Characterised by inappropriate state controls and weak corporate governance practices, state-owned enterprises mark a key challenge in the fight against corruption in Romania, Bulgaria, Croatia, Slovenia and Hungary. Anti-corruption efforts could have a positive effect on these businesses – for the public interest.

“State-owned companies operate as the Hungarian state does: often non-transparently. There is not a single state-owned enterprise in Hungary that discloses all of the data that is required by law”. “A majority of Croatian state-owned companies are oversized, inefficient and seen as hotbeds of corruption”. “Bribes, preferential tendering and disastrous management have turned these companies into ‘black holes’ in [Romania’s] state budget”.

These are but a few of the recent alarming media headlines on State-Owned Enterprises (SOEs) in Eastern Europe. Poor SOE performance seems to lead to a plethora of problems for government budgets, financial stability and market reforms.

In Romania, Bulgaria, Croatia, Slovenia and Hungary, state ownership of economic assets is a legacy of socialism and centralized control over the economy. There have been massive waves of privatisation in the region – many fraught with corruption. However, state-owned enterprises continue to occupy a central place in the national economies of the region, sometimes due to their size, other times due to their impact on regional employment and also because of the control they exert in strategic sectors like energy and transport.

In Croatia, for instance, employment in companies under public control exceeds 13 per cent of employment in the business economy. Not only are they not making profits; their net borrowing averaged 0.6 per cent of Croatian GDP from 2011 to 2014. In Romania, SOE arrears are approximately 3.7 per cent of the GDP, and sectors with massive triggers for the entire economy, like energy and transportation, are significantly dominated by public ownership. In Slovenia, one third of the increase in public debt from 2007 to 2014 can be attributed to state interventions related to financial and nonfinancial SOEs (in a timeframe in which gross consolidated public debt quadrupled).

Many corporate governance arrangements are poorly structured in Eastern Europe

It has been shown that, in general, SOEs perform worse than private firms in terms of profitability and productivity, while sectoral allocative efficiency is lower when a larger fraction of employees is working in SOEs.

It may be argued – and rightfully so in some cases – that the relative underperformance of SOEs has structural causes. They need to fulfill a number of public service obligations or exist in strategic sectors for advancing national policies, where profit is less important than other non-commercial goals.

However, this argument often hides the perpetuation of unethical business practices – preferential employment, covert financing of political parties and corrupt procurement being the best-known examples. Such a milieu is possible due to poorly constructed corporate governance arrangements: a lack of public scrutiny mechanisms, political appointments to managerial positions, no internal control practices and shallow external audits. Ultimately, this leads not only to low performance for individual companies, but also to significant losses for public finances.

Yet worse can be expected if sound governance and anti-corruption practices are not rolled out urgently in Eastern Europe. The region could experience an incident like the Petrobras scandal in Brazil at any time, with the same massive political and social implications.

Brazil’s Petrobras scandal

Petrobras is Brazil’s state-owned national oil company. It used to be the largest company in the Southern hemisphere by market capitalisation and employed excellent corporate governance and disclosure practices: local and international listing, a Big Four auditor, executive certification of financial statements, separation between the Chief Executive and Chairman positions, a Corporate Secretary and dedicated Corporate Governance Officer, as well as regular financial and non-financial reporting.

But all these “by the book” corporate governance practices proved to be nothing but window-dressing for mammoth corruption. In 2014, Brazil’s biggest corruption schemes, not yet fully uncovered, came to light. Petrobras, which had employed Brazil’s current president as CEO, had been involved in a kickback scheme involving contracts worth upward of 4 billion USD. Money from the inflated contracts was eventually fed back to the governing Workers’ party and other major parties for political campaigns. By 2015, over 100 executives and politicians were indicted for money laundering and corruption.

As the scandal unfolded, the company was virtually excluded from capital markets, and its shares lost as much as 14 per cent in a single month. At the moment, its debt stands at over 100 billion USD and is at risk of default.

President Dilma Rousseff’s popularity plummeted due to her alleged connection with the case. Graft allegations against some of Brazil’s top politicians infuriated the country’s citizens. Their outrage turned into a massive protest with millions taking to the streets in spring 2015. Ms. Rousseff narrowly avoided impeachment in December 2015, while Fitch downgraded the country’s sovereign debt rating to junk.

Corruption prevention mechanisms in Eastern Europe are weak

When you think of it, this all started from corruption in a state-owned enterprise. Smaller-scale scandals related to SOEs are abundant everywhere in Eastern Europe due to inappropriate state controls and weak corporate governance practices.

The latest EU Anticorruption Reporthighlights corporate governance as a specific area that requires more attention in a number of Eastern European countries. Public interest is endangered by the lack of merit-based appointments, unclear legislation, weak mechanisms to prevent and sanction conflicts of interest and weak transparency in regards to allocating funds and purchasing services made by state-owned enterprises.

The “corruption prevention” ranking of the Bertelsmann Stiftung’s Sustainable Governance Indicators (SGI) is similarly disappointing for Romania, Bulgaria, Croatia, Slovenia and Hungary. Regarding the question to what extent public officeholders are prevented from abusing their position for private interests, none of these countries score more than 5 out of 10 points. Hungary, where “widespread corruption has been a systemic feature of the Orbán governments for some time, with benefits and influence accruing through Fidesz’s informal political-business networks”, scores an abysmal 3/10.

It’s easy to overlook that each and every one of us, as citizens, are actually shareholders in our country’s state-owned enterprises. We may not own shares directly, but as members of the body politic, we ultimately do. As a result, we should have much greater expectations of public enterprises in terms of transparency, performance and evidence of anti-corruption practices.

New Eastern Europe

23 February 2016