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On privatization: For efficiency and equity gains

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    10Pointer
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    Economy
  • Published
    19th Mar, 2021
On privatization: For efficiency and equity gains

Introduction

  • One of the highlights of the Union Budget for 2021-22 was the bold resolve of the government to push for an aggressive privatization policy of public sector enterprises, which would seek to unlock their potential to create wealth in India’s economy.
  • Also, explicitly stating the government's philosophy on privatization, on February 24, the Prime Minister stated that “Government has no business to be in business”.
  • India has a mixed economy in which both Private and Public Sectors exist especially in the areas of Banking, Telecom, Road Transport, Education, Healthcare, Manufacturing, Education among others.
  • Businesses owned and operated by central governments are referred to as central public sector enterprises (CPSEs). Then, in the financial sector, there are public sector banks and insurance companies.
  • Many experts on the Economy are of the view that privatization could speed up economic growth with the increase in competition.
  • However, a number of them find that privatization could bring more problems like unemployment, taking the economy backward due to its inherent issues.
  • In this report, we shall understand these intricacies of Privatization.

A brief history of the public sector in India

  • Post-independence India had adopted a very conservative economy that was practically shut to the outside world.
  • Also, the 2nd Five Year Plan envisaged that the Public sector would occupy ‘commanding heights’ of the economy, while the private sector would play a supporting role.
  • This elaborate provision for public sector involvement in India’s economy post-independence was made due to the following reasons:
    • Technological backwardness in the private sector
    • Lack of capacity in the private sector to make investments in the capital goods sector
    • Large scale unemployment
    • To address Regional imbalance of industries and development.
  • For the first four decades, the policy of the Public sector as the ‘Engine of growth’ bore some results. However, the Public sector overgrew itself.
  • In 1991, the public sector accounted for more than 20% of the country's GDP.
  • However, some serious shortcomings started to appear in India’s Public sector undertakings (PSUs) from the 1980s onwards. Some of these shortcomings were:
    • Low capacity utilization and low efficiency due to overstaffing
    • Over capitalization of enterprises
    • Inability to innovate, inability to take quick timely decisions
    • Huge political interference in the decision-making process
  • Today the central government’s portfolio contains 274 CPSEs, plus 12 public sector banks and seven insurance companies (LIC in life insurance and 6 others in general insurance). The government is trying to privatize the majority of its portfolio as efficiently and effectively as possible.

What is meant by Privatization?

  • Generally speaking, privatization is a way of altering the relationship between the state and the private sector to enhance the role of the private sector in the functioning of the national economy as a whole. Accordingly, privatization broadly means any process that reduces the state’s dominant role indirectly owning and running the economic activities of a nation.
  • It is argued the private sector tends to run a business more efficiently because of the profit motive. However, critics argue private firms can exploit their monopoly power and ignore wider social costs.
  • In India, privatization is sought to be achieved through two measures:
    1. The disinvestment of the government’s equity in public sector undertakings, and
    2. The opening up of hitherto closed areas to private participation (Like railway operations)

Various modes of disinvestments followed by the Government

  • Disinvestment through minority stake sale in listed CPSES to achieve minimum public shareholding norms of 25 percent. While pursuing disinvestment of CPSES, the Government will retain majority shareholding, i.e., at least 51 percent and management control of the Public Sector Undertakings;
  • Listing of CPSES to facilitate people's ownership and improve the efficiency of companies through accountability to its stakeholders - As many as 57 PSUs are now listed with a total market capitalization of over Rs 13 lakh crore.
  • Strategic Disinvestment involves the sale of a substantial portion of Government shareholding in identified Central PSES (CPSES) up to 50 percent or more, along with transfer of management control.
    • NITI Aayog identifies PSUs for strategic disinvestment. For this purpose, NITI Aayog has classified PSUS into "high priority" and "low priority", based on (a) National Security (b) Sovereign functions at arm's length, and (c) Market Imperfections and Public Purpose. The PSUs falling under "low priority" are covered for strategic disinvestment.
  • Buy-back of shares by large PSUs having huge surplus;
  • Merger and acquisitions among PSUs in the same sector;
  • Launch of exchange-traded funds (ETFs) - an equity instrument that tracks a particular index. The CPSE ETF is made up of equity investments in India's major public sector companies like ONGC, REC, Coal India, Container Corp, Oil India, Power Finance, GAIL, BEL, EIL, Indian Oil and NTPC; and
  • Monetization of select assets of CPSEs to improve their balance sheet/reduce their debts and to meet part of their capital expenditure requirements

Potential benefits of privatization

1. Improved efficiency:

  • The main argument for privatization is that private companies have a profit incentive to cut costs and be more efficient.
  • Data presented in the Economic Survey 2019-20 showed that State-run entities where government offloaded stake were found to have performed much better than those under government control.

 2. Lack of political interference:

  • It is argued governments make poor economic managers.
  • They are motivated by political pressures rather than sound economic and business sense.
  • For example, a state enterprise may employ surplus workers which is inefficient. The government may be reluctant to get rid of the workers because of the negative publicity involved in job losses. Therefore, state-owned enterprises often employ too many workers increasing inefficiency.

3. Short term view:

  • A government many think only in terms of the next election.
  • Therefore, they may be unwilling to invest in infrastructure improvements that will benefit the firm in the long term because they are more concerned about projects that give a benefit before the election.
  • It is easier to cut public sector investment than frontline services like healthcare.

4. Shareholders:

  • It is argued that a private firm has pressure from shareholders to perform efficiently.
  • If the firm is inefficient then the firm could be subject to a takeover. A state-owned firm doesn’t have this pressure and so it is easier for them to be inefficient.

5. Increased competition:

  • Often privatization of state-owned monopolies occurs alongside deregulation – i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market. It is this increase in competition that can be the greatest spur to improvements in inefficiency.
  • However, privatization doesn’t necessarily increase competition; it depends on the nature of the market. E.g. there is no competition in railways if it is privatized, as the sector is a natural monopoly.

An account of the disinvestment process till now

  • As part of the larger economic liberalization policy changes which were adopted in 1991, the number of industries reserved for the public sector was reduced to 8 in 1991, 6 in 1993, and 4 in 1998-99
  • In the initial phase (1991-1996) after economic reforms, partial disinvestment was undertaken (MTNL, VSNL, and GAIL)
  • In 1993, the Rangarajan committee report on disinvestment suggested the following:
    • Less than 49% disinvestment in industries especially reserved (six sectors) for public sector (like arms, railways, atomic energy, coal, mineral oils, radioactive minerals)
    • Greater than 74% disinvestment of strategic industries which has a dominant market share
    • 100% disinvestment of all other industries
  • In the next stage (1996-98), disinvestment was done in a headstrong manner with the constitution of the Disinvestment Commission in 1996 (BPCL, HPCL, NALCO)
  • In 1999, the Department of Disinvestment (in MoF) was formed giving the process a whole new direction
  • From 2001 to 2004 maximum number of disinvestments took place
    • 11 CPSE underwent strategic disinvestment Ex: BALCO, Maruti, Hindustan Zinc
  • However, the process of disinvestment always remained a controversial issue. As a result, the process stagnated after 2004 till 2008. But between 2009-10 and 2013-14, speed increased speed due to political stability
  • Since 2014 the government is setting ambitious targets of disinvestment, but the actual disinvestment is less. We have not seen many big-ticket disinvestments. However, initiations have been made, for example in BPCL and Air India.

Privatization of Public Sector Banks (PSBs)

The Union Budget 2021-22 has announced the privatization of two public sector banks (in addition to IDBI Bank) and one general insurance company in the upcoming fiscal.

Need for Privatization in Banks

? Compared with private banks, PSBs continue to have high non-performing assets (NPAs) and stressed assets although this has started declining.

? After the Covid-related regulatory relaxations are lifted, banks are expected to report higher NPAs and loan losses. This would mean the government would again need to inject equity into weak public sector banks.

  • As per the RBI’s recent Financial Stability Report, the gross NPA ratio of all commercial banks may increase from 7.5% in September 2020 to 13.5% by September 2021.

? The government is trying to strengthen the strong banks and also minimize their numbers through privatization to reduce its burden of support.

? After 1990, when RBI allowed more Private Sector Banks, competition increased. Today, Private banks’ market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%.

Recommendations of Different Committees:

Many committees had proposed bringing down the government stake in public banks below 51%:

  • The Narasimham Committee proposed 33%.
  • The P J Nayak Committee suggested below 50%.

Performance of Private Sector Banks

? Rising Market Share: Private banks’ market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%.

?  Competition leading to better Products and Services:

After 1990, RBI allowed more private banks, which provided necessary competition to banks. They have today expanded their market share through new products, technology, and better services, and also attracted better valuations in stock markets.

  • HDFC Bank (set up in 1994) has a market capitalization of Rs. 8.80 lakh crore while SBI commands just Rs. 3.50 lakh crore.

Issues with Private Sector Banks

? Governance Issues:

  • The Bank MD and CEO of ICICI were brought under scrutiny for allegedly extending dubious loans.
  • Yes Bank CEO was not given an extension by the RBI and now faces investigations by various agencies.

? Under-reported NPAs:

When the RBI ordered an asset quality review of banks in 2015, many private sector banks, including Yes Bank, were found under-reporting NPAs.

Current Policy for Privatisation

  • Strategy: There has been a shift of strategy from ‘disinvestment based approach to investment based approach’ – where the objective now is maximizing the government’s equity stake value to maximize the price of sale of assets.
  • In this view, ‘Department of dis-investment and Public asset management (DIPAM)’ has been renamed as ‘Department of investment and Public asset management (DIPAM)’, with an expanded mandate. This shows the significant shift in the thinking process.
  • For 2021-22, the Centre has targeted Rs 1.75 lakh crore in revenue from disinvestment, privatization and asset monetisation.
  • In addition to several CPSUs, the government has expressed that it will take up the privatization of two public sector banks and a general insurance company in 2021-22.
  • The government has also said that it will maintain a presence in a handful of strategic sectors, these include atomic energy, space and defense, transport and telecommunications, power, petroleum, coal and other minerals and banking, insurance, and financial services.

Negatives of Privatisation

  • No Welfare State: The concept of the welfare state may get defeated with the Privatization of the economy. The private sector would not care about society as its main objective is to earn profits.
  • Less Social Development: Government or Public sector companies also keep doing social work simultaneously. In case privatization happens, it will result in fewer funds for society because private companies have no obligation to do social work.
  • Unemployment: Privatization will also result in the retrenchment of employees. In private sector enterprises, there is an emphasis on performance which indirectly results in work pressure and meeting deadlines or targets, and individuals who have been doing work for years without much pressure find it difficult to adjust to new settings and many end up resigning from their service.
  • Long Term Risk: The risk of short-term gains is prominent in private companies. There are decisions to start ventures which result in short-term benefits but may not be good for the long term.
  • Government loses out on potential dividends: Selling state-owned assets to the private sector can raise significant sums for the government, which can be used to offset deficit spending. However, this is a one-off benefit. It also means we lose out on future dividends from the profits of public companies.

Way Forward

  • Privatization is expected to play a significant role in improving competencies within enterprises, along with the building of resource efficiency among units at a time when PSEs have been incurring losses.
  • At a time when there is an urgent need to raise resources to fund spending on an economy that is recuperating from the COVID pandemic, the money garnered from the privatization process would come in handy.
  • However, moving forward, the government will have to deal with some of the key challenges in implementing the privatization agenda. These include:
    • opposition by the staff of the state-owned enterprises slated for privatization
    • the difficulty of determining the actual values of the enterprises, and
    • the usual apprehension that the government is selling off the enterprises at give away prices to political cronies
  • The replacement of public with private management does not of and by itself serve the public good. For a vibrant and resilient economy as envisaged through ‘Atma Nirbhar Bharat’, increased efficiency in the overall economy and governance is the need of the hour.

Conclusion

Central PSEs were initially created to fill gaps in the economy where the private sector was not willing to invest. Given that the prevailing business environment in India is largely characterized by a dynamic market economy and vibrant private sector, this approach may no longer be required. Thus, the lead taken by the Centre to implement its agenda of privatization or disinvestment at this juncture is both appropriate and welcome. However, the government must ensure that it can insulate the poor and vulnerable from the downsides of reduced welfare and unemployment that can be a short-term drawback of privatization.