TOPIC : DISINVESTMENT OR PRIVATISATION: POLICY CONUNDRUM

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THE CONTEXT: The government will soon come out with a policy on strategic sectors and simultaneously kick into motion a process of complete privatisation for companies in the non-strategic sectors such as BPCL, Air India, Container Corporation of India, and Shipping Corporation of India.

THE DEVELOPMENT

In a big step towards privatisation of many state-owned firms, the Modi government has identified 18 strategic sectors, including banking, insurance, steel, fertiliser, petroleum and defence equipment, where it will retain only a limited presence. If implemented in its entirety, it will mean the government is completely exiting non-strategic sectors through privatisation or strategic disinvestment. Even in strategic sectors, there will be a maximum of four public sector units and a minimum of one unit operating.

This is the first time since 1956 that the government has said it will not have state-owned companies in the non-strategic sector — and that the number in the strategic sectors too, would be reduced.
Banking, insurance, defence, and energy are likely to be part of the strategic sector list.

What are Strategic and Non-strategic Sectors of India?

• An industry is considered strategic if it has large innovative spillovers and if it provides a substantial infrastructure for other firms in the same or related industries.
• Earlier, the strategic sectors were defined on the basis of industrial policy.
• The government classified Central Public Sector Enterprises (CPSEs) as ‘strategic’ and ‘non-strategic’ on the basis of industrial policy that keeps on changing from time-to-time.

According to this, the Strategic sector PSUs are:

• Arms & Ammunition of defence equipment
• Defence aircraft & warships
• Atomic energy
• Applications of radiation to agriculture, medicine and non-strategic industry
• Railways

Banking, insurance, defence, and energy are likely to be part of the strategic sector list. All other PSUs apart from the strategic sectors fall under Non-strategic Sector including Power Discoms.

Disinvestment vs Privatization

• 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 (Public Sector Undertaking).
• Disinvestment indicates only a partial dilution of control by the Govt and still retaining overall ownership of a particular enterprise, whereas privatisation for all purposes signify relinquishing the entire ownership in favour of private parties.

Details of the new PSU Policy

Announcing the Atmanirbhar Bharat economic support package in May, Finance Minister Nirmala Sitharaman had said that the proposed policy would notify the list of strategic sectors requiring the presence of at least one state-owned company along with the private sector.
This is expected to be a long-term process rather than a one-time move on the privatisation of companies. After inter-ministerial consultations to finalise strategic sectors, the policy will be put up before approval of the Union Cabinet.
The Department of Investment and Public Asset Management (DIPAM) functioning under the finance ministry, which moved a cabinet proposal in July on ‘Redefining Public Sector Participation in Commercial Sector Enterprise’, has classified 18 strategic sectors into three broad segments — mining and exploration, manufacturing, processing and generation, and the services sector.

1. In the mining and exploration segment, the areas where government will retain limited presence are coal, crude oil and gas, and minerals and metals.
2. Similarly, in manufacturing, processing and generation segment, the areas where the government will retain limited presence are defence equipment, steel, petroleum (refinery and marketing), fertilisers, power generation, atomic energy and ship building.
3. And, in the services sector, the areas identified are — power transmission, space, development and operation of airports, ports, highways and warehouses and gas transportation and logistics (not including gas and petro-chemicals trading), contract and construction and technical consultancy services related to strategic sectors and subsectors, financial services for infrastructure, export credit guarantee, energy and housing sectors, telecommunications and IT, banking and insurance.

The biggest fallout is expected to be on sectors like banking, where a large number of state-owned banks operate. Even after the merger of 10 state-owned banks into four last year, and the mergers in 2017 and 2018, there are still 12 state-owned banks in India.

Private investors can prove to be a game-changer

• According to the plan, even in sectors that the government proposes to continue its presence, it will hold only that much stake in a firm that is required to retain control.
• But the timing of the government’s exit will depend on a number of factors, including market conditions and the feasibility of the proposal.
• Government has said that private sector participation will infuse private capital, technology, innovation and bring in best management practices.
  o The privatisation will give a big boost to the economy by generating jobs.
  o The sectors have huge potential, which is not being realised now because of various reasons. Private investors can prove to be a game-changer in such a scenario.
• According to the DIPAM proposal, unlocking of resources by strategic disinvestment of public sector enterprises could be used to finance social sector and development programmes.
• India has 348 public sector enterprises and the net worth of the government’s holdings in these firms is around Rs 7 lakh crore, according to government estimates. If implemented in its entirety, it would be the government’s most ambitious disinvestment plan since 2000 when the Atal Bihari Vajpayee government had started the process of completely exiting public sector firms.

Mix of further mergers of banks and privatisation likely

• The finance ministry will notify the policy within one month of cabinet approval. However, the actual implementation will take much longer. Initially, steps will have to be taken to bring down stakes in these PSUs and eventually exit.
• On the banking sector, the government’s first priority at present is to offload its remaining stake in IDBI Bank as announced in the budget.
  o In 2018, the Life Insurance Corporation had picked up a majority stake in the bank leaving the government with around 46 per cent shareholding.
  o The state-owned life insurer infused Rs 21,624 crore into the bank.
• Hence, there could be a mix of further mergers among banks and privatisation to bring down the number of state-owned banks to four.
• A holding company structure could also be used to house equity of smaller banks in one entity.
• The government has shifted its focus to having a few very large banks under its fold, and a decision regarding the smaller banks is expected after the policy is unveiled.

Where the policy will not apply

• Sources in the government said the proposed policy will not apply to autonomous organisations or trusts, regulatory authorities, refinancing institutions — many of which have been created through Acts of Parliament — such as major port trusts, Airports Authority of India, among others.
• It will also not apply to central public sector enterprises that provide support to vulnerable groups through financing of SCs, STs, minorities and backward classes, security printing and minting, organisations like railways and posts that undertake commercial operations with a development mandate.
• Department and organisations like railways, airports, ports and National Highways Authority of India, which are not covered under this policy but have undertaken asset monetisation or privatisation of various operations or activities, will continue to do all these.

But why not disinvest, rather than privatize?

• The government’s disinvestment strategy fail to address the basic issue, one of maximising value for taxpayer monies.
• Government equity in PSUs is nothing but capital invested by India’s taxpayers — it is therefore incumbent on the government to ensure maximum value for the investment made.
• A disinvestment programme, which is linked to a budgetary revenue target, is simply inefficient way of achieving it. Markets have cycles and a budgetary target necessitates equity sale even during weak market years.
• The result is either extraction of less-than-optimum value or (as is the case very often) a left-pocket right-pocket transaction of PSUs (and/or LIC) picking up disinvestment offers.
• Another problem in disinvestment is that it does not ensure a change in management of the enterprise. To make PSUs efficient, there is a need to bring in private management that runs it with the aim of maximizing profit.
• The Centre has had some success with disinvestment over the years. Of late, most of the disinvestments are funded by the Life Insurance Corporation of India.
• Thus, privatization is important and disinvestment a second-best alternative that yields revenues for the Centre, but does not improve the condition of the enterprise.

Benefits of privatisation

• The main argument for privatisation is that private companies have a profit incentive to cut costs and be more efficient.
• Most PSUs are making losses and are funded by the largesse of taxpayers. The public resources spent on them could be better utilized elsewhere, especially for development.
• Selling them can also yield non-tax revenue, which could be used to augment public infrastructure. Moreover, their turnaround by the private sector can generate tax revenue for the government.
• It is argued that political interference make poor economic managers. They are motivated by political pressures rather than sound economic and business sense. Private sector is free from such unavoidable interference.
• A government many think only in terms of the Short-term view or next election. Therefore, they may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term.
• It is argued that a private firm has pressure from shareholders to perform efficiently. A state-owned firm doesn’t have this pressure and so it is easier for them to be inefficient.
• Often privatisation of state-owned monopolies occurs alongside deregulation and increase the competitiveness of the market. It is this increase in competition that can be the greatest spur to improvements in efficiency. For example, there is now more competition in telecoms and distribution of gas and electricity.

Arguments against Privatisation

Private Sector is Inefficient too

• There are some good number of PSEs that are not loss-making enterprises; instead, some of them generate revenues. If PSEs are allowed to grow in an independent way, managers of these enterprises are expected to respond according to the changed requirements.
• Further, there is no evidence that can suggest that the Indian private sector performs satisfactorily. Private sector is inefficient too.
• During 1950-1990, India’s private industrialists functioned under the protective umbrella without putting much effort in increasing factor productivity. These industrialists felt no urgency in modernising their industries; they used old and obsolete technology which made this sector an inefficient one.
• There is no statistical evidence that can show a positive relationship between ownership and performance. In fact, performance is not be related to the ownership of industries.
• What is needed is the competitive environment in which any sector public sector and private sector can grow.

Financial burden in future

• There are so many private industries that are lying sick. Sometimes, private industrialists deliberately make their organisations ‘sick’—so that they can receive financial help from public sector institutions to tide over the crisis.

Infrastructures may not grow in Abundance

• Economic growth crucially depends on the growth of infrastructures. Infrastructures both economic and social and economic growth are positively linked to each other.
• Since infrastructure investments are lumpy in character, private capital shies away from such investments and thrives on state- support infrastructures.
• Therefore, move towards greater and greater privatisation means country’s slow and haphazard growth of infrastructural facilities.

Public interest

• There are many industries which perform an important public service, e.g., health care, education and public transport. In these industries, the profit motive shouldn’t be the primary objective of firms and the industry.

Problem of regulating private monopolies

• A natural monopoly occurs when the most efficient number of firms in an industry is one. For example, tap water has very significant fixed costs. Therefore, there is no scope for having competition amongst several firms. Therefore, in this case, privatisation would just create a private monopoly which might seek to set higher prices which exploit consumers.
• This needs effective regulations to prevent abuse of monopoly power. Therefore, there is still need for government regulation, similar to under state ownership.

Peripheral Social Responsibility

• Private sector is completely guided by the profit motive. This sector will invest in those areas that yield quick return the low priority industries.
• Above all, social responsibility or welfare objective of business is side-lined by the private industrialists.

Danger of Employment Loss

• Employment loss seems to be another argument against privatisation as far as present employment scenario is concerned.
• In the name of more and more profit, private industrialists have adopted ‘hire and fire’ policy of employment as well as labour-saving technologies.
• Further, private businessmen exploit workers in many forms (like extending working hours or increasing work load, sabotaging the power of the workers to negotiate with the employers, etc.). All these impact on wages. Income inequality, thus, gets widened.

Alternatives to privatisation (With past examples)

A firesale privatisation, as is prescribed by free market evangelists, is an also less efficient method of value maximization, besides being completely impractical in India’s political economy. Neither disinvestment nor the few outright privatisations that have taken place seem to have really maximised value for the key shareholder — the taxpayer of India.
The case for privatisation is trickierand the trick lies likely elsewhere – in control. Within the Indian landscape, there are examples, albeit few, where significant (or even majority) government ownership has not prevented the company from creating enormous value for shareholders. Since Independence, while most government-funded enterprises were set up as public sector undertakings, mostly under enabling legislations, there were other models explored too.

1. Maruti Udyog was set up as a Joint Venture of the government of India with Suzuki of Japan, with the latter initially holding a minority stake. But the cornerstone of the structure was on management control – government, despite its majority stake, allowed a very substantial amount of management and operational freedom to Suzuki to manage the company on commercial lines.
2. A second model used often, mostly in financial services, has been that of indirect ownership — via other PSUs while allowing private sector-level management and operational freedoms. The Industrial Credit and Investment Corporation of India (ICICI), the erstwhile parent company of ICICI Bank was set up as a joint venture of public sector banks, insurance companies and the World Bank.
3. UTI Bank (known as Axis Banknow) was sponsored by the government owned UTI-1, a special purpose vehicle created out of the restructuring of Unit Trust of India.
4. HDFC, the mortgage lender, was initially sponsored by ICICI, with minority shareholdings with IFC (part of the World Bank group) and the Prince Aga Khan foundation.

WAY FORWARD: Given the stupendous success of all three examples quoted above – all four are market leaders in their respective business lines and have created enormous amount of wealth not only for their private shareholders but also for the Indian taxpayer (who directly and/or indirectly owns significant parts of these companies).
While there would be several reasons for the success, a key common thread running across all the four cases is one of management control. The respective management teams (and/or minority stakeholders with domain expertise) were given full flexibility to run the enterprises on commercial lines.

CONCLUSION: In a country like India, Privatization in today’s concept is seen as a means of increasing output, improving quality, reducing unit costs, curbing public spending and raising cash to reduce public debt. However, privatisation takes a number of forms and has been approached in various ways with both pros and cons. Disadvantages of privatization should be balanced with proper rules and regulations. Privatisation must be accompanied by competition in the post-privatised scenario. In order to improve the performance of inefficient units, the creation of a competitive market environment is absolutely essential. Moreover, Privatisation of Public sector enterprises is a viable option only in case of ‘value subtracting enterprises’ but the process must not be in haste, just for the sake of meeting the disinvestment targets set by the Finance Ministry.