'Privatization of government assets as a tool of budgetary strategy'

(First of five parts)

Privatization has consistently been the source of additional funds for many governments. The disposition of publicly owned assets had its modest and quiet start in Chile and Bangladesh in the early 70’s but it was not until the success of the privatization program of Great Britain from the early 80’s to the early 90’s spearheaded by the former Prime Minister Margaret Thatcher that it became standard policy for many governments. Since then, privatization has taken on a more vibrant and utilitarian role in budgetary policy making.

The reasons for privatization and its underlying objectives may vary from country to country, from a deliberate disposal of a non-core asset to a purely economic aim of improving the service or delivery of a product currently done by the government, but the ultimate benefit is a positive contribution to the government’s fiscal position. It has thus become a tool for fiscal managers in managing their respective budgets.

In order to comprehend privatization’s role in creating budget strategies, it is noteworthy to understand first the meaning, the types, the various objectives of and the reasons for privatization.

A. Definition of privatization

Privatization is difficult to define accurately, as it has not one universally accepted or recognized meaning. In its simplest meaning, it is the “transfer of assets or service delivery from the government to the private sector, which can include the shifting of the production of a good or the provision of the delivery of the service from the government to the private sector.”1

Privatization however has a much broader definition, which has come to be accepted by many governments, and it relies on any or a combination of several methods:

1. A total divestment of government ownership in an asset

2. A partial divestment of government ownership in an asset

3. A partnership with the private sector in a project

4. An outsourcing of a service delivery or a production of a good

5. A temporary use or lease of the government asset, with a condition to return the asset to government after a period of time

These methods however, are founded on one of several underlying principles of what qualifies as privatization:

6. A total relinquishment of control of the asset

7. A less dominant role in the control and management of the asset

8. Subjecting the asset or some of its sectors to the stress and demands of the marketplace, such as the payment of regular taxes, market dictated pricing, market based costing (this can include exposing the asset to more transparent and market based governance rules without ceding any control, such as an IPO or share issue privatization where only a certain portion of the asset’s equity is sold to the private sector.)

9. A complete transfer or the sharing of the market risk on the value of the asset

The use of any or some of these methods in a privatization transaction would all lead to the improvement of the fiscal position of the government. It can be through the direct contribution of cash to the government’s treasury or the creation of fiscal space where the government can avoid spending in one sector and hence have the choice to allocate the resources to other projects it deems more important.

B. Types of privatization

The expansive definition has given birth to many types of privatizations which include:

1. Sale of the asset

The asset is simply sold to the private sector through a public bidding process or a negotiated sale.

2. Asset lease

The asset is leased out, normally on a long-term basis, to a private party who will use the asset for a certain purpose and pay the government a regular periodic fee for the use of the asset.

3. Contracting out (outsourcing)

Specific services, such as printing, messenger, computer maintenance, HR related training and development functions, and even janitorial services are outsourced to a private contractor for a particular period.

4. Management contracts

The management and operation of a certain asset is given to an operator who has the necessary skills to succeed in the job.

5. Public-private partnerships which include the Build-Operate-Transfer (BOT) scheme and all its approved variants, e.g.

• Build-Operate-Transfer (BOT)

• Build and Transfer (BT)

• Build-Own-and-Operate (BOO)

• Build-Lease and-Transfer (BLT)

• Build-Transfer and-Operate (BTO)

• Contract-Add-and-Operate (CAO)

• Develop-Operate-and-Transfer (DOT)

• Rehabilitate-Own-and-Transfer (ROT)

• Rehabilitate-Own-and-Operate (ROO)

The BOT concept operates on several key principles:²

a. The private sector’s role is key, hence in BOT’s, proponent provides the funds necessary to finance the project up to its completion and subsequent operation (which may include construction, maintenance and operations of the facility for the life of the contract)

b. Ownership of the asset, in most variants, remains with the government but project risks are shared with the proponent

c. The proponent is allowed to charge user fees on the project, e.g. toll fees to recover his investments over an agreed period of time

d. In most variants, the project is turned over to the government after the agreed operating period.

e. There is minimal or no government intervention during the operating period

The advantages of a BOT are therefore clear as private sector funds are marshaled to complete and operate the project and the government does not provide capital. In some cases though, the government has provided guarantees to foreign loans acquired by the proponent so as to afford easier access to credit.

Most of the projects in these public-private partnerships are in the infrastructure area that require large investments, such as roads and airports, which from the government’s perspective, may be difficult to fund out of its own budgets hence it has to seek funding from the private sector.

6. Franchising and concession type operations

A private party is given the exclusive right to operate a certain facility or provide a service within a defined area, such as a utility within a geographical area.

(To be continued)

(Vicente Julian A. Sarza is a Principal of Advisory Services of Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected])