Privatization in India and related issues | Timeline

India adopted a mixed economy model, where the Public Sector Enterprises (PSEs) were established on a socialistic pattern of development. However, due to the poor performance of several PSEs and the consequent huge fiscal deficits, privatization was pursued.

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For the ongoing fiscal year FY22, the government has set a disinvestment target of Rs 1.75 lakh crore. The plan includes privatisation of two public sector banks, public listing of the Life Insurance Corporation of India, Shipping Corporation of India, and many other PSUs.

The government (privatized) sold Air India to the Tata group for Rs 18,000 crore last year.

Privatisation means transfer of firms from the Public to Private Sector through the transfer of ownership, management and control.

Privatisation was intended to achieve the following objectives:

  • Improve the efficiency and financial discipline of PSEs.
  • Facilitate modernization of PSEs.
  • Reduce fiscal burden on government in maintaining PSEs.
  • Attract Foreign Investment.
  • Signal to the market that government is promoting free-market principle.

Privatization vs Disinvestment

In privatisation the government divests more than 51% of its shareholding in the company and the management control is transferred to the private sector.

In the case of disinvestment, the portion of shareholding that the government divests is equal to or less than 49% so that the ownership and control over the company remains in the hands of the government.

Disinvestment is a purely Indian term that connotes what it means. The government sells shares of companies so that it supports the Budget.

The tone of privatisation is different, as it means that the government is keen to get out of certain sectors that are not strategic. By selling its stake to below 50%, the ownership passes, and the company works like any other private sector enterprise.

For instance: Govt’s minority stake sales in companies such as National Mineral Development Corporation (NMDC), Housing and Urban Development Corporation (HUDCO) etc are part of the disinvestment process, while sale of Air India to Tata last year will come under privatisation.

Section updated on 15th Mar 22

Mains Marathon – 11th Feb 22

The Privatization exercise in India has been a mixed experience. The privatization drive picked the pace between 1999 and 2004. Many big companies like Maruti Udyog were privatized at that time and most recently Air India was privatised.

  • These companies have performed well since their privatisation. For example, Hindustan Zinc is now worth Rs 40,000 crore and government still holds a 29.5% stake. Thus, the government has benefitted from these companies.
  • It led to optimum utilization of resources of the economy, which were being spent on maintaining PSUs. It helps in fiscal consolidation of the economy.
  • It fostered competition in sectors monopolized by the PSEs leading to better services to consumers. For example, Maruti Suzuki has 50% share of the market at present.
  • It reduces political interference and bureaucratic delays in the functioning of the enterprises. Which raises the overall efficiency of the economy.
  • It increased democratization of the economy, with more participation from common citizens.

“It’s time to take a relook at privatisation” – The Hindu – 10th Feb 22
India’s fiscal deficit (for the Centre) in FY22 is expected to be at 6.8% of the GDP and with the debts of States, it will be 12.7% of the GDP. Fiscal deficit is growing wider every year and there is a consensus that privatization is the panacea. But, that’s not true.

One, the gap in growth between public sector undertakings (PSUs) with autonomy and private firms is not significant. For instance, British privatization initiative of British Airways, British Gas, and the Railways led to no systemic difference in performance.Two, privatization has mixed results in developing countries. There are examples like VSNL and Hindustan Zinc, but growth post-privatization is due to multiple factors like better funding and better business cycle. The issue with PSUs is government apathy and their inability to generate tax revenues.

Three, privatization as a policy has failed to raise significant funds and actual receipts from disinvestment have always fallen short of targets. For example, by FY20, ₹50,304 crore was raised against a target of ₹1 lakh crore (PRS India, 2021). In total, between FY11 and FY21, about ₹5 lakh crore was raised that is, about 33% of just FY22’s projected fiscal deficit.

Four, considering social and institutional constraints, India’s ability to privatise firms will be slow in the future. For example, BPCL.

Five, since interest rate is rising, this is not the right time to privatize. For example, the recently held auction of 21 oil and gas blocks had only three firms participating, of which two were PSUs and 18 blocks ended up with just a single bid.

Six, there is also a challenge of valuation. For example, about 65% of 300 national highway projects have recorded significant toll collection growth. The valuations of such assets should ensure that they capture potential growth in toll revenue.

Seven, there are also serious social consequences. PSUs generates employment and have multiplier effects on economy. Hence, a push for privatisation is a push for mass layoffs when there is already low job creation.

Eighth, another major concern is greater concentration of public assets in selected private hands. For example, telecom has only three players left. It will increase higher usage fees, inflation and also a loss of strategic control.

Mains Marathon – 11th Feb 22

  • Social justice: Privatization undermines the development of backward regions that are not economically viable.
    • The public sector provides employment to historically backward section under affirmative action, privatization will hinder affirmative action.
  • Employment: The Central Public sector India provides employment to over 1 million people, privatizing PSE may lead to mass layoffs in the when job creation is low.
  • Loss of revenue: Loss-making entities are not attractive for the private sector. However, selling profit-making and dividend-paying PSU would result in loss of a regular source of income to the government. In 2020-21, when the pandemic struck the economy, 45 PSU companies paid dividends of more than Rs 46,000 crore to the government.
  • Strategic and national security concerns: Privatizing PSUs in strategic sectors, like Oil, may threaten our strategic goals. For example, the attempt to privatise BPCL.
  • Failure in Resource mobilisation: The government has not been successful in achieving the disinvestment targets in many fiscal years. In FY11, ₹22,846 crore was raised against a target of ₹40,000 crore; by FY20, ₹50,304 crore was raised against a target of ₹1 lakh crore.
  • Short term solution to fiscal needs: Privatization with the aim to finance fiscal deficits is only a short-term solution and does not solve the bigger issue of mismanagement.
  • Creation of private oligopolies: With increased concentration of public assets in a few private hands will lead to higher costs to consumers and loss of strategic control with the Government. For example, Telecom sector in India only has 3 major players left.

“A change of course on privatisation” – Business Standard – 11th Feb 22

First, the objective is to bring more efficient utilisation of assets and fetch revenues. But for this to happen, the government must get the valuation right. For instance, in a depressed market, the chances of the asset being under-valued are higher.

Second, the firm needs to undergo a certain amount of restructuring before it is offered for sale so that it attracts the right suitors. To attract a better price, there must be multiple bidders. Ensuring these conditions is not a simple matter.

Third, rushing for privatization by setting targets with no proper valuation becomes controversial. For example, in the Hindustan Zinc Limited (HZL) sale, the Supreme Court has asked the Central Bureau of Investigation to conduct an enquiry into the transaction.

Fourth, for the sale of public sector banks (PSBs), there is a need to be clear as to who the potential buyers might be. The larger private banks of India are not interested due to legacy issues with a PSB.

Foreign banks are also not ready to come into India by setting up a wholly-owned subsidiary, as the Reserve Bank of India (RBI) wants.

Also, selling to a scattered group of foreign institutional investors creates a governance vacuum. For instance, public sector entities had a significant stake in the UTI Bank and a large stake was sold to FIIs. Now, they continue to hold a significant stake in Axis Bank.

Fifth, bank failure has numerous negative economic and political consequences such as disruptions in Parliament, paralysis of the administrative machinery and negative media coverage. For example, Yes Bank.

“A change of course on privatisation” – Business Standard – 11th Feb 22

Why the Budget has changed the course of privatisation?

The Budget has set a modest target for privatisation of Rs 65,000 crore. Also, much of the receipts for FY 21-22 will be accounted by disinvestment in LIC, not from privatisation.

Though the privatization of Air India is successful, but the fact is that the Air India’s privatisation took four years to conclude.

Also, to privatize it, the government took various measures such as taking over nearly 75 per cent of Air India’s debt, employees are guaranteed jobs for one year, and then it was sold to a trusted business group.

Taking so many measures for other public sector undertakings (PSUs) is time-consuming and impossible as well.

What does the government’s decision to de-emphasise privatisation reflect?

One, the Indian state lacks the capacity to execute privatisation on a large scale.

Two, carrying out the sale of public assets carelessly can prove costly in both political and economic terms.

Three, it is not helpful to turn privatisation into a benchmark of overall economic performance. It overshadows all other reforms and initiatives of the government.

Why LIC should be privatized?

“LIC disinvestment: Right and wrong” – Business Standard – 15th Feb 2022

First, the previous experience shows outcome of disinvestment in public sector banks has not been good for the taxpayer or for the economy. On the other hand, in case of proper privatization experience has been better.

Second, LIC has grown substantially over time and has a monopoly. That’s why it is suggested that GoI should privatise LIC, and it should give up the control to the private sector at the right price.

Third, it is said that it is not the business of the government to be in business. But it is very much the business of the government to provide public goods and services, which the private sector fails to provide. The proceeds of privatization can be utilized to improve public service delivery.

Instead of mere disinvestment, it is important to privatize LIC and use the sale proceeds for expanding and improving basic public services that are effectively productive. It will benefit the common person much more than those who are well-placed.

Why LIC IPO is important for the Govt?

“Lessons in our hiccups over selling an LIC stake” Live Mint15th Mar 22

The regulator’s approval of the IPO is valid only till mid-May. Any delay will upset the Centre’s fiscal math. It can also:

  • Provide significant revenue for the Centre.
  • Lead to reduction of fiscal deficit.
  • Will take LIC to the market
  • Further push disinvestment agenda.

What lessons do uncertainty over IPO hold out?

“Lessons in our hiccups over selling an LIC stake” Live Mint15th Mar 22

Need to take faster approach: First lesson stems from the fact that since the Ministry has 2 years to finalize the strategy, the IPO need not have been timed just before the end of 2021-22. Reasons for such a slow approach are not clear. They could be due to:

– Attempt to time the market: As financial advisors often advice retail investors to ride the bull run i.e. when market is growing.

– Politics: In the past, politics has played a role in deciding the timing of public-sector disinvestment. Example – Offshore listing of VSNL was pulled back due to apprehension of the coalition government that low prices will lead to Parliamentary opposition.

However such frequent flip-flops send mixed signals about share offer intended price range and also confuses investors.

Need to reduce over-reliance on disinvestment: Second lesson is related to the government’s over-reliance on disinvestment to get its fiscal right.

  • Earlier, disinvestment was used as an emergency measure to make up for revenue shortfalls.
  • Now it has been institutionalized. However, it has neither led to improvement in fiscal gaps over the year, nor has led to improvement in public sector efficiency.
  • There is continuous failure to meet the disinvestment targets year after year.

Hence, disinvestment can be effective as an utilitarian exercise, but it is vulnerable to failure if used as a means of grand transformation.

Privatization of Air India

“Flying Home” and “Win-win deal: Why Air India privatization has drawn little to no criticism” – Indian Express & Business Standard – 29th Jan 22

Why Air India privatization is seen as a beneficial move?

One, the airline had been losing money for the last 15 years. There are other government companies with a similar record, but the scale of losses was huge in the case of Air India.

Two, there was less hope available to transform the airline. The other difficulties with Air India were empty airport slots, 100 poorly maintained aircraft, and staff to be given terminal benefits. Hence, the write-off of the remaining Rs. 44,000 crore has been a win-win.

Three, the merger of Air India and Indian Airlines during the previous UPA government also resulted in disastrous consequences because the expected synergies were not realized. The then civil aviation minister was also questioned for ordering a huge number of aircraft, which led to the accumulation of more debt.

Why this sale is significant?

It marks the first major complete privatization of a public sector entity in recent years. Officials in the finance ministry worked out how to finance the liquidation of Rs 61,000 crore, the left-behind debt.

“Lesson from Air India sale: Do more by doing less” – Indian Express – 27th Jan 22

Priorities: Public commercial enterprises do not perform well in Human resource efficiency. Air India had 12 trade unions and employee cost was as high as 20% of the revenues.

The state’s job should be to maintain security, family healthcare, education, justice delivery, etc. Activities in which the private sector can do better should be left with a private sector.

Resources: In 1953 Hungarian economist Janos Kornai pointed out that state firms indulge in “investment hunger”, they don’t fear losses because they know they will be bailed out. For example, Air India costs the government only Rs.2.5 crore to buy. But it has consumed Rs 1.1 lakh crore since 2009. Kornai termed this as a soft budget constraint.

Even Supreme Court termed Air India’s acquisition of 111 planes in 2007 as excessive. This resulted in the loss of Rs.20 crore per day.

Mindset: The “fatal conceit” represented by Air India’s seven-decade tragedy suggests that India need a better role balancing between the three pillars of team India — private, public, and nonprofits.

Mains Marathon – 11th Feb 22

The present model of privatization may include the steps like de-bureacratisation and greater autonomy, especially for PSEs of strategic importance. The revenue generated must be utilised for capital investment.

India could follow the example of Singapore, where the government created an independent body (Temasek holdings) to corporatize and developing public sector units. Any policy on privatization must consider social and strategic benefits of PSUs apart from the economic benefits.

“A change of course on privatisation” – Business Standard – 11th Feb 22

First, government should set a modest target for privatisation, or it should avoid setting the targets and use the disinvestment and privatisation receipts as a balancing item in the Budget.

Second, government should consult the RBI on “fit and proper” criteria for potential buyers.

“It’s time to take a relook at privatisation” – The Hindu – 10th Feb 22

Third, stake sales can be considered a preferred route. It gives time to ensure price discovery, allowing improved performance to raise valuations over time.

For example, the Maruti model. The government had a joint venture with the Suzuki Corporation. Exits from Maruti were conducted in small tranches which ensured a better valuation for the government.

Fourth, a PSU with greater autonomy with the government retaining control via a holding firm can be a solution. For example, in China growth has been led by corporatised PSUs, all of them are held under a holding company (SASAC), which promotes better governance, appoints leadership and executes mergers and acquisitions.

In Singapore, the Ministry of Finance focuses on policymaking, while Temasek (the holding firm) is focused on corporatizing and expanding its PSUs.

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