This year the share of the active population in Latin America age 15-64 will start to decline after almost 60 years of increase (see chart 1). Low fertility rates, coupled with an increase in longevity, pose financial and social sustainability challenges for pension systems in the region that governments need to address.

Ineffective or untimely measures can lead to higher pension spending and increases in debt that could, in turn, limit economic growth prospects. At the same time, if pensions don't improve, it could lead to social unrest, especially as the population continues to age.

Currently proposed reforms in Chile, Colombia, and Peru and reforms approved in 2019-2023 in Brazil, Mexico, and Uruguay have implications for sovereign creditworthiness, depending on how they affect fiscal results, benefit debt composition and the development of local markets, and reflect institutional effectiveness.

Chart 1

Chart 2

Proposed Reforms In Chile, Colombia, And Peru Aim At Social Demands

Chile (foreign currency A/Negative/A-1): Increasing contribution rates will help rebuild fiscal and external buffers

In Chile, the assets from the individual account pension system represented 60% of GDP in 2023, which is high compared with the region (see chart 3). Most of the assets are invested domestically, deepening the local market, reducing domestic financing costs, and enhancing monetary policy transmission. The share of assets invested abroad can act as a domestic currency buffer, given pension asset managers tend to bring back money to the country to purchase domestic assets when they become cheap in dollar terms.

Many Chilean people have worked in both the formal and informal sectors of the economy during their careers, resulting in relatively low contributions to their private pension funds. This trend, along with a low contribution rate (10% of the employee salary) and a low real rate of return on pension assets, has led to low replacement rates upon retirement.

Such shortcomings have generated popular dissatisfaction with the system. Under intense pressure during the initial pandemic years, Congress approved early pension withdrawals to support household disposable income, which, coupled with value losses amid high interest rates, led to a reduction in pension assets of about 20% of GDP, hurting domestic market conditions.

Aiming to immediately strengthen replacement rates, the Chilean authorities in 2022 reinforced the noncontributory pillar of the pension system, covered by the government. The latest pension reform to bolster retirement income proposes an additional employer contribution of 6% of the employee salary, which will likely be divided between individual accounts and a contributory solidarity pillar. We expect this reform will be approved in 2024.

That said, we revised our rating outlook on Chile to negative in 2023, given our opinion of a weakening political consensus on key parameters of its political and economic agenda. The past four years have been marked by the political class's failure to find middle ground for approving and implementing reforms to rebuild fiscal and external buffers that eroded earlier in the pandemic, as well as to unlock stronger economic growth and improve social standards. These reforms include a pension reform, an income tax reform, and an overhaul of regulatory processes, among others.

Chart 3

Colombia (foreign currency BB+/Negative/B): Addressing inefficiencies and coverage at the cost of lower private funds relevance and potential fiscal pressure

Colombia's proposed pension reform aims at eliminating inefficiencies in design and enlarges the role of the public sector, to the detriment of private funds participation. While the details of the reform are still in the making, increased relevance for the defined benefit public system may be fiscally neutral in the short run, given assets from private pensions are redirected to the public system and implicit subsidies to higher-income percentiles reduced.

However, the increase in coverage will translate into higher budgetary pressure over time, especially considering that the age of retirement, replacement ratios, and other structural parameters remain unchanged.

Additionally, rules and procedures remain unclear on the use of the proposed new public pension fund to avoid spending unrelated to pensions. This is important because private pension funds have played a key role in the development of domestic capital markets in Colombia.

The reform presented in March 2023 proposes to redirect assets of contributors earning up to three minimum wages to the public system. It also institutes a multipillar system, including solidarity and semicontributory pillars, to increase coverage, given that only one-quarter of the population in Colombia meets the standards to retire.

Fixing the system's regressive implicit subsidies is another key goal. Under the current design and certain conditions, pensioners can switch between private and public pension systems, and about 80% of the individuals with private pension savings transfer their accounts to the public system to receive government subsidies, which has ultimately benefited the population in the highest-income percentile, whereas the lowest percentiles barely benefit.

Peru (foreign currency BBB/Negative/A-2): Limiting pension withdrawals while marginally improving benefits and coverage

Six pension withdrawals were approved in Peru after the pandemic started (2020-2022), lowering private pension fund assets under management by 40%, or 7.5% of GDP. We lowered our rating on Peru in March 2022 to 'BBB' from 'BBB+' due to a long political stalemate's impact on investor confidence and economic growth prospects, but also due to a change in debt composition after the pandemic began, with a higher share in foreign currency and nonresident holdings--which raised vulnerability to negative shocks.

This increased vulnerability in debt composition resulted partly from withdrawals and the limited capacity of pension funds to absorb government debt. There have been many proposals for a seventh pension withdrawal.

The executive branch submitted a pension reform proposal to Congress in October 2023. The reform includes a minimum guaranteed pension for the public pay-as-you-go and private individual account pension systems, as well as an expansion in pensions for more vulnerable groups. Partly due to limited coverage (informality is above 75% of the workforce), the estimated annual fiscal cost would be modest.

The reform also contemplates the inclusion of independent workers in the pension system, as well as incorporating all citizens once they turn 18 years old. Further, it limits future pension withdrawals, making them a possibility only in extraordinary circumstances and with caps.

Increasing benefits and coverage would be overall positive for the population. Fiscal costs seem contained, but if the reform led to broader fiscal pressure than expected, it could affect the rating. Meanwhile, we expect further withdrawals would continue damaging the local market while having long-term consequences for pensioners.

Chart 4

Approved Reforms In Brazil, Mexico, And Uruguay Aim At Addressing Mounting Fiscal Pressure

Brazil (foreign currency BB/Stable/B): A first step to address fiscal rigidity, a key rating weakness

Aiming to contain one of the central government's fastest-growing expenditure items, Brazil approved a meaningful, though back-loaded reform in October 2019 of its pay-as-you-go pension system. Key changes in the reform included a gradual transition to a minimum retirement age of 65 for men and 62 for women (from 60 and 55), the elimination of retirement by time of contribution only, changes to benefits, and new progressive contribution rates. A significant number of states and municipalities have subsequently made efforts to harmonize their pensions systems with the central government pension system parameters.

Expected savings in the first 10 years were estimated at 10% of GDP. Savings will be largest in the general private-sector pension regime, due to the increase in the minimum retirement age.

While Brazil's fiscal profile remains a key weakness for its sovereign creditworthiness, the pension reform, minimum salaries, and public employee salary freezes allowed for a marked recovery in public finances after one of the largest fiscal stimulus packages among emerging markets during the early pandemic years. The pension reform is among a series of reformist efforts from the Brazilian authorities, and in our view, it reflects an increasingly pragmatic institutional framework that helps anchor macroeconomic stability and helped improve the long-term sovereign rating to 'BB' from 'BB-' in December 2023.

Mexico (foreign currency BBB/Stable/A-2): Increases in contributions and minimum pension to improve replacement rates while deepening the local market

The December 2020 reform in Mexico built on existing strengths and sought to stave off problems seen elsewhere in the region related to low retirement income under the privatized systems. A gradual increase in domestic savings will contribute to strengthening private pension funds and the local currency debt market, which is already one of the most developed in Latin America.

With the reform, contributions to workers' individual accounts will gradually increase to 15% by 2030 from 6.5% of the base salary in 2023. This growth will pave the way for assets managed by the pension fund system to grow with little government spending increase, as mainly employers absorb the new contributions. National authorities estimate pension funds' net assets will reach 56% of GDP in 2040, compared with 21% at the end of 2022.

Mexico's reform through turbulent pandemic times reinforces the domestic capital market's growth prospects in the long run. Other countries in the region, like Chile and Peru, resorted to substantial pension fund withdrawals as a relief measure during the same period.

However, the Mexican reform was undertaken with an eye to bolster low retirement income under the current system, which covers only 32% of the population. In 2020, the Lopez Obrador administration introduced a constitutionally guaranteed basic old-age minimum pension. This is one component of fiscal pressure from the public contributory and noncontributory pension payments, which for 2024 will represent almost one-fifth of the total government's budget.

On Feb. 5, 2024, President Lopez Obrador sent a pension reform proposal to Congress that seeks to increase replacement rates to 100% of the last salary. The added money is slated to come from budget cuts, including elimination of public entities. It is not clear at this stage whether these sources of funding would be enough to achieve the reform's goal and whether the reform might affect our fiscal assessment of the sovereign. It is also uncertain whether this reform will pass before the end of the president's term later this year.

Uruguay (foreign currency BBB+/Stable/A-2): Social security reform reflects institutional strength and will contain long-term fiscal pressure

Uruguay's social security reform approved in April 2023 will not significantly change fiscal performance over the next couple of years, given implementation will be gradual. But we think the capacity to pass such a reform, which will contain pressure on the budget over the medium to long term--accentuated by demographic trends--reflects the strength of the country's institutions. Full implementation is expected for 2043.

Key changes included the transition to a unified framework, a gradual increase in the age of retirement to 65 from 60 in the defined benefit system with automatic adjustments based on life expectancy, the number of best years of salary considered for pensions increased to 20 from 10, and adjustments to the noncontributory pillar to support low-income workers.

The minimum 30 years of contributions did not change, nor did 15% of salary in contributions. Contributions to the public and private systems continue to depend on the level of income, but we don't expect the reform will significantly increase savings or deepen local capital markets. While the possibility of private pension funds increasing investment in external assets was raised, this will be discussed in a separate bill.

How Do Pension Measures Affect Sovereign Ratings?

The channels of impact from pensions or pension-related measures on our sovereign ratings are summarized below.

Related Research

• Colombia Outlook Revised To Negative On Subdued Economic Growth Prospects; 'BB+/B' Foreign Currency Ratings Affirmed, Jan. 18, 2024
• Chileans Reject The Latest Constitutional Draft, Paving Way To Focus On Reforms, Dec. 20, 2023
• Brazil Long-Term Ratings Upgraded To 'BB' From 'BB-' Following Tax Reform Approval; Outlook Stable, Dec. 19, 2023
• Chile Outlook Revised To Negative On Weaker Political Consensus; 'A/A-1' Foreign Currency Ratings Affirmed, Oct. 19, 2023
• Full Analysis: Peru, Aug. 2, 2023
• Uruguay Long-Term Ratings Raised To ‘BBB+’ On Stronger Fiscal Policy; Outlook Stable, April 26, 2023
• Full Analysis: Mexico, March 21, 2023
• Global Aging 2023: The Clock Ticks, Jan. 18, 2023
• Brazil Has Passed Pension Reform: What's Next?, Oct. 24, 2019
• Brazil Long-Term Ratings Lowered To 'BB-' On Less Timely And Effective Policymaking; Outlook Is Stable, Jan. 11, 2018