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Oct 19, 2002 | 01:12 GMT

4 mins read

Russia: The Impacts of Pension Reform

Summary

Russian state pension fund officials plan to invest heavily in Russian government bonds. Recent legal changes should help increase pension payouts, guarantee Moscow a reliable source of funding and even boost much-needed domestic investment.

Analysis

Russian State Pension Fund chief Mikhail Zurabov said Oct. 17 that the fund expects to invest 70 billion rubles ($2.2 billion) in Russian government bonds by the end of the year, and another 140 billion to 150 billion rubles ($4.4 billion to $4.7 billion) throughout 2003.

Reforms passed in December 2001 allowed the pension fund to expand its investment options. Previously, any contributions collected simply sat in the agency's account; the fund was not allowed to touch the cash. But now, the pension fund can invest in government bonds, and Zurabov claims it will invest in private corporate bonds as well beginning in 2005. These changes could herald a dramatic evolution in the way the Russian economy works: If all goes well, domestic investment could surge and the standard of living for average citizens could rise.

Assuming all goes well, the new regulations will have two significant effects: First, they could allow Russian taxpayers to have a direct say in some of the investments. Beginning in 2004, taxpayers can place 4 percent of their pension contributions into private investment funds, with the proportion increasing to 6 percent in 2006. Second, taxpayers will be able to direct their social taxes to selected foreign investment funds, giving Western investment houses a relatively risk-free means of testing out the Russian market. It is one thing to invest cash in a country that has, at best, an unproven legal environment; it is quite another to accept cash from that country and become involved in its pension network.

However, all of this — with the exception of the fund purchasing government bonds — remains at the theoretical stage. Russia's capital markets are embryonic, and its judicial system remains weak and inconsistent. Finally, while many of the oligarchs have cleaned up their images in recent months, all have skeletons in their closets — and none are likely to pass up cash that could be siphoned from the newly freed pension investments.

That said, the pension reforms carry huge potential payouts for Russia. At the simplest level, the pension fund plans to purchase $6.6 billion in government bonds by the end of 2003. That extra demand will drive down the amount of interest that the government will have to pay on its bonds and will guarantee Moscow a hefty cushion should it need to increase its borrowing in an emergency.

This not only benefits government finances, but citizens as well. According to the fund's own statistics, Russia's monthly pension payouts are pathetically small, averaging only 370 rubles ($11.70) per recipient. If the agency is able to invest its cash — and Russian bonds continue to perform reasonably well — then it should be able to increase overall holdings and, by extension, its distributions.

The Russian economy is also a potential winner. A dearth of investment capital remains one of the biggest obstacles to Russia's economic development. The wrenching transition from a centrally planned economy to the semi-free market system Russia has now created some of the most intense capital flight in modern history.

The fund takes in approximately $14 billion annually in contributions. Although the 4 percent of their contribution that taxpayers will be able to personally invest in 2004 may not seem like much, it still represents more than $500 million that could percolate through Russia's growing gaggle of investment firms — boosting often shaky domestic investment figures. More important, the remainder of the fund's cash soon could trickle through the bond market, aiding borrowers of all types — from companies in need of expansion capital to credit bureaus and mortgage-seekers. Developing these markets would be one positive step in its own right for Russia.

Given the scope of potential benefits, the government — not to mention the pension fund itself — has a vested interest in seeing the project through to fruition. The positive impact that the fund's expansion likely will have could qualify the program for financial support from multilateral development institutions. The World Bank, for example, is very keen on policies that free up pension funds. Key among those institutions will be the European Bank for Reconstruction and Development, which strives to help the former communist states adopt free-market principles.

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