Viewpoint The World Bank FPD Note No. 31 November 1994 Privatization by Capitalization The Case of Bolivia: A Popular Participation Recipe for Cash-Starved SOEs Andrew Ewing and Susan Goldmark As presidential candidate Gonzalo Sanchez de Lozada ("Goni") was pre- What is capitalization? paring his campaign for Bolivia's 1993 Capitalization is privatization with the elections, he faced, on the one hand, distinguishing feature that the sale proceeds populr prssur forfaster tangible stay with the company to finance future - gg_ popular pressure for faster tainvestment. If, for example, the net fixed results after a lengthy spell of economic assets of an electricity company have a stabilization policies and, on the other, market value equivalent to US$100 million, a populr anxiey abou certai reme- a strategic investor would pay US$1I00 .l . - a popular anxiety about certain reme- million into the company. The company dies. While minister of planning in the would now be worth US$200 million: reform-minded government of the mid- US$100 million of fixed assets and US$100 1980s7 he had used "shock therapy" to million of cash. In the Bolivian model, a popular participation feature is added: the help bring hyperinflation under control. govemment share of this new company Now, eight years and two governments would be distributed to the Bolivian peo- later, the economy was stable, but ple. This approach to privatization can Bolivians were mitigate some of the popular doubts about hardly growing. Most Bolivians were traditional trade-sale privatizations. Also, still very poor, struggling with the re- leaving the proceeds with the company gion's lowest literacy rates and high helps to solve the shortage of cash for infant mortality. Only double-digit rates working capital and investment that com- monly afflicts popular participation of growth could make rapid headway. schemes in Eastem Europe. The approach Privatization was one obvious answer. seems to be relevant in situations where: The state was still very much the key * The asset for sale is likely to be of interest to a strategic investor. player in important sectors such as - The government can afford to give up mining, hydrocarbons, and public utili- the direct proceeds of the sale. ties. These operations were generally *Popular participation may help avoid perceived as being inefficient and, in . political backlash. -The sector needs significant new some cases, corrupt. But Bolivians were investment. suspicious of privatization. They feared The Bolivian model has some way to go it meant a loss of jobs, a loss of the before its performance can be judged. Nevertheless, the approach is interesting nation's patrimony, and a return to enough to warrant the "mid-term' assess- (probably Yankee) imperialism. ment provided in this Note. When and if its success has been clearly demonstrat- ed, the Bolivian model will likely be Then the campaigning president-to-be adaptable for use in other economies. noticed the popularity of Eastern Eu- I , - nPrivate Sector Development Department FPD.Vice Presidency for Finance and Private Sector Development rope's voucher schemes for popular participation. from the general worry about how a relatively im- He read about the problems eastern Germany's poverished government can afford to give up the privatization program was having with its leveraged revenues from privatization, the key capitalization management buyouts. Though these buyouts gave issues are: enterprises new managers, the managers had no * How will a strategic investor with only 50% of a capital for investment. Combining the appeal of company's stock be assured of sufficient control popular participation with the new feature of retain- over the company to warrant the investment? ing the buyers' payment in the business, he pro- * In the short term, what restrictions will be put on duced the unique Bolivian model of capitalization. the company's use of the new investor's funds And thus in May 1993, he announced his campaign deposited in its accounts? strategy, "Plan de Todos." The Plan de Todos (loose- * If the longer-term purpose of these funds is to ly, plan for everyone) proposed a simple privati- facilitate investment in the company and sector, zation model for six large state enterprises in key how will this be spelled out, and what sanctions sectors. The enterprises would be offered for sale by will be applied if the investments are not made? international tender. The successful bidder would * How will "all adult Bolivians" be identified? Many pay the agreed price not to the government, but into Bolivians live in quite isolated areas, and there is the company itself, doubling its net worth. The cash no tradition of citizen registration. would be used for investment in the sector, stimulat- * What form will the distribution take? ing expansion and efficiency improvements together * Who will safeguard Bolivian citizens' interests? In with job creation. Initially, the strategic investor and particular, what is to stop the new majority share- the government would hold equal, 50% stakes in the holder from "ripping off" the minority shareholders? new company. In the original Plan de Todos, the government would immediately give its share in Giving up the revenuies equal parts to all adult Bolivians-about 3.2 million Sanchez de Lozada believed that the privatization rev- people. When this process was done for all six sec- enues would do more for ordinary Bolivians if these tors in the plan (telecommunications, electricity, oil funds were under the control of private owners of and gas, railways, aviation, and parts of mining), newly capitalized firms. He had two reasons. First, he about US$2 billion of shares would have been dis- thought this would lead to more investment and more tributed to Bolivian adults and about US$2 billion of new jobs and that eventually the budget would benefit new funds would be available for investment by the from larger tax streams. Second, he had misgivings now privatized Bolivian companies. In addition, the about how the government bureaucracy would use the government figured that these funds would allow money. He was afraid that large flows of privatization the privatized companies to leverage another US$6 revenues in the hands of the bureaucracy could con- billion or so of debt, if necessary. tribute to more inefficiency and possibly corruption. Sanchez de Lozada won the presidential election in Early shift to pension fund mode July 1993. With the help of World Bank advisors, he Fairly early on, the government decided that giving has been working to make this capitalization con- ordinary shares in six companies to over 3 million cept a reality. Bolivian citizens would create enormous logistical problems. So instead, it decided to use the shares to Special capitalization issues endow "pension accounts" that would be set up for While the process has been moving along fairly well each adult citizen. The pension accounts would be since then, it has run into many of the thorny issues managed by a number of competing private pension associated with traditional privatization schemes- funds. While the capitalization law passed in early sector reorganization strategies, the legal framework, 1994 specifically linked the citizens' participation to and regulatory considerations (see box on page 3)- a pension-based model, none of the infrastructure and a unique set of capitalization challenges. Aside for this scheme is yet in place. 2 Investor interests and obligations investor would be able to buy shares in open mar- A 50% stake in a company is usually enough to en- kets to increase the shareholding beyond 50%. sure management control. However, to avoid any uncertainty and the risk of a negative impact on the When the buyer takes over the company, cash bal- selling price, the capitalization law proposes that a ances will be more or less equal to what the buyer management contract be given to the strategic inves- paid for it. Potential investors have been quick to tor for a fixed period of time. After that time, the see the advantages of taking over a company with a Traditional privatization issues Progress in telecommunications is also well advanced. Here the situation is complicated by the fact that although a single state- After first passing a "capitalization law" to provide a legal owned company (ENTEL) has a monopoly on long-distance basis for the transfer of ownership, the government estab- and intemational telecommunications traffic, local service is in lished a strong Ministry of Capitalization in March 1994. A the hands of twenty-odd local cooperatives. The reorganization fairly standardized approach was developed for each of the solution that has been accepted will see the newly capitalized six sectors. Working groups were set up comprising gov- ENTEL make firm commitments to invest in the expansion of ernment officials and senior officers of the affected compa- the seriously underinvested local networks. The cooperatives nies, supplemented with foreign consulting expertise where will have the option of either merging with the new company required. The working group has to develop a strategy for or competing in the provision of local telephone services. reorganizing and privatizing the sector, and then draft whatever legislation would be necessary to make it hap- Oil and gas is the most complicated sector, and the capitaliza- pen. Technical, legal, and financial advisors and investment tion strategy is still evolving, with major questions remaining banks would be brought in to help get the transactions about how (or even whether) YPFB, the dominant state- done. A series of IDA-financed operations is assisting in owned oil company, should be broken up prior to capitaliza- this process. The most important is an adjustment opera- tion. Strategic and legal issues should be settled in the next tion, financed jointly with the IDB. This operation is de- few weeks, and capitalization transactions in the oil sector are signed to help the government cover the loss of transfer expected by mid-1995. payments from the oil and gas and other sectors until proper tax systems can be put in place to restore these The railways sector is also complex. There are two main rail revenues. It will also look at possible debt rescheduling systems, but they interconnect in Argentina, not Bolivia. One and separation payments as companies are prepared for of the systems is reasonably profitable; the other probably is sale. Supporting technical assistance operations are also not. Some operations effectively get subsidies because they under way. do not pay their taxes. How to organize the railways' assets for capitalization and what to do about subsidized operations The government has recently passed a law to regulate con- have proved to be the hard issues. Mid-1995 is the target for sumer-oriented and competitive parts of the electricity, com- initiating capitalization transactions in this sector. munications, hydrocarbons, transport, and water sectors. Under the new law, separate "superintendencies" will be The previous government had already tried and failed to established for each of these sectors, but they will all be privatize the national airline (LAB). The working group is grouped together under a "general superintendent" in a hoping to stimulate wider interest by proposing that interest- comprehensive single regulatory agency, with common ap- ed investors may capitalize the airline all or in part with peal processes. As of November 1994, achievements and aircraft rather than cash. Also included in the sector plan is further objectives are briefly as follows. the privatization of airports and services. Major transactions in this sector are expected in mid-1995. Plans for capitalizing the electricity sector are the most advanced. The separation of generation from distribution Capitalization of the mining sector is being limited to a rela- and transmission will take place, and generation will be tively small number of industrial smelters. These will be divided into three separate companies. Generation and offered for sale with long-term mining leases designed to transmission units will be offered for sale in separate "capi- secure ore supplies while not violating constitutional bans on talization" transactions. Investment bankers have been the sale of mining properties. Various groups of mines and retained, and sales should be taking place in the first quar- processing units are being considered; it is expected that the ter of 1995. first transactions will take place around mid-1995. 3 healthy and liquid balance sheet. Assuming that an citizens' interests during this interim period? Who will agreed investment program is part of the sales con- be the investors' partner? And what share voting tract, and since planning for capital investment has a rights will this partner have? The current plan is to lead time, the new owner will, in the meantime, be place these shares "in trust," with the trustee's voting able to manage these balances as for any other pru- rights limited to a few major categories of decision. dent company, with short-term, low-risk investments This would seem to be a workable and equitable within or outside of Bolivia. Enforcement mecha- solution, one that would allow time to develop prop- nisms or sanctions to ensure that the investor deliv- er answers to the pension scheme questions while ers on the "agreed" investment plan will be devel- not prejudicing the success of capitalization transac- oped for each sector on a case-by-case basis. Local tions or the rights of the Bolivian people. The final telephone services, for example, are so underinvest- decision will be made within the next few weeks, ed that it will be easy to follow the approach adopt- before any capitalization transactions are concluded. ed in other telecommunications privatizations-nu- merical regional targets for new installations. The Finally, with major multinationals as the likely strate- general approach will be to create a climate where gic investors, and yet-to-be-established pension funds investment by a company in its own sector will be a as the Bolivian people's representatives in the capital- logical and profitable option, making sanctions un- ized companies, who will look after the people's in- necessary. Contractual obligations will be clearly terests in the longer term? The safeguard system is spelled out at the time of the transaction. still being developed. At this stage it is proposed that even during the period when capitalized companies Popularparticipation issues are being managed by strategic investors under man- Having decided to take the pension account route, agement contracts, the articles of association will re- the government must now grapple with preexisting quire, for certain decisions (for example, related to financial problems in Bolivia's pension scheme. The the disposal of assets or to major capital investments), government is hoping to solve them in parallel as a "super majority" of shareholders, ensuring that the new rules are developed for capitalization. Clearly, it pension funds represented on the boards of directors will be important to ensure that the new pension of the companies are given a meaningful voice in scheme is not "contaminated" by the old problems. important strategic decisions. Second, the new pen- sion fund law now being drafted will closely control A citizen registration scheme for the pension ac- what pension funds can do with the resources en- counts based on voter registration is under way. But trusted to them and give strong regulatory powers to Bolivians-particularly those already past retirement pension fund regulators. Eventually, the pension age-still do not know when and in what form they funds, and Bolivian citizens, will be able to trade can expect a "payout" from the scheme-for exam- stock in capitalized companies on the Bolivian stock ple, whether it will be in lump sum or an annuity. market as well as in international markets. Although The first capitalization transactions will almost cer- the local stock market is barely regulated as yet, new tainly happen before the pension scheme is fully in laws and regulations should improve the situation. place. In the interim, the government needs to settle what will happen to the citizens' shares in the period Andrew Ewing, Manager, Private Sector Development Department, Susan between capitalization and the establishment of a Goldmark, Private Sector Development Specialist, Latin America and the private pension industry. Who will look after the Caribbean Country Department III This series is published to share ideas and invite discussion. It covers financial and private sector development as well as industry and energy. The views expressed are those of the authors and are not intended to represent an official statement of Bank policy or strategy. (D Printed on recycled paper. Comments are welcome. Please call the FPD Note line to leave a message: 202-458-1111; or contact Suzanne Smith, editor, Room G8105, The World Bank, 1818 H Street, NW, Washington, DC 20433, or Internet address ssmith7@worldbank.org. 4