Tread warily on privatisation
The government’s privatisation drive seems poised to move into higher gear. It is pushing ahead with the sell-off of Air India. It has also announced strategic sales — or the sale of a controlling equity stake — in five public sector units (PSUS) including profitable companies such as Concor and Bharat Petroleum Corporation Limited (BPCL).
The reforms brigade is cheering wildly. The government must be careful not to get carried away by the applause. Privatisation that is not carefully designed does little to help the economy — and it can be politically costly.
Take the case of Air India. There was much carping over the government’s failure to sell in the last attempt. It is plausible that the attempt failed precisely because the deal was correctly structured. Privatisation has a higher chance of success where assets are undervalued and the buyer stands to reap windfall gains.
The sweeteners now proposed for the Air India sale promise to do just that— confer windfall gains on the buyer. About half of the ~59,000 crore of debt of Air India was transferred last year to a special purpose vehicle. Of the remaining debt, another ~15,000 crore is now planned to be moved out.
With some of Air India’s debt moved out of its books, bidders will offer a higher price than they would have done otherwise. This may make for good optics — the public may get the impression that a good price is being paid for Air India. However, from the point of view of the fisc, it is the sale value net of debt taken over by the government that counts. Analysts and opposition parties will not be taken in by the sale value for Air India alone.
Another sweetener planned is selling 100 per cent of the government’s stake at one go. Not having the government as an equity owner in Air India will certainly appeal to potential buyers. However, it’s not the best way to maximise revenues for the government. The point about selling in tranches — after selling a controlling stake at the outset— is that it makes for better price discovery. As performance improves with time, the government can earn more on its residual stakes. For this reason, share issue privatisation, where there is gradual disinvestment of the government’s equity, has been preferred worldwide to asset sale, that is, the sale of all or a significant government stake at one shot.
The sweeteners proposed could well come to haunt the government. The government faces two other challenges in completing the sale. It has to ensure that Air India’s valuable real estate is moved off the books prior to the sale. It also has to find ways to address job security and benefits of Air India’s employees. Ignoring either can invite a serious political backlash.
The primary argument for privatising Air India is that a government-owned airline will make repeated demands on the exchequer. This is not such a compelling argument in an economy in which the public sector dominates banking. Several private airlines have gone bust, inflicting huge losses on the public sector banks that financed them. In the Indian economy, there is a cost to the tax payer regardless of whether an airline is publicly-owned or privately-owned.
What is missing in the current drive towards privatisation is a rigorous conceptual framework. It does not suffice to say that the government should not be in business. We need to be clear about what we want privatisation to achieve. Privatisation is driven by one or more objectives: Increasing efficiency in the economy; raising revenues for the government and bridging the fiscal deficit; promoting the development of the capital market; increasing private initiative in the economy in general. The last two objectives have been substantially met in the decades following economic liberalisation in 1991. It is the first two objectives that are relevant to the Indian economy today.
If efficiency improvement is the primary objective, it is the more inefficient and loss-making PSUS that should be privatised. Yet, the proposal now is to privatise well-run and highly profitable companies such as Concor and BPCL. The major goal clearly is bridging the fiscal deficit at a time when tax revenues are running way below projections for the second year running. It’s all about selling the family silver.
Those with long memories will recall the recommendations of the Disinvestment Commission (DC), set up in August 1996 and headed by G V Ramakrishna. The DC came out with a series of reports that provided a framework for disinvestment, strategic sales and restructuring of PSUS. Two recommendations of the DC are worth recalling. One, the disinvestment process should be de-linked from the Budget and, indeed, the proceeds of disinvestment must go into a disinvestment fund that would be used for restructuring PSUS and creating assets in rural areas. Two, there should be no strategic sale in “core” industries (such as the oil sector) or in the cases of the bigger, blue-chip PSUS.
The DC was informed by the philosophy that the public sector should be strengthened, not dismantled. The first National Democratic Alliance (NDA) government under Atal Bihari Vajpayee appeared to move away from this philosophy by pushing for strategic sales of PSUS. Following the NDA’S defeat in the general elections of 2004, Shiv Sena chief Bal Thackeray remarked bitterly that he had warned the government against the political costs of overdoing privatisation. One wonders whether old-timers in the Sangh parivar will resurrect the warning after the results of the two recent Assembly elections.