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Maksym Nefyodov: Most SOEs to be put up for sale are anything but a "gold mine". They are in a difficult condition

21:13, 18 October 2017
12 min. 638 Interview

Deputy Minister of Economic Development and Trade of Ukraine Maksym Nefyodov sat down with UNIAN to explain when exactly Ukraine should expect the arrival of big investors. He also elaborated on the new privatization legislation and the way the economy ministry is fighting fraud in public procurement.

Ukraine owns some 3,500 state-owned enterprises (SOEs), most of which date back to the Soviet times. The annual maintenance of all SOEs is a rather costly endeavor and, accordingly, taxpayers pay several billion a year from their pockets. Most of SOEs are unprofitable, with their assets being outdated and feasibility of their continued operations questionable. Clear and fair privatization can bring foreign investors into Ukraine and spur economic growth. However, the government's moves in this direction see fierce resistance on part of the system, which has transformed privatization in Ukraine into a sluggish and seemingly endless process.

Deputy Minister of Economic Development and Trade Maksym Nefyodov has told UNIAN, how to get out of the stalemate, what assets should better remain in state ownership and why.

Maksym, our first question is why this large-scale privatization so important for Ukraine and what should be the share of the state sector in the country’s economy once the privatization is completed?

Privatization is important for a number of reasons. First, there is an abnormally large number of SOEs in Ukraine. Central government authorities alone control almost 3,500 of them. These SOEs are washing away taxpayers' money and hinder the development of healthy competition. Such inefficient use of resources leads to corruption. A vicious cycle is created, which, if not broken, it will continue to suck money from the state budget and discourage investment.

Second, privatization is a huge investment opportunity. This is a much more clear strategy than starting to do something from scratch. There are state assets that require proper management and modernization, so you only need to reform them and invest funds - and it will all start working productively. Therefore, privatization is one of the most favorable areas for attracting investment.

The share of the public sector in Ukraine’s economy over the six months of this year has slightly decreased from 16.5% to 15.8%. Nevertheless, its share is abnormally large, if compared with any other country, except China. Japan is another special case, taking into account cross-ownership, when the state owns businesses, while businesses own the state. Our task is to reduce the share of the public sector to 6% by 2020. Perhaps it is ambitious enough, but it’s realistic if we work on it.

Did the share of the public sector in the first half of the year decrease due to the sale of certain assets?

It is declining, rather, evolutionarily. Businesses are growing and developing much better than the public sector. Although, it was only last year when they first became profitable in the entire history of the country's independence. But we calculate correctly all the concealed subsidies and other government assistance, the increases in the authorized capital, and preferential tariffs, I get an impression that the public sector has never been profitable since early 1990s.

In the history of Ukraine, not a single big SOE has been sold, except for Kryvorizhstal. According to various estimates, over the 26 years of independence, only 3% of SOEs have been privatized. What hindered and keeps hampering privatization?

I don’t believe that only 3% of SOEs were sold. After all, the vast majority of private businesses somehow evolved from state ownership. Mass privatization actually took place in the 1990's, it’s just that it wasn’t completed, so a significant number of assets remained in the hands of the state. We may criticize the privatization of the 1990s as it was actually, both from a technical and ethical point of view, conducted in a way far from perfect. We may claim that this was a predatory accumulation of capital. Only the strongest and most cunning ones gained something, while those were unaware of the value of privatization certificates just sold them for a bottle of horilka. Still, privatization took place.

There have been no significant successes ever since. The state sells small objects, while Kryvorizhstal remains the most famous of the big ones.

Why has it been going so slow? There are several explanations. First, there is a reason of a philosophical nature. In general, the Ukrainian society is paternalistic, which is even evidenced in Facebook discussions. All the time someone new comes to power and claims: "It's you who ran the country badly!" That’s if someday some worthy people will be at the helm. Honest, motivated people will come, who don’t need big salaries, especially since big salaries didn’t prove to be effective. But the realities are different. For 26 years, the state could not do anything with its assets, which only keep sucking taxpayers’ money. Besides, these SOEs are slowly dying out - every year about a hundred of them cease their operations. People pay out of their own pocket for the luxury of discussing the current situation on Facebook. This year the public sector was profitable thanks to TOP-5 enterprises boasting a total profit which topped that of the rest of the public sector. It would be weird to go on paying for this worthless feast.

The second reason is legislation. It dates back to the tumultuous 1990s and fails to meet the needs of today. If we want to sell (besides, we don’t sell companies like Apple, Google or Tesla – basically, we sell unprofitable post-Soviet enterprises with poor quality management), we need to try to succeed, instead of creating obstacles for investors.

And the third thing is the viability of the State Property Fund as the body responsible for privatization. A certain conflict of interests has been laid into it: on the one hand, it manages assets, while on the other hand, it must sell them. It is clear that those who manage are not really in favor of selling. Besides, these people never conducted mass privatization in their lives. They never sold 500 enterprises per year, while we need to sell more than that, that is, two enterprises per working day. See, all processes and all people involved are set for selling an SOE per month, but even that we fail to achieve.

All three problems must be solved.

And how do you solve them?

To combat populism, we must actively engage in propaganda and also explain our efforts to the public. For example, we regularly issue a TOP-100 analytical report to show the real state of affairs. We’ve developed and submitted to the Verkhovna Rada a draft law on privatization, designed to modernize legislation in the area. It has already passed the profile committee, and I hope that it will be adopted before year-end. And there’s a third thing. I don’t want to comment on what's happening in the State Property Fund (SPF) as it would be unethical. But I know that they are trying to modernize. I understand that it is as difficult for them as for any state body.

Nefyodov: We rely heavily on complaints on ProZorro system. Their share grows but it is still very small / Photo from UNIAN

Do you see any progress in the SPF's work?

There is definitely some progress. But, I repeat, it is very difficult to reform any state body. The SPF is moving in this direction: an overview of all assets being put up for privatization has been completed, and they also cooperate with us in preparing a pilot project on small-scale privatization. Besides, they learned how to work with foreign advisers, in particular, on preparations for the sale of Centrenergo. Is that enough? Definitely not, the work needs to be done faster.

In the summer, the economy ministry promulgated the list of SOEs subject to privatization. Is this a final list?

We carried out a "triage" - we formed a list of all SOEs under the management of central authorities. Before that moment, the state was unaware of how much assets it actually owned. But we do not rule out that we have missed outa couple of companies, and they just dream that everyone forget about them. This is a complicated story… Our SOEs are not the same as they are in the West.

These assets date back to the Soviet times. In many cases, it’s not about whether the state needs them, it’s about whether anyone needs them at all. Besides, any bureaucrat wants assets to grow as it gives them more authority. Meanwhile, for corrupt officials, it means more opportunities to steal. The "triage" was a very painful process because every state agency claimed that the listed enterprises should remain in state ownership. But ask any of them, and they will say they support privatization. Everybody says that we need to sell SOEs because we can’t go on living this way, so you go start with this other guy. And you tell them that they have an entire enterprise dealing with janitor work in the ministry. Can’t you just hire janitors or order a cleaning service? And they say that I don’t’ understand some things, like that is some kind of a facility where security clearance is required, besides they are good cleaners, and there is always a possibility to bargain with them...

We have this wonderful SOE run by the Ministry of Youth and Sports, called Ballet on Ice Ensemble. Do you know what it actually is? There is a building, which has not been commissioned, near the Gulliver shopping mall [in central Kyiv], so this is it. Can it be privatized? They say it can’t.

Also, there are other painful issues, the solution thereof sometimes requires restructuring of entire industries. There is a market where the share of the state is 10%, and there, of course, we can sell anything. But what should we do with segments where the state share accounts for 90%? At some of these enterprises, their real estate costs much more than the businesses. We need an action plan to get out of this situation.

Will all declared SOEs be put up for sale?

Some 900 enterprises were included in the privatization list. It’s those that we believe should be sold immediately. Approximately 1,255 enterprises no longer function, but they still have assets, for example, those in the ATO zone or Crimea. There are strategic enterprises that, in the near future, will not be sold.

This is not only about the security of the state, but also about the fact that it would not be realistic to privatize such an object - this requires creating an entire infrastructure. For example, take railways. Of course, they can be privately owned as in the U.S. But to achieve this, we need an independent regulator that will determine tariffs, rates, and we need to pass a tonne of new legislation to make everything work, draw up a liberalization plan, and move in line with it. We need to physically change the infrastructure because it is not focused on competition, it has bottlenecks.

There are still SOEs that cannot be sold but can be transferred to a concession, such as ports and airport terminals.

There are a number of assets dating back to the Soviet times, where the situation is way too complex. As a rule, such companies are not owned by the state in other countries. For example, take the National Opera. We cannot sell it as it looks insane from a cultural perspective. At the same time, there is no precedent across the world for such companies to be self-sustaining. It is believed though that with the circuses the situation can be different...

Tell us, what changes will the adoption of the privatization law bring?

Instead of seven privatization laws, we will have one. Besides, we will still have a separate law that regulates the privatization of state-owned banks. To replace the many groups to which state enterprises were divided, only two are created – big and small assets. Small ones will be privatized via e-auctions and offered for sale without special preparation, to be sold on the principle of selling the assets of the Individual Deposits Guarantee Fund. Big enterprises (there are 50-60 of them), if we lack internal resources, should be sold through outsourcing, with the involvement of investment advisers. Another innovation is that you will be able to use English law for contracts so that the investor feels more secure.

What has been implemented from what had been planned for this year?

In 2017, it was planned to attract about UAH 17 billion of privatization proceeds, while as of today, the SPF raised about UAH 3.2 billion, of which the greater part is for the sale of minority packages of regional power companies [so-called “oblenergos”]. On the one hand, there is significant growth compared to last year, while on the other we’re still far from the target of UAH 17 billion. Big SOEs, which are always referred to when we talk about privatization, were not put up for sale. There are still hopes for Centrenergo, where the process is ongoing. The sale of the Odesa Portside Chemical Plant [OPP] is definitely being postponed to the next year. That is, in terms of implementation of the plan, the situation doesn’t look nice. We are working on eliminating bottlenecks in the legislation, and I hope that the SPF is engaged in increasing its own capacity to actively sell SOEs.

EBRD Managing Director for Eastern Europe and the Caucasus Francis Malige branded privatization in Ukraine one of the biggest failures, while the sale of “oblenergos”, he said, was conducted not in line with international standards and not in the interests of the state. Do you agree?

By and large, the root of the privatization history mentioned goes back to the distant past. This is an example of how wrong legislation does not allow the state to maximize the price of assets. It makes no sense to sell 75+1 percent of the asset, leaving 20% or 25% for the government. Who would pay loads of money for a package of shares in an unprofitable enterprise, where your partner will be a big oligarch who, at the same time, manages a vertically integrated business and hypothetically has the opportunity to shift the profit center at his own will? Should they hope that he will pay dividends? And what if he won’t? Creating a healthy competition in these conditions is an unrealistic task. Maybe it would if these companies became public and their shares were quoted on stock exchange. But this is not the case.

Was it possible to sell them significantly better? Honestly, as a former investment banker, I doubt it. Our task now is not to repeat what happened.

After the legislation on privatization is adopted, will foreign investors come to our country? Are you seeing interest on their part?

Of course, there is interest. In any case, selling any asset is a matter of price and marketing. Most SOEs that will be put up for sale are anything but a "gold mine," they are in a difficult condition. Of course, we have assets such as Turboatom, a profitable, well-growing enterprise which will remain an interesting asset for strategic investors. But there are very few such SOEs. The main task of privatization is not to get the maximum value, but to find a strategic investor who will develop the business, create jobs, pay taxes, increase exports, and so on.

As a former investment banker, I can say that there is no guaranteed way to sell the enterprise. It should be a quality sale, the company should be effectively advertised, and the terms of sale – changed if the sale does not work out.

How will you deal with the artificial overstatement of price of the assets being sold?

It’s exactly to this end that we want privatization of smaller SOEs to start with a book value. If the auction fails, then we go on the principle of the Dutch auctions where the price goes down until the company is bought. At the same time, it’s the investment banks which should deal with managing the privatization of big SOEs. They will receive their bonuses only in case of a successful sale, so they will have no motivation to overstate the price.

Nefyodov: For 26 years, the state could not do anything with its assets, which only suck money from taxpayers; besides they are slowly dying off / Photo from UNIAN

Will you attract Ukrainian investment banks? If we talk about smaller companies, then yes, this will be Ukrainian banks. If we talk about big assets, first of all, we look forward to attracting foreign investors and, accordingly, foreign investment banks.

Will the enterprises remaining in state ownership be reformed?

The assets that the government in the medium term will leave under own management should work according to the principles of the Organization for Economic Cooperation and Development (OECD) - on the principles set out for SOEs, which are considered the gold standard across the world. They are very simple - you cannot keep politics and management in one pair of hands. The rules for SOEs should be the same as for the private sector. Otherwise, nothing will work out.

How do you assess the results of ProZorro's operations?

Probably, it’s not me who should assess this. It’s civic activists who control and monitor state procurement. If the state is responsible for this, then you will hear every morning what a good job Maksym Nefyodov did yesterday. But, nevertheless, in my opinion, ProZorro undergoes a normal evolutionary process. Compared to what we had three years ago, the difference is striking. Although, the situation is still not perfect as we see many problems from the inside. Some of them cannot be solved by an electronic system; they require other tools or add-ins. We have already gone beyond the limits of the known, practically in all directions, we are worldwide leaders. As of today, we have a huge plan for both legislative changes and the development of the system itself.

Do the results of Prozorro implementation vary geographically?

There are no deep geographical differences. There are regions with larger budgets and, respectively, it operates more actively there. Dnepropetrovsk region is among the leaders. Mariupol is also actively involved in state procurement. Naturally, in terms of concentration, the leader is Kyiv, where the offices of big SOEs are located and therefore the procurement stats are formally referred to Kyiv. Besides, the city budget is significant, too. We have individual bastions of resistance to reform - Kryvyi Rih, Cherkasy - but, with few exceptions, the difference is not sustainable.

How could the so-called "gray" schemes in public procurement be avoided? For example, the fragmentation of public procurement bids down to a pre-threshold level, or setting out auction conditions in a way to ensure that a particular company wins bidding, moreover, with an offered price higher than that of actual competitors. For example, for a few years, there has been a flow of reports that the Dubnevych brothers monopolized certain segment of public procurement for Ukrzaliznytsia. And ProZorro does not interfere with them...

As for our fight against breaking bits to a pre-threshold level, inflation is already doing its job, so gradually this mechanism is becoming less and less attractive. We must keep in mind that we already have the lowest threshold in Europe – it’s under $8,000, so there is nowhere to reduce it. We are finalizing our work on the bill, which makes the use of our system mandatory including at the pre-threshold level. This year it will not have time to pass it but we will still try to submit it.

Concerning the specifics of laying down the terms of auctions specifically to fit a certain company, I can say that this is a complex philosophical and ambiguous question. Neither you, nor I can claim that some paperwork was spelled out by Ukrzaliznytsia on some overly complicated technical kind of products to fit a certain company. After all, this requires training in engineering and knowledge of market realities. Therefore, our task is to provide people with response tools.

In our system’s operations, we rely heavily on incoming complaints. Their share is growing but it still remains very small, at around 2%.People should complain more. It is also possible to draw up an approximate specification when suppliers and representatives of various associations come together and develop a single non-discriminatory standard. We already have more than a hundred of such specifications.

CEO of Mekhanika, a company which competes with the one owned by the Dubnevych brothers, for example, assures that he had appealed numerous times to various ministries, yours included, over the actions of the Dubnevych brothers and the management of Ukrzaliznytsia. Have you come across these complaints?

Complaints must be submitted in due procedure to the Anti-Monopoly Committee of Ukraine, not to the ministries. There is also an appeal procedure. Therefore, I haven’t come across any of them.

Ksenia Obukhovskaya

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