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The successful passing of this bill becamepossible thanks to a compromise multi-level system of decision making withregard to privatization of objects. While it is President whose competenciesembrace strategic enterprises (nuclear plants, MIC, etc.) and particularly thelist of objects whose privatization is prohibited), the federal naturalmonopolies (the Ministry of Railway Transportation, RAO UES, and RAO Gazpromfall within the powers of the State Duma, while the other federal enterprisesare subject to the RF government’s rulings. As concerns privatization of regional and municipalproperty, the framework of a uniform approach suggested by the federal lawprovides that it is an authorized local agency that deals with this process. Inlight of this, the bill lacks traditional prohibitive lists, which implies thepossibility of privatization of practically any object. Accordingly, there willbe no conflicts between the Duma and the government with respect to annualapproval of the list of objects to be privatized and the annual (over 1998-2001) failure to pass the privatization program bills. It is envisaged thatannually in August the government should submit to the Duma the draft budgetwith the program of privatization of federal objects for the next year.

An important moment is the abolition of theregistration principle of privatization. While earlier an application from anindividual or an organization (alongside with the government’s initiative) was enough tostart the privatization procedure, now, according to the draft law, thisinitiative is not necessary to implement. It is also of principal importancethat the stipulations of the law are mandatory for each authority level in theRF.

Despite the noted positive innovations, thebill raises ambiguous attitude. According to some analysts, first, the billextends possibility for bureaucrats’ arbitrary actions(specifically, the possibility to amend conditions of a tender and thewinner’sobligations upon signing the respective contract) and intensifies inequalitybetween potential participants, regardless the principle ofparticipants’equality stipulated in p.1 of Art. 2 (especially with respect to procedures ofimplementation of privatization methods); second, the bill sets moresophisticated and labor-intensive procedures of privatization of theenterprises whose privatization is not prohibited. In other words, essentially,this concerns a considerable volume of stock packages remained in thegovernment ownership and not sold yet, due to various reasons. If suchrestrictions appear justified, as long as 700 strategic objects are concerned,their effect with regard to non-blocking minority stakes that should be sold byany means can be questioned.

Finally, a permanent absence of a clearprivatization strategy (apart from budget tasks) appears a clearly negativefactor. Once being designed, it should be based on the clear awareness of whichenterprises and sectors should be retained in the government ownership underany circumstances. Once this strategy completed, one could then startdiscussing the list of sales for a short-, medium and longer-term perspective.Such a list should obviously comprise both the sub-list of actually salable andattractive objects and the sub-list of non-liquid objects (due both tofinancial and economic indicators and already formed property structure). Aswell the Russian privatization suffers from traditional defects, specifically,transparency of deals and actual equality between participants in theconditions of systemic corruption, and in this case, sales procedures appear asecondary matter.

A special problem is the duration of theperiod of limitation for privatization transactions. The RF Civil Code and RFlaw No. 123 FZ of July 21, 1997, On Privatization of State Owned Property andon Principles of Privatization of Municipal Property in the Russian Federationcurrently in force do not stipulate a special limitation period with regard toconsequences of invalidity of privatization transactions. Accordingly, thegeneral period of limitation as set by Article 181 of the RF Civil Code isapplied to privatization transactions (10 years for the implementation ofconsequences arising from the invalidity of null and void transactions).

This period of limitation apparentlycreates an opportunity to carry out mass or contracted deprivatization ofpractically any privatized enterprise in Russia, depending on the political and(or) economic circumstances, since apparent or inadvertent offences, formalsmall mistakes, or farfetched pretexts may be found without much effort.It is also an ideal way to influence a company in terms of operativeadministrative pressure both at the federal and regional levels. For instance,the apparent risk that a company may be deprivatized in case there are foundany violation of the privatization law is one of the most serious obstacles toinvestment in Russia’s companies from the view point of practically all investmentinstitutions active in Russia.

However, in technical terms, it isdifficult to launch this process as a massive action. The two-sided restitutionpresupposes the necessity of compensation, what requires that a whole complexof problems must be settled: the stand with regard to bona fide purchasers(after a number of resales); the necessity to find funds to finance thecompensation (it will require a special budget item with targets for therespective year); a special method to evaluate shares; a special method for theevaluation of privatization coupons (vouchers); a special method to evaluateproperty complexes (of enterprises). There are also in place protection designsfeasible only for larger firms because of their cost intensity. An example ispresented as the Norilsk Nickel restructuring carried out after the GeneralProsecutor Office had demanded to return to the state the money allegedly notpaid in the course of privatization of the company.

On the whole, the necessity to reduce theperiod of limitation with regard to privatization transactions is justified.The respective amendment to the RF Civil Code to reduce the period oflimitation from 10 to 3 years was presented to the State Duma on November 30,2001 (the amendment was rejected). However, it would be enough to settle thislegal problem. For instance, the RF Criminal Code sets a 10 year period oflimitation for a number of crimes against the state. Apparently, in terms ofpolicy the reduction of the period of limitation with regard to privatizationtransactions is equal to a decision on tax amnesty. It may be maintained thatthe opposition to such an innovation will be exceptionally strong.

4.2. The State andCorporations

Consolidation of ownership, reorganizationof groups (holdings), intra- and inter-industry expansion remained the majortrends of the institutional development of the corporate sector in year 2001.This characteristic may be applied not only to largest private corporations andgroups, but also to a considerable degree to the policy of the state asrepresented by its executive branch with regard to the assets remaining in thestate ownership.

It is a known fact that the massprivatization in Russia resulted in the transfer of legal property rights forlarge Russia’scompanies to the hands of, first, small shareholders, predominantly employeesof enterprises. Second, foreign investors as the only participants ofprivatization having sufficient funds to buy shares at privatization auctionsbecame the owners of medium-sized blocks of shares. The state, which retainedcontrolling interest in companies in a number of strategic sectors of theeconomy, first of all, in the oil, natural gas, and metallurgy industries,remained the third owner of shares in privatized enterprises.

After large blocks of shares or controllinginterest in strategic enterprises were transferred to private investors in 1996through 1997 in the course of loans-for-shares auctions and investment tenders,there were formed prerequisites for the emergence of the market, or, moreprecisely, non-state transfer of ownership rights among economic agents. At thesame time, there were formed major financial and industrial entities(partnerships or personal interests), which play such an increasinglyimportant role in the modern Russia’s economy.

Having obtained partial control over one ora few large enterprises, groups faced the following problems arising as aconsequence of the mass privatization or presented by tax and forexconstraints:

- initially, a group had a relatively smallpercentage of assets of enterprises it controlled (as a result of multi-stageprivatization model the present owners of, for instance, of 49 per cent of TNKshares initially had only slightly over 12 per cent of shares in extractingenterprises, which were the actual owners of all fixed assets and licensees foroil extraction);

- at that time, the tax system allowed theindividuals owning companies to transfer about 10 per cent of profits generatedby the enterprises they controlled (not taking into account the share due tominority stakeholders) to their personal accounts in case they would run theirbusinesses absolutely honestly selling products at real market prices andwithdraw profits from their companies as dividends. After an honest split ofprofits with minority shareholders the controlling shareholders would receivefrom 2 to 5 per cent of profits depending on company.

- there were required considerablefinancial resources to reorganize the system of management of controlledenterprises, stimulate local and federal officials, to fight criminal groupsin regions, or cooperate with such groups. Naturally, there were also requiredconsiderable investment in production and funds to purchase technologicallyrelated enterprises, which became independent companies as a result of massprivatization.

- in a number of cases the controllinggroups also required resources to repay credits they used to purchase controlover enterprises.

An apparent way to meet these goals used bygroups controlling enterprises were:

- concentration of profits abroad by theway of transfer price setting with subsequent conversion of Rubles and illegalor gray export of foreign currency (large foreign banks and offshorefinancial structures, schemes where Russian residents purchase securitiesfrom non-residents), and also by the way of withdrawing profits via externaland internal tolling and setting too low export prices;

- after the funds obtained by the methodsmentioned above were transferred to controlled offshore companies, they weresplit up depending on priorities set by respective groups. In some cases moneywas withdrawn to personal accounts of group bosses; however, more often largegroups pursuing the aforementioned goals allocated the money for productionalpurposes (that is why these groups became large in stead of disappearing formthe Russian economy together with their owners).

The productional spending, alongside withaforementioned necessary investment, also included the investment aimed tostrengthen the juridical control and the parallel increase in the share incontrolled enterprises. In 1997 through 2001, large groups spend billions ofdollars to purchase shares belonging to minority and even controllingshareholders. It shall be noted that the majority of these funds left Russiafor good: the entrepreneurs of the first wave, who received them, haveretired and their investments, if any, are made as far from Russia as possible.The controlling groups also had to purchase blocks of shares belonging toforeign investors, who received them at the first stage of privatization andactively defending their rights in courts, mass media, etc.

Apart from purchase of shares, thecontrolling groups reduced minority interests in companies in other ways, forinstance, by eroding minority shares in the course of additional issues ofshares, premeditated bankruptcy of enterprises they controlled (upon obtainingcontrol over the bulk of creditor indebtedness of these enterprises), andexchanging shares in their own favor.

A comparative easiness of this process ofconcentration of their economic interests was caused by extremely low value ofminor blocks of shares, since the controlling groups concentrated practicallyall companies’profits in offshores, ephemerid companies, foreign traders and tollingers.Capitalization of the majority of Russia’s companies was extremely low,partly due to this robbing of companies, and partly due to the full collapseof the market after the crisis of 1998 and withdrawal of practically allforeign investors from Russia.

Year 2001 was in certain sense the finalyear of the epoch described above5. What are the current andmedium-term institutional trends

Intra- and intersectoral expansion of large groups basing inextracting industries seems to be close to its threshold. The factors behindthese developments are, first, a comparatively small number of freeattractive objects remaining available for purchase from private agents(including the first wave privatizators) or the state and being outside thespheres of influence of competing groups. As the privatization statisticsdemonstrate, the state has sold practically all its assets in oil, coal,aluminum industries, and ferrous metallurgy. Certain prospects arise inconnection to a comparatively limited number of non-privatized objects (forinstance, in the area of nuclear power, generating capacities in the electricpower industry, objects belonging to the Transport Ministry) and foreignexpansion on the part of largest companies. Second, in one to two next yearsthe financial resources appeared as a consequence of the crisis of 1998 willprobably be exhausted (first of all, in the oil and metallurgy sectors, whichwere the base for the property expansion in 1998 through 2001)6.

The process of mergers and takeovers,initiated by largest oil companies, was most typical in metallurgy, chemistry,coal industry, mechanical engineering, food industry, and forestry7.

The process of vertical consolidation (oil,natural gas, chemistry, metallurgy) caused the concentration of extracting andprocessing industries. It was most typical in industries involving aconsiderable number of technological processing stages and allowed to maximizethe group’saggregate income along the whole chain producing added value (also taking intoaccount the specifics of optimization of taxes and financial flows within thegroup).

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