Privatization proceeds for revenue or financing

The purpose of privatizationProgrammes launched by industrial and developing country governments alike, is to re-deploy assets from the public sector to the private sector — where they are expected to be used more efficiently.

If this is the case, privatization can enhance welfare and lead to a permanent increase in the aggregate level of output.

While privatization programs are not meant to fill holes in the budget, they have been profitable for some governments. Privatization programs in Chile and Mexico, for example, generated proceeds that averaged about 1 percent of GDP in their peak years.

Thus apart from their impact on the productivity of a nation's capital stock and on the long-term growth rate or output level of the economy privatization programs can have important short-run macro-economic and financial consequences.

In a new study, The Macro-economic Impact of Privatization, G. A. Mackenzie addresses some of these consequences. In particular, he examines whether privatization proceeds are best viewed as revenue that can alter the stance of fiscal policy (like taxes) or as financing (like a bond issue).

"Valuation Differential"

A number of elements determine the macro-economic effects of privatization. One that is particularly important is the "valuation differential" — that is, the difference between the present value of the net income generated by public sector enterprises to be privatized and the value that their shares would command with private sector investors.

For example, with a negative valuation differential, the value of a concern is worth less — or deemed to be worth less — in the public sector than in the private sector.

When the government privatizes the enterprise, it receives more for it than it is worth as a public sector enterprise.

Assuming that the government uses the privatization proceeds to reduce its debt — rather than to finance additional public expenditure — privatization could permanently reduce a deficit, just as a tax increase could.

At the same time, private sector wealth — and hence consumption — may increase. The fact that the private sector is willing to acquire the assets implies that the return on them must be no less than the return on alternative investments.

In turn, existing resources are used more efficiently and, although it may take some time for extra productive capacity to come on stream, productive capacity increases.Nevertheless, privatization may displace private sector investment that would otherwise have been undertaken — a result that policymakers need to bear in mind in setting fiscal and monetary policy.

When there is a positive valuation differential, the private sector may be more risk-averse than the government, so that it discounts the assets at a higher rate than the government does and pays less for them than they are worth.

Under these circumstances, privatization would actually worsen the government's finances, since the stream of income the government gives up is worth more to it than the proceeds of the privatization.

ln this case, the private sector would benefit from a wealth effect, implying an increase in aggregate consumption.

Privatization would have an expansionary impact on the economy in the short-run unless the government offset its effects with a contractionary fiscal policy.

Mode of Implementation

The impact of privatization also depends on the way governments implement privatization programs. Mackenzie looks at the impact of privatizations financed via share offerings as well as through voucher issues.

Share Offerings. Portfolio theory suggests that the private sector will not acquire shares unless the rate of return on financial assets increases.

In a closed economy, interest rates could rise following privatization, since the private sector becomes less liquid.

This increase in interest rates, by reducing the market value of financial assets, would reduce private sector wealth and aggregate consumption.This effect can, however, be offset if the government uses the proceeds to repurchase public debt held by the private sector or if the central bank conducts an open-market operation. A repurchase operation reduces the stock of bonds in the private sector's hands and increases the money by the same amount. The supply of money and the combined value of stocks and bonds will be the same as they were before privatization.Consequently, as long as the shares of the privatized concern are close substitutes for public debt instruments, privatization should not reduce private sector wealth.

In countries where financial markets are not very developed and, in particular, where there is no substantial outstanding stock of government paper that can be used to offset the impact on the liquidity of the privatization operation, privatization may require that shares trade at values that are well below the privatized enterprises' net worth.

A share offering in these circumstances may create a substantial wealth effect for investors who are relatively unconcerned about the marketability of their holdings.

However, the prices of other securities held by the private sector may be depressed by the privatization offering, especially if the outstanding stock of these securities is not large.

The low value obtained for the privatized shares also reduces the impact on the government's budget constraint, conceivably resulting in a tightening of its constraint.

Voucher Privatizations. The comparative thinness of financial markets in some countries, and the large scale of some privatization programs, have led some countries to adopt privatization by voucher.Under a voucher program, participants receive, for free, vouchers that make them owners of a part of an enterprise or group of enterprises.

Privatization by voucher is akin to a capital transfer by the government to the private sector financed by a sale of assets. The government's property holdings decline, but its liquid assets do not increase.

Unless the privatized concerns had zero or negative net worth, the government's budget constraint is tightened. The private sector, however, enjoys an increase in its wealth.

If it can trade or borrow against this wealth, consumption will increase. Hence, voucher privatization has, if anything, a positive impact on domestic consumption and investment. In setting fiscal policy, policymakers must keep this impact in mind.

Implications

Governments may be tempted to treat privatization proceeds as revenue. However, privatization — unlike a tax increase — entails an exchange of assets that does not reduce the net worth of the private sector.

The receipt of privatization proceeds therefore does not normally warrant a loosening of the fiscal stance.

In exceptional cases, the acquisition by the private sector of assets formerly in the public sector could displace private investment and consumption, so that the government would have to spend more — or tax less — just to maintain aggregate demand.

Because it is very difficult for policymakers to predict whether this will be the case, they should view privatization proceeds as a kind of financing, rather than revenue to be spent.

These conclusions do not, however, imply that privatization proceeds should always be used simply to retire debt.Just as there can be very good reasons for an increase in a government's reliance on non-bank or external borrowing during a period of, say, exceptional needs for infrastructure investment, there can be a good reason for using the proceeds of privatization to the same end.

The arguments for tax smoothing can be applied to justify reliance on the proceeds of privatization, although the desire to avoid tax hikes is not an argument in favour of "fire sales" of public enterprises.Privatization also affects an economy's potential supply. If the privatized assets are much more productive in the private sector than they were in the public sector, privatization increases potential output, although probably not at the moment of transfer of ownership.This increase may have implications for macro-economic policy, since the size of the gap between actual and potential output has a bearing on any assessment of the appropriate settings for fiscal and monetary policy.

Given the uncertain impact of privatization on aggregate supply, however, prudence would dictate that policymakers discount somewhat privatization's beneficial supply-side effects.

-IMF Survey

Problems of people getting too old

By Feizal Samath

Fewer infant deaths, lower fertility rates and higher life expectancy may lead the way for social progress in Sri Lanka, but it is also resulting in the inevitable - a population that is ageing.

Sri Lanka, according to recent studies, is experiencing a faster ageing of its population than any other country in the world. Whiledemographic ageing is a relatively new phenomena in Asian countries, its onset in Sri Lanka, experts say, will be more rapid than it has historically been anywhere else in the world.

"As a result, in 2025 Sri Lanka will probably have the third oldest population in Asia ," contends the Institute of Policy Studies (IPS), the county's foremost semi-government think-tank.

While ageing has always been considered a problem in the light of favourable social development indicators, its future burden on the social security system and health care prompted President Chandrika Kumaratunga to order the IPS to undertake a comprehensive study to examine the long-term implications on the country.

The IPS study on ageing and pensions, and other indications of a growing mismatch between the birth rate and the death rate, has led to a flurry of warnings, particularly from the World Bank and the International Monetary Fund for an urgent review of the country's pensions scheme.

Roberto Bentjerodt, World Bank representative in Sri Lanka, said that ageing would have a dramatic impact on government pensions and health care. "It is necessary to make provisions early for this as it could be hard to finance later," he said.

Health costs, he noted, would rise sharply in terms of an ageing population requiring costly items like hospitalisation and mental health care. Sri Lanka has one of the most cost-effective health systems in the world where it spends less money to accomplish a lot.

"We hope the health care structure would continue to be cost effective, but it definitely would be costlier," Bentjerodt observed. Within Asia, population ageing is happening at varying rates. The most rapid increase is expected in the newly industrialised countries and East Asia, with South Asia lagging far behind the rest of Asia except in the case of Sri Lanka. It took most western countries 45-135 years for their aged population to double while in Japan and other East Asian countries it happened in around three decades.

But in Sri Lanka, this process is expected to take only two decades, statistics indicate.

Some of the other salient features of the IPS study are that total fertility rates in Sri Lanka have fallen faster than projected; life expectancy - currently around 70 for males and 75 for females - is expected to be above 75 for males and 80 for females by 2025; population, now at 18.5 million, will stabilise at 21 million before 2025 while the labour force will fall and stabilise at around 14 million by 2011.

It said that the median age - the age that divides the population into two equal groups - will increase from 25 currently to reach 50 in less than 60 years or less than one generation. An ageing population can lead to all kinds of economic problems like the aged continuing to consume resources even after they have given up being productive by leaving the work- force.

When this occurs, the size of aged population with respect to the size of the labour force, and, the duration in retirement with respect to the duration of working years, creates an increase in the tax burden of the economy as a whole.

IPS said that while 30 years is considered to be a fully pensionable duration in service in the government sector, given the current statutory age in retirement, the aged in Sri Lanka can expect to spend 22 years in retirement.

"This is the second highest expected duration of retirement in the world," IPS noted, arguing that the need to provide retirement income support will have serious consequences on the economy as a whole in the next two decades. Sri Lanka's retirement income system consists of pension schemes and provident funds, both of which are not very successfully run.

Currently there is just one mandatory pension scheme which covers civil servants and is non-contributory for the recipient.

In the private sector, there are mandatory provident funds where employees and employers contribute towards an Employees Trust Fund and an Employment Provident Fund.

The annual pension bill stood at Rs.17.2 billion rupees in 1996 from 3.1 billion rupees in 1987 and the World Bank among other international donors have urged the government to cut pension expenditure as it is hurting the economy.

With pension costs, now accounting for about two percent of gross domestic product (GDP), set to be around five percent of GDP in the next decade as the burden grows, donors want Sri Lanka to trim costs or introduce a contributory scheme.

Heart to heart with Arittha

Q:You have stepped down from the pinnacle of the Securities industry where most people want to end their careers. What made you leave the SEC at such a young age?

A: One thing that I knew is that being in Government service is fine as long as you have independence. And I knew that after a certain age you don't have independence because you have to think about your own future as well.

You have to build-up something to give your children. And there's no way you can do it being a Government servant. Above all I wanted to be on my own.

I set myself a target that before I reached the age of 40, I'd leave Government service and build up a private practice. Because on several occasions I was ready to get up and walk out when various people tried to interfere.

But I knew that I could, not have done that if I was 50. Because you'd lose independence by then.

Q: Was that the only reason?

A: Ah, yes. There was a lot of controversy at the time, I left but that was totally independent of the reason I left.

Because I had informed the Commission

(Aritta was the Director General of the Securities and Exchange Commission.) One year before of my intention to leave, I left. And I had given three months notice before I did.

And I had given the word that I would not leave until I trained somebody to take over from me. And I did that. So it was a long-time transition rather than a sudden decision.

Well, that was one thing.

And another reason could be that the Director-General of the SEC is also a member of PERC. And I don't believe in just keeping my mouth shut and waiting.

If don't agree with something, I get up and say: "Look I don't agree with you". And I thought that at some point there may be instances where it could be some sort of embarrassment. And that also contributed to my leaving.

But I left totally of my own, say. That had nothing to do with my work. In fact I enjoyed my work. That was a tremendous experience, PERC as well as SEC. Actually I wanted to be more independent.

Q: What are you into now?

A: I am basically practising Commercial Law, with two partners.

Q: What is your best achievement at the SEC?

A: We brought in a set of regulations and we enforced it. It's all very good to have regulations on books but if you are not prepared to enforce them there is no use.

And enforcing regulations is not an easy task. The first thing you have to remember in enforcing regulations is that the securities industry is a highly specialised industry where you just can't go in and start investigating.

You need to know the technical rules of the market and, even who the participants are. I remember the first investigation we did and the first detection we made we spent nights going through trading records.

At first, it did not make sense but when you study them over and over again you begin to understand the connections and what people have been doing.

These are not investigations that can be handed-over to the police. Because even they don't have the expertise to investigate this sort of crime.

So, initially, I did most of it along with a couple of members of my staff but later we built an infrastructure that was made permanent.

We hired a few people from the industry and the stock exchange and we gave them the necessary training to be good investigators.

The set of regulations we brought in is supposed to be one of the best in the region, even when comparing with Malaysia, Indonesia and Thailand. And that's not what we say. That's what most Foreign fund managers who come to Sri Lanka say.

And the automation of the market is considered to be one of the most advanced in the world. And that again is not something we say. Even the 'New York Times' said that.

And people have forgotten that there were two bomb explosions very close to the Exchange. But on both occasions we did trading the very next day.

PERC

Q: You also served as a member of PERC. What do you think about the privatisations you did during your tenure?

A: Talking about privatisation is very easy. But there's nothing called a perfect privatisation. Because there are so many different interests of stakeholders which you have to try to balance. So considering all that we have done some very good privatisations.

We started-off with Telecom and AirLanka (of course our view was completely different from what finally came out).

We privatised the Gas Company. There was a lot of criticism of Shell but I am proud to say that we got a very good deal from Shell. In fact if you ask Shell as to what they thought of the deal they'd say that they got played-out.

Because the Government got far more than anybody expected to get from that transaction.

SHELL

Q: But you must admit that the Shell deal is still being criticised by people....

A: Why people are criticising the Shell transaction is because of the price consumers have to pay. But pricing of gas can only be done according to a mechanism spelt out in the privatisation agreement.

That agreement calls for a body to regulate prices. But that body has not been set up even by today to my knowledge. So it's not the privatisation that was bad but the post-privatisation procedure that had to be followed.

In fact, the Fair Trading Commission could have taken-up the job. That's what we thought at that time. But that has not been done for some reason.

The Shell transaction was criticised because there were two price increases within a year. If that regulatory body had been there the second increase could have been prevented.

Before the privatisation of the Gas Company the Government wanted to increase the price of gas. But we said no. We told them that let Shell do it after the takeover. And in fairness to Shell they agreed to that.

But if you look at the broad framework of the Shell agreement it was a good agreement. What's more important is that it was a transparent agreement. I remember that we used to have press conferences once in every two weeks on everything we did. We were completely transparent. And I think that was one reason why we were criticised.

Because we never did anything. Because we were prepared to take the criticism. To that extent I am very proud of what we did at PERC.

As I told you there are different ways of doing a privatisation. It's so complex. But we got the best advise possible. We consulted each other. We consulted the workers and all the stakeholders involved. And we did it the way we thought was the best.

That was the difference.

So, in short, the agreement provided for the mechanisms. It's not our fault that the Government did not enforce them.

AIR LANKA

Q: You said that you started-off the privatisation of AirLanka. What do you think about the final deal that has come-out of it?

A: I have not seen the agreement. So I can't tell you whether it was good or bad. But knowing the personalities involved I am sure they would have done a fairly decent job. What I fault them for is the lack of transparency.

Because nobody really knows what happenned in the AirLanka agreement. Having worked with Dr.Jayasundera I don't think he would have done anything wrong. In the circumstances I can't understand why they are not willing to be more transparent. That's the mistake PERC has done.

I mean if you are not acting dishonestly you shuld be willing to take criticism. That's part of the job. The yardstick here is that government servants are not there to impress people but to do a proper job. So let poeple know what you're doing.

And I am sure any national person will accept the transaction provided it's done transparently and in the best interests of the country. So the only thing I am criticising them is as to why they were not more transparent.

Q: You said that you had a different view on AirLanka. Can you explain this?

A: Well the (RFP) seems to be different. The original RFP obviously had no provision to buy aircraft or that sort of thing.

Again I am sure there must be a national explanation why they bought the aircraft they bought. So people should have been kept informed. Even now you can inform the people why it was done. It's because everything appears to have been done in secrecy people are criticising.

Q: What about the basis of it's (AirLanka)'s valuation?

A: Again the basis of valuation can vary. There are several ways of doing a valuation. Again we must understand that the Government Valuer does not have the capacity to value things in certain areas.

Valuing an airline or a telecommunication company is not the same as valuing a land or a factory. It's completely different so there are ways of doing a valuation.

But again if it was transparent as to how the valuation was done people can clearly see that they have done it in good faith. That's the way it should have been done.

There is no doubt that Emirates is a good partner. The question is valuation and should the aircraft have been bought? And with all the statements of the various members of the Cabinet a few months ago on buying the aircraft, how are they going to justify the purchase of aircraft now: That's the problem.

Q: But even the relevant Minister seems to have been unaware of the agreement?

A: The question is this. Was the Cabinet aware of it. Of course. Someday they'll have to answer to all this. Were even members of PERC aware of it? I mean if the members of PERC were not aware of this transaction, how did they recommend it to the Cabinet.

Q: And who negotiated it?

A:Precisely. Who negotiated it. I mean all that is irrelevant because obviously Emirates could not have negotiated this transaction with junior-level officers. Negotiation is a highly skilled-art.

So they would have brought in experts to negotiate. Who negotiated on behalf of PERC? Was it some Transaction Manager? What expertise does a Transaction Manager need to negotiate the sale of an airline? It has to be done professionally I am not saying that there weren't anybody who could have done that, but who did it? Nobody knows it.

Q: What about catering-service and ground handling were they in the original plan?

A: Yes I believe that they were in the original RFC. But I don't know whether it was for the same period. I doubt that. But I think AirLanka could not have been sold without catering and ground-handling. Because it was not worth it at that time.

But you have to understand one thing at the same time, - at the time we originally started privatisation plans for AirLanka it was not showing the profits it is supposed to be showing now. I mean after that they brought Harry Jayawardena who seems to have turned the airline around.

He claims to have done that and if he really has turned AirLanka around they shoud have factored that into the price. But that again is something that can be judged only if the facts were published.

On one hand Mr.Jayawar-dena says that he turned the airline around. On the other hand, PERC keeps ignoring it. So obviously there seems to be some sort of dispute. So what is the truth. The general public has a right to know the truth. That's why transparency becomes important.

SHARE MARKET

Q: What do you think about our share market

A: The problem with our market is that it is very very small. That's something we realised even at that time.

And our market is mostly foreign-driven. And foreigners don't think of Sri Lanka as Sri Lanka. They look at Sri Lanka in the context of south Asia.

Sri Lanka is far too small for them to put in resources to study independently so we have to broaden it. And there are ways of doing it. You have to try to get larger companies to come.

Another way is to increase listings. You need to get Telecom, Bank of Ceylon Insurance Corporation, Petroleum Corp. and likewise to get listed. You have to make foreign investors consider Sri Lanka alone worthwhile.

Another strategy could be to get Indian and Pakistan companies to list in CSE. It's not impossible but it takes a bit of an effort for that you need Government to Government trade discussions on that.

If you look at the last 3 years there have been less than 10 listings. Of course I am not counting the Plantations. But there are no independent listings. And that says a lot.

That means that people are not confident of getting listed themselves in the market.

Q: Is there a separate division /unit in charge of this awareness programmes?

A: There is a programme. But I don't know how effective it is.

Q: But a lot of incentives were granted by the last budget to the Stock Market, I believe..

A: Precisely. So with all those incentives why aren't people not coming forward. You cant expect people to come to you, you have to go to them.May be people are not doing well. No, I don't think so. And you know one thing that people fail to understand is that listings are only for John Keells or Aitken Spence of this country. If it's a successful market the listings should be from the smaller companies.

The Odel, the house of Fashion are the people who should be going for it. And we have made provision for that. There's a thing called a second board today. You don't need very much capital to get listed, you don't need to release too many shares, you need only release 10% to get a listing. So you should be going after them - the small entrepreneurs. They don't know the process of getting listed. You have to go and explain it to them, teach them.

Most of them are paying without even knowing that they are paying at these rates in vain. So the Banks are having a free ride. So either the Chambers of Commerce or the Government should be educating these people and helping them.

Q: What would you suggest for the betterment of the Market?

A: As far as the development of the market is concerned you got to go out of the grassroot levels and teach people and create awareness. That's the only way you do it. And the other thing is planning.

You know the very unfortunate thing about us is that we just sit and wait for things to happen. It does'nt happen like that you're got to create change.

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