BUDAPEST, Hungary -- The Hungarian government may reverse key elements of its 18-month-old pension reform, which could hurt the country's fledgling private pension funds as well as Hungary's relationship with the World Bank.
The Hungarian government is promoting a proposal that would convert the new pension system into a voluntary program for new entrants into the work force, undoing a requirement that they join the privately managed system.
A policy reversal by Hungary could jeopardize a pending request to the World Bank for a $150 million loan to finance health-care reform. A change also could undermine investor sentiment in the Central European country, which already has been weakened by its rising budget deficit.
"It would send out wrong signals" if Hungary changed course now, said Iain Batty, partner in the law firm of Cameron McKenna, Warsaw, Poland. "The privately funded second pillar is a key element of reform through the region. Hungary was the first country to implement the reform. It would be a shame if they backed away."
To a large extent, Hungary is a victim of its own success.
In 1998, 1.4 million Hungarians opted to join the new system -- well above the government's anticipated level of 800,000. Consequently, the deficit of the National Pension Fund -- the state pay-as-you-go system -- is larger than expected.
Last year, government officials projected the pension deficit would reach 20 billion forints ($84 million), but the actual figure was closer to 60 billion forints. Officials reportedly have said the deficit will hit 60 billion forints this year; observers fear it will be worse.
The new private pension system was ushered in on Jan. 1, 1998. It requires employees to put 6% of their salaries into private funds while employers continue to put an amount equal to 30.5% of a worker's salary into the state-run system.
Starting last July, all new entrants into the workforce had to join the new system; everyone else had the choice of joining it or staying put in the state plan.
The government proposal puts an extra marketing burden on the pension funds. Now they will have to advertise not only the benefits of their funds, but also the advantages of the entire system. Moreover, fewer clients means lower fees and higher costs.
"We are going to have less clients because of this," said Peter Zatyko, deputy managing director at Aegon Pension Fund Management Kft. in Budapest.
"This is a question of trust. The government can't keep making changes to the reform and then expect people to believe in the system."
Indeed, the latest proposal follows the government's decision last year not to raise the employee contribution to 7%. Next year, it was supposed to jump to 8%, but that seems unlikely now.
The proposal, which is expected to be introduced in parliament next month, has raised red flags at the World Bank, which gave Hungary a $150 million loan to finance the transition to the new pension system.
The timing of the move is especially troubling to World Bank officials since Poland just initiated a similar pension reform (see related story, page 16). Meanwhile, Croatia just passed a pension reform law and the Czech Republic and Slovenia are discussing ways to improve their systems.
"This could really weaken the (Hungarian) reform. These reforms really need to be nurtured," said Roberto Rocha, principal economist at the World Bank in Budapest.
Hungary's moves potentially could confuse countries considering reform, he added.
Countries considering reform "are going to just ask, 'why change?' How are they supposed to understand Hungary's moves when 1.4 million Hungarians opted for the new system?" Mr. Rocha asked.
Cameron McKenna's Mr. Batty, however, did not think a change by Hungary would affect other central European countries because of differing participation rules.
"Hungary got the numbers horribly wrong. In other countries, they will prescribe more narrowly those who can join the new systems. You won't see the same problems in other countries," he said.
Hungarian government officials did not return calls for comment.
If the government dismantles reform, Mr. Rocha said, World Bank officials may have to consult its lawyers about its options.
Observers do not believe the bank would call in the previous loan to finance pension reform -- especially given more egregious violations made in the Ukraine in Russia.
But a reversal in pension policy could jeopardize Hungary's chances to win a $150 million loan to finance health care reform. "We can't go to the World Bank board with a loan of the same size if pension reform is losing its meaning and character," Mr. Rocha said.
Experts hope the government may abandon this cost-cutting proposal since the resignation of Gabriella Selmeczl, the deputy state secretary who was the chief proponent of reversing reform. She stepped down because of an unrelated government scandal.
However, Aegon's Mr. Zatyko doesn't believe Ms. Selmeczl's departure will make a difference because the government's proposal already has been in the Hungarian press, and Prime Minister Viktor Orban won't want to back down.
There could, however, be a silver lining, at least in the short run.
Charles Robertson, emerging Europe economist for ING Barings Ltd., London, said changing the rules could, in the short term, aid Hungary's current account and budget deficits, both of which are rising.
But, he said, if "the World Bank outwardly criticizes Hungary about not doing enough to sort out the long-term budget problems, it won't be helpful to investor sentiment. And investor sentiment is hardly ideal now."