II. CONSIDERATIONS REGARDING PRIVATIZATION THROUGH FOREIGN
DIRECT INVESTMENT
The ultimate aim of Bulgaria's privatization program is to raise
the efficiency of the economy in a debt overhang climate. The
stability of the economy and long-run efficiency effect are to be
achieved if only privatization brings about "responsible" owners.
Most of the SOEs perform adversely and their subsidy-seeking
behaviour, raising the internal public debt stock is a burden for
the budget. Arrangements that involve replacement of state
ownership and management by private property are envisaged to
enhance the role of the private sector and overcome the constraints
on its development. DES mechanisms and the inflow of FDI they are
expected to bring about are an important vehicle for privatization
by strategic foreign profit-maximizing investors who are the
principal buyers in the secondary market.
The inflow of foreign capital in the country through debt-equity
swaps will ease debt servicing and its linkage through the fiscal
deficit. On the other hand, the mutual interlinkage between
privatization and inward FDI contribute to revive economy and
building up national competitive position.
Restrictive fiscal policy and sustaining budget deficit within
bearable limits are among the main policy concerns during the
transition. By the same token, there is little room left for the
Government to promote GDP growth by traditional fiscal measures.
Thus, DESs present a nonconventional mechanism for financing
privatization and growing Bulgaria out of the current crisis.
Equity investment is hoped to reduce state borrowing from overseas
for investment in the economy thereby reducing external
obligations.
2.1. Some Elements of The Profitable
Investment Climate
The economic analysis of an attractive investment environment in
a indebted country should consider from investor's point of view
the existence of sufficiently profitable investment opportunities
for DESs to take place. The mechanism of DESs entails equity
investment in the debtor country. There are three parties in the
debt-equity transaction: the investor (if he buys the obligation
from the creditor bank) who has positive time preferences and
decides to forgo current consumption and finance an equity
investment expecting certain return on it (investors can include
the original creditor banks, other financial institutions,
industrial firms, private individuals and institutional investors);
the debtor government who decides on the portion of debt to be
swapped; creditor banks.
Foreign investorвs perspective
Foreign investors' rationally expect higher return on the
equity. Thus, they adjust their investment behaviour in response to
the effect that debt reduction negotiated will have on competitive
returns to investment in the debtor country. Obviously, if these
anticipations affect favourably the terms of equity sales of some
domestic assets DESs may be in the interest of the debtor country.
Since the real costs and benefits for the debtor country depend on
the quality of economic policies pursued the efficiency of DES can
be improved. From the point of view of the government of the
indebted country the choice over the amount of debt to be swapped
is a matter of a time-consistent and credible policy (see L.
Golberg and Mark Spiegel, 1992). For an attractive investment
environment the government has to be credible when deciding on the
extent of DESs, buying back the bonds from the investors and
requiring from them to invest the cash in local equity. The scope
of DESs depends on the remaining nominal debt obligations. In this
aspect lack of clarity in the existing legislation and its
relevancy to DESs schemes as well as a time-concictent government
policy are important deterrents to investment.
The potential plausibility of welfare-enhancing DES is affected
if the government lacks enough stock to finance the programme.
Investors could be assured in the credibility of the transaction if
there are available loans and support provided by international
institutions. It is largely held that the initiation of the deal
implementation will open access for Bulgaria to many sources of
official funding from the World Bank, EU and other G-24 sources.
These resources will do away with the default-risk climate for debt
servicing and will further attract inward capital towards its free
allocation. Within the process of debt-equity auction fees and
discount rates for conversion are policy determined. This is very
much related to the prevailing economic climate and economic
management strategy. The government may successfully use this fee
basis as a means of generating revenue and thus influencing the
overall impact of debt-equity transactions. While sharing in the
yield on debt-equity conversion discounts by the fee setting
process government can exercise leverage in directing investment by
varying the fees across industries. This works through the
different subsidies provided to the foreign investor. To the extent
that these incentives influence investment activity they can be an
attractive element of the economic environment.
The location advantages for FDI in Bulgaria as an indebted
country are these elements that create an attractive climate for
debt-equity swaps. The elements of the current legal framework -
treatment of foreign capital, sectors open to foreign investment,
patterns of FDI in terms of types and capital structure, business
registration procedures; the relevant institutional structure; the
economic conditions in the country and the future prospect are
these location specific conditions that determine investor' choice.
Stable and contract-enforcing legislation is necessary to assure
foreign investors that once their equity investment became
productive they would not be subject to any undesired
expropriations and payment difficulties. The few years of the
reform have passed without clear privatization strategy which in
general have limited the inflow of foreign capital.
Bulgarian privatization and its appeal for foreign
investors
With the adoption of the Law on the Transformation and
Privatization of State-Owned and Municipal Enterprises in 1992
possibilities for foreign participation in the privatization were
open.
In respect to the Law all physical and legal Bulgarian and
foreign persons have equal rights to take part in the privatization
process. There are three exceptions to this option. Employees are
given the preference to buy up to 20 percent of the shares of each
company at a 50 percent discount, with the total amount of the
allowed discount per employee not exceeding its annual income.
These shares are non-voting for a period of three years. Only
Bulgarian citizens after a lengthy procedure for obtaining permits
from the Privatization Agency and the Ministry of Finance, may buy
shares of the companies by an installment payment scheme. In the
case of small-scale assets which are sold through tender or
auction, the employees are given up to 30 percent discount of the
price if they have won the auction or tender. The above
preferential status of the Bulgarian employees are minor and will
not have a serious effect on the pace of foreign privatization
(privatization of state assets by foreign capital).
The shares of the company can be sold by public offering, public
auctioning of blocks of shares, by publicly invited tender and
through negotiations with potential buyers. Direct negotiations
would be the most appealing procedure for foreign investments as
some of the recently concluded transactions have indicated. Foreign
investors may obtain up to almost 100 percent of each company.
Basically, there is no limitation for them to obtain immediately 80
percent of the shares and subsequently buy the remaining shares
that have not been sold to the employees within the three month
provided by the law.
Recently mass privatization schemes have been adopted which
entitle Bulgarian citizens to take part in the privatization of the
state enterprises, which will not be included in the list of assets
selected for debt-equity conversion. These schemes can not bring
"fresh money" into the economy and can hardly contribute to the
economic efficiency in their early "distribution" phase.
Furthermore, it is argued that mass privatization program will
negatively influence capital markets' developments due to the
provision that vouchers are non-voting for a period of three years.
Stock markets are a necessary environment for privatization since
they can provide for the presence of high-class companies and big
volume of transactions. Their small volume is a limitation to the
supply of viable projects for DESs. The lack of liquid markets and
institutional investors (trusts, pension and investment funds)
where households, firms and investors can trade assets and swap
risks with each other is an obstacle for a speedy privatization and
restructuring of the economy.
In general privatization procedures are simple and brief and are
coordinated by the Privatization Agency, branch ministries or
municipal councils according to the size of the assets and the type
of ownership (municipal or state ownership). The transactions
concluded by the Privatization Agency indicate that foreign
investors remain the only potential buyers of large enterprises. In
this sense, DESs will promote large-scale investments and speed up
privatization.
The procedures for tenders follow internationally established
principles which guarantee the transparency of the transaction. In
some cases the tender conditions may include requirements for
preservation of the company's profile, number of jobs, investment
profile, protection of the environment.
The specific and complicated nature of DES schemes needs a clear
regulatory framework which is to be based on the existing relevant
legislation. The pricing of equity swapped, the exchange rate and
techniques employed for valuating the assets may be a rather
controversial issue. The recent devaluation of the BLV and the
recession experienced further decline the price of the domestic
productive assets. In this respect the presence of consultancy
companies with world-known corporate image as KPMG Peat Marwick,
Price Waterhouse, Arthur Andersen, Ernest and Young, Deloite and
Touch, Coopers and Lybrands guarantee international quality and
standard.
Two years after the adoption of the Privatization Law its
achievements are evaluated as quite modest. Despite expectations
for rapid privatization the process is rather sluggish due to a
number of practical problems, the time-consuming establishment of
the real estate property rights and defining the shares of
privatized companies in another company (see D. Bobeva, Al.
Bozkov).
2.2. Foreign Investment Patterns
Legal Advantages
Foreign capital invested in Bulgaria is regulated by the
Business of Foreign Persons and Foreign Investment Protection Act
1992. The objective of act is to reduce bureaucracy and provide
effective legal guarantees for investors. Its conditions are said
to be one of the most liberal in Central and Eastern Europe.
Foreign investors can hold up to 100 percent of the company's
capital enjoying rights equal to those of domestic investors. A
foreign person may acquire ownership over buildings and limited
material rights over real estate. The legal forms of investment are
also rather diverse in comparison with the other Central and
Eastern European countries - foreign investors can set up branches
and commercial agencies. These forms of foreign economic activity
give certain advantages to foreign companies in the initial phase
of their investment profile when they get knowledge about the local
market. Later, this experience turns out to be an advantageous
basis for their investment plans.
The liberal legal conditions of the Bulgarian investment
legislation also offer variety of forms of investment. There are no
regulations prohibiting foreign investment in certain arrears with
the exception of only three cases which are subject to
authorization - banking and insurance, production and trade in arms
and military equipment, development or extraction of natural
resources. A special permitment is required in these cases if
foreign participation is sufficient to secure a majority in
decision making.
Foreign investment are protected against expropriation. The
repatriation of income from investment, the liquidation quota in
the cases of termination of the investment are not restricted,
subject of course to payment of local taxes prior to transfer.
Foreign exchange regulations have also been considerably
liberalized. Any foreign person may open accounts, deposit foreign
currency or BLV with Bulgarian Banks, as well as dispose of shares
and securities.
An important factor of the investment environment is the tax
treatment of foreign investment. Recently, some fiscal incentives
to foreign investment were withdrawn, so that domestic and foreign
investors are de facto subject to almost equal tax treatment. There
are tax exemptions during the first five years in the free trade
zones and thereafter a tax rate of 20 percent (the current profit
tax rate is 40 percent).
Despite the political hustle the open investment regime in the
country has remained in the course of the past years of the reform
and thus providing for a time-consistent Government policy. The
transparency of the investment climate is provided by the relevant
policy-coordinating governmental bodies - the Commission for
Foreign Investment at the Council of Ministers, the Privatization
Agency, etc. These institutions aim to sidestep the bureaucratic
hurdles facing an acquisition whilst in western management to
promote marketing and production efficiencies.
The rationale to throw "good" money after "bad"
The foreign direct investment process typically entails several
steps: strategic assessment of alternative investment
opportunities; evaluation of the environment, investment climate,
choice of financing strategy; estimation of the risks involved and
return on risks. The rationale for international investment is very
much influenced by the availability of attractive investment
climate and well-designed swap programme. Investors who are risk
averse attempt to diversify their investment portfolios so that
risk can be reduced. New portfolio diversification theories suggest
picking investments so that the total return on a portfolio is
correlated to the return in the market in general while the return
on each investment tend to be unrelated. Of course this "market
portfolio" can not do away with risk allocation with the market in
general. It is because of this property that Hanke suggests the
design of a "multi-market" diversified portfolio. This portfolio
will be expanded to include other markets (see St. Hanke). These
other markets will generate returns that are unrelated to those in
the original market. Thus, there is room for international markets
to come into play. A part of the portfolio will be invested in
other countries allowing the international investor to gain higher
returns per unit of risk than he would with a well-diversified
home-country portfolio. Among the financing options for investment,
equity is often among the least preferred, since this method
involves often difficult management process ( see K. Dezseri and J.
Marcelle). The ongoing process of transition is accompanied by
unstable foreign exchange and money markets which often have
unpredictable effects and thus limit investment initiative.
In general, investors consider local currency debt as the most
attractive form of financing because it explicitly matches currency
in cash and debt. At present the economic conditions in Bulgaria
considerably curb the scope of this channel because of its high
cost due to high interest rates and transaction costs. These are
DES schemes that will provide access to local funds at a discount
in the form of a subsidized price for the countryвs external
obligations acquired in the secondary market. This opportunity for
the international investor to buy local shares that are good values
is in addition to the attractiveness of Bulgariaвs market from an
overall diversification point of view.
To-date experience with FDI shows some specific features of the
Bulgarian patterns in terms of volume, structure, direction of
penetration, sending country and size.
A precise quantification of investment inflows has been
bedeviled by the lack of statutory requirements for registration of
all foreign investors. Quite often the transfer of know-how in the
local affiliate and the capital reinvested are also not registered.
Bulgaria suffers from shortage of capital mainly due to lack of
clear privatization and restructuring strategies, lack of clarity
in much of the existing legislation, the unsettled debt problem and
scarce publicity on long-term investment opportunities in the
country.
Clear attitude towards foreign privatization and introduction of
new mechanisms such as debt-equity-swaps (DES) will catalyze the
process. Undoubtedly, public support for foreign investment in
equity is a necessary element of an attractive investment climate.
In this respect, national sentiments and fear of "sell-out" the
country to profit-motivated foreigners can underrate the efficiency
of foreign investment in restructuring the acquired local
companies.
At present Bulgaria finds itself in the initial stage of foreign
investment penetration when economic conditions and policy concerns
limit foreign involvement to trade and service investments rather
than through the international capital markets. After a slow start,
foreign investment is now accelerating with companies such as UK's
Rover, considering establishing assembly plants, Heineken, Coca
Cola, Jacobs and Nestle S.A. with an arrangement for investment in
reconstruction, marketing and distribution network. Firms with
foreign capital follow efficient production behaviour since they
are concerned about the comparative advantage of their products and
liberal trade conditions. Their presence in the national economy
could bring about reduction of entry barriers of the country to the
markets of developed countries and reshaping of Bulgariaвs export
and trade flows.
A case study of fifteen companies with foreign participation in
Bulgaria presents evidence for analyzing investors' incentives,
entry strategy, aims, expectations and limitations in front of
their business. Companies with foreign participation pursue
efficiency- and market-seeking strategies. Initially, they exploit
country's differences in costs and factor endowment, acquire
information about prospects for specialization in local production.
Natural supply advantages of Bulgaria, such as climatic conditions
and geographic proximity to the enormous East markets are certain
incentives for multinational companies to invest. The operations of
efficiency-seeking investments can be further facilitated by
liberalizing trade restrictions, since they include intrafirm
trade. Intergovernmental arrangements on the protection of foreign
investment contribute to the presence of many multinational
companies in the country. This is an encouraging indicator of a
change in the country's investment opportunities. Contrary to the
initial wave of small investment at present foreign companies
pursue strategies to achieve objectives beyond short-term profit
maximization. Bulgaria as an investment site is a new strategic
market where new products can be developed and profits
proportionate to the risk can be earned. Undoubtedly, the present
environment of undeveloped market arrangements and deficient
infrastructure limit the operations of foreign companies.
Sectorial analysis of FDI inflows evidence their growing volume
in services. This process is triggered not only by supply factors
including technological advantages in communications and allowance
for informational services but also by the change in the
traditional investment patterns. Recently, worldwide an increasing
share of capital inflows is attracted in capital- and
technology-intensive industries. In Bulgaria this process takes
place in sectors which are said to be priority - transport and
telecomms, tourism (hotels and new leisure activities), electronics
and electrical engineering via introduction of information
technology, Western management, pollution controls (see Tables
5 and Table 6).
Distribution of Foreign Investment by Sectors
|
Number of foreign investment companies |
Trade |
279 |
Industry |
44 |
Services, tourism, housing |
40 |
Construction |
10 |
Finance, Insurance |
11 |
Electronics |
16 |
Transport and communications |
10 |
Agriculture |
3 |
Education and culture |
5 |
Distribution of Foreign Investments by Size
Up to $ 2,000 |
65.4% |
$ 2,000-20,000 |
20.0% |
Over $ 20,000 |
14.6% |
Small-scale investments make up 65,4% of all foreign investment
and only 14,6% of registered investments are above $ 20,000. Along
with the arguments raised above there are some claims that the
insignificant number of foreign investment is primarily due the
small number of joint ventures (see D. Bobeva and Al. Bozkov,
1992). Unlike all other countries in the region, where foreign
investments participated mainly in setting up joint ventures, these
figures are about 1,900 for Bulgaria. Setting up a joint venture
with a local partner may be beneficial if the local partner has
strong market share and local brand recognition The information
about the entire set of firm specific knowledge and advantages are
attractive for the foreign investor. Results from several
successive surveys carries out with managers of joint-ventures
indicate that despite these benefits foreign investors are keen to
keep direct control and alleviate efficiency-control problem
investing "on green". The problem with green-field investment is
that initially its cost is positively correlated with the
production factor intensity of the recipient industry. It also
takes time before production can begin.
Foreign investors need to distinguish among different groups of
companies looking for the most attractive site. At the time of the
preliminary talks with the creditors the Government's Foreign Debt
Management Committee outlined the criteria for choosing entities to
be swapped. These are mainly export oriented, in branches that have
gained relative profitability (tourism, food processing,
transport), indebted but with good production capacity. Foreign
investors may be importantly concerned about potential
restructuring costs and the indebtedness they have to bear for the
acquired local company. If these costs are higher than the asset
cost then the process can stop. Foreign privatization of companies
that are technologically or market dependent from foreign companies
should be promoted. This way the process will bring about sector
and technological restructuring, demand responsive production, new
patterns of trade policy. These considerations make direct FDI
privatization, i.e. transformation of the existing non-private
enterprise into private foreign ownership an attractive method.
Parallel to the institutional set-up a government policy for
intensification of foreign investors' participation in
privatization through DESs has to stipulate the guidelines for
these transactions: DESs conditions, percent discount of face value
of debt bonds, dividend remittances and capital repatriation
regulations , minimum period of ownership over the equity. The
flexibility of these guidelines is crucial for the attractiveness
of the debt-equity conversion schemes. The experience of some Latin
American countries, like Chile, Argentina, Mexico in terms of the
DESs regulatory framework they have applied is useful for drawing
lessons for Bulgaria . This framework has to be devised in the
context of the broader FDI policy. It needs to approach foreign
capital through policy-driven measures built around formal trade
and investment preferences through free-trade areas, customs and
common markets, and market-driven solution which is given by
multinational companies pursuing gains through integration of their
foreign affiliates at recipient country's level.
The various path and programmes of other countries that have
applied DES are potential testing procedure. Chile's conversion
program is said to be very successful, swapping 15% of Chile's
total long-term debt by schemes for privatizing SOEs on competitive
basis among potential strategic investors. This auction-based
system (also the case of Philippines, Argentina, Chile) is useful
for Bulgaria for screening the most suitable investor and raising
the price of the enterprise.
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