Nov. 4 (Bloomberg) -- Poland’s government will divert contributions from the privately managed pension system into a state-controlled account to contain a swelling deficit and curb public debt.

Finance Minister Jacek Rostowski and Labor Minister Jolanta Fedak’s departments are preparing legal changes to cut employee contributions to private pension funds to about 3 percent of salaries from 7.3 percent and keep the rest in the state system. The move would lower budget spending by about 13 billion zloty ($4.5 billion) a year, the Finance Ministry estimates, and reduce public debt by 1 percent of gross domestic product.

The European Union’s biggest eastern member risks losing investor confidence as it fails to rein in the deficit at a time when other countries in the region are reducing their shortfalls. The European Commission estimates Poland’s debt will breach the 55 percent of GDP limit next year and exceed the 60 percent constitutional threshold in 2011.

“The changes mean that public debt will grow more slowly; they don’t automatically mean public debt won’t reach the 55 percent limit,” Rostowski told reporters at today’s briefing. Yesterday, he denied a report the government may suspend the rules capping public debt.

‘Desperation and Determination’

Rostowski said the amendments weren’t primarily aimed at curbing debt and would benefit retirees, because funds diverted from private management would be credited to state-managed accounts bearing the same interest as government bond. The change sidesteps EU rules requiring transfers out of the state pension system to be treated as budget spending.

“This confirms that the government has its back to the wall on public debt,” said Maja Goettig, chief economist at Warsaw-based Bank BPH SA. “You can see the mixture of desperation and determination to avoid breaching the legal limits.”

The zloty strengthened to 4.2431 against the euro, up 0.5 percent since yesterday. Poland’s benchmark five-year note yielded 5.70 percent, unchanged from yesterday, according to Bloomberg data.

“This is undoubtedly a tempting move for the government” to narrow the deficit and cut public debt at a stroke, said ING Bank Slaski in a research note today

Bond-Positive

Fewer government debt sales “would be a long-term positive for the bond market,” said Arkadiusz Bogusz, who manages around 5 billion zloty in fixed-income instruments at Credit Suisse Asset Management SA in Warsaw.

Equity investors would be less welcoming of the move, said Adam Kaldus, head of investments at PTE Bankowy SA, a Warsaw- based pension fund. Cutting inflows to privately managed pension funds, which invest about 30 percent of their assets in stocks, “wouldn’t be good for the Warsaw Stock Exchange,” Kaldus said.

The proposed change probably won’t hurt government plans to raise 25 billion zloty by selling state-owned companies next year, many via initial public offerings on the Warsaw bourse, Kaldus said.

‘There are many other buyers on the market,” Kaldus said, citing this month’s debut of Poland’s largest power group, PGE SA. “PGE shows that shares could be sold to individual customers only.”

Vote Shortage

Amendments to Poland’s pension law must be approved by the two houses of parliament and signed by President Lech Kaczynski. The president, whose twin brother Jaroslaw leads the largest opposition grouping, the Law and Justice party, has criticized the government’s “neo-liberal” approach to the economy and benefits spending.

The ruling coalition doesn’t command the 277 votes in the lower house of parliament needed to override a presidential veto unless it can pick up support from a smaller opposition party, the Democratic Left Alliance.

To contact the reporter on this story: Katya Andrusz in Warsaw at kandrusz@bloomberg.net

Last Updated: November 4, 2009 10:30 EST