Tuesday, January 25, 2011
Class of 2012
(Winner - Bodhisatva Article Writing Contest)
Disinvestment, which is the dilution of the government’s stake in public sector units, is a policy pursued by the government for bridging the fiscal deficit, raising capital for expansion and growth, repayment of debt and also funding the government’s social welfare programs. After Independence, the Indian economy was at a nascent stage and the objective of the government was to get the economy on the right track. Such a scenario called for maintaining control over major sectors of the economy like Shipping, Mining, Power generation, Railways etc. Until 1990-91, the government closely held these companies and had a major say in their day-to-day operations. The Balance of Payments crisis in 1990-91 led not only to opening up of the economy for private players and foreign investment but also to the government taking the disinvestment route.
The Disinvestment policy, of late, is centered on raising funds for social welfare schemes or to reign in fiscal deficit. This is a myopic view as it concentrates on meeting short-term obligations rather than long term profitability and sustainable growth of the public sector enterprise. The Disinvestment policy should be oriented towards raising fresh capital from the market to fund expansion and growth, increase accountability, and reduce government intervention by providing greater autonomy. The government has already taken steps to provide greater autonomy to the PSUs like elevating the Navaratnas to Maharatnas based on whether these PSUs meet certain criteria set by the government. This has given greater financial autonomy to the PSUs by raising the investment limit (the amount that a PSU can invest without requiring government approval) from Rs 1000 Cr. to Rs. 5000 Cr. Currently, there are 4 Maharatnas – SAIL, NTPC, IOC and ONGC which have been elevated from their previous status of Navaratnas. This has led to greater financial autonomy without disinvesting in major PSUs which have been profitable over the years and are a source of revenue for the government in the form of dividends. ONGC, in which the government has 74.14% stake, paid out a total dividend of Rs 7058.28 Cr in the financial year ending 2010 alone. However, the government is planning to divest their stake in such PSUs. In the financial year ending 2011, it plans to divest 5% of its stake in ONGC to raise around Rs 10,000 Cr, 10% stake in IOC whose FPO will fetch Rs 20,000 Cr. Similar FPOs are planned for SAIL and NTPC as well, which have been very profitable and competitive. Apart from Maharatnas, the government also plans to divest its stake in profit-making Navaratnas and Mini-ratnas to meet the disinvestment target set forth in the budget (The target for the year 2010-11 is Rs 40,000 Cr.). Such a disinvestment policy is oriented towards meeting short term obligations rather than looking at a broader perspective. Disinvestment in profit-making PSUs will lead to more private participation where it is not required. In the current scenario, there is a flood of ‘hot money’ in terms of FII inflows in the economy which will expose these PSUs to global shocks when there is a recession or a crisis in the world economy. Volatility of FII inflows will lead to volatility in share prices and market performance of these units. Moreover, government investment power houses like SBI and LIC which invest heavily in such PSUs will see their investments erode and profits decline. A global crisis can hence have a domino effect on these enterprises and other related businesses owned by the government which have so far been insulated from the latest global recession in 2008-09. Also, such PSUs have substantial weightage in determining the Sensex and the Nifty indexes. Hence, such a policy pursued by the government will not only expose these enterprises to global shocks but also the stock markets leading to dampening of market sentiment.
The government, however, argues that the fiscal deficit which is around 6.8% of GDP, due to the various stimulus packages offered during recession, is unsustainable. The government needs revenues to bridge this deficit to 5.5% in FY11 and to 4% in FY12. Revenues can be easily recognized by disinvestment in profit-making PSUs and hence this route is being taken by the government.
One of the major uses of government revenues are the social welfare schemes. However, due to the inherent bureaucracy and rampant corruption, not even half the benefits reach the target population. This brings a lot of inefficiency in the system as it indicates that revenues from disinvestment in profit making PSUs are used to fund populist schemes which do not reach the common man. In the long run, the government is eroding its revenue base by giving away its stake in these units. As per the policy, the government can divest up to 49% in these PSUs while maintaining the majority shares. Once these targets are reached, keeping in mind the fiscal deficit and the funding for social welfare schemes for the short term, the long term prospects of government revenue from such PSUs look bleak.
Apart from the Maharatnas, Navaratnas and Mini-ratnas which have been profitable, there are sick PSUs which have not seen profit on their books for many years. Pre-liberalization, there was almost zero competition for the PSUs and this had led to complacency and inefficiency. Post-liberalization saw the entry of many private players which led to stiff competition and crowding out of inefficient enterprises. In spite of repetitive capital infusion by the government, these enterprises still make losses and are a drain on the exchequer. Such PSUs can be turned around by bringing in private players who can improve efficiency, reduce wastage and optimize resources. Taking the disinvestment route for these units and providing greater autonomy, the government can reduce its fiscal burden and concentrate the amount spent on these units to reducing public debt. However, a turnaround can happen only if there is a management change as part of the disinvestment policy. A strategic sale is a privatization process whereby a government enterprise is privatized by auctioning the state-owned enterprise. This is different from the sale of minority stake where it does not result in privatization although government stake in the enterprise is reduced. Strategic sale is pursued to infuse private capital and bring managerial acumen of private players into the unit. A case in point is VSNL. Before the year 2000, the government was only selling minority shares in VSNL. The P/E ratio was 6.0 at that time. The strategic sale to Tata Group in April 2002 gave a much higher P/E ratio of 11.0 as an indication of the market expectation of a better performance under private management. After the sale, the government holding became 26% and that of Tata Group was 45%. In 2006, VSNL acquired Teleglobe growing its global reach and operational strengths. In 2008, VSNL, its subsidiaries and acquisitions were combined and renamed as Tata Communications. In the end, to the customer, it was a step towards better quality communication services at competitive prices.
The disinvestment policy is of the view that the markets will provide adequate discipline to the performance of the firm. However, the capital structure of these firms is seldom designed to maximize the returns for the shareholder, which is the government. Capital restructuring should be part of government policy initially to maximize returns from its shareholding in a PSU rather than taking a plunge into disinvestment to raise money in the short-term. The government should emphasize on providing greater autonomy to profitable PSUs, capital restructuring if needed and dilution of its stake in loss-making PSUs to ensure future earnings. Inefficiencies can be removed by reducing government interference by providing autonomy which should lead to higher accountability and better performance.
The National Investment Fund (NIF) was formed in 2005 into which the realization from sale of minority shareholding of the Government in profitable Central PSEs would be channelized. 75% of this fund will be used to finance selected social sector schemes, which promote education, health and employment. The remaining 25% will be used to meet the capital investment requirements of profitable and revivable Central PSEs that yield adequate returns, in order to enlarge their capital base to finance expansion/diversification.
Although the planning is impressive with respect to investment in education and health care, the implementation is flawed. Unless efficiency is brought into these social welfare schemes, they will always be a drain on government revenues and in this case disinvestment of profitable PSUs.
In conclusion, a long-term view of the disinvestment policy must be studied and it should balance the need for meeting short-term obligations while keeping in mind the long term objectives.
Industrial Policy statement in 1991
• Public Sector Portfolio of public sector investment will be reviewed with a view to focus the public sector on strategic, high-tech and essential infrastructure. Whereas some reservation for the public sector is being retained there would be no bar for areas of exclusivity to be opened up to the private sector selectively. Similarly the public sector will also be allowed entry in areas not reserved for it.
• Public enterprises which are chronically sick and which are unlikely to be turned around will, for the formulation of revival/rehabilitation schemes, be referred to the Board for Industrial and Financial Reconstruction (BIFR), or other similar high level institutions created for the purpose. A social security mechanism will be created to protect the interests of workers likely to be affected by such rehabilitation packages.
• In order to raise resources and encourage wider public participation, a part of the government's shareholding in the public sector would be offered to mutual funds, financial institutions, general public and workers.
• Boards of public sector companies would be made more professional and given greater powers.
• There will be a greater thrust on performance improvement through the Memorandum of understanding (MoU) systems through which managements would be granted greater autonomy and will be held accountable. Technical expertise on the part of the Government would be upgraded to make the MOU negotiations and implementation more effective.
• To facilitate a fuller discussion on performance, the MoU signed between Government and the public enterprise would be placed in Parliament. While focusing on major management issues, this would also help place matters on day-to-day operations of public enterprises in their correct perspective.
Excerpts relating to public sector taken from Press release on July 24, 1991
• Disinvestment and Privatization in India Assessment and Options - A Study by R Nagaraj for the ADB Policy Networking Project
• PSU Disinvestment (2010) – a study by ‘arm’ research
• Privatization of Videsh Sanchar Nigam Limited – A study by Rekha Jain and Krishnan Venkataraman
• Database - Capitaline Plus – Dividend and Shareholding patterns of PSUs
Class of 2012
India is undergoing a paradigm shift due to change in its competitive position in the world. The Indian economy is on a robust growth trajectory and exhibits a stable annual growth rate, rising foreign exchange reserves and booming capital markets. From 2004 until 2010, India's average quarterly GDP Growth has been 8.37 per cent . India has emerged as the fourth largest economy in the world on the basis of purchasing power parity (PPP). Vast investment potential exists in sectors such as biotechnology, retail, real estate, power, and telecommunications. The investment prospects are strengthened by having a large pool of skilled and competitive manpower, huge research and development base, growth in the Indian domestic market owing to higher disposable incomes and abundant natural resources required to set up industries.
In spite of the above factors, India ranks 134 among 183 nations in a survey called “Doing Business 2011″ - that gauges the ease of doing business in a country — and is ranked behind countries like arch rival Pakistan, Bangladesh and Sri Lanka.
Evaluation System of Survey
The study conducted on the world’s economies gives ranking to countries after executing lot of calculations on various parameters on “ease of doing business”. It takes into account nine areas- (i)starting a business (ii) dealing with construction permits (iii) registering property (iv) getting credit (v) protecting investors (vi) paying taxes (vii) trading across borders (viii) enforcing contracts (ix) closing a business. Out of these, India ranks very low on (i), (ii), (viii) and (xi), as compared to its neighbors. China is way ahead of India in areas of registration of property and enforcing contracts. It shows a much stronger legal system and transparency in proceedings in China. Even, Sri Lanka and Pakistan are ahead of India in these areas.
Reasons for Non-conducive Business Environment
The major factors responsible for the appalling condition for starting and operating the business are inefficient bureaucracy, inadequate infrastructure, corruption, weak legal system, and law and order problem.
The red tape hassles inherited in bureaucracy and loads of paperwork makes doing business difficult in India. The Indian bureaucracy seems to carry the legacy of “License Raj”, which appears to be a black box to many entrepreneurs. The plight of Indian bureaucracy is that the structure of district administration in India has not changed since the pre-independence era. The bureaucrats work under the influence of politicians. They decide their promotions, tenure at a place or position so bureaucrats work under an apprehensive environment.
The Indian economy is losing 1.5-2.0 per cent in growth annually due to the poor state of the country's infrastructure. Most of the foreign firms often cite rickety infrastructure like congested ports and poor roads as the biggest challenge in doing in India. India’s trade, for example, could be rendered less competitive because of high transit time and congestion surcharges. India suffers an estimated food grain and agriculture produce loss of Rs50, 000 crore every year due to the lack of adequate post- harvest infrastructure and inefficient supply chain management by the country's farmers .
The business environment is very badly affected by the pervasive corruption at all levels of government. The awarding of public contracts is notoriously corrupted, especially at the state level. The numerous bodies charged with combating corruption have conflicting mandates and suffer from lack of qualified staff, funding and easy accessibility. India has slipped three places in global rankings of most corrupt countries, from 84 in 2009 to 87 this year .
A country’s law regulate business practices, defines business policies, rights and obligations involved in business transactions. In India, Justice delayed is justice denied" is the oft repeated sentence which itself is delayed and denied both in letter and spirit. In China there are 1, 30,000 courts while it is just 14,000 courts in India . Financial experts had put forward that the delay is dragging down GDP by 2 per cent on an average especially creating a hostile environment for investment and business, in general. Financial investors investing in India has a "legal risk premium" which is an additional cost involved for investment due to the weak legal system. This arises because of the obstacles affecting enforcement of a claim or a contract especially in matters relating to land acquisition, which is one of the criteria in evaluation system.
No country can claim to have a conducive business environment without having robust and effective law and order system in place. It is because business cannot thrive in an environment which cannot guarantee its security. The states like U.P, Bihar and Jharkhand lag in this aspect which is responsible for lesser investments in these states. The threat of naxalities in states of Jharkhand, Chhattisgarh, Orissa and north-east states has led to under utilization of vast natural and human resources in these states.
Improving business scenario
The conditions for doing business in India can surely be improved, provided, the problems are tackled through specific strategic solutions which may require, in some cases, revamping the whole existing system.
We need to have a system in which bureaucrats need to have autonomy. India's bureaucrats need to be insulated from political influence. They deserve transparent appointments and promotions and fixed tenures. The civil service needs a code of ethics which demands a “climate of probity in public life”. Bureaucrats should be able to use their own ways of managing their function, bringing new ways to tackle problems and proposing policy changes. They need to be motivated throughout their serving period through various programs and workshops and a clear aim of placing the interest of “the common man” in the center of their actions should be imparted.
Business prospects in the country increase with better infrastructure. It leads to fast and secure transportation of man and material, expansion of business through investments in various places and projects and high growth rate. Now, for developing infrastructure, we need capital. Experts believe that allowing more FDI propels economic progress, job creation for the people and growth of the economy. For investments into large infrastructure projects, India needs to ensure that it has insurance cover and bonding that will cover large projects that are initiated here. But FDI alone may not provide an overall positive impact because large capital inflows may result in depreciation of currency and widening of trade deficit. So, for a holistic solution, it should be accompanied by trade agreements with major trade partners. This will ensure rise in exports and, at the same time, access to hi-tech goods and technology with the improvements in areas of research and development.
We need to have result oriented organizations with clear goals, time frame and pathway to achieve its mission. For this, there needs to be strong supervision and monitoring, at various levels. Accountability can be a very effective tool in eliminating corruption from the system. Every job in the concerned government organization should have a set-time frame, clear requirements (documents or other essentials), the person responsible for completing the job and the supervisor. Transparency is also needed and information technology can play a vital role in this. We should have public access to status reports of various applications of permits, license, registration etc. in concerned department so that end to end view of functions is facilitated.
Indian legal system needs to have a new framework for delivering accelerated dispute resolution. The main problem is the lengthy and highly intricate court procedures and the resultant deferment due to them. The whole system needs a review, with elimination of unnecessary procedures and formalities. It is still in the frame of pre-independence era, with norms not suitable to conditions in India. The simplicity in the process, easy accessibility to legal service and fast dispute resolution are three required areas to work upon in the legal system. There should be time-bound resolution of cases, depending on the broad categorization of nature of the case. India may have Indian judicial service, on the lines of Indian administrative service, to attract talent in this field with bright and secure career prospects. But, in that system, it should have result oriented approach in dispute resolution and not red tape hassles.
Law and order situation can be improved more by focusing more on implementing the existing laws instead of making the existing ones more stringent. It is because latter one, in absence of transparency and results in increased corruption. All the states should give priority in providing secure environment to resources and business zones to ensure their survival and expansion. Also, experts say that , if best practices followed in different states of India are followed throughout the country, it can leap by fifty-five places in the rankings of “ease of doing business survey”. So, efforts should be focused to eliminate the regional disparities of business conditions, which will also help the existing units to come out of radar of officialdom, dodging taxes and ignoring rules.
India surely has a long way to go, getting rid of red-tape and improving infrastructure before it can celebrate being a world power, especially if it wants to encourage new business leaders. But, with a vast pool of talent and focussing towards progress-oriented actions, it can surely make its mark in today’s business world.
1. (tradingeconomics.com/economics/GDP-growth, 2010)
2. (http://www.indiainbusiness.nic.in/know India, 2010)
4. (http://blogs.reuters.com/india/2010/11/09/survey-says-doing-business-in-india-is-tough/, 2010)
5. (Dholakia, 2010)
7. (soutikbiswas, 2010)
8. ( http://www.hindu.com/2010/11/10/stories/2010111052271300.htm, 2010)
9. (Snipping Off shackles, 2010)