How not to disinvest

Indian Express, 15 March 2012

Don't repeat the ONGC mistake, instead steadily sell off PSU shares

Gearing up for the Union Budget, last week the central government made an attempt to keep the fiscal deficit for the current year under control through ONGC disinvestment. The auction did not go well. The events that unfolded point to inherent weaknesses in the implementation capacity of the government.

The ONGC disinvestment process ended up with public sector financial institutions, such as LIC, buying up the bulk of shares on offer. The auction was implemented through an initial change in the auction design, a design that appears to be less transparent than the standard auction, something that would likely not have been allowed for a private company. Later, it has been reported that concessions were given by exchanges and the stock market regulator to handle system glitches which arose because of the last minute load at the time of closing the auction. The disinvestment design also raises issues about the price which was above the secondary market price and therefore enough to turn off most investors. Further, it raises questions about whether public sector financial institutions should have large exposure to public sector enterprises, and what signals such disinvestment gives to international investors and credit rating agencies who are presumably among the intended targets supposed to be seeing the distinvestment as a positive signal about the Indian economy.

A reduction in fiscal deficit through disinvestment planned at the beginning of the year should have been rolled out throughout the year. The argument that the market did not look good is flawed as it is circular. Sentiments in the market, apart from being influenced by uncertainty in international markets, are strongly influenced by governmnet actions and policies that influence macroeconomic conditions. If the government had steadily sold shares of PSUs all through the year investor confidence in India would presumably have been higher and if markets had been upbeat about the economy, disinvestment proceeds would have been larger.

In terms of ownership and governance of companies the right path for India is to slowly and steadily to transform PSUs into dispersed shareholding companies. Companies like L&T, ITC, Infosys, HDFC, ICICI, etc. have no family in charge. There is a dispersed shareholding across a large number of shareholders - both local and foreign. The shareholders elect the board of directors and the board recruits the top management team. We can achieve this with PSUs by steadily selling off shares to the public at large.

This, however, requires continuous work through the year. The Department of Disinvestment needs to be reorganised so as to efficiently sell shares all the time. It is not difficult to use the exchange pre-opening auction system to sell 0.05% of every PSU every day, so that 12.5% of shareholding is sold off every year. This can be run in a smooth and efficient manner every single day.

Once DoD had failed on the disinvestment program this year, the right thing for government to have done, in February, is to admit failure and promise to do better next year. Instead, MoF succumbed to the temptation of using its control of financial regulation and financial firms to try to raise money through disinvestment.

From a fiscal point of view, it is hard to see what would be gained in moving shares of ONGC from the Government of India to LIC (which is 100% owned by the Government) at a price above the market price. Did the government think that credit rating agencies would be fooled by this dexterity in fiscal jugglery? The government needs to worry that fiscal dexterity raises the sceptre of Greece, which fudged its public accounts.

Another proposal is for public sector banks to lend to SUUTI which will then buy PSU shares. Government owns the banks, SUUTI and of PSUs whose shares will be sold. So things will move around from one hand of the government to another. Will this be genuine disinvestment? Who will be fooled by it? The only sensible course is to sell off everything that SUUTI owns and to close it down. That may actually bring the sort of results that are being desired.

The Indian economy is reeling under a wave of pessimism. In a short few years, we have gone from universal optimism about India to universal pessimism. The misrule of recent years has persuaded private and foreign investors that Indian governance cannot be trusted. The fracas about disinvestment, and the surrounding damage to institutional quality in the financial system, has done further damage. These events send out a signal to private and foreign investors that economic policy formulation and execution in India is suspect. This will do further damage to the outlook for investment. It will exacerbate the business cycle downturn, and damage long-run growth potential.

In the Union Budget for 2012-13 it is likely that estimates for the fiscal deficit will be high. Government expenditures on subsidies and welfare programmes has risen. The UPA does not have the majority it needs to make fuel prices market determined. This means a rising subsidy bill. At the same time, the GDP slowdown will yield lower tax collections.

It is thus likely that disinvestment will again be a means through which the government will try to keep the deficit under control. The lesson from ONGC should not be forgotten. The disinvestment programme should be slowly rolled out, in small parcels throughout the year, regardless of market conditions. It is not for the goverment to try to time the market and then make a rush for it in the weeks before the budget. There should be last minute attempt at clever schemes that are akin to fiscal fudging. The government needs to embark on a genuine path of disinvestment rather than merely trying to make it appear that it is doing so.

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