Romania: Analysis of a miscalculation
The Romanian government has decided to reduce contributions to the mandatory pensions system
• There have been protests at the decision to reduce second-pillar contributions
• The plans stop short of full closure or ending compulsion
• Local pension funds are among the best performers in Europe
Almost 10 years after Romania introduced a mandatory funded element to its state pension system, the government decided in November 2017 to cut contributions to the pension funds.
Despite protests – including from international organisations – contributions to the mandatory funded pillar of the state pension system were reduced from 5.1% to 3.75% at the beginning of the 2018.
When this pillar was introduced in 2007, the legislation put in place a gradual increase in contributions to 6% by 2016. However, from early 2017 the government started to discuss options including closing the funded segment of the pension system completely or making it fully voluntary. In the end, a significant cut in contributions was the preferred option.
The measure is one of the first major social policies implemented by the centre-left PSD, which was elected to government in autumn 2016.
Although changes to the pension system were one of the first items on the agenda of the new government, it first had to overcome a major domestic crisis with the ousting of the prime minister Sorin Grindeanu by his own party and replacement by Mihai Tudose.
It also has to be kept in mind that the PSD was a supporter of the minority government of the liberal party PNL, which had negotiated the introduction of the mandatory funded pillar in the first place.
The decision by the current Romanian government is viewed as yet another domino falling in the Central & Eastern European (CEE) pension system after Hungary fully appropriated second-pillar assets and Poland crippled its funded pillar.
Mihai Bobocea, secretary-general of the Romanian Pension Funds’ Association, calls it “a significant blow” to the system. “We estimate this decision is likely to slash future retirement income by at least 20% for all plan members as well as providing less capital to fund local businesses via the stock exchange.”
Friedrich Mostböck, head of group research at Austrian Erste Group Bank, offers a slightly less drastic view on the decision: “The impact of the change on actual sums flowing to the pillar-two systems will be mitigated by the fact that gross wages will have to be increased by 20% in the new taxation system for net wages to remain unchanged. As such, the net reduction of the absolute amount of inflows to the pension funds will be not be more than 11%, or around €150m.”
However, PensionsEurope condemned the step: “People in Romania are now facing a significant risk of suffering a decrease in their future retirement income.” The secretary general of the Pensions-Europe, Matti Leppälä, says: “Instead of decreasing the contributions, the government should increase them in accordance with the long-term plans. This would increase the citizens’ trust in the whole pension system, which is vital for any long-term policy.”
These comments came just a few weeks after Leppälä had attended the 10-year celebrations of the Romanian second pillar, where he stressed the importance of funded supplementary pension plans in an ageing Europe. “In Romania, private pension funds are essential for people to get what they want from their pensions, so it’s vital to continue their development.”
In fact, the government is facing additional costs for the state pension system. These have already been criticised by the IMF, which notes that wage and pension increases were among the “pro-cyclical policies” generating an unsustainable boost in growth in 2016.
Mostböck confirms that Romania “might see a deficit above 3% of GDP next year”. He adds: “CEE countries could see some slowdown in growth in 2018 as higher inflation could eat into real wages and fiscal expansion might be less pronounced – especially in Romania.”
Meanwhile, the mandatory pension funds are delivering good returns, as confirmed both by the OECD and the finance lobby group, Better Finance.
OECD statistics for 2017 indicate that Romanian funds have delivered one of the best (extrapolated) annualised real rates of return between 2006 and 2016, at 6.4%.
Data collected by the Financial Supervisory Authority (ASF) to July 2017 show a 4.7% weighted average annualised 24-month return rate for all seven pension funds in the second pillar.
The best performer was the second smallest pension fund by assets, the €525m BCR, with 5.5%. The largest pension fund, €2.9bn NN returned 5%. In total, assets in the second pillar amounted to €8.1bn in mid-2017.
Around that time, local media reported on mistrust in the pension system and criticism of asset allocation and performance. To counteract these reports, the ASF issued a statement: “Given the information circulating in the public on the situation of the privately managed pension funds (pillar two), the Financial Supervisory Authority wishes to reaffirm that pension pillar two is solid, with positive returns.”
Over the last few years, investment regulations for Romanian pension funds have become slightly more flexible. One recent step by the ASF was to raise the limit for exchange-traded funds (ETFs) to 5% of total pension fund assets and allow investment in bonds that are two credit ratings below sovereign, instead of just one.
As of July 2017, almost 64% of assets in second-pillar funds were invested in government bonds, most of them domestic. According to the ASF, another 20% were invested in equities, 7.5% in bank deposits, 3.6% in investment funds and another 3.38% in corporate bonds. The rest was invested in other fixed-income vehicles. Overall, 93% of the assets were invested domestically. The picture did not change considerably over the previous year.
As part of the original set-up for mandatory pension plans, further flexibility for investments in UCITs structures and other vehicles was planned. It remains to be seen whether discussions will take place between the industry and the AFS now that the government has removed some of its support for this part of the pension system.