(Bloomberg) -- As the debate over Chile’s pension reform drags on... and on... and on... the black hole at the center of the country’s capitals market that it’s meant to fill is just getting bigger.
Lawmakers are resuming debate over the pension bill this month amid disputes over the destination of funds raised through a new levy on wages, charged to employers. But after almost a decade of discussions over similar changes, frustration is mounting.
The issue is becoming more urgent due to capital flight out of the country totaling about $23.9 billion in the last five years, which has drained the pool of cash available for investment. Around $3.3 billion of that left in the first 10 months of last year. People have pulled money out of Chile following a wave of riots, attempts to change the constitution, economic stagnation and the pandemic. An increase in savings through pension reform is needed to fill the void.
“There is a certain pressure for this to be resolved as quickly as possible,” said Felipe Alarcon, an economist and external advisor to Santiago-based insurer Euroamerica. “The cost of financing has been increasing basically because the market has shrunk, so it is vital to recover that.”
Volume traded in fixed income assets in 2024 was at almost 60% of what was observed before the pandemic, according to Antonio Moncado, senior economist at Banco de Credito e Inversiones.
Also, a weaker capital market reduces the ability to face external shocks, in a context where higher global interest rates are negatively affecting the value of local assets, Moncado said. “Higher rates prevent greater growth in private investment due to higher financing costs, affecting the recovery of activity and deteriorating the capacity for long-term growth.”
One of the biggest set-back in talks over the pension bill came after the right-wing Republican Party objected to any of the new funds going to pay existing pensions. That caused a split on the center-right, whose support is needed to pass the legislation.
As negotiations resume this month, the government hopes congress can approve the bill before the country goes to the polls in November.
Global Model
Chile’s pension system, created in 1981, has become a reference point for reforms worldwide. People pay 10% of their wages into a personal savings account that they can only tap on retirement.
The beauty of the system is that it reduces the burden on the state that stems from a falling birth rate, and pushes up the savings rate required to finance investment.
The problem is, the system simply didn’t generate the savings required to pay decent pensions. So, for almost a decade, governments from the right and left have debated changes, including a new 6% levy on wages, charged to the employer.
But the issue has become more urgent after Chileans made one-time withdrawals from their pension accounts totaling about $50 billion during the pandemic. At the same time, political tumult meant much of the money that was still saved was taken out of the country in capital flight.
Savings as a percentage of gross domestic product has risen since the pandemic, but it is “still far away” from what we need, Alarcon said. “Apart from what is normally collected, we need that to be accelerated, and that is why it is vital that the reform be passed as quickly as possible.”
Finance Minister Mario Marcel recognized this issue in an event last month when asked about the weakness of the capital market. “We have to look for ways to increase savings volumes, and the pension reform is in line with that,” he said.
Lawmakers have also been discussing the possibility of a portion of the additional contributions to go towards improving pensions for current retirees.
Savings Boost
According to a report by the Finance Ministry dating from November 2022, the new pension bill would increase the stock of assets of pension funds invested in the domestic market from 27% of GDP to about 33.3% in 2030 and close to 61% by 2050.
That would boost economic growth by 1.1% a year in the long term, the report said.
But the report failed to inject urgency into the debate and the discussions have dragged on. The chamber of deputies rejected the new 6% levy on wages in a vote last year, forcing the government to reinstall the proposals in the senate. The government and the opposition are now negotiating the text at the senate.
A BCI report published last week had an even brighter outlook. In the event that all of the additional 6% levy on wages goes to individual savings accounts, the reform would restore Chile’s depleted capital market by 2030, with assets under management equivalent to 126% of GDP — similar to what advanced economies currently have. However, this is the most unlikely outcome as the government opposes to fully allocate the extra savings in personal accounts.
“A scenario where the individual contribution increases from 10% to 13% under the current administration system through 2028, pension fund assets would recover pre-2019 levels by 2030,” Moncado said.
A 1% increase in individual savings accounts would add 1% to the rate of private investment over GDP in the long run, while raising the GDP growth trend by 0.1%, according to the report. Without a reform to the pension system, recovering the assets managed by the system to pre-pandemic levels will take about 20 years, BCI economists wrote.
“We are going to advance this pension reform now in January,” President Gabriel Boric said in an event Monday, when he addressed the urgency to improve payouts to retirees. “We are in the final stretch to reach an agreement. There are many things we have already agreed on, but we still have the last mile.”
--With assistance from Matthew Malinowski.
(Updates with President Boric’s quote in last paragraph.)
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