The level of government pension funding may be cause for concern, writes Mike Metelits
The level of funding of government employee pensions, along with the method of paying for these obligations, may be distorting how foreign investors look at the level of indebtedness of South Africa, and thus how they rate our future prospects and currency. The method of funding may also be inflating the government deficit, making government finance more difficult.
The South African government, as a friendly employer, funds the General Employee Pension Fund (GEPF) for public employees. While the level of funding is not written in stone, says Leslie Maasdorp of the Department of Finance, it is currently at about 70%.
The government pays for the GEPF by issuing government bonds; in other words, by going into debt. The current practice is to issue bonds to the Public Investment Commissioners (PIC), the oversight body for the GEPF. This amounts to the government going into debt to itself to pay for its future commitments to its employees in the form of pensions.
But, says Pieter Le Roux of the University of the Western Cape, this has little direct effect on the economy as long as the PIC holds the bonds issued to fund the GEPF.
Le Roux suggests, however, that indirect effects can be troublesome. If the PIC sells the bonds, issued in large amounts, in favour of stocks or other securities, the size and extent of those sales can push bond prices down. When bond prices go down, interest rates go up, and that can have a restrictive effect on economic growth, since high interest rates make it difficult to borrow money.
The PIC has sold bonds to buy stocks to a degree over the last two years.
The second indirect effect might be even more telling. Since the GEPF is funded by debt, pension fund contributions appear on South Africa’s balance sheet, raising the level of debt seen by foreign analysts and investors. In the current environment of scepticism about emerging markets, this can sour foreigners’ view of the local economy.
This effect can be clearly seen through this example: at first glance, Italy and South Africa appear to have the same debt-to-Gross Domestic Product (GDP) ratio, approximately 60%, says Le Roux.
However, South Africa’s ratio includes a large measure of future pension commitments, due to the practice of funding these requirements with government debt.
Italy, by contrast, would have a debt- to-GDP ratio of about 460% if its future pension commitments were included in government debt. So South Africa looks relatively less healthy than it might if the GEPF were funded differently or at a lower level, because the pension fund contributions are “on-book” as debt.
An alternative model of pension funding is Pay-As-You-Go (PAYG), in which the funding of pension benefits is delayed until an employee is eligible for those benefits.
A number of countries now use PAYG systems to fund pension benefits, but a great deal of controversy exists about its relative merits as opposed to the current funding system. Public employees’ unions, like the Public Servants Association (PSA), oppose the idea strongly.
In an article, Caspar van Rensburg, the association’s head, suggests that the delay of funding pension benefits allows the long-term obligations to employees to be overshadowed by spending of the short-term savings to government. It may also place a massive tax burden on future generations to pay for unfunded but obligatory pension benefits.
While any uncertainty in pension benefits is to be avoided, it seems clear that a PAYG system would produce several benefits from the government’s point of view.
First, a more accurate debt structure might improve South Africa’s standing in international debt and currency markets, as investors and analysts get a picture of the country’s debt which is more in line with international conventions.
Second, the government deficit will be lower. In 1994, the deficit was 6,4% of GDP, while if a Pay-As-You-Go system were in place, it would have been 2,9%, according to a report by Dave Mohr of Old Mutual.
A lower deficit makes government finance easier, and improves the impression analysts get when examining our economy.
Nonetheless, employee and union worries over PAYG systems have some force, and negotiations over these issues can be thorny. Neither the Department of Public Services and Administration negotiator nor the PSA could comment on those issues.
It seems that while a full PAYG system might be unacceptable to unions, the current level of funding is having a negative impact on the perception abroad of the South African economy, and perhaps on interest rates as well. Clearly, some kind of compromise will have to be reached, perhaps by funding employees’ pensions at a lower level, or by finding alternative means to keep the GEPF afloat.