The Indian Analyst

Scale to Next Economic Level

 By Aravind Sitaraman

Early this year, the Government announced its decision to disinvest 10% stake in Bharat Heavy Electricals Ltd (BHEL) and 18.24% stake in Maruti Udyog Ltd (MUL). A recent Finance Ministry paper talked about a slew of disinvestment in ONGC, NALCO, Power Finance Corporation, and PowerGrid. Last year, the Government had disinvested around 25% of its stake in MUL through a Initial Public Offering (IPO). The hope is that the sale of these stakes will help bridge the fiscal deficit or finance social projects in education or healthcare. The credit for disinvestment clearly goes to this Government. The idea of disinvestment came from Mr. G. V. Ramakrishnan when he was the head of the Disinvestment Commission seven years ago.

This is also a significant decision for a Government that needs support from Communists, self-serving individuals running political parties, and state-level parties with narrow agendas. This coalition, called the United Progressive Alliance (UPA), came up with a Common Minimum Program (CMP)-- a platform that they could all agree with. Communists want the Government to borrow funds to finance social causes that benefit blue collared workers-- nobody else  matters. Ultra self-serving within the UPA, seemingly espousing the "oppressed" cause, are always looking for investments that would benefit them and their clan.  Dravida Munnetra Kazhagam (DMK) and the Marumalarchi Dravida Munnetra Kazhagam (MDMK) want investments that focus more on Tamil Nadu so they can claim success to wrest the State Government away from the All India Anna Dravida Munnetra Kazhagam (AIADMK).

However, soon thereafter, the Government also stated that it will be deferring this disinvestment plan to the next fiscal year. Many believed that this was due to internal pressure from its coalition partners and that the Government needed time to build consensus around the issue. Then came the quota regime that has become a signature statement of the Indian polity. The employees of BHEL will get a chance to own portion of the disinvestment while Indian public and Indian financial institutions will be given preference. It was also stated that a National Investment Fund will be setup with corpus raised from disinvestment of Public Sector Units (PSU) and a majority of this corpus will fund social sector projects and a portion used for capital expenses in profitable PSUs. While the Finance Minister took all the credit for creating the process of disinvestment, he failed to appropriate due credit to his predecessor in the National Democratic Alliance (NDA) for creating a Disinvestment Proceeds Fund and for channeling funds from such disinvestment to bridge the budget gap. The NDA had mobilized about USD 3.6 billion against a target of USD 3 billion during fiscal years 2003-2004. Six minority stakes in large PSUs -- ONGC, GAIL, IPCL, IBP, CMC, and Dredging Corporation of India, were sold to raise this money.

With the onset of the new fiscal year, the Finance Minister has restarted the topic of disinvestment in these PSUs with increased percentages. This time, apart from the traditional opposition from the three props of this Government, there are dissenting voices from within the Congress Party itself. Notably, Mr. Mani Shankar Iyer, the federal Petroleum Minister, has opposed this move by comparing the sale of PSU stakes by the Government to selling the "family silver to pay the butler." This argument is strangely similar to the one made by BJP leader and former petroleum minister Ram Naik who opposed Arun Shourie’s bid to sell strategic stake in Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL). However, the Prime Minister has firmly reiterated the Government's desire to disinvest in these PSU holdings.

Significant Decision

Regardless of the name, politics, and opposition, the decision is significant in many different ways:

Firstly, it signifies a new and bold approach with which Prime Minister Dr. Manmohan Singh seems to exert his influence on economic principles. While he takes in the opinion of the three props to his Government, he definitely does not seem to be weighed down by their narrow agendas. One reason perhaps is because the government’s disinvestment revenue had fallen from USD 3.6 billion in 2003-04 to USD 951 million in 2004-05. This fall is due to the UPA government's decision not to follow the NDA’s aggressive divestment policy when it came to power in May 2004. One year is already over and his government must expedite the much-needed economic reforms if the reformist credentials of his government are to be protected. Hence, although there is no budgetary target for revenues from disinvestment, the Finance Ministry is hoping to raise USD 2.3 billion this fiscal year half of them from BHEL, Maruti, and NALCO.

Secondly, while economic reforms have been slower than anticipated under the UPA, the Prime Minister has managed to get many contentious reforms underway. The Foreign Direct Investment liberalization in Banking, Printed Media, Airlines, Retail, Telecommunication, and Real Estate, despite strong opposition is a clear indication that the economist in the Prime Minister is more at play that the politician.

Thirdly, the Prime Minister seems to be standing up to hard-line ideological Communist agenda most opposed to the disinvestment process. Soon after forming the Government in 2004, CPI (M) general secretary, Mr Harkishen Singh Surjeet said "All the mistakes of the NDA Government have to be rectified. We cannot afford the disinvestment program followed by the NDA." The CMP "vision" of using "practical" and not "ideological" consideration to disinvestment is being used very well to stave off ideological opposition to disinvestment. Hence, the refusal to even review the disinvestment proposal of BHEL. The Communists  disagrees and calls it a breech of CMP. Some of the more hardened Communists call it "privatization through the back door."

Fourthly, the Prime Minister argues that "privatization" should not be equated with "disinvestment." This means that the Government may sell its stake in PSU so long as it does not lose majority stake. This should help Government fund social projects.

Fifthly, the opponents of the BHEL disinvestment say that the valuations are too low to sell. However, analysts and proponents of disinvestments have pointed out the valuations would continue to be the low 21 times 2004-05 Price to Earnings (PE) and a strategic sale of BHEL stake will raise the valuation to a more realistic 50 times 2004-05 PE. The Prime Minister seems to agree to this assessment.

Benefits of Disinvestment

The opponents of disinvestment miss the big picture.

Firstly, disinvestment is not about shedding Government investment in these enterprises. It is about spreading wealth. It provides the ordinary salaried people an opportunity to take part in a successful Government enterprise and earn wealth for their future. The employees of BHEL and general investors will also benefit from the disinvestment process as 15% of the proposed dilution is reserved for them. Since the government plans to split the stock, retail investors will be able to buy BHEL shares, which currently are beyond the reach of many due to the high price. It will allow retail investors, who now own less than 1 percent of BHEL equity, to increase their stake in a company that was funded by taxpayers' money. That will be true democratization of capital. The upshot will be greater corporate accountability and more professional management.

Secondly, disinvestment is about raising money to bridge increasing social expenses and fiscal deficit. The Government simply cannot afford deficit financing social projects lest it devalues the currency still further. With the absence of clear, equitable, and reliable tax collection methods, Government has to raise revenue elsewhere. Disinvestment is not about selling the family silver but an investment in the society. Last year, 24 loss-making PSUs were allocated Rs 517 crores in a package so that they would pay the statutory dues of their employees. It is quite a statement that a government which rewards private-sector companies for corporate governance should delay payments. This year, the budget has allocated Rs 14,040 crores (including railways) as equity support in addition to loans worth Rs 3,554 crores.

Thirdly, disinvestment is an option to raising money. While the Government can borrow funds from the public, the cost of borrowing will usually be too high to justify the financial move. The conventional wisdom is that public-sector enterprises create and sustain employment. The truth is that Central PSUs account for only six million of the 27 million jobs in the organized sector and a fraction of the total workforce of over 400 million people. Also it comes at a huge cost. The Economic Survey of 2004 lists that the average annual emoluments of a public-sector employee are Rs 2.24 lakh. Worse, on an equity of Rs 2,46,106 crores, the government earned a dividend of Rs 12,907 crores in 2002-3, or roughly 5.2 per cent. In other words, the government is earning less per year on its investment than it pays for its borrowings.

Fourthly, disinvestment is a clear path to getting the Government out of areas where it has no competence. There is a reason why a majority of Government enterprises are sick, unprofitable, and non-optimal while private enterprises are expanding their operations, making huge profits, expanding markets, and contributing to the economy. Of the 186 PSUs surveyed, nearly 40 per cent (73 out of 186) have a negative net worth. In terms of operations, 89 (or 47 per cent) show losses and 113, or 60 per cent of the companies have not paid a dividend in the year 2002-3. The erosion of net worth in the 73 enterprises is an astounding Rs 48,199 crores, or four times what the government budgets for primary education in a year, and the total losses of the 89 enterprises is Rs 9,881 crore, which is more than what has been budgeted for healthcare. Just the accumulated losses of the worst five PSUs totes up to Rs 30,966 crores or six times what has been allocated for drinking water supply. Hence, instead of trying to do something that it is bad at, the Government should spend its time where it is good at and that is sorely missed. These are defense, foreign relations, infrastructure investment, and social projects. The Prime Minister aptly summed up these points saying “The biggest challenge is to survive and flourish in the increasingly integrated and globalised world we are living in. The role of the state is being redefined in many sectors. The government is moving from being a provider of goods and services to being a regulator and facilitator ensuring fair play."

Fifthly, paralyzing a minority Government constantly by its allies who are not part of the Government has unintended consequences. For one, it paralyzes the country into inaction and affects Indian national interests in economic, defense, and international issues. For another, it casts the Government and its allies in very bad light. Come next election, the voters are sure to punish an ineffective Government more than a partially effective one. Perhaps, this is what the Communists hope for. By neutralizing the Congress and canceling out the NDA, they perhaps hope to form a "third front" in alliance with other ultra-left partners of the UPA to form a Government. While this may be a clever strategy, it would backfire on them. No political party in India or any other country for that matter, can afford to be isolationistic in their approach to economy, defense, and international relations. The failure and effects of such policy is evident when one sees the state of North Korea, Myanmar, Cuba, and Libya.

Sixthly, it is not that there has been an absence or lack of received wisdom. Since 1991, six different committees and initiatives, belonging to Congress, so-called Third Front, NDA, have attempted to address the problem. In fact, there is enough data in the international domain that proves beyond doubt that PSUs (outside of utilities and railways) perform better, create employment, and generate wealth for the people when passed on to the public or sold in strategic initiatives. They have all come to the same conclusion as this Government. In a Harvard University paper, Jeffrey Sachs along with Nirupam Bajpai say, "Privatization of public enterprises could raise significant funds as a per cent of GDP, which could be used to buy down the public debt. Not only would the stock of debt itself be reduced, but also the interest costs of servicing the debt would surely decline as the debt stock itself is brought under control. The cash value of these enterprises vastly exceeds the present value of profit flows that the state now collects on these assets."

Becoming an Economic Superpower

It is no longer enough to look at disinvestment in terms of narrow political, social, or even economic agendas. For sustained and increased growth, India has to scale to the next level of performance. This is not an option but a necessity and disinvestment is but a tool to get there. Increased population, unemployment, and poverty levels are prime reasons as to why India needs to scale. The cost of not scaling to the next level will see India eclipsed by China and other South East Asian aspirants leaving India to its internal chaos and implosion.

What is even more compelling is that India is on the verge of being an economic superpower with extra-regional influences. Its influence is already acknowledged in Asia and Africa. India's potential is recognized by the US, European Union, Russia, and Japan as is evident by the desire by these nations to set up a strategic alliance. This is precisely that even China wants a strategic partnership with India.  While Japan and Germany face grave obstacles in their bid for a permanent seat to the United Nations, there appears to be widespread lack of opposition for India, if not active support. For India to actualize its potential, it has to embark on a serious set of reforms in its economy, polity, judiciary, legal, and administration. It needs a 10% rate of growth in its GDP to continue to be competitive with China and potential emergent nations in South East Asia.  Resting on praise and success of Information Technology industry will soon see others taking over this crucial growth area.

The sooner India brings about change the faster it will empower its companies to compete globally even more efficiently than now. The Communists traditionally advocated foreign and national security policies designed to make India a surrogate or protectorate of one or another external power. Throughout the years of the Cold War, the CPI took its directions from Moscow and wanted India to follow a policy of strident criticism of the US and the western world. They learnt xenophobia from the Chinese but continued with such fear even after the Chinese followed active capitalism. Some of their fears were:

  • The Communists were worried about globalization and its adverse effects on Indian businesses and its labor. The growing expansion of the Indian industry has rubbished such fears. They continue to seek new markets abroad, acquire talent and production capacity globally, compete successfully against incumbents, and challenge every conventional unimaginative fear of the Indian communist.

  • The Communists feared large-scale unemployment of Indians. Now, any employable Indian laborer at home, white or blue collared, now has opportunities to work in many private companies and businesses and less by Government owned enterprises.

  • The Communists spread fear that globalization will bring about a brain-drain. Some even experimented with medieval ideas such as prohibiting education in English. Today, with unprecedented opportunities at home, there is a reverse migration of tens of thousands of workers from the US, Europe, Gulf, and Singapore.

  • The Communists were paranoid that technologies and globalization would rob what little the agriculturists and small businesses have. Today, farmers, planters, traders, and merchants exploit technology such as cell phones to further their businesses.

  • The Communists said that medicines and drugs would be priced beyond the reach of the common man. Today, Indian pharmaceutical companies are buying foreign counterparts in search of markets and production capacity. Indian generic and name-brand drugs and inventions are being patented abroad and certified in numerous nations.

  • The Communists were worried that Indian education will suffer as Government reduces its social spending. Today, Indian Universities attract students from other developing nations.

  • The Communists said that the only reason why foreign companies wanted business in India is to exploit the low cost labor and to expatriate profits. Today, expatriate workers from the US, EU, Japan, Korea, China, Russia, and other leading nations throng Indian cities and rural areas in not just Information Technology but old-economy industries such as mining, oil exploration and production, manufacturing, food products, agriculture, automobile, civil aviation, business process outsourcing, and hospitality industries. They are here doing high value projects including advanced technologies like avionics, aircraft design, networking, banking, vertical software systems, industrial design, biomedical applications, space collaboration, defense outsourcing, etc.

With internal squabbling and unrest created by the leftists, India is being left behind. At the best of times, the Communists have had minimal support of Indian electorate. However, they have a great propensity for chaos creation and widespread disruption. For example, the current communist armed movement in India is called the naxal movement. This communist movement has now spread from Karnataka to Uttar Pradesh, developed strong ties with Pakistan's Inter Services Intelligence (ISI), Nepal's Maoist terrorists, and Sri Lanka's Liberation Tigers of Tamil Eelam (LTTE). Because of the Central Government's reliance on the leftists, several State Governments started dialogues with these internal terrorists. They initiated ceasefires, transferred experienced officers and policemen from terrorist affected areas, allowed them to move about with their weapons, and even hold public rallies. The end result was that the terrorists used this space to regroup, recruit, buy more arms, train new recruits, set up camps, reorganize across state borders, and develop new weapons. Andhra Pradesh, whose Chief Minister probably is one of the worst in the history of this state, started this unwise move of negotiating without requiring a cessation of hostilities. By surrendering the initiative unilaterally, Andhra is essentially bankrupt and is also creating collateral damage to Karnataka, Maharashtra, Madya Pradesh, and Orissa.

Such capitulation to disruptive and economically retarding forces at the national level will take the country down to depths of political, economic, and social chaos unheard of in history. The United States has publicly announced that it will help India become an economic superpower. Leaving behind failed socialist ideology, India must take this offer seriously and undertake steps that will guarantee this evolution.

China: A Major Threat

Compared to India which has strong socialist tendencies rooted in democracy, China with strong communist tendencies with oligarchic structure and has moved away from communism. While democratic apologists may argue that China's growth is due to its lead time and non-accountable nature of Government, they must remember that while Indian universities and media continue to hold on to unworkable Nehruvian principles and socialistic ideology, China has essentially abandoned communism and has moved into being an active capitalistic state.

With years of single-minded and focused liberalization China has continued to grow its GDP at 8%. It attracts more than USD 50 billion Foreign Direct Investment (FDI) a year. Its manufacturing capacity and processes are superb and can compete globally. It continues to attract more investment every day. Many businesses though willing to operate from India are sometimes vexed with our clumsy, outdated, and restrictive labor laws. Chinese investments in higher education is superior to India's investment in science, social sciences, and premier educational institutions. China's capacity to control prices, currency rates, and economic pressures from growth-- which is ironically anti-globalization, has kept inflation and salaries low. This in turn has kept the cost to companies artificially lower than it should be and more competitive than the Indian scenario.

This is not to say that China does not have deficiencies. Even the most ardent Chinese proponent will accept that its growth is geographically lumpy and independently unverifiable. While India has established a functioning democracy with free-speech, plurality of opinion in decision making, an independent judiciary, and a vibrant press, China is still to prove itself on being able to handle itself as a democracy. Its currency is protected and its opinion and decision making process opaque. Its rural areas are virtually shielded from any oversight, investigation, or external influences. Already, there is disquiet about the lack of investments in the rural areas. While China is king of manufacturing in an industrialized world, it is unknown how they will function in a knowledge economy. Its bellicose foreign policy vis-a-vis its neighbors like Japan and India and partners like the US and European Union has initiated a serious rethink in Western think-tanks about the reliability of China as a globally responsible nation. China's environmental policies, its water-management techniques, its aggression to smaller neighbors, its too-clever foreign relations tactics raises a degree a suspicion in transparent societies.

In fact, some analysts say that because India does not fully adhere to the World Bank recognized form of reporting, India continues to under-report its FDI.  If some structural changes are made to include remittances by NRIs and other sources, Indian FDI will match China's numbers. In terms of software and business process outsourcing (BPO), India is way ahead of China controlling nearly 45% of the global market.

We have the capacity to take this to the next level. What we need is imagination, political will, and determination not just to succeed but to exceed our expectations of ourselves. For centuries before the European powers, prominent Indian kingdoms dominated trade with other erstwhile world powers such as China, Rome, Egypt, and Somalia in textiles, steel, spices, raw materials, food products, exotic goods, luxury goods, weapons, ships, and technology.

US Secretary of State wrote in the Foreign Affairs magazine in January 2000 saying that "India is not a great power yet but it has the potential to emerge as one." The big question is do we see ourselves achieving that past glory in the future?

Home Page