Privatization and Disinvestment

BY:

APALA GUPTA

GARIMA SONI

MINAKSHI SINHA

SHRADDHA CHAPEKAR

PRIVATISATION

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”.

WAYS OF ACHIEVING PRIVATIZATION 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.

DISINVESTMENT 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’.

TYPES OF DISINVESTMENT 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 PSU’s.

CONDITIONS FOR SUCCESS OF PRIVATIZATION

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

ADVANTAGES OF PRIVATIZATION Increased efficiency Specialization Corruption Accountability Security Goal

DISADVANTAGES OF PRIVATIZATION Short term view Downsizing Political interference Reliability

METHODS ADOPTED BY THE GOVERNMENT OF INDIA FOR DISINVESTING

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.

PUBLIC SECTOR IN INDIA 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 PSUs1. 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

DISINVESTMENTPolicies & Procedures

SCENARIO BEFORE 1991 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

TIMELINE 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

PHASE I (1991-92 TO 1995-96)

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 PSE’s, 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.

RANGARAJAN COMMITTEE 1992-1993 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.

PHASE II (1996-97TO 1997-98) 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.

SUMMARY OF DISINVESTMENT IN PHASE I & IIYEAR Target

amount (in crore)

Amount realised(in crore)

Enterprises disinvested

Methodology

1991-92

2500 3038.00 30 (30) Minority shares sold by auction methodin bundles of ‘very good’, ‘good’, and‘average’ companies.

1992-93

2500 1912.51 16 (2) Bundling of shares abandoned. Sharessold separately for each company byauction 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 fifthcompany.

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)

Amountrealised(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)

Amountrealised(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 ofHZL, 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 ofONGC; sale of shares to IPCLemployees

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)

Amountrealised(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-NHPC2247.05- OIL

PHASE III (1998-99 TO 2007-2008) 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.

MARUTI UDYOG LTD’S CASE

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.

PHASE III: CONTINUED

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 IPO’s.

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.

NATIONAL INVESTMENT FUND

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.

SALIENT FEATURES OF NIF 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.

PHASE IV (CURRENT SCENARIO) 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.

PSU’S ARE NOT THAT BAD!

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 India’s GDP.

PSUS – MORE RESILIENT IN CASE OF ECONOMIC DOWNTURN It is only due to the strong fundamentals of the PSU’s 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