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Disinvestment (Part - 2) - Economics, UPSC, IAS. Notes | Study Indian Economy (Prelims) by Shahid Ali - UPSC

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Difficulties faced in disinvestment 
Political Sensitivity

PSEs, being one of the largest employers in the country, their disinvestment have met with staunch opposition from trade unions and the political parties that claim to represent them. Also PSEs have always been treated as extended arms of government, and serve as sources of patronage to politicians and bureaucrats in power. They also practice methods of interference in the daily running of the enterprises, leaving the managers little or no autonomy. This is one of the reasons why India’s more than decade-long privatization program has made painfully slow progress until now.

Let’s take a look at how the process of disinvestment has been slowed down from the following examples:

  • In the case of Modern Foods the employees union challenged the legality of the sale in court but this challenge was not upheld. Subsequently, the reserve price fixed for the company was questioned on the grounds that it did not correctly reflect the value of land owned by the company.
  • The BALCO privatization was even more controversial because the Chief Minister of Chattisgarh, the state in which the unit was located, declared his opposition to the privatization by denying the new owners access to the premises. He also alleged impropriety in the sale procedure with vague charges of corruption and kickbacks at the political level. The privatization was also challenged legally on the grounds that mining rights in that area (being a notified Tribal Area) could only be given to a public sector unit, or to the tribals, and privatization of BALCO would violate this provision. The Supreme Court refused to stay the sale and even pronounced firmly that privatization was an issue of policy where differences should be resolved in Parliament and not through the Courts, and the privatization went through. 

Although all political parties opposed privatization, they took more varied stands by the end of the 1990s. Although both the BJP and Congress backed privatization in 2002, each qualified its support in different ways. The left-of-center political parties opposed it as well, but their opposition was less vociferous than in the past. Right-of-center groups like the Swadeshi Jagaran Manch opposed privatization because of their antipathy to foreign capital and fears that foreigners might gain more from privatization than nationals. Parties with a following among Dalits or Other Backward Castes opposed privatization because of its possible effects on jobs for their constituencies, but these fears were allayed as privatization agreements typically safeguarded the short-term interests of workers.

Operational Difficulties

The formation of coalition governments at the centre has created a lot of hurdles for the process of disinvestment. Some parties like the Left oppose disinvestment at the center while pursuing the policy of privatization in the states ruled by them. To appease all parties, it has now been decided to follow disinvestment in only loss-making PSUs and the Navratnas are completely excluded from this. What needs to be understood is that though the certain PSEs may seem to be making profits, it could be because the industry as a whole is doing well. In such a case it is better to sell of when the going is good. There are too many steps involved in disinvesting a unit and there are high chances of the process getting stuck in one of the stages of the bureaucratic mire.

Conflicting objective between economic growth and equity

Employing about 19 million persons, public sector currently contributes about a quarter of India’s measured domestic output. It is also a major employer of the backward castes of the Indian society. Hence, as such, PSEs, other than the objective of contribution to economic growth, have also had larger interests such as social justice as their objective.

Disinvestment has led to loss of jobs for these people and retrenchment has become an issue as was seen in the case of sale of Modern Foods. Disinvestment, though a handsome option to reduce fiscal deficits, is not without its social costs. There are some sectors like primary education, defense etc where private sector involvement will not meet the basic objective or may harm national interests. Thus the government has to be involved in areas 

where social interests cannot be fully served by private participation. Even if rate of economic growth has to be foregone, the social benefits of such a move have to be considered as the government is not a profit making body but is an instrument for overall well being of all citizens across sections of society.

Other Criticisms

Transparency: An important fact that needs to be remembered in the context of divestment is that the equity in PSUs essentially belongs to the people. Thus, several independent commentators have maintained that in the absence of wider national consensus, a mere government decision to disinvest is not enough to carry out the sale of people’s assets. Inadequate information about PSUs has impeded free, competitive and efficient bidding of shares, and a free trading of those shares. Also, since the PSUs do not benefit monetarily from disinvestment, they have been reluctant to prepare and distribute prospectuses. This has in turn prevented the disinvestment process from being completely open and transparent.

Trading concerns: The number of bidders for equity has been small not only in the case of financially weak PSUs, but also in that of better-performing PSUs. Besides, the government has often compelled financial institutions, UTI and other mutual funds to purchase the equity which was being unloaded through disinvestment. These organizations have not been very enthusiastic in listing and trading of shares purchased by them as it would reduce their control over PSUs. Instances of insider trading of shares by them have also come to light. All this has led to low valuation or under pricing of equity.

Crowding out: Further, in many cases, disinvestment has not really changed the ownership of PSUs, as the government has retained a majority stake in them. There has been some apprehension that disinvestment of PSUs might result in the “crowding out” of private corporates (through lowered subscription to their shares) from the primary capital market

Lastly, to the extent that the sale of government equity in PSUs is to the Indian private sector, there is no decline in national wealth. But the sale of such equity to foreign companies has far more serious implications relating to national wealth, control and power, particularly if the equity is sold below the correct price.


Disinvestment, though not a panacea, represents one aspect of a transformation in the place of the Government in our lives. The Government, at the moment, is a massive concentration of power that promiscuously intervenes as and when it please, frames rules to maximize its own rents and powers of patronage, uses taxes inefficiently and spends vast energies on things that are peripheral to bettering our existence.

  • Reorganizing government, to take it out of areas where it does not belong, so that it can better concentrate on areas where it ought to be the prime goal of reform. Disinvestment is one aspect of this aspiration.
  • Secondly, the economy needs credible signals for private initiative. Investors need to be assured that enterprise will not be stifled, curtailed, or distorted by a huge Government presence. But it also has to signal that the Government will not do what it did in the past: step in for the failing of every private initiative and pass the burden on to taxpayers. Disinvestment is a way of signaling that Government thinking on both these incentive-distorting interventions in the economy has changed. As a matter of principle it wants to restore the by now lost distinction between the Government and a trading company by getting rid of needless commercial involvement.
  • Thirdly, disinvestment is a way of reorganizing the Government’s priorities. Till now, the Government has used proceeds from disinvestment in a purely technical way: reducing fiscal deficits. What can be done, instead, is make a social contract that proceeds from disinvestment will be used to completely transform and reallocate the government’s budget. It would lead to massively greater spending on two sectors where the Government is badly needed: health and education. Unless disinvestment is linked to credible reform in governance and its gains earmarked for convincingly productive purposes, it will remain a precarious enterprise.

Disinvestment Policy

The present disinvestment policy has been articulated in the recent President’s addresses to Joint Sessions of Parliament and the Finance Minister’s recent Parliament Budget Speeches.

The salient features of the Policy are:

(i) Citizens have every right to own part of the shares of Public Sector Undertakings

  1. Public Sector Undertakings are the wealth of the Nation and this wealth should rest in the hands of the people
  2. While pursuing disinvestment, Government has to retain majority shareholding, i.e. at least 51% and management control of the Public Sector Undertakings

Approach for Disinvestment

On 5th November 2009, Government approved the following action plan for disinvestment in profit making government companies:

  1. Already listed profitable CPSEs (not meeting mandatory shareholding of 10%) are to be made compliant by ‘Offer for Sale’ by Government or by the CPSEs through issue of fresh shares or a combination of both
  2. Unlisted CPSEs with no accumulated losses and having earned net profit in three preceding consecutive years are to be listed
  3. Follow-on public offers would be considered taking into consideration the needs for capital investment of CPSE, on a case by case basis, and Government could simultaneously or independently offer a portion of its equity shareholding
  4. In all cases of disinvestment, the Government would retain at least 51% equity and the management control
  5. All cases of disinvestment are to be decided on a case by case basis
  6. The Department of Disinvestment is to identify CPSEs in consultation with respective administrative Ministries and submit proposal to Government in cases requiring Offer for Sale of Government equity.

National Investment Fund

On 27 January 2005, the Government had decided to constitute a 'National Investment Fund' (NIF) into which the realization from sale of minority shareholding of the Government in profitable CPSEs would be channelised. The Fund would be maintained outside the Consolidated Fund of India. The income from the Fund would be used for the following broad investment objectives:-

  1. Investment in social sector projects which promote education, health care and employment;
  2. Capital investment in selected profitable and revivable Public Sector Enterprises that yield adequate returns in order to enlarge their capital base to finance expansion/ diversification

Salient features of NIF:

  1. The proceeds from disinvestment of CPSEs will be channelised into the National Investment Fund which is to be maintained outside the Consolidated Fund of India

(ii) The corpus of the National Investment Fund will be of a permanent nature

  1. The Fund will be professionally managed to provide sustainable returns to the Government, without depleting the corpus. Selected Public Sector Mutual Funds will be entrusted with the management of the corpus of the Fund
  2. 75% of the annual income of the Fund will be used to finance selected social sector schemes, which promote education, health and employment. The residual 25% of the annual income of the Fund will be used to meet the capital investment requirements of profitable and revivable CPSEs that yield adequate returns, in order to enlarge their capital base to finance expansion/ diversification

Fund Managers of NIF

The following Public Sector Mutual Funds have been appointed initially as Fund Managers to manage the funds of NIF under the ‘discretionary mode’ of the Portfolio Management Scheme which is governed by SEBI guidelines.

i) UTI Asset Management Company Ltd.

ii) SBI Funds Management Company (Pvt.) Ltd.

iii) LIC Mutual Fund Asset Management Company Ltd.

Corpus of NIF

The corpus of the Fund is Rs.1814.45 crore being the proceeds from the disinvestment in

Power Grid Corporation and Rural Electrification Corporation. The pay out on NIF was Rs.84.81 crore in the year 2008-09, Rs.248.98 crore in the year 2009-10, Rs.107.32 crore in

2010-11 and Rs. 163.19 crores in 2011-12.

Use of Disinvestment Proceeds

The income from the Fund is to be used for the following broad investment objectives:

  1. 75% to finance selected social sector schemes, which promote education, health and employment
  2. 25% to meet the capital investment requirements of profitable and revivable CPSEs that yield adequate returns, in order to enlarge their capital base to finance expansion/diversification


However, in view of the difficult economic situation caused by the global slowdown of 2008-09 and a severe drought that was likely to adversely affect the 11th Plan growth performance, the Government, in November 2009, decided to give a one-time exemption to utilization of proceeds from disinvestment of CPSEs for a period of three years – from April 2009 to March 2012 – i.e. disinvestment proceeds during this period would be available in full for meeting the capital expenditure requirements of selected social sector programmes decided by the Planning Commission/Department of Expenditure. Now as the Country is facing very difficult economic conditions due to Continued financial/economic problems in Europe, impacting the economic growth in India, higher subsidy burden relating to petroleum, food and fertilizers, high Interest rate impacting the manufacturing sector, affecting excise collection, falling revenue collection, the exemption cited above has been extended upto March 2013.


Accordingly, from April 2009, the disinvestment proceeds are being routed through NIF to be used in full for funding capital expenditure under the social sector programmes of the Government, namely:-

  1.  Mahatma Gandhi National Rural Employment Guarantee Scheme
  2. Indira Awas Yojana
  3. Rajiv Gandhi Gramin Vidyutikaran Yojana
  4. Jawaharlal Nehru National Urban Renewal Mission
  5.  Accelerated Irrigation Benefits Programme
  6. Accelerated Power Development Reform Programme

What is the definition of MSME?

A.1. The Government of India has enacted the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 in terms of which the definition of micro, small and medium enterprises is as under:

(a) Enterprises engaged in the manufacture or production, processing or preservation of goods as specified below:

  1. A micro enterprise is an enterprise where investment in plant and machinery does not exceed Rs. 25 lakh; 
  2. A small enterprise is an enterprise where the investment in plant and machinery is more than Rs. 25 lakh but does not exceed Rs. 5 crore; and
  3. A medium enterprise is an enterprise where the investment in plant and machinery

is more than Rs.5 crore but does not exceed Rs.10 crore.

In case of the above enterprises, investment in plant and machinery is the original cost excluding land and building and the items specified by the Ministry of Small Scale Industries vide its notification No.S.O.1722(E) dated October 5, 2006 (Annex I).

(b) Enterprises engaged in providing or rendering of services and whose investment in equipment (original cost excluding land and building and furniture, fittings and other items not directly related to the service rendered or as may be notified under the MSMED Act, 2006 are specified below.

  1. A micro enterprise is an enterprise where the investment in equipment does not exceed Rs. 10 lakh;
  2. A small enterprise is an enterprise where the investment in equipment is more than Rs.10 lakh but does not exceed Rs. 2 crore; and
  3. A medium enterprise is an enterprise where the investment in equipment is more than Rs. 2 crore but does not exceed Rs. 5 crore.



  • The small scale industrial sector in India is divided into three categories: micro, small and medium. Together, they are known as Micro, Small and Medium Enterprises (MSME)
  • Micro scale sector: industries in which in the investment in plant and machinery is under Rs. 25 lakh. For service enterprises, this limit is Rs. 10 lakh
  • Small scale sector: industries in which the investment in plant and machinery is between Rs 25 lakh and Rs. 5 crore. For service enterprises, this limit is Rs 10 lakh – Rs 2 crore
  • Medium scale sector: industries in which the investment in plant and machinery is between Rs. 5 crore and Rs 10 crore. For services enterprise, Rs. 2 crore – Rs. 5 crore
  • The MSME sector in India employs about 60 million people, it is the second largest sector in terms of employment (after agriculture)
  • MSME sector accounts for 45% of industrial output and 40% of exports
  • The MSME sector in India falls under the purview of the Ministry of Micro, Small and Medium Enterprises. This Ministry was formed by the merger of the Ministry of Small Scale Industries and Ministry of Agro and Rural Industries in 2007
  • Registration of an industrial unit as a micro, small or medium scale enterprise is voluntary. However, benefits such as power and tax subsidies can only be obtained if registered
  • Registration is done by the Directorate or Commissioner of Industries for the respective states


  1. Micro, Small and Medium Enterprises Development Organisation (MSME-DO) 
    1. Established in 1954, headquarters New Delhi
    2. Also known as the Office of the Development Commissioner MSME
  2. It is the apex body for assisting the government for formulating and implementing policies for the MSME sector 
  3. The MSME-DO provides facilities for managerial consulting, technology upgradation, quality and infrastructure improvement, and human resources training and development
  4. Functions under the Ministry of MSME

National Small Industries Corporation (NSIC) 

  1. Established in 1955, headquarters New Delhi
  2. Helps in the fostering, aiding and promotion of growth of MSME
  3. Focuses on the commercial aspects of operation
  4. Provides services in the areas of material procurement, product marketing, technology acquisition, improved management practices etc
  5. Functions under the Ministry of MSME

Khadi and Village Industries Commission (KVIC) 

  1. Established in 1956, headquarters New Delhi
  2. Provides employment opportunities in rural areas by promotion and development of khadi and village industries
  3. Functions under the Ministry of MSME

Coir Board 

  1. Established in 1953, headquarters Cochin
  2. First coir industry in India was established by James Darragh in Alleppey in 1859
  3. Is responsible for formulation and implementation of schemes for the promotion and development of coir industry in India
  4. Primary coir exports include coir mats, coir textiles and coir pith
  5. The Coir Board functions under the Ministry of MSME

Small Industries Development Bank of India (SIDBI) 

  1. Established in 1990
  2. Objectives include the promotion, financing and development of small scale industries
  3. SIDBI was ranked among the top 30 development banks in the world by the The Banker, London 
  4. SIDBI functions under the Ministry of Finance


The Government has established three national level Entrepreneurship Development Institutes. These institutes develop training modules, undertake research and provide consultancy services for the MSME sector. All these institutes function under the Ministry of MSME





















National Institute for Micro, Small and Medium Enterprises



























National Institute of Entrepreneurship and Small Business







Development (NIESBUD)













Indian Institute of Entrepreneurship (IIE)


















Some of the important programmes are highlighted in this section. For a complete list of schemes and programmes see here and here

Cluster Development Initiative (CDI) 

  1. Clusters are defined as sectoral and geographical concentrations of enterprises that share common opportunities and threats
  2. Clusters facilitate the development of inter-firm cooperation to promote local production and collective learning
  3. Clusters account for over 60% of manufactured exports from India 
  4. India has over 400 clusters of Small and Medium Enterprises (SME) and 2000 artisan clusters
  5. The CDI in India is supported by the Cluster Development Programmer of the United Nations Industrial Development Organisation (UNIDO) 
  6. The CDI is a programme implemented by the Ministry of MSME

National Manufacturing Competitiveness Programme (NMCP) 

  1. Launched in 2005
  2. Aims to increase competitiveness in the face of liberalization and moderation of tariff rates
  3. Implemented by the National Manufacturing Competitiveness Council functioning under the Ministry of MSME

Scheme of Fund for Regeneration of Traditional Industries (SFURTI) 

  1. Launched in 2005
  2. Aims to achieve comprehensive development of clusters of khadi, village and coir industries
  3. Implemented by the KVIC and the Coir Board

Rajiv Gandhi Udyami Mitra Yojana (RGUMY) 

  1. Launched in 2008
  2. Aims to provide support and assistance to first-time entrepreneurs
  3. Helps in dealing with various procedural and legal formalities required for the establishment of the enterprise
  4. Implemented by the Ministry of MSME





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