The Hindu Business Line : Divestment not really crucial to reforms

The perceived fiscal problems of public sector units are more the result of flawed product pricing policies, says S. VENKITARAMANAN, quoting a recent study with startling revelations on PSU profitability. The Government should concentrate on improving these policies and, more important, realise that divestment is not an essential reform ingredient.

There has been a national debate on privatisation following the Government's aborted proposals to divest a small percentage of its equity in a few profit-making PSUs. The Government has put the proposals on hold, in response to protests from its coalition partners. International financial analysts have been quick to criticise this decision for its impact on the country's economic prospects.

Local commentators too have adjudged the Prime Minister as having been a flawed leader for bowing to pressure tactics from within and without the Congress party. Dr Manmohan Singh, however, judged the mood of the country right and has decided not to clash over an issue that is not fundamental to the reforms process. Whether or not the coalition partners were justified in raising the issue in the manner they did, the Prime Minister had decided the issue was not worth a bitter fight.

It is another matter that the Finance Minister, Mr P. Chidambaram, had chosen this route to raise funds for the Plan — indeed these funds would have, in his scheme of things, helped to restructure weaker public sector enterprises and create an overall resource balance for the programmes of the National Common Minimum Programme. The resources that he could have raised by sale of 10 per cent of NALCO and NLC may have been in the region of a few thousand crore rupees, not intrinsically a small sum, but relatively small in the overall scheme of finance — given the fiscal deficit of Rs 1,00,000 crore plus.

Further, the sale of 10 per cent stake would not have affected the public sector character of the enterprise. The Government would have still been in control. The trade unions' arguments against the divestment proposal as giving management control to profit-making private entrepreneurs are not valid. The trade unions stood against the proposal in spite of the Government's offer of shares to the workers.

Non-essential ingredient

One of the problems in this offer must have been labour's inability to raise the funds. A possible solution is for banks to offer loans to workers in the enterprise and enable repayment from out of the dividends in the company proportionately. Such loans are taken by investors taking equity in the IPOs of private sector companies. To be sure, the Government could have explored the details of such a settlement to engage labour positively with the 10 per cent divestment.

Overall, the Government was right in deciding that the issue was not worth rocking the boat for. It is particularly important to maintain the economy on a high-growth path. The stability of Government is more significant than a decision on divestment.

I believe Dr Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, put his finger on the spot when he said that divestment, or privatisation, was not an essential ingredient of reforms. He should know, as he has been part of the reform process since its initiation.

All this leads to a related, and important, question — the role of the public sector in the reformed and reforming economy. Witness the large number of profit-making PSUs in India.

Second, no one condemns China as being a non-reformer, in spite of its dominant PSUs and there being no conscious policy of divestment. Whether an economy adopts a policy of divestment or not is irrelevant to its economic growth path. What is material is the manner in which the state manipulates the levers of policy to induce economic savings, higher investments and growth.

High contribution of PSUs

Whether or not resources are raised through divestment is just a question of choosing specific means of resource mobilisation.

It is economically not significant unless one believes that the public sector is per se inefficient and the private sector profitable and efficient. Both these statements are contestable and the evidence in India, as in China, is that the public sector can be efficient even as the private sector can be inefficient and profit-seeking.

In this context, I must invite the attention of readers of this column to a perceptive article in the Economic and Political Weekly of June 24-29, 2006 by R. Nagraj on public sector performance since 1950.

In spite of benign neglect, accompanied by threats of elimination through divestment, the public sector in India has been contributing a sizeable 25 per cent of the gross domestic product, rising from less than one-tenth in 1960-61.

The study shows that the largest part of the value added by public sector, 12-15 per cent, comes mainly from utilities and infrastructure owned by the Central and State governments.

The public sector output share peaked in 1991-92 at 26.1 per cent, declining marginally thereafter as a proportion of GDP. The public sector contribution is significant.

In contrast, however, investment in the public sector, after peaking at 12.5 per cent of GDP in 1986-87, fell to 6.4 per cent in 2001-02, taking the ratio back to where it was in the mid-50s. As Nagraj wryly observes, today's reformers have undone in less than two decades what took three decades to accomplish!

Contrary to the general misconception that PSUs are unprofitable, Nagraj rightly addresses the issue of profitability by focussing on the rate of return on total capital employed, instead of on equity because of the problems of capital structure in PSUs.

According to Nagraj, it turns out that the PSUs' profitability rose from around 8 per cent in mid-1970s to 21 per cent in 2003-04, a respectable figure by any reasonable reckoning.

Net of the petroleum sector, the results are lower, but still show an irreversible rising trend, at 18 per cent return on capital employed in 2003-04.

Nagraj presents convincing figures to show how the public sector in India has been performing better in terms of physical indices. For instance, the plant load factor of Central electricity undertakings increased from 44.3 per cent in 1979-80 to 74.5 per cent in 2004-05.

Productivity growth in the public sector does not, however, show up in financial results because of flawed policies in product pricing and collection of user charges, which cannot be blamed on the public sector as such.

Populism, coalition

Competitive populism and coalition politics have a great deal to do with this; and it has led to a decline in public sector contribution as a percentage of GDP.

This obviously has its roots in confusion on the pricing of power and such services — a flaw of the policy-making structure in India dominated by political parties that seem to believe in free lunches, whatever it costs the economy.

In spite of public impression to the contrary, Nagraj points out that the Indian public sector has put up a very creditable performance in the face of neglect by the authorities.

Indeed, as he states tellingly, public sector output share has remained steady at a quarter of GDP in spite of investments in it being halved during nearly two decades. It is evidence of their greater efficiency, which we should encourage rather than discourage.

In conclusion, the debate about the public sector ignores the real contribution it is still making to economic development.

The apparent contribution of PSUs to fiscal problems is more the result of flawed product pricing policies. Government and political leaders should concentrate on improving these policies and stop insisting on the public sector divestment to punish it for its assumed flaws.

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