ADP, SNCF… deconsolidation, an alternative to privatization

While privatizations reduce gross debt, they can also worsen its trajectory by depriving the State of comfortable revenues. A policy that prioritizes display (the level of gross debt) to the detriment of its underlying reality (debt sustainability) can be risky. The 2008 financial crisis can be explained by the accumulation on investors' balance sheets of a risk that was poorly reflected in the key indicators of financial regulations.

The debt of publicly-owned companies that are not commercially autonomous must be consolidated, i.e. added to that of the State. SNCF réseau's debt of 45 billion euros has been added to the government's debt. The government is considering privatizing ADP and FDJ, which would have a €15 billion impact on public debt. We propose a strategy of debt deconsolidation through asset pooling, without divesting the most profitable companies simply for show.

This allows the government to show a reduction in gross debt levels, since SNCF debt would not have to be added to that of the State. This avoids a deterioration in the debt trajectory, since the State does not need to give up revenues that exceed the cost at which it borrows.

Debt level OR trajectory

Communication on a government's economic performance is based on key indicators such as GDP growth, real wages, unemployment rate, deficit and public debt.

The standard indicator of debt is its so-called Maastricht measure. Debt is measured gross, i.e. without subtracting even liquid and/or profitable assets. It is presented as a percentage of annual wealth creation (gross domestic product or GDP) in relation to two key thresholds, 3% deficit and 60% debt (the average gross debt of European states was 60% in 1992).

The debt of candidates for monetary union must be less than 60% of GDP; that of member countries must be sustainable: they are judged on their ability to honor their commitments and gradually reduce excessive debt towards the 60% threshold.

The key element in the debt trajectory is the public deficit, and variations in debt due to accounting reclassifications are irrelevant, and whether or not SNCF debt is consolidated does not change the economic reality or the sustainability of French debt. If interest rates, inflation and growth are zero, only a budget surplus can continually reduce debt (inflation and growth help, interest rates and the retired population penalize).

Public investment policies must be judged by their impact on debt sustainability. Unprofitable activities must be financed, and for a given budget, a trade-off may have to be made between them. Profitable activities can be undertaken, retained or privatized; each action has an opposite impact on debt levels and trajectories.

Selling a public asset valued at 10 billion euros, which brings in 500 million euros a year for the State, may help to reduce the level of debt, but by depriving the State of its income, it worsens its trajectory. The best decision therefore depends on the horizon considered.

The electoral horizon of our decision-makers is short, and may lead them to focus on the criterion of gross debt to the detriment of economic logic. In this case, it's a dressing-up strategy. This is the case if the private sector's ability to make the company prosper does not lead it to buy above its current valuation.

The argument remains the same, whether it's a question of repaying the State's debt or that of SNCF réseau, which currently stands at around 45 billion euros and needs to be consolidated. The French government could repay this debt by selling its main holdings in listed companies such as ADP, EDF and Engie.

800 million euros less a year

While SNCF réseau's 45 billion euros in debt cost one billion euros a year, its listed holdings with a market value of almost the same amount (43 billion) earn 1.8 billion. Selling in order to recapitalize would therefore represent an annual drop in revenue of 800 million euros for the community.

The calculation, based on recent stock market values and average annual revenues over the last few years, breaks down as follows, taking into account the State's share in the capital of these different companies:

• 50% of ADP, which has a market value of €10 billion and generates €500 million a year.
• 83% of EDF, whose market value is 35 billion euros and generates 1.4 billion euros a year.
• 25% of ENGIE, which has a market value of around 35 billion euros and generates 1.5 billion euros a year.

The debt of state-owned commercial companies is not accounted for, provided that these companies are commercially independent, i.e. that commercial revenues cover at least 50% of their sales. This is not the case with SNCF réseau: public aid to the railways totaled over 10 billion in 2017, excluding investment subsidies.

Repaying SNCF réseau's debt will not be enough to make it a commercially autonomous entity; the creation of an infrastructure division including SNCF and other structurally profitable transport companies would be necessary.

The State borrows more cheaply

This deconsolidation strategy would enable us to significantly reduce gross debt (45 billion versus 10 billion for the privatization of ADP), without depriving ourselves of stable financial resources; it would also facilitate the implementation of a territorial strategy, all the more so as the State can be a crucial player for certain long-term projects.

Indeed, for the same project, the State borrows at a lower cost than the private sector for structural reasons such as liquidity, institutional constraints (favorable treatment of public debt in balance sheets), and low default risk. If a project can be managed in the same way regardless of the shareholder (principle of separation of ownership and management), the value attributed to it by each shareholder depends on its financing cost. The State will assign a higher value to projects and companies that are profitable over the long term than a private shareholder.

So, while a state-owned company can be managed like a private enterprise, the opposite is not true, as certain investments are only possible with state support. In fact, some publicly-owned companies have achieved significant success worldwide.

Debt level AND trajectory

The simplest solutions are not necessarily the best. Selling the State's holdings reduces debt (a little) immediately, but deprives us of income for a long time to come.

The ideal solution would obviously be to improve our gross debt ratios, but without worsening our debt trajectory. The Maastricht rules do not force the government to privatize. Rather, they encourage it to think about building commercially independent economic clusters.

Creating such clusters makes it possible to combine short-term political logic with long-term economic logic. Deconsolidation through business combinations has a stronger instantaneous effect on gross debt than privatization; it also allows for a better trajectory of gross debt.

This article is the translation of the french version initially published in The Conversation under Creative Commons license. Read the original article.

Picture on freepik