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Navigating SOE reforms in an election year

This article was compiled by Dr. Malathy Knight. Dr. Malathy Knight is an economist and a Research Fellow at Verité Research. Research support for this article was provided by Imaad Rizwan, Junior Research Analyst at Verité Research)

Sri Lanka’s current State-Owned Enterprise (SOE) reforms coincide with an unprecedented economic crisis and the 2024 election year. The economic crisis heightens the need for reforms, but the election timing dictates that privatization should be off the table for now. Instead, reforms should focus now on fixing management, transparency, competition, and regulation. This will substantially improve the value of these SOEs to investors as well as society before privatization.
This Op-Ed argues against the counterview that SOE reforms should be rushed precisely because it is an election year. The view is that elections might reveal a societal consensus opposed to privatization, making it untenable afterwards. But, inviting bids now also invites private bidders to internalize higher risk because policy reversal can happen even after an election. This means lower bids because the risk premium is higher than if privatization is done in a more productive, measured manner, as discussed below.


There are several problems to solve


Sri Lanka’s SOEs have underperformed on multiple levels for decades. Many of the 52 SOEs identified as key by the government generate adverse efficiency, fiscal, and distributional impacts. Information gaps abound. Even the total number of SOEs is uncertain: estimates range from 300-500. Country reports under the current IMF programme in Sri Lanka show that Sri Lanka was long delayed in meeting the commitment to publish annual reports of the 52 SOEs, even up to 2022. Mismanagement and a lack of transparency pervade the sector, perpetuating corruption vulnerabilities and weak corporate governance. 
Deep reform is critical but requires a well-thought-out strategy given the sector’s multiple problems. After two privatization waves from the late 1980s-1994 and from 1995-2004, SOE reforms have shown little traction. SOE reform is difficult in the best of circumstances. It requires effective, accountable and inclusive political and economic institutions. The reform modality, timing, sequencing, public messaging and transparency, competition and solid regulation are critical to enhancing the value of these SOEs to investors and society. Privatizing now, instead of focusing on these aspects, puts the cart before the horse. 


State of play


The restructuring process has at present been moved forward in a sensible way through a number of constructive steps, including the following key initiatives. First, the Cabinet has established a State-Owned Enterprise Restructuring Unit (SRU) and approved an SOE policy with nine guiding principles, including the basis for privatization, competitive neutrality, and accountable oversight. This policy is being converted into legislation (Public Commercial Business Act). Second, a state holding company, like Singapore’s Temasek, is in the works to handle the management and governance of retained SOEs (although a long way off from successful implementation). Third, the Ceylon Electricity Board and the Ceylon Petroleum Corporation are being restructured under their respective Ministries. These reforms do not involve privatization, instead centering on unbundling, competition, separation of policy/operations/regulation and tariffs. 
The privatization of eight SOEs is on the cards with transaction advisors selected and publication of Divestiture Guidelines to enhance transparency and credibility. The SOEs listed for privatization are: Grand Hyatt Hotel, Hilton Hotel, Litro Gas, Sri Lanka Insurance Corporation Life, Sri Lanka Insurance Corporation General, Lanka Hospitals, Sri Lanka Telecom (SLT), and SriLankan Airlines (SLA). 
In April 2024, the SRU published the names of bidders. Privatization of all SOEs, except SLA, is expected to be finalized by August 2024, with SLA scheduled for September. Despite encouraging moves towards more transparency, the SLA bidding process in particular has been marred by multiple delays, and the government has also taken on US$ 510 million of the airline’s debt. Recurrent delays, shifting of debt and the overlapping of privatization with the proposed election timeline all raise risks that will only increase as the election approaches.


Countering potential pitfalls


While SOE reform is critical, it is just as important that it is done right. Given the state of play, restructuring must avoid a number of potential pitfalls, focusing on three key considerations:  (i) Transparency, (ii) Competition, (iii) Timing.
Transparency of data and analysis: Public availability of data and analysis is central to better decision-making and public trust, particularly because SOEs are custodians of public resources. 
The moving of SLA debt to government books without transparent data and analysis is a prime example of the need for more accountability. The public has no insight whether this transfer was reasonable or if declaring bankruptcy and shutting down operations would have been better. While it may not be possible to reverse this for SLA, there must be fuller disclosure
going forward.   
Competition and regulatory deficit: Ownership change is insufficient to increase efficiency and protect public interest. Effective institutions to facilitate competition and regulation are critical. Sri Lanka lacks a strong competition law and regulatory institutions. Privatization without solid competition and regulation increases the risk of rent seeking and of converting public monopolies/oligopolies into private ones. 
A good example of the benefits of competition and contestability and of sequencing is the 1997 SLT privatization. Fixed-line contestability combined with mobile competition, prior to privatization, with competition-centered regulation drove solid performance in market penetration and prices. Competition and regulation must be frontloaded in the SOE reform process to ensure that the exercise is not just a fire sale.
Timing: 
Privatization is now occurring during the run-up to elections. Increased uncertainty and perceived higher risk associated with elections will depress SOE asset prices as investors demand large risk premiums. The better option to enhance value for money is to move the bidding process after elections. 
If privatization must continue, the process must follow these principles. First, to increase public welfare, competition must precede privatization. Second, to achieve better long-term asset value, there must be transparent and independent accounting showing that the realized present value of assets from privatization is higher than their long-term value. Third, the process must ensure that short-term liquidity needs do not compromise public welfare or long-term asset values. 
In short, SOE reforms are critical. But privatization now, so close to elections, is likely to harm public welfare. A better approach is to move asset bids to after elections and immediately frontload efforts to firm up competition and regulation and fix mismanagement and transparency gaps. Prioritizing these measures can help achieve better long-term outcomes for the public. Sri Lanka has experimented with SOE reforms over a number of policy cycles. This time, with the country in its worst economic crisis, the stakes are higher. Not getting reforms right again may well result in throwing the baby out with the bathwater. 

Link to the original article published on the Daily Mirror Column.

Navigating SOE reforms in an election year - Opinion | Daily Mirror

2024-08-22
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