Divestment finally comes of age

The unprecedented success of the divestment programme in India in the current year bodes well for the future of the country's economic reforms.

More than Rs 15,400 crore (Rs 154 billion) was raised against the Budget estimate of Rs 13,200 crore (Rs 132 billion). This is the highest-ever level of divestment receipts in a single year and accounts for more than one-third of the cumulative total divestment receipts in India so far.

The Divestment Development: Complete Coverage

The ONGC issue was the largest-ever in the Indian capital markets. And it is only the fourth time that the government has been able to achieve its divestment target in the 13-year-old Indian divestment story.

One of the major reasons for this success has been the giving up of the dogmatic preference for strategic sale as the only method of divestment like it had been for the past three years. This continuum was broken only in the current financial year with the public offer of Maruti Udyog Limited.

This method was applied universally without taking into account the firm-level characteristics such as size and profitability, market conditions and its political acceptability.

Strategic sale had been emphasised as it was supposed to maximise revenues for the government. One of the cases often quoted is that the price-earnings ratio of the minority sale of VSNL shares was 6, which increased to 11 when divestment was done through strategic sale.

In the recent divestments, revenues earned through public offer have been quite substantial in terms of the PE ratio -- CMC (17.8), IPCL (16), ONGC (10.3), Gail (9.2), IBP (8.6) and Dredging Corporation (5.3). This negates the earlier belief that government revenues can be substantial only with strategic sale.

International experience would support the public offer route for raising resources from divestment. Using a sample of 2,477 state-owned enterprises from 108 countries, which raised $1.2 trillion between 1977 and 2000, Megginson, Nash, Netter and Poulsen (2002) analysed the choice between raising funds through public offer as compared to strategic sale. They found that 63 per cent of the proceeds from divestment were raised through public offer and the rest was accounted for by strategic sale.

Public offer may be a better method when the firm size is large (as in the case of ONGC) and the market conditions are buoyant. Another important factor is the political environment that provides the background for major policy initiatives.

It was in September 2003 that the judiciary, in its ruling related to the divestment of HPCL and BPCL, seemed to have dealt a death blow to the divestment programme of the country.

But the government took a path to divestment that was more acceptable politically, by spreading potential gains among the retail investors, thus insulating the process from charges of favouritism towards any particular industrial group.

Strategic sale also raises inconvenient issues about increased concentration ratio and monopolisation of the market. In fact, this issue was raised prominently in the case of divestment of IPCL to Reliance in 2002, as the combined polymers manufacturing capacity of IPCL and Reliance increased to 2.6 million tonnes a year. Such issues do not arise in the case of public offers as a method of divestment.

It is nobody's case that strategic sales are a wrong method of divestment. The point that is being made is that divestment can be done through a number of methods depending on a host of factors and that the government should not be dogmatic about a particular method.

The divestment in six companies in the past five weeks through public offer goes to show that the government has learnt the job and has refined the divestment policy.

The government, over the last 13 years, has taken a number of steps that have brought maturity to the divestment policy.  First is the clear definition of the domain of divestment. Divestment in central public sector undertakings is being undertaken to bring down government equity in non-strategic PSUs to 26 per cent or below, in the majority of cases.

The strategic PSUs are outside the ambit of divestment and comprise those that are in the areas of arms and ammunition and allied items of defence equipment; defence aircraft and warships; atomic energy (except in the areas related to the generation of nuclear power and application of radiations and radio-isotopes to agriculture, medicine and non-strategic industries); and rail transport.

Second, the government has also clarified that it does not matter whether the undertaking is profit-making for it to be considered for divestment.

Profitability is not an index of efficiency. Often, the public sector companies that are profitable in a monopoly situation become loss-making when put in a competitive situation. The classic case is that of BSNL, whose profits slipped 77 per cent in 2002-03 compared the previous year.

Long distance telephony, its cash cow, was opened to private competition in 2002 and players like Bharti and Reliance have provided strong competition to BSNL. To compete more effectively, BSNL should be divested.

Third, the government has standardised the various stages of divestment transactions for transparency. The divestment ministry has also recently formulated guidelines for divestment of loss-making enterprises, employee buyouts, and divestment of natural resource companies in order to address such cases in a structured way.

Fourth, employee concerns have been sought to be adequately addressed in the divestment policy. Public sector employees feel apprehensive about their situation once the company ceases to be a PSU. To address these apprehensions, a specified percentage of shares is reserved for the employees of the company that is undergoing divestment.

Further, specific provisions to protect the service conditions of workers are incorporated in the Shareholders' Agreement with the strategic partner at the time of divestment. These include the condition that the strategic partner shall not retrench any employee of the company for a period of one year from the closing date of the transaction.

Divestment can also give a fillip to employment as is evident from the case of CMC Ltd, where fresh recruitment of 558 people has taken place post-divestment.

Lastly, government is setting up the Divestment Proceeds Fund shortly, to which the receipts from divestment would be credited. The fund will be used to meet expenditure on social and infrastructure sectors, restructuring of PSUs, retiring public debt and provision of a safety net for workers.

If divestment proceeds are used for such purposes, many of the remaining criticisms associated with it are likely to be addressed, thus making the divestment policy more robust.

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