Ukraine spends 12% of GDP on pensions; this has to end

Ukraine’s pension system has long been a fiscal time bomb threatening the country.

And recently, the ticking got louder.

Today, the ratio of Ukrainian workers to pensioners is roughly 1:1, compared to typical ratios of at least 3:1 in Western economies. And in Ukraine the ratio is continuing to worsen due to low birth rates and migration.

As a result, in 2017 pensions will swallow up 35 percent of the country’s $40-billion state budget, or 12 percent of gross domestic product, which is way above the European average of 8 percent.

More alarmingly, the pension burden has been increasing at an even higher pace than expected. Back in 2008, the World Bank estimated that the number of pensioners in Ukraine would reach parity with the number of workers in 2020. In fact, this happened in 2014.

At the same time, even this huge amount of budget spending is only enough to provide the population with a paltry average pension of $70 a month, pushing millions of retired Ukrainians into poverty.

The Ukrainian government, urged on by the International Monetary Fund, has been trying to find a way out of the pension crisis.

But all the possible solutions will prove painful.

Proposed changes

The Ukrainian government in May drafted a package of pension laws that aim to raise pensions and cut the burgeoning $5.7 billion deficit in Ukraine’s pension fund.

While the average monthly pension in Ukraine is currently just $70, two thirds of the country’s 12.3 million pensioners get even less than that, while some categories of pensioners, including military officers and judges, qualify for much more generous retirement payments.

Currently, retirement pensions are calculated as a share of the average wage that the pensioner used to make while in the workforce. But because of Ukraine’s sky-high inflation, the average salaries of 10 or even five years ago are petty, and the pensions that were calculated from them are even smaller.

The government now proposes to peg pensions to the average wage, so that pensions automatically grow together with average salaries.

The parliament plans to adopt new pension laws before October. It would cause an immediate increase in pensions by a modest Hr 284 ($10) a month on average, while increasing annual expenditure on pensions by Hr 12 billion.

The increase in the minimum wage from the start of 2017 has already helped the pension fund collect additional revenues of Hr 7.9 billion from January-April, and it is expected to get Hr 4 billion more by October.

Ukraine’s pension fund deficit is the second largest in Europe, estimated at 6 percent of GDP. The beneficiary-to-contributor ratio is 1:1 because of Ukraine’s low retirement age (60 for men; 58 for women). Tax avoidance is also high, contributing to the deficit. Benefits are low for the 12 million pensioners with the average monthly payment being just $70.

Age battle

Currently, the retirement age in Ukraine is fixed at 60 years for men and 58 years for women – some of the lowest in Europe. In the United Kingdom, for example, workers typically retire at the age of 65 to 67.

The International Monetary Fund, as one of the conditions for the approval of its $17.5 billion loan to Ukraine, has been demanding that the country raise the retirement age to 63 years in order to help cut the pensions burden.

But Ukraine isn’t complying. Raising the retirement age would be a very unpopular move, and with the next presidential election being only two years away, politicians are reluctant to take it.

So the government came up with a compromise. The pension legislation that it proposed will not raise the retirement age, but instead raise the time spent in the workforce that is required to qualify for a pension: from the current 15 years to 25 years immediately, and gradually to 35 years in 2028.

If a person decides to push the retirement back and retire at 63 instead of 60, they will require 10 years of service less to qualify for a pension.

The government’s pension reform also improves conditions for people who have reached retirement age but are still employed. The draft law drops the current 15 percent cut in their pensions and cancels tax payments on large pensions.

Despite the fact that the government’s pension reform doesn’t meet all of the international donors’ recommendations, both the IMF and the World Bank have publicly backed it.

But Hryhoriy Ovcharenko, the head of local assets management at investment bank Investment Capital Ukraine (ICU) believes that even though both of Ukraine’s main international donors are avoiding criticizing the government’s plans, it doesn’t mean they are happy with its departure from their recommendations.

And the draft legislation was left unpublished weeks after it was presented by Prime Minister Volodymyr Groysman, probably due to the sensitivity of the issue among the population, Ovcharenko believes.

Why the hurry?

There are 11.9 million pensioners in Ukraine, which has a total population is 42 million people. Some 9 million have reached retirement age, while others receive other types of pensions.

All pensions are paid by the state. The funding for them comes from the “social tax” paid by the workforce, which is 22 percent of a worker’s salary.
However, the government says that 25 percent of the working population of 16.3 million people fail to pay the tax.

Besides, the current pension system provides privileged pensions for some categories, including military, judges, and workers involved in hazardous activities. This creates a disparity between the 20 percent of retirees who receive the privileged, much higher pensions, and the rest.

One of the main goals of the government’s pension reform plan is to reduce the pension fund deficit. According to Groysman, if the pension reform is carried out, the funding burden will from 6 percent of GDP to 3 percent over the long run.

Cosmetic change

All the same, experts doubt the current government pension reform will do much to fix Ukraine’s pension system. Ovcharenko of ICU says that while it includes two contradictory goals – increase pensions and shrink pension fund’s deficit – the pension reform draft can be nothing more than a “social initiative for the electorate.”

In the short run, pensions will increase, but in the longer term they will start to shrink again, the analyst says.
Mariana Onufryk of Institute for Social and Economic Research called the government’s plan a “cosmetic reform,” as it adds minor changes to the existing pension system, which is outmoded and needs overhauling.

She supports the introduction of accumulation plans via non-government pension funds – a measure not mentioned in the current pension reform draft.