Thomas Escritt charts the Hungarian government's highly controversial plans to nationalise the country's supplementary pension funds

While few things are certain about the future of Hungary's pension system nowadays, it looks likely January will see freezing lines outside the country's pension administration offices as savers register their desire to stay inside the state system.

Since the recent announcement by György Matolcsy, the national economy minister, that only those who choose to give their accumulated private pension assets to the state will receive a state pension on retirement, more details have emerged about the obstacles in the path of those who decide to remain within the private pension system.

According to the legislation, those who choose not to hand back the money in their funds will have to make their declaration in person - for "purposes of personal identification" - at a pension administration office by 31 January. The legislation is ambiguous, meaning it is unclear whether the declaration has to be made at one of seven regional administration centres or at one of 33 customer services centres. Either way, it is clear that, given the staffing practices and opening hours of public offices in Hungary, there will not be enough time for more than a fraction of the country's 3m mandatory fund members to make a declaration. According to one calculation, if one-third of current members were to refuse, 33 offices would need to process an entirely unrealistic one client every 30 seconds throughout January.

The legislation itself is just the latest in a series of money-raising schemes Hungary's government has floated since taking power in spring this year. Viktor Orbán, head of the populist conservative Fidesz party, promised in opposition to cut taxes and return Hungary to an economic growth path in short order. The original plan, undeclared during the election, was to convince the IMF and the EU, which had provided Hungary with a standby loan two years before, to allow it to run a much larger budget deficit than the 3.8% agreed to for 2010. When the lenders rejected this plan, a series of crisis measures were implemented, starting with a HUF200bn (€721m) windfall tax on banks, followed by similar windfall taxes on retailers, energy companies and telecommunications companies.

The idea of raiding the country's pension funds was already being floated in May, but the IMF overruled the proposal. During the summer, Hungary turned its back on the multilateral lenders, which wanted to see more evidence of a desire to cut back on loss-making state companies, and were worried about the temporary nature of the windfall taxes used to finance the deficit.

The previous government also made attempts to tap the HUF2,700bn (€9.7bn) held in the pension funds, opening the doors for those nearing retirement to opt back into the state pillar and introducing regulations forcing funds to buy more Hungarian state debt. But this move dwarves the previous government's in scale.

In a speech in November, Viktor Orbán, by then prime minister, said it was no longer possible "at a time of crisis" for the government to continue transferring HUF30bn a month into the country's pension funds, adding that no west European country "forced people to gamble their savings on the stock exchange" - a statement that in itself is factually incorrect. But what started as a 14-month temporary suspension of payments rapidly ballooned into a concerted effort to abolish the existing second pillar entirely, leaving just the state pillar and the existing third pillar in place.

In a 28 November interview, Matolcsy said: "The vast majority will opt back in. This will lead to a wave of mergers on the private pension fund market. But in the long run, the government wants to support self-reliance, and voluntary pension funds will have an extremely important role to play in this."

The initial assumption was that most would choose to opt back in without any incentives. When it emerged that many would choose to stay, Matolcsy announced that those who failed to opt back in would cease accumulating a state pension entitlement, but continue to need to make state pension contributions. Those who failed to opt back in were not playing their part in financing current pensions, he said in a speech, and had "written themselves out of the community".

Despite this, many are calculating that while opting back in involves the certainty that they will lose their private savings, there is no way of knowing how generous the state pension will be when they retire. Furthermore, both opposition parties have announced they will honour the hold-outs pension payments if they should take power, meaning there is a chance their entitlements will be restored. The upshot is that, despite the threats, a substantial number of savers may yet choose to keep their money where it is, leading to long queues outside public offices throughout a freezing January.

Even if the vast majority of scheme members do opt back in to the state system, this is not necessarily a fatal blow. "We would expect a lot of our business to move to our voluntary, third-pillar fund," says József Pellei, managing director of VIT, the electricity industry's sectoral fund. All mandatory fund providers also offer a voluntary fund - though plans to cap management fees at 0.9% of contributions and 0.2% of assets leave question marks over the kind of services providers will be able to offer.

As for the mandatory funds, they will certainly operate at a loss for the period of the contribution suspension, which was originally set at 14 months, and now looks like it may be indefinite. Independent occupational schemes like VIT will run down their reserves for the duration - Pellei says accumulated reserves will cover three years of operation - while those backed by large institutions like Aegon, Allianz or OTP will be dependent on their parents' largesse. Smaller funds are likely to be forced into merger.

Stabilitas, the umbrella association for Hungarian pension funds, is challenging the legislation, arguing that it violates fundamental rights. The outcome of a legislative challenge is unclear - when the Constitutional Court struck down a supertax on severance packages that was targeted at appointees of the previous government, Fidesz responded by removing budgetary matters from the Court's purview. The party, which has a two-thirds majority in parliament, in any case intends to adopt a new constitution next year. Further challenges to the European Court of Justice or the European Court of Human Rights could take many years, by which time any changes made may well be irrevocable.

Drain on resources
Hungary's mandatory pension pillar has been a drain on the country's state pension pillar since its inception. Under the system as originally conceived, new entrants and those who chose to opt in paid 8% of their salary into a private fund of their choosing, and 1.5% into the pay-as-you-go state pillar, out of which current pensions are financed. Employers made a further contribution amounting to a quarter of gross salary. On retirement, private savings were meant to contribute a quarter of the eventual pension, and the state the remainder.

This World Bank-approved model has caused strains throughout central and eastern Europe, since the money transferred into the mandatory pillar is lost to the state system, leaving a deficit when it comes to paying current pensions, demanding greater budgetary discipline. This has been a constant source of tension for countries in the region, especially since credit grew tight two years ago.

Earlier this year, several central and east European countries, including Hungary, turned to the European Commission regarding this issue, complaining that, since they were running higher deficits as a direct result of the pension reform they had introduced at the EU's behest, their efforts to meet the 3% deficit target of the Maastricht criteria should be treated more flexibly.

But while many disagreed with the European Commission's refusal to countenace this request, no country has taken its protest as far as Hungary. Fidesz accused the European Commission of bad faith, since it had "forced" the multi-pillar pension system on the country and was now refusing to address the consequences.

It is hard to argue, though, that the solution chosen will deliver a better outcome. Hungary has a declining population, a low birth-rate and sluggish economic growth. In effect, the government's decision amounts to the return of a pure state pay-as-you-go system. Out of a population of 10m, only 3m are in work, and almost half those are working for the state. Without private savings, there are real doubts over whether a future government will be in a position to provide the adequate pension provision the current government promises.

Furthermore, there is little evidence that the government has a plan beyond immediate revenue-raising. The announcement that the government would apply sanctions to those who failed to opt back in was followed by a spending announcement: maternity leave would be extended from two years to three, and current pensioners would receive a pension hike.

Nor is there evidence the new system has been thought through. Matolcsy initially promised that returnees' contributions to the treasury would be "accounted for" in individual accounts. This was thought to indicate the country was to move to the Swedish state pension model, in which contributions are recorded in virtual individual accounts.

Though the accounts are not linked to any underlying assets, an individual's pension entitlement is tied to the sum recorded in that account, giving earners an incentive to contribute more. But the government's most recent statements suggest the individual accounts will be no more than a regular statement of the value of the pensions contributors can expect to receive, with no relationship to contributions made. For now, nothing is clear.