1.  This memorandum sets out the economic objectives and policies for 1999 of the Government of the Russian Federation and the Central Bank of Russia (CBR). The economic program described below is aimed at overcoming the negative economic and social consequences of the economic crisis that arose in August 1998, restoring macroeconomic stability, and laying the basis for sustainable economic growth, financial and external viability, and the full integration of Russia in the world economy.

2.  The economic reforms pursued since 1992 have achieved a number of positive results. First, the liberalization of prices and external trade, along with enterprise privatization, has helped create a market-oriented economy in Russia. In addition, efforts were made to bring Russian laws into correspondence with the requirements of a modern economy. Finally, macroeconomic stabilization measures succeeded in bringing inflation under control from extremely high levels.

3.  Despite these achievements, however, the government has been unable to successfully address the underlying fiscal imbalance, setting the stage for the August crisis. The erosion of federal government revenue, and especially cash payments, made a durable fiscal consolidation and sustainable macroeconomic stabilization impossible. The continued fiscal imbalance led, in turn, to an excessive reliance on external borrowing and left the Russian economy extremely vulnerable to changes in world commodities and financial markets. Moreover, the continued absence of hard budget constraints throughout the economy contributed to the rapid spread of the nonpayment problem, limiting the possibilities for economic growth and severely complicating efforts of the government to collect tax revenue in cash.

4.  We readily acknowledge that these fundamental elements of the crisis reflect, in part, the fact that implementation of the government's economic program, over the past several years, has been incomplete. Further, in certain respects, weak implementation has served to worsen structural problems. In particular, the inability of the government to enforce cash payment of statutory tax liabilities and to pay its own bills in a timely fashion has played a significant role in the spread of the nonpayment problem. Moreover, potential benefits from reforms, most significantly privatization, have been diminished owing to the absence of transparency in the process and a failure to ensure that economic gains were broadly distributed among the population, and this has served to dampen public support for the reform process in general.

5.  Given the inability to advance structural reform and fiscal adjustment, the macroeconomic strategy followed since 1996 of combining fixed exchange rates with a heavy reliance on external borrowing proved unsustainable. While such a policy stance did allow earlier inflation improvements to be prolonged into mid-1998, sharp reductions in the world prices of key Russian exports, along with the significant spillover effects from the Asian economic crisis beginning in mid-1997, eventually brought this tenuous stability to an end. On August 17, faced with dwindling reserves despite dramatic increases in interest rates, the government announced a series of emergency measures, including a de facto devaluation of the ruble, a restructuring of ruble-denominated government debt falling due before December 31, 1999, and a 90-day moratorium on private sector payments on external liabilities. The most immediate impact of these measures was the insolvency of much of the banking sector. Interbank transactions virtually ceased, and the payments system was paralyzed, contributing to a sharp contraction in output. Meanwhile, driven by the depreciation of the ruble, inflation rose sharply, reaching 38 percent for the month of September.

6.  Since the events of August, the authorities have generally pursued cautious financial policies, aimed at reducing pressures on prices and the exchange rate and restoring confidence in the government. Inflation has fallen sharply, to 3 percent per month in March and April 1999, while the decline in output has been arrested. In addition, the government has formulated a bank restructuring plan, and has made efforts to strengthen the social orientation of the adjustment, including by ensuring timely payment of wages and pensions and through the clearance of budgetary arrears. Nevertheless, we recognize that a durable solution to the serious economic difficulties facing Russia requires a more comprehensive economic program addressing the underlying fiscal problems and providing for the implementation of wide-ranging market reforms, while devoting special attention to increasing support for the reform process.

7.  The government's ultimate objective is to generate sustainable economic growth, and enhance the well-being of the Russian population. To achieve this goal, we aim to develop, over the medium term, an efficient market economy, supported by a limited but effective public sector, and operating in an environment of macroeconomic stability and external and financial viability. The program for this year, as detailed below, will clearly move us only part way toward realizing this vision. However, in the present very difficult economic circumstances, it represents an important step forward, and sets the stage for further progress in the coming years.

8.  Our program for 1999 seeks to move Russia toward these goals through progress in four main areas:

• First, we are tightening substantially our fiscal stance, through both increased revenue collection and compression of noninterest spending. To ensure that this fiscal adjustment is a lasting one, the government will take steps to improve tax administration, eliminate unproductive expenditures, and enhance spending control.

• Second, we will pursue broad-based structural reforms needed to strengthen the basic elements of a market economy, and to eliminate fundamental bottlenecks to economic growth. To a large extent, this requires that we effectively implement policies planned over the past several years, including those aimed at encouraging economic restructuring and addressing the problem of nonpayment throughout the economy. Solving these problems will require the imposition of hard budget constraints, focusing initially on key sectors, but eventually throughout the economy. In addition, in the wake of the August crisis, the government and the CBR must take rapid action on bank restructuring to provide the basis for a banking system that can fulfill the financial intermediation needs of a market economy. We are implementing a comprehensive plan, within the context of the limited resources available for public support, focused on the rehabilitation of a core group of banks identified by transparent and objective criteria and the liquidation of a large number of nonviable banks.

• Third, monetary policy will be conducted in the context of a flexible exchange rate policy and will be geared to reducing inflation.

• Finally, in conjunction with our adjustment efforts, we are seeking an orderly restructuring of external debt accumulated prior to January 1, 1992, based on cooperative relations with, and comparable treatment of, our creditors. While we would wish to avoid the further accumulation of debt and the need for continued balance-of-payments assistance, this will only be possible over the medium term. However, we maintain the firm intention of servicing all external debt accumulated after January 1, 1992.

9.  On the strength of this policy package, the program targets a decline in the 12-month inflation rate to 50 percent by December 1999. The external current account is programmed to improve by about 8 percent of GDP, owing mainly to a sharp compression in imports, while gross reserves are programmed to remain broadly unchanged. Real GDP is expected to contract by about 2 percent for the year as a whole. Policies for 2000, which will be specified in greater detail later, will aim at further significant fiscal adjustment, a reduction in inflation, and an end to negative economic growth.

10.  The program for 1999 contains many elements of previous economic programs of the Russian Government and the CBR—including those supported by the 1996 extended arrangement from the Fund and the 1998 extension of the arrangement, including the SRF and CCFF facilities—that were not always implemented on a sustained basis. The government and the CBR intend to fully implement these earlier specified measures now. We believe that the broad political support that exists in the federal assembly for our economic program augurs well for our ability to implement policies. The up-front implementation of the key measures listed in Table 2 will provide evidence of the strong political resolve behind our program.

11.  The fiscal stance envisaged for 1999 is consistent with a steady reduction in inflationary pressures, and with a move, over the medium term, to financial and external viability. The program targets a federal government primary surplus of 2 percent of GDP, compared with a primary deficit of 1.3 percent of GDP last year. This major fiscal adjustment is based on a substantial rise in cash revenue collection and a significant reduction in real noninterest spending. As interest payments (on a commitments basis) will rise sharply in 1999, the overall deficit of the federal government would fall only from 5.9 percent of GDP to 5.1 percent of GDP. The deficit of the enlarged government is expected to be 5.1 percent of GDP as well.

12.  While the fiscal adjustment envisaged represents an important step toward achieving financial viability, the government recognizes that further efforts will be required over the medium term to allow a durable solution to the underlying fiscal imbalance. In this regard, we are aiming to reinvigorate our program to improve tax administration, and to build on our efforts initiated in 1998 to reduce unproductive expenditure and improve expenditure management. At the same time, steps will be taken to place the finances of the Pension Fund on a sound footing and to rationalize federal-regional fiscal relations. We are planning a further significant increase in the federal government primary surplus in 2000.

Revenue collection and tax policy

13.  The fiscal adjustment planned for 1999 includes an increase in cash revenue of nearly 3 percent of GDP. Efforts to increase revenues of the federal government will take a two-pronged approach. First, in order to close the fiscal gap in 1999, a number of tax measures will be implemented, aimed primarily at increasing taxation of consumption and at capturing some of the windfall gains to exporters owing to the large depreciation of the ruble since August 1998. Second, the government will implement measures aimed at improving taxpayer compliance, including several steps envisaged under previous programs, which will lay the foundation for improved collections in 1999 and beyond, and set the stage for an eventual reduction in the high statutory rates for direct taxes and the elimination of a number of particularly inefficient taxes.

14.  Underlying our efforts to improve revenue collection will be an end to the widespread use of tax offsets and ad hoc negotiated tax payments. In support of this step, the government will achieve passage in the Federation Council of amendments which remove from the Budget Code those articles permitting offsets. Abstaining from any form of tax offset arrangements will be a continuous performance criterion under the 1999 program. Further, the government will not, under any circumstances, conduct a tax amnesty.

15.  The government has adopted a package of revenue measures for 1999 which aims to raise 1¾ percent of GDP. The 1999 budget provides for the transfer of 3 percentage points of the personal income tax to the federal government, which will generate ½ percent of GDP in revenue and an increase of land- and water resource-related tax rates, which will increase collections by an additional 0.2 percent of GDP. In addition, given our overriding need to generate revenue, an export tax on oil, petrochemicals, timber, ferrous and nonferrous metals and other commodities has been introduced on a temporary basis, which is expected to generate about 0.6 percent of GDP in revenue this year. Additional revenue of 0.4 percent of GDP will be raised through the adoption of a number of measures to improve tax legislation, including the introduction of an annual tax on luxury automobiles; reduction of preferential (10 percent) VAT taxation; and enhancing administrative control over production and sale of alcoholic products. Finally, we will forego any reductions in the VAT rate until tax compliance has shown a durable improvement, and at least until January 1, 2000. In this regard the President has vetoed the law putting the VAT rate reduction in place as of July 1, 1999.

16.  A number of changes in the tax law will aid in revenue collection. We have reduced the number of tax preferences, including some tax exemptions for closed administrative territories. In order to further strengthen the tax system, the draft 2000 budget will contain a provision mandating the transfer of federal taxes collected in closed territories to the federal budget—which will automatically eliminate the possibility for closed territories to provide exemptions on these taxes—with corresponding compensation to the territories from the federal budget. In addition, the government will take additional administrative measures by September 30, 1999 to limit the application of these exemptions in 1999. Finally, we will restore the implementation of the gas excise tax on an accruals basis.

17.  We are revitalizing our efforts to enhance tax administration. Central to this program has been the passage of amendments to Part I of the Tax Code, in order to address a number of important deficiencies in the current Tax Code. Among the changes introduced are those: increasing the powers of the tax authorities by eliminating the need for the Ministry of Taxation to use the already over-burdened court system and giving them the ability to issue liens on bank accounts of delinquent taxpayers; introducing legal sanctions against tax agents who fail to deposit withheld taxes into government accounts in a timely fashion; eliminating the ceiling on total interest accruals on overdue taxes, as well as the ceiling on the interest rate; extending deadlines for collection orders; and introducing stronger penalties and sanctions for failure to file tax invoices, filing of false invoices, or bookkeeping practices in violation of the law.

18.  The government intends to increase its efforts to reduce tax arrears in the energy sector. The government has introduced individual schedules for each oil company to move progressively to full payment of taxes in cash in compliance with the law of the Russian Federation beginning from November 1999 and for Gazprom to do the same from July 2000. Until conventional tax administration proves fully effective and at least until the end of 1999 the government is taking an extraordinary short-term measure, starting with the monthly allocations for June 1999, to permit access to the export oil pipeline transport system only for oil companies, which themselves—or whose holding company and all affiliates thereof that have any significant commercial relationship with the oil companies in question—have no arrears of scheduled federal tax obligations arising on or after April 1, 1999. Any company with such federal tax arrears outstanding at the beginning of the month in which export pipeline allocations for the following month are determined will be denied access to export pipeline capacity for the entirety of the month in question. Pipeline access will not be limited by the government for any other reason unrelated to normal technical requirements and payment compliance as set out in oil transportation contracts. Pre-April, 1999 tax arrears will be cleared by December 31, 1999.

19.  In addition, to reduce the current very high level of tax arrears throughout the economy, we will intensify efforts to establish effective collection processes, and to initiate asset seizures and bankruptcy actions in appropriate cases; take action to impose sanctions, provided under the Criminal Code, on enterprise managers contributing to noncompliance; and redirect our tax examination program to focus on cases with maximum potential revenue yield. By end-1999, we will recover at least Rub 8 billion in tax arrears for the federal budget other than in the oil and gas sectors, based on tax examinations. Finally, we will take all necessary steps to make the Federal Debt Center—set up in 1998 to sell assets seized from tax debtors—fully operational, including the passage of a government resolution clarifying that it has an exclusive right to sell attached property.

20.  The government intends to support the implementation of recently-established plans in the Ministry of Taxation (MOT) that are designed to improve its ability to control the affairs of taxpayers whose business activities span several regions, and to achieve efficiency gains through a program of work consolidation initiatives. The government is also committed to strengthening control over and monitoring of the largest taxpayers. Toward this end, it will take steps to effectively implement the core system of large taxpayer inspectorates to deal with the largest taxpayers on a consolidated basis, and will ensure that the units are adequately funded and staffed, and are provided the necessary legal authority to conduct their work, direct taxpayers to file returns, and specify where tax payments will be made.

21.  Steps have also been taken to improve customs collections. To enhance coverage of shuttle trade, we have imposed a mandatory customs inspection for all importers declaring customs payments below a specified threshold per kilogram. In addition, the possibility for tax-exempt imports of cars has been eliminated, with privileges for certain groups of citizens and for cars clearing customs in Belarus removed. In order to reduce losses to the federal budget, the government will, by July 10, 1999, adopt a resolution increasing the list of commodities whose duty-free importation into Kaliningrad is subject to quotas. The government will do everything within its power to ensure that a federal law eliminating excise and VAT exemptions for goods imported to Kaliningrad is adopted by end-1999.

22.  In recent years, the federal government has received a decreasing share of revenues from collections of taxes defined as federal in Part I of the Tax Code, while the federal government's share of total tax arrears has been growing at a rapid rate. To address this issue, we will take several steps. Beginning with the 2001 budget, we will reflect sharing of federal taxes with the regions as an expenditure item, and will execute all such sharing through the federal treasury. Further, in the context of the 2001 budget, we will adopt a single rate of revenue assignment for shared federal taxes, to limit the scope for regions to abuse the revenue-sharing arrangement and to allow simplification of the tax payment process.

Expenditure policy and management

23.  Fiscal adjustment in 1999 and beyond will rest to a significant degree on substantial reductions in real spending as well as enhanced control of expenditure commitments to avoid a new buildup of budgetary arrears. The 1999 budget foresees a reduction in noninterest spending to 9.6 percent of GDP, a decline of 2 percent of GDP compared with 1998, implying large reductions in real spending. The government is concerned that these cuts will not be sustainable over the medium term, and is therefore undertaking a concerted effort to identify and eliminate inefficient or unproductive expenditure programs.

24.  To this end, the government began to implement already in 1998 a comprehensive expenditure reduction plan, including substantial downsizing and organizational reform in the public sector. The number of federal executive authorities and other legal entities that are first-tier recipients of federal money declined from 132 at the beginning of last year to 106 in the 1999 budget. In addition, the number of positions in the federal executive authorities was reduced during 1998 by about 79,000 or 19 percent, and additional reductions in employment have also been seen in transport, education, and health care. We will continue progress in these areas in 1999. As a first step we have prepared an analysis of the impact of the expenditure reduction plan in 1998, and a program for continued expenditure rationalization in 1999. This program includes substantial further reductions of 41,000, or 12 percent, in the number of public employees. In addition the government will take steps to control the off-budget assets of budgetary institutions; undertake an audit and reduction in the number of federal programs; complete the registry of federal government real estate; and introduce norms for assessing social programs. A new federal commission has been established to examine options for further streamlining the civil service, and it is anticipated that this will result in a further reduction in the number of federal agencies. The government is committed as well to conducting a public expenditure review during 1999, covering at least the health and education sectors.

25.  To enhance control over spending commitments, our plan to transfer all federal budgetary entities to the Treasury will be put in place. The operations of the Employment Fund will be brought under Treasury control by December 31, 1999, the operations of the Road Fund by December 31, 1999, and the operations of all other earmarked budget funds by June 30, 1999. Budgetary recipients of the Ministry of Defense will be included within the Treasury by June 30, 2000 and, to this end, a second pilot project for extending Treasury control over second and third-tier military expenditures was approved and launched at end-April 1999; and a program for modernization of the Ministry of Defense accounting system, fully compatible with that used in other government agencies, will be approved and fully implemented with execution of the 2000 budget. In addition, the government will refrain from setting up transit accounts for tax revenues, outside the Treasury. Further, the government will implement a system of pre-approval of all federal contracts, and all obligations lacking such approval will be declared invalid. This preapproval will rely on a reporting system monitoring the amount of registered contracts against budget limits on an ongoing basis, with all contracts that exceed federal budget spending limits being denied. Finally, all budgetary arrears from previous years will be verified in 1999 and measures to restructure these arrears will be proposed.

26.  We are concerned that cuts in spending fall heavily on the poorest segments of the population, notably pensioners. Proceeds of the sale of humanitarian assistance will be used for the clearance of pension arrears (see paragraph 29, below). The repayment of all pension arrears from previous years will limit the fall in actual cash payments to pensioners to 25 percent in real terms in 1999. In order to lessen the hardship on the poorest pensioners, the government has granted an increase of Rub 60 per pensioner to the lowest income pensioners (those with a pension less than Rub 300 per month). The government will, however, clearly have to make allowances for larger increases next year, especially for minimum pensions, offset by savings in other spending areas.

Social funds and regional governments

27.  The effort to address the fiscal imbalance in Russia will also need to encompass the social funds and subnational governments. To help ensure financial sustainability of the Pension Fund (PF), the government will avoid any indexation or general increases in benefits that cannot be fully financed by PF revenues, including allocations from the federal budget. In order to increase the rate of payroll tax collections, we will restructure tax arrears and provide incentives for early repayment, with particular attention to the largest enterprises. Steps will also be taken to improve the efficiency of expenditures by the Social Insurance Fund (SIF). The government will introduce legislation to the Duma limiting expenditures under the Social Insurance Fund to sick and maternity benefits effective January 1, 2000, and specifying that, effective January 1, 2000, sick benefits for the first three days of illness will be paid by the employer. To offset this increase in cost for employers, the government will submit to the Duma, by August 31, 1999, legislation to reduce the payroll tax contribution to the SIF from 5.4 to 4.4 percent. In addition, beginning January 1, 2000 the centralized portion of the SIF's resources (currently about 20 percent) will be fully managed through the Federal Treasury system.

28.  With regard to federal-regional relations, the government will begin to implement measures aimed at improving tax collection, eliminating unfunded mandates, promoting equitable treatment of regions, and encouraging structural reforms. To this end, by October 31, 1999 the government will establish the necessary details and legislation to support the Concept Paper on Subnational Fiscal Reform, which provides conceptual guidelines for the reform of intergovernmental fiscal relations. In addition, the government intends to adopt an improved formula for allocating transfers to regions, to take account more fully of the revenue-raising potential and expenditure needs of regions, which will be implemented in the context of the 2000 budget. The system of regional transfers will be made subject to greater conditionality, in particular on the nonaccumulation of arrears on wages, payroll taxes, and utility payments.

29.  About 0.5 percent of GDP in federal expenditure savings in 1999 is expected to arise from the repayment of federal loans by regional budgets and transfers from regions of proceeds from humanitarian aid to finance the payment of pension arrears. This is an area in which results have fallen far short of targets in the past. We intend to enforce these repayments by withholding transfers and VAT-sharing payments to regional governments that are delinquent in making payments. In this context, we have established a monthly payment schedule by region, and have begun to implement this mechanism to enforce repayments. Within the context of this schedule, we expect to collect at least Rub 1.1 billion in repayments on budgetary lending to regions by end-April, Rub 2.2 billion in repayments on budgetary lending to regions by end-May, and Rub 0.3 billion in humanitarian aid proceeds by end-June. We will provide monthly reports to the Fund on compliance with the payment schedules.

30.  Monetary policy will be conducted in the context of a flexible exchange rate policy, guided primarily by the evolution of reserve money. However, the assessment of reserve money is subject to particular uncertainty in the current economic environment, due to uncertainty concerning the demand for bank liquidity as bank restructuring is initiated and the interbank market starts functioning again, and about developments in the demand for money as individuals gain access to deposits in banks subject to restructuring. Under these circumstances, developments in the foreign exchange market will provide a particularly important indicator of the appropriateness of the monetary policy stance. The CBR will, accordingly, closely monitor developments in this market and stand ready to tighten reserve money growth, through a reduction in net domestic assets, in the event that pressures are observed.

31.  The monetary program for 1999 is based on the assumption that velocity will tend to rise somewhat during 1999 as individuals gain access to their deposits in restructured banks while confidence in policies takes hold only over time. It also takes into account the impact on the money multiplier of the sharp increase in aggregate liquidity over recent months, with a large rise in banks' free reserves at the CBR and in households' holdings of currency. The CBR will not, during 1999, provide rediscounting of promissory notes, or engage in targeted lending to specific sectors of the economy, including through earmarked lending to commercial banks. Furthermore, the CBR will provide no new rehabilitation loans or otherwise provide long-term credit to insolvent banks. The quarterly program reviews, and monthly monitoring, will provide the opportunity to review on a regular basis the appropriateness of the monetary program.

32.  While inflation has declined to monthly rates of 3-4 percent in February and March, developments in late March—when the injection of a small amount of liquidity led to strong pressures on the exchange rate and prices—indicate the precariousness of the situation. Further, the continued large balances of commercial banks at the CBR represent an additional potential source of pressure on prices and the exchange rate; for this reason we will be widely using operations to attract deposits from commercial banks at the regional level. The CBR is, however, currently constrained in its choice of instruments with which to mop up excess liquidity. Amendments to the CBR law will be enacted by July 15, 1999, whereby the issuances, volumes, and pricing of OBRs is left entirely to the CBR's discretion. The authorities will continue to review the range of monetary policy instruments available to the CBR to achieve the monetary policy objectives and develop them further as need arises. Also, the restructuring of government debt has left commercial banks without short-term instruments to manage liquidity. With a view to correcting this problem, the CBR and MICEX will jointly set up an interbank repo market. Finally, the draft 2000 Budget Law will contain provisions for interest payments at market rates on CBR credit extended after July 1, 1999.

33.  The exchange rate will be market determined; with the CBR's interventions solely guided by macroeconomic policy consideration, and with a view only to smoothing fluctuations in the rate. The CBR, in cooperation with MICEX and other organized currency exchanges, will also ensure that participation in the foreign exchange market is competitive and that the exchange rate is not being manipulated by private parties.

34.  The foreign exchange market was unified on June  29, 1999. All other remaining foreign exchange restrictions subject to approval under Article VIII will be eliminated during the period of the program. With respect to the recently-introduced deposit requirement for prepayment of imports, exemptions have already been introduced for clearly valid imports, such as those financed by letters of credit, and a market rate of interest will be paid on deposits. The requirement for deposits will be eliminated by September 30, 1999. In the meantime, we will put in place the necessary legal amendments and institutional mechanisms to allow the authorities to detect and punish illegal capital flows through fake import contracts without preventing normal trade activity. Also the prohibition on foreign exchange purchases with ruble balances in correspondent accounts of foreign banks was eliminated on June 30, 1999. In addition, during the period of the program, the Russian Federation will not impose or intensify any exchange restrictions, introduce or modify any multiple currency practices, conclude any bilateral payments arrangements that are inconsistent with Article VIII of the Fund's Articles, or impose or intensify any import restrictions for balance of payments purposes. We will consult with Fund staff before introducing modifications or amendments to the implementation of the system of capital controls.

35.  The CBR will continue to increase the transparency of its own operations and will put in place requirements to increase the transparency of commercial banks. The policy of announcing weekly data on Russia's gold and external reserves and on base money was begun in June 1998. The annual 1998 audit of the CBR by an international auditing firm was completed in May 1999 with a special focus on the financial relations between the CBR and commercial banks owned by the CBR, both abroad and in Russia. Comprehensive annual audits of the CBR will continue to be conducted in compliance with the deadlines established in the Law on the Central Bank. The investigation of the relationship between the CBR and FIMACO, of the reporting to the Fund under previous arrangements arising from the financial relations between the CBR and commercial banks owned by the CBR, both abroad and in Russia, as well as the handling of the July 1998 Fund purchase will be completed by July 10, 1999. The results of these investigations will be made public. The CBR will seek the adoption of amendments to the Law On Banks and Banking to require lending institutions to make annual public disclosure of banks' key financial indicators, such as capital adequacy ratios and provisions against bad assets, and income statements to be introduced by December 31, 1999 for fiscal year 1999; to have annual accounts prepared and audited by a qualified firm; and to publish quarterly reports. The CBR will continue to publish summary information on the financial situation of the largest banks on a monthly basis.

36.  As a result of the August crisis, with the attendant loss of access to international capital markets, Russia is currently unable to meet in full its scheduled obligations to external and domestic creditors. Total external debt of the federal government now stands at about $150 billion, or 90 percent of GDP, and the government's scheduled external debt service is projected to amount to about 90 percent of federal budget revenues, well beyond any realistic threshold for repayment capacity. The government is therefore seeking debt relief.

37.  Action has already been taken to restructure domestically-issued debt. In December 1998, following discussions with investors, the government announced a novation of the GKOs and OFZs on which payments were frozen as of August 17, 1998; in the course of the novation period 95 percent of domestic holders restructured their portfolios, and the corresponding number of nonresident holders was 88.5 percent. We will continue to make best efforts to reach agreement with the remaining holders of these securities. Where agreement cannot be reached, we will honor obligations according to the original terms, although the transferability of proceeds from such payments will be subject to restrictions.

38.  Russia will also honor its other obligations to external creditors. Our debt servicing difficulties are expected to continue for several years. Accordingly, we are seeking a rescheduling on debt-service obligations on external debt accumulated prior to January 1, 1992, the effective Paris Club cutoff date for debt of the former Soviet Union, while paying in full obligations accumulated by Russia since then. In preparation for this rescheduling, the government has been in close contact with its creditors and has expressed its intention to undertake the negotiations on debt rescheduling in a cooperative environment, with due attention to comparable treatment of creditors.

39.  The government remains committed to a liberalized trade regime. Since the August crisis, however, we have had to implement a number of measures, including the imposition of some export taxes, to address the government's difficult fiscal position. We intend to review and abolish these measures as soon as Russia's financial conditions permit. In the meantime, the government is committed not to impose new quantitative restrictions on international trade. Furthermore, to accelerate Russia's integration in the global economy, in 1999, the government will continue negotiations toward WTO accession, and will ensure that any new trade restrictions would be fully consistent with WTO rules.

40.  The government will take a number of important steps to further liberalize the trade and foreign investment regimes, many of which are being supported by the World Bank SAL3: (1) ad valorem tariffs on approximately 75 tariff lines will be lowered from 30 percent to 20 percent during each quarter of 1999; (2) specific duties on 80 tariff lines will be reduced during each of the years 1999 and 2000; and (3) the total number of exemptions from import tariffs specified in the law On Customs Tariffs will be reduced substantially in each of the years 1999 and 2000. Moreover, to help ease bureaucratic impediments to foreign trade, the authorities will take steps by September 30, 1999 to eliminate the functions of the Federal Service for Foreign Currency and Export Control (VEK) that duplicate the functions of the various government ministries, the CBR, and Ministry of Taxation. In order to eschew quantitative control of exports the government will also modify Government Resolution #155 by removing the mandatory aspect of controls of the quantity and quality of certain exports and by clarifying the voluntary nature of the export contract inspection system.

41.  The government recognizes that progress on achieving macroeconomic stability and enabling private sector growth depends critically on a revitalization of the program of structural reforms. To aid in reaching these objectives, we have agreed with the World Bank on a comprehensive program of reforms, in the context of a renewed SAL3. This program focuses on the broad objectives of: improving the competitiveness, transparency and accountability of infrastructure monopolies; enhancing the development of the private sector and industrial restructuring; liberalizing the policy regimes governing foreign direct investment and international trade; enhancing fiscal management; and reforming the financial sector. Two specific areas—bank restructuring and measures to deal with the nonpayment problem, in addition to the measures for fiscal structural reform—have been elaborated as critical elements of our structural reform program for support by both the Bank and Fund.

Bank restructuring

42.  The government's involuntary restructuring of part of its debt obligations and the devaluation of the ruble in August 1998 undermined the stability and solvency of the banking system, and revealed the fragile financial condition of the banks, notwithstanding the substantial efforts prior to the crisis to lay the legal and regulatory foundation for a market-based banking system. The government is undertaking, as a priority, the restructuring of the banking system in line with the recommendations of the joint IMF/World Bank team that has been assisting us.

43.  The current legislative framework for bank restructuring and bank liquidation represents a major roadblock in our efforts to reconstitute the banking system. Therefore, we are, as a matter of the highest priority, developing a more suitable legal framework. In this context, we will enact, by July 15, 1999, a self-standing Bank Restructuring Law as well as, by October 31, 1999, amendments to the Law on the Central Bank and the Civil Code. These legal changes will strengthen the ability of the authorities to write down the capital of banks, empower and regulate the activities of the Agency for Restructuring of Credit Organizations (ARCO), and ensure that sales of all bank assets by ARCO will be conducted in a transparent manner. In particular, the Bank Restructuring Law will contain the following elements: (1) banks can be referred to ARCO only by a directive of the CBR on the basis of specific criteria; (2) ARCO will be empowered to assess the viability of a bank referred to it and will have full authority to refuse acceptance of any referred bank; (3) where current owners are unsuitable or unwilling to invest new capital in the bank, plans for restructuring will include the write-down of shareholder value, the disenfranchisement of current shareholders, and regulatory seizure and assumption of full control over the bank by ARCO; (4) the law will provide an equitable and transparent mechanism under which creditor write-downs can be imposed; (5) ARCO will be empowered to restructure a bank as it deems necessary in the interests of the depositors and creditors (including the creation of a new bank and transfer of assets and household deposits to the new bank); and (6) ARCOwill have the power to seek to repudiate contracts and the undoing of affiliate transactions and transactions for inadequate value or made with intent to defraud depositors and creditors of the insolvent bank. Under no circumstances will current shareholders retain preferential rights to resume ownership of the bank after restructuring is completed.

44.  The Government of the Russian Federation will adopt necessary normative acts which will provide limited guarantees on household deposits in commercial banks which are subject to liquidation. Measures on transfer of deposits from commercial banks to be closed to other banks will be supported by providing these banks with the equivalent amount of assets in the form of government securities.

45.  The Bank Bankruptcy Law provides standards for the CBR to appoint temporary administrators for banks; gives the CBR the powers to certify receivers for bank bankruptcy and to propose candidates for receivers to the Arbitration Court; and provides an expedited liquidation procedure for banks. However, in order to facilitate the restructuring process, a number of amendments to the current law will be submitted to the Duma by September 30, for enactment by October 31, 1999: (1) to require that the temporary administrator remain in place until the bank has been restructured or the CBR revokes the license and the arbitration court appoints an arbitration receiver in a bankruptcy proceeding; (2) to provide that ARCO will be appointed arbitration receiver for banks it controls; and (3) to incorporate a capital insolvency definition as grounds for bank bankruptcy. Further, the general Bankruptcy Law will be amended to provide that any transaction made for inadequate value or made with the intent to defraud a bank, its creditors, the CBR or ARCO, can be undone (and that if the asset has been conveyed to a good faith purchaser, then the proceeds can be recovered), and to provide that sales of bank assets will be conducted by open tender or other fully transparent manner determined by the liquidator to maximize value. Finally, the Civil Code, the Law on Pledge, and the general Bankruptcy Law will be amended to strengthen the rights of secured creditors to recover promptly and liquidate collateral.

46.  In order to deepen the bank restructuring process, the CBR will, on an ongoing basis, use all powers granted to it to limit the activities of banks in poor condition, promote restructuring efforts, and revoke the licenses of insolvent banks. The CBR has identified from among the eighteen banks which were the subject of the 1998-99 financial review those which are insolvent and do not have the potential to prepare and implement successful restructuring plans, and revoked their banking licenses, and will initiate bankruptcy or liquidation proceedings against them shortly. For the remaining insolvent banks, the CBR will (i) immediately appoint temporary administrators for these banks, and (ii) refer these banks to ARCO. Within three months of the referral of any bank to ARCO, the Agency will determine for each of these banks whether they will be accepted for restructuring or should be immediately liquidated. With respect to those banks to be liquidated, the CBR will revoke their banking licenses and initiate bankruptcy/liquidation proceedings in accordance with the Federal Law on Insolvency of Credit Organizations. With respect to those banks to be restructured, ARCO will have sole responsibility for preparing, approving, and implementing of detailed restructuring plans developed according to an internationally accepted format.

47.  ARCO will have the sole responsibility for the restructuring of banks that receive public funds for recapitalization. The CBR will, as a matter of principle, provide liquidity support only through its existing regular facilities (Lombard credit, overnight credit, intra-day credit, and repos), when fully collateralized, and only to solvent banks or banks implementing restructuring plans approved by ARCO.

48.  Sberbank is the largest bank in Russia and will continue playing a key role in the country's payment system. With this in mind (i) a detailed assessment of the financial condition of the institution, including its branch network will be carried out, and (ii) on this basis, an analytical report on Sberbank's development strategy, which will also recommend actions (including firewalls between management, state and CBR with regard to the bank's day to day operations) to establish a level playing field for Sberbank to operate in a competitive environment, will be prepared. Terms of reference for financial review will be finalized by July 15, 1999, and the review will be completed by October 31, 1999. Terms of reference for the analytical report will be finalized by July, 31, 1999, work will begin by October 31, 1999 and the report will be completed by March 31, 2000. The CBR and the government will prepare a business strategy for the development of the bank by May 31, 2000.

49.  Draft amendments to the Law on Banks and Banking Activity have been submitted to the Duma, with a view to enactment by October 31, 1999 to provide that appropriate governance structures and fit and proper rules are applied stringently to bank shareholders and management when applying for approval of new bank licenses or for transfer or continuation of bank licenses in a restructured institution. Associated CBR regulations will also be amended by that date. The CBR will also establish revised and tightened fit and proper criteria for the licensing of banks. These will include changes in the calculation of initial capital, elimination of cross-holdings as a source of capital, consideration of the viability of the bank's business plan, and assessment of the transparency of corporate shareholder groups. These criteria will be applied to any shareholder with more than 5 percent direct or indirect ownership in the bank or who otherwise may be deemed to be able to exercise a comparable degree of influence in the bank's activities. On the basis of this test, and consistent with best international practice in defining fit and proper critera for bank owners, such shareholders having contributed to the insolvency of a bank shall be barred from continued ownership of any bank.

Addressing the nonpayment problem

50.  Our effort to deal with the growing problem of nonpayment is based on the enforcement of hard budget constraints throughout the economy, and follows four broadtracks. To a significant degree, this will require the effective implementation of policies developed in the context of previous economic programs supported by the Fund and World Bank. First, as discussed above, we seek to improve tax compliance, and will take a number of structural measures in this regard, including denying access to the oil pipeline for enterprises with tax arrears, and levying the gas excise tax on an accruals basis. Second, we will move to ensure that the government meets its own spending obligations. Third, we are committed to improving cash collections by infrastructure monopolies, which play a central role in sustaining the nonpayments chain. Finally, we will strengthen bankruptcy legislation and its implementation, and ensure that the government plays a full role in the bankruptcy process.

51.  With regard to government fulfillment of its spending obligations, we will ensure that there are no new arrears incurred by the federal government in 1999, and that budgetary expenditures are fully executed in cash, including for the consumption of energy by budgetary organizations. Further, the government will pass all enabling regulations to implement a mechanism by which federal financial assistance to regions can be adjusted depending on compliance with a number of requirements, including schedules to eliminate the outstanding stock of payroll tax and wage arrears; maintenance of wage arrears at 30 days or less of the current wage-bill; maintenance of payroll tax arrears at one month or less of average monthly liabilities; incentives for payments by households for utilities; and the gradual phasing out of offsets. The government will take all necessary measures to maintain accounts payable by the federal government and its related agencies to infrastructure monopolies of no more than 30 days sales equivalent.

52.  The government is committed to reduce domestic noncash payments and arrears in the infrastructure monopoly sector. Toward this end, we have ceased state directives to oil companies to supply nonpaying refineries, and will not issue further such directives for any deliveries without an agreed contract between suppliers and buyers. There will be no state orders for delivery except against cash payment or an agreed contract between buyer and seller. In addition, the government will reduce the list of "strategic" companies to which supply may not be terminated. To further increase collections, procedures for termination of supply to nonpaying consumers will be clarified and simplified, and suppliers will be indemnified against the consequences of legally implemented termination of service. Reflecting these measures, we have set quarterly targets for 1999 for cash collections as a share of total sales in each of these sectors. These require, for electric power, district heating, and natural gas, an increase to 25 percent by the end of the second quarter of 1999, 35 percent by the end of the third quarter, and 40 percent by end-year. For freight service provided by the railways, increases to 52 percent, 60 percent and 65 percent are required for the last three quarters of the year.

53.  The existence of an adequate bankruptcy law and the ability to employ it when necessary is perhaps the fundamental element underlying the enforcement of hard budget constraints. To enhance the efficacy of the bankruptcy process, the government hasconfirmed its commitment to make full use of such procedures and, to this effect, will rescind the government directive of January 27, 1999, to cease initiating bankruptcy proceedings against tax debtors. Further, except for the banking sector, the government will refrain from submitting to the State Duma draft laws which envisage special bankruptcy terms for any type of debtor, and will ensure the independent status of the Federal Insolvency and Financial Rehabilitation Service (FIFRS) and take measures to complete its staffing.

54.  To address shortcomings of the current Law on Insolvency (Bankruptcy), the government has submitted to the Duma with a view to ensuring passage by October 31, 1999, of amendments to eliminate the bias in the law towards reorganization rather than liquidation of enterprises, eliminate court discretion in overruling the creditors' decision to liquidate the debtor enterprise; and provide for the participation of the state in bankruptcy proceedings at all stages where relevant for the protection of the public interest. The amendments will also provide a legislative basis for creditors to utilize bankruptcy procedures in a special accelerated manner, including faster introduction of external management of enterprises under bankruptcy. Finally, to enhance the incentive of managers to maintain solvency of their enterprises and to abide by the Law on Insolvency, the government will submit to the State Duma, by November 30, 1999, a draft law providing for increased personal financial liability and management disqualification for improper conduct by management resulting in the insolvency of enterprises managed by them.

55.  Effective reform will, as indicated earlier, require improved governance and enhanced transparency. We have outlined above steps to improve the transparency of the CBR and the banking system, and have presented plans to bring all federal government operations under the treasury, which will serve to make activities of the public sector more transparent. In our view, this effort should be extended to the rest of the public sector and natural monopolies. To this end, by September 30, 1999, contracts will be awarded for the execution of financial management reviews, leading to annual audits, carried out in line with international auditing standards, of the Pension Fund, Social Insurance Fund, Medical Insurance Fund and the Road Fund. In addition, the government will issue a decision requiring Gazprom, RAO UES, the Railways, and Transneft to prepare and publish on a quarterly basis financial accounts consistent with the International Accounting Standards (IAS), commencing with accounts for the first quarter of 2000. Further, the consolidated IAS financial accounts of Gazprom, RAO UES Rossii, and Transneft are to be audited by independent qualified auditors in accordance with international auditing standards and published annually by June 30 of the following year, starting with the financial accounts for 1998. The same will be done for the Railways starting with 1999 financial accounts.

56.  The Government of the Russian Federation and the CBR are aware of the importance of public disclosure of information in restoring market confidence in economicpolicy and promoting greater public awareness of the choice of economic policy options. Clearly the timely publication of comprehensive economic and financial data which characterize the status of the real sector of the economy, government finance, the banking sector, and financial markets plays a key role in fulfilling this objective. In addition to the weekly publication of reserves data mentioned in paragraph 35, the CBR places an increasingly large amount of regular data on its website and through its bulletins and statements. Likewise the Ministry of Finance maintains an active website which will include this statement. Moreover, during 1999 a number of steps will be taken to improve current practices for compiling, and in line with the guidelines under the IMF's Special Data Dissemination Standard, publishing these data.

57.  The Government of the Russian Federation and the CBR will provide the IMF with the information needed to monitor the implementation of the program in accordance with the timetable established in the agreed Memorandum of Definitions, as well as other information that may be needed to monitor adequately financial and economic developments in Russia. Monitoring the program will be part of the responsibilities of the Government of the Russian Federation and the CBR. Monthly indicative targets have been established under the program and will be assessed in conjunction with IMF staff. Furthermore, the implementation of fiscal, monetary, and exchange rate policies and related structural issues under the program as well as macroeconomic and financial developments will be monitored jointly by the Russian authorities and the IMF staff on a continuing basis.