The principles of good governance continue to face an increasing number of challenges in the region of Southeast Europe. The war in Ukraine has starkly demonstrated how rule of law challenges in the region undermine not only its economic development but also the EU’s unity and resilience vis-à-vis external authoritarian threats. The new EU member states from the region are among the largest net recipients of EU funding. Yet, democratic backsliding and corruption continue to haunt their societies, despite continuing strong public outcry and protests, and the introduction of specific EU and US steps to address these challenges. Such steps included the Cooperation and Verification Mechanism to monitor anti-corruption and judicial reforms in Bulgaria and Romania after their accession in 2007, the much harsher rule of law requirements for Croatia’s accession in 2013, the US sanctions under the Global Magnitsky Act in Bulgaria in 2021, and the triggering of a newly devised penalty processes for freezing EU funds for Hungary in 2022. The Western Balkan countries, which all aspire to join the EU, face even steeper governance challenges. Coupled with the EU’s enlargement fatigue this has resulted in continuously delayed EU accession prospects, rising popular frustration in their societies and recurring undemocratic tendencies. Persistent governance gaps across Southeast Europe, have been further exacerbated by the COVID-19 pandemic and the Kremlin’s war in Ukraine.1 The SEE Good Governance Report aims to provide a deeper understanding of these challenges and pave the way for effective anti-corruption reforms in nine countries – four member states and five aspiring for EU membership – Bulgaria, Croatia, Hungary, Romania, Albania, Bosnia and Herzegovina, North Macedonia, Montenegro, and Serbia. This year’s report focuses on two of the most testing governance vulnerabilities in the region: public procurement and governance of state- owned enterprises in the energy sector.
Public procurement integrity
Public procurement constitutes a substantial portion of GDP in both high- and low-income economies. Across the globe it represents 15% to 30% of GDP. This huge volume of public spending could play a crucial role in economic and social progress if allocated efficiently. However, it is also one of the government activities most vulnerable to corruption.2 According to the United Nations Office on Drugs and Crime, 10% to 25% of a public contract’s overall value may be lost due to shady practices.3 While corruption in public procurement can take many forms, there is a clearly definable set of corrupt techniques that are actively used in Southeast Europe to siphon out public money for private gain.
- Favoritism and Clientelism. One of the most common forms of procurement irregularities in the region is the preferential treatment of companies due to the good political connections of their owners. For example, in Croatia, around a half of the total contract value is won by bidders which are not private entities, but companies partially or fully owned by the state.4 Many private companies across the region whose owners are closely linked with high-ranking politicians are winning public procurements that are almost exclusively created for them. For example, in Hungary during the last 11 years, the ruling party has created a new economic elite whose corporations receive large subsidies in sectors such as tourism.5
- Overpricing of contracts. Overpricing of contracts is another prevailing form of procurement fraud based on favoritism. It involves a broader spectrum of contracting authorities and suppliers. In Hungary, 90% of public procurement projects are overpriced by 25% on average.6 Similarly, in North Macedonia investigative reports have found large differences between market prices and contract prices of some products with identical specifications.7
- Tailored tender specifications. A frequent corruption technique is creating overly specific tender requirements that only fit the qualification and expertise of a specific firm.
- Conflict of interest in the tendering process. Cases of “high-level” conflict of interest were not rare in the past years in Serbia and became even more frequent since the COVID-19 pandemic started.8 In Bulgaria, conflict of interest has materialized in in-house procedures,9 in which budget funds were provided without tendering to a state-owned enterprise. The latter, instead of carrying out all activities in-house as foreseen by the law then sub-contracted private companies, which had been pre- selected in unrelated procedures. Such rogue in-house contracting reached EUR 4.4 billion or over 42% of the value of all government public procurement contracts in 2019 – 2020.10
- High share of non-open procedures. There are a few credible reasons for using closed or restricted procurement procedures, for example if revealing the content of the tender would pose a risk to the national security or if the value of the tender is small enough not to pose significant corruption risks. Nonetheless, SEE contracting authorities often overuse restricted procedures in cases where they would not be necessary.
- Contract modification in the implementation phase. CSOs from the region report the malicious practice of ex-post contract modifications, resulting in a much higher price than the initial expectations. These modifications are hard to track due to limited information on most of the official procurement websites.11
COVID-19 induced changes in public procurement and overuse of urgent procedures
The pandemic increased the number of inherently restricted “urgent” procedures that circumvent the usual procurement legislation. The quantitative assessment of the procurement market shows that it caused an overall decline in public procurement integrity, especially in the most affected – healthcare and other COVID-related product – markets. These issues have been exemplified by the infamous “Respirator Affair” in Bosnia and Herzegovina.12 In Croatia, the list of goods and services for which direct procurement agreements could be used was kept confidential until December 2020. The list was only published due to significant pressure from the general public.13 In Hungary, during the State of Emergency the Prime Minister had the power to decide which procedures were related to the COVID-19 pandemic, and hence could be purchased through direct awards.14
Procurement-related corruption risk in the healthcare sector
The big data analysis for the current report shows that between the first quarter of 2017 and the second quarter of 2021, the COVID market Corruption Risk Index (CRI)15 has increased by around 10 percentage points in Romania and Croatia.16 The increase was temporary and was followed by a slow but steady decline. The big data analysis also reveals that in the last one and a half years the healthcare sectors’ average buyer dependence significantly grew in Hungary, as well as slightly in Croatia, compared to the 2017-2020 period. Moreover, captured contracting authorities have not only provided a higher share, but also a higher value of public funds to their favored suppliers.
Governance of state-owned-enterprises in the energy sector
The energy sector is one of the main systematic governance problems leading to significant losses of public wealth17 and providing inroads for illicit finance and foreign authoritarian influence in the region.18 The energy sector is of crucial importance for Southeast Europe, due to its status as a natural monopoly (often owned by the state), the social sensitivity of the people to price increases (as protests throughout the region during the past decade have demonstrated), and the large investments and financial interests at stake. The State Capture Assessment Diagnostics (SCAD) identifies the sector as highly vulnerable to monopolization.19 The SEE countries have faced multiple allegations for blocking gas market liberalization in favor of local oligarchic corporate networks and for the benefit of Kremlin-controlled gas suppliers. Thus, unless properly governed the sector can undermine SEE countries’ independence and development.
Public accountability deficits in energy state-owned-enterprises (SOEs) are visible in a number of cases, uncovered by investigative media reports, civil society reports or the audits of relevant public authorities across the SEE region. These issues contribute to a socio-political environment where financial mismanagement practices at SOEs are allowed to thrive and inefficient or damaging investment decisions are carried out. The absence of a solid legal framework is a key factor that enables the limited financial transparency and widespread political meddling in the day-to-day management of SOEs.
Key governance risks for the management of the energy sector SOEs
Source: Center for the Study of Democracy, 2022.
The corporate governance regulatory framework is still under development in the region, although some improvements have been made in recent years. The legal framework regulating the management of energy SOEs in the Western Balkans is not compliant with the OECD Guidelines on Corporate Governance of State-Owned Enterprises.20 The EU member-states perform better in terms of applicable laws, however their implementation remains limited and slow.21 Companies in a worse financial shape tend to be less transparent. One way to improve their transparency is for them to go public, which has been the case for Romgaz and Hidroelectrica in Romania. In another positive example, MOL Group, a listed company in Hungary, posts its financial statements and discloses the amount of shares each Board Member holds.22 Financial data transparency remains particularly poor in the Western Balkans.23
Energy SOEs in the nine countries under study show a varying degree of financial vulnerability, revealed by their large debt exposure and high debt ratios, as well as low liquidity and falling current ratios. These financial difficulties have been particularly pronounced in fossil-fuel-based companies
that have struggled to cope with constantly rising CO2, coal and natural gas prices. The efforts of the government to keep energy prices artificially low to avoid a social backlash are at the expense of the financial health and political independence of SOEs, as well as the impartiality of the regulatory authorities. The low quality of financial management is often related to: a) excessive staff size; b) overly generous remuneration; and c) the mismanagement of public procurement. The unfolding energy price crisis in Europe since the second half of 2021, which started with gas shortages and continued with the war in Ukraine, will likely exacerbate vulnerabilities further, despite the windfall profits for some companies.
SEE’s long-standing dependence on fossil fuel imports from Russia, coupled with historical ownership, technological and managerial path dependence and deep (and often very opaque) financial links, has further exacerbated the vulnerability of its state-owned energy sectors. In practice, some of the largest investment projects in the SEE region are the result of intergovernmental agreements with non-EU states, most notably with Russia. The Russia-led TurkStream project24 is a prime example. Affecting directly Bulgaria, Serbia, and Hungary, and indirectly the whole region and Europe, it has benefitted from and contributed to the further weakening of energy policy-making institutions and to the entrenching of oligarchic networks of influence of both Russian and local private interests with close ties to the government. China, while a newcomer, has created its own investment framework in the region, in particular in the Western Balkans, Croatia and Hungary, setting the stage for further tensions in these countries’ further EU integration. Chinese investments, while welcome on cost terms, are often not consistent with EU technical standardisation and/or with the EU acquis on competition and public procurement. They also create, similar to the Kremlin, an erosion of democratic and market standards by their secret and opaque nature. In many cases such projects reinforce national coal industries, ignore environmental regulations, or are not compliant with the overall policy of decarbonisation and sustainable growth.25
Common path dependencies affecting the operation of SOEs
Source: Center for the Study of Democracy, 2022.
Appointment of CEOs and board members
The rules on the appointment of board members and other company leaders in SEE energy SOEs are also unclear, especially when considering potential political influence. There have been numerous examples of political meddling in the appointments of management boards in SEE SOEs and regulatory authorities, which has undermined professional expertise in the planning and execution of difficult decisions in the energy sector. Hence, the business activities of SOEs are often influenced or could even serve the interests of companies or individuals with strong political ties, at the expense of the SOEs’ financial performance.
Governance gaps in the energy sector public procurement
The energy sector shows particularly strong governance deficits in public procurement. Some of these deficits coincide with the general procurement risks discussed above, however some are even more pronounced and/or unique to the sector, due to its size, natural monopoly status, and technical complexity.
Public procurement irregularities observed in the energy sector
Source: Center for the Study of Democracy, 2022.
The way forward
Despite continuous uneven progress, the SEE countries face considerable good governance challenges, which have been compounded by internal and external authoritarian threats. The region stands to continue to benefit from rising substantial financial and technical support from the democratic community of countries within the EU, the European Economic Area (EEA), and the US. How each country uses such support to progress on the path of democratization and anti-corruption depends ultimately on the efforts of its citizens, businesses and governments. The SEE EU countries need to follow closely their commitments under the Rule of Law Mechanism as well as the European Semester and invest accordingly the enormous fiscal stimulus provided by the Recovery and Resilience Facility and the 2021 – 2027 Multiannual Financial Framework. All four EU countries need to overcome governance roadblocks but in particular Bulgaria and Hungary need to work on increasing the effectiveness of the judiciary and de-concentrating power in the executive, respectively. The SEE Western Balkans countries need to work unilaterally to carry out the reforms needed under the EU negotiating chapters even if formally the enlargement process might have been blocked, as in the case of Albania and North Macedonia. Serbia faces particular challenges given its close ties and dependencies to authoritarian regimes.
General good governance challenges often boil down to addressing two interconnected systems in the SEE national economies: public procurement and the management of energy SOEs. Based on the in-depth review provided in the current report, several key policy recommendations could be outlined for these two domains:
- The EU and its partners from the EEA and the US need to continue providing technical assistance in mainstreaming EU public procurement good practices both in the management of EU funds for the region and the governance of national resources. Particular attention needs to be paid to increasing the combined capacity and joint work of anticorruption and public procurement regulatory authorities in the executive, public prosecution and courts.
- SEE governments should be safeguarding public procurement integrity, through strengthened procurement monitoring (such as the Open Tender or SCAD tool), increased institutional efficiency, reduced share of non-open procedures and improved contract awarding mechanisms. The countries from the Western Balkans need to open their procurement data to allow better diagnostics and control, while the EU member-states from SEE need to continue building capacity to identify and tackle red-flags for public procurement corruption.
- National governments should withdraw the Covid-19 emergency procurement rules by reversing to the original procurement legislation. Emergency spending in the future should be accompanied with in-built stronger ex-post monitoring and evaluation of efficiency.
- SEE governments, SOEs and business associations should adopt and apply the best international standards on corporate governance of state-owned enterprises in the energy sector, such as those developed by the OECD. SEE SOEs need to strive to report to similar or higher standards of corporate disclosure than their publicly traded private peers in the EU.
- SEE parliaments and governments need to improve the independence of the national energy and competition regulators by increasing their administrative and financial capacity, and removing political appointments. Shorter mandates of board members should also be introduced. SEE energy regulators need to work closely with their EU peers on establishing a community of practice. Regulators’ decisions need to abide by the highest standards of public disclosure of information.
- SEE governments should refrain from entering into large-scale bilateral energy projects without proper safeguards, which as a minimum could include the involvement of international public financial institutions, such as EIB, EBRD or the World Bank. Such projects need to involve as a rule a system of information disclosure of higher standards than the typically prevailing in the SEE countries. Such system should also be made public in a timely manner, providing information regarding large-scale energy infrastructure projects, including a detailed cost-benefit analysis.
- SEE national governments need to work with the European Commission, EU and EEA member states and the US to introduce better safeguard to their economies from illicit or corrosive funds linked to authoritarian countries. This safeguard should include the introduction of better institutions and regulations regarding investment screening and sanctions monitoring mechanisms.
- SEE governments and their EU/EEA and US partners need to build sustainable interaction models with national and local civil society and investigative media with regards to increasing the monitoring of public procurement and energy SOEs. The R2G4P platform26 experience can inform such efforts at the regional level. There are already existing models of public support for civil society organizations across the region but these are either in their infancy or often invoke fears among CSOs and media about compromising their independence.