Centre for Policy Dialogue Working Paper

Bangladesh’s Privatization Policy

Tanweer Akram* Revised: January 28, 1999

Journal of Emerging Markets 4(2): Summer 1999 *Centre for Policy Dialogue, 6/A Eskaton Garden, Ramna, Dhaka, BANGLADESH; and Department of Economics, Columbia University, New York, NY 10027, USA. Correspondence Address: 362 Riverside Drive, Apt 10A2, New York, NY 10025, U.S.A.; E-mail: ta63@columbia.edu The author has benefited from discussions with officials from the Privatization Board, and scholars at the Centre for Policy Dialogue. The author thanks Mr. Aminur Rahman, Professor Rehman Sobhan, an anonymous referee, and participants at a seminar organized by the Privatization Board for their suggestions. The usual disclaimer applies.

Bangladesh’s Privatization Policy

AbstractThis paper provides an overview of Bangladesh’s Privatization Policy. The present policies can be improved if the terms and conditions of the sale are well-defined and upheld. Discipline in the financial sector is a necessary condition for the success of the privatization program. Without financial sector discipline, privatization may offer avenues for rent-seeking. The tendering process for selling enterprises should be strengthened to attract many potential buyers. The proceeds from privatization could be used for workers’ compensation and labor training. Privatized monopolies have to be well regulated. The issues of time framework, program effectiveness, and the role of the capital market in privatization are also discussed. Privatization policy must be accompanied by other policy measures to ensure that the buyer profits from productive endeavors because privatization is not an end itself. (JEL L330, L980, H800) Keywords: Privatization, Policy, Public Enterprise, Bangladesh

Bangladesh’s Privatization Policy

Objectives The stated objective of the authorities’ privatization policy is to increase the role of the private sector in order to accelerate economic development. The policy states that any public enterprise may be sold, irrespective of the size of its fixed asset, market share, or profitability. An implicit assumption of the policy is that the financial rate of return to capital in the private sector, Π PVT, is or shall be greater than the financial rate of return in the public sector, Π PUB. The authorities want to privatize because they assume that the social gains from private sector profits will be greater than the social gains from the public sector profits. Let α be the conversion factor for private financial profit to social gains, and β be the conversion factor for public financial profit to social gains. Generally, it is thought α ≤ β . Thus, the authorities believe that α Π PVT≥ β Π PUB. The authorities expect that as the share of the private sector in the level of activity increases the rate of economic growth will rise. Institutional Setting _The state has given the Privatization Board the authority for privatizing public enterprises in Bangladesh. In the near future substantial number of public enterprises will be privatized. The Board’s announced that its goal is to privatize, during the financial year 1997-98, 54 public enterprises in various sectors. The list of firms to be privatized include textile mills (15 firms); jute mills (7 firms); steel & engineering companies (9 firms); sugar & food companies (9 firms); chemical companies (8 firms); forestry-related companies (4 firms); and two firms in other sectors (Government of Bangladesh 1998a and 1998b). Table 1 provides the list of firms that have been selected for privatization. In order to strengthen its program, the authorities shall soon introduce a Privatization Bill in the National Parliament for its approval. Table 1: Firms to be Privatized

List of Firms to be Privatized

1997-98

# Name of the Firm

Textile Sector

1 Ahmed Bawany Textile Mills Ltd.

2 Amin Textile Ltd.

3 Chittaranjan Cotton Mills Ltd.

4 Darwani Textile Mills

5 Kokil Textile Mills

6 Kurigram Textile Mills

7 Luxmi Naryan Textile Mills Ltd.

8 Magura Textile Mills Ltd.

9 Meghna Textile Mills

10 National Cotton Mills Ltd.

11 Olympia Textile Mills Ltd.

12 R. R. Textile Mills Ltd.

13 Satrang Textile Mills Ltd.

14 Tangail Cotton Mills Ltd.

15 Zeenat Textile Mills

Jute Sector

16 Amin Old Field

17 Carpeting Jute Mills

18 Eastern Jute Mills

19 People Jute Mills

20 Rajshahi Jute Mills

21 R. R. Jute Mills

22 Star Jute Mills

Steel Sector

23 Bangladesh Machine Tools Factory

24 Chittagong Dry Dock

25 Chittagong Steel Mills

26 Dockyard & Engg. Works

27 Eastern Tubes

28 Gazi Wire Ltd.

29 Khulna Shipyard

30 Prince Iron

31 Progati Industries

Sugar & Food Sector

32 Carew & Company

33 Faripur Sugar Mills

34 Jaipurhat Sugar Mills

35 Kushtia Sugar Mills

36 Mobarakganj Sugar Mills

37 Rangpur Sugar Mills

38 Rajshahi Sugar Mills

39 Shetabganj Sugar Mills

40 Thakurgaon Sugar Mills

Chemical Sector

41 Insulator & Sanitary Ware Factory

42 Chattak Cement

43 Chittagong Chemical Complex

44 Karanaphuli Rayon & Chemical

45 Khulna Hardboard Mills

46 Khulna Newsprint Mills

47 North Bengali Paper Mills

48 Sylhet Pulp & Paper Mills

Forest Sector

49 Chittagong Board Mills

50 Eastern Wood Works

51 Fidco Furniture Complex

52 Khulna Cabinet Manufacturing Unit

Miscellaneous

53 Common Finishing Facilities

54 Khulna Industrial & Trading Co.

Source: Privatization Board, Government of Bangladesh

The Method of Privatization The policy states that the enterprises can be sold either by international tender or public offer of shares. The authorities

are expected to use a variety of methods in privatization: International tendering, offloading of shares in the capital market, auctioning, negotiated sales, and so forth. The authorities have declared that they would prefer to use Employee

Stock Option Program (ESOP) if the workers of the enterprise are willing to buy it. It is not clear from the policy statement whether the authorities want to use ESOP in addition to or as the primary method of privatization in place of

other methods of privatization. However, the actions of the authorities reveal that ESOP will be used sparingly in addition to other methods of privatization rather than as a substitute for convention modes and methods of

privatization. ESOP and Workers’ Participation in Privatization

According to the authorities, an ESOP shall be attempted in the textile sector. If workers choose not to exercise ESOP, then other means of privatization shall be sought. The policy of attempting to apply ESOP is probably motivated by

political expediency because it suggests that the authorities are eager to serve the interest of workers. However, the application of ESOP may be limited to few firms due to several reasons. Firstly, workers have neither the financial resources to buy enterprises nor access to working capital to operate an enterprise. Secondly, workers may not be

interested in putting a bulk of their wealth in one asset. Thirdly, an enterprise may benefit from being bought by an outside strategic investor who brings in additional investment and managerial skills. Fourthly, workers need to have fairly

democratic organization and a sophisticated knowledge base to operate firm effectively. Fifthly, while widespread ownership of equities might be desirable objective in itself, for effective corporate governance a strategic buyer or group

needs to establish managerial control. ESOP would be appropriate only for sectors where most of the value added originates from simple, unskilled or semi-skilled, direct labor but the level of technology and capital required is low and the scale of operation relatively

small. Since the objective of ESOP is to ensure workers’ support for privatization, the authorities may reserve some shares of enterprises to be divested for workers’ to buy at a discount. It can be argued that labor ownership of the firm

may reduce political opposition to privatization. Preparation for Privatization and Valuation

_The assets and the liabilities of the enterprises will be valued by a selected accounting firm, using one or more generally accepted accounting methods, subject to review by the authorities and, if necessary, revaluation by another selected

accounting firm. The authorities will provide the valuation report and other relevant documents, including three years’ financial and performance data of the firm, to potential buyers.

_The authorities should try to ensure that there is no collusion between the accounting firm and the potential buyer. Collusive practice would undermine the point of carrying forth the valuation exercise.

Terms and Conditions of the Sale _The policy states that there shall be no provision for writing-off long-term debt of the enterprise that will be privatized.

The buyer shall assume the long-term liabilities for the firm upon transfer. The short-term liabilities, such as claims of workers and incomes taxes, shall be assumed and be written-off by the state. If the value of the assets exceed bank loans, then the buyer will have to pay the excess amount either in cash or within one year along with a simple interest rate of 10

percent. _Short-term and long-term liabilities have to be clearly defined prior to privatization. A clear and consistent demarcation

of liabilities needs to established and upheld. If, however, the state does write-off long-term debt following privatization, it will be a transfer to the buyer of the firm. The policy also states the buyer shall assume full legal responsibility for all

pending court cases against the enterprise. _There should be absolutely no scope for renegotiating the terms and the conditions of privatization after the sale. Scope for renegotiating creates opportunities for rent-seeking and gives advantages to privatized firms over other firms in the

sector. _Intended buyers will need to submit 2.5 percent of the bid price along the tender. The wining bidder must pay 22.5

percent within one month. The balance of 75 percent has to be paid within 5 years at half-yearly installments along with compounded interest of 9 percent per year. In case the buyer pays the entire amount within 30 days of signing of the

agreement, there will be a 10 percent discount. Bank Guarantees

_When the price is not paid in cash, the buyer is required to provide a bank guarantee. But a guarantee from a bank with poor asset quality, low profitability, and poor management is worth very little. If the bank guarantee is issued by a

nationalized commercial bank, then ultimately it is the state that assumes the responsibility for the buyer’s credit. Such guarantees can have adverse effects by creating an incentive to default. Indeed, state bank’s guarantee may be contrary to

the objective of privatization as the public indirectly ends up assuming the burden if the buyer defaults. If the bank

guarantee is issued by private commercial banks with a reco rd and propensity for insider loans, such guarantee would be of little value. Bank guarantees would be acceptable when the bank can assume the responsibility for default and has the financial ability to meet its obligations without recourse to the state exchequer. Only guarantees from financially solvent

banks are reliable and trustworthy. If the authorities sell enterprises partly on credit, a strong mechanism for credit collection is required. Discipline in the banking and the non-banking financial system is necessary for the success of the

privatization policy because otherwise there will be both incentives and means for rent-seeking. Without proper incentives, buyers may borrow from banks against collateral of little value, refuse to repay bank loans, try to delay

payments to the state, and so forth. Land Use Constraint

_The policy states the land of the firm may be used only for industrial purposes. This provision may have been set to deter buyers from buying the enterprise for its land value rather than for operating the given enterprise as a

manufacturing unit. This provision is unduly restrictive and may be inappropriate because service and circulation activities are complementary to manufacturing. For instance, it may be beneficial for a firm to establish an on-site sales or service center or storage facility for inventories and produced commodities. Such a binding constraint will reduce the

sale price of the enterprise. _Recently the authorities have stated that the land will be unbundled from public enterprises and sold separately. There

is a tradeoff between the sale price of public enterprise and whether the surrounding property is unbundled. Unbundling the surrounding property and then selling the property at the market price is motivated by the desire to raise higher

revenue from privatization. The benefit of unbundling the property is that it creates a good number of new industrial estates with considerable market value because of booming real estate market and the scarcity of suitable industrial plots

in Bangladesh. The demerit of unbundling the adjacent property from the enterprise is that it restricts the scope for future expansion. It also requires the state to engage in more transactions incurring higher transaction costs.

Market Valuation and Tendering _Generally the market price reflects the "value" of the firm, provided it is being valued in a well-functioning and

informed market place, composed of a rather large number of agents. The authorities should, therefore, ensure that the tendering process is competitive and draws a large number of buyers. In the absence of a competitive environment there is scope for under valuation, particularly in a small group oligopoly market where the number of potential buyers are few

and there may be structural features that enable collusive behavior. _Under the present policy if the number of bidders is greater than or equal to three then the highest bid price will be

accepted even if the amount offered and the long-term debt accepted is less than the net worth of the firm. If the number of bidders is less than three then the highest bid price, along with the long-term debt assumed by the bidder, will

be accepted if and only if it is greater than the net worth of the firm. When the number of bidders is less than three but the bid price is lower than the net worth of the firm then it will be tendered again. In the second round of tendering,

irrespective of the number of bidders, the highest bid price will be accepted even if it is lower than the net worth of the firm.

_This mechanism for the disposal of the firm can be improved. The tendering process used in public sector procurement and sales in Bangladesh is weak. The institutional mechanism for tendering can and should be made more

effective by using a wide variety of practical and feasible auction techniques that have already been developed in the theoretical literature.

_The authorities can establish an appropriate reservation price for the firm to be privatized. If the bid price is lower than the reservation price, then the authorities can convert the public enterprise into a joint stock company and sell its shares.

When a strategic buyer, who is willing to pay above the reservation price, is not forthcoming, the state can use initial public offer scheme. The policy has provisions for such procedures to be followed.

Features of the Fledging Capital Market in Bangladesh and its Effect on Privatization The capital market in Bangladesh is attenuated. It does have potential for growth; it is evolving. There are two stock

exchanges in Bangladesh: Dhaka Stock Exchange and Chittagong Stock Exchange. Dhaka Stock exchange, based in the capital city, is older of two, whereas Chittagong Stock Exchange, based in the main port city, is recently established. Dhaka Stock Exchange was incorporated in April 1954 as East Pakistan Stock Exchange and commenced trading in

1956. However, trading was suspended during the National Liberation in 1971. It resumed trading in 1976 with only 9 listed companies. Chittagong Stock Exchange was incorporated in April 1995 and commenced trading in October 1995.

Dhaka Stock Exchange has 195 members and Chittagong Stock Exchange has 124 members. In 1998, the average number of actively traded securities at Dhaka Stock Exchange was 150 and at Chittagong Stock Exchange was 65. At

both exchanges, trading is now automated. Both exchanges trade in equity shares, debentures, and mutual funds. As of June 30, 1997, market capitalization was approximately 5.2 percent of Gross Domestic Product (1997). The capital

markets witness a brief period of speculative boom from mid-1996 to early 1997, when the bubble burst dramatically. Since then investors have been quite reluctant to invest in financial assets despite the authorities attempt to revive the

stock market. Data concerning the capital markets, as of June 30, 1998, is provided in Table 2 below.

Table [2]: Capital Market In Bangladesh Capital Market in Bangladesh Data Concerning the Stock Market As on June 30, 1998 Dhaka Stock Exchange Chittagong

Stock Exchange

Total Number of Companies 204 131

Total Number of Mutual Funds 9 9

Total Number of Debentures 11 4

Total Number of Listed Securities 224 144

Total Number of Shares of all Listed Companies

520,115,359 396,677,190

Total Number of Certificates of Mutual Funds

2,250,000 1,250,000

Total Number of Debentures of All Companies 841,104 266,000

Total Number of All Securities 523,206,463 398,193,190

Total Issued Capital of all Companies (Tk) 28,329,361,780 22,378,612,890

Total Issued Capital of all Companies (US$) 607,926,218 480,227,744

Total Issued Capital of all Mutual Funds (Tk)

225,000,000 225,000,000

Total Issued Capital of all Mutual Funds (US$)

4,828,326 4,828,326

Total Issued Debentures (Tk) 1,657,109,600 694,650,000

Total Issued Debentures (US$) 35,560,292 14,906,652

Total Issued Capital (Tk) 30,211,471,380 23,298,262,890

Total Issued Capital (US$) 648,314,836 499,962,723

Total Market Capital of All Companies (Tk) 60,526,953,565 48,582,474,005

Total Market Capital of All Companies (US$) 1,298,861,664 1,042,542,361

Total Market Capital of Mutual Funds (Tk) 537,884,500 618,300,000

Total Market Capital of Mutual Funds (US$) 11,542,586 13,268,240

Total Market Capital of all Debentures (Tk) 1,199,530,080 792,600,000

Total Market Capital of all Debentures (US$)

25,740,989 17,008,584

Total Market Capitalization (Tk) 62,264,368,145 49,993,374,005

Total Market Capitalization (US$) 1,336,145,239 1,072,819,185

All Security Price Index 676.47 294.72

US$ 1 = Taka 46.60 (December 1998)

Source: Security and Exchange Commission, 1998

The privatization policy assumes a developed, fairly competitive, and efficient capital market, including a market for corporate control. However, the flow of information for investors in the capital market is imperfect and incomplete. The firms’ accounting records and accounting and auditing standards are poor. Investors lack access to accurate material information and reliable data about firms. There are often delays in the publication of annual reports. The capital market regulations are lax and not properly implemented. The financial press is underdeveloped. The absence of investigative financial journalism makes it difficult to check and forestall insider trading and malpractice in the capital market. The reliability of information and data about firms in the capital market is poor. Thus, the highest bid price may not reflect the value of the firm in terms of economic fundamentals. The authorities should allow buyers to sell "privatization bonds" in the capital market to raise funds to buy enterprise. However, the state and the nationalized commercial banks must not underwrite or purchase bonds issued to finance the leveraged buyout of the public enterprise. In essence, there should not be any state subsidy to the buyer of the enterprise. The private sector must assume full financial and economic responsibility for running the enterprise. At present various non-government organizations have been able to pool the savings of lower income social groups through credit schemes and income generating activities. Some of these non-government organizations have developed managerial expertise, and experience in operating commercial ventures. These organizations might also be encouraged to participate in the privatization program. The Proceeds from Privatization and Labor Issues _Under present policy, the revenue from privatization accrues to the Government of Bangladesh. The proceeds should not be viewed as dividends but as sale of assets. The proceeds from privatization of enterprises may be used for addressing the problems arising from labor retrenchment due to privatization. As firms downsize under private ownership, many jobs will be abolished and some workers will be replaced. As a result, this will increase unemployment in the manufacturing sector because not all dismissed workers will be able to find jobs. _The working class will oppose privatization unless its losses are compensated and privatization leads to the creation of new employment. Thus, funds from privatization should be used for (a) workers’ compensation (severance payments), and (b) labor training and relocation programs. Labor retraining program shall improve labor productivity. At present, there are only a limited number of vocational training institutes in Bangladesh. State policies should support vocational training and skill development programs because the country needs productive workers in many sectors. Privatization of Monopolies and Regulatory Framework _The present policy framework does not contain any mechanism for creating and enforcing regulatory and competition policies. If the authorities carry forth the privatization program, then the state would eventually also transfer public monopolies in utilities, infrastructure, and communications to the private sector. However, in order to ensure gains from privatizing in non-competitive sectors, industry regulations must be in place and be implemented rigorously to protect consumer interests and social objectives. Properly regulated monopolies and oligopolies transferred to the private sector have limited ability to abuse market power and are governed by a good set of incentives that promote improvement of productivity and service. For Bangladesh, privatization and private sector entry in monopolies and oligopolies should be accompanied with a strong, credible, transparent regulatory framework that limits the scope for abusing market power and appropriating rents. Speed, Time Framework, and Program Effectiveness _The authorities had announced that 54 firms are to be privatized within the financial year 1997-98. But the authorities were unable to privatize such a large number of firms. The Awami League government reconstituted and strengthened the Privatization Board since assumed power in 1996. However, since then only four enterprises have been privatized and handed over to the private sector. The pace of the program is slow even though the authorities are determined to privatize a large number of enterprises within two or three years. The parameters and scope of privatization has not yet been agreed upon at the highest level. The policy does not provide a time framework for the completion of the privatization program in Bangladesh. If followed accordingly, an indicative timetable for privatization, with set goals for each stage of privatization, would send strong signals to investors and create confidence in the authorities’ commitment to an effective and goal-oriented privatization program. _A rapid and well-planned privatization is to be preferred over a slow and ill-conceived privatization. A slow and ill-planned privatization program can demoralize workers and managers in the public sector. The management of enterprises may engage in capital depletion if they have no stake in the privatization process. At present they fear that they will lose their job security after the transfer of ownership from the public sector to the private sector. Privatization should be carried out quickly, retaining the loyalty and morale of the firm’s workforce. _According to the policy, the state shall ensure that the transfer of the privatized enterprises is complete within 90 days of signing of the agreement. The less delay there is in the transfer process, the better it is for corporate management. Conclusion

_The criteria for successful privatization are as follows: (a) efficient use of capital and labor in production; (b) dynamic gains from drawing in additional investment from both domestic private sector investors and overseas investors; and (c) better macro-economic performance. The success of privatization of public enterprises is contingent upon not only proper valuation and competitive market for corporate control, but also a tough central bank, strong asset quality of financial institutions, well-functioning capital market, competitive labor market, and proper regulatory framework for monopolies and the financial system. The authorities need to pay close attention to policy factors and business environment required for improved post-privatization corporate performance (Mahmood 1999). _The objective of privatization policy should be to increase economic growth by better management of resources. Therefore, privatization policy would have to be accompanied by a set of policies that ensure that entrepreneurs profit from productive endeavors rather than at the expense of the public and the development of the country’s financial system. The policy should not regard privatization as an end in itself but as means towards increasing efficiency and economic growth. n References

1. Government of Bangladesh (1996). Privatization Policy. Dhaka, Bangladesh: Privatization Board, Government of Bangladesh.

2. Government of Bangladesh (1998a). Privatization in Bangladesh . Dhaka, Bangladesh: Privatization Board, Government of Bangladesh.

3. Government of Bangladesh (1998b). Privatization Policy in Bangladesh and Options. Dhaka, Bangladesh: Privatization Board, Government of Bangladesh.

4. Mahmood, Syed Akhtar (1999). "Privatization in Bangladesh: Some Critical Questions," Scanner.