Themes > Features

28.12.1999

Disinvestment, at What Price

Through the 1990s, consecutive governments at the Centre have advocated the sale of public sector equity as a means of public sector 'reform'. Equity sale, the industry policy statement of July 1991 argued, was a means of ensuring financial discipline and improving performance. The fact that there is little theoretical justification for or empirical validation of this position has of course been ignored. The immediate reason is fiscal convenience. Having internalised the IMF prescription that reducing or doing away with fiscal deficits is the prime indicator of good macroeconomic management, the government has found privatisation proceeds to be a useful source of revenues to window dress budgets. To boot, such window dressing could be defended on the grounds that privatisation was taking the economy in a market friendly direction.
 
This has meant that, while there has been much talk of managerial reform, voluntary retrenchment and greater public sector autonomy, the thrust of public sector reform has been the sale of equity. In the event, the target for disinvestment has been increasing. It was placed at Rs. 2,500 crore in 1991-92, Rs. 3,500 crore in 1992-93 and 1993-94, Rs. 4,000 crore in 1994-95, Rs. 7,000 crore in 1995-96, Rs. 5,000 crore in 1996-97, Rs. 4,800 crore in 1997-98, Rs. 5,000 crore in 1998-99 and an ambitious Rs. 10,000 crore in 1999-2000.
 
Over these years, the nature of the privatisation has also changed. Initially the emphasis was on divestment of a part of equity, with the controlling block still being with the government. Since shares of different public sector units (PSUs) would be valued differently by the market because of variations in performance, shares were offered only in "bundles" which combined equity from poor and good performers. In practice, rather than help the government divest shares in loss-making enterprises at reasonable prices, bundling resulted in the government obtaining an extremely low average price for each bundle, implying that prime shares where being handed over at rock-bottom prices. Thus, in 1991-92, when the bundling option was resorted to, the average price at which more than 87 crore shares were sold stood at Rs. 34.83, as compared with the average price of Rs. 109.61 realised since then (Table 2). While the growing tendency to sell equity in the best PSUs partially accounts for this difference, it was also due to the low prices obtained for even premium shares in that year. As Table 1 shows, MTNL, ITI, VSNL, CMC and Cochin Refineries were some of the firms in which the government's equity was divested that year.

With the experience of 'bundling' proving to be disastrous from a price (and revenue) point of view, the government soon began talking of the need for privatisation, as opposed to just disinvestment. It was argued, by a committee headed by former RBI Governor C. Rangarajan, that equity sales could be of magnitudes that brought the government's stake below 50 per cent and even as low as 25 per cent in some cases. This, it was held, was not merely in keeping with the objective of the State withdrawing from non-core and non-strategic areas, but also provided a greater incentive to the private sector to acquire public sector equity. More recently, after the constitution of the now dissolved Disinvestment Commisssion in 1996, the government has gone further and advocated 'strategic sales' of particular PSUs, or sales of equity blocks to a single buyer accompanied by the transfer of management to the private investor. What is amazing is that in some cases such as IPCL, a highly successful and profitable PSU, the transfer of management has been recommended to any private party which acquires a 25 per cent in the company.
 
The willingness to hand over control through strategic sales has resulted in allegations of complicity between sections of the government and particular domestic or international business groups such as Reliance industries in the case of IPCL. Such allegations are also buttressed by the fact that if Reliance does manage to acquire control of IPCL, it would have a virtual monopoly over certain segments of the market for hydrocarbons. But setting aside such allegations, it is clear that the longer the government persists with its privatisation agenda, the greater are the concessions it has to make to private sector buyers of government equity.
 
These concessions are of three kinds. First, lower prices. While the first issue of global depository receipts (GDRs) by VSNL in March 1997 was prices at $13.93 and was oversubscribed 10 times, the GDR issue in February 1999 was priced at $9.25. Not only was the February price much lower than the March 1997 price, but it amounted to a discount of 12 per cent relative to the 10-day average price of VSNL GDRs on the London Stock Exchange at that time.
 
More recently, there has been much controversy surrounding the sale of 18 per cent equity in GAIL (acquired mainly by GAIL's potential competitors Enron and British Gas) at Rs. 70 per share, when the ruling market price was Rs. 79.80. While the government raised Rs. 1,095 crore through the disinvestment of 155 million shares represented by 22.5 million GDRs, it has at the minimum suffered a loss of Rs. 145 crore, besides giving GAIL's international competitors an initial stake which can be built up into a voice in the management of the company. However, it is not just the discount relative to prevailing market prices that reflects the low prices at which prime public assets are being sold. Even market prices most often do not reflect the real worth of the assets of many of these companies and definitely not the true value of these assets for some of the companies acquiring them.
 
The second concession the government has had to make is that it increasingly has to put the best assets of the public sector up for sale. Charts and 3 and 4 detail the percentage of shares disinvested by the government between July 1991 and March 1997 and the total extent of sale of the government's shareholding in these companies as on March 31, 1997. What is clear is that much of the disinvestment has indeed occurred during the years of reform and that among the companies in which a third or more of equity had been divested even by 1997 March were successful public sector giants like VSNL, Bharat Petroleum, IPCL, HOCL and Hindustran Petroleum. Even including the less profitable PSUs in which government equity has been divested, the average rate of return (gross profit to total capital employed) during 1994-95 to 1996-97 in companies subjected to privatisation stood, at 22.2 per cent, well above the average of 14.93 per cent for the public sector as a whole (Chart 5).

Finally, the third concession which the government has had to increasingly offer for pushing ahead with privatisation is a willingness to provide management control to "strategic investors" from the private sector, even in instances where the investor concerned does not hold a majority of shares.
 
Unfortunately for the government, despite these concessions, equity sale has not proved an easy task. As Chart 1 shows, there have been only three years (1991-92, 1994-95 and 1998-99) in which proceeds from divestment in the budget have been of consequence. The government's "success" in these three years was however attributable to widely divergent reasons. In 1991-92, success was due to the decision to accept extremely low bids for share "bundles" which included equity from public sector units which would have otherwise commanded a handsome premium. In 1994-95, success can be traced to the willingness to offload a significant chunk of shares in attractive targets like BHEL (11.74 per cent), Bharat Petroleum (3.42 per cent), Container Corporation (20 per cent), Engineers India (5.99 per cent), GAIL (3.37 per cent), Hindustan Organic Chemicals (23.1 per cent), Hindustan Petroleum (9.47 per cent), ITDC (10 per cent) and MTNL (12.82 per cent) (See Table 1).

Finally, the experience in 1998-99 when the government exceeded its disinvestment target by a wide margin, was in substantial part the result of the decision to get cash-rich PSUs to "cross-hold" shares in related PSUs by buying the same off the government. Of the Rs. 9,000 crore garnered in 1998/99, only Rs. 1195.25 crore were raised through market disinvestment in Concor (Rs. 225 crores), GAIL (Rs. 184 crore) and VSNL (Rs. 786.25 crore). Much of the rest came from cross-holding investments by the oil PSUs, ONGC, GAIL and IOC. Cash rich public sector corporations were forced to buy-back the government's holding of their equity or the equity of other public sector enterprises. This amounted to forcing PSUs, that need resources to allow for restructuring in order to face up to the more liberal and competitive environment, instead to hand over their investible surpluses to finance the fiscal deficit of the government. As Chart 2 shows, in all three years in which disinvestment proceeds have been significant, they helped finance around 8 per cent of the fiscal deficit that would have shown up in the budget but for privatisation.
 
The 1999-2000 budget had provided for these sale proceeds to finance as much as 10 per cent of the projected deficit without privatisation. With just 3 months to go, the government has managed to raise just about Rs. 1,500 crore of the budgeted Rs. 10,000 crore, much of which has been garnered by the distress sale of GAIL shares. While factors like the elections did tie the government's hands a bit, the main reason for this year's failure on the disinvestment front is the unwillingness of private buyers to offer the government a reasonable price for its shares. The government had, in fact, to defer the launch of its plan to sell an additional 19 million shares, which was expected to yield $100 million because of the low prices that were on offer in the market.
 
Faced with this situation the government appears to be resorting to two options, First, to use a revised version of the cross-holding route. Power Minister Rangarajan Kumaramangalam recently created a stir by announcing the government's 'decision' to transfer its shareholding in the National Hydroelectric Power Corporation (NHPC), which reportedly survives on a budgetary handout of Rs. 450 crore every financial year, to the National Thermal Power Corporation (NTPC), for a princely sum of Rs. 4,500 crore.
 
Among the reasons for the transaction, the Minister clearly declared, was the effort to garner the resources needed to meet the target of Rs. 10,000 crore from privatisation set in the budget. Virtually pre-empting the question as to where the NTPC itself was to find the money to pay the government, Kumaramangalam's statement described a structured process in which the NTPC would hive off a few of its units into a new subsidiary. Subsequently, 51 per cent of NTPC's holding in the subsidiary would be offloaded to the private sector. That strategic sale was expected to yield the resources to pay the government Rs. 2,500 crore this financial year and Rs. 2,000 crore in the next financial year.
 
Even to those initiated in the intricacies of the ideology of privatisation, the proposal sounded peculiar. Clearly what was being privatised at the end of this process was not the NHPC but a segment of the NTPC. If that be the case, the government could have chosen to offload a part of its shareholding in the latter corporation to directly obtain the Rs. 4,500 crore, so that a truncated NTPC is not left burdened with NHPC's less profitable assets.
 
This suggests that the government is seeking to achieve two objectives at one go. The first, to use the words of Finance Minister Yashwant Sinha, is to treat the NTPC as a "big ticket item", which could immediately yield large revenues from equity sale to solve the problem of this year's burgeoning fiscal deficit. The second is to transfer that money to the government through the devious route of NHPC acquisition so that the returns on the assets remaining with the NTPC could cover the deficit in the NHPC's accounts and reduce the government's future budgetary burden.
 
Needless to say this amounts to a strategy of virtually killing one of the "Navratnas" in the public sector, to meet the immediate "revenue" needs of a cash-strapped government. It is virtually forcing one of the better performers in the public sector to resort to a strategic sale of some of its best assets in order buy up poorly performing public sector units. This would only render the public sector even more of a burden on the exchequer.
 
In fact, it has been reported that as a quid pro quo for the NHPC buy-out deal, the government has promised to cap dividend payments by the NTPC as well as leave the Navratna status of the corporation untouched even if it contracts debts that have to be guaranteed by the government, such as multilateral loans. That debt is seen as an important way of keeping the NTPC afloat is reflected in Kumaramangalam's statement that the buy-out of NHPC by increasing the asset base of the corporation would increase its leverage in the financial market. Put simply, the strategy appears to be one of reducing the fiscal deficit in the central budget by substituting government debt with public sector debt.
 
Secondly, given the cash-crunch the devious buy-back and equity cross-holding schemes are to continue. According to reports, the government is expecting to garner Rs. 500 crore from a buy-back of government equity by the Rural Electrification Corporation and the Power Finance Corporation. This would imply that in the long run, the returns which the government gets in the form of dividends from profitable public enterprises would fall, while its commitment to cover the losses of loss-making public enterprises would remain, worsening thereby the fiscal situation.
 
Finally, the distress sale of equity in leading PSUs like MTNL, VSNL and IPCL cannot be ruled out. If the divestment of large chunks of equity is to be persisted with, the prices of these otherwise valuable assets are bound to fall. And all indications are that the government is firmly set to move in this direction. The final loss may be borne not only by the citizens who ultimately finance the government's budget through their direct and indirect tax payments, but also by consumers who may have to deal with private monopolies in critical areas of domestic economic activity.