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# **I. Introduction**

Macroeconomic analysis suggests that regional budgets in Russia have been becoming a relatively more important source of those budget subsidies and transfers that remain in the economy. While subsidies funded by the federal government were cut dramatically over 1992-95, those funded by regional authorities demonstrated the opposite trend: they increased during 1992-94 and even after a significant drop in 1995, when measured as a percent of GDP, they were still higher than in 1992. The total volume of subsidies' funded by regional budgets in 1995 as estimated amounted to 5.2% of GDP, while the federal government spent less than 2% of GDP for these purposes.

At the same time, recent regional developments in Russia demonstrate the large and growing variation in models of economic policy conducted by regional governments. (Lavrov, 1996b; Mau and Stupin, 1997; Polishchuk, 1996; TACIS, 1996; Vereshagin, 1996). In a situation where the federal government has a limited leverage on regional decision-making, regional policies are heavily influenced by numerous local factors, which _de facto_ lead to regional experimentation with quite different (sometimes contradictory) policies and approaches to the reform process. The incidence of regional subsidies is an important indicator in such an environment because it could be considered as an informative measure of the policy priorities of particular regional governments as well as of the speed of the regional reform process in general (Balcerowicz and Gelb, 1994; Lavrov, 1996b).

The primary idea of this paper was to examine inter-regional variation in subsidy allocation and to explore the basic determinants of budget subsidies in the 87 regions of the Russian Federation for which data are available from 1992-95.2 Central to the analysis has been the attempt to provide some answers to the following three questions: (i) How large is the variation across regions in the incidence of subsidies and what are the recent trends in such variation?

(ii) What are the relative influences of supply and demand factors in determining the current levels of subsidization in Russian regions?

(iii) What is the role of federal budget transfers to regions in determining the existing level of regionally-funded transfers to local enterprises?

The last issue has attracted special attention because it is closely related to debates about evolving patterns of inter-governmental fiscal relations in Russia (Wallich, 1994; Le Houerou, 1994; World Bank, 1995a). In particular, the present system of federal budget transfers to the regions suffers from many well-known problems. It has too many recipients (Dmitriev, 1996), In this paper, the term "budget subsidies " includes both conventional budget subsidies allocated to finns and various budget transfers such as investment grants and subsidized budget loans granted to the enterprisc sector. However, various cash transfers allocated among households (such as child allowances) were excluded from the analysis. "Off-budget subsidies" includes various explicit forms of govermnent support such as tax exemptions and transfers from extra-budgetary funds. The term "regional budgets" means consolidated budgets of subjects of the Russian Federation.

2 Chechny **a** nd Ingushetia are excluded from this analysis due to the absence of data for most variables.