Sri Lanka’s State-Owned Enterprises (SOEs) have accumulated losses of Rs. 1.8 trillion from 2006 to 2021 and a debt of Rs. 1.5 trillion, as revealed during a recent panel discussion conducted by the Advocata Institute titled ‘IMF and the Urgency of State-Owned Enterprise Reforms’.
Speaking at the discussion, Advocata Institute Research Economist Rehana Thowfeek said that Sri Lanka’s problems primarily stemmed from the large budget deficit the country had been running for a long period.
In 2022, there were 527 SOEs in Sri Lanka. From these, 287 are monitored by the Department of Public Enterprises, while the rest are monitored by the Department of National Budget. Both these departments function under the Finance Ministry and these 527 SOEs are governed by either the Finance Act No.38 of 1971 or the Companies Act No.7 of 2007.
Thowfeek said: “The dominant issue now is with respect to the operational and financial underperformance of these SOEs. Underperformance is not a hidden issue. Even the Department of Public Enterprises, which oversees 287 of these SOEs, has acknowledged this in its annual reports. The root problem with SOEs is their conflicting objectives, stemming from the lack of clearly defined ownership and responsibilities for each stakeholder.”
According to her, it is a classic principal-agent problem where the interests of principals, in this case the public, differ from the interests of the agents, in this case the Government and the managers of the SOE. Therefore, SOEs operate in the best interests of the agents who abuse resources for election purposes and use SOEs as an outlet for political patronage.
This resulted in highly undesirable outcomes with respect to efficiency and profitability, she added.
Undesirable outcomes
Compounding this operational inefficiency which stems from conflicting interests are soft budget constraints. Soft budget constraints measure the willingness of the Government to intervene and bail out loss-making SOEs, according to Thowfeek.
“The absence of commitment to fiscal discipline and the degree of willingness to impose budget restraints on SOEs is illustrated by the complete disregard for fiscal rules set in place by laws such as the Fiscal Management Responsibility Act (FMRA), which places a ceiling on the budget deficit and the Government borrowing that can be incurred.
“The Government of Sri Lanka regularly circumvents these legislative limits through Parliament and SOEs have benefited from these loose restraints. The FMRA originally set out a limit of 4.5% of GDP on the amount of Government guarantees that can be incurred on SOE liabilities. This limit has been raised three times already and in 2021, this limit was further extended to 15%, more than thrice the original level,” she revealed.
Further, she added that the Government also routinely provided letters of comfort or Treasury guarantees for SOEs. As a result, these loss-making SOEs have accumulated billions in publicly guaranteed debt. Moreover, other than for publicly listed entities, there is no mandate to publicly disclose audited financial and performance reports, which means that the principals, in this case, the people of Sri Lanka, do not even know the extent to which these SOEs are failing.
Thirdly, she explained that in order to serve the Government’s social objectives of providing goods and services at low cost to the general public, price controls on essential commodities were a policy that all successive governments of Sri Lanka had pursued.
SOEs and private competitors are forced to sell these items at controlled prices, even if they do not cover the production, import, and distribution costs. These controls have inevitably led to supply shortages and surpluses, leading to losses, which are ultimately borne by the Central Government through subsidies or direct budget allocations, financed largely by debt.
“In some instances, particularly with regard to energy prices – electricity and fuel – these price controls fail to also address the core issue of income inequality altogether. When price controls are imposed on utilities like fuel and electricity, which are disproportionately consumed by higher income groups, much of the Government’s subsidy is funnelled to higher income households, making these price controls and subsidies both regressive and ineffective.”
Healthcare sector impacts
She stated that the social costs of SOE misgovernance and corruption were illustrated well in the currently unfolding events with respect to medicines provided in State hospitals.
Recent investigations have revealed the malpractices at the Health Ministry, which have led to substandard life-saving drugs being imported from unregistered foreign companies and being administered to patients, thereby endangering their lives. Previous investigations into the State Pharmaceuticals Corporation (SPC) have revealed similar issues with respect to the quality of medicines.
“Despite these serious allegations, however, a no-confidence motion introduced to oust the Health Minister in charge has been defeated, perfectly illustrating the conflict of interest we discussed before. Therefore, the reality of the state in which SOEs operate in Sri Lanka is such that, while marketed as national assets, which will provide equitable services at a lower cost, SOEs actually end up being vehicles for corruption, designed to benefit politicians and their allies, racking up huge and hidden debt, which become a massive burden to the general public.”
According to her, assessing the performance of all of these SOEs is an extremely difficult task, mostly due to the lack of information on financials and performance. However, given that Rs. 920 billion has been channelled into SOEs by the banking sector, and that Rs. 75 billion in Treasury support has been granted to these SOEs, people have a right to know how these funds are utilised.
Accordingly, Advocata has devised a scorecard method to assess the financial and governance performance of SOEs. It found that overall, 13 out of 52 SOEs – including notable SOEs like the Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC) – are a complete failure in terms of both the fiscal and governance aspects.
It had also assessed the return on assets of these 52 SOEs. Some of the prominent SOEs like the CEB, CPC, and SriLankan Airlines have a return on assets in the red and are failing ‘miserably,’ while others like the Bank of Ceylon and People’s Bank, although marginally successful, generate a return on assets below the average effective interest rate. Hence, very few SOEs actually perform on par with private competitors and regional counterparts.
SriLankan Airlines
Meanwhile, Independent Consultant Ravi Ratnasabapathy provided the SriLankan Airlines story as an example.
He added that in 1998, the Government had sold 43.6% of the shares to Emirates for $ 70 million. Then in 2010, the Government took back the stake, paying only $ 53 million for it.
“They sold it for $70 million and took it back for $ 53 million, seemingly making some profit. A Cabinet paper that was submitted at the time said that it was desirable that strong institutional investors such as State banks should be allowed to purchase shares because they would benefit from the prevailing economic conditions and the tourism boom. This was in 2010, just after the end of the war.
“However, who actually purchased the shares? It wasn’t the Treasury. The Bank of Ceylon purchased 33.54% of the company, the People’s Bank bought 8.23% of the company, and the National Savings Bank bought another 8.23%. Meanwhile, the EPF bought 3.62% of the company. These four Government institutions are now the owners who bought the stake from Emirates.”
He pointed out that the subsequent losses incurred by SriLankan since its purchase by the Government were well known and said that the Government had offset these losses by printing money at the Central Bank and spending money that did not exist.
“First these banks bought the shares and then they financed the losses. Accordingly, the Bank of Ceylon is owed Rs. 62,207 million while the People’s Bank is owed Rs. 103 billion. If we consider the balance sheet of SriLankan Airlines, the amounts due to the Bank of Ceylon and the People’s Bank constitute about 43% of all liabilities of the airline.
“If the lease liabilities are excluded, a large part of the liabilities is the amounts payable on aircraft leases. If the lease liabilities are removed from the equation, it can be seen that banks constitute 98% of those that have put in the interest bearing liabilities, apart from lease liabilities,” Ratnasabapathy said.
Intl. best practices for SOEs
Addressing how the performance of SOEs could be improved, Thowfeek stated: “SOEs are not a Sri Lankan phenomenon. There are thousands of SOEs around the world, especially in emerging economies. International best practices for corporate governance of SOEs are well documented.”
The Organisation for Economic Co-operation and Development (OECD), for instance, has mapped out seven guidelines on corporate governance for SOEs, and these are followed by 38 OECD members, as well as three partner countries. The guidelines state that the state should have clear rationale for ownership, with clear policies on the state’s role in the operation and governance of the SOE, as well as the roles and responsibility of each stakeholder involved.
The state is expected to act as an informed and active owner, while allowing full operational autonomy to the SOE board and its managers. SOE objectives should be clearly defined. The legal, regulatory, and institutional frameworks within which SOEs operate should ensure a level playing field and fair competition in the market.
Moreover, all SOEs should be subject to the same standards of disclosure as publicly listed companies and audit requirements. SOE board members should also be nominated based on merit and be free of any conflicts of interest.
The Temasek model
One of the most touted models for reforming Sri Lanka’s SOEs is the Temasek model. Temasek is a publicly owned holding company which manages the Singaporean Government’s commercial assets and SOEs.
According to Thowfeek, since its inception, Temasek’s compounded growth rate is at 14%. The company holds investments across Asia and sits apart from other sovereign wealth funds as it is entirely self-financed through dividends, divestment proceeds, investment earnings, and long and short-term debt.
“While the Temasek model is not a one-stop fix for the problems of all Sri Lankan SOEs, some of which need to be outright divested or shut down, a holding company model is a suitable alternative for those which cannot be immediately divested or those that present a strong rationale for Government ownership.”
She stated that the two key principles that enabled the success of Temasek were the Singaporean Government’s non-intervention and non-preference principles.
Temasek Holdings was created in 1974 based on the idea that the government should not be involved in the management of businesses and that the government and civil servants should focus on policy.
The success of the Temasek model can be attributed to its compliance, in most cases, to the tenets of good corporate governance, having clearly defined ownership roles for the state as an owner, having objectives for SOEs, and having clearly defined responsibilities for the boards and managers of SOEs.
The way forward
Government Linked Companies (GLCs) are expected to compete on a level playing field. As a result, all GLCs are publicly listed and are subject to the rigours of market competition. The government does not play an active role in the daily operations of the holding company or its SOEs.
“As we see it, the way forward is quite clear. The losses accumulated by Sri Lankan SOEs are a source of macroeconomic instability for our economy. Urgent reform is needed for several large SOEs like the CEB, CPC, and SriLankan airlines. Allowing these entities to continue to operate without reform will lead to an increased debt burden on the people of Sri Lanka.”
She emphasised that SOE reform should lead to improved productivity and reduced budget deficits, although reforms were feared by various factions of society as they were viewed as upsetting the status quo.
Thowfeek further noted that SOE reforms needed to be properly sequenced, along with wider economic reforms to improve export orientation and private sector growth. On an immediate and high priority basis, measures must be taken to divest ownership of viable SOEs which have ready buyers.
“Passing the SOE law to make way for these transactions should be expedited. Divestment can take place through partial privatisation and through listing entities on the stock exchange. SOEs which cannot be divested but continue to accumulate large losses should be shut down or downsized to prevent the build-up of larger losses. For SOEs which have a strong rationale for Government ownership and those which cannot be sold off or shut down, a Temasek-style holding company can be established to manage them.”
In addition to enforcing fiscal governance on this holding company and its subsidiaries, measures must be taken to improve and bring the levels of corporate governance to an acceptable international level.
Thowfeek highlighted that subjecting SOEs to the forces of competition through privatisation and liberalisation were an essential part of these reforms, underscoring the importance of non-preference. Further to these proposed reforms, Advocata also proposed critically evaluating the need for Government intervention in SOEs.