Disinvestment (Part-1) - Economics, UPSC, IAS. | Indian Economy (Prelims) by Shahid Ali PDF Download

Disinvestment

Disinvestment is a procedure whereby some parts of public sector enterprises (PSEs) are

sold  to  private  organizations  or  individuals. There  are  two  ways  to  go

about disinvestment:

• Strategic sale with complete transfer of management to an enterprise in the private sector
• A second procedure is partial disinvestment whereby the government still retains effective control by holding 51 per cent or more of equity.

This has been the procedure adopted in the majority of cases. In this case, a decision has to be made as to who would be eligible to acquire the shares – other enterprises, employees or the public at large – and the manner in which the shares are to be off-loaded.

Disinvestment involves the sale of equity and bond capital invested by the government in PSUs. It also implies the sale of government’s loan capital in PSUs through securitization. However, it is the government and not the PSUs who receive money from disinvestment.

The fixation of share/bond price is an important aspect of disinvestment. Now, the Disinvestment Commission determines the share/bond price. Disinvested shares are listed, quoted and traded on the stock market. Indian and foreign financial institutions, banks, mutual funds, companies as well as individuals can buy disinvested shares / bonds

THE ROAD TO DISINVESMENT

Why Disinvestment?

The cornerstone of the case for privatization is the concept that private ownership leads to better use of resources and their more efficient allocation. Throughout the world, the preference for market economy received a boost after it was realized that the State could no longer meet the growing demands of the economy and the State shareholding inevitably had to come down. The ‘State in business’ argument thus lost out and also the presumption that direct and comprehensive control over the economic life of citizens from the Central government can deliver results better than those of a more liberal system that directly responds according to the market driven forces.

Another reason for adoption of privatization policies around the globe has been the inability of the Governments to raise high taxes, pursue deficit / inflationary financing and the development of money markets and private entrepreneurship.

The rationale behind of market-oriented economic structures can be summarized as:

• the government must not enter into those areas where the private sector can perform better
• market-driven economies are more efficient than the state-planned economies
• the role of the state should be as a regulator and not as the producer
• Government resources locked in commercial activities should be released for their deployment in social activities.

The objectives of the disinvestment programme vary from improving efficiency of the Public Sector Enterprises to transformation of the society.

Because of the current revenue expenditure on items such as interest payments, wages and salaries of Government employee and subsidiaries, the Government was left with hardly any surplus for capital expenditure on social and physical infrastructure. Whereas the Government should be spending on basic education, primary health and family welfare, huge amounts of resources were blocked in several non-strategic sectors such as hotels, trading companies, consultancy companies, textile companies, chemical and pharmaceuticals companies, consumer goods companies etc.

Thus, the primary objectives for privatizing the PSEs are as follows :

• releasing the large amount of public resources locked up in non-strategic PSEs, for redeployment in areas that are much higher on social priority, such as, public health, family welfare, primary education and social and essential infrastructure;
• stemming further outflow of these scarce public resources for sustaining the unviable non-strategic PSEs. It is contended that many PSUs have been characterized by low productivity, unsatisfactory quality of goods, excessive manpower utilization, inadequate human resource development and low rate of return on capital. For instance, between 1980 and 2002, the average rate of return on capital employed by PSUs was about 3.4% as against the average cost of borrowing, which was 8.66%.
• reducing the public debt that is threatening to assume unmanageable proportions, transferring the commercial risk, to which the tax-payers’ money locked up in the public sector is exposed, to the private sector wherever the private sector is willing and able to step in – the money that is deployed in the PSEs is really the public money; and, is exposed to an entirely avoidable and needless risk, in most cases.
• releasing other tangible and intangible resources, such as, large manpower currently locked up in managing the PSEs, and their time and energy, for redeployment in areas that are much higher on the social priority but are short of such resources.

Benefits from Disinvestment

The benefits expected to be derived from privatization are: -

• Disinvestment would expose the privatized companies to market discipline, thereby forcing them to become more efficient and survive or cease on their own financial and economic strength.

• They would be able to respond to the market forces much faster and cater to their business needs in a more professional manner.
• It would also facilitate in freeing the PSEs from the Government control and introduction of corporate governance in the privatized companies.
• Disinvestment would result in wider distribution of wealth through offering of shares of privatized companies to small investors and employees.
• Disinvestment is generally expected to achieve a greater inflow of private capital and have a beneficial effect on the capital market; the increase in floating stock would give the market more depth and liquidity, give investors easier exit options, help in establishing more accurate benchmarks for valuation and pricing, and facilitate raising of funds by the privatised companies for their projects or expansion, in future.
• Opening up the erstwhile public sectors to appropriate private investors would increase economic activity and have an overall beneficial effect on the economy, employment and tax revenues in the medium to long term.
• In many areas, e.g., the telecom sector, the end of public sector monopoly would bring relief to consumers by way of more choices, and cheaper and better quality of products and services – as has already started happening.
• It will increase the use of private management practices in PSUs, as well as enable more effective monitoring of management discipline by the private shareholders of

THE DISINVESMENT PROCESS

Phases of disinvestment

As per the Department of Disinvestment, the process of disinvestment in India can be

divided into 2 distinct phases:

• Phase 1: 1991-1998-99 which is the initial phase of disinvestment in India.( the first disinvestment commission expired in the year 1999).
• Phase 2: 1998-99-now which can be called the phase of genuine privatization.

Phase – I

This phase of the evolution of public sector reform began with the balance of payments crisis of 1991. It was also a necessary condition for obtaining IMF support, which was essential to manage the crisis and to restore confidence. One of the measures which could help to reduce the fiscal deficit was the sale of equity in public sector enterprises.

Forty seven profit making public sector enterprises were included in the first disinvestment program. Although direct sale of shares to institutions with possible resale to individuals meant that the new private shareholders would acquire voting rights (unlike the case with the earlier proposal) the government repeatedly emphasized that there would be no effective reduction in government control since the dilution of the government’s stake was limited to 20%.

In a report submitted to Parliament in 1993 the Controller and Auditor General (CAG) criticized the first year’s disinvestment program on the grounds that the bundles had been 

sold at bid prices which were lower than the reserve price which the government had originally fixed for each bundle based on reserve price valuations of individual shares. Since the stock market softened considerably after 1993 it became difficult to achieve any sale without running the risk of criticism of undervaluation.

In order to explore alternative modalities for disinvestment, the government initially appointed a Committee on Disinvestment of Shares in Public Sector Enterprises under the chairmanship of Dr V. Krishnamurty, Member, Planning Commission and later reconstituted it under the Chairmanship of Dr. C. Rangarajan, Governor of the Reserve Bank to advise on the matter. The report was submitted in April 1993 and made important recommendations as follows which pointed the way forward for policy.

1. The government should retain majority control (51%) only in sectors reserved for the public sector and in other sectors the government’s holding should go down to 26% in those cases where the government wanted to retain some limited control and in other cases it should be reduced to zero.
2. Once a reasonable market price is established in a normal trading atmosphere, it would be better to sell shares at a fixed price offer to the general public through a prospectus. In other cases, sale could be by auction with as large participation as possible.

The policy of the Government on disinvestment has evolved over a period and it can be briefly stated in the form of following policy statements made in the chronological order:

A. Interim Budget 1991-92 (Chandrasekhar Government)

Policy: To divest up to 20% of the Government equity in selected PSEs in favour of public sector institutional investors.

Objective: To broad-base equity, improve management, enhance availability of resources for these PSEs and yield resources for the exchequer.

B. Industrial Policy Statement of 24th July, 1991

Policy: To divest part Government holdings in selected PSUs

Objective: “to provide further market discipline to the performance of public enterprises”

C. Budget Speech :1991-92 (Congress Government)

Policy: To offer up to 20% of Govt. equity in selected PSUs to mutual funds and investment institutions in the public sector, as also to workers in these firms.

Objectives: “to raise resources, encourage wider public participation and promote greater accountability”.

D. Report of the Committee on the Disinvestment of Shares in PSEs (Rangarajan Committee): April 1993 emphasized the need for substantial disinvestment, and stated that 

while the percentage of equity to be divested should be no more than 49% for industries explicitly reserved for the public sector, it should be either 74% or 100% for others.”

E. The Common Minimum Programme of the United Front Govt.: 1996

Policy:

• To carefully examine withdrawal from non-core strategic areas.
• To set up a Disinvestment Commission for advising.
• To take and implement decisions to disinvest in a transparent manner.
• Job security, opportunities for retraining and redeployment to be assured.

F. Disinvestment Commission Recommendations: Feb.1997- Oct. 1999

• 72 PSEs were referred to the Disinvestment Commission during 1996-99 The Disinvestment Commission gave its recommendations on 58 PSEs.
• The Disinvestment Commission recommendations gave priority to strategic/trade sales, with transfer of management, instead of public offerings, as was recommended by the Rangarajan Committee in 1993 also.

The following table gives the details:

Phase – II

This phase has often been referred to as the phase of genuine privatization. In this phase government explicitly recognized that it should withdraw from managing public sector enterprises and hand over management to private sector owners.

A. Budget Speech: 1998-99

Policy:

• To bring down Government shareholding in the PSUs to 26% in the generality of cases, (thus facilitating ownership changes, as was recommended by the Disinvestment Commission).
• To retain majority holding in PSEs involving Strategic considerations.
• To protect the interest of workers in all cases.

B. Budget speech: 1999-2000

Policy:

• To strengthen strategic PSUs.
• To privatise non-strategic PSUs through gradual disinvestment or strategic sale.
• To devise viable rehabilitation strategies for weak units

Approval of Clear Guidelines for Strategic / Non strategic Classification by the Cabinet on

the 16th March 1999

Strategic & Non-strategic Classification: Cabinet classified the PSUs into strategic and

non-strategic areas.

Strategic PSUs:

• Defence related
• Atomic energy related, with some exceptions
• Railway transport

Non-strategic PSUs:

All others

Policy for Non-strategic Public Sector Enterprises:

Reduction of Government stake to 26% to be worked out on a case to case basis, on the following considerations:

• Whether the Industrial sector requires the presence of the public sector as a countervailing force to prevent concentration of power in private hands, and
• Whether the Industrial sector requires a proper regulatory mechanism to protect the consumer interests before Public Sector Enterprises are privatised.

C. Budget speech: 2000 – 2001

Policy: The main elements:

• To restructure and revive potentially viable PSUs.
• To close down PSUs which cannot be revived.
• To bring down Government equity in all non-strategic PSUs to 26% or lower, if necessary.
• To fully protect the interest of workers.
• To put in place mechanisms to raise resources from the market against the security of PSUs’ assets for providing an adequate safety-net to workers and employees.
• To establish a systematic policy approach to disinvestment and privatisation and to give a fresh impetus to this programme, by setting up a new Department of Disinvestment.
• To emphasize increasingly on strategic sales of identified PSUs 
• To use the entire receipt from disinvestment and privatisation for meeting expenditure in social sectors, restructuring of PSUs and retiring public debt.

D. Budget Speech: 2001 – 2002

Objectives :

To use the proceeds for providing –

• Restructuring assistance to PSUs.
• Safety net to workers.
• Reduction of debt burden.
• Additional budgetary support for the Plan, primarily in the social and infrastructure sectors (contingent upon realization of the anticipated receipt.)

Magnitude of Disinvestment in India

The following table indicates the actual disinvestment from 1991-92 till date, the methodologies adopted for such disinvestment and the extent of disinvestment in different CPSUs :

# Figures (inclusive of control premium,dividend/dividend tax,restructuring and transfer of surplus cash reserves prior to disinvestment).

Sector wise Analysis of Disinvestment

The following data show the sector wise break up of disinvestment program in India

India