CGI Asks: Who Wins From Russia’s Privatization?

February 5, 2016

In each installment of “CGI Asks,” a selection of experts respond to a question about developments in Russia and the broader region. This week, we ask about the Kremlin’s announced plan to sell stakes in major state companies to help shore up the federal budget.

Sergey Aleksashenko, Former Deputy Finance Minister of Russia


SAleksashenko.php - CopyThere are two aspects to privatization in Russia: the financial one (raising funds for the state budget through asset sales) and the institutional one (limiting the government’s role in regulating the business sector). Right now there is no discussion of giving up state control of Rosneft, VTB or Aeroflot—the government plans to maintain control of these companies in the future and preserve its majority on their boards of directors. I can’t think of a single large company the Russian government has sold in the last 15 years, while it has acquired at least a dozen of them.

Putin’s economic doctrine is based on the idea that the government has to be the controlling investor in the country’s “attractive assets,” and they shouldn’t be given away to anybody. Therefore, we can forget about the institutional part of privatization in this case. In terms of the financial aspect, Russia’s economic development minister Alexey Ulyukaev said it pretty clearly: the budget is in critical condition and they’re in desperate need of money. The Russian government faces some difficult choices: they can sequester the current budget, or raise taxes, or dip into the federal reserve fund more than planned, or sell off state assets. None of these options can really be called a good one.

Privatization is just one way to finance the budget deficit, but today there is weak demand for Russian assets. And a number of state assets (such as VTB and Rosneft) are currently under Western sanctions, making them practically impossible to sell. On top of that, Putin said that state assets should not be sold at bargain prices, despite the fact that stocks in Russia’s largest state companies have stayed the same price in rubles during the last 2-3 years—which means they have lost more than half their value in dollar terms.

Overall I think the government will try to sell small blocks of shares in state companies, keeping control of the companies in its own hands. This will provide a small injection of funds for the budget, but it will clearly not be enough to make up for the revenue lost due to falling oil prices at the end of 2015-beginning of 2016. In that case, the only winner from this operation will be the Russian Finance Ministry, which will have the resources it needs to finance current state spending, and will retain enough reserve funds to finance the budget deficit for the next two years.

Harley Balzer, Associate Professor of Government and International Affairs, Georgetown University

BalzerPrivatization, even at current depressed prices, could be a positive action, raising needed funds and potentially enhancing the efficiency and competitiveness of major Russian companies. But any gains beyond short-term revenue will require genuine privatization.

In the same manner that “sovereign democracy” is not really democracy and the Russian Federation is not really a federation (no powers are reserved to the subjects of the Federation), this proposed “privatization” does not end state control of the firms. President Putin has made it clear that controlling interests in “strategic assets” will be retained by the Russian state. Examples of the initial proposals include offering a 19.5 percent stake in Rosneft, a 10.9 percent stake in VTB, and a 25 percent stake in Sberbank. Only the Sberbank stake would offer a buyer any influence under Russian law, but only the power to block some actions. As is the case in the United States, minority shareholders in Russia have little real influence over key decisions.

Everyone in Russia except the current managers of state enterprises would benefit from genuine privatization. The limited sale of stakes in major companies that has been proposed would benefit the budget in the short term, and prolong the rent seeking opportunities of current managers in the longer term.

Chris Miller, Associate Director, Program in Grand Strategy, Yale University

MillerThe first question to ask about the privatization program is whether it will actually happen. The government has repeatedly proposed selling stakes in state-owned enterprises over the past several years, only to postpone the decision after it proved too controversial.

Facing a gaping budget deficit in 2016, Russia’s government is understandably looking for new sources of funds, and some officials believe that privatization can help. But asset sales are likely to bring in far less revenue today than it previously would have. For one thing, existing financial sanctions will deter many Western investors from participating. Second, many potential Russian buyers are strapped for cash given the economic downturn. Third, because of low commodity prices, stakes in many of the most valuable firms, such as oil producers Rosneft and Bashneft, are worth far less today than several years ago.

President Putin has declared that privatization can only go forward if assets are not sold at “bargain prices.” But the economic climate means that potential investors will demand steep discounts to previous valuations. Rosneft’s shares in London, for example, trade at half the level of 18 months ago. Does that count as a bargain price?

Daniel Russell, President and CEO, U.S.-Russia Business Council

RussellRussia’s privatization could be a “win-win” opportunity for all parties, depending on the structure and valuation of asset sales. The Russian government now appears set to sell partial stakes in several strategic companies and could begin to do so within the next year.

Investors in privatization could be winners, given low Russian share prices, particularly relative to their emerging market peers.  For comparison, Rosneft has a price-to-earnings (P/E) ratio of 7.4, while PetroChina has a P/E ratio of 15.4 and ExxonMobil’s is 20.

One big question will be pricing. President Putin said earlier this week that the assets for privatization should not be sold at “knockdown” prices. Another question will be structure. President Putin has declared that the state must retain a majority stake in these companies and it is not clear if foreign investors will be able to participate and, if so, under what terms.  Protection of minority shareholder rights will be important to attract potential investors.

Russia could be a winner beyond the revenue generated by asset sales. Successful privatizations have in most cases led to more competitive, commercially-driven firms. Beyond increased returns, privatization delivers other benefits and generally works best when it is part of a larger program of market-driven reforms.  A World Bank examination of twelve privatizations in four countries found that divestiture was good for the economy and led to higher productivity and faster growth in all but one case. New private sector shareholders could help Russian state-owned companies introduce management reforms and improve corporate governance with the end result being a more profitable enterprise making a greater contribution to the Russian economy.   

The bottom line is that international and Russian markets would welcome a carefully-crafted Russian privatization program that would bolster competitiveness, efficiency and transparency.  Privatization is not a cure-all for state-owned enterprise performance, but global experience suggests that Russia’s privatization could reward new investors, the host companies, and the overall economy.

The Center on Global Interests provides an open platform for discussion. The views expressed here are the authors’ own.