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Table 3.6: Structure of Budget Spending on Housing and Utility Services to the Population (main programs of direct budget support) (%) Expected Financing Actual Financing 2001 2002 2003 2001 2002 100 100 100 100 Total budget spending: - direct subsidies to cover tariff gaps 70.4 73.5 67.4 83.7 82.1 71.- compensation of tariff benefits (lgoty) 26.7 20.4 21.2 13.2 12.3 17.- housing allowances 2.9 6.1 11.4 3.1 5.7 11.Memo: Federal transfers to regions to compensate for housing divestiture, as % 1.3 2.5 n.a.

of total budget spending Source: Staff estimates based on the data from Roskomstat and Gosstroi.

where structural reforms in general have been lagging, in 2003 households spent on average 11 percent of their budget on HUS.

3.27 Main budget programs in the sector could be summarized as follows:

Budget subsidies to service providers. This is the main budget program in the sector, which accounts for more than 70 percent of the total direct budget support. Its preservation is a direct reflection of the slow pace of reforms in the HUS. Prevailing tariffs are below actual costs and respective governments have to compensate local utilities for these tariff deficiencies. This is a traditional example of bad subsidies, which are highly regressive: wealthier households tend to live in larger apartments, consume more services and receive more subsidies. This subsidization also undermines incentives to improve efficiency in the sector.

Housing benefits (lgoty). Recently, more than one-third of Russian households were eligible for various discounts from the established HUS tariffs, usually as high as percent. The total annual cost of this program amounted to 0.45 percent of GDP in 2002-03. Most of these programs are occupation-based, but not income-based, and many are relicts of social program priorities of the Soviet era. The analysis of their beneficiaries clearly suggests that non-poor households received most of the benefits.

In addition, actual budget financing of benefits never exceeded 70 percent. In the summer of 2004, the Government of Russia adopted a radical program of reforming the lgoty starting from 2005. So far, it has announced a limited monetization of lgoty through a replacement of specific programs in health and public transportation. See a more detailed analysis of lgoty in a separate section below.

Housing allowances. The introduction of the housing allowance program represents one of the major successes of housing reform during the 1990s. It is the first Russian program of targeted social assistance, and as such it has a major impact on defining an overall approach to the reform of social protection in the country. The program has been established practically in every municipality, and its evaluation suggests that it has been rather effective. As of September 2003, 13.8 percent of Russian households participated in the program. In several Russian regions more than 30 percent of households became recipients of housing allowances. It is expected that in the course of the reforms the share of participants would increase further, but it is believed that the existing infrastructure has the capacity to handle more applicants. A replacement of other current programs of housing financing with additional funding of housing allowances would add a major efficiency gain to the system, because it would provide for the channeling of most of the budget expenditure in the HUS for the support of low-income households and more broadly for a reallocation of subsidies from producers to consumers.

3.28 Before 2004, the current legislation on housing allowances provided for two parallel eligibility criteria as well as a formula to determine the benefit size:

a) General. Household spending on housing and utility services (within the established limits of housing size) should not exceed the threshold share in overall household income; this threshold is established by the decisions of regional governments and in most regions equals 22 percent of family income.

b) For low income households. Households with per capita incomes that are below the subsistence minimum are eligible for a housing allowance if their total housing and utility spending exceeds 50 percent of the current minimum wage.

3.29 It was believed that the second criterion was too generous, and that it led to excessive subsidization of low income households and distorted the entire process of housing assistance.

This is especially problematic, given the quite low value of the Russian minimum wage. In 2004, the Government adopted the decision to eliminate the 2nd criterion.

3.30 The elimination of the second criterion, as estimated by the IUE, other factors being intact, would reduce the number of eligible participants in the program by about 75 percent, bringing the number to 7.5 percent of households. In our simulations we also assumed that the second criterion would be eliminated. Respectively, the number 7.5 percent is used as a benchmark for our analysis of potential changes in the number of allowance recipients as a result of the proposed tariff adjustments in the HUS.

3.31 In the course of recent reforms in the division of powers between different government levels in Russia, it was decided that all functions related to social policy should be concentrated at the regional level. As a result, the responsibility for financing housing allowances was moved from the municipal to the regional budgets. While this change expands the funding base for housing allowances, it also creates a potential incentive problem. Having no responsibility for financing this program themselves, municipalities may relax control over program administration, which could erode the efficiency of its targeting. The governments instrument to mitigate this risk is through an introduction of the unified system of regional housing standards that would encourage municipalities to follow a single region-specific set of eligibility criteria for housing allowances.

3.32 The earlier analysis identified two essential weaknesses in the administration of housing allowances (Hamilton, 2004). First, their availability shows too high a variation by region, which by far exceeds the variation in housing affordability. Second, the program remains predominantly urban-based, with rural households being mostly left without access to it49.

3.33 Indirect budget programs (investment support, expenditures for liquidation of emergencies and delivery of fuel to the North). This is the least transparent and least efficient part of public financing in the HUS, and is provided mostly on an ad hoc basis. The funds spent through this channel are not reported in the conventional budget reports as spent on housing sector support. Preservation of these programs reflects primarily the failure of sectoral reforms to date to create an institutional framework for sustainable investment financing that would include efficient mechanisms for tariff regulation, competitive mechanisms for service delivery, and providers that are creditworthy and have access to regular commercial credit. The overall amount of budget funding through this channel is estimated by the IUE to amount to about 0.6 percent of GDP a year, or more than one-third of funding under the conventional budget programs in the HUS (Table 3.7).

3.34 When indirect budget financing is included, total annual government spending on the HUS is estimated to amount to 2.4 percent of GDP. If, in addition, the amount of quasi-fiscal financing through cross-subsidization is reflected, the total amount of fiscal and quasi-fiscal funding in the sector reaches 3.3 percent of GDP (Table 3.7).

It is worth noting, however, that most rural households in Russia continue to benefit from much lower energy tariffs.

Table 3.7: Estimates for Total Fiscal and Quasi-fiscal Support to the Housing and Utility Sector in bn rbl % of GDP Direct budget support provided 234 1.Indirect budget support 82 0.- Preparation for the winter 55 0.- Fuel delivery to the North 16 0.- Emergency rehabilitation 11 0.Quasi-fiscal financing: Cross-subsidies (*) 125 0.- heating 20 0.- electricity 50 0.- gas 55 0.Total fiscal and quasi-fiscal financing 441 3.Costs of annual under-investments (missing rehab) 135 1.(*) Estimates relate to services provided to both population and budget organizations.

Source: IUE 3.35 Table 3.8 presents an estimate of the total volume of actual financing in the Russian housing and utility sector through all available channels. It amounts to 5.8 percent of GDP, which is quite high, given the predominantly low quality of the existing housing. Moreover, given the available estimates of annual under-financing in proper maintenance and rehabilitation, the total annual sector needs in financing under the existing institutional arrangements may amount to as much as 6.8 percent of GDP. The latter number should be considered primarily as an indicator of the sectors inefficiencies, and not as a benchmark for future growth in tariffs and subsidies. Many sectoral experts believe that under the proper incentive regime the total costs of operation in the sector could be reduced by at least 20%. At the same time, as shown below, the sector is facing some additional cost increases associated with growth in domestic energy prices and with a need to incorporate capital costs into the tariffs.

Table 3.8: Total Volumes of Available Financing in the Sector, 2003 (% of GDP) 1. Direct financing of housing and utility services 4. o/w: Households 2. Budget 1.2. Indirect budget financing 0.3. Total cash financing, (1)+(2) 4.4. Quasi-fiscal financing 0.5. Total available financing, (3)+(4) 5.6. Under-financing 1.7. Total financing needs under the existing institutional arrangements, 6.(5)+(6) Source: Staff estimates, based on the data collected and estimated by the IUE.

D. RECENT TRENDS IN HOUSING AND UTILITY TARIFFS 3.36 In the period that followed the 1998 Russia crisis, the government tariff policy in the housing and utility sector was inconsistent. In 1998-2001 the tariff growth in housing and utility services lagged behind general price growth (Table 3.9). The largest gap between the two occurred in 1998: HUS prices grew by only 12 percent50, while annual CPI inflation was 84 percent. This led to a considerable deterioration in the financial situation in the sector. In 2002, as a reaction to this extended period of under-financing, the annual tariff increase in the HUS for the first time surpassed the rate of CPI inflation.

Table 3.9: Inflation and Price Growth in Housing and Utilities, 1998-Implicit growth of Annual growth Consumer Annual growth Annual growth tariffs for a non of electricity Price Index of HUS tariffs of gas tariffs energy part of HUS tariffs services 113.108.1998 184.5 112.0 136.5 125.0 119.162.0 90.2000 120.2 111.3 141.129.0 99.2001 118.6 110.9 137.130.0 138.2002 115.7 134.5 125.Source: IUE, Roskomstat.

3.37 It is worth noting that in 1998-99 the tariff growth in the electricity and gas sector was even slower than in the HUS. However, the period of depressed tariffs was much shorter there. Starting from 2000, growth in electricity and gas tariffs surpassed the CPI rates and provided enterprises in these sectors with a more adequate level of cost recovery.

3.38 Overall, the HUS was used as a major shock-absorber during the period of high inflation and economic instability of 1998-99. By keeping housing and utility services costs low, the Government of Russia was trying to maintain social and budgetary stability at the cost of the deteriorating financial position of the HUS.

3.39 The last column in Table 3.9 provides estimates of growth in tariffs that corresponds to a non-energy component of HUS services. These indices were estimated by de-composing the total costs of housing and utility service delivery in energy (electricity and gas) and nonenergy components.51 As can be seen from Table 3.9, in 2000-01, when energy tariffs started to grow relatively rapidly, but growth in HUS tariffs remained depressed, the implicit tariffs for a non-energy part of the HUS were declining even in nominal terms.

3.40 Since the growth in HUS tariffs in the post-1998 period was kept below general inflation, the accumulated under-financing has become quite significant. In this report it is assumed that to provide the sector with conditions for financial rehabilitation at least a portion of this deferred inflation effect has to be compensated through future accelerated tariff growth.

3.41 In Table 3.10 we estimated the accumulated size of this under-financing in the nonenergy part of the HUS for the period of 1997-2002 as of 126 percent relative to the CPI inflation rate. It is worth noting that this price gap declined considerably in 2002 after a major adjustment in HUS tariffs. Still, this gap indicates that the real level of non-energy housing tariffs in 2002 was less than half of their 1997 level. In our simulations, we assumed that the future growth in housing tariffs would compensate for about 25 percent of this effect of The index of HUS tariffs is estimated based on the data for a federal standard of HUS costs, annually adopted by a resolution of the Russian Government as a part of the budget preparation process.

Both direct and indirect consumption of electricity and gas were taken into account. See the next section for more details.

deferred inflation. This means that in the model we assumed that for the first three years of reforms the non-energy part of the HUS costs would grow at a rate about 10 percentage points higher than the expected CPI rate, after accounting for all other factors that will influence the future HUS tariff dynamics.

Table 3.10: Estimates for the Effect of Deferred Inflation in the HUS (non-energy part), 1997-Implicit growth of tariffs for a Deferred inflation effect (a gap CPI, non-energy part of HUS between CPI and non-energy 1997=services, 1997=100 HUS tariff index) 184.1998 113.8 1.251.1999 146.4 1.302.2000 133.1 2.359.2001 131.8 2.411.2002 182.0 2.Source: IUE, Roskomstat.

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