- Privatisation is not the only option for SOE reform
- Crucial to re-establish credibility in reform process
- Absolutely no room for wasteful expenditure, inefficiencies
- Narrow the gap between policy rhetoric and implementation
- Establish clear, practical, and transparent restructuring plan
- Any hint of backroom dealing will discourage bidders, investors
The current move to restructure Sri Lanka’s State-Owned Enterprises (SOEs) is different in that it stems from a highly-constrained fiscal space and, given the ongoing economic crisis, there is absolutely no room for wasteful expenditure or inefficiencies, asserts Dr. Malathy Knight.
“The accumulated losses of the 52 SOEs in the first eight months of 2022 amounts to Rs. 727 billion. These losses outweigh total SOE losses for 2021. Indeed, and somewhat ironically, this crisis has given us yet another opportunity, perhaps the final chance, to reform our SOEs in a sustainable fashion,” she added, in an interview with The Sunday Morning.
Pointing out that privatisation was not the only option for SOE reform, Dr. Knight stated that international best practice and Sri Lanka’s experience showed a range of modalities. She also called for competition in the reform process, minimising the possibility of a public monopoly transmuting into a private monopoly.
“Solid institutions must be in place to ensure transparency, accountability, and effective regulation. Easier said than done, but there really is no choice at the moment. SOE reform must happen one way or the other.”
Dr. Knight also spoke on the importance of public buy-in, investor confidence, and accountability in light of Sri Lanka’s latest move to restructure its SOEs.
Following are excerpts of the interview:
Successive governments have been speaking of SOE restructuring for decades, with little to no concrete or lasting action being taken. How do you view the current move to restructure SOEs?
It is not entirely correct that SOE reforms were on the backburner – at least from the late 1980s to around 2004. During this period, we saw two waves of privatisation. In the first wave, from 1989 to 1994, around 43 commercial entities were privatised. The second wave, from 1995 to 2004 saw the privatisation of larger, more complex sectors such as telecommunications, gas, and airlines. In fact, the much-hailed Sri Lanka Telecom (SLT) privatisation was carried out during this period.
However, the SOE reform process has stalled from about 2005. In 2011, expropriation legislation was enacted to acquire and manage 37 underperforming or underutilised private enterprises. Restructuring did not get underway in the post-2015 period, even with an International Monetary Fund (IMF) Extended Fund Facility (EFF) in place that specified particular SOE reforms.
SOE restructuring is inherently difficult in the best of circumstances and requires a particular set of inclusive (as opposed to extractive) institutions to be in place if they are to succeed. The realities of a coalition government with differing ideologies made this process politically difficult and we missed this window of opportunity.
The current move to restructure SOEs is different in that it stems from a highly-constrained fiscal space. Given the ongoing economic crisis, there is absolutely no room for wasteful expenditure or inefficiencies. The accumulated losses of the 52 SOEs in the first eight months of 2022 amounts to Rs. 727 billion (Ministry of Finance) and calculations by Verité Research show that these losses outweigh total SOE losses for 2021.
For context, SOE losses in 2021 amount to 73.9% of health expenditure, and 92.1% and 516.5% of education and Samurdhi expenditures, respectively. Indeed, and somewhat ironically, this crisis has given us yet another opportunity, perhaps the final chance, to reform our SOEs in a sustainable fashion.
Is privatisation the only answer to Sri Lanka’s SOE woes? What are the key concerns/risks? What would be the ideal approach/model in undertaking SOE reform?
No, privatisation – as in a partial or full sale of assets – is not the only option for SOE reform. International best practice (as well as experience from our own two waves of SOE reform) indicates that there are a range of modalities.
For instance, performance contracting, management contracting, Public-Private Partnerships (PPPs), holding companies, listing on the stock market, Employee Stock Ownership Plans (ESOPs), etc. There is no single model. It is also important that we look to our past experience with SOE restructuring – both positives and failures – rather than reinvent the wheel.
Each SOE is unique, and the modality used for reform has to be tailored to the entity’s specific characteristics, requirements, and obligations. The approach that works for SriLankan Airways will not be suitable for the Ceylon Electricity Board (CEB) and what works for the State-owned hotels will not work for the Ceylon Petroleum Corporation (CPC).
The question that must be asked is: how best will the interests of the principals of these entities (the public) be served by the reform process, and which approach is best suited to do this? Although the mechanisms may differ, there are certain essential principles that the process must adhere to in order to safeguard the interests of principals.
For example, ensuring competition must be at the centre of the reform process. The restructuring process must minimise the possibility of a public monopoly transmuting into a private monopoly. Further, solid institutions must be in place to ensure transparency, accountability, and effective regulation. Easier said than done, I recognise, but there really is no choice at the moment. SOE reform must happen one way or the other.
How can the Government ensure transparency and clear communication to the public in this exercise and how can public buy-in be ensured?
Clear communication to all stakeholders is the keystone of any successful reform process. In the first wave of privatisation, the process was dubbed ‘peoplisation’ in an effort to get public buy-in. Another useful example is that of the SLT privatisation, where policymakers productively and proactively engaged with trade unions to obtain buy-in.
The key tasks that must be undertaken by the SOE Restructuring Unit include developing a coherent and persuasive message, implementing an accessible communication strategy (in all three languages), and instituting a process where the public is aware of the entire SOE restructuring drive. This must be done right away and before a single SOE is restructured.
How can Sri Lanka boost confidence among investors, multilateral lenders, and bond holders that it is serious about economic reforms?
It is crucial to re-establish credibility and to narrow the gap between policy rhetoric and implementation. To do this, it is important to establish a clear, practical, and transparent SOE restructuring plan and timeline and stick to it. Lessons from the past indicate that policy reversals and gaps can result from the absence of these kinds of plans and timelines.
Institutional and governance reforms are also central to the SOE reform process. For instance, it is critical to ensure that the bidding process is ultra-transparent so as to prevent rent-seeking and corruption. Any hint of backroom dealing will discourage participation from genuine bidders and other potential investors. The private sector also has a crucial role to play in this regard by adhering to ethical business practices and instituting robust internal governance processes.
Does Sri Lanka have the fiscal capacity to fund the required SOE reform agenda?
I would frame the question as does Sri Lanka have the fiscal capacity not to engage in SOE reform to stem the red ink and deficit spending? As discussed earlier, the answer is no. SOE restructuring must be implemented not so much to raise revenue but so as to stem colossal losses.
The problem of waste and inefficiency is compounded by the murky environment within which SOEs operate. For instance, there is not even a firm number of SOEs operating. The Government classifies 52 SOEs as ‘strategic,’ but fails to list the potentially hundreds of additional ‘non-strategic’ SOEs. Under some estimates, the true number of SOEs stands at around 400, while other sources indicate that the number is over 500.
The problem is compounded by the existence of a complex and confusing array of subsidiaries associated with a number of major SOEs, such as CEB and Sri Lanka Insurance Corporation (SLIC).
Sri Lanka’s SOEs fail miserably when it comes to accountability. How should this be addressed and ensured?
Accountability hinges on transparency – both are crucial to public interest. An absence of information and transparency is a huge problem in the SOE space. Indeed, in my view, it is a fundamental, core challenge in the restructuring process.
According to an analysis by the Advocata Institute, of the 52 strategic SOEs, financial information was available for only 29% in 2021 (based on Annual Reports). Without such information, the operations of SOEs are a black box to the general public and potential investors.
On the flip side, even without performing huge restructuring steps, enforcing basic disclosure obligations can take us a very long way to setting the stage for reform and increasing public trust. Key information such as how tariffs are set, what are the true costs of production, explaining the basis for cost-reflective tariffs, and data for regulatory decisions are essential not only to get the reform process right and to make informed decisions, but also for stakeholder buy-in. Analysis is critical for a sustainable reform process and for rigorous analysis, information is key.
SOEs must be required to disclose certain information and maintain openness and transparency. This is a part of their obligation to be accountable to their principals – the public. These types of disclosure requirements are referred to as ‘Sunshine Laws’ in the US and are essential to promote ethical standards and prevent fraud/corruption – increasing public trust and accountability.
A mechanism already exists to implement disclosure: securities reporting obligations for public companies. SOEs should be listed as non-tradeable entities on the Colombo Stock Exchange (CSE) to impose the same disclosure obligations that publicly traded companies face.
Which SOEs do you see as needing immediate reform in terms of privatisation or restructuring? Which SOEs/public services/businesses require State ownership or oversight and why?
The questions that must be asked when deciding on SOE restructuring are: what are the objectives and obligations of these entities and do these SOEs meet them? The primary objective of an SOE is its public service obligations: providing quality goods and services efficiently and in a competitive manner to its principals. In Sri Lanka, few SOEs meet this threshold. Restructuring is imperative and long overdue.
However, as discussed earlier, privatisation may not be the only or most suited option for every SOE. We need to use multiple approaches. Decisions on whether to privatise or take an alternate approach have to be based on clear criteria, including does the entity provide an essential good or service (PSO), can the private sector deliver this in a competitive manner, and what is the structure of the market (is it competitive or a natural monopoly)?
Consider the top five loss-making SOEs from 2020 to the first eight months of 2022: CEB, SriLankan Airlines, CPC, Sri Lanka Transport Board (SLTB), and National Water Supply and Drainage Board (NWSDB). It is clear that all these entities need deep and comprehensive restructuring.
For example, in the first eight months of 2022, SriLankan Airlines was losing Rs. 472 million every day. In my view, SriLankan is not a ‘strategic’ enterprise nor an entity that requires State ownership. It is a clear candidate for complete divestiture, after carving out the profitable catering and ground handling services and ensuring competition when restructuring these subsidiaries.
Just as India went ahead and privatised Air India, there is no rationale for us to hold on to the airline. Although the sale of SriLankan Airlines will likely not generate significant revenue, it will stem the budgetary haemorrhaging. The sale of this SOE will also demonstrate commitment on the part of the Government and will signal to investors that we are serious about reforms.
A different approach is required with SOEs that provide essential services to the public and require significant State oversight such as the CEB and the NWSDB. In the case of the CEB, the transmission segment is a natural monopoly. The first-best solution for an entity like the CEB is to unbundle and divide up generation, transmission, and distribution into separate entities; ringfence and maintain financial separation between the units; introduce private competition in the contestable generation and distribution segments and adopt cost-reflective tariffs.
If this fundamental restructuring is not possible, the second-best solution is to force information disclosure through benchmarking, once again highlighting the importance of transparency and accurate data disclosure.
How can competition be ensured in the restructuring exercise and what approach do you recommend in terms of regulation?
Competition and pro-competitive regulation are important for a number of reasons, including safeguarding public interest, securing efficiency gains in the reform process, and ensuring that inefficient public monopolies or oligopolies are not replaced with inefficient private monopolies or oligopolies.
A good example of the benefits of competition and contestability is the SLT reform process, where contestability in the fixed-line market and competition in the mobile market together with pro-competitive regulation drove solid performance in the industry in terms of market penetration and prices.
Competition and regulation in the context of SOE reforms must be based on certain fundamental principles: ensuring competitive neutrality, avoiding heavy-handed regulation, and separating institutional responsibility for sector policy, operations, and regulation to avoid conflicts of interest (trifurcation). Reformed SOEs must be exposed to competition to ensure that the exercise is not just a fire sale to stop deficit spending; buyers must not be promised that they will be protected from competition.
However, competition and regulation are only as effective as the institutions within which they are embedded. Issues of independence and regulatory capacity pervade most of our institutions. I would like to illustrate this point using our competition law and the Consumer Affairs Authority (CAA).
Competition law is an essential precondition for a sustainable SOE reform process. Sri Lanka has language on two of the three standard pillars of competition law in the Consumer Affairs Authority Act: prohibitions against abuse of dominance and anticompetitive practices. What Sri Lanka does not have are provisions to deal with blocking anticompetitive mergers. Still, we do have language in the law to tackle many types of anticompetitive conduct, including price fixing, bid rigging, and predatory pricing.
While the law does need to be updated to address anticompetitive mergers, the bigger problem is the lack of competition law enforcement.
Research carried out by Verité Research found that there was not one investigation of anticompetitive behaviour (according to CAA Annual Reports) from 2010 to 2020 and that stakeholders prefer to seek relief from courts rather than lodge complaints with the CAA. This enforcement failure stems from CAA’s lack of independence and capacity. This is an organisational failure stemming from the general institutional and governance malaise that pervades the broader policy space. Passing additional laws or establishing new regulatory agencies is useless if there is not adequate institutional support.
To address these challenges, several changes to CAA should be implemented. First, rather than reporting to a single line ministry, CAA should report to a parliamentary body with the power to determine appointments, salaries, and removal. Second, CAA receives most of its funding from the State, supplemented by a small percentage from fines. Reliance on the State for funds combined with the relatively small amount received, undermine regulatory independence and restrict the hiring of professionals at skills-based salaries.
Addressing the problem of inadequate finance and lack of competent personnel is complex and will have several phases. The CAA has to be revamped, with a renewed and strong focus on competition. This new, reinvigorated entity should be made the appellate body for the country’s specialised regulators – for instance, the Public Utilities Commission of Sri Lanka (PUCSL), the Telecommunications Regulatory Commission of Sri Lanka (TRCSL), and the Securities and Exchange Commission (SEC). The benefit of this arrangement is that the competition agency’s costs would be funded by regulatory levies collected by these specialised regulators.
Collective decision-making to ensure continuity has thus far been out of reach for Sri Lanka, given how decisions are driven by political interests and according to election cycles. What is your advice to policymakers in this regard?
There needs to be a recognition that even short-term political interests are currently aligned with reform. As I stated earlier, the country’s policy choices are severely constrained and SOE reform cannot be avoided.
With or without IMF conditionality, SOE restructuring should have occurred long ago and can no longer be delayed. Stopping the budgetary bleeding in the short term and ensuring that reformed SOEs are competitive and effectively provide services (and employment opportunities) in the longer term are absolute imperatives politically and for the country’s wellbeing.
For SOE reforms to be sustainable, there needs to be a well-thought-out, clear, and transparent restructuring plan with realistic deadlines that is communicated to the public. Effective reform will not occur without public and political support.
Fact box
- Accumulated losses of 52 SOEs in first eight months of 2022: Rs. 727 billion. These losses outweigh total SOE losses for 2021
- SOE losses in 2021 equalled 73.9% of health expenditure, 92.1% of education expenditure, 516.5% of Samurdhi expenditure
- Top five loss-making SOEs from 2020 to first eight months of 2022: CEB, SriLankan Airlines, CPC, SLTB, NWSDB
- In first eight months of 2022, SriLankan Airlines was losing Rs. 472 million every day
Profile: Dr. Malathy Knight
Dr. Malathy Knight, Research Associate at Verité Research, is a Senior Economist with extensive academic and public policy experience.
Prior to joining Verité Research, she served as Research Fellow and Head of Industry, Public Enterprise Reform and Regulatory Research, Institute of Policy Studies, Sri Lanka; Research Fellow, LIRNEasia; Visiting Research Fellow, Centre on Regulation and Competition, University of Manchester; and Consultant Economist, Law & Society Trust. Dr. Knight continues to serve as a Fellow at the CUTS Centre for Competition, Investment and Economic Regulation, Jaipur.
Her specific areas of expertise include state-owned enterprise reform, regulatory economics, competition policy, telecommunications policy and regulation, and new institutional economics and she has published extensively in these areas. She has also served on several Government commissions and private sector committees that have played a key role in shaping national policies in these areas.
Dr. Knight has a B.A. in Economics and Political Science (Double Major) with a Concentration in Public Policy from Swarthmore College, an M.A. in Economics from the University of Colombo, and a PhD in Development Studies from the University of Manchester.