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Privatization: Serbia

Tania Jakobi

During the 50 years that the Communists ruled Serbia, virtually all companies were considered “socially owned enterprises.” It was a vague term that could be taken to mean that workers owned the company that they worked for, or that workers owned all the companies in the country.

The first privatization law was introduced in 1990 by the last prime minister of the former Yugoslavia, Ante Markovic. At that time, Markovic’s proposal was considered revolutionary, because it introduced the idea that companies could be bought and sold like private property. All privatization laws in Serbia from 1990 to 2000 were variations of that first law, which focused on turning workers into the major shareholders of their companies. By 1997, legislation stated that a company choosing to go private must allocate 60% of its shares either to its own employees, or workers at other state-owned companies. The rest of the shares would remain in the hands of the state. But former Serbian President Slobodan Milosevic, who took power at the start of 1990s, after the former Yugoslav Republic began to break up, was never really in favor of privatization and did little to push the process forward.

Some 850 of about 7,000 companies in Serbia decided to go for this so-called “workers’ privatization”. But this early effort at privatization was largely unsuccessful. The system was similar to the voucher scheme used elsewhere in Central Europe and had the same disadvantage of preventing small shareholders from exercising control over the management of privatized companies. Without a developed stock exchange in Serbia, most small shareholders had no idea of the real value of their shares and sold their stock to the management for only 10% or 20% of its face value. In other cases, with little experience of how companies operate in an open and competitive market, employee-shareholders would often decide to spend profits on higher salaries instead of reinvesting them to make the business grow.

There was little foreign interest in investing in Serbia during the civil wars in the former Yugoslav Republic, mostly due to trade sanctions imposed on Serbia by the United Nations and the European Union for much of the period from 1992 to 2000. Telecom Serbia was sold to a consortium of Italian and Greek state telecommunication companies, in a process separate to the “worker’s privatization” scheme. But, in general, foreign investors who might have been interested in buying into a company after it was privatized were discouraged from entering the market by Serbian managers unwilling to lose power to foreign partners. The managers played on workers’ traditional feelings that they were the owners of the companies and so persuaded the employees to oppose foreign ownership, as well.

A new era of privatization was ushered in after the fall of Milosevic and the rise to power on October 5th 2000 of a democratic coalition in what remains of the former Yugoslavia: its dominant republic, Serbia, and the much smaller Montenegro republic. Both the World Bank and the European Bank for Reconstruction and Development were deeply involved in advising the Serbian government as it drew up a new privatization law, and they attempted to avoid mistakes made in previous Central European privatizations. Since the models of voucher privatization and management buy-out had failed in other Central European countries, it was decided that the Hungarian approach of direct sales had the best chance of attracting foreign investors, strengthening the country’s companies, and boosting exports.

The Serbian government badly needs the funds it hopes to raise from the privatizations to plug its budget deficit, which is 6% of GDP at a time while public spending—including spending on health care and pensions—is more than 50% of GDP. The government is struggling to find the money it needs to maintain the country’s pension and health care system, and to repay foreign debt. Industrial output and exports are just 40% of the level seen in 1991, the last normal year before the civil wars.

The new privatization law, passed by the Serbian Parliament in June 2001, states that companies can privatize by selling 70% of their stock to foreign or domestic investors. Large companies must be sold by public tender, that is, buyers must submit purchase offers publicly to the government, while the stock in small companies must be sold through a public auction.

To try to build share ownership among the public, a small company being privatized must give the remaining 30% of its stock to its employees for free. Large companies must give 15% of their stock to their employees; another 15% will go to a state fund to be distributed to the general public. There is also a built-in incentive to encourage workers to speed up privatizations. If a company is privatized within four years of the June 2001 approval of the privatization law, an even larger amount of free shares will be allocated to the employees. If they privatize during the first year they will get 30%, in the second year they will get 20%, and so on.

To encourage buyers in the auction sale of small companies, investors need to pay just one third in cash immediately, while the remaining two-thirds of the sale price can be paid off in six installments. However, the new owner will have the right to manage the company as the majority owner even before the entire price has been paid.

The Serbian minister for privatization, Aleksandar Vlahovic, believes that of the 7,000 companies likely to be privatized, some 1,500 will find potential buyers, while the rest aren’t viable and will be liquidated. Large utilities, such as the PTT postal service, oil and power utilities will only be privatized later in several phases, after they have been reconstructed and reorganized. These companies were converted from “socially owned” entities to full state ownership during 1991 and 1992.

To avoid the Hungarian experience, where some foreign companies bought local firms, only to shut them down and take over the domestic market themselves, the Serbian government wants to ensure foreign buyers invest in the development of the local economy. So, investors attempting to buy a controlling stake in a firm must submit a strong business and investment plan, and the government has said it will be setting a higher value on bidders’ proposed investment than on the cash price offered. Buyers must also offer a social package that will guarantee the majority of workers keep their jobs for at least three years after the sale. The government set this condition in an attempt to prevent privatizations being followed by massive layoffs, at a time when the unemployment rate is uncomfortably high at 25%. For those workers that are laid off, the new owners must give incentives for retraining or retirement.

Since the law was passed, 70 big companies have begun the tender procedure and some 20 could finish the process by the end of 2002. They include companies from the chemistry, pharmaceuticals, and food processing sectors, and the government expects their sale will raise between $150 million and $200 million.

However, independent economic analysts have warned that most of the companies in Serbia are in such bad shape that they won’t be able to attract serious investors. Due to political turbulence in the Balkan region, especially last year’s civil war in neighboring Macedonia, as well as divisions within the Serbian government, the country risk is still high and foreign investors are hesitant about entering the market.

In fact, one of the major problems with the tender model to date has been the sluggish pace of the procedure. Large international investment banks and law firms with extensive experience are involved in preparing the privatizations, which take between six and nine months. But the process has been hampered by the uncertain political situation in the Balkans, strong disagreements within ruling political coalition, and the upcoming presidential elections in Serbia on September 29.

Another problem is the government’s involvement in selecting the winning bidder. The final decision on a bid is made by a tender committee appointed by the Ministry of Privatization and its internal Privatization Agency, together with one representative of the company and one representative of the local municipality where the company is based. Many economists believe that the management of the companies would often have much better sense of which strategic partners are more suitable for them. In theory, the management may encourage their long-term commercial partners to submit an offer to a public tender, but they have little say as to which buyer is chosen in the end.

So far, just three cement plants have been successfully sold through the tender process, with well-known foreign companies Lafarge of France, Holcim of Switzerland and Titan of Greece each acquiring a 70% stake in a different cement plant. The foreign purchasers praised the privatization tender, organized by Hong Kong investment bank HSBC and law firm CMS Strommer Reich-Rohrwig Karasek Hainz, as transparent and corruption-free. But there was some concern that the Serbian government felt pressured to favor the French company’s bid since France, at the time, chaired the Paris club of creditors, which was in the process of deciding what percentage of the former Yugoslav Republic’s $4.2 billion debt it might write off.

The concern was sparked when the Serbian government said it would sell the plant to Lafarge without first going through a public tender. The government reasoned that Lafarge had been close to purchasing the cement plant during Milosevic’s regime, but the contract was never signed due to the sanctions imposed by the European Union in reaction to Serbian intervention in Kosovo in early 1998. Therefore, Lafarge shouldn’t have to go through a public tender competition to buy the company, according to the Serbian government. However, the government’s motives were viewed as suspect, because it had been visiting Paris to discuss the negotiation of the debt at the time, and in November 2001, Serbia and Montenegro were granted a 66% write-off of the debt they owed to the Paris club of countries creditors. A strong public outcry prompted the Serbian government to backtrack and force Lafarge to go through a public tender, and the French company eventually bought the cement plant through that process in December 2001.

For the small companies being auctioned off, the problems are different. The Privatization Agency believes the initial auction price was set too high for many of the companies. At the first auction in April 2002, nine companies were offered, including textile, rubber production, and car maintenance firms, but just three were sold. The Ministry of Privatization decided that most of the assessments of the companies’ values were unrealistic because they assessed property rather than cash flow. Many Serbian companies own a lot of property but have next to no cash flow, or viable market-oriented production.

For two companies that were sold, just one investor showed an interest in each company, while the third was sold at one third of its starting price. In one case, a local entrepreneur bought a car maintenance service. In another case, a group of four employees (members of the managing board) bought the company they worked in. In the third one, a private company from the same town bought the state one.

Privatization Agency General Manager Vladimir Cupic has launched a marketing campaign to push the idea of privatization and to press banks to extend credit to investors. But Serbia’s recent history is complicating the creation of a new private sector. Miodrag Zec, an advisor to the Privatization Ministry, believes there is still strong distrust in a local economy that in the past decade has been severely shaken by hyperinflation and the collapse of the domestic banking system. Zec predicts that demand for companies is likely to be weak with most money still circulating outside the country’s official channels.

Until recently up to an estimated 60% of the economy was operating underground. Under United Nations and European Union sanctions, smuggling was virtually the only way to supply goods such as crude oil, cigarettes, weapons, food, equipment and even cosmetics. After the introduction of the euro, the flood of Deutsche marks that were suddenly brought forward to be exchanged for euros and other currencies in the country suggested that ordinary Serbian citizens had been keeping about 4 billion euros under their mattresses. However, only 1.5 billion euros were deposited into local bank accounts, while the rest was put back under the mattresses. And even though it was and still is officially forbidden, it is very common practice for especially wealthy persons to keep their money in Swiss accounts, while many citizens have accounts in Hungary.

Privatization Minister Vlahovic is concerned that many of the country’s wealthy people may be discouraged from investing in privatizations because of a new law requiring an extra-profit tax to be paid by persons or companies that had special privileges during the Milosevic regime, such as cheap loans or trade licenses.

But some independent economists fear that those who made their fortune under Milosevic may not be the ideal investors. Branko Milanovic, an economist who is a member of the G-17 independent group of analysts, worries that Milosevic’s tycoons, who made their money though political ties rather than entrepreneurial efforts, won’t be a good choice for new company owners. It will do little to develop the local economy and create jobs if investors aren’t interested in improving production, and merely snap up valuable equipment to sell if off. For example, the private entrepreneur who bought the car maintenance service in his local town told the local media that he still has no idea what to do with the purchased company.

Milanovic also points out that there are no guarantees that the investors will stick to their obligations to invest in the privatized companies. Although the bidder has to sign an agreement that he will stick to the investment plan, at present the judicial system is weak. If agreements aren’t enforced, any widespread layoff of workers and liquidation of companies could create massive social tensions, especially in smaller communities where the impact would be felt most strongly.

A weak judicial system also creates room for more serious abuses. Serbia is rated among the most corrupt countries in the world and Milanovic warns that it could be possible to see the kind of intimidation of bidders that marred the Russian privatization process. In some cases in Russia one bidder would bribe his rivals to back out of auctions or tenders. In the worst cases, a bidder would call his rivals and threaten to kill them or the members of their families if they didn’t allow him to purchase the company. So far, there have been no examples of such abuses in Serbia.

However, there have been signs of less violent abuses, prompting the Privatization Ministry to change its auction process at the end of July 2000. Initially, when a small company was auctioned, if there were only one bidder, the company was sold at its initial offered price. If the bidders were not willing to pay the initial price, the amount was cut by 10% of the original price until it reached one third of the starting price, a process known as the Dutch Auction. If there were no interested bidders for the offered companies, they went to another round of auctions within seven days at a lower price.

But the Ministry uncovered signs that some bidders were fake ones, acting together to drive the price down by refusing to bid. As a result, at the end of July 2002, the Serbian government adopted new rules setting the initial price based on the value of the property held by the company, adjusted for losses, or debts. The minimum price is then set at 20% of that initial price.

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