Divestment and privatisation

Disinvestment and Privatization are two different terms

in technical sense, thoughboth involve the sale of
Governments share in the Public Sector Undertakings.
The term privatization is used for a stake sell in which
there is a transfer of 51% or more equity to the private
players.
In disinvestment, the government sells only a part of
the equity which is essentially less than 51% so that
ownership and management rights can be hold by the
Government itself

 The Disinvestment process in India

The following are the three methods adopted by the Government of India for
disinvesting the Public sector undertakings. There are three broad methods involved,
which are used in valuation of shares.
1. Net Asset Method:This will indicate the net assets of the enterprise as shown in
the books of accounts. It shows the historical value of the assets. It is the cost price
less depreciation provided so far on assets. It does not reflect the true position of
profitability of the firm as it overlooks the value of intangibles such as goodwill, brands,
distribution network and customer relationships which are important to determine the
intrinsic value of the enterprise. This model is more suitable in case of liquidation than
in case of disinvestment.
2. Profit Earning Capacity Value Method:The profit earning capacity is generally
based on the profits actually earned or anticipated. It values a company on the basis of
the underlying assets. This method does not consider or project the future cash flow.

3. Discounted Cash Flow Method:In this method the future incremental

cash flows are forecasted and discounted into present value by applying cost
of capital rate.
The method indicates the intrinsic value of the firm and this method is
considered as superior than other methods as it projects future cash flows and
the earning potential of the firm, takes into account intangibles such as brand
equity, marketing & distribution network, the level of competition likely to be
faced in future, risk factors to which enterprises are exposed as well as value
of its core assets.
Out of these three methods the Discounted cash flow method is used widely
though it is the most difficult.

 Timing of Disinvestment (Through Technical Analysis)

Unless the disinvestment is a distress sale, it has to be well
timed to reap the optimum gain. Such timing can be sought
from research analysis of the market trends called Technical
analysis. There are many methods prevailing for finding the
significant timing for disinvestment of shares. The most
significant method is "Relative Strength Index" method.
Relative Strength Index (RSI):The most vital method of
finding the timing for disinvestment of shares in RSI, which
was developed by 'Wells Wilder'. RSI is calculated for each
scrip to identify the inherent technical strength or weakness.

Rational behind
divestment
It is believed that theprivate ownership leads to better use of resources and their
more efficient allocation.
Theproliferation of market based economy resulted in the fact that State could no
longer meet the growing demands of the economy. It was believed that the
government can deliver better results when it responds according to the market driven
forces.
Globalization and WTO commitments need quick restructuring of the Public Sector
Undertakings. If they are not able to adapt to this, they would not be able to survive.
Public enterprises, because of the nature of their ownership, can restructure slowly
and hence the logic of privatization gets stronger.

Besides, techniques are now available to control public monopolies by

regulation/competition, and investment of public money to ensure protection of
consumer interests is no longer a convincing argument

 The policy at privatization pursued by the NDA regime

was disinvestment of the profit making CPSUs.
However, later UPA Government declared that no profit
making PEs will be disinvested.
However, currently, it is not a policy of the Government
to disinvest or privatize only profit making or only loss
making company.

Objective of divestment
Objective of Disinvestment -- To meet the budgetary
needs To improve overall economic efficiency To reduce
fiscal deficit.

To diversify the ownership of PSU for enhancing efficiency

of individual enterprise
To raise funds for technological up gradation,
modernization and expansion of PSUs
To raise funds for golden handshake (VRS)

Philosophy of the
government
what is the Philosophy of the Government?
The Government says that as long as that it retains
control over the PE, and its public sector character is
not affected, the government may dilute its equity and
raise resources to meet the social needs at the people.
Thus, the government takes the Disinvestment and
privatization as useful economic tools and wishes to use
them selectively

Divestment times in india

.
1991

1992

1993

1996

1998-2000

Interim budget, Government announced 20% disinvestment in selected

PSUs.
Their shares were sold to Mutual funds and financial institutions (UTI,
EPFO, LIC etc.)

Government decides to sells shares to FIIs, PSU

employees and banks.
Rangarajan Committee suggests:
1.49% disinvestment in PSUs reserved for public
sector
2.74% disinvestment in all other PSUs
Government did not implement.
Disinvestment commission under GV Ramakrishna.
It was a non-statutory, advisory body (similar to
UPAs NAC).
Vajpayee Government classifies PSUs into two
parts
1.Strategic:arms-ammunition, railway, nuke
energy etc.=> here we wont do disinvestment
2.Non-strategic: those not in above category.=>
here we will do disinvestment in a phased manner.
Hindustan Zinc, BALCO, Maruti Disinvestment
taken up.

2004

2005

2005-09

2009 onwards

UPA comes into power, Common Minimum

program (CMP) updates disinvestment policy
Sick PSUs will be revived
No disinvestment in profit making PSUs
PSUs will get commercial autonomy
Whatever Money Government earns from selling
its PSU shares- itll goto National investment
fund (NIF)..
Disinvestment remains stagnant because Left
allies of the UPA Government stonewall
everything.
UPA-2 without left parties. Government
resumes disinvestment process.
All PSUs can be disinvested, but upper limit:
49%
Disinvestment Method: only public offer.

2013-14

Chindu wanted to earn 40,000 crores via

disinvestment of Indian Oil, BHEL, NHPC,
Neyveli lignite etc. but hardly managed to get
~16,000 crores. Main reasons for #EPICFAIL:
1.Oil ministry, mining ministry, trade unions
opposed the move, files were delayed.
2.Lukewarm response from investors because
sharemarket was down due to internal &
external factors.

2014

Modi cabinet approves disinvestment in NHPC,

Coal India, ONGC
6 EPICFAIL PSUs will be closed down.
5 loss making but viable PSUs will be revived.

Methods of divestment
IIP
Via Institutional placement program.
Directly selling the shares to another
company / institution / mutual fund or
other large player.

Via stock exchange

Directly selling shares on stock exchange

Requires more clearances.

Faster, needs less clearances.

SEBI requires in each PSU, minimum 25%
shares be held by public.
Hence Government using this method to
quickly comply with SEBI norms.

Friendly to institutional investors (Mutual

funds, pension /insurance funds etc.)

Friendly to retail investors.

 Retail investors participation? Hardly!

So, In theory, disinvestment via stock exchange = retail investors should be
able to purchase those sarkaari shares.
But, after disinvestment, the market price and issue price of the company
shares start converging.
Therefore, a retail investor cannot reap the benefit (by selling it to third party at
higher price). Hell have to wait for medium to long term before company share
prices begin to rise again.
But retail investors dont like to wait that long, hence disinvestment doesnt
generate interest of retail investor

cons

Divestment pros and

Against

Socialist / leftist ideology: private sector

cannot achieve equal distribution of
resources for all classes.
Private enterprises only focus on profit
maximization. They wont cater poor
people.
Therefore Government needs to control all
or some industrial sectors.

In Favour

Such Government controlled units cannot

compete in free market economy due to
political interference and price control
mechanisms.
Ultimately more public money is wasted in
running these loss making entities.

Whatever dividend Government earned

so far- compared to that, Government has
Governments dividend income will
spent far more crores rupees to revive
decline. (Because theyll have less shares).
these PSUs.
Consequently, Fiscal deficit will increase.
There is no point in throwing good money
after bad money.
A survey indicated 0.5% retail
participation (i.e. Aam Admi investment) in
equity market.
Meaning, only Large corporates and
financial institutions will benefit from this
drive.
Itll not help in financial inclusion

Absurd logic, that just because corporates

will benefit, we shouldnt begin
disinvestment.
Government already taken plenty of
initiatives on financial inclusion front.

The funds received from disinvestment are

used to finance fiscal deficit. This is
unhealthy practise, like selling family gold
to buy daily dose of desi liquor.

Need amendments in FRBM act to ensure

this doesnt happen.

After disinvestment employees of PSUs will

loss their jobs
If board of directors have many private
sector experts- they may approve plans to
reduce staff strength, to increase
profitability.

Overstaffing = One of the main reasons

why PSUs dont make optimum profit. At
some point weve to swallow the bitter
pill.
Besides, such employees are given
attractive VRS offers.

Disinvestment would lead to private

monopolies

Dragging the logic too far. Unlikely to

happen in todays world. CCI is always
watching and punishing the firms that try
to create monopoly or oligopoly.

Allegations that PSEs are sold cheap to

preferred parties e.g. BALCO

That used to happen in 90s era, when

Government sold shares to specific private
companies at an arbitrary price.
But, Unlikely to happen if shares directly
sold via stock exchange. + CAG, Media
very active these days.

To complete the disinvestment targets,

Government asks one PSUs to buy shares
of another PSU.
Need for a clear policy on disinvestment to
e.g. ordering LIC to buy ONGCs shares
stop this practice.
Iski topi uske sir pe. In such cases,
disinvestment doesnt decrease
Government control over those companies.

Divestment speed

Rapid speed

1993: Czech Republic disinvested ~1000

state owned enterprises.
Russia did same.
Results were disappointing in both the
cases.
Hence rapid approach= not
recommended for India

Slow speed

China- after more Open Door Policy in

1978.
But speed too slow- thousands of
enterprises still under Government
ownership.

Middle speed

Most suitable for India

Data not important except for random GK in non-UPSC exams & interviews
Org

NHPC

Coal India Ltd

Modi PSU-reform1: Disinvesting NHPC, Coal India, ONGC

Approved
Note:
in PSUs, Government
owns the shares, in the
name of President ofIssues
India.
underMinistry
govt.shareholding
disinvestment

Power

coal

86%

~90%

11.36%

Has 20
hydroelectric
power stations.
Unable to
recover dues
from electricity
utility
companies=>
company making
huge losses.
Hence it share
price wont fetch
truckload of cash
to Government.

10%

Labour union
strike may bring
down share price.
So Government
maynot earn
truckload of cash
from selling
these coal India
shares.
Maharatna PSU
If Government
clears the gas
price policy,
ONGCs share

Modi PSU-reform2: Revive 5 and shut down 6

2014, Sep. week2: Union Government finished reviewing 11 PSUs: 5 worth savings and 6 worth closing.
5.October week2:HMT watches in news, because theyve tied up with flipkart.com to sell away the remaining stock of wrist watches.

Names not important except for random GK in bank exams

6 epicfails beyond saving
5 worth saving
1.Hindustan Photo Films
1.HMT Machine Tools
2.HMT Bearings
2.Heavy Engineering Corporation
3.HMT Watches
3.NEPA
4.HMT Chinar Watches
4.Nagaland Paper & Pulp Co
5.Hindustan Cables.
5.Triveni Structurals
6.Tungabhadra Steel Products Ltd
These will be given 1000 crore rupees to
give VRS to employees then shut down
operations. Total employees ~3600

Challenges before divestment

process
Process of disinvestment is not favoured socially as it is against the interest of
socially disadvantageous people.
Political pressure from left and opposition Loss making units dont attract
investment so easily.
Lack of well defined investment policy The disinvestment process needs to be
taken up more seriously by the government.
The Government should try to come out with a time bound programme to conduct
the process with transparency in all the activities need to reach.
Some consensus is very essential. Only then the real benefits can be reaped