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Pakistan’s privatisation dilemma as it seeks IMF bailout

20 December 2018

The article at a glance

Reluctantly seeking an IMF bailout for its balance-of-payments crisis, Imran Khan’s nascent government in Pakistan has already devalued its currency, hiked utility …

Reluctantly seeking an IMF bailout for its balance-of-payments crisis, Imran Khan’s nascent government in Pakistan has already devalued its currency, hiked utility rates and imposed new taxes in an effort to be “ready” for IMF reforms. As if these measures were not enough to make the government sufficiently unpopular, it now faces demands to immediately privatise large loss-making state-owned enterprises.

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Kamal Munir
Dr Kamal Munir

For a few reasons, the government has so far been reluctant to sell these off. Two reasons stand out in particular. First, selling of these state-owned enterprises is likely to generate significant unemployment. Politically speaking, this would be a highly unpopular move, as Khan’s new government promised to create millions of jobs within five years. Second, given the outstanding debts of Pakistan’s state-owned enterprises, there will be few takers unless the government clears up the balance sheets first.

Whichever course the government takes, it would be foolish to ignore the lessons from Pakistan’s troubled history of previous privatisations – three spring to mind.

1. Telecoms and homegrown talent

First, do not sell a state-owned enterprise because you are getting a good price. The 2005 privatisation of Pakistan Telecommunication (PTCL), the national telecoms operator, is illustrative in this regard.

After painting the highly profitable corporation as an inefficient, incompetent, out-of-date behemoth, the government sold off a 26 per cent stake (along with full management control) to Dubai-based Etisalat for US $2.6 billion. Yet at the time of its privatisation, PTCL was technologically one of the strongest telecoms players in South Asia with a number of technology firsts in the region. Financially, the company had just posted annual revenues of US $1.4 billion with a net profit of US $452m.

Within four years of its privatisation, thanks to the incoming, highly inexperienced management, the company’s market value had declined by 75 per cent – resulting in a loss of around US $3 billion for the Pakistan government (the majority shareholder). On top of that, Etisalat today still owes the government more than US $800m (from the acquisition price), which would be twice the value now. Ironically, rather than recovering this amount, the government is now asking for loans from the UAE.

PTCL’s privatisation not only destroyed a treasure trove of technological capabilities that the enterprise had nurtured over decades, but it also deprived Pakistan of a chance to turn a national champion into a regional, South Asian one.

2. Energy sector and competition

The privatisation of Pakistan’s energy sector has single-handedly crippled the entire economy. It illustrates the importance of ensuring the new entity competes fairly to earn a profit.

From 1994 onwards, investors were invited to set up power plants in exchange for a guaranteed US dollar-based internal rate of return of 15-18 per cent. This was further backed by sovereign guarantees from the government of Pakistan (which meant an extremely high return with zero risk and zero competition).

The plants were reimbursed for all the fixed costs of the power plant including debt servicing, and handed the highly lucrative equity return on top. These payments were to be made irrespective of whether or not the independent power producer was asked to produce electricity. Plus, the investors were reimbursed for all variable costs of production, regardless of the type of fuel used and its market price.

The privatisation landed Pakistan in a vicious debt cycle. Energy prices have only gone up, which is unsurprising given the independent power producers face no competition. The state has been unable to keep up with the exorbitant bills it is presented with by investors, and has had to start borrowing in international and domestic markets to honour the contracts. As well as racking up huge debts, Pakistan has suffered from severe and prolonged power outages.

3. Banks and profitability

The third lesson comes from the privatisation of Pakistan’s banks. They became more profitable after privatisation in the early 2000s. But a closer look at their performance once privatised shows that much of this profitability came from lending to the government. Lending to the private sector actually declined. This shows the importance of not privatising when an state-owned enterprise can do the same job more cheaply.

There is little point having private banks if all they do is lend to the government, which could easily own those banks and lend to itself without having to factor in an equity return. The allocation of credit to different sectors of the economy did not improve either. Manufacturing, agriculture, and small businesses – the sectors which were supposed to benefit from privatisation – continued to be deprived of credit.

But, consistent with the general history of privatisation in Pakistan, banking privatisation was great for the new owners. Many got bargain basement deals – while doing little for the cause of national economic development.

Above all, the government should realise that in the absence of a broader national development policy, privatisations are not going to yield the desired benefits. Before contemplating any sell off, the government needs to first figure out the roles it needs various institutions to play and devise appropriate regulatory and monitoring frameworks.

Goals such as maximising the value of an enterprise before its sale or enhancing its profitability, should be supplanted by aims that are in line with a larger development plan. In order to avoid the mistakes of previous governments, longer-term goals must be prioritised.

This article was originally published in The Conversation.