Foreigners may be surprised to find long queues in front of Halk and Ziraat bank offices towards the end of the month. It is payday for the country's retired people. With a median age of roughly 25 years, the Turkish population is young and contrasts strongly to Europe's rapidly aging inhabitants, half of who are older than 37 years. Yet, a very low retirement age may force Turkey to forsake the benefits of its favourable demographic structure. Its high old-age dependency ratio of more than 60% is considerably higher than in the EU 25 at 24.9%, constitutes an increasing pressure on IMF-mandated fiscal austerity. Moreover, the ever-growing share of unregistered employment aggravates the collection of workers' retirement contributions, which under a pay-as-you-go system results in a widening of the pensions deficit from 2.5% in 2000 to 3.5% in 2004.

Although important efforts were made in 1999 to increase the retirement age of men and women to 60 and 58, respectively, the IMF is worried the deficit may rise to more than 7 % in the long run. Given small pensions and a life expectancy generally lower than the European average, there might yet be time to fix these structural problems. "With state pensions below the subsistence level and a low inflationary environment, a supplementary private pension system has become an important issue for ordinary people," says Cengiz Gürleyik, representative of human resource consulting giant Hewitt in Turkey.

The fully-funded private pension system, based on the Private Pension Law (law 4632) of April 2001, aims at stopping what Tuna Ugun from Anadolu Hayat Emeklilik, the leading private pension provider in Turkey, considers to be an income erosion for the middle class after retirement. Fully implemented since October 2003, the law envisages a voluntary system for both employees and employers with individual accounts and defined contributions which are paid to one of the 10 licensed pension companies and invested in special pension mutual funds. The management of these assets, however, is delegated to separate portfolio managers who earn a fee for their services.

The system is supervised by the Undersecretariat of the Treasury in conjunction with the Capital Market Board, reflecting its importance for the development of the Turkish capital markets. Despite the Istanbul Stock Exchange's dazzling performance in 2005 and individual contributors' rights to choose the funds contributions are invested in, the asset allocation remains conservative. According to the 2005 Progress Report issued by the Pension Monitoring Center, a semi-private body set up by the Treasury and the pension companies, close to 80% of the assets were parked in government bonds and bills and 10% invested in domestic stocks. This is more conservative than the legal provisions stipulating that government debt share must equal at least 30%.

"Increasingly investing in domestic equity would be - after all - highly beneficial," reckons Ugur Erkan, Assistant General Manager of Anadolu Hayat Emeklilik. Reducing volatility and ensuring more balanced returns hinges upon attracting long-term investors and deepening the domestic capital markets. This may also help addressing what Gürman Tevfik, CEO of IS Asset Management, calls "a preoccupying shortage of corporate capital in Turkey". "Education is the key," he continues, pointing at the need to supply investors with as much information as possible on the assets that they are investing in. In the long run, Tevfik expects the management of pension funds' assets to be the number one business opportunity for Turkish asset managers.

So far, this seems to be holding true as the system is rapidly growing, mainly due to tax incentives. Contributions and investment gains are tax exempt. Of the final sum when it is finally withdrawn, 75% is taxed at 5%, while the remaining 25% are tax exempt. Starting with a mere 16,000 contracts at the end of 2003, the pension market is growing fast, standing at more than 940,000 contracts in July 2006. Total invested contributions have reached $1.15bn (€1.2bn), with a small slump following the depreciation of the New Turkish Lira (YTL) in May 2006. Depending on the outcome of current reforms, the number of pension contracts could grow even faster as the corporate side has so far fallen short of expectations.

Consolidated pension firms' expectations suggest a solid but slower growth of both the number of contracts and the amounts invested by the end of 2006. The Pension Monitoring Centre, which hosts a detailed electronic system aggregating a wide range of data across all pension providers, estimates the number of contracts will increase by 72% to 1.23m by the end of 2006, less than the 110% increase recorded in 2005. While 2005 investments rose by 283%, 2006 will see an increase of 90%, an uninspiring number for Turkey, reflecting a certain basis effect and the revaluation of the YTL. Industry insiders maintain that the system still suffers from a communication problem. Those who witnessed Turkey's uneasy relationship with inflation and its boom-and-bust cycles seem to be sceptical about the very concept of defined-contributory schemes. "In the past high-inflationary environment, people simply concentrated on what they earned in that very month," Gürleyik says, "but this is bound to change now".

Yet, much remains to be done to catch up with the OECD's average share of more than 80% of GDP invested in pension funds. With an estimated GDP of $406bn and expected pension investments of $1.55bn, Turkey does not even compare with emerging economies like Poland and Mexico, both recording investments of more than 6% of GDP. Even taking into account the savings accumulated in company foundations like those of the Koç conglomerate, Turkey's ratio remains at a low level. Meral Ak Egemen, general manager of Sabanci Group's AKPensions (AK Emeklilik), speculates that foundations may triple the amount invested in the system to around $5bn, still a mere 1.2% of GDP.

Among practitioners, there is agreement that the pension system will take off only once corporate needs are fulfilled. More specifically, multinational companies and the big established Turkish conglomerates will set the trend, Gürleyik believes, and that Turkish SMEs - still employing more than 98% or the workforce - will follow. Currently, however, the incentives for corporates to invest in employee pension contributions are minimal. Contributions count as tax-deductible expenses only up to the level of the minimum wage, currently at $342 per month; too low a figure to make it attractive for well-paid executives. Moreover, vesting rights remain unclear, thereby seriously hampering corporates' appetites to engage in the system.

Yet, reforms are underway, mainly driven by pressure from pension companies and convergence steps towards EU standards. After its summer break, parliament is expected to decide on the legal basis of vesting rights for private group pension plans, the status of multinational companies, the technicalities of the transfer of defined benefit plans of associations and foundations to the system's defined contribution schemes. This could spur growth in group pension plans, currently around 25%, about half the share expected at the inception of the scheme and about a third of the figure in western Europe and the US.

A growing Turkish pension market is bound to attract foreign interest from both pension companies and asset managers. As distribution channels and economies of scale are keys to growth in the market, the sector is unlikely to see start-ups. "There will be a sector consolidation through joint ventures, mergers and acquisitions; the right number of companies are estimated at around six to seven," says Meral Ak Egemen of AKPensions, one of Turkey's biggest pension funds. Strongly capitalised foreign pension groups may consider venturing into Turkey, but they would be well advised to find a local partner. With clients becoming more sophisticated and requesting asset classes currently not available in Turkey, the market may open up to foreign portfolio managers.

Turkey's pension market has unrivalled growth potential in Europe as long as healthy competition amongst pension providers further drives down costs. The regulatory framework continues to benefit corporate participants and increases public awareness of the scheme's advantages. Enjoying the strong initial growth of a latecomer, Meral Ak Egemen estimates the pensions market will expand to $20bn within 10 years, benefiting retirees, pension service providers and the Turkish capital markets alike.