Go easy with the family silver - Privatisation

Of all the affronts that the slogan ‘India Shining’ evoked in 2004, none was symbolically more fatal for the political fortunes of the Bharatiya Janata Party than the “strategic sale” of key public sector assets to a handful of lucky private companies.

In the most well-developed of capitalist economies with bureaucratic transparency, a well-functioning judicial system and deep competition, the auction-based sale of companies is fraught with problems of price discovery. That is why the offering of PSU shares to the public through the stock market has been the preferred route to privatisation in advanced market economies rather than the outright sale of the company. India, where virtually none of the textbook conditions for efficient auctioning obtains, made the mistake of following the second route with disastrous results.

Whether there was collusion or not, the sale of Modern Foods, BALCO, IPCL, Centaur and the numerous standalone hotels of ITDC amounted, in the public mind, to little more than sweetheart deals. Not only did the erstwhile National Democratic Alliance government not realise the full value of all underlying assets these companies came bundled with, especially land, but the very rationale for privatisation was never very convincing.

At a time when a single bungalow in Lutyens Delhi was selling for more than Rs. 100 crore, the sprawling Lodhi Hotel complex nearby was auctioned for just Rs. 72 crore. The official valuation made of BALCO, sold to Sterlite/Vedanta for Rs. 550 crore, was a scandal, as was that of IPCL, a fact noted by the CAG. And the extensive property owned by Modern Foods in every big metro was not valued, with the government claiming — falsely — that the new owners, Hindustan Lever, would have no right to dispose of the land.

In 2001, the Supreme Court unwisely put its imprimatur on the sell-off process by declaring in the BALCO case that economic policymaking was beyond the purview of judicial review. However, the political controversy generated by these sales — and the inter-corporate battle over who would get to grab the lucrative rents on offer — led to the slowing down and eventual suspension of the privatisation drive even before the NDA’s defeat in 2004. When the Congress-led United Progressive Alliance government came to power that year, it did not require much prodding from the Left to declare that disinvestment would no longer be a priority. And with India’s GDP continuing to grow at a fast rate, it became clear the lack of privatisation was not a binding constraint on the economy’s potential.

Nevertheless, for the corporate sector and followers of the Sensex cult, the fact that this potential ‘sale of the century’ had come to an end so abruptly was always the source of heartburn. And today, with the economy in the doldrums and the stock markets not quite in recovery mode, the sale of public sector assets is being pushed as a tonic for restoring investor confidence, kickstarting growth, promoting economic efficiency and reducing the fiscal deficit.

In the run-up to the budget, the markets had worked themselves up into a frenzy because the re-election of the Congress and the formation of UPA-II without Left support seemed to suggest the return of aggressive reforms. When the budget failed to deliver the opportunities for quick enrichment that ‘reformers’ were clamouring for, the markets tanked. However, it would be a mistake to assume that the privatisation agenda has gone away. In their post-budget statements, Prime Minister Manmohan Singh and Finance Minister Pranab Mukherjee have both spoken of the importance of disinvestment. One can only assume the government is waiting for a more propitious moment, both politically and financially, before rolling out its sell-off plan.

Before going down this route, however, it is essential that the case for privatisation be discussed anew from first principles. And that this discussion be conducted rationally, without the free market dogma and leftist sentimentality that has tended to cloud the real picture.

Broadly speaking, one needs to ask four questions. First, is public ownership of industry inherently inferior to private? Second, is private ownership the only way to deal with managerial inefficiency? Third, is there a difference in the positive and negative outcomes produced by privatisation through the strategic sale route and through the sale of shares to the public? Fourth, is plugging the fiscal deficit a sound rationale for disinvestment?

In his recent book, Privatisation in India: Challenging Economic Orthodoxy(RoutledgeCurzon, 2005), by far the most comprehensive and rigorous study of the issue in the Indian context, T.T. Ram Mohan of the Indian Institute of Management, Ahmedabad, conclusively debunks the assumption that the private sector is more efficient than the public. After carefully reviewing both financial performance and input-output related physical productivity in the two sectors, he concludes that “the evidence thus shows that the perception that the private sector is uniformly superior to the public sector … rests on a weak evidential foundation.” This does not mean other aspects of the reform package are necessarily bad.

Indeed, Professor Ram Mohan argues that the advent of reforms in the early 1990s has led to a convergence between the public and private sectors. If this is so, there is a strong case for looking at the reforms process — especially the introduction of greater competition, and the partial public listing of PSUs — as a way of unshackling the public sector rather than doing away with it altogether. Indeed, the empirical data of the past decade strongly indicates that those PSUs which had greater functional autonomy and public accountability through mechanisms like stock market listing and professional boards improved their financial performance.

Like other serious scholars of management, Prof. Ram Mohan also points to the pervasive nature of the “agency problem” in modern capitalism where there is a separation between ownership and control in large corporate entities. Public ownership may exacerbate this problem but poor corporate governance and law-enforcement make it likely that agency problems will be as acute under private ownership. In other words, serious reform should focus not on a change in ownership but on devising mechanisms for more effective governance. One suggestion has been made by R. Nagaraj of the Indira Gandhi Institute of Development Research in a recent paper: that the government examine the feasibility of “Japanese and German style interlocking ownership of complementary PSUs tied together with a bank that enforces greater managerial accountability, and encourages long term outlook of output growth and acquisition of technological capabilities.” There may be other ways of doing this as well.

On the third question, international evidence suggests there is no reason to assume that the strategic sale of PSUs will produce better efficiency outcomes than the sale of PSU shares to the public. So far, at least, it seems as if this is one lesson the Manmohan Singh team seems to have learned from the negative experience of the BJP’s experiments with privatisation. Mr. Mukherjee’s budget speech spoke of bringing the government’s holdings in the public sector down to 51 per cent. If this is done gradually, the limited sale of shares to retail investors may raise substantial revenues. Prof. Ram Mohan’s study conclusively suggests that this kind of limited disinvestment enhances the managerial efficiency of PSUs, especially if it is accompanied by greater autonomy. But care has to be taken to ensure that the issuing of shares does not turn into a cover for the eventual transfer of ownership to private hands, an outcome that would have no fiscal, commercial or social rationale if the PSU concerned is actually making profits.

If there is a rationale for the limited and well-planned divestment of PSU equity as part of a long-term process of governance reform of the public sector, it would be utterly myopic on the government’s part to think of such sales as an easy means of plugging the fiscal deficit. The deficit ought not to be an issue when there is a global recession lurking around the corner. But to the extent to which it is, it is far better for the government to find ways of broadening the tax base and ensuring better compliance. Here again, the myth of the private sector needs exploding. This year’s budget papers contain a study of revenue foregone under the Central tax system in the previous financial year. There we see that the effective tax rate of the corporate sector was 22.24 per cent “which was substantially lower than the statutory rate of 33.99 per cent.”

When the corporate data is decomposed, the tax liability turns out to be unevenly distributed: PSUs pay a larger proportion of their profits than the private companies; IT enabled service providers and BPO service providers and software development agencies had a tax liability of just 15 per cent and 12 per cent respectively. Total revenue foregone from corporate taxpayers in 2008-9 was Rs. 68, 914 crore. That is 17 per cent of this year’s budgeted fiscal deficit. If the government wants to cut its deficit, let it focus its efforts on the tax system. For that will pay recurring dividends rather than the one-time payoff that each piece of family silver will fetch. The only thing worse than disinvesting badly is to do so unnecessarily.