Privatisation in the Republic of Kyrgyzstan
©1997 Pangaea Partners, Ltd.
Located in the heart of Central Asia, Kyrgyzstan is a land-locked country the size of England and Scotland (or the U.S. State of Washington). It is situated at the junction of two great mountain systems (the Tien Shan and Pamirs), with only one-eighth of the country lying below 1,500 metres (4,920 feet). Kyrgyzstan is sparsely populated with a total of 4.5 million people of whom less than 40% live in urban areas. Since 1991, the country has worked to eliminate centralized economic controls, to restructure and privatise the economy, and attract new investment. Inflation has been dramatically reduced from more than 1,200% in 1993 to the current 30%. Agriculture is the largest economic sector, accounting for 34% of total GDP. Blessed with extensive deposits of gold, coal, antimony and uranium, the bulk of initial foreign investment has been concentrated in the mineral extraction sector.
As part of the country's economic restructuring process, the country launched a privatisation programme in 1991. Since that time there have been three distinct phases to privatisation.
Phase I of Privatisation: Tentative Steps
Phase I of the programme lasted from 1991 to 1993. It focussed on establishing the legal framework and institutional infrastructure required to enable ownership of private property (other than land) and private enterprise. Land reform began with 17,000 peasant farms and new agricultural cooperatives being formed from a number of state and collective farms.
This period also saw two principal approaches to the privatisation of companies:
1. A small-scale privatisation programme. By the end of 1993 more than 3,400 small-scale enterprises in retail trade, catering and services had been sold via cash auctions.
2. A Mass Privatisation Programme (MPP). The principal purpose of the MPP was to transfer a portion of state property to the citizens of Kyrgyzstan free of charge in order to compensate them for their contribution over the course of their working lives to what, in the Soviet period had been the "property of all of the people". Government also felt that it was important to have the broadest possible involvement in privatisation. Special MPP vouchers were issued and distributed with the employment record of each citizen determining the quantity received. Vouchers were to be used to buy public housing or to transfer ownership of medium and large scale enterprises (MLE's) which were being partially privatised. Unfortunately, few of the vouchers were used, nor was there much trading of them.
Thus, Phase I saw creation of the infrastructure for privatisation and the largely successful privatisation of small-scale enterprises. However, privatisation of the MLE's was minimal since the programme was effectively limited to converting the enterprises to joint-stock companies. The state and enterprise staff continued to hold majority ownership and only a small percentage of equity in the enterprises was distributed to voucher holders. Other problems incurred by the MPP included: irregular privileges enjoyed by a number of worker's collectives, restrictions on the adjustments new owners could make at newly privatised enterprises, and a loose regulatory framework. Accordingly, the MPP programme offered few opportunities to change management of these enterprises.
Phase II: Coupon Auctions, Restructuring and Moderate Privatisation
Phase II of the privatisation programme (1993-1996) began with the adoption of a new privatisation strategy, which brought about important changes.
With some key exceptions, all MLEs became immediately available for privatisation. Private investors, Kyrgyz or foreign, were allowed to own up to 100% of the equity of the MLE's.
The MPP vouchers, most of them still unused, were replaced by privatisation coupons. Coupons could be used to purchase equity in state enterprises at coupon auctions where typically up to 25% of an enterprise's equity was offered. Coupons could also be used to buy the state-owned dwelling in which the coupon holder lived. Coupons were transferable, and both Kyrgyz nationals and foreigners - including institutional investors - could trade freely in them.
In addition to the coupon auctions, individual privatisations, cash auctions (which typically took place following an enterprise's coupon auction) and investment projects were the main methods of privatisation used during this stage. Typically, up to 5% of an enterprise's equity was distributed gratis to the employees, as much as 25% was sold at coupon auctions with the remainder being offered to individual and corporate investors at cash auctions or through specific investment and privatisation bids.
Phase II also saw the creation of the Enterprise Restructuring and Resolution Agency (ERRA) in May 1994 under the World Bank-supported Privatisation and Enterprise Sector Adjustment Credit (PESAC) to deal with 29 large loss-making enterprises. This group of companies needed either radical restructuring or liquidation. Diagnostic studies were conducted on each of the enterprises, and liquidation begun on those determined to be unsalvageable. ERRA shut down production at these enterprises, instituted "care and maintenance programmes", and placed the bulk of their employees on paid leave. Within the group judged to be salvageable, there was restructuring to relieve the companies from the burden of old debts and non-core assets. Some received rehabilitation assistance in the form of loans from the PESAC programme and have successfully resumed operations. Once completely resuscitated, controlling blocks of shares will be offered for sale by tender to strategic investors.
All told, Phase II encompassed the complete or partial privatisation of an additional 1,000 enterprises. Disposition of the 4.4 billion privatisation coupons which were printed during this period has been as follows:
41.26% were used at auctions by individuals and companies;
9.82% were used at auctions by investment funds;
0.20% were used to purchase apartments(1);
0.72% were used to purchase property1;
27.55% were distributed but remain uninvested; and
20.45% have yet to be distributed (as of October 10, 1996).
1. The small number of coupons used for purchase of apartments and property stems from two reasons. First, the proportion of the population living in municipally owned housing is relatively low in comparison to other former Soviet countries. Second, apartments and properties were sold at fully written down prices set by the Bureau of Technical Inventory, making it possible to buy a 2 room apartment in a 20 year old block for some 40 Soms (i.e. $2.37). Thus, the number of coupons used to buy housing does not reflect the scale of ownership transfer to be expected.
As these figures demonstrate, there is a serious problem of "coupon overhang", which can be attributed to the following reasons:
i. The MPP vouchers were time-limited and a proportion of the population lost their entitlement to convert them into coupons because they did not do so prior to their expiry date.
ii. The general population had little confidence in the value of privatisation coupons. At a current market price of 1.22 - 1.35 Soms for a bill ("upais") comprising 100 coupons, each coupon is worth approximately US$0.0008 making the distributed coupons equal to only US$0.625 per person in Kyrgyzstan. As a result, the coupons were not always taken seriously by the voucher holders.
iii. While Government's motives for retaining a portion of the coupon issue are not known to the authors, it is known that the Government has periodically sold small groups of coupons into the market. At their current market price, the 20% of the coupons which remain in Government hands are worth approximately $0.75 million. However, each time a group of coupons are sold, the market price has fallen and effectively diluted the value of the outstanding coupons held by Kyrgyz citizens. This action effectively transferred part of the value of Kyrgyzstan's assets back into the hands of the State. To reverse this trend, the best course of action would be for the Government to destroy all remaining undistributed coupons, but it remains to be seen what Government will do.
iv. A significant amount of coupons in circulation remain uninvested. Thus, portions of those companies to be sold in Phase III of the privatisation programme (see below) must be offered to the general public in exchange for the outstanding coupons; otherwise the uninvested coupons will be useless.
Phase III: Privatisation of Large Companies
Phase III of the privatisation process was set out in a decree dated February 1996. The main privatisation mechanisms -- coupon auctions, cash auctions, and competitive tendering for large investment projects -- will continue to be used, as well as direct sales and/or long term lease to investors selected by the State Property Fund. Phase III is distinguished from Phase II by the nature of the companies involved, which are predominantly large scale enterprises in mining, construction, transport and tourism; public utilities; and infrastructure projects. Phase III also includes about 100 MLE's that had already been partially privatised but in which Government continues to retain significant share holdings. These companies will now be reviewed and offered for sale by the State Property Fund (the legal owner of all the state industrial assets).
Eleven of the largest concerns will be the subject of thorough feasibility studies with the primary purpose being to propose enterprise specific privatisation sub-programmes. The eleven entities that have been selected for this in-depth analysis include:
|Property Name||Main Activity|
Kyrgyzstan Aba Joldoru
Bishkek machine building plant
Kyrgyz Mining & Metallurgy Combine
Kadamjai Antimony Combine
Printing & Publishing
Electricity generation & distribution
Oil & gas extraction & distribution
Natural gas import & distribution
Uranium & molybdenum
A similar approach has been adopted for five groups of smaller assets in health care, tourism, scientific and technical institutions, sports and entertainment, as well as some unfinished public construction projects. These studies will focus on sub-sectoral rather than enterprise level.
The Government has stated that it will consider investment proposals from any interested party, whether resident or non-resident. However, Government may also permit state-owned companies to acquire some of the enterprises scheduled for privatisation, a measure that could be counterproductive to privatisation efforts.
Another important objective for Phase III is to improve the management of enterprises being retained by the state as well as those that have already been partially privatised. Private sector expertise, obtained via management contracts, will be one option by which such advice and training is obtained.
Foreign Participation in Privatisation
International firms have been encouraged to participate throughout all phases of the Kyrgyz privatisation programme, with no restrictions on foreign equity participation. As of mid-1996, over 60 foreign investors had participated in the privatisation of 52 MLE's covering a variety of industrial sectors. This foreign investment originated in 14 countries, with the bulk of it coming from five: Russia, Kazakstan, Germany, Turkey and the United States. In the economy at large there are more than 300 investments or joint-ventures by overseas companies.
With the commencement of the Phase III of the privatisation programme, new investment opportunities continue to become evident. The individual and sub-sectoral privatisation programmes, as well as sales of governments holdings in numerous Joint-Stock companies, are expected to generate considerable international interest. This is encouraged by an official policy of promoting foreign participation in a wide range of forms such as management expertise, finance, equity partnership and foreign ownership.
Kyrgyzstan's privatisation has made good progress. Yet, when compared to other types of reforms made in the country and in comparison to privatisation in some other countries, it is clear that Kyrgyzstan's privatisation programme could be even stronger. First, as with many countries in transition to the market economy, the degree of nepotism involved in the sale of companies needs to be reduced. The pace of privatisation could be significantly quickened and the quality of the process improved if:
i. Prices for international share auctions were set at more realistic levels and time frames longer;
ii. Government sold more companies on an "as-is" basis versus undertaking restructuring;
iii. Government out-sourced more of the work of selling larger enterprises to investment banks, as a number of other countries do, rather than undertaking the process on its own;
iv. Financial statements of large companies were prepared to international standards and the enterprise's legal status clarified;
v. Bureaucratic obstacles were reduced (arbitrary inspections and fines are commonplace); and
vi. Privatisation policies were clearly delineated and procedures followed more strictly and transparently.
Government has indicated a willingness to relinquish control of the biggest and/or best Kyrgyz enterprises -- doing so expeditiously and transparently would enhance the local economy. As such everyone would win: investors, citizens working in a dynamic and growing economy, and Government, all of whom would benefit from renewed growth.
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