Retreating from the commanding heights: privatization in an Indian context.

Author:Goulding, A.J.
Position:Andrew Wellington Cordier Essay - Privatization: Political and Economic Challenges

The question today being asked [regarding the

public sector] is commanding heights of what?

Red-tapism. Inefficiency. Absurdity.

Antiquity....There is no alternative to a

thorough-going privatization.

--S. Pandey (italics original)

The idea of transferring the ownership from

public sector to private sector for India is too

immature, rather wrong...the state is more

knowledgeable and objective and the market is

imperfect and short-sighted.(1)

--K. Das


In the period between 1988 and 1993, about 2,700 state-owned enterprises (SOEs) were privatized in 95 countries, excluding large-scale voucher privatizations.(2) By 1995, the total value of privatization deals exceeded $300 billion. None of these major deals have been in India. There are two main reasons for this. First, in contrast to former communist countries, the government controlled less of the economy, meaning there was simply less to sell. Second, India's open political system has meant that the strong sentiments aroused by the issue of privatization--exemplified by the quotes above--have tended to cancel each other out, reducing the incentive for elected officials to act.

Up until now, India has pursued a unique approach that I call "parallelization." This includes encouraging the development of private sector competition for state-owned firms--known as Public Sector Undertakings (PSUs) in Indian parlance--while at the same time slowly establishing independent regulatory agencies to oversee the newly established players. However, a realignment may be taking place. The once dominant Congress Party, after a strong challenge by the Bharatiya Janata Party (BJP), has been replaced in government by the United Front, made up of regional and left-of-center parties that exclude both the BJP and the Congress.(3) This may allow for further evolution of privatization policies.

Parallelization is not the result of a premeditated, publicly articulated strategy. Instead, the term describes a bureaucratic response to multiple and contradictory pressures: low returns from SOEs, lack of funds for modernization, inability to fire workers, and demands from consumers to improve service. Nonetheless, it has helped India avoid the pitfalls faced by privatization programs in other emerging economies. Creation of private-sector employment alternatives allows for the gradual absorption of workers from overstaffed SOEs and lays a foundation for future sell-offs. Rapid growth in sectors formerly monopolized by the government means that labor, a potent opponent of privatization efforts worldwide, may eventually be co-opted by the availability of higher-paying opportunities in the private sector. Controlling the pace of private-sector involvement allows time for regulatory institutions to mature. These developments will in time emphasize the superfluity of SOEs to the Indian economy. This in turn will make it more politically acceptable to use proceeds from full denationalization to contribute to eliminating the fiscal deficit (at least in the short term) without making drastic cuts in social services.

Denationalization vs. Parallelization

It is important to define what is meant by the term "privatization. The International Finance Corporation (IFC) notes that,

...a generous stance would admit any transfer of

ownership or control from public to private sector. A

more exacting definition would require that the transfer

be enough to give the private operators or owners

substantive independent power. This will often though

not always imply majority ownership. Transfer

techniques can include trade sales to a strategic

investor, public offer, closed subscription, joint venture,

liquidation, concessions, auctions, voucher or certificate

based transfers, employee or management buyouts, or

most combinations of all of these.(4)

In this paper, I distinguish between two types of privatization: "denationalization," or the sale of a more than 50 percent voting share in a government-owned enterprise to the public or to a strategic investor, and what I call "parallelization." The latter is sometimes referred to as "greenfield privatization," that is, allowing private-sector projects in industries previously reserved for the public sector. However, this term seems inadequate, because it implies isolated instances of private-sector initiative designed to supplement, but not supplant, government enterprises.

Parallelization would include not only significant private-sector entry, but the creation of independent regulatory authorities, the disaggregation of supporting government infrastructure from the SOE with which the private sector will be competing (e.g. separation of the government-owned airline from the government-owned airports) and the liberalization of pricing regimes. It is important to recognize that Indians who claim to oppose "privatization" often do not oppose both sorts. Opponents of the "privatization of education," for example, are not talking about a nefarious plot to list shares in Jawaharlal Nehru University on the Bombay Stock Exchange. Rather, they are against the growth of parallel institutions of higher education not sponsored by the government. Likewise, when it is said that there is no consensus on privatization, most politicians are actually talking about denationalization.

History of SOE Reform

To understand the extent to which India's experience with privatization is distinct, we should first review the relevant reforms which have taken place. Three and a half decades of SOE pre-eminence in the Indian economy is bracketed by the Industrial Policy Resolutions of 1956 and 1991. The 1956 Resolution is the embodiment of the "commanding heights of the economy" theories of Nehruvian socialism. In two schedules it established a list of 17 industries in which units would be set up exclusively by the state and enumerated an additional 12 sectors in which both the state and the private sector could set up units. All other industries were tacitly within the purview of the private sector.(5) However, "over the years, the policy-based division between public and private enterprise has gradually collapsed....In the Indian public sector today, there are a number of enterprises whose public purpose is hardly discernible."(6) By 1993, only 60 percent of total SOE investment was in "commanding heights" areas.(7)

It became clear that reform was imperative in the late 1980s. Among the many distressing statistics, the public sector represented close to 50 percent of investment in manufacturing but only 15 percent of value-added. It consistently lagged behind the private sector in terms of profitability. In fact, when the petroleum sector is excluded, SOEs as a whole lost money eight out of ten years between 1981 and 1991. Even if the oil companies are included, the government's rate of return on its SOE investments has generally been less than a third of its borrowing costs.(8) Initial efforts at reform began after 1985 with the drive for Memoranda of Understanding (MOUs) between the Government of India and major SOEs identifying performance targets and granting operating autonomy. This was followed by the revisions to the Industrial Policy Resolution in 1991, the major features of which are highlighted below.

Aspects of Post-1991 Reforms Related to Privatization

* Number of sectors reserved solely for SOEs reduced to six; even in these six, joint ventures with private firms are allowed

* Government to sell up to 49 percent of equity in profit-making companies

* Budgetary support to SOEs to be phased out after 1994-1995

* SOEs allowed to form joint ventures, raise equity to finance expansion, and borrow

* Sick SOEs referred to BIFR

Source: GOI 1993

Although intellectuals saw MOUs as an efficiency-improving alternative to privatization, they are now generally acknowledged to have been a failure. The World Bank examined MOUs with the National Thermal Power Corporation (NTPC) and the Oil and Natural Gas Commission (ONGC) starting in 1987. "The contracts may actually have contributed to a deterioration in performance...the only association between the achievement of contract targets and performance is a negative one." Contracts specified levels of output with no reference to inputs. Thus, while both firms achieved ratings of excellent, they did so merely by increasing inputs; ONGC drilled more bad wells, and NTPC produced more electricity using ever more coal. "Negotiations on targets have sometimes dragged on so long that the targets were set to be the same as actual performance."(9) Moreover, even when the enterprises performed as specified in their contracts, the government repeatedly failed to live up to its end of the bargain, failing to enforce collection of arrears from other SOEs, provide autonomy to invest, give pricing freedom, or streamline red tape.(10)

During the 1990s, the Indian government has increasingly looked towards other strategies for improving SOE performance. Former government departments were corporatized, that is, set up along the lines of a limited company rather than a bureaucracy. The "C" in ONGC now stands for corporation instead of commission, and assets were taken from the Department of Telecommunications to create the Mahanagar Telephone Nigam Limited (MTNL). Since 1991, shares in over 30 enterprises have been floated in several rounds. These offerings have generally comprised less than 20 percent of the government's holdings.(11) Foreign investors have been allowed to participate in these offerings in a limited way since 1994. Several major firms in the banking, telecommunications, oil, and steel industries have been included in this process. There has recently been some discussion of even letting the government's stake drop below 51 percent in the petroleum sector. The government has made it clear that, for all SOEs, "future survival, let alone prosperity, of these units will depend on performance."(12)

"Sick" SOEs are increasingly being...

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