How to get Disinvestment Going Building India's Future

How to get Disinvestment Going Building India's Future Report of the Special Subject Group Members : Shri GP Goenka Shri Rajeev Chandrasekhar Shri Nusli  Wadia  How to Get Disinvestment Going "Building India’s Future" 1.  Why disinvest? Since reforms began in 1991, this is the first time after 1993-94 that one feels that reforms are going to go forward. Except industrial delicensing and some changes in the financial sector, almost nothing has so far happened on domestic economic reforms. The second generation of reforms is about domestic economic reforms. And domestic economic reforms have to begin with public sector reform and privatization. Without this as a prerequisite, nothing else is possible. Nothing else can happen. Modern Foods is a good beginning. This report will express some skepticism about what is proposed for Indian Airlines. But more than these two, what has been reported in the media about the government’s intentions is the really positive signal. Why is disinvestment necessary? THE CITIZENS’ CHARTER v     Who are shareholders of public sector undertakings (PSUs)?  Indian citizens are, the government only acts on their behalf. v     As percentage of GDP (gross domestic product), does the government need to spend so much?  The government in India spends 32.6% of GDP.  Indonesia spends 16.2%, South Korea 17.8%, Malaysia 23.2% and Thailand 18.6%. v     Only 3.5% of GDP is spent on education. v     If government expenditure is reformed, 5.1% of GDP can be saved – 1.5% from privatization and repurchase of public debt, 0.6% from fertilizer subsidies, 0.2% from PDS, 0.3% on public administration and 2.5% from smaller transfers to States.  This is an additional expenditure that can be made on primary education and rural health care. v     The government subsidizes losses of almost Rs 80 billion per year made by around 120 Central PSUs. v     Each individual citizen pays Rs 80 a year, each household pays Rs 400 a year.  Are 6 million jobs in PSUs worth it? v     The government has no right to decide, shareholders must decide. The future of India is at stake. India’s balance sheet is in a mess. It is obvious that over the last 50 years huge amounts of Public money have been invested into the public sector. Hundreds and thousands of Crores of Public money has been invested into various Public Sector Units. However, these investments have not resulted in creation of value on the balance sheet. All in all investments have yielded very little or no return on investments, but creating a huge hole in the balance sheet. This huge hole in the balance sheet is being further exasperated through the excessive borrowings every year and the resultant interest burden India’s revenue – Profit & Loss statement is also in a mess If one adds up four items of current revenue expenditure – interest payments, defence expenditure, wages and salaries of government employees and subsidies – and compares this figure with total current revenues (tax plus non-tax), there already is a deficit. That means that even if the government stops functioning and ceases to do anything else, there will be a deficit. This is not tenable. The government should have a surplus on the revenue account to finance a deficit on the capital account. Capital expenditure is what the government should be doing. But there is no money for this. The government should be spending on infrastructure – social and physical. The government should be spending on primary education and rural health care. But there is no money for this. The situation is worse. A deficit can only be financed through borrowing, which pushes up interest rates and crowds out necessary private sector investments, or through monetisation of the deficit and resultant inflation. Inflation is the most regressive form of taxation that there is. It hurts the poor more than the rich, the poor don’t have inflation-indexed incomes. The government doesn’t have a treasure chest. The poor will pay through higher interest rates or higher inflation. Inefficient PSUs are largely responsible for the macroeconomic crisis India faced in the 1980s, a phenomenon that spilled over into a balance of payments (bop) crisis in 1990-91. Some of these PSUs shouldn’t have existed in the first place. That is, they are sick private sector units that should have been closed down. Instead, to protect a few existing jobs, they were absorbed into the public sector. It is necessary of course to point out that the public sector can mean various things. The government itself (Centre or State) sometimes runs undertakings, these are PSUs proper. Then there are departmental enterprises like railways, post offices or telecommunications, which are not separately incorporated, but are run as government departments. Finally, there are those that are separately incorporated and are run as independent companies. Since such distinctions are not important for this report, when the expression public sector is used, it means all three types. EMPLOYMENT v     A 7.5% growth rate means 11 million new jobs a year. v     A 6% growth rate means 9 million new jobs a year.  v     Lack of PSU reform implies a loss in growth rate from 7.5% to 6% - a loss of 2 million jobs a year. v     In three years, the country can recover the entire present employment in PSUs. A large chunk of revenue expenditure is interest payments on past government borrowing. If the interest payment problem can be solved, there will no longer be a fiscal deficit problem and the government will have money to spend on capital expenditure or infrastructure. In a country like India, there cannot be a moratorium on interest payments. While borrowing at market-determined interest rates and curbing present government expenditure disciplines future borrowing, the only solution to the debt overhang of earlier borrowing is disinvestments that can be used to retire public debt. That is what the ordinary citizen stands to gain from successful disinvestment. This argument can be reinforced. PSUs (public sector undertakings) were not created only for the purpose of providing employment.1  They were meant to generate surpluses that flow into the government’s non-tax revenue.2   This hasn’t happened. Disinvestment will improve PSU performance, it will improve PSU competitiveness. Those who have jobs in PSUs will enhance their job and economic security. Disinvestment accomplishes more. RETURNS v    Who will be satisfied with a return on capital of between 2 to 5%? v    That’s the figure for PSUs. v     If one excludes the ones that are monopolies, the rate of return is      lower still. v    The government borrows at 12% for this rate of return and citizens pay for this stupidity. Inefficient PSUs also constrain the efficient performance of the private sector, since the private sector requires inputs and infrastructure services provided by monopoly suppliers in the public sector. Not everyone can have a job in a PSU. Disinvestment improves efficiency and pushes up growth rates. Growth provides jobs and employment. If the Indian economy can grow at around 7.5%, the backlog of unemployment will begin to disappear. These points were made with the Central government in mind and the Central government has equity in around 240 PSUs, 27 banks and 2 insurance companies. But at the level of the States, where there are around 1000 PSUs3, the situation is even more serious. Most States are bankrupt. They don’t have money to pay wages and salaries of government employees, forget education and health care, or infrastructure. India is bound to have a current account deficit in the foreseeable future. This current account deficit has to be financed through capital account inflows. Such inflows can be borrowing or non-debt creating inflows like foreign direct investments (FDI). As the East Asian experience also demonstrates, non-debt creating capital inflows like FDI are preferable. Disinvestment helps to attract global capital. In fact, it helps to attract domestic capital as well. 1  Coal India employs 700,000 people, of whom, one-third are redundant.  In the entire governm ent, 2 million people are believed to be redundant.  This is out of a total employment of 20 million, of which, 6 million is in PSUs, 3 million in the Central government, 7 million in State governments and 2 million in local bodies. 2   The cash value of most PSUs is more than the present value of profit flows, even if the cash value is evaluated on book value of assets.  The conclusion is stronger if valuation is done at current value.  Perhaps it is necessary to mention that some loss-making PSUs also have positive market value. 3   Roughly half of these make losses.  Of the ones that make losses, roughly half have eroded their net worth and these figures are only for the Centre. BUILDING INDIA’S FUTURE SECOND GENERATION REFORMS PSUs have never earned profits that have exceeded 6 per cent of capital employed (Table 1)4. Their return on capital has been between 5 and 7 percentage points below the rate of interest on long term government bonds. That is just one measure of the lost opportunity cost of return. Table 1: Profitability of Indian PSUs   91-92 92-93 93-94 94-95 95-96 96-97 No of PSUs 237 239 240 241 239 236 PAT as % of CE 2 2 3 4 6 5 PAT as % of GS 2 2 3 4 4 4 No of profitable PSUs 133 131 121 130 132 129 No of non-profitable PSUs 104 108 116 109 102 104 These poor returns have occurred despite huge rents that accrue from government monopolies like petroleum and power. Once these are netted out, PSUs show negative return (Table 2)5. 4  Public Enterprises Survey. PAT = Profits after tax; GS = Gross sales; CE = Capital employed. 5  L. Bhandari and O. Goswami, The Wasted Years: The Public Sector in India, National Council of Applied Economic Research, forthcoming, 2000. Table 2: Differential PSU profitability (%) PAT/Net Sales 91-92 92-93 93-94 94-95 95-96 96-97 All non-service PSUs 2 2.2 3 4.4 4.9 4.4 Less petroleum 0.1 - 0.1 - 1.2 1.6 3.4 2.7 Less petroleum & power - 2.4 - 2.3 - 3.4 - 0.2 1.3 0.1 Less petroleum, power, coal & lignite (pure manufacturing PSUs) - 5.3 - 5.4 - 6.9 - 2.3 - 2.4 - 4.3 The controlling shareholder of PSUs has distinctly different objectives. Commercial viability, profitability, cost minimization, optimal investment decisions rarely figure among the concerns of a typical Member of Parliament or a Minister. Next in the hierarchy of shareholders’ representatives comes the civil servants. Bureaucrats specialize in proper procedures. This creates an inconsistency between the organizational forms of governments and those of modern financial and industrial entities: governments and their agents are process oriented, whereas firms have to be result oriented. The mismatch gets exacerbated by a civil servant’s aversion to risk taking. Given such non-commercial objectives of the representatives of shareholders, most chief executives of PSUs quickly adopt the line of least resistance, develop the ‘don’t rock the boat’ syndrome. Thus, organizational changes are not made, erring staff remain undisciplined, loss-making plants are neither down-sized nor closed, wages are not linked to productivity, and redundant workers are not retrenched. Above all this, there is Article 12 of the Constitution of India, which defines ‘the State’ as "the Government and Parliament of India and the Government and Legislature of each of the States and all local or other authorities within the territory of India or under the control of the Government of India". Since most PSUs have more than 50% government ownership, they fall under the ambit of ‘the State’. This has affected PSUs in several adverse ways. All PSUs are expected to achieve a wide variety of non-commercial objectives which are imposed by the Ministries and the Parliament. There is an annual audit by the Comptroller and Accountant General (CAG) in addition to the audit by the statutory auditor. The area where CAG audits inflict the greatest ex antedamage is in purchases and tenders. PSU managers invariably veer towards selecting the lowest bid, even when they know that the quality is poorer. Innumerable CAG allegations of financial impropriety only on the basis of rejecting the lowest bid have taught PSU managers that propriety dominates profitability. There are constraints on appointment of senior management personnel, which can only be done through the Public Enterprise Selection Board (PESB) and, thereafter, clearance from the Department of Personnel, the Home Ministry, and, in many instances, by the Office of the Prime Minister. This has led to delays, non-appointment of CEOs and executive directors, and excessive emphasis on seniority — which means that very few CEOs can enjoy their full term. Since PSUs are interpreted as ‘the State’, they are subject to writ petitions to the Supreme Court under Articles 32, and High Courts under Article 226 of the Constitution. Again by virtue of being considered as servants of ‘the State’, managers of PSUs are often subjected to criminal investigation by the Chief Vigilance Commissioner and the Central Bureau of Investigation. State status limits managers from down-sizing plants, retrenching or re-deploying employees. Finally, the directors of PSUs have little autonomy in finalizing investment decisions. For a while, governments tried the system of having target-setting memoranda of understanding (MOUs) between PSUs and their administrative ministry. The idea was to make a PSU achieve greater efficiency without diluting the government’s majority ownership and control. Despite the Department of Public Enterprises showing high ‘success’ rates, the MOUs failed.6   First, there is a sample selection bias: virtually no loss-making PSU signs a MoU. Thus, over 55% of the PSUs remain outside the MOU ambit. Second, the targets are set low enough to ensure achievement. The post-MOU performance of the so-called ‘excellent’ and ‘very good’ achievers is no better — and often worse — than before.                                6  Bhandari and Goswami (2000). 2. Tactics and strategy There is a difference between tactics and a strategy. So far, disinvestment has been driven by the tactical compulsion of financing the fiscal deficit. This is perhaps the reason why the word privatization has not been used until recently, the word disinvestment tending to imply a soft choice. This is in contrast to a country like Britain, where privatization and disinvestment were driven by a conscious recognition that this improves efficiency.7  However, there are no soft choices. As countries like Peru, Brazil, Chile, France, Morocco, Poland, Indonesia, Malaysia, the former German Democratic Republic, the Philippines, Pakistan, Sri Lanka, Taiwan, Indonesia and New Zealand have recognized, the fiscal deficit or releasing resources for social or infrastructure sectors cannot be the only reasons for disinvestment. Other reasons are improved efficiency and competition and broadening and deepening the capital market. PSU reform attempts go back to the 1980s, where there was some attempt to increase functional autonomy of PSUs, without privatization and disinvestment. Post-1991, there were ad hoc equity sales in around 50 PSUs, with equity sales ranging from 5% to 49%. There was a hang-up about letting go of more than 51% equity.8   This led to some improvement in efficiency and pre-tax profit as a percent of capital employed in PSUs more than doubled from the base figure of 3.4% in 1990-91.9 This illustrates what is possible with full-fledged reforms. 7   However, the Rangarajan Committee Report (Report of the Committee on Restructuring Public Enterprises), 1992, did mention improved efficiency as an objective. 8   As a parallel move, fresh issues of equity in global markets for expansion also diluted government equity. 9   See detailed figures in M.S. Ahluwalia, “India’s Economic Reforms: An Appraisal” in Jeffrey D. Sachs, Ashutosh Varshney and Nirupam Bajpai edited, India in the Era of Economic Reforms, Oxford University Press, 1999. SECURING THE FUTURE OF INDIA’S PSUs The hang-up about giving up more than 51% equity was possibly given up with the setting up of the Disinvestment Commission in 1996, a commission that has now been wound up. The Disinvestment Commission examined 50 PSUs, ostensibly non-strategic and non-core, where government equity could be brought down to zero and management handed over. In most cases, it is now accepted that government equity can be brought down to 26%. The 51% figure is important. Any firm where the government has more than 50% equity is legally interpreted as part of Article 12 of the Constitution and is accountable to administrative ministries, government audits and Parliament. There will also be the Central Vigilance Commission (CVC) and the Central Bureau of Investigation (CBI). Moreover, with a 51% hang-up, new private shareholders will always be a minority on the boards. Naturally, bids would have been higher had the government agreed to dilute equity to 26% in a time-bound fashion. However, driven by tactical considerations, the entire disinvestment process so far has been left to bureaucrats who do not necessarily have a perfect understanding of how capital markets operate or how international investor decisions are taken. Therefore, issuance is piecemeal, there are long delays in appointment of lead managers and finalization of IPOs (initial public offerings) and flawed criterion used in selection of lead managers. There has been lack of transparency, a fact that reports of the Comptroller and Auditor General (CAG) of India have also commented on. It should not be surprising that foreign investments in the disinvestment process in India are a trickle compared to global investments that flow into disinvestment processes world-wide. It is remarkable that not a single PSU is yet under autonomous private management and the cross-holdings by oil companies is a particularly perverse illustration of this phenomenon. It is only recently that the government has become a bit more serious about disinvestment. As the following will make clear, this report favours what has been done for Modern Foods, but not what has been done for Indian Airlines, unless that is a temporary step. Unlike what happened historically, a strategy will have a proper vision and plan of action. First, the management and responsibility of the entire disinvestment process should exclusively be with the Disinvestment Ministry (DM). Setting up such a DM ensures transparency and fairness and also contributes to a comprehensive approach to disinvestment, as opposed to ad hoc decisions. This is one reason why most developing countries have opted for formal structures. Other ministries can be co-opted only if it is absolutely necessary. The Secretary of DM must have sufficient capital market experience. For each proposal, the DM will be responsible for taking the proposal to a Cabinet Committee on Disinvestment that will consist of the Prime Minister, the Finance Minister, the Disinvestment Minister and any other economic ministry that may be necessary from the point of view of the specific proposal. The DM will be a specific pre-determined target of capital that will be raised over a fixed time horizon, say the next two years. Thus, for the next two years, the DM will develop a plan and course of action that addresses individual companies and sectors and draws up a strategy for each. The strategy need not be the same across all companies or across all sectors. To ensure a realistic and successful course of action, the DM will have an Advisory Board. The Advisory Board will have as members, individuals who have sufficient capital market and international investor experience. Examples are representatives from financial institutions, management consultants, merger and acquisition (M&A) experts and private companies. It is important to ensure that the DM and politicians and bureaucrats involved in the disinvestment process are granted immunity from prosecution and investigation by the Central Bureau of Investigation (CBI) or Central Vigilance Commission (CVC). If the process is transparent, as is argued in this report, the need for these will not arise. In this framework, there is no need to revive the Disinvestment Commission. It has no further role to play. HOW MANY OF THESE JUSTIFICATIONS FOR PSUs ARE VALID NOW? v     Infant industry v     Heavy industry based development strategy v     Right distribution of ownership of capital v     Lack of resource v     No technical competence in private sector v     Under-developed capital market v     Balanced regional development v     Employment promotion v     Protection Second, the candidates for disinvestment must be chosen carefully. Stronger PSUs are the ones that must enter the market first, in the immediate short run (the first four years). This will whet the appetite of investors and make India a success story, a phenomenon that tends to snowball. Creation of markets is in fact an indirect positive fallout of successful disinvestments. In the medium term however, all government companies that are non-strategic should be candidates for disinvestment. Strategic or core must be carefully defined. Other than arms, ammunition and defence equipment, atomic energy, radioactive minerals and railway transport, there is nothing else that can appropriately be defined as strategic or core. Therefore, in every other case, there is no reason why government equity should not be brought down to 26% and this includes banking, insurance, aviation, the petroleum sector and tourism. 26% equity is enough to ensure that the government has some influence over corporate decision making. The only caveat to 26% can be if prior privatization of management enhances valuation. The disinvestment process is best managed if there are a defined number of large transactions per year, as opposed to a large number of small transactions. Perhaps some overall restructuring of PSUs through mergers and acquisitions (or even winding up) is therefore necessary prior to disinvestment. Stated differently, one of the first decisions the DM has to take is on the extent of disinvestment. Will there be total disinvestment? Will there be partial disinvestment with managerial control retained by the State? Will managerial control be handed over to a strategic investor, with only minority share holding granted to such an investor? As the statements above indicate, this report argues for total disinvestment. The selling of bundles of portfolios of shares will not work. Moreover, selling lots of 5 or 10% is counterproductive because buyers know that further shares will be offered. The mindset that a PSU, even if does not make losses, is a going concern must change. Instead, the block of assets must be sold. Whether the enterprise will continue to be a going concern or not, is for the new management to decide. There is some urgency in doing this. Before liberalization, many PSUs were monopolies. They are now being exposed to competition. This process will intensify as further liberalization of trade (cuts in tariffs and elimination of quantitative restrictions) and investments (foreign direct investments) take place. To get a good value for these PSUs, the time to disinvest is now. Not later. Third, the present system of selecting lead managers on the basis of bidding for fees is entirely unsatisfactory. Second-best lead managers are chosen and are often not interested, or do not deliver their best resources, to issuances. Globally, there are only 5 or 6 top lead managers. All these should be empanelled and additions to this panel can be through co-managers from smaller investment banks. The norms for fees can be fixed and such norms can be suggested by a team of financial institutions that have requisite expertise. These empanelled lead managers can be allotted initial issuances in random fashion and further issuance mandates can be based on performance (over-subscription, market-making, pricing). All this will eliminate delays in the process of selecting lead managers. Fourth, the process of disinvestment need not be completely capital market driven, as it is today. The capital market focus, the small percentage of equity disinvested and an overall lack of clarity result in a less than optimum value being derived from the disinvestment process. There are nine, not mutually exclusive, options possible for the disinvestment process and PSU reform and all nine can be used to ensure flexibility and maximum value from disinvestments. Often, the choice may be dictated by whether the eventual shareholding is meant to be narrow or wide. These nine options are the following. First, there can be strategic majority sales to a partner and global trends show that there is more realizable value (about 20 to 30% more) through strategic sales to companies in the same sector. 51% or even 100% equity can be sold to such strategic buyers. Second, there can be open public auctions for units to bidders, with or without pre-qualifications. However, sales should not be only to public sector financial institutions and their subsidiary mutual funds. Third, there can be public sales through stock exchanges in the domestic capital market. One can continue with capital market disinvestments, except that larger shares of equity must be off-loaded through initial IPOs. It is necessary to privatize management before IPOs for value to be maximized. Global trends are that 20 to 30% more value is obtained through disinvestments after privatization of management than before privatization of management. Fourth, it is possible for PSUs to enter into joint ventures (JVs) with the private sector and transfer their business for stock in the new enterprise. However, in such cases, shareholder agreements between the private company and the PSU must over-ride government decision making or policy. Once the JV route has been followed, capital market transactions are possible. Fifth, GDRs/depository receipts can be issued in international capital markets.10   Sixth, as an imperfect framework of disinvestments, there can be management contracts for limited periods of time with private operators. Seventh, there can be sales in blocks. Eighth, despite all attempts at reform, there will be some clear cases of winding up. Ninth, there can be mergers and restructuring. For Central PSUs, this report later gives suggestions about what modality can be attempted for which PSU. Since employees and Indian citizens in general have to be part of the disinvestment process, employees must first be given up to 10% of stock at par or at discounts on market values. This can be spliced with deferred payment for employees and loyalty bonus of shares if shares are held for a minimum period. In addition, a small additional IPO or up to 10% of capital can be offered to Indian citizens in individual capacity. There can be a caveat that a single individual cannot have more than 1000 shares. This will eliminate some resistance to disinvestment and employees or others will become part of the process that creates more value for their company. PSUs will move from being employment creators for those who are employed with the company to enterprises that create wealth for their share-holders, the citizens of India. This is what should have happened with PSUs in the first place. In addition, it may be necessary to ensure that willing employees are provided attractive severance packages. Without the possibility of surplus manpower being shed, bids will be marked down. The role of a media campaign in generating consensus also needs to be emphasized. What is the need to privatize profit making PSUs? v    Because it fetches better prices. v    Unless an enterprise is in the strategic sector and        unless          the market structure is a monopoly,   profit    making    is    an          argument for disinvestment – not an     argument against it. There will continue to be a problem with loss-making PSUs, many of which historically are loss-making private sector enterprises that should have been closed down, but were nationalized in the 1970s. The Board for Industrial and Financial Reconstruction (BIFR) is supposed to examine these and recommend ones that cannot be revived. Not a single one has been closed down, primarily because of court intervention on labour grounds. While loss-making PSUs that have positive market value can be sold, this is also true of loss-making PSUs that have eroded their net worth,11   provided that the assets are sold as a block. There may be a few cases where actual closing down is necessary. Properly used, the National Renewal Fund (NRF) can be used to retrain and re-deploy people who are retrenched because of closing down. However, the NRF cannot be equated with a Voluntary Retirement Scheme (VRS). As originally stated, the NRF was supposed to be used for VRS, retraining and unemployment insurance. Only the first has come about. The proceeds of disinvestment should not go into the Consolidated Fund of India. They have to be used to retire the public debt or for a genuine NRF (from which Rs 1000 crore can be earmarked for VRS). In fact, the present value of future wage and pension flows of workers is easy to compute. From funds obtained through sales, this amount can be set aside, so that a worker who loses a job does not lose the income security. There has to be fresh legislation to ensure fast transfer or leasing of government land and user rights. This can even provide for special tribunals, without violating Article 14 of the Constitution. Otherwise, the entire process can get stuck in the court system. 10 In passing, there should be greater resort to the American Depository Receipt (ADR) route, which has greater depth and can therefore offer higher valuation. 11   A rough figure will be 60 at the Central level and at least 60 at the State level. 3.  Sequence and transition For the entire mechanism and process to be credible, two units must be sold by 31 March 2000. Thereafter, there should be a clear target for the next two years. 12 billion US dollars over the next two-year time span is a reasonable target, that is, Rs 52,000 crores. It is not possible for this report to be specific about the time sequencing of disinvestment. However, some principles can be mentioned. First, there is urgency about sectors where monopoly is being threatened because of liberalization. Second, the government is generally bad in areas where there is a service orientation. Therefore, services, manufacturing and trading are sectors where the initial flush of disinvestments can take place. This emphasis on service orientation also explains why banks have to go first. Barring the strategic sectors, no more than 26% government equity need be retained. But in the interim period, the government might wish to continue as the single largest shareholder. Retaining government shareholding directly will constrain PSUs because of interference from government ministries, Parliament and government audits. Once government equity is below 50%, decisions on appointing management must be left to Boards and not to Joint Secretaries in administrative ministries. Another advantage of bringing equity down to 26% is avoidance of the Central Vigilance Commission (CVC), the Central Bureau of Investigation (CBI) and the Prevention of Corruption Act (PCA). Section 13 of the Prevention of Corruption Act defines that a public servant is guilty of criminal misconduct (corruption) if a decision taken by the public servant benefits a third party, unless it can be proved that this benefit to the third party is in the public interest. Any decision taken benefits a third party and it is impossible to prove that this benefit to the third party is in the public interest. Therefore, public servants become risk averse and don’t take decisions. There is no point asking PSUs to function along commercial principles as long as such a section continues. Ideally, until the government shareholding is brought down to below 51%, there should be a National Shareholding Trust as a non-profit trust under the Societies Registration Act or the Companies Act. The entire government shareholding can be transferred to this Trust. On the advice of the DM, the Trust will sell equity in block sales to banks, financial institutions or mutual funds or directly to retail investors. In the interim, there can be a stipulation that shares held by the Trust will not drop below the 26% threshold. The Trust will be preferable to a Special Purpose Vehicle as it will take the enterprise out of the purview of the CVC, CBI, PCA, government ministries, Parliament and government audits. However, if this is not done and government shareholding is more than 50%, the enterprise must still explicitly be taken outside the CVC, CBI, PCA, government ministries, Parliament and government audits. The salaries paid to management must also be delinked from government salary structures. Management salaries have to be decided by boards and by no one else. There has to be a proper competition policy to cover unfair and restrictive trade practices and issues like transfer pricing. The competition policy must also cover mergers and acquisitions. At present, no prior approval is required for mergers and acquisitions, although that is the practice in many developed countries also. Subsequent de-monopolization through breaking up involves significant transaction costs. It is a better idea to require prior approval. One must also be careful in some service sectors. With many individual countries, service sector liberalization depends on reciprocity clauses – banking and aviation are examples. These may have to be renegotiated if government equity drops below 50%. Incidentally, there is no reason to exclude banking from disinvestments, although changes in the Banking Regulation Act will be necessary. Banks, when privatized, can have certain guidelines on lending for priority sectors. But these guidelines must be set out by the Reserve Bank in the offer letter itself, and not introduced subsequently. In line with these points, this report suggests the following modalities for Central PSUs. In the annexure table, "X" indicates that the route is appropriate for a PSU, the absence of "X" indicates that for that PSU, that route is not appropriate. 4.  The road map Explain to citizens the benefits of disinvestment – more expenditure on education, health care and infrastructure, higher growth, more employment, lower interest rates, lower inflation and costs of the present status quo. Use media campaigns. Disinvestment should be driven by efficiency, rather than fiscal deficit compulsions. There should not be ad hoc sales, nor any hang-ups about clinging on to 51% equity. With a 51% threshold level, new private shareholders will be in the minority on boards and realizations will be higher without this limit. If government equity is brought down to 26%, the enterprise will no longer be "State" as defined by Article 12 of the Constitution. It will thus be outside the ambit of the Central Vigilance Commission (CVC), the Central Bureau of Investigation (CBI), administrative ministries, government audits and accountability to Parliament. Disinvestment cannot be left to bureaucrats who have no experience of capital markets or international investor sentiments. They will delay appointment of lead managers, finalization of IPOs (initial public offerings) and develop non-transparent processes. As a result of this, not a single PSU has changed hands since 1991. There must be Disinvestment Ministry (DM), other ministries can be co-opted only if absolutely necessary. The Secretary of DM must preferably have capital market experience. DM will be responsible for taking the proposal to a Cabinet Committee on Disinvestment consisting of the Prime Minister, the Finance Minister, the Disinvestment Minister and any other economic ministry considered necessary. There is no need for a Disinvestment Commission. The DM will have an Advisory Board consisting of members who have sufficient capital market and international investor experience and there will be a transparent and strategic approach. The DM will have a specific pre-determined target of capital that will be raised over a fixed time horizon, such as, 12 billion US dollars over the next two years. The DM and politicians and bureaucrats involved in the disinvestment process must be granted immunity from prosecution and investigation by the Central Bureau of Investigation (CBI) or Central Vigilance Commission (CVC). If the process is transparent, the need for these will not arise. POSSIBLE STRATEGY FOR DM v      Monopoly market, efficient PSUs and high social obligation sectors – retain 51% initially v      Monopoly market, efficient PSUs and low social obligations – down to 26% v      Competitive market, efficient PSUs and high social obligations -– retain 26% v      Competitive market, efficient PSUs and low social obligations – down to 0% v      Monopoly market, inefficient PSUs and high social obligations – management contracts v      Monopoly market, inefficient PSUs and low social obligations – joint ventures v      Competitive market, inefficient PSUs and high social obligations – down to 0%, sales as block v      Competitive market, inefficient PSUs and low social obligations – down to 0%, sales as block or close down Candidates for disinvestment must be chosen carefully by the DM. The stronger PSUs must enter the market first, so as to create an appetite for investors. Before this, there may be a need for mergers and acquisitions and winding up among existing PSUs. All non-strategic government companies should eventually be brought down to 26% government equity, unless prior privatization of management ensures better valuation. 26% is enough to ensure influence on managerial decision making. There must be a defined number of large transactions per year, not a large number of small transactions. Arms, ammunition, defence equipment, atomic energy, radioactive minerals and railway transport are the only strategic sectors. Everything else can eventually be divested, including banks. The present system of selecting lead managers on the basis of bidding for fees is unsatisfactory. Globally, there are only 5 or 6 top lead managers and they can constitute the panel. Empanelled lead managers can be allotted initial issuances in random fashion and further issuance mandates can be based on performance (over-subscription, market-making, pricing). The disinvestment process should not be capital market driven and all nine forms of disinvestment and PSU reform can be judiciously used by the DM – first, strategic majority sales; second, open public auctions for units to bidders, with or without pre-qualifications; third, domestic public sales through stock exchanges; fourth, joint ventures, where shareholder agreements must override government decisions; fifth, GDRs/depository receipts; sixth, management contracts; seventh, block sales; eighth, winding up; and ninth, mergers/restructuring. Until government shareholding is brought down to below 51%, there should be a National Shareholding Trust as a non-profit trust under the Societies Registration Act or the Companies Act. The entire government shareholding can be transferred to this Trust. On the advice of the DM, the Trust will sell equity in block sales to banks, financial institutions or mutual funds or directly to retail investors. The Trust will be preferable to a Special Purpose Vehicle as it will take the enterprise out of the purview of the CVC, CBI, Prevention of Corruption Act, government ministries, Parliament and government audits. However, if this is not done and government shareholding is more than 50%, the enterprise must still explicitly be taken outside the CVC, CBI, Prevention of Corruption Act, government ministries, Parliament and government audits. Managerial salaries should be delinked from government salaries. To address the political economy of the disinvestment process, employees can be given 10% of stock at par or at a discount on the market value. There can also be an additional IPO of up to 10% to citizens in individual capacity, with a stipulation that no individual can hold more than 1000 shares. PSUs that have eroded their net worth must be closed. Disinvestment proceeds should not flow into the Consolidated Fund of India and be used to finance revenue expenditure. A stipulated percentage can be earmarked for capital expenditure and building physical and social infrastructure. Another percentage can be used for retiring public debt. The remainder, which should be a smaller percentage, can be used for a National Renewal Fund, which should not be equated with a Voluntary Retirement Scheme only. There must be fresh legislation for the transfer of government land and assets. Special tribunals to dispense with time-consuming court procedures need to be set up. Enact a competition policy and renegotiate reciprocal service sector agreements where necessary. PSU Strategic sales Open public auctions to select bidders Domestic capital market sales to public Joint ventures GDRs, ADRs Management contracts Block sales Winding up Mergers, restructuring Air India, Pawan Hans X     X           Indian Airlines     X   X         Airports Authority X     X   X       Bank of Baroda, Bank of India, Canara Bank, Corporation Bank, SBI, Syndicate Bank, PNB     X   X       X All other banks             X X X BCCL, CCL, NCL, SECL, WCL, Coal India           X       Bharat Earth Movers X               X BHEL X                 IOC, ONGC, GAIL   X     X         BPCL, HPCL, IPCL, IBP, Bongaigaon Refinery, Cochin Refineries X               X Cement Corporation             X     Central Inland Water Transport Corporation X         X       Central Warehousing Corporation X   X   X         Cochin Shipyards, Goa Shipyards, Hindustan Shipyard           X       Container Corporation X                 CMC X                 Cement Corporation             X     DTC           X       Dredging Corporation                   EIL/EPIL X     X           ECGC     X   X         Fertilizer Corporation, FACT, GSFC, Madras Fertilizers, National Fertilizers, Southern Pesticides X           X   X Paradeep Phosphates             X   X FCI           X       Handicrafts & Handloom Exports Corporation           X       Hindustan Antibiotics X     X           HAL (spinning off airframes, engine maintenance)       X   X       Hindustan Cables, Hindustan Copper, HEC, Hindustan Fertilizers, Hindustan Fluorocarbons, Hindustan Latex, Hindustan Insecticides X           X     HMT       X         X Hindustan Newsprint, HindustanPaper X                 HOCL X           X   X HTL X     X           Hindustan Zinc X                 Hotel Corporation X           X     HUDCO     X   X         Indian Additives X                 IDPL X     X           IFCI, IDBI, LIC, GIC     X   X       X ITI X                 IISCO, Sponge Iron             X X X ITDC X   X     X       KRIBHCO     X   X         Kudremukh Iron Ore X     X           Konkan Railway, IRCON, RITES     X   X         Lubrizol India X                 MTNL   X X   X         MMTC, STC   X X   X         BALCO, NALCO X X X X X       X NBCC     X   X         NHPC, NTPC                 X NFDC           X       National Seeds X                 NTC             X X   Neyveli Lignite X           X   X PFC                 X Power Grid Corporation     X   X X       Semiconductor Complex X           X     SCI X   X   X X       SAIL X                 VSNL   X X   X         Vizag Steel X           X