Why Russia Desperately Needs a Pension Reform - World Federation of Young Investors

Russia has frozen its usual semiannual pension indexing this half year, citing financial difficulties. As of February 1, when the payments rose by 4 percent, the average pension in the country accounts to 13 132 rubles, which is roughly equal to 200 USD. Inflation in 2015 was almost 13%, and circa 6% by the end of Q3 2016.

Instead of indexing pensions a second time 2016, the government decided on a cheaper and non-permanent solution: a one-time payment of 5 000 rubles, which was a small victory for the liberal wing in the country’s top leadership. However, most of their concerns regarding the current pension system have not been addressed, and with the arrest of Economy Minister Ulyukayev and cases against Shuvalov’s advisers and affiliates, it looks like the liberals will have an even tougher period ahead of them.

Russia has the lowest pension age in all of the developed world – 60 for men and a mere 55 for women, with the average life expectancy constantly moving upward – now standing at 67 for men and 77.3 for women. The reason for men’s being much lower than women’s has its roots in the collapse of the Soviet Union when a considerable portion of the male population died from alcohol related problems.

The low pension age causes serious issues with financing the elderly population. Added to that, there are 9.7 hospital beds per 1 000 population compared to 2.7 in Sweden and 2.9 in the US, which is higly ineffective and costly. Healthcare is free, and the government subsidices housing.

Due to this, the pensions are rather small. For elderly to survive, the solution so far has been to  grant the elderly right to up to 25 percent of their childrens’ income in a reversed child support.

Some of these problems could be resolved easily by raising the pension age, something that President Putin has been reluctant to until this year, when it was first agreed to raise the pension age for state servants, and then for the rest of the population too.

Others are more difficult. There is a pension fund as the system works today, however, it runs at approximately 2 trillion rubles deficit, which is covered by funding from the treasury. This enormous gaping hole is therefore covered by the state’s cash flow, which was undesirable even in 2012 when the oil and gas price was high and the sectors accounted for 16 % of GDP.

In 2014, Russia blocked contributions from its cash flow to the pension fund for the second year running in order to finance pension payments, costing the economy 15.2 billion USD in unrealised investment projects. Moreover, money was taken from the pension fund to bail out state development bank VEB.

The US and other countries have been critisiced for using its people’s money for capital injections in banks. In Russia, there is an entire different dimension to this problem, namely the fact that it already owns VEB and cannot take shares in exchange for the bailout.

The government is not oblivious to the fact that the pension system is not working properly, but reforms have come in quantity rather than quality. They were conducted a staggering ten times in the past twenty years: in 1996, 1998, 2001, 2002, 2005, 2010, 2011, 2013, 2014, and 2015.

In the best of worlds, a final reform should have taken place in the early 2000s or by 2009. The current situation, with low oil prices and western sanctions, is far from optimal, but worse will come in the 2020s and 30s when the demographics curve will worsen due to the dreadful effect of the 1990s when poverty, crime and deaths sky rocketed.

The best practice states that the pension fund should be completely separate from the state’s cash flow, allowing it to earn compound interest over the 40 years of a person’s working life instead of the state taking it after just one. This way, it also cannot be used as a political tool when parties or presidential candidates need support from pensioners in order to secure victory or influence.

This is for the same reason as to why central banks should be independent – otherwise the leading party or president could lower the interest rate to stimulate the economy short-term, causing long-term issues.

With Nabiullina as Governor, the Central Bank of Russia has acted impeccable in tough circumstances and received acclaim even from Forbes. Now it is time for building an independent pension fund too.

The issue for Russia is that the investment options in stocks within the country are limited, and mostly oil oriented. Due to the economy being dependent on that specific sector, it is wise to diversify the risk and invest in other industries. These stocks can only be found abroad.

Sweden is a small country but with a very well diversified economy. Regardless of this, the main pension fund invests 50 % of its capital in the US. Russia could look to other markets too – not necessarily the US, as it would be complicated out of a geopolitical point of view, but definitely to China, India and other emerging markets.

This way, the pension system would not be so dependent on the oil price and internal political interests. Of course, the period of change from one system to the other will be painful and straining on the budget, as it will have to live without the funds it currently takes from its citizens by taxes in order to invest into the pension fund. However, Russia’s debt stands at an extraordinarily low 25 %. This is when it is well worth to suffer the short term consequences in order to fix the system by the time the pensioners will be too many for the working population to support.

 

Elizavéta Lindström

Secretary General at World Federation of Young Investors

 

All rights reserved

Contact us on secretarygeneral@wfyic.org if you wish to republish this text