Heading For The Exits In Prague

Shady dealings have foreigners fleeing the stock market

When Prime Minister Vaclav Klaus wanted to privatize the Czech Republic's state-owned companies back in 1992, he hit on a novel solution. Klaus gave vouchers to Czech citizens, let them use the scrip to bid for corporate shares, and set up an exchange where they could be traded. Once stock trading got going, he figured foreign investors would pile in--and they did. But five years later, the foreigners are getting fed up.

Disappointed that new securities laws are not being enforced and that the government still has not set up an independent market regulator, a growing number of money managers from London, Zurich, and New York are pulling out. "People are saying, `Right, I've had enough,"' says Vladimir Jaros, market analyst with Wood & Co., a Prague broker.

HUNGARY'S GAIN. The foreign exodus is turning the Prague market into the laggard of the region's major markets (chart). Trading volumes have sharply declined, and the Prague index is up only 21%, in dollars, since the start of last year, against 87% for Warsaw and 137% in Budapest. Analysts estimate that up to $500 million has fled Prague in recent months. Indeed, Arpad Pongracz of Zurich-based Vontobel Asset Management has dropped his Czech holdings to 5.6% of his portfolio, from 21% a year ago. He dumped a cross-section of industrial companies, hanging on to a few blue chips, such as SPT Telecom, and shifted more cash into Hungary. "It made no financial sense to stick around," he says.

On paper, at least, the Czechs are offering investors a square deal. The government passed sweeping laws last July regulating the stock market. Among other things, they require investors to report large stakes and that anyone buying 51% of a company offer to buy out the remaining 49% at the average price of the previous six months.

Meanwhile, Prague Stock Exchange chief Tomas Jezek has introduced ethical standards that bar brokers from drawing money out of clients' accounts without their approval and that forbid them from trading ahead of their clients. But the local crowd is laughing at attempts to rein in the market. The new rules are easy to evade. And the Czech Republic still is swarming with shadowy investments, hidden corporate debt, secret side deals, and cozy relationships among banks and industries.

FAMILIAR FACES. For example, Chemapol, a large holding company, and Vojenske Stavby, a construction firm, own stakes in Investicini a Postovni Banka, a major lender. Representatives of both companies sit on the bank's board. The bank, in turn, is a shareholder in Chemapol and Vojenske Stavby. Such close ties have brought some banks to ruin. At the end of 1996, many large investment funds began moving money into smaller banks, to be funneled in turn into illiquid investments and risky loans. This resulted in several banks failing. As a result, the Finance Ministry in December seized two investment funds for unethical trading and threatened to yank the licenses of 20 others.


Despite the moves, Klaus still leans toward laissez-faire management of the market. But critics say Klaus does not seem to understand the importance of a transparent capital market in attracting cash from abroad. Without foreign investors, the country will be hard-pressed to find takers for new bond and stock issues. And the Czechs also need all the foreign cash they can get to balance a drop in exports caused by the strong crown. "The balance is very fragile," says Vontobel's Pongracz.

Indeed, the yearend bank failures and fund seizures may be an indication that governing the stock market with a nudge and a wink may no longer be acceptable to the big-bucks investors the Czechs still need. True, the Prague stock market has jumped 11% in recent weeks. But analysts say this was caused more by local fund managers churning their portfolios than by any new influx of foreign investment. And once the boomlet wanes, the same old questions about Prague's investor-unfriendly ways will linger on.

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