Troika terms for privatisation make sense

PIMCO, the firm appointed to look at the requirements for bank restructuring, appears to be estimating their recapitalisation needs at €10 billion. This has brought to the forefront the issue of privatisation as a way of helping repay the bailout. Given the strident reaction of political parties to this development and the urgency of the issues raised, it seems appropriate to correct some of the impressions given and to suggest a framework for analysing the subject.
The main difficulty that arises in trying to estimate how much assistance is required by Cyprus from the EU arises from the difficulty in calculating the requirements of the banking sector. The problems arise because Cyprus banks hold about €100 billion in deposits, more than five times the level of GDP, mainly in branches of the two largest local banks (Bank of Cyprus and Laiki). About a quarter of these branches are in Greece. That they are branches, not subsidiaries, creates a major problem that needs to be addressed, but is not the issue here.
Three interrelated factors need to be considered. One is the capital requirement of banks set at 9 per cent in 2014, another is the level of non-performing loans, and the security guaranteeing loans (mainly mortgaged property). There is also the problem of the financial instruments used by the two main banks to recapitalise the losses from the Greek haircut, said to be around €1.8 billion. These are said to affect 60,000 people, but here there is no other possible solution than to give bank shares in exchange. Neither the banks nor the government can cover the cost of compensation, but irregularities should be considered by the courts and the appropriate authorities.
The politicians state that the preliminary estimate by PIMCO of €10 billion is an extreme estimate, which should be reduced by about 40 to 50 per cent and thus make the island’s debt both manageable and viable. It appears that the PIMCO terms of reference have been set by a joint committee of the troika and the government/central bank. Any assessment is complex. In the first place terms of reference have to be established, and then the methodology agreed. It seems that this was not undertaken in a manner consistent with normal planning procedures. For example, one would have expected that PIMCO would be required to develop a lowest likely estimate, the maximum (the reported €10 billion), and the most probable outcome (possibly between the two). Logically, however, the consultants should for each case also show the proportion of the three estimates covered by real guarantees.
A strong case should be made for the recapitalisation requirements to exclude the guarantees. But this raises another issue of disagreement with the troika – the period required for bank foreclosure on property covered by mortgages. Here again, the troika proposals of two to three years are reasonable, and should have been accepted on condition that borrowers are given the chance to repay under easier terms, or to sell their property to repay the loan. In other words the time period should be used to find and agree on reasonable solutions. The failure to agree to the troika’s suggestions would force any consultant to make a larger assessment of requirements.
The question then arises as to how Cyprus can raise the money for repayment of the €6 to €10 billion that may be the final estimate agreed upon (possibly next week as PIMCO is expected to report on January 15). Here, the troika states that Cyprus must consider privatising those state controlled organisations that are profitable and suitable for privatisation. Again the troika is right. The profit-making state institutions have profits, capital and reserves that could significantly improve repayment of state commitments. The problem is the government is dead against this option, even though it is the one which has the least effect on the household purse. Why should the middle class and the poor be forced to pay through regressive Value Added Tax and pension cuts for the sake of the key state organisations’ highly paid staff and their extra-ordinary perks?
The Memorandum of Understanding with the troika tackles privatisation in two ways, first by an agreement to consider Public Private Partnerships (PPPs), like the very successful Hermes Cyprus airports. This has enabled two new airport terminals to be built at no cost to the government, and at the same time provided payments to the state for the land and other concessions. PPPs have not all been successful in Cyprus and elsewhere, but the airport deal shows that at their best they can lead to modernisation and benefits all round. These systems may for example be appropriate for the ports, land development and infrastructure.
The memorandum also calls for a full inventory of government wealth, so that the potential for PPPs can be determined and the management of wealth improved. This is a much needed provision that will greatly help both development and the improvement of government returns on capital.
On privatisation the memorandum concludes that if “necessary to restore debt sustainability the Cyprus authorities will consider a privatisation programme for state owned and semi-public companies”.
The focus here has been on the Cyprus Telecommunications Authority (CyTA) and the Electricity Authority (EAC) both of which are profit making and have substantial assets. However, a review of the institutions established under public law examined by the auditor general (2011 Report) shows that there are 63 such institutions, though many cover social and health functions or are otherwise unsuitable for privatisation. An examination of those involved in commercial activities shows that there are twelve potential candidates for privatisation as follows (all figures for 2011):
(i) CYTA which had a surplus of €83 mln, revenues of €526 mln, a reserve value of €875 mln cash of €242 mln and state bonds of €36 mln, and 2869 staff.
(ii) EAC had a surplus of €75 mln, revenues of €926 mln, assets of €2.2 bln and a reserve value of €959 mln and 2,370 staff.
(iii) Cyprus Ports Authority which had a surplus of €30 mln, revenue of €68 mln reserves in cash at 150 mln, and very valuable property.
(iv) Cyprus Stock Exchange is currently loss making, and in Cyprus given the problems of the stock market is probably not suitable for privatisation.
(v) Housing Finance Organisation has restrictive regulations for profits, a surplus of €8 mln, but deposits of €926 mln, and could be converted into a mortgage bank and equity sold on CSE.
(vi) Land development Corporation has restrictive regulations on profits, a surplus of €4 mln, a budget of €37 mln, and handed over to purchasers 313 housing units.
(vii) Cyprus Grains Commission did not submit accounts, but could be broken up and sold since it has considerable assets.
(viii) Cyprus State Fair did not submit accounts, but controls large areas of valuable land and may be suitable for PPP.
(ix) Olive Products Council should not be closed but sold.
(x) Central Slaughterhouse should be converted to PPP.
It is difficult to estimate the value of the above, in part because the auditor’s reports do not give full details and the value of the land is unknown. A further difficulty is that land prices at present are low and what response flotation on the CSE of shares may have is an unknown factor. But CyTA and EAC should be worth between €3 to €5 billion over time and with their prospects, while the others could fetch another €1 to €2 billion. So they would help pay for much of the debt. Assuming the banks go well then the government could sell off shares and get back much of what was put into the banking sector.
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Costas Apostolides is chairman of EMS Economic Management Ltd ([email protected])