Oecd Economic Surveys: Russian Federation 2000

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OECD Economic Surveys

Russian Federation ECONOMICS

March 2000

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OECD ECONOMIC SURVEYS 1999-2000

Russian Federation

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which came into force on 30th September 1961, the Organisation for Economic Co-operation and Development (OECD) shall promote policies designed: – to achieve the highest sustainable economic growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy; – to contribute to sound economic expansion in Member as well as non-Member countries in the process of economic development; and – to contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations. The original Member countries of the OECD are Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countries became Members subsequently through accession at the dates indicated hereafter: Japan (28th April 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29th May 1973), Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary (7th May 1996), Poland (22nd November 1996) and Korea (12th December 1996). The Commission of the European Communities takes part in the work of the OECD (Article 13 of the OECD Convention).

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Table of contents Assessment and recommendations

9

Introduction I.

31

Macroeconomic overview The financial crisis of 1997-98: the causes and consequences Output: from decline to constrained recovery The balance of payments: from weakness to strength Monetary policy under new constraints The federal budget and fiscal policy Government debt Income, employment, and welfare Commercial bank restructuring and regulation: the enormous challenge

II.

Demonetisation: the causes and policy implications Demonetisation and money surrogates: recent trends The causes of demonetisation The fall in the share of surrogates in 1999 Policy options

III.

Fiscal federalism Fiscal federalism and the case of Russia The basic institutions of fiscal federalism in Russia Revenue division, expenditure assignments, and transfers: the formal system The outcomes of the system: budgetary balance, incentives, and the regional financial crisis Policy options and reforms

33 34 45 54 56 60 65 68 73 83 84 92 108 109 113 114 116 123 135 146

Notes

150

Bibliography

161

Annexes I. Expenditure assignments in the Russian Federation II. The legal framework for subnational borrowing

171 175

••••• Boxes 1. 2. 3.

Recent changes in federal tax laws and procedures GKO-OFZ restructuring Commercial bank restructuring and ARKO

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4. 5. 6. 7. 8.

The Perm region programme for increasing the share of cash in tax revenue The organisation of the Russian fiscal system Agreements between the Federal Government and Regional Administrations on intergovernmental fiscal relations Changes in tax and budget laws in 1999 Can regional administrations explicitly withhold federal tax revenues?

111 118 122 127 142

Tables 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19.

Basic economic indicators Volume index of Russia’s main export commodities The balance of payments The federal budget The general government budget External government debt Selected balance sheet indicators of the 30 largest banks Types of payments in large firms and natural monopolies by industrial branch, December 1998 Correlations between surrogates and selected economic variables across Russian regions Russian fiscal organs operating in the regions Indicators of asymmetry in fiscal federalist relations Decentralisation in Russian state finance The composition of regional and local budgetary revenue The share of local budgets in major regulated taxes Major federal mandates in 1998 Planned and actual transfers from the FFSSF to selected regions Indicators of subnational budgetary imbalance Territorial state (federal) extra-budgetary funds relative to revenue of consolidated regional budgets Size and structure of subnational debt and loan guarantees in 53 regions

34 50 55 61 63 67 79 87 91 119 123 124 125 129 132 134 138 141 145

Figures 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Short-term capital flows, current account balance and the federal deficit The Russian stock market: boom and bust Open foreign position and government bond holdings of Russian commercial banks Interest rates on GKO and Eurobonds Federal tax collection in cash and surrogates The mounting burden of federal debt GDP volume indices Industrial output Key Russian export prices The dollar value of imports and exports Import substitution in Russian industry CPI, PPI, energy and transportation price inflation Effective exchange rates Fixed capital investment CPI monthly inflation and the exchange rate Nominal and real M2

36 37 39 41 42 43 45 47 48 48 51 51 53 53 56 58

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International gold and currency reserves of the CBR Government debt as share of GDP Unemployment Unemployment and spells of joblessness Real income, wages, and pensions Retail turnover (real terms) Real household deposits in commercial banks Profitability of the 30 largest Russian banks The share of non-cash receipts for industrial firms The share of non-cash receipts for large firms and natural monopolies The real value of attracted resources through issues of veksels by commercial banks Enterprise arrears Non-cash receipts as a share of federal and consolidated regional tax revenue Commercial credit to the non-financial sector, non-cash transactions and average returns on GKOs Real indices for electricity, gas, and transportation prices Surrogates and tax arrears to consolidated regional and federal budgets, 1997 Wage arrears The decline of surrogates in tax revenue and regional export intensity The share of sub-national budgets in total revenue in selected federations The size and structure of federal transfers and loans to subjects of the Russian Federation Deficit finance of the consolidated regional budgets: 1995-1998 Subnational repayment/borrowing ratios Subnational wage arrears and federal credits Accumulated subnational domestic debt since 1995

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59 67 69 69 71 72 74 78 85 85 87 88 90 94 100 104 106 109 124 134 137 137 140 144

BASIC STATISTICS OF THE RUSSIAN FEDERATION (1998 unless otherwise noted) THE LAND

Area (sq. km.) Agricultural area (thousand sq. km)

THE PEOPLE

Population (thousands, end-year) Inhabitants per sq. km (end-year) Average annual population growth (per cent, 1992-98) Employment (millions, end-year) By sector (per cent of total, 1997) State and municipal enterprises and organisations Private sector Mixed form of ownership By branch (per cent of total, 1997) Industry Agriculture and forestry Construction Unemployment rate (per cent of labour force, end-year) Inhabitants in major cities (thousands) Moscow St. Petersburg Nizhnii Novgorod Novosibirsk

GOVERNMENT/ ADMINISTRATION

Bicameral Parliamentary system (The Federal Assembly) Council of the Federation (upper house) State Duma (lower house) Number of registered political groups in the State Duma Regional government Subjects of the Federation, of which: Republics Krais (territories) Oblasts (regions) Autonomous oblast Autonomous okrugs (areas) City of Moscow City of St. Petersburg

17 075 2 220 146 338 8.6 –0.5 63.3 40.1 39.9 18.3 23.0 13.7 8.7 13.3 8 4 1 1

299 163 364 446

178 seats 450 seats 6 89 21 6 49 1 10

PRODUCTION

GDP (Rbs trillion, current prices) GDP per capita ($US, market exchange rate)

PUBLIC FINANCE

General government revenue (per cent of GDP) General government expenditure (per cent of GDP) Domestic public debt (per cent of GDP, end-year)

FOREIGN TRADE AND FINANCE

Exports of goods and services ($US billion) Imports of goods and services ($US billion) Central bank gross foreign exchange reserves ($US billion, end-1999) Gross external public debt (per cent of GDP, end-year)

12.5 54.5

Monetary unit: Rouble Currency units per US dollar (period average): Year 1999 December 1999

24.6 26.8

THE CURRENCY

2 685 1 862 30 35 28 87.5 73.6

The draft Survey was prepared by John Litwack and Douglas Sutherland, under the supervision of Silvana Malle. A primary consultant, Aleksei Lavrov, also made a major contribution. Vladimir Shuvalov, Vladimir Capelik, and Sergei Aleksashenko gave additional support as consultants. Technical assistance was provided by Laura Garcia, B´eatrice Gu´erard and Oleg Zasov, and secretarial assistance by Hazel Rhodes and Anne Prioul. The Survey was carried out in the context of the CCNM country-specific programme for the Russian Federation, and was presented at a meeting of the Economic and Development Review Committee on 7 December 1999. This Survey is published under the responsibility of the Secretary-General of the OECD.

Assessment and recommendations The record of economic performance in the Russian Federation over a decade of economic transition has been disappointing

The recovery of the Russian economy from the major economic crisis of 1998 provides an important context for a reexamination of economic policies pursued throughout the decade of transition. While Russia has made some progress toward the creation of a market economy in the last decade, the record of economic performance has been disappointing. Progress in macroeconomic stabilisation since 1995, leading by 1997 to modest gains in output, living standards and financial market development, raised some hopes that the Russian economy had finally turned the corner in the direction of economic growth and social welfare. But these hopes soon faded in the context of the major financial crisis of 1998 and further economic decline. The crisis victimised a number of areas that had experienced the most impressive progress during 1994-97, including the credibility of monetary policy and the regulation of commercial banks and financial markets. Important initiatives for strengthening institutions of bankruptcy and corporate governance have suffered along with the virtual paralysis on domestic financial markets since mid-1998. The effect of the crisis was particularly severe for emerging entrepreneurship, which is concentrated in services and import trade.

The 1997 OECD Survey identified unsustainable trends

While praising some recent accomplishments, the 1997 OECD Economic Survey of the Russian Federation nevertheless identified unsustainable trends in the fiscal sphere at all levels of government, which were visible in widening budget deficits, a spiral of official debt, and an increasing reliance on money surrogates in budgetary operations. The Survey also emphasised the structural roots of these worrisome fiscal trends, including a poorly functioning tax system and a lack of clarity in fiscal federalist relations. Myopically

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focused ‘‘emergency,’’ and often extra-legal, federal tax collection drives contradicted the vital goal of creating a workable tax system, consistent with strong incentives for profits and tax compliance. They also further weakened the position of creditors other than the state with regard to insolvent enterprises, a factor that hindered commercial banks in developing profitable loan portfolios and fulfilling their role as financial intermediaries. In this context, in spite of impressive progress in the regulation of commercial banks between 1994 and 1997, most banks came to depend on large portfolios of government securities or special financial co-operation with state organs. In addition, the 1997 OECD Economic Survey documented an increasing concentration of financial and economic activity in large financial-industrial groups, many of which operated on the basis of special relations with government institutions. A corresponding lack of transparency in privatisation, competition, and other economic policies, together with high and unstable taxation, contributed to a depressed environment for domestic and foreign fixed capital investment. Consequently, the substantial inflows of foreign capital to Russia in late 1996 and the first half of 1997 consisted largely of short-term portfolio investments, primarily in government securities (GKO).

The 1997 Survey stressed the need for accelerating structural reform

On the basis of this assessment, the 1997 Survey concluded that ‘‘the economy will not take off without further, deep reforms’’. It emphasised the necessity of major tax reform, progress in fiscal federalist relations, the improvement of the environment for fixed capital investment, changes in bankruptcy legislation and procedures, and general measures to promote the rule of law and fair competition. The Survey expressed hope that a strong reform mandate from the 1996 presidential elections, together with relatively low and stable inflation, success in restructuring the foreign debt, and some favourable developments on financial markets in early 1997, would provide a window of opportunity for major progress in this vital structural reform agenda.

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Recovering from the crisis

Underlying fiscal imbalances and structural problems made the economy highly vulnerable to changes in the external environment

The special window of opportunity in 1996-97 proved very limited indeed. The stock market crashed in late October 1997, followed by a halt in capital inflows and growing pressure on the rouble. Domestic interest rates soared, generating a rapid spiral of government debt and, eventually, a general financial crisis in mid-1998. Two major external factors contributed to this alarming turnaround in Russian financial markets, both of which were related to the financial turmoil in Asia: sharp falls in the prices of key export commodities and more cautious general attitudes of investors toward emerging markets. The underlying fiscal imbalances and structural problems summarised above made the economy highly vulnerable to such changes in the external environment. Indeed, the entire programme for fiscal consolidation and debt management in 1997 assumed that recently achieved relatively low interest rates on government bonds would be maintained. In the Russian context, this implied an assumption that the strong capital inflows would continue. Capital inflows, together with a strong current account surplus, had essentially financed larger fiscal deficits in 1996 and 1997. Once these inflows ceased and the current account weakened, monetary policy commitments became inconsistent with the large fiscal imbalances.

Emergency measures to restore a degree of macroeconomic stability have been effective

In addition to its direct adverse effect on many areas of structural reform, the crisis of August 1998 diverted much of the government’s attention away from medium-term objectives in favour of emergency measures to restore macroeconomic stability. Following the rapid depreciation of the rouble and the virtual collapse of financial markets in the second half of 1998, the government and Central Bank acknowledged a genuine threat of hyperinflation, and have managed to avert this threat through rather restrictive macroeconomic policies. The effectiveness of these policies has been supported by a major strengthening in the current account, following a decline in imports of over 40 per cent. After a period of very rapid depreciation and inflation, monthly inflation fell to under 3 per cent from February

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1999, while the rouble was stable at around 25 to the dollar for most of 1999.

But the challenges to monetary policy are enormous and speak for the importance of preserving Central Bank independence

The 1995 Law on the Central Bank had granted significant independence to monetary authorities and limited their objectives to the defence of the currency, the efficient operation of the payments system, and bank regulation. Since the crisis, however, the Central Bank has come under political pressure to adopt a monetary policy strategy that includes the broader aim of stimulating real economic activity. The management of the Central Bank has so far resisted this pressure and continues to pursue independent policies consistent with the objectives of the 1995 law. In the current Russian context, the preservation of Central Bank independence is important for the achievement of macroeconomic stability and restoration of the credibility of monetary policy. The current demands on monetary policy are already enormous and the degree of macroeconomic stability remains fragile. International reserves are still low and have come under constant pressure from the demands of foreign debt service.

Russia needs a major restructuring of foreign debt to get back on track and boost its international credibility

Following the dramatic depreciation of the currency, the burden of foreign debt has become so high as to make the servicing of all scheduled payments unfeasible. Indeed, such a strategy would have devoted the equivalent of over 80 per cent of planned federal tax revenue in 1999 to foreign debt service alone. Instead, the Russian government has been following a strategy of servicing only the part of foreign debt incurred by the Russian Federation itself, as opposed to the inherited debt of the Soviet Union. Negotiations are continuing on debt restructuring agreements that Russia needs to get back on track and boost its credibility with the international community.

A weaker rouble has provided a foundation for an industry-led recovery in GDP

A weaker rouble has provided a foundation for an industryled recovery in GDP. After declining sharply in the context of the crisis, industrial output began to recover rather quickly in late 1998. The speed of this recovery is explained in part by the low historical dependence of most Russian firms on external finance, a factor that limited the impact of

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the financial and banking crisis on the real sector. GDP reached its pre-crisis level by mid-1999, fuelled by an expansion in both export-oriented and import-substituting industries. The relatively rapid adjustment of industrial firms to the new economic conditions gives evidence of genuine progress toward the creation of a market economy in the Russian Federation. In addition to the weaker rouble, the industrial recovery received an additional boost from favourable movements in some key Russian export prices during 1999.

But some of the factors supporting this growth may be only temporary

While the industrial recovery represents a generally healthy response to the depreciation of the exchange rate, some of the factors supporting this expansion may be only of a temporary nature. Increases in controlled energy and transportation prices have lagged far behind producer and consumer price inflation, leading to probable price distortions that support energy-intensive manufacturing firms, and raising questions about the overall quality of the industrial recovery. A stronger current account and restoration of ‘‘normal’’ rouble demand have led to a real appreciation of the rouble since the second quarter of 1999, a process which may eventually contribute to a slowing of the industrial expansion. As another constraint on growth, fixed capital investment has not recovered along with output in 1999, remaining close to its depressed 1998 level. The activity of small entrepreneurs and businesses continued to suffer in 1999.

Some real appreciation of the rouble should be expected and energy and transportation price policies should be given particular scrutiny

In the context of economic recovery, some real appreciation of the rouble is natural and should be expected by the Russian government. Given the current constraints on macroeconomic policy, an attempt to control the real exchange rate explicitly would likely have very limited success, and could further jeopardise economic stability. The repressed input prices for industrial firms may be associated with substantial economic costs. While some manufacturing firms may profit from the maintenance of low energy and transportation prices, a large wedge between domestic demand and supply for these commodities will entail distortions, losses in economic welfare, and an increase in administrative allocation and corruption. Artificially low

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domestic energy prices may also weaken incentives for restructuring toward energy-efficient technologies, a particularly important task given the nature of the inherited infrastructure from the USSR. Finally, the combination of weak financial markets, high export taxes, and repressed domestic energy prices could deprive the energy sector of muchneeded resources or incentives for investment. Thus, adjustments in controlled prices in energy and transportation should receive careful consideration.

The fulfilment of a relatively austere 1999 federal budget appears to be on track

A weaker rouble, the recovery in industrial output, and adjustments in tax policy have alleviated pressures on the federal budget somewhat in 1999. The fulfilment of a relatively austere federal budget in 1999, which prescribes a primary surplus of 2 per cent of GDP, appears to be on track. A higher rouble value of export receipts and a larger share of VAT revenue accruing to the central government gave federal tax collection a particular boost. In addition to higher overall receipts, the federal government has managed the difficult task of collecting all taxes in cash since the second quarter of 1999. This contrasts with a strong reliance on various money surrogates in the past. The pursuit of a 2 per cent primary surplus has significantly compressed non-interest expenditures in real terms, a policy that may be difficult to sustain in light of the increased distress of a large part of the population.

Tax reform is still a major imperative

The nature of the Russian tax system, which is plagued by an excessive number of continually-changing tax rates, regulations, and exemptions, has long been a major thorn in the side of Russian economic transition. This system both encourages tax avoidance and depresses incentives for investment and restructuring. After many years of political confrontation and delays, a first (general) part of a tax code finally became law on 1 January 1999. The first part of the Tax Code places strong limitations on the number and type of taxes that can be employed at various levels of government. Nevertheless, the rules surrounding these various taxes, as well as exemptions, are still determined in a largely discretionary manner, either during the drafting of the annual budget or by government decree. Furthermore, the crisis has increased further the uncertainty in tax poli-

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cies. Hopefully, the preliminary success of the Russian government toward fiscal consolidation in 1999 will provide an impetus toward new initiatives to create an effective and workable tax system. This includes an effective division of tax authority between different levels of government (see below).

Poverty and social distress have increased for a large part of the population

Despite the recovery in GDP, real incomes remain considerably lower than pre-crisis levels, while poverty and social distress have increased for a large part of the population. This deterioration is visible in demographic and health as well as economic indicators. The implied challenges to social policy have further exposed the weakness of the social security and health systems. Pensioners have particularly suffered from real declines in their benefits, while a major pension reform initiative of 1997-98 has been postponed in the aftermath of the crisis. Unemployment also rose substantially in the early months of the crisis, but has subsided somewhat along with the industrial recovery.

The government has very limited financial means to confront the current problems in social policy

The Russian government has very limited financial means to confront the current challenges in the area of social policy, particularly given the high burden of foreign debt service and the collapse of most domestic markets for subnational debt. Real outlays on social expenditures have declined in 1999, exactly at a time of greater need. It is nevertheless important that the government continue to move ahead to the greatest degree possible with policies to target social assistance better and provide the foundation for selfsustaining pension and health care systems. The overall nominal level of pensions will need to be increased. A forthcoming OECD Survey on Russian social policy will offer more concrete policy advice. One general consideration regarding the division of responsibility for social expenditures is presented below in the discussion of fiscal federalist relations.

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Bank restructuring and regulation

The regulation and restructuring of commercial banks presents enormous challenges

The restructuring and regulation of commercial banks presents enormous challenges to the Central Bank and Russian government. The sharp devaluation of the rouble and virtual collapse of securities markets left the majority of large Moscow banks in financial devastation: insolvent, illiquid, under-capitalised, and loss-making. In the immediate aftermath of the crisis, the Central Bank took largely successful emergency measures to restore the payments system and prevent further bank runs by the population. Since this time, the Central Bank has been burdened with two exceedingly difficult tasks in bank regulation: the liquidation or rehabilitation of insolvent and under-capitalised large Moscow banks and the close monitoring of all banks in the face of declining overall profitability and a deterioration in the quality of asset portfolios.

The rehabilitation or liquidation of the large insolvent banks has been problematic

The rehabilitation or liquidation of the large insolvent banks has been particularly problematic. In the wake of the crisis, the Central Bank and government had neither the resources for recapitalisation, nor the political or legal leverage for confronting the tasks of bankruptcy and liquidation. Even attempts simply to withdraw the licenses of two large insolvent banks were contested and overturned in the courts. As a result, extremely little progress was achieved in bank restructuring until mid-1999. Under-capitalised and insolvent banks, while not servicing their liabilities, continued to operate under highly distorted incentives, leading to widespread asset stripping. Subsequently, the bank restructuring process has received new momentum from two new laws of February and June 1999 on the bankruptcy of financial institutions and the empowerment of a new Agency for the Restructuring of Credit Organisations (ARKO). In mid-1999, the Central Bank also finally withdrew the banking licenses from 6 large Moscow banks, beginning a now obligatory process of bankruptcy and liquidation. The Anti-Monopoly Ministry has also recently been delegated the function of monitoring competition in the banking industry and financial markets.

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New legislation for bank restructuring places a large amount of power and responsibility in the hands of the Central Bank and ARKO

The new legislation places a very large amount of power and responsibility in the hands of the Central Bank and the Agency for the Reconstruction of Credit Organisations (ARKO), as opposed to other institutions with claims on insolvent banks. This is perhaps the best solution in the particular Russian context, where strong potential conflicts of interest exist between competing creditors of these banks, many of which belong to large financial-industrial groups. The Central Bank and ARKO will continue to be challenged, however, to remain objective and detached, properly weighing the interests of banks’ creditors, depositors, and shareholders. They must also quickly identify problem banks, appoint qualified temporary administrators, and allocate efficiently very scarce resources for refinance and recapitalisation. The process of bankruptcy cannot begin until the Central Bank withdraws the license of the bank in question, while even small delays in this process could seriously compromise the interests of creditors or depositors. The process of bank restructuring thus promises to be a constant source of challenge for the Central Bank and ARKO, and will also be an inevitable source of controversy in coming years.

The crisis has also left banks with very limited sources of profitability

The crisis has also left a large number of banks with very limited sources of profitability. Securities, particularly government treasury bills (GKO), were a major source of banking profits before 1998. This market has virtually collapsed and risk coefficients for domestic securities have been raised considerably in prudential regulations. The crisis has also brought a significant deterioration in the quality of loan portfolios, particularly the large share of loans denominated in foreign currency. The legal and institutional environment of the Russian economy makes supporting profitable loan portfolios quite difficult for most commercial banks, while new regulations require provisions of 40 per cent even for performing loans. Aggregate commercial bank balances reveal a very high degree of liquidity, with very few new credits and a large share of assets held as cash or bank deposits in foreign currency. Aggregate profitability of the Russian banking sector remains significantly negative. Given this very problematic state of the banking sector, the Central Bank has continued to withdraw the licenses of a

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number of distressed banks and relaxed the former schedule for toughening minimum capital requirements and some other prudential regulations. In addition, ARKO has focused some of its attention on the rehabilitation of regional banks, many of which did not suffer the same type of decline in capital as their (larger) Moscow counterparts.

The successful reconstruction of the banking sector requires legal and institutional measures to protect the interests of commercial creditors

The successful reconstruction of the banking sector, including the transformation of Russian commercial banks into effective financial intermediaries, continues to require legal and institutional measures to protect the interests of creditors in the event of default on commercial loans. A new bankruptcy law of 1998 had a positive effect in this regard, as witnessed by the first active pursuit by a number of commercial banks of their claims through the court system. Complications in the application of this law in the Russian context, however, have slowed its effective implementation. According to this law and other legislation, the state receives priority claims over commercial creditors, although it is not represented in the committee of creditors that appoints external management. Given the fact that most insolvent firms in Russia have enormous tax debts, this has created incentives for creditors other than the state to appoint an external manager who pursues their interests while avoiding outright bankruptcy. While current efforts by the Russian government to amend the bankruptcy law to increase the power of the state are understandable, they might be accompanied by simultaneous measures that change the prioritisation of claims to protect at least partially the interests of commercial creditors. This protection is essential to foster the development of credit markets, healthy commercial banks and financial intermediation in Russia.

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Demonetisation

A particularly alarming recent trend has been the ‘‘demonetisation’’ of economic transactions and budgetary operations

A particularly alarming trend of recent years in Russia has been the ‘‘demonetisation’’ of economic transactions and budgetary operations. This process is associated with the rise in prominence of various forms of money surrogates, including barter, debt offsets, and various bills of exchange (veksels). As documented in the previous OECD economic Survey, this trend was already visible in 1996. By early 1998, money surrogates had mushroomed to the point of accounting for a majority of industrial transactions and subnational budgetary operations (taxes and expenditures). The rise in money surrogates has been accompanied by an elaborate system of multiple prices for the same commodity depending on transaction type. The corresponding economic costs to the economy and transition process have been formidable, and can be associated with high transaction costs, a lack of transparency in accounting and greater opportunities for corruption and illegal activities. Surrogates have also arguably impeded efficiency, restructuring, corporate governance, and the implementation of tax and other regulations. Neither state budgets nor firms have typically possessed enough cash to make basic wage, pension and other payments. The system of multiple prices also defies the basic logic of a market economy, as payments in kind are given a premium, as opposed to a discount, over cash payments. While some factors since the economic crisis have reduced the extent of demonetisation to some degree, the problem and its basic underlying causes remain.

The solution to demonetisation will require a comprehensive set of measures that address the structural roots of the problem

A number of studies have identified several competing groups of factors that may have contributed to the demonetisation process. Chapter II concludes that the primary causes are found in the particular conditions under which state organs and natural monopolies operate. The avoidance of commercial bank accounts that have been blocked by either tax authorities or the courts has been another possibly important factor. These conditions, in turn, are related to a number of fundamental problems in the nature of taxation, fiscal federalist relations, accounting, and the bankruptcy of large insolvent enterprises. The solution to demonetisation will therefore require a comprehensive

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set of measures that address the structural roots of the problem.

Particular institutional arrangements cause the noncash economy to be especially concentrated in the electricity and gas industries

In the context of the multiple price system, natural monopolies, particularly gas and electricity, accept non-equivalent exchange in the form of commodities or other money surrogates at inflated values. This owes to a combination of three factors: restrictions on the ability of natural monopolies to cut off non-paying consumers, the interests of regional and local administrations in supplying firms and organisations in their jurisdictions with cheap energy, and a managerial incentive system within the natural monopolies that does not properly discount receipts in non-cash form. In this context, natural monopolies, enterprises, and subnational state administrations all have an incentive to reach an agreement that implicitly reduces payment for a firm that is difficult to cut off from supplies, while at the same time not adversely affecting the balance sheet profitability of the natural monopoly. The latter is achieved through a non-cash payment evaluated at an inflated price. For this reason, the non-cash or so-called ‘‘virtual’’ economy is particularly concentrated in the electricity and gas industries.

A series of accounting and other measures can address these problems

Part of this problem can be addressed directly through changes in accounting practices in natural monopolies. A heavy discounting of non-cash payments in balance sheet profitability would induce managers of local branches of the electricity and gas monopolies to prefer cash to non-cash receipts of equivalent value. This is far from a complete solution, however. As the power of natural monopolies to reduce supplies differs greatly for different customers (firms), the former would still be inclined to employ barter or other surrogates as a means of differentiating prices on an individual basis. From the point of view of accounting and economic efficiency, however, the appropriate policy would be to set uniform rates and demand cash payments. Under these conditions, a build-up in payment arrears of enterprises that cannot be easily cut off from supplies (neotkliuchaemye potrebiteli) would make the implicit energy subsidies that they receive clearly visible and transparent. Parallel measures should be taken to shift the burden of these subsidies from the natural monopolies to the budgets of

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state organs that are protecting these enterprises. These subsidies could be financed in part by greater cash tax receipts from the natural monopolies themselves. This would have the effect of eliminating distortions, clarifying accounting, and separating the difficult problem of the bankruptcy of large insolvent enterprises from those of the non-cash economy (demonetisation) and regulation of natural monopolies.

State organs, particularly at the regional and local levels of government, also have an interest in the use of money surrogates

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In addition to the natural monopolies, state organs, particularly at the regional and local levels of government, have an interest in employing at least some money surrogates in budgetary operations. This owes to many factors summarised in chapter II of the Survey. Some primary considerations are as follows: First, as only taxpayers, and not state organs, pay interest and penalties on their arrears, state organs have an incentive to use a deliberate build-up of mutual tax and budgetary payment arrears as a means of budgetary fulfilment. Money surrogates, in the form of offsets, then emerge as a natural mechanism for clearing mutual debts at the end of the year. Second, particularly given the fact that the state treasury divides tax revenue only on a firm-by-firm basis, the use of money surrogates by subnational administrations can increase the amount and share of tax revenue received by these levels of government. Third, the fact that operations involving money surrogates, particularly offsets, are not subject to approval of parliamentary bodies or monitored by the Anti-Monopoly Ministry, make them a relatively easy mechanism for disguising corrupt or illegal activities. Fourth, the use of offsets expands significantly the degree of leverage that subnational administrations have over economic policy in their jurisdiction, including the implicit individualisation of taxation. This latter set of factors is further emphasised below in the discussion of fiscal federalist relations.

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OECD Economic Surveys: Russian Federation

The federal and some regional governments have been taking measures to limit the use of money surrogates in budgetary operations

Nevertheless, the federal and some regional governments have been taking measures to limit the use of money surrogates in budgetary operations. Indeed, despite the incentives to utilise money surrogates, state administrations operating with demonetised budgets have commonly found themselves with insufficient cash revenue to cover even basic expenditures on wages and transfers, which by law must be made in cash. A consequential build-up in wage and other arrears, together with increased official cash borrowing, has placed at least some pressure on state administrations to increase tax collection in cash. This pressure has now increased, given the current difficulties on domestic financial markets that limit official borrowing. The federal government has substantially reduced its reliance on money surrogates in 1999. Some regional governments have also made progress in this area, although the record is very uneven.

Government organs should be forced to pay interest on their arrears, while the rule by which the state treasury divides revenue should be changed

Further policy adjustments to alleviate the chronic problem of money surrogates in budgetary operations, as well as that of payment arrears, could include several measures. First, symmetric conditions should be introduced under which government organs should be forced to pay interest on their arrears under conditions similar to those for taxpayers. Otherwise, state organs at all level of government will continue to operate under strong incentives to delay payments, as well as (possibly) the processing of tax documents whenever possible, then employing offsets eventually to clear mutual debts. While such a rule may cause some short-run difficulties for budget management, it is a necessary condition for improving the current highly dysfunctional relations between state and economic organisations. Second, to the degree that the state treasury continues to divide tax revenue between various budgets, the division rule should be adjusted to account more fully for revenue received in the form of offsets. In particular, the current strict firm-by-firm division rule should be changed in the direction of accounting for aggregate cash and non-cash tax revenue in a particular region.

OECD 2000

Assessment and recommendations

The current efforts of the government toward a restructuring of accumulated tax arrears are justifiable, but need to be accompanied by other comprehensive measures

23

A huge debt overhang of tax arrears, which built up very quickly between 1995 and 1998, has complicated the conditions for solving payment and demonetisation problems. Indeed, the blocking of bank accounts by tax authorities or the courts has become an additional important incentive to rely on non-cash transactions. Particularly given the fact that these tax debts consist in large part of interest and penalties that accumulated under the asymmetric and distorted conditions described above, the current efforts of the government toward a major restructuring of this debt appear both expedient and justifiable. But this should be accompanied by simultaneous measures, as proposed elsewhere, to address the root cause of this problem, as well as a tough policy commitment to convince economic organisations that they should not expect a similar restructuring in the future. Again, the state can set the example by making its budgetary organs also responsible for executing payments on time, and levying interest and penalties on those organs that do not comply. The ultimate success of financial discipline in this area depends greatly on the further activation of the threat of bankruptcy, not only for economic organisations but for state organs as well (see below).

Fiscal federalist relations

Problems in regional and local polices can be associated with a poor general state of fiscal federalist relations

OECD 2000

This Survey gives special attention to problems in fiscal federalist relations, which lie at the heart of a number of issues already discussed above. The 1997 Survey stressed problems with economic policies at the regional and lower levels of government. In comparison with most other transition economies, these policies are typically considerably less favourable toward investment, entrepreneurship, fair competition, and the rule of law. They can often also be associated with a high degree of corruption. This represents one of the primary obstacles to reform and economic growth. These problems, in turn, reflect the difficult and distorted conditions under which subnational administrations currently operate, and the poor general state of fiscal federalist relations.

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OECD Economic Surveys: Russian Federation

While some progress has been made towards the construction of a fiscal federalist system, interbudgetary relations remain largely in a state of disarray

Some progress has been made toward the construction of a fiscal federalist system in Russia. Relatively stable and uniform rules have replaced much of the chaotic bilateral bargaining between the centre and regions in the early years of transition, while federal transfer policies have improved, gaining at least a small degree of stability and transparency. The explicit quantitative division of budgetary revenue and expenditures between the federal and subnational level in Russia now resembles that of many developed federalist countries. Nevertheless, the entire system of fiscal federalist relations in Russia remains largely in disarray. Recent years have witnessed a striking and growing contrast between a formal highly-centralised fiscal federalist system and actual practice, under which a large degree of financial authority is exercised at the subnational level through informal channels. The reform of fiscal federalist relations continues to be a critical, as well as a politically and economically complicated, aspect of economic transition in Russia.

Subnational governments have very little explicit autonomy in the determination of tax policies and revenues

While roughly half of all consolidated government revenue in the Russian Federation accrues to the subnational budgets, less than 20 per cent of subnational revenue comes from sources that could be considered autonomous in any sense. The vast majority of (explicit) subnational revenue is determined on the basis of laws and regulations of the superior level of government, while a single (federal) Tax Ministry collects all taxes. While the rules that determine the division of revenue and transfers between the federal and regional (Subject of the Federation) level of government exhibited at least some degree of stability during 1995-97, major tax changes introduced in 1998 and 1999 have once again increased the degree of uncertainty. Furthermore, the rules for the division of revenue between the regional and local levels of government are continually changed and determined on an individual basis. A law of 1997 attempted to address this problem to some degree, but appears not to have had a major effect for various reasons. The first part of the new Tax Code reiterates severe limitations on the explicit autonomous tax authority of subnational governments. While these restrictions were understandably motivated by a proliferation of many seemingly irrational subnational taxes between 1994-96, it is doubtful

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Assessment and recommendations

25

that such severe formal restrictions on subnational tax authority can be implemented in any practical sense (see below). The proliferation of subnational taxes before their ban in 1996 may have been more indicative of a symptom than of the disease itself.

Serious problems persist in expenditure assignments and unfunded federal mandates

OECD 2000

Ambiguity in expenditure assignments has plagued the development of fiscal federalist relations in Russia throughout the transition period. These assignments continue to remain highly unclear in many areas, with subnational levels of government often financing a part of expenditures under federal responsibility and the federal government assuming at least implicit responsibility for some expenditures at the subnational level. The delegation of the vast majority of social expenditures to the subnational level has been highly problematic for at least two reasons: the relative weakness of subnational budgets in the most socially-distressed regions and political pressure on the federal government to insure implicitly a large portion of these expenditures. Second, and perhaps most important, the expenditure side of subnational budgets has been increasingly victimised by unfunded federal mandates. The sheer number and size of these mandates makes their fulfilment at the regional level simply unfeasible. Despite a law of 1993 that forces the federal government to delegate unfunded mandates only on a recommended, as opposed to obligatory, basis, sufficient legal ambiguities have led the courts to rule on many occasions that such mandates are indeed obligatory. After such a ruling, the accounts of local authorities are typically impounded for the satisfaction of a particular group of claimants. As with the revenue side of the budget, this state of affairs, together with numerous other federal norms and regulations affecting regional and local expenditures, leaves little explicit room for manoeuvre by subnational officials.

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The highly centralised formal system stands in sharp contrast to a significant degree of de facto autonomy at the subnational level, thereby distorting incentives

This highly centralised formal system stands in sharp contrast to the significant degree of de facto autonomy that Russian regions have acquired since the outset of economic transition. As the formal system does not recognise this authority, regional financial policies are realised largely through informal mechanisms. In fact, ironically, both the high level of centralisation and unfeasibility of the formal system actually serve the interests of many regional officials. It affords subnational administrations an excuse to absolve themselves of the responsibility for the execution of the (formal) budget, and instead concentrate their energies in the informal arena. As emphasised above, the extensive use of money surrogates has been one primary means for the realisation of independent subnational policies that bypass the formal system. Another mechanism is the diversion of revenue, through various means, into a number of extra-budgetary funds and accounts. Some of these funds are officially ‘‘voluntary’’, although, in practice, subnational authorities have the power to make ‘‘contributions’’ to such funds either profitable or obligatory. Regional and local administrations also participate directly in the capital of many firms and financial organisations in their jurisdictions. In the absence of a legal framework of bankruptcy for a Subject of the Federation or local government, subnational governments also attracted substantial resources through various debt instruments from 1996-98, a process that culminated in the default and insolvency of numerous regions and localities in 1998 and 1999.

A workable fiscal federalist system should include a higher degree of both financial autonomy and responsibility for lower levels of government

Thus, the recent federal strategy aimed at retrenching much of the fiscal decentralisation of earlier years on the basis of increasingly rigid regulations and mandates has apparently backfired. The existing system leaves regions with sufficient de facto authority to realise their own economic policies, but absolves them of much of the responsibility for formal budgetary and debt management. A workable formal system of fiscal federalist relations must therefore recognise a high degree of financial autonomy and responsibility for lower levels of government, although within clearly defined bounds. Furthermore, a clear legal concept of insolvency and bankruptcy for a subnational administration is essential for the realisation of this responsibility. This would include

OECD 2000

Assessment and recommendations

27

provisions for the introduction of temporary administration by a superior level of government in the event of insolvency, and a detailed legal investigation that could hold individual officials responsible for improper budgetary management. These measures should also be accompanied by improved and more transparent accounting methods that better reflect various off-budget funds and accounts at the subnational level.

The particular circumstances in the Russian economy today favour accompanying greater fiscal autonomy at lower levels of government with measures to ensure a larger relative size of the federal budget

Despite the many advantages of fiscal decentralisation in a country the size of Russia, the particular circumstances in the Russian economy today favour accompanying greater fiscal autonomy at lower levels of government with measures to ensure a larger relative size of the federal budget. This would involve a higher degree of centralisation and more responsibility for social expenditures to the federal level, which could better account for the very large variance in social distress across Russian regions. This particularly concerns direct responsibility for the numerous federal expenditure mandates, a measure that would ensure greater rationality in the drafting or nullification of such mandates. In fact, this would make explicit a number of the responsibilities that the federal government already implicitly shares. A significant part of the so-called ‘‘regional’’ and ‘‘local’’ revenue that is currently determined by federal laws and regulation could become explicitly federal. It is also important that compensation mechanisms be strengthened to cover any further federal assignments to the subnational level.

The implementation of such an approach to fiscal reform is a political challenge

The implementation of such a ‘‘carrot and stick’’ approach to the reform of fiscal federalist relations, which offers genuine autonomy to the subnational level in exchange for a higher federal share of tax revenue and expenditures, would be politically challenging. It would generally receive support from a large number of subnational administrations, which commonly complain that the federal government takes insufficient responsibility for the needs of the region in the absence of adequate local resources. Richer regions could be more difficult to win over, but they should also appreciate the advantages of much more autonomous tax policies in the future stemming from higher income levels or

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OECD Economic Surveys: Russian Federation

resource bases. Some opposition may come from the large number of officials who profit from current arrangements, enjoying substantial rents from the combination of informal fiscal authority and a lack of formal responsibility. Given the very mixed past record of the federal government in honouring its various commitments, convincing the regions of the credibility of this proposal will also be difficult.

Greater independence of local budgets from the regional government (Subject of the Federation) is also an important policy goal

A complicated question for the further development of fiscal federalist relations concerns the degree to which the independence of local budgets should be protected relative to those of the region (Subject of the Federation). The large size of most Russian regions, together with a common absence of a progressive political orientation at the regional level, makes this a particularly important direction for policy and reform. To what degree could a widespread application of federal authority and coercion for the protection of local from regional budgets be efficient and practical? As illustrated in chapter III, limited federal attempts to address this problem in recent years have been seriously flawed, and actually may have been counterproductive. The particular nature of localities and local budgets is so varied within Russia as to make the application of uniform principles of independence very difficult. Nevertheless, the provision of a basic legal framework that protects, at least to some degree, the independence of local budgets should indeed be of federal responsibility. But the improvement of interbudgetary relations between local governments and Subjects of the Federation will depend greatly on solving the current problems in the federalist relations between the latter and the federal government. Once incentives for responsible budgetary management are established at the regional level, some administrations of the Subjects of the Federation may themselves become motivated to work toward straightening out problems with the localities in a manner that avoids excessive centralisation and takes accounts of local conditions and information.

OECD 2000

Assessment and recommendations

Current reforms to improve federal transfers are important, and complementary to other measures suggested above

29

The Russian government is currently undertaking important reforms to make federal transfers to the regions more transparent and stable over time. These measures have elevated the Federal Fund for Financial Support of Subjects of the Federation (FFSSF) to be the main channel for the distribution of transfers and are making the methodology for the allocation of this fund more stable and economically rational. This serves to combat the perception at the regional level that levels of transfers will be adjusted in a ‘‘soft’’ manner to measures of past budgetary performance. Under new changes in methodology, a larger share of the FFSSF is also devoted to the poorest and most needy regions. This is an important direction of reform that has already improved the nature of federal transfer policies. The implementation of general measures to improve fiscal federalist relations, as summarised above, will give this area of policy an additional boost. The current very high degree of formal centralisation of fiscal authority and responsibility hinders the ability of the federal government in its efforts to separate transfer policies from the day-to-day needs of regional budgetary balance.

Concluding comments

Summing up

OECD 2000

The economic crisis of 1998 has victimised a number of important areas of institutional development and increased social distress among much of the population. A responsible fiscal and monetary response to the crisis, bolstered by a strengthened current account, has helped to stabilise inflation and the exchange rate, although the low level of reserves, the demands of foreign debt service, and threats to the independence of the Central Bank speak of the continued fragility of the achieved level of stability. A restructuring of foreign debt is critical for consolidating trends in the fiscal sphere. While the quick onset of a recovery in GDP in the wake of the weaker rouble is encouraging, delays in structural reforms and low administered input prices raise concern about the quality and sustainability of this growth. The restructuring and regulation of the commercial banking sector continues to pose major challenges to the Central Bank and the Russian government. Throughout a

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OECD Economic Surveys: Russian Federation

decade of transition, problems in demonetisation and fiscal federalist relations, the particular focus of this Survey, have been important underlying structural obstacles to economic reform. Although some institutional reforms have provided a foundation for a market economy, delays in addressing these and other fundamental problems have impeded efficiency and increased the comparative vulnerability of the Russian economy to external shocks. The future stability and growth of the Russian economy will require the continuation of responsible macroeconomic policies, but depends first and foremost on progress in structural reform, including tax reform, effective institutions of bankruptcy, competition, more decisive and comprehensive measures to combat the process of demonetisation, defend the rule of law, and realise fundamental reform in fiscal federalist relations.

OECD 2000

Introduction This is the third OECD Economic Survey of the Russian Federation. Like its predecessors of 1995 and 1997, this Survey provides an overview of the general economic situation in the country and devotes special attention to selected structural topics. The experience of a decade of transition in Russia points to major failures in fiscal management and a number of peculiar economic distortions that beg explanation. The current Survey addresses two particularly important and complicated aspects of this experience: demonetisation and fiscal federalist relations. The Survey is intended to be complementary to previous OECD surveys, as well as to current work on the Russian Federation in other OECD directorates on issues such as tax administration, agriculture, the environment, social policy, competition, education and corporate governance. The overview chapter begins with an assessment of the causes and consequences of the major economic crisis of 1998, concluding that a deterioration of the federal fiscal position made the economy highly vulnerable to shocks from the external environment. The fiscal weakness, in turn, reflected a number of problems in structural reform. The chapter then turns to the performance of the economy since the crisis, focusing in particular on the nature of the industrial recovery, living standards, and changes in monetary and fiscal policies. A final section of this chapter is devoted to the particularly challenging task of commercial bank restructuring. The primary problems in the Russian economy continue to be structural, including the nature of the tax system, financial markets, institutions of bankruptcy, fiscal federalist relations, competition, and a poor environment for entrepreneurship and fixed capital investment. The 1997 Survey related a number of these problems to the nature of economic policies at the regional and local levels of government. These policies, both formal and informal, often appear inconsistent with the healthy development of market institutions and commonly feature a high reliance on the use of money surrogates in budgetary operations. These observations helped to motivate special work since the beginning of 1998 on subnational state finance, fiscal federalist relations, and regional economic development. The primary goal of this work, the first results of which are presented in

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chapters II and III of this Survey, is to understand better the particular conditions and incentives under which subnational administrations operate in the Russian Federation. This work involved missions to the regions of Novosibirsk, Kostroma, the Republic of Mari El, Cheliabinsk, Perm, Rostov, and Volgograd. We have relied on the close co-operation of the Ministry of Finance and the administrations of these regions. Chapter II addresses the causes and consequences of the overall process of demonetisation of the Russian economy, associated with the rise of barter and money surrogates in economic transactions and budgetary operations. This process, which is peculiar to the Russian experience, has imposed a heavy burden of transaction costs and other distortions on the economy. It has also been the subject of a number of previous studies both inside and outside of the Russian Federation. Although, for various reasons, the immediate impact of the economic crisis of 1998 has reduced somewhat the absolute level of demonetisation in the economy, this level remains significant, accounting for close to 40 per cent of industrial transactions and subnational budgetary operations as of mid-1999. The first section of chapter II describes the nature of the demonetisation process, summarises the conclusions of a number of existing studies on the topic, and then provides a synthesis that combines considerations raised in earlier studies with new evidence and analysis. While the present Survey echoes and clarifies the central role of relations with the natural monopolies in explaining demonetisation, it also stresses the activities of subnational state administrations; the conditions under which they operate and the various opportunities afforded to them from the use of surrogate money. This analysis suggests a number of specific policy recommendations and motivates the subsequent examination of fiscal federalism. A number of questions already raised in chapter II are clarified further in chapter III in the context of a general overview and analysis of the state of fiscal federalist relations in the Russian Federation. This chapter, in particular, profited greatly from a high degree of co-operation with the Ministry of Finance. While this chapter does note important progress in some areas of fiscal federalist relations in the Russian Federation, the overall conclusion is that the system remains largely in disarray. The formal system is highly centralised, in stark contrast to a de facto high degree of decentralisation in practice. The result is a system under which subnational administrations are compelled to realise their own economic policies largely through informal means, while the high degree of centralisation, lack of transparency and (often) unfeasibility of formal interbudgetary arrangements seriously weakens financial responsibility at lower levels of government and encourages corruption. The Survey identifies a direction of reform that explicitly recognises much of the already-existing regional autonomy, delegates genuine financial responsibility to lower levels, and simultaneously increases the share of revenue and financial obligations that are explicitly federal.

OECD 2000

I.

Macroeconomic overview

Since the completion of the previous OECD Economic Survey in 1997, Russia has endured an eventful and difficult period. Financial markets have been on a veritable roller coaster. A boom in capital inflows and asset prices in 1997 quickly gave way to instability, investor panic, and capital outflows by the end of the year, a process that culminated in the macroeconomic chaos of mid-1998. The Russian population and government have had to face a harsh new reality since the financial crisis, with substantially lower real incomes and tighter constraints on economic policy. In addition to the increased poverty and hardship of the population, the most significant costs of the crisis have been in institutional and structural reform. Despite remaining problems, Russia had made important progress since 1994 in commercial bank regulation, the development of financial markets, and the credibility of monetary policy. More limited progress was also achieved in bankruptcy, corporate governance, and the attraction of foreign direct investment.1 All of these areas have suffered notably in the context of the crisis. Some recent developments have been encouraging, however. Recent tough macroeconomic policy measures succeeded in averting the threat of hyperinflation, thereby providing a foundation for economic recovery. A weaker rouble and stronger current account have supported such a recovery in industrial output, an increase in rouble demand, and improvements in federal tax collection. The rather rapid adjustment of industry to a weaker rouble is strong evidence of at least some progress in the creation of a market economy in the Russian Federation. Yet the challenges remain formidable. While the macroeconomic situation has stabilised somewhat, it remains fragile. International reserves are still low and under constant pressure from the burden of foreign debt service. The crisis in the banking sector continues, requiring difficult and decisive measures for reconstruction. The financial tightening at a time of heightened social distress places greater pressure on the government to develop more effective means of targeting social benefits. In addition, the future growth and prosperity of the Russian economy depends, first and foremost, on the ability of the government to jump start the process of structural reform in this difficult context.

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34

Table 1.

Basic economic indicators

Real GDP (average yearly percentage growth) CPI inflation (Dec./Dec.) Exchange rate (Rb/US$, average)2 Unemployment (ILO-type measure, end-year, % of labour force) Exports of goods (billion US$) Imports of goods (billion US$) Current account (level): $ billions Per cent of GDP Budget balance (general government, in per cent of GDP) CBR gross foreign exchange reserves (billion US$, end-period)

1996

1997

1998

19991

–3 22 5 10 89 69 12 3 –9 15

1 11 6 11 88 74 4 1 –7 18

–5 84 10 13 74 59 2 1 –5 12

3 37 25 12 70 40 18 10 –4 11

1. Projections. 2. ‘‘New roubles‘‘. Prior to the start of 1998 1 new rouble = 1 000 old roubles. Source: Goskomstat, Central Bank of Russia, Ministry of Finance, and OECD estimates.

The first section of this chapter examines the causes of the financial crisis of 1997-98 with the goal of understanding its consequences for the current policy environment. Subsequent sections examine recent developments in output, the balance of payments, monetary policy, the federal budget, government debt, income, employment and welfare, and bank restructuring.

The financial crisis of 1997-98: the causes and consequences In early 1997, despite many remaining weaknesses, the Russian economy appeared stronger than at any previous time during the transition period. The sharp yearly declines in output had finally stabilised, with annual GDP growth turning slightly positive. Tight monetary policy, anchored by a narrow exchange rate band and toughened commercial bank regulations, had brought CPI inflation down from 131 per cent in 1995, to 22 per cent in 1996, and 11 per cent in 1997. In stark contrast to the past, inflation and the exchange rate had become two of the most stable and predictable economic variables, while monetary policy had gained an important degree of transparency and credibility. Living standards, which had deteriorated markedly for a large part of the population in the first years of transition, had begun a modest recovery. The result of the 1996 presidential elections provided a critical mandate for the continuation of economic reform and the further integration of Russia with the world economy. While acknowledging these accomplishments, the previous OECD Survey also pointed to sluggish progress in a number of critical areas of structural reform, including taxation, fiscal federalist relations, bankruptcy, competition, corporate

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Macroeconomic overview

35

governance, the regulation of natural monopolies, the environment for foreign and domestic investment, and small business development. At the macroeconomic level, the combined burden of these problems manifested itself in chronic fiscal imbalances, increased government indebtedness, poor financial intermediation, and low levels of fixed capital investment. Relative to most other transition economies, Russia has experienced low per capita direct foreign investment and a slower development of a small business sector. In contrast to the progress in monetary policy, the federal budgetary balance deteriorated sharply in 1996, remaining weak in 1997 in the context of falling tax revenue and a growing demonetisation of the economy. This latter process is examined in detail in Chapter II. Nevertheless, from mid-1996 to mid-1997, a current account surplus and strong portfolio capital inflows essentially financed the larger fiscal deficit (Figure 1). These inflows came on the heels of the 1996 presidential elections and progressive measures to liberalise the government bond (GKO, OFZ) market for foreign investors. High domestic interest rates helped attract substantial foreign portfolio capital to this market. By late 1997, foreigners explicitly accounted for roughly 30 per cent of the GKO market, while the activities of Russian commercial banks, which held most of the remaining 70 per cent, often involved foreign participation or co-operation (see below). In 1997, foreign interest also spilled over to the emerging corporate stock market, temporarily making this market the best performing in the world. Balance of payment figures from mid-1996 to mid-1997 show portfolio capital inflows of roughly US$20 billion, the vast majority of which in government bonds. In this context, annualised interest rates on GKOs fell dramatically from over 150 per cent in mid-1996, to 50 per cent in the fall of 1996, and under 20 per cent by mid-1997. With upgraded international credit ratings, the Russian government succeeded in floating Eurobonds at interest rates close to 10 per cent, while restructuring agreements with the Paris Club, the London Club and other creditors greatly increased the average maturity of Russian foreign debt. While maintaining a currency corridor that depreciated the rouble gradually with inflation, the Central Bank (CBR) began to accumulate substantial foreign exchange reserves. Gross international currency and gold reserves approximately doubled in the first half of 1997, reaching US$24 billion. Russian government officials began to express hope that they would no longer require financial support from the IMF. The presence of strong portfolio, as opposed to direct, foreign investment also pleased some political constituencies in Russia that exhibited cautious attitudes toward the sale of fixed assets to foreigners.2 The Russian government recognised, at least up to a point, that growing fiscal imbalances and government indebtedness needed to be brought under control. A series of measures, beginning in 1996, attempted to toughen tax administration, although with rather poor results (see Chapter II). In early 1997, the

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36

Figure 1. Short-term capital flows, current account balance and the federal deficit Billion US$

Billion US$

10

10

8

8

6

6

4

4

2

2

0

0

-2

-2

-4

-4 Portfolio capital inflows

-6

-6

Change in gross international reserve position of CBR Current account balance

-8

-8

-10

-10 Q1

Q2

Q3

Q4

1996

Q1

Q2

Q3

Q4

1997

Q1

Q2

Q3

Q4

1998 % of GDP

% of GDP

0

0

-2

-2

-4

-4

-6

-6

-8

-8

-10

Federal budgetary balance

-12

-10 -12

Source: Ministry of Finance, Central Bank of Russia, OECD calculations.

Ministry of Finance unveiled a medium-term plan for sequential fiscal consolidation that targeted a primary surplus by the year 2000. In addition to various other problems in implementation, this plan, and the entire underlying macro-policy framework, were based on the implicit assumption of maintaining the relatively low interest rates on government securities achieved in early 1997. In the Russian context, this amounted to an assumption that the strong capital inflows would

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Macroeconomic overview

37

continue. The reliance on this assumption made plausible another negative scenario, however, under which increasing uneasiness over short and medium-term prospects would cause short-term capital flows to slow or even reverse, thereby making the fiscal consolidation programme unfeasible and jeopardising macroeconomic stability. The financial turmoil in Asia and world economic slowdown, through their effects on investor expectations and export prices, added further plausibility to such a scenario. A sharp decline in export prices caused the rapid evaporation of Russia’s former sizeable current account surplus in late 1997 and early 1998. As shown in Figure 1, the Ministry of Finance did manage some modest progress in deficit reduction in early 1998 through cuts in a number of federal expenditures. But given the slowdown in capital inflows and the deterioration in the current account, this progress proved insufficient to calm expectations and prevent an eventual debt spiral and financial crisis. The first jolt of instability came with the plunge of Russian stock prices on 27-28 October 1997, beginning a downward spiral that continued until the end of 1998 (Figure 2). Despite very low initial prices, the meteoric rise of the Russian stock market in 1997 had the appearance of a bubble that could not be maintained indefinitely. A potentially high ‘‘fundamental value’’ of Russian assets in resource extraction and other areas could not be separated in practice from basic

Figure 2. The Russian stock market: boom and bust Daily observations, 1 September 1995 = 100 Index

Index

700

700

600

600

500

500

400

400

300

300

200

200

100

100

0 June

Dec. 1995

June

Dec. 1996

Source: Russian Trading System.

OECD 2000

June

Dec. 1997

June

Dec. 1998

0 Dec.

June 1999

38

OECD Economic Surveys: Russian Federation

unfavourable conditions toward outside investors, including high and unstable taxation, de facto insider corporate control in most firms, poor protection of the interests of outside share-holders, and political risks from ambivalent attitudes toward foreign direct investment in some Russian political circles. The consequential short-run and speculative orientation of a large part of foreign investors set the stage for an eventual correction in stock prices. Similar corrections had already occurred in several other transition countries with emerging stock markets, most recently in the Czech Republic. Catalysts for the correction came from several sources: more cautious attitudes of investors toward emerging markets following the financial turmoil in Asia, a further deterioration in Russia’s fiscal position, which prompted the IMF to withhold a scheduled tranche of its EFF loan, and growing confrontations between the Russian government and parliament that hindered the reform process. After the collapse in stock prices, concerns immediately surfaced over the possibility of a general financial crisis in Russia. Foreign investors began opting en masse for special forward contracts that would allow the future repatriation of their portfolio capital,3 thereby further heightened concerns over Russia’s international reserve position and the credibility of the exchange rate commitment. The defence of the exchange rate in November 1997 and the first half of December alone depleted Russia’s gross international reserves from US$23 to 17 billion. The high medium-term vulnerability of Russia’s fiscal position to changes in capital flows was already noted above. Still another cause of concern was the high exposure of Russian banks to domestic financial markets and exchange rate risk. Indeed, while banking regulations and incentives had improved significantly since 1994, and Russia did not suffer from the same type of bad debt overhang that plagued most of the Asian economies in crisis,4 a combination of factors still made Russian commercial banks very vulnerable to instability on domestic financial markets. Particularly in the light of a scarcity of profitable loan opportunities in the real sector of the economy,5 a number of the dominant large Moscow banks derived profits primarily from implicit or explicit co-operation with state financial organs, including the Ministry of Finance. This included holding portfolios of government securities (considered ‘‘riskless assets’’ in prudential regulations), servicing budget funds at little or no interest, or financing various federal budgetary operations under state guarantees.6 GKOs, which approached 30 per cent of aggregate commercial bank assets by 1998, provided banks with a particularly vital source of profits between 1996-98. An even greater source of vulnerability for the large banks was the structure of both on and off-balance-sheet liabilities. Largely unable to attract household deposits, Russian commercial banks came to rely increasingly on debt as a source of attracted resources.7 During the short-lived financial market boom, a large share of the dominant Moscow banks secured substantial foreign loans,

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Macroeconomic overview

39

leading to a rise of foreign-denominated bank liabilities relative to assets. As of July 1998, 75 per cent of the foreign currency liabilities shown in Figure 3 were concentrated in the 20 largest banks, generating a share of foreign loans in balance sheet liabilities for these banks of over 20 per cent.8 Given the fact that Russian commercial banks enjoyed privileges for investments in government bonds relative to foreigners, such contracts had natural mutual advantages. A number of banks also suffered from an imbalance in the maturity structure of foreign-denominated assets and liabilities, with the latter being generally of a more short-term nature.9 During the course of 1998, banks sought to address the growing imbalance in their open foreign positions by issuing new credits in, or converting old credits into, foreign currency.10 Of course, this did not solve the problem of risk from devaluation, as a large share of these dollar-denominated loans simply could not be repaid by Russian debtors under a much weaker rouble.11 In addition to what is shown in Figure 3, a substantial amount of hardcurrency liabilities of the large Russian commercial banks were off-balance-sheet, consisting primarily of forward contracts signed with foreign investors for the hedging of exchange rate risk. Net obligations of Russian banks according to such contracts were believed to be at least US$6 billion in the first half of 1998, with at

Figure 3. Open foreign position and government bond holdings of Russian commercial banks As shares of all assets %

%

30

30 Government securites Foreign-denominated assets

25

25

Foreign-denominated liabilities

20

20

15

15

10

10

5

5

0

01-01-97

01-01-98

Source: Central Bank of Russia, OECD calculations.

OECD 2000

01-01-99

01-04-99

0

40

OECD Economic Surveys: Russian Federation

least US$3 billion of this sum concentrated in the nine largest banks.12 Four of the large Moscow banks also had another combined US$1 billion in implicit liabilities in the form of guarantees for Eurobond issues of their foreign affiliates.13 In sum, it became clear already in 1997 that the large Moscow banks, and consequently the Russian banking system, could not withstand a combination of excessive declines in bond prices and a sharp depreciation of the rouble. This fact was one of the reasons for the strong determination of the Central Bank to continue to defend the rouble until mid-1998. In this determination, the CBR announced a series of measures on 11 November 1997, including a shift to a different exchange rate policy that allowed greater fluctuations (up to 15 per cent) around an average annual exchange rate. Ironically, the simultaneous announcement of average exchange rates for 1999 of 6.2, and the next three years of 6.3 roubles to the dollar, actually strengthened the CBR commitment to a strong rouble relative to the previous sliding band. During the turmoil of late 1997, the Central Bank first intervened simultaneously on the currency and GKO markets, defending both the rouble and interest rates, but soon wisely withdrew from the bond market, allowing interest rates to rise. These measures, along with indications of possible support from international official and private sources, succeeded in calming this first wave of instability. Although financial markets experienced a few new brief bouts of instability in early 1998, the spring brought a relative calm, with interest rates on GKO again falling below 30 per cent (Figure 4). At this time, three primary questions were central to the prospects for maintaining financial stability in Russia. First and foremost was Russia’s fiscal position. As the Ministry of Finance could no longer rely on the capital inflows and the relatively favourable borrowing conditions of 1997, only major progress in fiscal consolidation could prevent the escalation of interest rates, a debt spiral, and loss of financial control. Second, the downward trend in Russian export prices, with implications for the current account balance, became an ever greater cause for concern. Third was the question of the willingness of the IMF and the international community to commit substantial resources to a possible bailout of Russia. After what appeared to be a notable improvement in early 1998, federal tax collection declined dramatically in the second quarter of the year (Figure 5). A sudden dismissal of the government in March, falling export prices, and a growing recession in industry (see below) all contributed to the federal tax problems. Another important cause of the sharp fall in reported federal tax revenue was an (ultimately unsuccessful) attempt by the government to collect taxes only in cash as of March 1998.14 The reliance on money surrogates in federal taxation had been the source of numerous problems, thus motivating the decision to shift to a cashonly rule (see Chapter II). But the use of tax offsets had also relieved some of the

OECD 2000

Macroeconomic overview

41

Figure 4. Interest rates on GKO and Eurobonds1 Annualised per cent yields 100

100

90

90

80

80

70

70 60

60 GKO

50

50 40

40 30

Eurobonds

30

20

20

10

10

0 Jan.

Apr.

July 1997

Oct.

Jan.

Apr.

July 1998

Oct.

0

1. Yield indices are a geometric mean of: the volume-weighted effective annual yields of all tranches of Russian T-bills (GKOs) outstanding; the volume-weighted effective annual yields of all tranches of Russian Eurobonds (only US$-denominated bonds). Source: Skate.

burden of fulfilling overly ambitious budgetary targets, as expenditures and (often otherwise uncollectable) tax revenue were written off together. In addition, firms that doubted the credibility of the federal resolve to adhere to the new rule likely delayed tax payments in expectation of future offsets. As illustrated in Figure 5, the decline in federal tax revenue in 1998 directly parallels falls in receipts in money surrogates. Cash revenue even increased marginally during this period. (Nominal) federal tax revenue rose again toward the end of the year along with a decision by the government to once again utilise offsets. The decline in federal tax revenue in the first half of 1998, together with the continued weakening of Russian export prices, supported a growing concern that the devaluation of the rouble might become an objective necessity. As interest rates on government bonds began their last fatal ascent in May 1998, debt service mushroomed to over 40 per cent of federal expenditures and the deficit widened (Figure 6). The prospect of over US$15 billion in Russian foreign debt payments due in 1999 was also a major worry. Finally, May witnessed the first failure of a large Russian bank, Tokobank, due to an inability to service shortterm foreign currency liabilities. The final approval of the IMF rescue package in mid-July, totalling an estimated US$22.7 billion and including commitments by the World Bank and the

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OECD Economic Surveys: Russian Federation

42

Figure 5. Federal tax collection in cash and surrogates Constant prices, CPI-deflated Index

Index

450

450

400

400

350

350

300

300

Tax collection1

250

250

200

200

150

150

100

100

50 0 Janv.

Surrogates

Cash

50 0

Mars

Mai

Juil. 1997

Sept.

Nov.

Janv.

Mars

Mai

Juil. 1998

Sept.

Nov.

1. January 1997 = 100. Source: OECD calculations based on data of the Ministry of Finance.

Japanese government, represented the last hope of maintaining the monetary policy course and preventing financial collapse in the short or medium term. But the success of the entire programme hinged on the calming of investors’ expectations in the short term, bringing interest rates low enough to make feasible the emergency consolidation (expenditure reduction) programme that had been announced by the Russian government. As shown in Figure 4 above, interest rates did decline briefly in July, but it became apparent very quickly that the response of investors to the rescue package was insufficient, making the crisis of August 1998 inevitable. In fact, the overall situation had deteriorated to such a degree by July 1998 that a number of banks had already defaulted on their forward contracts with foreign investors.15 The Central Bank had been refinancing almost all maturing GKO-OFZ issues since 15 June, putting further pressure on reserves. The reluctance of the Duma to approve quickly a number of clauses associated with the emergency fiscal consolidation package also had a negative impact on expectations. As soon as bond prices began to turn down again in early August, a number of commercial banks rushed to sell their GKO portfolios in a desperate attempt to meet their current obligations on foreign loans and protect themselves from exchange rate risk, exerting further pressure on interest rates and the exchange rate. By the end of the first week of August, interest rates had

OECD 2000

Macroeconomic overview

43

Figure 6.

The mounting burden of federal debt

%

%

170

170 Stock of GKO/OFZ and Eurobonds as a share of previous 12 months of federal revenue

160

160

150

150

140

140

130

130 GKO/OFZ and Eurobonds

120

120

110

110

100

100 GKO/OFZ

90

90

80

80

70

70 Jan.

Mar.

May

July 1997

Sep.

Nov.

Jan.

Mar.

May

July 1998

%

%

50

50 Interest payments as a percentage of federal government expenditure

45

45

40

40

35

35

30

30

25

25

20

20

15

15

10

10

5

5

0

0 Jan.

Mar.

May

July 1997

Sep.

Source: Ministry of Finance, OECD calculations.

OECD 2000

Nov.

Jan.

Mar.

May

July 1998

44

OECD Economic Surveys: Russian Federation

shot up to record levels, a large number of Russian banks were in default, the interbank credit market had collapsed, the payments system was breaking down, and depositors were running on the banks. The package had clearly failed. On 17 August 1998, the Central Bank and Russian government, acknowledging this failure, announced a series of measures: a new exchange rate band to accommodate a limited devaluation of the rouble (on 2 September changed to a full-fledged float), the cessation of payments on GKO/OFZ with maturity before the end of 1999, pending a restructuring of this debt, and a 90-day moratorium on payments by Russian banks and private firms on obligations to foreigners. This announcement, combined with some initial suggestions of accommodative policy by the new government and Central Bank management, triggered a further panic and accelerated the depreciation of the rouble from 6 to 16 to the dollar between mid-August and end-September. In addition to the panic on the demand side, some emergency measures by the Central Bank to provide liquidity to the devastated large commercial banks and restore the payments system added further pressure on the rouble from the supply side (see below). Given the existence and future prospects of large capital outflows, a series of restrictions were introduced for the currency and capital markets.16 Monthly CPI inflation soared to 38 per cent in September. But the government and Central Bank quickly acknowledged the threat of hyperinflation and took rather restrictive measures in late 1998 and 1999, thereby restoring at least some element of stability to the overall macroeconomic situation. The financial crisis has fundamentally changed the scope and prospects for economic policy and transition in the Russian Federation. Unfortunately, the crisis has victimised precisely those areas of the economy that witnessed the most rapid institutional development in previous years: financial markets, commercial banking, and the credibility of monetary policy. The collapse of financial markets has had a strong negative impact on the development of the key institutions of bankruptcy and corporate governance, while also limiting the scope for fiscal and monetary policy. While small businesses and entrepreneurs, which are typically concentrated in import trade and services, had finally showed some signs of growth in late 1997, output from this sector declined by an estimated 31 per cent in 1998. In trade and catering, this fall reached 46 per cent.17 Real incomes and the standard of living, which had been exhibiting modest positive trends since 1996, suddenly declined by close to 40 per cent. Regional governments became increasingly defiant in refusing to co-operate with Moscow. With a weaker rouble, the burden of foreign debt service became so acute that the government decided to suspend service on part of this debt (the inherited former Soviet debt) and request a major restructuring agreement. The majority of large commercial banks, upon whose shoulders rested the banking and payments system, became decapitalised and loss-making, while the imperative of tight financial policies left insufficient resources for their immediate recapitalisation.

OECD 2000

Macroeconomic overview

45

Attracting foreign direct investment became more difficult than perhaps at any other time during the transition period, while the money laundering scandals of 1999 have also made official support for Russia more uncertain. These are the harsh economic realities that the Russian population and government have had to contend with since mid-1998. While the challenges to macroeconomic policy during 1997 and 1998 were tremendous, these challenges may now have become even greater. On the positive side, the weaker rouble has provided a foundation for a recovery in industrial output, a stronger current account, and offered a degree of relief to the chronic problems in federal tax collection.

Output: from decline to constrained recovery Following progress in stabilisation and some positive trends on financial markets, 1997 witnessed an end to almost a decade of economic decline in the Russian Federation. GDP growth was marginally positive for the first time in the transition period, picking up some momentum in the second half of the year (Figure 7). Even fixed capital investment, which declined by 5 per cent year-onyear relative to 1996, exhibited an upward trend toward the end of the year. While

Figure 7. GDP volume indices Same quarter of the previous year = 100 Index

Index

110

110

100

100

90

90

80

80

70

70

60

60

50

50 T1 T2 1995

T3

Source: Goskomstat.

OECD 2000

T4

T1 T2 1996

T3

T4

T1 T2 1997

T3

T4

T1 T2 1998

T3

T4

T1 T2 1999

T3

T4

46

OECD Economic Surveys: Russian Federation

some of this momentum carried into 1998, the economy was already sliding into recession by the second quarter of the year, with industrial output down by 7 per cent relative to the same period in 1997. The initial impact on output of the financial shock of August 1988 was negative. As early as November, however, output showed signs of recovery, expanding quickly to pre-crisis levels by mid-1999. Indeed, according to official estimates, by the second quarter of 1999, industrial output and GDP were already a respective 5 and 1 per cent higher than in the same period of 1998. Given the particularly low levels of industrial output and GDP in the second half of 1998, the annual growth rates for these variables for 1999 should be even higher. The recovery has come primarily from industry. The more than 3-fold depreciation of the rouble played a key role in supporting this recovery, increasing the profitability of exports and providing possibilities for import substitution. Also, the negative effect of the banking and financial market collapse on the real sector was limited by the very low historical dependence of most Russian firms on external finance.18 The rather rapid adjustment of the economy to a weaker rouble is certainly an encouraging development overall, although, for reasons discussed below, it may only be of a temporary nature. The foundation for future sustainable growth continues to hinge on critical structural reforms. Figure 8 clearly illustrates a rather sharp downturn in Russian industry even before the events of August 1998. Perhaps the most important factor behind the recession in the first half of 1998 was the economic slowdown in Asia and the world economy, which took a toll on the demand for Russian exports and export prices. Figure 9 illustrates the dynamics in key export prices in 1998 and 1999, while Figure 10 shows the related sharp fall in the dollar value of Russian exports. A recent positive development for Russian foreign trade has been the strong rise in oil prices in 1999. Although most of the fall in the value of exports in late 1997 and early 1998 shown in Figure 10 is explained by declines in prices, some export-oriented sectors also began reducing output volumes in the first half of 1998. This particularly concerns oil products other than crude, chemicals, and a number of nonferrous metals (see below). Exports of crude oil and gas, which are largely up against pipeline and extraction constraints, remained relatively stable in volume terms. But the collapse in world prices cut deeply into profits in these industries, feeding into an overall payments crisis and ‘‘cash shortage’’ throughout the country. In addition, before the stock market crash and tightening of financial markets, large firms in oil, gas, and some other export industries had enjoyed growing access to external finance, in contrast to most other Russian firms. But the subsequent financial market difficulties severely limited the ability of these firms to supplement liquidity through external sources in 1998. As discussed in more detail in Chapter II, the first half of 1998 witnessed an unprecedented rapid growth in payment arrears of all types. Some studies have also linked the fall in

OECD 2000

Macroeconomic overview

47

Figure 8. Industrial output Three-month moving averages Index

Index

120

120 Same month previous year = 100

115

115

110

110

105

105

100

100

95

95

90

90

85 Index

85 Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. 1997 1998 1999

115

Index

115 January 1997 = 100

110

110

105

105

100

100

95

95

90

90

85

Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. 1997 1998 1999

Source: Goskomstat, OECD calculations.

OECD 2000

85

OECD Economic Surveys: Russian Federation

48

Figure 9. Key Russian export prices 110

110 Non-ferrous metals

100

100 Ferrous metals

90

90

Timber/paper products

80

80 Fertilizers Natural gas

70

70

60

60

Crude oil

50

50 40

Q1

Q2

Q3

Q4

Q1

1997

Q2

Q3

Q4

1998

Q1

Q2 1999

40

Q3

Source: Goskomstat.

Figure 10.

The dollar value of imports and exports Three-month moving averages

Billion US$

Billion US$

9

9 8

8

Exports of goods

7

7

6

6 5

5 Imports of goods

4

4

3

3

2

2

1

1 0

0 Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep.

1996

1997

1998

1999

Source: Goskomstat.

OECD 2000

Macroeconomic overview

49

industrial output to increased capital flight in the context of the heightened financial uncertainty of 1998.19 In this context, surveys of Russian firms in the spring of 1998 revealed increasingly pessimistic attitudes toward ‘‘solvent demand’’ for their products, as well as accumulating inventories of finished goods.20 In addition to the relatively unfavourable conditions for exporters and their supporting industries summarised above, disposable income and domestic final demand also appear to have weakened in early 1998 (see below). This is related to falls in profits and other nonwage income, which could be expected in the wake of the sharp declines in Russian asset prices since the fourth quarter of 1997. Output suffered during the financial chaos of August and September 1998. First, the more than three-fold increase in the rouble price of imported inputs, together with new payments and currency restrictions, caused confusion for many firms. Expectations of high inflation, together with a more restricted access to the currency market, gave firms an incentive to wait before selling off inventories or producing new goods. Finally, the banking crisis led to various breakdowns in the payments system. The liquidity shock from the virtual absence of new bank credit may have also been of importance for some enterprises, particularly exporters. As indicated above, the aggregate output of small businesses and entrepreneurs suffered particularly from the currency depreciation. But industrial output began to rebound in the fourth quarter of 1998, led by export-oriented and import-substituting industries. On the export side, substantial growth has come in large part from the oil and oil product industries, which account for over 20 per cent of all Russian exports. Reported export volumes from these industries increased by a respective 4.2 and 18 per cent in the first half of 1999.21 As shown in Table 2, strong increases in export volumes have also come from metals, chemicals, and timber. Figure 11 indicates that the recovery in some import-substituting industries, including light industry, passenger automobiles, and, to some degree, food, has also outpaced the upward trend in industry as a whole. Despite lower incomes and domestic demand in 1999, an over 40 per cent reduction in imports is indicative of higher aggregate demand for a number of domestically-produced commodities. The combination of rouble depreciation, inflation, and price controls has fundamentally changed the relative prices faced by Russian manufacturing firms. As shown in Figure 12, the increase in consumer prices has far outpaced producer price inflation. As of June 1999, 12-month PPI inflation amounted to only half of the 120 per cent CPI inflation. Part of the reason for this discrepancy is a higher concentration of imports in the consumer basket. The PPI index has also increased somewhat faster than the CPI index since early 1999. But tight regulations on input prices have also been important, most particularly those for gas, electricity, and transportation. Prices for these commodities only increased by 10,

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OECD Economic Surveys: Russian Federation

50

Table 2.

Volume index of Russia’s main export commodities Same period of previous year = 1001 1997

Fuels Natural gas Crude oil Oil products Ferrous metals of which: Ferroalloys Iron Non-ferrous metals of which: Aluminum (crude) Nickel (crude) Refined copper

1998

1999

H1

H2

H1

H2

H1

100.0 102.7 120.7

102.5 98.9 95.2

98.1 108.8 72.1

101.7 107.4 70.2

100 104.2 118

114.7 82.7

126.0 165.2

101.8 107.6

92.2 100.5

106.8 133.6

Share value of total exports 1997 %

1998 %

45.9 19.0 17.0 8.4

40.0 18.4 14.2 5.8

9.3

9.0

0.3 0.4

0.4 0.4

7.4

8.0

100.0 145.8 103.4

87.2 123.2 98.8

103.3 88.6 83.9

103.3 103.4 120.1

110.4 97.3 117.4

4.4 1.7 1.3

5.2 1.5 1.3

37.4 67.4

57.6 71.5

92.6 104.3

182.9 42.9

176.5 54.6

9.9 0.1 0.5

10.5 0.1 0.5

Chemicals and petro-chemicals Nitrous fertilisers Potassium fertilisers

84.7 104.6

68.4 173.5

86.4 113.6

120.3 98.1

134.6 112.9

3.1 0.7 0.6

3.2 0.6 0.6

Lumber and paper Newsprint Plywood Unprocessed timber

91.0 99.6 119.9

95.2 105.4 103.2

124.2 119.9 103.1

124.2 114.4 123.3

119.6 112.4 145.9

3.0 0.4 0.3 1.2

3.4 0.6 0.3 1.3

Machine-building and manufactured metals Trucks Passenger cars

1. Except where specified otherwise. Source: Goskomstat.

15, and 20 per cent during the same period, respectively. Along with the effects of devaluation, low energy and transportation prices have undoubtedly contributed to the higher profitability of many manufacturing firms since the August 1998 crisis. The ability of the government and regional administrations to enforce severe controls on energy prices is related to high export taxes and, especially, pipeline capacity and other constraints that limit access to export markets. It should be noted, however, that the huge relative price change in Figure 12 is somewhat exaggerated for the Russian case, as a number of ‘‘socially important’’ firms were already receiving very low implicit energy prices due to

OECD 2000

Macroeconomic overview

51

Figure 11. Import substitution in Russian industry Same period previous year = 100 Index

Index

180

180

160

160

140

140 Passenger cars

120

Food

120 Total industry

100

100

80

80

60

60

Light industry

40

40 Sep.

Oct. Nov. 1998

Dec.

Jan.

Feb.

Mar.

Apr.

May

June July 1999

Aug.

Sep.

Source: Goskomstat, OECD calculations.

Figure 12. CPI, PPI, energy and transportation price inflation December 1996 = 100 Index

Index

275

275

250

250

225

225

200

200

CPI PPI

175

175

150

150

Transportation

125

125

100

100

Electricity prices paid by producers Gas prices paid by producers

75

75 Dec. 1996

Mar.

Source: Goskomstat.

OECD 2000

June Sep. 1997

Dec.

Mar.

June Sep. 1998

Dec.

Mar.

June Sep. 1999

Dec.

52

OECD Economic Surveys: Russian Federation

either non-payment or payment in barter at non-equivalent rates (see Chapter II). Lower energy prices have been accompanied by a campaign, particularly in electricity, to increase cash receipts and crack down on non-paying customers. From this point of view, the policy option of maintaining low domestic energy prices in the very short run may have some advantages. Nevertheless, the economic costs of this policy must also be considered. An excess of demand over supply for cheap energy products will unavoidably lead to an increase in administrative decisions regarding priority allocations, a process that usually bears a very weak relation to economic efficiency and fosters corruption. The activities of many, possibly negative-value-adding, energy-intensive firms will receive a boost, while incentives for restructuring toward energy efficient technologies will be weakened. This latter problem is particularly acute in Russian industry, which inherited a very energy-intensive technological infrastructure from the Soviet period. The operations of many of these firms also have a negative impact on the environment.22 Supply and much-needed investment in the energy sector may end up lower than the social optimum, particularly given high export taxes, more restricted access to domestic external finance, and more cautious attitudes of foreign investors. Indeed, surveys in the energy industry reveal a still complicated situation for net profits and liquidity, even for oil exporters that face much stronger prices.23 Thus, the presence of repressed energy and transportation prices raises important questions about the quality and sustainability of the current industrial expansion. As shown in Figure 13, the real effective exchange rate, calculated with the producer price index, has started to appreciate in 1999. This can be understood as a natural consequence of the strengthened current account and restoration of ‘‘normal’’ rouble demand, and mirrors purchases of foreign exchange by the Central bank since the second quarter of 1999. The extent of this real appreciation, and its corresponding impact on competitiveness, is another important question for the medium term. In general, throughout the transition period in Russia, the presence of large and relatively price inelastic energy exports has placed an implicit burden on (restructuring) manufacturing firms through upward pressure on the real exchange rate. This is another factor that may contribute to a future slowdown in the output expansion of Russian industrial firms. A current primary limiting factor on pressures for appreciation is high foreign debt service. Still another sign of the possible fragility of the industrial expansion is the fact that fixed capital investment is recovering much more slowly than output. Reported fixed capital investment declined by an estimated 6.7 per cent in 1998, and remained at roughly the same depressed level through the first half of 1999. An upward trend in fixed capital investment did become visible in the third quarter of 1999, although part of the corresponding growth illustrated in Figure 14 reflects the very low comparative level of investment in the immediate aftermath of the crisis in 1998. While the share of investment in industry, as opposed to

OECD 2000

Macroeconomic overview

53

Figure 13. Effective exchange rates1 January 1997 = 100 Index

Index

120

120

100

100

80

80 Real using CPI

60

60

40

40 Real using PPI

20

0

20

Nominal

Jan.

June 1997

Dec.

June 1998

Dec.

June 1999

Nov.

0

1. Estimated with a weighted-average of the exchange rates of Russia’s main trading partners. Source: Central Bank of Russia, OECD calculations.

Figure 14. Fixed capital investment Same period of previous year = 100 Index

Index

115

115

110

110

105

105

100

100

95

95

90

90

85

85

80

80

75

Jan.

June 1997

Source: Goskomstat.

OECD 2000

Dec.

June 1998

Dec.

June 1999

Nov.

75

54

OECD Economic Surveys: Russian Federation

individual construction, did increase marginally, so did the share of fixed capital investment categorised as ‘‘short term’’.24 Most of the economic recovery in the first half of 1999 was confined to industry. Although agriculture stands to benefit somewhat from the expansion of the domestic food industry, this sector remains rather depressed, with output estimated to be 4 per cent lower than in the first half of 1998. The effects of the disastrous harvest of 1998 are still being felt in agriculture, although a number of new administrative restrictions, introduced primarily at the regional level, may have also contributed to the sluggishness of the recovery.25 Another poor harvest in 1999 will hinder recovery in agriculture at least until the harvest in 2000. Output in transportation was close to the same level in the first half of 1999 as in 1998. Services and retail trade continue to be the most depressed areas of the economy, reflecting the fall in domestic demand. Given the high concentration of the ‘‘grey’’ economy in this area, it is possible that activity in this sector has also declined.26 Although Goskomstat attempts to account for the grey economy in its statistical calculations, the measurement of informal activity is understandably much more difficult than that of the output of large industrial firms. For this reason, the economic recovery could be weaker than indicated by official statistics.

The balance of payments: from weakness to strength As indicated in Table 3, the second half of 1997 brought the current account into deficit, which, together with a weak capital account and severe fiscal deficit, ultimately proved too severe to maintain monetary policy commitments by mid-1998. The weakening of the current account during 1997 and the first half of 1998 can be associated primarily with the trade balance, as discussed in the previous section, although greater foreign debt service obligations decreased the investment income balance as well. The capital account has also weakened during this period. Strong portfolio capital inflows in the government bond (GKO/OFZ) market declined sharply in the fourth quarter of 1997, although little of the capital that foreign investors placed in forward contracts for possible repatriation at that time appears to have actually left the country. At the same time, the negative entry in ‘‘other investment’’ in the fourth quarter of 1997 derives primarily from an estimated build-up of US$9.6 billion in cash foreign currency holdings of Russian non-financial enterprises and households, a figure related to both external and internal capital flight. During the short-lived relative financial calm in the first quarter of 1998, capital inflows to the GKO/OFZ market actually resumed, exceeding US$3.1 billion, but subsequently fell to negligible levels. Portfolio capital inflows in the second quarter of 1998 were essentially limited to the placement of a US$4 Eurobond issue.

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Macroeconomic overview

55

Table 3.

The balance of payments In million US$ 1996

Jan.-Jun.

1997

July-Dec.

Current account Goods and services Exports Imports Invest. income and comp. Receivable Payable Current transfers Received Paid

5 6 49 –42 –1 3 –4

Capital account Capital transfers Received Paid Direct investment Abroad To Russia Portfolio investment1 Assets Liabilities Other investment1 Assets Liabilities

–638 –3 985 –285 –179 1 424 1 642 –1 709 –1 820 225 1 483 –447 –323 673 1 805 2 756 6 002 67 –240 2 688 6 242 –3 334 –11 291 –12 707 –16 245 9 374 4 954

Changes in reserves Errors and omissions

Jan.-June

1998

July-Dec.

Jan.-June

1999

July-Dec.

Jan.-June

640 6 541 4 257 –276 –5 242 6 885 8 978 903 10 548 7 668 5 085 120 13 535 11 969 108 54 617 48 217 55 018 43 626 44 108 37 174 204 –44 070 –40 549 –49 933 –43 505 –30 573 –25 206 168 –4 171 –3 336 –5 077 –5 049 –6 549 –3 018 351 982 3 148 1 219 3 313 988 2 977 519 –5 154 –6 484 –6 294 –8 361 –7 539 –5 996 –94 164 –76 –286 –314 –101 28 276 494 213 197 140 130 287 –370 –331 –289 –481 –454 –230 –259 9 158 –2 973 –431 –365 956 1 180 –1 388 –1 546 1 290 2 746 –1 279 –1 323 2 569 4 070 14 108 3 325 145 –301 13 964 3 625 –5 809 –8 679 –5 090 –21 522 –719 12 843

9 566 –6 694 –281 –101 878 826 –1 159 –928 478 1 256 –595 –432 1 073 1 689 7 964 223 –603 347 8 567 –124 1 405 –8 072 –5 731 –10 450 7 136 2 378

–4 998 –130 406 –535 494 –870 1 364 –372 –225 –147 –4 990 –5 518 528

–201

–1 157

9 287

–7 332

–1 676

–3 579

645

–5 203

–3 713

–4 128

–4 083

–6 000

–3 770

–3 335

1.

These figures differ from official CBR figures for July-December 1997. For this period a restructuring of part of the foreign debt was included by the CBR as a large entry in ‘‘portfolio investment’’ and subtracted from ‘‘other investment’’. For analytical clarity, we have netted this out of the figures in Table 3. Source: Central Bank of Russia, OECD calculations.

The turnaround in the current account from a US$5.2 billion deficit in the first half of 1998 to a surplus of US$9 billion in first half of 1999 is due primarily to a contraction in imports by US$18 billion, or more than 40 per cent. Despite modestly higher export volumes in the first half of 1999 relative to the same period in 1998, weak prices on Russian exports pushed their dollar value 15 per cent lower. Following the strengthening in oil prices, the dollar value of Russian exports finally began to increase in the third quarter of 1999. Since the August crisis, capital inflows have remained quite modest. A notable feature of the Russian balance of payments in recent years is highly negative errors and omis-

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56

sions, indicating a weaker reserve position than would be implied by current and capital account developments. These errors and omissions appear to be linked to hidden capital outflows, although nothing more than a very general relationship can be established. In fact, the CBR believes that annual capital flight has actually exceeded US$ 10 billion from 1996-98.27

Monetary policy under new constraints Along with the strengthening of the current account, restrictive monetary policy has made an important contribution to the partial stabilisation of the chaotic macroeconomic situation of late 1998. After depreciating from 6.2 to 24 roubles to the dollar between mid-August 1998 and February 1999, the exchange rate stabilised in the range of 24-27 for the remainder of the year, while monthly inflation fell to under 3 per cent (Figure 15). In 1999, the Central Bank has adopted rather strict refinance policies toward commercial banks, affecting money supply primarily through interventions on the currency market. Although the official exchange rate policy has changed to a float, the CBR continues to

Figure 15. CPI monthly inflation and the exchange rate %

Roubles/US$

45

30 US$ exchange rate, end-of-period

40

25 35 30

20

25 15 20

Month-on-month inflation

15

10

10 5 5 0

0 Jan.

Apr.

July 1998

Oct.

Jan.

Apr.

July 1999

Oct.

Source: Goskomstat.

OECD 2000

Macroeconomic overview

57

intervene actively on the currency market with the goal of maintaining exchange rate stability. Another motivation for intervention has been the accumulation of sufficient reserves for foreign debt payments. Given the current state of financial markets and the banking sector, this intervention has, in fact, become the primary tool of monetary policy. Due to the borrowing constraints faced by the Ministry of Finance, the CBR is also financing most of the fiscal deficit, although this has been virtually limited to payments on the foreign debt. The high burden of these payments and the low level of international reserves speak for the continued fragility of the achieved degree of macroeconomic stability. The crisis in the banking sector and financial markets places direct constraints on the scope and effectiveness of the usual monetary policy instruments. The Law on the Central Bank of 1995 provided a new foundation for monetary policy in the Russian Federation.28 This law granted the Central Bank a high degree of independence and confined its objectives to defending the currency, ensuring the proper operation of the settlement system, and regulating credit institutions (banks). But political changes in the wake of the August 1998 crisis raised fundamental questions about the future of the Central Bank and its policies. A movement in the state Duma sought to change the 1995 law with the goal of limiting Central Bank independence, while statements of the new CBR leadership indicated that the goals of monetary policy would be broadened to include objectives associated with overall economic development.29 In practice, however, there has been little or no evidence of any such shift in monetary policy. Even emergency measures that provided liquidity to some banks under special conditions in the second half of 1998 (see below) cannot be viewed as a major accommodation to the rapid depreciation and inflation of August and September. As shown in Figure 16, money supply (M2) contracted in real terms by almost 30 per following the August 1998 crisis and has remained rather stable since that time. Finally, in the context of negotiations with the IMF, the Central Bank management signed a declaration of economic policy in mid-1999 (Zaiavleniie (1999)) that indicated a firm continued commitment to the spirit of the 1995 CBR law, limiting Central Bank policy to the three specified objectives. Nevertheless, the presence of strong political forces supporting a shift in the underlying principles of Russian monetary policy remains a potential threat to the current policy stance. Since the collapse of the government bond market in August 1998, the Central Bank has been highly restricted in its ability to conduct open market operations. As rouble liquidity began to grow in the banking sector in 1998, the Central Bank responded by issuing a limited number of its own bills (OBP) with the intention of mopping up excess bank liquidity, relieving some pressure on the rouble, and providing struggling banks with at least one highly-liquid and tradable domestic asset. But the Federal Securities Commission took actions that resulted in a temporary ban on the right of the CBR to issue securities. A new amendment to the Central Bank Law has granted the CBR the right to resume such

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OECD Economic Surveys: Russian Federation

58

Figure 16. Nominal and real M2 Billion roubles 700

700

600

600

500

500 Nominal

400

400

300

300

200

200

Real

100

100 Jan.

Apr.

July 1998

Oct.

Jan.

Apr.

July 1999

Sep.

Source: Central Bank of Russia, OECD calculations.

issues, however30 In the light of limitations on open market operations, the Central Bank has been attempting to make much more use of both deposit facilities and reserve requirements for the regulation of bank liquidity and money supply. Given the mid-1998 liquidity crisis in the banking sector, reserve requirements were lowered steadily from 11 all the way to 5 per cent in December 1998, before gradually being increased to 5.5 (households) and 8.5 (juridical persons) by June 1999. The (voluntary) deposits of commercial banks with the Central Bank have increased from 1.5 to 4.5 per cent of aggregate bank liabilities between September 1998 and September 1999. This can be partly associated with the creation by the CBR of new two-week, one month, and three month facilities in October 1998, February 1999, and March 1999, respectively. A disadvantage of the deposit facility relative to securities, however, is the absence of the tradability of the former. Part of the increase in commercial bank deposits simply reflects overall higher liquidity and confidence in the rouble since the August crisis.31 The overall weakness of the banking sector potentially limits the elasticity of the response to changes in interest rates paid on CBR deposits. The effectiveness of the usual monetary policy tools thus remains constrained in the current situation. In the immediate aftermath of the August 1998 crisis, the Central Bank introduced a series of restrictions on the currency and capital markets with the

OECD 2000

Macroeconomic overview

59

goal of exerting at least some control over the depreciation of the currency and capital flight. But most of these restrictions have been, or are due to be, lifted in the context of the 1999 agreement with the IMF.32 One remaining restriction is the requirement that exporters quickly convert 75 per cent of their export earnings into roubles on the currency market. The CBR temporarily shut down the interbank currency market during the chaos of August 1998. Subsequently, it set up two sessions, a morning session that determined the ‘‘official’’ exchange rate, in which exporters supply foreign currency and only banks with special orders from clients (importers) represent demand. A later evening session allowed banks to trade on their own behalf. On 29 June 1999, these two sessions were unified without a measurable impact on the exchange rate. One important remaining restriction forces importers to collateralise advance payments for imports with bank deposits of equal value (returned only if the goods are delivered). The most active monetary policy tool remains intervention on the currency market. After minimal intervention in the first quarter of 1999, a higher demand for the rouble in the second quarter of the year supported the purchase by CBR authorities of close to US$3 billion, while preserving stability of the nominal exchange rate. This led to a growth of currency in circulation of 24 per cent in the second quarter of 1999, as opposed to a 7 per cent decline in the first

Figure 17. International gold and currency reserves of the CBR Billion US$ 30

30 Foreign exchange Gold

25

25

20

20

15

15

10

10

5

5

0

0 Dec. Feb. Apr. June Aug. Oct. Dec. Feb. Apr. June Aug. Oct. Dec. Feb. Apr. June Aug. Oct. 1996 1997 1998 1999

Source: Central Bank of Russia, Ministry of Finance, OECD calculations.

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OECD Economic Surveys: Russian Federation

quarter. The rouble came under a bit more pressure later in the year, however, amidst the uncertain impact of international money laundering scandals on foreign aid to Russia, the conflicts in Dagestan and Chechnya, and (perhaps) heightened political uncertainty from the coming elections. On several occasions, the CBR has been compelled to intervene on the other side of the market, selling foreign currency to relieve pressure on the rouble. The still weak international reserve position of the CBR (Figure 17), and the pressure of foreign debt payments thus speaks of the continued fragility and delicate balance of the achieved degree of stabilisation. Despite the purchases of foreign currency by the CBR in the first eight months of 1999, gross international gold and currency reserves declined by US$1 billion due to foreign debt payments.

The federal budget and fiscal policy As stressed in the first section, problems in federal tax collection and budgetary execution were key contributing factors to the Russian financial crisis. The stabilisation achieved through tight monetary policy in the period 1995-97 proved unsustainable in the context of large fiscal imbalances, following a weakening of the current account and capital inflows. The financial crisis and government programme has imposed new constraints on the federal budget and fiscal policy. Most notably, the Ministry of Finance has become restricted in its ability to borrow either domestically or on international markets. While the restructuring of GKO obligations has lowered domestic debt service, the weaker rouble has increased the burden of the foreign debt significantly. Since the collapse of the government bond market, the federal deficit has been financed primarily by direct CBR credit in the form of foreign debt service. In this context, the 1999 Federal Budget Law was notably more austere than its predecessors, prescribing a primary surplus of 1.6 per cent of GDP, a target that was later increased to 2 per cent in the context of an agreement with the IMF. The envisioned progress in fiscal consolidation is based on a compression of non-interest expenditures to under 10 per cent of GDP and an additional 1.5 per cent of GDP in tax revenue beyond that achieved in 1998. During the first half of 1999, tax collection and budgetary execution appeared at least close to target. While the budget showed a primary surplus of close to 1.0 per cent of GDP for the first half of the year, this figure had already increased to 1.8 per cent by the end of the third quarter, moving overall federal budgetary balance to an estimated –2.1 per cent of GDP. As illustrated in Table 4, the primary improvement relative to previous years has been in tax collection. While federal tax revenue remained at under 10 per cent of GDP in the first quarter of 1999, it subsequently jumped to over 11 per cent in the second quarter. More favourable export prices, together with a weaker rouble and higher

OECD 2000

The federal budget

As percentage of GDP 1998 H1

1999 H2

1997

1998

H1

Budget law 1999

1999 IMF Programme

Budget law 2000

11.8

11.6

14.9

16.8 7.1

16.0 4.1

Year

Revenues of which: Tax revenues Value-added tax Profit tax Excise taxes Customs duties Other tax revenues Non-tax revenues Revenues of budgetary funds

10.5

7.8

12.2

10.0

9.0

8.9 4.0 1.4 1.8 1.4 0.3 0.4 1.2

6.8 2.9 0.9 1.4 1.3 0.3 0.3 0.7

10.6 4.4 1.5 2.1 2.0 0.6 0.8 0.8

8.1 3.6 1.1 1.6 1.1 0.5 0.4 1.5

7.7 3.4 1.1 1.6 1.4 0.3 0.4 0.9

Expenditure Debt service Domestic debt service GKO/OFZ debt service Foreign debt service Non-interest expenditure

15.6 5.4 4.1 3.7 1.3 10.2

12.6 2.9 1.2 1.2 1.7 9.7

15.8 4.4 1.8 1.4 2.6 11.4

16.8 4.7 3.7 3.5 0.9 12.1

13.9 4.0 2.4 2.2 1.5 9.9

14.4 4.2

10.2

9.6

11.9

Primary balance

0.3

–1.9

0.8

–2.2

–1.0

1.6

2.0

3.18

Budget balance

–5.1

–4.8

–3.5

–6.8

–4.9

–2.5

–5.1

–1.08

5.1 2.6

4.8 1.6

3.5 –0.3

6.8 1.6

4.9 2.0

2.5

5.1

1.08

2.5 2.3 0.6

3.3 –0.1 6.0

3.9 –0.3 5.7

5.2 4.9 –

2.9 0.9 3.7

1 151.8

1 532.8

1 843.2

2 562.6

2 684.5

4 000

4 000

5 350

Financing Net foreign financing Net domestic financing (incl. changes in cash balances), of which: GKO/OFZ3 Central Bank of Russia1

Memorandum item: GDP (billion rubles)2

61

1. Including cash operations on GKO/OFZ restructuring, and including Central Bank purchases. 2. Including purchases of OFZs. Source: Ministry of Finance (1999).

Macroeconomic overview

OECD 2000

Table 4.

62

OECD Economic Surveys: Russian Federation

export taxes, boosted excise tax and customs receipts. A higher share of VAT revenue and personal income tax accruing to the federal budget has increased federal receipts from those taxes as well.33 But perhaps the most impressive accomplishment in the budgetary sphere since the second quarter of 1999 was the collection of virtually all federal revenue in cash. This contrasts with the disastrous similar attempt in 1998 discussed above. Expenditures were close to 16 per cent of GDP in the first half of 1999, but fell to below 15 per cent by the end of the third quarter, in accordance with the budget law. This indicates a continuation of the austerity measures taken in 1998, as federal outlays had been close to 20 per cent of GDP before this time. Given the fact that the CPI index has far outpaced GDP deflators since the crisis, federal expenditures have fallen significantly in real terms in 1999 relative to 1998. Deflating by CPI inflation, expenditures in the first half of 1999 were 27 per cent lower than in the first half of 1998. As shown in Table 4, the high domestic debt service in the first half of 1998 has been replaced by a greater burden of foreign debt payments since the crisis. In addition to interest payments on the foreign debt of an estimated US$ 1.6 billion (2.6 per cent of GDP) in the first half of 1999, repayment of principal amounted to another US$907 million (1.4 per cent of GDP). In 1999, the federal government has also generally avoided the previous practice of sequestration as a means of reducing the cash deficit, and has been on target for the (aggregate) realisation of planned budgetary expenditures in 1999.34 The federal government also reportedly spent Rb 52 billion between 1 October 1998 and 1 July 1999 on the payment of back wages, pensions, and social subsidies in arrears, an amount equal to 12 per cent of all budgetary expenditures during this period.35 Despite the current favourable trends for federal budgetary fulfilment, it is much too early to declare an end to Russia’s chronic fiscal woes. The nature of the tax system itself continues to encourage evasion and discourage investment, while fiscal federalist relations remain in a poor state (see chapters II and III). As discussed in the second section of this chapter, the recovery of industrial output and GDP in 1999, which has given the federal budget a boost, may be only of a temporary nature. World export prices remain unpredictable. Given the increased hardship and poverty of the population in 1999 (see below), the cuts in real expenditures may be difficult to maintain. This particularly concerns the level of transfers to the regions, a large part of which is used for social needs. Deflating by the CPI index, federal outlays to the social sector and transfers to the regions were 30 and 41 per cent lower in the first half of 1999 relative to the same period in 1998. Indeed, fiscal trends in the regions have not been as favourable as at the federal level, with a lower share of VAT revenue not being completely compensated by the new sales and imputed income taxes. Despite the positive federal

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Macroeconomic overview

63

trends, the estimated share of tax revenue to consolidated regional budgets (collected by the Ministry of Taxes and Collection) fell from 11.5 to 10 per cent of GDP in the first half of 1999 as compared to the same period in 1998. Most regional governments currently face very tight borrowing constraints, leading to a decline in expenditures of consolidated regional budgets. These and other problems affecting subfederal budgets are examined in detail in chapter III. In the light of the positive trends in federal revenue, the draft budget for 2000 is considerably more ambitious than that of 1999. The budget employs assumptions of GDP growth of 1.5 per cent and CPI inflation of 18 per cent. Annual federal expenditures are to increase to 16 per cent of GDP, while debt service is to remain at 4 per cent and the overall deficit is to fall to 1 per cent (a 3 per cent primary surplus). The planned increase in non-interest expenditures and deficit reduction are supported by rather ambitious federal revenue and tax targets of 14.9 and 12.6 per cent of GDP, respectively. Although favourable movements in export prices, along with possible increases in the rates of customs duties, should continue to support higher federal revenues, these targets may nevertheless prove difficult to fulfil in practice.

Table 5.

The general government budget As percentage of GDP 1996

1997

1998

Federal government Revenue Expenditures of which: transfers to regions of which: transfers to extra-budgetary funds Balance

13.6 21.7 2.2 0.5 –8.1

10.0 16.8 2.6 0.9 –6.8

9.0 13.9 1.6 0.4 –4.9

Consolidated regional budgets Revenue of which: transfers from federal government Expenditures Balance

15.0 2.2 16.0 –0.9

16.5 2.6 17.7 –1.3

14.8 1.6 15.2 –0.4

Extrabudgetary funds Revenue of which: from federal government Expenditures Balance

8.1 0.5 8.2 –0.1

9.9 0.9 9.8 0.1

8.4 0.4 8.4 0.1

General government Revenue Expenditures Balance

34.0 43.2 –9.2

32.9 39.7 –6.8

29.8 35.1 –5.3

Source:

Ministry of Finance, OECD calculations.

OECD 2000

Budget law 1999

11.8 14.4 –2.5

OECD Economic Surveys: Russian Federation

64

Box 1.

Recent changes in federal tax laws and procedures

As emphasised in the previous Survey, the nature of taxation in the Russian Federation has long been a thorn in the side of economic transition. An excessive number of taxes and exemptions, instability in rules, and frequent ‘‘emergency’’ collection campaigns have adversely affected both incentives for investment (restructuring) and tax compliance. The use of money surrogates in tax collection and the division of authority and revenue between various levels of government are two additional problems that receive detailed attention in the next two chapters. A typical myopic focus of the Russian government on current budgetary fulfilment has often stood in contradiction to the vital medium-term objective of creating an explicit tax system that is simple, feasible, stable, and fair. While comprehensive reform initiatives, including the drafting of a Tax Code, began as early as 1993, most of these efforts fell victim to political conflicts within the government, parliament, and regional administrations. A first general (obshchaia) part of a tax code was finally passed by the Duma in February 1998 and became law as of 1 January 1999.1 In addition to a clarification of the rights and obligations of taxpayers, this part of the Tax Code limited the number and type of possible taxes for the federal, regional, and local levels to a specific list (see chapter III). The first part of the Tax Code was amended by an additional law of July 1999, which strengthened the leverage and power of the Tax Ministry to collect taxes and information, and to put pressure on delinquent taxpayers and/or banks that delay payments.2 But the determination of various federal, regional, and local tax rates, exemptions, and revenue sharing rules is still determined in a largely discretionary manner, either during the drafting the annual budget or by governmental decree. Subsequent parts of the tax code that might address this problem are still being debated. Since mid-1998 the federal government has made a number of adjustments with the goal of augmenting tax revenue. This includes temporary import duties of an additional 3 per cent and special taxes levied on exporters of oil, gas, petrochemicals, metals, lumber, and a number of other products. A 5 per cent rate was set on most of these export commodities in January 1999, although some of the rates have been subsequently increased to 10. On 4 February 1999, an additional tax of euros 2.5 a ton (later raised to euros 5 with further increases planned) was imposed on exports of crude oil outside of the CIS. A new luxury tax on certain automobiles was introduced, some exemptions for the VAT were eliminated, and a campaign was launched for greater state control over alcohol production and taxation. A share of the personal income tax (3 per cent) is being channelled into the federal budget as of January 1999. The government has also announced its intention to limit the exceptional status of certain ‘‘special economic zones’’ such as Kaliningrad.3 The VAT, which provides over 40 of all federal tax revenue, has also undergone some important changes in 1999 amidst some controversy between the Ministry of Taxation, the Duma, and the Ministry of Finance. The Ministry of Taxation first proposed to decrease the VAT rate from 20 to 10 per cent as a measure to relieve the tax burden on businesses, while compensating for tax losses through better administration and other adjustments. The Ministry of Finance announced its opposition to this measure, however, due to the prime importance of the VAT for federal revenue. A compromise solution was reached whereby the VAT would be decreased in a stepwise manner, first to 15 per cent in mid-1999, while the federal budget would be compen(continued on next page)

OECD 2000

Macroeconomic overview

65

(continued)

sated by an increase in its share of all VAT revenue from 75 to 85 per cent. A corresponding amendment to the VAT law was passed by the Duma and, as of 1 April 1999, the federal government has received 85 per cent of all VAT revenue. Yet, with further support of the Ministry of Finance and IMF, the planned decrease in the VAT rate on 1 July 1999 to 15 per cent was blocked by a presidential veto. Despite the limited progress in tax reform, little has changed from the point of view of Russian taxpayers. Various tax rates and exemptions remain highly unstable and subject to regular alterations for the purpose of increasing short-term tax collection. A number of the consequences of these problems receive attention in the next two chapters. Hopefully, the relatively positive results of federal budgetary fulfilment in 1999 will provide a context for much needed progress in tax reform. 1. Nalogovyi Kodeks... (1998). 2. ‘‘O vnesenii izmenenii i dopolnenii v chast pervuiu Nalogovogo Kodeksa Rossiiskoi Federatsii’’ (Federal Law of 9 July 1999, No. 154-F3). 3. A discussion of these changes can be found in ‘‘Zaiavlenie (1999)’’.

Government debt As discussed in the first section of this chapter, a rapid build-up of very short-term government debt obligations preceded the financial crisis of August 1998. Since this time, the restructuring of GKO obligations (Box 2) and the paralysed state of the internal bond market can be associated with a decline in domestic debt. After this restructuring, the estimated ratio of domestic government debt to GDP fell from 28 per cent at the end of 1998, as shown in Figure 18, to 18.4 per cent by mid-1999. At the same time, the depreciation of the rouble has increased the burden of scheduled foreign debt service to the point of unfeasibility, implying the necessity of a major restructuring agreement for Russia to get back on track. Indeed, if Russia had attempted to service the estimated US$17.5 billion in external debt payments due in 1999, it would have had to devote the equivalent of over 80 per cent of all planned federal tax revenue to this purpose. For this reason, Russia has adopted a strategy that differentiates between ‘‘Russian Federation debt’’, incurred after 1991, and the inherited debt of the Soviet Union. These respective debts stood at US$52 and 95 billion at the end of 1998. The government is currently servicing the Russian Federation debt, for which it budgeted over US$9 billion in 1999, but has ceased servicing the former Soviet debt in anticipation of restructuring agreements.36 Neither the London nor Paris Club of creditors, which hold US$71 billion of former Soviet debt, has declared a formal default, and both have indicated a willingness for negotiations on restructuring the debt.37

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66

Box 2.

GKO-OFZ restructuring

On 17 August 1998, the Russian government announced its intention to cease the servicing of its domestic bonds (GKO-OFZ) with maturity before 1 January 1999, pending restructuring. These bonds had a face value of 387 billion roubles. Roughly 30 per cent of these GKO-OFZ were owned by foreign investors, most of the rest being held by Russian commercial banks. Negotiations over the terms for restructuring these bonds have been somewhat controversial. Initial announcements indicated that (distressed) Russian banks would receive preferential treatment over foreign investors. This plan was later retracted, although the final terms offered to resident creditors were slightly better than those that the majority of non-residents eventually accepted in March 1999.1 While residents accepted the terms of the agreement relatively quickly, negotiations with non-residents dragged on until March 1999.2 The final conditions of the restructuring involve two packages, one offered only to resident creditors and one offered to all creditors. The ‘‘value’’ of the frozen GKO and OFZ was determined by adding 50 per cent annualised interest from August 19 1998 to the scheduled date of redemption of the bond. The first package offered resident creditors 10 per cent of this value in cash, 70 per cent in new OFZ bonds with 4 and 5-year maturities, paying 30 per cent in the first year and 5 per cent less in each subsequent year, and 20 per cent in a 3-year OFZ with no coupon.3 The second package paid only 3 and 1/3 per cent in cash, 6 and 2/3 per cent in three and six-month GKO with annualised interest of 30 per cent, and the remaining 90 per cent in the same OFZ bonds as the first package. In addition, these proceeds can be repatriated only under severe restrictions, either deposited in non-interest bearing accounts for one-year period or through several limited auctions organised by the Central Bank in mid-1999 for a total sum of US$200 million. Those creditors who refused the terms of the restructuring package would receive payments in accordance with the original (nominal rouble) terms of their GKOs and OFZs. Non-residents cannot repatriate assets received in this manner for a period of five years. If an investor who opted for the restructuring package for non-residents liquidated all of the bonds at their market value as of 15 March 1999, he or she would have received roughly 37 per cent of every rouble invested in August 1998. Accounting for the change in exchange rate, this amounts to 7 to 8 cents on the dollar, which can only be repatriated at full value in a year. 1. The terms offered are contained in the Government order ‘‘O novatsii.... (1999) and (for foreign investors) in ‘‘Summary... (1999)’’. 2. The policy memorandum of the Russian government of mid-1999 (Zaiavlenie... (1999)) reports that 95 per cent of residents and 88 per cent of non-residents accepted the terms of restructuring. 3. The OFZ that does not pay a coupon can be used at par value to pay tax arrears to the federal budget on 1 July 1998 or purchase newly issued shares of a Russian bank.

As shown in Figure 18, the ratio of foreign debt to annual GDP mushroomed from 30 to 113 per cent between December 1997 and December 1998. While most of this increase can be associated with the decline in the dollar value of Russian GDP, Table 6 also indicates a build-up of US$23.6 billion

OECD 2000

Macroeconomic overview

67

Figure 18. Government debt as share of GDP1 %

%

120

120 Internal:

110 100

External:

Other

Russian

GKO/OFZ

Soviet

110 100

90

90

80

80

70

70

60

60

50

50

40

40

30

30

20

20

10

10

0

0 1996

1997

1998

1. Stock of debt at end-of-period; external debt is converted at end-period exchange rates. Source: Ministry of Finance; OECD calculations.

Table 6.

External government debt Billion US$

1991

1992

1993

1994

1995

1996

1997

1998

Federal Government Former USSR debt To official creditors To commercial creditors Bonds Debt accumulated by the Russian Federation To multilateral creditors To official creditors Bonds Subnational governments

96.8 96.8 62.2 32.9 1.7

107.7 104.9 69.2 34.0 1.7

112.7 103.7 68.1 34.0 1.6

119.9 108.6 69.9 37.0 1.7

120.4 103 62.6 39.3 1.1

125.0 100.8 61.9 38.8 0.1

123.5 91.4 56.9 33.9 0.1

147.1 95.2 59.5 35.2 0

0 0 0 0 0

2.8 1.0 1.8 0 0

9.0 3.5 5.5 0 0

11.3 5.4 5.9 0 0

17.4 11.4 6 0 0

24.2 15.3 7.9 1.0 0.0

32.1 18.7 7.6 4.5 1.1

51.9 26.0 9.7 16.0 2.2

Total

96.8

107.7

112.7

119.9

120.4

125.0

124.6

149.3

Source:

Ministry of Finance, IMF.

OECD 2000

68

OECD Economic Surveys: Russian Federation

in debt during 1998. This consists primarily of commercial borrowing, numerous Eurobond issues, and payment arrears on the former Soviet debt. The greater reliance on foreign debt in 1998 reflected the prohibitive costs of domestic borrowing for deficit finance during much of the year. The particular maturity structure of the external debt will make foreign debt service a problem for Russia in the short and medium term. Payments due in 2000 amount to US$16.4 billion, of which 9.6 billion is ‘‘Russian Federation’’ debts. In the absence of a restructuring agreement, obligations will fall slightly in 2001 and 2002, but rise again to an estimated US$18 billion in 2003.38 A major restructuring agreement is thus an important task for Russia in its struggle to gain back credibility and improve its credit rating with the international community.

Income, employment, and welfare A sharp decline in living standards in 1998 brought an abrupt end to marginal improvements in welfare in recent years. Average real incomes began to decline in the first half of 1998 in the context of the economic recession, and then deteriorated sharply with depreciation and inflation in the second half of the year. Unemployment also increased notably with the crisis, but has since declined along with the industrial recovery. Although incomes have shown a slight upward trend in 1999, they remain on average significantly below their pre-crisis values. Poverty and inequality have also increased, together with a deterioration in health and other demographic indicators. The implied challenges to social policy have further exposed the weakness of the social security and health systems. As discussed elsewhere, real budgetary expenditures on social policy have declined notably at all levels of government. The main extrabudgetary funds for pensions, unemployment benefits, and medical insurance have largely failed to cope with the greater social distress of the population. Poor targeting of social assistance and very modest funding continue to plague social policy in Russia.39 As shown in Figure 19, unemployment by the ILO definition rose to alltime high of 14.1 per cent in February 1999, but has since declined, falling below 12 per cent in the fourth quarter of 1999. Registered unemployment and those qualifying for unemployment benefits remained almost unchanged throughout 1998 at around 2 per cent, creating an even larger wedge between officially recorded unemployment and survey-based measures. The nature of the Russian labour market and unemployment benefits still leaves little incentive for the majority of the unemployed to register.40 Declines in employment have been particularly concentrated in trade, finance, and construction. The Goskomstat labour force survey of 1998 also reveals an increase in the average duration of unemployment through late 1998 (Figure 20). The average

OECD 2000

Macroeconomic overview

69

Figure 19. Unemployment As share of the labour force %

%

16

16

14

14

12

12

10

10

ILO-type measure

8

8

6

6 Registered

4

4

2

2

0

0 Jan.

Apr.

July 1997

Oct.

Jan.

Apr.

July 1998

Oct.

Jan.

Apr.

July 1999

Oct.

Source: Goskomstat.

Figure 20. Unemployment and spells of joblessness % share of labour force

Number of months

Long-term unemployed – left scale

14

10

Time spent searching for work – right scale

Unemployed – left scale

12

8

10 6 8 6

4

4 2 2 0

Oct. 1995

Source: Goskomstat.

OECD 2000

Mar. 1996

Oct. 1997

Oct. 1998

0

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spell of joblessness grew to over 9 months, while the share of the long-term in total unemployment rose to 41 per cent. Apparent growing difficulties for the young to enter employment find reflection in high and growing rates of unemployment in their particular age cohorts.41 Regional disparities in unemployment remain high, and the patterns have not changed significantly since the crisis. Ratios of unemployed people to vacancies are particularly high in the Far East, Siberia, the North and the North Caucasian republics. Although out migration has tempered the development of very high levels of unemployment in some regions,42 the rigidity of the housing market and other administrative constraints have limited this type of adjustment. Real incomes of the population remain depressed since 1998. Real incomes were already down to roughly 90 per cent of their corresponding 1997 values in the first half of 1998. The decline in all income relative to wages and pensions during this time is indicative of losses from falls in Russian asset prices and lower profits of exporters. It should be noted, however, that Figure 21 slightly exaggerates the levels of wages and pensions throughout 1998 due to mounting wage and pension arrears. According to some estimates, average delays in wages may have accumulated to as much as 9 months by the end of 1998.43 While accrued wages in the first half of 1998 were almost 4 per cent higher than their corresponding level in 1997, actual (paid) wages were roughly the same. The inflation of the second half of 1998 brought average real income, wages, and pensions to under 70 per cent of their corresponding levels at the end of 1997. Income has recovered somewhat in 1999, although quite slowly, rising to approximately 80 per cent of its corresponding 1998 level by July. The recovery in reported wages has been slower, although an allowance must again be made for the clearance of wage arrears. While, in the first half of 1999, average reported wages stood at 63 per cent of their 1998 level, actual (paid) wages were a bit higher at 68 per cent. As indicated in Figure 21, the decline in real pensions since the crisis has been particularly severe. Pension arrears also accumulated to an alarming degree in 1998. By the end of the year, RLMS survey evidence indicated that four-fifths of pension recipients had not received their pensions for more that 3 months, while estimates of aggregate pension arrears for 1998 range between Rb 26 and Rb 37 billion (1 to 1.4 per cent of GDP).44 The Pension Fund has suffered chronic problems due to a shrinking contribution base and ageing population. During 1998, a new formula that increased average pensions in February 1998, combined with declining contributions, exacerbated already existing imbalances.45 Despite the success of the Russian government in eliminating pension arrears in 1999, the average pension has fallen dramatically in real terms, contributing to growing poverty among the elderly. A major reform initiative to move from the current pay-as-you-go pension system to one based on mandatory and voluntary

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Figure 21. Real income, wages, and pensions Three month moving average, January 1997 = 1001 130

130

120

120

110

Real wage

110 100

100

90

90 Real income

80

80

70

70

60

Real pension

50

50 40

60

Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. 1997 1998 1999

40

1. Deflated by CPI. Source: Goskomstat.

contributions had received some momentum in late 1997 and early 1998. In the context of the crisis in late 1998, the Ministry of Labour and Social Policy has announced that these reforms would be delayed indefinitely.46 In contrast to the small signs of recovery in income and wages, real pensions remained flat in 1999 at one half of pre-crisis levels. Falls in income and demand find reflection in lower retail trade activity (Figure 22). During 1997, retail trade turnover increased for the first time since 1992, with most of the growth coming in the second half of the year. A downward trend in retail trade in the first half of 1998 was briefly interrupted in August, as many people frantically converted cash holdings into goods.47 Since the crisis, retail trade has remained at roughly 15 per cent below pre-crisis levels. The crisis has led to an unquestionable increase in poverty in the Russian Federation. The share of families in Russia living below the officially-determined subsistence level jumped to over 35 per cent of the population in early 1999, as opposed to 21 per cent at the end of 1997. Despite greater proportional declines in income in relatively wealthy regions such as Moscow and Saint Petersburg, which have a high concentration in finance and trade, estimated income inequality has reportedly increased somewhat since the crisis. This fact is related to the dependence of poorer segments of the population on nominal wages and

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Figure 22. Retail turnover (real terms) Three-month-moving average (January 1997 = 100) 110

110

105

105

100

100

95

95

90

90

85

85

80

80

75

Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar. May July Sep. 1997 1998 1999

75

Source: Goskomstat, OECD calculations.

pensions. The Gini coefficient rose for the first time since 1994, while the decile ratio of the incomes of the poorest and richest ten per cent of the population also edged upward.48 In the Goskomstat household survey, the share of income spent on foodstuffs increased from 43 to 51 per cent between October 1997 and October 1998. Previous studies have concluded that the incidence of poverty has been the highest in households where people were unemployed, households with several children, and single parent families.49 The RLMS survey of November 1998 reveals that 25 per cent of the new poor since 1996 are pensioners.50 This again reflects the particular burden that the crisis has imposed on the elderly population. Various demographic indicators give a further indication of the deterioration in living standards. For the first half of 1999 relative to the same period in 1998, the Ministry of Health reports an increase in the death rate from 14 to 14.9 per thousand people. Infections of the upper respiratory tract, the majorrecorded illness in Russia, increased by 4 per cent over the year, while a number of other illnesses show an even larger increase. For example, the incidence of bacterial dysentery increased by 69 per cent.51 The increasing incidence of illness is likely related to more limited access to medical services and products by the poor.52 Reforms of recent years that aimed at developing voluntary contributions

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to private medical insurance companies have met with very limited success, leaving the burden of provision on regional authorities. Regions themselves have a wide variance in their abilities to finance basic medical care and such care often involves significant informal expenses.53 Those regions that can collect more contributions through the 3.6 per cent payroll tax can also provide more services. The Federal Medical Insurance Fund, which attempts to balance provision across Russia’s regions, had funds at its disposal worth only 0.05 per cent of GDP in 1998. Finally, given a high reliance of the Russian medical industry on imported medicines, the depreciation of the rouble has greatly increased the cost of medical supplies for much of the population.54

Commercial bank restructuring and regulation: the enormous challenge The regulation and restructuring of the commercial banking sector presents one of the greatest challenges to the Central Bank and Russian government in the wake of the crisis. As documented in the previous Survey, the Russian banking and payments system had come to be dominated by a small group of large Moscow banks. Following a major loss in depositor confidence, the collapse of the GKO market, and the dramatic depreciation of the rouble, the vast majority of these banks became insolvent, illiquid, decapitalised, and loss-making. While aggregate capital in the Russian banking system had already declined in the first half of 1998 along with falls in security prices, the August crisis had a devastating impact. According to figures of the CBR, excluding the large state savings bank (Sberbank), aggregate capital in the banking system fell from Rb 102 billion on 1 August 1998 to Rb 46.4 billion on 1 May 1999. Deflating by CPI inflation, this implies a real decline in capital of 80 per cent. The CBR faced a genuine policy dilemma. The imperative of avoiding a hyperinflationary spiral limited the scope for refinance policies or recapitalisation. At the same time, depositors were running on already illiquid banks and the payments system was breaking down. The declines in real household bank deposits illustrated in Figure 23 vastly understate the extent of attempted withdrawals, as many banks shut their doors and a significant share of deposits were frozen.55 The withdrawals hit particularly hard six large commercial banks (other than Sberbank) that had a high share of household deposits in liabilities, leaving them unable to service their liabilities. In addition, the CBR lacked sufficient coercive and legal power to take effective control of the problem banks, most of which are at the centre of powerful and influential financial-industrial groups (FIGs). Although the Central Bank did theoretically have the explicit power to remove licenses or appoint external administrators to these banks, the few attempts to exert such control in the immediate aftermath of the crisis were unsuccessful. Decisions by the CBR to revoke the licenses and introduce external management in two large banks,

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Figure 23. Real household deposits in commercial banks Billion January 1998 roubles 200

200

180

180

160

160

140

140

120

120

100

100

80

80 Jan.

Mar.

May

July 1998

Sep.

Nov.

Jan.

Mar.

May 1999

July

Sep.

Source: Central Bank of Russia, OECD calculations.

Inkombank and SBS Agro, were contested and overturned in the courts.56 In this context, the Moscow banks retained the rights to continue banking operations, buying and selling assets or granting new credits, despite the fact that they were not servicing a large portion of their liabilities. Given the decapitalised nature of the banks themselves, this implied strong incentives for asset stripping. As still a further complication, a number of the clients and creditors of these banks typically belonged to the same owners (FIG) as the bank itself, while complicated cross shareholding among numerous on and off-shore holding companies makes both the legal identification of owners and consolidated accounting very difficult. This fact supported possible strategies of: a) writing off the debts of FIG creditors with the liabilities of the bank at the expense of outside creditors, b) moving clients accounts to a ‘‘new’’ solvent banks within the same group, or c) using remaining resources in the old bank to satisfy only the interests of ‘‘special’’ creditors.57 Forced to function within this exceedingly difficult legal and political context, the Central Bank took several sets of measures to confront the crisis. When the large Moscow banks began experiencing serious liquidity problems and deposit withdrawals in late July and early August, the CBR began selective refinancing of a number of banks under special conditions, including special long-

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term credits to two large banks and Lombard credits secured with GKO.58 Two primary objectives were to provide minimal liquidity for servicing household deposits and prevention of a chain reaction of defaults on the interbank loans market. In retrospect, it appears that these measures backfired in practice. As discussed above, many of the large Russian banks at this time were frantically unloading rouble-denominated and purchasing foreign-denominated assets. The cost of delaying an interbank loans crisis was further pressure on the exchange rate and the depletion of international reserves. Given the prospect in July of an imminent IMF bailout package and the continued determination of the CBR to avoid a general bank and exchange rate crisis, the logic of the policy decision was still understandable at the time. In the immediate aftermath of the August crisis, the CBR adopted further emergency measures aimed at restoring the payments system, depositor confidence, and minimal liquidity in the key banks.59 Although some of the additional liquidity thus provided certainly spilled over to the foreign exchange market, putting more pressure on the rouble, these measures largely succeeded in their key objectives. The six commercial banks other than the state savings bank (Sberbank) that had a substantial share of household deposits in their liabilities were temporarily forbidden to work with or service these deposits, and instead forced to come to an agreement with the CBR for conditions that would allow depositors to transfer voluntarily their holdings to Sberbank under certain conditions. The exchange rate for converting foreign currency deposits implied heavy losses for depositors.60 Partly for this reason, a number of depositors did not accept this scheme, opting instead to leave their frozen claims in the problem banks in the expectation of either rehabilitation or bankruptcy. As of May 1999, the majority of household deposits in foreign currency formerly held in banks other than Sberbank still remained in these banks.61 But this scheme was successful in preventing further mass withdrawals by the population.62 Other important measures included decreasing reserve requirements, giving banks temporary access to their reserve deposits with the CBR, and setting up a central clearing system for payments. The payments system was thus restored to operation relatively quickly. Due to the problems summarised above, 1998 witnessed virtually no progress in bank reconstruction. But 1999 has brought at least some limited progress. Two new key laws have provided a first foundation for bank bankruptcy or rehabilitation: the Law on the Insolvency (Bankruptcy) of Credit Organisations (BCO law) of February 1999 and the Law on Restructuring of Credit Organisations (RCO law) in June 1999.63 The details of the latter law are discussed in Box 3. The BCO law increases the leverage of the CBR to discipline problem banks, including the ability (in fact requirement) of the CBR to file for bankruptcy after the withdrawal of a license of a problem bank within 45 days. At the same time, a greater burden is placed on CBR management for the timely withdrawals of bank licenses,

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Box 3.

Commercial bank restructuring and ARKO

The severe distress and insolvency of the majority of large Russian banks in the aftermath of the August 1998 crisis has necessitated a comprehensive approach to bank restructuring and recapitalisation. Due to numerous complications associated with uncertainty over available resources, the lack of a clear and effective legal framework, and a high degree of politicisation, the overall process of bank restructuring has been very slow and controversial. The Russian government and Central Bank first announced a general strategy for bank restructuring in a document of mid-November 1998.1 This programme proposed the identification of a closed list of Moscow and regional banks worthy of rehabilitation, as well the creation of a special Agency for the Restructuring of Credit Organisations (ARKO). All remaining problem banks would face rapid mergers or liquidation. ARKO was founded as a joint stock company in March 1999, granted Rb 10 billion in charter capital from the Ministry of Finance, and assigned with the entire task of bank rehabilitation. Until mid-1999, however, little progress had been made in this direction. Initial lists of ‘‘systemically important’’ large Moscow banks deserving rehabilitation implied too high a financial burden for ARKO’s very limited resources. The degree to which ARKO should be subordinate to CBR management was also a major point of controversy. Finally, as discussed elsewhere, the legal basis for the needed coercive power of the CBR or ARKO over distressed banks was insufficient and legally ambiguous. The extension of a Rb 1 billion credit by ARKO to one large Moscow bank stirred additional controversy, as this loan was used by the bank for expanding its branch network into new regions within Russia, as opposed to augmenting its capital.2. A Law on the Restructuring of Credit Organisations (RCO Law) of July 1999 (FZ 6270), together with the February 1999 Law on the Insolvency (Bankruptcy) of Credit Organisations (BCO Law), provides a more workable legal framework for beginning a process of bank restructuring. The removal by the CBR of licenses from six of the largest Moscow banks in June 1999 also indicates a change of strategy that will focus limited ARKO resources on only a select few large banks, along with simultaneous programmes aimed at the rehabilitation of key smaller regional banks. ARKO is to receive financial support from various sources, including the state budget, the Central Bank, international organisations, and its own bond issues. The RCO Law makes ARKO the sole body responsible for the rehabilitation of problem banks. The Central Bank has also announced that it will limit all future refinancing to healthy banks or banks operating with a restructuring programme approved by ARKO. According to the law, the CBR is now obliged to transfer commercial banks satisfying certain criteria of financial distress to ARKO, together with the appointment of a temporary administrator to the bank. After an examination of the bank and potential restructuring programmes, ARKO decides whether or not to accept the transfer of the bank. In the event of a refusal by ARKO, the CBR must remove the bank’s license, leading to obligatory bankruptcy and liquidation procedures. In the event of acceptance, ARKO is granted significant authority over the bank, including the ability to write down or expand the capital or nullify improper transactions undertaken by the bank’s management in the last three years. A bank undergoing an ARKO-based rehabilitation is also granted a temporary moratorium on the servicing of its debts and liabilities. The Law on the Bankruptcy of Credit Organisations provides for only limited authority (continued on next page)

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(continued)

of temporary administrators over bank management. The RCO law, however, contains a clause that obliges ARKO to hold a controlling block (75 per cent) in banks undergoing rehabilitation, which, in theory, offers complete control over management. The large Moscow bank, Rossiiskii Kredit, transferred a controlling block to ARKO as part of its rehabilitation programme. ARKO can negotiate terms of restructuring for individual banks with government institutions, the CBR, and the creditors of the bank. It can also abandon rehabilitation efforts at any time in favour of a withdrawal of the banking license, bankruptcy, and liquidation. As of September 1999, the activities of ARKO had been quite limited, involving close to 13 banks. This included the large Moscow bank, Rossiiskii Kredit, while the controversial question of the rehabilitation of SBS Agro was still under discussion. Resources spent by ARKO have been less than Rb 4 billion from March to September 1999, while the provision of sufficient resources by the government for the expensive restructuring plan of SBS Agro and other banks remains a source of uncertainty and controversy. The BCO and RCO laws place a significant amount of authority and responsibility in the hands of the Central Bank and ARKO. Given the potential conflicts between creditors in the context of financial-industrial groups discussed above, it is perhaps advantageous to transfer such authority to an outside party in this way. The challenge will be for the CBR and ARKO to remain objective and detached, properly weighing the interests of the banks’ creditors, depositors, and shareholders at all times. The complicated nature of the task of temporary administration and rehabilitation also requires highly qualified and incorruptible personnel. While the process of bank restructuring has recently received a boost, it promises to remain challenging and controversial for years to come. 1. ‘‘O merakh... (1998)’’. 2. Vestnik ‘‘Ekonomika Finansy’’, (1999).

as bankruptcy proceedings against a bank cannot be filed by any body until its license is removed.64 In addition, only the CBR, and none of the bank’s creditors, has the right to appoint an external administration or remove existing management.65 Unfortunately, the Russian banking crisis is not limited to the rehabilitation or bankruptcy of the large Moscow banks. Most operating banks in Russia today have found themselves with extremely limited opportunities for profits. The majority of smaller and regional banks had been distressed long before the general financial crisis, a fact that partly explains the increasing dominance of the larger Moscow banks since 1996.66 Despite active measures by the CBR in revoking banking licences, associated with a decline in the number of operating credit institutions by roughly 1 000 from 1995 to mid-1998, the number of operating banks in Russia still stood at close to 1 400 in mid-1999. It is likely that a large

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share of these banks are experiencing problems. Relatively healthy banks appear to be those connected directly to profitable exporters, natural monopolies or the state administrations of relatively prosperous regions. In aggregate, losses in the banking sector continue to accumulate and overall profitability is negative (Figure 24). The decline in the profitability of Russian banking operations is linked with several factors. For various reasons, most Russian banks have never had high returns on their credit portfolios, a fact reflected in the very low share of commercial credit in GDP in Russia.67 Investments in securities, particularly GKO, represented a major source of profits since 1996. Since the crisis, however, these and other such securities have become scarce and their risk coefficients have been increased significantly in regulations. Second, the crisis brought a significant deterioration in the quality of commercial bank loan portfolios, and greater corresponding requirements for provisions. This particularly concerns loans in foreign currency, which came to dominate the portfolios of the large banks in 1998.68 As of February 1999, the CBR increased the provision requirements for even ‘‘normal’’ loans to 40 per cent, although many banks have apparently yet to comply with this regulation. For classified loans, provision requirements were increased to 75 per cent in 1999, with the goal of reaching 100 per cent by February 1999. The

Figure 24. Profitability of the 30 largest Russian banks Net profits as a share of capital %

%

5

5

0

0

-5

-5

-10

-10

-15

-15

-20

-20

-25

-25 July

Sep. 1998

Nov.

Jan.

Mar.

May1

July 1999

Sep.

1. May 1999 value interpolated. Source: Central Bank of Russia.

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difficulties for many banks implied by these regulations, however, motivated a letter (pismo) of 1 March 1999, which indicated that disciplinary action will not yet be taken against banks that have met at least a 50 per cent provision requirement for classified loans before February 2000.69 On the liabilities side, household deposits have fallen, with over 70 per cent of remaining deposits still concentrated in Sberbank. Table 7 below indicates the general evolution of the balance sheet assets and profits of the 30 largest operating commercial banks between July 1998 and July 1999. As illustrated in Table 7, the real value of the assets of the 30 largest banks in Russia fell by an estimated 25 per cent between July 1998 and July 1999. This is close to the corresponding figure for the banking sector as a whole (23.8 per cent). The share of credit in assets has remained stable, although this reflects a combination of two counter trends: a sharp decline in new credits issued and a revaluation of hard-currency denominated credits in the light of the depreciation of the rouble. Credits denominated in foreign currency appear to account for roughly 40 per cent of all credits in bank balances. Investments in securities have declined by 50 per cent, representing 24 per cent of the assets of the largest banks by July 1999. By contrast, ‘‘other’’ assets of the banks actually grew in real terms between July 1998 and July 1999, reaching 35 per cent of all assets. Such assets are largely non-working, representing mostly deposits and cash balances held in foreign currency. Table 7 also shows a doubling of the share of reported arrears in commercial credit between July and December 1998. The subsequent fall in this share is actually due to the removal of six of the most problematic banks from the sample after the withdrawal of their licenses in June 1999.

Table 7.

Selected balance sheet indicators of the 30 largest banks In %; as shares of assets unless otherwise indicated

All assets Credits Securities Other assets Share of arrears in commercial credit Net profits

Memorandum item: Share of 30 largest banks’ assets in total banking assets 1. CPI-deflated. Source: Central Bank of Russia; OECD calculations.

OECD 2000

July 98

January 99

July 99

Real growth1 July 99/July 98

100.0 40.7 35.8 23.6 6.6 0.4

100.0 43.5 20.8 35.7 12.6 –0.5

100.0 41.3 24.0 34.7 10.9 –2.3

–25.0 –24.5 –49.7 10.4 64.2 –575.0

68

74

67

80

OECD Economic Surveys: Russian Federation

In the light of the overall distress of the banking sector, the CBR has changed its overall strategy toward bank regulation somewhat. Policies that progressively toughened minimum capital requirements and other prudential regulations between 1995 and 1997 favoured the consolidation of banking activities in the large Moscow banks at the expense of smaller and regional banks. Since the onset of the crisis, however, the CBR, together with the bank restructuring agency, ARKO, is looking more to regional banks as part of a possible future foundation for banking in Russia. Despite the fact that the majority of these banks have also suffered financial distress in recent years, they were not as exposed to the crisis as the large Moscow banks, and did not experience the same type of decline in capital. In this spirit, the minimum capital requirement of 1 million ECU, scheduled for introduction in 2000, has been postponed. ARKO is concentrating a good part of its activities in the regions. Nevertheless, the banking crisis in Russia promises to endure well into 2000. The successful attraction of foreign capital to the Russian banking sector in the near future could play a potentially important role in the restructuring and recapitalisation process. The 1997 Economic Survey of the Russian Federation emphasised the need for a much greater protection of the rights of commercial creditors as a prerequisite for the development of credit markets and the health of the banking sector. This becomes an even more vital consideration in the post-crisis period, following the decline of sources of bank profits other than commercial loans. In fact, the implementation of the new bankruptcy law of 199870 did appear to have a positive effect on the promotion of creditors’ rights, as witnessed by a sudden rise in the pursuit by commercial banks of their claims through the courts. In the period prior to the adoption of the new law in March 1998, virtually all bankruptcy claims were filed by either state organs or enterprises, while surveys of commercial banks revealed a general attitude of hopelessness toward the use of the courts for this purpose. By contrast, according to the figures of the Russian Federal Insolvency Service, the implementation of the new bankruptcy law not only led to a significant increase in the number of bankruptcy claims filed (6 489 in 1998 versus 3 759 in 1997), but commercial banks came to account for 22 per cent of those claims by the fourth quarter of 1998. The implementation of the 1998 bankruptcy law has also been highly problematic and controversial, however. Most of this controversy has come from a combination of three factors. First, according to the new law, state organs are not represented in the committee of competing creditors that appoints external management to an insolvent firm. Second, Russian law gives priority to claims of the state over those of other creditors in the event of bankruptcy. Third, state organs, in contrast to other commercial creditors, are not in a position to renegotiate their claims. Given the fact that most insolvent firms have very high (tax) debts to the state, the combination of these conditions gives the committee of creditors an incentive to appoint external management that will pursue their interests only

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through the decapitalisation of the firm, as opposed to concluding the bankruptcy process and handing over a large, if not complete, share to the state.71 For this reason, the government has been actively pursuing an amendment to the bankruptcy law that would increase the power of the state, giving it equal representation on the committee of creditors.72 While such an amendment is an understandable response to current problems, a simultaneous change in the prioritisation of claims might also be appropriate and expedient as a measure to give at least some protection to commercial creditors. Such protection remains a key ingredient in the development of credit markets, commercial banking, and corporate governance in Russia today.

OECD 2000

II.

Demonetisation: the causes and policy implications

Based on the experience of 1995 and 1996, the previous OECD Economic Survey of the Russian Federation documented an increasing demonetisation of the Russian economy, involving a rapid increase in arrears and the share of money surrogates in industrial transactions and budgetary operations. Such surrogates include commodities (barter), various bills of exchange (veksels), federal, regional, and local government securities, and (often complex) offset arrangements. The years 1997 and 1998 witnessed a continuation, and intensification of, this process, with the share of various forms of money surrogates reaching over half of industrial transactions and consolidated regional budgetary revenues. In a number of regions, shares exceeded 70 per cent. This trend has confounded widely-held expectations that progress in macroeconomic stabilisation, as occurred in 1995-1997, would lead to the rapid expansion of wholesale markets based on the (cash) rouble. Also, ironically, the re-emergence of macroeconomic instability in mid-1998 was followed by a decline in the use of money surrogates, although their levels remain significant, comprising roughly 40 per cent of industrial transactions and regional budgetary operations in the first half of 1999. While money surrogates in the Russian economy can be associated with some positive developments, including the multilateral clearing of mutual debts and greater working capital for some liquidity-constrained firms, the costs appear to have been far more significant. The additional transaction costs associated with barter and offset arrangements relative to cash are quite high.73 Neither state budgets nor firms typically possess enough cash to make basic wage, pension, and other payments. The confusion and lack of transparency in business and government accounting, owing in part to a multiplicity of prices for the same commodity depending on payment type, has arguably impeded efficiency, restructuring, corporate governance, and the implementation of tax and other regulations, while facilitating corruption and illegal activities. The system of multiple prices also defies the basic logic of a market economy. While such logic would imply that sellers might discount receipts received in non-cash form, particularly receipts in commodities that need to be resold for cash, the opposite is true in

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practice. Commodities delivered as payment in Russia are generally valued significantly higher than their cash equivalent. Under these conditions, it is almost always cheaper for a firm to make a payment in commodities than to sell the same commodities for cash at the market price and to subsequently pay in cash. Furthermore, the very same enterprises that accept commodities in payment at a premium complain bitterly about their own severe liquidity constraints and cash shortages. The seriousness and complexity of demonetisation in Russia have motivated many recent studies. These studies contain rather conflicting points of view on the causes of demonetisation, placing various degrees of stress on institutions inherited from the Soviet period, the restrictive nature of monetary policy since the mid-1990s, and key institutional weaknesses in the fiscal system, bankruptcy, contract enforcement, and corporate governance.74 This chapter attempts a comprehensive overview of the nature, causes, and policy implications of the demonetisation process in Russia. It offers a new perspective that combines a synthesis of some points raised in previous literature with new evidence and insights. This contribution is based on OECD field work that has been concentrated in seven representative Russian regions since early 1998, as well as close co-operation with the Russian federal government.75 The chapter is organised as follows: The first section provides background and basic facts about the process of demonetisation, together with important quantitative and qualitative changes of recent years. The second section seeks to identify the root causes of the demonetisation process. A final section then turns to the policy implications of the previous analysis.

Demonetisation and money surrogates: recent trends No single comprehensive measures exist of the extent of demonetisation in the Russian economy. But a combination of statistics compiled from limited statistical surveys, the Tax Ministry, the Ministry of Finance, and the State Statistical Committee (Goskomstat) provides a consistent picture. Figures 25 and 26 give two measures of the share of non-cash payments in the wholesale transactions of Russian industrial firms. Figure 25 derives from monitoring by the Russian Economic Barometer since 1992 of approximately 200 industrial firms dispersed across Russian regions. This shows the share of non-cash payments rising steadily from 8 to 54 per cent between 1992 and mid-1998, before falling to 43 per cent by April 1999. Figure 26 presents results of monitoring by Goskomstat of 2 000 larger firms and natural monopolies since June 1997. This reveals an even higher degree of demonetisation in larger firms, with the share of non-cash settlements reaching over 70 per cent by early 1998, and falling to under 60 per cent in 1999. Both of these measures are consistent with other limited surveys and monitoring, as well

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Figure 25. The share of non-cash receipts for industrial firms1 %

60

50

50

40

40

30

30

20

20

10

10

0

0

Fe b M . ay Au g No . v. Fe b. M ay Au g. No v Fe . b. M ay Au g No . v. Fe b. M ay Au g No . v. Fe b. M ay Au g No . v. Fe b. M ay Au g No . v. Fe b. M ay Au g No . v. Fe b.

%

60

1992

1993

1994

1995

1996

1997

1998

1999

1. Based on a sampling of 160-200 enterprises, mostly of medium size, in various regions of the Russian Federation. Source: Russian Economic Barometer.

Figure 26.

The share of non-cash receipts for large firms and natural monopolies

%

%

80

80

60

60

40

40

20

June

Aug.

Oct. 1997

Dec.

Feb.

Apr.

Aug. June 19981

1. Due to the absence of data, March, April and May 1998 are interpolated. Source: Goskomstat.

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Oct.

Dec.

Feb. 1999

20

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as OECD interviews with representative firms during 1998 and 1999.76 In addition to being concentrated in larger firms, the share of non-cash transactions exhibits a high variability across sectors and regions, as examined below. The share of noncash payments in the larger firms monitored by Goskomstat appears to be uniformly high across regions, however. Of 88 Subjects of the Federation, only seven regions revealed a majority of transactions in cash in large firms on average between July 1997 and February 1999. This includes the cities of Moscow (66 per cent cash) and Saint Petersburg (52 per cent cash). The types of non-cash payments employed in Russia are numerous. First, there is direct barter exchange between firms. This can take either a simple form of an agreement between two firms or involve a complex chain of deliveries of goods and services between a group of organisations, often arranged by specialised professional intermediaries. Second, non-cash payments often take the form of offsets (zachety), where deliveries of goods or services are accepted in exchange for writing off debts or future payment obligations. Offsets can also vary greatly in complexity, ranging from the settlement of debts between two firms to elaborate chains of deliveries to and from numerous organisations. As illustrated below, offset arrangements have been a primary means of state budgetary fulfilment at all levels of government. In addition to pure barter and offset arrangements, explicit bills of exchange (veksels) and other securities are commonly used as a means of facilitating multilateral exchange. The very rapid proliferation of such paper surrogates in 1996 to early 1997 was documented in the previous OECD Survey (1997). The most widely-used securities have been veksels issued by large reputable enterprises (especially natural monopolies and oil companies), commercial banks, and federal and regional governments. The recent financial crisis and newer restrictive legislation have had the effect of limiting somewhat the use of bills of exchange and securities as money surrogates, particularly those of state organs and, to some degree, commercial banks. No reliable figures appear to exist on the volume of outstanding veksels in the Russian economy. A partial measure of the downward dynamic is given by the real value of attracted resources in roubles through issues of veksels by commercial banks (Figure 27). For firms, the type and significance of non-cash payments firms differs notably across sectors of the economy, as illustrated in Table 8. A notable implication of Table 8 is the rather low share of pure barter in non-cash transactions in late 1998. Pure barter accounted for an average of only 7.5 per cent of receipts in these firms. The share of pure barter is relatively significant in agriculture and also important in machine-building, construction, and construction materials. The most demonetised sectors appear to be machinebuilding and electricity, with the latter receiving over 60 per cent of payments in securities and (especially) offsets. In general, offsets are the most significant category of non-cash settlement, accounting for over 30 per cent of payments. Most payments categorised as ‘‘other’’ are probably also offsets of one type or

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Demonetisation: the causes and policy implications Figure 27.

87

The real value of attracted resources through issues of veksels by commercial banks December 1996 = 100

Index

Index

120

120

100

100

80

80

60

60

40

40

20

Dec. 1996

Feb.

Apr.

June Aug. 1997

Oct.

Dec.

Feb.

Apr.

June Aug. 1998

Oct.

20

Source: Central Bank of Russia (Biulleten bankovskoi statistiki), various issues.

another. Table 8 also indicates that non-cash settlements are relatively important in primary and producer goods industries, while less important in the light and food industries. The relatively high share of cash in fuels, as compared to electricity, is likely related to high (cash) export earnings in the former. The oil and oilrefining industries are notably more monetised than gas. In the Interministerial

Table 8.

Types of payments in large firms and natural monopolies by industrial branch, December 1998 As percentage of total payments

All firms Electricity Fuels Machine-building and metalwork Construction and construction materials Transportation Light industry and food Agriculture Trade and public catering Source:

Goskomstat.

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Cash

Offsets

Securities

Barter

Other

Total

43.4 19.5 39.4 14.1 26.0 37.4 69.8 65.1 84.4

29.5 45.2 36.5 37.4 44.6 45.8 12.7 3.3 11.6

11.5 16.7 15.2 31.3 7.8 11.0 4.0 0.5 3.2

7.5 4.1 4.7 13.5 18.5 0.3 7.6 28.6 0.3

8.1 14.5 4.2 3.7 3.1 5.5 5.9 2.5 0.5

100 100 100 100 100 100 100 100 100

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Balance Commission study of the 204 largest tax debtors in 1998, gas firms (branches of Gazprom) showed only 9 per cent of their receipts in cash, while the figure for the oil industry was 31 per cent.77 Figure 25 indicates that non-cash settlements have been significant throughout the transition period in Russia. Yet recent years have witnessed important qualitative as well as quantitative changes. First, the sectoral breakdown of non-cash settlements has changed dramatically. In 1993, the highest shares of non-cash settlements could be found in manufacturing industries (12-21 per cent non-cash settlements), particularly chemicals, while electricity and fuels reported the incidence of non-cash receipts at only 4 and 10 per cent, respectively.78 Thus, the concentration of the problem in primary industries is only of recent years. Second, the rise of offsets as the dominant form of non-cash settlement also appears to be new. Offsets first became important in 1994, but then grew rapidly in relative significance, particularly in 1996-98. As offsets are primarily concerned with clearing debts, their growing significance is paralleled by growing arrears in payables and receivables, as indicated in Figure 28, and their increasing use by state organs for budgetary operations (see below). In addition to the increasing quantitative importance of enterprise arrears as a share of GDP, Figure 28 illustrates another notable trend of recent years: a

Figure 28. Enterprise arrears As percentage of GDP %

%

70

70 Payables

60

Payables, of which to state budgets and extra-budgetary funds

60

Receivables

50

50

40

40

30

30

20

20

10

10

0

1994

1995

1996

1997

1998

0

Source: Goskomstat, OECD.

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divergence in arrears on enterprise payables from those on enterprise receivables. This difference is explained almost entirely by a build-up of arrears to state budgets. The shift in the structure of arrears is an important basic factor for understanding the nature of the Russian non-cash economy. Commander and Mumssen (1998) interpret this to be indicative of a large flow of implicit soft credit from state budgets to enterprises during this period. While there may be an element of truth to that conjecture, an institutional detail is very important for the interpretation of these figures. While state organs pay no interest and penalties on their accumulated arrears, data from the Ministry of Finance suggest that much of the build-up in arrears to budgets shown in Figure 28 can be accounted for by such penalties and fines levied on firms. Penalties and fines were negligible in 1994, but accumulated very fast under conditions of lower inflation since 1995. This was also due in part to the fact that the rate of increase in nominal penalties was adjusted downward only with a substantial lag after the decline in the inflation rate. According to figures of the Ministry of Finance, penalties and fines accounted for 65 per cent of all debt to the federal budget by the end of 1997. Figures for extrabudgetary funds are similar. Thus, from an economic point of view, a very large part of the build-up in arrears to budgets represents an (asymmetric) increase in fines and penalties in the enterprise sphere on outstanding mutual debt rather than a net inflow of implicit credit. If the same fines and penalties had accumulated on state payment arrears, the gap between arrears on enterprise payables and receivables would have been substantially lower, if not negligible. Ironically, rather than being a net inflow of implicit credit or subsidies to the enterprise sector, the accumulation of arrears to state budgets in recent years may instead reflect incentives of state organs to use arrears for gaining leverage over enterprises in their jurisdiction and facilitate the transfer of resources from the enterprise to the state sector. This point is examined further below. The widespread use of tax and payment offsets as an instrument of state budgetary fulfilment is also a relatively new phenomenon, and is undoubtedly a major reason for the current predominance of offsets in non-cash settlements. Figure 29 summarises partial figures on the rise in the share of taxes paid in money surrogates. The exception to the upward trend is federal revenue for 1998, which reflects an initial (ultimately unsuccessful) attempt to eliminate the use of offsets in federal budgetary operations (see below). The share of non-cash settlements in budgetary expenditures is usually similar to receipts, although sometimes slightly lower.79 This share of surrogates in federal tax revenue increased rapidly from under 10 per cent in 1994 to 41 per cent in 1997, before dropping to 23 per cent in 1998. Although we know of no such figures for consolidated regional budgets before 1996, interviews with regional officials also indicated a similar rapid build-up of non-cash budgetary operations during 1994-97. Field work in the regions by Woodruff (1998b) revealed that offset operations already existed in

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Figure 29. Non-cash receipts as a share of federal and consolidated regional tax revenue %

%

60

60 Share of surrogates in federal tax revenue

50

Share of surrogates in regional tax revenue

50

40

40

30

30

20

20 10

10 (1)

0

0 1995

1996

1997

1998

Note: Federal number is for all revenue (approximation). 1. Data are not available for share of surrogates in regional tax revenue in 1995. Source: Ministry of Taxation, Ministry of Finance.

some regions in 1994, although they were just beginning to become significant. The federal government began using securities for offset operations in late 1994 (Treasury Bills (KO) and later so-called Treasury Tax Exemptions (KNO)), a practice that was later duplicated at the regional and local levels in many areas. Legislation since mid-1996 forbids regions to issue or undersign their own veksels, although many administrations exploited loopholes in this legislation to continue a widespread use of securities in budgetary operations.80 After building to record levels in 1998, the share of non-cash settlements in consolidated regional budgets has shown a slight decline in 1999. The incidence of non-cash tax payments shows a high variance across regions of the Russian Federation. The cities of Moscow and Saint Petersburg are outliers, with non-cash tax receipts of less than 10 and 20 per cent, respectively. Over 10 Subjects of the Federation had non-cash tax receipts of over 70 per cent in 1997. Partial data indicate that the number of such regions was probably even higher in 1998. Table 9 shows the degree of correlation between the share of surrogates in budgetary operations and enterprise transactions with some other economic and political variables by Subject of the Federation in 1997. As might be expected, surrogates are correlated with arrears. There is also a strong persistence in the use of surrogates in tax collection in various regions from year to year.

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Demonetisation: the causes and policy implications Table 9.

91

Correlations between surrogates and selected economic variables across Russian regions1 Share of surrogates in regional tax

Share of surrogates, 1996 Share of tax arrears Wage arrears per worker Fall in industrial output, 1990-1996 Gross regional product per capita Federal transfers as a share of budgetary income Pure barter between enterprises Share of urban population Exports in industrial output, 1995 Share of fuels in industrial output Vote for reformist parties,2 1995 Vote for Yeltsin, 1996

Share of surrogates used by enterprises

All

Without Moscow and St. Petersburg

All

Without Moscow and St. Petersburg

0.87 0.37 0.39 0.15 –0.10

0.85 0.38 0.36 0.02 0.16

0.27 0.37 0.11 0.00 –0.21

0.16 0.32 0.07 –0.03 –0.13

0.16 0.07 –0.05 –0.48 0.21 –0.36 –0.29

0.06 0.05 0.02 –0.33 0.03 –0.24 –0.14

–0.07 0.29 –0.20 –0.34 –0.08 –0.17 –0.14

–0.13 0.30 0.02 –0.20 –0.12 0.04 –0.03

1. 1997 unless otherwise indicated. 2. The reformist parties include primarily Yabloko, Democratic Choice. Source: OECD calculations based on data from Goskomstat, Ministry of Finance, Ministry of Tax and Collections.

The share of exports in industrial output, a source of cash revenue, also shows a negative relationship with the use of surrogates. Surrogates in tax revenues are negatively correlated with political variables indicating support for reformist political parties or President Yeltsin in elections. General indicators of the state of the regional economy exhibit only weak or no measurable correlation with the share of surrogates in tax revenue. This is particularly the case after the removal of the special cases of Moscow and Saint Petersburg from consideration. The magnitude of the industrial output decline in the region, gross regional product per capita, and the share of federal transfers in budgetary revenues show virtually no correlation with surrogates. Neither does urbanisation. Finally, interestingly enough, the share of pure barter in enterprise receipts appears to bear little relation to the significance of surrogates in budgetary operations, a fact that casts doubt on suggestions by some regional officials that the demonetisation of state budgets is nothing but a reflection of the demonetisation of the real sector. Another important recent trend is the emergence of a multiplicity of prices for a single commodity depending on the type of transaction. This includes a cash (denezhnaia), barter (barternaia), veksel (vekselnaia), and offset (zachetnaia) price. Furthermore, the following regularities are observed in virtually every Russian region: the barter and offset prices of a commodity are typically close or

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equal to each other and roughly 40 to 50 per cent higher than cash prices. Veksel prices tend to be between cash and barter (offset) prices. This regularity is quite striking. First, this represents the reversal of a previous trend in the early 1990s, whereby barter prices were commonly deflated below cash prices as a means of tax avoidance, particularly for the VAT. Second, as indicated above, given the coexistence of the cash and non-cash economy, this price relationship defies basic market logic. The analysis in the next section will emphasise this perverse price relationship as a primary clue to the general root causes of the proliferation of the non-cash economy. To summarise the numerous points presented in this section, the Russian economy has become increasingly demonetised in recent years, with rising shares of non-cash settlements in enterprise transactions and state budgetary operations. The share of non-cash settlements reached a peak in late 1997 and the first half of 1998, but has fallen somewhat in 1999. Important qualitative changes in the nature of non-cash transactions since 1995 are: a) a major sectoral shift in concentration toward primary industries, particularly electricity and gas, b) a growing predominance of offsets as a share of non-cash settlements, mirrored in growing enterprise and budgetary arrears, c) a dramatic increase in the use of offsets and other non-cash settlements in state budgetary operations, especially at the regional and local levels of government, and d) the emergence of a price system that exhibits a high degree of regularity across regions, whereby offset and barter prices are significantly higher than cash prices of the same commodities. Surrogates reveal a positive correlation with the relative build-up in payment arrears across Russian regions. They are also negatively correlated with the share of exports in industrial output, but bear no obvious relationship to general measures of the state of the regional economy or urbanisation. The share of surrogates in tax revenue has no obvious relationship to the predominance of pure barter in the transactions of enterprises and reveals a negative association with political support for reformist parties and President Yeltsin in past elections.

The causes of demonetisation Suggestions in recent literature as to the causes of demonetisation are numerous. Most of the focus is on three categories of problems: a) the burden of inherited Soviet institutions, b) the consequences of restrictive monetary and fiscal policies adopted in recent years, and c) problems and delays in structural reforms. Three major studies, Gaddy and Ickes (1998), Woodruff (1998), and Commander and Mumssen (1998), develop theories that place stress on factors from all three of these categories, with the former two placing more emphasis on institutions and structural reform and the latter on monetary and fiscal policy. This section considers each of these three categories in succession.

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Inherited institutions The importance of inherited institutions for understanding the prevalence of non-cash settlements in Russia has been particularly emphasised in Makarov and Kleiner (1998), and Anderson (1998). Indeed, the Russian economy has never been completely monetised. Soviet planning realised an allocation of producer goods through direct administrative methods, aided by informal barter relations among enterprises within a given region.81 Studies that stress inherited institutions argue that barter occurs, to a great extent, between firms that have economic relations dating back to the Soviet period. It can also be noted that barter is commonly facilitated by trade organisations that resemble the vestiges of Gossnab, the territorial state planning agency that formerly played a major role in Soviet administrative planning after a decline in the power of the branch ministries in the 1980s. While inherited institutions do indeed provide part of the context for the Russian non-cash economy, they alone cannot explain its paradoxical rapid rise in the context of progress in economic stabilisation in 1995-97, as well as the other qualitative changes of recent years outlined in the previous section. The experience of Russia also differs notably from that of other transition economies that possessed similar institutions. In fact, the beginning of radical economic transition in Russia in the 1990s gave rise to what appeared to be a rapid convergence toward a single unified currency and unit of account. Remaining significant levels of barter in the early years of transition were commonly attributed to a combination of high and unstable inflation and tax advantages. In this context, why didn’t the achievement of a significant degree of macroeconomic stabilisation, combined with a crackdown on the use of barter for tax evasion, lead to a decline in the non-cash economy? The persistence of barter in these circumstances might be explained theoretically by the presence of an ‘‘institutional trap’’ (Polterovich (1998)), under which a certain critical mass of barter and offset transactions gives rise to an institutional environment that locks enterprises into barter networks. Indeed, several firms interviewed by the OECD that rely on professional intermediaries for barter deals indicated a complete lack of knowledge about even where to seek a consumer or wholesale trader willing to pay cash for many of their products. Such a lock-in theory still leaves many factors and trends discussed above unexplained. But it may very well be true that the reasons for the persistence of non-cash settlements are somewhat different from the reasons for their initial emergence.

The effects of changes in macroeconomic policy The rapid build-up of arrears and non-cash settlements followed measures that severely tightened monetary policy since the latter half of 1994. This included a virtual elimination of substantial directed credits and a toughening of

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the regulation of commercial banks. These measures were mirrored in a reduction of commercial credit to the non-financial sector to levels that are quite low even in comparison to other transition economies of Eastern Europe (Figure 30). Firms that had been financing working capital through soft bank credit suddenly found themselves operating under severe liquidity constraints. Many loss-making enterprises no longer had an explicit means of finance for covering losses. As these policy measures followed several previously unsuccessful attempts by the Central Bank since 1992 to ‘‘get tough’’ and restrict directed credits, it was natural for enterprises to question the initial credibility of the new monetary policy course. In this context, they commonly accepted the debt of other enterprises with little regard to solvency, contributing to the initial build-up in arrears shown in Figure 28 above. Given the sudden severe scarcity of commercial credit, it is also natural that enterprises would seek arrangements for obtaining some or all of their working capital as commodity credit. Commander and Mumssen (1998) and Ledeneva and Seabright (1998) also make the case that commodity credit can have certain advantages over cash credit for reducing the risks of debt contracting in the particularly hazardous environment of the Russian economy. OECD (1997) made a similar argument for veksel-denominated credits, which became widespread in Russia beginning in 1996.

Figure 30. Commercial credit to the non-financial sector, non-cash transactions and average returns on GKOs Yield on GKOs1

Percentage of GDP

40

80 Commercial bank credit to the non-financial sector

35

Barter as a share of industrial transactions

60

30

40 GKO yield

25

20 20 0 15 -20

10

-40

5 0

1992

1993

1994

1995

1996

1997

1998

-60

1. Real GKO yield: the average annualised GKO yield deflated by the annualised actual change in the CPI. Source: OECD calculations based on Central Bank data (as in Figure 27).

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While the above explanation may be sufficient for understanding the initial build-up of interenterprise debt and the increase in barter in late 1994 and early 1995, it cannot account for the continuation and intensification of the process even after the toughness of monetary policy gained credibility. One commonly cited explanation for this (Commander and Mumssen (1998), Institut Perekhodnoi Ekonomiki (1999)) concerns the simultaneous high yields on government securities (GKO). Not only did the presence of these high-yield securities provided banks with a disincentive to lend, but also increased the opportunity cost of using cash for transactions. While this factor may have indeed been of some importance, a detailed examination of the evidence also suggests that the magnitude of its relative contribution to the demonetisation process may have been limited. First, demonetisation appears to be even greater in regions with relatively poorly developed financial markets and more limited access to Moscow and other GKO trading centres. Even excluding the case of Moscow, the shares of surrogates in budgetary revenues in the seven other Russian cities with their own GKO markets was 45 per cent in 1997, as opposed to 53 per cent in other regions. Also, even eliminating Moscow from consideration, the share of surrogates in tax revenue has a strong negative relationship to the number of registered banks in the region.82 The analysis in OECD (1997) revealed most regional banks to be working with a rather high degree of liquidity in the form of non-invested cash balances during the time of intensive demonetisation. While large Moscow banks also had branches in many regions, GKO investments were a relatively small part of the activities of the majority of these banks.83 Furthermore, a large share of domestic holdings of GKO can be associated with Sberbank, the large savings bank controlled by the CBR, whose primary attracted resources are household deposits. Interest rates on such deposits remained modest even during the period of exceptionally high returns on state securities. The severe decline in commercial lending following the elimination of soft directed Central Bank credit owes more to poorly-developed institutions for bankruptcy and a weak protection of the rights of commercial creditors than to high yields on state securities.84 In general, barter is commonly cited as a means by which a loss-making enterprise can survive in the context of harder budget constraints since the mid-1990s. Yet this conjecture requires further explanation. Other than gains from trade, pure barter is a zero-sum game. In this context, why would solvent firms and organisations accept the debt of insolvent firms, particularly given the weak state of bankruptcy institutions in the country? Why would they allow firms to pay in commodities evaluated at prices higher than those of the market? The answers to these questions, and the general root causes of demonetisation, can only be found in a consideration of the particular institutional environment of the Russian economy. The primary explanations lie in the nature of the fiscal system, fiscal federalist relations, the regulation of natural monopolies, and problems of insolvency.

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Institutional problems Barter and tax evasion As already indicated, barter and non-cash transactions have long been a means of facilitating tax evasion in Russia. Hendley et al. (1997) and others have noted that a primary advantage of barter is an avoidance of bank accounts, which could be monitored or controlled by tax authorities. This has particularly become the case since 1996, following measures that allowed tax authorities to take direct control of tax-delinquent firms and channel any funds from these accounts directly to the State Treasury or respective budgets (kartoteka).85 The approval of the first part of the Tax Code in 1998 expanded the direct control of tax authorities over the accounts of virtually all enterprises.86 Given the accumulated penalties and fines on tax debts described above, this concerns a very large share of Russian enterprises.87 While large payments of cash between firms outside of the banking system are illegal, barter is a perfectly legitimate means of avoiding bank accounts. OECD interviews in the regions left little doubt that the avoidance of bank accounts is often an important consideration in decision-making, not only for enterprises but for regional state officials as well (see below). The major empirical question is the importance of tax evasion by firms themselves relative to other factors discussed below. Surveys of enterprise managers consistently rank tax avoidance well below a number of other considerations such as liquidity and their dependence on barter networks for realising sales.88 In interviews, managers typically convey rather passive attitudes toward barter and offsets, often citing them as the only feasible means of doing business. As the barter or offset price is higher than the cash price, non-cash settlements between two firms commonly increase rather than decrease the tax burden. The high levels of barter and offsets shown above in Figure 26 above, for example, derive from balance sheet information, i.e. revealed transactions that are subject to taxation. Furthermore, a firm that pays taxes with its own output must also pay an additional VAT for the output thus produced and realised.89 Finally, there are other means of avoiding bank accounts blocked by tax authorities such as opening accounts in the name of subsidiaries.90 Nevertheless, as argued below, the burden of existing incentives for firms to avoid bank accounts is reinforced by similar, possibly even stronger, incentives of regional and local authorities. Barter and offset prices: a key to understanding demonetisation The fact that barter or offset prices far exceed cash prices for the same commodities provides a strong clue for the identification of the causes of demonetisation of recent years. Note first that, in the case of pure barter with no taxation, the absolute price level is indeterminate and insignificant. Only relative prices determine the terms of trade. Furthermore, tax advantages initiated by

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firms themselves would work in the favour of lower, not higher, barter prices. On the level of a single firm, it has been suggested that inflated prices can help to disguise losses and avoid bankruptcy. Again, however, in the case of a pure barter economy, inflated prices could not disguise losses unless they were accompanied by distortions in relative prices. In the theory of Gaddy and Ickes (1998), higher barter prices are meant to give the illusion that production and the economy are larger than in reality. In this case, a question remains as to which institutions have a strong interest in such an illusion, as well as the power to create it. A number of studies propose a cost or liquidity-based theory of why barter prices are higher than cash prices.91 In the former theory, given the fact that barter arrangements typically involve more transaction costs than cash deals, the additional cost is passed on in the price. Important components of this additional cost include the complex services of intermediary organisations and typical long delays between deliveries and the realisation of offsets in barter chains. In our opinion, however, this theory confuses cause and effect. The fundamental economic question here is not why firms or intermediary organisations feel a need to increase the prices of commodities in barter transactions, but why the goods are accepted as payment at these inflated prices. Again, this question is entirely irrelevant for pure barter operations, where the prices of both goods are equally inflated, and matters only for cases where either the cash and non-cash economies interact in some manner or regulatory restrictions limit the price flexibility of certain commodities. This points directly to what we argue to be the root cause of the recent demonetisation process: the conditions under which both state organs and natural monopolies operate in Russia. Demonetisation can be explained by the changes in the macroeconomic environment discussed above in the context of these conditions. The nature of the Russian labour market is another factor of potential importance, as workers represent the third group that actively accepts non-equivalent exchange under conditions of barter. Liquidity-based theories propose that price differentials according to means of payment can be understood as discounts imposed on less-liquid surrogates. For payments in veksels, the price of the commodity is increased to discount the (less liquid) veksels relative to cash. If payment is made in a still less liquid commodity, it is argued, the price should thus be even higher. We believe that this theory is valid for the case of veksels and other securities, but cannot explain an overall higher level of barter or offset prices in the economy. In pure barter, the exchange of commodities for commodities, the question again is only one of the terms of trade, or relative price. While relative barter prices may vary somewhat with liquidity, the regularity that overall (average) barter prices are roughly twice as high as cash prices begs further explanation. To become convinced that the overall cash/barter price relationship is indeed ‘‘perverse’’ from the point of view of liquidity, it may be simplest to consider an offset operation. As indicated above, offset operations now account for the largest share of surrogate transac-

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tions in the economy, and offset prices are generally very close or equal to barter prices. Suppose firm A owes firm B Rb 1 million. If firm A pays off this debt in cash, it will cost Rb 1 million. If it pays the debt in commodities, however, these commodities will typically be valued at the offset or barter price, which is higher than the cash price. Firm B is thus giving firm A a premium rather than a discount for paying in commodities, thereby setting the liquidity-based theory on its head. Of course, not all firms would accept these terms of payment. But certain firms and organisations have consistently accepted such terms in the Russian economy, again most notably natural monopolies, state organs, and workers. It is such transactions that serve to anchor the aggregate level of barter and offset prices relative to cash prices. Natural monopolies Given Russia’s rich resource reserves and large geographical size, the natural monopolies of electricity, gas, and railroad transportation occupy particularly important places in the economy. The fact that the natural monopolies, particularly electricity and gas, have been central to the demonetisation process is directly suggested by the data presented in the first section of this chapter. This fact has also been recognised, to some degree in several previous studies (Buckberg and Pinto (1997), Gaddy and Ickes (1998), Woodruff (1998a, 1998b), Commander and Mumssen (1998)). In the ‘‘virtual economy’’ model of Gaddy and Ickes, the use of barter prices inflates the value of manufactured goods relative to primary goods (electricity and gas), leading to the illusion that negative valueadded firms are actually profitable. Woodruff emphasises the basic and essential point that natural monopolies operate under political and regulatory restrictions that prevent them from behaving as purely market organisations. It is for this reason that such enterprises may be compelled to accept a non-equivalent exchange for their products. Also, the status of these firms as quasi-fiscal organisations supports an environment where managers and employees of natural monopolies may not shoulder the social costs of such arrangements themselves. The OECD Secretariat’s interviews with financial administrations, enterprises, and representatives of natural monopolies in several Russian regions clarified and confirmed this latter point. Some important factors are as follows: tariffs on the products of natural monopolies are heavily regulated by branches of the Federal Energy Commission, which has a close relation with the regional administration. In contrast to other commodities, gas, electricity, and transportation typically do not have separate prices for different types of transactions. Therefore, for example, when an electricity company is accepting non-cash settlements, it is implicitly lowering the price for the firm in question, i.e. electricity is cheaper for those enterprises that do not pay in cash. Although both Gazprom and RAO UES have attempted to implement partial measures in recent years that would allow the reduction of tariffs for those who pay in cash, local representa-

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tives of these organisations have not yet been given effective incentives to implement these provisions on a significant scale. Their performance is typically evaluated on the basis of balance sheet profitability that does not discount noncash payments. Thus, given the limited power of natural monopolies to reduce services to non-paying customers, local representatives of natural monopolies, enterprises, and officials of the regional administration all have an incentive to reach non-cash settlements in problematic cases. This is a means of implicitly reducing the price for the enterprise involved without adversely affecting the balance sheet of the natural monopoly. This particularly concerns large enterprises, many of which are still financing large social infrastructures of importance to the region. Limiting the supply of energy to such firms is typically not a feasible option for Gazprom or RAO EES. This problem is related to the continued delay of the transfer of social assets from enterprises to municipalities. Even in cases where formal transfer occurs, the enterprise still often retains informal responsibilities for finance. Retaining social infrastructures protects enterprises from bankruptcy and allows them the possibility of obtaining implicit energy (and tax) subsidies through either non-payment or non-cash settlements. Municipalities that lack funds for covering social assets are usually more than willing to comply. Deficiencies in technological infrastructure, including the nature of pipelines, central heating systems, and the absence of meters, have also often limited the ability of energy companies to reduce supplies only to selected non-paying consumers In the model of Gaddy and Ickes, such implicit subsidies from the energy sector prop up negative value-added firms. This is indeed the case for many industrial dinosaurs. But the particular institutional framework of the Russian economy gives an incentive to all enterprises, value-adding or subtracting, and regional administrations to exploit whatever bargaining power they have to finance their operations and local economies at the expense of energy, amassing arrears or settling by non-cash means to the maximum degree possible. In a recent survey conducted by the EBRD, 75 per cent of all enterprises that had some exposure to non-cash settlements replied that they used such settlements for electricity, while 70 per cent used them for gas. This is consistent with the data presented above in the first part of this chapter. Of other sectors, only state budgets received anything close to such responses (60-70 per cent).92 Given the above, a key factor that set the context for the rise in nonpayments and money surrogates were sharp increases in the relative price of natural gas, beginning in 1995 (Figure 31). The increase in gas prices came at precisely the time that tougher monetary policy greatly reduced the former soft credits that were often used for energy consumption. Given the distribution of bargaining power described above, the build-up of arrears and ‘‘creative’’ solutions involving non-equivalent exchange with money surrogates can be understood as a logical consequence of this process. The central role of ‘‘high’’ energy

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100

Figure 31. Real indices1 for electricity, gas, and transportation prices Cumulative, 1993 = 100 250

250

200

200 Gas

150

150

100

100 Freight

Electricity

50

50

0

0 1993

1994

1995

1996

1997

1998

1. PPI-deflated. Source: Goskomstat, OECD calculations.

prices in explaining this build-up is also emphasised in the pioneering study by the Interministerial Balance Commission (Neplatezhi 1998), although this study argues that inflated energy prices themselves are actually the root cause of the problem. More precisely, a primary cause of non-payment or surrogate payments in energy is due to a lack of flexibility or incentives to adjust cash prices on an individual basis to reflect relative bargaining power. Relative bargaining power, in turn, is itself related to problems in the bankruptcy of large firms, implicit and explicit regulatory, as well as technological, restrictions on natural monopolies (such as those pertaining to limiting supplies to non-paying customers), regional economic policies, and the nature of fiscal federalist relations. This latter group of problems is particularly emphasised below and in the following chapter. Organs of state power In addition to natural monopolies, the particular conditions under which federal, regional, and local state bodies operate are essential to understanding the process of demonetisation. Along with natural monopolies, state budgets at all levels of government are the primary institutions that accept offsets valued at inflated prices. This represents a direct loss to the budget relative to cash, raising the question as to why the government would agree to accept commodities as tax

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revenue under such conditions, if at all. The primary focus for this question will be on the regional level of government where surrogates in budgetary operations have been particularly high. A number of the arguments here generalise to the federal level and local levels, the latter of which typically operates under the heavy influence of the regional administration (see Chapter III). Gaddy and Ickes suggest the advantage that conducting both tax collection and expenditures in offsets at inflated prices serves to inflate the overall budget and make the (virtual) fiscal situation on paper appear better than in reality. Why might officials be interested in creating such an illusion? A primary reason is that the combination of numerous federal regulations and mandates (see chapter III) and the parliamentary budgetary process typically leads to very ambitious plans for revenue and expenditures, placing the financial administration under pressure. This is the context that can motivate the creation of a ‘‘virtual budget’’. On the other hand, there are at least two major reasons why regional administrations may not be interested in inflating their budgets on paper in this manner. First, at least part of budgetary expenditures must be realised in cash, including outlays on state wages and other social payments to the population. It has been typical for demonetised regional and local budgets to possess insufficient cash for these payments, forcing the administration either to borrow money or accumulate wage arrears. This places at least some pressure on the administration to generate tax revenue in cash. Second, there is a widespread perception at the regional level that showing higher levels of budgetary revenue on paper serves to decrease federal transfers and other support for the region (see Chapter III). Given these problems, most regional and local administrations do have a stated preference for cash over non-cash revenues, and many have taken measures to ensure that those firms with reasonably high cash flows pay a high percentage of their taxes in cash (see below). There exist other countervailing incentives, however, that encourage regional and local administrations to promote at least some degree of non-cash budgetary settlements. In fact, it appears to be at least as common for regional and local administrations as it is for firms to initiate tax offsets.93 These incentives derive from four main sources: a) the fact that only taxpayers, and not state organs, pay interest on their debts; b) factors that allow subnational administrations to expand their influence over resource allocation in their jurisdiction; c) factors that allow subnational administrations to increase tax revenue through offsets, including the share of revenue that remains in the region, and d) the blocking of local, regional, or enterprise bank accounts in the context of arrears. We briefly turn to each of these categories. As a direct implication of the fact that state organs do not pay interest or penalties on delinquent debt, the deliberate promotion of the accumulation of mutual arrears has actually become a primary tool of budgetary fulfilment at all

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levels of government. Offsets then emerge as a natural mechanism for the settlement of these arrears at the end of the quarter or year. Budgets can benefit in this way from the accrual of implicit or explicit interest on withheld payments, while obligations to budgets simultaneously accumulate. In addition to withholding expenditures, deliberate delays in the processing of tax or offset documents for large and profitable taxpayers can also be advantageous.94 Interestingly enough, for the case of a complex offset arrangement involving a barter chain, the tax debt of the first firm in question is not considered ‘‘settled’’ at the time that this firm makes the required delivery, but at the moment that the state expenditure in kind is realised at the end of the chain. Thus, state organs can also profit directly from the creation of barter chains of long duration. Offsets also expand the scope for economic policies at the regional and local levels. As discussed in chapter III, subnational administrations currently possess extremely limited explicit means for conducting their own economic policies and affecting distribution within their jurisdiction. The vast majority of revenue sources and expenditure obligations in subnational budgets derive from federal laws and regulations. Even tax rates theoretically controlled by lower levels of government can usually be changed only within very restricted bounds, with such change requiring the approval of the regional or local parliament. Explicit tax exemptions must also be approved by the parliament and, according to the Law on Competition, cannot target individual enterprises. All such legislation is checked by the regional branch of the Anti-Monopoly Ministry. In numerous cases, regional and local administrations have been pressured to repeal legislation that gives perceived preferential treatment to an individual or a subgroup of enterprises within an industry.95 By contrast, documentation for offset arrangements, as well as the arrangements themselves, are not checked by the Anti-Monopoly bodies.96 Nor do these arrangements need any approval or involvement of government bodies other than the regional administration itself. Under these conditions, offset arrangements represent a very convenient and flexible additional regulatory tool for regional authorities. The case of energy consumption in the region has already been discussed above. In addition, by choosing which enterprises to grant the right to pay taxes in kind at inflated ‘‘offset’’ prices, regional authorities realise implicit individualised tax exemptions. Through offset arrangements that include chains of deliveries of goods and services, regional authorities directly affect the composition of output and consumption in the region. This process even retains some of the flavour of the administrative planning of the past, with which most officials in the administration are quite familiar. The value of offsets to regional administrations therefore depends directly on fiscal federalist relations: the substantial explicit federal restrictions on the fiscal authority and autonomy of regional officials, the distorted incentives under which state officials work in the regions, and problems in the common

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misalignment of revenue and expenditure assignments. These issues are the subject of Chapter III. Still another important related issue concerns recent trends whereby a group of unsatisfied budgetary recipients, due to receive payments from a local budget according to one of numerous federal expenditure mandates, succeeds in seizing control of the accounts of local authorities through the courts. In such a situation, the incentives of local and regional officials to avoid bank accounts, and hence cash, for budgetary operations are enhanced, reinforcing similar incentives described above for enterprises. Thus, even if enterprises answer honestly in the opinion polls described above that they do not use surrogates primarily for tax avoidance, this does not imply that strategies to avoid bank accounts are not of first-order importance. As with the problems identified in the proceeding paragraph, this issue is directly related to deficiencies in fiscal federalist relations. As demonstrated in chapter III, subnational governments do not possess anything close to the budgetary resources necessary to fulfil all unfunded federal mandates. Offsets also offer ample opportunities for corruption, due to their inherent lack of transparency and the absence of a paper trail. This not only involves direct rents for state officials from the enhanced discretionary authority over distribution, but the profits of intermediary barter organisations. These organisations often work in close association with officials tied to the regional or local administration, siphoning off a good part of the so-called ‘‘additional costs’’ included in high barter and offset prices. The opportunities for the diversion of funds and goods are numerous, as documented by OECD meetings in Russian regions. In one typical case, an enterprise that had supposedly settled its tax debts through an offset operation was again approached to settle the same tax debt through another offset operation. The absence of documentation prevented the enterprise from proving that it had already settled the debt.97 This is apparently quite common in some regions and actually motivated explicit legislation in Volgograd oblast. In another case, deliveries of goods representing budgetary payments to organisations did not arrive in the quantity specified. The manager of the recipient organisation, however, was given a side payment to behave as if the required quantity of goods had been received. While this type of corrupt deal could also be realised with explicit cash flows, the advantage of offsets is, again, the lack of transparency and paper trail. Offset deals are simply not monitored. A third potential advantage to subnational administrations from offsets concerns the possibility of increasing tax revenue within the region, and also that of affecting the distribution of tax revenue between the federal and lower levels of government. The 1997 OECD Survey presented evidence that those regions with the highest share of offsets in tax revenue were able to collect a higher share of taxes due relative to the federal budget. This is illustrated again with more recent

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and complete figures in Figure 32. The horizontal axis of this figure shows the share of surrogates in tax collection, while the vertical axis represents the ratio of the share of arrears in federal tax revenue collected in the region to the corresponding share of arrears in consolidated regional taxes. A region higher in the graph represents a situation where federal tax arrears are more serious than regional tax arrears. As officials from regional branches of the State Treasury readily explain, the presence of greater offsets at the regional level is virtually the only reason why the actual share of ‘‘regulated’’ (shared federal) taxes, such as the VAT, is typically higher in a particular region than that prescribed by law. Two main conditions support the possibility for increasing revenue and influencing the division of tax revenue at the regional level through offsets: a) the budget-specific nature of offsets and, b) the particular division rule for tax revenue that is employed by the State Treasury. Under the current rules, all cash receipts for the major taxes that are divided between budgets are channelled to the State Treasury. These include the VAT, excise taxes, and the income tax (until 1999). The Treasury also receives information from the tax authorities on all offset operations performed, which it takes into account when dividing the revenue between various budgets. Offset operations, however, are budget-specific, i.e. an enterprise will typically settle tax debts only to one particular budget as a result of a single offset operation. In addition, the Treasury applies the division rule on

Figure 32. Surrogates and tax arrears to consolidated regional and federal budgets, 1997 Relative shares of tax arrears1

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Share of tax payments collected in surrogate money by region

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1.

For each region according to the formula:

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a firm-by-firm, and not aggregate revenue, basis. For example, the treasury divides VAT revenue into 85 per cent for the federal budget and 15 per cent for the regional budget. If a single firm A pays 85 per cent of its VAT in cash and 15 per cent through an offset operation with the regional budget, the Treasury should take into account the offset and channel all of the cash to the federal budget. On the other hand, if one firm A paid its entire VAT bill in cash and another firm B paid nothing in cash and settled the regional part of its VAT obligation through an offset, the Treasury would still channel 15 per cent of the cash received from firm A to the region. In other words, the Treasury does not consider offsets performed with firm B when dividing the revenue received from firm A. In this context, there are several possibilities for affecting the distribution of revenue: first, it is possible to allow arrears to accumulate and delay offsets to the end of the year, at which time most of the cash revenue has already been divided by the Treasury. This provides still another incentive for regional organs to initiate delays in fiscal operations, followed by the clearance of debts through offsets at the end of the year. Second, for the large share of enterprises that are not able to settle their taxes in full during the calendar year, state organs can potentially profit from performing offsets rather than insisting on cash payments. A simple example will clarify how the use of an offset operation can both increase real regional tax revenue and affect distribution of tax receipts at the expense of the federal budget. Suppose that a certain firm A cannot (or does not plan to) fulfil all of its VAT obligations of Rb 10 million. This includes Rb 8.5 million due to the federal budget and 1.5 million due to the regional budget. Firm A has relatively liquid assets in cartons of milk, which it could sell for only Rb 1 million in cash. If it does sell this milk to pay taxes, the Treasury will receive Rb 1 million in cash, channel Rb 0.85 million to the federal budget and leave 0.15 million with the region. But suppose instead that the regional administration approaches firm A to arrange an offset for the part of taxes due to the regional budget (Rb 1.5 million). To make this profitable to the firm, it establishes an offset price on milk that allows firm A to settle its entire debt of Rb 1.5 million by transferring this quantity of milk to schools that are due to receive payments from the regional budget. In this operation, the firm wins. It covers a larger share of its overall tax debt. The regional budget wins. It receives revenue worth Rb 1 million in cash rather than 0.15 million. In fact, the operation is even worth more than Rb 1 million to the region since the administration continues to overvalue the milk when delivering it to the schools, writing off 1.5 million of budgetary expenditures. The loser is the federal budget, which receives 0 instead of Rb 0.85 million. The labour market While the problems relating to natural monopolies, state organs, and tax avoidance discussed above appear to represent the primary causes of

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demonetisation, the picture is not complete without a consideration of peculiarities in the Russian labour market. Workers are the third group that accepts nonequivalent exchange in the form of (non-interest-bearing) wage arrears and surrogates. The latter are commonly used for settlements between enterprises and workers, as regional and local administrations are tied by regulations that require state wages and many social payments to be in cash. As with barter and offsets, commodities used for the payment of wages in kind are regularly overvalued, implying de facto wage decreases even above the additional time and effort often required of workers to sell these commodities for cash. In some regions, such as Cheliabinsk, groups of enterprises have set up explicit distribution networks. Instead of cash, workers receive the nominal value of their wages in ‘‘credit’’ that can be redeemed at a number of special stores throughout the city. But the selection of commodities is highly limited and the prices are inflated. Such in-kind payments and arrears are among a number of devices that Russian firms have employed to reduce compensation for redundant labour during the transition period, while avoiding layoffs or nominal wage decreases.98 Both social pressures and economic considerations have supported strategies at the enterprise level to encourage quits through the reduction of real compensation as opposed to layoffs. The apparent downward stickiness in nominal wages is

Figure 33. Wage arrears December 1997 = 100 Index

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160

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M ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec M . ar Ju . ne Se p D . ec .

Index

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1996

1997

1998

Source: Goskomstat.

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a somewhat complicated question, however. Indeed, simple reductions in nominal wages as a means of lowering real compensation would appear to have several advantages over the use of arrears and in-kind payments. First, a lower nominal wage bill decreases very high social security and other taxes. Second, lowering nominal wages could support a more efficient allocation of risk. Under current arrangements of widespread arrears and in-kind payments, individual workers assume risks that could be shouldered by large limited-liability and betterdiversified firms or the state. The answer to this question appears to be complex, involving social and political as well as economic factors. With regard to state budgets, the explanation is clearer. First, as described above and in the previous chapter, the sequestration of expenditures and accumulation of arrears has been a primary tool of budgetary fulfilment at all levels of government throughout the transition period. Wages in the budgetary sector represent one such category of expenditures. Nominal wages in the state sector are subject to federal guidelines. Other schemes have employed veksels for the payment of wages. Under these schemes, the veksels are evaluated at face value and not discounted, implying that they are worth less than their cash ‘‘equivalent.’’ Second, as indicated in the previous section, the lack of cash funds to pay wages can often be viewed as a consequence of the overall demonetisation of budgets. Third, a moral hazard problem has also been important here. The accumulation of wage arrears at the regional and local levels of government have typically led to federal bailout programmes of one type or another (see Chapter III). The case of the enterprise sector is more complicated. As with budgets, part of the problem appears to be a consequence of the overall demonetisation process that often leaves firms with little cash for the payment of wages. Clarke (1998), Desai and Idson (1999), Gimpelson and Lippoldt (1996), and Earle and Sabirianova (1999) find evidence that firms commonly differentiate between workers within a single firm, paying some employees on time in cash, while building arrears in payments to other workers. This suggests that some firms may often be following a strategy of channelling cash to those employees who are most important for the operation of the firm, while arrears or in-kind payments are directed at redundant labour. Also, the incentive to avoid bank accounts supports a strategy that avoids cash wage payments when possible. Finally, the informal sale of commodities received as wages by individual workers has the advantage of avoiding taxes. Still, the fact that de facto real wage decreases are commonly realised either through arrears or overpriced in-kind payments, as opposed to nominal wage decreases, requires further explanation and research. It is most likely related to political and social pressures that make nominal wage decreases, as well as layoffs, difficult to realise in practice.

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The fall in the share of surrogates in 1999 As indicated in the figures from part 1 of this chapter, 1999 has witnessed somewhat of a decline in the share of surrogates in budgetary operations and the transactions of enterprises. What was the cause of this decline and to what degree might this trend be permanent? In the light of the discussion above, a number of factors can be identified. First, during the high inflation that followed the exchange rate crisis of mid-1998, regulated energy prices declined sharply in real terms. In fact, keeping down energy and transportation prices was an explicitly announced policy goal of the government of former Prime Minister Primakov, and continued to receive vocal support from the subsequent government of Prime Minister Stepashin. Lower energy prices have made settlements with Gazprom and RAO EES easier for many industrial firms, and have perhaps increased the ability of the natural monopolies to insist on cash payments from relatively liquid consumers. Indeed, the increase in the rouble value of cash export earnings following the depreciation of the rouble has boosted the liquidity of many exportoriented firms. As indicated in Chapter I, inflation has also reduced average real wages in industry by roughly 30 per cent since mid-1998, perhaps also reducing the pressure to employ arrears and in-kind payments as a means of decreasing real compensation. The new macroeconomic environment has also affected state budgets in several respects. First, as shown in chapter III, since wide-scale defaults on federal and regional debt issues, raising money on financial markets to finance deficits and generate sufficient cash for wages and social expenditures has become exceedingly difficult in general. This places more pressure on authorities to raise cash revenue. Second, as shown in Chapter I, the substantial real decline in budgetary expenditures at all levels of government following inflation has had the effect of reducing deficits. Again, the increased liquidity of exporters, and their supporting industries, has provided an important potential source of cash revenue. The reduction of the share of surrogates in tax revenue shows a positive relationship to regional export intensity (Figure 34). The lion’s share of the budgetary windfall from higher cash export earnings has gone to the federal government, however, in the form of customs duties and VAT revenue. Finally, as described below, a number of measures have been taken both at the federal and regional level to limit the use of surrogates in budgetary operations. These measures resemble, to some degree, less successful attempts to limit the use of surrogates in the past. This suggests that the relative effectiveness of these policies in 1999 owes largely to external factors described above, many of which may only be of a temporary nature. Only policies that address the root causes of demonetisation can be expected to have a permanent effect.

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Demonetisation: the causes and policy implications Figure 34.

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The decline of surrogates in tax revenue and regional export intensity

Percentage change in share of regional tax revenue in cash

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2 Regional export intensity

3 1

1. Scale represents exports as a share of industrial production, normalised such that zero is the regional average. Source: OECD calculations based on Goskomstat and Ministry of Finance data.

Policy options As described above, the demonetised state of the Russian economy reflects a complicated and interrelated set of institutional arrangements. Altering these arrangements in favour of remonetisation requires a comprehensive set of measures. A special effort is necessary to make these measures firm and credible, as otherwise their effects on incentives could be undermined by the expectation that they will eventually be revoked or altered. Chapter I contained a summary of the ill-fated attempt of the federal government to collect all taxes in cash during mid-1998. Higher export tax revenues and a strong decline in real expenditures since the crisis have supported the fulfilment of federal budgetary targets under a cash- only rule since the second quarter of 1999. These external factors have also provided a window of opportunity for combating demonetisation through measures that address the root causes of the problem. Areas that require attention are divided into six separate categories: 1) accounting problems, 2) the debt overhang, 3) natural monopoly regulation and pricing, 4) problems in the tax system and tax administration, 5) problems in insolvency and bankruptcy, and 6) fiscal federalist relations. We now touch briefly on each of these areas.

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The discussion in the previous section places a strong emphasis on current distorted accounting practices employed in state organs and natural monopolies. As long as state organs do not pay interest and penalties on their arrears, they will operate under an incentive for allowing both payment and tax arrears to accumulate, while employing offsets as a natural mechanism for the eventual clearance of these debts. As long as branches of natural monopolies are evaluated on the basis of balance sheet profitability, where receipts in barter and offsets at inflated prices are not properly discounted, they will continue, along with state officials and firms, to view surrogates as an advantageous means of settling accounts. The rule employed by the Federal Treasury, under which revenue is divided on a strictly firm-by-firm basis, could also possibly be adjusted to ensure that offsets performed at the regional or local level lead to a smaller share of divided cash revenue to the corresponding budget in most situations. This would reduce at least one reason for regional administrations to favour the use of offsets. Furthermore, the general clarification and rationalisation of state and enterprise accounting can have multiple positive effects in increasing transparency and the value of price signals in the economy. This chapter has also indicated that the accumulation of arrears to budgets has increased incentives to use surrogates as a means of avoiding controlled bank accounts. The extent of this problem has declined somewhat since the 1998 crisis, due to the combined effects of inflation, which devalued outstanding arrears in real terms, and measures that restructured a part of this debt in 1998. But many of those enterprises that are currently profitable still suffer from the inability to pay back arrears that have accumulated since 1994. Given the fact that a large part of this debt accumulated under asymmetric and, arguably, unfair conditions, a once-and-for-all restructuring appears to be justified. But such a partial debt cancellation would likely be successful only as part of a comprehensive package of measures, including those described in this section, which could support the credibility of the state to resist similar measures, should arrears to budgets accumulate again in the future. Other than adjustments in accounting, the regulation of natural monopolies is a key to problems in non-payment and the use of surrogates. As long as natural monopolies remain limited in their ability to reduce or cut supplies to non-paying consumers, it will be difficult for them to insist on timely full cash payments from all customers. Even in these circumstances, however, unless the natural monopoly branch actually has a use for commodities received, paymentin-kind at inflated prices would appear to be an inefficient outcome to the bargaining process, reflecting a need to circumvent existing regulations. Existing proposals that would allow discounts for customers who pay in cash would appear to be promising, if accompanied by simultaneous measures to change accounting practices, as indicated above. On the other hand, the strong recent measures by the government to keep energy and transportation prices low, while perhaps

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helping to reduce the use of surrogates, need to be assessed on a comprehensive basis that properly accounts for the costs to the economy from possible price distortions. Ultimately, policies should promote the clear identification of subsidies as subsidies, and shifting the provision of subsidies from the natural monopolies to state budgets, while correspondingly taxing monopoly rents. While the vital task of reducing energy subsidies will remain a complicated political, social, and technological issue in coming years, measures to make these subsidies explicit, shifting their burden from energy firms to state budgets, while adjusting accounting practices as described above, can separate this problem, at least to some degree, from that of demonetisation. The complicated interrelationship of the payment and tax systems have made barter and offsets important means of tax avoidance or, more precisely, the avoidance of confiscation by tax authorities or unsatisfied groups of citizens. For

Box 4.

The Perm region programme for increasing the share of cash in tax revenue

The region of Perm has introduced a particularly comprehensive programme in an attempt to reverse the trend in the demonetisation of the regional budget. The central elements of this programme are the following: a) A list prepared in February 1999 identifies 222 firms in Perm oblast with outstanding debts to the regional budget as the only firms eligible for offset operations until the end of the year. All other firms or organisations must pay taxes in cash or highly liquid veksels (such as those of Lukoil). b) Each one of the firms on the list can conclude a separate explicit contractual agreement with the administration. These firms are eligible to settle only a part of their outstanding debts through offsets, the amount of which is specified in the list of February 1999. This eligibility is also conditional on the payment of another specified amount in cash. Thus, the administration is making a take-it-or-leave-it offer to these firms to settle a certain portion of their tax arrears in cash in order to become eligible to settle another portion through offsets. c) No current tax payments will be accepted in offsets, only the clearing of tax arrears. d) The documentation and monitoring of offset operations is to be stepped-up significantly. Officials in the Perm administration consider this programme to be a tool for phasing out offsets over time. Firms not included in the 1999 list should not be included in lists for future years. Furthermore, the share of cash payments demanded relative to the value of offsets is to be increased over time. While the programme of the Perm region is one of the most comprehensive and ambitious, other regions have recently adopted similar measures to combat demonetisation.

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this reason, Hendley, Ickes, and Ryterman (1998) propose possible measures to separate the payments and tax systems. To a large degree, this problem is also a consequence of the build-up in arrears, fines, and penalties since 1994. This creates a difficult situation even for firms that have successfully restructured and are able to make current tax payments. Indeed, the separation of the payment and tax systems appears to be an important general policy goal. The above discussion makes clear that the nature of fiscal federalist relations is central to problems in demonetisation. The use of money surrogates by regional authorities can often be understood as a response to distorted incentives and irrational constraints imposed by the current system of interbudgetary relations. This is the central topic of Chapter III. The budgetary crises, which have afflicted many regions and tightened borrowing constraints since mid-1998, have motivated some regional administrations to adopt their own programmes for increasing the share of cash in revenues. These strategies sometimes involve separating enterprises into groups. Firms that are known to be profitable and receive a high share of cash revenue can be put in a group for which taxes are accepted only in cash. Other enterprises may be further grouped according to maximum shares on non-cash payment that are allowed. In some regions, enterprises allowed to pay taxes in surrogates sign explicit contracts with authorities every year that specify the maximum levels of such payments. The goal is to reduce these maximum levels over time. Box 4 summarises such a programme for Perm region. It should be stressed, however, that, given the fact that current fiscal federalist and other regulations encourage at least some non-cash budgetary operations at lower levels of government, the problem itself will not be solved without the attention of the federal government.

OECD 2000

III. Fiscal federalism The development of fiscal federalist relations between the central, regional, and local governments is a central element in the economic and political transformation of the Russian Federation. The budgetary system of the former Soviet Union, although formally federative, centralised almost all fiscal authority in practice. The system operated by the principle of ‘‘one big till (odna bolshaia kassa)’’, whereby all state revenue was divided by the central government according to a central plan for output and expenditures, leaving officials of regional and local administrations no room for independent financial policies. Centrifugal forces unleashed during the period of Perestroika in the 1980s transferred more explicit and implicit decision-making power to the regional level, a trend that further accelerated during the first decade of economic transition in the 1990s. A significant degree of decentralisation in fiscal authority in the Russian Federation has now become a political reality that would be exceedingly difficult to reverse. Thus, separate from the potential economic and political advantages from decentralisation in a country as large and diverse as the Russian Federation, a fiscal federalist system that delegates a large share of responsibility to lower levels of government has become the only feasible option. An effective federalist system must support incentives for subnational governments to exercise their high degree of authority in a manner that is responsible and conducive to progress in economic reform.99 This chapter examines trends in the development of fiscal federalist relations in Russia during the period of economic transition, with a particular emphasis on the experience since 1997. Some notable areas of progress are identified. In particular, relatively stable and uniform rules for the division of revenue and fiscal authority have gradually replaced the chaotic bilateral bargaining and conflicts of earlier years. Federal transfer policies have been improved. Nevertheless, this chapter highlights a major asymmetry in the development of fiscal federalist relations in Russia: a contrast between the formal system of laws and regulations, which maintains a very high degree of centralisation in fiscal authority, and a reality in which a high degree of de facto authority rests with lower levels of government. This inconsistency has had two detrimental effects on tax

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and budgetary performance in the Russian Federation. First, the very high degree of explicit federal involvement in, and regulation of, subnational budgets has provided regional and local officials with an excuse to absolve themselves of responsibility for the consequences of poor budgetary and debt management. Second, the highly restrictive nature of the formal system has encouraged regional and local administrations to exercise their de facto authority primarily though informal means that circumvent laws and regulations. In this context, primary policy tools for the realisation of regional and local policies have been various uses of money surrogates, especially tax and expenditure offsets, arrears, extrabudgetary funds and accounts, guarantees for commercial loans, direct participation in economic organisations, and, until mid-1998, growth in subnational debt. The many negative consequences of this state of affairs suggest that fundamental reform of the system of fiscal federalist relations remains one of the most critical policy tasks for coming years. The chapter is organised as follows: the first section places the problem of the chapter in the context of recent theoretical and applied literature, also noting several particular characteristics of Russia that require consideration in an effective system of fiscal federalist relations. The second section briefly describes basic trends in the evolution of fiscal federalist relations in Russia, outlines the basic institutions of interbudgetary relations, and clarifies some points regarding existing bilateral ‘‘Agreements (Soglasheniia)’’ between the federal government and a number of regions. The third section turns to the nature of the formal system, highlighting the very high remaining degree of formal centralisation in fiscal authority and the enormous burden of federal laws, regulations, and guidelines at lower levels of government. The continued very high dependence of most local administrations on regional governments is also noted. The fourth section examines some of the major tools by which (largely informal) fiscal authority is actually realised at the regional and local levels. Finally, the fifth section discusses current reform efforts and policy options.

Fiscal federalism and the case of Russia The classic theoretical economic studies of fiscal federalism focused on an efficient division of fiscal control in a static economy (Tiebout (1956), Musgrave (1959), and Oates (1972)). This literature supports the conclusion that a significant degree of fiscal decentralisation can enhance efficiency and welfare in a country the size of Russia through the exploitation of informational advantages and differences in local preferences. More recent research has shifted attention to the relationship between fiscal federalist relations, economic growth, and reform. Pioneering work of North and Weingast (1989) and Weingast (1995) linked a concept of ‘‘market-preserving federalism’’ to historical rapid economic growth in

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England and the United States. Subsequent studies expanded this analysis to the cases of China (Montinola, Qian and Weingast (1995)) and India (Parich and Weingast (1997)). Market-preserving federalism is defined as the presence of five conditions: 1) a well-defined federalist system (a hierarchy of government with a clearly delineated scope of authority), 2) a high degree of regulatory authority of subnational governments in their jurisdictions, 3) the central government has a recognised authority to enforce a common market and the absence of barriers to trade and factor mobility, 4) revenue sharing and borrowing is characterised by hard budget constraints, and 5) the allocation of authority has an institutionalised degree of durability that cannot be altered unilaterally or through a coalition of governments. In this context, the protection from confiscation by the federal government, trade and factor mobility, and hard budget constraints combine to create conditions under which regional or local governments will have an incentive to compete actively for business and investment, supporting the adoption of policies conducive to economic reform and growth. As demonstrated in this chapter, the case of the Russian Federation involves the gross violation of virtually all of these conditions, while economic policies have a reported anti-reformist orientation in many regions. This raises the question as to what degree some or all of the conditions of market-preserving federalism should be embodied in a blueprint for the future development of fiscal federalism in Russia. Some studies have expressed rather cautious attitudes toward the expediency of fiscal decentralisation in a country like Russia, however. Fukasaku and de Mello Jr. (1997) stress that, based on international experience, fiscal decentralisation in a country like Russia can likely lead to a loss of control over national finances and aggravate problems in monetary and fiscal policy. More specifically, Shleifer and Treisman (1999) contend that fiscal decentralisation in Russia has been a contributing factor to the chronic crisis in federal tax collection, as subnational authorities have been using their power to siphon off larger shares of revenue. Freinkman and Yossifov (1999) note that, in Russia, more decentralisation can be associated with poorer budgetary performance at the local level of government. Treisman (1998b, 1999a, 1999b) argues that fiscal decentralisation, in and of itself, can be associated with higher inflation, higher rates of corruption, and a possible policy bias in favour of more mobile or multi-regional firms. Several additional specific factors raise questions as to the optimal extent of fiscal decentralisation in the Russian Federation. A highly uneven endowment of resources across the country has two potentially important implications. Regions ‘‘blessed’’ with rich endowments of oil, gas, or other resources may not feel pressured to adopt reformist economic policies even in the presence of competition with other regions. The regional elite can still live well and attract foreign investment even in the absence of reform. Second, large resulting dispari-

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ties in income and poverty between Russian regions arguably necessitate a strong federal presence for the smoothing of inequality (Morozov (1999)). The sheer size of Russia, with poor transportation and financial market infrastructures, also weakens the potential benefits from competition between regions under marketpreserving federalism. Partly for this reason, some studies have suggested a role for federal coercion in promoting the interests and independence of local governments from regional administrations (Shleifer and Vishny (1998), Zhuravskaia (1999)). Finally, most Russian regions inherited an inefficient structure of production from the Soviet period. In this context, reform commonly involves trading off welfare today for the benefits of restructuring tomorrow, something that regional and local governments may be reluctant to undertake, given their limited terms as civil servants and close relations with interest groups in their jurisdictions. What Russia currently needs is a federalism that is ‘‘market-creating’’ as well as ‘‘market-preserving’’. The design of an effective system of fiscal federalist relations in the Russian Federation is therefore a difficult and complex task. Given the politically charged nature of the issues involved, the implementation of such a system is no easier. For various reasons discussed above, a continued strong federal presence is most likely unavoidable in the near future. But this presence must somehow be embedded in a system that nevertheless delegates considerable authority and responsibility to lower levels of government. For Russia, the task is to develop a system of fiscal federalist relations under which some of the advantages of market-preserving federalism might be exploited, yet the fiscal role of the federal government remains significant. We return to this question later in the chapter.

The basic institutions of fiscal federalism in Russia The evolution of fiscal federalist relations in the Russian Federation can be divided into four distinct periods. Quite chaotic relations between central authorities and the regions followed the dissolution of the Soviet Union in 1991. Regions lobbied hard for larger shares of tax revenue and transfers, while the federal government responded by pushing down expenditure responsibilities to the regional level. While two major laws of 1991, On the Fundamental Principles of the Budgetary System and Budgetary Process100 and, especially, On the Fundamental Principles of the Tax System,101 sought to provide a general framework for the standardisation of interbudgetary relations, the actual division of tax authority between federal, regional, and local governments mostly followed individual bilateral negotiations. These negotiations typically favoured more politically problematic regions (Helf (1994), Litvack (1994), Solnick (1995), Treisman (1996, 1998a, 1998b)). Expenditure assignments were particularly unclear and unstable (Wallich (1994)). A law from 1993, On the Budgetary Rights of the Subjects of the Russian Federation,102 did legitimise

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some budgetary authority of Subjects of the Federation, granting them a degree of legal protection from federal decisions, including those delegating expenditure responsibilities without sources of funding. The new Constitution of 1993 marked the beginning of a new stage in fiscal federalist relations, which continued through 1994 and 1995. This period witnessed the first notable progress in the standardisation of interbudgetary relations. The Constitution strengthened the position of the federal centre, while Articles 71 and 72 formalised general competencies for the federal and subnational governments. The 1994 federal budget prescribed uniform sharing rules for almost all regions for the most important federal taxes,103 while the allocation of a large share of federal transfers was moved to a new explicit formula-based Fund for Financial Support of the Subjects of the Federation. A presidential decree, On the Formation of the Republican Budget of the Russian Federation and the Relationship with the Budgets of the Subjects of the Russian Federation in 1994,104 granted regional and local governments the right to introduce their own taxes, a privilege that was rescinded, however, in 1996.105 Progress in the reform of fiscal federalist relations slowed considerably in 1996-97. One important accomplishment from this period was an unprecedented degree of stability in tax-sharing norms. But political tensions between the regions and central government increased, while the determination of federal transfers became less transparent and more subject to the whims of political bargaining.106 The only major piece of legislation on fiscal federalist relations from this period was a law aimed at strengthening the autonomy of local budgets: On the Financial Foundations of Local Self-Government.107 As discussed below, however, this law may have had little positive impact in practice. At the same time, regional and local finance began to show signs of an impending crisis in the form of growing deficits, the demonetisation of budgetary operations (see Chapter II), and mounting official debt. 1998 brought some new momentum to the reform of interbudgetary relations, a process that endured into 1999. A Budget Code and the first part of the Tax Code finally passed through parliament. The Budget Code, which came into effect on 1 January 2000, further codifies and standardises basic budgetary processes, while the first part of the Tax Code reduced the overall number of taxes and clarified the relative tax authority of federal, regional, and local authorities. The federal government concluded basic agreements with most Subjects of the Federation on the improvement of regional finance. For the first time, these agreements make federal transfers conditional on policies at the regional level of government, including those aimed at reducing subsides, the use of money surrogates, and wage arrears in the budgetary sphere. In July 1998, the federal government approved a basic ‘‘Conception for Restructuring Intergovernmental Fiscal Relations in 1999-2001’’.108 The basic elements of this plan are discussed below.

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Box 5.

The organisation of the Russian fiscal system

The Russian fiscal system consists of three levels of authority: federal, regional (Subject of the Federation), and local. In additional to separate financial administrations for federal, regional, and local budgets, each of the five main state extrabudgetary funds has a formal two-level administration. The exceedingly low degree of independence of most local budgets from the regional budget, however, has motivated the identification of the Russian fiscal system in a number of important legal documents as only a two-level hierarchy: federal and (consolidated) regional. While some recent reforms have attempted to boost the independence of the local level of government, its legal status remains ambiguous.1 For practical purposes, local budgets can essentially be divided into two groups: large cities and former ‘‘districts (raiony)’’, some of which exhibit at least a small degree of fiscal autonomy, and other localities (towns, villages, rural settlements). For most analytical purposes, the latter could simply be treated as a part of the larger regional (Subject of the Federation) budget. A particular feature of the Russian fiscal system is the strong presence of federal financial organs in the regions (Table 10). Federal organs are responsible for the collection of all taxes, federal, regional, and local, as well as their division between various budgets. With the exception of Tatarstan, regions and local administrations do not have their own tax services or treasuries.2 As indicated in Table 10, although the majority of fiscal organs in the regions have a formal federal subordination, they also depend on regional and local administrations, even for parts of their explicit financing. This gives rise to a type of informal dual subordination that is an important, but confusing, characteristic of Russian interbudgetary relations. In fact, according to an informal rule, the regional governor can usually even veto the appointment of the head of the respective branch of the Ministry of Taxes and Revenue. The financial departments of regional administrations also have had a dual subordination in that they received a part of their salaries directly from the federal government until 2000, and can theoretically be fired by their federal superiors. In reality, however, they usually remain completely loyal to the regional administration. While the Pension and Social Insurance Funds are held under rather tight control by the federal government, other extrabudgetary funds (Medical Insurance Fund, Road Fund, Employment Fund) are essentially controlled by the regional administration.3 1. Indeed, a number of articles of the Constitution indicate that local ‘‘organs of selfgovernment’’ are not actually to be considered a part of the government power structure, despite the fact that budgetary legislation delegates them various financial responsibilities. A clause in the law On the Financial Foundation of Local Self-Governance (O finansovykh osnovakh... (1998)) that allows any ‘‘populated area (naselenii punkt)’’ to declare itself a municipality has also caused a great deal of confusion in practice. It has complicated the implementation of reforms aimed at giving local governments (municipalities) more independence, as separatist movements in very small areas, such as the territory immediately surrounding a large principal taxpayer-enterprise, could pose a serious threat to regional finance and other poorer localities. 2. While it is true that a few other Subjects of the Federation have a financial apparatus that they refer to as a ‘‘Treasury,’’ this is typically little more than a name for the usual financial apparatus in the region: the regional financial apparatus of the Central Bank or special ‘‘authorised’’ commercial banks. 3. Strictly speaking, the Road Fund is formally classified as a ‘‘budgetary’’ rather than ‘‘extrabudgetary’’ fund. Yet, in practice, it is based on separate legislation and an explicit source of revenue such as an extrabudgetary fund. There are a few other such ‘‘budgetary’’ funds, although their sizes are relatively insignificant.

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Russian fiscal organs operating in the regions Fiscal authorities (organs) functions and subordination

Structure Functions

Status (subordination)

Head appointment

Wages for staff

Other provisions

Formal

Real

Approval of regional (local) budgets, regional (local) taxation, intra-regional fiscal relations

R(L)

R(L)

Election

R(L)

R(L)

Budget preparation, presenting and reporting to legislatures, fiscal policy (including offsets), borrowing

R(L)

R(L)

Election

R(L)

R(L)

Coordination of budget preparation, execution of regional (local) budgets, reporting to Ministry of Finance

D

R(L)

R

F(R)

R(L)

Fiscal control inspectorate (Ministry of Finance)

Control and inspection of budget execution and reporting

F

F

F

F

D

Regional (local) offices of the Federal Treasury (Ministry of Finance)

Execution of federal expenditures within a region, tax-sharing

F

F

F

F

D

Regional offices of the Ministry of Tax and Revenue (former State Tax Service)

Registration of tax-payers, control over tax payments, monitoring tax arrears

F

D

D

F

D

Regional Tax Police offices

Investigating and preventing tax offences and evasion

F

D

F

F

D

F

F

F

F

D

Regional (local) legislature

Regional (local) administration

Financial departments of regional (local) administrations

Duty and foreign trade tax collection

Regional offices of Pension Fund

Collection of pension insurance payments, pension provision

F

D

F

F

D

Collection of social insurance payments, social benefits provision

F

D

F

F

D

Regional offices of Social Insurance Fund

119

Regional offices of State Custom Committee

Fiscal federalism

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Table 10.

120

Table 10.

Russian fiscal organs operating in the regions (cont.) Fiscal authorities (organs) functions and subordination

Structure Functions

Status (subordination)

Head appointment

Wages for staff

Other provisions

Real

Collection of medical insurance payments, financing of health care (through insurance companies)

D

R

R

R

R

Regional Employment Funds

Collection of employment payments, financing of unemployment benefits and working places support programmes

D

R

R

R

R

Regional Road Funds

Financing road repair and construction

D

R

R

R

R

Regional offices of the Central Bank

Budgetary accounts and payments

F

F

F

F

D

Regional Medical Insurance Funds

F – federal, R (L) – regional (local), D – dual. Source: OECD interviews with state officials (1997-1999), federal legislation.

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121

As noted in the first section, a shift from negotiated bilateral agreements of the early 1990s to more uniform and stable revenue-sharing rules and expenditure assignments for all regions can be regarded as a primary accomplishment in budgetary relations since 1994. Indeed, the 1993 Constitution grants equal status to all Subjects of the Federation. Ironically, however, this period has simultaneously witnessed the proliferation of explicit bilateral Treaties (Dogovory) and corresponding Agreements (Soglasheniia) between the federal government and numerous Subjects of the Federation. This includes the special cases of the republics of Tatarstan, Bashkortostan, and, to some extent, Sakha (Yakutiia), which continue to operate under arrangements that do not conform to the relatively uniform conditions assigned to other regions. In particular, the first two of these republics (as well as the very special case of Chechnya109), keep a much larger share of taxes than other Subjects of the Federation, while being responsible for a larger share of expenditures. As could be imagined, the special arrangements granted to the three ‘‘special’’ republics have been a focus of controversy, fuelling independence drives in other relatively rich and self-sufficient regions. In fact, as shown in Box 6, subsequent to the signing of the agreements with Tatarstan, Bashkortostan, and Sakha (Yakutiia), thirteen other regions also concluded official individual Agreements on intergovernmental fiscal relations. The individual privileges promised in these newer Agreements have not been implemented, but the very presence of such legal documents adds to the overall confusion and lack of transparency in fiscal federalist legislation. Table 11 below gives some partial measures of how the second half of the 1990s brought more uniformity to revenue sharing and expenditure arrangements between the federal government and the regions. While Tatarstan, Bashkortostan, and, to some degree, Sakha (Yakutiia) remain special cases, even they now engage in at least some revenue sharing with the federal government. Some studies argue that regions with republican status continue to enjoy somewhat privileged conditions among Subjects of the Federation. As can be seen in Table 11, however, budgetary outlays in these republics have become similar on average to those in other regions (oblasts and krays), with somewhat higher transfers compensating for lower average tax revenue. A more detailed analysis that compares republics with neighbouring regions with similar social and economic characteristics still finds measurable, though rather small, advantages granted to regions of republican status (Lavrov (1997a, 1997b)). Much larger budgets in recent years in the autonomous oil producing regions of Khanty-Mansi and Yamalo-Nenets resulted from the application of uniform tax-sharing rules to those regions. Regions rich in natural resources have benefited in general from the sharing of taxes and royalties levied on the exploitation of those resources. The uniform sharing of VAT revenue has also favoured export-oriented regions.110

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Box 6.

Agreements between the Federal Government and Regional Administrations on intergovernmental fiscal relations

Following the Agreements (Soglasheniia) on Intergovernmental Fiscal Relations of 1994 and early 1995, which granted a special privileged status to Tatarstan, Bashkortostan, and Sakha (Yakutiia), several other Subjects of the Federation have sought to conclude similar special bilateral arrangements. In general, these arrangements are in conflict both with the Constitution and the basic policy strategy of guaranteeing uniform rules of the game for all Subjects of the Federation.

Bilateral agreements on intergovernmental fiscal relations Region

Republic Tatarstan Republic Bashkortostan Republic Sakha (Yakutia) Udmurt republic Sverdlovsk oblast Krasnodar kray Komi republic Khabarovsk kray Irkutsk oblast Nizhny Novgorod oblast Rostov oblast St. Petersburg Vologda oblast Murmansk oblast Yaroslav oblast Chelyabinsk oblast

Dates signed

1

2

15.02.94 03.08.94 28.06.95 17.10.95 12.01.96 30.01.96 20.03.96 24.04.96 27.05.96 08.06.96 29.05.96 13.06.96 02.07.97 30.10.97 30.10.97 04.07.97

• •

•

•

•

•

3

4

5

• • • • •

•

•

•

•

•

6

8

•

• • • •

7

•

•

•

• • •

9

10

•

• • • • •

•

• • • • •

11

12

• • • • •

Key 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

for the principal clauses: Regions can keep 100 per cent of some federal taxes collected in the region. Individual agreements over tax-sharing rates. Federal expenditures in a region are financed by retaining federal taxes collected in the region . Rights to conduct individual offsets between the region and federal budget. Gold guarantee fund for region’s obligations. Individual agreements over transfers and the data used to calculate them. Agreements over ‘‘minimal‘‘ budgets and tax-sharing to finance them. Compensation from the federal budget for federal mandates. Special centre-region funds to finance ‘‘targeted expenditures‘‘. Financing federal expenditures in a region by the Federal Treasury from federal taxes collected in the region. 11. Financing regional programmes from the federal budget. 12. Authority over revenue and expenditures of the regional part of federal extra-budgetary funds and, in some cases, to approve appointments of their heads. Source: Agreements (soglasheniia) OECD analysis on the basis of Ministry of Finance information.

The regions of Saint Petersburg, Sverdlovsk, and Krasnodarsk actually succeeded in signing Agreements that offer privileges comparable to those received by Tatarstan, Bashkortostan, and Sakha (Yakutiia). For example, the Agreement with the city of Saint Petersburg allows at least 70 per cent of taxes to remain in its budget as well as 100 per cent of payments to extrabudgetary social insurance funds. Furthermore, it allows Saint (continued on next page)

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(continued)

Petersburg to introduce its own taxes. Nevertheless, except for the cases of Tatarstan, Bashkortostan, and Sakha (Yakutiia), the individual privileges promised in these Agreements have not been implemented in practice. This concerns clauses 1-9 in of table above. Clauses 10-12 have been implemented to some degree, but apply uniformly to all regions with or without such signed bilateral Agreements. The inherently unconstitutional nature of these Agreements continues to be controversial. When the official Agreement with Bashkortostan expired, it was renewed only informally, without a corresponding signed legal document. The arrangement with Tatarstan has been formally renewed, but on the basis of a lower-level official document.

Table 11.

Indicators of asymmetry in fiscal federalist relations Budgetary expenditures per capita (regional average = 1)

Regional average Tatarstan, Bashkortostan, and Sakha (Yakutiia) Other republics Oblasts and krays Cities of Moscow and St. Petersburg Autonomous oblast and okrugs of which: oil- and gas-producing1 Other

Share of federal aid in total revenues, %

Share of taxes transferred to consolidated regional budgets, % of total tax collection

1993

1998

1993

1998

1993

1998

1

1

18.1

13.15

62.9

62.93

1.46 0.91 0.88 1.48 2.74 2.98 2.27

1.56 0.77 0.77 1.8 5.48 7.19 1.6

0 47 17.6 10.6 29 5.2 79.4

17.18 35.56 14.35 1.01 7.25 3.45 45.18

100 65.6 62.2 54.6 50.3 49.1 67.3

84.33 70.57 68.13 45.35 69.18 68.7 79.14

1. Khanty-Mansi and Yamalo-Nenets autonomous okrugs. Source: OECD calculations based on data of the Ministry of Finance.

Revenue division, expenditure assignments, and transfers: the formal system Russian budgetary figures indicate a substantial decentralisation of state finance during the transition period (Table 12). This process was particularly pronounced during the chaotic years of 1992-93. While revenue to the federal budget steadily fell from 16 to 11 per cent of GDP between 1992 and 1998, revenues (before transfers) to consolidated regional budgets have remained remarkably stable. This observation has motivated conclusions in some recent studies that the chronic difficulties in tax collection in the Russian Federation should be understood only as a federal problem.111 Expenditures have shown a

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Table 12.

Decentralisation in Russian state finance

Revenues before transfers

Net expenditures Federal transfers % of GDP % of GDP Subnational to regions Subnational Total Federal Subnational (% of total) (% of GDP) Total Federal Subnational (% of total)

1990 1992 1993 1994 1995 1996 1997 1998 19991

n.a. 28 25 27 25 27 24 21 24

n.a. 16 10 12 14 14 10 9 12

n.a. 12 15 15 11 13 14 13 12

41 44 58 54 48 48 58 62 49

n.a. 1.7 4.3 4.5 1.8 2.2 2.6 1.6 1.4

n.a. 31 32 36 30 35 32 27 26

n.a. 19 16 18 15 19 14 12 13

n.a. 12 16 18 15 16 18 15 13

39 39 50 49 49 46 56 56 49

1. January-June. Source: OECD calculations based on data of the Ministry of Finance and Goskomstat.

similar trend, with the federal outlays falling from 19 to 13 per cent of GDP at the same time that subnational expenditures increased from 12 to 15 per cent. These data alone might be interpreted as supporting the conclusion that the Russian

Figure 35. The share of sub-national budgets in total revenue in selected federations %

%

60

60 Regional government

50

Local government

50

40

40

30

30

20

20

10

10

0

Australia

Canada

Germany

United States

RUSSIA

0

Source: Ministry of Finance, OECD.

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Federation is already converging to revenue and expenditure-sharing proportions common to developed federal countries (Figure 35). As demonstrated below, however, these and many other aggregate figures mask much of the nature of the real evolution of fiscal federalist relations in Russia.

Revenue As stressed in the second section of this chapter, some important progress has been made in the formal division of budgetary revenue. As illustrated in Table 13, however, the vast majority of revenue to both regional and local budgets still derives from taxes and sharing rules determined at the higher level of

Table 13.

The composition of regional and local budgetary revenue In per cent 1997

Total revenues of which: tax collection Shared taxes Regulated1 of which: profit tax Fixed federal2 Subject to federal ceiling3 of which: profit tax Other taxes4 Non-tax revenue Transfers from higher-level budgets and extra-budgetary funds 1.

1998

Regional

Local

Regional

Local

100 69 55 31 – 3 21 19 13 6

100 67 54 40 11 12 2 – 8 2

100 64 50 30 – 3 17 15 14 6

100 64 52 38 10 12 2 – 12 4

24

31

30

32

Rates and sharing rules are set annually by the superior level of government. a) For regional budgets: VAT, personal income tax, excises, and tax for natural resources (except payments for natural deposits and land tax). b) For local budgets: VAT, personal income tax, single imputed income taxes, and taxes for natural resources (except payments for natural deposits and land tax). * – The rate for the personal income tax for the regional budget is actually set by a separate (not annual budget) law. 2. Rates are set entirely by the superior level of government and sharing rules fixed by federal legislation. a) For regional budgets – payments for natural deposits. b) For local budgets – payments for natural deposits, sales tax, and property tax (enterprises). 3. Rates and sharing rules are set primarily by the superior level of government, but allowing the discretion to change tax rates (bases) within fixed federal ceilings (norms) and/or to introduce additional tax exceptions. a) For regional budgets – profit tax, single imputed income tax (legal entities), and road tax. b) For local budgets – land tax. 4. Rates, tax bases and exemptions are set decentrally, but within a federal legal framework. a) For regional budgets – sales tax, property tax (enterprises), licences and registration fees, and single imputed income tax (personal). b) For local budgets – licenses and registration fees, property tax (persons), advertising tax, social infrastructure and other local taxes (are to be cancelled after the introduction of the sales tax). Source: OECD calculations based on data of the Ministry of Finance.

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government. Regulations and laws pertaining to the so-called ‘‘regulated taxes’’ (VAT, excise taxes, personal income (until 1999)) are determined exclusively at the federal level. These taxes account for 31 and 40 per cent of revenue in 1998 to regional and local budgets, respectively. Another 3 and 12 per cent of revenue to respective regional and local budgets comes from ‘‘fixed taxes’’ set by the immediately higher level of government. Furthermore, a major source of revenue for budgets of the Subjects of the Federation (19 per cent of all revenue) is the regional profit tax. In theory, the rate of this tax is determined at the regional level. In practice, however, it is governed by federal legislation, and only very few regions have exploited their sole delegated right to reduce the rate below the federally-imposed ceiling (now 19 per cent).112 Adding all of these taxes to revenue from interbudgetary transfers, it becomes apparent that, from the point of view of regional and local administrations, roughly 80 per cent of all (formal) budgetary revenue comes from sources entirely under the control of higher levels of government. A mere 13 and 8 per cent of revenue, respectively, come from taxes that can be considered to be under the discretion of regional and local administrations. Even these taxes, however, are subject to numerous federal regulations. Thus, the major formal decentralisation in revenue to lower levels of government depicted in Table 12 has not been accompanied by a significant simultaneous formal decentralisation in fiscal authority on the revenue side of the budget. In addition, major changes in tax laws and regulations in 1999 (Box 7) have brought back a high degree of instability and unpredictability to subnational revenue. If the division of revenue between federal and consolidated regional budgets has converged to at least some degree of uniformity across Subjects of the Federation, this is not yet the case for relations between regions and local governments. Regional administrations continue to set highly differentiated rules for sharing revenues with local budgets. The additional absence of stability in these rules, combined with very high levels of ‘‘soft’’ subsidisation of local budgets by the region, raises the analytical question as to whether most local governments should be considered as having independent budgets at all. In a study of 35 different cities between 1992-1997, Zhuravskaia (1998) estimates that 90 per cent of all increases in income at the local level were siphoned off into the regional budget either in the form of lower sharing norms for regulated taxes or in a corresponding reduction of transfers. Subsequent studies, including a recent 1999 survey of eleven cities by EA Ratings, reached similar conclusions.113 A major law of 1997, On the Financial Foundations of Local Self-Government (FFLS),114 was intended as a step toward rectifying this situation. Among other provisions, this law prescribed minimum average norms for the share of revenue from federal regulated taxes that must be retained in the local budget. Furthermore, the law also requires Subjects of the Federation to set minimum norms for

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Box 7.

127

Changes in tax and budget laws in 1999

After three years of relative stability, 1999 brought substantial changes to the sharing rules for tax revenue between the federal government and Subjects of the Federation. These changes are to remain for the year 2000.

Changes in tax-sharing rules in 19991 1996-1998

VAT Profit tax (rate) Personal income tax Excise taxes: Oil, gas, petrol, cars Alcohol Other Natural deposit payments Sales tax Imputed income tax

1999

2000 (draft)

25 22 100

15 19 802

15 19 852

0 50 100 60 – –

0 50 100 60 100 503

0 50 100 60 100 503

1. 2.

Percentage of tax collection assigned to regional consolidated budgets. The federal budget receives personal income tax at a 3% rate (the average income tax rate is approximately 15%). 3. Legal entities pay 25% to the federal budget and 25% to social extra-budgetary funds, individuals pay 75% to regional and local budgets, and 25% to extra-budgetary funds. Source: Ministry of Finance.

Although the declared plan was to retain a roughly 50-50 division of revenue, a number of regions lost a considerable amount from these changes. The possible (continued on next page)

each local budget. Average and individual minimum norms are to remain stable for a period of three years. So far, however, the effect of the FFLS law appears to have been minimal. First, the prescription of only a minimum average norm did not address the problem of the degree of differentiation of these norms across localities, nor did it actually guarantee any stability of the norms themselves as long as they remain above the prescribed minimum. In fact, survey data show that 1999 sharing norms for local governments were changed for at least two federal taxes in every one of 53 regions sampled.115 Second, the prescribed average norm in the FFLS was actually lower than the previously existing average across regions. Given the

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(continued)

introduction of a regional sales tax and an imputed income tax were intended to compensate for lower shares of the VAT (since 1 April 1999) and income tax. But these two new taxes have proven considerably more difficult to implement and enforce than the relatively reliable VAT and income tax, contributing to a fall in real tax revenue to the regional budget (figure below). Thus, at the same time that the federal government managed to increase its share of tax revenue by 1.7 per cent of GDP in the first half of 1999 relative to the same period in 1998, aggregate tax revenue to consolidated regional budgets fell by an estimated 1.3 per cent of GDP, reflecting in part lower revenue from the VAT in the second quarter of the year.

Tax revenue to consolidated regional budgets1 As per cent of GDP 12

12

11.5 10.2

10 8

10 8 6

6 Other tax revenue

4

4

VAT

2

2 1.9

0 1998H1

1.5

0

1999H1

1. For first half of the year. Source: Ministry of Finance and OECD.

prescribed rigidity of norms for a three-year period, regional administrations generally responded by reducing them on average, a strategy that preserves the maximum amount of flexibility for redistribution. This is illustrated in Table 14. It appears that regional governments particularly decreased the sharing norms for major cities and relatively rich regions.116 As discussed in Chapter I, after many years of fierce debate and delays, the first part of the Tax Code was finally signed into law in 1998. While the Tax Code did marginally increase the sphere of tax policy at the regional level, it cannot be viewed as granting a significant degree of fiscal autonomy to lower levels of government. The Tax Code delegates to the regional level of government

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Fiscal federalism Table 14.

129

The share of local budgets in major regulated taxes

VAT Profit tax (rate) Personal income tax Excise taxes

1996

1997

Minimal norms set by FFLS Law1

1998

11 9 66 3

14 9 67 5

10 5 50 5

13 7 63 6

1. Average within a region. Source: Ministry of Finance, OECD calculations.

a limited number of, mostly insignificant, taxes,117 while subsequent parts of the Code promise to place strong restrictions on how these taxes can be used (maximal rates, the definition of the tax base, etc.). Some of the motivation for such strong limitations on subnational fiscal autonomy in the tax code derives from the experience of 1994-1996. During this time, a temporary condition that allowed the introduction of new regional and local taxes led to a proliferation of seemingly irrational taxes, further complicating the already confusing tax environment. Nevertheless, as will be argued below, it is doubtful that such formal severe restrictions on subnational fiscal authority could ever be implemented in a practical sense. For every restriction, there seemingly exists a (usually informal) loophole. As the Tax Code represents a potentially long-term document for the regulation of tax policy in the Russian Federation, excessive restrictions on the fiscal authority of subnational governments could backfire in preventing an effective and workable formal fiscal federalist system from emerging.

Expenditures In the first comprehensive study on the development of fiscal federalist relations in the Russian Federation, Christine Wallich (1994) emphasised that the legal framework for the assignment of expenditures to different government levels lagged far behind progress in sharing tax revenue. This includes not only measures to clarify expenditure obligations, but to ensure a feasible balance between the capacity to raise revenue and these obligations. As discussed in the first section, the early years of transition witnessed a very chaotic process under which the federal government pushed expenditure responsibilities down to lower levels in the absence of a basic legal foundation. This often took the form of a simple refusal by the federal government to finance certain expenditure categories (subsidies and investment) or legislation that delegated responsibilities, typically in the absence of an explicit indication of sources of finance. Subsequent legislation, including the new Budget Code, has imposed some order and

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standardisation on expenditure assignments. The full list of these current assignments, shown in Annex I, now roughly resembles divisions of responsibility in other federations. Nevertheless, as argued below, these measures have not yet been sufficient to guarantee a basic workable degree of clarity, stability, and feasibility in the division of expenditure responsibilities. In fact, Wallich’s general conclusions remain valid today. In some respects, the situation may have even deteriorated. First, from the formal point of view, current legislation leaves many points on expenditure assignments unclear. Even the new Budget Code allows for rather wide areas of ambiguous ‘‘joint’’ financial responsibility. A substantial share of specific federal legislation and regulations on expenditures either does not specify which level of government bears financial responsibility or states that this responsibility belongs simultaneously to several levels.118 As a result, regional and local levels of government end up financing a part of expenditures formally under federal responsibility (including various federal programmes and utilities and rents for federal institutions, including the military), while the federal government has, on many occasions, at least implicitly taken on responsibility for subnational finance (for example, wage arrears; see below). Second, the expediency of the formal division of some expenditure assignments is highly questionable. Given the huge degree of disparity between the wealth of different regions, and the corresponding burden on the federal government to smooth distribution, the delegation of virtually all social expenditures to the regional and local levels makes little practical sense. Relatively wealthy regions typically end up with higher income subsidies for the population than poorer ones (Freinkman and Haney (1997)). This puts more pressure on the federal government to tailor tax sharing and transfer policies to the drastically different social needs of individual regions, hindering the uniformity and transparency of such policies. Another questionable clause is the federal responsibility for the major part of higher and secondary institutions of learning, most of which are associated with regional and local labour markets. Third, and perhaps most important, subnational budgets are currently crippled with numerous unfunded federal mandates. As stated in the second section of this chapter, a 1993 law actually eliminated the right of the federal government to delegate unfunded mandates to lower levels of government. This ban is also upheld in the new Budget Code. Subsequent to the 1993 law, a presidential decree119 declared all federal mandates that increase the expenditure burden on lower levels of government to be only of a ‘‘recommended’’ nature, subject to obligatory implementation only to the degree that they are accompanied by explicit sources of finance for respective budgets. In spite of this legislation, federal mandates continue to be interpreted by the population and, most importantly, the courts (see below) as obligatory objects of subnational

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finance. This position of the courts derives from an ambiguous wording in federal documents to the effect that mandates are accounted for in the general calculation of federal transfers to the regions. Furthermore, the federal government has allowed mandates to accumulate in recent years, lacking the decisiveness to nullify past mandates even in cases where there is an obvious feasibility constraint. In reality, aside from other problems in the derivation and timely payment of federal transfers to the regions, these transfers do not come close to accounting for existing unfunded mandates. As discussed in the following section, federal transfers to the regions account for less than 2 per cent of GDP, the majority of which is aimed only at general revenue and income smoothing. There presently exists no study that attempts to account for all unfunded federal mandates. Table 15 lists 25 of the most important such mandates in 1998 that were identified in a recent survey of 68 of the 89 Subjects of the Federation.120 Their combined estimated burden is almost 8 per cent of GDP (60 per cent of consolidated regional revenues). Each of the mandates in Table 15 was identified as important by at least 7 (10 per cent) of the 68 Subjects of the Federation surveyed. On the other hand, the combined burden of all federal mandates identified by at least one region in the survey would amount to 22 per cent of GDP (170 per cent of revenues). In the survey, many regions deliberately excluded a number of existing mandates that they believed had an insufficient legal foundation. As shown in Table 15, regional and local administrations have been willing or able to finance these mandates only partially. Indeed, the nature of the revenue position of subnational governments makes the complete fulfilment of these mandates simply not feasible. Administrations have been paying the cost for this state of affairs, however. Beginning in 1997, groups of citizens left unsatisfied by unfunded mandates began to initiate court proceedings against local administrations in many regions. The courts have typically ruled in favour of the citizens, leading to the impounding of the bank accounts of local administrations and the channelling of all funds from these accounts to the relevant single group of citizens. This reinforces an already strong incentive for local officials to conduct budgetary operations outside of their explicit accounts, either through the use of money surrogates or off-budget funds (see below). Other than mandates, a number of other federal regulations have an important impact on the activities and expenditure position of lower levels of government. These include numerous federal instructions and norms on the number and type of budgetary organisations, civil servants, and wages for civil servants. The federal government also controls the minimum wage rate, changes in which have immediate consequences, first and foremost, for the regions. The latter are responsible for most social payments that are typically indexed to the

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Table 15.

Major federal mandates in 1998

Federal legal act1 ‘‘On veterans’’ ‘‘On social protection for invalids’’ ‘‘On child allowances’’ ‘‘On the status of military service’’ Presidential Decree ‘‘On social support for families with many children’’ ‘‘On social protection for victims of Chernobyl’’ ‘‘On donors’’ ‘‘On education’’ ‘‘On funerals’’ ‘‘On the rehabilitation of victims of political repression’’ ‘‘On compensation for food for students in professional training schools’’ ‘‘On the militia’’ Governmental Decree ‘‘On social protection for orphans’’ ‘‘On additional social guarantees for orphans’’ ‘‘On fire protection’’ ‘‘On social services for the elderly and invalids’’ Supreme Soviet Decree ‘‘Provision on law enforcement bodies’’ Governmental Decree ‘‘On state support for the medical industry and the provision of medicines’’ Governmental and trade-union central committee decree ‘‘On privileges for qualified civil servants and workers in rural communities’’ Governmental Decree ‘‘On urgent measures to improve social conditions for children’’ ‘‘On state guarantees and compensations for employees and inhabitants in the Northern areas’’ ‘‘On the social development of rural communities’’ Presidential Decree ‘‘On the local militia’’ Governmental Decree ‘‘On regulation for free provision to one-to-two-year-old children with milk products’’ ‘‘On medical insurance’’ Total

Year enacted

Regions identifying act as a federal mandate (%)

Estimated cost to regional budgets (% of GDP)

% of obligation financed in 1998

1995 1995 1995 1998

86 82 77 47

1.64 0.64 1.16 0.15

29.3 21.2 39 69

1992 1991 1993 1996 1996

46 42 37 34 31

0.16 0.02 0.02 0.15 0.01

25.2 34.6 54.7 31.1 56.7

1991

31

0.08

31.4

1996 1991

29 24

0.28 0.07

15.9 36.1

1992 1996 1994 1995

20 16 15 15

0.12 0.08 0.03 0.58

26.2 34 22.6 8.4

1992

15

0.08

46.8

1994

13

0.3

17.9

1930

11

0.06

41.7

1992

10

0.1

10.8

1993

9

0.99

18.5

1990 1993

8 7

0.23 0.15

96.4 41.6

1997 1997

5 2

0.08 0.23

11.7 13.5

7.74

30.6

1. Federal law unless otherwise stated. Source: Ministry of Finance (1999c).

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minimum wage (also by federal regulations). A large number of regional budgets are also highly dependent on federal transfers, which have exhibited a high degree of unpredictability and unreliability.

Interbudgetary transfers As indicated in the previous two sections, regional and local governments possess extremely limited formal fiscal authority, with a large share of revenue receipts and expenditure obligations deriving from federal laws and regulations. This implicitly places a substantial share of responsibility on the federal government for ensuring a feasible balance for the budgets of the Subjects of the Federation, who in turn must struggle with the balance of local budgets. This fact, together with the highly politicised nature of transfers, complicates the realisation of purely distributional aims through federal transfer policies. Some studies have indeed cast doubt that transfer policies have succeeded in their primary goal of smoothing distribution.121 The establishment of the Fund for the Financial Support of Subjects of the Federation (FFSSF) as part of the federal budget in 1994 was an important step forward in the development of federal transfer policies. Before the adoption of this fund, transfers primarily took the form of individual block grants, the differentiation of tax-sharing norms, and various so-called ‘‘mutual settlements (vzaimnye raschety)’’, discussed below. These amounts were determined in a largely discretionary and highly politicised manner that bypassed the federal budgetary process altogether. Since 1995, the majority of federal transfers have been allocated through the FFSSF, the size and distribution of which is determined as part of the annual federal budget law. As Figure 36 shows, so-called mutual settlements and budgetary loans still remain significant alternative sources of federal transfers (see below). Although the division of the FFSSF between regions follows an explicit methodology, its allocation in practice has remained somewhat politicised and subjective.122 The Duma has frequently altered the relative sizes of planned transfers during the political bargaining associated with the drafting of the budget. The allocation of the FFSSF has also been highly uneven in practice, with some regions receiving greater-than-planned allocations, and others receiving as little as 80 per cent of their entitlements (Table 16). The methodology for the division of the FFSSF has also been subject to much criticism.123 Perhaps most important, the methodology has employed past achieved levels of revenue and expenditures as a primary criterion for allocation, thereby dulling incentives to improve fiscal performance at the regional level. Given the conclusions of the previous two sections, however, it is not clear to what degree the methodology has been a problem in and of itself, as opposed to being a consequence of the very nature of interbudgetary relations. As the federal

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Figure 36.

The size and structure of federal transfers and loans to subjects of the Russian Federation As share of GDP

%

%

3.0

3.0

2.5 2.0

Transfers Mutual settlements Federal loans Other

2.5 2.0

1.5

1.5

1.0

1.0

0.5

0.5 0

0

-0.5

-0.5 1995

1996

1997

1998

1. As a sum of monthly reports, including net federal loans; excluding budgetary operations carried out after the end of the budgetary year. Source: Ministry of Finance, OECD.

Table 16.

Planned and actual transfers from the FFSSF to selected regions 1997

Kaliningrad Yaroslavl Nizhnii Novgorod Belgorod Orel Ulianovsk Altai republic Primorskii Vladimir Adygeya Orenburg Kursk Voronezh Krasnodar Stavropol Vologda

1998

Share in FFSSF (%)

Proposed share in FFSSF1 (%)

Approved share in FFSSF1 (%)

Actual provision (% of planned)

0.51 0.45 0.81 0.24 1.12 0.91 0.35 4.80 0.97 0.70 0.84 1.11 1.48 3.17 2.38 0.26

0.15 0.24 0.00 0.03 0.91 0.18 0.34 5.24 0.22 1.39 0.13 0.60 0.16 0.00 4.11 0.13

0.44 0.40 0.71 0.18 1.27 0.79 0.31 4.20 0.93 1.14 0.95 0.97 1.30 2.76 2.30 0.23

116 115 109 107 106 104 104 90 89 89 87 87 82 81 81 80

1. Re-calculated without Chechnya. Source: Ministry of Finance.

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government has put itself in a position of sharing responsibility for the balance of regional budgets, the difficulties of separating the allocation of transfers from a consideration of achieved past budgetary balance are indeed understandable. Mutual settlements and budgetary loans remain even less transparent than the allocation of the FFSSF. The broad category of mutual settlements includes virtually any transfer to the region that is not subject to regulation from the budgetary process. Such settlements usually represent the result of bilateral negotiations and political lobbying, and include various federal programmes and directed subsidies. One important category of mutual settlements consists of grants for the upkeep of social infrastructure that has been transferred from privatised enterprises to municipalities. By their very nature, mutual settlements muddle the understanding of distinctive fiscal responsibilities for various levels of budgets. While budgetary loans would appear a more effective device for bilateral assistance, these loans have often not been repaid in practice (see below). With the exception of a number of major cities, the dependence of local governments on the region is generally much greater than the dependence of the region on the federal government. Transfers to local budgets from regional administrations account, on average, for an estimated 30 per cent of revenues. For a number of localities, this figure is as high as 80 per cent.

The outcomes of the system: budgetary balance, incentives, and the regional financial crisis As concluded in the previous section, the formal system of fiscal federalist relations remains much more centralised than a first glance at basic budget data might indicate. The larger part of explicit (cash) revenue and expenditures at subnational levels of government is guided and controlled, to a very large degree, by the higher level. Federal bodies in the regions and localities also perform the basic function of tax collection. The combination of severe limits on tax authority, mandates for expenditures, and other instructions and regulations places lower levels of government in an exceedingly difficult position with regard to budgetary fulfilment. This section examines how subnational officials actually behave in this environment, and the consequences for budgetary execution and balance. The nature of the formal system has adverse effects on the incentives for regional and local officials from at least three main points of view. First, the plethora of federal regulations and the outright unfeasibility of the explicit system gives subnational administrations an excuse to absolve themselves of the responsibility for raising revenue and executing the budget in a responsible manner. Second, the instability of numerous regulations and controls reinforces the per-

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ception that improving budgetary performance today will only ratchet up the pressure for better performance in the future, leaving insufficient rewards at the regional or, especially, local level. Both of these first two conditions, together with very low pay for civil servants, increase the relative attractiveness of rent-seeking activities relative to responsible economic policies.124 Third, the extremely limited abilities of subnational administrations to conduct their own fiscal policies within the constraints of the formal system induce regional and local officials to seek other means of realising these policies. The sheer size of the Russian Federation and related informational and other advantages of local and regional officials imply that disciplinary measures of the federal government alone will always be woefully insufficient to rectify this situation.

Budgetary balance Subnational budgets have exhibited a chronic imbalance between expenditure obligations and financial resources. These imbalances first emerged in the chaotic period of 1991-93, when the share of expenditure responsibilities delegated to lower levels of government exceeded the increased share of revenue accruing to subnational budgets, and became more acute during 1996-97. The usual economic indicator of budgetary balance, the formal budget deficit, offers a very incomplete picture of this phenomenon. Most significantly, this figure does not show one of the most important means for the achievement of budgetary balance in regional and local budgets: expenditure sequestration and the accumulation of arrears in payables. Until 1995, the accounting methods employed by lower levels of government were insufficient for the calculation of budgetary balance, although there exist partial evidence of growing imbalances.125 Data since 1995 show a consolidated regional budget cash deficit, which increased to 1.25 per cent of GDP in 1997 before falling to only 0.35 per cent in 1998 (Figure 37). After a steady deterioration during 1995-97, 1998 brought what appears to be a major turnaround in budgetary balance, with the majority of Subjects of the Federation actually experiencing budgetary surpluses. This can be understood as a consequence of the financial crisis. The first half of 1998 looked similar to previous years. But after the August crisis, most regional governments found themselves no longer able to finance deficits through securities or loans from the federal government. As indicated in Figure 37, commercial bank loans, typically from a bank closely tied to the regional administration, provided the only remaining significant source of outside finance. In fact, the majority (67 per cent) of commercial loans to subnational administrations in 1998 was channelled toward the repayment of other outstanding credits. As seen in Figure 38, 1998 witnessed net outflows of external finance, in contrast to the consistent inflows of previous years. In this context, the primary mechanism for the achievement of budgetary

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Figure 37. Deficit finance of the consolidated regional budgets: 1995-1998 As share of GDP %

%

3.5

3.5 Federal loans

3.0

3.0

Banks credits Securities

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0

0

-0.5

-0.5 1996

1997

1998

Source: Ministry of Finance.

Figure 38. Subnational repayment/borrowing ratios 2.5

2.5 Securities Federal loans

2.0

Commercial credit

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0

0 1995

Source: Ministry of Finance.

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1997

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Table 17. Indicators of subnational budgetary imbalance Percentage of GDP

Revenue Federal aid Expenditures Cash deficit Growth in tax arrears Growth in payable budgetary arrears1 ‘‘Accruals deficit’’ Unfunded mandates ‘‘Expanded accruals deficit’’

1996

1997

1998

12.8 2.2 16.0 –1.0 1.1 1.1 –1 4.6 –5.6

13.9 2.6 17.7 –1.2 0.7 0 –0.5 5 –5.5

13.2 1.6 15.2 –0.4 0.7 0.7 –0.4 5.3 –5.7

1. Excluding child allowances. Source: Ministry of Finance.

balance in 1998 was the contraction of real expenditures during the inflation of the second half of 1998 and early 1999. In the first eight months of 1999 relative to the same period in 1998, consolidated regional expenditures fell from roughly 15 to 13 per cent of GDP. Table 17 presents alternative measures of subnational budgetary balance that attempt to account at least partially for arrears in payables of regional and local governments. Adding both the explicit reported growth in arrears in receivables (tax arrears) and payables, the corresponding (pseudo) accruals measure actually shows a lower imbalance in 1997 and an identical deficit in 1996 and 1998. But officially reported arrears in payables of subnational administrations do not include the underfulfilment of federal expenditure mandates, as listed above.126 The fact that the population and most courts consider these mandates to be obligatory, and administrations do make at least some effort to fulfil them, could argue for their inclusion in a measure of the accruals deficit as payables. As a rough approximation, Table 17 adds the unfunded portion of the 25 mandates listed in Table 15 in 1998 to payable arrears in 1996-98. The explicit payable arrears listed in Table 17 consist almost entirely of wage and utility subsidies and do not include the unfinanced part of federal mandates. Using the information given in Table 15 on the degree of funding of federal mandates, Table 17 adds a conservative estimate of the additional implied ‘‘payables’’. The result is worrying: the corresponding consolidated regional budget deficit rises to over 5.5 per cent of GDP.

Surrogates, arrears, and extrabudgetary funds Regional and local officials operate within and around the formal system of fiscal federalist relations in various ways. As already indicated above, a primary

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means of making ends meet is the underfulfilment of expenditure obligations, particularly those associated with numerous federal mandates. In addition, administrations have various tools that can be used as a foundation for active regional and local economic policies. These tools typically involve circumventing the formal system to one degree or another. Basic sources of economic power within regional and local jurisdictions offer a foundation for the exercise of genuine fiscal authority, despite the constraints of the formal system. Other than formal fiscal instruments, regional and local officials control such variables as licensing, water supply, access to privileges for settling taxes and energy payments in offsets, protection from bankruptcy, inspections, and guarantees for commercial loans. Subnational administrations also typically participate directly in the capital of a number of banks and firms in the region or locality. The combined formal and informal leverage of regional and local administrations over firms and organisations in their jurisdictions is so ubiquitous that ‘‘good’’ relations with authorities is still widely considered to be a general prerequisite for successful business in most regions. The widespread use of money surrogates in regional and local budgetary operations since 1994, particularly in the form of tax and expenditure offsets, has greatly expanded the scope for economic policies at the subnational level of government. Chapter II details numerous advantages for subnational administrations from the use of these instruments. In addition to expanding directly the set of feasible tax and expenditure policies, the use of surrogates allows for implicit individualised tax exemptions and the reallocation of revenue from the federal to regional or local budgets. They are a primary means by which regional administrations can realise implicit energy subsidies in their jurisdictions at the expense of branches of natural monopolies in gas, electricity, and transportation. Offsets also create a lack of transparency in accounting that can be used to manipulate regional and local budgetary accounts. As state organs, in contrast to other organisations, do not pay interest or penalties on their payable arrears, the deliberate accumulation of mutual arrears is also a mechanism for promoting budgetary balance. Offsets are then naturally used to clear these arrears at the end of the calendar period. The use of surrogates in budgetary expenditures also eliminates interest payments that would need to be made on otherwise borrowed (cash) funds. In addition, money surrogates facilitate rent-seeking and corruption. The proliferation of offsets in budgetary operations has thus been a natural response to a formal system of fiscal relations that ties the hands of subnational administrations and offers little incentive to pursue responsible budgetary policies. In addition to the direct advantages from interest-free debts as arrears, the confused nature of formal expenditure assignments and responsibilities allows subnational administrations to shift at least a part of the burden of these arrears to higher levels of government. The inverse dependence of federal trans-

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fers on budgetary performance offers at least one such implicit means. But federal programmes for the elimination of chronic regional and local wage arrears offer the most dramatic example of this phenomenon in recent years. In the presence of social discontent and the confusion of fiscal responsibility, the federal government has provided substantial ‘‘loans’’ to regions for the clearing of their wage arrears since 1996. Figure 39 shows the relationship between the provision of federal loans and subnational wage arrears since 1996. A major campaign by the federal government to clear wage arrears, including those of regional and local governments, began in the context of the presidential election campaign in 1996. This was later transformed into a scheme that required every rouble of a federal loan to be matched by a rouble from regional budgets. The federal government opened special earmarked accounts for the clearing of wage arrears in budgetary organisations, while loans totalling Rb 19 billion (0.8 per cent of GDP) were granted to the regions. As illustrated in Figure 39, subnational budgetary wage arrears fell to relatively insignificant levels by the end of 1997. As soon as this campaign ended, however, wage arrears in the budget sphere began another rapid ascent, reaching an average of 2.6 months by September 1998. In an attempt to reverse this trend, the government offered regions the prolongation of the previous loans, as well as some new loans, under

Figure 39. Subnational wage arrears and federal credits As share of GDP %

%

1.0

1.0

0.9

0.9

0.8

0.8 0.7

0.7 New federal loans

0.6

0.6

0.5

0.5 Wage arrears

0.4

0.4

0.3

0.3

0.2

0.2

0.1

0.1 0

0 Q1 1996

1997

Q2

Q3 1998

Q4

Q1 1999

Source: OECD calculations based on data of the Ministry of Finance.

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the condition that no less than 40 per cent of regional budgetary resources be devoted to wages and the clearing of arrears. But even these measures proved inadequate to prevent the continued rise in arrears in 1998. Only the effects of rapid inflation, including its boost of the revenue position of subnational budgets, facilitated the decline of wage arrears by almost 30 per cent in the first four months of 1999. Extrabudgetary funds at regional and local levels of government represent still another tool for supporting independent ‘‘informal’’ fiscal policies. These funds can be divided into three groups: territorial branches of state (federal) extrabudgetary funds (listed in Table 18), funds of Subjects of the Federation, and funds of local governments. Federal law places strong restrictions on funds in these latter two categories, essentially limiting them to collections of voluntary contributions or various fines. In light of the discussion above, however, subnational administrations possess ample means of making ‘‘voluntary’’ contributions either profitable or obligatory for economic organisations. As a simple example, an administration could promise a firm the right to settle a certain share of its explicit tax debt in offsets (at an inflated price) under the condition that a certain cash contribution be made to an extrabudgetary fund. By some reports, these funds have become particularly widespread at the local level of government, where small businesses often complain of pressure for contributions.127 In additional to explicit extrabudgetary funds, departments of regional and local administrations have their own accounts (Sumy po porucheniiu), where various ‘‘nontax’’ payments can be collected. In addition to the strictly regional and local funds and accounts, territorial branches of state (federal) extrabudgetary funds also offer some advantages to subnational administrations. As shown in Table 18, the size of each one of these funds relative to the budget has grown during 1996-1998. One such advantage is

Table 18.

Territorial state (federal) extra-budgetary funds relative to revenue of consolidated regional budgets1

Extrabudgetary funds of which: Pension fund Medical insurance funds Social insurance fund Employment funds Road funds 1. Based on a survey of 68 regions. Source: Ministry of Finance.

OECD 2000

1996

1997

1998

41.5

43.0

53.5

24.5 3.5 3.8 1.4 6.7

26.1 3.7 3.5 1.4 6.5

31.5 5.0 4.8 1.9 9.0

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that revenue in these funds is generally not taken into account in the determination of federal transfers or (soft) loans to cover budgetary imbalances. Second, while the allocation of the pension and social security funds is approved and controlled by the federal government and, in the latter case, trade unions, this is

Box 8. Can regional administrations explicitly withhold federal tax revenues? While tax and treasury officials are technically federal employees, they can be strongly influenced by regional administrations as well. In disputes between the federal and regional governments, threats by regional governors to withhold the federal share of tax revenue in the region have been common. Furthermore, the republics of Tatarstan, Bashkortostan, and Sakha (Yakutiia) have proven that the withholding of federal revenue is indeed possible under certain circumstances. These facts have supported a presumption in a number of studies on fiscal federalism in the Russian Federation that the ability to withhold federal tax revenue is a primary source of bargaining power for regional governments (Bahl (1994), Kirkow (1996), Shleifer and Treisman (1999)). Nevertheless, the previous OECD Survey of 1997 indicated that, in practice, there is no evidence that regions other than Tatarstan, Bashkortostan, Sakha (Yakutiia), and Chechnya have succeeded in actually implementing such a threat. It is true that some regions succeeded in withholding the federal part of the (small) land tax for a period of time. But the land tax is a local, not federal, tax. Proceeds from the land tax are passed directly to local budgets, with centralised portions later submitted upward to the regional and federal governments. This is not the case for the major taxes, the revenue from which is under the direct control of the branch of the Federal Tax Ministry, the Federal Treasury, or Federal Customs Service. The Federal Customs service submits revenue directly to the federal government, while the Federal Treasury divides tax revenue between different budgets. The accounts themselves are held either in the financial apparatus of the Central Bank or an ‘‘authorised’’ bank of the federal government, most likely Sberbank, which is state owned. Withholding revenue from the federal budget would require officials from one or more of these institutions to follow a local or regional order in explicit violation of federal law. Although the influence of regional authorities on branches of federal organs and banks in their jurisdiction is strong, it does not appear to be that strong outside of the exceptional regions mentioned above. Events since the publication of the 1997 OECD Survey provide further evidence for this conclusion. In 1997, the regions of Saint Petersburg, Tula, Krasnoyarsk, Irkutsk, and Sakhalin announced their intentions to withhold revenue from the federal government, even going as far as issuing official instructions to that effect. In no case did the corresponding federal organs follow these instructions. In the context of the financial crisis of 1998, the governors of at least 9 regions made similar announcements. This time, in one case (the republic of Kalmykiia), the local branch of the Federal Treasury actually followed the regional order, in violation of federal law, and channelled an estimated 206 million roubles of federal money to the regional budget. The federal government responded immediately and harshly, however. The official in the Treasury was fired, all federal aid to the region was suspended, and the Central Bank stopped the operation of its branch in Kalmykiia. The financial administration of Kalymykiia then surrendered and rescinded its unlawful decision very quickly. (Rubchenko (1998)).

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much less the case for the remaining territorial federal funds. Regions largely plan the allocation of these funds themselves, and thus may possess somewhat more liberty in expenditures than is true for the explicit budget. Subnational administrations may therefore prefer diverting revenue to these funds. No reliable information exists on the number and size of extrabudgetary funds and accounts created by regional and local administrations. These funds are not advertised by the administrations themselves. Nevertheless, in a recent survey of 68 regions by the Ministry of Finance in 1999, 41 Subjects of the Federation admitted to having their own such funds. Their size and significance apparently varies considerably across regions. In the survey, Subjects of the Federation reported amounts held in their own extrabudgetary funds to be the equivalent, on average, of 2 per cent of regional budgetary revenues. This reporting, however, is almost certainly subject to a strong downward bias. Furthermore, it does not even include an estimate of the (possibly more significant) extrabudgetary funds at local levels of government. In fact, even at the regional level, it is believed that the size of autonomous extrabudgetary funds may approach the level of the budget itself in some Subjects of the Federation.128 Scattered reports from the press and surveys of firms also indicate the general importance of regional and local extrabudgetary funds.129 As concerns the additional off-budget accounts (sumy po porucheniiu), 42 Subjects of the Federations surveyed in 1999 indicated an average of 37 such accounts per region, and average holdings in these accounts amounting to the equivalent of roughly 5 per cent of tax revenue.130 As with extrabudgetary funds, these figures should be treated only as lower bounds. Subjects of the Federation have limited information on the existence of such accounts at local levels of government, and may be reluctant to reveal their own accounts. In fact, three sampled regions reported amounts in these accounts equivalent to over 30 per cent of tax revenue.131 One certain conclusion can be deduced from this survey evidence: the infrastructure for the use of off-budget funds and accounts for the diversion of resources does indeed exist at lower levels of government. But the extent and size of such funds is very unclear.

Subnational debt and loan guarantees The period from 1992 until the crisis of mid-1998 witnessed a steady growth of borrowing, debt, and loan guarantees at regional and local levels of government. Given the system of interbudgetary relations discussed above, Subjects of the Federation and municipalities have many reasons to pursue very actively the attraction of resources through the accumulation of debt and guarantees. A weak sense of responsibility for financial imbalances, and thus the solvency of the administration, translates into little concern for downside risk. Indeed, there is yet no concept of bankruptcy for a subnational administration,

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supporting the perception in many regions that the Ministry of Finance implicitly insures their debt and solvency. As emphasised in Chapter II, a shortage of cash in budgetary receipts also forced many administrations to borrow beyond requirements implied by the budget deficit alone in order to finance cash budgetary wages and subsidies. Many regional administrations also employ bills of exchange (veksels), usually of commercial banks or large enterprises, for the execution of budgetary payments. In these payments, veksels are offered at face (rather than discounted) value, a practice that allows administration officials to profit directly at the expense of budgetary recipients.132 Figure 40 illustrates the general upward dynamic in subnational debt since 1995 on the basis of very incomplete data.133 A federal law of 1993 guaranteed regional and local administrations the right to borrow and issue their own debt under few restrictions.134 Even before this time, administrations had the right to issue their own veksels. An explosion in subnational state veksel issues in 1995-97 motivated a law of mid-1997 that explicitly forbids this practice.135 As discussed earlier, however, this law contained a number of loopholes that allowed regions to continue the extensive use of such instruments. A series of presidential decrees in 1997 also permitted some relatively strong regions to issue Eurobonds on international markets. Twelve regions attempted such issues, with only Moscow City, St. Petersburg, and Nizhnii

Figure 40. Accumulated subnational domestic debt since 1995 As share of GDP %

%

2.5

2.5 Federal loans Bank credits

2.0

Securities

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0

0 01.01.96

01.01.97

01.01.98

01.01.99

Source: Ministry of Finance.

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145

Size and structure of subnational debt and loan guarantees in 53 regions Consolidated regional debt

Regional debt

Municipal debt

Internal debt and guarantees Billion roubles As % of own revenues As % of gross regional product (1997)

89 50.1 6.2

50.4 n.a. 3.5

38.6 n.a. 2.7

Structure of debt and guarantees, % of total Total Securities Agrobonds Promissory notes Bank credits Budgetary loans Guarantees

100 9 3.7 0.9 28.2 24 34.2

100 15.8 6.6 1.4 18.4 18.4 39.4

100 0.2 0.2 40.9 31.3 27.5

Share of overdue debt, % of total debt by categories Total Securities Agrobonds Promissory notes Bank credits Budgetary loans Guarantees

35 29.4 n.a. 37.5 11.4 54.7 45.7

25 29.3 n.a. 41.2 27.5 31.7 22.5

48 10.3 n.a. 3.3 1.9 72.4 89.2

Debt servicing planned by debtors, % of annual own revenues 1999 2000 2001

49.7 5.2 3.1

47.4 7.7 4

52.2 2.4 2.1

1 272 17.9 2.2

1 177

96

2.1

0.2

Structure of debt and guarantees, % of total Total Securities Bank credits IBRD and EBRD loans Guarantees

100 31.2 28.8 10.8 29

100 33.7 31 3.9 31.4

100 – 2 95.4 0.6

Share of overdue debt, % of total debt by categories Total Securities Bank credits IBRD and EBRD loans Guarantees

9.2 0 29.4 5 1

9.4 0 29.2 1.4 1

6.6 0 4.1 6.8 –

Debt servicing planned by debtors, % of annual own revenues 1999 2000 2001

6.4% 5.1% 6.7%

7.9% 6.2% 8.1%

1.0% 1.1% 1.7%

External debt and guarantees Mln USD As % of own annual revenues As % of gross regional product (1997)

Source:

Svistunov (1999) and OECD calculations.

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Novgorod succeeding. Guarantees for commercial credit or securities represent another major policy tool for the attraction of resources to the region. Until 1999, virtually no figures existed on the extent of outstanding veksels and obligations stemming from loan guarantees in regional and local debt. An extensive 1999 survey of 53 regions, conducted by the Ministry of Finance, provides the first statistical estimates of these figures that can be treated with any degree of reliability. The figures in Table 19 give a much more serious picture with regard to regional debt obligations than the partial measures of Figure 40. From this sample, total subnational internal and external debt plus guarantees accounted for over 8 per cent of gross regional product at the beginning of 1999. A startling revelation is that subnational loan guarantees, a large share of which are in arrears, accounted for roughly one third of this figure, or 2.8 per cent of gross regional product. Despite the law forbidding subnational governments from issuing their own unregistered debt instruments, regions admitted that such instruments still account for roughly 1 per cent of internal debt. Another striking implication of Table 19 is the large share of arrears in subnational debt and obligations stemming from guarantees, a figure that amounts to an estimated 35 per cent of internal and 9 per cent of external debt. The true figure for arrears on internal debt is most likely greater still, as agrobonds, for which sample data do not exist, had particularly high default rates.136 The picture that emerges from Table 19 points to the overall insolvency of subnational administrations on 1 January 1999. The very short-term nature of most regional obligations, combined with very limited current abilities of regions to roll over debts, implies that the situation could still further deteriorate. A more detailed analysis by Svistunov (1999) of 32 regions revealed that only one region had estimated commercial debt servicing requirements in 1999 of less than 15 per cent of its own revenues.137 The recent Budget Code, together with the Law on the Financial Foundations of Local Self-Government have, for the first time, placed restrictions on the overall debt position of subnational governments. Annex II summarises these formal restrictions on the size of subnational debt, increases in debt, and estimated needs in debt service. The number of these restrictions, combined with accounting ambiguities, has so far generated a large degree of confusion in interpretation. This will most likely need to be worked out in subsequent legislation and instructions. A large number of regions clearly already exceed the prescribed norms, one of which is a 15-per-cent-of-revenue limit on debt service, corresponding to the sample exercise described in the previous paragraph.

Policy options and reforms The analysis of this chapter and Chapter II leave little doubt that the reform of fiscal federalist relations is one of the most urgent and complicated

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tasks of the Russian economic transition. The recent experience in fiscal federalist relations resembles one in which the federal government has attempted to retrench much of the decentralisation of earlier years, subjecting the revenue and expenditures of lower levels of government to increasingly rigid federal regulations and mandates. The fact that these measures have not succeeded in reversing the de facto decentralisation of authority to lower levels of government, however, has caused the general strategy to backfire. The current system can be associated with highly distortionary incentives that encourage subnational officials to take little responsibility for financial management, on the one hand, and, on the other, to rely on ‘‘shadow’’ policies that circumvent numerous federal laws, regulations, and mandates. These federal requirements together leave little opportunity even to balance subnational budgets, let alone pursue genuine explicit regional or local economic policies. Furthermore, under current arrangements, regional and local officials themselves typically work with a very unclear picture of the actual size of their property, revenue sources, and other assets, or of their liabilities and various expenditure mandates. Given the current economic and political realities in Russia, an effective fiscal federalist system would need to include not only a clear delineation of revenue sources and expenditure assignments, but a high degree of autonomy for each level of government within that division. With this autonomy must come responsibility as well, including well-defined provisions to handle the insolvency, or possible bankruptcy, of a subnational administration, which could trigger the immediate removal of administration officials and the appointment of external management by the corresponding higher level of government. For reasons discussed in the second part of this chapter, a strong federal presence in fiscal affairs will most likely remain a necessity in the near future. Yet it is essential that federal policies be realised within the federal budget itself, not through the delegation of unfunded mandates to lower levels of government. Given the key responsibility of the federal government for smoothing large income disparities between Russian regions, a number of social expenditures that are currently under formal subnational responsibility might be centralised into the federal budget, along with a corresponding explicit centralisation of tax revenue currently channelled into lower-level budgets. In this case, mandates passed by the federal government, most of which are directed at social benefits, would also naturally become a federal responsibility. A large share of social expenditures in subnational budgets is already implicitly federal, as corresponding revenue provisions and allocations follow obligatory federal guidelines. In general, a larger explicit federal budget could be part of an agreement reached with subnational administrations that offers in exchange much greater autonomy and flexibility within the context of smaller regional and local budgets. On the revenue side, such arrangements could be supported by completely separating federal, regional, and local taxes, and ending the current highly problematic practice of

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revenue sharing. Different levels of government could also possess their own tax service and treasury.138 The highly politicised nature of reform in the area of fiscal federalism unfortunately limits the set of feasible options and threatens even well-developed reform proposals with delays or damaging political compromises. The general direction of reform outlined above would likely receive political support from many regions, particularly those with modest levels of income. The primary demand of the administrations of such areas is typically that the federal government take more responsibility for fiscal affairs in the region. Richer regions promise to be harder to win over. In a number of regions, a source of political resistance might come from the large number of officials who currently enjoy substantial rents and limited liability under the existing system. Nevertheless, the present situation necessitates a political solution that isolates such groups that currently profit at the expense of social welfare in the interest of creating a genuine workable fiscal federalist system with clearly allocated fiscal authority and responsibility. The Russian government launched a 3-year comprehensive programme for the reform of intergovernmental relations during 1999-2001.139 This programme gives only limited attention to the major problems in revenue sharing, expenditure assignments, and the division of fiscal authority discussed above, perhaps reflecting the inherent political complexities. One important part of the programme is an inventory and analysis of federal regulations pertaining to subnational expenditure, including existing federal mandates. On the basis of this analysis, the Ministry of Finance is currently preparing a series of amendments to the new Budget Code, and proposes four draft laws aimed at reducing federal mandates by Rb 80 billion in 2000. This represents the first explicit attempt on the part of the federal government to address the problem of mandates. These laws must pass through the Duma, however. Another important part of the official Concept Paper for Intergovernmental Reform recognises the importance of a legal status of ‘‘quasi-bankruptcy’’ for a subnational administration. This concern has yet to be translated into any plan of policy action, however. General problems in the division of revenue and autonomy of respective budgets do not appear to be receiving much attention as of yet in the programme. One major focus of the new programme is the methodology for the allocation of the Federal Fund for the Financial Support of Subjects of the Federation (FFSSF). As discussed above, the previous allocation of this fund on the basis of achieved levels of revenue and expenditure (decreasing in revenue and increasing in expenditures) adversely affected incentives for improving budgetary performance at lower levels of government. The methodology for 1999 used only information on expenditures from larger groups of regions in a territory, which weakened the dependence of a transfer for a particular region on its own past

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level of expenditures. Plans for 2000 are more ambitious. Certain stable measures of financial need and revenue capacity will replace recently achieved levels altogether as the primary criterion for the allocation of the fund.140 In addition to the FFSSF, the reform programme envisions the creation of two additional funds in 2000. A fund for regional development, under the authority of the Ministry of the Economy, will target regional investment programmes. But the degree to which this fund will receive finance from the 2000 budget is still uncertain. Another Fund for the Development of Regional Finance, created on the basis of a World Bank structural adjustment loan, will allocate funds to special regions conditional on the implementation of economic reforms. The small size of this fund in 2000 (US$60 million) will probably limit its availability to not more than three pilot regions. It may then be expanded. A greater conditionality of federal transfers on appropriate regional policies has been suggested in many studies on fiscal federalism in Russia.141 In sum, the current comprehensive programme includes a number of important directions of reform, but is mainly focused on small adjustments to the existing system as opposed to fundamental change. As economically and politically difficult as these fundamental issues may be, they demand attention. A genuinely workable and effective system of fiscal federalist relations represents one of the key structural prerequisites for a successful economic transition in Russia.

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Notes

1.

A detailed assessment of these accomplishments is given in OECD (1997).

2.

This is the spirit of amendments made by the Duma to the Law on Production Sharing in 1996, the implicit exclusion of foreigners from participation in a number of privatisation auctions, and limitations introduced on foreign shareholding in companies such as the gas and electricity monopolies, Gazprom and RAO EES. See OECD (1997).

3.

According to regulations existing until 1 January 1998, foreign investors wishing to repatriate their earnings or capital from the government bond market were obliged to first purchase special forward contracts. They could hedge the exchange rate risk in the interim period through additional forward contracts for foreign currency. The rationale behind this regulation was to give warning to monetary authorities before large amounts of capital could leave the country. By the first week of November 1997, such contracts had already been signed for roughly US$4 billion, Aleksashenko (1999a), p. 112.

4.

In the years immediately preceding the crisis, the share of commercial credit to the non-financial sector in Russian GDP fell into the range of 10-16 per cent of GDP. This can be compared with shares (in 1997) of well over 100 per cent in Hong Kong, Thailand, and Korea. The share in Indonesia was an estimated 70 per cent. Bulgaria, which also experienced a general financial and banking crisis in 1996 and early 1997, had a share of commercial credit to the non-financial sector in GDP of over 40 per cent before the outbreak of the crisis.

5.

The reasons for the highly limited profitable loan opportunities for Russian banks are examined in detail in OECD (1997). A primary problem is the lack of legal protection of the rights of commercial creditors, even in the event of secured loans.

6.

See OECD (1997), Chapter II.

7.

In recent years, even before the crisis, more than 70 per cent of household deposits have been concentrated in the single savings bank (Sberbank), for which the Central Bank is a majority shareholder. Consequently, household deposits accounted for little more than 10 per cent of the aggregate liabilities of other commercial banks (CBR data), although remaining deposits were concentrated in a few large Moscow banks, as discussed below.

8.

Bankovskii... (1999), p. 14.

9.

According to the data of the CBR, on 1 January 1998, 37 per cent of all loans of Russian banks denominated in foreign currency were of over one-year maturity and 14 per cent had a maturity of over 3 years. This is higher than the corresponding figures for rouble-denominated loans: 23 and 6 per cent, respectively.

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10.

The share of commercial credit denominated in foreign currency reportedly increased from 35 per cent at the beginning of 1998 to over 40 per cent by the summer. Obzor... (1999), p. 328.

11.

In fact, as a number of banks began to realise the growing risk of their own eventual insolvency, a strategy of increasing loans in foreign currency to their client enterprises (often of the same owners as the bank) may have also served as an implicit means of decapitalising the future ‘‘shell’’ of the bank (see the section on commercial bank restructuring in this chapter).

12.

Bankovskii... (1999), p. 15. According to CBR data, aggregate balance sheet liabilities (and assets) by forward contracts amounted to an astounding Rb 1 trillion on 1 January 1998, equivalent to about US$140 billion, or over 130 per cent of the amount of assets in the entire Russian banking system. This is due, however, to multiple hedging. Foreign investors hedged with the large banks, which then balanced their risks and open foreign position by hedging with a number of medium-size banks, which hedged with still smaller banks, etc. On the basis of an analysis of BIS data, the (Russian) Bureau of Economic Analysis gives an ‘‘upper bound’’ for the net indebtedness of Russian banks by forward contracts at around US$20 billion. (Obzor, 1999, p. 328). Thus, estimates by expert institutions differ. US$6 billion, proposed by the Development Institute, should probably be treated as a conservative estimate.

13.

Obzor... (1999), p. 323, footnote 3.

14.

The collection of federal taxes in money surrogates in 1998 was banned by presidential decree (‘‘O dopolnitelnykh... (1997)’’). The Ministry of Finance justified the use of surrogates in January and February 1998, however, as corresponding to the previous financial year. In the context of the crisis, this ban was later lifted, but imposed again as of March 1999.

15.

In July, about 10 court cases were reported concerning defaults of commercial banks on forward contracts with foreign investors. Obzor,... (1999)... p. 334.

16.

These restrictions are described below in the discussion of monetary policy.

17.

Goskomstat.

18.

See footnote 4.

19.

See, for example, Obzor... (1999), p. 108, par. 1.

20.

This is visible in the regular monitoring of Russian industrial firms by the Institute for the Economy in Transition (Rossiiskii Biulleten Koniunkturnykh Oprosov. 1998-99). A small downward trend in perceived ‘‘solvent demand’’ was already visible in early 1998. This trend became stronger in May and June in almost all branches of industry. The upward trend in output in 1998 was accompanied by a corresponding trend toward a decumulation of inventories of finished goods. This trend was reversed in the spring of 1998, with most firms reporting ‘‘excess inventories’’. Goskomstat. These problems are discussed in detail in OECD (1999). A discussion of this can be found in Tsentr Razvitia... (1999). According to Goskomstat statistics, fixed capital investment in the first half of 1999 was 99 per cent of the first half of 1998, with the share of such investment going into industrial machines and equipment increasing from 27 to 35 per cent, and the amount of investment classified as ‘‘short term’’ moving from 60 to 73 per cent. Goskomstat (July 1999).

21. 22. 23. 24.

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25.

The Ministry of Agriculture reports that at least 17 Subjects of the Federation have introduced and, as of mid-1999, retained various restrictions on exports of certain agricultural products from the region. A majority of regions have also introduced price controls on certain products, most particularly bread (Tsentr agroprodovolstvennoi... (1999). An overview of problems in the agricultural sector can be found in OECD (1998).

26.

As of 1998, Goskomstat estimated that the informal economy accounted for 20-25 per cent of economic activity in Russia. Some other independent estimates place this share as high as 40 or 50 per cent. The methodological foundation of these unofficial estimates is rather unclear, however.

27.

In addition to capital flight, errors and omissions can also derive from a high degree of unregistered barter and shuttle trade. See Aleksashenko et al. (1999b) for a discussion of this. On the other hand, capital flight under the guise of the under-invoicing of exports, for example, would not show up in errors and omissions. Recent official estimates of capital flight by the CBR can be found in IMF (1999). For the years 1994 to 1998, the annual estimates are 4.1, 8.8, 14.1, 15.3, and 11.9 billion US dollars.

28.

O Tsentralnom Banke... (1995).

29.

Not only were a number of statements to this effect made by high ranking CBR officials in 1998, but such objectives were included in a number of official documents. For example, the official programme of the Central Bank for 1999, as presented to the state Duma on 1 December 1999 in accordance with Russian law, contained such clauses as ‘‘A floating exchange rate regime will provide the Central Bank with the opportunity to increase the monetary saturation of the economy. An exchange rate determined freely by the market, by not being a drain on foreign exchange reserves, will allow the Central Bank to devote more attention to problems in the real sector of the economy’’. (Osnovnye Napravleniia, p. 5).

30.

O vnesenii dopolnenii... (1999).

31.

For comparative purposes, the share of (voluntary) deposits with the CBR in liabilities of commercial banks was 3 per cent in January 1998, before declining to 1.5 per cent by mid-year, a decline related to both the bank liquidity crisis and flight from the rouble.

32.

As part of the agreement with the IMF, Russia is removing restrictions that are seen to violate the conditions of Article VIII on current account convertibility.

33.

The share of the VAT accruing to the federal budget was increased from 75 to 85 per cent as of 1 April 1999. First quarter federal receipts from the VAT were even a smaller share of GDP (4.1 per cent) than in the first quarter of 1998 (4.3 per cent). But the second quarter receipts were much higher (4.6 versus 3.8 per cent). As discussed in the first section, the decline in VAT receipts in the second quarter of 1998 can be associated with a shift to a cash-only rule. Thus, the federal government introduced the very same rule in the second quarter of 1999 with much more success. (Ministry of Finance data and OECD calculations).

34.

According to the Economic Expert Group of the Ministry of Finance, for the first 7 months of 1999, federal non-interest expenditures were fulfilled by 91 per cent, as opposed to 77 per cent in the same period of 1998. The underfulfilment of expenditures by 9 per cent in the first half of 1999 is evidently only a ‘‘timing effect’’, however, and this figure has fallen in the second half of the year. (Ministerstvo Finansov...1999a).

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35.

As stated in the official press release of the Ministry of Finance on the fulfilment of the federal budget in the first half of 1999 (Ministerstvo Finansov... 1999b).

36.

Certain debt issues occupy an uncertain grey area between Russian Federation and former Soviet debt. An example are the so-called OVVZs, also known as Minfins or Taiga bonds. Although these bonds were issued in 1993, the intention was to cover hard currency deposits frozen in Vneshekonombank in 1991. When the Russian government failed to make payment on these bonds (OVVZ series III), it was already widely anticipated by investors. At the same time, the government did reportedly made payments in December 1998 on ‘‘IAN bonds’’, representing previously restructured interest arrears on the former Soviet debt.

37.

The Paris Club announced its willingness in principle to reschedule US$8 billion at the G8 Summit in Cologne in June 1999 (in ‘‘Russian and Baltic Economy: The week in review, 24 June 1998’’). The London Club has apparently also agreed to negotiations (‘‘London Club... (1999)’’).

38.

Estimate of Lehman Brothers from ‘‘Russia: Formulating... (1999)’’.

39.

See, for example, Rutkowski (1999).

40.

In the Russian case, this is not only due to low and frequently unpaid unemployment benefits. In many cases, employees prefer to remain legally registered at firms where they no longer work due to possible social benefits or future opportunities. In October 1998, unemployment for workers under 20 was 46 per cent and for workers between 20 to 24, 22 per cent. In Chukotka, between 1993 and 1997, employment fell by 14 thousand, but ILO-type unemployment only rose by under 4 thousand. This was due to a fall in the local labour force of about one-fifth during the same period, mainly through out migration. Dmitriev (1999), on the basis of RLMS data. It should be noted that the official Goskomstat estimate is considerably less: 4 months delay. Mokhtari et al (1999) estimate pension arrears of 37 billion roubles, whereas Dmitriev (1999) puts the figure at 29 billion roubles. The IMF figure is Rb 26.3 billion (IMF (1999), p. 70). Large debtors to the Pension Fund included RAO EES, regional budgets, the military industrial complex, heavy engineering, and construction. Part of the problem with this initiative was the indexation of the pension formula to a measure of the subsistence minimum. This formula would have implied a huge increase in pension outlays relative to contributions after the inflation of the second half of 1998. Retail trade turnover in early 1998 was roughly similar to the corresponding period of 1997, but this measure fails to take into account the significant real growth in the second half of 1997. Russia’s estimated Gini coefficient was .375 before the crisis in 1998 and increased to .397 in the second quarter of 1999. The decile ratio jumped from 13 to 15 per cent during the same period (Goskomstat). See, for example, Klugman (1997). Dmitriev (1999). Goskomstat figures. Dmitriev (1999).

41. 42.

43. 44.

45. 46.

47.

48.

49. 50. 51. 52.

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53.

Some regions, such as Kaluga and Karelia, have introduced formal charges for health services, but informal fees for medical assistance are also common. Yudaeva and Gorban (1999), using RLMS survey data, argue that 40 per cent of the hospitalised made payments in late 1998, as compared with 23 per cent in 1996.

54.

Rutkowski (1999) reports that, before the crisis, 60 per cent of medicines and 90 per cent of chemicals used by the domestic pharmaceutical industry were imported.

55.

As of September 1999, it is estimated that at least a quarter of the deposits frozen in 1998 have still not been recovered by depositors (Biuro ekonomicheskogo... (1999)).

56.

For the case of SBS Agro, the official complaint came from depositors who suggested the CBR management was interfering with the ability of the bank to service its liabilities. For Inkombank, the administration of the bank itself filed the court complaint.

57.

Inkombank reportedly used the delay before its license was revoked to offset the liabilities of its special clients with debts of these clients to the bank (‘‘Russian Banking Sector... (1999), p. 21). Two of the largest banks, Oneksimbank and Menatep, created new banks, Rosbank and Menatep-Saint Petersburg. In both cases, the new bank inherited the client accounts and multi-branch infrastructure of the old bank. It would appear, however, that a normalisation of their relations with foreign creditors and investors would likely involve confronting the question of the liabilities that they left in the shell of the old banks. The case of Tokobank has stirred particular controversy, as the interests of one particular creditor appear to have received unwarranted priority during the period of external management (Russian Banking Sector... (1999), p. 21).

58.

Lombard credits granted by the CBR to commercial banks averaged Rb 6.9 billion per month in the first 6 months of 1998, but increased to Rb 14.5 billion by August. Special refinance loans to commercial banks for the support of financial stability and the claims of depositors amounted to an estimated Rb 21.5 in the second half of 1998.

59.

This included special 6-month credits to 7 banks with a high share of household deposits for a total of Rb 9.3 billion, as well as a continued use of Lombard credits and repo agreements with GKO/OFZs, despite the fact that they had been frozen.

60.

These six banks were Inkombank, SBS-Agro, Most-Bank, Rossiiskii Kredit, Menatep, and Promstoibank Rossii. As of August 1998, they held roughly 12 per cent of all household deposits, with 70 per cent in Sberbank. Only the principal of household deposit as of 1 August could be transferred to Sberbank, and foreign currency deposits could be transferred at the rate of exchange prevailing on 1 September (9.3 roubles per dollar). Parts of the assets of these 6 banks were also transferred to Sberbank along with the liabilities.

61.

‘‘Russian Banking System... (1999),’’ p. 4. According to a report of the Development Centre, while 73 per cent of all rouble deposits in Menatep were transferred to Sberbank, households opted to transfer only 25 per cent of foreign currency deposits. For Inkombank, the numbers were 67 and 34 per cent (Bankovskaia, p. 22).

62.

In this respect, Russia was more fortunate than Bulgaria, where a similar attempt led to runs on the state savings bank itself in 1996. Such a situation began to occur in Russia as well, but was stemmed partly by an increase in deposit interest rates in Sberbank to over 40 per cent. The conversion of foreign currency deposits into rouble deposits for households moving their deposits to Sberbank was an element

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Notes

63. 64.

65.

66. 67.

68. 69. 70. 71. 72. 73.

74.

75.

155

that helped to support the credibility of implicit state deposit insurance in the Russian case. ‘‘O nesostaiatelnosti... (1999)’’ and ‘‘O restrukturizatsii... (1999)’’. Thus, creditors wishing to file claims against a bank must first petition the CBR to withdraw the license. If the CBR refuses to do so, however, it can potentially be found liable at a later date. In fact, the appointment of a temporary external administration and the removal of existing management are far from equivalent under the existing law. After the appointment of an external administration, existing management continues to make day-to-day decisions, although requiring approval from the CBR administrator in the event of a deal involving real estate or property valued at more than 1 per cent of the bank’s assets. If the existing management is deemed unco-operative or disruptive by the CBR administrator, however, the latter can petition to remove management for the period of the temporary administration. The nature of this crisis is outlined in Chapter II of OECD (1997). Commercial credit to the non-financial sector in GDP has remained less than 20 per cent since 1995. Exceptions to the low profitability of credit portfolios are credits given with state guarantees or the very short-term finance of foreign trade operations. See the first section of this chapter for a discussion of this. Central Bank letter (pismo) No 77-T of 1 March 1999. ‘‘O nesostaiatelnosti... (1998)’’ This problem is given a detailed and interesting discussion in Zhukov (1999). Such an amendment was first prepared as a government order as early as June 1998 (rasporiazhenie 878-r), but has still not received the approval of the Duma. Additional transaction costs of over 20 per cent associated with barter are commonly cited by managers in surveys of enterprises (See, for example, Hendley et al. (1998)). During visits to regional administrations in 1998 and 1999, the OECD secretariat was shown official documents for a number of budgetary offset arrangements involving the deliveries of goods and services in a chain beginning from a tax debtor to a budgetary recipient. Even operations worth less than US$20 in offsets included several pages of quite extensive documentation that specifies the numerous firms and organisations involved, the exact quantities of goods and services to be delivered, the prices at which these goods and services are to be evaluated, and the signatures of representatives (directors) of every organisation. The first published comprehensive study was conducted by the Russian State Interministerial Balance Commission (Neplatezhi (1998)). This was followed by numerous works cited in this chapter. The rather comprehensive contributions of Gaddy and Ickes (1998), Woodruff (1999), and Commander and Mumssen (1998) deserve special notice. Since early 1998, the OECD has conducted several missions primarily aimed at better understanding financial flows in cash and non-cash at the regional level and the interactions between firms, state organs, financial institutions, and natural monopolies. This included concentrated study in 3 regions in 1998 (Novosibirsk, Kostroma, the Republic of Mari El) and 4 regions in 1999 (Cheliabinsk, Perm, Rostov, Volgograd). Missions involved data acquisition and extensive interviews with officials from regional administrations (finance, economic policy, prices), branches of

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federal bodies (the Tax Ministry, the Treasury, the Insolvency and Bankruptcy Agency, the Anti-Monopoly Ministry), local administrations, enterprises, natural monopolies (electricity), and banks. Our work on this topic has also profited from the close co-operation of the Ministry of Finance, Ministry of the Economy, and the State Statistical Committee (Goskomstat). In addition, research for the previous OECD Economic Survey of the Russian Federation, which also touched on topics of demonetisation, included missions to Novosibirsk, Kemerevo, Tatarstan, Samara, Ulianovsk, Yaroslavl, and Nizhnii Novgorod. 76.

A World Bank survey conducted in several regions indicates that the share of barter in wholesale transactions increased from 11 to 47 per cent between 1992 and 1997 (Hendley et al. (1998)). A recent EBRD survey showed that, of 350 enterprises from 34 regions that were exposed to barter, non-cash transactions accounted for roughly 60 per cent of sales (Commander and Mumssen (1998)). For larger firms, the State Interministerial Balance Commission, which closely monitors the 210 largest tax debtors in Russia, found non-cash payments to account for 73 per cent of average receipts in 1998 (Neplatezhi... (1998)).

77.

Neplatezhi... (1998).

78.

From data collected by the Russian Economic Barometer. See Aukutsionek, S. (1998).

79.

This conclusion is based on OECD interviews and survey data from 1996 and 1997. The reason that cash budgetary payments are sometimes higher than receipts is due to the necessity to realise some payments (wages, pensions, and certain subsidies) in cash. The excess of cash payments over receipts in regional or local budgets has often forced authorities to borrow for financing ‘‘cash deficits’’ even in the event that the budget, including surrogate operations, may be balanced on paper.

80.

Perhaps the most common way around the legislation is the following: most regional administrations will employ the services of at least one commercial bank. The bank issues veksels, which are used by the administration for expenditures and accepted as tax payments. The administration does not need to underwrite or guarantee these veksels explicitly in order to support their value, since the fact that they are accepted at face value for tax payments is sufficient for this purpose.

81.

On the role of barter in the Soviet system, see Grossman (1977). The nature of the ‘‘non-cash’’ monetary circuit in the former Soviet system is described in Garvy (1977) and Kasai (1996).

82.

A least-squares regression with the share of surrogates in regional tax revenue as the dependent variable and the ratio of banks registered in the region to the region’s population as the independent variable reveals that the higher the ratio of banks to population the lower the share of surrogates (t-statistic of –7.12). Even after removing Moscow and St. Petersburg from the regression, the estimated coefficient remains statistically significant (t-statistic of –2.29).

83.

OECD (1997), Chapter II. Of the large Moscow banks, only relatively few had a substantial share of investments in GKO in 1996 and 1997.

84.

See OECD (1997), Chapter II.

85.

‘‘O merakh... (1996).’’

86.

Nalogovyi kodeks (1998), Article 31.

87.

Hendley et al. (1998) cite a figure attributed to the State Tax Service that 80 per cent of industrial enterprises have tax arrears.

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157

88.

In a recent EBRD survey, less than 20 per cent of enterprise managers responded that tax advantages were an important explanation for the use of surrogates. More than 70 per cent cited liquidity problems, while roughly 50 per cent stressed problems in outstanding debt and maintaining production levels (Commander and Mumssen (1998). This is similar to results from an earlier Russian Economic Barometer Survey on the causes of barter: 47 per cent of managers noted a shortage of working capital, 39 per cent cited a goal of quickening the sale of output, while only 17 per cent agreed that tax avoidance was important. 89. An example can clarify this point. For simplicity, consider only the VAT. Suppose a firm sells 100 units of output for Rb 100 million in cash. It would then keeps 80 million and transfer 20 million (20 per cent) to the tax authorities as payment of the VAT. Suppose instead that the firm realises 100 units in a barter operation. If it pays taxes with its own output rather than cash, it first owes the equivalent of 20 units (20 per cent) to the government. (This assumes that the barter and offset price are the same, which is usually roughly the case.) If it produces another 20 units to make this payment, however, this 20 units is counted as realised output and thus subject to another 20 per cent tax and so on. In the end, the firm owes ∞ i Σ (.20) (100) = 25 units to the government. Thus, under barter, the effective VAT rate i=1

90.

91. 92. 93. 94. 95. 96.

97.

98. 99.

increases from 20 to 25 per cent. Authorities have attempted to crack down on this practice. Presidential Decree no 1006 of 23 May 1994 requires all firms opening bank accounts to present documents confirming their registration with tax authorities. There have apparently been widespread violations of these conditions, however. See, for example, Volkonskii et al. (1998). Commander and Mumssen (1998). In interviews with regional administrations, it was consistently noted that a good share of offset arrangements were planned and initiated by the administration. Deliberate delays in the processing of tax documents were admitted in interviews with officials of some regional administrations. In 1998, branches of the Anti-Monopoly Ministry initiated more than 1 700 acts against bodies of executive power, resulting in 749 court cases. This was a consistent response in OECD interviews with Anti-Monopoly authorities in the regions. In none of the 7 regions chosen for detailed study was offset documentation monitored at all. At the same time, most regions carefully monitored all explicit legislation, in many cases exposing cases of perceived unfair competition and taking actions to pressure authorities to reverse such decisions. In fact, this type of problem commonly emerges even in the absence of corruption. A firm may deliver a good or service to a third party in satisfaction of a tax payment. But due to the failure of another firm in the chain to make a subsequent delivery, the budgetary recipient never receives the ‘‘budgetary payment’’ in kind. In this case, due to problems in documentation and other ‘‘local’’ rules governing offsets, the first firm may never actually receive credit for making the tax payment. Other commonly-used devices include ‘‘unpaid holidays’’ and forced part-time regimes. This chapter adopts the following conventions: for the three levels of government in the Russian Federation, the top level is referred to as ‘‘federal’’ or ‘‘central.’’ The

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100. 101. 102. 103.

104. 105. 106. 107. 108. 109. 110.

111. 112.

113. 114. 115.

116.

117.

118.

OECD Economic Surveys: Russian Federation second level is ‘‘regional’’ or ‘‘Subject of the Federation’’. The third level is ‘‘local’’ or ‘‘municipal.’’ The second and third levels together are referred to as ‘‘‘‘consolidated regional’’ or ‘‘subnational’’. ‘‘On the Fundamental Principles... (1991).’’ ‘‘Ob osnovakh nalogovoi... (1991).’’ ‘‘Ob osnovakh budzhetnykh prav... (1993).’’ The exceptions to the application of these norms were Tatarstan, Bashkortostan, and Sakha (Yakutiia), who signed separate agreements with the federal government, as discussed below. ‘‘O formirovanii... (1994).’’ Presidential Decree 1214 of 1996 again limited regional and local governments to the fixed list of taxes included in the 1991 fundamental tax law (‘‘O priznanii... (1996)’’). This is discussed in the section on transfers below. ‘‘O finansovykh osnovakh... (1997)’’ ‘‘O kontseptsii... (1998).’’ In recent years, Chechnya has had virtual complete formal financial independence from the Federation. This property of the VAT has motivated conclusions in several studies that all revenue from this tax should be centralised. See, for example, Keen and McAuley (1996). See, for example, Shleifer and Treisman (1999). Former exceptions include the regions of Saint Petersburg, Perm, Nizhnii Novgorod, and Tatarstan, all of which set profit tax rates below the former ceiling in 1998 of 22 per cent. Given the difficult state of regional financial affairs, including substantial wage arrears in the budgetary sector, most regional administrations could be understood as politically bound to the maximal profit tax rate. Eigel (1999). See also Alexeev and Kurliandskaia (1998) ‘‘O finansovykh osnovakh... (1997).’’ Ministry of Finance (1999). In this sample of 60 per cent of all regions, the sharing norms with local budgets corresponding to 5 federal taxes were changed on an average of four different times during 1997-1999. Some regions changed norms as many as seven times. A study by Euro-Asian Ratings (Eigel (1999)) of 11 selected cities corresponding to an IBRD project showed evidence of major declines in the share of federal taxes accruing to city budgets in 1998. Permitted regional taxes are the enterprise property tax, real estate (property) tax, road tax, transportation tax, sales tax, casino tax, and regional licensing fees. From eleven formerly permitted local taxes in the 1991 Fundamental Tax Law, local authorities are left with only the personal property tax, land tax, advertisement tax, inheritance tax, and local licensing fees. An important practical question concerns the nature of the new real estate (property) tax at the regional level, given the simultaneous existence of local taxes on personal property and land. This is the conclusion of a comprehensive analysis of existing budgetary laws, regulations and norms undertaken by the Ministry of Finance in 1999 (Ministry of Finance (1999c)).

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Notes

159

119.

‘‘O formirovanii...’’ (1993).

120.

This survey was a part of the same study described in footnote 13. This is, by far, the most comprehensive attempt to date to account for relative expenditure competencies and the burden of federal mandates at the regional level.

121.

See, for example, Le Houerou and Rutkowski (1996) and Treisman (1996). On the other hand, McAuley (1997), Stewart (1997), and Hanson and Kirkow (1997) conclude that transfer policies have smoothed income differentials to at least some degree.

122.

Political economy aspects of transfer policies are examined in Treisman (1996), Solnik (1995), and Kirkow (1996).

123.

See, for example, Lavrov (1997a, 1997b), Martinez-Vazquez and Boex (1998), Morozov (1999), Treisman (1996), and Hanson (1997).

124.

Explicit monthly wages in 1999 for the heads of financial departments in regional administrations of the Russian Federation fell into the range of Rb 1 500 to 1 900 a month, plus and additional 50-70 per cent in allowances. This makes explicit pay close to US$100 a month. Even a Deputy Governor receives explicit wages only in the range of Rb 4 000 to 5 000, or less US$200 a month.

125.

Previous accounting methods did not allow for a complete separation of genuine revenues from attracted resources (below-the-line deficit finance). In 1994, for example, although regions posted official budget surpluses, 50 Subjects of the Federation generated so called ‘‘revenues’’ from federal and commercial loans totalling at least 0.27 per cent of GDP.

126.

Reported payable arrears of subnational governments consist almost entirely of unpaid wages and utility subsidies. As an exception, the 1998 and 1999 figures on payable arrears also include unpaid child subsidies according to the corresponding federal mandate. We have accounted for this in reducing the initial figure for ‘‘growth in budget arrears’’ in Table 17 by a corresponding amount.

127.

This problem was discussed in the previous Economic Survey of the Russian Federation (OECD (1997)).

128.

See, for example, Uliukaev (1997).

129.

For example, the Republic of Bashkortostan reportedly created a Fund for Science and Technical Development in 1997, along with a ‘‘tax’’ of 1.5 per cent of enterprise costs of production (in violation of federal law) (Nazarov (1998)). Smolensk oblast apparently generates a Fund for Future Generations from a tax on trucks in transit in the region (Latynina (1998)). The governor of Kemerovo oblast apparently announced the creation of an Investment Fund, for which he ‘‘requested’’ enterprises to contribute 2 per cent of their revenues.

130.

As stated above, these accounts consist primarily of payments collected entirely offbudget. In addition, administrations can channel certain portions of excess budgetary funds in these accounts as a result of ‘‘economising’’ on particular budgetary expenditure categories.

131.

Ministry of Finance (1999). A discussion of off-budget environmental funds can be found in OECD/EU PHARE (1999).

132.

For a discussion of the uses and problems with veksels, see OECD (1997).

133.

These official Ministry of Finance data omit many categories of debt, including all debt issued before 1994, numerous unregistered (neuchtennye) veksel issues, obliga-

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160

tions arising from commercial loan guarantees, agrobonds, and, it would appear from Table 19 below, some bank credits. 134.

‘‘Ob osnovakh biudzhetnykh... (1993).’’

135.

‘‘O perevodnom... (1997).’’

136.

The so-called agrobonds represent an issue of particular contention between federal and regional governments. In 1997-1998, the federal government forced regional administrations to issue these bonds to cover overdue credits to agriculture. These credits were issued in 1996 by the federal government under a formal guarantee by the regions. Based on historical precedents, regions had no reason to perceive that these guarantees would be binding. According to one source, only 32 per cent of regions succeeded in servicing these agrobonds in full, while 36 regions, perhaps in an act of defiance, did not service them at all. In addition, a reported 72 per cent of these bonds matured before 17 August 1998, indicating that most defaults came before the general financial crisis (Frolovsky (1999)).

137.

For this exercise, it was assumed that existing commercial debts would be retired in three equal parts over the next three years under a yearly interest rate of 60 per cent, with foreign currency obligations calculated at the prevailing exchange rate of mid-1999.

138.

This type of clear separation of functions is also supported in Shelifer and Treisman (1999).

139.

The development of this programme began in 1997, leading to the drafting of a ‘‘Concept Paper’’ by the government Commission for Economic Reform in February 1998. The new government of Prime Minister Kirienko approved this Concept Paper and set up a trilateral working group of government, Duma, and Federation Council representatives for further work. Government Decree 862 of 30 July 1998 approved the revised Concept Paper, while a government order of the Primakov government in December 1998 gave it official status. On the basis of this legislation, a plan of action for 1999 was developed, as well as a draft plan for the year 2000.

140.

The new methodology will also allocate sequentially 50 per cent of the fund to regions with adjusted revenue per capita below the national average, and the second 50 per cent of the fund only to the very poorest Subjects of the Federation.

141.

See, for example, Freinkman and Haney (1997), Institute for the Economy in Transition (1998), Kouznetsova, Hanson, and Sutherland (1999).

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Ob osobennostiakh emissii i obrashcheniia gosudarstvennykh i municipalnykh tsennykh bumag (On features of the emission and circulation of state and municipal securities), Federal Law No. 136-FZ, 29 July 1998. Obzor ekonomicheskoi politiki v Rossii za 1998 god, Bureau of Economic Analysis (Biuro ekonomicheskogo analiza), Rossnep, Moscow, 1999. OECD (1997), OECD Economic Surveys: The Russian Federation, Paris. OECD (1998), Review of Agricultural Policies: Russian Federation, Paris. OECD (1999), Environmental Performance Review of the Russian Federation: Main Report, Paris. OECD/EU PHARE (1999), Sourcebook on Environmental Funds in Economies in Transition, Paris. On the fundamental principles of the budgetary system and budgetary process, Federal Law No. 1735-1, 10 October 1991. Osnovnye napravleniia edinoi gosudarstvennoi denezhno-kreditnoi politiki na 1999 god, (The programme of the Central Bank for 1999, as Presented to the Government Duma on 1 December 1998 in accordance with Article 44 of the Law on the Central Bank), Kommersant Daily, 8 December 1998. Parikh, S., and Weingast, B. (1997), ‘‘A Comparative Theory of Federalism’’, mimeo. Polterovich, V. (1998), ‘‘Institutsionalnye lovushki i ekonomicheskie reformy,’’ Discussion paper of the New Economic School, Moscow. Prezident podpisal federalnyi zakon o restrukturizatsii kreditnykh organizatsii, i spetsiualisty ARKO v strochnom poriadke zanialis ‘‘podgonkoi’’ pod nego svoikh vnutrennikh dokumentov, Ezhednevnik banki ibirzhi, Internet edition, 12 July 1999. Rossiisskii Biulleten Koniukturnykh Oprosov, Institute of the Economy in Transition (Institut Ekonomicheskikh Problem Perekhodnogo Perioda), various issues, 1998-99. Rubchenko, M. (1998), ‘‘Mifi biudzhetnogo federalizma’’ Ekspert (30 November). ‘‘Russian Banking Sector: At the Crossroads’’, Troika Dialog Research, June 1999. ‘‘Russian Banking System’’, Report of EU Vedi, 1999. Rutkowski, M. (1999), ‘‘Russia’s Social Protection Malaise: Key Reform Priorities as a Response to the Present Crisis’’, World Bank Social Protection Discussion Paper No. 9909. Shleifer, A., and Treisman, D. (1999), Without a Map: Political Tactics and Economic Reform in Russia, Cambridge, Ma, The MIT Press. Forthcoming. Shleifer, A., and Vishny, R. (1998), The Grabbing Hand: Government Pathologies and Their Cures, Cambridge, Ma, Harvard University Press.

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OECD Economic Surveys: Russian Federation

Soglasheniie o sotrudnichestve po stabilizatsii polozheniia v ekonomike RF, ‘‘Agreement’’ (on prices, payments, and surrogates in Russian industry prepared by the Russian government), Kommersant, June 16 1999. Solnick, S. (1995), ‘‘Federal Bargaining in Russia’’ East European Constitutional Review (fall), 52-58. Stewart, K. (1997), ‘‘Are Intergovernmental Transfers in Russia Equalizing?’’ UNICEF Innocenti Occasional Papers No. 59. Summary of GKO/OFZ Refinancing Programme for Non-residents, Ministry of Finance of the Russian Federation, http://www.minfin.ru/off–inf/112.htmnorm, 26 March 1999 . Svistunov, P. (1999), ‘‘Subnatsionalnye zaimstvovaniia v Rossiiskoi Federatsii’’ (Unpublished report of EA Ratings). ‘‘Tekushchee sostoianiie bankovskoi sistemy, (Obzor)’’, Central Bank of Russia, (http://www.cbr.ru/system/overview.html). Tiebout, C. (1956), ‘‘A Pure Theory of Local Expenditures’’ Journal of Political Economy, 64 (5), 416-424. Treisman, D. (1996), ‘‘The Politics of Intergovernmental Transfers in Post-Soviet Russia’’ British Journal of Political Science, 26, 299-335. Treisman, D. (1998a), ‘‘Deciphering Russia’s Federal Finance: Fiscal Appeasement in 1995 and 1996’’ EuropeAsia Studies, 50 (5), 893-906. Treisman, D. (1998b), ‘‘Fiscal Redistribution in a Fragile Federation: Moscow and the Regions in 1994’’ British Journal of Political Science, 28, 185-222. Treisman, D. (1999a), ‘‘The Causes of Corruption: A Cross-National Study’’ Mimeo. Treisman, D. (1999b), ‘‘Decentralization and Inflation: Commitment, Collective Action, or Continuity?’’ Mimeo. Treisman, D.(1999c), ‘‘Tax Evasion and Regional ’’Fiscal Protection‘‘ in Federal States: A Model with Evidence from Russia’’ Mimeo. Tsentr agroprodovolstevennoi ekonomiki, Biulleten, No. 1 (1), 1999. Tsentr razvitiia (Development Centre) (1999), ‘‘Obozreniie,’’ No. 6, http://www.dcenter.ru:8101/obzor/index.htm, 13 September. Uliukaev, A. (1997), ‘‘Poslednii resurs bedniakov,’’ Novoe Vremiia, , No. 5. Vestnik ‘‘Ekonomika, Finansy (severno-zapadnyi raion), 15 September 1999. Volkonskii, V., Gurevich, E., Kuzovkin, A., and Saburov, E. (1998), ‘‘Analiz vlianiia formy rachetov na urovni tsen’’ Ekonomika i Matematicheskie Metody: Vol. 34: 4.

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Wallich, C., ed. (1994), Russia and the Challenge of Fiscal Federalism, Washington, D.C., The World Bank. Weingast, B. (1992), ‘‘The Economic Role of Political Institutions’’ Institute for Policy Reform, Working paper No. IPR46. Weingast, B. (1995), ‘‘The Economic Role of Political Institutions: Market-Preserving Federalism and Economic Growth’’ Journal of Law, Economics, and Organization, 11, Spring. Woodruff, D. (1998a), ‘‘Making Money: The Political Economy of Post-Soviet Russia’’, manuscript. Woodruff, D. (1998b), ‘‘Prospects for Monetary Consolidation in Russia After the August Crisis’’, mimeo. Woodruff, D. (1999), Money Unmade: Barter and the fate of Russian Capitalism, Cornell U.P. Yudaeva, K. and Gorban, M. (1999), ‘‘Health and Health Care’’, Russian Economic Trends Quarterly, 8 (2). Zaiavlenie Pravitelstva Rossiisskoi Federatsii i Tsentralnogo Banka Rossiisskoi Federatsii ob Ekonomicheskoi Politiki na 1999 goda, (Memorandum of the Russian government and Central Bank on economic policy in 1999), http://www.minfin.ru/Ssrd/Ssrd.htm, 1999. Zhukov, P.‘‘Lenivyi sobstvennik sredi ‘velikikh kombinatorov’’’, Ekonomika i Zhizn, pp. 1, No. 15 (8761). Zhuravskaia, E.(1999), ‘‘Inter-Governmental Relations in Russia’’ Russian Economic Trends 8 (1), 44-47. Zhuravskaia, E. (1998), ‘‘Incentives to Provide Local Public Goods: Fiscal Federalism, Russian Style’’, mimeo, Harvard University.

OECD 2000

Annex I

Expenditure assignments in the Russian Federation

OECD 2000

172

Expenditure assignments in the Russian Federation Federal budget

Regional budgets

Local budgets

Public administration

Federal bodies, including local departments

Regional bodies; co-financing: regionally-based federal bodies

Local bodies; co-financing: locally-based federal and regional bodies

Foreign relations

Foreign missions, foreign debt obligations, external borrowing

Individual projects and programmes

Defence

All expenditures

Housing for servicemen

Co-financing registration and enrolment offices

Law enforcement

Courts, prosecutor offices, Ministry of Interior troops, law enforcement agencies, prisons, national security agencies, frontier guards, custom houses

Law enforcement agencies (militia and road traffic police), fire brigades, notaries, co-financing of courts

Municipal police, district inspectors, juvenile inspections

Fuel and food price subsidies

Science and research

All expenditures

Manufacturing, power production and building industries

Subsidies for mining, nuclear power production, conversion programmes, federal investment programmes

Enterprise subsidies

Farming and fishery

Maintenance of federal food stocks, seasonal loans, subsidies

Livestock farming subsidies, Veterinarian services, social facilities maintenance of regional food stocks, of agricultural enterprises land improvement

Environmental programmes

Meteorology, geodesy, cartography-related federal programmes

Regional programmes

Individual programmes

Transport and communication

National and interregional roads, communications, mail services

Intra-regional, including commuter transport, roads, telecommunications

Urban and commuter transport services, tariff subsidies, city roads

Centralised purchase of fuel, capital investments

Housing subsidies, water, sewerage, heating, landscaping and waste disposal

Some high schools, universities, and secondary vocational schools; specialised schools, boarding schools

Comprehensive schools, nurseries and kindergartens

Housing and utilities

OECD 2000

Education

Higher education, some secondary vocational training

OECD Economic Surveys: Russian Federation

Expenditures

Expenditures

Federal budget

Regional budgets

Local budgets

Medical care, fitness and sport

Federal medical centres, sanitary and epidemiological services

Specialised hospitals, polyclinics, and clinics; health insurance payments for the unemployed

Municipal and district hospitals, outpatient clinics, paramedic and obstetric stations, emergency services, purchase of drugs for orphanages and asylums, sports and recreation facilities

Culture and art

Individual facilities and events

Individual facilities (theatres, museums) and events, archives

Public libraries, community centres, parks

Social policy

Contributions to Pension Fund, pensions for retired servicemen, specific allowances, federal programmes

Social institutions (specialised hostels for elderly people and invalids)

Allowances and privileges set by federal laws, social safety net

Debt service

Federal domestic and foreign debt

Regional debt

Local debt

Transfers to lower-level budgets

Transfers to subjects of the federation and closed towns

Transfers to municipalities

Transfers to towns, settlements, and rural administrations

Source:

Annex I

OECD 2000

Expenditure assignments in the Russian Federation (cont.)

Ministry of Finance (1999c), OECD interviews with regional and local officials; 1997-1999 federal and regional budgets; Martinez-Vazquez and Boex (1998).

173

Annex II

The legal framework for subnational borrowing

OECD 2000

176

The legal framework for subnational borrowing

Legislation

Federal Law On the securities market (No. 39-FZ, 1996)

Federal Law On the financial foundation of local self-government, (No. 126-FZ, 1997)

Presidential Decree On the procedures for issuing foreign bonds by the executives of subjects of the Russian Federation (No. RF N 696,1998)

Regional and municipal

Municipal

Regional

Federal Law On features of the issue and circulation of state and municipal securities (No. 136-FZ, 1998)

Budget Code (No. 145-FZ, 1998)

Regional

Municipal

Regional

Municipal

Federal Law On the budgetary rights of subjects of the Russian Federation (No. 4807-1, 1993)

Regional and municipal

Securities

All debt obligations

Securities

All debt obligations including guarantees

Securities

All debt obligations

Source of borrowing

Internal

Internal

External

Internal and external

Internal and external

Internal

Total volume of accrued debt

Set independently

15 per cent of budgetary expenses

30 per cent of own revenues

15 per cent of own revenues

Not specified

In accord with legislation

Deficit financing limits

Not specified

Not specified

Not specified

Deficit financing limited to 30 per cent of own revenues

Deficit financing limited to 15 per cent of own revenues

Debt service limits

Not specified

Not specified

15 per cent of own revenues

15 per cent of total expenditures

15 per cent of total expenditures

Not specified

Employment of borrowed funds

Not specified

Loans for development programmes

Fiscal reform

Deficit financing

Deficit financing

Investment

Accounting

Registration of securities issues with the Ministry of Finance

In accord with legislation

Registration of securities issues with the Ministry of Finance

Registration of issues, legislative approval, maintenance of Debt Ledger

Registration of issues, legislative approval

In accord with legislation

Lenders’ rights

Not specified

Not specified

Ratings assigned by two rating agencies

Not specified

Ratings assigned by two rating agencies

Not specified

Deficit financing limited to 30 per cent of own revenues

Deficit financing limited to 15 per cent of own revenues

Not specified

OECD Economic Surveys: Russian Federation

OECD 2000

Object of regulation

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Seq: 1 Page: Free: 3020D Next: 0D VJ: R

BASIC STATISTICS: INTERNATIONAL COMPARISONS

4-MAR-96

BASIC STATISTICS: INTERNATIONAL COMPARISONS Units

Population Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thousands Inhabitants per sq. km . . . . . . . . . . . . . . . . . . . . . . . . . Number Net average annual increase over previous 10 years . . . . . . . % Employment Total civilian employment (TCE)2 . . . . . . . . . . . . . . . . . . Thousands of which: Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Services . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Gross domestic product (GDP) At current prices and current exchange rates . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ At current prices using current PPPs3 . . . . . . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ Average annual volume growth over previous 5 years . . . . . % Gross fixed capital formation (GFCF) . . . . . . . . . . . . . . . % of GDP of which: Machinery and equipment . . . . . . . . . . . . . . . . . % of GDP Residential construction . . . . . . . . . . . . . . . . . . . % of GDP Average annual volume growth over previous 5 years . . . . . % Gross saving ratio4 . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP General government Current expenditure on goods and services . . . . . . . . . . . . % of GDP Current disbursements5 . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Current receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Net official development assistance . . . . . . . . . . . . . . . . . % of GNP Indicators of living standards Private consumption per capita using current PPPs3 . . . . . . . US$ Passenger cars, per 1 000 inhabitants . . . . . . . . . . . . . . . . Number Telephones, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . Number Television sets, per 1 000 inhabitants . . . . . . . . . . . . . . . Number Doctors, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . . . Number Infant mortality per 1 000 live births . . . . . . . . . . . . . . . . Number Wages and prices (average annual increase over previous 5 years) Wages (earnings or rates according to availability) . . . . . . . . % Consumer prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Foreign trade Exports of goods, fob* . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Imports of goods, cif* . . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Total official reserves 6 . . . . . . . . . . . . . . . . . . . . . . . . . Mill. SDRs As ratio of average monthly imports of goods . . . . . . . . . . Ratio

Reference period 1

Australia

1996 1996 1996

18 289 2 1.3

1996 1996 1996 1996

8 344 5.1 22.5 72.4

Austria

Belgium

8 060 96 0.6 3 737 7.2 33.2 59.6

10 157 333 0.3

(94) (94) (94) (94)

1996 1996 1996 1996 1996 1996 1996 1996 1996 1996

398.9 21 812 372.7 20 376 3.9 20.3 10.2 (95) 4.6 (95) 5.6 18

228.7 28 384 172.4 21 395 1.6 23.8 8.8 (95) 5.9 (95) 2.1 21.9

1996 1995 1995 1995

17 35.6 34.9 0.36

19.8 48.6 47.4 0.33

1996 1994 1994 1993 1995 1995

12 596 460 496 489 2.2 (91) 5.7

1996 1996

1.7 2.4

5.2 2.9

1996 1996 1996 1996 1996 1996 1996 1996

60 288 15.1 7.5 61 374 15.4 9.7 10 107 2

57 870 25.3 7.1 67 376 29.5 5.9 15 901 2.8

* At current prices and exchange rates. 1. Unless otherwise stated. 2. According to the definitions used in OECD Labour Force Statistics. 3. PPPs = Purchasing Power Parities. 4. Gross saving = Gross national disposable income minus private and government consumption. 5. Current disbursements = Current expenditure on goods and services plus current transfers and payments of property income. 6. End of year.

12 152 433 466 479 2.7 5.4

Canada

Czech Republic

Denmark

Finland

France

Germany

Greece

29 964 3 1.3

10 316 131 0

5 262 122 0.3

5 125 15 0.4

58 380 106 0.5

81 877 229 3

10 465 79 0.5

(95) (95) (95) (95)

13 676 4.1 22.8 73.1

4 918 6.3 42 51.7

2 593 4 27 69

2 087 7.1 27.6 65.3

21 951 4.6 25.9 69.5

35 360 3.3 37.5 59.1

3 824 20.4 23.2 56.4

(95) (95) (95) (95)

268.2 26 409 222 21 856 1.2 17.3 7.5 (95) 4.6 (95) 0.3 22.2

579.2 19 330 645.1 21 529 2.2 17.7 6.6 5.4 2.2 17.8

56.2 5 445 .. .. 2 33 .. .. 9.4 ..

1 536.6 26 323 1 198.6 20 533 1.2 17.4 7.8 4.4 –1.5 18.7

2 353.5 28 738 1 736.1 21 200 1.4 20.6 7.6 7.3 0.2 20

91.2 8 722 133.5 12 743 1.3 17 7.7 3.3 0.5 16

(95) (95)

18.7 45.8 42.7 0.38

21.5 .. .. ..

19.4 50.9 46.9 0.55

19.8 46.6 45.9 0.31

20.8 (95) 52.1 45 0.13

12 244 488 4838 559 3.4 5.3

9 473 199 478 202 3.9 (94) 8.1

3 675 2.5 26.7 71.4

14.5 52.2 49.9 0.38

174.9 33 230 118 22 418 2.2 16.7 7.9 (95) 3.2 (95) 2 17.6 25.2 59.6 58.1 0.96

125.1 24 420 96.7 18 871 1.6 16.1 6.4 (95) 3.5 (95) –4.1 19.6 21.9 55.9 52.8 0.32

13 793 416 449 453 3.7 (94) 7.6 (94)

12 959 466 576 618 2.2 6.3 (94)

.. 282 209 476 2.9 7.7

12 027 312 604 538 2.9 (94) 5.5

2.7 2.2

2.4 1.4

.. 11.9

3.2 1.9

3.8 1.5

2.6 2

4.2 3.1

202 320 34.9 9.7 170 931 29.5 7.7 14 202 1

21 910 39 .. 27 721 49.3 .. 8 590 ..

51 030 29.2 6.2 44 987 25.7 5.6 9 834 2.6

40 576 32.4 12.1 30 911 24.7 7.3 4 810 1.9

288 450 18.8 6.3 271 348 17.7 3.9 18 635 0.8

521 263 22.1 5.4 455 741 19.4 3.3 57 844 1.5

170 2237 63.5 7.6 160 9177 60 5.9 11 7897 0.9

10 282 368 551 504 2.8 4

12 506 430 547 412 2.9 5.8 (94)

(95) (95) (95) (95) (95) (95)

11.8 11.6 11 501 12.9 (95) 5.8 27 402 30.4 (95) 6.6 12 171 5.3

7. Data refer to the Belgo-Luxembourg Economic Union. 8. Data refer to western Germany. 9. Including non-residential construction. 10. Refers to the public sector including public enterprises. Sources: Population and Employment: OECD, Labour Force Statistics. GDP, GFCF and General Government: OECD, National Accounts, Vol. I and OECD Economic Outlook, Historical Statistics. Indicators of living standards: Miscellaneous national publications. Wages and Prices: OECD, Main Economic Indicators. Foreign trade: OECD, Monthly Foreign Trade Statistics, Series A. Total official reserves: IMF, International Financial Statistics.

BASIC STATISTICS: INTERNATIONAL COMPARISONS (cont’d) Units

Population Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thousands Inhabitants per sq. km . . . . . . . . . . . . . . . . . . . . . . . . . Number Net average annual increase over previous 10 years . . . . . . . % Employment Total civilian employment (TCE)2 . . . . . . . . . . . . . . . . . . Thousands of which: Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Services . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Gross domestic product (GDP) At current prices and current exchange rates . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ At current prices using current PPPs3 . . . . . . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ Average annual volume growth over previous 5 years . . . . . % Gross fixed capital formation (GFCF) . . . . . . . . . . . . . . . % of GDP of which: Machinery and equipment . . . . . . . . . . . . . . . . . % of GDP Residential construction . . . . . . . . . . . . . . . . . . . % of GDP Average annual volume growth over previous 5 years . . . . . % Gross saving ratio4 . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP General government Current expenditure on goods and services . . . . . . . . . . . . % of GDP Current disbursements5 . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Current receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Net official development assistance . . . . . . . . . . . . . . . . . % of GNP Indicators of living standards Private consumption per capita using current PPPs3 . . . . . . . US$ Passenger cars, per 1 000 inhabitants . . . . . . . . . . . . . . . . Number Telephones, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . Number Television sets, per 1 000 inhabitants . . . . . . . . . . . . . . . Number Doctors, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . . . Number Infant mortality per 1 000 live births . . . . . . . . . . . . . . . . Number Wages and prices (average annual increase over previous 5 years) Wages (earnings or rates according to availability) . . . . . . . . % Consumer prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Foreign trade Exports of goods, fob* . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Imports of goods, cif* . . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Total official reserves 6 . . . . . . . . . . . . . . . . . . . . . . . . . Mill. SDRs As ratio of average monthly imports of goods . . . . . . . . . . Ratio

Reference period 1

Hungary

Iceland

Ireland

Italy

Japan

Korea

Luxembourg

Mexico

Netherlands

New Zealand

1996 1996 1996

10 193 77 –0.3

270 3 1.1

3 621 52 0.2

57 473 191 0

125 864 333 0.4

45 545 458 1

418 161 1.3

96 582 48 2

1996 1996 1996 1996

3 605 8.4 33 58.6

142 9.2 23.9 66.2

1 307 10.7 27.2 62.3

20 036 7 32.1 60.9

64 860 5.5 33.3 61.2

20 764 11.6 32.5 55.9

212 (95) 2.8 (95) 30.7 (90) 66.1 (90)

32 385 (95) 23.5 (95) 21.7 (95) 54.8 (95)

1996 1996 1996 1996 1996 1996 1996 1996 1996 1996

43.7 (95) 4 273 (95) .. .. –2.4 (95) 19.3 (95) .. . . –0.9 (95) ..

7.3 27 076 6.3 23 242 1.5 17.5 6.7 3.9 –1.4 15.6

70.7 19 525 68.8 18 988 7.1 17.2 5.5 (95) 4.9 (95) 6 21.7

1 214.2 21 127 1 148 19 974 1 17 8.8 4.5 –1.4 20.5

4 595.2 36 509 2 924.5 23 235 1.5 29.7 10.1 (95) 5.3 (95) 1.3 31.4

484.8 10 644 618.5 13 580 7.1 36.8 13 7.6 6.9 34.2

17 40 791 13.5 32 416 4.8 20.8 .. .. 0.2 37.5

1996 1995 1995 1995

24.9 (95) .. .. ..

20.8 35.1 36 ..

14.1 39.2 (94) 39.3 (94) 0.29

16.4 49.5 44.5 0.15

10.6 15.1 25.1 0.03

13.6 .. .. 0.36

1996 1994 1994 1993 1995 1995

.. 212 170 427 3.4 11

14 244 434 557 335 3.9 (94) 6.1

1996 1996

.. 23.2

.. 2.6

3.7 2.2

3.5 4.5

1.8 0.7

.. 5.3

.. 2.4

–1.6 19.7

2.4 2.5

1.5 2

1996 1996 1996 1996 1996 1996 1996 1996

15 674 35.9 8.9 18 105 41.4 9.6 6 812 ..

1 891 26 4 2 032 27.9 3.4 316 1.9

48 416 68.5 14.8 35 763 50.6 11.5 5 706 1.9

250 842 20.7 8.2 206 904 17 2.5 31 954 1.9

411 067 8.9 5.5 349 149 7.6 8 150 663 5.2

129 715 26.8 12.5 150 340 31 13.9 23 670 ..

.. .. .. .. .. .. .. ..

96 000 29.1 17.6 89 469 27.2 12.4 13 514 1.8

203 953 51.5 8.9 184 389 46.6 7.8 18 615 1.2

14 316 21.7 8.2 14 682 22.3 11.8 4 140 3.4

* At current prices and exchange rates. 1. Unless otherwise stated. 2. According to the definitions used in OECD Labour Force Statistics. 3. PPPs = Purchasing Power Parities. 4. Gross saving = Gross national disposable income minus private and government consumption. 5. Current disbursements = Current expenditure on goods and services plus current transfers and payments of property income. 6. End of year.

10 020 264 350 301 3.4 6.3

12 224 517 429 429 3.0 (94) 6.6 (94)

9.7 28.5 32 0.28 13 912 342 480 618 1.7 4.3

7 354 115 397 215 1.6 (92) 9

17 811 544 564 261 1.8 (94) 5.3 (94)

329.4 3 411 751.1 7 776 1.7 18 8.8 4.7 –0.7 22.7 9.710 .. .. .. 5 045 91 93 150 1.1 17 (94)

15 494 380 0.6

3 640 14 1.1

6 983 3.9 22.4 73.8

1 688 9.5 24.6 65.9

396 25 511 324.5 20 905 2.3 19.7 9.4 5 2.2 25.7

65.9 18 093 63.6 17 473 3.7 20.9 10 5.6 9.6 16

14 51.8 50 0.81

14.4 .. .. 0.23

12 477 383 509 491 2.2 (93) 5.5

10 895 457 470 1.6 7.2 (94)

7. Data refer to the Belgo-Luxembourg Economic Union. 8. Data refer to western Germany. 9. Including non-residential construction. 10. Refers to the public sector including public enterprises. Sources: Population and Employment: OECD, Labour Force Statistics. GDP, GFCF and General Government: OECD, National Accounts, Vol. I and OECD Economic Outlook, Historical Statistics. Indicators of living standards: Miscellaneous national publications. Wages and Prices: OECD, Main Economic Indicators. Foreign trade: OECD, Monthly Foreign Trade Statistics, Series A. Total official reserves: IMF, International Financial Statistics.

BASIC STATISTICS: INTERNATIONAL COMPARISONS (cont’d) Units

Population Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thousands Inhabitants per sq. km . . . . . . . . . . . . . . . . . . . . . . . . . Number Net average annual increase over previous 10 years . . . . . . . % Employment Total civilian employment (TCE)2 . . . . . . . . . . . . . . . . . . Thousands of which: Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Services . . . . . . . . . . . . . . . . . . . . . . . . . . . % of TCE Gross domestic product (GDP) At current prices and current exchange rates . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ At current prices using current PPPs3 . . . . . . . . . . . . . . . . Bill. US$ Per capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ Average annual volume growth over previous 5 years . . . . . % Gross fixed capital formation (GFCF) . . . . . . . . . . . . . . . % of GDP of which: Machinery and equipment . . . . . . . . . . . . . . . . . % of GDP Residential construction . . . . . . . . . . . . . . . . . . . % of GDP Average annual volume growth over previous 5 years . . . . . % Gross saving ratio4 . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP General government Current expenditure on goods and services . . . . . . . . . . . . % of GDP Current disbursements5 . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Current receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % of GDP Net official development assistance . . . . . . . . . . . . . . . . . % of GNP Indicators of living standards Private consumption per capita using current PPPs3 . . . . . . . US$ Passenger cars, per 1 000 inhabitants . . . . . . . . . . . . . . . . Number Telephones, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . Number Television sets, per 1 000 inhabitants . . . . . . . . . . . . . . . Number Doctors, per 1 000 inhabitants . . . . . . . . . . . . . . . . . . . . Number Infant mortality per 1 000 live births . . . . . . . . . . . . . . . . Number Wages and prices (average annual increase over previous 5 years) Wages (earnings or rates according to availability) . . . . . . . . % Consumer prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Foreign trade Exports of goods, fob* . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Imports of goods, cif* . . . . . . . . . . . . . . . . . . . . . . . . . Mill. US$ As % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Average annual increase over previous 5 years . . . . . . . . % Total official reserves 6 . . . . . . . . . . . . . . . . . . . . . . . . . Mill. SDRs As ratio of average monthly imports of goods . . . . . . . . . . Ratio

Reference period 1

Norway

Poland

Portugal

Spain

Sweden

Switzerland

Turkey

United Kingdom

United States

1996 1996 1996

4 370 13 0.5

38 618 123 0.3

9 935 108 –0.1

39 270 78 0.2

8 901 20 0.6

7 085 172 0.8

62 695 80 2

58 782 240 0.3

265 557 28 1

1996 1996 1996 1996

2 110 5.2 23.4 (95) 71.5 (95)

14 977 22.1 31.7 46.2

4 475 12.2 31.4 56.4

12 394 8.7 29.7 61.6

3 963 2.9 26.1 71

3 803 4.5 27.7 67.4

20 895 44.9 22 33.1

26 088 2 27.4 71

126 708 2.8 23.8 73.3

1996 1996 1996 1996 1996 1996 1996 1996 1996 1996

157.8 36 020 106.7 24 364 4.1 20.5 8.4 2.6 (94) 2.8 29.9

251.7 28 283 171.4 19 258 1 14.8 7.9 1.9 –2.6 16

294.3 41 411 180.6 25 402 0.1 20.2 9.3 119 –0.8 27.1

1 153.4 19 621 1 095.5 18 636 2.2 15.5 7.6 3 1.3 14.6

7 388.1 27 821 7 388.1 27 821 2.8 17.6 8.3 (95) 4.1 (95) 6.9 16.6

26.2 63.8 57.5 0.77

14.3 47.7 53.8 0.34

117.9 (95) 3 057 (95) .. .. 2.2 (95) 17.1 (95) .. .. 5.4 (95) ..

103.6 10 425 130.1 13 100 1.5 24.1 11.7 (93) 5.2 (93) 2.2 21.6

16.9 (95) .. .. ..

18.5 42.5 (93) 39.8 (93) 0.27

1996 1995 1995 1995

20.5 45.8 50.9 0.87

1996 1994 1994 1993 1995 1995

11 593 381 554 427 2.8 4

.. 186 131 298 2.3 13.6

8 522 357 350 190 3 7.4

1996 1996

3.2 1.9

.. ..

.. 5.6

1996 1996 1996 1996 1996 1996 1996 1996

49 576 31.4 7.8 35 575 22.5 6.9 18 441 6.2

24 417 20.7 .. 37 185 31.5 .. 12 409 ..

24 614 23.8 8.6 35 192 34 6.1 11 070 3.8

* At current prices and exchange rates. 1. Unless otherwise stated. 2. According to the definitions used in OECD Labour Force Statistics. 3. PPPs = Purchasing Power Parities. 4. Gross saving = Gross national disposable income minus private and government consumption. 5. Current disbursements = Current expenditure on goods and services plus current transfers and payments of property income. 6. End of year.

584.9 14 894 587.2 14 954 1.3 20.1 6.1 (95) 4.3 (95) –1 20.7 16.3 41.2 37.9 0.24 9 339 351 371 400 4.1 (93) 6 (94)

10 096 406 (93) 683 470 3.1 4

15 632 451 597 400 3.1 (94) 5

5.8 4.7

4.8 2.7

.. 2.2

102 067 17.5 11.2 121 838 20.8 5.5 40 284 4

84 836 33.7 9 66 825 26.5 6 13 288 2.4

79 581 27 5.3 78 052 26.5 3.2 26 727 4.1

181.5 2 894 383.3 6 114 4.4 25 11.9 8.4 (95) 6.9 22.3 11.6 .. .. 0.07 4 130 47 201 176 1.2 46.8 (94)

21.1 42.3 (94) 37.2 (94) 0.28

15.6 34.3 32.1 0.1

11 865 372 489 435 1.6 (94) 6.2 (94)

18 908 565 602 816 2.6 (94) 8 (94)

.. 81.6

4.9 2.7

2.7 2.9

23 301 12.8 11.1 43 094 23.7 15.1 11 430 3.2

259 941 22.5 7 287 033 24.9 6.5 27 745 1.2

625 075 8.5 8.2 795 289 10.8 10.3 44 536 0.7

7. Data refer to the Belgo-Luxembourg Economic Union. 8. Data refer to western Germany. 9. Including non-residential construction. 10. Refers to the public sector including public enterprises. Sources: Population and Employment: OECD, Labour Force Statistics. GDP, GFCF and General Government: OECD, National Accounts, Vol. I and OECD Economic Outlook, Historical Statistics. Indicators of living standards: Miscellaneous national publications. Wages and Prices: OECD, Main Economic Indicators. Foreign trade: OECD, Monthly Foreign Trade Statistics, Series A. Total official reserves: IMF, International Financial Statistics.

OECD PUBLICATIONS, 2, rue Andre-Pascal, ´ 75775 PARIS CEDEX 16 PRINTED IN FRANCE (10 2000 37 1 P) ISBN 92-64-17537-7 – No. 51109 2000 ISSN 0376-6438