Privatization Policy implementation follow ups Case of Pakistan

Pakistan has a population of 165 million (2008) of which about 35% live in urban premises and 65% is living in rural areas. This country is ranked low on gross domestic product (GDP) and Human Development Index (HDI) indicators. Since its inception, Pakistan has suffered many setbacks internally as well as externally so the foreign investment portfolio remains to a subsistence level for a long period of time. Since the early 1990s, the Government of Pakistan has taken notable macroeconomic measures to make a resurgent economy. Though the decade of 1990s is remarked by political instability yet the consistency in macroeconomic policies coupled with robust financial sector reforms and privatization policy has resulted into a greater degree of macroeconomic stability. During last four years real GDP of Pakistan has increased to an average rate of 6.5 to 7% while population growth rate was 1.9% so this contributing in achieving 5.6% growth rate per capita income. The unemployment rate in Pakistan has declined to 6.5% (2006). It is noteworthy that since its existence, weak institutional structure, poor governance, political instability, poverty and mass illiteracy remained prime problems for Pakistan.

In many ways, Pakistan provides an excellent testing ground for hypotheses about privatization and its impact, except that so far privatization has not been attempted on a scale that researchers would like to see. The country has a large and well-diversified public sector. Privatization in Pakistan generally goes by the name of ‘disinvestment’ or ‘divestment’ of equity. This is because privatization has thus far not meant transfer of control or even of controlling interest from government to anyone else. The government has sold stakes ranging from 1% to 40% but no company has its stake fallen below the magic figure of 51% which is seen as conferring controlling interest. The privatization program is itself relatively new to the country. It is part of an ambitious process of economic reforms covering industry, trade, the financial sector and agriculture and also involving a program of macro-economic stabilization. Privatization is seen as a necessary concomitant of deregulation of industry, necessary in order to enable firms in the public sector to compete and survive in the new environment.

2.2 National History

During 70’s Social democracy model provoked Bhutto to follow the policy of nationalization; the profit-earning private-sector institutions gave the Pakistani economy a good shake. The situation was made worse by declaring some of the business areas out of bond for private investors. Bhutto argued his action by saying,

“The possession of money institutions in the hands of private parties is the source of exploitation which uses national wealth and private deposits to create money for the financing of monopoly capitalist. All big industries have been set up entirely on bank loans, which mean, on the money of depositors. Such loans can be said to have been the misappropriation of public money by the bankers. To this sort of abuse, which is inherent in any system where banks are in private hands, there has been added the control of banks in cartel belonging to industrialist families. Unless the State takes hold of all the banks by making them national property, it will not be able to check inflation. The State’s financial policy is at present a prisoner of the bankers. All the banks and insurance companies will be forthwith nationalized”.

But towards late 1980’s as nationalization policy was not yielding expected results and moreover, there was an international wave of privatization round the world. This caused inefficiency and lack of managerial control. This burden had started showing multiplying impacts over the period of time. A consensus was emerged that the state is not the best entrepreneur for such industries because by then most of SOEs had started showing negative characteristics like:

management incompetence,

over-staffing,

over-branching,

over-purchasing and

over-investment

Poor level of service.

Deterioration in quality of goods

Corruption in purchases, hiring practices and privileges-abuse

Inappropriate investments

Large debt burden and financial losses

During the Zia regime, the privatization process was fostered by introducing the concept of denationalization. Initial steps were taken by reinstating the ownership of Nowshera Engineering and Hilal Ghee Mills in late 1970s. In addition, the control of the Ittefaq Foundry was given to the Sharif family. Transfer of Managed Establishments Ordinance 1978 provided the legal cover to these measures. Many financial authors believe that the process of privatization was bolstered in 1991 though Privatization Commission of Pakistan has started this program in 1988. In 1985, a committee on Disinvestment, Deregulation and Privatization was constituted. The committee took some time in getting things sorted out and then in 1988 a small number of PIA’s shares were offered to the public for the first time as a modest beginning towards privatization.

2.2.1 Benazir Bhutto’s Regime (1989-1990)

During April 1989, Benazir Bhutto engaged Mr. Rothschild & Sons to undertake study on privatization strategy and selection of projects suitable for privatization. These consultants identified 14 units for privatization in two phases. It was then decided that 10% shares of PIA, 30-40% shares of Pak-Saudi Fertilizer and 60% shares of MCB will be privatized in late 80s. But the government could not carry out its intended plans except privatization of 10% shares of PIA. Benazir government was dismissed in 1990 by giving way to Nawaz Sharif’s first government.

2.2.2 Nawaz Sharif Regime (1990-1993)

During this phase, the government facilitated privatization process on larger scale and 1974’s Act was amended in 1990, empowering the Federal Government to sell all or any part of the share capital of Nationalized Commercial Banks (NCBs.). Privatization Commission was established on January 22, 1991 to identify the enterprises to be privatized and to make recommendations on how this process should take place. The Commission invited bids for 25 units between March and July 1991. In August 1991 the Commission invited bids for 100 units and the national newspapers described it as the world’s single biggest lot offered for privatization. A total of 235 bids for 81 units were received for which 26 bids were accepted by the government. Government has allocated 115 units for privatization and when this government was dismissed on April 18, 1993, two banks, 68 industrial units and 10% shares of Sui Northern Gas Pipeline were privatized. In August 1991 the Commission invited bids for 100 units and the national newspapers described it as the world’s single biggest lot offered for privatization. A total of 235 bids for 81 units were received for which 26 bids were accepted by the government of Pakistan. On 6th April, 1991, 26 % shares of MCB were sold to National Group. Upon completion of disinvestments of 51 % shares, the application of Banks Nationalization Act 1974 ceased on MCB. The branch remained in operations under the management of Habib Credit & Exchange, a subsidiary of HBL until early 1998 when it was re-named Bank Alfalah and then the other banks like UBL, Allied Bank, Bankers Equity Ltd. Habib Bank Ltd were privatized and out of which Bankers Equity ltd is closed now.

The benefits of privatization were experienced in the banking sector that was previously dominated by public sector and characterized by high intermediation costs, over-staffing and over-branching, big portfolio of non-performing loans, poor customer services, undercapitalized, poorly managed / narrow product range, political involvement in lending, loan recovery & appointments.

2.2.3 Benazir Bhutto’s Privatization (1993-96)

During her second tenure, Benazir Bhutto espoused privatization as a prime agenda focusing on the sale of large scale units like WAPDA, Pakistan Telecommunication and banks. The important milestones were 20 industrial units, one financial institution; Kot Adu was major privatization and 12% shares of Pakistan Telecommunications Ltd. The government believes that one of the principal benefits to the nation from privatization of its public assets is by way of reduction of our public sector debt burden. The burden of domestic and international debt can be reduced from the sale of those very assets for which the debt was partially created”. Paula Newberg, (1994),

2.2.4 Nawaz Sharif Government (1996-1999)

During his 2nd term, Mian Nawaz Sharif adopted a professional approach to revamp privatization program with the World Bank financial aid of 210 million US dollars. Government hired highly paid professionals, for the restructuring of the banks. In the first phase, these professionals reduced the size of employees and 20,000 workers were forced to take a Golden Shake Hand and early retirement benefits. Trade unions and trade union activities were banned within banks premises. However, differences with the establishment did not allow Sharif’s to fulfil his promises and even to complete his tenure.

2.2.5 General Musharraf (1999 to 2009)

Privatization, liberalization and deregulation were the cornerstones of the Economic Reforms of President General Pervez Musharraf during the last six years. On September 28, 2000, the Government promulgated the Privatisation Commission Ordinance 2000, which strengthened the PC’s legal authority as a corporate body for implementing the government’s privatisation policy. This legal framework increased PC’s independence and accountability and has provided greater comfort to investors a copy of the Ordinance is available on PC website http://www.privatisation.gov.pk. In November 2000, the Ministry of Privatisation was created, to enhance the stature of privatisation and facilitating transactions. The Chairman of the PC was designated as Minister for Privatisation, while the Secretary of the PC became the Secretary of the Ministry of Privatisation. The Ministry has now been renamed as Ministry of Privatisation and Investment.

the Privatization Commission achieved important milestones by successfully completing transactions, which included sale of PTCL, KESC, Mustehkam Cement, PTCL shares in Carrier Telephone Industries, machinery of Bolan Textile Mills and launch of UBL IPO. The Commission has remitted an amount of Rs. 97.259 billion to GOP for debt retirement and poverty alleviation and paid an amount of Rs. 23.301 billion to DFI/owners for their shares sold in 2005-2006. The GDR of Oil and Gas Development Company Limited (OGCL) Global was the first global offering by a Pakistani company for more than a decade.

2.3 Current GOP Policy on Privatisation

GOP policy-makers intend to use the proceeds obtained from privatisation program to minimize public debt. The other important objectives are to ensure that the privatisation process is tailored to get the best price for the units, that it is conducted in a transparent and fair manner, and that any other legal disputes arising are resolved expeditiously. In order to achieve the above mentioned goals, a privatization law was enacted that contained salient features pertaining to framework of Privatisation in Pakistan and Executive Bodies. Since its inception the Privatization Commission has been a part of the Ministry of Finance with the mandate of managing the process of privatisation. However, it never had the power to make crucial decisions such as approving the successful bidder and the final sale agreement. These powers were dispersed in a number of bodies of the Federal Government.

Initially in 1991, there was the Cabinet Committee on Privatisation (COOP) headed by the Minister of Finance and Economic Affairs. The Minister for Production, the Minister for Industries and Interior, and Minister for Commerce were included as members. Subsequently, the Minister for Communications, Minister for Labour, Minister for Water & Power, Chairman, Privatisation Commission, and Deputy Chairman, Planning Commission were included in the COOP. This arrangement continued till September 1998. From September 1998 to September 1999 there was the Privatisation Board of Pakistan (PBP) headed by the Prime Minister. It also included the Ministers of Finance, Commerce, Communications, Industries, Petroleum, Railways, Water and Power, Chairman and Secretary of the Privatisation Commission, and the Chairman of the Board of Investment. Policy issues relating to privatisation could also be referred, when necessary, to the Economic Co-ordination Committee (ECC) of the Federal Cabinet or to the full Cabinet. In practice, however, the bulk of the important decisions relating to privatisation choice of units and method, appointment of advisors, pre-qualification criteria, and approval of the successful bidder- were taken by the Committee of PBP. Currently, COOP has been revived.

Privatization efforts began in earnest after the creation of Privatization Commission on January 22, 1991. Although the PC mandate initially restricted to industrial transactions, by 1993 it had expanded to also include Power, Oil & Gas, Transport (aviation, railways, ports and shipping), Telecommunications and Banking and Insurance. During January 1991 to June 2009 the Commission completed 167 transactions for Rs 476.421 billion.

Public enterprises making losses due to a number of factors such as inappropriate location, poor technology, etc. cannot be divested, and as such they are prime candidates for liquidation and not divestiture. However, losses due to poor management may be overcome through transfer of management and control with or without transfer of the assets.

In terms of the Privatization Commission Ordinance 2000, Privatization includes a transaction by virtue of which any property, right, interest, concession or management thereof is transferred to any person from the Federal Government or any enterprise owned or controlled, wholly or partially, directly or indirectly, by the Federal Government. The Privatization Commission is, therefore, mandated to divest title, interests, rights, ownership and control in the SOEs by means of various modes of privatization.

According to the Privatization Commission Ordinance the net privatization proceeds received by the Federal Government are utilized in the following manner: –

i) 90% for retirement of Federal Government Debt.

ii) 10% for poverty alleviation programs.

In terms of the Privatization Commission Ordinance 2000, Privatization includes a transaction by virtue of which any property, right, interest, concession or management thereof is transferred to any person from the Federal Government or any enterprise owned or controlled, wholly or partially, directly or indirectly, by the Federal Government. The Privatization Commission is, therefore, mandated to divest title, interests, rights, ownership and control in the SOEs by means of various modes of privatization.

2.4 Objectives of Privatization Program in Pakistan

Thanks to the international wave of privatization from the last two decades which resolves many issues in Pakistan like the other developed and developing countries.

The objectives of privatization in Pakistan are common to many other countries, particularly those from the developing world. They include the need to reduce government debt by the sale of state-owned industrial and commercial units, to improve their profitability and performance, and to make the role of government that of facilitator of commerce as opposed to a producer of goods and services. Other stated goals include the strengthening of capital markets and the securities industry, increasing local savings, and broadening the ownership of economic assets through publicly listed companies. Remarkably, each of the governments in power since 1988 has made privatisation the cornerstone of their economic program.

Though privatization program is multifaceted yet there are three pertinent objectives incurred from any privatization program round the world.

Increased industry efficiency is a product of market competition that commits benefits consumers.

Spreading shares among a large number of public stakeholders

Increase in public sector revenues in the best possible manner.

Privatization is intended to benefit customers, employees and the economy all and sundry. Privatization program yields greater market efficiency, broader choices and better services to public. There is maximum likelihood that dynamics of market based competition can be ascertained in the better mode as research & development culture is instituted to cope with the market rivalry and people get benefits of innovative products and services at competitive rates. In Pakistan, Privatization Commission outlined the following objectives

“Privatization is envisaged to foster competition, ensuring greater capital investment, competitiveness, and modernization, resulting in enhancement of employment and provision of improved quality of products and services to the consumers and reduction in the fiscal burden”.

Furthermore, the additional objective of privatization is to reduce the impact of corruption in the public sector. In the start, Pakistan succeeded in alleviating the impact of corruption delineated by public ownership of businesses by implementing an impressive privatization program in a remarkable time. Growth led by sustainable, sound, and innovative institutions is the best way to ensure that massive numbers of poor Pakistanis will have permanent access to diverse benefits of the privatization program. Decision makers and senior ministry official allocate public funds by invoking favouritism that entails great sacrifices and losses. This may occur via kickbacks on the purchase of goods and services or by providing favoured treatment to an individual or company. However, three important tenets, namely improving state finances, widening and deepening capital ownership and protecting the interests of employees are evident even in overstretching state.

Another objective in countries like Pakistan is that the privatization decision must be a well-thought out decision calculated to benefit a small group of employees and a private firm or individual at the expense of society. Theft and abuse of public property are other forms of corruption. Some employees of public companies providing services such as electricity, telephony, or banking may collude with certain consumers to provide free or cheap services in exchange for side payments. People may strengthen the situation by staffing state-owned enterprises with their cronies and supporters and by pressuring state-owned banks to lend funds to bankrupt state-owned companies or to influential businessmen for risky or dubious projects. Honest consumers and taxpayers become the big losers. So, privatization will be instrumental in curtailing all such forms of corruption.

Privatization initiatives in banking were singled out for their success as they resulted in more efficient banking services, lower transaction costs, a wide range of services, removal of the need for equity injections, reduction in political lending and improved regulation. The social impact on consumers was positive, likewise with the impact on capital markets and ownership. On the negative side some first time shareholders suffered from buying shares in companies that did not get restructured that were not operating under a proper regulatory framework and that had no strategic shareholder.

Another important tenet of the privatization process is aimed at balancing the interests of the major stakeholders, namely consumers, taxpayers, investors, and employees. It is also aimed at ensuring transparency in the sale process, which will, in turn, maximize sale proceeds subject to decisions relating to balancing stakeholder interests. For this reason there are many checks and balances in the system, making it extremely difficult for any individual or group to influence decisions. Independent firms are appointed to estimate the value of the property being privatized.

An additional objective of privatization is to encourage direct foreign investment. The direct foreign investment in profitable public units is not likely to be beneficial for the economy, as against the benefit of an initial purchase price, one has to calculate the recurring remittance of profit in foreign exchange for years and decades to come. Direct foreign investment, therefore, should be attracted by policy and design into new and risky ventures rather than through the purchase of profitable enterprises. In fact, purchase of existing operational units by foreign buyers is not an addition to the capital stock of the country.

The objectives of privatisation in Pakistan are common to many other countries, particularly those from the developing world. They include the need to reduce government debt by the sale of state-owned industrial and commercial units, to improve their profitability and performance, and to make the role of government that of facilitator of commerce as opposed to a producer of goods and services. Other avowed goals include the strengthening of capital markets and the securities industry, increasing local savings, and broadening the ownership of economic assets through publicly listed companies.

According to (Kemal. A. R. 2000), the objectives of privatization in Pakistan include higher levels of efficiency, investment, production, employment, and physical and social infrastructures and retirement of the public debt.

2.5 Modes of Privatization in Pakistan

The Privatization Ordinance specifies the following modes of privatization:

Strategic Sales Management through Open Auction frame

Asset Sale

Public Offering through Stock Exchanges

Buyouts (Management & Employees)

Concession Contracts

Public enterprises may be liquidated or divested partially or completely, and the divestiture may take different forms including flotation of shares in the stock exchange market, sales through financial institutions and equity tap and outright auction.

Following are the six different modes through which public enterprises in Pakistan were divested:

Divestiture through bids

Sale of suitable amounts of shares through the stock exchanges

Sale to Workers’ Management Group on the basis of an evaluation of assets liabilities and net worth and matching the maximum bid received

Sale to modaraba companies, working on the Islamic profit-and-loss sharing principle, which raise funds for purchasing shares

Management contracts with modaraba companies, leasing or contracting of management to private entrepreneurs for a specified period

Lease management contract with the workers for a specified period to enable them to buy out the enterprises they have been working in

2.6 Steps in Privatization

This is important to consider following factors before discussing the different steps of privatization:

Proportion of shares being offered for privatization

Issue of transfer of management

Selection of a particular way of privatization

A brief description of different steps of privatization is provided below.

2.7.1 Identification

The first step is the identification of the entity or list of entities to be privatised. In a typical transaction, the Privatisation Commission, in consultation with the relevant ministry, submits a summary of the proposed transaction to its board. The summary justifies the need for privatising the property, outlines the likely mode of privatisation, and sometimes seeks guidance on issues relating to such matters as pricing, restructuring, legal considerations, and the regulatory framework. Once endorsed by the board, it is submitted to the cabinet or its subcommittee, the cabinet Committee on Privatisation, for approval.

2.7.2 Hiring of a Financial Advisor

In major transactions, the process to hire a financial advisor is carried out by the transaction manager with the approval of the board. Terms of reference for the FA are finalised, expressions of interest from prospective FAs are solicited, an evaluation team is constituted, and short listed firms are invited to submit technical and financial proposals in a common format.

.7.3 Due Diligence

The next step is to carry out the legal, technical, and financial due diligence. This is aimed at identifying any legal encumbrances, evaluating the condition of the assets, and examining the accounts of the company in order to place a value on the company. For most industrial units and some small transactions, this is done using in-house transaction managers and for major privatisations or when the proposed privatisation mode is different from the initial plan, the plan is then submitted to the Board, the CCOP, or the full Cabinet for approval.

2.7.4 Enacting any Needed Regulatory and Sectoral Reforms

For major transactions, the ability to privatise and the amount of proceeds realisable depend critically on the level of regulated prices for the public enterprise’s inputs or outputs and other regulatory policies.

2.7.5 Valuation of Property

In order to obtain an independent assessment of the value of the property being privatised, the Commission relies primarily on external firms. The Financial Advisor, where there is one, carries out the valuation to obtain a “reference price” for the property. In other cases, the Commission contracts with an external valuation firm or accounting firm as specified in the rules on the valuation of property, which can be obtained from the privatization commission website. Therefore it is important to focus on designing appropriate transaction structures, on advertising in relevant media, in choosing and implementing appropriate pre-qualification criteria for bidders, and in following an appropriate bidding process to obtain a fair price for the privatisation.

2.7.6 Pre-bid and Bid Process

Expressions of Interest (EOI) are invited by advertising in the relevant media. The PC Ordinance 2000 spells out some of the advertising procedures. Depending on the kind of transaction, the EOI describes the broad qualifications that potential bidders must possess.. Pre-qualified bidders are then given a specified period to conduct their own due diligence, following which they are invited to a pre-bid conference where their questions and concerns can be addressed. The meeting is useful in determining the bidding procedure to be followed (for example, open auction, sealed bids, or some combination) and could even determine the proportion of shares that the Government may want to offload. The bidding itself is done openly, with all bidders and media invited.

2.7.7 Post-bid Matters

Following bidding and identification of the highest bidder, the Board of the PC makes a recommendation to the CCOP as to whether or not to accept the bid.

 In summary, the privatisation process is lengthy for major transactions, mainly to assure transparency in the process. After receiving CCOP approval for the privatisation, it typically takes about 18 months to close a major transaction, even when no major restructuring of the company is required (see charts).

2.8 Impact of Privatisation on Employment in Pakistan

Among the factors of production, labour occupies a very special position. While privatising the SOEs, the government has given due care to safeguard the interests of the labour. In most of the cases the government has encouraged the workers management group to purchase the privatising unit by putting competitive bid. So far, the government has transferred the management of 12 different units to the workers management group through competitive bidding process.

An effective retrenchment policy is a by-product of privatization which would fulfil the divergent goals of attracting investor interest and satisfying workers’ concerns and attendant labour unrest. In response to this challenge, the GOP has offered fairly generous settlements to workers who choose to leave voluntarily. Unionised employees are offered voluntary retirement though a Golden Handshake Scheme which entitles them to their `legal’ dues (e.g. provident fund, gratuity/pension, pay arrears) and four months extra basic salary for each completed year of service. The buyer of the unit is responsible for the so-called `legal dues’ and the GOP picks up the salary payment. For officers and non-unionised staff, the corresponding scheme called the Voluntary Separation Scheme is somewhat less generous as only two months extra salary for each completed year of service is offered. Under this scheme too, the buyer pays not only the `legal dues’ but also shares with the GOP in equal proportion the salary payment. For employees who do not opt for the appropriate voluntary retirement scheme, the buyer must retain them on their original terms of employment; such employees shall also continue to benefit from the labour laws in force in Pakistan. In spite of these programs, union oppositions remain the norm in privatisations and a continuous worry for GOP planners. Employees are also permitted to bid for the units on sale provided they meet the Privatisation Commission’s requirements regarding capital, technology and management. Such privatisations are rare, although the sale of Millat Tractors in 1992 can be cited as an example, a company which, incidentally, has done very well in its post-privatisation phase.

While improvements in productivity would eventually result in higher levels of well being, the impact of privatization on prices, employment and wages and other employment benefits determine the resultant impact on social fabric of the country.

The economic performance of the privatised units after their sale has been mixed, with greater success noted in the banking sector than in the agricultural and manufacturing sectors. It may be observed that the poorer performers were often affected by economic depression in their respective sectors. The GOP has benefited from privatisation by the reduction in subsides, by the revenues raised from the sales some of which have been used to retire debt, and by the relief from the risk and administrative burden of managing commercial enterprises. The stock market has benefited from the sale of 12% of PTCL and the listing of companies subsequent to privatisation. The social impact of privatisation has been positive overall. Private companies have a better record of providing schools, health and leisure facilities to their employees than their public counterparts.

Most of the units transferred to the workers group have been very successful, like Milliat Tractors Ltd. and Allied Bank Limited. By introducing better management practices, productivity as well as workers’ benefits have gone up. In other cases of privatisation, the workers have benefited in terms of increase in salary and better working environment i.e. Kot Addu Power Company and MCB. However, in many other cases like Quality Steel Mill, the workers have suffered due to unqualified new management.

It is very difficult to make a real assessment of the privatisation process in Pakistan due to a number of reasons, which include, inter alia, lengthy process of privatisation, which makes it difficult to evaluate the results of privatisation in the short run and the fact that the privatisation has been limited in few sectors. However, privatisation of SOEs is an important instrument to remove most of the ills of the economy. Government gives high importance to the genuine interests of th