Disinvestment in India

Privatisation and Related issues

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : Paper 3- Issues with privatisation and way forward

Context

There is a consensus that privatization is the panacea. Policymakers often cite the private sector’s ability to grow faster. This may not always be true.

Meaning of Privatisation

It means the transfer of ownership, management, and control of the public sector enterprises to the private sector. India adopted a mixed economy model, where the Public Sector Enterprises (PSEs) were established on a socialistic pattern of development. However, due to the poor performance of several PSEs and the consequent huge fiscal deficits, privatization was pursued. 

Privatization can suggest several things-

  • Migration of something from the public sector to the private sector.
  • It is also used as a metonym for deregulation when a massively regulated private firm or industry becomes less organized.
  • Government services and operations may also be (denationalised) privatised. In these circumstances, private entities are tasked with the application of government plans or the execution of government assistance that had earlier been the vision of state-run companies. Some instances involve law enforcement, revenue collection, and prison management.
  • Privatization of the public sector companies by selling off parts of the equity of PSEs to the public is known as disinvestment.

Objectives of Privatisation

1. Providing strong momentum for the inflow of FDI

2. Improving the efficiency of public sector undertakings (PSUs)

  • The efficiency of PSUs is improved by giving them the autonomy to make decisions.
  • Some companies were given special categories of Navratna and Miniratna.

3. Reduce the fiscal burden on the government in maintaining PSEs.

Ways of Privatisation

Government companies are transformed into private companies in two ways.

Transfer of ownership

Government companies can be converted into private companies in the following two ways:

  • By the withdrawal of the government from the ownership and management of public sector companies
  • By the outright sale of public sector companies.

Disinvestment

  • Disinvestment, or divestment, refers to the act of a business or government selling or liquidating an asset or subsidiary or the process of dilution of a government’s stake in a PSU.
  • The rationale for disinvestment is that the government has no business to be in a business. Thus, the government continues to disinvest in sectors where private companies are already the dominant player.

However, there are six methods of privatization.

  • Public sale of shares
  • Public auction
  • Public tender
  • Direct negotiations
  • Transfer of control of enterprises that were controlled by the state or by municipalities
  • Lease with a right to purchase

Benefit of Disinvestment

  • Improves corporate governance: It would result in the introduction of corporate governance in the privatized companies by freeing the PSEs from Government control and giving more scope to innovation. Enhanced corporate and with the introduction of independent Directors.
  • Develops and deepens the capital market through the spread of equity culture: The disinvestment would benefit the small investors and employees as it would lead to a wider distribution of wealth in the form of public offerings of privatized companies.
  • Disinvestment funds can be utilized for long-term goals such as:
    • Financing large-scale infrastructure development.
    • Investing in the economy to encourage spending
    • Expansion and Diversification of the firm
    • Repayment of Government Debts: Almost 40-45% of the Centre’s revenue receipts go towards repaying public debt/interest
    • Investing in social programs like health and education
  • Fiscal space for the relocation of resources locked with CPSEs: Disinvestment also assumes significance due to the prevalence of an increasingly competitive environment, which makes it difficult for many PSUs to operate profitably. This leads to a rapid erosion of the value of the public assets making it critical to disinvest early to realize a high value.
  • Resources locked in sectors developed enough to raise money from the market are channelized into areas of the economy that are less likely to access resources for the market because of their stage of economic development. Letting go of these assets is best in the long-term interest of the taxpayers as the current yield on these investments is abysmally low.
  • Unlocking of shareholder value: It is done with the help of issuing IPO. IPO means Initial Public Offering. It is a process by which a privately held company becomes a publicly-traded company by offering its shares to the public for the first time. Offering an IPO is a money-making exercise. Every company needs money for expansion, to improve their business, to better the infrastructure, to repay loans, etc.
  • Employees: Employees of a firm are benefitted by disinvestment through:
    • Pay rises, which has been done in past disinvestments.
    • Greater opportunities and avenues for career growth and further employment generation through capacity expansion.

Is privatization a solution?

  • No significant difference in performance: Studies indicate that the gap in growth (and service) between public sector undertakings (PSUs) with autonomy and private firms is not significant.
  • Experience of the privatization in the UK: One study highlighted that the famed British privatization initiative of British Airways, British Gas, and the Railways led to no systemic difference in performance.
  • Evidence on performance after privatization is even more mixed in developing countries.
  • Multiple factors: Growth post-privatization is often due to multiple factors, for example, better funding under a private promoter versus a starved government budget, a better business cycle.

Failure of Privatisation

  • Privatization as a revenue source:  As a state, we have sought to hock our generational wealth in PSUs for the past two decades, with limited success.
  • Failure to raise funds: Actual receipts from disinvestment have always fallen significantly short of targets.
  • In total, between FY11 and FY21, about ₹5 lakh crore was raised (that is, about 33% of just FY22’s projected fiscal deficit (PRS India, 2021) – some of this, notably through stake sale to other PSUs.
  • Considering social and institutional constraints, it is a slow process. For instance, BPCL’s long-awaited journey.

Challenges

  • Challenge of valuation: For instance, about 65% of about 300 national highway projects have been recording significant toll collection growth; any valuations of such assets will need to ensure they capture potential growth in toll revenue, as NHAI’s highway expansion bears fruit and the economy recovers.
  • Social consequences: There were about 348 CPSUs in existence in 2018, with a total investment of ₹16.4 trillion and about 10.3 lakh employees in Central Public Sector Enterprises (in 2019). Push for massive privatization resulting in mass layoffs in a period of low job creation.
  • Concentration of wealth: A greater concentration of public assets in select private hands is also a medium-term concern. About 70% of all profits generated in the corporate sector in FY20 were with just 20 firms.
  • Across sectors, a whiff of oligopoly is emerging – cigarettes continue to be dominated by a single player, paints have one entity with ~40% in FY21, airports now have a new operator with about six airports plus a 74% stake in Mumbai’s international airport, while telecom has just three players left.
  • Such concentration, mixed with the privatization of public assets, is likely to lead to higher usage fees (already being seen in telecom) and inflation, coupled with a loss of strategic control.

Way forward

  • Outright privatization is not a solution: Selective PSU Reform must be considered.
  • The Maruti model is instructive – the government had a joint venture with the Suzuki Corporation, but ceded control, despite Suzuki having only 26% shareholding, in return for a push by Suzuki for greater exports from India and manufacture of global models in India
  • Stake sale route: Empirical evidence highlights that stake sales are considered a preferred route (about 67% of all PSUs sales in about 108 countries between 1977 and 2000 were conducted via this route), as it gives time to ensure price discovery, allowing improved performance to raise valuations over time.
  • Global Experience: In China, for the past few decades, growth has been led by corporatized PSUs, all of them held under a holding company (SASAC), which promotes better governance, appoints leadership, and executes mergers and acquisitions.
  • In Singapore, the Ministry of Finance focuses on policymaking, while the holding firm is focused on corporatizing and expanding its PSUs on a global scale.
  • PSUs with greater autonomy, with the government retaining control via a holding firm, can also be subject to the right incentives.

Conclusion

The time has come to take a relook at privatization. Simply pursuing this path, while utilizing such proceeds for loan write-offs or populist giveaways in the election cycle will not do.

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