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IPE special report May 2018

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Reeta Paakkinen assesses growing calls for liberalisation to Turkey's private pension investment regime as interest rates drop to single figures

General elections scheduled for 12 June, are dominating the news agenda in Turkey. Both the governing AK Party (AKP), a conservative party with Islamic roots, and the opposition Republican People's Party (CHP) are promising changes to the existing social security landscape.

AKP is promising to bring down the country's social security deficit to less than 2% of the gross domestic product and increase the dependency ratio from 1.8 to 2.5 by 2023. CHP, on the other hand, is promising to cancel the additional social security fee that is being charged on pensioners still in active employment, to reduce gaps between pension payments and transfer a part of the growth of national income to pensions.

Although the median age in Turkey is 29.2 years, pensions remain a critical issue due to a social security funding gap, which totalled TRY26.4bn (€11.7bn) in 2010. The grey economy and the relatively slow pace of reforms have maintained the gap. The retirement age increased from 48 years for men and 44 years for women to 65 years as recently as October 2008.

Although the government has adopted a strict stance towards tax evasion, there are still considerable numbers of employers who do not pay their employees social security contributions in full, or evade paying them altogether. Furthermore, the tradition of private saving for pensions is a relatively fresh one (Turkey's private pensions system was launched in 2003). Pensions are still perceived to be, by and large, the responsibility of the state.

The finance minister, Mehmet Şimşek, noted in April that Turkey is trying to gradually do away with its social security deficit. "Even if the social security reform AKP introduced during its last four years in power was limited, it still took place. We have looked at the social security deficit and asked ourselves ‘could we bring this nearer down to zero around 2040?' Undoubtedly, keeping even to that [timeframe] will be difficult," Şimşek said.

He also commented on CHP's election promises: "The opposition says they will remove the additional social security fee that is currently charged from pensioners in active employment. However, income from that charge is used to fund incentives for employing young people. It is a policy that exists to discourage early retirement."

Domestic pension companies, on the other hand, hope the next government will introduce more liberal investment regulations for the market and launch second pillar pension plans. Private pension companies would also like to see more tax incentives and a Turkish public more informed about the benefits of private saving.

At present, the private pensions market in Turkey consists of 13 companies managing 140 investment funds with total assets of TRY12.91bn (€5.8bn). The limited assets in the system are reflected by the number of participants: only 3.26% of a population of 73.7 million has a private pension plan.

Erhan Adalı, general manager of €888m Garanti Pension hopes the next government will launch second pillar vocational or a compulsory pensions system. Employer sponsored group plans make currently only 20% of all contracts.

"We already have a well-established and functioning third pillar system that is voluntary. Shift to second pillar would be easy. It would also enable employees to be completely ready for their retirement, reducing the burden on the government," Adalı said.

Adalı noted also wider tax incentives are of utmost importance for the system and private savings in Turkey to grow. At present, only 36% of the participants use the available tax incentives. "Wider tax incentives could consist of increasing the existing 10% upper limit to encourage corporate plans, he says. "Currently, the 10% limit [on tax deductible pension contributions with a cap of annual minimum wage] restricts the contributions to be fully eligible for tax deductions. When an employer sponsors a plan and pays for the health and life insurance of the employee, it can easily exhaust the limit, leaving little room for the employees to use the tax incentives for the contributions they make for themselves. If there would be a tax credit system, all participants would get the tax incentives across the board on an egalitarian basis. This would bring the system more than a few steps forward."

Since April 2010, Turkey's private pension assets have grown from TRY9.88bn to TRY12.91bn. At the same time, the number of participants has gone up from 2m to 2.4m. It is expected that Turkey's private pension assets will reach approximately TRY200bn by 2023. "In case the tax credit system is introduced the system's assets could double the expected TRY200bn. The introduction of a second pillar would give an even strong boost to the growth of the system," Adalı noted.

Taylan Türkölmez, chief executive officer at €880m Yapı Kredi Emeklilik, would like to see Turkish public better informed about the benefits of long term saving and developing macroeconomic landscape. "This is one of the first years we have had a single digit interest rate, approximately 8%, which indicates returns will also be of the same range," Türkölmez comments. "Single-digit returns are quite unfamiliar for the Turkish population. The general expectation is for much higher returns but Turkey should adapt to new return environment."

"Because of the high returns in the past many still prefer taking loans to making investments. During the crisis, we also saw a lot of people stop paying into their pension plan and directing their cash elsewhere. We have to change the mindset of people from short to long term investment," Türkölmez continues.

Both Türkölmez and Adalı would like to see a more diverse choice of investment vehicles in the market. At present, the asset allocation of Turkish pension funds is relatively conservative. In January 2011, the assets of Turkey's private pensions system were mainly invested in government bonds (62.67%), stocks (12.01%) and reverse repo (10.94%). Foreign securities made only 0.35% of all assets, whilst 0.03% of the assets were invested in money market instruments and the remaining 13.98% to other investments, according to Turkey's Capital Markets Board (SPK).

"Pension funds here should be invested in precious metals like gold, silver and copper," says Türkölmez. "Due to regulations, we are not able to establish, for example, a pure corporate bond pension fund right now. The existing regulatory framework needs an update in order for the sector to develop and grow."

Yapı Kredi Emeklilik is planning to launch a set of new funds in the future, including a second equity fund for dividend income purposes, an income indexed bonds fund and a more long-term fixed income bond fund having a minor, 3-5% exposure to equities, Türkölmez said.

Adalı believes Turkish pension funds will invest increasingly in stocks in the future. "We expect average exposure to stocks to grow from the current 12% to 30%, as is the case in most developed economies," he says. "We expect to see more international funds. In addition, new funds comprising a mixture of gold-denominated financial investment instruments are expected to be established in the upcoming years."

Low penetration rate in private pensions sector is a good indicator of growth potential in the market, continues Adalı: "Market penetration in the private pensions sector in countries like Mexico, Poland, Hungary and the Czech Republic, which have similar systems to ours, stands between 4% and 14% of gross domestic product while in Turkey the equivalent figure is 1%. This means a lot of untapped potential," he concludes.
 

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