Advice to the IMF
An open letter to Mr. Jeffrey Franks, IMF representative for Romania
Dear Mr. Franks
Here’s some advice to the International Monetary Fund (IMF) which loves to give advice and instructions to all and sundry governments about how to run their affairs. That advice always draws from the same fountain of ideologies, orders the same old, tired, discredited set of prescriptions.
For instance, large scale privatization and deregulation, inspired by the dominant Reagan-Thatcher era ideology, have produced mixed results. Even in the best of circumstances such as in the UK, the outcome has often been disappointing and led to several failures. The British railways are privately run but government-subsidized; the French railways are State-owned. Guess which country has the better railway system. British airports were privatized; yet Heathrow has a dismal performance record (but investors who bought the shares at the time of privatization made piles of money).
Remarkably, even in the wake of the financial crisis, which has cast a permanent pall on the supposed virtues of “free markets” and “market efficiency”, there remains pockets of ideologues (and self-interested promoters) advocating wholesale privatization of State-owned companies in the developing world.
The IMF has been a haven for these ideologues, a loud and truculent promoter of massive privatization of State–owned enterprises.
Your strategies and tactics are rightly condemned by scholars and practical people for their callousness, inefficiency and the unacceptable harm they visit on populations.
Whenever the IMF has leverage over a government, it prods, pushes and cajoles it to implement its stale, even poisonous, recipe of yesteryears: free all markets, generate cash by quickly selling national assets to foreigners, privatize everything the State owns, essentially get rid of the government’s ability to steer the country’s economic development (they will only make a botch of it, is the IMF’s condescending view of any government dependent on its assistance).
Of course, if the country is a postulant or a new entrant in the European Union, its government will be further constrained and shackled in setting its economic, social, fiscal policies and, ultimately, having joined the Euro zone, even in its monetary policies.
The Romanian government, under pressure from the IMF, is considering a second wave of large-scale privatization of its remaining SOEs. The Casa de Economii si Consemnatiuni (CEC), essentially the only large Romanian retail bank not in foreign hands, should be privatized, says the IMF. CEC has 3.4 million clients, EURO 3.1 billion in assets and operates the largest network of branches; in fact, out of the 1000 bank branches serving rural areas of Romania, CEC operates 870 of them! (Roland Berger Consultants, 2010).
The Romanian government has been trying to stall or postpone the process of privatization in this case, looking for ways to shore up the capitalization of the CEC but the EU and the IMF are adamant that no public funds should be channelled to the CEC.
Of course, almost all banks, Austrian, Irish, Spanish, German, British, whether private or State-owned, have received equity injections and loan guarantees from their governments, often drawn from European emergency funds and IMF funding provided to the country; these funds are usually managed by the IMF, the enforcer of the European Union.
For instance, the Austrian banks Erste Group and Raiffeisen International, which own or control the largest banks in Romania, received from the Austrian State capital injections of EUR 1.22 billion and EUR 1.75 billion respectively. In addition, the Republic of Austria is guaranteeing bonds issued by these banks up to EUR 6 billion and EUR 10 billion respectively. All these private banks and privatized banks brought about the worst financial crisis in half a century. Several private banks had to be nationalized to save the financial system from collapse. Great empirical support for the IMF dogmas!
Indeed, Michael Lewis might have been describing the IMF’s policies when he wrote that what we have now is socialism for the banks and capitalism for the rest of us (in his book The Big Short, 2011).
But the Romanian government is “ordered” by the IMF not to support its only remaining retail State-owned bank. Let’s remember that half of the banks in Poland are State-owned or controlled. China, India, Brazil and countless other countries refuse to cede completely the control of their banking sector to “market forces” and are even more adamant not to let their banking sector pass into foreign hands.
Even Canada and the USA, generally market friendly countries will not let foreigners control their banks. In Canada, there is no State controlled retail bank but no single shareholder (or a group of related shareholders) may own more than 10% of the voting shares of a chartered bank and foreign investors, collectively, may not own more than 20% of the voting shares. Yet, Canada is renowned to have the best banking system in the world, a rare one to have weathered the 2007-2008 financial storm unscathed.
What are the policy options for CEC
First and foremost, the Romanian government should declare that the CEC will not be fully privatized. To the extent that retained earnings are not likely to raise sufficiently quickly the level of the bank’s capital to meet international (Based III) standards, the government should partly privatize the bank but only to the extent needed to raise sufficient capital. Its shares should be listed on a stock exchange.
The government should state that only Romanian individuals and entities owned by Romanians will be authorized to own shares in the CEC.
But, let’s be clear: the IMF does not understand, or want to understand, that the alternative to full privatization is better corporate governance of State-owned and State-controlled enterprises.
“Perhaps the most notable change in the practice of state-owned enterprises is the fact that corporate governance has changed significantly in the last decade and a half. Many SOEs have changed their charters to improve internal governance, include outside directors on their boards, provide incentives to managers for good performance, and professionalize management…
In the first place, companies that privatized part of their shares through issues of stock had to induce investors to buy shares by self-imposing limits on the capacity the government had to extract resources from the company. In order to do that, management was professionalized, outside directors were invited to the boards to monitor the company, and financial reporting was improved. Listing on a stock exchange, either to sell shares or bonds, forced companies to comply with high accounting standards, to report financial statements quarterly, and to hire auditor companies like PricewaterhouseCoopers, Ernst & Young, and KPMG. With the monitoring of shareholders, the oversight of stock exchange regulators (like the Securities and Exchange Commission), and the hiring of auditing companies, it became harder for the managers of SOEs to steal profits or to follow fraudulent accounting practices—not impossible, but much harder…
The end result has been a significant improvement in corporate governance and financial reporting and control.”
(The Return of State-Owned Enterprises: should we be afraid?, Francisco Flores-Macias and Aldo Musacchio, Harvard International Review, April 4, 2009)
“State-owned banks should be required to operate on a commercial basis. This requires competent staff and efficient internal systems…[The] governance measures…can ensure that competent senior management are retained with the mandate and freedom to implement the same kinds of systems and controls that would be adopted by any prudent commercial bank”. (“State-owned Banks…Practical Policy Decisions in a World Without Empirical Proof”, A.Michael Andrews, IMF Working Paper, October 2005)
Everywhere governments seek to improve the corporate governance of their SOEs. The balance of advantages and disadvantages of privatized companies over State-owned ones shift in favour of the latter, if and when SOEs are well governed. A well-governed and well-run State-owned enterprise brings the benefit of efficiency in the interest of all citizens of a country, not merely for shareholders.
Of the 100 largest Canadian companies (by revenues) fully 13 are State-owned. Of the largest corporations of the world, on the basis of stock market value, four are State-controlled enterprises.
At Davos 2011, the Chinese and Indian representatives were openly condescending towards the neo-liberal economic model so dear to some western countries and promoted with such touching fervour by the IMF and the World Bank. However all smart governments know that they must improve the governance of their SOEs.
What pressures may be exerted on SOEs to improve their governance and ensure their viability and efficiency:
1. Whenever possible, open the market to competition; the SOE, having to compete, will adopt the governance and management practices to succeed.
2. Turn SOEs into hybrid enterprises where private investors may buy a percentage of the equity capital but the State retains control; a State enterprise which becomes partly owned by private investors and which lists its shares on a stock market will have to implement all the rules and regulations of securities commissions and stock exchanges. If it wants to raise additional capital through share or debt issues, it will have to demonstrate that it operates with a high quality of governance.
3. Finally, if the SOE fails to improve its performance, the option of privatization may be re-activated.
The CEC can play a vital role in the economy of Romania as a State-owned or controlled bank. Several programs of financial assistance to small and medium size enterprises as well as for the agricultural sector resort to government guarantees of bank loans. These programs were devised to help Romanian businesses and farmers access the large European sums available for Romania under various programs of “convergence”. Yet, little has been done. These large amounts remain unclaimed and unspent, a real scandal for a struggling country like Romania.
The CEC should become, on government orders, the prime mover of a dynamic program of financial and technical assistance for entrepreneurs and agri-businesses applying for these European funds.
By law (“a law on modernization of State-owned enterprises”), the government should mandate the CEC and SOEs to adopt state-of-the-art governance principles and processes:
1. The government should appoint a majority of independent board members; independence means that a board member, or any person related to him/her, has no personal interest in the decisions of the company, receive no monetary incentives other than publicly divulged fees as board members;
2. All related-party transactions (i.e. between the company and any entity or individual connected to the board or management) must be publicly divulged; the interested member of the board may not participate in the discussion and decision on this transaction.
3. Mandate the creation of an audit committee as well as a governance and ethics committee; impose on SOEs to be audited by internationally recognized auditing firms;
4. Require the board to adopt a code of ethics and to publish the code on its Web site and in its annual report;
5. Give the board the responsibility to appoint and set compensations for senior management but with the approval of the government.
6. Mandate full transparency, in particular all SOEs should:
· Publish an annual report available on their Web site containing all relevant information on their operations, measures of their performance, audited financial statements; total compensation of board members and senior management, experience and expertise of board members, their status as independent (or not), the code of ethics, any related-party transactions, etc.
The annual report must be deposited in parliament within three month of the end of the SOE’s fiscal year; the chair of the board and the chief executive must appear before relevant committees of parliament to respond to all question and issues raised by their performance.
The Proprietatea Fund, in its bid to become listed on the Bucharest stock exchange, has adopted several governance measures along the line of what is proposed here. It could go further in some areas of governance. For instance, the independence of board members is not well established and several board members have serious conflicts of interests.
Nevertheless, the Proprietatea Fund has taken a giant step in the right direction. Given the sizeable stakes in several State-owned companies (as well as in many private companies) the Proprietatea Fund should push all of these companies to adopt quickly (within a year) the governance principles the the Fund itself has put in place.
The message to the IMF is simple: get on board; stop advocating passé policies; work with governments in improving the governance of State-owned enterprises.
For governments of eastern and central Europe, our message is clear: your well governed SOEs are your only remaining grasp on some control over your country’s economic and political sovereignty.
It is your moral and fiduciary duty to retain control of that lever!
Prof. Acad. Yvan Allaire, Ph.D. (MIT)
Chairman, Institute for governance of private and public organizations (Canada)
Prof. Mihaela Firsirotu, Ph.D. (Mc Gill)
School of Management, UQAM (Canada)
(The opinions expressed here are strictly those of the authors).
 Obviously written before the collapse of the private banking system in 2008-2010; the author might have been less confident in the practices of “prudent commercial banks”