Attitudes towards Debt-Equity-Swaps and Privatization of State-Owned Enterprises in Chile
Milman, Claudio, Public Budgeting and Financial Management
ABSTRACT. This study describes the privatization experience of Chile focusing primarily on the role played by debt-equity-swaps (DES). The use of a survey instrument and archival data suggest that DES speeded up the privatization process in Chile and made the privatization of large State Owned Enterprises (SOEs) easier. This is the first empirical study linking financial innovation (e.g. DES) to a privatization program.
Governments around the globe are increasingly looking at ways to privatize state-owned-enterprises (SOEs). Being dissatisfied with the consequences of import substitution industrialization policies, Latin American governments are trying to reverse decades of economic and social stagnation by allowing the private sector to play a much larger role in their economies.
The objective of this study is to examine some critical aspects of the privatization activities of Chile between 1985 and 1989 (time period when most SOEs were privatized) with special emphasis on DES. One among these aspects is to examine the effects of using DES in the privatization program on foreign direct investment, foreign debt reduction, and capital flight reversal. This study will assess the principal motivators behind using DES in the privatization program. This research seeks to provide a better understanding of the privatization process experienced by Chile focusing on DES.
DEBT EQUITY SWAPS AND PRIVATIZATION
Debt-equity-swaps have become important vehicles for privatizing SOEs and attracting foreign direct investment. Between 1985 and 1993, four Latin American countries (Argentina, Brazil, Chile and Mexico) were responsible for 79% of debt converted worldwide. Between 1985 and 1989, Chile was responsible for over 21% of debt converted.
Since 1985, DES have been used to manage the foreign debt problem of Third World nations. In these debt-equity-swap schemes, private investors buy outstanding Third World debt at market prices (Peru's debt is being sold at 12% of its face value) and then swap the debt for local currency (at 80-90% of its face value) which can be used for new or existing projects. DES could facilitate the privatization of large conglomerates without creating unnecessary inflationary pressures. Even though there are numerous studies on DES, none of these has empirically linked this financial instrument with privatization efforts.
Chile is an interesting case to study since it was, between 1985 and 1989, the most active Latin American country engaged in privatizing SOEs (Meller, 1993). Of the 596 SOEs operating in Chile in the 1970's, only 45 have remained state owned. Between 1985 and 1989, Chile was able to reduce its foreign debt by $9 billion (a 50 percent reduction in its medium and long term private debt held by commercial banks) with the use of DES.
The privatization experience of Chile could be divided in two different phases. The first firms to become privatized occurred between 1973-1978 after the military led by Pinochet assumed power in September 1973, a regime which lasted until March 1990. This phase included the "free of charge" return of 240 SOEs to their legitimate owners that were confiscated during the government of Allende (19701973), and "debt-lead divestiture" from 232 SOEs (Hachette & Luders, 1993). The second round of privatizations (1985-1989) included the sellout of 80 SOEs (including the reprivatization of 50 SOEs) that fell again in government hands in 1982 due to the privatization modes used during the first phase (Hachette & Luders, 1993) as well as the economic and financial crisis that afflicted most of Latin America.
By surveying knowledgeable individuals about the Chilean experience, this study identifies their attitudes toward DES and privatization of SOEs in Chile. Even though many authors have talked about the financial techniques needed for a successful privatization program, additional research continues to be needed focusing primarily on the financial role and effect that debt-equity-swaps could have on privatization. …