"Raising Revenue" with Privatization

Privatization is most accurately described as a restructuring of government assets rather than as "raising revenue".  Privatization involves exchanging ownership of a relatively illiquid asset (a state-owned company) for a current asset (cash).  Considering privatization from a balance sheet perspective also emphasizes that revenue from privatization is not a cash flow like tax revenue.  Privatization revenue for a government is like an increase in a company's working capital.   Nonetheless, governments often turn to privatization for revenue to fill budgetary gaps, i.e. shortfalls in cash flow.  Governments using privatization revenue to fill budgetary gaps need to ensure that such revenue is not merely obscuring a budgetary position unsustainable in the long term.

The Kenyan government's financial position had some influence on the privatization of Kenya Airways.  The cash from the sale of 26% of Kenyan Airways to KLM came at a point when the government particularly needed additional cash, and this need for cash helped to propel the sale forward.  The privatization of Kenya Airways also helped to strengthen Kenya's record of policy reform.  Kenyan leaders felt that clear signals of reform would help Kenya attract capital both from private lenders and international financial institutions such as the World Bank.

Attaching too much significance to generating cash through privatization can lead to industry and regulatory structures that have a large social cost.  Investors are often willing to pay more for a company that is granted a de facto or de jure monopoly for particular products or services.  Monopolies raise consumer prices and create deadweight loss, in addition to often being not cost-efficient and not innovative.  Governments preoccupied with maximizing the value of a privatization will be tempted to include with a privatization monopoly rights or regulatory guarantees that suppress competition.   Granting such rights in order to garner more cash is often a short-sighted policy with high social welfare costs.

As part of the privatization of Kenya Airways, the Kenyan government made commitments to retain the existing regulatory structure of the Kenyan airline market for at least five years.  In particular, the Kenyan government committed

While these commitments give Kenya Airways a certain measure of protection from possible domestic competitors, they do not imply a grant of monopoly power to Kenya Airways.  The foreign correspondent on any bilateral route provides some competition for carrying passengers from and to Kenya on that route.  A more radical liberalization of airline markets, such as one which would eliminate the bilateral route structure and allow open competition for carriage between country pairs, would require an international agreement rather than merely Kenyan government action.

A government's revenue target for a privatization may affect its judgment about an acceptable private bid for shares or about an appropriate offering price in an initial public offering. There can be considerable uncertainty about the value of a state owned enterprise. A preoccupation with valuation may cause significant delays.  On the other hand, governments may face a political backlash if state assets are sold to private investors at what are perceived to be unrealistically low prices. Governments need to recognize that significant social returns from privatization, such as promoting the development of a competitive industry and deepening equity markets, are not incorporated in the value of the privatization transaction. These returns from privatization suggests the importance of a pragmatic approach to valuation that allow privatization to proceed expeditiously.

As the timeline shows, a policy goal of privatizing Kenya Airways was established in 1992. Overall the Kenyan government sold 77% of Kenya Airways. From KLM's purchase in December 1995 of 26% of Kenya Airways, the Kenyan Treasury received US$26 million cash (equivalent to about KShs. 1,374 million at the bid acceptance date). Kenya Airways also received from KLM technical and service facilities valued at US$3 million. From the public offering of 51% of Kenyan Airways shares, completed in May, 1996, the Kenyan Treasury received KShs. 2649 million.

Questions for Discussion

1. If the Kenyan government had significant surplus cash flow in its budget, would it have privatized Kenya Airways?  Should it have privatized Kenya Airways if there was no need for cash?

2. Was an appropriate regulatory structure for the Kenyan airline industry established in conjunction with the privatization of Kenya Airways?

3. What were the net implications for the Kenyan budget of restructuring and privatizing Kenya Airways?

Go to Kenya Airways: Case Study in Privatization

Go to Topics in Economic Policy