Stop or go?

There are many reasons why regional governments should move ahead with privatisation, but the process still faces plenty of challenges.

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By  David Ingham Published  March 2, 2003

Why privatisation is a good idea|~||~||~|On the face of it, the process of privatisation seems to have had a good run in recent months. The IPO of 30% of Saudi Telecom Company in January was three times oversubscribed and raised around $3 billion for the Saudi treasury. The $100 million selloff of 10.5% of Jordan Telecom (JTC) in November, although short of the government’s target of 15%, was even deemed a success by many, given the climate of uncertainty in the country.

Now that these two high profile transactions have taken place, numerous other industries in various countries are on the table. In Saudi Arabia, for example, there has long been talk of selling off Saudia, but attention now appears firmly focused on utilities. The water sector, in particular, requires massive investment if the Kingdom is to keep up with rampant population growth and achieve its goal of total self sufficiency in water.

In Lebanon, privatisation is being driven primarily by the demands of donors like the Paris Club, which recently gave the country a hefty $4 billion loan. In return, those donors want to see a big dent being made in the country’s $30 billion plus debt pile.

In Jordan, it’s a similar story. There, the government is under pressure from the IMF and World Bank to sell off state industries and pay down debt in return for further financial assistance.

The arguments in favour of privatisation go well beyond the question of debt, however. In theory, privatisation means increased choice for consumers, more competitive pricing and, in the long term at least, more jobs. “Privatisation is expected to reap wide benefits to the economy as a whole from improved governance, increased competition, higher service quality, wider consumer choice and greater efficiency,” says Florence Eid, professor of economics & finance, American University of Beirut.

The question on everyone’s lips now is whether or not privatisation will actually go ahead. On this note, the consensus appears to be that whilst things are moving slowly, and there may be delays, privatisation will take hold. “One of the drivers of privatisation is WTO membership, which mandates liberalisation of various sectors… and to bring currency into countries that are strapped for cash,” says Joseph Braude, senior analyst at Pyramid Research. “I think it will go ahead, but it inevitably faces delays.”
||**||The main candidates|~||~||~|
Attention is particularly focused right now on Lebanon and Jordan, both under pressure to privatise because of their debt situations. Lebanon is publicly committed to an extensive selloff programme as part of its bid to clear its massive public debt.

The immediate candidates for privatisation in Lebanon are telecomms, electricity, water, oil & gas and ports. Lebanon is looking to raise US $5-7 billion from the privatisations in the next five years.
Florence Eid at AUB acknowledges that some may be cynical as to whether anything really will get done, particularly given the country’s complex political system. She is confident, however, that those in authority are serious this time round.

“What’s almost certain this time is that people are much more serious than in the past,” she says. “They’ve realised that the budget deficit and the debt situation have reached untenable levels, and people also realise, through Paris II, that there is international support for Lebanon if we get our act together. All those are significant carrots.”

Besides, she argues, the private sector has always been better at doing things in Lebanon than the public sector. “The only thing that really works in Lebanon is the private sector,” says Eid. “All you have to do it let it go and it works.”

Governments like Lebanon’s have several avenues open to them when it comes to the method of privatisation. Public offerings are the obvious choice when companies have reached a certain level of maturity, as is case with companies like SABIC or many Saudi banks. ‘BOOT’ works for sectors like utilities where significant investment in infrastructure and technology are needed.

Then there are private equity sales to ‘strategic investors’, a route that we may see taken in Lebanon and which is exactly what Jordan did when it sold 40% of JTC to France Telecom and Arab Bank. Although there have been bumps in the relationship, France Telecom has managed and improved JTC to a stage where Jordan’s government was able to take it the stock market last year. Such an arrangement could be a model for other industries.

In fact, for its size, Jordan has an incredibly ambitious privatisation programme. In an interview with Arabian Business magazine, Michel Marto, Minister of Finance, reiterates his desire to sell stakes this year in state-owned energy, phosphate and potash industries.

At this stage, the only thing that has been sold off is 40% of JTC to France Telecom two years ago and the 10.5% that was sold to the public last November. However, James Reeve, country analyst at the Economist Intelligence Unit, believes that the momentum towards privatisation is gathering pace. “Despite the low-key response to the [JTC] sale the government still has hopes of raising around US $1 billion in privatisation revenue in the coming year,” he says.

The process will start with the sale by the Jordan Investment Corporation of its 51% stake in the Arab Mining Company, a 25% stake in the General Maintenance Company, and a 30% share in Royal Tours. Other possible sales are its 8.4% holding in the Jordan Tourist Transport Company (JETT) and 26.2% of the Equipment Renting and Maintenance Company.

Those companies would not generate much money, but serious money could be made if the government finds buyers for profitable Jordan Phosphate Mines Company, Arab Potash Company (APC) and the electricity generating and distribution companies. The names of interested parties are currently being kept under wraps by Marto. Negotiations are believed to be underway, however, with Canada’s Saskatchewan Potash Company over JPMC.

The state airline, Royal Jordanian (RJ), has been available to interested buyers for a long time, but has probably missed its chance to find a suitor. Expect the government to try to sell more of JTC when there is an end to the Iraq crisis.

Joseph Braude at Pyramid believes that Jordan should be an attractive proposition for investors right now precisely because of its location close to Iraq. “If Iraq opens up, Jordan will be a very attractive base of operations for Western companies,” he says.

As for Jordan’s motives, its government, like so many in the region, clearly wants to create jobs for a growing population. But a much more prominent factor in Jordan’s privatisation debate has been its debt burden, with the IMF putting it under heavy pressure to cut debt and open its economy. “The money is for the treasury account to cut down debt,” says Marto. “This money is not to be spread around.”

Another country making a lot of positive noises about privatisation is Saudi Arabia. The debate there has focused really on two things, selling off government stakes in companies that are already listed and bringing strategic investors into key sectors, such as power and water.

The Saudi government still owns something like 30% of the Saudi stock market’s total capitalisation. Selling off stakes in successful companies such as SABIC, SCECO and some of the Kingdom’s banks could generate a lot of revenue that could be used to pay down debt.

On paper, it would be relatively easy to do, but the key challenge would be timing. Selling off too many shares at once could drive down the market and mean less money for the government. “They would have to offload this slowly to the general public without disturbing the market,” says Muhammad Younas, senior economist, National Commercial Bank.

In sectors where infrastructure investment is needed, the government may bring in investors on a build, operate, own/transfer (BOOT) basis. One such area is water, where the government needs investment of around SR25-30 billion in the coming five to six years, according to Younas. “There is a big need,” he says. “Ultimately, time will force them into privatisation.”
||**||Obstacles to privatisation|~||~||~|
Plenty of obstacles stand in the way of privatisation, of course. If privatisation is supposed to create more jobs in the long term, it can also mean politically unpopular job losses in the short term as inefficient industries become subject to the rules of the market. Take Jordan as an example.

Although Michel Marto, Jordan’s Minister of Finance, might argue that Jordan’s privatisation candidates have been through the necessary ‘restructuring process’, others aren’t so sure. James Reeve at the EIU believes that privatisation candidates, “need restructuring,” to make them more attractive propositions. “Even JPMC is well overstaffed,” he says.

That is also the case in Lebanon, according to Florence Eid. “Headcount reductions are needed,” says Eid. “There is a need to streamline and rationalise all the industries slated for privatisation.”

In the case of Saudi Arabia, however, job losses at state industries could help the government achieve a key policy goal of reducing the expatriate ratio to 20% of the population.

“The total workforce is 7.3 million in this country and more than half of that is non-Saudis,” explains Muhammad Younas at NCB. “If you merge and privatise and in the process you lose jobs at intermediate levels and lower levels this would speed up the process of Saudisation.”

On the other hand, some industries may cry foul when exposed to competition. Joseph Braude offers an example.

“The call cabin operators in Saudi Arabia, a relic of an older telecomms venture, are pressing STC for a rescue package because they blame STC’s prepaid mobile phone cards for a severe downturn in call cabin revenues,” he explains. “Given that call cabin operators employ 60,000 people in Saudi Arabia, which is three times as many as STC employs, I think the regulator will need to address this issue and the way it will do it is by slowing the impact of market forces on the labour pool.”

On the investors’ side, there must also be concerns about whether or not their investments will be safeguarded. The mobile network episode in Lebanon, for example, cannot have helped foreign investors’ perception of the country.

There, two operators, Cellis and Libancell, had their contracts to operate mobile networks cancelled unilaterally in 2002 and were told that they would have to rebid for them. Florence Eid describes the incident as a, “tempest in a teapot” and says that, “there are always problems, at least in the first round of privatisation.” Whether potential foreign investors see things the same way is debatable.

Then there is the question of pricing in industries, often subsidised, where state monopolies have been replaced by private monopolies. Saudi Arabia’s water sector is a perfect example.

Desalinated water is incredibly expensive to produce at SR5 per cubic metre, according to Muhammad Younas at NCB. However, it is sold to the public at a price of about 12-15 Hilalas per cubic metre.

“So there is a huge amount of subsidy and it has to be worked out what the pricing levels will be,” Younas says. “This is a sensitive area because they cannot increase prices immediately to SR5 per cubic metre.”

There is potentially a similar situation in Jordan’s electricity sector, where a private monopoly would replace a public one in the case of a sale. Michel Marto promises a pricing formula that will allow the operator to still make a good profit.

“You do these things with an equation and formula,” Marto says. “But if they [the operator] are more efficient, they make more money. If they are less efficient, they make less money.”

It’s clear that privatisation in the Middle East faces challenges, but even as the debate about how and when to move ahead with it continues, one thing that can’t be forgotten is that it is ultimately only one part of the process of economic reform. Alongside restructuring and selling off state industries, governments have to be prepared to liberalise labour markets, safeguard the rights of foreign investors and remove obstacles that stifle the private sector.

“I don’t think privatisation is a solution to everything,” says Florence Eid. “Other things need to be done, like encouraging the private sector to create new companies through entrepreneurial skills and innovation, because we are a highly innovative society.”

As long as it is handled properly, privatisation should, on balance, be positive for regional economies. In the short term there may be job losses, but in the long term privatisation should create more jobs, increase consumer choice and allow governments to redirect revenues into more productive activities.||**||

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