Poland Details Plan to Scale Back Pension Funds to Reduce Debt

Poland will downsize its fund-based pension system to curb the country’s public debt, choosing one of three methods for the overhaul after a month of public debate, Finance Minister Jacek Rostowski said today.

“The present structure” of the privately-managed pension funds “is a gigantic burden on public finances,” Rostowski told a news briefing in Warsaw on the findings of a government report on the system. “It isn’t a model we want to promote.”

Poland will probably revise its 2013 budget as the European Union’s largest eastern economy battles its worst slowdown in 12 years and tax revenues fall short of plan, Prime Minister Donald Tusk said on June 11. Transfers to the 14 funds will cost 11.3 billion zloty ($3.4 billion) this year as Finance Ministry sells more bonds to make up for the shortfall in payments to current retirees, according to the government report.

Warsaw-listed stocks tumbled to a 10-month low before recovering most losses after Rostowski said “nationalization” of the pension funds wasn’t an option. The WIG20 Index declined 0.4 percent at 2,237.93 at 2:33 p.m. in Warsaw. The zloty weakened 0.1 percent to 4.3430 against the euro and the yield on the government’s 10-year bonds fell five basis points to 4.35 percent, according to data compiled by Bloomberg.

‘Second Pillar’

Poland’s cabinet will vote next week on the review of the pension system, which includes a mandatory “second pillar” of privately-managed pension funds set up in 1999. Two of the three alternative policy courses recommended in the review would transfer the 16.2 million Poles enrolled in second-pillar funds back to the state-run pension system unless they file declarations to remain. The third would cancel 120 billion zloty of government bonds now held by the funds.

Polish pension funds held 280 billion zloty in assets, including 110.8 billion zloty in equities as of May 31, data from Poland’s financial markets regulator show.

The government’s proposals are a short-term fix, according to Piotr Krolikowski, Chief Executive Officer of the Warsaw-based pension fund owned by Nordea Bank AB.

Two years ago, Hungary took over $13 billion in privately managed pension assets to reduce the budget deficit and cut debt by canceling government bonds held by funds. Poland’s Finance and Labor Ministries, which co-authored the report, specifically advised against eliminating or gradually phasing out privately managed funds, Rostowski said. The report also recommended against suspending contributions to the funds.

No Nationalization

“The key for us is that the changes don’t lead in any way to nationalizing the shares,” Rostowski told reporters. “We’ll approach the question of voting rights cautiously, too.”

Bonds held by Poles who return to the state-run system would be canceled, according to the recommendations. Equity holdings wouldn’t be immediately sold, as the Social Security Fund could entrust them for management to private financial institutions, including the existing pension funds, or to the state-operated Demographic Reserve Fund, Rostowski said.

“The most important thing is that they unequivocally ruled out the possibility of nationalizing pension funds; that means the worst-case scenario hasn’t materialized,” Andrzej Domanski, who manages the equivalent of $165 million in stocks at Noble Funds TFI SA in Warsaw, said by phone. “It’s also important that stocks held by funds won’t be sold on the market.”

The first of two main recommendations in the report called for the state-owned Social Security Fund to handle payouts of retirement pensions from the privately-managed funds. This would involve gradual transfer of an individual’s assets from the funds to the state system starting 10 years before retirement.

Reducing Debt

The review’s second recommendation called for a “thorough restructuring” of second-pillar funds, by three alternative methods. The first option would cancel the 120 billion zloty in government bonds held by the funds, cutting public debt by 11 percentage points of gross domestic product, according to the report. The value of the bonds would be credited to an individual’s retirement account in the state-run system and would bear interest at a rate equivalent to Poland’s average GDP growth over the previous five years.

Caps on equity holdings by second-pillar funds would be lifted and they would be banned from buying bonds, according to the recommendations.

Under the second option, Poles enrolled in pension funds would have three months to declare whether they want to remain in the second pillar. Those who don’t file a declaration, along with their assets, would be transferred to the state-run, pay-as-you-go system. Contributions to funds would remain the same, rising to a planned 3.5 percent in 2017.

Below Czech

The third method would be identical to the second, except that those remaining with the funds would have to make an extra payroll contribution of 2 percent, increasing the total contribution to the funds to 4 percent.

“We want to curb the growth in public debt caused by the pension system,” Rostowski told reporters. “If we hadn’t introduced the capital pillar in 1999, our public debt would be below 40 percent of GDP, less than the Czech Republic’s, and our debt service costs would also be lower.”

Poland’s public debt stood at 55.6 percent of GDP last year, according to EU accounting methods. Investors demand 198 basis points in additional yield to hold Poland’s 10-year bonds over similarly-dated notes from the Czech Republic.

Rostowski’s proposals won’t cover the 60 billion-zloty yearly deficit in Poland’s social security system, Nordea’s Krolikowski said in an interview in Sopot, Poland today.

“Liquidating bond holdings or transferring assets back to the Social Security Fund is a short-term remedy,” Krolikowski said on the sidelines of a financial conference in Sopot, Poland. “We want to hear how the government plans to finance pensions in five or 10 years.”

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