The mechanics of privatisation

We hear the same things over and over again. You can open the headlines from half a century ago and they will scream of the same few plagues. It is trade deficit this, devaluing rupee that, and some panic about the balance of payments or the other. For its 72 year existence, Pakistan has, for all intents and purposes been unable to conquer these two or three core issues that seem to grow more alarming with every passing day that they are not brought to heel.

With the direction that the current government has taken since it came to power in 2018, these loaded and somewhat complicated matters have taken center-stage in the policies adopted by the PTI’s economic team. The current regime has prioritized increasing its foreign currency reserves as a key policy initiative aimed towards the economic overhaul of the country.

And as the rupee continues to be obsessively devalued, the resultant sharp interest hike to curb industry demand and improvement in balance of payment numbers is being  watched greedily. Whether these recent measures are aiding or detrimental to our economy is perhaps a discussion for another time. The more immediate concern is Pakistan’s need to improve its access to foreign reserves on an ongoing basis, and achieving it in a fashion that does not curb, but rather encourages economic growth.

We are a dollar starved economy. The nation is continually torn between balancing its external finances and meeting the fiscal requirements of its government and people. A clearer path to help ameliorate this dollar shortfall is through maximizing the value of both listed and privately held state-owned assets via sale to strategic or financial investors.

This mechanism, if executed correctly, can generate value for the state by creating national wealth, both in the form of ownership interests sold to external investors as well as the improved valuation of the residual ownership retained by the State.

Privatisation efforts in previous regimes did not achieve the success expected of them. There is a plethora of reasons one can point to for this outcome but the crux of it can be distilled into a few key facts. First, is the inability to restructure a majority of these assets from an operational and financial perspective. Second, investors, specifically foreign institutions, have not effectively been communicated the true value of these state assets. Lastly, there is an incomplete understanding of the availability of in-country liquidity available towards monetization of these assets. Each of these issues warrants a closer look.

As a first order concern, almost all state-owned assets are in dire need of financial and operational restructuring. Without optimizing corporate efficiency, balance sheet issues, profitability and governance, the prospects of attracting serious investor interest in such assets will continue to remain low.

Restructuring of such assets falls beyond the purview of existing management teams. Rather, it requires the assistance of sophisticated advisors that specialise in this area. Any privatisation program, to date, has seen the omission of such advisors.

Another key impediment to maximizing value of state-owned assets has been the fundamental misunderstanding of how international capital markets view Pakistan as an investment destination. The global investment dollar is highly mobile in that it seeks the best risk-reward available to it. It tends to be geographically agnostic for the most part.Most importantly, the investment dollar seeks confirmation bias, that is,  it seeks evidence that other investment dollars have been deployed and extracted return successfully. Without this confirmation bias, the investment dollar moves seamlessly elsewhere. This is precisely what has transpired with Pakistan over the years, especially in relation to other regional economies of similar or lesser investment attributes which have attracted significantly higher amounts of foreign capital.

The first step to alleviating the above mentioned ailments would be to appoint a panel of restructuring experts to comprehensively evaluate and restructure state owned assets along operational, strategic and financial lines. They must be empowered to make the necessary realignments needed within ailing companies to effectively make them attractive to investors globally.

To be clear, these experts are not be confused by transaction advisors, typically investment bankers serving as marketers in any said transaction, and which have been hired by the government periodically in the past. These are firms and individuals that specialize in fixing inefficient operations, upside down balance sheets and a host of other corporate ailments that prevent businesses from achieving their true potential.

The government should also strive to create the conditions necessary to result in a successful investment, and eventually a timely and profitable exit by investors in any privatisation deal. A combination of cleanly restructured assets, clear legality, sovereign financial support (where applicable), and reasonable valuations are all examples of measures the government can introduce and leverage to show investment success and ultimately the confirmation bias global investors seek.

The ongoing privatisation of SME Bank is a relevant example to illustrate the arguments made above. This is a bank marred by financial losses that effectively make it insolvent, an inflated operating cost base and the absence of a scalable platform. These ingredients guarantee that a sale of the bank will not fetch the government proceeds anywhere close to what would be a desirable outcome, assuming it attracts any serious bids at all.

A more viable approach might be to clean up the balance sheet to a full provisioning of the toxic loan book, fresh injection of liquidity in terms of equity or a low interest loan by the government and restructuring of the cost base in line with the bank’s earning capacity over the near to medium term. Only then, would serious investors view SME bank as an operational platform rather than the purchase of a commercial bank license from the government.

What the privatisation regimes of the past have lauded themselves for, are in reality, sales of shares of already listed companies where the government happened to own a stake. These sales hardly qualify as true privatisations and unfortunately have been made at significant discounts to the intrinsic value of the companies involved.

Sale of non-listed public sector companies have been non-starters given the structuring complexity around such transactions and the lack of expertise needed to execute them. This is where the government needs to change their approach this time around.

To wrap up, there are significant pools of untapped investment capital within Pakistan, which can and should be investing in state-owned assets prior to participation from foreign investors. These pockets of capital within Pakistan can and should be incentivised to participate in the initial stages of the rehabilitation of state-owned enterprises.

Assuming the assets have already been restructured, and the government has provided the conditions for investors to believe they can earn a market return on their investments, local development financial institutions (DFIs) as well as other private capital can be galvanised to rotate their funds from government securities and mutual funds to such state-owned assets.

Currently these firms tend to be invested in mutual funds and liquid securities, reflecting their level of risk averseness. There is no reason why with attractive and actionable opportunities in restructured state-owned assets, these players cannot serve as early and therefore profitable investors in state-owned assets.