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backEUROtalk April, 2005

Privatization progress in Central Eastern Europe

In terms of the private sector share of gross domestic product, the new EU member states from Central and Eastern Europe (CEE-8) have achieved substantial convergence towards the developed Western countries. Private activities generate over 80% of national income in the Czech Republic, Estonia, Hungary and Slovakia, 75% in Lithuania and Poland, 70% in Latvia and 65% in Slovenia.

Furthermore, the 2004 Transition Report of the European Bank for Reconstruction and Development gives the whole CEE-8 a ranking of 4.3 (in a range of 1.33 to 4.33) in small-scale privatization, a structural indicator comparable to the average of advanced capitalist economies. In contrast to the Soviet successor states (e.g., Armenia and Georgia), whose high private income shares reflect the outsized role of retail trade and services with little value-added, private small and medium-sized enterprises in CEE make a significant contribution to regional manufacturing and local job creation along with a growing integration in foreign trade.

However, nearly a year after EU accession and 15 years after the 1989 revolutions, the CEE-8 still exhibit significant gaps in large-scale privatization. The EBRD identifies Poland and Slovenia as the main laggards, with Latvia and Lithuania occupying intermediate positions behind the Czech Republic, Estonia, Hungary and Slovakia. However, even early reformers like Hungary, which began large-scale privatization in the early 1990s, have encountered delays privatizing major state-owned enterprises. The CEE-8's remaining SOEs are clustered in four sectors: financial institutions, energy, telecommunications and transport.

In November 2004, Poland's Treasury Ministry divested its shares of PKO BP, the country's largest state-owned bank, via a public issue on the Warsaw Stock Exchange (WSE). Ministry officials conceded that the offer price was lower than what might have been obtained--underscoring that political considerations can influence the use of public offerings as a divestiture tool in CEE. Major insurer PZU may follow this year.

Following the global trend towards cross-border consolidation, foreign mergers and acquisitions are driving bank privatization in other CEE-8 countries, where political concerns over the remaining "national assets" being bought by foreign firms are generally less than in Poland. For example, in January 2005, Austrian-based Erste Bank exercised an option to purchase the residual 20% shares of Slovakia's Slovenska Sporitelna to supplement its assets in Czech Republic, Hungary, Slovenia and Croatia. Possible candidates for further privatization in Hungary include the Land Credit and Mortgage Bank.

Under pressure from the EU to restructure their energy sectors, CEE governments are turning to strategic foreign investors to buy shares in state energy companies: The authorities in Bratislava are in discussions with Italy's Enel to sell 66% of power monopoly Slovenske Elektrarne; Nafta Polska, the state agency overseeing energy privatization in Poland, is negotiating with ConocoPhillips, possibly to purchase a 17.5% stake in oil group PKN Orlen; PKN is expected soon to finalize its purchase of a 63% stake in the Czech Republic's Unipetrol, signalling the growing importance of intraregional investments in CEE power; and regional investors are also figuring importantly in the divesture of state shares of Hungary's energy giant MOL, which initiated trading on the WSE in December 2004 to augment its long-standing listing on the Budapest bourse.

However, political factors have impeded energy privatization in CEE-8. For example, citing unacceptably low bids, the Czech government cancelled a tender for coal-mining firm Severoceske Doly in March 2004. The low offer prices reflected conditions (notably the effective exclusion of foreign buyers) imposed to avoid mine closures. The country's accession to the EU removed the foreign investor restriction and opened the way for a renewal of the Severoceske tender in 2005. The government must now reconcile the allure of an attractive offer price (which would boost privatization revenues to lower its budget deficit) with the socio-economic fallout of a foreign divestiture (which might heighten unemployment at marginal mines). The government has postponed the privatization of energy firm CEZ beyond the 2006 parliamentary elections.

The Czech government has pursued a more proactive strategy in the telecoms sector, launching an aggressive restructuring of Cesky Telecom (CT)--the last state-owned telephone company in the CEE-8--to maximise the firm's attractiveness to foreign buyers. From a $78 million loss in 2003, the company reported a $235 million profit in 2004, the best performance of any telecoms operator in CEE. This will be the country's flagship privatization this year. Government authorities have invited tenders from five bidders (including Belgacom, Swisscom, Telefonica and Tiscali), whose final offers are due by March 29, and anticipate proceeds surpassing $2 billion for the 51.1% stake.

Rising fuel costs, eroding pricing power and diminishing margins have complicated divestiture of CEE-8 transport sectors. The Czech Republic has deferred privatization of Czech Airlines and Czech Airports until after the 2006 elections. Similarly, the Hungarian government has postponed selling railway firm MAV and bus company Volan until after the next electoral cycle. However, Hungarian officials are proceeding with plans to divest state shares of troubled national airline Malev--problems in privatizing the company have exemplified the challenges to divestiture of state-owned carriers in CEE.

The CEE-8 stock exchanges (led by Slovakia, Slovenia and the Baltic states) posted stellar performances in 2004, well surpassing those of the West European bourses. This largely reflected the salutary effects of EU accession, strong GDP growth and increasing trading activity. However, the regional stock market surge also demonstrates the growing use of initial public offerings as a privatization method in CEE. This phenomenon is most pronounced on the WSE, which, in addition to issues by MOL and PKO, has served as an IPO platform for Polish liquor companies (Polmos Lublin) and biotechnology firms (Bioten). Notwithstanding the controversy surrounding the PKO offer price, the CEE stock markets will be important mechanisms for divestiture of the region's remaining state banks.

Yet IPOs are unlikely to become dominant privatization venues for CEE's energy, transport and telecoms sectors, whose large capital requirements favor strategic foreign investors. Among a dwindling number of regional divestiture targets, those sectors are apt to attract the bulk of privatization-related foreign investment as "second wind" FDI ramps up in the new member states.

Economic factors--namely the absorptive capacity of local equity markets and the strategic calculations of Western investors--are likely to shape the final phase of CEE privatization during the second half of the decade. However, political sensitivities remain, and will continue to complicate and potentially delay some major sell-offs.

Oxford Analytica is an independent strategic consulting firm drawing on a network of more than 1,000 scholar experts at Oxford and other leading universities and research institutions around the world. For more information please visit www.oxan.com, and to find out how to subscribe to the firm's Daily Brief Service, click here.