Policy clarity needed to allay fears over privatisation

Source: India Abroad News Service

-by Taponeel Mukherjee

Public opinion on privatization ranges from proponents who say it increases efficiency to opponents to fear it will lead to higher charges. As we evaluate potential policies regarding privatization in India, it would be useful to look at the specific asset and policy features that can help create an efficient privatization process.

The type of asset being privatized needs careful evaluation regarding the competitiveness of its industry. Assets held by public sector firms in India range from those that operate in highly regulated markets tending towards monopolies to those that are in more competitive sectors.

For starters, it would be prudent to privatize assets in competitive industries. The competition will mean that the pricing of the service delivered will be primarily determined by market forces, thereby reducing the fear that prices will go up disproportionately for the public. A relatively competitive environment for pricing also ensures that the asset buyers have the incentive to innovate to deliver value and create profits for themselves.

Another point that deserves attention is that certain assets, specifically within infrastructure, are better suited to privatization than others. In a study titled “The Lessons of Long-Term Privatizations: Why Chicago Got It Wrong and Indiana Got It Right”, Aaron M. Renn lists the features that make an asset a better privatization candidate.

Two of the features that merit discussion are the “tangible capital” asset feature and the degree of “over determined form” feature.

An asset is better suited to privatization when its primary value is incumbent upon its “tangible capital”, as opposed to what Renn describes as “intangible economic rights”. Every asset will have some degree of “intangible economic rights” associated with it, but those assets that have less of the intangible rights are more suited for privatization.

As Renn correctly points out, an airport is more of a tangible asset that is better suited to privatization than, say, parking rights around cities. A “tangible capital” asset is more straightforward to value, thereby leading to a consensus regarding privatization value.

Assets with a high degree of “over determined form” also make for better privatization candidates. A high degree of “over determined form” means merely assets built for a specific purpose with little or no optionality to change their use. Such assets are better privatization candidates since their use is clearly defined, and the alternative opportunity costs are low or non-existent.

A clearly defined purpose is essential for framing policies around valuation to avoid any future debate regarding historical estimates. For example, a toll road can be used only as a toll road since it is a distinctive asset as opposed to a building that can potentially have multiple uses such as retail, hospitality and office purposes. An asset with various uses is more challenging to value leading to possible complications further down the road.

It is also vital to use sales proceeds from privatization to create new assets and not to finance government consumption expenditure, as such use may lead to potential sub-optimal use of the money. To elaborate, it is essential that the policy clearly defines cash usage from the privatization sales proceeds.

In an ideal scenario in an infrastructure deficit country such as India, the prime focus of asset privatization must be to use the sales proceeds to create new assets – and they must be in the same sector as the privatized asset. So, airport privatization must be used to expand airport infrastructure. Discipline around cash flow management will be critical for the privatization policy to deliver results.

Fears around privatization emanate from unfortunate experiences of the past. A clearly defined policy that lays out the capital use from the sales proceeds to create infrastructure in India will help allay fears around privatization. It is important to realize that non-tax revenues from privatization can be a catalyst for world-class infrastructure.

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