Vol 2, No 1
10 January 2000
C O R R U P T I O N:
Stealing the Eastern Slovak Steelworks
Michael J Kopanic Jr
During the decade of the 1990s, no one in independent Slovakia grew wealthy as quickly as Alexander RezeÅ¡. Purchasing a controlling share of the Eastern Slovak Ironworks Holding Company (VSÅ½ - VÃ½chodnÃ© slovenskÃ© Å¾eleziarne) at bargain prices, he soon became one of the richest men in post-Communist Slovakia. Protected by his friends in former Prime Minister VladimÃr MeÄiar's government and bankrolled by financial concerns closely tied to the state, in a very short time RezeÅ¡ built a personal fortune unmatched in Slovak history. His case is a prime example of the kind of brazen corruption which has occurred in the post-Communist transition.
Interest in this topic first arose when I was traveling across Slovakia as a tour-group leader during August 1998. Our native Slovak tour leader and the bus driver both expressed a cynicism about politics and the "new order" that was emerging since the fall of Communism. Instead of equal opportunity for all, they said, a small group of influential people was milking Slovakia and its people for all they wrench out of country. The new found fortunes of RezeÅ¡ were offered as a prime example of how those with political muscle and connections could openly flaunt the ideals which the democratic revolution of 1989 had sought to realize. Such examples had led to a certain skepticism about democracy itself. After citing a long list of newfound hardships â including the rising prices of necessities and skyrocketing unemployment - one man commented, "To je vaÅ¡a demokracia!" (This is your democracy!).
Political power had degenerated into a game of "get rich quick" for the chosen few, that is, those who cuddled close to the regime in exchange for favors which redistributed the wealth of the country into their own pockets. This was the perception. Since Vladimir MeÄiar's government was believed to be aiding and abetting such legal parasites, the September 1998 elections "threw the bums out," and a new government under MikulÃ¡Å¡ Dzurinda and his coalition has set out to right the wrongs of the past. So far, it has had limited success and has found that some of its own members are subject to the same shady behind-the-scenes deal-making and favoritism of relatives and friends which they had accused MeÄiar's merry men of committing when they held the reins of power. A skepticism about politicians in general remains widespread among much of the population.
Fairy tale of prosperity
But let us now turn to the origins and causes of the situation which allowed people such as RezeÅ¡ to accumulate a fortune at such a rapid rate that we might compare him to the robber barons of late nineteenth-century America. Confronted with a newfound situation and inadequate laws to deal with the rapid industrialization of America, a few powerful individuals - such as Rockefeller, Carnegie, and Morgan - came to dominate the business of a growing country. Only the powerful influence of the Progressive movement and reform politics enabled the country to arrest the monopolistic practices of corporate America. One might surmise that a similar reform movement with grassroots support must take place in Slovakia. Prime Minister Dzurinda would like people to see him as the man leading the charge to clean up corruption.
It is easy to see why RezeÅ¡ became so rich. He acquired a controlling share of VSÅ½ at a fraction of its real worth. VSÅ½ became an economic powerhouse which vaulted to the top of profitable Slovak companies. In 1997, VSÅ½ recorded a profit of Sk (SlovenskÃ© koruny or Slovak crowns) 600 million, which at the time was worth about USD 20 million. As the largest company in Slovakia, VSÅ½ alone accounted for as much as 8% of the gross national product (GNP) of all of Slovakia. It was the 14th largest Central European company, the second largest employer and the biggest Slovak exporter (14%). According to one source, at one point it produced as much as 16% of Slovakia's industrial production and 26% of its total exports (Roman Frydman et al, Capitalism with a Comrade's Face: Studies in the Postcommunist Transition, Budapest: Central European University Press, 1998, p 60).
During its halcyon days when it appeared to be a paragon of profitability, many praised it as a prime example of the wonders of MeÄiar's brand of privatization and capitalist enterprise. Little did everyone know that the steel behemoth rested on a shaky foundation of questionable loans and shady deals. As an article in The Economist pointed out: "Slovakia has not had much to boast of in recent years, but it may have produced the biggest corporate default in Central Europe since the collapse of Communism" (2 January 1999).
The fairy tale of prosperity began to unravel with the onset of the world economic slowdown in 1998. As world commodity prices for steel fell, the company found it ever harder to service its huge debt. The troubles first reached the public eye when it defaulted on its loan payments. It was revealed that on 9 November 1998, VSÅ½ could not repay a USD 35 million syndicated loan from the American investment banking firm Merrill Lynch.
Slovak newspaper and magazines revealed how RezeÅ¡ had squandered the resources of the company, venturing into businesses that had nothing to do with the steel industry. The most outlandish was his purchase of a Prague soccer team. RezeÅ¡ also used the company to grant generous favors to relatives and friends, including the political treasure chest of MeÄiar's Movement for a Democratic Slovakia (HZDS). He also purchased an expensive villa on the Mediterranean and made frequent trips around the world in his own personal jet.
Since the default became public, VSÅ½ has struggled to pay off its debts and divest itself of unrelated businesses. It plans to return to profitability with more responsible management. The new Slovak government under Prime Minister Dzurinda has taken control of a sizeable portion of the company's assets through its ownership of Slovak state banks - to which VSÅ½ was indebted. RezeÅ¡ himself is under investigation, as the full extent of the corruption is unraveled.
The Velvet Revolution unwinds
Every revolution starts out in a wave of euphoria. The Velvet Revolution which engulfed Czechoslovakia in November 1989 was no exception. As the country shed the vestiges of Soviet-style Communism, democracy and Western standards of living were seen to be just around the corner. Little did the people know that Communist culture would continue to infect the way in which business was carried out well into the future.
Privatization of state-owned businesses started out as an honest attempt to divest the resources of enterprises to its citizens. First administered as coupon distributions to all, it soon degenerated into a vehicle for rewarding friends, political partners, and relatives.
The Czech-Slovak divorce enabled the controversial Slovak Prime Minister VladimÃr MeÄiar to delay the second wave of coupon privatization and tailor it to fit his own plan for rewarding his political allies. He personally played a more direct role in the way properties were sold and even served as minister of privatization and head of the National Property Fund (NPF) in early 1994. His Deputy Prime Minister, JÃºlius Toth, also held posts as both minister of finance and chair of the NPF. The two used their positions to push through a flurry of last minute privatizations before MeÄiar was forced out of office in March 1994. These "midnight privatizations" rewarded MeÄiar 's friends, including his chauffeur - who acquired a meatpacking plant for 5% of its real value. Although the new MoravÄÃk government disallowed more than a dozen of these deals, many remained valid, and RezeÅ¡ had already started building his empire at VSÅ½. The pattern was clear. MeÄiar and his allies used privatization "as a way to concentrate political power instead of a means of economic transformation" (Carol Skalnik Leff, The Czech and Slovak Republics, Boulder, 1997, 196-97).
The Eastern Slovak Ironworks Touted as one of the greatest success stories of privatization in Slovakia, VSÅ½ got off to what appeared to be a stellar start. During its first year as a private company in 1995, VSÅ½ had annual sales of Sk 49.8 billion (USD 1.66 billion). The Slovak business newspaper Trend ranked it as number one among Slovakia's top 100 companies. In 1995 alone, VSÅ½ accounted for 11.6% of Slovakia's total exports and appeared to be an economic behemoth.
Its history went back to the Communist era. The company was intended to serve as a neo-Stalinist paragon of the kind of job-producing heavy industrial giants that the Communists brought to Slovakia. First established in 1960, the enterprise quickly grew into one of the largest employers in Slovakia. By 1964, it was producing its first metal plates. The next year, it was producing iron and by 1966, steel. It incorporated machine production with new technologies such as oxygen converters and continuous casting and in time became one of the largest and most modern metallurgical complexes in Communist Czechoslovakia. (Slovakia and the Slovaks, 161).
When VSÅ½ was first privatized, investment funds and those with investment vouchers held 72% of its stock. VSÅ½ directly managed seven companies and invested in both domestic and foreign companies. In 1992, as a privatized company, VSÅ½ employed 22,963 people and had revenues of over Sk 42 billion, earning a profit of Sk 1.33 billion. By 1995, VSÅ½ boasted annual sales of Sk 49.9 billion (USD 1.66 billion) and sizeable profits of Sk 5.26 billion (USD 175.3 billion).
Privatization of VSÅ½However, although VSÅ½ was privatized, politics continued to interfere with its main business - steel. The company already had too many employees and a sloppy management when MeÄiar sold off a controlling share of the enterprise for one-fifth its real value.
Control of the company lay in the hands of its top managers, most of whom were holdovers from the Communist era. These same managers fostered intensely close ties with MeÄiar's party and government. The leading personalities were Alexander RezeÅ¡ and JÃ¡n Smerek, who served as the company president when RezeÅ¡ held a position in MeÄiar's cabinet.
After the Velvet Revolution, RezeÅ¡ quickly moved up to become vice-president of VSÅ½ and later chairman of its board of directors. RezeÅ¡ acquired a large share of VSÅ½ stock while he worked for VSÅ½. He fostered close ties with then Prime Minister VladimÃr MeÄiar and became a candidate for elections in MeÄiar's party, the Movement for a Democratic Slovakia (HZDS). Using his position at VSÅ½ to help raise funds which bankrolled MeÄiar's election campaign in the fall of 1994, RezeÅ¡ was rewarded with the post of Minister of Transport, Communications and Public Works (Slovakia and the Slovaks: A Concise Encyclopedia, Bratislava, 1994, 431, 726). RezeÅ¡ also worked as MeÄiar's campaign manager during the 1998 parliamentary elections.
JÃ¡n Smerek was chairman of VSÅ½ 's supervisory board until March 1998, when he was moved to the company's executive board. In the fall of 1998, he was a HZDS candidate during the parliamentary elections.
Both men acquired a huge share of the company's stock on account of the National Property Fund's preferential treatment. They were able to purchase shares of VSÅ½ stock at prices which amounted to less than half of their market price at the time of purchase. The shares were purchased on credit that was generously doled out by state-sponsored banks (Miklos, Ivan, "Economic Transition and the Emergence of Clientalist Structures in Slovakia," in Slovakia: Problems of Democratic Consolidation and the Struggle for the Rules of the Game, Bratislava, 1997, p 71).
VSÅ½ also secured easy credit by buying controlling interest in a number of leading Slovak banks. These banks included PriemyslnÃ¡ banka KoÅ¡ice, DopravnÃ¡ banka and PostovÃ¡ banka. The company obtained its controlling share of the last two banks from state-owned businesses operated by the cabinet ministry which RezeÅ¡ headed. VSÅ½ also owned a significant chunk of mid-sized banks such as Istrobanka and PoÄ¾nobanka. Its financial acquisitions continued into 1996, as it bought a 40% share of InvestiÄnÃ¡ rozvojovÃ¡ banka (IRB), which ranked among Slovakia's top three banks. VSÅ½ acquired a huge financial empire in a very short period of time.
In addition to claiming a stake in banking, VSÅ½ also acquired a dominant share of SlovenskÃ¡ poistovÅa (Slovak Insurance), which controlled 78% of all insurance sold in Slovakia in 1995.
One of the biggest mistakes that RezeÅ¡ and company made was to become overly ambitious in their attempt to diversify in areas that had nothing to do with steel. Rather than investing in updating VSÅ½'s aging plant, RezeÅ¡ had the company buying soccer clubs, newspapers, banks and holiday homes in Spain (Financial Times, 26 January 1999). The purchase of the well-regarded newspaper NÃ¡rodnÃ¡ Obroda was seen as an attempt to gain more influence in the media. The acquisition proved to be not only a financial loss but also led to an offer of resignation from the editor, Tatiana RepkovÃ¡, one of Slovakia's most respected journalists. In order to keep her on board, VSÅ½ had to reshuffle the publishing company's board and offer her a new contract with guarantees of editorial independence.
After RezeÅ¡ gained control, VSÅ½ continued to acquire other companies at a rapid pace. This included non-Slovak companies. For instance, VSÅ½ purchased a 20% share of the Czech steel company TÅineckÃ© Å¾eleziarne. It also bought out the debt-ridden Czech soccer club, Sparta Praha, for Sk 1 billion (USD 33 billion).
Leapfrogging legalitiesWhen VSÅ½ could not get its way, its management resorted to leapfrogging legal hurdles. For example, in October 1996, the National Bank of Slovakia (NBS) objected to VSÅ½'s acquisition of a large share of InvestiÄnÃ¡ a rozvojovÃ¡ banka (The Investment and Development Bank) without preliminary approval. According to the Slovak Banking Act, control of more than 15% of any bank required NBS consent. Even though the International Monetary Fund praised the NBS decision, VSÅ½ president JÃ¡n Smerek was determined to go ahead with the deal.
VSÅ½ had decided that IRB would help finance its ambitious expansion plans. IRB was reluctant to grant extensive loans, because it already had many outstanding loans in the energy sector, which would require a government bail out if they went sour. When he encountered resistance, Smerek secured control of the bank through manipulation. In January 1997, IRB's Supervisory Board, which VSÅ½ controlled, removed all but one of IRB's Board of Directors. Of course, persons with ties to VSÅ½ dominated the new board, even though many of them had little experience with banking. Vojtech Vranay, one of RezeÅ¡' relatives, became the new IRB president, and VSÅ½ got its way (Miklos, 72).
The banking sector had not been fully privatized and was lacking capital. It was one of the sectors MeÄiar had labeled as strategic and thus not subject to full privatization. Very little foreign capital was allowed into Slovakia, and there was potential for a banking crisis. This led Moody's financial service to lower Slovakia's credit rating in the summer of 1998. It termed the level of irregular loans in Slovakia as "among the highest among Central European countries, with the trend showing little improvement" (Financial Times, 29 April 1999).
As RezeÅ¡ and his associates heaped company upon company in their hands, they amassed more and more political and economic clout. RezeÅ¡ used his political muscle as cabinet minister to obtain a 13.5 to 20% reduction in transport costs paid to Slovak State Railways. This would annually save VSÅ½ between Sk 850 million and Sk 1.5 billion (USD 28.3 to 50 million). Since the railways had already been losing money, this amounted to government subsidy in order to increase VSÅ½ profits.
By 1998, VSÅ½ under RezeÅ¡ had become a huge holding company with controlling interests in companies and banks across Slovakia and in foreign countries such as the Czech Republic, Hungary, and the Netherlands. RezeÅ¡ maintained control of most decision-making by fostering personal ties with leading loyal managers, whom he generously rewarded with limousines and other perks. He had become one of the most powerful men in Slovakia.
Michael J Kopanic Jr, PhD, 7 January 2000
Editor's Note: Part two of this article will be in next week's issue of CER
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