Curing ailment of loss-making state enterprises

An year ago, the well-known economist Dr. W.A. Wijewardena had analysed the losses of the top 12 state-owned enterprises (SOEs) to the opportunity cost (cost forgone) of some of the better known expenditure heads of the government.

This analysis can be seen as the flip side of the same coin, which Mirror Business carried on Tuesday, July 18, under the title, ‘SOE debt accounts for 14 percent of economy’. This is a shocking statement, though the analysis is not. For example:

• One-third of the income tax collection in 2013 was wiped off by the aggregate losses of the 12 SOEs in that year.
• The losses of the 12 SOEs are close to 25 percent of the budgets of nine of Sri Lanka’s most vital socio-economic ministries.
• In 2013, the government spent an impressive Rs.24.3 billion in programmes to transform education towards the needs of a knowledge economy. The losses of the 12 SOEs could have funded a near threefold increase in these programmes.
• The projected losses of the two state-owned airlines (SriLankan Airlines and Mihin Lanka) in the following three years will be 10 times what Sri Lanka spends each year on education-related welfare like text books, uniforms and school meals.
• The SOEs in a range of sectors made profits in 2013, totalling Rs.76.4 billion. But 83 percent of those profits were wiped out by the losses of just five SOEs.
• The losses of Mihin Lanka (Pvt.) Ltd (then) were equivalent to almost one-fourth of our annual education budget.

The above situation has only escalated and not become manageable. Time and time again the senior politicians have deplored the status of SOEs and complained about the burden these institutions place on the people of Sri Lanka but have failed to implement concrete actions to privatise them or at least to introduce public/private partnerships (PPPs). Some time back, a respected senior minister spoke of a number of ‘monsters’ that undermine Sri Lanka’s development prospects. 

These monsters are the SOEs, which incur large losses that eventually have to be borne by the people of this country through higher direct or indirect taxes. The losses of SOEs, such as the Sri Lanka Transport Board (SLTB), Ceylon Electricity Board (CEB), Ceylon Petroleum Corporation (CPC) and SriLankan Airlines/Mihin Lanka are due to many reasons and include mismanagement, corruption, political interference, non-cost-reflective pricing policies and utter disregard for pubic assets and money (see more detailed analysis in Table 1).

Overview of SOEs
Though it is identified that there are over 200 SOEs, the published accounts available in the public domain are those of 55. Based on the finalised accounts of these SOEs, for the eight-month results ending August 31, 2016 (Finance Ministry Fiscal Report March 2017), 19 SOEs are presently making losses (see Table 1). The losses accumulate to Rs.35.3 billion for this period.

Table 1 also reveals an estimated turnaround of another 10 SOEs. These figures are based on the forecasted revenue on the business plans and in most cases are not realised at the end of the fiscal year. A good example is Mihin Lanka (which is now amalgamated with the burgeoning losses of SriLankan Airlines as at date).

Although some SOEs are profitable and performing well, collectively they represent a risk to public finance (either directly or through the state banks, which fund the largest SOEs). CPC and the CEB, according to the International Monetary Fund (IMF) memorandum of understanding (MoU) with the Finance Ministry, have incurred financial losses in fulfilling non-commercial obligations because of the implicit energy subsidies—retail fuel and electricity prices have been set below cost-recovery levels. 
According to the same memorandum, SriLankan Airlines has been poorly managed and continues to incur significant losses on a monthly basis. The government now recognizes the need to decisively address the issue of SOE performance and minimize fiscal risk. 

The strategies the IMF supports in this direction are:

• A resolution strategy for SriLankan Airlines, which will be completed and approved by the cabinet to effectively remove this company from the government’s accounts (structural benchmark). 
• To enhance the oversight and financial discipline of the six largest SOEs (CPC, SriLankan Airlines, Airport and Aviation Services Limited, the CEB, National Water Supply and Drainage Board and Sri Lanka Ports Authority), which will agree with the Finance Ministry and the relevant line ministry and publish a statement of corporate intent (SCI), which encompasses the SOEs’ mission, high-level objectives and multiyear corporate plan, capital expenditure and financing plans, which will include explicit financial and non-financial targets and description of non-commercial obligations.
• Reform of energy and other utility subsidies. This would entail the implementation of a formula-based automatic pricing mechanism for petroleum products, so as to reduce the possibility of future financial losses by CPC and avoid large adjustments in retail prices. 
• The legislative reforms to ensure that the Public Utilities Commission of Sri Lanka (PUCSL) will have the sole authority to set electricity tariffs in a cost-reflective manner. The automatic fuel and electricity pricing mechanisms that ensure the retail prices above the cost-recovery levels and a financial position of CPC and the CEB capable of covering the debt service will be introduced. This strategy will be extended to water tariff settings too, when the PUCSL starts regulating the water sector. 

The risk arising from this ‘leakage’ of the government budget is much broader as one researcher (Dananath Fernando, DM, May 19, 2016) had pointed out (during the previous year).
The cumulative losses of the top five SOEs (2006-2015) amount to Rs.605 billion, while the total loss of 55 SOEs (accounts of which are published) is Rs.636 billion.  This reiterates the blaring truth that (1) CPC (2) the CEB (3) the SLTB (4) SriLankan Airlines and (5) Mihin Lanka account for 95 percent of the losses. Now it is confirmed the aggregate losses amount to 14 percent gross domestic product (GDP). 

A detailed report of an independent authority overseeing the SOEs in 2016 revealed that (1) policy incoherence, confusion and lack of a strong set of metrics among the regulatory and monitoring agencies account for this confusion (2) lack of domain expertise within these enterprises with bloated structures and (3) the desire on the part of these inefficient officials (includes the SOE senior staff and the politically-appointed board members to the SriLankan board is a case in point) to maintain a culture of inefficiency, advantageous to them or their political backers.”

Little surprise that when the prime minister called for plans along with the key performance indicators (KPIs) *through his designated officer (director general of the Project Management and Monitoring Department of the National Policy and Economic Affairs Ministry) in January 2016 hardly any had done so even by April 2016. Developing and aligning the strategy and setting the KPIs require in-depth knowledge and competencies, which can hardly be acquired over four months.
The MoU of the IMF and Finance Ministry (sighted above) speaks of the SCI but does not identify a measurement framework, replete with the KPIs. 

What ails SOEs
What then ails these SOEs? Some serious reasons for this erosion of competitiveness are:  

• Ineffective boards governing these enterprises: Either most of those directors are ‘yes people’, who will not challenge the wrong doings/poor decisions of the board or they are altogether incompetent.
• Lack of domain knowledge: Both in board appointments and/or senior management positions such as chairman, CEO or managing director or key management positions (possible reason for this is giving precedence to political loyalty than competency in these appointments. It also highlights the unwillingness/or lack of faith in controls and oversight mechanisms of the executive).
• Lack of competencies in senior officers in these enterprises for implementation of their mandated goals and/projects (both local and foreign funded).

SOE profitability is a question of responsible/competent boards and astute management. Public Enterprise Development Deputy Minister Eran Wickremaratne in March last year observed that the public service at present is evaluated and funded on the basis of how much is spent rather than on the actual outcomes on performance. A system that links pay to KPIs is essential to promote efficiency and bind accountability in the public sector. He also said that the public enterprises must focus on empowering people (within the organisation) to ensure better performance.

Interestingly, Prof. Razeen Sally (Centre for Public Policy, National University of Singapore) in a feature also observed that (1) there is no point in setting up a state holding company (the public wealth trust*) and calling it something, if you are not going to change the current operating system. (2) He recommends that we differentiate those SOEs that need to operate commercially and others like the CEB and SLTB, which have social ends to meet. Recommends only those in the former to be bundled into the holding company (3) need to introduce independent directors to the board, rather than appoint some lawyer (possibly a political activist) without prior commercial experience to a commercial SOE. This yardstick also applies to the appointment of CEOs. (DM, May 12, 2016, ‘Solving the SOE problem in Sri Lanka’) 

The Pathfinder Foundation too had observed in many of its perspectives on the SOEs in the past that “not only the impact of the inefficiencies and poor management that should be examined but also the underlying factors which compromised the performance of the SOE.”

We need to recognize the fact that we cannot litigate success of a failing enterprise nor for that matter can you litigate performance? Concluding my thoughts on arresting this trend of mismanaging the SOEs, I shall site the competency framework (Table 2) developed by the Government of Mauritius in 2014 for appointment of independent directors of SOEs.  

A guide to the competencies required of directors (does not mean minimum qualifications and senior managerial experience) attributes and skills which will enable them to fulfil the oversight function expected of them:

The subject minister/ministry secretary will do well to remember the above guideline when selecting nominees for the board of directors of SOEs, particularly where the mandate requires ‘turning around’ of these enterprises.

(Rauff Reffai is Institutional Specialist, International Development Agency, World Bank. He can be reached at [email protected])