[MGSA-L] [FINANCIAL] Lessons from Greece’s Fiasco

[June Samaras]

http://wallstreetpit.com/102276-lessons-from-greeces-fiasco/
Lessons from Greece’s Fiasco

By *Paolo Manasse* Feb 1, 2014, 8:58 AM

*Sales of state-owned assets have been proposed as a way for
highly-indebted countries to ease the pain of fiscal consolidation. This
column argues that, despite the potential merits of privatisation in terms
of long-run efficiency, in practice it is unlikely to improve short-run
fiscal solvency. Since governments rarely alienate control rights, the
efficiency gains from privatisations are often small. Moreover, financial
markets may not fully reflect these gains – particularly during a financial
crisis. The implication is that the Troika policy of linking financial
assistance to privatisations is inappropriate and self-defeating.*

In the midst of the European debt crisis, it is tempting to think that
high-debt countries could alleviate the recessionary impact of the
budget-consolidation process by selling (poorly managed) assets and stakes
in their state-owned enterprises (SOEs), and by using the proceeds to buy
back their debts (Hope 2011). In addition to providing a cushion for
ongoing adjustment programmes and improving solvency, privatisations are
deemed to entail long-term efficiency and welfare gains by attracting
foreign direct investment and managerial expertise, thus spurring
competition and growth.

Indeed, privatisations have been part of the Troika’s conditionality in
Greece since the outbreak of the crisis. In March 2011, Greece signed an
agreement with the Troika for a very ambitious privatisation plan. This
envisaged the sale of public utilities, tourism resorts, concessions for
the Athens airport and the port of Piraeus, and government shares of the
OTE telephone company, as well as the partial privatisation of the Greek
Agricultural Bank. In exchange, Greece could have borrowed from the
European Financial Stability Facility at more favourable rates. The
original plan was to raise €50bn – about 17% of the (then) outstanding debt
– by 2015.

The plan’s progress was disappointing – in 2012 only two out of 35
privatisation tenders were completed (see Table 1), mainly due to delays in
the required legal and regulatory changes (‘Government Pending Actions’ in
the Commission’s jargon). In 2013, just 10 tenders were completed.

*Table 1*. Greek privatisations

[image: Lessons from Greece’s Fiasco]

*Source*: European
Commission<http://www.madariaga.org/images/madariagaevents/vignal%20-%20privatisation%2012.12.13.pdf>

In the following years, the expected revenue from privatisations of
state-owned enterprises, real estate, and banks was dramatically scaled
down (see Table 2), dropping to just €8.7 billion in the Memorandum of
Understanding of 2013.

*Table 2*. Expected revenues from privatisations

[image: Lessons from Greece’s Fiasco]

*Source*: European Commission

In this column I will focus on the following question: Is large-scale
privatisation a viable option to improve the solvency of high-debt
countries? I will argue that, in practice, the conditions required for
state asset sales to improve solvency are unlikely to be met, particularly
when a country is in financial distress. Thus the lessons from the recent
Greek privatisation fiasco are probably quite general. I will first provide
a simple numerical example, and then describe the relevant empirical
evidence.

*An example*

Consider the following example (Table 3). A country (call it Greece) has a
debt coming due amounting to €100, consisting of 100 promises (bonds) to
pay €1. Greek revenues come from two sources: one (tourism) generates €74
for sure, and one (say, the port of Piraeus) yields, on average, €20. Since
the value of total (expected) revenues (€94) falls short of the debt coming
due, Greece is insolvent, and its debt sells at a discount of 94 cents to
the euro (this is the ratio of total expected payments, €94, to the value
of outstanding bonds, €100).

*Table 3*. An example of privatisation

[image: Lessons from Greece’s Fiasco]

In order to improve solvency, the government (e.g. the Troika) decides to
privatise the port of Piraeus, and to use the proceeds to buy back some of
the debt. This example describes a very large asset sale – about one-fifth
of the total debt at pre-privatisation prices. Let’s first consider the
benchmark case in which the public sector is as (in)efficient as the
private sector in managing ports (lower part of the first column, Table 2).
In this case, the port of Piraeus will sell for €20 (the net present value
of revenues), and with the proceeds the government will buy back 20/0.94 =
21.28 units of debt. After the privatisation, the total outstanding debt
will thus fall to 100 – 21.28 = 78.72 units.

Has government solvency improved? Not at all. The government has forgone
€20 of revenue from the port of Piraeus, and now it has to repay €78.72
worth of debt with only tourism receipts (€74). It is exactly as insolvent
as before, and in fact the price of the debt on the secondary market is
unchanged – expected payments/outstanding debt = 74/78.72 = €0.94.

Now consider the case in which the private sector is much more efficient
(+30%) than the state at running ports, and may generate €26 (instead of
€20) from managing the port of Piraeus (second column of Table 2). If
capital markets are competitive, the port will now sell for €26. It will
always be profitable for private investors to bid up to this price. It easy
to show that, after the sale, the secondary price of debt will rise to €1,
so that the government will buy back exactly €26 worth of its debt. Thus,
only €74 of debt will be left – exactly equivalent to the remaining
revenues from tourism (which confirms that the debt must sell at par).

*Three lessons from the example*

This example teaches us three lessons:

1. First, the government benefits from privatisation only as long it
appropriates the increase in the asset value generated by the private
sector. However, it takes a very large public inefficiency (-30%) in order
to generate a small improvement in solvency (the price of debt improves
from €0.94 to €1);
2. Second, for these benefits to materialise, the government must
relinquish the control rights on the privatised asset – selling minority
stakes or keeping ‘golden shares’ won’t work.
3. Third, financial markets must be competitive and have ‘deep pockets’, so
that the state-owned enterprises are priced at the present value of the
future dividends they generate;

Finally, note that a ‘successful’ privatisation plan should be associated
with an improvement in the secondary market price of debt.

*The evidence*

How large are the gains in profitability, productivity, dividends, and
capitalisation of privatised (ex) state-owned enterprises? There is a large
empirical literature, mainly referring to the privatisation episodes of the
1980s and 1990s. The results are often inconclusive and vary over time,
episodes, and countries, as issues such as the regulatory and legal
framework and the details of the privatisation process are crucial. Table 4
is taken from Megginson and Netter (2001), and compares the pre- and
post-privatisation performances of 113 ex-SOEs.

*Table 4*. Empirical studies on privatisations

[image: Lessons from Greece’s Fiasco]

Whatever measure of efficiency we consider, the gains from privatisation
appear at least an order of magnitude below the scale required for solvency
to improve (30% in the example). Note that, from a methodological point of
view, this literature is unconvincing – it does not compare the pre- and
post-privatisation changes of SOEs and that of a ‘control group’ of SOEs
which were not privatised, so the inference of the effect of the
privatisation ‘treatment’ is quite dubious. Goldstein (2003) looks at the
evidence of the Italian privatisation experience of the 1990s and compares
pre- and post-privatisation changes to those of a control group of
enterprises in the same sector. He finds no significant effect of
privatisations.

The second issue is that of the transfer of control rights. Bortolotti and
Faccio (2004) present evidence from a sample of 118 SOEs privatised during
the 1990s in Europe. The evidence suggests that the transfer of control
rights after privatisation was far from complete – in as many as 65% of the
cases analysed, the government retained 10% or more of the shares of the
privatised firms and/or control rights through ‘golden shares’ (see Table 5
below). This fact highlights how reluctant politicians are to loosen their
grip on SOEs, and provides a possible explanation for the
less-than-expected gains from privatisations.

*Table 5*. Control rights

[image: Lessons from Greece’s Fiasco]

*Source*: Bortolotti and Faccio (2004).

Finally, it seems unlikely that a country which has lost access to the
international debt markets can sell assets at a profit, although this
cannot be ruled out in principle. The recent Greek episode provides an
example of a lack of improvement in the secondary market price of debt
following the announcement of an ambitious privatisation plan.

*Conclusion*

Privatisations should be judged on their own merits. Things like reducing
the role of the state in the economy (particularly when this is associated
with corruption) and boosting competition in the medium term are valid
goals. As a tool for improving solvency, by contrast, privatisations are
unlikely to be effective. Governments rarely alienate control rights, and
the resulting efficiency gains are often less than expected. Moreover,
financial markets, particularly during a financial crisis, may not price
assets according to their expected returns. In the short term, a
crisis-stricken country has little alternative to resorting to a mix of
fiscal restraint, debt restructuring, and real depreciation. The
implication is that the Troika policy of linking financial assistance to
privatisations is inappropriate and self-defeating.

*References*

•Bortolotti, B and M Faccio (2004), “Reluctant privatization”, EGCI Working
Paper 40.
•Goldstein, Andrea (2003), “Privatization in Italy 1993–2002: Goals,
Institutions, Outcomes, and Outstanding Issues”, CESifo Working Paper 912.
•Hope, Kerin (2011), “Greek PM calls for consensus on privatisation”,
*Financial
Times*, 14 March.
•Megginson, William L and Jeffry M Netter (2001), “From state to market: A
survey of empirical studies on privatization”,*Journal of Economic
Literature *39(2): 321–389.
[image: Lessons from Greece’s Fiasco]


-- 
June Samaras
2020 Old Station Rd
Streetsville,Ontario
Canada L5M 2V1
Tel : 905-542-1877
E-mail : june.samaras at gmail.com
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