SLOVAKIA: GOING BACKWARDS ON PENSION REFORM

UNCLAS SECTION 01 OF 02 BRATISLAVA 000514 SENSITIVE SIPDIS STATE FOR EUR/CE K. ERTAS AND L. LOCHMAN STATE PLEASE PASS TO TREASURY FOR L. NORTON STATE FOR EUR/ERA B. ROCKWELL AND J. KESSLER E.O. 12958: N/A TAGS: EFIN ECON EINV LO SUBJECT: SLOVAKIA: GOING BACKWARDS ON PENSION REFORM SUMMARY -------------- ¶1. (U) The Slovak government will soon re-open the private pension pillar in an effort to get 150,000 workers to transfer back to the public pension system. This is only the latest attack in a long-running war on the second pillar, which has been subjected to blistering criticism from PM Robert Fico and from the new head of the state social insurer, who recently told Slovaks that the financial crisis had obliterated their second-pillar savings. Despite the rhetoric, it is widely thought that the government simply needs the money to prop up the public pension system. The private system has enjoyed great success since its 2005 introduction and is a rich target for fiscal raiding. Moving workers back to the failing old system represents a failure to grasp the importance of structural reform for future economic growth. End summary. 2.(SBU) As of mid-November, the GoS will take another step backward in its structural reforms by reopening the second (private) pillar of the pension system for six months. The government has said that it hopes to draw 150,000 participants out of the private system. This target is widely understood to have been determined by the size of the deficit in the first pillar (pay-as-you-go) and the need to move the general budget deficit from 2.3 percent of GDP to 1.7 percent. Nevertheless, the publicly stated rationale for urging people out of their private funds is that their savings are not safe, and that pension funds cannot be trusted to the hands of capitalists whose motive is profit. A SUSTAINED ATTACK ON PRIVATE FUNDS -------------- ¶3. (SBU) This is the second attack on the second pillar in less than a year. The government had opened it for the first six months of 2008 and succeeded in getting 105,000 participants to leave, while 20,000 participants switched in the other direction--a net loss to the second pillar of 85,000. PM Robert Fico has maintained a steady drumbeat of criticism of the private funds for making risky investments (when in fact they are highly regulated toward conservative investments),for taking excess fees, and for delivering poor returns (an argument helped by willfully misstating the returns--a misrepresentation egregious enough to elicit a correction from the normally docile National Bank of Slovakia). As the subprime mortgage crisis unfolded, Fico cited that as grounds for reopening the pillar, at one point comparing the private funds to Iceland. In addition to a propaganda war on the second pillar, the government has also tried to divert funds from it by lowering its contribution ceiling. ¶4. (SBU) Now that a serious financial crisis is underway (though mainly beyond the borders of Slovakia) Fico seems to have turned the role of lead critic over to the recently appointed head of the Slovak Social Insurance Agency, SMER party stalwart Dusan Munko. In an an interview published on October 25, Munko said, "Let me be clear...people who joined the second pillar have lost all their savings." Munko's remarks were promptly blasted by economists and politicians alike, and since then he has found himself increasingly isolated from other government figures. While opposition politicians have demanded Munko's resignation, both Parliament's social benefits committee chair and the Minister of Labor (neither of them exactly Chicago School economists) have both publicly asked Munko to explain his remarks. The criticism of Munko has continued through the past week, and even PM Robert Fico has characterized his remarks as "needlessly frightening people." As he often does with members of his government, though, Fico declined to take responsibility for his appointee's remarks. ENTHUSIASM FOR SECOND PILLAR -------------- ¶5. (U) Despite the government's determination to scare participants out of the system, Slovaks have been enthusiastic about the private pension option, introduced by the Dzurinda government in 2005. Workers must pay 18 percent of their salaries into the pension system, half of which must BRATISLAVA 00000514 002 OF 002 go into the first pillar (pay-as-you-go) and half of which may, at the participant's option, be paid either into the first pillar or into one of six private pension funds (collectively known as the second pillar). Some 1.5 million Slovaks pay into the second pillar, of a total of 2.2 million paying into the pension system. The private funds are currently managing about SKK 63 billion ($2.6 billion) in assets and operate based on gross asset management fees. To date, the funds have suffered only minor losses as a result of the financial crisis. COMMENT: RETREAT FROM THE FUTURE -------------- ¶6. (SBU) The consensus here seems to hold that Fico's determination to gut the second pillar stems as much from a native hostility to capitalism as from his need for a quick shot of money to keep the state insurer afloat and to trim the general budget deficit. Still, this latter motive is becoming more urgent, and he is not hesitating to exchange a higher pension liability in the future for more budgetary freedom today. Nor is this a trivial amount of money. According to the Ministry of Labor and Social Affairs, the defection of 150,000 second-pillar participants would bring about SKK 951 million ($39.6 million) to the state insurance company in 2008, and it would see its financial resources increase by SKK 8.6 billion ($358 million) next year, with an additional revenue stream of SKK 3 billion ($125 million) per year from continuing contributions. It should be noted, too, that social insurance is part of the general budget, not a separate fund, so the government could use this windfall to pay other expenses, including reducing the deficit or increasing other social spending. There is talk that the second-pillar windfall will be used to make up for lower tax revenues during the expected economic slowdown. ¶7. (SBU) Perhaps the most troubling aspect of Fico's fight for second-pillar money--apart from the cynicism of scaring workers out of their savings to prop up a failing first pillar--is that it represents a failure to grasp the importance of structural reform. Instead, it is in essence a populist patchwork approach to both the pension system and the general budget. Right across the southern border is the spectacle of Hungary's economic crisis, and the certain knowledge that it was caused by the failure to make the very structural reforms that Fico is trying to unravel here. Rather than fix the pension system and get payroll deductions under control, this government is retreating from the future. OBSITNIK