The new draft law on pensions: a threat to VEB
On November 14, the Russian President Vladimir Putin has supported the new draft law on pensions, which implies reduction of allocations to the funded component of pensions from 6% to 2% of payroll, redistributing 4% for insurance (distribution) component of the retirement pension. In addition, the President proposed to postpone the bill entry into force until 2014.
It is important that the President proposed to provide the citizens an opportunity to take the decision to invest money in private pension funds after January 1, 2014. If it means that from 2014 the individuals will have the right to choose, whether to leave 6 % of their salary with the funded part of the pension, or to transfer 4% to the distribution component and leave 2% with the funded component, such solution can be considered as the best option, because it removes all political claims to the pension system restructuring. In addition, this solution keeps in place all financial institutions, including private pension funds (PPPF).
I would like to note, that about 20% of our citizens have already made their choice in favor of PPFs, i.e., have withdrawn their pensions from the RPF and VEB management company. The share of those individuals is increasing, as many PPFs’ interest rates exceed the inflation.
Previously there were many claims to the funded pension system. In fact, there were two basic reasons of the system inefficiency. First, it was the macroeconomic situation in the past years, when negative interest rates in Russia were below the inflation rate, which made pension accumulation meaningless. In the last two years, the situation has changed - even a bank deposit brings interest by 1-2 p.p. above inflation. Therefore, funds accumulation becomes reasonable.
Second, the low yield of RPF is based on conservative approach to its investment portfolio, imposed by the government. The reason for this is the requirement for the PFs to ensure positive nominal returns of pension savings per annum, which actually means a ban on investing in securities, since the prospective return on equity for the one-year term is unpredictable. However, in the long run, only investments in securities bring stable high positive returns, but currently investments in securities do not exceed 10%. If the requirement for a nominal positive return per annum is removed, the PPFs will be able to invest in higher-yielding securities.
The above interpretation of the President’s words does not affect PPFs, but there is a threat for VEB: if the funds of the so-called “undecided” pensioners are forwarded to the distribution system, VEB will be losing its funds.
Anyway, the situation is not so disastrous. This involves only a relocation of funds within the budget. VEB was mainly investing in government bonds, i.e., in government debt. In fact, we were transforming those savings into debt, which was used to cover the deficit of the pension system. Now we will cover the gaps of the pension system directly, avoiding VEB engagement and national debt.
V.S. Hazarov, Head of Budget Federalism Department
I would like to note, that about 20% of our citizens have already made their choice in favor of PPFs, i.e., have withdrawn their pensions from the RPF and VEB management company. The share of those individuals is increasing, as many PPFs’ interest rates exceed the inflation.
Previously there were many claims to the funded pension system. In fact, there were two basic reasons of the system inefficiency. First, it was the macroeconomic situation in the past years, when negative interest rates in Russia were below the inflation rate, which made pension accumulation meaningless. In the last two years, the situation has changed - even a bank deposit brings interest by 1-2 p.p. above inflation. Therefore, funds accumulation becomes reasonable.
Second, the low yield of RPF is based on conservative approach to its investment portfolio, imposed by the government. The reason for this is the requirement for the PFs to ensure positive nominal returns of pension savings per annum, which actually means a ban on investing in securities, since the prospective return on equity for the one-year term is unpredictable. However, in the long run, only investments in securities bring stable high positive returns, but currently investments in securities do not exceed 10%. If the requirement for a nominal positive return per annum is removed, the PPFs will be able to invest in higher-yielding securities.
The above interpretation of the President’s words does not affect PPFs, but there is a threat for VEB: if the funds of the so-called “undecided” pensioners are forwarded to the distribution system, VEB will be losing its funds.
Anyway, the situation is not so disastrous. This involves only a relocation of funds within the budget. VEB was mainly investing in government bonds, i.e., in government debt. In fact, we were transforming those savings into debt, which was used to cover the deficit of the pension system. Now we will cover the gaps of the pension system directly, avoiding VEB engagement and national debt.
V.S. Hazarov, Head of Budget Federalism Department