FISCAL BALANCING ACT

Shiran Fernando explains the urgent need to reform SOEs

Last month, this column examined how Sri Lanka can sustain its economic recovery through exports, investments and competitiveness. This time around, the issue under consideration is how the country can balance its fiscal picture by reforming state-owned enterprises (SOEs).

Historically, SOEs have been a burden on the treasury and taxpayers due to the loss making nature of some of them – energy and the airlines, for example. The others that are profitable could deliver higher dividends to the state if governance and efficiency are improved.

Furthermore, SOEs have become a popular option for providing jobs during election cycles.

TURNAROUND In 2023, the 52 key SOEs classified by the Ministry of Finance reported a profit before tax of Rs. 455 billion, following a cumulative loss of 777 billion rupees in the prior year.

This improvement was driven by entities such as the Ceylon Petroleum Corporation (CPC), the Ceylon Electricity Board (CEB) and SriLankan Airlines reporting profits. The CPC and CEB alone accounted for 39 percent of cumulative profits, while banking and financial services were responsible for 28 percent.

SriLankan Airlines reported an operating profit of only Rs. 1.1 billion but this was a reversal following the losses it’s been making over the last decade or more. The national airline’s accumulated losses stood at 611 billion rupees.

There was a marked improvement in dividends and levies provided by the 52 SOEs to the Treasury as they increased from Rs. 28 billion to 76 billion rupees.

This profitability in 2023 can be attributed to the cost reflective pricing through adjustments to electricity tariffs and the monthly fuel price formula.

There was also significant restructuring of the balance sheets of these SOEs with legacy debts being transferred to the state’s balance sheet. About US$ 3 billion in foreign currency debts have been transferred from the CEB and CPC to the government balance sheet over the past two years.

SOEs such as the CPC and CEB were reliant on borrowing from state banks, and non-repayment caused liquidity pressure in the state banking sector. The Treasury also infused capital into some of these state-owned enterprises to help them settle their debts with other SOEs.

For instance, the infusion to CEB helped reduce its outstanding debts with the CPC and independent power producers from Rs. 192 billion in 2022 to 78 billion rupees the following year. The Treasury also infused Rs. 102.5 billion in capital to SriLankan so that it could settle its debt to the CPC.

This also highlights the interlinkages between the key SOEs. The CEB and SriLankan Airlines, which are reliant on fuel from CPC, have to perform well to repay their debts.

SUSTAINABILITY The introduction of cost reflective pricing over the last two years led to higher spending by consumers, following many years of prices and tariffs being held and subsidised.

While unpopular, this was a key requirement for the Ministry of Finance to help improve its fiscal position and return to debt sustainability. Under the IMF programme, it is a structural benchmark for past and future disbursement under the Extended Fund Facility (EFF).

With or without an International Monetary Fund programme, it will be prudent to continue with a cost reflective pricing formula. To ensure that prices don’t rise further for consumers, cost management will need to be enhanced.

In the electricity sector for example, further integration of renewable energy will reduce the dependency on coal and thermal fuel. The introduction of new entrants to the fuel distribution sector should help improve competition and move the market from two players to five.

The absorption of costs by the state is simply moving the debt from one pocket to another without paying it off. However, it’s a crucial first step in terms of providing transparency on debts and helping SOEs with their own restructuring. The government will manage the transferred debts as part of its overall public debt management strategy.

SOEs will now have to stop relying on the government to bail them out and use their operating profits to repay future debts. The new Sri Lanka Electricity Act should help unbundle the CEB, and bring in competition, investors and efficiency to the sector. This is expected to translate into better cost management and pricing for consumers.

DIVESTMENT Several pieces of legislation such as the Public Finance Management Bill, Public Debt Management Act and proposed SOE reform policy will help the country institutionalise the gains made in reforming state-owned enterprises.

As we have seen in the past, these can be easily reversed by a future government. However, it is key that the 22 million Sri Lankan citizens – who are the ultimate shareholders of SOEs – are able to see better governance, transparency, procurement and eventually, less burden on taxpayers and consumers, from future actions related to state-owned enterprises.