MacroScan (Printable Version) - Privatisation on Hold

On 16 September 2003, the Supreme Court of India delivered a landmark verdict. It stripped the executive of its self-assumed autonomy in the areas of disinvestment and privatization. The court, in essence, ruled that any enterprise created under or transferred to public ownership by Parliament cannot be privatized without parliamentary approval. This was a major ruling in itself, given the fact that the Parliament has been repeatedly by-passed in the course of the accelerated privatization programme adopted by the NDA government in recent times.

But the judgment went much further. It provided a definition of public ownership that cannot be violated without parliamentary approval, which has far-reaching implications. The case in question related to the disinvestment of shares in the oil majors Hindustan Petroleum Corporation Limited (HPCL) and Bharat Petroleum Corporation Limited (BPCL). These were units that were acquired in the early 1970s by Acts of Parliament which expressly states that the activities in which they are involved (especially the distribution and marketing of petroleum products) need to be brought under the aegis of the state. They must, therefore, vest with government companies or units in which the government has a majority stakeholding and exercises managerial control.

The proposed disinvestment of the two oil retail majors—involving a sale of 34.01 per cent of equity in HPCL to a strategic partner who would be offered managerial control, and a sale through the market of 35 per cent of public equity in BPCL—violated both these requirements of the parliamentary Acts. The government’s equity stake would have fallen well below 51 per cent, given the pre-existing shareholding structure, and there would have been an explicit or implicit transfer of managerial control. Their sale without parliamentary approval and revision of the Acts concerned would therefore have been an obvious legal violation.

According to a reading of the judgment by the constitutional expert Rajeev Dhavan, in the course of restraining the sale of HPCL and BPCL, the two-judge bench went still further. It suggested that a process by which a company is set up by the government as an ‘instrument of service’, even if not through a specific Act, and is explicitly provided grants through the government’s budget, meets the ‘technical requirement of parliamentary approval’. Therefore, in such cases too, parliamentary approval for reducing the government’s stake or transferring managerial control to the private sector is required.

The highest court’s opinion is clear. If the Parliament of India has either explicitly or implicitly approved of a particular unit being run as a government company, then the Parliament’s approval is needed for changing the status of the company and handing its control to the private sector. Thus, the HPCL/BPCL judgment completely deprives the government of the right to by-pass the Parliament as implicitly provided by earlier judgments. Those judgments had accepted the view that disinvestment and/or ‘strategic sale’ (involving the transfer of managerial control to an entity acquiring a minority block of shares) were matters of public policy to be left to the executive to decide upon. In fact, an immediate consequence of the Supreme Court judgment, which has angered the Disinvestment Minister Arun Shourie, is that it challenges the validity of many, if not all, acts of disinvestment and privatization undertaken under the reform strategy pursued since 1991.

Beyond issues of constitutional correctness, the new judgment is an important milestone also because experience indicates that absolving the executive of accountability to the Parliament is disastrous from the point of view of economic policy. Originally, privatization was seen as just one of many initiatives needed to restructure the public sector, and was to be restricted to loss-making units that are best divested. Over time, however, not only has privatization become the sole means of public sector restructuring, but it has also been presented as the best option in the case of virtually every public unit.

Depending on the particular spokesperson who defends privatization, its role has been variously presented as: (i) ensuring the exit of the government from areas in which it must not be seen to exist, since it is prone to inefficient management of those assets; (ii) unburdening the government of units that are a drain on the exchequer and contribute to a fiscal crisis of the state; and (iii) garnering ‘revenues’ that can be used to (a) reduce the fiscal deficit as is being demanded by international finance and its representative, the IMF, (b) retire government debt and improve the government’s finances in the medium term, or (c) meet much-needed social expenditures that the government is hard put to finance.

The view that the government should not have been present in most areas it has entered, has a two-fold ideological thrust. It presumes that the private sector should be pre-eminent, with the government undertaking an economic activity only where the private sector for one reason or another is unwilling to enter. It also assumes, contrary to the evidence provided by many a public enterprise, that public sector units are by definition inefficient. The latter assumption allows the attribution of losses suffered by public units for reasons completely unrelated to efficiency, to inefficient functioning.

Even ignoring the fact that prejudices of this kind should not be allowed to influence policy, this particular ideological frame should be permitted to drive the management of the public sector only if it is supported by a representative majority. Clearly, the post-judgment ‘confession’ by the government and the private sector-controlled media that the requirement of parliamentary approval for privatization amounts to dumping the policy, indicates that nobody believes that such a majority, let alone a consensus exists. Advocates of reform who contend that there is consensus around it .are obviously not willing to subject their view to a democratic test.

On the other hand, the view that privatization is justified since it garners revenues to deal with various kinds of fiscal problems faced by the government is just plain wrong. Any private entity acquiring a stake in a public sector unit has the choice of using the same resources to invest in government bonds that carry no risk whatsoever, since they carry a sovereign guarantee. Thus, the minimum return expected from an investment is the interest rate applicable to government bonds. If, therefore, a private investor chooses to invest in equity instead, he/she would expect not just a margin above the going interest rate on government bonds but also a premium to cover the risk associated with choosing this option.

In sum, unless the expectations are that the purchase of public equity will yield much higher returns than those offered by government bonds, no private investor will choose to invest in such equity. If that be the case, disinvestment cannot be rationally resorted to, since it would involve a net loss of revenues for the government. If resources from disinvestment are used by the government to retire public debt, revenues will be lower since the assets sold are capable of yielding a much higher return than the interest that was being paid on the debt being retired. On the other hand, if disinvestment is opted for as a substitute for borrowing in order to finance additional expenditures, the revenue lost as a result of disinvestment will be greater than the interest payment saved through reduced borrowing.

The only instance where privatization of potentially or actually profitable assets can be defended is when it is presumed that the government is incapable of running a unit as well as the private sector can and, therefore, is incapable of earning the higher potential return. But to advance such an argument is also irrational, since there are many areas, from national security to poverty alleviation, where the government must perform, since they cannot be privatized. If the government is seen as capable of delivering on those fronts, there is no reason why it cannot be reformed to deliver in spheres of production which, for a variety of reasons, were seen as areas in which public presence was a must.

Unfortunately, specious arguments of the kind cited above have been used by the executive to proceed with privatizing some of the most profitable public sector units. What is more, this process of sale of public assets has involved prices that are patently unreasonably low. In the controversies surrounding the privatization of units varying from Modern Foods to Balco, technical experts have been at pains to point out that the price received by the government for its equity was a fraction of that warranted by the value of the underlying assets. Evidence on the prices of land, mining rights and assets like captive power plants was provided to advance this case.

The executive has at all times chosen to dismiss this view by referring to specious arguments involving accounting principles, stockmarket prices and discounted present values. Even when Centaur Hotel, Mumbai, which the government had sold for Rs 83 crore, was resold four months later by the original buyer for Rs 115 crore, the validity of the argument that the government was undervaluing public assets because of its desperation to sell or for other reasons, was dismissed. To top it all, in order to attract buyers and make successful its accelerated privatization programme, the executive decided to resort to ‘strategic sales’, wherein the purchase of a minority stake at basement bargain prices was adequate to acquire managerial control. As the VSNL experience illustrates, such control can provide the private buyer access to resources that make the investment more than lucrative. In this case the Tata group, which purchased the strategic stake in VSNL, tapped the cash reserves of the company to expand Tata Teleservices, a telecom start-up it controlled.

Besides extra-economic reasons, the only explanation for this misuse of executive power that was made possible by the lack of parliamentary accountability, is the once-for-all ‘benefit’ of garnering resources to finance the budget. Having partly eroded its own tax base by providing tax concessions and under international pressure to curtail the fiscal deficit, the government chose to rely on the short-term strategy of privatization to finance its additional expenditures. Not surprisingly, in the aftermath of the HPCL/BPCL judgment, Finance Ministry officials rushed to the press to declare that it would not be allowed to affect the level of the fiscal deficit in financial year 2003-04. This was an admission that resources from privatization are a form of budgetary finance.

The budget for 2003-04, we must recall, provides for Rs 13,200 crore of ‘revenues’ from privatization. Only a fraction of that sum has been mobilized in the first six months of the fiscal year. How the required substitute resources will be found, is not clear. But that should only bother the government. From the point of view of the ordinary citizen, the Supreme Court has done the country well by putting on hold wanton misuse of executive power in pursuit of a wholly irrational strategy of privatization.



Themes > Current Issues	22.09.2003


Privatisation on Hold

C. P. Chandrasekhar

On 16 September 2003, the Supreme Court of India delivered a landmark verdict. It stripped the executive of its self-assumed autonomy in the areas of disinvestment and privatization. The court, in essence, ruled that any enterprise created under or transferred to public ownership by Parliament cannot be privatized without parliamentary approval. This was a major ruling in itself, given the fact that the Parliament has been repeatedly by-passed in the course of the accelerated privatization programme adopted by the NDA government in recent times. But the judgment went much further. It provided a definition of public ownership that cannot be violated without parliamentary approval, which has far-reaching implications. The case in question related to the disinvestment of shares in the oil majors Hindustan Petroleum Corporation Limited (HPCL) and Bharat Petroleum Corporation Limited (BPCL). These were units that were acquired in the early 1970s by Acts of Parliament which expressly states that the activities in which they are involved (especially the distribution and marketing of petroleum products) need to be brought under the aegis of the state. They must, therefore, vest with government companies or units in which the government has a majority stakeholding and exercises managerial control. The proposed disinvestment of the two oil retail majors—involving a sale of 34.01 per cent of equity in HPCL to a strategic partner who would be offered managerial control, and a sale through the market of 35 per cent of public equity in BPCL—violated both these requirements of the parliamentary Acts. The government’s equity stake would have fallen well below 51 per cent, given the pre-existing shareholding structure, and there would have been an explicit or implicit transfer of managerial control. Their sale without parliamentary approval and revision of the Acts concerned would therefore have been an obvious legal violation. According to a reading of the judgment by the constitutional expert Rajeev Dhavan, in the course of restraining the sale of HPCL and BPCL, the two-judge bench went still further. It suggested that a process by which a company is set up by the government as an ‘instrument of service’, even if not through a specific Act, and is explicitly provided grants through the government’s budget, meets the ‘technical requirement of parliamentary approval’. Therefore, in such cases too, parliamentary approval for reducing the government’s stake or transferring managerial control to the private sector is required. The highest court’s opinion is clear. If the Parliament of India has either explicitly or implicitly approved of a particular unit being run as a government company, then the Parliament’s approval is needed for changing the status of the company and handing its control to the private sector. Thus, the HPCL/BPCL judgment completely deprives the government of the right to by-pass the Parliament as implicitly provided by earlier judgments. Those judgments had accepted the view that disinvestment and/or ‘strategic sale’ (involving the transfer of managerial control to an entity acquiring a minority block of shares) were matters of public policy to be left to the executive to decide upon. In fact, an immediate consequence of the Supreme Court judgment, which has angered the Disinvestment Minister Arun Shourie, is that it challenges the validity of many, if not all, acts of disinvestment and privatization undertaken under the reform strategy pursued since 1991. Beyond issues of constitutional correctness, the new judgment is an important milestone also because experience indicates that absolving the executive of accountability to the Parliament is disastrous from the point of view of economic policy. Originally, privatization was seen as just one of many initiatives needed to restructure the public sector, and was to be restricted to loss-making units that are best divested. Over time, however, not only has privatization become the sole means of public sector restructuring, but it has also been presented as the best option in the case of virtually every public unit. Depending on the particular spokesperson who defends privatization, its role has been variously presented as: (i) ensuring the exit of the government from areas in which it must not be seen to exist, since it is prone to inefficient management of those assets; (ii) unburdening the government of units that are a drain on the exchequer and contribute to a fiscal crisis of the state; and (iii) garnering ‘revenues’ that can be used to (a) reduce the fiscal deficit as is being demanded by international finance and its representative, the IMF, (b) retire government debt and improve the government’s finances in the medium term, or (c) meet much-needed social expenditures that the government is hard put to finance. The view that the government should not have been present in most areas it has entered, has a two-fold ideological thrust. It presumes that the private sector should be pre-eminent, with the government undertaking an economic activity only where the private sector for one reason or another is unwilling to enter. It also assumes, contrary to the evidence provided by many a public enterprise, that public sector units are by definition inefficient. The latter assumption allows the attribution of losses suffered by public units for reasons completely unrelated to efficiency, to inefficient functioning. Even ignoring the fact that prejudices of this kind should not be allowed to influence policy, this particular ideological frame should be permitted to drive the management of the public sector only if it is supported by a representative majority. Clearly, the post-judgment ‘confession’ by the government and the private sector-controlled media that the requirement of parliamentary approval for privatization amounts to dumping the policy, indicates that nobody believes that such a majority, let alone a consensus exists. Advocates of reform who contend that there is consensus around it .are obviously not willing to subject their view to a democratic test. On the other hand, the view that privatization is justified since it garners revenues to deal with various kinds of fiscal problems faced by the government is just plain wrong. Any private entity acquiring a stake in a public sector unit has the choice of using the same resources to invest in government bonds that carry no risk whatsoever, since they carry a sovereign guarantee. Thus, the minimum return expected from an investment is the interest rate applicable to government bonds. If, therefore, a private investor chooses to invest in equity instead, he/she would expect not just a margin above the going interest rate on government bonds but also a premium to cover the risk associated with choosing this option. In sum, unless the expectations are that the purchase of public equity will yield much higher returns than those offered by government bonds, no private investor will choose to invest in such equity. If that be the case, disinvestment cannot be rationally resorted to, since it would involve a net loss of revenues for the government. If resources from disinvestment are used by the government to retire public debt, revenues will be lower since the assets sold are capable of yielding a much higher return than the interest that was being paid on the debt being retired. On the other hand, if disinvestment is opted for as a substitute for borrowing in order to finance additional expenditures, the revenue lost as a result of disinvestment will be greater than the interest payment saved through reduced borrowing. The only instance where privatization of potentially or actually profitable assets can be defended is when it is presumed that the government is incapable of running a unit as well as the private sector can and, therefore, is incapable of earning the higher potential return. But to advance such an argument is also irrational, since there are many areas, from national security to poverty alleviation, where the government must perform, since they cannot be privatized. If the government is seen as capable of delivering on those fronts, there is no reason why it cannot be reformed to deliver in spheres of production which, for a variety of reasons, were seen as areas in which public presence was a must. Unfortunately, specious arguments of the kind cited above have been used by the executive to proceed with privatizing some of the most profitable public sector units. What is more, this process of sale of public assets has involved prices that are patently unreasonably low. In the controversies surrounding the privatization of units varying from Modern Foods to Balco, technical experts have been at pains to point out that the price received by the government for its equity was a fraction of that warranted by the value of the underlying assets. Evidence on the prices of land, mining rights and assets like captive power plants was provided to advance this case. The executive has at all times chosen to dismiss this view by referring to specious arguments involving accounting principles, stockmarket prices and discounted present values. Even when Centaur Hotel, Mumbai, which the government had sold for Rs 83 crore, was resold four months later by the original buyer for Rs 115 crore, the validity of the argument that the government was undervaluing public assets because of its desperation to sell or for other reasons, was dismissed. To top it all, in order to attract buyers and make successful its accelerated privatization programme, the executive decided to resort to ‘strategic sales’, wherein the purchase of a minority stake at basement bargain prices was adequate to acquire managerial control. As the VSNL experience illustrates, such control can provide the private buyer access to resources that make the investment more than lucrative. In this case the Tata group, which purchased the strategic stake in VSNL, tapped the cash reserves of the company to expand Tata Teleservices, a telecom start-up it controlled. Besides extra-economic reasons, the only explanation for this misuse of executive power that was made possible by the lack of parliamentary accountability, is the once-for-all ‘benefit’ of garnering resources to finance the budget. Having partly eroded its own tax base by providing tax concessions and under international pressure to curtail the fiscal deficit, the government chose to rely on the short-term strategy of privatization to finance its additional expenditures. Not surprisingly, in the aftermath of the HPCL/BPCL judgment, Finance Ministry officials rushed to the press to declare that it would not be allowed to affect the level of the fiscal deficit in financial year 2003-04. This was an admission that resources from privatization are a form of budgetary finance. The budget for 2003-04, we must recall, provides for Rs 13,200 crore of ‘revenues’ from privatization. Only a fraction of that sum has been mobilized in the first six months of the fiscal year. How the required substitute resources will be found, is not clear. But that should only bother the government. From the point of view of the ordinary citizen, the Supreme Court has done the country well by putting on hold wanton misuse of executive power in pursuit of a wholly irrational strategy of privatization.



© MACROSCAN 2003