ECONOMYNEXT – The discourse around restructuring Sri Lanka’s state-owned enterprises (SOEs) is unhelpfully focused on a misplaced dichotomy between loss-making and profit-making entities, according to the head of a government-appointed SOE restructuring unit.
Suresh Shah, head of the Finance Ministry’s SOE Restructuring Unit, speaking at a webinar on Wednesday June 14 said that the loss-making versus profit-making debate is a “major fallacy”. The webinar was organised by the Central Bank of Sri Lanka (CBSL)’s Centre for Banking Studies.
According to Shah, any enterprise, whether public or private, tends to return only dividends to the shareholder(s) while the profits proper generally go back into the company. In the case of a profitable SOE fully owned by the state, government revenue from the enterprise would comprise only dividends and, in terms of cash flow, those dividends would account for a very small component of total government revenue.
For example, he said, if an SOE made 1 billion rupees in profit in a given year and declared a dividend of 100 million rupees, only that 100 million would contribute to government revenue while the balance 900 would remain with the company.
“If you look at the last 10 years’ average of the dividends declared by all SOEs to the government, as a component of government revenue, it works out to about 0.5 percent,” said Shah, adding that this includes dividends declared by the state banks.
The SOE Restructuring Unit headed by Shah was appointed to oversee the divestment of state-held shares of the following SOEs:
- Sri Lankan Airlines Ltd including Sri Lankan Catering Ltd
- Sri Lanka Telecom PLC
- Sri Lanka Insurance Corporation Ltd
- Canwill Holdings Pvt. Ltd., (Grand Hyatt Hotel)
- Hotel Developers Lanka Ltd., (Hilton Hotel Colombo),
- Litro Gas Lanka Ltd., including Litro Gas Terminals (Pvt) Ltd., (LPG retailing)
- Lanka Hospital Corporation PLC
Various critics including Sri Lanka’s main opposition party the Samagi Jana Balawegaya (SJB) have spoken against the privatisation of profit-making SOEs.
According to Shah, however, this is a moot point.
By privatising SOEs, profitable or otherwise, he said, the government could earn greater revenue through taxation in addition to the revenue generated through the initial sale.
The ultimate objective of restructuring SOEs, the official, is to improve products and services delivered to consumers in a competitive economic framework ensuring fair pricing, increased quality and more availability.
“This is what restructuring is all about,” he said.
The profit vs loss-making debaprte aside, the state will still have to make a call on which enterprises should be privatised and which should be retained. According to Shah, this decision depends on whether or not there is a market failure. One reason a market failure could occur would be the emergence of a monopoly or a handful of players controlling the market leading to consumers not repeating the benefits of fair competition.
“You try to address this through the SOE system if and only if other mechanisms are not possible,” said the official, explaining that one such mechanism is regulation, through which the government can intervene to ensure fair pricing, product availability, etc.
Ideally, the government must only concern itself with the provision of essential goods and services. From a sales perspective, he said, there is a case for some state involvement, though, again, not necessarily through an SOE, to ensure an adequate supply of an essential good or service such as fuel. The government can take a call on whether it should step in to ensure supply or leave it in the hands of the private sector.
“The fundamental decision pointing to the government getting involved rests on this market failure,” he said.
Regulation is the mechanism through which the government can ensure there are enough private players in a competitive environment to ensure price, quality and availability, and this alone should be the deciding factor in whether or not a business should be unchained from the government, said Shah.
He reiterated that the fallacy of profit vs loss-making entities with regard to privatisation is unhelpful.
“Today’s loss making enterprise can be tomorrow’s profit making enterprise,” he said.
He stressed once again that revenue even from a profitable SOE would be minimal.
“If you take any entity, if you were to divest those listed entities today at the market price without a premium on the majority holding and you invested that proceeds of that in a fixed deposit, the deposit interest you will earn out of those proceeds is about four to five times the dividends the enterprise will declare in any given year,” said Shah.
“In purely cash flow terms, it makes sense to divest these entities,” he added, noting that 15 percent in value added tax (VAT), 2.5 percent as social security levy and 30 percent of the profit as income tax will all add to the total revenue generated.
The tax revenue alone would more than compensate for any dividend the “unchaining” of a profitable SOE the state would lose, said Shah.
“In purely cash flow terms, this story about profit vs loss making enterprise simply does not hold water,” he added.
Shah also warned that there is a danger in overly focusing on the government turning a profit, as the state’s responsibility to the public is to provide essential services such as health and education, areas in which the government should not be motivated by profit.
“They have public interest obligations they need to focus on,” he said, noting that the government has a monopoly on collecting tax revenue which it can use to fund its obligations.
“Profits should be the purview of the private sector not of the government,” he said.
“This is why we need to consider putting SOEs into private hands,” he added.
However, Shah acknowledged that some SOEs will have to remain with the state, especially where market failures might occur.
“We need to create a proper system to manage those enterprises. This is part of restructuring,” he said, adding that this is arguably more important than the discussion on privatisation.
The official also identified several reasons for the failure of SOEs over the past few decades. These include parking government subsidies within the SOEs rather than adding them to the government’s own balance sheet. The Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC) maintaining poor balance sheets as a result of this eventually led to an energy crisis in the country, he noted.
Among other reasons Shah highlighted for SOE failures were poor management, political appointments and overstaffing and government systems and controls preventing efficiency.
Decision-making at an SOE would necessarily involve an arduous process and chain of command going all the way up to the cabinet of ministers, which would often take months. The cabinet may also not comprise the expertise such decisions demand. In the hands of a private player, on the other hand, the approach to such decision-making would be more efficient and take significantly less time.
The SOEs whose divestment is being contemplated have stakeholders that total 22 million people, and therefore transparency in the restructuring process is crucial, said Shah.
Transaction advisors have been sought via advertisements published locally and internationally and expressions of interest (EOI and requests for proposal (RFP) have been obtained, he said, adding that the restructuring unit is now in the midst of shortlisting advisors for the entities that have been identified for privatisation.
These advisors, once appointed, will help the unit with due diligence on the sales side and with valuation and the creation of investor data rooms, he added.
“We will then open up through EOIs and RFPs to invite bids from anyone making a proposal for any of the SOEs,” he said.
The cabinet will then make an award upon proper evaluation, and the entier process will be “very transparent,” said Shah.
“At the end of the day, all of us in the unit believe we have a responsibility to all citizens of this country,” he said. (Colombo/Jun14/2023)