Economic Problems:Explain the meaning, objectives, and models of disinvestment being followed in India

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Economic problems and politics

Explain the meaning, objectives, and models of disinvestment being followed in India. Discuss some recent policy changes in this regard.

As a part of ongoing privatization, PSU equity is being unloaded in the market. This is known as disinvestment. By the year-end 2003-04, the Government could auction off 2.00 per cent of its investments in the public sector, raising Rs. 44,00 crores in the process. The sale of equity in many PSUs has generated an enthusiastic response among the investors, both small and institutions. The government has fixed a target of raising Rs. 16,000 crores through this route during the year 2004-05.


(1) The overall objective of the disinvestment policy is to raise resources from within the public sector for meeting the following three categories of costs associated with transforming the Indian public sector:                                                                                                                                                          (i) A part of these resources will be used to pay for the cost associated with the closure of enterprises declared as terminally sick by BIFR. These costs would primarily include expenses relating to the voluntary retirement scheme (VRS).                                                                                                              (ii) Another part of the revenues would be used for restructuring those enterprises which are on the verge of becoming chronically sick but are as yet not beyond redemption. these enterprises will be an extra infusion of capital after ensuring that the management accountability system based on MOUs is in place.                                                                                                                                                          (iii) A big part of the money raised from disinvestment will be used for retraining of the workers displaced or affected as a result of the closure and internal restructuring involving downsizing.

(2) Another objective of disinvestment policy is to create conditions conducive to raising productive efficiency in all its dimensions….lowering costs of production (including unit labour costs), improving product quality and variety, improving innovative behaviour, and fostering investment based on prospective profitability.

(3) A part of the proceeds from privatisation may be used for retiring public debt-primarily by buying back treasury bills from the banks.

Models of Disinvestment

In pursuance of the above objectives, different models of disinvestment have been formulated and implemented in India during the last decade.

(1) Public Offer: This model was adopted in the early 1990s. Equity was offered to retail investors through domestic public issues. A lot of bluechip PSUs also tapped the overseas market by selling GDRs. This model has some good points. It was a sincere effort to broaden base the investor base, create shareholder value, and return a portion of the wealth generated by PSUs to the people of the country. Unfortunately, investors ended up losing heavily.

(2) Cross-holdings, golden share, and warehousing: In the case of cross-holdings, the government would simply sell part of its shares on one PSU to one or more other PSUs.

(i) Under the model of Warehousing, government-owned financial institutions were expected to buy the government’s stake in selected PSUs and hold them until any third buyer emerged.                              (ii) The golden, share concept is engineered to protect the government’s interest in the PSUs. In this model, the government retains a 26 per cent stake in the PSU-but a lesser stake does not make it a minority shareholder. Instead, this 26 per cent share will continue to give the government the status of the majority shareholders.

(3) Strategic Sale: This plan is being currently pursued by the government.
Its major features are as follows:

(i)Government to offload above 51 per cent in strategic scales; new cap fixed at 74 per cent.                  (ii) Disinvestment price to be market-determined and not prefixed.                                                            (iii) Structural mechanism to speed up disinvestment process to be put in place. Under the structural mechanism, PSUs selected for disinvestment will be freed from the administrative control of the parent ministry and placed under a new body, to be created for piloting the process.

Recent Policy Changes
In Pursuance of this strategy, important changes have been introduced recently:

(1) The sale of PSU shares will be under the newly created Department for Disinvestment.

(2) Disinvestment of PSU shares will be delinked from the Union budget exercise. This will have the following effects:
(i) There will be a medium-term disinvestment strategy against an annual one pursued till now.            (ii) It would relieve the government from immediate pressures to offload the equity notwithstanding the market realities.                                                                                                                                      (iii) Disinvestment can be in larger chunks in one go; equity can be sold either in the market or to strategic investors on the basis of open bids.                                                                                              (iv) A Disinvestment Proceeds Fund will be set up.

(3) Guidelines for the disinvestment of natural asset companies will be formulated.

(4) Government will ensure that disinvestment does not result in private monopolies.

(5) Setting up of an Asset Management Company to hold, manage and dispose of the residual holding of the government in the companies in which government equity has been disinvested is being considered.

 Where do we go from here?

Three issues, as follows, need to be highlighted:

(1) Momentum for privatisation will pick up under the force of the pressures that are building up. The screw of budgetary support to finance public enterprise investments and losses is gradually being tightened. This reflects India’s public finance situation which continues to be bad. Public enterprises are experiencing difficulties in responding to the new environment. This may substantially weaken the public enterprise employees’ opposition to privatisation.

(2) As privatisation proceeds, there is a more urgent need for pushing through public sector reforms. Decision-making is still centralised, at the government level, covering all areas from determining the size of the investment, choice of technology, product mix to project location. It is vital to allow the PSUs to face the challenges of the market to become much more efficient, i.e., to provide a level-playing field, or, to change the simile, asymmetrical battlefield.

(3) As momentum picks up there is a need to formulate a comprehensive privatisation policy. The policy needs to address at least the following issues: Why privatise? What to privatise? When to privatise? Which organisation will serve as the nodal agency for privatisation and what will be its composition, powers and responsibilities? What are the institutional mechanisms that will be put in place to gain public, enterprise employees’ support for privatisation? And what is the role that India would like foreign investors to play in its privatisation programme?


PSUs have to be restructured before they are sold. The idea behind this is to maximise revenues from sales. When restructuring is done the focus will have to be on three areas:

(1) Corporate Governance: A code of corporate governance will have to be put in place so that the enterprises would be run in the interest of their shareholders including minority shareholders.

(2) Financial Restructuring: Financial restructuring is required not only in loss-making PSUs but may be needed for other PSUs where the capital structure may be skewed in favour of either debt or equity.

(3) Business and Technological Restructuring: It is pertinent to determine what are the core competencies of each PSU and decide on the relative importance of each business. The business restructuring may involve hiving off businesses that are no longer attractive from the viewpoint of returns or are a drag on other profitable ventures. In addition, technological upgrading or restructuring may be required to either sustain or improve the competitive position of technology-driven PSUs.

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