By Syed Talha Hassan Kazmi
The government of Pakistan has announced to intervene in the market of bottled water by launching a state-owned mineral water brand. Mr. Fawad Chaudary, Federal Minister for Science and Technology claimed that the bottled water costs Rs 1 per liter and it will be introduced in two phases. In the first phase, it will be used at government offices and in the second phase it will be made available to the general public.
Mr. Chaudary also said that it would be a cheaper alternative to other mineral water brands available in the market. In simple words, the government has decided to launch a SOE to compete with private market players. This article explains why such decisions are bound to fail. It also recommends some basic solutions to fix financial woes of the State Owned Enterprises.
Existence of a SOE can be justified only in that segment of the economy in which private sector is not willing to participate. Launching of “Safe Mineral water” cannot be justified in the presence of multiple private enterprises in this sector. In Lahore and other cities, one can find several privately-owned water shops providing quality water to the consumers at their door step at a price of around Rs. 5 per liter. Does the government really want to compete with them?
Ironically, we have many other sectors of economy in which loss making SOEs are unfairly contesting with private enterprises. For instance, despite having multiple privately-owned steel mills, Pakistan Steel Mills (PSM) is haunting the economy with total losses and liabilities of over Rs 480 billion. PSM was closed down in 2015 but government is bearing an expenditure of Rs 370 million every month in terms of employees’ salaries.
SOEs are generally established to provide certain goodsat a lower price. These goods are not normally provided by the market as they are usually non-rivalrous and non-excludable. Provision of a good at an economical price requires efficiency at each and every stage of business process. However, most of the SOEs in Pakistan have lost their financial viability stemming from bad governance, over staffing andpolitical interference. Most of them are so inefficient that they cannot even meet their operating costs.
There is no economic or even moral justification behind the existence of SOEs in those sectors of economy in which private sector is participating actively. Every year government injects huge sums of tax payers’ money to keep them alive. We the taxpayers are facing consequences of the crimes which we haven’t committed but the white elephants still exist and incurring huge loses.
A report prepared by the Ministry of Finance reflects that the net losses of SOEs have surged by 330 percent in FY17 and reached to Rs191.5 billion. Among the top ten loss making SOEs, National Highway Authority sealed top position with net losses of around Rs 133 billion, followed by Pakistan Railways Rs 40.7 billion, PIAC Rs 39.6 billion and losses of PSM jumped up to Rs 14.9 billion. This is the price of government intervention in the markets.
Explaining why SOEs fail
The answer to this question lies in looking at the end result of government programs. The owners of private enterprises and the people who are involved in running SOEs have the same incentive: to serve their own interest. However, the bottom line is different in the private sphere than in the public sphere. Under a well -functioning market mechanism if an enterprise fails it will go out of the market and owners will lose their investments. So, they have a strong incentive to make it efficient to avoid losses. However, if same people run a government program and it fails, they know that can get a bailout package from the government. They have no incentive to make it efficient.
After coming to power, the PTI government has given two bailout packages worth Rs 38 billion to keep the national flag carrier in the skies. The first bailout package of Rs 17 billion was approved in November 2018 and the second “dose of oxygen”was provided in February 2019. In August 2019, PIA management has demanded another injection of nearly Rs10bn to remain afloat. The fresh assistance was demanded to pay off foreign loans and for repair and maintenance of aircrafts. The government however, showed its reluctance to inject more money due to IMF restrictions.
As of June 2019, SOEs domestic debt peaked to Rs 1.4 trillion (3.6 percent of GDP). The financial black holes are also borrowing from commercial banks which is fast crowding out private sector. SOEs have borrowed Rs 228 billion from banks for commodity operations.
What needs to be done?
The government of Pakistan must privatize all the loss-making SOEs as revamping of these loss-making entities is not an easy option. Many governments have tried first to revamp these entities before putting them on the privatization list. PTI government also wasted one year to realize that the privatization of loss-making entities is the only solution to avoid further losses.
However, before privatization, the government of Pakistan must formulate a sound privatization policy and create an enabling business environment. The policy should explain the prerequisites for privatization, its process, and criteria. The government of Pakistan must also reduce the regulatory burden and liberalize the economy to incentivize private investment.
It is highly appreciated that the PTI government has selected 17 SOEs for privatization. It is recommended that the government must ensure transparency in the whole process and rules should not be violated to give any SOE to a particular group or individual.
In those sectors of the economy where the private sector is not participating, corporate structure can be introduced to minimize the losses. Pakistan introduced corporate governance rules in 2013 but these rules were practically ignored by the government of PMLN. World Bank has recently launched the “Report on Observance of Standards and Rules”. The report highlighted serious flaws in the affairs of SOEs, such as lack of performance management system, fragmented ownership structure and lack of staff with financial and commercial expertise.
Many countries have implemented corporate governance rules to ensure accountability, transparency, and clarity in the mandate of all the stakeholders. Independent central boards in the form of holding companies, specific boards, and monitoring authorities are established to enhance the efficiency of the SOEs. Examples include Tamasak Holding of Singapore; Department of Public Enterprises in India and New Zealand’s crown monitoring authority. The PTI government has also decided to set up a holding company named Surmaya e Pakistan Holding Limited (SPHL) for the management of SOEs. Under this initiative all the entities will become subsidiaries of PSHL and shares of the federal government in all the SOEs will be transferred to holding company. The initiative will not only be helpful in improving coordination among different public entities, but it will also help them in focusing on their core matters and non-core issues such as legal services can be outsourced to PSHL.
SOEs lack capital due to which the entities face problems in the development of new assets and in maintaining the existing ones. This issue can be resolved through public-private partnerships. For instance, private investment can be mobilized into the aviation sector of Pakistan. The aviation policy of 2015 provides a business-friendly framework that can be helpful in attracting private investment in the airline. Private investment can also be mobilized to minimize budget constraints faced by Pakistan Railway. For instance, trains can be outsourced to the private sector and the receipts generated through this initiative can be utilized to maintain railway tracks. Also, redundant real estate assets owned by Pakistan Railways can also be utilized to attract funds.
Most of the SOEs in Pakistan are facing severe financial crises. Custodians of Naya Pakistan have to realize that bailout packages have done more harm than good.
It is recommended that all loss-making enterprises which are unfairly competing with private enterprises must be privatized. But, before privatization, the government should formulate a sound privatization policy. The government should also minimize regulatory constraints and reduce its control over market forces to incentivize private investment.
Public Private Partnership and corporate governance may also help in revamping the SOEs which are operating in those segments where private sector is not willing to invest.
The PTI government must understand that government intervention in an efficiently functioning market mechanism is always destructive and Pakistanis have already paid enough price of such misadventures.
Author is a Research Fellow at PRIME Institute and holds an MPhil in Economics.