Will Wage Arrears Continue in Russia?

Total wage arrears in all sectors of the Russian economy reached 57.8 billion rubles ($9.51 billion) as of March 1, official statistics show. Of that figure, the federal and regional governments owe 7.6 billion rubles ($1.2 billion). The government declared last summer it had paid off billions of rubles to longsuffering pensioners, and later set a schedule to pay off debts to the military and other key groups. President Yeltsin set a deadline of January 1, 1998 for all arrears to be paid off. The government said it has pieced together the funds, and blamed regional authorities when some workers remained unpaid after the New Year. Just three months later, debts to both public and private sector employees were piling up again.

Prime Minister Kiriyenko said responsibilities had to be clearly divided between the federal and regional authorities in order to avoid the confusion that had reigned at the beginning of the year.

Wage arrears began to grow rapidly in mid1995. In the midst of faltering state authority and the collapse of contractual obligations and their enforcement, the government resorted to more wage cuts, enterprises withheld tax and wage payments, and local governments diverted federal funds earmarked for employee remuneration. The level of arrears in March 1997 reached 27.7 percent of total state sector wages. Wage arrears afflicted virtually every region. Many workers were waiting six to eight months for their wages. More than half of employees in state enterprises were claiming at least two months’ unpaid wages.

Stubborn Liabilities

Wage arrears are much higher at the regional and local government levels, where the bulk of public sector employment is concentrated: teachers, police, public health workers, and the like. The bulk of employment at the federal level is in the military. The transfer was financed through increased privatization revenues, a sharp rise in tax collection (for the full year however, tax collection remained at 60 to 65 percent of planned levels), greater customs receipts, and substantial loans from multilateral lenders, particularly the World Bank.

Government debts to private contractors for goods and services, particularly in the defense industry, still total an estimated 19 billion rubles, government officials acknowledge. As a consequence, millions of private sector workers have not received wages for months, with arrears amounting to around 30 billion rubles. And there are other budget arrears to address, including 13.5 billion rubles of unpaid child benefits (the responsibility of local budgets) and arrears in support for northern regions and other special subsidies and payments. In the Russian armed forces arrears in salaries, social benefits, and food allowances stood at 18.6 billion rubles ($3.1 billion) in December 1997. As the newspaper Novye Izvestia remarked sarcastically in January, “A new year has started. Time to make more debts.” What are the chances that wage arrears will continue?

A Plethora of Veksels

A cinema in Altai, Siberia, allowed customers to pay two eggs for a ticket; when eggs ran short locally, the price of entry was payable in empty bottles. On a larger scale, tax officials say that across the fuel and energy industries, only 20 percent of transactions are settled in ready money. The balance is paid, if at all, in barter, bills of exchange, mutual offsetting of debts, and tax credits. The proportion of inter-enterprise transactions being conducted on a barter basis was estimated at between 40 and 70 percent, as of the end of 1996.

The nonpayment of wages is part of a much wider phenomenon of nonpayment. The overdue debt of enterprises and organizations in industry, transport, construction, and agriculture almost doubled during 1996 to a total of 538 billion rubles, almost 25 percent of annual GDP, an average of almost five months of overdue payments. Overdue debts continued to pile up in 1997, reaching 700 billion rubles ($127 billion) in December 1997. This is more than twice the amount of money in circulation.

Unpaid bills pervade every corner of Russian life. Companies cannot pay their suppliers; suppliers cannot pay their workers; workers cannot pay their utility bills or their rent—and almost everyone holds off on paying taxes. The vicious cycle of nonpayment has become particularly acute in the past 18 months, largely as a consequence of the central bank’s tough measures to fight inflation. Those policies abruptly choked off the money supply and reduced inflation to less than 15 percent, from more than 200 percent in 1994. But the other result is the cash shortage

This has led to a $15 billion market in IOUs (“I owe you” promissory notes), known in Russia as veksels. (Veksel comes from the German word “wechsel,” for exchange. Germany resorted to IOUs for a brief period after World War II.) Many veksels are redeemable for cash, while others are good for oil, electricity, tires, chemicals, or cement. The use of veksels exploded during 199697. Companies issue them to pay their suppliers, who then barter them for other goods or resell them to speculators for cash. Banks and brokerage companies trade more than $100 million worth of such notes each month, and post prices for them on the Internet. Even a few American investors are snapping them up, viewing them as a Russian variant on American high yield junk bonds.

Gazprom has issued its suppliers about $170 million worth of IOUs, which are redeemable primarily for natural gas. Whether the IOUs get swapped for natural gas or for money, they are valuable. Analysts at Renaissance Capital Group, a Moscow-based investment firm, calculate that Gazprom veksels yield a profit of roughly 25 percent a year. Conventional government bonds in Russia yield about 18 percent a year.

The IOUs are notoriously intricate, with each one tied to the bill paying problems of a particular company and many of them loaded with quirky conditions. A number of IOUs never trade in the open market but are simply swapped between companies that do business with each other on a regular basis. The International Monetary Fund has been sharply critical of veksels, saying they distort the true indebtedness of the country and the companies and give companies a way to avoid taxes—as the profit on IOUs takes place almost entirely outside the official economy and is generally not taxed.

Cashless Society

In 1996 about 15 percent of Russia’s employee wages were paid in kind, as were many social benefits, such as unemployment benefits. The situation has provoked much dissatisfaction. For example, fishermen of the Preobrazhensk Trawler Fleet in Primorskii Krai have been regularly receiving their wages in vodka. In an open letter the fishermen’s wives accused Preobrazhensk of “deliberately addicting” their husbands to alcohol, and this while the families did not have enough money to buy food. They have demanded that the company stop its remuneration practices.

In November 1997 workers at a cash-strapped Russian clock factory in Penza, received a bonus—and needed three days to get the loot home. But they didn’t feel that much richer because the bonus was paid in toilet paper, with each worker getting about 150 rolls, according to the daily Izvestia. Workers had trouble “spending” the bonus, the report said. One worker tried to pay her rent in toilet paper, but municipal housing officials refused to accept it.

Underlying Causes

According to some experts, more firms would pay their wage debts in cash if the system obliged them to do so. But Russian law is weak, officials are malleable, and few penalties await managers who shun their obligations. Nonpayment of wages is tolerated the more readily because it keeps unemployment down. If everyone who worked had to be paid a cash wage, unemployment would shoot far above the current rate of about 9.3 percent. Russia’s employees—long accustomed to receiving an array of benefits, including school, hospital and daycare services, and low-cost housing, through the workplace—settle for receiving these entitlements in preference to losing their jobs.

Others argue that the strapped manufacturing industry in Russia can hardly afford to pay due wages. Fifty-six percent of Russian manufacturing enterprises made losses in 1996. One-third of all enterprises were insolvent and fewer than one-third had assets more than double their liabilities, the ratio they are required to maintain under the Russian law on insolvency. Considering that most enterprise assets include a large inventory of obsolete products and overdue debts of trade partners, the financial situation of the enterprises is even worse than the financial balances show.

Experts point fingers at the Russian banking system, which has been unable to provide financial services to the enterprise sector. The shortage of cash has prevented even profitable enterprises from paying wages. Russian companies have had no chance to borrow short-term from banks in order to finance their working capital. Moreover, Russia’s banks and financial institutions are not equipped to evaluate the financial position of enterprises as a condition of extending credit and loans, so they cannot initiate bankruptcy proceedings. The very limited involvement of Russian commercial banks in the manufacturing sector means that they are not able to play the regulatory and financing role that banks play in developed economies. Bankruptcy is still an uncommon practice in Russia.

The shortage of cash to pay wages worsened by competition with tax authorities for the cash resources of enterprises— which make up a disproportionate part of government revenue. The government has been working to reduce arrears in the payment of taxes, to limit the budget deficit. Until August 1996 the tax authorities had first claim on all money coming into company accounts. An amendment to the Civil Code has meant that since August 1996 the payment of wages has taken precedence over tax payments. However, the penalty for nonpayment of taxes is far higher than any penalties incurred for nonpayment of wages. Thus the amendment is effective in hardly discouraging the nonpayment of wages and there is no sign that barter is in decline.

The envisaged reform of the tax and social insurance system has a vital role to play in relieving the financial burden on manufacturing enterprises and hence easing the arrears problem. Nonpayment is in part a result of shortcomings in the government’s economic strategy. The government has pursued a strategy of stabilization and structural adjustment, based on restrictive monetary policies, high interest rates, and lack of credit.

But, without a banking and financial system to monitor the performance of enterprises, extend credit to those with prospects for the future, and initiate bankruptcy procedures against those that are unsalvageable, this strategy can hardly be effective. Enterprises find themselves outside the reach of financial regulation but also deprived of the resources they need to pay wages and taxes. These days, when they can earn high rates of return by investing in government securities, Russia’s banks ignore much of the enterprise sector, which faces low profits and uncertain prospects. It is clearly urgent that an appropriate financial and regulatory framework, with greater government involvement, be developed in Russia.

Based on reports from Oxford Analytica, the international research group (OxfordU.K.) as well as news agency reports.