Penulis: Ibrahim Kholilul Rohman [1], M. Alvin Prabowosunu [2]
The financial sector is an important catalyst to spur economic development through capital accumulation and technological progress. It does this by increasing the savings rate and mobilizing and pooling savings, as well as optimizing the allocation of capital.
In a developing country like Indonesia, while the pace of development should go hand-in-hand with financial sector development, it is apparent that the non-bank financial institutions (NBFI) have been growing at a slower growth rate than banks, particularly due to the low uptake and low literacy levels in society. A survey conducted by the Financial Services Authority (OJK) in 2019 showed that nationwide literacy on NBFI was lower than on banks. Literacy on pension funds was particularly low at 14 percent, compared with banks at 36 percent and insurance at 18 percent.
Recent issues involving pension funds in Indonesia have been widely discussed. In particular, discussions have been related to the scheme that covers civil servants and the armed forces, where Finance Minister Sri Mulyani Indrawati argued that the current scheme would add substantial pressure to the government budget without proper reforms.
Indonesia is currently reaping the advantages of a demographic dividend, where the share of the productive population exceeds the non-productive population, namely the youth and elderly. However, due to a slowdown in the birth rate, it is estimated that in the next 15 years, we will experience the aging population phenomenon. This is similar to what is currently happening in South Korea and Japan.
There are several challenges that need to be addressed in the pension funds industry in Indonesia. These challenges can be divided into the demand-side, mainly related to the size of coverage and contribution, and the supply-side challenges, concerning the institutional setting and the governance of the industry.
From the demand-side analysis, the pension fund penetration rate in Indonesia is still sub-optimal relative to other comparable countries. The mandatory pension-funds-asset to GDP ratio was only around 4.8 percent of GDP in 2021. This ratio is much lower than other ASEAN countries such as Malaysia (61.4 percent) and Thailand (12.7 percent).
Among the reasons, to be enrolled in a pension security program in Indonesia, a person must be identified as a formal worker. However, the number of formal workers is still minuscule, at less than 45 percent of the total labor force. Thus, the number of workers that have pension fund membership forms is around 16 percent of the total labor force. Moreover, Indonesia’s mandatory contribution rate for both the Old-Age Security and the Pension Security amounts to 8.7 percent of workers’ income, which is less than almost every country in ASEAN except Thailand’s mandatory pension fund.
The lower pension fund penetration is attributed to the lower income of Indonesia’s workers compared with other countries. IFG Progress estimated that assuming income was the single factor deciding pension fund ownership, Indonesia needed around 10 years to achieve Asia’s average pension-fund penetration rates.
Hence, there is a bidirectional relationship, where without a proper pension scheme, some fraction of the future generation might face hardships in making a living. On the other hand, there is an income level required for someone to put their money into a pension fund account.
On the supply-side challenges, Indonesia’s pension funds industry does not perform well in terms of investment allocation policy and the implementation of governance. In terms of investment allocation, Indonesia’s public pension funds mostly allocate assets into fixed-income instruments. While this partly happens due to a specific rule set by OJK to allocate at least 50 percent of pension fund assets into fixed-income instruments, it might not be beneficial in the long run. Economic volatility is seen to be more prevalent in equity class assets vis-à-vis fixed-income instruments. However, in the longer-term period, equity returns always beat fixed income. It may be necessary to revisit the regulation.
Pension funds are also peculiar in their liability-side characteristics, which vary depending on the policy owner. In a defined benefit scheme such as the one implemented in the Pension Security, the investment strategy should always maintain asset-liability management to manage the risk of insolvency and ensure a risk-adjusted optimal return for every liability profile. Otherwise, there will be a looming risk of a pension fund deficit if this strategy is not performed.
Moreover, the governance aspect is also crucial. According to Mercer-CFA Institute Global Pension Index, Indonesia’s pension fund score for governance is still below the average score compared with 39 other sample countries. To achieve its maximum potential, prudent pension fund management is required. Improving governance is one of the keys that the government can strive to achieve. This strategy might be introduced by setting proper investment governance guidelines, effective risk management, accountability, transparency and strong mutual oversight.
Besides the demand-and-supply factor, the Indonesian pension fund industry should also anticipate unforeseen external circumstances due to economic downturns. Lessons learned from the United Kingdom shed light on the importance of anticipation of the consequences if both the fiscal and monetary policies contradict.
The UK pension fund blow-up in late September 2022, which was the result of desynchronized policies between the monetary and fiscal authorities. The UK central bank implemented a contractionary monetary policy by raising interest rates while the fiscal side of the finance ministry preferred a more expansionary fiscal policy through tax cuts. These contradictions had a detrimental effect on bond market yields, thus disrupting fixed-income instruments’ valuation and pension fund liquidity.
In the short run, as the global economy is predicted to experience more uncertainties in 2023 due to possible global stagflation, denoted by high inflation and economic-slowdown, policy harmonization will be critical to protecting the pension fund industry in Indonesia where its asset allocation has been mostly in the fixed income instruments.
This article was published in thejakartapost.com with the title “Addressing challenges in Indonesia’s pension funds”. Click to read: https://www.thejakartapost.com/opinion/2023/01/15/addressing-challenges-in-indonesias-pension-funds.html.
[1] Senior Research Associate of IFG Progress
[2] Research Associate of IFG Progress
