Performance Review of the Privatised Manufacturing Enterprises in Pakistan

by

Mr. Abdul Hafeez Chaudhry

Joint Secretary

Ministry of Industries & Production, Pakistan

BACKGROUND OF PRIVATIZATION

Privatization process in Pakistan was formally started in 1991 with the setting up of the Privatization Commission (PC). The impetus for privatization came largely from the poor performance of state-owned entities (SOEs). Since the early 1970s, Pakistan had relied on the public sector to operate virtually all infrastructure and financial services and many industrial units. All major industries with the exception of textile industry were nationalized and a number of industrial/economic activities were earmarked for the public sector only. In addition to about 100 industrial enterprises, the government owned and operated services in banking, energy, communications, infrastructure, and transport.

The experiment of nationalization proved to be a failure because of the following characteristics exhibited by SOEs:

1.       Mismanagement and overstaffing

2.       Inappropriate and costly investments

3.       Poor quality and coverage of services

4.       High debt and fiscal losses

5.       Production and profits that were well below their potential

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 suitability for the position. Prices for many goods and services were kept artificially low. Cross-subsidies and pricing inefficiencies became widespread and in many cases the prices had 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 the goods and services were used by them or not. In short, Pakistan's SOEs completely failed in delivering.

PRIVATIZATION POLICY

The need to privatize the state owned enterprises was realized by the Government of Pakistan in mid 80s and privatization of state owned enterprises in UK etc was studied to formulate privatization policy and strategy. The Privatization Policy of the Government 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 SOEs from public sector red tape and procedures.

The main features of Privatization Policy being followed by Government of Pakistan are listed below:

a.       Enhance competitiveness and improve the operational efficiency of State Owned Entities (SOE);

b.       Mobilize private-sector capital and expertise, and reduce fiscal deficit;

c.       Enlarge the ownership base and strengthen capital markets; and

d.       Realize sale proceeds for the retirement of national debt.

e.       Strategic assets will remain outside the program;

f.         Proceeds of privatization will be used exclusively for the retirement of debt;

g.       The stock market will have a role in the privatization process to ensure that its benefits filter down the general public, to broaden and deepen the stock market and to prevent concentration of privatized units in a few hands; and

h.       Overseas Pakistanis will be involved in the process of privatization.

The Government's policy of privatization and liberalization is aimed at promoting market-based, private sector-led growth. 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.

Privatization is also being used for broadening the ownership of assets, mobilizing 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 savings. Simply listing of 100 percent government owned companies on the stock exchanges helps in improving their corporate governance, as the companies are obliged to comply with the stringent reporting requirements of the stock exchanges and Securities and Exchange Commission.

The Government is firmly committed to carrying out the privatization 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. In addition to specifying advertising requirements to ensure the widest possible participation in privatization, it is also ensured that monopolies are not created in the privatization process. For this purpose the economy has been deregulated to the maximum extent possible and the regulatory framework strengthened.

To ensure that the proceeds of privatization are not squandered away, 90 percent of privatization proceeds are being used for debt retirement and 10 percent for poverty alleviation.  Appropriate provisions have also been incorporated in the recently enacted Privatization Law so that the successor governments may not deviate from this policy.

PRIVATIZATION PROGRAM

Privatization programme of the Government of Pakistan was implemented on fast track during the first phase (1991-1994) and 66 privatization transactions were completed by the Privatization Commission.  By end of 1997, the number of privatization transactions had increased to 92 while by end of 2000 the number stood at 106. At that stage the gross privatization proceeds were about Rs. 60.9 billion (US$ 1.8 billion).

Out of the Rs.60.9 billion in gross receipts, 80 % were turned over to the Federal Government, 9.5% were used for restructuring expenses associated largely with golden handshakes, 5% were returned to companies on whose behalf shares were sold, and 4.5% were used for privatization process related expenditures. While almost all the transactions were settled in local currency, almost three quarters of the proceeds were received in foreign exchange. Bulk of these proceeds came from the privatization of minority shares of Pakistan Telecommunication Company Ltd. (12%) and Kot-Addu Power Company (36%).

During the last two years, a number of major privatization transactions were finalized and in June 2002, the number of privatized State Owned Entities stood at 122 and the total sale proceeds were about US$ 2.322 billion. Sector wise break-up of 103 privatized units, sales proceeds and date of transfer is given in the table at annexure-A.

The Privatization program of the Government of Pakistan is part of the framework for the restructuring and liberalization of the economy for the overall benefit of people of Pakistan. In order to achieve the goals, the Government of Pakistan has taken following steps to implement the privatization program in a transparent and equitable manner:

a.       The privatization process was given due protection by ‘Privatization Law’.

b.       The Privatization Commission (PC) and the Cabinet Committee of Privatization (CCOP) were reconstituted with public and private sector professionals reflecting a more balanced arrangement of specialized expertise and business acumen.

c.       A comprehensive privatization program for the short, medium and long-term was prepared, in accordance to the economic environment and investment conditions;

d.       Regulatory institutions are being strengthened.

e.       The bidding process was made more transparent, and generalized processes and standards of performance was spelt out; and

f.         Communication with different stakeholders in the privatization process was enhanced.

g.       Prepare the entities for privatization, prior to offer for sale to maximize the sale proceeds

h.       Adopt two-track policy of:

                                       i)      Involvement of middle-income Pakistanis through Stock Exchange; and

                                     ii)      Strategic sale to bring in expertise and technology.

Maximum emphasis has been placed to enhance credibility and investor confidence through the expeditious completion of certain relatively small but manageable transactions. Similarly, priority emphasis has been given to local investors and overseas Pakistanis prior to bringing major transactions for investments by international investors. Following are the key elements of the strategy adopted for the development of the privatization program:

·         Consensus on the privatized program from all stakeholders, and approval of the agreed program at the highest level.

·         Demonstrate will to implement the government decisions in letter and spirit.

·         Identify marketable transactions under the current conditions.

·         Develop a cohesive short and medium/long-term program.

·         Complete the necessary background/restructuring work for major transactions to re-launch them in the medium and long-term.

·         Develop credible track record before bringing transactions to market.  

Privatization Process

The privatization process, which is aimed at selling government property in an open and transparent way with a view to obtaining the best possible price, varies somewhat depending on the nature of the asset being privatized, on the proportion of shares being offered for privatization, and on whether transfer of management is involved or not.  The Privatization Commission in consultation with the related ministries/departments decides as to what kind of process will be followed.

The privatization process is lengthy for major transactions, mainly to ensure transparency in the process. Following steps are normally taken in completing one transaction: -  

1.       Identification of SOE

2.       Hiring of a Financial Advisor

3.       Due Diligence

4.       Enacting any Needed Regulatory and Sectoral Reforms

5.       Valuation of Property/Shares

6.       Pre-bid and Bid Process

7.       Post-bid Matters

The flowcharts detailing steps in a transaction involving “Transfer of Management or Sale of Assets /Business” and “Capital Market Transactions” are enclosed at annexure B & C respectively.

After receiving Cabinet Committee on Privatization’s approval for the privatization, it typically takes about 15 months to close a major transaction, even when no major restructuring of the company is required. This includes three/four months to appoint a Financial Advisor and another three or four months for the FA to complete its legal, technical and financial due diligence and to propose a privatization strategy. Following approval of the strategy, the marketing and bidding process may take five or six months (valuation efforts proceed in parallel), while it may take another two months after bidding to obtain approvals, finalize sale documents, and close the transaction. Additional delays in privatization are often caused by waiting for the necessary regulatory framework and sectoral policies to be put in place and for any needed restructuring to occur.

PERFORMANCE REVIEW OF PRIVATIZED

MANUFACTURING SOEs

More than 80% of the privatization transactions were State Owned Industries, which were operating under the administrative control of Ministry of Industries & Production. Most of these industrial units were operating with the support of the Government in the form of bank loans, restricted competition/ monopolistic market conditions, subsidies etc.

It was apprehended at the time of privatization that the buyers of the privatized units will experience difficulty in the operation of these units due to the following reasons:

As expected, the performance of a large number of privatized SOEs was not very good during the first few years.  The comparison of the post privatization (1991-99) performance of these units with the pre-privatization  (1987-91) period on the basis of major performance indicators exhibited the following:

(i)	Around 70% of the privatized SOEs are operating successfully and the remaining have been closed or liquidated.
(ii)	Automobile Sector- Automobile sector proved most successful in terms of number of units operating after privatization, expansion in capacities and improvements in sales and productivity. The growth of automobile sector continued @ 15%. The production capacity and production quantity increased significantly during the post privatization period showing improvement in efficiency level.
	The rate of pre tax profit increased from 50% to 57% during the post privatization period.
	The average annual increase in production cost came down from 38% (prior to privatization) to 16.2% during the post privatization.
	The average annual rate of growth in taxes and duties during post privatization period came down from over 20% to 7.8% only.
(iii)	Cement Sector: The net sales of the privatized cement plants grew @ 9.6% during the post privatization period.
	During the post privatization period average annual growth in taxes and duties was 10% against 19% in the pre privatization period.
(iv)	Chemical Sector: - Out of 11 privatized SOEs 3 were closed down. The performance of the operational units was generally satisfactory in the light of major indicators i.e. profit, production, sales etc.
(v)	Vegetable Oil / Ghee Sector: - Ghee (Vegetable Oil) Corporation of Pakistan was incurring huge losses prior to the privatization of its units. After privatization about 50% of the 20 privatized vegetable oil / ghee units were closed down by the buyers as they were not found viable.
(vi)	Engineering Sector: - One of the privatized units namely Ittefaq Foundry is performing well in the private sector and has implemented Balancing, Modernization, Rehabilitation and Expansion (BMRE).  However, the performance of most of the other privatized engineering units was not found to be satisfactory after the privatization.
(vii)	Petroleum Refining Sector: - The privatized units of State Petroleum, Refining & Petrochemical Corporation (PERAC) are operating profitably after privatization and their post privatization performance is much better than the pre-privatization period.

The critics of privatization allege that the performance of the privatized SOEs during the post privatization period was not as good as it was during the pre-privatization period.  However, the factual position is quite different as the economy of the country has greatly benefited from privatization in the form of improved competitiveness of the industrial sector, drastic reduction in the quantum of Government guaranteed loans, bonds etc and direct/indirect subsidies.

The closure of some of the privatized SOEs became necessary due to huge liabilities of the pre-privatization period, obsolete equipment and machinery, open competition, over staffing etc.  The decision to privatize such non-viable units was not a correct decision.  It would have been more appropriate to wind up/liquidate such industrial units/companies.  The Government policy in this regard was subsequently reviewed and non-viable industrial units have been excluded from the privatization list; such units are now being wound up / liquidated by the Government itself.

The privatization of the SOEs has absolved the Government of the responsibility to make additional investment, which was necessary for the viability of these entities.  Due to delay in the privatization of nationalized commercial banks, the Government was forced to inject an amount of Rs. 31 billion into 2 major nationalized commercial banks (United Bank Ltd. and Habib Bank Ltd). Whereas the strategic sale of just 26% shares of Muslim Commercial Bank in 1991 resulted in revival and very impressive growth of the bank. This improvement was achieved through better management, rightsizing etc and without any additional injection of equity by the Government (holding 74% shares).

In view of the positive impact of privatization on the economy of the country, all the 6 Governments in power since 1988 have made privatization the corner stone of their economic programs and the implementation of the privatization programme is continuing.  However, in the recent past the pace of privatization has slowed down due to the complex nature of the privatization transactions being currently handled by the Privatization Commission.  These transactions mainly relate to utilities, transport and banking sectors and require sensitive decisions on pricing, restructuring, rightsizing etc. For instance, the restructuring of WAPDA’s power business into 8 distribution companies, 3 generating companies, and 1 Transmission Company has been on-going for several years. Similarly, gas pricing policy, which is essential to allow privatization of the country’s vast oil and gas assets, has yet to be finalized. Handing over management control of many important utilities/service sector SOEs also required the establishment of regulatory frameworks to promote competition, balance the interests of consumers, investors and the Government, and ensure a level playing field.  Designing appropriate legislation, attempting to reach consensus on the legislation, licensing and tariff rules, and establishing and staffing regulatory agencies proved to be a time-consuming process.

 

IMPACT ANALYSIS OF PRIVATIZATION

Impact analysis of privatization in Pakistan was carried out by Francies, J. and Tufail, A, under a study funded by the Asian Development Bank. 92 privatization transactions carried out between 1991–1997 were evaluated and concluded that the experience was a success overall.  It was found that most of the objectives including improving the efficiency of enterprises and economy, broadening ownership base, improving public finances and safeguarding the interests of employees have been achieved to a great extent. Detailed analysis of 21 enterprises was also carried out and it was found that there had been significant economic benefit in case of 10 enterprises, no improvement or deterioration in case of 6 enterprises and lesser performance in case of 5 enterprises.

There was no negative impact of privatization on employment as a slight increase in employment was noted.  The social impact as well as the impact on consumers was also found to be positive.  However, the first time shareholders who bought shares of the newly listed companies suffered, as some of the privatized entities were not managed well by the majority shareholders.  The study also concluded that Pakistan’s Privatization Commission was quite well organized and properly staffed.

The above analysis of the performance of the privatized State Owned Entities reveals that the privatization experience of Pakistan was quite successful and beneficial for the economy of the country. It can be hoped that the privatization of the remaining SOEs will help in promoting market based, private sector lead growth, improving access to quality goods and services by the poor.

 

 

ANNEXURE-A