June 1, 2016
Ukraine Needs to Stop Dragging its Feet on Privatization
By Aivaras Abromavičius
Ukraine has 3,350 state-owned enterprises, of which only 1,824 are in operation. Many of these state firms are holdovers from the Soviet economy, which was managed by the state and highly inefficient. In 2014, the top one hundred state-owned firms posted $4.6 billion in losses. But 2015 was different: losses dropped from approximately $5.5 billion in 2014 to a preliminary estimate of approximately $750 million in 2015 for two reasons: Naftogaz dramatically improved its financial position and there was an increase in transparency and openness as part of efforts to reform state-owned enterprises.
Despite herculean efforts to reform state firms since the Euromaidan, privatization has stalled. Only 117 minor objects were sold in 2015 and privatization proceeds totaled a miniscule $6 million in contrast to the almost $800 million the government had expected. Not a single large state firm was privatized in 2015 or 2016. There are four reasons why privatization failed during this period:
- The legislative framework is inadequate to ensure a transparent, fair, and competitive privatization process. It took sixteen attempts to approve legislation in the Rada, Ukraine’s parliament, and that was only the first reading. When the government crisis erupted in early 2016 and the poor track record at state enterprises received additional publicity, MPs quickly approved the legislation in the second reading. Hence, one of the main obstacles to real reform, the so-called 5/10 percent rule, was removed. The old rule allowed oligarchs to buy small minority stakes and then influence or block the sale of the remaining part of the company. Additionally, parliament must clean up an old list of companies that aren’t subject to privatization, which will require an additional vote in parliament that may turn out to be rather challenging.
- Large state firms were unprepared for privatization as there was no vendor due diligence or international audit. Even among the largest 150 state firms, only nineteen have undergone an international audit in line with the newly approved criteria.
- The State Property Fund had no financial resources to hire advisers. Any large-scale financial transaction has advisers on both sides of the table, for the buyers and the sellers. Brand name advisers normally guarantee the transparency of the process and help maximize the value for the seller.
- A lack of qualified staff at the State Property Fund. A new team has been in place for a year, but there have been few signs of a major restructuring at that organization. It’s a Soviet-style organization that is involved in too many functions with over 2,000 employees.
Privatization is always controversial. The principles of transparency, professionalism, and simplicity must be observed. In my view, one of the largest problems in Ukraine over the past few years has not been numerous bad decisions but rather that important decision have not been made at all. Endless discussion between various stakeholders often lead nowhere. That is why simplicity, clarity, and transparency are paramount.
When I was Minister of Economy and Trade, we suggested splitting the country’s state-owned enterprises into three groups. That would have meant sizeable companies with high potential to attract foreign investors (twenty-two companies), sizeable companies with low potential to attract foreign interest (137 companies), and the rest (more than 1,000 companies, basically objects of mass privatization). The sale of companies from the first group should involve hiring leading international banks as advisers, while it would be enough to hire local advisers for the second group. A simplified procedure without advisers through a transparent online auction system (already created by the State Property Fund) should be applied to the third group, which would represent an opportunity for Ukraine’s small and medium sized businesses to participate in the mass privatization of smaller state firms.
What are the next steps to kick-start privatization?
- Now that the 5/10 percent rule has been removed, the Rada needs to adopt certain initiatives to prevent asset drain in advance of mass privatization (golden parachutes, unfavorable long-term supply contracts, unexpected increase in debt obligations) as soon as possible.
- The Rada should review and reduce the list of enterprises banned for privatization. The list currently contains nearly 1,500 companies.
- The government should extend the list of companies to be privatized beyond the current 450 (mainly small) by a government decree.
- The Rada should increase the capacity of the State Property Fund with professional people, including foreign advisers, or even better, entrust the privatization process to a new institution with very limited but professional staff.
Sadly, there has been not enough political will to move ahead with privatization. To resolve this deadlock, the International Monetary Fund needs to keep privatization as a key condition. As is normally the case in Ukraine, the best things happen with a bit of pressure from the outside.
Aivaras Abromavičius was Ukraine's Minister of Economy and Trade from December 2014 to April 2016. He tweets at @aivaras_aivaras.