Saturday, Jul 22, 2017, 8:50 AM CST – China

Economy

Pension Fund Investment

Golden Eggs

A new investment policy for China’s basic pension fund is supposed to add value to an undervalued resource. As with any investment, this will only happen if the operation is fair and efficient

Seniors work out at a park in Beijing, August 24, 2015 Photo by CFP

"Is my nest egg safe?”

This is one of the main questions keeping Chinese people awake at night. For most of them, their nest eggs are represented by a national basic pension fund designed to secure the well-being of current and future retirees. According to China’s Ministry of Human Resources and Social Security (MOHRSS), there was an approximate US$547 billion surplus in the national pension fund by the end of 2014, held mainly by banks in the form of demand deposits, the safest option when compared with any other alternative.

However, this national safe deposit box is perhaps not as secure as one would imagine. If the actual value of the fund keeps shrinking, noted Chen Liang, director of the MOHRSS social security insurance supervision department, a cash deposit that today could pay for a bag of flour to feed a family for a few days may in the future only be enough to buy a single steamed bun. In an online video interview with webportal china.com.cn on September 2, 2015, Chen explained that since China’s current pension system was established in the late 1990s, the rising prices of everyday goods and services have outpaced interest rates on pension deposits, thus devaluing them. It is estimated that more than US$90 billion of the fund has evaporated due to inflation, jeopardizing the retirement security of the world’s largest aging population.

On August 17, 2015, the State Council, China’s cabinet, finally decided to turn this fund into a money-making “golden egg” by diversifying investments. Aside from depository products and treasury bonds, investment opportunities with higher returns (and thus higher risks) will now be exploited. MOHRSS deputy minister You Jun, speaking at a press conference on August 28, commented that about US$313 billion of the existing surplus could be used for investment.

Before these golden eggs can be retrieved from bank vaults and placed into other “baskets,” however, pension funds in the hands of some 2,000 municipal and county jurisdictions around the country need to be pooled into provincial accounts. Such a fragmented system will make it almost impossible to maximize investment returns – indeed, it has already hindered the free flow of labor for years. Analysts say the new investment policy provides an “unmissable” chance to create provincial accounts and, ultimately, a national account – a long sought-after goal. Once this breakthrough is achieved, it is also necessary to introduce more competition into the market operations of pension fund investments.

Too Cheap to be Safe

China’s senior population (people aged 60 years and over according to the UN standard) had reached 214 million, or 15.5 percent of the country’s total, by the end of 2014. This number is predicted to rise to 248 million, or more than 17 percent of the total population, by 2020, according to statistics from the China National Committee on Aging. The annual MOHRSS report shows that more than 800 million citizens had joined the national basic pension fund scheme by the end of 2014, a scheme built on contributions from individuals, employers and public funds. The same report states that the average increase in fund expenditures outpaced parallel increases in contributions collected between 2009 and 2014.

As corporate annuities are not provided by most Chinese employers, the basic pension scheme remains the sole source of income for most of the country’s retirees. Pension provision has been on top of the agenda when it comes to the life plans of most Chinese people, and has thus taken center stage during public policy debates.

It used to be widely agreed that bank deposits and treasury bonds were the only ways to secure China’s basic national pension fund. In practice, the majority of funds are channeled into demand deposits, due to both the need for instant access at any time and the limited availability of treasury bonds, which provide higher interest rates than deposits with similar maturity periods.

This concept of security has begun to change in the past few years as consumer prices have risen. For example, after the central bank cut interest rates in August, the current interest rate for national pension fund demand deposits stood at 1.35 percent, while the consumer price index (CPI) rose by 2 percent. This immediately drained about US$3 billion from the fund.

Such contrasts are much more striking when compared with the operation of China’s other two pension schemes. One of these is the national social security reserve, which is fully funded by the central government’s fiscal budget. According to the reserve operator, the National Council for Social Security Fund, which was set up in 2000, the annual average yield from its investments in the domestic and overseas markets was 8.4 percent by the end of 2014, much higher than the 2.4 percent average rate of inflation recorded in the years since the fund’s inception. The average annual yields from the investment of corporate annuity reached 7.87 percent, noted MOHRSS official Chen Liang.

“Keeping money in banks does not mean it is safe,” Professor Shen Shuguang, vice director of the China Social Security Association, told NewsChina.

Other benefits from market-oriented investment of China’s basic pension fund are anticipated. As much as 30 percent of the US$313 billion investable fund surplus will be permitted to be invested in the domestic stock market, giving stock market investors access to a new source of capital that they have desired for years. As Zheng Bingwen, director of the International Social Security Studies Center, Chinese Academy of Social Sciences (CASS), remarked in his September 2 video interview with china.com.cn, judicious use of the national pension fund, which pursues long-term, stable returns, could help smooth fluctuations in the Chinese stock market, where retail investors frequently both hold and trade the majority of shares. Zheng said that pension funds hold 30 to 60 percent of stock market investments in developed economies, while in China this number is less than 2 percent even if all the quotas for the basic fund, reserves and corporate annuities are fully utilized. According to the annual report of the National Council for Social Security Fund, yields on reserve investments in corporate shares exceeded 11 percent by the end of 2014, better than returns on other reserve investments.

Bigger Baskets

In 2007, China’s labor and finance ministries decided to place all local basic pension funds in provincial accounts, which would in theory pave the way for a single national account. However, progress has been slow. “Places with surpluses do not want to see their money used to subsidize places in the same province that have deficits,” Professor Hu Jiye of the China University of Political Science and Law told NewsChina. A similar situation also exists at the provincial level. A reluctance to share remains the biggest barrier to establishing a national account.

Another important factor underlying slow progress in this regard is the reluctance of local governments to lose control of such a huge amount of capital. A CASS report issued at the end of 2014 shows that some of China’s basic pension fund has already been used for purposes other than pension payments. The National Audit Office and media reports uncovered cases in which basic pension funds were spent on local infrastructure projects and government office buildings.

This fragmented system, Hu said, not only increases the risk of corruption, but creates the conditions that could allow local protectionism to be placed ahead of investment efficiency. Recent State Council guidelines clearly state that provincial accounts have to be established for basic pension fund investments which in turn must be commissioned to a national institution. This approach is regarded as China’s last, best chance at achieving the goal of a national account for the country’s basic pension fund. Once local governments gain power over the allocation of funds, it will become virtually impossible to establish a unified national pension fund, Zheng Bingwen told National Business Daily in early 2015. Free movement of labor will be greatly facilitated if all citizens have paid into a unified national account that consolidates all their social security records.

In working towards this goal, some provinces are moving faster than others. The wealthy industrial provinces of Guangdong and Shandong have already commissioned their pension funds operation to the National Council for Social Security Fund. Nonetheless, there remains no timetable for the streamlining of all local funds into either provincial accounts or a national one.

However, the issues of the misuse of money and investment efficiency may remain a problem even after the fund investment is made at the national level. Besides treasury bonds, China’s basic pension fund can also be invested in national-level mega-projects and local government bonds. The efficiency of such government projects, whether funded by the central government or local governments, has long been questioned by market analysts. When such projects fail, losses are borne by taxpayers, and those losses are compounded when the wasted capital is sourced from national pension funds designed to provide for those same taxpayers in their old age. In China, 28 percent of wages are paid into the basic pension fund, a rate already higher than most OECD countries.

Misuse of money, such as spending it on administrative costs, by the National Council for Social Security Fund, which according to existing standards is the only candidate that can operate the basic pension fund investment, was exposed by the National Audit Office in 2014. Professor Shen Shuguang argues that there are many eligible investment institutions in China’s financial market, the products of years of capital market expansion. “What is needed is a set of standards and a risk management system to allow the prudent selection of potential bidders,” he said.

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