Privatization-panacea

Privatization is often thought of as below-the-line savior to the debt problems in the euro area. But a crisis may not the right time to privatize, other than to raise liquidity that cannot be obtained else.

From a flow perspective, it would always make sense to hold on to assets that have a higher return than the liabilities, rather than disposing of the asset to pay down debt. From a stock perspective, both assets and liabilities suffer in times of crisis, so depending on the relative drop in value privatization may or may not become more attractive. Usually, prices of equity reacts more strongly than debt to a downturn, but in a situation in which debt is so risky that it resembles equity, the logic may not hold.

For Spain, it makes financially sense to hold off with the Loteria privatization from a flow perspective, and (given ECB’s interventions) also from a stock perspective:

• From a flow perspective, Loteria’s profitability massively exceeds the cost of debt service. Loteria’s return on equity is about 17 percent. Compare this to average yields of Spanish government bonds of 4-5 percent!
• From a stock perspective, Loteria’s expected sale value has fallen by 20 percent (from EUR21 billion to EUR17 billion) since December 2010. Assuming that at in December 2010 a privatization-debt-buyback deal would have been optimal (which is doubtful anyway), the sale would still make sense if bonds would have also dropped by 20 percent. This is not the case (the 10 year benchmark dropped by about 6 percent), and would only become the case if 10-year yields would rise from currently 5.2 to more than 7.5 percent.

Thus, governments should be cautious when wishing for higher privatization to fill below-the-line financing gaps. Notwithstanding legal obstacles, a better solution to utilize government assets would be to securitize and bring them onto the balance sheet so they can be used as financial collateral to acquire funding.