Loss Making Key Public Enterprises: CPC To Mattala

By W.A. Wijewardena -April 23, 2013 

Dr. W.A. Wijewardena

Loss Making Key Public Enterprises: Postponing the needed reforms will be fatal pretty soon

The power shock is to be followed by other shocks too

When the new electricity rates were announced last week, newspaper headlines cried “power paralysis”, “power shocks” and “power betrayal”. Given the increase this time – more than 60 per cent in a single increase – it is not unusual for media to express their shock in equally shocking terms. However, the media and political reaction to the electricity rate increase appears to have been concentrated on this single one-off incident, ignoring the more alarming big picture emerging in the country’s public enterprise sector. Key public enterprises, namely, Ceylon Petroleum Corporation or CPC, Ceylon Electricity Board or CEB, Sri Lankan Airlines, Mihin Air, Sri Lanka Transport Board or SLTB and Sri Lanka Railways or SLR have been making losses in colossal amounts year after year for some time. Many others, though they had made profits, had not done justice to the capital employed in them by the country’s taxpayers from time to time. But this fact had been largely ignored by media and politicians.

Loss making public enterprises have eaten up 2.5% of GDP

This writer in a previous My View on Losses in Public Enterprises had equated them to ‘violation of property rights’ because people have to bear those losses one day by cutting their wellbeing, a situation similar to when their property rights are taken away by coercive action. The IMF had warned in its report on Sri Lanka issued in March 2012 that the losses in CPC and CEB alone were one and a half per cent of GDP in 2011 and would be in the region of two per cent of GDP in 2012 if prices are not revised during the remaining part of the year. Instead of heeding to this advice, the Budget 2013 had criticised the critics of the loss making public enterprises on the ground that the critics had ignored the contribution made by them to ameliorate the lives of the people in far corners of the country (p 59). But, according to the new numbers just released, the total operating losses of these two corporations standing at Rs 151 billion in 2012 have exceeded 2 per cent of GDP, vindicating IMF. When the operating losses of Sri Lankan Airline, Mihin Air, SLTB and SLR are also added to this number – losses totaling Rs 181 billion – the total losses of the six key corporations have just reached 2.5 per cent of GDP. In a country which depends on foreign remittances to boost its national savings because the domestic savings are just 17 per cent of GDP, a loss of two and a half per cent of GDP is not a simple matter that could be ignored.

Official reports silent on an emerging catastrophe

Thus, the revision of electricity rates by this magnitude was inevitable. Yet, its inevitability – and the inevitability of price revisions in many more loss making public enterprises that are yet to come – had not been highlighted in any of the official publications of the government. For instance, Annual Report of the Ministry of Finance and Planning for 2011 had devoted one chapter to State Owned Business Enterprises or SOBEs but there had not been a detailed analysis of why losses are being made by key SOBEs except providing a generic description of their weaknesses. The Budget 2013 had in fact praised these corporations for the social contribution they make. However, to its credit, the Central Bank which is supposed to give apolitical advice to the government has, in its Annual Report for 2012, deviated from the above-mentioned tradition of the Ministry and emphasised the need for improving the operational efficiency of CEB and CPC to make them viable (p 4). But the Bank’s singling out only CEB and CPC for comment may have given the impression to the Minister of Finance, Members of Parliament and the public that the public enterprise sector of the country poses no problem as a whole and therefore does not fixing by the government.

The Central Bank had a tradition of speaking out

This appears to be a deviation from the past tradition of the Central Bank where the Bank had adopted a very critical approach when commenting on public enterprises. For instance, the Annual Report 2001, while highlighting the structural reforms being carried out in the public sector and in many public sector enterprises, the Central Bank had brought to the notice of the Minister of Finance and others the following: “However, the structural reform programme should be continued with more vigor. In particular, the reforms relating to the strengthening of the public sector financial institutions (Writer’s note: because they were all technically bankrupt at that time), improving the flexibility of the labour market, restructuring CEB and CPC, improving efficiency in ports and land registration, introducing automatic and transparent price adjustment systems in public sector corporations, commercialising railway and postal services, facilitating the operation of the private pension funds and improving efficiency in civil service need to be implemented without further delay. Similarly, due attention has to be given to expedite the long overdue institutional reforms and deregulation/regulation in order to improve the efficiency and the flexibility of the economy” (pp 29-30).

With regard to CEB, the same report had advised the Minister of Finance that the following should be done: “The existing crisis situation in electricity supply has an adverse impact on the country’s productivity and expansion of production capacity. The present power tariffs in Sri Lanka are the highest in the region, significantly weakening the country’s external competitiveness. A comprehensive reform package including unbundling of generation, transmission and distribution activities of CEB, introduction of automatic, transparent tariff adjustment system, correcting biases against production activities through cross subsidy, reducing system losses which are as high as 20 per cent, involving private sector participation and removing political interference in power sector expansion activities are essential to improve the viability and future prospects of the power sector” (p 42).

CB can even reprimand the government

Since the economic reforms had not taken place at the pace at which the Central Bank had desired, the Annual Report for 2002 had mildly reprimanded the government. It has told the government that the slow progress in economic liberalisation and other structural reforms had prevented the country from realising the full benefit available under a market oriented economic policy framework. Regarding the loss making public enterprises, this is what the Annual Report 2002 had to say: “The continued operation of inefficient and loss making public enterprises has been one of the major causal factors for many economic problems faced by the country today. Their losses added to pressure on the fiscal deficit or increased public sector bank borrowings, exerting pressure on interest rates and crowding out private investment. Their inefficiency reduced the growth in productivity in the economy and raised costs of production exerting cost-push inflationary pressures. The adverse impact of their continuing functioning has been clearly shown up in the poor performance in the infrastructure facilities, weakening the country’s external competitiveness and investor confidence. For example, the power sector has been in crisis for long, resulting in an inadequate and unreliable supply of electricity and the highest energy costs in the region” (p 51).

CB should keep on nagging the government

It is rarely politicians listen to outside advice. Yet, a central bank cannot neglect its duty of telling a government what is wrong in its policy and what should be done to correct the same. This a central bank can do by being an ‘impartial spectator’ if one borrows a term from Adam Smith and not by being a part of the government. This role of the Central Bank was reported to have been stressed even by a left-wing Finance Minister, Dr N.M Perera when he addressed the senior central bank officers in 1971, according to a report filed by Ceylon Daily News. Thus, the Central Bank’s educating the politicians should be done continuously, as a former Governor, the late Mr N U Jayawardena, had said that it is the function and the duty of a bank Governor (so, the central bank as well) to “nag the government skillfully and continually”. So, a central bank should keep on nagging the government in the same way a wife would continually nag her husband to bring him to the correct path despite the personal risks to her life and welfare.

Structural reforms a must

So, what had the Central Bank talked about in its Annual Reports for 2001 and 2002? The problem with the loss making public enterprises is not a problem of periodic price adjustment alone. It is rather a problem of reforming these enterprises which the Bank had referred to as ‘structural reform’. This had been succinctly put by the IMF too in its report on Sri Lanka referred to above. It had said that immediate action should be taken to reduce the costs of these enterprises along with changing prices. This is nothing but the structural reforms which the Central Bank had advocated. To reduce the costs of the loss making public enterprises, it is necessary to improve their productivity, namely, the output they make by using one unit of input. Since they are making losses, they are presently producing less than one unit of output in money terms by using one unit of input. The productivity improvement requires them to reverse this and produce in money terms more than one unit of output. This is not a new thing and even during Kautilya’s time, some 2400 years ago, that was the benchmark used by the king’s businesses in India. Kautilya had emphasised that king’s businesses should necessarily make profits; if they do not make profits, he had equated it to a situation where the public officials eating up not only the wealth of the king, but also the labour of workers who had been employed in those enterprises.

So, what are the structural reforms that are necessary to improve the productivity of these enterprises? There are many as had been emphasised by the Central Bank in its Annual Reports for 2001 and 2002. The present government now facing a catastrophic situation cannot ignore them anymore.

Stop multiplying the public sector

First of all, at national level, the government has to revisit its state expansion policy. The government is not only adding more people to the existing public sector organisations, but also is creating new organisations without carrying out proper appraisal studies. These organisations continue to operate without proper vision, mission or strategic planning or understanding the local and global realities that are unfolding as threats or opportunities. The result is that they spend money voted by Parliament, borrow from state banks with the blessings of the Treasury if the voted money runs out and send the bill to the Treasury when they continue to incur losses eroding their capital base. The Treasury too in the past had been accommodating their requests for covering losses without inquiry or probing. No study has ever been undertaken by the Treasury before recapitalising these public sector organisations to ascertain the impact they have created in the economy. Such impact studies will give an opportunity to the Treasury to review their operations and recommend their closure if the impact is found to be negligible or negative. In the absence of such a system, it gives incentives to managers of these enterprises to continue to make losses since they know that the Treasury will come to their rescue when things have gone wrong mainly due to their own incompetence.

Keep politicians at arm’s length

Second, having revisited its state expansion policy, the government should take measures to staff the state enterprises with competent managers. It is the innovative skills of the managers today that will ensure the success of businesses. If the managers are successful they should be rewarded; if they are not, they should be removed forthwith. So, managers should feel that their continued career advancement will depend only on the success rate they produce. Once the managers have been given a free hand, they should be freed from political interferences. One may tend to argue that the politicians being elected representatives of people have a right to interfere in the affairs of a state enterprise. They have a right not as individuals but as a body. Not as individuals, because individually they have all the incentives to use the public enterprises for their own personal gains, a problem which arises in the Principal-Agent Problem or PAP today. In the PAP problem, politicians being agents of people who elect them to office work for their own personal benefits ignoring what they should have done to improve the welfare of the people. But when they work as a body, it is very rarely they could bring personal interests to the forefront when they supervise public enterprises.

Have viable business plans

Third, it should be made compulsory for all state enterprises to have viable business and marketing plans. The business plan should take notice of emerging local and global developments and how the enterprise would respond to such developments. This can be explained by reference to Sri Lanka’s second port at Hambantota. The port project had three stages of development, the first to provide bunkering services to ships that pass through Hambantota, the second to function as a transshipment port and the third to operate as a port proper. Some of the factors which the port project had taken into account when the initial planning of the project was done appear to have changed now. At the initial stage, it was mostly the ships that carried manufactured goods from China to the East Coast of the United States and Western Europe that had passed through Hambantota. It was safe to assume that this flow will increase over time along with the increase in China’s trade with the West. However, a new production model is now emerging in USA and in the Western Europe by using 3 Dimensional Printing (3D Printing) technology for manufacturing. It has been predicted that this production model will change the current “Made in China” label to “Made in USA” or “Made in EU” label thereby putting all these ships that shuttle between China and the West now to retirement. If this happens, the present installed capacity at Hambantota for bunkering will go waste and the Port Project will have to redesign its business and marketing plan accordingly. A similar business plan is called for the new airport at Mattala. A mere television advertising campaign targeting the local population and telling them the many beauties of the airport will not induce planes to use the airport; instead, new pleasure, entertainment and business activities have to be developed around the airport to get international passengers on a regular basis. Along with international passengers, the much needed planes will also come to the airport.

Unbundle big public enterprises

Fourth, the management of these public enterprises has now become unwieldy because they have not only become too large but also have expanded by means of so many associate and subsidiary companies. In addition to that, these enterprises are seeking to produce the whole range of their services under one management. This has made these enterprises both inefficient and costly. The Central Bank had therefore suggested earlier that they should be unbundled, meaning that different operations such as production, distribution and marketing etc should be separated and handled by means of separate enterprises set up for that purpose. Such unbundling that will attract private sector involvement will help these enterprises to improve the technology they are using in main production lines. For instance, in the case of CEB, instead of relying on hydro or thermal power, further research could be undertaken to use nano solar, as has been done in California today, to develop nano technology to harvest solar power to produce electricity.

Price revisions to be accompanied by structural reforms

Hence, mere periodical price revisions will not rescue the loss making public enterprises. They should be accompanied by a comprehensive structural reform programme to make them both financially and structurally viable. The postponement of this reform programme as has been done in the past will surely be fatal to Sri Lanka.

*W.A Wijewardena can be reached at waw1949@gmail.com