State-Owned Enterprises in Azerbaijan: What to do? - Nariman Mannapbekov and Aimee Hampel-Milagrosa

Op-Ed / Opinion | 7 October 2020

In many parts of the world, state-owned enterprises (SOEs) are often inefficient, poorly run, and drowning in debt. This is particularly the case in emerging economies. What is less often discussed is the fact that successful SOEs can produce fundamental improvements in public service delivery and sustain economic growth, especially when focused on economic activities where market failures tend to deter the private sector.

In Azerbaijan, the Government presides over several SOEs across many sectors. These include companies that provide critical public goods such as power generation and distribution, oil and gas production, the supply of water and heat, airways, railways and freight services. Many of these SOEs exist to address market failures. But other SOEs exist to maintain national control of industries, promote economic development, and ensure the provision of vital public services. In Azerbaijan, a large proportion of the working population is employed by the more than 12,000 national and municipal state firms and together contributed 18% of GDP annually from 2014-2016.

But SOEs could also pose a problem for the economy. An Asian Development Bank (ADB) review of the country’s 14 largest SOEs found that between 2013-2017, the underperformance in state firms was equivalent to an average efficiency loss of 4.2% of GDP. This means SOEs could have contributed much more to the economy but did not.

For this reason, the Government has launched an ambitious reform program to improve the performance of its SOEs. The objective is to transform SOEs from being a massive burden on the state budget to a key driver of development and economic growth. Initial reforms efforts have addressed some of the key issues plaguing SOEs including the introduction of selected corporate rules and standards. But to bring about far-reaching, long-term change, the government can go further with its reforms. Critical to its success are reforms in four key areas:

First, to adopt an explicit SOE policy and support sector reforms. These can help push SOEs to become efficient business entities with a clear division between their commercial and non-commercial functions.

Second, to establish key targets and performance indicators for SOEs. Procedures should be established setting out how the Government, through the Ministry of Finance and Commission on Large SOEs, will exercise oversight, monitor performance, and deal with possible risks and weaknesses, such as SOEs’ abilities to service their debts.

Third, to strengthen the corporate governance structure in SOEs including the establishment of Supervisory Boards. This will help ensure transparency and oversight in the decision-making process, and other necessary financial control mechanisms.

Fourth, to ensure that SOEs disclose detailed financial and operating information, such as annual financial reports, by tightening legal loopholes that currently allow them to avoid their disclosure obligations.

These reform measures are potentially controversial, complex, and will no doubt take time to implement. But the lessons from other countries that have trodden a similar path – such as Australia, Georgia, Indonesia, Malaysia, New Zealand, and Singapore – suggests the effort will be worth it.

For example, Malaysia introduced a performance-based culture for SOE management, a critical factor in making the companies profitable. Between 2004 and 2014, Malaysia’s 20 largest SOEs tripled their market capitalization.

The recently created Azerbaijan Investment Holding is mandated to boost corporate reforms in SOEs. The first sets of tasks have begun, but there remains considerable hard, meticulous, and painstaking work ahead given that every SOE has different challenges and needs. What may work for an SOE in one country may not work elsewhere. Above all, SOEs reform must be approached from a sector reform perspective. But when it comes to applying corporate governance principles, the Government can be bold and take an “if not, why not” approach to its SOEs, starting with audits.

Currently many SOEs engage external auditors to provide an independent opinion on the SOE’s financial statements. Performance audit initiatives should also be introduced to improve accountability audit quality and ensure that goods are acquired economically (in the right quality, quantity, and at the right time and place), used efficiently to maximize output, and applied effectively to meet the firm’s operational goals.

Conducting performance audits to enhance SOE efficiency is standard practice in many countries and works well. SOEs should strengthen their internal audit units to start the process. This will also support the Government’s broader reform agenda to institute a performance-based budgeting and agency results framework.

Conducting dual audits (financial and performance) is costly and could be used as a reason not to introduce them. But if the work is done by a reputable and experienced auditor, the costs are soon repaid through improvements in performance and financial health. This work should be funded by SOEs themselves.

Azerbaijan now has an opportunity to transform its SOEs and advancing reforms in key areas can help achieve this – for the good of its economy, development and most importantly its people.