Rationale and policy

Experience with State Owned Enterprises

The impetus for privatisation comes largely from the negative experience of state-owned enterprises (SOEs). Since the early 1970s, as in most developing countries, Pakistan has relied on the public sector to operate virtually all infrastructure and financial services and many industrial units. The government nationalized many businesses and enlarged the areas where the private sector was prevented from competing. In addition to a number of important industrial enterprises, the government owned and operated services in banking, energy, communications, infrastructure, and transport.

The experiment proved to be a failure. Sooner or later, SOEs exhibited the following characteristics:

As in many countries, decision makers and senior officials in SOEs often used the enterprises to further their vested interests. Staff and managers were often appointed with little regard to their appropriateness for the position. Prices for many goods and services were kept artificially low. Cross-subsidies and pricing inefficiencies became widespread, with many prices bearing little relation to cost and a few interest groups benefiting from subsidies at the expense of the general public. Many enterprises were kept afloat solely because of coerced lending from state-owned banks or government support via such means as equity injections, loans and bonds, budgetary subsidies, and explicit or implicit government guarantees. Such forms of government support were paid for by higher taxes on the people, whether they use these goods and services or not.In short, Pakistan's SOEs have failed to deliver. Whether you take power, banking, petroleum, telecommunications, or industry, the outcome in terms of quality, output, profits, or prices is below expectations, and far below potential.

Take the Karachi Electric Supply Corporation. Despite high power tariffs and army efforts to reduce theft, KESC is bankrupt and its customers suffer from frequent blackouts, sharp voltage fluctuations, and many billing problems. Losses average Rs 1.2 billion monthly. These are picked up, directly or indirectly, by the Federal Government, which in turn, imposes ever increasing taxes to finance the losses. KESC's poor financial condition makes it difficult to allow making needed investments to improve services or reduce losses. The high tariffs and unreliable service also discourages new business investments and puts existing businesses at a competitive disadvantage. As a result, less is produced and fewer people are employed than if reliable and affordable power were available.

Publicly owned commercial banks have also hurt taxpayers. During 1998, the Government injected Rs 32 billion of taxpayer monies into United Bank and Habib Bank Limited to finance past losses. The losses stemmed largely from the banks being pressured to lend to cronies of decision makers or to bankrupt state companies. In addition, decision makers appointed their favorites to top management positions regardless of their qualifications. Even after injecting equity and bringing in good quality management, there is little assurance that past practices will not be repeated and that the banks will not need equity injections in the future.

Virtually all publicly owned industrial units are making losses. Not only do we pay for the losses by paying higher taxes, the quality of most industrial goods is below comparable imported products and their prices are often higher. This puts our industries that rely on such products at a disadvantage.

Even profitable companies fail to deliver. While PTCL and OGDCL are profitable, this is not surprising as telecommunications and petroleum firms make money in almost all countries, especially when the companies operate in a monopoly environment or in an era of attractive oil prices. The test is whether they offer good services and have satisfactory coverage or output. Here, PTCL's customer satisfaction, while improved, leaves much to be desired, with low coverage, relatively high charges, and many billing problems. Similarly, OGDCL's output is well below potential, with limited exploration activity. Inefficiencies, overstaffing, and poor business decisions in both OGDCL and PTCL mean that company profits and tax contributions are well below their potential.

Privatisation is aimed at strengthening public finances and bringing in new investment while simultaneously enhancing the quantity and quality of goods and services. By attracting better management and staff and by freeing the company from public sector red tape and procedures, privatisation can unleash the potential of the company. The greater efficiency and availability of capital, coupled with built-in incentives to improve customer service, will result in more satisfied customers and a lowered need to raise taxes.

Government Policy and Objectives

Only a strong and dynamic private sector can help Pakistan achieve its long-term economic growth and employment objectives. The Government's policy of liberalisation and privatisation is aimed at promoting market-based, private sector-led growth. Long-term growth is at the heart of poverty reduction. Distorted prices, lack of competition, and poor government management of businesses have hindered economic development, introduced inefficiencies, generated unproductive and unsustainable employment, slowed down investment, reduced access to services by the poor, resulted in sub-standard goods and services, and contributed to fiscal bleeding. Privatisation can help change this.

Privatisation would also send a strong signal to investors of the Government's faith in the private sector to generate economic growth and productive employment. International investors, in particular, view privatisation as a principal proxy of the seriousness of a government's reform program. Privatisation also provides an impetus for needed pricing, deregulation, and taxation reforms and for an improvement in services, such as electricity and telecommunications, which are essential for a supportive business climate and the generation of productive jobs, economic growth and prosperity.

An improved business climate would bring in new investment, reversing the capital flight that has occurred in recent years. Privatisation would also bring in better management with the right incentives to cut waste, reduce corruption, and improve the coverage and quality of services that are essential for both businesses and households. To the extent that excess staff are laid off, human capital would be freed up that could be more productively employed in the private sector, which would become more vibrant after receiving improved infrastructure services. At the same time, the Government would be free from micro-managing businesses. Senior policy makers presently spend much time and effort in making business decisions to attempt to stop the fiscal bleeding from state-owned enterprises and/or to improve their efficiency.

In addition to privatising companies by handing over management control to new investors, the Government would like to use privatisation as a means of broadening the ownership of assets, mobilising savings, and helping strengthen capital markets. For this reason, the Government plans to sell minority shares via the stock market in selected companies either before or after the transfer of management control. Listing and selling companies in the local stock exchanges is likely to give a much-needed boost to the stock markets and help tap into savings. Simply listing a 100 percent government owned company in the stock exchange may also improve corporate governance as the company will be obliged to comply with the stringent reporting requirements of the stock exchange and Securities and Exchange Commission.

The Government is firmly committed to carrying out the privatisation in a fair and transparent manner. This includes ensuring a level playing field for existing and future entrants, protecting consumer and taxpayer interests, and dealing with public employees in a fair manner. The PC Ordinance 2000 strives, among other things, to ensure that such policy objectives are met. In addition to specifying advertising requirements to ensure the widest possible participation in privatisation, the Ordinance directs the Privatisation Commission to advise that monopolies are not created in the privatisation process, to propose or strengthen a regulatory framework for independent and fair regulation, and to advise on deregulating the economy to the maximum extent possible. To download a copy of the Ordinance, click here.

To ensure that the proceeds of privatisation are not squandered away, the PC Ordinance specifies that 90 percent of privatisation proceeds will be used for debt retirement and 10 percent for poverty alleviation. Reducing the debt service burden will help strengthen the fiscal situation. Fiscal finances will also be strengthened as the Government will no longer have to finance the losses of the SOEs that have been privatised. Also, as privatisation is likely to enhance profits, the resulting higher income tax revenues and increased profits per share on any remaining Government shareholdings will further strengthen the fiscal position.

Last, but not least, privatisation is seen as a way to reduce corruption. The experience in many countries, including Pakistan, is that public ownership of businesses provides many opportunities for corruption. Allocating public funds to unfairly benefit an individual or firm is typically the costliest form of corruption. This may occur via kickbacks on the purchase of goods and services or by providing favoured treatment to an individual or company. Often a poor business decision is really 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. Decision makers, senior ministry officials, and other influential people may exacerbate 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. Privatisation will help curtail all such forms of corruption.

Achievement of the above objectives will, in turn, enhance economic growth, which is the key to sustainable poverty reduction and improved living standards. The biggest gainers are likely to be poor consumers, most of whom do not presently have access to services. The other large and diverse group that will benefit substantially is the taxpayer, who currently pays a variety of direct and indirect taxes to cover the losses of state-owned enterprises and fails to get a satisfactory rate of return on taxpayer monies that have been invested in state-owned companies. The third large group to gain is the worker who is capable and willing to work, whose job opportunities and rewards will expand with privatisation as the private employer will be more able and willing to remunerate in line with the individual's contribution and is more likely to empower the individual to make decisions that benefit the company.