George Papaconstantinou, Greece's minister of finance, announced on Monday a plan to create a sovereign wealth fund, a sort of Greek “Treuhandanstalt”1 that would implement the ambitious privatisation programme agreed with the EU and the IMF. The plan should raise approximately €50 billion by 2015.
- About €15 billion, within 2013, should come from the concession of the port of Piraeus and the privatisation of a luxury resort on the Athenian coast;
- The remaining €35 billion should come from airports, ports, the sale of the government share of the OTE telephone company (30%), the privatisation of public utilities, tourism, and a restructuring of the state-owned Greek Agricultural Bank (Hope 2011).
This is an ambitious agenda that would reduce Greece's outstanding debt €300 billion by approximately 17%.
Doing the maths
The EU has already approved a loan extension of three years (until 2021) from the European Financial Stability Facility (EFSF), plus a one-point cut on the loan’s interest rate (Hope 2011). In return for privatisations, Greece would obtain the opportunity to sell bonds to the EFSF in the very likely event that it does not regain market access by 2012.
The Dutch and Germans seem adamant in calling for privatisation. While worthwhile on its own merit, will privatisation solve Greece's liquidity and solvency problems? I believe that for this to happen, the privatisations would have to make the privatised entities very much more profitable than they were when government-owned – an outcome that markets do not seem to share, at least for now.
Consider the following simple numerical example. Suppose that Greece’s debt is equal to €100, and the government‘s revenue comes from two sources. The first is tourism. Suppose it is certain and equals €74. The second, which we suppose is uncertain, is revenue from the public management of islands’ ports. In the “good state”, which happens, say, one third of the time, it equals €30; in the “bad state” which happens two thirds of the time, it equals €15. Thus the expected government revenues from ports is €20 (= 1/ 3 x 30 + 2/3 x 15), which added to the tourism revenues (74), totals €94, compared with a debt of €100. Supposing that the country is expected to be insolvent and creditors refuse to lend new money, Greek debt would be priced at 94 cents on the euro in my simple illustration.
Privatisation reduces public debts and public revenues
Now suppose that the government privatises the ports. If private operators have the same efficiency as the public sector, the government can collect an extra €20 from the port sale. As the debt continues to trade at 94 cents2, the government can now buy up €21.28 (=20/0.94) of debt, leaving €78.72 outstanding. But obviously, the government would be left with only tourism revenue, €74, so that privatisation does not make it more solvent. Both its debts and its revenues have fallen.
Obviously, reducing debt and revenue does not help unless the market price of the privatised assets exceeds the present value of the current expected revenue of these assets. This can happen – after all, there is no reason to suspect the Greek government is particularly good at managing ports. But how much higher would the value have to be in private hands to help substantially Greece’s debt situation?
In order to ensure that Greece can regain access to financial markets, the private sector should achieve very substantial profitability gain. In the simple, illustrative example, it is possible to come up with a very precise number. The increased value of the assets when in private hands would have to be at least 35%. Assume that private management increases the probability of good outcome to four fifths (and reduces that of a bad one to one fifth), then the government could raise €27 (= 30 x 4/5 + 15 x 1/ 5) from the ports’ privatisation. Since the debt would now sell at par, this would leave only €73 of debt outstanding which the government could service just with tourism income (€74).
This example shows that even a large-scale privatisation (about 20% of outstanding debt) can solve a country’s solvency problem only if it achieves a substantial increase in the profitability of the privatised entities (equal here to 35% = 27/24 -1). This is a high number compared with even the most favourable estimates of the positive effects of privatisations surveyed in Megginson and Netter (2001). Moreover, the announcement of such a programme should be immediately reflected in a rise of the secondary market price of the debt, a feature that, unfortunately, we have (yet) to observe for Greece.
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, June.
1 The agency that privatised the East German enterprises after the German unification.
2 In fact the new debt price x must satisfy: x = expected payments/remaining debt = 74 /(100 – 20/x) which is solved for x=0.94 (and x=0).