Strategic Investment | Economics Optional Notes for UPSC PDF Download

Introduction

• The government's plans to divest its holdings in Bharat Petroleum Corporation (BPCL), Container Corporation of India (Concorp), and Air India are unlikely to be concluded by March 2020. This raises the possibility of falling significantly short of the disinvestment target of Rs 1.05 trillion for the fiscal year 2019-2020.
• Disinvestment is the process of selling or liquidating assets by the government, typically involving Central and state public sector enterprises, projects, or fixed assets. The government undertakes disinvestment to alleviate the fiscal burden on the exchequer or to generate funds for specific needs, such as addressing revenue shortfalls from other regular sources.
• Strategic disinvestment, on the other hand, involves transferring ownership and control of a public sector entity to another entity, primarily a private sector entity. Unlike simple disinvestment, strategic sale represents a form of privatization. The disinvestment commission defines strategic sale as the sale of a substantial portion (up to 50% or a higher percentage determined by the competent authority) of the government's shareholding in a central public sector enterprise (CPSE), coupled with the transfer of management control.
• In India, strategic disinvestment aligns with the economic principle that the government should not engage in manufacturing or producing goods and services in sectors where competitive markets have matured. The potential of such entities may be better realized under the management of strategic investors, leveraging factors like capital infusion, technological upgrades, and efficient management practices.

Disinvestments - An Historical Overview

• In the initial four decades post-Independence, India embraced a development trajectory where the public sector was envisioned as the driving force for growth. However, the public sector expanded beyond sustainable levels, leading to evident deficiencies such as low capacity utilization, inefficiency due to overstaffing, diminished work ethics, overcapitalization from extensive time and cost overruns, a lack of innovation, delays in decision-making, and excessive interference in the decision-making process. Consequently, in 1991, a decision was made to adopt the path of disinvestment.
• The shift in India's approach commenced in 1991-92 when 31 selected Public Sector Undertakings (PSUs) were disinvested for Rs. 3,038 crore. In August 1996, the Disinvestment Commission, chaired by G V Ramakrishna, was established to advise, supervise, monitor, and publicize the gradual disinvestment of Indian PSUs. However, the Disinvestment Commission ceased to exist in May 2004.
• The Department of Disinvestment was established as a distinct department in December 1999, later renamed the Ministry of Disinvestment in September 2001. From May 27, 2004, the Department of Disinvestment was brought under the Ministry of Finance. Subsequently, the department was rebranded as the Department of Investment and Public Asset Management (DIPAM) on April 14, 2016, becoming the nodal department for strategic stake sales in PSUs.
• The National Investment Fund (NIF) was formed in November 2005 to channelize proceeds from the disinvestment of Central Public Sector Enterprises.

Recent Developments

• In 2015, the government reintroduced the policy of strategic disinvestment to open up sectors for private enterprise, aiming to enhance management efficiency for overall economic development.
• For the fiscal year 2019-20, the government set a disinvestment target of 1.05 lakh crore rupees. A recent cabinet decision approved the plan to sell 53.3% of its stake in BPCL, 63.8% of SCI, and 30.8% of CONCOR to strategic buyers. Additionally, 74.2% of its stake in THDCIL and 100% of NEEPCO are slated to be sold to NTPC.

Primary Objectives of Disinvestment in India

• Fulfilling Budgetary Needs: Disinvestment serves as a means to meet budgetary requirements.
• Reducing Fiscal Deficit: It aims to decrease the fiscal deficit, contributing to overall fiscal discipline.
• Enhancing Public Finances and Economic Efficiency: The process seeks to improve public finances and boost overall economic efficiency.
• Diversifying Ownership of PSUs: By diversifying ownership, disinvestment aims to enhance the efficiency of individual enterprises within the Public Sector Undertakings (PSUs).
• Funding Technological Upgradation, Modernization, and Expansion: Disinvestment raises funds for the technological upgradation, modernization, and expansion of PSUs.
• Funding Golden Handshake (VRS): It provides funds for implementing Voluntary Retirement Schemes (VRS) or golden handshake initiatives.
• Introducing Competition and Market Discipline: Disinvestment introduces competition and market discipline in the functioning of PSUs.
• Funding Growth and Development Programs: Disinvestment contributes funds for various growth and development programs.
• Encouraging Wider Share of Ownership: It aims to encourage a wider share of ownership among the public.
• Depoliticizing Non-essential Services: Disinvestment works towards depoliticizing non-essential services and operations.
• Transfer of Commercial Risks: The strategic sale of PSUs involves the transfer of commercial risks to private entities.

Importance of Disinvestment

• Short-term Financing: It provides short-term financing solutions, particularly in managing the increasing fiscal deficit.
• Long-term Goals: Disinvestment funds can be utilized for long-term goals, including large-scale infrastructure development, investments to encourage spending, and the expansion and diversification of firms.
• Repayment of Government Debts: A significant portion of the government's revenue receipts goes towards repaying public debt/interest.
• Investing in Social Programs: Disinvestment funds can be directed towards social programs such as health and education.
• Creating an Investment-Friendly Environment: It contributes to generating a better environment for investment.
• Enhancing Competitiveness: Disinvestment becomes crucial in a competitive environment, enabling PSUs to operate profitably and preserving the value of public assets.
• Facilitating Strategic Buyer Involvement: The strategic buyer/acquirer, introduced through disinvestment, may bring new management, technology, and investment for the growth of companies.
• Rationalizing Government Presence: Disinvestment rationalizes government presence, especially in non-strategic sectors, preventing distortions in competitive dynamics and minimizing the impact of inefficient PSU operations on consumers and taxpayers.

In summary, the rationale behind disinvestment can be encapsulated in the phrase, 'government has no business being in business.' Past strategic sales have demonstrated success stories, exemplified by Hindustan Zinc's remarkable profits and expansion under Vedanta's ownership since 2002.

Challenges in Disinvestment

• Loss of Regular Income: The sale of profitable and dividend-paying Public Sector Undertakings (PSUs) would lead to a loss of regular income for the government.
• Risk of Asset Stripping: There is a possibility of "asset stripping" by strategic partners, particularly because many PSUs possess valuable assets such as plant and machinery, land, and buildings.
• Strategic and National Security Concerns: Some experts view the strategic disinvestment of Oil PSUs as a threat to national security, given the strategic nature of oil as a natural resource. Foreign ownership may not align with national strategic goals.
• Impact on Social Security: Disinvestment can affect the social security of labor forces associated with PSUs.
• Concerns about Cronyism: Disinvestment raises concerns about the potential for cronyism in the process.
• Market Depressions and Limited Buyers: The current depressed state of markets and a shortage of reasonable buyers may lead to unfavorable deals.
• Unhealthy Fiscal Deficit Bridge: Using disinvestment funds to bridge the fiscal deficit is considered an unhealthy and short-term practice, akin to selling family assets for immediate financial needs.
• Risk of Privatization Resulting in Private Monopolies: Complete privatization may lead to public monopolies transforming into private monopolies, exploiting their position to raise service costs and increase profits.
• Majority Stake Sales to Other CPSEs: A majority stake sale to another Central Public Sector Enterprise (CPSE) may not bring about a real change in ownership.

Conclusion

• Ensure Increased Competition: It is crucial to ensure that privatization, specifically strategic disinvestment, results in greater competition in all cases.
• Prudent Reinvestment: The proceeds from strategic sales should be reinvested prudently in long-term infrastructure assets, rather than being used for interest or salary payouts.
• Fair and Transparent Process: To address concerns of cronyism, the strategic sale process should be fair and transparent, incorporating a minimum reserve price that reflects the value of assets being auctioned off. A third-party valuation of each PSU's assets and a minimum number of bidders should be necessary prerequisites for each sale.