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. Last Updated: 07/27/2016

THE ANALYST: New Government Proposal Targets Cash Cow Debtors




Corporate debt restructuring in Russia is a disaster. This has become an indelible economic verdict for 1997. The government's attempts to shepherd the stray calves of tax delinquency have yielded no solidarity, nor extra beef for the budget: The shepherd lacks resolve in his task, and the calves, now fat cows that fear no punishment, are still out to pasture.


But it isn't for a lack of effort. Earlier this year, the government adopted a measure to coerce the country's enterprises into restructuring their debts to the federal government, including fines and penalties accrued on this debt. Order 254, possibly Vladimir Potanin's greatest achievement during his brief tenure as a deputy prime minister, was signed by Prime Minister Viktor Chernomyrdin on March 5 and quickly become the hope of a nation caught in a morass of nonpayments and indebtedness. The gist of the order, which still has legal force, was to get a company to pay off, on a monthly basis, its core debt in five years, and fines and penalties in 10. If it failed to make payments during two consecutive months, a controlling stake in the company, issued in advance in the government's name as collateral, could be sold to the highest bidder. The alternative was to face the government in bankruptcy court.


Although the plan offered far more stick than carrot, ultimately no one suffered so much as a splinter. The bottom line -- bankruptcy -- turned out to be an empty threat (not one enterprise has gone into receivership as a result of flouting Order 254), and out of the 3,300 enterprises that were supposed to be cleansed through the debt restructuring system, only 48 volunteered to do so. And out of the 48, only 13 are considered to be major debtors (more than $3.5 million in debt). Company directors, livid at the prospect of issuing a potentially dilutive, controlling equity stake as collateral -- a stake that would exist in limbo until all outstanding debts were paid off -- procrastinated in every way possible, hoping (not in vain) that a new government would come along and save the day by abolishing this nefarious Order 254. Some companies just didn't have the cash flow needed to make monthly payments. A couple of corporations, such as AvtoVAZ and Norilsk Nickel, eventually caved in and signed a restructuring plan.


If the truth be told, the government lacked the political will to execute Order 254. Even AvtoVAZ had to be cajoled and prodded for several months before it signed a deal. For any restructuring system to work, the government must adopt a merciless, "take-no-prisoners" attitude. No less important is to invent a system which will entice indebted companies to pay up without driving them further into a pit of insolvency. No good will be served if corporations start dropping out of the economy.


With these assumptions in mind, representatives of the State Tax Service, the Finance Ministry and the State Duma recently drafted a new concept for corporate debt restructuring, one that aims to avoid some of the vulnerabilities of Order 254. First and foremost, the authors want their document passed into law. A document cranked through the rusty wheels of government and signed by the president will provide more influence than a seemingly spontaneous government edict. Second, the time frame for restructuring has been shortened from an average of five years to one (although this may change during subsequent debate). Third, the government plans to target a debtor's assets.


This is how the proposed system will work. All outstanding corporate debt will be restructured into the framework of a loan. The loans, in turn, will be guaranteed by a company's property: machinery, offices, cars and trucks, and securities. The choice of assets will be made by the creditor -- the government, that is -- which will basically opt for whatever is liquid. Once it has handed over some form of collateral to the government, corporate debtors will have to even up with the government on a monthly basis. If they fail, they lose their collateralized property, which will be sold on the open market. The draft law on debt restructuring thus simplifies the alternatives, the execution and the time frame.


Both the short-term fiscal impact and the long-range economic significance of debt restructuring cannot be overstated. To be sure, if the government is to undo the knot that has tied up the economy and slowed reform, corporations must be made to settle their debts. Fiscal 1998 depends upon it: Now that the government has capitulated to legislators' demands to boost spending, an additional 27.5 billion rubles ($4.6 billion in re-denominated currency) in income must materialize from somewhere. Bureaucrats have hypothesized that 4.2 billion rubles ($705 million) can be raised through corporate debt restructuring, and this is the amount they will be asked to come up with next year.


Gary Peach is the editor of the weekly newsletter Capital Markets Russia.