Wednesday, May 18, 2011

Fight of the Century: Keynes vs. Hayek Round II

Very interesting. This is Round II.

Here is Round I.

Inefficient SOEs of Nepal: The triumph of politics over economic imperatives

This article is a product of the productive usage of the banda last Friday organized by Nepal Federation of Indigenous Nationalities (NEFIN)! It is about the sorry state of three major inefficient state-owned enterprises (SOEs) of Nepal: Electricity Authority (NEA), Nepal Oil Corporation (NOC), and Nepal Airlines Corporation (NAC). The very presence and operation style of these SOEs is distorting market prices and incentives. Their condition shows the triumph of politics over economic imperatives in the public sector in Nepal. For specific sources for stats in this article, see this earlier blog post.

Inefficient SOEs

The existing product market scenario is frustrating for consumers. A majority of the people cannot get petroleum fuel even if they are willing to pay higher prices. They cannot get enough electricity despite being willing to pay more to get extra power to light up their bulbs, and cooking and cooling devices. Furthermore, even after paying nominal charge they are still seeing dry taps in their houses. Also, those willing to fly on the national carrier are not being able to do so because of the failure of Nepal Airlines Corporation (NAC) to correctly fathom the evolving airline market.

These are some of the examples of the consequences of letting inefficient state-owned enterprises (SOEs) to either fully or partially control markets on which consumers heavily bank on to meet their daily needs. Out of a total of 36 SOEs, 18 are operating in loss and even more have negative net worth. The government’s loan investment in SOEs is over Rs 80 billion annually.

Instead of resuscitating these SOEs each time they run in fiscal trouble, squandering taxpayer’s money at the cost of development activities in rural areas and services delivery in urban areas, the optimal solution would be to either purge or reform or privatize most of the loss-making SOEs that are not strategically linked to vital security and national interests. The reason why most of these SOEs are surviving is not related to economics, but vested political interests.

Let me discuss the state of three major inefficient SOEs—Nepal Electricity Authority (NEA), Nepal Oil Corporation (NOC), and NAC—that are draining state resources each year without adding much value to productive capacity of the nation. Subsidizing and keeping these mammoth SOEs alive means that our fiscal deficit, which is 3.9 percent of GDP, will further widen and budget for a number of hospitals, schools, rural roads, and food and agriculture aid curtailed. A complete structural reform—with regards to market, price, management and operation—is essential to ensure that taxpayer’s money is efficiently utilized and that these enterprises delivery what they are supposed to.

The NEA was earning profit until FY 2058/59, but is incurring loss of about Rs 19.47 billion, which is several times more than its total assets, for a decade now. It is unable to supply electricity as per market demand. During FY 2009/10 the annual peak demand reached 885.28 MW, a 8.96 percent growth over the peak demand a year ago. Of this around 30 percent was managed by load-shedding and import from India. It is expected that total electricity demand will be around 1,400 MW by 2015. With the existing pace of power generation, it is virtually impossible to keep up with the growth in demand. The market situation is so pathetic that despite being naturally endowed with rivers having potential to power the entire country and even to supply surplus to India, we are compelled to import, at a high rate, approximately 15 percent of the existing electricity supply from India.

The state of NOC is even miserable. It is running a deficit of Rs 15 billion and monthly loss of about Rs 2 billion. Its creditworthiness is so bad that none of the financial institution is willing to lend money against any guarantee to settle outstanding debt owed to Indian Oil Corporation and to procure more fuel to satisfy increasing demand in the market.

Recently, it was reported that the government had to implore Employment Provident Fund to lend Rs 2 billion and request India to give Rs 3 billion line of credit to resolve fuel shortage for two months. This comes on top of approximately Rs 1.5 billion already given to NOC by diverting funds from a rural roads development project. The market is so distorted that even when people are willing to pay high prices they are not getting fuel as demanded. Already a liter of petrol costs over Rs 125 in the black market.

The state of NAC is heartbreaking. It is supposed to be a pride of Nepal, ferry domestic and international travelers on aircrafts with the iconic Nepali flag, and assist Nepal to achieve its tourism potential. Unfortunately, it is deeply embroiled in repeated scandals related to financial theft during purchase of badly needed aircrafts, appointment of staff, repayment of loans and so forth. It has become a hiring bank for supporters of major political parties. Its total asset is worth Rs 16.80 billion, but losses are over Rs 2 billion. It has just two big aircraft and three small aircraft. Note that at one time the NAC had 21 aircraft, including eight Twin Otters, two Boeing 727s and two 757s, and was one of the biggest foreign currency earners. With mounting losses, mismanagement, and competition from private players, NAC has lost its relevance.

A noticeable question is: How come the SOEs having a healthy balance sheet a decade ago go bankrupt and lose creditworthiness? It is because of myopic financial and operations management, poor governance and accountability, and most importantly the triumph of politics over economic imperatives. The fragile financial health of SOEs and their inability to efficiently and sufficiently satisfy market demand is a recurrent problem that cannot be resolved by applying band aid (such as providing loan sufficient to resuscitate them for few months). It requires sweeping structural changes, which may involve making painful decision of firing redundant politically-appointed staff and adjusting prices upward to reflect changing market dynamics and investment costs.

Unfortunately, this has not happened yet. The NOC is not allowed to adjust market prices. As of last week, it was incurring loss (per liter) of Rs 8.10 in petrol, Rs 23.42 in diesel, Rs 13.61 in kerosene, and Rs 322.6 in a cylinder of LPG gas. Its monthly loss is over Rs 1.96 billion. Similarly, NEA is not allowed to adjust market prices depending on market dynamics and investment costs. At present, per unit investment is Rs 8.97, but power is sold at Rs 6.57 per unit (a loss of Rs 2.40 per unit). Its total annual income is about Rs 1.5 billion but yearly operating expense is Rs 1.65 billion.

The country cannot afford to repeatedly bail out SOEs by slashing development expenditures. Worse, most of the subsidies meant for the poor are captured by the well-offs in urban centers. Effective market and product differentiation is one aspect of goods and services delivery to the targeted group. But, there is no simple fix to the inefficiencies of SOEs except for increasing ownership by management and exposing them to competitive market forces. The consumers should be the king, not the political leaders who dictate the SOE’s board to play to its pricing tunes, whose pitch depends on mood of party cadres.

Apart from stopping leakages and ensuring efficiency, allowing these institutions to adjust prices is one option in the short run to restructure their financial position, and facilitate adequate and timely delivery of goods and services. In the long run, political meddling in all SOEs should cease. They should be allowed to operate freely and competitively. If some of them fail to perform then we should let them exit the market. Meanwhile, NOC and NEA should be broken up into independent units responsible for procurement, production, distribution and retailing. It would help facilitate the entry of private players as well. They should not hold monopoly (market characterized by one seller, many buyers) and monopsony (market characterized by one buyer, many sellers) powers.

That said, subsidizing some SOEs that are vital to maintaining national and security interests are justifiable. But, NEA, NOC and NAC do not fall in this category. The more we bail them out of their financial mess and let politics overcome economics, the more inefficient will be our economic and public goods delivery systems.

[Published in Republica, May 16, 2011, p.7]