beyondbrics

The core of central Europe is heading in increasingly different directions when it comes to the thorny issue of balancing necessary reforms to the pension systems with growing dissatisfaction from populations who have grown accustomed to public benefits.

While Hungarian and Polish governments are focused on slashing pension fund schemes altogether and moving in the direction of their western European counterparts, the Czechs and Slovaks are taking a different tack.

Hungary has taken the most radical approach, all but gutting its reformed pension system and returning to the pay-as-you-go scheme favoured by most west European countries. The approach has had the immediate benefit of lowering the deficit and public debt, but carries large future risks when today’s workers begin to retire.

Poland’s government yesterday took a more moderate approach – approving a plan that slashes the money flowing into private pension funds as a way of ensuring the budget deficit does not rise to alarming levels.

Currently, Polish employees pay 7.3 per cent of their salaries into private investment funds, which are supposed to generate higher returns than the government-run system – under which employees pay for the pensions of current retirees.

The new scheme calls for funds flowing into the private system to be cut by 5 percentage points to 2.3 per cent, with the money instead going into the state pension system. Donald Tusk, the prime minister, says plan would reduce Poland’s borrowing needs by 190bn zlotys ($67bn) to 2020.

Meanwhile, the Czechs and Slovaks are taking the opposite approach. Rather than slashing pension funds altogether, the centre-right government in Prague is forging ahead with creating its own two-pillar pension system.

The new Czech system will create a voluntary opt-out from the current pay-as-you system, with part of the current 28 per cent social security tax flowing into the new privatised pension system.

In order to ensure that the scheme is revenue neutral (something that the Poles failed to do) VAT rates will be unified at 20 per cent, raising an additional Kc58bn ($3.3bn), an amount that will be supplemented by dividends from state controlled companies like energy generator CEZ.

The Czech government says that by creating a new system it will repair the country’s long-term finances. At the moment public debt is low by European standards – below 40 per cent of gross domestic product – but the current pension system is already generating an annual deficit of $1.6bn, a figure that will get worse with time.

Creating new pension funds could also boost local capital markets – something that had a key effect in creating Poland’s successful stock exchange.

However, the plans have not found much public support – which is likely to create trouble for the increasingly wobbly coalition government of Prime Minister Petr Necas. A new poll has found that only one-third of Czechs understand the new system, and only one-fifth think the scheme is credible.

In Slovakia, the pension system was attacked by Robert Fico, the previous populist prime minister, but the current reformist government of Prime Minister Iveta Radicova has no plans to weaken it.  The previous government had made the system voluntary and had discouraged risk, because Fico was very suspicious of the privatised pension system. He felt it favoured private investment funds, and wanted Slovakia to return to a pay-as-you-go pension system.

Under Radicova, Slovakia’s finance ministry has been working on making the system mandatory again and encouraging fund managers to invest in higher yielding assets like shares.

“We want to strengthen the second pillar,” says Ivan Miklos, the finance minister.