BUDAPEST - Hungary is speeding toward creating a mandatory private pension system, but the new system will not provide a long-desired shot in the arm to domestic stocks.
Two factors will limit the boost the system will give the Budapest Stock Exchange: a lower than expected contribution rate and a required minimum return that will steer investments to the fixed-income market.
"The benefits for the stock market will be less than what we expected," said Peter Holtzer, an associate, fund management, at Creditanstalt Securities Ltd., Budapest.
Nonetheless, Hungary will be the first of the former Soviet bloc countries to reform its pension system and the second European country after Switzerland to have a mandatory private system. Poland is hoping to follow Hungary's footsteps but parliamentary elections this fall might block its path. Later this month, the Hungarian government will send the bill to reform the country's pension system to Parliament. The bill, scheduled to take effect Jan. 1, is expected to pass because Hungary's ruling coalition holds 72% of the Parliament's seats.
The bill will divert an estimated $1 billion annually into private funds in the first few years from the state pension system. While that certainly is a substantial sum, it is less than what was expected.
An earlier version of the bill would have required employees to put 10% of their salaries into private funds but the level was trimmed to 6%. Employee contribution rates will, however, rise to 8% of pay by 2000.
Employers will continue to put 30.5% of workers' salaries into the state pay-as-you go system, but nothing into the new system.
"The drop (in contribution rates) means there is less money in the capital markets, less money for investing. That's not good," said Adam Gere, managing director of Sedgwick Noble Lowndes Kft., Budapest.
Minimum return required
The bill also says the private pension funds will be required to provide a minimum guaranteed return. It is still to be decided how the guarantee will be set or how high it will be, although it might be pegged to treasury rates.
Analysts agreed any type of return requirement will push money managers into the less volatile fixed-income market.
"The guarantee sets a herd mentality," Mr. Gere said.
Tibor Parniczky, vice president of the Supervision of the Voluntary Mutual Benefit Funds, a government agency leading the reform, defended the country's decision to institute performance guarantees.
"These are mandatory funds that have a social security role so they need to be very secure," Mr. Parniczky said. "We want a smooth performance."
The irony is that many government and market officials had hoped the new pension system would create a substantial domestic investor base, to relieve the stock market's dependence on the whims of foreign investors.
Of course, some of the $1 billion in annual contributions will find its way to the Budapest Stock Exchange, but the flow would have been larger without the restraints, said Keith Exall, manager-Central and Eastern Europe, William M. Mercer Ltd., Budapest.
Some domestic savings are going to Hungary stocks. In late 1993, Hungary passed legislation to establish Voluntary Mutual Benefit funds - a form of long-term savings. There are 197 voluntary funds in Hungary with $153 million in assets.
Mr. Parniczky noted these funds can invest 60% of their assets in the domestic equity market but only have put 10% of their money there. Another 5% can be invested in international securities.
It has yet to be decided what percentage of the new mandatory funds' assets will be to be invested in equities and to what extent international investments will be allowed. Funds that don't meet the minimum return will have to compensate for the shortfall out of their own reserves.
Meanwhile, Hungary's stock market has been a very attractive investment. In 1996, the BUX index skyrocketed 125.66% and in the first two months of this year it rose 32% to 5462.88.
Pooled funds to be created
The new system is expected to create about 50 large investment funds with no fewer than 2,500 employees in each. A few large employers could set up their own funds, but in most cases individuals will select in which fund they will invest.
Mr. Holtzer said Creditanstalt will open a fund, but the minimum return requirements will make it tougher for the players to stand out in terms of performance. Tight margins might limit the number of players entering the field, he said.
"The only strategy for differentiating oneself is price and that's not good for the market," Mr. Holtzer said.
All new entrants into the job market are required to participate in the new system while those under age 45 can opt to join. However, Mr. Parniczky said the bill discourages workers from switching because if too many people choose the new system, it will put more pressure on the state's pension system which had a $262 million deficit last year.
Mr. Parniczky said the deficit this year will exceed the budgeted $96 million. The pension bill will cause the deficit to soar to $395 million in 1998 and the deficit won't start to go down until 2020, he said. However, he said the shortfall caused by the reform will be financed through government paper that will be sold to the new pension funds.
Poland's reform efforts
Like the Hungarian system, Poland's state pension system would go bankrupt if it is not changed. But it is still unclear if reform will be pushed through before parliamentary elections this fall. A draft bill is expected to be finished by early April.
"This is bad timing for such a project. It is possible to get reform done before the elections, otherwise it will get put in everyone's political propaganda," said Stanislava Golinowska, an economics professor at Warsaw University.
Even if the bill is adopted before the fall, reform wouldn't be instituted in Poland until 1999 because more groundwork that needs to be laid. There are no private pension plans in Poland.
Moreover, Poles don't contribute to their own pensions now. Under the new system, they would pay an estimated 10% of their salaries into the private funds.
Currently, employers contribute an amount equal to 48.2% of workers' salaries into the pay-as-you go system. That amount will fall under the new system but it is unclear how substantial the drop will be.
Iain Batty, an attorney at the London-based law firm of McKenna & Co. who helped draft the Polish law, said it has yet to be decided if everyone under 30 will have to participate in the new system or if it will be only new entrants into the workforce.
Either way, he estimated about $3 billion annually will pour into private funds in their initial years. He added Poland might compensate for the money being diverted from the pay-as-you go system through revenue from the sale of convertible bonds issued by some of Poland's leading state-owned companies, such as Telecommunications Polska SA, state airline Lot, and state-owned banks. In five to seven years, the bonds would be convertible to shares.
Mr. Batty expects the reform to benefit the Polish stock market. Although some type of minimum return is being discussed, it is likely to be far more flexible than the Hungarian standards, he said. Polish funds would be required to ante up money only if their performance is dramatically below the average, he added.
"This will have a substantial scope for the domestic equity market," Mr. Batty said.
