State-owned enterprises and COVID-19: Policy principles

Part II. Policy principles on emergency state aid to SOEs, bailouts and nationalization

This blog is part two of a 2-part series on state-owned enterprises and COVID-19. 
^{Part I. Why governments support SOEs during the COVID-19 outbreak and what are the market implications?}

In response to COVID-19, many countries have opted to support SOEs across a variety of sectors to continue the delivery of essential goods and services. Additional public interest considerations—due to the significant level of employment, strategic assets involved, suspension of important or essential services—led to bailouts by governments or transfer of ownership from private shareholders to the public. 

Based on a sample of 482 COVID-19 related aid packages approved across five continents (as of July 2020), state aid totaled around US$7 trillion. About half of state aid schemes provide support for cross-cutting objectives to all types of firms . About 37 percent targeted micro-, small-and medium-sized enterprises (MSMEs), and 9.5 percent targeted large enterprises. Finally, 4.6 percent targeted support to SOEs. Close to half of the support aimed to help at least one sector, e.g. air transport, agriculture, health, and tourism (Subsidy and State Aid Tracker​).

^{Figure 1. Number of Subsidies and State Aid Schemes to MSMEs, large enterprises and SOEs}

State aid granted to SOEs has taken multiple forms. They include subsidized loans, capital increases, tax and fees deferral, direct grants, State guarantees to loans, deferral in the payment of concession fees (Subsidy and State Aid Tracker​).

Covid-19 effects have posed huge stress on many companies’ solvency, and some governments have offered bailouts of their major SOEs.  History has shown that recapitalizations and nationalizations can generate market inefficiencies. This is particularly the case when market considerations were not included in the government support measures meant to address emergency situations. An assessment of bank restructuring and recapitalization in 77 cases during the global financial crisis indicated a recovery of 40 out of 77 banks in the eurozone area. The most frequent form of financial assistance, in addition to guarantees, was recapitalization combined with restructuring and/or mergers. Nationalization and liquidation were applied mostly to small and medium-sized banks. Liquidation was less frequently used for large systemic banks, which may indicate that during the crisis the main approach was to bail out too big to fail banks.

Specifically, the European Commission required bail-in measures (capital shortfalls should be acquired from shareholders and subordinate debt holders first), a restructuring process, a capital raising plan demonstrating how profitable banks would be in the long term, and certain commitments before restoring to public recapitalization or asset protection measures. The Commission has been particularly demanding in cases where the financial assistance resulted in the nationalization of the entity.  

Principles for designing SOE support measures during crises

To ensure that resources are deployed swiftly during crises, state support should be designed with clear rules that make it transparent for both SOEs and private sector players.  Based on prior experience, below are some principles in designing emergency response measures related to SOEs.

1. SOEs that provide undisrupted public services or emergency assistance should be properly funded to carry out their mandates. The best practice to avoid soft budgeting seems to be creating separate budget for temporary and special public policy assignment, such as the polices in Sweden. This involves calculating financial return target for conventional operations so as to clarify the additional cost for Covid-19 response for reimbursement. Such support measures differ from the bailout in that they are targeted at budget gap to either avoid shutting down services or undertaking special tasks, whereas bailouts aim at ailing enterprises. It is also to for the Governments to require SOEs to publish financial statements and a list of all support given to various beneficiaries.
2. As public resources are scarce, governments need to consider if support to specific SOEs is the best use of limited resources. Governments should take this opportunity to review the economic rationale of the SOEs and whether support is not exclusively and unnecessarily granted to dominant SOE, especially in countries with a large SOE footprint. Support to SOEs with structural issues that were incurring in losses prior to the coronavirus outbreak should be limited to the minimum. Support should also involve commitments on measures to monitor and strengthen SOE corporate governance.
3. Governments should apply objective criteria for aid to minimize market distortions:
   • State aid should be designed and granted based on clear types of aid allowed and not only limited to SOEs in a certain sector, maximum amounts, and timeframes. For example, loans by state-owned financial institutions can be limited in their duration and size.  Subsidized loans can also imply minimum interest rates.  The risk taken by the State regarding the guarantees for loans can be capped to a certain percentage and a minimum premium can be designed.
   • Criteria for recapitalization measures should include (i) that the viability of the company would be at risk without State intervention; (ii) proof that were no other available measures to raise capital;  (iii) recapitalization measures are limited in time; (iv) an appropriate remuneration is established and (v) structural and/or behavioral commitments are adopted, notably in form of prohibition on misuse of financial support and engaging in aggressive commercial expansion.
4. Exit policies. Exit strategies are also important to avoid distorting the level-playing field by granting SOEs an undue advantage in the medium- and long term. It is not only about the exit of support measures, such as state equity participation as a result of bailout, as mostly used in high-income economies, but also about SOEs exiting the sectors where they previously expanded into during the crisis time to rescue employment.

The authors would like to thank Clara Alexandra Stinshoff, Ana Amador, Xiao’ou Zhu and Monica Paganini for their research inputs.