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Reforms await the detail

Last month’s elections in Lithuania may just be what was needed to jump-start the pension reform process which has been underway for some time now. The victory of the Liberal alliance is looked on by many analysts as the final push which has been missing under the previous administration of Andrius Kubilus.
“Although there has been a general consensus on reform across the political parties, not much progress has been made,” says Saulius Raceviéius of VB Investment Bank in the Baltic state’s capital Vilnius. “The new alliance is very keen on the reforms, and I would expect no delays from now on.”
Lithuania has eschewed the Polish model of welfare reform with plans for a supplementary 2nd and 3rd pillar system. The reforms are far reaching, and some of the original proposals have met with opposition from employers and trades unions alike.
Unusually the proposals which govern third pillar savings accounts were the first to be passed by parliament. These regulations came into effect from the beginning of this year, but to date no products are available. “While this is disappointing it must be remembered that without the second pillar these funds are unlikely to be attractive to most Lithuanians,” says Raceviéius. “The third pillar cannot be seen or taken in isolation from the rest of the system, and when the second pillar is in place I am sure the third pillar will work. At the moment, however, there are no advantages to be gained by investing in this area, despite proposals for tax relief on up to 25% of salary.”
This also seems to be the viewpoint of the companies which might provide such products. A number of insurance companies have expressed interest, but have failed to find sufficient take-up on the street. These providers too are looking at the new government to take the reforms to completion. One other complication is that there has been a suggestion that the Board of Pension Funds will set a minimum level of profitability, but some operators feel this will place unnecessary restraints on investment.
Given that a revision of the system has been under discussion for almost 10 years, what is the hold up? Well, in common with neighbouring countries, the problem has been two-fold. Firstly, there was the debt which occurred when Lithuania became a genuinely independent republic. This was not only created by the former Soviet Union defaulting on pension funding, but also by the disappearance of savings from Russian banks. This threw the pension system out of kilter, but the problems were then exacerbated by the economic slump which followed. Putting the economy back on the road has taken longer in Lithuania than in Estonia or Latvia, and consequently the country is lagging behind its neighbours in terms of reform.
Root and branch overhaul of the system combined with fiscal constraints has been one of the major problems, and the government is still likely to have problems with the funding of a new mandatory system. Significantly the question of what age individuals should join any mandatory scheme, what options are available to older workers who may stick with the pay-as-you-go state system, and how the new system is to be funded are still under discussion. Given the debate of the past year, however, some clues can be gleaned which point to how the new legislation might look. They also highlight possible pitfalls.
Plans to change the state first pillar have involved proposals to increase the retirement age and an overhaul of the social security contribution and taxation system. Increasing retirement from 55-years-of-age for women and 60 for men to a universal 62.5 has not been popular with voters. Nevertheless, the commission investigating reforms has suggested a unisex age of 65. It is unlikely that such a drastic rise would be acceptable, although it may be done on a voluntary basis. One other issue which has been discussed is what to do about those not covered by the present system. Some have suggested that the reforms should be used to bring everyone within the system, both contributors and non-contributors. Although the costs may be prohibitive, such a proposal does have its supporters within the new government.
More intractable is the problem of contribution reform. At the moment it stands at a global 31% of salary contributed rather unevenly by employers and employees. First of all the government has proposed an additional 1% increase to cover disablement benefits, this would be provided by employers.
At the moment the division of the contributions is 30% paid by employers and 1% by employees. Clearly this imbalance needs to be addressed, but the government came up with a rather unusual solution.
It suggested a new employer-employee split of 16% and 15%. It has been suggested that the figure of 3.5% be dedicated to the new second pillar. On the surface this seemed more in line with other countries, but needless to say workers were concerned about the effect on their net wage. To overcome the problem the government suggested that workers be compensated by an increase in their basic salary. Unsurprisingly employers rejected these proposals earlier this year, causing them to be placed on the back-burner for the time being.
The tripartite meetings of the government, employers and unions have led to agreement about the problem of the imbalance of the social security budget, but little in the way of a solution.
Nevertheless the question of funding remains crucial. The outgoing Social Welfare and Labour minister, Irene Degutiene, says the question of re-balancing the contributions is crucial to the reforms. She hopes, however, that the new government will be able to use funds on stream from the privatisation process to help bridge the expected deficit when fully-funded schemes are in place.
Raceviéius believes that despite the plans to have legislation on the books next year and introduce the schemes by 2002, privatisation revenues will be insufficient to fund the proposals. This despite the fact that the government is likely to divert virtually all proceeds from the sale of a tranche of Lithuania Telecom to the reforms. “The fiscal deficit is definitely the major stumbling block to reforms,” says Raceviéius. “The World Bank has been very active in the region, however, and its advisers have been key to some of the discussions to date. I would hope that they would be prepared to help the government out here, subject to them being able to revise their borrowing targets.’
What is certain is that the reform of the pension system is gaining in urgency. There is a desire among the populace to get something in place, and a will among all political parties. The problem is now in the detail.

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