US embassy cable - 05WARSAW1057

UNCLAS  WARSAW 001057 
 
SIPDIS 
 
 
Sensitive 
 
STATE FOR EUR/NCE TARA ERATH AND MICHAEL SESSUMS 
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS AND MWILSON 
TREASURY FOR OASIA MATTHEW GAERTNER 
FRANKFURT FOR TREASURY JIM WALLAR 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, PREL, PL, Economy, EUN 
SUBJECT:  Poland Still Lobbying EU on Open Pension Fund 
Classification as Part of its Convergence Strategy 
 
Ref: (A) 2004 Warsaw  3901 (B) 2004 Warsaw 2780 
 
 (U) This cable is sensitive, but unclassified, and NOT for 
Internet distribution. 
 
1. (SBU) Summary: Poland is concerned that it will not be 
able to meet the 2007 target date agreed with the EU for 
meeting the Maastricht criteria on the road to adopting the 
Euro if the EU does not change the way it counts pension 
fund assets.  In 2004, the EU's statistical agency, 
Eurostat, decided that individual accounts under Open 
Pension Funds had to be excluded from the calculation of 
government deficits.  In 1999, Poland enacted landmark 
pension reform which allows the creation of IRA's under 
Social Security, similar to reforms currently being 
considered in the United States.  These funds are currently 
generating a significant surplus which Poland wants to be 
included in the deficit calculation, which would help it 
meet Maastricht criteria.  This is not an idle statistical 
debate.  Excluding the revenue surplus currently generated 
by Polish pension funds would increase Poland's projected 
deficit-GDP ratio from 2.2% to 3.9% in 2007.  Poland is 
concerned that the EU definition would force it to make 
drastic cuts in spending at a time when it plans heavy EU- 
related expenditures.  Should Poland persuade the EU to 
change its definition, it would facilitate pension reforms 
in other EU countries.  End Summary. 
 
2. (U) On February 15, Ministry of Finance U/S Grzegorz 
Stanislawski told Econoffs that Poland continues to lobby 
the EU hard on the issue of how to classify Open Pension 
Funds (OFE in Polish).  Stanislawski explained that Poland 
is proud of its groundbreaking pension reform, introduced in 
1999, which set up a smooth transition for existing workers 
towards a system which would be able to finance pension 
benefits without busting the government's budget.  Under the 
reform, the government authorized the creation of individual 
retirement accounts (IRA's) for the first time.  It also 
created a system under which, over time, all workers will 
direct a portion of their mandatory pension deductions from 
their salary to IRA's.  The reform set out a transition 
period, dividing workers into three categories.  Those born 
before 1948 remained under the old pay-as-you-go (PAYG) 
system.  Those born between 1949 and 1968 had a choice of 
either remaining with the old PAYG system, or opting for the 
new system under which they can direct a portion of their 
deductions to an IRA (similar to reforms currently under 
consideration in the United States).  Those born after 1968 
must participate in the new system. 
 
How it Works: 
- - - - - - - - 
 
3. (U) Wages in Poland are subject to almost 39% in 
deductions, one of Europe's highest totals.  The pension 
component (19.52% of gross salary) is financed jointly by 
employees and employers (each paying 9.76%). The full amount 
of contributions from Poles under the PAYG system goes to 
the Social Insurance Office (ZUS), which transfers the money 
to the budget.  For those under the new system, ZUS sends 
12.22% of the combined employee and employer contributions 
to the budget, and 7.3% to an IRA in a pension fund as 
directed by the individual. 
 
What's in Dispute? 
- - - - - - - - - - - 
 
4. (U) Poland is concerned because only a few EU members 
have enacted pension reform (along with Sweden).  Because 
most EU countries remain in the pay-as-you-go system, 
Eurostat did not issue guidance until 2004 on how to 
classify these funds.  In 2004, Eurostat ruled that Poland 
(and other EU members) must exclude OFE's from the 
government sector because the government does not guarantee 
their returns. 
 
5. (U) The only portion of this system under dispute with 
Eurostat is how to account for the 7.3% contributions to 
IRA's under the new system.  Currently, these contributions 
are generating a significant surplus, as pension funds will 
not begin paying benefits until 2010.  Meanwhile, they are 
taking in close to one billion Zloty a month ($330 million), 
which they are investing in government and local bonds and 
in the stock market.  The Ministry of Finance expects that 
 
 
the current surplus should gradually dissipate as the funds 
under the new system begin to pay benefits after 2010.  As 
the surpluses diminish, Finance expects the issue will 
become less sensitive with Eurostat.  In the meantime, 
Eurostat argues that these surpluses should not be included 
in calculating deficit ratios, while Poland argues that they 
should. 
 
6. (SBU) This is not just an idle statistical debate, but a 
critical issue in determining when Poland will meet the 
Maastricht Criteria to adopt the Euro.  Poland forecasts 
that its deficit to GDP ratio will be 2.2% in 2007 if OFE's 
are included, and 3.9% if they are excluded.  Excluding 
OFE's will increase the projected public debt to GDP ratio 
from 45.4% to 51.9% in 2007.  Excluding them will require 
the GOP to come up with much more drastic public spending 
cuts to meet the 3% deficit limit, and will likely delay 
Poland's entry into the ERM II by at least a year, in 
MinFin's estimation. 
 
Tactics: 
- - - - 
 
7. (SBU) Poland regards the 2004 Eurostat decision as the 
opening of discussions within the EU, setting out the 
framework for debate.  In September, Eurostat published a 
paper outlining some of the statistical issues at stake.  In 
that paper, it recognized that some countries, like Poland 
and Sweden, had invested considerable resources in pension 
reform several years earlier.  As a result, it granted 
Poland a transition period until 2007, through which time 
OFE revenue will be included in the deficit calculation. 
Poland is concerned about what happens afterwards. 
 
8. (SBU) Poland is hoping that the EcoFin council will make 
a final decision on this difficult issue at its March 
meeting.   Finance believes that the UK and Sweden already 
support Poland's position, and that a number of countries 
contemplating pension reforms, including Italy and Germany, 
are increasingly sympathetic.  Stanislawski understands some 
finance ministers are concerned that accepting Poland's 
argument would open the door to a range of subsidies. 
Stanislawski said Poland understands those concerns, and 
opposes loosening fiscal discipline as well.  Poland 
disputes the notion that this is a subsidy for the pension 
system.  Should the EU insist on excluding OFE's, 
Stanislawski said this would be tantamount to insisting 
Poland renationalize its pension funds, which would 
significantly weaken the stability of Poland's budgets over 
the longer term.  If the EU refuses to budge, Poland will 
request a further derogation until the end of 2009, to match 
the period when OFE's will begin to pay pensions. 
 
Convergence Issues: 
- - - - - - - - - - 
 
9. (SBU) Stanislawski said there has been considerable 
discussion about possible changes to the Stability and 
Growth Pact within EcoFin, including increasing the deficit- 
GDP ratio to 3.25% or 3.5%.  The GOP will stand by its 
target of 3% or less by 2007, as outlined in its convergence 
plan.  In its latest assessment, the EU moderated its 
criticism of Poland, although it expressed concern that the 
planned savings under the Hausner plan looked doubtful (ref 
b), and questioned whether Poland would meet its GDP growth 
projections over the next three years (5%, 4.8% and 5.6%). 
 
Comment: 
- - - - - - - 
 
10. (SBU) Poland implemented landmark pension reform at 
considerable political cost in 1999 to deal with a 
demographic shift which will see ever more retirees and 
fewer workers over the next decades.  The Polish Government 
correctly forecast that future governments would not be able 
to increase payroll taxes beyond their already high levels 
to sustain a pay-as-you-go system.  Poland has been very 
pleased with the results of this reform, which have allowed 
pension funds to develop as major sources of domestic 
investment.  The GOP would be very upset if the EU would 
effectively penalize them by excluding OFE assets from 
deficit calculations.  One of the most important effects of 
the pension reform was to reduce a major threat to the long- 
term stability of the Polish budget.  It would be ironic 
 
 
indeed if the EU forced Poland back into a less fiscally 
sustainable position to accommodate the EU's narrow 
definitions under the Stability and Growth Pact.  We expect 
Poland will continue to push this issue over the next month 
with other EU officials.  Should Poland prevail, it will 
improve prospects for pension reforms in other EU members. 
 
Munter 
 
 
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 2005WARSAW01057 - Classification: UNCLASSIFIED