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Did the pension reform pay off?

Kadyrzhan Damitov in an interview with told about the pension system of Kazakhstan and the intermediate results for 20 years
Did the pension reform pay off?

The accumulative pension system of Kazakhstan is 20 years old. The Concept of Reformation of the Pension System adopted in 1997, and then the Law on Pension Coverage in the Republic of Kazakhstan caused numerous disputes in the expert community. Many Kazakhstanis simply did not believe that sometime in the future they would be able to receive a decent pension out of the funds the state obliged to deduct from wages. Nevertheless, Kazakhstan made a difficult decision to move from a solidary system to a mixed model of pension provision based on a funded component, and it was the first in the entire post-Soviet space to do that. Since then, the republic has a multi-level pension system: a solidary component, compulsory accumulation part and voluntary contributions. Kadyrzhan Damitov, former chairman of the National Bank of the Republic of Kazakhstan (1998-1999), and now a member of the board of directors, an independent director of the Single Accumulative Pension Fund, told about the main stages of development and achievements of the pension reform.

- Kadyrzhan Kabdoshevich, why was Kazakhstan the first among the CIS countries to decide on the implementation of the pension reform? What factors influenced this decision?

- An independent Kazakhstan inherited a solidary or distributive pension system from the Soviet Union. The main principle of such a system is the solidarity of generations, when the working population provides retirees. The most pressing social problem in the world is still the aging of society, which leads to a reduction in the ratio of working citizens and pensioners. This, in turn, entails an imbalance in income and payments within the framework of solidary pension systems. That is why many countries are moving from a distributive to accumulative or mixed model of the pension system. And Kazakhstan is no exception.

Moreover, the pension reform in our country was also conditioned by the macroeconomic situation. Let us recall that almost all economic and demographic indicators worsened in the 1990s. There was a shortage of essential products in the country, many enterprises and industries were closed, people were not paid wages for months, the number of unemployed increased, and pension payments were delayed. In 1992, the country was shaken by hyperinflation, which according to the Statistics Agency of the Republic of Kazakhstan, was 2960.8%. It was reduced to 60.3% only by 1995.

The distributive pension system has become incapable of meeting the minimum needs of the majority of pensioners, due to a heavy burden on the economy and budget of our country. There was also a demographic peculiarity: the birth rate in the post-war years grew dramatically, while in the nineties in most republics of the former USSR, including Kazakhstan, it dropped and the number of retired people rose. Later, if the situation in the pension system remained the same, we would face a great social shock. All this needed the existing pension system to be reformed.

- Why was the Chilean model chosen?

- There are only two models of pension provision in the world: a distributive, which I mentioned above, and accumulative. Due to economic or historical factors, the first or second or mixed models of pension systems function in different countries.

To solve a number of problems arisen in the pension system of young sovereign Kazakhstan, the foreign experience of the accumulative pension systems of Chile, Singapore, and Switzerland were studied. In fact, the cumulative component is present in the pension systems of many countries of the world, such as Hong Kong, Malaysia, Australia, Denmark, Peru, Mexico, Uruguay, Colombia, etc.

The Kazakhstani pension system was called Chilean, since it had similar characteristics: compulsory pension contributions at a fixed rate of 10% of the employee's income, availability of a private pension fund market, and the choice of a pension asset management strategy. Today there are a number of significant differences. For example, in Chile there is no state guarantee for the safety of accumulations inherent in the Kazakhstani model of pension provision. Besides, the Kazakhstani government pays a basic pension payment for all citizens who have reached retirement age.

- Kadyrzhan Kabdoshevich, what is the main essence of the accumulative component?

- The main principle of the accumulative component is the people’s responsibility for the future pension: you will receive exactly how much you have earned and saved up. A certain part of the accumulative component is investment: incoming contributions are invested in the financial markets and generate revenue. Besides, the stock market receives a long-term capital, which through various financial instruments ensures the development of domestic economic sectors.

The Kazakhstani pension reform was conceived and implemented in such a way that contributions made and paid by currently employed citizens entered the individual pension account of every Kazakhstani citizen, i.e. people in the future receive pension payments in accordance with their employment record and income. As by the moment of reformation in 1998, citizens did not have individual pension savings, the obligation to pay pensions out of the solidary component was retained by the state. This refers to people who have, at least, six months of employment service before January 1, 1998.

- How did the population react to the pension reform? Was it difficult for people to choose 1 out of 14 active accumulative pension funds?

- The Law "On Pension Provision in the Republic of Kazakhstan" came into force on January 1, 1998. It is the birthday of the accumulative pension system of independent Kazakhstan. The first participant in the pension services market was the State Accumulative Pension Fund (GNPF). It was established in September 1997, and on January 19, 1998, the first compulsory pension contribution was received by the GNPF. Soon there were also private accumulative pension funds, though the State Accumulative Pension Fund had remained the champion for several years. Initially the population had not much choice, until 2003 GNPF remained the fund by default. It is impossible to say that immediately has been an understanding that from now on everyone is to save for retirement on their own. Many perceive compulsory contributions as a tax. And, unfortunately, despite the great explanatory work being carried out both at the dawn of the pension reform, and now, many still relate in this manner to this day.

- To what extent is it necessary and rational, in your opinion, to merge private accumulative pension funds?

- With the advent of private accumulative pension funds, citizens have had a choice to trust their savings. Competition in the pension market of Kazakhstan initially had a quite positive effect, but over time, some APFs began to show vulnerabilities. An unhealthy competition occasionally appeared, when the funds did not involve new customers in the accumulative pension system, but drew them over from each other.

Often, in pursuit of large profits, private pension funds invested in risky instruments and lost. The aggressive investment policy of the APF and the crisis in the country's economy led to losses, first of all borne by depositors - ordinary citizens receiving less income from savings. All this, unfortunately, not only discredited certain funds, but also undermined the population's confidence in the accumulative pension system as a whole. And expressing my personal opinion, I would like to note that it was perhaps necessary to significantly increase the requirements to private pension funds so that only the strongest and most transparent funds were left, and those with an inadequate level of corporate governance were closed, and their shareholders would have made up for losses on distressed assets.

- What did the creation of the Single Accumulative Pension Fund and the transfer of assets in a single pair of hands bring?

- In 2013, based on the state accumulative pension fund, the Single Accumulative Pension Fund was created; and the pension assets and liabilities of private accumulative pension funds were handed over to it. As a result, the migration of depositors from one fund to another stopped, and the operation of the state guarantee for of pension contribution safety became logical given the level of inflation. Now the government, as the sole shareholder of the SAPF and the National Bank as an investment manager, is responsible for the pension capital safety. In addition, the creation of the SAPF reduced operational and administrative expenses. The level of commission fees was significantly reduced compared to commissions charged by private funds. Besides, the risk of committing knowingly loss-making transactions with affiliated entities was eliminated.

After the creation of a unified depositors' database, the recovery of the portfolio of financial instruments of SAPF, the issue of bringing several players, the pension asset management companies (PAMC) is again being considered, but there is no definitive solution. However, the SAPF will remain the sole operator and administrator of all financial flows. Thus, the state control over pension savings will remain.

- One of the pension reform tasks was to lay the foundation for the stock market development in Kazakhstan. Do you think it worked?

- The accumulative pension funds have become long-term institutional investors, being the main buyers of securities of Kazakhstani emitents.  It stimulated the development and economic recovery of the early 2000s. An active participation of pension funds in the program "People's IPO" has also contributed to the stock market development in Kazakhstan. However, further crisis moments both in the global and domestic financial markets affected the state of the emitent companies and the profitability of pension funds, which investment management was ultimately declared ineffective.

When private accumulative pension funds, listed companies, had exited the market the number of stock exchange members naturally decreased. Today all financial flows are concentrated in one powerful investor, SAPF. In this regard, the procedure for making decisions on investment of pension assets has changed significantly. In particular, as of 2016 the body that determines strategic directions for investing pension assets is the Management Council of the National Fund of the Republic of Kazakhstan. The investment declaration is approved by the Board of the National Bank, and the Government of Kazakhstan approves the list of permitted financial instruments.

All these processes and this is far from an exhaustive list are aimed primarily at soundness of people’s pension savings. The pension asset management policy is moderately conservative. It is worth noting that during this period the quality of pension assets management has significantly improved, the share of risk instruments has decreased, the profitability of pension assets has increased in comparison with inflation. At the same time a gradual decline in activity on the domestic stock market has been observed. This is due to limitation of access to pension assets of market participants who do not have the appropriate ratings. As I have already said, proposals are now being developed to introduce pension asset management companies into the structure of the pension market; and they, in my opinion, can give a new impulse to the stock market development in general.

- Kadyrzhan Kabdoshevich, how can you assess the state of the Kazakhstani pension system today, 20 years after the reform? Did we succeed in achieving the set goals?

- It is too early to assess the system solvency, as it should take more time than 20 years, the same period at least. Any system should come the full cycle so we are able to evaluate its effectiveness and accurately answer the question of achieving the goals set 20 years ago. If we talk about intermediate results to date, it should be noted that the multi-tier pension system has been functioning successfully and has already confirmed the correctness of the made choice.

In addition to creating a fair pension system, the reform had to solve a number of economic problems, including reducing the burden on the state budget. The accumulative pension system coped with that task. Therefore, today there is no need to drastically deviate from the existing pension model, the principles of which, in fact, are fair. Besides, Kazakhstanis gradually realize that the future pension largely depends on them. There is now a positive return on investment of pension assets, which has a positive impact on the savings increase.


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