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Ukraine – another kind of volatility

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It looked like a political marriage made in heaven. He was the handsome hero who had been disfigured in the battled to bring democracy to his country, and she was the beautiful ‘orange princess' in trademark halo-like blond plaits who stood by his side during a tense 10 days in the bleak winter of 2004 leading protestors against an attempt to steal an election.

But the against-all-the-odds victory of Viktor Yushchenko and Yulia Tymoshenko did not lead to the happy-ever-after ending. Instead, all too soon their relationship began to unravel and the story line changed from being a romantic novel to that of an American country and western song.

And pension reform was one of the casualties of that breakdown.

In mid-2003 the then president, Leonid Kuchma, followed up on an April 1998 white paper on pension reform by proposing legislation to introduce new funded pension systems. A second pillar bill, which included a reformed first pillar, foresaw 7% of wages being invested in an externally invested pension fund in a scheme that would be mandatory for new entrants to the labour force and those with more than 20 years until retirement.

The proposals were in many ways similar to those adopted by Ukraine's neighbours. Legislation for the mandatory scheme outlined a framework of provisions for a second pillar but left the specifics, including how it would be administered and an implementation date, up in the air. The expectation was that it would be implemented in 2004 or 2005.

But the second pillar was never implemented. "It never came into effect because no follow-up legislation was adopted," says Anders Åslund, senior fellow at the Washington DC-based Peterson Institute for International Economics. "Ever since, everybody has agreed that a pension reform is needed, but since hardly any legislation has been adopted because of the political chaos, no advances have been made on pension reform either."

The political chaos was the Orange Revolution, which faced down an attempt by Kuchma's prime minister Viktor Yanukovych to succeed him as president, and the subsequent breakdown of the relationship between Yushchenko and Tymoshenko to the point where Yushchenko sacked Tymoshenko and appointed Yanukovych as prime minister. There was also a subsequent rapprochement ahead of a 2007 general election after which Tymoshenko again took the premiership. The alliance again broke down a year later and expectations of early elections were only dampened by the growing economic crisis.

However, in April 2007 Yanukovych revived Kuchma's initiative and the parliament, the Verkhovna Rada, gave a first reading to a second pillar law. But it has not progressed any further. When she returned to office later that year, Timoshenko lacked a clear parliamentary majority and the bill is still in a legislative limbo between a first and second reading. The coalition has always been shaky and although it did a number of things initially, it did not pass the second pillar.

"Timoshenko wanted to look at the bill again because pensions is a very important area in Ukraine," says Gary Hendricks, the pension project expert at USAID in Kyiv, which advises the government. "While there are 16m people in the formal labour force there are 13m pensioners, so it is a very big issue. And pensions are low so initially she focused on the first pillar and gave an across-the-board increase in benefits, although with 20% inflation it has a fleeting impact."

There are several reasons for a lack of progress on the second pillar. "At its first reading the second pillar bill said that for the first 11 years the government, the pension fund of Ukraine, would manage all the accounts and assets," says Hendricks. "Many were afraid that if the government had control of all the money - $500m in the first year growing to $4bn a year in six years - it would be very tempted to invest it in infrastructure, which had no rate of return, or use it to buy government securities, which would be a PAYG system rather than a funded system."

And there is a reluctance to give the money to private institutions. "Until the capital markets are more disciplined, have greater transparency and function better, and there is a stronger regulatory structure, there is nowhere to go with a programme that would create a huge amount of assets," Hendricks adds. "The Rada is loath to send the country's money outside Ukraine to invest so the assets would eat every financial instrument in the country in about four years."

 "The two major political parties are on record as supporting a second pillar," says Hendricks. "They cannot get it off the ground because there just seems to be one distraction after another in terms of the political process, which is disrupted by elections and changes in the government and in the Rada."

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