Business Magazine

Privatization in Ukraine: Not So Fast

Posted on the 30 June 2016 by Center For International Private Enterprise @CIPEglobal


In Ukraine, thousands of companies are still owned and operated by the government — a legacy of Soviet central planning that bleeds money from the already strained state budget. With the country in economic crisis, there have been renewed calls for Ukraine to speed up its privatization process and sell these firms to private owners who can restructure them and run them more efficiently.

Ukraine’s former Minister of Economic Development and Trade, Aivara Abromavicius, recently made a well-reasoned argument for faster privatization on the Atlantic Council’s blog. Similarly, the IMF has also urged Ukraine to speed up the pace of privatization.

However, focusing on the pace rather than the quality of privatization will likely result in a botched privatization process — which will undermine the little bit of faith Ukrainians have left in the free market and state institutions, potentially leading to the growth of populist movements and destabilizing the current government.

Ukrainian state-owned enterprises (SOEs) remain a drag on the national budget. They serve as incubators for corruption and gray market deals and in some cases serve as piggy banks for Ukrainian politicians. While I agree with Abromavicius that “simplicity, clarity, and transparency,” must be maintained in order to successfully privatize Ukrainian state owned enterprises, his concept of creating a simplified privatization procedure (without advisers) through an online auction of over 1,000 smaller SOEs will likely lead to public anger over a process that would surely enrich insiders.

Without independent advisors overseeing the due diligence process and hiring independent auditors, bidders will not have transparent access to information about the companies listed. This would, in effect, be like buying from an unrated seller on eBay with only a vague description of what is for sale – something that would not inspire confidence in potential buyers.

A lack of independent advisors–and the transparency and investor assurances they would bring to an auction—can lead to lower realized prices for the Ukrainian government, attracting only those bidders with inside knowledge of the true status of the enterprises for sale.

Furthermore, Ukrainian small-and-medium-sized enterprises (SMEs) consistently note that a lack of access to affordable long-term credit is a pressing issue. In order to successfully purchase these SOEs through an online platform, one can assume a credit facility will need to be in place, or else the buyer will need to have enough cash on hand for the full purchase price. Should an SME be fortunate enough to secure long(er) term financing, the bank will likely underwrite the to-be acquired business due to a lack of independent advisors within the selling process. It is unlikely that a bank would make a loan based on limited, and potentially biased, information.

This lack of access to finance can be remedied through cooperation with an international financial institution specializing in offering financing to SMEs. However, this cannot be done without efforts to provide access to affordable long-term credit to average SMEs that are otherwise prevented from participating the bidding process (leading to a prevalence of wealthy and/or connected insiders dominating the auction).

Marketplaces can only thrive when there is transparency and abundant independent information for purchasers to make decisions. Without independent advisors, sale prices will drop, potentially curtailing the number of bidders due to the perceived increase in risk. An auction with a particularly small number of bidders could lead those with inside knowledge to put in better bids, lowering potential revenue to the government in the sale. The bidder with insider knowledge would essentially be receiving a state subsidy in the sale.

Lastly, the online bid system itself can—and most likely will—be rigged by those in the Ukrainian State Property Fund. Ukrainians view the State Property Fund as the entity that generated the oligarchy in Ukraine and believe it is one of the most corrupt institutions in the country. The public may be justified in its skepticism thanks to a stream of stories of corrupt dealings by State Property Fund officials Ivano-Frankivsk and Kherson. Though reforms to the State Property Fund may have indeed made it less corrupt, the negative public perception continues and any online auction brokered by the State Property Fund would be viewed with skepticism and suspicion.

I am not suggesting that former Minister Abromavicius’ idea is unworkable. I believe that an online auction has potential to help the state offload a large number of SOEs in a relatively quick and transparent manner. However, this can only be successful if appropriate controls are in place.

The process of privatization of SOEs could occur at a reasonable pace over the next three to five years. The auction process should incorporate a team of international advisors to provide independent verification of the assets and liabilities of the SOEs, along with appropriate supervision and verification of independent audits. The issue of lack of access to long-term affordable credit also needs to be addressed if Ukrainian SMEs are the intended purchasers of the SOEs.

And lastly, the Ukrainian State Property Fund should not take the lead on the auction. While the State Property Fund can play an important role, many in Ukraine still question its trustworthiness. In order to have a successful and transparent online auction, outside parties should participate in the auction process to provide purchasers with needed faith in the integrity of the process.

Eric Hontz is a Program Officer for Eurasia at CIPE.

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