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Section 4. Institutional and Macroeconomic Challenges 4.1. The Dynamics of the Privatization Process in Russia As the name suggests, the entire period of the so-called cash privatization (from 1994 until now) was primarily influenced by budget considerations and it was not uncommon for biggest and most important deals to get governmental approval only by the end of the year, incidentally also the time for reconciliation of budget revenues.

All the more heartening that since 1999 the government at least no longer expects on receiving a fixed amount of revenue from privatization, which hopefully would translate itself into a sounder privatization policy.

Table 1 Revenues from Sale and Use of State Property between 1995-2003 (in current terms1) 2003 1995 1996 1997 1998 1999 2000 2001 2002 (est) Actual Number of Privatized Enterprises 2200 1063 6000 5000 3000 2583 595 320 170 (planned) (planned) Revenues from Sale of State Property (non-renewable source) in billion Rubles Approved Budget in 4,991 all 12,3 all 6,525 all 8,125 (c) 15 (e) 18 18 35 51 rubles revenues revenues revenues Actually Received 15,442 7,319 (a) 1,532 18,1 (b) 8,547 31,368 10,11 91,2 (f) Funds in rubles (d) Actual Revenues from Use of State Property (renewable source) in billion Rubles Dividends on Feder- 3,675 10,25 118 (35 575 (200 848 (600 ally-Owned Stakes in 92,8 270,5 (1050 6,478 (708 10,5 JSC) JSC) JSC) Enterprs JSC) JSC) 4,896 on 7,843 on assets Payments on Lease of assets 2,3 116,7 N.D. 305 466 2,191 3,427 3,917 7,3 State Property from from land land 13,622 12,3 from VS; 9.9 VS VS, 2,5 783 from 209.9 from Revenues (profits) from Vi- 5,675 11,687 from131 809 State from State-Owned - 5 26 State etsovpetr from VS from VS State Unitary Enterprises Unitary o (VS) Unitary EnterEnterEnter- prises prises prises Total 209,5 123 610,7 1,824 8,714 18,789 29,122 31.19 Cumulative Revenue from Use and Sale of State Property in billion Rubles 122,Actually Received 7,529 1,655 18,702 17,266 17,262 50,157 39,233 vs. 70,6 - planned Since 2001 another positive trend regarding state property and its effect on the budget came with a shift of reliance from non-renewable to renewable sources of income. In other words instead of receiving big one-off sums for selling its property the government is now a) approved budget was adjusted in December 1995, 70.8 % of actual revenue came from share-for-loans auctions; (b) including US$1.875 billion from sale of stake in Svyazinvest holding; (c) adjusted to 15 billion rubles in April 1998 (on governmental level); (d) including 12.5 billion rubles from sale of 2.5% stake in Gazprom; (e) from 1999 funds from privatization are not included in the budget revenue; (f) includes.775 and 1.86 billion from the sale of state stakes in Lukoil and Slavneft respectively RUSSIAN ECONOMY in trends and outlooks more keen on extracting stable revenue via retaining and better management of its assets.

Thus in 2001, 75% of governments cumulative revenue from its property (includes sale and use) came from renewable resources, whereas in 1997 that number amounted to only 3%. Encouragingly enough the trend continued in 2002 and the governments revenue from renewable resources 3 times exceeded the sums received from privatization (excluding a deal on Slavneft and Lukoil shares which remained uncertain till the end of the year).

Preliminary 2002 data from the Ministry of Property the cumulative budget revenues from use and sale of state property amounted to 122.39 billion rubles, three times the number from previous year. Cumulative income from use of state-owned property came up to be 31.19 billion rubles including the 7.8 billion from property lease, 10.25 billion from dividends on state-owned shares, 9.9 billion from the shares in Vietsovpetro, 2.3 billion from lease payments on federally-owned land and 0.9 billion from profits in state unitary enterprises. In the meantime revenues from sale of state property in 2002 were only 91.2 billion rubles with more than 80% of that sum coming from 2 large deals in (surprise!) December of 2002 (sale of stakes in Slavneft and Lukoil). Sale of state-owned land brought in.6 billion rubles.

Although the new privatization Law came into force only in 2002 much of the privatization program for the year is based on changes introduced by this legislation. Thus the privatization program expects that thanks to a row of newly available methods of privatization the government would be able to get rid off its minority stakes and illiquid holdings and thereby drastically reduce the number of entities in state ownership, a goal that has been widely discussed since the mid-nineties. This should also apply to state unitary enterprises a number of which, especially with November 14, 2002 enactment of Law on State and Municipal unitary Enterprises, is expected to be cut to 2.5 thousand by the end of 2003. In addition, reorganization of such enterprises (mergers, liquidations, incorporation, partial sale, etc) would also affect their subsidiaries.

However ambitious the Property Ministrys plans appear at a first glance, most of actual privatization revenues come from large individual sales. Often, final decisions on whether to put a particular enterprise up for sale are made abruptly and arbitrarily, regardless of an approved privatization plan. At the same time sale of other enterprises can be put off a year after a year, and similarly, a deal on a verge of being closed can be cancelled at the last moment.

In 2002 state-owned stakes in the following enterprises were expected to go for sale:

Lukoil (5.9%), Slavneft (19.68%), Eastern Oil Company EOC (36.817%), Svyazinvest, a telecom holding (25% minus 2 shares), Vorkutaygol (38.41%), Magnitogorskii Metallurgic Plant (17.77%) and a number of others.

On May 24, 2002 results of the EOC auction were announced and Yukos victory did not come as a surprise. Since Yukos is already a majority stakeholder the final bidding price exceeded the starting bid ($225 million) by only $.4 million. Conveniently, TNK, Yukos main contender made a decision to withdraw from the auction following a scandalous court row and, also, perhaps, due to an understanding that Yukos was unlikely to let go of shares of EOC subsidiaries.

State-owned 5.9 % stake in Lukoil was planned to go up for sale in the form of ADR on London Stock Exchange in August 2002. The Board of Directors presiding over Privatization Project Company, an outfit responsible for the sale deemed the price offered at the time too low (close to current price offered at the Russian Stock Exchange) and suspended the sale.

The stake was finally sold in December 2002 for what some sources cite was a maximum feasible price of $15.5 per share with demand outstripping supply by a factor of 2 and the Rus INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru sian government walked away from the deal with a total of $775 million. It still owns a hefty 7.6% in Lukoil and has no immediate plans to sell the stake, although any decision to do so would obviously depend on the world oil prices as well as the companys success at restructuring.

Sale of governments stake in Svayzinvest, a telecom holding was also scheduled for 2002 but did not go through and is now included in the 2003 privatization plan. A need for further consolidation of the holding and creation of 7 interregional operators, which would be completed only by the end of 2002 were cited as possible reasons for the sale postponement.

In addition, the government hopes that a tariff reform would help the company raise its capitalization, and with it the value of state stake in the company.

Table 2002 Privatization Program Additional Total number of % of total Designated for list of PrivaEntities in Posses- registered in Privatization in tization Dession of the Rus- the Russian 2002 (2001 Pri- ignated Entisian Federation Federation vatn Plan) ties from the new Law Federal UNITARY Enter9394 (9708 as of prises (FUE) Total FUE 12 152 October 2002) 20,000, and 65,000 municipal Joint Stock Companies with 4407 9 426 shares owned by the state Including state stakes of:

100% 90 - 6 - above 50% 646 - 33 - 25-50% 1401 - 127 - 25% and less 2270 - 260 - GOLDEN share 750 - - - Source: data from the Ministry of State Property, and the currently updated Property Registrar of the Russian Federation. Data from this Table can be compared with data from September 1, 2001: 9855 federally owned UNITARY enterprises and stakes in 4308 joint stock companies. Some sources claim that the number of joint stock companies with state stakes exceeds 6,000 far from completion and creation of Federal UNITARY Enterprise Registrar.

A more complicated story concerns the sale of state-owned 19.68% stake in Slavneft.

Initially, a simple auction was scheduled for October-November 2002 with an expectation that it would raise somewhere between $300-350 million. The mechanism of sale, however was subsequently changed several times and scandals involving changes in Slavneft management all but guaranteed a delicate nature of the deal. First of all, the stake in Slavneft was the last Russian oil company where a major state-owned stake was offered for sale (the government has not plans to privatize Rosneft anytime soon). Add to that a bitter feud between various industrial and financial clans, an international element brought in by the Belarussian-owned stake of 10.83% and here is a Russian privatization drama.

Prior to the privatization, the Russian government owned 75% of Slavneft shares (55.27% were held by the Ministry of Property, 19.68% belonged to RFII). DKK, a closed joint stock company owed another 13.18% (Sibneft and TNK owed 25% each of the remaining stake and the rest of the shareholders are unknown).

RUSSIAN ECONOMY in trends and outlooks The battle for the governments stake fired up well before the start of the auction. In April, 2002 Mr. Gutziriev was replaced from this post of President of the company by Mr.

Sukhanov who was widely seen as a Sibneft favorite. While the government was busy discussing various models for privatization of Slavneft, Sibneft and TNK were buying up shares of Slavneft subsidiaries. Such acquisitions (blocking stakes in Yaroslavnefteorgsintez and Megionneftegaz among others) allowed TNK and Sibneft not only send an unambiguous warning to potential rivals but also gain considerable leverage for making changes in the Board of Directors and issue additional shares. Control over subsidiary companies also reduces a risk of harsh competition for buying up the holding company itself and lays out the necessary groundwork for consolidating the companies shares and ultimately obtaining a controlling stake in the future.

The government in the meantime has reconsidered its initial plan to sell only 19.69% of Slavneft stake thus retaining government control and changed a scenario in favor of what some experts argued was going to be a more transparent and competition-enhancing deal of selling an entire controlling stake of 74.95%.

Sadly when the sale did go through on December 18, 2002 competition hardly triumphed. The 74.95% stake of about 3.5 billion went to Investoil, a Sibnefts and TNK frontage for $1.86 billion, a merciful increase over the starting price of $1.7 billion and significantly below expert estimates of $2-4 billion. Although the high end of that range was probably exaggerated given the TNK and Sibneft control over major stakes in Slavnefts subsidiaries, a fair auction and a higher return for the government could have taken place.

Even a faintest chance for competition was eliminated when TNKs and Sibnefts main possible rivals in the bid, Lukoil, Surgutneftegas and Yukos withdrew literally on the eve of the auction. The spokespersons for the companies muttered something about unexpected financial and legal difficulties. Rosnefts participation in the auction (legally murky from the very start, it is after all a state-owned company) was ordered to withdraw by a regional Court.

CNCP, a Chinese petroleum company and potentially the most dangerous rival was also forced to pull out under threats that its victory would be deemed invalid. Apparently the government suddenly changed its initial zeal to attract foreign bidders to the deal. All in all, companies withdrew from the auction and the 7 remaining were in one way or the other affiliated with the interests of TNK and Sibneft. Clearly, large privatization deals in Russia remain beyond mere economics, while political muscle still generates a lot more than simple respect.

As a result of the auction, the two winning companies now owe 98.96% of Slavneft shares. Although at this point it is unclear what kind of re-structuring the new owners plan to undertake, their attitude to minority stakeholders is obvious. Article 80 of the Law on Joint Stock Companies clearly states, than a majority shareholder (30% of shares and above) must make an offer to purchase shares from minority shareholders at a price no-lower than a month weighted average. The new majority shareholders at Slavneft, however, intend to avoid the cumbersome procedure by pushing for an appropriate vote in the general shareholder meeting.

Such unfair moves could be forestalled with right changes in the Law on the Joint Stock Companies that would specify minority shareholder rights in cases of mergers and buy-outs of 95% of shares and above. A similar law is already planned in the European Union.

The government approved the new 2003 privatization plan on August 20, (amended on October 9, 2002), according to which the revenue from privatization in INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru should amount to about 51 billion rubles. Please see table 1 for details on renewable sources of income. Land privatization is expected to generate approximately 2.2 billion rubles.

The privatization plan also calls for sale of 628 joint stock companies (including joint stock companies, or 95% from the total thus completing the privatization process) and 435 Federal unitary enterprises (fue). The remaining state-owned joint stock companies would continue to have state ownership of 51 and 25.5% of charter capital respectively (this sentence makes little obvious sense). fue, privatization of which is considered at the Ministry for Property as a primary goal for this year, would be re-organized into joint stock companies or sold in their entirety as commercial or industrial complexes.

In 2003, joint stock companies and fue in the agrarian, energy and defense industries would be affected the most.

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