The disinvestment debate

Disinvestment in India Policies, Procedures, Practices by Sudhir Naib; Sage Publications, New Delhi, 2004; pages 478, Rs.700.

AFTER a great deal of initial excitement and reservations, disinvestment of public sector enterprises has become an ongoing process in the country. But the debate continues, with some enthusiastically endorsing it and others expressing apprehensions and opposition. By and large, this debate has been at the ideological level. Ideology cannot be kept out of the debate, but disinvestment has other dimensions too. The modalities of disinvestment are important. So are its consequences.

It is on these aspects that Sudhir Naib's work on disinvestment assumes significance. It is one of the few comprehensive treatments of disinvestment in India. After dealing with the evolution and rationale of the public sector in India (which may be familiar material) and a discussion of the influence of ownership on efficiency, the author moves on to an evaluation of privatisation and disinvestment in other parts of the world; in the United Kingdom in the 1980s during the prime ministership of Margaret Thatcher; in the Eastern European countries and the former Soviet Union after the collapse of communist regimes; in the East Asian countries and China; in Latin America; in West Asia and North America. The critical assessment of disinvestment in other parts of the world forms the background to Naib's detailed empirical account of disinvestments in India. (The material covered in this section of the book is not easily available to readers in India.)

Public sector enterprises (PSEs), which were given a special role in India's planned economy, grew both in terms of numbers and investment for over four decades from the early 1950s. At the commencement of the First Five Year Plan there were five PSEs with a total investment of Rs.29 crores. At the end of the Seventh Plan in 1990, there were 244 PSEs and the investment in them had gone up to Rs.99,329 crores. Although disinvestments had started from the early 1990s, at the end of the Eighth Plan in 1997, investment had soared to Rs.213,610 crores. At the end of the fiscal year 2000-01, PSEs had a total investment of Rs.274,114 crores. The PSEs made a significant contribution to industrial production, 100 per cent in lignite, over 80 per cent in coal, crude oil and zinc, almost 50 per cent in aluminium and over 30 per cent in finished steel.

In terms of profitability, the PSEs showed diverse patterns. In 2000-01, 122 enterprises made a profit with the top 10 among them - giants such as the Oil and Natural Gas Corporation (ONGC), the National Thermal Power Corporation (NTPC), the Indian Oil Corporation (IOC) and the Videsh Sanchar Nigam Limited (VSNL) - accounting for close to 70 per cent of the total net profit of Rs.19,604 crores. Sector-wise, petroleum, power and communications contributed to 60 per cent of the profits. During that year, there were 111 loss-making enterprises with a total loss of Rs.12,839 crores. The major contributors to the losses were Hindustan Fertilizer, the Fertilizer Corporation of India (FCI), Bharat Coking Coal, and some other enterprises dealing with coal. The return on investment of all PSEs taken together remained low - post-tax profitability being only about 5 per cent on capital employed. The author says: "The public sector in India, which was perceived to be the vehicle of speedy economic development, has run into rough waters. It not only failed to produce surpluses which it was expected to generate for future growth, but the return on investment remained poor." The question that is examined is whether disinvestment and privatisation can lead to better results.

According to the author, at the theoretical level the poor performance of PSEs can be attributed to three factors: they are not governed by profit maximising considerations; there is no direct equivalent of bankruptcy constraint; and since shares are not traded in the market, the discipline that the market imposes is absent. The general presumption is that these three factors adversely affect the enterprises. However, this is not a matter that can be or should be settled on a priori theoretical arguments. Since the disinvestment of PSEs has been taking place over a fairly long period, it is now possible to submit it to empirical scrutiny. The strength of Naib's work is that he reviews the empirical evidence from different parts of the world and has conducted empirical studies of his own in India.

Before moving to these decisive empirical aspects, there is another important matter to be considered: how exactly is the disinvestment of PSEs to be achieved? One possibility is strategic sale with complete transfer of management to an enterprise in the private sector. Modern Food Industries, Bharat Aluminium Company Limited (BALCO), VSNL, Centaur Hotel Airport Mumbai and a few others were sold off in this manner. A second procedure adopted was partial disinvestment whereby the government still retained effective control by holding 51 per cent or more of equity. This has been the procedure adopted in the majority of cases. This is not a simple procedure, though. A decision has to be made as to who would be eligible to acquire the shares - other enterprises, employees or the public at large - and the manner in which the shares are to be off-loaded. In Chapter 5, the core chapter of the book, the author gives a detailed and critical account of the policy decision favouring disinvestment fairly soon after the economic reforms were launched, the setting up of the Disinvestment Commission, its recommendations and the modalities adopted for disinvestment year after year, right from the beginning up to 2002-03. The chapter also touches on the difficulties in the valuation of PSEs to arrive at appropriate reserve price before placing the shares on the market.

Turning now to the performance of the enterprises after disinvestment, the treatment is in two parts. First, in Chapter 2 there is a survey of the literature dealing with this aspect at the theoretical and empirical levels. Naib points out that at the theoretical level the presumption is that public enterprises would perform less efficiently and profitably than private enterprises and that, therefore, the expectation would be that disinvestment would lead to better performance of the enterprises concerned. But the empirical studies lead to a more qualified conclusion. "First, when market power is significant... there is no systematic difference between public and private firms... . Second, in competitive markets where other allocative inefficiencies associated with market failure are not substantial, often, private firms are more efficient than public ones... . Third, the key factor driving performance is competition. When public enterprises operate in markets where they have market power, they do just as well (or poorly) as private firms operating under similar markets under regulation."

The second part of the empirical appraisal relates specifically to the Indian situation on the basis of secondary data as well as the author's own inquiries of the performance of selected PSEs after disinvestments. Apart from the fact that in the short period of a decade or less there was not enough time for the divested enterprises to make necessary adjustments, these empirical studies faced two limitations. The first was that in many instances the disinvestments were partial, with the government retaining management and control. Secondly, for reasons not related to disinvestments as such, there was an industrial recession in the second half of the 1990s and the early part of the present century, which adversely affected many enterprises making it difficult to trace the impact of disinvestment.

Out of 38 disinvested enterprises examined, six recorded losses; they include Hindustan Photofilms, Hindustan Machine Tools (HMT), ITI and the Steel Authority of India Limited (SAIL). On the other hand, ONGC, IOC, the Gas Authority of India Limited (GAIL), VSNL, Neyveli Lignite, Bharat Heavy Electricals Limited (BHEL) and several others increased their profitability. The explanation that the author offers is that the fall in profitability was in the case of enterprises operating in a competitive environment while improvement in profitability was in the case of enterprises operating in a monopoly environment. Employment levels dropped following disinvestment, but because voluntary retirement schemes were in operation, it is difficult to attribute the fall to disinvestment as such.

The author has tried, and in large measure succeeded, in examining disinvestment of PSEs taking place currently almost throughout the world without taking an ideological position for or against the phenomenon. His survey of the theoretical literature and his concentration on empirical evidence make the book a very valuable contribution to a highly contested theme.

However, at the deeper level the work reflects some conceptual confusion. The first is the assertion in the introductory chapter that "disinvestment which is a form of ownership transfer comes under the umbrella of privatisation". It can be readily granted that during the past two decades or so the term `disinvestment' has been used to refer to the transfer of ownership of public sector enterprises and hence has been associated with privatisation. But surely, transfer of ownership and disinvestments are standard and routine practices within the private sector. In fact, transfer of ownership is one of the basic premises of the corporate form of organisation and that is what is taking place everyday in the stock market. It is also common practice for private enterprises to hive off part of their activities to other enterprises. The practice of buying and selling entire enterprises is also quite common. If so, it is not correct to bring disinvestments under the umbrella of privatisation.

At the same time, it is equally important not to treat the investment and disinvestment decisions and actions of the state on a par with similar activities of other (private) enterprises in the economy. This is not because the activities themselves are different, but because the role of the state in the economy is not the same as that of other units. The role of the state in the economy as a whole in relation to other units is somewhat similar to that of the central bank in relation to commercial banks. Just as the performance of the central bank cannot be evaluated in terms of the criteria used to judge the performance of commercial banks, the function of the state, including its investments and disinvestments, calls for different procedures of evaluation. This is because the "bottom line" of enterprises in the private sector, the profitability factor, is easy to locate, but in the case of the state (as that of the central bank) the bottom line is not so specific. It may be standard practice to use the criteria of private sector enterprises (essentially some profit ratios) to judge the disinvestments of state-owned enterprises, but that is a limited, and often less than proper procedure. However, that is what the author has relied upon in the book.