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3.12 At the same time, the reforms to date have not succeeded in resolving the main problem transforming the sector from an administratively managed one into a market driven one. The major remaining problems can be summarized as follows:

The sectors operations remain heavily subsidized.

Consumers in the HUS have quite limited opportunities to influence the performance of service providers.

Competition in housing maintenance is highly restricted, and the sector is still dominated by municipally owned monopolies and quasi-monopolies.

Most operators in the sector do not have real incentives to improve the efficiency of their service delivery.

The sector does not have a market-based mechanism for investment financing. At the same time, it is affected by years of under-maintenance and under-investment, which undermines the quality and reliability of service delivery. For the time being, government budgets are the only regular source of investment financing in the HUS.

Regulatory policies and practices in the sector are affected by administrative interventions and are neither sufficiently transparent nor stable. This makes the HUS quite unattractive/risky for the new private sector.

The incidence of new private arrangements (such as condominiums) for managing multi-unit housing is low. While more than half of the housing units are privately owned, practically all urban housing is still de facto managed by municipal This section is based primarily on Starodubrovskaya (2003) and IUE (2003b).

administrations. By late 2003, less than 6,000 condominiums were established in Russia.

3.13 The political economy analysis of developments in the sector suggests that the existing incentives of municipal governments are likely to be a key barrier to reform acceleration in the HUS. Municipal governments are seen as the main potential losers in future market transformation in the sector. The reforms would drastically reduce the sphere of their administrative control, while their access to a considerable cash flow in the sector would be lost. Moreover, government control over utilities at the moment creates a major political advantage for administrations during the election campaigns, because it allows for easy access to and communication with local voters.

3.14 It is not surprising that under the circumstances most municipal governments have never been keen on supporting market reforms in the HUS. Instead, considerable efforts were made to imitate market transformations but to keep the essence of administrative regulation intact. This lack of reform incentives at the municipal level was further aggravated by additional factors. First, there has been little external pressure for change -- neither from the private sector (tenants or business) nor from the federal authorities. The federal government was not consistent in its political signal to expedite HUS reform, which, owing to its political sensitivity, has never topped the list of federal policy priorities. Second, the system of interbudgetary relations has been unstable and generally has not provided sufficient incentives for budget savings, and thus for reforms that could lead to a reduction in municipal budget subsidies. Massive redistribution of funds by regional administrations in general tends to benefit those municipalities that are not too proactive in reforming the HUS and thus could easily justify their needs for additional budget transfers.

3.15 The government adopted its new Housing and Communal Services Reform Program in November 2001. The program called for significant reforms in the sector to be implemented in steps over 2002-10. The main priorities of the government strategy include: increased cost recovery in tariffs, which should be achieved parallel with strengthening the safety net for the poor; improvements in the quality of services and in reducing the costs of services; and the expansion of private sector participation. However, the implementation progress has been modest to date. The acceleration of cost recovery increases after 2000 has been the most visible aspect of the change. While progress remains highly uneven across the regions, the reported average cost recovery in tariffs exceeded 70 percent in 2003, which is a major step forward when compared to about 30 percent in 1997-99. The Government resolution of August 26, 2004 set up an objective of attaining 100 percent cost recovery in tariffs in 2005.

3.16 The Bank analyzed the reform implementation constraints in the HUS, faced by subnational governments and other stakeholders, in the recent Policy Note, Housing and Communal Services in Russia: Completing the Transition to a Market Economy (World Bank, 2003a).

3.17 Based on the lessons from the earlier analytical work (see World Bank 1998 and 2003;

IUE, 2003a; Starodubrovskaya, 2003a), this Chapter argues that the reform acceleration in the HUS could be sustained only through simultaneous government actions in several important directions:

Advancing reforms in inter-budgetary relations, in particular providing a more transparent regulatory framework for fiscal redistribution among municipalities within the regional budgets and expanding a local tax base for municipalities. Recent amendments to the Tax and Budget Codes were an important step in this direction. A future priority relates to the introduction of a local real estate tax. In addition, more active political pressure and monitoring on the part of the federal government would be required to change prevailing municipal government incentives.

Reforming housing financing: changing disbursement mechanisms by transferring most of the budget support funds directly to customers of the HUS instead of service providers.

Improving the regulatory framework, especially for tariff setting, as a tool to make the sector attractive to large private investors. While day-to-day regulation would remain decentralized, the federal government has to strengthen a unified national approach to HUS regulation which would define clear rules of the game for subnational regulators.

Creating conditions for established private investors to enter the HUS. Under the circumstances, large private firms, with their ability to withstand potential local political pressures, could become a real driving force for market transformation in the sector. This would require, inter alia providing a legal framework that supports longer-term contracts between private operators and municipalities (such as a good Law on Concessions in local utility networks) and strengthening the judiciarys ability to enforce such contracts.

C. GOVERNMENT INVOLVEMENT IN FINANCING RESIDENTIAL HOUSING Recent trends in housing and utility financing 3.18 At the moment, the population is still paying about half of the total housing and utility costs, with the rest coming from budgets, enterprises, accumulation of arrears and degradation of the housing stock and utilities (Table 3.1).

3.19 The total costs of government programs that explicitly relate to the financing of the HUS exceeded 1.75 percent of GDP in 2003 (about US$8 billion, see Table 3.2), while the large cities historically have been spending about a third of their budgets on housing and communal services.47 Direct subsidization of heating and hot water services make up about percent of the total budget support in the system.

Table 3.1: Structure of Housing Financing (%) 2001 2002 Population 47.4 46.8 52.Budget (only direct budget support) 35.8 41.4 37.Enterprise sector and under-financing (residual) 16.8 11.8 9.Source: Staff estimates based on the data from Roskomstat and Gosstroi.

This includes spending on operational subsidies, housing allowances, and investments in rehabilitation.

Table 3.2: Financing of the Housing Sector (% of GDP) COSTS/EXPECTED ACTUAL FINANCING FINANCING 2001 2002 2003 2001 2002 Total costs of services, estimated on the basis of the 4.03 4.73 4.67 3.35 4.17 4.reported tariffs o/w: 1. Households 2.01 2.46 2.68 1.91 2.21 2. 2. Budget: 2.01 2.26 1.99 1.44 1.96 1.- direct subsidies to cover tariff gaps 1.42 1.66 1.34 1.21 1.61 1.- compensation of tariff benefits (lgoty) 0.54 0.46 0.42 0.19 0.24 0.- housing allowances 0.06 0.14 0.23 0.04 0.11 0.MEMO: 1. Enterprise sector, residual 0.68 0.56 0. 2. GDP, bn 8,944 10,834 13,Source: IUE.

3.20 The average cost recovery in tariffs in residential housing reached 69 percent in 2002, a major improvement relative to 53.5 percent in 2000 (Table 3.3) and 33 percent in 1993. The collection level remains relatively high, at about 90 percent. However, the actual billings are almost 20 percent lower than those that would correspond to the reported cost recovery levels because of considerable benefits (lgoty) in the system. As a result, the actual household payments amount to just 50 percent of the current housing costs.

3.21 By the end of the third quarter of 2003, the average cost recovery in tariffs increased further to 73 percent, and cost recovery in payments increased to 55 percent. However, it should be emphasized that the cost recovery levels reported in Table 3.3 are considerably upwards biased because they are estimated relative to the prevailing average level of domestic prices for energy resources, but not as a ratio to the long-term marginal costs (LRMC) of energy production and delivery. This discrepancy is especially important for gas and electricity supply. In the gas sector, for instance, assuming the average RLMC level is between US$35 and US$40 per 1000 cub m, the 2002 average gas tariffs in Russia were at about 40 percent of the RLMC. Because gas tariffs for households were below the average tariff, while the costs of gas delivery to households were above the average, the properly estimated cost recovery in tariffs for population at the time was closer to 30 percent.

Table 3.3: Cost Recovery and Collection Rates, 2000-02 (%) Total Housing maintenance 2000 2001 2002 2001 Cost recovery in tariffs 53.5% 58.2% 69.1% 50.9% 50.0% 67.5% Billing coeff. 1/ 86.8% 84.2% 80.6% 78.5% 79.1% 76.8% Collection ratio 86.9% 87.8% 89.8% 89.4% 89.4% 91.8% Cost recovery by payments 40.3% 43.0% 50.0% 35.7% 35.3% 47.6% Water Heating and hot water 2000 2001 2002 2001 Cost recovery in tariffs 53.6% 61.9% 68.8% 43.5% 52.5% 65.8% Billing coeff. 1/ 87.9% 84.1% 79.9% 84.6% 83.4% 84.1% Collection ratio 84.2% 86.1% 88.6% 87.0% 85.2% 87.4% Cost recovery by payments 39.6% 44.8% 48.7% 32.0% 37.3% 48.4% Power Network gas 2000 2001 2002 2001 Cost recovery in tariffs 76.8% 81.8% 81.5% 82.5% 88.6% 85.7% Billing coeff. 1/ 85.7% 83.2% 78.3% 100.0% 90.0% 80.0% Collection ratio 87.4% 89.6% 91.1% 82.6% 92.8% 90.9% Cost recovery by payments 57.5% 61.0% 58.2% 68.2% 74.1% 62.3% 1/Actual billings adjusted for discounts and lgoty.

Source: Staff estimates based on the data from Roskomstat and Gosstroi.

3.22 The financial performance of the housing and utility sector remains weak, which is a result of both the existing government tariff policy and the poor operational efficiency of the service providers, which primarily remain unreformed municipally owned entities. Total losses in the sector amounted to 0.8 percent of GDP in 2002 (Table 3.4), while the stock of total payables (mostly for energy) was at the level of 2.7 percent of GDP in early 2003.

Table 3.4: Financial Indicators for the Housing and Utility Sector (% of GDP) TOTAL o/w Heating & Hot Water 2000 2001 2002 2000 2001 Total losses in the sector -1.03 -0.99 -0.79 -0.51 -0.49 -0. o/w: from services to population -1.21 -1.26 -0.95 -0.66 -0.61 -0.Total receivables, stock 3.17 2.54 2.22 1.02 0.83 0. o/w: - from budgets 0.95 0.66 0.59 0.41 0.30 0. - from population 0.44 0.44 0.52 0.13 0.14 0.Total payables, stock 3.25 2.58 2.69 1.20 1.02 0. o/w: - to budgets 0.39 0.37 0.41 0.11 0.12 0.Source: Staff estimates based on the data from Roskomstat and Gosstroi.

3.23 In 2000-01, average spending on housing and utilities amounted to only about 6-percent of household budget expenditures. In 2002, housing and utility prices rose by percent in real terms, while real incomes increased by about 20 percent. As a result, the share of housing spending exceeded 8 percent, which historically is a relatively high level in Russia (Table 3.5). This share amounted to about 2 percent in 1993 (World Bank, 1998a). In comparison, households in Poland and Hungary typically spend over 20 percent of their income on HUS (World Bank, 2003). Even in Belarus, Table 3.5: Average Household Expenditure on Housing and Utilities (% of total household expenditures) 1997 1998 1999 2000 2001 Average 6.3 6.7 6.0 6.1 7.0 8.Median 4.6 4.6 4.3 4.5 5.2 6.Source: Staff estimates based on the HBS.

3.24 It is worth mentioning, however, that even after accounting for the lgoty, the existing statistics on utility tariffs for households continue to overestimate considerably the actual level of cost recovery. This is due to two primary factors:

Services to the population are still cross-subsidized through higher tariffs from commercial consumers. The total annual amount of cross-subsidization may be close to 1 percent of GDP (see Table 3.7 below).

The tariffs heavily underestimate the investment component. It is estimated that the amount of annual under-investments in rehabilitation and repair of local utilities may reach another 1 percent of GDP.

3.25 Therefore, the actual financing needs of the sector, at the current level of its efficiency, are much higher than the cost estimates based on the reported information on tariffs and cost recovery, and exceed 6.5 percent of GDP (see also Table 3.8 below). At the moment, annual household housing payments make up about 2.5 percent of GDP (i.e. they cover less than percent of the total amount).

Structure of budget support in the housing and utility sector 3.26 Table 3.6 presents the structure of the main budget programs in the sector. There have been four main types of budget channels that provide regular financing to the HUS. Most of this financing is provided by the subnational budgets. The role of the federal government in HUS financing is limited to: (i) providing special central budget transfers to regions related to the financing of housing recently divested from local enterprises; and ii) providing indirect budget support to the sector by financing non-regular programs of the emergency type (Table 3.7).

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