(Caijing Magazine) The international pension system may have suffered only slightly less than the international banking system during the past year's market turmoil but, in the long run, it may be the biggest casualty of the financial crisis.

The impact of the crisis on financial asset values, combined with a decline in value in the real economy for commodities and other assets, has led to massive declines in pension fund assets. The OECD estimates pension funds lost more than US$ 5 trillion in 2008. In addition, a number of governments worldwide, faced with the crippling costs of refinancing the banking system, are cutting their contributions to funded pensions, raiding national pension reserves or even, as in the case of Argentina, nationalizing pension assets altogether.

In terms of direct impact, the low integration level of China's financial and pension systems with those in the rest of the world seems to have been a blessing in disguise. While social security departments fretted about missing out on rising returns as world equity markets soared in 2005-'07, many will now be glad that at least they will not have to post a minus return. The National Social Security Fund (NSSF) in China did post a loss, but its cautious allocation strategy reduced the impact (even if its loss would have been greater on a "mark to market" valuation basis).

However, even if the direct impact is limited, it would be wrong to see China's pension system as immune to the impact of the financial crisis. The most obvious impact from the loosening of monetary policy and the need to provide liquidity has affected bank deposit and government bond returns. These have fallen to less than 2 percent, and they provide the reference accrual rate for the indexing of individual accounts in urban and rural pension systems.

Other impacts are likely to come from the spillover effects of declining economic growth and higher unemployment. For many urban workers, this will lead to falling pension contributions either from reduced wages or actual breaks in contribution records during spells of unemployment. It was common knowledge in 2008 and this year that many migrant workers emptied their individual accounts prior to returning home for Spring Festival, effectively reversing tentative steps made to include them in the pension system.

The worst impact of the financial crisis, however, is that it is likely to dampen appetite for reform just at the moment when the government needs to make important and bold decisions on the future direction of social security policy and pension reform. This can already be seen in the draft of the new Social Insurance Law, which is silent on the move to a funded, individual account system and bases the accrual rate on the gross bank interest rate and commodity price index. This is precisely the time when a more aggressive investment policy focused on buying equities and distressed debt may deliver high, long-term returns.

The current crisis may induce a sense of "wait and see." But the march of time allows for no such delay. First, of course, are the government's promises to deliver a unified national social security system by 2020. Second, financial crisis or not, China's elderly population is increasing by more than 3 percent every year. There is a significant danger that these next few years could be lost years in terms of tackling weaknesses in the pension system.

Big Picture

We also must not miss the big picture. One underlying cause for the current economic crisis is the imbalance between consumption and savings in different parts of the world, between China-East Asia and the oil producers on one hand – those who accumulated huge surpluses -- and rich countries, notably the United States and European Union countries that have expanding deficits.

Most of these surpluses have been invested in what were considered (wrongly) to be the best developed and regulated -- and most liquid -- financial markets. The hope was that they would provide higher and risk-free returns.

If problems similar to that caused by the sub-prime mortgage crisis are to be averted in the future, three things need to happen: the overall volume of saving probably needs to come down; the balance of saving between different countries need to change (with China saving less and the United States saving more, for example); and the recycling of savings both in national and international financial systems to fund genuinely profitable opportunities needs to be much more efficient.

This brings us back to questions about pension reform, which has a potential impact in these areas. First and foremost, pension and social security reforms must play a part in reducing high levels of precautionary saving in East Asia, and persuading workers that it is all right to spend. Second, pension reform can have a positive impact on the development of financial markets by widening the channel of funds available to private business. One of China's problems is the almost total reliance on the banking system for enterprise funds. This reliance on banks has starved the small and medium enterprise sector of funding because SMEs are relatively high risk and cannot provide adequate collateral. The evidence from Latin America, where pension reform has been combined with financial market liberalization, suggests such reform may significantly reduce capital costs in the long term.

So the question for reform is not "if" but what type.