PRIVATIZATION IN NACC COUNTRIES Defence Industry Experiences and Policies and Related Experiences in Other Fields COLLOQUIUM 1994 ********* COLLOQUE 1994 PRIVATISATION DANS LES PAYS DU CCNA Experiences et politiques des industries de defense et experiences comparables dans d'autres secteurs Colloquium 29-30 June, 1 July 1994 Brussels --------------------------------------------------------- FOREIGN INVESTMENT AND PRIVATIZATION IN ESTONIA Kaja KELL Estonia is the third most favoured nation in Eastern Europe for foreign investors. Joint ventures and foreign-owned companies are doing good business, and this year, investment from abroad exceeded domestic investment for the first time, says Kaja Kell. Tax breaks are bringing in a lot of money and a big chunk of it comes in from offshore tax havens. As the privatization programme progresses more slowly, it seems that foreign investors would rather start new companies than buy up old ones. Kaja Kell is Deputy Head of the Information Department with the Bank of Estonia. Looking at foreign investment (and privatisation) issues in the three Baltic states (Estonia, Latvia and Lithuania) it can be said with reasonable certainty that, besides some very important individual features for each of the three, there seems to be quite a lot of common ground. The following problems will be discussed in a bit more detail below (on mainly Estonian examples). - Foreign investors prefer new ventures to companies to be privatised (generally ill-equipped and debt-laden). - Privatisation decisions by politicians cannot always be aimed at maximising economic effect. That can lower the interest of potential investors. - Ineptness in solving organisational problems and conflicting legislation has turned out to be surprisingly important as a source of problems. - Country-risk inherent in the geographical position of Estonia and the other Baltic states (and to a smaller extent - risks connected to the rapidly changing economic environment) tend to play a major role in investment decisions. - Any statistics concerning foreign investment should be handled with caution. Dealing with relatively small economies even a single figure for an individual investment can bring quite substantial changes to the overall picture. Investment in Estonia - General Background ------------------------------------------ The number of entities in the Estonian state company register increased from 30,431 in December 1992 to 41,820 in November 1993. By March 1994 the number of registered enterprises was 53,421. 78% of the registered enterprises are private-owned. It should be noted as well, that the overwhelming majority of businesses fall into the categories of small businesses (up to 19 paid workers) and medium-size businesses (20 - 99 paid workers). The panel used by the Estonian State Statistics Board for its company-finance survey, consists of 17,553 companies divided into the following groups (see Table 1). Table 1. --------------------------------------------------------- | | Number | % | |-------------------------------------------------------| | Individuals | 5163 | 29,4 | | 1-19 paid workers | 9078 | 51,7 | | 20-99 paid workers | 2530 | 14,4 | | 100-499 paid workers | 686 | 3,9 | | > 500 paid workers | 96 | 0,6 | --------------------------------------------------------- Approximately 54% of the total sales fall to the companies considered "large" according to Estonian conditions (100 and more paid workers). During the first of 1994 the share capital of Estonian companies increased by 1,125,8 million kroon. Banks credits and foreign capital have gained in importance as sources of real investment. The table below shows the importance of different sources of financing in real investment. Table 2 - Various sources of financing real investment --------------------------------------------------------- | | 1992 | 1992 | 1993 | 1993 | | |million | % |million | % | | |kroons | |kroons | | |-------------------------------------------------------| |Companies'own capi.| 1174 | 74.0 | 2140 | 61.6 | |Local budget | 119 | 7.5 | 201 | 5.8 | |Bank credits | 72 | 4.6 | 316 | 9.1 | |of which foreign | | | | | |banks | | | 117 | | |Foreign capital | 55 | 3.5 | 258 | 7.4 | |Private capital | 42 | 2.7 | 169 | 4.9 | |Other | 40 | 2.5 | 122 | 3.5 | |-------------------------------------------------------| |TOTAL | 1581 | 100.O | 3473 | 100.0 | --------------------------------------------------------- No significant changes in the above proportions have been predicted for 1994. There have been some changes during 1993 in the structure of real investment, however. The importance of the following sectors of the economy as investment targets has fallen (1993 compared to 1992): - agriculture and forestry 2.4% (6.4%) - housing construction 3.3% (8.3%) - property, renting, business services 0.9% (2.1%) The importance of the following sectors has increased (compared to 1992): - governement, defense, welfare 6.4% (0.5%) - finance, insurance 5% (0.9%) - hotels, catering 3.4% (1.3%) The bulk of the real investment has been used by manufacturing industries - 26% (31.1% in 1992), transport storage-communication 22.8% (23.2% in 1992). Foreign Investment in Estonia ----------------------------- The bulk of the foreign investment in Estonia so far has come in the form of capital for new joint ventures or foreign-owned companies set up. Joint ventures in Estonia date back to 1987, when 13 were established between 1987 and 1988. The law was liberalised in 1988 to allow full foreign ownership as opposed to the previous 40% maximum stake, while the following years laws were passed concerning joint-stock companies and the opening of foreign representative offices. Foreign investment is governed by the law on Foreign investments. Up to January 1, 1994 firms with a minimum 30% foreign capital reveived a two-year holiday on profit tax, followed by further reductions for another two years. Those with a minimum of 50% foreign capital investment (USD1 million and more) reveived a three-year tax holiday and a 50% reduction fot the following five years. Unlike the other two Baltic states, foreign business can buy land outright. With the growing external convertibility of the kroon, foreign currency regulations were gradually relaxed during 1993. The last restrictions remaining from the time of the 1992 monetary reform, concerning private individuals' foreign currency accounts, was abolished in April 1994. Both foreign and local companies have been able to open accounts in any currency from January 1993 and there are no restrictions (besides an obligation to adhere to customs formalities) for exporting/importing cash or securities (see appendix to this paper for a short summary of changes in foreign exchange regulatons). The regions of Central and East Europe used only about 3% of the total foreign investment made in the world in 1993. Estonia has so far been generally somewhat more successful in attracting foreign investments than its two Baltic neighbours, Latvia and Lithuania, and took the third place in East Europe (after Hungary abd the Czech Republic) for foreign direct investment per head of population. It should be stressed immediately, that statements and calculations like the above must not be taken without a certain caution. Some possible sources for the quite large variation in basic figures are shown below on Estonian examples and its reasonable to suspect that the problems might be very similar in other European countries as well. The following table shows the foreign investment figures according to the balance of payments compiled by the central bank. Table 3. --------------------------------------------------------- | | 1993 | 1993 | 1993 | 1993 | 1994 | | | Q1 | Q2 | Q3 | Q4 | Q1 | |-------------------------------------------------------| |1.Equity capital |334.0 |119.2 |354.3 |425.5 |356.2 | |-of which new ventu-| | | | | | | res |280.0 | 98.0 |166.0 |220.0 |268.2 | |-of which privatisa.| 0.0 | 11.9 | 5.2 | 63.3 | 6.5 | |-of which additional| | | | | | |investments into ex-| | | | | | |isting companies | 54.0 | 9.3 |183.1 | | | | |142.2 | 81.5 | | | | |2.Reinvested profits| 49.2 | 94.7 |122.8 | 97.9 | 92.3 | |3.Liabilities to di-| | | | | | |rect investor(i.e. | | | | | | |long&short term cre-| | | | | | |dit granted by inve-| | | | | | |stors minus loan | | | | | | |payments) |101.1 |167.3 |162.6 |203.8 |125.0 | |3.Claims on direct | | | | | | |investor(i.e.long & | | | | | | |shor-term credit gra| | | | | | |nted to investors) |-8.6 |-14.5 |-31.7 |-27.0 |-21.0 | |-------------------------------------------------------| |TOTAL |457.7 |336.7 |608.0 |700.2 |552.5 | --------------------------------------------------------- The figures for 1993 have been adapted to the version V of the Balance of Payments As seen below, the figures can look somewhat different sources and data-gathering methods (the state company register, for instance). Foreign Investment in Estonia During the First Quarter of 1994 --------------------------------------------------------- During the first three months of 1994, 630 new companies with mixed or foreign ownership were registered in Estonia (total foreign investments of 607 million kroon according to the state company register - the corresponding figure in the balance of payments is 268.2 million). It should be noted here that according to exoert estimates only 60-70% of the sums declared for the company register are really invested in Estonia. Part of the companies registered will never start their activities at all. The significant increase in the interest shown by foreign capital in new ventures in Estonia during the first months of 1994 can be explained, to a large extent, by the fact that from 1 January 1994 the tax holidays and reductions for new companies with a share of foreign capital have been abolished. For that reason as many enterprises of this type as possible were registered at the end of 1993. (In Estonia the companies registered by local authorities are included in the state company register only after a delay of several months). Besides that, the figures for the month of January include one exceptionally large foreign investment from Egypt made into a new company named Monir El Noba & Abu Simbl As whose registered share capital amounts to 250 million kroon. This investment alone coverd 45% of the total for January 1994. (By May 1994 the registered amount of foreign capital had not really been paid in and consequently the figures for the balance of payments compiled by the bank of Estonia do not include this amount.) Table 4. Total foreign investments in new ventures by countries --------------------------------------------------------- | | 1994 Q1| 1994 Q1| 1993 | 1993 | | |thousand| % |thousand| % | | |kroons | |kroons | | |-------------------------------------------------------| |Egypt | 273000 | 45 | 0 | 0 | |Finland | 80720 | 13 | 195547 | 22 | |Sweden | 78461 | 13 | 284953 | 22 | |USA | 50141 | 8 | 145511 | 16 | |Germany | 33079 | 5 | 35524 | 4 | |Bahamas | 25316 | 4 | 12342 | 1 | |United Kingdom | 12677 | 2 | 22110 | 2 | |Russia | 10815 | 2 | 53289 | 6 | |Other | 43596 | 7 | 157690 | 17 | |-------------------------------------------------------| |TOTAL | 607805 | 100 | 906966 | 100 | --------------------------------------------------------- More than 3 million kroon each has been invested in new Estonian ventures by investors from Denmark (7 million EEK), Ireland (5.5 million), China (5.2 million), Pakistan (4.1 million), Pakistan (4.1 million), Turkey (3.2. million) and Kazakhstan (3.2 million). Disregarding the exceptionally large investment from Egypt mentioned above, Finland and Sweden continue to remain the most important sources of foreign investment for Estonia. It should be noted that several (relatively) large foreign investments have come to Estonia from tax havens (i.e. Bahamas, Panama, Cyprus, Vanuatu etc...). The volume of investments from Rusia has decreased, to some extent. There have been instances where Estonian capital comes back to Estonia under the guise of foreign investment via various tax havens. It can be partially explained by the lucrative tax reductions until recently offered to foreign companies. Money laundering might well count for a second reason, and the possibility of transferring profits earned by local branches to mother companies set up in tax havens, thus avoiding income tax in Estonia is a third consideration worth mentioning. Besides the tax havens, countries like Ireland, Turkey, Sweden, USA, Hungary and Poland have been used both by Estonian and Russian capital for this type of operations. The influence of the recent changes in taxation of new foreign-owned companies can be clealy traced in the figures for the average size of foreign investment. While the average foreign investment into the share capital of a new company registered in January 1994 amounted to 1.148 million kroon, the average for the whole 1993 was only 0.308 million, the average for february 1994 - 0.264 million and march 1994 - 0.324 milliion. Table 5. Average foreign investment in new ventures by countries --------------------------------------------------------- | | 1994 Q1 | 1993 | | | |---------------------------------------| | |Enterprise|Average |Enterprise|Average | | | |investm.| |investm.| | | |thousand| |thousand| | | |kroons | |kroons | |-------------------------------------------------------| |Egypt | 1 | 273000 | 0 | - | |Finland | 355 | 189 | 1364 | 119 | |Sweden | 48 | 1427 | 284 | 866 | |USA | 40 | 1206 | 86 | 1516 | |Germany | 37 | 807 | 1121 | 286 | |Bahamas | 7 | 3617 | 9 | 1371 | |United Kingdom | 24 | 528 | 42 | 503 | |Russia | 46 | 152 | 237 | 191 | |-------------------------------------------------------| |Total | 630 | 758 | 2416 | 308 | --------------------------------------------------------- A significant (and incresing) part of the new enterprises based on foreign capital - 53% in 1994 - can be characterised as 100% foreign-owned companies with single owner. The average share of foreign capital in a joint venture amounts to 85% (65% in 1993). 52% of the capital of new companies entered in the state register in the first time the volume of foreign investment has exceeded the volume of domestic investment. Manufacturing industries have lost some of their attractiveness for foreign investors, wholesale and retial gaining at the same time. Table 6. Foreign investments in new ventures by sectors of economy --------------------------------------------------------- | | 1994 Q1 | 1993 | | |------------------------------------------| | |Number of |Capital | %|Number of |Capital | | |enterprise|thousand| |enterprise|thousand| | | |kroons | | |kroons | |-------------------------------------------------------| |Wholesale & | | | | | | |retail trade| 351 | 394940 |65| 1311 | 235961 | |Industry | 113 | 141996 |23| 423 | 409525 | |Finance | 9 | 45610 | 8| 30 | 74455 | |Property, | | | | | | |renting,busi| | | | | | |ness service| 63 | 6875 | 1| 296 | 67423 | |Transp.,ware| | | | | | |house,commu.| 29 | 4774 | 1| 117 | 55576 | |Hotels,rest.| 10 | 4194 | 1| 59 | 20956 | |Agric.,fores| 15 | 1912 | 0| 42 | 28184 | |Other | 40 | 7504 | 1| 138 | 14886 | |-------------------------------------------------------| |TOTAL | 630 | 607805| | 2416 | 906966 | --------------------------------------------------------- The bulk of the foreign investment (80% in all) was made in Tallinn in the first quarter of 1994. (In 1993 the share of Tallinn in total foreign invstment had been 65%). A few large foreign investments have been made in the counties of Jogeva (31 million kroon) and Voru (20 million) and in the town of Narva (20 million). According to the latest estimates by the Estonian Ministry of Economy there should be a modest increase in foreign investment during the second quarter of 1994, the average amount invested remaining modest as well. In a longer perspective, the recent decision by Eesti Pank/Bank of Estonia to make Estonian kroon - Deutschmark futures and swap of up to 7 years maturity available to the banking sector might well play a significant role. The new instruments offer an additional way to the foreign investor to hedge the possible currency risks. It is a mark of the success of joint ventures and 100% foreign-owned companies that although only 6% of the total workface was engaged by these companies in 1993, their share in total wages paid was 9%, their share in value-added tax revenues - 14%, net turnover (sales) - 16%, and total net profit - 13% in 1993. The fact that foreign-owned companies have taken an especially active role in foreign trade operations is reflected by the fact that their sahre in the total customs tariffs paid in 1993 amounted to more than a third. Privatization in Estonia ------------------------ The Estonian press has from tme to time published rather gloomy warnings that Estonia's assets would all be sold out to foreign investors. This danger is strongly exaggerated. The results of the first two privatisation tenders show that only 18.5% of the sales contracts of large enterprises were awarded to foreign buyers. According to the balance of payments quartely figures, privatisation revenues have amounted to approximatively 10% of the total foreign investment in Estonia for the last three quarters. Despite having had the only systematic privatisation programme in the Baltic states for a long time, Estonia's attempts to dispose of its public enterprises, particularly the larger ones, have been fraught with difficulties. Since August 1993 the programme has been directed by the Estonia Privatisation Agency formedmby merging two former bodies, one of which had been rsponsible for large enterprises, the other for small privatisation. By January 1, 1994 the privatisation authorities had sold off 54 large-scale enterprises. Small-scale privatisation having been more successful, an estimated 80% of small business had been privatised by the end of 1993 according to the Ministry of Economy. (54% of the country's retail outlets were in private hands and another 30% were run by cooperatives while 8% had remained state- owned, for instance). By mid-1994 the government hopes to introduce public share offerings, retaining a 25% stake which will subsequently be sold off for vouchers. The privatisation programme for 1993 of the Government of Estonia stressed the following: - choosing the best method for privatisation in every individual case (tenders with preliminary negotiations, public offer of shares, auction); - auctions should be used more often (for the relative speediness and resource-effectiveness of this method); - tenders with preliminary negotiations should be used mainly for large and middle-sized enterprises; international tenders should be used only in case it is realistic to hope that there would be sufficient interest abd additional stipulations should be used with great care. In the Estonian Ministry of Economy quartely review for QI 1994 the Privatisation Agency is criticised for having not followed the above principles to the full. The Ministry of Economy has noted that the interest of foreign investors in enterprises to be privatised has, in general, fallen:there are more competitive investments possibilities available, and the the political instability in Estonia's neighbouring regions (i.e. potential markets) seems to be on the increase. It is in this context that the results for the three international tenders for the sale of state-owned enterprises should be looked at. Tender I -------- - 38 enterprises, 180 offers (of which 53 or 51.5% from foreigners) Tender II --------- - 52 enterprises, 180 offes (of which 77 or 42.8% from foreigners) Tender III ---------- - 40 enterprises, 109 offers (of which 12 or 11% from foreigners). Privatization Results for 1993 in Estonia ----------------------------------------- a) so-called large-scale privatisation (tenders) 54 contracts were signed for 353,194,951 kroons in all. The buyers guaranteed total investments of 237,755,964 kroons. The buyers took over old debts for 195,562,292 kroon. 9,099 jobs were guaranteed (see table in the appendices to the present paper for individual contracts). b) so-called small privatisation (auctions). Only 29 entities were sold for 23,643,500 kroon in all (it must be noted that only 9 entities were sold for a price higher than the initial price). In its latest quarterly review in Estonian Ministry of Economy had to admit that from "a purely business point of view" it must be recognised that the (privatisation) ideology chosen and the slowness of reform (especialy in solving issues of restitution and compensation) is "continuously lessening the interest of foreign investors in Estonian privatisation". It seems that there have been similar feelings in Latvia as well. It is quite natural that the foreign investor would repfer a new firm without inherited liabilities or problems. Both the Estonian and the Latvian experience show that it is necessary to balance the renewwal of ownership rights which existed before the occupation by the USSR with the interests of the present users as well - and even more important - to direct the process in such a manner that it not impede the transition towards a marked economy. APPENDIX II CHANGES LIBERALISING THE RULES REGULATING FOREIGN CURRENCY USE DURING 1993 AND 1994 1. On February 4, the Estonian President signed "The Law on Changing the Foreign Currency Law of the Republic of Estoniaopted by the parliament on January 26. 2. The Bank of Estonia regulations No 39 (March 1, 1993) imposed the procedures of opening foreign currency accounts in Estonian authorised banks for legal entities. 3. The Bank of Estonia regulations No 40 (March 1, 1993) imposed the procedures of opening foreign currency accounts abroad for legal entities. 4. The Bank of Estonia regulations No 49 (March 31, 1993) imposed the amended rules Rules of issuing licences for independent foreign currency transactions to Estonian banksnd invalidated the former rules passed by the Bank Board on June 18, 1992. 6. The Bank of Estonia regulations No 90 (August 2, 1993) imposed the amended Procedures of opening and using foreign currency accounts abroadnvalidating the procedures imposed with regulations No 40 of March 1. 8. The Bank of Estonia regulations No 99 (August 18, 1993) imposed the amended On transactions with non-convertible foreign cashfted the restrictions on transactions with foreign non-convertible cash, invalidating the Bank regulations No 164 of November 24, 1992. 10. The Bank of Estonia regulations No 133 (December 1, 1993) imposed new procedures on opening foreign currency accounts in Estonian and foreign banks, invalidating the Bank regulations No 90 and 91 of August 2. 11. The Bank of Estonia regulations No 139 (December 16, 1993) that took effect on December 15 invalidated the regulations No 69 (July 6, 1992). That means abolishing any restrictions concerning the exchange rates used for commercial banking operations. 12. Decision of the Board of the Bank of Estonia (December 21, 1993) cancelled all restrictions on import and export of cash, invalidating the Bank Board decision of June 18, 1992. In 1994, the following documents were formulated and imposed: 13. The Bank of Estonia regulations No 16 (March 16, 1994): invalidated articles 3 and 8 of the regulations No 85 (July 24, 1992). That meant abolishing any restrictions concerning opening correspondent accounts with banks of the former rouble zone and opening rouble accounts for clients. 14. The Bank of Estonia regulations No 17 (March 18, 1994): Procedure of recording foreign currency and securities at customs. ---------------------------------------------------------- Copyright 1994 NATO All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic tape, mechanical, photocopying, recording or otherwise, without permission in writing from the copyright holders. Authorization may be requested for redistribution of the text on a non commercial base by research and educational services. Requests should be addressed to the Economics Directorate, NATO, via e-mail 'scheurweghs@hq.nato.int'. First edition 1994 ISBN 92-845-0079-6 This is the latest in a series bringing together papers presented at the NATO colloquia organised by the NATO Economics Directorate and Office of Information and Press on economic issues in the former USSR and Central and East European countries. For further information please write to the Director, Office of Information and Press, 1110 Brussels, Belgium. The articles contained in this volume represent the views of the authors and do not necessarily reflect the official opinion or policy of member governments or NATO.