Privatisation of Public Sector Enterprises in India

Privatisation is a process by which the government transfers the productive activity

from the public sector to the private sector.

Privatisation offers many advantages.

Methods of Privatisation adopted in India.

Initial Public Offers (IPO).

 IPOs are the most favoured method of privatisation followed in the developed
countries of Europe and OECD. Under this method, the shares/equity holdings of the
PSUs are sold to the private retail investors and institutions like Mutual Fund houses,
Pension Funds and Insurance Companies etc.

The prerequisite for the IPOs to be successful is that a country must have a well-
developed and well-functioning Capital Market.

The main advantages of the IPO method are:

 It ensures wide participation of retail investors.

 It is likely to face less resistance from the PSUs stakeholders like employees, as the
method involves only selling of PSUs shares without any change in the management
and policies.
 It can be used to offer shares to the employees.
 The method is best suited when the government wanted to raise financial resources
without losing on the management and control of the PSU.

Strategic Sale.

Strategic Sale is a method in which the government decides to sell PSU shares to a
strategic partner. The management in all such cases passes to the strategic buyer.

The various advantages of the method are:

 The performance of the PSU is expected to improve as the private player selected
will already have an expertise in the management and operation of the PSU.
 The strategic partner will be willing to pay a better price for the PSU as his business
interest lies in combining his own business with that of PSU.
 The method helps in infusion of capital and modernisation of the PSUs.
 The method also helps the government in transferring the loss making PSU which
could not have been attractive to retail buyers otherwise. The strategic partner will
acquire such business as he has the prerequisite skills to turnaround the PSU.
 The method is very important for countries having less developed capital market.

Disadvantages:
 Sale to Foreign Firms.

The method is a variant of the strategic sales method where the government decides
to sell the PSUs to the foreign firms.

Management and Employees Buy outs.

In this route, management and employees come forward to but the shares and
equities of the PSUs.

Disinvestment.

The method is followed in India from time to time. The method involves the sale of
the Public sector equity to the private sector and the public at large.

Methods of Disinvestment

There are primarily three different approaches to disinvestments (from the sellers’
i.e. Government’s perspective)

 Minority Disinvestment
 Majority Disinvestment

 Complete Privatisation

Potential benefits of privatisation

1. Improved efficiency

The main argument for privatisation is that private companies have a profit incentive
to cut costs and be more efficient. If you work for a government run industry,
managers do not usually share in any profits. However, a private firm is interested in
making a profit, and so it is more likely to cut costs and be efficient. Since
privatisation, companies such as BT, and British Airways have shown degrees of
improved efficiency and higher profitability.

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 which will benefit the firm in the
long term because they are more concerned about projects that give a benefit before
the election.

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 privatisation 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 efficiency. For example, there is now more competition in telecoms
and distribution of gas and electricity.

However, privatisation doesn’t necessarily increase competition; it depends on the

nature of the market. E.g. there is no competition in tap water because it is a natural
monopoly. There is also very little competition within the rail industry.

6. Government will raise revenue from the sale

Selling state-owned assets to the private sector raised significant sums for the UK
government in the 1980s. However, this is a one-off benefit. It also means we lose
out on future dividends from the profits of public companies.

Disadvantages of privatisation
1. Natural monopoly

A natural monopoly occurs when the most efficient number of firms in an industry is
one. For example, tap water has very significant fixed costs. Therefore there is no
scope for having competition amongst several firms. Therefore, in this case,
privatisation would just create a private monopoly which might seek to set higher
prices which exploit consumers. Therefore it is better to have a public monopoly
rather than a private monopoly which can exploit the consumer.

2. Public interest

There are many industries which perform an important public service, e.g., health
care, education and public transport. In these industries, the profit motive shouldn’t
be the primary objective of firms and the industry. For example, in the case of health
care, it is feared privatising health care would mean a greater priority is given to
profit rather than patient care. Also, in an industry like health care, arguably we don’t
need a profit motive to improve standards. When doctors treat patients, they are
unlikely to try harder if they get a bonus.

3. Government loses out on potential dividends.

Many of the privatised companies in the UK are quite profitable. This means the
government misses out on their dividends, instead going to wealthy shareholders.

4. Problem of regulating private monopolies.

Privatisation creates private monopolies, such as the water companies and rail
companies. These need regulating to prevent abuse of monopoly power. Therefore,
there is still need for government regulation, similar to under state ownership.

5. Fragmentation of industries

In the UK, rail privatisation led to breaking up the rail network into infrastructure and
train operating companies. This led to areas where it was unclear who had
responsibility. For example, the Hatfield rail crash was blamed on no one taking
responsibility for safety. Different rail companies has increased the complexity of rail
tickets.

6. Short-termism of firms.

As well as the government being motivated by short term pressures, this is

something private firms may do as well. To please shareholders they may seek to
increase short term profits and avoid investing in long term projects. For example,
the UK is suffering from a lack of investment in new energy sources; the privatised
companies are trying to make use of existing plants rather than invest in new ones.

Essay on the Reasons for Privatisation:

There are many reasons for privatisation. The most important of
them has been a disillusion with the capacity of the nationalized
industries to deliver effective and efficient services to the public and
to achieve social goals they were set up to attain. For nationalized
industries the principal agent problem was particularly acute.

The objectives of the politicians who owned the companies were

often conflicting, the government department in charge of the
company added another layer of complexity, with the result that
management has no clear objectives and no sustained incentive to
perform. One major objective of privatisation was to make the
company more efficient.

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Second, closely related to the above, governments wished to

introduce competition into the sectors hitherto dominated by the
state ownership. If this was done while the companies remained in
the state ownership, their chances of successfully coping with
competition would be increased by being run by the private sector
rather than public sector.

Third, many nationalized industries were notorious losers. The

liberalisation of trade threatened even further loses. Selling them
was seen as a way of reducing or eliminating budget deficit. Fiscal
benefits could also accrue on the state’s capital account from the
sale of the assets.

Obviously the proceeds from the sale of profitable state companies

or from those with potential to earn more under private sector
management such as telecom and energy utilities promise to be
especially large.

The proceeds from privatisation yielded £65 billion in 1997 to the

UK exchequer. During the 5 years, 1995-99, Italy’s privatisation
proceeds came to $80 billion. According to OECD estimates,
revenues from privatisation between 1990-98 amounted to 24% of
Hungary’s GDP in 1998, 20% of Portugal’s GDP and 15% of New
Zealand’s.

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Many less developing countries saw privatisation as a golden one-
off opportunity to reduce public sector debt and to set motion a
lower tax environment without damaging increases in budget
deficits. Fourth, politicians came to the conclusion that the balance
of the mixed economy has shifted towards the public sector.

This belief was fortified by the abuse of power by many public sector
trade unions with frequent use of the strike weapon.

Former communist countries have been profoundly affected by the

privatisation of their economies. However, the origin of their
privatisation programmes and the context in which these are being
implemented are obviously very different to those of the west. For
one thing, these countries where being transformed from a situation
in which almost the entire economy was state-owned.

For example, East Germany had privatized some 12,000 firms,

about 85% of all firms in the previous regime operating under state-
ownership. In many of these countries, governments had large
budget deficits and a limited capacity to raise revenues through
higher taxes. Thus, privatisation, to them, was a way of disposing of
all loss-making companies and providing desperately needed
revenues to the state.

There is something paradoxical about privatisation of state-owned

companies in Western countries. After all, these companies were
originally set up to resolve some economic problem not to cause
one. Many were established to deal with the problems created by
private monopolies and to create competition among them so that
monopoly profit and social cost of monopoly can be done away with.

Nationalisation was designed to encourage exploitation of scale

economies and to ensure that monopoly profits, if any, would
accrue to the state, which they would be able to distribute them in a
socially optimum way. In retrospect these expected advantages fail
to materialize. Too often nationalized industries abused their
monopoly power. They provide bad services at higher prices.

They suffered extensive x-inefficiencies.

Their industrial relations were surprisingly very bad. Against this
background, it is easy to believe a European Commission estimate
that complete liberalisation of the European airline would bring
about a 10% decline in costs and prices which will bring benefits of
some $1 billion per year, obtained through lower pay costs, more
efficient deployment of the workforces and lower overheads.
\

The government is eyeing around $1 billion (about Rs

7,000 crore) from the sale of national carrier Air India in
the next financial year, a government official said.
The government will initiate the process of strategic
disinvestment of Air India in the second half of 2019-20
and in between it would work towards selling some of its
subsidiaries and monetise assets.
Air India has a debt burden of Rs 55,000 crore. In
November last year, a ministerial panel headed by
finance minister Arun Jaitley had approved transferring
Rs 29,000 crore debt to a special purpose vehicle (SPV)-
- Air India Asset Holding Company.
"We are eyeing $1 billion from the sale of Air India," the
official told PTI.
After a botched attempt to sell Air India in May last year,
the Jaitley-led panel in June decided to scrap the stake
sale plan for the time being. It was decided to infuse
more funds into the carrier and cut down debt by raising
resources by selling land assets and other subsidiaries.
Representational image. Reuters.
The government had initially planned to offload 76
percent equity share capital of the national carrier as
well as transfer the management control to private
players. The buyer was required to take over Rs 24,000
crore debt of the carrier along with over Rs 8,000 crore
of liabilities.
However, the stake sale failed to attract any bidders
when the bidding process completed on 31 May.
In August 2018, the government had received
Parliament nod for Rs 980 crore equity infusion in Air
India under a "turn around plan". Earlier this month,
Parliament approved a further Rs 2,345 crore equity
infusion into the airline.
The ministerial panel has already cleared the strategic
sale of Air India's ground handling subsidiary, Air India
Air Transport Services. Plans are afoot for selling
another subsidiary, Air India Engineering Services.
The proceeds from the sale of subsidiaries and land and
building assets would go to the SPV and will be utilised
towards lowering the debt burden of the airline.
The national carrier had in September last year invited
bids to sell its properties located across India.
The airline had put up for sale 28 flats in Mumbai, seven
flats in Ahmedabad, and two flats and office space in
Pune, besides several other properties across the
country.
On December 27, the civil aviation ministry told the Lok
Sabha that the government has prepared a revival plan
for Air India.
A comprehensive financial package, including the
transfer of non-core debt and assets to an SPV,
implementation of robust organisational and
governance reforms by the board and differentiated
business strategies for each of the core businesses of Air
India, are part of the plan.