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Privatisation: The Right Way

For countries like Pakistan, the privatisation argument is mostlybased on two elements. First, the fiscal argument that governments improve their financial positions by selling public business enterprises. Second, that allocation of capital between alternative investments would improve if governments were not involved in the process. While these are true, privatisation should primarily have an economic reform focus.

By Agha Waqar

[The writer is a former consultant at the Privatisation Commission. This article first appeared in The News on July 29, 2013.]

For countries like Pakistan, the privatisation argument is mostly based on two elements. First, the fiscal argument that governments improve their financial positions by selling public business enterprises. Second, that allocation of capital between alternative investments would improve if governments were not involved in the process. While these are true, privatisation should primarily have an economic reform focus.

In developing economies privatisation sends a strong signal to investors that the government has faith in the private sector. However, without necessary groundwork and sectoral reform, whatever few benefits of privatisation are realised can disappear very quickly.

The present government’s decision to revitalise, restructure and privatise at least some major state-owned enterprises (SOEs) responsible for financial loss of about Rs500 billion is a step in the right direction. It is, however, important to conduct a reality check before we press on with the privatisation agenda. Pakistan’s privatisation programme stands stalled; not a single transaction has been completed in the past six to seven years.

The Privatisation Commission’s capacity to undertake major transaction has suffered since most of the experts have moved on. The board of directors also remains to be reconstituted ensuring that no conflict of interests occurs. We are at a stage where most smaller units and entities have already been put under the hammer, leaving us with complex major transactions ie electric and gas utilities, banks, insurance companies, PIA, the Railways, Utility Stores, airports, pension funds, Pakistan Post, PTDC, PMDC, NPCC, etc.

For the privatisation process to be revitalised, initiatives outside the ministry also need to be undertaken simultaneously. Regulators, Nepra, Ogra need to chalk out how best to safeguard the interests of the masses in a post-privatisation scenario. New regulators need to be established in sectors where there are none. Competition and dispute resolution laws need to be streamlined, the security situation needs to improve, and the cost of doing business needs to go down.

While realising that a given privatisation transaction’s success is largely based on the momentum with which it is carried out, it is important to make a distinction between privatisation transactions and a privatisation programme. The privatisation programme should first be allowed to achieve the required momentum by pursuing other reform initiatives and building a general sense of complete transparency.

The way forward for privatisation is to restart the process with realistic ambitions. For this it is imperative to first announce that the government is committed to deregulation, privatisation and liberalisation as important pillars of its economic reform agenda.
Second, all systemic distortions and anomalies need to be removed and finally those transactions need to be pursued first that do not create transparency issues i.e. capital market transactions.

The privatisation process will not only gather momentum but also win the confidence of the masses, which is the single most important factor in the success of any privatisation initiative. It is important to note that private investors decide independently whether they want to buy shares. If they believe the government will abandon privatisation in the face of political opposition or expediency, they will be less willing to invest, and there will be a `low equilibrium’ level of privatisations.

The government can improve its reputation with investors more quickly by selling only a fraction of the shares in the first phase. Where perceived political risk is large, the government may also signal its commitment by pricing the initial sale on discount.

Therefore, progress should be one step at a time. In the first phase it is advisable to pursue capital market transactions (public offering) of 5-10 percent shares of certain institutions. These could be finalised in six to eight months. The benefit of these transactions would be that the Pakistan will reappear on investors’ radars.

Concurrently, other reforms to bring the economy back on track need to be undertaken. Pakistan sovereign credit ratings need to recover by stabilisation of current account, foreign exchange reserves and political outlook. Once improved we should be able to pursue more complex transactions of equity-linked instruments like convertible bonds/exchangeable bonds and GDRs for which PIA, OGDC, PPL, Kapco etc would be prime candidates.

However, detailed and well-thought-out business plans need to be spelt out upfront. For this to happen, the respective boards of directors need to be reconstituted. The representation of the Privatisation Commission on the boards as envisaged under PC Ordinance 2000 remains essential. All this should take 8-12 months (Phase 2).

In Phase 3 (work on which should start simultaneously with other two phases) we should look at strategic sales of big ticket items like the NBP, PIA, the Railways, the Steel Mills, airports, bridges, etc. However, before attempting these we need to streamline institutional arrangements, remove hitches from the system, modify the law, build capacity and remove systemic distortions from the capital and financial markets.

It has often has been observed that various government departments operate in relative isolation and are oblivious of conflicting agenda pursued by some other department. This results in redundancies, confusion, etc. The reform agenda should be well coordinated among various federal ministries as well as provincial governments. The Cabinet Committee on Privatisation and the Council of Common Interest can play an important role in this effort.

It is important to note that the political leadership of the privatisation ministry will be responsible for pushing the reform agenda within the government. This usually forms a major stumbling block. Officials of various affected ministries do not cherish their kingdoms being reduced and, therefore, become a hindrance to the privatisation programme. This can be countered by the relentless support of the head of the government.

The PC Ordinance 2000 stipulates that 90 percent of privatisation proceeds will be used for debt retirement and 10 percent for poverty alleviation. The problem with the current utilisation arrangement is that it cannot be determined how much debt has been retired and how much has been spent on poverty alleviation. What this does is allow governments to replace their budgetary allocations under these heads with privatisation proceeds (creating fiscal space).

On the practical side this motive generates enormous pressure on the Privatisation Commission to materialise maximum transactions within a given fiscal year so that budget deficit can be funded. This also gets linked to multilateral and DFIs loans as covenants. Consequently the real reform initiative is quickly replaced by a quest to plug budget deficits. The utilisation of privatisation funds may be considered reinvestment in pension fund for general public mandated to provide pension to all citizens (without access to safety net) past the age of superannuation.

It may be prudent to understand that privatisation is not a quick fix, no economic initiative is. It is here that most regimes falter; they try to bulldoze privatisation without the necessary groundwork, failing to realise that privatisation is actually an exercise in correcting the very fundamentals of the economy.

Privatisation is pursued as a means to fill the budgetary deficit. It is in such instances that the argument of “selling the family silver” gains strength. [Courtesy The News]