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The Nizhny Novgorod Region (Nizhny Novgorod) was assigned foreign currency credit ratings BB- (assigned by Standard & Poor’s) and Ba3 (Moody’s). Corresponding ratings were assigned earlier to Russia and Moscow.

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Nizhny Novgorod was a pioneer in reform and privatization. The Region has The Region’s population is one of the largest among Russia’s Regions - about 3.7 million people live in Nizhny Novgorod. The city of Nizhny Novgorod has 1.4 million inhabitants. Nizhny Novgorod was headed by several years by Boris Nemtsov (up until March 1997, when he became First Vice Prime Minister of the Russian Federation); it was he who put the region firmly on the path of economic reform. The hope that economic reform will ultimately yield positive results led to the election as new governor of Mr. Nemtsov’s local political ally, Ivan Sklyarov. As a prime center of the Soviet Union’s military-industrial complex, the Region was closed for foreigners until 1991. Defence-related production in 1996 comprised 25% of Nizhny Novgorod’s total output, compared to 8% in 1995. The military enterprises are slowly being converted to civilian manufacturing. Nizhny Novgorod has relatively cheap skilled and well-educated labor force.

Nizhny Novgorod has suffered from the same financial difficulties and budget disturbances as that of Russia. Late payment, non-payment, or under payment of taxes remain the most worrying element underpinning the uncertainties in revenue generation in the region - and for the Federation as well. Region’s fiscal-revenue problems are augmented when some of these large taxpayers fall deeply behind with payments - which have been the case with GAZ. The 1996 deficit was 0.8% of total revenue, but increased to approximately 27% of total revenue in 1997.

Real income in Nizhny Novgorod consequently decreased during 1995/1996 by 4% and 10% respectively. In 1997, real income decreased again by approximately 4%.
 
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Strengths
 

• Nizhny Novgorod has considerable autonomy. Within the framework of the Russian Constitution and its own laws, the Region can sets its own budget and can not be forced to undertake money wasting investments or to carry out deficit generating policies, as is sometimes the case in more centralized system. The Region has a significant share of tax revenues of about 75% of total revenue.
• A rating equivalent to the sovereign ceiling is justified. Nizhny Novgorod Region has won government approval to issue Eurobonds. Nizhny Novgorod government considers debt payment expenditures as a “protected” (priority) item in regional budget.
• Partially successful attempts for economic modernization have gained pace in Nizhny Novgorod. A major challenge in the Region has been the restructuring of military-related production into modern demand-driven manufacturing.
• Nizhny Novgorod’s economy recovered last year, growth was driven by the industrial sector - industrial output increased by 3.6% in 1997. The cumulative amount of foreign investment in the Region by January 1, 1998 constituted $332 billion. Foreign investment is considered as one of key factors of the future economic growth.

• The Region experienced a significant increase of budget deficit in 1997 up to 26.6% of total revenue. This growth in the deficit could be cause for concern, as Nizhny Novgorod has no real municipal bond market and it has earmarked its Eurobond funds for investment purposes.
• The Region has inherited from the Soviet era an economic base that is largely dependent on heavy industry. Lack of economic diversification amplifies the effect of tax arrears. Nizhny Novgorod is highly vulnerable to taxpayer-concentration risk.
• Fixed investment decreased substantially last year - the real level of fixed investment declined by 25% in 1997 in comparison with 1996. Capital investment has declined in recent years, because revenues have been lower than expected. However, the capital-expenditure needs of the regions have risen - for social, infrastructure, and business-related investments that are long overdue.

Nizhny Novgorod is located in the central European part of Russia at the junction of the Volga and Oka rivers. The city has a large river port providing access to the Baltic, Black, Caspian, Azov and White seas.
 
The Region has a territory of 70 thousand square kilometers. Its territory accounts for about 3% of the territory of the Russian Federation and is larger than Belgium and the Netherlands together.
 
Nizhny Novgorod is not an oil- or gas-rich territory but has various natural resources. About 46% of the Region is covered with forests. The Region’s total timber reserves amount to 352.16 million cubic meters. The Region has huge deposits of rock salt appropriate for production of high-quality table salt, chlorine and caustic soda. There are small deposits of non-ferrous metals (copper, lead and zinc), rare metals (molybdenum), dispersed elements (scandium, yittrium and lanthanum) and rare-earth elements (neodymium, cerium and ytterbium) in the Region. Nizhny Novgorod is also rich in building sand, gypsum, anhydride, peat and sapropel.
 
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In the first 9 months of 1997, the Gross Regional Product (GRP) of Nizhny Novgorod amounted to 27.6 trillion rubles. In real terms, it decreased by 2% during that period, compared to the same period of the previous year. Production of goods decreased by 1.7% (agricultural output decreased by 13%, the construction industry’s output decreased by 11.7%, while industrial output grew by 2%). Provision of services decreased by 2.2% (the provision of information and computation services decreased by 5%, while the retail trading, public catering, transport and telecommunications sectors reduced their output by 4%). According to preliminary results of 1997, the GRP in 1997 amounted to approximately 38 trillion rubles, and decreased by 1% in real terms compared to 1996.
 

Such deviations can be explained by unsound financial positions of many companies. During the first ten months of the year, the share of overdue receivables in key companies’ assets increased to 88.9%. Budget offsets amounted to 2.4 trillion rubles, while consolidated budget revenues were 4.9 trillion rubles and expenditures were 5.2 trillion rubles.
 
In the first nine months of 1997 the physical volume of shipped goods was slightly higher than that of manufactured goods. Slight growth in production has a positive effect on unemployment and the availability of jobs.

According to forecasts, gross material product will amount to 62.6 billion “new” rubles in 1998 and increased by 8% compared to 1997.

Industry

Real industrial production increased by 3.6% in 1997 after a significant reduction by 11.7% in 1996. Key industries in Nizhny Novgorod include military complex, vehicle manufacturing, chemical and petrochemical production, forestry, construction and the production of consumer goods.

The Region’s manufacturing industry is the major revenue earner for the Regional government. It accounts for more than 80% of the Region’s Gross Regional Product (GRP). Machine-building, metal-working, oil-refining, electricity, chemical and petrochemical plants account for the largest share in the Region’s industrial output. Ferrous metallurgy and the timber, wood-working, pulp and paper, building materials, light and food industries make a significant contribution to the Region’’ economy. The Nizhny Novgorod’s manufacturing enterprises account for about 3% of the total Russia’s industrial output.

A large share of processing industries in the Region’s economy is one of the peculiarities of Nizhny Novgorod. A significant part of revenues of the Region’s consolidated budget are provided by 47 key companies in the Region, which account for more than 40% of the profit tax transferred to the Region’s consolidated budget. 11 key companies provide more than 80% of this amount. A large share of defense plants in the Region’s industrial output is another peculiarity of the Region. Their existence depends mostly on the government’s ability to fulfill its spending obligations (Budget Law).

In nominal terms, the Region’s 1997 industrial output is estimated at 38 trillion rubles, or 9.7% smaller than the forecast level. The industry’s structure changed noticeably in 1997, compared to the previous year. In particular, the following changes took place:
 

• the share of fuel industry decreased from 6.4% to 4.7% (due to changes in the accounting policy at AO NORSI);
• the share of the food industry increased from 7.3% to 8.2% as a result of the Regional administration’s measures in respect of the production and sales of alcohol products;
• the share of the machine-building and metal-working industries increased. According to estimates, it will exceed the 1990 share of 46.6% and amount to more than 50%.

Profitability of industrial production amounted to 7% in Nizhny Novgorod during the first nine months of 1997. During that period, production profitability grew in three industries, including construction materials, glass, machine-building and metal working. Production profitability decreased significantly in ferrous metallurgy and the timber, pulp and paper, wood-processing and microbiological industries. Profitability levels continue to decline in the food industry.

The highest level of production profitability is in the glass industry (40%), while the highest losses were in the timber, wood-processing and pulp and paper industries (-27%).
   

As planned, the Region’s industrial output will amount to 40-41.5 billion new rubles in 1998. Industrial output is expected to grow in all industries. The Region’s major tasks to provide the growth include the following:
 

• restructuring of enterprises in order to improve their financial and business activities;
• mass transition to more effective management techniques (development of corporate culture, improvement of marketing and financial planning);
• investment in projects that have the highest economic efficiency and help create new job places.

• Development of the power industry and modernization of electricity networks;
• Optimization and modernization of the Regional and district heat supply systems;
• Resolution of issues relating to the gas installation and fuel supply in the Region.

A favorable situation in the machine-building industry is determined by stable operation of GAZ, which is now in a phase of economic growth. Its new model, Sobol, will be launched in the second half of 1998. GAZ also plans to launch production of three latest models of the Italian FIAT. The launch of the GAZ-FIAT plant will increase production of parts at plants that are members of the Nizhny Novgorod Vehicles Financial and Production Group (Nizhegorodskiye Avtomobili). Production of Volga cars that are very much in demand and 8- and 13-seat Gazelles will increase in 1998.

The Vyksun metallurgical plant is an expanding enterprise in Nizhny Novgorod’s ferrous metallurgy. It accounts for 70% of the industrial output (its output grew in 1996 and 1997 and is expected to grow in 1998). The current production trends will continue in the industry unless the situation in the international market changes.

The Region’s defense enterprises face various production, financial, economic and social problems. Production declines faster in the defense industry than in other industries. At the same time, the following can be expected in 1998:
 

• An increase in production of aircraft due to lending, financing and placement of state orders to Sokol;
• A slight increase in the output of consumer goods due to the implementation of purpose-oriented Regional programs;
• Development of new products and utilization of new technology at the radio- and electronic-enterprises that submitted projects in order to receive funds raised through the issue of eurobonds.

Nizhny Novgorod is a large Region in Russia’s non-black-soil area. Soils are mostly podzolic or gray. In 1996, the Region produced 18.1 metric centers of grain per hectare of farm land, 118 metric centers of potatoes per hectare, 189 metric centers of open-soil vegetables per hectare and 115 metric centers of sugar beet per hectare.

Trade

In 1997 the Region’s goods turnover is estimated at 95% of the 1996 level. The deviation of this indicator from the forecast level by 16.7% is explained by the fact that personal incomes were lower than the forecast level, while wage and pension errears grew in the first half of 1997.

A steady trend towards further worsening of the retail trade turnover can be explained by the facts that private income in Nizhny Novgorod is traditionally lower than income in other Russian regions. In particular, wages in the Region are traditionally lower than the Russian average.

The forecast 1998 retail trade turnover is 15,500 billion rubles. In constant prices, it will amount to 101% of the 1997 level. Further growth of prices for goods will be restricted by the population’s effective demand for goods and services. Prices for goods are expected to rise on average by 8-10% in 1998, while prices for services (primarily for transport and housing) are expected to increase by 20-22%.

Investment

Fixed Investment

The continued decline in capital investment in Nizhny Novgorod, as well as in other Russian regions, is determined for by the existing economic situation. As investments in the real sector are long-term by nature, they are rather sensitive to the non-transparency of legislation, the rate of monopolization of the economy, inflation and interest rates. This results in a very small share of commercial banks’ long- and medium term loans to the real sector.

In 1997, fixed capital investment in Nizhny Novgorod amounted to 6.9 trillion rubles, or 75% of the previous year level (in real terms). The Federal government investment accounted for 5.9% of total investment, compared to 3.4% in 1996. Regional government investment accounted for 16.4% in 1997 (14% in 1996). Investment from enterprises own funds, which accounted for 75.5% of total investment in 1996, dropped to 65.4% in 1997. In 1996 fixed investment amounted to 6.1 trillion rubles and declined by 18%in real terms compared to 1996.

Capital investments will amount to 9 billion rubles in 1998. This forecast of fixed capital investment was made with consideration of social and economic development trends, forecast rates of development of material production and resources of the centralized (budgetary) sources. In constant prices, they will decrease by 4%, compared to estimates of 1997 capital investments. 73% of the total investments will be used to finance construction of production facilities, with 30% of investments to be used for financing construction of production facilities for the transport and 23% of investments to be used for financing construction of production facilities for the machine-building and metal-working industry. In 1998, major sources of investment will come from the undistributed profit of enterprises (78-80% of the total investment).

In 1998, the volume of government capital investment from the Federal and Regional budgets is expected to remain at the 1997 level. This will be because the provision of funds from the budgets was below the planned level in 1997. In particular, various bodies of state administration did not receive about 230 billion rubles, or 54% of the initially planned amount. The share of individual funds in capital investments will increase by 0.6%. This will make it possible to build 250,000 square meters of residential housing in 1998, a 50% increase over 1997.

A number of investment funds will be directed for the development of the construction materials industry. Reorientation of the construction materials industry towards production of high-quality goods continues in the Region.
 
Foreign Investment

Nizhny Novgorod Region in actively seeking foreign investment by offering tax cuts and exemptions. As a part of a plan to lure investment into the Region, former plants have been designated as tax-free industrial zones, offering five-year federal, regional and municipal tax benefits and customs privileges eliminating up to 80% of otherwise incurred costs. There are three such zones in Nizhny Novgorod city and one in the nearby town of Sarov.

Total foreign investment in Nizhny Novgorod Region over 1995/1996 was $200.6 million. The Region attracted $140.8 million in 1996, some 2.2% of the country’s total. German investors and IFC are the predominant foreign presence in the Region. Germans opened the first foreign bank in the area, Westdeutsche Landersbank AG, and are involved in numerous projects.

New foreign investment in 1997 accounted for $145.4 million, or approximately 1.4% of total new foreign investment in Russia. Private investments were channeled mostly to retail trade and services, while many of government investment programs for industry were frozen. Nonetheless, Nizhny Novgorod is among the first ten Russian regions ranked according to the total volume of foreign investments attracted. And the total amount of attracted resources grows every year.
 
Transport and Communications
 
Nizhny Novgorod’s convenient geographical location, its traditional function of a trade center and the Region’s military significance accounted for the creation of a relatively well developed transport infrastructure in the Region. The Region has more than 1,000 kilometers of waterways. Most of these waterways are equipped with lighting and light-reflecting devices and have a guaranteed depth of 3.5 meters. There are more than 14,000 kilometers of roads (the road density is nearly 5 times Russia’s average) and more than 1,000 kilometers of railroads. The development of the Region’s railroad network is already completed. The electrification of the Region’s railroads will soon be completed.
 
The city of Nizhny Novgorod has its Metro since 1985 and an international airport since 1994. From this airport, flights along 20 domestic routes are made. In addition, a flight from Nizhny Novgorod to Frankfurt is made by a local airline together with Lufthansa. There are several international from the Nizhny Novgorod city airport.
 
Income
 
According 231.8 billion to estimates, individual income decreased by 4.3% in 1997, compared to 1996. The decline in individual income leads to further decline in effective demand from the population.
 
The structure of private spending shows the following dynamics: while private savings in bank deposits continue to decrease, the share of income used to buy goods and services is growing. At the same time, the amount remaining in hands of the population continue to decrease. The share of income used to buy hard currency is still large.

According to forecasts, the individual income is expected to amount to 31.68 billion rubles in 1998, some 1.7 times greater than in 1997. Real income is expected to grow by 6-7%. The average monthly wage will amount to 790 thousand rubles, compared to 729 thousand rubles in 1997.

The trend towards further changes in the structure of consumer spending in favor of services will continue in 1998. According to forecasts, the private spending will amount to 29.2 billion “new” rubles, a 16% increase over 1997. Households will spend 65% of their income on goods and services. The amount of spare funds held by the population will be about 25 billion “new” rubles. This will create prerequisites for the attraction of spare funds held in the hands of the population to the Region’s economy.

Pensions have been paid without delays since July 1997. As a result, federal pension arrears have decreased by more than 100 billion rubles. As of December 4, 1997, they amounted to rubles. As of January 1, 1998, wage arrears in the Region amounted to 657.7 billion rubles.

Education and Science

On September 1, 1996, there were 59 secondary education institutions and 20 higher education institutions in Nizhny Novgorod. There were also more than 100 organizations involved in research and development and design work. The Russian Academy of Sciences has a number of research institutes in the Region, including the Institute of Applied Physics, the Institute of Microstructure Physics, the Institute of Metalloorganic Chemistry, the Institute of the Chemistry of Pure Substances, the Nizhny Novgorod Branch of the Institute of Machine-Building and the Nizhny Novgorod Department of the Institute of Sociology. There are also the Nizhny Novgorod Center for the Development of Science-Intensive Technology and the International Research Center in the Region.
 
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 In 1996, Nizhny Novgorod’s export amounted to $1,349 million, while import amounted to $724 million. Thus, the Region’s foreign trade surplus amounted to $625 million. In 1997, both export and import decreased and consequently the Region’s foreign trade turnover also decreased. Since export decreased more than import, the Regions’ foreign trade surplus decreased by $127 million. Far abroad countries accounted for more than 60% of the Region’s foreign trade turnover.

A forecast of the Region’s major macroeconomic indicators for 1998 provides for further decline in import and a slight increase in export. The Region’s foreign trade balance is expected to increase up to $580 million.

In 1998, the Region’s foreign economic activities will be determined by the behavior of the international commodity markets, including, in the first place, the fuel and raw materials markets, which account for a significant part of the Nizhny Novgorod’s export. The local government policy aimed at attracting foreign investment and resources of joint ventures based in the Region will increase the Region’s export in 1998.
 

In 1998, the following companies will account for the greatest part of the Region’s exports:
 

• The NORSI-OIL oil company - a large exporter of refined products;
• The Vyksyn metallurgical plant - an exporter of ferrous metals (according to forecasts, its exports will increase 1.5 times in 1998);
• The Volga Balakhnino Paper Mill, a joint venture. The modernization carried out in 1997 made it possible to produce European-quality goods. This, in turn, gives grounds to believe that the company will not only fulfill the existing contracts, but will also increase its exports;
• A number of chemical companies based in the city of Dzerzhinsk, including Kaprolaktam, Orgsteklo, Korund and Sintez - exporters of chemical products (in 1998, their exports are expected to increase by 10%, compared to the preliminary results of 1997);
• AO GAZ - the leader in foreign economic activities in the Region.

One hundred percent of the income tax, excise taxes (with the exception of the excise tax on alcohol, 50% of which is transferred to the federal budget), property tax, natural resources tax and residential housing tax are transferred to various-level budgets of Nizhny Novgorod. The Region also retains 25% of VAT collected in its territory. The Regional profit tax rate is 22% for companies and 30% for banks, exchanges and insurance companies. The Federal government’s profit tax rate is 13%.

According to Nizhny Novgorod’s 1998 budget, tax offsets must not account for more than 40% of budget revenues after January 1, 1998 and 10% of budget revenues after April 1998.
 
In 1998, machine-building, metal-working and metallurgical companies, as well as light-industry companies, will be allowed to pay only 50% of the Regional profit tax on all profits received from export of consumer goods (raw materials excluded) to countries outside the former Soviet Union or from an increase in sales, compared to the previous year, calculated in constant prices.

A tax incentive allowing to reduce the profit tax on companies, organizations and banks that make tax payments in due time by 5 percentage points will not be applied in 1998 because it has proved to be ineffective.

Significant tax incentives have been provided to manufacturers of cars, trucks and car and truck components who launch new production together with foreign companies, as well as to small business.
 
Revenue
 
The following table sets forth the Region revenue for the periods indicated.
 

Deficit Financing
 
In 1994 through 1995 Nizhny Novgorod had no budget deficit. The Regional government’s revenues exceeded expenditures by 39 billion rubles in 1994 and by 2.5 billion rubles in 1995 (The Region knew no budget deficit even in the last pre-reform years). In 1996, Nizhny Novgorod’s budget deficit amounted to 62 billion rubles, or a little more than 2% of budget revenues.

In 1997, the Region’s budget deficit grew significantly and amounted to 854 billion rubles or 26.6% of budget revenues. This deficit was financed by the issuance of eurobonds (596 billion rubles), raising of loans (378 billion rubles) and loans from the federal budget (228 billion rubles). In 1996, the Region’s budget deficit was financed mostly by loans raised. The total amount of loans raised during that period was 149 billion rubles, while the expenditures on previous loans repayment amounted to 88 billion rubles.

In 1997, Nizhny Novgorod launched $100 million in five-year, dollar-denominated Eurobonds with a semi-annual 9.25% coupon. Primary the Eurobond funds were planned to be utilized in four main areas:
 

• assistance to the large industrial concerns that comprises the Region’s chief taxpayers;
• water purification program to the city of Nizhny Novgorod;
• investment projects involving industrial and agricultural enterprises in the tax-free zone of Sarov;
• program to grant mortgage credits to individuals.

Budgetary expenditures will have a structure similar to their 1997 structure. This means that financial aid to other levels of government will account for more than one-third of the total spending in 1998. Up to 1% of budget revenues will be spent to support of market infrastructure development and small business in the Region. Spending on state administration and industry will be similar in volume.
 

 Loans to support small business investment projects and modernize the fuel and energy complex were received from Sberbank.

 Qualitative changes took place in the chemical and petrochemical complex. Debts of NORSI and NORSI-OIL were restructured. The Regional administration signed agreements on long-term cooperation in the spheres of chemistry and petroleum chemistry with LUKoil and a number of banks. A development program for chemical companies based in Dzerzhinsk is being worked out.

The Region’s largest companies, including GAZ, PAZ, Svyazinform, Nizhnovenergo, the Borsk glass plant and others, are preparing large-scale investment projects directly or together with the regional and local administrations. Prospective investors are already defined.

A package of documents to implement the Regional Law on Guarantees for Private Investments has been drafted. It includes the following:
 

The Regional Program for Stimulating Investments in Nizhny Novgorod in 1997 through 1998. The program provides for the resolution of the investment problem in two stages:

1. Assessment of investment potential and strengths and weaknesses of the Region;

2. Development and implementation of the regional development strategy providing for a complex of con stantly implemented marketing and organizational and technical measures aimed at attracting investments to Nizhny Novgorod.

From the viewpoint of investment activity, the major event of 1997 was the assignment of international credit ratings to Nizhny Novgorod. This made it possible for Nizhny Novgorod to issue eurobonds worth $100 million. The money raised will be used to finance investment projects in the Region. If guarantees are adequate, the Regional administration provides loans in US dollars at an 11.5-percent interest.

In 1997 the regional government began to hold tenders among investment projects that can be financed through the sources raised on international markets.

Projects is selected according to the following criteria:
 

• social, economic and budgetary efficiency of projects,
• guarantees that funds will be returned;
• attraction of addition resources;
• creation of prospects of growth in the Region.

The largest projects approved for financing include the following:
 

• 2 city projects (Chistaya Voda and Vetkhi Fond) will use $39 million raised through the issue of eurobonds;
• production of city buses at Pavlov Bus Plant. Borrowing through the issue of eurobonds will amount to $15 million;
• production of Gzhel airplanes at AOOT Sokol. Borrowing through the issue of eurobonds will amount to $6 million.