Privatization

SriLankan Airlines and the Case for Privatisation

Originally appeared on Sunday Times

By Aneetha Warusavitarana

The government’s policy document ‘Vision 2025: A Country Enriched’ positions Sri Lanka as a knowledge based, highly competitive, social market economy; and much of the content of the document is in line with increasing competition, productivity and efficiency.

The state of SriLankan Airlines, however, is in the antithesis of efficiency and productivity. The airline has been raking in losses for years now, and on Monday the 7th of January, the president appointed a committee to once again work on its restructuring. The new committee will assess the previous reports and restructuring plans and have now completed their recommendations.

It is evident that state ownership of this airline is not working, so what are the solutions?

Back when SriLankan Airlines was still Air Lanka, it was privatised. The government sold a 40% shareholding to Emirates Airlines in 1998, and contracted Emirates to manage the company for ten years with the government of Sri Lanka retaining majority shareholding. In 2008, the government took back complete ownership of the airline, and from then on, the losses began [1].

Source: Sri Lankan Treasury Annual Report (2008, 2018)

Source: Sri Lankan Treasury Annual Report (2008, 2018)

Privatisation has worked in the past, and the argument for privatisation of a state-owned airline is strong. To begin with, the aviation industry is an investment heavy industry, which requires expertise and foresight. Beyond procuring airplanes and terminal space, there is a web of domestic and international regulations to navigate, not to mention standards to adhere to. From then on, once you have the planes and are ready to start, the airline needs to be competitive in order to survive. It requires strong management and effective marketing, with a team that can adapt to external shocks in fuel prices, domestic and international politics, and changes in foreign exchange rates. Even if it has the money, a government is ill-equipped for this task, evidenced by the track record of the airline in state hands. During the period of 2009-2017, when the airline was under state management, it has accumulated losses of Rs. 148,707 Mn [2]. Repeated promises of restructuring or turnaround have remained unfulfilled.

While privatisation of SOEs, and specifically the privatisation of state-owned airlines is theoretically sound, appropriate implementation is necessary. The Organization for Economic Co-operation and Development (OECD) has done extensive research on privatisation of state-owned enterprises and has identified some key features that successful privatisations have had in common. Detailed below are some features that are relevant to Sri Lanka [3].

  • Strong political commitment to privatisation at the highest level in order to overcome bureaucratic inertia and to resolve inter-institution rivalries in order to move the process forward.

  • Clearly identified and prioritised objectives in order to provide the policy with focus and a sense of trade-offs that may be required.

  • A transparent process to enhance the integrity of the privatisation process, gain credibility with potential investors and political support from the public.

  • An effective communication campaign to explain the policy objectives of privatisation and the means by which they are to be achieved in order to respond to public concerns and to gain support for the policy.

  • Allocation of adequate resources in order to meet the demands of the shift to privatization.

Partial privatisation of SriLankan as a more viable solution?

Privatisation does not always have to be full divestiture of the asset; the option of partial privatisation is open. In this scenario, governments sell a minority stake and retain a degree of control, while the enterprise reaps the benefits that accompany privatisation. The process of privatisation will bring with it a much needed infusion of private equity, new management, clearly defined guidelines and a more flexible financial structure. The focus of the airline will shift towards increasing profitability and efficiency, with the aim of increasing shareholder value. Given Sri Lanka’s past success story with the partial privatisation of Air Lanka, it is possible that this solution will be pursued or at least considered.

The pitfall of partial privatisation

Drawing from the experience of privatisation in other countries when governments remain the majority shareholder, the space for political interference continues to exist [4]. This is the biggest potential pitfall, and the SriLankan experience can attest to the damage this can cause. As of now the government is struggling to create interest in the purchase of the airlines, and the fear that the government will once again step in and interfere with the management is the most probable reason behind this.

If the government is considering partial privatisation, steps should be taken to ensure that the government’s interests remain those of a shareholder and not those of a political entity. Given past track records, assurances of non-interference are unlikely to inspire confidence.

In 2015 the Hon. Prime Minister, Ranil Wickremesinghe mentioned that the government was considering the Singaporean Temasek model of a holding company as a solution to the problems of SOEs in Sri Lanka [5]. Establishing a holding company for SOEs would help bolster investor confidence and improve the functioning of the airline. It would professionalize the management and create distance from local politics [6]. It is a shame that even though this idea was brought out in 2015, it was never implemented. The question that remains is whether the government will take this into consideration and take decisive action on this problem four years later.

Emirates vs. SL Govt.PNG

[1] Ratnasabapathy, R. (2016). The renationalisation of SriLankan airlines and the follies of state enterprise. In: The State of State Enterprises in Sri Lanka. Colombo: The Advocata Institute.

[2] Ten Year Review: SriLankan Airlines Annual Report 2016/17. Colombo.

[3] Privatising State-Owned Enterprises: An Overview of Policies and Practices in OECD Countries. (2003). Paris: OECD Publishing.

[4] Ibid

[5] Wettasinghe, C. (2015). Temasek model to make public enterprises viable. Daily Mirror. (Online - Accessed 16 Jan. 2019)

[6] Kim, K. (2018). Matchmaking: Establishment of state-owned holding companies in Indonesia. Asia & the Pacific Policy Studies, 5(2), pp.313-330.

SOEs in Sri Lanka : Beyond "Profit & Losses"

The state has a long history of involvement in the economy in Sri Lanka; state ownership of utilities dates back to the colonial era. Post-independence experiments with socialism saw the expansion of the state into many new areas of business. Despite some reforms in the 1977-2005 era, state enterprises still account for a significant share of the economy.

The 2005-2015 period saw a halt to the privatisation process and a renewed wave of expansion in state businesses. Between 2009 and 2014 the number of SOEs grew from 107 to 245 while the number employed grew from 140,500 to a staggering 261,683.

Although the Department of Public Enterprises is supposed to improve governance in Public Enterprises (Commercial Corporations, Government Owned Companies and Statutory Boards), by its own admission only 55 SOEs come under its purview. The last available performance report (2014) indicates the 55 SOEs that were considered strategically important obtained budgetary support of Rs.126bn and treasury guarantees of Rs.47.6bn that year. Bank borrowings by these SOEs stood at Rs.471.2bn as at end 2014.

The size of the SOEs and the breadth of their activity make it an important determinant of the overall productivity of the economy. Consequently, the governance of SOEs will be critical to ensure their positive contribution to a country’s overall economic efficiency and competitiveness.

Ensuring that whether held nationally, regionally or locally – the state’s investments to actually deliver the societal outcomes desired is extremely difficult due to certain inherent problems.

1) Governments are run by politicians, not businessmen. Politicians can only make political decisions, not economic ones and these decisions will tend to be focused on short term publicity and benefits, ignoring long term consequences. An example is the launch of a company called Polipto Lanka to convert rubber and polythene waste to diesel. It was launched in 2009 amidst much fanfare but despite regular grants from the treasury it is yet to show any commercial results or even demonstrate that the process is economically feasible. Coincidentally, the launch took place a week before a general election. Polipto Lanka receives regular budget support from the Treasury; support for the last three years amounting to Rs.120m.

 

2) Governments use other people’s money; businesses must risk their own money. If a business does not earn a profit, the owner will need to keep infusing funds and this provides a powerful incentive to improve efficiency. The general public, whose money is effectively at risk in a state venture do not have the wherewithal or knowledge to hold managers or politicians to account. Politicians would prefer to postpone hard decisions than risk personal unpopularity, which is why state enterprises can keep running losses year after year.

The Janatha Estates Development Board (JEDB) and Sri Lanka State Plantation Corporation (SLSPC) have not reported a profit in the last five years, Mihin Lanka has barely made a profit since its inception, yet they continue to operate, the losses being paid by taxpayers because politicians will not risk bad publicity that may follow any attempts to reform them.

The Director General of Public Enterprises admitted as much in his report of 2009:

"We have found some boards take affairs of the enterprise very lightly regardless of their strategic importance even in a situation where PE [Public Enterprise] faces very difficult time. Since there is

no formal procedure to hold the chairman and the board of directors accountable, for their weak performance or unacceptable practices, some boards act with sheer indifference in discharging their responsibility."

 

3) State enterprises tend to be monopolies or restrict competition from the private sector. A business that faces no competition will find it easier to report profits. Where state businesses face competition the Government may grant SOEs preferential tax or other benefits that hinder the ability of the private sector to compete, causing deterioration in service or increasing costs to consumers. A few years ago VAT was imposed on large supermarkets but LakSathosa was exempted from this. The previously unprofitable LakSathosa started to make profits, while the efficient local supermarkets were penalised.

SOEs which operate as monopolies may not deliver an adequate level of service or charge excessive prices, which may lower the productivity/efficiency of the wider economy.

When Telecom was in state hands, obtaining a telephone connection, essential for business was a luxury that required a wait of several years. Thanks to liberalisation of phone connections, now they are available over the counter but businesses still struggle to obtain power connections and may have to invest in standby generators due to unreliability.

Energy costs (fuel and electricity) do not reflect the decline in global oil prices partly due to inefficiencies within the CPC/CEB (Ceylon Petroleum Corporation/ Ceylon Electricity Board), impacting on the competitiveness of business.

Inefficiencies in the state managed port terminals are a drag on trade but fortunately throughput at the privately managed SAGT (South Asia Gateway Terminal) Queen Elizabeth Quay is far greater and a boon to business.

The SAGT terminal has been ranked number one for terminal productivity in South Asia by the Journal of Commerce in the USA and ranked number four in the world. Because of the faster turnaround time ships prefer to dock at Queen Elizabeth Quay where it operates.

SOEs, especially those that lose money, are partly funded by banks. When a large chunk of bank lending is directed towards SOEs, the private sector will find it harder to obtain funds and higher interest rates could lead to a phenomenon referred to as "crowding out".

 

4) Governments cannot boost overall employment by hiring workers to the state sector. Giving people state-sector jobs may appear to create employment but this causes a problem because each new position brings with it a tax obligation that imposes a burden on the private sector, where wealth is generated and taxes paid. Effectively, since the salary of a public-sector employee reduces the amount of funds available to private employers, a job created in the public sector causes an offsetting loss in the private sector.

 

5) State-owned enterprises may enjoy hidden subsidies in a variety of forms including preferential borrowing costs, lower rents or taxes. Thus the actual costs will be higher than reported in the accounts and very difficult to quantify without detailed analysis. For example, imagine if ministries or SOEs had to pay market rents for the space in Government buildings that they utilise. Few would occupy the highly-valued areas they do now and would probably occupy less office space.

Indeed there is a massive opportunity cost of state- owned property in that they do not generate a net tax income for the state. If these properties were utilised by the private sector they would generate taxes as well as rents. Secondly, government office buildings in city centres create additional congestion. Given the current state of information technology, most government offices could and should be moved far from city centres. Hence, it is clear that the problems with SOEs are not limited to losses; their inefficiencies also can be a serious drag on the wider economy.

A more worrying issue is that the public is unaware of the full extent of the problem. The Treasury and other bodies that are supposed to monitor SOEs do so only partially and by all accounts ineffectively. Hence the question is - how much of public resources are being drained away in this financial black hole? The tax payers and citizens surely deserve better.

At a minimum, the Government needs to publish regular, comprehensive performance report giving the investments, outstanding debts and profits/losses of all SOEs. The question of reform needs to be urgently addressed and privatisation should remain an option.


A version of this article originally appeared in “The State of State Enterprises in Sri Lanka” Report as well as The Island.

What we could have done with the losses of state-owned enterprises

By Dhananath Fernando

The article originally appeared on the Daily Mirror on May 15, 2016

 

Would you believe the Sri Lankan government could have declared a Rs. 5000 bonus for each and every citizen in 2016 April New Year if Sri Lankan Airlines even if they had broken even for last 10 years.

The subject is State Owned Enterprises (SOE) and strangely most of them do not have proper financial data (Data is publicly available for 55 out of 255 SOE’s). I am adding my two cents worth to write about the mega losers of public money and some ‘why’ factors for the reader’s consumption.

The total losses of the 55 SOE’s from 2006-2015 amounts to a gigantic Rs. 636 billion. Interestingly 5 key institutes are responsible for 95 percent of the losses which adds up to Rs. 605 billion losses. Namely Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lankan Air Lines, Mihin Lanka and Sri Lanka Transportation Board are the money eating machines of poor taxpayers. 

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Surprisingly significant discrepancies were identified even in the figures disclosed to public through the COPE report, the Treasury Annual Report and Fiscal Management Report for the same institute.

Obviously all 3 the figures cannot be true and we can come to a reasonable conclusion that either two figures or all 3 figures are false. The simple reason we cannot ignore the discrepancy is because it exceeds Rs. 5 billion of tax payer’s money. If I take examples of other institutes this column will run out of space

Naturally, with such drastic discrepancies the following appalling questions cross our minds: nAre accepted accounting standards followed when profit calculations are made?  nIs the data fabricated to misguide the 20 million population?

Has COPE done their job well and does the money spent on the COPE committee justify taxpayer’s money.

If these government workers cannot manage these institutes and cannot even calculate profit and loss accurately, are they worth the money they are paid from tax payers’money.  The ‘Profits and losses’ analysis shows that in 2011 and 2012 there is a sharp increase in losses and the reasons for the increase in losses should be investigated to avoid reoccurrence of such situations in the future. 

Although it is a fact that the global economic conditions took a beating in 2012, but Sri Lanka had just emerged from a war situation in 2009, and this was a huge advantage to the Sri Lankan economy. SLTB and Mihin Air has failed to make any profit for last 10 long years and if a company cannot be turned around in 10 years, the ability of the management should be questioned. How many years must one wait to see a progress being made? 

Sometimes we the ordinary citizens of Sri Lanka cannot comprehend the value of Rs. 605 billion. Most of us, including the ministers and parliamentarians confuse millions and billions. In order to illustrate the potential of Rs. 605 billion, a list of things which could be done, if the 5 key institutes were well managed and were able to break even is given below:

1. Ten more highways

The cost of southern high way was 60 Billion rupees and we could have easily built 10 southern highways connecting all corners of the island with this money because the cost of the southern highway was way above the average cost. The Ministry of Highways attributes the high cost to the high prices paid for land acquisitions and land diversity. Even if this is true, 10 highways with similar capacity could have been constructed for the same price.  

2. Eleven harbours

The Hambantota port cost US$ 361 million and we could have built 11 ports and even saved another 600 million for the grand opening ceremony  

3. Cover 81% of the current budget deficit

The current budget deficit is estimated to be LKR 740 billion rupees and if the 5 institutes mentioned herein could have performed at breakeven level, we could easily cover 81% of the current budget deficit  

4. Twenty more airports

The current government is planning to make Sri Lanka an aviation hub and if they think they need airports like Mattala, even if it is only to store paddy during the harvest season, 20 similar airports could be built. The San Francisco Air Port in the USA, which incidentally is one of the top airports in the world, with the size of the runway being 3600 meters long and 45 meters wide is smaller than the Mattala airport runway which has a 3500 long and 60 meters wide runway. So I am talking about an investment of 20 airports having a capacity equal to the San Francisco Airport, not small domestic airports carrying light aircrafts  

5. Nine power plants as Norochchole

Making a Sri Lanka a hub of energy is another popular topic in town. The first phase of Norchchole cost US$ 455 million and losses made by the 5 key SOE’s in 10 years is 9 times  this cost.  

6. 10% of the Megapolis project 2030

The initial mega project in 2016 targeting to make Sri Lanka a middle income country by 2030, requires an investment of US$ 44 billion. The Government could easily cover 10 percent of the total investment with the losses made by these key 5 institutes.  

7. Relief of 22% of total tax revenue in 2016 on tax payers

The total estimated tax revenue of the government for 2016 is Rs. 1,584 billion. Even if Sri Lankan Airlines and Ceylon Petroleum Corporation could operate at breakeven level it could still cover 22 percent of the total estimated tax revenue from 2016 budget. I reiterate the values are just face values and the net present value (NPV) will show a worse situation  

8. Rs. 30,000 bonus by the first citizen with his annual greeting SMS

Leaving alone all of the above, the President instead of sending a SMS message to all Sri Lankan citizens who own a phone, wishing them a happy Sinhala and Tamil New Year, could give a cash gift of Rs.30,000 to every citizen of this country, including newly born infants, if these 5 key loss making institutes performed better by breaking even. (Rs. 120,000 for a 4 member house family) With the losses incurred by Sri Lankan Airlines alone, the President could gift Rs. 5000 to each citizen. 

What would be the solution?

It is a globally accepted theory that when you run a business, focussing on your strengths is a must and establishing monitoring and evaluation procedures is essential. If you do not possess the required skills or expertise within your organizations, you have to either hire the right people or outsource the job.I t is sad that the words like “Privatization” are injected as terrorist words into the blood of the nation but the reality is just leaving these 5 institutes in the hands of honest politicians had lost the country 605 billion which no one can justify. Those who promote concepts like state ownerships and big government has absolutely no idea on financial management.

If they had any sense on fiscal management a decade is a too long period even for a below average management.  The fear of privatization is same as fear of failure and the success is always lies beyond our comfortable zone. It is Albert Einstein, the brain of the 21stcentury, who said “Insanity is doing the same thing over and over again and expecting different results”. 


Dhananath Fernando is the Chief Operating Officer of AdvocataInstitute; an independent Sri Lankan think tank works for economic freedom. He could be reached via dhananath@advovata.org

The re-nationalisation of SriLankan Airlines and the follies of State enterprise

A couple of weeks ago, Prime Minister Ranil Wickremesinghe announced that the debts of SriLankan Airlines, amounting to a mammoth US$ 3.2 billion, will have to borne by the taxpayer. He said the government is taking this action to defuse an economic ‘landmine’ and that his government is actively looking for an international partner to manage the airline.

When a three billion dollar bill is passed on to ordinary Sri Lankans, many of whom have never flown the airline, it’s worth examining what let do this disastrous situation. In examining the data, it’s clear that Srilankan Airlines provides an excellent example of the problems that arise from state-owned enterprises.

Air Lanka, the state-owned airline was privatised in April 1998. The government of Sri Lanka sold a 40% shareholding to Emirates Airlines, which was also contracted to manage the company for a period of 10 years. The government of Sri Lanka continued to retain the majority shareholding but management was relinquished to Emirates.

Emirates re-branded the airline as ‘SriLankan’, overhauled the airline’s infrastructure and adopted a new approach to its operations. Cost-effective strategies were introduced; new pro-active management teams were put in place; Information technology became the basis of everyday activities. The airline’s network was constantly reappraised and product enhancement became a part of the airline’s philosophy. The airline was completely re-fleeted with an all-Airbus fleet of A340, A330 and A320 aircraft replacing the ageing Lockheed Tristars.

Although the privatisation and restructuring attracted a lot of criticism at the time, the exercise was eventually deemed a success; indeed in many quarters it was hailed as model for other airlines.

At an international seminar on airline restructuring and privatisation, held a couple of years after the divestment; the President of the employees union of Srilankan spoke on how union rights were protected and the improvement of working conditions.

At the time of the privatisation all employees were gifted shares by the government based on the number of years of service. Although a voluntary retirement scheme was also implemented the President of the union stated that employees were given an excellent deal if they wanted to leave and no-one was made redundant. Collective Agreements signed by the airline with employee unions guaranteed increments to employees. New human resource development programmes were instituted after privatisation to upgrade employees’ skills and a new grade and pay structure put in place.

Union representatives from other state-owned airlines were also impressed by the manner in which the airline disclosed information to employees; “they had never seen such transparency from an airline’s management,” said K J L Perera president of the employees union. SriLankan published its quarterly financial results in its staff newsletter.

Following a spat in December 2007 the Chief Executive Peter Hill, had his work permit revoked.The dispute began when Hill refused to bump 35 passengers from a full London-Colombo flight to make way for Sri Lanka’s president and his entourage. The Government cancelled the work permit of the CEO of the airline and in March 2008, Emirates did not renew the management contract. The airline, which had been consistently profitable under the management of Emirates last reported a profit in 2008; a bumper Rs.4.4bn. Since then the airline has racked up enormous losses; according to the latest published accounts for the year ended March 2015 losses stood 123.26bn rupees.

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The airline reported an operating loss of Rs.16bn in the year 2015, an improvement from the loss of Rs.31.3bn in 2014. To put these figures into context, the Government bought out Emirates for only US$53m (or Rs.7bn at today’s exchange rate). Last year alone the airline lostfour times its original purchase price, a truly remarkable feat.  The airline’s accumulated losses amount to almost a billion dollars; the entire Southern highway was built for around 700 million dollars, cost overruns included.

The management of the airline has claimed that the recession in Europe and high oil prices caused the losses. The public was urged to look beyond the “mere profitability aspect” and understand the “catalyst role played” by the airline in tourism; in the words of the former CEO.

Airlines are global businesses and the same factors affect all airlines. Singapore Airlines cited by many who try to justify state ownership of airlines reported a marginal operating loss in only a single year during the last ten years; a loss of US$38m in 2009/10.

Singapore airlines is no less affected by the recession and oil prices, but it did not report losses. Singapore Airlines is a well-run state airline that is something of an exception. Many cite it’s example but few have been able to emulate its success, so we should not try to justify our Government’s ownership by looking to Singapore. Srilankan Airlines own track record is what we need to examine.

What changed when the Government took it over? They inherited a profitable business with the same staff, systems and infrastructure; the principal difference was in the management. The truth is that the airline suffered from gross mismanagement and corruption, some of which has recently been uncovered.

These problems seem to plague state owned enterprises (SOE’s), but why do they occur?

There are two elements to explanation: the principal-agent problem and the free-rider problem, both based on the assumption of self-seeking individuals.

An SOE is run by managers who do not own the firm. In a firm under state control managers know that their salaries will be paid regardless of how the business performs, therefore there is no incentive to maximise efficiency.

Frequently in Sri Lanka the Government will be under pressure to appoint various loyalists to key positions. In some, (although not all) instances, those who seek political patronage to be ‘fixed up in a job’ are people who lack the skills or abilities to find a job on their own merits. Thus the enterprise may become stuffed with incompetents; good staff will find it very difficult to work with these people so they either leave or give up trying to do any work and concentrate on keeping in the good books of the bosses.

The maxim of “more work, more trouble, less work, less trouble and no work, no trouble” is applied. In any case pay and benefits are not dependent on performance, so why bother to stick ones neck out? Soon, this attitude poisons the enterprise and staff work on surviving in their jobs rather than trying to manage the business.

This problem would not exist if the citizens, who are the owners (principals) of SOEs, can perfectly monitor the SOE managers (their agents) but individual citizens do not have the incentive, and means, to monitor the SOE managers.

This leads to the second element of the problem, even if they did try to hold the SOE to account, the costs that an individual citizen incurs in monitoring SOE managers (obtaining and analysing financial information, seeking explanations through public channels etc.) are solely his or hers, while the benefits of improved management accrue to all owners. Time and effort will be expended in the exercise by the citizen who receives no immediate benefit. Thus, individually, the citizens have little incentive to monitor the SOE managers, which means that in the end, no one monitors them. This is the so-called free-rider problem.

This is the fundamental structural flaw with SOE’s which explains why many operating in truly competitive markets are doomed to failure. There are apparently profitable SOE’s but In some instances they operate as a monopoly, like the Sri Lanka Port Aunthority.  In other instances such as LakSathosa, Governments  may  create an  uneven-playing  field  in  markets  where  an  SOE  competes  with private  firms,  as  they  have  a  vested  interest  in  ensuring  that  state-owned  firms  succeed. LakSathosa is exempt from the VAT and NBT charged on other supermarkets giving them a significant competitive advantage.

Accordingly, despite its role as regulator the government may, in fact, restrict competition through granting SOEs various benefits not offered to private firms. In such instances SOE’s may appear to be profitable but this is due to hidden subsidies and distortions which are ultimately borne by taxpayers.  

Airlines used to be regarded as a key part of transport infrastructure, like roads or bridges, which should be owned by the Government. Until the mid-1980s, most governments did own airlines and protected flag-carriers by restricting new entrants. This thinking has changed.

Privatisation made air travel more competitive and liberalisation brought competition from low-cost carriers. Most airlines in state control have failed to adapt and are losing money. There is little strategic interest in owning an airline; Switzerland and Belgium have done without a flag carrier for years.

The airline is currently a huge drain on the treasury and the previous experience with Emirates demonstrates the clear benefit of privatisation.


A version of this article originally appeared in “The State of State Enterprises in Sri Lanka” Report as well as Ground Views