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April 2000 - In Russia, implicit subsidies amounting to 10 percent of GDP per year in the form of nonpayments have stifled growth, contributed to the August 1998 macroeconomic crisis through their impact on public debt, and made at best a questionable contribution to equity. Hardening budgets requires that these nonpayments - or mutual arrears and noncash settlements among the government, the energy monopolies, and manufacturing firms - be eliminated with energy bills, taxes and budgetary spending settled on time and in cash. Pinto, Drebentsov, and Morozov analyze the links between Russia's disappointing growth performance in the second half of the 1990s, its costly and unsuccessful stabilization, the macroeconomic meltdown of 1998, and the spectacular rise of nonpayments. Nonpayments flourished in an environment of fundamental inconsistency between a macroeconomic policy geared at sharp disinflation and a microeconomic policy of bailing enterprises out through soft budget constraints. Heavy untargeted implicit subsidies flowing through the nonpayments system (amounting to 10 percent of GDP annually) have stifled growth, contributed to the August 1998 meltdown through their impact on public debt, and have made at best a questionable contribution to equity. Dismantling this system must be a top priority, along with promoting enterprise restructuring and growth (by hardening budget constraints) and medium-term macroeconomic stability (by reducing the size of subsidies). Getting the government out of the nonpayments system means settling all appropriately controlled budgetary expenditures on time and in cash, and eschewing spending arrears, thereby setting an example for enterprises and laying the groundwork for eliminating tax offsets at all levels of government, and insisting on cash tax payments. To stop energy-related subsidies would require not only that the government pay its own energy bills on time and in cash, but also that the energy monopolies be empowered to disconnect nonpaying clients. This will enable the government to insist that the energy monopolies in turn pay their own taxes in full and on time. This paper - a product of the Economics Unit, World Bank Office, Moscow - was produced as part of the Economic and Sector Work Program, Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region.

Arrears --- Banks and Banking Reform --- Budget --- Budgets --- Corporate Governance --- Credibility --- Debt Markets --- Devaluation --- Economic Theory and Research --- Emerging Markets --- Finance and Financial Sector Development --- Financial Literacy --- Foreign Direct Investment --- Government Spending --- Inflation --- Investment --- Investment Climate --- Macroeconomic Environment --- Macroeconomics and Economic Growth --- Nonpayment --- Nonpayments --- Oil Prices --- Private Sector Development --- Promissory Notes --- Public Debt --- Public Sector Economics and Finance --- Settlement --- Soft Budget Constraints --- Tax --- Taxation and Subsidies

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May 2000 : Russia gets relatively little foreign direct investment and almost none of the newer, more efficient kind, involving state-of-the-art technology and world-class competitive production linked to dynamic global or regional markets. Why? And what should be done about it? Foreign direct investment brings host countries capital, productive facilities, and technology transfers as well as employment, new job skills, and management expertise. It is important to the Russian Federation, where incentives for competition are limited and incentives to becoming efficient are blunted by interregional barriers to trade, weak creditor rights, and administrative barriers to new entrants. Bergsman, Broadman, and Drebentsov argue that the old policy paradigm of foreign direct investment (established before World War II and prevalent in the 1950s and 1960s) still governs Russia. In this paradigm there are only two reasons for foreign direct investment: access to inputs for production and access to markets for outputs. Such kinds of foreign direct investment, although beneficial, are often based on generating exports that exploit cheap labor or natural resources or are aimed at penetrating protected local markets, not necessarily at world standards for price and quality. They contend that Russia should phase out high tariffs and nontariff protection for the domestic market, most tax preferences for foreign investors (which don't increase foreign direct investment but do reduce fiscal revenues), and many restrictions on foreign direct investment. They recommend that Russia switch to a modern approach to foreign direct investment by: Amending the newly enacted foreign direct investment law so that it will grant nondiscriminatory national treatment to foreign investors for both right of establishment and post-establishment operations, abolish conditions (such as local content restrictions) inconsistent with the World Trade Organization agreement on trade-related investment measures (TRIMs), and make investor-state dispute resolution mechanisms more efficient (giving foreign investors the chance to seek neutral binding international arbitration, for example); Strengthening enforcement of property rights; Simplifying registration procedures for foreign investors, to make them transparent and rules-based; Extending guarantee schemes covering basic noncommercial risks. This paper - a product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Regional Office - is part of a larger effort in the region to assist the Russian authorities in preparing for accession to the World Trade Organization. The authors may be contacted at hbroadman@worldbank.org or vdrebentsov@worldbank.org.

Barriers --- Corporate Governance --- Debt Markets --- Developing Countries --- Domestic Market --- Economic Theory and Research --- Emerging Economies --- Emerging Markets --- Enforcement --- Finance and Financial Sector Development --- Financial Literacy --- Foreign Direct Investment --- Foreign Investment --- Foreign Investor --- Foreign Investors --- Global Market --- International Economics & Trade --- Investment and Investment Climate --- Investor --- Labor Policies --- Law and Development --- Macroeconomics and Economic Growth --- Natural Resources --- Outputs --- Price --- Private Sector Development --- Property Rights --- Public Sector Corruption and Anticorruption Measures --- Social Protections and Labor --- Tax --- Technology Transfers --- Trade --- Trade and Regional Integration --- Trade Law --- Transition Countries