Cyclopedia Of Economics 3rd edition

In article 90, item 3 of the above mentioned Law, it is predicated that a domestic party, on the basis of a foreign exchange deposit of a foreign depositor, may keep foreign exchange on a foreign exchange account in an authorized bank for working abroad, if said party has contracted to keep the foreign exchange in the foreign exchange account, or to use it for purposes consolidated in the deposit agreement.

In 1993, when this law was passed, there was no stock exchange in Macedonia, but after its inauguration, and after the passing of a law which stated that any trade in securities must be conducted through the stock exchange (article 186 of the Law for Issuing and Trading Securities), no one in Macedonia found a reason (nor wanted to find one) to amend this Law.

A lot of illogical situations regarding foreign capital are to be found in the chapter dealing with the purchase of securities and titled "Frozen Savings", - facts which are contrary to the statements of Macedonia that there is a great need and great wish to attract foreign capital.

These problems are regulated with the Manual for the Means and Procedures for using the Deposits of Foreign Exchange which belongs to the citizens for buying shares and portions of Companies with Social Capital (Official newspaper of RM No 7/95).

This manual constituted a permit to use the deposited foreign currencies which belonged to the citizens, for the purposes of buying shares and portions of companies in transformation. This was allowed only to domestic or foreign individuals who are buying shares or portions of these companies. Because the serious foreign investors are legal entities (although exceptions do occur), in practice this Manual meant that insiders in the companies (called: "The Management Team", the establishment) who were in control of the management could buy the company at a 35%-45% discount, through the so called "frozen foreign exchange" and buy stock companies according to the Law. If any foreign company wanted to buy the same company through the Agency for Privatization it would have had to pay in cash without such a discount. This deprived the legal companies of their right to have received an equal discount of 40% of the price they should have paid for the Macedonian non-privatized social enterprises. And this is when Agency for Privatization and the government of Macedonia were proclaiming that they would gladly sell to a foreign investor, but such an investor is nowhere to be found.

Sam: I do not need to protect my reputation as a severe critic of the way that the privatization was handled. I just, again, would like to put things in perspective. The same gimmicks – and worse – were employed by virtually all the nomenclatures throughout the former socialist block. National wealth was plundered not only in Macedonia. Foreign exchange restrictions which applied to purchase and sale of securities were in existence as late as 1990 in Israel and even in the USA some form of them existed until 1971. I suggest not to be too harsh on yourselves. Cronyism, nepotism, corruption, legal stupidity – are human traits, not confined to Macedonia. They are typical of all the corners of the Earth inhabited by humans. To my mind, the question is not what has been done wrong – because it cannot be reversed. Any reversal now will damage Macedonia more than any status quo. The future should interest us. The big guys finished their lunch, let us enjoy the crumbs. There is no point in going home hungry. This is why I appreciate your practical suggestions: the elimination of these parts in the laws that make foreign investments prohibitive and dangerous. Let us hope that the incentive – that evidently existed – to keep them on the books has waned.

Nikola: I did not mention the domestic legal entities on purpose, because the largest part of the sale (privatization) of the social enterprises in Macedonia, was made to domestic physical persons (management teams and employees).

The stock exchange in Skopje is less and less transparent. You can see the reports of the trade from time to time in only one Macedonian newspaper.

The domestic investors can be informed about the operation on the stock exchange only if they call the brokers and probably the stock market on the phone. That is not a problem of the newspapers, but of the stock exchange. The foreign investors can follow the happenings on Telerate and sometimes on Reuters (without information regarding the prices of the shares that can be bought with frozen foreign currency) and the lack of a stock market index is discouraging them.

There are other possibilities for changing some existing systems in Macedonia: changing the concept of the stock exchange, that is introducing computer trading and/or new members of the stock exchange, dealers, or specialists who will offer prices for selling and buying at every moment (Law for Issuing and Trading Securities). This would improve the liquidity of the stock exchange, and would allow to create a kind of an index (better than none). This is a subject that should be explained separately. Changing the stock exchange model will give more efficient results, if it is followed by changes in the laws that I mentioned.

One part the law states that in Macedonia every physical and legal person, resident or not, is a taxpayer of the income tax, that is the profit that will be realized on the territory on the republic, and on another place (article 33 of the Law for the income tax) it is stated that in the first 3 years, under certain circumstances, the profit generated by the foreigner from invested funds is exempted from tax.

The uncertainty about existing official secret gazettes as a remainder from the communist period is increasing the confusion.

A repatriation of profit is encumbered by a 10% tax (article 33 of the Income Tax Law) and article 26 of the same Law states that potential investors who would like to invest in speculative deals (short term buying and selling with profit) are de-stimulated. Under current conditions, with a totally illiquid capital market - this is pure masochism.

According to this article, capital gains from the sale of shares and bonds (the capital generated by a sale minus the respective liability or cost assumed during the purchase) that the taxpayer held for a period of less than 12 months will be completely included in the tax base. Long-term capital gains from the sale of shares and bonds that the taxpayer owned for12 months or more, will be included in the tax base in an amount equal to 50% of the difference between the cost of purchase and the sale's income.

To think and act long-term, an investor needs security, something that the foreign investors doesn't see in Macedonia (for now). Without their risk capital there will be very little or no liquidity at all on the stock exchange. No businessman is against quick profit. The only difference between the investor and the speculator is in how long they remain in the same market. The joke that the investor is a speculator who did not succeed in his speculation is very famous.

There are similar regulations in the laws of other countries. For example, in Germany there is a deadline of 6 months, instead of 1 year in Macedonia. Not only is the deadline twice shorter, but the fact that Germany is not as risky a state as Macedonia is crucial.

The speculators are essential in the markets with high uncertainty and in the economies in transition. They are very important in this phase of the economic cycle in Macedonia. In these circumstances when long term investors are hard to attract, the speculators would be a good temporary replacement, and the Macedonian tax law should not stop it.

However, experience in tiny to small stock exchanges (example: Vancouver, Tel-Aviv) teaches us that it is better to discourage speculation as long as the market is thin and immature. In the absence of transparency, sophistication, experience and, above all, liquidity, speculation deteriorates very fast to market cornering, stock manipulation and insider trading. This, in turn, leads to major crashes and, ultimately, to long years of illiquidity. I, therefore, do support the law. I think that it is reasonable, under the circumstances. I know of no country in the world that does not have similar provisions – a discrimination in the treatment of capital gains in accordance with the length of the period of holding. Some countries prefer not to levy capital gains at all – or to treat capital gains as a regular income to all intents and purposes. The former approach might be the best for Macedonia. Israel has no capital gains tax applicable to traded securities. It helped to turn the Tel-Aviv Stock Exchange from a puny, criminal ridden, place to the vibrant, interesting small stock exchange that it is today.

 

PART SIX


Nikola: The possibility for certain privileges on the basis of the invested foreign capital is provided in the Law of Customs Officials (The Gazette of the Republic of Macedonia no. 20/93, 1/95, 24/95, 31/95,63/95,40/96 and 15/97) and in the Income Tax Law (Gazette of RM no. 80/93……71/96) which are not sufficiently compared to the same laws in some other countries in transition.

At first sight, article 33 of the Income Tax Law provides some benefits, but when one analyzes the article, one sees that only a small number of foreign investors (those who plan to keep the capital in Macedonia for a period longer than 6 years) are able to enjoy these benefits. According to this article, to the three years of tax exemption, at least three more years should be added, in which the capital must not leave the firm of the foreign investor in order not to have to return the tax exemption to the state. Again, the speculators that are needed so much at this moment are discouraged.

It is interesting that the new laws (for example the Law of Business Associations) that replaced some old ones (Law for Foreign Investments) do not have any particular planned modifications for improving the conditions for attracting foreign capital.

The transfers of the deposit and the profits of a foreigner are regulated in article 28 of the Law for Business Associations, paragraph 2 and in article 48 of the Law for Working with Foreign Capital (Gazette of RM no. 30/93 and 40/96). Again, these are all right at first sight, but when it is scrutinized, many unascertained things are revealed.

Some countries, Poland for example, which are very successful in promoting shareholding and their domestic companies, introduced tax benefits in the years when their stock exchanges were forming. They exempted from taxation the capital gain realized with issuing securities through brokerage firms. Besides that, countries like France and Great Britain offered tax benefits for collective investment programs. The objective of Macedonia must be to create the most favorable environment for attracting foreign capital. The means for achieving this, must not have any negative effect on the budget income, and should contribute to the global development of the national economy in the country.

Actually the main problem in the tax sphere is not the low degree of exempting foreigners from taxes, but the large and slow bureaucratic procedures in carrying it out, the indetermination and the ambiguity of the Macedonian laws.

For example, on the question how many percent should the legal persons - foreign investors pay on interest income from bonds, on dividends and capital gains in Macedonia, one Macedonian expert answered: "maybe they will pay 15% and maybe nothing. Many details in this field are not regulated, so if they don't pay nobody will charge them … except, if they are in the way"...

Is it all accidental, or is it a result of a thought-out policy in Macedonia?

Sam: I, personally, am no fan of conspiracy theories. There is a famous "Hanlon's Razor" which says "Never attribute to malice that which can be adequately explained by stupidity". I think that in the case of Macedonia, a shock was involved, so enormous, that it paralyzed the elites. Short term thinking is the daughter of insecurity. People began to seize whatever they could, as though there will be no tomorrow. The legislation reflected the total chaos that ensued. I see no policy in the mess that Macedonian laws are – I see human beings cast into a totally unknown situation, fearsome and awesome, with enormous potential and even greater risks.

Nikola: Besides the provision for unlimited participation of foreigners (in the Law of Business Associations) in an enterprise partly or wholly foreign-owned, foreigners can not obtain a majority stake in other associations.

If this case, the rights of the association which holds the majority will be limited at the depending association based on the number of shares.

The bureaucratic procedure for foreign capital according to the same law is too complicated. The investments of foreigners in the newly founded or the existing association must be registered at the Ministry for Economic Relations with Foreigners. On the request of the foreigner, the authorized ministry will issue a permit for the foundation of an association which is totally in the ownership of one or more foreigners, meaning that they have the majority (article 27 from LBA). If within 60 days from the day of submitting the request, the authorized ministry does not issue a permit then the permit for foundation i.e. foreign holding is deemed to be denied (!!!). When the foreigner does not reach or exceed a major holding, the participation in the newly formed that is the existing association is only registered in the Register of Foreign Investments, in this Ministry.

The question is asked:

What will happen to the prices of the shares of a Macedonian private company on the stock exchange, when one whole Ministry (which means the entire public) will find out that a certain foreign company intends to buy the majority of the shares? (especially if the domestic company is totally privatized through an employee buyout scheme). We must not forget that Macedonia is a small country, and news travel fast. We are forced to conclude that the small shareholders will ask for a higher price for their shares, even before the foreign company asks for a permit from the ministry. This is a serious reason why the foreign investor should reexamine his intention. This method is acceptable (in a milder form) for taking over a domestic bank or specifically determined legal entities which are of a strategic importance for the state. But does Macedonia need this kind of barriers in its present conditions?

Sam: When I go to a hotel with my Macedonian girlfriend, I pay twice as much as she does, in the best case. My passport is confiscated and my details are immediately reported to the police on a special form. This is discrimination, not to say xenophobia. The law should treat locals and foreigners in the same way as far as ownership is concerned. Trading shares, buying and selling them from other shareholders voting rights, capital rights – there should be no difference. That there is still a registrar of foreign investors is outlandish. That a foreign investor should depend for his investment on a bureaucrat who usually is not qualified or educated to deal with these matters is surrealistic. These things, these remnants of a dark past of idiocy should be immediately and unconditionally abolished if Macedonia wishes to become a respectable (European …) member of the family of economic nations. There is nothing to fear. Foreign investors don't bite and most of them do not even have horns. This is provincial thinking of the worst kind.

Nikola: Legislating a law of investment funds is one of the conditions for the creation of a free and liquid market. The investment funds are an ideal medium for saving, through which the domestic and foreign investors will be able to invest money in Macedonia. These funds will allow the potential investors to diversify the risk and through one policy of long-term investments to contribute to the stabilization of the prices.

In the Macedonian law the term "open funds" does not exist, and the status of the trusts is not regulated. Although conditions for proper forming and regulating investment funds can be created with a law, their formation and operation can not be brought about only by a law. Additionally, a market for their functioning can not be provided by making a law in this field.

The segment into which Macedonia can attract foreign investments the quickest, is state and municipal bonds. But the legislator created a "riddle" here both for those who want to issue the bonds and for those who are interested in investing their money in them. In the Law for Changing and Supplementing the Law for Building Terrain (Gazette of RM no. 21/91) the legislator, in article 5 declares: "the terrain in the cities and other regions prepared for housing construction and other complex construction for which an urban plan is made belongs to the republic."

This means that the communities don't nave their own property – in the form of territory, and if they want to construct with their own and/or borrowed money (bonds) they have three negative alternatives:

First, to tear down an old building on already existing locations that belong to them and with an alteration to the urban plan, to construct anew with the taxpayers money. This is a very long and complicated procedure, and in most cases impossible.

Second, to ask the republic (government) to award them a land plot for construction, which is even more complicated and the probability for realizing it is smaller. When one considers the bureaucracy, politics and the incomplete concept regarding when, where and to whom the state can (not) award land… and

Third, not to build, which means to stagnate. This is the most likely variant, judging by my conversations with several mayors of the biggest communities in Macedonia. Who is winning and who is loosing? It seems that everybody is loosing (the state, people, municipality, investors etc.) and nobody is winning.

The arguments "for" this law, which later is incorporated in several other laws, is not to endow the municipalities with greater power, especially those whose leaders have "suspicious intentions". But there are many other methods and means for the state to control the municipalities and their leaders, then to take away their land.

I hope that this explains the present situation with foreign investments in Macedonia, and why the foreign investors are bypassing Macedonia. But that is not all.

1. 
   Decreasing the risk to the foreign investor's money transfer;
   
2. 
   Creating competition between the domestic banks, which results in a healthier and more resilient banking system;
   
3. 
   Possibility for the injection of direct foreign credits to the economy and to the population;
   
4. 
   To return the trust of the clients in the banks.
   

1. 
   Totally unknown (they never heard about them, and they can find their name only if they open the bank register);
   
2. 
   High risk with low performance;
   
3. 
   Banks with low capitalization, the same or lower than the amount of the transfer that would be done if they choose to invest 50 or 100 millions DEM in Macedonia in opening their own branch.
   

In Macedonia there were objective factors, which prevented banks from opening branches (instability of a region in war, closed borders, small market etc.). Still, there is information that in the first 5-6 years of the existence of Macedonia as an independent state, the Macedonian negotiators have been setting specific conditions to the interested Western banks: they were not allowed to accept savings, so that the Macedonian population was not likely to have transferred its money from the Macedonian banks to the foreign ones. Another prohibition was to ban them from making foreign exchange transactions, transfers, etc. Besides the already existing obligations for limited financial placements, in financing that was more than an unreal request. Subject to such restrictions and in view of the mentioned problems in Macedonia, we could ask what will those banks have done? Our opinion is that equal working terms should be completely supplied and extra state advantages should be given to the branch offices of the foreign banks: free location, unlimited financing, tax benefits for a longer period, time allowances for realizing the juridical processes which the bank will conduct in Macedonia until the law provisions in this field are settled etc.

Some of the domestic banks can not fight the competition and they will join or merge with the other banks or they will stop working.

The sick part of the Macedonian banking system will be amputated, the healthy part will become healthier and stronger. The foreigner's money transfer risk (short term and long term) and the risk of working with our banks (midterm and long term) for foreign investors and domestic investors and clients will decrease. The domestic banks will emulate the working methods of the Western developed banks, and this will influence the domestic economy (midterm and long term) By the way, without a doubt, the law that regulates the payments of the credit requirements of the banks must be urgently copied from the Anglo-Saxon law, because the existing situation in this field would seriously question the positive implications from the above mentioned suggestions.

Attracting at least two branch offices of famous Western banks to Macedonia will be a big plus in the eyes of the potential foreign investors. Also, the more efficient healing of the banking system on the domestic front will be thus achieved. This will have strong positive effects on the national economy, and obtaining credit will not be a privilege, or a result of personal interest, family relations and friendships, but the outcome of the quality of a project.

Besides that , the banks will expand and modernize the volume and quality of the operations, and will achieve the form of real banks - secure and more resistant.

It is somewhat misleading to talk about "banks" as though they were uniform entities. They are not. There are important differences between a retail bank and an investment bank or a commercial bank. Because of the restrictive Glas-Steagall act, there are major differences between American and Continental (all-purpose) banks. Macedonia should open itself, initially, to retail banks and to investment banks. The appropriate legislation should be adopted. The right infrastructure should be made available. That foreign banks should not be discriminated against, goes without saying. Maybe a good place to start is with the capital requirements. A branch of a foreign bank has to come up with 21 million USD. This is a huge amount, unjustified by the size of the territory and by the potential to do business. Local banks require only 9 million USD. The conclusions?

1. 
   Capital Risks;
   
2. 
   Capital (Credit) Supply.
   

Romania has this problem of involving politics and finances, and it seems that the reforms in this country were blocked because the ex prime minister did not dare to jeopardize his cozy relations with business and finances.

The Czech failure at restructuring its industry because of the "old boys" network that connects the banks, the funds and the managers of the companies was similar.

But the Asian collapse demonstrated one truth: businessmen and politicians can realize their dreams of poor judgement, but when the income stops, the collapse is inevitable.

On the other hand, if you start from the formulation that the inner economic stability of a country means:

1. 
   Stable prices in the national economy, and
   
2. 
   Complete employment (in the relative sense of the word),
   

1. 
   Stabile rate of the domestic currency,
   
2. 
   A balanced balance of payments.
   

The low inflation rate is a plus for the introduction of foreign capital into Macedonia, but it must be mentioned that if the other problems are solved, foreign investors are ready to invest even in case of a higher rate of inflation. Proof of this is that almost all the other Eastern European countries have a higher rate of inflation and, yet, much more foreign investment. An inflation rate of up to 20% annually, is not a serious obstacle for foreign investments, providing that the other mentioned problems are improved.

For example, the Serbian pharmaceuticals factories are producing medicines that they did not manufacture until now and that they used to import from Macedonia. This is closing the Serbian market to Macedonian exporters. Furthermore, their products started penetrating the Macedonian market. A lot of foreign capital was invested in the Croat firm, Pliva, (only Nomura invested 92 million German marks in 1996). It bought a pharmaceuticals and veterinarian food factory on the brink of destruction in Poland for a very high price. This way, the company will penetrate the Polish 35 million strong market through the back door. Also, thanks to the large export markets and connections that the factory has in Russia, Pliva will also enter the 200 million strong market of the Russian federation, where at the moment, Macedonian manufacturers are placing large quantities of exports. Following this deal, the German corporation BASF offered to Pliva to buy the mentioned ruined Polish factory for a higher amount. Pliva refused, but that represented an additional appreciation of the deal. The market capitalization of PLIVA before being listed on the London Stock Exchange was 500 million dollars, and after a short period of time it reached 2 billion dollars. In February 1998 PLIVA, according to its capitalization, was ranked on the 466th place among all companies in Europe.

The Slovenian Krka is building (from scratch) a new factory in Poland. Many western companies, directly (by buying Russian factories) or indirectly (by constructing new ones) are now penetrating Russia and are competing in the Russian market, so the Macedonian exporters are wasting their time in exploiting article 290 from the LBA and are missing great opportunities for foreign investments. In the meantime, they are "gaining" serious competition in their traditional Eastern European export markets.

Two years ago, two Czech research institutes prepared a special detailed study concerning foreign investments and the national economy of the country, and reached a conclusion that the Czech companies, without foreign capital, are realizing only 64% of their productivity potential compared to those with foreign capital. In certain industrial branches, for example in textiles, the processing of lumber, printing, the glass industry and the ceramics industry the number was only 50% or less. The companies that didn't have foreign capital were exporting on average 10% of their own production, while the companies with foreign investments were placing approximately 40% of their production on the foreign markets. The presence of foreign capital can bring fresh capital from abroad, enhance productivity and exports and establish a new work ethos , something that Macedonia needs badly.

Sam: This is precisely what worries me. Time does not stand still for anyone. While one country is held back by its internal problems, the others take its place. Luckily, international trade is not a "zero-sum" game. It is not that what is gained by others is eternally lost to us. Markets are constantly growing and we can still re-enter them but the price of penetration increases steeply the more a country is out of tune with the world.

Nikola: The model of privatization, whose strategy closed the door to foreign capital, regressed Macedonia, and obviously did not achieve the anticipated - paid privatization with a full state treasury.

The idea behind the mass privatization in the Czech Republic was based on the assumption that the state should not try to realize profits from the process: that will slow privatization down, and with the exception of selling monopolies, like telecommunications, is not successful. The fact that the Czechs weren't burdened with large state debts, like Macedonia and others, contributed to avoiding this stupid mistake. The importance was to eliminate the state or the party from making business decisions as fast as possible, and to leave a space for developing a system, open enough to evaluate from within itself. This does not mean that this kind of a system doesn't have certain weaknesses, but they are far less damaging.

The concept of "case by case" privatization (Macedonia) requires the existence of financially powerful individuals and institutions (big amounts of domestic savings), that will be interested in what is offered and of a developed financial system. The alternative is to open the doors and to attract foreign investments. Unfortunately, Macedonia had neither, but a quasi-system of domestic insider purchases, after which the state was again left with an empty treasury as a result of this "commercial privatization".

When we talk about the domestic potential investment audience, it should be noted that choosing this direction, the state media should educate and inform the domestic public. A series of educational programmes on subjects related to the capital markets, five minutes every day in the main news and one page in a weekly newspapers should have been devoted to the current financial events in the world.