Christian Petter of BNP Paribas looks at how
European countries are balancing short and long-term goals in
the face of an ageing population
Countries in the CEE (central and eastern Europe) and SEE
(south-eastern Europe) regions are feeling the immediate
pressure of the aftermath of the financial crisis and the
future pressure of demographics. Some are strong enough to
withstand the temptation, and so should western investors.
The question many countries, including those in the CEE and
SEE regions, are now facing is whether a bird in the hand is
really better than two in the bush. Over the past decades, many
countries in the region have started to build an often
mandatory pension system which some politicians under pressure
of short-term market evaluations feel the need to tap for
short-term budget hole fixes.
But such an approach lacks long-term vision and puts too
much emphasis on the often very gloomy short-term outlook for
the region, which is often distorted by misinterpreted
dependencies on Russia or the oil price.
Taking a look at the figures on CEE and SEE countries
reveals the debt situation is in fact often better than in many
other European countries. In a talk in Zurich in January this
year, Martin Janssen, head of the Ecofin (Economic and
Financial Affairs Council) group, pointed out "only Luxembourg,
Denmark and a few Eastern European countries (such as Russia,
Bulgaria, Estonia, Latvia and Lithuania) are within the
It must be conceded that the economic outlook for the region
is not too rosy. However, recent investor surveys show interest
in emerging markets, including Eastern Europe, is slowly coming
back with the first signs of recovery.
Similarly, the analysts at Erste Group see the economic
outlook for many countries in the region improving and over the
mid-term most will be back to economic growth, albeit sometimes
from a very low starting point.
If these countries stick to the course they started of
accumulating supplementary pension assets in funded pension
solutions, they will also be prepared for future demographic
challenges. This in turn means that, over the long-term, their
overall economic situation could improve more significantly
than that of countries which have not yet started to tackle
their pension problem – including western European
countries like Austria.
One case in point is Croatia, where the pension system is
growing more than the economy. In the third quarter of 2014,
pension assets in the three mandatory second pillar funds
amounted to 20% of GDP, having increased 14% over the last nine
months to K65 billion ($11.5 billion).
"I would say there is a lack of understanding by the capital
markets about the existence of a fully funded system that will
support public spending by paying pensions. It is something
that should be taken into account but my impression is that we
are not capitalising on that" Dinko Novoselec, president of the
Association of Croatian Pension Fund Management Companies, was
quoted in Investment & Pensions Europe magazine in
"Croatia is at
least trying to tackle future challenges regardless of
As of February 5 2015, the Standard & Poor credit rating
for Croatia stood at BB+; Moody's rating for Croatia sovereign
debt was Baa3 and Fitch's credit rating for Croatia was BBB-,
as listed on to the online platform tradingeconomics.com.
According to the Croatian Agency for Financial Sector
Supervision (HANFA) the average annualised return from the
second pillar stood at 7.5% for the period between 2002 and
2013 when the mandatory system was first set up. These returns
are significantly higher than the average wage growth during
that period at 3.8% and will therefore help the Croatian people
cope with what is one of the most difficult demographic
situations in Europe.
The World Bank states that 'Croatia is one of the oldest and
rapidly aging transition economies with significant challenges
faced by the pension system', especially in the first pillar.
Statistics reveal 17.3% of the population are over 65 and the
old-age population dependency ratio stands at 23.8%. Only
Bulgaria and Latvia are facing similarly difficult
Over the past years, pension reforms in Croatia saw a few
ups and downs in the wake of the financial crisis. However, the
European Commission confirmed in a 2014 report that the country
had already taken 'significant measures' in the field of
pensions, but added the reform would need 'stepping up'.
Regarding the mandatory pension funds, the government is
obviously keen to develop them further, having allowed
life-cycle choices last year. This means people can choose
different risk strategies within the pension funds. On the one
hand, this transfers risks to the members, but on the other
hand an informed member can make an investment decision
suitable for their current living situation, age range or
Additionally, investment regulations were loosened, allowing
higher equity quotas and more foreign currencies in the
The economic situation remains a worry but most analysts,
including the World Bank, OTP Bank and Raiffeisen Research,
agree the Croatian economy will most likely stop shrinking this
year and even see growth next year. These forecasts are based
on various measures introduced by the government as well as an
initiative for more (part) privatisations which could also
involve the Croatian pension sector.
At the time of writing, the Croatian mandatory pension funds
were among the bidders for debt to be issued by the state-run
motorway operator. However, it must be kept in mind that unions
are very strong in Croatia and mostly opposed to full
Nevertheless, it can be said that Croatia is at least trying
to tackle future challenges regardless of short-term bumps
contrary to a trend of myopic assessments.
On Romania, economic analysts are much more enthusiastic. In
a research paper, OTP Bank pointed out the country 'became the
good guy' in the CEE region in 2013 with over three percent
growth and less than three percent deficit. For 2015, entities
like the European Bank for Reconstruction and Development
(EBRD), the main institutional investor in Romania, the
International Monetary Fund (IMF) and the European Commission
(EC) forecast economic growth between 2.5% and almost three
percent. With the IMF, Romania reached an agreement in
principle to cut the 2015 deficit to 1.8% of GDP on a cash
All these measures are mainly taken to ensure Romania's goal
of being able to join the euro by 2019. Although analysts
expect these ambitious goals to be derailed following the
surprise win of right-centre alliance candidate, Klaus
Iohannis, Raiffeisen Rearch noted it does not expect 'major
political slippages in the near term'. Even if the agreement
with the IMF should falter, 'a public budget deficit of around
two to 2.3% of GDP should not worry investors too much' the
These debt cuts had also helped Romania regain the
investment grade status in Standard & Poor's rating in May
2014. The agency added in a statement issued in the autumn of
last year the economic growth 'should aid moderate further
consolidation of government finances' and make it more likely
for reform programmes to 'exceed expectations'.
A development that has already exceeded expectations in
Romania was the increase in second pillar pension assets by 37%
last year. This was 'driven mainly by good investment returns'
of 8.7% on average for the seven funds in the system, according
to the local pension fund association APAPR (Asociatia
pentru Pensiile Administrate Privat din Romania). Since
inception in 2008, the average annualised return in the
mandatory second pillar is 11%.
The World Bank noted in its most recent assessment of the
Romanian pension system that 'reforms have contributed to
poverty reduction, but further reforms are needed to meet the
challenge of an aging population' – an assessment
which is true for almost any country in Europe. However, in
Romania, initial reforms helped to stabilise the public pension
deficit at three percent for 2012 and 2013. The organisation
warns 'the aging population and shrinking labour force' will
further challenge the pension system. But compared to Croatia
or Bulgaria the situation is slightly better: the old age
dependency ratio in Romania is still under 20% and the quota of
people aged over 65 stands at 13%.
A look at the overall amount of accrued assets of just over
L19 billion ($5.8 billion) in relation to the country's GDP
reveals a very low percentage at just over three percent.
Despite this seemingly minor role of pension assets in the
state finances, it has to be stressed that Romanian pension
funds are investing over 90% of their assets within the
country, rendering them important institutional investors for
the country's economy and stock exchange.
Looking at Bulgaria, there the verdict was still out at the
beginning of the year on how new reform proposals for the
pension system might impact the second pillar. But people in
the local pension industry as well as European organisations,
including Pensions Europe, are trying to reason with the
authorities to take a longer-term view.
Over recent years, there had been rumours and calls from the
opposition parties to use the money in the second pillar to
improve state finances, but the government had shrugged off
this temptation. Pension assets accrued in the mandatory second
pillar amounted to more than Lev6 billion ($4.2 billion) and
annualised average returns for the two-year period between 2013
and 2014 were calculated at 5.45%.
Most Bulgarians are saving in one of the 10 so-called
universal pension funds and in total the pension assets make up
around eight percent of GDP.
The government had considered forcing people to choose
between the first and the second pillar with no chance of
changing their minds at a later stage. In turn, the
attractiveness of the first pillar was increased last year.
From July 2014, automatic indexation was implemented based on
what the IMF calls the golden Swiss rule, linking pension
increases to the average growth of insurable income and CPI
(consumer price index) inflation. Further, the gradual increase
in retirement age was halted. However, the IMF pointed out the
authorities 'recognised the importance of pension
sustainability and saw the halt in increases to the retirement
age as temporary'.
The World Bank halved its economic outlook for Bulgaria
since June 2014 to just over one percent, but added it was
'more optimistic about Bulgaria's economy in 2016 and 2017,
with growth forecasts of two percent and 2.7%, respectively'.
Already in 2013, the organisation warned the government public
funding of the first pillar pension system would have to
increase because contributions to the PAYG (pay as you go)
pillar were too low.
So, like many countries in Europe, Bulgaria is facing the
problem of a soon unsustainable first pillar, especially with
an old-age dependency ratio of almost 25%, fiscal challenges
(despite being one of the very few European countries to
achieve the Maastricht criteria). On the other hand, it has
established a long-term hope of a mandatory second pillar
helping with future demographic challenges.
In our view, despite the bleak short-term outlook on most
economies in the CEE and SEE regions, these countries have made
a first step in tackling the problem all European countries are
facing: the lack of sustainability of PAYG pension systems.
Looking ahead, old-age poverty will present a much bigger and
more long-standing challenge to the economies than most
In Japan, the model old-age society, with one of the highest
old-age dependency ratios in the world at over 40%, old-age
pensions are financed by a mix of first and second pillar as
well as personal savings, but mostly by many people working
well beyond retirement age. Although many European countries
are yet to achieve a sensible old-age participation rate when
it comes to the labour force, the proliferance of elderly
supermarket cashiers is not the future vision for the European
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So the question is how investors should assess individual
countries' attempts to deal with pension problems and future
demographic challenges, even if sometimes these might lead to
short-term effects on the immediate economic growth. Sometimes
two birds in the bush can be better than one in the hand
– because they are further from the reach of
short-term financial needs. In a financial environment, where
quarterly statements are sometimes deemed outdated and
live-streaming of information aided the arrival of
high-frequency trading, it is often difficult to take a really
long-term view on investments. But particularly when it comes
to retirement savings, it is much more important to be aware of
a country's ability to deal with future retirement issues than
to consider its short-term fiscal status.