As we saw in the previous chapter, governments can seek to achieve fiscal credibility by cutting themselves off from access to certain financing sources, something that they would be unlikely to do if they anticipated requiring recourse to those sources of finance in the future. While this may help to signal the seriousness of the government's fiscal intentions, and may even help to discipline future governments not as inclined to fiscal rectitude as the one that institutes the measure (see Chapter 17), the impact of such measures on the public sector's perceived solvency is problematic, since actual and potential creditors will correctly perceive that the government has deprived itself of a source of funds with which to service debt.

An alternative mechanism for enhancing the credibility of fiscal adjustment is to “lock in” the adjustment in present value terms by undertaking measures in the present that are irreversible – or at least, that are very costly to reverse – and that can be expected to exert favorable effects on the government's budget over the indefinite future. Privatization or reform of loss-making public enterprises is one such measure that has been widely adopted in developing countries. This chapter explores how such measures can be used by the government as mechanisms to enhance the credibility of fiscal adjustment. It also describes the economic arguments for privatization, and analyzes the implications of privatization for the government's intertemporal budget constraint, emphasizing that the effects are not limited to the revenue received from the sale of such enterprises.