Privatization: Cure or Disaster for Pakistan?


The following is the original draft of the article published in the renowned “Blue Chip” journal as an Op-Ed  in its April – June 2016 Edition.

Privatization: Cure or Disaster for Pakistan?

Prof Dp

By: Omer Zaheer Meer

Preamble:

Privatization of public enterprises and organizations is one of the hotly debated and contentious economic issues facing Pakistan today. While some term it as a solution to Pakistan’s economic woes, others simply paint it as an attempt to sell national assets for peanuts. The reality perhaps lies somewhere in between. Public enterprises are those that are owned by governments and thereby the public at large. They include government owned/controlled corporations.

Privatization is a somewhat controversial phenomenon in Pakistan. It is commonly defined as the transfer of ownership of state owned assets from a government to a non-state entity. It is also described as the transition from a publicly traded and owned company to a company which is privately owned and no longer trades on a stock exchange publicly. However our focus is on the privatization of state owned enterprises.

Privatization Commission:

The incumbent government in Pakistan had constituted a privatization commission to administer the privatization efforts. The commission has shortlisted 31 institutions to “sell” atleast “partially” but with a transfer of control and management including the likes of PIA which resulted in quite a storm of protests lately.

Pro-privatization:

On the face of it, some of the arguments of the proponents of privatization appear to be sound and make sense. Privatization is put forward as a solution to the economic challenges faced by the government of Pakistan by some economists backed by the likes of International Monetary Fund (IMF) and World Bank (WB).

  • It’s pointed out that a government’s primary function is to run the state affairs and it should focus on facilitating the businesses by creating a favorable environment instead of running businesses itself.
  • The strongest argument put forward by the supporters of privatization is that “white elephants” in the shape of loss generating public sector enterprises (PSE) are actually costing the national exchequer billions of Rupees annually which can and must be saved and instead spent on public welfare.
  • Another strong argument for the advocates of privatization of publicly owned entities is the supposed increase in efficiencies resulting from private ownership driven by a focus on profit maximization.

World Bank’s checklist for successful Privatization:

Some of the vital requirements for successful privatization as per none other than the World Bank itself are outlined below. One can judge how almost all of them are lacking in the case of Pakistan, hence the case of past disasters giving a lesson to look elsewhere for solutions. The relevant extract with seven points is shared below:

  1. Privatization works best when it’s part of a larger program of reforms promoting efficiency. New Zealand, the U.K., Mexico, and Chile are all successful privatizers. Their privatizations were accompanied by reforms to open markets, remove price and exchange rate distortions, and encourage the development of the private sector through free entry. Revenue maximization should not be the primary goal of privatization. Far better to eliminate monopoly power and unleash potentially competitive activities than to boost the sales price by divesting into protected markets. Also it is far better to create regulations to protect consumer welfare than to maximize price by selling into an unregulated market.
  2. Regulation is critical to the successful privatization of monopolies. In the sale of Chile Telecom, everybody won–consumers, labor, government, buyers–and the productive efficiency of the company increased as a result of a well-developed, well-administered regulatory framework.
  3. Countries can benefit from privatizing management without privatizing the ownership of assets. Management contracts, leases, and concessions have been successfully used the world over, particularly in sectors where it is difficult to attract private investors. In Côte d’Ivoire, the leased water company improved technical efficiency, increased new connections, became more efficient in billing and collection of receivables –and reduced the number of expatriate employees by 70%. But because a change in ownership is usually needed to lock in performance gains, private management arrangements are likely to work best when they are a step toward full privatization.
  4. The sale of large enterprises requires considerable preparation. Successful privatizations of large enterprises have entailed breaking them into competitive and marketable units (in East Germany, Argentina, and Mexico), bringing in dynamic private sector managers (in many telecom and airline sales around the world), settling past liabilities, and shedding excess labor (in steel and railways in Argentina). Successful privatizing governments also assiduously avoided large new investments for plant modernization and equipment, since getting the private sector to finance and manage these investments was itself a major reason for privatization.
  5. Transparency is critical for economic and political success. Mexico and the Philippines made the sale of enterprises transparent by adopting competitive bidding procedures, developing objective criteria for selecting bids, and creating a clear focal point with minimal bureaucracy to monitor the overall program. A lack of transparency can result in political backlash, as in the early days of privatization in Poland, or even bring the process to a halt, as in Guinea.
  6. Governments must pay special attention to developing a social safety net. In Tunisia, generous severance packages encouraged voluntary departures and reduced the need for outright dismissals. In many countries–most recently in Eastern Europe and Central Asia–employee ownership schemes, unemployment benefits, and retraining-redeployment programs are being developed to ease the social costs of privatization.
  7. In changing the public-private mix in any type of economy, privatization will sometimes be less important than the emergence of new private business. Countries can freeze or restrain the expansion of public enterprises and encourage the growth of a dynamic private sector through free entry, as happened in Korea and appears to be happening in China.

Privatization issues in Pak:

However once we start to dig deeper the situation is not as simple as it may appear at first, more so in Pakistan’s context. First of all a successful privatization exercise has some pre-requisites like those listed above including a conducive environment with investors’ confidence, a strong government able to enforce the agreements, proper selection of non-vital PSE’s and a fair process carried out in a transparent manner. Sans this, privatization cannot turn-around the state of PSE’s or the economy. Pakistan’s past experiences are a testament to this.

Once again the incumbent government is focused on privatization but unfortunately is ignoring the vital pre-requisites. The faulty selection of profitable and strategically vital entities, the extreme haste in the proceedings, missing policy guidelines, a lack of clarity and transparency in processes, non-conducive investment atmosphere and a less-than-desirable track record all warrants caution in examining the proposed solution of privatization.

Amidst the noise of overhauling loss-leaders, several profitable institutions are also earmarked for privatization, which besides funneling billions to the treasury are also providing products/services at cheaper rates to the public as compared to the private sector in the international market.

  • One such example is the Oil and Gas Development Company Limited (OGDCL) which generated a profit of billions of Rupees in last few years while providing the gas at heavily reduced prices as compared to those offered by the private sector in international market.

 

  • Another example is Pakistan State Oil (PSO) generating an after-tax net profit of approximately PKR 21,818,000,000 in the year 2014, a 72.36% increase from the previous financial year. Recently in 2015, it posted after-tax net profit of PKR 6,936,000,000 despite slump in petroleum prices and margins globally.

Privatizing such institutions would not only lead to loss of billions to the exchequer but also an increase in the comparatively cheaper prices currently offered to the masses.

Past Privatization Experiences:

Moreover, while all the pro-privatization arguments have their merits and some may even sound convincing theoretically, one needs to consider the local context to appraise the potential outcomes.

Past experiences can always serve as good benchmark to begin with when deriving objective conclusions. Unfortunately for the proponents of privatization in Pakistan, the above mentioned pro-privatization arguments do not seem to hold merit in the case of Pakistan, based on past experiences of privatized entities. A brief discussion of some key examples below will help us elaborate this observation.

 

 

PTCL:

A case in point is the handing over of PTCL control to Etisalat by the Musharraf regime in which a minority shareholder effectively got all of PTCL for a paltry sum to be paid in installments still partially outstanding.

  • What is iconic is the fact that Etisalat itself is a PSE of UAE. This means that while as per the proponents of privatization “state cannot run vital services”, however it is believed that a foreign state owned enterprise can come to Pakistan and do the same. This nullifies one of the strongest pro-privatization arguments.

 

  • As for the privatization of PTCL, the control was transferred for a paltry stake of 26%.

 

  • And just to analyze how effectively has this privatization venture gone we should realize that the same PTCL which was generating profits of billions of PKR started reporting heavy losses despite increased tariffs and with a falling standard of customer service often complained about. Just recently, PTCL has started reporting some profits.

 

  • Moreover, the initial investment was allowed to be made in installments with a material amount ($ 800 million) still outstanding.

 

  • This is in effect tantamount to allowing a foreign Government owned entity to buy a state asset of Pakistan for peanuts, make heavy funds transfer to its’ home country, not bother to invest in infrastructure and service quality as required and not even pay the agreed upon sum.

This can be labeled as a one-off badly executed privatization transaction as claimed by proponents of privatization including the honorable Mr. Zubair Umar, Chairman of Privatization Commission. So let us briefly touch upon couple of other privatization experiments in Pakistan.

KESC:

The now infamously inept KESC was also privatized with high hopes of a turnaround with substantial investments forecasted by the new private stakeholders in decaying infrastructure.

  • Unfortunately none of the expectations have been met and instead it has become a much bigger white elephant requiring continuous rescue by the government while the new private owners continue to remit their profits abroad.

 

  • The efficiency has gone down. Their failure to even invest in the necessary infrastructure and maintenance has lead to undue load-shedding over and above that necessitated by load-management.

 

  • Infact, rather than investing in the infrastructure, the news within the business community is that the private party has sold the premium copper wires replacing them with cheap stuff resulting in increased line losses and breakdowns.

Unfortunately this disastrous privatization has also become a bigger strain on public resources then before privatization, still requiring continuous rescue injections by the government. The new private owners however continue to happily remit their profits abroad.

MCB:

If the above still did not convince you, then to put things in perspective let us also recall the privatization of MCB to Mian Mansha led Nishat Group, undoubtedly amongst the strongest business conglomerates in Pakistan.

The deal was done at a fraction of the fair value of the tangible assets of MCB let alone considering the value of the brand and goodwill. Obviously such moves do not boost confidence particularly when the same group’s head attends important government policy meetings, finance the largest party of the country sitting in government and is said to be interested in getting “good” deals on more national assets at the expense of the nation.

Some of these notions can be avoided by ensuring proper mechanisms in place with transparency that masses can see and put their faith in.

Pressure from lending “partners”:

It is therefore interesting to observe that most of the countries in IMF and World Bank lending programs initiate destitution programs even when it is not conducive to the economic excellence due to lack of necessary requisites including strong regulatory monitors. Pakistan’s policy makers unfortunately seem to be treading a similar path.

The common knowledge within economic circles is that the pressure emanating from the terms of the IMF package accepted by Pakistan is the prime reason behind the hasty privatization attempts. This undue urgency leading to lack of planning should be avoided.

The government needs to ensure it is not selling off profitable and strategically vital PSE’s in the name of privatization for short-sighted capital injections at the cost of long-term stability and revenues. Furthermore institutions providing vital services to the masses should not be on the wish-list of the potential sell-offs either.

Privatization’s not a blanket solution:

Continuing further, it would be interesting for the proponents of privatization to read the following extract from a World Bank report on privatization:

“Most privatization success stories come from high-income and middle-income countries. Privatization is easier to launch and more likely to produce positive results when the company operates in a competitive market, and when the country has a market-friendly policy environment and a good capacity to regulate. The poorer the country, the longer the odds against privatization producing its anticipated benefits, and the more difficult the process of preparing the terrain for sale ……………………………. 

Privatization is not a blanket solution for the problems of poorly performing SOEs. It cannot in and of itself make up totally for lack of competition, for weak capital markets, or for the absence of an appropriate regulatory framework.”

Ground Realities:

One need to realize that the ground realities of Pakistan are very different from the dynamics of some developed markets where privatization has been more successful. In all the above discussed privatization episodes in Pakistan, not only has the government of Pakistan lost revenues from healthier dividends and resulting taxes, it has also lost by falling share prices of its remaining stake in these entities. The public has suffered a deteriorating service and higher prices.

Moreover the economic detractors of privatization argue that the vital services needs to be efficiently provided by the state in addition to the fact that privatization does not have a very bright history in third world countries. The question then is as to what could be an effective solution to deal with the loss-leading white elephants within the realms of the public sector?

Also, unfortunately the past experiences of privatization in Pakistan does not support the leading argument for privatization advocates that since the private sector is driven by profit, the efficiency and performance of institutions is supposed to improve in private hands. As discussed before, be it PTCL or KESC, not only did their profits but also the standard of their services too nose dived in private hands. It maybe that the private owners mint personal profits but that seems to be sans the necessary investments and benefits expected from the destitution program.

 

Challenges:

The interesting challenge in this regard is as to why the government cannot possibly introduce effective checks and balances along with incentives to ensure a turnaround they expect from private entities.

Moreover, in developed countries strict legislation has been introduced to ensure avoidance of the common pitfalls of privatization, protecting the interests of all shareholders and safeguarding the continuation of service(s). Same needs to be done in Pakistan to address the issues already facing us from past privatization ventures which effectively handed over whole PSE’s for a paltry minority stake in ownership.

Plan of Action:

Going forward, a proper plan of action is needed for loss generating entities like PIA, Pakistan Railways, e.t.c. With a proper plan and political will there is no reason why the government cannot introduce checks and balances along with necessary incentives to induce a turnaround they expect from private investors.

While some proponents of the privatization point out the previously failed attempts at turning-around of state institutions, they conveniently ignore that the major reasons of failure were undue interference, political appointments and misappropriation by government officials which can all be avoided.

Successful Turnaround:

The success stories like the successful turnaround of a loss-making steel mill into a profitable enterprise are also conveniently forgotten. The same institution is again in ruins but can revert to its’ past standards.

The privatization proponents also choose to set aside the fact that if enterprises like PIA are privatized, which have the highest ratio of employees per aircraft of almost 500 compared to international standards of fewer than 150; it will still lead to layoffs and resulting backlash which can be better handled within the realms of a public sector restructuring.

Moreover, the core problem for PIA is the heavy debt financing costs which is crippling it financially. This was discussed in details in a previous research article by this writer on these pages earlier.

New Age Phenomenon:

  • With regards to the privatization debate, there has been an interesting economic phenomenon in the making for the past few decades with public sector enterprises turning towards efficiency based corporate models while still ensuring the provision of cost-effective services/products to the local populace.

 

  • They then expand into foreign territories and use their capital bases to derive profits which are funneled to grow the organization and subsidize the local population. A case in point is Etisalat, a public sector enterprise from UAE currently controlling a privatized public sector enterprise PTCL in Pakistan.

 

  • This is phenomenal as it nullifies all the arguments of pro-privatization proponents in Pakistani context as a foreign public sector enterprise is now controlling the major section of telecommunications services in Pakistan.

Restructuring, not Privatization:

Unfortunately, Pakistan has been the laboratory to test extremes of economic perspectives in Nationalization and Privatization when the cure for its’ economic woes lie somewhere in between as outlined below:

 

  • Establishment of an independent and empowered restructuring institution (RI) to overhaul PSEs can make the restructuring process less resented compared to a private venture while still ensuring provision of cost-effective quality services to the masses from a revenue-generating asset of the nation.

 

  • Competent professionals at top positions based solely on merit to run the PSE’s with introduction of a system of appropriate checks and balances run by professionals. Performance based packages can be offered spurring motivation and ensuring excellence via improved performances.

 

  • This can be further elaborated in that all successful private businesses hire top-notch professionals at lucrative packages with performance based pays. The results are professionally run and highly profitable ventures. There is no reason why the services of similar professionals cannot be engaged by Government which can even convert PSEs into Public Corporations which, while still adhering to Government regulations will be allowed to follow professionalism, efficiency and mechanics of a modern enterprise.

Conclusion:

To sum it up, privatization alone cannot be termed as the solution to all of Pakistan’s economic woes. Moreover, an out of box thinking is required to spearhead us out of the economic abyss we’re currently in.

We can begin with focusing on creating an environment conducive to doing business while strengthening the institutions and regulatory environment. Meanwhile, what is critically required by the proposed RI as discussed above is to:

  • place top professionals of utmost integrity at the key positions based solely on merit to run the PSE’s

 

  • introduce a system of appropriate checks and balances run by professionals whose life is driven by measuring performance against goals, spurring motivation and ensuring excellence via improved performances.

 

If for some reasons a privatization is still deemed necessary in some instances then:

  • a hurried privatization without a proper policy, appropriate selection of PSE’s and laws safeguarding the national interests as well as protecting the masses should be avoided as it will only lead to less efficiency by investors with conflicting interests, more unemployment, resulting lawlessness, inflation, loss of revenues and government bailouts.

 

  • appropriate selection of non-vital and loss making PSEs along-with stringent laws safeguarding the national interests as well as protecting the masses should be ensured.

 

  • the process should be transparent and properly outlined with ground work done to attract best possible investments. This can help reduce lower efficiency by private investors, increased unemployment, inflation, loss of revenues and forced government bailouts as witnessed in the past.

By following the above proposals in letter and spirit, there is no reason why we cannot turnaround the PSE into national assets once again.

The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced fellow Chartered Certified Accountant and anti-money laundering expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or omerzaheermeer@hotmail.co.uk

 

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