This paper examines a few selected aspects of adjustment and restructuring in the Czech enterprise sector. It examines financial performance of the Czech enterprise sector, drawing on data reported by nonfinancial enterprises to the Czech Statistical Office (CSO) in 1993. The findings reveal that significant progress has been made in the nonfinancial aspects of adjustment, but a large part of the enterprise sector has been slow to adopt measures to achieve sustainable financial viability.

Abstract

This paper examines a few selected aspects of adjustment and restructuring in the Czech enterprise sector. It examines financial performance of the Czech enterprise sector, drawing on data reported by nonfinancial enterprises to the Czech Statistical Office (CSO) in 1993. The findings reveal that significant progress has been made in the nonfinancial aspects of adjustment, but a large part of the enterprise sector has been slow to adopt measures to achieve sustainable financial viability.

I. Adjustment in the Czech Enterprise Sector 1/

1. Introduction

The reform program launched by the former Czech and Slovak Federal Republic (CSFR) in January 1991 to establish a market economy drastically altered the economic environment in which enterprises operated. Almost at one stroke, the distortions in the price structure that prevailed under central planning were substantially reduced, and central directives ceased to be the basis for the allocation of resources. Under the reform program, virtually all prices at both the producer and retail levels were freed, subsidies were sharply cut back, and the foreign exchange and trade system was extensively liberalized in order to open the economy to international competition. The impact of these measures on the structure of domestic prices was further reinforced by the dismantling of the CMEA (Council for Mutual Economic Assistance) trade and price arrangements. The shift to pricing at world market prices and to settlement in convertible currencies worsened the former CSFR’s external terms of trade and led to a several-fold increase in the koruna prices of energy and industrial raw materials imported from CMEA members.

The changes in relative prices and the opening of the economy to international competition were accompanied by a number of other measures aimed at strengthening enterprise efficiency and financial discipline. Enterprises began to face harder budget constraints: budgetary subsidies were cut back; fiscal and monetary policies were designed to be restrictive; a fixed exchange rate regime was maintained; the Government declared its intention not to bail out enterprises and launched a program of rapid privatization; and extensive reform of the banking sector was initiated to improve financial intermediation and ensure that bank lending decisions were based on risk return criteria. However, because of the lead time needed to implement privatization and banking sector reform, their impact was not immediate. Until enterprises were eventually privatized and new owners assumed control, regular mechanisms of corporate control of state-owned enterprises in the Czech Republic were effectively absent. Moreover, initially, the incentives for banks to enforce debt contracts and initiate bankruptcies were weak. Although a number of measures were taken by the authorities to strengthen the balance sheets of banks, the banks were undercapitalized and lacked adequate loan-loss provisions and reserves.

The response of enterprises in the Czech Republic, as well as in other transition countries, to the course of reforms and the new market environment has been a subject of considerable interest. The decline in output following the introduction of reforms and the collapse of the CMEA trading system, and the trends in employment and wages are well documented. 2/ But, the picture on enterprise sector restructuring and financial performance is less clear. A common perception based on macroeconomic evidence--the slow turnaround in economic activity, low rate of unemployment, relatively small number of bankruptcies, and depressed investment activity--is that the pace of enterprise restructuring has been slow. However, the strides made in reorienting exports to western markets and the widespread division of large state-owned enterprises into independent units suggest that there have been considerable changes in product markets and internal organization. Such changes have also been noted in a number of individual case studies on the behavior of enterprises in different industries. The case studies also record information on financial performance, but it is difficult to say to what extent the findings are applicable for a particular branch of activity or the enterprise sector as whole. As Carlin et al. (1994) note, many of these studies suffer from inherent selection bias.

In this study, we examine financial performance of the Czech enterprise sector, drawing on data reported by nonfinancial enterprises to the Czech Statistical Office (CSO) in 1993. 1/ All enterprises with 25 or more employees were required to provide on a quarterly basis information on selected indicators of financial performance and selected items of assets and liabilities for the current quarter and for the same period of the previous year. The annual estimates for 1993 and 1992 were derived by aggregating the quarterly returns of enterprises that filed in all four quarters. It is estimated that the data cover about 95 percent of all enterprises with 25 or more workers. The data released by the CSO are grouped by branch of activity and show separately profitable and loss-making enterprises. An important strength of the data base is that information for a common set of firms is available for two years, thereby avoiding the problems that arise because of variable sample size and breakup of enterprises.

To put the analysis of the financial performance of the enterprise sector in perspective and to get a broader picture of restructuring, we also examine sectoral developments in output, the changing size distribution of enterprises, and evidence on the timely settlement of scheduled payments to creditors.

2. The structure of production

Following the introduction of reforms and the collapse of the CMEA, output suffered. The decline in economic activity was concentrated mostly in 1991. Thereafter, real GDP fluctuated around the low level reached in the last quarter of 1991 for the next two years, and began to rebound only in early 1994. After suffering a cumulative decline of about 20 percent during 1991-93, measured real GDP increased by 2.6 percent in 1994.

Rapid growth in services propped up the level of economic activity in 1992-93, while industrial output declined progressively and bottomed out only in late 1993. The growing importance of services and the declining share of industry in GDP--from 39 percent in 1990 to 33.5 percent in 1994--is an important part of the reallocation of resources that is expected during the transition to a market economy. However, there also have been changes in the structure of production in the industrial sector itself. Gross production declined in all branches of industry during 1991-93, but the fall has varied considerably across branches. The sharpest drops were experienced by the electrical equipment, machinery, and textiles branches, all of which recorded a cumulative decline of over 50 percent. At the other end of the scale, utilities, food products, and mining fell by 30 percent or less (Table 1.1 and Chart 1.1).

Table 1.1.

Industrial Production and Exports, 1991-94 1/

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Sources: Statistical Yearbook, various years; and data provided by the Czech Statistical Office.

In 1991, enterprises with 100 or more workers. From 1992 onward, enterprises with 25 or more workers. All changes are measured at constant prices.

Staff estimates derived from growth rates according to ISIC classification.

As reported by enterprises. A similar classification of exports as recorded in customs or balance of payments data is not available.

CHART 1.1
CHART 1.1

CZECH REPUBLIC: INDUSTRIAL PRODUCTION BY BRANCH OF ACTIVITY

(Cumulative percentage change)

Citation: IMF Staff Country Reports 1995, 085; 10.5089/9781451809992.002.A001

Sources: Czech Statistical Office; and staff estimates.

The output decline bottomed out in the course of the second half of 1993 in all branches of industry, except for food products and transport equipment. Following a pronounced fall in output in 1991, the food industry has continued to decline at a slow pace. In the transport equipment sector, the fall in output was arrested in mid-1992, but, after holding steady for about a year, output declined sharply in the second half of 1994. The output recovery has been strongest in paper and publishing, electrical equipment, and nonmetallic mineral products. In sectors where the recovery has been modest, average annual output showed a further small decline in 1994 because of carryover effects.

The degree of output decline in any sector depends on several factors: the impact of stabilization policies, the distortions in the price and cost structure that prevailed prior to the reforms, reliance on the CMEA market for inputs or for exports, and the speed of adjustment by enterprise managers. The pronounced decline in output in all sectors in the first year of transition reflects the dominant impact of economy-wide factors associated with the reforms and stabilization. Since then, with the pace of decline varying considerably across sectors, the other factors are likely to have become increasingly important.

However, the observed, sectoral pattern of output developments is not easily explained. In particular, sectoral developments do not follow closely the pattern of comparative advantage that has been estimated for Czech industry. Hughes and Hare (1992) calculated domestic resource costs (DRCs)--defined as the ratio of value added at domestic prices to value added at international prices--for different branches of Czech industry prior to price and trade liberalization. Domestic resource costs measure the level of protection offered to each industry and the degree of adjustment in domestic costs and prices necessary to face international competition. The higher the DRC or if it is negative, the less competitive a sector will be after price and trade liberalization, and we would expect output in these sectors to contract the most. Hughes and Hare noted that the entire food products industry had negative value added at world prices and was, therefore, the most vulnerable sector. The food products industry, however, has experienced one of the smallest declines in output, which may be partly explained by the fact that enterprises in this sector continued to receive inputs at below cost owing to excess supply in agriculture. With excess supply in agriculture largely eliminated by mid-1994 and prices beginning to cover costs, a substantial adjustment in output in the food products industry may be expected in the coming years. On the other hand, output decline in the machinery and transport equipment sectors was higher than would be predicted on the basis of estimated DRCs. For both sectors, estimated DRCs were below that for industry as a whole and close to unity; yet, output contracted by more than average industrial production. Two cases in which the output declines and estimated comparative advantages are in line are the electrical equipment and textiles industries; both sectors had DRCs among the highest, and they figured among those with the greatest loss in output.

The lack of a significant relationship between domestic resource costs and cumulative change in output is also confirmed by a regression exercise in which sectors were ranked according to their DRCs and cumulative change in output during 1991-93. Equations were estimated for two alternative groupings of manufacturing industry. In one specification, the International Standard Industry Classification (ISIC) at the three-digit level used by Hughes and Hare was followed, except that food product industries were combined into one group; thus, there were 24 branches in all. In the second specification, manufacturing industry was grouped into 11 branches according to the statistical classification of economic activities in the European Community (NACE). 1/ Neither of the two regression equations was statistically significant. 2/

The loss of external markets was an important factor behind the output decline in the electrical equipment, machinery, and transport equipment sectors. Exports of these three sectors declined steeply in 1991-92 and again in 1994 in the transport equipment sector. The subsequent output recovery in the electrical equipment sector also owed much to the discovery of new export markets. In contrast, the textiles sector, which also is among the more export-oriented industries, suffered only a mild decline in exports; the sharp drop in output in this sector can thus be attributed to competition from imports and the contraction in domestic demand. In the basic metals sector, too, the decline in output reflects a fall in domestic (investment) demand, as exports have increased considerably every year (see Table 1.1). 1/

Enterprise-level factors also are likely to have had an important effect on output performance. This is suggested by the fact that many firms were expanding production at a time when, in the aggregate, output was declining in all sectors, and that a large number of enterprises continued to experience drops in output in 1994, when most sectors were on the recovery path. Forty percent of industrial enterprises reported declining output in 1994, compared with 50 percent in 1993.

3. Size distribution of industrial enterprises

Since the introduction of reforms, there has been an enormous change in the size distribution of enterprises in industry. Under central planning, large enterprises were the norm and there was a considerable amount of horizontal and vertical integration. With the elimination of central planning, enterprises began to break up into smaller independent units. In the beginning, the breakups were initiated by plant managers, motivated by the expectation of engaging in management or employee buy-out when the privatization program began. Subsequently, the privatization program itself offered ample opportunity for the breakup of enterprises. Privatization proposals solicited by the Government from enterprise managers and outside parties in a large number of cases proposed splitting up the enterprises and independently privatizing the separate parts. Proposals for organizational restructuring as part of privatization mostly came from managers of financially stronger plants that were well-suited for survival in competitive markets, and such proposals were generally approved (Charap and Zemplinerova (1993)).

In 1990, before the introduction of reforms, enterprises employing less than 100 workers were rare (and were not enumerated for statistical purposes), and slightly more than one third of the enumerated industrial enterprises had more than 1,000 employees. With the proliferation of smaller-sized firms, from 1992 the threshold for enumerating enterprises was lowered to 25 employees. Reflecting the growing number of small firms, the proportion of industrial enterprises with more than 1,000 employees has fallen progressively to only 6 percent in 1994 (Table 1.2).

Table 1.2.

Distribution of Industrial Enterprises by Size, 1990-94

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Source: Statistical Year Book, various years, and Statistické Přehledy.

The breakup of large enterprises has taken place in all branches of industry, indicating that multiplant operations and vertical integration were widely prevalent. Large enterprises, however, continue to exist in sectors where economies of scale arising from indivisibilities are important. In general, such enterprises tend to be capital intensive. This pattern is borne out in the Czech Republic. 1/

4. Profitability of enterprises

The profit position of enterprises deteriorated in 1993. The proportion of enterprises which reported making profits fell to 57 percent, from 67 percent in 1992. The shift in profit-making status was not all in one direction. While 18 percent of all enterprises moved from profitability in 1992 to loss-making in 1993, about 8 percent of enterprises ceased to make losses and reported profits. The sharpest decline in the proportion of profit-making enterprises occurred in the hotels and restaurants sector (35 percentage points), followed by a second group comprising transport equipment, paper and publishing, wood, and nonmetallic mineral product sectors and trade, all of which recorded net declines of 15 to 20 percentage points (Table 1.3). The experience of the hotels and restaurants sector and trade may appear surprising, given the growing attractiveness of the Czech Republic as a tourist destination. However, the results are consistent with the fall in 1993 of total sales (in real terms) in retail trade and public catering. Also, it is likely that the enterprises enumerated by the CSO were losing business to the smaller-sized unenumerated enterprises. Indeed, in the course of 1993, it was becoming increasingly apparent to the banks that they had overestimated profitability in trade and in the hotels and restaurants sector, and they scaled back credit to both sectors in the fourth quarter. 1/

Table 1.3.

Enterprise Sector Profitability, 1992-93

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Source: Data provided by the Czech Statistical Office.

Profits in percent of value of current production.

Owing primarily to the fall in the proportion of enterprises making profits, the profit rate for the enterprise sector as a whole fell to 4 percent in 1993, from 8 percent in 1992. 2/ However, the profit-making group also recorded lower profits in 1993, despite the fact that many of them had graduated to profitability from loss making in the previous year, implying that the financial position of enterprises which recorded profits in both 1992 and 1993 had deteriorated. This phenomenon was noticeable among profit-making enterprises in virtually all sectors.

Changes in the profit position can arise from changes in operating revenue and expenses, provision for depreciation, and in the nonoperating account. In the case of profitable firms, the weakening of the profit position essentially reflected a narrowing of gross operating surplus, whereas for loss-making firms, all three sources were important. These aspects are discussed in detail below (Table 1.4).

Table 1.4.

Financial Position of Enterprises, 1992-93

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Source: Data provided by the Czech Statistical Office.

a. Materials and energy costs

For the enterprise sector as a whole, the ratio of materials and energy costs to the value of current production rose, from 64.5 percent in 1992 to 66.5 percent in 1993. In the aggregate, both profit-making and loss-making enterprises reported increases, though the extent of the increase was higher for loss-making firms. There were, however, notable exceptions to the overall trend. Profit-making enterprises in most branches of manufacturing industry reported a decrease in the materials and energy costs ratio. This was also the case for loss-making enterprises in agriculture, leather industry, and the transport and communication sector.

The considerable improvement in efficiency in the use of intermediate inputs in agriculture is particularly striking, since this occurred despite a marked deterioration in the internal terms of trade in 1993. Whereas agricultural producer prices rose by about 8 1/2 percent, the increase in the index of agriculture input prices was about 27 percent. The increase in materials and energy costs observed in a large part of the nonagricultural sector cannot be attributed to the worsening of relative prices but rather reflects worsening efficiency. Increase in energy prices was not a significant factor. Crude oil and natural gas prices declined in 1993, and the increase in domestic tariffs of electricity and gas for the enterprise sector was about 5 percent, which was below the increase in the producer prices indices for virtually all branches of the manufacturing industry and the GDP deflator. In some industries, such as textiles and manufacture of rubber products, raw materials prices declined. Despite this, materials and energy costs rose for loss-making enterprises in these two sectors.

b. Labor costs

Labor costs (basic wages plus payroll taxes and social insurance contributions) also increased in 1993, relative to both value of current production and value added. The increase occurred in all sectors of the economy, with the exception of agriculture and transport and communication, among both profit-making and loss-making enterprises. However, the increase was larger for the latter group. The increase in labor costs was primarily due to an increase in wage costs, as employer-paid taxes on wages were significantly reduced in 1993--from 50 percent of wages to 36 percent-following the introduction of direct employee contributions for social security.

It is useful to breakdown developments in wage costs in terms of changes in employment and average wages, since the changes in these two components were in opposite directions. Employment declined in all sectors of the economy in 1993, except for construction and hotels and restaurants. For the enterprise sector as a whole, employment fell by about 7 percent. Significantly, in every sector, loss-making firms shed more labor than profit-making firms or increased employment by less. However, at the intersectoral level, there was no significant relationship between change in employment and profitability. Generally, we would expect labor intensive sectors to lead the way in labor shedding, but there was no evidence of this in the Czech enterprise sector.

The favorable impact of lower employment was more than offset by sharply higher average wages. Average nominal wages in the enterprise sector increased by 24 percent in 1993, compared with increases of 21 percent and 16 percent, respectively, in consumer prices and the GDP deflator. Wages moved briskly in both profit-making and loss-making firms. For the enterprise sector as a whole, growth of average nominal wages in these two groups were about the same. In a number of sectors, wage growth in loss-making enterprises was higher than in profit-making firms: these include agriculture, nonmetallic mineral products, electrical equipment, transport equipment, and utilities. At the intersectoral level, there was no significant relationship between wage growth--of both nominal wages and real product wages--and profitability.

c. Depreciation

The experience of profit-making firms with regard to depreciation differed from that of loss-making firms. Among the profit-making group, depreciation as a ratio of gross fixed assets fell slightly in 1993 in a large number of sectors and in the aggregate. In contrast, depreciation increased among loss-making enterprises in virtually all sectors. This pattern reflects a younger vintage of capital for loss-making firms, 1/ which put them in a better position to take advantage of a new law introduced in 1993 permitting enterprises to calculate depreciation on an accelerated schedule. To the extent higher losses arise from increased deductions for depreciation, they do not reflect lack of adjustment.

d. Interest costs

The burden of interest costs of enterprises rose in 1993, in part due to a 1 percentage point increase in the average lending rate of banks. Relative to the value of current production, the increase in the interest costs was higher for loss-making enterprises. On average, the interest burden of loss-making firms in 1993 was twice as large as that of profit-making firms, mainly reflecting a higher level of indebtedness and, possibly, higher rates of interest.

For both the profit-making and loss-making groups, the interest payment burden of a sector was positively associated with liabilities (as a ratio to net worth) and negatively associated with the ratio of net worth to total assets. In regression equations for these two alternative specifications, the size of the coefficient of the explanatory variable was larger in absolute terms for the loss-making group (Table 1.5). This tends to suggest, not surprisingly because of higher risk, that loss-making enterprises are charged higher rates of interest by creditors.

Table 1.5.

Regression Analysis of Interest Payments 1/

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Source: Data provided by the Czech Statistical Office.

Figures in parentheses are t-ratios.

Significant at the 1 percent level.

Significant at the 5 percent level.

e. Other developments in the nonoperating account

The balance in the nonoperating account, excluding interest costs, deteriorated for loss-making enterprises to a deficit of 3 percent of value of current production in 1993, from a slight surplus in the previous year. In contrast, the deficit for profit-making enterprises narrowed from 2 1/4 percent of value of current production in 1992 to about 1 percent in 1993. The widening of the nonoperating deficit of loss-making enterprises can be attributed to new policy initiatives introduced in 1993 in the form of tax credits for investment and provisions for dubious claims abroad, and to losses from sales of fixed assets. Direct evidence on these components is not available, though information exists on the amount of fixed assets sold and is discussed below.

5. Decapitalization and investment behavior

Sales of fixed assets are to be expected as enterprises restructure and adapt to a market economy. Enterprises that are in the process of downsizing and those that are upgrading their capital to take advantage of new technology are likely to dispose of old capital equipment. However, when corporate governance is weak, decapitalization can be a means for financing higher labor and input costs and for delaying adjustment. Evidence suggests that this latter phenomenon may have been at work to some extent in the Czech enterprise sector.

The sales of fixed assets by profit-making firms in 1993 were the equivalent of 1 1/2 percent of value of current production, an increase of 1/2 percentage point over the previous year. In contrast, sales of fixed assets by loss-making firms as ratio to value of current production increased from about 2 1/2 percent in 1992 to 4 1/2 percent in 1993. In both 1992 and 1993, sectors with higher wage costs tended to have higher sales of fixed assets. Regression equations were estimated in which the levels of sales of fixed assets in 1992 and 1993 were related to the levels of wage costs (both variables appropriately scaled), separately for profit-making firms, loss-making firms, and all firms. For all three groups, the coefficient on wage costs was positive and statistically significant in both years. The size of the coefficient was larger in 1993 than in 1992, indicating that enterprises had become more prone to sales of fixed assets (Table 1.6). Regression analysis also shows that among loss-making firms, sectors with greater increases in wage costs also had higher increases in sales of fixed assets.

Table 1.6.

Regression Analysis of Sales of Fixed Assets by Enterprises 1/

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Source: Data provided by the Czech Statistical Office.

Figures in parenthesis are t-ratios.

Significant at the 1 percent level.

Significant at the 5 percent level.

Significant at the 10 percent level.

Another indicator of decapitalization, suggested by Pinto et al. (1993) and Pinto and van Wijnbergen (1994), compares investment and depreciation. However, they argue that decapitalization does not necessarily signify deliberate squandering of assets. Rather, if profitable firms are found to invest more relative to depreciation, then decapitalization should be seen as a part of normal adjustment during the transition period.

By Pinto et al.’s measure, decapitalization has been widely prevalent in the Czech enterprise sector among both profit-making and loss-making enterprises. The most severe cases were agriculture, mining, textiles, leather, machinery, and electrical equipment sectors: the ratio of investment (defined as purchases minus sales of fixed assets) to depreciation in these sectors in 1993 was 50 percent or less. In both 1992 and 1993, in virtually all sectors and branches of the economy, profit-making enterprises invested more, relative to depreciation, than loss-making enterprises. The differential in the investment ratios of the two groups widened in 1993, as profit-making firms increased investment or cut it back to a smaller extent than loss-making firms. This aspect is also reflected in the results of a simple investment function estimated for 1992 and 1993. For all firms considered together and for profit-making firms, investment (scaled by depreciation) was a positive function of the profit rate in both 1992 and 1993, but the coefficient of the explanatory variable was larger in the equation for 1993 (Table 1.7). A similar result holds in an alternative specification in which the gross operating balance (as a ratio to current production) is entered as an explanatory variable. For loss-making firms, there was no significant relationship in either year between gross operating balance or loss rate and investment.

Table 1.7.

Regression Analysis of Investment Behavior of Enterprises 1/

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The figures in parenthesis are t-ratios. Results for loss-making firms are not reported, as none of the regressions was statistically significant.

Significant at the 1 percent level.

Significant at the 5 percent level.

Significant at the 10 percent level.

6. Financial arrears of enterprises and corporate governance

An important gauge of the financial strength of enterprises is their ability to service debt and make payments to suppliers on a timely basis. The problem of overdue payments on bank credit to enterprises has become acute. A number of measures were taken by the Government during 1991-92 to reduce the burden of bad debts of the banking system inherited from the days of central planning. 1/ Nevertheless, a considerable amount of new bad loans has since emerged. At the end of 1992, about 19 percent of outstanding bank loans to enterprises were classified as nonperforming, but the share had jumped to 38 percent by the end of 1994. Although much of the increase is due to the adoption of tighter classification criteria in 1994, the level is quite high. Nearly one half of the nonperforming loans were in the “loss-making” category, implying that payment was overdue by more than 360 days.

The bulk of the nonperforming loans at end-1994 was in manufacturing industry and trade; each sector accounted for about one third of the total. This reflects the dominance of these two sectors in economic activity and the distribution of total bank credit. The incidence of nonperforming loans in manufacturing was about the same as that for the economy as a whole, but in trade it was among the highest recorded--54 percent (Table 1.8). In general, sectors and branches of activity that were less profitable had a higher incidence of nonperforming loans. The negative relationship between loan quality and profitability is apparent in all years since the recording of asset quality started and has strengthened over time. Regressions of proportion of loans classified as nonperforming on sectoral profit rates were run separately for 1992, 1993 and 1994. The coefficient of the independent variable is negative and statistically significant in all three years, and becomes progressively larger in absolute size (Table 1.9). Regressions were also estimated to examine if the deterioration in the portfolio quality of banks in any particular year could be linked to the worsening financial situation of enterprises, over and above the influence of improvements in reporting. The results show that in 1993 the less profitable sectors experienced a greater increase in the share of loans classified as nonperforming, but that in 1994, there was no significant relationship between deterioration in portfolio quality and profitability. This confirms that the strengthening of reporting requirements affected the classification of nonperforming loans in all sectors.

Table 1.8.

Incidence of Nonperforming Loans by Branch of Activity, 1992-94

(In percent; end-of-period)

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Source: Data provided by the Czech National Bank.
Table 1.9.

Regression Analysis of Nonperforming Bank Loans to Enterprises 1/

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Figures in parentheses are t-ratios.

Significant at the 1 percent level.

Significant at the 5 percent level.

Significant at the 10 percent level.

An additional source of information on timely settlement of obligations is the monthly surveys of business opinions. However, no data are collected in these surveys on amounts overdue. The survey data indicate that delays in settlement of scheduled payments are widely prevalent in industry and retail trade (Table 1.10). The problem of overdue payments is particularly severe in the textiles, basic metals, machinery and equipment, and other transport equipment (that is, excluding motor vehicles and trailers) sectors. At the end of 1994, nearly three fourths or more of the enterprises in these sectors were behind in making scheduled payments. Overall, however, the incidence of delays appears to be declining with a smaller proportion of firms reporting delays in both 1993 and 1994.

Table 1.10.

Percent of Enterprises in Each Branch of Activity Reporting Delays in Making Scheduled Payments, 1992-94 1/

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Source: Data provided by the Czech Statistical Office.

As reported in the monthly surveys of business opinions. These surveys include about 750 industrial enterprises (representing about 60 percent of total output in industry), 320 construction enterprises (representing nearly one half of total construction output in enterprises with 25 or more workers), and 280 enterprises in retail trade (representing about one fourth of retail turnover among enterprises with 25 or more workers). The surveys include enterprises in all size groups.

This is also confirmed by quarterly data on the enterprise sector published by the CSO, which show that, at the end of 1994, about 19 percent of the enterprise sector’s liabilities to nonbanks was overdue, compared with about 21 percent at the beginning of the year. There are no official data on interenterprise debt for 1992-93, but Čapek (1994) estimates that in 1992 about one third of interenterprise credit was in arrears.

Despite the widespread failure of enterprise debtors to make scheduled payments, there has been little effort by creditors to enforce debt contracts, thereby relieving the pressure on enterprises to adjust. The legal framework for enforcing financial discipline on enterprises was put in place in April 1993 with the passage of the amended bankruptcy law. Since then, only about 500 bankruptcies have taken place through the end of 1994; most of these cases were small companies and small entrepreneurs.

Creditor passivity in interenterprise credit can arise due to several reasons: the creditor enterprise fears that it will be caught in a chain of bankruptcy proceedings because it also has overdue liabilities and its underlying financial position is not sound; the debtor enterprises happen to be the creditor enterprise’s major clients whom it is reluctant to lose; or the cost of initiating bankruptcy is greater than the amount the enterprise expects to recover. 1/ Banks, too, have not been eager to initiate bankruptcy proceedings because of insufficient loan-loss provisioning for the bad loans in their portfolios. 1/ Creditor passivity of banks is also often attributed to the cross-ownership of banks and Investment Privatization Funds which have major stakes in the delinquent enterprises. Yet another reason has been noted by Túma (1994): in some instances, where an enterprise is large and its closure would lead to an intolerable level of regional unemployment or wipe out the windfall wealth of a large interest group, the Government has been reluctant to see bankruptcy proceedings being initiated by the major creditors and has come to the rescue of the enterprise. However, measures in this regard have not involved any direct transfers from the Government. Measures have typically been in the form of credit guarantees by the National Property Fund, participation in debt-equity swaps by the Consolidation Bank, and other forms of financial and restructuring arrangements with the major creditors.

7. Conclusions

The transformation of the enterprise sector is an essential element of the transition from a centrally planned economy to a market economy. Enterprise restructuring has many dimensions and has to be undertaken at both the firm level and the sectoral level. This paper has sought to examine a few selected aspects of adjustment and restructuring in the Czech enterprise sector. The overall picture that emerges is that significant progress has been made in the nonfinancial aspects of adjustment, but that a large part of the enterprise sector has been slow to adopt measures to achieve sustainable financial viability.

By the end of 1993, the decline of economic activity that followed the introduction of reforms and the collapse of the CMEA trade regime had come to an end virtually all across the economy. The data did not reveal that resources had moved toward sectors with relatively low domestic resource costs, as a simple version of comparative advantage theory might predict and as had been expected in the initial stages of the transition process. The rebound in activity did not involve all firms. Within each sector, a sizeable proportion of enterprises continued to scale back production in their struggle to survive in the new market environment.

In the aggregate, there was no improvement in the financial position of enterprises during 1992-93. While many enterprises made strides in increased efficiency in materials and energy use, there was little adjustment in this regard for a large part of the enterprise sector. Little was achieved also by way of restraining labor costs. Enterprises shed labor, and this occurred to a larger extent in loss-making firms, but large wage awards more than offset the gains from lower employment. Evidence suggests that financially weak enterprises partly financed the wage increases through decapitalization, in the form of both sales of fixed assets and investing less than depreciation. Weak financial performance also resulted in difficulties in servicing bank debt.

In a market economy, banks are expected to impose financial discipline on enterprises and put pressure to adjust. However, saddled with bad loans in their books and inadequate loan-loss provisions, Czech banks have not exercised their enterprise governance role in any significant way. The passivity with regard to adjustment on the part of enterprises, especially those included in the voucher privatization scheme, is not surprising since regular mechanisms of corporate control and governance were effectively absent in 1993. Enterprise managers were awaiting the completion of privatization and the arrival of new owners, with the distribution of shares of the first round of voucher privatization completed only in May 1993 and the second round completed in February 1995. When data become available for 1994-95, a similar analysis will show whether restructuring accelerated following the completion of the privatization process.

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1/

Prepared by Biswajit Banerjee.

1/

Data for 1994 are still being processed by the CSO.

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The DRCs for the NACE classification were calculated as weighted averages of the disaggregated estimates derived by Hughes and Hare. The leather goods sector and manufacturing, n.e.c. were excluded because their average DRCs could not be calculated on the basis of available information.

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The results are not affected if the reference period for the cumulative change in output includes 1994. Neven (1995) also found no significant correlation between DRCs and changes in production during 1988/89-1991/92, in an exercise based on sectoral groupings according to the three-digit ISIC level. However, when sectors were grouped into six broad categories, Neven obtained statistically significant rank correlations. On this basis, he concludes that DRC should be taken as a broad estimator of competitiveness and that not too much attention should be paid to the precise values of these calculations. Borensztein et al. (1992), too, found no significant relationship between DRCs and output change, though in this case the output change was for only the first year of the reform program. They note that the lack of a significant relationship might be a reflection of the weaknesses of DRC estimates, which are based on a large number of judgmental assumptions. DRCs are based on the assumption of a fixed coefficient technology and do not consider the possibility of different elasticities of substitution across sectors. Problems also arise from the existence of nontraded goods, substantial quality differences, and peculiar exchange rate arrangements in the CMEA area. Further, Glyn (1994) has argued that value added at domestic prices during the pre-reform period--an important input in the calculation of DRCs--may not be an adequate measure of domestic resources absorbed.

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The analysis here is based on export data provided by enterprises and not on exports as recorded in customs or balance of payments data, which follow a classification scheme different from that for industrial output. Export growth rates based on enterprise data may be biased if changes occur in the share that is exported directly by the enterprise rather than through a trading organization.

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A regression of the share of enterprises with 1,000 or more workers in total number of enterprises in 1993 (SHRLARGE) on fixed assets per worker in 1993 (KLRATIO) yields the following estimates (t-ratio in parentheses):

SHRLARGE=6.4414+0.0084(2.44)KLRATIOR2=0.2994

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Partial data for 1994 indicate considerable sectoral variation in financial performance. The situation in trade and in the hotels and restaurants sector improved marginally. There was a noticeable increase in the proportion of profit-making firms in agriculture, transport and communication, and other services. However, despite the turnaround in activity, profit making declined in many branches of industry. These include: food products, leather, paper, rubber, metals, and manufacturing, n.e.c. In all sectors there was considerable movement into and out of profitability. For the enterprise sector as whole, 14 percent of firms moved from losses in 1993 to profits in 1994, while 12 percent slipped into loss making.

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The profit rate is defined here as the ratio of aggregate profits to aggregate value of current production. The profit rate derived from data on aggregate profits will not match the average of profit rates of individual enterprises in the sector. The latter is a more desirable measure.

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Cumulative depreciation as a ratio of gross fixed assets was lower for loss-making firms.

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A description of the measures implemented by the Government to strengthen the balance sheet of banks is contained in Czech Republic--Recent Economic Developments, SM/94/194 (7/20/94), Annex III.

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In order to reduce the prospect of a chain reaction of linked bankruptcies, the Government carried out two rounds of netting out of interenterprise arrears soon after the introduction of the bankruptcy law. However, participation was limited and only Kc 15 billion of arrears (about 16 percent of the estimated outstanding arrears at end-1992) were reduced.

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The major banks made considerable progress in 1994 in accumulating loan-loss provisions, but until the audit reports are available, it is not possible to determine whether provisions and collateral provide adequate cover against likely losses. However, provisions and reserves of small banks, as a group, fell substantially short of international norms.