The Kelkar committee’s report on fiscal consolidation contains two interesting suggestions to revive the stalled disinvestment programme. Both are innovative examples of financial engineering. The first, a “call option model”, requires the Centre to offer the shareholdings targeted for disinvestment over a period of, say, three months. Investors would be sold call options on those shares at various strike prices and expiry dates. As with any option, the premium is forfeited if the option expires unexercised. An exercised option would lead to a transfer of the underlying shares at the agreed strike price. This model could work well where the underlying companies are already listed and price discovery is, therefore, transparent. It would enable the sale of additional stake in staggered volumes, at multiple price points over a long period, rather than in a large volume at a single price as done through a standard follow-on public offer (FPO). For the relatively low cost of the premium, an option-holder would receive a large upside if the underlying price rises above the strike price. Price-volatility concerns are reduced compared to a normal FPO where the sudden increase in supply can trigger a fall in the price. However, an option-based model does not work easily with unlisted securities, where transparent price discovery is unavailable. It may also confuse retail investors unfamiliar with derivative mechanisms.
The second method is as intriguing and more focused on tapping retail. The government could adopt a model based on exchange-traded funds (ETF) to enable follow-on disinvestment in the 50-odd listed central PSUs. It would establish an AMC (asset management company). Then, acting as an authorised participant, it would transfer some shareholdings in the target PSUs to the AMC. The AMC would, in effect, be in charge of managing a PSU stock index. It could issue a large number of low-priced units equal to the value of that basket of shares. The units would be sold to retail investors and traded on the secondary market, like any ETF. The AMC could judiciously stagger the issue of units in tranches to avoid large-impact costs and liquidity concerns. An ETF model would give households a chance to acquire diversified PSU equity exposure without making prohibitively high investments. At the same time, the government would continue to hold the shares it transferred to the AMC. The AMC would also retain the dividend payouts made to those shares. In essence, money would be received for doing no more than creating and administering an ETF without actual disinvestment being required! Again, the ETF model only works for already-listed securities where transparent price discovery mechanisms exist. There are also interesting turf issues associated with the transfer of shares to the AMC. If the AMC holds controlling stakes, this could remove PSUs from the oversight of the respective ministries that control those. While this might make control by ministry bureaucrats more difficult, it may make oversight by Parliament (and the Comptroller & Auditor General) more difficult, too. It will be worth seeing if this will be avoided by ensuring that the AMC did not hold controlling stakes.
The Indian financial markets have robust derivatives and ETF segments and the institutional capacity to manage either of these models certainly exists. It may, however, be considered too radical for implementation. There could also be hidden flaws that are not obvious at first sight. However, they do deserve careful consideration because they seek to address some key issues that have hampered the disinvestment programme.
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