CER | Czech Republic: Privatisation for Whom?

Privatisation for Whom?
The Czech state, citizens or foreign investors
Mark Preskett

Emerging from "splendid isolation"

The collapse of Communism brought an end to Czechoslovakia's "splendid isolation." In 1989, the country emerged with little foreign debt and few foreign-owned companies. Unlike Poland and Hungary, which began introducing economic reforms under Communism, Czechoslovakia maintained a strict command economy throughout the 1980s.

After 1993, the Czech Republic followed post-Communist Czechoslovakia's lead in pursuing liberal economic reforms. According to Josef Poschl of The Vienna Institute for International Economic Studies (WIIW), "Uniquely in Central Europe, Czech companies were advanced enough to stand a chance of surviving in a market economy."

The Czech Republic remained among the most industrialised countries in Central Europe-a legacy leftover from the Austro-Hungarian Empire, as well as the early years of Czechoslovak independence. The country has continued to benefit economically from both its geographical location and educated workforce.

These factors have made the Czech Republic a prime investment site for Western companies. Despite these advantages, however, by the mid-1990s, the economy was shrinking instead of growing and even the Czech National Bank publicly voiced doubts concerning the country's economic future.

The scheme that failed

What went wrong? Much of the blame for the Czech Republic's economic decline lies with the country's privatisation voucher scheme. Intended as a quick way of transferring state-owned firms to private hands, each citizen of the Czech Republic paid CZK 1000 for a coupon book, which was to be exchanged for company shares. Though millions of Czechs became instant shareholders, the scheme failed to bring in intended amounts of investment.

A second problem was that much of the privatisation was illusory. The state maintained majority or controlling shares in the country's largest banks. The banks in turn set up investment funds, which purchased the citizens' coupon books. By concentrating the funds from those purchases, the banks ended up controlling much of the economy, including the industrial giants.

Finally, the first wave of the privatisation scheme limited investment by excluding the sale of property and businesses to foreigners. This dearth of foreign investment continued until recently.

Czech provincialism

Why the reluctance to sell to foreigners? The heart of the matter is that many Czechs see foreign companies as exploitative, rather than operating in the best interest of the Czech Republic. A classic example is the case of the IPB/Nomura affair.

The Japanese investment firm, Nomura, took control of IPB, then the fourth largest bank in the Czech Republic, in 1993. From the beginning, Nomura did not act like a strategic investor and was instead accused of asset stripping. The purchase of the Czech breweries Plzenský Prazdroj and Radegast, financed by IPB assets, is still being disputed today. When Nomura sold the two breweries to South African Breweries (SAB), IPB saw none of the money.

Despite the decline in popularity for the ruling Social Democrats (ČSSD) (polls show that only 15 per cent of Czechs intend to support the party in next year's general election), ČSSD has helped drag the economy from the mire and in doing so has realised the importance of attracting foreign capital.

Prime Minister Miloš Zeman has spent much time abroad, as well as at home, attempting to persuade foreign businesses that the Czech Republic is a safe place to invest. In 1998, the government introduced the Foreigner Investment Scheme indicating its willingness to forfeit the state's controlling shares over hundreds of industries.

Foreign direct investment (FDI) figures show that the majority of foreign capital invested in the Czech Republic in recent years has been concentrated in the areas of telecommunications and banking. Despite a few high-profile investments, however, FDI figures remain low. There are a number of individual cases that show that Czechs remain reluctant to sell to foreigners-what President Vacláv Havel has called "Czech Provincialism."

For example, when in 1999 the Swedish construction giant, Skanska, first attempted to buy a controlling stake in IPS, the Czech Republic's biggest builder, it was given a polite but firm "no." Most of IPS's shares at the time were held by the investment funds of three Czech banks. These funds were forced to sell their shares in order to meet the government's new privatisation requirements. Středoevropské stavební, a year-old subsidiary of the Sekyra Group, a real-estate firm, won the right to purchase the shares. The reasons? Sekyra's bid was CZK three per share higher than Skanska's, totalling CZK 2.1 billion. In addition, Sekyra was a Czech firm.

"IPS is in Czech hands," boasted the headline in Construction Journal, a Prague trade magazine. The group's chairman, Ludek Sekyra, told the magazine that "IPS is a strategic firm that can grow just as well under Czech control."

Unfortunately, holes began to appear in the Sekyra bid when it came time for money to change hands. Despite Sekyra's claim to be in possession of a nine-year bank loan and supported by minority partners, the CZK 1.5 billion loan was in fact just a 30-day note and the minority partners never materialised. In addition, 70 per cent of the financial backing came from Investiční a Poštovní banka (IPB), a bank which was later placed under forced administration by the state in May 2000. When Československa obchodní banka (ČSOB), a second Czech bank bought IPB, it quickly sold the controlling stake in IPS to Skanska. Skanska was ultimately rewarded for its patience.

Parking, payment and promises

A second example of Czech reluctance to sell to foreigners can be seen in the case of the American parking firm, Central Parking System (CPS). In 1997, a public tender was held for the lease of the parking garage complex at Prague's main railway station. Lukas, a Czech firm, won the tender. CPS placed second.

Two years later, the Prague City Council cancelled the contract with Lukas as a result of non-payment of rent. The tender was then offered to CPS-a decision that was later challenged by another Czech firm, Eltodo. As a result, the Council decided to announce a new selection process.

The executive board of Eltodo, CPS's new rival for the contract, included the former Mayor of Prague, Jan Koukal, his assistant, Martin Vlk and Petr Zajicek, former chairman of the controlling commission for the City Council. Both Eltodo and CPS submitted their tenders for consideration. The following day, copies of both tenders were leaked to the Czech daily Mlada fronta Dnes.

According to MF Dnes, 80 per cent of Eltodo's tender was identical to the tender put forward by CPS in the original selection process in 1997. The newspaper printed a section of the two tenders whereby Eltodo had forgotten to change the initials CPS to Eltodo.

When MF Dnes approached Filip Dvorak, the spokesman for Eltodo, for a reaction he stated "We have never seen CPS's business plan because they are our competition. We know nothing of this firm, we know only that some foreigners work for them." It came as little surprise when Eltodo was offered the contract at the beginning of last year.

"Every meeting with the City Council came down to one thing," said Chris Guilds, CPS's General Manager for the Czech Republic. "They would not believe that we were serious about the Czech Republic and would hold to our investment promises."

Foreign firms and local support

While examples, such as the IPB/Nomura case, support Czech fears concerning foreign investment, conversely, there is much to be gained from cooperation with foreign firms. For example, foreign firms can offer local firms contacts abroad, as well as access to new markets; skills and experience that differ from locally owned firms. Most importantly, foreign firms can contribute much needed capital. Unfortunately, with more and more foreign firms entering the market, many local businesses will go bankrupt-the main cost of modernising the economy. However, as the Polish management consultant Ron Nawrocki said, "Transition is painful."

In the immediate future, FDI figures are likely to increase as the state plans to sell some large industry leaders. These companies include: the telecommunications firm, Český radiokomunikací, the largest bank, Komerční banka and the power utility giant, ČEZ.

Two important issues will affect future levels of foreign investment in the Czech Republic. Next year's general election is expected to influence foreign investment, whether or not the new government will continue selling off companies that remain in state hands. Second, the question remains as to whether the Czech people are willing to cast aside negative views of foreigners and welcome the investment that they can bring.

Mark Preskett, 7 May 2001

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