The case for privatisation
Excerpted from a talk presented by Dr Ishrat Hussain (former Governor, State Bank of Pakistan and currently Dean & Director, IBA), at the inaugural session of the KESC Thought Leadership Forum
There is a consensus now, whether it is Africa or Europe or Asia, that the state has to be strong to combat the excesses of the market and cope with market failure. The global financial crisis of 2008 has brought this truth home that without the intervention of the governments in the United States and European countries, the global financial system would have completely melted down. It was preserved and saved because of strong government intervention.
It is not that the state should play a lesser or a reduced role but it has to play a different role insofar as it provides an enabling environment for equitable and sustainable development. And if it creates necessary conditions for growth through investment in human development and infrastructure, the government has to play an effective role in regulating and monitoring the market to promote healthy competition and avoid the rigging of the market by vested interests. If you do not have a strong regulatory framework which is independent, competent and honest, then forget about privatisation because privatisation won’t work.
Markets are the best known vehicle for efficient allocation and utilisation of resources. The decision as to what goods and services to produce, how much to produce, distribute and trade, can be done well only by the private sector.
This division and redefinition is also essential to reduce corruption and generate and sustain equitable growth in the country. If you do not allow the market forces and market prices to determine as to what is to be produced … we have all seen what the Soviets were able to do… they destroyed the complete wealth creation capacity of a huge republic within 70 years.
Market-based competition, privatisation and a strong regulator have successfully reformed the banking sector in Pakistan and this is a model which should be considered for replication elsewhere in the economy.
What is that we can learn from the banking sector? We started with banking sector reforms in the 1990s when Prime Minister Nawaz Sharif was initiating the economic reforms and despite the changes in the government, which were quite frequent, the process of privatisation continued without interruption. There were ups and downs – there was fast progress and slow progress – a hiatus – but there was no reversal of that particular process. One of the lessons is that it requires a long period of time and no interruption and political support in order to move it to its logical culmination.
At that time, the three big banks – Habib Bank, United Bank and Allied Bank – were all losing money. They were bailed out by the exchequer and we had to put in Rs41 billion in the early 2000s in order to repair the balance sheets of these banks and capitalise them so that they could be sold to the private sector. Without repairing the balance sheet and without restructuring them, you could not think about privatisation.
By 2007, these three banks which were privatised, were making profits before tax of Rs32 billion and, by 2011, they were making profits of Rs73 billion. They have paid corporate taxes amounting to approximately Rs25 billion. In addition, the government, as a shareholder in these banks, has earned huge dividends every year since privatisation.
The residual equity holding of the government in these banks has multiplied several times of the value which they received at the time of privatisation. That is what is reversed – that from a state of paying from the taxpayer’s pocket, we are now collecting taxes and dividends for the socio-economic development of the country.
It is very difficult to construct a counter factual argument, but if the government had held on to these banks and not divested the shares along with the management of the private sector, the net losses suffered by these banks would have risen to Rs50 to Rs100 billion every year and the 2008-2009 crisis would have created a major shock to Pakistan’s economy.
But it is not the fiscal aspects of privatisation as other financial soundness indicators have also improved since 2002. The gross non-performing loans which had reached almost 25 per cent had declined to seven per cent by 2008 but during the last four years, they have again risen because of the sluggishness in economic activity. They are now up to 15 per cent.
The Steel Mills is a typical example of what is wrong with public ownership. It has antiquated machinery, is highly overstaffed, poorly managed, has weak governance, almost no oversight and accountability and huge under-investment. There are leakages and preferential pricing to favour a selected few at the cost of the consumers and the tax payers, contracts are awarded not on merit but on considerations other than the lowest competitive bid, frequent changes are made in the key management positions and arbitrary and whimsical decision-making and discontinuity in policies have damaged the core business of the
Steel is a commodity which is quite prone to competitive pressures, both in imports as well as domestic production. All downstream industries are suffering because of the high cost and inefficiency of the Steel Mills. Since 2007, according to newspaper reports based on Public Accounts Committee deliberations, the mill has lost Rs100 billion. Several hundred millions in foreign exchange were incurred in order to bring in steel because the Steel Mill was operating at 25 to 30 per cent capacity.
This is the reason why in a competitive market, a homogenised commodity like steel belongs to the private sector rather than the public sector. The taxpayer’s money should be spent on education, health, poverty reduction and infrastructure rather than on bailing out losses of the Steel Mills, while the automobile industry and the construction industry suffering because of the high cost of production of steel.
A revolution has taken place in the telecom sector after the historic decision to break the monopoly of the state-owned PTCL, by privatising and open up the sector. This has affected the lives of a majority of Pakistanis.
Had the PTCL remained a state monopoly, with its control on the infrastructure and the backbone, the private sector operators would not have come forward to participate in the auction for 2G spectrum and the sector would not have opened up for fierce competition.
The penetration ratios would not be anywhere close to what we have achieved in the last five or six years and the consumer would not have benefitted from the price, services and convenience as he is today.
I do recognise that PTCL has not come up to our expectations because they have not paid back $800 million which is outstanding for several years and which is part of the contract but it must also be conceded that unlike stateowned enterprises, they have quickly responded and adapted to the changed market conditions. They realise that the fixed line telephony voicesegment business has no future in light of mobile telephony and therefore have shifted to the data services segment, wireless local loop, broadband, corporate services solutions, carrier services and international telephony business.
With its spectrum, infrastructure and networks, they can do even better but had PTCL remained a state-owned company, the changes which we are observing in PTCL’s business model would, I doubt, have taken place. The decline in revenues which people criticise, earned by PTCL during the pre-privatisation were not really the profits. They were the monopoly rents because they were the only player in town. But when you have high competition and your product mix has changed, you have to go for a different business model.
They have adapted and they are responsible for the penetration of broadband, both wired and wireless, in this country which is the requirement of the future. I do not consider any bureaucrat to be so far-sighted as to be able to perceive the market and technological changes which are taking place and adapt the company for that purpose.
I have been criticised by the media because in one of my interviews, about eight or ten years ago to The Herald, I had said that it will be a great service to the country if Karachi Electric Supply Corporation (KESC) was sold for even one paisa and since then I have been watching with great interest the progress of this institution.
It is true that they inherited a very difficult legacy and, therefore, their task was quite difficult. They were trying to run a public utility company with a private business model where, if you have excess manpower and you want to offer them voluntary severance payments, they resort to political influences, which is a part of public enterprises. All public enterprises have excess labour and they cannot be removed but if you allow a private owner and operator to come and run the business, he is not there for social welfare. He is there to maximise profits and also to provide services. If you have excess labour, you have to find ways in order to shed it off and that was certainly a major problem where KESC had to struggle and had to earn some reputational damage - also because the media was full of all these strikes and other activities taking place.
But I don’t think they drifted from their main goal, which was to reinstate in Karachi a modern, successful, well-functioning power supply company, despite the fact that the fuel mix is not what it should be. Gas, which is required for generation, is not available and there is a plethora of problems.
And why has this taken place? I ponder over and I compare this with what I had witnessed when it was under public ownership. The first and most important thing is that a competent and dedicated management team is in place and working hard to get the job done.
Secondly, the shareholders are continuously monitoring and keeping a vigilant eye over their performance and providing them all the backup support they need to meet their objectives. They have investment plans in generation, transmission and distribution, which are at various stages of execution and some of them have been partially achieved. They have systems and procedures which have been put in place rather than individual whims and caprices, which drive the organisation.
Intelligent use is made of technology to manage load distribution and peak demand allocation. Customer service units have been empowered and retooled, and given training to adopt a customer-friendly, problem-solving attitude. This is the beginning of a process which would ultimately lead to a brighter tomorrow for Karachi.
This is the slow, tortuous process of change, renewal and restructuring, and it requires nurturing. Sustainable development requires more efficient allocation of resources, better deployment of human resources, improvement in the processes and procedures and the use of technology to find solutions, and the environment for all these ingredients is hardly found in stateowned enterprises.
Where there is no competition, like in public utilities, the regulator has to play an extremely important role, because pricing and consumer protection is something the public utilities can exploit to their advantage and take the customers for a ride. Therefore, in order to have a successful private sector environment, you need a competent and honest regulator and that together will lead to better and efficient utilisation growth, and eventually sustainable growth.