The Need for Privatization of PSUs and Banks

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Context

  • In the Union Budget 2021-22, the government has presented the most ambitious plan to privatize central public sector enterprises (CPSEs).
  • The government will maintain a bare minimum presence in only four strategic sectors and all other CPSEs in other sectors will be privatized.
  • Two public sector banks and one general insurance company will also be taken up for privatization.

Relevance
Mains: GSIII-

  • Indian Economy & issues relating to planning, mobilization of resources, growth, development & employment.
  • Effects of liberalization on the economy, changes in industrial policy & their effects on industrial growth
What is privatization?
  • The transfer of ownership, property, or business from the government to the private sector is termed privatization.
  • The government ceases to be the owner of the entity or business.
  • Privatization is the opposite of nationalization, a policy resorted to by governments that want to keep the revenues from major industries, especially those that might otherwise be controlled by foreign interests.

Privatization can also suggest the following things:

  • Statutory restrictions on competition between privately and publicly owned enterprises may be lifted. Thus, it also indicates deregulation.
  • Government services and operations may also be (denationalized) privatized; in this circumstance, private entities are tasked with the application of government plans or execution of government assistance that had earlier been the vision of state-run companies.

Features of Privatization:

  • It is a means of establishing economic democracy.
  • State dominance in the economic sphere is reduced.
  • It aims at protecting the private sector.
Objectives of privatization
  1. To improve the operational efficiency of Public Enterprises.
  2. To develop competitive efficiency in the industries.
  3. To generate resources for a deficit budget.
  4. For the globalization of domestic Industries.
  5. To invite foreign capital (FDI).
  6. To earn foreign currency through export promotion.
  7. To exploit the natural resources of the country with efficiency
  8. To create an environment for rapid industrialization.
  9. Accord priority to the Welfare activities by the government.
  10. To operate public enterprise on a commercial basis.
  11. To free the government from The Loss-making Enterprises.
  12. To promote market dynamism, where markets follow integral economic values of demand and supply.
Methods of Privatization
  1. Competitive Bidding – In this method, the company’s shares and assets are sold by way of tender. An enterprise may choose to sell an undertaking instead of the whole business.
  2. Public Flotation of Shares – In this method, the shares of a government-held enterprise are sold to the general public by way of listing them on the stock market.
  3. Private Placement – Private placement refers to transferring ownership to the hands of a few private individuals. The government may decide to transfer the public company's ownership to select individuals who meet their requirements and criteria.
  4. Dilution of Capital – In this method, instead of selling the shares of the public sector company, the capital is raised by issuing them to private investors. Hence, the stake of government in such companies becomes diluted.
  5. Management Employee Buyout – It involves the selling of the stake of the entire or a part of the enterprise to the employees.
  6. Mass Privatization – It is a method by which a large number of enterprises are privatized in one go. For this, a combination of various methods mentioned above is used.
Advantages of privatization
  • It provides opportunities for private businesses to establish and expand
  • It allows healthy competition in the economy resulting in fair pricing of goods and services
  • There will be growth in domestic and private investment
  • It leads to job creation as more and more business houses enter the sector
  • Involving the private sectors also improves the quality of goods and services
  • There will be an efficient utilization of Resources, as the private sector uses resources much more efficiently than the public sector
  • There will be improved performance and customer experience
  • Privatization removes the chances of government monopoly in a particular industry
  • Government can exit from loss-making industries and generate revenue from the sale
  • Political interference will be reduced
Disadvantages of Privatization
  • There are high chances of some private players taking in the lead and creating a monopoly market in their favor.
  • As the main motive of private companies is profit generation, they are not advisable in social sectors like health, education, etc. which should be non-profit oriented.
  • Private business players, to increase their immediate profits, may be reluctant to invest in long-term projects.
  • The industries which are privatized may become fragmented, with no person taking responsibility in their hands.
  • They may not cater to vulnerable and marginalized sections
  • Certain strategic sectors cannot be privatized due to security and strategic concerns
Privatization vs disinvestment
  • Disinvestment happens when a government sells only a part of its stake in a public sector company and retains the majority of it.
  • And, privatization is when the entity is completely handed over to a private company
  • In privatization, the government sells more than 50% of its shareholding, while in case of disinvestment shareholding less than 50% is sold by the government.

Why not disinvest, rather than privatize?

  • The Centre has had some success with disinvestment over the years.
  • Of late, most of the disinvestments are funded by the Life Insurance Corporation of India (LIC).
  • The problem with disinvestment is that it does not ensure a change in the management of the enterprise.
  • To make PSUs efficient, there is a need to bring in private management that runs them to maximize profit.
  • Thus, privatization is important and disinvestment a second-best alternative that yields revenues for the Centre, but does not improve the condition of the enterprise.
Public Sector Enterprise Policy

As part of the ‘Aatmanirbhar Bharat Abhiyan’, Finance Minister Nirmala Sitharaman had announced that there would be a maximum of four public sector companies in strategic sectors, and state-owned firms in other segments would eventually be privatized.

The reasons for this include

  • Scarcity of public resources
  • Inefficient and loss-making operations of existing public sector enterprises.
  • To build our capabilities and emphasize our domestic production for global and domestic outreach at a globally competitive cost.
  • To enhance wealth, improve R&D, and contribute to the growth of the economy
  • Fosters competition
  • The government also wished to have a strong and impactful public sector in a strategic sector.

 

Privatization of Public sector banks
  • The banking landscape in India is set to change with the government’s decision to privatize two public sector banks.
  • Coming after 51 years of nationalization of government-owned banks in 1969, the move will give the private sector a key role in the banking sector.
  • RBI has allowed more private banks since the 1990s. 
  • India has 22 private banks and 10 small finance banks.

Why were private banks nationalized?

  • Then Prime Minister Indira Gandhi decided to nationalize the 14 largest private banks on July 19, 1969.
  • The idea was to align the banking sector with the socialistic approach of the then government.

Need for Privatization

  • Years of capital injections and governance reforms have not been able to improve the financial position of public sector banks significantly.
  • Many of them have higher levels of stressed assets (NPA) than private banks and also lag the latter on profitability, market capitalization, and dividend payment record.
  • Privatization will free up the government from continuing to provide equity support to the banks year after year.
  • The government is trying to strengthen the strong banks and also minimize their numbers through privatization to reduce its burden of support.

Are private banks doing better?

  • Private banks’ market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%.
  • They have expanded the market share through new products, technology, and better services, and also attracted better valuations in stock markets.
  • However, in the last couple of years, some questions have arisen over the performance of private banks, especially on governance issues.
  • Moreover, when the RBI ordered an asset quality review of banks in 2015, many private sector banks, including were found under-reporting NPAs

What has been the government and RBI stand on privatization since 1969?

  • The UPA government of 2004-14 refrained from taking any decision on privatization.
  • Many committees had proposed bringing down the government stake in public banks below 51% — the Narasimham Committee proposed 33% and the P J Nayak Committee suggested below 50%.
  • The NDA government, in its second term, has been pushing for privatization and reducing the number of PSU banks to five or six.
  • An RBI Working Group recently suggested the entry of business houses into the banking sector.

As former RBI Governor Dr. Y V Reddy once said, nationalization was a political decision, so privatization too will have to be one. Seen in this context, the privatization of two banks and the indication of carrying it further is a major reform signalling a changing political approach. These moves, along with setting up an asset reconstruction company entirely owned by banks, underline an approach of finding market-led solutions to challenges in the financial sector.

Private investment in Indian Railways
  • In a country of 1.3 billion, the Indian Railways plays an integral role in running the world’s fourth-largest rail network in the world.
  • It cross-subsidizes low passenger fares by artificially high freight rates
  • In recent years it is confronted with its dwindling finances.
  • It has been mulling ways of generating revenue through different streams, including the non-fare revenue segment, leasing out its vast pool of vacant land, and, most importantly, opening doors for Public-Private Partnership (PPP).
  • It has felt the need to bring in private investment to upgrade its facilities and infrastructure.
  • In 2015, a committee led by then Niti Aayog member Bibek Debroy endorse private entry into the railways' sector.
  • The railway ministry, on July 1, 2020, began the formal process of allowing private trains on 109 routes—a process that aims to, for the first time, open up one of the government’s most prominent enterprises.
  • Indian Railways plans to introduce private trains on its network in phases, with the first dozen due to start running in the 2023-24 financial year and all 151 by 2027.
  • The Indian Railways is also considering having private companies operate 90 train stations.

Need to bring private players

  • A shift in international practices
  • Enhanced revenue crisis
  • Need to keep up with the competition and alternatives easily available to passengers
  • An ideological makeup that is open to involving the private sector in key areas

Advantages of bringing in private players

  • Modern technology will be introduced
  • Will introduce competition and private companies may offer attractive prices for customers
  • Creates potential for railways to contribute towards India’s growth
  • There will be improved amenities and travel comforts for passengers

Disadvantages of bringing in private players

  • Profit Motive of private players will hamper inclusive and welfare approach of Indian Railways 
  • The safety of the passengers might be compromised
  • There is a possibility of increase in train fares, which makes train journey unaffordable for the poor
  • Private players may only be interested in running trains on busy and congested routes and may ignore the remote and unserved areas.
  • The job reservation policy of the government cannot be continued

Case study of Japan

  • Japanese National Railways (JNR) was privatized in 1987 and broken into six regional rail companies and one freight company. 
  • According to a working paper series by the Asian Development Bank Institute, privatization helped the railways sector to remain profitable and dynamic.
  • The JRs subsequently ventured into commercial and real estate businesses, increasing its non-transport revenues substantially.
  • JRs also have the Shinkansen bullet trains as their primary business and express trains that subsidize other smaller, unprofitable lines.
  • The consequences from the privatization of Japan Railways are still evolving and could serve as important references for developing countries on how to reforms of major State-owned entities could be done with structural reform and technology development.

Due to the daily mass interface and the political importance of the railways, the government is keen to emphasize that it is opening up the sector, but not privatizing it.

Will the privatization drive be successful?
  • India’s attempt at dismantling the PSUs over the years has seen little success, with the last big-ticket privatization taking place between 1999 and 2004.
  • Since then, most governments have tried to disinvest and privatize.
  • But this has led only to incremental progress, with no big-ticket privatization taking place since then.
  • A good example is Air India, the national carrier that the Centre has repeatedly tried to privatize.
  • However, it has met with limited success.
  • Stiff opposition from unions, concerns of allegations of graft, and criticism of the sale of “family silver” act as major hurdles to the drive for privatization.

Case study of Hindustan Zinc

A good example of privatization and its effect on the enterprise is Hindustan Zinc. The Atal Bihari Vajpayee-led BJP government sold 45% of Hindustan Zinc for ₹ 769 crores in 2002. The 30% stake the government retained was valued at over  ₹ 20,000 crores The company became the world’s second-largest zinc-lead miner and one of the top 10 silver producers. Management change and privatization can thus raise shareholder wealth through improved efficiency.

Conclusion
  • Most PSUs are making losses and are funded by the largesse of taxpayers.
  • The public resources spent on them could be better utilized elsewhere, especially for development. 
  • Selling them can also yield non-tax revenue, which could be used to augment public infrastructure.
  • Moreover, their turnaround by the private sector can generate tax revenue for the government.
  • As long as privatization is done in a manner that leads to competition and not just the transfer of a public sector monopoly to a private sector monopoly, privatization will be effective.



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