How Real Is the Privatization Plan for Russia?

The Russian government has introduced an expanded state asset sale program and has extended it through 2017, as it seeks to reduce the state’s role in the economy and balance the budget.

The expanded plan, however, does not mention any company from the list of Russian state corporations that represent a significant part of the Russian economy. The exclusion of these state-owned corporations will prevent a more rapid and robust improvement in productivity and hold back overall modernization and innovation in Russia, especially considering that the planned privatization is partial.

Many State Companies excluded

State Corporations, or goskorporatsiya, are a special form of state-owned enterprises in Russia. They are non-commercial organizations that are subordinate not to the government but to the president and to the president only. They are not limited companies owned by the government, nor are they state unitary enterprises. They cannot go bankrupt and are free from disclosure requirements. Unlike a unitary enterprise, which is independent on commercial issues, but obliged to give more profits to the government, state corporations own their own property. Unlike a state owned company they do not distribute profit back to the treasury.

Today there are seven state corporations in Russia – the national development bank Vnesheconombank (the Bank of Foreign Economic Activity), Russian Technologies (Rostekhnologii), Rosavtodor (Russian Road-Building Company), the Deposit Insurance Agency (ASV), the Fund for Reforming the Housing and Utilities Sector, the Rosatom (the State Atomic Energy Corporation), and Olimpstroi, which is building facilities for the Sochi 2014 Winter Olympics. Rosnano (Russian Corporation of Nanotechnologies) used to be a state corporation until 2011 when it became the first Russian state-owned corporation to be transformed into a joint stock company (albeit 100% state-owned).

This structure of state corporations, which was established at the end of Vladimir Putin’s presidency, was formed to ramp up the innovation process and the modernization of the Russian economy. The existence of state corporations has aroused a lot of controversy in Russia has been dubbed by some experts a “gratuitous privatization” and “corruption under the veil of modernization”; they have been accused of being overly politicized, serving the governing elite’s grabs for property and restraining competition in the market.

Many of them exhibit governance problems including unclear responsibilities of boards of directors since there are no criteria for evaluating the degree of target achievement; exemption from the bankruptcy law; no unified legal framework etc. Some of the state corporations are seen as whole ministries[1]. “Russian Technologies” (“Rostekhnologii”), for example, employs 600 thousand people and consists of 562 enterprises, 300 of which provide products for defense procurement. It also includes large companies like AvtoVaz, Kamaz, VSMPO-Avisma. Earlier last year the head of the corporation announced that 30% of the companies included in the corporation are on the verge of bankruptcy. Having received 334 billion rubles from the government, the company generated net profit of only 70.2 million rubles while the size of the total liabilities accounts for 5.1 billion rubles including credit debts of 669.4 million rubles.

Until now the main hindrance to privatizing “Rostekhnologii” is “the special nature of the products that are delivered to the overseas market”[2] according to the company’s top management. One of the suggestions being discussed by the Russian government to overcome the obstacle is to legally use the opportunities of embassies and permanent missions of Russian Federation to promote the products of the companies that are parts of the corporation (including military and defense products).

Although other state corporations don’t have these hindrances, they still remain inactive on their path to privatization relying on excuses that can be undermined by the examples of companies that have successfully provided IPOs.

Change of plans or change in market situation?

In May 2011 Yandex (operator of the most popular Russian search engine) jumped 55% in Nasdaq Stock Market trading after raising US$1.3 billion in an initial public offering that sold above the proposed price range. At that time a lot of other Russian private companies were attracting investors and foreign interest. Nevertheless, state corporations that were included in the privatization plan 2011-2013 deferred planned IPOs by explaining the risk that they may be underpriced.

Initially the government planned to privatize more than 1300 companies, but retain a majority stake. At the beginning of this year everything was set to go according to plan; in mid-February the government began its privatization program by selling a 10% stake in VTB Bank, Russia’s second largest bank. However, some included companies started to make statements about delaying the sale of the government’s stake. The first company was “Sovkomflot,” which planned to sell 50% minus 1 share in 2011, later it was “Russian Helicopters” (98.5 % of stakes belongs to the “Oboronprom” which is part of “Rostekhnologii”) that deferred IPO indefinitely. Mobile retailer Euroset postponed IPOs in April – the company was asking for too high a valuation, though the official explanation was “market volatility”. After that, “ALROSA” (Russia’s largest diamond company) announced a significant increase of profit and stated that “in this favorable diamond market situation there is no necessity to entice investors this year”.

The reason why state corporations delay privatization seems to be trivial: when the oil price is higher than $100 per barrel the government doesn’t have a compelling need to increase government revenues through privatization. Nevertheless, leaving aside the oil prices, the urge to sell state assets may increase in 2012 since government expenditures are expected to remain high. In August 2011, the Finance Ministry has already announced that state debt may exceed 21 percent of GDP by 2013 or 2014 if oil prices drop to $60 a barrel. Under that scenario, cash from state asset sales might be leveraged to finance the government’s revenue shortage that might increase after the decline of oil prices.

Political Process to Interfere with Privatization

Important decisions are likely to be left until after the upcoming presidential elections. Potential investors also look forward to the outcome of the president elections as it increases clarity over the future business environment. However, the government may encounter more pressure, as large Russian companies might want a stake in the most attractive companies, which have the potential to increase profits and can be integrated into already existent businesses. For these purposes, a successful privatization, even if it’s partial, will require more transparency in state corporations that is nowadays lacking.

Prosperous Russians also might not show much interest in the stakes of state corporations: businesses with minimal state participation used to be the most attractive for wealthy Russians. Some middle-income Russians regard the stock market no more seriously than gambling according to Russian media. This obscures their role as a corporate financing vehicle. Selling companies to the public doesn’t seem possible in this situation.

Nevertheless, there are a lot of investors who view favorably highly liquid and well-protected “state” stocks. Given the “trading” mentality of Russian markets, these considerations are privileged. The sale of state portfolios will make shares of state corporations more and more liquid and therefore more attractive.

The privatization plan announced in 2010 was expanded in 2011, but the final decision on the entire plan has yet to be approved and still subject to changes.

Looking at Russia’s past experience with privatization, an incomplete privatization plan is standard for the government. In 2010 the privatization program should have raised about 100 billion rubles in state revenues while in reality the government raised only 23 billion rubles and privatized assets of 169 companies instead of planned 663. A similar situation occurred between 2007 and 2009. Given political constraints and global uncertainties, we expect the 2011 experience to be similar. Already, several of the planned listings have been deferred, posing a risk both to the government privatization and modernization plans.

[1] They can be compared with the Ministry of General Machine-Building Industry in the Soviet Union, for example. The Ministry oversaw all issues related to space exploration in the USSR and consisted of a large number of companies and research institutes. Another Ministry – the Ministry of Medium Machine Building oversaw the Soviet nuclear industry and employed several thousand people (which is very similar to state corporations that in some cases dominate the industry and employ several thousand people.)

[2] A lot of companies within “Rostechnologii” produce military/defense products.

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