Why Diversifying Pension Fund Investment is Long overdue in Ethiopia

By Nathnael Tsegaw

While chatting pleasantly with an old friend recently, I pointed out to him that our pension payments are, in reality, a tax and not something we will get to use later on in any meaningful way.

His apparent confusion prompted me to raise the issue with more of my friends. As I explained how inflation is rapidly chipping away at our pensions, their response was the same: “What are you talking about?”

The fund doesn’t increase or earn much profit, so it only increases by a small percentage of earnings garnered from investments in treasury bills and, more recently, banks’ shares, which still leaves the fund exposed to inflation.

For example, let’s say you are 25 years old and earn a good salary of 20,000 birr per month. As you age, your salary increases, and you finally retire on a salary of 60,000 birr per month at the end of your career.

This means that you will be entitled to a maximum monthly stipend of up to 42,000 birr depending on when the raise happens. But this is not something to look forward to in any way.

Even if the inflation rate winds down to 5% over the next decades, you will need 552 birrs to buy the things you can have now for only 100 birrs. Thus, your stipend will need to increase fivefold to afford the things you can buy with it now.

As the implications of my statement sank in, my friend’s immediate response was, “But the pension is being invested, right?” When I told him that, thus far, it was only being used to buy treasury bills, earning a meagre 9% return or 5% annually from treasure bonds, he all but screamed, anticipating never retiring.

His sensational remarks were a rational response to the prospect of facing retirement and finding out that the fund you counted on to see you through this time has been rendered worthless.

Most Ethiopians, whether employed in the private or public sector, contribute 7% of their salary to a pension fund, while their employer contributes 11% more.

Thus, 18% of their gross pay is added to the pension fund every month, so they have something to fall back on when they retire. It is generally assumed that this will be enough to live on when the time comes to leave the workforce and rest. That isn’t the case currently, as inflation and government policy have conspired to relieve us of our future spending power.

You see, at the current level of inflation (34.7%), pension funds earn essentially negative returns. This means the pension funds, and by extension, us, are essentially paying the Ethiopian government to take and spend our money.

This is because such low returns in the face of this rampant inflation are subject to negative interest rates. In this case, any investment made into treasury bills, which was the only legal investment allowed for pensions until recently, returns only 25 cents on the birr (losing 75% of its value).

Unfortunately, this no-cost source of funding hasn’t gone unnoticed by the government, which has been using it as an option to supplement its budget to the detriment of pensioners for so long.

The total capital collected from pensioners reached around 200 billion birr in 2020/21 and has been too accessible for the Ethiopian government to resist.

Looking at the end of the 2020/21 fiscal year’s outstanding treasury bills, 55.3% of which were held by the pension funds to the tune of 64 billion birr, is evidence that the government is using it as a cheap way to finance its spending by selling the pension funds treasury bills for a 1% return.

This return, which seems even more ludicrous compared to soaring inflation, isn’t a gain in the end but a loss.

In developed countries, pension funds are massive investors that greatly impact the sectors they have a stake in. Guided by fiduciary duties, which ensure outside interest does not influence investment decisions, and prudent investment strategy aimed at minimizing losses and diversifying assets, they are huge players in any of the more developed stock markets, something we may want to learn from.

These investments, which usually prioritize mitigating the effects of inflation, protect the hard-working people whose money is bundled in there and even make a healthy profit.

Luckily for us, the government seems to have also come to the same conclusion. Parliament enacted a proclamation last year that allows pension funds to be invested in sectors that assure returns. This decision overturns the prior stipulation that pension funds could only be invested in treasury bills, and pension funds can now be put into other profitable endeavors.

With the impending arrival of a capital market, there seems to be an ideal alignment of means and access to invest pension funds into worthwhile ventures that will help weather the effects of inflation while producing meaningful returns.

Although it is still quite substantial, the decreasing share of pension funds in the treasury bill market gives me hope that we may yet pull this off.

And there are already enough signs of the change to come. Investment in profitable ventures other than treasury bills yielded 3.2 billion birr in revenues for the Public Servants’ Pension Fund Administration until the end of the third quarter of the just-ended fiscal year.

The fund was able to meet 130 percent of its target in the reporting period as a result of the announced policy change, resulting in a profit of 7.2 billion birr.

The new departure enabled the entity administering the pension collected from civil servants to invest in the financial sector and seek other profitable ventures.

Adding to its investment in bonds of the Development Bank of Ethiopia (DBE), the fund bought shares from five commercial banks, including Bunna and Berhan banks. Each investment yielded a 20% dividend on each 1,000 birr worth of shares.

Of course, expecting profits that will completely offset the effects of inflation, at least in the short run, might be impractical in light of the inflation levels we are currently experiencing.

However, it is crucial to diversify pension fund investments and seek higher returns to have something left of the fund when we need it decades later. If we want to enjoy retirement and not toil at 80 years of age, we have to push for pension funds to invest in ventures that will earn positive returns or, at the very least, dampen the effects of inflation.

In addition, such funds can directly or indirectly be used to gain access to finance, foster innovation, etc., while also securing our lives at old age. Financial innovation is critical for doing that. Creating a conducive environment for easy investing is a good way to ensure our futures are provided for while supporting innovation, financial and otherwise, and economic growth in Ethiopia.

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Nathnael Tsegaw is the manager of Shega Insights and is interested in economics and innovation.