Thursday, July 31, 2008

Malakoff, IPP and Privatisation: Learning from Fannie and Freddie

As we know, in a fit of anxiety over rising oil and food prices, the Malaysian government recently decided to partially remove oil subsidies to great public opprobrium. As part of the fitful reaction, the government also decided to impose windfall taxes for the oil palm plantation companies and the independent power producers (IPP).

In relation to the IPPs, the opprobrious reaction came from the stakeholders of the IPPs, particularly the bank and investment intermediaries who deal with bonds issued by the IPPs. Of these, the greatest outcry came from Malakoff and its stakeholders. See Malakoff bondholders in a bind.

The bind that Malakoff's stakeholders may find themselves in is due to the fact that the windfall tax will eat into Malakoff's cashflow and profit margins which, in turn, will affect Malakoff's ability to meet obligations to bondholders. Why is Malakoff worse off than other IPPs? The answer may be that Malakoff's numerous corporate exercises and restructuring has generated greater debt obligations when compared to other IPPs. This is one of the downside risks of privatisation; where privatised businesses can get into financial problems.

This leads to the basic issue that I want to raise about the nature of privatisation of utilities, roads and public transportation in Malaysia.

Privatisation was fashionable in the past 2 decades
Despite his Look East and Buy British Last policy in the early 1980s, Dr M was enthralled with Margaret Thatcher's privatisation policies. Starting from the privatisation of Sports Toto in 1985, the Malaysian government quickly became a major adherent of privatisation. Construction of highways were privatised. Utilities such as electricity and telecommunications were privatised. Public transportation was privatised. Waste disposal was privatised.

Privatisation means public goods are carried out by privateers
In essence, privatisation means the transfer of the government's basic obligations to the tax paying public for certain goods and services to private enterprises.

Originally, these public goods such as roads, electricity, telecommunications and water were obligations of the government and government agencies. The conventional wisdom that evolved in the 1980s was that privateers were able to deliver these public goods more efficiently and, more cost-effectively.

Has the Malaysian experience validated this conventional wisdom? I suspect that the answer would be in the negative and, I'll tell you why I suspect so.

Higher costs of living with privatisation
The privatisation of public goods has resulted in higher costs of living for Malaysians. In all privatisation concession agreements there are built-in pricing mechanisms which escalate over time.

The major road concessionaire, PLUS, has such in-built incremental pricing (subject to Cabinet approval, which is a dubious safeguard). The early IPPs have such mechanism in the Power Purchase Agreements (PPA).

By its very nature, public goods have inelastic demand meaning that the consumers of public goods have no choice but to continue the usage of privatised roads, electricity, water and so on. So, any increase in price will be passed on the the public users resulting in higher costs of living.

Where are the benefits to the public from privatisation?
There is a pervading sense that these public goods are mandatory obligations of the government anyway. The government is obliged to provide these public goods. And, by privatising these public goods a middleman has been created to derive a profit from the delivery of public goods.

These middlemen have a singular goal of making profits. These profits go into private pockets. In contrast, a government that delivers these public goods, even if profit was made, goes back into the Consolidated Revenue of the government.

The indebtedness of IPPs as an example of the downside of privatisation
In opposing the windfall tax, the IPPs have argued that an entire superstructure of bonds have been created. The windfall tax will affect the ability of the IPPs to meet payment obligations to bondholders, especially so in the case of Malakoff.

While many of us understand that the construction of electricity power generation plants require debt-financing, loans and capital-raising, we should also wonder why the government does not want to undertake this role? Or, at the very least allow Tenaga Nasional to undertake this role.

This same wonderment applies to all public goods that have been privatised.

Two decades of privatisation experience has shown that there is little public accountability in privatisation activities. There is a club system where tycoons that own privatised businesses are accountable to Cabinet ministers in an opaque structure that even Parliament cannot peer into!

The basic proposition: If any privatised entity experiences financial failure, where will the bailout come from?
This is the basic test of whether privatisation should be phased out: Who will bail out these privatised entities if they experience financial failure?

If the experience of Malaysian Airlines under Tajuddin Ramli is anything to go by, the answer is obviously, the Government of Malaysia.

This leads me to share with you one of the current thoughts about the US experience with Fannie Mae and Freddie Mac. Alice M. Rivlin of the Brookings Institution posed the question about whether Fannie Mae and Freddy Mac, as key players in the US housing market, both of which are adversely affected by the imploding US housing market - whether these entities that have a pervading impact on the socio-economic life of the US, should be placed under public hands, that is, government control? Here's an extract of what Rivlin wrote:

Recent history suggests that we want the mortgage giants to be private when they are making breathtaking profits for their investors and executives. But when the going gets tough, we need Fannie Mae and Freddie Mac to keep the credit flowing to homeowners even if it means putting taxpayer resources on the line. Willem Buiter at the London School of Economics has called this ambivalence “the most deceitful socialism I know.” And he may have a point.

Read the full article here.

Likewise, in the Malaysian context, the question is, Do we want privatised public goods to be public or private?


Anonymous said...

Malakoff hits the headlines because the company is a holdco that owns various IPPs. In a normal IPP, the windfall tax will hit shareholders but spare the lenders.

Malakoff, due to its high gearing thanks to the debt funded take over by MMC, will be hit especially hard. Leverage works both ways!

The personalities (owners) involved will, in this bolehland, lobby hard with the government to ensure that their interests are protected.

Like I commented before all these privatisation exercises have not benefited the public 1 bit, but served to enrich a few.

de minimis said...

Yes, that is exactly right, lasersharp. Privatisation has to be phased out.

Anonymous said...

ct choo,

Have left my 'economics' a long, long time ago, so do not have much helpful thoughts to put through.

"By its very nature, public goods have inelastic demand meaning that the consumers of public goods have no choice but to continue the usage of privatised roads, electricity, water and so on." - that is basic economics exactly and one thing the government has failed to take note (or perhaps they know it; know it all too well even).

Public goods are what make modern life possible. The public has to use those goods irrespective of any upward changes in price. Since demand is inelastic, where even a sharp rise in price will not reduce the quantity of demand (by the public), the public will of course suffer with the increase in price and this would lead to a 'higher costs of living' as mentioned.

"The conventional wisdom that evolved in the 1980s was that privateers were able to deliver these public goods more efficiently and, more cost-effectively" is also a fallacy. There are reports that hundreds of schools in rural areas still do not have proper electricity supply. Does any private IPP corporations care about these people? Private corporations only care about the bottom-line.

So, the question "Do we want privatised public goods to be public or private?" is a resounding "public goods should and must not be 'privatised'. Public goods should be the obligations of any good government. I believe most people, layman included, would concur.

Privatisation of public goods is the call of right-wing politicians, social darwinist, and capitalists. Life is not always fair to everyone, nor is it 'just'.

My two-cents on this, and i'm not even an economist to see that.