Privatisation in Ukraine offers a historic opportunity for Polish companies

By Paweł Musiałek and Michał Wojtyło

This article is published in cooperation with the Jagiellonian Club think tank.

The privatisation of state assets in Ukraine is opening new possibilities of foreign expansion for Polish companies. With western support – from the European Union, International Monetary Fund and United States – Kyiv is implementing reforms to the country’s political and economic system. The Polish government and its agencies should support companies keen on involvement in privatisation in Ukraine. In October, PGNiG made one such groundbreaking agreement. Other Polish companies should follow suit.

Poland’s path could inspire Ukraine

The path of Poland’s economic transformation, though a bumpy one, has clearly led in the right direction. The economic slump that followed brought about high unemployment. But after a phase of chaos came a gradual rebound. When it became clear that there was no turning back from the course towards democracy and free-market democracy, Poland became an increasingly attractive marketplace for foreign companies.

As well as the often controversial purchase of national companies, there was no shortage of greenfield investments, providing jobs and paving the way for technology transfer and teaching modern management skills.

Locations of investments were initially based on low labour costs. Gradually, however, business demanding higher competences came to Poland. Foreign giants began to transfer more advanced processes, and in some cases also research departments. Polish companies learned from the foreign competition, making use of Poles’ increasing purchasing power. In many sectors (including food), Polish companies began to have success competing with the west.

Growing numbers of companies in Poland began exporting goods abroad. After gaining know-how and exhausting the Polish market, they stepped up efforts to find new markets, often successfully. Between 2000 and 2018, Poland’s share in global trade grew by a factor of 2.5 – one of the best results in the world. Even compared to the dynamic increase in exports from the Central Europe region, Poland had the fastest growth.

Furthermore, unlike Czechia and Germany, Poland has a relatively high proportion of national capital in export of industrial goods. It is pleasing that the companies in question are not just large ones, but also medium-sized, and that more and more firms aim for foreign expansion from the outset. Bumpy as it has been, the Polish road can provide a positive example for further development of the Ukrainian state.

The final step

Poland’s maturing companies now need to take the next step if they are to continue their development. This will be bolder investment expansion, especially in less developed countries, as the government’s Responsible Development Plan emphasises.

The cumulative value of direct investments from Poland at the end of 2018 was 28.5 billion zloty, according to a Polish Economic Institute report. This is not much in comparison with the size of exports and potential of our economy, and only puts Poland in third place in Central and Eastern Europe, behind Hungary and Czechia.

This statistic, based on UNCTADstat data and adjusted for population size, reveals an even worse picture – Poland ranks just seventh in CEE ($748). Top of the list is Estonia, with eight times more investment per capita than Poland ($6,085), while Czechia’s figure is four times higher ($3,271). According to the report, only 10% of Polish exporters invest abroad. In 2017, just 23 companies made investments exceeding €1 billion outside of Poland. This shows the size of the gap between increasing sales of goods and expansion of capital.

Today, after 30 years of development and accumulation of capital, for the first time in living memory Polish firms are starting to have the resources for increased foreign expansion. This applies not only to large state companies, although they naturally lead the way. Increasing numbers of Polish firms are starting to treat foreign markets not only as a potential site for their products, but also as somewhere to invest.

If the Polish economy is to catch up with the west, we must follow the current source of additional profits for foreign companies – search for places to invest the gradually growing Polish capital where it might get a higher rate of return. This need is particularly urgent considering the increasingly difficult expansion in the already mature Polish market as well as an ever more expensive workforce.

The role of not just companies but also the government should be to monitor places with high potential. Particularly important are those countries where development as well as domestic and external security are in Poland’s interest, such as Ukraine.

The Ukrainian window of opportunity

Kyiv should become one of Warsaw’s priority directions. Its proximity and fast-improving infrastructure reduce investment costs. Polish enterprises’ have the advantage of having learned to operate in conditions of unfavourable institutions and uncertainty of the law in their own backyard, whereas many western companies are unaccustomed to working in an unconducive regulatory environment. Polish firms also have a privileged position having acquired experience with the Ukrainian side, as many are already active in Ukraine. Increasing investments would therefore be a natural step in the development of foreign expansion.

The positive changes taking place in recent years in Ukraine are significant. The conflict with Russia notwithstanding, the association agreement with the EU and activity of the International Monetary Fund (IMF) in Poland’s eastern neighbour are delivering genuine Europeanisation of many areas of public life. This often takes place as a result of strong external pressure and is an effect of conditionality policy (macroeconomic help in exchange for reforms).

For Polish companies, however, it is not the Ukrainian government’s motivations that are important, but the effects of their policy, which are increasingly promising for business. Kyiv has given its clear backing to a western orientation, rather than the uncertainty-inducing balancing act between east and west that was characteristic of Ukraine’s foreign policy before the outbreak of war in Donbas.

From the point of view of Polish interests, the privatisation of many state assets, taking place according to new rules dictated by the IMF, should be particularly important. Although this is not a politically easy decision to swallow for Kyiv, it is forced to respect the IMF’s expectations if it wants to receive further tranches of aid. This policy therefore opens a window of opportunity to Polish companies, as strategic assets are to be sold into private hands. The low price anticipated by investors is a consequence of international business’s low level of trust towards Ukraine.

Also important is the political context. Ukraine is a strategic partner for Poland, which has a vested interest in the Europeanisation and economic development of its neighbour. Kyiv has all the assets to be a testing ground for Polish business and a valuable political and economic partner.

The involvement of international institutions in the reforms of the domestic economic and political system is a significant factor reducing the investment risk in Ukraine. These entities exert an influence on Kyiv in the form of conditional macroeconomic support, the tranches of which are released as the reforms progress. The political and economic model these institutions promote is based on the rule of law and rules of liberal economics, and one of its objectives is to increase the level of foreign direct investment.

Ukraine’s new privatisation law

Mass privatisation in Ukraine has not previously succeeded because foreign companies were concerned about opaque procedures, corruption and the weakness of the country’s judicial system. A further reason was the strong influences of oligarchs, who did not want transparent rules to weaken their position.

Ukraine has the chance to carry out organised and transparent privatisation of its state assets. On 7 March 2018, with EU and IMF support, a new law on state privatisation and local government property entered into force. It introduced transparent rules on sales of state assets, with the objective of encouraging investments from foreign entities. Passage of the privatisation law was a condition for payment of a $1.9 billion tranche of macroeconomic aid from the IMF.

The new law brought in two types of privatisation: small and large. The latter concerns businesses with a value above 250 million hryvnia (approx. €8 million). The starting price in the auction of objects of large privatisation is specified by an external consultant or auction committee in accordance with the valuation methodology approved by the Ukrainian government with the support of international institutions.

The law also introduced various guarantees for investors. For example, certain transactions (loans, land sale agreements, shares) can only be implemented after the company that won the auction has received the title deed. Russian entities are directly excluded from the privatisation process.

In the first round of large privatisation, 23 entities were earmarked for sale, including distribution network operators, power stations and combined heat and power plants, a fertiliser factor, ore mines and titanium processing plants. The Ukrainian authorities planned for some of the assets to change owner by the end of 2018, but the state’s institutional weakness and the election campaign going on at the time caused delays.

Progress under Zelensky?

Despite his election promises, to date Volodymyr Zelensky’s presidency has not proved to be a breakthrough in improving the investment climate and progress for foreign businesses. Privatisation continues to be a slow process (annual privatisation plans are still not being implemented), although income from it was supposed to be crucial for the Ukrainian state budget, still weakened by the crises. Corruption and significant problems in judicial reform are leaving their mark on analyses of the risk of investors from outside the country.

Yet progress has certainly been made. Notably, the impasse over the unbundling of the state company Naftogaz after the change in power has now been broken, separating its transmission from its production activity, which is essential for introducing genuine market competition by removing the tools of discrimination of competition. The result is an independent gas pipeline operator controlling transit pipelines, Gas Transmission System Operator of Ukraine. Although there are question marks over the operator’s actual independence from political and oligarchical pressure, this is certainly a step in the right direction.

The Polish government wants to exploit the liberalisation of the Ukrainian economy. On 13 October 2020, during President Andrzej Duda’s visit to Ukraine and the Polish-Ukrainian business forum that accompanied it, President Zelensky overtly invited Polish companies to become more active in Ukraine, as well as to participate in privatisation. He also said that he hoped for a major increase in foreign direct investment (FDI) from Poland, which in 2019 was worth around $7.7 billion (Poland is the second biggest importer for Ukrainian exports).

Gas cooperation can connect the countries  

One of the areas where Polish companies can try their chances is the energy sector. As the Ukrainian government have begun to adapt to EU guidelines and regulations, the transparency of the natural gas market in Ukraine has increased markedly. The market’s gradual liberalisation has increased its attractiveness for foreign investors, including those already present, such as Polish ones.

In 2019, around 13% of Ukrainian gas imports came from Poland, with a volume of 1.4 billion m³, and some of the gas purchased by Poland ultimately remains in Ukraine. Construction of a Polish-Ukrainian interconnector is planned, which would mean a threefold increase of gas transmission, even to 6.6 billion m³. Gas cooperation and its further prospects are also strengthened by the terminal in Świnoujście, through which the first imports of liquefied natural gas ordered by Ukraine, including from the United States, have already been transported.

On 14 October, Polish state-owned oil and gas company PGNiG signed an agreement with the State Property Fund of Ukraine on confidentiality of sensitive data concerning planned privatisation of state assets. This allows PGNiG to commence the process of assessing the profitability of takeovers as part of the privatisation of the Ukrainian energy sector. Unofficially, there is talk of several power plants being modernised to run on gas instead of coal. PGNiG’s participation could provide the significant funds required for this.

Collaboration with Ukrainian partners is nothing new for PGNiG, as its then CEO Jerzy Kwieciński stressed when making the deal. In the first half of 2019 alone, this state-owned company sent 0.9 billion m³ of natural gas to Ukraine, and it plans expansion by extracting gas from Ukraine’s large deposits. Kyiv has for years been promising to use them to achieve gas self-reliance, but the difficult access to deep deposits demands large funds and modernising knowhow, and barriers remain.

PGNiG sees extraction of hydrocarbons as its chance. In the first half of 2021, it will begin to search for suitable deposits in Ukraine. In October last year, the Polish state giant also signed a contract with a private company, Energy Resources of Ukraine (ERU), which is beginning a joint investment project to locate and extract deposits near to the Polish border.

What should Poland do?

Support for Polish companies wishing to participate in the privatisation in Ukraine should be a priority for the Polish government. The experiences acquired during sales of state-owned companies can be applied during the Ukrainian privatisation of state assets.

Polish diplomacy and specialised state departments such as the Polish Investment and Trade Agency as well as insurance company KUKE should be involved in the process. By creating suitable financial instruments, they can reduce investment risk, thereby encouraging expansion of Polish businesses.

EU and IMF involvement in the reforms in Ukraine should also be encouraged, to reduce the investment risks for Polish companies. Supporting the entry of smaller Polish businesses in well-planned joint ventures with other foreign entities could additionally reduce the cost of loans and the political risk of investments, with the final premium at a similar level.

Poland needs to make the next step in its transformation and become much more involved in investments abroad. Ukraine seems to be the right direction. Strengthened Polish-Ukrainian cooperation at economic level can bring mutual benefits, accelerating the development of both countries. This is a chance we must not waste.

The original Polish version of this article can be found here. Translated by Ben Koschalka

Main image credit: Krzysztof Sitkowski/prezydent.pl

Paweł Musiałek is a board member of the Jagiellonian Club think tank and director of its Analysis Centre

Michał Wojtyło is editor and publisher of the Jagellonian Club website and a member of its Analysis Centre