Here’s how we fix Pakistan’s SOE problem

The government’s primary role is to make sure that consumers are protected from unnecessary exploitation by businesses, that they know what their rights are, and that they are getting those rights. Sometimes, however, governments are the ones setting up companies and businesses, called State Owned Enterprises (SOEs), to achieve these objectives, and tread into the arena where private sector generally shies away but the provision of products and services in these constituencies are essential for the masses like utilities

The requirement, however, is that these SOEs will have the highest standards of corporate governance, which is supposed to result in financial stability and sustainable growth. Essentially, the government creates a body to take care of  bureaucratic red tape that would inevitably seeps into projects that the government undertakes directly.

That sounds like a pretty picture, right? If the government faces a task it feels will get bogged down by bureaucracy, it can set up a SOE and have the issue managed easily and efficiently.

But here is a problem: the ecosystem of state owned enterprises in Pakistan is not in the best of shapes. It is plagued with systemic problems. The good news is that despite this there have been some moments that prove SOEs in Pakistan still have potential, which means a serious attempt at rectifying the situation which may do the trick of making them efficient.  

There are currently 206 entities that are labeled SOEs in Pakistan. The number seems a little more daunting than it actually is. You see, of these 206, only 186 are Public Sector Companies (PSCs), and of them only 139 are considered commercial entities, including subsidiaries. 

According to the Asian Development Bank, if we were to consider these subsidiary SOEs as part of their parent SOEs, the actual number of these commercial entities would reduce to a much more manageable 57. The real problem, however, is the price tag at which these companies operate. A very conservative estimate of the drain, direct and indirect, actual and potential, that these companies have on the fiscal deficit is Rs 1 trillion. SOEs are not, of course, inherently bad. In fact, if they are well managed, they are actually supposed to become profitable, may not be at the same level as private sector’s, and positively contribute to the public exchequer, nevertheless, along with social dividends for the public. 

What we need to get to this point is a serious conversation about the “lack of political will” over the years to reform structural problems, considering the privatization option, and figuring out what the future outlook of SOEs should look like. 

The privatization option 

After decades, and decades of mismanagement, Pakistanis rightly do not trust the capabilities of government to run businesses. They are not wrong to be this cautious given their experiences, which is why any time there is a conversation about government entities, a snap reaction is to go the privatization route. That is why it is worth getting this argument evaluated/ assessed impassionately and objectively first, before we proceed into the future of how SOEs should be managed. 

Even though many people believe in this approach, I quite frankly consider it as an approach of “passing the buck” which with all due respect I find as an irresponsible strategy, especially when there are solutions available to effectively run existing SOEs. Let us admit over here, that privatization is not without its merits. Many countries have successfully used this method. In fact, given the nature of SOEs, one could argue that privatization is a natural part of the evolution of any SOE. But here’s the rub: in Pakistan, while those arguing for privatization may be well intended, the implementation may be done for the wrong reasons. People have a preconceived notion that the government is incapable and want the private sector to come in and save them. The government is all too happy to give up rather than taking the painful route of reforms. Organizations like the International Monetary Fund (IMF) and the World Bank are also excited by the prospect, and not only encourage privatization, but provide ready made solutions that are not necessarily tailored to what Pakistan needs. This would mean that we are given half baked solutions and end up accepting them when they are not even the best way to privatize, let alone the best way to deal with SOEs. What is the possible result? Privatization, which is supposed to be the cure, causes more adverse symptoms in the system, particularly in the long run, that outweigh all of the problems that existed before. 

If privatization is the way to go, then we must do it in a different way. It should not be for the gaze of the IMF and other bodies. It should be for Pakistan and by Pakistan, and for the people of Pakistan and their welfare, and after taking into consideration the country’s business and social maturity life cycle. There is no room for one-size-fits all over here, and the process has to be thoughtful and well planned. A strong regulator is a prerequisite for privatization; otherwise, the side-effects could negate the benefits. 

The state of the SOEs

The problems that SOEs in Pakistan face are a reflection of larger problems that this state faces everyday. Those are the root causes, some in particular with regards to SOEs, and fixing them has the potential to fix SOEs. Now, we have a whole list of reasons why SOEs in particular are not doing too well in Pakistan. Inconsistent macroeconomic policies, excessive auditing culture, a lack of independence, the selection process for the executives in these entities, the country’s weak regulatory environment, and the constant political interference. But all of these problems have had one root cause: lack of political commitment. 

The problems that SOEs face are structural in nature, so even if we were to go the privatization route, it cannot be a success, and let us have the maximum benefits, unless we restructure them first. Even this option must only be explored phase wise, and that too after gaps are identified and treated beforehand. 

Try to take stock of exactly how bad the situation is. Businesses and organizations survive and thrive on consistency and certainty; uncertainty kills them. SOEs are the biggest victim of this uncertainty. For example, at the macro-economic level, we’re still debating if capitalism or socialism or a hybrid of the two are suitable for us. Add to this the fact that a weak regulatory environment means that the owners of SOEs are actually stronger than regulators. This results in undermining the regulators, who are no longer empowered to supervise these entities in an effective way, and unable to extend them the much needed regulatory cover to take right and bold decisions which are needed for efficient operations of the business.

There have been far too many agencies chaperoning SOEs with limited understanding of the business, unstructured protocols and unlimited powers, creating an over-regimented environment with excessive auditing and inspection exercises. One of the most common problems are conflicting interests of different stakeholders. There is often a lack of appreciation for changing environment and business needs at the Government’s level, particularly in the space of technology, meaning SOEs remain outdated and sluggish as compared to their private sector competitors. 

And then there is the issue that SOEs face,  Appointments of board members and executives are made on political considerations. Wonders can be done with a competent and sincere board of directors and most importantly the CEO in charge. 

Have SOEs been successful in Pakistan? 

From everything that has been discussed up until now, the reader will not be shocked that the answer to this question is very much no. The experience in Pakistan of SOEs has been less than ideal to put it mildly. However, it has also not been completely disastrous, even if it has been messy for the most part. Keeping in view economic and social factors, the experience has been a mixed bag at the end of the day. 

You see, even though they should ideally be making profits, since these entities are set up for the public good and end up eating money instead of making it. However, this does not change the work that they are doing. This is not merely the case in emerging markets either, but has also been witnessed in developed markets like the UK. The commercial entities under the public sector always are at a deficit as compared to the private sector entities due to inherit structural limitations, which are endemic in the public sector. On the other hand, the public sector entities would do those businesses, which are a must for the larger public good, albeit at a loss, and that the private sector would not necessarily deal with. 

Now, this again points towards the argument that perhaps privatization, maybe in parts, might be the solution to these problems. Although it could have been if the process had been handled better and perhaps rolled out in phases. We must remember that the core problems of SOEs are structural in nature, and without first filling those gaps, we should not be looking for a solution because there is no viable solution. Case in point: banking reforms, and then privatization, in the late 1990s and early 2000s.

So what do we do? 

The first possible solution is to set up a state-owned entity along the lines of a Sovereign Wealth Fund. It would essentially be a professional entity that would overlook the commercial SOEs. 

Currently, we have the federal government that looks after these 57 companies. Different ministries of the federal government look after different SOEs. Under this new model, a Board of Directors appointed professionally would overlook a professional management setup that would be responsible for appointments, performance, and everything else essentially, in these SOEs and their success. 

This model would bring many benefits with it. For starters, there would be a relevant expert for every sector at the holding company level. The model would also take on the challenges of bureaucracy. Most importantly, however, it is a hybrid system that takes the good from both privatization and government ownership, or in other words it would be the privatization of the management of SOEs and not the assets. By handing all SOEs over to another entity for management, the government ownership remains intact with efficiency closest, if not at par, with the private sector. This has also been a tried and tested method in countries of this region, including Singapore, Korea, Malaysia, UAE, etc. 

This has been what is happening in Pakistan recently as well, with the government launching the Sarmaya Pakistan Limited (SPL) in February 2019. The most critical aspect and objective of Sarmaya Pakistan was to get those “for-profit” or “commercial” entities out of the administrative control of various line ministries and expose them to the professional management with the requisite sectoral expertise. 

The other option, of course, is that instead of forming another company like SPL or a Sovereign Wealth Fund, Pakistan chooses to implement exclusive laws relevant to SOEs. Essentially, this would entail redefining the ownership rights of the government with regards to commercial SOEs. The government would continue its role as a regulator, and there would be a defined criteria for the selection of a board of directors for any SOE. Such a law has already been framed, and the apparent cabinet approval for enactment of this law has already been secured.

Under this law, like any other private enterprise, every SOE will have owners and regulators. The purpose of the law should be to help the Federal Government maximize returns and service quality through its ownership of “commercial” SOEs. As mentioned before, the Government will continue to have an interest in “regulation” through line ministries, and other specialist regulators of the sectors within which the SOEs operate. 

The core issue that this law must improve on, however, is that over regulation and multiple auditing and inspection requirements have not been dealt with. The law or the incorporation of sovereign funds shall be a mere starting point, there would be more that is desired and steps to be taken. 

The Big Five Theory

The Big Five Theory rests on how the fiscal account is structured. Its two main components are taxation (where the Federal Board of Revenue is involved), and the other one is the non-tax component, which involves the performance of SOEs. With the right policy actions and a strong willed government, both these components do not require any external support. 

Now within these two main components, there are a number of regulators and a number of SOEs. This theory proposes that the top five entities within each component, chosen in relative terms of importance and influence, tobe made independent, and eventually reformed. The ‘Big Five’ regulators would be the SBP, the Securities and Exchange Commission (SECP), the National Electric Power Regulatory Authority (NEPRA), the Oil and Gas Regulatory Authority (OGRA), and the FBR. Similarly, the top five SOEs would be the Pakistan International Airlines (PIA), the Pakistan Railways, the Water and Power Development Authority (WAPDA), the National Transmission and Distribution Company (NTDC), and the Oil and Gas Development Company Limited (OGDCL). 

On the one hand, by empowering regulators, the over-regimentation and excessive auditing and inspection could be, in fact, shall be rationalized, and SOEs will be able to operate independently and professionally, which will ensure attracting talented individuals on the board and in the management. On the other, giving the Big Five SOEs independence will mean the optimal exploitation of natural resources (water, gas, etc.), and will have a positive effect on the fiscal deficit. 

The prime example of how this change would work is the FBR. Under this theory, the FBR would be divided and restructured along the lines of policy and collection. Currently, the FBR is playing fast and loose within the line between regulator and commercial SOE because it has an agenda of incentive based revenue collection. Making a distinction between policy and collection will address any existing, and potential, conflict of interest. This will also help in better engagement of policy-makers with the various stakeholders in the industry to come-up with business-friendly taxation policies. On the other hand, the collection team will focus on the enhancement in collection alone without tinkering with the taxation policies to achieve the collection targets.  Furthermore, the appellate forums starting from first appeal may be made independent by appointing chartered accountants, cost accountants and lawyers from the private sector. This will help in getting expeditious justice and mitigate the element of unprofessional practices considerably.