Restructuring public sector debt

• Establishment of a State and Local Government Financing Fund (SLFF)

By Damien Fernando

Several State institutions such as the Ceylon Petroleum Corporation and Ceylon Electricity Board regularly complain about the non-payment of the debts owed to them by State sector institutions, State-owned airlines and the local government institutions.

Obviously this is an impediment for the functioning of these institutions.

This could result in a cross subsidy situation where certain institutions have to bear the cost of borrowings and pass on the cost to the customers, whilst another set of institutions get cost free funding and their customers will benefit from a lower price of the goods and services than the actual cost.

In the case of some State institutions where the funds are allocated by the Treasury, the funds allocated for (their expenses including) electricity and fuel, etc., could be used for other non-productive expenditure.

Defaulting State institutions is a cost free and a convenient method of financing for other State and local government institutions and hence the motivation to default them.

a.If a centralised authority, say a State and Local Government Financing Fund (SLFF) is set up as a State financial institution and to restructure these debts in a simple manner, i.e.:

b.All receivables of the State sector institutions from other State sector institutions and the local government sector to be transferred to the SLFF.

c.All payables of the State sector institutions and the local government sector from the other State sector institutions also to be transferred to the SLFF.

d.The receivables and payables of a same institution can then deducted from the other and the balance amounts will remain as the amounts payable or receivable from SLFF.

The debts owed to SLFF by the institutions to be converted to loans. The loans will have to be charged interest at the rate of cost of capital of SLFF plus 2% plus suitable non-negotiable penalties for delayed payments of capital and interest. These institutions will also be required to provide repayment plans based on the cash inflows of such institutions with say 10% to 20% allocation of the cash flows for the debt payments to SLFF.

e.SLFF will issue long-term Sri Lanka Rupee bonds/debentures with Government guarantee, for durations from five, 10, 15, 20 years on both fixed as well as variable rates based on weighted average SLIBOR plus 1%-3%. The rate of income tax on interest received from SLFF to be fixed at 10%. Part of these debentures or bonds could be sold to state and private sector life insurance funds and retirement benefit funds that require long term instruments and also to the general public. The Insurance Board of Sri Lanka will have to be advised to categorise SLFF debentures to have 100% liquidity for the purpose of liquidity computations of the insurance companies. The instruments could also be listed in the Colombo Stock Exchange to provide flexibility to the holders and also to reduce the administrative work of SLFF with regard to short period redemption requirements of the instruments.

f.Based on the amounts that will be raised from the debentures and also depending on the financial requirements of the relevant institution to which SLFF owes, the funds could be released. For the balance amounts if any, SLFF will pay interest at a rate of weighted average cost of capital of SLFF plus 1%.

g.If the State or local government institutions require further goods on credit from the other State institutions those too to be handled through SLFF that will function as the settlement institution. To ensure that the State and local government institutions do not increase their debts beyond an acceptable level the additional credit to be controlled with possible assessment of the short term repayment capability and also based on the repayments of the previous debts. Especially with the purchases of non-capital nature like electricity and fuel the institution that is borrowing should be able to repay within 30-60 days based on their income cycle, without adding to the existing long term debt.

h.The institutions that are in debt beyond their repayment capacities could be encouraged by SLFF to transfer excess assets such as land holdings in settlement or to mortgage the land and vehicle assets to SLFF. For regular defaulters of loan or interest payments SLFF should have the authority to request the Treasury or any other banking institution to deduct and remit from any funds due to the State institution or to a local government.

i.SLFF will also to have the expertise and also be responsible to provide income and expenditure management expertise to the State institutions and local government institutions that are in debt to SLFF, so that they would improve the income generation, recovery of dues, pricing decisions, cost reduction, asset utilisation, elimination of wasteful expenditure and other techniques to management the debt position of the institution. In case of the State institutions that owe substantial funds to SLFF, it should be authorised to appoint a person of the boards of such institutions that are in debt, who will be responsible to look after the SLFF interests.

j.To ensure that SLFF will not become a money gobbler, the expenditure of SLFF should be limited to a maximum of 0.5% of the funds owed on the debentures and bonds. Using the latest technologies and possible outsourcing of repetitive work the costs of SLFF should be kept to a minimum. Ideally SLFF should be given tax free status and a surplus if any could be used to build up capital redemption funds to redeem the debentures and bonds when due.

This will benefit the management of debts of the State institutions and reduce the financial difficulties of the institutions due to non-payment of bills and also release funds borrowed by the State institutions from State banks to be used to lend to the development sectors.