Ege University Working Papers in Economics 2013 http://www.iibf.ege.edu.tr/economics/tartisma

THE EVALUATION OF PRIVATIZATION PROCESS IN KYRGYZSTAN: 1991-2001

Ertuğrul Deliktaş Ömer Selçuk Emsen

Working Paper No: 13 / 01 January 2013

Department of Economics Ege University

THE EVALUATION OF PRIVATIZATION PROCESS IN KYRGYZSTAN: 1991-2001 Ertuğrul DELİKTAŞ 1 Ömer Selçuk EMSEN 2 1.Introduction After the collapse of the Union of Soviet Socialist Republics (USSR) in 1991, the fifteen republics 3 declared their independences. The collapse of the USSR gave rise to different political circumstances and to new economic conditions for these countries. In this context, Kyrgyzstan has decided to establish a competitive market economy by accepting capitalist economic system and started the economic reform process which is mainly privatization centered. For most analysts (see e.g. Lipton and Sachs (1990), Hinds (1990) Fischer and Gelb (1991)), establishing the market economy in transitional economies mainly depends on four inter-related policies on the microeconomic side: price liberalization, integration to the world economy, reducing barriers to entry by new firms and privatization. These policies are also suggested by the International Monetary Fund (IMF) and the World Bank (WB) in transitional economies: stabilization-liberalization and privatization (Canning and Hare, 1996, 13). It was hoped that these policies taken together would motivate a supply response at the industry level which would alter the structure of national production, the pattern of sales, both domestically and internationally, the quality and variety of output and enterprise productivity (Estrin, 1996, 6). In the transition process privatization is a central point or a backbone of economic reforms. Because privatization ensures the success and speed of all economic reforms. In the USSR or communist countries ownership of entities were almost belong to state 4 . It is a defining characteristic of all the countries ruled by communist system. For this reason, the reforms required to change communist economies into capitalist ones would therefore have to place privatization on the first priority.

2. Privatization Process in Kyrgyzstan Kyrgyzstan started the privatization process to transfer publicly-owned enterprises to private hands with the collapse of the USRR in 1991. Kyrgyzstan, like other transitional economies, pursued its own strategy in privatization. The major privatization policy of the country has relied on some form 1 2 3 4

Prof. Dr., Department of Economics of Ege University Prof. Dr., Department of Economics of Atatürk University Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. That is the private ownership was rare anywhere in communist countries and virtually non-existent outside in agriculture.

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of mass privatization. Mass privatization involves in effect placing into private hands the savings that are required to purchase state assets. The attractiveness of the method is its speed and distributional equity. Mass privatizations allow ownership to be transferred despite the absence of alternative owners which are capable of purchasing the assets, but provide no resources either to the governments in return for the assets they are transferring, or to the firms themselves to assist in restructuring. Moreover, the principal advantage of such schemes - the fact that they offer in principle a highly equitable way to transfer assets - means that the resulting ownership pattern is likely to be highly dispersed, and corporate governance therefore significantly weakened (Estrin, 1996, 11) As a result of the voucher privatization or coupon method, each person is hoped to obtain a piece of the state property slated for privatization. Bu this share of state property is trivial, and in the real terms these shares of state property will not produce a single capitalist. Although this reality, the policy of voucher privatization was governed by the ideology of socialist justice. Privatization process realized so far can be examined in the three periods which are 19911994, 1995-1997, and 1998-2001 in Kyrgyzstan. For each period, the number of privatized firms can be seen in Table 1 with respect to the sectors of Kyrgyz economy. Table 1 :Privatization of State Owned Enterprises in Kyrgyzstan:1991-2001 Sectors

1990* 1991-1994

%

1995-1997

%

1998-2001

%

1991-2001

%

Industry

608

376

61.80

155

25.49

19

3.12

550

90.46

Agriculture

855

333

38.95

21

2.46

16

1.87

370

43.27

Services

6180

4424

71.58

378

6.11

243

3.93

5045

81.63

-Public Services

3192

2195

68.76

154

4.82

170

5.33

2519

78.91

-Trade

1963

1769

90.11

112

5.70

41

2.08

1922

97.91

-Construction

730

345

47.26

73

10.00

16

2.19

434

59.45

-Transportation

295

115

38.98

39

13.22

16

5.42

170

57.63

Other Branches

2346

326

13.90

347

14.79

455

19.39

1128

48.08

Toplam

9989

5459

54.65

901

9.01

733

7.33

7093

71.00

(*) shows the number of state enterprises before privatization process starts Source: State Property Fund, Bishkek, Kyrgyzstan-2002.

The first period involves the radical transformation of the economic system under insufficient technical knowledge of persons involved privatization, and inexperienced governments about privatization. Although these insufficiencies, in this period, especially small scale industrial enterprises, shopping centers or magazines, restaurants, hotels were privatized. According to the first period,, the 54.65 percent of total state owned enterprises were privatized. As can be seen in Table 1, rapid privatization process developed in all sectors. The sectoral distribution of privatized enterprises is as follows: 61.80 percent in industry, 38.95 percent in agriculture, 71.58 percent in

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the total service sector including trade, transportation, construction and public services, which are health, education, science, culture, art, sport and tourism, and other sectors (13.90 percent) including public utilities, semi-finished construction, and others. The average privatization rate is very high for a short period. But, this is understandable because the privatized small and medium sized industrial or other enterprises that provide daily consumer services or engage in different trade and restaurants are more familiar with the market or closer to market operations period (Koichuev, 2001, 51). The second period, 1995-1997, includes the transformation of medium and large scale enterprises. In this period, it was tried to create a multiple and competitive economic structure in Kyrgyzstan economy. However, by contrast the first period, it seems that the privatization of enterprises has developed at a slower pace in all sectors, except for other branches in economy. Because in this period, medium and large scale enterprises were subject to privatization. The adaptability of these enterprises to market is not easy due to their structural characters, such as organizational, managerial, and valuation difficulties. Under these restrictions, the total privatization rate is 9.01 percent for the second period. The sectoral distribution of privatized enterprises is as follows: 25.49 percent in industry, 2.46 percent in agriculture, 6.11 percent in total service sector, and 14.79 percent the other sectors mentioned above. In the third period, the privatization rate which accounted for 7.33 percent of all state enterprises in 1990 is also lower than first and second periods. The sectoral distribution of privatized enterprises is as follows: 3.12 percent in industry, 1.87 percent in agriculture, 3.93 percent in total service sector and 19.39 percent the other sectors. It is also seen that the rates of privatization in sub-sectors of economy are low. Because this period includes the privatization of large scale enterprises and it has been aimed to be privatized of the key and strategic sectors of Kyrgyz economy, such as energy, telecommunication, airlines, metallurgy, and communication sectors. In this context, Kyrgyztelecom in communication sector, Kyrgyzenergo in energy sector, Kyrgyz Airlines in transportation sector, Kyrgyzneftgaz in petroleum refinement sector, Kant Cement Factory, Aynek Glass Factory, Kyrgyz Stone Factory in construction sector, have been in privatization process. It is also reported in “the Program of Economic Stabilization For 1999-2001” that the Government intends to attract foreign investors through selling state blocks of shares of the following enterprises Tekstilshchik, Mata, Akbula, and VLKMS via international tenders. The production of the terry clothing products, furniture, tapestry, the linen with an annual volume of 1.26 million com will be organized at the Jyldyz Joint-Stock Company together with a German partner (www.bisnes.doc.gov).

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3.Privatization Methods Privatization process is very complex in transitional economies. Because, any attempt to organize public offerings in these economies as a way to privatize the bulk of the economy faces insurmountable practical problems. There are some restrictions of selling publicly-owned enterprises to private hands. At the aggregate level, the stock of private savings is far too small to purchase the assets of the industrial sector at anything faintly resembling market prices. On the supply side, however, the governments in reforming economies had an enormous number of assets to sell, and, in order to avoid rapid asset dissipation by theft, the transfer had to be undertaken rather quickly. Governments could still of course seek to use auction or public tender methods to sell a few selected firms, either to domestic purchasers or to foreigners. This happened in most countries, especially those of Central Europe where progress in reform as a whole was more advanced. Foreign owners would clearly be outsiders to the existing managerial structures, and could be expected to introduce some form of Western governance apparatus on the enterprise. Sales to domestic customers could be either to insiders or outsiders, and given the virtual absence of substantial private stocks of savings, managers and workers, either together or separately, would be the most obvious buyers. Only Hungary (and perhaps East Germany) has been willing or able to sell an appreciable share of former state owned assets to foreigners. Some governments, notably in Romania and Kyrgyzstan, have instead encouraged the emergence of insider owned firms with ownership centered upon Trusts controlled by managers and or workers. These management and employee buyouts have also been an important element in the Kyrgyzstan privatization The methods used in the privatization of state enterprises for period 1991-2001 in Kyrgyzstan can be seen in Table 2. Table 2: Privatization Methods and Percentage Distribution of Enterprises:1991-2001 Pirivatization Methods

(I) (A) (S) (O) Total % % (a) % (b) % (c) % (d) % % % Leasing for later purchase 9 1.6 4 1.1 32 1.3 4 0.9 48 2.5 - - 43 3.8 140 1.9 Joint- Stock Companies 406 73.8 130 35.1 322 12.8 308 71 200 10.4 143 84.2 184 16.3 1693 24 Sales through auction 16 2.9 6 1.6 218 8.7 11 2.5 159 8.3 2 1.2 118 10.4 530 7.4 Sales through competitive bidding 12 2.2 2 0.5 544 21.6 3 0.7 581 30.2 - - 62 5.5 1204 17 Direct sales to private persons 21 3.8 40 10.8 836 33.2 13 3 328 17 5 2.9 390 34.5 1633 23 Direct sales to employees 52 9.4 178 48.1 492 19.5 71 16.3 551 28.7 15 8.8 275 24.4 1634 23 Limited liability 30 5.4 10 2.7 63 2.5 24 5.5 55 2.8 5 2.9 37 3.2 224 3.1 Free 4 0.7 - - 12 0.4 - - - - 19 1.7 35 0.5 Total 550 100 370 100 2519 100 434 100 1922 100 170 100 1128 100 7093 100 Note: (I),(A),(S) and (O) are the capital letters of the main sectors, such as industry, agriculture, total service sector, and other branches, respectively and small letters represent subsectors of the total service sector, such as (a) represents public services, (b) represents construction, (c) represents trade, and (d) represents transportation sector. Source: State Property Fund, Bishkek, Kyrgyzstan-2002.

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It is seen in Table 2 that the most widespread form of privatization is the formation of joint-stock companies, which is 24 percent of all privatized enterprises in economy. This are followed by sales to private persons and to employees of the enterprises, accounted for 23 percent for both of two methods. The third method is sale through competitive bidding, accounted for 17 percent. This is followed by sale through auction, which is 7.4 percent. Limited liability accounts for 3.1 percent, leasing for later purchase is 1.9 percent, and free distribution is 0.5 percent of all privatized enterprises 5 Direct sale to private individuals began in 1993 and sale through competitive bidders first appeared in 1994.These forms of privatization of small and medium sized enterprises is more accessible for purchasers. Large enterprises were also converted into state/joint stock companies in order to being able to purchase. It was thought that this form will become one of the most dynamic structures of the mixed economy (Koichuev, 2001, 54). On the other hand, in terms of the sectors of economy, the following methods are used in privatization process. In industry the predominant form is the formation of joint-stock companies; in agriculture direct sales to employees of enterprises and secondly the formation of joint-stock companies, in consumer services direct sales to private individuals and secondly is sales through competing bidding. In construction, the predominant form is the formation of joint-stock companies; in trade sector sales through competing bidding which is 30.2 and secondly is direct sales to employees of enterprises, in transportation, the formation of joint-stock companies is predominant form. In the other branches of economy, the direct sales to private individuals is predominant form and secondly is direct sales to employees of enterprises

4. Privatization and Performance of Enterprises In Western Literature, it argued that privately owned enterprises will perform better than state owned ones and the transfer from public to private ownership brings efficiency related changes in the way a company is run, for example in terms of total factor productivity which divided into two pars: technical efficiency and technological change (Maldeikis, 1996, 1). However, in transitional context, it should be careful in defining good performance. Because profitability in immediate postreform era is a seriously inappropriate as well as poorly measured performance index. Because in the transition process, an appropriate economic environment and competitive structure have not occurred yet. Market structures are highly imperfect in most transitional economies because 5

In 1991-94, the most widespread form of privatization was direct sale to the collective, which accounted for 26.2 percent of all privatized entities. This was followed by sales to private individuals, 20ç9 percent; sales through competitive bidding, 20.1, and formation of joint-stock companies, 17/86 percent. The creation of state/joint stock companies accounted for 4,64 percent of the total number of privatized enterprise. The proportion of enterprises leased for later purchase was 1.2 percent. Limited liabilities comprised 3.1 percent of the privatized entities (Koichuev, 2001).

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industry size distributions were determined according to the convenience of planners. The restructuring of this privatized enterprises and re-entrances to existing market will take times. The performance of privatized firms also depends on the existence of capital markets in the country. It is necessary to issue new equity and redistribution of privatization coupons among sellers and buyers. If the capital markets does not exist or not perform well, privatization will not reach its aim. In Kyrgyzstan this market has been in the way of development. In addition to capital markets, it is important who owns the privatized enterprises in transitional economies. Enterprises perform differently according to whether ownership is primarily located in the hands of workers or managers, namely insiders and outsiders which are foreigners, competitive bidders, private individuals, and so on. In Kyrgyzstan most firms are owned by insiders, which accounted for 47 percent of total privatized enterprises in 1991-2001. It is unclear what this implies about company performance. But, the Western literature places emphasis on external capital markets as the disciplinary mechanism against inefficiency and rent seeking. Insider control raises new agency problem however, that seem likely to damage enterprise performance due to restrictions on access to external finance (Estrin, 1996, 18). Early and Estrin (1995) purposed that the contribution of privatization towards enterprise restructuring be evaluated against some criteria: long term enterprise restructuring; short term enterprise restructuring, developing a politically independent and market oriented enterprise sector, termed depolitization. It is well known that there is a strong relationship between the free market economy or liberalization and democracy. Because market economy requires the freedom of production and choice. If private producers and consumers have a freedom of choice, the resources are distributed among the best alternatives. Therefore, both producers’ profit maximization and consumers’ utility maximization are provided. In this context, liberalization and democracy index is also used as an indicator of performance of enterprises. The indices are follows with respect to transitional economies.

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Table 3: The Cumulative Liberalization Indices Advanced Reformers Hungary 6,84 Poland 6,81 Slovenia 6,77 Czech Republic. 6,39 Slovakia 6,05 Average 6,57

High-intermediate Reformers Estonia 5,72 Lithuania 5,39 Latvia 5,00 Bulgaria 4,92 Albania 4,56 Romania 4,47 Average 4,93 Low-intermediate Reformers Slow Reformers Kyrgyz Republic 4,35 Uzbekistan 2,83 Russia Federation. 4,32 Belarus 2,54 Kazakhstan 3,39 Ukraine 2,54 Moldova 3,80 Turkmenistan 1,53 Average 3,97 Average 2,36 Countries affected by regional tensions Croatia 6,53 Azerbaijan 2,64 Fry Macedonia 6,34 Tajikistan 2,21 Armenia 3,37 Georgia 3,26 Average 4,06 Source: Gerni, Cevat and Yılmaz Kuskay (2001), A Review of Macroeconomic Stabilization Experience of Transition Economies: Lessons for Turkey in the Aftermath of the Recent Crises, (Fortcoming), p: 7.

According to cumulative liberalization index 6 for period 1990-2000, Kyrgyzstan takes place among lowintermediate Reformers

5.Conclusion In Kyrgyzstan, vouchers are primary privatization methods in rapid privatization process. Vouchers are seen the answer, for they would give purchasing power to the population in order to able to establish market economy with a transparent consolidation of shares. As a result of the voucher privatization or coupon method, each person is hoped to obtain a piece of the state property slated for privatization. The privatization process has continued since 1992 in Kyrgyzstan. The 71 percent of total state owned enterprises was privatized between 1991-2001. The privatization rates are 90.46 in industry, 43.27 percent in agriculture, 81.63 in total service sector including public or consumer services, trade, transportation and, construction sub-sectors. In the privatization process, the first period (1991-94) witnessed high privatization rate, accounted for 54.65, the rate of second period is 9.01, and the rate of third period is 7.33. Some key enterprises will be privatized in 20012003 according to decision of Kyrgyz parliament in 2000. The key enterprises which will be 6

This index is a measure of the depth of structural reforms in respect to direct foreign investment, foreign capital flow into the country.

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privatized are Kyrgyztelecom, Kyrgyzenergo, Kyrgyzgas, and Kyrgyz Airlines. In addition, 10 large scale and 131 medium scale enterprises will be privatized in this period. In the privatization process, the widely used methods are the formation of joint-stock companies, sales to private individuals and sales to employees. That is, the insider form of ownership is the predominant form in Kyrgyzstan. This form of ownership is criticized from different sides in the literature. Insider ownership may weaken the prospects for long term restructuring because of the inferior access to capital, but strengthen short term restructuring because of superior knowledge of the market and technology (Estrin, 1996, 19). Privatization to workers and managers is not beneficial. A reasonable hypothesis for the ineffectiveness of diffuse or insider ownership is the lack of an adequate institutional framework. That framework would include strong mechanisms of corporate governance, including rules to protect minority shareholders, rules against insider deals and conflicts of interest, and adequate accounting, auditing, and disclosure standards. These owners probably had neither the ability to provide the capital to modernize the enterprise nor the market experience to cope in a competitive environment, nor the drive and vision to guide the radical restructuring often required improving enterprise performance (World Bank, 2002, 71). However, we will not able to do this critic in terms of effectiveness of enterprises for Kyrgyzstan due to lack of statistical data. But it is obvious that there are mistakes in voucher privatization in the country. Because the heads of commercially successful enterprises also became co-founders of joint-stock companies and their shares of stock was quite substantial. These shares change between 20 percent and 51 percent according to different industries and enterprises. Moreover, the concessions (the difference between the privatization price and assessed value of enterprises) were considerable. As a result, the policy of formation of joint-stock companies resulted in the income looses of state due to low prices and distortion of property and income distribution in Kyrgyzstan. The policy of voucher privatization was governed by the ideology of “socialist justice” the desire to make everyone a property owner (Koichuev 2001, 65). But, it is seen that this aim has not been realized in ten year -period. It would have been more logical to privatize the state-owned enterprises by selling at real market prices to both insiders and outsiders including foreigners and other form of ownerships. Foreign investors are often in the best position to provide the resources and skills for restructuring state enterprises. But it is a reality that selling to foreigners is politically difficult and such investors are sometimes less available for a given the overall uncertainties about the investment climate and lack of political uncertainty, inadequate legal framework, and weak institutional capacity. On the other hand, The countries in which privatization takes place may have some fear about foreign investment and therefore, they want to bring some restrictions in selling of enterprises.

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References Canning, Anna and P. Hare (1996), “Political Economy of Privatization in Hungary”, CERT (Central for Economic Reform and Transformation), September, pp: 1-49. Earle, J.S. and Estrin, S., “Employee Ownership in Transition”, in C. Gray et al, op cit, 1995. Estrin, Soul (1996), “Privatization in Central and Eastern Europe”, CERT (Central for Economic Reform and Transformation), March, pp: 1-36. Fischer, S. and Gelb, A., “The Process of Economic Transformation”, Journal of Economic Perspectives, 5 (1), 1991. Gerni, Cevat and Yilmaz Kuskay (2001), “A Review of Macroeconomic Stabilization Experience of Transition Economies: Lessons for Turkey in the Aftermath of the Recent Crises”, (Fortcoming). Gilchrist, Simon and John C.Williams, Transition Dynamics in Vintage Capital Models: Explaining the Postwar Catch-Up of Germany and Japan, The World Bank, Washington D.C., January 2001. Hinds, M., “Issues in the Introduction of Market Forces in Eastern European Socialist Economies”, EMENA Discussion Papers, No. IDP-0057, Washington: World Bank, 1990. Kyrgyz Republic State Property Fund Data, 1991-2001, Bishkek, Kyrgyzstan. Koychuev, Turar, The Economy of Kyrgyz Republic on the Way of Reforms, Bishkek, 2001. Koychuev, T., P. Koychuev and R. Toktomatov (2001), “Kyrgyzstan’s Development Dynamics and Problems”, Reforma, No: 1 (9), pp: 4-13. Kyrgyz Economic Outlook (3/2001), Center for Social and Economic Research in Kyrgyzstan. Lipton, D., and Sachs, J., “Creating a Market Economy in Eastern Europe: The Case of Poland”, Brookings Papers on Economics Activity, 1990. Maldeikis, Eugenijus, (1996), “Privatization in Lithuania: Expectations, Process and Consequences”, CERT (Central for Economic Reform and Transformation), February, pp: 1-31. The World Bank, Transition First Ten Years, Analysis on Lessons for Eastern European and the Former Soviet Union, Washington D.C, 2002. Wyplosz, Charles, Ten Years of Transformation: Macroeconomic Lessons, The World Bank, Washington D.C., April 28-30, 1999. www.adb.org, Key Indicators of Developing Asian and Pacific Countries, (December 2001). www.bisnisidocigov/bisnis/country/990409kr.htm, Kyrgyzstan: The Program of Economic Stabilization for 1999-2001.