IntroductionPrivatization

Privatization is the act of reducing the role of government, or increasing the role of private sector, in an activity or in the ownership of assets. Privatization has been prescribed as a means of improving the efficiency and profitability of public enterprises, which are not performing well. The privatization of government owned enterprises is nowadays a large-scale process for the transfer of state owned enterprises to the private sector. Privatization, as an instrument for development is finding significant currency in industrial and developing countries throughout the world and is one of the important components of socio-economic reform programmes being implemented around the world. The major aim of this policy is to reduce the drain on the government resources, caused by the persistent losses of public enterprises, and to create greater opportunities for private investors to expand and modernize these enterprises with the aim of liberalizing the economic environment for rapid industrialization. The importance of state owned banks in these developing countries contrasts worryingly with recent research findings that state ownership of banks has pernicious effects. Barth, Caprio and Levin (2001) (BCL) found that state ownership is negatively associated with bank performance and overall financial sector development, and does not reduce the likelihood of financial crises. La Porta, Lopez-de-Silanes, and Shleifer (2002) (LLS) find that greater state ownership in 1970 was associated in 1995 with less financial development, slower growth, and lower productivity.

Given its negative effects, one might expect governments to move quickly to phase out state ownership of banks. While some have done so in recent years, others have been reluctant, and the banking crises of the 1990s even led to re-nationalizations in some countries.

The privatization of State Owned Enterprises (SOE) became an important instrument of economic policy of the government in late 80s. However, it was in 1991 that privatization process in Pakistan became effective.

The privatization process in Pakistan has passed through different phases and it has been very instrumental to redefine the relationship of private and public business with the government institutions. A large-scale privatization effort was launched in November 1990, the government declared privatization as its primary economic policy objective, when the Disinvestments and Deregulation Committee was established to identify the enterprises to be privatized and to make recommendation on how this process should take place. The agenda of privatization announced by the Government covered a wide spectrum of fields like industries, banks, development finance institutions, telecommunications, energy sector, and electricity and infrastructure facilities for the stimulation of private sector.

Privatization in Habib bank limitedOn December 29, 2003 Pakistan's Privatization Commission announced that the Government of Pakistan had formally granted the Aga Khan Fund for Economic Development (AKFED) rights to 51% of the shareholding in HBL, against an investment of PKR 22.409 billion (USD 389 million). On February 26, 2004, management control was handed over to AKFED. The Board of Directors was reconstituted to have four AKFED nominees, including the Chairman and the President/CEO and three Government of Pakistan nominees.

Although HBL was privatized in 1997 if we look back at the process of privatization it was initiated way back in 1997 when government appointed Mr Shaukat Tareen as the president of HBL. He introduced the foreign teams in HBL’s management which was the last effort made by the government in order to restore the HBL’s management system in its proper condition.

Statement of problem:

The inefficiency of government to run public enterprises today that calls for the privatization of these enterprises. However, one notes that privatization may not likely be the only solution of getting government-run enterprises on the ideal path of efficiency, deregulation and market oriented economy. The study therefore, believes that there should be some silent initiatives that if properly harnessed could be the shining light to lead the nation’s ship to the desired harbor.

Hypothesis:

Significance of the Study:The result of this study would be beneficial not only for the researcher, but also to the

improvement of several financial institutions of Pakistan and around the world.

Habib bank limited (HBL). This study can help the company improve the

understanding level in order to learn the positive impact of privatization Of Habib

bank limited and in order to increase the productivity level of the bank

Employees of Habib bank limited: The employees of habib bank limited would be

another party to benefit from the study. The information can provide them the ideas

on the current status of the profitability and productivity of the bank after privatization,

and be able to improve them to increase the performance of the bank

Bank’s customer: The study can help the customers understand

what are the impacts of privatization on Habib bank limited

Privatization commission of Pakistan:

Other financial institution of Pakistan:

In the field of business administration of AMA International University: This

study will provide relevant information to the Business Administration of the

University to their studies in the field of Finance

Scope and limitation:

Definition of terms:

VariablesWe are interested in the effect of partial privatization on the followingcategories of firm performance: (1) profitability; (2) labor productivity; and(3) employment. We use the annual values of (log) revenues from sales and(log) accounting profits as measures of profitability. Annual sale revenuehas been used in other studies to also estimate productivity. Profits aremeasured as the income before tax from the main activity of the firm andit does not include any payments made by the government (or other entity)to the firm. Our two measures of efficiency are the (log) average product oflabor and returns to employment (ratio of operating income to labor). Thefirst is the ratio of net sales to employment and is a standard measure oflabor productivity in the literature, the second variable measures averageincome generated per worker and is used by LaPorta and Lopez-di-Silanes(1999) among others. We also have (log) annual employment as a dependentvariable. The construction of the variables are described in the Appendix.The explanatory variable we focus on is PRIVit which measures the fractionof equity of firm i, taking a value between 0 and 100, that is privately ownedin period t.11 Firm specific controls include lagged performance, lagged (log)annual assets to control for firm size, competition policy changes, and thelagged share of government financing(loans and subsidies) in total borrowingas a measure of political interference.

Chapter II

Review of literature and studies:

Related literature

Foreign literature:

A large theoretical and empirical literature, summarized in Shirley and Walsh,

2003, examines government ownership and privatization of state owned enterprises

(SOEs). Much of the rationale for government ownership in this literature comes from the

theoretical view that government is composed of well -- or even perfectly – informed

agents whose principal goal is to maximize social welfare. Under this assumption,

government ownership reduces the cost of government intervention to correct market

failures (Sappington and Stiglitz 1987) including natural monopolies (Millward 1983),

reduce income inequality (Willner 1996), and undertake a host of other social goals

(Choksi 1979). Seen in this light state ownership of banks could be justified as an

efficient way to raise capital for projects with high social returns but low private returns

or to provide finance to poorer borrowers that would be neglected by less well informed

or motivated private bankers.

Local literature:

The concept of privatization is not new to the policy makers of Pakistan. It may be traced

as back as in 50s, when Pakistan Industrial Development Corporation (PIDC) was

established in 1952 to boost up the industrial development in the country. This premier

Corporation established over 50 industrial undertakings in the length and breadth of the

country and after their successful operation and management; these units were transferred

from the public to the private sector. The tide of nationalization, which swept the whole

economy in the first half of 70s, was reversed in 1977. The privatization of State Owned

Enterprises (SOE) became an important instrument of economic policy of the

government in late 80s. However, it was in 1991 that privatization process in Pakistan

became effective.

The privatization process in Pakistan has passed through different phases and it has been

very instrumental to redefine the relationship of private and public business with the

government institutions. A large-scale privatization effort was launched in November

1990, the government declared privatization as its primary economic policy objective,

when the Disinvestments and Deregulation Committee was established to identify the

enterprises to be privatized and to make recommendation on how this process should take

place. The agenda of privatization announced by the Government covered a wide

spectrum of fields like industries, banks, development finance institutions,

telecommunications, energy sector, and electricity and infrastructure facilities for the

stimulation of private sector.

In the early phase of privatization, the program was unsuccessful with few bidders for the

targeted firms. Since privatization was a cornerstone of the government's economic

policy, the government revised its strategy and accelerated the process. It improved the

legal and administrative procedures, and while it had decided initially to adopt the policy

of offering only few units for sale at a time. Attempts were also made to make the entire

privatization procedure more transparent and effective, that is why the creation of

Privatization Commission on January 22, 1991. The Commission was required to

pinpoint and identify the industrial units for sale purpose. It identifies 115 units in three

phases:

All the nationalized Banks and Insurance Company were to be privatized.

In addition to banks, many other units, which were the monopoly of the Public

Corporations, were to be privatized.

It included power generation, Transport (aviation, railways, ports, shipping,

road construction), Pakistan Steel Mills, Oil & Gas and Telecommunications

etc.

Banking sector:

Until the end of 1980s, Pakistan’s banking sector was heavily regulated in most pursuits

as financial sector was largely directed by the government as a means to implement its

development strategy’ (Hardy & di Patti, 2001, p. 4). The government’s nationalization

of the banking system in the 1970s created an industry structure where competition was

unknown to the management of banks. Forced by structural reform agenda and a desire to

strengthen its financial system, Pakistan initiated financial sector reforms in the early

1990s. It started with the privatization of state-owned commercial banks and the

induction of new ones from the private sector to establish a market-based banking

system.

The banking market in Pakistan is diverse, comprised of public sector commercial banks,

private, and foreign banks. Through the agenda of continued reforms and its drive

towards an efficient banking system, the government of Pakistan managed to privatize

the United Bank Limited (UBL) and the Habib Bank Limited (HBL), the two biggest

nationalized commercial banks, during the years 2002 and 2003, respectively. The

privatization of public banks and a move towards the consolidation of weak financial

institutions (through mergers and acquisitions) has helped to shift the assets of the

banking sector from the public to the private sector. The share of the private sector in

bank assets stood at 41.5% in the year 1996, while it increased to 77.1% in the year 2005

(SBP, 2006B)

This has guided to an effective competition among banks in the deposit market, which

poses a serious challenge for the banks to increase their deposits by offering attractive

returns to their customers.

Indicators

2001 2002 2003 2004 2005 2006

A- Capital AdequacyCapital to risk weighted assets (CRWA)

8.7 11.4 8.5 10.5 11.3 12.7

Capital to total assets

3.8 4.8 5.5 6.7 8.0 9.4

B- Liability StructureDeposits to total assets

75.9 75.5 77.2 78.6 77.4 74.8

Borrowing to total assets

13.8 12.5 11.8 9.4 9.2 8.0

C- Assets Quality

Non-performing loans to total loans

23.4 21.8 17.0 11.6 8.3 6.9

Net non-performing loans to Net loans

12.1 9.9 6.9 3.8 2.1 1.6

Provision to non-performing loans

54.7 60.6 63.9 70.4 76.7 77.8

D- Management and ProfitabilityCost/Income ratio

62.4 59.1 50.5 52.0 41.7 40.3

Interest rate spread

5.2 4.6 3.8 3.6 5.1 5.3

Return on Assets (ROA) before tax

0.1 0.9 1.8 1.9 2.8 3.1

E- LiquidityLiquid Assets/Total Assets

38.1 46.7 45.1 36.6 33.7 31.9

Liquid Assets/Total Deposits

50.7 61.8 58.5 46.5 43.6 42.7

F- Other indicatorsLoans to Deposits

61.7 54.9 56.4 65.8 70.2 74.6

Source: SBP (2006b, 2007)As part of the on-going reforms process, considerable efforts have been made encompassing enhanced capital adequacy, strengthening asset quality and improved management practices. Furthermore, policy measures like interest rate deregulation, abolition of credit controls and further developments in the capital market have also created a competitive environment for banks. Consequently, Pakistan’s banking sector has witnessed a visible improvement in its size, structure, outreach, and financial health during the last few years. Banks managed to appear better capitalized as the capital to risk weighted assets (CRWA) ratio increased to 12.7% in 2006 compared to 8.7% in the year 2001 against the minimum requirements of 8 per cent (State Bank of Pakistan (SBP), 2006a). Capital adequacy is a risk management tool used to counter contingencies that help banks to manage their unexpected losses arising out of the risky operations.Considerable changes have occurred in the asset-liability structure of banks during the last five years. Earning assets represented a large part of the total assets during the period 2000-2006 (See table-1). Growth in assets was largely financed out of the growth in deposits and capital that allowed the banks to reduce their borrowings and eventually their liabilities. Non-performing loans (NPLs) are expected to have a significant adverse impact on the cost of banking operations since these constitute a part of the non-interest expenses. The improved market discipline and loan appraisal

standards by the banks across Pakistan have helped to reduce the NPLs over the period of analyses.Factors on management and profitability areas, as displayed in Table 1, reveal a mixed tale. A consistent rise in return on assets (ROA) alludes towards profitability of the banking sector, reinforced by a decreasing pattern of cost income ratio. However, fluctuations in interest rate spreads signal the fact that it is hard for the banks to keep their profits moving up due to increasingly competitive nature of the market. Such a scenario is supported by decreasing pattern of liquidity ratios. A higher level of liquidity provides the means to fulfill current and near future obligations for the banks. However, these levels appear to be declining for the period 2002 through 2006 largely due to strong growth in credit

The concept of privatisation is not new to the policy makers of this country. It may be traced as back as in 50s, when Pakistan Industrial Development Corporation (PIDC) was established in 1952 to boost up the industrial development in the country. This premier Corporation established over 50 industrial undertakings in the length and breadth of the country and after their successful operation and management, these units were transferred from the public to the private sector. The tide of nationalisation, which swept the whole economy in the first half of 70s, was reversed in 1977. The privatisation of State Owned Enterprises (SOE) became an important instrument of economic policy of the government in late 80s. However, it was in 1991 that privatisation process in Pakistan became effective. Privatisation of SOEs is a multi-faceted, complicated as well as politically and socially sensitive process. A well-devised privatisation plan of SOEs essentially takes care of all the stakeholders, which include labour, consumers, investors, government and the economy. It helps to promote capital, goods and labour markets in the country. The privatisation process in Pakistan has passed through different phases and it has been very instrumental to redefine the relationship of private and public business with the government institutions. The following paragraphs elaborate the history and evolution of privatisation process in Pakistan.

PRIVATISATION POLICY DURING LATE 1970s The nationalisation policy of the early 70s increased the size of the public sector to an unmanageable extent. The nationalisation process also failed to deliver what was expected from it. In July 1977, the new government introduced the policies of denationalisation, disinvestment and decentralisation to restore the confidence of private investors. As a part of these policies, the government announced denationalisation of around 2000 Agro-based industries, in September, 1977. Apart from that, the government offered a number of SOEs on Management Contract and introduced performance signaling system, in order to improve their performance and bring efficiency in operation and management. In September 1978, Transfer of Managed Establishment Order, was promulgated, which empowered the Federal Government to offer to the former owners of nationalised industries, the shares or proprietary interest in acquiring their establishments. This Order explicitly recognised the pre-emptive right of the previous owners for transferring management. However, in case there was no positive response from former owners, the government was free to transfer the management and control to any other party on whatever terms it considered fit. The Order also envisaged the transfer of management of profit making units. Due to limited scope of disinvestment policy of the government and lack of any legal and institutional framework not much headway was made and only two industrial units were returned to their former owners, during this period.

SETTING UP OF CABINET DISINVESTMENT COMMITEE IN 1985 In early 1985, a Cabinet Committee was set up under the directive of the then Prime Minister to consider and identify units (which produced simple technology products and were running into loss) for disinvestment to private sector. The Cabinet Disinvestment Committee had the following composition: a) Minister For Finance Chairman. b) Minister For Production Member c) Minister For Industries Member The Committee took certain important policy decisions and devised procedures for disinvestment of selective SOEs falling under the Ministry of Production. Some of the important points included in the policy were: - - Competitive quotations be invited through the press. - The quotation received be evaluated and negotiated by a committee comprising

representatives of the Ministries of Production and Finance, Pakistan Banking Council and NDFC.

- The recommendation of the negotiating Committee be placed before the Cabinet Disinvestment Committee for a final decision.The Disinvestment Negotiating Committee concluded the sale/disinvestment of Tarbela Cotton and Spinning Mills and handed it over to a private party. In addition, the committee considered the sale of a couple of units, i.e. Domestic Appliances Ltd and Pak Iran Textile Mills at Uthal. The processing of disinvestment of other units namely Quality Steel, Karachi Pipe Mills, Pioneer Steel Mills, Special Steel Mills and Trailer Development Corporation was, however, held up for want of an amendment in the Managed Establishment Order, 1978. Although some positive developments were made during this period like setting up a high level Ministerial Committee, devising the rules and procedures for disinvestment, however, the overall progress remained unimpressive. Inadequate legal framework and institutional support as well as lack of political will mainly hampered the process of transferring the SOEs to the private sector.

PRIVATISATION IN 1988 - 90 In December 1988, the new government appointed a British firm M/s N.M. Rothschild in April 1989, as consultants, to undertake a study on privatisation strategy and selection of prospective candidates. The consultants submitted their report to the government in May 1989, namely “Privatisation and Public Participation in Pakistan.” The report recommended privatisation on widespread ownership basis as an appropriate strategy for Pakistan. By "Wide Spread Ownership" the consultants meant development of Pakistan's capital markets by bringing hundreds of thousands of small savers into share ownership for the first time. The report, however, warned that wide spread participation strategy should be carefully structured so as to avoid over ambition on price or size (particularly at the start), inadequate preparation, inappropriate regulation, insufficient marketing and lack of communication with the workers. After analysis of more than 50 companies, the consultants short-listed seven companies as potential first candidates for widespread offers. These included Habib Bank, Muslim Commercial Bank Pakistan National Shipping Corporation (PNSC), Pakistan International Airlines Corporation (PIAO). Pakistan State Oil (PSO), Sui Southern Gas Company (SSGC) and Sui Northern Gas Pipelines Ltd (SNGPL). On the basis of detailed analysis, SSGC was recommended as the first candidate for widespread offering. In addition, the report recommended that for further seven companies, a minority stake could be divested during the five-year program to the consortia of workers and private sector parties. The first three such disinvestments were recommended to be in respect of Pak Saudi Fertilizers, Pak Suzuki and National Refinery.

The consultants also suggested that a new department should be established under the Ministry of Finance, to co-ordinate the complex transactions involved in wide spread offers. The establishment of the new department was also recommended on the grounds that it would be helpful in implementing future privatisation programme of the Government. The report also indicated the need of financial restructuring of the units identified for privatisation, in order to make them an attractive proposition. The report further suggested the need of adopting special techniques, new procedures and incentives to attain wide dispersal of offers both within the country as well as abroad. The Government, following the advice of the consultants, first made efforts to privatise SSGC that was recommended as a leading candidate. However, after having done all the spade work, the proposal to privatise Sui Southern was abandoned. Instead, it was decided by the Government in January, 1990 to disinvest 10% shares of PIAC, amounting to Rs 274 million, 30-40% shares of Pak Saudi Fertilizer and 60% shares of Muslim Commercial Bank (MCB) (Later reduced to 49%) shares). The decision, however, could not be implemented in full. Only ten percent shares of PIAC were disinvested in May 1990 at par value. Again due to lack of institutional framework, legal and other complications the privatisation programme could not make any headway.

PRIVATISATION IN 1991 - 93 Soon after assuming power in November 1990, the then government declared privatisation as its primary economic policy objective. The agenda of privatisation announced by the Government covered a wide spectrum of fields like industries, banks, development finance institutions, tele-communications and infrastructure facilities. As a first step towards privatisation, a Committee on Dis-investment and De-regulation was formed. The Committee in its preliminary report, submitted to the government in January 1991, recommended the disinvestment of 118 industrial units, which included 45 nationalized units taken over during the period 1972-74. The government approved this disinvestment plan and

announced the creation of a Privatization Commission on 22nd January 1991 to implement the disinvestment programme within the shortest possible time. The birth of Privatisation Commission institutionalised privatisation efforts in Pakistan. At the same time, a Cabinet Committee on Privatisation (CCOP), with the Minister for Finance and Economic Affairs as its Chairman, was constituted to approve the recommendations of Privatization Commission.

Foreign study:

Local study