Taking a rational approach to SOE restructuring

 SOE restructuring cannot be done with a ‘broad brush’ approach

• There are some sectors where liberalising the market by allowing more players to enter is far more important than divesting ownership of the existing state entity/entities. Petroleum distribution and electricity generation are two good examples of where progress is being made. Disposing of state entities in these sectors may be cumbersome due to the accumulation of past losses and debt as well as labour issues. However, opening the sectors or parts of them to introduce competition wherever possible will bring about the desired benefits to all stakeholders
• Where there are two or more entities performing a similar service, it would make sense to amalgamate them to eliminate duplication. Even if they are potential candidates for divestment, it may make sense to amalgamate first to create a stronger more marketable entity prior to divestment. However, the identification of such entities should be done after a proper study of their purpose and current operations
• There are numerous SOEs that are either defunct or not serving any useful purpose. Some of these have been identified as candidates for liquidation years ago. While some progress has been made regarding a few of them, there is still a large number for which this process must be taken to completion so that any available resources are reallocated, and management time is not wasted any more on these entities

It is pleasing to note that the Government of Sri Lanka has embarked on an SOE Reform process back again with the newly established SOE Restructuring Unit driving it. Therefore, as someone who has been involved with this process from time to time, I thought it would be timely to share a few thoughts. Let me begin by busting a few myths that tend to cloud our understanding of the subject. 

Myth#1: There are over 500 SOEs in Sri Lanka

A State-Owned Enterprise is typically defined as a government owned or controlled entity which generates most of its revenue from selling goods and services on a commercial basis. In other words, they need to be commercial entities that are state owned. A closer look at the numerous state-owned institutions that operate in Sri Lanka will reveal that only about 130 entities would fall into the category of SOEs. The rest of them are regulatory agencies such as the Public Utilities Commission of Sri Lanka, promotional institutions such as the Export Development Board, research and development agencies, educational institutions, and a multitude of others. While these entities have their own issues that may require attention, it does not make sense to include them into the category of State-owned enterprises that are essentially commercial entities.

Myth#2: Most SOEs are 

loss-making

Even though it is a popular belief that most SOEs are incurring substantial losses causing a burden to the Government, a deeper analysis will indicate that a substantial majority are in fact profitable entities. An unpublished study carried out recently revealed around two-thirds of SOEs made profits in each of the years 2015-17. Of the balance one-third that incurred losses, it was only 3 or 4 entities that contributed to over 85% of the total loss incurred by all SOEs. This is confirmed by more recent evidence as well. According to the Annual Report of the Ministry of Finance, of the 52 key SOEs monitored by the MOF, 32 were profitable while 20 of them made losses in 2021. Further, 96% of the total loss was accounted for by just three entities. Hence, if the objective of SOE reform is only to reduce the financial burden on the Government, focusing on a handful of entities can address that issue to a great extent.

Myth#3: Most privatisations carried out in the past in Sri Lanka have failed, apart from Sri Lanka Telecom

Sri Lanka has had a rich history of using privatisation as a tool of SOE reform. Between the period 1989 to 2002, as many as 84 SOEs have been fully or partially privatised. It is interesting to note that this period covered two different regimes led by the two leading political parties at that time accounting for an equal number of privatisations between them. Apart from SLT which is often cited as one of the most successful privatisations, there are plenty of other success stories such as Puttalam Cement (currently under Insee Cement), Cinnamon Grand and Cinnamon Lakeside Hotels, Lanka Lubricants (Caltex), United Motors, Ceylon Oxygen, Lanka Milk Foods, etc. There have been a few failures too which were primarily a result of non-adherence to best practice in the execution of some of these transactions.

Close examination of each SOE to select an appropriate reform option

It should be clear from the discussion so far that SOE restructuring cannot be done with a ‘broad brush’ approach. Instead, it is necessary to painstakingly examine each SOE and categorise them according to different dimensions as given below.

a) Is there a strategic reason to retain the specific entity under the State?

While it is best for the Government to stay away from running business entities, there could be a few instances where it could be justified, for example, based on national security needs, being a natural monopoly where it is difficult to establish a competitive market, need for price-setting in the case of an essential product/service, or addressing a market failure. However, these justifications also need to be examined further to see whether there are alternate ways of achieving the same objective. Having strong regulatory bodies may help to look after national security needs (e.g.: ports, airports, telecom) as well as the need to manage prices of essential utilities (e.g.: petroleum, electricity, gas). With regard to addressing market failures such as the provision of public transport on commercially unviable routes/times, a concession agreement can be structured with a subsidy element to facilitate private sector participation through a competitive bidding process for route licenses.

b) Is it profitable or loss making?

While this may be a factor in determining the method of restructuring to be adopted and the timing, one must not rush to the conclusion that simply because an entity is profitable, there is no justification to divest ownership. First, one needs to examine the concept of profitability being used. Some entities may show profits only due to the revenue grants they receive from the treasury. In the unpublished study referred to earlier, most such cases were adjusted to unravel its real profitability. Even in instances where they are genuinely profitable, there are very good reasons given below as to why the Government should consider divesting these entities as well.

(i) Government doesn’t have the capacity to invest more capital to meet the investment needs of these entities. That stifles the growth of these institutions that require significant investment to optimise the productivity of their asset base. (e.g.) Hotels

(ii) GOSL needs funds urgently to meet the immediate requirements of more vulnerable sections of the public. (e.g.) salaries, pensions, cash transfers, other welfare payments, etc. By exiting these ventures, the Government can generate funds that can be channelled towards these priority needs.

(iii) This is a good opportunity to attract much needed FDI into the country. While profits may flow out over a long period of time, there will be an immediate injection of foreign currency when the transactions take place.

(iv) When profits are maximised under private sector management and enhanced capital investment, Government can earn more in the form of taxes on such profits.

(v) As SOEs, these institutions are subjected to a lot of unwanted political and bureaucratic interferences as well as government processes relating to procurement, recruitment, etc. that hamper their growth. Shifting them to the private sector will free their management and staff to compete more effectively with other private sector entities without any hindrance and provide a better service to customers.

c) Size and scale of operation

This is a factor that needs to be considered in terms of the potential impact any reform process could have on key stakeholders as well as on the economy. Hence, entities such as Ceylon Petroleum Corporation (CPC), Ceylon Electricity Board (CEB), Sri Lanka Ports Authority (SLPA) and the state banks will require extra attention while some smaller entities can possibly be amalgamated prior to being considered for divestment.

Possible options for reform

There are several options that can be considered and the option that fits each specific entity must be selected after adequate consideration of all the above factors.

1. Divestment (Total/Partial)

As the Government is not best equipped to run businesses in a sustainable manner in the interest of all stakeholders, divestment may be the most suitable option for a significant number of SOEs barring a few. Where any entities have been identified for full or partial divestment and Cabinet approval obtained, a transparent process needs to be adopted with a transaction advisor appointed and their support enlisted for the preparation of an Information Memorandum, performing a valuation, and arranging the due diligence process among other things. As preparatory steps, financial statements must be brought up to date, balance sheets cleaned up and pending legal issues resolved to the extent possible. Obtaining the support of all stakeholders, creating adequate awareness among all potential investors, and making sufficient information available to interested parties are key success factors that can ensure a smooth process resulting in the best possible outcome. Government may need to strike a balance between the twin objectives of realizing the best value from the transaction and the need to select a competent investor who can take the entity forward creating value for all stakeholders.

2. Market liberalisation

There are some sectors where liberalising the market by allowing more players to enter is far more important than divesting ownership of the existing state entity/entities. Petroleum distribution and electricity generation are two good examples of where progress is being made. Disposing of state entities in these sectors may be cumbersome due to the accumulation of past losses and debt as well as labour issues. However, opening the sectors or parts of them to introduce competition wherever possible will bring about the desired benefits to all stakeholders. This may require unbundling of certain entities like the CEB and separating regulatory powers and commercial operations from entities that play a dual role such as SLPA, Airport and Aviation Services (Private) Limited and State Film Corporation. In each of these sectors, there is a need to have a strong independent regulator that has absolutely no commercial interests in the sector.

In some sectors such as public omnibus transport, a new model needs to be carefully designed and implemented to take the competition ‘off the road’. The ideal method for consideration would be to introduce a concession agreement for each route with one operator being selected through a competitive bidding process, where typically the operator offering to provide the required services at the lowest fare or lowest subsidy per kilometre (on unprofitable routes where the Government determines the fare) will be selected. Existing bus owners should be encouraged to form corporate bodies and bid collectively pooling their resources. 

Sri Lanka Transport Board (SLTB) and any other local or foreign new entrants can also bid on the same basis with no preferential treatment given to any party. The selected operator should be required to maintain its service according to a given timetable with the current model of competing ‘on the road’ with other operators being eliminated. This will ensure predictability and safety to passengers and other road users as well as commercial viability to the bus owners. Introducing a simple electronic fare payment system which can accept credit and debit cards issued by all banks must also be introduced simultaneously.

3. Single supervisory body for SOEs

All SOEs that will be retained under state ownership along with those pending divestment should be brought under a single independent entity. It can be a holding company or a state agency operating under the Ministry of Finance or ideally, an independent Ministry of Public Enterprises. It is of critical importance to shift the SOEs out of line ministries that are engaged in policy making related to the respective sectors. This will ensure that the SOEs are required to compete with other private sector entities on a level playing field with no ability to influence policy making related to the sector.

The independent supervisory body or holding company should be responsible for ensuring proper corporate governance through the appointment of Boards of Directors for the SOES and monitoring how they function. Managing the performance of the SOEs through periodic monitoring and evaluation will be another important task it will have to perform. Like any other Board, it needs to provide equal attention to both ‘conformance’ and ‘performance’. 

It is understood that the Cabinet has already approved the establishment of a holding company for this purpose. Its incorporation should be expedited with a Board of Directors comprising independent professionals, with no conflicts of interest. They must be appointed through a transparent process, preferably through the Constitutional Council. This must be followed by the transfer of all identified entities under it by a gazette notice.

4. Amalgamation

Where there are two or more entities performing a similar service, it would make sense to amalgamate them to eliminate duplication. Even if they are potential candidates for divestment, it may make sense to amalgamate first to create a stronger more marketable entity prior to divestment. However, the identification of such entities should be done after a proper study of their purpose and current operations. One possible example that can be given is State Mortgage and Investment Bank (SMIB) and Housing Development Finance Corporation (HDFC) which can be amalgamated to establish a strong housing bank.

5. Liquidation

There are numerous SOEs that are either defunct or not serving any useful purpose. Some of these have been identified as candidates for liquidation years ago. While some progress has been made regarding a few of them, there is still a large number for which this process must be taken to completion so that any available resources are reallocated, and management time is not wasted any more on these entities.

Managing key stakeholders to ensure success

When embarking on a socially and politically sensitive endeavour, such as an SOE Restructuring Program, it is essential to ensure that the potential impact of each transaction or process is evaluated from the perspective of each key stakeholder group. For instance, if we look at the public omnibus transport sector, due attention must be given to all stakeholder groups including passengers, employees of the state owned SLTB, bus owners, employees of bus owners such as drivers and conductors, etc. If one goes through this process methodically, it is possible to identify the positive and negative impacts on each of these groups along with their concerns and apprehensions which may be, sometimes, based on perceptions more than reality. 

Such an analysis will help the SOE Restructuring Unit to design methods of addressing these issues before they begin to manifest themselves in a manner that could threaten the success of the program. It will be like a Risk Management process carried out by a corporate entity which identifies risks and takes action to mitigate them. If this process can be backed by an effective communication campaign targeting the wider public, the chances of successfully completing the restructuring process will be so much greater.

(The writer served as Director General, Public Enterprises Reform Commission (PERC) during 2003-4 and as Consultant – Divestment and Restructuring, Ministry of Public Enterprise Development during 2017-18. He was also a Commission Member of the Securities and Exchange Commission (SEC) during 2018-19 and last served as Secretary General and CEO, Ceylon Chamber of Commerce during 2020-23.)