Bank of Estonia publishes further analysis of pension reforms; IMF warns against changes

The Bank of Estonia (Eesti Pank) has published further analysis of the country’s planned pension reforms, which involves making the second pillar non-compulsory.

Last week the government published its controversial plans to reform the pension system. The planned reforms involve Estonia’s second-pillar system becoming voluntary, while the level of the state pension will be increased. Those with savings in the second pillar will be able to suspend contributions and transfer out to a personal investment account.

In a statement on its website, the bank said it has undertaken a detailed impact analysis of the reforms, building on initial analysis undertaken in October. Eesti Pank governor Madis Müller said the bank remains sceptical of the plans, and stated that the second and first pillar should not be in competition with each other, and instead, work to complement each other.

“More than 700,000 people in Estonia are saving for their pensions through the second pillar, and in future the second pillar is supposed to provide one third of each person’s pension. The first and second pillars do not compete with each other, they complement each other,” he said.

He said that a responsible place to start when changing the pension system would be a description of a quantifiable aim of the changes and their expected long-term impact.

“It has not been explained during the current process of making changes what size of pension the government plans to ensure for the people of Estonia in the future, nor how it should be funded. Such an important issue ought to be widely agreed in society before changes are made to the current bases of the pension system,” he added.

The impact analysis prepared by Eesti Pank in the middle of October found that making funded pensions voluntary could mean that old-age pensions will be smaller in future. It would also increase the pressure to raise taxes in future.

Eesti Pank noted that the approach to changing the pension system that the government has planned may lead to a short spurt of growth in the Estonian economy if a lot of people leave the second pillar. However, this temporary boost would be followed by slower growth or even a recession that would hurt the living standards of people in Estonia.

It also found that Estonian exporters would become less competitive over the years, as the temporary boost to growth in the economy would fade, but labour costs would remain higher than before.

In particular, it has three major concerns that it believes the government needs to address. Firstly, if a lot of people leave the pension funds, it is probable that the funds will have to sell some assets that are hard to dispose of quickly. A quick sale of assets would cause both those leaving the fund and those remaining in it to lose money.

Secondly, after the changes it would be riskier for funds to buy assets that give good returns but are hard to sell quickly. The bank has questioned what certainty can there be that funds would in future buy assets for future pensioners that would be more profitable?

Finally, pension funds have in recent years invested in Estonian companies and played an important role in funding them. Therefore, the bank has asked how the gap could be filled for Estonian companies in the funding that they need to improve their productivity and create new jobs?

The International Monetary Fund (IMF) has also recommended that the government keep the second pension pillar mandatory. Drawing on the experience of other countries, the IMF recommended moving forward very carefully with changes to the pension system.

It considers it important that the long-term impact of the planned pension changes be assessed and that all interested parties be involved in a thorough discussion of the changes.

“The findings of the assessments by Eesti Pank and the IMF are similar. The first and second pension pillars complement each other and are crucial in a country with an ageing population. This discussion affects the savings of 700,000 people. If a lot of people leave the second pension pillar, the pension assets of those who remain in it will probably be reduced,” Müller said.

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