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Fiscal Policy and Pension Reform
Joaquín Vial
Chief Economist, Global Trends Unit, Research Department
BBVA
June 1st, 2007
FIAP Conference, Varna, Bulgaria
What is involved in Pension Reform
•
Move from Defined Benefit to Defined Contributions:
-
Pensions linked to saving efforts over a lifetime
-
Shifts risks from the government to the individuals
•
Move from State Managed Funds to Private Pension Funds
•
Move from Centralized Pooling to Individual Accounts
•
Move from unregulated pensions management to state supervision of private
firms
•
Move from Implicit Fiscal commitments to Explicit fiscal compromises with First
Pillar as well as with the transitional generation.
Not all reforms entailed all five elements, but most of them did
Research Department
2
Fiscal effects of Pensions Reform look very
different, depending on the accounting of
pension liabilities
•
Cash Flows (one – period horizon):
-
Government receipts fall, due to the transfer of affiliates to the new system
-
Government outlays rise, due to transfer of previous contributions to individual, privately
managed accounts (Recognition bonds)
-
•
Government deficit rises
Net Wealth of the Government (infinite- horizon):
-
Unfunded (implicit) Pension Liabilities of current and future generations disappear
-
Pension liabilities of the transitional generation are made explicit (and probably rise to
induce the transfer to the new system).
-
New debt might be contracted to finance the cash flow deficit caused by the transition.
-
Most likely the reduction in the Implicit Pension Debt of the government will be large
enough to compensate the increase in the explicit debt to finance the transition.
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One example: the cash fiscal impact of the
Chilean Pension Reform
Chile: Cash Fiscal costs 20 years after the reform
(% of GDP)
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
1999
2000
2001
Operational Deficit INP
2002
2003
2004
Recognition Bonds
Cash flows associated to the transition costs are still negative and in the range of 3%
of GDP, after 20 years of the reforms (they reached 6% of GDP in the early 80s)
Research Department
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However, the change in Fiscal Net Worth in
Chile looks very different from the cash flows
Chile: Pension Liabilities in 2050
(% GDP)
350%
Fuente: A. Zviniene and T. Packard: "A Simulation of Social Security Reforms
in Latin America: What Has been Gained?" World Bank background paper for
regional study on Social Security Reform. 2002.
300%
250%
200%
150%
100%
50%
0%
No Reform
Explicit Pension Debt
Reform
Implicit Pension Debt
If the Fiscal Net Worth improves, then the government can finance part of the
cash costs through borrowing (beware of currency mismatches)
Research Department
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Fiscal considerations for Pension Reform
• How to fund the cash flow problem during the transition?
• Changes in the First – Pillar associated to the reform, and fiscal
impacts over time
• What will be the final fiscal Net Worth position after the transition?
• First – Pillar design and incentives to Labor Market formality
• Fiscal position over time and Pension Funds portfolios
One “non consideration”: Fiscal cash flows should not be the deciding factor, if
Fiscal Net Worth improves due to Pension Reform
Research Department
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Typical path of fiscal (cash) outcomes of the
transition
Fiscal impact
(%GDP)
Contributions Old System
Time: years
0
7
25
35
45
60?
Pension benefits in Old System (ex-ante)
Pension benefits in Old System (ex-post)
Recognition Bonds
Pension Benefits in Old System are attractive focal points for politicians: high
risk of departure from ex-ante fiscal path.
Research Department
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But accounting can make a big difference,
especially for Recognition Bonds
Accounting for the Fiscal Impact of BR (Chile)
2,00%
1,50%
0,50%
0,00%
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
20
06
20
09
20
12
20
15
20
18
20
21
20
24
20
27
20
30
20
33
(% GDP)
1,00%
-0,50%
-1,00%
-1,50%
Cash Expenses RB
Accued interest
Net asset changes (-)
Research Department
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Fiscal costs of the transition: valuation
•
•
Transfers to the new system: voluntary or mandatory?
•
Number of Transfers*average salary* contribution rates = Monthly loss of
revenue in the Old System.
•
Estimate the number of people as well as their pensions for those remaining
in the Old System (do not forget beneficiaries of Death and Disability
Insurance)
•
Estimate the number, value and maturities of Recognition Bonds. This is a
key component for actuarial calculations as well as for the estimate of the
path of fiscal outlays linked to the transition.
•
If there are minimum pension guarantees or other first pillar components,
estimate the number of beneficiaries as well as a realistic path for the value of
minimum pensions. This requires good actuarial projections (income,
contributions, rates of return).
If voluntary: What is the best estimate for the number of transfers? (Be ready
to update your calculations after the transfer window closes)
Research Department
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Fiscal costs of the transition: preparation
•
Key decision: How much will be funded through fiscal adjustments and how
much will be covered by borrowing
•
In some lucky cases, countries can sell assets to help finance the transition
(privatization of state owned enterprises, for instance)
•
There are key issues of accounting involved here:
-
Recognition bonds: Are they public debt? Chile and the IMF agreed to compute
accrued interests as current expenditure and principal repayments as debt reductions
(below the line operations)
-
Minimum Pension Guarantees: identify expenses due to beneficiaries in old and new
system (Good actuarial projections are the key).
-
Evaluate the change in total public debt (explicit and implicit) before and after the
transition.
•
The importance of the initial position: issuing debt might not be an available
option (small domestic market, large external debt).
•
Macroeconomic effects of the reform will depend critically on how much the
transition cost is funded out of fiscal adjustment (maximum) or debt (minimum).
Research Department
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Some lessons from the Chilean transition (1)
•
Fiscal adjustment came before the Pension Reform
Central Government (cash) surplus (%GDP)
10,0%
Year of Pension Reform
5,0%
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
0,0%
-5,0%
-10,0%
-15,0%
Source: Author´s calculation based on data from F. Larrain, Controller´s Office and Budget Office
-20,0%
Research Department
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Some lessons from the Chilean transition (2)
•
•
Number of transfers was known quickly.
•
No good records about the demographics of those who transferred neither of
those who remained.
•
The number of beneficiaries of Minimum Pension Guarantees was
overestimated, because of overly optimistic assumptions on contributions
densities (in fact far few people has been able to fulfill the 20 years of
contributions required).
•
•
•
The value of the Minimum Pension has risen much faster than expected.
Old System was unable to provide accurate records and/or the newly created
institution (INP) was unable to process them: big uncertainty about the Size
and Number of Recognition Bonds (not to mention the demographics of RB
recipients)
Most of pensioners in the Old System are beneficiaries of MPG (70%?)
The number of non-contributory pensions has been higher than expected (A
consequence perhaps of low density of contributions?).
Research Department
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Fiscal Situation and Pension Funds Investments
Pension Funds Portfolio Composition (June 06)
AY
G
U
R
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om
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in
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an
PE
R
R
ep
.
U
O
M
EX
I
O
D
SA
LV
A
C
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H
IL
C
R
EP
.D
O
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IN
IC
AN
A
/D
EL
C
O
O
ST
A
LO
M
R
IC
A
BI
A
IA
LI
V
BO
C
AR
G
EN
TI
N
A
100,00%
90,00%
80,00%
70,00%
60,00%
50,00%
40,00%
30,00%
20,00%
10,00%
0,00%
Sector Estatal / State Sector
Sector Financiero / Financial Sector
Activos Disponibles / Liquid Assets
Sector Empresas / Corporate Sector
Sector Extranjero / Foreign Sector
Weak fiscal positions tend to translate into too much public debt in Pension
Funds. This could be a major source of risk for workers.
Research Department
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Summarizing…
•
•
Pension Reform will put a lot of pressure on fiscal cash flows
•
Privatization might help bridge short-term cash problems, but proceeds must go to the
public sector.
•
•
•
•
Pension Funds will absorb part of the Public debt required to finance the transition…
•
•
•
•
•
Ex-ante calculations might show long-term gains in Fiscal Net Worth, but…
If cash flows are a constraint, then a fiscal adjustment must go hand in hand with a
Pension Reform
But they cannot bailout an insolvent public sector
(neither an insolvent financial system, by the way…)
Pension Reform requires good institutions (good handling of rights of the transition
generation)
Beware of the evolution of short-term benefits during the transition,
Beware of lack of adequate coverage of the First Pillar,
Beware of excessive concentration of PF portfolios
Moving from DB to DC introduces great flexibility and allows better handling of fiscal
problems of ageing societies.
Research Department
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Fiscal Policy and Pension Reform
Joaquín Vial
Chief Economist, Global Trends Unit, Research Department
BBVA
June 1st, 2007
FIAP Conference, Varna, Bulgaria