DAFFE/PRIV A. INTRODUCTION AND BACKGROUND. 1. Political and Economic Context

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1 A. INTRODUCTION AND BACKGROUND 1. Political and Economic Context Since the collapse of the Communist regime in 1989, Bulgaria has made a major effort to restructure its economy. While the process of political transition started in 1989, significant economic reforms did not begin until Like many transition economies, Bulgaria encountered both internal and external challenges to reform. State control of production and tremendous price distortions created difficult internal conditions while dependence on trade within the former Soviet block created a massive fall in export flows and foreign exchange currency. Between 1991 and 1996, the political situation was fragmented, the pace of economic reforms was slow and often inconsistent. Political uncertainty, with eight different governments between , combined with slow progress to implement reform measures early in this period led to a host of financial, social, and economic problems that undermined credibility in economic management. This culminated in late 1996 and early 1997 with the implosion of the banking system, hyperinflation, and a subsequent dramatic depreciation of the local currency. Following the severe financial and economic crisis, two factors contributed to the significant improvement in Bulgaria s macroeconomic environment and commitment to reforms. First, the new pro-reform government, elected in May 1997, has made a commitment to expedite structural reforms to achieve sustainable economic growth and make Bulgaria a viable candidate for European Union (EU) accession. Second, it put in place what has proven to be a successful macroeconomic stabilisation programme, based on the IMF s 1997 stand-by agreement and the introduction of a currency board under which the Bulgarian currency (BGL) is linked to the deutsche mark (and will eventually be linked to the Euro). This dramatically changed the macroeconomic policy framework and has allowed the government to focus its attention on sustaining growth through a renewed commitment to structural reforms. Restoring the interest of foreign investors and accelerating the pace of privatisation has become the main pillar of the government s reform strategy Bulgaria As a result, a number of regulatory changes were made in 1997 and the pace and quality of privatisation began to show signs of improvement. However, there is still room for considerable improvement. It is hoped that the terms of the recently approved Extended Fund Facility (EFF) will continue to generate high-level political support and a sustained momentum for reforms. As part of the conditions set by the IMF and World Bank for access to credit facilities, the Government of Bulgaria (GOB) has committed to selling a substantial number of major state-owned-enterprises (SOEs) to foreign investors in On the supply-side of privatisation, an effort has been made to offer a more attractive selection of enterprises, including major companies such as the Bulgarian Telecommunications Company, Balkan Airlines, Bulgartabac Holding, National Electricity Company, and others. On the demand-side, a new approach, using international privatisation intermediaries, has been launched to allow for greater foreign participation in the privatisation of key strategic enterprises. The GOB has set the official target date for completion of the current privatisation programme for late 1999 to early Institutional and legal framework After eight drafts presented to Parliament in June 1990, the Privatisation Law, Transformation and Privatisation of State-Owned and Municipal-Owned Enterprises Act was finally passed in It sets out the basic principles for and process of the transformation of SOEs into the private sector under the Commercial Code. The law establishes the objects subject to privatisation 1 ; the institutions responsible for 1 The objects of privatisation are: state-owned and municipal enterprises transformed into companies; state-owned 1

2 implementing the privatisation transactions; and types of privatisation transactions and methods. As of August 1998, fourteen amendments have been made to the Privatisation Law. Numerous additional amendments have been recently proposed which seek to address some of the key impediments to privatisation. These are related to both the institutional process and privatisation techniques. Many of the issues were identified during the preparation and negotiation of the EFF and are related to the conditionality of the loan. All the revisions and proposals to the Law have been grouped together and presented with the 1999 programme of privatisation. B. PRIVATISATION POLICY ISSUES I. Current general issues Institutions responsible for privatisation of SOEs under Article 3 2 The Privatisation Agency (PA) was established in 1992 to develop the annual privatisation plan and execute the sale of enterprises whose book value at the time exceeded 70 million BGL (the threshold was raised to 350 million BGL in 1997 and now again to 1 billion BGL). In addition to its function as the main privatisation body, its mandate has been recently enhanced to serve at the co-ordinator of the entire privatisation process. The PA is managed by an Executive Director and a Supervisory Board appointed by the Council of Ministers. Branch Ministries exercise the state s rights of ownership over small and medium-sized enterprises (agriculture, industry, tourism, transport, etc.). Their competence covers the privatisation of enterprises whose fixed asset book value does not exceed 1 billion BGL. Municipal Councils manage the privatisation of municipal enterprises as well as municipally owned shares and interests in these firms. The Council of Ministers is responsible for enterprises included in the mass privatisation programme, which is administered by the Centre for Mass Privatisation (CMP). The list of privatised enterprises must be approved by Parliament on a yearly basis. Privatisation in Bulgaria began in 1992 with the land restitution programme and continued in 1993 primarily through direct negotiations, tenders, auctions or MEBOs. Between 1992 and 1997, divestiture of state ownership concerned less than 20 % of the state s long-term fixed assets. This hesitant start reflected the lack of a pro-reform consensus, the strength of vested interests defending the status quo and the shortage of administrative resources. The limited interest of foreign investors and increasing macroeconomic imbalances also had a negative impact on privatisation. In the second half of 1996, amid the severe economic crisis, the implementation of an emergency programme offering a number of the largest state-owned enterprises helped to accelerate privatisation. This momentum was carried over into early 1997, during the term of the care-taker cabinet and continued with the appointment of the current government. Relative to the early years of transition, 1997 showed signs of significant progress in privatisation policy. The PA entered into transactions worth a total of $ 1.5 billion (of which $ 572 million were cash payments, compared to $ 185 million in 1996), an amount roughly equal to the cumulative sum of such contracts for This turnaround can partially be explained by the fact that many privatisation projects had reached fairly advanced stages and then had stalled. A change in the (stocks and shares) and municipal enterprises not transformed into companies (sold as commercial entities under the commercial code); autonomous parts of SOEs and municipal enterprises (regardless of whether they are companies or not) are sold as independent property; land, buildings, machines and equipment; objects of uncompleted construction; and fixed assets. 2. The Law also provides for some flexibility to delegate responsibility to outside agents on a contract basis, such as the EU-funded Privatisation Advisors and Transaction Agents (PATAs). 2

3 political climate brought them to completion relatively easily. Acquisitions by foreign investors also contributed to the acceleration in cash privatisation, a welcome signal since Bulgaria does not rank very high among FDI recipients in transition economies. The recent government wants to build upon initial successes in 1997 by accelerating and deepening structural reforms. To accomplish this, it has made a commitment to pursue a broad array of structural reforms: the acceleration of privatisation is the main pillar of the Bulgaria 2001 programme. The objectives include the privatisation of all commercial enterprises, as well as a significant part of the utilities, by end-1999 representing about 70 % of fixed assets. However, to successfully achieve this ambitious target, the pace of privatisation should be greatly accelerated considering the disappointing results in the first half of The World Bank estimates that 25.8% of long-term assets have been privatised through July , which is below the expected 40%, outlined in their loan conditions. Cash privatisation accounts for approximately 15% of long-term assets, the first wave of mass privatisation resulted in the transfer of ownership of 8.8% of long-term assets, and some 1.2% were achieved by sales of assets through liquidation proceedings. Privatisation techniques under the Strategy for Accelerating Privatisation The new government s privatisation programme has adopted a flexible and complex approach, employing a wide variety of privatisation methods. These include: Pool privatisation: Sale of large enterprises through primarily international privatisation agents/contractors in 2 programmes: EU-funded privatisation advisors and transaction agents (PATA programme) and international consultants funded by other donors such as USAID and World Bank. Public offerings of majority (representing 2 per cent of long-term fixed assets) and minority stakes (another 2 per cent) of state-owned enterprises on the stock exchange. Direct sales, auctions and centralised tenders (the latter will be used to a lesser extent than in previous years) by the PA. Privatisation of a large number of small and medium enterprises via management and employee buy-outs (MEBOs). Tenders for small and medium-sized enterprises will be organised by the branch ministries. Further use of foreign debt (Brady) and domestic debt (ZUNK bonds) 3 instruments in privatisation transactions, including by domestic non-bank residents. Widespread use of privatisation vouchers (as a second mass privatisation wave) in a variety of transactions, including MEBOs. Competition between bidders for cash and vouchers is authorised; individuals can use their vouchers and bid either directly or via pension funds. 1) What is the importance of privatisation in the government s structural reform programme? What are the government s main objectives and plans for acceleration of the process? 2) What are the main institutions involved in privatisation? Are their mandates and competencies clearly designed? Is their capacity adequate? 3 Since December 1997, Brady bonds (debt-for-equity swaps), issued to restructure the foreign debt of the country, may be used for paying up to 50 per cent of a privatisation deal (for state-owned assets only), and they are considered at par value. The internal debt bonds, (ZUNKs) which have replaced the non-performing loans in banks portfolios, can also be used as a means of payment in privatisation. Both internal and external bonds are used at a discount off the par value. 3

4 3) What are the main methods used? What are the initial results of the programme? 4) What are the main obstacles and problems? How are the problems being addressed? II. Systemic Privatisation a. Mass Privatisation The government initially intended cash sales to be the primary method of medium and large enterprise privatisation. However, recognising the political difficulty of pushing through an effective larger privatisation programme, a voucher-based mass privatisation programme (MPP) was launched in 1994 largely based on the Czech model. A specific feature of the programme is that it combines cash and mass privatisation for the same enterprises. The MPP was designed to quickly privatise a large number of companies, establish viable investment funds, support the development of the stock exchange and eventually a secondary market for shares of companies and privatisation funds, and to improve corporate governance based on financial intermediation. The legal and institutional framework, including relevant amendments to the Privatisation Law, were adopted in 1994 and finalised in The Center for Mass Privatisation (reporting to the Council of Ministers) was created to oversee this programme, manage the organisation of the centralised public auctions and the issuance of vouchers. The PA and branch Ministries, however, decide upon the selection of enterprises and information prospectus which means that the CMP serves largely as an administrative body for handling the issues related to vouchers. The first wave of mass privatisation began in January 1996 and was successfully completed in Three million eligible citizens acquired shares in 1,050 enterprises (nominal value of $3.1 billion), representing about 8.8 % of long-term fixed assets. The lower than expected public interest can partially be explained by the crash of financial pyramids in 1995, just before the MPP was launched and the delayed licensing of privatisation funds. Voucher holders participated either indirectly, by exchanging their vouchers for shares 4 in 81 privatisation funds 5 (15 of which have foreign participation); directly, by bidding for enterprise shares at the centralised public auctions; or employees, managers and former employees could acquire up to 10% of the shares offered for mass privatisation free-of-charge. According to preliminary data, privatisation funds acquired 87 % of the shares of the mass privatised enterprises. Of the total enterprises offered, 747 were majority privatised. The residual shares of these enterprises are now being offered for cash, will be included in the second voucher wave. The second voucher-based mass privatisation wave was adopted in July The first public auction was expected to take place in early September but has been postponed given that the list of enterprises is not finalised. The rationale behind this second wave is the insufficient privatisation demand from foreign and domestic strategic investors in the context of cash privatisation. Non-tradable, dematerialised vouchers will be issued and distributed to the adult population for a symbolic fee. They can be used in all types of 4. Shares are available in the following three categories: (i) 25 % in large enterprises; (ii) up to 67 % in mediumsize firms in which the state wishes to retain a controlling interest; (iii) and up to 90 % for most small and medium-size companies (10 % is retained primarily for restitution claims). 5 A sound legal framework for privatisation funds was established in December 1995 when the Privatisation Funds Act was adopted. Subsequently, the Council of Ministers appointed the members of Bulgaria's Securities and Exchange Commission (BSEC), which began to monitor the activities of the privatisation funds. Privatisation funds were subject to strict licensing requirements and were required to submit applications and prospectuses to BSEC for approval. 4

5 privatisation transactions, including cash deals, directly bidding shares in centralised public auctions, indirectly through a licensed investment intermediary, or used in order to purchase shares in MEBOs. Foreign investors can participate in the process by acting as an investment intermediary or as a partial owner of a voluntary pension fund. Foreign citizens may also participate in the centralised public auctions but only with cash, not vouchers. The mechanism for participation in mass privatisation through voluntary pension funds is being established. However, it remains to be seen whether the capitalisation of the pension system through mass privatisation can create a solid base for either pension reform or better corporate governance and entrepreneurship. 1) What are the results of the first mass privatisation wave? What is the impact in terms of corporate governance? 2) What is the evidence on the performance of mass privatised enterprises? What institutions are responsible for the management of the residual state shares in mass privatised enterprises? 3) What are the main reasons for implementing a new voucher wave? What are its main characteristics, initial results and main difficulties for its implementation? 4) What is the role of the various privatisation institutions in the new voucher wave? How are responsibilities co-ordinated? What is the role of pension funds? 5) What is the role of privatisation funds in the management of enterprises? Has there been progress in the participation of the funds in trading at the Stock Exchange? What other methods for consolidating their portfolio have been used? 6) What is the status of the transformation of the funds into holding companies and investment funds? What are the initial results, procedures for this transformation? What is the time-frame? b. Isolation Programme (Liquidation or Rehabilitation of larger troubled enterprises) To address the problems of financially non-viable enterprises, two separate financial and restructuring programmes were launched during the 1996 financial crisis. The initial liquidation programme sought to close down 64 loss-making enterprises, and by mid-1998 all but eight had been closed or sold. In July 1996, 71 companies -- accounting for approximately 75 % of state enterprise losses and 7.6 % of longterm assets -- were included in the new Isolation Programme. Companies in the programme are cut off from bank financing, and are prevented from running arrears. Companies are prohibited from incurring new debt, while their is a moratorium on existing debt. The new source of external finance has been a special Rehabilitation Fund, managed by the Ministry of Finance; the World Bank and the European Union monitor its implementation. The isolated enterprises are divided into two groups: 30 in Group A (subsidised utilities, including the national electricity company NEK, and mines) and 41 in Group B (manufacturing companies, including Balkan Airlines). The objective was to restructure Group A companies and to either privatise or liquidate Group B companies. Performance of both Group A and Group B companies has declined in 1998 as companies continue to accumulate inter-enterprise arrears. Several companies are confronted with cash flow and trading difficulties that have created cause for concern about planned privatisation. Only a few firms included in the isolation list were transferred to private investors at a very low or zero price, although the purchaser was obliged to assume outstanding debts. As a result of delays in implementation, 5

6 the mandate of the programme has been extended until mid ) What is the division of responsibility between the various institutions, including amongst the Ministry of Industry and Ministry of Finance, in managing enterprises in the isolation programme? Is coordination with the PA effective? 2) What is the status of enterprises from the isolation and liquidation lists? Has liquidation and bankruptcy of other non-viable enterprises proceeded as planned? What are the main obstacles and problems to its implementation? 3) What are the proposed methods for dealing with inter-enterprise arrears prior to privatisation of larger enterprises? 4) What measures have been taken to speed up liquidation? Is the adequate legal framework in place? Are implementation mechanisms functioning? III. Privatisation of Large State-Owned Enterprises a. Foreign Participation in the Privatisation of Large Enterprises Privatisation can provide opportunities for foreign investment, which is essential to obtain additional capital, but also to provide much-needed technology, management skills. Cumulative foreign investment inflows in the period (until 30 June) amount to $ 1,547.2 million. Belgium, immediately followed by Germany with respectively $ and $ million, are the top investors. Industry attracted more than half of the total investment inflows. Fifty enterprises (out of 900 privatised since 1993) have been sold to foreign strategic investors, of them 19 in 1997 and 6 in the first half of The government expects to attract $ 1,200 million in 1998, or approximately as much as the total accumulated foreign investment inflows in Bulgaria has not been as successful as other transition economies in attracting foreign investment largely as a result of uncertainties related to the frequent changes of governments and the legal and regulatory framework. Privatisation of large SOEs, an essential element in the strategy to accelerate privatisation, seeks to attract strategic foreign investors primarily through the use and intermediation of international privatisation consultants in so-called pool privatisation, grouped by industry. The privatisation advisors and transaction agents (PATAs) have been appointed by the PA with funding support from the EU Phare programme, USAID, and the World Bank to manage the privatisation of 16 pools of large SOEs. The scope for division of responsibility is regulated under a Memorandum of Understanding between the GOB and the European Union, signed in June The text of the agreement stipulates that the Bulgarian government is committed to giving full powers to the PATAs as regards the sale of enterprises; as well as independence and responsibility for all actions deemed necessary for finalising the privatisation process within a certain time-frame. In the event that the PA does not agree with the final selection of the investor, it can restrict the sale but only on serious grounds with concrete arguments. The PATAs operate either on a retainer plus success fee basis or at pre-defined rates, or on a success fee only. The programme started in the third quarter of 1997, and contracts of up to 20 months were signed that will expire in mid ) What is the role of foreign investment in large SOE privatisation? 6

7 2) What are the main impediments to foreign direct investment in Bulgaria? What are the institutional and legal steps which are being taken to address these problems and in particular to tackle the structural and informal barriers? 3) What is the role of international intermediaries in the privatisation of large enterprises? What are some of the challenges associated with the PATA programme and how are they being addressed? What is the incentive structure of these programmes? Is the role of the PA clearly defined in the monitoring of the relevant procedures, starting from the selection of intermediaries and ending by the completion of the deals? 4) What is some of the initial evidence in co-ordination amongst donors and Bulgarian institutions (for specific companies, such as certain large holdings)? What are the results and lessons from the experience until now? 5) Have other methods of privatisation of large enterprises been successful in attracting foreign investors? Which types of enterprises are privatised by which methods? What are some of the initial results and main problem areas? b. Utilities Privatisation The GOB has launched a major initiative to improve the country s infrastructure. In addition to starting the privatisation procedures for the sale of Balkan Airlines, a comprehensive plan for restructuring and privatising Bulgarian Railways is being developed. The regulatory and institutional framework will be amended accordingly. The rehabilitation of the company is being financed by the World Bank, EBRD and EU Phare programme. The Government's telecommunications reform policy provides for full liberalisation of the telecom market after 2002 when the term of the Bulgarian Telecommunications Company s (BTC) exclusive rights over the fixed network and telephone services expires. The government hopes to privatise BTC by Energy sector Bulgaria is dependent on imports for 70 % of its energy supplies. There are virtually no oil and gas reserves. Electricity is mostly generated by the National Electric Company (NEK) although all power stations operate as separate entities. The NEK manages capital spending and the government oversees policy on pricing and output. Bulgaria benefits from large deposits of brown coal but the quality is reportedly quite low, thus the type needed for power stations continues to be imported. Hydroelectric power, providing just over 5 % of total energy capacity, is limited by the uncertain flow of the rivers. Recently, attention has been shifted to nuclear power. One nuclear station at Kozloduy accounts for 40% of Bulgaria s energy needs. The GOB has adopted a comprehensive energy sector reform programme with the objective of restoring its financial viability and ensuring the efficient allocation of resources. It plans to phase out all subsidies, initiate appropriate pricing mechanisms, and create a regulatory environment that is conducive to private sector participation in the energy sector so that much needed resources for investment can be attracted on commercial terms without incurring excessive budgetary liabilities and risks. The government plans to strengthen and accelerate restructuring efforts for utilities and monopolies in the isolation program (especially district heating, railways, and urban transportation). Efforts to clarify procedures will be welcome signals to foreign investors who have in the past been critical of the lack of transparency. 7

8 1) What is the strategy for restructuring infrastructure enterprises? Which institutions are involved? What is the role of the PA in the process and how is co-ordination proceeding with outside advisors or agencies? 2) What are the main methods of privatisation? What is the relationship between privatisation and regulation? Are competition considerations being addressed? 3) What is the perceived role for foreign investors in infrastructure privatisation? Which institutions are responsible for facilitating their participation in the privatisation process? What are the key methods of privatisation or agreements allowing the private sector to be included in the operation of infrastructure and utilities, short of privatisation- management contracts, concession agreements, etc.? IV. Privatisation and the Banking Sector A two-tier banking system was introduced in Bulgaria in 1989 with the Bulgarian National Bank (BNB) assuming the role of a central bank and its branches (plus the banks created in the 1980's to finance sector specific projects) started operating as independent commercial banks. In 1992, at the BNB s initiative, a Bank Consolidation Company (BCC) was established to act as a shareholder in the state banks on behalf of the government. Its initial mandate was to consolidate 70 small state-owned banks into a few larger banks, prepare them for privatisation, and as a result create a more efficient banking sector. The consolidation took place between However, in May 1996 the entire banking sector nearly collapsed due to weak supervision by the BNB, numerous insider loans and non-existent financial discipline. As a result of the financial crisis, the new closed down 16 troubled banks and established a currency board. This helped to engender some confidence in the government s capacity to stimulate an economic turnaround. Strengthening the banking sector and creating confidence in the stability of the financial system is therefore one of the GOB s main priorities. It will continue to privatise state banks, make adjustments to the legal and regulatory environment to improve bank intermediation, and strengthen banking supervision. In 1997, the BCC has been given a mandate to privatise the six banks in which it had a majority interest and that had not been included in the isolation programme. Overall, the process has been successful with the privatisation of the first bank in The BCC expects that the Bulgarian banking sector will be substantially privatised during 1999 and fully privatised by the end of ) What are the results of the consolidation and rehabilitation programmes of the banking sector in Bulgaria? Is further consolidation needed/planned to improve the functioning of the sector (especially regarding its lending capacity)? 2) What are the objectives of bank privatisation / main expectations of the market place for bank privatisation? What steps will be taken up-front to ensure that the bank privatisation process is a success (i.e. recent changes in the banking regulation, including bank bankruptcy legislation and its impact on the financial and real sector; implementation problems)? 3) What is the institutional/operational framework for bank privatisation? How is co-ordination proceeding between the banks and the privatisation authority? 8

9 4) What are the methods for privatisation and reasons for their choice? What is the initial impact of the chosen method on the preparation for privatisation of the bank? How is foreign participation in bank privatisation being encouraged? 9