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‘The World Bank ‘Washington, D.C. 20433, USA, ‘SHIGEO KATSU Fax. (202) §22.2758 May 12, 2009 Mr. Peter Socha, President Mr. Viktor Kouril, Vice President ADSS Bajkalska 30, P.O. Box 86 820 05 Bratislava 25 Slovak Republic Dear Messrs. Socha and Kouril, ‘Thank you for your letter inquiring about the World Bank’s recommended measures for financing the fiscal deficit of pensions systems as a result of the global economic and financial crisis — a topic addressed at the Pensions Conference held in Bratislava on May 4, 2009. The list of possible measures to address the fiscal deficit of pension systems were reviewed in the presentation made by Zoran Anusic, World Bank Senior Economist, with a careful consideration of their advantages and drawbacks. Here are the main points of this assessment: - The preferred source of financing the additional short-run PAYG deficit is to reduce expenditures elsewhere in the pension or central budget or to resort to borrowing, where feasible: - Temporary second pillar rate reduction has been considered by some countries as a source of financing PAYG deficit. While this measure would bring extra revenues to the first pillar in the short run, it would also generate sizable additional expenditures in the long run, increase the implicit public debt and, especially if prolonged, undermine the credibility of the second pillar and the development of long term instruments in the capital market. On the whole, therefore, there are more arguments against second pillar rate reduction than in favor; - Opening of the second pillar for exit to all contributors and new entrants, already done by the Slovak Republic, is a measure with significant costs over and above those enumerated above for the temporary rate reduction. These include the irreversibility of decisions made by individuals based on short run developments when pension policies and the structure of pension systems should be based on long run considerations; -2- May 12, 2009 - Simultaneous introduction of voluntary opt-out from the second pillar and reduction of the second pillar rate would seriously undermine the viability of the second pillar and, in the case of Slovakia, damage the long-term fiscal sustainability of the pension system. In summary then while we understand that countries under severe fiscal duress and few other options may need to resort to sub-optimal responses, we have serious reservations about prolonged second pillar rate reductions, especially when combined with a voluntary opt-out option. Our broader messages are twofold. We would advise governments 1) to avoid the temptation to respond hastily and make decisions now that are better made once more information is available on the depth and the duration of the economic downturn; and 2) to keep the focus on the long run challenges of putting in place a fiscally affordable pension system given the demographic trends in Slovakia and many other countries in Central and Eastern Europe which would require parametric changes to PAYG pillars. Finally, we believe that the rationale for multi-pillar pension systems is as strong as ever, with the case for risk diversification as a critical feature of pension systems having received a further boost in light of the global crisis. Let me add in closing that we will soon be finalizing a note on pension systems in crisis in Eastern Europe and Central Asia, following a regional conference that was held in Brussels on May 8. The note will further explore the issues that I have touched upon above. In the meantime, you might be interested in consulting the recent World Bank's Pension Primer Note that provides additional details. I attach the link below: http://siteresources. worldbaik.org/INTPENSIONS/Resources/395443- 1121194657824/PRPNote-Financial_Crisis_12-10-2008.pdf Sincerely yours, ————— eS a Shigeo Katsu Vice President Europe and Central Asia Region