(Contract between Hyundai and the Slovak Government)
On 4 March 2004, the Government of the Slovak Republic approved the Draft Investment Contract regarding the proposed construction of a car assembly plant near Žilina between KIA Motors Corporation, the Slovak Republic and the City of Žilina as well as the Investment Contract on the proposed construction of a car spare-parts and modules manufacturing plant near Žilina between Hyundai Mobis, the Slovak Republic and the City of Žilina. Following the conclusion of the investment contracts on 5 March 2004, in mid March the Government approved the Memorandum of Understanding between the Government and Hyundai/Kia Automotive Group, signed by the Prime Minister and the President of Hyundai Kia Automotive Group. The document expresses both parties' desires to implement and fulfil the provisions of both investment contracts.
The Investment Contracts has set legal obligations and duties, according to which both Korean companies, Kia and Mobis, will build a car manufacturing plant and a plant for spare parts for Kia.
Furthermore, the Slovak Republic and the City of Žilina have undertaken to render necessary assistance and support to both companies, exert adequate effort so that all required permissions are granted, and endeavour to ensure generally favourable development of the business environment with a positive impact on the whole area of car and spare-parts manufacturing.
The new car manufacturing plant will be built approximately 10km from Žilina on the area of 166 hectares. The structures should be finished in late 2005 and in 2006. When the plant launches production, Kia is expected to directly employ 2811 people. The annual production of three different models is forecasted at 300,000 cars a year. The total investment of Kia is set at Euro 1.15bn (Sk 46.5bn). Of this amount, the car manufacturer, Kia Motors, will expend Euro 900m (instead of initially intended Euro 700m) and the supplier of spare parts, Hyundai Mobis, Euro 250m (instead of initially intended 190m). The concern plans to finance a half of the investment from its own resources, the remainder will probably be obtained from a European loan. Within the state support, Kia will not be granted any tax holidays as the support will rather be directed to the construction of the plant itself. Total public expenditures associated with this investment project will reach Sk 8.83bn. Of this amount, direct financial assistance should reach Sk 6.93bn. These funds will be used for the acquisition of freehold, procurement of fixed assets and allowance for the education of future plant employees. The proposed amount of the subsidy is consistent with the EU rules that stipulate that a state may offer an investor assistance totalling to maximum 15%
of the total volume of investment (in this case Sk 6.975bn). The remaining tranche of the state support of Sk 1.9bn will be spent for the roads and infrastructure in the region.
Of the total state subsidy, Sk 2bn will be necessary as early as in 2004. After deducting tax effects, in the opinion of Ivan Mikloš, the Minister of Finance, this year it will be necessary to allocate Sk 1.5bn to 1.6bn to the project from the state budget. The Minister of Finance planned to get the money from the budgets of other ministries as the Members of Parliament, when voting on the budget, reduced the 2004 state reserve to Sk 260m. The exact state subsidy financing plan was to be approved by the Ministers in April. However, some members of the Cabinet disagreed with financing the subsidy from individual ministries' budgets, which was the most likely solution, because some anticipated projects will have to be cancelled and some ministries' budgets will be cut down. The Deputy Prime Minister of the Slovak Republic for the European Integration, Pál Csáky, expressed a contrary opinion to the cuts in the ministries' budget, particularly raising the issue that money allocated to healthcare, education and labour that had already been quite tight.
The Minister of Finance acknowledged that during the year some of the funds from the ministries' budget will possibly be returned and if the state revenues show favourable development, the ministries will be allowed to expend the full funds budgeted. The Minister of Economy admitted that one of the possible solutions to financing Slovakia's obligations associated with the project would also be the increase of the fiscal deficit by 0.1% of the GDP (Sk 1.3bn).
Besides the investment incentives associated with the construction of the industrial complex, the Government has undertaken to build a motorway to Žilina. The car manufacturer's representatives were given a promise that the motorway will be completed by November 2006 (The Korean party initially requested October 2006 and the Government the end of the year). The finalisation of the 42-kilometre-long motorway section from Ladce to Žilina will, in the opinion of the Ministry of Transport, Post and Telecommunications, consume approximately Sk 22bn. There are three alternatives of financing: first, from the state budget; second, a bank loan with a state guarantee that will be taken by the construction company Doprastav; and finally, it could be financed from private funds, pursued by the Minister of Transport, Pavol Prokopovič. The most likely alternative however is a combination of all three options. The major hindrance to finishing the motorway on time is the terrain with a large number of bridges and difficult parts as well as buying freehold.
According to the projects of the Slovak Road Administration, the motorway was originally planned to be put into operation no sooner than 2009 and it is presently not certain that it will be possible to meet the earlier deadline. As a part of the "indirect support" to the car manufacturer, Slovakia will also complete a railway terminal and modernise an airport in Dolný Hričov. Support was also offered by the City of Žilina, which decided, in order to respond to the needs of the car manufacturer, to build 1,000 to 2,000 flats, provide a policlinic, provide premises for training, support educational opportunities in the English language and ensure public transport.
As regards the land where the plant is to be built, it is necessary to buy 7,000 plots owned by 12,000 people, of whom all have been identified. To get the land ready for Kia Motors and Hyundai Mobis, the Ministry of Economy (MH) has established the companies Gov Invest I and Gov Invest II. Based on a Mandate, the purchase of freehold is also carried out by Žilina Invest. The freehold acquired and ready will then be purchased by the Korean company for a symbolic Sk 1. The price per square meter, initially estimated at Sk 95, has been much criticised by freehold owners, who thought it was much too low and requested minimum Sk 350. The freehold owners have therefore decided to submit a petition claiming that the land price in Teplička nad Váhom is at least Sk 360 per square meter (an estimate of an official appraiser). The dissatisfied citizens argue that the price of the best land may even be at Sk 500 to Sk 700 per square meter. The Minister of Finance has pointed out that the more money is used for purchasing freehold, the less there will remain for other purposes (fixed assets, allowance for future employees' education, etc.). The company buying the land, finding itself in the situation where there was too much information about various prices of freehold, approached the Authorised Institute of Engineering in Žilina and asked for assistance in dealing with the situation by approaching official appraisers who will later elaborate final opinions, by informing them of the rough price span from Sk 103 to Sk 126 per square meter of freehold in the given area. The Minister of Economy, Pavol Rusko, as well as the Mayor of Žilina, Ján Slota, threatened that the land will be dispossessed should the owners do not agree with the proposed prices.
The car manufacturer in Žilina is expected to decrease the unemployment in the regions, currently reaching 27,480 people. In three years, the plant plans to directly create 2,811 jobs, while other jobs will depend on suppliers' plants and their location across Slovakia. Slovakia's rivals in this respect are Poland and the Czech Republic. The experience of Volkswagen (VW) in Bratislava shows that suppliers in the vicinity of the plant will create up to twice as many jobs than the plant itself. It is likely that along with the car manufacturer, seven to ten direct suppliers will build their plants in a park located 60 to 100 kilometres far from Žilina. The volume of this additional investment has been estimated by the SARIO agency at roughly Sk 2bn to Sk 3bn. The President of the car manufacturer said that eight other firms that will supply the car-making plant will invest about Sk 10bn (USD 300m).
Based on the experience with VW, the economists think another indirect effect associated with the car manufacturer will be the rise of wages, which are likely to achieve the average level in the region and hence to increase the inhabitants' purchasing power. On the other hand, the economists point out that one of the main reasons why the Korean car manufacturer chose Slovakia was cheap workforce. Contrary to Bratislava with a relatively high price of labour, it is, in their opinion, unrealistic to expect a similar rise in average wages in Žilina.
The Minister of Finance has also highlighted the effect of higher growth of the economy and the living standard. After the launch of the production, the country's economic growth should increase by 1% of the GDP. Economic benefits of the plant for the Slovak economy were assessed by the MH using the so-called effect number method. By 2010 the benefits will amount to Sk 9.224bn and hence the state support will be returned within four years after the commencement of the production.
Attracting another major investor in Slovakia did not receive only a warm welcome (see also the investment made by PSA Peugeot Citroën in Trnava – page 40 and HESO 3/2003). Some experts point at high costs that will be covered from public resources. They do not regard a state support to investment as the best approach to boosting the economy. As the critics argue, savings of up to billions of korunas, if there were no subsidies to large investors, could help decrease corporation tax rates and hence, in the future, investors would be lured by a quality business environment
rather then by selective advantages. It is also necessary to take into consideration the alternative development of the regions affected, where similar investment will suppress other entrepreneurial activities. A large investment changes the economic structures of regions affected, which become cyclically dependant on a particular industry. Immediately after the approval of the arrival of a new strategic investor in Slovakia, the questions regarding stimuli to and transparency of such an investment were posed. They mainly concern the maximum limit, beyond which supporting investors is no longer worthwhile. Critics also pointed at the unwillingness to publicise agreements with investors, which they deem inappropriate as state subsidies are paid from a public pocket.
The Minister of Economy said that the use of public money for the state support to this investment will be released so that it can be under public scrutiny. Business secrets however will remain protected as their publication could help competitors.
The Korean manufacturer will build its first plant in Europe in Slovakia. Its whole production will be aimed at the European market, where last year, with 150,000 cars sold, Kia's sales rose by 40%.
One of the drivers to move the assembly plant to Europe was the attempt to avoid a 10% customs duty on exports to the EU. The initial impulse however was the rising sales and market share on the Continent. The company is the fastest growing brand in Europe and one of the fastest growing brands around the globe.
Initially, apart from Slovakia there were two other countries competing to attract the investor, of which, after the Czech Republic lost the game, remained only Poland and Slovakia. The decision to invest in Slovakia was taken in early March after the Korean company analysed the terms and conditions offered by each of the countries. The Prime Minister, Mikuláš Dzurinda, said that Kia's decision for Slovakia was primarily affected by the reforms in taxes, social policy, healthcare and the quality of the workforce. The car manufacturers' top representative said that the decisive factor was the cheap and qualified workforce. Additionally, an important role in the decision-making process was also played by the fact that the Slovaks are less prone to strikes.
Rough estimates show that after both car manufacturers - PSA Peugeot Citroën in Trnava and Hyundai/Kia in Žilina - commence production, Slovakia will produce about 1.2 million passenger cars a year. In absolute figures, Slovakia will become the tenth largest producer in the world and the leading car manufacturer per capita.
Evaluation of the Experts’ Committee:
The investment incentives provided by the Slovak Government were, without any doubts, one of the main reasons why Slovakia won another major foreign investment in the automotive industry.
The arrival of Kia to Slovakia was regarded by the Experts' Committee to be a great success. It is good PR and an excellent signal to abroad communicating the attractiveness of the Slovak investment environment. The extensive investment will be beneficial for the whole Slovak economy and create new jobs in the region with quite a high unemployment rate. After the commencement of production, the positive effects arising from the bigger economy's output will multiply. In the opinion of one respondent, by attracting this extensive investment, the Slovak economy's position changes in that it will no longer be necessary to attract major foreign investment at any cost, as was the case of Hyundai/Kia Motors.
Several experts emphasised that the state will recover the money invested in a relatively short period of time after the plant commences production in the form of increased tax revenues, lower expenditure on the unemployed and overall development of the region. The state support was also partly defended by the fact that all Central European Countries offer similar incentives to attract foreign investors. Some experts criticised the amount of the state support that seemed exaggerated to them. They commented on this fact by saying that "we are more catholic than the Pope". As was the case of all other selective incentives, it would be appropriate to provide a better-founded reasoning and the cost/benefits analysis of means expended compared to its alternative use. The provision of the state support will, in the short term, narrow the space for decreasing taxes. One respondent however believes that the argument that the taxes could have been cut by the amount of the support, which would create space for spontaneous inflow of investment, is naïve. Arguments can also arise regarding the costs for the accelerated construction of the motorway as well as its financing.
The main problem, as critics see it, is rooted in selective support to large foreign investors, which is unsustainable in the long run. This gives rise to a negative precedent that Slovakia will support some private businesses more than the others and, furthermore, it will be paid by taxpayers. A more systemic support would be to create generally favourable conditions for investment and making business, which would improve the whole business environment, e.g., the elimination of corruption and barriers hindering business development, the decrease of taxes and other contributions, ensuring law enforceability, etc. It is always risky when a state, acting from a position of strength, gets to the forefront of entrepreneurial activities, as it deforms the market.
For example, we may point at the dispossession of the freehold for the plant.
An important aspect regarding investment incentives is the transparency of the use of public finances. It is therefore necessary to publicise the whole agreement.
Some respondents think it is doubtful which resources should be used as the harvest will mostly be reaped in one region. They said that this kind of a state support should not be to the detriment of the Central and East Slovakia's regions which struggle with a high unemployment rate.