The Selected Issues paper and Statistical Appendix analyzes output developments in the Russian Federation since the 1998 crisis. It outlines near-term growth prospects for the economy. The paper highlights that output growth accelerated in 1999 and the first half of 2000, but has slowed since then. The initial output recovery was led by import substitution as a result of the large exchange rate depreciation in 1998. One finding in the context of an overall policy package is that the real exchange rate and oil prices were the main determinants of growth after the 1998 crisis.

Abstract

The Selected Issues paper and Statistical Appendix analyzes output developments in the Russian Federation since the 1998 crisis. It outlines near-term growth prospects for the economy. The paper highlights that output growth accelerated in 1999 and the first half of 2000, but has slowed since then. The initial output recovery was led by import substitution as a result of the large exchange rate depreciation in 1998. One finding in the context of an overall policy package is that the real exchange rate and oil prices were the main determinants of growth after the 1998 crisis.

VI. Structural Reforms1

A. Overview

1. The pace of structural reform accelerated markedly in mid-2001. Until late spring 2001, the implementation of the government’s structural reform program for 2000–01, approved in July 2000, was behind schedule, particularly banking and natural monopoly reform. However, a package of amendments to banking laws was adopted in spring 2001, aimed to facilitate the regulation and consolidation of the sector, followed by government approval of a restructuring plan for the railways in May. Subsequently, reforms across the board accelerated in the summer. The government approved a restructuring plan for the electricity sector in July, and before its summer recess, the Duma passed the profit tax chapter of Part II of the Tax Code; a package of laws to deregulate economic activities; and a law against money laundering. A new land code was passed at the start of the fall session and a Government Regulation on housing and communal services reform was issued in September. A new Labor Code, key pension reform legislation, and parts of the judicial reform were adopted at end-2001.

2. The government also adopted a new medium-term program for 2002–04 in July. The emphasis remains on the improvement of the investment climate for the private sector and on the achievement of long-term sustainability in public finances. Underlying this emphasis is the view, articulated by both President Putin and the government, that economic growth should be increasingly led by private investment and that reliance on volatile raw material exports should be reduced. Starting in fall 2001 and continuing into the medium term, the main challenges in implementing the reform agenda include the initiation of reforms in electricity and railways sectors; the implementation of business deregulation, pension, labor, land, and housing and communal services reforms; the adoption of customs and remaining judicial reforms; and the formulation of further reforms in the areas of banking, foreign exchange liberalization, gas sector restructuring, and intergovernmental relations.

3. The depth and breadth of the reform agenda pose significant implementation and coordination challenges. To ensure consistent and universal implementation of the enacted reform acts and measures at all levels of government across the whole country is the main challenge and risk for the success of the reform program. The implementation of many reforms will also have significant fiscal implications, which, while not readily quantifiable at this early stage, will necessitate good coordination of reform design and implementation so as to avoid the emergence of excessive fiscal and macroeconomic shocks and imbalances.

B. Energy Sector Reform

Electricity sector

4. In general, the broad aim of a market-oriented electricity sector reform is to separate out naturally monopolistic from potentially competitive activities. The naturally monopolistic activities include electricity transmission from producers to retail sellers (utilities) along high-voltage grids and electricity distribution from utilities to consumers along low-voltage grids. The need for grids generally makes transmission and distribution natural monopolies, and state regulation and supervision of these activities is required to limit the abuse of monopoly power. The potentially competitive activities, in turn, include electricity generation (production) and retail sales. Both privatization and liberalization are generally undertaken to introduce competition in these activities.

5. Currently, the state dominates all activities in the Russian electricity sector. The state controls electricity generation, transmission, sales, and distribution through its 52 percent stake in RAO UES, which in turn has ownership stakes in all but 2 of the 74 vertically integrated regional energy companies. Of total generation capacity, 84 percent is accounted for by RAO UES, the regional energy companies under its control, and the nine state-controlled nuclear power plants. The federal high-voltage grid belongs to RAO UES, while parts of the regional high-voltage grids and the low-voltage grids belong to regional energy companies. Tariff regulation in the wholesale market and in electricity transmission is conducted by the recently established Single Tariff Agency, with the government approving any tariff changes, but it remains to be decided whether the Single Tariff Agency or Regional Energy Commissions control retail tariffs. At present, the implicit subsidy due to below-market electricity pricing is estimated at roughly at 3–6 percent of GDP. In addition, there is significant cross-subsidization of residential retail tariffs by industrial retail tariffs.

6. The main problem in the electricity sector has been insufficient investment. As a result of insufficient investment in generation capacity over the last 15 years and the recent upswing in industrial activity which has boosted the demand for electricity, the risk for supply shortfalls in the medium-term has increased. While RAO UES’s annual investment budget is currently only around $1 billion, it is estimated by the World Bank that investments of $30–70 billion are needed over the coming ten years for power plant rehabilitation and construction and for maintaining and developing the transmission and distribution networks. While the state will continue to invest in the natural monopoly segments of the power industry, a reform plan for the entire electricity sector has been developed to attract large-scale private investments, including from abroad, into the potentially competitive segments of the sector.

7. The Russian government has approved a three-stage reform plan for the electricity sector. The broad reform plan, which covers a period of 8–10 years as detailed below, was approved on July 13, 2001. Ultimately, the plan envisages the liberalization of both wholesale and retail electricity tariffs, as well as the withdrawal of the state from electricity generation (with the exception of nuclear power generation) and sales. As a first step to this end, the government approved a detailed action plan for the initial stage of the reform on August 3, 2001.

8. The first stage of the reform is chiefly preparatory in character. It covers the period through spring 2004, by when the necessary legal and organizational changes are to be completed and the wholesale electricity market is to be established, as detailed below. While tariff regulation in both wholesale and retail markets will remain in place throughout the first stage, the retail tariff will be linked to the wholesale tariff through a formula.

  • The necessary legal changes include the introduction of a new federal framework law for the electricity sector, as well as amendments to existing legislation pertaining to, e.g., natural monopolies, tariff regulation, and competition.

  • The organizational changes include the creation of a federal high-voltage grid company; a system operator; a number of generating companies consolidating RAO UES’s existing power plants; and a holding company to manage RAO UES’s stakes in regional energy companies, which are to spin off their distribution assets into separate subsidiaries. All these new companies will initially be fully-owned subsidiaries of RAO UES, so the shareholders of RAO UES will receive stakes in these companies on a pro rata basis. Furthermore, all existing nuclear power plants will be merged into one fully state-owned generating company. The regulation of the electricity sector will be consolidated into a uniform system, with a view to ensuring a level playing field in both wholesale and retail markets and to enhance investment.

  • The organizational changes will be accompanied by financial rehabilitation and measures to enhance financial transparency. Financial rehabilitation includes cost-cutting and, when necessary, the restructuring of companies’ debts and receivables. Relatedly, a system of social assistance for workers displaced in the reform process will be adopted. Measures to enhance transparency, in turn, include the separation of accounting for different activities and the conduct of a full inventory of RAO UES’s assets.

  • The establishment of the wholesale market involves the setting-up of the market infrastructure, a trading system administrator, a payment system with a settlement center, and the introduction of forward and futures contracts for the wholesale market.

9. The second stage will culminate in the liberalization of both wholesale and retail markets in parts of Russia. Following the establishment of the wholesale market in the first stage of the reform, independent sales companies for the retail market will be introduced in the second stage, including from regional energy companies; these will divest themselves of their transmission and, in only a few cases, distribution assets against due compensation from RAO UES. Independent sales companies are not required to spin off their generation assets, so some degree of vertical integration of competitive activities (generation and sales) will be allowed to remain. Tariff regulation will be discontinued in the wholesale market and in the retail markets in European Russia, Ural region, and in Siberia. The deregulation is expected to lead to a rough doubling of wholesale prices from their current levels. All in all, the second stage will take place two-three years after the completion of the first stage.

10. In the third stage, the state will withdraw from electricity generation and sales. In the course of the next three-four years, RAO UES will divest itself of its stakes in power plants and regional energy companies, while increasing its stake in the federal high-voltage grid company; in other words, RAO UES will eventually become a transmission company controlling the naturally monopolistic high-voltage transmission network. The privatization of all assets in the competitive segments of the sector (which will have been liberalized during the previous stage) is expected to ensure sufficient and appropriate investment in generation capacity.

11. The strategic choices embedded in the plan follow largely those made by industrial countries that have embarked on market-oriented electricity sector reforms. In the past two decades, a number of OECD countries have embarked on electricity sector reforms to liberalize both wholesale and retail electricity markets and to strengthen the regulation of the naturally monopolistic segments of the markets. While no universal consensus on electricity sector reform has emerged, it appears the Russian government’s plan described above follows the mainstream in terms of key strategic choices (see Box 1).

Gas sector

12. The current structure of the Russian gas sector resembles that of the electricity sector. The state exercises significant control of the sector through its 38-percent ownership of Gazprom and its majority representation at the Board of Gazprom’s Directors. Gazprom operates as a vertically integrated company with both naturally monopolistic activities (gas transmission and distribution) and potentially competitive ones (gas production and sales). Gazprom accounts for some 90 percent of gas production in Russia; it controls 80 percent of gas reserves; it controls the gas transportation network; and it has monopoly rights to gas exports outside the CIS. Gas transportation tariffs as well as Gazprom’s domestic retail tariffs are controlled by the Single Tariff Agency, with the government approving any tariff changes. Notably, independent gas producers are in principle free to set their own retail tariffs.

13. Problems in the gas sector have included:

  • Gazprom’s control over the pipeline network and below-market regulated tariffs for its domestic sales have created a barrier for independent producers to enter the domestic market. This, in combination with Gazprom’s export monopoly beyond the CIS (with only Itera allowed to export to CIS countries), has curtailed independent producers’ incentives to invest in their gas fields, which have significant potential, and to start up and expand production.

International Experiences in Reforming the Electricity Sector

Until the late 1970s, the electricity sector was viewed either as a single natural monopoly (in Europe) or as a private monopoly that required public regulation (in the US). Following the oil shocks of the 1970s, fuels other than oil were introduced into electricity generation, which contributed to the unbundling of generation from transmission. Vertical disintegration of the electricity sector allowed the introduction of competition in some of its segments, first in generation and subsequently in sales. The first set of countries embarking on reform along these lines included the UK, Norway, Sweden, Australia, and New Zealand, with more recent entrants including all EU members, the US, Canada, and Japan. The experience from these reforms, most of which are still on-going, suggests that the following are among the key strategic issues:

Unbundling. The naturally monopolistic activities need to be separated from the potentially competitive ones to prevent the abuse of the naturally monopolistic segment as a barrier to entry (e.g., a generating company controlling transmission could prevent other generators’ access to the grid). While there are many ways to separate activities, ownership separation is generally a better guarantee against discrimination than, e.g., mere operational or accounting separation.

Retail market liberalization. To benefit the end-consumer, electricity sector reform needs to include the liberalization of the retail market which, in turn, requires the unbundling of sales from distribution. Retail market liberalization needs to encompass both free entry and free tariff-setting.

Regulation. Regulation needs to develop in parallel with the reform and encompass both the regulation of the naturally monopolistic activities and the implementation of an appropriate competition policy in the competitive segments. The regulatory authority should be independent of the regulated and of the government, particularly in cases where the government is a grid owner. The role of competition policy, in turn, has been particularly important in merger control and in the elimination of explicit subsidies.

Sequencing. While most reforms have proceeded from legal changes to regulatory reforms to restructuring and privatization, the sequencing of privatization and liberalization has varied between countries. For example, utilities were privatized before liberalization in the UK, while liberalization preceded privatization in the Nordic countries.

Sources: International Energy Agency Electricity Market Reform. An IEA Handbook (1999) and Competition in Electricity Markets (2001)

  • Gazprom’s exports, particularly to non-CIS countries, have cross-subsidized its domestic sales, which have been subject to not only below-market tariffs (the current tariff for industrial consumers is around one-tenth of the world-market price and below the break-even level) but also, until last year, to pervasive nonpayments. Abstracting from nonpayments, the implicit subsidy due to below-market pricing is estimated at roughly 3 percent of GDP. Exports to many CIS countries have also included a subsidy element in the form of below-market pricing or nonpayments.

  • Gazprom’s corporate governance record has suffered from poor transparency, particularly related to its relationship with Russia’s second-largest gas producer, Itera, and extensive operations outside its core business. Also, the ring-fence around Gazprom’s domestic share market (foreigners are not allowed to purchase Gazprom’s shares in Russia; they can only hold Gazprom’s ADRs) has created a dual market for its shares and prevented foreign shareholders from exercising normal shareholder control.

14. Some of these problems are being addressed. Gazprom’s cash collections for current domestic shipments have improved from below 20 percent in the spring of 1999 to 80–100 percent since spring 2001. Progress has recently been made in restructuring other CIS countries (notably Ukraine) arrears to Gazprom. To enhance transparency, Gazprom has prepared financial statements based on International Accounting Standards since 1998. Also, Gazprom commissioned in the spring of 2001 its regular auditor to conduct a special audit of the relationship between Gazprom and Itera. Gazprom has furthermore initiated the development of its own corporate governance code. Finally, a working group has been working on a proposal to gradually liberalize Gazprom’s domestic share market.

15. A comprehensive restructuring plan for the gas sector will be developed in the near future. While the government’s program for the second half of 2001 envisaged a draft plan to be finalized by end-2001, this schedule may slip because of the need to first conduct a thorough inventory of Gazprom’s assets. The main elements of the restructuring plan would concern the reform of gas transportation and the liberalization of domestic gas market and exports. On gas transportation, the key issue to be determined is whether it will be spun off from Gazprom into a separate state-regulated natural monopoly. On domestic gas market liberalization, the government’s long-term energy strategy envisages that domestic gas prices rise gradually to the “European level” (net of taxes and transportation costs) by 2007. On gas exports, it remains to be determined to what extent and how fast they will be opened up to independent producers.

Oil sector

16. The reform of the oil sector has advanced further than the reforms of the electricity and gas sectors. Oil exploration, production, refining, and sales have been separated from pipeline transportation, and the majority of oil companies were privatized in 1995–96. The state retains majority interest in two vertically integrated companies, Slavneft and Rosneft, which account for less than 10 percent of Russia’s total crude oil production. Although the majority of the oil sector has been privatized, however, administrative control of exports have distorted domestic markets by depressing prices and by encouraging excessive substitution of other fuels by oil and oil products.

17. The state controls the oil pipeline company and allocates access to the pipeline administratively. Transneft, the oil pipeline company, is 75 percent state-owned. The Single Tariff Agency controls Transneft’s tariff-setting, with the government approving any tariff changes, and a special governmental commission regulates oil companies’ access to the export pipeline. While part of the pipeline capacity is allocated among oil companies on the basis of their production volumes—with small and medium-sized oil companies allowed to export a larger share of their production than large ones—the commission has considerable discretion to allocate the residual capacity.

18. The administrative control of exports of both crude oil and refined oil products drives a wedge between domestic and world market prices. The production-based allocation of part of the export pipeline capacity creates an incentive for oil companies to overproduce crude oil. The excess production is either sold domestically, which widens the wedge between domestic and world market prices further, or refined. However, as the state has in the past conditioned certain refined products’ exports on the fulfillment of domestic delivery targets, a wedge has also been driven between domestic and world market prices for these refined oil products. The significance of these administrative export restrictions depends naturally on the volatile world market prices for oil products. Fund staff estimates suggest that the wedge between domestic and world market prices was approximately 2 percent of GDP at end-2000.

19. The government is contemplating some liberalization measures. While auctions to allocate export pipeline capacity among oil companies have not been introduced yet, preparatory work to this end is underway. Also, the government hopes to eliminate the need to introduce domestic delivery targets for oil products while ensuring sufficient supplies to the domestic markets by creating a physical oil product reserve and by continuing the use of export tariffs for that purpose. Nevertheless, quantitative export quotas were imposed on fuel oil in the last quarter of 2001. Finally, the government envisages the privatization of a blocking stake in Slavneft in 2002.

C. Other Structural Reforms

Railways restructuring

20. Currently, the Ministry of Railways controls the entire railways sector. The Ministry controls a large vertically integrated structure of production facilities; railway infrastructure; railway operations; repair services; social services, including education and health facilities for railway employees and their families; and even regulatory and supervisory bodies. Current problems in the sector include the lack of oversight, accountability, financial transparency, and profitability resulting from vertical integration; insufficient investment in infrastructure and rolling stock; overstaffing; and tariff cross-subsidization (freight tariffs subsidizing passenger tariffs and export/import tariffs subsidizing domestic tariffs).

21. The government approved a restructuring plan for the railways sector in May 2001. The broad aim of the restructuring is to separate out naturally monopolistic activities (railway infrastructure) from the potentially competitive ones (both passenger and freight transportation as well as repair services) and to eventually liberalize and privatize the latter (see Box 2). In addition, the plan envisages the spin-off of non-core functions from the railway sector (social and educational responsibilities currently borne by the Ministry of Railways) and the establishment of an independent authority to regulate and supervise the sector. Also, cross-subsidization is to be phased out within five years, and the on-going reduction of the number of employees is to continue.

22. The restructuring is envisaged in three stages. In stage one (2001–02), the necessary legal bills will be drafted and approved, paving the way for the reorganization of the sector. Also, a fully state-owned holding company is created to control a railway infrastructure company; regionally independent commercial railway companies (selling passenger and freight transportation services); and other non-core functions. In stage two (2003–05), the potentially competitive activities are spun off from the holding company into daughter companies, and regulatory functions will be separated out from the Ministry of Railways. In stage three (2006–10), the holding company will be liquidated and commercial railway companies will be privatized on a case-by-case basis.

Separation of Railway Activities

The economic rationale for separating naturally monopolistic from potentially competitive activities in the railway sector goes beyond the introduction of competition within the sector. In the power sector, electricity and gas face few, if any, perfect substitutes that would not need to use and finance the maintenance of a naturally monopolistic segment (power grid, pipeline). However, rail transportation (both freight and passenger) faces competition from other means of transportation, including road, sea, and air, which need not maintain any naturally monopolistic segment; on the contrary, they often benefit from subsidized supporting infrastructure. Therefore, a vertically integrated railway sector has a competitive disadvantage vis-à-vis its competitors as it has to bear the cost of maintaining the railway infrastructure.

While many European countries have recently proceeded with the separation of railway activities, they have chosen different approaches to privatization. In the UK, separation was followed by the privatization of all activities, including infrastructure and traffic control. In Germany, while the state-owned railway company both manages the infrastructure and provides transportation services, a phased introduction of competition into transportation operations is taking place. In France, a separate infrastructure authority has been created without any privatization of non-infrastructure activities.

Separation has improved financial transparency but raised questions about regulation. There are technical, as opposed to economic, arguments for integrating railway infrastructure with locomotive fleet and rolling stock. To the extent that financial and ownership separation lead to technical separation, concerns about compatibility and maintenance may arise. Therefore, and in order to ensure fair access to and non-predatory pricing of the naturally monopolistic services, an adequate regulatory framework is required.

Business deregulation

23. As part of the effort to improve the investment climate, the Duma approved, in July 2001, a package of laws aimed to deregulate the conduct and establishment of business activities. Running or establishing a private business has been administratively burdensome as the regulatory framework has been ambiguous and numerous authorities at different levels of government have had far-reaching powers of administrative intervention. This has also created a fertile breeding ground for corruption and poor governance.

24. The deregulation package consists of three laws. Specifically, they aim at easing the administrative burden on enterprises by limiting state inspections of businesses; reducing the number of activities requiring a license and eliminating subnational licenses; and simplifying the registration of new firms, as detailed below.

  • Regulatory bodies’ (e.g., fire safety and sanitary inspectorates, but excluding tax and financial inspections) ability to carry out unannounced inspections will be limited to cases of filed complaints, which may not be anonymous. Regular inspection visits will have to be preannounced and there will be authority-specific annual caps on the number of inspection visits per enterprise.

  • The number of activities requiring state licensing will be cut from the current level of above 2000 (including both federal and subnational licenses) to about 100, and subnational licenses will be eliminated. Licenses issued by the designated federal agency will be automatically recognized throughout the country. The process of obtaining a license is streamlined and made unambiguous by including all requirements in the law.

  • Registration of new enterprises will be moved to an announcement basis (as opposed to a permit basis, except for activities requiring a license) and to a one-window basis, where the responsibility of informing tax, social, health, and other authorities of the establishment of the new firm will be shifted from the firm itself to the registering authority. Also, a five-day time limit for registration is established where all relevant registration documents have been provided by the entrepreneur.

25. Deregulation is part of a comprehensive agenda to support private sector growth. Apart from deregulation, the tax reform, strengthening of property rights (particularly through land reform), labor reform, and judicial reform will all—if adopted and implemented—significantly stimulate the growth of particularly small and medium-sized enterprises, which have been the engine of sustainable growth in most transition economies. In addition to these reforms that have already been adopted or formulated, progress on financial sector reform will be a key determinant of the private sector’s growth potential.

26. Deregulation has merits in its own right but needs to be accompanied by competition policy to be fully effective. The specific role of deregulation is to lower barriers to entry and to reduce the costs of establishing and conducting business. While deregulation therefore has potential in its own right to enhance competition, the simultaneous formulation and implementation of an adequate competition policy is necessary to ensure that competition takes place on a level playing field. To this end, the government’s recently adopted medium-term program specifies measures aimed at leveling the playing field, particularly between public and private sector enterprises.

Land, reform

27. Land reform is another key element in the effort to improve the investment climate and strengthen property rights. While the right to private land ownership was written into the 1991 constitution, its exercise was effectively blocked by the absence of a legal and procedural framework. These frameworks have been created in the Civil Code (whose Chapter 17 “On Transactions with Land” was unfrozen by the Duma at the beginning of 2001) and the Land Code (that was adopted in October 2001, and will come into force at the beginning of 2002). In addition, the improvement of the land cadastre is a priority so as to allow the strengthening of the link between the cadastre and the registration of land rights.

28. The Land Code covers only urban land. It establishes the right and procedures for owning, trading, and collateralizing commercial and residential land as well as household plots and family farms by resident and non-resident individuals and enterprises. This covers all non-agricultural land except land occupied by military or nuclear facilities; lands of ZATOs (closed administrative districts); and conservation areas and national parks. Foreigners are not allowed to own land in border areas and other special territories, as defined in other legislation.

29. Ownership of and trade in agricultural land will be regulated separately. As stipulated in the draft Law on Differentiation of Land Property, which regulates public land ownership between different levels of government, agricultural land belongs currently to municipalities. A separate law on the ownership of and trade in agricultural land is being drafted, with a view to submitting it to the Duma in March 2002 (see Box 3 on agricultural reforms more broadly).

Labor reform

30. The Duma approved a new Labor Code in December 2001. The old Labor Code originated from the Soviet era and thus, among other things, did not recognize private employment. Therefore, it only covered a fraction of the current labor force. The new Labor Code aims to be better compatible with a market economy and to increase the flexibility of labor markets, including by granting employers the right to terminate labor contracts; by extending the use of fixed-term labor contracts; and by streamlining the collective bargaining process. In addition, the new Labor Code details the basic parameters of labor contracts, such as minimum wage (which is to converge to the official minimum living standard over a transitional period), working time, overtime compensation, leave entitlements, penalties for wage arrears, etc.

31. At the same time, the authorities will strengthen the social safety net. From the viewpoint of labor markets, the most relevant pieces of social legislation to be prepared according to the government’s program are bills aimed to improve active and passive employment assistance, including the Employment Law. The former consists of improving access by the unemployed to already existing employment assistance programs as well as of introducing procedures to evaluate the efficiency of active employment assistance programs. The latter, in turn, consists of enhancing the adequacy and efficiency of the existing unemployment benefit system. The medium-term program envisages strengthening the system of mandatory social insurance for work-related injuries and occupational diseases.

Agricultural Reforms in Russia

Background. Agricultural production could be among Russia’s main comparative advantages. Its arable land area is vast; a significant share of arable land has very fertile soil; the growing season is long particularly in southern Russia; and agricultural human capital remains abundant.

However, lack of farm-level restructuring in combination with declining subsidies and the introduction of market mechanisms into agricultural input and output markets has hit the agricultural sector hard in the past decade. Total agricultural production dropped by one-third between 1990 and 2000—with livestock production halving and crop production declining by a quarter—and the GDP share of agriculture declined from 14 percent to 6.5 percent. By 1999, the share of the rural population with cash income below the subsistence level had reached almost three-quarters. Some 90 percent of farms are now unprofitable, and 70 percent of the debts of agricultural enterprises are in arrears.

Reforms so far. Agricultural reforms to date have focused on limiting distortions from federal government intervention in the agricultural sector. Agricultural prices have mostly been liberalized (although a revival of federal procurement to regulate grain markets is being planned); federal trade protection of agriculture is low compared to many industrial countries; and direct subsidies from the federal budget are only one-third of their level in OECD countries. Furthermore, 90 percent of enterprises servicing farms and enterprises processing farms’ output have been privatized. One positive result of the reforms so far has been the emergence of private farming (mainly household plots), which now accounts for as much as 60 percent of all agricultural production despite operating only around 10 percent of agricultural land.

Remaining agenda. At the federal level, a general rural development strategy remains to be developed, aimed in particular at leveling the playing field between public and private producers by ending the current policy which has used soft budget constraints and debt forgiveness to favor large collective enterprises. Therefore, a comprehensive program of debt settlement is needed, combined with farm restructuring, genuine privatization, bankruptcy where necessary, and hardening of budget constraints. To support this agenda, agricultural land reform is key, as is the development of a market-based system of agricultural financing. However, the bulk of agricultural reform need is at the regional level. Regions have considerable autonomy in formulating their agricultural policies, and this autonomy is exploited by many regions in main agricultural production areas to support inefficient production. This is done through regional trade barriers; physical food reserves aimed at controlling prices; implicit subsidies (including in the form of tolerance for nonpayments); as well as the use of commodity credit schemes as a way of non-cash public procurement. All these practices are inherently distortionary and stand in the way of farm-level restructuring and, hence, Russia’s ability to utilize its comparative advantage in agriculture.

Source: World Bank

Housing and communal services

32. Housing and communal services are characterized by pervasive implicit subsidies and other non-market features. Cost recovery levels for housing and communal services are low; for example, operational cost recovery (i.e., cost recovery excluding long-term investment needs) for public housing maintenance is estimated at below 50 percent (1999); for heating, water, and sewage at 35 percent (2000); for gas at 50 percent (2000); and for electricity at 40 percent (2000). Utility tariffs are partly cross-subsidized, with industrial consumers subsidizing low tariffs for the household sector. In addition, public housing construction—which in 2000 still accounted for 20 percent of all residential housing construction by area—as well as publicly organized housing maintenance remain characterized by the absence of market-based and transparent tendering procedures.

33. The government aims to introduce market mechanisms into housing and communal services. Operational cost recovery in both housing and communal services is envisaged to be achieved by 2004. Furthermore, municipal housing maintenance and construction will be moved to a competitive tender basis. To facilitate the financing of housing investments by households, legislation on mortgage markets and instruments will be introduced.

34. These principles are spelled out in the government’s reform program for housing and communal services. The program, approved by the government in September and further detailed in November 2001, has four main parts to it: administrative and financial reform of housing and communal services; provision of access to affordable housing; reform of housing construction; and fulfillment of current housing obligations of the state to certain categories of citizens. The program covers the period through 2010 and is divided in two phases. Apart from the financial measures mentioned above, the first phase (through 2004) consists of legal, regulatory, and organizational changes, including the approval of a new Housing Code. The second phase (2004–10) comprises the refinement and universal implementation of the reform measures introduced in the first stage.

35. The reform, while improving economic efficiency generally, could necessitate significant fiscal subsidies. Given the current low cost recovery levels, housing rents and communal services’ tariffs need to increase substantially over the medium and long term. Preliminary estimates by Fund staff suggest that if all households whose housing and communal services expenditures exceed 22 percent of their income (which has been established as a threshold) are to be compensated for the difference between their actual expenditures and the threshold, the fiscal cost of introducing operational cost recovery could amount to 0.7 percent of GDP annually. Additional subsidies would be needed to compensate budgetary organizations for increased utility tariffs, which in the case of electricity alone could amount to some 0.4 percent of GDP. With the threshold described above, the introduction of full cost recovery could imply a fiscal cost of subsidies to households of as much as 3–4 percent of GDP.

36. Several factors, however, can mitigate the fiscal impact of the reform. First, given the present inefficiencies in housing construction and the production and provision of some communal services, the estimated operational and investment-inclusive costs are likely exaggerated, resulting in too high projections for fiscal subsidy needs. Second, consumption-side inefficiencies due to below-market pricing imply scope for savings, in particular through energy conservation, which will also reduce the fiscal subsidy need. Furthermore, the reform will also likely generate higher fiscal revenues through improved profitability in the utilities’ sector, which will reduce the net fiscal cost of the reform. Nevertheless, as all these offsetting effects are difficult to quantify, measures to improve the efficiency of the subsidy schemes (e.g. introducing metering to utilities other than electricity, which is currently the only metered utility) need to be taken to ensure the affordability of the reform.

External trade reform and WTO accession

37. The reform of the external trade system comprises import tariff reform and customs reform. A major revision of the import tariff schedule was approved in November 2000 and came into force at the beginning of 2001, with the number of basic rate bands declining from 7 to 4 and the maximum tariff declining from 30 to 20 percent (except for automobiles for which the tariff rate is 30 percent). The tariff schedule has subsequently been amended, further reducing the level and dispersion of tariffs. Customs reform, in turn, aims to streamline and modernize procedures for customs clearance and the organization of the State Customs Committee (SCC). Customs procedures will be streamlined by a new draft Customs Code, which is aimed to be WTO-compatible and compatible with the Kyoto convention on harmonization and simplification of customs procedures. Discussions concerning the reorganization of the SCC are ongoing.

38. Russia is also in the process of negotiating membership in the World Trade Organization (WTO). Russia’s formal application for membership was submitted in 1993. The approval of the tariff reform in the fall of 2000 marked an acceleration of the accession process, and the current government has declared WTO accession a priority. The ongoing stage of accession negotiations involves a multilateral review by the Working Party on Russia’s Accession of Russia’s trade regime, as well as the preparation of bilateral agreements between Russia and WTO member countries on future market access commitments. The Russian authorities’ apparent objective is to join the WTO by 2004.

39. The accession negotiations have focused on trade protection and the necessary legal changes and their implementation. Tariffs for some 20–30 percent of a total of 11,000 categories of goods remain to be negotiated, with agriculture, machinery and equipment (aircrafts, trucks, cars), furniture, pharmaceuticals, and chemicals among the sectors where progress has been slowest. In the area of non-tariff barriers, negotiations have focused on certification and standardization requirements. Apart from tariff and non-tariff barriers, the extent of protection of domestic producers through direct agricultural subsidies and indirect energy subsidies—as well as through restricting foreigners’ access to services (particularly banking, insurance, telecoms, transportation, and health care)—remains to be agreed upon.

40. Apart from the approval of relevant legislation, legal enforcement has been a concern in the accession negotiations. As for introducing necessary legal changes, the Duma is scheduled to consider a package of important bills, including the draft Customs Code, in its spring 2002 session. As for legal enforcement, negotiations have focused on the protection of intellectual property rights, including on audiovisual products, as well as on the implementation of relevant laws and agreements at subnational levels of government.

Judicial reform

41. The transformation of the Soviet judicial system began in the early 1990s. The most important changes at that juncture were organizational in character, including the establishment of the Constitutional Court as well as special courts (arbitration courts) to handle commercial disputes instead of the system of state arbitration. However, the division of responsibility for commercial disputes between arbitration courts and courts of general jurisdiction was ambiguous. Therefore, commercial disputes are often brought to both arbitration and general courts, which has led to prolonged processes.

42. Current judicial reforms aim to simplify and professionalize the court system improve the status and independence of judges and provide a more humane penal system. The court system is envisaged to be simplified by a better delineation of responsibilities between different types of courts, including by a transfer of all commercial disputes to arbitration courts. Enhancements to the professionalization of the court system and to an improvement in judges’ status and independence will result from significant increase in judges’ average salaries; an imposition of age and term limits on judges, and a shift of power from prosecutors in favor of judges. In addition, judges’ independence from regional authorities and legislature is to be increased by removing their right to approve judicial appointments and by shifting the financing of the judiciary to the federal budget. Finally, the use of jury trials will be generalized, suspects in criminal cases will be protected against police brutality, and separate first-tier appeal courts are to be created in selected regions.

43. Approximately one-third of the legal bills relating to the reform have been enacted. They relate to legislation on the judicial system and the Constitutional Court; on crirninal investigation and court procedures; and on the appointment and status of judges. Also, the government has approved a judicial reform program through 2006, including financing for wage increases for judges and computerization of courts.

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Prepared by Timo Valila (EU2).