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Seeing divestment through

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October 13, 2003 11:41 IST

The recent Supreme Court ruling on divestment of the two oil companies, BPCL and HPCL, is being seen by many observers as another nail in the coffin of the strategy.

The process over the last eleven years has been anything but smooth.

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The Divestment Development


But, even in the face of all the resistance and controversy, it had gained momentum during the last three years. Several relatively small enterprises had been sold including some major ones as well.

A few months ago, the public offering of the shares of Maruti Udyog Ltd. generated very quick and significant returns to small investors, a significant event in the bull run currently under way in the stock market.

Just when the path seemed to have been finally cleared, a legal ruling has not only raised a rather imposing barrier, but also given new energy to an anti-divestment feeling that has always been simmering.

The court ruling simply says that since the oil companies were acquired by the government through an act of Parliament, their disposal is also subject to the same process.

It has to be viewed in the broader context of the division of responsibilities between the executive and legislative branches of government and the accountability of the former to the latter.

However, in the specific context of divestment, what the ruling effectively does is to ask the government to seek a widespread political consensus on an issue on which it has never existed.

It brings into focus the way in which governments have been going about the process all these years -- with little apparent conviction -- the very term 'divestment' reflects this, full of guilt and angst, shying away from potential political battles and opportunistically sneaking through a company here or there.

The ruling forces the government to do what should have been done right at the beginning -- make out a politically saleable case for privatisation, laying out the broader economic benefits while offering a credible transition programme for stakeholders.

That this never happened is perfectly understandable. As much as we would like to see economic reforms as a well-planned, orderly, efficiently executed process, the universal reality is that they are unpredictable, uncontrollable and turbulent.

Opportunism is critical to eventual success and communication and consensus-building, while theoretically essential to the process, inevitably falls victim to the isolation that reformers often find themselves in.

So, this article is not going to make any judgments of how the process should have been handled if the government wanted to get full mileage out of it. That is water under the bridge.

Rather, it argues that the relative success of the process in the last two or three years actually reflects the fact that a number of political battles have already been fought and won.

The remaining distance to a wider consensus is not that great. If it is bridged, the path to privatisation and its benefits should be clear forever. If not, we shall simply have to come to terms with the status quo.

Two important hurdles have been crossed in recent episodes of privatisation. The first was the end of the uncertainties about valuation, which provided the basis for political resistance.

Were we selling the family silver at the price of brass?

Were we being cheated out of fair value by collusion? For many enterprises, particularly the very large ones, competitive bidding was impossible, because the industries themselves are inherently concentrated, with a few, large players.

The establishment of a credible minimum price below which bids would be rejected was essential to deal with this source of resistance.

In the Balco episode, this was achieved by applying several alternative methods of asset valuation and fixing a minimum bid price based on some degree of convergence between them. Whatever the subsequent controversies about the Balco privatisation were, valuation was not amongst them.

Making the valuation process transparent and invulnerable to accusations of manipulation overcame one significant roadblock.

Subsequent episodes did not provoke any real reaction about the prices at which the assets were sold. However it is done, as long as the valuation process is transparent, it is no longer going to be a factor.

A second source of disquiet was about the distribution of gains. Including proceeds from privatisation into general revenue receipts precluded their association with any specific initiative, with tangible benefits in the mould of, for example, the fuel cess and the highways programme.

Particularly for profitable enterprises, this problem was reflected in the dilemma between the strategic sale route and the public offer route.

The former had advantages in terms of transaction costs, both for the acquirer and the government, but the entire 'control premium' which the buyer paid for acquiring controlling interest, accrued to the government.

The latter was messy because the person who was interested in acquiring control would have to acquire shares from the market with all the attendant uncertainties about cost; but, the premium would accrue to individual shareholders.

To the extent that there were many small investors in this category, the profits would be widely dispersed, generating political dividends.

This was the essential lesson from the Maruti public offering.

Of course, in this instance, the control premium had already been garnered by the government in its arrangement with Suzuki Motors, so that was not at stake here.

However, even with that gone, the government selling off a substantial chunk of its holding at a price that earned lots of people 25 per cent or more premiums at listing bought the government an enormous amount of goodwill.

For the first time, it seemed that the public at large could actually gain from privatisation.

The government needs to build on this success by working out a judicious blend of strategic sale and public offering, which will allow for a relatively easy transition of control as well as yield good returns to a dispersed body of investors.

As significant as these hurdles were, the travail does not end with their successful crossing. There are two major remaining battles.

One is with the employees of the enterprises, particularly those, which have very little future as going concerns.

The other is with state governments, particularly those in which public enterprises comprise the bulk of the industrial sector and private sector development has simply not happened.

The government needs to engage these groups with a combination of carrot and stick to get them to stop resisting the process.

One element of this is that a transparent and tangible share of the benefits must flow to each group.

Neither of these are insurmountable barriers, but they will require effective political management.

The best interpretation of the Supreme Court ruling is perhaps this: political problems require political solutions, they cannot be won with administrative weapons.

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Subir Gokarn
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