If the government of India were to create a holding company for the 808 public sector undertakings (PSUs) that it owns and runs, it would floor investors with size. Revenues of its large flock would add up to Rs 20,55,000 crore­—equal to the gross domestic product (GDP) of Norway, ranked 24 in the world. Their combined net profit would be Rs 1,07,000 crore, which would be higher than the revenues of all but six listed companies in India. And the value of assets would even exceed the size of the Indian economy—103% of GDP, to be precise.

Still, it would take a whole lot of convincing for investors to see this holding company as anything more than an asset play. According to CMIE Prowess database, as many as 360 of them posted a loss in 2008-09; and a further 212 PSUs posted a profit of below Rs 10 crore. The 808-strong unit was grossly inefficient in the way it used assets. Its return on assets (RoA) —net profit as a percentage of assets—was a dismal 1.68%. To put that figure in perspective, the average RoA of the 30 companies that comprise the BSE Sensex is 4.2%.

Business in the hands of the government has never been pretty. “In a government set-up, PSUs can’t be autonomous,” says Suresh Tendulkar, former Chairman of the Prime Minister’s Economic Advisory Council. In stark contrast, in nearly all the cases where the government has shown the boldness to let go, the business has seen a dramatic jump in performance.

Metals major Sterlite took over aluminium producer Balco, and turned a Rs 43 crore loss into a Rs 678 crore profit in seven years. It whipped Hindustan Zinc into shape—the company’s net profit last year was 19 times of what it posted in 2003, when the government offloaded 22% to Sterlite. Revenues and profits at Maruti have increased with the government’s reduced presence in the company.

Clearly, government getting out of a business is good for the company, its employees, its shareholders—and by extension, the economy. Yet, despite such hard evidence, it’s been six years since the government privatised PSUs. Disinvestment, in the truest sense of the word, remains captive to the politics of the day and couched in euphemisms.

In its first tenure from 2004-09, the ruling United Progressive Alliance (UPA) did not dare the Left parties, whose stand on disinvestment is abundantly clear: no sale whatsoever. In its second stint, with the Left off its back, UPA-II has made small beginnings. It’s selling small stakes in PSUs to the public.

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The Case For Privatisation

In the last 10 years, there have been 14 minority stake sales and 7 privatisations. Whichever way one sees it — financial growth or shareholder returns — privatisation has delivered more than stake sales.

Figures show percentage of companies that showed an improvement in growth/increase in market cap after their disinvestment Source: CMIE Prowess

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This will result in the government getting money, though nowhere close to what it could get. It will lead to, at best, a small change in the functioning of those companies. “After external shareholders took a stake, we became more alert to external responsibility,” says MS Ramachandran, ex-Chairman of IOC. “We faced analyst queries on a quarterly basis, which made us more transparent and accountable.” RP Singh, former Chairman of PowerGrid Corporation of India, which went public in 2007, says employee commitment went up significantly once the company got listed. PowerGrid employees own 2.5% of the company’s equity, through the IPO. “They feel like owners of the company,” says Singh. “This led to a perceptible change in performance of the company.”

Those are significant changes, no doubt, yet small in the larger scheme of things. The big difference, both to the government’s finances and the health of PSUs, comes from their outright sale or the induction of a strategic partner, as Balco, Hindustan Zinc and Maruti have ably demonstrated.

Management Logic

The process of disinvestment began as part of the sweeping reforms undertaken by the Congress in 1991 to fix the crisis-ridden economy. But unlike, say, the British model of disinvestment initiated under Margaret Thatcher, where a private partner took over, ownership didn’t change hands in the Indian model.

Small chunks of equity of 53 PSUs (including 10 banks and five financial institutions) were sold to the public and the companies listed. Sometimes, these were as little as 1% of the company’s equity. The floating stock of several PSUs—for example, MMTC and NMDC—is still at those levels, giving rise to situations where an artificial scarcity of floating stock drives up share prices to unreasonable levels. Those small offerings continued and money kept dribbling into the government’s coffers.

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The Case For Selloffs

The seven PSUs that the government sold to the private sector have made big strides since.

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Financials: Then: year of sale; Now: latest full fi nancial year; Growth and returns: Then: CAGR in three years preceding sale; Now: CAGR since sale; Market cap: Then: average in year of sale; Now: average in 2009

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It was only after the BJP-led government National Democratic Alliance (NDA) came to power in 1999 that there was a graduation from disinvestment to privatisation. The government sold a majority stake in seven PSUs—Balco, CMC, Hindustan Teleprinters, Hindustan Zinc, IPCL, Jessop & Co, and VSNL—to private entities through the tender route. It offloaded its stake in Maruti, in tranches, to the public and Suzuki. It sold its stake in 20 hotels to the private sector.

Privatisation has been a success. We assessed improvement in financial growth and shareholder returns of the seven above-mentioned companies for two periods: in the three years preceding the sale, and from the date of sale till December 2009. So, for example, 22.1% of Hindustan Zinc was sold to Sterlite in 2002-03. The pre-sale period would be calendar 2000 to 2003, and the post-sale period from 2003 to 2009.

Employees felt like owners when we listed. Their commitment increased, which rubbed off on performance.RP Singh, Former Chairman of PowerGrid Corporation of India

In 5 out of 7 cases, the jump was pronounced—in multiples. The remaining were competent (See graphic: The Case For Selloffs). The promise of ownership, majority or significant, and management control is a lure for private shareholders. And, it is the best thing that happened for these companies, and their employees, shareholders, and customers.

A similar spike in performance was missing from the PSUs where the government reduced its stake but retained majority control. Between April 2000 and February 2010, the government sold minority stakes in 17 PSUs. We ran the same exercise—pre-sale and post-sale—for these companies as well. Just three of the 14 companies for which numbers were available—GAIL, REC and Indian Overseas Bank—grew at a faster clip after the stake sale. Growth in the other 11 companies slowed in spite of having a few years where the economy hit a purple patch.

This seems to suggest that selling shares to the public, who have ownership but cannot exercise control, does not make the radical difference to productivity of PSUs that it should. “The motivation for disinvestment or privatisation should not be narrowly seen as being only about maximising proceeds from the sale of assets,” said Vijay Kelkar, Chairman of the Thirteenth Finance Commission, at a recent public lecture. “The real big gains come from the full picture. We gain when the private sector attains higher productivity. And this happens even with mere disinvestment, but it happens much more strongly with privatisation.”

Tendulkar favours strategic sales, where substantial equity is given to one private player and management control is ceded. “There’s a compelling argument in favour of strategic sales in companies like BSNL and Air India,” says Tendulkar. “The buyer can bring in new technology and has a strong incentive to take an interest in running the company. It can displace government control.”

Numbers Game

The focus of the current disinvestment drive, however, is on stake sales. By itself, it is the first step for a lot of these companies in straining to break free from government hold and being exposed to the rigours and challenges of delivering and reporting to the outside world. But unless it leads to the next logical step, privatisation, chances are, gains for the company will be incremental. And they will taper off, sooner rather than later.

As the RoA of 1.68% of the government’s portfolio of companies shows, it’s a lousy manager. In an economy starved of capital, this is colossal under-utilisation of assets. Despite the abysmal payback on those assets, the government continues to pump in money and create new assets year after year. In 2008-09, Rs 25,500 crore—3.6% of the budgetary outlay—was earmarked for PSUs as equity support. In many cases, it is a case of throwing good money after bad.

There’s a trade-off here for the government. “When the State chooses to own Re 1 of something, it comes at the cost of owning Re 1 of something else,” said Kelkar. It is estimated that India needs $500 billion to fix its infrastructure in the current five-year plan period ending 2012. Could this money have been better used there? Or elsewhere?

The stake sale is only to generate resources to plug the deficit. Majority sales won’t happen anytime soon.DK Joshi, Economist, Crisil

If letting go leads to improvement in performance, it would be smart to exit in tranches. Prime Database, a Delhi-based organisation that tracks the primary market, looked at the value of the government’s stakes in PSUs that were listed in the last five years and have been listed for at least a year. Four PSUs—NTPC, Power Finance Corporation, PowerGrid and Rural Electrification Corporation—made up this group. The government’s stake in these PSUs has appreciated 181% since listing. For example, in NTPC, the government’s stake of 89.5% is worth Rs 1,50,000 crore, compared to Rs 46,000 crore at the time of divesting in October 2004. Once again, that has the potential of putting more money in the hands of the government to do the things that it needs to do.

According to Prime, there are 214 Central PSUs (the remaining are state PSUs and local bodies). Of these, 46 are listed. As on January 31, they made up 25% of the market capitalisation of the Bombay Stock Exchange (BSE). Adding the listed state PSUs (like Andhra Pradesh Power Finance Corporation and Tamil Nadu State Marketing Corporation) and PSU banks (like SBI and Canara Bank) to this list, the government-controlled enterprises make up about 30% of BSE’s market capitalisation, or Rs 18,30,000 crore.

A 10% stake sale in all listed companies alone could result in the government mopping up Rs 1,80,000 crore. That’s enough to plug nearly two-third of the Central government’s revenue deficit. Lower deficit means more money available to spend on creating social infrastructure like schools, hospitals and transport systems, where the private sector finds less incentive to invest.

The Way Forward

With privatisation, the pickings will be greater, both in tangible and intangible ways. More so in companies that have been listed for some time and have found a valuation benchmark.

Economists in favour of disinvestment say a bold statement from the government that it intends to vacate sectors where there are vibrant private players would be a major reform signal. It will also help the government to attract greater private participation in the sector, as the presence of state-owned firms in a sector where the government is also a regulator increases ‘political risk’ for investments. In theory, yes. Practically, it’s not going to happen anytime soon. “The stake sale by the central government is only a temporary relief to generate resources to plug the fiscal deficit,” says DK Joshi, an economist with Crisil, a ratings and advisory firm.

“Disinvestment of a majority stake is not going to happen anytime soon.” All that does is further erode the RoA number of 1.68%.