Tuesday, February 6, 2018

China's Pension Risk Looms Large?

Bloomberg News reports, China's Next Debt Bomb Is an Aging Population:
China’s pension shortfall is emerging as the next big challenge for policy makers as they intensify their years-long campaign to keep rising debt from derailing the economy.

Aging in the world’s most populous country means pension contributions by workers no longer cover retiree benefits, forcing the government to fill that gap since at least 2014. Pension expenses rose 11.6 percent to 2.58 trillion yuan ($410 billion) in 2016, leaving the government a 429.1 billion yuan tab to cover the shortfall, according to the latest available data from the Finance Ministry.

That shortfall will reach 600 billion yuan this year and 890 billion yuan in 2020 if the system isn’t reformed, according to Wang Dehua, a researcher at the National Academy of Economic Strategy in Beijing. Enodo Economics in London, which has advised policy makers on the matter, forecast last year that it could soar to 1.2 trillion yuan by 2019. The finance ministry doesn’t release estimates.

“China’s biggest fiscal risk is pension risk,” said Wang, whose institute is under the Chinese Academy of Social Sciences, the government’s top think tank. “There are big problems in the pension system if it can only keep operating with large fiscal subsidies.”

The shortfall adds urgency to President Xi Jinping’s quest to stem rampant growth in corporate debt, given the government will need to fund widening deficits of its own in coming years. Leaders may offer an update to the pension outlook on March 5 when they convene for the annual National People’s Congress in Beijing.

While government revenue rose 7.4 percent last year for its first acceleration since 2011, that’s unlikely to keep rebounding amid slower economic growth. That would limit Beijing’s ability to cover the shortfall, which may push policy makers to issue debt to bridge the gap.


“China has been doing so well in many aspects in the past years, but it has really been left behind in pensions,” said Stuart Leckie, chairman of Stirling Finance Ltd. in Hong Kong, a consulting firm for pension funds and asset managers in Hong Kong and mainland China. Though the government may always be able to pay pensions, contributions from employees and companies could rise drastically or payouts may be cut, he said.

Premier Li Keqiang pledged in his report to last year’s congress to increase the allowances. “We will weave a strong safety net to ensure people’s well-being,” Li said. “We will continue raising basic pension payments and see they are paid on time and in full.”

The population is graying quickly. The State Council said last year that about a quarter of China’s population will be 60 or older by 2030, up from 13.3 percent in the 2010 census. Meanwhile, scrapping the one-child policy hasn’t raised birth rates as high living costs deter larger families. Births fell to 17.2 million last year from 18.5 million in 2016.

Still, unbalanced demographic and employment trends may help the economy as they support further rebalancing and consumer spending, Enodo’s Chief Economist Diana Choyleva says.

“China’s graying population is often analyzed in the context of a rising old-age dependency ratio and the strain it implies for the public finances,” she wrote in a report this month. “But it’s worth pointing out that a higher proportion of pensioners, who consume but do not produce, should lead to a structural increase in the share of consumer spending in GDP.”

Those benefits aside, signs of strain are already visible in the pension system, and the deficit is poised to “quickly increase” after 2020, according to Liu Shangxi, director of Chinese Academy of Fiscal Sciences, a think tank affiliated with the Finance Ministry.

The central government said in November that a handful of larger state-owned enterprises and financial institutions would transfer 10 percent of their state-owned equity to social security funds to help ease pension payment pressure. New details haven’t been released.

The Finance Ministry and Ministry of Human Resources and Social Security didn’t respond to requests for comment faxed Monday morning. The MOHRSS has delayed the release of annual social insurance reports, offering a less-timely glimpse into the nation’s pension burdens.

China has been paying retirees with contributions made by the working population since it set up the current pension system in early 1990s. The gap between money coming in and payments going out has been widening as more retire and fewer join the workforce.

“China should encourage individuals to invest more for their retirement to reduce the burden on the government, which can’t shoulder the responsibility all on its own,” said Zhang Bin, a senior researcher at the China Finance 40 Forum, a Beijing-based think tank.
There is nothing new here. Shannon Tiezzi of The Diplomat brought up China’s Looming Social Security Crisis five years ago where she noted:
China’s pension system faces the challenge common to all countries with an aging population: how can the government fund an ever-growing pool of retirees based on pension contributions from an ever-dwindling number of active workers? A report by the Paulson Institute estimates that by 2050, China will have 1.6 active workers for each retiree, a far cry from the current ratio of 4.9 to 1. China is far from alone; the same report estimates that the European Union, Japan, and South Korea will actually have lower ratios of active to retired workers in 2050. However, China’s social security system does face some unique challenges.

For one, the pension systems are generally controlled by provincial or city governments, resulting in a maze of different regulations and standards that serves as a barrier to labor mobility. There are also completely different pension systems for urban and rural workers. Worse, with pension money in the hands of local governments, many been unable to resist the temptation to “borrow” money from current workers’ individual retirement accounts in order to foot the bill for today’s retirees.  According to estimates, individual accounts could be short over 2 trillion RMB (around $330 billion), and might be missing up to 90% of their funds.

All funding problems aside, many Chinese see the pension system as inequitable. “The Decision” tacitly admits this by calling for a “fairer” system. The fragmented nature of the system causes pensions to reflect the preexisting income equalities in China’s rural-urban and coastal-inland divides. Further, Chinese government employees receive a guaranteed pension at levels as high as 95% of their salaries. Workers for private companies receive closer to 40% of their salaries as a pension — after having been required to kick in 8% of their salaries to a retirement fund, a rule from which government employees are exempt. This creates what is known in China as the “dual track system”, where government employees can contribute no money and still expect their pensions to be two to three times higher than those of their private sector counterparts.
I've been discussing China's pension black hole since 2012. In fact, back then I even wrote this:
Demography is indeed China's Achilles heel, placing pressure on policymakers to implement sensible reforms like raising the retirement age.

But China also desperately needs to modernize its entire pension system and create state pension plans that adopt the Canadian governance model, allowing them to invest across diverse public and private investment assets around the world.

The key word here is governance, which admittedly is hard to implement in China where abuse and corruption are rampant.
Exactly one year ago, top executive at Canada's largest pension fund, CPPIB, signed a deal to help grow the fund's relationship with Chinese pension officials and help fix China's pension future.

It isn't by accident that CPPIB recently announced a huge investment in Chinese properties and a firm commitment to grow its public and private investments in China. Canada's largest pension fund is very connected in China and that's actually a good thing.

Still, leaving aside CPPIB's initiative to help modernize China's pension system, the key things that need to be addressed arent' too different from what needs to be done in many other countries:
  • Raise the minimum retirement age to reflect longer lifespans.
  • Bolster public and private defined-benefit pensions.
  • Get the investment assumptions and discount rate right to properly estimate your future liabilities.
  • Get the governance right to separate the operations of pension funds from any government interference.
  • Adopt a shared-risk model which means benefits will need to be cut or contributions raised when pensions run into trouble and experience a serious funding gap. 
  • Consolidate smaller pension plans into a larger plan where it's easier to scale activities and cut costs.
  • Invest across global public and private markets and invest using a long investment horizon.
  • Be ruthlessly transparent about your pension investments and liabilities. Hide nothing and be very open with your public documents.
Now, I realize this is China, not Canada, Norway or the Netherlands, so some of the things I'm stating here are wishful thinking on my part but you'd be surprised at what China can accomplish when its policymakers put their mind to it.

Who else is looking at China's retirement market and salivating? Big North American, Asian and European banks and insurance companies who see tremendous potential to expand their wealth management operations in China over the next 30 years.

All this to say, yes, China has a huge pension problem, one that is getting worse with each passing year, but the situation isn't hopeless if the country starts tackling this problem in an intelligent way, one that incorporates best practices from all over the world.

I will end by stating even though I see economic problems ahead for China over the next three to five years, I'm pretty bullish on its long-term prospects.

Is China perfect? Of course not, no country is and even the US has huge pension problems it's failing to properly address. The global retirement reality is something that affects us all, not just China.

There is a $400 trillion dollar pension time bomb waiting to be detonated and when it goes off, it will impact global growth for a very long time. That's why it's important to discuss these issues openly and come up with the right policies for the future.

I'm sure with the help of CPPIB and other large Canadian pensions, China is on track to address its looming pension crisis. If it doesn't address this issue and chooses to ignore it like the US, it will suffer serious consequences down the road.

My fear is that we are entering a prolonged period of economic stagnation and China will focus more of its attention on short-term growth concerns, less on this long-term pension problem. This would be a grave mistake.

Below, an older clip (2014) from China Forbidden News exposing some of the major issues with China's pension system. Given the source of this commentary, I'd take it with a grain of salt as it's overly critical.

Also, JP Morgan Asset Management Chief Market Strategist for UK & Europe Stephanie Flanders discusses the challenges of China's pension system with Bloomberg's Francine Lacqua on "The Pulse"(2016).

Third, Canada Pension Plan Investment Board (CPPIB), the country's largest pension fund, currently has 4 percent of its portfolio in the mainland — a figure that president and CEO Mark Machin said is too low for a globally diversified portfolio such as his in a CNBC interview last year.

Lastly, Jeffrey Snider, head of global investment research at Alhambra Investments, says China is not booming, which sounds disheartening for commodity investors. He reckons a crucial investment metric has weakened, pointing to slower economic expansion. Watch this clip on BNN here. If he's right, hunker down, slower growth lies straight ahead.


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