As expected, the president of Argentina formally announced yesterday that she would be sending a bill to Congress to re-nationalize the social security system, which was partially privatized in 1993.
Actually, the counter-reform of the pension system has been going on since the beginning of last year. First, the government incorporated 1.3 million new pensioners into the public, pay-as-you-go system (PAYG) via a moratorium that gave workers the right to collect a minimum pension despite not having contributed during most of their active lives.
Then, the government allowed AFJP affiliates to opt out of the private capitalization system back into PAYG. To encourage the transfer, the Social Security Administration (ANSeS) improved the PAYG defined-benefit formula from 0.85% of pensionable wage per year of contribution to 1.5%, whereby “pensionable wage” is defined as the average of annual earnings obtained in the last 10 years prior to retirement.
Yet, despite the government’s aggressive move to revitalize PAYG, few people chose to shift voluntarily prompting the Nestor Kirchner administration to rule that, in the case of workers subject to special regimes, such as teachers and security forces, or who had accumulated less than AR$20,000 in their private accounts, the shift to PAYG was mandatory. In this way, the government was able to show an improvement in the cash flows of ANSeS at the expense of burdening the government with more contingent liabilities payable over the distant future. Moreover, the government computed the once-and-for-all transfer of assets from individual pension accounts as an “above-the-line” revenue item, hence inflating the 2007 primary surplus to the tune of 1% of GDP.
Now, it is the turn of Ms. Kirchner to go for the full monty. Using as excuse the fact that the prices of some of the assets managed by the AFJPs (mostly government bonds) have declined since the start of the international financial crisis, the government decided to kill the capitalization system altogether. Ironically, this decision has caused the price of government bonds and corporate stocks to fall by 17% and 11%, respectively.
The Effect on Government Finances
The quantitative effect of the re-nationalization of the social security system on government finances has two dimensions: flows and stocks. At the flow level, the transfer of funds from the AFJPs to the government represents AR$1bn/month (AR$12bn or US$3.5bn/year), as this is the amount of personal contributions the AFJPs were expected to collect this year. This substantial figure (equivalent to 1% of GDP in new taxes) will, in all likelihood, allow the government to close the financial gap it would otherwise have had in 2009 by increasing the primary surplus from 2% to 3% of GDP.
In terms of stocks, the effect is also very significant. By the end of September of this year, the AFJPs were managing the equivalent of US$30bn. More than half of this amount (AR$16bn) was invested in government debt. As these assets are transferred from the AFJPs to ANSeS, the government will be able to rollover interest and amortizations coming due in the next few years (about $3bn per year) without having to negotiate market conditions.
Of the remaining portfolio, US$3.4bn were invested in stocks, US$2.5bn in cash and bank deposits, US$1.8bn in foreign bonds, and the rest (near US$6bn) in less liquid domestic assets. The transfer of these assets to ANSeS will allow the administration to create space for its own financing between now and 2011 by gradually replacing them by government debt.
The Effect on Capital Markets
The counter-reform of the pension system does not only compromise the already soiled reputation of the government of Argentina as debt payer and guarantor of financial security, but represents a massive blow to the development of capital markets.
On the one hand, the measure amounts to yet another massive confiscation of private wealth, following the trend initiated in 2002 with the freezing and pesification of deposits, the default and subsequent unilateral restructuring of the external debt, the repudiation of bilateral investment agreements now under litigation at ICSID, and the adulteration of the CPI, which amounted to an implicit default on domestic public debt.
On the other hand, given the important role the AFJPs have played in terms of creating an institutional demand for corporate paper, Argentina has taken a giant step back in terms of capital market development and financial deepening.
Will the Bill Pass in Congress?
We believe that the bill has a high probability of passing, albeit not without some debate. Regrettably, there are more congressmen who favor going back to the old system of PAYG than improving the existing capitalization system.
The opposition will probably want to make sure that: (a) some of the benefits accrued by the federal government will also accrue to the provinces; and (b) the funds transferred to ANSeS will remain in ANSeS rather than be disposed of by the Treasury. On the first condition, we judge that the government will have no alternative than to compromise. On the second condition, we think that the government will promise that the confiscated assets will be placed in a Social Security Fund to serve as guarantee for future pension payments. But, in reality, one cannot talk of a “guarantee fund” for a public PAYG system if all its reserves are invested in public debt, as will likely be the case.
In terms of credit risk, the effect of the re-nationalization of social security is two-fold. On the one hand, the combination of flow and stock revenue effects reduces the need for debt restructuring in 2009, 2010 or 2011. On the other, the legal and contractual implications increase the uncertainties regarding the government’s willingness to honor its obligations. Whatever the expectation of the authorities, the reaction of domestic markets in the past two days indicates that investors have clearly paid more attention to the second effect than to the former.