Publication: Monitor Volume: 7 Issue: 121

But while higher tariffs may improve these companies’ cash flow, there is no guarantee that Russia’s corruption-plagued financial system will put these rubles to good use. Two other reform measures now being prepared by the government and Central Bank of Russia (CBR) underscore the pitfalls of entrusting Russian financial institutions with more responsibilities. The government’s pension reform program, the first steps of which are to be introduced in 2002, envisions movement away from the tradition system (where retirees’ pensions are funded directly by payroll taxes levied on workers) towards a “fully funded” system, whereby individual workers’ payroll taxes are invested in their own private retirement accounts. The pay-as-you-go system is slated to “wither away,” leaving Russia’s pension fund assets fully in the control of financial markets.

Similar pension reforms were introduced in the mid-1990s in Hungary, Poland and Latvia, and have generally worked well. Demographics and the desire to create new sources of financial capital have driven these reforms. The same is true in Russia: The ratio of employees to pensioners is projected to drop from 2.9 now to 2.3 in 2015, and to 1.0 by 2035. And Russia’s financial system is in desperate need of new sources of capital. But the Central European and Baltic countries have well-regulated, transparent financial systems that afford pension fund managers a variety of domestic debt and equity instruments. These generate the returns needed to finance future pension payouts and keep these systems solvent. Their highly convertible currencies also allow pension fund managers in these countries to invest in government bonds and blue chip stocks issued in New York, London and other international financial centers.

By contrast, the August 1998 financial crisis largely destroyed Russia’s domestic debt market, and the regulation of Russia’s securities markets pales in comparison with market supervision in Central Europe. To generate the returns needed to finance workers’ future retirement incomes, Russian pension funds would have to be able to invest the rubles in workers’ retirement accounts abroad. But such investments would require removal of the CBR’s controls on capital outflows that are ostensibly used to prevent capital flight. In part for this reason, the government and CBR are currently drafting proposals to liberalize foreign investments by Russian pension fund managers. But the poor regulation of Russia’s financial institutions suggests that pension reform could become a new conduit for capital flight, money laundering and other financial malfeasance (Reuters, May 11).