Pakistan Sovereign Wealth Fund Has Created Governance and Public Financial Management Challenges: WB

The World Bank said that the formation of the Pakistan Sovereign Wealth Fund (SWF), valued at about $8 billion, creates governance and public financial management challenges because the State-Owned Enterprise (SOEs) transferred to this Fund are exempted from the SOE Act’s best corporate governance practices.

The Bank in its latest report “Pakistan Development Update: Fiscal Impact of Federal State-Owned Enterprises released on Tuesday stated that the SOEs within the SWF should be classified as commercial SOEs and be governed by the SOE Act and Policy.

All SOEs, including those under the State Wealth Fund (SWF), should be covered under the purview of the SOE Act to ensure financial transparency and good corporate governance practices, the Bank recommended.

In August 2023, the government set up SWF to support long-term economic growth aimed at managing assets of large profit-making SOEs by using the best global practices to ensure such assets grow and benefit the people over the medium to long term. There are seven entities that have been transferred to the SWF under SWF Act, 2023, all of which are profit-making SOEs or the subsidiaries of SOEs: Oil and Gas Development Company Limited (OGDCL), Pakistan Petroleum Limited (PPL), National Bank of Pakistan (NBP), Pakistan Development Fund, Government Holdings Private Limited, Mari Petroleum Company Limited, and Neelum Jhelum Hydro Power Company Limited.

The Bank stated that dividends from OGDCL, PPL, NBP, and Government Holding Private Limited have been significant, at around 0.05 percent of GDP. A clearly defined dividend policy for SWF is critical. Further, the transfer of these four SOEs may significantly change the outlook of the SOE portfolio. In fiscal year 2022, these four SOEs accounted for 42 percent of total profits and 12 percent of total assets in the portfolio.

The Bank stated that if the government owns and controls the SWF, the SWF itself could be designated as a commercial SOE to ensure appropriate oversight and alignment with best corporate governance practices. The government should ensure adequate governance arrangements are introduced for the newly created SWF to safeguard assets and stakeholders’ interest. The Government should plan an annual evaluation of the SWF against its mandate. Further, the Government should consider the SWF for membership in the International Forum of Sovereign Wealth Funds (IFSWF) and adopt to IFSWF’s performance and reporting standards.

The World Bank Update highlights the high fiscal costs of SOEs operating in key sectors of the economy. These SOEs have been consistently making losses since 2016, and the government has been providing significant financial support through subsidies, grants, loans, and guarantees, leading to large and growing fiscal exposure.

In FY22, direct government support to SOEs in the form of subsidies, loans, and equity investments accounted for 18 percent of the federal budget deficit and 2 percent of GDP (Rs1.303 trillion), which is more than the total expenditure on health at 1.4 percent of GDP.

Direct support to federal commercial SOEs exceed their financial contributions. Fiscal inflows to the Federal Government from SOE taxes and dividends were 0.6 percent of GDP (Rs421 billion) in fiscal year 2022, significantly lower than government transfers to the SOEs, which were 2 percent of GDP in fiscal year 2022. In FY22, the net fiscal gap between the government financial support and financial return from SOEs has further widened despite an increase in corporate tax flows from federal commercial SOEs.

Annual issuance of total new government guarantees has been averaging 0.9 percent of GDP over the fiscal year 2016-22 period but remains below the ceiling of 2 percent of GDP stipulated by the Fiscal Responsibility and Debt Limitation Act 2005 (FRDLA). Over 75 percent of the stock of guarantees is against the power sector for financing the circular debt.

The Bank stated that concrete outcomes for the implementation of the SOE Triage have yet to materialize. The delays in enacting these and other reforms resulted in the Federal Government bearing a fiscal cost of 0.8 percent of GDP in fiscal year 2022. The Government has agreed to absorb the existing debt into public debt and clears portion of it every year (as certain debt mature). In addition, the IMF has imposed increasing the surcharge for power consumers to clear the markup under PHPL loans.

Structural issues, poor planning, and substantial subsidies have resulted in huge inefficiencies across the power sector, affecting the reliability of supply and generating huge deficits (referred to as “circular debt”). While the pace of accumulation has slowed since FY23, the power sector circular debt has continued to grow. As of the end of January 2024, the circular debt stock stood at Rs 2,635 billion (2.4 percent of GDP), including an additional flow of Rs 463 billion since end-June 2023.

Circular debt on gas has emerged as another challenge for the sector. As of January 2024, gas circular debt stood at Rs 2,866 billion (2.7 percent of GDP) compared to Rs 2,391 billion in June 2023.

The National Highway Authority (NHA) has the largest fiscal impact among commercial SOEs, with a loan stock equal to 4 percent of GDP and an asset base amounting to 9 percent of GDP. It was excluded from the triage exercise due to its unique financing model and the extensive level of services it undertakes on a socioeconomic basis.

However, the NHA requires significant financial restructuring. It has a capacity to finance its viable projects from the capital market and to seek credit ratings. Upon becoming a corporate entity, the NHA will have the opportunity to pursue various funding avenues, including self-financing, capital market loans, and public–private partnerships, without sole reliance on government loans or guarantees. Until the transition to corporatization is complete, the NHA should receive funding through PSDP grants for socioeconomic projects. Additionally, the NHA should implement sound financial management practices as mandated through amendments in the NHA Act of 2023, which requires the development of a business plan for commercial activities and costing of public service obligations for socioeconomic activities.

To contain fiscal exposure from SOEs, the report recommends rapid progress with government plans for privatization, restructuring, and divestment—per the 2021 Triage plan. In addition, the Update recommends establishing new guarantee issuance rules, mitigating credit risks, ensuring adherence to International Financial Reporting Standards, and developing risk monitoring procedures.

The Government has initiated reforms to improve the financial discipline of SOEs and strengthen oversight under the new State-Owned Enterprises (Governance and Operations) Act 2023 and the SOE Ownership and Management Policy 2023. Full and effective implementation of these reforms is now critical, along with accelerating privatizations and implementing the SOE Triage exercise completed in 2021. The government should move to eliminate the practice of covering SOE operating losses with transfers from the federal budget and implement measures to manage fiscal risks associated with explicit and implicit obligations, such as holding SOEs accountable for performance and responsible for fiscal risks arising from their operations.

The Government should manage fiscal risks with new guarantee issuance rules, credit ratings, International Financial Reporting Standards (IFRS) adherence, risk monitoring, and debt transparency.

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