What is disinvestment?

The term disinvestment is used to indicate the process of privatization of public sector enterprises. In the beginning of the eighties, the functioning of the public sector began to be questioned. It was held that public sector performed well only when protected through restrictions. The fall of the Soviet Union towards the end of the eighties followed by several
East European countries eroded the faith in the public sector further. The chinese government also pleaded for market socialism. Since in the socialist economies, disinvestment of state owned enterprise was undertaken on a big scale, the critics of the public sector argued for reducing the area of operation of this sector in also.

In India, quite a large number of public sector units incurred losses year after and year and it was argued that the State should not have to meet these losses out of the taxpayers’ money. The public sector had entered into a lot of areas and it was felt that the state should withdraw from many or some of these areas through privatization. Disinvestment is the process through which privatization could take place.

In those areas where investment is mainly infrastructure in nature and where private sector participants are not likely to come forth to an adequate extent within a reasonable time perspective; As the main operative principle of all public sector enterprises, unless the commodities and produced and distributed are specifically for protecting the poorest in the society. These are the main objectives with which the future of our public sector enterprises is being determined. Giving the rationale for disinvestment, the Ministry of Disinvestment has identified the following as the primary objectives:

1. Releasing the large amount of public resources locked up in the non-strategic PSEs higher on the education and social and economic infrastructure;
2. Stemming further outflow of these scarce public resources for sustaining the unviable non-strategic PSEs
3. Reducing the public debt that is threatening to assume unmanageable proportions;
4. Transferring the commercial to the private sector wherever the private sector is willing and able to step in; and
5. Releasing other tangible and up in managing PSEs and sectors that is short of such resources.

Broadly speaking, there are two major reasons given for other is to improve the efficiency of the enterprise. The demands of the government both at the state and the centre are increasing; there is a compelling need to expand activities such as health and education. It is thus legitimate that a share of the revenues required for these activities comes from the sale of the shares of government, which it has previously built up through its resources.

The resources thus earned could be used for retiring past debts and thus reducing the interest burden of the government or in any case it can reduce the need for the government to borrow funds. The second argument in favour of disinvestment is the improvement in efficiency of the PSEs. Induction of private ownership increases the accountability of those in charge of the enterprise. The shareholders would need to be compensated and this in turn would compel the enterprise to run more efficiently and earn more profits.

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Principles for the Extent of Disinvestment:

The extent of eventual disinvestment in a particular PSE will depend on the classification of the PSE as strategic, core and non-core. Since public sector units were set up with objectives relevant at different time periods, it has become necessary to review whether their continuation is justified in the public sector at present.

Strategic Group: At present as per the policy statements of the government, only four industries, viz. 1) Arms and Ammunition 2) Atomic Energy 3) Minerals specified in the schedule to Atomic Energy and 4) Railway Transport is exclusively reserved for the public sector. These industries are important from the national security point of view and the question of disinvestment in these industries does not arise.

Core Group: Sectors, which are capital and technology intensive, here the most common market form may be an oligopoly. Examples of such industries are telecom, power generation, and petroleum exploration. Here the presence of the public sector is important to prevent the concentration of economic power and protect public interest. In some of these industries, PSEs have a considerable market presence and the private market is yet to fully develop and the public sector needs to be present here until such time that the market becomes fully competitive. Here a public sector disinvestment may be limited to a maximum of 49%. Examples: ONGC, SAIL, MTNL, GAIL etc. (20 PSEs)

Non-Core Group: Over the years, private sector in many industries has increased considerably. The markets in these industries have become competitive and the presence of PSEs is not required to prevent the concentration of economic power.

Need for a long term disinvestment strategy

The public sector in India continues to be an important component of the Indian industry even after liberalization unlike the experience in many other countries. The PSEs, in general, must be managed on sound commercial lines and generate enough revenue to compensate for the quantity of resources invested in them. PSEs will continue to play an important role in the core sectors of budgetary support and they should be able to compete with the private sector.

Long term disinvestment strategy: 

Strengthen PSEs, where appropriate, in order to facilitate disinvestment: this can promote greater competitiveness and profitability and enhance share values. Also, strengthen marginally profitable PSEs and reduce their future dependence on the budget and restructure and revive loss-making PSEs to invite private capital in the long term. This can sustain long term employment by turning around loss making PSEs. Provide adequate and fair compensation through VRS to surplus work force and provide for employee participation in . Broad base ownership: Enhance retail reach of PSE shares to the small investor and offer at a suitable price discount as compared to the private institutional investor. Augment receipts for the government: Enhance government receipts by disinvestment in profitable PSEs and also eliminate the need for budgetary support in loss making PSEs.

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Approach to disinvestment of loss making PSEs:

The question of eventual disinvestment of loss making PSEs raises the question of funds required for revival and restructuring. However, this one time expenditure is better than the recurring drain on the budget of the loss making PSEs. In any case, it would be important to protect the interest of the work force by devising suitable schemes either for retraining, redeployment for VRS with adequate compensation. The advantages of the above long term strategy are:

  1. The savings in recurring budgetary provisions towards loss making PSEs can then be released for investments in sectors like.
  2. Dispersal of ownership will exert necessary pressure on the PSEs to improve the performance, earn profits and declare dividends.

Why should the government privatise such PSEs that have a good track record?

Critics of the disinvestment policy would have you believe that there is no need for disinvestment of such PSEs except for the purpose of raising funds for the government. However, the rationale for privatizing or not privatizing a PSE is based not on the fact of whether it is profitable or loss making but whether it is in the strategic sector or the non-strategic sector. Also, whether the taxpayers’ money can be saved from commercial risks by transferring the risk to the private sector wherever the private sector is willing to step in and assume such risks.

How to Disinvest?

The government does not seem to follow a uniform policy on the methodology of disinvestment. The government followed the policy of open auction sale and allowed NRIs and other persons legally permitted to hold equity to participate. This method gave excellent results in 1994-95 and as against the target of Rs. 4000 crores, the realization was that of strategic sale. It has been argued by the Disinvestment Ministry that the public offer method is dilatory and thus would take very long to complete the process of disinvestment of all the PSEs. This method is transparent and thus liable to much less abuse.

It has been successful internationally and thus there is no reason why it should not be used in the future. One intriguing example is that in the case of BPCL and HPCL, both oil giants, the government has appointed two approaches- In case of BPCL it will adopt a public offering methodology and HPCL to a strategic investor. Business Line, in its editorial date December 10, 2002 criticised the government decision and stated that why two enterprises, which are otherwise so similar, be treated so differently. If BPCL is not being offered to a strategic investor, as it is a core industry, then shouldn’t be the same rule apply to HPCL? However, due to Supreme Court intervention, even this process has been stalled.

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To summarise the various issues raised by the critics:

  1. Is it desirable to disinvest profit-making public enterprise, while keeping the loss-making PSUs under state ownership?
  2.  What should be the procedure for disinvestment- public offering through stock exchange or strategic sale to a private party?
  3. How should the interest of the workers and employees be safe guarded?

In addition to the above, it has been seen that the price worked out for any PSE has always been questioned. The important thing is to understand that price is not valued and so far no methodology has been devised to plug in if that happens, directly benefits the buyer and this is what the buyers invariably aim at. In some cases where the new investor in the PSE acquires more than 50% of the shares, he gets complete control over all the assets of the PSE. Some analysts feel that this aspect was not taken care of fully in the case of disinvestment in VSNL.

Therefore, certain rudimentary principles require to be adhered to in the process of valuation, like taking both the deep value and surface value parameters into account. While surface value is the market price, deep value is investment value based on the intrinsic economic value of all assets independent of the prevailing market price. PSEs have enjoyed government’s patronage and own large real estates in most of the cases and unless these assets are properly appraised for their value, this might result in the plundering of valuable public property.

Road block to Disinvestment:

A recent ruling by the two-member bench of the Supreme Court, however, has put the disinvestment policy on hold. The government has been directed to seek parliamentary approval before disinvesting its stake in oil companies, HPCL and BPCL. The judgement has cited Section 7 of the Esso (Acquisition of Undertaking in India) Act 1974 and similar sections of the Acts of 1976 and 1977, under which the government acquired the assets of Esso Standard, Burmah Shell, and Caltex. According to the relevant provisions, the government can transfer the acquired oil undertaking only to those entities where it has a minimum 51% stake.

Since disinvestment transfers the ownership to a strategic investor in case of HPCL, and the public in case of BPCL, parliamentary amendments to the acts would need to be made for their sale. This judgement would greatly affect the whole process of disinvestment and put the sale of previous PSUs (such as Maruti’s sale to Suzuki) under scrutiny. On December 3, 2003, the Disinvestment Ministry is to place an “Options Paper” before the Cabinet Committee for Disinvestment. Thereafter the government would decide on the future course of action, the key decision being the amendment of the Esso Act.

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