. High payroll taxes -- 28% on a worker's first $3,175, less after that -- help pay for government pensions, yet the average payment to pensioners is about $50 per month. That's $8 below Russia's official poverty level. With the pension burden growing each year as the population ages, the sustainability of the program is an issue that no longer can be ignored.

To deal with its pension time bomb, Russia has opted for semi-privatization. Under the new system being implemented by Economic Development Minister German O. Gref, employers of Russians under 35 have begun paying 10.7% of the payroll tax into individual pension accounts, now administered by the state. That will rise to 21.4% starting in 2005. Those age 35-50 will pay a third as much (the over-50 crowd is exempted). Workers will soon be asked to pick a private asset manager for their new accounts. By one estimate, the share of pension assets earmarked for private management will rise to $2.2 billion by 2005 (chart), or nearly a third of the total accumulated funds. "The impact on capital markets will be huge. You'll get this captive pension money that will be invested in Russian assets," says Roland Nash, research head at Moscow-based Renaissance Capital.

Yet the average Russian remains skeptical. In one recent opinion poll, only 7% of those surveyed say they'll choose a private asset manager over the state-managed fund. The investment advisory industry, however, is salivating over the opportunity to dip into the public pension chest. The first contracts to qualified pension-fund managers are expected to be awarded within the next few weeks. By 2010, some $17 billion could be available for professional investment, and that number should double by 2015, according to Renaissance Capital. Says Pallada's Hebert: "That's a lot of money from anybody's point of view."

Supporters of the reform point out the injection of privately managed pension money could add liquidity and stability to Russia's low-volume stock and bond markets. But critics complain there has been no serious attempt to explain the new pension system to citizens -- who are supposed to pick an asset manager by Oct. 1. "The lack of a proper public-relations campaign means the majority of the population is definitely not ready to make any choices," says Elena Zotova, a pension specialist at the World Bank.

One big concern is the lax regulation of Russia's fund-management industry. Another is that most pension investment decisions may not be made by workers themselves but by employers -- often members of the pervasive business oligarchy. In fact, each worker's choice of pension scheme must be approved by a public notary or -- more likely -- his boss. Neither option makes it easy for a worker to choose an independent fund. The operation of existing voluntary pension plans isn't encouraging: The two largest, run by oil and gas producers Lukoil and Gazprom, both invest their pension money almost exclusively in company assets.

For the reforms to work, the government must do more to increase public awareness and ensure average Russians are free to choose competitive funds. Russia, long a victim of its own financial mismanagement, needs a smart pension system more than it needs another botched financial opportunity. By Jason Bush in Moscow


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