India’s disinvestment conundrum

Strategic disinvestment as a public sector reform dates back to former Prime Minister Atal Bihari Vajpayee’s government (1998-2004). At the time, nearly half of the 242 central public sector undertakings (CPSUs) were making losses and a quarter sick. Vajpayee embarked on a course correction with his famous declaration in Parliament: “Disinvestment/privatisation is the only panacea for ills of loss-making public sector undertakings.”

Disinvestment (a euphemism when the government sells in the stock exchange a small minority stake in a wholly-owned government company but retains the controls and management) or privatisation (when the government sells a government company and its control to a private person) is always an emotional subject especially for an economy which has been raised on the belief that one of the primary responsibilities of the government is to invest in business and create jobs. Hence for India, the government normally looks at a business more like a social and political investment rather than a financial one, where any expectation of profits is a residual element after taking care of social and other objectives.

Any conversation of strategic disinvestment or privatisation gets controversial as employees and other stakeholders, including unions and political parties, often feel that transferring government control to private players betrays the interests of the people, no matter how perennially unviable or irrelevant that PSU may be or for what period it may need to be funded by tax payers.

Like in any sale , the key process is to determine what constitutes fair value–which often is subjective. The other is to determine which assets or companies to sell–profitable or loss-making ones–as well as the timing of the sale.

In the first generation privatisation programme of 1998-2004, national debates revolved around undervaluation of some of the PSUs (Modern Food, BALCO, ITDC etc) while attempts to disinvest stakes in a profit-making oil major like IOC or an aluminium company like NALCO raised questions on why the government was selling its “crown jewels” or the “family silver”. Some evocatively described some of the deals as “privatisation of profits and nationalisation of losses”.

The question we need to ask is what business should the government be operating and what is its relevance to public interest? Does the government serve its duties by being in highly competitive industries like telecommunication, hospitality, aviation, consulting etc? Can national assets be put to use more efficiently by private players and should government not use the proceeds from the sale to build physical and social infrastructure?

Economist Ila Patnaik argues that privatisation increases efficiency of utilisation of resources, both labour and capital. Even with partial privatisation, the levels and growth rates of profitability, labour productivity and investment spending improve significantly. Several studies have come to similar conclusions using different methodologies. A recent one by NIPFP analysed CPSUs’ performance using policy variables and factors affecting efficiency and productivity, and the results support disinvestment as a tool to improve performance. Privatisation not only improves labour productivity and efficiency but also improves overall efficiency. The study goes on to argue for a bolder privatisation even of CPSUs making operational profits because privatisation unlocks capital for use elsewhere and reduces the possibility of political interference.

It is fairly well known that rarely does any government company get a higher price earning multiple ratio than its private sector peers due to discounts factored in by markets on management freedom, efficiency parameters, and the ability to change/implement strategy etc. For example, the results of companies for all key performance indicators like Maruti, BALCO, VSNL (now Tata Communications) etc. are significantly better under private owners than under government ownership.

The present government faces a similar situation as that of Vajpayee. One-third of CPSUs today are making losses. Between 2007 and 2016, sick CPSUs reportedly registered a loss of Rs 19.68 lakh crore and many of them would never turn cash positive ever. Further, once-profit-making entities like BHEL, ITDC, MTNL, and BSNL have now turned into loss-making entities.

India traditionally has been shying away from taking tough decisions in selling stakes in PSUs. The country has followed, for most parts, a path of least resistance–selling small parts of government stakes in public markets but retaining government control and principal ownership. For example, most PSU banks or oil majors are listed companies but operate under government control which are partly fuelled by private capital from minority shareholders. But more often than not, managements are changed not for poor performance but with a change in government while administrative ministries have contractual rights to intervene in decision-making and day-to-day affairs. Such government control has, at times, led to accusations of undermining minority interests as government as owner takes all key decisions without any reference to the board or the other shareholders of the company.

London-based The Children’s Investment Fund Management (TCI) exited from Coal India after filing a class-action suit citing strongarm tactics of the government which runs contrary to the promises made by the government while raising finances from the public markets. This agency problem where government as owner and manager (as they appoint all directors and the board) is one of the factors that deters patient international capital from flowing into government companies in a disinvestment plan. The value realised from such listing is much lower than the premium received for change of control as in a strategic sale to private players. The value received for Balco, VSNL, Hindustan Zinc etc. through a global bid process bears testimony to this.

In any sale, optimising gains depends on timing (demand and attractiveness steeply declining with time) or value proposition and the price. For example, Air India has an accumulated loss of about Rs 50,000 crore and an equal amount of debts. MTNL and BSNL, which were making huge profits in 2004, ran up losses to the extent of Rs 2,000 crore and Rs 8,000 crore, respectively, in 2014. Even a maharatna like BHEL has slipped from a profit of Rs 7,400 crore in 2011-12 to a loss of Rs 913 crore in 2015-16. Air India, BSNL, and MTNL, among other companies like Pawan Hans or Hindustan Latex, are classic examples of attempts at privatisation of bleeding public sector companies which have gone way past their prime to be attractive to any buyer as a business enterprise, though they may have value intrinsic to the landing rights, licences they carry and similar assets.

MTNL, BSNL or Air India were extremely valuable companies in the late 1990s and the delay in taking tough calls due to weakened political will in the wake of burgeoning losses has seen such value almost decimated. This inability to privatise at the right time ended in the closure of HMT, once a leading light in machine tools and watches.

There was justification for government to set up and run businesses at the time of independence but there is little now. Private capital and management have proven to produce better returns and run globally competitive businesses. The government should focus its resources and energy on improving social indicators like health, education, nutrition, and other welfare needs. The losses of unviable PSUs employing a few lakh people are in reality borne by crores of people living below the poverty line. A sound plan for utilising disinvestment proceeds in an equitable manner would rather serve the economy better. Getting out of business that it need not run appears in sync with the Prime Minister’s credo: “Minimum government and maximum governance.”

(The author is a Director at Thought Arbitrage Research Institute)

(The views expressed in this article are not those of Fortune India)