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The trading on the secondary market isconfined to an extremely limited number of privatised enterprises. Thefirst such deals occurred in 1992-1993 (the shares of certain Far Eastern andSouth Urals enterprises, the department store GUM and some otherenterprises). As far as the structure of turnover, as reported by theMoscow Central Stock Exchange, i concerned, in 1993 only 10.6% was insecurities, and of these the shares of joint stock companies accounted for only13.6%, while 65.7% consisted of trading in securities of commercial banks andbrokerage houses. The low liquidity of the shares of privatised companiesis confirmed by analysis of off-market trading at the start of 1994: ofthe joint stock companies mentioned in the middle of 1993, three were listed onstock exchanges and twenty-one were not listed; the three were Permavia,Voctochny Port and GUM.

In January-September 1994 all the stockexchanges in Russia together were trading in the shares of some 70enterprises. While at the outset all occasional trading was on theregional stock exchanges and involved the shares of local enterprises, when theauctions of major enterprises and enterprises of the fuel and energy complexwere completed, the markets in these shares became more dynamic, especially onthe Moscow stock exchanges.

Yet the exchange and off-exchange marketsstill exist as markets divided into closed regional enclaves which do not havesufficient connections for safe circulation of securities and other relatedmonetary assets. More than 90% of the securities (basically local issueswithin a region) traded in all transactions in June 1994 were quoted only onone exchange, and more than 97% on no more than two exchanges. As aresult, investors' funds are locked in their own regions and are pumped out tothe Moscow financial market through the bank networks, bypassing the securitiesmarket (Mirkin, 1994a).

If there is competition, share prices onstock exchanges or other markets may reach several hundred times the nominalvalue. It goes without saying that the underlying reasons are not theclassical economic factors that affect prices, but again a desire (and weshould mention here directors first of all) to do the utmost to establishcontrol of an enterprise. This is why, for example, the fact that themarket price of the shares of one of the largest enterprises in the fuel andenergy complex, Surgutneftgaz, is 12 times the nominal value does not at allmean that the company is less attractive for an investor than the Komsomoletspaper and pulp factory, for which the tender price for shares exceeded thenominal value 291 times (MIFR, 1994a) or the Lebedinsky Integrated MiningWorks, whose shares were sold at a price exceeding the nominal value 1127times.

All in all, to judge by the results of thefirst half of 1994, the volume of stock trading at the 17 leading stockexchanges of Russia exceeded 50 billion rubles, with 75% of the total turnoveron 5 Moscow exchanges: the Central Russian Universal Exchange, the MoscowInternational Exchange, the Russian Exchange and the Russian Commodity and RawMaterials Exchange (stock division). Almost 20% of the total turnoverconsisted of the shares of privatised industrial and trading enterprises.It should also be noted that privatised industrial and commercial enterpriseswere the issuers of the largest blocks of shares sold in 1994 on the stockexchanges.

Starting from July 1994 there was a markedshift in the sectoral structure of the stock exchanges with shares ofindustrial and trading enterprises coming to the forefront. For example,for one week alone in August 1994 the volume of transactions in this segmentamounted to 15.5 billion rubles or 63.1% of the exchange turnover (MIFR,1994b). In absolute terms this sum is 1.5 times higher than thecorresponding figure for the entire first half of 1994. This isattributable to a series of factors.

Firstly, more and more new securities ofprivatised enterprises are being floated on the Russian market, and thesesecurities, irrespective of their quality, outweigh other segments of themarket/32/.

Secondly, shares in the largest enterprisesof industry and the fuel and energy complex, /33/ which are in strong demand,are now on sale. There is a fierce competition for these blocks of sharesand the major participants are large shareholders, the management and foreigninvestors. In cases the management of these enterprises tried in everyway possible to block the appearance of new shareholders, including foreignshareholders.

Thirdly, and this is the most importantfactor in the dynamic growth of quotations of major enterprises, the first halfof 1994 saw the volume of portfolio investment by Western financialinstitutions in the stock of Russian privatised enterprises reach $400million. Estimates are that if the conditions are favourable the secondhalf year may see investment go up by some $600-800 million (Skatershchikov& Zinkevich, 1994). Actually, with almost no secondary retail marketin the shares of the largest enterprises and with heavy demand from foreigninvestors, the prices of shares are being determined by a narrow circle ofrepresentatives of foreign investors and Russian intermediaries.

As a rule, that strategy of foreigninvestors is to acquire initially at least 2-10% of the shares in a company,with a subsequent aim of acquiring a controlling interest of 25-30%. Theacquisition of 10% of the shares will make it possible to nominate a member ofthe Board of Directors. Most foreign buyers make use of the services ofWestern intermediaries, who either act directly or themselves employ Russianinstitutional intermediaries or brokers.

At the same time, there are no signs thatin the near future one can expect any marked growth in the number ofenterprises whose shares are the object of secondary trading in the `classical'sense. First of all, the fixed assets of most of the enterprises areseverely depreciated and therefore profits are likely to be used for thepurpose of modernisation rather than dividends. The market value ofshares is expected to increase due to simple revaluation of the fixed assets(if we abstract from the demand associated with the struggle for control);however, getting revenue from the resale of shares will be limited by theilliquidity of most of the shares (Shvetsov, 1993). At the same time,these factors do not play a significant role in investmentdecisions.

The control motive still remains a dominantforce for most of the trading. The most important motive for foreigninvestors is the relative cheapness of most of the assets of Russianenterprises. Finally, speculation was an important factor in the rapidgrowth of quotations of certain shares in summer 1994.

In the short and medium-term perspectiveone can probably expect the following developments on the secondary market,which, despite the overall demand, may cause a sharp drop in the prices ofshares which are of far from first quality:

- financial difficulty or lack ofreal strategy for the future - something quite characteristic of manyenterprises - may cause a direct sale of a portion or the full block of sharesthat have been accumulated by the management;

- voucher funds may sell a numberof blocks of shares they have acquired at voucher auctions to pay their ownshareholders and to improve their financial position;

- if the secondary market isoverheated, one can expect dumping of a part of the stock accumulated by theintermediaries who were buying in order to resell later;

- it is quite possible thatblocks of share will be resold if they are secured in the form of federalproperty;

- many enterprises may try toimprove their situation by resorting to a second issue of shares, which canhardly be placed by means of open subscription, without a specific investorinterested in it.

Thus, while a potential investor may have agood chance to acquire a considerable portion of the capital of an enterpriseon attractive terms, there may be a situation of crisis for the securitiesmarket, which is quite weak by itself. This model of privatisation hasprovided no solution to the problem of attracting real investment. Thequestion of the strategy of privatisation since the middle of 1994 and theproblem of a favourable environment for the post-privatisation development ofRussian enterprises is now extraordinarily important.

Chapter9. Reform in the `Post-Voucher Epoch'

9.1. Radical Change of Landmarks

As in the case of the two previousprivatisation programmes, the adoption of the new programme was preceded by along and extremely politicised debate in the State Duma, the government, thebusiness community and public circles in Russia. The first Parliamentaryhearings in March 1994 on the issue of privatisation began although, thenecessity of drawing up a new programme served only as grounds for most of thefactions and parties to wage a bitter fight - a fight that was largelyirrational and designed for self-advertisement - to criticise the voucherprivatisation and its architects. However, it may be regarded as anindisputable achievement that now practically nobody spoke againstprivatisation as such. And, without the slightest doubt, one should takeinto account not only ideological motives but the critics' awareness that itwould be suicidal for their political career if they opposed privatisation whenmore than half the enterprises in Russia had already beenprivatised.

Through most of July 1994 no solution couldbe found to the question to present a new privatisation programme from thelegislative point of view - through a federal law (this is a prerogative of theParliament) or through Presidential decree. Only on 22 July 1994 was atemporary solution found (until a law is passed by the federalgovernment): the President of the RF signed a decree which set forth theFundamentals of the State Programme of privatisation of state and municipalenterprises in the Russian Federation after 1 July 1994. Since it doesnot run counter to the current programme of privatisation, the programmeapproved by the President in December 1993 also remains in force.

First of all, the second stage of Russianprivatisation, which was begun in July 1994, should be qualitative in nature,in view of the real purpose of the previous stage (see Chapter 7). In itsbroadest sense this stage should be directed to ensuring effective and legallyguaranteed passage of the property rights acquired in the course of the initialdistribution to owners who bear real responsibility (see Chubais,1994).

As far as privatisation as such isconcerned, the new programme is a change over from the system of freeallocation of property to real sale, from accelerated `privatisation for thesake of privatisation' as a quantitative reform base - to a rather slowprivatisation designed to ensure restructuring and investment. In otherwords, the new privatisation model should incorporate two key ideas determiningthe procedure of `large' privatisation: investment orientation of salesand opportunity for an investor to get a major shareholding in the initialplacement of shares. Let us now look at the key innovations of theFundamentals in greater detail.

1) The main items of privatisationat the new stage comprise three types of property: state-owned blocks ofshares in privatised enterprises, land of privatised enterprises andproperty. The value of the latter will equal if not exceed that of theprevious stage, this approach was based on evaluation of the effective demand(Appendix 2).

As to the traditional list of restricted branches and lines ofproduction, the norms set out in the second programme remain in force.This means that a considerable number of specific sectoral features willremain; there are, of course, too many of them. Yet at the same timereduction of these prohibition lists is necessary owing to the dilemma that thestate faces today: either it must attract the financial resources tosupport these enterprises or it must privatise them.

2) Transition to a money model ofprivatisation is expected greatly to enhance the budget receipts of all levelsfrom sale of state-owned blocks of shares, newly privatised enterprises andproperty. At the same time there is a broad range of estimates of thelikely revenue of the federal budget in 1994. While the budget passed bythe Parliament on 24 June 1994 (first reading) sets revenue from privatisationat a figure of 1224 billion rubles (and all revenue in excess of this sum is tobe directed to a special fund for housing for the military), the GKI estimateis much more modest: about 500-600 billion rubles or, at the utmost, 900billion rubles. Some absolutely unreal figures were also advanced:one envisaged up to 20 trillion rubles. One should also bear in mind thefact that the revenue from the sales agreed in 1994 will mainly go into thebudget in years to come. in addition to everything else, this means thatthere is a potential social conflict over failure to fulfil commitments by thisfund.

3) As to the valuation of propertyin the course of privatisation GKI retains its formal position: the finalselling price should be determined on the basis of auctions and tenders (i.e.through open bidding and money auctions). Yet the initial reserve pricehas been raised and it is based on one of the revaluations carried out after 1January 1992. Although in total (after all the revaluations that havebeen made) the book value of the enterprises has gone up approximately 800-1000times (Demchenko, 1994), for the privatised enterprises it means that there isan increase in the book value of property of some 10-20 times. Suchgrowth, in the opinion of the GKI management, reflects the existing marketconditions that have to be taken into account when selling property at auctions(Vasiliev, 1994a).

This sort of revaluation should also affect the state-ownedblocks of shares in enterprises that have already been privatised, which willbe offered for investment tenders. Many of these blocks are now veryclose to controlling blocks of shares and for that reason their real value isnot reflected by the nominal value determined according to the old bookprices.

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