A Government’s Credit Rating Perspective on Privatization∗

We study how government’s debt-rating considerations affect privatization policy, due to their differential effect on the government’s valuation of the monetary and social-benefit aspects of public enterprises. "Credit-market discipline" presses the government to put more weight on the monetary aspect, as this increases its creditors’ confidence in its ability to repay debt. Informational problems undermine this discipline, leading to a costly downgrading of the credit rating. Dynamic inconsistency occurs when the monetary to social-benefit tradeoff is made only after the credit market has priced government’s debt (such as in the decision of the toll on a road): projects are operated with an excessive emphasis on social benefits. Adverse selection occurs when the government has private information regarding a prospective project’s characteristics (such as anticipated traffic). Project selection is tilted towards those with high social benefits and low monetary benefits. We study the possible roles for privatization to alleviate these informational problems, and evaluate the regimes with and without the option for privatization. ∗Preliminary and incomplete. Comments welcome. We benefitted from the comments of seminar audiences at Tel-Aviv University and the Hebrew university.