Criteria for sequencing divestment

The criteria should be to first privatise firms operating in sectors where markets are well developed and where the relevant policy regime is liberalised, writes DEVESH KAPUR.

THE VARYING degrees of financial health and locational context of State owned Enterprises (SOEs) means that a "one-size" approach to divestment cannot be meaningful. However, an approach that treats each SOE as sui generis will only mean that the process will drag on for too long.

In the cases of some sub-categories, such as that of the Navaratnas, the sale of SOEs is likely to be the trickiest and may raise the most political hackles. Opposition to the sale will come less from labour (which will face only moderate redundancies) than from the Swadeshi Jagran Manch (SJM) and the left, which will object on the grounds that family silver is being sold to foreigners for a song. As many of these cases involve quasi-monopolies and/or are still operating in heavily regulated markets, there are considerable complexities in designing the sale. However, the market positions of most of these firms are slipping, which means that greater the delay, the greater the erosion in market value.

The criteria for sequencing should be to first privatise firms operating in sectors where markets are well developed and where the relevant policy regime is liberalised. This means that sales in both oil and power should be delayed (other than IBP), given the considerable problems of their respective policy regimes, as the markets will only discount their value. In contrast, in telecommunications, there is little reason why a firm such as VSNL should not be immediately privatised. The telecom policy regime is now quite liberal, and delays will only penalise the Indian informatics industry, which desperately needs faster and cheaper bandwidth access, as well as erode these firms' market positions as private sector firms muscle into the market.

Here too, strategy can make the difference between divestment in a narrow sense and divestment as part of a larger vision of economic reforms. For instance, the Prime Minister could skillfully exploit his forthcoming trip to the U.S. and to Silicon Valley by announcing the privatisation of the VSNL and then inviting the Indian diaspora in Silicon Valley to bridge the "digital divide" emerging in rural India. There is little reason these entrepreneurs could not prove wrong those sceptics who believe that, with the public sector out, the private sector will simply "skim the cream" in wiring high value-added urban India. If done properly, this invitation could well energise the considerable resources of the overseas Indian community for this area.

Rapid divestment is similarly critical if the considerable values of Maruti, IPCL, BHEL, Air-India and Indian Airlines are not to be eroded. For the most part India would gain considerably if the privatisation resulted in control rights passing on to foreign firms. This would ensure that India becomes an integral part of global production networks, provide large non-debt creating resources flows, and help gain access to frontier technologies. However, there are pitfalls to purity. Ensuring that privatisation results in domestic private capital emerging in control in a few cases is an entirely appropriate policy objective. Privatisation has an inherent symbolism, even more so in India.

There are important substantive reasons as well. For the domestic private sector to emerge on the world stage, it helps to have a strong domestic base. Moreover, in these cases, the GOI should invite two alternative bids. One, an unconditional divestment and the other a "conditional" divestment - conditional on new (green- field) investment rather than on the GOI retaining a certain portion of equity, as is currently the practice. The Government can be completely transparent about this trade-off and the weights it assigns to the trade-off, which may well vary from sector to sector.

There are quite a few SOEs where the best course of action will be to wind them up as rapidly as possible. No matter how much one flogs them, they simply cannot be resuscitated. Examples include the NTC, the HFC, the HEC, and almost all the flotsam and jetsam of the private sector that was nationalized in the Seventies and Eighties. The employees are unlikely to find alternative employment, either because they simply lack the skills (NTC mills in Mumbai) or because they are located in States where alternatives are few (e.g. HFC or the engineering firms that are part of Bharat Yantra Nigam or Bharat Bhari Udyog Nigam whose factories are in Bengal and Bihar). Opposition to divestment will come from labour and regional allies (e.g. TMC).

The key asset of these firms is real estate, as many occupy prime urban land. This offers an unprecedented opportunity to redeploy this land for imaginative urban development, be it for educational institutions, convention centres, technology parks, hotels, housing, or public parks. Most state governments are eager to use this land and the Centre could offer the States the land for redevelopment under certain guidelines - such as insisting that global proposals and global bids be invited to further the development of these parcels of land. A certain fraction should be reserved for public purposes, while the revenues from the rest can be used to set up a pension fund that would provide security to all laid-off workers.

With such a scheme, it is possible to kill three birds with one stone: the Centre rids itself of fiscal millstones around its neck, the States gain from much needed urban revitalisation - critical given the importance of urban centres as engines of economic dynamism, and a safety-net is ensured for the workers that allows liberalisation to move forward without breaking their backs. The Centre will have to wipe out all the accumulated debt of these firms as well as forgo any financial gains from sale of assets such as land. However, the design ensures that key veto points are largely neutralised.

Yet a third group of SOEs consists of companies with component units that are attractive and can be revived if injected with new owners and market incentives. In some cases, their relatively small size (examples include IDPL, HMT, MECON, HOC, EIL) and the nature of their activities means that divestment can and should move rapidly due to relatively muted political opposition and also to the comparatively simple technical aspects of privatisation. These firms are for the most part, engaged in activities where competitive markets exist and complete divestment through a simple auction procedure should suffice.

The downside risks of making a mistake in the design of the bidding are unlikely to be significant. Crucially, the signalling effects of rapid sales will have positive reputational externalities for other sales - once the markets see that 10-15 firms have been fully sold, the number of potential bidders in other sales is likely to increase.

Finally, there is a small group of very large firms that also have component units that are attractive and could be revived if injected with new owners and market incentives but whose large size requires major financial and labour restructuring. Steel and coal are good examples.

These SOEs pose some of the most serious challenges in that the social implications of closing/restructuring them are considerable - they are often located in single-company towns where few labour alternatives exist. A twin strategy of downsizing, managerial restructuring, and opportunistic sales (IISCO) is possibly the least worst short-term option with sales projected for the medium term.

The political costs-to-economic benefits ratio probably implies that these firms should be placed late in the queue. However, in the case of such SOEs, the strategic objective of "crowding-in" investment - the additional investment that a bidder agrees to bring in over a defined time horizon should have considerable weight in the bidding.

Divestment in India has unfortunately been viewed as a reluctant political medicine rather than as something that may actually offer positive political opportunities. Contrary to popular belief, greater political imagination and conviction can overcome the political impediments and technical difficulties that have plagued reform.

A shift in tactics and strategy offers important possibilities to both enhance decentralisation and the alleviation of poverty, goals whose importance for India cannot be overemphasised.

(Concluded)

(The author is Assistant Professor of Government, Harvard University)

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