Economic Survey Vol.1 Ch.9: Privatization and Wealth Creation

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In November 2019, India launched its biggest privatization drive in more than a decade. An “in-principle” approval was accorded to reduce Government of India’s paid-up share capital below 51 % in select Central Public Sector Enterprises (CPSEs). Among the selected CPSEs, strategic disinvestment of Government’s shareholding of 53.29% in Bharat Petroleum Corporation Ltd (BPCL) was approved.

Evolution of Disinvestment Policy in India
  • The liberalization reforms undertaken in 1991 ushered in an increased demand for privatization/ disinvestment of PSUs.
  • In the initial phase, this was done through the sale of a minority stake in bundles through auction. This was followed by a separate sale for each company in the following years, a method popularly adopted till 1999-2000.
  • India adopted strategic sale as a policy measure in 1999-2000 with the sale of a substantial portion of government shareholding in identified Central PSEs (CPSEs) up to 50% or more, along with transfer of management control. This was started with the sale of 74 % of the Government’s equity in Modern Food Industries Limited (MFIL).
  • Thereafter, 12 PSUs (including four subsidiaries of PSUs), and 17 hotels of Indian Tourism Development Corporation (ITDC) were sold to private investors along with transfer of management control by the Government.
  • Another major shift in disinvestment policy was made in 2004-05 when it was decided that the government may “dilute its equity and raise resources to meet the social needs of the people”, a distinct departure from strategic sales.
  • Department of Investment and Public Asset Management (DIPAM) has laid down comprehensive guidelines on “Capital Restructuring of CPSEs” in May 2016 by addressing various aspects, such as payment of dividends, buyback of shares, issues of bonus shares and splitting of shares.

This recent approval of strategic disinvestment in Bharat Petroleum Corporation Limited (BPCL) led to an increase in the value of shareholders’ equity of BPCL by INR 33,000 crore when compared to its peer Hindustan Petroleum Corporation Limited (HPCL) and this reflects an increase in the overall value from anticipated gains from consequent improvements in the efficiency of BPCL when compared to HPCL which will continue to be under Government control. This chapter, therefore, examines the realized efficiency gains from privatization in the Indian context.

The survey after analysing the before-after performance of these CPSEs came to the following results:

Comparison with peer firms: Post-privatisation, these privatized CPSEs, on an average, perform better than their peers in terms of their net worth, net profit, return on assets (ROA), return on equity (RoE), gross revenue, net profit margin, sales growth and gross profit per employee. For example, on average, the net worth of privatized firms increased from 700 crores before privatization to 2992 crore after privatization.

Individual performance: Each privatized CPSE witnessed improvement in net worth, net profit, gross revenue, net profit margin, sales growth in the post-privatization period compared to pre privatization period.

Dynamic aspects of performance in comparison to peers: the performance of the privatized CPSE and its peers is quite similar during the period of 10 years before privatisation. However, post-privatization, the performance of the privatized entity improves significantly over a period of 10 years when compared to the change in the peers’ performance over the same time period.

Way forward: 

  • Aggressive disinvestment, through the route of strategic sale, will bring in higher profitability, promote efficiency, increase competitiveness and promote professionalism in management in CPSEs. This would, in turn, unlock capital for use elsewhere, especially in public infrastructures like roads, power transmission lines, sewage systems, irrigation systems, railways and urban infrastructure. Many of the CPSEs are profitable but they have generally underperformed the market.

The aim of any privatization or disinvestment programme should, therefore, be the maximisation of the Government’s equity stake value. For this, the survey proposed a structure for the Corporatisation of Disinvestment. Under it, the Government can transfer its stake in the listed CPSEs to a separate corporate entity managed by an independent board. This entity would be mandated to divest the Government stake in these CPSEs over a period of time. This will lend professionalism and autonomy to the disinvestment programme.

 

Terms

Strategic disinvestment is guided by the basic economic principle that the Government should discontinue its engagement in manufacturing/ producing goods and services in sectors where competitive markets have come of age.

Net worth: The net worth of a company is what it owes its equity shareholders. 

Net Profit: This is the net profit of the company after tax.

Gross Revenue: It indicates the income of the company from sales of goods and other non- financial activities.

Return on assets (ROA): It captures the ratio of profits after taxes (PAT) to the total average assets of the company, expressed in percentage terms. An increase in ROA indicates that privatized firms have been able to use their resources more productively

Return on equity (ROE): It is profit after tax (PAT) as a percentage of average net worth. An increase in ROE reflects an increase in a firm’s efficiency at generating profits from every unit of shareholders’ equity.

Net profit margin: Net profit margin of a company is PAT as a percentage of total income. An increase in Net profit margin reflects that out of a rupee that is generated as income, the share of after-tax profit in the income increases

 



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