Chapter

4 Financial Underdevelopment and Macroeconomic Stabilization in Russia

Editor(s):
Timothy Lane, D. Folkerts-Landau, and Gerard Caprio
Published Date:
June 1994
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Author(s)
Barry W. Ickes and Randi Ryterman1 

Macroeconomic stabilization has proved to be one of the most problematic aspects of the transition in Russia. This fact is troubling because macroeconomic stabilization is merely a precondition to the more important aspects of economic reform: creating a market economy. The introduction of the institutions of a market economy are critical for any improvement in Russian economic performance. A destabilized economy, however, inhibits the development of these institutions. That stabilization has proved to be more complex than optimists envisioned is due to many factors. In this paper, we focus on one key factor: financial underdevelopment.

Financial markets play a critical role in market economies—coordinating the behavior of savers and investors and fostering an efficient payment system. Thus, one may view them as important institutions for the market economy, once it develops. In the context of the Russian transition, however, the role of the financial sector is also critical. Unfortunately, the underdeveloped state of the financial sector in Russia has become a key roadblock in the transition to markets.

Financial underdevelopment has hindered market reform in Russia in two important ways. First, macroeconomic stabilization has been hindered because of the Government’s inability to impose a regime of hard budget constraints. This failure, we argue, can be directly related to financial underdevelopment. Second, market reform has been hindered by a lack of restructuring. With ineffective capital markets, it is hard for enterprises to raise funds for restructuring. These problems are exacerbated when policymakers attempt to implement a stabilization program in a financially underdeveloped environment. This program induces agents, especially enterprise directors, to adapt their behavior in unexpected and often undesirable ways. And these adaptations are most often inimical to market reform.

If financial underdevelopment has such serious consequences, why has it been such a low priority? One reason, no doubt, is that given the relative irrelevance of financial institutions under central planning, the importance of the financial system in the transition has caught many policymakers and observers off guard. More important, however, is the view that financial development is inimical to stabilization. We explore this argument below.

The purpose of this paper is to examine the link between financial underdevelopment and market reform in Russia. We find that the absence of efficient systems of payment and financial intermediation have had important real effects on the level of production and, consequently, on the amount of taxes collected. In addition, the absence of these systems has led to the development of an informal financial market—the interenterprise credit market—which has undermined the credibility of macroeconomic policy. Hence, we argue that the failure of the Russian Government to stabilize the economy is, in large part, due to its level of financial underdevelopment.

Stabilization and Financial Underdevelopment

Financial development in Russia has been arrested by the complications presented by the need to stabilize the economy. Financial discipline is critical to economic reform for incentive reasons; as long as enterprises face soft budget constraints, they have little incentive to restructure. The need to impose financial discipline on enterprises is also important for budgetary reasons. Until privatization can be completed, financial losses of enterprises result in public sector deficits. In the period between the onset of the transition and the transfer of ownership, there are good reasons to expect that this fiscal motive will be important. The demise of planning leads to a decline in coordination among enterprises. This decline in coordination reduces output and, hence, tax collection because enterprises in the former Soviet Union and Eastern Europe contribute the bulk of tax revenue. Consequently, there is a direct fiscal motive for imposing financial discipline on enterprises.

Ronald McKinnon has argued that financial development must be postponed in order to gain macroeconomic stability.2 In McKinnon’s view, early financial liberalization reduces central financial control. Therefore, in the early stages of the transition it is better for the financial opportunities facing enterprises to be limited. McKinnon (1991, p. 139) argues that an optimal sequencing of liberalization would involve two stages:

  • Stage 1: Liberalized enterprises are confined to self-finance and to borrowing from the nonbank capital market.

Then, after a lapse of some years, when price stabilization has been achieved:

  • Stage 2: Commercial banks begin limited and fully collateralized short-term lending to liberalized enterprises according to the “Real Bills Doctrine.”

McKinnon’s reasoning is based on the fact that, in the early stages of the transition, state-owned enterprises lack the financial discipline to make prudent economic decisions. Premature financial liberalization affords these enterprises the opportunity to borrow from nascent financial institutions that possess neither the incentives nor the information needed to provide loans on a commercial basis. Enterprises will use these loans to raise wages, which, in turn, will fuel inflation. Hence, in the early stages of the transition, the financial opportunities facing enterprises should be limited.

McKinnon’s argument is intimately tied to considerations of macroeconomic balance. McKinnon argues for financial development to lag other reforms because of the need to impose financial discipline on enterprises.3 Postponing financial development may impose microeconomic costs, since enterprises must operate under self-finance, but these costs must be borne to achieve macroeconomic stability.

This argument reflects what seems to be conventional wisdom, that there is a trade-off between the macroeconomic benefits of an underdeveloped financial system in terms of monetary control and the microeconomic costs of an inadequate financial system in a modern economy. The key point, however, is that this trade-off is illusory. One reason is that, with underdeveloped financial markets, implementing tight monetary policies is exceedingly difficult. The central bank does have greater control over the stock of money if financial markets are underdeveloped. But using this control is complex in economies in transition because restructuring and stabilization cannot in fact be separated.4 As we demonstrate below, financial underdevelopment weakens the credibility of a stabilizing government.

The second reason why financial underdevelopment does not contribute to stabilization is that the attempt to impose financial discipline in such an environment leads to the development of informal financial markets. These informal markets, which are impossible to regulate, increase the opportunities for tax evasion, as well as preserving structures inimical to economic reform.

Sources of Financial Underdevelopment

The primary cause of financial underdevelopment in Russia and in the former socialist economies in Eastern Europe and the former Soviet Union is the passive role of the financial system in a centrally planned economy. Although financial flows are present in command economies, they serve primarily as a record-keeping device that can be used to monitor enterprise transactions (Grossman, 1963). Nevertheless, these financial flows do create patterns of surplus and deficit in enterprise bank accounts that must be financed. Under central planning, this financing is nearly automatic and is provided by the state bank using funds from the state budget.

Because the financial system is passive in a command economy, financial flows between enterprises have little effect on resource allocation. In effect, the guarantee of the state to provide funds to finance deficits in enterprise accounts guarantees the solvency of all enterprises without regard to their creditworthiness. Consequently, the size of the surpluses and deficits have little economic meaning other than the presence of product prices that do not equate supply with official demand.

With the demise of planning and the autonomy of enterprises, financial flows must be transformed from passive to active flows. The state banking system must be transformed from a collection device to an intermediary that coordinates the actions of savers and investors, allocating credit based on commercial criteria. In Russia, the former state bank, Gosbank, did smooth out the irregularity of payments and receipts—essentially providing trade credit to enterprises—but in an environment in which both payment and receipt were a response to the economic plan. Now, the newly privatized branches of Gosbank and other new private banks must create the correct system of incentives to ensure that the nascent financial sector is able to provide the basic services that are fundamental to market transactions. We describe below these basic services—settlement of accounts and financial intermediation—and their implications for enterprise behavior.

Settlements

A functioning payment system is so fundamental to a market economy that its role is usually taken for granted. Yet, with enterprise autonomy, it is crucial that enterprises be able to make and settle payments rapidly.5 Without the means to make payments in a rapid and certain fashion, enterprises must routinely extend credit to their trading partners, relying on their history of trade with one another as “collateral” for the loan.6 This reliance on historical relationships as a basis for obtaining credit has two important consequences.

First, it creates a powerful disincentive for enterprises to adjust. Entry into new markets requires new sources of supply and, hence, new suppliers. However, without a history of trade, these new suppliers are reluctant to sell goods without some guarantee of payment, such as payment in advance. However, if the official payment system is poorly functioning, the ability of the enterprise to pay in advance is sharply curtailed.

Second, reliance on historical relationships increases the importance of enterprise directors in traversing the complex terrain of the underdeveloped financial system. Most historical relationships are based on personal friendships between enterprise directors rather than institutional relationships between enterprises. Consequently, workers in enterprises view the individual occupying the position of director as key to the survival of the enterprise. This feature of financial underdevelopment provides many enterprise directors with a perverse incentive to undermine the development of financial and other institutions that rely on arm’s-length transactions, at least to the extent that it jeopardizes his or her employment.7

The system of payments inherited from the Soviet period was a paper-oriented system, designed to monitor the behavior of enterprises. Since financial flows under planning are a means of assessing the fidelity of an enterprise to the plan, rather than an initiator of economic activity as in a market economy, the speed at which payments flow through the system is of little importance. Consequently, the payment system that was in place at the onset of the Gaidar stabilization program in January 1992 was highly centralized and used the poorly functioning postal system to transmit payments.

This centralization forced the incredibly large mass of payments to flow through a single institution, the Central Bank of Russia, thereby delaying settlement. The Central Bank maintained a network of approximately 1,400 cash settlement centers, through which payments were made (Summers, 1992). Every branch of every bank maintained an account at its local center. Payments flowed from the various cash settlement centers and through the Central Bank itself by paper, through the public mail, creating two effects. First, the system utilized reserves inefficiently because a bank spread its accounts over various centers. Second, because payments were processed physically, the time lag was further lengthened.

The time delay in settlement exacerbated the liquidity problems of the banking sector owing to the nature of the accounting system used by the Central Bank of Russia. The account of the payor is debited when payment is made, but the account of the payee is not credited until the payment is received. In the interim, the funds are, in effect, frozen, creating what is called “payment system float” (Summers, 1992). The longer it takes for payments to be made, the larger is the float. This credit float shows up on the balance sheet of the Central Bank of Russia, but if it is not offset by the Central Bank, it results in a decline in the liquidity of the banking system. Thus, the technical delays associated with processing transactions further aggravate the problem of inadequate reserves, which, in turn, exacerbates the problems of the payment system.

The delays in settlement between banks and the difficulties that enterprises faced in obtaining working capital combined to bring the payment system to a crawl. Enterprises were often forced to wait for receipts to be credited at the bank before they could make payments. The lag between delivery of goods and receipt of payment became larger. Hence, a mismatch existed between the timing of flows of goods between enterprises in production and the corresponding flows of payments between enterprises.

Intermediation

In a market economy, an important role for the financial sector is intermediation. The savings of households are deposited in banks and other financial institutions. These institutions then lend these funds to qualified enterprises for working capital and investment. At present, financial institutions in Russia do not play this role. Financial institutions are not intermediaries between households and enterprises, but rather between the public sector, via the Central Bank, and enterprises. Credit in Russia is provided to commercial banks by the Central Bank, which is then lent to enterprises.

This problem is a legacy of the prior regime. Under central planning, the Government generated investment funds by taxing profitable enterprises, then reallocated these profits across enterprises based on criteria related to economic development. The savings of individuals could be deposited in the former state savings bank, Sberbank, but these deposits did not play an important role in the provision of financial capital to enterprises.

At present, interbank markets in Russia are developing, but funds allocated through this process are still less important than funds provided by the Central Bank. Low real interest rates on deposits make the incentive for individuals to deposit their savings in commercial banks low. Under these circumstances, commodities and deposits in foreign financial institutions become more attractive stores of wealth.

The integral role of the Central Bank of Russia in the provision of credit has important implications for the allocation of credit in the economy. Currently, the Central Bank is pursuing a policy of targeting specific enterprises as recipients of low-interest loans. Commercial banks compete for these loans, using personal connections to attract the attention of the Central Bank. This feature provides commercial banks that are former branches of Gosbank with a distinct advantage, since many Central Bank staff are also former employees of Gosbank.

Another important aspect of financial intermediation is the allocation of credit to the most qualified borrowers. To perform this function effectively, commercial banks, first, must be able to assess the creditworthiness of prospective borrowers and, second, must have the correct incentives to provide the most creditworthy of the prospective borrowers with loans.

Underdevelopment of the financial system makes adequate performance of these two aspects of credit allocation difficult. To assess the creditworthiness of enterprises accurately, bank officers must evaluate the credit history and net worth of enterprises. However, the relatively short period of transition diminishes the importance of an enterprise’s credit history in this evaluation. Furthermore, without well-functioning capital markets, accurate information on the value of an enterprise’s assets is not available. Consequently, bank officers are forced to base their assessment largely on the liquidity of the enterprise. However, with underdeveloped financial markets, this information is even more scant. Imperfections in the formal sector cause informal credit markets to arise, as we explain below. These markets are difficult to monitor. Hence, they complicate any analysis of liquidity.

Without adequate information to assess the creditworthiness of prospective borrowers, bank officers must rely on collateral to secure their loans. However, for many enterprises, their title to their assets is still ambiguous. Consequently, bank officers often resort to personal relationships as a basis for allocating credit. Many bank officers previously worked in Gosbank and, consequently, have a long history of relations with enterprises that were their clients in the prior regime. Again, the importance of trust in the allocation of credit has important effects on the behavior of enterprises. In particular, it makes continuity in top management critical to their survival.

Given the difficulties in assessing the solvency of enterprises one may suppose that the optimal policy is, following McKinnon, to impose self-finance, or a cash flow constraint on enterprises. This constraint would force enterprises to cover their costs out of their current revenues and retained earnings. The problem is that the replacement of soft budget constraints with cash flow constraints is an exceedingly harsh regime change, even in an economy where payments can easily be made. In an economy where payments take several weeks, or even months, to clear, moving to a cash flow constraint would be disastrous. But it is not just the lag in payments that renders the cash flow constraint impossible to implement. Given the economy’s distance from equilibrium at the onset of the transition, imposing such a constraint could imply shutting down a large portion of the economy.8

Self-finance has more deleterious consequences for economies in transition than for market economies. In the transition, enterprises are unlikely to respond to the imposition of financial discipline by restraining their demand for labor and goods. Enterprises in the transition are survival oriented. We explain this behavior below.

Survival-Oriented Enterprises

During the early phases of the transition to a market economy, survival is the primary motivation of enterprise management.9 In any system, enterprises are concerned with survival, but, during the transition, the extreme uncertainty that they face induces peculiar forms of behavior.

The primary distinguishing characteristic of the survival-oriented enterprise is that it operates in an environment in flux. The enterprise in a planned economy and the firm in a market economy each operate in a relatively stable environment. By a stable environment, we refer to the status of the other “players” in the economy and to the rules that govern the survival of organizations. In a planned economy, the enterprise takes the survival of other enterprises as given, since enterprises are not permitted to fail. In a market economy, entry and exit occur, but the number of enterprises that enter or exit an industry in any period is small compared with the size of the industry as a whole.10 Thus, in both cases, the industrial structure can be taken as given for short-term decision making by the organization.

In the transition economy, on the other hand, the industrial structure is in a state of flux. The rules that govern the survival of the organization are no longer evident. The transition from a system with no exit to a system with exit entails a period of uncertainty as directors of survival-oriented enterprises learn how bankruptcy criteria will be implemented. Moreover, impending privatization may alter the picture as well, as the director may find himself no longer in control of the enterprise. But these uncertainties are compounded by the fact that they apply to all enterprises in the economy. It is this potentially simultaneous restructuring that makes decision making at the enterprise level so complex.

One of the most important implications of survival orientation is that it causes enterprises to resist restructuring. Enterprises are very dependent on their present network of suppliers and customers.11 Presently, they are very uncertain about their ability to find new suppliers and customers. By identifying strategies that enable them to resist restructuring, enterprises and their trading partners can ensure their survival. In addition, the struggle for control rights makes directors reluctant to shed workers for fear that this will hurt their chances to stay in control of the enterprise. The problem for enterprise directors is first to stay in control; only after this has been achieved can their focus be reoriented toward the longer run.12

When enterprises are survival oriented, they respond to attempts to impose financial discipline differently from how we would expect a firm in a market economy to respond. In Russia, the first attempt to impose financial discipline led to an explosion of interenterprise lending. The arrears crisis is an excellent example of how enterprise adaptation to stringency may lead to unintended consequences.

Interenterprise Credit Markets in Russia

One of the most fascinating consequences of the Russian economic reform program has been the phenomenal growth in interenterprise arrears that took place in the first half of 1992, when they grew from less than Rub 40 billion to over Rub 3.2 trillion. We view interenterprise arrears as a response by survival-oriented enterprises to survive tight credit policies in an economy with an underdeveloped financial market.13

With underdeveloped financial markets, interenterprise lending seems inevitable. Under central planning, the enterprise sector was the primary source of savings.14 In the early phases of the transition, household savings were inadequate to meet the needs of the enterprise sector, not just for restructuring, but even for trade credit. If financial markets were well developed, enterprise savings could be intermediated by institutions. In the Russian environment, however, the inadequacy of financial information inhibited the growth of these markets, at least with respect to the state-owned sector, leading to the interenterprise lending results.

Trade credit is an important component of finance in modern economies. In the United States, for example, total trade credit of nonfinancial corporations was $973.5 billion in the first quarter of 1992 (United States, 1992). Trade credit was thus about the size of the narrow money supply (Ml) and about one-fifth of GNP. In an industrial economy, firms borrow from their suppliers and customers on a regular basis. There is one critical difference, however, between trade credit in the Unites States and interenterprise lending in Russia. In the former, the interest rates that are charged tend to be quite high, and certainly higher than interest rates charged by banks (Jaffee and Stiglitz, 1990, p. 879). The nominal interest rate on interenterprise lending in Russia, on the other hand, is almost always zero, translating into a negative real rate. Trade credit in the United States is a means of financing that firms use when they cannot gain access to bank credit.15 The higher interest rate reflects the increased risk associated with the loan. The fact that real interest rates are negative for interenterprise lending suggests either that enterprises have few alternative investments or that lending to trading partners has the highest return for an enterprise’s survival.

The problem of large interenterprise arrears is not unique to Russia and the former Soviet Union.16 Economic transition has severed the connection of enterprise balances to the government budget, so that the financial losses of enterprises may become manifested in arrears. What distinguishes the experience in Russia from that of other previously centrally planned economies is the explosive growth in the level of arrears. The resulting large stock of arrears proved to be a great hindrance to economic reform.17 Arrears make privatization of state enterprises problematic by making it impossible to assess the financial viability of relevant establishments. Also, large outstanding debts tend to exacerbate the difficulties of enterprises seeking to secure further credits, especially from banks. Furthermore, arrears are an important mechanism through which the problems of some loss-making enterprises are spread throughout the entire economy. The rapid growth in the level of arrears indicates that this phenomenon is more than the natural mismatch of expenditure and receipts in a modern economy.

The growth of arrears in Russia is linked to financial underdevelopment in two important ways. First, the malfunctioning of the system of payments caused long delays between delivery and payment. While enterprises waited for payments to clear, their own liquidity and, indeed, their solvency was subject to payments risk from other enterprises. Delays in payments, by themselves, can cause growth in interenterprise arrears (Ickes and Ryterman, 1992).

Second, financial underdevelopment causes arrears through the loss of financial information. One role of financial markets is to enable market participants to distinguish illiquid from insolvent firms. This capacity was conspicuously absent in 1992. Consequently, enterprises were unable to borrow to finance short-term liquidity.

In an environment of underdeveloped financial markets, the financial autonomy of enterprises poses a severe constraint. Imposing hard budget constraints in such an environment essentially imposes a cash flow constraint on enterprises. This constraint is more severe than the net worth constraint that most firms operate under in market economies. Even in an interdependent economy—let alone one with a slow system of payments—imposing a cash flow constraint is probably a sufficient condition to create a large chain of arrears.

In the case of Russia, however, the cash flow constraint was not the only factor that worked in this direction. A critical factor was the survival orientation of enterprises. Survival orientation leads to arrears because the enterprise has more to fear from failure to meet payrolls than from debts to other enterprises. The consequence of the former is the very survival of the enterprise. If the director wishes to stay in control, a necessary, but hardly sufficient condition is that the enterprise stay in operation. Survival requires payrolls to be met. Delays in paying for materials could, in principle, result in delays in their delivery. But even if delays in delivery occur, the consequences for the enterprises are less acute.

The basic reason why survival-oriented enterprises refrain from restructuring is that, at present, there are better uses for their funds. Because of the high level of economic uncertainty that characterizes transition, the return to long-term investment in Russia is not always clear. This information problem is compounded because directors of state-owned enterprises, through loss of employment, may not be able to appropriate the gains from investments with future benefits. Consequently, investments that promise a rapid return and are highly liquid are preferred. Of course, such investments are limited. One present in the current environment is speculating against the ruble.

Perhaps the best use of funds, however, is to lend to other enterprises with which historical relationships are important. This is a direct investment in survival, since the survival-oriented enterprise perceives that its survival depends on the viability of its suppliers and customers. This influence certainly works against the development of capital markets. A capital market would move funds to higher-valued uses, but this move may not coincide with higher “survival investments.”

It is interesting to note how the growth in interenterprise arrears strengthens the role of the current directors in the enterprise. Enterprises can get away with arrears because suppliers are unwilling, or unable, to cut them off. But such an informal credit market works because of the historical relationships that enterprise directors have built up over the years. If the enterprise becomes reliant on this source of finance, the enterprise director’s marginal product is significantly enhanced. Replacing the director may jeopardize the relationships that have been built up, both with other enterprises and with banks, that are critical to survival.

There is a widespread belief among observers in both Russia and the West that the arrears crisis is history. It is certainly true that the level of accumulated arrears is presently much below the peak reached in June 1992. Institutional changes, such as prepayment, have had some effect.

The system of prepayment has greatly increased the problems of enterprises. The sudden change in the system of credit has made it very difficult for enterprises to obtain inputs. Prepayment requires enterprises to pay for inputs before selling the goods produced from them. When external sources of credit are limited or inflation is high (rapidly eroding the real value of internal financial reserves), this constraint is severe.

This difficulty in obtaining inputs has two effects. First, enterprises have drawn down their inventories of inputs. During the first half of 1992, enterprises accumulated inputs, often involuntarily. When prepayment became the rule, they drew them down. In a sense, the growth of arrears allowed enterprises to develop a cushion, which they used in the summer of 1992. The stock of inventories is not unlimited, however. The second effect of prepayment, therefore, is a decline in production. This decline in itself reduces the flow of new arrears; with lower production, less interenterprise credit is needed to finance production.

The system of prepayment is not universal. Enterprise directors still give credit to customers with whom they have historical relationships.18 Nonetheless, one might have expected that prepayment would have had an even more disruptive effect than it seems to have had. The reason that it has not is that the Central Bank has increased its credit emissions dramatically since the summer of 1992. Between June and October, central bank credit to commercial banks trebled, from Rub 580 billion to Rub 1.5 trillion, an increase in real terms of 100 percent.19 These credits were then lent to enterprises, often at interest rates that were highly subsidized.20

The importance of subsidized, targeted credit cannot be overemphasized. In 1992, directed credits from the Central Bank of Russia and the Ministry of Finance to enterprises were approximately 23 percent of GDP, and most of this was concentrated in the second half of the year. These credits are typically targeted by the Government to important enterprises. The Central Bank of Russia extends credits to commercial banks for the express purpose of lending to these enterprises, at annual interest rates far below the rate of inflation, and far below the interest rate in the interbank market.21

The key point is that as long as monetary policy remains loose, arrears should not be expected to grow. Arrears are the response of enterprises to tight credit policies. Moreover, institutional adaptation has taken place in Russia. The proliferation of banks that are used to acquire central bank credit suggests that the next time that credit is tightened in Russia the crisis will manifest itself differently.

The Link Between Enterprise Behavior and Stabilization

The role of financial development in macroeconomic stabilization is not well understood. Some economists argue that development undermines central financial control because it expands the variety of credit instruments that are available; hence, it weakens the connection between base money and nominal income, as velocity becomes more unstable. They argue, therefore, that financial development, as well as financial liberalization, should be postponed to a later stage in transition.

However, such an argument ignores two important effects that financial underdevelopment has on the ability of a government of a country in transition to provide macroeconomic stability. First, the absence of efficient systems of payment and financial intermediation have important real effects on the level of production and, consequently, on the amount of taxes collected. Second, the absence of these systems leads to the development of certain systemic features that undermine the credibility of macroeconomic policy.

Loss in Tax Revenues

Financial underdevelopment undermines the ability of the government to collect taxes. In Russia, the delay in payments between enterprises led to a delay in the realization of profits. It also resulted in enterprises searching for more efficient, and often unrecorded, means of transacting. This delay and decline resulted in a significant reduction in the real value of taxes collected.22

But perhaps more important and more subtle is the loss in taxes associated with the loss of output owing to financial underdevelopment. Problems in both the system of payments and the allocation of credit were significant economic shocks to enterprises. Without intervention by the government and other nonbank providers of credit, these shocks might have initiated widespread failures of illiquid, yet technically solvent, enterprises.

Enterprises responded to these shocks by creating an interenterprise credit market and other informal mechanisms to facilitate payment, such as barter and coupons redeemable for goods. Although these informal mechanisms alleviated some of the pressure created by the underdeveloped financial system, they are necessarily inferior to a well-functioning financial system. First, these informal mechanisms use real enterprise resources in their operation. For example, negotiation of interenterprise credit or barter transactions or the creation of near money use the time of senior enterprise managers, which could have been devoted to supervising production. In addition, transactions involving barter require the use of physical resources, such as labor and trucks to transport the goods.

Second, these informal mechanisms tend to operate based only on local information. For example, enterprises provide credit to their trading partners, in part because they do not possess information about the creditworthiness of other enterprises.23 Because the allocation of credit is not based on full information, it cannot be optimal in a first-best sense.

Finally, these informal mechanisms tend to rely on personal connections to make them work. As we explain above, this reliance on personal connections dissuades enterprises from adjusting. To adjust, enterprises must break away from historical relationships and create relationships with new trading partners, new bankers, and other agents. When the principal mechanisms of payment and finance are informal, this movement away from historic relationships introduces extra costs. Consequently, financial underdevelopment provides an important motive not to adjust. In this sense, underdevelopment is responsible for the gains from adjustment and for forgone taxes.

Loss in Credibility

The central paradox facing reformers in Russia today concerns the potential cost of signaling a commitment to market incentives in an environment ripe with the potential for market failure. The decline of communism affords policymakers the chance to alter fundamentally the rules of behavior in the economy. This is advantageous if the impediment to change is expectations developed in response to the old policy regime. It is dangerous, however, when that impediment is not expectational but structural.

The idea behind a commitment to the policy mix of low fiscal deficit, tight money, and hard budget constraints is that enterprise directors will change their behavior sufficiently that the threat of bankruptcy will not have to be executed. This threat must be credible; otherwise behavior will not change. Enterprise directors must believe that the policy regime has changed.

It is apparent that hardening budget constraints is a necessary condition for economic reform, but how to accomplish this objective is not clear. Early in the transition, it was thought by some (and still is today) that hard budget constraints could be imposed by will alone. The problem with this view is that, in the transition from planning, many enterprises will have to be shut down because they are not viable in a market context. Hardening budget constraints can alter the behavior of viable enterprises, but, for those without positive net worth under current credit conditions, the enterprise will fail no matter how vigilant the monetary authority.

More than credibility is at stake here. This fact is often forgotten when analyzing the consequences of shock therapy.24 Shock therapy does involve a regime change, and the comprehensive nature of the changes combined with the stakes involved may suggest that the assumption that the change is credible is warranted. But even if directors believe that the regime has changed, bankruptcies will still occur simply because some enterprises will not be viable in a market context.

It is useful to distinguish between two types of state-owned enterprises that are present at the onset of transition. These are enterprises that cannot adjust in a market context, the CA, and enterprises that will not adjust, the WA, because adjustment is costly. The key difference between the two types is that the lack of adjustment by the WA is a function of inadequate incentives, while the CA do not adjust because the opportunity cost of the resources they use is too high.

It is evident that the CA will shut down, but the question is when. The pace at which the CA are shut down depends, among other factors, on the stance of monetary policy. One of the costs of a strict monetary policy is that enterprise liquidations occur sooner than might otherwise happen. If the policymaker was indifferent to the timing of bankruptcy, there is no cost to a tighter policy that shuts them down quickly. But, if there are costs, the policymaker may wish to postpone shutdowns until the transition is sufficiently under way that labor can be absorbed elsewhere.25

A policymaker could be sensitive to the timing of shutdowns for various reasons. Timing could be important for political reasons. The policymaker could assume that if too many enterprises shut down at once, he will be fired. An economic argument about timing could point to congestion externalities; if many enterprises are shut down at once, the resources cannot immediately be absorbed into other uses. Or, social safety nets may be inadequate to cope with mass liquidations. Alternatively, the policymaker may believe that with time some of the CA can restructure, so that if bankruptcies can be delayed they can be avoided altogether.

The goal for the policymaker is to induce separation of the CA and the WA. The policymaker has some prior beliefs on the proportions of CA and WA in the economy as a whole. This probability judgment affects his or her willingness to commit to the tight money regime. If the proportion of CA is high, the tight monetary policy will precipitate their shutting down. To avoid adverse effects, the policymaker may prefer a more gradual sequence.

Let λ be the proportion of enterprises that are CA (λ = CA/(CA + WA)). It is important to note that λ is a function of credit policy. The higher are interest rates, the greater the proportion of enterprises that cannot adjust. The extreme case is where there is no credit, so a cash flow constraint exists; in that case, any enterprise that cannot cover its current costs is a CA.

The policymaker must estimate the likely behavior of enterprises, but the actions of enterprise directors (at least of the WA) depend on their expectations of what others will do. If all the WA adjust, and if λ is low, then for an enterprise not to adjust is costly, because it will stand out. If the director expects that others will not adjust, or if he expects that λ is high, then the likelihood that the director will not adjust increases. An essential strength-in-numbers phenomenon is at work here.26

A mixture of two uncertainties pertains here. First, there is uncertainty over types—whether the enterprise is CA or WA. The policymaker cannot distinguish these types ex ante. Second, there is uncertainty over actions—whether others will adjust or not. It is the presence of the uncertainty over types that allows for the possibilities for pooling. If λ = 0, the government induces adjustment by imposing a sufficiently strong penalty, which in equilibrium it never has to enforce.

It is much more difficult for policymakers to be credible about hard budget constraints when λ is high than when λ is low. When λ is low, few enterprises actually have to be shut down. When λ is high, and thus it is easier for WA enterprises to pool, it is much costlier for the government to carry out its threat. But it is precisely the credibility of the threat that is needed to get WA enterprises to adjust. The ability of the government to minimize the economic dislocation that occurs when hard budget constraints are imposed depends on the extent to which the government’s commitment to this policy is deemed credible by enterprises. The more credible the commitment, the greater the number of enterprises that will adjust. Consequently, a credible commitment leads to fewer enterprise failures.

However, in Russia during 1992, the credibility of the Government’s commitment to hard budget constraints was undermined in four important ways. First, the credibility of the Government’s policy announcements was weakened by intergovernmental conflict. The Central Bank of Russia was not under the authority of the Government of Yeltsin, but rather answered to Parliament, until the events of October 1993. But the Central Bank is the key provider of credit to enterprises. Therefore, even if the Government stuck to its policy, the Central Bank could let enterprises off the hook. The Government’s commitment to a low fiscal deficit is not a sufficient condition to ensure tight money. Thus, during 1992, the Government was relatively successful in reining in the fiscal deficit, but credit growth was still excessive.

Second, the relationship between net debt and gross interenterprise debt is arbitrary.27 Consequently, the government could not know, ex ante, how many enterprises would fail if the policy was, in fact, implemented. Hence, it could not identify the full economic costs of this policy before its implementation. This uncertainty provided opponents of this policy fertile ground for dissent. It is in this aspect that the transition problem in Russia differs most markedly from that of stabilizations in other countries. The problem in Russia is not just that the loose fiscal policies of the Government relieve the pressure to adjust, but that the legacy of central planning is an industrial structure that is ill-suited to markets. Unfortunately, the Government does not know how ill-suited it is; only through marketization will this information be revealed.

Third, in Russia, the decision about the viability of enterprises focuses almost solely on the liquid position of the enterprise. In a real economy, the decision about viability should be based on the net worth of the firm. To calculate net worth, information about the value of an enterprise’s assets is needed. However, without developed financial markets, this information cannot be obtained. In Russia, assets are valued at historical values, which, given the developments in Russia during 1992, renders them useless.28 This lack of information makes it nearly impossible for enterprises to borrow against future income. The measure of viability of enterprises in such a regime is not the net worth of the enterprise, but rather its current cash flow. Under such circumstances, imposition of a hard budget constraint may not only result in the wrong enterprises being shut down, but also in directors making decisions that lead to declines in the present value of the assets. Without information regarding the financial viability of enterprises, no arbiter can evaluate the proper disposition of an illiquid enterprise.

Finally, enterprises themselves can affect the level of information about enterprises that is available in the economy, specifically, by manipulating the level of payments in arrears. As explained above, the absence of financial markets heightens the importance of information about the liquidity of enterprises when assessing their viability.29 When many receivables remain uncollected and many debts remain unpaid, even the liquid position of most enterprises is difficult to assess. Consequently, arrears provide enterprises with a weapon to sabotage the government’s commitment to hard budget constraints.

Interenterprise credit plays a crucial role here. The ability of WA enterprises to pool requires a source of credit. First, credit is needed by the CA to stay open. “Normal lenders” would refuse to lend to a CA. Interenterprise credit plays an important role, because it is motivated largely for reasons other than expected profitability. Enterprises lend to others because of survival orientation. Also, many do not know if they are WA or CA; this is an important characteristic of the noisy phase of the transition.

Interenterprise credit expands the strategy space of enterprises. Without this credit, the government would find it much easier to enforce separation between CA and WA. Moreover, without this source of credit, the cost to WA enterprises of not adjusting would be much higher. It is the presence of this type of funding that makes this strategy preferable.

The development of financial markets is a critical step to enable policymakers to distinguish CA from WA. The purpose of financial institutions is to separate these two types of enterprises. When financial institutions are underdeveloped, there is little information at the enterprise level. As we have emphasized, financial underdevelopment in Russia makes it extremely difficult to distinguish insolvency from illiquidity. What does this tell us about stabilization and regime change? At the very least, it suggests that it is naive to think that tight credit policies can be enforced without severe consequences. The idea that enterprises will adjust to a credible tight monetary policy would be valid if λ were close to zero. As Russia must restructure from a position where λ is much higher, tight money is just not credible. This feature suggests that imposing financial discipline on enterprises will be a prolonged process.

Given that hard budget constraints cannot be enforced immediately, what should policymakers do? To improve efficiency, it is important to convert subsidies from ex post to ex ante. Subsidies that are ex post do not induce cost-minimizing behavior because the government will pick up the losses. Ex ante subsidies, on the other hand, alter the incentives that enterprises face.

It is also critical to induce enterprises to operate in financial markets rather than interenterprise debt markets. The goal of policymakers should be to improve information at the enterprise level.

Adaptation

Even (especially) in an underdeveloped financial system, banks and enterprises adjust to financial shocks. One of the effects of the arrears crisis was a change in the behavior of banks and enterprises. These adaptations to financial stringency have effects on the functioning of the system. In particular, if banks and enterprises adapt by adopting more informal mechanisms, the effectiveness of the financial system decreases, as does the capacity of the center to control events.

Financial innovation as a response to tight monetary policy is a common phenomenon. In the United Kingdom and the United States, the adoption of precommitted monetary targets in the late 1970s led to a series of financial innovations that have severely weakened the relationship between monetary aggregates and nominal incomes.30

We have already explained how interenterprise arrears exploded as a response to tight credit in Russia in 1992. But this experience has also induced financial innovation by Russian enterprises. Indeed, as Thornton (1993) emphasizes, “the build-up of inter-firm arrears has provided a means by which managers of firms with poor long-run prospects can capture the income from production in the short-run while leaving the government with the obligations to print rubles to cover the unpaid costs of the firm.” Thornton quotes Nikita Kirichenko (Kommersant, Vol. 42, October 18–24, 1993, p. 4):

Many enterprises have already undergone a process of clearing arrears and know how it is done. Among other things, they know how to acquire subsidized credits: simply arrange a sham contract to supply a shell organization with a few units of output at fantastic prices and the desired credits will be forthcoming.

The essential point is that in an environment of underdeveloped financial markets enterprise directors, who control rather than own their enterprises, are innovative at finding means of decapitalizing the assets. Our argument is that this process is enhanced by financial underdevelopment.

Perhaps the most important example of this is the proliferation of banks, formed by groups of enterprises, as a means of obtaining subsidized credit from the Central Bank. The vast majority of these banks act more as agents than as financial intermediaries. Thornton (1993) refers to them as “quasi-state organizations” because their activities are largely oriented to preferential or subsidized financing, responding to administrative rather than market-based incentives.

As the proliferation of quasi-banks is the response to the opportunities to obtain subsidized credit in an environment of inflation, it becomes increasingly difficult to assess the viability of individual enterprises or the quality of loan portfolios of these banks. The danger inherent in this situation is that when the next credit crunch occurs, the crisis will be centered in the banking system. In this case, financial underdevelopment will continue to make tight monetary policy problematic, but the manifestation will not be interenterprise arrears, but arrears from enterprises to banks. If this happens, a future credit crunch may pose grave danger to the entire banking system.

Another important innovation to the current environment in Russia is the development of financial-industrial groups. These groups solve two problems for their members. They secure deliveries for enterprises by strengthening vertical relationships. In this way, they enable enterprises to circumvent the difficulties posed by an inefficient distribution system. This tends to solve an important problem for enterprises: maintaining supply relationships in the wake of the collapse of the state supply system (Gossnab). For our purposes, however, the more important function that these groups provide is financial. These groups enhance enterprise viability by being a source of finance to the members.

The proliferation of these financial-industrial groups may result in a “balkanization” of financial markets. Such a process could have important long-run effects for Russian economic development. These groups are likely to be regional in nature. Moreover, they tend to preserve existing relationships between enterprises rather than promote restructuring and market reform.

The likelihood that the next financial crisis will appear in a different form is enhanced by the efforts of these financial-industrial groups to insulate themselves from the next credit crunch by establishing banks. For these groups, banks serve as a means of securing for themselves a source of finance. It is also a means of circumventing an ineffective payment system. However, a banking system that is created out of these motives is not likely to be stable.

The arguments we present in this paper suggest that, in an economy in transition with an underdeveloped financial system, monetary policy must be sufficiently restrictive to encourage enterprises to adjust, but not so restrictive that enterprises choose to react in a way that undermines economic reform. If the government chooses to tighten credit too quickly or too severely, the credibility of the policy will once again be brought into question. Moreover, as long as financial markets are underdeveloped, tight credit policies have deleterious unintended consequences, such as gridlock in the payment system and arrears in the payment of taxes. Efforts to impose financial discipline on enterprises must therefore be associated with progress in developing the financial system in Russia.

Comment

Jacek Rostowski

The magnitude of the interenterprise debt problem seems to have diminished sharply in Russia recently. Whereas payments arrears on the kartoteka dva—that is, as calculated by commercial banks-accounted for Rub 3 trillion (about 50 percent of annual GDP in June 1992—at June 1992 prices), by December the estimate for “accounts receivable” was Rub 5 trillion, or only about 16 percent of GDP.1 The question is whether the problem will return in its acute form after stabilization.

The Polish experience2 shows that if a stabilization program is credible, interenterprise debt will decline in real terms rather than increase. In Poland after stabilization the real value of such debt fell by almost half (from 18 percent to 10 percent of GDP), and has since remained at approximately that level. This occurred in spite of an almost complete absence of bankruptcies in the first six months of the Polish program. The key factor seems to have been high interest rates on loans and particularly on deposits. The latter made suppliers unwilling to give credit to customers.

Just how likely this is to happen in the Russian case depends to a large extent on one’s explanation for the decline in real interenterprise debt since the summer of 1992. The optimistic explanation for this decline is that, although there was a multilateral clearing of such debt in August-September 1992, it came too late to save the enterprises that had extended this credit from severe losses owing to the fall in its real value. In this case, one can be quite optimistic about the likely behavior of interenterprise debt upon stabilization. The pessimistic interpretation would put most of the stress on the very rapid rate of growth of nominal credit since the multilateral clearing exercise. However, the fact that the ratio of bank credit to nongovernment GDP rose only slightly, from 12 percent in June 1992 (which was when real interenterprise debt reached its peak) to 14 percent in March 1993, inclines one toward the optimistic interpretation.

Nevertheless, given the quality of current economic data in Russia, it is as well to be prepared for the possibility of a surge in interenterprise debt after stabilization as occurred in 1992 after liberalization. How should such an explosion of interenterprise debt be dealt with? The worst action is to inject money into the economy. The next worst is a multilateral clearing, as this is in effect a government-sponsored equalization of the value of all debtors’ interenterprise liabilities and also the setting of their real value equal to their nominal value. As such it causes severe moral hazard problems. The best way of handling a surge in interenterprise debt is to do nothing: Latvia, which had an interenterprise debt/GDP ratio very similar to that of Russia in May 1992, refused to carry out a multilateral clearing, and now has inflation of a few percent a month and a fully convertible currency that has been appreciating against the U.S. dollar. An important part of doing nothing is, of course, to have positive real interest rates as part of the stabilization program.

However, if there are doubts about the authorities’ political ability to resist calls for inflationary solutions such as multilateral clearing or money creation, making interenterprise debt tradable should be considered. One of the main reasons for the difficulties surrounding such debt is that a properly functioning bankruptcy system does not exist in most previously centrally planned economies,3 so that interenterprise claims cannot effectively be enforced directly against debtors. If this debt is made tradable, creditors can obtain liquidity by “by-passing” their debtors and selling their claims at a discount to the debtors’ debtors. The creditor’s liquidity gain is the debtor’s loss, as the debtor will not then obtain the money he is owed by his own debtor. For this to happen, the debtor’s debtor must be able to set the face value of his creditor’s liability against his own liability to his creditor, and only be required to pay any residual. Debtors themselves would of course be able to bid for their own liabilities by offering to buy them at a discount in exchange for immediate payment. Tradable debt is after all the solution that has been generated by the market in that other area in which bankruptcy is impossible-sovereign debt.

The simplest way of ensuring that interenterprise debt is tradable is to require suppliers to obtain a properly executed bill of lading, bearing the signatures of the relevant authorized persons representing the customer. If such a bill is not obtained when goods are delivered, the goods would be deemed by law to be a gift from the supplier to his client. If the bill is obtained, it is deemed a formal liability of the client, obliging him to pay within a certain period, and can therefore be sold by the supplier at will.

The question of what happens if the debtor goes into liquidation while it has outstanding interenterprise debt that has been bought by one of its debtors is not an insurmountable problem. First, the right to offset a debtor’s interenterprise liabilities against his assets is needed because of the absence of a functioning bankruptcy system. Thus, problems in exercising this right will not normally arise as a result of bankruptcy. Second, the right to offset interenterprise liabilities against assets could only be made good against the debtor before his bankruptcy has been declared, as with other kinds of liability; after this date they would have to be submitted to the liquidator for settlement.4

The most important result of such an interenterprise debt market is that it eliminates the danger of a “liquidity logjam,” by which whole chains of enterprises can claim that they cannot pay each other or—possibly more dangerously—the budget, because they have not themselves been paid. If interenterprise debt is tradable it will allow liquidity to flow to where it is most needed, possibly cutting out whole bands of nonpayers, and at the same time revealing the true revenues of suppliers.5 In this way, most of the arguments for inflationary solutions to the interenterprise debt problem will be eliminated. The pressure to increase the money supply so that it can affect the existing nominal mass of payments due should disappear when the nominal value of these payments can adjust itself automatically to the existing money supply.

Furthermore, interenterprise debt trading will—if public—generate useful information regarding the standing of various enterprises. A firm, its suppliers, and its direct customers are likely to be as well informed about its financial situation as any group of actors in the economy, and in public auctions of interenterprise debt their collective assessment would become available to all. If such auctions existed, and if, furthermore, this debt was made convertible into equity (at nominal value into the book value of enterprises’ “own funds”), this could be a powerful tool for the privatization of the economy. Something similar is being done in Poland under the enterprise and bank financial restructuring program. As part of a compact between creditors and a bad debtor, bank and interenterprise debt can be traded, and any holder of more than 30 percent of a bad debtor’s liabilities can have them converted into equity at par (subject to the approval of the Ministry of Privatization).

References

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1

The views expressed should not be attributed to the World Bank, its Board of Directors, its management, or any of its member countries.

2

McKinnon is nonetheless a well-known advocate of the role of financial development for economic growth.

3

“Such reliance on self-finance is the simplest technique for imposing financial restraint on liberalized enterprises. Bankruptcy would be virtually automatic if their internal cash flows became negative for any significant length of time” (McKinnon, 1991, p. 139). McKinnon is clearly correct that self-finance is the most transparent rule for implementing a hard budget constraint. There are two problems, however. First, it is not clear that the inability to self-finance is the optimal liquidation rule. Second, as we explain below, it is not clear whether a government can credibly commit to such a rule under the conditions of transition.

4

This problem does not plague most countries that have underdeveloped financial systems because they usually have underdeveloped industrial systems as well. What makes Russia, and by extension other previously centrally planned economies, interesting is that the development of the latter proceeded so far ahead of the former.

5

The nature of the payment system and its role in generating interenterprise arrears is analyzed in Ickes and Ryterman (1992).

6

Enterprise directors frequently emphasize the role of “historical relationships” in discussing the financial system in Russia in 1992.

7

Enterprises are very active in creating banks. However, as we explain in the final section, the dominant purpose of these banks is not to conduct arm’s-length financial transactions, but to provide their founders with low-interest sources of credit.

8

The implications of this problem on the credibility of announced changes in the monetary regime are discussed below.

9

For a discussion of the survival-oriented enterprise, and its implications for the transition, see Ickes and Ryterman (1993b).

10

Especially if measured in terms of value added or employment.

11

For a discussion of the vertical dependence of enterprises in Russia and its relationship to industrial concentration, see Brown, Ickes, and Ryterman (1993). This dependence is clearly a force that leads to the formation of financial-industrial groups.

12

It is the same as the problem for the cowboy trying to ride a bronco (never having ridden a horse before) from Moscow to Paris. At first, the cowboy does not care whether the bronco is going north, south, east, or west. All he cares about is not being thrown off the horse. Only after the horse is under control does the cowboy turn the horse toward the sunset.

13

For more on the arrears crisis in Russia, see Ickes and Ryterman (1992, 1993a).

14

For more discussion of savings under the old system, see Ickes (1993).

15

Large firms in the United States tend to have greater access to bank credit and the commercial paper market than do small firms. Therefore, large firms often borrow from banks and lend to small firms (Jaffee and Stiglitz, 1990, p. 879).

16

For a discussion of the Romanian case, see Clifton and Khan (1993). For Hungary and the former Yugoslavia, see Mitchell (1993).

17

To a large extent, the growth in arrears reflects the contradictions in the reform process. That is, arrears have risen precisely because many enterprise directors did not believe that the program’s calls for hard budget constraints were credible. As they continued to behave as if it was business as usual, the arrears have been the outcome.

18

This response was common among enterprise directors interviewed in October and November 1992.

19

The Economist, December 26, 1992, p. 107. Central bank credit to commercial banks is especially important in Russia because deposits from the public (except for those in Sberbank) are almost nonexistent. These credits were part of a program of directed credits targeted to industry. The credits came from the Central Bank, with an interest subsidy paid by the Government. It seems to be true, however, that the Finance Ministry borrows from the Central Bank to finance the interest subsidies.

20

Central Bank of Russia credits to industry that were “not subsidized” carried interest rates 3 percent above the Central Bank’s refinance rate. This rate was 80 percent annually in the fall of 1992. With inflation at 25 percent a month, 80 percent still seems quite a good value.

21

There are really two parts of the subsidy. First, the explicit subsidy is the difference between the central bank finance rate and what the enterprise was charged. But the central bank rate is itself below market; hence, it embodies an implicit subsidy. One measure of this implicit subsidy is the difference between the central bank rate and the nominal interest rate that would make the real interest rate equal to zero.

22

See Ickes and Ryterman (1992) for a discussion of the tax implications of arrears.

23

Enterprises also tend to favor their trading partners in the allocation of credit because they benefit directly from the continued operation of their trading partners.

24

Shock therapy is too simplistic a term to describe the reform policies employed in Russia (or Poland), but the name, unfortunately, has stuck.

25

Ericson (1994) analyzes the problem of how to shut down enterprises optimally in the transition.

26

Calvo and Coricelli discuss the role of strength in numbers in generating arrears in Chap. 11 of this volume.

27

For an explanation of this relationship, see Ickes and Ryterman (1992).

28

Assets were revalued in October 1992, but given the monthly inflation rates in the last quarter of 1992, book values have again lost any serious meaning.

29

This information problem also makes difficult an oft-heard suggestion for dealing with this problem—securitization. The idea of allowing secondary markets in arrears seems appealing. But under the conditions that prevail in Russia it is precisely the trading partners of an enterprise that are most informed about (or at least interested in) its viability. The lack of information explains the absence of other lenders. Who would buy the “securitized” arrears? If agents were willing to lend to these enterprises, why have they not simply lent to them directly? Such markets have not yet formed precisely because of these information problems.

30

Goodhart (1989, pp. 377-80) provides an excellent analysis of this process. In the United Kingdom and the United States, the effect of monetary targeting in a period of high inflation was to increase the variation in the burdens of tight money (since large depositors could receive market rates of interest). This increase in variation, in turn, led to pressure to deregulate and to financial innovations around restrictions. These developments in turn weakened the relationship between monetary aggregates and nominal income.

1

I am grateful to B. Granvelle for the figures for monthly GDP in June and December 1992, which allowed the calculation of annual GDP in June and December 1992 prices through the simple expedient of multiplying by 12, and to Russian Economic Trends, Vol. 1, No. 3, for the June 1992 figure for interenterprise debt. The December 1992 figure for receivables was provided by the Russian Government’s Center for Economic Reforms. The figure given by Ickes and Ryterman seems to relate receivables at end-1992 to nominal GDP throughout 1992. Since inflation was very rapid, this would understate GDP in December 1992 prices and thus overstate the receivables/GDP ratio. However, all GDP figures for Russia in 1992 (and particularly those for monthly GDP) must be very tentative. The extent to which the arrears data for June and December 1992 are comparable is also questionable: the first figure comes from the kartoteka dva (the so-called File No. 2) on bank accounts and is therefore exhaustive; the second is merely an estimate by various Russian Government institutions.

2

Described in Jacek Rostowski, “The Inter-Enterprise Debt Explosion in the Former Soviet Union: Causes, Consequences, Cures,” Communist Economies and Economic Transformation, Vol. 5, No. 2 (1993), pp. 131-59.

3

The existence of a bankruptcy law is not the same as the existence of a bankruptcy system. Only Hungary has an efficient bankruptcy system. Poland has had a law since the beginning of its reforms and a system that is still very inefficient but is slowly improving. The Czech Republic’s bankruptcy law only came into force in April 1993.

4

A market of this kind exists in the interenterprise debt of Polish coalmines, and these liabilities are used as payment to the mines by some of their customers. In Poland the right to set interenterprise assets and liabilities against each other derives from the civil code.

5

It is of course these and not the formal sales prices that must be taken into account in calculating profit and sales taxes.

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