Closing the pension gap

The World Bank says China faces an unfunded pension shortfall of US$900bn, which would amount to three quarters of the country's GDP. Economists at the Washington-based institution have a penchant for making heroic projections of future numbers.

The Chinese Minister of Labor and Social Security, Zheng Silin, has put the figure at RMB2.5trn, or US$300bn. That is bad enough. It is a headache for the authorities now growing into a migraine. And it is no consolation that the ailment is shared by governments in Western economies as well as in much of Asia. We are all getting old and have not been reproducing ourselves quickly enough.

China's situation, as usual, is more complex. The one-child policy, in place for a quarter of a century, is leading to the so called 4-2-1 formula. The prospect of having to help support four grandparents and two parents is daunting for today's 25-year-olds. Privatizing of state companies and dubious accounting among many SOEs has seen unrealistic 80% retirement pension expectations retreat into a mirage. The problem is exacerbated by the migration of farm workers, who are historically outside any pension system, pouring into the cities at the rate of 90m a year.

There are already some 48m city dwellers of pensionable age. Official forecasts are for those numbers to grow to 70m million by 2010 and top the 100m mark by 2020. By then, China's urbanization rate is expected to be approaching 60% or close to 900m people.

The Beijing State Council issued directives in 1997 which envisaged the provinces taking the weight of pensions paid out of a social pool funded by employers and workers. It soon became apparent that this pool was being drained by payments to existing pensioners and there was not enough in the kitty for newcomers. Some provinces were "diverting" billions of yuan by dipping into the personal accounts of working age people to support those already retired. It became clear that more capital had to be transferred from the coffers of central and local governments and state assets converted into cash.

In 2000, a National Social Security Fund (NSSF) was set up, headed by former finance minister Xiang Huaicheng, with the mandate of helping address the gross under-funding of pensions. It gets its money from several sources, including the Ministry of Finance, the national lottery and, importantly, 10% of the cash raised in any IPOs by Chinese companies on international stock markets.

The initial plan was that nearly 10% of China's state assets, then worth about RMB12trn would be transferred to the NSSF over a period of five years, and would swell sufficiently to head off the scary demographics of future pension needs. But this super welfare fund is not shaping up. As of the end of 2004, it had just RMB170bn under management. During the year, it earned a yield of only 3.32% on its investments – less than the rate of inflation.

There are a number of possible reasons for this slow start. Among its first equity investments were shares in Sinopec, the second-biggest state oil company. Sinopec got off to a rocky debut when listed on the Shanghai Stock Exchange in August 2001 – ironically because of a steep fall in the market partly triggered by fears of sales of state shareholdings. China's equity markets, save for a few flurries, have been in a protracted decline since the establishment of the NSSF. More than one third of its assets are on bank deposits and the bulk in fixed interest instruments favored over domestic stocks. The fund badly needs some oomph that can only come from investing in overseas financial markets. At the same time, it must be risk averse and have an ultra long-term outlook.

China gave the green light early last year for selected institutions to invest abroad. The markets are still keenly waiting for regulations to be promulgated for the proposed qualified domestic institutional investor (QDII) program. It is now anticipated that this will happen before the end of 2005 and that the NSSF will be among the first cabs off the rank. Naturally there would be a stampede of foreign money managers and bankers anxious to help them out. Most will be disappointed. Xiang Huaicheng has indicated that only one or two large financial institutions will be initially appointed to hold the towel while the fund dips its toes into overseas bourses.

Some observers are getting concerned about the role of the NSSF, which is billed as the fund of last resort as far as pensions go.

It is administered separately from the local social security funds which are overseen by the local governments and the Ministry of Labor and Social Security. That should mean being ring-fenced from demands to meet competing welfare needs and losing focus

The NSSF remains experimental, but it has raised interest internationally. It may have been among the models studied when the Australian government assembled its soon to be launched Future Fund. This is needed to pay for the unfunded superannuation liabilities of federal public servants and politicians, i.e. themselves.