Portugal: Focus on sustainability
Reforming the country’s public pension system is an integral part of the government’s efforts to impose fiscal stability, as agreed in its bailout programme.
Regulation in summary
• Portugal has cut public pension benefits and has raised the retirement age as part of a drive to reduce public spending.
• Competing parties have already announced further cuts ahead of the general election later this year.
• There are no signs that the pay-as-you-go system will be reformed.
• So far the second and third pillars have been left untouched.
The main economic indicators are improving for Portugal, a sign that the €78bn bailout programme, signed in 2011 with the IMF and the EU and formally completed last year, has restored some confidence. GDP grew by 0.9% in
2014, and is forecast to increase by 1.6% in 2015, according to the IMF, after the contraction of the preceding two years.
As part of the bailout programme, the country had to take serious steps towards fiscal stability, including easing the burden of public pensions. This was achieved by cutting pension benefits and raising the retirement age.
The benefit cuts approved over the past three years seemed harsh initially. Law 66-B/2012 introduced an “extraordinary solidarity contribution” (CES), a measure applied to pensions in payment above €1,350. Cuts ranged from 3.5% to 50% of income, with the higher cut applied to pensions above €7,545.96. Later on, the measure was broadened, targeting pensions above €1,000 and cutting by a half those above €7,126.74.
From next year, however, the scope of benefit cuts is going to be reduced. This year, the CES will be applied to pensions exceeding €4,611.42 per month, which will be cut by 15%, while pensions above €7,126.74 will be lowered by 40%. The government plans to reduce cuts to pensions in payment by 50% next year and scrap the CES altogether in 2017.
Law 83-A/2013, which concerns the retirement age, allows for the normal retirement age to increase in line with increases in life expectancy. Previously, the retirement age had been increased from 65 years to 66 years and 43 years of contributions, but that may be raised further as life expectancy increases.
However, these plans are by no means definitive. A general election is scheduled for October this year, when the Portuguese people will be given the opportunity to have their say on how the government has managed the worst economic crisis since the country turned its back on dictatorship in 1974.
As in Greece, another deeply troubled economy, it is likely that the Portuguese election will shape up around the austerity debate. The centre-right coalition that has guided the country through the bailout programme is up against a centre-left party that has expressed a cautious position on austerity.
Whether or not the country maintains austerity, the development of the pension system is clearly a key factor in Portugal’s future economic path. The opposing parties have presented reform proposals to further reduce pension expenditure, as the pressure mounts.
However, so far the proposals only amount to further cuts to benefits. Gert Verheij, senior investment consultant at Towers Watson in Lisbon, says there is no sign that the spending reduction measures will be replaced by a more comprehensive pension reform. “It is clear that the current pay-as-you-go system is no longer sustainable,” he says. “Real change will come about when lawmakers realise that.”
The ruling coalition between PSD and CDS, two liberal parties with a conservative and Christian background respectively, proposes capping contributions to social security and allowing workers to make further voluntary contributions to either public or private schemes.
“Whether or not the country maintains austerity, the development of the pension system is clearly a key factor in Portugal’s future economic path”
Benefits would also be capped, and although the details of the proposals are not yet clear, the coalition has indicated that it is open to discuss them with social partners.
The centre-left party, PS, proposes broadening the sources of funding for social security, which would entail taxes being raised.
Both parties have made it clear that current pension payments will not be cut further after 2017. However, future benefits will be reduced in the name of achieving fiscal sustainability.
At the moment, however, there has been little focus on how to encourage growth of the second and third pillars. This inertia is common around Europe, and it was reinforced in Portugal by the recent difficulties faced by the financial sector.
Just as the country was about to complete its bailout programme, in July last year a major domestic financial group, Banco Espírito Santo (BES), went bankrupt, amid allegations of fraudulent operations involving some the group’s subsidiaries.
Only recently, the former head of the group was put under house arrest as investigations into the group’s collapse continue. Meanwhile, the government had to split the bank and inject €4.9bn to ensure the stability of the country’s financial sector.
This created a strong sense of worry among investors, particularly pension savers. Because existing Portuguese pension funds are still inextricably linked to domestic asset managers, as a result of regulation, savers feared that the collapse of the BES group would affect their pension savings.
While the industry has made an effort to reassure investors, Portuguese pension funds of all sizes are starting to warm to international asset managers. Administration remains in the hands of domestic managers, but the actual management of the assets is being increasingly outsourced abroad, and fiduciary management models are becoming more frequent.
Over the years, the country’s pension funds industry has moved steadily to defined contribution (DC), with almost all defined benefit schemes closed to new entrants, but the shift to DC has not resulted in portfolio diversification.
In recent months, funds have started to shift fixed income assets away from the domestic government bond market, in favour of overseas fixed-income assets.