Can revival of SOEs create an opportunity to alleviate the crushing debt burden?

The Budget speech provides an opportunity for the Government to elaborate on a program which offers the prospect of reducing the debt burden in a manner that contains the pain inflicted on the people of Sri Lanka – Pic by Shehan Gunasekara 

The Government of Sri Lanka has announced that it will implement reforms and strategies to revive State-Owned Enterprises (SOEs), while maintaining its policy decision to discontinue privatisation. Effective implementation of the proposed reforms would increase the value of SOEs. An important issue to be addressed is whether this creates an opportunity to raise financing for alleviating the country’s onerous debt burden. 

The crushing effects of this debt burden on the people of this country has been demonstrated by the constrained response of the Government in protecting people and livelihoods during the pandemic. Sri Lanka’s fiscal stimulus as a percentage of GDP has been significantly lower than comparator countries. 

The Central Bank of Sri Lanka and a well-capitalised banking system have been able to step into the breach. However, the impact of the burden imposed on the capital adequacy of the banking system will only be known after the moratoria are lifted. 

The Government’s success in containing the pandemic (March-September 2020) was a major positive factor in coping with its unprecedented effects, particularly through the early opening up of the economy. 

Addressing debt burden

This note argues that the Government’s efforts to reform SOEs creates an opportunity to address the onerous debt burden by selling public assets. Where the Government intends to retain control, it can consider selling minority stakes. However, there is a strong case for the sale of assets like the Hilton and Hyatt hotels once market conditions become more favourable. The emergence of a vaccine that is 90 percent effective is likely to accelerate the bounce back of the hotel and tourism sector.

The Government is seeking to introduce a holistic program of reform for improving the management of SOEs. In doing so, there is merit in drawing on the Statements of Intent (SOIs) drawn up by the major SOEs in recent years. The current initiative is pushing for the professionalisation of the management of SOEs through rigorous recruitment schemes and capacity building in order to promote prudent decision-making and operational efficiency. 

The upgraded management teams will be called upon to develop medium-term strategic plans which identify growth strategies, including through business process engineering, mergers and amalgamations. These new business models are expected to respond to emerging opportunities in the post-pandemic world and meet challenges particularly in relation to logistics and supply chain resilience. Each SOE will also be expected to develop robust key performance indicators. In addition, monitoring mechanisms are to be established at the line ministries and Treasury.

Pricing policy and subsidies

An important gap in the proposed reforms relates to pricing policy. The largest proportion of the losses incurred by SOEs is attributable to pricing policy. Economic services (CPC, CEB, SLTB, SLR and NWS&DB) are provided below cost. There is a considerable body of empirical research which demonstrates that such subsidies are a very inefficient means of supporting the poor and vulnerable. In practice, they tend to benefit higher income groups disproportionately. It is more effective to provide a social safety net through a well-designed and targeted income transfer scheme.

The highly inefficient (poorly designed and poorly targeted) Samurdhi Programme should be reformed to achieve this objective. This would provide greater leeway for adopting pricing policies that do not impose an unsustainable burden on the Government Budget and/or balance sheets of State banks. The current subsidy-based model of delivering economic services is no longer affordable given the highly-constrained fiscal space and the debt dynamics which threaten the wellbeing of the people. 

Employer of first resort

The Pathfinder Foundation is concerned that the lack of fiscal space and the possibility of a debt crisis highlights the unsustainability of the Government being the employer of first resort. Sri Lanka’s post-colonial history involves the commitment of successive governments to creating unproductive public sector employment. However, the current highly constrained fiscal space calls for a radical re-think of the traditional approach of the Government being the employer of first resort. 

Historically, successive governments have been unwilling or unable to introduce economic reforms that would increase gainful employment outside the government sector. For SOE reforms to be effective, there should be complementary policies which generate productive employment opportunities throughout the economy. 

The way forward

The agenda for reforming SOEs includes the following: improved corporate governance; appointment of competent CEOs; recruitment of qualified professionals for procurement, finance, human resource development and other key management positions; adoption of realistic pricing policies and investment strategies; institutionalising performance audit and financial management controls; and expenditure management. 

Success depends on taking tough decisions. It is noteworthy that governments, such as Norway and Abu Dhabi, have refused to provide additional financial support to their national airlines even though these two jurisdictions have two of the largest sovereign wealth funds in the world. Yet Sri Lanka, despite its parlous public finances, has not been able to take tough decisions in relation to its national carrier. 

Successful implementation of SOE reforms will reduce the burden on the budget and strengthen state bank balance sheets. In addition, the valuation of these enterprises will be enhanced and the opportunity will be created to consider very seriously how a programme of asset disposal can contribute to alleviating the unsustainable debt burden. This course of action would be a less painful option for the general public than raising taxes or cutting priority expenditure. 

Consideration should be given to categorising State-owned assets into those which can be sold outright, such as the Hilton and Hyatt hotels. A second category could be assets which can generate considerable financing for the Government through the sale of minority stakes.

For instance, the sale of 10-15% of the Bank of Ceylon and People’s Bank would generate a considerable amount of money. Part of this can be allocated to the employees of the institutions. Furthermore, if these stakes are sold through the stock market, the listing regulations would result in disclosure requirements which would improve corporate governance. There could be a third category of public assets for which the Government can decide there should be no change in ownership structure.

A separate vehicle can be created (similar to a sinking fund) into which the sale proceeds can be credited. These funds can be earmarked solely for the purpose of debt-management. The timing of such transactions should be determined by the improvement in market conditions. It would be timely to commence thinking about such an initiative at a time when sentiment and confidence, at home and abroad, is being boosted by the emergence of a vaccine which is over 90% effective. 

The Pathfinder Foundation believes that the Budget speech (17 November) provides an opportunity for the Government to elaborate on such a program which offers the prospect of reducing the debt burden in a manner that contains the pain inflicted on the people of Sri Lanka. Such a program will also transmit a positive signal to investors and creditors, both at home and abroad, as well as to rating agencies thereby increasing the credit worthiness of the country. 

(This is a Pathfinder Alert of the Pathfinder Foundation. Readers’ comments are welcome at www.pathfinderfoundation.org.)