Samir Arora: Poor pace of reforms has helped markets

Nearly all economists and analysts have criticised successive Indian governments for lack of privatisation and the generally slow pace at which the government has sold its state-owned companies so far. This lack of political resolve has been much criticised, particularly in comparison with China, which has been much more aggressive in selling parts of its government companies to foreigners at exorbitant valuations.

Although economists and purists (and investment bankers) may have valid reasons to criticise the government for this lack of political will, I believe that, in fact, India's privatisation record is pretty impressive. I also believe that stock market investors should be thankful to the government for much of the gains that they have made in the markets are due to the privatisation strategy followed by the government.

To understand India's track record in privatisation, we must first understand and correctly define privatisation. Does privatisation only mean sale of previously state-owned companies to the private sector? Can we expand the definition to correctly state that opening any sector to private sector companies and allowing free entry of privately-owned companies to sectors previously reserved for only public (state)-owned companies is also privatisation?

Due to pressure from various factions, no Indian government has been able to strategically sell any state-owned company (other than, perhaps VSNL, CMC and IPCL). However, what India has done instead has been remarkable. The government has allowed private companies free entry into sectors that were previously in government control. The entry of private companies in sectors such as media, banking, asset management, insurance, airlines, and telecommunication has allowed these companies to gain enormously at the expense of the incumbent, state-owned companies that were not strategically transformed prior to the opening up of the sector. These new, private companies have not only created value by participating in the growth of these sectors, but have done it in quick time by winning market share from the public sector.

Would it have been so easy for Jet Airways to reach its current size and value if Indian Airlines had been privatised in the beginning? Would Bharti Televentures have been the fund managers' favourite telecom stock if Mahanagar Telephone Nigam Ltd, the government-owned incumbent telecom company, had been sold to a strategic investor years earlier. India has followed the strategy of privatising sectors without privatising its incumbent, state-owned company (ies) and that has turned out quite well.

Many purists will argue that this has been a non-optimal way of achieving privatisation of sectors because the government has not maximised its realisation of value from its holdings in public sector companies. That is, of course, the case but who says that realising maximum value for government holdings is the only measure of a successful privatisation programme? In a strategic sale, the beneficiary of future gains from the purchase of the state-owned assets would have been the one or two successful bidders. Most probably, the sale of state-owned companies to a strategic investor would have come with some conditions that the monopoly of these companies be extended for some more years to allow the new management to transform the companies that they would have bought. How would the stock market investors have benefitted if the government had directly sold its companies to foreign strategic investors?

In fact, what has happened is that due to political compulsions, the government has been unable to strategically sell its companies. Unintentionally, successive governments have reacted by following reforms that are much deeper, longer lasting and have created wealth for private investors and stock market participants. Even though India has been unable to sell its so-called crown jewels and has forgone this realisation of value, it has opened sector after sector to private companies. In essence, it has encouraged entry of private sector by transferring this value (of its state-owned companies) to private sector participants in each of these newly opened sectors. By competing with these state-owned companies, Indian entrepreneurs have created enormous wealth.

Allowing private sector free entry has meant more participants in each sector, more investors in and beneficiaries of their success, more competition (and, therefore, more choices and benefits for the consumer) than would have been the case if the biggest company (that is, state-owned company) had been strategically sold (and, therefore, in essence its relative monopoly would have been preserved for a longer time). Stock market investors should remember that part of the reason why they have made money in companies such as Zee Telefilms (in the past), Bharti Televentures, Jet Airways, HDFC Bank/ICICI Bank, HDFC, Indian Rayon and so on is because the Indian government did not privatise Doordarshan, MTNL/BSNL, Indian Airlines, State Bank of India (SBI) and Life Insurance Corporation. Lack of supply of new equity offerings from state-owned companies (due to reluctance or unwillingness of government to reduce its ownership in these companies) also helped the overall market to do well as foreign investment flows were not matched by large supplies of primary paper.

Many strategists have lamented that for the Indian markets to continue to do well, India should pursue big ticket reforms more urgently. Although there is no dispute that reforms are needed for India to sustain its growth and investment, many of the reforms that market analysts are looking for, in fact, have limited relevance for the stock markets. In fact, the first thing to note is that uncontrolled and aggressive reforms do not necessarily help the stock markets. Continuous reforms and progress are important, but there is no evidence that full reforms and aggressive opening of the economy to the outside world help stock prices.

Does this mean that India does not need to pursue any reforms? Of course not "" it needs to desperately privatise and reform sectors such as airports, ports, roads and other aspects of infrastructure, reform its bureaucracy, reform agriculture to allow and encourage more investments and efficiency and improve its subsidy delivery mechanisms for the needy. The correct strategy for the government is to prioritise reforms internally and then use many of these so-called reforms as bargaining tools that it can give up anytime without any real-life impact. For starters, the government can easily afford to sacrifice reforms such as increasing stake of foreign companies in Indian insurance companies, increase of FII stake in SBI and disinvestment of ONGC /BHEL as long as it is committed, and allowed, to pursue much more substantive reforms.

The writer is Managing director, Helios Capital