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covered wage bill in Hungary (the total base of contributions to the pension system, including the first and second pillars) decreased sharply during the late 1980s and early 1990s due to evasion, and has recovered only slightly in recent years.<sup>6</sup> 20. The second pillar grew at a faster rate in 2004, due to the increase in contributions and a much better rate of return. The increase in contributions was in turn due to the increase in the contribution rate, the continued increase in membership and the increase in the contribution ceiling. The future growth of the second pillar will be influenced to a large extent by government policies. Sustaining a high growth of assets will require maintaining the contribution rate at the current levels, keeping the contribution ceiling at the current level of 2.5 times the average wage, maintaining the rules of transition to the new pension system, contributing to adequate returns through the development of new financial instruments, and containing costs and fees.

|**Table 7: Evolution of Secon**|**d Pillar C**<br>|**ontrib**<br>|**utions**<br>|**, 1998**<br>|**– 200**<br>|**4**<br>||
|---|---|---|---|---|---|---|---|
||**1998**|**1999**|**2000**|**2001**|**2002**|**2003**|**2004**|
|Contributions (% of GDP)|0.27|0.49|0.61|0.66|0.68|<br>0.87|<br>1.06|
|Contribution rate (%)|6.0|6.0|6.0|6.0|7.0|<br>7.0|<br>8.0|
|Contribution base (% of GDP)|4.6|8.1|10.1|11.0|11.4|<br>12.4|<br>13.2|
|Determinants of contribution base:||||||||
|Membership (thousands)|1,347|2,064|2,193|2,253|2,214|2,304|2,402|
|Contribution ceiling/Average covered wage|-|2.0|1.9|1.8|1.6|<br>-|<br>2.5|
|Covered wage bill (% of GDP)|22.1|22.4|22.2|23.5|23.9|<br>24.2|<br>-|
|Memo item:||||||||
|Contribution base/Covered Wage Bill|20.7|36.1|45.7|46.9|47.5|<br>52.4|<br>-|

Source: HFSA raw data.

21. A recovery of the covered wage bill would also contribute to larger contributions and more rapid growth of the second pillar. As shown in Table 7, the base of contributions to the second pillar has been growing in line with the increase in membership, and is now more than half of the covered wage bill. At the end of the transition, when all contributors are enrolled in the new pension system, the base of contributions to the second pillar will be the same as the covered wage bill, and the growth of the second pillar will depend on the growth of the covered wage bill itself. It is possible that the covered wage bill will recover to the levels prevailing in the late 1980s (about 33 – 34 percent of GDP) because these are the levels consistent with Hungary’s per capita income and the ones observed in neighboring countries, but this will require more efforts to address tax evasion and may take a decade or more to be achieved.

# **IV.   PERFORMANCE OF THE SECOND PILLAR: PORTFOLIOS AND INVESTMENT RETURN**

MPFs have maintained a conservative investment policy since the start of the second pillar in 1998. As shown in 6 The covered wage bill in Hungary declined from 32 percent of GDP in the 1980s to 22 percent of GDP in the mid-1990s (Palacios and Rocha (1998) and Rocha and Vittas (2002)). By comparison, the covered wage bill is 33 percent of GDP in Slovakia and the Czech Republic and 42 percent of GDP in Slovenia.