Privatisation and Disinvestment

Privatisation means the transfer of ownership and/or management of an enterprise from the public sector to the private sector. It also means the withdrawal of the State from an industry or sector, partially or fully. Another dimension of privatization is opening up of an industry that has been reserved for the public sector to the private sector.
According to the World Bank, privatisation is the transfer of ownership of State owned Enterprises (SOEs) to the private sector by sale (full or partial) of going concerns or by sale of assets following their liquidation.

Rationale for Disinvestment: Releasing of large amount of public resources locked up in non strategic PSUs for redeployment in areas such as basic health, family welfare etc. Reducing public debt. Economic inefficiency in the production activities of the public sector, with high production costs, inability to innovate and costly delays in delivery of goods produced. Ineffectiveness in the provision of goods and services, such as failure to meet objectives, political interference etc and transferring of commercial risk, to which taxpayers money locked up in public sector is exposed. Rapid expansion of bureaucracy.

The Privatisation Reaction

There are different ways of achieving privatization:

Divestiture: Privatisation of ownership through the sale of equity ie. Selling stock to the public. This has largely been undertaken in industrial countries. Contracting: Government contracts out services planned and specified to other organizations that produce and deliver them. Common in public works and defence etc. but there is scope of corruption in this as long term contracts tend to encourage monopolistic behaviour by the private supplier.

The Privatisation Reaction

There are different ways of achieving privatization:

Strategic sale by auction method: There is a transfer of a block of shares by government to the strategic partner. Companies that have witnessed strategic sale in India in the recent past include Modern Foods, BALCO, VSNL, ITDC hotels etc. In India this method has been preferred to that of sale of equity shares to the public. Withdrawing from the provision of certain goods and services leaving them wholly or partly to the private sector Privatisation of management using leases and management contracts. Liquidation involves the closure of an enterprise and sale of its assets. Informal liquidation is when the firm retains its legal status even though its operations have been suspended.

Obstacles to Privatization in Developing Countries

Government usually want to sell the less profitable organizations, which the private sector is not willing to buy at prices offered by the government. Divestiture tends to arouse political opposition from employees who may lose their jobs, politicians fear short term unemployment, bureaucrats who tend to lose patronage and those who fear that the national assets would be owned and controlled by the rich. Undeveloped capital markets make it difficult for the Government to float shares and for individual buyers to finance large purchases.

Conditions for Success of Privatisation

Commitment from the Political leadership is mandatory. Any alternative institutional arrangements chosen should not stifle competition among suppliers. There should be a multiplicity of suppliers in the industry and government monopoly should not be replaced by private monopoly. Overregulation of industry discourages private initiative. There should be freedom of entry to provide goods and services. Long term contracts and franchises limit competition and consumers choice. In capital intensive industries, freedom of entry is difficult to achieve.

Conditions for Success of Privatisation

Public services to be provided by the private sector must be specific or have a measurable outcome. Lack of specificity makes it difficult to control and quantify. Consumers should be able to link the benefits they receive from a service to the cost they pay for it. It is extremely important to educate the consumers. Privately provided services should be less susceptible to fraud if they are to be effective. Equity is an important consideration in the delivery of public services. The benefits of privatization can accrue to the capital owner, to the consumer who receives a more efficient service and to the public at large.

Benefits of Privatisation

Reduces the fiscal burden of the State Enables the Government to collect funds. Helps the State trim the size of the administrative machinery. Enables the Government to concentrate on the essential state functions. Helps accelerate the pace of economic development. May result in better management of the Enterprises. May encourage entrepreneurship. May increase the number of shareholders and thereby distribution of wealth. In areas such as telecom and insurance, it would bring an end to the monopoly and thereby result in wider choices for consumers.

Disadvantages of Privatisation

Will encourage concentration of economic power. Privatization should not result in substitution of government monopoly by private monopoly. Could result in foreign firms acquiring national firms. Privatisation of profit making public enterprises would mean foregoing future sources of income. Privatisation of strategic and vital sectors is against national interests Capital markets of developing countries are not adequately developed for carrying out privatization. Privatisation at times is a half hearted measure and thus is not properly executed. Private sector is driven more by a profit motive than the public sector, which sees its aim as more of a social guardian providing employment and security to all.

Privatisation in India
Disinvestment Policy: The Industrial Policy Statement 1991 stated that the Government would divest part of its holdings in selected PSEs, but did not place any cap on the extent of disinvestment. Objective of the policy was to improve management, enhance availability of resources for these PSEs, yield resources for the exchequer, encourage wider public participation and promote greater accountability. The objective was to provide further market discipline to the performance of the public enterprises. However, the Budget 1991-92 reinstated the cap of 20% for disinvestment. In 1993 the GOI set up a Committee in Disinvestment under the chairmanship of C. Rangarajan.

Privatisation in India
Rangarajan Committee: The recommendations of this report emphasized the need for substantial disinvestment. The committee suggested that the percentage of equity to be divested could be upto 49% for industries explicitly reserved for the public sector and over 74% in other industries. Holding of 51% or more equity was recommended only for the 6 industries: coal and lignite, mineral oils, arms and ammunition, atomic energy, radioactive minerals and railway transport. Best method of disinvestment is by offering shares to the general public at a fixed price.

Privatisation in India

Rangarajan Committee (contd..) Instead of year wise targets of disinvestment a clear cut action plan should be made. Disinvestment to be in stages and sales shall be staggered to get the best possible prices. Scheme of preferential shares to workers and employees to be devised. 10% of the proceeds to be set apart for lending to the public enterprises on concessional terms.

Privatisation in India

Rangarajan Committee (contd..) The Common Minimum Programme, 1996 sought to carefully examine the Public sector non strategic areas and to set up a Disinvestment Commission for advising on disinvestment related matters: Draw up a long term program of disinvestment. To determine the extent of disinvestment in each of the PSUs. To prioritise the PSUs referred to it by the Core Group in terms of the overall disinvestment programme. To decide on instrument, pricing and time. To supervise the overall sales process and take decisions on pricing, timing etc.

Rangarajan Committee (contd..)

To select the financial advisors for the specified PSUs to facilitate the disinvestment process To monitor the progress of disinvestment process and take necessary measures To ensure that appropriate measures are taken to protect the interests of the employees. The Commission was disbanded in 1999 and was thereafter handled by a separate department for Disinvestment created in Dec 1999 which later became a full fledged Ministry and is now existing as the Department of Disinvestment.

National Investment Fund:

On Nov 30, 2005, the Government set up the National Investment Fund into which proceeds from the sale of PSUs will be credited. The major objectives of the fund are: to invest the proceeds in social sectors like education, health and employment generation. To finance the capital projects in potentially profitable PSUs.

Public Private Partnership (PPP):

Of late, the thinking of the Government is to involve private sector in ownership and management of projects, instead of privatising public sector undertakings. This arrangement is largely felt in infrastructure and service sectors.