The government's decision to divest public sector equity before the end of the financial year has put it at the mercy of large investors, especially FIIs, which implies a substantial revenue loss for it.
AN abiding feature of India's economic landscape has been a spending spurt towards the end of the financial year - the so-called "March rush". Lethargic government departments, enterprises and corporations, having failed to utilise a large chunk of their annual budgeted expenditures through much of the financial year, indulge in a spending spree at the end of the year. The sight of roads, bridges and buildings being desperately re-laid, renovated or painted has been an annual end-of-year feature in various parts of the country.
However, post-reform India is witnessing an all-new version of the phenomenon: the rush to divest public equity before the end of the financial year, so as to ensure at least the partial realisation of disinvestment targets. Through much of the 1990s, governments have set themselves disinvestment targets every year only to find that poor market conditions, democratic opposition or just plain absence of interested investors, results in those targets remaining unrealised. But under the National Democratic Alliance (NDA) rule, especially the second half of that rule, there has been a noticeable change.
Initially, driven by the need to win friends and legitimacy both within the country and outside, the NDA government was gripped by an almost irrational urgency to push the neo-liberal "reform" agenda. One area in which this sense of urgency was visible was the euphemistically termed "disinvestment process". Through discounted sales of "strategic" stakes, the government in recent years has been seeking to put as much of the profit-making public sector as possible under private control.
But strategic disinvestment has not just been controversial and embarrassing (as in the case of the Airport Centaur Hotel, Mumbai), but has also run up against the law in the case of companies established under an Act of Parliament. This has meant that the desperation to sell has not been matched always by the ability to do so. This has created an altogether different problem for a government, which sees in disinvestment not just the realisation of its dream of complete privatisation, but also a source of revenue. These additional revenues are crucial because they help cover the deficit created by the loss in revenue resulting from customs duty reductions and the huge direct and indirect tax concessions provided as sops to the rich, both of which are adopted as part of the reform agenda.
In the past, the government has on occasion garnered "disinvestment" revenue even when the privatisation process was stalled, by opting to compel large, cash-rich public sector corporations to acquire government equity in other similar corporations through the "cross-holding" route. This not only met with opposition from such corporations but also from the media and the public at large, which saw it for what it was - the misuse of the surpluses earned by successful public sector undertakings (PSUs) to meet profligate budgetary concessions, dress up the budgetary figures on revenues and curtail the fiscal deficit.
Having been deprived of even that option, and emboldened by the buoyancy in stock markets, the government has now chosen directly to divest itself of blocks of shares in PSUs to neutralise the loss in tax revenues that liberalisation entails. These blocks of equity are either a part of the government's holding in companies it controls or is the residual stake of the government in companies that it has privatised by handing over a strategic stake and managerial control to a private investor.
The first instance of such sale of equity this financial year - that of Maruti Udyog - was driven not just by revenue considerations, but influenced by the lobby that has won out in the push to hand over complete control of the company to Suzuki. But, the substantial revenues garnered from that exercise seems to have persuaded the government that this is a potential means of "resource mobilisation". This has generated a new "March rush", that of rushing to market with huge lots of public sector shares to be sold through a book-building process involving an auction subject to a floor price specified by the government. Over a period of around three weeks starting mid-February, the government has chosen to put out offers of shares for six companies - the Indo-Burma Petroleum Company (IBP), the Cimputer Maintenance Corporation (CMC), Indian Petrochemicals Corporation Ltd. (IPCL), Dredging Corporation of India Ltd, Gas Authority of India Ltd. (GAIL) and the Oil and Natural Gas Commission (ONGC). This would amount to the sale of shares worth around Rs.14,000 crores, with Rs.10,000 crores to be raised from the sale of ONGC shares alone, amounting to 10 per cent of the equity of that petroleum major.
Putting huge amounts of shares on sale in this manner in a short period of time does not make sense in a market that lacks width and depth. It is known that despite the presence of a few small, retail investors, the Indian stock market is dominated by financial institutions, foreign institutional investors (FIIs) and large corporates parking their funds to benefit from possible capital gains. On the other hand, there are very few companies whose shares are actively traded on a regular basis in the secondary market. And even in the case of these companies, the quantum of shares out of the total issued capital that is traded is small.
If in such a market there is a sudden infusion either of investment funds (from FIIs, for example) or shares (from PSUs in this case), the impact on the share price is bound to be significant. If the "dumping" of PSU shares results in excess supply, investors are bound to hold back purchases in the expectation that share prices would fall. In fact, with such expectations there could be many players who shortsell these shares for later delivery in the conviction that these shares can be acquired at a low price and sold even at below the prevailing market price for a profit. This tendency is all the greater because market players expect that in order to attract investors the government would set the floor price for these issues well below the market price that prevails immediately prior to the start of the sale process, imparting some downward pressure on market prices. In sum, large-scale divestment in a short period must involve substantial discounts.
Experience has confirmed the fact that discounted sales were inevitable for the government. Thus IPCL shares were being offered at a floor price of Rs.170, which was well below the Rs.195.70 at which the share was being quoted on the National Stock Exchange just before the offer opened. The corresponding figures were Rs.475 and Rs.541.50 for CMC and Rs.620 and Rs.717.75 for IBP.
According to the government, these discounts were unavoidable since the decision to go to market in February-March with a huge bundle of shares was unavoidable. As disinvestment messiah Arun Shourie reportedly put it: "There's very little that we can do as the disinvestment proceeds are required by North Block by the end of the current fiscal to arrive at that magic figure of the fisc." In his view, the strategy to obtain the best deal was to start with the government's residual shareholding in "privatised" companies like IPCL and CMC and with small issues like that for Dredging Corporation of India Ltd. and then move on to the real winners like GAIL and ONGC.
THE point was that despite offering discounts it was not clear that such a large offering in six different companies would be picked up. In practice, in the initial days of the process it appeared that there were no takers even at the discounted prices for shares of companies like IBP. Moreover, there were clear signs that the market was sinking under the weight of this huge volume of shares that was flowing into the market, dragging the Sensex down. That could hardly be good news for a government that had pointed repeatedly to the buoyant stock market as one indicator of the fact that India was shining.
Disinvestment Minister Shourie panicked, went to the press with the view that the market was being manipulated and held the financial advisers to the issues responsible for motivating public purchases. What was remarkable was that by the next day news flowed in that the issues that were on sale at that time were almost fully subscribed or oversubscribed.
There could be two ways in which this remarkable turnaround could be interpreted. The first is that Shourie jumped the gun. That investors were only on hold to observe movements and were planning to come in with a small delay. The second is that some investors were forced to enter the market when Shourie decided to cry hoarse about fraud.
In fact, both of these were true. The most important fact to note is that in the new game of resource mobilisation that the government is playing, individual (retail) investors hardly play a role. Looking at the pattern of subscriptions in terms of type of investor by February 26, four days after the Shourie drama, it is clear that his remarks had not by any chance queered the pitch for the retail investor, who was being kept out by the manipulative moves of speculators. The small investor was actually nowhere in sight, accounting for just 4 per cent and 3 per cent respectively of the IPCL and CMC issues respectively, which were the two cases where the issue had been oversubscribed by two and three times. In these two prize companies, FIIs accounted for 75 and 55 per cent respectively, of the demand.
But Shourie's real concern was not with these companies but with IBP, in which the FIIs did not appear to be interested at all. Their presence amounted to merely 2 per cent of demand as on February 26. Retail investors in this case accounted for 6 per cent of demand. If the big players were not coming, the issue was bound to fail. A larger discount would have been needed next time around. Further, the implications of such failure for other offers yet to come to market may have been adverse.
Shourie's face was saved because financial institutions and mutual funds (mainly those under government control) had come forward to take up 44 per cent and 36 per cent of the demand respectively, at a time when the issue was still not oversubscribed. These investors could well have chosen to come in here because of the "pressure" that Shourie's statements had put on them. Where the threat of failure was large, the government seems to have "persuaded" the institutions to fill the gap. The question as to who was manipulating the market was an open one.
This whole episode only goes to show that the decision to rush to the market at the end of the financial year, has put the government at the mercy of large investors, especially the FIIs. Where they see in the sale an opportunity to book high profits, they do acquire shares. Where they see no such opportunity, they hold back. Thus large-scale disinvestment to garner resources for the budget must involve a substantial loss for the government, since it must be made attractive for the investor.
Disputing this by pointing to the "small" discrepancy between the offer price and the prevailing market price of the shares involved will not do. Market prices of public sector equity rarely capture the real value of the assets underlying them. A proper evaluation, independent of prevailing stock market values, would have yielded a floor price at which takers for multiple bulk transactions would have been missing. That was something the economist in Shourie must have realised when he went to market with his bulging bundle of goodies. So the discount must have been larger than visible. The moot question therefore is: how much has public equity been discounted to finance the fiscal profligacy that tax concessions imply?
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