Disinvestment is the action of an organization or government selling or liquidating an asset or subsidiary. Absent the sale of an asset, disinvestment also refers to capital expenditure (CapEx) reductions, which can facilitate the re-allocation of resources to more productive areas within an organization or government-funded project.

The government undertakes disinvestment to reduce the fiscal burden on the exchequer, or to raise money for meeting specific needs, such as to bridge the revenue shortfall from other regular sources. In some cases, disinvestment may be done to privatise assets. However, not all disinvestment is privatisation. Some of the benefits of disinvestment are that it can be helpful in the long-term growth of the country; it allows the government and even the company to reduce debt. Disinvestment allows a larger share of PSU ownership in the open market, which in turn allows for the development of a strong capital market in India.

Are disinvestment and privatisation related?

The government, whenever it so desires, may sell a whole enterprise, or a majority stake in it, to private investors. In such cases, it is known as privatisation, in which the resulting ownership and control of the organisation does not rest with the government. The government usually avoids doing this. The government mostly retains more than half of the stake in the public sector enterprise so that the control remains in its hands. But when it doesn’t, then the ownership is transferred to the private sector, which results in privatisation. It is also known as majority disinvestment or complete privatisation wherein 100 per cent control goes to the private sector.

Impact of Disinvestment on Indian Economy

Public sector undertakings were established in India as a part of mixed economy with the objective of providing necessary infrastructure for the fast growth of economy & to safeguard against monopoly of industrialist community. However, the entire mechanism did not turn out as efficient as it ought to be, all thanks to the prevailing hierarchy and bureaucracy.

To illustrate the trailing scenario, the average return on capital employed (ROCE) by PSUs have been way too low as compared to the cost of borrowing. For instance, between 1940 and 2002, the average ROCE was 3.4% as against 8.6% average cost of borrowing. PSE survey by NCAER shows that PAT has never exceeded 5% of sales for or 6% of capital employed. The government pays a higher interest though, by at least 3 percentage points.

As per an NCAER study report the cost structure of PSEs is much more than the private sector (the following table shows a comparative scale) :

Lack of autonomy, political interference, nepotism & corruption has further deteriorated the situation. For instance, the head of a PSU is appointed by the Government, who in turn appoints all employees who play major roles in the organization. So directly or indirectly the Government itself controls the appointment of all manpower in these organizations. It is not the business of the Government to do business, i.e. it is best controlled by experts and professional managers.

To address operational inefficiencies in PSEs without comprising on their social objectives, disinvestment policy is often used. However, there are concerns regarding the extent of impact on firm performance since disinvestment may involve transfer of ownership but not control. Analysing data from 1991-2010 on all manufacturing PSEs owned by the central government, this column shows that the average annual efficiency score of disinvested enterprises rose by almost 20%.

Public sector enterprises (PSEs) have an indistinct mandate of meeting objectives beyond the narrow paradigm of profit maximisation. Generating employment, investing in projects that have long gestation periods, setting up operations in certain locations, and regulating prices of some of their products, are some of the objectives that may fall under the social ambit of PSEs. When this multidimensional mandate is combined with an environment free of competitive pressure, PSEs may suffer from operational inefficiencies. To address this inefficiency without compromising on the social objectives that PSEs are expected to achieve, minor disinvestment may be a useful remedial policy.

Implications of Disinvestment on Indian Economy

Disinvestment will be extremely positive for the Indian equity markets and the economy. It will draw lot of foreign and domestic money into the markets. It will allow PSU to raise capital to fund their expansion plans and improve resource allocation in the economy. It will allow the government to stimulate the economy while resorting to less debt market borrowing. Private borrowers won’t be crowded out of the markets by the government and will have to pay less to borrow from the open market. Disinvestment will allow government to have much better control over the market economy without upsetting norms of market behavior.

In future disinvestment will assume the role of a major instrument of policy intervention by government as 48 PSUs listed on BSE as of February 8, 2010, account for close to the 30% of the total market cap of the exchange. This is significant as a total of 4,880 odd companies were listed on the exchange. As of February 8, 2010, the BSE PSU index had a total market cap of Rs 17,14,466.96 crore.

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