Central and eastern Europe’s stock exchanges are on a bull run. In the first three months of this year prices at the Warsaw Stock Exchange (WSE) shot up by 50% and Budapest registered a similar rise. Prague’s surge of 12.8% was more modest and dwarfed by the performance of the admittedly smaller Bratislava Stock Exchange, where SAX index shot up by 38% in the first two months of the year.
The rises are part of a global trend spearheaded by fund managers, notably those from the US, to move into emerging markets this year. “Emerging markets were bad last year and fund managers lost their confidence,” says Ian Kennedy, head of emerging markets and equities sales at Nomura International in London. “This year they are more positive and are allocating money throughout the various markets, though central and eastern Europe has the lowest p/e ratios.”
As of March, p/e ratios averaged 7.6 in Hungary, 7.4 in Warsaw, 8.8 in Prague and 5.4 in Bratislava. Compare this with Singapore (22), Thailand (18.1), Philippines (16.5) and Malaysia (21). Market capitalization as a proportion of GDP is 23% in the Czech Republic and a mere 5% in Poland and Hungary, still tiny compared that with emerging market countries in south-east Asia, such as Thailand (85%) and Malaysia (265%). As Mark Mobius, president of Templeton Emerging Markets Funds, observes, “When you look at those comparisons, you realize that all the central and eastern European countries still have a long way to go in achieving markets that are representative of the economy.”
Is history repeating itself? Central and eastern European markets experienced a phenomenal surge in 1993. The WSE, for example, increased by nearly 800% in dollar terms; the following year the WIG index fell by some 70% and languished in 1995. All the emerging markets were also badly hit by the Mexican crisis at the end of 1994 as US investors returned to the safety of their home market.
This time around analysts believe that the markets will prove more resilient because of the broader base of investors. Nomura has been encouraging general European funds to allocate a portion of their portfolio eastwards, and itself has allocated 2.5% of its model European equity portfolio to Poland. Nomura’s Kennedy notes that these general European investors will be less inclined to withdraw their money at the first sign of a market correction.
In fact individual central and eastern European markets have sustained their surge despite serious political upset. February 18 saw the resignation of Hungarian finance minister Lajos Bokros, the architect of a highly unpopular but essential austerity package designed to reign in the country’s ballooning budget and current account deficits. The Budapest Stock Exchange’s BUX index fell by 5% but rebounded after the appointment of Peter Medgyessy, the former chairman of Paribas Hungary.
The Polish market weathered not only the defeat of president Lech Walesa by Aleksander Kwasniewski in last November’s presidential elections, but the resignation of prime minister Jozef Oleksy, who faced investigations of spying charges. Even the prospect of Boris Yeltsin’s possible defeat in the Russian presidential election this June, coupled with neighbouring Belarus’ growing political and economic union with Russia, have failed to dent investors’ faith in Polish stocks.
This attitude is in sharp contrast to that prevailing during the boom and bust cycle of 1993-94 when p/e ratios rocketed to the high-20s. “Two years ago people were purchasing stock because it was new and uncommon; now they are buying on fundamentals and going for quality stock,” says Marcus Klug, east European analyst at Creditanstalt Investment Bank in Vienna. Average daily turnover on the WSE is about $50 million compared with $15 million last year. The food producer Animex has this year registered the highest turnover, and the biggest returns, 132.9% in dollar terms, as of the end of February.
Investors who anticipated the Polish bull market last year have netted impressive gains. In the past six months, share prices of the engineering giant Elektrim have increased by 100%, those of paint company Polifarb Wroclaw and the tyre manufacturers, Stomil Olsztyn and Debica, 150%, and aluminium manufacturer Kety by 160%. “Prices for Polish shares were absurdly low last year,” says Martin Taylor, investment analyst at Baring Asset Management, the managers of Baring Emerging Europe Trust. “The initial concept of investing in emerging markets is high returns for high risk, but in Poland the risk is very low indeed. The debt-to-GDP ratio and budget deficit would qualify Poland for Maastricht.”
How far the Polish market will continue to rise remains an open question. “On fundamental p/e ratios there’s a limited upside for the big industrials, while the banks are already fairly valued,” observes Guy Czartoryski, an analyst at Deutsche Morgan Grenfell. However, Poland’s privatization has lagged behind that of the Czech Republic and Hungary. It was only towards the end of 1995 that Poland’s shopping list of giant utilities and resource companies emerged. This year is set to see the privatization, for example, of KGMH Copper Combine, LOT Polish Airlines, and the Ruch chain of newsagents cum public transport ticket offices. The government has also announced that in 1997 it will sell off Telekomunikacja Polska (Polish Telecom) which dominates local telephone traffic and holds the monopoly on international
connections.
“The peculiar thing about Poland is that it hasn’t had any flagship privatizations to date,” says Czartoryski. “There is undoubted demand locally and abroad for this type of paper, and these forthcoming sales will be the key to developing the Polish market.”
Secondly, Poland’s mass privatization programme, which only started issuing participation certificates in November 1995, has yet to make its impact on the stock market. The MPP will introduce three new classes of securities to the exchange. The certificates themselves are set to be dematerialized and listed in the second half of this year. Shares in the national investment funds (NIF), which are restructuring the companies, are set to appear on the WSE towards the end of the year. The first batch of the 514 companies in the MPP itself, which are good enough to meet the exchange’s listing criteria, will also start trading this year.
The Czech Republic, with the most privatized economy and a stable political climate (dominated by free-marketeers widely predicted to win the largest number of votes in June’s general elections), should by rights be leading the way. Prague’s market capitalization, at $19 billion to $20 billion, outstrips Warsaw, Budapest and the other central and eastern European bourses combined, while the Prague Stock Exchange (PSE) lists a staggering 1,764 combined. “Prague is Europe’s second largest bourse after London,” says Zdenek Skoba, spokesman for the PSE.
However, as the saying goes, size isn’t everything. Only 50 shares trade with any regularity and only a handful of stocks are genuinely liquid – Komercni Bank, Czeska Sporitelna bank, the energy utility CEZ and SPT Telecom. “The blue-chips have led the market rally this year,” says Vladimir Jaros, research manager at brokers Wood & Co in Prague. These are also the only shares that most foreign investors can lay their hands on.
Trading is fragmented between the PSE, the RM trading system used by retail investors and for collecting blocks of shares by voucher investment funds, and the OTC market which accounts for between 60% and 70% of all trades. If that wasn’t enough, there is also talk of introducing a fourth exchange to be run by the private company RTP.
The fragmentation of the market works against price transparency, and is considered the biggest handicap facing the Czech market. The PSE’s existing fixing mechanism which provides one price a day based on supply and demand is also a disadvantage. In March, though, the exchange started piloting continuous trading on five stocks – SPT Telecom, Komercni Bank, Ceska Sporitelna, Komercni Bank Fund and CEZ – and the system now has capacity for 45 stocks, a step seen by the exchange as crucial and evolutionary. “This service will be appreciated by foreign and domestic investors, will boost trading volumes and increase liquidity and transparency,” predicts Skoba. “It is also a prerequisite for trading futures and options, which we would hope to introduce in 1997.”
The widely criticised opacity of the Czech market has been exploited by one notable investor to address another widespread criticism – the lack of corporate restructuring among privatized Czech companies. Last autumn, Stratton Group of the US built up significant holdings in seven Czech companies through share acquisitions, including forward-purchase agreements, from the Czech investment group Harvard Capital and Consulting. The investments included majority stakes in Sklo Union, the republic’s leading glass and crystal manufacturer, and the large paper manufacturer Sepap, companies which are set for a large corporate overhaul to boost earnings.
The speed and secrecy with which Stratton acquired its holdings was only possible in the Czech market, (and to some extent Slovakia where the company is engaged in similar takeovers) because of the weakly regulated market. “Unlike Poland, we created the market first and then the regulations,” says Jaros at Wood & Co.
July should see a package of new securities legislation devised by Tomas Jezek, who is head of the parliamentary budgetary committee and widely predicted to be the PSE’s new chairman. The legislation will introduce stricter disclosure requirements and greater powers for the exchange to enforce reporting, plus protection for minority shareholders, including the rule that investors who accumulate significant stakes, declare takeover bids and offers to buy out smaller investors. Other proposals include sub-registers at all the brokerage houses, clarification of ownership of shares (which are now viewed as owned by custodians rather than clients) and fines for trading on insider information. The law is good news for foreign investors, who, according to Skoba now account for around 50% of the exchange’s turnover, but who complain about the continuing opacity of the market.
Hungary has also benefited from the influx of institutional investor money into central and eastern Europe, with the BUX index breaking new records throughout February and March. Between January and March the index rocketed from 1,500 to 2,400. In Hungary’s case, investor confidence was aided by dramatic improvements in the Hungarian economy, including record privatization receipts at the end of 1995, cuts in the budget and current account deficits, a 2% growth in last year’s GDP (which had been expected to be flat) and in March an agreement with the IMF for a $387 million stand-by loan. “The credit of the country has improved substantially in the eyes of foreign investors, and that is driving the market this year,” explains Istvan Simon, a trader at Concorde Securities in Budapest.
The Hungarian market is split between the Budapest Stock Exchange, which lists 41 stocks and has a current market capitalization of about $3.3 billion, and a large OTC market that also acts as the launch pad for new issues. “We have to fight for every company and show them the benefits of being listed,” says Joszef Rotyis, chief executive officer of the Budapest Stock Exchange.
In addition, Hungarian shares have for several years traded in Vienna, more recently in Germany and on the London market as GDRs. This fragmentation is a double-edged sword, on the one hand depriving local brokers of liquidity, on the other increasing the exposure of Hungarian companies to international investors.
Average daily turnover on the Budapest exchange has jumped to $5.2 million, from $1.4 million in 1995, much of it driven by foreign investors who are estimated to account for a colossal 75% of Hungarian share trading. According to Klug at Creditanstalt Investment Bank, investors have been going via the exchange for liquid stocks, such as the oil and gas company MOL, the savings bank OTP, the pharmaceutical giants Richter Gedeon and Egis, and the food producer Pick. The PVC producer BorsodChem, Hungary’s largest chemicals company, listed on March 22, is also popular with foreign investors.
New listings in 1996 could include bank privatizations, for example that of Hungarian Credit Bank and Hungarian Commercial and Credit Bank. There could also be further share issues from a number of the electricity companies that were partially privatized in 1995 by sales to strategic foreign investors. “We have to convince the new private owners, but if we succeed the market capitalization of the Budapest Stock Exchange would increase by 100%,” says Rotyis.
The Budapest exchange has virtually completed its shift from open-outcry to automated electronic trading – the latter now accounts for 90% of trading – and this year will allow some 50 brokers to trade by remote access from their offices. This will relieve pressure on the overcrowded exchange and enable it to offer more seats, and in the longer term lengthen trading sessions from just two-and-a-half hours a day to a full day. Book-entry registry is also in the pipeline.
Budapest is also the only central and eastern European market with developed derivative products. Brokers in the OTC market have long used stock options strategies, and last year the exchange launched the BUX futures contract. Hungary’s currency exchange laws prevent derivatives from being used by foreign investors, although this situation will change in April. Domestic investors have tended to use the contract for some speculative trading, but, says, Rotyis, there could be a dramatic increase in turnover once foreign investors start hedging their large Hungarian portfolios. The exchange’s new Central European Stock Index (CESI), comprising eight Hungarian, six Czech and 13 Polish stocks – the region’s most liquid shares – also has the potential to underlie a futures contract.
Hungary’s derivative market will also be boosted by new securities legislation which will allow locals, as well as registered companies, to trade. The legislation is part of a package now under discussion that includes the formation of investment banks and the merging of banking, securities and insurance regulators into one financial supervisory body.
While central and eastern Europe’s three main markets – Poland, the Czech Republic and Hungary – are now strong enough to weather changes, the remainder are lagging behind because of political or economic pressures. Initially, Slovakia’s market developed in tandem with that of the Czech Republic. There are two licensed exchanges in Slovakia: the Bratislava Stock Exchange with 19 listed shares as of the end February, and the RM-system for retail investors, with 868 unlisted shares. The two recently reached a price cooperation agreement to improve transparency. Trading at the Bratislava exchange has been exceptionally buoyant this year with volumes in January and February equivalent to nearly 45% of the 1995 figures, though the market is still tiny, with a capitalization of only about $2 billion. Active shares include the petrochemicals giant Slovnaft, steel company VSZ, the gas storage concern Nafta, Plastika and the voucher investment fund VUB Kupon.
Slovakia has some good, cheap companies trading on the market, but this factor is overshadowed by the dictatorial tendencies of prime minister Meciar that have had a direct impact on the stock market itself. Last year, the government cancelled the second wave of voucher privatizations on the grounds that the scheme was ceding too much control into the hands of investment funds, and that it was allowing foreign investors to obtain shares at too low a price. In 1995, too, the government closed down the Bratislava options bourse, the only such dedicated exchange in the region, supposedly to concentrate liquidity at the Bratislava Stock Exchange.
Slovakia does have other potential derivatives projects in collaboration with OTOB, the Austrian Futures and Options Exchange. OTOB is the manager and initiator of the Central European Clearing House and Exchanges (CECE) which aims to provide a centralized clearing house in Vienna for central and eastern European derivatives. It has held discussions with the Slovak RM-system on derivatives. The Slovenian Commodity Exchange, has also expressed interest in the project as a means for clearing international trades in its currency futures. OTOB is also tendering to provide Vienna-based clearing, to guarantee international trades for Budapest.
“Many central and eastern European countries have delivery and settlements systems but lack specific clearing houses which can assimilate counterparty risk and provide ‘goodness’ for the market,” says Bjorn Adolfsson, head of OTOB’s international division. “The CECE would also provide a link between eastern and western investors.”
Romania is in the early throes of setting up a stock market. It only kick-started its mass privatization programme late last year, in November reopening, after 50 years, the Bucharest Stock Exchange. Of the exchange’s 11 shares – syringe-maker Sanevit, the only private [as distinct from privatized] company listed – accounts for between 90% and 99% of trading volume. An OTC market, based on the US NASDAQ Portal system, is due to open this month.
Bulgaria is even further behind. It held back with privatization, and its stock market operated dispersed trading through 15 different exchanges until late last year when a central exchange was formed.
War-torn Croatia, with a large privatization programme in the pipeline, has chosen to flag its markets with an international listing for the drugs company Pliva. This drugs company has a blockbuster antibiotic, known as Sumamed, recently licensed to the US drugs giant Pfizer. Croatian investment still carries high political risk, unlike that of Slovenia. However Slovenia’s securities legislation dates back to a time before the break-up of the state of Yugoslav and foreign investors find the market notoriously difficult to penetrate.
However, the biggest disappointment has been Russia. Between January and mid-February, the Moscow Times 50-share market-capitalization based index lost 4% of its value in dollar terms, and by March prices were down to their May 1995 levels. Yuri Lopatinsky, director of sales and trading at Creditanstalt-Grant in Moscow estimates total foreign capital invested at about $4.5 billion. Foreign investment drives Russian share prices, but negligible amounts have flowed in since the beginning of 1996 and the situation is unlikely to change until after the presidential elections scheduled for June.
“We’re recommending that portfolio investors stay out of equities until mid-year, or invest in short-term government bonds,” says Lopatinsky. Corporate clients who can invest in Russian companies with export potential are in a better position. Shares are cheap and unlike the blue-chips, which have had the spectre of renationalization raised against them, such firms are unlikely to be affected by the outcome of the elections.
Political risks aside, investors remain deterred by back-office problems. “Clearing is the biggest issue here; delivery-versus-payment does not exist yet,” says Lopatinsky. Furthermore, there is no government guarantee forthcoming for any clearing initiatives, leaving investors no legal recourse should a counterparty default.
Among the 30,000 companies which were privatized in Russia, only five shares can claim to be liquid and trading actively: Lukoil, Mosenergo, the electricity generator United Energy System of Russia, Rostelecom and Norilsk Nickel. Between them they account for 85% of the Moscow Times index. Lukoil and Mosenergo also trade internationally via American Depositary Receipt (ADR) programmes. According to Danielle Downing, managing director of research and sales at Alliance-Menatep in Moscow, investors prepared to take a longer-term perspective have shown some interest in less actively traded stocks such as the Gorky Automobile Factory, and regional telecoms companies such as Irkutsk, Nizhniy Novgorod and Samara.
Yet the Russian market has made great strides. Aside from a few well-publicised registrar abuses, there have been remarkably few scandals. A number of western banks, such as Chase and ING Barings are offering custodial services; State Street in conjunction with Credit Suisse Moscow is set to follow suit. Bid/offer spreads have narrowed from double figures a couple of years back to between 1.5% and 3% today, to the point where brokers claim it is difficult to make money on equity trades.
Russia’s Professional Association of Stock Market Participants, the broker/dealer body with about 200 members, has established an arbitration board and is structuring trading and listing rules for companies, improving corporate disclosure and establishing independent registrars. The association’s growth has gone hand-in- hand with growing use of the US Portal trading system which now handles some 50% of trades. Says Downing: “The market is still dependent on a small number of liquid stocks, but unlike last year you have people on both sides – even in today’s downward trending market – and the volumes are greater, and that indicates greater depth.”
A region of individuals beckons fund managers
Restructured through privatizations and newly-created stock exchanges, the central and eastern European markets remain diverse while offering fund managers ample opportunities for investment diversification. Krystyna Krzyzak reports
Individual central and eastern European countries are beginning to gain reputations for themselves among fund managers. Hungary’s market is seen as small but well-formed, the Czech market is impenetrable, Romania and Bulgaria have low liquidity, and Slovakia, though showing good economic performance, is in need of a new government.
At the moment the top dog is Poland. “This country has the best potential, it has well-run companies with good entrepreneurs who know what they are doing, and a supportive government,” explains Klaus Martini, director of Deutsche Bank’s Dm32 million DB Osteuropa Fund, which is 55% weighted in Poland, 25% in the Czech Republic and 20% in Hungary.
“Poland has enjoyed the fastest growing economy in Europe, substantial falls in inflation and interest rates, and real currency appreciation of about 15% against the dollar in 1995,” says Martin Taylor, investment analyst at Baring Asset Management (BAM) the managers of the Baring Emerging Europe Trust (BEET). With a net asset value of $110 million, the BEET fund is weighted 33% in Poland, 18% in the Czech Republic, 11% in Hungary, 16% in Russia and 2% in Slovakia.
All central and eastern European funds are heavily invested in Polish stocks, on average between 40% and 50%, even in portfolios weighted by market capitalization. Some fund management companies are now establishing dedicated Polish funds. Foreign & Colonial, which runs a Dm32 million central and eastern European Fund, has recently established the $40 million open-ended First Polish Investment Fund.
“Poland was the only viable market where we could have done this, because of its good liquidity, its structure, and the potential for the economy,” explains Isabel Knight, senior fund manager at Foreign & Colonial Emerging Markets. “We feel it is the most exciting market in the region.” The fund is currently only in listed equities, but will invest a portion in mass privatization certificates through the over-the-counter (OTC) market.
Liquidity constraints, the main concern expressed by fund managers investing in the region, restrict them to the top three markets, and Slovakia to a lesser extent. “If we don’t have liquidity, we can’t price our portfolios, and we run the risk of selling too high to an investor,” observes Mark Mobius, president of Templeton Emerging Markets Fund. “And when you have such narrow liquidity, even a slight demand for stock can push prices up quite quickly.”
Poland has the largest population and potentially the largest economy, although the total number of Polish listed shares – 57 on the main market as of mid-February and 14 on the parallel market – is low for a country of its size. Nevertheless, liquidity is good enough to give investors access to stocks in a far wider range of sectors including banks, construction, engineering, food and holding companies, than is possible in the Czech Republic and Hungary.
“Poland’s market is the broadest in central and eastern Europe and it is not concentrated on a few highly-capitalized stocks,” says Michael Konstantinov, fund manager of DIT-Dresdner Osteuropa. Konstantinov favours the tyre manufacturers Debica and Stomil Olsztyn, in which Goodyear of the US and Michelin of France respectively recently acquired majority strategic stakes.
Both Polish companies, along with alumunium producer Kety, will inevitably benefit from new automobile investment – South Korea’s Daewoo is investing $1.1 billion in Poland’s second largest manufacturer, while General Motors is building a greenfield site at Gliwice. The fund, weighted 50% in Poland, 31% in the Czech Republic and 17% in Hungary, uses market capitalization and fundamental screening of individual stocks as selection criteria. In the exclusive case of Polish stocks, Konstantinov adds, there is sufficient historical data of a good enough quality to enable Dresdner to apply quantitative techniques to the portfolio.
Of the banking stocks available, Export Development Bank (Bank Rozwoju Eksportu or BRE), the first state-owned bank to be privatized and now with Germany’s Commerzbank as a strategic shareholder, is the fund manager’s favourite. “We are generally cautious on bank stocks because of the risks involved, which include what they may be carrying on their balance sheets,” notes Deutsche’s Martini. “With the banks which have foreign shareholders, you can be relatively sure that they’re all right, and BRE has made a very good impression.”
Even though brokers may find it claustrophobic, Poland’s regulatory environment also gets high marks. For example, companies on the main market have to produce monthly reports. “Market regulation in Poland is perhaps too good, to the extent that it creates some rigidities which make it difficult to operate,” comments Mobius. For example, local brokers must put any orders they receive immediately into the market. Consequently many fund managers tend to use international firms to drip-feed large buy or sell orders to avoid moving the market.
The securities commission is fussy about who is allowed onto the Warsaw Stock Exchange; its permission is required for just about everything. “The Polish securities commission has got teeth and it uses them,” says Taylor. “Poland has one of the tightest regulatory environment and the most transparent pricing system in Europe.”
The Polish government itself is also receptive to shareholder concerns. A capital gains tax on foreign investors, due to be introduced at the beginning of 1996, has been scrapped after complaints. The government has also backed down on a controversial plan to retain its remaining stake in Bank Przemyslowo-Handlowy. The bank was privatized during 1994 in a consolidation scheme involving a number of yet-to-be-privatized banks, after the aggrieved strategic shareholders – notably the EBRD and ING Barings – mounted a protest.
By contrast, the Czech Republic remains poorly regulated. Responsibility for securities trading lies with the finance ministry, but there is no dedicated commission. Minority shareholders fare badly because, at the moment, there is no obligation for investors building up stakes to declare a takeover bid and acquire the remaining stakes. New securities legislation to be implemented this summer will rectify this, but the biggest headache remains the sheer opacity of the Czech market. “The market is not transparent. There is a lot of OTC and interbank trading, and you never know whether shares are trading at discounts or premiums,” says Konstantinov of Dresdner. The problem is exacerbated by the market being fragmented among the Prague Stock Exchange, the RMS electronic system and the OTC market.
By capitalization the market is large by central and eastern European standards at around $19 billion because of the early and by now almost completed voucher privatization programme. By common consent, however, the programme did little for corporate governance. “The Czech privatization programme did not promote company restructuring, while the investment funds have not forced companies to improve profitability, and that’s reflected in the moderate earnings growth seen relative to the market valuation,” observes Jurgen Kirsch, fund manager at Mercury Asset Management. Czech companies are forecast to average 10% earnings growth in 1996, while the market is currently valued at nine to 10 times 1996 earnings.
Liquidity is concentrated in a small number of shares, notably Komercni Bank, Ceska Sporitelna Bank, and SPT Telecom. “It is extremely difficult to build up stakes in promising medium-sized companies which have sufficient liquidity and which are not over-valued,” says Konstantinov. The tendency of the funds to sit on their shares contributes to both the high price and the poor liquidity. “Many Czech companies also have strategic investors who are building up stakes and they are not friendly to minority shareholders,” he adds.
The funds, which tend to trade at substantial discounts of more than 35% in some cases, also provide an alternative route for taking on Czech exposure. But their role in the Czech market economy is controversial to say the least.
The funds are, however, moving into medium-sized companies and beginning to restructure them, or in the case of the large Prague-based Harvard fund, selling significant stakes to the US investment company, Stratton, for restructuring.
This has been good news for the companies concerned, but it has also highlighted a frequent complaint from foreign investors about the extent to which they are being kept in the dark. The Dresdner Fund invested in the Harvard Growth Fund before the Stratton deals and has since seen its value fall, while the rest of the market has moved upwards. “Their strategy is unclear. The Harvard Group is clearly not interested in its shareholders. For illustration, look at what happened to the Harvard Dividend Fund. In a dubiously arranged extraordinary shareholders’ meeting (in late March), in a small town 300 kilometres from Prague, the fund was transformed into Harvard Industrial Holding joint stock company. Hence the company is no longer regulated by the Investment Companies Act and investors will depend solely on Harvard supplying proper financial accounts. So far, Harvard has refused to comment on why the net asset value of the fund has done so poorly compared to the market,” says Konstantinov.
Hungary has consistently outstripped others in the region by attracting direct foreign capital, but its poor economic fundamentals last year left portfolio investors cold until the fiscal tightening by Lajos Bokros (then finance minister) started to make an impact. “We were very impressed with the macroeconomic turnaround and the implementation of the austerity package,” says Mercury’s Kirsch. “There have been clear improvements on the current account and budget deficits, and last year’s privatization revenues overshot the target.” The resignation of Bokros was a set-back, but fund managers are generally positive about his successor Peter Medgyessy.
Hungary is seen to be reasonably well regulated. It has the most diverse stock market, with an OTC market that until recently dwarfed the stock exchange, and several Hungarian stocks that have long traded in Vienna. As a result Hungarian companies received early exposure to international markets. But the market is fragmented. The BUX futures contract is not yet available to foreign investors, although a few people say they’ll show interest in the product once it proves itself. “We would first want to see it in action during a sharp correction or down market, and then we would be willing to hedge our positions,” says Alfred Neimke, managing director at Creditanstalt Fund Advisory.
Liquidity and disclosure are thought relatively good for the top-10 companies, but this group includes some of the best firms in the region with well-regarded managements and strong export markets. Hungary’s pharmaceuticals companies such as Richter Gedeon and Egis are world-class. Egis, currently trading at below seven times 1996 earnings, is the present favourite buy, while Richter, at 10 times 1996 earnings, is closer to its assumed correct value. The construction companies Graboplast and Pannonplast are also popular, as is the PVC manufacturer BorsodChem and the hotel chain Danubius.
Last year’s flotation of MOL (oil and gas company) gave investors access to central and eastern Europe’s only vertically-integrated oil and gas company. “It was nicely priced and well placed, and we made some money from it,” says Termpleton’s Mobius. “Governments must realize the importance of share pricing; investors need a good taste in their mouths. The issue was also important because it added size and liquidity to the Hungarian market.” The inclusion of MOL in a Hungarian portfolio is almost inevitable given that it accounts for 40% of the Hungarian market capitalization, but many investors have been unimpressed. It is a politically-sensitive stock: MOL’s need to raise tariffs to maintain earnings growth could conflict with the finance ministry’s policy of lowering inflation in 1996. More disturbing was the series of profits warnings which followed the company’s flotation in November last year, including a 50% downgrading for 1995 profits.
Slovakia remains an acquired taste. Mercury’s MST eastern Europe fund has a relatively high weighting in Slovak shares in comparison with other funds. Favourites at the moment include construction giant Vohostav, the metallurgy companies VSZ and Drotovna, and the chemicals firm Chemolak. “We like Slovakia because of the low valuations,” says Kirsch.
Slovak construction companies are 50% cheaper than their Czech counterparts, but with a good earnings growth potential because the country’s building industry is set to move out of recession. “On a micro level, some of the companies are more attractive than those in the Czech Republic because Slovak management is somewhat more aggressive in restructuring companies and taking business forward,” Kirsch says.
Unlike the Czech Republic, Slovakia also has a takeover code in place which obliges any shareholder with a stake of more than 30% to make a bid. In practice, however, there is little to stop two or three funds acting in concert to take a company over.
Baring Asset Management’s BEET fund added a 2% Slovak weighting early this year because of the country’s good economic performance. But the authoritarian government of prime minister Vladimir Meciar is the big deterrent for fund managers. “Fund managers don’t like to invest in dictatorial regimes,” observes Baring’s Taylor. In 1995 the Meciar government cancelled the second privatization wave, and instead gave many managements large shareholdings at significant discounts. “A big chunk of Slovak industry is now owned by management, which means there is little incentive for protecting minority shareholder rights,” says Taylor.
Further down the line, Romania has the potential to be the next boom market. “It’s a country of significant size and it’s launching an aggressive privatization programme, so there could be interesting things happening there,” says Templeton’s Mobius. But the Romanian government’s attitude to investors is schizophrenic to say the least. Bucharest did itself no favours by last month suspending the foreign exchange activities of a number of banks, including those of ING Barings. Liquidity on the newly-opened Bucharest stock exchange is very poor.
Low liquidity also applies to the Bulgarian stock market. Funds such as Foreign Colonial’s east European fund, which has about 2% invested in Bulgaria, obtained its country exposure through Brady bonds.
Within the Baltic states, the two countries that do have functioning stock exchanges, Latvia and Lithuania, are still recovering from the collapse of their big banks and the drag that this has had on their economic growth. Estonia, the first of the former Soviet republics to engineer an economic recovery, has delayed opening a stock exchange until May this year to ensure that its market starts off on a sure regulatory footing. Its leading private bank, Hansapank, is quoted on the Helsinki Stock Exchange; that move has provided a route for managers to obtain Estonian exposure.
In Russia ongoing custodial and registry issues have effectively put the country off-limits for many managers. “Our trustees will not allow us to invest in Russia until it’s a recognized market,” says Isabel Knight of Foreign & Colonial. She, and other fund managers under similar constraint, can gain limited exposure through the two American Depositary Receipts (ADRs), Lukoil and Mosenergo.
Russia, in any case, is effectively being ignored until after the June presidential elections. “The stocks are cheap,” acknowledges Creditanstalt’s Neimke, “but you’re paid to do a good job, not be a hero. Cheap stock can become cheaper, and with the uncertainty of the elections, we would rather miss an opportunity cost of between 20% and 30%, than get caught in a situation where we can’t get rid of the stock.”
Investors in Russia’s former satellites are also keeping an eye on the outcome of the elections. These investors believe, however, that central and eastern Europe’s eventual integration into western structures, such as the European Union and Nato, will counterbalance any revival of Soviet domination. “If the Russian election goes wrong, investors will demand a risk premium, and east European p/e ratios will have to be discounted by between 10% and 20%, but the political will of the EU will play a much bigger role,” predicts Neimke. “Russia itself will still need international funding, and if it shows its muscles, without respecting the political will in Europe, it won’t get any investment.”
Honourable mentions
Central and eastern European fund managers are well-served by the international brokers and analysts that swamp them with research, although they may appreciate a few more sell recommendations. All the large firms, including Nomura International, CS First Boston, Merrill Lynch, Creditanstalt, ING Barings and Union Bank of Switzerland, are ranked evenly. Creditanstalt gets special mention for keeping its research brief but to the point. Nomura’s work is acknowledged as controversial – which some fund managers consider a plus – and this company is also rated as one of the best execution brokers.
Local company, Wood & Co in Prague, which has an office in Warsaw, is consistently singled out for praise. “Innovative, with good ideas, though sometimes market liquidity is against them,” says one observer. Prague-based Atlantik also gets a mention, while Concorde Securities, in Budapest, is highly rated. In Poland, most fund managers polled say they use one of the international firms rather than local companies. But a couple of managers point out Carnegie International for its intensive research backed by regular visits to Polish companies.
For Russian equities it’s best to look long term
Short-term, Russian equities have been hit by uncertainties surrounding the upcoming presidential election and the enhanced attractions of government paper. But brokers are convinced the market offers excellent long-term value for those prepared to wait. Philip Moore reports
Dirk Damrau, head of research at Moscow-based Renaissance Capital (and formerly at Salomon Brothers), recently returned to Russia after a three-week whirlwind tour of the Americas and Europe seeking out investor opinion. Every investor Damrau met, he recalls, expressed confidence that Russia’s equity market would offer handsome dividends over three to five years.
The same view is routinely expressed by others who have set up shop in Moscow. “We wouldn’t be here if we weren’t bullish about the long-term prospects for Russia,” says Martin Andersson, director of Moscow-based brokerage Brunswick. “It’s a market in which I’m very happy to keep a large chunk of my own money,” says Alex Kastner, chief executive at CS First Boston (CSFB) in Moscow.
Investors who have already invested in the Russian market will be even more encouraged by the confidence expressed by houses which seem to have little vested interest in promoting Russia rather than any other emerging or transitional market. Foreign & Colonial Emerging Markets (FCEM) in London, for example, was happy to state in April 1995 that “investment in Russia…will shortly become a requirement rather than a whim for the global investor”. More recently, Morgan Stanley initiated coverage of the Russian market with a 73-page report entitled “Not If, but When”. This advised clients that “a shrewd investor with a long-term view is likely to reap spectacular rewards”.
The economic argument supporting this confidence can be simply stated. Russia was not known until recently as a superpower for nothing. By area it is the largest country in the world and it has 34% of its known gas reserves, 10% of its oil, about 25% of its forests and vast quantities of diamonds.
The fundamental argument supporting equity investment is also easy to grasp. “The Russian manufacturing sector is geared up to support an economy of 150 million people, but you can buy it all on the stock exchange for less than the value of Hanson Trust,” says Charles Harman, a partner at MC Securities in London. “The car industry has the capacity to build 2 million units a year, but it has a market capitalization of about $200 million. So in terms of asset plays, Russia is unbelievably cheap. Earnings are less easy to quantify, but most of the companies we follow are trading on two to three times earnings.” Equities in Poland, on a p/e ratio of nine, look almost Japanese in their priciness by comparison.
Another bullish argument presented by Harman rests on a simple supply and demand model. “Last year the market was flooded by an unbelievable supply of new paper,” he says, “all of which hit the market at the same time. The government has said that there will only be two significant privatizations between now and the [presidential] election [in June], so we won’t see the supply problems that we had last year. If we did, it would frankly be disastrous for the market.”
None of these arguments, though, has been sufficiently compelling to send local or international investors (even emerging market funds awash with liquidity) scurrying for undervalued Russian stocks. Between its peak in September 1994 and the end of December 1995, the market lost around 70% of its value. Today, according to Harman, there are “no significant flows of new money” finding their way into Russia. This holds true for direct as well as for portfolio investment: between 1991 and 1995 Russia attracted just $4.9 billion in direct investment – about the same as tiny Estonia and roughly half as much as Hungary.
The easy explanation for this is the presidential election scheduled for June. In December’s Duma (parliamentary) election, the Communist party, led by Gennady Zyuganov, took the largest share of the vote (22%) and concern has mounted that a Communist government might take power. The fear of some observers is that the party might eventually reverse many of the financial reforms of the past five years once in government. In this view the forthcoming election will be like a spin of the roulette wheel. If the ball lands on black (a Yeltsin victory), investors will double their money; on red (a Communist landslide), investors will lose their shirts. “We’re not talking here about a danger of an interest rate rise which may take 10% or 15% off the market,” says a London-based analyst. “We’re talking about a downside risk of 100%.” That would imply an abrupt end to privatization followed, presumably, by widespread renationalization.
Seasoned observers of the Russian political and economic scene consider this black-and-red view outdated. “I think the big difference between now and three years ago is that the downside is no longer zero,” says Renaissance’s Damrau. “The downside is that you’ll make nothing for three years.” Steven Bates, head of emerging market research at Fleming Investment Management in London, is also dismissive of the 100% downside prognosis. “The market is already discounting Armageddon,” he says, “but the downside won’t be 100%. The potential downside is that there will be an anti-foreigner climate, but the public rhetoric is unlikely to be matched by public policy.”
Others agree, insisting that the return of a Communist presidency would not spell the end of financial market reform any more than the revival of Communism as a political force in Warsaw has put paid to Polish progress. “The Communists have a real chance of capturing the Russian presidency in June,” notes research published by Moscow-based United City Bank, an associate of MC Securities. “They are not fanatical revolutionaries. Their hearts may be in the past, but they probably lack the will, and certainly the means, to reverse Russia’s political and economic transition. So Russia will not disappear from the international investment map.”
June’s election may be the biggest cloud on the horizon for Russian equities, but a number of observers suggest it is a mistake to view politics as the only factor determining their performance. MC Securities’ Harman points out that domestic selling has also played an important role, with local investors irresistibly attracted to the new Russian T-bill market, which at one stage offered yields of 100%. “Yields have now fallen from 100% to 50%,” he says, “but with inflation at 3% per month, that is still pretty attractive.”
Renaissance’s Damrau also downplays politics. “It’s one element,” he says, “but if Yeltsin is re-elected it won’t necessarily be a green light for the equity market. Apart from one or two identifiable companies, on the whole Russians are still not shareholder-friendly, especially to foreign shareholders. We’ve been peeling off layer after layer of infrastructural problems for equity investors in the market.” Templeton would concur. Last year its Templeton Russia Fund raised $69 million, although by early 1996 only half the money had been invested, largely because a number of Russian companies simply refused to register foreign investors. In an extreme case, one Templeton analyst who showed a registration contract to a Russian executive was told: “I will wipe your face on this table before I sign this contract.”
The most graphic example of Russian antipathy towards the sort of fair practice which western investors have come to expect came in the recent loans-for-shares programme. This involved banks and other institutions lending the government money, being granted shares in large companies as security. Foreign investors’ primary objection was that they were totally excluded from the programme, but they also point out that it diverted much-needed funds from the languishing stock market. As Morgan Stanley’s recent primer on Russia points out: “If the $1 billion earmarked for the loans-for-shares scheme had gone directly into the equity market instead, the performance of the Moscow Times index during 1995 would have looked very different.”
Probably the most worrying aspect of the programme – for the longer-term health and reputation of the Russian securities industry – was the way in which the share auctions were conducted. An account of the process published in February by law firm Clifford Chance highlights the blatant (even comic) manipulation which suggests that in the new Russia some investors are more equal than others. In the first transaction, says the report, 40.12% of Surgutneftgaz was acquired by the company’s own pension fund through an auction which occurred during an information blackout. “The auction commission reportedly refused even to consider bids from outside the company; among the least subtle obstacles to external participation was the reported closing of the airport to rival bidders.” Equally bizarre were the sales of stakes in Norilsk Nickel (the world’s largest nickel producer) and oil giants Lukoil, Sidanko and Yukos. Here, the winning bidders often
triumphed despite tendering lower bids than their competitors. “Perhaps the most memorable comment on the whole affair,” notes Clifford Chance, “came from a spokesman from another high bidder whose bid was disallowed for technical reasons: ‘it seems that, in Russia, $35 million is less than $16 million.'”
Anecdotes such as these have dark undercurrents. Clifford Chance’s report notes that the trend towards prikhvatizatsiya (“grab-it-ization”) rather than privatizatsiya (privatization) might be used by a Communist administration as a pretext for renationalization. Others note that at a much broader level the management of the loans-for-shares programme has disturbing implications for the future of a level playing field in any Russian initial public offering.
Other market participants are more relaxed about the programme – some even consider changes for the better will emerge because of the universal derision it attracted. “I don’t hear very much about the loans-for-shares business any more,” says CSFB’s Kastner. “It’s universally accepted that the programme was flawed and won’t be repeated. The basic concern was with whether or not it was symptomatic of what we can expect in the future, but I think most people see it as a one-off.” Renaissance’s Damrau puts an even more positive spin on the episode, suggesting that ultimately the means justified the ends. “On the positive side, there was a strong desire on the part of many of the banks to take controlling stakes in these companies, to halt the process of asset-stripping which has been going on all over Russia and to manage the companies as going concerns.”
On the more general aspect of shareholder-friendliness, bankers appear to be encouraged by the growing responsiveness of senior management at Russian companies, which can only be a positive indicator for the longer term. “One clear theme is that more and more reliable information is coming out of Russian companies,” says Brunswick’s Andersson. “Investors are now in a much better position to make deeper analysis based on assets, profit-generating capacity and strategies going forward,” he says. “A year and a half ago all an oil company would tell you was that it was an oil company. Now you can actually sit down and talk to management at many Russian companies.”
Investors who still remain nervous of dealing directly with the Russian equity market, but seek exposure to it can invest in funds managed by such companies as Templeton, Fleming Investment Management, Baring Investment Management and Framlington. A less obvious approach is by way of companies listed in, say, London, which are involved in the oil industries of Russia and other former Soviet republics, such as Bula Resources, JKX Oil and Gas, and Dana Petroleum.
Another alternative, which will shave off some of the Russian administrative risk (but also remove some of the potentially stratospheric returns), is the new market in Russian American depositary receipts (ADRs), which began late last year when Salomon Brothers arranged the first such ADR on behalf of Moscow-based power utility Mosenergo. Originally quoted at $9, it has since fallen to $6.50, which would suggest a p/e ratio of 0.7 times current earnings. John Parker, vice-president and head of emerging market sales at Salomon Brothers in London, is relaxed about this disappointing performance. “It partly reflects concerns ahead of the elections,” he says, “and partly reflects lack of liquidity in the stock. We originally had about 20 investors in the book, half of which were US mutual funds. But we haven’t seen much selling; if anything, people who bought the original offer have been adding to their positions. When we did our research on the company and compared it with western European utilities, we calculated that it had an upside potential of 200% or 300%. Now, we’re probably looking at an upside potential of 500%.”
Parker and others are convinced there will be several more Russian ADRs. Lukoil has already followed suit with the first Level 1 ADR issue, and Morgan Stanley notes that Rostelekom, Chernogorneft, Purneftegas, United Energy Systems and Yukos are all contemplating ADRs. Whether or not these issuers will find ready buyers among western fund managers depends only superficially on the outcome of June’s elections. More important, it depends on investors’ preparedness to lock their stocks away for the long term.
| Indicative share price movements of leading Russian equities | ||
| March 15 1996 | ||
| Company | Offer price | Weekly change |
| Chernogorneft | $5.80 | -0.85% |
| Irkutskenergo | $4.15 | -3.26% |
| KamAZ | $1.05 | -4.55% |
| Komineft | $1.45 | -3.33% |
| Lukoil Holding | $4.05 | -1.22% |
| MegionNG | $1.05 | -7.89% |
| Mosenergo | $0.20 | -6.82% |
| N VartovskNG | $5.75 | -2.54% |
| Norilsk Nickel | $4.15 | -7.57% |
| NoyabrskNG | $3.65 | -5.19% |
| Purneftegaz | $1.20 | -7.69% |
| RAO UES | $0.03 | -5.69% |
| Rostelecom | $0.87 | -4.92% |
| SurgutNG | $0.08 | -9.41% |
| Tomskneft | $2.80 | -1.75% |
| Yuganskneftegaz | $6.15 | -3.91% |
| Source: AIOC Capital. | ||
Moscow Times index
Central and eastern European brokers: which come highly recommended?
Brokerage sevices vary widely from country to country in central and eastern Europe. Even in the four largest markets – the Czech Republic, Hungary, Poland and Russia – the quality of local brokerages ranges from excellent to appalling. So who do those in the markets recommend? Euromoney finds out
Czech Republic: quality local brokerage firms remain hard to find
by Joe Cook
Foreign portfolio investment in the Czech Republic topped $1.4 billion last year, an increase of 47% over 1994, to bring the total amount of foreign-held Czech securities to some $2.7 billion as of the end of 1995, according to preliminary estimates by the Czech National Bank.
Since the beginning of this year, the Czech stock market has risen by about 12%, or 9% in dollar terms, on the back of increased foreign interest, and analysts report that the inflow will likely remain strong as more and more mainstream funds join the specialist emerging market funds that have for the past 18 months driven foreign portfolio investment in the Czech Republic. For the country’s 94 equity brokerages, that will open a potentially lucrative range of new business opportunities. Yet only a select group of about 10 Czech brokerages are currently positioned to serve the requirements of foreign institutional investors.
Of those, five are the local branches of internationals CS First Boston, ING Barings, Creditanstalt Securities, Nomura and the investment banking arm of Bank Austria. The Czech branch of Austria’s Ballmaier & Schultz is cited by institutional investors for its flexible service, while Patria Finance, a Prague-based investment banking firm in which MC Securities of London has a 49% stake, is also highly regarded by foreign investors. Yet there are only two Czech brokerages that are consistently mentioned by foreign investors: Wood & Co in Prague, which has been stalwart on the Czech market ever since the Prague Stock Exchange opened in June 1993, and the Brno-based Atlantik Finanhi Trhy, which with a turnover of some Kr28 billion ($1.04 billion) in 1995, is the biggest brokerage in the country.
“They are the only two domestic brokers that have the experience that foreign institutions expect,” says Domonic Bokor-Ingram, a fund manager with London-based Regent Kingpin Capital Management, which runs the Czech Value Fund, a closed-end fund with $80 million of assets under management. Regent also buys Czech stock through MC Securities, which, says Bokor-Ingram, “probably means going through Patria”.
Wood & Co, Patria and Atlantik are also cited by Martin Taylor, an investment analyst at Baring Asset Management. “They are the only three that are making any kind of serious attempt to court international investors,” says Taylor, adding that they “combine integrity and fundamental research which is an unusual combination in the Czech Republic.” Baring Emerging Europe Trust, a regional fund, has $110 million of assets under management, with the Czech Republic currently accounting for about 18% of that.
Guy Czartoryski, an analyst at Morgan Grenfell in London, has found that only three Czech brokerages, one of which is attached to a local investment fund, come up to scratch, although he declines to name them. “If your’re sitting in London, it’s actually your job to make the broker sit up and listen to what you want,” says Czartoryski, “and over a period of time it’s not difficult to get a broker to learn what’s needed and expected.”
Analysts say that many Czech brokerages frequently fall short in two basic areas: being able to deliver quality lines of stock in sufficient volumes and doing so at reasonable prices. One analyst warns that some Czech brokers will try to “sting you on the forex”, while another says that finding an “honest broker is nothing short of a miracle in the Czech Republic”. Indeed, one prominent Prague brokerage has lost more than $1.7 million as a result of Czech entities, both brokerages and investment funds, reneging on trades. The quality of local research – especially that produced by the investment funds – can also be unreliable, say some foreign analysts. Taylor adds that “you are as likely to get Czech stock out of the US as you are in Prague”.
Hungary: foreign players overpower Budapest’s brokers by Henry Copeland
It’s been a long six years for brokers in Budapest. Founded in June 1990, the Budapest Stock Exchange (BSE) initially soared as investors flooded into central Europe’s first stock market, eager to take a flutter on the promise of post-communist nirvana. Lured by the prospect of broking for a revolution, 41 firms opened.
But the market stalled and dreams of quick riches for either brokers or customers faded. By emerging market standards, the BSE’s average daily turnover in 1991 looked respectable at $500,000, yet one-third of the year’s turnover took place on just 17 days, with 87% of that trading in only three stocks. With a few block trades accounting for much of the action, most Budapest brokers had to fight strenuously for odd-lots.
Today, the BSE’s capitalization is up 10-fold, and trading volume is up even more, regularly hitting $10 million a day in the first two months of 1996. But, for the average broker, life has not improved proportionally. Few Budapest-based brokers have the language skills and quantitative background to impress the foreign fund managers who today account for an estimated 80% of Budapest’s volume. Those locals who have had the talent to vie for the foreign money – Creditanstalt and Concorde – have been squeezed by later-arriving international powerhouses such CS First Boston, ING Barings, and Nomura.
Still, some local players relish the competition, even if it means pressure on commissions. “The market is becoming a market,” says Andras Simor, managing director of Creditanstalt Securities Budapest. Creditanstalt has regularly ranked first in the BSE’s yearly trading volumes since 1991.
“It’s not the same business, and it won’t be the same in two years’ time,” says Simor. “The market is absolutely more competitive, much more sophisticated. We need to give much more to the client in terms of service than we ever dreamed of.”
Although Nancy Curtin, head of Barings’ emerging markets fund management division, complains that Creditanstalt gives “terrible service” – “I get masses of stuff from Creditanstalt but no-one ever calls me” – the firm otherwise gets high marks both from competitors and London fund managers. The firm has five analysts and three salespeople in Budapest dedicated to local equities, giving it the largest Hungary-dedicated team.
Budapest’s other local old-timer, Concorde Securities, is run by youngster Gyorgy Jaksity. Jaksity, 29, started working in Hungarian securities markets in 1988, when he was still a college student and the market was not yet strictly legal. Jaksity’s firm was one of the top volume traders on the BSE last year, and also gets high marks for its research. “It’s the only local firm we deal with,” says Barings’ Curtin.
Even as the number of international money managers shoving money into central and eastern Europe has grown dramatically in the past two years, so have the number of keen competitors for that broking business, says Jaksity. “Two or three years ago there weren’t many players, so whenever a new money manager appeared, you could easily make friends just by showing up.”
Now, “we need to work extremely hard”, says Jaksity, adding that “sometimes the fund managers know some of the companies much better than you do. Your daily routine has increased from 10 to 11 to 12 hours just to keep up.” To cope, Concorde has doubled the team of analysts to four, and replaced one trader with a salesperson, bringing its salesforce to three.
Unlike most of his fund managing competition, London-based Jochen Gutbrod doesn’t deal with Concorde or any other non-international brokers. Gutbrod, a fund manager at Schoder Investment Management, explains that, “I’m not talking to the local brokers, with them we always have the problem of getting them through our risk control people.” Gutbrod thinks Creditanstalt, Nomura and ING Barings are “very good” but adds that CS First Boston’s Tamas Csonka is “probably the best salesperson covering Hungary”.
ING Barings has topped the BSE’s volume sweepstakes so far in 1996, followed by Creditanstalt and then CS First Boston. But competitors say the Dutch-owned firm does all its trading through Budapest’s market, giving it a statistical leg-up on CS First Boston, which does large volumes on SEAQ. Both firms have salesmen and analysts in Budapest and London. But Nomura Research Institute passes up both trading and selling from Budapest and goes it alone from London. It executes trades through an independent local broker, and picks up accolades for its sometimes barbed research.
Although competitors snipe that Nomura’s reports can be “sensationalist” its 43-odd page report in January 1995 deconstructing Hungary’s best-known stock, retail conglomerate Fotex, tipped that company’s share price from $2.5 a share then to $0.90 a share last month.
But the days of broking Budapest stocks from a suitcase, whether for Nomura or other competitors such as Merrill Lynch, may be waning. Local pools of money are growing steadily, which will necessitate a local presence. Domestic fund managers have over $500 million under management, and recently-created private pension funds may accumulate $5 billion within a decade. Although local fund managers are now debt happy, their money may eventually give a big push both to Budapest’s market, which is capitalized at $3 billion, and to its embattled local brokers.
Poland: local brokers have a way to go by Jules Stewart
Twenty-one of Poland’s domestic stockbroking firms are members of the Warsaw Stock Exchange. In addition, there are many smaller brokers that use the established houses for clearing operations. Despite having been established for only a few years, these brokers have come a long way in terms of research and the calibre of people they employ. But as one London banker put it: “They have some way to go before they can come up with most of the services western investors expect. Apart from a few exceptions, there has been a slow improvement in the Polish market compared with the Czech Republic, largely because of the tight grip custodian banks have on the business. Brokers just don’t have to provide research to be competitive.”
Some of the bigger brokers produce relatively sophisticated, slickly presented research, but they lack salespeople who are able to give clients a true flavour of the marketplace. “They still haven’t taken the plunge into making forecasts or taking information on companies forward,” says a US banker. “It is well presented but largely uninspired material.”
The industry is regulated by the Trust Funds and Public Trading in Securities Act, which allows virtually anybody to set up as a stockbroker. Indeed some of the smaller players were formed by businessmen who decided to cash in on local interest in the country’s voucher-privatization programme. KDM, for example, a small broker based in Krakow that is not a stock exchange member, targeted small retail investors – at one point in 1993 it had a queue of customers two kilometres long waiting to open an account.
In order to become exchange members, however, licensed brokers need to be Warsaw Stock Exchange shareholders. The main domestic houses include Bank Handlowy w Warszawie, Bank Polska Kasa Opieki (Pekao), Bank Rozwoju Eksportu and Polski Bank Rozwoju. It is no coincidence that most are subsidiaries of the country’s largest retail banks.
The exchange has set very high standards for market operators. This includes an exam – considered draconian locally – for anybody who wants to be qualified to give investment advice. “In fact, a British or US-trained MBA would not be daunted by the exam, but it is likely to be several years before Polish applicants will be able to take the same casual attitude toward it,” says the London banker.
Those who have passed the exam are considered highly qualified and hence are expensive for local firms to hire. “As a result, a large proportion of the funds coming in are executed by foreign brokers,” says the banker. “The system will suffer from this handicap until there is a local institutional salesforce. Once they start to give western-style coverage we will see a greater flow of funds.”
Some of the domestic houses have begun to offer the sort of services expected in western Europe and the US, such as a custody department which is used as a mirror account manager for foreign clients that wish to place orders in the local market. The brokers that have the largest custody departments tend to attract the strongest fund flows, and most of the market is controlled by the big retail banks, operating through their broker subsidiaries. Domestic investors tend to use their banks to deal on the stock market, and foreigners, who need to give orders to a custodian bank, will use them as well.
Pekao and Bank Handlowy have already established custody operations and are among the brokers most widely used by foreign investors. Pekao employs 20 analysts who produce quantitative research and look at specific stocks.
Polski Bank Rozwoju, which describes itself as a merchant bank, has one of the largest brokerage businesses. It was the first to set up options on WIG (the Warsaw Stock Exchange Index) last year and has an active corporate advisory department. The group is also extending longer-term loans, a high proportion of which are for five years. But foreign clients are wary of its activities as a merchant bank and remain unconvinced that it has sufficient experience in this sort of work. “For large-scale projects one has to be realistic and people are still more likely to use western banks,” says the US banker.
As the market becomes more deregulated commission competition is likely to increase and this could freeze out some marginal players. However, by eastern European standards 21 is not considered an excessively high number of local brokers with exchange seats. By comparison, the Czech Republic has more than 40 brokers in a market with lower capitalization. The growing presence of foreign brokers, with their vastly greater capital resources and expertise, is likely to accelerate consolidation. Citibank and Creditanstalt are already exchange members and ING Barings is applying for a seat.
Russia: a market is needed by Craig Mellow
Russian stockbroking has come a long way in three years. Then, Bernard Sacher a broker at Troika-Dialog used to lead a clutch of raw local recruits to the State Property Committee every day with $5 million in cash to invest more or less blindly in voucher auctions. Today, Sacher and his competitors at Brunswick, Grant or Rinaco-Plus field teams of bicultural young hotshots, who slouch over their Reuters screens and bark sell orders with the best in the business. Now all they need is something to broke.
Russia’s stock market had a brief moment of glory during the spring and summer of 1994. Some $2 billion in foreign cash poured into undervalued oil and mineral companies, jump-starting an equities market of sorts. But by the end of year, the Chechen war and collapse of the Mexican peso cooled the market.
Last summer witnessed another surge of optimism, this time from financial houses themselves. Boris Jordan, who had played a big role in driving the market as head of CS First Boston in Moscow, left to start his own firm, Renaissance Capital. Jordan’s one-time boss Hans-Joerg Rudloff launched the Moscow operation of his London-based MC Securities. Menatep, one of Russia’s largest banks, set up Alliance-Menatep as its investment banking and brokerage arm.
So far their timing seems less than brilliant. The market was looking weak before the Communist Party’s victory in the parliamentary elections last December. Since then it has hit a series of record lows, and is unlikely to improve until after the June presidential elections.
Even if Boris Yeltsin wins, quite a few obstacles remain to block Russia’s path to a modern securities market. Neither industrial directors nor the state, in their hearts, accept that “their” enterprises can be given away to some stranger who happens to buy a controlling stake. Paying dividends to “legitimate” shareholders such as employees while refusing to pay dividends to “speculators” is a widespread practice.
The most dramatic corporate governance conflicts have involved Russian investors. Moscow’s largest factory, belonging to car manufacturer Zil, has been at a standstill for most of the past year because of a boardroom battle between the former managers and investment fund Microdin. At Siberia’s Kuznetsk Metal Combinat, a director appointed by outside investors fought his way into the office with armed guards, but had to yield when none of the company’s foremen would come to a staff meeting.
International investors have been have been involved in battles for control too, notably at Krasnoyarsk Aluminium, but they have yet to take a tilt at large nationally-renowned companies, where outside shareholdings remain small.
Moscow brokers have faced more dangerous situations too. They have not been immune to the murder wave that has affected their commercial banking counterparts. In a horrible twist even by local standards, last year assassins aiming at Grant’s president missed him but killed his six year-old daughter, who was sitting beside him in the car.
Financial institutions have also been going bust. Last month the sudden bankruptcy of the well-regarded AIOC Capital made bankers in Moscow wonder where there is such a thing as a good credit risk in Russia any more. AIOC was backed by the large US metals trading firm of the same name.
Russian commercial banks have been helped out of their current difficulties by short-term government securities, GKOs and MinFins. Annual yields on three-month notes have been running at between 60%-90% – attractive even for foreign investors as long as the government can keep the rouble stable. The state, not wanting to pay such high spreads forever, opened the market to foreign capital early this year but under rules which largely cut out Moscow-based brokerages. The first international tranches were distributed through Moscow Narodny Bank and other former Soviet state banks abroad. In March, however, the government announced internationally-targeted deals lead-managed by Merrill Lynch and Salomon Brothers.
Moscow brokerages have little choice but to hang on and hope Yeltsin wins the presidential election. “This isn’t like New York where you can lay off people when the marker is low, then hire them back,” says Yuri Milner, chief executive of Alliance-Menatep. “The talent pool is too thin.”
And if Yeltsin does not win? “I think everything will freeze for at least six months,” predicts Troika-Dialog’s Sacher. “Obviously some people won’t survive that period.”
| The 10 top-rated Russian brokerages | |
| 1- Troika-Dialog | |
| 2 – Brunswick | |
| 3 – Grant | |
| 4 – CS First Boston | |
| 5 – Rinaco-Plus | |
| 6 – Tserikh | |
| 7 – Alfa Capital | |
| 8 – Alliance-Menatep | |
| 9 – OLMA | |
| 10 – Moscow Partners | |
| (Source: survey of market participants by A&M Consulting, October 1995). | |
What the brokers say
The different markets of central and eastern Europe offer equity investors a wide range of choices and vastly different histories. Euromoney asked leading brokers and analysts active in the region for their assessments
The Baltics: equities begin to blossom
Until the summer of 1995 the Baltic securities markets were largely undiscovered by international investors. Since then several factors have contributed to a marked change in activity and an estimated inflow of approximately $200 million from the western capital markets – firstly into government debt instruments and then into mainly bank shares.
Latvia became the pioneer among post-Soviet Republics to tap the Eurobond market with a ¥4 billion offering in August. Extensive marketing and analysis by Nomura, the lead manager, drew significant attention from the markets and paved the way for eye-opening opportunities in the high-yield local T-bill markets of Latvia as well as Lithuania. Yields on short-term bills have oscillated between 20% and 35% per annum, depending mainly on auction timing in relation to a rapid sequence of banking and political crises which plagued both Latvia and Lithuania last year.
This did not, however, prohibit Lithuania from opening the Eurodollar market for Baltic credits with a $60 million issue in November. Neither has it deterred The City of Tallinn’s plans for a Deutschmark issue in the near future, and by doing so lead the way for other post-Soviet municipal borrowers. The macroeconomic potential and overall reformist political trends among Baltic nations has been accepted by the international financial community as attractive enough to warrant diversification of funds to capture some of the higher returns on offer when compared to western and even central European securities. In the equity markets, the banking sector (particularly in Estonia) has been one of the first to attract interest.
The ability of a certain number of these banks to produce positive audited results, relatively healthy balance sheets and comprehensive strategic plans which differentiated them from the majority of licence holders in the area have made these banks stand out in the market. Due to the embryonic state of the local stock exchanges (Estonia remains to open in May this year), lacking even minimum volumes and quality information and research, investors were pleased to be offered reasonable investment size through a handful of primary share offerings targeted internationally. While investors wait for more sizeable offerings via the planned privatization of larger utility companies, the banking sector remains by far the most active sector in the region.
The banking sector has played a pioneering role in tapping international capital markets, with some half dozen Baltic banks undergoing the arduous process of compiling an international prospectus and presenting their institution to overseas fund managers.
Investors have been attracted, in particular, to the Estonian banking sector since its representatives offer the following critical attractions and assurances:
* minimum of three years’ audited accounts to international standards;
* significant growth prospects, reflecting a small banking sector (in terms of available capital) which is servicing a buoyant economy where demand for credit far outstrips supply;
* good track record for non-performing credits, with bad debt ratios not exceeding 3% to 4% of loans;
* competent and entrepreneurial manageers who can successfully communicate their business and future strategy, in English, to investors;
* highly reasonable stock valuations.
It is highly probable that, when the Latvian and Lithuania banks can generally provide all of the above, then we will see many other international public offerings from the region’s banks. The major difference between Estonia and its two Baltic neighbours, as far as the banking sector is concerned, is one of timing. Estonia suffered its banking crisis early (back in 1992-93), and has since witnessed the growth of a reduced number of highly competent banks. The banking crises in Latvia and Lithuania were more recent (April and December 1995 respectively), such that it is still early to pick winners with great confidence.
Bank stocks in Baltic Region are still attractive (most attractive, of course, in the undiscovered markets of Latvia and Lithuania, where risks are greater than in Estonia) and, while liquidity remains a problem, it should be remembered that those investors who turned down Hansa Bank in 1994 as being too small (market capitalization was just $33 million then) missed share price appreciation of 250%, and a stock whose market capitalization now exceeds $120 million.
Finally, for those who wish to take an indirect approach to the Baltic markets two new funds are being planned by Flemings and Nomura: respectively the Baltic Basin Fund, a venture capital fund for the Baltics including north-west Russia (St Petersburg), and the Hansa Property Fund, which will target prime real estate in the Baltic capital cities, where hard currency rental yields have reached as high as 30% per annum.
A report compiled by Nomura Institute and Nomura International, London.
| Baltic data | |||
| 1995 statistics, estimated | Estonia | Latvia | Lithuania |
| Capital city | Tallinn | Riga | Vilnius |
| Population (m) | 1.50 | 2.55 | 3.80 |
| PPP GDP per capita ($) | 7,000 | 5,000 | 3,500 |
| GDP Growth 1996c (%) | 4 | 5 | 5 |
| Private sector in % GDP | 65 | 60 | 55 |
| % exports to EU/EFTA | 56 | 47 | 40 |
| FX Reserves * in % of M2 | 67 | 28 | 51 |
| Budget balance as % GDP | +0.5 | ¬3.0 | ¬0.2 |
| Listed/quoted companies (number) | 6 | 21 | 401 |
| Market cap ($ m) | 230** | 27 | 175 |
| * Excluding gold reserves | |||
| ** OTC estimate by Hansabank. | |||
| Tallinnn Stock Exchange is set to open May 1996. | |||
| Sources: Nomura Research Institute, World Bank, EBRD and | |||
| national statistics. | |||
Croatia: equity markets are dominated by small investors
The Croatian equity market is generally dominated by small investors who have become shareholders through the privatization process. Thus, it remains a very illiquid market. There are currently over 500,000 private shareholders, but, as yet, no institutional shareholders.
The pension and health funds, which receive parcels of shares as part of the privatization process, have not sought to manage their portfolios. The leading players in the market are the commercial banks and private brokerage houses which are members of the Zagreb Stock Exchange (ZSE). The Croatian Privatization Fund (CPF) is also active on the market, though only as a seller, as it seeks to dispose of its holdings.
A new Securities Act has recently been passed which has instituted primary and secondary market procedures and regulations along western lines. The Act has also set up a Croatian Securities and Exchange Commission (CROSEC) which is charged with supervising the primary and secondary markets. It is hoped that the CROSEC will help to improve secondary market liquidity, which is currently very poor. Total trading in 1995 slumped to Dm65.9 million ($44.6 million).
The ZSE was re-opened after the fall of communism in 1991 and is controlled by 34 shareholders who appoint a six-member board of directors. The board manages and administers the ZSE and decides on admission to membership. Currently, membership comprises 17 Croatian banks, two insurance companies and 22 brokerage houses. Brokers are allowed to trade for their own account as well as to act as intermediaries.
There are only three companies which are fully listed, although a further 62 have satisfied less rigorous requirements for second-tier listing (known as TN quotation). In addition, one municipal bond and 11 bonds created from frozen foreign currency deposits are listed.
The ZSE’s main market is the Telecommunications Supported Trading System-1 (TEST-1) which is an electronic market for the trading of fully-listed shares and bonds. But currently only a minimal amount of trading takes place through this system. Special one-way open-outcry auctions take place twice a week when the CPF offers parcels of shares; these are mostly swapped for frozen foreign exchange deposits. Futures and options trading has not yet been established. Settlement is seven-day and takes place directly between the counterparties – there is no centralized clearing house.
There are three other OTC markets in Croatia; Zagreb, Varazdin and Osijek, which are independent of the ZSE. These markets, particularly the Varazdin OTC market, tend to be more liquid than the official ZSE, but lack the regulatory and disclosure environment.
A report compiled by Union Bank of Switzerland, London.
Czech Republic: a significant turn in fortunes for equities
A large part of the Czech economy – assets worth Kr480 billion ($17.6 billion) – has been privatized. The lion’s share of this – around Kr350 billion – was privatized in two waves using the coupon privatization method in which most of the citizens of the Czech Republic took part.
Very quickly, many people became shareholders, either directly in privatized companies or in investment funds. These investment funds, which came into being in the course of privatization, used the investment points entrusted to them by individual investors. This set the mould for the nascent capital market, giving shape to its two main features: the dispersion of shares among many minority shareholders and the birth of powerful investment funds. Most of the participants (70% in the first phase of coupon privatization, 64% in the second phase) entrusted their points to investment funds, and these therefore currently control a considerable part of the Czech economy.
Shares from the second phase of coupon privatization were introduced to the market in March 1995. As early as mid-year, mergers, acquisitions and management buy-outs began, mostly involving smaller firms – a consequence of the dispersion of shareholdings. In this manner many larger companies won controlling interests in smaller ones, enabling them to impose their own policies. This rationalization was a step towards greater capital-market transparency. At present more than 1,700 companies trade on the Prague stock exchange. However, it can be expected that most of the non-liquid companies will trade on other markets, such as the second public market (the RM-S). It is also quite probable that the liquidity of some of the companies, in which a majority owner has begun to establish itself, will drop, thereby releasing funds and raising the liquidity of the larger companies trading on the Prague stock exchange.
Several steps have been taken to raise the transparency of the Czech capital market. The stock market has been divided from two into three markets. Despite a humble beginning (with seven shares) continual trading began in March. It is expected that a law on the protection of minority shareholders will be passed this year. Some of these steps could have been taken earlier, but developments are positive, with the Czech capital market continuing to move closer to the standards of capital markets in developed countries.
Foreign capital is playing a significant role in the completion of privatization. Important developments in 1995 included the entrance of international oil consortium IOC into the Czech refining industry and participation by US investment company Stratton Investments in a broad range of companies with the aim of winning controlling interests. Attractive opportunities include the electricity and gas distribution utilities.
Another characteristic of the Czech capital market is the high discounts of shares in investment funds. The average long-term discount ranges between 30% and 40%, predominantly at the higher end of the spread. Assuming quality portfolios, such high discounts make for decidedly attractive long-term investments. Furthermore, such discounts encourage investors wishing to take control of undervalued funds to buy these shares – such activity was witnessed during the second half of 1995.
Price falls were a discouraging feature of the first two full years of trading on the Prague stock exchange. The PX-50 index lost 17% in 1994 and declined by a further 23% in 1995. The first months of 1996 appear to bode well for a significant turn in fortunes. From January 8 to March 15 this year the index rose 10.6%. Also, in February, the index rose above its 200-day moving average for the first time – which is indicative of a growth trend.
A report compiled by Komercní Banka, Prague.
Hungary: equities move somewhere past exotic
When searching for adjectives to describe the Hungarian equities market, one must keep an eye on its torrid pace of development and its current position in the life cycle. At roughly 9% of GDP, with turnover doubling in real terms over each of the past two years, the Budapest Stock Exchange is somewhere past “exotic”, but still shy of “second-tier” European market status. The BUX index is up 46% in dollar terms so far this year, spurred both by the global trend of inflows to emerging markets as well as investor euphoria following Hungary’s unprecedented sell-off wave of its utility sector at the end of 1995, further solidifying its status as the favourite target for western direct investment in the region.
The austerity programme, designed by outgoing finance minister Lajos Bokros, has put the country firmly on track for an IMF lending package and sustainable growth with falling inflation. In 1994 the current account deficit and the central budget deficit reached 9.8% of GDP – prompting concerns about a Mexico-type scenario. The twin deficits should decline to 2.8% and 3.5% respectively in 1996. This dramatic turnaround has laid the groundwork for a re-rating of the Hungarian market, leading to higher earnings valuations and lower risk premia.
Having appreciated dramatically so far this year, market-players may be starting to have cold feet about Hungarian stocks. Valuations, however, remain attractive with the market trading at 8.6% of current year’s earnings (excluding oil company MOL) and at 11% of dollar earnings growth forecast for the year. Most consumer and financial companies continue to slump however. Random “dartboard strategies” simply don’t work now. This is a classic stock picker’s market and it has been our experience that brokers who do their homework can consistently outperform the local index. There is no substitute for consistent and comprehensive bottom-up research, combined with a sound understanding of local political and economic trends.
Out of over 40 listed stocks, between 15 and 20 are investable for most institutions, but for some non-regional or non-emerging market funds, this may narrow to five or six stocks (those with some type of depositary receipt programme and sufficient market capitalization). Therefore, waves of liquidity (such as the one we are now witnessing) tend to focus first on big companies with GDRs and then the money trickles down to second-tier growth stocks. When is the market primed for a correction? A good clue is given by a sudden surge of interest in low-growth, illiquid stocks such as breweries or retailers after a prolonged rally. This what’s still cheap? effect is usually an indicator of a shift to declining returns, and a good time to take profits for those with shorter time horizons.
From an analyst’s perspective, the market breaks down many of the numbing statistical realities which keep indicating that the value-added element of stock-picking is approaching zero as information becomes instantly incorporated into prices. This is not yet the case in the emerging markets. Here in Hungary, it is still very much a period when the market can be outsmarted through exhaustive research and a superior understanding of the country’s sometimes confusing political developments. As for the future, it is clear that information is increasingly available and consistent, and as the market continues to grow, it will enter the ranks of the developed markets sooner than most may imagine.
A report compiled by CS First Boston, Budapest.
Poland: undervaluation offers good prospects for this year
Prospects for further appreciation of Polish publicly-traded stocks in 1996 look good. Corporate earnings will grow several times faster than the economy, inflation will abate, and many securities still trade below their full market potential.
This year, further consolidation of the growth trends which brought GDP up 5.2% in 1994 and 7.5% in 1995 is expected. Economic grow will slow down to a rate of 5% to 6% this year, but this easing in the gorwth rate is not a full-scale contraction. Overall, next year should see an extension of the trends in faster investment inflows, industrial growth and slowly declining inflation. However, structural impediments (the budget deficit, the social security shortfall and the slow pace of the privatization programme) will hamper acceleration of growth rates.
After the effective revaluation of the zloty in December 1995, it looks likely that the central bank will continue with a policy of gradual devaluation. The central bank will be bolder than previously in tackling the upward presure on the zloty. A rate of Z2.80 per dollar by December this year is forecast.
On the industrial side, growth will abate in the process industry sectors and drop below 10% in annual average terms by December this year. Hot sectors to watch in 1996: construction, instruments, computers, chemicals, rubber and plastics and heavy machinery. Losers include apparel, textiles, leather, mining and basic metallurgical industries.
External trade balances will deteriorate, with the foreign trade shortfall deepening to over $3 billion. However, the deficit will be comfortably covered by short-term capital inflows and substantially higher net foreign investment. Indeed, foreign investment should reach $2 billion in direct spending alone. None of the external coverage ratios will reach dangerous proportions and inflation for this year should register around 18%.
Poland’s capital market expanded further in 1995 to reach – as of last month – over 70 companies listed on the Warsaw Stock Exchange (WSE). Their combined capitalization approximated $6.8 billion, up from 44 companies with a $3 billion capitalization as of December 1994.
However, equities are still not fully valued at current multiples of 10 times historic earnings. Strong growth in corporate earnings of around 22% to 25% in the next 12 months will offer fundamental reasons to overweight the Polish equity segement. Strategic investors buying Polish tobacco companies earlier this year, for example, valued them at over 10 times earnings compared to respective ratios of five to seven for other IPOs.
Soon there will be plenty more to choose from. In the next 12 months many of the “mezzanine” firms of the mass privatization programme will hit the primary market. Shares of the national investment funds (NIF) – pooled holdings of privatized companies – should not be far behind to list on the WSE. Share certificates – vouchers entitling holders to bid for shares in NIFs – will start trading on the exchange as early as between May and June this year.
Privatization of three other large companies – expected in 1996-97 – will ofer additional depth to current pickings. All three are heavyweights, profitable, and highly regarded: KGHM (copper), TP SA (telecommunications), and PBK (banking). The copper producer’s $3 billion flotation alone may be too much for retail investors to absorb, however. Outright sales to foreigners and/or special incentives for domestic ones (for example, tax write-offs) may be needed to assure success.
What are the hot picks for the next 12 months? Paints and coatings should do well due to solid export markets in the east and a tidal wave of domestic modernization. New technologies and quality standards will assure international competitiveness. Energy-related businesses also look favourable. Energy generation, transmission and distribution will require tens of billions of dollars worth of modernization. Companies catering to such restructuring will have guaranteed contracts well into the 21st century. Tyre manufacturers are also desirable due to projections of double-digit car ownership growth rates for the foreseeable future. In addition, there are multi-billion dollar investment plans in the domestic auto manufacturing sector in the pipeline. Computer makers are also stocks to be bullish about. Investments in upgrading information technology by Polish companies has nowhere to go but up as firms scramble to catch up with efficiency standards seen in the industrialized countries.
So where are the pitfalls? To start with the WSE remains fundamentally risky market. With 70 listings, market capitalization of $6.8 billion, and only a 5.5% share of GDP, the Polish equity market will remain shallow for many months to come. Despite quieter more trades in the recent past and wider sectoral representation, the listed market suffers from limited diversification options. Retail investors, who trade in smaller lots for speculative short-term gains, still dominate. The market is devoid of large institutional players, including foreign ones. All of this limits sectoral plays and counter-cyclical moves.
These drawbacks notwithstanding, the Polish market offers attractive valuations for the more risk-loving investor.
A report by Pioneer First Polish Trust, Warsaw.
Russia: liquidity is the key
Liquidity is the key to the structure of the Russian equity market. The capitalization of a given company is not necessarily any guide to its attractiveness. Foreign portfolio investors are able to acquire only stocks that are available, not necessarily the most desirable companies. Holdings have therefore been concentrated in three sectors in particular: oil, telecoms and utilities, with a relatively small number of liquid shares in other industries.
In virtually all companies, large stakes are held by parties whose prime interest in buying the shares was corporate control, rather than bargain hunting. These investors are not necessarily motivated by cheap relative valuations when making investment decisions. The most obvious alternative benchmark to capitalization in this environment is free float or liquidity. With very few exceptions, this figure is extremely difficult to identify.
The result is that, in terms of share ownership at least, there is no such thing as a typical Russian company. The free float will vary according to the privatization process and the extent to which the original share purchasers have been willing to pass them on.
Foreign investors in the Russian equity market today seem to fall into two main categories. The first group comprises specialist firms dedicated to investing in Russian equities; the second is made up of those hedge funds that are not prevented from investing in the market by a lack of western-standard custody services. Both groups are long-term investors whose managers do not generally sell their portfolio stock back onto the market.
Of the domestic players, only the brokers are particularly active on the market at present. Unlike Poland, the domestic retail investor – scarred by scandals such as the MMM debacle – is conspicuous only by his absence. The voucher funds established in the immediate wake of privatization have, by and large, established positions in companies in which they have some degree of control over management.
The banks have also been generally more interested in taking strategic stakes in enterprises, particularly through the recent loans-for-shares scheme. Potential short-term players on the equity market have had their focus diverted by the short-term bond (GKO) market, which offers 85% annualized yields, much of which will be in hard currency if the rouble corridor policy continues. For overseas investors the proportion of liquid stock will stay relatively low for the time being at least.
The current free float is estimated (with any meaningful accuracy) at between $2 billion and $3 billion. Liquidity, however, is impossible to pin down becasue of the OTC nature of the market. There is still considerable argument about the size of portfolio inflows to the market from abroad. During the heady days of late summer 1994, Russian government sources estimated the inflow of foreign funds at $500 million per month. Frankly, this estimate seems very high; the OECD figure of an average of $100 million to $150 million per month during 1994 seems more realistic and the net inflow from abroad remained positive in 1995, although probably at a somewhat lower rate. Liquidity, on a strong day, might total $20 million to $50 million.
Oil and gas companies make up the largest sector of the equity market (excluding Gazprom because of low liquidity and restrictions on trading its stock). The sector comprises vertically-integrated companies whose stocks are by far the most liquid in the market.
For a number of more liquid oil companies there are restrictions on the amount of stock that can be held by foreign investors (15% in the cases of Lukoil and Yuganskneftegaz). Despite this, the relatively large size of the companies in terms of their asset base means that the oil sector dominates the whole Russian market, even at a tiny percentage of valuations accorded to their peers in western markets.
Much of the supply onto the market, for the next couple of years at least, is likely to come from the oil and gas sector. Existing shares in these companies will be repackaged and sold to investors, possible in ADR form. The sector is also likely to be among the first with secondary issues. This process is likely to be accelerated by the loans-for-shares scheme, which has settled the control issue for a number of leading companies.
The utilities and telecoms sectors have much in common besides their domination by large national companies with regional distribution arms. Foreign ownership is much higher, as a proportion of outstanding capital, than any other branch of privatized Russian industry.
Rostelekom leads the group, with about 34% of its equity in foreign hands. UES, the national power grid, is close behind. Foreign investors hold significant stakes in MGTS (Moscow City Telephone), St Petersburg Telephone and the power companies Irkutskenergo and Mosenergo.
The banking sector has a high weighting in all the capitalization indices used. However, there is virtually no liquidity in any banking shares, for two reasons. First, the equity capital of private banks is held extremely tightly, usually by the founding institutions. Second, a foreign investor must get explicit permission for the central bank to buy bank shares – not necessarily a straightforward process. There have been plans for a number of banks to issue ADRs, although none of these has yet come to fruition.
In the manufacturing sector there is little liquidity in many of the leading companies. The majority of the shares in the most attractive manufacturing companies have, in effect, been taken into private hands, primarily by the management but in certain cases by other investors interested in establishing control. Of particular note are the following sectors:
* Cement: by and large snapped up in the imediate aftermath of privatization;
* Aluminium: stocks became the subject of a lengthy and well-publicized battle for control, which culminated in Krasnoyarsk Aluminium deleting a 20% stake bought by Transworld, a Russian trading company. The legal battle continues;
* Pulp and paper: bought up by a combination of strategic and portfolio investors who were early into the market in 1994;
* Automotive: shares in the two largest manufacturers, Gaz and Avtovaz, are largely in the hands of their managers and associated interests.
An edited extract from, Russian Equity Market: Not if, but When, Morgan Stanley, London.
Slovakia begins to entice
The total volume of securities traded in 1995 on Slovakia’s organized capital markets – the Bratislava Stock Exchange (BCPB), the Bratislava Option Exchange (BOB) and RMS (second public market) reached Sk59 billion ($1.96 billion), compared with Sk10 million in 1994. BCPB’s 1995 share of total volume of securities traded was 68%, RMS’s 30% and BOB’s 2%.
In 1995, shares to the value of Sk44 billion were traded, almost five times the Sk9.3 billion traded in 1994. BCPB reports 43.6 million shares traded in 1995 with a total volume of Sk34.7 billion, a fivefold increase in shares traded on 1994, and a volume increase of 4.5 times. Direct share dealing in 1995 amounted to Sk24.3 billion, a five-fold increase on 1994. Floor trading reached Sk0.4 billion in 1995, a 50% drop on 1994 figures.
As of December 22 1995 – the last business day of the year – 887 shares were traded at the BCPB. At this time, market capitalization was Sk173 billion, and 19 shares quoted on the exchange had market capitalization of Sk39.1 billion.
The value of the official stock exchange index (SAX), dropped in 1995 by 29% compared with 1994. This index is based on the 12 most liquid shares. The value of SAX at the end of the year was 153.8 points; having peaked on January 2 1995 at 216.3 and dropped to its lowest value on December 12 at 147.1.
The value of the Sevis-100 index (consisting of the shares of 100 joint-stock companies) dropped by 10% in the same period (1994-95), the closing value at the end of 1995 being 482. The Sevis-100 index reached its peak on March 9 at 577 points, and its lowest value on July 11 and September 5, at 441 points.
The price falls during 1995 and dividend revenues have stimulated investor interest in Slovak shares, in particular those of Slovakia’s financial institutions. A dividend return of almost 12% was achieved by the shares of Vseobecna Uverova Banka and Investiona a Rozvojova Banka. The dividend returns of listed shares vary by around 5%.
Developments in the share market last year were also affected by an amendment to the securities legislation (Act 600/1992) that came into force on August 15. The law now requires all direct deals to take place on the organized market (either at the BCPB, the RMS or BOB). Before this amendment, fewer than 20% of securities transfers were carried out on the organized market. The new rules are designed to make the capital market more transparent and liquid, obliging issuers to publish half-yearly results on time and annual reports within five months of the end of the calendar year. Additionally, as protection for small investors, the maximum holding in any one company is fixed at 30%. Any holding above this level has to be offered for sale.
Since the start of this year, there has been a revival in the share market, with an increase in volumes as well as prices. During the first two months of 1996, Sk15.7 billion was traded – amounting to 35.68% of the total traded in 1995. The value of the SAX index has risen 20.33% since the beginning of the year (as of late March), and the value of the Sevis-100 index has increased by 15.98%.
A report compiled by VUB Invest, Bratislava.
Slovenia: still shallow
The Slovenia equity market is relatively shallow, with little interest shown by foreign equity market investors. Most equity activity to date has focused on direct investment. But this could change this year as shares in the first privatized companies start trading. This will be the initial opportunity for foreign investors to buy a broad selection of equity in various industrials.
The exchange is actually the oldest in the region – founded in 1989 – but it has been very slow in developing. At year-end 1995 only 12 companies were listed on the Ljubljana Stock Exchange. Market capitalization was only about Dm500 million.
However, over 70 companies have issued shares as part of their privatization schedules, but to date only one Kolinska (food processing) trades its shares on the exchange. Several additional firms are expected to begin trading their shares later this year.
But for foreign investors direct investment remains the primary avenue for equity investment in Slovenia.
Almost all sectors of the economy are open to foreign investors. Wholly foreign-owned companies are not allowed to invest in well-defined strategic activities, such as the production of military equipment, rail and air transport, telecommunications, insurance, mass media and auditing. In addition, there are ownership restrictions in some types of finance-related operations: a maximum 49% foreign shareholding is permitted in auditing firms, 24% in stockbroking companies, and 20% in fund management companies.
Foreign legal entities, established and registered in Slovenia, enjoy the same property and real estate ownership rights as domestic firms, but foreigners and non-registered foreign legal entities cannot own real estate.
The Foreign Investment Law allows foreign capital of whatever origin to be used in all forms of business in Slovenia, including wholly and partly foreign-owned companies, joint ventures,
concessions, build-operate-transfer (BOT) agreements, and investments in free trade and customs zones.
Partly and wholly foreign-owned firms – and share acquisitions in existing companies – like their domestic counterparts, must register in the local court. Any share or asset deal with a local
company that has not been privatized needs the approval of the Agency for Restructuring and Privatization, before registration.
The minimum capital for setting up a new company is T1.5 million ($12,000) for a limited liability company and T3 million for a joint-stock company. Foreign investment may take the form of cash, tangibles (fixed and other assets in Slovenia or abroad) or rights, for example to know-how or industrial property.
The government believes that political and monetary stability, an open economy, a market-friendly legal framework, and Slovenia’s strategic location, will go a long way towards attracting investment. Slovenia is not convinced that tax holidays are the most effective way to attract foreign investment. Nonetheless, investments do attract tax benefits and, with a 30% profit tax rate, Slovenia ranks as one of Europe’s lowest taxed countries.
Companies (including foreign firms) operating in designated free trade zones are exempt from taxation on profits in the first five years and for a part of the profits generated by the export of goods and services. The only export promotion measure is a reduction in import duties and other charges paid for the inputs included in exported products.
The Foreign Investment Law guarantees foreign investors free and unrestricted transfer of profits (including repatriation) and the right to free repatriation of invested capital by the foreign investor, a facility that includes cases of liquidation, bankruptcy or compulsory settlement.
A report compiled by SKB Banka, London.
Slovakian capital markets (volume traded)
Budapest’s regional index upsets the neighbours
The Central European Stock Index is as good a measure of jostling national egos as of gyrating equity prices, says Henry Copeland
Conceived two years ago by staff at the Budapest Stock Exchange (BSE), the Central European Stock Index (CESI) was launched on February 1 1996. The capitalization-weighted index is made up of 27 of the largest, most liquid, and officially listed stocks traded on the Budapest, Prague and Warsaw exchanges.
That formulation left a conspicuous hole in the centre of central Europe: Bratislava. “It’s a little bit strange that it [Bratislava] has been excluded,” says Michele Spong, an analyst at Nomura Research Europe. The capitalization weighted NRI-East European Index launched in October 1994 today includes 19 Slovak stocks, as opposed to only 16 from Hungary.
The exclusion turned heads in Bratislava as well. “We were a bit surprised that we were excluded. Until then we had very good cooperation with our colleagues at the BSE,” says Barbara Lazarova, head of the Bratislava exchange’s listing department.
“In comparison with Hungarian market [50 companies], we have more than 800 companies. I think we have a very good market, some very large and interesting companies,” says Lazarova. “What the intentions of the Hungarians are, I cannot guess.”
Budapest’s intentions may not be so hard to guess, however. While not exactly beleaguered – the BSE’s own index is up 50% so far this year – the BSE’s glamour has slowly faded since it was launched in 1990. As a table in CESI’s brochure reveals, Budapest’s capitalization of $2.35 billion at the end of 1995 pales in comparison with Prague’s $10.3 billion, and Budapest’s 1995 trading volumes of $3 million a day look feeble in comparison to Warsaw’s daily turnover of $22 million.
Whether intended or not, Bratislava’s exclusion had the effect of keeping yet another potential competitor for Budapest out of the limelight. In the first two months of 1996, daily Slovak volumes outpaced those in Hungary. And, of the 20 largest capitalized companies in central and eastern Europe on June 30 1995, four were Slovak, with a capitalization of $1.1 billion, compared to two Hungarian firms with a capitalization of $1.2 billion.
It’s not just the Slovaks who feel slighted by the CESI’s formulation. Czech and Polish officials also have their quarrels.
“I should tell you that the CESI is not confirmed by the Prague or Warsaw Stock Exchange,” says Vladimir Ezr, director of trading of the Prague Stock Exchange. “Our Hungarian colleagues are publishing this index on their own because we didn’t agree on the mechanism. They artificially cut the weight of our shares.”
Unadjusted, two Czech equities – SPT Telekom and power company CEZ – would account for 45% of the CESI index. To reduce their influence, the Hungarians sliced the number of shares of each to 10% of the original basket. This reduced the Czech share of CESI from 65% to 50%, a result which Ezr says he can understand. But the capping left SPT and CEZ each with equal weighting to Komernci Banka, which accounted for 9.9% of the original basket. Ezr finds this skewing unreasonable.
The Poles have their own bone to pick with CESI. “We proposed that they take into account the market capitalizations and trading volumes,” says Leonard Furga, head of international relations at the Warsaw exchange. Warsaw weights its own index using this methodology, notes Furga, adding that this mechanism was borrowed from the IFC, which has created indexes all over the world.
But if CESI’s formulation inflated Budapest’s in the index, that is the way it should be, says Spencer Jakab, an equity analyst at CS First Boston in Budapest. An index should simulate the likely universe of investor preferences, he says. The CESI’s biases correctly reflect the large roll that Hungary’s market plays in international investors’ portfolios. “Hungary deserves more than a 10% or 20% weighting, because of the amount of foreign money present.”
Likewise, turnover would not be so useful for an international investor because “it would skew an index inordinately towards the Polish stocks, since there is a large domestic investment base there. You have something like 400,000 retail investors, while in Hungary you would be lucky to find 1,000 active local investors, if that,” he adds.
Jakab thinks the tussling over the CESI reflects the justifiable pride of each market’s creators. “I think its understandable that there are feelings of rivalry. They developed in three totally different ways, and in all three countries, they feel they’ve created the best model and feel that their market has certain attractions that the others lack.”
An ideological retreat on economic policy?
Delays in implementing reforms and calls for a “socially-oriented, state-controlled” economic model have investors wondering about the conduct of future economic policy. Rupert Gordon-Walker reports
Ukraine’s path towards economic transition has not been eased by a comfortable political or social environment. Last autumn strikes closed 75% of the mines in the Donbass coalfield, thousands of pensioners demonstrated in the streets of Kiev for higher pensions, and rioting followed the funeral of the late patriarch of the Ukrainian Orthodox Church exposing ethnic tensions between nationalists and the country’s large Russian minority.
Nor can the ex-Soviet republic feel territorially secure. President Leonid Kuchma has also had to fight revanchist ambitions from Moscow hardliners, but has resisted integration into CIS economic and defence structures and not submitted to Russian claims on the Black Sea Fleet ot the Crimea. Neighbouring Belarus’s moves to greater cooperation with Russia and President Lukashchenko’s call for a federal union between the three countries adds to the nervousness already raised by a probable communist victory in Russia’s June elections.
It is not surprising that Ukraine’s government has appeared reluctant to impose shock treatment with such insecure foundations and so few guarantees of stability. “Reform must not harm the Ukrainian people,” says National Bank of Ukraine (NBU) chairman, Viktor Yushenko, in response to IMF complaints at the slow pace of structural change. But, claims Viktor Pynzenyk, deputy prime minister for economic reform and one of the president’s “young turks”, it is significant that there have been no steps backwards since Kuchma announced his radical reform programme in October 1994. He adds that a return to a command economy is now impossible because the non-state sector, which already accounts for 40% of GDP would simply take over.
The October 1994 programme contained standard IMF/World Bank prescriptions: price liberalization and reductions in state subsidies; reducing the budget deficit to 4% of GDP by 1997, and imposing tight fiscal and monetary stabilization policies; accelerating privatization through a system of auctions and developing capital markets used by financial intermediaries to facilitate the process; and finally, creating a treasury bill market to help finance the budget deficit.
Professor Anders Ashund, senior associate at the Carnegie Endowment for International Peace and an economic adviser to the government, believes Ukraine is progressing well towards becoming a free-market economy. Three years of confusion after 1991 have been followed by domestic trade and price liberalization, a reduction of import barriers, macroeconomic stabilization and substantial privatization. “The reforms are true this time,” he says. But he warns that Ukraine is three years behind Russia, so investors and agencies should be patient.
But at the beginning of the year the IMF withheld the fourth tranche of its $1.5 billion standby loan worth $350 million, citing slow progress in the privatization programme, the persistence of deficit-fuelling state subsidies, and the country’s failure to pay off its gas debts to Russia and Turkmenistan. Although the money will probably be released in April following deputy prime minister for the economy Roman Shpek’s meeting with IMF officials in Washington in February, the IMF remains concerned about the pace of reform.
Last year, parliament excluded some of the most attractive sectors from privatization – agribusiness and oil and gas – and disputes over priority rights between suppliers and employees of enterprises meant less than 1,000 of the 8,000 large businesses listed were offered for auction. Privatization of small enterprises – cafes, bars and shops was more successful – about 25,000 enterprises have been privatized so far, but apathy and scepticism about the value of many of the companies offered for sale at the Ukrainian Stock Exchange (USE) has meant that only 50% of citizens have redeemed their privatization vouchers. The government is confident that new compensation certificates will generate greater interest. Unlike the vouchers they can be exchanged; but unfortunately they are trading at a 70% discount in the black market, which bodes ill for the April auction when they can be exercised for the first time.
Competing interests in the Rada (parliament) cannot be blamed for all the delays. The council of ministers (cabinet) withdrew support for an ambitious scheme to restructure the country’s energy markets at the beginning of the year. Energy prices have already been freed, forcing consumers to pay 60% of the real cost after years at 4%, but the pain has not been rewarded by the breakup of the electricity monopoly. Autonomous suppliers were supposed to sell energy into a wholesale market and bid for contracts from regional distributors. Instead the scheme has been shelved. Pynzenyk is confident that it will eventually come into effect but the danger is that deregulation will force prices up even further. He asks, “What would happen if western governments suddenly raised energy prices 15-fold, as we did last year? Politically it is not easy, and we must take account of the social costs.”
Ukraine hopes to obtain $6 billion of overseas aid this year. In addition to further tranches from the IMF, about 20 projects for World Bank financing are planned, including schemes for thermal power rehabilitation, telecommunications, housing, transport and education. A rehabilitation loan of $1 billion has already been disbursed to fund imports and help implement economic changes. The World Bank is prepared to lend up to a $1 billion a year during the next decade, conditional upon sustained structural reform.
The IFC has established operations in nine cities in Ukraine to help introduce small-scale privatization, following a successful pilot project in L’vov in 1993. IFC-assisted cities have now sold between 30% and 70% of their municipal enterprises. Also active in the development of the private sector is the EBRD, which has promised to lend a further $130 million to the Ukraine in addition to its investment operations, which increased substantially last year after a rather cautious beginning.
Ukraine received a further $900 million in bilateral loans in 1995. The US Congress recently approved $255 million in assistance for this year, which will make Ukraine the third largest recipient of US aid in the world, well ahead of Russia which has been allocated $195 million.
Foreign inward investment of $750 million since 1991 is low compared to Russia or the transitional economies of central Europe. Potential investors are put off by unstable legislation, opaque dealings in newly-privatized state assets and an onerous catalogue of taxes. Nevertheless, some sectors and regions are attracting foreign capital. About 70% is concentrated in Kiev, Donetsk, Cherkasy, Odessa and Dnipropetrovsk oblasts (regions) where business and financial institutions are most developed.
In the agriculture sector the collapse of the state order system provides an opportunity for foreign firms to supply inputs – such as machinery and fertilizers – which can be bartered for processed and exported crops. For example, Monsanto provides $150 million in credits to local farmers to buy inputs in Donetsk oblast, and Kiev-Atlantic Ukraine operates a one-stop supply and processing centre near Kiev funded by $7 million in loans and equity from the EBRD. A major obstacle to developing the agricultural sector further is the absence of land reform. A spokesman at Britain’s Know-How Fund, who is based in Kiev, points out that although 50% of land in L’vov oblast is “private”, there are no ownership deeds, a situation that prohibits transfers and results in the consolidation of small shareholdings into viable enterprises.
Another sector which should attract interest is oil and gas. The Black-Azov Sea basin contains 45.8 billion cubic metres of natural gas and 1.3 million tons of condensed gas, according to the State Oil and Gas Committee. But only 500 million cubic metres is extracted annually, so Ukraine continues to depend on imports from Russia and Turkmenistan. Yevgen Dovzhok, the committee’s chairman, reckons that for an investment of less than $300 million, more than 40 billion cubic metres of gas and 20 million tons of oil could be extracted within 15 years.
Vladimir Yemelyanov, deputy chairman of the supreme Rada commission on basic industry, recognizes that Ukraine has an image problem. But a reputation for low-quality products and an economy that is commodity-driven should not, he says, deter western investors from sectors – metals, chemicals and mineral extraction in particular – that are likely to prosper through selective strengthening of economic ties with Russia.
However, on the macroeconomic front the situation is still difficult. Positive GDP is not expected until 1997. But at least the rate of decline has slowed, from -24% in 1994 to -12% last year, according to government figures.
The IMF is pleased with progress in other areas. At the end of 1993 monthly consumer price inflation was more than 100%, the budget deficit was 10% of GDP, and throughout the following year, as Alexander Sundakov, the IMF’s Kiev representative recalls, “every week without IMF money meant Ukraine was on the verge of disaster”. But last year average monthly inflation fell to 9.2%, reaching a low of 2.6% in December and the IMF accepts that the current underlying rate is around 3%.
The budget deficit has been brought down to 3.5% of GDP from 6.7% last year, which although still too high is manageable, says Sundakov. Roman Shpek hopes that the new treasury bill market, which last year funded 6% of the deficit, will this year take a more significant role as a non-inflationary financing mechanism.
In 1994 the NBU used interest rates as its main monetary tool to control inflation, but last year rates were static except for a hike in December to discourage commercial bank lending. But lending rates remain high at 20% a month, offering little incentive for new enterprises to seek debt-financing. Robert Speelman, seconded four years ago from MeesPierson to be vice-chairman of First Ukrainian International Bank, believes companies should look to the banks rather than foreign equity investment for growth, to strengthen long-term banking partnerships along the lines of the German hausbank model. But high rates and inadequate credit lines – elements of the immature banking industry – mean his vision will take time to realize.
Continued inflationary fears have prevented the Kiev government from introducing its planned new currency, the hryvna, but last year Ukraine’s interim currency, the karbovanet was relatively stable compared to previous years. The official dollar rate determined at the Interbank Currency Exchange fell 72% to around Kbv180,000 and the street rate by just 39%. In 1994, the karbovanets depreciated by 726% at the exchange and 259% in the black market, and by 1,876% and 3,600% respectively in 1993. At the beginning of this year the NBU bought $100 million in the open market to stop the currency appreciating. Officials at the bank say the hryvna will be introduced soon, but refuse to be more specific.
Professor Ashund argues that Kuchma, and prime minister Mutchuk, are committed to reform, and is encouraged that other reformists hold key positions in government. However, the IMF has good reason to be suspicious about Kuchma’s determination to proceed at the pace they agreed before signing the standby loan. In his annual address to parliament last April, Kuchma agreed with his parliamentary critics that transition must also protect the social needs of the population and provide a strong safety net. Instead of pursuing a rigid monetarist policy, he insisted that Ukraine must devise its own model, partly based on “the primordial wisdom of the country’s soul”, which he called a “state-regulated socially-oriented economy”. It would have room for state, collective and private forms of ownership. Some state enterprises which he considers part of the national patrimony would remain under government control, and others would be converted into joint-stock companies (corporatized) in which the state would retain a majority interest. Prices would be regulated indirectly and some state-guaranteed jobs would be preserved.
Whether Kuchma’s trimming indicates an ideological retreat from his original October 1994 commitments, or a pragmatic but temporary pause prompted by parliamentary opposition and social discontent, is unclear. For the time being the IMF gives him the benefit of the doubt.
The equity market needs encouragement
The equity market in Ukraine remains hampered by the slow privatization process, government dithering and the lack of an established legal framework. Yet its development is essential for future growth
“Not even God can understand how to buy shares in Ukraine,” admits Viktor Pynzenyk, deputy prime minister for economic reform. Yet the development of an efficient stock market is an essential corollary of the privatization programme. The problems lie with the privatization process and the difficulties in creating a legal framework to support the concepts and practices of an ownership-based society.
Privatization has been viewed as a general disappointment to date. Indeed, this prompted the IMF to withhold the fourth tranche of its standby loan at the beginning of the year. By the end of last year, according to Yuri Yekhanurov, chairman of the State Property Fund, 25,000 enterprises had been privatized, and a further 30,000 are scheduled to be privatized by the middle of this year. The aim is to fulfil President Kuchma’s ambition, stated in October 1994, to complete the sell-off programme by the end of this year. But according to Roman Shpek, deputy prime minister for the economy, and a principal architect of Ukraine’s free-market reforms, this will mean that only 50% of all previously state-owned enterprises will be in private hands.
The government’s primary emphasis has been to privatize small businesses – 13,000 changed ownership last year. One reason is philosophical. As Kuchma explained to a group of economists last November “small businesses in the West proved themselves the most dynamic carriers of scientific and technological progress, a guarantee of structural flexibility of production, effective employment and social stability”. The second reason is pragmatism: dismantling and privatizing big businesses is contentious, often involving competing ideological and commercial interests. But although the numbers may look impressive, only 58% of the small businesses have been privatized. The redistribution of large company assets has been even less successful, only 3,120 medium and large businesses have been “corporatized” (made into joint-stock companies) out of the 8,000 listed by Kuchma. The cabinet of ministers had approved about 5,000 but the Ukrainian Rada (parliament) rejected 6,000 of the total, ostensibly because they were strategic or defence-related operations.
One example epitomizes many of the difficulties of privatization. On October 5 last year, the Rada passed a law on “the peculiarities of privatization in agro-industrial complexes”, which contravened all previous ownership legislation. Employees in large enterprises have priority share rights, and have exercised them in management and lease buy-outs in the past, but the new law proposed to give 51% to suppliers. Furthermore, it was intended to be retroactive so suppliers could claim their new rights if an enterprise is successful. However, there is no legal definition of a “supplier” or “agro-industrial complex”. It is important to note that members of parliament represent various regional and business interests, and because the actual procedures for law-making are unclear, a lobby or faction can in effect promulgate its own law even if, as in this case, it contradicts another statute. Kuchma has twice vetoed the agro-industrial complex law, but the dispute continues to impede the privatization programme. Parliament is a problem, says Professor Anders Ashund, an economic adviser to the president, “but then there should be problems in a country that is transforming to a free-market democracy.”
Having persuaded or bludgeoned opposition (most commonly ignoring it by issuing presidential decrees because, as Nataliya Kuznetsova, vice-president of Salkom, a Ukrainian law firm says, “his prerogative is not explicitly denied”, the government, through the State Property Fund, has to persuade ordinary Ukrainians to become share-owners. But privatization voucher coupons (PVC) have not only generated apathy, they have also caused confusion. Two values coexist, one of Kbv1.5 million and another of Kbv50 million, for companies whose assets have been re-valued to take into account the effects of inflation. The assets have not changed – they are still often poor and obsolete – but as lawyer Artyom Nagdalyan says, “it is hard to persuade my mother to redeem her vouchers for even these assets when the law seems determined to create anomalies and increase complexity.”
On February 15 the State Property Fund issued the first compensation certificates, which will henceforth coexist with the old-style vouchers, in a new attempt to kick-start the privatization programme. Certificates indexed at 2000 times the CPI will be distributed by the state Savings Bank and Oranto Bank to people who lost the real value of their savings during the hyper-inflation of 1992-94. Unlike privatization vouchers, these new instruments are in bearer form and can be exchanged.
However, their legal status is also unclear. They are neither securities nor money and are not attached to any underlying object, according to Kuznetsova. “Existing law does not incorporate them, so for instance, the courts can’t punish people for stealing them.” But, she adds, “that is tomorrow’s problem”.
A more immediate worry is whether the certificates will be eligible for April’s privatization auction as planned. The State Property Fund (SPF) intends to reserve one-third of its list of enterprises for holders of the certificates, but the ministry of justice is threatening to block the scheme. Old-style vouchers cannot be sold at less than their market value, as determined by the volume of subscriptions for an enterprise, but compensation certificates can be traded at any price. The ministry objects to their more favourable treatment, and is also concerned that the bearer form of the certificates gives them another advantage over vouchers. Holders of either must indicate which company shares they want to buy at auction, but whereas voucher applicants cannot change their minds, the SPF will not be able to prevent certificate owners from simply selling them to a third party who can then change their original designations to a different company.
A third problem is more basic: the public isn’t very interested. The certificates have a nominal value of Kbv1 million, but their price on the black market has fallen to Kbv300,000, and although the SPF reckons the April company auctions will re-establish their face value, by ignoring the market if necessary, the heavy discount reflects the apathy and scepticism that continues to afflict the old scheme. Expressing its concern, the cabinet of ministers issued a statement on February 22 revealing that 25 million people had failed to take up their vouchers, despite an intensive education campaign by a western public relations firm last year.
The ministry of finance has issued licences to 850 brokers to handle certificates and vouchers, but as Sergei Oksanich, president of Kinto Investment and Securities, points out, only 50 do any business and they are mostly subsidiaries of commercial banks, like Gradobank, Privitbank and Interprom. Thirty-four per cent of these brokers are registered in Kiev, and the Ukraine Stock Exchange (USE) – with 20 branches throughout the country – easily dominates rival exchanges in Kharkiv and Odessa. In addition, the SPF has granted more than 500 licences to trust companies and investment funds, in an attempt to create portfolios from the more than Kbv100 trillion worth of securities supposedly available on the exchanges.
Kinto Investment and Securities in particular is 49%-owned by European Privatization and Investment Corporation (EPIC) and securities firm Wasserstein Perella Emerging Markets. It holds stakes in over 40 Ukrainian companies. Oksanich offers no pretence of transparency when he or one of his 300 staff target a company. He is interested only in large blocks of shares – small transactions are too costly – which he buys over the phone by acquiring the rights to vouchers. The restrictions on voucher transfers are circumvented, and Kinto (and other funds) accumulate strategic holdings outside exchange, and therefore public, scrutiny.
Against all this background jostling, the semblance of a capital market structure is beginning to take shape. But secondary market activity on the USE remains almost non-existent. Trading volume for the whole of February, for example, amounted to just $120,000 in value. The exchange still functions largely as a primary market, where shares are offered by the SPF either by electronic auction or through more popular open-outcry auctions.
Oleg Mozgovoi, chairman of the Federal Securities Commission, agrees that there are many problems to overcome, although his appointment to a new post with sole authority for developing the market should improve the chances of success. Oksanich sees this as a positive development “before, many were responsible, but no one took responsibility”.
Mozgovoi identifies several objectives, which are echoed by both local and foreign participants. Perhaps the most important, certainly for attracting overseas portfolio investment, is the creation of independent share registers, which would facilitate custodial services. As Sir Michael Alexander, deputy chairman of Wasserstein Perella & Co says, “No western bank provides custody, and nor is it viable for local institutions either, as long as it is unclear what constitutes legal title to share ownership. Yet custodial services are a prerequisite for serious foreign interest in the market.” USAID is currently helping to devise a scheme and last year funded a pilot project at Privatbank. President Kuchma recently decreed that a company must submit its register to an independent registrar if the number of shares exceeds 500, although it is unclear how that can be done in practice. But Yekhanurov at the State Property Fund is confident that independent registers will be widely available soon.
In February, brokers took an important step towards self-regulation when the USE’s most active, including Sofia Securities, Fondoviy Budynok Vointer and Olma-Ukraina, formed a stockbroker’s guild. It aims to create a regularly up-dated information-base on legislative changes affecting stock market operations and to establish its own organic trading code. In addition it intends to exclude unlicensed entities from participation in State Property Fund auctions, introduce margin payments and impose penalties, ranging from fines to disqualification, against defaulting share buyers.
But even with these developments, much remains to be done. For example, last year Ukraine received just $85 million in portfolio investment, according to CS First Boston in Moscow. And portfolio investment, claims CS First Boston, is an easier method of gaining access to Ukrainian assets and markets, because it avoids tax and regulatory hurdles as well as avoiding the arbitrary restrictions sometimes imposed against foreigners in competitive tenders. Yet Ukraine attracted only 0.7% of foreign flows into world emerging markets, even though Ukrainian companies are significantly undervalued on a sales-to-capitalization basis: the energy sector by two times compared to Russia and nine times compared to the West, metallurgy six and 26 times respectively and shipping two and 16 times.
Yet, according to Alexander at Wasserstein Perella, legislative uncertainty provides a disincentive to portfolio investment too. The lack of independent share registers and custody facilities is compounded by conflicting ownership codes. Furthermore, what he perceives as underdeveloped corporate governance ascribes more power to company managers than to shareholders. Managers can dilute share-holdings by up to one-third without approval, nor need they grant pre-emptive rights: holding the register at the company offices means that a manager can choose whether or not to recognize a change of share ownership. “Too many deals are struck off-stage, so many voucher companies never come to the market,” he adds. “It is important to have a level playing field, one which does not favour the domestic investor at the expense of the foreigner.”
“Capital markets do not exist in Ukraine, or at most only in a fledgling way,” says Peter Goldscheider, managing director of EPIC. Personal contacts and street savvy matter most; as foreign investors already realize, it is equally important to find a well-connected local partner to negotiate and hustle for portfolio investment opportunities as it is for direct investment. As Oksanich observes, “while state property is being distributed, politics is what counts. Technical tools for M&A business will be useful once we know what the rules are.”
| Securities market statistics | |||
| (karbovanets bn) | |||
| Jan 1995 | April 1995 | Increase | |
| Shares | 6,837 | 10,000 | 146% |
| Bonds | 349 | 2,112 | 605% |
| Treasury instruments | 1.2 | 1.2 | 0% |
| Saving certificates | 13,509 | 33,200 | 246% |
| Bills of exchange | 31,401 | 65,900 | 210% |
| Other securities | 3,024 | 3,786 | 125% |
| Total | 55,123 | 115,000 | 209% |
| Source: Ministry of Statistics Ukraine | |||
GDP and industrial production
Privatization sell-offs
Encouraging, but limited, bond market prospects
The government is commited to encouraging the development of the government and municipal bond markets. However, like the equity market, deficiencies in transparency and efficiency remain problems to be solved if foreign investors are to enter the market in substantial numbers
Last month deputy prime minister of the economy Roman Shpek announced that the government expects to cover a “considerable part” of its budget deficit this year, forecast at 3% to 4% of GDP, through the sale of government bonds. A non-inflationary method of financing the deficit is essential for sustainable economic growth and to satisfy the demands of the IMF while attracting foreign investment.
A draft securities bill recently introduced in parliament will allow foreign investors to buy government bonds, but they are unlikely to be interested unless the official inflation target of 35% seems achievable. Inflation worries were raised last summer following president Kuchma’s hints that he might stall the reform programme, which was already exacerbated by credit emissions to farmers and currency instability. But investor confidence is the key to the success of the government’s ambitious funding plans, but a more transparent, secure and efficient secondary market also needs to evolve.
The debt programme started in March 1995, and was based on three cabinet resolutions providing for Kbv1 trillion ($5.27 million) of 12-month notes paying 140% and two tranches of 90%, three, six and nine-month paper totalling Kbv30 trillion. At the end of the year a net amount of Kbv17 trillion was outstanding, which satisfied the target agreed with the IMF.
In retrospect the programme will look like a pilot project. The 1996 budget requires Kbv320 trillion of issuance to achieve a net Kbv150 trillion of bonds in the system by December, which also implies an average maturity of about six months, compared to an average term last year of three months.
Only 6% of 1995’s deficit was covered by bond sales – the rest came from external financing (mostly IMF loans) and National Bank of Ukraine (NBU) credits. This year the government hopes the figure will be nearly 35%. Its task is not being made any easier by the continued delay in passing the budget through parliament.
Consistent for a country with an interim constitution and an interim currency, the cabinet of ministers decreed a temporary resolution in January providing for the sale of Kbv60 trillion of bonds to maintain the debt programme. For the first time individuals were able to bid at that auction, held on Janaury 18, although the Kbv1.7 trillion of bonds were sold almost entirely to banks.
The nascent bill market suffers from similar mechanical deficiencies seen in the stock market. Last year all trading was conducted over-the-counter (OTC), but no standard method of registration existed within the national bank central depository to confirm transfer of ownership rights. Trades were therefore conducted on a sale/repo basis, compounding market risk with commercial bank credit risk.
From the beginning of this year electronic screen trading at the Ukrainian Interbank Currency Exchange (UICE) began, with three sessions held each Thursday. Orders submitted via the national bank’s electronic mail system are matched by the UICE and are settled the following day. However, the process tends to be slow, and despite protests from some participants, the national bank banned OTC trading in bills, presumably to give the exchange-based system a chance to work. Liquidity is also undermined by a 30% tax on trading profits, so investors tend to hold positions taken at auction until maturity.
Nevertheless, the government and NBU are committed to the market, and it is in their interests to make it more efficient – which means listening to the representations of bank participants. Shpek would like to issue longer-dated government bonds, but inflation fears deter investors for the moment. The City of Kharkiv (Ukraine’s second largest) issued 12-month bills last year, and the country’s two other municipal issuers, Kiev and Dnipropetrovsk, are likely to do so this year. Investors have the security of a charge against city assets, which has prompted one local institution to allocate 10% of its first open-ended fund to the sector.
Still part of the wild east
Direct foreign investment remains woefully inadequate compared to other economies in the region. Developing an investor-friendly market to increase investment is vital if Ukraine is to modernize its industry
“Why is free trade one-way?” asks Roman Shpek, deputy prime minister of the economy. Export-led growth is vital for Ukraine, yet the EU and US restrict Ukrainian exports, such as textiles, through licences and quotas. By contrast, tariffs on imports into the Ukraine average only 3.5%. As Viktor Pynzenyk, deputy prime minister for economic reform, points out, it is hard to persuade parliament that these should be lower when the EU continues to raise its barriers. “The biggest help to Ukraine would be the opening of world markets to its exports,” Pynzenyk says.
But first, Ukrainian industry needs capital and management expertise to make it competitive, says Shpek. Along with the privatization programme must come foreign investment to revive economic growth. IMF and World Bank loans cannot sustain long-term development, which can be attained only by investment and institution-building. Since 1991 Ukraine has received $4.7 billion from external sources, but almost all of it has come from multilateral agencies and Russian and Turkmenstein gas credits. Ukraine does not intend to depend on charity, says Shpek, but although he acknowledges that western companies must make profits, he believes that “at certain stages in a transforming country’s development, investors should be philanthropic”.
Investors have their own views on this. A representative from a British food-processing company spends a few days in Kiev to negotiate the purchase of a 30% stake in a west Ukrainian plant. Vladimir Bondar, first deputy at the national bank, who has a list of enterprises the State Property Fund is happy to see sold off to foreign investors, is cooperative and convivial, entertaining the representative at expensive restaurants. If only our man could simply make his deal with his generous host and send a triumphant fax to his company back home. Unfortunately for him, life is more complicated than that.
The management of his target enterprise has suddenly become cooperative – offering to help persuade its 1,800 workers to sell their shares to him, for example. This will be a hard job because most of the workforce is superfluous, he says, so many will be paid to stay at home and then after five years be given early retirement. He is concerned that a notorious labour leader, whose wife is rumoured to spend most days shopping in Vienna and whose daughter is apparently being privately educated in England, has started to show an interest in his activities. He is also anxious that US broker Cargill might accumulate a spoiling stake in his target. But what really worries the representative is the management’s sudden cooperation: he suspects that they might have found an arcane law, perhaps enacted only yesterday, to move the assets to another entity, so his company will end up buying a shell. He will instruct his hyperactive local lawyers to check that they haven’t.
At a two-day conference in mid-March organized by Euroforum at the new Kievskaya Rus Hotel in Kiev, US and European businessmen exchanged similar stories during coffee breaks. In the conference hall, they were more sanguine and less cynical about the prospects for investing in the Ukraine. But, while enthusiastic about the potential, they were vocal and unanimous about the need for legislative, regulatory and taxation stability and transparency.
Pynzenyk recognizes that it is not easy to do business in Ukraine. Obstructive bureaucracy is often the result of competing authorities, and corruption is inevitable for the time being: “The more licences, the more bribes,” he says. But he reckons the rewards can be greater because “there can be bigger fish in murky waters”.
But total foreign direct investment in Ukraine since independence amounts to just $750 million. Last year, it received $266 million, which compares badly with the $2.5 billion invested in Poland and $1 billion in Russia.
Foreign investors are less sanguine than Pynzenyk about catching big fish when they can’t see what they are doing. Sir Michael Alexander, deputy chairman of Wasserstein Perella, which has recently set up an investment fund in Ukraine, suggests that one reason is that western investors simply have a herd instinct and Ukraine isn’t fashionable yet. But Stewart Reich, president of UTEL, who has been operating from Kiev for four years, expresses a more commonly held view that Ukraine needs to be more investor-friendly. “Most of all, investors require a regulatory environment characterized by three features: stability, stability and stability.” On the other hand, says Sergei Oksanich, president of Kinto Investment and Securities, “it is unrealistic to demand stable legislation at this stage in a transition economy. Ukraine is like a growing child who must change his shoes as he gets bigger”.
The most common method of foreign investment is through joint ventures with Ukrainian partners. Each contribute assets to a new entity and take an equity interest in return. Currently this is the only way to buy into a state enterprise, but has the advantage that the deal can be tailored to suit the foreign investor. There are many hazards, so there’s plenty of work for lawyers.
Helen Kryshtalowych, the managing partner of the Kiev office of law firm Squire, Sanders & Dempsey, is kept busy. In the first instance, investors need to know who they are dealing with and who is authorized to sign on a local partner’s behalf. Approval for joint ventures is required from the state property fund, the anti-monopoly committee, a relevant ministry, possibly parliament and certainly an oblast council. Government approvals take 30 days, and it is not unusual for a department to demand more information on day 29. Due diligence and checking the fine print on every facet of a deal is imperative, says Kryshtalowych.
A typical joint venture, says UTEL’s Reich, combines a western company’s financing, technical, operating and management skills with its Ukrainian partner’s more intangible assets – its local knowledge and its relationships. In addition, Ukraine has less subtle attractions. It has the most fertile black soil in the world, offering the potential to be the “bread-basket of Europe”, and according to Mark Tomlinson, director of the Ukraine team at the EBRD, the greatest number of qualified engineers per head of population. Western bankers at the Vienna-based European Privatization and Investment Corporation (EPIC) and CS First Boston now recruit real rocket scientists from Ukraine’s nuclear-military complex.
Once the venture is secure, investors face new hazards. George Sharpe, director of taxation services at Ernst & Young in Kiev, believes that if investors make a profit in the Ukraine it will be “despite the country’s fiscal environment”. There are too many taxes with over-complex calculation bases, varied payment schedules and a number of different reporting authorities. The compliance burden is onerous and opaque, which leads many businesses to trade outside the law. One good tax, a 30% charge on profits rather than revenues, is up against a plethora of bad ones. These often have an unclear status too, because the president, the council of ministers and the Rada (legislature) can all impose taxes unilaterally. Sharpe cites a 5% sales tax introduced by president Leonid Kuchma last September. The following month parliament vetoed it, in November the tax inspectorate collected it, in December companies complained but Kuchma declared that the veto had been illegal, and finally in January the tax was abolished.
The worst tax of the lot is value-added tax (VAT) which, says Sharpe, penalizes business because it is almost impossible to reclaim. Pynzenyk agrees, blaming an ill-thought-out budget which created three levels of VAT collected by different authorities, which are reluctant to take responsibility for reimbursement. Sharpe believes the problem goes deeper. “In the Ukraine the tradition of the administrator is stronger than that of the legislator,” he says. “Furthermore, tax collectors are inappropriately motivated – because they are rewarded for the number of penalties they impose, they set out to hinder companies. Companies need to know their cost base, but at present they cannot plan three weeks ahead.”
UTEL’s Reich concedes that investors cannot expect immediate returns and must adjust their risk-reward profiles. His company has invested $100 million in the Ukraine, 13% of the country’s total foreign direct investment. “Anyone doing business here cannot expect ideal conditions, but small steps have a cumulative effect and eventually realize ambitious goals, ” he says. Reich has chosen to extend his stay a further two years.
Many foreign investments have started with EBRD cofinancing. The bank has a 30% stake in Iveco’s joint venture with Kraz to assemble trucks in Kremenchuk and provided term funding for JKX Oil and Gas (UK) to form an oil exploration company with subsidiaries of the state committees for geology and for oil and gas, in Poltava. The bank’s Ukraine Fund, set up in 1992, has now made 17 investments worth Ecu310 million ($247 million), with an additional Ecu130 million from partners. According to Thomlinson it is considering a further 60 proposals valued at Ecu400 million.
The EBRD initiated 12 new projects last year, a 50% increase on 1994, and plans a “significant increase this year”. Thomlinson sees the bank’s role as a catalyst for the development of other sectors, which will, he believes, be particularly helped by improving the credit standing of indigenous banks and extending their range of financing services.
Other independent investors include the major tobacco companies. Philip Morris has operated a factory in Kharkiv for a year and BAT bought into a joint venture in Pryluky, east of Kiev, and shipped over a self-contained camp for its expatriate employees. Tate and Lyle opened a representative office in Odessa six years ago and now runs a sugar-processing plant. GEC/Philips plan to manufacture lamps at a factory in Poltava, and Swiss chocolate manufacturer Kraft Jacobs Suchard is committed to a confectionery operation in Trostianets. Kraft’s country manager, George Logush, describes his factory as a “Ukrainian enterprise. It simply functions properly with sufficient capital and technological know-how. It also pays its taxes and provides the highest wages in the oblast. We want to be good corporate citizens of the Ukraine.” Evidence of Kraft’s sense of responsibility is its funding of 50 flats as part of a municipal housing plan, its assistance to local hospitals and its continued support for a nearby kindergarten.
Bohdan Kupych, general manager of Digital Equipment, Ukraine, also believes foreign investors must become good corporate citizens of their host countries. They must also pass on business ethics, which means refusing to pay bribes. Digital’s investment in Ukraine is, he admits, “a mere drop in the Black Sea”, but it has had success in the banking sector where it has supplied the SWIFT payment technology, initiated automated teller machine programmes for 14 banks and installed a new teller system at one of them, Prominvest. Kupych prefers to work with small entrepreneurial customers and plans next to market Digital’s services to the energy sector, and continue to expand its sales of Alpha technology to the country’s developing internet servers.
“What this country needs is industrialists,” says Peter Goldscheider, managing director of EPIC. Founded in 1989 to invest in transition economies, EPIC funds more than 300 projects at a cost of $2.4 billion. It has made $250 million of equity investments in the Czech Republic, a country with a fifth of the population of Ukraine, which in contrast has received just $15 million. EPIC is hesitant “because corporate governance in Ukraine is undeveloped”. Goldscheider believes the population must be educated about business practices and ethics before foreign inward investment can grow. His view is shared by Yuri Yekhanurov, chairman of the State Property Fund, who believes the mentality of Ukrainians can perhaps be changed through Soviet-style ideological training, which is more important than simply transferring ownership of state assets. “The people first must be taught to be economic agents, to be their own masters,” he says.
But Goldscheider has a vision of institutional construction which will facilitate that change – a vision shared in the step-by-step approach favoured by the EBRD. He points to the post-war reconstruction experience of Germany and Japan, which was based on strong banks with symbiotic ties to industry, forming clusters of cooperative power groups. Poland, the Czech Republic and Hungary are already moving in that direction, and the National Bank of Ukraine (NBU), with the aid of the EBRD, seems to be laying foundations. From late 1994, the EBRD provided credit lines of Ecu100 million through the NBU for five private banks to lend to private businesses. The banks, including Privatbank and Gradobank, also participate in a development programme to bring them up to international standards.
Yet this evolutionary mechanism is not favoured by many Ukrainian industrialists, who are impatient for more concrete investment. Professor Yakov Aizenberg, general director of Khartron, a Kharkiv-based nuclear power producer, complains that the EBRD is misguided. “Rather than invest in real enterprises, it gives money to commercial banks which are more interested in making short-term loans at crippling interest rates.” Aizenberg is also critical of private foreign investors, including Khartron’s US partner, Westinghouse Electric. “Too much time is spent on feasibility studies, and when investment does come, its objective is to maximize western profits and protect western jobs.”
Scott Carlson, president of the western NIS Enterprise Fund, repeatedly tells his Ukrainian clients and partners that “life is simple – markets are efficient”. His venture-capital fund operates in Ukraine, Moldova and Belarus and was set up with $150 million capital from the US government four years ago. It is now supported by several Wall Street luminaries and focuses its investment on small growth-oriented enterprises. Carlson also envisages a role as crusader for western management techniques to create a more service-sensitive and efficient economy, eventually purged of ossified command institutions. The Soros Foundation has a similar, official education purpose.
The black market accounts for between 40% and 50% of Ukraine’s economy, according to the World Bank. Price liberalization offers opportunities for energetic entrepreneurs, but investors cannot expect to find a mature system with established rules of corporate governance, nor a deregulated “tiger economy”. Perhaps Wasserstein Perella’s Alexander is right. Time and fashion will bring foreign investment, which will in turn force a more a benign regulatory environment and recognizable codes of business conduct. For the moment, the Ukraine remains part of the wild east.
