Economics

Types of Disinvestment: India’s Disinvestment Policy

Types of Disinvestment

Disinvestment, quite a hot topic after the introduction of the budget of the financial year 2020-21, in which the government set a target of raising Rs. 2.1 lakh crore from privatization and sale of minority stakes in state-owned companies. The main objective of the government for setting such a big disinvestment target is to keep the mounting fiscal deficit in check. The fiscal deficit of the government is at a record high, which is mainly because of the stimulus packages introduced by the government to stimulate the struggling economy and facilitate a hastened economic recovery from the depression caused by covid-19. However, certain people aren’t very happy with the government’s decision to sell stakes in the public sector companies, especially the various employee unions. There are various conflicting opinions about this matter, some call it progressive, and some condemn the decision. So, today we’d be discussing ‘disinvestment’ in detail along with the different types of disinvestment.

Types of Disinvestment
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Types of disinvestment

What is disinvestment?

In the simplest of terms, disinvestment refers to the reduction of investment. Disinvestment refers to the process of selling ownership in a company. The term ‘disinvestment’ is used mainly used in the case of a government-owned company. Through disinvestment, a private organization or government liquidates its assets or sells them, which is mainly aimed to optimize the resources and deliver maximum returns.

Reasons for disinvestment

As stated earlier, the government undertakes the process of disinvestment in the publicly owned companies, called Public Sector Undertakings (PSUs) and Public Sector Enterprises (PSEs) to optimize the resources and ensure the maximum returns. And the government takes the steps to ‘optimize the resources’ because of several reasons such as-

Reducing the fiscal deficit
Types of Disinvestment
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One of the major reasons why the Government of India set such a large disinvestment target for the financial year 2020-21 is the mounting fiscal deficit. From the beginning of the pandemic, the government has spent an enormous amount of money to support the struggling economy and prevent it from collapsing. Due to the pandemic, thousands of people have lost their jobs or faced a cut in their wages, and the businesses also faced a massive blow, due to which the overall demand fell to a record low. So, to sustain the lives of these people and keep the businesses afloat, the government has introduced a massive stimulus package and other smaller monetary incentives. But as the economy collapses, the government’s revenue is also at a record low.

So, the government has to borrow from various sources to finance the schemes, which has highly increased the fiscal deficit of the government. And in order to reduce this financial burden, the government aims to raise a considerable amount of money from selling or liquidating the assets it owns, such as the PSUs.

Initially, the Government of India started disinvesting its stake in government-owned companies in the 1990s, in the wake of economic policy reforms of Liberalization, Privatization, and Globalization (LPG). (what compelled India to undertake such policy measures? Click here for the answer)

There are other major reasons for disinvestment-

Types of Disinvestment
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  • For the improvement of government finances
  • To open market for the private firms to step in and maximize the efficiency of the underperforming government-owned firms
  • To raise funds for other developmental initiatives of the government such as social and infrastructure programs
  • To introduce or enhance competition in the market and prevent monopoly
  • To enhance private partnership in the economic activities
Different types of disinvestment
Token Disinvestment

The process of disinvestment started in India with great caution, rather than the radical process of disinvestment, the government aimed for a gradual process of disinvestment. The process started with political caution and the type of disinvestment that the government initiated is known as the ‘Token Disinvestment’, which is also called the ‘minority stake sale.’ Through the token disinvestment, the government made the policy to sell the shares of PSUs a maximum of up to 49 percent, which means that the government would retain the ownership of the companies.

However, the government sold only 5-10% of the shares in the companies. This type of disinvestment brought some additional funds to the government, which were mainly used to reduce the financial burden on the government, i.e. mitigating the high fiscal deficit. And this type of disinvestment didn’t substantially enhance the efficiency of the government-owned firms and no structural changes were made in the companies, as the sole ownership and the powers to take all the major decisions remained in the hands of the government. And this is the reason why token disinvestment is heavily criticized by economists around the world.

Types of Disinvestment
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So, due to this drawback, experts around the world suggested the Indian government to go for a more radical form of disinvestment, in which the ownership of the company could be transferred from the government to the private sector, i.e. the 49 percent cap should be breached and the private sector should be allowed to have a majority stake (51%) in the PSUs.

Strategic Disinvestment

Under the strategic disinvestment, the government sells a majority stake (minimum 51%) in the public sector company to the private sector. And this ‘strategic’ sale of shares would be done to a ‘strategic partner’ who has international class experience and expertise in the particular sector. So, as the majority of the shares would go into the hands of these specialized private players, they’ll be able to take all the major decisions concerning the business operations and can bring major changes in its functioning.

The government undertakes the process of strategic disinvestment in order to enhance efficiency and to bring about some structural reforms in the PSU, which would lead to better optimization of its resources and maximize profits. The government strategically disinvests in those sectors of PSUs in which the private sector has developed better efficiency. Through strategic disinvestment, government de-burdens itself from managing these PSUs and concentrates more on areas such as social services.

Types of Disinvestment
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The process of strategic disinvestment in India was initiated with the disinvestment in Modern Food Industries Limited (MFIL), followed by BALCO (Bharat Aluminium Company Limited).

Some other PSUs are-

  • VSNL (Videsh Sanchar Nigam Limited)
  • HTL (Himachal Futuristic Communications Limited)
  • CMC Ltd. (Computer Maintenance Corporation)
  • IPCL (Indian Petrochemicals Corporation Limited)
  • HZL (Hindustan Zinc Limited)
  • ITDC (India Tourism Development Corporation) (only 13 hotels)

So, Token and Strategic are the two types of disinvestment that are undertaken by the Government of India.

Methods of Disinvestment
Structure of the Indian Capital Market
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  • IPO (Initial Public Offering)- Initial Public Offering is the event when a company issues its share in the market for the first time. In an IPO the investors can buy the securities directly from the issuing company.
  • FPO (Further Public Offering)- Further Public Offering is also called follow-up public offering, it is when a listed company (that has already issued its shares through an IPO) issues additional shares after an IPO. Follow-on offerings are also known as secondary offerings.
  • OFS (Offer for Sale)- Through OFS, shares are auctioned on the platform provided by the Stock Exchange.
  • QIP (Qualified Institutional Placement)- The QIP is also a type of private placement through which companies issues equity shares, debentures, or other types of securities to the Qualified Institutional Buyers (QIB). The QIBs are the investors who are deemed to have the required financial knowledge and are legally recognizable by the securities market regulators.
  • CPSE Exchange Traded Fund- Disinvestment through ETF route allows the simultaneous sale of the Government’s stake in various CPSEs across diverse sectors through a single offering. It provides a mechanism for the Government to monetize its shareholding in those CPSEs which form part of the ETF basket.

Click here to learn more about the topic.

Disinvestment Department
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The Department of Investment and Public Asset Management (DIPAM) is responsible for the process of disinvestment in the PSUs (Public Sector Undertakings). DIPAM works under the Ministry of Finance. DIPAM deals with all the matters relating to the management of Central Government investments in equity including disinvestment of Central Public Sector Undertakings (CPSEs).

The four major areas of its works relate to-

  • Strategic Disinvestment
  • Minority Stake Sales
  • Asset Monetization
  • Capital Restructuring
India’s disinvestment policy
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As stated earlier, the process of disinvestment in India was initiated in the 1990s in the wake of LPG reforms. The ideology behind the policy of disinvestment, as stated by the DIPAM (Department of Investment and Public Asset Management), Ministry of Finance, is-

  • Public ownership of the PSUs to be promoted as they are the wealth of the nation;
  • Government to hold minimum 51 percent share in case of minority stake sale;
  • Up to 50 percent or more shares might be sold off under ‘strategic disinvestment.’

And the current disinvestment policy, Disinvestment through minority stake sale, approved by the government on 5th November 2009 is-

  • Already listed profitable CPSEs(Central Public Sector Enterprises) are to be made compliant to the 25 percent norm, through Offer for Sales (OFS) by the government or the CPSEs through the issue of fresh shares or a combination of both.
  • CPSEs that haven’t been listed, which have accumulated no losses and earned net profit in three preceding consecutive years are to be listed.
  • Follow-on public offers would be considered taking into consideration the needs for capital investment of CPSE, on a case-by-case basis, and the government could simultaneously or independently offer a portion of its equity shareholding.
  • DIPAM to identify the CPSEs in consultation with respective administrative Ministries and submit the proposal to the government in cases requiring Offer for Sale of Government equity.

India’s disinvestment policy for ‘strategic disinvestment’

  • The process would be undertaken through a consultation process between different Ministries/Departments, including the NITI Aayog.
  • The process of identifying the CPSEs for strategic disinvestment would be undertaken by the NITI Aayog. Moreover, the NITI Aayog would advise the mode of sale, the percentage of the shares to be sold off the identified CPSE, and the method of valuation of the CPSE.
  • CGD (Core Group of Secretaries on Disinvestment) to consider the recommendations of the NITI Aayog to facilitate a decision by the CCEA (Cabinet Committee on Economic Affairs) and to supervise/monitor the process of implementation.
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