Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Divestment: More than just revenue

Financial return cannot be the sole reason for investing in PSUs. They have to serve social/strategic purposes

NITI Aayog, the official think tank, was supposed to place its recommendations on divesting the government’s stake in public sector units (PSU), and strategic sale of sick units by April-end. The document, though yet to be released, will be an important one as it will play an integral role in changing the Union government’s perspective towards PSUs. The state of our PSUs is vital if we want schemes such as Make in India to succeed. Besides, this will hopefully clarify the role of the government versus market on the one hand and government ownership versus regulation on the other.

Divestment in India is a by-product of the economic reforms initiated in 1991 whereby the role of the government versus the market was sought to be redefined, market discipline was sought to be injected in PSUs’ decision-making, loss-making public enterprises were sought to be revived and additional resource needs for containing the fiscal deficit and capital expenditure generated.

However, over the years, the policy of divestment has increasingly become a tool to raise resources to cover the fiscal deficit with little focus on market discipline or strategic objective. Keeping with the tradition, this year’s budget has set the total target for divestment for 2016-17 at 56,500 crore.

Although the objective of redefining the role of the government versus the market started in 1991 and there was considerable discussion on the role of PSUs, the process of divestment was formalized only after the Divestment Commission was set up in 1996 to examine and suggest withdrawal from non-strategic sectors. The department of divestment was formed in December 1999, which later was made the ministry of disinvestment in September 2001. In May 2004, it was shifted to the ministry of finance as one of the departments under it.

Divestment is an important aspect for improving the structure of incentives and accountability of PSUs in India. It is the approach towards divestment that defines the incentive for any PSU to run efficiently. An ad-hoc approach towards divestment only reduces the incentive for the firm’s managers to make significant investment in the enterprise. Therefore, it is essential for PSUs that divestment is not limited to raising revenues. The Fourteenth Finance Commission in its report underlines this point by suggesting various measures to modify the divestment policy.

The primary requirement for the divestment policy is to define the priority sectors for the government based on its strategic interests. Considering the limited resources with the government and its diverse role, it is evident that the government has a low capacity to manage PSUs. Use of scarce resources, including land and financial capital, has high opportunity cost and the justification for investment in PSUs has to be in terms of generation of adequate social and strategic returns. Furthermore, financial return cannot be the sole reason for investment in PSUs. They have to serve social/strategic purposes. The key role of a PSU is to maintain competition in the sector and limit excessive monopoly. Besides, government ownership is required for sectors with strategic relevance such as defence, natural resources, etc. The government should, therefore, exit non-strategic sectors such as hotels, soaps, airlines, travel agencies and the manufacture and sale of alcohol.

The outlook towards strategic divestment should move from the current policy of emphasizing on public ownership and retaining majority shareholding to looking at the strategic interest. As per the current divestment policy, “government has to retain majority shareholding, i.e., at least 51% and management control of the PSUs". The policy thereby limits the scope to create divestments that would allow easy exit for the government from non-strategic sectors. Even strategic investment as per the department for divestment is limited to less than 50% shares and management control. Merely allowing ownership of less than 51% will be the first step in the right direction. Eventually, the objective of divestment should be to limit the government ownership to strategic sectors.

It is important to realize that ownership is not a substitute for regulation. Therefore, instead of creating PSUs in non-priority sectors, the government should look into strengthening the regulatory framework that ensures efficient market conditions. In fact, regulation should be extended to both public and private entities. For instance, Air India, India’s flag carrier airline, was a monopoly for long. However, with a number of new entrants in the market after the sector was liberalized, there is no longer a need for the government to run the airline and spend taxpayers’ money in bailing it out year after year. Hence, the government should consider exiting the airline business and instead create regulations that would ease the entry of new players. The regulations should also ensure that the basic necessities of the consumers are met.

It is time that divestment is not seen as an option to cover for short-term fiscal gains; instead, it should be part of a strategic plan to improve the production of goods and services in India.

Devika Kher is a policy analyst at the Takshashila Institution.

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