Bolivia: Capitalization, Pension Reform and their impact on Capital Markets

1. Bolivia: Capitalization, Pension Reform and their impact on Capital Markets By Pablo Gottret, Ph.D. 13th Plenary Session of the OECD Paris, France September, 1999

2. Bolivia: General information • Population (1997): 7,8 millions • 7.09 inhab/km2 • 61% urban • 39% rural • Net income per capita: $ 1078

3. The economy during 1985-1993 • Annualized inflation rate: 25,000% (august/85) • GDP growth: - 1.68% (1985) • Negative Int’l Reserves • Causes • Fiscal deficit of more than 20% GDP • Protected and deficient industry/low foreign investment • Fixed and overvalued exchange rate • Subsidized interest rates/bankrupt financial system. • High external debt and moratoria of payments

4. The economy during 1985-1993 • Reforms adopted • Liberalization of prices • Liberalization and unification of capital flows • Liberalization of labor markets • Simplification of tax regime • Closure of deficitary public companies • Results • Decline of inflation rates to 8% (1994) • Positive GDP growth by 4% (1990-1994) • Price stability • However, private investment was only 7.08% of GDP (1993)

5. Challenges in 1994 • Key companies continued under Government administration • Utilities required large amounts of investment • Most public investment directed to productive and infrastructure sectors (24% and 48%) in lieu of social sectors • Most private investment financed out of pocket and with development credits channeled through the Central Bank

6. Challenges in 1994 • Low long term internal savings applied to pay retirement pensions • Non existent capital market development • Weak pay as you go pension system • Underdeveloped insurance industry

7. Capitalization Program • A strategic partner takes over 50% of public Co. and administrative control. • 100% of partner´s cash contributions, representing 50% of the investor´s best market value estimate, is committed for new Co. projects. • The remaining 50% of the shares is transferred to a fiduciary fund managed by private pension administrators • The benefits of the latter are distributed among the adult Bolivian citizens through a fund known as FCC (Collective Capitalization Fund)

8. Capitalization Program Features of the program: • Modern sectoral laws and regulations • Exclusivity periods • Introduction of supervisory bodies. • Contracts define specific investment plans • The FCC is valued in US$ 1.7 bn. at capitalization prices

9. Capitalization financial results (millions of US$) • ENTEL (telecommunications): $ 610 (EuroTelecom/Stet Int´l) • YPFB (hydrocarbons): $ 833 (3 Co., Amoco/PerezCompanc; YPF; Enron/Shell) • ENDE (Electricity): $ 138 (3 Co., Dominion Energy; Constellation energy; Energy Initiatives) • ENFE (railroads): $ 48 (2 Co., Cruz Blanca) • LAB (airline): $ 47 (VASP)

10. Pensions Reform General Situation of the pay as you go system in 1995: • Administration: divided in Basic (public) and Complementary (semipublic) • Covered population: 315.000 affiliates (22% of urban labor force) and 115.000 pensioners • Disclosed mean salary: $ 200/month Financial situation: the system was bankrupt, needed transfers regularly from the Treasury Causes • Active/passive ratio: 3/1 • Hyperinflation in the mid ‘80s • High administrative costs (17% of total contributions) • High evasion rates and private sector debts

11. Pensions Reform Design First pillar: consists of the benefits for every Bolivian adult citizen financed by the fund derived from capitalization process Second pillar: is based on a mandatory contribution from the employees salary to an individual capitalization account, which is privately managed. Contributions: 14% (Incl. 4% premia for common risk & workers compensation)

12. Pensions Reform • Benefits • No fixed retirement age. Retirement allowed once the individual account is actuarially enough to cover a for life pension of at least 70% of the reference salary • There is no minimum pension guaranteed by the State. Management • 2 private fund managers (AFP), appointed in international bid. Contract grants them exclusivity for a 5 year period. • Affiliates were preassigned to an AFP.

13. Pensions Reform • Compensatory Pensions • These compensations will be paid monthly upon retirement. Current retirees • Their pensions are entirely funded by the Treasury. Financing of the fiscal cost • The pay as you go system was completely closed • The fiscal cost in 1999 will be $300 millions (more than 3.2% of the GDP • Government will borrow from the new system ca. 140 million.

14. Capital Markets • Prior to reforms, capital market was shallow, low volumes of trading (mainly short term debt instruments) • However, post reforms, the structure of the capital market hasn’t changed significantly. Reforms had little impact in the capital market due to: • Govt. crowds out most funds collected by pension system • Capital market’s law recently passed (March,1998) • Capitalized companies not listed in the Bolivian Stock Exchange • FCC expected to bring new dynamism to trade equity once the capitalized companies are listed.

15. Results (Capitalization) • The administration of capitalized Co. was transferred from public to private sector • Clear rules and regulations were established • The public sector activity is limited to regulation • Capitalized Co. are complying with investment commitments • Additional foreign invest (hydrocarbons and mining) • Change of structure of investment: 1998 Private investment : 14.2% of GDP, public investment 6.3% of GDP vs. 1993: 7.1% and 9.8%

16. Results (Capitalization) • Change of Public investment composition - 1993 social sector investment: 19.2% of total public investment vs. 48% in 1998 • In 1993 most private investment were carried out through developed credits channeled by the Central Bank vs. 1995-1998 were most private investments were channeled by capitalized companies • Capital Market will soon list the capitalized companies and will receive long term resources from FCC

17. Results (Pensions) • 1995 covered pop. 300,000 vs. 400,000 in 1998 • 1995 contributions inflow: $105 mm. vs. 1998: $180 mm. • 1998 rate of return of funds: 8.7% in real terms • Long term resources expected to be provided by AFPs • Capitalization resources not used to finance fiscal pension cost. Such cost is financed by Treasury by borrowing funds from the new system • Contributors to former system were obligatorily transferred to the new. Treasury pays compensatory pensions to these people

18. Concluding Remarks Required preconditions for a capitalization process: • Stable macroeconomic and legal framework • Independent regulatory authorities • Exclusivity periods may be required • Fiduciary players must have international recognition and correct incentives.

19. Concluding Remarks • Capitalization is a good marketing tool that puts the country in the international scene • Capitalization does not bring cash to the Treasury. Therefore, when carried out jointly with a pension reform, the Treasury must be able to cope with the cost of the reform. • These reforms don’t necessarily immediately strengthen the capital markets