Since the Soviet era a stereotype has prevailed in society, that what is the states means it is nobody’s. The absence of a physical owner produced the corresponding attitude: if I steal, the state will not grow poor. Ukraine is experiencing the effects of such an attitude to this very day. This is most evident with respect to state enterprises.
Numerous studies that cover different countries, not only post-Soviet ones, confirm that the state is an ineffective owner. The World Bank’s research “Bureaucrats in Business: The Economics and State Administration Policy” has brought closure to this issue. Therefore, it has become clear that the problem of state-owned property is not a peculiarity of Ukraine. When it comes to enterprise development and investment, there are solutions based on intuition, and they are always risky. All current decisions regarding enterprise management and its development – not to mention innovations where it is impossible to foresee anything at all – are too risky. It is hard to substantiate certain business movements and give them a clear explanation since it is impossible to prescribe how to take a decision. Therefore, if the decision is taken by bureaucrats who are not responsible for the consequences with their own property, in most cases it is not successful, or it is not made at all since bureaucrats are people who avoid risk. With rare exceptions, this is the reason for the decline of state-owned enterprises, and it works all over the world, regardless of the “quality” of the state.
So far, people in Ukraine consider state-owned enterprises as nobody’s but on the other hand – as public, “the people’s”, and accordingly, they begrudge them being sold off cheaply. This attitude is crucial for understanding what people think about the privatization and management of state-owned enterprises. Both the first and second statements are true, as this property is “nobody’s” and “public”, but these are different aspects of property rights. Ownership rights have at least four aspects: legal possession, when the person is the owner, and the documents certify it; the disposition right; the right of operational management; the right to receive property income. In the case of state-owned enterprises, there are two problems: de jure, they belong to the state, and de facto, to those who control it. The people of Ukraine have no ownership rights to state-owned enterprises and possess these enterprises only to the extent that they control their own state.
In its turn, the state has title rights, but, in fact, it does not manage the property. At least until 2014, there was a massive practice when there were “supervisors at all state-owned enterprises”, “directors” or representatives of clan groups who received these companies to pump out funds. In fact, the right to manage and, accordingly, the right to receive income has been usurped until now and remains to be usurped by such groups. Thus, people do not own these enterprises, not only because they cannot control the state, but also because the state does not control these enterprises either. This situation existed even during Soviet times: the population did not control the Soviet state, and the state did not control the so-called “red” directors. Accordingly, during the privatization of the 1990s, people did not lose anything, since they did not have anything.
Such management conditions are favorable for soaring corruption, the scope of which has only recently been measured in statistics. According to the National Anti-Corruption Bureau of Ukraine, in 35 state-owned enterprises, of which 15 are among the top 100 state-owned companies by size of assets (according to the Ministry of Economic Development and Trade), the losses alone from corruption offenses exceed UAH 20 billion. The most corrupted are companies in the fuel and energy complex, agro-industrial complex, mining and metals sector, chemical industry and transport industry. Among the most resonant investigations, it is worth mentioning cases involving the following companies: Ukrgazvydobuvannya, Zaporizhiaoblenergo, the State Food and Grain Corporation, Odessa Port Plant, and others. Existing schemes of corruption and the withdrawal of funds from state enterprises are not too intricate: selling products or providing services at low prices; carrying out deliberately unprofitable operations; providing prepayment for goods and services, following which the contractor disappears or becomes bankrupt; the purchase of goods and services at inflated prices; reduced Bank deposit rates, etc.
At the same time, the state, in relation to loss-making assets, followed the philosophy of “a bag without a handle”: it is hard to carry, but impossible to throw it away. There was not enough political will, understanding of the problem, or skilled personnel to carry out radical reforms. State property and financial flows of state-owned enterprises became another “honeypot” for sticky fingered dealers and officials.
It should be noted that the total cost of keeping strategic state-owned companies afloat until recently was enormous. NJSC Naftogaz received the biggest amount of subsidies from the state, which in 2014 amounted to UAH 110 billion. However, with the beginning of reform of the monopolist its financial situation began to improve, the NJSC ceased to be a “yoke” for the state. In 2015, the deficit of the state-owned enterprise was reduced to 0.9% of GDP from 5.6% in 2014. According to the results of 2015, NJSC incurred a net loss of UAH 25.1 billion (in 2014 this figure amounted to UAH 90 billion) and earned an operating profit of UAH 4.5 billion for the first time in six years. While in 2016, Naftogaz earned a net profit of UAH 26.5 billion for the first time in the last five years. However, the improvement in Naftogaz’s performance was mainly because the company was obliged to supply gas to the population (and not only to the population) at bargain prices. Since this situation was improved, it is natural that Naftogaz began to earn profits.
If we talk about the largest state assets, then the total losses of the top 100 largest enterprises in 2015 decreased to UAH 42.6 billion from UAH 119 billion in the previous year. Already in the first half of 2016, this group of state companies showed a profit of UAH 31.6 billion. In addition to the chemical industry, all sectors have shown positive dynamics of net income. Following the results of 2016, it is expected to receive UAH 20-23 billion worth of profit. This indicator was based on the NJSC’s indicators (due to price rises for energy products and tariffs for the appropriate services).
The general inefficiency of the functioning of state enterprises requires radical changes. The first step is privatization. However, the privatization policy in Ukraine over the past three years can be considered a failure. For the third consecutive year, plans to earn UAH 17 billion from the privatization of state property (the funds will go to the state budget) have been postponed for the subsequent year. The nominal reason is non-compliance with the privatization revenue plan. Thus, privatization revenues received by the state budget in 2015-2016 amounted to UAH 151.5 million (3 times less than in 2014) and UAH 188.9 million (+ 25% by 2015), respectively. The actual reason is the disruption of privatization tenders and their delay. The privatization of Odessa Port Plant and other large energy facilities was postponed until 2017. The privatization of Oblenergo (regional power suppliers) in 2016 (Kharkivoblenergo, Zaporizhyaoblenergo, “Mykolayivoblenergo”, Khmelnytskoblenergo, Ternopiloblenergo and Centrenergo) failed to take place due to recommendations by advisers to sell these companies only after the adoption of new laws in the field of electrical energy industry (adopted in April 2017).
A reminder that privatization by 2005 (the Rubicon was the sale of Kryvorizhstal for USD 5 billion) was carried out under non-transparent rules, the applicants for one or another asset were already fixed, the competitions were fictitious, with the participation of affiliated members who gave the appearance of competition. All of this influenced the value of state assets, which was not a market value.
Privatization helped to form oligarchic groups; however, they already owned substantial assets at that time.Another way is to eliminate the state enterprise. In Ukraine, there are about 3,500 state enterprises, and only about 1,800 of them actually function. This figure does not include the separate assets of different state-owned companies but includes enterprises located in the ATO zone and Crimea. About 1,300 companies are in the process of elimination or on the verge of bankruptcy. At the same time, the Ministry of Economic Development and Trade had no data about more than 300 state-owned companies. Now, within IMF requirements, the Government is preparing for large-scale privatization or liquidation of unprofitable and formally existing state companies. However, enterprises of the military-industrial complex will not be enlisted in this process.
One more way is the corporatization of state-owned companies, which can be considered as preparation for the privatization of state enterprises. In 2015, the Ministry of Economic Development planned to corporatize all state-owned enterprises from the top 100, later the mandatory corporatization of all public enterprises, except for Government facilities was mentioned in the coalition agreement. However, there is a list of state-owned objects that are not subject to privatization, but they could be corporatized, that is, there is a modification of the form of management of state-owned companies. In the draft bill On the list of state property facilities that are not subject to privatization, approved by the Government in April 2016, out of 705 state-owned facilities, 394 are subject to corporatization, that is, to the creation of a new transparent and publicly accountable management structure. In November of last year, the Cabinet of Ministers passed a package of decisions regulating the procedure for the corporatization of state-owned companies. It includes the appointment of independent supervisory boards, the procedure for the competitive selection of heads of state companies, improvements to the management structure, etc. Corporatization will affect the 46 largest state enterprises.
In addition, there is an option with a concession, in which the Ministry of Economic Development considers 362 companies, including the two biggest airports in the country – Boryspil and Lviv, and possibly Ukravtodor too.
The current situation
The reform was launched in May 2015 after the Cabinet approved the Strategy for Efficiency Improvement of the Business Entities of the Public Sector of the Economy. The main provisions of the approved strategy are as follows:
• To increase the level of transparency in the activities of business entities (disclosure of information, financial audit by independent auditors);
• To step up budgetary supervision;
• To segregate the functions of the Cabinet of Ministries and the ministries as a management entity of state property facilities and the regulator;
• To improve corporate governance by business entities;
• To align the interests of executive staff and owners of business entities;
• To introduce supervisory boards and independent directors;
• To arrange detailed restructuring plans for business entities that are subject to the highest fiscal risks.
Significant impetus to the process of reforming the management of state-owned companies was provided by the so-called law on corporate governance adopted in June 2016, which contained the following innovations:
• It could create supervisory boards in unitary state companies and objects of communal ownership prior to corporatization;
• The institution of independent directors was established, making up the majority of members of supervisory boards of all state companies;
• The requirement for a mandatory independent financial audit of state companies was introduced, and more demanding standards of information disclosure about state companies and their management were established.
Under the memorandum with the IMF, by the end of June 2017, independent supervisory boards should be appointed at the 15 largest Ukrainian state enterprises. According to estimates made by the Ministry of Economic Development, by the end of 2016, new supervisory boards with mostly independent members were required at 41 state companies (where the size of assets exceeds UAH 2 billion, and revenue exceeds UAH 1.5 billion). At the same time, the agency reported on the completion of the necessary regulatory framework. On the other hand, in April 2017, the Cabinet abolished the ratification of supervisory boards of state companies, including with the Ministry of Finance and the Ministry of Economic Development. That is, state enterprises received more powers.
Other important changes include the introduction of a transparent process for the appointment of state-owned enterprise executives through competitive selection with the involvement of independent experts and the establishment of a market level of compensation. The current remuneration system and financial incentives do not correspond to the level of responsibility assumed by the top managers of state companies. Changes have already begun in at least some state-owned companies (Naftogaz, Ukrposhta, etc.).
In 2016, Ukraine improved the conditions for privatization so as to attract more buyers, including foreign investors. Now the sale of 5-10% of shares on the stock exchange before an auction is not mandatory. In addition, there are plans to sell unprofitable and small state-owned assets through the ProZorro system, but it has not yet come to “big” privatization, and if it will, it would be considered a great victory. Unfortunately, that is not the case for now.
It should be noted that, according to the recommendations of the Organization for Economic Cooperation and Development, the concept of the National Holding Company was developed to differentiate the functions of forming and implementing state policy with the management function of state-owned objects, that is, for transferring responsibilities from ministries and departments.
The processes of reforming the management of state property provide that facilities that are part of critical infrastructure will remain in state ownership, including natural monopolies in the railway and energy sectors, defense and national security sector, and strategically important enterprises.
By reducing the number of state-owned objects and increasing the operating efficiency of the remaining ones, the state will be able not to scatter existing investment resources, but to focus them exclusively on strategic projects of state and regional importance, which, due to low investment attractiveness, will not be appealing to private companies.
Now the Government is forced to privatize in very unfavorable conditions: low assets value, low level of trust on the part of potential investors, push back from those Government departments who do not want to part with their assets, etc. To remove part of these obstacles, the Cabinet simplified the procedure for transferring property to the State Property Fund of Ukraine (SPFU) in January 2017: from now on, the absence of some individual documents cannot be a reason to suspend privatization.However, despite a slight increase in macroeconomic indicators, there is no reason to expect a significant improvement in the investment climate. The obligation to conduct privatization is “here and now”, so the Cabinet must demonstrate political will, maximum openness, and transparency to increase the level of trust to investors.
The current situation in this area is characterized by the fact that the IMF considers privatization as one of the three key reforms that should be implemented urgently. For its part, the Government recognizes delays in the reform of public property management and privatization, and the need to accelerate this process.
To provide legislative support to the process of reforming the management of state property and privatization, many normative documents have already been adopted. In addition to that mentioned above, it is worth noting the Resolution of the Cabinet of Ministers On Certain Aspects of the Audit of Business Entities of the Public Sector of the Economy; on conducting a competitive selection of the heads of business entities of the economy’s state sector; bills on amendments to the laws On Privatization of State Property, On the List of state property objects that are not subject to privatization; a resolution on the protection of investors’ rights, etc. At the same time, it is also necessary to adopt a new law on the state privatization program and create a regulatory framework for the implementation of corporate governance of state enterprises.In addition, the State Property Fund of Ukraine has, with the help of international experts, already developed a new privatization law, which, if approved, will contribute to improving the mechanism for determining the initial price of state property and proceed to the market pricing of state-owned assets. Large privatization facilities will be sold with the involvement of an investment advisor. The advisor will study the demand for the facility and suggest the starting price to the State Property Fund of Ukraine. The winner of the bidding process will be determined in a two-stage auction.
A change in people’s attitude is necessary for conducting a successful and transparent privatization of a state enterprise. The current situation is convenient for politicians whose corrupt interests are combined with political ones. Privatization is not a popular reform; therefore, its implementation means a reduction in public support and the votes of voters. It is about choosing between a populism that is nice to hear and a reality that is sometimes difficult to accept.
International Monetary Fund. At present, the primary factor in the reform of state property management and privatization is Ukraine’s commitment to the IMF to receive another loan tranche from the fund. At this stage, the IMF’s pressure on the Government is the most effective driving force for privatization. The memorandum of March 2, 2017, states the following:
1. Supervision of fiscal risks of state-owned enterprises.
The financial risk management unit, whose task is to monitor and analyze fiscal risks within the Ministry of Finance will be strengthened. It is planned that a comprehensive report on the fiscal risks of the state-owned enterprises’ sector will be included in the documentation on the 2018 State Budget.
2. Governance and reform of state-owned enterprises.
• Governance. After the adoption of the law on corporate governance of state-owned enterprises, the Cabinet of Ministers will adopt decisions regulating the creation of supervisory boards. By the end of June 2017, the appointment of independent supervisory boards in the 15 largest state companies and writing of audit reports will be completed. Also, the options will be explored for the creation of a single national holding company, whose task will be to manage strategic commercial state enterprises.
• Classification of all state enterprises. Public enterprises without a clear national strategic interest will be privatized or liquidated. By the end of August 2017, the Cabinet of Ministers will approve the classification data and transfer state enterprises to the State Property Fund of Ukraine (SPFU).
3. Liquidation of state enterprises.
Based on the results of the classification, it is planned to centralize the liquidation of non-operating state companies under the direction of the SPFU. A draft bill is currently being prepared, which will allow the SPFU to simplify the liquidation procedure of state companies with zero assets or whose assets are less than their liabilities. In addition, analysis of the Law On Bankruptcy regarding state enterprises will be carried out, and the necessary changes will be introduced (approval of the bill by the Verkhovna Rada is planned by the end of June 2017).
• Improving the legislative framework. The Verkhovna Rada will approve amendments to the Law On Privatization so as to improve transparency and further optimize the process of privatization of medium-sized enterprises by the end of August 2017.
• Broadening the range of enterprises subject to privatization. Based on classification and approval of legislation on the reduction of the list of companies banned from privatization (expected by the end of June 2017), a schedule for the transfer of additional state companies to the SPFU will be developed.
• Acceleration of privatization of small public companies and small-scale assets (real estate, equipment). There are plans to hold sales via electronic auctions through the ProZorro.Sales system. It is expected that the first auctions will be carried out by the end of June 2017.
• Privatization of large state enterprises. The key task is the privatization of Odessa Port Plant (whose sales competition fell apart twice in 2016). For this purpose, the necessary measures on settlement of balance deficiencies were taken to attract international investors (the completion of privatization is scheduled for the first half of 2017).
In addition, the privatization of many state enterprises will be initiated by the end of September 2017: Centrenergo, Turboatom, whose shares have already been transferred to the SPFU, and regional energy distribution companies, Oblenergo, whose shares will be transferred to the SPFU. To conduct the privatization of Ukrspyrt SE, it is necessary to approve amendments to legislation so that the competitive sale can be completed by the end of September 2017.
Independent experts from various organizations closely monitor the implementation of the reform of the administration of state property and privatization, among which the following can be noted:
Center for Social and Economic Research CASE-Ukraine – case-ukraine.com.ua
Center for Economic Strategy – ces.org.ua
Independent analytical platform VoxUkraine – voxukraine.org
Non-profit organization EasyBusiness – easybusiness.in.ua
Center of Reform Support – csr.kiev.ua
Institute for Economic Research and Policy Consulting – ier.com.ua
The problem with privatization of state-owned enterprises
From the political and economic point of view: the politics are driven by the interests of those who control the financial flows of enterprises. There is also an appropriate term – “privatization of financial flows”. This is a very profitable business, and the one who is “sitting” on these flows has great interest in the enterprise not being privatized in any way whatsoever. On the other hand, there are the interests of the state to get money and plug the hole in the State Budget. In addition, there are the interests of the future buyer – who pays the market price for the company and receives marketing profit on invested capital. However, for him, this business is much less profitable than for those who have not invested anything. Accordingly, the privatization of state-owned enterprises takes place in two ways: non-transparent, as it was during the presidency of Leonid Kuchma when the right people received assets for a trifling sum; or when the state is strong enough to put the public interest above the personal interests of the “directors”. In Ukraine, such a fair privatization happened once, in the case of Kryvorizhstal.
January 2015 – The Strategy for Sustainable Development Ukraine-2020 was adopted.
May 2015 – The Strategy for improving the efficiency of business entities of the state sector of the economy was approved.
June 2015 – The Supervisory Board for the reform of state-owned enterprises was created.
June 2016 – The Verkhovna Rada approved the Law On Amending Certain Legislative Acts of Ukraine on the Management of State-Owned Objects (On Corporate Governance).
March 2017 – A memorandum was signed with the IMF, in which one of the obligations undertaken by Ukraine is the reform of state property management and the privatization process.
April 2017 – The Government approved the Medium-term Plan of Priority Actions for the Government until 2020.