GD RETURN TO ARCHIVE S IN HBl-001 0 o I';N #9 D3 1L s~~~~S kcc#lA2 D0 E3 N 0 I 0 e Source: Intemational Telecommunication Union (2000). Box 3: Backbone Transmission Services International Internet connections are provided by Rostelecom, Relcom, Sonera or through resellers. Rostelecom itself provides almost no end-use access to the Internet but rather is positioning itself as a carrier of ISP traffic, being the only operator with a nation-wide broadband backbone capacity and high quality international connectivity. Rostelecom provides a network for over 70 ISPs, with 41 hubs in 35 Russian cities, with the biggest hubs being in Moscow, St. Petersburg, Novosibirsk, Khabarovsk, Rostov-on-Don and Samara. At the end of 1999 Rostelecom had 192,800 km of trunk lines, of which only 16.7% were digital. Data transmission is based on a number of networks including Global One, Rosnet, Rospak, Infotel, MMTEL, Business Net and Sovam Teleport. Licensing. The Licensing Law establishes that each type of licensed activity be covered by a separate license. Licenses issued by the federal authorities are valid within the Russian Federation, whereas regional licenses (issued by regional authorities) only apply within specific regions. Licenses are issued for a period of at least 3 years and up to 10 years. The Department for Communication Activities Supervision has the right to monitor communication activities, suspend, renew and revoke licenses. Box 4 reports the most relevant drawback and distortions created by the Russian licensing system. The key regulatory issue emanating from the telecom operators we studied is the lack of transparency in licensing procedures, aggravated by the lack of formalized and specific appeal procedures. Most ISPs need two basic licenses (one telematic-email and hosting-and one for data transmission). Several other licenses are required by ISPs that provide a range of services (including Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 47 channel leasing, equipment certification, and software for mail). Certification of telecommunication equipment is required by Art.1 of the Communication Law. The procedure entails a telecoms equipment manufacturer to send an application to the Certification Department of the Ministry of Communications for preliminary technical analysis. The equipment is then tested for quality assurance by one of designated certification laboratories. This involves testing in the field and at the enterprise's site. Equipment certification procedures are often cited as unduly burdensome. IP telephony has been legalized as a telematic service and consequently it has been subject to less complex regulation than if it had been designated as telephony service. Box 4: Cream-Skimming and Licensing The current licensing regime enables new competitors to concentrate on providing services to the cream of the market. They provide services that are lucrative because there have been no restrictions and negligible fees imposed on them when receiving licenses. As a result, competition has not developed outside of the most profitable regions, including Moscow, St. Petersburg and Krasnodarskii. Additionally, 7,500 licenses have been issued for specific services in narrowly defined geographic markets. This contributes to further distortions. Finally, licensing decisions have not followed uniform industry development plans. Even within the number of active licenses, the intensity of competition is limited to certain customer segments -particularly for business users- and regions (Greater Moscow and the NorthWest). Every year during the lifetime of the license, each license is subject to confirmation. Problems of red tape and formal complications abound. Formal technical requirements are very unclear and, in some cases, inconsistent between each other (see Box 5). Box 5: Certification of Equipment and Technical Requirements A small ISP operating in St. Petersburg has complained of the serious problems faced in the process of getting certification of equipment. The application is frequently sent back to the company saying that it does not fulfil all of the requirements, but not specifying which ones. When the company approached different officials, it received different answers, so that this process has been protracted for almost a year. A recent entrant in the Internet market in Moscow that received a license in 1997 complained that telematic and data transmission licenses contain requirements in terms of quality standards that are not further defined. It is not clear how to ensure quality for Internet users and thereby obtain compliance with the license conditions and thus receive confirmation. ISPs report that it is often very hard to locate the appropriate documents for licensing and certification requirements and that one learns about interpretation of rules only during the inspection. One ISP had problems even with certification of air conditioning equipment. An example of the cost and time required for fulfilling such requirements is illustrated in Box 6. Box 6: The Cost of Abiding by Licensing and Certification Procedures According to a Yekaterinburg ISP, the local preparation of its papers took about 3 to 4 months, then another 3 months for the papers to be considered by the MoC. All license application papers had to be sent to Moscow to the federal Ministry. The cost was about US$10,000 in 1997, which is substantial since the fees are multiplied by the number of oblasts in which the company operates. The process of certification of equipment was considered particularly onerous in terms of time and associated costs, as the company had been forced to prepare itself most of the required documentation and pay a fee to the specialized entity for signing the documentation. Inspectors from the local surveillance body visited the company and tested the quality of equipment in detail. It is sometimes necessary to actually downgrade the parameters of existing equipment in order to be granted the required certification. Required compliance with government surveillance systems imposes significant costs on ISPs. A federal law of August 12, 1995 "On Operational-Investigative Activities" initiated a surveillance system known as SORM (System for Operational-Investigative Activities) which is operated partly by the Federal Security Service (FSB), the government agency responsible for surveillance. The 48 The Regulatory Regime in Russia regulation requires all ISPs, automatic telephone exchanges and also mobile telephone and paging companies to install special transmission monitoring devices so that government can monitor electronic traffic, including e-mails. It requires all providers to finance the cost of additional equipment needed to make their systems compliant. A warrant is required to monitor individual e- mail correspondence. SORM-2, a technical regulation issued jointly in July 2000 by the FSB and Gossvyaznadzor, requires ISPs to provide the technical upgrades (including criminal investigative functions and expertise) necessary to reroute all transmissions directly to the FSB in real time. Seven other state entities, including the Interior Ministry and the Tax Police, are also able to access transmissions. Reportedly, the intention of such regulation is to uncover terrorists, spies and other illegal activities, following the arrest of five suspected hackers, who were accused of stealing credit card numbers from Internet retailers for an amount of US$630,000. Nevertheless, it represents a very onerous requirement to Russian ISPs (see Box 7). Box 7: Surveillance Requirements Every ISP has to host a "black box" interceptor to tap Internet traffic. The ISP pays for the black box and a high- capacity line to the FSB state security service headquarters. Failure to put in the bugging devices means the loss of the ISP's license. Apparently the FSB uses the fact that Echelon, a satellite traffic-tapping system, is also operated by the US and UK as justification for its stance. In the UK, however there must be a warrant issued by the Home Secretary according to online security laws (Regulation of the Investigatory Power Act). The harsh sanctions for refusing to implement SORM is illustrative not only of the operational problems that companies face when not implementing costly surveillance rules but also the discretionary powers of Gossvyaznadzor in interpreting other telecom-related regulations. SORM is reportedly a red flag to investors looking at Russian telecoms and the Internet. This requirement has caused concern among human-rights activists because e-mail, e- commerce transactions and other Internet traffic can be easily monitored without anyone ever knowing, regardless of-whether a court warrant has been obtained. The unpredictability of changes in licensing terms at the time of renewal is extremely high. This dramatically reduces ex-ante incentives to invest in view of the ex-post renegotiation of licensing conditions (see Box 8). Overall, such a regulatory environment creates an uneven playing field, which penalizes new entrants not only because they find more restrictions on their operations, but also because of more complicated procedures. Telecom operators with a presence in more than one oblast also find that in each oblast they experience idiosyncratic problems due to the absence of standardized licenses, clear guidelines and different interpretations of the same law. Box 8: Uncertainty in Renegotiation Terms Telecom operators that went through the process of renewing a license experience a dramatic change in the conditions attached to the license. Specifically, at the start, the Ministry of Communication attaches to the license very strict conditions for obliging the telecom operator to make investments in the network or reach certain targets. The trend is now going in the opposite direction; that is, licenses are becoming extremely restrictive in terms of services and at the same time much less demanding in terms of obligations. Interconnection. Users and operators are given the right to interconnect their network and terminal equipment to the PSTN if they meet the "interconnection requirements" set out by the government, which are provided by the common carriers or stipulated in the license. Since the list of conditions under which access can be denied includes lack of technical capabilities, many carriers experience delays and difficulties. The very same problems are reported all over the visited oblasts and relate to the severe under-investment in the basic network. There are provisions of non-discrimination among operators when issuing technical requirements for interconnection, but the criteria to assess discriminatory behavior are not defined, nor is the role for the regulator to detect and deal with discrimination. Lack of transparency and reasonableness with respect to fees prevail as well (see Box 9). Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 49 Box 9: Discriminatory International Interconnection Terms ISPs are victims of discriminatory behavior in getting international connection. Not only are prices set in a discriminatory way, but price increases are not uniform and hit some enterprises in a severe way. The only way forward by these firms is to unite together and complain directly to the provider of the interconnection or build their own infrastructure (a very expensive alternative). Notably, the few ISPs that rely on their own infrastructure report problems of restrictive policies for telecom operators to establish their own equipment. On the other hand, the remaining operators complain with respect to barriers to entry created by ISPs owning their own infrastructure, by creating de facto monopoly access and refusing to resell access to other players. A local ISP that started operations 3 years ago in Moscow finds that although it is prepared to pay, it often faces difficulties in acquiring new lines, with the leading regional operator refusing to give lines to all but its own subsidiaries, on the grounds that they lack technical capabilities. Problems appear to be particularly severe in less developed oblasts, very likely because of the quasi-monopolistic structure for interconnection providers. From the firms studied in Yekaterinburg, there is a striking difference between the interconnection-related problems across different operators, depending on their links with the local fixed line operator. An ISP that has ownership links to the main city operator enjoys a very privileged position, as it can negotiate very aggressive interconnection prices and does not have any interconnection problems. The situation varies substantially for other ISPs in the same city for which interconnection costs are very high, amounting to 60-70% of revenues. Currently there are well-connected telecom operators that receive special terms of access to the network, tilting even further the already very unequal playing field. Box 10 provides strong evidence of the different terms of faced by small versus large ISPs. Box 10: Uneven Playing Field: Access to the Local Network A small ISP in St. Petersburg experienced serious problems in having access to the local exchange. It spent an average of 3-4 months to get access to new lines after applying for them. Three months after they bought 100 lines, they were informed of a price of more than 5 times the original price. It tried to appeal without success: the main reason is that contracts are designed so that any terms of the contract (including prices) can be changed and the only obligation on the suppliers' side is to inform of any variations. The general manager tried to negotiate for a long-term contract (setting the prices for at least for a year, much shorter than that for larger ISPs, which have on average 3 year contracts); but he did not reach any agreement. The same company also had to give up access to digital lines as soon as the provider decided not to offer discounts and the unit price per line (US$130) was higher than their maximum revenue per line (US$100). They appealed this decision, as there were no other alternative suppliers of such services. But they have not received any answer after 6 months. Most of the ISP companies studied do pass high interconnection charges onto the customers. Among the main complaints that they receive from business customers are the lack of lines for good quality access and the high price for dedicated channels. ISPs do not feel they have much control in improving the situation unless they invest in lines, which, as already noted, can be a very expensive alternative. There appears to be reluctance by ISP operators to launch formal complaints regarding interconnection problems. To address those instances where the two parties cannot come to an agreement on their own, Russia established an Inter-agency Commission for Dispute Settlement in September 1999, under instructions from MoC and MAPSE. However, of the 17 cases that came forward in the first year, none related to Internet or mobile telephone providers, with almost all brought forward on technical grounds by traditional voice operators. Where interconnection problems are more severe, e.g. in less developed oblasts, problems of interconnection both at the federal and departmental MAPSE have not been raised by ISPs. The reluctance to launch formal complaints in an environment where switching providers is not an option might be explained by the desire to avoid subsequent problems with businesses that one is compelled to keep working with. 50 The Regulatory Regime in Russia Other Regulatory Distortions. Interestingly, the same enterprises suffering from problems of access to the Internet network face similar problems in access to electric power-they are switched off from electricity provision without any explanation. This causes serious problems in terms of interruption of service, direct compensation that the company needs to pay to their customers, as well as reputational losses and consequent loss of clients. In general, we found that regulatory distortions are biased against smaller companies. Given the fixed nature of regulatory costs, the burden of regulation falls most heavily on smaller start-ups. Costs can be substantial relative to revenues generated by a small enterprise. There is also the continuous uncertainty of new regulations (see Box I 1). Box 11: Regulatory Costs Biased Against ISP Start-Ups According to a Yekaterinburg ISP that has 30-35 employees, administrative and utility-specific regulatory requirements are very rigid. Although a small company in terms of employees, they must employ a part-time specialist on labor safety, sanitary and hygienic standards. It takes significant expenditures of time. This company estimates that the total costs of meeting all requirements amounts to 7-10% of annual revenues. The uneven playing field penalizing smaller ISPs is aggravated by the problems on the demand side. Such problems include less attractive customers that view the Internet as less essential for their work, as the largest customers are served by few privileged ISPs (see Box 12). However, very limited problems of non-payment are experienced, because of pre-paid tariffs-increasingly used after the 1998 financial crisis (especially in the case of riskier groups)-and due to the practice of dealing only through agencies that guarantee the payment of the associated enterprises. Box 12: Privileged Access to Customers The largest telecom players provide services to the corporate network of Russia's large firms, government entities, and infrastructure providers, whereas smaller players concentrate on individuals, but increasingly target SMEs. Some telecom operators identify the fact that for many users the Internet is still a curiosity rather than a necessary tool, although such attitudes are gradually changing. Privileged access arises from the fact that the main providers keep prices relatively high and adopt a competitive strategy aimed to ensure high quality in order to keep their most lucrative customers, rather than targeting the smaller customers. The main determinants of the effective use of the Internet in Russia on the demand side are the cost and availability of services and purchasing power, as well as the availability of Russian language content. If the average Russian Internet user spends the same percentage of his/her income on the Internet as the average US user (adjusted by a deflator based on the relative Internet penetration), this would amount to just under US$ 9 per year per regular user. This does not seem to be a prohibitive amount for the average Russian. As a result, the main barriers to the use of Internet seem to be the lack of Internet penetration, and the difficulty of the conducting the transaction, rather than the lack of purchasing power. We have already examined in detail the main drivers for the lack of Internet penetration, which depends mainly on the supply side and the lack of competition, which keeps prices artificially high. The difficulty of conducting a transaction via Internet depends on the low credit card penetration in Russia, which is aggravated by the little faith that Russians have in their banks (apart from Sberbank) after the crisis of 1998, when those Russian retailers who accepted credit cards were badly burned. One channel to pay for transactions over the Internet is through Sberbank, which could make transfers to Russian sites that accept such forms of payment (such as Cyberplat.ru, Webmoney.ru, Paycash.ru, Assist.ru and Intemetbank.ru) and provide for transactions with participating Internet stores. Prepaid cards provide another alternative, but they are subject to a commission to the dealers and to VISA or some other financial intermediary. Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 51 A more general problem depends on the lack of market awareness. A survey on public awareness of the Internet, conducted by the Obshchestvennoye Mneniye (Public Opinion) Foundation was released in 2001. The survey involved interviews with a sample of 69,610 people in 115 Russian cities. The main findings were that 51.04 million Russians (55.9%), are barely aware of the existence of the Internet: 20.3% said that they had heard nothing about the Internet and 35.6% declared that they had heard 'something'. The survey suggested that 10.3 million Russians (11.3%), have access to the Internet at work, at home or through friends. It also suggested that the number of actual users is only 3.3 million people (3.6%); that Web use is dominated by the capital city, as Muscovites make up as much as one quarter of users, with the inhabitants of St. Petersburg coming next; and that interest in the Internet is, however, growing gradually in the major cities of the Urals, the Volga and the South Federal Districts. The availability of quality telecommunications services both attracts new investment to a region and increases the return on investments made. For industries that are intensive user of Internet services or where Internet use is essential, improvements in the availability, price and quality of Internet services stimulates the entry of enterprises and results in a whole new range of products being offered. More broadly, the benefits of rapid growth in e-commerce is in inducing the number of intermediaries necessary for transactions, reducing costs and stimulating further activity. Carrying transactions over the Internet brings more transparency to the conduct of business, thereby also increasing efficiency; see Box 13. Box 13: The Impact of Internet on the Real Economy The impact of improvements in Internet services is most direct in two types of industries. First, there are those industries that directly generate all or a large part of their revenues from the Internet, such as Internet application providers (web design, web hosting, Internet consulting), Internet intermediaries (portals, online brokerages) and companies conducting online transactions (e-tailers and online entertainment). RFK (Russian Financial Communications), a company that offers Internet payment systems, has calculated that if all Russia's Internet users were to make their water, gas and electricity payments online, that would draw well over 380 million rubles or over US$ 13.5 million to the Internet each month. Second, there are those industries that do not generate revenues directly from the Internet but are intensive users of Internet services, such as software producers, financial institutions and media companies involved in publishing and broadcasting. Although Internet costs are not sizeable in terms of overall expenditures for intensive downstream business users, such as software companies, access to high-quality Internet services is essential for business innovation. The key benefits for software companies is the intra-company exchange of information between developers as well as the exchange of ideas with foreign developers. The Internet boosts efficiencies by making possible joint work for a group of part-time developers. Box 14 illustrates how the Internet has already directly provided for the development of new lines of business and innovation in Russia, using as examples two small Moscow-based software companies. Without the Internet, these new lines of business would not exist. (More detailed case studies on the Russian software industry as an intensive user of enhanced telecom services are discussed in the previous chapter on competition.) The Reform Agenda and Policy Recommendations Regulatory Reforms Underway A presidential decree 'On basic principles of structural reform in the sphere of natural monopolies' (28 April 1997, number 426) provides that the purpose of telecoms reform is to improve the quality of service to customers, to increase profitability, and to develop competition in the industry. Reforms were supposed to be implemented in two steps: 52 The Regulatory Regime in Russia (i) During 1997 a mechanism for settlement between operators and for the regulation of tariffs for traffic (in order to secure equal access) was introduced. Cross-subsidization of certain spheres of the industry and groups of customers has also been reduced. (ii) During 1998, the introduction of a dual-tariff system for business and non-business customers was supposed to be completed, though this program has not been fulfilled to date. Box 14: The Impact of the Internet on Software Enterprises This traditional IT hardware distribution and systems integration company was established in the late 1980s, and it formally established its e-commerce solutions department in January 2000. Not only are the department's product ranges entirely related to the Internet (software allowing access to and search for databases, ordering and customization allowing for presentation of different prices for different customers with different delivery options, direct on-line queries, etc.), but its inputs and production processes are also fully dependent on the Internet. Without access to the latest software development tools and the latest design information from the Internet, it could not produce its outputs. The Internet also is essential to communicate with all their clients. Whereas Internet-related software systems accounted for 40% of revenues at end- 1999, its share rose to 60% by end-September 2000. The company plans to increase its software developers from the current level of 8 persons to 50-60 persons over the next 18 months. Another fully Internet-dependent company-a multimedia web design company-was founded in 1997. Initially developing top-quality CD-ROMs with in-house developed software, the company has produced a large number of sophisticated corporate web sites and has acquired a telematics license to provide information and other Internet services on-line. Tariff Increases. Delays by regional administrations in introducing more rational policies towards the telecoms sector stifle needed investments in network infrastructure, adversely affecting all operators, including ISPs. The fact that tariffs for local calls for residential customers are so low has starved regional operators of funds for investments, in turn exacerbating the problems surrounding access to the required network infrastructure. Starting from November 1999, MAPSE started to raise telecom tariffs by an average of 20%. The increases exceeded inflation and ruble depreciation, with tariffs starting to grow in real and dollar terms. However, tariff regulation continues to lack predictability, as there is no clear tariff formula and increases are authorized sporadically. Moreover, the process of tariff changes is open to political interference at the local level. A company must make the request to MAPSE and justify the increase. MAPSE reviews the requests and then confers with the relevant regional authority, which may oppose the hike. In November 2000 a joint board of MAPSE and MoC announced plans to regulate private telecommunications firms and their tariffs. However, this should not necessarily immediately affect alternative operators, all of which have foreign investment. The tariff controls will only cover household calls, which form only a small part of competitive local exchange carriers' revenues. Their control of the high-end corporate market is unlikely to be affected by the planned changes, which also include the hiking of local household tariffs by state-controlled regional operators by 20%. On the one hand this is positive news, as it will allow them to move towards a position where they cover their costs. At present, many operate at a loss, due to highly regulated local tariffs falling well below operating costs. The government had talked about imposing a social tax on alternative operators, the revenues from which would be used to subsidize loss-making regional operators. However, there has been little news about these plans in recent months. Sviazinvest has recently proposed a gradual three-stage approach to tariff reforms. The first stage involves a 20-30% average increase from current rates. During the second stage, Sviazinvest proposes the introduction of a return on capital approach, expected to be in place in late 2002 or early 2003. The final stage entails the move to price-cap regulation. The success of the planned tariff reforms depends on government support and implementation by the regulator, expected to be the Unified Tariff Body. In 2001, MAPSE (then the regulator) only revised the tariffs once, approving a 15-20% increase in the first quarter of the year. In January 2002 there was approval for a 25% rate hike. However, that increase does not take into account the new methodology for cost calculation Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 53 approved by the MoC and MAPSE. Once this is adopted (expected in July 2002), further tariff increases are likely to take place in the second half of 2002. Tariff reforms are still a subject of intense political debate. Sviazinvest and the MoC are lobbying hard to liberalize tariffs and to reduce the power of the MAPSE, which is one of the main opponents of higher tariffs. It is still too early to assess the likely impact of the establishment of the Unified Tariff Body, but it raises several key issues that need to be resolved. One is the potential benefits and costs coming from the establishment of a single cross-sectoral regulator. Worldwide, sectoral agencies are considered to be more desirable because of the presence of strong economies of specialization and because they diversify the risk of institutional failure. Another key issue to be resolved is the definition of the (sub)sectors that can be considered as "natural monopolies" and should as such be subject to regulation at all. In telecommunications, technological progress has rapidly eroded monopolistic practices and "protected markets", even for fixed line local providers, so no segment of the sector can any longer be considered a natural monopoly (see below). Time-Based Billing. The proposed of introduction of time-based billing has raised a lot of opposition among low income subscribers and their political representatives. Moreover, the process of installing per-minute equipment to outdated analogue lines is costly and time consuming. In Sverdlovsk oblast, the Governor initially banned the change. Eventually, time-based billing equipment was introduced in the region at the end of February 2001. The Scope of "Natural" Monopoly Conditions in the Telecom Sector. In practice, regulation of private telecom operators means including them on the government's list of "natural monopolies" (see Box 15). The first to enter the list were six companies in Tatarstan-Tattelekom, Kazan City Telephone Network, Teleset, Intelset, Svyazinvest (Naberezhniye Chelny) and Kama- Teto-probably not coincidentally often perceived as one of the more politically autonomous parts of Russia. Predictably, the move was not well-received and some observers expressed doubts about whether the move is in line with the federal law on competition. (In November 2000 there were only 200 registered "natural monopolies", but MAPSE said that this could be increased to 3,000.) Box 15: "Natural" Monopolies under Russian Law According to Russia's Law on Natural Monopolies, which came into force in 1995, a natural monopoly is a condition in the market for goods or services: i) where the satisfaction of demand in that market is more effective in the absence of competition, due to the technical particularities of production, and ii) where goods and services produced by monopolies cannot be replaced by the consumption of other goods, so that demand is not as susceptible to price changes as for other types of goods. The Law on Natural Monopolies includes communications services in the list of natural monopolies subject to state control and regulation. There are three basic methods for such control and regulation: 1) Tariff regulation. 2) Protection of consumers (operators cannot refuse to enter into a contract with a consumer). 3) Control over transactions and investments (MAPSE must be consulted on the acquisition of any major assets with a value over 10% of the value of the acquiring company, and must be informed within 30 days of any acquisition of more than 10% of the voting shares of a natural monopoly). Subsequently in early 2001, MAPSE announced that 60 telecom companies in the Sverdlovsk region would be included in the list, meaning that 10% of Russia's 4,500 firms in the telecoms sector were to be classified as natural monopolies. The same month MAPSE said that it would look into the possibility of including into the list firms offering local, domestic long-distance and international telephony (including fixed-line, cellular and Internet firms). This raises the possibility that MAPSE intends to regulate domestic long-distance and international, as well as local tariffs. A process of consolidation is currently underway in the sector, following the recommendations made by a study carried out by Arthur Andersen funded by a World Bank administered grant. 54 The Regulatory Regime in Russia Overcoming fragmentation has very significant strategic payoffs as it would allow for the realization of the economies of scale and scope in this industry that relies so heavily on network efficiencies. Svyazinvest merged Rostelecom with Moscow Intercity and International Telephone (formally completed in October 2000), and in late 1999 it initiated consolidation of its largest elektrosvyaz in St. Petersburg, Novosibirsk, Yekaterinburg and Rostov On-Don, to bring its number of subsidiaries down from 86 to 77. The process of consolidation in the initial phases has not been smooth, with significant opposition from minority investors, managers, and regional governments. However, recently it is going ahead faster than expected, with the merger process approaching its final stages. Finalizing the merger terms is a crucial step, allowing investors to assess the contribution of individual operators to the new enlarged supra-regionals. The remaining steps in the consolidation are largely formalities. The Federal Securities Commission needs to register the new share issues and MAPSE needs to approve the mergers (as it has already done for the enlarged Ural Telecom). The enlarged regional companies are expected to be tradable in the next 10 months. The expected impact of the consolidation is expected to be significant in terms of strengthening the new companies in terms of revenues, added liquidity through their ADR programns and greater transparency implied by consolidated IAS accounts. Such an impact is expected to be greater if accompanied by the introduction of a predictable and transparent tariff regime. Telecom tariffs are currently only 50% of their pre-crisis levels in US dollar terms. Further tariff increases are needed to finance much needed investment and to make the companies attractive to foreign strategic investors. In addition to tariff increases, other important drivers of revenue growth should be further development of Internet and data services, which currently represent a very small fraction of telecom operators' revenue but are rapidly expanding. In particular, Internet revenues are expected to grow substantially with the introduction of per-minute billing. Political Interference. If the government wants to find investors for the fixed-line holding Svyazinvest and its seven pan-regional subsidiaries, it will have to convince them that there will be less political interference in the sector over the next few years. The political risk in the telecoms sector has heightened over the past year. The fairness and transparency of the regulatory procedures cannot be guaranteed. This was shown in September 2000, when the Telecoms Ministry sent letters to VimpelCom and MTS, requiring them to vacate 20 (of its 35) 900Mhz channels and 22 (of its 73) channels by November 1, 2000. When this news went public, the companies' shares crashed in value. In November 2000 both companies finally received letters from the Telecoms Ministry confirming their rights to their frequencies. InternationalAgreements. Russia is not yet a WTO member, but negotiations are in progress. The country's legal framework provides for co-operation with the EU, with the aim of gradual integration at the technical level. The law provides for most-favored nation treatment, but both the EU and Russia have made reservations on this regarding some telecoms services, including mobile and satellite services. The Agreement on Partnership and Co-operation between Russia and the EU restricts Russian market access to some EU member states in the fields of complementary services and infrastructure. In 1997, the members of the Commonwealth of Independent States (CIS), i.e., the former Soviet Union minus the three Baltic States, signed an Agreement on Co-operation in the Development and Use of Mobile Cellular Telecommunications Services (the 'CIS Co-operation Agreement'). The parties agreed to ensure the free movement of mobile phones within the CIS, provide roaming for mutually approved standards, and take measures with the purpose of harmonizing national legislation on telecoms services. They also agreed to develop recommendations for the co-operation of cellular operators. Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 55 Policy Recommendations Broad-based policy recommendations include the following: (i) Promoting Further Private Sector Involvement in Telecom Sectors, with specific priority measures to stimulate competition. Options include unbundling Svyazinvest by separating and liberalizing international long distance and local calls; move forward the consolidating local telecom operators and allowing them to compete with each other; and licensing additional wireless local loop operators as alternative access providers. (ii) Establishing an Improved, Independent, Transparent and Publicly Accountable Regulatory Oversight Process and Institutions (bringing Russia close to meet WTO and EU requirements). In this context, Russia should consider giving the regulatory power for interconnection to the same institution responsible for price regulation, ideally vesting both functions in a new sector- specific regulatory agency. With the creation of an independent sector regulatory agency, MAPSE would no longer be responsible for tariff-setting processes and supervision, leaving technical and pricing regulation to the specialized agency. On the other hand, MAPSE could play a more forceful role in the determination of the appropriate scope of the regulatory authority, of the appropriate market structure of the telecommunications markets, and focus on controlling anti-competitive conduct by dominant enterprises. (iii) Strengthening and Ensuring Appropriate Coordination for the Institutions Charged with Implementing and Enhancing Competition, such as the MOC and MAPSE, especially the latter's oblast branches that appear to lack authority in addressing cases of abuse of dominant position and discriminatory license or terms of access to the network. The local branches of MAPSE are aware of the key problems hindering the development of Internet, but lack authority in taking decisions that are mainly made in Moscow. This is particularly evident after centralization of the key functions (as a result of the transfer of regulatory authority from the regional government to the Moscow MAPSE itself in January 1999). Effectively, local branches of MAPSE exert merely supervisory roles and opinions (their view points have been asked only recently). Less cumbersome regulations seem facilitated by the openness of local regulatory institutions to the legitimate business needs of (small) ISPs. In Moscow Oblast, local associations and interest groups have intensively lobby for improved regulation, though their impact remains limited. (iv) Adopt Uniform Guidelines: apart frcm more transparency in licensing procedures, the same interpretation and requirements in different oblasts should be ensured. Moreover, clear formalized appeal procedures need to be established. (v) Establish Clear Terms of Licensing Renewal: From our case studies, ISPs seem to experience dramatic and unjustified changes in license terms. The unpredictability is a serious concern as it acts as a deterrent to investment in light of the ex-post renegotiation issues at stake. (vi) Ensure Non-Discriminatory Terms of Interconnection: ISPs are exposed to discriminatory behavior in getting access to connection in terms of price, quality and even the opportunity to get access to the network itself. Currently the law leaves interconnection to be determined as a bilateral negotiation between operators, a procedure that is largely inappropriate in the presence of one party (the provider of access) who has a much stronger bargaining position (in most cases acting as a monopolist). Interconnection needs to be address in a clear way, to avoid conflict of interest. Public policy requires interoperability of networks. Consequently all public network operators should be obliged to interconnect their networks with one another. Those operators with the ability to abuse their market power should be subject to special rules (ex ante regulation) to ensure that they do not abuse their dominance. These include: a requirement to meet all reasonable demands for interconnection services from other network operators; transparent and cost based interconnection; unbundling of interconnection charges; and non-discrimination and publication of interconnection offers (terms and condition of contract and prices). 56 The Regulatory Regime in Russia* The resulting price needs to be economically efficient, guarantee fair recovery of costs for all operators and provide the right entry signals. Long run incremental cost methodologies meet these criteria and entails the calculation the total costs of provision of the additional capacity needed when one operator causes another to provide an essential component of service. (vii) Ensure that E-Business Legislation has a Strong Bias Towards Promotion Rather than Control, including moving forward with the adoption of a sound electronic digital signature law extending the scope of the current law (viii) Promote a Russia-Wide Dialogue on Informatics and Communications Policy. The provision of Internet services and e-commerce potentially affects all citizens and would benefit from a consensus-based higher-profile national debate on telecommunications, information and media policy. Mark Dutz, Maria Vagliasindi, and Harry G. Broadman 57 Bibliography Arthur Andersen. (2000). OAO Syazinvest Project to Advise on Valutation, Restructuring and Privatization Option. June. Aghion, P., and Schankerman, M. (1999). "Competition, Entry, and the Social Returns to Infrastructure in Transition Economies." Economics of Transition. International Telecommunication Union. (2000). World Telecommunication Report. ITU, Geneva. IV. Corporate Finance in Russia's Regions: Demand and Supply Constraints Stijn Claessens* and Esen Ulgenerk** Introduction Many of the bottlenecks that businesses face in Russia to get started and grow are finance related. Examination of bank-enterprise relationships at the regional level reveals that finance is aggravating business development in several ways. On the supply side, the volume of financing is very limited as banks have small deposit and capital bases. A series of crises, most particularly the 1998 crisis, has eroded the confidence of the public in the fledgling banking sector, with only Sberbank and a few large banks enjoying any trust today. Short-term bank credit is scarce and highly priced, and requires liquid collateral of up to two times loan amounts. The limited contract enforcement environment discourages banks to lend, except to those enterprises in which they have shareholdings or another relationship. Most banks and other financial institutions-especially in the regions-do not have the expertise or skills to properly assess risks and structure financial products and services which meet the needs of the real sector. Furthermore, the banking sector is highly concentrated in urban centers, further limiting the access of many enterprises to finance. The lack of long-term bank and other financing means corporate capital investment, outside of foreign investments, is mainly limited to internal earnings. Yet the capital market is very limited in size and mostly caters to the top Russian corporations that also have access to foreign sources of finance. Equipment leasing is only available to some extent. The lack of financing is, however, not just a problem for capital investment, but also extends to trade finance and makes it difficult for enterprises to maintain normal operations. The working capital shortage from the banking system is aggravated by the fact that few enterprises offer trade credit because of the lack of credit tracking and underdeveloped dispute settlement mechanisms. The lack of adequate working capital and trade credit financing discourages the expansion of firms and the establishment of new firms. The existence of large arrears by many, often insolvent entities and the many informal business links among enterprises further encourage non-monetary forms of payments. This in turn increases the costs of operation to the productive sector as enterprises spend resources to screen their trade partners for credit-worthiness and to collect non-cash payments. The existence of barter, offsets and countertrade encourages further non-transparency and discourages the use of formal channels to finance viable enterprises. This chapter primarily discusses the various constraints to finance on the supply side, using case study examples from various regions on how demand from potentially viable enterprises is often not met. The next section contains a general description of the Russian financial sector, highlighting that the formal financial system has little to offer to most firms, especially to de novo firms. The subsequent three sections analyze what other forms of financing are available for de novo firms and capital investments for existing firms. The case studies suggest that the most important source is internal financing. Next are local and other government forms. Some specific credit lines by international financial institutions are also being used. Trade finance is normally an important source of working capital financing for firms, but in the case of Russia it is tied up with arrears and other * Professor of Finance, University of Amsterdam (formerly Lead Economist, Financial Sector Policy Department, The World Bank). ** Consultant, Istanbul Turkey (formerly Lead Financial Sector Specialist, Financial Sector Policy Department, The World Bank). This chapter draws on background material written by Tatiana Nenova and on joint work by Stijn Claessens and Daniela Klingebiel. Stijn Claessens and Esen Ulgenerk 59 non-market forms of financing. The chapter concludes with an overall assessment of the financing prospects for Russian firms and with suggestions for policy changes. The Russian Financial System The Russian financial system is small in absolute and relative terms and underdeveloped compared to countries with similar per capita incomes. At the start of 2001, the ratio of M2 to GDP in Russia was 16.6 percent of GDP, compared to an average of 50.6 percent for Central European countries and 76.3 percent for OECD countries. With only 12.0 percent of GDP, the ratio of private credit to GDP in Russia is substantially less than in Central European countries and OECD countries. The high currency to deposit ratio in Russia furthermore indicates that a large part of monetary transactions takes place outside the banking system and that public confidence in the banking system is very low. Underscoring the low public confidence in the financial system is the fact that a large amount of savings are held outside the financial system in hard currency. The small size of the Russian financial system can largely be attributed to a lack of trust of households and enterprises in the financial sector, a lack that arises from past experiences with hyperinflation, the government's default on its domestic currency debt, and a weakly governed and fragile domestic banking system. Table 1: The Size of the Russian Financial System Relative to Other Financial Systems | Liquid | Private| Deposits Currency to Change Liabilities Credit Deposit Ratio In CPI Russia (2000 est.) 16.6 12.0 16.21 40.6 20.2 All countries 59.9 60.94 52.57 8.11 Eastern Europe 50.55 27.08 48.89 11.53 of which Czech Republic 71.05 59.9 71.10 11.3 8.45 Hungary 42.3 22.5 34.91 23.4 18.07 Poland 35.44 15.58 30.81 18.7 15.91 Ukraine 11.85 1.82 8.63 96.6 15.94 Kazakhstan 4.99 17.39 Lower middle income countries 44.6 36.35 36.69 11.46 OECD countries 76.28 88.51 73.22 6.72 Source: IMF, International Financial Statistics. For countries other than Russia, data are for 1998. Russia's total banking system in terms of assets amounts to $78 billion, which is comparable to the asset size of a medium size bank in countries like the U.S. The largest Russian bank has assets of about $18 billion and the second largest about $4 billion. Reflecting the small scale of the Russian banking system, even the largest banks are very small on a global scale. The total assets of the three largest Russian banks, for example, amount to only around 60 percent of assets of the three largest banks in the Czech Republic and Poland and only 1.1 - 1.5 percent of the asset size of their European counterparts in UK, France or Germany. The numerous, small banks have limited deposit and funding bases to lend to the new and existing enterprises. While the overall Russian banking system is very small, Russia has more than 1,200 banks, many of which are very small. Out of these, only 93 banks have paid-in capital over $10 million and only the top 50 banks have assets exceeding $100 million. Most of the banks are thus too small to cater to the financing and investment needs of large and medium Russian enterprises. In fact, the average Russian bank has assets of only $51 million, and total capital of $9 million, much too small to be profitable, assuming the bank wants to intermediate effectively. Most of the banks today are little more than pocket institutions for local, regional and federal government authorities, oligarchs, and financial industrial groups. 60 Corporate Finance in Russia's Regions The banking system has a very limited outreach. At the start of 2001, banks operating in Russia had a total of 3,869 branches, or only 2.8 branches per 100,000 inhabitants. This compares to an average for the EU of 48 per 100,000 inhabitants. The government-owned savings bank, Sberbank dominates the branch network, with 1,564 branches and over 34,000 small outlets throughout the country. No other bank except the near-bankrupt, state-controlled SBS-Agro which has 1,200 branches, has a nationwide branch network. The rest of the banking sector has limited access and distribution points for enterprises and households. The majority of the banks are concentrated in Moscow and St. Petersburg. Approximately 50% of the banks that have no branches are headquartered in Moscow. Central and Northwestern Russia has 35% of the branch network and 60% of the banks in Russia. The Eastern regions (Urals, Siberia and Far East) of the country have only 16% of banks and less than 30% of branches, of which more than 80% belong to Sberbank. Given this limited and geographically concentrated bank and branch network, newly established enterprises outside of the urban centers have very limited access to the formal financial channels, even for simple banking transactions. The banking sector is also recovering from a severe crisis that has eroded the public's confidence. The August 1998 crisis did not result in a consolidation in the sector, as the corporate and banking laws and the general political economy and institutional setup did not allow for the resolution of many failed banking institutions in an orderly way. Instead, the principals of major failed banks simply transferred the assets of their 'failed' banks to bridge banks. This weak resolution effort has further undermined the limited trust in the banking sector among the population that already suffered from a series of high inflation and large devaluation episodes during the last decade. Furthermore, there is little interest in the banking sector in lending and development of new products and services. The sector is dominated by Sberbank, which holds more than 80% of the total deposit base and around 35% of the lending. With its relatively large deposit base, Sberbank remains the major supplier of corporate finance to all sizes of enterprises in Russia (Box 1). Since the 1998 crisis, there are very few other banks that enjoy the confidence of households and business, and there is no bank competition to speak of. Most small companies, especially outside of large urban centers like Moscow and St. Petersburg, have no choice but to use Sberbank for all their transactions. Most Russian banks, except for Sberbank, are not fulfilling the traditional intermediation functions of a commercial bank. Instead they concentrate on (and/or are directed by their shareholders to perform) a much more limited set of functions (Box 2). Furthermore, banks in Russia are relatively new organizations, with limited skills in evaluating enterprise risks and no capacity to design and offer financial products and services that meet enterprises' needs. Enterprise finance from the banking sector is scarce and rarely allocated in a market-based fashion. The small financial sector and the poor way in which it allocates resources means many firms do not get financing. At the start of 2001, loans to the real sector were around $32 billion, 41% of total banking sector assets and approximately 12% of GDP. For comparison, the loan to GDP ratio for Poland is around 20%, while it is 80-120% in most developed countries. Recent estimates by the Central Bank of Russia indicate that the share of bank credits for financing of fixed investments during 2000 was around 10%. And this scarce lending from banks is primarily directed toward either own- shareholder enterprises or large and often state-controlled enterprises, many of which are in the fuel and energy industries; see Box 3. Available official data generally understate the problems of financing for the second-tier and small and medium Russian enterprises, as large firms take up the bulk of the available financing. These top tier Russian enterprises, as well as those that have multinational ownership and/or buyer/supplier relationships, have access to a relatively competitive short-term loan supply, although seldom on market-based terms. While long-term resources through either equity, bonds and/or bank credit are limited, even for these enterprises, preferential access to the limited savings is crowding out Stijn Claessens and Esen Ulgenerk 61 other, smaller enterprises or making their access more costly. Apart from the very limited supply of savings, micro-factors are also serious constraints to the financing of smaller and medium firms. These include high spreads, excessive collateral requirements, and many CBR requirements, including that banks cannot lend without collateral. Box 1: Sberbank Sberbank held a quarter of all banking system assets and more than 60% of household deposits at end-1997. Its ownership was controlled by the State through 58% ownership by the Central Bank of Russia and its privileged status included an implicit state guarantee on all household deposits held by the bank. While it was the primary repository for household deposits throughout Russia, the bank did not channel these funds into loans for investment in the economy. In mid-1998, prior to the financial crisis, loans to businesses were only 14 percent of its total assets. Currently, however, Sberbank holds 30% of the total banking system's loans to the enterprises and the share of loans to the industry on Sberbank's books has increased to 35% from 14% in 1998. Following the 1998 crisis, CBR encouraged the transfer of household deposits from a number of failed Moscow- based and regional banks to Sberbank on a voluntary basis while at the same time explicitly announcing a deposit guarantee for Sberbank. Some R 10 billion (representing around 70% of local currency and 30% of foreign currency deposits of the largest commercial banks in Russia) was transferred from commercial banks through this scheme. In addition to the household deposits, many enterprises also shifted their accounts from other banks to Sberbank during 1998/99 to protect themselves against any payment illiquidity or risks. In some regions, many enterprises were instructed by their state suppliers to shift their accounts to Sberbank. As a result, Sberbank currently controls around 85% of ruble and 46% of hard currency deposits. In addition to its government subsidy (through the implicit deposit insurance) in the deposit market, Sberbank also has monopoly rights on the processing of settlements on municipal services and the pension fund receivables/payables. Its assets (26% of the total banking sector in Russia) exceed those of the next largest bank (Vneshtorgbank) by five times. Its large branch and sub-branch network, about 37,800 outlets in every region of Russia, far exceeds that of the next largest network, that of the near-bankrupt SBS-Agro, with about 1200 branches, and vastly exceeds the networks of the most private commercial banks, which have at most 25-30 regional branches each. Traditionally used as an instrument for budget finance, Sberbank is increasingly diversifying its assets from govemment bonds to domestic corporate lending. The equity capital of the bank (around $2.1 billion-or 15% of the total banking sector capitalization) is 2.1 times the capital of the largest bank (Vneshtorgbank). The relatively large capital base makes Sberbank practically the only source of financing for Russia's largest corporate borrowers and/or exporters without violating the single borrower limits of the Central Bank. Some recent noted transactions were Sberbank loans of $300 million to Tyumen Oil Company; a loan for equivalent of $200 million to UES (Unified Energy System of Russia) to finance its arrears to Gazprom and tax authorities; a loan for $80 million to Vymelkom and one for $50 million to Severstal. Sberbank may also have priced these loans below market and there appears to be an increasing tendency to perceive of Sberbank's relatively large deposit base as a source of cheap funding to support the 'strategically important' industrial sector in Russia. For those that can access the lending market, loans are expensive and take many steps. The majority of lending is short-term, up to 1-6 month maturities. In mid 2001, rates for I-month loans in rubles were around 36-40%, and for 6-month loans between 42-46%, compared to a Central Bank refinancing rate of 25% and MIBOR (Moscow Interbank Overnight Borrowing Rate) rates of around 13-15%. Most companies report that their profit margins are not sufficient to cover the cost of capital. Lending is burdensome in other ways. Banks usually requires the borrower to have kept their accounts with the bank for a minimum of 1-2 years, in order for the bank to track the borrower's cash flows and to have some idea of the repayment ability of the borrower. In addition, collateral is required, typically 1.5-2 times the amount of the loan. The collateral is required to be liquid, with only securities, veksels, goods in process or finished goods acceptable. Immovable property and motor vehicles are problematic as collateral, and perceived as carrying excessive resale risk. Third party guarantees are often required in case of loans of more than 6 months maturity. Finally, loan application and negotiations take a long time. 62 Corporate Finance in Russia's Regions Capital markets function very ineffectively in Russia. This ineffectiveness extends to all the normal dimensions of a capital market: allocating funds, pricing claims, diversifying risks and disciplining management in Russia. The evidence of poorly functioning capital markets is plentiful. Capital markets exhibit low depth, with the stock market representing less than 10% of GDP (Table 2), and trading is inefficient, with high bid-ask spreads. The corporate governance framework is poor, with only few of the OECD corporate governance principles enforced. Enforcement of minority shareholder rights is especially weak, resulting in large-scale expropriation (Black et al, 2001). As a consequence, few investors are willing to allocate any of their wealth to Russian capital market instruments. According to official figures, less than 0.5% of new company financing in 1998 was from the issue of shares.' Box 2: The Typical "Bank" in Russia Apart from Sberbank and a handful of large banks, one can distinguish between four types of "banks" in Russia according to the functions they perform: 1. Act like afinancial arm of large enterprises or groups of enterprises. These type of banks settle payments for shareholder and/or 'client' enterprises, providing banking services to their managers and employees, and engage in investment activities on behalf of these enterprises. Some of the industrial FIG banks or 'pocket' banks of large enterprises (e.g., Gazprom) are examples of these banks. Most of these banks provide these functions only to their main owners or affiliated companies 2. Manage or support the Russia's quasi-money and/or non-monetary system, issuing veksels or structuring as well as brokering transactions to help companies and government agencies manage intricate operations of barter, credit and taxes. Numerous small banks owned by regional governments or municipalities are active in these types of transactions. 3. Act like a lender to the government, federal as well as local. Some banks held as much as 70% of their assets in government (federal and local) paper prior to the August 1998 crisis. 4. Perform treasury functions for the governments, local and federal. If they meet minimum reserve requirements at the federal level or compete successfully in the bidding process (local and federal level) banks can qualify as repositories and/or transfer agents for state funds-budget subsidies, salary, wage and pension payments, tax payments, various budgetary funds, customs revenues, etc. Box 3: "Barriers" to Bank Finance: Several Firms' Experiences In Novgorod oblast an organic fertilizer producer was refused the guarantee of the regional administration and was thus unable to finance a productive facility of the size the founders had planned. The firm will nevertheless start construction of the new facility. A software firm in Novosibirsk oblast borrowed from a bank seven years ago. The bank went under in the middle of the loan repayment, and the creditors of the bank used criminal methods in order to collect their debts from the bank's clients / borrowers. As all other borrowers, the firm's founders got pressured to repay fast. The company has avoided bank credit ever since. A Vladivostok fishing company was refused credit for purchasing second hand a fishing vessel, even though the project was economically viable, because the loan amount requested was too small to warrant the attention of the bank. Equity markets are especially thin. Market turnover, defined as the value of trading over market capitalization, is low, amounting to only 3.9 percent. This makes the Russian stock market less liquid than its comparators in almost all other transition and emerging markets. For example, market turnover is 93 percent in Hungary, 81 percent in the Czech Republic, and 69 percent in Poland. And market turnover in Russia trails developed countries' markets significantly. Market turnover is 167 percent in Germany, for example, and 127 percent in Portugal. The low market turnover in Russia is due the large concentration of ownership, implying a relatively limited free float, a lack of institutional Stijn Claessens and Esen Ulgenerk 63 investors, and the migration of trading of shares in some large firms to international financial centers. Many of the existing enterprises also do not want to attract new shareholders for fear of losing control or for preference to keep a low profile in an uncertain environment. Bond markets are dominated by state-issued paper. From the mid- to late-1990's, many regional and federal authorities resorted to bond issues to finance their budgets deficits. As of mid- 2000, federal domestic and international bond issues amounted to $73.6 billion nearly equal to the size of the banking sector, about $78 billion, and the large presence of government securities has crowded- out the corporate sector from the bond markets. Private bond issues have been few and in small amounts (Table 2). Private corporations most often do not have the expertise to properly structure cash flows to back up bond issues, nor do they have sufficient liquid collateral. Banks and other financial institutions have not been able to provide investment-banking services to guide the enterprises. Unclear articles in the Civil Code on the tax deductibility of non-bank borrowing interest have also discouraged potential issuers. The supply of funds from institutional investors is also very limited. There are currently around 80 foreign investment funds that have invested around $7-8 billion in Russia. By way of comparison, 59 funds exist in Hungary, a much smaller economy, with a market value of around $4 billion in 1998. Domestically, there are 229 licensed non-state pension funds with total assets of about $300 million; 28 unit investment trusts with an value of about $20 million, and one shareholder investment fund with investments of about $700 million.2 Table 2: Russia's Capital Markets Size by Type of Assets Relative to Other Capital Markets Country GDP Total Equities Bank Claims on r Goverment l_________ Total__ Equities Private Sector Total Bonds Bonds orporate Bonds In In %of In %of In %of In %of In %of billions billions GDP billions GDP billions GDP billions GDP billions GDP l________ of US$ of US$ of US$ of US$ _ of US$ of US$ Russia 277 21 8% 29 12% 76.2 30.4 73.9 29.4 2.3 1% (2000) _ Czech 56 12 22% 35 63% 7 12% 2 4% 4 7% Republic Hungary 48 14 29% 8 17% 12 25% 12 25% 0 1 % Slovak 20 1 5% 9 45% 3 17% 3 14% 1 3% Republic _ Poland 158 20 13% 31 20% 13 8% 13 8% 0 0% France 1,455 991 68% 1,122 77% 1,210 83% 731 50% 479 33% Germany 2,123 1,093 52% 2,673 126% 2,006 95% 866 41% 1,140 54% Italy 1,186 569 48% 741 62% 1,580 133% 1,216 103% 364 31% The 378 603 159% 469 124% 244 64% 199 53% 44 12% Netherlands I I I_ I UK 1,399 2,374 170% 1,690 121% 853 61% 1 464 33% 388 28% Japan 3,787 2,495 66% 5,046 133% 5,214 138% 3,701 98% 1,513 40% USA 8,511 13,451 158% 5,413 64% 13,973 164% 8,002 94% 5,971 70% Source: JP Morgan, World Financial Markets Institute of Intemational Finance (11F); IFC Emerging Stock Markets Factbook 1999 IMF, International Financial Statistics IFC, Emerging Markets Information Center Bond Database; BIS International Banking and Financial Market Developments. Data for Russia refer to 2000; data for other countries are generally for 1998. The weakness of the domestic financial system is confirmed in the large offshore financial intermediation. Many large, publicly listed companies, mostly involved in resource extraction or telecommunications have successfully raised equity financing abroad. The total share of capital raised abroad was some 15% of all capital raised. Trading is also migrating abroad. The turnover of Russian depository receipts is significantly higher abroad than is trading in the underlying shares on the 64 Corporate Finance in Russia's Regions domestic market. For example, the turnover of Russian depository receipts was in 1999 more than twice as high as the turnover of the same instrument in Moscow. Continued capital flight discourages domestic financial intermediation. Due to large capital outflows since the start of the transition, the size of flight capital is estimated to exceed Russia's financial system by a factor two and much intermediation is thus happening outside of Russia. Estimates of capital flight during 1995-2000 are about $20-25 billion annually.3 Officially recorded capital flight (estimated as the sum of non-repatriated export earnings, unredeemed import advances, and errors and omissions in the balance of payments) was about $6.5 billion in the first half of 2000, up from $4.2 billion in the first half of 1999. According to government's own sources, capital flight from Russia increased to some $28 billion during 2000. An important role of the Russian financial sector is then also the facilitation of an outflow of capital, rather than mobilization of domestic savings and allocation of funds domestically. Internal and Non-Bank Financing Sources As the formal financial sector is providing little financing for new and existing firms, a variety of sources is being used by enterprises to meet their financing needs. Most of financing for investment comes from internal earnings and shareholder funds. Working capital financing is often financed in this way as well. Much of these sources, especially the trade financing arrangements, are, however, neither transparent nor market-based. And the total amount of financing falls far short of the financing needs. Given the lack of financing from the formal financial system, companies source capital mainly out of their own or related sources. A survey among the largest companies in Russia in 1998 found that about 50% of the liabilities of these companies are equity provided. Suppliers' credit and long term credit from shareholders averaged 20% and 15% respectively. After tax and other arrears, short- term bank credit represented only 2-3% of the total liabilities of these large companies.4 A survey of the leading 100 companies in 2000 (by the Investor Protection Association) found that 91% of corporations reinvested their profits fully while only 14% issued new stock for financing of expansion of operations. Another survey among leading manufacturing enterprises from diverse sectors in Russia indicated that 57% of these enterprises expected to use internal funds and 41% loans from own suppliers and/or municipal/government funds to finance their new investment in 1999. Only 2% expected to borrow long-term funds from banks.5 The lack of extemal financing is even more severe among medium sized and smaller firms. New firms obtain some financing from outside the banking system for start-up and working capital needs. Our case studies show that De novo firms in Russia have financed their start-up investment in one of several ways (see Box 4). Many new firms start on the basis of trade-based activities, with little need for extemal financing. They then use the accumulated intemal eamings to expand into production activities. Widespread pressures from local inspectors and other controlling authorities, however, to share in the SME eamings-via health, fire, sanitation, and licensing graft-dramatically reduce any chance of profitability for small business start-ups, and discourage investment. SMEs are the easiest target for such activities, not least because of the unclear and complex regulatory framework, limited local enforcement of federal laws, and the large number of controlling agencies. (See the earlier chapter on competition.) Another source of financing for de novo firms are existing enterprises. Some enterprises with excess cash flows are expanding their business empires and are interested in investing or providing supplier credits to new firms. Although a source of financing, this strategy is inefficient to the extent that cash-rich firms are likely to promote projects that are not necessarily profitable or are often benefiting from regulatory or other protection from competitive market conditions. Evidence from Russia and elsewhere shows that internal markets do not necessarily allocate funds in the most efficient manner. And, much of this financing is at very high interest rates. Stijn Claessens and Esen Ulgenerk 65 Box 4: Five Start-Ups and Their Financing This Novgorod food processing and distribution firm was established as a greenfield investment in 1991. The founders, who previously held positions as state administration employees, had extensive contacts with regional banks, dating from pre-1991. Thus the firn was able to secure a series of small credits without offering collateral. These funds were used as working capital as the company started a small-scale operation in the food- stuffs trade. The entire profits from trading were reinvested in the following several years, as the firm expanded into foods-stuffs production, purchasing shops, trucks, and a facility for food processing. This Novosibirsk design and construction company was able to secure a start-up hard currency loan from foreign sources (including BNP, France). The firm backed up the loan with guarantees from the federal government. In 4-years' time, the company closed its obligations to the foreign banks using retained earnings. Two large SOEs established a large Novgorod wire producer in 1989. The founders provided the start-up with technology and equipment. This Vladivostok business had been trading imported fabrics for 4 years when they decided to expand into clothes production. In 1996, they identified a sewing factory with relatively new equipment, but with serious tax arrears, 9 months of unpaid wages, and accumulated payables to suppliers. Using their trading revenues, the firm was buying shares in the sewing factory for 2 years before they attained 50%. Once the firm had a majority stake, it called a general shareholders meeting and offered employees to get the factory operational again and pay all wages, if in return the employees sold to the firm all of the remaining shares. The firm then acquired completely the sewing factory. The company sold off some of the sewing factory's property to cover the wage and tax arrears, and took the suppliers to court arguing (successfully) that the new owners are not responsible for the accumulated debt to suppliers. This organic fertilizer producer in Novgorod was established in 1998. One of the founders had been previously managing his own trading firm, whose assets were fully used at the new company's start-up. The two founders were unsuccessful in negotiating a loan in the amount they needed for new equipment, since they were denied a loan guarantee from the regional administration. Instead, they obtained a smaller loan from Sberbank for 6 months at 80% (the refinancing rate was 60%), against the collateral of their personal property, and bought second-hand equipment. An alternative of securing investment funds is to partner up with a foreign firm and procure equipment and know-how in return for an equity share. Such deals are more difficult with foreign partners because the issue of control is sensitive, and as FDI has been limited to a few big cities and selected industries; see Broadman and Recanatini (2001). Further, federal level laws are restrictive and present problems to regions that have chosen to pursue policies more open to foreign investment. For example, Novgorod oblast, where some $800 million foreign capital is invested, equal to 62% of the region's GDP, is forced to look for "loopholes" in the federal laws in order to ease the foreign investment environment at the regional level. Buying up or merging with a Russian enterprise is more widely practiced. Successful and liquid companies often expand geographically, buying up firms in their business line in other regions, and making those operational with infusions of working capital (see Box 5). Retained earnings, the main source of capital investment for existing firms, are very limited as well. Most operating privatized enterprises face the problem of old equipment (on average 75% is fully depreciated due to wear and tear). Only 4.5% of the equipment in the manufacturing sector is estimated to be less than 5 years old, and most of the equipment is more than 10 years old. As a result, productivity in the real sector is extremely low, with production non-competitive and of low quality. Profitability and demand for many goods has been low and operating funds continue to fall short of capital investment needs. Investment has been largely limited to equipment maintenance and repair, and has precluded major renovation of the production base. Nevertheless, the supply of internal financing has improved for many firms as their profitability has improved.6 66 Corporate Finance in Russia's Regions Box 5: Some Strategies Used for Financing Expansions A Novgorod food processor and marketer has used leasing extensively in the past several years, among others to acquire German meat-processing equipment and an Italian macaroni minifactory. The company currently plans a $300,000 investment in a minifactory for production of mayonnaise, ketchup, and sauce. The leasing terms quoted were 30% cash down payment, 8% annual service cost on the foreign exchange contract, for a 3-year maturity. This firm, part of a holding company, once the largest milk factory in Primorsky Krai, was modemized upon a control change. The parent invested DM 1.5 mln in German sterilization equipment and a further $300,000 for packaging equipment. In both cases, neither leasing nor long-term credit was used. This building component manufacturer in Novgorod attempted to obtain funds for equipment renewal and working capital from a Finnish partner, in exchange for a 50% or higher equity share. The negotiations, however, stalled. The company found financing recently in a private deal with several St. Petersburg companies. The financing costs that the deal offers are markedly lower than those offered by banks. The deal is structured as a loan, where the firm's parent is to provide its own production (residential housing) as collateral. This Novosibirsk pasta and brushes producer was all but removed from the pasta market in 1998 because of the low quality of their product, which was manufactured using worn-out equipment. It considered buying Italian pasta equipment, but the leasing or bank credit options seemed unaffordable. It therefore undertook to construct the equipment in-house, following the Italian model, and the quality of their pasta is reported to have improved. This Novosibirsk wood processing firm needs funds for capital investment. The company cannot afford a long- term bank loan. It attempted to procure investment funds from suppliers and clients, but was refused since it had no way to guarantee repayment. The company likewise attempted to find a foreign source of capital investment funds, via the regional administration, unsuccessfully. Next, the company applied for a government-subsidized loan, to no avail. A $200,000 loan is being negotiated with Alphabank Leasing for equipment purchase, at the terms of 24% interest, 18-month maturity, and 20% cash down payment. This once-dominant clothes manufacturer in Primorsky Krai, has been refusing foreign investors' offers for capital infusion in exchange for equity due to the reluctance of its management to allow some control transfer to the foreign partner. Lease terms are more affordable than bank loan terms for comparable sums and maturities, as well as more flexible, faster, and simpler in terms of arrangements. After own-financing, leasing is the second most popular source of equipment financing. Still, leasing activity in Russia is relatively very small, financing only 1.5% of capital investment, compared to some 30-40% in OECD countries.7 Out of roughly 1000 registered leasing companies, only 30% are active, and those are heavily concentrated in European Russia, particularly Moscow. Private and donor-funded initiatives are helping develop leasing as a source of finance for the small and medium enterprises. One example is the Volkhov Business Incubator Project (Box 6). But the amounts remain small. Given that most leasing deals involve the purchase of foreign-sourced equipment, another important limiting factor is the exchange rate risk that leasing companies, equipment sellers, and non-exporting lessees alike are very reluctant to assume. Lease terms currently also require additional collateral, in addition to the customary retention of the title of the leased equipment. Finally, secondary markets for property and equipment are thin, adding considerable resale risk to leasing operations. Government Support Programs and Donor Credit Lines Some of the currently large firms that we studied (among others) were created in the early 90s from subsidized government loans and guarantees. This strategy has proven inefficient and politically and financially untenable, both in view of the favoritism that is typically involved in the selection of loan recipients, which surely creates opportunities for corruption, and the undermining of the nascent Stijn Claessens and Esen Ulgenerk 67 commercial banking sector. Notwithstanding the salutary fiscal impact of high oil prices currently, it is also not prudent financial budgetary practice. Box 6: Micro-Leasing: The Volkhov International Business Incubator Project Volkhov is a small city with a population of 50,000, about 120 kilometers from St. Petersburg. The employment in the city had fallen dramatically during the first half of the 1990's due to closures or capacity decline in the local state enterprises. Many residents have, however, started their own businesses and the number of people working in small and medium sized enterprises doubled each year during 1993-95. The Volkhov Business Incubator was created in 1995 on the initiative of the local municipal govemment and the Alliance of American and Russian Women. In addition to fulfilling the functions of a traditional business incubator (consulting, office space and office services for new entrepreneurs), the organization also serves as a training center and provides micro leasing through its Leasing Fund. In order to provide lease finance, the Incubator obtained a leasing license from the federal Ministry of Economy and Trade. A grant from USAID was used to set up the fund. When the grant expired, a two-year loan from US-Russia Investment Fund (TUSRIF) was obtained to support the program. The borrowers under this program are private entrepreneurs and small businesses from St. Petersburg, as well as farmers from the Volkhov area and other cities and towns in the Leningrad region. Since the leasing program began, the business incubator has financed 80 deals. Of these, 32 lessees were involved in trade, 12 in industry, 24 in services and 12 in agriculture. As of April 2000, the Incubator Lease Fund had 50 active agreements and plans to increase to 120 within the year. The program allows for the lease of old or new equipment. The value of the leased equipment can range from $400 to $25,000. The lease terms are usually for two years with 12.5-25% advance payment and 20-25% annual percentage rates in dollar terms. The repayments are monthly at the prevailing CBR exchange rate. The Volkhov Business Incubator insures the equipment in its favor for which the lessee pays the premiums. No other collateral is taken. Delays in payments were experienced in only 2% of the portfolio. One agreement had to be terminated prematurely due to the lessee's insolvency, but the lessee retumed the leased equipment voluntarily and the incubator was able to resell it. Source: Likhachova, Irina. 'Volkhov International Business Incubator' IFC Leasing-Courier Russia. April 2000 A more effective approach has been initiatives for start-ups on the regional and municipal levels. Novosibirsk's regional authorities are discussing the implementation of business incubators, as well as the setting up of a system for transfer of state and regional property to start-ups at favored conditions. In Vladivostok, the regional government set aside a notional sum for financing a Fund for Support of Small Business. The Fund provides information, (paid) legal services, education, and (paid) consulting to help with organizing the business, drafting a business plan, developing accounting, processing registration and licensing, and providing some very limited financing. Finally, credit unions are starting to appear in Russia. Those are funded by their members and lend to members at relatively low interest rates, using simplified loan approval procedures. The volume and reach of these credit unions remains very limited, however. Donor credit lines remain small as well, but they show that there is scope for viable lending. Private and donor-funded initiatives have also been a source of finance for the small and medium enterprises. One example is the EBRD-initiated Russia Small Business Fund (Box 7). These initiatives have been small in terms of the overall needs of the Russian economy, but they show that there is some scope for productive lending. Trade Credit and Non-Monetary Forms of Exchange Today, corporations in Russia rarely use normal forms of trade financing. Often arrears will be labeled "trade credit", but these are "extended" involuntarily, for lack of liquidity of the trade partner. The lack of normal trade finance is mainly due to the weaknesses in dispute settlement mechanisms and credit rating and tracking mechanisms for non-payments. Although there are some efforts underway, so far there is no centralized system to keep track of defaults or other negative information and a private credit rating agency has not yet been established. Due to non-existing credit record tracking mechanisms, virtually all firms require new clients to pay in cash, part in advance, with 68 Corporate Finance in Russia's Regions the balance on delivery. Charging interest on trade credit is more the exception than the rule. Some companies are, however, offering a discount if payments are made in cash. Box 7: EBRD's Russia Small Business Fund (RSBF) The RSBF program was conceived as a way to stimulate new, viable production and employment. It received a great boost in 1993 when the G-7 pledged $150 million, to be matched by $150 million from EBRD. The RSBF program has three components: (1) Micro Loans-from $100-30,000 for a period of 1-36 months to enterprises in all sectors up to 20 employees; (2) SME Loans-up to $150,000 for a period of 1-36 months to enterprises in manufacturing and services, typically with fewer than 80 employees; and (3) Small Enterprise Equity Funds (SEEFs) to provide a combination of debt and equity financing up to $500,000 for small businesses employing up to 150 people in the production and service industries. Since 1994 the RSBF has made more than 36,000 loans totaling more than $400 million to entrepreneurs in more than 60 towns and cities across 25 regions of the Russian Federation. The average loan disbursed is $14,000, the largest loan issued was for $150,000 and the smallest just $30. The average tenor has been 9 months and average amount $7500 for micro loans, and 18 months and average $58,000 to SME's. The borrowers have been a very diverse group of enterprises in all sectors, from retail kiosks to high-tech medical manufacturing. Many of the small loans had also been fully repaid within one year of disbursements with limited repeat borrowings. The loans are on lent through selected intermediary banks for 2-5 years maturity. Currently RSBF works with 4 partner banks and EBRD's own SME- finance Bank, KMB Bank. The goal of RSBF is to disburse 3000 loans per month through the existing and future intermediary banks spread across Russia within the next two years. The RSBF Program provides intensive technical assistance to the participating banks where external experts and consultants on credit risk analysis train loan officers. Loan officers are trained to analyze the management, the market and the financial situation of the borrower, including cash flow forecasts before they examine the collateral. The program stresses the value of repeat loans for developing credit history and for loan officers to see the client as a client for life. This is essential in micro and small lending, where loans are often too small to cover the transaction costs of the bank. The participating banks are also encouraged to consider non-traditional forms of collateral. Loans under the RSBF have been made with many forms of collateral, for example, real estate, automobiles, television sets, porcelain, jewellery and, in one case, pure bred dogs. The high repayment rate has justified the flexibility. The Russian banks participating in the program have learned to change their conservative lending behavior, stressing collateral and connections to one based on cash flow and credit analysis. They have also learned that lending to small and micro enterprises can be profitable if successfully structured and risks are properly managed. Some also had to change their centralized credit approval structures since small-scale finance requires decentralized structures and delegation of authority to trained staff at the branch level. To the extent, trade credit is being offered, it is either between entities within the same business group or to buyers with whom there is a long-term relationship; see Box 8. Frequently the terms for this form of trade finance are 3 weeks and for between 10% and 30% of the amount due. The length of the trade relationship is of paramount importance to the terms of trade credit. Relative market power of the trade partners (and thus ability to bargain) is also an important factor in trade credit. For example, a seller will extend trade credit if the client purchases a major part of the output. If that client is further liquidity constrained, as is likely, the term of the trade credit can reach several months or generally up to the turnover period of the client. Foreign partners offer trade credit with much more willingness than domestic ones. Many companies are uncomfortable and unequipped to deal with issues like sales, placement, marketing, credit checks, collections, etc. Box 8: Two Examples of Trade Credit in Russia This Novosibirsk wood-processing firm has three Tomsk-based suppliers, with whom the company has worked since the 70s. The Novosibirsk firm makes large purchases in the fall, to stock up for the winter and assure uninterrupted production. The company usually finds it difficult to finance this bulk purchase. Supply payments are made with a lag of 3-4 months, 70% in cash and 30% in exchange for the new production. No interest is charged for the late payments. This Vladivostok milk and yogurt products manufacturer is required to pay all suppliers up front, in cash. However, it pays its foreign packaging company three months after receipt of goods with no interest charges. Stijn Claessens and Esen Ulgenerk 69 In an environment of limited bank finance and no formal trade credit and liquidity, non- monetary forms of payment provide the liquidity and credit for the exchange and sales among enterprises. To a large extent enterprises build in premiums or discounts into the prices of the goods or liabilities exchanged, thus substituting trade terms (payment and interest) for price gains, and where the exchange of goods or offsets serves as immediate collateral. Substituting barter for trade credit should be no surprise in Russia, also given the weak contract enforcement environment. But, it is having long-run costs as it prevents the development of market-based financial transactions and a real financial system. Although declining, non-monetary payments are still much used, especially in the remote regions for conducting trade transactions, to resolve arrears or for continued non-transparency reasons as well as to sustain non-viable enterprises. For the manufacturing industry as a whole, the share of barter in total sales is estimated to be some 20%, down some 15-percentage points from 1999. Non- monetary payment forms can be grouped in one of three categories: barter, exchange of goods or exchange of a good against a debt; debt offsets, exchange of goods or veksels of third parties against tax or wage arrears or inter-enterprise payables/receivables; and veksels, either own or third party veksels in exchange for goods or payables (tax, wages, etc.). There are many structural reasons for the continued use of non-monetary forms of payment in Russia. One is the restriction on large volumes of cash payments and lack of near-cash instruments within the system. Also there is no large or automated bank branch network that would make clearing/payments less costly and efficient for enterprises. Except for Sberbank, there is no single operating national bank with a branch network covering all parts of Russia. Furthermore, some monopoly suppliers of goods to illiquid regional governments often request higher prices for their goods to offset tax liabilities. And enterprises with previously established sales and distribution networks can often continue operating even if they are loss making and need financial and operational restructuring. Today there are two types of veksels in Russia, corporate and bank veksels. Some of the bank veksels are like certificates of deposit as they are redeemable at sight or at a later date. However, bank veksels can also be issued against credit extended (veksel credit loan) giving the banks limited capacity (up to 100% of charter capital) to create money. Corporate veksels can be in the form of promissory notes sold at a discount or with fixed rate coupons for longer periods. Although regulations stipulate that a corporation can issue own veksels only up to 30% of its chartered capital, there is no central oversight over veksels issued by enterprises. Both bank and corporate veksels are used for collateral against bank lending, trade credit among enterprises and non-monetary means of netting of inter-enterprise receivables/payables. The total volume of primary issue of corporate veksels is estimated to be about several billion dollars, mainly issued by Gazprom (Russia's largest enterprise). Gazprom veksels are issued to pay its own suppliers but much of the paper is then sold in the secondary market to the buyers of Gazprom who in turn use them to offset their own payables. The high secondary market demand for Gazprom veksels have created a premium for this paper and today Gazprom can issue its own veksel to the suppliers at a discount of its actual obligation. There is a secondary market, centered in Moscow for bank and corporate veksels of prime names. The most in- demand bank veksels are those of Sberbank and most in demand corporate veksels are those of Gazprom. The daily turnover in this market is estimated to be around $50 million. While there are some of improvement in the framework for inter-enterprise lending, much of the non-payments starts with budgetary agencies. Recently, the federal government has been pressing for cash settlement of taxes, and in general reducing the scope for transfers coming from government related agencies. Thus, relative to earlier years, the share of barter payments has declined somewhat and the federal government, utility providers, and the railroad monopoly are pressing for settlements in cash and financial instruments. Telephone providers and the railroad monopoly are refusing in-kind payments almost entirely. Increasingly, electricity providers are refusing barter settlements to all enterprises that are judged liquid enough to settle in cash. The recent reduction in government arrears 70 Corporate Finance in Russia's Regions is affecting the corporate sector positively. In Novgorod, a major wire producer, for example, has seen the share of barter deals in its business fall from 40% in 1996 to 5-10% in 2000. Suppliers and business clients' transactions, barter payments to utility providers, and tax offsets at the federal and local level all turn often complex. In settlements with suppliers, illiquid enterprises pressure for in-kind payments. Usually heavy industry is more prone to settling in barter, due to the lack of a liquid market for their production. Suppliers who are more dependent on a single big client are more willing to tolerate in-kind payments. On average, 30-60% of supplier payments is barter deals, as opposed to 5-10% for more liquid companies. There are also some attempts to create alternative mechanisms that could provide some form of credit certification and payment enforcement. One such mechanism is a voluntary association of enterprises (usually with the support of the regional administration) where all members accept the association's power of contract enforcement among the members. However, this mechanism has limited enforcement power (e.g., usually only among the association's members), and may further have the problem of limited self-enforcement (e.g., when a powerful member has no interest in enforcement, he could not be stopped from dropping out of the association). This alternative would be effective to the extent that reputation concerns are becoming important among Russian businesses. Several regions in Siberia, for example, have united their administrations and business associations in annual identification of credit-worthy companies. Currently, there are some 360 firms in Siberia that possess a "credit-worthy partner" certificate issued by two administrative authorities and two business associations. In addition to regional business organizations, associations within the same industry are being created, comprising all of Russia, for credit quality tracking. Those associations are used mainly to disseminate information. Both regional and industrial types of associations are being used as a forum for lobbying and communication with different levels of government. For those enterprises that cannot yet afford to set up their own networks, using intermediaries can increase cash collections and improve turnover. Despite setbacks, some companies have been able to set up dealer networks to support sales and collections. Own-dealer networks, if a company can afford them, are useful for both sales related marketing information gathering as well as for assistance in collection activities (Box 9). They have thus some function in improved credit allocation. Specialized companies have sprung up to arrange "barter chains"-clearance mechanisms that attempt to create a closed chain of mutually needed goods-that provide liquidity. The principle of those chains is that illiquid firms will accept product to be sold at a discount, while cash rich firms will only participate in the chain if offered a premium. Alternatively, if the organizer manages to create a closed chain among only illiquid firms, the organizer collects the profit from all discounts offered by participants in the transaction (see Box 10 for an illustration). The demand for such chains comes from illiquid enterprises or budgetary organizations that either cannot pay cash for their supplies, or are forced to make payments for essential inputs such as gas, electricity, and telephone. Thus the chain usually involves a utility provider, and the municipal or oblast government. Policy Recommendations Moving forward, the government should start with improving the basics for commercial transactions. This means a basic, legal framework for gny commercial transaction, whether among corporations or between corporations and financial institutions. This legal framework of course also needs to be enforced. To date, the legal basis for many commercial-to-commercial transactions in Russia is very weak and enforcement very limited, leading to large-scale barter, non-payment, and high transactions costs. In the short to medium term, given the limited state of development of the Stijn Claessens and Esen Ulgenerk 71 financial system, intra-firm credit, whether for trade-finance or for investment purposes, will have to be the most important source of external financing for most firms. To achieve this will require building up a truly independent judicial system with well paid judges that have the incentives to enforce the legal framework; see the chapter on dispute settlement. And it will require a better functioning system for transacting payments. With more efficient and reliable intra-firm financing, a basis for a more productive role of the banking system in Russia can be established. Box 9: Dealer Networks as Surrogate Credit-Tracking and Payment Collection Mechanisms This Novgorod wire producer sells both directly and through dealers. Any direct sale requires 100% payment in advance. As for indirect sales, initially the firm used many dealers, among them some small ones. Most were dropped soon, and currently the company sells via three dealers in the Northwest part of Russia: in St. Petersburg, Tver, and Novgorod. The firm has worked with those dealers for two years. The company has concluded dealership agreements, according to which the dealer gets 20-25 days to sell, and them needs to transmit the money to the firm, keeping the dealer's margin. The firm has even attempted to encourage the dealers to repay (and sell) faster. The dealers get a "discount" according to how much they have sold last month. This Novgorod fertilizer producer sells via a dealership network that is currently being established. Dealers are required to deal only in its product, but have otherwise no ownership or governance ties. One dealer in each city or town is given exclusive rights to distribution of the product. Dealers set their own price for the product, and pay the firm a fixed pre-determined asking price. Dealers pay exclusively in cash, via the firm's corporate settlement account at the bank. The first year the firm sold directly, but did not find il optimal, because it was difficult to study the market in each locality. Dealers have a comparative advantage in that they know and can control the market in each city or town, and maintain contact with local stores. This building component manufacturer in Novgorod does not obtain payments from clients affiliated with the company's parent. Instead, at end-month, the firm draws up a total of sales receivables from the parent's affiliates, and all sales receipts are sent out to the parent, who either collects payment or clears out mutual payables with its affiliates. This Novosibirsk sewing company has created a 100% owned subsidiary that deals with sales, where all employees work for a percentage of sales. Box 10: Barter Chains - A Costly Source of Liquidity This Novgorod foodstuff producer presents its "offsets" business as one of its core activities. The firm creates barter chains among enterprises, gas and electricity providers, and local and oblast authorities. As an example of a barter chain, the firm sells foodstuffs to another firm, who cancels the respective amount of its outstanding receivables with a brick producer, who in turn "pays" with brick production to a metallurgical plant. The laner uses the bricks as inputs and pays for it with metal that is shipped to a budget organization, which in turn uses that for construction and repair. The regional administration pays for the metal by offsetting the taxes of the foodstuff producer's suppliers, who complete the chain by providing raw materials to the firm. There are usually 6-10 pieces to a barter chain. Strengthen Creditors' Rights. Across countries, in addition to a stable macro-economic environment, the legal and regulatory environment in which financial institutions operate is the most important determinant of financial development, and in turn for economic growth. The rights of secured and unsecured creditors, the rights of equity holders and the enforcement of these and other contracts are the most important components of this legal and regulatory environment. Credit market development depends crucially on the ability of creditors to enforce their claims on borrowers. The weaknesses in many components of its legal and regulatory framework, combined with the general lack of contract enforcement and poor macro-performance over the past decade, largely explain the low-intermediation trap in Russia and the feeble contribution of the financial sector to growth. Strengthen Equity Investors' Rights. Similarly, Russia's capital market development is impeded by weakly enforced equity rights. Significantly, in countries where there are strongly 72 Corporate Finance in Russia's Regions enforced shareholder rights, there is a greater number of listed firms and higher stock market capitalization. Also, across countries, firm valuation is found to be a declining function of the degree) of shareholder protection.8 Correspondingly, the cost of capital for firms is higher in weak corporate governance settings, which has social costs as profitable investment opportunities are bypassed. Russia ranks among the lowest of all countries in terms of effective minority shareholder protection; as a result, market valuation of its firms will likely be only a fraction of that in comparison with developed countries' capital markets. Indeed, this is confirmed for a sample of Russian firmns where the deviation of local valuation from international benchmarks varies greatly depending on a firm's corporate govemance behavior (see Black, 2001). Adopt International Accounting Standards. The non-transparency and the inefficiencies of non-monetary forms of payments are further hindering the development of normal, market-based financial transactions. Adopting International Accounting Standards (IAS) and applications in both the real and financial sectors would decrease the non-transparency and allow financial institutions to start intermediating funds more productively. A normal set of contractual relationship among enterprises will be a requirement for the eventual development of a functioning financial system. And, without a functioning financial system yet, normal contractual relationships among corporations is the only way to some sustainable enterprise growth in the near future. The lack of transparency is also a major deterrent for other external financing sources for the real sector. In a May 2000 survey, Price Waterhouse has estimated that non-transparency costs Russia around $9.8 billion annually in foreign direct investment.9 ImplementAuditing Reform. Audit reforms are also necessary to encourage transparency and full disclosure of information by the corporations. The majority of the companies are unlikely to undertake the efforts necessary to achieve full and timely disclosure of information, such as implementing generally accepted international accounting standards and changing the management mentality, until audit reforms have been implemented. Harsh treatment by the Tax Police and the threat of expropriation act as disincentives for disclosing information by companies as well as revealing fully the identity of key shareholders. A more rationally enforced tax system will be a necessity for better quality financial information and fuller disclosure. Proceed with Comprehensive Banking Reform. Increasing confidence in and capitalization of the financial system is a must for the longer-term. The development of a fully functioning financial sector in Russia will be a long-lasting effort. One crucial prerequisite for any meaningful reform is the full political commitment of the Russian government (GOR), including the Central Bank (CBR) and the Ministry of Finance (MOF), to banking system restructuring and financial reform. This will be a necessity to create greater confidence over time among households and investors in the Russian financial system, thereby increasing the available financial savings and capital, and thus make greater financing available for the corporate sector. Building confidence requires that the government enforces its own set of rules. Enforcement of existing rules includes the closure and liquidation of insolvent banks according to already set procedures. Up to the present, instead of liquidating insolvent banks the government has, through various means, supported favored banks and through generally limited actions allowed other insolvent banks to remain in business as "zombies." The government also has only made limited efforts in stopping asset stripping in defunct or even officially intervened banks. Before any active restructuring, the liquidation of insolvent banks has to proceed first. Without the political will to take the minimum steps necessary to liquidate insolvent banks and stop asset stripping, support for building a legal or institutional framework for more active bank restructuring will be ineffective, and is most likely counterproductive. Recent changes in the banking legislation are steps in the right way but questions still remain about their implementation. Several amendments to the banking legislation have been approved by the Russian Parliament. In addition to clarifying the existing definitions for bank capital and insolvency, these amendments also give more powers to CBR to properly intervene and resolve problem banks. Stijn Claessens and Esen Ulgenerk 73 All of these amendments could improve the transparency of the banking sector and the supervisory oversight and powers of the CBR. However, the passage of these amendments does not necessarily mean that banking reform has become a priority. Progress toward adopting international accounting standards in the banking sector is very slow, with 2004 estimated to be the earliest date of its adoption by the full sector. And the idea of building a systemwide deposit insurance, while already repeatedly delayed, remains being discussed, although this remains an undesirable measure given the supervisory weaknesses in Russia. Any deposit insurance scheme will also need to take into account the still large role of Sberbank in deposit mobilization. Foster Competition in the Banking Sector. The state should be the regulator and supervisor of the financial sector, rather than a direct participant. State-ownership in the banking system is still large with more than 45% of assets and nearly 90% of the deposits. The large state dominance in the banking sector continues to stifle competition and encourages directing the funds of the state banking sector into politically important projects, sectors or enterprises. While the government has recently made announcements with, respect to its intention to privatize some of these banks, it has yet to provide more specific information. Recent history in Russia has shown that poorly executed privatization strategies entail large risks. The government could signal its commitment to deeper reforms by, for example, announcing its intention to privatize some state banks to reputable strategic investors. Encouraging further foreign bank entry in general would also increase the available capital and confidence in the banking sector. To date, however, nothing has been done about easing foreign access to the banking sector. 74 Corporate Finance in Russia's Regions Bibliography Black, Bernard S. Forthcoming. "The Corporate Governance Behavior and Market Value of Russian Firms." Emerging Markets Review, Vol. 2. Broadman, Harry, and Francesca Recanatini. (2001). "Where Has All the Foreign Investment Gone in Russia?" World Bank, Washisngton, D.C. Policy Research Working Paper. 2640. La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W. Vishny. (2000). "Investor Protection and Corporate Valuation." Harvard University, Boston, MA. Likhachova, Irina. (2000). 'Volkhov International Business Incubator' IFC Leasing-Courier Russia. Pistor, Katharina, Martin Raiser, and Stanislaw Gelfer. (2000). "Law and Finance in Transition Economies." European Bank for Reconstruction and Development Working Paper. 48. Policy Note on Capital Markets. (1999). CMD 020. WB, The Center for Capital Markets Development and the UK Department for International Development. Policy Note on Capital Markets. (1999). Policy Note on Capital Markets Development. (1999). World Bank. Tsukhlo, S. (1999). "Demand Guidelines and Investment Preferences of Russian Enterprises." Publication INDIKATOR. 12. Ustinov, Vladimir. (2001). Global Corruption Conference. The Hague, The Netherlands. In 2000, the share of loss-making enterprises declined from 1999 by 7 percentage points, the majority (54%) of managers assessed their financial position as good or normal, and only 22% of managers believed their enterprises was facing bankruptcy in the next one or two years, down from 27% in 1999 (source: Russian Economic Barometer). "Financial Leasing in Russia: Market Survey 1998-9," IFC 2000 contains a detailed description of the leasing companies operating in Russia, and the leasing market conditions. The study can be found at: http:/Hwww.ifc.or./russianleasing/enp./analit/mrkt surv99/index.htm. Stijn Claessens and Esen Ulgenerk 75 Endnotes 1 Policy Note on Capital Markets. CMD 020 Dec. 1999. WB, The Center for Capital Markets Development and the UK Department for International Development. 2 Policy Note on Capital markets, 1999. 3 As reported by the prosecutor-general, Vladimir Ustinov, on May 31, 2001, at the Global Corruption Conference, The Hague, The Netherlands. 4 Policy Note on Capital.Markets Development, World Bank, 1999. S S. Tsukhlo "Demand Guidelines and Investment Preferences of Russian Enterprises," publication INDIKATOR No.12, 1999. 6 In 2000, the share of loss-making enterprises declined from 1999 by 7 percentage points, the majority (54%) of managers assessed their finanacial'position as good or normal, and only 22% of managers believed their enterprises was facing bankruptcy in the next one or two years, down from 27% in 1999 (source: Russian Economic Barometer). 7 "Financial Leasing in Russia-. Market Survey 1998-9," IFC 2000 contains a detailed description of the leasing companies operating in Russia, and the leasing market conditions. The study can be found at: http://www.ifc.org/russianleasing/eng/analit/mrkt surv99/index.htm. 8 La Porta et al. 2000. 9 The IMF estimates that foreign direct investment to Russia in 2000 was around $2.7 billion. V. Dispute Resolution in Russia: A Regional Perspective Kathryn Hendley* and Peter Murrell** Introduction The reality of institutional performance often differs markedly from the assumptions of the conventional wisdom. It is often even markedly different from the conventional wisdom held by those in the knowledge business, such as academics, journalists, and poJicy practitioners. Frequently, all institutions become tarred with the general brush of a country's reputation. Assumptions on how specific institutions are functioning are often based on the general economic performance of a country or on general observations of the character of government and politics, rather than on detailed observations of the specific institution. In the case of legal institutions in Russia, there is another factor: some deem the phrase 'Russian Law' to be an oxymoron. Tsarist and Soviet history and tales of the modem Russian mafia seem to provide a filter, which excludes the possibility that there can be some bright spots amid the Russian legal and economic gloom. Views on the arbitrazh courts, the courts pertinent to businesses in Russia, seem more reflective of these factors than of detailed evidence on the use and functioning of these courts. An odd consensus has emerged among commentators that the arbitrazh courts are simply not up to the task before them and irrelevant to the needs of the economy. With few exceptions, the literature on Russian legal developments contends that the arbitrazh courts are not being actively used, and that their pervasive flaws have doomed these courts to peripheral status.' Commentators have argued that law is not terribly relevant in the emerging Russian market and that the shortcomings of the legal system are a key factor stymieing development.2 The arbitrazh courts, according to this consensus, are compromised by judges' lack of competence, by the taint of outside influence, by slowness of decision-making, and by the difficulty of enforcing judgments. As a result, enterprises are shunning the courts, even turning to private enforcement to resolve disputes.3 Such views might be justified if all parts of the Russian legal system exhibited the same properties, on average, as Russian institutions in general. Such views would be conceivable if the arbitrazh courts exhibited the same properties as Russia's courts of general jurisdiction, which are pertinent to legal matters outside the business sphere. But as we will show in the pages below, the arbitrazh courts are quite distinctive. The views that are summarized in the previous paragraph could not now arise from a careful consideration of the evidence on the use and functioning of these courts. A central premise of this paper is that a sound empirically based assessment of existing institutions is a crucial input into policy and reform. Without such an input, conventional wisdom, which sometimes reflects prevailing dispositions rather than detailed empirical work, can affect important decisions, as it insinuates itself into the informational base used by policy makers and advisers. Thus, in a paper written this year for an international financial institution, the authors commented that "The legal system is not a useful route for settlement of any dispute..." in Russia and referred to a "lack of...dispute settlement mechanisms." This is an example of an instance where the conventional wisdom on the courts has reached a position where it can influence the direction of policy and reform, given the important role of the international financial institutions in guiding reforms in developing and transition countries. * Professor of Law and Political Science and Director of the Center for Russia, East Europe, and Central Asia, University of Wisconsin-Madison. ** Professor of Economics and Chair of the Academic Council of the IRIS Center, University of Maryland; and Economist, The World Bank. Thanks are due to Alla Mozgovaya of the Institute of Sociology of the Russian Academy of Sciences and to Catherine Weaver. We gratefully acknowledge the support of the National Council for Eurasian and East European Research. 77 Kathryn Hendley and Peter Murrell In this paper, we take issue with the prevailing views and argue that the arbitrazh courts play a role in the Russian economy that is widely underestimated. They are used extensively and they are viewed relatively benignly by business. We do not argue that the arbitrazh courts are without problems, indeed far from it. This is to be expected, they are embedded in a society in which the historical legacy is far from helpful for legal processes, in which many of the institutions that are complementary to the arbitrazh courts function poorly, in which the central government has frequently reneged on financial commitments, and where conflicts between central and regional governments can cause problems even for the best designed institutions. Nevertheless, the arbitrazh courts must be examined as a distinctive institution and general perceptions on the functioning of these courts are far from reality.4 Consistent with the tenor of the overall study of which this paper is a part, we pursue our argument using empirical information obtained on the ground, reflecting circumstances in a variety of Russian regions. The points we make are driven by information collected on the day-to-day operations of enterprises and courts, from enterprises and from the courts directly, rather than from more generally available published sources of information. There are three primary sources of information. First there is the regional case-study field research conducted by Hendley at various times over the past decade. In keeping with the spirit of the other essays in this volume, we place particular emphasis on the findings from the field research in 2000 and 2001 (but we are able to put these results in a broader context). This field work has taken place in enterprises and in the courts themselves, observing judicial proceedings, interviewing judges and litigants, and examining upwards of a thousand case files.5 Second, there are the data that the individual arbitrazh courts submit annually to the Higher Arbitrazh Court. These data are not published regularly and therefore this information will be new to all but a tiny number of readers.6 We are able to provide a picture of the functioning of the regional arbitrazh courts that reflects a variety of experience across regions, a picture that is based on the behavior of individual courts.' The third source of information comprises the results gained from a survey of 220 Russian enterprises.8 The sample was drawn from four cities (Moscow, Novosibirsk, Yekaterinburg, Saratov), with each represented equally.9 This third source of information provides evidence that is based on the behavior of individual enterprises in different regions of the country. This type of field research, reflecting the circumstances of many enterprises, offers information that is less detailed than derived from case studies on individual enterprises, but provides information that is much more specific to the questions being addressed than contained in any standard enterprise data-base. Although this survey was conducted in mid-1997, before the 1998 financial crisis, the results are still highly pertinent today. As we will show below, the interactions between enterprises and the legal system did not evidence any strong structural shifts in response to the 1998 crisis. Moreover, the legal system itself did not change in any dramatic way between 1997 and the present. Therefore, the results of this survey are still pertinent for current deliberations. We emphasize that our data examines the courts from a variety of different perspectives using information from the three different sources. It is the consistency of the composite picture that emanates from the varied information that argues most strongly for our conclusions. We do not pick upon a single aspect of the arbitrazh courts nor do we rely on a single source of information, but still we are able to obtain a consistent message, at odds with the conventional wisdom. This conclusion is reinforced when pursuing the second theme of our argument, the variety of experience at the regional level. We examine how the arbitrazh courts are functioning across a variety of Russian regions and find a consistent picture across the regions. We begin the presentation of the evidence by providing a background to the paper in the next two sections, placing the arbitrazh courts in the Russian institutional landscape and discussing the characteristics of the regions that are examined in this study. We then turn to the presentation of data on the arbitrazh courts. Sections 4, 5, and 6 examine the intensity and the patterns of use of the arbitrazh courts, noting changes over time, variations between regions, and the growth in the number of cases that involve the government. Sections 7-11 study the empirical evidence on features of the arbitrazh courts that are most often mentioned in the standard criticisms of these courts. We examine whether the courts are slow and expensive. We look for evidence of lack of competence of the judges and of corruption. We examine the issue of enforcement of decisions. We find, in most cases, that these standard criticisms are over-stated, and in some instances there is virtually no evidence supporting the criticisms. We do not conclude, however, that the arbitrazh courts are 78 Corporate Finance in Russia's Regions without problems. There are clearly identifiable areas of the operations of the arbitrazh courts that could be addressed by suitable reforms. Section 12 considers some policy implications of our findings. The Arbitrazh Courts In Russia, arbitrazh courts are the state-sponsored tribunal charged with resolving economic disputes.'° Arbitrazh courts are not entirely new to post-Soviet Russia. They are the institutional successor to state arbitrazh (gosudarstvennyi arbitrazh or gosarbitrazh), which existed during the Soviet period. Gosarbitrazh was a quasi-administrative agency that resolved disputes between state enterprises." Like all Soviet-era judicial organs, gosarbitrazh was politicized. It operated within the confines of the administrative-command system, with the underlying goal always plan fulfillment.'2 As a result, the arbiters who decided cases looked more often to the implications of the case for the economy than to the law when making their decisions. This Soviet legacy is one source of the pervasive criticisms of the Russian legal system. Under the old system, legal institutions were highly permeable. Laws bent to the political winds, as did the courts. '3 In view of this history and the difficulty of quickly legitimizing carryover legal institutions, many commentators have argued that law is not terribly relevant in the emerging Russian market and that the shortcomings of the legal system are a key factor stymying development.'4 The inadequacies of gosarbitrazh were apparent from the earliest days of the transition. The introduction of new property forms in the late 1980s and early 1990s required a similar expansion in jurisdiction. Consequently, new procedural rules were adopted and put into effect in 1992.15 One of their most important institutional innovations was to discard the administrative agency persona of gosarbitrazh and, in its place, to create arbitrazh courts (arbitrazhnye sudy). In addition, these newly constituted arbitrazh courts were no longer limited to resolving disputes between state enterprises, but were empowered to resolve disputes between all types of legal entities, and even between legal entities and the state.'6 Although this new arbitrazh procedure code (APK) represented a step away from gosarbitrazh, it also proved inadequate. The arbitrazh procedure code was again rewritten and, in July 1995, a new set of rules took effect. '' The profound transition from gosarbitrazh to arbitrazh courts was not achieved overnight. To some extent, judges and litigants were adjusting to the new institution throughout the period under consideration in this paper.'8 In fact, presently before the Duma is a new draft of this procedural code that attempts to address some of the problems that have become apparent over the past six years. In May 2001, this draft code had its first reading. According to officials at the Higher Arbitrazh Court, more than one thousand comments and proposed amendments were generated. Consequently, at this point, it is impossible to know which aspects of the new law will survive. In the text that follows, we note where the current draft would change practice and relate the predictions of court insiders as to its prospects for ultimate success. The present-day arbitrazh courts remain institutionally distinct both from the courts of general jurisdiction and from the constitutional court.'9 The courts of general jurisdiction hear cases involving individuals, while the arbitrazh courts consider cases filed by legal entities.20 Thus, most commercial litigation in Russia is concentrated in the arbitrazh courts. One area in which the jurisdiction of the two courts has overlapped is corporate governance. Because the arbitrazh courts are generally barred from hearing cases involving individuals (except when they have registered as entrepreneurs), claims brought by shareholders who are physical persons are shunted off to the courts of general jurisdiction. The draft procedural code adjusts the jurisdictional boundaries to allow the arbitrazh courts to hear all corporate governance cases. In a June 2001 conversation with officials at the Higher Arbitrazh Court, we were cautioned that the Russian Supreme Court had not yet agreed to this adjustment. Whether the courts of general jurisdiction will give up their right to hear these cases is unclear. At present, arbitrazh courts hear two basic types of cases: (I) economic disputes between legal entities, including bankruptcy2' (these disputes between enterprises or other non-governmental entities are referred to as "civil" cases22); and (2) economic disputes between legal entities and the govemment.23 Disputes that pit enterprises against the government are known as "administrative" cases. 79 Kathryn Hendley and Peter Murrell As market reforms have progressed, the disputes submitted to the arbitrazh court have grown more and more complicated. Not surprisingly, cases now take longer to process. The increased use of penalties means that the amounts being demanded are no longer symbolic. The arbitrazh courts have struggled to come up with mechanisms for ensuring compliance by the losers.24 In the view of Russian lawyers, the inability to enforce judgments is the single biggest shortcoming of the arbitrazh courts. The chairman of the Higher Arbitrazh Court, which stands at the apex of the arbitrazh court system, has acknowledged that implementation is the Achilles' heel of the system.2 One interesting question, not fully addressed in the literature and obviously important for this paper, is the place of the arbitrazh courts in the much vaunted struggles between federal and regional authorities. Hendley, Murrell, and Ryterman (2000) provide some insights into this issue based on the results of a 1997 survey in six different regions. In examining the strategies that enterprises pursue in addressing transactional problems, they find that enterprises who rely more on the vestiges of the old Soviet planning and ministerial system are more likely to resort to the federal government for help. Appeals to the regional government are associated with use of the arbitrazh courts. This suggests that, despite the fact that the arbitrazh court system is a national level institution, patterns of use have a local dimension that should be investigated. The Regions under Study Following the orientation of the overall project of which this paper is one part, the discussion here has a significant regional dimension to it. There are several sets of regions that appear in this paper. The basic set of regions contains those oblasts that are the subject matter for the overall study of which this chapter is one part: City of St. Petersburg, Leningradskaya Oblast, Novgorodskaya Oblast, City of Moscow, Moskovskaya Oblast, Volgogradskaya Oblast, Samarskaya Oblast, Saratovskaya Oblast, Sverdlovskaya Oblast, Novosibirskaya Oblast, Omskaya Oblast, and Primorskii Krai. We will also consider subsets of these regions in individual analyses, where the limited availability of data dictates. The reader should assume that where a subset is considered then the decision is dictated by the availability of data. Tables 1-3 provide some summary information on the regions under study. Table I focuses on politics. There is substantial variation among the regions in terms of the length of tenure of governor, the support that governor received in the region when elected, and the extent to which the region is politically aligned with winning presidential candidates. It is clear that the data in this paper will reflect a variety of experience on the issue of federal-regional relations. Table 2 focuses on basic economic statistics and reveals somewhat more homogeneity among the regions. They are all large in terms of population and none of the regions is at the lowest level of development relative to the spectrum of Russian regions. All these regions are highly urbanized and in all of them there is a significant industrial component to the economy, although there has been a substantial decline in industrial production over time. Table 3 focuses on the enterprise sector, which of course is the sector that is pertinent to the arbitrazh courts. The relative size of this sector in the economy will be one ingredient in the relative patterns of use of the arbitrazh courts. Patterns of use are also likely to vary with the relative importance of joint-stock enterprises, which are more likely to be privatized, older, and large, versus non-joint-stock enterprises, which will primarily be new private businesses that are quite small. The effect of the relative importance of different types of enterprises on patterns of use of the courts will reflect two countervailing effects. The older firms will more likely have the legal resources to use the court system and experience with that system,26 but they will also have established relationships that can be used to solve disputes without going to court. The regions in the study do have sufficient variation in this respect to give us confidence that the results appearing below reflect a variety of Russian experience. Let us take Novgorod and St. Petersburg/Leningrad (skipping the extreme of Moscow). The latter region has nearly double the number of enterprises per capita and a greater proportion of workers in the enterprise sector who are in small enterprises (6 times the number of small enterprises per capita as Novgorod). 80 Corporate Finance in Russia's Regions In sum, the statistics below on the use of arbitrazh courts reflect the situation in a variety of Russian regions. To the extent that we can find patterns that are consistent across these regions, one can be sure that these patterns are not anomalous, but rather provide a general picture of what is happening in Russia at present. Intensity of Use of the Arbitrazh Courts For 1999 and 2000, Table 4 details the total number of cases filed and decided in the arbitrazh courts. The data presented in this table have been gathered from the official statistical forms that the individual arbitrazh courts submit annually to the Higher Arbitrazh Court. The number of cases decided represents a good indicator of demand for the services of the arbitrazh courts. At the same time, one should note that the number of cases decided is less than the number of petitions filed. Cases drop out for a variety of reasons. Some parties reach negotiated settlements, in which case the court could be providing a valuable service since the negotiations would be carried out under the shadow of the expected actions to be taken by the court. In other instances, the petitions are improperly drafted and cannot be accepted for consideration by the court.27 The large absolute number of cases is the first striking impression from Table 5. If enterprises are shunning the courts in favor of private enforcement as is commonly stated,28 then the data on use of the courts does not seem to reflect a lack of demand for the courts. Note also that 1999 does not seem to be an exceptional year (as one might imagine given the aftermath of the August 1998 crisis). Eight of the eleven regions have an increase in the number of cases from 1999 to 2000. To provide some scale to these data, the last columns of Table 4 compare the number of cases to numbers of enterprises in the region. We use two counts of the number of enterprises (see Table 3), first the total number of private enterprises in the region and second the number of joint-stock companies. The latter would be the category that contains the larger companies who are more likely to use the courts intensively. Even when the very smallest enterprises are included in the analysis, the regional median number of cases per enterprise is 0.2. Using the number of joint-stock companies as the base, all but one region has more than one case per enterprise and the median across the regions is 2.57. Table 4 can give some initial insight into the causes of regional variation in the intensity of court use. Moscow and St. Petersburg/Leningrad have much higher numbers of cases per inhabitant, but one factor causing this is the number of enterprises in these regions. The litigation rate per enterprise is actually lowest in these regions. But factors other than regional differences in the number of enterprises must come into play. Consider the contrast between Saratov and Samara, the former having a higher litigation rate per enterprise and double the litigation rate per joint stock enterprise. A glance at Tables 2-3 suggests that the differences might be because Saratov has a much larger number of privatized enterprises and a much more depressed economy than does Samara. Of course, a study using multivariate analysis with a larger number of regions would be necessary to explore this observation more fully. Table 5 strongly reinforces the message from Table 4, presenting results from our 1997 survey. In all four of the regions in that survey, more than 70% of enterprises had been a plaintiff or defendant in the two years prior to the survey and more than 60% had been a plaintiff. The cross-regional patterns in the intensity of court use are also broadly consistent between the two tables, with Moscow evidencing lower litigation rates per enterprise than other regions: Temporal Patterns in the Use of the Courts Table 6 examines how the use of the courts has changed over time. The number of cases decided decreased significantly in all regions from 1992 to 1994, and then began to recover. The drop-off was most precipitous outside Moscow. It is hardly surprising that the decline occurred simultaneously with the institutional rebirth of the arbitrazh courts. Enterprises needed time to familiarize themselves with the new "rules of the game."29 The percentage of petitions that have been dismissed for not complying with the procedural rules has steadily declined, indicating that enterprises are successfully absorbing these new rules. 81 Kathryn Hendley and Peter Murrell The end of the planned economy brought a fundamental change in the function of the arbitrazh courts. When appealing to gosarbitrazh, Soviet state enterprises were less interested in monetary recovery than in signaling their ministerial superiors that fault for poor performance was not theirs. Soviet-era managers did not have to be concerned with mounting debt, since soft budgets would compensate for any shortfalls. Privatized enterprises, by contrast, are necessarily more financially constrained. Inter-enterprise arrears emerged as a serious problem in the early 1990s.30 Yet the sharp decline documented in the table suggests that enterprise management initially looked away from the courts for relief. By 1997, the level of demand for the courts had risen above the 1992 level on a national basis and by 2000 the level of demand was above 1992 levels in all regions, with Sverdlovsk, at the lower end, 16% above the 1992 level, while Novosibirsk was fully 63% above the 1992 level. Since demand for the courts in 1997 was already higher than in 1992, this rise in the number of cases from 1994 onward cannot simply be ascribed to the 1998 crash. Thus, Table 6 suggests that enterprises in all regions of the country are availing themselves of the opportunities provided by the courts. This is not a picture that would be expected were the arbitrazh courts irrelevant in the affairs of enterprises. The Increase in Administrative Cases One common criticism of the courts is their complete powerlessness in the face of pressures from federal and regional governments. Were the courts hopeless in this respect, then one would not expect to see enterprises bringing suits against the government, because of the supposed futility of such an action, and one would not expect the government to need to bring suit against enterprises, since the courts could not add to their power. In fact in contrast to this prediction, Table 7 shows one very significant factor in the rise in demand for the courts in the last half of the 1990s, the rising proportion of administrative cases. Arbitrazh court cases can be divided into two categories. Disputes between enterprises or other non-governmental entities are referred to as "civil" cases.3' Disputes that pit enterprises against the government are known as "administrative" cases. What accounts for this astonishing increase in administrative cases? This surge suggests that enterprises and other legal entities are growing bolder. They are more willing to challenge governmental decisions that affect them (e.g., confiscations of property by the tax inspectorate) when they believe them to be 32 -oitsaehscnrbtdt illegal or arbitrary. Perhaps the lack of authority that has characterized the post-Soviet state has contributed to a perception that state institutions are more vulnerable and/or less competent. There may also be a demonstration effect at work, e.g., when enterprises observe their trading partners prevailing in disputes with the government, it may inspire them to pursue similar claims. At the very least, the data indicate that suing the government is not regarded as futile or quixotic. Although the number of claims brought by enterprises against state agencies has increased steadily, the explosion in administrative cases in 1999 and 2000 is the result of a somewhat artificial increase in state- initiated cases. Traditionally, the tax authorities were not required to seek judicial approval for the confiscation of the property of alleged tax delinquents. With the new tax code, which went into effect in 1999, the tax authorities have been reined in. They can now act only in accordance with judicial decision. Not surprisingly, the number of tax cases has risen precipitously. For the two Moscow courts, tax cases account for the entire increase in administrative cases between 1999 and 2000.3 For many of the other courts, tax cases make up a significant percentage of the increase in administrative cases in both 1999 and 2000.34 Are the Courts Slow? One of the most common criticisms of the arbitrazh courts is that cases are not decided in an expeditious manner.3 The law requires that cases be resolved within two months of being filed.36 Detailed records are kept on compliance. Table 8 sets forth the percentage of cases in which the deadline was violated from 1993 and 2000. The data paint a remarkably different picture than emerges from conventional wisdom. Delays have not been commonplace. Nationally, delays have never exceeded 5%.37 82 Corporate Finance in Russia's Regions There is regional variation in the levels of delays, for example Moscow city always more tardy than the national average and Saratov always quicker. The disparate levels of delays may result from poor management and/or inadequate staffing and/or the complexity of the cases heard. Court personnel constantly complain about meager funding.38 The difficulties in filling vacancies on the arbitrazh courts are well-known, the chairman of the Higher Arbitrazh Court estimating that as many as 24% of judicial posts are vacant.39 Naturally, these vacancies are not spread evenly across all courts. Some courts are more severely affected and these would be less capable of processing cases quickly. (See Box I on insights into the causes of delays in certain courts.) How well a given court copes with personnel shortages and with demanding caseloads depends, to some extent, on how well the court is managed. The chairman of each court is basically a manager, assigning cases and generally facilitating the work of the court. Some place a high priority on meeting the two-month deadlines, while others have a more casual attitude. At the Saratov arbitrazh court, which consistently had low levels of delay, the chairman of the court placed great emphasis on speed. In interviews conducted between 1993 and 1997, the Saratov judges seemed obsessed with not violating the deadline. Information about the compliance levels of judges was known within the court, and affected the reputation of judges among their colleagues. Complexity is a likely explanation for the higher level of delays in Moscow. The combination of the concentration of corporate headquarters and the widely held opinion that the Moscow City court is more competent than many regional courts leads potential litigants to file cases raising cutting edge legal arguments in Moscow.40 Complicated cases take more time to process, given that they often involve legal issues of first impression and additional third-party participants who, depending on their level of legal sophistication, may engage in adversarial strategies specifically designed to delay the proceedings. The evidence on delays can be backed up by data from the survey. The general directors were asked whether private enforcement or arbitrazh courts were speedier in resolving disputes. In Moscow, 64% of respondents said private enforcement was speedier, but the corresponding figures were only 38% in Novosibirsk, 48% in Saratov and 28% in Yekaterinburg. Since the popular image of private enforcement is speed without concern for due process and procedure, it is remarkable that in three of the regions under study the arbitrazh courts are rated as superior to private enforcement even on speed. Even justification for the conventional wisdom relied on the data for Moscow, that justification would not be very strong, since it would still be quite a surprise to find that only two-thirds of enterprises thought that private enforcement was speedier than the courts. Some of the reforms proposed by the draft procedural code threaten to undermine the courts' ability to dispose of cases swiftly. The draft code introduces a new stage in the judicial process for preparing the case for a hearing. As currently conceived, the parties would meet with the judge in order to explore the possibility of working out a settlement. In theory, this reform would seem to be helpful, given that it is aimed at achieving quicker resolutions of cases with less acrimony. Similar reforms have proven helpful in the U.S. judicial system. The Russian reality is different. The majority of civil cases involve non-payments. In our case studies of non-payments cases arising in 2000 in the Moscow city, Saratov, and Sverdlovsk courts, three-fourths of the cases reviewed were resolved at the first hearing, indicating that delay is not a pressing concern. Further complicating matters is the high percentage of default judgments. Given that the defendants took no part in more than half of civil cases reviewed, the value added of an additional hearing is questionable. Are the Courts Expensive? Another commonly encountered criticism of the arbitrazh courts is that the cost of filing lawsuits is prohibitive.4' In interviews, Russian enterprise managers usually emphasize filing fees as a key obstacle to using these courts (second in importance after problems with enforcement). When filing a case in arbitrazh court, a petitioner (istets) is required to pay a fee (gosudarstvennaia poshlina or gosposhlina) equal to a statutorily set percentage of the value claimed for the case by the petitioner in the complaint (iskovoe zayavlenie). If the petitioner prevails, then the court will order the defendant 83 Kathryn Hendley and Peter Murrell (otvetchik) to reimburse the petitioner for these expenses. If the petitioner loses, then the fee is forfeited to the state. Given that the amount of money involved in such cases can be quite substantial, gosposhlina is not an insignificant concem for petitioners. Requiring payment in advance is not a market-driven innovation, but was a standard feature of gosarbitrazh. In fact, payment of court fees by the petitioner in advance is commonplace throughout continental Europe and in other countries that share the civil law or Romanist tradition. Beginning in 1996, gosposhlina was lowered, and a sliding scale was established based on the amount being sought in the case.42 The change in the law was prompted by a concern that cases were not being brought due to the inability to pay the filing fee. Lowering gosposhlina did not solve the problem. Enterprises fighting for survival found it difficult to justify using their scarce resources to pay gosposhlina, even when the enterprise believed it would win the case. Box 1: Delays The regional data for 2000 show a marked increase in delays in the Sverdlovsk court, where the percentage of cases that did meet the statutory deadline doubled. In a February 2001 conversation, the chairman of this court lamented this trend, but saw it as unavoidable given what she sees as the persistent increase in the number of cases filed without a corresponding increase in the number of judges. Over the past two years, the number ofjudges has increased from 48 to 54, but this is still substantially less than the number of 64 positions that are authorized (but not funded). She pointed to bankruptcy cases as particularly problematic. They are inevitably time-consuming and, in her view, the easing of the threshold requirements for initiating a bankruptcy action has opened the floodgates. At the time of the conversation, there were 500 bankruptcy cases pending in the Sverdlovsk court. The complaints about judges' workload have some basis in fact, through it does not explain why delays have spiked in Sverdlovsk in particular. Among the regions we are analyzing, the monthly per judge caseload for 1998-2000 is consistently highest in the Leningrad court, where it averaged 42.2 cases per judge in 2000 (up from 33.7 cases in 1998). More typical is Saratov, where judges heard 38 cases per month in 2000 (up from 27.8 cases in 1998). By contrast, arbitrazh judges in Ekaterinburg heard an average of 36.6 cases per month in 2000 (up from 24.1 cases in 1998). The increase in the Sverdlovsk court has been dramatic, but the actual workload is not unusual. In Sverdlovsk, delays are substantially more common in cases involving the government than in contractual disputes. In 2000, more than one-third (36.5%) of these so-called administrative cases encountered delays, compared with a delay rate of only 4.4% for contractual disputes. The same phenomenon can be observed in 1999, when the delay rate for administrative cases was 24.8% and for civil cases was 3.1%. Prior to that, the discrepancy is not noticeable. Administrative cases can take longer because the procedural code requires that they be heard by a three-judge panel whereas contractual disputes are generally heard by a single judge. Scheduling multiple-judge panels can be difficult and can give rise to delay. In fact, a similar disparity in delay rates in 1999 and 2000 can be observed in a number of other courts, including Moscow City, Moscow Oblast, St. Petersburg and Leningrad Oblast, and Novosibirsk. Though nowhere else has it had the profound impact found in Sverdlovsk. Another explanation for the increase in delay may be that judges are beginning to pay attention to the admonitions within the APK to write careful well-reasoned opinions rather than the terse opinions that did little more than announce which party had prevailed that were standard in the days of gosarbitrazh. For example, in Saratov, during the first four months of 2001, the judge who had the most cases that violated the statutory deadline (II out of 147, or 7.5%) turns out to be the judge who consistently writes the longest and most well reasoned opinions. Enterprises did not simply walk away from arbitrazh courts. (See Box 2 on the interplay between the courts and enterprises on the postponement of filing fees.) Instead, they began to ask judges to waive the requirement that gosposhlina be paid when the case was filed in favor of collecting these fees from the losing party at the conclusion of the case (otsrochka). Judges responded to these requests in a variety of ways. Significantly, however, in interviews conducted with arbitrazh judges in Saratov and Yekaterinburg in 1996 and 1997, no judge claimed to reject such requests out-of-hand. As opposed to interpreting the requirement to pay gosposhlina prior to hearing the case as an absolute statutory requirement, they regarded the decision as to whether to grant the waiver as being completely within their discretion. This sort of flexibility goes against the usual practice of Russian judges to interpret the rules narrowly. In response to the evident demand from cash- poor enterprises for relief from the burden of paying gosposhlina, the Higher Arbitrazh Court reviewed this question in a plenary session in 1997, and issued a decree that established a standard procedure for seeking a delay ("O nekotorykh voprosakh" 1997). The reaction of the arbitrazh courts - both at the trial and appellate 84 Corporate Finance irn Russia's Regions level - to this problem indicates that they are able to make systemic responses that might prevent their playing their assigned role within the Russian institutional framework. Box 2: Postponement of Filing Fees When enterprises first began to ask that the obligation to pay filing fees be postponed until the resolution of the case, some judges responded with suspicion. In a 1996 conversation, the chairman of the Saratov arbitrazh court expressed skepticism about enterprise claims of poverty. He cited examples of enterprises requesting relief, but then mysteriously finding the necessary resources when their request was denied. The affidavits from banks attesting to the empty coffers of enterprises, which are routinely offered as evidence, did not persuade him. In his opinion, enterprises deliberately drain their bank accounts in order to evade taxes, and then use this apparent illiquidity to escape other obligations. He pointed to the increase in filings during the summer of 1995, when trial courts were forbidden to delay payment of gosposhlina, as demonstrating the absence of a link between filing fees and litigiousness. In 1996, one Saratov trial court judge related an incident when she refused to allow a petitioner to delay payment. She said that she had a feeling that the enterprise had money squirreled away. She felt vindicated when the petitioner did find the money and paid the fees. I asked whether she punished the petitioner for having lied to her. She had not. In fact, though she conceded that complete honesty was rarely encountered, the idea of fining liars struck her as bizarre. The link between fining litigants for material misrepresentations made to the court and building respect for the court as an institution that is often taken for granted in Western contexts is not apparent to Russian arbitrazh court judges. The requirements for delaying the payment of gosposhlina are now straightforward. The plaintiff merely has to submit affidavits from its bank(s) confirming that its coffers are empty. In order to be certain that information is sought from all relevant banks, an affidavit is also required from the Tax Ministry detailing the banks at which the plaintiff has open accounts. Of 55 non-payments cases reviewed in Saratov in 2001, delays were sought and granted in 40 (73%). In some cases, the plaintiff tried to tug on the heartstrings of the judge. For example, in a case filed by the Ukhtinskii Experimental Mechanical Factory against the Saratov subsidiary of Gazprom, the plaintiff went on at some length about their financial predicament: "The plaintiff requests a respite during the case from the payment of gosposhlina ... in connection with the extraordinarily difficult financial condition, the absence of funds in the bank account, the existence of a kartoteka, the refusal of the bank to provide credit. We have done everything possible to repay the kartoteka and to eliminate our debts to creditors, however, due to the lack of monetary resources of our debtors, we have no choice but to conduct transactions through non-monetary exchanges. We ask ... that you grant us the delay in paying above all in the interests of the labor collective, bearing in mind its priority to receive wages." This appeal was successful. Then again, the following one-sentence request in the complaint made by Eletrotekhkomplekt in its lawsuit against Ozinskii kombinat stroitel'nykh materialov was also successful. "In connection with the complicated and difficult material condition at the enterprise, we ask that full payment of gosposhlina be delayed until the decision is entered by the court in this case." A review of recent cases in Saratov, Moscow, and Ekaterinburg shows that the decision on granting a delay in paying gosposhlina has been removed from the discretion of the trial court judge and routinized. A new issue may be whether judges will begin to reduce fees imposed on losing parties. We uncovered three cases in Saratov - all with the same judge - in which he unilaterally reduced the gosposhlina to a nominal 1000 rubles due to the enterprise's difficult financial situation. Two of the three losing defendants were unrepresented at trial, indicating that the initiative to reduce the fees was with the judge. We found no analogous cases in Moscow or Ekaterinburg, but this trend bears monitoring. Table 9 shows that the petitions for postponing the payment of gosposhlina are being filed with great regularity. Moreover, they are being accepted in over 80% of cases in all regions and in some regions almost without exception. Is Lack of Competence an Important Problem? One common criticism of the arbitrazh courts is that their judges evidence a lack of competence in the law and the economics of market economies. In fact, of course, it would be astounding, given the heritage of the courts and the educational institutions that train lawyers, if this criticism were not technically correct. (In Box 3, we cast the criticism of judges' levels of competence in more general perspective by presenting 85 Kathryn Hendley and Peter Murrell observations from field research on the level of competence of lawyers appearing in arbitrazh courts.) But presenting some absolute standard does not seem to be the appropriate method of analysis for an institution that is in its formative years and embedded in a society where a similar criticism could be made more or less across the board. Rather, the critical issue is whether this perceived deficiency represents some fundamental barrier to the use of the courts, so that the courts could not play a useful role in the meantime and so that the judges would not be able to learn by experience. Box 3: The Role of Lawyers in the Arbitrazh Process The literature tends to focus on the competence of arbitrazh judges to handle disputes arising from complicated market transactions. Given that approximately half of the current judicial corps previously worked as arbiters in the Soviet-era gosarbitrazh, a fear that they would not be up to the job of acting as referees in the market economy is certainly legitimate. After having observed literally hundreds of cases in Moscow, Ekaterinburg and Saratov from 1994 through 2001, it is difficult to deny that mistakes are occasionally made by judges. But what is more striking is the frequently poor quality of representation of litigants at these hearings. For example, a hearing in the Moscow City court in February 2001 was cut short when the judge determined that the defendant was located outside the city limits, which meant that the Moscow Oblast court had jurisdiction. This rule that, absent a specific agreement to the contrary, disputes are heard in the locale of the defendant is elemental. Yet the plaintiffs lawyer was unaware of it and, even more striking, did not seem even slightly embarrassed by this display of legal illiteracy. When questioned, judges complained that this sort of lackadaisical attitude toward procedural detail and a more general unpreparedness was standard. Sometimes the exchanges between judges and unprepared parties devolve into shouting matches. In a May 2001 hearing in Saratov, the judge began in typical fashion by asking the plaintiff to state the legal basis for its claim, i.e., what legal norm had been violated. The plaintiff's representative, who was the manager appointed during the bankruptcy process, kept going back to the facts and the basic unfaimess of the situation. When the judge advised him to get a lawyer, he responded that he was, in fact, a lawyer. Yet he was unable to respond to this basic question. Finally the judge grew so frustrated that she declared a five-minute recess and gave the plaintiff a copy of the Civil Code and told him to find a legal basis for his complaint. He was unable to do so and she ended up dismissing the lawsuit. In the hundreds of cases observed from 1994 through 2001, these sorts of incidents emerge as relatively common, though certainly not typical. The frustration exhibited by the Saratov trial judge is mirrored by almost every judge interviewed in the field work. One judge in the Sverdlovsk court said that, in the days of gosarbitrazh, she would send criticisms (chastnoe opredelenie) of in- house lawyers who came to her hearing unprepared. Now she feels this is a waste of time - she feels that no one would pay any attention. At the same time, arbitrazh judges at all levels recognize that improving the quality of legal representation cannot be accomplished ovemight. There is a general consensus that there has been a steady improvement over the life of the arbitrazh courts. A comparison of the three courts observed in the filed work indicates that the improvement is most obvious in Moscow where a business bar seems to be developing and thriving. Yet in all of the courts it is becoming increasingly rare to have enterprises send non-lawyers to serve as their representatives, though this is allowed by the APK. A draft of amendments to the APK would, if adopted, require arbitrazh courts to establish a list of qualified lawyers. Precisely how this new rule would operate in a legal system without any nationwide licensing for lawyers is unclear, but it reflects the frustration of judges in dealing with incompetent lawyers. We have previously presented evidence on the intensity of use of the courts. The high level of use itself suggests that the level of competence of the judges cannot be a fundamental barrier to the demand for court services. We can also present some comparative evidence. The two previous sections have used direct evidence to argue that one cannot use expense and slowness to back up the conventional wisdom that the arbitrazh courts are hopeless. Our survey evidence examines the issue of competence versus expense and slowness. On the enterprise survey, we asked enterprise lawyers how important various obstacles were to using the courts. They were asked to score the strength of the obstacle on a scale of 0 to 10, with 10 being a very large obstacle. The obstacles and the answers to this question appear in Table 10. In all four regions, speed and expense rate as greater obstacles to using the courts than perceived knowledge of the judges on market transactions. Let us use one example, the case of Saratov, to make the argument here clear. In 1997, when our survey was conducted, over 30% of enterprises were successful in their petitions to postpone the payment of court fees, suggesting that expense was not a large barrier to using the court. In addition, over 99% of cases were being decided within the 2-month statutory deadline, indicating that length of time to judgement was not 86 Corporate Finance in Russia's Regions an important issue. Nevertheless, in Saratov in 1997 as Table 10 shows, the enterprises in our survey rate the competence of the judges as less of an obstacle to using the court than either lack of speed or expense. Foreign lawyers from highly developed countries might be especially sensitive to the issue of competence, given the sophistication of law and legal theory in those countries. And indeed, use of the arbitrazh courts by foreigners, especially outside Moscow, is still quite limited.43 Hendrix (2001) has surveyed the available evidence relating to use of the courts by foreigners and the perceptions of foreign litigants. Here we simply paraphrase some of these perceptions:44 A foreign party should not fear appearing in a Russian ordinary court or arbitrazh court ... We have found Russian judges to be intelligent and objective... The courts are quite reliable, with a level of integrity and efficiency that you might not expect... They are not corrupt and we have won a number of cases in them against the tar authorities... There are many experienced andfair judges....Russian judges are reasonable and make reasoned decisions. Hendrix's conclusion, based on the evidence of the interaction between courts and foreigners is consistent with the overall perspective of this paper: "In the-wake of the financial crisis, which engulfed Russia in the middle of 1998, it has become fashionable to dismiss Russia's post-Communist reforms as a sham. With regard to the judicial system, at least, these views do not appear to be well-founded." Is Corruption an Obvious Problem? Some commentators allege that corruption is rife in the Russian judicial system.45 For example at a 1999 OECD conference, the figure of 70% was put forward as an estirnate of the percentage of judicial decisions tainted by corruption.46 We first examine the issue of corruption in exactly the same way as the previous one: using the insights from Table 10. The pertinent question from the survey is whether judges not being impartial is an obstacle to using the courts-corruption, of course, being one element of possible partiality. The analysis and conclusion is the same as in the previous section: enterprises in our survey rate the partiality of the judges as less of an obstacle to using the court than either lack of speed or expense. Since we have argued in the previous sections of the paper that expense and speed do not stand out as egregious problems with the courts, we do not see levels of corruption as posing an insurmountable barrier for enterprises. Of course, we do not claim that corruption is absent from the courts: this would be a very unlikely proposition given the problems of corruption that Russia is perceived as having in general. But perhaps corruption is less of a problem in the arbitrazh courts than elsewhere. This is an issue that we can consider using survey data. To examine the question of the relative importance of corruption in the courts, we take a comparative approach, comparing Russia to other countries and comparing Russian legal institutions to other Russian institutions. To implement this approach on our 1997 survey we used a question that had been previously asked in Canada: "How would you rate the honesty and ethical standards of the types of people listed [in the survey question]?"47 Unfortunately, the Canadian survey did not ask directly about judges, but there is sufficient information to place the Russian results in context. The pertinent results appear in Table 11. It is clear that the arbitrazh judges receive a fairly high rating in terms of honesty and ethical standards. The data in Table 11 could hardly have been obtained if corruption in the arbitrazh courts were as rife as the conventional wisdom maintains. Can Decisions be Enforced? The ability to enforce decisions without having to expend undue time or money is critical to the willingness of litigants to use any legal system. As we noted above, complaints about the difficulty of implementing decisions of the arbitrazh courts is frequently voiced by enterprise managers. As Table 11 87 Kathryn Hendley and Peter Murrell illustrates, the difficulty of enforcing judgments is regarded as the greatest barrier to using the courts in all the regions surveyed. Indeed, according to the results of the survey, fully 58% of enterprises believe that it is the single largest problem. Although the problem of enforcement is often laid at the door of the courts, the reality is that, in Russia (as in most countries), judges have no responsibility for enforcing their decisions. Indeed, judges share the frustration of litigants, complaining that their hard work is in vain if the end result is a decision that is never enforced. (See Box 4 on the difficulties of enforcement in the Russian situation). Box 4: Enforcement Review of the case files of approximately 100 non-payment cases in the Moscow City, Sverdlovsk, and Saratov courts suggests that enterprises have a variety of expectations when they initiate lawsuits in the arbitrazh courts. For some plaintiffs, merely filing the claim seems to be enough to spur the desired repayment. It seems clear that additional claims for penalties or interest are coupled to the demand for debt repayment as an incentive to quick action and are then forgiven when settlements are reached. For example, in a case filed by Kalinovskii zavod rezinovykh izdelii in the Sverdlovsk court against Komproduktsiya, the plaintiff agreed to forego the demand for interest (assessed pursuant to article 395 of the Russian Civil Code) once the debt had been repaid. In cases that are dismissed because neither side shows up, it can be concluded that repayment had likely been forthcoming. A particularly intriguing example involved a regional branch of the Ministry of Intemal Affairs in Moscow, which had been supplying security services for a state enterprise and now wanted to be paid. It is worth noting that even security firms are making use of the arbitrazh courts. Of course, some enterprises resist to the end. A good example is provided by a case filed by the firefighting service in Saratov against the Saratov Aviation Plant. The defendant acknowledged the debt, but pleaded poverty in its correspondence with the plaintiff. After waiting more than a year for the debt to be satisfied, the firefighters went to court and asked for interest as well. Within a month of filing the case, the aviation plant arranged for its debt to be satisfied through an account receivable from Gazprom (which resulted from refitting several planes for the use of its executives). The court sanctioned this barter transaction, but still awarded the firefighters the interest The aviation plant waited for the sudebnye pristavy to ask them to pay this additional obligation. The final twist to the case relates to the aviation plant's obligation to pay the filing fees (gosposhlina). Although its lawyers had been present when the decision was issued and so knew full well of the plant's obligation, this fee (which was less than 4,000 rubles) was not paid voluntarily. The tax inspectorate (which has the obligation to collect gosposhlina) failed to keep a receipt of having sent a demand for payment to the plant and thus, when the tax inspectorate appealed to the court for an extension of time to collect these fees, the request was denied. In a letter from its chief financial officer, the aviation plant claimed ignorance of the obligation. This sort of scorched-earth strategy is perhaps understandable among enterprises that are barely hanging on. Whether it will persist as enterprises return to financial health is unclear. Enterprises always have the option of paying judgments voluntarily. The lack of liquidity of many Russian enterprises makes them resist paying until no other choice is available, which raises the specter of state- sponsored enforcement. From 1998 on, this function has been carried out by sudebnye pristavy (loosely translated as "bailiffs").48 These officials are charged with carrying out decisions of both the arbitrazh courts and the courts of general jurisdiction, and are subordinate to the Ministry of Justice. In fact, the vast majority of decisions handled by the sudebnye pristavy originate in the courts of general jurisdiction and involve the payment of child support and alimony.49 In any given office, there may be one or two bailiffs who specialize in enforcing judgments in contractual disputes. Only in Moscow is there a special office that deals only with arbitrazh court decisions, and it only handles judgments in excess of 3 million rubles. This lack of attention to the special skills and knowledge needed in order to get enterprises to pay judgments no doubt contributes to the less-than-stellar record of enforcement. Sudebnye pristavy become involved in the collection process at the request of the party who prevailed in the litigation. Even once they become involved, the law still builds in an incentive for the losing side to comply more-or-less voluntarily. If the judgment is paid within 5 days of receipt of an official request, then the losing side does not have to pay a fee to the sudebnyi pristav. If not, then in addition to paying the judgment, the losing side is assessed an additional fee amounting to 7 percent of the judgment. This five-day grace period is somewhat controversial within the bailiff hierarchy. In conversations that took place in April 2000, one Moscow official argued that it gives unscrupulous enterprises enough time to hide their assets and when the sudebnyi pristav returns, nothing is left. On the other hand, a top official in Saratov contended that it was not enough time for law-abiding enterprises to gather the resources necessary to pay the judgment, and that the 7 percent fee sometimes eats up funds that should go to the winning side in the dispute (and not to the state). 88 Corporate Finance-in Russia's Regions Assessing the true state of affairs is complicated by the refusal of the Ministry of Justice officials in charge of the sudebnye pristavy to make systematic data available on the effectiveness of enforcement efforts. Conclusions and Policy Recommendations A central premise of this paper is that a sound, empirically based assessment of existing institutions is a crucial input into policy and reform. Such an assessment enables reformers to understand more fully the nature of institutions and the ways that businesses use them. Then, reforms can be suitably designed to build on existing strengths and address present weaknesses. Conventional wisdom, even that held by those in the knowledge business, is often a poor basis for conducting institutional reform. The effective reform of an economic institution, such as the business-related elements of the legal system, requires obtaining answers to a number of questions. Is the institution used by businesses? What do the businesses value in the institution? In what ways is the institution not performing adequately, given its intended function in the economy? Why is the institution not performing adequately? What features of the institution would potentially be valued by businesses (and other users) if the institution functioned better? These are factual questions that cannot be answered purely on a theoretical basis or from casual study. To answer these questions requires systematic information gathering and careful research, using the gamut of modem social science methods. If the pertinent empirical analysis is not undertaken, it is quite plausible that a reform could be ineffective or even make matters worse, for the businesses that use the legal system and for the participants who work in the system. Of course, if an institution is ineffective and serves no purpose for its putative users, reformers would be justified in taking greater risks and could proceed with reforms using somewhat less knowledge than would otherwise be appropriate. However, this is not the case for the institution examined in this paper. One of the policy implications of our paper is that the arbitrazh courts do play a significant role in the affairs of many businesses. Therefore reform of these courts should be preceded by intensive study of their functioning. The information presented above is only one small element of that intensive study and therefore we will be conservative in offering policy recommendations. The following seem consistent with such an approach: Procedural Rules. Some of the reforms proposed by the draft procedural code threaten to undermine the courts' ability to dispose of cases swiftly. The draft code introduces a new stage in the judicial process for preparing a case for a hearing. As currently conceived, the parties would meet with the judge to explore the possibility of working out a settlement. In theory, this reform would seem to be helpful, given that it is aimed at achieving quicker resolutions of cases with less acrimony. Similar reforms have proven helpful in the U.S.. However, the Russian reality is different. The majority of civil cases involve non-payments. In our case studies of non-payments cases arising in 2000 in the Moscow City, Saratov, and Sverdlovsk courts, three-fourths of the cases reviewed were resolved at the first hearing, indicating that delay is not a pressing concem. Further complicating matters is the high percentage of default judgments. Given that the defendants took no part in more than half of civil cases reviewed, the value added of an additional hearing is questionable. Fining Unprepared Litigants. The ability of the arbitrazh courts to operate effectively has been undermined by the tendency of litigants and their counsel to appear for hearings without being fully prepared. The most common reason for postponing cases is the failure of the parties to bring relevant evidence. Other countries have found that imposing fines on those who appear unprepared serves to discourage such behavior in the future. The current rules place substantial procedural obstacles in the way of imposing these sorts of fines. The drafters of the new procedural code ought to be encouraged to work out a procedural mechanism for fining the unprepared. 89 Kathryn Hendley and Peter Murrell Implementation. The "bailiffs" (sudebnye pristavy) charged with implementing arbitrazh court decisions ought to be institutionally distinct from their colleagues charged with implementing the decisions of courts of general jurisdiction and/or protecting judges. The enforcement of judgments in disputes involving enterprises requires knowledge and experience that is different from that required to enforce the child support and alimony judgments that comprise the bulk of the work arising from the courts of general jurisdiction. Funding. The draft procedural code calls for a substantial expansion in arbitrazh court personnel. Each judge is to be provided with an assistant, who will take care of preparing the documentation (protokoly) of judicial hearings and will meet with litigants in anticipation of the trial to seek out a settlement. If such reforms are to go forward, then additional funding will have to be provided to the courts for salaries and office space. 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Moscow Time: 4. 94 Corporate Finance in Russia's Regions Endnotes X See below for the few exceptions. 2 E.g., McFaul, 1995, pp. 95-96; Aslund, 1995, pp. 5-7, 138; Eckstein et al, 1998, p. 146; Ernst et al, 1996, p. 292. 3See, for example, Halverson, 1996, pp. 100-103; O'Donnell and Ratnikov, 1996, pp. 83841; Black and Kraakman, 1996; Hay and Shleifer, 1998; Hay, Shleifer, and Vishny, 1996 pp. 560-62; Syfert, 1999, p. 381; Volkov, 1999; Leitzel, Gaddy, and Alekseev, 1995; Shelley, 1995, p. 830. 4 Some elements of this different view of the arbitrazh courts has appeared in the recent literature, both in papers by ourselves, Hendley (1996), Hendley (1998a), Hendley (1998b), Hendley (1998c), Hendley, Murrell, and Ryterman (1999), Hendley, Murrell, and Ryterman (2000), Hendley, Murrell, and Ryterman (2001), and in papers by others, particularly Hendrix (1997), Pistor (1996), and Halverson (1996). s. For more details on the nature of this field research, see for example Hendley, 1996, 1998a, and 2001. 6. These data are used by the staff of the Higher Arbitrazh Court to prepare the annual statistical summary of the arbitrazh courts that is published in the Vestnik Vysshego Arbitrazhnogo Suda. However, only the Federation level aggregations are published regularly. 7 Making judgments based on caseload statistics is always problematic, since they represent only disputes that have been pursued to the fullest extent of the law, and fail to take account of the vast majority of disputes that are resolved through negotiation. The fragmentary nature of the arbitrazh court data make them even more problematic. Though we know how many, and what sort of, cases are filed, no specifics about the enterprises involved are provided. Notwithstanding the shortcomings of these data, they provide us with an indication of the trends in usage. Moreover combining them with other sources of information allows us to present a relatively complete picture of the effectiveness of these courts. 8 In each enterprise, surveyors administered different survey instruments to four top managers: the general director, the heads of the sales and purchasing (supply) departments, and the official responsible for legal issues. The enterprises span ten major industrial sectors. Size ranged from 30 to 17,000 employees, with a median of 300. Most of the enterprises were established during the Soviet era, and about three-fourths (77%) are privatized. 9 We report the results here only for the four regions that are included in the broader study of which this paper is a part. The original survey actually included six regions and 328 enterprises. 10 We use the transliterated Russian term deliberately. Others have translated arbitrazh courts as arbitration courts but such a translation only confuse matters because the English words chosen fail to capture the essence of how the Russian arbitrazh courts operate. " Pomorski (1977) and Halverson (1996). 12. There were two types of gosarbitrazh. The first was organized geographically, and heard disputes in which at least one of the state enterprises was local. The second was organized through the system of economic ministries that was integral to the Soviet administrative-command system. This was known as departmental (vedomstvennyi) arbitrazh. The present-day arbitrazh courts are the successor to the former. 13 Hendley, 1996. 14 E.g., McFaul, 1995, pp. 95-96; Aslund, 1995, pp. 5-7, 138; Eckstein et al, 1998, p. 146; Ernst et al, 1996, p. 292. 15 Arbitrazhnyi protsessual'nyi kodeks Rossiiskoi Federatsii (1992). Ob Arbitrazhnom sude (1992). 16 Traditionally, state enterprises did not have the right to sue the state. The Gorbachev-era law on state enterprises ostensibly changed the rule by allowing state enterprises to sue a ministry when it issued an order that violated the rights of the enterprise, and that the enterprise could recover losses that are a consequence of the improper exercise of the higher- level agency's duties with respect to the enterprise. 0 gosudarstvennom predpriiatii (ob"edinenii) (1987). In practice, however, few lawsuits were filed. During the Soviet era, the ministries controlled access to key supplies, and enterprises were unwilling to risk their ire. 95 Kathryn Hendley and Peter Murrell 17 Arbitrazhnyi protsessual'nyi kodeks Rossiiskoi Federatsii, (1995) [hereinafter APK]; Federal'nyi Konstitutsionnyi Zakon (1995). 1 Hendley, 1998b. 9 This structure is also found in France and Germany, and in some other continental European legal systems. 20 Art. 22, 1995 APK, lakovlev and lukov, 1996, pp. 43-63. 21 The in-house statistical forms of the arbitrazh courts list 21 different categories of so-called economic disputes. Almost all of them are some type of contractual dispute. 22 From 1993 through 1995, the arbitrazh courts included bankruptcy cases within the category of "civil" cases when compiling statistics. Obviously it was not a perfect fit, since bankruptcy is not an adversarial process. Beginning in 1996, bankruptcy was broken out as a separate category of case, equal in status to the "civil" and "administrative" disputes. 23 These so-called disputes in the sphere of governance (spory v sfere upravleniia) are quite varied, including tax cases, appeals from a refusal to register legal entities, and problems relating to privatization. The in-house statistical forms list seven different categories of disputes. See generally APK, art. 22. 24 See Hendley, 1998b. 25 Vasil'eva, 1996; see also Hendrix, 1997, pp. 1098-1100; Hendley, 1998a 26 Hendley, Murrell, and Ryterman, 2001. 27 See generally, arts. 102-11, 1995 APK. 28. See, for example, Halverson, 1996, pp. 100-103; O'Donnell and Ratnikov, 1996, pp. 838-41; Black and Kraakman, 1996; Hay and Shleifer, 1998; Hay, Shleifer, and Vishny, 1996 pp. 560-62; Syfert, 1999, p. 381. 29 Hendley, 1998b. 30 Ickes and Ryterman, 1993. 3' From 1993 through 1995, the arbitrazh courts included bankruptcy cases within the category of "civil" cases when compiling statistics. Obviously it was not a perfect fit, since bankruptcy is not an adversarial process. Beginning in 1996, bankruptcy was broken out as a separate category of case, equal in status to the "civil" and "administrative" disputes. 32 E.g., Schwartz, 1997; Weinberg, 1997. 33 Between 1999 and 2000, the number of tax cases resolved by the Moscow City court increased by 3,297, whereas the total number of administrative cases increased by only 2,102. Along similar lines, for the same period, the number of tax cases resolved by the Moscow Oblast' court increased by 2,718, whereas the total number of administrative cases increased by only 1,353. 3` For example, tax cases comprised 57.3 percent and 82.2 percent of the increase in administrative cases resolved by the Sverdlovsk court in 1999 and 2000, respectively. 3' E.g., Greif and Kandel, 1995, p. 312; Black and Kraakman, 1996, p. 1926; Hay et al, 1996, pp. 560-61. 36 Art. 114, 1995 APK. 37 By contrast, the delay rate of-the courts of general jurisdiction has averaged about 14 percent for the years from 1992 to 1997. Solomon and Foglesong 2000, p. 119. 38 Katanian, 1997. 96 Corporate Finance in Russia's Regions 39 Poimenova, 1997. 40 Enterprises are more likely to include a special clause requiring that disputes be litigated in the Moscow City court than other courts. For example, of the 33 non-payment case files heard in this court reviewed in early 2001, 13 (39%) were based on a contract that had a forum clause ceding jurisdiction to the Moscow City courL By comparison, in only 2 of the 34 case files reviewed in the Sverdlovsk court did the contract specify that court. 41 E.g., Greif and Kandel, p. 311; Hay et al, pp. 560-61. 42 0 vnesenii izmenenii i dopolnenii v Zakon RF "O gosudarstvennoi poshline," (1996). For claims up to I million rubles, fees were equal to 5 percent of the amount sought. For claims between I and 10 million rubles, the fees were 50,000 rubles plus 4 percent of the amount sought in excess of I million. For claims between 10 and 50 million rubles, the fees were 410,000 rubles plus 3 percent of the amount sought in excess of 10 million. For claims between 50 and 100 million rubles, the fees were 1,610,000 rubles plus 2 percent of the amount sought in excess of 50 million. For claims between 100 and 500 million rubles, the fees were 2,610,000 rubles plus I percent of the amount sought in excess of 100 million. For claims in excess of 500 million rubles, the fees were equal to 1.5 percent of the amount sought. Id., art. 4. 43' Hendley, 1998c. 44 See Hendrix 2001 for citations, full quotes, and a great deal more evidence. 45 See the references in Hendrix (2001). 46 Hertzfeld, 1999. 47 Survey Research Consultants International (1993). 48 Two new laws were passed in mid-1997 and went into effect in 1998 ("Ob ispolnitel'nom proizvodstve" 1997; "O sudebnykh pristavakh" 1997). Prior to that time, enforcement was handled by sudebnye ispolniteli ("judicial enforcers") who were housed in, and subordinate to, the courts of general jurisdiction, though they also enforced arbitrazh court decisions. As a rule, they were women who handled child support issues and who had little knowledge of the intricacies of business law. According to the deputy director of the bailiff service, between 50-900/o of these former officials have become sudebnye pristavy in the new system, though he was quick to note that many young men have been attracted to the reformed institution. He regards the gender shift as indicating the enhanced importance of the institution. 49 According to a top official in the bailiff service in Saratov, 80% of the 478,000 claims they handled in 1999 involved child suppor, while only 5,000 originated in the arbitrazh courts. Table 1: The Regions and their Politics Region Name Governor Years in Office Political Party Date of Most Percent of votes Percent of Votes Percent of votes for Affiliation Recent won in most for Putin in 2000 Yeltsin in the first Regional recent regional Presidential round of the 1996 Election election election Presidential St. Petersburg V. A. Yakovlev 1996 - present All Russia May 2000 72.69 62.4 49.6 Leningradskaya V. P. Serdyukov Appointed Sept 1998, Unity Sept. 1999 30.3 66.71 37.46 Oblast elected Sept 1999 l Novgorodskaya M. M. Prusak Appointed 1991 Our Home is May 1999 91.56 64.73 35.68 Oblast elected 1995-present Russia City of Moscow Y. M. Luzhkov 1992- present Fatherland Dec. 1999 63.88 46.22 61.16 Moskovskaya B. V. Gromov Jan 2000 - present Fatherland Jan 2000 48.09 47.99 44.15 Oblast Volgogradskaya N. K. Maksyuta Dec. 1996 - present Contmunist Dec. 2000 36.72 53:5 28.59 Oblast Party Samarskaya K. A. Titov Appointed 1991 Union of Right July 2000 53.25 41.06 36.13 Oblast elected 1995 - present - Forces Saratovskaya D. F. Ayatskov Appointed April 1996 Our Home is March 2000 67.26 58.29 28.38 Oblast _ Sept. 1996 - present Russia l Sverdlovskaya E. E. Rossel' 1995 - present Independent Sept. 1999 63.09 62.74 59.45 Oblast ___ l Novosibirskaya V. A. Tolokonskii Jan 2000 - present Independent Jan 2000 44.32 39.91 25.61 Oblast _ _ Omskaya Oblast L. K. Polezhaev Appointed 1991 Unity Sept 1999 57.03 38.14 32.8 elected 1995 - present Primorskii Krai Acting Governor: Appointed February 40.12 29.55 Valentin Dubinin 2001 _I_I_ I_ _I I *** Following the resignation of the previous govemnor ofPrimorskii Krai, elections for his successor are currently underway. The first round was held in May2001. The runoff between the two top contenders will take place after this draft is finalized. Source: Central Election Commission of the Russian Federation; Orttung, ed. (2000). Table 2: The Regions: Basic Statistics Region Name Annual Population % of Recorded Provision of Gross Industry as Industrial growth rate Density population crimes (per telephone regional % of gross production Population of pop 92- (people per in urban 100,000 access per product per regional 1998 as 1999 99 (%) square km) areas 1999 persons) 100 families capita 1000 product percentage 1999 1998 1998 rubles 1997 1998 of 1990 industrial production City of St. Petersburg 4728 -0.83 100 1898 88.8 15908.5 34.4 33.07 Leningradskaya Oblast 1681 0.07 66 2228 46.2 11580.4 24.4 52.66 Lenin. Ob. & St. Pete. 6409 -0.60 74.1 91.1 1984 77.7 14783.2 31.2 40.16 Novgorodskaya Oblast 736 -0.31 13.3 71.1 2135 39.8 10460.8 30 53.29 City of Moscow 8630 -0.54 100 806 101.6 37073.0 42.7 37.15 Moskovskaya Oblast 6547 -0.35 120 79.8 1178 44.3 14824.1 26.2 31.08 Volgogradskaya Oblast 2694 0.27 23.6 74.1 1588 38.6 12026.3 26.1 33.86 Samarskaya Oblast 3308 0.22 61.7 80.5 1604 36.0 21935.2 18 58.07 Saratovskaya Oblast 2721 0.05 27.1 73.2 1426 27.4 11654.8 23.9 41.06 Sverdlovskaya Oblast 4641 -0.41 23.8 87.5 2078 36.7 15853.5 25.7 33.92 Novosibirskaya Oblast 2752 -0.04 15.4 74 2297 43.8 14220.1 36.1 36.52 Omskaya Oblast 2178 0.05 15.6 67.3 1908 35.6 15526.5 27 37.62 Primorskii Krai 2197 -0.73 13.2 78.3 2274 32.7 13720.9 33.1 44.53 Source: Goskomstat (1999). Table 3: The Regions: Basic Statistics on the Enterprise Sector % of % of Number of % of % of Number of Number of Return on employed employed enterprises and enterprises and enterprises and small enterprises assets in population in population organizations organizations organizations enterprises privatized active Region private non- in joint- per 1000 pop. that are private that are joint- per 1000 93-98 enterprises, joint-stock stock firms 1998 end of year non-joint-stock stock firms population 1998 (%) firms 1999 City of St. Petersburg 46.3 14.9 35.22 78.53 12.57 23.65 3009 -5.6 Leningradskaya Oblast 46.6 14.9 15.36 76.12 7.37 7.20 858 0.2 Lenin. Ob. & St. Pete. 46.6 14.9 30.02 78.21 11.88 19.33 3867 -4.8 Novgorodskaya Oblast 38.5 18.7 17.66 60.68 8.14 3.67 795 -13.2 City of Moscow 42.1 21.6 72.49 81.38 11.77 20.30 4174 -2.7 Moskovskaya Oblast 37.6 15.1 15.95 77.71 8.13 5.44 2545 -1.6 Volgogradskaya Oblast 49.1 16.6 19.00 76.15 4.54 5.01 1621 -0.5 Samarskaya Oblast 35.4 30.2 18.61 77.58 7.73 6.56 1657 1.7 Saratovskaya Oblast 48.6 10.2 16.39 77.56 4.17 4.81 2281 -5.9 Sverdlovskaya Oblast 40.6 15.7 17.30 75.01 5.71 5.58 3316 1.9 Novosibirskaya Oblast 37.4 15.8 23.32 75.65 8.46 7.41 1410 1.6 Omskaya Oblast 46.7 14.7 17.67 75.21 6.91 5.51 1034 -0.7 Primorskii Krai 38.2 19.6 17.41 70.86 12.04 4.60 1030 -4.9 Source: Goskomstat (1999). Table 4: The Intensity of Use of Arbitrazh Courts, Based on Court Statistics Cases Filed Cases Filed Cases Decided Cases Decided Cases filed per Cases filed per joint 1999 2000 1999 2000 enterprise, 1999 stock company, 1999 Lenin/St. Pete. 33105 34545 28642 29869 0.17 1.45 Novgorod 3519 3482 3346 3026 0.27 3.33 Moscow City 52191 47700 43014 40012 0.08 0.71 Moscow Oblast 17023 18293 13848 15225 0.16 2.01 Volgograd 11393 14347 9085 11034 0.22 4.91 Samara 12420 17400 11179 14991 0.20 2.61 Saratov 10765 13030 9552 11630 0.24 5.80 Sverdlovsk 17739 21670 14579 17158 0.22 3.86 Novosibirsk 10080 11421 8579 9743 0.16 1.86 Omsk 10026 11683 8871 8917 0.26 3.77 Primorskii krai 11823 10318 10080 6628 0.31 2.57 Source: Annual Reports on Activities, submitted by arbitrazh courts to the Higher Arbitrazh Court for 1999 and 2000. Table 5: The Intensity of Use of Arbitrazh Courts, Based on an Enterprise Survey % of enterprises that had been a % of enterprises that had been a % of enterprises that had been either defendant in arbitrazh court in plaintiff in arbitrazh court in a plaintiff or a defendant in previous 2 years previous 2 years arbitrazh court in previous 2 years Moscow city 40.00 61.82 70.91 Novosibirsk 63.64 74.55 74.55 Saratov 61.82 61.82 70.91 Sverdlovsk 52.73 78.18 85.45 Source: Authors' survey. Table 6: Temporal Changes in the Use of the Arbitrazh Courts 19921 1993F 1994 19951 19961 19971 19981 19991 2000( 21090 as:of 2000 as % of 1994 National 338,162 275,304 208,081 237,291 290,094 341,537 398,622 496,739 539,490 160% 259% Moscow City N/A 24,604 17,427 18,208 26,996 29,348 34,467 43,014 40,012 163% 230% Moscow Oblast 10,578 8,595 5,729 6,154 7,722 9,087 10,333 13,848 15,225 144% 266% Lenin/St. Pete. 18,662 14,473 8,916 8,813 12,651 16,651 21,361 28,642 29,869 160% 335% Novosibirsk 5,963 4,925 3,311 4,655 4,779 6,774 7,026 8,579 9,743 163% 294% Sverdlovsk 14,730 10,453 7,869 8,000 7,980 8,464 10,120 14,579 17,158 116% 218% Saratov 7,354 6,193 3,686 4,002 3,999 5,412 7,469 9,552 11,630 158% 316% ** 2000 as % of 1993 for Moscow city. Source: For the national-level data: Sudebno-arbitrazhnaya statistika 1995, 1997, 1998, 1999, 2000, 2001; for the oblast level statistics: Annual Reports on Activities, submitted by arbitrazh courts to the Higher Arbitrazh Court for 1992, 1993, 1994, 1995, 1996, 1997, 1998, 1999, and 2000. 1992 information for the Moscow City court was not available. Table 7: Changes in the Proportion of Administrative Cases in the Arbitrazh Courts 1992 1993 1994 1995 1996 1997 1998 1999 2000 National 1.6 3.9 8.5 10.0 15.3 13.5 Moscow City 1.9 3.8 4.0 7.0 12.0 17.8 34.8 42.7 Moscow Oblast 7.6 10.8 12.6 14.5 10.6 17.0 28.6 34.9 Lenin/St. Pete. 3.1 7.1 9.3 11.0 15.2 22.3 48.1 47.8 Novosibirsk 2.7 6.0 7.0 13.9 19.7 16.8 33.4 49.6 Sverdlovsk 3.3 8.4 10.6 15.9 20.6 20.0 34.8 40.8 Saratov 2.7 8.6 4.9 14.8 28.5 48.5 48.3 55.1 Source: For the national-level data: Sudebno-arbitrazhnaya statistika 1995 , 1997, and 1998; for the oblast level statistics: Annual Reports on Activities, submitted by arbitrazh courts to the Higher Arbitrazh Court for 1992, 1993, 1994, 1995, 1996, 1997, 1998, 1999, and 2000. Beginning with the report on 1998, information as to the breakdown between civil and administrative cases was no longer provided in the national-level data. The oblast-level information for 1992 did not break down the total number of cases between civil and administrative. Table 8: Percentage of Cases Not Decided Within the Two Month Statutory Deadline (Delay as Percentage of the Total Number of Cases Decided) Region 1993 1994 1995 1996 1997 1998 1999 200 National 3.4 1.5 1.6 3.6 4.1 3.3 3.9 4.6 Moscow City 13.3 3.2 2.2 5.5 7.2 4.5 5.4 8.3 Moscow Oblast 9.1 3.8 4.6 10.4 6.4 5 6 6.6 Leningrad/ St. Petersburg 1.9 1.1 1.0 3.3 4.8 3.8 5.4 4.1 Sverdlovsk 2.9 1.9 1.1 1.9 1.7 3.4 10.6 20.7 Novosibirsk 2.6 0.5 1.3 5.4 3.4 3.1 3.3 3.5 Saratov 0.1 I 1.2 0.4 0.8 1.1 0.8 0.9 Source: For the national-level data: Sudebno-arbitrazhnaya statistika 1995, 1997, 1998, 1999, 2000, 2001; for the oblast level statistics: Annual Reports on Activities, submitted by arbitrazh courts to the Higher Arbitrazh Court for 1993, 1994, 1995, 1996, 1997, 1998, 1999, and 2000. Tabge 9: Petitions for Delayed Payment of Filing Fees in Arbitrazh Court 1996 1997 1998 1999 2000 A: petitions as % of cases 20.1 22.9 18.4 14.4 11.8 Moscow City B: % of petitions granted 71.6 66.3 71.4 77.1 80.2 A: petitions as % of cases 18.6 18.5 12.4 12.5 Moscow Oblast B: % of petitions granted 76.4 85.6 91.8 93.2 A: petitions as % of cases 16.2 14.8 9.2 11.5 eningrad Oblast & St. Petersburg B: % of petitions granted 97.7 87.2 91.1 66.9 A: petitions as % of cases 17.0 24.3 28.4 24.6 22.5 Novosibirsk B: % of petitions granted 65.6 91.2 96.1 95.8 98.7 A: petitions as % of cases 24.6 28.5 22.1 15.5 Sverdlovsk B: % of petitions granted 70.7 78.2 74.1 79.1 A: petitions as % of cases 33.7 26.5 32.3 31.1 Saratov B: % of petitions granted 93.9 55.2 95.4 98.7 A: petitions as % of cases 35.5 32.6 20.1 Samara B: % of petitions granted 81.6 96.6 96.4 A: Petitions for delay of gosposhlina as a percent of cases filed. B: Percent of petitions granted. Source: Annual Reports on Activities, submitted by arbitrazh courts to the Higher Arbitrazh Court for 1996, 1997, 1998, 1999, and 2000. Although the statistical form began soliciting this information only beginning in 1997, the Moscow City and Novosibirsk courts provided this information on a voluntary basis for 1996. Table 10: Importance of Various Obstacles to Using the Arbitrazh Courts: Average Scores on a 0-10 Scale Filing a claim is expensive | The time between filing a 1 Judges are not f Judges are not Judgements of the court claim and judgement is too knowledgeable about impartial are not enforced long market transactions Moscow city 6.16 5.73 4.36 4.86 7.76 Novosibirsk 7.25 5.23 4.19 3.82 7.77 Saratov 6.23 4.96 4.13 4.73 6.87 Sverdlovsk 6.61 4.8 3.96 4.44 6.96 Source: Authors' survey. Table 11: Perceptions of Honesty and Ethical Standards in Various Professions Percentage of respondents reporting various levels (high, average, low) of honesty and ethical standards of different profe`ssionals. Police Lawyers Members of Arbitrazh Arbitrazh Arbitrazh A;,', azh Parliament Judges Judges Judges Juc S__ Canada Russia Canada Russia Canada Russia Novosibirsk Sverdlovsk Country (1992) (1997) (1992) (1997) (1992) (1997) Moscow (1997) (1997) Saratov (1997) (1997) High 54.1 3.9 23.2 15.1 11.1 4.2 16.7 22.4 17.4 15.2 Average 38.8 33.0 46.3 64.8 39.4 34.3 66.7 73.5 60.9 71.7 Low 7.1 63.1 30.5 20.1 49.5 61.5 16.7 4.1 21.7 13.0 Note: The Canadian survey sampled 1027 members of the general public. Source: Survey Research Consultants International (1993); authors' survey. Recent World Bank Discussion Papers (continued) No. 384 Integrating Social Concerns into Private Sector Decisionmaking: A Review of Corporate Practices in the Mining, Oil, and Gas Sectors. 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