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State-Owned Enterprises: Debt Neutrality and Subsidies

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Practice Advice on Public Financial Management

State-Owned Enterprises: Debt Neutrality and Subsidies (OECD) 

Summary AdviceThe OECD recommends that SOEs (state-owned enterprises) should access finance according to competitive conditions and on purely commercial grounds.

Main Points: Governments must ensure that that commercial entities they control do not benefit from subsidised finance - not least since the subsidies would normally be provided by government itself.  State aids and subsidies directed to inefficient firms distort firms' behavior, as they subject them to softer budget constraints than their non-subsidised rivals. Government loans provided at below market interest rates or against collateral or securitisation that would have been acceptable under purely commercial terms, are tantamount to direct grants and can have the same distortive outcome. Subsidies and state aids  may improve the SOEs cash flows, which may allow them to raise additional debt financing or equity capital, due to a perceived lower default risk. SOEs may have access to favourable credit rates or enjoy government-provided credit guarantees which reduce their cost of borrowing and enhance their competitiveness vis-à-vis their privately owned rivals. Even in cases where SOEs do not enjoy preferential credit rates or receive government aid, the market may view them as enjoying some sort of guarantees from the government.

The  OECD recommends putting in place mechanisms to ensure that SOEs and other government businesses pay the same interest rate on debt obligations that they would incur as a private enterprise in similar circumstances. The suggested good practices are:

  • a clear distinction must be made between SOE, the state and creditors
  • the state should not give an automatic guarantee in respect to SOE liabilities
  • there should be fair practices with regard to the disclosure and remuneration of state guarantees
  • SOEs should be encouraged to seek other sources of financing such as equity
  • mechanisms should be put in place to avoid conflicts of interests between SOEs and state-owned banks/financial institutions
  • credit to SOEs must be granted on the same terms as the private sector

The need to avoid concessionary financing of SOEs is commonly accepted since most policy makers recognize the importance of subjecting state-owned business to financial market disciplines.  Debt neutrality remains an important area to tackle if the playing field is to be levelled. Many government businesses continue to benefit from preferential access to credit in the market due to their perceived government-backing.

Source: OECD (2012) "Competitive Neutrality: A Compendium of OECD Recommendations, Guidelines and Best Practices" at http://www.oecd.org/daf/corporateaffairs/50250955.pdf  (accessed February 12th, 2013).

Page Created By: Khilola B. Zakhidova on 20 February 2013; updated by Ian Clark 8 March 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.

 

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