Imposing discipline and Extending encouragement

1. Imposing discipline and Extending encouragement Sezgi BALCI Cándido CABANA PORTO

2. Imposing Discipline Inevitably there were consequenses of liberalisation in the economies of the countries which are involved in transition. Through these consequences we are going to see the disciplines that should be applied in the mechanisms of economies in these countries. Then the consequences will be examined.

3. These disciplines which should be impiled are; Instruments such as budget constraints and competition in the markets for their products. Strengthment of instutitions of corporate government. Monitoring of managers’ behavior by councils of workers or by banks. Governments’ requirements to finance a targeted social safety net for thosehurt by the imposition of discipline on inherited enterprises. Requirements of governments and enterprises tomeet their expenditure obligations on time and in cash to prevent payments arrears.

4. Those disciplines were to neutralize and regulate these consequences which were faced by the transition economies especially in the CIS countries rather than encountered in EEC countries. Some of those consequences were ; Soft Budget Constraints Can Create Macroeconomic Crises Nonpayments Weaken the Incentives for Efficiency and Restructuring

5. Soft Budget Constraints Can Create Macroeconomic Crises Loss of fiscal control after transition caused implicit and contingent liabilities. These are more likely seen in CIS countries rather than in EEC countries. Soft budget constraints are seen highest in Caucaus, Moldova, Czech Rep., Slovak Rep. , Croatia, Russian Fed. , Ukraine, Romania, Kyrgyz, Kazakhstan These countries have corporations reported arrears to tax authorities and state-owned energy producers which are 2 significant sources of implicit subsidy.

6. Business Enterprise Environment and Performance Survey

7. The state budget deficit was about 1.3 percent of GDP in the Czech Republic in ‘97 ’98, because of budget constraintIn Croatia and Lithuiania because of foreign borrowing with a guarantee of government caused big deficitsIn Bulgaria and Romania an excessive use of off-balance-sheet items erupted into full-blown macroeconomic crisesAs a result, all these countries needed “second generation” stabilization efforts in the second half of the 1990s.Russia had problems on imposing hard budget constraints through this they faced a wide range of arrears this led to financial crisis in ’98.

8. Nonpayments Weaken the Incentives for Efficiency and Restructuring Many governments tried to keep the bad financially situated corporations alive by making implicit subsidies through energy companies In Ukraine it is estimated that regional energy companies have provided enough financing to the nonpayers as an amount which will fullfill the 4% or 5% of GDP. Payments arrears eventually had to be absorbed by the budget, often through tax offsets, or, for energy-dependent CIS countries, through intergovernmental agreements with Russia or Turkmenistan.

9. Solutions for nonpayments crisis : The government pays its bills in cash Energy companies pay their taxes in cash and on time. Social assets traditionally provided by enterprises (such as housing, health clinics, and kindergartens) are divested to local governments. Benefits are targeted to the low-income households most affected by an increase in energy prices to international levels. Some types of one-company towns in distant regions of the CIS get some special arrangements.

10. Exit Mechanisms: Implement Now, Revise Later Experience suggests that it is preferable to implement existing insolvency laws and revisethem once they have been put into practice. Restructuring and exit will require a transfer of responsibility for housing and other social assets Measures of administrative liquidation need to be strengthened.

11. Competition Is Linked to Innovation and Growth Enterprises facing an intermediate degree of competition (one to three competitors) develop new products, replace managers, or change their organizational structure if they are subject to a hard budget constraint, through this they encountered innovation. Competition also helped monitoring the enterprise managers which was really hard to be achieved before competition. As a result competition innovation and growth are linked to each other helping the markets to move forward.

12. Extending Encouragement 1. Corruption & anticompetitive practices mar the investment climate Taxes and regulations are important impediments in the expansion of new enterprises,being corruption and anticompetitive practices one of the most serious obstacles. • Granting & renewal of licenses CIS & SE are in worse position than CE & Baltics: Anual revenue on bribes: SME’s: 5’8% Large Enterprises: 2’8% Frecuency of bribe payments: SME’s: 37% Large Enterprises: 16% • Business licensing – particulary troublesome because of opportunity for corruption & high bureacracy • Regulations for customs, foreign trade, currency and exchange The solutions for this administrative problem will be: • Simplifying the process in order to gain transparency and consistency • Customs reengineered for transparency and avoidance of arbitrary decisionmaking and abuse of power

13. 2. Enterprises lack confidence in legal and judicial institutions Fewer than 30% of enterprises in countries such as Croatia, Estonia and Poland lack confidence in the security of property rights, compared with more than 70% in Russia and Ukraine. According to the BEEP survey, in 13 of the sample countries: More than 90% of the enterprises report to be inadequately consulted in the drafting process for new laws or policies. More than 80% report to be not adequatelyinformed of changes in rules they are affected by. The quality of the judiciary is unbundled into Fairness Cost Likelihood of enforcement And it exists a wide variation in its percepcion from country to country.

14. Almost 2/3 of variations in security of property rights can be attributed to variations of their systems of legal drafting and effectiveness of their judiciary. Studies show interesting features: • Enterprises with least secure property rights invest a 40% less than those with the most. • Reinvestment of profit is a bigger source of investment capital than bank funds or trade credit. So on, in less secure countries, achieving this is more important for promoting an Investing climate than reforms in banking, wich will be the natural following step.

15. 3. Financial deepening is slow but progressive • Key to sustain the growth of new private sector • Financial sectors remain undeveloped by international standards • Banking system – in most of transition countries – remains small in an international perspective, even with the removal of credit to public sector and the attention confined to private enterprises • Stock market capitalization shows that financial development lags behind other world countries with similar per capita incomes

16. Banking sector is moving forward Ratio of operations costs to total assets reveals that several CE countries have progressed, while Baltic and remaining transition economies have not matched them, although they have seen overall efficiency improved. The difference between the average interest rate on loans to the private sector and the resident deposit rate also shows CE and Baltics in a favorable situation, but not SE and CIS.

17. It’s important that private credit flows to new enterprises – and this has been accomplished by those countries who early sold commercial banks to private investors, encouraging growth of financial intermeditation to new private clients. Can the discipline-and-encourage strategy quicken the pace? • Hard budget constraints should apply to banks and enterprises alike • Increasing bank efficiency through privatization to strategic investors • Facilitating the entry of foreign financial intermediaries can accelerate the development of the sector • This is a quick way of importing managerial and supervisory skills

18. 4.Privatization attracts FDI and positive spillovers follow Differences in cumulative FDI per capita flowing between 1991-2000 • CIS - $115 • CSB - $800, having Czech Republic and Hungary the highest amounts around $2000, followed by Estonia, Latvia and Croatia This is highly correlated with cumulative privatization revenues. Some studies have proved a clear relationship between the growth of FDI and the indices of economic liberalization, as cash flows to in response of improved policies & business enviroment. Spillovers: • FDI has proved resilient in volatile international capital markets • Countries reluctant to foreign participation in privatization process –Russia, Ukraine- attract few amounts of FDI but substantial portfolio investment, most of it going to the finance of public sector deficits from a soft budget constraint climate.

19. 5. Tax reform: Broadening the base and lowering rates Broadening the base and lowering rates are the key objective of the tax reform: • Eliminate tax exception enjoyed by favored enterprises • Harden budget constrains • Reduce burden of taxation on viable enterprises – encourage the informal sector to come within the tax system Small business enterprises: • Taxes are widely reported to be disincentive for its creation • Should be subject to SME tax regime – simple as a fixed annual lieu of taxes Large enterprises: • Turnover tax at a moderate rate, or • Simplified cash flow tax using simplified accounting This approach will relieve the administrative and reporting burden on the taxpayer and reduce the interaction between the taxpayer and the tax authority.

20. 6. Intergovernmental Fiscal relations supporting discipline & encouragement Subnational governments should have incentives to identify with small businesses • SME’s taxes and property taxes could be allocated to that level of government • Compliance with property tax will be enhanced if its tied to improvements in public service • Make sure there’s no incentive to treat enterprises differently because they provide social services – so there’s no special treatment to unrestructured, old enterprises – placing responsability of services in the municipality • Roles & responsabilities of subnational governments have to be clarifies • Enough resources in order to fulfill the additional responsabilities of absorbing social assets from enterprises – reducing incentives to favor old enterprises

21. Thank you for listening