SOE sector: Promises of change on the horizon?

Originally appeared on Daily FT

By Maleeka Hassan

With the harsh reality of a global recession slowly descending on Sri Lanka, questions about Government expenditure and its allocation of resources have begun to dominate dinner table discussions. Fears of higher taxation to cover the losses earned and to sustain the blows from the impending recession have started to emerge.

There is a simple solution: introduce reforms to prevent areas for corruption and inefficiency within SOEs – thus preventing the State from bearing tremendous losses. However, there is hesitation and discomfort amongst the general public, when consolidation or privatisation of SOEs are discussed. This begs the question: why?  

Why are SOEs so popular amongst the public?

One of the reasons could be due to the portrayal and framing of the SOE sector, over the years. SOEs are perceived by the public as a source of stable employment as well as a source of goods and services at affordable prices. This perception is backed up by the fact that the SOEs hire over 200,000 people; framing the sector as ‘people-oriented’ over ‘profit-oriented’, with no consideration given to the losses sustained by these entities. Moreover, privatisation is often viewed in the same light as capitalism: cold, hard and unforgiving.

This perspective could be propelled by our history with the SOE sector. In the 1980s, the incumbent Government was pushed to reform the SOE sector. This was due to SOE products struggling to remain competitive amongst imported substitutes and therefore turning to the State to fund and sustain most of them. In addition, foreign aid agencies lobbied the Government to adopt a privatisation programme in order to secure external aid. However to avoid backlash from labour unions and state employees, the media and other campaigns around the policy were careful to avoid associating the policy with employee redundancy. Privatisation was concealed by the word ‘peoplisation’, and involved providing 10% of the shares to employees from former public enterprises.

Another reason behind the immense support for SOEs could be due to their heavily subsidised products. However, when products are sold below cost, the cost is still indirectly borne by taxpayers in the form of higher taxes, to recover the loss. The belief that privatisation will result in the prices of goods rising is contingent upon the creation of a monopoly. However, with the reduction of red tape and appropriate measures taken to prevent anti-competitive practices, prices may reduce or remain the same in a competitive market. An example of this was the conversion of Sri Lanka Telecom to a public company. This resulted in an improvement of internal operational efficiency and the number of new connections provided increased from 72,457 in 1997 to 143,075 in 1998.2

A similar reason that may have contributed to shaping current public opinion that SOEs are most effective at serving the people when they remain public, was the introduction of ‘The Revival of Underperforming Enterprises or Underutilised Assets Act’ of 2011 (also known as the Expropriation Act). This is where 37 businesses that were classified as ‘underperforming and ineffective’, were nationalised – suggesting to the public that privatisation wasn't always effective and ideal. However, these attitudes may be fuelling the problem.

Why are these perceptions wrong?

By utilising the narratives above, certain SOEs and officials attached are able to conceal corruption and nepotism behind the idea of employment, and ‘helping the people’. An example of this is the Sathosa scandal that emerged earlier this year, relating to 67 files that tied Sathosa to controversial transactions, such as land deeds that were purchased under various names and involved hundreds of acres, that cost the State billions of rupees.

Similar instances of bribery are easily carried out, and go unrealised, due to the absence of monitoring and oversight of the rest of the 524 SOEs that are ‘not essential’. The lack of transparency with regards to the financial reports of the SOEs makes it easier for these companies to commit such acts. In the Annual Report for 2019, published by the Ministry of Finance (MOF), only 14 SOEs had submitted their Annual Reports for 2018 out of the 52 that are monitored by the MOF and Public Enterprise Department (PED). Even more worrying is the fact that 21 out of the 52 companies hadn't submitted their 2017 Annual Reports either. 

Despite the introduction of the COPE reports and the appointment of the Department of Public Enterprises (PED) to monitor the operations and efficiency of SOEs, the SOE sector continues to amass tremendous losses. The recently published Annual Report by the Ministry of Finance estimates a total loss of Rs. 151,439 million from the 52 essential SOEs for 2019 based on provisional data.

These numbers would change drastically if they included data for the rest of the 524 SOEs (which include subsidiaries and sub-subsidiaries that have been gazetted but are not monitored by the Ministry of Finance, due to them not being ‘essential). The opacity of this sector would usually raise alarm bells amongst the Sri Lankan public if it was occurring anywhere else – and yet it doesn’t with SOEs. change drastically if they included data for the rest of the 524 SOEs (which include subsidiaries and sub-subsidiaries that have been gazetted but are not monitored by the Ministry of Finance, due to them not being ‘essential). The opacity of this sector would usually raise alarm bells amongst the Sri Lankan public if it was occurring anywhere else – and yet it doesn’t with SOEs.

Evolving circumstances propelling change

Despite these concerning particulars, there may still be hope on the horizon. The manifesto of President Gotabaya Rajapaksa indicated that whilst privatisation was not up for consideration, consolidation was still an option. Additionally, a board was appointed to select the heads for loss-making, inefficient SOEs, in order to reform and improve such entities.

More importantly, however, is the question of SOEs in a COVID-19 economy. 

With predictions for Sri Lanka’s estimated real GDP (percentage change) for 2020 amounting to -0.5 due to COVID-19, some economists predict that large scale reforms may be introduced in order to improve efficiency and increase its global competitiveness when seeking foreign direct investment and increased capital inflows. These reforms may extend to the SOE sector – in order to improve the financial accounts of the country and to reduce room for corruption and bribery.

What reforms can the Government adopt?

Reform of SOEs, focusing on underperforming entities, in particular, could create some much needed fiscal space for the treasury. The first phase of reform would be improving governance and accountability in SOEs. The Government should compile a comprehensive list of all SOEs; at present, the Government only tracks the financial of the key 52 entities. This should be expanded to include all entities. Clear reporting guidelines for SOEs should be introduced and enforced, with COPE and COPA strengthened to improve accountability. If these reforms are adopted, the SOE sector will increase productivity and efficiency immensely, saving the Government and the average taxpayer – millions of rupees.

The second phase of reform would be on the consolidation of SOEs. Of Sri Lanka’s 524 SOEs, the Government recognises only 52 of these as strategic or key entities. In line with Government policy, underperforming, non-strategic SOEs should be identified for a consolidation plan. 

This may be the golden window of opportunity to reform and improve the transparency of the sector, but if missed – may not come again for a long time. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

The ingredients of a ‘system change’

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

The mandate given by the people of Sri Lanka to His Excellency Gotabaya Rajapaksa can be interpreted in multiple ways. All interpretations funnel down to a single insight: Change the system. The word “change” is powerful. However, “change” is difficult to execute. In contrast to setting up things from scratch, altering an existing system is not an easy task under any circumstance. 

The President’s desperation is clear. He has been given a mandate to “change the system” in five years; of which, seven months have passed. With elections coming up, it seems that it will take almost 10 months to really get to the starting line. In other words, the existing “system” itself has pushed the man in charge of “system change” to the wall and the clock is ticking.

Last week’s column discussed the systems that need change and how the President could start. We highlighted that state-owned enterprises (SOEs), public transport, land reforms, and e-courts would be the four big aspects that can be implemented with minimal capital investment. If the President succeeds, the people of Sri Lanka will be able to witness a considerable change in their standard of living, and it is important that the opinion leaders support this system change in a democratic framework, and leaders at the frontline make sure the changes take place within the same framework.

Today, let’s explore a few insights on how to execute a system change. 

Understanding the system

If you ask the common man: “How can we change the system?”, a popular answer is that we can do it by imposing strict laws and regulations. Some believe the leader has to be firm and critical and supervise their team closely.

While the aforementioned is true, a sustainable system change requires the establishment of three main components: (1) ownership of the system, (2) incentives and rewards, and (3) accountability and capable people who drive the system.   

If you look at the current inefficient system, it is completely faulty due to many factors. The incentives in most government institutions and systems promote inefficiency; a system where work is delayed, and individuals are paid overtime to reward that. 

Take our judiciary system for example. In most instances, lawyers charge their clients based on the number of appearances, so the incentive is to have more appearances. Therefore, postponing cases is common and as a result, the average time taken for contract enforcement is 1,318 days with 22% of claim value. There is no pressure to finish a case within a stipulated time frame, so there’s no accountability and monitoring. 

At the same time, there is no ownership for the system as individual performance is not measured and no one will be questioned on the delays in procedure. Imagine a scenario where you hire a mason bass for a small-scale construction project at a daily rate, but you fail to monitor his work. The obvious result would be that the work will go for months, making the system completely inefficient. 

Ownership of the system

Any successful system runs on the ownership of risk. A main reason investors want to engage in businesses is because they have invested risk in the form of money, reputation, time, etc. This means they have an ownership stake and an interest to recover what they invested. For a system change, the upcoming government and President are required to consider engaging people who invest risk in the form of money, reputation, time, etc. and provide them with the opportunity to own the system as well as the results of their action.

Public-private partnership (PPP) is a great model to consider and many forms of PPPs are available and it just requires detailed attention. This would be a fundamental factor in changing any system. 

On that basis, the appointment of the ministerial portfolios’ board for SOEs cannot be just a blanket appointment – an ownership of risk has to be associated with it. In implementing large-scale projects, the President advised a few months ago, to explore acquiring investment from the private sector instead of taking loans and expanding debt stock. That means getting private investors to invest their money (risk) in projects which they can recover through profits. 

The Government can incorporate similar practices to a range of sectors. The government sector is too large, from managing airlines to managing cashew production. It will be difficult to bring private risk ownership across the board, but we can roll it out on a priority basis. Until we get the election results, time can be spent on setting up ownership structures for key institutions and a mechanism on how they can invest risk into the system. The structures have to differ based on the sector and on the type of the business and service model. Take our President for example, who has an ownership of the trust of 6.9 million people where he has invested risk. Hence, he is under pressure to deliver results. Shouldn’t the same be applicable for the rest of his supporting divisions?

Incentives and rewards

Setting up the correct incentive structures and rewards is the second important factor in a fluid system change. The current incentive structure is driven by inefficiency and corruption. Regardless of whether you perform well or underperform, you get the same benefits. So no one has an incentive to take things into their hands and do it differently. The recent discussion on the Central Bank is a good example. Whether the Central Bank maintains monetary stability, regulates license banks and non-banking financial institutions (NBFI) in the right manner or not, their destination won’t change. 

Incentives can be negative and it should not need to be positive always. If there had been a positive or negative incentive structure bearing on salaries of bureaucrats on maintaining the stability of NBFIs, I am certain they would have taken matters more seriously instead of waiting for some financial institutions to collapse completely (institutions need to provide the necessary legal authority to regulate effectively). Having regulations without incentives is a sure way of not fixing the system. 

If you are surprised by the friendliness and politeness of hotel staff, it is not just because they were asked to do it or not because the management installed CCTV cameras, but it is because they receive a financial incentive for being friendly. At the same time, we should not misinterpret that the hotel staff is kind and pleasant just because of the financial incentive. The fact that their genuineness is incentivised, which in turn makes system efficiency sustainable, is the bottom line.

Accountability and people 

Checks and balances have to be maintained if we are to monitor and evaluate the incentives and ownership of risks. That is where “accountability” and the people who drive “accountability” matter. If we have the accountability structures, we can make decisions based on meritocracy.

For example, most of the SOEs haven’t produced their annual accounts or annual reports. Most of these institutions do not even have a website. Most of the institutions that have a website have only updated the welcome message by the newly appointed minister. 

The people who drive reforms have to make a significant contribution. However, we have to keep in mind that the people-driven regulatory model where a system change is driven by personality and personal charisma has a shorter life span. But without the right people, it would be difficult to drive a system change.

We need people who can drive the system to overpass their personal charisma, so even without their presence, the system starts to function. The next government will have the challenge of identifying the right people who can fix a system rather than just pushing on getting daily operations done.

For the right people who have been identified to change the system, the broader mandate is straightforward; identify ownership structures, identify incentive systems, and set up accountability procedures are the main mandate. We should not confuse the skill of “changing the system” with project management skills. “Changing the system” is a unique visionary sport. There could be good project managers, but transforming to a system change goes far beyond project management, although it has some components of project management. 

System changes are not popular

We need to remember that system changes are not popular. Most of the people who demand a system change are usually beneficiaries of the inefficient system. Changing the system will have a direct impact on them and resistance may come with it. That is why the transferring of ownership of risk comes to the forefront when looking to change the system. 

It is important that we learn from past mistakes. The previous government too received a mandate for a system change to establish rule of law, but the same people who gave them the mandate decided to pick a different regime, again, pretty much on the same promise, that is to “change the system”.

Ownership, accountability, and the right people who could drive system changes were not in charge of policy implementation during the last Government; all were preoccupied with micromanagement without looking at the bigger picture or considering rapid implementation.

Policy statements of the main leaders of the Government went in two different directions, as did the heads of ministries and their officials.

The Vision 2025 policy plan was introduced a considerable time after taking office. The policy statements on institutions were contradictory and as per media reports, and the basic composition of the security council was questionable. 

System changes are visible, and people will experience tangible differences, such as in the government balance sheet. There will not be a better time than one of crisis to engineer a system change – we should not waste this opportunity.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

"Changing the system": How the President could start

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

A day has 24 hours but the clock ticks faster in some countries, and Sri Lanka is certainly one of them. We have many things to get done, but time is running out and the conditions are right to brew the perfect storm. Our economy’s fundamentals have been in poor shape for a few decades. The country’s economic growth was 2.3% in 2019, a budget deficit of 8.5% in comparison to the GDP of  2020 is expected this year, and we are already on an IMF (International Monetary Fund) bailout programme. There is nearly $ 7.2 billion as reserves in Treasury coffers, but debt servicing payments account for nearly $ 6 billion up to December 2021.

Amidst these conditions, a pandemic was the last thing we needed and its abrupt arrival damaged the main economic engines of Sri Lanka on a larger scale than ever before. Tourism, which brought in $ 4 billion revenue in 2018, and the export industry were severely impacted, and the unfolding events in the US, which is the market for 37% of our apparel exports, are not in our favour. The impact on the Middle East will not only bring down nearly $ 7 billion worth of remittances but will also result in job losses and the repatriation of Sri Lankans due to the global economic contraction.

In that context, it seems President Gotabaya Rajapaksa will have to sacrifice nearly nine to 10 months of his five-year tenure to address unexpected challenges. He has been pushed to a difficult corner with many restrictions from the system itself (postponement of elections, etc.) to convert decisions into actions. Leaving this gloomy story aside, let’s unpack a few opportunities hanging around to get things done along with priority actions to be taken during this difficult time up until the general election in early August.

Reforms through structural changes 

Considering our public finances are weak and the spending capacity is limited, we have a grand opportunity to make structural changes to the system rather than investing our time on micromanagement. The President’s mandate was to “change the system” within a democratic framework and set up a new, functional system. Since the clock is ticking at a faster pace, we need to identify a few major reforms that could generate faster results and meaningfully benefit the people of Sri Lanka.

Below are a few areas the President could focus on in carrying out major reforms through which an impact would be visible within his five-year tenure.

Governance structure and KPIs for State-Owned Enterprises (SOE’s)

The big gaping hole in our national account is the losses of state-owned enterprises (SOEs). In 2018 itself, 54 strategic SOEs out of 527 SOEs made a Rs. 28 billion loss and received government budgetary support of Rs. 58 billion. The total of these two figures is almost two times the entire allocation of the Samurdhi fund. The initial attempt to appoint a separate panel to appoint qualified members for state institutions was commendable, but it had its own challenges.

Since a new Cabinet and new ministers are to be appointed post general election, if we are able to set key performance indicators (KPIs) for SOEs at the soonest time as the first step at the year end, then the President can evaluate the performance of SOE boards and make them accountable accordingly. When every minister is given their appointment letters when the new Parliament is appointed in a grand red carpet ceremony at the Presidential Secretariat, every minister receives an additional file listing the institutions under their purview and indicators under which the minister will be monitored along with their respective institutes’ boards.

In the list of deliverables, we can start with including basic requirements such as presenting an annual report with profits, losses, and employment for each institute so as to ensure the newly appointed boards are accountable. Ideally, the KPIs can be published before the election in selected SOEs as there would be less reluctance from the newly appointed ministers when they take over the job. In terms of management, it would be easier to get the consent for already established guidelines rather than imposing guidelines after they take up the job.

If we have the political capital, we can consolidate a few institutes early on and publish the plan to facilitate the appointment of members for all 527 SOEs, of which the total number of people in the boards alone would be a factory of senior people. When the governance structures are in place, performance will improve and losses, in turn, will decrease. Therefore, the changes will be visible to showcase to the people, and it will bring significant relief to the Treasury. At the same time, it is easier to identify the poor-performing institutes and so the boards of those can be shuffled based on meritocracy.

Public transportation

As highlighted in “The coordination problem” column earlier, public transportation bottlenecks are mainly caused by structural issues rather than investment issues. One main issue every individual goes through every morning and evening is public transportation. Regardless of whether they travel in their own car or via bus/train services, the experience is essentially the same.

In this regard, re-implementing the bus lane structure is a positive move. Removing the route permit structure and having a more open and competitive system is an easy and quick way of improving the public transport system before moving on to large-scale infrastructuring projects, given the tight public finance situation. A period of four years is a good time frame to showcase improvements on public transportation, and these reforms are fairly easier to implement especially as Covid-19 has given the perfect opportunity.

Buses are already operating only under the capacity of the number of seats and we expect that the University of Moratuwa would release official data on the improvement in average speed with the new bus lane system. This is a golden opportunity to implement the long-awaited plans of reformation with the blessings of the people and the industry. 

Establishing E-courts 

Another hassle for a majority of Sri Lankans is the delay in court cases. The outside of every court is fully crowded on weekdays with disappointing faces seen in every direction due to a completely inefficient system. Mostly, the poorest in society have fallen prey to this problem and the problem extends to prison and every sector of the economy. In Sri Lanka, the time for contract enforcement is 1,318 days and it’s just 22.8% of the claim value.

An e-court is a system of services that ensures minimum use of paper during the course of a court proceeding with digitally captured information, an unbroken chain of data exchange, readily available case histories, electronic fee payments, and an overall streamlining of court proceedings. Since a plan already is in place to digitise Sri Lanka, a two-year time frame is more than enough to establish a functioning e-court with necessary legal reforms, given the Covid-19 social distancing guidelines. If less complicated cases are moved to e-courts, there will be space for more complicated cases to proceed with the physical presence. Isn’t this the main mandate of the Minister of Justice and Legal Reforms after the election?

Land reforms

Land is the most precious resource in Sri Lanka and it’s very limited given the size of our country. Most of our economic bottlenecks have a greater bearing on land titling. We should not forget that land is a stable capital asset and only 18% of it is owned by our people whereas the rest (82%) is owned by the government. It is well documented how badly we have managed even our forest cover and sanctuaries which account for 30% of our land. Most of the bottlenecks in agriculture and investments are due to our land concerns. Investment is slow (investments from Sri Lankans) and technology is not entering our shores.

In an age where Google provides live updates of real-time traffic movement at our fingertips, we Sri Lankans cannot spend anymore time without a digital land registry, with the decades-old land registry at government offices wasting our precious time. As long as we continue with the unresolved land issues, which are to an extent connected to our judiciary system, Sri Lanka will not see a connection to the Fourth Industrial Revolution.

Above are the big four insights the present Government should focus on. In my humble opinion, a four-year time frame (calculating for many unexpected events in the global context) is a reasonable period to achieve reasonable progress. Even more importantly, people across Sri Lanka will experience a tangible difference if the above reforms take place. Furthermore, except for e-courts and land reforms, the other two big reforms are comparatively less investment-driven.

Execution over politics

Most of the leaders who take up the challenge to lead the country find themselves preoccupied with micromanagement, appearing in one meeting after another or one ceremony after another. In building the needed political capital, we should not misread the President’s mandate to “change the system” and his voter base appears to be measuring him based on the execution of his big ideas rather than the traditional political micromanagement.

I hope the current Government is reading the peoples’ mandate correctly and would not drift away and lose sight of it after the general election on 5 August. I hope…

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.