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 privatize large loss-making state-owned enterprises. 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 has 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 privatizations -- three spring to mind.
Telecoms and homegrown talent
First, do not sell a state-owned enterprise because you are getting a good price. The 2005 privatization 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After painting the highly profitable corporation as an inefficient, incompetent, out-of-date behemoth, the government sold off a 26% stake (along with full management control) to Dubai-based Etisalat for $2.6 billion.
Yet, at the time of its privatization, 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 $1.4bn with a net profit of $452m.
Within four years of its privatization, thanks to the incoming, highly inexperienced management, the company’s market value had declined by 75%, resulting in a loss of around $3bn for the Pakistan government (the majority shareholder).
On top of that, Etisalat today still owes the government more than $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 privatization 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.
Energy sector and competition
The privatization 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%. This was further backed by sovereign guarantees from the government of Pakistan (which meant an extremely high return with zero risks 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 privatization 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.
Banks and profitability
The third lesson comes from the privatization of Pakistan’s banks. They became more profitable after privatization in the early 2000s. But a closer look at their performance once privatized 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 privatizing when a 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 privatization -- continued to be deprived of credit.
But consistent with the general history of privatization in Pakistan, banking privatization 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 realize that in the absence of broader national development policy, privatizations 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 maximizing 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 prioritized.
Kamal Munir is an Associate Professor of Strategy and Policy, Cambridge Judge Business School. This article previously appeared on The Conversation UK.
