Peru - The management and sale of state owned enterprises

Report No. 4088&PE Peru: The Management and Sale of State-owned Enterprises August 27, 1982 FOR OFFICIAL USE ONLY Document of the World Bank / Intemational Finance Corporation This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without authorization of the institutions.  CURRENCY EQUIVALENTS Currency Unit = Sol (S/.) Annual Averages 1979 1980 1981 I ~~ US$1 = S/. 224.6 S/. 288.7 S/. 426.6 SV. 1,000 = US$ 4.45 US$ 3.46 US$ 2.34 FISCAL YEAR January 1 to December 31 GLOSSARY OF PRINCIPAL ABBREVIATIONS AEROPERU - Aerolinas del Peru (Peruvian Airlines) BCR - Banco Central de Reserva del Peru (Central Reserve Bank of Peru) BN - Banco de la Nacion (National Bank) CENTROMIN - Empresa Minera del Centro del Peru (Central Peruvian Mining Enterprise) CIAEF - Comision Interministerial de Asuntos Economicos y Financieros (Interministerial Commission on Economic and Financial Affairs) COFIDE, S.A. - Corporacion Financiera del Desarrollo, S.A. (Development Finance Corporation, Inc.) CONADE - Corporacion Nacional del Desarrollo (National Development Corporation) CPV - Corporacion Peruana de Vapores (Peruvian Shipping Company) DAASA - Deshidratadora de Alimentos de Arequipa (Arequipa Vegetable Freeze Drying Plant) ELECTROPERU - Empresa Electrica del Peru (Peruvian Electricity Enterprise) EMDEPALMA - Empresa para el Desarrollo y Explotacion de la Palma Aceitera (Palm Oil Development and Production Enterprise)  - - FOR OFFICIAL USE ONLY ENAFER - Empresa Nacional de Ferrocarrilles (National Railroad Enterprise) ENAPU - Empresa Nacional de Puertos (National Ports Enterprise) ENATA - Empresa Nacional del Tabaco (National Tobacco Enterprise) ENCI Empresa Nacional de Comercializacion de Insumos (National Input Marketing Enterprise) ENTELPERU - Empresa Nacional de Telecomunicaciones del Peru (Peruvian National Telecommunications Enterprise) FERTISA - Fertilizantes Sinteticos (Synthetic Fertilizers) HIERROPERU - Empresa Minera del Hierro del Peru (Peruvian Iron Mining Enterprise) ICSA - INVERSIONES COFIDE (COFIDE Investments) INP - Instituto Nacional de Planificacion (National Planning Institute) MEFC - Ministerio de Economia, Finanzas y Comercio (Ministry of Economy, Finance and Commerce) MINEROPERU - Empresa Minera del Peru (Peruvian Mining Enterprise) MINPECO - Empresa de Comercializacion de Productos Mineros (Mining Products Marketing Enterprise) PEPESCA - Peruana de Pesca (Peruvian Fishing Enterprise) PESCAPERU - Empresa Nacional Pesquera del Peru (National Peruvian Fishing Enterprise) PETROPERU - Petroleos del Peru (Peruvian Petroleum Company) QUIMPAC - Quimica del Pacifico (Pacific Chemicals) SEDAPAL - Servicio de Agua Potable y Alcantarillado de Lima (Lima Water and Sewerage Service) SIDERPERU - Empresa Siderurgica del Peru (Peruvian Steel Company) TASA - Tractores Andinos (Andean Tractors) This document has a restricted distribution and may be used by recipients only in the performance of | their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - iii - This report is based on the findings of a joint World Bank/International Finance Corporation mission that visited Peru in November/December 1981. The mission was composed of: Mary M. Shirley (Chief of Mission) Joel Bergsman (Sale of Enterprises) Alfred Saulniers, Consultant (Public Enterprise Management) Frank Veneroso, Consultant (Sale of Enterprises) Sybile Lazar, Consultant (Research Assistant) The text and tables were typed by Miss Alexandra Blackhurst.  - iv - TABLE OF CONTENTS Page No. I. SUMMARY AND CONCLUSIONS ..................................... 1 Size, Structure and Importance of the Parastatal Sector ..... I Assessment of Performance ................................... 1 Main Problems of State-Owned Enterprises .................... 2 Recommendations for Improved Management ..................... 4 Other Measures .............................................. 4 The Sale of State-Owned Enterprises ......................... 5 Recommended Selling Strategy ................................ 6 II. SIZE, STRUCTURE AND IMPORTANCE OF THE PARASTATAL SECTOR ..... 9 Background .................................................. 9 Structure of Administration ................................. 10 Legal Framework ............................................. 11 Significance of the Parastatal Sector to the Economy ........ 12 State-Owned Enterprises and the Treasury .................... 13 III. ASSESSMENT OF THE PERFORMANCE OF STATE-OWNED ENTERPRISES.... 16 Overview .................................................... 16 Characteristics of the Sample ............................... 17 Performance ................................................. .20 Summary ..................................................... 30 Main Problems of State-Owned Enterprises .................... 30 Issues Related to State Control ............................. 31 Relations Between State-Owned Enterprises .................... 35 Problems of Firms ........................................... 36 IV. RECOMMENDATIONS FOR IMPROVED MANAGEMENT ..................... 39 Management by Objectives .................................... 39 Measures to Improve the Environment for Parastatal Enterprises 44 Measures to Improve the Operations of State-Owned Companies. 46 V. THE SALE OF STATE-OWNED ENTERPRISES ......................... 49 Objectives of the Government ................................ 49 Magnitude of the Sale ....................................... 50 Issues Related to the Sale .................................. 54 Recommendations for Selling Strategy ........................ 57 Mechanics of the Sale ....................................... 59 STATISTICAL APPENDIX ....................................... 62 ANNEX I (Effects of Inflation on Financial Accounts) ....... 74  v TABLES IN THE TEXT Page CHAPTER II: 1. State Owned Enterprises by Activity, November 1981 ............ 10 2. Current Savings of Nonfinancial Public Enterprises ............ 13 3. Public Enterprise Cost to the Treasury ........................ 14 4. Public Enterprise Debts Assumed by the Central Government..... 15 CHAPTER III: 5. Net Profits of Selected State-Owned Enterprises in 1979 and 1980 16 6. Sample of State-Owned Enterprises ............................. 18 7. Prices, Production Sales and Employment of a Sample of State- Owned Enterprises ........................................... 22 8. Profit Margins and Returns to Net Equity of a Sample of State- Owned Enterprises and Publicly-Traded Private Companies ..... 25 9. Returns to Assets of a Sample of State-Owned Enterprises and Publicly-Traded Private Companies .......................... 27 10. Comparison of Debt and Liquidity Ratios for Sample of State- Owned Enterprises and Publicly-Traded Private Companies..... 28 FIGURES IN THE TEXT 1. Management by Objectives System for State-Owned Enterprises.. 40 2. Hypothetical Example of a Management by Objectives System for a State-Owned Power Company ................................ 43 3. Strategic and Other Implications of Various Objectives for the Sale of State-Owned Enterprises ............................ 51  CHAPTER I - SUMMARY AND CONCLUSIONS 1. This report examines the present role of state-owned enterprises in Peru, assesses their performance and identifies key macro and micro problems that affect these companies. Based on this analysis it recommends policy measures to help improve the efficient operation of these enterprises. Finally, as requested by the Government, the report examines major issues related to the proposed sale or transfer of publicly-owned companies and recommends a strategy for divestiture. Size, Structure and Importance of the Parastatal Sector 2. The number of state-owned enteprises in Peru grew quickly and in an uncoordinated fashion after the military takeover in 1968. Some enterprises were created by the State, but most were acquired through nationalization or the takeover of bankrupt companies. Today there are about 140 state-owned enterprises in a wide variety of activities. They range in size and nature from the large public mines and petroleum company to supermarkets. The shares of these companies are administered through a complex, overlapping system. Their legal status and corporate structures vary widely as does their degree of autonomy. 3. State-owned enterprises are responsible for an estimated 20 percent of Peru's GDP. Parastatal companies dominate certain sectors of Peru's economy, notably the production of electricity, gas, water, fertilizers, iron and steel, pulp and paper, fish products, petroleum and cement, rail transport and telecommunications. They also control much of the country's mining, commerce and financial sectors. 4. The Central Government of Peru made transfers which averaged US$24 million a year for 1978-1980 to those (approximately 30) public enterprises which are considered part of the public budget. Most of the current transfers are subsidies for petroleum derivatives and essential foodstuffs marketed by public enterprises. If these consumer subsidies are excluded, the bulk of the cost of these companies to the Treasury is investment financing. The State supports this investment mainly through capital transfers but also by assuming the debts of some companies and foregoing dividends when firms reinvest their profits. Given the size of this investment burden to the Treasury, there is a clear need to assure that these resources are used for high priority projects. Assessment of Performance 5. Judging from the incomplete data available for 97 state-owned enterprises, as a whole these companies earned a profit that amounted to a 4 percent return on equity in 1980. 1/ Profits of public enterprises are generally difficult to evaluate, however, and there are also considerable problems with the accounts of Peru's state-owned companies. (For example, assets may not be correctly valued.) To better judge the performance of the parastatal companies, a more in-depth assessment was made of a smaller sample of 20 firms chosen to represent some of the most important state-owned companies. The sample includes 13 companies producing cement, paper, steel, 1/ Profits after depreciation of fixed assets are partially adjusted for inflation (60 percent in 1980). Full inflationary accounting could dramatically change these returns -- see Annex 1.  petroleum, copper and other minerals, fish products, freeze dried vegetables, tractors and petroleum and 7 service enterprises providing electricity, port services, telecommunications, air and water transport, water and sewerage and marketing services. All but one of the firms are wholly state-owned. 6. The firms in the sample appear to fall into two main categories: (a) companies, often nationalized, which were allowed to operate with considerable autonomy under private law, enjoyed continuity of management and did not receive transfers from the State; and (b) companies, often State creations, which were subject to extensive government interference in their structure and daily operations, had high turnover of managers and often received transfers. 7. In general the more autonomous firms in Group a earned higher profits and had lower debts and greater liquidity than the rest of the sample. At the same time, their production was expanding more slowly, probably reflecting the fact that their investment decisions were more attuned to market and financial constraints than to strategic, political or other considerations. In contrast some of the companies with the largest losses were expanding output. These companies undertook -- sometimes ill-advised -- investment programs, which were financed principally by debt. As a result, some of them show the highest debt:equity ratios. The less autonomous firms were also more likely to be used to pursue some social goal to the detriment of their financial performance. 8. The performance of the 20 state-owned companies in the sample was well below that of the average private firm. 2/ The 1980 return on assets of the sample, for example, was 0.4 percent compared to 10.1 percent for a sample of private manufacturing companies in Peru. Profits were sacrificed to social goals, such as subsidized prices, and eroded by costly government intervention. In addition, price controls and the monopoly position of these firms, plus a lack of incentives to maximize profits, contributed to a lower operating efficiency in these firms than in private companies. The more autonomous publicly-owned companies (Group a) did perform better than the sample as a whole, although still below private firms (6 percent return on assets in 1980). Group a firms also show debt:equity and liquidity ratios more on a par with private firms in Peru. Main Problems of State-Owned Enterprises 9. Based on its analysis of the sample companies, the mission identified three categories of problems that are especially significant for parastatal enterprises in Peru: (i) problems related to Central Government control; (ii) problems of relations between state-owned enterprises; and (iii) problems specific to the firm. The more autonomous companies have been able to escape some, but not all, of these problems. Some of these problems have been alleviated by measures adopted by the present Government in 1980 and 1981. 10. Central Government Control. In the past publicly-owned companies faced multiple, unrealistic and often poorly defined goals. Demands on firms were not coordinated with other state actions and companies were not given the resources to fulfill their objectives. A confusing and uncoordinated 2/ The sample's performance was also below that of the larger group of 97 parastatal companies (0.7 percent return to net worth versus 4 percent), probably reflecting the fact that the larger sample includes more mixed companies whose performance was superior to wholly state-owned firms in 1980.  - 3 - system of ex ante and ex post control resulted in conflicting signals, delays and excessive interference in enterprises' operations, yet afforded the Government little effective control over results. In addition, certain laws, notably the law governing procurement, may hamper operations. 3/ The Controller General's office may have added to the problem by applying criminal penalties for poor business practices and undertaking lengthy investigations of complaints. Managers complained that this has led to an atmosphere of suspicion resulting in timid management and overextended reviews of decisions. 11. In the past, price controls hampered efficient management; the Government often delayed price increases for political reasons or was late in paying subsidies. This problem has been much reduced by the recent elimination of many price controls. Past efforts to control public foreign indebtedness created a bureaucratic bottleneck that could seriously delay investment projects, yet did not succeed in rationing borrowing or channelling foreign credits to the best uses. New procedures for approval of foreign borrowing have enhanced State control but can continue to cause needless delays. 12. Relations Between Publicly-Owned Corporations. The relations between state-owned enterprises in Peru can create problems. Enterprises are often forced to subsidize other publicly-owned companies by charging lower rates or buying their output at artificially high prices. The result is a complex system of hidden subsidies which distorts the performance of the enterprise. Furthermore, the costs of these cross-subsidies cannot be weighed against their benefits. Late payments of bills by other public enterprises and the Central Government are common and also distort performance. 13. Forcing publicly-owned companies to use public monopolies (such as the insurance company or shipping line) can also be costly for these firms. Managers in particular complained about being required to use the Banco de la Nacion (BN). The BN pays no interest on deposits, will not conduct operations by telephone or telex and does not have sufficient branches or liquidity to handle the demands of the larger parastatal firms. 14. Problems of Firms. A major problem of some of the state-owned firms has been the high turnover of their boards of directors and, even more importantly, of their top managers. In addition, the less autonomous firms lack sufficient skills in some key areas, specifically: financial management, marketing, corporate planning, in particular, planning and evaluation of investments, and project preparation. Production problems also arise in some firms because their operations are unbalanced or excessively complex. Having to manage unrelated subsidiaries further complicates things for Peru's public executives. Many publicly-owned firms may also have excess unskilled staff, which are almost impossible to fire under Peruvian law. In addition, because of the way the parastatal sector grew with reorganizations and mergers, employees of the same firm may fall under different labor laws. The lack of uniform norms for salaries, vacations or pensions creates a large personnel management burden for these companies. 3/ The bidding law requires all government agencies and majority-owned enterprises to follow a lengthy and cumbersome procedure for relatively small purchases. Under its provisions the bid with the lowest evaluated cost cannot be selected.  -4- Recommendations for Improved Management 15. Management by Objectives. There are about 70 state-owned enterprises which seem likely to remain under public management for some time, assuming the Government retains traditionally public utilities, most of the public financial institutions, and enterprises in strategic sectors or the commanding heights of the economy. The Government of Peru has begun to implement measures to improve the management of these enterprises by increasing their autonomy. Increased autonomy can be combined with more effective State control by means of a system of management by objectives. 16. Recent legislation (Law 216, mid-1981) created a structure for controlling the parastatal sector that could form the framework for a management by objectives system. The cabinet-level Interministerial Commission for Economic and Financial Affairs (CIAEF), which has been made responsible for coordinating Government planning and action in the state-owned sector, could oversee the management system. The Corporacion Nacional de Desarrollo (CONADE) has been designated by law the general agency in charge of the parastatal sector. As such, it would seem the appropriate entity to develop general objectives for the sector and coordinate the ministries, the enterprises and INVERSIONES COFIDE (ICSA, the public holding company) in negotiating specific objectives for each state-owned enterprise in line with the general and sectoral goals. If CONADE is to play this role it -- and ICSA -- would have to be strengthened. 17. Each enterprise's obJectives would be quantified as performance goals that the enterprise's management pledges to achieve. Enterprises would be compensated for the costs of pursuing non-commerical objectives. Management would be held accountable for results with allowance made for aspects that they cannot affect, such as the condition of capital stock. An appropriate system of incentives would be designed to reward managers for their achievements. Also, an information system to monitor results would have to be created. Such a system could be housed in ICSA and ICSA would prepare a yearly report on the results, which, after discussion with the ministries and enterprises, wou d be finalized by CONADE and presented to CIAEF. The management by objectives system assumes that enterprises would be granted sufficient autonomy to operate more independently and be evaluated on results. Other Measures 18. For this system to function effectively, many problems mentioned earlier would have to be resolved. Enterprises which already operate with considerable autonomy can probably adapt most easily to this system. The less autonomous enterprises will require more assistance. 19. Some of the measures that would improve the success of this management system are: A. Improve the Environment of Parastatal Enterprises by: (1) Reforming the legal framework for parastatal companies and in particular revising the bidding law to allow these firms to follow more cost effective procurement procedures;  (2) Curbing any excessive interference by the Controller and allowing firms to select their own external auditors; (3) Streamlining the debt control procedures and involving COFIDE, S.A. at an early stage of project preparation to avoid excessive delays; (4) Requiring state-owned enterprises to pay a portion of their profits as dividends -- except as justified by their investment programs -- to control better the allocation of resources and the growth of the public sector (this measure should be combined with profit sharing to offset any disincentive to earn profits); (5) Strengthening competition and improving the commercial environment by further reducing tariffs (the Government plans to lower tariffs to an average of 25 percent by 1984), eliminating price controls and public monopolies, reducing state control of certain sectors of the economy and eliminating cross-subsidies and late payments; and B. Improve the Operations of State-Owned Firms by: (6) Strengthening the enterprises' ability to do long- and short-range corporate planning and in particular to evaluate and prepare new investment projects; (7) Reducing the high turnover of managers and directors by raising salaries, developing a career service and lengthening the terms for boards; (8) Studying the capital structure of the enterprises to determine which firms are severely undercapitalized and how this can be alleviated; and (9) Providing state-owned enterprises with technical assistance as needed including comprehensive management advice on reorganization. The Sale of State-Owned Enterprises 20. The Government of Peru plans to sell or otherwise transfer a number of state-owned enterprises over the next three years. A number of reasons were given for the divestiture, including reducing the burden on government officials, improving the efficiency of resource allocation, injecting new capital in these companies and rationalizing the role of government in the economy. In order to design an appropriate strategy for the sale, the Government will be defining its objectives and determining what it seeks in the way of price, timing and terms. There are a number of issues related to a sale of this size that must also be considered in formulating a sales strategy. 21. Although the Government has not specified what equity it will divest, the mission compiled an unofficial list of about 70 likely candidates for sale. Partial financial data are available for only 50 of these firms. Using both discounted book value and earnings capitalization approaches and adding estimates of the value of firms and other assets for which there are no data, the mission estimates the fair market value of the sale to be around  - 6 - US$400-600 million. 4/ To develop a strategy for a sale of this magnitude it is important to consider potential market and political constraints as well as possible economic and social costs. 22. Market Constraints. The combined value of the state equity for sale represents about 2-3 percent of Peru's GDP and about one fourth of the stock of private domestic quasi-money. It could require a sizeable ch,ange in portfolio preferences of private financial holdings in Peru to absorb anasset transfer of this magnitude. The experience of other countries is that portfoilo preferences change only slowly. Existing preferences, therefore, constitute a constraint which should not be underestimated. 23. The constraint on the domestic market may be overcome by selling some shares to foreign investors. The Andean Pact, however, prohibits selling to investors outside the Andean Group. Further, foreign buyers may be wary of purchasing previously nationalized firms. 24. Political Constraints. The controversy surrounding the sale may also constrain the Government's scope for action. Not any price or terms would be acceptable politically. It might also be politically difficult to sell large blocks of shares to a few wealthy groups or to foreigners. 25. Economic and Social Costs. Depending on how it is conducted, the sale could also entail some economic and social costs. The sale of a large volume of existing assets for cash could sate demand for new equities and thus reduce new productive investment in Peru to the detriment of future growth. Similarly, foreign investors may buy an existing asset from the State rather than make new investments in Peru. This might limit Peru's access to new technology and foreign markets that often accompanies foreign direct investment. 26. If the enterprises were sold at low prices or on generous terms to the small number of Peruvian business groups, it could increase ownership concentration. Such a sale could create monopolies and ologopolies or strong links between financial institutions and industries that could have adverse effects on the allocation of resources, hampering government's efforts to strengthen competition. If the sale prices are low and the returns high, income distribution could become more skewed. Recommended Selling Strategy 27. Strategy. Selling the smaller and/or less profitable companies first could be the best strategy given the constraints on the Government and the costs that might be associated with the sale. Loss-making companies could probably be sold at a deep discount without strong political opposition and their sale would reduce the fiscal and human resource drain on the State. The sale of these firms at a low price and of smaller firms is not likely to depress new investment or contribute to the creation of monopolies. 4/ According to a recent draft law, the State would sell its equity in 62 enterprises. This excludes companies and assets included in the mission estimates valued at about US$250 million. On this basis INVERSIONES COFIDE estimates the value of this sale to be only about US$200 million, which would also imply a greater discount than that used by the mission.  - 7 - 28. This strategy would allow the Government time to build channels to sell or transfer part of the firms, particularly the larger, profitable companies, to a larger number of Peruvians. Given some time, institutions, such as pension funds or social security schemes, could be developed to tap additional sources of savings to purchase shares of publicly-owned companies. In addition, ICSA could organize a campaign to market shares to small savers. In this way the Government could sell the better caliber companies at more generous terms without strong political opposition and also reduce the risk of increasing the concentration of assets or curbing new productive investment. 29. Classifying the Companies. The sale candidates can be grouped according to different suggested sales strategies: (1) Not Economically Viable. Some companies should probably be liquidated and the assets sold off separately; (2) Economically Viable with Restructuring. Companies with serious but solvable problems might best be sold at generous terms or leased to entrepreneurs who would reorganize them for a share of the profit. It would probably be too large a drain on the public sector's scarce managerial resources to reorganize such firms prior to sale; (3) Immature Projects. New and not fully developed projects should be allowed to mature and be sold later when they command a higher price; (4) Medium- and Small-Companies in Fairly Good Financial Shape. Many of the smaller, profitable firms can probably be sold quickly through private placement; and (5) Large, Profitable Enterprises. Part of the shares in the larger profitable companies, which represent the bulk of the market value of the sale, could be sold to a wider group of investors. In addition, some of these larger enterprises might lend themselves to subdivision into smaller companies which could be more easily sold, or the Government might sell portions of the shares in the company gradually, according to the absorptive capacity of the market. 30. Mechanics for Sale. According to this proposed strategy the state-owned enterprises would be sold both through private placement to large business groups and through savings schemes and ICSA to a large number of small investors. Private placement would mean negotiating with prospective buyers followed by an auction. This would require a sophisticated financial, engineering and marketing analysis, probably by a group of outside experts. Establishing prices and terms for each sale would involve complex and difficult negotiations. ICSA, which has been designated to manage the divestiture, will need to expand and strengthen its own staff and also to receive assistance from outside experts such as foreign investment banks and domestic banks or law firms. 31. Selling shares to a broader base of investors would require some institution-building. In most developed countries, the bulk of all long-term financial assets are held by contractual savings institutions. Similar channels could be created in Peru, possibly through forced savings institutions such as social security funds. For this arrangement to be successful the funds should be decentralized and operate like a private  - 8 - market with full ability to change the composition of their portfolio. To give these institutions that sort of flexibility, a small part of the shares of the companies transferred to the savings funds could also be sold eventually on the local stock exchange. The existing securities market is presently too small to function as a secondary market for these shares. It would have to expand gradually by a modest amount as the savings institutions develop. The experience of other countries indicates that the market could grow sufficiently to absorb the limited amount of shares needed for this scheme some institution building, a proper regulatory framework and some strictly limited fiscal incentives. 32. ICSA could also underwrite the sale of the shares it owns and organize a selling group to campaign actively to reach smaller savers. In addition, ICSA could trade actively to help develop a secondary market for the shares. Although this strategy will require some time and institution-building efforts, it would reduce the risks of asset concentration, stimulate savings and encourage the growth of capital markets in Peru.  - 9 - CHAPTER II - SIZE, STRUCTURE AND IMPORTANCE OF THE PARASTATAL SECTOR Background 33. The number of state-owned enterprises in Peru increased dramatically after the military takeover in 1968. That year there were 40 state-owned enterprises. This number grew to a high of about 175 and was subsequently reduced to about 142 today. 1/ Close to 100 of these 142 enterprises are wholly or almost wholly state-owned (over 90 percent of shares pertain to the State) and the Government controls over 50 percent of the shares of another 17. 34. The expansion of the parastatal sector was largely uncoordinated and unplanned, often without clear objectives. Some of the companies were created by the State, but most were acquired through nationalization or the takeover of bankrupt firms. During 1968-75 most large foreign companies were nationalized and the State also expropriated private firms operating in designated strategic sectors (such as fishing, paper, cement, fertilizer, chemicals). In addition, the Government acquired title to shares of other, often unrelated, companies that were held by the intervened firms. Through nationalization and takeover of bankrupt companies and banks, the Peruvian Government became owner or part-owner of a wide variety of companies, including movie houses, supermarkets, a tractor assembly plant, a nylon producer, a plywood factory. As a result, the activities of these enterprises run the gamut from the traditional public services, such as electricity, water or transport, to mining, banking, marketing and manufacturing (see Table II.1). There are state-owned enterprises in virtually every sector of the economy, including some of the largest Peruvian firms and some of the smallest. 35. The present Government, which took office on July 28, 1980, has announced its intention to reduce the number of state-owned companies by selling or transferring all or part of its shares, and to improve the management of parastatal enterprises by reorganizing the parastatal sector and reducing direct State interference in operations. Thus far the approach to these goals has been rather disjointed. The 1979 Constitution confirms a commitment to economic pluralism, free private initiative and a market economy and calls on the State to act to promote economic development, provide basic services and protect national security. A special commission of leading private and public officials, meeting in mid-1981 to study Peru's state-owned enterprises, reached the conclusion that the State should principally act to promote the private sector, limiting its direct involvement in the economy to priority areas where, because of size, risk or low private (versus social) returns, the private sector will not act. Beyond these broad guidelines, however, there is still much to be done toward establishing a coherent approach to the parastatal sector. The administrative and legal framework for state-owned companies, described below, illustrate the need for a more systematic treatment of the parastatal firms. 1/ A complete inventory was not available to the mission. The report of the Multisectoral Commission on Public Enterprises (August 1981) found about 140 enterprises but there are some state-owned enterprises that apparently were not counted.  - 10 - Table II.1: PERU - STATE-OWNED ENTERPRISES BY ACTIVITY, NOVEMBER 1981 (Number of Enterprises) % State Ownership Activity Total 90-100 50-90 20-50 20 1. Production Agriculture, Agro-Industry & Wood 11 7 1 - 3 Fishing & Fishmeal 8 5 2 - 1 Mining 17 11 3 2 1 Oil & Gas 2 1 1 - - Paper 4 4 - - - Cement 5 2 - 3 - Chemical 4 4 - - - Steel, Metalwork & Related 11 2 4 2 3 Other Manufacturing 4 1 - 2 1 2. Finance Banking & Investment 29 19 3 - 7 Insurance 2 2 - - - 3. Other Services Marketing & Related Services 7 7 - - - Electricity 8 8 - - - Water & Sewerage 4 4 - - - Transportation 6 6 - - - Communications 7 5 - 1 1 4. Misc. (incl. Military Companies) 13 8 3 1 1 TOTAL 142 96 17 11 18 Source: Table 1 of the Statistical Appendix Structure of Administration 36. The system for administering the shares of the enterprises is complex and confusing (see Table 2 of the Statistical Appendix). 2/ The shares of 46 companies are held directly by a ministry, which means the ministry appoints the shareholders' board and may appoint or approve some or all of the board of directors. The shares of the remaining companies are held by other public enterprises, such as the National Development Corporation, CONADE (Corporacion Nacional de Desarrollo), or the Banco de la Nacion. With some exceptions, the enterprises run directly by a ministry have had far less autonomy than those run indirectly. 2/ The system is also changing rapidly and some of the information in Table 2 of the Statistical Appendix may already be out of date.  - 11 - 37. Recent legislation (mid-1981) gives CONADE "custody" of all state shares but responsibility for appointing boards remains with the shareholding entity. The Government is now considering streamlining ownership by transferring all State shares to INVERSIONES COFIDE, a subsidiary of CONADE. CONADE consists of a board of directors and a manager with a small staff whose main function has been to administer its two subsidiaries: COFIDE, S.A. and INVERSIONES COFIDE (ICSA). COFIDE, S.A. must approve and negotiate foreign borrowing by publicly-owned enterprises. ICSA will act as the holding company for the State's shares in 33 enterprises and is the entity designated to administer the sale of state-owned enterprises. Both COFIDE and ICSA have their own boards of directors appointed by CONADE. 38. More than one public entity may hold the shares of one company. For instance, ownership of public shares in the refrigerator manufacturer, Moraveco, is split between INVERSIONES COFIDE (46.6 percent), the Banco Internacional del Peru (39.1 percent), the steel company, SIDERPERU (4.0 percent) and other owners (10.3). Furthermore, shares of similar kinds of companies may be held by a number of different public entities. For example, there are mining companies under the auspices of COFIDE, the Ministry of Energy and Mines, public mining enterprises (MINEROPERU and CENTROMIN) and the mining bank (Banco Minero). Legal Framework 39. The legal framework for state-owned enterprises is especially confusing. Parastatal enterprises can be either under public or private law. The essential legal distinction between the two is that companies under public law can be transferred certain attributes of government sovereignty, such as the right to levy fines, issue regulations or exercise power of eminent domain. Enterprises under public law have their attributes defined by special public legislation, their budgets are part of the national budget and subject to a lengthy approval procedure and they cannot go bankrupt or be sold. Generally these enterprises are run by the ministries. Although circumstances vary, they usually need prior ministerial approval of their production and investment plans, large purchases, prices, salaries, and a number of other operating decisions. Their directors and managers often change whenever the minister does. Since the early 1970s, the bulk of public and mixed companies have operated under private law with the same legal status as private limited liability corporations. In mid-1981, 27 State enterprises under public law were converted into limited liability corporations under private corporate law. Only 15 public companies are now operating as "enterprises under public law" and they have also been given corporate form similar to private firms. 3/ 40. Ordinarily, State-owned enterprises under private law are subject to the same legislation as private corporations with some exceptions, such as foreign borrowing, choice of auditors and investment plans. In practice this usually means they can determine their corporate structure, they can set their salaries, draw up budgets and make most operational decisions subject to review by the board of directors. The 27 enterprises that were recently changed to corporations under private law, however, have their own legislation which in some cases strictly limits their autonomy and prohibits 3/ The enterprises still under public law are: CONADE, four water companies, five development banks and the Banco de la Nacion, the food marketing institute, the housing construction firm, the military industrial enterprise, the fishing quality control institute, and the agricultural marketing enterprise.  - 12 - their sale or liquidation. Further, the legal attributes of companies with apparently similar corporate status varies according to the State's position as shareholder. For example, the ministries or agencies acting as shareholders always appoint the stockholders' board and the board of directors is then appointed by the stockholders' board. If the enterprise has majority state ownership, the President of Peru must also approve the directors. The chairman of the board of 100 percent state-owned companies is appointed by the minister and approved by the President, the chairman of majority-owned companies is appointed by the stockholders' board and approved by the President. Only in minority state-owned companies is presidential approval not required. 41. The powers of the boards of directors and the stockholders' boards also vary from company to company. The principal power of most stockholders' boards is to appoint directors, but some have the attributes of a board of directors, and approve investment plans, budgets, new debts and the like. (This is the case, for example, with the fishing company, PESCAPERU.) Sigificance of the Parastatal Sector to the Economy 42. The number of Peruvian state-owned enterprises is not especially large by Latin American standards. Ecuador, for example, has over 100 public and mixed enterprises, Argentina has over 300, and the number in Brazil and Mexico exceeds 400. Unlike Peru, however, these countries count a considerable number of local and municipal bodies as public enterprises. The diversity of the parastatal sector in Peru is also less typical. 43. The state-owned enterprises play a major role in the economy. They are responsible for an an estimated 20 percent of GDP. The four largest companies in Peru are owned by the State (the petroleum company, PETROPERU; a mining firm, CENTROMIN; the steel plant, SIDERPERU; and a paper company, Paramonga) and their 1979 value added alone was 4 percent of GDP or 11 percent of mining and industrial value added. Public enterprises accounted for over half of all public investment and 18 percent of total fixed investment during 1975-1980. 4/ 44. State-owned enterprises dominate certain sectors of the economy. They control all production of electricity, gas, water, fertilizer, iron and steel, rail and telecommunications and dominate the fish processing industry, as well as the production of paper and cement. The public petroleum company purchases all oil production (four foreign petroleum companies are active in Peru) and controls domestic sales and exports. Government mines produce about 25 percent of copper output, and 40-50 percent of zinc, silver and lead. 45. State-owned companies also control much of Peru's commerce. Until recently mineral exports were dominated by a public marketing monopoly. Public marketing enterprises also import or purchase domestically and sell such basic foodstuffs as rice, wheat, corn, sugar, coffee, vegetable oil, and milk products. In 1980, for example, about 70 percent of all exports and 35 percent of consumer and raw material imports passed through the hands of 4/ Includes only enterprises treated as part of the public sector by the BCR. In this report these companies are termed public enterprises; state-owned or parastatal is used to refer to all companies with state participation.  - 13 - publicly-owned enterprises. Similarly, state banks and investment houses prevail in Peru's financial sector. In 1980 public financial institutions plus the Central Bank were responsible for three-fourths of all loans and two-thirds of all sight and savings deposits. State financial institutions do virtually all medium- and long-term lending in Peru. State-Owned Enterprises and the Treasury 46. An oft-heard argument for the sale of state-owned enterprises is that the companies represent a sizeable financial drain on the Treasury. The burden is usually overstated since it includes current transfers for subsidies for petroleumderivatives and essential foodstuffs marketed by state enterprises. If these sums are excluded from their fiscal accounts, the public enterprises show much larger current savings (see Table II.2). 5/ Table II.2: PERU - CURRENT SAVINGS OF NONFINANCIAL PUBLIC ENTERPRISES a! (Millions of Soles) 1976 1977 1978 1979 1980 b/ Current Savings of Nonfinancial Enterprises -2,510 143 12,595 43,101 -70,506 Current Transfers for Food and Petroleum Price Subsidies 17,634 57,029 61,312 155,761 94,074 ENCI & ECASA 7,145 20,592 4,695 57,431 94,074 PETROPERU 10,489 36,437 56,617 98,330 - Current Savings Excluding Cost of Price Subsidies 15,124 57,172 73,907 130,132 23,568 Tax Payments 4,925 6,872 54,471 130,600 244,700 Current Savings Excluding Taxes 20,049 64,044 128,378 260,732 268,268 a/ State-owned enterprises under public law. b/ Preliminary, excludes CENTROMIN. Source: Central Reserve Bank 47. Excluding the transfers for these price subsidies, most of the cost to the Treasury results from the enterprises' capital expenditures. From 1976-1980, current and capital transfers to enterprises plus interest on that part of the enterprises' foreign debt which was assumed by the Central Government (and excluding dividend payments to the Treasury) averaged 49 percent of the Central Government deficit and 7.5 percent of Central Government expenditures (see Table II.3). 5/ Fiscal accounts were constructed by the Central Reserve Bank of Peru for those enterprises which were under public law plus a few others (principally MINPECO and AEROPERU).  - 14 - Table II.3: PERU - PUBLIC ENTERPRISE COST TO THE TREASURY (Billions of Soles) 1976 1977 1978 1979 1980 A. Current Transfers a/ 4.8 2.2 5.0 0.8 5.7 B. Capital Transfers 15.4 11.5 14.0 32.4 84.5 b/ Nonfinancial 10.3 9.1 10.6 19.4 62.3 b/ Financial 5.1 2.4 3.4 13.0 22.2 C. Interest on Foreign Debts Assumed by Central Govt. 0.1 1.1 2.2 3.5 4.9 D. Dividend Payments to Treasury 0.6 0.3 0.3 0.1 0.1 Total (A+B+C minus D) 19.7 14.5 20.9 36.6 95.1 Central Govt. Deficit 50.0 79.1 84.9 25.1 143.4 Central Govt. Expenditures 160.3 233.2 348.7 577.3 1160.0 Total as % Central Government: Deficit 39.4% 18.3% 24.6% 145.8% 66.3% Expenditures 12.3% 6.2% 6.0% 6.3% 8.2% a/ Excludes transfers for petroleum and food price subsidies. b/ Includes S!. 23.6 billion in taxes which PETROPERU pays to the Treasury for its contractors and which was retained by PETROPERU in 1980. Source: Central Reserve Bank of Peru 48. The total cost to the Central Government of public enterprise investments is not just the expense to the Treasury, but also the dividend payments foregone when enterprises reinvest their profits. Despite a law requiring that 80 percent of anticipated profits (100 percent for financial institutions) be turned over to the Treasury, actual transfers are quite low. In 1980, for example, profitable enterprises with over 90 percent state participation earned net profits of S/. 62 billion while unprofitable companies had losses of S/. 27 billion. Total dividends to the Treasury, however, were only S/. 92 million. 6/ In addition, revenue is sacrificed when the Treasury capitalizes the taxes associated with public enterprise investment projects. COFIDE estimates that capitalized taxes will be S/. 24 billion in 1981. 6/ An additional S/. 294 million were paid in dividends to COFIDE by enterprises with over 90 percent state shares.  - 15 - 49. The Government also supports the enterprises' investment programs by guaranteeing their foreign credits and in some cases assuming their debts. As of June 30, 1980, the debt outstanding and disbursed of the directly administered public enterprises was US$1,918 million, all of it contracted with goverment guarantee (see Table 3 of the Statistical Appendix). This compares to a total outstanding and disbursed public foreign debt of US$6,203.6 million. These guarantees represent a potential drain on the Treasury which has become an actual cost in some cases. From 1976 to 1980 the Central Government assumed US$422 million of the foreign debt of the public enterprises. The 1980 service of the debt assumed by the Government was US$37.7 million. Table II.4: PERU - PUBLIC ENTERPRISE DEBTS ASSUMED BY THE CENTRAL GOVERNMENT, 1976-1980 a/ (US$ Thousands) Enterprise Debt ENATRU (Tourism Enterprise) 41,445.6 ENAFER (Railroads) 41,009.1 AEROPERU (Airline) 26,251.5 ELECTROPERU (Electricity Co.) 151,250.8 SIMA-PERU (Naval Industry) 20,758.9 ENCI (Agri. Prds. Marketing) 5,939.7 PETROPERU (Petroleum) 79,543.6 TOTAL 421,657.0 a/ Excludes credits for imports of food and hydrocarbons. Source: Central Reserve Bank 50. Controlling the fiscal drain of the state-owned enterprises clearly goes beyond the sale of enterprises or even the more profitable management of retained companies. Also at issue is whether the retained profits, capital transfers and foreign credits are being invested in high priority, profitable projects. Presently, only investments which require foreign credits are reviewed in any systematic way. The reinvestment of profits is virtually automatic. Efforts to improve the profitability of state-owned enterprises should be combined with measures to ensure that the major shareholder -- the State -- benefits from greater profits, either through dividend payments or by investing the profits in high priority projects (see Chapter IV).  - 16 - CHAPTER III - ASSESSMENT OF THE PERFORMANCE OF STATE-OWNED ENTERPRISES Overview 51. Financial data are available for 97 of the 142 parastatal enterprises for 1979 and 1980. Most of the information covers the larger companies with over 90 percent state ownership. These data show that, as a whole, the enterprises earned a profit. In 1980 close to 70 percent of these enterprises earned profits totaling US$239 million (see Table III.5). The remaining firms recorded losses of slightly more than US$100 million. 1/ The 97 enterprises thus earned a net profit of almost US$140 million in 1980. (Profits were $120 million in 1979 when six enterprises which were profitable in 1980 registered losses and nine of the 1980 loss-makers earned profits.) This yields a return to net worth of 3-4 percent, well below that earned by a sample of Peruvian private companies (see Table 1II.8). 52. In general, profits alone are an inadequate measure of the performance of public enterprises. In many countries state enterprises lose money because of price controls or government procurement, credit or personnel regulations. On the other hand, enterprises frequently hold lucrative monopolies or receive (sometimes hidden) subsidies. Since they often must meet a number of social goals, profit maximization may not be a very high priority objective. For the same reasons, there are usually few incentives for public managers to maximize profits or minimize costs. Table III.5: PERU - NET PROFITS OF SELECTED STATE-OWNED ENTERPRISES IN 1979 AND 1980 a/ (Millions of soles) 1979 1980 Profits (net of taxes) 54,520 64,367 Losses (net of taxes) 27,349 23,046 Net Profits 27,171 41,321 Less Current Transfers b/ 60 1,311 Net Position 27,111 40,010 Net Worth 632,783 1,273,620 Return to Net Worth (%) 4.3 3.1 Memo Item: Capital Transfers b/ 26,403 39,261 a/ 97 state-owned enterprises (includes depreciation of assets partially revalued for inflation). b/ Transfer data differ from data in Table II.3 because of differences irL coverage and definitions. In particular, current subsidies to ENCI arnd PETROPERU are excluded. Source: COFIDE 1/ Four enterprises account for two-thirds of the losses: two fish processing companies (PESCAPERU and PEPESCA), the Peruvian airline (AEROPERU) and MINEROPERU.  - 17 - 53. The situation is similar in Peru. Some state enterprises enjoy lucrative monopolies or captive markets, for example, the Banco de la Nacion, the Reinsurance Company, or, until recently, the Mineral Marketing Company (MINPECO). On the other hand, many of the companies were subject to price controls. Besides the rates for electricity, gas, water and transportation, the State set prices for many foodstuffs, petroleum, fertilizer, cement, and construction steel. In addition, the prices of producers operating in a sector where the State held a monopoly -- such as paper, chemicals or tractors -- were regulated by the government. As part of its liberalization progam the Government has lifted many of these controls and reduced tariffs to allow a more competitive market to signal prices. 54. Results can also be distorted by anomalies of the companies' accounting methods. For example, the telecommunications company, ENTEL, recorded a lossin 1980 because it was allowed to deduct 25 percent from gross operating income for an expansion fund. If that deduction had been corectly classified as a capital expense the company would have earned a profit. In contrast, the food dehydration company, DAASA, depreciated its assets at a rate of only 3 percent a year, substantially understating its true depreciation. Poor information and accounting systems in some parastatal enterprises also affect the financial accounts (see below). Furthermore, the failure to use full inflationary accounting distorts the accounts of public and private firms in Peru. 2/ 55. To get a clearer picture of the performance of state-owned companies, the mission analyzed a sample of enterprises. The mission interviewed the managers and collected production and financial data on 20 parastatal firms. In addition, the mission spoke with a number of government officials and persons from the private sector, including some of Peru's largest industrialists and financiers, as well as lawyers, accountants and stockbrokers. Based on this information the mission evaluated the performance of these companies and identified some of the key problems -- both internal and vis-a-vis the Government -- common to Peru's parastatal sector. Characteristics of the Sample 56. The sample covers thirteen production and seven service enterprises, including some of the largest companies in Peru (see Table III.6). The sample was chosen to represent some of the most important state-owned companies, excluding financial institutions. With the exception of the 2/ For example, plant and equipment are only partially adjusted for inflation; profits are after depreciation of these revalued assets. Since land and inventories are not revalued, net worth, operating costs and depreciation are understated. Monetary gains (purchasing power gains on net monetary assets) and holding gains (increases in the current value of inventory, plant, property and equipment in excess of inflation) are not computed. See Annex I.  - 18 - Table III.6: PERU - SAMPIE CF SrA=-OW E)N1ES State Nuaber of Net Equity Net Profit Budgeted Transfers frao Main Participation Eployees in 1980 in 1980 d/ the Central Covenment Name of Eiterprises Full Title Activities (%) 1980 (IlS$000) (IS$0) 1981 (in milnion soles) Produrtion Enterprises ClENlDS YUA* Canentos Yura S.A. CGent 100 320 37,021 ( 6,862) 700 CE2rR(llN PERU Empresa Minera del Centro del Peru MIning 100 16,905 241,870 69,411 DAASA Deshidratadora de Alintos de Food 100 99 1,280 ( 489) Arequipa S.A. Processing EMEPAIMA* Empnresa para el Desarrollo y Explor- Edible Oil 100 a/ 849 16,693 ( 2,002) tacicn de la Palm Aceitera S.A. FEEalSA* Fertilizantes Sinteticos S.A. Fertilizer 100 410 7,514 232 MINENIPEj Empresa Minera del Peru Mining 100 2,665 146,585 (22,833) 1,754 PARAMXE Sociedad Paramoga Ltda. S.A. Paper 100 c/ 3,702 153,040 8,438 PEPESCA* Peruans de Pesca S.A. Fishing 100 1,600 12,996 ( 7,041) 1,1% PESCAPJ Empresa Nacional Pesqtera del Peru Fishing 100 7,OXD 155,034 (17,489) PE1FIIJw Petroleos del Peru Oil Ccaawy 100 8,682 340,995 23,734 12,000 QJDeAC2 Qutuica del Pacifico S.A. Cheuical ODFlE 1OD 260 13,210 835 SIIERPER1 Empiresa Siderurgica del Peru Iron-Steel 100 4,809 163,169 ( 5,210) 225 TASA* Tractores Andinos S.A. Tractors 51.0 b/ 153 4,367 1,077 Service Enterprises AE.DPERL* Empresa de Transporte Aereo Airline 100 1,527 3,400 (12,106) 3,718 del Peru C(7 Corporacion Pertxa de Vapores Transport 1OD 1,588 33,200 10,ODO ZEC12)PERU EBresa Electrica del Peru Electricity 100 5,612 942,920 ( 5,300) 23,041 ENAWU Empresa Nacional de Prartos Ports 100 4,328 78,185 ( 2,116) EaEpresa Nacional de Mrketing 100 1,226 22,103 5,258 915 C'arcializacircn de Insuas ENIELPERI Empresa Nacional de Telecriunica- 100 7,093 45,917 ( 1,278) Telecomnnicaciones del Peru tions SEAPAL Servicio de Agua Potable y Water Supply 100 3,360 171,539 436 Alcantariliado de Lina * Possible andiidate for sale. a/ WFIDE 60(, HUI 40a. b/ ODFIDE 25.5%, QINlP 25.5%, Massey Fergusson 49% of shares. Ol WFIDE 98.1%, IIDUERU 1.08% of shares. d/ Figures in parenthesis indicate a loss. Source: DWIERSICNES ODFEs and mission estimntes  - 19 - tractor assembly plant, TASA, all the sample companies are over 90 percent state-owned. Eight of the firms are likely candidates for sale and a ninth, the Paramonga paper conglomerate, may also be sold. The Freeze Dried Food Company of Arequipa (DAASA) is presently shut down and will likely be liquidated. 57. Nine of the state-owned production companies were either nationalized firms or enterprises created out of several smaller, expropriated companies (such as MINEROPERU and PESCAPERU). Three companies were created by the State: Cementos Yura, DAASA and EMDEPALMA. 58. Interviews with the managers of these companies indicated that their degree of autonomy varied widely in the past. Seven of the firms were allowed to operate with much of the freedom of private companies: the four nationalized firms (the mining company, CENTROMIN, the chemical producer, QUIMPAC, the Paramonga paper conglomerate and the FERTISA fertilizer plant), two of the State created enterprises (the Arequipa cement plant, Cementos Yura, and the palm oil plantation, EMDEPALMA) and the mixed ownership company, TASA. 59. The nationalized firms have kept many of the same managers and procedures they had as private companies. They were able to pay salaries high enough to retain experienced staff. Most of them adjust their pay according to a published quarterly survey of industrial wages. Of course, these firms have experienced some degree of Government intervention beyond that of purely private companies. First, their boards of directors were appointed by the State and in some cases changed frequently. Second, the accounts of all majority state-owned enterprises are audited yearly by the Controller General's office, which also investigates complaints of irregularities. Third, they are also supposed to maintain their deposits in the Banco de la Nacion (interest free) and abide by the public procurement law, but some of the firms are ignoring these requirements. Finally, most of the companies also confronted government-controlled prices; many of these controls have since been removed. 60. The Government has also interfered more directly in the operations of some of these semi-autonomous companies. For example, since the end of 1978 Paramonga has been forced to run a money losing plant set up by the State to reach self-sufficiency in newsprint. The plant represents a large financial and managerial burden for Paramonga. It produces newspaper from bagasse using a new and complex technology. The plant is operating at about one-third capacity because of technological problems. It has also lost part of its market to imports because of the drop in tariffs and quality control problems. Further, the factory was set up with 90 percent debt financing and Paramonga has been forced to assume part of its debt service. The cost of this unprofitable plant has sharply reduced Paramonga's profits. 61. Notwithstanding such interventions, these companies operated more like private firms than the rest of the sample enterprises. Most of the other state production companies and service firms in the sample were less autonomous. All except ENCI (Basic Food and Material Inputs Marketing Enterprise) operated under public law until July 1981, when all but SEDAPAL (Lima Water and Sewerage Service) were transformed into limited liability  - 20 - corporations under private corporate law. These companies are, in fact, state creations, even when they were formed out of nationalized elements. In most cases, the impetus behind their creation was more political or social than commercial, and as a consequence even the commercial companies were not designed to be successful business ventures. DAASA, for example, was set up by the State to freeze-dry garlic for export in an area that consumes almost all of its fresh garlic production. No market study or adequate appraisal was done and the plant soon faced marketing as well as supply problems. Its production costs exceeded sales income and it is now shut down. Performance 62. The performance of the sample enterprises was assessed on the basis of several quantitative indices. Operating performance was judged according to trends in: (i) production volume; (ii) sales in constant prices; and (iii) labor productivity. Since prices have a major impact on results, individual price indices were calculated for each company. Financial performance was measured using: (iv) profit; (v) debt; and (vi) liquidity ratios. The financial data are distorted because of lax internal controls and poor information as well as deficient accounting practices. For these reasons, and because the controls affecting the enterprises differed greatly, cross-company comparisons must be treated cautiously and the indices taken as only a crude indication of performance. These indicators were complemented with evidence gathered from the interviews.3/ 63. The data show certain similarities between the production enterprises which operated with relatively greater autonomy compared to those operating with less autonomy. To facilitate comparison the production enterprises were divided in two groups: Group A contains enterprises subject to less interference than Group B. With the exception of two borderline cases (Cementos Yura and EMDEPALMA) that were founded by the State, the companies in Group A share certain characteristics: they were set up as private companies, they never operated under public law and hence were not directly under the Government's budgetary control, they have had the same managers for many years and they do not receive transfers from the State. The firms are on a continuum, however, and the distinction is not always clear. The service companies seem to fall generally in the less autonomous category but some of them (notably the State Shipping Company, CPV) operate with considerable independence. 64. Market Position and Prices. The performance of the sample enterprises was influenced by their operating environment. The market position of most of the firms and government price regulations reduced the pressures and incentives for efficiency. Only 5 of the 20 companies operated in something resembling a competitive market -- the 2 mining enterprises, DAASA, CPV and AEROPERU. Even their exposure to market forces was limited since the mining companies sold to a public minerals trading monopoly and Government agencies were required to use CPV and AEROPERU. Of the rest, ENCI has import monopolies for certain products; TASA until recently had a virtual tractor monopoly; the service companies are public monopolies; SIDERPERU controls steel imports and PETROPERU controls the domestic petroleum market. The other firms confronted competitors owned and operated by the State, or 3/ Ideally the enterprises should also have been judged on the achievement of their social objectives, especially since these social costs seriously affected financial performance. The social goals, however, were usually unclear, changing and difficult to quantify and information on results was not always available. t  - 21 - sold to State monopolies. Further, at one time most of the sample enterprises were subject to some form of government price regulation. The exceptions are the fishing companies and the mining firms, although again the latter had to sell to a government monopoly. Generally, prices were determined by negotiations between the enterprise and the ministry and were supposed to cover costs. Price increases were often delayed, however, and the enterprise had to absorb any losses resulting from inflation during the interium period. Furthermore, price hikes were often kept below cost increases for political reasons. 65. The situation has changed for many companies. Tariff reductions since 1978 have increased competitive pressures and the Government is in the process of removing most of the price controls and eliminating the monopolies of the State trading companies. This has the added advantage of reducing the need for government subsidies (see below). 66. Unit prices were calculated by dividing sales in soles by the volume of sales (Table III.7). The problems these firms have in covering costs is shown by the fact that the 1980 unit price indices for firms with regulated prices were usually below the wholesale price index and well below the WPI for imports. (In some cases, the unit price index may be rising faster than the rate increase authorized by the Government, since firms which receive part of their sales income in foreign currencies are allowed to reap the benefits of the devaluation of the sol.) Nevertheless, some of the enterprises, such as Fertisa, were able to earn profits notwithstanding low prices by keeping their costs down. 67. Expansion of Production. To determine how quickly production and sales were increasing, volume production indices were calculated and the net sales of the sample enterprises for 1976 to 1980 were deflated by each company's price index. Although these data and the production figures vary greatly from firm to firm, the more autonomous companies (Group A in Table III.7) generally show modest increases in output and sales. EMDEPALMA is growing quickly because it is a new plantation, not yet fully operative, while Paramonga's growth is partially due to the addition of the newsprint plant mentioned earlier. The largest expansion in real sales occurred in some of the least autonomous companies which are also usually the largest loss-makers (MINEROPERU, PEPESCA, ELECTROPERU, ENTEL and SEDAPAL).In some cases, the investment programs of the less autonomous enterprises were directly determined by the State. In other cases, the company pushed through a project over government opposition. Price controls insulated the companies' investment decisions from market signals. Much of this expansion was financed by debt since these companies generated little self-financing -- most show losses -- while government capital transfers were concentrated on the largest firms (MINEROPERU, PETROPERU and ELECTROPERU) and covered less than half of their investment.  - 22 - Table III.7: PERU - PRICES, PRODUCTION, SALES AND EMPLOYMENT OF A SAMPLE OF STATE-OWNED ENTERPRISES a/ Average Annual Increase 1976-1980 1980 Sales in Produc- Number 1980 Index of Price Constant tion of of Output Index 1976 Prices Volume Employees per Worker (1976=100) (Percentages) (1976=100) f/ Production Enterprises 0.8 A. CEMENTOS YURA 538 11.1 5.8 -0.9 128.6 CENTROMIN 1607 -7.4 1.8 1.5 101.2 EMDEPALMA 520 18.4 a/ 13.7 n.a. - FERTISA 473 13.5 b/ 2.7 0.2 112.8 PARAMONGA 789 6.2 9.6 n.a. - QUIMPAC 557 11.3 28.0 9.9 193.4 TASA 593 -1.5 2.4 9.2 85.5 B. DAASA 840 -12.7 -20.3 -5.4 47.2 MINEROPERU 834 27.0 19.0 1.4 189.4 PEPESCA 825 16.0 b/ 15.5 7.2 144.6 PESCAPERU 771 -16.2 -20.3 -25.9 106.7 PETROPERU 969 7.4 6.7 1.9 120.0 SIDERPERU 606 1.3 1.3 1.7 112.8 Service Enterprises 8.9 AEROPERU 779 3.1 7.2 e/ 2.6 119.4 CPV n.a. -4.9 c/ -3.0 c/ 2.1 99.7 ELECTROPERU 532 13.7 14.0 4.2 143.5 ENAPU 1134 -9.2 -7.0 3.1 84.7 ENTEL 508 19.2 8.6 d/ 16.4 75.0 SEDAPAL 595 14.5 2.8 5.9 88.8 MEMO ITEMS Wholesale Price Index 673 - For imports 804 Consumer Price Index 578 a/ Excludes ENCI. b/ 1977-1980. c/ 1976-1979. d/ No. telephones. e/ Passengers. f/ Index of production/index of employment. Source: Tables 4 and 5 of the Statistical Appendix  - 23 - 68. The more autonomous production firms of Group A were not facing any State mandated expansion program. Most chose to keep their indebtedness down and undertake only moderate, largely self-financed investments (see Table 6 of the Statistical Appendix). This may also reflect a cautious, sometimes overly cautious, attitude of boards of directors, which is explored in more detail below. In addition, the slow expansion of some of the former multinational companies may have been a consequence of a lack of skill in corporate planning. Policy formulation and corporate planning was usually centered in headquarters and the firms were left with limited in-house capacity in these areas after they were nationalized. 69. Productivity. Judging from the index of output per worker in Table III.7, labor productivity in two thirds of the sample enterprises has been improving. In the case of some firms, such as MINEROPERU or Cementos Yura, this reflects a large increase in capacity, while PESCAPERU's productivity increased thanks to the sale of its fishing fleet to the crews. In other cases, for example, FERTISA and QUIMPAC, there were no large expansion projects and rises in labor productivity apparently stemmed from improved operating efficiency. 70. Despite these improvements, the level of productivity in these firms may still be quite low. Many of the managers interviewed complained of excess staff. Since firing of workers is very difficult for public and private firms under Peruvian law, those publicly-owned enterprises which are especially vulnerable to political pressures for hiring could be overstaffed. Some random cross-country comparisons seem to bear this out. 4/ 71. One of these firms was more able to follow market signals and shows a different trend. CENTROMIN's real sales fell by an average of over 7 percent a year during the period, but it was able to keep profits up by shifting from product to product to adjust to varying market conditions. (Silver was responsible for 60 percent of its income in 1980 compared to 28 percent in 1976.) 4/ For example, Cementos Yura averaged 1.51 employees per thousand tons of cement during 1976-1980 compared to the 1974 average in Colombia of 1.4 and the 1972 OECD average of 0.55. SIDERPERU averaged 73 MT of steel per employee during 1977-1979 compared to 235 MT in U.S. plants and 200 MT in Japan in 1976. An Argentine company with similar total capacity as SIDERPERU but not an integrated producer (Acindar) averaged 79 MT per man year during 1974-76. (These examples must be treated carefully since firm circumstances may not be similar.)  - 24 - 72. Profits. The profitability of parastatal companies is much lower than their private counterparts (see Table III.8).5/ The ratio of profits to sales of state-owned enterprises averaged less than 3 percent during 1976-80, compared to 11 percent for private industrial companies. The profitability figures for the private firms are also much less volatile than those of the state-owned firms and show an increasing trend. The low profits of state-owned firms in part reflect the sacrifice of profits to social goals, such as subsidized prices or expanded employment, plus the imposition of government regulations which raise costs, and in part result from lower operating efficiency. Thus, profits were eroded by the failure to raise prices to cover costs and to pay subsidies promptly to cover artificially low prices or government-imposed costs. Government red tape and direct intervention in their operations also reduced profits. Paramonga's profits, for example, were sharply reduced by the imposition of the newsprint plant in November 1978, while AEROPERU is forced to operate unprofitable domestic routes. Furthermore, as mentioned, the expansion programs of firms were usually financed by debt. As a result, these companies must meet sizeable interest payments. Some also have idle capacity because of ill-advised expansions while other plants, such as the steel mill, are a suboptimal size. At the same time, price controls, their monopoly position, and the lack of incentives to earn profits or minimize costs, contributed to lower efficiency than their private counterparts. Many of the problems contributing to the lower profits of these firms are explored in more detail below. 5/ Care should be taken in pushing this comparison too far. It is based on the -- perhaps unrealistic -- assumption that Peruvian publicly-owned and private companies follow generally similar accounting practices, as they are required to do by law. Some of the extreme cases of poor accounting and control practices (PEPESCA or AEROPERU) are unlikely to be found in publicly-traded companies. On the other hand, the extent of the differences in performance is such that it cannot be attributed to differences in accounting alone. Further, the profits of the publicly-owned companies are overstated by the inclusion of current transfers as operating income. Private profits are more likely to be understated in an effort to avoid taxes. During this period some items produced by private firms were subject to government price controls (pharmaceuticals, for example) and also benefitted from high protective tariffs.  - 25 - Table III 8: PERU - PROFIT MARGINS AND RETURNS TO NET EQUITY OF SAMPLE OF STATE-OWNED ENTERPRISES AND PUBLICLY-TRADED PRIVATE COMPANIES 1/ Profit:Sales Profit:Net Equity 1976 1977 1978 1979 1980 1976 1977 1978 1979 1980 State-Owned Prod. Companies Neg. Neg 4.4 5.3 0.9 Neg. Neg. 7.0 10.8 1.6 A. CEMENTOS YURA 19.0 16.6 9.2 2.6 Neg. 9.3 4.6 2.9 0.1 Neg. CENTROMIN 3.6 6.5 12.1 14.4 9.5 8.6 12.8 23.7 33.8 24.2 EMDEPALMA Neg. Neg. Neg. Neg. Neg. Neg. Neg. Neg. Neg. Neg. QUIMPAC 6.0 7.8 8.7 9.5 8.0 3.3. 3.9 5.3 10.4 5.3 PARAMONGA 12.5 7.4 13.3 0.0 5.1 14.8 6.0 8.6 0.0 4.7 FERTISA - 9.5 13.4 0.5 2.2 12.8 12.2 22.3 0.7 3.6 TASA 1.0 Neg. 2.0 15.0 11.4 2.5 Neg. 4.8 30.4 20.9 B. DAASA 0.0 Neg. Neg. Neg. Neg. Neg. Neg. Neg. Neg. Neg. MINEROPERU - 7.3 Neg. Neg. Neg. - 1.0 Neg. Neg. Neg. PETROPERU 2.0 0.4 0.5 0.7 2.0 6.8 1.6 2.4 5.1 5.9 SIDERPERU Neg. Neg. 3.9 1.0 Neg. Neg. Neg. 3.8 1.1 Neg. PESCAPERU Neg. Neg. 12.5 7.5 Neg. Neg. Neg. 23.2 11.4. Neg. PEPESCA - Neg. Neg. Neg. Neg. - Neg. Neg. Neg. Neg. State-Owned Service Enterprises Neg. Neg. 7.2 7.6 Neg. Neg. Neg. 2.5 3.6 Neg. AEROPERU Neg. Neg. 0.0 Neg. Neg. Neg. Neg. 1.2 Neg. Neg. CPV 11.0 5.8 4.1 4.0 12.0 10.4 4.5 5.6 8.3 29.8 ELECTROPERU Neg. Neg. 28.0 21.4 Neg. Neg. Neg. 2.7 3.6 Neg. ENAPU Neg. 3.6 6.0 11.6 Neg. Neg. 1.1 1.9 4.3 Neg. ENCI 5.4 1.5 3.6 6.4 7.0 80.6 16.3 57.4 72.9 20.1 ENTEL 7.2 8.9 2.4 2.6 Neg. 9.0 9.0 2.9 3.6 Neg. SEDAPAL Neg. Neg. Neg. Neg. 1.6 - Neg. Neg. Neg. 0.0 Publicly-Traded Companies 2/ Industrial 9.7 9.6 11.4 11.2 11.5 15.6 12.2 14.4 14.7 16.1 Mining 8.5 12.8 18.1 21.7 13.4 11.0 13.6 20.6 31.6 13.6 1/ Includes current transfers. 2/ Approximately 36 industrial and 13 mining companies traded on the Lima Stock Exchange. Source: Financial statements of publicly-owned enterprises, Lima Stock Exchange and INVERSIONES COFIDE  - 26 - incentives to earn profits or minimize costs, contributed to lower efficiency than their private counterparts. Many of the problems contributing to the lower profits of these firms are explored in more detail below. 73. Among the state-owned production companies, the most consistent profit makers are the ones with the greatest autonomy (Group A in Table III.8). Two of this group recorded temporary losses in 1980. EMDEPALMA because it is not fully operative and Cementos Yura because electricity shortages force it to operate at half capacity.6/ Many of the other firms in this group are operating at close to full capacity and have programs to reduce costs through detailed weekly cost accounting and research and development. Even these enterprises earn below the average returns of private firms, however (see Table III.8). 74. The companies in Group B have had to function with frequent management changes, direct intervention in their operations, loss of staff because of low pay, as well as price controls and red tape. As mentioned, many of these firms have expanded rapidly and confront large interest payments and in some cases idle capacity as a result. Added to this, some confront serious operational imbalances or irregularities. (PEPESCA, for example, is trying to process sardines with equipment designed for tuna.) The less autonomous firms are also used more often to serve some social goal to the detriment of financial profits. These firms consistently earn low or no profits. 75. The profits of the service companies are also affected by extensive government intervention plus rates that generally have not kept pace with rising costs. Nevertheless, three of these, CPV, ENCI and the Telecommunications Enterprise, ENTEL, are consistent profitmakers. ENCI's profits result in part from Government subsidies which cover its losses on subsidized foodstuffs. The shipping line, CPV, operates in a more competitive environment than the other service enterprises, although under very favorable circumstances. All government agencies are supposed to ship on CPV but it can seldom meet this demand and it passes part of this business on to its competitors. Both ENTEL and CPV benefit from selling part of their services in international markets. These companies use their foreign exchange earnings to offset losses in domestic sales. 76. Returns to net worth vary more erratically, reflecting the fact that some public companies are highly leveraged. As a result the Government on occasions earns a much higher return than the private investor, although on average the profit:equity figures are lower. Increases in equity in most of these firms primarily result from the yearly revaluation of fixed assets fcr inflation and the occasional capitalization of their debts by the Central Government. 77. The ratio of profits to assets is similarly low (see Table 1II.9). Here again the Group A companies show a better performance than the rest of the parastatal companies in the sample, but below private companies. The overall return on the Government's investment in these companies has improved somewhat in recent years but is still well below the returns earned by private investors. 6/ Cementos Yura's expansion was designed to coincide with a planned expansion of Arequipa's electricity company, SEAL. SEAL, however, delayed part of its expansion program and also underestimated the growth in Arequipa's demand for electricity. Severe drought also contributed to the power shortage.  - 27 - Table III.9: PERU - RETURNS TO ASSETS OF A SAMPLE OF STATE-OWNED ENTERPRISES AND PUBLICLY-TRADED PRIVATE COMPANIES (Percentages) Profit:Total Assets 1976 1977 1978 1979 1980 State-Owned Enterprises -0.4 -0.3 1.4 2.4 0.4 Production -0.6 -0.4 1.3 2.6 0.5 Group A 4.5 4.5 6.7 6.7 5.9 Group B -1.5 -1.2 0.2 1.1 -3.0 Service 0.1 -0.0 1.6 1.8 0.2 Private Manufacturing 7.4 5.7 8.2 8.9 10.1 Mining 7.3 9.1 14.6 20.3 8.9 Source: Individual companies' financial statements, Lima Stock Exchange and INVERSIONES COFIDE 78. The performance of the publicly-owned corporations, like Peru's private companies, has been affected by recent changes in the Government's macroeconomic policy. Four of the sample enterprises have had their price controls lifted or will confront decontrolled prices in 1982 (Cementos Yura, TASA, Paramonga and QUIMPAC). In a number of cases, the Government traded the freedom to set prices for the elimination of import prohibitions and a drop in tariffs on competitive imports. The resulting reduction of tariffs exposed many of the production enterprises to greater competition from imports, with varying effects. For example, the prohibition of tractor imports was eliminated and the tariff reduced from 60 percent to 25 percent, the tariff on the imported tractor pack assembled by TASA fell from 10 to 5 percent and tractor prices were freed. TASA has successfully coped with this change so far by purchasing lower cost assembly packs from Brazil and exporting part of its output to Venezuela to take advantage of Peru's export subsidy. In another instance, Paramonga lost half of the local market for PVC when tariffs were dropped. Imported PVC is selling below Paramonga's costs and the firm is considering processing PVC into other products (such as plastic bags). 79. In the long run, if tariffs are lowered further, more of these firms may be unable to compete. The adaptability of the state-owned companies may be less than many private firms. State control has made for more rigid management and the Government's inability to invest new equity capital in these firms reduces their options.  - 28 - 80. Debt and Liquidity. In general public firms show higher indebtedness and lower liquidity ratios than private companies. Since their debt and income is often guaranteed by the State, they can affford to be less conservative than private firms which must show sound financial ratios in order to borrow. The situation is somewhat similar in Peru. On average the state-owned production companies in the sample are more heavily indebted than their private counterparts (see Table III.10). These figures are distorted, however, by the inclusion of PETROPERU's large debt. If PETROPERU were excluded, the State production firms' average debt:equity ratio would be 55:45 for 1976-1980, compared to 40:60 for private industrial companies. The service enterprises show a surprisingly low debt:equity ratio in part because the Treasury assumed a large part of ELECTROPERU's debt in 1978 and 1980 and AEROPERU's debt in 1977. The figures vary greatly from company to company and over time (see Table 6 of the Statistical Appendix). Some of the heaviest borrowers are large loss-makers, such as MINEROPERU, AEROPERU, and PEPESCA. Table III.10: PERU - COMPARISION OF DEBT AND LIQUIDITY RATIOS FOR A SAMPLE OF STATE-OWNED ENTERPRISES AND PUBLICLY-TRADED PRIVATE COMPANIES 1976 1977 1978 1979 1980 DEBT:EQUITY RATIO a/ Sample Enterprises Production 79:21 80:20 81:19 76:24 65:35 (excl. PETROPERU) (63:37) (61:39) (60:40) (51:59) (53.47) Service 55:45 50:50 33:67 35:65 27:73 Private Enterprises b/ Industrial 52:48 54:46 43:57 40:60 37:63 Mining 34:66 33:67 30:70 36:64 34:66 CURRENT RATIO c/ Sample Enterprises Production 0.9 0.9 0.9 1.0 1.0 Service 1.1 1.3 1.3 1.4 1.5 Private Enterprise Industrial 1.4 1.3 1.3 1.4 1.7 Mining 2.2 2.0 2.0 1.8 1.5 a/ Total liabilities/equity. b/ Publically-traded private companies. c/ Current assets/current liabilities. Source: Statistical Appendix Table 6  - 29 - 81. The decline in the debt:equity ratios reflects in part the Central Government assumptions of enterprises' debts. In addition, some companies -- for example, PESCAPERU -- sold fixed assets to reduce their debt. More importantly, the debt:equity ratio of both private and public companies has been steadily eroded by inflation. The exceptions are firms with primarily foreign debts, such as MINEROPERU, AEROPERU, CPV, ENTEL and ELECTROPERU. For a company like ELECTROPERU this foreign exposure represents a considerable exchange risk since its revenues are principally in soles. 82. The bulk of the debt of production enterprises is short-term, reflecting their large working capital needs. Long-term borrowing averaged only about 37 percent of their total liabilities.7/ The opposite is true of the service enterprises which have two-thirds of their liabilities in long-term debt. Some observers asserted to the mission that public enterprises use short-term debt to finance fixed equity investments. Since long-term borrowing is strictly controlled by COFIDE, S.A., some public companies may resort to short-term borrowing to avoid this control. Most short-term borrowing in soles is from the Banco de la Nacion which will roll over short-term credits automatically. This assertion requires more investigation. Nonetheless, it does not seem to be borne out by the sample data. Only two of the companies show a large real increase in their fixed assets coupled with an increase in short-term borrowing and, in particular, in bank overdrafts. 83. Many managers complained that their companies were undercapitalized, asserting that the State would burden them with debt rather than investing equity. Certainly some of the public enterprises have been saddled with heavy debts for sometimes ill-conceived investment projects. The most striking example is PEPESCA which borrowed to purchase a fishing fleet capable of handling a catch of 25,000 tons of tuna a year. The actual catch has never exceeded 4,000 tons a year because of lack of fish, technical problems with the boats and the fact that two of the ships were kits which have never been assembled. Tuna has never been plentiful in Peruvian waters and PEPESCA is now catching and processing sardines, although its equipment is not well adapted for this. In 1980 PEPESCA's sales totaled S/5.3 billion versus interest payments of S/. 3.8 billion; its debt:equity ratio was about 80:20. Other examples are MINEROPERU, which had a debt:equity ratio of about 70:30 in 1980 and AEROPERU, which had a debt:equity ratio of almost 90:10. Nevertheless, the State has capitalized some of the largest borrowers by occasionally assuming their debts. 84. Judging from the current ratio, the liquidity of the state-owned companies is improving, although still not on a par with private companies. 8/ The quick ratio (current assets excluding inventories/current 7/ The figures can be misleading, however. For example, the bulk of the short-term debt on PEPESCA's balance sheet is in fact long-term credits, which have fallen due and are being paid by the guarantors. provisions for bad debts. 8/ The current and quick ratios of public firms are not strictly comparable to those of private firms. Some public firms show subsidies owned by the Government as current assets. Also many appear to make inadequate provisions for bad debts.  - 30 - liabilities) is a more significant indicator of liquidity for companies which carry large inventories. Here too the state-owned production companies appear to be less liquid than private firms in Peru. The quick ratio for state-owned production companies was 0.52 in 1980 compared to 0.77 for traded private manufacturing firms. Service companies had a higher quick ratio of 1.0 in 1980. The service companies' current assets may be inflated by large accounts receivable. Their 1980 accounts receivable amounted to 77 days of sales compared to 43 for state-owned production firms in the sample. The service firms appear to have cronic collection problems (see below). Summary 85. The performances of the sample enterprises vary widely but there are certain similarities. The enterprises able to operate with more autonomy and in an atmosphere closer to a competitive market environment are generally profitable, with debt:equity ratios similar to private firms in Peru. With some exceptions the production of Group A companies grew at moderate rates or not at all over the 1976-1980 period. Generally, the companies used their retained earnings to finance replacement and moderate levels of net new investment and chose not to undertake more ambitious investment programs that would have had to be financed by debt. As a result the equipment and plants of many of these companies appeared to be outmoded and many faced pressing needs to diversify in order to adapt to Peru's changed economic conditions. 86. In contrast, most of the less autonomous companies are losing money or are marginally profitable. Their prices are regulated and, with some exceptions, have not kept pace with their costs. Some have undertaken major, sometimes ill-advised, investments and the firms which have generally confront high debt:equity ratios. Less autonomous firms are also more likely to be required to pursue costly social objectives. These companies are usually asset rich and management poor. 87. Both groups of state-owned companies appear to earn a lower return than their private counterparts. This results in part from the sacrifice of profits to social goals. It also reflects the lower operating efficiency in the parastatal sector stemming from costly government intervention and a lack of incentives to maximize profits. MAIN PROBLEMS OF STATE-OWNED ENTERPRISES 88. On the basis of this performance record and interviews with company managers and others, the mission analyzed some of the principal problems of the state-owned enterprises. These problems fall into three categories: (1) problems related to the Central Government and the control apparatus for public enterprises; (2) problems between public enterprises; and (3) firm-specific problems. 89. Judging from the sample enterprises, the problems of state-owned firms which have experienced low levels of government interference differ from those of companies subjected to extensive State involvement. Except for sporadic intervention, some companies have been able to function more like private firms. Such companies avoided some of the problems common to the other public enterprises since they were often set up by their former owners with sound administration procedures and have been free to adapt to the latest commercial practices.  - 31 - 90. Nevertheless, there are several ways in which the Government systematically encroached on the freedom of these companies: (1) through laws, such as the bidding law, applicable in theory to all state-owned enterprises; (2) through yearly audits and investigations by the Controller; (3) through foreign debt control; (4) through price controls (most of which are now being eliminated); and (5) by being forced to deal with other public enterprises. 91. Except for these areas, most of the discussion which follows concerns the problems of state-owned companies which have been subjected to extensive government involvement. The problems of such companies are of special interest since these are the firms the Government is most likely to retain under public management. Issues Related to State Control 92. There are a number of problems related to State efforts to control the enterprises stemming from the lack of clearly defined objectives, a multilayered apparatus for control and a confused system for monitoring performance, laws which may hamper efficient operations, sometimes excessive control by the Controller General, the administration of price controls and subsidies, and the system for debt control. 93. Lack of Clearly-Defined Objectives. There has been no system in Peru to develop general objectives for the parastatal sector, to assure that the demands made on the companies were reasonable and consistent, or to monitor their performance and evaluate the outcome. Most ministers simply incorporated the investment programs drawn up by the enterprises into a sectoral plan which was then aggregated into a national plan. Government objectives were usually imposed by direct intervention in operations. 94. All the parastatal enterprises have suffered from poorly defined objectives and priorities and the lack of a coordinated approach to the state-owned sector. It appears that in the case of many of the commercial enterprises, the Government's aim was simply to own shares in certain key sectors or to prevent bankruptcies, and not to use the firms to pursue some social goal or to transfer resources to the Treasury. On occasion, however, the State did use these firms for some social purpose, usually in an unplanned and frequently ill-advised fashion. 95. For enterprises subjected to more extensive State involvement the lack of a coherent strategy was even more detrimental. Companies were expected to pursue multiple objectives with no clear priorities and the demands on the firms were not coordinated with other government actions. Public companies were called on to operate efficiently, earn profits, sell at prices that did not always cover operating costs, expand employment and make politically-motivated new investments. A number of companies suffered because their initial goals were unrealistic and improperly implemented. For example, MINEROPERU was called upon to explore, study, initiate and operate large mining projects. The company, which operates a copper mine and refinery and just completed a zinc refinery, was also expected to develop and execute a large inventory of new projects. MINEROPERU never had the staff or resources to achieve these goals but it did not trim its program in order to advance substantially a few projects. Instead, it made little progress on a large number of projects.  - 32 - 96. PETROPERU is another example of a company confronting multiple and conflicting goals. It was set up to handle all State operations in petroleum, including marketing and petrochemical production, maintain Peru's self-sufficiency in petroleum and expand its exportable surplus, increase the country's oil and gas reserves and operate profitably in a competitive fashion. At the same time the firm was called upon to sell petroleum locally at highly subsidized prices as well as pay the taxes and royalities owed by foreign contractors to the Treasury. Transfers from the Central Government to cover the subsidy were late and insufficient and PETROPERU's financial situation deteriorated. Under these circumstances the company had little incentive to improve its efficiency. 97. Since the late 1970s, the Government has acted to rationalize the objectives of many companies, including MINEROPERU and PETROPERU. MINEROPERU is being transformed into a holding company which will promote joint ventures with private mining companies in a reduced portfolio of new investment projects. This will remove much of the burden of operating mines. PETROPERU's prices are being steadily raised and it is permitted to keep part of the payments owed for the contractors' taxes. The company is currently studying ways to improve its structure and operations with the help of outside experts. 98. While such measures have improved the situation of some individual firms, as yet there is no coherent strategy for the parastatal sector as a whole. Enterprises continue to confront multiple, uncoordinated and conflicting demands from state authorities. Some of the pressing areas for improvement are monitoring and control systems, pricing and subsidies and debt control. 99. Control. As the preceeding discussion shows, there has been no central mechanism capable of assuring that parastatal enterprises act in accordance with national objectives, or to note and act on major enterprise problems. Rather, a number of different bodies with overlapping functions were given responsibility for controlling the state-owned sector with little effective coordination. The system of administration resulted in conflicting signals, delays and excessive interference in the enterprises' daily operations, yet it afforded the Government little effective control over performance since the lines of authority were unclear and the feedback on results was inadequate. 100. Recent legislation governing state business activity (in particular, laws 206 and 216) attempt to create a more effective system for control.9/ According to this legislation ex ante control will be the responsibility of the Interministerial Commission of Economic and Financial Affairs (CIAEF), which will "coordinate, consolidate and evaluate" the plans for state business activity. (The CIAEF consists of all Peru's cabinet members involved in economic or financial matters.) These plans will be incorporated as a special chapter in the national plan drawn up by the National Planning Institute (INP) and will form the basis for the operative plans of the enterprises. CONADE is designated the technical secretariat of the CIAEF and given "custody" of all state shares. CONADE will also develop an investment and reinvestment policy for nonfinancial enterprises to be submitted to CIAEF for approval. Law 216 charges CONADE to exercise ex post control of the enterprises by monitoring and evaluating their performance, 9/ Both laws were passed in July 1981.  - 33 - without interfering in their normal operations. CONADE must then communicate the results of this management control to the sectoral ministries as well as prepare an annual report to the CIAEF evaluating performance and recommending any necessary changes in legislation. In addition, the Controller General will also continue to exercise ex post control through annual audits and investigations. 101. It is too early to judge how this system will fare when it is fully operational, but it is possible to foresee potential problems stemming from the lack of a clear delineation of authority. Although CONADE is given "custody" of all the state shares and responsibility for "management control," the ministries and other agencies still control the shares and hence appoint the stockholders' boards. The system for administering shares shown in Table 2 of the Statistical Appendix is thus left intact. As noted earlier, the lines of authority between these shareholding agents and the enterprises are complex and overlaping and the relationship between the various shareholding agents is unclear. Some observers told the mission that control of all shares may be transferred to CONADE to be administered by its operative arm, ICSA, as the public holding company, but others questioned whether this might happen. In any event the ministries are still deeply involved in running those enterprises that were directly under their sway, even when these firms have been made limited liability corporations. CONADE is supposed to report to the ministries on the results of its control but it is not specified what the follow-up will be or how CONADE's role will be coordinated witi the ministries. 102. Nor is it clear how CONADE's role in developing parastatal investment policy will be coordinated with that of the INP. INP has responsibility for all public investment plans and for reviewing and approving all investment projects. In the past INP has been a bottleneck in approving investment projects. For example, a purchase of two ships by the CPV was held up five years awaiting INP approval. There is a need for a review system that can effectively eliminate poorly designed, low priority investment projects without causing excessive delays. 103. Problems may also arise in coordinating the monitoring of public enterprises. The ministries, Central Bank, national statistical office, planning office, COFIDE and others all request information from the state-owned enterprises. One director claimed to have accumulated 33 government questionnaires during a six month period in 1978 which are still unanswered (a response is required by law). The information collected when, and if, the enterprise does reply is incomplete and inadequate. The questionnaires respond to the need of each central unit but do not provide information that might allow the Government or the enterprise to evaluate and improve performance. 104. Another control problem arises from laws which may seriously hamper efficient operations. The most blatant example is the bidding law. Bids are required for any procurement over US$300,000 by the Central Government and all companies with state majority ownership. The procedure is cumbersome, requiring 90 days and extensive preparation work. With such a low ceiling, this law creates a huge bottleneck for a company of any size and obviously carries a high opportunity cost. To give an extreme case, the State shipping line, CPV, is supposed to follow the procedures to purchase fuel or undertake major repairs, even when docked in a foreign port. The law also leads to a  - 34 - buildup of large inventories. In addition, the bid with the lowest evaluated cost cannot be selected. The law requires that an average be taken of all bids plus the base price and all bids 10 percent above or below this average are eliminated. The average of the remaining bids plus the base price must then be calculated and the bid below and closest to the average is selected. No consideration of other factors -- proposed construction methods, compatibility of equipment, etc. -- is allowed. It would be unrealistic to expect a public manager to minimize costs while following this bidding procedure. 105. The newly-issued statutes of some public enterprises (CPV among them) provide for exceptions to the bidding law in cases of emergency, for routine purchases and for any increase, repair or maintenance of existing installations which does not involve any major technological changes. The legality of these provisions, however, is currently being reviewed. Some managers are ignoring the law under the mistaken impression that it applies only to construction works. 106. Controller General. The Controller General's office represents a special problem for most state-owned enterprises. The Controller is supposed to assure that Peruvian government officials are held accountable for their use of public resources. To this end all publicly-owned enterprises are required to have a yearly audit by an external auditor chosen from a list of three selected by the Controller's office. The Controller also investigates complaints of irregularities and can impose criminal penalties for misuse of the public trust. The Controller's office has expanded recently; in 1981 its staff grew from 260 to 480 and its budget tripled. 107. Many managers complained to the mission of overzealous action on the part of the Controller leading to criminal penalties for simple business mistakes. Managers felt that the Controller's investigations sometimes responded to politically motivated complaints and were unnecessarily prolonged, tying up the enterprises' own personnel and damaging morale. The result was said to be an atmosphere of uncertainty that leads to timid management and over-extended reviews of major investment decisions by the boards of directors, driving more dynamic managers out of the public sector and reducing the enterprises' flexibility. (For example, Paramonga's managers proposed to diversify production in response to changed market conditions but its Board has been reviewing the decision for several years.) This situation, if true, may be linked to the existence of some laws that managers felt they must disobey to operate. 108. In addition, almost all managers consulted by the mission complained that the list of external auditors selected by the Controller were not of a caliber to do an adequate audit. Most of the larger, prestigious auditing firms do not take part in the Controller's bidding for the yearly audits. 109. Pricing and Subsidies. The price control system for publicly-owned enterprises consists of prices and rates that are supposedly set and adjusted to cover costs and allow some profit, as well as some prices at below cost but that are offset by transfers. In most cases the firms develop price proposals which are then submitted to a complex process of approval that usually takes at least two months. Even longer delays can occur (AEROPERU had to wait a year for its last price hike) and the final price may be held below the enterprises' cost estimates for political reasons. The enterprises  - 35 - have to absorb losses due to inflation during the decision making period. In the end, as Table III.7 shows, prices were often not raised sufficiently to keep pace with costs. Further, the Government is habitually slow in transferring subsidies. For example, unpaid fertilizer subsidies to FERTIPERU, a company which was merged with ENCI in 1974, were not paid as of September 1981 -- seven years later. 110. This situation has eased considerably with the recent elimination of many price controls. Furthermore, the Government has tried to raise prices and rates regularly on the basis of a technical study of costs, although interference and delays can still occur. 111. Debt Control. Problems can also arise out of the effort to control public foreign indebtedness. In the past the Government was often unable to effectively control parastatal debt despite a multilayered procedure for approval of foreign borrowing. Frequently, control efforts would delay investment proposals, but not eliminate many low priority or poorly conceived projects. Recent legislation has strengthened government control by making COFIDE, S.A. sole financial agent for all medium- and long-term foreign borrowing (more than one year maturity) by majority state-owned enterprises. Projects which require foreign credits must first be approved by the minister and studied by the planning office (INP). The investment is then submitted to a committee made up of representatives of the Ministry of Finance, the Banco de la Nacion and COFIDE, S.A. If approved, the project goes to COFIDE, S.A. which negotiates the financing. This procedure has enhanced debt control but may also delay investments. COFIDE must reassess an approved project even though the enterprise has already studied the project in detail and in some cases begun to negotiate the financing. Furthermore, COFIDE, S.A. enters the picture late, after the project is well advanced, making it harder and more costly to adjust project design to suit better the available financing. Relations Between State-Owned Enterprises 112. The relations between state-owned enterprises in Peru can create problems for the companies involved. These relate to cross-subsidization, late payments and public monopolies. 113. Cross-Subsidization and Late Payments. There are numerous instances of cross-subsidization between public enterprises that do not follow any discernable policy. These subsidies can take various forms. For example, CPV is required to purchase new ships from the Government-run shipyards rather than buy used ships on the world market as its local competitors do. This amounts to an additional cost to CPV of about US$20 million per ship. In another instance, ENCI subsidizes PETROPERU's urea plant by paying it a price to cover its costs which is 40 percent above world market prices. A third example is found in the lower rates charged by the State port and shipping line on products marketed by ENCI. Finally, publicly-owned enterprises must use State banks and other monopolies (see below) which offer services at higher cost than their private competitors. All of these hidden subsidies distort the performance of the enterprises and make it difficult to evaluate the cost of public enterprises to the Government. 114. Late payments also distort performance. Several firms, in particular the public utilities, told the mission that other public enterprises were among their major debtors. For example, one third of ELECTROPERU's 1980 current assets consisted of accounts receivable and close to half of these  - 36 - were owed by state-owned enterprises. SEDAPAL's executives estimated that SI. 11 million of the companies' S/. 13 million in non-recoverable claims was owed by now defunct public enterprises. These unpaid bills are especially costly in an era of 60 percent inflation. The current practice shifts the financial burden from one firm to the next, leading to poor financial performance for all public enterprises in the service sectors. 115. Public Monopolies. State-owned enterprises have been required to deal with certain public monopolies, including the State shipping line, the State insurance companies, the Banco de la Nacion and the state minerals trading company, MINPECO. Some of these monopolies have been lifted, and the more autonomous enterprises have also been able to avoid some of them. Nevertheless, managers complained that the remaining monopolies curtailed their independence and increased public sector inefficiency. In particular, managers faulted the Banco de la Nacion as being slow and costly to their companies. Public enterprises are supposed to keep their deposits with and -- until recently -- do all short-term borrowing in soles through the Banco de la Nacion. The Bank offers no interest on deposits and does not condact operations by phone or telex. Nor does it have enough branch offices to meet the needs of all the parastatal sector. The BN's lack of liquidity forces companies to withdraw cash slowly over a period of weeks to meet their payrolls and the Bank will not provide facilities to pay workers directly as commercial banks will in Peru. A number of executives told the mission that forcing state-owned firms to use the Banco de la Nacion hampers the introduction of modern financidl management. Problems of Firms 116. Finally, at the level of the firm the mission encountered a number of problems starting with top management and continuing with some common managerial problems and labor problems. 117. Top Management. Many of the state-owned firms, including some of the more autonomous ones, have suffered from a lack of continuity In their boards of directors. The terms of dircctors vary but many are only for one year. Actual tenure may be even less since new ministers tend to appoint new directors, sometimes as a political reward. The problems this causes are exacerbated by the tendency to appoint persons without any technical qualifications or knowledge of the enterprise's sector. As a result, managers complained of spending a lot of time educating boards to the operations of the enterprise only to see the directors replaced, This adds to the pressures on management to be overly cautious in operating publicly-owned enterprises. Managers cited cases where the expansion or diversification of an enterprise's activities was blocked because the board was unable to make a decision of any importance. 118. A high rate of turnover of top and mid-level managers is also a severe problem for the less autonomous public enterprises. Each new minister tends to replace the top executives of the public enterprises under his sway, while these in turn often introduce new individuals as their own management team. Added to this, salaries in enterprises operating under public law have been restricted by the Government to levels preventing them from retaining competent executives. This constraint was removed when most of the companies were shifted to private law in 1981, but many public  - 37 - enterprises are still under political pressures not to raise salaries. On occasion, ministers have refused to allow salary increases recommended by the board of directors. As a result salaries in many of the less autonomous public enterprises are still not competitive. 119. General Management Problems. Because of overregulation, lack of competitive pressures and the absence of incentives to reduce costs, the less autonomous public enterprises in the sample lack some of the administrative skills that could improve their efficiency. Recent measures to correct these deficiencies have improved the situation considerably, but further eforts will likely be needed. The main areas for improvement are: (1) financial management; (2) marketing; (3) production; (4) subsidiaries; and (5) planning and investment. 120. First, in the area of financial management, accounting systems are generally poor and few of the enterprises have detailed cost accounting systems. Basic sales data and inventory accounts are also deficient. Billing control is often inadequate, contributing to a large buildup of overdue accounts, and firms make insufficient provision for doubtful accounts. 121. Second, because these companies often enjoyed virtual monopolies, marketing skills are in short supply and market surveys are generally not available. Quality control is sometimes lax and the companies have little capacity to develop new products. Procurement skills are equally limited. 122. Third, production problems arise in some firms because their operations are unbalanced or unnecessarily complex. For example, not only does SIDERPERU have excess rolling capacity, it produces steel using three different techniques in a plant that is small by world standards. The plant uses both open hearth and electric arc furnaces to produce steel and is now introducing a direct reduction process to produce sponge iron for the electric arc furnaces. 123. Fourth, some of these companies are also straddled with unrelated operations or subsidiaries that further complicate management. PEPESCA, for example, owns a hotel. CPV, unlike its competition, maintains a navy yard, warehouses and repair facilities. In the past the Government would acquire an asset through nationalization or bankruptcy of a private firm and attach it seemingly at random as a subsidiary to a parastatal firm. 124. Finally, companies are also weak in long-term planning and in planning and evaluating investment projects. Some of the firms have no planning department, or do no long-term planning, because their scope of action used to be so circumscribed. Judging from some past investments, many firms, as well as ministries, were unable either to evaluate investment proposals properly or to resist political pressures. The mission encountered a number of instances where investments were apparently made without adequate study of the costs, the market, the supply of raw materials, the balance of production lines, the rate of return, and so forth. 125. Labor Problems. As mentioned, excess staff was cited as a problem in many state-owned firms. Because of Peru's Labor Stability Law, firing excess staff is almost impossible for both private and public firms. This has created especially severe problems for public companies subject to political pressures to expand employment. Some companies have reduced their workforce  - 38 - by offering staff bonuses to resign. Public firms may also have another option that private firms do not. Some public enterprises have transferred excess staff to the National Public Administration Institute (INAP). The staff members remain on the enterprise's payroll while INAP attempts to place them elsewhere in the Government. 126. Another difficulty arises because the parastatal sector grew through nationalizations, reorganizations and mergers. As a result workers in the same sector, and at times in the same firms, fall under a variety of laws. The norms for wages and salaries, bonuses, holidays and pensions vary according to whether the person was hired under civil service statutes, laws for fixed term contracts or laws pertaining to private companies. The lack of uniformity forces companies to maintain large personnel departments and expend great effort to try to maintain wages, salaries and benefits at the level of the greatest common denominator.  - 39 - IV - RECOMMENDATIONS FOR IMPROVED MANAGEMENT 127. There are 60 to 70 state-owned enterprises that the Government of Peru will likely retain under public ownership. These include 16 financial enterprises, 10 mining or hydrocarbon companies, the State electricity, transport, water, communications, tourism and trading enterprises, the steel mill (SIDERPERU) and the companies run by the military. Some of the commercial parastatal companies being considered for sale may also be under public management for some time (see Chapter V). 128. The Government is trying to improve the management of state-owned enterprises by, among other things, increasing their autonomy. Increasing the autonomy of public enterprises, however, will not assure that they efficiently achieve the State's objectives. Greater autonomy has enhanced the profitability of some of the production companies, but in many cases the State had no other objectives for these firms beyond earning a profit. In contrast, many of the enterprises to be retained by the State have important social objectives that may not be compatible with profitability or are monopolies that are not subject to the discipline of the market place. The achievement of social goals and efficient operations will require continued government direction, although not the extensive involvement of the past. Instead a system of management by objectives should be established to allow parastatal enterprises sufficient autonomy to actflexibly and efficiently, while creating a monitoring and incentives system to assure that the Government's goals are being met. Management by Objectives 129. Under a system of management by objectives, the Government's central and sectoral planning units would establish general objectives and broad guidelines for the public enterprises. Within that framework the state agencies controlling the enterprises would meet with managers to work out specific performance objectives. These would incorporate efficiency goals, such as cost minimization or labor productivity, as well as social goals and take into account circumstances affecting performance. The enterprise would periodically provide one set of standardized, detailed information to a monitoring agency on its results. Managers would be held accountable for results and an appropriate system of incentives would reward or penalize managers according to their achievements. 130. As the previous discussion shows, few of the components of such a system exist in Peru at present. Management of state-owned companies is characterized by too much interference in some cases and too little in others. While the State may intervene extensively in daily operations, the enterprise may also plan or make investment decisions with little effective Government control. Because objectives and lines of authority are not clearly defined, it is difficult to evaluate performance or assign accountability. Consequently, extensive government control of processes within an enterprise is combined with little control over results. 131. The framework for managing the parastatal sector created in the July 1981 legislation could form the basis for a management by objectives system, as shown in Figure 1. Under this scheme, one entity -- the Interministerial Commission on Economic Affairs -- would be given the responsibility and staff to translate the Government's economic and sector  - 40 - FIGURE 1 PER[: MANAGEMENT BY OBJECTIVES SYSTEM FOR STATE-OWNED ENTERPRISES CAEF MINISTRIES CONADE ICSA ENTERPRISES - Provide central coordination - Provide sectoral expertise - Coordinate management - Manage State's portfolio - Do strategic and operational of publicly-owned of companies. planning on basis enterprises. - Act as secretariat to objectives. CONADE. - Implement plans. - Monitor enterprises, act as clearinghouse for information. - Provide technical assistance, troubleshooting. NATIONAL~~~~ ~ ~~~~~~~~~~~~~~~~~~ PARASTATALALECTORCT |INPUTS ON, l l|INUSO ||IPTSN| ENTERPRISECODNTO NEPIEETRRS OBJECTIVESOEETVSOJCIS