The Future of Privatization

According to some estimates, 60-70% of Ukraine's GDP comes from the private sector.  In 2006 the country's government plans to privatize more of its major assets.  Professionals experienced with the process discuss the challenges of privatization in the new Ukraine

Jorge Zukovski (President, American Chamber of Commerce in Ukraine): Gentlemen, all of you around the table today have had extensive experience with privatization in Ukraine and in some cases in other countries as well.  That experience comes from both purchasing assets for your organization or rendering services to those investors who have successfully been involved in the privatization process.  That being said, in general terms, what is your attitude toward privatization?

George Logush (Managing Director, Kraft Foods Ukraine, Chamber Board member): It is hard to imagine anywhere in the world today where you would want to have State enterprises, except in some unusual situations.  Where do you get new technologies that are not freely available, that come along with strategic investors? How do you get openings into markets and so on?  Clearly, these are all reasons why you want to have as many of your enterprises privatized as possible-so that they can do what they are supposed to  do with all the strengths that privatization and investment can do what it is supposed to do, which is provide for roads and schools.  I do not think for Ukraine the question is whether we should privatize or not, but now far privatization should go, and what should be left in the State domain.

John Richardson (General Manager, British American Tobacco, and Chamber Board Member): Our Company would classify Ukraine as an emerging market.  In lots of markets in Eastern Europe, not only was there a large number of State bodies, but most of what we would classify as the private sector was also held by the State.  These assets, when privatized, allowed the investor to refresh them in a manner that met the needs of the consumer.  Privatization has been an effective way of bringing expertise, technology and training into the market, and is a necessary form of investment in an emerging market.  The question is how far you take it.

Boris Krasnyansky (Managing Partner, PricewaterhouseCoopers, Chamber Board Member): However you do it, privatization is not necessary fair, but there is no better way to improve and economy.  And so that is what has to happen.  The question at this stage must be:  How should it be done?  What methods should be used to privatize large enterprises in Ukraine?  And the answers depend on the objectives of privatization.

James Hitch (Managing partner, Baker&McKenzie, Chamber Board Member): I think the problem is in how privatization is carried out.  People were not concerned with who ended up with Kryvorizhstal, but how they got it and how much they paid.  UP until now, the privatization process has not been very good, particularly for foreign investors looking to spend millions of dollars.  Due diligence is not allowed.  The State Property Fund gives you a six-page standard contact and you cannot make any changes in it.  There are no representations and warranties.  You do not get much advance notice of a tender, usually only thirty days. I think there are many short-comings in the current system that needs to be changed before the government can expect multimillion dollar acquisitions by world class multinational corporations.  These companies would bring benefits not only to themselves, but to Ukraine.  The government is not handing privatization in a way that is a attractive to foreign investors, and that should be changed.

Tomas Fiala (Managing Director, Dragon Capital): I believe the companies that have been acquired by Western strategic investors are growing faster than their sectors, and they have reported much higher profits and have been paying more taxes.  There has been a clear fiscal benefit to Ukraine from FDI and privatization.

Alexander Pisaruk (General Manager, ING Bank Ukraine): I think the efficiency of privatization is also confirmed by the experience of the countries in Central Europe.  For example, there have been banking sector privatizations in the Czech Republic, Poland and Hungary, and in virtually every case, the efficiency of the institutions privatized increased.

John Richardson: The easy part of privatization is determining the price.  The most difficult part understands what the underlying liabilities and obligations are.  Most of our difficulties or successes stem from what happens after the privatization, in other words, a thorough understanding of the obligations of the parties.  This could include taxes, investment concessions, or obligations under the charter.  This is where we had to invest the most effort-after the privatization.

James Hitch:  Actually, the preconditions have been a big problem with many of the past privatizations.  The conditions that determined an investor's eligibility for privatizations were not always rational.  Post-privatization-acquisition conditions are also a problem.  Some contracts include obligations that prevent you from firing workers, or from firing workers for three years.  Those conditions are not economically viable.  The conditions should not be unilaterally imposed by the State Property Fund, but rather negotiated with the investor.

Boris Krasnyansky:  These conditions, however, did not stop Arcelor or Mittal from bidding for Kryvorizhstal.  The State, as any owner, may put any conditions it wants on a property up for privatization-if you do not like them, do not buy it.  It would be nice, though, if all those conditions were the only conditions, and none were added later.  That is where the trouble starts.  After investors buy, sometimes they start to experience enormous difficulties with the local authorities, with the tax authorities-things they were not aware of when they bought the property.

George Logush:  Setting conditions reduces the number of participants in a tender, and it lowers the price of the property.  If the State wants to get the most possible money from to get the most possible money from a tender, it should make the tender as clear and transparent as possible, and it should minimize the burden on the investors.  Not only will the government get more money from the tender, but the asset will be run better and more efficiently, bringing larger benefits to the treasury in the long run.  Transparency, an even playing field, time to respond to a tender-violation of these simple principles is the classic blunder that in the end hurts the state.  In the case of Kryvorizhstal, these mistakes cost the State four billion dollars.  This should be the main argument of the investment community, both domestic and foreign: it is to our and the State's benefits that a tender be transparent.  Every investor wants to see an economy that is developing and prospering, because that is the best environment in which to run a business, and this brings the best benefits for consumers and the state.

Jorge Zukoski:  I would like to add that the government should also ensure that privatization tenders do not exclude certain entities, especially foreign investors, from participating.  That said, is Ukraine's current privatization policy clear?

Tomas Fiala:  I do not think it has been set.  We do not know what is going to happen this year, what companies will be privatized and under what terms.  We can just guess that privatizations will proceed in a fashion similar to the privatization of Kryvorizhstal: there will be open tenders with people sitting in the same room and raising their hands.  That will probably be the case for the largest companies, like Ukrtelecom and the Odessa Port Plant.

Boris Krasnyansky: The government has never clearly articulated the objectives of privatization.  Different messages were coming from different levels of the government.  Nobody, especially in the parliament, can assess whether the government's privatization program is good or bad, nobody knows why some companies are on the list and why others are not.  I think the first stage of privatization has been completed: Ukraine is getting market economy status.  To do that, it was necessary to create a critical mass of private business in the country.  Even when that was the goal, there was no measuring stick.  The State Property Fund did not track what percentage of GDP came from the private sector.  At that stage of development, certain methods were used to privatize state assets, and you can argue whether they were good or bad.  Now two benchmarks have been crossed: Ukraine receiving market economy status and Mittal Steel has purchased Kryvorizhstal.  Having reached that benchmark, every single privatization should be done in a way that maximizes value to the state and to the economy.  The methods and rules of privatization have to change in order to achieve that goal.

Alexander Pisaruk: It is important to realize that when the government makes statements about privatizations of certain companies, but never implements them, it hurts the credibility of the government and the valuation of the company itself.  I do not think statements should be made before a consistent privatization policy is developed.

Jorge Zukovski: In your opinion, what measures should be taken in regards to disputed past privatizations?

George Logush:  On one side, the government could go though the thousands of murky privatizations that may have involved a loss for the state.  The gains would be not only moral and ethical, but economic.  If owners have gained their enterprises on a competitive basis, they will probably be more efficient as managers, and create more income and tax revenue than owners who use them to pump up VAT accounts or to hide profits.  The other side says: do not do anything, because if you do, you will disturb the investment climate and scare away investors from Ukraine.  This is a pragmatic point of view: forget about what happened in the past and make sure everything is clean in the future.  It is hard to determine where to fall on this spectrum.  This issue is often painted in very clear colors, but it is pretty complicated.  Even if the government undertakes a lot of re-privatization.  It will not stop the flow of investment; it will change the kind of investment that comes in.  On the other hand, if the government gives up on re-privatization, and kills the negative buzz around Ukraine, it will probably see a lot more of a certain type of investment, but not into those industries that were badly privatized.  This might be a problem in the long run.

Tomas Fiala:  At the beginning of last year I said: it would be fair to re-privatize certain companies that were sold to insiders under corrupt circumstances over the previous year and a half, but that the list should be announced by the end of March and should be limited to 30 companies, and the re-privatization should be completes by June at the latest.  Otherwise, the process would damage not so much the investment environment, but GDP growth.  Unfortunately, the negative scenario came about-the list was never announced and the process has been dragged out.  This is not the only reason GDP growth slowed down, but it is one of the factors.

Alexander Pisaruk:  For those few assets that are being considered for re-privatization, I think the best solution is an amicable settlement with the government.  But even if such a settlement is not attainable, it is crucially important that the process is carried out in an entirely legal way.  This is crucial for maintaining the government's credibility and a positive investment climate.

James Hitch:  I think that "the rule of law" is much more important than re-privatization.  The old government privatized certain properties, and the new government does not have the right to undo them.  Now that the new government has missed the window of opportunity to re-privatize assets, it is up to the courts.  It is up to private individuals to bring legal suits against bad privatizations, not to the government.  It no longer has that authority.  Most of the beneficiaries of bad privatization are selling off those privatized assets now.  They cannot complete.  And Western investors are picking up these assets.  They will come in and pay the market value for these assts.  I do not think the threat of thousands of re-privatizations is what Ukraine needs.

Boris Krasnyansky:  I think there must not be any more re-privatizations.  Either there are no re-privatizations, or you open the door to hundreds of re-privatizations.  It is an either-or situation.  If you re-privatize one asset, you show no respect for private property, and after that, where do you stop?  If short-term investors see any sort of instability or threat, they will strip their assets and take their money out of the country.

John Richardson:  This government is struggling to implement its agenda, and I question whether it has the political capital to carry through with re-privatization.  We now have a market economy in Ukraine; hence the government has a great opportunity to receive significant value from its assets, and needs to set out a clear agenda for privatization.

Jorge Zukovski:  So what does the government of Ukraine need to do improve the privatization process?

Tomas Fiala: It is fair to judge the government for the last year.  They have done some things wrong, and have succeeded in other things.  Overall, the new government has been very positive for positive for business.  We and our clients are very happy with what has happened in Ukraine over the last twelve months, both politically and economically.  There has been basically no privatization over the last year except for Kryvorizhstal.  What we would like to see in 2006 is more privatization in a variety of sectors.  In terms of the method of privatization, the precedent set by the Kryvorizhstal privatization is very positive and hopefully will be followed in the future.

Boris Krasnyansky:  There is no rush to privatize now, as three was in the early 1990s.  The government should prepare well before they privatize Ukrtelecom or any other large company.  And if it takes years to prepare, it is still more beneficial for the country to do it professionally, as any private owner would do, in order to maximize the benefits for the entire economy. 

George Logush:  Ukraine has the potential to grow very rapidly and have a very dynamic market.  The more investors come in, the more privatizations are done, and the quicker Ukraine will fulfill that potential.  The business community should emphasize this at all times.

John Richardson:  In other markets, governments have set up professional privatization agencies and laid out clearly how that agency will operate and how privatization will progress-a system that has worked well.

Alexander Pisaruk:  Kryvorizhstal is a successful example of how privatization can be property done in Ukraine.  Public auctions probably bring the highest revenue to the government, and should be the main method of privatization in the near future.  But the government may need to consider the sale of minority stakes on the domestic market to domestic investors.  This would bring more liquidity to the equity market and build up the domestic investor base.  A combination of public tenders and the sale of some minority stakes is probably the best way to go forward.

James Hitch:  The process is just as important as the product.  There will not be privatizations that people are proud of without a clear, fair, transparent process.  We can not have a game in which players do not know the rules.

Jorge Zukoski:  Gentlemen, thank you for sharing your insights on privatization in Ukraine.  The Chamber continues to advocate for the development of a clear and transparent privatization plan that allows both domestic and foreign investors to complete on a level playing field.  From what I heard during this Round Table everyone seems to agree.

January-February, 2006

Commerce

Page 22-26