Russian Economic Reform


Medvedev should ease up on “privatization”!

Published on July 18 2011
Posted by: jeff

President Medvedev is trying to give further privatization a hurry-up, but perhaps he should ease up a little.  

In 1992, after my second visit to Russia as Chief Economist of HSBC (Australia) I wrote about the reform plans then contemplated: “The pace of privatization is unachievable because of the lack of an existing market and institutional framework to support it. … The other danger with rapid privatization of larger enterprises is that its lack of control may deliver many state assets into the hands of only a few groups who will then exercise monopoly powers and control over the economy.” (See left hand-side of page for full article.)

The institutional framework is obviously now much better, but possible impediments to competition enhancing transactions which give the state a decent price remain. Moreover, some of the suggested sales in the “natural monopoly” area are possibly counter-productive.

“Vedomosti” reported last week that meetings have been held under the chairmanship of First Vice-Premier Shuvalov, where officials have discussed the sale of 10% of Rusnano, and a reduction in state ownership to 50% plus one share in each of Russian Railways, MRSK-Holding (the Inter-regional Electricity Distribution Grid), FGC (Federal Electricity Grid) and Transneft (monopoly on main oil pipelines). Because they are “infrastructure” companies there is apparently more work being done to consider the consequences of such changes in shareholdings. Russian Railways is presently 100% owned by the state, which also has 53.69% of the shares of MRSK-Holding, 79.48% of the shares of the FGC, and 78.1% of Transneft.

There are suggestions of a possible sale of 10-15% of Rosneft in 2012, with subsequent sales resulting in the state retaining only a “golden share”. It will permit state representatives on the board of directors who can veto very significant transactions (equal to more than 25% of value of net assets), changes in authorized capital, corporate reorganization and changes in statutes. The present state shareholding is 71.16% in Rosneft.

Some reports suggest that a similar “golden share” fate is suggested for RusHydro in which the state now owns 57.97%, although other reports have suggested that the “50% plus one share” option is more likely. Given that hydro-electricity stations are likely to have wider and more identifiable “externality” issues than carbon based electricity generators, I would be surprised if the “golden share option” was accepted. There are lots of infrastructure-type issues associated with such water control, and the government should retain the pro-active possibilities of “50% plus one share” rather than the reactive possibilities of a “golden share”.

While the state ownership of a “golden share” may frighten-off some potential shareholders, some officials suggest that some investors may welcome such shares as evidence that the state cares about the fate of such companies.

In my view, there is little sense in reducing share-holdings in Railways, MRSK-Holding, FGC and Transneft to 50% plus one share. There are core natural monopoly assets in each of these organizations, and these will necessarily remain regulated as to both prices and services. Of course, it could be argued that if investors are willing to buy such shares then the government should take their money – and then just ignore them!

But, “outside” investors should not be allowed to become “insiders” with special access to cash flow. It has been suggested that a “strategic investor” (such as China’s “Yangtze Power”) might be interested in RusHydro. This would, at least, bring technical expertise. 

Having said that, there are two more urgent issues concerning these entities. One is transparency and, as  the case of Transneft demonstrates, the government has been pathetically slow and weak in enforcing this. The other issue is that each of these organizations have components (either as departments or separate legal entities) that undertake various activities which could be outsourced with a resulting significant reduction in costs (something Expert Group 18 has looked at).

So, why is Medvedev now pushing so hard on privatization?

It may be that he thinks that it will assist in helping to resolve these two micro-economic issues – ie transparency and outsourcing.  Given his strong push to remove ministers from the boards of state owned corporations, this could be the case. However, for my liking, it has a little too much of the smell of the Gaidar/Chubais approach to solving such problems. At the very least, those businessmen who have benefited from previous privatizations should not be allowed a look-in with the new round. There is already excessive concentration of business power in Russia.

Another possible reason is to reduce the budget deficit.

If final approval is forthcoming, total receipts from privatization are expected to be 6 trillion rubles (ie 1,200bn each year) in the 2012-16 period. The present projected budget program for 2012-14 foresees annual privatization receipts of 300 billion rubles. The latest 3-years projections for the Federal budget suggest that the deficit is not a particular problem, with little macro-economic imperative to quickly privatize. The deficit is projected to be 719bn rubles (1.3% of GDP) this year; 1,570bn (2.7% of GDP) in 2012; 1,744bn (2.7% of GDP) in 2013; and 1,648bn (2.3%) in 2014. Of course, much depends on oil prices (projected to average $US118 per barrel this year, and $US125 in the next three years), but Russia official debt levels are not high.

Thus, in my view both sets of issues – ie micro and macro – suggest that Medvedev should consider a more cautious approach on the privatization issue. He needs to concentrate on the micro issues, but adjust his approach (which should include more of the often good management practice of simply sacking people).

I also want to make a point which is more general in character. The simple fact of a budget deficit is not necessarily a good reason for asset sales. It partially depends on the nature of expenditures — ie are they current or capital. Sometimes, it may be better to borrow and retain the assets – with resultant little or no change in net state assets.

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