This record is a partial extract of the original cable. The full text of the original cable is not available.

101442Z May 05

UNCLAS SECTION 01 OF 03 ANKARA 002696 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR INTERNATIONAL AFFAIRS - MMILLS AND CPLANTIER 
NSC FOR BRYZA AND MCKIBBEN 
 
E.O. 12958: N/A 
TAGS: EFIN PGOV TU
SUBJECT: TURKEY'S PENSION REFORM 
 
REF: ANKARA 2161 AND PREVIOUS 
 
¶1. (SBU) Summary: The Turkish government has submitted to 
Parliament a major reform of Turkey's social security 
institutions.  The reform--a requirement of IFI 
programs--will consolidate three separate social security 
agencies into one, aligning the three systems' parameters on 
a less costly glide path, and thereby setting the stage for a 
long-term decline in Turkey's large social security deficits 
as a percent of GNP, currently 4.5 percent.  Despite delays 
in sending the legislation to parliament, the Government 
appears to have recognized the need for reform now, while 
Turkey's relatively young population eases the transition to 
more sustainable parameters, reining in the excessive 
generosity of the current system.  The cost savings of 
combining the three systems, combined with the very gradual 
adjustments in parameters used in calculating pension 
payments, will mean few Turks will feel the change in the 
short run.  One notable exception will be civil servants, 
especially high-level civil servants, whose generous pension 
system is being aligned with the less generous system used 
for private sector employees. The reform has yet to provoke 
much protest, perhaps because only the civil servants will 
feel a significant impact, and they are in a weak position to 
demand better treatment than other employees. End Summary. 
 
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The GOT Bites the Bullet of Pension Reform: 
------------------------------------------ 
 
¶2. (SBU) Earlier this month, the GOT finally submitted 
long-awaited Health and Pension Reform legislation to 
Parliament, fulfilling one of three prior actions required 
for the new $10 billion IMF program.  The social security 
reform had been in preparation since before last summer, when 
the Ministry of Labor and Social Security released a "white 
paper" prepared in close coordination with the World Bank. 
Though in recent months the focus has been on the delays 
since a December agreement with the IMF staff on the outlines 
of a new IMF program, the big news is that the Social 
Security reform is a major structural reform that, over time, 
should put Turkey's retirement and health systems on a much 
more sustainable basis.  In recent years, the combined 
deficits of Turkey's three social security institutions 
reached 4.5 percent of GNP.  The deficits were not only 
large, but were increasing: the pension deficit alone rose 
from 2.5 percent of GNP in 2000 to 3.5 percent of GNP in 
2004, and were projected to rise to 7 percent of GNP in the 
absence of reform.  These deficits have been a major 
contributor to Turkey's financial problems.  According to the 
white paper, the resources used to finance the deficits in 
the last ten years equate to 1.24 times Turkey's consolidated 
debt stock.  The white paper also makes a convincing case 
that now is the time for Turkey to move to a more sustainable 
system, while it has a relatively young population that can 
support its smaller retiree age group during the transition: 
only in 2012 will 7 percent of Turkey's population be over 65 
years old, a threshold reached by the U.S. in 1945.  By 2039, 
however, 14 percent of Turkey's population will be over 65. 
 
----------------------------------------- 
Earlier Governments' (Mosty Bad) Policies: 
----------------------------------------- 
 
¶3. (SBU) The Social Security situation is a microcosm of the 
economic policy quandary faced by the AKP government: earlier 
governments' irresponsible or inept policies left a 
fiscally-unsustainable legacy that AKP has to take 
politically-unpopular steps to correct.  In the early 1990s, 
Prime Minister Demirel changed the pension rules to allow 
people to receive pension payments as early as age 42 for men 
and 38 for women.  This has meant legions of Turks drawing 
pensions while still in their forties.  This feature was 
reformed in 1999, when the retirement ages were raised to 60 
for men and 58 for women, but with a very long-term phase in, 
such that people are still retiring in their forties.  Other 
parameters were not altered significantly in the 1999 reform. 
 As a result, the reform was inadequate.  In addition to its 
excessive generosity, Turkey's social security system is 
inefficient because it consists of three separate agencies, 
one for civil servants, one for self-employed and farmers, 
and one for all other employees. 
 
----------------------- 
Dialogue with the IFI's: 
----------------------- 
 
¶4. (SBU) In order to see through this very difficult reform, 
the GOT made the inspired decision in 2003--encouraged by the 
IFI's--to transfer Tuncay Teksoz, the Treasury economist 
following social security issues, to the Ministry of Labor 
and Social Security and give him responsibility for 
shepherding the reform.  Teksoz assembled a team of 
economists from Treasury and the Central Bank who recognized 
the severity of the problem and did both the technical work 
and consulted with stakeholders, patiently explaining the 
need for the changes. Though the political level sometimes 
quibbled over how to implement the reform, and in December 
2003 Prime Minister Erdogan exacerbated the social security 
deficit with an above-inflation increase in payments, having 
Teksoz and his technocrats running the process helped get a 
consensus around the unavoidable need to rein in the deficit. 
 
¶5. (SBU) Social security and IFI officials have told us that 
when there were frictions with the IFIs over the social 
security reforms in recent months, it was mostly about the 
assumptions used in the elaborate World Bank-provided 
model--there were 585 variables.  When the GOT tried to use 
more optimistic growth assumptions, for example, it took some 
of the pressure off of how harsh the parametric changes (see 
below) needed to be.  The IFIs pushed back, however, and 
eventually agreement was reached. 
 
¶6. (SBU) The IFIs left the exact mix of parametric changes to 
the GOT, relying on the model to come up with a menu of 
options for a given overall cost reduction, and leaving the 
politically-delicate decisions on which parameters to change 
to the GOT.  Instead, there are near-, medium-, and long-term 
targets under the IMF program, expressed in terms of the 
overall social security deficit to GNP.  For the coming three 
years, the target is to keep the deficit at no more than 4.5 
percent of GNP, the idea being that if nothing were done the 
deficit would surpass this threshold. Over ten years, by 
2015, the target is to achieve a cost savings on the pension 
component equivalent to close to 1 percent of GNP. In the 
long run, the goal is to bring the overall social security 
deficit under 1 percent of GNP. 
 
 
Projected Deficit of Retirement System (in percent of GDP): 
 
      2005  2010  2020  2030  2040  2050 
 
Without reform:   3.6   3.5   3.7   4.0   5.8   7.0 
 
With reform:      3.4   2.9   2.2   1.5   0.6   0.1 
 
------------------------------ 
The Devil is in the Parameters; 
------------------------------ 
 
¶7. (SBU) The above targets are to be achieved from a 
combination of parametric changes and cost-saving 
efficiencies from the merger of the three 
institutions--Bag-Kur (for self-employed and farmers), Emekli 
Sandigi (for civil servants) and Social Security (for 
everyone else).  There are five parameters affecting the cost 
of the pension payments: 
 
--valuation of wages: the value placed on a lifetime of wages 
in order to determine the size of the retirement pension 
payment.  In a country like Turkey, which has experienced 
near-hyperinflation, it can make a big difference whether the 
rate of growth of wages or that of prices (i.e. inflation) is 
used to value past wages. 
 
--indexation of benefits: how much pension payments increase 
during retirement. 
 
--replacement ratio: the size of pension benefit a worker 
receives in retirement for each year worked. 
 
--years required to receive full benefit. 
 
--retirement age: the age at which one can retire and be 
eligible for pension payments. 
 
¶8. (SBU) In the end, the GOT managed to make the reform 
politically palatable by finding a formula that would achieve 
the targets without many Turks feeling a significant 
near-term impact.  The GOT accomplished this by leaving 
already-vested rights alone, and only gradually applying the 
new formulae to future earnings.   New entrants to the labor 
force, on the other hand, will be entirely subject to the new 
regime.  As for future pain, the main group that will see a 
sharp reduction in what it would have expected to receive 
upon retirement are civil servants, especially high-level 
civil servants.  The civil servants' plan was more generous 
in several respects: replacement ratio, indexation, and 
work-years required to qualify (see below).  Teksoz pointed 
out it would be awkward for the civil servants to protest 
over no longer getting preferential treatment: in 2004 the 
civil servants' pension plan's deficit was about TL 8 
Quadrillion ($5.7 billion), while the total deficit of the 
other systems' was TL 11 Quadrillion ($7.6 billion), despite 
the fact that civil servants accounted for only 15 percent of 
total employees in all three systems. 
 
¶9. (SBU) In general, the reform achieves savings by aligning 
all three systems around less costly parameters: 
 
--Valuation of wages will be based an equal weighting of wage 
growth and inflation (CPI basis). This was reportedly a 
compromise between the IFI's and the GOT, with the former 
wanting the slower-growing inflation rate and the GOT wanting 
wage growth. 
 
--Indexation of benefits: pension payments will increase in 
line with the CPI rate of inflation, whereas both civil 
servants and farmers in the Bag-Kur system were indexed to 
more costly wage growth. 
 
--Replacement ratio: Whereas the civil servants had earned 3 
percent of their salary in pension payments for every year 
worked, the other systems earned less.  Under the new system 
all will earn 2.5 percent until 2016, and 2 percent 
thereafter. In addition, civil servants' pensions were 
calculated based on their final salary.  Under the new, 
unified system pension calculations will be based on an 
employees average salary during their entire working life, 
substantially reducing the size of the pension payment. 
 
--Retirement age/years required to receive full benefit: all 
systems will require 9000 days worked, with a continual 
phase-in of the 1999 retirement age requirement, followed by 
increasingly older retirement ages beginning in 2035.  The 
higher retirement age after 2035 is being justified in terms 
of projected increases in life expectancy.  Though this will 
achieve little savings in the near-term, in the long run it 
is a crucial change from Turkey's very early retirement age. 
 
¶10. (SBU) The IFI and Turkish experts expect the targeted 
cost savings to be achieved over time through a combination 
of the above-described parametric changes and substantial 
savings from the merger of the three separate systems. The 
actual merger of the three systems will require additional 
legislation but Teksoz told us the plan would be to have a 
unified agency by the beginning of 2006.  In addition to the 
efficiency gains from combining three separate systems into 
one, Treasury and Social Security officials say that a single 
system will be better able to track people who fail to pay 
their premia, or who fradulently receive pensions from more 
than one system. 
 
¶11. (SBU) Comment and Conclusion:  The pension reform is a 
major step forward, putting the country on a glide 
path--albeit a gradual one--to a sustainable, less costly 
pension system.  It is one area of reform in which the GOT 
seems to have real ownership, having recognized the need to 
take action while Turkey still has a relatively young 
population.  Pension reform also has the benefit of 
simplifying Turkey's currently complicated retirement system. 
 
 
 
EDELMAN