AR 106, EC/EW (98) 7, Original: English, SUB-COMMITTEE ON EAST-WEST ECONOMIC
CO-OPERATION AND CONVERGENCE
PRIVATISATION IN HUNGARY POLAND AND THE CZECH REPUBLIC
DRAFT REPORT, MR. KEES ZIJLSTRA (NETHERLANDS), RAPPORTEUR*
International Secretariat 9 April 1998
* Until this document has been approved by the Economic Committee it represents only the views of the Rapporteur. Annex i
TABLE OF CONTENTS
Page
I. INTRODUCTION ................................................................................................................. 1
II. METHODS ........................................................................................................................... 2
III. HUNGARY ......................................................................................................................... 5
IV. POLAND............................................................................................................................. 8
V. CZECH REPUBLIC............................................................................................................ 12
VI. COMPARATIVE POINTS................................................................................................ 17
VII. CONCLUSION ............................................................................................................... 18
APPENDIX: Changes in the Hungarian Czech and Polish stock indexes 21
NOTES AND REFERENCES 22
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I. INTRODUCTION
1. It would be mistaken to understand privatisation in Eastern Europe as reflecting a purely technical economic agenda. Among the general aims of privatisation are: achieving greater economic efficiency at the micro and macro levels social justice improving state finances and creating a broad basis for the support of market reforms. But behind these goals there are undoubtedly a slew of private interests at work.
2. While one oft-proclaimed goal of privatisation is to reduce the state's administrative burden paving the way for privatisation requires expert state supervision which can be in short supply in transition countries. Effective privatisation thus presupposes the positive presence of the state-something which can sometimes be neglected when societies enthusiastically embrace alaissez-faire economic strategy after years of central planning.
3. Privatisation in Central Europe is considered integral to the very creation of market economies and democracy. There the task of selling off the state's business patrimony has unfolded in the context of profound political social and economic transformation. The British government only privatised 5% of commercial assets over a ten-year period whereas Central European governments have privatised over 50% of business activity over a half decade.
Western and Eastern privatisation experiences have thus differed both quantitatively and qualitatively.
4. The first challenge in comparing the privatisation experience of Hungary Poland and the Czech Republic is to define the term. This is not as easy as it might seem for privatisation can broadly imply the degree to which economic activity is controlled by private operators or more narrowly describe only the process by which the state off-loads publicly-owned companies to the market (“privatisation from above”). The first definition would measure the extent to which new private “start-up” companies have emerged as well as the presence of foreign-owned firms in the domestic economy once a market liberalisation regime is in place. The second definition refers only to the methods newly democratised and capitalist oriented states employ to sell their “inherited” commercial patrimony.
5. Privatisation should be understood in a broader context. A successful sell-off of state-owned firms - one which involves the transfer of most publicly owned companies to private hands the failure of those companies which are beyond redemption and a fire sale of their marketable assets and finally the restructuring of firms with the potential to succeed in a competitive environment - both shape and are shaped by the prevailing macro-economic legal and political climate.
6. On the one hand the extent to which the state has off-loaded state-owned firms and as far as these firms have either restructured or been allowed to suffer the consequences - the process Schumpeter called “creative destruction” - unambiguously shapes the general macro-economic climate in which new entrepreneurs must operate. Often a transition society is better off abandoning loss-making investments than trying to resuscitate enterprises which for various reasons are simply unworkable.
7. On the other hand the sale of state-owned companies is virtually meaningless if a stable macro-economic order is not in place and if the local market lacks a transparent legal and administrative structure rendering the rules of the game both clear and fair. Success thus hinges not only on the state’s effectiveness in selling national industries to private operators but also its capacity to reduce inflation eliminate administered pricing restrain public spending enforce market rules and construct an efficient tax structure. High inflation for example fosters a very uncertain environment for investment just as an overly tight monetary policy can weaken firms by curtailing demand.
8. The broader definition of privatisation must also incorporate the state’s capacity to foster a favourable financial structure capable of generating capital resources needed both to underwrite the purchase of huge stocks of state-owned assets and to restructure these long-neglected assets. This requires either the deepening of capital markets or policies which somehow compensate for the dearth of locally available capital. The voucher system of privatisation is the most commonly used of these innovative devises but it alone cannot create capital out of nothing. By engaging a mass of capital-less investors many of whom lack a basic understanding of the market it can also lead to problems of corporate governance. Well-structured internationally oriented equities markets provide a more reliable vehicle for corporate financing. Properly administered equities markets help ensure corporate transparency while imposing performance standards upon management. Openness to international capital can also help generate demand for state-owned assets.
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II. METHODS
9. The need to shed extensive state assets rapidly and in an orderly fashion has compelled officials to employ numerous privatisation methods. The most visible form of these entails the direct sale of huge state-owned firms which were the very embodiment of the Communist economic model. But the transfer of small and medium firms shops and farms is also critical to the privatisation process as is the restitution of property or its equivalent to former owners. Restitution in some form is essential to establishing a strong foundation for future property rights. Yet it is nearly impossible to restore all existing property rights as they existed in the pre-Communist era.
10. There are several primary routes to privatisation:
(i) self-transformation of a firm by eliminating bureaucratic interference and ending the centralised allocation of production inputs. In this case the state merely establishes guidelines and final approval for the firm to privatise itself;
(ii) “small privatisation" through the sale or leasing of small state assets such as shops and restaurants;
(iii) privatisation of small- and medium-sized firms employing 100-500 workers either through employee or management buy-outs or by closing down these firms and auctioning off their assets;
(iv) “classical privatisation” by which the state auctions assets to the highest bidder;
(v) “mass privatisation" by which shares and share options or vouchers are distributed widelyt hroughout society at no or very low cost ostensibly ensuring a broad dispersal of ownership in order to grant a large portion of the public a direct stake in the privatisation process but oftentimes resulting in the concentration of ownership in the hands of speculative investment funds;
(vi) "covert privatisation" or the hidden transfer of assets though distorted pricing arrangements for example by secretly selling firm assets to private operators oftentimes at very low prices - this has clearly occurred in Russia;
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(vii) “organic" or “growth privatisation” which simply permits the state sector to shrink “naturally” while the private sector expands.
11. The three states under discussion employed many of these techniques at various times or applied some of these techniques to certain sectors and other techniques to other sectors. Careful scrutiny of privatisation in each of our three countries reveals important differences in method and results.
12. General patterns are nevertheless discernible. Small shops were normally sold through auction in the three countries and this proved to be one of the more successful elements of privatisation. Auction sales however become more rare the larger the firm due to capital shortages and insufficient demand for loss-making enterprises. The state generally first transforms large firms into joint stock companies. The state a ministry or a holding company will then nominally “own” shares in the new joint stock company. This grants the “owner” certain powers of control ultimately making it possible to transfer part or all of the assets to private market operators. This transfer constitutes formal privatisation. Yet the process is repeatedly slowed by deliberations over which social and economic groups will have access to shares the method for establishing the sale price and problems on the demand side. Often the most prized assets are sold off earlier while the state clings to crises-ridden “dinosaurs” in the hope that restructuring will render these firms more valuable in the eyes of potential purchasers. Obviously preserving jobs is a motivating factor for democratically elected governments as overly high unemployment can politically set back the entire marketisation process.
13. Transition governments must all ensure that the private and state sectors can compete on an equal footing. This generally requires a dramatic reduction in subsidies to the industries remaining instate hands.
14. When shares in a state-owned firm are made available on the market who actually is invited to participate in their purchase can be of decisive long-term importance. Potential shareholders include the general public investment funds employees and management and selected “strategic investors” who often represent foreign firms or financial institutions. The degree of ownership concentration is also very important. Diffuse or “mass” ownership structures most evident in the Czech Republic but also found in Poland hypothetically lend themselves to a kind of popular capitalism compensate for capital shortages and improve the potential for portfolio diversification. Yet no real new capital is generated this way and having so many "owners" can contribute to passive management oversight which can then bog down restructuring. Whether this occurs partly depends on the role played by financial intermediaries like investment funds that should act as a bridge between voucher holders and the firms but which can also play a purely speculative role. These funds are most likely to exercise discipline over privatised firms when they share a financial interest in these firms becoming profitable and competitive. Finally mass privatisation is expensive and difficult to administer.
15. Mass ownership schemes are not the only structure posing problems for corporate governance If a firm’s workers own a large share in the enterprise as was the case in Poland's Gdansk shipyards shedding labour which may be crucial to the firm's ultimate survival could prove exceedingly difficult. On the other hand labour’s role as a shareholder can help impart a broader "capital holder's" perspective on the labour force and potentially make it more willing to make certain concessions designed to improve long-term competitiveness. One can also equally argue that if high-ranking managers from the old nomenklatura gain control over ownership shares their primary instincts could well be to shield the firm from rather than prepare it for the global economy. There is also the risk that the public could associate the market system with that nomenklatura something which threatens to de-legitimise the market at the outset. On the other hand if management has adjusted quickly to
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new conditions allowing it a stake in share ownership could prove a powerful mechanism for improving efficiency.
16. A third set of issues involves the pace of privatisation. Here there is still a great debate regarding whether it is best to off-load state assets quickly and let the private sector oversee the process of restructuring or alternatively to undertake privatisation slowly allowing the state or hired “proxies” initially to assume restructuring responsibilities. Those who support the fast approach argue that it renders privatisation irreversible denies bureaucrats an opportunity to influence the process and grants capital markets and consumers the final say in determining a firm's viability. That of course presupposes that banks are allocating scarce capital on a purely profit-seeking basis and are not themselves owners of the assets in question.
17. On the other hand by moving slowly the state can perhaps ensure that there is sufficient capital available to purchase assets at prices reflecting underlying value while giving the companies a fighting chance to prepare themselves for the rigors of competition. In other words by delaying privatisation firms can begin the process of restructuring somewhat insulated from the harsh winds of global competition. This helps managers accommodate themselves to the radically altered conditions in which they must now operate. Upper management thereby is granted sufficient time to hire new personnel with the experience to operate in these new conditions and insofar as is possible to invest in new plant and machinery while shedding excess capacity and functionally unemployed workers still on the payroll. If this process is carried out well when the firm is finally fully privatised it will both attract a higher price than it would have had it been privatised immediately - something whichobviously brings much needed resources into state coffers - and is likely to have a better chance of surviving in an international economy.
18. Privatisation invariably takes time; suddenly flooding the market with a vast array of assets will naturally greatly depress their collective value. Thus the state must monitor market conditions before tendering offers. Moreover by selectively withholding assets from the market inevitable job losses and output changes can be staggered over time effectively spreading out these shocks and giving the public and the market time to adjust to the coming changes. With few exceptions the inauguration of economic transition introduced radical falls in GDP but these falls might well have been even greater had Central and East European states sought to privatise all state-owned enterprises in one fell swoop.
19. It should also be mentioned that if rapid privatisation is the overriding goal of national leadership it is more than likely that some form of voucher privatisation will be the chosen method. There are several reasons for this. First in the initial years of the transition acute shortage of investment capital are probable and if there are restrictions on foreign investment foreign investors cannot compensate. Therefore demand for shares in firms sold through the auction process will be reduced simply because there is little capital available to finance share purchases.
20. Ultimately officials must make difficult judgements about which firms can survive marketexposure quickly which ones need time and resources to prepare themselves and most difficult of all which firms are simply beyond redemption and should be allowed to fail in order to free up resources for those firms with a fighting chance of survival. Finally one should distinguish between questions involving the pace of privatisation with very important issues surrounding the rate of macro-economic adjustment. Poland for example was very quick to introduce draconian macro-economic policies designed to ring out inflation and budget deficits quickly but was far slower in getting privatisation of large industry underway. Czech leaders proved far more anxious to privatise as quickly as possible
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and the Hungarians after several years of delay only sped up the process dramatically in 1995 in conjunction with the introduction of a tough austerity policy.
21. Financing privatisation and restructuring are also critical and obviously shape long-term prospects for firms. The dilemmas are manifold. How do societies which for years failed to accumulate adequate reserves of capital needed for investment suddenly come up with the resources to purchase shares in privatising companies? It is precisely in the financial field where governments entrepreneurs bankers and the general public have had to think creatively.
22. Foreign investors are often the only economic actors with sufficient access to capital to bid on large state-owned firms and they may possess the knowledge resource technology and commercial networks to transform loss makers into profitable operations. Foreign investors can fill the gap in know-how while linking the newly privatised firms directly to the global economy. On the down side this can mean that valuable assets slip from national to foreign control and even the appearance of waning "economic sovereignty" can cause significant political problems.
23. Finally privatisation cannot succeed without an adequate legal and institutional structure in place general social accommodation to the altered parameters of economic life and a reasonable degree of macro-economic stability. The whole idea of risk for example was virtually unheard of in the old Communist system. Yet it is central to capitalism and society must somehow accept its place in economic life. The institutional framework established by the state becomes a central vehicle for reconciling the general public to such unfamiliar norms. Perhaps the state's most important function is to lay out rules of the game. Laws governing share trading for example must be transparent and enforced. Pervasive abuse and corruption in share trading feed public fears and cynicism and can de-legitimise the market. Hyperinflation has similar effects. By necessity privatisation takes place at the same time that governments are overseeing a radical overhaul both in the institutions of the state and in regulations governing economic life and given the enormity of the task it is not surprising that it is in this area where governments have made mistakes.
III. HUNGARY
24. Hungary’s privatisation experience can most succinctly be characterised by its gradualism a willingness to experiment with various methods and openness to international capital. This is not surprising given that Hungary began the reform process well before 1989 and early on enjoyed close links with world financial and commercial markets. Small privately owned businesses were operating throughout the 1980s and large enterprises were active on world markets. After the collapse of the old system the government initially promised mass voucher privatisation but then abandoned the idea before it got underway. It is instructive that the first large-scale privatisation in Hungary in 1989 was the sale of Tungsram Light to the American multinational GE. Although the privatisation of numerous other large firms was subsequently delayed when companies have gone on the market foreign capital has generally participated as an equal - a major reason why so much investment has poured into this small economy. More than half of the state’s receipts from privatisation come from foreign sources.
25. Originally Hungary pursued a policy of decentralised privatisation which allowed managers a large influence over the process of incorporation. This led to accusations that the government was creating a nomenklatura dominated market which rewarded managers from the old system simply because they were in the position to exercise control over privatisation. In response to this criticism the government in 1990 created the State Property Agency (SPA) to manage assets slated for privatisation. It solicited bids from private management companies to oversee the restructuring of
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numerous state-owned companies prior to privatisation. Restructuring often involved breaking up firms along sectoral or factory lines and endowing each entity with a separate board of directors. By late 1991 most state-owned enterprises had been converted to joint stock companies and were held by the SPA. Ideally the SPA would be more disinterested than for example a ministry which might hold an historically rooted interest in or link a policy objective to the "success" of a particular firm.
26. Many of these firms were not ready for immediate privatisation so in 1992 the government created the State Holding Company to manage “strategic” firms that the state was unlikely to privatise immediately. The SPA transferred to it shares in those "strategic" companies. Critics charged that the new holding company transferred funds derived from profitable concerns to less profitable but politically connected enterprises. Some feared that the new State Holding Company would not act as a demanding shareholder something which many economists argued was an essential prerequisite to effective privatisation. There were also apparent political pressures on the holding company to play a patronage function. All of this complicated and slowed down privatisation.
27. In May 1995 a new privatisation law merged the SPA and the State Holding Company to create APV Rt. or the Hungarian Privatisation and State Holding Company which now has sole responsibility for the management and sale of state assets. The law has rendered the privatisation process more transparent and since then the pace of privatisation in Hungary has picked up.
Although the law gave unions local governments and ministries a say in the process and included employment protection clauses these potential impediments did not significantly slow the pace of privatisation. APV Rt. has generally employed direct sales methods and its revenues have helped lower dramatically Hungary's foreign liabilities. By the end of 1996 nearly 70% of GDP was created in the private sector. A major scandal surrounding the privatisation agency did not slow down the process as many predicted it might. The current Prime Minister Gyula Horn was compelled to move decisively to fire those responsible for paying huge and unwarranted consulting fees and recommitted his government to privatisation.
28. Although the state has used various methods to off-load public companies after 1994 auctions became the most commonly used means to privatise firms. By its very nature the auction system has led to a very concentrated ownership structure in Hungary which in turn has made decisive corporate leadership possible. This phenomenon has inspired some protest but never has this dissent been sufficient to alter fundamentally government policy. Indeed restructuring has gone farther in Hungary than in Poland and the Czech Republic. Most of the Hungarian economy is now genuinely in private hands and more banks operate out of reach of the state than in either the Czech Republic or Poland. Officials expect perhaps optimistically that privatisation will be completed sometime this year.
29. Although Hungary had until recently experienced far lower growth rates than either the Czech Republic or Poland this could well have reflected the capacity of Hungarian and foreign management to implement profound restructuring strategies which initially included sharp falls in employment. Hungary had begun to reform in the 1980s and thus experienced earlier some of the gains from rationalisation. A willingness to allow many failing firms to collapse a process facilitated by a stringent bankruptcy law also accounted for low growth. But prospects for the longer term are brighter because the most painful component of restructuring is now behind Hungary. Costs have been slashed subsidies largely reduced useless companies closed redundant labour and management laid off and new plant and equipment purchased. This process clearly depressed domestic demand but now there are undeniable signs of sustainable supply-side growth. Exports have increased by 13 - 16% per year since 1994 and represent a vital engine of economic growth.
On the macro-economic front Hungary has made impressive strides since 1995 in lowering inflation stabilising the currency and reducing the debt burden all critical to providing a stable economic context to newly privatised firms.
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30. Hungary's economy is expected to strengthen in 1998. Growth in export expansion is not likely to continue. The old rate of 13 - 16% growth is not likely to continue but more modest (but still respectable) growths rates of around 10-12% will be achieved. Investment growth accelerated sharply last year and is forecast to continue growing at about 10% in 1998. 17
The Hungarian economy grew a respectable 4% (estimated) which is particularly impressive give the negative growth rates of the early ‘90s.18
31. Another very important factor in Hungarian privatisation has been the increasingly important role played by the stock market. The government has established very stringent rules for trading and company transparency. Although this initially precluded many firms from issuing stock it has meant that market operators worked in a very secure environment and this has boosted investor confidence in the bourse. Obligatory company disclosures make it possible to judge management decision-making and this too has helped attract waves of foreign capital into the Hungarian market. Not surprisingly in 1996 the Hungarian bourse was the second fastest growing stock market in the world.
32. The list of privatised companies is impressive as is the degree to which many of these firms have been restructured with the help of fresh cash infusions from abroad. The pharmaceutical industry for example has forged an impressive array of international alliances to ensure earnings growth distribution networks and research and development financing. 19
The energy sector is increasingly opening up to foreign capital and is being restructured in a manner to ensure greater competition. Moreover dual pricing and subsidies have been largely eliminated facilitating long-range planning and boosting profits. The government has sold most of the state’s remaining common shares in many important firms including its 25% share of Matav 20 the telecommunications company in which Deutsche Telecom already held a 67% share. Demand for these shares as well as those for the energy company MOL Rt. and the pharmaceutical firm Gedeon had been very high. The state however will retain “golden shares” in many of these firms which could allow politicians a say in strategic decisions such as mergers. This could prove cumbersome.
33. The banking sector began a profound restructuring prior to privatisation a process which included writing off bad debt and laying off managers and personnel in these previously over-staffed institutions. Foreign investors were drawn to these "stripped down" banks and indeed many of Hungary’s larger commercial banks are now foreign-owned. The government plans to sell the state’s remaining common shares in the large OPT Bank although only 50% of company shares can be owned by foreign investors.21
In January 1997 APV Rt. put up for sale a 61% share of Takarek Bank which is an umbrella for 249 co-operative savings banks. 22
Foreign banks are apparently very attracted to its extensive branch network which could prove extremely beneficial as retail banking takes off. But there are strings attached as co-operatives own 33% of these banks and have options to buy as much as 50% of the shares 23 a prospect which could complicate the task of managing operations.
34. Some elements of Hungarian privatisation have created problems. A recent pension reform in Hungary is likely to have several important effects on newly privatised firms and over time could contribute positively to the general macro-economic climate in which they operate. Although newly established private pension funds will be limited to purchasing 10% of securities on any single share issue these funds will nonetheless significantly deepen capital pools in the country. 24
Many of the state’s remaining assets are the least attractive and probably cannot be sold until they have been restructured. Some of these have been liquidated although the pace of liquidation has slowed since 1992.25
Nevertheless the government plans to conclude its sale of properties this year - the state still has stakes in about 370 companies down from around 2 000 in 1989. 26
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35. Some elements of Hungarian privatization have created problems. Compensating local governments for privatised land has posed difficulties as has the requirement that purchasers of companies submit long-range investment plans. Those plans at times have been decisive in determining which firms win bids but this practice can facilitate a decision-making which grants officials overseeing privatisation too much discretion. APV Rt. has also used its power to engage in restructuring to delay inevitable bankruptcy proceedings and has even re-nationalised privatised companies that had been declared bankrupt. In response to this "abuse" Parliament reformed the privatisation law and compelled APV Rt. to accept any reasonable offers even when there is only one bidder and to re-tender unsold companies within 90 days. Tender conditions cannot be changed after the process is underway and written memoranda of all important privatisation decisions must be publicised. 27
This has helped reduce discretionary decision-making.
36. The APV Rt. has also had to pay out substantial compensation to local governments for privatised land and to the two indebted social security funds although this particular obligation was recently reduced. APV Rt. still holds shares in roughly 50% of equity of many firms. The holding company is required by law to hold about one-third of these assets. The goal now is to sell quickly most of its minority shareholdings although this could flood the asset market and spark sale price problems. Moreover many holdings must be further restructured if they are to generate adequate market interest. Two key problems are the role that APV Rt. assumes once its primary privatisation task is completed. The agency will retain management responsibility for those assets still in public hands and it will still hold some minority shares. It could either evolve into an investment fund or become a holding company engaged in the management of its assets. The latter alternative however could tempt political interference.
37. Finally Hungary’s agricultural sector remains uncompetitive and vulnerable. It is a large sector that once exported many products throughout Central and Eastern Europe but it is now poorly structured and in real need of reform. By comparison the Czechs have made more progress in revamping their agricultural sector. A key problem is that Hungarian farmers have been well organised politically and used their political clout to resist reform.
IV. POLAND
38. If the Polish transition began with dramatic macro-economic shock therapy privatisation itself has unfolded slowly. Indeed until very recently privatisation of state assets had been somewhat limited although the general growth of the private sector has been impressive due to virtual explosion of start-up companies and burgeoning foreign investment. 28
39. In its multi-track privatisation law of 1990 the Polish government established several methods for privatisation. Some firms were to be commercialised and sold either to single buyers or put on public offer with the supervision the Ministry of Ownership Transformation. Various ministries or regional governments would oversee privatisation. A year later the government approved the public auction of small and medium enterprises a process which would engage as purchasers not only firm employees but also domestic and foreign investors. In the early years the most common form of privatisation was liquidation with company employees leasing firm assets or purchasing them with the participation of outside investors many of whom were foreign. But most of the firms involved in this process remained small.29
40. Large state-owned companies were initially transformed into wholly state-owned joint stock companies as a first step towards privatisation. But the process often seemed to end there. Many of these firms were slated for mass voucher style privatisation but all manner of delays meant that they
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remained in state hands. Part of the problem had been the stalemate in Polish politics the effort to link privatisation to pension reform - an unwieldy initiative that made it exceedingly difficult to off-load state assets - and the state’s hopes to reorganise and restructure firms before putting them on the market in order to secure adequate prices. Coalitions soon emerged between managers and personnel at the privatising agency SPA making it relatively easy to delay privatisation in order to allow managers vulnerable to job or income loss in the event of privatisation to strengthen their positions within the firms. 30
Some crises-ridden companies were nevertheless liquidated and their assets were sold to the private sector. 31
Many firms remain in state hands are making large losses and direly need restructuring.
41. In 1991 the government also established the National Investment Fund programme (National Investment Funds [NIFs] which was not actually implemented until December 1994. The 15 Polish NIFs are similar to Western mutual funds and have been more insulated from direct political influence than their Czech counterparts. Management groups engaging Polish and international bankers oversee most of these funds and answer directly to the investment fund’s board of directors. 27.4 million Poles obtained shares in the NIFs through vouchers that cost $6.70. Each fund was permitted to choose roughly 35 companies which allowed for a one-third ownership per NIF. Of the remaining stock 27% was distributed between the other 14 NIFs (averaging 2% per company) 15% went to the employees while the state retained a 25% share. Unlike other voucher schemes that had allowed for unregulated bidding processes and permitted some investment funds to hold controlling positions in the companies the Polish model allows strategic investors to exercise influence through the purchase of minority share holdings.
42. As of June 1997 those vouchers could be exchanged for shares in the NIFs which were floated on the bourse. 32
To date only eight out of 26 million vouchers have been converted into shares although the Treasury Ministry has launched an advertising campaign to remind citizens that they must do so by the end of 1998. If the voucher expires it will automatically be converted into shares in each of the 15 funds. 33
Some NIFs have spun off some of their holdings to strategic investors and are becoming more akin to venture capital firms. Others are organising themselves along sectoral lines and pushing hard for firm level restructuring. Stringent stock market reporting requirements and built-in management incentives encourage fund managers to ensure that their holdings are restructured with an eye on share value. The NIF presence on the stock market has markedly increased the Warsaw exchange's capitalisation and attracted international interest.
43. The system has generally protected small investors who buy into diversified investment funds and not into individual companies. As professional investment portfolio experts are in charge of the funds and operate with long-term incentives to render the entire portfolio more profitable mismanagement and abuse is less likely. Although there have been problems associated with the high fees paid to Western investment specialists in Poland the services they render are essential. These fees which remain relatively low in comparison with fees charged in the West might best be seen as a normal transition cost. The Polish government appoints the Boards of Directors in each of the funds. 34
Gridlock has been known to set in when investment fund managers and the Boards of Directors have disagreed over the fate of strategic holdings. But as a general rule fund managers have enjoyed a relatively high degree of autonomy.
44. Although the NIFs are now managing roughly 500 companies nearly 4 000 other firms remain in state hands or roughly 50% of the national economy. 35
Many of these companies are in poor shape and until recently the state had not acted with sufficient alacrity to chart out a privatisation strategy for them. Much of the delay was due to political gridlock and expectations are that newly created private pension funds would eagerly purchase shares in state-owned enterprises. Such expectations were unreasonable particularly given that many of these firms
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would be regarded as risky investments. At any rate one reason why Poland has not matched Hungary in attracting foreign capital is that it has simply been too slow to put state holdings on the auction block.
45. Last year the government spurred by warnings that the still large public sector would inevitably prove a burden to growth began to speed up privatisation which above all had been slowed by political infighting fear of the potential unemployment associated with restructuring and powerfully entrenched interests dedicated to the status quo within state-owned enterprises. The new governing coalition will take this several steps further. Leszek Balcerowicz the Deputy Prime Minister and Finance Minister and the original architect of Polish “shock therapy” has introduced a new plan to privatise 100 of the largest state enterprises worth an estimated $40 billion and at the same time cut regulation in most sectors while strengthening financial regulation. He has also vowed to rid state-owned firms of “political appointees” and claims that all these measure are a fundamental prerequisite for reform of the highly inefficient pension and health care systems. 36
46. The newly-elected government recently announced plans for an additional privatisation scheme known as national enfranchisement fund (NEFs) which will come into effect this summer. This scheme will cost Z60bn and will be larger in scale than the NIFs. The scheme will seek to off-load state assets including the railways mines steel works and power stations. These funds will be regionally or sectorally focused in order to attract investment from pension funds. The major difference between these funds and the NIFs is that shares in the NEFs will not be distributed to the general public. Foreign investors will be able to purchase them only after they are listed on the Warsaw Stock Exchange (WSE). 37
The new government also wants to grant greater autonomy to fund managers. As Mr. Leszek Balcerowicz the Finance Minister told the American Chamber of Commerce in Poland: “We need to accelerate privatisation. We need to make it genuine and change decision-making power from political to non-political bodies.” 38
47. Under the previous government the state has created some sectoral holding companies which many analysts see as too large and unwieldy. For example the oil sector is being consolidated into one company which it is hoped will be sufficiently powerful to withstand intense foreign competition. With a net value of between $20 and $30 billion it is probably too large to attract investor interest. 39
Already 2 800 smaller firms have been turned over to local governments (Voivods).
48. The banking sector poses another set of problems. Until very recently Polish banks were verwhelmingly state-owned and protected from foreign competition - a condition which granted them artificially high profit margins. Although regulations and oversight improved significantly between 1994 and 1995 Polish banking undoubtedly requires further restructuring. Banks for example continue to make two-thirds of their loans to the state sector. 40
The new government appears to be moving in the right direction. Poland will soon open the banking sector to greater international competition which is partly why the government is accelerating the privatisation of the country’s largest bank Polska Kasa Opieki SA. The previous government had planned only to float a 15% minority share of the bank on the Warsaw Stock Exchange. The new government intends to sell a 35% share to a strategic investor. 41
Officials have also encouraged reworked loan terms with troubled corporate borrowers oftentimes through debt for equity swaps and they have told bankers that privatisation can only proceed if their balance sheets are cleaned up. 42
49. In a country where organised labour played such a central role in the political transition it is not surprising that so much emphasis has been laid on giving workers significant managerial control. Many state-owned firms were sold with provisos regarding employment but such requirements often discourage potential investors and can prove unworkable over the long term.
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50. A law on commercialisation passed in 1996 seeks to address some of these problems. While calling for efforts to prepare state-owned enterprises for privatisation it suspended old requirements that enterprise “insiders” approve a particular privatisation strategy. Powerful workers councils with managerial responsibility have been abolished because they had increasingly dedicated their energies to slowing down privatisation. The law thus ostensibly rejected old aspirations for consensus in favour of more rapid privatisation. On the other hand it granted employees a 15% share of company stock free of charge. Moreover 5% of shares in commercialised firms were to be set aside to underwrite social security reform. 43
The law also recognised the possibility of “commercialising” firms without necessarily privatising them and called for new mass voucher issues some of which were to go to pensioners in lieu of indexed pay-outs. The danger is that these shareholders may not provide stable ownership. 44
The new round of privatisation will also grant preferential shares to various categories of workers. 45
Finally wage settlements are still made through tripartite negotiations engaging representatives employers and the state. Some investors fear that this lends itself more to a “stakeholders forum than firms dedicated to “shareholder value”. 46
51. It is important that restitution of property nationalised by the Communist state be settled quickly. Until old claims are settled current ownership status remains uncertain and the legal "limbo" of some property has caused the Supreme Administrative Court to overrule several privatisations. This pattern could discourage potential investors.
52. Decentralisation of direct privatisation is another reform which may prove cumbersome. Local governments may be less willing than central authorities to privatise firms in the knowledge that restructuring and local lay-offs are sure to follow. Another reform of the previous government called for the creation of sectoral funds dealing in shares of heavy industry. Fund certificates would be distributed in regions where firms are located. 47
This too could sharply limit firm autonomy.
53. In 1996 the previous government launched a number of major privatisation projects. The new government now wants to privatise a larger share of heavy industry energy and utility assets but will probably not move too quickly on many of the lowest concerns. Among the firms slated for privatisation are the Pekao SA Banking Group LOT Airlines the telecom operator TPSA and the oil company NAFTA Polska. But calls for further restructuring and the need for a proper utilities' regulatory framework could slow this agenda down. 48
The state has designed streamlined tender procedures to facilitate capital privatisation in the pharmaceutical food and the machine tool sectors. 49
The guidelines for 1997 had already called for public offerings of 120 firms including large banks and telecommunications firms and the direct privatisation of an additional 200-300 firms. The new government will sell many other enterprises directly to strategic investors in telecommunications energy chemicals pharmaceuticals and alcohol. 50
The Prime Minister has announced that privatisation will be completed by the end of his four-year term. 51
54. Some have argued that the list of potential offerings is likely to exceed demand. But there are indications that demand for Polish assets has been pent-up. Complex conditions imposed on investors had also discouraged investors. This too is changing.
55. From the beginning the Poles laid out very strict equity market rules. As in Hungary these were so stringent that at first very few companies could meet the criteria to issue stock. But the Warsaw exchange has grown over time and it is now in a phase of exceedingly rapid expansion. The Warsaw exchange rose by 65% in 1996 while that of the Czech Republic grew by only 17.5%.52
In February of this year it rose by 25%. 53
The daily turnover of the exchange has grown in Poland from $54 million in 1994 to $75 million today. In the Czech Republic by contrast the turnover in 1996 was $38.6 million and today it is $42 million while in Hungary daily turnover in 1994 grew from $1.4 million to $85 million. 54
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The growth of these respective markets is reflected in the graphs in the Appendix. Unlike their Czech counterparts Polish companies are not reluctant to turn to this market to raise needed capital and they are less dependent on state-owned banks for finance as a result.
56. There is nevertheless plenty of room for improving the overall Polish regulatory environment. Many market oversight rules were drafted in the 1950s and are obsolete to say the least. It is still very difficult for foreigners to purchase land and leasing laws are inadequate. 55
Many prices are still controlled administratively and corruption remains a problem. Nor is it clear that giving local governments a greater say in privatising remaining state assets will actually speed up the process. Local officials are potentially even more likely to defend the status quo if privatisation leads to lay-offs particularly when this could strike a serious economic blow to one region. Another potential problem is that newly created sectoral holding companies might obscure cross-subsidisation by which profitable enterprises underwrite loss-makers - a practice which could erode the overall competitiveness of Polish industry. The banking sector remains fragmented despite a government effort to encourage concentration. That effort led to some “unnatural” mergers that have proved difficult to consummate. Such mergers tend to work better when orchestrated by the private sector not by an overreaching state. 56
57. Despite these problems the Polish foray into privatisation has enjoyed important successes. Although the NIFs are only operating in part of the national economy they have offered an innovative solution to privatisation in the absence of deep capital markets. Moreover the incentive system has been structured in such a way that fund managers generally work to improve the productivity and profitability of their holdings. In the Czech Republic where state-owned banks control the funds the incentives for restructuring have been far less apparent.
V. CZECH REPUBLIC
58. Of the three cases under consideration privatisation in the Czech Republic appears to have encountered the most serious problems. Until early last year deficiencies in Czech privatisation strategies evaded scrutiny largely because of the country’s impressive growth the rapid pace of privatisation and startling low unemployment. By the end of 1996 74% of GDP was generated in the private sector. Yet the strategy of "transition without pain" has failed to yield once promised results. Low unemployment for example may have been partly the consequence of a financial system which tended to keep afloat firms clinging to the status quo and did little to encourage restructuring which invariably leads to job loss over the short-term. Only over the past two years have stagnant growth burgeoning debt a Koruna crisis bank failures insufficient industrial restructuring financial scandals party funding scandals possibly linked to the privatisation of Trinec Steelworks indications that the stock market has been insufficiently supervised and ultimately the fall of the Klaus government clarified the depth of Czech economic problems. The Czech trade deficit has plummeted as a resu t of the Koruna depreciation in December which precipitated falling import demand. 57
Growth was only 1.5% in 1997 58 and will be modest this year. Wages although relatively high are static or falling unemployment is rising inflation is now about 10% and government deficits are evident. 59
Ivan Pilip has asked his cabinet to consider issuing bonds to finance hitherto undisclosed public debts amounting to roughly $5 billion. The announcement suggests that fiscal policy has been looser than previously believed and reveals a genuine problem of transparency in government statistics. The shortfall is equal to roughly 6.4% of GDP. This comes as a surprise as official statistics revealed budget surpluses every year between 1993 and 1995 and deficits of less than 1% of GDP in 1996 and 1997. Much of this debt is held by Konsolidacni Banka Ceska Inkasni and Ceska Financi which were all set up to manage poor quality loans and assets. 60
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59. This is not to say that the situation is disastrous; indeed there are many examples of important advances at firms like Skoda and the tool maker ZPS Zlin and Czech democracy itself seems robust and healthy despite the problems. Yet the Czechs have begun to slip behind both the Hungarians and Poles in terms of industrial restructuring and in the confidence of the international business community. This trend if not corrected could bode ill for the country’s long-term economic prospects.
60. Czech governments of the post-Communist era made the speed of privatisation a top priority. Privatisation was seen as a way to educate the public quickly in the moves of the market. Yet little attention was paid to matters related to corporate governance. 61
This proved a fatal mistake. Many smaller firms were privatised in 1990 while large voucher privatisations were undertaken in 1992 and 1994 ostensibly transferring 30% of state holdings into private hands. Millions of Czechs were given an opportunity to purchase vouchers which could then be exchanged for shares in companies and investment funds. These shares were traded on the bourse after 1993. 62
The structure had two important characteristics - widely diffused ownership as a large swathe of Czech society acquired shares in formerly state-owned firms and the increasingly important role played by investment funds which bought up vouchers. An estimated two-thirds of the 6.2 million Czechs who participated in mass privatisation ultimately turned their vouchers over to Investment Funds which acquired ever larger stakes in former state enterprises. 63
61. Czech authorities consciously sought to encourage banks and industry to co-operate closely. But unique problems have burdened the system. First of all because banks controlling many investment funds had not yet been privatised the state essentially reacquired assets it had just off-loaded. According to David Grund of Austria's Creditanstalt “There is only quasi-privatisation here. If the companies privatise through the banks that pump funds into them ultimately the economy is still totally in the hands of the state.” 64
Moreover 18 investment funds ultimately transformed themselves into holding companies which allowed them to evade regulatory supervision. They were thus able to engage in all manner of hostile take-overs of vulnerable firms and asset sell-offs which often generated large profits for management without remunerating investors - a practice which often turned potentially viable firms into hollow shells. 65
Such deal-making often left powerless shareholders holding large losses while top managers earned wind-fall profits and fees oftentimes despite poor fund performance. Investors in the Harvard Investment Fund unwittingly paid out $30 million in management fees and advertising expenses much of which went directly into the pockets of the fund’s top managers. The absence of a clear legal framework governing banking rules and equities markets opened the door to Czech and foreign “con artists” who effectively siphoned capital away from potentially productive uses. The ODS-led government long resisted regulation of this market: a report issued last September catalogued 1 420 cases of illegally "tunnelling out" wealth in 1996. Normally strong protection of minority shareholders could prevent this but their rights have not been adequately safeguarded. 66
62. Because the ownership structure of many firms is so diffuse and given the still important role of the state corporate governance has emerged as a most serious problem. Unlike in Hungary where concentrated ownership structures have encouraged managerial accountability privatised Czech industry is burdened with highly fragmented ownership. Rarely is there a single shareholder or group with the power to make demands upon management a condition which means that management can operate largely in defence of its vested interests and not necessarily those of investors whose capital is at stake. The world economy increasingly compels companies to make "share value" profitability and investment a top priority but the Czechs were very slow to move in this direction. Czech management had tended to be very production-oriented and many top managers lacked marketing and financial skills which are now crucial to survival in the global economy. 67
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63. At the same time state-owned banks are represented on management boards through their investment funds. So too is the National Property Fund giving the state an important if not always apparent role in corporate governance. In concrete terms this has tended to slow restructuring. It has also led to a certain degree of politicisation of capital meaning that investments have not always been made according to strictly economic criteria. Vaclav Junek for example exploited his many contacts in the state to gain large loans to underwrite the expansion of his shaky Chemapol empire. According to some analysts many of those loans may ultimately prove to be unserviceable. 68
64. At times it seems that there has been much more energy and talent expended on corporate raiding and asset stripping than on restructuring Czech industry. Conflict of interest has been a serious problem with investment funds borrowing heavily from their parent banks to build up their portfolios. Commercial banks exercise power both as shareholders and creditors and this has undoubtedly complicated restructuring efforts. Banks have tended to treat their vulnerable industrial holdings with a great deal of indulgence and not applied pressure on management to restructure their enterprises.
65. A serious dearth of stock market regulation and the lack of real supervisory bodies overseeing asset markets and banking have made abuse not only likely but inevitable. The lack of regulation and the insider dealing to which it led also had the effect of discouraging firms from turning to the stock market in order to raise capital. This in turn deprived Czech industry of a vital potential source of investment capital - a critical tool in any restructuring effort. Many business leaders in the Czech Republic are reluctant to turn to the stock market in order to raise capital because they fear that market rules are not sufficiently transparent. Managers have been compelled to turn to banks and bond issues to raise capital. But these sources have not been sufficient to meet Czech industry’s needs. 69
Given the dearth of investment capital or its misallocation many Czech factories are not operating as well as they could if the capital allocation process were more efficient. 70
66. The general public and foreign investors have also turned away from the Czech bourse. An estimated $500 million were pulled out of the Czech stock market in 1996 and the bourse fell by 3.8% in dollar terms at a time when the Polish and Hungarian stock markets were booming. 71
The Czechs have attracted relatively low levels of Foreign Direct Investment (FDI) since the start of market transition. Cumulative FDI since 1989 stands at $7.3 billion compared with $13.5 billion in Poland and $16.2 billion in Hungary. This is partly due to the lack of investor privileges granted to foreign investors and administrative delays which complicate foreign "greenfield" investments as well as domestic investment decision-making. Corruption high tax rates and problems in transport infrastructure have also made investors leery. Finally capital inflows have also slowed because most of the state’s quality assets have been sold.
67. At a recent EBRD conference a number of foreign fund managers publicly complained about the lack of shareholder protection in the Czech Republic. 72
Investors have grown far more way not only due to the perception that the equities market is poorly supervised but also because of the Czech Republic's relatively high wages. The government undoubtedly erred in applying pure laissez-faire principles and failing to recognise the important role a state must play in stock market regulation. The subsequent lack of transparency insider trading and other unscrupulous practices defeated the very purpose of an equities market. Polish and Hungarian authorities by contrast established a very strict set of market controls which initially few companies could meet. But in those countries managers now trust the bourse. Last February the Finance Minister Ivan Pilip presented a very critical report to the government and called for better organised and regulated financial markets which would ensure that managers of investment funds are subjected to stricter regulations. 73
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68. To counter the problem the Czech government recently introduced stricter rules governing investment companies and investment funds and adopted a Securities Commission Act which creates a stronger watchdog agency over equities markets. It has the power to fine companies up to $3 million for not complying with trading rules and can freeze cash or securities accounts to protect shareholders and investors from illegal transactions. 74
This was a good start but the Czech parliament recently introduced amendments that have taken away the Commission’s power to regulate itself. Moreover the Commission was scheduled to be running by 1 January 1998 but this has been put off.
69. The precarious condition of Czech banks is particularly ironic in that the country enjoyed a relatively developed banking sector when the old system collapsed. Czech banks still play a larger role in the economy than their Hungarian and Polish counterparts. The value of Czech bank corporate lending equals 50% of GDP as opposed to 20% in Poland. This could reflect the high development of Czech banking but it could also be a product of its poorly regulated stock market; business leaders have no choice but to appeal to banks for capital. Czech bank lending to business has not been particularly profitable because of the recent poor performance of industry. 75
Provisions for collateralising debt are not well-developed and the court system has made it difficult for creditors to acquire collateral when debt remains unserviced. 76
Many Czech financial institutions may also fail to meet the usual criteria for solvency and their outstanding loans will have to be gradually written off. The government is now encouraging bank managers to sell off non-performing loans and to divide securities holdings into strategic and trading categories in order to strengthen bank portfolios and encourage stable long-term industrial restructuring.
70. In 1996 a banking crisis led to the failure of numerous Czech financial institutions. The crisis compelled the government to reconsider the old policy of loose supervision which granted banks an extraordinary amount of leeway in making often questionable loans to firms in which the banks themselves were important shareholders. Yet the privatisation of the three largest banks remains an unfulfilled promise. 77
71. The resignation of the Klaus government may further delay the privatisation of state shares in the Komercni Banka (49% state owned and partly owned by the Slovak Republic) Ceska Sporitelna (45%) and Ceskoslovenska Obchodny Banka (66%). The Klaus government had announced the impending sale of these assets in November 1997 and many analysts continue to see this divestiture as key to ending the “habit of using state funds to prop up loss-making enterprises with non-performing loans.” 78
It would also open both the banking sector and commercial sectors to more foreign participation. But recent revelations of bad debt particularly at Komercni Bank have slowed the process. One equity analyst reported that the percentage of bad loans in the bank's portfolios is 34% at Komercni 23.3% at Ceska Sporitelna and 16.6% for CSOB. 79
Audits conducted by a potential Japanese purchaser of Investicni a Postovni Banka another important bank on the sale block have come up with a valuation which diverges sharply from Czech state-sponsored audits. 80
72. In March the new government selected advisers to help oversee bank privatisation. After several months of analysis and a search for potential buyers the advisers will in May lay out a timetable for privatisation. Yet it is still unclear when the government will finally sell off its shares in these banks. The Social Democratic Party which is expected to fare well in June elections has announced that it wants to delay privatisation another two years and at least half of the general public agrees.81
Every delay in banking privatisation is proving costly to the economy. Some analysts are convinced that no matter what the Czechs do a critical opportunity has been lost. The banks are in a very weakened state and will bring in significantly less to state coffers than would have been the case had privatisation occurred earlier.
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73. On February 1998 an amendment to the banking law entered into force which could finally help separate the loan operations of banks from their investment activities and role as portfolio managers. he new law forbids a member of a bank's statutory body from serving simultaneously on the board of another legal entity engaged in business activities. With several exceptions it also proscribes banks from controlling any legal entity which is not a bank a financial institution or a banking services provider. Qualified participation by a bank in a non-banking institution must not exceed 15% of the registered capital of the bank and the total amount of all qualified participation in non-banking institutions must not exceed 66% of the registered capital of the bank. It gives banks three years to divest their holdings and in the first year they must decrease by 50% the excess of their share holding in each non-banking institution which is more than the 15% threshold. 82
Some have argued however that the obligations to sell quickly controlling or qualified participations could depress stock prices particularly in light of the low liquidity of Czech capital markets. 83
Despite such qualms this is precisely the kind of reform that is needed and the Czech government should be applauded for recognising the problem and correcting it.
74. As in Poland and in Hungary the Czech state still de facto owns shares through its National Property Fund (NPF). These holdings are of two types: firms that failed to achieve a desired clearing price and so-called strategic holdings which the state has been unwilling to relinquish. Strategic holdings include electrical distribution petrochemical coal mining steel aerospace and pharmaceutical industries. The NPF also holds the state's shares in the banking sector. According to the OECD this has meant the state continues to have interests as a shareholder in industry and banking as a tax collector and a regulator - a set of roles laden with incompatible interests. 84
The Klaus government had announced that all of these industries eventually will be privatised and that the management of state-owned companies would be turned over to various ministries from the National Property Fund. It is not clear however that this will ensure superior oversight. There are also efforts underway to limit institutionalised conflicts of interests improve price transparency on markets restrict bank influence over companies improve information on capital markets and overhaul bankruptcy rules. The board of the Prague Stock Exchange has also de-listed 500 companies and will probably de-list more in order to improve transparency on the exchange.85
75. Until recently the Czech economy had not experienced the degree of bankruptcies that was seen in Hungary. 86
This is probably not due to the inherent competitiveness and productivity of Czech industry. Many economists believe that as in Poland the ”dead wood” has not been sufficiently cleared from the Czech economy. The state for example still owns 67% of the Nova Hut and Vitkovice steel plants and successive governments have seemed disinclined to allow either to fail or downsize despite the Czech’s very apparent over-capacity in the steel sector.
76. Czech politics are now suspended in a kind of limbo until elections in June. The respected former central banker Josef Tovosky now heads a caretaker or technical government but he has no real policy mandate. Klaus’s Civic Democratic Party (ODS) is in disarray and if the left wins the coming elections privatisation is likely to be further delayed. Added to the string of bank failures charges of corruption and insider trading scandals the international business community now expresses deepening concern about the potential of the current caretaker government or its successor to address several key problems. One serious problem is that the previous government’s privatisation policy has failed to trigger much needed restructuring and in the minds of some voters this could de-legitimise entirely the fundamental goals of privatisation. That could represent a genuine set-back to the transition process. Finally although the agricultural sector has many problems the government moved quickly to reduce the level of intervention. The sector is largely in private hands and lower government support has led to significant if painful restructuring.
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VI. COMPARATIVE POINTS
77. In terms of the width of privatisation - that is the share of commercial activity that has been transferred from the state to the private sector - of the three countries Hungary has made the greatest strides the Czech Republic ranks second while Poland where there are still numerous state enterprises is third. A second point of comparison is the depth of privatisation - meaning the degree to which firms are operating autonomously and free of state controls administrated prices subsidies and credit allocation which is not driven by commercial logic. Here again Hungary has made the most progress while Poland and the Czech Republic lag behind. The Polish and Czech authorities often through the banking sector have sometimes insulated firms from market forces. Poland is now moving quickly away from these practices although Czech policy while nominally dedicated to the same end is moving more slowly because of political uncertainty. Finally one should also compare the transparency of the privatisation process. Here Hungary has set a fairly high standard while numerous scandals surrounding Czech privatisation have created serious economic and political problems.
78. Another point of comparison is the degree to which foreign investors are participating in the life of the economy. Here Hungary has unambiguously made the most progress and now hosts a huge share of the region’s foreign investment. Poland has also attracted a great deal of foreign capital although less than Hungary on a per capita basis. The Czech Republic was once seen as a very attractive transition economy and has also managed to attract many important investors. But the opaque nature of economic administration has slowed down the inflow and inspired complaint from the foreign business community.
79. A related category is the degree to which a stable and transparent equities market has emerged and the extent to which has it facilitated privatisation provided newly privatised firms a venue for raising capital and attracted foreign investors. Here again Hungary has made the most impressive strides followed closely by Poland. Both countries made an early effort to set up strict market rules which demanded great transparency on the part of firms seeking to raise capital on the market. The Czechs here have lagged behind. 87
Many firms have opted not to use the Prague Bourse because of insufficient transparency. Czech authorities have finally recognised this deficiency but the uncertain political climate could slow down implementation of needed changes. In broader terms administrative corruption remains a problem in all three countries and this reflects the fact that bureaucratic streamlining is still necessary.
80. All three countries have done remarkably well in stabilising the macro-economic climate which is a critical criteria to ensure a healthy climate for newly privatised firms. The Poles moved very quickly to firm up the Zloty and reduce budget deficits. Last year there were signs of price rises and balance of payments difficulties there but the new government seems dedicated to tackling the problem. The Czechs too had great success in keeping inflation at reasonable rates but they too are now confronting inflationary difficulties as well as slower growth and rising unemployment. Despite the currently uncertain political environment the caretaker Czech government is now redoubling the effort to get this situation under control. The Hungarians on the other hand were slow to enact macro-economic reform and this led to a serious debt problem that bordered on a crisis situation. In 1995 however the government undertook important stabilisation measures resulting in impressive reductions in inflation and public debt. Growth has begun to edge upward and the inflation rate has fallen.
81. Banking privatisation represents another key variable because it can help ensure that capital isallocated in a manner that stresses economic rather than political criteria. Capital will thus flow toward
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the most potentially profitable enterprises not to those that enjoy the most patronage. Here again Hungary appears to have made the most important advances. Most of its banks have been thoroughly restructured and foreign banks have purchased numerous assets. Hungarian bankers however are still reluctant to extend long-term credits particularly to medium-sized enterprises. Polish and Czech banks have lagged behind in terms of the degree of privatisation and their balance sheets reflect many questionable loans. Their privatisation will be more difficult as a result. A process of consolidation has taken place in Polish banking prior to privatisation and the new government now intends to privatise a large share of the sector. The future of Czech banking privatisation hinges on political developments there.
82. Finally the Czechs appear to have made important progress in restructuring their agricultural sector while the Hungarians have lagged behind on this front. The Polish also face a serious challenge not so much in privatisation (many farms were privately held under Communism) but in restructuring this very large and undercapitalised sector.
VII. CONCLUSION
83. Although it is premature to draw final conclusions about privatisation in all three countries certain lessons are beginning to become apparent. These could be of use to officials elsewhere who are leading efforts to move state administered economies toward privately organised markets.
i) For various reasons a transition state might choose not to move too quickly to sell off its industrial patrimony although this should not be an excuse for inaction. There are also reasons why speed can be essential particularly if there are fears that inaction might encourage the old management to strip away assets for their personal gain. Clearly a balance has to be struck and this will ultimately depend on local conditions political realities and whether a proper market and regulatory framework is in place. Certainly when immediate privatisation is not possible the state can at least begin the restructuring process while the firms are still under its wing and it is unwise to sell before market rules are spelled out and the macro-economic stabilisation is well underway. Indeed hasty privatisation means little if there is hyper- inflation or if proper regulatory environment is not put in place. An under-regulated stock market can subject newly privatised firms to pressures that gravely complicate restructuring. Regulated equities markets on the other hand not only funnel capital to potentially viable companies but also act as a kind of gage with which to judge the effectiveness of management.
ii) Foreign investors are a vital source of capital and know-how. Government officials should endeavour to ensure that these important actors are able to operate under transparent conditions and are not subject to discrimination.
iii) Mass voucher privatisation if not properly structured can lead to poor corporate governance and provide the state with a way to maintain control over formally privatised companies. This is particularly true if state-owned banks or even ministries acquire shares in investment funds which aggregate vouchers. Conflicts of interest become apparent when state banks own large shares in the firms to which they are also lending and this invariably distorts the allocation of capital. When this occurs restructuring becomes all the more difficult as political considerations
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will continue to shape management thinking.
iv) Direct sales through transparent and open auctions have the virtue of cutting firms off quickly from state capital and can bring in resources to the state quickly. Moreover auctions help ensure that capital is then more likely to be allocated based on bottom-line economic considerations.
v) Banking privatisation is critical to the introduction of market forces. If the state continues to administer or subsidise banks throughout the privatization process there is a risk of politicising credit allocation which in turn can blunt the drive to restructure bloated and inefficient industries. Banking privatisation should also involve writing-off bad debts so that potential investors can come to a reasonable approximation of a bank’s potential value.
vi) Officials in transition states must recognise that bankruptcy plays a vital role in capitalism and should be considered part of the privatisation process. In brutal terms enterprise failure clears away non-viable enterprise and ultimately helps firms with more potential to survive by freeing up highly scarce capital. Of course this is easier said than done and no politician would want to make this the central plank in his or her re-election campaign. Nevertheless the bankruptcy in today’s headline can over the medium term facilitate more sustainable job creation. This appears to have been recognised in Hungary while the Czechs maintained their much heralded low unemployment levels by keeping many inadequate and irredeemable firms afloat. They are the worse off for having done so.
vii) Newly privatised industries are better off in the long run if they are able to operate in an environment in which prices are not regulated. Regulated prices blunt the signals firms need to restructure properly and make it possible to postpone painful decisions which are better made early in an investment cycle.
viii) Labour issues are clearly another critical element of privatisation which requires at the very least the tacit consent of the work force if it is to succeed economically and politically. But this is not easy particularly as selling state-owned companies virtually by definition strips away decades of cherished job security. On the other hand it can be potentially rewarding to that workforce if the company succeeds. Appropriate incentives must be put in place to encourage workers and their unions to embrace this new logic. This is never easy and may require years of patient negotiation. One strategy is to encourage an enterprise’s work force to acquire minority shares in newly privatised firms. Finally the state should offer assistance to those that do lose their work and re-training is one very fruitful way to prepare them for the economy. Retraining and tax credits designed to bring unemployed back to the work force can help ensure that the transition process brings long-run benefits to a broader range of society by ensuring that human capital is not squandered in the process. Such policies can bring important social as well as economic benefits not only to transition societies but to Western ones as well.
ix) Management too must also accommodate itself to the new modalities of the market. This is not as easy as it would seem particularly as competition can put pressure on top managers to cut back layers of professional staff accumulated over years of centralised state economic management. At the same time infusions of fresh blood and retraining can be critical to revitalising this important component of the workforce. Here too the presence of foreign investors can be of particular benefit.
x) Finally the overall privatisation strategy should not neglect agricultural privatisation and reform.
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A backward agricultural sector can burden the entire economy by commanding large infusions of state spending. Although there is a general tendency in many developed and developing countries to exclude agriculture from the rules of the market many market rules are perfectly applicable to the farming sector. Along these lines foreign capital should not be excluded from the privatization and restructuring process as its presence can prove a genuine impetus to modernisation.
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APPENDIX
CHANGES IN THE HUNGARIAN CZECH AND POLISH STOCK INDEXES
Source: Renee Postma "Central Europa vangt klap Azië-crisis soepel op" NRC Handelsblad 2 April 1998.
NOTES AND REFERENCES
1 Eva Ehrlich "Private Sector and Privatisation in Some Central and East European Countries: Peculiarities in Hungary" Privatisation in NACC Countries: Defence Industry Experiences and Policies and Related Experiences in Other Fields NATO Colloquium 1994 pp. 41-52 p.33 Anony.
2 Vic Duke and Keith Grime "Privatisation in East-Central Europe: Similarities and contrasts in its application" pp. 144-168 The New Great Transformation? Change and Continuity in East Central Europe Eds. Christopher G.A. Bryant and Edmund Mokrzycki London and New York Routledge (1994).
3 Wlodzimierz Brus "General Problems of privatisation in the process of Transformation of the Post Communist Economies" Privatisation in the Transition Process: Recent Experiences in Eastern Europe: United Nations Conference on Trade and Development.
4 Op. cit. Note 2.
5 See NAA Sub-Committee Moscow trip report 1997
6 Stanislaw Gomulka "Poland a glass half full" p. 200; and Ehrlich op. cit. Note 1.
7 Op. cit. Note 1 pp. 41-52 p 26.
8 Op. cit. Note 2.
9 Ibid.
10 Op. cit. Note 3.
11 "Progress in Market Oriented Reform" Transition Report Update April 1997 European Bank for Reconstruction and Development p. 29.
12 Marvin Jackson “Critical Issues in Privatisation: The Central and Eastern European Experience -Privatisation in NACC Countries” Defence Industry Experiences and Policies and Related Experiences in Other Fields NATO Colloquium 1994 pp. 25-39.
13 Jeff Freeman "Hungarian Utility Privatisation Moves Forward" Transition Vol. 2 No. 9 3 May 1996.
14 OECD Report Economic Survey: Hungary 1997 p. 56.
15 The Economist 19 July 1997 p. 100.
16 Hungary’s debt: Payback Time Business Central Europe December/January 1997.
17 EIU Country Report The Economist Intelligence Unit Limited 1st quarter 1998
18 Brian A. Brown "Hungary’s Unlikely Liberal"- The Wall Street Journal Europe January 20 1998.
19 "Hungarian Pharmaceuticals: Home Cured" Business Central Europe December 1996/ January 1997.
20 "Hungary’s Economic Plans seen intact through 1998" The Wall Street Journal 11 June 1997.
21 Ibid.
22 Recent Economic Developments in Hungary National Bank of Hungary July 1997. 23 Sheryl Lee “Hungary’s Takarek Bank : Selling Cinderella” Business Central Europe March 1997.
24 “Cabinet finalises broad reform plan that would boost role of private funds” BNA’s Eastern Europe Reporter 19 May 1997.
25 Op. cit. Note 14 p. 58.
26 Op. cit. Note 18.
27 Op. cit. Note 14 p. 59.
28 Op. cit. Note 11 p. 20.
29 Op. cit. Note 7.
30 Ibid.
31 OECD Report Economic Survey: Poland 1996/1997.
32 Trading places: cautious Poles teach laissez- faire Czechs how to build a bourse” The Wall
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Street Journal 3 March 1997. 33 Oonagh Leighton "Growing pains" Central European December 1997- January 1998.
34 Christopher Bobinski "Poles leaping toward privatisation" Financial Times 13 May 1997. 35 Michael Kapoor "Slow Death" Business Central Europe April 1997.
36 David Woodruff and Peggy Simpson “Get ready for another shock” Business Week
2 March 1998.
37 Op.cit. Note 33.
38 Daniel Michaels "After delay Poland readies Privatisation" Journal Europe 14 January 1998.
39 Daniel Michaels "Lode of Trouble" The Wall Street Journal 27-28 June 1997.
40 Op.cit. Note 11.
41 Op.cit. Note 38.
42 Daniel Michaels "Tough Lessons: East Europe’s banks show how success hinges on reform" a The Wall Street Journal 11-12 April 1997.
43 OECD Report Economic Survey: Poland 1996/1997.
44 Op.cit. Note 39.
45 "There is less and less resistance to privatisation" Business Week 2 March 1998.
46 Op.cit. Note 39.
47 Op.cit. Note 43.
48 EIU Poland 1st quarter 1998 p.21
49 Op.cit. Note 43.
50 Op.cit. Note 38.
51 Christopher Bobinski "Polish PM in promise over sell-offs" Financial Times 11 November 1997.
52 "An awesome future" The Economist 31 May 1997.
53 Op.cit. Note 36.
54 Renee Postma "Central Europa vangt klap Azië-crisis soepel op" NRC Handelsblad 2 April 1998.
55 "In Hype and Halos: A Survey of Poland ” Business Central Europe February 1997.
56 Michael Kapoor "Recipe for Fudge" Business Central Europe March 1997.
57 EIU Country Report The Czech Republic 1st quarter 1998.
58 The Economist 6 December 1997.
59 Vincent Bland "Czechs take a knife to budget spending" Financial Times 4 April 1997.
60 Joe Cook "Prague seeks cash after debt shock" Financial Times 2 April 1998.
61 OECD Report Czech Republic 1995/1996.
62 “Trading places: Cautious Poles teach laissez-faire Czechs how to build a bourse” The Wall Street Journal 3 March 1997.
63 "Bohemia’s fading rhapsody" The Economist 31 May 1997.
64 Anna Willard "Making the break" Central Europe December 1997 - January 1998.
65 “Czech Investment Funds: Worrying Trend" The Economist 29 March 1997.
66 Op.cit. Note 57 p.18
67 "Past Glory Shaky Future: Czech Republic Survey" Business Central Europe July/August 1996.
68 "A Man for all Seasons" The Economist 24 January 1998.
69 Op.cit. Note 62.
70 Ibid.
71 Op.cit. Note 65.
72 Vincent Boland and Kevin Done “Economic Reforms still to be completed" Financial Times 14 May 1997.
73 Op.cit. Note 57 p.17
74 Anna Willard “Better Late than never?” Central European December 1997 - January 1998.
75 Op.cit. Note 42.
76 Michael Kapoor “Czech Bank Wobbles” Business Central Europe April 1997.
77 Joe Cook “Slow Fix” Business Central Europe February 1997.
78 Op.cit. Note 64.
79 "Klaus's resignation casts doubt on timing of further sell-offs" BNA’s Eastern Europe Reporter 15 December 1997
80 “Provisional Problem ” The Economist 12 January 1998.
81 Ibid.
82 “Privatisation Advisers chosen for Nation’s three largest banks” BNA’s Eastern Europe Reporter 9 March 1998.
83 Tomas Skoumal "New Amendment to the Czech Banking Act ” BNA’s Eastern Europe Reporter 9 March 1998 pp. 176-177.
84 Op. cit. Note 11 p. 29.
85 “Czech Reform Package calls for import deposit security agency" BNA Eastern European Reporter 21 April 1997.
86 Op.cit. Note 63.
87 "Klaus’s Proud Legacy” The Wall Street Journal 12 January1998.