Privatization and Disinvestment

BY:
Dr Neelam Tandon
JIMS

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.


Divestiture:

Privatisation of ownership through the sale of equity i.e.
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 behavior by the
private supplier.

Withdrawing from the provision of certain goods and
services leaving them wholly or partly to the private sector.



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.

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.


It refers to the action of an organization or the government in selling
or liquidating an asset or subsidiary. In simple words, disinvestment
is the withdrawal of capital from a country or corporation.

Some of the salient features of disinvestment are:

Disinvestment involves sale of only part of equity holdings held by
the government to private investors.

Disinvestment process leads only to dilution of ownership and not
transfer of full ownership. While, privatization refers to the transfer
of ownership from government to private investors.

Disinvestment is called as Partial Privatization.
Offer for sale to public at fixed price: in this type of disinvestment,
the government holds the sale of the equity shares to the public at large
at a pre determined price. examples:-MFIL, BALCO, CMC, HTL, IBP,
HZL, PPL, and IPCL.

Strategic sale: in this type, significant management rights are
transferred to the investor i.e. majority of equity holdings are divested.
examples: -offer of 1 million shares of VSNL, listing of ONGC IPO.

International offering: this is essentially targeted at the FII (Foreign
Institutional Investors). ex:-GDR of VSNL, MTNL etc.

Asset sale and winding up: this is normally resorted to in companies
that are either sick or facing closure. this is done by the process of
auction or tender. ex:-auction of sick PSUs.
Commitment from the Political leadership is mandatory.

There should be a multiplicity of suppliers in the industry and government
monopoly should not be replaced by private monopoly.

There should be freedom of entry to provide goods and services.

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.

It is extremely important to educate the consumers.

Privately provided services should be less susceptible to fraud if they are to
be effective


Increased efficiency
Specialization
Corruption
Accountability
Security
Goal

Short term view
Downsizing
Political interference
Reliability



1. NET ASSET METHOD:

This will indicate the net assets of the enterprise as
shown in the books of accounts. It does not reflect the
true position of profitability of the firm as it overlooks
the value of intangibles such as goodwill, brands,
distribution network etc. This model is more suitable in
case of liquidation than in case of disinvestment.


2. PROFIT EARNING CAPACITY VALUE METHOD:
The profit earning capacity is generally based on the profits
actually earned or anticipated. It values a company on the basis of
the underlying assets. This method does not consider or project
future cash flows.

3. DISCOUNTED CASH FLOW METHOD :
In this method the future incremental cash flows are forecasted and
discounted into present value by applying cost of capital rate. The
method indicates the intrinsic value of the firm and this method is
considered as superior than other methods.
Objectives for the formation of PSUs

To help in the rapid economic growth and industrialization of the
country and create the necessary infrastructure for economic
development

To earn return on investment and thus generate resources for
development

To promote redistribution of income and wealth

To create employment opportunities;




To promote balanced regional development

To assist the development of small-scale and ancillary
industries

To promote import substitutions, save and earn foreign
exchange for the economy

Problems of PSUs
1. Price policy of the Public Sector undertakings.
2. Underutilization of capacity.
3. Problem related to planning and construction of projects
4. Problems of labour, personnel and management
5. Lack of autonomy
Low productivity of investment.

Year 1950-51 1960-61 1970-71 1980-81 1989-90
Investment
(Current Prices,% GDP)
10.2 15.7 16.6 22.7 24.1
Investment
(Constant 1980-81 prices, % GDP)
14.7 18.1 18.7 22.7 21.8
Domestic Savings
(Current Prices, %GDP)
10.4 12.7 15.7 21.2 21.7
Year
1960- 61
to 1964-65
1965-66 to
1969-70
1970-71 to
1974-75
1975-76 to
1979-80
1980-81 to
1984-85
1985-86 to
1989-90

Revenue 12.7 13.4

14.6

17.8 18.1 20.0
Current
Expenditure
11.8 12.9 14.2

16.3 18.6

23.0
Current Revenue
Balance
0.9

0.5

0.4

1.5

(0.5)

(2.9)

Capital
Expenditure
6.6

6.0 5.1

6.9 7.5 7.1
Total
Expenditure
18.4 18.9 19.3 23.2 26.1

30.0

Fiscal Deficit 5.7 5.5 4.7 5.4 8.0 10.0
Primary Fiscal
Deficit
5.3 5.2 4.2 4.7 6.8 7.5
Fiscal situation in 1980
Other important factors

RBI adopted sharp contractionary measures and had taken
huge amounts from International Monetary Fund in July,
1990 and January, 1991 amounting to $2.4 billion.

Foreign Exchange Reserves were reduces $ 1 Billion which
could support only two weeks imports.

Inflation was staring at 14%

On July6, 1991 47 tons of gold were transferred from RBI
to Bank of England, London. Already 20 tons of gold were
sold in International market through State Bank of India

The first phase being 1991-92 to 1995-96 where partial
disinvestment was taken in piecemeal manner.

Second Phase 1996-97 to 1997-98, an effort to institutionalize
the disinvestment process was undertaken on a firm footing by
constituting the Disinvestment Commission.

The third Phase 1998-99 to 2007-08 where Department of
Disinvestment (Now a Ministry) and National investment fund
was formed to look after the disinvestment process and the funds
generated from it.

Fourth phase, the Current one where government is planning to
sell its stake in NTPCL, SJVNL, RECL and NMDCL


It started when Chandrasekhar government, while presenting
the interim budget for the year 1991-92 declared disinvestment
up to 20%.

The Industrial Policy Statement of 24th July 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.

During this Phase the sole was to generate revenue without
following any objective seriously.

16 industries were reserved for public sector prior to 1991
which reduced to 8 after July 1991.

The Highlights of the committee report
were as follows:

49% of equity could be divested for industries explicitly reserved
for the public sector

In exceptional cases the public ownership level could be kept
at26%.

In all other cases it recommended 100 per cent divestment of
Government stake.

Holding 51% or more equity by the Government was
recommended only for six Schedule industries.


The government constituted Public Sector Disinvestment
Commission with the objective of preparing an over-all long
term disinvestment programme for public sector undertakings .

A comprehensive overall long-term disinvestment programme
(extent of disinvestment, mode of disinvestment etc.) within 5-
10 years for the PSUs.

Industries were divided into core and non-core industries.

The commission recommended disinvestment up to 49% in core
industries and 74% in non-core industries.

YEAR Target amount
(in crore)
Amount realised
(in crore)
Enterprises
disinvested
Methodology
1991-92 2500

3038.00

30 (30) Minority shares sold by
auction method
in bundles of very good,
good, and
average companies.
1992-93 2500

1912.51

16 (2)

Bundling of shares
abandoned. Shares
sold separately for each
company by
auction method
1993-94 3500 Equity of 7 companies sold
by open
auction but proceeds
received in 1994-95.

YEAR Target amount
(in crore)
Amount realised
(in crore)
Enterprises
disinvested
Methodology
1994-95 4,000 4843.08 16 (7)

Sale through auction
method, in which NRIs and
other persons legally
permitted to buy, hold or
sell equity.
1995-96 7,000 362.00

4(-) Equities of 4 companies
auctioned andgovt piggy-
backed in the IDBI fixed
price offering for the fifth
company.
1996-97 5,000 380.00

1 (-)

GDR (VSNL) in
international market.
1997-98 4,800


902.00 1 (-)

GDR (MTNL) in
international market.
Year Target
amount
(in crore)

Amount
realised
(in crore)

Enterprises
disinvested
*
Methodology
1998 99 5,000 5371.11 5 (-) GDR (VSNL)/ Domestic offerings
with the participation of FIIs
(CONCOR, GAIL). Cross purchase by
3 oil sector companies i.e., GAIL,
ONGC & IOC.
1999 00 10,000 1573.78 5 (1) GDR (GAIL) in international market,
VSNL domestic issue, cross-holding
in IOC and ONGC, and strategic sale
of MFIL.
2000 01

10,000


1868.73

3 (1) BALCO, KRL (CRL) & MRL through
Strategic sale/acquisition
2001 02 12,000

3130.94

6 (3)

Strategic sale of CMC, HTL, IBP,
VSNL and PPL. Sale of eight hotels
and long term lease of one hotel of
ITDC.
Year Target
amount
(in crore)
Amount
realised
(in crore)
Enterprises
disinvested
*
Methodology

2002 03

12,000

3265.14

5 (1)

Strategic sale of HZL, IPCL,
Maruti Udyog Ltd. Sale of 10
properties of ITDC and residual
equity of MFIL
2003 - 04

14,500

15,547

10

Strategic sale of JCL, call option of
HZL, offer for sale of MUL, IBP,
IPCL, CMC, DCI, GAIL, and ONGC;
sale of share of ICI Ltd
2004 - 05

4,000

2,764.87

3

Offer sale of NTPC and spill over
of
ONGC; sale of shares to IPCL
employees
2005 - 06

No target
fixed

1,569.68

1

Sale of MUL shares to Indian
Public Sector financial institutions
and banks and employees
2006-07 No target
fixed
- - -
Year Target
amount
(in crore)
Amount
realised
(in
crore)
Enterprises
disinvested
*

Methodology

2007-08 No target
fixed
2,366.94 1 Sale of MUL shares to
public sector financial
institutions, public sector
banks, and Indian Mutual
Funds
2008-09 No target
fixed
- - -
2009-10 No target
fixed
4,259.90 - 2012.85-NHPC
2247.05- OIL
This phase marked a paradigm shift in the disinvestment process.

First, in 1998 99 budget the BJP government decided to bring
down the government shareholding in the PSEs to 26 %to facilitate
ownership changes which were recommended by Disinvestment
Commission.

In 1999 2000 government stated that its policy would be to
strengthen strategic PSEs privatise non-strategic PSEs through
disinvestment.

For the first time the term privatisation were used instead of
disinvestment.

The government later formed the Department of Disinvestment on
10 December 1999.


In 1998-99, the government decided to disinvest through offer of
shares in GAIL, VSNL, CONCOR, IOC and ONGC.

In 1999 2000, the government disinvested from Modern Foods
India Ltd and did a strategic sale to their strategic partner HLL for
Rs 105, 45 crore for a 74 % equity stake.

This was the first time government had sold more than 50 %
holding.

In 2002-03, target of the government for disinvestment in the year was Rs
12,000 crore.

The major highlight was the two-stage sell off in Maruti
Udyog Ltd with a Rs. 400 crore right issue at a price of Rs
3280 per share of Rs 100 each in which the government
renounced whole of its rights share (6,06,585) to Suzuki, for a
control premium of Rs 1000 crore. Relative share holding of
Suzuki and government after completion of the rights issue
was 54.20 % and 45.54 % respectively.

The second stage government offloaded its holding in two
tranches first where government sold 27.5 % of its equity
through IPO in June 2003. The issue was oversubscribed by
over 10 times.


Later keeping in view the overwhelming response from sale
of Maruti, government sold its remaining shares in the
privatised companies of VSNL, CMC, IPCL, BALCO and
IBP to public through IPOs.

Strategic sale of IPCL was also finalised in May 2002. The
decision to disinvest IPCL was although taken in December
1998, it took three and half years to finalise the deal. Reliance
Petro industries Ltd (Reliance group) was finally inducted as
a strategic partner with a 26 % sale in IPCL.
On 27th January 2005, the Government had decided to
constitute a National Investment Fund (NIF) into which the
realisation from sale of minority shareholding of the
Government in profitable CPSEs would be channelized. The
Fund would be maintained outside the Consolidated Fund of
India. The income from the Fund would be used for the
following broad investment objectives: -

Investment in social sector projects which promote education,
health care and employment;

Capital investment in selected profitable and revivable Public
Sector Enterprises that yield adequate returns in order to
enlarge their capital base to finance expansion/
diversification.

The corpus of the National Investment Fund will be of a
permanent nature.

The Fund will be professionally managed to provide
sustainable returns to the Government, without depleting the
corpus. Selected Public Sector Mutual Funds will be
entrusted with the management of the corpus of the Fund.

75 per cent of the annual income of the Fund will be used to
finance selected social sector schemes, which promote
education, health and employment. The residual 25 per cent
of the annual income of the Fund will be used to meet the
capital investment requirements of profitable and revivable
CPSEs that yield adequate returns, in order to enlarge their
capital base to finance expansion/diversification.


With the Left no longer in the power equation, the
government has decided to focus on selling government
shares either through public offers or institutional placements
(especially for listed blue-chips).

The issue of disinvestment has grown in importance because
the government faces a fiscal deficit of 6 per cent of Gross
Domestic Product, owing to farm loan waivers, pay increases,
a country-wide rural job guarantee scheme and a fiscal
stimulus package.

The government has prepared a list of over 40 companies in
which it is planning to divest part of its shareholding through
the stock market. This includes 15 listed entities in which the
government holds more than 90 per cent.
The government has also prepared a list of around 25 unlisted
companies with a net worth of Rs 200 crore which have earned a net
profit in each of the last three years for selective disinvestment.

Some of these are Bharat Sanchar Nigam Ltd, Rashtriya Ispat
Nigam, Coal India, Hudco, Export Credit Guarantee Corporation,
Indian Railway Finance Corporation and North East Electric Power
Corporation Ltd.

The government concluded public offers of equity in NHPC and Oil
India. The market capitalisation of these companies, post-listing, has
increased to Rs 37,702 crore and Rs 27,220 crore, respectively, a
rise of 106 per cent and 177 per cent. There was a mix of direct
disinvestment as well as fresh equity in the case of these companies.
The government plans to offer six loss-making public sector units on
long-term lease to private players for periods up to 99 years.

The companies that may be offered on lease are HMT , Hindustan
Fertiliser, Scooters India , Hindustan Cables, Triveni Structurals and
NEPA.

The Rs8,286 crore issue of NTPC Ltd. received a lukewarm
response from both retail and institutional investors.

With recent issues from state-run companies receiving lukewarm
response from the markets, the government has downscaled its
disinvestment programme this year, restricting it to a maximum of
eight companies.
A significant part of the disinvestment target would be met through
stake sales in companies such as Coal India Ltd (CIL) and Steel
Authority of India Ltd (SAIL), he added.

Other big issues could come from Bharat Sanchar Nigam Ltd
(BSNL) and MMTC, while Hindustan Copper, Manganese Ore India
Ltd (MOIL), SJVNL and Engineers India Ltd (EIL) would be
smaller issues.

6 out of Top 10 companies in India are Public Sector
Companies.

Of the 50 companies which make up the NIFTY, 10
companies are PSUs.

In many businesses PSUs are virtual monopolies.

Top 18 PSU companies (called Navratnas) total
income is equal to 15% of Indias GDP.


It is only due to the strong fundamentals of the PSUs that
they are among the most profitable companies in India. The
strong fundamentals of these companies provided a
substantially high growth of 19.37% in the past 10 years.
Something private companies envy upon.
Balance Sheet virtually debt free.

Ability to show greater resilience in an economic downturn
less vulnerable to a slowdown in earnings growth.

Huge cash on books puts them in an advantageous position
when it comes to funding their expansion plans