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Foreign Investments and Developing Countries: Dialog With Former Finance Minister of Macedonia Nikola Gruevski, Part VIII

Sam Vaknin, Ph.D. - 2/26/2006

Nikola: A second big problem for the entry of foreign capital, is that in the current Foreign Exchange Working Law (Official newspaper of RM No 30/93) a specific possibility for the entry of foreign currency into Macedonia for the purposes of buying securities is not foreseen.
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.

Sam: The Macedonian Stock Exchange really deserves a separate treatment. But I am afraid that changes that are merely technical or technological in nature will not suffice to revive it. An index is very important when there is liquidity. Liquidity is there when shares are on offer. Shares are on offer when companies think that they will benefit by listing. But in Macedonia, there are no companies, there are only managers. They have very little incentive to introduce new shareholders to their little kingdoms. Shareholders ask questions, sometimes uncomfortable questions. So, very few companies are listed. The dull supply attracted even duller demand, lack of liquidity ensued and the market died. It was up to the government to resuscitate this vital instrument. It could have privatized through it, borrowed through it and it could have forced the new class of shareholders to conduct trading through the stock exchange. None of this happened. There was no political commitment to the success of a stock exchange. There was no mass education campaign, there was nothing to offer, there was too much paranoia and hostility.

Nikola: The impression, to put it mildly, is that the indeterminate strategic objective of the Macedonian legislation regarding foreign investments is not coincidental. This can be seen in the following:


TAX LAWS

According to many domestic and foreign legal and economic commentators, in this group of laws, the tax laws in Macedonia regarding the taxation of capital, especially foreign capital, are written as though they should not be understood. Unintelligible would also mean ambiguous. It means that they can be interpreted "either way", at whim, as it suits somebody in a given moment.

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.

Sam: Speculators have two important functions. Firstly, they provide liquidity to illiquid markets. They are like high risk bankers. They stop the gap between conventional financing (mainly debt) and long term financing (equity and multilateral lending). Additionally, they help the markets generate a price mechanism. In other words, speculators fix prices by taking into consideration all the information, both publicly available and less available. The prices fixed by speculators in themselves constitute important information: corporate warnings, exciting announcements, major crises – the speculators know it all and convey these data to us through the prices that they trade in. Speculators also carry out invaluable arbitrage transactions. They equate the prices of the same good, commodity, or securities in two or more markets by buying (at a rising price) in the cheaper market and selling (at a declining price) in the more expensive one.

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.

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