Emerging markets in Asia and central and eastern Europe (CEE) have been a favorite of investors for some time. Offering strong, if sometime volatile GDP growth, these countries provide a measure of diversification in a comprehensive portfolio and are valued because they are seen as young and dynamic.

But hold that thought for a second. On closer inspection, these countries are not as young as they appear. Take China for example. The Middle Kingdom is expected to pass the United States as the world’s largest economy within the next 30 years. In the same period, China will also pass the US in terms of age. The Chinese old-age dependency ratio, the ratio of pensioners to every 100 people of working age, is projected to rise from 11 in 2005 to 39 by 2050. While this will not be as high as Western European EU members (ratio of 53), it will occur at an unprecedented rate: China will become old within one generation. Consequently, analysts describe the country as being in a race to get rich before it gets old.

Other countries within Asia and CEE face similar challenges, according to a recent working paper by the International Pensions Department of Allianz Global Investors. Entitled “Pension Trends in Emerging Markets,” the paper states Bulgaria, Slovakia and the Czech Republic are among CEE countries that will experience a speed of aging that will surpass western Europe. In Asia, Hong Kong, Singapore and Taiwan will all experience dramatic changes, but South Korea will have the most fundamental shift. There the old-age dependency ratio will rise from 13 to 64 within the next forty years. In other words: South Korea and Taiwan show the steepest increases. The speed of the aging process will challenge them to adapt to the new circumstances.

Aware of the issues surrounding old-age provision, the 18 countries examined have initiated far-reaching reforms. What is noticeable about these reforms is that they show great similarity. Obviously, significant economic, political and cultural differences exist between the emerging economies in Asia and CEE, which makes the convergence in the pension systems even more surprising. Broadly, countries in the two regions seem to be converging to the World Bank model of pension reform after having opted for a strongly funded pension pillar in the form of individual defined contribution (DC) accounts.

While industrialized countries have also undergone pension reforms, those reforms that have been undertaken in the countries that were analyzed have been far more profound.

Demography is a powerful driver of the reforms, but not the only one. In CEE, the pensions systems fostered by the socialist rule proved unsustainable in a market economy. In response, all CEE countries initiated reforms, such as increasing retirement age, reducing incentives for early retirement and establishing a stronger link between contributions and benefits. Of the eleven CEE countries, eight have also introduced a mandatory capital-funded pillar consisting of individual DC accounts.

Meanwhile, Asian countries aspired to establish or expand their systems. Many had to create these from scratch as traditional family-based support systems declined in the face of industrialization, falling fertility, increasing longevity and rapid urbanization. The rush toward funded DC pensions began in the late 1990s. Since then, China, Hong Kong, India, and Taiwan have introduced DC schemes, while Thailand plans to do so. The emergence of fully funded DC systems with individual accounts echoes a worldwide shift away from defined benefit (DB) schemes. These developments will see an impressive build up of pension assets in CEE and Asia in the decades to come. Based on current data, pension assets in CEE will grow from € 50.8 billion to €244.9 billion in 2015. This corresponds to a compound annual growth rate of 19.1%. Pension assets in the Asian emerging economies are projected to grow from €251.9 billion to €1,049.3 billion in 2015, a compound annual growth rate of 17.2%.

The working paper states action is required to ensure that these massive build ups in assets will provide retirement security through sufficient accumulation of wealth. Financial education needs to be improved, the design of pension plans needs to take behavioral dispositions of members into account and asset managers need to provide transparent products. The paper also cautions that regulations should not overly restrict investment opportunities. If this can be achieved, the emerging markets will give their citizens a head start in the race to establish an adequate income for retirement, while ensuring they do not burden the state later.

Published by PROJECT M in December 2008