The disingenuous Minister

By going ahead with the accelerated public sector sell-off programme, the Central government, which has constituted itself to manage a country as large and complex as India, implies that it is incapable of managing the assets of the PSUs as effectively as by the private buyers.

JUDGING by a recent missive sent by Disinvestment Minister Arun Shourie to members of Parliament, the government is set on pre-empting criticism of its recently launched accelerated public sector sell-off programme. There are three elements to that programme, now being spearheaded by Shourie. First, it is being executed as per a time-bound agenda cleared by the Cabinet Committee on Disinvestment (CCD). Secondly, it operates on the premise that the sale of equity of public sector undertakings (PSU) can be ensured only through the strategic sale route, which involves handing over management control to those who acquire a pre-specified proportion of the shareholding, even if this only amounts to a minority shareholding. Thirdly, the sale is clinched with the bidder who offers the highest premium above the reserved price computed on the basis of valuation procedures that are proving extremely controversial, and which the Comptroller and Auditor General has refused to vet.

The accelerated programme to divest equity through the strategic sale route was formalised in the September 27, 2001 decision of the CCD, which drew up a timetable for the sale of 13 PSUs by the end of March 2002. These included Computer Maintenance Corporation (CMC) Limited, Hindustan Teleprinters Ltd (HTL), Maruti Udyog Ltd, India Tourism Development Corporation (ITDC), Hindustan Zinc Ltd, IBP Company Ltd, Videsh Sanchar Nigam Limited (VSNL), Indian Petrochemicals Ltd (IPCL), the Hotel Corporation of India, Jessop & Co, NEPA Limited, Instrumentation Control Valves and Bharat Heavy Plates and Vessels. Besides this, the process of divestment of companies such as Indian Airlines, National Fertilisers Ltd, Madras Fertilisers Ltd (MFIL) and Hindustan Copper Ltd is under way.

The error in pursuing such an agenda should be clear. To start with, such accelerated and time-bound divestment is bound to affect adversely the price at which equity is being sold, since potential buyers see an opportunity of winning a bargain out of the desperation implicit in the government's manoeuvres. Secondly, this effort is being pursued at a time when all is not well in India's stock markets, with shares of many companies ruling well below what insiders consider appropriate. In fact, in some cases share prices have mysteriously slumped after the announcement of the disinvestment proposal. Thus, in April this year, officials found that the VSNL scrip, which had ruled at close to Rs.400 when the proposed disinvestment was announced, fell to Rs.300. This amounted to an implicit valuation of the company at Rs.9,000 crores, when cash reserves with the company amounted to Rs.7,000 crores. The difficulty is that the low share values tend to influence the price at which disinvestment takes place, even if they do not determine the actual disinvestment value.

Finally, given its urge to complete the disinvestment process in a time-bound fashion, the government is forced to be "reasonable" when valuing PSUs as part of the process of determining the reserved price, as well as offer unusual concessions to cajole private players into buying into even profitable PSUs.

The principal concession that the government is making to coax private players into lapping up PSU equity at a fast enough pace is the strategic sale option. With equity shares as low as 25 per cent, a single private buyer would have full management control provided through a favourably framed shareholders' agreement. From the point of view of the private buyer this has many advantages. First, it provides control over the operations of a company with investments that are small relative to the size of the operations of the PSU involved. Secondly, if the buyer is an entity already involved in the area in which the PSU concerned operates, the purchase of management control at a small price would substantially strengthen its oligopolistic position in the market. This would, for example, be true in the petrochemicals area if Reliance is successful in its bid to acquire a 25 per cent strategic stake in IPCL. Finally, the buyer is assured of a partner who would not merely not interfere in the functioning of the company, since the privatisation process is aimed at ridding PSUs of government control, but would, as is happening with Suzuki in Maruti, be able to buy up a larger share of equity at a later date if the profitability of the enterprise warrants it.

Despite this, insiders tracking the privatisation process believe that there is reason to assume that PSUs are being routinely undervalued when put up for sale. This was argued in the case of Modern Foods Industries, based on an assessment of the value of the real estate held by the company, of Bharat Aluminium Company Ltd (Balco), based on the value of a number of components of the company such as the captive power plant and the mining lease it holds, and of the valuation underlying the proposed sale of IPCL.

Most recently, the sale of the ITDC's Bangalore properties in the form of a 30-year lease has triggered a controversy between the corporation and the Department of Disinvestment (DoD). When the deal was first announced, Bharat Hotels was to take over the Bangalore Ashok Hotel for a 30-year period in return for an upfront payment of Rs.39.41 crores and a minimum guaranteed payment of Rs.4.11 crores every year. However, when the deal was finalised, the hotel was transferred along with a profit-making restaurant of the ITDC in Bangalore, which had recorded an operating profit of just over Rs.4 crores last year. According to reports, the ITDC has objected to the inclusion of the restaurant on the grounds that it was an independent unit, which had not been mentioned in either the demerger scheme that released individual ITDC properties for sale or in the expression of interest for eight ITDC properties. Given the fact that the restaurant is capable of earning profits close to the minimum guaranteed annual payment, the deal, in the view of the ITDC itself, amounts to offering the lease at just the amount paid upfront. The DoD has of course dismissed these protests saying that the restaurant was part of the deal and was taken into account in deciding the reserved price.

FACED with such criticism, which is only likely to increase once the accelerated privatisation drive currently under way is completed, Arun Shourie has decided to launch a personal campaign to pre-empt such criticism. The first point being made by Shourie is that the interest earned or saved by the government on the sums realised from strategic sales made thus far of equity in four PSUs (MFIL, Balco, CMC and HTL) is many multiples of the dividend it used to earn by holding on to those shares. The interest earned or saved even assuming a 10 per cent interest rate would have amounted to Rs.112 crores a year, whereas the dividend that was being received from those shares was just Rs.7 crores a year. Thus there is in his view an annual gain of Rs.105 crores by foregoing the Rs.7 crores dividend.

That Shourie is being his disingenuous self by touting these figures should be obvious from his choice of the dividend for comparison with the interest saved. Dividend is the part of the profit of an enterprise that is paid out to shareholders. The actual gain in a year for a shareholder is, however, the profit per share. The shareholders of a company, in this case the government, may choose not to pay out the full profit as dividend, but to retain some for reinvestment purposes. It is through such decisions that VSNL, for example, had accumulated cash reserves to the tune of Rs.7,000 crores, which the government is stripping it of prior to divestment.

So if the interest earned or saved on the sum garnered by selling a share is to be compared with anything, it should be with the profit per share. That should have been obvious even to someone with a rudimentary knowledge of arithmetic and accounting, which you presume the Minister has. So there must be some other reason why he chose to compare non-comparables.

Further, even profit is not an adequate indicator of the gain from the creation of a PSU. Public sector enterprises, economists agree, are not pure profit-making machines, but instruments used by governments to achieve a range of objectives. These could vary from closing infrastructural gaps that may remain if investment was purely private to ensuring access to products crucial to development at appropriate prices. This would imply that investments are made even in areas where profits are low or non-existent because of the external benefits such projects deliver, or that profits are foregone in order to keep prices down in pursuit of other objectives. To ignore such possibilities and make profits, which contribute non-tax revenues to the government - the sole reason for establishing public sector units - is to conceal the actual grounds on which public capital formation has occurred in post-Independence India or elsewhere in the world.

Finally, Arun Shourie's comparison of interest and dividends makes every private buyer of a public asset a bit of a fool. Consider any one of the buyers who have acquired public properties. Just as Shourie presumes that the government could have invested the sums paid by these buyers in interest-bearing financial assets offering a 10 per cent return, these investors could have done the same. This implies that when they chose not to invest these sums in such deposits but to purchase PSU equity instead, they were betting on earning returns from their investment that were significantly higher than 10 per cent, so as to make the decision to take on the risk involved in managing real assets worthwhile.

Thus, what Arun Shourie is saying is not that the government through disinvestments was earning more returns, but rather that he and the government he represents, which has constituted itself to manage a country as large and complex as India, and is even trying to engineer a change in its attitudes and culture, are incapable of managing the assets of PSUs as effectively as would be done by the private buyers acquiring a 'strategic' stake that gives them management control.

In fact, Shourie seeks to make this incompetence he confesses to into a virtue when he informs members of Parliament that after the sale: (i) the five companies concerned "are running and would continue to run at higher capacity utilisation and thus would give more taxes and revenues to the State and Central government"; (ii) "no worker has been retrenched or would be retrenched (except providing for restructuring through VRS route as is done in CPUs also); and (iii) when compared to instances where minority shares have been sold without the "strategic" hand-over of control to the purchaser, the price-earnings ratio, or the price at which the shares were sold divided by the dividend per share, was much higher in the case of the five instances of strategic sale he refers to.

Thus, the fact that the private buyers have been able to keep the companies running at higher levels of capacity utilisation without any retrenchment, is seen not as an indictment of the government's incompetence and inability to manage these relatively small-sized corporations, but as a vindication of privatisation itself. That is, any sign of government failure should not result in a replacement of that government by one that is competent (as is expected to happen in the case of private management failure), but by the handing over of the responsibilities of the state to the private sector. Unfortunately, that logic cannot work in all cases. The Indian government has failed to eradicate poverty or put the country's children to school even five decades after Independence. No one would think of handing over such tasks to the private sector, nor would there be any private takers for such "unprofitable" activities.

As far as price-earnings ratios go, the Minister is once again making spurious comparisons and arriving at unwarranted conclusions. Let us start from the widespread concern that public enterprises are being sold at values below those warranted by their assets and their potential. Given that, does a lower price-earnings figure for non-strategic sales indicate that the government has been even more incompetent in divesting minority equity, or does it prove that the price garnered through strategic sales was better than expected? Further, a high price-earnings ratio can be the result of a high price for equity sold or a record of low dividend payments. Shourie's government has consciously run down PSUs in the run-up to their divestment. This has made surpluses earned and dividends paid by these PSUs unusually low relative to their record.

A striking example is a company like IPCL that was extremely profitable in the past. If this is the general trend, a high price-earnings ratio at the point of sale of equity is not the reflection of a high price but rather of a low dividend. Once again, Shourie seems to have not exercised his arithmetical common sense.

Finally, Shourie gives the game away when he says that past efforts at making non-strategic sales of equity have been unsuccessful because, since the Indian stock markets lack depth there were not enough takers for these shares, and purchases were made largely by financial institutions such as the Unit Trust of India at prices which have subsequently fallen, leading to losses. This implies that attempting to get a reasonable price for equity, given the asset position of the PSUs, is a near impossible task. This would be all the more true when the accelerated privatisation of a number of PSUs is sought to be undertaken.

If, despite this, the government insists on going ahead, certain consequences are inevitable. Prices would be low relative to asset values, and major concessions such as provision of a "strategic stake" or management control even with a minority shareholding would have to be given. Even with such concessions sometimes a sale may be difficult to clinch, as has happened in the case of the Ashok Hotel in New Delhi and Hindustan Zinc Limited.

In the circumstances, the best option is to drop the disinvestment programme, close down the DoD and invest time in restructuring PSUs to exploit their potential. Arun Shourie's effort to win the support of MPs with the aid of a poorly drafted letter full of faulty arguments perhaps shows he too fears that this truth is now too obvious.