SOEs: performance & accountability

The World Bank’s recent report, titled ‘Pakistan Development Update, fiscal impact of Federal State-Owned Enterprises’, highlights a significant improvement in our economy, attributed mainly to enhanced and better management strategies, and fresh external inflows.

Despite facing multiple challenges such as deficient macroeconomic management, escalating global commodity prices, tightening global monetary policies, impact of catastrophic flooding in 2022 and lingering political uncertainties, in 2023 Pakistan was teetering on the brink of an imminent economic collapse.

Against this tumultuous backdrop and with forex reserves perilously dwindling, approval by International Monetary Fund (IMF) in July 2023 of a 9-month US$3 billion Stand-By Arrangement (SBA) injected a renewed sense of hope for economic recovery. Success of this endeavor remains contingent upon the steadfast implementation of the programme.

Remarkably, over the past 18 months, both political and interim governments have demonstrated commendable fiscal restraint across various sectors heralding a conducive environment.

While the anticipated outcomes of these measures may only yield modest improvements, they have nonetheless succeeded in reinstating market confidence.

Though these positive developments are encouraging, yet it is critical to recognize the ongoing high risks, given unaddressed factors important for sustainable economic growth.

Deteriorating financial position, along with burgeoning debt levels and a precarious foreign exchange reserve, largely supported by borrowed funds, underscore the urgent need for a robust structural reform programme without which, growth prospects are likely to remain subdued, perpetuating external imbalances.

In the first half (H1) of current fiscal year [FY24], the primary surplus registered Rs 1.8 trillion that is a substantial increase compared to last year’s corresponding period.

Despite this period, fiscal deficit continues to widen annually, reflecting unabated struggle to meet financial requirements within the given revenue generation.

During H1 of FY24, fiscal deficit expanded to Rs 2.4 trillion, a significant leap from Rs 1.7 trillion recorded in the same period of FY23. This widening gap is primarily attributed to the escalating debt servicing, fueled by unprecedented accumulation of costly debts over recent years.

There is an urgency to address areas in need of improvement. The report outlines specific actions aimed at advancing the overarching goal of economic growth.

These measures are crucial for steering the economy towards a more sustainable path and mitigating the risks associated with widening fiscal imbalances. It is thus imperative for policymakers to implement these recommendations diligently to safeguard fiscal stability and promote long-term prosperity.

Through prioritizing targeted reforms and exercising prudent fiscal management, Pakistan can effectively navigate past the prevailing challenges paving the way towards a prosperous future.

World Bank’s recommendations include enhancing the quality of expenditures, minimizing the intrusive presence of the state in the economy, introducing reforms in state-owned enterprises (SOEs), privatization, rationalizing untargeted subsidies and streamlining federal expenditures in areas delegated to provinces.

There is also a pressing need to expand the tax base, which entails augmenting taxes on sectors such as agriculture, retail, and property, while simultaneously reducing tax exemptions and addressing administrative inefficiencies, particularly through digitalization initiatives.

Additionally, regulatory barriers hindering private sector activity must be met by simplifying bureaucratic processes and facilitating foreign investment.

Furthermore, rectifying the anti-export bias in trade policies is imperative, necessitating tariff rationalization and the overhaul of export subsidy schemes. Lastly, the energy sector requires urgent attention to rectify inefficiencies and reduce costs. This involves sustained tariff reforms and fostering increased private sector involvement in energy distribution and transmission.

The report underscores the urgent need for SOEs’ reforms, emphasizing their pivotal role in managing significant fiscal drain and associated risks. With SOEs operating across diverse sectors of the economy, their substantial footprint necessitates immediate attention.

However, over the past decade, these entities have consistently incurred losses, exerting immense pressure on fiscal resources. Notably, the aggregate profitability of SOEs has witnessed a stark decline since FY14, transitioning from a profit equivalent to 0.8% of GDP to a loss of 0.2% of GDP in FY22.

Of particular concern is the power sector, which stands as the largest contributor to federal commercial SOEs’ financial losses, closely followed by infrastructure, transport, and communication.

The persistently negative performance of these entities underscores the criticality of implementing comprehensive reforms swiftly. Addressing inefficiencies within SOEs and enhancing their operational effectiveness is paramount to alleviate the burden on public finances.

The government support to these SOEs in various forms, including subsidies, grants, loans, and guarantees, constituted 18% of the federal budget deficit in the fiscal year 2022. Notably, the government guarantees, often required for concessional loan approvals for SOEs from bilateral or multilateral agencies, have seen a substantial increase from 2.2% of GDP in FY16 to 4.5% of GDP in FY22.

Additionally, direct support to federal commercial SOEs, which amounted to 2% of GDP in FY22, surpasses their financial contributions to the treasury in terms of taxes and dividends paid, which only totaled 0.6% of GDP.

This confirms the significant fiscal burden associated with sustaining these enterprises. Such extensive support calls for a comprehensive reevaluation of SOEs’ operational efficiency and financial sustainability to ensure optimal utilization of public resources and mitigate fiscal risks.

In summary, the substantial government support provided to SOEs underlines the urgency of implementing reforms to enhance their financial viability and reduce their dependence on public funds. This strategic shift is essential for fostering fiscal sustainability and promoting long-term economic resilience.

The World Bank’s report recommends discontinuing the practice of covering SOE operating losses through transfers from the federal budget. Instead, SOEs should be held accountable for their performance and bear fiscal risks arising from their operations.

Of particular concern are the fiscal risks stemming from federal SOEs’ non-payment of domestic and/or foreign debt and the realization of contingent liabilities, such as guarantees.

The report presents alarming statistics, revealing that in FY21, nearly one-third of the total outstanding domestic loans to federal commercial SOEs consisted of overdue principal and interest payments. Furthermore, in FY2021, SOEs managed to pay off only a mere 2.8% of the total overdue domestic loan amount, equivalent to Rs 17 billion out of Rs 612 billion. These figures represent the pressing need for comprehensive reforms.

Addressing these challenges requires a concerted effort to strengthen governance mechanisms and improve transparency in SOEs’ financial management.

Holding SOEs accountable for their performance and timely debt repayment are necessary steps towards ensuring fiscal sustainability and promoting responsible use of public resources.

Copyright Business Recorder, 2024