Disinvestment and Privatization

The concepts of disinvestment and privatization have been integral to India's economic reforms. Here are the key definitions and considerations associated with these terms:

1. Disinvestment:
• Definition: Disinvestment involves the sale of shares of the government to various entities, including the retail public, employees, mutual funds, domestic financial institutions, or Foreign Portfolio Investors (FPIs).
• Ownership Percentage: The government retains more than 50% of equity, ensuring that the unit remains under government control.
• Capital Raising: The primary purpose is to raise capital by selling shares in limited quantities to different individuals and institutions.
• Management Control: The sale of shares does not transfer management control, and no single buyer holds a substantial say in the management.
2. Strategic Sale:
• Definition: A strategic sale occurs when the government sells a significant portion of equity (e.g., 26% or 51% or more) to a single buyer, and management control is handed over to that buyer.
• Buyer: The buyer, in this case, is termed a strategic partner, and the sale is often associated with privatization.
• Strategic Partner Characteristics: The strategic partner typically has a presence in the sector and can add substantial value to the unit.
• Examples: IPCL was sold to Reliance Industries Ltd (RIL), and BALCO was sold to Sterlite.
3. Privatization:
• Definition: Privatization is a broader term that encompasses strategic sales where equity and management control are transferred to a private owner.
• Strategic Sale and Privatization: If the sale of equity and the transfer of management occur in favor of a private entity, it is considered both a strategic sale and privatization.
• Examples: Sale of HPCL to ONGC, PFC to REC, and IDBI Bank to LIC.
4. Advantages of Strategic Sale (Privatization):
• Investment: Attracts investment from the strategic partner.
• Further Investments: The strategic partner, with management control, often invests further for diversification and technological improvement.
• Market Perception: Improves market perception as the unit is no longer a government company.
• Shareholder Value: Increases shareholder value.
• Improved Functioning: With improved functioning, workers' protection is also guaranteed.
5. Corporatization:
• Definition: Corporatization involves reorganizing government units along business lines.
• Business Principles: Government units operating as corporations are required to pay taxes, raise capital from the market without government backing, and operate based on commercial principles.
• Level Playing Field: Even government corporations operate on a level playing field with the private sector without special advantages.

The concepts of disinvestment, strategic sale, privatization, and corporatization are essential elements of India's economic reforms, aimed at enhancing efficiency, attracting investments, and improving overall economic performance.

Advantages of Disinvestment/Privatization:

1. Financing Government Restructuring:
• Raises finances for the government, enabling it to undertake restructuring initiatives in Public Sector Enterprises (PSEs).
2. Allocation to Social Sector Priorities:
• Provides additional finances for social sector priorities, directing funds toward critical areas such as education, healthcare, and welfare programs.
3. Market Discipline and Efficiency:
• Exposes enterprises to market discipline, compelling them to enhance efficiency and rely on their own financial and economic strength.
4. Reduced Budgetary Support:
• Professionalization and increased profitability of units lead to minimized budgetary support, freeing up resources for essential social and infrastructural needs.
5. Wider Distribution of Wealth:
• Offers shares to small investors and employees, resulting in a wider distribution of wealth and ownership.
6. Capital Market Benefits:
• Enhances the capital market with the increase in floating stock, providing more depth and liquidity. This facilitates PSEs in raising funds for future projects or expansion.
7. Economic Activity and Employment:
• Opening the public sector to private investment stimulates economic activity, leading to benefits such as increased employment and higher tax revenues in the medium to long term.
8. Reduction in Public Debt:
• Reduces public debt, preventing it from reaching unmanageable levels.
9. Consumer Benefits:
• Breaks public sector monopolies in areas like the telecom sector, offering consumers more choices and better quality products and services. Competition encourages improved performance from PSEs.
10. Improved Performance:
• The end of public sector monopolies often results in improved performance as PSEs adapt to market forces and consumer demands.
11. Long-Term Economic Growth:
• Promotes long-term economic growth by fostering a competitive business environment and encouraging private investment.
12. Quality and Cost Benefits:
• Consumers benefit from more choices, improved quality, and potentially lower costs as PSEs strive to compete effectively.

Disinvestment and privatization are viewed as strategic measures to enhance efficiency, financial viability, and overall economic prosperity by introducing market forces into the functioning of public enterprises.

Top of Form

Criticism of Divestment:

While there are compelling advantages to divestment, criticisms have been raised, emphasizing the following concerns:

1. Family Silver Liquidation:
• PSEs are considered as the "family silver" and critics argue against their liquidation, viewing them as valuable national assets that should be retained.
2. Check on Private Sector:
• PSEs are seen as essential in regulating the private sector within the broader marketplace. Their presence is believed to prevent issues such as cartelization and ensure fair competition.
3. Contribution to Public Finance:
• PSEs contribute to public finance through dividends and profits, serving as significant sources of government revenue. Critics contend that divestment may lead to a reduction in these financial contributions.
4. Revenue Deficit Filling:
• Critics argue that the primary motive behind divestment is to fill the revenue deficit rather than focusing on the long-term benefits and efficiency improvements in PSEs.
5. Prudent Middle Path:
• Calls for adopting a prudent middle path, considering factors such as the extent of divestment, selection of units, pace of the process, and the method employed (IPO, strategic sale, etc.). There is a debate on the valuation process.
6. Resource Target Pressure:
• Concerns about setting high disinvestment targets, leading to potential pressure to meet these targets even if it may not be in the best interest of the enterprises or the economy.
7. Potential Job Losses:
• The privatization process may lead to restructuring, and critics argue that it could result in job losses and negative implications for workers.
8. Impact on Strategic Sectors:
• In strategic sectors, critics express concerns about the potential impact of privatization on national security and key areas such as defense, atomic energy, and telecommunications.
9. Unequal Wealth Distribution:
• Critics argue that divestment may contribute to unequal wealth distribution, as shares may be concentrated in the hands of a few, reducing the intended benefits of wider wealth distribution.
10. Overemphasis on Short-Term Gains:
• Divestment initiatives may face criticism for prioritizing short-term gains, potentially at the expense of long-term economic and industrial development.

Balancing these concerns with the potential benefits of divestment remains a complex challenge, requiring careful consideration of various factors and stakeholder interests.

Valuation of Shares:

The valuation of shares for Public Sector Enterprises (PSEs) is typically determined using the Discounted Cash Flow (DCF) model. The DCF model is a method of assessing the present value of a business based on the projection of its future profits or cash flows. This approach is considered one of the best methods for share valuation.

Net Asset Valuation is not commonly adopted for running businesses but may be applicable to units undergoing winding-up processes.