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Report on Disinvestment of Public Sector Enterprises in India

Editor, TRANSFIN.
Jul 12, 2020 6:04 AM 5 min read
Editorial

With the COVID-19 pandemic in India wreaking considerable strain on tax revenues, calls for more disinvestments are louder than ever. In fact, the Government’s disinvestment target for FY2021 is its highest ever since 1991.

But meeting this would be easier said than done.

The pandemic has adversely affected economic activity which has no doubt deteriorated disinvestment prospects. The nationwide lockdown forced the Government to extend the deadline for several Expressions of Interest (EoI) including for Air India. Record low oil prices meant bad news for Bharat Petroleum's (BPCL’s) envisaged disinvestment.

The only silver linings in these uncertain times are the buybacks and dividends by Public Sector Undertakings (PSUs) to the Government (which have their own demerits) and a stake sale from the state-owned Numaligarh Refinery. However that is not a pure play disinvestment as the buyer would be another state-owned firm.

In light of these challenges, even Government officials admit that the previously stated FY21 target is now “irrelevant”.

Let us look at a brief history of disinvestments to bring much needed context to the disappointing state of progression in this matter, both for disinvestments currently being undertaken or planned.

Why Disinvest?

Disinvestment is the act of selling or liquidating an asset or subsidiary by an organisation, in most cases this being the Government. If you think about it, it’s the opposite of investment. Whereas “investment” involves infusing capital in a company in exchange for ownership, “disinvestment” involves relinquishing ownership in a company in exchange for releasing capital.

The capital released through this transaction (i.e. The disinvestment proceeds) are a form of revenue for the Government.

Since Independence, Government-owned enterprises, also known PSUs, have remained important pillars of the economy. The public sector employs close to 30m people, contributing ₹3.5trn ($46.5bn) to the public exchequer. But their dominance has dimmed since the 1990s, as evidenced by the dwindling share of their market cap to total market cap (from 31.6% in 2004 to 11% in 2019).

 

From PSU Reform to Fiscal Diversification

PSUs’ low efficiency and proclivity for loss-making is not new information. An analysis of the Return on Capital Employed (ROCE) shows that PSU returns dropped by almost 50% through 2009-2018.

According to the Public Enterprises Survey 2018-19, there are 249 operating Central PSUs (excluding insurance companies), of which 178 are profit-making and 70 are loss-making. But among profit-making public companies, just ten (mostly from oil, gas and power corporations) account for two-thirds of all PSU earnings.

Meanwhile, loss-making PSUs have continued to pile on debt and continue to be a massive drain on the exchequer. It is estimated that 10-15% of the total gross domestic savings are being affected on account of low savings from PSUs.

So it’s fairly obvious that some degree of reform is necessary to stop the continued wastage of taxpayer money and better utilise resources. One way out is for the Government to divest its stake in these companies via disinvestment and use the capital raised in the process for other purposes.

After all, enough has already been said on how PSU disinvestment can improve public finances by reducing dependency on tax revenues, encourage better management and more innovation, deleverage the Government, enhance competition, and depoliticise (i.e. Remote control from Finance Ministry) functioning of enterprises at-large.

 

A Brief History of Disinvestment in India

As a policy objective, disinvestments were embraced by the Government during the economic liberalisation of the early 1990s. The first disinvestment was announced by then Finance Minister Manmohan Singh during his Interim Budget speech on July 24th 1991. In that year, minority shares were sold by auction method in bundles of "very good", "good" and "average" companies.

In the two decades that followed, disinvestments continued to take place but at a relatively weak pace. There was a brief increase in targets and proceeds in the early 2000s but there were also many years when no targets were set and no disinvestment proceeds achieved.

It was only in the 2010s that activity picked up. Since FY2011, the Government’s disinvestment targets and proceeds have remained high (although the former has been higher than the total receipts in all but two years in this 10-year period).

Interestingly - but perhaps unsurprisingly - the drive to disinvest is driven by ideology i.e. It depends on which political party is in power at the Centre. The BJP-led NDA, which is perceived as economically more right-wing, accounts for more than 58% of all disinvestment since 1991.

 

How to Disinvest?

Now that we understand what disinvestment actually is, let’s delve into the different methods of disinvestment. As per current policy, disinvestments can be of two types:

  1. Minority stake sale: Here, the Government post sale continues to retain majority shareholding i.e. Greater or equal to 51%.
  2. Strategic disinvestment: This involves the Government selling a substantial portion of its stake - 50% or more - and relinquishing management control of the PSU.

Some other ways to disinvestment can be:

  1. Initial Public Offering (IPO): First time offer of shares by an unlisted PSU to the public for subscription.
  2. Secondary Offering: Offer of shares by a listed PSU to the public for subscription.
  3. Institutional Placement Programme (IPP): Only qualified institutions can participate in an IPP placement.
  4. Exchange Traded Fund (ETF): Disinvestment through ETF route allows simultaneous sale of Government's stake across diverse sectors through single offering.
  5. Share Buybacks: A PSU can offer buyback of shares from the Government at a premium (You can read more on PSU Share Buybacks and Dividends here).

 

Challenges and Obstacles of Disinvestment

Just as there are numerous advantages to disinvestments, there are also numerous challenges:

  1. It’s not universally popular. Selling “family jewels” or “nation’s treasures” is viewed unfavourably by disinvestment’s many critics, who include labour unions and politicians.
  2. PSUs are Government companies and thus the profit-making ones are a source of regular income. Their privatisation would mean a loss of this income channel.
  3. Strategic, national security and public interest concerns. Some PSUs are significant in a strategic sense. Bharat Petroleum, for example, is one of the world’s biggest corporations and holds considerable sway over the country’s oil and gas wealth. Its privatisation would imply an ill-conceived notion that private companies can lay claim on ownership of natural resources and not the public.
  4. Labour concerns. Private companies can streamline the operations of a PSU to make it more profitable. This could lead to job losses and labour unrest, which are politically charged issues.
  5. Unsurety of incentive for the private sector. Many PSUs are loss-making and in bad shape. The Government may be eager to divest its stakes in these enterprises, but they might not garner much enthusiasm from investors.

FIN.

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