How to Assess Fiscal Risks from State-Owned Enterprises: Benchmarking and Stress Testing
Author: Alberto Soler1 and Mouhamadou Sy2
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
Publication Date:
19 Aug 2021
eISBN:
9781513591698
Language:
English
Keywords:
SOE performance; SOE net contribution; income statement; SOE debt; SOE risk analysis; Public enterprises; Liquidity; Fiscal risks
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The size and operation of state-owned enterprises (SOEs) can imply significant risks for governments. SOEs are present in virtually every country in the world and are major players in domestic economies and in global markets. In some countries, they number in the thousands and are owned by national or subnational governments. SOEs are among the largest corporations in some advanced economies and comprise a third or more of the largest firms in several emerging markets. Many operate with systematic losses and carry significant liabilities. If SOEs face adverse shocks and financial distress they can impact the government budget or balance sheet through numerous transmission channels. This How to Note describes a newly developed SOE risk assessment tool to help country authorities and IMF country teams. The analysis can provide inputs for annual budgets and medium-term fiscal planning. This includes providing estimates of possible transfers to and from SOEs to the budget and possible financing needs. The note outlines the main steps and elements of the template to assess fiscal risks for governments from individual SOEs. The first step is to collect financial information on SOEs and their relation to the government budget, and to provide a benchmark against other SOEs in similar sectors. A second step is to do a forward-looking analysis based on baseline forecasts and stress scenarios, to identify and analyze possible risks and their impact on government accounts.

Abstract

The size and operation of state-owned enterprises (SOEs) can imply significant risks for governments. SOEs are present in virtually every country in the world and are major players in domestic economies and in global markets. In some countries, they number in the thousands and are owned by national or subnational governments. SOEs are among the largest corporations in some advanced economies and comprise a third or more of the largest firms in several emerging markets. Many operate with systematic losses and carry significant liabilities. If SOEs face adverse shocks and financial distress they can impact the government budget or balance sheet through numerous transmission channels. This How to Note describes a newly developed SOE risk assessment tool to help country authorities and IMF country teams. The analysis can provide inputs for annual budgets and medium-term fiscal planning. This includes providing estimates of possible transfers to and from SOEs to the budget and possible financing needs. The note outlines the main steps and elements of the template to assess fiscal risks for governments from individual SOEs. The first step is to collect financial information on SOEs and their relation to the government budget, and to provide a benchmark against other SOEs in similar sectors. A second step is to do a forward-looking analysis based on baseline forecasts and stress scenarios, to identify and analyze possible risks and their impact on government accounts.

Introduction

The size and operation of state-owned enterprises (SOEs) can imply significant risks for governments. SOEs are present in virtually every country in the world and are major players in domestic economies and in global markets. In some countries, they number in the thousands and are owned by national or subnational governments. SOEs are among the largest corporations in some advanced economies and comprise a third or more of the largest firms in several emerging markets. Many operate with systematic losses and carry significant liabilities. If SOEs face adverse shocks and financial distress they can impact the government budget or balance sheet through numerous transmission channels (see Baum, Medas, Soler, and Sy 2020). For instance, government bailouts have been sizable in the past in many countries. IMF (2020) found, for a sample of countries, that bailouts average 3 percent of GDP and can reach more than 10–15 percent of GDP in some cases.

Nevertheless, in general, the analysis of fiscal risks from individual SOEs is underdeveloped. Assessment of financial soundness of SOEs, when done, usually focuses on a few financial indicators based on the most recent financial report. Typically no comparison to other SOEs is done; however, such a comparison could provide a critically important perspective on the relative performance of the company, a determination of whether public money is being used efficiently, and a first assessment of fiscal risks (for example, if the SOE is excessively leveraged when compared to its peers). In addition, forward-looking risk assessments of SOEs are rare, or they are done in an ad-hoc manner and when the SOE is already asking for government support.

This How to Note describes a newly developed SOE risk assessment tool to help country authorities and IMF country teams. The analysis can provide inputs for annual budgets and medium-term fiscal planning. This includes providing estimates of possible transfers to and from SOEs to the budget and possible financing needs. The note outlines the main steps and elements of the template to assess fiscal risks for governments from individual SOEs. The first step is to collect financial information on SOEs and their relation to the government budget, and to provide a benchmark against other SOEs in similar sectors. A second step is to do a forward-looking analysis based on baseline forecasts and stress scenarios, to identify and analyze possible risks and their impact on government accounts.

The note is structured as follows. Section II outlines linkages between SOEs and public accounts, both in terms of flows and stocks.1 Section III presents a first overview of the template. Section IV discusses benchmarking of SOE financial indicators. Section V discusses baseline and stress scenarios to provide a more in-depth analysis of fiscal risks. Annex 1 presents the structure of the template.

SOEs’ Link to Public Accounts

There are several links between SOE performance and public accounts, both in terms of flows and stocks. SOEs are government assets and, hence, part of its net worth. They generate a flow of net income to the government budget, the sign and size of which is ultimately driven by their performance and financing structure. Net income is mainly determined by taxes and dividends on the revenue side, and subsidies and transfers on the expenditure side. Government assets include loans to SOEs, which generate interest receipts. Government liabilities may be impacted if the government takes over SOE debt, which triggers interest payments on the expenditure side. All these assets and liabilities can be subject to valuation effects, which tend to be correlated with SOE performance.2 In terms of the consolidated public sector, SOE liabilities lower public net worth and can be a key driver of financial sustainability.

Table 1.

Direct Links to Government Accounts

article image
Note: Transfer of fixed assets is not listed but could be a nonfinancial flow to/from the budget. A positive (negative) sign denotes an increase (decrease) in financial worth. Liabilities considered in the table are only firm, but contingent liabilities may become firm as underlying risks materialize.

SOEs are a source of contingent liabilities for central or subnational governments. They can be explicit, when they are formalized by a legal contract or an explicit commitment, or implicit, when there is an expectation that the government may step in and help the firm even if there is no legal obligation.3 A debt guarantee granted to an SOE is a typical example of an explicit contingent liability. Sometimes explicit contingent liabilities directly assumed by SOEs (for instance, public-private partnership contracts) are also implicit contingent liabilities for the government.4

SOE financial distress can impact fiscal outcomes indirectly. Indirect effects operate through the linkages of SOEs with the rest of the economy. For example, when SOEs carry out a significant share of public investment and the latter slows down, multiplier effects may follow for the real economy, prices, and public revenues. If SOE distress impacts the public budget, its equity and loans may be repriced or written of because of negative expectations on the SOE’s financial performance. Lower net financial assets on SOE balance sheets affect public net worth and solvency negatively, and governments’ liabilities may also be higher if a part of SOE debt is assumed by the government.

Governance and financial and operational vulnerabilities of SOEs exacerbate fiscal risks and raise their potential fiscal costs. SOEs continuously experience external shocks of different size and length. These shocks can have a macroeconomic origin (for example, a slowdown in private consumption, with cross-cutting effects) or be market-specific (for example, the fall in the relative price of the product sold by the SOE). Fiscal impacts of these shocks are determined not only by their severity, but also by the ability of SOEs to weather them. In turn, the latter depends on the financial situation of SOEs, including their overall liquidity and solvency conditions, their exposure to international prices and exchange rate fluctuations, their market position, and their perceived capacity to generate future incomes and honor non-financial obligations.

Assessment and quantification of SOE fiscal risks are increasingly done by means of forward-looking analytical tools. SOE risk analysis can only be done based on standardized and comprehensive financial information, and medium-term business and financial plans. This information sheds light on financial vulnerabilities and the kind of shocks that can trigger the most significant consequences for government accounts. Analysis should ideally combine backward-looking and forward-looking elements, i.e., the current financial position of the company, market dynamics and, when available, data on past distress episodes, with scenario-design or sensitivity analysis.

The Template: Overview

The template builds on previous FAD work on fiscal risk assessment and quantification. Its primary reference is a previous template customized for the Indonesian authorities a decade ago (FAD, 2008), but also builds on further work developed in recent years, including as part of the Fiscal Stress Test methodology for the public sector.5

The template provides a framework to help assess fiscal risks from non-financial SOEs (Figure 1). It can be used for all SOEs, but, depending on capacity constraints, governments could focus on the ones that are larger or pose large risks. The template combines: (i) a benchmarking of the SOE’s financial indicators to assess the relative performance of the company and identify main vulnerabilities; and (ii) a forward-looking analysis of the impact of different scenarios on the SOE and public finances. There are two main scenarios illustrating shocks of different nature, size, and length: a baseline and a stress scenario. The template quantifies the financial performance of the SOE, projects its outstanding debt stock and its impact on public finances over a 6-year horizon. The results can help inform the approval of SOEs’ financial plans and risk mitigation measures around budget preparation. It can also provide inputs for public debt sustainability analysis and wider fiscal stress tests, such as those proposed by IMF (2017, 2018), to assess the resilience of the entire public sector to large shocks.6

Figure 1.
Figure 1.

Mechanics of the Fiscal Risk Template

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors.

The template provides significant flexibility. The commercial and operating structure of the company, its linkages with international markets, as well as its financial objectives and dividend policy can be tailored to the individual SOE. When the company operates in a regulated environment or has non-commercial mandates, quasi-fiscal activities can be embedded in the analysis through the sensitivity of sale prices to inflation. In addition, forecasting formulas could be adjusted to allow for expected one-offs or to incorporate other information based on an analysis of longer time series and past stress episodes.

The operationalization of a large set of projections requires some simplifications in the analysis:

  • To make the template manageable we abstract from details about the financial and technological structure of the company. For example, the company is assumed to issue only long-term debt in the projection period. Financing gaps can also be financed by incurring arrears, a possibility not contemplated in the current version of the template. From a technological perspective, multi-product SOEs are not considered (which may be relevant for holding companies) and staff downsizing is not an option to reduce costs.

  • Governance settings, not specifically analyzed, can be important for how well SOEs can weather shocks. Weak governance could be associated with higher fiscal risks. The template does not cover governance issues beyond the direct financial links.

  • The template does not assess indirect fiscal costs. Weak SOE performance could impact the economy. Spillover effects to the financial sector or other SOEs are not analyzed, but they may be relevant for systemically important companies. Nonetheless, these second-round effects can be better captured by fiscal stress test tools.

Inputs and Assumptions

The template’s assessment is based on SOEs’ standardized and comprehensive economic and financial information, as well as their medium-term business and financial plans. The following information is needed: (i) past SOE financial statements, essentially the Income Statement and the Balance Sheet; (ii) relevant medium-term macroeconomic and market-specific projections;7,8 (iii) a set of parametric assumptions regarding the influence of the macroeconomic environment on the SOE performance, its microeconomic fundamentals, and its relations with the public sector. It will be important to ensure that main assumptions and projections (for example, plans of the SOE) are credible and consistent.

Macroeconomic and market-specific projections and parametric assumptions provide the necessary elements for projecting SOE financials in the baseline and stress scenarios. There are several ways macroeconomic variables can affect SOE financials. Some are automatic (for instance, the value of FX-denominated debt in local currency depends on the exchange rate). Other links depend on sensitivity parameters, for instance the sensitivity of sales volume to real GDP growth. These parameters are defined by the user based on past data, sectoral studies, or information provided by the company. Using a range of values for these parameters can be useful, particularly if there is large uncertainty. Other parametric assumptions involved in the projections can often be drawn from financial statements of the company, such as the structure of revenues, costs and debt, and its business plan. The main elements of macroeconomic projections and parametric assumptions are shown in Table 2, which include those that are optional.9

Table 2.

Key Macroeconomic Projections and Parametric Assumptions

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The stress scenario is constructed by considering deviations in macroeconomic projections and changes in parameters relative to the baseline. By default, parametric assumptions in the stress scenario are the same as in the baseline but can be modified. For instance, the user can set a lower real GDP growth, or the share of imported inputs may be lower in the face of a sharp and protracted exchange rate depreciation. Dividend pay-out rates or effective tax rates can be different in the stress scenario, allowing for a stronger buildup of cash during recessions. The modifications of structural parameters across scenarios should be handled with care to facilitate the interpretation of results and their comparability.

Benchmarking

The first step of the analysis is to assess the relative performance of the SOE relative to its peers in other countries. Such comparison provides an initial diagnostic of the firm’s efficiency and potential risks. For example, if labor costs are significantly higher than in other SOEs in the sector, the SOE may be fulfilling employment goals for the government or reflect technical inefficiencies. SOE leverage that is significantly higher than that of peers may signal excessive risk taking or financially unsustainable operations.

The financial indicators used are grouped according to the following categories:

  • Profitability: For example, return on equity or assets provide an indication of whether government assets and likely future flows to the government (transfers or payments of dividends) are being used appropriately.

  • Capital structure: For example, leverage (the ratio of non-current liabilities to total assets) gauges the level of indebtedness of the SOE, the risk of financial distress, and the need for government support.

  • Liquidity: For example, the current ratio assesses cash needed by the SOE to cope with short-term obligations.

  • Operating efficiency: For example, revenues and costs per worker (operating revenue per employee or labor cost per operating revenue) assess how the resources of the SOE are used to earn profit.10

The template allows benchmarking of non-financial SOEs across different sectors. The information is based on the ORBIS database for about 22,000 SOEs around the world.11 Benchmarking can be done across approximately 80 sectors or sub-sectors and by income country group. The indicators are expressed as ratios to ensure comparability across firms. Indicators such as operating revenue per employee are expressed in millions of US dollars. The benchmarks are calculated as the median, top 75th and bottom 25th percentiles of the distribution for each indicator across all countries by sub-sector. This allows identification of the most typical value and the most ‘’extreme’’ values and comparison with the last year and the average (last 2-years) of the benchmarked SOE.

Performance across different indicators can vary significantly for each SOE. Figure 2 illustrates the case of an SOE in the electricity, gas, steam, and air conditioning supply sector. The different panels show that the company is relatively profitable (high ROA and ROE). While operating revenue per employee is above the 75th percentile, the firm appears inefficient given exceptionally high labor cost per operating revenue. Similarly, its liquidity—proxied by the current ratio—seems to be adequate, but the firm seems highly leveraged—proxied by the non-current liabilities to assets ratio—compared to other SOEs in the same sector. The high leverage and inefficiency could indicate vulnerabilities.

Figure 2.
Figure 2.

Benchmarking State-Owned Enterprises

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.

The benchmarking exercise indicates potential areas of risk, but further analysis may be needed to have a full assessment. Attention should be paid to the size of the sample of comparators, comparability of the countries involved, and cross-country regulation differences. Ongoing restructuring efforts or enhancements in governance should also be taken into consideration.

Forward-looking Analysis: Baseline and Stress Scenarios

Baseline

A second step is building a baseline scenario for the SOE’s financial indicators. The tool calculates a set of profitability, liquidity, solvency, and efficiency indicators for each projection year, as well as a breakdown of financial flows between the SOE and the budget and its contribution to net public worth. These are based on projections for the Income, Balance Sheet, and Cash Flows Statement over a 6-year period. These statements follow broadly an International Financial Reporting Standards (IFRS) structure, with a low degree of disaggregation compatible with available financial information in most countries.

Financial projections draw on past financial information, macroeconomic and market-specific projections, and parametric assumptions. In the template, macroeconomic developments affect SOE performance through parametric assumptions. For example, sales volumes are linked to domestic and international GDP, while prices are linked to domestic and international inflation and, for oil and gas companies, the oil price. Interest income and interest expense is linked to domestic and international interest rates. The rates for royalties and fees, corporate income tax, value added tax/sales tax rate and dividend payout ratio are set by the user. End of the year cash balances are determined considering targeted liquidity ratios. Any cash requirements that cannot be met through borrowing, because the solvency parameters (maximum leverage ratio) would be breached, are assumed to be provided by the government as a capital injection.12

The structure of the financial statements (Tables 3–5) are:

  • Income Statement (Table 3). Operating revenue primarily depends on sales, which are sensitive to domestic and foreign GDP growth, market-specific factors, inflation, and the exchange rate. Other operating revenue is linked to inflation. Operating expenses are determined by the sensitivity of personnel costs to inflation and staff recruitment plans, the elasticity of input demand to production, domestic and foreign prices of imported inputs and the exchange rate. Other operating expenses, mainly reflecting overhead costs, are linked to inflation. Non-operating income includes capital transfers from the government (endogenously determined), interest and dividend incomes on the previous year’s financial assets, and other non-operating revenues, linked both to inflation, realized capital gains, and, when applicable, receivable write-downs.

  • Cash Flow Statement (Table 4). Operating cash flows are obtained by adjusting operating profit by non-cash items (that is, depreciation and amortization and changes in receivables, payables, and inventories). Non-operating cash flows comprise the net cash inflows from investing activities and financing activities, principally net acquisition of assets, net borrowing, servicing of interest and distribution of dividends. The items related to changes in the stocks of financial and non-financial assets and liabilities are imported from the Balance Sheet, while property incomes are drawn from the Income Statement. Capital injections are recorded as a separate item, to clearly identify their contribution to final cash balances, and their determination is described below.

  • Balance sheet (Table 5). On the asset side, cash holdings reflect cash balances from the cash flow statement, and receivables and inventories are calculated as a ratio of sales, less receivable write-downs.13 Property, plant and equipment, and investment property take into account the investment plans of the company, adjusted by revaluation effects and, in the former case, by the depreciation of the capital stock as well. On the liability side, debt dynamics are governed by new borrowing and the debt amortization profile. Equity reflects retained after-tax profits and any capital increases. Payables are proxied as a stable ratio of purchases of goods and services, and benefit and retirement obligations grow in line with personal expenses. Other non-current assets and liabilities are assumed to be constant. Other comprehensive income captures non-realized revaluation effects on assets and liabilities. Financial projections are then mapped into Government Financial Statistics (GFS) data. The tool provides an accrual statement of operations in a simplified GFS format. This captures an operating balance, net transactions in non-financial assets, and the resulting net lending/borrowing of the company. Gross financing needs are also estimated, based on the net borrowing requirement and the financing needed, to meet the debt amortization schedule. Likewise, a GFS-type balance sheet is drawn from the balance sheet statement, and this allows the calculations of the SOE’s contribution to net financial worth and public net worth.

Table 3.

Simplified Representation of SOE Financial Statement: Income Statement

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Source: IMF staff
Table 4.

Cash Flow Statement

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Source: IMF Staff
Table 5.

Simplified Representation of SOE Financial Statement: Balance Sheet Statement

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Fiscal Risks and Financial Relations with the Government

A core element of the template is that it provides a baseline projection of the SOE’s contributions to the general government overall balance, as well as the impact on government debt and public sector net worth (Figure 3). The impact of SOE performance on the public sector financial position is estimated both with IFRS and GFS. As summarized in Table 1 previously, there are many possible links between the government and SOEs. The template estimates two key measures. One is an estimate of net budgetary inflows: the difference between taxes plus dividends plus interest payments from the SOE, and subsidies and transfers to the SOE. However, because SOEs can affect the balance sheet of the public sector through other ways (for example, changes in the size of assets or liabilities of the company), it also provides an estimate of the full contribution of the company to the public sector balance sheet (PSBS)—in particular, how the operations of the SOE affect the net worth of the entire public sector.14

Figure 3.
Figure 3.

Fiscal Flows and Stocks in the Template

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.

The projected impact on budget revenues is derived from the Income Statement and debt projections:

  • Corporate income and sales taxes and royalties and fees are calculated by applying tax rates to their respective tax base, i.e., pre-tax earnings in the first case, gross sales for sales tax and fees, and net sales minus production costs for royalties.15

  • Dividends are obtained by applying the exogenous payout ratio to after-tax profits (if positive).

  • Interest payments are estimated by applying an endogenous effective interest rate to the outstanding stock of government loans to the SOE.16

Budget outflows (or bailouts) to SOEs reflect subsidies or capital transfers:

  • Subsidies compensate for operating losses and are an expense for the government.

  • The government is assumed to use capital transfers or injections to address liquidity needs of the company that cannot be met through additional borrowing as it would breach the leverage threshold.17 For simplicity, it is assumed that capital transfers take the form of equity purchases and are fully disbursed in cash. Capital injections are recorded as transfers (and higher deficit) when they are not expected to have a reasonable rate of return (GFSM 2014).18 The user can enter any share of these injections that are to be recorded “above the line” (government spending) as part of the parametric assumptions.

If all or part of capital injections are expected to be remunerated at or above market rates, then they are reported as an increase of government’s financial assets.

The projected capital injections depend on liquidity and solvency thresholds. These thresholds should be set considering the ability of the firm to manage volatility and impact on the economy more generally. Users should specifically consider lowering the leverage cap and/or increasing the liquidity floor when: (i) the strategic importance of the SOE for the government is greater (for example, if a disruption in operations will affect poorer households or the economy); (ii) market access of the company during a financial distress episode is expected to be disrupted; (iii) the government’s capacity to monitor managerial performance and mitigate moral hazard is high; (iv) the government’s fiscal space to undertake deficit-generating transfers. The thresholds are defined in terms of the quick liquidity and debt to equity ratios, respectively.19 The end-year cash balances before new borrowing are then compared with the target balance implied by the quick ratio floor, resulting in a liquidity gap that can be filled either through new borrowing or capital injections.20 The company fills the liquidity gap by borrowing until the debt-to-equity cap is reached. When equity is negative, new borrowing is not allowed. Beyond the debt-to-equity ceiling, the residual liquidity gap is filled with capital injections.

It is worth noting that the template can also be applied to quantify the impact of a portfolio of SOEs on public accounts. The analysis for each individual SOE can be aggregated to assess their net fiscal inflows into the budget. This approach can be particularly useful when cross-subsidies across companies are substantial.

Main Outputs

The tool summarizes projections for a set of liquidity, solvency, and profitability indicators over the projection horizon. These projections are made for two cases: (i) use of capital injections by the government, if necessary, to meet the liquidity and solvency thresholds; and (ii) absence of capital injections, so that liquidity needs are exclusively filled by borrowing. The liquidity floor is always met in both examples, but the leverage cap may be breached in the second one. This counterfactual exercise provides an indication of the implications if the government does not provide financial support.

As an illustration, Table 6 shows projections of selected financial indicators for the same electricity SOE discussed above between 2018 and 2024, and in the absence of capital injections. The floor of the liquidity ratio is set at 0.6 in 2019. The company’s profitability would significantly decline in 2019, with the ROA being close to zero, mainly due to the reversal of exceptional profits in 2018.21 In addition, in 2019 the company’s debt amortization increases sharply. Tis, together with a lower operating cash flow, depletes its cash balances and causes an overdraft. Meeting the liquidity floor would require additional borrowing, as reflected by the jump in the debt-to-equity and the debt-to-GDP ratios. The quick ratio reaches the floor of 0.6. After 2019, profitability gradually improves and allows the debt-to-equity ratio to decline gradually. Assets to GDP also decline over time as well as liabilities, reflecting lower gross financing needs.

Table 6.

Selected SOEs’ Performance Indictors (excluding transfers)

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Sources: SOE annual report and authors’ calculations.

In this example, capital injections from the government will be needed. Given that the initial debt-to-equity ratio is higher than the leverage ceiling of 1.5, the liquidity gap in 2019 must be filled with capital injections. Under the baseline, government transfers are more than 0.3 percent of GDP in 2019 (Figure 4). These transfers raise the apparent profit-ability, and the net financial worth of the company becomes positive. Without transfers, the net contribution of the SOE to the budget in 2019 would have been positive due to indirect tax revenues. However, this would be at the cost of weaker profitability, liquidity and net financial worth of the firm. Despite the net flows to the budget turning positive in 2020, the contribution of the SOE to public net financial worth remains negative for the entire projection period, given relatively long debt amortization periods and the cost of debt service. From 2020 onward, liquidity needs can be met by additional borrowing without breaching the leverage cap. Public net worth would also be impacted negatively by the potential cost of the government providing capital injections, although this is not shown in the chart.

Figure 4.
Figure 4.

Fiscal Cost of Government Bailouts

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.

Stress Scenario

The next step is to use different stress scenarios to assess possible fiscal costs to the government. This could reflect temporary or permanent shocks to macro-economic, market, or company-specific variables. SOEs can also be affected by financial distress in other parts of the public sector (spillovers effect). The principal transmission channels through which these shocks operate are the following:

  • Negative shocks to real (domestic or foreign) GDP growth and inflation reduce gross sales.22 A negative shock to domestic inflation will reduce the value of sales, but also the expenditure on goods, services, and wages, for which the degree of indexation is entered by the user. The net effect will depend on the starting operating profit and the sensitivities of different line items to inflation. Similarly, the impact of oil prices will depend on whether the firm is an oil producer or not.23

  • Negative shocks on the indexation of sales prices to inflation can increase financing needs. These shocks can be induced by the government if regulated prices are only weakly indexed to inflation, while inflation is fully passed through onto the company’s costs. Alternatively, the shock can also reflect a reduction in the market power of the company, that manifests itself in lower mark-ups. Operating profits worsen, and in general this leads to higher financing needs and debt accumulation.

  • A negative shock to households and corporate liquidity can trigger a slowdown in payments by buyers. This shock increases the ratio of receivables to gross sales and can raise the rate of receivables at risk. As a result, cash flows deteriorate, and the liquidity gap widens.24 Note that this type of shock can capture relevant interlinkages between SOEs or between SOEs and private companies, as a result of which liquidity shortages in one spread quickly into others through an increase of doubtful receivables.

  • An exchange rate depreciation versus the USD generates several effects with net effect depending on the operations of the firm: (i) an increase in revenue of any foreign sale in local currency; (ii) higher import costs in local currency; (iii) an increase in the value of foreign-denominated assets and liabilities in local currency; (iv) an increase in the amount of interest and amortization payments of foreign-denominated debt; (v) for a given borrowing requirement in local currency, a reduction in the value in USD of any new foreign borrowing.

  • An increase in medium-and long-term interest rates, domestic or foreign, will raise the interest costs of debt issued in domestic currency. The more sensitive interest rates are to market conditions, the more the shock is transmitted to interest payments.

  • The financial viability of the SOE can also be affected by higher levels of taxation or dividend payout ratios. Higher tax and dividend payout ratios increase the amount payable by the SOE to the government, but this could be offset by higher government transfers if the SOE has larger liquidity needs that cannot be met through borrowing. Stress scenarios can be quantified for different tax and dividend policies, providing insight about their impact on the SOE’s vulnerabilities.

For the same electricity SOE, we present a stress scenario with a sharp economic slowdown caused by heightened turbulences in international financial markets. This entails a negative growth shock in 2019, which is gradually reversed by 2024. The exchange rate experiences a temporary 20 percent depreciation between 2019 and 2020, driving inflation upwards. Domestic and foreign interest rates also increase because of currency depreciation and a higher risk premium on corporate debt.

Profitability is severely impaired by the macroeconomic shocks (Figure 5). 90 percent of the SOE’s sales are in the domestic market, which is severely affected by the shock. Sales fall sharply in volume. Costs surge on the back of the sharp depreciation, which more than offsets the fall in oil prices. Additionally, the low indexation of regulated domestic prices to inflation impedes a substantial pass-through of costs into sales prices, which further squeezes profits. Moreover, higher interest rates push up the debt service. The delinquency rates of receivables jump during the shock, as liquidity-constrained clients incur arrears. All these factors turn profitability (return on assets) negative and hurt the SOE’s operating cash flow.

Figure 5.
Figure 5.

Selected Financial Indicators (Baseline and Stress Scenarios without Transfers)

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.

Lower profitability exacerbates the firm’s liquidity pressures and, absent capital injections, would raise leverage to unsustainable levels. Weaker net income translates into higher financing needs and larger liquidity gaps.25 Filling them by borrowing the full amount, coupled with a negative valuation effect of FX-denominated debt (50 percent of outstanding debt in 2019) would increase the debt-to-equity ratio to almost 4, possibly leading the firm to lose access to debt markets. Moreover, interest payments would go up, preventing the ROA to return to its baseline after the shock.

The contribution to the government’s budget becomes even more negative over a protracted period (Figures 6 and 7). Negative pre-tax profits mean the firm will not pay CIT until 2022, whereas lower sales tax payments reflect the fall in gross sales. There are no projected dividends until 2023 and they are smaller than in the baseline afterwards. Capital injections surge between 2019 and 2020, given that the starting high leverage ratio limits borrowing. The net present value of net inflows into the budget deteriorates from –0.1 percent to –0.3 percent of the pre-shock GDP (Figure 7), reflecting the increase in capital injections and a decrease in revenues.

Figure 6.
Figure 6.

Breakdown of the SOE’s Contribution to the Budget

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.
Figure 7.
Figure 7.

NPV of SOE Net Contribution to the Budget

Citation: IMF How To Notes 2021, 009; 10.5089/9781513591186.061.A001

Source: Authors’ calculations.
Cover IMF How To Notes
How to Assess Fiscal Risks from State-Owned Enterprises: Benchmarking and Stress Testing
Author: Ms. Anja Baum, Mr. Paulo A Medas, Alberto Soler, and Mouhamadou Sy
Volume/Issue:
Volume 2021: Issue 009
Publisher:
International Monetary Fund
ISBN:
9781513591698
ISSN:
2522-7912
Pages:
27
DOI:
https://doi.org/10.5089/9781513591186.061

Mechanics of the Fiscal Risk Template

Benchmarking State-Owned Enterprises

Fiscal Flows and Stocks in the Template

Fiscal Cost of Government Bailouts

Selected Financial Indicators (Baseline and Stress Scenarios without Transfers)

Breakdown of the SOE’s Contribution to the Budget

NPV of SOE Net Contribution to the Budget