CROATIA'S UNBEARABLE PENSION BURDEN

UNCLAS SECTION 01 OF 02 ZAGREB 000153 SIPDIS SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON ELAB SOCI HR SUBJECT: CROATIA'S UNBEARABLE PENSION BURDEN ¶1. (SBU) SUMMARY: With a quarter of its population receiving pensions, Croatia's pension expenditures amount to 11% of GDP and a third of the proposed 2008 state budget. The ratio of pensioners to contributors, currently 1:1.4, is expected to improve slightly over the next decade as employment levels rise, but then fall to 1:1 by 2050. Many of the reforms begun in 1998 to reduce the system's fiscal burden have been stalled or reversed. As a result, the current system is fiscally unsustainable and will become more so if the government implements the measures of the Croatian Democratic Union's (HDZ's) coalition agreement. Returning to a path of reform will be difficult, politically and economically, but if the government does not stabilize the pension system, it risks hampering Croatia's economic growth and passing an even more difficult problem to the next government. End Summary. HIGH PROPORTION OF "YOUNG" PENSIONERS; LOW CONTRIBUTOR-PENSIONER RATIO ¶2. (U) About 1.1 million people receive pensions in Croatia. Just over half (578,500) of these beneficiaries qualify by age. About 240,000 qualify based on disability and another 235,000 qualify as survivors. The remaining 67,700 are Croatian army and Croatian Homeland War veteran beneficiaries, 53,000 of whom qualify by disability. The 1.1 million pension beneficiaries represent a quarter of Croatia's population. According to Danijel Nestic, researcher at Zagreb's Institute for Economics, because the government has used early retirement plans to ease the effects of job losses due to privatization and restructuring, and because of the high proportion of disabled beneficiaries, Croatia has 45% more pensioners than it has residents age 65 or older. Currently, the ratio of pensioners to contributors is 1:1.4. Nestic and other analysts expect this ratio to improve slightly over the next decade as employment levels rise, but longer term projections estimate a 1:1 ratio by 2050. LOW AVERAGE PENSIONS, HIGH COSTS ¶3. (U) The average pension for non-military beneficiaries is 2000 HRK ($400) per month, although about half of non-military beneficiaries receive 1,500-3,000 HRK ($500-1000) per month. The average pensions for military beneficiaries are higher: 3160 HRK ($630) for Croatian army beneficiaries and 5610 HRK ($1120) for Homeland War beneficiaries. Pension payments equaled about 11% of Croatia's GDP in 2007. Payroll contributions cover about 60% of the payment costs, with the remainder financed from the budget. At more than 33 billion HRK ($6.6 billion),pension payments constitute about a third of the government's recently proposed 2008 budget. LIMITED SUCCESS AT REFORM ¶4. (U) In 1998, due to the fiscal pressure of the pension system, the GoC began a set of reforms by adjusting the existing pay-as-you-go (PAYG) parameters and setting the structure for a multipillar system. Elements of the reform included a gradual increase in retirement age, an increased penalty for early retirement, less generous benefit calculations, and introduction of wage-price indexation for benefits. The government introduced the "second pillar," a fully funded, defined-contribution plan that is mandatory for workers age 40 and under, in 2002. When the reforms were launched, World Bank analysis indicated that the changes to the PAYG parameters would reduce first-pillar spending from above 13% to below 10% of GDP by 2020 and 6% by 2040. The deficit between contributions and benefits was expected to decrease from 3.6% of GDP to 1.1% by 2005, thereby creating the fiscal space to raise the proportion of contributions going to the second pillar. However, policy interventions (reform reversals, in several cases) introduced in the meantime resulted in a 2007 pension deficit of 3% of GDP. According to World Bank forecasts from January 2008, continuing the current policies would keep pension payments at or above 11% of GDP for 10 years and prevent the pension deficit from falling below 2% of GDP for 20 years. PROPOSED ADJUSTMENTS: ANOTHER BLOW TO FISCAL SUSTAINABILITY ¶5. (U) The coalition agreement reached by the Croatian Democratic Union (HDZ) and its partners in January 2008 includes three pension policy measures: 1) an increase in replacement rates for current PAYG pensioners from 41% to 50% by the end of the government's mandate (2011); 2) introduction of an "old-age subsidy" for elderly persons not participating in the pension insurance system; and 3) an increase in the minimum pension for 25 years of service. According to Zoran Anusic, senior economist at the World Bank Regional Office in Zagreb, the second and third measures could have a minor fiscal impact, depending on the yet-to-be-decided details. He estimates, however, that ZAGREB 00000153 002 OF 002 raising the replacement rate to 50% would raise pension expenditures to 13.6% of GDP by 2011, while the pension deficit would rise to 5% of GDP. ¶6. (U) Because of changes to the system in 2007, pension expenditures will grow by more than any other item in the proposed 2008 budget, and they are forecast to constitute 12% of GDP. Anusic believes even this current system is fiscally unsustainable, and the changes dictated by the coalition agreement would be another step in the wrong direction. The general worsening of macroeconomic conditions in Croatia reduces the chances the agreement provisions will be implemented, and the proposed budget does not include funds for implementation in 2008. However, Anusic sees little chance the government will get the reforms back on track. ¶7. (U) While Anusic and other analysts caution against the recent and proposed adjustments, the Croatian Pensioners Party (HSU),some unions, and pensioner advocacy groups continue to push for further changes to improve the lot of current pensioners. Citing estimates that the average beneficiary spends half his or her pension on housing, leaving just 33 HRK ($6.60) per day for other expenses, representatives of these organizations have called for raising current pension amounts by the percentage that GDP has grown and changing from wage-price indexation to wage indexation. COMMENT ¶8. (SBU) Although the financial situation of many current pensioners may be difficult, increasing their benefit amounts will likely create a fiscal burden Croatia cannot afford. Abandoning the earlier reforms also risks penalizing future pensioners, while reinforcing the expectations of younger generations that they can rely completely on the state to take care of them in retirement. Reneging on promises to increase current pensions and returning to reform measures will be difficult, politically and economically. But if the government does not find a way to stabilize the pension system, it risks hampering Croatia's economic growth and passing an even more difficult problem to the next government. Bradtke