Abstract

Ashok K. Lahiri and Daniel A. Citrin

Ashok K. Lahiri and Daniel A. Citrin

During the process of adjustment from central planning to a market-oriented system, many transition economies have experienced the problem of enterprises not receiving payments from each other on time for goods and services delivered.1 Such nonpayments—or interenterprise arrears—signal a lack of financial discipline, can retard investment and the process of privatization, and can undermine the conduct of prudent macroeconomic policies. This paper examines developments in interenterprise arrears in the Baltics, Russia, and other countries of the former Soviet Union, identifies its possible sources, and sets out policy options toward resolving the problem.

The potential adverse effect of interenterprise arrears can be much wider than its direct impact on enterprises that did not get paid for goods and services delivered. First, these enterprises themselves may incur arrears on their payables because of insufficient liquidity. Enterprises can quickly become entangled in multiple layers of arrears, with one enterprise’s payment to a second contingent on receipt of payment from a third, and so on. Such a snowballing of arrears can threaten the viability of fundamentally profitable firms as well as that of lossmaking enterprises. Second, massive amounts of receivables and payables on enterprise balance sheets, much of dubious value, can confuse and hinder a realistic assessment of the financial situation of enterprises by their own managers, suppliers, banks, and potential investors. As a result, investment, credit, and privatization decisions may be impeded. Third, interenterprise arrears (and trade credits, more generally) constitute a form of financial disintermediation and can complicate monetary management, in particular, by leading to a decline in the demand for bank credit and an increase in the velocity of money (see Section III).

In the Baltics, Russia, and other countries of the former Soviet Union, interenterprise arrears grew rapidly during the first six months of 1992, from relatively modest initial amounts. The subsequent behavior of interenterprise arrears has varied across countries. Although a cross-country comparison is complicated by the lack of reliable data on a consistent basis,2 the problem, by the end of 1994, appeared to have subsided considerably in countries that made significant progress toward macroeconomic stability and structural reform—for example, in the three Baltic states. In contrast, some other countries—most notably, Azerbaijan and Ukraine—which were not well advanced in stabilization and reform, saw an intensification of the arrears problem.

It should be noted that while the interenterprise arrears problem has been accompanied by a buildup in wage and tax arrears, the discussion here focuses on overdue payments obligations between enterprises. Overdue payments between enterprises across national boundaries are also an important aspect of the arrears problem. The interstate component of arrears mainly relate to the energy sector in most countries. Such arrears are often large in volume and complicate not only the balance of payments but also interstate financial relations.

The evolution of interenterprise credits and arrears in the Baltics, Russia, and other countries of the former Soviet Union is discussed here first, followed by some conceptual issues regarding interenterprise credit and arrears and some of their probable causes. Policy options to deal with the existing stock of debt and to prevent the emergence of new arrears are then considered.

Evolution of Interenterprise Credit and Arrears

Under central planning, access to bank credit was virtually automatic for activities approved by the plan, and the need for interenterprise credit was extremely limited. Interenterprise transactions were carried out in “account” or “deposit” money by making money transfers through the old interbranch settlement system. A supplier usually received payment by submitting a payment demand order to its own bank requesting payment from the buyer.3

Under this system, overdue payments were only a minor problem. Unpaid bills of enterprises were recorded under File No. 2 (kartoteka nomer dva) of commercial banks, and any arrears at the end of the financial year were written off by the extension of automatic credit.4 At the end of 1990, for the entire U.S.S.R., total interenterprise receivables for goods and services were equivalent to 13 percent of GDP, and at the end of 1991, the outstanding balance in File No. 2 for the region stood at an estimated 7 percent of GDP.

Initial Transition Period, Early 1992 to Mid-1993

All this changed with the phasing out of strict central planning in all the countries by early 1992.5 The banking sector ceased to function as an administrative arm of the planning mechanism, and bank credit to enterprises ceased to be automatic. Furthermore, the phasing out of state orders, which had provided an assured market for a large portion of enterprises’ output, implied that enterprises had to look for customers, start to engage in marketing activities, and also perhaps coax buyers by providing trade credit.

Interenterprise credit, which had been mostly confined to the File No. 2 of banks, began to appear outside the purview of the banking system, and the File No. 2 system was abolished in many states by the middle of 1992.6 Enterprises were free to instruct their banks which creditors to pay, if at all, and not necessarily in order of chronological seniority. At the same time, the outstanding amounts in the File No. 2 were no longer guaranteed, and the quality of such claims suddenly became highly questionable.

Total interenterprise credits (including those not considered to be overdue) increased rapidly in almost all countries during 1992 and the first half of 1993. Indeed, these credits rose substantially in relation to the stock of broad money, contributing to inflationary pressure. Nevertheless, at the end of the period, the levels of interenterprise credits were modest (Table 4.1) compared with the standards of both established market economies, and those of other reforming economies in eastern Europe such as Poland, Hungary, and the former Czechoslovakia, at a comparable stage of transition. As of mid-1993, total interenterprise receivables ranged from 5 percent to 19 percent of GDP in Belarus, Russia, and Ukraine—the only three countries for which data on total interenterprise credits exist at higher-than-annual frequencies.7 In the 1980s, in the United Kingdom, interenterprise credit among industrial and commercial companies alone ranged from 17 percent to 20 percent of GDP,8 while in the United States, trade credit of nonfinancial corporations stood at 17 percent of GDP in the first quarter of 1992. The levels of interenterprise receivables were equivalent to 20-60 percent of GDP in Poland and the former Czechoslovakia during 1988—91 (Chart 4.1).

Chart 4.1.
Chart 4.1.

Other Central and Eastern European Countries in Transition: Interenterprise Arrears

Source: IMF staff estimates.1End-year stock in relation to annual GDP.2End-year stock in relation to end-year stock broad money.
Table 4.1.

Belarus, Latvia, Russia, and Ukraine: Interenterprise Credit

(Payables, end of period)

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Sources: Data provided by country authorities; and IMF staff estimates.

Defined as average during the quarter as a percent of annualized quarterly GDP.

Includes payables to the government as well as banks.

Turning to the overdue portion (arrears), their levels—when measured in relation to GDP or in terms of total interenterprise credit—also remained relatively low (Table 1.5).9 For example, in the Czech Republic, just under 50 percent of total receivables were overdue at the end of 1991, and in many western European countries nearly half the firms wait until bills are two weeks or more overdue before paying them.10

Nevertheless, by mid-1992, the rapid growth of interenterprise arrears became a major source of concern among policymakers, particularly in the countries of the Commonwealth of Independent States (CIS). While the Baltic states followed a policy of benign neglect, in the CIS meetings in Bishkek and Tashkent in May 1992, broad agreement was reached among officials on a four-pronged plan of action to (1) increase the responsibility of enterprises for assuring prompt payment for their sales; (2) raise the interest rate that enterprises were advised to charge on arrears; (3) net out arrears first within each state and subsequently at the interstate level; and (4) replenish the working capital of state enterprises. While action on the first two components of the policy package was not immediately obvious, all countries of the CIS carried out netting out exercises for interenterprise arrears and followed these up with additional bank credit to clear the net outstanding claims as well as to replenish the working capital of enterprises. In the event, these actions added to inflationary pressures, and the reprieve to the arrears problem achieved by the exercise proved to be temporary.

Russia provides a clear example of these developments. By mid-1992, interenterprise arrears had risen to 21 percent of GDP,11 and deliveries started to become sensitive to payments, with reports of enterprises delivering cash by truck or plane against delivery of goods. In response, the authorities carried out a multilateral netting out of arrears in the second half of 1992, through the establishment and operation of special accounts in commercial banks. Furthermore, net positive balances of creditors remaining after that operation—which amounted to about 3 1/2 percent of GDP—were then monetized by making them usable for tax payments and for paying off liabilities to banks.12 While a significant arrears problem did not re-emerge in Russia until the end of 1993, with the level of overdues averaging around 2 1/2 percent of GDP in the first half of 1993, the clearing and bailout operation clearly had expectational and inflationary implications.

Mid-1993 to Late 1994

For the period from mid-1993 to late-1994, the countries for which information is available can be placed in three distinct groups: (1) Latvia, Lithuania, and the Kyrgyz Republic, where the arrears problem diminished; (2) Russia and Turkmenistan, where it slowly increased; and (3) Azerbaijan, Belarus, Kazakstan, and Ukraine, where it escalated rapidly.

In Latvia, total interenterprise credits fell below 18 percent of GDP by the end of 1993, implying even lower values for overdues. In Lithuania, overdue payables, after a modest increase in the third quarter of 1993, declined steadily not only in relation to GDP, but also as a proportion of broad money (Table 1.5). The evolution of arrears in the Kyrgyz Republic was similar to that in Lithuania with one exception: although the stock declined as a proportion of GDP, the ratio to broad money remained stubbornly high at around 2 1/2 until the third quarter of 1994.

There was a rather modest rise in interenterprise arrears—as measured against GDP—in Russia and Turkmenistan during this period. Overdue payables did increase more significantly in relation to broad money in both countries, however, with implications for the effective conduct of monetary policy. Also, the interstate component of interenterprise arrears was a problematic aspect of the arrears problem in both Russia (Table 4.2) and Turkmenistan, reflecting in particular debts on energy deliveries. In Russia, arrears involving the fuel and electrical energy sectors amounted to almost one half of total interenterprise arrears in 1994 (Table 4.3). In Turkmenistan, overdue receivables of gas companies from enterprises in other states of the region rose by about $0.5 billion during the first nine months of 1994 to about 60 percent of GDP at the end of September, 1994. These nonpayments significantly complicated inflation control in Turkmenistan, with the authorities granting additional credits to enterprises in lieu of the receipts from abroad.

Table 4.2.

Russia: Interstate Interenterprise Arrears, as of October 1, 1994

(In billions of rubles)

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Source: Goskomstat.

Commonwealth of Independent States consists of Russia and the other states of the former Soviet Union, except the Baltic states.

Table 4.3.

Russia: Sectoral Composition of Interenterprise Arrears

(Overdue payables, end of period)

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Sources: Data provided by country authorities; and IMF staff estimates.

In contrast, interenterprise payables and arrears rose to relatively high levels in Azerbaijan, Belarus, Kazakstan, and Ukraine during this period.13 In Ukraine, arrears began to re-emerge relatively soon after an arrears clearing and bailout operation conducted in February 1993, and increased sharply in late 1993 and early 1994, particularly in relation to broad money. Two further netting out operations were carried out in Ukraine in 1994. In Kazakstan, arrears rose sharply during the second half of 1993. In response, in early 1994, the Government of Kazakstan carried out a netting operation, following which net creditors were paid the full amount of their claims. Part of these payments were in the form of government bonds, where the debtors became liable to the government and their payments obligations were to be enforced through the threat of bankruptcy. In the event, most of the debt to the government was not repaid, and liquidation proceedings have only been initiated for a small proportion of the debtors.14 Moreover, arrears once again rose sharply in the third quarter of 1994.15 Finally, in Azerbaijan and Belarus as well, interenterprise arrears escalated in spite of clearing operations carried out in the third quarter of 1993.

Although little information is readily available regarding the volume of interenterprise arrears in Uzbekistan, it is likely it also belongs to this third group of countries. And indeed, the Uzbek authorities undertook, under the auspices of the central bank, a netting out of gross overdue interenterprise claims and liabilities between August 15 and September 5, 1994.

Thus, indications are that by late 1994, while arrears ceased to be a serious problem in some countries, they appeared to be of significant concern in a number of others. Moreover, in Russia (Table 4.2) and Turkmenistan, while the aggregate level of domestic arrears appeared to be modest, they were highly concentrated in a few sectors. And it would seem that the higher the concentration, the more the pressure for an ultimate government bailout of such overdue obligations. Indeed, the one of Turkmenistan serves as a vivid example of this.

Factors Causing Arrears

Interenterprise credit and arrears are common features in all market economies, and it can be argued that some increase in the volume of such credit and arrears—from very low initial amounts—can be expected as these economies move toward market-based systems.16 However, it is important to distinguish between the natural adaptation to markets and special factors present during transition that drive the accumulation of arrears. A brief discussion of these different factors follows.

Normal Factors Operating in a Market Economy

Interfirm trade credit is quite substantial and normal in market economies.17 The various explanations of trade credit include (1) transactions costs associated with cash payments; (2) informational costs associated with bank lending or credit market imperfections (e.g., interest rate spreads) that raise the relative cost of bank loans; and (3) goods market imperfections that force firms to provide credit as a marketing activity.18

Market imperfections can be hypothesized to have played a significant role in the rapid growth of interenterprise credit in the Baltics, Russia, and other countries of the former Soviet Union from insignificant initial amounts. The process of replacing the previous system of planning and state orders by a set of perfectly functioning product markets will be gradual and tortuous. Furthermore, the system of distributing a large part of the available limited amount of credit to selected enterprises at subsidized rates continued well into 1994 in many of these countries and was a source of credit market imperfections.19 The spreads between lending and deposit rates in many of the countries—for example, more than 50 percentage points on an annual basis in Russia in the second half of 1994—continued to be very high through 1994.

Nonetheless, and although overruns on informal credits between firms are also common in market economies,20 the explanation of maturity overruns on the scale registered in some of these countries cannot rely on these imperfections alone. This leads to possible explanations of the arrears problem in terms of structural factors, including the expected policy stance of the governments.

Additional Factors in the Transition Economies

In the initial stages of transition, the managers of state-owned enterprises have little experience with the rules of the market, and the institutional arrangements and incentives structure do not change in a dramatic way toward encouraging market behavior. The high level of uncertainty regarding relative prices and prospective stance of macroeconomic policies, and regarding the future ownership and management structure, compound the problem of inadequate incentives for efficient management. In such circumstances, managers seek to avoid conflicts with the work force on employment and wage issues, often buying raw materials and inputs on credit and maintaining a level of production even if there is insufficient demand. Such behavior may lead to either the accumulation of inventories or delivering output in exchange for future promises to pay to buyers with questionable prospects. When the promises to pay are not honored in time, arrears build up. The absence of a sound banking and payments system, of a stable macroeconomic framework, and of suitable laws and institutions perpetuate a management culture inappropriate for a market economy and financial discipline. The role of these relevant factors in the evolution of interenterprise arrears is briefly discussed below.

Undeveloped Financial Systems

Underdeveloped financial systems are likely to have contributed to the growth of interenterprise credit and arrears in the region. The services provided by financial intermediaries in market economies, for example, making payments and facilitating transactions and risk management, monitoring firm managers, and credit assessment, were either irrelevant or of minor importance under central planning.21 During the initial stages of transition, the supply of these financial services expanded but generally fell far short of demand. Enterprises were led to organize financial arrangements among themselves to sustain trade and output. In the process, suppliers assumed high risks that at least partly ended up as overdue receivables.

Delays in the settlements system also were a factor. Under the newly emerging market system, payments orders could be executed only after clearing, and lack of adequate computing and communication facilities led to inordinate delays in both domestic and interstate payments.22 The disintegration of large enterprises into many autonomous units, often across state boundaries, also may have contributed, by increasing overall credit needs of enterprises and the volume of financial transactions in the economy.

Credit market imperfections also may have exacerbated the arrears problem, particularly when restrictive monetary policies were pursued by some countries to combat high inflation. In imperfect credit markets characterized by widespread use of artificially low interest rates and credit rationing, a deceleration in the growth of credit expansion may have led to the substitution of bank lending by forced lending by enterprises to each other, and hence interenterprise arrears.

Thus, inadequate progress in financial sector reform is likely to have contributed to the buildup of arrears. Indeed, the containment of the interenterprise arrears problem in Latvia and Lithuania may partly be attributed to the progress made toward establishing sound and efficient banking and payments systems.

Uncertainties, Macroeconomic Instability, and Collusion

Transition in the Baltics, Russia, and other countries of the former Soviet Union has been characterized by an unpredictable economic environment. Uncertainties have prevailed in relative prices, in macroeconomic policies, and in the availability of supplies of inputs and markets for output because of disruption in traditional interstate trade and financial linkages. In such circumstances, enterprises have had extreme difficulties evaluating credit risks of different buyers and may have found it optimal to seek buyers indiscriminately but at a price adjusted upward to take account of higher credit risk.23 A consequence of such behavior has been the accumulation of arrears, as a high proportion of credits have proved to be of bad quality.

Dramatic changes in relative prices following price liberalization, particularly with regard to energy products, has severely affected the profitability of enterprises—particularly those intensive in energy use. Thus, the asset quality of receivables from such enterprises has suffered heavily in the process and has contributed to the arrears problem.24

The failure to address large macroeconomic imbalances and associated balance of payments problems has also had implications for the accumulation of arrears in Russia and some of the other countries of the former Soviet Union. After the dissolution of the U.S.S.R., the volumes of interstate interenterprise trade—historically high in energy, raw materials, and intermediate products—remained substantial. Aside from the same factors influencing domestic interenterprise arrears, shortages of foreign exchange or the escalating domestic costs of imports because of rapidly depreciating currencies, or both, are likely to have contributed to the rise in interstate arrears.

The government’s determination in pursuing stabilization policies is often tested by enterprises in transition economies by collusive behavior. Such behavior, often only “implicit” and without a well-coordinated scheme, may arise from the enterprises’ rational beliefs about each other’s likely response to policies in light of management’s and workers’ entrenched interests.25 Frequently, the initial attempt at stabilization started off with the authorities trying to control inflation by curbing the supply of credit from the central banks. One of the aims of such a tight monetary policy was to promote financial discipline among enterprises, induce them to restructure, and encourage them to substitute internal finance for bank credit. In response to a tightening in financial policies, enterprises—anticipating the likely response of other enterprises—may have delayed any adjustments in their behavior, guessing that if every enterprise built up arrears, the government would be unwilling to risk the consequences of a systemic collapse and would be forced to ease policies. In other words, the government’s policy stance was not seen to be credible, and enterprises stopped paying each other, knowing that a general bailout was inevitable down the road.26

Developments in Russia during the first half of 1992 are a case in point: the uncertainties regarding the future policy stance—including the tenure of the central bank governor—are likely to have contributed significantly to the expectation of a bailout, a rapid buildup of arrears, replacement of the central bank’s management, and, indeed, an eventual bailout in the latter part of the year.27 Similarly, the rise in arrears that accompanied the tightening of monetary policy in Russia during the first quarter of 1994 may indeed partly reflect collusive behavior by some selected and big enterprises. The arrears were concentrated in the energy, ferrous metallurgy, chemicals, machinery, and construction sectors, which are dominated by large state-owned enterprises from the Soviet era. The enterprises involved are typically those that are commonly perceived to be “too big to fail,” and it is likely that expectations—or at least hopes—of an eventual bailout by the government encouraged the accumulation of arrears.28 The lack of credibility in the authorities’ tight policy stance was likely reinforced by the earlier bailout in 1992, and also the departure of key reform-minded ministers from the government in early 1994.

Any demonstration of the lack of steadfastness of government policies—in the form of a temporary loosening of monetary policy, a selective doling out of subsidies to state enterprises, or netting out of gross interenterprise arrears, and clearing the remaining claims by central bank credit—only adds to the arrears problem in the long run (see below). Thus, the determined pursuit of stabilization policies by Latvia and Lithuania resulted in a rapid deceleration of inflation, a stable macroeconomic framework, and containment of the arrears problem. On the other hand, the stop-go nature of policies in a number of countries, and the bailout of enterprises through multilateral clearing of interenterprise arrears, seems only to have led to a quick re-emergence of arrears and contributed to the persistence of the protracted problem of high inflation and macro-economic instability.

It should be noted that the sharp rise in the ratio of arrears to broad money in some of the countries of the region has strengthened the appeal of the “excessive credit contraction hypothesis”—a hypothesis that has its root in the simultaneous drastic falls in real credit and output in those countries.29 But as already discussed above, the substitution of bank lending by interenterprise arrears reflects imperfections in the credit market and structural inadequacies. Any decrease in arrears brought about by a one-shot increase in credit is likely to be transient at best, with the gain quickly dissipated through a fast transmission of higher credits into even higher prices.30

Structural Inadequacies

In the Baltics, Russia, and other countries of the former Soviet Union, like in other transition countries, the transformation toward market-based systems began without the laws and institutions necessary to support the functioning of markets. Accurate and meaningful financial statements, clearly defined property rights, and a legal system with full powers of enforcing contracts are necessary for the proper functioning of the loan market and limiting loan delinquencies. In a functioning market economy, failure to service a loan obligation on time affects future access to credit, and ultimately involves the threat of bankruptcy. Enterprises do not incur arrears when the costs of incurring them are high,31 and the legal and institutional framework is crucial for determining these costs. Of course, structural reforms need to be reinforced by a clear “no bailout policy,” as any bailouts strengthen the expectation of yet another bailout in the future.

In the event, in most of the region, accounting laws were inappropriate for a market economy, and enterprises did not have accurate and meaningful balance sheets or profit-and-loss statements. Property rights were not clearly defined and there was no bankruptcy law with the power to fully enforce contracts. The emerging private sector was dominated by an overwhelmingly large state-owned sector where corporate governance left much to be desired. The dismantling of planning along with the weakening of central controls led to the transformation of state-owned enterprises and banks into organizations controlled by insiders (managers and workers), particularly prior to privatization. In such circumstances, extremely weak balance sheet positions encouraged risk taking by enterprise managers and actions were taken to protect short-term output and employment at all costs.

The interaction between inadequate bankruptcy laws and weak balance sheet positions of enterprises led to “creditor passivity” and contributed to the perpetuation of the interenterprise arrears problem.32 First, creditors may not have initiated bankruptcy proceedings because the costs of enforcing bankruptcy exceeded the expected value of the debtor’s assets, or because of the option value of waiting. Second, initiating action against the debtor enterprise may have signaled the existence of financial problems in the creditor enterprise itself, and hence undermined the confidence of the creditor’s creditors. Third, with multiple creditors, the incentive for individual creditors to wait for others to initiate proceedings may have been acute, particularly when the net worth of the debtor was in doubt.

Thus, together with better bankruptcy laws, restructuring—including recapitalization—and privatization of the state-owned banks and enterprises are crucial for establishing a framework of adequate incentives and efficient operation of economic activity in these transition economies. Indeed, the evolution of interenterprise arrears in the Baltics, Russia, and other countries of the former Soviet Union clearly demonstrate the importance of structural reform for containing arrears. Latvia and Lithuania, which have made significant progress in the structural front, have also been successful in managing the arrears problem.

Policy Options

Interenterprise arrears can only be contained on a sustained basis by ensuring that enterprises adjust to the emerging market system and observe financial discipline. A stable macroeconomic framework and a structure of appropriate incentives are essential in this regard and can be achieved only by the steadfast pursuit of strong stabilization policies and accelerated structural reform, including financial and enterprise sector restructuring. Such policies provide the best antidote to the arrears problem over the medium term.

Some transition countries, such as the former Czechoslovakia, Poland, and the Baltic states of Latvia and Lithuania have followed a hands-off policy toward interenterprise arrears. They have left the resolution of the problem to the market; so far the approach is successful. On the other hand, the gridlock created by interenterprise arrears sometimes poses a serious threat—or a perception thereof—of an imminent collapse of the payments system, and hence production, in the process of transition. Thus, countries in the region have taken exceptional measures—some more than once—to deal with interenterprise arrears.

Romania took exceptional measures on several occasions in 1991–92 to deal with interenterprise arrears.33 The measures included government-sponsored netting out exercises, the extension of central credits and government transfers and, on one occasion, a scheme under which banks were required to extend credit to enterprises, under government guarantees, for the sole purpose of clearing arrears.34 The creation of additional liquidity as a result of these operations was clearly inflationary; while there was a temporary reprieve to the arrears problem, ultimately the government moved to enact a stringent bankruptcy law and launch a public campaign to combat the moral hazard problem inherent in the implementation of such schemes and convince enterprises that no further bailout was likely.

The experience with exceptional policy measures to deal with interenterprise arrears indicates the need for extreme caution in applying such measures in the Baltics, Russia, and other countries of the former Soviet Union. Thus, in designing any such measures to address the “stock” problem of existing arrears, it is critical to ensure that the measures include steps to avoid the emergence of new arrears (i.e., the “flow” problem), and also are governed by the following two key considerations. First, the creation of a market environment where enterprises must accept responsibility for their own indebtedness and must behave in a financially responsible way or face the consequences. Second, at a time when the governments are facing the urgent and difficult task of reducing inflation, the measures must avoid additional credit creation that could lead to new inflationary pressures.

The Stock Problem

The resolution of the stock problem should be achieved by encouraging debtors to reschedule their overdue payables through voluntary bilateral contacts with creditors. In addition, enterprises should be encouraged to securitize their interenterprise claims to make them tradable: an enterprise in need of liquidity could sell an interenterprise claim at a discount to another firm; the buyer could then either hold the claim or set it off against its own liabilities to the original debtor firm (on whom it now owns a claim), if such liabilities exist. Banks could also become involved in this activity, purchasing and selling securities subject to normal prudential regulations. The opportunity for profitable trade in interenterprise claims in a market environment should help resolve the problem of arrears. Development of requisite safeguards to prevent insider trading and other manipulative practices in the securities market should proceed in parallel with the securitization of claims.

In the short term, governments and central banks can promote a solution to the “stock” problem of existing interenterprise arrears by promoting decentralized bank-enterprise debt workouts with a menu of options, as well as a secondary market where arrears could be traded. Such an approach could lead to a netting out of interenterprise arrears without any extension of government or central bank credit, and send a strong signal to enterprises and banks that the authorities will no longer bail out firms with arrears or bad debts, thereby promoting the restructuring process through the adoption of hard budget constraints.35

The involvement of governments and central banks should be limited to providing an adequate regulatory and institutional framework, for example, regulations that appropriately govern trading in interenterprise credits. Rules allowing limited forms of multilateral netting, whereby a group of firms form an arrangement to net out debts within the group, should also be considered. In any event, market-based solutions are unlikely to work without some credible threat of bankruptcy for notorious delinquencies, and there should be no government guarantees for the securities.

Public concern over the arrears problem leads to pressure on governments to organize clearing schemes to net out gross arrears. Such explicit netting out exercises need not directly involve credit creation. However, an important argument against compulsory netting out operations—whether or not they involve the creation of additional bank credit—is that the expectation of even these operations creates perverse incentives. Firms will be more willing, on the one hand, to withhold payment for their inputs and, on the other, to ship their output to customers they strongly suspect will not pay—calculating that these arrears will cancel out in the next netting out operation. Moreover, there is always a strong risk, particularly because of uncertainties regarding the valuation of claims, that the government’s involvement creates expectations of a bailout of the net claims remaining after the implementation of a clearing scheme. Furthermore, such netting out exercises take time to complete and create considerable uncertainty for macroeconomic management. These considerations argue strongly against a government-sponsored netting out exercise.

Preventing New Arrears

Apart from measures to improve the payments system, so as to shorten the period of uncertainty about the creditworthiness of the payer, policies to prevent new arrears should focus on convincing enterprises that they must accept responsibility for collecting their own claims on other enterprises, and that they should not expect government intervention of any sort. In addition to avoiding any bailout component in the measures designed to deal with the stock of existing arrears, a few other specific steps could be helpful.

First, bankruptcy criteria and judicial procedures should be streamlined with a view to providing not only for the closing of insolvent enterprises, but also for their reorganization in an attempt to avoid future liquidation and closing. Creditors should be empowered to sell their debtors’ assets if debts are overdue for more than a certain period of time. Any judicial protection debtors receive to delay such asset sales should be accompanied by appropriate interest and penalty payments on the overdue claims.

It is unrealistic, however, to expect a bankruptcy system to emerge rapidly just with the enactment of the appropriate laws. Given the relative inexperience of judicial courts in bankruptcy cases and the limited availability of trained liquidators, and hence the uncertainty of the judicial awards, creditors tend to fight shy of becoming “pioneers” and incurring large startup costs in bankruptcy proceedings.36 Until bankruptcy procedures work smoothly and convince enterprises to alter their behavior and be financially responsible, governments must clearly demonstrate their willingness to allow enterprises to close. The government should identify a narrow set of enterprises responsible for a large proportion of the arrears. After monitoring these enterprises for a clearly defined period, the government should decide on their long-term viability. If they are deemed to be not viable, then bankruptcy proceedings should be initiated by the government. In exceptional circumstances, if bankruptcy is not a viable option for a particular enterprise because of strategic considerations, the flow problem should be dealt with by restructuring the enterprise and identifying budgetary support over the medium term. Furthermore, it is important to make the provision of budgetary support conditional on, inter alia, the clearance of existing arrears and their avoidance in the future.37

Second, to ensure that managers are accountable for all payments obligations of their enterprises (including taxes and wages), governments should impose financial and administrative penalties on managers of state enterprises, including termination of service, and should acquire the legal authority to place restrictions on the wage bill of state enterprises that have arrears in excess of agreed limits.38

Third, for customers with arrears in excess of agreed limits, state-owned enterprises should be required by law to ship products only on the basis of preshipment payment or on the basis of promissory notes of the receiver of goods and services, duly guaranteed by commercial banks.39

Fourth, central banks should impose prudential limits on the amount of guarantees that a bank can extend in relation to its total assets. Promissory notes issued by enterprises should never carry government or central bank guarantees.

Finally, the timely and regular monitoring of the underlying financial position of state enterprises as well as their arrears should be ensured. A standard definition of overdue claims should be introduced and firms should be required to observe well-documented and transparent reporting requirements on a periodic basis.

Interstate Arrears

Interstate interenterprise arrears among the Baltics, Russia, and other states of the former Soviet Union are an important problem, contributing significantly to interenterprise arrears in a number of sectors (particularly energy). With regard to these arrears, it is important to distinguish between quasi-governmental arrears incurred by state enterprises operating under intergovernmental trade agreements, and others. Much of the interstate interenterprise arrears pertaining to the energy sector are of the quasi-governmental variety, as in most cases trade in energy products was, and still is, carried out on the basis of intergovernmental agreements on trade volumes, prices and means of payments.40

Governments should take responsibility for interstate interenterprise arrears of the quasi-governmental variety. The existing stock of such arrears should be regularized through the negotiation of rescheduling agreements with a realistic mechanism for settlement. In working to prevent the emergence of new arrears of this type, governments should remove themselves from intergovernmental trading activities. In the process, they should make it clear that they will not undertake any future responsibility for payments related to this trade; in so doing, expectations of financial assistance to suppliers in the future will be avoided. Should the government feel compelled in the immediate future to remain involved in interstate trade to some degree, any payments obligations should be clearly defined at the outset and reflected in the budget. Moreover, all parallel trade features under intergovernmental agreements should be eliminated so as to make trade transactions and associated payments fully transparent. All this would also foster the development of a transparent and market-oriented trading environment within the region.

Enterprises with overdue claims on others across state boundaries, without any involvement of the government, should be left on their own to take responsibility for their decision to supply goods on credit. However, any resolution of the past stock of interstate interenterprise arrears of the purely nongovernmental variety is crucially dependent on debtor enterprises having full access to foreign exchange to settle their debts. Governments should ensure availability of foreign exchange for settlement of interstate interenterprise arrears.

The Energy Sector

It is clear that the energy sector (including electricity, oil, gas, coal, and peat) plays a critical role in the arrears situation in Russia and Turkmenistan. Most of Turkmenistan’s, and also Russia’s, exports of energy products to other states of the former Soviet Union are still carried out on the basis of intergovernmental or quasi-governmental agreements on trade volumes, prices, and means of payment. As noted above, intergovernmental trading activities should be eliminated as soon as possible. In the interim, they should be regarded as quasi-fiscal operations and be brought on budget, and the energy enterprises should be paid market prices on their supplies to other states of the former Soviet Union.

Conclusions

Interenterprise credit and arrears have increased in the Baltics, Russia, and other states of the former Soviet Union during the transition process. Such an increase is to be in part expected as a natural response to the transformation from central planning to a market-oriented economy. Furthermore, in a number of countries the levels of these credits and arrears appear modest by the standards of other east European countries during comparable periods of transition. In a number of countries, however, there were attempts to check the rapid increases in arrears by official netting out and clearing operations, although these had inflationary consequences and sustained the lack of financial discipline in the enterprise sector. Also, in some countries, these credits and arrears have been heavily concentrated in a limited number of sectors, raising concerns that governments will not succeed in imposing discipline because enterprises in those sectors will be perceived as “too important to fail.”

The experience of Latvia, Lithuania, and several east European countries clearly demonstrates the importance of moving toward an efficient financial and payments system, achieving macroeconomic stability, and furthering structural reform in promoting the ability and willingness of enterprises to honor their financial obligations on time. The accumulation of interenterprise arrears in a number of countries (e.g., Azerbaijan, Belarus, and Ukraine), on the other hand, is one of the many manifestations of slippages in stabilization and reform efforts during the transition process.

The experience with the exceptional measures taken in a number of countries clearly demonstrates the temporary nature of relief to the arrears problem provided by such measures. Netting out and bailout exercises merely address symptoms rather than underlying causes, and indeed perpetuate and compound the problem by strengthening expectations of future bailouts of debtor enterprises by the government. Instead, governments should maintain a hands-off policy and deal with arrears by promoting the financial health and discipline of enterprises through the maintenance of a stable macroeconomic environment, ensuring a sound banking system, and establishing the legal and institutional prerequisites of a market system through accelerated structural reform. Among the latter are bankruptcy procedures. It should be recognized, however, that improvements in these procedures are likely to add to financial discipline only gradually because of the need not only to pass the relevant legislation but also to develop courts and other institutions and to improve the benefit-cost ratio of enforcing bankruptcies. Thus, until bankruptcy procedures are working smoothly, governments—as the formal owners of state-owned enterprises—should take a highly visible role by identifying state enterprises that are major offenders of financial discipline through the accumulation of arrears, and initiating steps to restructure, privatize, or close them down.

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1

In the Baltics, Russia, and other countries of the former Soviet Union, the disruption of the interrepublican payment system in the immediate aftermath of the U.S.S.R. was a special factor that contributed to the initial buildup of arrears.

2

See the appendix of Section I for a discussion of data issues.

3

A detailed description of the payments system prior to mid-1992 is available in Bigman and Leite (1993).

4

In years of poor economic performance, the write-offs could be large enough to have a macroeconomic impact (as with the agricultural debt write-offs of 1986).

5

The initial transition period begins with the dissolution of the U.S.S.R. and ends just prior to Russia’s demonetization of pre-1993 Russian rubles.

6

It has not been abolished in Azerbaijan, Turkmenistan, and Uzbekistan. In July 1992, the Central Bank of Russia changed the regulations regarding File No. 2: in case of insufficient funds, payment demands in most cases were not to be queued anymore but returned to the originator. Thus, the coverage of the data that continued to be compiled under File No. 2, clearly changed from July 1992. Regulations regarding File No. 2 were changed again in October 1993. (After this paper was written, File No. 2 was abolished in Uzbekistan in mid-1995. Eds.)

7

In Russia, prior to the third quarter of 1993, data on interenterprise credit and arrears cover only the industrial and construction sectors. However, for the subsequent period, data indicate that total interenterprise credits are typically 10-20 percent higher than the corresponding figures for industry and construction only. The corresponding levels of interenterprise payables in mid-1993 were in the range of 4 percent to 23 percent of GDP in these three countries (Table 4.1).

9

As explained in the appendix to Section I, cross-country comparisons of interenterprise arrears are subject to the caveat that the definition of when a payment becomes overdue and hence when an interenterprise credit becomes an interenterprise arrear varies across countries.

11

The interenterprise payables of Russian enterprises on File No. 2 of banks amounted to Rub 3 trillion by the end of June 1992. See Fan and Schaffer (1994).

12

See Rostowski (1994), pp. 19-21.

13

For Belarus, separate data on overdues are not available, but one might presume that the rise in total payables was accompanied by a rise in arrears.

14

Provisional results showed that there was a reduction in gross arrears of around 38 billion Tenge, or 8 percent of GDP. Claims of net creditor enterprises were settled by a payment by the government of T 1.1 billion (mainly to the energy sector) and T 8 billion of one-year, U.S. dollar indexed treasury bills, bearing a 3 percent interest rate.

15

Kazakstan is a major producer of energy, like Russia and Turkmenistan. While no information is readily available on overdue interenterprise receivables in Kazakstan, a large part of it also appears to be concentrated in the energy sector.

17

For example, stocks and flows of trade credit, on average, are about twice the corresponding amounts of bank credit in the United States and the United Kingdom, see Crawford (1992).

18

An overview of the literature of trade credit is available in Crawford (1992).

19

According to enterprise surveys in Russia, part ownership of banks by enterprises made borrowing easier—more evidence of credit market imperfection. See Fan and Schaffer (1994).

20

For example, according to a survey of more than seven hundred firms in the United Kingdom, the maturity overrun on trade credit is about one month on the average. See Fan and Schaffer (1994).

22

Reportedly, a payment order could take as long as three months to be executed.

24

Residential and industrial customers were in arrears to utilities producing electricity and heating, which in turn were in arrears to the gas and petroleum companies. In energy-importing countries, these led to large overdue payables to foreign suppliers.

26

For example, according to an enterprise survey in July 1993 in Bulgaria, even when no clearing of interenterprise arrears was being actively debated, a fifth of the managers of state enterprises covered by the survey admitted that suppliers provide goods on credit to uncreditworthy enterprises in the expectation of a bailout. See Perotti (1994).

27

See Section VIII, pp. 119-20.

28

The prevalence of arrears may also differ between upstream and downstream industries. Producers and retailers of final goods may get paid in cash, but “pay” their suppliers with arrears, while producers of intermediate goods may “pay” and get “paid” with arrears. But it is unlikely that the upstream and downstream differences alone explain the sectoral concentration of arrears.

29

See Section II for a discussion of the general plausibility of this hypothesis. Also see Calvo and Coricelli (1994).

30

Containing of the inflationary impulse and establishing credibility through price and wage controls is not an appealing option because of the high level of initial distortions in relative prices and wages in transition economies.

31

For example, in a simple model, Calvo and Coricelli (1994) have shown that an enterprise will not incur arrears, if it reckons that arrears incurred this period increase into costs next period at a rate higher than the rate of interest that wage earners can earn on their deposits.

32

See Begg and Portes (1992) and Mitchell (1993) for a discussion of creditor passivity.

33

Albania and Bulgaria also took some exceptional measures involving public sector financing to address interenterprise arrears. In January 1993, the Albanian authorities adopted a decree to move enterprises from a system of automatic postshipment payments administered through banks to a system of preshipment payments, and also set aside funds to provide selective partial compensation to net creditor firms with good performance in the past six months. In Bulgaria, a debt write-off was organized in December 1992, mainly to enable the energy sector severely affected by the problem of unpaid bills to partially clear off its arrears to enterprises and banks.

35

The approach played a part in the restructuring of enterprise debt in Poland.

36

According to Rostowski (1993), p. 155, in Poland in mid-1991, that is, 18 months into the stabilization program, there were only six trained liquidators for the courts to hire. The slow startup in bankruptcies is illustrated by the experience of the Czech Republic, where according to Hrncir and Klacek (1995), the number of declared bankruptcies went from 5 in 1992 to 60 in 1993 and to 254 in 1994.

37

In Poland, more than 1,200 enterprises have been liquidated by the government because of their financial nonviability. In late 1992, the Government of Estonia initiated bankruptcy proceedings against two state enterprises because of tax arrears and insolvency.

38

In Hungary, for example, the 1991 law on bankruptcy made the failure on the part of managers to declare bankruptcy, when payments were overdue for more than 90 days, punishable according to the provisions of the Civil Code. See Hungary (1991), Section 9, p. 19.

39

In the former Yugoslavia in the 1980s, promissory notes with a maturity up to 90 days, which were the most important category of interenterprise credits, had to be guaranteed by a bank and backed by a physical transaction.

40

Some of these agreements call for parallel deliveries of goods, or essentially barter trade. This frequently complicates both the measurement of the arrears problem and the determination of who bears the ultimate responsibility for the arrears.

Note: Guzel Anulova, Anthony Pellechio, Volker Treichel, and Asegedech Woldemariam collaborated as coauthors in the production of this paper. The authors wish to thank Teresa M. TerMinassian, Milka Casanegra de Jantscher, and Howell Zee for their valuable comments.