Restructuring State Owned Enterprises

My last article questioned whether direct taxation would collect the envisaged revenue, and hence achieve the governments’ objectives of debt sustainability. Given this apprehension, the Governments’ success in the restructuring of State Owned Enterprises’ (SOE) are critically important.

A report published by the Ceylon Chamber of Commerce stated that 83% of the profit of all the SOE’s are generated by six entities, and 97% of the losses are made by five entities in 2020. This report went on to state that 52 SOE’s had absorbed Rs. 920 billion worth of bank credit, in addition to Rs. 75 billion worth of support from the Treasury.

Why is SOE Reform important?

Revenue

The restructuring of profitable entities such as Sri Lanka Insurance, the Government stake in Hotels, Financial Institutions and Lotteries could bring in significant foreign exchange revenue. The Government has estimated that they can collect US$ 2-3 billion from the restructuring of SOE’s, which is critical in our current economic context.

Reduced Government Expenditure

The restructuring of loss making SOE’s can help curtail Government expenditure and guaranteed credit. Profitable SOE’s can be a strong source of tax revenue for the Government.

Investor Confidence

The Government actually going out and restructuring of SOE’s would make a clear policy announcement that they are serious about long-term economic reform, and also make the announcement that Sri Lanka is ‘open for businesses. This could boost investors’ confidence and help attract more FDI.

Challenges to SOE Reform

Political Consensus

Political consensus is key to successful SOE reform, and broader economic reform, which are prerequisite to Sri Lanka’s economic recovery. Sri Lankan politicians have not demonstrated the ability to build political consensus on key economic strategy, and this is a contributor to our economic destruction. President Ranil Wickremesinghe has demonstrated his commitment to the reform process. He needs the support of his Government and the Opposition if successful economic reform is to be implemented.

Public Consensus

Sri Lankan’s are often insecure about globalization, and outward orientation. They feel that ‘foreigners’ are waiting to steal Sri Lanka away from them. The local reaction to the MCC project can be cited as an example of this sentiment. The economic hardship that Sri Lankan citizens had to face, could help the Government show the nation of the need for FDI. Public discussion and debate, supported by social and business leaders could help this process, so the public will see the facts that support this policy.

Discounted Prices

The much-publicized Sri Lankan economic crisis will lead to potential investors in SOE’s expecting to buy assets cheap. Sri Lanka faces significant country risk. We have earned a reputation for political instability, which has led to a lack of policy consistency. Whilst we boast of some very successful privatization’s that are global case studies of best practice, we have also many examples of policy ‘U-Turns’ and renationalization. This could impact the price that we can achieve on the restructuring of SOE’s.

Risk Indemnification

Buyers of SOE’s can demand indemnification and security against such policy changes causing a negative financial impact to them. Legal mechanisms to achieve this will need to be worked out.

Such indemnification should also be granted to Government officials involved in the SOE reform process. Again, history shows examples of court cases against officials involved in the restructuring process, and these officials having to bear their legal costs privately. Giving officials’ security could enable them to discharge their duties more effectively.

Understanding Complexity

The complexity of the SOE reform process is significant and cannot be underestimated. Whilst some SOE’s are PLC’s and lend themselves to efficient ownership change, others are much more complex. The restructuring of Government owned commercial entities is less complex and should be prioritized.

SOE’s performing a public service are more complicated, but that doesn’t mean they should remain under Government ownership. Even the health and education services could be restructured, with public service guidelines embedded into the restructuring. For example, the government hospitals in Singapore have a three tired price policy, with one price for Singapore citizens, a second for residents and a third for others. Such a pricing structure could facilitate the restructuring of health care. A similar system could be used for education. The result of successful restructuring could be better public service, and a funds inflow (instead of outflow) to the Government. The restructuring process is however complicated and is not always successful. The British postal system is an example of a successful restructuring whilst the restructuring of British Rail has been less successful.

Sri Lanka has internal success stories of creating strong regulatory agencies, such as the Telecom Regulatory Commission and more recently the Petroleum Development Authority. The creation of the Golden Share Holder in the plantation restructuring could have been very successful, sans the politicization of dealings with labour unions. These examples support that Sri Lanka can structure strong regulatory agencies, and this should be a part of the SOE restructuring process.

How to restructure

Whilst this section justifies a separate article, three key factors could be raised in brief.

Cabinet Appointed Committee (CAC)

A Cabinet appointed committee, led by the President and comprising of key members of the Government, the Opposition, technocrats and sector specialists can be argued as a requirement for successful SOE reform. A committee that is structured thus will by its very structure have political consensus, and the ability to obtain specialist knowledge. Such a structure can facilitate much investor confidence.

Holding Company (HC)

Examples of Temasek in Singapore and Khazanah in Malaysia suggest that a holding company can be a very effective tool in managing SOE’s. This will bring the management of SOE’s under the governance norms of the PLC section of the Sri Lanka Companies Act of 2007 which has proven to be successful.

The HC could be owned by the Treasury, whilst strategic agencies like the World Bank or IFC could have shares or preference shares as a means of bringing starting working capital into the entity. If the HC collects the SOE sales proceeds, retains a percentage to support its running, and forwards the balance to the Government, this would give it adequate working capital and give it financial independence.

The CAC could function as the Board of the HC, and executive positions could be filled in a transparent manner, hiring suitably qualified professionals at competitive remuneration.

Restructuring Process

The HC structure facilitates the restructuring of SOE’s being carried out through the Stock Exchange, which will support the market capitalization of the exchange, giving investors more choice, and bringing more liquidity into the market.

The successful restructuring of SOE’s can be the cornerstone of the successful restructuring of the Sri Lankan economy that will facilitate sustainable long-term development. Sri Lankan has a god given opportunity to implement this reset, and one hopes that the Government, the Opposition, business leaders and social leaders will combine to achieve this.