The Cost of Reforming Pensions in El Salvador

By Rocio Campos, International Budget Partnership— Mar 10, 2015

Salvadoran workers have lost hundreds of millions of dollars in interest that the government should have paid on state pensions, according to a recent decision handed down by El Salvador’s Supreme Court of Justice. Despite interest rates on private savings averaging around 7 percent, the government has paid just 1 percent interest on public pension savings. Between 2007 and 2013 alone, this would have meant an additional USD 930 million being paid into the state pension system.

This shortfall prompted the Workers Committee for the Defense of the Pensions Funds (WCDP), a group made up of union representatives, to take legal action. The Supreme Court ruled in their favor, finding that the low interest rate for pensions is unconstitutional and jeopardizes workers’ social security. The court ordered the government to increase its pensions budget, adjust the interest rate,  and amend the Law on Pensions Savings System and the Trust Act (Ley del Fideicomiso de Obligaciones Previsionales) accordingly.

By increasing the amount of money that the government pays into the state pension system, the court order could have significant fiscal implications. The strain on the budget from the decision could be compounded by other issues threatening the health of the pension system and put pressure on spending on other social services.

Debate and Proposals
State pension reform, and the impact it could have on the amount of funds available for other public services, was a big topic of debate at a forum on social spending in El Salvador organized by IBP last year. To widen the conversation beyond government, the event brought together academics, civil society representatives, the media, and policymakers to discuss the future of public finance in El Salvador. Earlier this year David Morales, Attorney General for the Protection of Human Rights, hosted an event on human rights and social security during which participants urged the government to build a fair and sustainable pension system that prioritizes equity and justice.

Since these events, more voices have joined the debate. This includes those looking to mitigate the fiscal impact of the court decision and those looking to bolster pensions for workers.

The nonprofit organization Fundación Dr. Guillermo Manuel Ungo (FUNDAUNGO) suggested that the government should gradually raise the interest paid on pensions by 1 percent a year, to stagger the impact of the increase on the public purse.

On the other side, WCDP, in a proposal submitted to the legislature, is pushing for more aggressive action to be taken. They are calling for the interest paid on state pensions to be based on the interest rate set by the Central Bank plus an additional 3.5 percent. In today’s market this would mean an immediate increase of 8 percent.

The Costs of Reform
Mauricio Choussy, the former president of the Central Bank, has estimated that each extra percentage point paid in interest on pensions could add as much as USD 40 million to the annual budget. Data released by the Financial System Superintendence (Superintendencia del Sistema Financiero) support Mauricio’s estimate.

El Salvador’s total budget in 2014 was USD 4.6 billion, with 874 million spent on education, 555 million on health, and 431 million on pensions. Assuming the figure of 40 million is accurate, even a 5 percent increase in the interest paid on pensions would add USD 200 million to the annual budget.

Moreover, there are other mounting pressures on the pension scheme to consider.

A recent paper by the think tank Fundación Salvadoreña para el Desarrollo Económico y Social (FUSADES) highlights the growing gap between present spending levels and anticipated needs: the need to expand coverage to those employed in the informal sector; increases in life expectancy driving a growing number of retirees; and a current fiscal deficit that would be unable to sustain sudden debt increases.

The Way Forward
Legislative and municipal elections were held in El Salvador earlier this month. While the winners have so far not been confirmed, the new legislature faces some tough choices on state pension reform. How quickly the interest paid on state pensions can be brought in line with a fairer rate will inevitably involve tradeoffs with spending on other social services. As such, it is impossible to separate the pension debate from a wider debate on budget priorities.

More importantly, it is crucial that Salvadorans understand that the pension debate is not only a concern of retirees, but of all Salvadorans. Civil society across sectors must participate in a frank public discussion on the tradeoffs between implementing a fairer pension scheme and maintaining other social services.

The pension debate asks some tough questions on what the priorities should be for public spending, the answers are likely to affect the country far into the future.