Privatization in Ukraine – a historic opportunity for both Warsaw and Kyiv?
Polish companies are facing an opportunity. In connection with the privatization of state assets in Ukraine, there are new prospects for them to expand abroad. Kyiv, with the support of the West – i.e. of the European Union, the International Monetary Fund and the United States – is reforming the country’s political and economic system. The Polish government and its subordinate agencies should support domestic companies that wish to participate in privatization in Ukraine. In October, PGNiG entered into a ground-breaking agreement on this matter, and other Polish entities should follow suit.
Poland as inspiration for Ukraine?
Polish economic transformation has undoubtedly been a bumpy road, but clearly the one in the right direction. In its first phase, the Third Polish Republic suffered an economic crisis and the collapse of inefficient industrial plants, which resulted in high unemployment. After the stage of chaos, the time came for a gradual rebound. When it was clear that there is no return from the course toward democracy and the free market economy, Poland became an increasingly interesting country for foreign corporations. It was seen as an attractive place to sell goods.
As Poland’s credibility was strengthened, capital flows grew, which were partly intended for the purchase of Polish plants, thus often causing controversy in Poland. However, there were also many greenfield investments, which created new jobs, allowed for technology transfer and learning modern management methods. Investments were initially made with low labor costs in mind. However, gradually, business requiring more competence has emerged in Poland. Foreign giants began to move more advanced processes here. The domestic companies grew, while learning from foreign competition and benefited from the increasing purchasing power of Poles. In many industries (e.g., the food sector), Polish companies have successfully started competing with the West.
More and more companies in Poland have started exporting goods abroad. After acquiring the know-how and reaching the limits of expansion in the Polish market, they began to seek new outlets more and more intensively, often with success. Between 2000 and 2018, Poland’s share of world trade had increased by more than 2.5 times, which was one of the best results in the world. Even against the backdrop of the rapidly developing exports of the region of Central Europe, our country has had a record pace of growth. Moreover, contrary to the Czech Republic and Germany, Poland has a relatively high share of domestic capital in the export of industrial goods. It is good news that they include not only large, but also medium-sized companies, and that more and more new entities are looking to expand abroad from the beginning.
Though bumpy, Poland’s path could be a positive example for the further development of the Ukrainian state.
The last step is still ahead of Poland
After the time of crawling, it is time for maturity. In order for Polish companies to develop further, the next step is a bolder investment expansion especially in countries with lower levels of development, as the Responsible Development Strategy clearly emphasizes.
The report of the Polish Economic Institute of December 2019, Foreign investment expansion of Polish enterprises – trends, perspectives, indicates that the cumulative value of direct investments from Poland at the end of 2018 amounted to PLN 28.5 billion (only the 3rd place in Central and Eastern Europe – behind Hungary and the Czech Republic).
These statistics, built based on UNCTADstat data relative to GDP, show an even bleaker picture – Poland is at the 7th place in the CEECs (USD 748)! Estonia, which leads in this ranking, has an eight times higher investment ratio per capita (USD 6,085) and the Czech Republic has a four times higher ratio (USD 3,271). According to the report, only 10% of Polish exporters invest abroad. This shows how large the gap between the increase in sales of goods and the expansion of capital is.
Today, after 30 years of capital development and accumulation, it can be argued that for the first time for many centuries Polish companies are starting to have resources for a stronger foreign expansion. This applies not only to large state-owned companies, although they naturally pave the way. More and more Polish companies are starting to treat foreign markets not only as a potential place for marketing their own goods, but also as a place for investment.
If the Polish economy is to catch up with the West, we must do what is currently the source of additional profits for Western companies – look for places to invest the slowly growing Polish capital, where it can obtain a higher rate of return. This is a particularly pressing need, given the increasingly difficult expansion of the Polish market, which is already mature, and the increasingly expensive labor force. The role of not only companies but also authorities should therefore be to monitor promising places. Countries whose development as well as internal and external security are in the interest of Poland, such as Ukraine, are particularly important.
Ukrainian window of opportunity
Kyiv should become one of the priority directions for Warsaw. The close proximity and improving infrastructure reduce investment costs. The ability of Polish companies to navigate in conditions of unfavorable institutions and legal uncertainty, which they have acquired in their domestic market, is a significant advantage over numerous companies from the West, which are not accustomed to operating in an unfavorable regulatory environment. In addition, the privileged position of Polish companies comes from already acquired experience in cooperation with the Ukrainian side. Currently, many Polish companies are already active in Ukraine. Increasing investment would, therefore, be a natural step for many companies in their foreign expansion.
The positive changes that have taken place in Ukraine over recent years are important. In spite of the conflict with Russia, thanks to the association agreement with the EU and the International Monetary Fund (IMF) activity, real Europeanization of many areas of public life is taking place in the country. It is often the result of strong external pressure and the policy of conditionality (macroeconomic assistance in exchange for reforms).
The results of Kyiv’s policy are increasingly promising in the area of conducting business. The government has clearly expressed its support for Western orientation, and not for the very uncertain balancing between the East and the West, which had been a characteristic feature of Ukraine’s foreign policy until the outbreak of the war in Donbass.
From the point of view of Polish interests, the privatization of many state assets, which takes place according to new rules dictated by the IMF, should be particularly interesting. Although this is not an easy decision for Kyiv in political terms, Ukraine is forced to respect the expectations of the Fund if it wants to receive further installments of aid. The IMF policy therefore creates a “window of opportunity” for Polish companies, as strategic assets are to be sold to private entities. The low price expected by investors is a consequence of the low confidence of international business in Ukraine.
The political context is also important. Ukraine is a strategic partner of Poland, whose Europeanization and economic development are in the vital interest of our country. Kyiv has every asset to become a testing ground for Polish business and a valuable political and economic partner.
The involvement of international institutions in the reforms of the national economic and political system is an important factor reducing the investment risk in Ukraine. These entities have a tool to influence the government in Kyiv in the form of conditional macroeconomic assistance. The political and economic model promoted by these institutions is based on the rule of law and the principles of the liberal economy, and one of its objectives is to increase the level of foreign direct investment.
New privatization law in Ukraine
So far, massive privatization in Ukraine has failed because foreign companies have been afraid of unclear procedures, corruption, and the weak state judicial system. Another reason was the strong influence of oligarchs, who feared that transparent rules would weaken their position.
Ukraine has an opportunity to carry out a structured and transparent privatization of state assets. On March 7, 2018, with the support of the EU and the IMF, a new law, On state privatization and local government property, entered into force. It has introduced transparent rules for the sale of state assets, and it aims to encourage foreign entities to invest. The adoption of privatization law was a condition for the disbursement of an installment of macroeconomic assistance in the amount of USD 1.9 billion from the IMF.
The initial price in the auction of large-scale privatization facilities shall be determined by an external adviser or an auction committee in accordance with the valuation methodology approved by the Ukrainian Government with the support of international institutions.
The act also introduced additional guarantees for investors. For example, certain transactions (loans, land sales contracts, and shares) can only be carried out after the transfer of ownership to the entity that won the auction. Russian entities are directly excluded from the privatization process.
In the first round of large-scale privatization – companies over UAH 250 million (approx. EUR 8 million) – 23 plants were intended for sale, including distribution network operators, power plants and combined heat and power plants, a fertilizer plant as well as ore mines and titanium processing plants. The Ukrainian authorities planned that some of the assets would change ownership by the end of 2018, but this date turned out to be unrealistic. The delays were caused by the institutional weakness of the state and by the electoral campaign underway at that time.
Despite the electoral promises, to date, the arrival in power of Volodymyr Zelenskyy has not proved a breakthrough in improving the investment climate and progress for foreign actors. The process of privatization remains slow (annual privatization plans are still not being implemented), although the revenues from it were to be crucial for the Ukrainian state budget, additionally weakened by the crisis. Corruption and significant problems in the reform of the justice system affect the risk analyses of investors outside the country.
However, it must be acknowledged that progress is being made. It is particularly important to highlight the end of the stalemate following the change of power related to the process of unbundling (separation of transmission and manufacturing activities which is necessary to introduce real competition on the market by removing competition discrimination tools) of the state company Naftohaz, due to which an independent pipeline operator, Operator of the Gas Transmission System of Ukraine (OGTSU), was established, which controls transit pipelines. Although the real independence of the OGTSU from political and oligarchic pressure is being called into question, it is certainly a step in the right direction.
The Polish government wants to take advantage of the liberation of the Ukrainian economy. On October 13, 2020, during the visit of President Andrzej Duda in Ukraine and the related Polish-Ukrainian business forum, President Zelensky openly invited Polish companies to increase their presence in Ukraine and to participate in privatization. He expressed hope for a significant increase in foreign direct investment (FDI) from Poland, which currently amounts to (only) over USD 800 million, as well as trade, which was worth about USD 7.7 billion in 2019 (Poland is the 2nd largest importer for Ukrainian exports).
Pleased to welcome @AndrzejDuda in #Kyiv. Together we gave a new impetus to the relationship between #Poland and #Ukraine. We are determined to boost bilateral trade and strengthen economic ties. Looking forward to ???? Forum in #Odesa. pic.twitter.com/APzPMUPIX4
— Володимир Зеленський (@ZelenskyyUa) October 12, 2020
Natural gas as bridge for cooperation
One of the fields in which Polish corporations see their chances is the energy sector. As the Ukrainian authorities starting adapting to EU guidelines and regulations, the transparency of the natural gas market in Ukraine has increased considerably. Gradual liberalization of the gas market increases its attractiveness to foreign investors, including those already present on it, like Poland.
In 2019, approximately 13% of Ukrainian gas imports came from our country and their volume amounted to 1.4 billion m3. In addition, since January this year, Kyiv has taken advantage of the virtual reverse with Poland (part of the gas bought by Poland ultimately stays in Ukraine) and it is planned to expand the Polish-Ukrainian interconnector, which would allow a three-fold increase in gas transmission to even 6.6 billion m3. Gas cooperation and its further prospects are strengthened by the terminal in Świnoujście, through which the first deliveries of liquefied gas (LNG) purchased by our eastern neighbor, i.e. from the United States, have arrived.
On October 14 this year, Polish energy giant, Polskie Górnictwo Naftowe i Gazownictwo (PGNiG), signed an agreement with the State Property Fund of Ukraine on the confidentiality of sensitive data related to state assets that are planned to be privatized. Thanks to the agreement, PGNiG can start the process of assessing the viability of potential acquisitions as part of the privatization of the energy sector in Ukraine.
Unofficially, several combined heat and power plants are to be modernized from coal to gas supply, and to this end, there is a need for large funds that PGNiG can provide through its participation.
The energy company, which is the largest in Poland in terms of stock capitalization, also plans expansion related to natural gas extraction from Ukrainian deposits, which are significant. Kyiv has been announcing for years the plans to use them to achieve gas self-sufficiency, but difficult access to deep deposits requires large funds and the modernization know-how: these are still the barriers that have not been broken. PGNiG sees an opportunity in hydrocarbon extraction projects in Ukraine. In the first half of next year, the search for suitable deposits in the territory of our eastern neighbor is set to begin.
What should Poland do?
Support for Polish companies that wish to participate in privatization in Ukraine should be a priority of the Polish government. The experience gained from the sale of the Polish State Treasury assets may be applied to the Ukrainian privatization of state assets.
Polish diplomacy and specialized state agencies, e.g., the Polish Investment and Trade Agency (PAIiH) and the Export Credit Insurance Corporation (KUKE) should engage in the process. By creating appropriate financial instruments, they can reduce investment risks and thus encourage Polish companies to expand.
It is also important to support the EU’s and IMF’s engagement in reforms in Ukraine, which reduces investment risks also for Polish companies. Support for the participation of smaller domestic companies in a properly planned joint ventures with other foreign entities could further reduce credit costs and political investment risks with the final bonus at a similar level.
Poland should take another step in its transformation and become much more involved in investing abroad. Ukraine seems to be the right direction. Polish-Ukrainian economic cooperation enhanced in this way can provide mutual benefits, thus accelerating the development of both countries. Poland and Ukraine should not let this opportunity to pass by.
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The publication co-financed by the Ministry of Foreign Affairs of the Republic of Poland as part of the public project "Public Diplomacy 2020 – new dimension" („Dyplomacja Publiczna 2020 – nowy wymiar”). This publication reflects the views of the author and is not an official stance of the Ministry of Foreign Affairs of the Republic of Poland.