Sri Lanka: Correct The Price Distortion for A Sustainable Development – Part 2

Public is happy if the quality of goods and services is satisfactory and reliable at a reasonable price, regardless of the ownership of the business.

by Sirisena Amarasekara

This is the second part of this series by the author, Click here to read the first part -Editors

Water Supply

Providing safe drinking water and improved sanitation services have been the government’s priority for many decades. In 1975 National Water Supply and Drainage Board (NWSDB) was established, and the responsibility was transferred to it. Before that, it was a local government function, and cost recovery was not considered an important issue. The local authorities provided Dug wells in rural areas, and the pipe-boned water supply was limited to urban areas. Their priority was to roadside public stand posts for free water, and the domestic connections were charged a nominal amount. Hence water was considered a free public good without a price.  Irrigation for agriculture is still a free public good with no price.

With the introduction of the Community Water Supply Projects, pipe-borne water supply was expanded to many rural areas, and today 58% of households have access to pipe-borne water. Gradually NWSDB expanded its operation to rural areas with high population density. The capital costs of projects are now shared 50:50 between the treasury and NWSDB. Still, domestic water is considered a government responsibility and only a part of the cost is recovered from the poor. Yet 25.8% of the total production falls under the non-revenue water category, which is put into the water supply system but not billed. This is mainly due to poor maintenance, leakages, and management issues such as water thefts, calculation errors, etc.

Employees of Sri Lankan apparel industry [ Photo: Export Development Board Sri Lanka]

The average unit cost of producing potable water has increased from Rs.48.87 in 2020 to Rs. 60.63 in 2021 (Economynext 05.06.2022). According to the Water Tariff Revised in 2022, water is billed under 12 different categories for different purposes at different rates. Samurdhi beneficiaries are charged a nominal tariff of Rs.5.00 per unit for the first five units (5000Lt.), Rs. 10.00 per unit for the second 5 units, and Rs. 15.00 per unit for the following five units. Accordingly, 15,000 Lt. per month is highly subsidised for them, and the subsidy element (tariff below the cost of production) exists for up to 25 units (from 16to20 units Rs. 40 and 21 to 25 units Rs.58 per unit). In contrast, Domestic(other) Category consumers will have to pay four times higher than the Samurdhi recipients for the first five units (Rs. 20.00 per unit), and the subsidy element exists only for up to 15 units. Beyond that, an exceptionally high punitive tariff, which increases with the usage from Rs.86.00 up to Rs. 238 .00 per unit, is being changed.

There are four other categories where the tariff is much below the cost of production, namely, (a) Non-Samurdhi Tenement Gardens, (b)Public Stand Posts, (c)Schools, religious and charitable institutions, and (d) Local Authorities.  It means that out of 12 categories, 5 have a substantial subsidy. The tariff for the other seven categories (production-oriented) is much higher than the cost of production. In addition to the usage charge, a monthly service charge, increasing parallel to the consumption, is also levied from those categories. Therefore, the tariffs applicable to production-oriented and non-samurdhi household categories are punitive and discouraging. For instance, tariffs for the port and shipping, SOEs, BOI companies, and industries are Rs670, Rs.116, Rs.85, and Rs 82 per unit, respectively.

However, the NWSDB has demonstrated that it can recover a considerable portion of the subsidy cost through punitive tariffs from production-oriented and high-user domestic categories. According to the 2019 Annual Report, the losses for 2018 and 2019 were Rs. 1,176 and Rs. 580 million, respectively. According to the Economynext-05.06.2022, the NWSDB had posted a profit of 507 million rupees in 2020 but again lost 3,087 million in 2021, with salaries rising 19 per cent. If not for the salary increase, the NWSDB could have remained at least at the break-even point in 2021. With the tariff revision in 2022, it may reach the break-even point. Unlike other SOEs, NWSDB delivers essential public goods without a massive loss. This is mainly due to the capital costs subsidy granted by the treasury and the tariff structure to charge more from whom it is affordable to pay. But NWSDB is also overstaffed, and remunerations are relatively high.

Due to the scattered nature of housing and settlements, the capital cost of water distribution in rural settlements is very high. Many rural water supply schemes are found in hilly terrain in the wet zone, where water sources are abundantly available in good equality. Still, due to the hilly terrain, the capital cost of the distribution network is high. But in contrast, drinking water is a critical issue in the dry zone, covering about 70% of the country’s land area. This is the area chronic kidney disease is prevalent and suspected that the cause is poor-quality drinking water. Unlike in the wet zone, water sources are not found easily, and the quality is also unacceptable. Dry zone communities face many inconveniences and opportunity costs, such as risky long-distance travel and consuming many hours of the day to collect a pot of drinking water. If they purchase potable water from the market, they will have to pay more than Rs.50.00 a litter. Under this scenario, selling one unit (1000 litres) of water for Rs. 5.00 or Rs 20.00 in the wet zone and urban areas can’t be justified on humanitarian grounds. Therefore, financing potable water for the dry zone is justifiable, even at a higher cost, considering social justice and equal access to safe water. Further, the NWSDB must take serious action to reduce the 25.8% non-revenue water supply to a technically acceptable minimum level to increase its revenue. Currently, six tariff categories are below the cost of production, which seems highly irrational.

Instead of ad-hoc political decisions to revise the tariff for electricity and water from time to time, it is more logical to commission an in-depth study to restructure the tariffs to make water and electricity prices affordable to domestic users, discourage excessive unproductive use of subsidised products and remove punitive tariffs from the production-oriented categories.

Aviation

The national carrier rebranded as Sri Lankan in 1998 following its partial acquisition by Emirates. In 2008, the government re-acquired all the shares and management rights from Emirates. Then the accumulated profit of Sri Lankan was Rs. 9.288 billion (Wikipedia). In any case, Sri Lankan was not a burden to the treasury; instead, a share of the profit was paid to the treasury from time to time. It was revealed at the COPE meeting in July 2022 that the loss of the Sri Lankan as of 31 March 2021 from the day it was taken over from the Emirates was 372 billion, and the daily loss is about Rs 84 million.  Mihinlanka, which commenced its business in 2007, also amalgamated later with Sri Lankan with an accumulated loss of Rs 13 billion.  In 2020 Sri Lankan’s debt obligation exceeded Rs 372 billion. Also, its net worth was negative Rs.262 billion. Most of the above debts are to the Bank of Ceylon, the People’s Bank, and the CPC. Further, it had sovereign guaranteed internationally issued bonds worth UDS$ 175 million. If the government declares insolvent or shuts down the airline, the two banks and the CPC must write off all debts. This will severely affect the two banks’ liquidity, sustainability, and profit. The CPC is also heavily indebted to the above two banks. So eventually, that burden also will pass to two banks. The government owns two banks, and finally, all these responsibilities fall on the shoulders of the taxpayers. Moreover, the government could face multiple jurisdictions worldwide regarding the non-settlement of foreign liabilities.

Subsidising essential services is understandable. But subsidising foreign travel by affluent Sri Lankan citizens and foreigners has no meaning for the taxpayers. More than 99% of taxpayers do not benefit from this colossal subsidy. Many airlines provide services from and to Colombo to many destinations, even at a lower price than Sri Lankan. So, Sri Lankan does not fill any service gap too. If there is any justification for continuing the operation of Sri Lankan with subsidies, it would be to support tourism and strengthen linkages with foreign economies. In any case, earning from tourism cannot compensate for such a colossal loss/subsidy. It may be possible to justify the operation of a national carrier for national pride. If so, the airline must be restructured and scale down its operation to match that intention without a loss, at least on a cost-recovery basis.

However, the establishment of Mihinlanka Airlines, re-acquiring Sri Lankan from the Emirates, and pumping public funds to Sri Lankan to expand its operation without a well-thought business plan are economic crimes for which the decision makers are responsible.

 Lose-Making SOEs

Subsidising the losses of state-owned enterprises (SOEs) and selling their products below the cost of production also amounts to direct subsidies to their employees and indirect subsidies to consumers while distorting the market prices. Sri Lanka has 527 SOEs. Of which 52 have been classified as “Strategically Important “enterprises by the general treasury. But some strategic enterprises, which are involved in purely commercial activities, such as CEB, CPC, CWE, CTB, Sri Lankan, Hotel Development Lanka Ltd, etc., have been running as loss-making enterprises for many years.

 Out of the non-strategic enterprises, 287 SOEs are also commercial ventures that can be run more efficiently by the private sector. According to the information available from the Department of Public Enterprise, out of 527 entities, only 57 are self-funding. In 2019, the total losses sustained by 52 SOEs amounted to Rs 151 billion. According to the above information, budgetary support amounting to Rs. 49 billion has been provided to loss-making institutions, of which Rs. 20 billion was for recurrent expenditure. Most SOEs’ pricing is not cost-reflective and sells their goods and services below the cost of production(subsidising). Perhaps, if the price becomes cost reflective, their products may be unaffordable to the people because the cost of production is very high due to inefficient management, wastage, and corruption.

The private sector may produce those at a lesser cost resulting in lower selling prices and tax revenue for the government. According to the Advocata research team, the total accumulated loss of strategic SOEs from2006 from to 2020 amounted to Rs 1.2 trillion. As per the Public Finance Data, the top five losers, namely, CPC (Rs.628 bl.), Sri Lankan (Rs.248 bl.), CEB(Rs.47 bl.), Airport and Aviation Services (Rs.6 bl.), and SLTB (Rs.1 bl.) have recorded a total loss of 930 billion for the first four months of 2022. The government revenue for the same period is only Rs 543.6 billion. SLTB has a loss of Rs.1 billion in providing transport facilities for many middle- and low-income commuters. But Sri Lankan has a loss of 248bl., which provides aviation facilities to a minimal number of well-to-do Sri Lankans and foreigners.

When SOEs in short of funds or on the verge of bankruptcy, they do not follow the due process to borrow, liquidate or re-structure the business. They borrow inputs from other SOEs or borrow money from state-owned commercial banks. But it is done not on the strength of their balance sheets but at the request of the treasury, sometimes on verbal instructions, even without a treasury guarantee.  They continued to do so for many years. For instance, Sri Lankan, GCR, and CEB borrow their inputs from the CPC and keep accumulating debts.  The CPC borrows from the Peoples Bank and Bank of Ceylon to fill that gap. If CPC can’t borrow further due to cumulative outstanding debts, the treasury issues a long-term financial instrument to the CPC and passes the liability to the next generation. The CPC trade it and settle previous loans, and continues borrowing. This is a big cross-subsidy between SOEs. This amounts to a pyramid operation by the government. This can’t continue forever, and all resources will get exhausted and may collapse all institutions at once. It is advisable to allow major institutions to operate independently. Then who can sustain will sustain on its own strength. Others may get a boost to adopt sound management practices or restructure/privatise/liquidate.

But trade unions and politicians argue that those enterprises should come under state ownership to ensure the national interest and to prevent exploitation. As discussed above, the exploitation of consumers and taxpayers is very high under state ownership. However, policymakers may have a genuine interest also to keep essential services like energy, transport, health, education, etc., under government control to ensure the national interest/national security, respond to disasters, and assist the poor. But there are many low-cost and efficient solutions to achieve such objectives.  For instance, petroleum infrastructure and regulatory power may be kept with the CPC while allowing the private sector to import and sell fuel competitively. Railway Department can own the railway infrastructure and regulatory authority, while the private sector is running trains. Such arrangements ensure the government’s control over the service while the advantage of quality and price competitiveness passes to the consumers.

The impact of subsidising the loss of SOEs is not trickledown down to the large segment of the population, the consumers, and the taxpayers. But some groups with a vested interest have developed private sector phobia and hold the taxpayers and consumers to ransom for their economic, political, and power gain. Employees want to keep those under state ownership to secure higher income and fringe benefits with little or no work. Trade union leaders want to maintain SOEs at any cost to demonstrate/excise the power and authority and strengthen linkages with the upper echelons of political parties. Politicians wish to use the employees and other resources free for election campaigns and give jobs to their supporters. Further, they can support campaign funders by appointing them to management boards and promoting business linkages such as contracting, outsourcing, granting business permits, etc. Also, sometimes they can financially benefit by being involved in corrupt practices in procurement, service delivery, and recruitment.

But the public is happy if the quality of goods and services is satisfactory and reliable at a reasonable price, regardless of the ownership of the business. For instance, if a reasonably priced, reliable power supply is available, the customers don’t want to verify whether it is by the CEB or a private supplier. The customers don’t consider whether the fuel is from the CPC or Indian Oil Company if it is reliable, convenient and reasonably priced. But without knowing the facts, the taxpayers and the consumers also fight against the privatisation of loss-making entities.    

In the case of infrastructure or capital expenditure, passing the liability to the next generation is justifiable because they also become beneficiaries of those investments. But recurrent /consumption expenditure incurred by SOEs like SLTB, Sri Lankan, and Railways is only for the benefit and convenience of the present generation. Accumulating losses, defaulting and long-term borrowings for such expenses means passing the liability of luxurious consumption of the present generation (politicians, employees, trade unions) to the next generation, for which decision-makers have no rights. It is an unforgivable, very dangerous economic crime. If the private sector runs those commercial activities, the government can collect more revenue as taxes instead of subsidising the losses. Also, the government will have more time and resources to do its primary function, governing the country, which has been neglected hitherto by all governments.

To Be Continued

Sirisena Amarasekara is a Sri Lankan public servant and diplomat. He is the former Sri Lankan High Commissioner to South Africa, Mozambique, Namibia, Zambia, Zimbabwe, Lesotho, Angola, Botswana, and Eswatin. He had functioned as the secretary to the Prime Minister on two occasions, and as the secretary to the Cabinet of Sri Lanka. Having completed more than 50 years of public service, Amarasekara is one of the most senior Sri Lankan public servants.

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