ISLAMABAD: Highligh­ting contingent liabilities of the state-owned enterprises (SOEs) at almost eight per cent of GDP — or about Rs5 trillion — as a major fiscal risk, the International Monetary Fund (IMF) has linked the continuation of its ongoing programme with “parliamentary approval” of the new SOE law by the end of June to ensure transparent management of these companies.

“Contingent liabilities from loss-making SOEs — to the extent not covered by government guarantees — continue to represent additional risks to debt sustainability,” the IMF has noted in a special chapter in a recent report on Pakistan’s economy.

It said the authorities have recognised about 1pc of GDP contingent liabilities in the circular debt, but the remaining contingent liabilities from circular debt (amounting to less than 0.8pc of GDP) as well as “contingent liabilities from other loss-making SOEs (assumed to be in the range of 5-6pc of GDP) and/or from the financial sector are accounted for by a stress test to debt dynamics consisting of a contingent liability shock”.

Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event, such as the outcome of a pending lawsuit. Contingent liabilities are not shown in the balance sheet but must be given adequate disclosure.

The IMF report said Pakistan’s SOE sector was saddled by poor performance and weak corporate governance, posing significant fiscal risks. Non-financial commercial SOEs held total assets amounting to 44pc of GDP in 2019 (up from 31pc in 2015), but only provided about 0.7pc of total formal employment.

Based on a comprehensive triage report published by the Ministry of Finance in 2021, which provides a snapshot of the federal-level SOE landscape as of the end of fiscal year 2019, there are 213 SOEs, of which only 85 are commercial operations (18 financial and 67 non-financial).

The overall revenues of all non-financial commercial SOEs in FY2019 were about Rs5tr, or 14pc of GDP. “Despite their important role in the economy, the financial performance of many SOEs is weak, with one-third consistently generating losses”, it said, adding that both stronger governance and a smaller footprint of the state were crucial to boosting efficiency in the SOE sector.

The IMF has asked the government to accelerate the legal, regulatory and policy framework update of the SOE sector for which it has set a structural benchmark to ensure “the parliamentary approval of the SOE law in line with IMF recommendations” by the end of June this year.

This means the parliament has to approve the SOE law by all means, as in the case of the recent State Bank of Pakistan law, to define a rationale for state ownership, ensure commercially sound SOE operations and regulate oversight and ownership arrangements.

Additional steps include defining a new ownership policy, amending several SOEs’ Acts, and operationalising a central monitoring unit within the Ministry of Finance. To further foster efficiency and reduce fiscal risks, the IMF has also asked for following through with a gradual reduction of the footprint of the state in the economy, with only a small number of SOEs considered strategic under state ownership.

This includes finalising the divestment of two LNG-based power plants and two small public banks. The IMF “insisted that regular and timely audits of key SOEs remain crucial, including of the Utility Stores Corporation”.

As a result, the government has committed to operationalising a central monitoring unit within the finance ministry by the end of May. The unit will centralise SOE monitoring functions and provide better analysis at the aggregate SOE level.

The government has also given a commitment to the IMF to attempt to finalise some additional work by the end of May, including cabinet’s adoption of an SOE ownership policy to help operationalise SOE law principles into a policy that clarifies ownership arrangements and the division of roles within the federal government and selection of four SOEs and submission of amendments to their acts to the parliament to help ensure that the scope of the SOE law brings governance changes to statutory enterprises.

In this regard, the government has told the IMF that it had advanced plans to privatise two power plants using regasified LNG and two small public banks and complete the process by the end of June, with proceeds to be channelled to debt reduction and poverty programmes.

Simultaneously, the government would complete the 2018-20 outstanding annual audits of the other bank by end-June and the 2021 annual audit by end-August, with the aim to complete the privatisation process by the end of this year.

The IMF noted that almost half of the SOEs operated at a loss in 2019, including one-third of commercial SOEs that are consistently generating losses; among the major ones were the National Highway Authority, power sector distribution companies (or Discos), Pakistan Railways, and Pakistan International Airlines, which owns the Roosevelt Hotel in New York and the Scribe Hotel in Paris.

Commercial SOEs recorded Rs143bn losses in the 2019 fiscal year. A recent work published by the World Bank in 2021 estimated the liabilities of loss-making SOEs in Pakistan in the range of 14–18pc of GDP, posing considerable potential fiscal costs.

The new proposed law already introduced in the parliament intends to separate the regulatory and policymaking functions of the state with regards to its SOEs. This will require SOEs to set company mandates and strategies through a publicly available statement of corporate intent.

An ownership policy document will subsequently integrate this framework and will clarify the processes for developing strategy and negotiating performance agreements as well as the respective roles of all involved institutions.

The reforms in the proposed act are also expected to strengthen the central role of the board in its oversight of SOE operations, hence strengthening internal and external controls as well as reporting and disclosure standards.

In that respect, the new act provides a timeline for compliance with international financial and account rule standards and disclosure of non-financial information and the aggregate reporting on an annual basis at a minimum.

Under the new act, the board of each SOE will be expected to adopt a three-year business plan every financial year, laying out targets, strategic direction and operational and financial performance measures.

This business plan mandated by the new act is envisaged to serve as the performance agreement between the government and the SOE. The performance of such entities would be assessed on annual and quarterly bases, supported by timely audited annual financial statements following the best international standards.

Published in Dawn, February 14th, 2022