Disinvestment, the buzzword

Disinvestment is a buzzword now. Economic Survey 2009 indicates that the central government would mobilise Rs 25,000 crore from disinvestment of its holdings in state-owned enterprises (or public sector enterprises). The target is abysmally low (at Rs 1,120 crore) in the budget 2009-10 presented by the Finance Minister. We may assume that the target is Rs 25,000 crore for the year 2009-10. The government is committed to disinvestment, although some of its coalition partners and trade unions are against it. There-fore, although there is no debate on the issue within the lead coalition partner, there are some questions that remain unanswered.

The mode of disinvestment
Disinvestment means off-loading government’s stake in state-owned enterprises (SOE) by selling to one or more strategic partners or to the public. When the government offloads its stake in state-owned enterprises, the proceeds goes to the government exchequer (National Investment Fund). The government, as per the present policy, uses the 75 per cent of the income from the corpus of the fund for investment in the social sector. Public offerings (e.g. initial public offering) by state-owned enterprises are not disinvestment.

The proceeds of public offerings go to the state-owned enterprises and not to the government kitty. However, it reduces the percentage of government holding in the state-owned enterprises. It also relieves the government, to an extent, from providing fina-nce to the company for capital investment or for working capital. For example, if the State Bank of India issues shares in the market, the government is relieved from infusing capital in the bank to enable the bank to meet the capital adeacy requirements commensurate with its deposit growth.

The mode of divestment has not yet been clearly spelled out by the government. However, as reported in the press the government will go for creeping disinvestment in listed companies in which the government stake is more than 90 per cent. There are about a dozen listed public sector undertakings (PSUs) in which the government’s stake is between 90 per cent and 99 per cent. The government is expected to offload a small per centage (5 per cent or so) of its stake as part of IPO by some companies (e.g. NHPC). For loss-making state-owned enterprises, it has no alternative but to sell a part of its stake to a strategic partner.

If we look at the budget speech by the Finance Minister, it appears that the government will enforce the rule for 25 per cent public holding for listed companies and will reduce its stake to at least 75 per cent in listed state-owned enterprises. The government has decided not to reduce its stake below 51 per cent in state-owned enterprises. Thus, state-owned enterprises will continue to maintain the state-owned enterprises status.

The disinvestment objective
In the current fiscal year, the primary objective of disinvestment is to mobilise resources to support social sector projects and to reduce the dependence of state-owned enterprises on government funding. It is matter of judgement whether the government should borrow or divest its stake in state-owned enterprises. Although I believe that disinvestment should be not mobilise funds for social sector projects because by disinvesting from profitable state-owned enterprises the government will forego a source of continuing cash inflows. This essay does not aim at to discuss this issue. This essay addresses other arguments in favour of disinvestment.

It is difficult to understand the argument that the government has no business to be in ‘businesses’. There is no reason why the government cannot continue as a major shareholder in profit-making commercial state-owned enterprises. If the argument is that the government is not competent to run commercial enterprises efficiently and effectively, then it is equally true that the government cannot implement the social sector projects efficiently and effectively.

But today we look for an efficient government. Therefore, the government has to improve its efficiency. The government should remove bureaucratic hurdles from all activities that it undertakes. Therefore, ‘inherent government lethargy and inability to respond quickly to environment changes’ is no more a tenable argument. After all, an enterprise is run by professional managers and the board of directors and not by shareholders directly unless it is a family run business.

The government should not make fresh investments in commercial ventures, except in those which are of strategic importance; because now enough private capital is available to invest in commercially large projects and the government has to necessarily invest in social sectors. The policy of allowing state-owned enterprises to tap capital market should continue.

It is also not a very strong argument that listing in stock market itself bring discipline. We know that a large number of listed companies cannot be said to be highly disciplined. However, listing provides government with capital market parameters to measure the performance of state-owned enterprises. Using market-based parameters to measure quarter-to-quarter or year-to-year performance of state-owned enterprises may not be a very good idea. It is established that the use of market-based parameters in determining the variable compensation to top management often leads to accounting fraud and short-termism. Analysts use many accounting (e.g. economic value added) and non-accounting parameters to evaluate the performance of companies.

I am not suggesting that market-based parameters for evaluating performance should be abandoned. But the argument that disinvestment will improve performance evaluation due to availability of market based parameters is a weak argument in favour of disinvestment.

Management uses share price movements to understand capital market’s perception about the company’s corporate and functional strategies, and capital market’s confidence in management’s ability to implement strategies. However, share price movements provide signals only if there is adequate public holding in the company. The present public holding in most state-owned enterprises is not adequate for the purpose. The government should achieve the target of 25 per cent public holding in listed state-owned enterprises in stages, but not through the route of disinvestment. It should achieve the same by allowing state-owned enterprises to issue shares in the capital market.

Bureaucratic intervention
The government should not meddle in the day-to-day operation of state-owned enterprises. It should be left to the board of directors. The board should be made accountable to the government in the same line as the board of a private enterprise is accountable to its shareholders. The present government policy gives some autonomy to state-owned enterprises which are designated as navaratna and min navaratna companies.

This policy is flawed. Autonomy should be given to all the state-owned enterprises irrespective of their size or performance. There is no logic for holding autonomy to smaller or non-performing companies. It is wrong to assume that bureaucratic intervention improves operating efficiency. Perhaps, the opposite is true. Therefore, bureaucratic intervention should be avoided.

The government should close down sick state-owned enterprisess which have no potential for revival or it should sell its stake to a strategic partner, if it can find an interested party to invest in the company. However, that would be a more political than economic decision. In democracy, politics cannot be ignored and it is an incorrect to argue that economic considerations should always override political considerations.

In the next issue of this column we shall discuss corporate governance issues in state-owned enterprises.