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The City was assigned foreign-currency debt ratings BB+ (Fitch IBCA) and BB- (Standard&Poor’s) in March 1997. This credit assessment recognizes St. Petersburg’s position as one of the economically strongest Russian regions. The rating is constrained by the BB+/BB- foreign currency ceiling of the Russian Federation.

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St. Petersburg at 4.8 million has the second largest population of any city in the Russian Federation, and rivals the capital of Moscow in history and esteem. St. Petersburg was one of the most enthusiastic supporters of market reform since the collapse of the USSR and its civic leaders are anxious to push ahead on a broad front. St. Petersburg is a major international city with many assets: a well educated workforce and excellent educational and research facilities underpinning its high tech ambitions and businesses.

Output has fallen sharply since the collapse of the USSR, as in the rest of Russia. The City was particularly hard hit because it was a major center of the industrial-military complex, a legacy of its historic connection with the Russian navy.

The City has experienced major financial difficulties. Despite imposing deep cuts in budgeted expenditure during the course of recent years (the policy of sequestration of non-protected expenditure) the annual deficit has risen from effectively zero in 1993 to almost 2.3 trillion rubles in 1996 (23% of total revenue).

Debt service has been recognized by the City Administration as the highest priority and with over half the budget categorized as non-protected expenditure, the City ought to be able to meet its obligations in all but the most severe of revenue crisis.

Real income of the City’s inhabitance decreased by 6% in 1995, increased by 5% in 1996 and decreased again by more than 7% in 1997.

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Strengths
 

• The City receives only a small part of Federal funds and has high autonomy. The City sets its own budgetary priorities and retains a considerable share of various taxes paid by its inhabitants. Tax revenue provided around 90% of total budget revenue.
• St. Petersburg has the most advance municipal bond market - with the most reliable infrastructure - in Russia. Internal debt financing is often considered the most fiscally responsible means of resolving budget deficit.
• Tourism could give a great boost to St. Petersburg, which already sees more tourists than any other Russian city.
• St. Petersburg is a major transportation hub for the region and the country. Its port is the largest seaport in the country and is open to large vessels in the spring, summer and fall.

• Considerable growth of budget deficit in 1996 to 2.2 trillion rubles or 23% of total revenue. This reflected huge expenditures that were not supported by revenues. Such deficits could possibly occur in the future, leaving little cash for investment in the Ciy.
• Debt outstanding rose to 3.7 trillion rubles in 1997 or 28% of total revenue. This implies significant debt service payment that can deteriorate economic growth in the future.
• Significant decline in industrial production. In Soviet times the City’s economy was heavily militarized, with two-thirds of output related to the defense industry. Today those enterprises are slowly restructuring.

St. Petersburg is one of the two cities with federal status in Russia - the other is Moscow. Technically they are both among 89 “constituent subjects of the Federation” (others include ethnic republics, provinces, regions etc) and are the constitutional and legal equal of the others, with a wide range of rights and powers. The City of St. Petersburg is mainly or exclusively responsible for primary and secondary education, housing, transport, health and other social services, such as town planning and economic development.

St. Petersburg is in addition the forth largest net contributor among the 89 provinces to the Federation Budget, one of only 8 provinces which are also net contributors rather than recipients.

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Local power in St. Petersburg is based on the “division of power” principle. There is an elected Legislative Assembly, with currently 49 members, which first came into being in December 1994 following a period of ad-hoc legislative arrangements after the collapse Soviet power. The assembly has a four-year term and the next elections and consequently due towards the end of 1998. Broadly, the assembly has power to pass local legislation and is required to debate and approve the City budget. The political balance in the Assembly is heavily weighted towards supporters of democratic and market reforms.

The executive branch consist of the Governor of St. Petersburg (also known as the Mayor), the Governor’s office, the St. Petersburg Government and various lower level district and sectoral organizations. The present Governor is Vladimir Yakovlev, who was elected in June 1996. He is best described as a technocrat, with an engineering and managerial background, and is not a member of any political party.

The Government of St. Petersburg exercises executive power on behalf of the Governor. It operates through 23 formal committees, which are chaired by the leading members of the Administration.

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Gross City Product

The economy of St. Petersburg has undergone the same strains and stresses as that of Russia and indeed the rest of the former Soviet Union and Eastern Europe since the collapse of the Soviet system in 1991. Gross City Product (“GCP”) fell precipitately and may only now be stabilizing. The extend of the fall is open to question.

The huge figures indicated the tremendous fall in GCP are doubtful because of several reasons. The Russia statistical system is not well prepared to measure the output of smaller firms, probably in services and the informal sector. The “hidden” economy is widely said to account today for some 30% to 40% of economic activity and it is widely thought that the official statisticians grossly inadequate allowance for growth outside the traditional industrial sector. Furthermore, the official relatively low unemployment figures are difficult to reconcile with such a large fall in output, even when due allowance is made for hidden unemployment of employees who remain on books of large state enterprises but receive no pay. See (“Employment”).

In 1996, GCP amounted to 63.4 trillion rubles and increased by 35% in nominal terms compared to 1995 (47.0 trillion rubles). Real GCP decreased by approximately 10%. In 1997, nominal GCP was approximately 72.4 trillion rubles and grew by 14%. Real GCP growth was about 0%.

Industry

Industrial output, as conventionally measured by net material product, which is one proxy for real GCP, has fallen by more than 40% between 1992 and 1995. The transportation and construction industries were even harder hit during the same period - output fell by some 75% in real terms according to official data. In 1995 industry fell by 13% in the City while overall Russia industrial output fell by only 3%. In 1996 industrial output of the City’s amounted to 79.4% of the previous year in real terms.

The year of 1997 became the first year of industrial recovery in St. Petersburg since 1991. Industrial production amounted to 27.3 trillion rubles last year and increased by 8.1% in real terms.

The leading industries in St. Petersburg are mechanical engineering and machinery construction; shipbuilding and transport; food processing; electricity generation and paper processing. Engineering concerns Elektrosila and the local telephone company SPTS are poised for continued strong earnings growth.

Trade turnover

Trade turnover fell continuously during 1992/1994. In 1995 trade turnover within the City increased by 16% in real terms. However, in 1996, trade turnover fell again by approximately 8% in real terms and accounted for 32.8 trillion rubles. In 1997 trade turnover proceeded to decrease. It fell by 5% in real terms and amounted to 35.3 trillion rubles.

Inflation

The levels of consumer and producer prices in the City were close to those in the Russian Federation as a whole in 1995/1996. Estimated annual consumer and producer price indexes in 1997 were about 15% and 9% correspondingly. Price stabilization in Moscow reflects corresponding process in Russia.

The following table sets forth the average consumer and producer price indexes for both Moscow and Russia as a whole for the periods indicated.
 

Foreign exchange market

The Central Bank of Russia has repeatedly proclaimed that stability of the national currency is a primary goal of its activities.

The introduction of the pre-set exchange rate range (the “ruble corridor”) is one of the major mechanisms enabling the Central Bank to affect exchange rate fluctuations. For the first time, it was introduced in the summer of 1995 and remained in place for rather a short time (from July 5 to October 1, 1995). During those three months, the exchange rate was 4,300-4,900 rubles to the dollar.

Later on, the Central Bank repeatedly extended the term of application of ruble corridor and prolonged its action first to six month and later to one year. The boundaries of the corridor also became slanting. However, though the limits for exchange rate fluctuations were fixed, the exchange rate showed a trend towards growth. For instance, the limits for exchange rate fluctuations were 4,300-4,900 rubles to the dollar in the middle of 1995 and 5,000-5,600 rubles to the dollar in the middle of 1996.

A change in the mechanism of fixing the official exchange rate was another mechanism enabling the Central Bank to exercise control over the situation on the foreign exchange market. Beginning from the middle of May 1996, the Central Bank has been quoting the purchase and selling rates for the dollar every banking day. The average rate is the official dollar rate for the next day. The introduction of limits on daily fluctuations of exchange rate (the so-called daily corridor), which could not exceed 1.5%, made it possible to reduce the maximum possible fluctuation of the exchange rate during one day.

The measures taken by the Central Bank of Russia slowed growth of the ruble rate. For instance, in 1995 the cost of the dollar grew by only 30.7% compared to 184% in 1994. Last year, it grew only by 7.6%.

 When announcing major lines of its exchange rate policy for 1998, the Central Bank proclaimed the central exchange rate of 6.2 denominated rubles to the dollar as the main target for the next three years (1998-2000). Possible deviations from this rate should not exceed 15%. That means that the dollar rate will remain within 5.25-7.17 denominated rubles to the dollar. According to the Central Bank’s forecasts, the average exchange rate should be 6.1 denominated rubles to the dollar in 1998.

Investment

Fixed investment

The total decline in fixed investment in the City’s economy during 1995/1997 was approximately 25% in real terms (compared to 30% decline in Russia as a whole). The decrease in real fixed investment reflects the destruction of economic links between the republics of the former Soviet Union.

The share of fixed investment in St. Petersburg as a portion of gross fixed investment in Russia has fallen continuously in recent years. Fixed investment amounted to 2.6% of total in 1995 and only 2.2% of total in 1997.
 
The following table sets forth the nominal volumes and the real growth rates in fixed investment in both St. Petersburg and Russia as a whole for the periods indicated.
 

Foreign investment

New foreign investment in the non-financial sector in St. Petersburg amounted to $171 million in 1997 which accounted for approximately 105% of foreign investment in 1996 ($160 million). Foreign investment in 1995 amounted to $153 million.

Foreign investment accounted for 1.6% of new foreign investment in the Russian Federation in 1997. New foreign investment grew significantly in the construction sector as well as services sector including in the areas of finance, insurance, pension services and market infrastructure.

New foreign direct investment amounted to $98 million in 1997, representing approximately 57.3% of all new foreign investment. There was no portfolio investment in the City. Other investment amounted to $73 million or approximately 42.7% of total foreign investment.

Employment

The total labor force is about 2.6 million, roughly half the resident population. Official unemployment rate has remained about 3% of the City’s population (around 50,000 people) over the past three years. In 1996, official unemployment was approximately 54,200. In 1997 it has decreased to 40,500. Basically this reflects the lack of incentive under present social security arrangements for workers to register as unemployed.

The structure of employment changed significantly between 1993 and 1996. The fall in the level of employed people in the major production categories (industrial, transport and construction) is obvious in recent years, as is the rise in trade. The number of employees in industrial sector fell by 13%, in transport by 10% and in construction by 5%. Total employment in production sector decreased by approximately 9% between 1993 and 1996. However, employment in trade has grown by almost 30% during the same period. The critical decrease in the level of employment occurred in science. It fell by approximately 20%.

Privatization

St. Petersburg was a pioneer in Russia of privatization and transferred ownership of more than 4,300 companies to the private sector over the last five years. KUGI, the “Committee for City Property management”, sold many small enterprises in the service sector, e.g. retail outlets on a mass-scale, mainly in 1992. This first stage was followed by the privatization of medium and large companies, many in the consumer goods industry, in 1993/1994. Now nearly 85% of small and medium enterprises have been privatized, and half of the vary large enterprises.

St. Petersburg started to privatize its own real estate property in 1994: about 42% of the 1 million apartments in the municipality have now been privatized. The transformation into joint-stock companies and subsequent sale of medium and larger enterprises was accomplished via a non-cash voucher system. The future sale of land and non-residential property is expected to constitute a major source of revenue in the years to come.

 This revenue from real estate sales is to be divided between the City budget (70% or 10% if Federal property) and the Federal budget (10% or 70% respectively) and has to cover in addition administrative costs (20%). St. Petersburg’s share in 1996 was 44.1 billion rubles (approximately $8.6 million).

 In 1997 St. Petersburg privatized 64 enterprises (126 enterprises in 1996) including 13 industrial and 20 commerce enterprises. The City received approximately 315 billion rubles in 1997 (174 billion rubles in 1996) that accounted for approximately 11% of the aggregate proceeds from privatization in the subjects of the Russian Federation (excluding the privatization proceeds from sales of the Federal property). Nominal proceeds from privatization in 1997 were 1.8 times greater than in 1996 while less enterprise were privatized. This reflects that larger enterprises were privatized and that the more effective privatization scheme was used in the last year.

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 The most important City Administration activity is the annual budget formulation and its consequent implementation and supervision. A major feature is that the budget may be adjusted during the course of the year to reflect changes in the underlying assumptions on which it was based. In practice, the most significant factor has been a shortfall in revenue, necessitating expenditure cuts in mid-year.

 During the budget making process, all expenditure is categorized by the Legislative Assembly in line with powers granted under Federal Law into protected and non-protected. In broad terms, protected expenditure includes debt repayment, public sector wages, certain health services, social security payments and scholarships.

 St. Petersburg, like many Russian regions, companies and other entities is caught up in multiple payment delays and mutual debts: St. Petersburg unpaid tax is the focus of the problem. Broadly, a number of enterprises and other institutions in St. Petersburg, including the large state owned Lengaz and TEK fuel companies, owe Gazprom, the massive state owned gas production company, either directly or indirectly, about 2 trillion rubles. At the same time the Federal Government owes a similar amount to (mainly) other enterprises in the City. These and other enterprises together owe the City itself about 1 trillion rubles in taxes and there are other substantial amounts (about 300 billion rubles) due to the City directly from the Federation. There was clearly scope for mutual cancellation of debts or payments. Beginning with February 1998, the Federal Government restricted tax offsets and mutual cancellation of debts.

Revenue of the City Budget

 Total revenue of the budget increased by 35% in nominal terms in 1997. This increase is significantly higher than the level of inflation. The major sources of the City’s revenue are tax receipts. These receipts amounted to approximately 89% of total revenue in 1997. Non-tax revenue accounted for more than 7% of total revenue last year. Another source of the City’s revenue is transfers from the Federal budget.

 The following table sets forth the information regarding revenues of the City Budget for the periods indicated.
 

 Tax revenues increased by approximately 65% in nominal terms from 1995 to 1997. In 1997 tax receipts grew by 34% that significantly exceeds the inflation rate. However, the tax revenue share as a portion of the total City’s revenue fell from 91.6% in 1995 to 88.8% in 1997. This can be explained by the decrease in direct taxes. The share of direct tax receipts fell from 52.4% of total in 1995 to 39.4% in 1997. This was primary the result of a decrease in profits of industrial enterprises. Taxes on goods and services (including VAT and excise taxes) increased by 38% and accounted for approximately 22% of the total revenue. VAT receipts were about 1.9 trillion rubles in 1997 and their share as a portion of revenues from taxes on goods and services was approximately 64% in 1997. Property tax receipts grew by approximately 70% in nominal terms in 1997. The share of property tax in total City’s revenue increased from 7.5% in 1995 to 13.4% in 1997.

Non-tax Revenue

 In nominal terms, non-tax revenues grew by 32% in 1997. The main source of the non-tax revenue is the revenue from government property or activities. Their share as a portion of non-tax revenues was about 61% last year. However, the receipts from government property or activities increased by only 9%in 1997 and their share fell from 5.6% of total revenue in 1996 to 4.5% of total revenue in 1997. Revenues from the sale of government property doubled last year. This reflects the more intelligent privatization policy that was conducted by the City’s government last year. See (“Privatization”).

Transfers

 A vertical compensation scheme does exist in Russia in the form of transfers and subsidies from the Federal budget - through the Federal Fund for the Support of Regions - to those regions that need to cover essential budgetary expenses and deficits. These subsidies and transfers are determined by the Russian Ministry of Finance, which accordingly divides subjects in net contributors and net beneficiaries. St. Petersburg is considered a net contributor as the amount of federal taxes collected locally exceeds the amount of Federal transfers and subsidies. St. Petersburg generates some 5% of total Federal budget revenues.

 The City receives direct transfers of cash from the Federation for specific projects. The Federation also funds directly organizations dealing with matters deemed to be a national responsibility. Examples include the construction of new metro stations and the reconstruction of the historic center of St. Petersburg.

 In 1997, transfers from the Federal budget accounted for approximately 505 billion rubles, some 2.2 greater than in 1996. The share of transfers as a portion of total revenue increased from 1.5% in 1995 to 3.8% in 1997.

 The following table sets out the structure of the total revenue of the City Budget for the periods indicated.
 

As already indicated, when major disparities have occurred during the budget year between revenue and expenditure, the latter has been to cut to bring it into line with available resources, although not sufficiently to eliminate deficits altogether.

 The following table sets out the total expenditure of the City Budget for certain categories of expenditure for the period indicated.
 

Total expenditure increased by 39% in 1996 and by 15% in 1997 in nominal terms. In real terms (adjusted to inflation) total expenditure did not changed in 1997 as compared with 1996 data. However, in nominal terms total expenditure increased less than total revenue last year. This reflects a significant reduction of budget deficit in 1997.

 The rationalizations and improvement of budget setting and expenditure controls have been the main techniques to achieve the reduction in current spending together with the replacement of general subsidies in the form of free or reduced cost services by limited, direct subsidies to those in need. Significant steps have been taken towards introducing market pricing but political sensitivities have limited the speed with which the City Administration can implement its objectives. The major areas of expenditure are outlined below.

Housing and Communities Affairs

 Housing and communities affairs expenditures accounted for approximately 3.6 trillion rubles in 1997. In nominal terms, these expenditures grew by 12% in 1996 and only by 1% in 1997. The share of these expenditures as a portion of total expenditure accounted for 36.6% in 1995, 29.7% in 1996 and 26.0% in 1997. The main objectives now are to encourage private ownership and involvement in maintenance. Already about 45% of the housing stock has been privatized.

Education

 Education expenditure accounted for approximately 17% of total expenditure in 1997 compared to 16% in 1995. In nominal terms, education expenditure increased by approximately 44% in 1996 and by approximately 22% in 1997. The City still provides an extensive network of primary and secondary schools, and other institutions including libraries and vocational, teacher training and medical colleges. Many further education colleges are funded directly by the Federation.

Transport and Communications

 Transport and communication expenditures increased by approximately 44% in 1996 and by approximately 8% in 1997. The share of these expenditures in total expenditure accounted for approximately 12% of total expenditure. Relatively high transport expenditures are explained by low fares on City’s transport. These fares cover less than 20% of the costs of the train and trolley service, 29% of bus costs and just half the costs of the metro. All three services require extensive investment and despite the City’s intentions for reform, only a few bus routes have some private involvement. A major problem is the very large proportion of the population entitled to free travel or reduced fares.

Healthcare

 Health and physical culture expenditure increased by 22% in 1996/1997. The share of healthcare expenditure accounted for 11.8% of total expenditure in 1997 compared to 12.7% in 1995. Healthcare for people in work is mainly financed by a payroll tax. The City directly services for non-working people. Main services including hospitals, specialized medical centers and free medicines for designated groups are still provided. However considerable cuts have been made on capital projects.

Social Policy

 Social policy expenditure increased significantly in recent years. In 1997, social policy expenditure grew by 62%, in 1996 by 78%. The share of this expenditure as a portion of total expenditure accounted for 9.7% in 1997 compared to 5.4% in 1996. Major City expenditure is on child benefit and social security veterans. There are varieties of other social programs.

 The following table sets out the structure of the total expenditure of the City Budget for the periods indicated.
 

St. Petersburg exhibited budget deficit in 1995/1997. The deficit was some 11% of total revenue in 1995 and dramatically increased to 23% of total revenue in 1996. This increase reflects poor tax collection during the year and further increase in expenditure. In 1996, total revenue grew by approximately 25% and total expenditure grew by approximately 39%. The City’s government managed to reduce budget deficit in 1997 to approximately 4.5% of total revenue.

 The following table sets forth information with respect to the City’s deficit financing for the periods indicated.

 Other financing mainly consists of bank credits. In 1997, other financing was negative because the major bank credits were repaid. Another source of the City budget deficit financing is budget. In 1997, they accounted for 100 billion rubles.

 Debt outstanding rose rapidly to almost 3.4 trillion rubles by the end of 1996 (34% of revenues). Much of deterioration in 1996 may be attributed to the effects of the two elections - Presidential and Gubernatorial - when incumbents made excessive financial promises to the electorate and abstained from necessary tariff increases. Projected revenues were also adversely affected by lower than projected inflation. Debt increased to approximately 3.7 trillion rubles in 1997 (28% of revenue). Interest on the outstanding debt alone was approximately 2.1 trillion rubles in 1997 (16% of revenue).

 The major items of debt outstanding have been commercial banks and municipal bonds (in domestic currency). The City now intends to reduce sharply the reliance on commercial banks in favor of both domestic and foreign currency bonds, and to considerably lengthen maturities from 3-6 months, which was normal until mid-1996, to the present norm of a year or more. The switch from bank credits will reduce interest costs appreciably.

1998 Budget

 The following table sets forth the planned revenues and expenditures according to the 1998 City Budget law.

 Expenditure is planned at 14.5 billion rubles. Expenditure on housing and community affairs is planned at approximately 2.9 billion rubles, or 20.0% of total expenditure. The share of expenditure on housing and community affairs as a portion of total expenditure in 1998 will decrease by 23.1% compared to 1997. Expenditure on education is planned at 2.7 billion rubles, or 18.8% of total expenditure. Expenditure on healthcare accounts for 1.7 billion rubles, or 11.5.2% of total expenditure. The shares of healthcare and education expenditures will not change a lot in 1998 compared to 1997.

 For the first time, the 1998 City Budget contains an expenditure item on debt service. Debt service accounts for 1.0 billion rubles, or 7.0% of total.

 The 1998 City Budget law envisages a zero budget deficit.

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 To support key industries and to normalize capital flows in the city, the St. Petersburg administration can provide guarantees to back liabilities arising from loan agreements. The 1998 budget fixes the limit on guarantees at 10% of the current budget revenues. The planned amount of guarantees to be issued as of January 1, 1999 is 1.4 billion rubles. Beginning in 1998, guarantees to non-government commercial organizations will be issued on a commercial basis, while investment projects will be subject to evaluation procedures specified in enforceable enactment. Guarantee agreements between banks and organizations financed from sources other than the city’s budget will be executed only on the basis of the Governor’s instructions. In special cases, guarantee agreements between banks and organizations financed from the city’s budget will be executed by the Debt Servicing Department on the basis of an order from the Chairman of the Committee for Finances.

 Guarantees of the St. Petersburg administration which are expressed in rubles are usually provided for short-term loans, including those provided by Russian commercial banks, for a term within one financial year. The total amount of ruble guarantees provided as of January 1, 1998 was 88 million rubles. The total amount of hard-currency guarantees provided as of January 1, 1998 was equivalent to 1 billion rubles.

 In 1997, Vodokanal, a St. Petersburg-based company, and the European Bank for Reconstruction and Development signed an agreement on the provision of a DM127-million loan (two tranches amounting to DM55 and DM72 million) for 10 years at 6.95% per year against guarantees of the St. Petersburg administration and with support of the Russian government and consulting firms from donor countries, including Finland, Germany, Denmark, Great Britain and Sweden. The money will be used to finance a short-term investment program to develop St. Petersburg’s water supply and water disposal system. The program provides for emergency measures aimed at expanding the Northern water supply station, increasing the number of water treatment facilities in the city of Sestroretsk and water saving.
 

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