Privatization in India: Challenging Economic Orthodoxy (India in the Modern World)

Privatisation in India Over the past decade India has been undertaking a programme of economic reform, and at the same...

Author: T.T. Ram Mohan

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Privatisation in India

Over the past decade India has been undertaking a programme of economic reform, and at the same time the economy has been growing at a high rate. As part of the reform programme, and in line with prevailing economic thinking, India has been privatising its large, ungainly public sector. One assumption underlying this programme is the dogma that public-sector enterprises are doomed to inefficiency, and that only through privatisation can their efficiency be improved. But is this really true? Combining rigorous data analysis with case studies to provide a balanced evaluation of the process of deregulation and privatisation within the overall context of economic reforms, the author demonstrates, remarkably, that, contrary to the prevailing view, private-sector firms do not outperform public-sector firms across all sectors. He argues that the dominance of family businesses, rather than professionally managed firms, and the level of corporate governance are important constraints on the privatisation process in India. He also shows that revenue-raising considerations have weighed more heavily with the government than efficiency objectives. Broadbased shareholding of publicsector firms, not sale to private groups, should, therefore, be the preferred route to enhancing efficiency at public-sector firms. Overall, this study of the reform process in India, with its unique long-standing mix of private and public sectors, will be of great interest to all those studying reform and transition worldwide. T T Ram Mohan, who obtained his doctorate from the Leonard Stern School of Business, NYU, is Associate Professor and Chairman, Finance & Accounting Area, at the Indian Institute of Management, Ahmedabad. Prior to entering academics, Professor Ram Mohan had a varied career in consulting, banking and investment banking. He has also been New York Correspondent for The Economic Times, India’s leading financial daily, for which he now writes a fortnightly column.

India in the Modern World

Privatisation in India Challenging economic orthodoxy T T Ram Mohan

Privatisation in India Challenging economic orthodoxy

T T Ram Mohan

To Nandu, joy of my life. And to Jayashree, who provided me much of the motivation to undertake this venture, and whose words of encouragement and support kept me going through testing times.

First published 2005 by RoutledgeCurzon 2 Park Square, Milton Park, Abingdon, Oxon., OX14 4RN Simultaneously published in the USA and Canada by RoutledgeCurzon 270 Madison Ave, New York, NY 10016 This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” RoutledgeCurzon is an imprint of the Taylor & Francis Group © 2005 T T Ram Mohan All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-39808-4 Master e-book ISBN

ISBN 0-203-67124-4 (Adobe eReader Format) ISBN 0-415-33191-9 (Print Edition)

Contents

List of figures List of tables List of appendices Foreword Preface Acknowledgements List of abbreviations 1

2

Introduction 1.1 Public sector versus private sector: the policy debate in India 1.2 Public ownership in India: origins 1.3 Winds of change 1.4 The Memorandum of Understanding 1.5 Competition and disinvestment 1.6 The ‘Navratna’ concept 1.7 On to privatisation 1.8 Disinvestment in the banking sector 1.9 The public sector in the Indian economy 1.10 Conclusion Privatisation: theory and evidence 2.1 Introduction 2.2 Theory 2.3 Empirical evidence Case studies Cross-sectional comparisons of public and private enterprises Statistical analysis of pre- and post-privatisation performance Privatisation in less-developed countries 2.4 Conclusion

ix x xiv xv xix xxi xxii 1 1 3 5 6 10 13 15 20 21 24 25 25 25 32 32 35 37 39 42

vi

Contents

3

Comparison of performance in industry and study of impact of privatisation, using financial measures 3.1 Introduction 3.2 Our methodology 3.3 Results Aggregate data Sectoral analysis Pre- and post-privatisation performance Case studies Comparison of industry-adjusted performance of sample firms 3.4 Conclusion

4

5

Comparison of performance in industry, using input–output quantities 4.1 Introduction 4.2 Performance measures and DEA Overview of DEA Technical efficiency Tornquist and Malmquist indices Cost efficiency 4.3 Previous studies and our methodology Previous studies Methodology: firm sample, output and inputs 4.4 Results Technical efficiency scores Malmquist total factor productivity growth Tornquist productivity index Cost efficiency Aggregate results 4.5 Discussion of results Performance of public- and private-sector banks in India and the impact of privatisation 5.1 Background: Indian banking before and after deregulation The nationalisation era The post-reform era Reforms and performance Public sector banks in the post-reform era 5.2 Review of literature 5.3 Methodology Comparison of performance using financial ratios Comparison of performance using input–output quantities Comparison of pre- and post-disinvestment performance

44 44 45 49 49 55 65 71 79 79

84 84 85 85 86 87 93 93 93 95 97 97 103 106 109 111 113

115 115 115 116 118 121 125 128 128 130 133

Contents 5.4

5.5

Results Comparison of performance using financial ratios Comparison of performance using input–output quantities Pre- and post-privatisation performance of listed PSBs Conclusion

vii 136 136 139 144 148

6

Method of sale: is strategic sale the best option? 6.1 Introduction 6.2 From disinvestment to strategic sale 6.3 Does strategic sale maximise efficiency and revenues? Reserve prices Auctions, efficiency and revenue maximisation First-price sealed bids Collusion in auctions 6.4 Empirical evidence 6.5 Popular misconceptions about strategic sales Share-price movements and market structure Superior valuations in strategic sales Market impact of strategic sales A false comparison 6.6 Conclusion

150 150 151 153 153 154 156 158 160 163 164 164 166 167 168

7

Governance and privatisation 7.1 Institutions and governance 7.2 Governance in the public sector 7.3 Governance in the private sector 7.4 Conclusion

170 170 173 177 181

8

China’s privatisation: a synoptic view 8.1 SOE reform in China: an overview 8.2 Disinvestment and performance of Chinese enterprises 8.3 SOE reform versus privatisation 8.4 Conclusion

183 183

Summary and implications for privatisation policy 9.1 Comparing public and private-sector performance 9.2 Comparing financial performance Aggregate level results Sectoral level results Post-privatisation performance 9.3 Comparison based on input–output quantities

194

9

186 190 192

194 194 194 195 196 197

viii

Contents 9.4

9.5 9.6

9.7

Banking sector Comparison of financial performance Comparison of bank performance based on input–output quantities Post-privatisation performance State ownership in banking versus state ownership in industry Privatisation and the fiscal deficit Implications for privatisation policy and role of SOEs in India Limitations imposed by weak governance A role for SOEs Implications for privatisation policy

References Index

197 197 198 198 199 200 202 202 203 205 207 213

Figure

4.1

Decomposition of the Malmquist TFP Index

90

Tables

1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13 3.14 3.15 3.16 3.17

SOEs covered under the MOU system Criteria for performance evaluation of Heavy Engineering Corporation, 1989–90 Performance rating of SOEs in the MOU system Record of Disinvestment List of enterprises to be privatised Break-up of public sector enterprises by category The public sector’s contribution to total industrial production Investment in SOEs Descriptive statistics for the sample firms at aggregate level Descriptive statistics for sample firms in sectors Comparison of aggregate profitability in the private and public sectors Summary of results on profitability across three periods Comparison of aggregate efficiency in private and public sectors Summary of results for aggregate efficiency in the private and public sectors Summary of results on aggregate profitability and efficiency Comparison of aggregate profitability in the private and public sectors on an adjusted basis Comparison of aggregate efficiency in the private and public sectors on adjusted basis Comparison of profitability in 1988–9 to 1999–2000 Comparison of profitability in 1991–2 to 1999–2000 Comparison of profitability in 1994–5 to 1999–2000 Summary of results on profitability across three periods Comparison of efficiency in 1988–9 to 1999–2000 Comparison of efficiency in 1991–2 to 1999–2000 Comparison of efficiency in 1994–5 to 1999–2000 Summary of results on efficiency across three periods

8 9 10 18 19 22 23 23 46 47 50 50 51 51 52 53 53 54 55 56 57 58 59 60 61

List of tables 3.18 3.19 3.20 3.21 3.22 3.23 3.24 3.25 3.26 3.27 3.28 3.29 3.30 3.31 3.32 3.33 3.34 3.35 3.36 3.37 3.38 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11

Summary of results on aggregate profitability and efficiency Summary of results on profitability and efficiency in the mineral sector Summary of results on profitability and efficiency in the service sector Summary of results on profitability and efficiency in the chemical sector Summary of results on profitability and efficiency in the electronics sector Summary of results on profitability and efficiency in the steel sector Summary of results on profitability and efficiency in the nonelectrical machinery sector Summary of results on profitability and efficiency in the transport sector Comparison of performance of state-owned enterprises before and after privatisation Summary of results on profitability and efficiency before and after privatisation Post-privatisation performance of disinvested SOEs Firm-level analysis of pre-and post-disinvestment performance Profile of BHEL BHEL’s key ratios before and after disinvestments Profile of HPCL HPCL’s key ratios before and after disinvestment Profile of Nalco Nalco’s key ratios before and after disinvestment Comparison of industry-adjusted performance of stateowned enterprises before and after privatisation Summary of results on profitability and efficiency before and after privatisation Comparison of debt–equity ratios in the public and private sectors Descriptive statistics for the sample firms Technical efficiency in the chemical sector Technical efficiency in the electronics sector Technical efficiency in the steel sector Technical efficiency in the mineral sector Technical efficiency in the non-electrical machinery sector Technical efficiency in the services sector Technical efficiency in the textile sector Technical efficiency in the transport sector Technical efficiency results Tobit regression estimates

xi 61 62 62 63 63 64 64 65 66 66 67 70 72 73 75 76 77 78 78 78 80 96 97 97 98 98 98 99 99 99 100 102

xii 4.12 4.13 4.14 4.15 4.16 4.17 4.18 4.19 4.20 4.21 4.22 4.23 4.24 4.25 4.26 4.27 4.28 4.29 4.30 4.31 4.32 4.33 4.34 4.35 4.36 4.37 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 5.15

List of tables Selected coefficients from the revised model Malmquist index growth comparison Malmquist productivity growth rates Malmquist index for the chemical sector Malmquist index for the electronics sector Malmquist index for the steel sector Malmquist index for the mineral sector Malmquist index for the non-electrical sector Malmquist index for the service sector Malmquist index for the textile sector Malmquist index for the transport sector Tornquist index growth comparison Tornquist productivity growth rates Tornquist index for the chemical sector Tornquist index for the electronics sector Tornquist index for the steel sector Tornquist index for the mineral sector Tornquist index for the non-electrical machinery sector Tornquist index for the services sector Tornquist index for the textile sector Tornquist index for the transport sector Cost efficiency comparison Technical efficiency comparison Allocative efficiency comparison Summary of results of comparisons of efficiency and productivity Results according to sectors Progress of commercial banking in India Liquidity and credit-based indicators of financial development Share of the top five banks – assets, deposits and profits Net interest income (spread) to total assets Intermediation cost to total assets Real interest rates Comparative performance of banking systems Key performance indicators for public-sector banks Key performance indicators for 19 nationalised banks Change in profitability in 1999–2000 relative to 1991–2 and 1992–3 Profile of banks by category in 1999–2000 Variability in revenues and costs Descriptive statistics of privatised banks Bank stocks and first and last dates of trading Comparison of performance of public, private-sector and foreign banks in the period 1994–5 to 1999–2000

102 103 104 104 104 104 105 105 105 105 106 106 107 107 107 107 108 108 108 108 109 110 110 111 112 113 116 117 119 120 120 121 121 122 123 124 129 132 133 135 137

List of tables 5.16 5.17

5.18

5.19 5.20 5.21 5.22 5.23 5.24 5.25 5.26 5.27 5.28 5.29 5.30 5.31 5.32 5.33 5.34 5.35 6.1 6.2 6.3 6.4 6.5 7.1 7.2

Comparison of performance between PSBs and old privatesector banks in the period 1994–5 to 1999–2000 Comparison of performance between PSBs (other than weak banks) and old private-sector banks in the period 1994–5 to 1999–2000 Comparison of performance between nationalised banks (other than weak banks) and old private-sector banks in the period 1994–5 to 1999–2000 Comparison of Tornquist TFP growth, using income as outputs Comparison of Tornquist TFP growth in Indian banking Average distribution of banks in the Tornquist TFP growth range Growth rates of Tornquist TFP growth, using alternative method Comparison of Tornquist TFP growth in Indian banks Averages for Malmquist TFP growth for bank categories, by year Comparison of Malmquist TFP growth in Indian banks Distribution of banks by Malmquist TFP growth ranges Revenue maximisation efficiency for bank categories, by year Comparison of banks on revenue maximisation efficiency Average distribution of banks in efficiency range in 1992–2000 Summary of comparison of performance of bank categories Comparison of public-sector banks before and after privatisation Unadjusted relative returns of listed banks Comparison of returns in different bank categories Risk-adjusted relative returns of listed banks Comparison of adjusted returns in different categories of banks Strategic sales of SOEs in India Comparison of auction methods under different assumptions SIPs and asset sales, by region Price–earnings multiples in public offers Change in market capitalisation in SOEs Legal institutions in India Protection of shareholder rights

xiii 137

138

138 139 140 140 140 141 141 142 142 142 143 143 144 145 145 146 147 148 152 158 161 165 166 172 173

Appendices

3.1 3.2

Description of variables used Details of shares disinvested since 1991–2, by year and by PSEs

82 82

Foreword

Privatisation is admittedly a product of the 1980s. The word found its way into a standard dictionary only in 1983. Apparently, the practice of privatisation as a policy preceded the concept. Students of economics in general and policy-makers in particular are aware of the need to view privatisation as a process of rebalancing the relative roles of state and market, but generally the concept is used in the context of enterprises. Thus, privatisation may be described as a process by which some or a major part of the ownership and control of enterprises is shifted from the government to the private sector. In India, the policy of privatisation virtually preceded a meaningful debate or analysis in academic or intellectual circles. In view of the need to move forward with economic reforms in the context of a mixed economy with a heavy bias in favour of public enterprises, policy-makers have been pursuing privatisation while keeping in view several constraints, including, in particular, the fiscal ones. Professor Ram Mohan’s book Privatisation in India is a pioneering work that sets the debate in proper perspective and provides convincing answers to several issues that are currently debated with inadequate theoretical understanding or empirical evidence. The unique approach to analysing India’s experience adopted by Professor Ram Mohan provides innovative and universally applicable tools for study of the phenomenon in other countries as well. In particular, differentiating privatisation of industrial enterprise from that of banking is of lasting significance in as much as dominance of the externalities and the appropriateness of the regulatory framework are brought out as key elements in the process of privatisation. It is interesting to explore the themes around which the privatisation debate is often conducted in India. It is argued that privatisation is good for improving public finances. This is based on the assumption that the government will be able to realise capital receipts, which in terms of net present value are in excess of the revenue receipts in the future under a set of assumptions in regard to the functioning of enterprises in the future. Often, only the dividend is taken into account in computing the revenue receipts whereas the tax payment by the public enterprises is, on all accounts, significant compared to a private

xvi

Foreword

enterprise with exactly similar operations and a substantively similar balance sheet. In many cases, the bidders for shares in a public enterprise expect higher profitability due to enhanced efficiency under private-sector management and this perception is critical to ensuring fiscal gains through the process of privatisation. It is sometimes argued that privatisation is good for economic efficiency. There is a point of view that holds that efficiency has nothing to do with ownership, while empirical evidence, by and large, shows that in many, but not necessarily all sectors or cases, efficiency gains are obtained through privatisation, recognising that there are several contentious issues in defining and measuring efficiency. Efficiency gains, howsoever defined, would depend on the relative efficiency of public or private ownership and control in the context of a country. There are some other possibilities, such as public – private ownership and widely held partial private ownership coupled with government control. In this context, the distinction between privatisation and disinvestment as brought out by Professor Ram Mohan is illuminating, and addresses these nuances. Similarly, the dominance of family-controlled business as a factor in assessing the benefits of privatisation focuses on the contextual nature of relative efficiency between public and private enterprises. There is often public opinion against selling profit-making units, while some argue that no one will buy shares of loss-making units. It must be recognised that a unit can be made profitable by financial re-engineering such as debt write-off, and hence a possible criterion should really be the financial return to the government in excess of its cost of borrowing. However, the real issue is whether government is better off in fiscal terms by selling rather than holding on to the ownership, and this would best be determined by the likely valuation of the shares at which the private sector would buy. Similarly, the loss-making units may also be sold, but the critical issue is the price. If there is investor perception of enhanced profitability by several means, including use of idle assets or better technical efficiency, by virtue of privatisation or disinvestment, then the fiscal gains are more likely. There is a debate on the virtues of ‘strategic sale’. To the extent that future ownership and control is identifiable, there are possible gains in the value of the shares. However, to the extent that the dominant shareholder who wants to gain control is paying a premium, it could also reflect the expectation of undue benefits to the controlling group, to the detriment of dispersed private shareholders. Professor Ram Mohan approaches this issue from a slightly different perspective, but emphasises the possible downsides to this approach. There are also issues relating to actions prior to privatisation that are often ignored in assessments. For example, financial restructuring, unbundling, asset-stripping, inducing competition, and regulation are critical issues and need to be addressed in the context of each sector and enterprise, while taking account of possible trade-offs involved between fiscal gains and economic efficiency. Further, there are attempts to conclude that there was undervaluation of shares merely on the basis of share values quoted

Foreword

xvii

immediately after the sale. Clearly, large movements in share prices soon after privatisation may warrant analysis but by themselves they do not warrant a presumption regarding valuation at the time of privatisation. There are some misconceptions about the nature and role of public enterprises, mainly because the diverse nature of such activities is ignored. Thus the argument that public enterprises provide ‘public goods’ is untenable given the definition of public goods as understood by students of economics. It is also held that if only there was no political interference, public enterprises would be efficient; but it was argued in UK at the time of initial debate that such a wish is akin to assuming that politicians should cease to be politically active. It is also necessary to recognise that political factors that influence the functioning of public enterprises cannot be wished away during the process of privatisation; there could be an attempt to obtain once-for-all political gains in lieu of loss of future influence on existing public enterprises. Privatisation is sometimes associated with financial liberalisation – in particular as a mechanism for enhancing the role of capital markets and for attracting foreign investment or capital flows. It is very clear that most of these assertions need to be considered by taking a disaggregated view of the activities of the public enterprises concerned and the objectives of privatisation of a specific enterprise, as distinct from indirect gains or losses to the economy, society, financial sector, etc. associated with the process of privatisation as a whole. No doubt, privatisation undertaken as a consequence of crisis management in emerging countries provides less room for independent policy assessments. In India the process was at most triggered by but not associated with crisis, and innovative experiments were possible in view of the autonomy enjoyed by public policy in India in this regard. It is interesting to note that the threat of privatisation itself promotes efficiency if the objective conditions within the control of enterprise concerned are enabling. However, in some cases there could be serious adverse consequences or even pre-emptive anticipatory actions to undermine the process. Professor Ram Mohan has rightly emphasised the deleterious effects of uncertainties in regard to privatisation policies. In a way, opening up a sector to green-field private investments and imparting uncertainties to the process of privatisation may have adverse effect on all the public enterprises, with consequential loss of future benefits due to later privatisation. Professor Ram Mohan’s book makes fascinating reading and those who have any stake in the theory and practice of privatisation would miss reading this scholarly work at their own risk. It questions dogmas and shows the criticality of the context in any assessment. It emphasises the weighing of relative strengths of public and private sectors, in a dynamic setting, in considering and designing the policy and process. A valuable point made is that governance in both sectors could be weak, giving little scope for a clearcut choice in aggregate without addressing such large issues. The criticality of the design of the process is highlighted by a masterly exposition, and in this context a conceptual distinction between privatisation and disinvestment

xviii

Foreword

derived from Indian experience is in some ways an original contribution. The book illustrates that some privatisation, some private enterprises and efficient public enterprises could co-exist, and market discipline through partial private sector shareholding could induce the much-desired autonomy in public enterprises. In brief, it is seldom that we come across a book on a contentious subject exhibiting such objectivity, scholarship and command over detail; this is one such book. Dr Y V Reddy Governor, Reserve Bank of India Mumbai, September 2004

Preface

Privatisation has been under way in one form or another in India for nearly a decade now and yet it continues to stir deep emotions among people. For all the talk of a ‘consensus’ on the need for privatisation, there are deep divisions about what to sell, how to sell and whom to sell to. This book is intended to document India’s efforts at privatisation and to critically examine various issues related to it. A central issue is the supposed inefficiency of India’s state-owned enterprises (SOEs) that, to some, provides the rationale for the ongoing programme of privatisation. While India’s SOEs are condemned as being inefficient, there is a dearth of studies that document such inefficiency on any rigorous basis. Yet, since improvement in firm efficiency is one of the basic objectives of privatisation, one would imagine that, in formulating privatisation policy, it is important to know whether efficiency is indeed lower in the public sector than in the private sector. Further, since a certain degree of privatisation has taken place among both industrial firms and banks, it is worth examining what impact this has had on performance so far. This book explores both of these themes at some length, subjecting to close scrutiny the performance of SOEs and private firms in both the industrial and banking sectors. It arrives at conclusions that, at the very least, challenge some of the dogmas that dominate popular debate on the subject. Going beyond the performance of public and private sectors, the book examines the design of privatisation as well – in particular, whether outright sale of SOEs to private owners is uniformly preferable to lowering the government’s shareholding through offers to the public. This is a highly emotive issue in India, as the Vajpayee government – or at least some elements in it – have sought to portray outright sale alone as constituting ‘genuine’ privatisation. Not least, the book draws on China’s experience in enterprise reform to see whether this hold any lessons for India or indeed reinforces lessons driven home by India’s own experience. It is my hope that the Indian and Chinese experiences will offer other developing countries a ‘middle path’ to privatisation that steers clear of dogmatic extremes at both ends of the political spectrum. Instead of only one form of ownership of commercial enterprises,

xx

Preface

state or private, we could think of the two forms co-existing with each other and subject to market discipline. The manuscript was submitted to the publishers in early 2004 when the government of Prime Minister A. B. Vajpayee was in power and before the government of Prime Minister Manmohan Singh assumed office. It does not, therefore, cover the change in privatisation policy that has taken place under the new government – and that, incidentally, is in line with what this book advocates. This book grew out of my doctoral dissertation at Stern School of Business, New York University. I would like to thank my advisor, Professor Bill Greene, who made this proposition possible in every way and whose guiding hand was invaluable in helping me complete the final stage of the doctoral programme. I am also deeply indebted to my dissertation committee members – Professor Subhash Ray, Professor Roman Frydman and Professor Anthony Saunders – for agreeing to serve on my committee and for giving me their time and attention. I am grateful to Dr Y. V. Reddy, Governor, Reserve Bank of India, for writing the Foreword. This is a subject on which Dr Reddy has had much to say in his speeches and writings. Small wonder that, in a brief space, he has summed up the key issues in the privatisation debate in his own inimitable way. Peter Sowden, my editor at RoutledgeCurzon, responded with alacrity to my book proposal and has been supportive throughout. My heartfelt thanks to him. The Indian Institute of Management, Ahmedabad, gave me study leave to enable me to write up my dissertation and also provided some financial support. I am grateful to the Institute and to its then Director, Professor Jahar Saha. My thanks are also due to colleagues at IIMA, Bakul Dholakia, Rakesh Besant, J. R. Varma, T. Madhavan, and Gopal Naik for their comments and suggestions. I am indebted to many others for making this book possible. My wife, Jayashree, gave me the confidence to undertake this project and shored up my spirits throughout my stay in the US, as did my son, Nandu. My parents and also my wife’s parents provided moral support and good wishes aplenty – these sustained me through the ups and downs inevitable in the completion of any dissertation. Dhimantbhai and Bhavnabhen, close friends, were always around to cheer me up and to lend a helping hand. Job Ittoop helped me out with the logistics in New York, a daunting task for any visitor, and in many other ways too. Venkat and Soosan, friends of mine in New York, were unfailing in their support – they seemed to have more faith in my abilities than I did. Praveen Chowdhary, Dheeraj Awasthy and Vivek Gupta helped me out with the programming and data collection, for which I am thankful. Finally, Arjun Panchal was a great help in preparing the manuscript and the tables. My thanks to all of them.

Acknowledgements

I gratefully acknowledge permission from the following: The Economic and Political Weekly, for letting me draw on papers published in that journal. Sunil Khilnani, for the use of quotations from his book, The Idea of India. Subhash C. Ray for use of material related to the non-parametric DEA methodology in his forthcoming book, Data Envelopment Analysis: Theory and Techniques For Economics and Operations Research, Cambridge University Press, 2004.

Abbreviations

BHEL DEA HPCL IPO NALCO PSB SOE TFP

Bharat Heavy Electricals Limited Data Envelopment Analysis Hindustan Petroleum Company Limited Initial Public Offer National Aluminium Company Public-sector bank State-owned enterprise Total Factor Productivity

1

Introduction

1.1 Public sector versus private sector: the policy debate in India While the Indian public sector is widely perceived as being inefficient and there is a clamour for privatisation from international institutions, foreign investors, and sections of the media and the Indian public, there has been surprisingly little effort to document the comparative performances of the public and private sectors with any degree of rigour. In official statements and in the popular press, there are references to the large number of loss-making firms in the public sector, the losses they have accumulated to date, the burdens these impose on the exchequer, and the poor quality of service in the public sector generally. There are frequent utterances about returns from public-sector firms being low and even negative, but it is often unclear what are the bases for these statements. The comparisons of performance in the public and private sectors that have been attempted have been sketchy at best and are by now rather dated. The case for privatisation in India today thus rests overwhelmingly on theoretical or ideological considerations, as indeed has been true of similar experiments elsewhere. There is a sense, stemming from the great movement towards privatisation worldwide over the past two decades, that a transfer of ownership to private hands will make for better performance of state-owned enterprises (SOEs) and will boost overall economic performance. In particular, the sale of SOEs, it is argued, will make available funds for badly needed investment in physical and social infrastructure, and will also release government from running businesses and free it for tasks that it is better equipped to handle. A more recent strand to the argument for privatisation is entirely ideological in nature: the state has no business to be running commercial enterprises; instead, it should be focusing on things it does best, such as investing in social and physical infrastructure. While advocates of privatisation have sought to portray it as vital to the rejuvenation of the Indian economy in the new millennium and any opposition to it as antediluvian, hostility towards privatisation remains strong in India. Nor is it not confined to labour unions and political parties. Nowadays, such

2


opposition is rarely couched in ideological terms: with the possible exception of some of the parties of the left, few people would argue for the retention of SOEs on the ground that they are an instrument for furthering socialistic objectives. Rather, in public discourse, one discerns a variety of concerns underlying the opposition to privatisation. One is undoubtedly a deep-seated suspicion of Indian businessmen and a perception that they remain fundamentally unaccountable, given the poor quality of law enforcement and corporate governance in the country. There is also an apprehension that enormous public assets, seen as the product of years of sacrifice on the part of the Indian people, will be handed over on the cheap to businessmen by corrupt politicians. Many fear that privatisation would lead to widespread job losses that would not be offset by fresh job creation through more rapid growth. Above all, it is felt that many SOEs have strong professional management, are well run and have shown a commendable ability to focus on commercial objectives in the competitive environment that has been ushered in consequent to economic liberalisation. The way to improve performance at the better-managed SOEs, it is felt, is not to hand these over to family-owned industrial houses but rather to establish a broad-based ownership through the sale of government shares to retail and institutional investors. In public discourse in India, the first is referred to as privatisation and the latter tends to be characterised as disinvestment. While we adhere to this terminology in this book for the sake of convenience, the implied suggestion that disinvestment is in some sense not genuine privatisation is simply not true. As we shall see later in this book (Chapter 6), privatisation through public offer has dominated outright sale of SOEs worldwide. Strangely, however, advocates of privatisation in India have come to equate it with outright transfer of control to a private business group or firm. They are convinced that where the state has majority ownership or is even the largest single minority shareholder, the scope for improvement in performance is severely constrained. Overseas observers tend to overlook this point and hence are unable to comprehend why privatisation in India evokes as much opposition as it does. Opposition to privatisation very often represents opposition to the particular method of sale that is to be adopted, rather than to the notion of SOEs being answerable to a dispersed body of shareholders, including institutional shareholders This book attempts to fill a lacuna in public debate on the subject by subjecting to empirical scrutiny the theoretical arguments about the superiority of private enterprise and the case for privatisation in the Indian context. Primarily, the book attempts to answer the following questions: •

Is it true that the private sector in India has uniformly performed better than the public sector?

Introduction • •

3

Has there been any improvement in performance in the public sector since the onset of economic reforms? Has the disinvestment that has taken place to date made any difference to performance?

In seeking answers to these questions, we begin with a brief review of the literature on privatisation (Chapter 2). In Chapter 3, we make detailed comparisons of the performance of private firms and SOEs in India over different time periods. We also examine the impact of disinvestment on the performance of SOEs. These comparisons are based on commonly used financial measures of performance. Next, we compare the performance of private and SOEs in eight industrial sectors, using physical quantities (Chapter 4). We then apply the same approaches to the banking sector (Chapter 5). In Chapter 6 we go on to address the controversy in India over the method of sale. This is followed by a discussion of corporate governance issues and its implication for privatisation in India (Chapter 7). In Chapter 8, we examine the privatisation record in China, a country with which Indians like to compare their own. We conclude, in Chapter 9, with a summary of our basic findings and recommendations for the future design of privatisation in India. The rest of this chapter is devoted to a brief outline of the evolution of the public sector in post-independence India and the course of SOE reform, beginning with modest attempts at focusing on commercial objectives and ending up with the current focus on privatisation.

1.2 Public ownership in India: origins In many ways, India provides an excellent testing ground for hypotheses about the relative performance of public- and private-sector enterprises, as also the impact of privatisation. Not only does the country have a large, welldiversified public sector but, unlike many of the transition economies, it also has a long tradition of private enterprise, with some of the private companies being large in size. There are some sectors in which private sector participation is quite new, these sectors having been reserved until recently for the public sector. The public sector itself is the creation largely of India’s first prime minister, Jawaharlal Nehru (1947–64). To what extent Nehru’s thinking on the public sector was governed by ideology and how far it was dictated by practical considerations has been greatly debated. The point has been made that at the time of independence, India had one of the most-developed private sectors in manufacturing in the Third World. However, it is also true that the private sector at the time lacked the ability to mobilise resources for the heavy industries that Nehru regarded as a priority. One political scientist, Baldev Raj Nayar, has suggested that ideology was the dominant motivation, although the creation of an industrial state and

4


the preservation of national autonomy were important motivations (Nayar, 1990: 28): The public sector in Nehru’s design was both the measure of socialism as well as the route to a fully socialist society of the future. . . . Through the non-capitalist path of development, India was destined to be an independent center of economic power, meeting others on the basis of equality and not subordinate to them. For Nehru, the public sector was not only the path to socialism of the future but also the mechanism to bring about India’s industrialisation and modernisation. Nayar contends that there has been a tendency from the 1980s onwards to portray Nehru’s focus on the public sector as essentially pragmatic, if only to make the point that, since the ground realities have changed, the role of the public sector needs to be viewed very differently. But these, he avers, were ‘an afterthought to reinforce a posture which had already been independently arrived at on the basis of ideology’. But another political scientist, Sunil Khilnani, is dismissive of the suggestion that ideology or any infatuation with the Soviet model might have influenced Nehru’s thinking on the role of the public sector in India (Khilnani, 1998: 76): Nehru’s economic thinking is commonly traced to an over-impressionable liking for the Soviet model of planned industrialisation. Yet this is a crude reading of his purposes and practice. Not merely was Nehru from his very earliest encounters with the Soviet experiment critical of its political consequences, . . . his own practice after 1947 was more improvisatory than ideological, and aimed to unite into a single, coherent strategy quite diverse intentions. Khilnani suggests that an important consideration was the need to safeguard India’s political sovereignty: this might easily by compromised if India became dependent on foreign capital in its efforts to industrialise. Further, Nehru saw the public sector in Keynesian terms: it would act as a counterweight to the ‘swings and fashions of private investment’. More ambitiously, Nehru viewed the public sector as generating the surpluses needed to sustain the welfarist ambitions of the Indian state, given that levels of taxation were rather low. Khilnani (ibid.: 77) writes: The ancestry of this argument for the public sector is therefore not correctly traced to the Soviet model of a command economy, nor did it derive from an ideological conviction in the virtues of collectivism. Rather, in its distributive ambitions, it had obvious resonances with the policies adopted in many western European countries in the post-war period.

Introduction

5

The pre-eminence of the public sector was secured through the Industrial Policy Resolution of 1956, which excluded the private sector from basic industries such as power, oil, heavy engineering, steel, and several others. The public sector was, to use the oft-quoted expression, intended to ‘annex the commanding heights of the economy’. This fitted into the broad strategy for rapid industrialisation laid out in the Second Five-Year Plan of 1956 and continued in the Third Five-Year Plan, a strategy based on import substitution and massive investment in the capital goods and heavy industries.

1.3 Winds of change There was a subtle attempt to underplay the importance of the public sector and indeed centralised planning during the brief tenure as prime minister of Lal Bahadur Shastri (1964–6) who succeeded Nehru. The initial years of Indira Gandhi (1966–77, 1979–84), who came next, saw a sharp cut in public investment arising form a budgetary crisis, which set the clock back somewhat so far as the public sector was concerned. There followed a phase of economic radicalism, partly driven by Mrs Gandhi’s bid to gain the upper hand over senior leaders in the Congress party, in which 14 leading banks were nationalised. This naturally added to the public sector’s sphere of influence. Nationalisation of other industries followed: coal, general insurance, copper, a portion of the textile industry, and the wholesale wheat trade (though the takeover of the wheat trade was subsequently reversed). The stagnation in industry in the first half of the 1970s and widespread economic discontent forced a rethinking of policy and ushered in a phase of cautious liberalisation from 1975 onwards. This point is worth noting as there is a tendency to believe that India embraced economic liberalisation only with the onset of a balance of payments crisis in 1991; others would more charitably date liberalisation back to the Rajiv Gandhi era, i.e., 1985 onwards. As Nayar (ibid.: 34) rightly observes, ‘. . . the origins of liberalisation in India lay in its own specific experience in the early 1970s, even though later it may have felt encouraged in that path by the worldwide trend’. In Indira Gandhi’s post-1975 phase, there was greater freedom for private sector expansion and, by implication, a subtle underplaying of the role of the public sector. The Janata government’s rule (1977–9) saw the small-scale sector being favoured, with the list of industries reserved for it being expanded and price preference for SOEs being removed. When Gandhi returned to power in 1980, she set up an Economic Administration Reforms Commission under a seasoned economic administrator, L. K. Jha, with a mandate to recommend greater liberalisation in the Indian economy. Among the major measures initiated was an opening to the private sector, including foreign companies, of several industries that had been closed to it.

6


In a clear sign that she was impatient with the existing state of affairs with SOEs, Gandhi also set up a committee, headed by an economist, Arjun Sengupta, to review the role of public enterprises. The perception had gained ground that, no matter what their contribution to various social objectives, the time had come for SOEs to show better financial performance. This perception informed the government of Rajiv Gandhi, Indira Gandhi’s son, who became prime minister on the assassination of his mother. Better return on investment in the public sector came to be seen as one of the pre-conditions for stemming the deterioration in public finances. A deficit had emerged on the government’s revenue account that had to be met by borrowings, a situation that was seen as laying the seeds for an internal debt trap. The public sector, far from generating surpluses and fostering accumulation in the economy, was getting in the way of such accumulation. Improved efficiency at SOEs was also seen as essential for the provision of vital inputs such as energy and transport. Flowing from these perceptions, a few tentative suggestions were beginning to be heard in public discourse. One was that the focus would have to be on getting more out of the existing SOEs, instead of attempting additional investments. As a corollary to this, further nationalisation was to be ruled out. A second was that the public sector might have strayed too far from strategic sectors of the economy into areas that it should have shunned. By implication, the public sector must hereafter concentrate on the core sectors of the economy. Third, future investments must be made to a larger extent than in the past in the private sector, where it might be expected to more productive. Other new ideas also found their way into policy-making and were implemented in varying degrees: longer tenures for chief executives of SOEs; greater operational autonomy; memoranda of understanding between SOEs and their parent ministries; freedom for SOEs to raise resources from the market; etc. Thus, the movement towards better performance at SOEs initiated in Mrs Gandhi’s time received considerable impetus under Rajiv Gandhi.

1.4 The Memorandum of Understanding While sensing the need to promote the efficiency of SOEs, Rajiv Gandhi was constrained to rule out privatisation and also to underline the continuing relevance of SOEs to broad economic and social objectives. In other words, the public sector must stay but it must justify its existence by becoming more efficient. There was, however, a certain vagueness about how the objective of greater efficiency was to be measured in a context when SOEs were not subject to market discipline. Profit was not the sole objective and SOEs were not listed on stock exchanges, so it was also not possible to use share prices for measuring efficiency of SOEs. The perception gained ground that an

Introduction

7

instrument was needed that could measure the performance of PSEs (publicsector enterprises) taking into account the social as well as financial objectives they had to meet and translating these into measurable parameters. The instrument that was devised to meet the heightened expectation of performance in the late 1980s was the Memorandum of Understanding (MOU), a mechanism that had been tried in a few other countries, notably France, with mixed results. As mentioned earlier, the Arjun Sengupta committee on SOEs set up in 1984 in Indira Gandhi’s time had recommended the monitoring of SOEs through MOUs. The MOU concept was introduced in 1988. The Public Enterprises Survey, brought out each year by the Bureau of Public Enterprises, spelt out the rationale for MOUs in its 1988–9 issue: In order to improve the performance of the public sector, government took a policy initiative by introducing the concept of Memorandum of Understanding. MOU is an instrument which defines clearly the relationship of the PSU (public-sector undertaking) with the government and clarifies the respective roles of the PSUs as well as the government, to achieve better performance. The MOU is also an attempt to bring a proper balance between accountability and autonomy. The emphasis is on achieving the negotiated and agreed objectives rather than interfering in the day-to-day affairs. The last sentence underlines an important aspect of the MOU mechanism, conferring greater autonomy on SOEs. Once the objectives had been agreed upon by the SOE concerned and its parent ministry through a process of negotiation, the SOE was to be left free to pursue these. Practitioners of management might, perhaps, choose to label the MOU concept as a variant of the concept of management by objectives. Although the Sengupta committee had intended the MOU to cover only select SOEs, the government came progressively to include in its coverage more and more SOEs. There were only four MOUs in the first year, 1987–8. The number jumped to 71 and 102 in 1991–2 and 1992–3 respectively, although it rose only marginally thereafter (Table 1.1). The MOU typically had three sections. The first consisted of a mission statement, followed by a list of objectives that would conduce to the attainment of the mission. In the second section were listed various performance criteria, broken down into ‘hard’ measures such as turnover, return on investment, etc., and ‘softer’ ones such as corporate planning, research and development, etc. (For some reason, the first was categorised as ‘static operational efficiency’ and the latter as ‘dynamic effects’.) Each of these performance criteria was given weights that were agreed between the administrative ministry and the SOE. For each of the hard measures, there was a rating scale that ranged from 1 (‘excellent’) to 5 (‘poor’), with prior agreement as to desired values for each of the ratings. Table 1.2

8

Privatisation in India Table 1.1 SOEs covered under the MOU system Year

Number of MOUs signed/finalised

1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 2000–01 2001–02

4 11 18 23 72 98 101 100 104 110 108 108 108 107 105

Source: Public Enterprises Survey, 2000–01, Government of India

reproduces Section II for an SOE, the Heavy Engineering Corporation, in the year 1989–90. Based on the actual performance on each parameter, a score would be given (ranging from 1 to 5), and an aggregate score across all parameters computed using the weights for each parameter. If the aggregate score was, say 1.5, the SOE would be somewhere between excellent and good. The third section of the MOU spelt out the obligations on the part of the government towards the SOE and the assistance it was required to provide in order to enable the SOE to meet the desired objectives. This could be financial assistance, help in securing clearances from various authorities, tax concessions, approvals for raising funds, etc. An elaborate bureaucracy was created to carry out the task of evaluation. At the top was a committee comprising the cabinet secretary and other secretaries and senior bureaucrats. This was the ‘Committee to Review Performance of PSUs Signing MOUs with the Government’. Next was the ‘Committee for Monitoring and Evaluating MOUs’ headed by the Secretary, Department of Public Enterprises and staffed by middle-level bureaucrats. Finally, there was an advisory panel of about 50 persons called the ‘Ad hoc Task Force’ that comprised retired secretaries, academics, former CEOs, members of parliament, and some others. The Task Force formed smaller teams for evaluating the MOUs. There is a large literature on the performance of the MOU mechanism in India (see Trivedi (1990) for example) that points up shortcomings in the methodology as well as in its implementation. Many of these related to the choice of parameters, the weights accorded these and the difficulties in measuring performance using some of the parameters.

Introduction

9

Table 1.2 Criteria for performance evaluation of Heavy Engineering Corporation, 1989–90 Criterion value 1 No. Criterion 1

2

3

4

Static operational efficiency 1) Production 2) Gross Margin 3) Inventory (Net) 4) Sundry Debtors (Net) Dynamic effects 1) Order Booking 2) Training of employees 3) Diversification (Value of production) 4) R&D (Expenditure) Project Implementation 1) Delivery of Equip./TK as per schedule for projects in steel and coal section 2) Plan outlay expenditure Other Indicators 1) Value of spares supplied from service depots at the customer’s sites

Total

Units

2

3

4

5

Wt. High

Low

Rs mn 25 Rs mn 12 Rs mn 8 Rs mn 5

4040 392.1 1880 570

3850 373.4 1980 600

3660 354.7 2080 630

3470 336.1 2180 660

3080 298.7 2380 720

Rs mn 18 Nos. 4

4250 4000 3800 3600 4200 4000 3800 3600

3200 3200

Rs mn Rs mn

5 2

735 36.6

700 34.9

665 33.2

560 27.9

Rs mn

10 8

(*) 210

(**) 200 0

(***) (****) (*****) 190 180 160 0 0 0

Rs mn

3

105

100

95

630 31.4

90

80

100

(*) Before scheduled date (**) On Scheduled date (***) Delay by 6 months (****) Delay by 6 months to 1 year (*****) Delay by more than 1 year Source: Government document reproduced in Trivedi (1990)

For instance, the parameters tended to overlap, which meant that a particular parameter actually had more weight than indicated. If turnover and value added were used as parameters, a good performance on these might be expected to lead to improved performance on yet another parameter, return on investment. A more important shortcoming was that the measurement system did not incorporate the social objectives, such as development of backward areas or reservations for particular castes, that were believed to detract from commercial performance. Thus, the MOU system failed to meet one of its avowed objectives, namely to capture the multifarious contributions of SOEs. Indeed, it may have had the unintended, but not unwelcome, effect of getting SOEs to better focus on commercial objectives. Methodological issues apart, there were problems in implementation as well. The administrative ministry and SOEs under its tutelage had every

10


Table 1.3 Performance rating of SOEs in the MOU system No. of SOEs Rating

1996–97

1997–98

1998–99

1999–00

2000–01*

Excellent Very Good Good Fair Poor Total

46 28 18 11 7 110

45 25 13 22 3 108

44 30 13 19 2 108

49 29 9 16 3 106

49 26 12 12 7 106

*Provisional Source: Public Enterprises Survey, GOI

incentive to set modest targets, the surpassing of which would make both look good. In the recent past, nearly 70 per cent of SOEs have ended up with ratings of ‘excellent’ or ‘very good’, which might cause some to wonder why there was so much talk about SOE reform or privatisation in the first place (Table 1.3). To mention just one other problem in implementation, SOE managers were apt to complain that the MOU was often not drawn up sufficiently ahead of a financial year for the SOE to apply itself in earnest to the targets. Most critically, the fundamental objective underlying MOUs, conferring greater autonomy, was not met. There was a widespread perception that bureaucratic and political interference continued, and that MOUs had merely increased the paperwork that SOEs were required to carry out. At a different level, neither the general environment nor the organisational form of SOEs conduced to the objective of greater efficiency. Competition and deregulation are essential for the pursuit of efficiency. For all the liberalisation that had taken place, these conditions were far from being fully met. Moreover, another requirement for efficiency, the imposition of market discipline in the form of traded share prices, was absent as none of the SOEs happened to be listed on the exchanges. Indeed, the MOU was devised precisely as a mechanism for fostering efficiency in an environment where these elements were lacking. It followed that SOEs would be truly enabled to become more efficient only if market forces were allowed to operate more freely. While not articulated in these terms, it was this recognition that paved the way for the next phase of SOE reform, namely disinvestment in a context of economic liberalisation.

1.5 Competition and disinvestment At the beginning of the 1990s, satisfaction over the contributions of SOEs to the economy co-existed with a profound unease over the returns they were producing.

Introduction

11

The contributions of SOEs towards meeting broader social objectives were many and were readily acknowledged. SOEs had helped create a diversified industrial economy. They had laid the foundations for research and development. They had fostered the development of backward areas. They had helped further the objective of uplifting weaker castes and tribes in Indian society. They were model employers in many ways, paying wages and benefits to workers that were superior to what much of the private sector had to offer. However, with the government’s fiscal situation having deteriorated, there was a sharper recognition that SOEs had to deliver better returns. This was necessary in order to benefit the exchequer and also to improve overall economic performance. It was also recognised that budgetary support to SOEs could no longer be sustained at past levels and that SOEs, in general, ought to become self-supporting. Further, the government had begun to take the view that the betterperforming SOEs needed to contribute more to the exchequer than dividends. This could only happen if government sold some of its equity in SOEs. This was seldom explicitly stated in the early 1990s, but in the government’s straitened circumstances, revenue generation was undoubtedly an important motivation for the sale of government equity in SOEs – or what was termed ‘disinvestment’. The evolution of the policy of disinvestment has been well summarised by the Ministry of Disinvestment at its website; we draw upon this material in chronicling the course of disinvestment. It was the government of Prime Minister Chandrashekhar that first announced a policy of disinvesting government equity in SOEs in the interim budget of 1991–2. It spoke of selling up to 20 per cent in such firms, that too to public-sector institutional investors. Thereafter, disinvestment evolved in the 1990s in a climate in which SOEs were, for the first time, subjected to a significant measure of competition, domestic as well as foreign. The disinvestment programme became part of an ambitious process of economic reforms covering industry, the external sector, the financial sector and agriculture, and also involving a programme of macro-economic stabilisation that commenced in 1991 under the government of Prime Minister Narasimha Rao, in which an economist, Manmohan Singh, was Finance Minister. The highlight of industrial reform was the Industrial Policy Statement of June 1991 that, among other things, drastically reduced the number of sectors of industry reserved for the public sector from 17 to eight. This list was subsequently truncated to four: defence, atomic energy, specified minerals, and railway transport. Moreover, all areas other than the ones on the restricted list earlier reserved for the public sector were exempted from the system of industrial licensing under which the private sector was required to obtain a license from the government in order to start a business. These de-reservations have had the effect of exposing the public sector to competition in most industries.

12


Another important measure was to refer ‘sick’ SOEs (firms that have accumulated losses of an order defined by the statute) to the Board for Industrial Finance and Reconstruction that had earlier been responsible for taking decisions on bankrupt firms in the private sector only. This meant that the government would be bound by decisions issued by the BIFR where ‘sick’ SOEs were concerned and might be obliged to close down unviable firms and rehabilitate others as ordered by the BIFR (although actual closure tends to be a long drawn-out affair in India because of various legal constraints). The state of drift at SOEs with huge losses could continue no longer. The Industrial Policy Statement neither placed an upper limit on disinvestment nor did it talk of selling government equity to any particular class of investors. It cited injection of greater market discipline into PSUs as the objective of disinvestment, which is a quite different matter from raising resources for government or the government getting out of business. In the budget of 1991–2, however, the government reinstated the upper limit of 20 per cent mentioned by the Chandrasekhar government, and also a preference for disinvesting to public-sector financial institutions and to the workers of the firms involved. There was a shift in the avowed objectives as well. Disinvestment, the budget said, was meant to ‘raise resources, encourage wider public participation and promote greater accountability’. Subsequently, in 1993, a committee headed by C. Rangarajan, an economist, that had been asked to outline a framework for disinvestment recommended a more radical course. The committee recommended that the government could disinvest up to 49 per cent in industries reserved for the public sector. In cases where the enterprise had a dominant market share or where there were strategic considerations, the government could disinvest up to 74 per cent. In all other cases, the government could disinvest up to 100 per cent. Evidently this framework was not acceptable in the political climate then obtaining, for in 1996 the United Front government decided to set up a Disinvestment Commission to advise on disinvestment. The Disinvestment Commission was to draw up a comprehensive programme of disinvestment over a five to ten year period for public sector undertakings (PSUs) referred to the Commission by a Core Group of government secretaries. The Commission was also asked to advise on such matters as the extent of disinvestment, the mode of disinvestment, selection of financial advisors to facilitate the process, etc. The Disinvestment Commission formulated a broad approach to disinvestment and also made specific recommendations in respect of 42 out of 58 PSUs referred to it by the Core Group. Of the remaining 16 cases, it recommended no change in 12 cases and closure or sale of assets in four. The recommendations are spread over eight reports. The Commission broadly distinguished between ‘core’ and ‘non-core’ industries. In the core group are industries such as telecommunications, power, petroleum, etc. that are capital-intensive and where the market struc-

Introduction

13

ture could be an oligopoly. The core group also includes basic industries in which PSUs have a considerable market presence and in which private sector presence is still limited. For the core group, the Commission advocated selling government equity up to 49 per cent, i.e., the government would retain 51 per cent of equity. In the non-core group, the Commission advocated sale of up to 74 per cent of government equity. The Commission thus took a slightly different approach from the Rangarajan Committee cited earlier, which had advocated sale of 74 per cent or more equity in all but a few strategic enterprises in the public sector. As for the 42 PSUs for which the Commission has made specific recommendations, these include strategic sale of a large chunk of equity to a private party in 37 instances and offer of shares to the public in five. The Commission was disbanded in 1999 and all matters related to privatisation in the industrial sector were thereafter handled by a separate Department for Disinvestment created in December, 1999. The Department later became a full-fledged ministry. In August 2001, the government announced the revival of the Commission, presumably to function alongside the Ministry of Disinvestment but little has been heard of it since.

1.6 The ‘Navratna’ concept With the opening up of the economy to greater competition in the 1990s, many felt that SOEs lacked the agility to respond to the challenges of the new environment. Rakesh Mohan, an economic advisor to the government, posed the issue as follows (Mohan, 1994): The opening of new entry to both domestic and foreign firms has injected substantial new competition in all the manufacturing branches where PSEs (public sector enterprises) operate. PSEs now have to compete in the market with private enterprises – for resources, for markets, for personnel, and for technology. New communication technologies have made the need for fast and flexible commercial decision-making much more important than the PSEs have been accustomed to in the past. Overall, the impact of the economic reform requires much greater operational autonomy for PSEs, or it requires their privatisation. We dwelt earlier on the attempt to confer a measure of autonomy on SOEs through MOUs and how that mechanism had very limited success in that respect. In the context of a controlled economy, the absence of autonomy may not have been a serious limitation although it would undoubtedly have inhibited efficiency. In the liberalised environment, autonomy seemed a pre-condition for the survival of SOEs. Whether the requisite degree of operational autonomy can ever be achieved has been one of the abiding issues in the debate on privatisation through

14


the 1990s and it continues even today. Because SOEs are accountable to parliament, the creation of administrative ministries that would monitor these and report to parliament was inevitable. Parliament itself supervises SOEs through various committees, such as the Committee on Public Undertakings, the Standing Committees attached to particular ministries and the Estimates Committee. SOEs also come under the Comptroller and Auditor General of India, who takes up SOEs for scrutiny by turns and issues reports related to various aspects of their functioning. They are also covered by the Chief Vigilance Commissioner, an authority who investigates complaints of malfeasance against public sector officials. Board-level appointments to SOEs are made by the Public Enterprise Selection Board and need to be cleared by the Appointments Committee of Cabinet. Top appointments are also subject to intelligence checks for security clearance. The process of selection is time-consuming and often results in top positions at SOEs being vacant for considerable lengths of time. Capital expenditure beyond a certain limit requires approval from the Planning Commission. Such elaborate supervision is seen as slowing decision-making in SOEs, creating a culture of risk-aversion and generally preventing SOEs from being able to compete effectively in the new liberalised environment. In 1997, the government of Prime Minister Deve Gowda made an attempt to provide greater autonomy to select SOEs, at least in so far as their relationships with their parent ministries was concerned. SOEs that had the potential to do well were divided into three categories: Navratna (‘nine jewels’, the reference being to nine SOEs that were conferred this honour; later the Navratna status was extended to two more SOEs, making the title something of a misnomer); Mini-Ratna I; and Mini-Ratna II. The nine SOEs that initially made it to the Navratna category were chosen because of their potential to become global players based on their size, performance, nature of activities, future prospects, etc. The Navratna enterprises were delegated substantial powers, the most important of which, perhaps, was the freedom to incur capital expenditure without any monetary ceiling. Other powers delegated to them included entering into technology joint ventures, opening new offices in India and abroad, and the appointment of functional directors. To be sure, there were some qualifications to these powers. For instance, the Navratna SOEs were told that government nominees on the Boards must be present when key decisions were taken and that all important financial proposals must be vetted by professionals or by financial institutions. Nevertheless, the powers conceded were quite substantial by past standards. To qualify as a Mini-Ratna I enterprise, an SOE needed to satisfy three conditions: it should have made profit in the previous three years; it should have a positive net worth; and the pre-tax profit should have been more than Rs 300 million in at least one of the three years. Mini-Ratna II SOEs were those that satisfied the first two of these three conditions.

Introduction

15

Mini-Ratna I SOEs were allowed to incur capital expenditure up to Rs 3 bn and Mini-Ratna II SOEs up to Rs 1.5 bn or an amount equal to their net worth, whichever was lower. The two categories of SOE were given varying degrees of freedom in respect of setting up joint ventures, subsidiaries and overseas offices. While nobody would argue that the Navratna and Mini-Ratna concepts liberated SOEs from the clutches of politicians and bureaucrats, they undoubtedly contributed to a greater degree of operational freedom than at any time in the past and also to the gradual introduction of a Board-driven culture at least in the Navratna SOEs. Two other attempts at fostering greater autonomy in SOEs may be mentioned. One was a proposal mooted in 1998 by Vijay Kelkar, a government economist, for the creation of a Special Purpose Vehicle to which 51 per cent of the government’s holdings would be transferred. The SPV would gradually divest its equity holdings to financial institutions and others. The government’s equity holdings would fall below 49 per cent, which would automatically mean that the various statutes covering SOEs, including the elaborate mechanisms of parliamentary and other forms of accountability, would cease to apply. A variant of the above was a proposal made by the then Chairman of the Disinvestment Commission, G. V. Ramakrishna, for the setting up of a National Shareholding Trust to which all of the government’s shares would be transferred. The Trust’s shares in SOEs would eventually decline to 26 per cent. The Trust itself would be managed by professionals and representatives from the Finance ministry, the Disinvestment Commission, banks and financial institutions. The idea underlying both the proposals was the same, namely to immediately distance SOEs from political control. Neither of these proposals found favour with the government.

1.7 On to privatisation As the preceding discussion makes clear, the focus through most of the 1990s was on SOE reform through one means or another. Towards the end of the 1990s, however, an argument, heard in muted accents earlier, began to voiced more assertively. It was inspired, no doubt, by debates that had taken place in other parts of the world about the role of the state. The state, it was contended, ought to concentrate on its central role of providing physical and social infrastructure. Running businesses was inconsistent with this role and was best left to the private sector. Privatisation was no longer to be justified merely on the strength of the need to improve performance. The argument being made was about the comparative advantages of the public and private sectors. It did not matter whether some SOEs were performing well or not, or whether the measures taken to improve their performance had borne fruit. As a general rule, government ought not to be engaged in business. Besides, the

16


government could garner adequate resources to fulfil its primary role of investing in infrastructure or even to contain the fiscal deficit only by selling off its stakes in SOEs in their entirety, not just small portions. In the first half of the 1990s, the need to improve productivity of public assets had dominated the ideological argument about the relative roles of the public and private sectors in the economy. Hence the preference for disinvestment, the shedding of small portions of the government’s equity in SOEs, as distinct from privatisation, the outright transfer of control to private ownership. In the latter half of the 1990s, however, the ideological argument about the legitimate role of government began to gain the upper hand. The first sign of the shift in philosophy was seen in the budget for 1998–9 presented by the new government headed by Prime Minister Vajpayee. The budget announced that the government’s equity stake would fall to 26 per cent in the generality of PSUs and that the government would retain majority holdings only where ‘strategic’ interests were involved. In March 1999, the government clarified what was meant by ‘strategic’ enterprises. It said that enterprises in the following areas would be regarded as strategic: • • •

Arms and ammunitions and defence equipment Atomic energy (except for nuclear power generation and some applications of it in agriculture) Railway transport.

In one of those seemingly endless nuances to policy, the announcement also said that the decline in the government’s stake to 26 per cent would not be ‘automatic’. Rather, the determination of how much the government’s stake should decline below 51 per cent was to be made on the basis of whether, in a given industrial sector, the presence of the public sector was required as a countervailing force to the private sector, and whether the industrial sector required a proper regulatory mechanism for protecting consumer interests ahead of privatisation. In other words, the government seemed to hark back to the Disinvestment Commission’s categorisation of core and non-core sectors. In the budget for 1999–2000, the government dared to use the word ‘privatisation’ for the first time. Whereas disinvestment too could be characterised as a form of privatisation, and was indeed the method of privatisation adopted by countries such as the UK, the government meant to signal that it was happy to cede control to a private buyer. From 2000 onwards, privatisation came to be identified with a particular method of sale called ‘strategic sale’, the transfer of a controlling stake to a private party at one go. The budget for 2000–1 seemed to carry privatisation policy a step further. The government said that it was willing to reduce the government’s equity

Introduction

17

stake in non-strategic enterprises even below 26 per cent if necessary. It also said that the proceeds of privatisation would be used for specific purposes: restructuring of PSUs; retirement of public debt; and provision of a safety net for workers. In its 2001–2 budget, the government explicitly earmarked the expected proceeds for the first two purposes. The actual proceeds from disinvestment to date have been modest: disinvestment of equity in 42 SOEs has yielded about Rs 202 billion ($4.2 bn) so far. Table 1.4 provides the details of the receipts from disinvestment over the years, and also the mechanism of sale adopted from time to time. For the most part, so far profit-making enterprises have been offered for sale. In the first round of disinvestment in 1991–2, the government offered ‘bundles’ of shares of various SOEs (each bundle carrying a notional reserve price) to local institutions. Shares in 31 SOEs were sold by grouping these into 825 bundles. The SOEs were divided into three categories: ‘very good’, ‘good’ and ‘average’. The categorisation was based on the Net Asset Value (NAV) of each firm in relation to the book value of Rs 10 a share. To rate as ‘very good’, the NAV of a firm needed to be above Rs 50; for the other two categories, the NAV had to be Rs 20–5 and below Rs 20 respectively. Each bundle consisted of shares of nine SOEs, three from each of three categories. The NAV itself was computed on the basis of book values and not current market values. It should be obvious that the method of valuation chosen for categorising firms was distinctly crude. There was a second offering in 1991–2. This time, only 16 of the 31 SOEs were on offer. On the basis of the same categorisation adopted earlier, 120 bundles were formed. The bundling method was abandoned thereafter. From 1992–3 onwards, firms were auctioned separately. There was a progressive opening up to investors other than domestic financial institutions. In 1994–5, non-resident Indians were allowed to participate. In 1996–7, the first GDR issue by an SOE took place. The first offer to domestic retail investors was made only in 1998–9. Through all the years of disinvestment, there were only three offers to the domestic public. The point is worth noting, as there is a tendency to contrast the valuations obtained through disinvestment with those in the case of strategic sale. This overlooks the fact that comprehensive public offers within India, targeting both retail and institutional investors, have been a rarity in the disinvestment programme until 2003. There have been several criticisms of the disinvestment process. One is that the valuation processes were unsound and that the government gave away its stakes too cheaply. Second, disinvestment has been merely a revenue-raising affair for the government, with little thought being given to the requirements of the firms concerned. Third, the government’s reluctance to disinvest more than 51 per cent and relinquish control over PSUs has meant that the government has been unable to attract high bids, as bidders do not believe the firms’ performance would improve significantly with small government

18


Table 1.4 Record of Disinvestment (Rs bn) No. of PSEs in which equity sold

Target receipt for the year

Actual receipts

47 (31 in one tranche and 16 in other) 35 (in 3 tranches)

25.00

30.38

Minority shares sold by auction method in bundles of ‘very good’, ‘good’, and ‘average’ companies.

25.00

19.13

1993–94

–

35.00

Nil

1994–95

13

40.00

48.43

1995–96

5

70.00

3.62

1996–97 1997–98 1998–99

1 1 5

50.00 48.00 50.00

3.80 9.02 53.71

1999–00

3

100.00

15.84

2000–01

3

100.00

1868

Bundling of shares abandoned. Shares sold separately for each company by auction method. Equity of 7 companies sold by open auction but proceeds received in 94–95. Sale through auction method, in which NRIs and other persons legally permitted to buy, hold or sell equity, allowed to participate. Equities of 4 companies auctioned and Government piggy-backed in the IDBI fixed price offering for the fifth company. GDR (VSNL) in international market. GDR (MTNL) in international market. GDR (VSNL)/Domestic offerings with the participation of FIIs (CONCOR, GAIL). Cross purchases by 3 oil sector companies i.e. GAIL, ONGC & IOC GDR (GAIL) in international market & MFIL’s strategic sale. VSNL domestic issue. BALCO, KRL(CRL) & MRL through strategic sale/acquisition

Total

42

543.00

202.61

Year 1991–92

1992–93

Methodology

Source: Ministry of Disinvestment, website

stakes being offloaded. This third contention is open to dispute, as we shall see in Chapter 6, but it nevertheless provided the impetus for a switch to strategic sale as the preferred method of sale from 2001 onwards. In the year 2001 the government seemed to have made up its mind that it would adopt the method of strategic sale in the generality of cases, although the small number of bids has raised questions as to whether this method conduces to the government obtaining the best possible price for enterprises. (In at least one case, Computer Maintenance Corporation, there was just one

Introduction

19

Table 1.5 List of enterprises to be privatised No.

Name of SOE

1 2 3 4 5 6 7 8 9 10 11 12 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32

Air India Ltd. Bharat Breaks & Valves Limited Bharat Heavy Plates & Vessels Ltd. Bharat Pumps & Compressors Ltd. CMC Limited Engineering Projects (India) Ltd. Hindustan Cables Ltd. Hindustan Copper Ltd. Hindustan Insecticides Ltd. Hindustan Organic Chemicals Ltd. Hindustan Salts Ltd. Hindustan Zinc Ltd. IBP Ltd. Indian Airlines Indian Petrochemicals Corporation Ltd. Indian Tourism Development Corporation Instrumentation Ltd. Jessop & Company Ltd. Madras Fertilizers Ltd. Maruti Udyog Limited Minerals and Metal Trading Corporation of India Ltd MSTC Ltd. National Fertilizers Ltd. NEPA Ltd. Paradeep Phosphates Ltd. Praga Tools Ltd. Scooters India Ltd. Sponge Iron India Ltd. State Trading Corporation Tungbhadra Steel Product Ltd. Videsh Sanchar Nigam Ltd.

Source: Ministry of Disinvestment, website

bidder.) However, in 2002 the government ran into strong resistance from political parties and labour unions when it contemplated the strategic sale of two big oil refineries, BPCL and HPCL, and an aluminium producer, Nalco, and had to temporise in these cases. The government’s expectation that transparency in the bidding process and the inviting of global tenders would overcome criticism of strategic sales of SOEs has thus so far not been entirely borne out. The Ministry of Disinvestment put up at its website a list of enterprises it hoped to privatise in the coming months (Table 1.5). In Chapter 6 we examine at length the controversy over the method of sale and the relative merits of strategic sale and offer to the public. The entire controversy over strategic sales came to a head in December 2002 when the Minister for Disinvestment, Arun Shourie, announced in parliament

20


the government’s plan to offer a 34 per cent stake in the oil company HPCL through strategic sale. In another oil company, BPCL, the government would offer to the general public a 35 per cent share in the company. The announcement sparked a furore in parliament and elsewhere, with questions being raised as to the legality of the move. It was contended that since these two companies had been acquired by the government through an act of parliament, parliament alone had the power to authorise their sale. This could not be done through an executive order. Following a petition filed in the Supreme Court challenging the government’s decision, the Court ruled in September 2003 that disinvestment in the two oil majors indeed required parliamentary approval. The judgement raised a question mark over disinvestment in other SOEs that happened to be governed by acts of parliament, and it also raised doubts about some of the disinvestment that had taken place earlier. It must be said, however, that the number of companies acquired through acts of parliament is small in relation to the total number of SOEs. While a larger bench of the Supreme Court is to decide on the merits of the judgement handed down in the cases of the two oil companies, the judgement and the controversy surrounding it appears to have caused some rethinking in government as to the merits of going down the strategic sale route in the case of large SOEs that happen to be performing well.

1.8 Disinvestment in the banking sector That is the story so far in respect of privatisation in the industrial sector. Financial-sector liberalisation and bank privatisation have been overseen by the Reserve Bank of India, India’s central bank. Bank privatisation has so far not involved transfer of ownership from government to private hands, i.e., no strategic sales have taken place in the banking sector. Also, the government’s holding has been brought down not through sale of government stakes but through issue of fresh equity. This has happened in 16 out of a total of 27 government-owned banks, and in all instances the government’s ownership remains above 51 per cent despite sale of fresh equity to the public. Unlike in the case of industrial firms, every sale of equity has targeted the domestic market, and such sales in the years 2002 and 2003 have proved remarkably successful. Not only have issues in recent years been oversubscribed but investors have been richly rewarded in terms of appreciation in stock prices. The government announced in its budget for 2000 that it would lower its equity holding further to 33 per cent while still retaining the public-sector character of these banks, implying that it would appoint top management and generally retain control over key decisions. Any fall in the government’s stakes below 51 per cent, the government has stated, would be achieved through fresh sale of stock and not through sale of government equity to private parties. Banks are governed by the Banking Companies Act. A bill to bring

Introduction

21

them under the Companies Act and also to permit lowering of government equity in banks to 33 per cent is pending in Parliament. Privatisation policy in India thus presents a curious dichotomy. Even as the government professes lack of confidence in the efficacy of disinvestment and swears by strategic sales where industrial firms are concerned, it has been constrained to stick to disinvestment in the banking sector. This is because its hands are tied in the banking sector by statutes governing nationalised banks and also by opposition from well-organised unions. Moreover, as we shall see in Chapter 4, disinvestment in the banking sector has been accompanied by a striking improvement in firm performance, and this renders the case for strategic sales in banking rather weak. In overall terms, we can see an evolution of policy aimed at an improvement in performance at SOEs: from the signing of MOUs in a controlled economy through the use of competition as a spur to improvement, to listing on the exchanges and a broadening of ownership, and finally to an outright transfer of control. In the present climate, there is little opposition to the notion that SOEs must focus on commercial objectives and be subject to market discipline. The quarrel is over the method to be adopted to achieve these ends. It is the insistence on strategic sale and transfer of ownership that is the bone of contention in privatisation policy today. Given the pulls and pressures of a democratic polity, the debate on whether or not to hand over important SOEs to private owners tends to be a contentious and long drawn out affair. An unfortunate outcome is that the SOEs in question are often subjected to varying degrees of paralysis until the debate is resolved. This in itself is bound to tell on performance and cause the government to lose revenue on sale of its equity. There is little to suggest that the advocates of whole-hogging privatisation are sensitive to the costs of having the sword of Damocles hanging over the heads of SOEs for long periods of time.

1.9 The public sector in the Indian economy India’s public sector can be divided into three categories. One is the governmental bureaucracy – central, state and local. In the second category are ‘departmental enterprises’ that are run directly by government and are not separately incorporated, such as the postal services, railways and parts of the telecommunication system. The third category comprises ‘non-departmental enterprises’ incorporated as independent companies and includes firms in manufacturing as well as services. Our study focuses on enterprises in the third category, enterprises that embrace virtually the entire gamut of commercial activity in the country. The public sector is present in a wide range of industrial and services sectors: chemicals, electronics, metals, engineering goods, textiles, transport equipment, minerals, telecommunications, financial institutions, tourism, etc.

22

Privatisation in India Table 1.6 Break-up of public sector enterprises by category No.

Category

I II

Enterprises under construction Enterprises Manufacturing/Producing Goods 1. Steel 2. Minerals and Metals 3. Coal & Lignite 4. Power 5. Petroleum 6. Fertilizers 7. Chemicals & Pharmaceuticals 8. Heavy Engineering 9. Medium & Light Engineering 10. Transportation Equipment 11. Consumer Goods 12. Agro-Based Industries 13. Textiles Sub Total Enterprises Rendering Services 1. Trading & B Marketing Services 2. Transportation Services 3. Contract & Construction Services 4. Industrial Development & Technical Consultancy 5. Tourist Services 6. Financial Services 7. Telecommunication Services 8. Section 25 companies Sub Total

III

Grand Total (IIIIII)

Number 8 7 11 9 4 12 8 21 15 23 12 14 4 17 157 18 9 9 13 9 7 2 8 75 240

Source: Government of India, Public Enterprises Survey, 1999–2000

The division of public-sector enterprises into different sectors is provided in Table 1.6. In keeping with the socialistic philosophy of the public sector annexing the ‘commanding heights of the economy’ that the country started out with, the public sector looms large in what might be described as heavy industry (Table 1.7). In finished steel, its share of output is around 30 per cent, while in chemicals and transport equipment its share is 15–20 per cent. In fuels, petroleum and non-ferrous metals its share ranges from 50 to 100 per cent. In consumer goods, its share is lower: in textiles, for instance, its share is estimated to be under five per cent. Investment in the public sector has grown from Rs 290 m in 1951 to Rs 2741 bn in 2001, although incremental investment has tended to flag since the initiation of economic reforms in 1991 (Table 1.8).

Introduction

23

Table 1.7 The public sector’s contribution to total industrial production National Production (NP) Product

1968–69

Public sector Production (PSP)

1999–00 1968–69

⇒ Fuel (Million Tonnes) – Coal 71.4 300.05 – Lignite 3.98 22.12 ⇒ Petroleum (Million Tonnes) – Crude Oil 6.06 31.95 – Natural Gas NA 28.45 – Refinery Crude 16.55 85.96 ⇒ Basic Metals (Million Tonnes) – Finished Steel 4.58 26.71 ⇒ Non Ferrous Metals (’000 Tonnes) – Aluminium 125.3 617.99 – Primary Lead 1.9 44.4 – Zinc 17.00 125.0 ⇒ Fertilizers (’000 Tonnes) – Nitrogenous 563 10890 – Phosphatic 213 3399

PSP to NP

1999–00

1968–69 1999–00

12.61 3.98

290.75 22.12

17.66 100

96.73 100

3.08 NA 8.09

27.93 24.98 68.85

50.83 NA 48.88

87.42 87.8 80.1

2.55

8.52

55.68

31.9

Nil 1.9 13.70

307.01 35.1 145.70

Nil 100 80.60

49.67 79.05 83.25

401 53.0

3431 777

71.23 24.86

31.51 22.86

Source: Government of India, Public Enterprises Survey – 1999–2000

Table 1.8 Investment in SOEs Year

Cumulative Investment (Rs bn)

Enterprises (Numbers)

1951 1956 1961 1966 1969 1974 1979 1980 1985 1990 1992 1997 1998 1999 2000 2001

0.29 0.81 9.48 24.10 38.97 62.37 155.34 181.50 426.73 993.29 1354.45 2136.10 2310.24 2391.67 2527.45 2741.14

5 21 47 73 84 122 169 179 215 244 246 242 240 240 240 242

Source: Public Enterprises Survey, 2000–01, Government of India

24


1.10 Conclusion The public sector came quickly to have a large presence in post-independent India, partly for ideological reasons such as the pursuit of a socialistic society but also because this meshed well with the model of growth based on heavy industry that India chose to adopt. While a lively private sector had developed under British rule with competence in manufacturing, it was perceived as incapable of making the sort of investments required for heavy industry. Considerations of sovereignty also weighed heavily with Prime Minister Nehru in his choice of the public sector as the primary vehicle for India’s industrialisation. Private capital would include foreign capital, and with the associations of private capital with imperialism being as strong as they were at the time, foreign capital was viewed with suspicion. The public sector helped establish a diversified industrial base but one that was perceived to be inefficient in the import-substituting, high-cost economy of the initial decades after independence. By the 1980s, as SOEs began to impose strains on the exchequer, there was a clearly perceived need to improve efficiency in SOEs. There followed several attempts at SOE reform: the institution of Memorandum of Understanding in the late 1980s, exposing SOEs to competition and disinvestment through the 1990s and a push for autonomy in the late 1990s. These attempts at SOE reform gave way to a focus on strategic sale or the transfer of control to private owners from 2000 onwards. In recent years, privatisation policy has shown a disregard for what deregulation, disinvestment and a measure of autonomy have contributed towards improved performance, whether in the industrial sector or in banking. The thrust towards strategic sales seemed to acquire a momentum of its own but has been checked in recent months by concern about the electoral implications of handing over to the private sector high-profile firms such as oil refineries.

2

Privatisation: theory and evidence

2.1 Introduction A great wave of privatisation has swept the world in the past two decades, embracing the industrial economies, the transition economies of East Europe and large parts of the less developed world, and it continues to roll on. It is interesting, however, that the basis in theory for such a vast movement was by no means unambiguous to start with. Moreover, a sizeable enough body of empirical evidence, on which hypotheses about the impact of privatisation could be tested, became available only several years down the road. So much of the initial impetus to privatisation entailed a leap in faith, and, as happens all too often in the development of knowledge, attempts to explain its impact have followed on the heels of widespread practice. Contrary to popular supposition, neither the theory nor the empirical evidence on privatisation provides unqualified support for the belief that privatisation leads to outcomes superior to those under public ownership. The theoretical literature, while pointing to the potential benefits of private ownership, also underlines the many conditions required for such benefits to materialise. As for the empirical evidence, while a large body of literature has emerged that purports to establish that private ownership and privatisation make for superior performance, the evidence is actually quite mixed. Further, the methodology used in many of these studies is widely perceived to suffer from a lack of rigour. This chapter is intended to provide a bird’s eye-view of the large body of theoretical and empirical literature that has emerged on privatisation and, in particular, to assess what the findings are with respect to emerging markets as distinct from industrial economies.

2.2 Theory Governments have generally sought to justify privatisation in relation to certain objectives. These objectives include one or more of the following:

26


• • •

To promote increased efficiency To raise revenues for the state (and thereby to bridge fiscal deficits) To reduce government interference in the economy and promote greater private initiative To promote wider share ownership and the development of the capital market.

•

Of these, the first objective, the promotion of efficiency in running commercial organisations, has been the dominant motivation. There is a sense that public ownership somehow leads to lower levels of efficiency than are possible under private ownership. Inefficient enterprises, in turn, are seen as creating other problems, such as pre-emption of government revenues badly needed for investment in social sectors in the less-developed countries through subsidies or recapitalisation of uncompetitive firms in the economy. These considerations underlie the sentiment, often heard in privatisation debates, that ‘governments have no business to be in business’. The implication is that most commercial tasks are better performed under private rather than public ownership. A more radical view is that even if there are certain social obligations to be performed by commercial enterprises, these are better done under private auspices. The theoretical literature about the impact of ownership on efficiency is quite recent in origin. Neo-classical theory does not have much to say about firm ownership. It dwells instead on the importance of market structure or competition in generating efficient outcomes. If anything, the theory suggests that, in instances of market failure that cannot be entirely rectified through Pigouvian taxes or subsidies, there is a case for public ownership or control in order to meet over-riding social objectives. The familiar instances of market failure are, of course, monopoly, public goods, externalities, and imperfect information. Subsequent literature, drawing on property rights and public choice theory has, however, come up with a number of reasons why private ownership might be superior in general. The property rights school of thought focuses on the agency problems under the two forms. Public choice theory emphasises that outcomes are sub-optimal where organisations are saddled with multiple and conflicting objectives. The property rights school contends that agency problems are more acute under public ownership. Managers will perform only if they are monitored and incentivised (Jensen and Meckling, 1976). From the standpoint of the property rights school, managers in the public sector lack monitoring and incentives. These, in turn, stem from the fact that ownership is diffuse and hence property rights in the shape of rights to profit are ill-defined. Besides, SOEs are not publicly traded and hence not vulnerable to the threat of takeover. This reinforces the poor level of monitoring. Thus, from the perspective of the property rights school, inefficiency in SOEs arises from the failure to clearly assign property rights.


27

Or, to put it differently, politicians and bureaucrats, who are vested with the job of monitoring on behalf of the public at large are not as good at such monitoring or at designing incentive systems as are shareholders in a private company (though very often, institutional shareholders perform the monitoring role on behalf of small investors). Shleifer (1998) approaches the ownership question from the perspective of the theory of incomplete contracts. Where government can write complete contracts, specifying exactly what it wants, ownership does not matter. The problem arises where contracts are incomplete with respect to ‘quality’. As he puts it, ‘The choice of public versus private provision depends on how different ownership patterns affect the incentives to deliver this noncontractible quality, as well as on the cost of such delivery’. Shleifer argues that incentives to reduce costs or to innovate and improve quality are weak when assets are publicly owned, which takes us back to the problem of incentives raised by agency theory. Public ownership would make sense only where high-powered incentives to reduce costs might impact adversely on quality. For example, private hospitals might refuse to treat patients on whom they lose money. But even where there is loss of quality in some respects, Shleifer suggests, private ownership might deliver compensatory gains through its sheer ability to innovate. Moreover, even quality concerns could be addressed through competition and reputational effects. If, for instance, a health provider was compromising on quality, he might lose out to another provider. Thus, there is only a very narrow set of circumstances in which state ownership might be preferable: the loss of non-contractible quality is significant, innovation is relatively unimportant, competition is weak, and so are reputational effects. Public choice theory complements what the property rights approach has to say about relative inefficiency in the public sector by focusing on the behaviour of politicians and bureaucrats. Unlike their counterparts in the private sector, managers in the public sector might lack focus because they are expected to pursue a variety of objectives, not all of which are calculated to maximise profit (Shleifer and Vishny, 1996). Multiplicity of objectives arises from the fact that public-sector managers are answerable to different constituencies, such as legislators, civil servants and ministers, each with its own objective. In particular, politicians, who are answerable to constituencies such as labour, would tend to push public-sector managers to pursue objectives, such as an increase in employment, that militate against profit maximisation. The problem is bad enough with benevolent politicians in so far as incentives for managers to reduce costs are weak. With malevolent politicians, which some would say is the norm, costs are actively increased for firms because of politicians’ desire to cultivate particular constituencies. Politicians use SOEs not just to pursue larger political goals; they are also interested in lining their own pockets, which does not help the cause of firm efficiency either. Political interference in SOEs also takes the form of not

28


permitting bankruptcy – this is the ‘soft budget’ constraint that SOEs operate under. Managers in the public sector can expect to be bailed out by public funds and hence have no incentive to improve performance (Kornai, 1980). Broadly speaking, both the approaches, property rights and public choice, suggest that behaviour and hence performance of managers will differ in the public and private sectors because the objective functions are different and so are the constraints. Good performance is not incentivised in the public sector, nor is bad performance penalised through takeover or bankruptcy. Martin and Parker (1997) argue that the suggestion of superior performance in the private sector implied by the property rights and public choice approaches literally need not be taken at face value. They argue that it is simplistic to suppose that public and private sector companies are two distinct categories, each with a particular organisational design and orientation. In fact, there is a continuum of organisational types, ranging from the archetypal government bureaucracy (such as the Foreign Office), through various types of agencies (such as public corporations) and private sector firms heavily dependent on government contracts (such as defence firms), to limited-liability companies and small businesses. At the same time, all types of firms are subject to some degree of state influence on account of regulations, taxes and macro-economic management. It seems more plausible, therefore, that ‘public and private sector firms may have similarities that define their behaviour and performance more clearly than the presumed differences’. Indeed, a shortcoming in much of the literature on public ownership and privatisation is a tendency to think of SOEs exclusively as 100 per cent government-owned entities with no traded stock. While this may have been true of SOEs in the transition economies, it does not hold true in China and India. Many SOEs are listed on the exchanges and a portion of the stock is owned by retail as well as institutional shareholders, including foreign investors. The counterpart in the private sector to the stereotype of the SOE is a firm that is 100 per cent owned by an individual. In India, where large firms are concerned, there is one large shareholder, either the government or an industrial family, who holds the largest or the majority stake, with the rest of the shares being held by institutional and retail shareholders. In both SOEs and industrial houses, there are professional managers controlled by the dominant shareholder, the government in one case and the industrial family in the other. It is hard to see why one form is intrinsically superior to the other in respect of governance. The model of professional managers accountable to large institutional shareholders is still a rarity in India. The preceding discussion should make clear that much of the case for private ownership rests primarily on two considerations: there are stronger incentives in the private sector and private firms are subject to the market for corporate control. It is worth taking a closer look at these two propositions.


29

To start with the question of superior incentives in private ownership, Stiglitz (1997) makes the point that in neither form of ownership would incentives be particularly strong. Since managers can appropriate only a small fraction of any improvement in productivity, in neither case would managers have any incentive to design good incentive structures. The first part of the statement is true. One of the well-known studies of top management incentives, that by Jensen and Murphy (1990), found the pay–performance sensitivity to be about $3.25 per $1000 change in shareholder wealth. However, while managerial rewards might form only a minuscule portion of additions to firm value, these are, nevertheless, quite substantial in absolute terms. Indeed, executive compensation has provoked much outrage in recent times as the sums in question are often seen to be obscenely large. It is hard to believe that the rewards that obtain under private ownership today do not constitute incentives to performance, as Stiglitz seems to suggest. At any rate, such incentives are stronger than in the public sector, most certainly in the Indian context. It is worth asking, however, whether there is anything about state ownership that precludes the institution of such incentives. Stiglitz cites the extraordinary performance of SOEs in certain provinces of China to make the point that economic success is possible even under conditions in which property rights are ill-defined. Researchers have ascribed such success to the ability of Chinese SOEs to devise performance incentives for managers, for example, Hay et al. (1994) (we explore this theme in greater detail in Chapter 8). If Chinese SOEs could introduce incentives for performance, why not Indian SOEs? For instance, why can managerial rewards not be linked to value creation in publicly traded SOEs in India? It could be argued that bureaucrats in India would never countenance a situation where the head of an SOE had a compensation structure that was superior to theirs. There have, however, been attempts at enabling SOE compensation to break out of the government straitjacket; to cite a trivial example, many SOE chiefs today are permitted up-market cars in place of the standard cars that bureaucrats and politicians still tend to use. There are also some instances where firms within the SOE fold have been allowed market-based compensation packages. SBI Capital Markets, an investment bank that is part of the government-owned State Bank of India, is a case in point. Martin and Parker (1997) also make the point that too much should not be made of the lack of incentives, especially pecuniary incentives, in the public sector and the effect of this on the performance of public sector managers. Managers could have broader motives than the usual self-seeking ones. Large, well-run SOEs offer opportunities to make an impact, jobs can be enriching and professionally fulfilling, and the existence of life-time job security is in itself an important incentive in a country like India where professional

30


incomes are still low by international standards. This is not to minimise the role of pecuniary incentives but to urge a consideration of incentives in much broader terms. It is also contended that managers in the public sector would find it difficult to use their track record in the public sector to enhance their value in the private sector (Martin, 2002). This is because ready measures of performance are not available in the public sector. Private managers, on the other hand, can always use their performance to recontract elsewhere, so here again the private sector provides superior incentives. This is debatable and indeed must seem odd to many in India, given the high-profile migrations of top managers from the public to the private sector in recent years. Such migrations reflect a clear recognition on the part of the Indian private sector of the skills and abilities developed by managers during their long association with the public sector. The mobility available to top managers in the Indian public sector in the post-reform period is consistent with the observation of Fama (1980) that the labour market for management may enable managers to capitalise their performance quite independently of the form of ownership of the firm they happen to working for. Finally, in light of the scandals in the US business world that involved misbehaviour by top management at some of the best-known names, there is room for scepticism as to the link between high-powered financial rewards and performance. For one thing, high-powered rewards available to managers all too often reflect, not the workings of a competitive market for managers, but the power that managers wield in the boardroom. More importantly, the question has been asked whether high-powered rewards do not create perverse incentives for risk-taking on a scale that can end up destroying firms. It is said that public ownership is favoured in situations where high-powered incentives are dysfunctional. Following the problems in the US corporate world in recent years, we might be forgiven the impression that high-powered incentives per se are dysfunctional! All this is forcing a rethink of the role of pecuniary incentives in firms. It may well be that pecuniary incentives may have to be under-emphasised somewhat and viewed as part of a broader set of incentives, including nonpecuniary ones. In this broader conception of incentives, it is by no means self-evident that public sector firms must be at a disadvantage. Turn now to the other advantage that private ownership is said to enjoy, its being subject to the discipline of the market for corporate control, which is stronger than any discipline that politicians and bureaucrats might impose on SOEs. If private sector managers fail to maximise shareholder wealth, they will be duly disciplined by the capital market. Shareholders will sell underperforming shares, causing prices to fall and creating conditions for a takeover by another firm. In practice, however, the market for corporate control falls well short of being perfect. There are transaction costs to trading shares and also unsatisfactory disclosures. Lack of access to funds may constrain takeovers


31

of larger firms; indeed, the market for corporate control is seen to be weak for large firms even in developed capital markets. A problem specific to the Indian context is concentration of large shareholdings in the hands of owner–managers belonging to industrial houses. Along with restrictions on foreign firms’ acquisitions of shares, this renders takeovers virtually impossible at large firms and rare even in smaller ones. It explains why management remains unchanged despite years of underperformance. At least in relatively underdeveloped markets such as India, the argument about the market for corporate control imposing discipline on private management is largely in the realm of the hypothetical. We can see that the supposed superiority of private over public ownership rests on strong assumptions about the existence of competition as well as reasonably efficient financial markets. Moreover, when people make this comparison, they typically have in mind the form of private ownership that obtains in large firms in the Anglo-Saxon world: professional managers accountable to institutional shareholders with concentrated shareholdings. They also have in mind a particular form of state ownership: 100 per cent state-owned firms that are not traded on the stock market. When these two forms are compared, private ownership would score on both incentives and susceptibility to the market for corporate control. However, the Indian context does not fit this stereotype. Private firms are typically family-managed businesses with large owner shareholdings. Many of the large SOEs have varying degrees of retail and institutional ownership. It is not obvious that the theoretical considerations that favour superior performance under private ownership would apply in such a context. Suppose we brush aside the above considerations and assume for a moment that private ownership would indeed make for better performance. We would still need to grapple with the problem of getting the process of privatisation right. For, it turns out that if the process is botched, then the superior outcomes associated with private ownership might not materalise. We saw earlier that one of the drivers of privatisation is the conviction that governments are inherently corrupt and, therefore, cannot be expected to get the best results out of SOEs. However, Shleifer (1998), who makes this point, also concedes that the same corrupt governments might hand over SOEs to inefficient private parties in exchange for bribes and campaign contributions. Shleifer tries to get round this problem by arguing that it is easier in general to design corruption-free privatisation programmes than to fight corruption within state firms. But this seems more like wishful thinking. One of the countries he cites as being able to design a corruption-free programme in spite of having corrupt bureaucracies happens to be Russia, which is now widely regarded as a privatisation disaster. In a Coaseian world, getting the process of privatisation right in the first instance is not terribly important. All that would be needed is exchangeable property rights. Assets in this world would quickly be assigned to the most

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competent owner thanks to low transaction costs. But, then, in a world of low transaction costs, the organisational form itself does not matter. Where transaction costs are not negligible, the process of privatisation – how exactly it is carried out – becomes important. And getting the privatisation process right is contingent on the existence of well-developed capital markets, a framework of company law and non-corrupt governments, conditions that cannot be readily assumed in less developed economies. We address the question of method of privatisation at length in Chapter 6 and that of governance in Chapter 7. To sum up, the case for privatisation is less than overwhelming on purely theoretical grounds. Given the many ifs and buts about the theoretical merits of privatisation, researchers have inevitably had to turn to the evidence on the ground in order to arrive at conclusions. But the empirical evidence on ownership and efficiency, contrary to impressions that might have been created by media, is by no means unambiguous, least of all where lessdeveloped countries are concerned – as the following sections outline.

2.3 Empirical evidence The empirical evidence on privatisation has been documented with some thoroughness by Megginson and Netter (2001) and Djankov and Murrell (2002). We do not, therefore, wish to attempt a comprehensive coverage of the literature here. We shall content ourselves instead with indicating the different types of empirical studies on privatisation, citing a few studies in each category, highlighting methodological issues and pointing out areas of ambiguity. The empirical research on the subject of privatisation falls into three categories: (i) Case studies (ii) Comparisons of performance of SOEs and private firms (iii) Statistical analysis of pre- and post-divestiture performance of SOEs. We review these and, separately, the literature on less-developed countries. (i) Case studies These typically focus on the performance of a given firm. The firm’s performance is compared with its own before privatisation, or with other firms that were not privatised, or with firms already in the private sector. We shall first mention a few studies in this category. Adams, Cavendish, and Mistry (1992) used country case studies from eight developing countries and found improvements in efficiency in Malaysian firms after divestiture. Bishop and Kay (1989) compared the performance of a number of divested enterprises in the shipping, airline, gas, telecommuni-


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cations, oil, and automobile industries with that of undivested enterprises in the coal, rail, steel, and postal sectors in the UK, using indicators such as revenue, employment, profits, profit margins, and TFP. They found an improvement in enterprise performance in both sets of firms. They concluded that the business cycle and the very threat of divestiture could explain the improvements in performance. Using total factor productivity, Foreman-Peck and Manning (1998) compared the performance of British Telecom (after it was privatised) with that of five telecommunications enterprises elsewhere in Europe and came up with ambiguous results. They found that BT was apparently less efficient that its counterpart in both Norway (where the company was state-owned) and Denmark (where ownership was mixed) but more efficient than those in Spain and Italy (where ownership is mixed). A more thoroughgoing set of case studies, involving 12 privatised firms in four countries, has been carried out by Galal, Jones, Tandon, and Vogelsang (1994). This study stands out in the literature for two reasons. First, the authors compare the performance after privatisation with the ‘counterfactual’, i.e., the predicted performance of the firms had they not been privatised. This is in contrast to the more standard approach in which the performance post-privatisation is compared with that before privatisation. Second, the authors do not use financial measures of performance preferred by most studies on privatisation. Instead, they compute the net change in welfare at the privatised firms, defined as the sum of the changes in welfare of consumers, enterprise profits (including effects on buyers, the government and other shareholders), welfare of labour, and welfare of competitors. They conclude: ‘Did divestiture make the world world a better place, or not? In our twelve cases, this question is answered with a surprisingly uniform and resounding, “yes” ’. Martin and Parker (1997) provide a review of several other studies of the impact of privatisation using relatively small samples of firms. The evidence is inconclusive as to whether privatisation uniformly led to better performance. The authors highlight two shortcomings in studies in this genre. The periods chosen were often too short to determine the postprivatisation impact. Besides, in many cases the comparison of pre- and post-privatisation performance did not control for the stage of the business cycle. A third problem that is worth emphasising is the failure of many studies to disentangle the effects of privatisation from those of deregulation or economic liberalisation. Privatisation is very often one component of a broad package of economic liberalisation, and it is only too easy to fall into the trap of ascribing all firm improvement to privatisation while ignoring the benefits of liberalisation and deregulation. Megginson and Netter (2001) cite five studies in the telecom industry covering different countries that indeed attempted to separate out the effects of privatisation and deregulation/liberalisation. All the studies indicated

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that liberalisation was associated with significant improvements in telecom services but the impact of privatisation was not as clear-cut. In their own study of British privatisation, Martin and Parker try to address two of the methodological weaknesses mentioned above, the short periods of post-privatisation performance and the failure to take into account business cycle effects. They examine the performance of 11 British firms that were privatised in the 1980s: British Airways, British Airports Authority, Britoil, British Gas, British Steel, British Aerospace, Jaguar, Rolls-Royce, National Freight Corporation, Associated British Ports, and British Telecom. As this study relates to one of the great experiments in privatisation and also approaches the question of the impact of privatisation with rather more rigour than most studies, it is worth dwelling on it at some length. The authors measure changes in performance across six different periods: nationalisation; pre-privatisation (the period preceding the announcement of privatisation); post-announcement (the period following the announcement of privatisation); post-privatisation; a recession period from 1998 to 1992; and a latest period, from 1992 to 1994–5. The first three periods were under public ownership and the latter three under private ownership. Except for the post-announcement and the latest periods, each period, in general, averages four years and the figure reported is a four-yearly average. Thus, each enterprise is tracked over a period ranging from 14 to 21 years. By using such long periods, the authors believe that performance is effectively captured over an entire business cycle and also ensures that short-term effects from privatisation are not taken as proof of sustainable improvement. Also, they contend that their approach helps them to isolate the effects of privatisation per se from anticipation effects, as there is often considerable improvement in firm performance ahead of privatisation. The post-announcement period for nine out of the eleven firms was relatively short (one or two years) and it usually overlapped with the preprivatisation period. So, while reporting results for all six periods, the authors leave out this period and concentrate on comparing the nationalisation period with the four other periods. The authors suggest that a comparison of the nationalisation period with the pre-privatisation period would capture what they term the ‘once-for-all shake-out effect’ of privatisation. Comparing the nationalisation period with the three different periods under private ownership would bring out any ‘persistent differential’ between private and public ownership. Four performance indicators were used: labour productivity growth; total factor productivity growth; the growth in value-added per employee; and the rate of profit (defined as profit before interest and tax divided by capital employed). Here, the authors make an important departure from most studies. Except for the rate of profit, every indicator is calculated by subtracting from its value for a given firm the corresponding indicator for the economy as a whole or for manufacturing, thus adjusting for business cycle effects.


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The authors found that performance in the nationalisation period was better than either the post-privatisation or recession periods. However, the pre-privatisation and the latest periods saw better performance than the nationalisation period. Overall, 82 observations showed improvement while 77 deteriorated following privatisation. The authors found, using the nonparametric sign test, that the null hypothesis that there is no difference between the performance of publicly and privately owned companies could not be rejected. It is worth adding that, if we took away the pre-privatisation period when firms were still under public ownership and compared only the postprivatisation period with the nationalisation period, then we would get 62 declines compared to 58 improvements. The authors conclude that there is ‘little evidence of any systematic improvement in performance’. They add, ‘Generally, the great expectations for privatisation evident in ministerial speeches have not been borne out’. Thus, going by at least one rigorous study, British privatisation, widely seen as the one of the totems of the great movement towards privatisation worldwide, is not the emphatic success it has been made out to be. (ii) Cross-sectional comparisons of public and private enterprises As Galal et al. (1994) have noted, ‘the most striking characteristic of this body of work is its almost laughable diversity of results’. One of the earlier studies of this kind was done by Boardman and Vining (1989). They compared performance measures for 500 non-US international firms. Of the 489 firms for which they obtained complete data, 409 were private corporations, 57 were state-owned enterprises, and 23 were mixed enterprises having both public and private control. The analysis was done for the year 1983 and was based on Fortune 500 data. The performance measures used were: four profitability measures (return on equity, return on assets, return on sales, and net income); two productivity measures (sales per employee and sales per asset); and assets per employee. These dependent variables were regressed against several independent variables, such as sales, assets and number of employees. Dummy variables were used for market concentration, industry, country, and ownership form. The study found that private-sector performance is superior. The average return on equity was plus 4.3 per cent for private corporations (PCs), minus 10 per cent for state-owned enterprises (SOEs) and minus 14 per cent for mixed enterprises (MEs). There was less difference among the three corporate types in return on assets and return on sales, although the order here too was the same as with return on equity. Net income again was highest in PCs, as well as sales per employee and sales per asset. Assets per employee were lower in PC s than in SOEs but higher than in MEs. However, the paper noted that while PCs were represented in all industries, SOEs were found most frequently in petroleum, metal manufacturing and

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transportation. Also, it is hard to explain why MEs fare worse than SOEs on key indicators, given that they have some private ownership. Another problem with this study is that it does not avoid selection bias; this could occur, for instance, if some of the state-owned firms happened to have been firms taken over by the state because they could not compete. A similar study was carried out by Picot and Kaufman (1989), using Fortune 500 data for six countries (UK, Canada, France, Germany, Italy, and Sweden) and fifteen industries. They too concluded that SOEs had lower rates of return and productivity than PCs. Dewenter and Malatesta (2001) attempt a more ambitious comparison of SOEs and private firms along the lines of Boardman and Vining study. They use Fortune 500 data over a 20-year period comprising a total of 1139 firm-years, of which 147 are government firms. The authors compare profitability, leverage and labour intensity at SOEs and private firms. Profitability is significantly higher at private firms but not leverage and labour intensity. The more striking part of the study is that the authors repeat the comparison, controlling for industry, location, business cycle effects, and firm size, thus seeking to address one of the principal criticisms of privatisation studies. Private firms do significantly better in respect of all variables. As against the Dewenter and Malatesta study must be set the evidence from other studies that confine themselves to SOEs and private firms in a given industry. There is evidence from several studies that, at least in some industries, public-sector performance compares favourably with that of the private sector. Caves and Christensen (1980), for instance, found that two railroads, one in the public sector and the other in the private sector, had almost the same levels of total factor productivity. This does lend some credence to the view that, in some industries at least, public-sector performance may not be inferior to the private sector. Other studies on regulated industries have also cast doubt on the supposed superiority of the private sector. Finsinger (1984) found public insurers had lower costs than private insurers. Yunker (1975) and Meyer (1975) found that in the US electric power industry, public-sector companies had lower costs per unit of output than private sector utilities. This finding was confirmed by Fare, Grosskopf and Logan (1985), who found a higher level of technical efficiency in publicly owned utilities. Martin and Parker (1997) review a number of other international studies that compared state and private-sector enterprises and find that the evidence is mixed; there are at least some studies that point to superior efficiency in the public sector. They conclude: ‘In sum, the international studies do not provide unequivocal support for privatisation programmes’. The authors also look at comparisons made in the UK between public- and private-sector companies. Here again, the diversity of results is striking. It must be added, though, that many of the studies cited seem not to have come


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to grips with the problem of comparing like with like; the public- and privatesector firms often belong to different (and not comparable) sectors. Galal et al. (1994) attempt an explanation as to why studies of privatisation come to contradictory conclusions. One reason is that some of the studies compare competitive enterprises in the private sector with monopoly enterprises in the public sector, and, not surprisingly, find superior performance in the former category. Second, some find private-sector performance legitimately superior because they are comparing reasonably competitive enterprises, and small public enterprises in a competitive situation cannot be expected to do better than private enterprises. Third, some of the studies compare public and private monopolies, and this is an area where, as the authors put it, ‘the results are all over the map’. (iii) Statistical analysis of pre- and post-privatisation performance In this category of studies are those that examine a large sample of firms that have undergone privatisation, whether in a given country or across several countries. Among the most detailed studies to date is one by Megginson, Nash and van Randenborgh (1994). They compared the pre- and post-privatisation financial and operating performance of 61 companies from 18 countries and 32 industries during the period 1961 to 1990. The comparison was done between performance three years before privatisation and three years after for each company, with the mean of each parameter being compared. They found increases in profitability, efficiency, capital spending, employment (which they admit is a surprising result), and real sales after divestiture. It is worth pointing out, however, that their study found the increase in profitability (measured by return on sales) to be insignificant for regulated industries, such as utilities and banking, which would appear to reinforce the doubts raised by some of the other studies mentioned earlier about the superior performance of the private sector in such industries. This celebrated study suffers from the common shortcomings of such studies noted earlier, namely, the failure to control for business-cycle effects (which in itself could contribute to improved performance in the postdivestiture period). Further, there is the problem of selection bias: the sample tends to be biased towards larger firms and the healthier SOEs, as the latter are most easily sold. If only the better firms are selected for privatisation and the inferior ones are left out, we would not know much about the impact privatisation has on the average. There are other shortcomings as well, both in this study and many others of its kind. Very often, there is restructuring ahead of privatisation, the benefits of which are realised in the post-privatisation period. Firms that have suffered from neglect for long are subjected to considerable attention – and this itself

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serves to improve performance. This is not factored in and the improvement in performance is incorrectly ascribed to the change in ownership. Not least, there is also the problem, cited earlier, of not disentangling the effects of privatisation from those of deregulation and economic liberalisation. John Nellis (1999) has a telling quote from Pankaj Tandon, one of the authors of the comprehensive study on the welfare effects of privatisation, cited earlier: . . . there are of course many cases where privatisation appears to have ‘resulted’ in efficiency improvement; in most of these cases, however, the privatisation appears to have been contemporaneous with deregulation or other types of competition-enhancing measures. A fourth problem with pre- and post-privatisation comparisons is that managers and workers would have no incentive to perform once the privatisation decision is announced and preparations are made to privatise a firm; indeed, they might have perverse incentives to under-perform if they were planning to take control. Once the new owners come in and demand results, performance will improve. The longer the privatisation process takes, the greater will be the degree of under-performance in the period before privatisation. Again, miracles will be attributed to privatisation by comparison with a period in which effective management under public ownership has been absent. Given the extraordinarily long period for which the Damocles’ sword of privatisation has hung over Indian public-sector enterprises, one must be fully prepared for precisely such flawed inferences to be drawn should Indian privatisation gather steam. One study that at least attempts to avoid the problem of selection bias is that on East European privatisation by Frydman, Gray, Hessel, and Rapaczynski (1999). They evaluate the impact of privatisation on firm performance, using a standard panel data treatment evaluation procedure, with privatisation viewed as the treatment variable. They compare the performance of the group subjected to the treatment (privatisation) with that of the non-treatment group (state firms), while controlling for potential pre-privatisation differences between the two groups. Annual rates of growth of performance measures (revenue, employment, etc.) are used to evaluate the impact of privatisation. The sample consisted entirely of firms that were state-owned at the beginning. The largest available sample consisted of 218 firms, 90 of them state-owned and 128 privatised, drawn from three countries, the Czech Republic, Hungary and Poland, and covers the period 1990–3. The authors found that privatisation works on the average in that it increases revenue and employment. But the authors go on to make the crucial point that such a statement does not address the issue at the appropriate level of generality. They find that privatisation involving insiders – whether


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employees or managers – does not have much have of an impact on performance, while privatisation involving outsiders makes a significant difference. Thus, the design of privatisation – how exactly privatisation is effected – has a crucial bearing on the results that follow. There is an important qualification to the benefits of privatisation that must be underscored. The effects of privatisation on employment seem, at the very least, to be ambiguous, both in industrial economies and elsewhere, a fact acknowledged by Megginson and Netter (2001) in their survey. In a democracy such as India’s, a decline in jobs consequent to privatisation would negate any improvements in firm performance that might ensue. The adverse impact on employment of privatisation, should this result or be seen as likely to result, would thus pose a major impediment to the pursuit of privatisation, especially where, as is true of India, a safety net for displaced workers and welfare schemes in general are almost non-existent. (iv) Privatisation in less-developed countries Many of the studies cited above have been carried out in the developed world economies. When it comes to less-developed countries (a category that, in the World Bank’s classification, excludes the transition economies of Eastern Europe), it becomes even more difficult to come by unambiguous evidence in favour of privatisation. In its review of privatisation programs, the World Bank (1992) noted, ‘Most privatisation success stories come from high- or middle-income countries. It is harder to privatise in low-income settings, where the process is more difficult to launch’, although the study was quick to add, ‘but even in low-income the results of some privatisation experiments have been highly positive’. It is interesting to note that the study by Megginson et al. (1994), cited above, while finding improvements in profitability in developing countries post-privatisation, found increases in efficiency only in companies headquartered in OECD countries. One of the earlier surveys done by Millward (1988) noted quite emphatically: ‘There is no evidence of a statistically satisfactory kind to suggest that public enterprises in LDCs have a lower level of technical efficiency than private firms operating at the same level of operation’. In its assessment of privatisation in sub-Saharan Africa, the World Bank (1994) concluded that ‘such limited privatisation has had little impact on efficiency and economic growth’. On Mexico, we have two studies with differing conclusions. Weiss (1995) looked at the 500 largest enterprises in Mexico over the period 1985–90, and compared measures such as sales at constant prices, sales per worker at constant prices and sales per unit of total assets at constant prices. His conclusion: ‘In terms of the influence of ownership, which is the main focus of this analysis, there is no support for the view that state ownership per se implies poor performance. . . . What is clear . . . is that the results give

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no support for privatisation of the remaining enterprises on efficiency grounds.’ The other study on Mexico, one that has a great deal of rigour to it, is by La Porta and Lopez-De-Silanes (1999) on Mexico. Their findings are diametrically opposite to those of the study mentioned above. The study covered 218 firms in 26 different sectors, privatised between 1983 and 1991. The authors examined seven broad indicators of performance: profitability; operating efficiency; employment and wages; capital investment; total output; prices; and taxes. For each firm, they measured the change in any given indicator of performance by comparing its value in 1993 (which falls in the postprivatisation period) to its average value over the four years preceding the privatisation of the firm. The mean (median) firm in their sample had been privatised 4.25 (4) years prior to 1993. They found that profitability, measured by the ratio of operating income to sales, increased by 24 percentage points. Operating efficiency improved significantly. The employment levels nearly halved, which points to transfers from workers to shareholders. Investment rose moderately. Real sales recorded a spectacular rise. (The authors suggest some of this might reflect redistribution away from customers who obtained firms’ output at low prices on account of incompetence or corruption; for example, theft was rampant at utilities.) The tax to sales ratio also rose significantly. The authors decomposed the gains into three components: increase in prices; reduction in workers; and productivity gains. They found that price increases accounted for a mere 5 per cent of the increase in profitability, while transfers from laid-off workers contributed 31 per cent of the increase; the remainder, the authors surmise, may be ascribed to productivity increases. The authors tested for business-cycle effects by adjusting the ratios for overall industrial or sectoral growth. The conclusions remained unaffected. The authors also tested for the effects of deregulation that was taking place along with privatisation, using dummy variables for various measures of deregulation. They found that deregulation was associated with much better post-privatisation performance: in other words, while privatisation contributes to improvement in performance, this effect is much greater with deregulation. This would seem to buttress the view that privatisation studies that do not disentangle the two effects are incorrect in ascribing all improvement in performance to privatisation. Finally, the authors suggest that the large improvements in performance owed to a great extent to the fact that control was transferred to outsiders through auction sales that were carried out in a transparent manner. Note, however, that even this study, which is probably more rigorous than most, rests on a comparison of financial performance in just one year after privatisation with a four year pre-privatisation average. This, of course, says little about post-privatisation performance over a longer period. More importantly, as mentioned earlier, one should not be


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surprised if, following a period of relative inertia in the run-up to privatisation, one gets superior results in the immediate aftermath of privatisation. Boubakri and Cosset (1998) looked at the impact of privatisation using data of 79 companies from 21 developing countries. They found significant improvements in return on sales, real sales and capital expenditure/sales, but, as with many of the studies in the industrial world, not in employment. In a more recent survey, Nellis (1999) notes observes that ‘the further east one travels, the less likely is one to see rapid or dramatic returns to privatisation’. He cites research on countries such as the Republic of Georgia, Mongolia, Kazakhstan, Ukraine, Moldova, the Czech Republic, and, of course, Russia, which casts doubt on the efficacy of privatisation. The same survey also draws attention to the fact, underlined by others such as Stiglitz, that China, which has adopted a cautious approach to privatisation, has nevertheless been among the fastest-growing economies in the world in recent years. Stiglitz (1998) suggests that the Chinese experience shows that ‘an economy might achieve more effective growth by focusing first on competition, leaving privatisation until later’. Nellis (1999) has telling comments on why privatisation has produced poor results in many contexts, including the disaster in Russia, which has been chronicled in some detail. Nellis is worth quoting at length because he happens to be associated with the World Bank, an agency that has prodded economies towards privatisation: The international financial institutions must bear some of the responsibility for the poor outcomes, since they so often insisted on the primacy of economic policy (or uncritically followed the lead of intensely committed reformers). That is, they requested and required transition governments to privatise rapidly and extensively, assuming that private ownership by itself would provide sufficient incentives to shareholders to monitor managerial behavior and push firms to good performance, Competitive policies and institutional safeguards could follow at a later date; the key need was to create a basic constituency of propertyowners. The prime assumption was that to build capitalism, one needed capitalists; lots of them, and fast. But capitalism is revealed to require much more than private property; it functions because of the widespread acceptance and enforcement in an economy of fundamental rules and safeguards that make the outcomes of exchange secure, predictable, and of reasonably widespread benefit. Where such rules and safeguards, such institutions are absent, what suffers is not just fairness and equity, but firm performance as well. Why? Because in an institutional vacuum the chances are high that no one in a privatised firm is interested in maintaining the long-run health of the assets. . . . In such circumstances, privatisation is more likely to lead to ‘stagnation and decapitalisation’ than to improved financial results and enhanced efficiency.

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There are, of course, good reasons why privatisation may not have quite the same impact in LDCs as in the developed world. It is by now well recognised that, broadly, two conditions need to be satisfied for successful outcomes to result from privatisation. The first is the prior existence of a market-friendly macroeconomic environment, supported by institutional and regulatory capacity, while the second is openness of the economy to competition. In many LDCs, neither of these conditions may be met adequately. More particularly, there are various adverse factors in play, such as weak law enforcement, thin capital markets, and the absence of mechanisms that spur private-sector performance, such as takeovers and monitoring by institutional shareholders (many of which apply in the Indian context). Under these circumstances, private ownership cannot be expected to produce high standards of performance. Indeed, many of the studies of privatisation in LDCs point to one or other of these factors to explain why privatisation has not quite produced the expected results.

2.4 Conclusion Megginson and Netter (2001) contend that privatisation ‘ “works” in the sense that divested firms always become more efficient, more profitable and financially healthier, and increase their capital investment spending’. Our brief survey of the theoretical and empirical literature must, at the very least, induce a measure of doubt with regard to such sweeping generalisations about the efficacy of privatisation. The case for superior performance under private ownership rests mainly on the existence of superior pecuniary incentives. These are said to ensure that agency problems are less acute under private ownership. Yet, as the problems of corporate governance in the US during the bubble years of the 1990s have shown, the existence of such incentives does not guarantee an alignment of managerial actions with shareholder interests. Moreover, the example of China demonstrates that there is no reason to suppose that public ownership precludes the institution of such incentives. Besides, it is not necessary to think of SOEs as exclusively governmentowned. Both in China and in India, many SOEs happen to listed and it is possible to devise incentives that align managerial actions with shareholder wealth creation. The proposition that agency problems are less acute under private ownership also presupposes a minimal degree of law enforcement and corporate governance. Where law enforcement and corporate governance are weak and capital markets underdeveloped – and we must expect both of these in most emerging markets – there is every likelihood that agency problems under private ownership will be as bad as or even worse than under public ownership.


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Successful privatisation in the industrial world is seen to have taken place in a context where capital markets are able to impose a fair degree of discipline. This is also a culture in which professional managers, with very small holdings of stock, are accountable to large institutional investors. Such a culture is yet to develop in many emerging markets, including India, where the corporate sector is dominated by industrial families with large shareholding. We shall explore this theme in greater detail in Chapter 7. Likewise, the empirical evidence on privatisation does not encourage sweeping generalisations about the impact of privatisation. Where privatisation is claimed to have delivered improvement, the methodological shortcomings of many of the studies to which we have drawn attention must cause many of these conclusions to be viewed with a measure of scepticism. Business-cycle effects are not taken into account, nor are the effects of deregulation and liberalisation. The time periods over which privatisation is seen to have shown improvement are often far too short for us to be satisfied with the conclusions. All too often, industry and size effects are ignored. Not least, there are studies where the same methodologies do not point to improvement or improvement on all counts. We have seen, for instance, that the evidence about the impact of privatisation in emerging markets is less emphatic than in developed markets. Similarly, regulated or monopolistic industries seem to be less susceptible to the vaunted effects of private ownership than are competitive businesses. The presumption that that private ownership will everywhere produce superior performance, regardless of such factors as the state of financial markets and the legal system, thus rests on weak ground.

3

Comparison of performance in industry and study of impact of privatisation, using financial measures

3.1 Introduction India’s SOEs are frequently condemned for their poor financial performance and are commonly perceived to be inferior to their private sector counterparts. Yet, for all the pronouncements that are made and duly echoed in the popular press, there have not been any systematic efforts to document these claims. The few studies that do exist are dated and, interestingly, offer little support to popular perceptions of shoddy performance on the part of the public sector. Bhaya (1990) compared performance over the period 1981–2 to 1985–6 by examining data published in the government’s Annual Survey of Industries (ASI). He looked at fixed capital, working capital and inventory in relation to net value added, as also gross output and net value added per employee. He found no difference, although the private sector did better in terms of return on investment. The magnitudes of the ratios were compared without being subjected to any tests of significance. Jha and Sahni (1992) compared performance in four industries: cement, cotton textiles, electricity, and iron and steel, again using ASI data over the period 1969–70 to 1982–3. They found no difference in performance. Ramaswamy and Renworth (1994) compared performance in the period 1998–9 to 1991–3, using balance sheet data for a sample of 55 firms from each of the two sectors. They used the same ratios employed by Bhaya, and found that no differences in managerial efficiency exist, although public sectors firms were less profitable. Ahluwalia (1995) cites a study by the Institute of Public Enterprises that compared the performance of 221 central public enterprises with that of 541 large companies in the private sector for the three years from 1983–4 to 1985–6. The average gross return on capital employed was found to be 13.9 per cent in the private sector and 12.3 per cent in the public sector. When petroleum enterprises were excluded from the public sector, the return for the public sector fell to 8 per cent. This comparison, be it noted, pertains to the pre-reform period when public sector companies lacked a profit orientation and freedom of pricing. Moreover, only large companies were included in the private sector sample.

Performance in industry: financial measures

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The same paper also cites a comparison made by the Centre for Monitoring the Indian Economy (CMIE), an independent Bombay-based database firm, over the period 1980–1 to 1989–90, again pre-dating the reform era. The ratio of gross profit to capital employed was found to be lower (although there is no indication that this was based on statistical testing) for the public sector. (The gross profit to sales ratio for the public sector, however, compared favourably with that of the private sector over the entire period.) Leaving aside the lack of rigour in many of these comparisons, there remains the issue of how meaningful such comparisons are in a period in which profit-maximisation was not over-riding objective of the public sector. We attempt here a rigorous comparison of public and private sector performance at the aggregate level, as well as at the level of industry groups.

3.2 Our methodology Our study is based on firm-level data available in the database Prowess, supplied by the Bombay-based independent agency, the Centre for Monitoring the Indian Economy (CMIE). The database provides detailed data for the period 1988–9 to 1999–2000, and this is the period that we cover. The period spans three years before the commencement of economic reforms and eight years after reforms. We carry out two exercises. First, we compare performance in public- and private-sector firms. Next, we focus on 39 firms in which a very limited form of privatisation has taken place and compare pre- and post-privatisation performance. To elaborate on the comparison between the public and private sectors first. We compare profitability and efficiency over three different periods: 1988–9 to 1999–2000, covering three years prior to economic reforms and eight subsequent years; 1991–2 to 1999–2000, covering nine years that belong entirely to the post-reform period; and 1994–5 to 1999–2000, covering the last six years in the post-reform period. Our intention here is to see what difference, if any, reforms have made to the comparison: is there a widening of the performance gap or is there a catching-up as the shackles were eased at firms both in the public and private sectors? The comparison of public- and private-sector firms is done at two levels. We first compare performance at the aggregate level. In the public sector, we focus on 227 firms that are controlled solely by the central government and are in the industrial sector. We exclude finance companies and banking firms. The firms included are thus overwhelmingly in manufacturing, with a few firms in services other than financial services. For the private sector, we choose all manufacturing firms and include both domestic and foreign firms, but exclude a category called ‘cooperatives’. The number of firms for which data are available varies from year to year. In the public sector, data are available for most of the firms for the greater part

46


Table 3.1 Descriptive statistics for the sample firms at aggregate level Sector

No. of firms

Mean Net Sales

Standard Deviation

Public Private

192 2730

13975.3 778.7

65903.69 2524.1

Note: All figures are 12-year averages; financial figures are presented in Rupee millions (Rs 47 $1)

of the period but not in the first two and last two years. In the private sector, the number of firms in the database varies from year to year, reflecting both exit of some old firms and entry of new ones. The descriptive statistics for the firms are provided in Table 3.1. Next, we compare performance of public and private sector firms in selected industrial sectors. We choose eight industrial sectors as per the CMIE’s classification. In this classification, a company falls in a given sector if 50 per cent or more of its output falls in that sector. The eight sectors chosen were: chemical, electronics, iron and steel, mineral products, service industry, textiles, and transport. (In a more recent classification, ‘iron and steel’ appears as part of a broader category called ‘Base metals’; however, we prefer to use ‘iron and steel’ as a separate category so as not to lump it with disparate non-ferrous metals.) These sectors together account for a total of 172 firms or 76 per cent of the 227 firms covered in this study, although the number of firms for which data are available varies from year to year. For reasons mentioned later, we have left out textiles, so that our analysis encompasses seven sectors. The descriptive statistics of firms in the seven sectors are provided in Table 3.2. The rationale for carrying out the analysis at a sector-level is two-fold. One is to see whether the results at the aggregate level hold true for diverse industrial sectors. Second, there is a perception that the public sector does well only in certain regulated or monopolistic sectors (chiefly petroleum and power) and that, minus these, the superiority of the private sector would be overwhelming. We would like to test whether this is indeed true. Both at the aggregate level and the sectoral level, we used three ratios to compare profitability. These were: net profit/net sales, net profit/net worth and profit before interest, and tax/ capital employed. We used another three ratios to compare efficiency: total cost/total income, net sales/net fixed assets and net sales/wages. A definition of these terms is provided in Appendix 3.1 at the end of this chapter. In some public-sector firms, the accumulated losses are so great as to wipe out the net worth, so that their net worth tends to be negative. This is partly because of the inability of the government, for political reasons, to close down public-sector firms and partly also because of the unsatisfactory bankruptcy procedures in India. (It could take more than ten years to close down a firm in conformity with the procedures laid down.)


47

Table 3.2 Descriptive statistics for sample firms in sectors Number of firms

Mean

Standard deviation

Sector

Private

Public

Private

Public

Private

Public

Chemical Electronics Steel Mineral Non-electrical Service Transport

426 165 241 67 150 343 124

12 10 10 28 7 44 5

518.7 418 646.2 304.9 452 390.9 1300.8

3957 3170.6 14141.6 24061.1 6492.4 8361.1 3212.5

1051.8 1011.2 2558.7 807.7 744 856.6 3982.9

4899.9 4844.5 35604.1 47422.7 12713.9 21725 4415

Note: All figures are for 1994; sales are net of excise duties; financial figures are presented in Rs million (Rs 47 $1)

At the sectoral level, we chose to exclude firms with a negative net worth, whether in the public sector or the private sector. This is for two reasons. First, as the net worth turns negative, the ratio net profit/net worth turns positive and becomes a misleading indicator both of the firm’s performance and of the aggregate performance of the sample. (At the aggregate level, we did not exclude firms with a negative net worth, partly because there is less distortion created at this level by the inclusion of a few firms with negative net worth, but also because we wanted to make comparisons as this is done conventionally. We would like to test how far conventional perceptions of performance are substantiated by rigorous comparisons.) Second, in many of the public-sector firms with large negative net worth, there is little business activity. It is just that employees continue to be on the payroll because of the government’s reluctance to retrench large numbers of workers in a context in which there is no social security net. Our comparisons of performance are very largely about making judgements on managerial efficiency in the two sectors. It is appropriate, therefore, not to include situations over which managers have no control, such as the inability to close down a firm whose net worth has turned negative. The inclusion of such firms in our sample is bound to detract from our objective, which is to compare operational efficiency in the firms being studied. It is worth mentioning that many of the conventional comparisons of performance in the public and private sectors in the Indian context are vitiated by sample biases of this sort. To give another example: there are private-sector firms that raised capital in the post-reform era but the promoters simply decamped with the funds. The number of such firms, referred to as ‘vanishing companies’, runs into hundreds. The finances of these firms would not enter into any database and this introduces a positive bias into estimates of private-sector performance. We found that, in the textile sector, the public sector consists overwhelmingly of negative net worth firms, leaving us with only two firms to compare with the private sector, and this for only a portion of the period.

48


Hence, we decided to not to proceed with the analysis of the textile sector. Accordingly, we present results for just seven sectors. We compare the means of the three ratios of profitability at the aggregate level, using the t-test; we do this separately for efficiency. We make the comparisons for three different periods: 1989–2000, 1992–2000 and 1995–2000. Thus, we have six comparisons for each period. We repeat the comparison of the six ratios for seven different sectors. We thus have 42 comparisons for each of the three periods at the sectoral level. It is often contended that the public sector’s performance is inflated by the performance of petroleum monopolies, and that excluding these from aggregate comparisons would be a better way of comparing public and private sectors in the aggregate. Our view is that, if this is to be done, then a large category of loss-making enterprises taken over from the private sector by the government (categorised by CMIE as ‘taken-over enterprises’) must be excluded from the public-sector sample. Second, the public-sector enterprises that we are analyzing are overwhelmingly in the industrial sector, whereas the private sector has a large number of firms in software services, which has been a dynamic sector of the Indian economy in recent years. To facilitate an appropriate comparison, we believe software services should be deleted from the private sector. We attempt this ‘adjusted’ comparison of public and private sectors as well. Finally, we evaluate the impact of the very limited form of privatisation that has taken place so far in India. As mentioned in Chapter 1, this goes by the name of ‘disinvestment’, whereby the government has made small sales of its equity holdings to financial institutions and the public. Of the 40 firms in which the government sold its equity between 1992–2 and 1996–7, we consider all but one firm that happens to be a development bank, i.e., 39 firms. (This chapter focuses on government firms in manufacturing and services other than financial services. The banking sector is considered in Chapter 5). Appendix 3.2 at the end of this chapter gives the list of firms in which divestment has taken place, and the government’s equity stake in various years. The share of government equity sold has not been significant. In 19 of the 40 firms in which disinvestment has taken place, equity sold added up to less than 10 per cent of the total equity; in seven, between 10 and 20 per cent; in six, between 20 and 30 per cent; in six, between 30 and 40 per cent; and in two, between 40 and 50 per cent. Moreover, most of the equity that has been sold far has been to government-owned financial institutions. There has been no transfer of controlling interest and management in any of the 40 firms. Nevertheless, even disinvestment was expected to stimulate better performance, first, by bringing into the picture shareholders other than the government (in some instances, foreign investors) and by getting management to focus on movements in quoted stock prices. We compare pre- and post-privatisation performance by comparing the means of the six finance ratios under consideration in this study. We consider


49

the year of initial disinvestment to be the year of privatisation and exclude that year from consideration (except for one instance where the initial disinvestments was less than one per cent and there was a higher level of disinvestment down the road.) The year of disinvestment was 1991–2 for 30 firms, 1992–3 for two firms and 1994–5 for seven firms. The pre-privatisation performance was computed as the mean for all the years from 1988–9 to the year prior to the year of privatisation; post-privatisation performance was computed as the mean for the all the years from one year after privatisation up to 1998–9. The year of privatisation was excluded from consideration. Of the 39 firms, three had negative net worth at some point and were deleted from the sample. The means of six ratios for the remaining 36 firms before and after privatisation were subjected to the t-test. In addition, the two sets of figures were compared using the Wilcoxon signed-rank tests. Thus, we have a total of 12 results available for comparison. In order to adjust for business-cycle effects, we repeat this comparison, using industry-adjusted ratios. The six ratios are computed for industry as a whole for each year. This industry-adjusted ratio for a given company is its own ratio minus the ratio for industry as a whole. The six ratios before and after privatisation were compared as above, using the t-test and the Wilcoxon ranked-sign test.

3.3 Results Aggregate data Comparison of profitability Table 3.3 gives the profitability results for the public and private sectors on the three measures used over the three different periods. Table 3.4 summarises the results in qualitative terms, indicating whether or not there was any difference in the performances of the two sectors. In 1989–2000, the private sector does better on two out of three ratios at a 5 per cent level of confidence. In 1992–2000, it does better on one ratio at a 5 per cent level and on one at a 10 per cent level. In the most recent period, there is no difference whatsoever. It is striking that, while in the first two periods the private sector’s means are higher in absolute terms, this trend is reversed in the last period. Then it is the public sector whose means are higher, although not in statistical terms. Comparison of efficiency The results on aggregate efficiency are given in Tables 3.5 and 3.6. As can be seen from Table 3.6, the private sector does better on two ratios in 1989–2000; in 1992–2000, it does better on the third as well, although only at a 10 per cent

50


Table 3.3 Comparison of aggregate profitability in the private and public sectors

1989–2000 Pat/Net sales Pat/Net worth PBIT/Capital 1992–2000 Pat/Net sales Pat/Net worth PBIT/Capital 1995–2000 Pat/Net sales Pat/Net worth PBIT/Capital

Private sector

Public sector

t-statistic

4.47% 12.36% 16.81%

3.88% 7.80% 11.18%

1.00 3.05a 4.57a

4.64% 11.20% 16.00%

4.05% 8.44% 12.00%

0.80 1.62 b 2.84a

4.63% 9.66% 14.37%

4.77% 10.01% 13.54%

0.15 0.20 0.68

Note: T-statistics that are significant at 5% or 10% level of significance are bold faced and carry sub-scripts of a and b respectively

Table 3.4 Summary of results on profitability across three periods

Parameter 1989–2000 Pat/Net sales Pat/Net worth PBIT/Capital Total 1992–2000 Pat/Net sales Pat/Net worth PBIT/Capital Total 1995–2000 Pat/Net sales Pat/Net worth PBIT/Capital Total

No difference

Private sector superior at 5% level


Public sector superior at 5% level


Total

1 0 0 1

0 1 1 2

0 0 0 0

0 0 0 0

0 0 0 0

1 1 1 3

1 0 0 1

0 0 1 1

0 1 0 1

0 0 0 0

0 0 0 0

1 1 1 3

1 1 1 3

0 0 0 0

0 0 0 0

0 0 0 0

0 0 0 0

1 1 1 3

51

Performance in industry: financial measures Table 3.5 Comparison of aggregate efficiency in the private and public sectors

1989–2000 TCost/TIncome NSales/NFA NS/Wages 1992–2000 TCost/TIncome NSales/NFA NS/Wages 1995–2000 TCost/TIncome NSales/NFA NS/Wages

Private sector

Public sector

t-statistic

77% 178% 1240%

81% 131% 1170%

5.51a 3.82a 1.1

78% 160% 1309%

81% 133% 1208%

4.5a 2.56a 1.57b

78% 146% 1360%

81% 140% 1262%

3.06a 0.59 1.22

Note: T-statistics that are significant at 5% or 10% level of significance are bold-faced and carry subscripts of a and b respectively

Table 3.6 Summary of results for aggregate efficiency in theprivate and public sectors

Parameter 1989–2000 TCost/TIncome NSales/NFA NS/Wages Total 1992–2000 TCost/TIncome NSales/NFA NS/Wages Total 1995–2000 TCost/TIncome NSales/NFA NS/Wages Total

No difference





Total

0 0 1 1

1 1 0 2

0 0 0 0

0 0 0 0

0 0 0 0

1 1 1 3

0 0 0 0

1 1 0 2

0 0 1 1

0 0 0 0

0 0 0 0

1 1 1 3

0 1 1 2

1 0 0 1

0 0 0 0

0 0 0 0

0 0 0 0

1 1 1 3

52


Table 3.7 Summary of results on aggregate profitability and efficiency

Parameter

No difference


1989–2000 1992–2000 1995–2000

2 1 5

4 3 1




Total

0 2 0

0 0 0

0 0 0

6 6 6

level of confidence. In 1995–2000, it does better only on one ratio, while there is no difference in two ratios. Combined results on profitability and efficiency The combined results on profitability and efficiency at the aggregate level are summarised in Table 3.7. In the total period under review, 1989–2000, the private sector is seen to do better in four out of six instances, with the remaining two being tied. In the post-reform period, 1992–2000, the private sector does even better: it has significantly superior results in five out of six instances, although in two instances only at a 10 per cent level. In the most recent period, 1995–2000, however, it does better in only one instance; in five instances, there is no difference between the two sectors. Comparison of adjusted profitability Tables 3.8 and 3.9 give the results for profitability and efficiency respectively in the public and private sectors on an adjusted basis. In these comparisons, we have computed the results for one more period, namely, the four-year period, 1997–2001, in addition to the three periods used earlier. The publicsector figures were calculated after excluding the petroleum sector and bankrupt firms taken over by the government from the private sector. The private-sector figures exclude software firms. As Table 3.8 shows, the private sector does better on all three parameters in the first two periods and on two out of three parameters in the third period. However, in the most recent period, there is a dramatic change: there is no difference in any of the three parameters. Thus, the results on profitability even on an adjusted basis point to a trend towards convergence in performance in the most recent period. However, we do not see such a trend in the efficiency results in Table 3.9: in all the four periods, the private sector emerges clearly superior. In the aggregate, therefore, the perception that any comparison between the public and private sectors would be unflattering to the former if the petroleum


53

Table 3.8 Comparison of aggregate profitability in the private and public sectors on an adjusted basis* Public sector 1989–2000 Pat/Net sales Pat/Net worth PBIT/Capital 1992–2000 Pat/Net sales Pat/Net worth PBIT/Capital 1995–2000 Pat/Net sales Pat/Net worth PBIT/Capital 1997–2000 Pat/Net sales Pat/Net worth PBIT/Capital

Private sector

t-statistic

2.73 4.58 9.59

4.38 12.17 16.70

2.72a 5.06a 5.86a

3.07 5.28 10.60

4.52 10.97 15.80

1.92a 3.35a 4.08a

3.49 6.09 11.70

4.46 9.35 14.24

0.91 1.51b 2.04a

3.44 5.85 12.09

3.04 6.38 12.58

0.52 0.34 0.57

Note: T-statistics that are significant at 5% or 10% level of significance are bold faced *Public sector statistics arrived at after removing petroleum companies and taken-over firms from dataset; private sector statistics exclude software firms

Table 3.9 Comparison of aggregate efficiency in the private and public sectors on adjusted basis*

1989–2000 TCost/TIncome NSales/NFA NS/Wages 1992–2000 TCost/TIncome NSales/NFA NS/Wages 1995–2000 TCost/TIncome NSales/NFA NS/Wages 1997–2000 TCost/TIncome NSales/NFA NS/Wages

Private sector (%)

Public sector (%)

t-statistic

84 98 742

77 177 1252

8.82a 6.95a 10.57a

84 99 745

78 159 1325

7.04a 6.83a 15.04a

85 103 722

78 146 1383

6.03a 6.35a 20.9a

85 104 696

80 137 1369

5.06a 5.58a 18.27a

Note: T-statistics that are significant at 5% or 10% level of significance are bold faced *Public sector statistics arrived at after removing petroleum companies and taken-over firms from dataset; private sector statistics exclude software firms

54


Table 3.10 Comparison of profitability in 1988–9 to 1999–2000

Chemical Pat/Net sales Pat/Net worth PBIT/Capital Electronics Pat/Net sales Pat/Net worth PBIT/Capital Steel Pat/Net sales Pat/Net worth PBIT/Capital Mineral Pat/Net sales Pat/Net worth PBIT/Capital Non-electrical Pat/Net sales Pat/Net worth PBIT/Capital Service Pat/Net sales Pat/Net worth PBIT/Capital Textile Pat/Net sales Pat/Net worth PBIT/Capital Transport Pat/Net sales Pat/Net worth PBIT/Capital

Private sector

Public sector

t-statistic

5.78% 14.22% 18.02%

3.07% 5.07% 10.77%

2.72a 5.76a 5.33a

5.07% 15.05% 21.50%

1.29% 3.91% 16.05%

2.99a 3.62a 2.34a

3.45% 7.86% 11.42%

0.82% 2.49% 5.04%

2.04a 2.55a 4.89a

4.50% 12.77% 15.77%

5.64% 11.61% 13.76%

1.63 b 0.4 0.57

5.39% 16.68% 25.21%

5.51% 14.18% 22.88%

0.08 1.47 1.066

5.36% 15.90% 18.75%

4.37% 12.00% 14.91%

1.19 2.11 2.49a

3.31% 9.69% 15.47%

2.15% 1.74% 2.72%

2.35a 4.01a 6.87a

4.95% 15.62% 21.39%

5.72% 12.99% 15.49%

0.94 1.38b 2.28a

Note: The first two columns represent means over the period; t-statistics that are significant at 5% or 10% are bold faced and carry subscripts of a and b respectively.

firms were omitted from the public sector is supported by the results, except for a comparison of profitability in the most recent period. However, this conclusion would still be subject to some of the caveats mentioned earlier: • •

A large number of private sector firms that disappeared after raising capital – the so-called ‘vanishing companies’ – do not figure in the data Social expenditure incurred by public sector firms – such as running schools, hospitals, town maintenance, etc. – are not excluded in the computation of profitability.


55



Private sector

Public sector

t-statistic

6.40% 13.89% 17.79%

3.25% 5.47% 11.68%

2.5a 4.0a 3.57a

5.99% 15.28% 21.43%

0.74% 2.63% 16.99%

3.47a 3.34a 1.53 b

3.31% 6.76% 10.54%

1.79% 4.08% 4.93%

2.08a 2.28a 3.93a

6.62% 10.08% 11.38%

5.49% 11.95% 14.28%

0.9 0.62 0.83

5.61% 15.75% 24.61%

6.09% 15.22% 24.07%

0.539 0.263 0.20

5.77% 14.95% 18.36%

5.06% 13.14% 16.20%

0.75 0.82 1.19

2.85% 6.97% 13.83%

2.65% 1.02% 3.12%

3.28a 3.23a 4.95a

5.24% 15.14% 21.14%

6.67% 14.17% 18.78%

1.81a 0.19 0.92

Note: The first two columns represent means over the period; t-statistics that are significant at 5% or 10% are bold faced and carry subscripts of a and b respectively

Sectoral analysis Profitability comparison The results for the different sectors for each of the three periods considered are summarised in Tables 3.10, 3.11 and 3.12 respectively. We can better compare performance between public and private firms by summarising the results on the three measures of profitability across the eight different sectors, as in Table 3.13.

56




Private sector

Public sector

t-statistic

7.05% 13.39% 17.22%

2.75% 4.59% 11.22%

2.5a 3.35a 2.66a

6.69% 14.65% 19.35%

0.82% 0.98% 15.88%

3.95a 3.20a 0.93

2.74% 4.88% 9.53%

1.54% 4.39% 5.39%

1.16 1.3 2.17a

5.35% 5.39% 5.63%

5.78% 12.91% 16.11%

0.26 4.46 8.21a

5.94% 15.16% 23.09%

7.11% 16.72% 27.41%

1.1 0.58 1.37 b

5.45% 11.66% 15.42%

5.87% 13.48% 16.55%

0.33 0.86 0.7

1.85% 3.52% 11.39%

2.73% 0.90% 0.51%

6.30% 16.68% 21.42%

7.12% 15.71% 21.62%

2.12a 1.68 b 8.97a 1.07 0.39 0.06


Looking first at the total period, 1989–2000, the private sector has significantly better results in 12 out of 21 instances or in 57 per cent of the cases. When we confine ourselves to the post-reform period, 1992–2000, the private sector is seen to do better in nine out of 21 instances or 43 per cent of the time. In the most recent period, 1995–2000, the private sector’s superiority on profitability is considerably less emphatic: six out of 21 or in 29 per cent of the cases. In the last period, the public sector does better in 14 per cent of the cases, with no difference in performance in the remaining 57 per cent.

57

Performance in industry: financial measures Table 3.13 Summary of results on profitability across three periods

Parameter 1989–2000 1. Pat/Net sales 2. Pat/Net worth 3. PBIT/Capital Total 1992–2000 1. Pat/Net sales 2. Pat/Net worth 3. PBIT/Capital Total 1995–2000 1. Pat/Net sales 2. Pat/Net worth 3. PBIT/Capital Total





Total

3 2 2 7

3 4 5 12

1 1 0 2

0 0 0 0

0 0 0 0

7 7 7 21

3 4 4 11

4 3 2 9

0 0 1 1

0 0 0 0

0 0 0 0

7 7 7 21

5 4 3 12

2 2 2 6

0 0 0 0

0 1 1 2

0 0 1 1

7 7 7 21

No difference

The results do suggest, therefore, that the public sector has been catching up with the private sector in respect of profitability with deregulation in the economy Efficiency comparison We repeated the analysis done above for the efficiency parameters chosen for this study. Tables 3.14–3.16 give the results for the three periods. Aggregating, as in the analysis of profitability, the results across the three measures of efficiency over the three different periods (Table 3.17) enables us to get a better handle on the differences in performance between the private and public sectors. In the complete period, the private sector has nine out of 21 results in its favour. This changes only slightly to ten out of 21 results over the shorter periods, 1992–2000 and 1995–2000, although in the latter case one result is at a 10 per cent level of confidence. However, whereas in the first period, ten out of 21 results were tied – or about 50 per cent of the cases – and the public sector had two in its favour, this changes in the subsequent two periods. In both the latter periods, there are ties in seven out of 21 results or in 33 per cent of the cases, and the public sector has four results in its favour. This reinforces the impression gained from the analysis of profitability that there is an element of catching up in the public sector’s performance in the most periods.

58


Table 3.14 Comparison of efficiency in 1988–9 to 1999–2000

Chemical TCost/TIncome NSales/NFA NS/Wages Electronics TCost/TIncome NSales/NFA NS/Wages Steel TCost/TIncome NSales/NFA NS/Wages Mineral TCost/TIncome NSales/NFA NS/Wages Non-electrical TCost/TIncome NSales/NFA NS/Wages Service TCost/TIncome NSales/NFA NS/Wages Transport TCost/TIncome NSales/NFA NS/Wages

Private sector

Public sector

t-statistic

79% 191% 1405%

95% 170% 1644%

15.22 1.51 2.2

81% 336% 1402%

86% 358% 482%

2.34 0.71 10.91

82% 123% 1378%

84% 72% 742%

0.5 3.44 10.43

80% 214% 1905%

78% 210% 1758%

0.97 0.07 0.64

81% 332% 898%

81% 514% 599%

0.13 6.22 11.56

87% 224% 1720%

87% 211% 1574%

0.10 0.74 1.23

76% 287% 1083%

89% 314% 381%

2.32 0.53 16.33


Combined results on profitability and efficiency Combining the results on profitability and efficiency (Table 3.18), we are in a better position to take a view on the comparative performances of public and private firms at the sectoral level. Over the entire period 1988–9 to 1999–2000, we get significantly higher scores for the private sector in 23 out of 42 instances, in 20 of these at the 5 per cent level of confidence. In the post-reform period, 1991–2 to 1999–2000, this figure falls to 20; and, in the most recent period 1995–6 to 1999–2000, it falls further to 16. The number of ties rises modestly from 17 in the aggregate period and 18 and 19 respectively in the two abbreviated periods. More strikingly, whereas there are only two instances of superior performance in the public sector in the full period under review, we get four and seven instances respectively of superior performance in the two shorter periods. The


59



Private sector

Public sector

t-statistic

79% 173% 1475%

95% 179% 1522%

13.09a 0.62 0.72

81% 312% 1381%

87% 381% 460%

2.73a 2.35a 8.75a

82% 104% 1432%

83% 70% 730%

0.034 5.15a 11.8a

78% 99% 2086%

79% 211% 1844%

0.64 3.24a 0.88

81% 310% 913%

81% 550% 579%

0.32 8.24a 11.74a

87% 222% 1860%

88% 188% 1541%

0.33 2.0a 2.61a

76% 278% 1135%

87% 364% 385%

1.79a 1.47 b 17.04a


advent of reforms may be said to have led to a narrowing of the gap between public and private firms in the industrial sectors studied here. Thus, the sectoral comparisons, which involve weeding out of negative net worth firms from the sample, reinforce the conclusion suggested by the cruder comparison made at the aggregate level about the trend towards convergence in comparison between the public and private sectors. The aggregate comparison suggests that it is the presence of petroleum firms alone that renders the performance of SOEs comparable to that of the private sector. This might foster the impression that, absent the petroleum firms, SOEs as a category have nothing to boast of. The broader point that is often sought to be made is that the performance of the public sector at the aggregate level is boosted by its performance in a

60




Private sector

Public sector

t-statistic

78% 165% 1492%

95% 170% 1433%

10.28a 0.45 1.29

82% 288% 1257%

90% 382% 413%

2.95a 2.63a 7.12a

81% 96% 1522%

83% 72% 687%

0.044 3.76a 18.27a

79% 39% 2271%

80% 215% 2087%

0.44 11.98a 0.54

82% 299% 911%

82% 590% 551%

0.14 12.05a 9.58a

88% 219% 1957%

88% 172% 1437%

0.28 3.59a 4.01a

76% 262% 1186%

89% 425% 390%

1.43 b 2.11 b 15.64a

Note: T-statistics that are significant at 5% or 10% level of significance are bold faced

few sub-sectors in which it has monopolies and that, absent these, the aggregate comparison would be extremely unfavourable to the public sector. It is useful, therefore, to look at how SOEs and private firms fare in individual sectors. We consider this in the next section. Performance of individual sectors We would now like to ascertain the sectors in which the private sector is seen to do better or vice versa. Let us start with sectors in which monopolistic conditions have obtained in sub-sectors. The broad categories we have considered cannot be said to constitute monopolies. Of the seven sectors we have studied, two fit the description of monopolistic conditions in varying degrees, namely, minerals and service.

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Performance in industry: financial measures Table 3.17 Summary of results on efficiency across three periods

No difference

Parameter 1989–2000 1. TCost/TIncome 2. Sales/NFA 3. NS/Wages Total 1992–2000 1. TCost/TIncome 2. Sales/NFA 3. NS/Wages Total 1995–2000 1. TCost/TIncome 2. Sales/NFA 3. NS/Wages Total





Total

4 4 2 10

3 1 4 8

0 1 0 1

0 1 1 2

0 0 0 0

7 7 7 21

4 1 2 7

3 2 5 10

0 0 0 0

0 3 0 3

0 1 0 1

7 7 7 21

4 1 2 7

2 2 5 9

1 0 0 1

0 3 0 3

0 1 0 1

7 7 7 21

Table 3.18 Summary of results on aggregate profitability and efficiency

Period

No difference


1989–2000 1992–2000 1995–2000

17 18 19

20 19 15




Total

3 1 1

2 3 5

0 1 2

42 42 42

In the mineral sector (Table 3.19), in the overall period 1989–2000, there is no difference in performance in five measures and the public sector does better on one at a 10 per cent level of confidence; in the period 1992–2000, again there is no difference in performance on five measures, and the public sector does better on one dimension at a 5 per cent level of confidence; in the last period, there is no difference on three measures and the public sector emerges superior on three measures. A plausible inference is that greater freedom of pricing has worked to the benefit of public firms that have operated in monopolistic conditions. In the service sector (Table 3.20), there is no difference in performance on four measures in all the three periods and the private sector does better on two

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Table 3.19 Summary of results on profitability and efficiency in the mineral sector

Period

Parameter

Private sector superior No at 5% difference level

1989–2000

Profitability Efficiency Total Profitability Efficiency Total Profitability Efficiency Total

2 3 5 3 2 5 1 2 3

1992–2000

1995–2000

0 0 0 0 0 0 0 0 0



Public sector superior at 10% level Total

0 0 0 0 0 0 0 0 0

0 0 0 0 1 1 2 1 3

1 0 1 0 0 0 0 0 0

3 3 6 3 3 6 3 3 6

Table 3.20 Summary of results on profitability and efficiency in the service sector

Period

Parameter


1989–2000


1 3 4 3 1 4 3 1 4

1992–2000

1995–2000

2 0 2 0 2 2 0 2 2




0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

3 3 6 3 3 6 3 3 6

measures. This is, perhaps, explained by the fact that this sector includes a large number of public sector firms that are not monopolies. Second, even firms that were monopolies at the beginning of reforms have been exposed to substantial competition in recent years. So, a fair conclusion would be that increased exposure to competition has made no difference in relative performance. Now to take up the other sectors, one by one. In the chemical sector (Table 3.21), which includes pharmaceutical and fertiliser firms, the private sector has superior results in five out of six instances in the total period; in the other two periods, the private sector does better in four out of six instances. The private sector seems to have a clear edge in this sector.

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Table 3.21 Summary of results on profitability and efficiency in the chemical sector

Period

Parameter


1989–2000


0 0 0 0 2 2 0 2 2

1992–2000

1995–2000

3 1 4 3 1 4 3 1 4




0 1 1 0 0 0 0 0 0

0 1 1 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

3 3 6 3 3 6 3 3 6

Table 3.22 Summary of results on profitability and efficiency in the electronics sector

Period

Parameter


1989–2000


0 1 1 0 0 0 1 0 1

1992–2000

1995–2000

3 2 5 2 2 4 2 2 4




0 0 0 1 0 1 0 0 0

0 0 0 0 1 1 0 1 1

0 0 0 0 0 0 0 0 0

3 3 6 3 3 6 3 3 6

In the electronics sector again (Table 3.22), the private sector demonstrates a convincingly superior performance. The scores for the three periods are: five, four and four respectively over the three periods studied. In steel (Table 3.23), the scores are five, five and three. Here, the public sector is seen to be catching up. In non-electrical machinery (Table 3.24), the two sectors are tied in the first two periods: we have four scores that are no different, one superior score each for the private and public sectors. In the last period, we have three ties, one superior score for the private sector and two superior scores for the public sector

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Table 3.23 Summary of results on profitability and efficiency in the steel sector

Period

Parameter


1989–2000


0 1 1 0 1 1 2 1 3

1992–2000

1995–2000

3 2 5 3 2 5 1 2 3




0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

0 0

3 3 6 3 3 6 3 3 6

Table 3.24 Summary of results on profitability and efficiency in the non-electrical machinery sector

Period

Parameter


1989–2000


3 1 4 3 1 4 2 1 3

1992–2000

1995–2000

0 1 1 0 1 1 0 1 1




0 0 0 0 0 0 0 0 0

0 1 1 0 1 1 0 1 1

0 0 0 0 0 0 1 0 1

3 3 6 3 3 6 3 3 6

In the transport sector (Table 3.25), while the private sector has three superior scores over the entire period, this comes down to two and one over the two shorter periods, with the public sector actually recording one superior score in each period. Thus, in this sector too, there is evidence of the gap between the private and public sectors narrowing in the post-reform era. In sum, the proposition that it is only a monopolistic presence that helps the public sector do well is hard to sustain, except possibly in the mineral sector. In only two sectors do we see the private sector having a majority of superior scores even in the most recent periods: chemical and electronics. In three other

65


Table 3.25 Summary of results on profitability and efficiency in the transport sector

Period

Parameter


1989–2000


1 1 2 2 0 2 3 0 3

1992–2000

1995–2000

1 2 3 0 2 2 0 1 1




1 0 1 0 0 0 0 1 1

0 0 0 1 0 1 0 0 0

0 0 0 0 1 1 0 1 1

3 3 6 3 3 6 3 3 6

sectors, steel, non-electrical machinery and transport, this is not the case and indeed in non-electrical machinery, the public sector has more superior scores than the private sector in the most recent period. Pre- and post-privatisation performance Changes in performance of sample firms Table 3.26 gives the results of our analysis of the performance of 39 stateowned enterprises before and after privatisation. Table 3.27 summarises the results in terms of the number of instances in which performance after privatisation improved, worsened or remained the same. In six out of 12 instances, there was no difference; in four instances, performance improved, two each at the 5 and 10 per cent confidence levels; and in two instances, performance worsened, one each at the 5 and 10 per cent confidence levels respectively. On balance, the results suggest that there has been either no improvement in performance consequent to disinvestments, or that such improvement has been small. A closer look at pre- and post-disinvestment performance We noted above that the improvement in performance for the sample as a whole has been quite small. It is worth looking at what happened at the level of individual firms. We have done so, taking into account the total of six measures of profitability and efficiency. Out of a total of 36 firms, 17 firms showed improvement in four or more parameters out of six (Table 3.28). Three firms showed improvement in three

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Table 3.26 Comparison of performance of state-owned enterprises before and after privatisation

A. Profitability Pat/Net sales Pat/Net worth PBIT/Capital B. Efficiency TCost/TIncome NSales/NFA NS/Wages

PrePrivatisation

PostPrivatisation

0.09 (5.88) 0.13 (12.13) 0.17 (15.04)

0.09 (6.43) 0.12 (11.65) 0.19 (15.66)

0.79 (78.48) 2.32 (2.23) 3.24 (3.13)

0.80 (80.86) 2.40 (2.37) 3.17 (1.13)

t-statistic

z-statistic

0.29

0.17

0.65

0.41

1.4 b

1.55

0.48

0.89

2.36a

2.18a

1.44b

2.36 b

Note: The table gives mean values before and after privatisation for the 39 firms under study. Means were compared using the t-test. The samples were also subjected to the Wilcoxon rank-signed test. Values significant at a 5 or 10 per cent confidence level are bold faced and denoted by a and b respectively.

Table 3.27 Summary of results on profitability and efficiency before and after privatisation Parameter

No difference

Better at 5% level

Better at 10% level

Worse at 5% level

Worse at 10% level

Total

Profitability Efficiency Total

4 2 6

0 2 2

2 0 2

0 1 1

0 1 1

6 6 12

Note: The table indicates in how many instances, the results showed no difference, better performance or worse performance after privatisation, based on the t-test and the Wilcoxon rank-signed test

parameters; the remaining 16 showed improvement in fewer than three parameters. Thus, 20 out of 36 firms showed an improvement in three or more parameters out of six. It is, of course, inappropriate to ascribe either the improvement or the worsening to disinvestment alone: the initial position of a given firm, overall economic as well industry-specific factors, deregulation, and the degree of autonomy enjoyed by a firm are all factors that would have impacted on firm performance. However, we are concerned here with addressing the proposition that firms in which disinvestment has taken place have shown no improvement post-


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Table 3.28 Post-privatisation performance of disinvested SOEs Company

Score

Andrew Yule & Co. Ltd M M T C Ltd. Bharat Earth Movers Ltd. Hindustan Organic Chemicals Ltd. Hindustan Zinc Ltd. State Trading Corpn. Of India Ltd. Hindustan Copper Ltd. Indian Oil Corpn. Ltd. Kudremukh Iron Ore Co. Ltd. Bharat Electronics Ltd. Bongaigaon Refinery & Petrochemicals Ltd. Chennai Petroleum Corpn. Ltd. Hindustan Petroleum Corpn. Ltd. ITI Ltd. Kochi Refineries Ltd. Steel Authority Of India Ltd. Bharat Petroleum Corpn. Ltd. Ircon International Ltd. Oil & Natural Gas Corpn. Ltd. CMC Ltd. Dredging Corpn. Of India Ltd. National Aluminium Co. Ltd. National Fertilizers Ltd. Neyveli Lignite Corpn. Ltd. Shipping Corpn. Of India Ltd. Videsh Sanchar Nigam Ltd. National Mineral Devp. Corpn. Ltd. Container Corpn. Of India Ltd. Engineers India Ltd. Bharat Heavy Electricals Ltd. Indian Petrochemicals Corpn. Ltd. Rashtriya Chemicals & Fertilizers Ltd. Gas Authority Of India Ltd. Fertilisers & Chemicals, Travancore Ltd. Mahanagar Telephone Nigam Ltd. India Tourism Devp. Corpn. Ltd.

0 0 1 1 1 1 1 1 1 2 2 2 2 2 2 2 3 3 3 4 4 4 4 4 4 4 4 4 4 5 5 5 5 6 6 6

Score indicates number of parameters out of six on which performance has improved; in the rest of the parameters performance has worsened

disinvestment. This is clearly not the case. There has been an improvement in the majority of firms, if we define improvement to mean improvement in three or more parameters out of six. To the extent that performance has improved in the majority of firms since disinvestment, it would appear to undermine the contention that the mere listing of public sector firms serves no purpose and that privatisation – or the transfer of control to a private party – is a necessary condition for any improvement.

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What has caused improvement in some firms but not in others? An examination of the 16 firms where performance has improved on fewer than three parameters – which is to say that performance has worsened or more than three parameters – since disinvestment provides useful clues. Of the 16 firms in question, five are petroleum companies. Performance has worsened since disinvestment because refining margins have been squeezed by the rise in crude oil prices during the period under review. But this ‘worsening’ in performance is an optical illusion to a large extent because profitability has merely gone down from abnormally high levels to a level that is still acceptable. More importantly, for most of the period under review, the petroleum companies operated under an administered price regime under which they would later be compensated for rises in international oil prices. Much the same applies to Bharat Electronics, which caters to the Indian defence industry and also to the consumer sector. One of the parameters, pat/net worth, shows only a marginal decline. If we were to ignore this small decline, then we would have improvement in three parameters out of six. One important parameter, pbit/capital employed, has in fact risen significantly post-disinvestment. We now turn to cases where the decline in performance is more real than in the above instances. In three cases, the absence of budgetary support coincided with a sharp decline in fortunes consequent upon deregulation. This effectively meant that the companies could neither raise capital on their own nor was government funding forthcoming. A brief account of each of these three cases follows. Hindustan Copper found itself having to compete with imports following reductions in tariffs. However, it lacked the funds needed for modernisation. The company needed to raise its smelting capacity to economic levels, reduce its workforce and close down unviable mines. However, the requisite funds were not forthcoming from the government. With the company moving into the red, it was unable to raise funds on its own either. So this is clearly an instance where disinvestment, unaccompanied by restructuring, led to worsening of performance following deregulation. Kudremukh Iron Ore Company’s fortunes were adversely impacted by fluctuations in iron ore prices and also by some financial investments going bad. But the company also suffered for want of a stable top management – it was without a Chief Executive for a long time and its Board of Directors was not fully filled. It also came up against a funding constraint during the period under review: it required funds in order to improve operations and extend its lease, but was unable to access these. Hindustan Organic Chemicals was adversely impacted by competition from imports as well as domestic producers. The company needed to downsize its workforce and also to scale up its plants. However, given that its profitability was driven down and also the adverse market conditions, it was unable to raise funds on its own.


69

This may be interpreted as proof of lack of competitiveness, but it could be contended that the government should have prepared the company for competition by incurring the necessary capital expenditure before the economy was exposed to greater competition. However, fiscal constraints apart, little thought seems to have been given to the ability of public-sector enterprises to cope with competition where once they had operated in a sheltered market. The declines at three companies, Andrew Yule, Bharat Earth Movers and SAIL, largely reflect industry-specific factors. Another company, Hindustan Zinc, was affected by trends in international prices and by the scarcity of power in the state in which it operates – both factors beyond management’s control. Only of three firms can we firmly state that disinvestment was an inadequate solution to their problems in the sense that even continued government support would not have made a difference. One of these, State Trading Corporation of India, an agency that is involved in making imports, has suffered on account of imports being opened up to private agencies: earlier STC had a monopoly over imports of several products. The firm now has only the government for its client. The firm has been unable to reduce its manpower costs in keeping with the decline in revenues, and it also lacks the nimbleness required in trading operations. So, disinvestment can be said to have been an inadequate remedy for this firm. That also holds for another trading house, MMTC, which handled government-related minerals and metals imports and exports. The other firm, Indian Telephone Industries, is an example of a publicsector company in which disinvestment failed to impart the necessary strengths in an increasingly competitive environment. The company has been adversely impacted partly by the decline in demand from its principal customer, the government’s Department of Telecommunications, but competition from multinationals has also been a factor. ITI has depended on Alcatel to supply it technology. With the opening up of the Indian market, Alcatel has become a competitor and cannot be relied upon to provide technological upgradation. To sum up, the majority of the firms in which disinvestment took place were intrinsically strong firms. This should not come as a surprise, given that it is the stronger firms that are privatised first in most privatisation programmes. Following disinvestment and economic liberalisation in general, these firms were able to adapt to the new environment by better focusing on profitability and by using opportunities to tap lower-cost capital from international markets in some cases. They were also helped after 1997 by the granting of greater autonomy with respect to capital expenditure, entering into joint ventures, etc. made possible by the categorisation of public sector enterprises into three categories: Navratna (literally ‘nine jewels’, a reference to nine strong performers in the public sector), Mini-Ratna I and Mini-Ratna II, with the degree of autonomy decreasing in descending order. Table 3.29 indicates

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Table 3.29 Firm-level analysis of pre-and post-disinvestment performance Company I.

Autonomy Status

Firms that have improved on four or more parameters out of six NA Dredging Corpn. Of India Ltd. MR-I National Aluminium Co. Ltd. MR-I National Fertilizers Ltd. MR-I Neyveli Lignite Corpn. Ltd. NA Shipping Corpn. Of India Ltd. MR-I Videsh Sanchar Nigam Ltd. Navratna National Mineral Devp. Corpn. Ltd. MR-I Container Corpn. Of India Ltd. MR-I Engineers India Ltd. MR-I Bharat Heavy Electricals Ltd. Navratna Indian Petrochemicals Corpn. Ltd. Navratna Rashtriya Chemicals & Fertilizers Ltd. MR-I Gas Authority Of India Ltd. Navratna Fertilisers & Chemicals, Travancore Ltd. MR-I Mahanagar Telephone Nigam Ltd. Navratna India Tourism Devp. Corpn. Ltd. MR-I II. Firms that have improved on three parameters out of six Bharat Petroleum Corpn. Ltd. Navratna Ircon International Ltd. MR-I Oil & Natural Gas Corpn. Ltd. Navratna II. Firms that have improved their performance on less than three parameters out of six Andrew Yule & Co. Ltd NA MMTC Ltd. MR-I Bharat Earth Movers Ltd. MR-II Hindustan Organic Chemicals Ltd. MR-I Hindustan Zinc Ltd. MR-I State Trading Corpn. Of India Ltd. MR-I Hindustan Copper Ltd. NA Indian Oil Corpn. Ltd. Navratna Kudremukh Iron Ore Co. Ltd. MR-I Bharat Electronics Ltd. MR-I Bongaigaon Refinery & Petrochemicals Ltd. MR-I Chennai Petroleum Corpn. Ltd. MR-I Hindustan Petroleum Corpn. Ltd. Navratna ITI Ltd. NA Kochi Refineries Ltd. MR-I Steel Authority Of India Ltd. Navratna Note: NA – No rating available for company MR-I: Mini-Ratna I MR-II: Mini-Ratna II


71

the status in respect of autonomy of each of the firms in which disinvestment was undertaken. A few firms that had been created in a context of a sheltered market and with an assured buyer in the government simply lost their rationale in the new environment. The rest of the firms, however, suffered because they had not been prepared for the shock of deregulation. It must be remembered that the bout of economic reforms that was inaugurated in 1991 was a response to an acute balance-of-payments crisis and was dictated by the need to meet conditions set by the IMF, from whom financial assistance had been sought. Many SOEs were thus exposed to competition without suitable preparation. Had they been listed much earlier when they were stronger, they could have raised funds from the market and prepared themselves for change. Not only was this not done but the government was unable to provide them with funds, given that the federal budget was severely strained. A further complication was that the Indian stock market has been repeatedly rocked by scandal in the decade since reforms, and there has been an erosion of investor confidence. Their own weaknesses apart, this precluded any possibility of many of the public-sector firms accessing funds for modernisation and restructuring from the stock market. It is this combination of factors that has caused a deterioration in performance in 16 out of the 26 firms in which disinvestment has taken place. It would be incorrect to ascribe the deterioration to ownership per se. Case studies We have thus far compared the performance of SOEs before and after disinvestment, and have examined whether managerial autonomy and capital expenditure might explain why some SOEs have fared better after disinvestments and others note. In this section, we take up three case studies of SOEs whose performance has improved and attempt to document the strengths of these companies, as also the positive changes that disinvestment might have ushered into these companies. Bharat Heavy Electricals Limited (BHEL) BHEL is a public sector company worth examining in depth because it exemplifies some of the best possibilities under government ownership (Table 3.30). (i) Background Established in 1964, BHEL is the dominant player in the electrical industry in the whole country. Its operations fall into two broad categories: power equipment and industrial products. In the power sector, BHEL is in the business of designing and erecting power plants, supply equipment and providing maintenance. Industrial products cover a range

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Privatisation in India Table 3.30 Profile of BHEL (Rs in million)

Sales Net Profit

1999–00

1998–99

1997–98

66340 5994

67950 5446

64710 7195

of transmission products, transportation products and other electrical equipment. The company has operations spread over 14 locations. The power sector was the preserve of the government until 1991, when resource constraints impelled the government towards opening up the sector to private investment. The main consumers in the industry are the state electricity boards and utilities set up by the federal government. In the power sector, BHEL faces competition within India from the likes of Siemens, ABB and GE. Despite such competition, BHEL has been successful in winning orders in competitive bidding and it has been responsible for setting up 65 per cent of total capacity in the power sector. (ii) Sources of competitive advantage BHEL is small compared to the players who dominate the industry internationally. However, it remains competitive in the Indian market for a number of reasons. Indeed, it is an example of how a national champion can cope with competition from bigger global players even after tariff and other barriers to entry have been scaled down. The sources of competitive advantage are: • • •

• •

Depreciated plant and equipment. This, along with land cost, constitutes a major entry barrier. Availability of domestic manufacturing facilities, which is vital in an industry in which freight costs are high. Low employee costs, partly because of the wage levels in India in general, but equally because managerial compensation in the public sector tends to be much below the levels in the private sector. This has not resulted in any significant loss of personnel to competition, partly because enterprises such as BHEL can offer generous housing and medical care benefits. These, along with security of employment, suffice to contain employee turnover at acceptable levels. Fully integrated operations, which enable the company to meet the entire range of customer needs. Diversified product mix, which has helped cushion revenues from earnings volatility in the power sector.

(iii) Impact of disinvestment The government first sold 20 per cent of its equity in BHEL in 1991–2. Subsequent sales have resulted in 32 per cent of equity resting with private shareholders. This is a significant amount of


73

Table 3.31 BHEL’s key ratios before and after disinvestments

Pat/Net Sales Pbit/Capital Employed Pat/Net Worth

Average Predisinvestment (%)

Average Postdisinvestment (%)

3.13 20.62 10.53

6.89 28.70 19.15

floating stock in the Indian context, and not just by the standards of publicsector firms (Table 3.31). BHEL was a strong organisation at the time of disinvestment, so it would be incorrect to ascribe the improvement in its results – as noted earlier, all three parameters of profitability have improved since disinvestment – to the fact of disinvestment. Indeed, one of the key strategic moves made by BHEL, diversifying into industrial products, was made in the 1980s before disinvestment took place; this move stood it in good stead in the 1990s when investment in the power sector declined sharply. However, it is fair to suggest that the company has been better able to leverage its strengths in consequence of disinvestment. There are a number of reasons for this. The key change ushered in by the induction of outside shareholders is a keener appreciation of the objectives of profitability and maximisation of shareholder value in both the government and the company. This is reflected in the change in weight assigned to profitability in the annual Memorandum of Understanding signed by the company with the parent ministry. This weight changed from 30 per cent in the early 1990s to more than 60 per cent. Senior executives at the company also stress the benefits from interaction with institutional investors and analysts. The Chairman spends an average of five to seven hours a week interacting with the investing community and responding to questions about the outlook for profitability and share prices. The frequent visits of analysts to the company and their interaction with executives down the line have also contributed to a heightened profit orientation in the company. This greater focus on profitability has manifested itself in several ways. The company has pruned labour costs through a voluntary retirement scheme. As a result, the size of the workforce declined from 62,000 to 48,000 during the period. It has centralised sourcing of key raw materials, and this has resulted in cost savings. It has moved to address its high level of receivables by focusing on business where payments can be recovered faster. Not least, it has adopted superior project management techniques that have helped reduced cycle times and improve cash flows. Yet another change consequent to disinvestment is that the company has entered into alliances with its competitors where it might have been unable to

74


obtain a contract on its own. This has required BHEL to adopt the role of a sub-contractor instead of seeking the entire contract for itself. BHEL’s competitors, for their part, have been happy to use BHEL’s position as a low-cost producer to further their business in India. This has also enabled BHEL to overcome its inability to come anywhere near the research and development (R&D) spend of its international competitors and to provide the latest technologies on its own. At the same time, BHEL has sought to get the biggest bang for its R&D buck by networking with research institutions in the country and farming out research projects to these. This enables BHEL to make use of India’s low-cost technical manpower without adding to its fixed-cost base. BHEL’s inability to match financing packages offered by competitors has been considered a handicap, as financing is very often the key to winning power contracts. The company has moved since disinvestment to overcome this disability as well. Its debt–equity ratio being very low, it has raised Rs 5 bn worth of bonds to augment its finances. It has also entered into arrangements with financial institutions to provide finance where required. Part of the dynamism acquired by the company consequent to disinvestment is the result of greater autonomy conferred by the government. In 1997, BHEL was one of nine enterprises characterised as ‘Navratnas’ (i.e. the nine jewels; later this list was expanded to 11 as noted earlier) that deserved greater autonomy. In these instances, the government amended rules to permit capital spending without authorisation, signing of technical collaborations and creation of joint ventures without requiring prior authorisation from the ministry. This has imparted a certain nimbleness to the company. With greater autonomy has also come greater professionalisation of the Board. BHEL’s 12-member board has six operating directors, two government nominees and four independent directors appointed through a search committee constituted for the purpose. Some of the independent directors have been leading executives from the private sector. BHEL illustrates not only the possibilities of disinvestment but also why, in some cases, it may be unwise to rush into outright privatisation, i.e., transfer of control to a private party. One of the reasons put forward for privatisation, namely access to funds required for providing finance packages, has turned out to be less compelling than previously thought for the reasons mentioned above; BHEL has adapted successfully to this constraint. The other reason is that the induction of a large international player alone can enable BHEL to retain its edge technologically. As mentioned, BHEL has got round this problem by making it attractive for its competitors to collaborate in the bidding for contracts. But, also, the induction of a strategic partner could create serious dislocation at BHEL because the company has sourced technology over the years from multiple sources. If any large player is brought in as a strategic partner, all other sources of technology will dry up and BHEL will have to move to a single technology across the board. This could take years and entail significant costs for BHEL.


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Table 3.32 Profile of HPCL (Rs in bn) Particulars

1999–00

1998–99

1997–98

Sales Net Profit

338 11

239 9

144 7

It is not just BHEL’s strong performance but also various factors specific to the firm that argue against handing over control to a strategic partner. BHEL’s experience thus suggests that the approach to privatisation has to take into account not only the specifics of a given context but the specifics of firms as well. A dogmatic or formulaic approach is unlikely to foster the objectives that drive privatisation. Hindustan Petroleum Company Limited (HPCL) HPCL is one of three integrated oil companies in India. It has a refining capacity of 12.5 million tonnes and is a partner in a joint venture that has a refining capacity of 9 million tonnes. The company has a 20 per cent share of the market and a 12 per cent share of refining capacity. Its retail outlets, numbering 4600 and spread all over the country, testify to the investment that public-sector companies in India have made in distribution. The government holds a 51 per cent share in its equity with the balance being distributed among government-owned banks, foreign institutions and individuals (Table 3.32). Petroleum products have long been subject to an administered price regime, with prices being set in relation to a determined return on capital. The administered price mechanism for refinery products was dismantled in 1998. With effect from April 2002, this mechanism was dismantled for marketing as well and retail prices were thereafter linked to international prices of crude. Thus, the story of deregulation in the oil industry is a sub-story within the larger context of economic deregulation in India. HPCL illustrates where the better-performing public sector companies derive their strengths from: engineering competence, relentless investment in infrastructure (such as pipelines), relatively low-cost manpower, and formidable distribution reach. Transportation by pipelines costs only about a third of the cost of transport by rail. In India, only about 20–25 per cent of petroleum is transported by pipelines, compared to around 60 per cent in the developed world. The tariffs charged for supply through pipelines have been regulated by the government. With deregulation, HPCL’s investment in pipelines should provide a boost to profitability. A retail outlet would cost Rs 10 m. This means that a new entrant would have to invest Rs 46 bn (or nearly US$ 1 bn) to match HPCL’s retail reach.

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Privatisation in India Table 3.33 HPCL’s key ratios before and after disinvestment




2.72 27.70 26.52

3.30 27.41 19.61

Post-disinvestment performance More so than in other cases, it is difficult in the case of HPCL to disentangle the effects of disinvestment per se from those of deregulation. This is because deregulation has been a very big factor in the oil industry. Moreover, HPCL has been a consistently profit-making company: its net profit has grown at a compound rate of 25 per cent since 1974. In response to a questionnaire, the company concedes that listing and the associated accountability to a large body of shareholders made a difference to its performance, but believes that deregulation and the opportunities as well as threats it has created have contributed more towards a profit orientation in the company (Table 3.33). ‘The orientation towards profitability’, the company says, ‘has manifested itself in increased emphasis on cost reduction, improved productivity, higher efficiency, faster decision-making, logistics planning, investment to improve logistics and reduction in basic cost, customer orientation, innovative marketing, etc.’. Another factor that has helped, according to the company, is the induction of independent directors on the board, which reinforces what we have heard from other strong public-sector companies. The oil sector has been thrown open to the private sector in recent years. While three major industrial groups in the private sector have set up oil companies, none has yet been able to mount a challenge to the entrenched public-sector companies. One of these (Mangalore Refineries and Petrochemicals Limited) was set up as a joint venture with HPCL but with private-sector management. The venture accumulated losses and the private partner, the Aditya Birla group (one of India’s biggest), exited the company after selling its stake to ONGC, an SOE. This underscores the competitive strengths of the stronger publicsector firms in India. It is a different matter that these strengths have not been reflected in financial performance, either because of controls of one form or another or because of the multiplicity of objectives with which public-sector firms had been saddled. National Aluminium Company (Nalco) No case typifies the controversies that have swirled around India’s programme of privatisation better than Nalco (Table 3.34). One of India’s leading aluminium producers, this public-sector company is seen as the pride of the


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Table 3.34 Profile of Nalco (Rs in bn)

Total Income Net Profit

1999–00

2000–01

2001–02

23.03 5.1

25.5 6.6

25.4 4.1

Source: Prowess database, CMIE

eastern Indian state of Orissa and attempts at transferring a controlling interest to a private buyer have aroused strong passions among the locals. In the event, Nalco’s privatisation has become something of an on-again, offagain story, with the government promising a combination of a public offer and a strategic sale and, up to now, carrying out neither. Nalco, originally promoted in collaboration with Aluminium Pechiney of France, produces alumina and aluminium metal, with installed capacities of 1.05 m tonnes and 230,000 tonnes respectively. It is the largest producer and exporter of alumina in India. It competes with the privatised Balco and Hindalco, part of the industrial house of Aditya Birla. Nalco is among the lowest-cost producers of alumina and aluminium in the world, with estimated cost of production of $104/tonne and $855/tonne for alumina and aluminium respectively. This is the result of several favourable factors: •

• •

Proximity to plentiful reserves of bauxite of high quality. The reserves on the Indian east coast are said to be the largest in Asia and the fifth largest in the world. Fully integrated operations, including captive power, rail and port facilities. Use of sophisticated production technologies.

On the flip side, the company’s dependence on lower-end products makes it extremely sensitive to fluctuations in the international price of aluminium. The company has moved to address this shortcoming through investment in downstream operations, for instance through the acquisition of International Aluminium Products Limited in March 2000. It is true that the primary aluminium industry in India has only three major players (although there are plenty of players in aluminium products) thanks to the high entry barrier in the shape of capital costs. Nevertheless, competition among the players is quite intense, and besides, players are now exposed to international competition. Nalco demonstrates in many ways the ability of a strong SOE to retain its competitive edge through continuous expansion and upgradation. Post-disinvestment performance As Table 3.35 shows, Nalco’s profitability ratios improved dramatically post-disinvestment. There is the familiar problem, of course, of disentangling the effect of disinvestments from

78

Privatisation in India Table 3.35 Nalco’s key ratios before and after disinvestment




11.10 7.30 6.11

23.87 12.57 13.95

Table 3.36 Comparison of industry-adjusted performance of state-owned enterprises before and after privatisation

A. Profitability Pat/Net sales Pat/Net worth PBIT/Capital B. Efficiency TCost/TIncome NSales/NFA NS/Wages

Preprivatisation

Postprivatisation

tstatistic

Significance

zstatistic

Significance

5.38% 3.63% 4.00%

3.99% 2.27% 0.49%

1.37 0.68 2.31

0.09 0.25 0.01

1.37 0.27 2.5

0.08 0.39 0.01

1.75% 1036.00% 2984.00%

6.05% 979.00% 2050.00%

3.11 0.47 2.3

0.00 0.31 0.01

2.76 1.49 3.71

0 0.07 0

Note: The table gives mean values before and after privatisation for the 39 firms under study. Means were compared using the t-test. The samples were also subjected to the Wilcoxon rank-signed test. Values significant at a 5 or 10 per cent confidence level are bold faced and denoted by a and b respectively.

Table 3.37 Summary of results on profitability and efficiency before and after privatisation Parameter

No difference

Better at 5% level

Better at 10% level

Worse at 5% level

Worse at 10% level

Total

Profitability Efficiency Total

2 1 3

0 0 0

0 1 1

2 2 4

2 2 4

6 6 12

Note: The table indicates in how many instances, the results showed no difference, better performance or worse performance after privatization, based on the t-test and the Wilcoxon rank-signed test

business-cycle effects, a problem that is especially acute in an industry whose fortunes are closely linked to international metal prices. However, what can be stated safely is that the company has managed to preserve its competitive position through both expansions in capacity and modernisation and upgradation of facilities, in some sense reflecting the hardcore technological capabilities of India’s better-run SOEs.


79

The company’s stock price has seen a sharp rise and its price–earnings multiple, which was historically lower than that of its peers in India and abroad, has moved ahead of those of peers. This is generally ascribed to the prospect of strategic sale. However, as both a domestic and international public offer have been simultaneously announced, this explanation seems a little glib. Comparison of industry-adjusted performance of sample firms Finally, we have also compared performance, using industry-adjusted ratios. Tables 3.36 and 3.37 present the results. We find that performance worsened in eight out of 12 instances, four each at a five and ten per cent confidence level; there was no difference in three instances and in one instance performance improved.

3.4 Conclusion Two broad conclusions are possible from the analysis of performance of the private and public sectors in India at the aggregate and disaggregated levels. First, when we look at a long period covering both the pre-reform and postreform years, the private sector appears to have done much better. We get four out of six results in favour of the private sector at the aggregate level and 23 out of 42 at the disaggregated level. However, when we look at the most recent period, we find the gap narrowing considerably. At the aggregate level, there is only one out of six results in favour of the private sector and at the disaggregated level 16 out of 42 results. A first plausible explanation is that in the controlled era, there was a tendency to underprice public-sector goods in what was perceived to be the larger public interest. With deregulation, there has undoubtedly been greater freedom in pricing for public-sector firms. Second, the government has taken steps to confer greater autonomy on public-sector firms and this has conceivably made a difference to performance. Third, there is also greater profit orientation in the public sector – as distinct from the ‘social objectives’ favoured in an earlier era – and a focus on shareholder value among many that have been listed. (One sign of this is the large-scale retrenchment of labour through voluntary retirement schemes.) All in all, SOEs seem to have responded well to the greater competition and operational freedom ushered in by deregulation. As we saw in our discussion of the impact of disinvestment on BHEL, listing on the exchanges and the induction of private shareholders in itself seems to have contributed towards enhanced profit orientation at some SOEs. And finally, many SOEs have the advantages of size and they have been better able to leverage this advantage consequent to deregulation.

80

Privatisation in India Table 3.38 Comparison of debt-equity ratios in the public and private sectors

Sample size Cos with d/e less than 0.5 Cos with d/e between 0.5 and 1 Cos with d/e between 1 and 2 Cos with d/e greater than 2

Private

Public

3938 31.31% 21.91% 24.35% 22.35%

83 43.37% 22.89% 12.05% 21.69%

It has often been contended that the only SOEs that do well are those that are in regulated or monopolistic industries (notably, petroleum and telecommunications). Our analysis at the sectoral level, however, indicates that the private sector does not do uniformly better in sectors where the public sector does not have monopolies. Of the seven sectors we analysed, two have sub-sectors in which the public sector has or has had monopolies. In the remaining five sectors, private firms have consistently fared better only in two. It does appear, therefore, that the perception of public sector under-performance is based on the performance of an earlier era and has not taken into account the improvements in the most recent period. It is only when we eliminate petroleum firms from the public sector sample that we find that the comparison is favourable to the private sector for all three periods. Even in this comparison, when we look at the most recent four-year period, we find the public sector catching up on profitability. One issue about comparisons of performance between the public and private sectors that is worth highlighting is that very often the sole measure used is profit/net worth. Such comparisons can be misleading because the public sector has a lower debt/equity ratio and this tends to depress return on net worth. We compared the debt/equity ratios for the central public sector firms and for private firms in 1999, after eliminating firms with negative net worth from both lists. The results are shown in Table 3.38. The proportion of publicsector firms with debt–equity ratio less than 1 is 67 per cent, compared with 52 per cent for the private sector. Thus, at the very least, the use of the profit/net worth for purposes of comparison needs to be supplemented by the use of other measures, as we have done in this study. As regards the limited privatisation that has taken place, it does appear that merely listing the companies in question has not, on the average, contributed to better performance. However, we also find that, while on the average performance may not have improved, 20 out of 36 firms showed an improvement in three or more parameters out of a total of six parameters of profitability and efficiency. An examination of the 16 cases where there was deterioration in performance suggests that industry-related factors and an inability to fund capital


81

expenditure were important causal factors for the decline in performance at several firms. Two of these 15 firms largely lost their rationale in the deregulated environment, as they had been set up to meet needs in a controlled environment. More importantly, we documented cases where government ownership has been consistent with strong performance thanks to the intrinsic competitive advantages of the firms in question and also the grant of greater autonomy to public sector firms. Where SOEs were in good shape to face the onslaught of deregulation, were able to fund capital expenditure and were granted a measure of autonomy, they were able to improve performance consequent to disinvestments. Thus, on the whole, the experience in India thus far does suggest that any contention that disinvestment does not work and that a transfer of control to private owners alone can deliver improvement is ill-founded. Improved performance at SOEs thus requires firm-specific solutions rather than solutions based on dogmas about the superiority of private ownership.

82


Appendix 3.1 Description of variables used Variable

Description

pat net sales pbit capital employed

profit after tax sales indirect taxes (net profit tax exp interest lease rent) equity capital pref capital reserves revaluation reserves – miscellaneous expenditure not written off total borrowings short-term bank borrowings – commercial paper equity capital pref capital reserves revaluation reserves misc expenditure not written off) cost of sales administration and other costs sales other income change in stocks net fixed assets

net worth total cost total income Nfa

Appendix 3.2 Details of shares disinvested since 1991–2, by year and by PSE % of Central Govt. Holding No. Name of the PSE 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Andrew Yule Bharat Earthmovers Ltd. Bharat Electronics Ltd. Bharat Heavy Electricals Ltd. Bharat Petroleum Corpn. Ltd. Bongaigaon Refineries & Petro. Ltd. CMC Ltd. Cochin Refineries Ltd. Dredging Corpn. Ltd. Fert. & Chem (Travancore) Ltd. HMT Ltd. Hindustan Cables Ltd. Hindustan Copper Ltd. Hindustan Organic Chemicals Ltd. Hindustan Pertoleum Corpn. Ltd. Hindustan Photofilms Mfg. Co. Ltd. Hindustan Zinc Ltd. Indian Petrochemicals Corpn. Ltd. Indian Railway Const. Co. Ltd. Indian Telephone Industries Ltd.

1.7.91 31.3.92 31.3.92 31.3.94 31.3.95 31.3.96 71.30 100.00 100.00 100.00 100.00 100.00

62.80 80.00 80.00 80.00 80.00 80.00

62.80 80.00 80.00 79.54 70.00 74.60

62.80 80.00 80.00 79.46 69.62 74.59

62.80 60.08 75.86 67.72 66.20 74.47

62.80 60.08 75.86 67.72 66.20 74.47

100 61.16 100.00 98.69

83.31 55.04 98.56 97.46

83.31 55.04 98.56 97.35

83.31 55.04 98.56 97.35

83.31 55.04 98.56 97.35

83.31 55.04 98.56 97.35

100.00 95.14 100.00 96.36 100.00 100.00 100.00 80.00

90.32 97.97 98.88 80.00

90.32 97.97 98.88 80.00

90.32 97.97 98.88 56.90

90.32 95.97 98.88 56.90

100.00

80.00

70.00

69.72

60.25 51.00*

100.00

87.47

87.47

87.47

87.47 87.47

100.00 100.00

80.04 80.00

75.93 80.97

75.93 62.40

75.92 75.07 62.40 61.43

100.00

99.74

99.74

99.74

99.74 99.74

99.65

79.72

77.79

77.67

77.02 77.02


83

Appendix 3.2 (continued) % of Central Govt. Holding No. Name of the PSE

1.7.91 31.3.92 31.3.92 31.3.94 31.3.95 31.3.96

21 22

84.62 100.00

67.70 80.00

67.70 80.00

51.80 80.00

51.80 51.80 67.18 65.73

100.00

99.33

99.33

99.33

99.33 99.33

100.00 97.28 100.00 97.72 100.00 100.00

87.20 97.66 98.38

87.19 97.66 98.38

87.15 87.15 97.65 97.65 98.38 98.38

100.00 100.00

98.86 92.50

94.19 92.50

94.19 93.29 92.50 92.50

23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

Madras Refineries Ltd. Mahanagar Telephone Nigam Ltd. Minerals & Metals Trading Corpn. National Aluminium Co. Ltd. National Fertilizers Ltd. National Mineral Dev. Corpn. Ltd. Neyveli Lignite Corporation Rashtriya Chemicals & Fertilizers Shipping Corpn. of India State Trading Corpn. Steel Authority of India Ltd. Videsh Sanchar Nigam Ltd. Container Corporation of India Indian Oil Corporation Oil & Natural Gas Corpn. Engineers India Ltd. Gas Authority of India Ltd. Indian Tourism & Dev. Corpn. Kudermukh Iron & Ore Company Ltd. Industrial Dev. Bank of India

95.42 94.36

100.00 81.49 81.49 81.49 80.12 100.00 92.02 91.02 91.02 91.02 100.00 95.01 89.49 89.45 89.04 100.00 85.00 85.00 85.00 85.00 100.00 100.00 100.00 100.00 80.00

80.12 91.02 88.93# 82.02 76.92

99.88 100.00 100.00 100.00 100.00 100.00

91.04 96.12 94.01 96.63 89.97 99.03

99.88 100.00 100.00 100.00 100.00 100.00

99.88 100.00 100.00 100.00 100.00 100.00

99.88 100.00 100.00 100.00 100.00 100.00

96.08 98.00 94.01 96.63 90.00 99.03

100.00 100.00 100.00 100.00 100.00 72.14

4

Comparison of performance in industry, using input–output quantities

4.1 Introduction1 In the previous chapter, we examined performance in the private and public sectors in India and the impact of privatisation using financial ratios. In this chapter, we attempt an evaluation based on measures of efficiency and productivity that use quantities of outputs and inputs. There are several reasons why such an exercise might be meaningful. One, it helps validate results obtained through financial analysis. Two, given that accounting norms may vary across companies and over time within a company, measures of efficiency based on output–input quantities may be more reliable. Most importantly, however, measuring efficiency or productivity using quantities may enable us to understand what exactly underlies differences in financial performance. Is it a difference in technical efficiency, i.e., the maximum output that can be realised from a given input? Or are there differences in allocative efficiency, which reflects the ability of firms to use inputs in optimal proportions, given the prices of these inputs? Such decomposition can have useful policy implications. Examining differences in technical efficiency can tell us something about the quality of human capital in the two categories. Is it true that public-sector firms cannot get quite the same output bang for a given input buck, because their managers and workers are not of the same quality as their counterparts in the private sector or because they lack suitable incentives for doing so? If there are no significant differences in technical efficiency, then is allocative efficiency the factor that makes a difference? If so, is this because public enterprises lack the freedom to choose appropriate inputs? The answer, in terms of improving performance at public-sector firms, could then well be creating structures of governance that confer greater autonomy rather than handing over control to private-sector firms. Analysis of performance using quantities can thus prove invaluable, and indeed there are studies that

1 The section on technical efficiency in this chapter draws on Ram Mohan and Ray (2003)

Performance in industry: input–output quantities

85

have sought to assess the relationship between efficiency in production and financial performance [for instance, Elyasiani, Mehdian, Rezvanian (1991)]. The performance measures we have chosen to study are efficiency and productivity. Efficiency measures a firm’s performance relative to a benchmark at a given point in time; productivity measures a firm’s performance over time. Both measures are relevant in attempting a comparison between the private and public sectors. The rest of this chapter is organised as follows. Section 4.2 briefly discusses the measures of performance and the Data Envelopment Analysis (DEA) method used for computing these. In Section 4.3, we review studies that have applied DEA methods to the study of public and private firms in the Indian context and the empirical procedures we have used. In Section 4.4, we discuss results, and in Section 4.5 we present a summary of our findings and their implications.

4.2 Performance measures and DEA Overview of DEA Technical efficiency measures the actual output of a firm compared with the maximum output that is theoretically feasible. It can be measured by the ratio of its actual output to the maximum output producible from its observed input bundle, defined by the frontier production function. In parametric models, one specifies an explicit functional form for the frontier and econometrically estimates the parameters using sample data for inputs and output. Hence the validity of the derived technical efficiency measures depends critically on the appropriateness of the functional form specified. In contrast, the method of DEA introduced by Charnes, Cooper and Rhodes (CCR) (1978) and further generalised by Banker, Charnes and Cooper (BCC) (1984) provides a nonparametric alternative to parametric frontier production function analysis. In DEA, one makes only a few fairly weak assumptions about the underlying production technology. In particular, no functional specification is necessary. Based on these assumptions, a production frontier is empirically constructed using mathematical programming methods from observed input–output data of sample firms. Efficiency of firms is then measured in terms of how far they are from the frontier. Consider an industry producing a scalar output, y, from bundles of m inputs, x (x1, x2, . . . , xm). Let (x j, y j ) be the observed input–output bundle of firm j (j 1, 2, . . . , n). The technology is defined by the production possibility set T {(x, y): y can be produced from x}. An input–output combination (x0, y0) is feasible if and only if (x0, y0) ∈ T.

86

Privatisation in India We make the following assumptions about the technology:

All observed input–output combinations are feasible. Thus, (x j, y j ) ∈ T (j 1, 2, . . . , n). (ii) The production possibility set, T, is convex. Hence, if (x1, y1) ∈ T and (x2, y2) ∈ T, then (x1 (1 )x2, y1 (1 )y2) ∈ T, 0 1.

(i)

In other words, weighted averages of feasible input–output combinations are also feasible. (iii) Inputs are freely disposable. Hence, if (x0, y0) ∈ T and x1 x0, then (x1, y0) ∈ T. This rules out negative marginal productivity of inputs. (iv) Output is freely disposable. Hence, if (x0, y0) ∈ T and y1 y0, then (x0, y1) ∈ T. Varian (1984) pointed out that the smallest set satisfying assumptions (i)–(iv) is n

n

n

j1

j1

j1

S {(x, y) : x jx j; y jy j; j 1; j 0; j 1, 2, . . . , n}. Let n

n

n

j1

j1

j1

x¯ jx j, y¯ jy j; j 1; j 0. By virtue of convexity (¯x, y¯ ) is feasible. Then, for any x x¯ , (x, y¯ ) is feasible. Finally, for any y y¯ , (x, y) is also feasible. Technical efficiency Technical efficiency of any firm producing output y0 from input x0 is 1/ *, where * Max : (x0, y0) ∈ S. Note that this is an output–oriented measure of efficiency. Alternatively, one could use an input-oriented approach, where efficiency lies in conserving inputs while producing the observed output quantity. To compute outputoriented efficiency one solves the following linear programming problem: Max t t ∈ (1, . . . N)

(1)


87

such that N

x¯ nx nj xtj j 1, . . . J, n 1, . . . N

(2)

n1

N

x¯ n yn t yt

(3)

n1

N

x¯ n 1

(4)

n 0.

(5)

n1

This BCC model allows increasing, constant, or diminishing returns to scale along the frontier of the production possibility set at different levels of inputs. Tornquist and Malmquist indices Productivity Productivity of a firm is measured by the quantity of output produced per unit of input. In the single-output, single-input case, it is merely the ratio of the firm’s output and input quantities. Thus, if, in period 0, a firm produces output y0 from input x0, its productivity is 0

y0 . x0

(1a)

Similarly, in period 1, when output y1 is produced from input x1, the productivity is 1

y1 . x1

(1b)

Moreover, the productivity index in period 1, with period 0 as the base, is 1

1 y1/x1 y1/y0 . 0 y0/x0 x1/x0

(2)

This productivity index shows how productivity of the firm has changed from the base period. The rate of productivity growth is the difference in the growth rates of the output and input quantities respectively.

88


When multiple inputs and/or multiple outputs are involved, one must replace the simple ratios of the output and input quantities in (2) above by quantity indexes of output and input. In this case, the index of multi-factor productivity (MFP) is 1

1 Qy , 0 Qx

(3)

where Qy and Qx are, respectively, output and input quantity indexes of the firm in period 1 with period 0 as the base. Different measures of the multifactor productivity index are obtained, however, when one uses alternative quantity index numbers available in the literature. Tornquist index of total factor productivity By far the most popular quantity index number is the Tornquist index, measured by a weighted geometric mean of the relative quantities from the two periods. Consider the output quantity index first. Suppose that m outputs are involved. The output vectors produced in periods 0 and 1 are, respectively, y0 (y10, y20, . . . , ym0) and y1 (y11, y21, . . . , ym1). The corresponding output price vectors are p0 (p10, p20, . . . , pm0) and p1 (p11, p21, . . . , pm1) respectively. Then, the Tornquist output quantity index is TQy

y11 y10

v1

y21 y20

( )( )

v2

...

ym1 ym0

vm

( )

m

; vj 1. 1

Here, vj m

pjyj

pkyk 1

is the share of output j in the total value of the output bundle. Of course, the value shares of the individual outputs are, in general, different in the two periods. In practical applications, for vj , one uses the geometric mean of vj0 and vj1, where vj0

pj0yj0

and vj1

m

1 pk yk 0

0

pj1yj1

.

m

1 pk yk 1

1

It may be noted that in the single-output case, the Tornquist output quantity index trivially reduces to the ratio of output quantities in the numerator of (2). This is also true when the quantity ratio remains unchanged across all outputs.


89

Similarly, let the input vectors in the two periods be x0 (x10, x20, . . . , xn0) and x1 (x11, x21, . . . , xn1). The corresponding input price vectors are w0 (w10, w20, . . . , wn0) and w1 (w11, w21, . . . , wn1). Then, the Tornquist input quantity index is x1 TQx 10 x1

s1

x21 x20

( )( )

s2

x1 . . . n0 xn

sn

n

( ) ; s 1. j

1

Here, sj

wjxj n

1 wkxk

is the share of input j in the total cost of the input bundle. Again, in practice, one uses the average of the cost share of any input in the two periods. The Tornquist productivity index is the ratio of the Tornquist output and input quantity indexes. Thus, TQ

TQy . TQx

When TQy TQx , output in period 1 has grown faster (or declined slower) than input, as a result of which productivity has increased in period 1 compared to what it was in period 0. It may be noted that the Tornquist productivity index can be measured without any knowledge of the underlying technology, so long as data are available for the input and output quantities as well as the shares of the individual inputs and outputs in the total cost and total revenue, respectively. Malmquist index of total factor productivity Unlike the Tornquist index, the Malmquist productivity index is a normative measure based on a reference technology underlying the observed input– output data. It was introduced by Caves, Christensen, and Diewert (CCD) (1982) and was empirically applied first by Färe, Grosskopf, Lindgren, and Roos (FGLR) (1992). They also identified technical change and change in technical efficiency as the two components of productivity change. Like CCD, FGLR also assumed constant returns to scale. Subsequently, Färe, Grosskopf, Norris, and Zhang (FGNZ) (1994) considered technologies characterised by variable returns to scale and offered an extended decomposition of the Malmquist productivity index, with another factor capturing changes in scale efficiency.

90

Privatisation in India R1 Output (y) Q1

Q0

R0

D1 U0

U1

P1

C1 C0

A1

D0

P0 T0

B1

T1

A0

B0

O

E1

E0

x 0 X0

X1

Input (x)

Figure 4.1 Decomposition of the Malmquist TFP Index Source: Ray and Desli (1997)

Ray and Desli (RD) (1997) provide an exposition of the Malmquist total factor productivity index and an alternative decomposition. Their exposition is briefly summarised here. Consider an industry consisting of four firms A, B, C and D, as in Figure 4.1. Points A0 through D0 show the observed input–output levels of these firms in period 0. Similarly, A1 through D1 show their input–output levels in period 1. Firm A uses input 0x0 to produce output A0x0 in period 0 and input 0x1 to produce A1x1 in period 1. Thus, the productivity index for firm A in period 1 is A (A1x1/0x1) / (A0x0 /0x0) The free disposal convex hull is the set of points bounded by the horizontal axis and the broken line E0B0C0D0 – extension. Under variable returns to scale (VRS), all points in this region represent feasible input–output combinations in period 0. Under constant returns to scale (CRS), however, all


91

radial expansions and (non-negative contractions) of feasible input–output bundles are also feasible. Thus, the CRS production possibility set in period 0 is the cone formed by the horizontal axis and the ray OR0 through the point C. Similarly, the VRS frontier in period 1 is the broken line E1B1C1D1 extension and the CRS frontier is the ray OR1 through the point C1. In period 0, the maximum producible output from input 0x0 is P0x0 under the CRS assumption and T0x0 under the VRS assumption. Suppose that the production function y f(x) exhibits CRS and is of the form f(x) ax, a 0. Then, the production possibility set is T {(x, y): y ax}. Shephard defined the output-oriented distance function as D(x, y) min : (x, 1/y) ∈ T. Evaluated at (x0, y0), D(x0, y0) y0/ax0. This distance function is the same as technical efficiency as defined by Farrell. The distance functions are D0c (x0, y0) A0x0/P0x0 D0c (x1, y1) A1x1/P1x1 under CRS, and D0v (x0, y0) A0x0 /T0x0 D0v (x1, y1) A1x1/T1x1 under VRS. The productivity index of firm A can be expressed alternatively 0A D0c (x1, y1)/D0c (x0, y0) 1A D1c (x1, y1)/D1c (x0, y0).

92


The authors provide the following decomposition: The productivity index, , can be written as D0c (x1, y1) D0v (x1, y1) D0v (x1, y1) SE 0 (x1, y1) A . , D0 (x , y ) D0v (x0, y0) SE 0 (x0, y0) D0v (x0, y0) 0c 0 0 D v (x0, y0) D0v (x1, y1).

where SE represents scale efficiency. In a perfectly analogous manner, A

D1v (x1, y1) SE 1 (x1, y1) . . D1v (x0, y0) SE 1 (x0, y0)

Hence,

DD

0

(x1, y1) D1v (x1, y1) SE 0 (x1, y1) SE 1 (x1, y1) . 1 . . . SE 0 (x0, y0) SE 1 (x1, y1) v (x0, y0) D v (x0, y0) v

0

The first factor on the right-hand side can be further decomposed as

DD

0

(x1, y1) D1v (x1, y1) . 1 (x 0, y0) D v (x0, y0) v v

0

[

]

D0v (x0, y0) D0v (x1, y1) D1v (x1, y1) . . . D1v (x0, y0) D1v (x1, y1) D0v (x0, y0)

Thus, A (TC) . (TEC) . (SC), where TC

[

]

D0v (x0, y0) D0v (x1, y1) . , D1v (x0, y0) D1v (x1, y1)

measures technical change, TEC

D1v (x1, y1) , D0v (x0, y0)

measures (pure) technical efficiency change, and SC

[

]

SE 0 (x1, y1) SE 1 (x1, y1) . SE 0 (x0, y0) SE 1 (x0, y0)

measures the effect of change in scale.


93

Cost efficiency Cost minimisation is obtained by solving the following: Minimise,xi wi’xi* such that yi Y 0, xi* X 0, N1’ 1 0, where wi is the vector of input prices for the ith firm and xI* (which is calculated by the LP) is the cost-minimising vector of input quantities for the ith firm, given the input prices wi and the output levels yi. The total cost efficiency (CE) of the i firm is calculated as CE wi’xi*/wi’xi. The allocative efficiency is calculated, following Farrell (1957), as AE CE/TE. It should be noted that the TE computed here is input-oriented technical efficiency; our earlier computations of TE were of output-oriented technical efficiency.

4.3 Previous studies and our methodology Previous studies Ahuja and Majumdar (1998) and Majumdar(1998) have analysed the performance of SOEs in India, using DEA methods. Ahuja and Majumdar (1998) examined the performance of 68 SOEs in the period 1987 to 1991. These enterprises were all drawn from the manufacturing sector and data on these were obtained from the Centre for Monitoring the Indian Economy. The authors used net value added as a measure of output, and the number of employees and fixed assets (gross as well as net) as measures of inputs. They used nominal as well as deflated values of gross and net fixed assets, using the wholesale price index for manufacturing as deflator. They arrived at average

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values of mean efficiency in the range of 0.35–0.39. They suggested that the low values of efficiency pointed to substantial scope for improvement through measures such as privatisation. Interestingly, however, they found that it was the older and smaller firms that were the poorer performers, while the larger firms performed better. This, they contended, pointed to the need for privatisation policy to focus on smaller firms, unlike in other countries where the thrust of privatisation had been on large, state-owned monopolies. The authors readily acknowledged, however, that they were comparing efficiency of SOEs only relative to each other and that a more meaningful study would include a panel of private-sector firms as well. Second, technical efficiency is measured across a highly heterogeneous sample of firms drawn from varied sectors and thus incorporating differing technologies. Technical efficiency comparisons are more meaningful when there is at least a modest degree of homogeneity in the firms being compared. Yet another limitation is that it is based on a small sample, considering that there are over 200 firms owned by the central government alone (as mentioned, the authors examine only 68) and it leaves out sectors in industry other than manufacturing. Majumdar (1999) attempts a broader evaluation. He compares performance across four categories: central government SOEs; SOEs owned by state governments (India is a federation of states); enterprises jointly owned by the government and the private sector; and private-sector enterprises. The comparison is based on aggregate data obtained from the Annual Survey of Industries and covers the period of 1973–4 to 1988–9. In other words, there are four data points for each year and a total of 16 years. Output is defined again as net value added, and inputs are staff employed and deflated values of book values of capital. The author estimates mean technical efficiency for the categories of ownership and subjects the results to a Wilcoxon test. There is no significant difference between the central government-owned and state government enterprises; the central government-owned enterprises are less efficient than private enterprises and enterprises in the joint sector; and the joint sector is less efficient than the private sector. The results are not different over two sub-periods, 1973–80 and 1981–8. Majumdar concludes that the private sector clearly emerges a superior performer, although he acknowledges that that the aggregate results may hide differences in performance within industrial sectors. (It is worth mentioning that the author also found that over the second period, in which various reforms in the public sector had been initiated, the annual rate of growth of efficiency was higher in the public sector than in the mixed sector or the private sector). The problem of lumping together disparate industrial categories applies to this study as well. A more serious limitation is that technical efficiency is measured over a 16-year period, i.e. there is one efficient frontier posited for


95

the entire period, which clearly ignores the effect of technical change over such a long timeframe. Methodology: firm sample, output and inputs Our study attempts to address some of the limitations in the earlier studies discussed above. Unlike Majumdar (1999), it uses firm-level data obtained from the CMIE database, rather than aggregate data. At the same time, unlike Majumdar (1998), we use both public- and private-sector firms in our sample. Second, it covers a long enough period, namely, 1991–2 to 1998–9, coinciding with the post-reform era in India. We use a balanced panel of data over the entire period (as in Majumdar (1998), except that our sample comprises both public and private firms). While this leads to a sample that is smaller than the complete set of firms in a given year, it eliminates distortions in comparisons that could be created by the entry or exit of firms in parts of the total period. Third, the technical efficiency of any firm from any particular industry is judged against a production frontier constructed from observed input–output data for firms from that industry alone. This controls for technological heterogeneity across industries and provides a more meaningful measure of efficiency. We compare performance of public and private firms separately in eight different industrial sectors, instead of lumping together firms in disparate industrial sectors. Fourth, we use annual cross-section data from different industries for measurement of efficiency of firms in different years. This avoids confusing technical change with efficiency change over time. The CMIE’s classification is based on whether 50 per cent or more of a firm’s output falls within a given category. The CMIE’s classification does contain sub-categories for the industrial sectors we have chosen. However, we chose to carry out our analysis at the overall sectoral level, as sub-categories do not produce sufficiently large balanced panels of private and public firms. The descriptive statistics for these firms are provided in Table 4.1. The sample size varies from 34 to 173. Finally, we compute three different measures. One is VRS technical efficiency. This is obtained for a pooled sample of public and private firms in a given industrial sector separately for each year, i.e., relative to an efficient frontier for that year. We thus obtain the average technical efficiency for public and private firms for each of eight years. (The technical efficiency score for any given firm would range from 0 to 1). These eight observations for public and private sectors are subjected to a t-test for difference in means. We also estimate Malmquist and Tornquist total factor productivity growth. The Malmquist productivity index for each year (which yields the growth year on year) – and hence the logarithm of each year’s index – is obtained by DEA estimates. The Tornquist index for each year is computed, based on the definition of the same, and hence the logarithm of this index.

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Table 4.1 Descriptive statistics for the sample firms

Chemical Electronics Steel Mineral Non-electrical Service Textiles Transport

No. of firms

Mean Output

Standard Deviation

Minimum

Maximum

173 61 86 34 96 102 141 91

1634 1811 3608 27439 1536 3821 1184 2825

2584 3324 14746 73873 4895 9773 1509 7556

14 10 12 33 5 5 10 22

17001 15985 128062 393129 45247 57319 9663 51629

Note: All figures are eight-year averages; financial figures are presented in Rupee millions (Rs 47 $1)

The mean of the logarithms over seven years is the logarithm of compounded growth of productivity, Malmquist and Tornquist. We subject the means for public and private sectors to a t-test for difference in means. We compute cost efficiency using a program for data envelopment analysis (DEAP), that also provides the break-up of cost efficiency into technical efficiency and allocative efficiency. As the logarithm of cost efficiency is the sum of the logarithms of technical and allocative efficiency respectively, we compute logarithms for the efficiency figures obtained for all firms in a given sector for a given year by running DEAP and hence the average of the logarithm for each type of efficiency. The averages of the logarithms for the public and private sectors for each type of efficiency over the eight-year period, 1992–2000 are compared, using t-tests. For gross output, we use net sales of firms (i.e. sales net of excise duties) adjusted for changes in inventories. For inputs, we use wages, raw materials, energy, and capital. As energy and raw materials are included separately as inputs, the use of gross output, rather than net value added, is appropriate. (Net value added is used when the only inputs are labour and capital.) All nominal values are deflated by an appropriate deflator. In the case of output, the deflator is the wholesale price index for the relevant industrial sector; for wages, it is the consumer price index for industrial workers; for energy, it is the wholesale price index for energy; for capital, it is the wholesale price index for equipment. Different raw material indices were constructed for individual industry codes. For capital, we do not use gross or fixed assets, unlike the studies cited here. Instead, we take capital to mean the summation of four items: interest, depreciation, repairs, and other rent. In other words, we prefer a measure for capital that is based on flows to one that is based on stock, as measures for output and other inputs are all based on flows.


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Further, we use wages instead of number of employees, as the database does not provide the latter. Wages, deflated by the price index, yield quantities of labour.

4.4 Results Technical efficiency scores The technical efficiency results obtained for the public and private sectors in each of the eight industrial categories are presented in Tables 4.2–4.9. The averages and the t-statistics for differences in means are summarised in Table 4.10.

Table 4.2 Technical efficiency in the chemical sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.82 0.79 0.79 0.81 0.80 0.80 0.80 0.83

0.77 0.73 0.74 0.73 0.69 0.70 0.68 0.67

Average

0.81

0.71

Av 1992–95 Av 1996–99

0.80 0.81

0.74 0.68

Table 4.3 Technical efficiency in the electronics sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.84 0.82 0.84 0.85 0.84 0.81 0.82 0.80

0.87 0.88 0.90 0.91 0.91 0.91 0.87 0.74

Average

0.83

0.87

Av 1992–95 Av 1996–99

0.84 0.82

0.89 0.86

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Privatisation in India Table 4.4 Technical efficiency in the steel sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.91 0.90 0.86 0.92 0.91 0.85 0.89 0.86

0.87 0.85 0.79 0.86 0.83 0.75 0.78 0.79

Average

0.89

0.81

Av 1992–95 Av 1996–99

0.90 0.88

0.84 0.79

Table 4.5 Technical efficiency in the mineral sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.78 0.71 0.72 0.73 0.75 0.67 0.65 0.63

0.77 0.76 0.74 0.77 0.79 0.75 0.68 0.54

Average

0.71

0.73

Av 1992–95 Av 1996–99

0.73 0.68

0.76 0.69

Table 4.6 Technical efficiency in the non-electrical machinery sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.84 0.43 0.68 0.53 0.71 0.83 0.82 0.72

0.84 0.36 0.61 0.42 0.64 0.79 0.81 0.69

Average

0.70

0.64

Av 1992–95 Av 1996–99

0.62 0.77

0.55 0.74

Performance in industry: input–output quantities Table 4.7 Technical efficiency in the services sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.56 0.56 0.39 0.43 0.36 0.37 0.31 0.32

0.70 0.72 0.59 0.61 0.60 0.60 0.58 0.52

Average

0.41

0.61

Av 1992–95 Av 1996–99

0.48 0.34

0.66 0.57

Table 4.8 Technical efficiency in the textile sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.88 0.87 0.84 0.86 0.85 0.84 0.84 0.82

0.89 0.76 0.70 0.67 0.73 0.69 0.57 0.58

Average

0.85

0.70

Av 1992–95 Av 1996–99

0.86 0.83

0.76 0.64

Table 4.9 Technical efficiency in the transport sector PVT

PSU

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

0.80 0.92 0.88 0.90 0.91 0.77 0.88 0.91

0.81 0.95 0.93 0.89 0.88 0.72 0.87 0.93

Average

0.87

0.87

Av 1992–95 Av 1996–99

0.88 0.87

0.90 0.85

99

100

Privatisation in India Table 4.10 Technical efficiency results Private

Public

t-statistic

Chemicals

0.81

0.71

Electronics

0.83

0.87

Steel

0.89

0.81

Minerals

0.71

0.73

Non-electrical

0.70

0.64

Service

0.41

0.61

Textile

0.85

0.70

Transport

0.87

0.87

6.97a (0.00) 2.20a (0.03) 4.01a (0.00) 0.59 (0.28) 0.61 (0.276) 4.76a (0.00) 4.12a (0.00) 0.04 (0.485)

Note: Technical efficiency scores are averages over the period 1991–92 to 1998–99

Table 4.10 reveals the following: • • •

In three sectors – chemicals, iron and steel, and textiles – the private sector’s technical efficiency scores are superior. In two sectors – electronics and services – the public sector’s scores are superior. In three sectors – minerals, non-electrical machinery and transport – there is no difference between the two sectors.

Thus, out of eight sectors, only in three does the private sector exhibit superior technical efficiency. We have separately computed technical efficiency averages for the first four years and the last four years of the period under study. We note the following: • • •

In five sectors – electronics, steel, minerals, services and textiles – the average for the last four years is lower than in the first four. In two sectors – chemicals and transport – it is almost the same for the private sector and lower for the public sector. Only in one sector – non-electrical machinery – do we find that technical efficiency is higher in the second half of the period covered.

The above findings are of interest because they appear to be consistent with the general deceleration in growth in industry in the later years of economic


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reforms, a matter that has been the subject of much comment in the media and in policy-making circles in India. Comparing performance after controlling for scale and time It is often contended that if some public-sector firms in India do better than their private-sector counterparts, it is only because they have the advantages of size. In other words, private-sector performance would be superior to that of the public sector once we adjust for scale effects. This would imply that, while public-sector firms in some industries might be doing better than the private sector, if the same firms were to be handed over to private ownership, the performance of these firms would be even better. We examine whether these propositions about the advantages of size in the public sector are correct. We do so by using a Tobit model, with technical efficiency as the dependent variable, and scale and time as independent variables, with dummy variables for ownership, industry and industry interacted with ownership. The specified Tobit model is 8

lnTEit 0 1 lny jit 2(ln jyit)2 jDj Pubi j2

8

98

jDj Pubi tTt it ,

j2

t93

where y jit output of firm i in industry j in the year t Dj 1 if the firm is from industry j (industry code 1 is the reference) Pub 1 if the firm is a PSU 0 if the firm is in the private sector Tt 1 if observation is from year t (year 1992 is the reference). We initially ran the model for all eight industries. As reported in Table 4.11, the coefficient of ownership in industry code 1, , turned out to be insignificant. So did j, the coefficient of the industry interacted with ownership variable, in the case of four industries. We then ran the model after omitting the ownership variable Pub and also the industries in which j was insignificant, and then examined what the effects of ownership were in the remaining four industries. Selected coefficient estimates from the model after omitting the ownership variable, Pub, and the industries in which the ownership effects were insignificant are reported in Table 4.12. The output coefficient is significant, which implies that technical efficiency increases with size. In three industries, chemicals, steel and minerals, private

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Table 4.11 Tobit regression estimates Parameter

Estimate

Standard Error

Chi-Square

Pr ChiSq

Intercept d2ind (2) d3ind (3) d4ind (4) d5ind (5) d6ind (6) d7ind (7) d8ind (8) dtype () dt2ind(2) dt3ind(3) dt4ind(4) dt5ind(5) dt6ind(6) dt7ind(7) dt8ind(8) ln(y)(1) ln(y)2(2) dyr93(93) dyr94(94) dyr95(95) dyr96(96) dyr97(97) dyr98(98) dyr99(99)

0.3129 0.0064 1.0359 0.2984 0.1602 0.0162 0.1963 0.0609 0.0581 0.1551 0.2419 0.0416 0.1272 0.1871 0.0262 0.1761 0.0477 0.0009 0.1163 0.142 0.1429 0.1145 0.1372 0.1512 0.1602

0.0247 0.0198 0.0224 0.0219 0.0426 0.0223 0.0245 0.0191 0.0542 0.0729 0.064 0.0776 0.0776 0.0926 0.0802 0.0684 0.0083 0.0012 0.0203 0.0203 0.0204 0.0203 0.0203 0.0203 0.0203

160.56 0.1 2142.12 186.35 14.13 0.53 64.03 10.15 1.15 4.53 14.29 0.29 2.69 4.08 0.11 6.64 32.88 0.53 32.81 48.74 49.32 31.82 45.7 55.38 62.43

0.0001 0.7474 0.0001 0.0001 0.0002 0.467 0.0001 0.0014 0.2835 0.0334 0.0002 0.5917 0.1012 0.0434 0.7437 0.01 0.0001 0.4679 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001

Table 4.12 Selected coefficients from the revised model Industry/Output

Coefficient j*

Level of significance

Chemical Service Steel Minerals ln (y)

0.2328 0.1865 0.2098 0.3276 0.0540

0.0001 0.0001 0.0043 0.0001 0.0001

*j is an estimate of the difference between public and private ownership within a given industry

ownership is seen to be significantly superior when we have controlled for scale and time effects. In one industry, services, the public sector is seen to be significantly superior. In four industries there are no differences. This means that, even after adjusting for scale, we do not find evidence of across-the-board superiority in private-sector performance. The score is 3–1 in favour of the private sector, with a tie in four industries. This does under-


103

mine the proposition that public-sector performance would be uniformly inferior to that of the private sector but for the advantages of scale that public-sector firms enjoy. It also implies that we cannot hope to see improvements in performance in all industries through a transfer of ownership from government to the private sector. Malmquist total factor productivity growth The Malmquist productivity index for each year was derived by applying DEA to the panel data (Tables 4.13–4.22). The logarithms of the index for each of the seven years were computed. The means of these logarithmic values and the t-statistic for the differences in these means are summarised in Table 4.13. In Table 4.14, the implicit compounded growth rates of productivity are shown. We note the following: • •

In six out of eight sectors, there is no difference in Malmquist productivity growth between private and public firms. Only in two sectors – minerals and electronics – is there a significant difference, that too at only a 10 per cent level of confidence. In minerals, the public sector is a superior performer, while in electronics, it is the private sector that does better.

Table 4.13 Malmquist index growth comparison Public sector

Private sector

Chemicals

0.01

0.00

Electronics

0.11

0.02

Steel

0.01

0.01

0.02

0.03

Non-electrical

0.04

0.02

Service

0.13

0.12

Textile

0.01

0.03

Transport

0.02

0.08

Minerals

t-statistic 0.68 (0.25) 1.72 (0.06) 0.17 (0.434) 1.58 (0.07) 0.44 (0.33) 0.27 (0.39) 0.73 (0.24) 0.87 (0.20)

Note: 1. Private and public sector values are averages of logarithms of Malmquist productivity indices over seven years 2. Significant t-statistics are bold faced; values in parentheses are signficance values

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Privatisation in India Table 4.14 Malmquist productivity growth rates

Chemicals Electronics Steel Minerals Non-electrical Textile Service Transport

Private sector

Public sector

0.94% 11.74% 1.21% 2.09% 4.27% 0.60% 14.38% 1.54%

0.34% 1.59% 0.83% 3.39% 1.66% 2.78% 12.54% 8.32%

Note: Compounded annual growth rates over 1991–92 to 1998–99

Table 4.15 Malmquist index for the chemical sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.01 1.03 0.99 0.99 1.02 1.00 1.02

1.01 1.08 0.95 0.99 1.03 1.01 0.96

Table 4.16 Malmquist index for the electronics sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.65 1.22 1.01 1.00 0.97 1.01 1.09

1.00 0.97 0.94 0.91 1.07 1.02 0.98

Table 4.17 Malmquist index for the steel sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.01 1.02 1.02 1.01 1.08 1.02 0.94

1.00 1.03 1.04 1.07 1.00 0.99 0.94

Performance in industry: input–output quantities Table 4.18 Malmquist index for the mineral sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

0.88 1.10 1.01 1.05 0.90 0.97 0.96

1.06 1.04 1.00 0.99 1.12 1.00 1.03

Table 4.19 Malmquist index for the non-electrical sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.20 1.08 1.14 1.00 0.96 0.98 0.97

0.96 0.89 1.00 1.03 0.89 1.17 1.22

Table 4.20 Malmquist index for the service sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

0.98 1.19 1.12 1.15 1.02 1.55 1.07

1.18 1.13 1.16 1.21 1.05 1.11 1.04

Table 4.21 Malmquist index for the textile sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.01 1.04 0.95 0.98 1.05 0.95 1.05

0.84 1.04 1.14 1.10 0.89 0.94 0.89

105

106

Privatisation in India Table 4.22 Malmquist index for the transport sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.00 1.07 1.04 1.03 1.02 0.97 0.97

0.97 1.02 1.10 0.94 1.53 0.88 1.28

Table 4.23 Tornquist index growth comparison Public sector

Private sector

t-statistic 1.65 b (0.06) 2.41a (0.02) 1.5 b (0.08) 0.48 (0.32) 0.61 (0.28) 0.30 (0.38) 3.54a (0.00) 1.12 (0.14)

Chemicals

0.01

0.03

Electronics

0.09

0.01

Steel

0.02

0.00

0.01

0.01

Non-electrical

0.03

0.00

Service

0.09

0.12

Textile

0.01

0.21

0.02

0.12

Minerals

Transport

Note: 1. Private and public sector values are averages of logarithms of Tornquist productivity indices over seven years 2. Significant t-statistics are boldfaced; values in parentheses are signficance values subscripts a and b indicate significance at 5 and 10 per cent levels respectively.

Tornquist productivity index Table 4.23 gives the Tornquist productivity index growth comparison between public and private firms in the eight industrial sectors, while Table 4.24 gives the compound growth rates of productivity. Tables 4.25–4.32 give the detailed results for each of the eight sectors by year.

Performance in industry: input–output quantities Table 4.24 Tornquist producitvity growth rates

Chemicals Electronics Steel Minerals Non-electrical Service Textile Transport

Private sector

Public sector

1.04% 9.16% 1.76% 0.56% 2.82% 9.91% 0.53% 1.63%

3.03% 1.23% 0.03% 1.04% 0.29% 12.58% 18.60% 12.31%

Note: Compounded annual growth rates over 1991–92 to 1998–99

Table 4.25 Tornquist index for the chemical sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.02 1.04 1.00 1.00 1.01 0.99 1.02

0.96 0.98 0.98 1.08 0.97 0.96 0.87

Table 4.26 Tornquist index for the electronics sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.54 1.19 1.01 0.98 1.00 1.03 0.99

0.97 1.00 0.97 0.95 1.06 1.04 0.92

Table 4.27 Tornquist index for the steel sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.00 1.03 1.03 1.05 1.00 1.01 0.99

0.97 1.03 1.02 1.01 0.98 1.00 0.98

107

108

Privatisation in India Table 4.28 Tornquist index for the mineral sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

0.88 1.10 1.01 1.05 0.90 0.97 0.96

1.06 1.04 1.00 0.99 1.12 1.00 1.03

Table 4.29 Tornquist index for the non-electrical machinery sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.06 1.08 1.10 0.99 0.98 1.00 0.99

0.95 0.92 1.03 1.00 0.89 1.07 1.18

Table 4.30 Tornquist index for the services sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

0.94 1.48 0.98 1.13 1.00 1.23 1.02

1.04 1.05 1.05 1.14 0.96 1.46 1.24

Table 4.31 Tornquist index for the textile sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.01 1.04 0.95 0.94 1.03 1.03 0.96

0.66 0.92 0.99 0.74 0.85 0.87 0.73


109

Table 4.32 Tornquist index for the transport sector

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99

Private

Public

1.02 1.06 1.03 1.03 1.02 0.99 0.96

0.91 1.01 1.12 1.08 1.75 0.89 1.30

We note the following: •

• •

In four sectors – minerals, non-electrical machinery, services and transport – there is no difference in Tornquist productivity growth between public and private firms. In two sectors – electronics and textiles – the private sector’s performance is superior at a 5 per cent level of confidence. In two sectors – chemicals and steel – the private sector’s performance is better at a 10 per cent level of confidence.

Comparing these results with the Malmquist productivity growth figures given earlier, we note that both indices point to exceptional productivity growth in two sectors, electronics and services. We note also that only in one sector do both the Malmquist and Tornquist indices point to superior privatesector performance, electronics, although at a 10 per cent level of confidence in the former and a 5 per cent level of confidence in the latter. Cost efficiency Tables 4.33–4.35 present the results for cost efficiency, technical efficiency and allocative efficiency respectively for the eight different sectors. As all the values shown are on logarithms, it will be noticed that the technical and allocative efficiencies add up to the figures shown for cost efficiency. The results reveal the following: •

• •

There are no differences in cost efficiency in four sectors – steel, nonelectrical, services, and transport. In only one sector, non-electrical, is this due to the fact that there is no difference in the constituent efficiencies, namely technical and allocative. In steel, the private sector is superior in respect of technical efficiency but this is offset by higher allocative efficiency in the public sector. In the service sector, the public sector scores on technical efficiency but there is no difference in respect of allocative efficiency.

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Table 4.33 Cost efficiency comparison Public sector

Private sector

t-statistic

Chemicals

0.46

0.77

Electronics

0.81

0.73

Steel

0.34

0.33

Minerals

0.54

0.49

Non-electrical

0.54

0.58

Service

2.43

2.18

Textile

0.37

1.35

Transport

0.35

0.35

6.02 (0.00) 1.73 (0.05) 0.33 (0.37) 1.57 (0.07) 0.72 (0.42) 0.84 (0.21) 5.46 (0.00) 0.02 (0.49)

Note: 1. Private and. public sector values are averages of the logarithms of cost efficiency scores over eight years. 2. Significant t-statistics are in bold; values in parentheses are significance values.

Table 4.34 Technical efficiency comparison Public sector

Private sector

t-statistic

Chemicals

0.24

0.42

Electronics

0.21

0.16

Steel

0.13

0.22

Minerals

0.28

0.19

Non-electrical

0.48

0.56

Service

1.09

0.87

Textile

0.17

0.42

Transport

0.15

0.14

7.91 (0.00) 1.58 (0.07) 3.69 (0.00) 4.07 (0.00) 1.45 (0.35) 1.45 (0.08) 3.64 (0.00) 0.3 (0.38)

Note: 1. Private and public sector values are averages of logarithms of technical efficiency scores over eight years 2. Significant t-statistics are bold faced; values in parentheses are significance values


111

Table 4.35 Allocative efficiency comparison Public sector

Private sector

t-statistic

Chemicals

0.21

0.34

Electronics

0.60

0.56

Steel

0.21

0.11

Minerals

0.27

0.29

Non-electrical

0.35

0.31

Service

1.34

1.31

Textile

0.18

0.84

Transport

0.20

0.21

3.88 (0.00) 1.02 (0.16) 3.39 (0.00) 1.01 (0.16) 0.81 (0.22) 0.206 (0.42) 6.22 (0.00) 0.29 (0.38)

Note: 1. Private and public sector values are averages of logarithms of allocative efficiency scores over eight years 2. Significant t-statistics are bold faced; values in parentheses are significance values

• •

•

In the transport sector, the private sector is superior on allocative efficiency but there is no difference on technical efficiency. In the chemical and textile sectors, the private sector is superior on cost efficiency, the result of superiority on both technical and allocative efficiencies. In electronics and in minerals, the public sector is superior on cost efficiency, although this is the result only of superiority on technical efficiency.

The results on cost efficiency are, perhaps, the most surprising of all the comparisons attempted in this essay because there is a general perception that over-manning in the public sector must lead to higher costs in achieving a given level of output. We find that, in general, this is not true. Aggregate results Table 4.36 summarises our findings on the three dimensions on which we have compared public and private firms: technical efficiency, Malmquist productivity growth, Tornquist productivity growth, and cost efficiency. We have a total of 32 observations, eight on each dimension. In 17 out of 32 observations, there is no difference between public and private firms. In another five instances, the public sector is seen to perform

112


Table 4.36 Summary of results of comparisons of efficiency and productivity

Parameter 1. Technical efficiency 2. Malmquist productivity growth 3. Tornquist productivity growth 4. Cost efficiency Total





Total

3

3

0

2

0

8

6

0

1

0

1

8

4

2

2

0

0

8

4

2

0

1

1

8

17

7

3

3

2

32

No difference

better. Only in ten cases – less than one-third of the total observations – is private-sector performance superior. Indeed, even if we were to look at superior performance at a 5 per cent level of confidence, only in seven observations – about 22 per cent of the total – does the private sector emerge as a better performer. Sectoral view We have also tabulated the results by sector in order to assess whether there are sectors in which the three measures together point to the superiority of private firms over public firms or vice versa. Table 4.37 summarises these results. • • • • • •

In two sectors, non-electrical machinery and transport, there is no difference whatsoever between public and private firms. In two sectors, textile and chemicals, the private sector is better on three out of four measures. In steel, the private sector is superior on two out of four measures. In electronics, the score is 2–2 for private and public sectors In minerals, the public sector does better on two measures. In services, the public sector is better on one measure and there are no differences on the other three measures.

Overall, only in three out of eight sectors do we find the private sector clearly superior to the public sector. In two sectors there is no difference on


113

Table 4.37 Results according to sectors

Parameter

No difference


Chemicals Electronics Steel Minerals Non-electrical Service Textile Transport Total

1 0 2 2 4 3 1 4 17

2 1 1 0 0 0 3 0 7




Total

1 1 1 0 0 0 0 0 3

0 2 0 0 0 1 0 0 3

0 0 0 2 0 0 0 0 2

4 4 4 4 4 4 4 4 32

the different measures, while in one the score is even and in two the public sector does better, if only on one or two measures out of four. Thus, the proposition that the private sector is superior is across all sectors other than the one in which the public sector has a monopolistic position (which is true of sub-sectors in minerals) is hard to sustain on the basis of a comparison based on the measures of efficiency and productivity that we have employed.

4.5 Discussion of results We have attempted in this chapter to compare the performance of public and private sectors in the period since economic reforms, using DEA methods. We have examined measures of efficiency and productivity based on quantities of inputs and outputs used, as distinct from the financial measures used in the previous chapter. Our analysis covers balanced panels of private and public firms over the period 1991–2 to 1998–9 and includes eight industrial sectors, based on the CMIE’s classification. Our findings would seem to call into question the presumption of superior private performance that is common in policy debate in India today and that certainly underlies the clamour for privatisation in the Indian context. It is worth noting that the private enterprises in our sample comprise both domestic and foreign firms, so the results cannot be ascribed to the quality of management in domestic private firms alone. Nor can the results be ascribed to the absence of competition, widely regarded as a pre-condition for private enterprise to demonstrate superior performance: Indian industry has seen considerable deregulation and competition since the onset of reforms in 1991. While not central to our objective, our findings lend support to certain perceptions expressed in official circles and in the media. One is that

114


productivity growth has been tardy in all but two sectors, electronics and services, which accords with the perception that the industrial sector has failed to exhibit dynamism in the post-reform period and that it is the service sector alone that has exhibited dynamism. (In the official statistics, many of the firms in CMIE’s electronics sector would be categorised as services.) Second, performance in the second half of the 1990s seems to be inferior that of the first half along the dimensions that we have measured, which holds true for industrial growth as a whole. Our results have important implications for privatisation policy. First, it could be plausibly argued that, to start with, the cause of lifting overall economic performance would, perhaps, be better served by focusing on sectors in which the private sector has done better. Public-sector firms in these sectors should be the focus of privatisation efforts. Second, the government has withdrawn or curtailed budgetary support to several firms in the years consequent to economic reform nor has it allowed many of these firms to raise capital on their own. Budgetary constraints apart, an oft-cited argument is that providing capital to public-sector firms is ‘money down the drain’. This argument is hard to sustain in cases where the public sector is seen to do as well as the private sector.

5

Performance of public- and private-sector banks in India and the impact of privatisation

1

5.1 Background: Indian banking before and after deregulation The nationalisation era The story of contemporary Indian banking begins in 1969 when 14 major banks were nationalised. These joined the one bank that had been nationalised way back in 1951 and re-christened the State Bank of India. Subsequently, in 1980, another six banks were nationalised. The State Bank of India and its seven subsidiaries, referred to as the SBI group, is governed by a separate act from the nationalised banks. The public-sector bank category comprises the SBI group (eight in all) and the 19 nationalised banks (one of the 20 nationalised banks has since been merged with another). Thus, for two decades prior to financial deregulation, which was set in motion in 1992–3, the banking sector overwhelmingly comprised three distinct segments: public-sector banks (PSBs), domestic private-sector banks (hereafter to be referred to as ‘private-sector’ banks) and foreign banks. The market structure remains unaltered to this day although, with financial deregulation, private banks have made small gains in market share. State-owned banks had two clear objectives in the two decades prior to deregulation: to expand their branches into rural areas and increase deposit mobilisation; and to increase the share of the ‘priority sector’ in loans (the ‘priority sector’ included agricultural activities, small businesses and exportrelated activities). Another objective, not stated as explicitly but built into the regulatory framework, was that the banking system should make available funds to the government through investment in government securities. Before deregulation began in 1992–9, the statutory liquidity ratio (SLR) that defined the portion of liabilities that needed to be invested in government securities was 38.5 per cent. (At its peak, the incremental SLR was as high as 63.5 per cent.) There was no mention in this period of profitability as an objective, leave alone the over-riding objective. 1 Parts of this chapter draw on Ram Mohan, T. T. (2002) and Ram Mohan, T. T. (2003a).

116


Table 5.1 Progress of commercial banking in India Indicators/Year

Jun-69

Jun-75

Jun-80

Jun-85 Mar-90

Mar-95 Mar-00

Number of scheduled commercial banks (including RRBs*) Of which: RRBs Other scheduled commercial banks Number of bank offices Population per office (thousands) Number of PSB offices Per capita Deposits (Rs) Per Capita Credit (Rs)

73

74

148

264

270

281

297

– –

– –

73 75

183 81

196 74

196 85

196 100

8,262

18,730

32,419

51,385

59,752

62,367

67,339

64

32

21

15

14

15

15

6,669

15,064

25,828

35,629

41,874

44,764

45,957

88

208

494

1,026

2,098

4,242

8,247

68

148

327

678

1,275

2,320

4,705

*RRBs – regional rural banks Source: Report on Currency and Finance (1999), RBI

Indian banks responded well to the objectives placed before them. The number of branches rose sharply from 8262 in 1969 to around 67,339 in 2000, with most of the expansion taking place in the rural areas. Various other measures of growth in banking operations are available (Table 5.1). The share of the priority sector (defined as agriculture, small businesses and exports) in the total credit of commercial banks rose from 14 per cent in the same period to the mandated 40 per cent. The contribution of public-sector banks to financial deepening has been significant: deposits as a proportion of GDP rose from 16.4 per cent to 43.8 per cent (Table 5.2), thus bringing a large portion of savings into the organised financial system. Public-sector banks came to dominate the banking landscape and continue to do so, currently accounting for 80 per cent of total assets in the banking sector. Domestic private-sector banks account for 12 per cent of total assets and foreign banks for the remaining 8 per cent. The post-reform era With the move towards a market-oriented economy in 1991 and also with concerns rising about the financial position of many of the state-owned banks, the government constituted a committee under the chairmanship of M. Narasimham, a former governor of the Reserve Bank of India (RBI), to

Performance of banks 117 Table 5.2 Liquidity and credit-based indicators of financial development

Period

Aggregate Deposits

(As per cent GDP at current market prices) 1970–71 to 1974–75 16.4 1975–76 to 1979–80 24.1 1980–81 to 1984–85 30.0 1985–86 to 1989–90 36.1 1990–91 to 1994–95 39.6 1995–96 to 1999–2000 43.8

M3

Bank Credit to Government

Bank Credit to Commercial Sector

25.9 33.0 39.1 45.4 49.3 53.8

13.3 14.0 18.7 22.9 23.6 21.9

15.6 21.8 26.9 30.3 29.0 28.6

Source: Report on Currency and Finance (1999), RBI

outline a blueprint for reform of the banking sector. Another committee with the same chairman was set up later and it submitted its report in 1998. The package of financial-sector reforms unveiled since 1992 has been based on the reports of these two committees. Very briefly, lending and deposit rates were deregulated (the only regulated rate that remains is that of savings deposits); the statutory liquidity ratio was lowered to 25 per cent; prudential norms for bank capital were laid down in keeping with the Basle norms; accounting norms for provisions and non-performing assets were tightened; there was greater freedom for foreign banks to enter the Indian market and for the existing ones to open new branches; the dividing lines between commercial banks (with their focus on working capital) and the development banks (which had been confined to long-term loans) were blurred; new domestic banks were licensed; and mergers were made possible. The government has, in the post-reform years, recapitalised banks through a total infusion of funds of Rs 204 bn; the funds so acquired by banks were invested in Recapitalisation Bonds issued by the government. On top of it all, a halting movement towards privatisation began with nine banks being allowed to raise fresh equity from the markets, resulting in a lowering of the government’s stakes in these banks. Towards the end of 2000, the government introduced legislation in parliament seeking approval for the lowering of its equity holding in nationalised banks to 33 per cent. Although the government stated for the record that such dilution would take place through fresh issue of shares to the general public, there was some scepticism initially as to whether this was feasible, given the comatose state of the Indian stock market and the weak balance sheets of many of the PSBs in question. On the other hand, the road to acquisition of PSBs is strewn with statutory and regulatory obstacles. The RBI is averse, in principle, to industrial houses getting into banking. At the same time, the existing private-sector banks are too small and lack the financial muscle to acquire PSBs. The possibility of

118


acquisition of Indian banks by foreign banks has been talked about, but this too faces a number of roadblocks – although many of these have recently been removed. Total foreign ownership in banking (comprising direct and portfolio investment) had, until recently, been restricted to 49 per cent, with a ceiling of 20 per cent on foreign direct investment (FDI). The Reserve Bank of India amended the rules in February 2002 to allow FDI alone up to a limit of 49 per cent. Further, the government in its budget for 2002–3 removed the restriction on 10 per cent voting rights that applies to private ownership in banking in the case of foreign banks. Another change in rules is that foreign banks can now set up subsidiaries; earlier, they were allowed to set up branches only. (Foreign banks now have to choose between the two forms.) But other obstacles to foreign bank expansion remain. PSBs are governed by the Banking (Companies) Act and not by the Companies Act that applies to other companies. Under the former, government control over banks and the ‘public-sector character’ of PSBs would continue even after the government’s equity holding fell below 50 per cent. This would make PSB acquisitions unattractive to foreign banks even if parliament were to pass legislation, currently pending, that would allow the government’s equity in PSBs to fall to 33 per cent. Thus, privatisation of PSBs would require further legislation under which they come to be governed by the Companies Act that relates to companies in general and not by the Banking (Companies) Act, as is the case now. This would result in the ‘public-sector character’ proviso falling away. But all this is in the future. So far as the past decade is concerned, we can say that there has been a decisive shift from banking driven by social objectives to one with a profit orientation and based on international norms for capital and accounting. There is reason to believe that the performance of public-sector banks has improved as a result. Reforms and performance The RBI (1999) provides the central bank’s initial perspective on how deregulation has impacted on bank performance. The principal findings of this review are: •

•

•

There has been a decline in spreads (defined as net interest income to total assets), a widely used measure of efficiency in banking, and a tendency towards their convergence across all bank groups except foreign banks. Intermediation costs as a percentage of total assets has also declined, especially for PSBs and new private-sector banks, due largely to a decline in their wage costs. Capital adequacy and asset quality (measured by the net NPAs as a percentage of net advances) have both improved over the period 1995–6 to 1999–2000.

Performance of banks 119 •

• • •

Median profit per employee of PSBs witnessed a significant rise between 1996–7 and 1999–2000, due largely to a rise in the same in the case of the SBI group. Non-interest income to working funds rose modestly for the median PSB. The ratio of wage bill to total expenses remained at a high level for PSBs. The cost to income ratio declined at PSBs.

While the performance of PSBs in the initial years after deregulation was somewhat erratic, the RBI is quite emphatic on the period subsequent to 1995–6. The RBI states: Developments in the subsequent period indicate that a majority of the public sector banks have been able to progress considerably towards the direction of passing the ‘acid test’ of achieving competitive efficiency. They have been actively engaged in overcoming the challenges of progressively conforming to the international best practices in various areas. The RBI (2001–2) revisited the issue of the impact of financial sector reforms on efficiency and stability in Indian banking. Its key findings were: •

•

•

Competition in Indian banking has increased as reflected in the bank concentration ratio, measured by the share of the top five banks in assets, deposits or profits (Table 5.3). The share of the top five banks in total assets, for instance, declined from 51.7 per cent in 1991–2 to 43.5 per cent in 2001–2. Similar trends were noticeable in deposits and profits as well. The net interest income as a proportion of assets has declined, following an increase in the initial years. The RBI ascribes this to greater competition (Table 5.4). The intermediation cost to total assets ratio declined between 1996–7 to 2001–2 for all scheduled commercial banks from 2.85 per cent to 2.19 per cent (Table 5.5). For foreign banks, however, this ratio rose

Table 5.3 Share of the top five banks – assets, deposits and profits (per cent) Parameter

Assets Deposits Profits

1991–92

1995–96

1998–99

2000–01

2001–02

1

2

3

4

5

51.7 49 54.5

45.9 45 190.7*

44.7 44.4 49.1

43.9 43.9 44.8

43.5 43.3 41.4

*Owing to presence of loss-making banks. Source: Report on Currency and Finance (2001–02), RBI

120


Table 5.4 Net interest income (spread) to total assets (per cent) Bank Group (Average) Public Sector Banks Old Private Sector Banks New Private Sector Banks Foreign Banks in India Scheduled Commercial Banks

1992– 95

1996– –97

1997– 98

1998– 99

1999– 00

2000– 01

2001– 02

2.72 3.24 1.17* 3.98 2.84

3.16 2.93 2.88 4.13 3.22

2.91 2.57 2.23 3.93 2.95

2.8 2.15 1.98 3.47 2.78

2.7 2.33 1.95 3.92 2.73

2.86 2.51 2.14 3.63 2.85

2.73 2.39 1.15 3.25 2.57

*Data for New Private Sector Banks are available from 1994–95 onwards Source: Report on Currency and Finance (2001–02), RBI

Table 5.5 Intermediation cost to total assets (per cent) Bank Group

1996–97 1997–98 1998–99 1999–00 2000–01 2001–02

Public Sector Banks Old Private Sector Banks New Private Sector Banks Foreign Banks in India Scheduled Commercial Banks

2.88 2.52

2.66 2.31

2.66 2.26

2.53 2.17

2.72 1.99

2.29 2.08

1.94

1.76

1.74

1.42

1.75

1.12

3 2.85

2.97 2.63

3.59 2.67

3.22 2.5

3.05 2.64

3.03 2.19

Source: Report on Currency and Finance (2001–02), RBI

•

between 1996 and 1999 due to the advent of new banks that had to begin their operations with high start-up costs. Another measure of efficiency is the trend in real interest rates in the economy. Neither the real deposit rate nor the real interest rate shows a clear trend in the post-reform period (Table 5.6). Both these real rates have gone up since the second half of the 1990s (1996–7 to 2001–2) relative to the first half (1992–3 to 1995–6).

The RBI also attempts a comparison of key parameters of performance in the Indian banking system with those of other economies (Table 5.7). An important observation is that the public-sector dominated Indian banking system, often faulted for its low profitability, is more profitable than the East Asian and industrial economies on the average. Although operating costs are higher in Indian than in East Asia and the industrial economies, the higher spread more than compensates for this.

Performance of banks 121 Table 5.6 Real interest rates (per cent per annum) Year

Real Deposit Rate

Real Lending Rate

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 2000–01 2001–02 1992–93 to 1995–96 1996–97 to 2001–02

0.9 1.5 1.3 4.5 7.8 7 4.8 6.8 2.4 4.9 1.40 5.62

8.1 9.8 2.2 7.8 9.5 9.2 6.7 8.5 4.1 7.6 6.98 7.60

Source: Report on Currency and Finance (2001–02), RBI

Table 5.7 Comparative performance of banking systems East Asia4

India

Latin America5 G36

Variable

1992–971 1999 1992–97 1999

1992–97 1999 1992–97 1999

Spread Other Income Operating Cost Loan Losses2 Pre-tax Profit3

2.9 1.4 2.7 1.6 1.6

5.2 2.3 5.5 1.2 1.4

2.8 1.3 2.7 0.9 1.5

2.6 0.7 1.6 0.6 0.8

2.2 0.8 2.3 1.8 0.7

5.4 2 5.7 1.7 2.4

2 0.7 1.7 0.2 0.7

2 1 1.8 0.3 0.8

Note: Figures for India pertain to Scheduled Commercial Banks. 1. Simple average over the period. 2. For India, refers to provisions and contingencies. 3. For India, pre-tax profit refers to gorss profits. 4. Simple average of Indonesia, Korea, Malaysia, Philippines and Thailand. 5. Simple average of Argentina, Brazil, Chile, Colombia, Mexco and Peru 6. Simple average of Germany, Japan and US. Source: Report on Currency and Finance (2001–02), RBI

Public sector banks in the post-reform era Before we go on to a comparison of PSBs and private-sector banks, we would like to provide our own perspective on the performance of PSBs by themselves. Table 5.8 shows how the PSBs performed in respect of five key performance indicators: interest spread, intermediation cost, non-performing assets, provisions and contingencies, and net profit, all measured as a percentage of total assets over the period 1991–2, one year before financial deregulation was initiated, to 1999–2000. From the numbers, it should be evident that there has been an improvement in every one of these indicators in 1999–2000 over 1991–2 (1995–6 in the case of non-performing assets).

122


Table 5.8 Key performance indicators for public-sector banks (as % of total assets) 91– 92 Interest spread Intermediation cost Non-performing assets Provisions and Contingencies Net profit

92– 93

93– 94

94– 95

95– 96

96– 97

97– 98

98– 99

99– 00

3.22 2.61

2.39 2.63

2.36 2.65

2.92 2.83

3.08 2.99

3.16 2.88

2.91 2.66

2.80 2.66

2.70 2.52

NA

NA

NA

NA

NA

3.65

3.27

3.14

2.94

1.57

1.92

2.14

1.16

1.56

1.03

0.81

0.95

0.89

0.28

0.99

1.15

0.25

0.07

0.57

0.77

0.42

0.57

NA – not available Source: RBI report on Trend and Progress in Banking in India, 1999–2000

However, it is not as if there has been a clear trend towards improvement over the entire period – a clear trend is discernible only in the most recent period, 1996–7 to 1999–2000 (which perhaps explains why the RBI’s evaluation has been confined to this period), although even in this period net profit has tended to move both ways. In the initial years, we see ups and downs in all indicators as banks struggled to come to grips with deregulation. In the more recent period, the interest spread has declined, which is a sign of improved efficiency in the system. So have intermediation costs, nonperforming assets and provisions. Profitability improved sharply over the initial period. The dip in 1998–9 is somewhat misleading because it was the result of SBI’s profitability being adversely impacted by costs incurred on the Resurgent India Bonds scheme. Incidentally, the failure to account for such items, which really do not have a bearing on operational efficiency, or for one-off items such as VRS charges, often leads to incorrect perceptions of performance at PSBs. The picture is not very different when one leaves out the SBI group, which is the better-managed component of PSBs. At the 19 nationalised banks too, one finds an improvement in the indicators, with a clear trend in most indicators in the most recent period (Table 5.9). The net profit to asset ratio of 0.44 is close to the figure of 0.5, which must be regarded as healthy, despite the fact that 19 banks include three ‘weak banks’, identified by a governmentappointed committee, that had languished for want of capital to meet the capital adequacy norms. As the weak banks were hobbled in their operations for several years pending recapitalisation by government, it would be more appropriate to evaluate the performance of both PSBs and the nationalised-bank category after leaving these banks out. It is not possible to compute averages for PSBs minus the weak banks using published data, but it is fair to suggest that if we

Performance of banks 123 Table 5.9 Key performance indicators for 19 nationalised banks (as % of total assets) 91– 92 Interest spread Intermediation cost Non-performing assets Provisions and Contingencies Net profit

92– 93

93– 94

94– 95

95– 96

96– 97

97– 98

98– 99

99– 00

2.86 2.69

2.02 2.63

2.17 2.64

2.73 2.76

2.92 2.93

2.97 2.85

2.78 2.65

2.77 2.63

2.67 2.56

NA

NA

NA

NA

NA

3.95

3.48

3.26

3.14

0.97

2.12

2.7

1.02

1.5

0.85

0.71

0.85

0.86

1.98

0.1

0.36

0.41

0.62

0.37

0.44

0.3

1.71

NA – not available

did so the net profit to total assets ratio of the 19 nationalised banks too would move from 0.44 to close to 0.50. The point has been made by some that nine out of 19 nationalised banks showed losses in 2000–1 (eight in 1999–2000) after adjustment of interest on Recapitalisation Bonds, i.e., the bonds in which the banks invested the recapitalisation funds they received from government. The implication is that the aggregate profitability numbers for this category are deceptive. There are two ways of responding to this contention. A purely accounting response would be that if the equity provided to the banks is to be used in the denominator in computing return on assets, then it is only appropriate that the relevant income also be included in the numerator. But if we wish to move away from scoring points in accounting terms, we could argue that at least some of the banks could have raised capital when they needed it, had they been allowed or enabled to do so; perhaps, some might have had to under-price their issues, but they could have raised capital all the same. Had they raised capital on their own, they might have invested the proceeds in higher-return avenues such as loans, instead of in bonds yielding around 10 per cent. So the profits of the nine banks in question, it could be argued, are understated by adding interest on recapitalisation bonds. Either way, there is little reason to evaluate the banks’ performance by excluding such interest. What exactly has driven the improvement in profitability over the period 1992–2000 for PSBs as a whole? It is useful to compare the last year, 1999–2000, with the year immediately preceding deregulation, 1991–2, as well as the first year of deregulation, 1992–3. Table 5.10 presents the break-up of the components of profitability in both cases. The individual components presented in the table would not add up to the net profit figure because items

124

Privatisation in India Table 5.10 Change in profitability in 1999–2000 relative to 1991–2 and 1992–3 (as % of total assets)

Interest spread Intermediation cost Provisions and Contingencies Net profit

Change over 1991–92

Change over 1992–93

0.52 0.09 0.68 0.29

0.31 0.11 1.03 1.56

such as ‘other income’ and ‘tax’ are absent. Nevertheless, we can judge how the key components of profitability have behaved. Comparing, first, 1999–2000 with 1991–2, we find that there is an improvement in net profit as a percentage of total profits of 0.29 percentage points. This is a huge decline in spread – entirely to be expected in the wake of deregulation – that has been offset by a decline in intermediation cost and, more significantly, by a decline in provisions and contingencies as the level of non-performing assets came down. When we compare 1999–2000 with 1992–3, the first year of deregulation, the picture changes somewhat. There is a bigger jump in profitability, 1.56 percentage points. An increase in spread has contributed to this jump. Provisions decreased substantially – understandably since these were very large in the first two years of deregulation when banks’ balance sheets were being cleaned up – and a modest decline in intermediation cost. Putting together the pictures for the two years, three points are worth making. First, relative to the year prior to the advent of deregulation (1991–92), there has been an improvement in efficiency in PSBs as a whole, going by the decline in interest spread. Second, a decrease in provisions has driven the increase in profitability. Third, when we consider only the post-deregulation period, an increase in spreads has also contributed to improved profitability. In other words, the spread took a big knock at the onset of deregulation but has since looked up, although it has stayed below the pre-deregulation level. The recovery in spreads over the deregulation period is worth remarking because, in general, the decline in spreads that follows deregulation is not only steep but hard to reverse. Typically, banks respond to the squeeze on spreads and hence on profitability by taking on bigger risks, and this ultimately destabilises the banking system. In India, the decline in spreads has been contained. By giving banks more time to get their acts together, this factor has contributed to stability in banking. The decline in spreads has been contained because disintermediation, which typically accompanies financial deregulation, has been aborted in the Indian context. Companies are unable to use the capital market as an alternative to banks, hence the downward pressure on loan yields is less than it might have been if the capital market had taken off.

Performance of banks 125 More importantly, perhaps, deposit growth has not been threatened because depositors are reluctant to desert banks in favour of capitalmarket instruments, given their experience with the stock market. Bank deposits as a proportion of GDP have risen from 40.3 per cent of GDP in 1990–1 to 41.7 per cent in 1999–2000; a stronger indicator of aborted disintermediation is the decline in the ratio of shares and debentures in saving of the household sector from 14.3 per cent in 1990–1 to 2.5 per cent in 1998–9, the last year for which RBI data is available (RBI, 2000). Thus, a combination of factors has worked in favour of an improved performance of PSBs consequent to deregulation.

5.2 Review of literature The issue of efficiency in financial institutions has been the subject of considerable examination. Berger and others provide a survey of the research on scale and scope economies, X-inefficiency in banking (which describes all allocative and technical efficiencies) and the impact on efficiency of bank mergers. (Berger, Hunter and Timme, 1993). The authors note the research finding that X-inefficiencies account for around 20 per cent or more of costs in banking, while scale and product-mix inefficiencies are found to account for less than 5 per cent of costs. They also observe that the measured inefficiency varies considerably depending on the choice of measurement method. One interesting finding they highlight is that output inefficiencies are on average larger than input inefficiencies, which suggests that most of the inefficiencies are in the form of deficient revenues rather than excessive costs. This suggests that focusing on the cost function could understate bank inefficiency. As regards the sources of X-inefficiency, the authors highlight research findings that suggest this could be the result of agency problems between owners and managers, regulation and organisational and legal structures and scale and scope of operations. The literature on bank privatisation itself is rather scanty. In one of the few studies of its kind, Verbrugge, Owens and Megginson (1999) investigated bank privatisations that used public security offerings as the divestment mechanism. Their study covered 65 banks from 12 high information and 13 emerging economies, although pre- and post-privatisation data was available for only 36 banks, of which 31 were located in high-information economies and five in emerging economies. The authors found ‘limited improvement’ in bank profitability, operating efficiency, leverage, and non-interest revenue after privatisation. There were significant returns to IPOs (although there was no information to compare these with market returns), which were consistent with those found in other non-financial privatisation studies and in the IPO literature in general. This conclusion was limited to high-information economies, as pricing data for

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emerging economies was very limited. Seasoned issues were not significantly underpriced. The authors found that the government retained substantial ownership even after the IPO; only in seven cases was government ownership totally eliminated at the IPO stage and there were eight cases where such ownership was eliminated with a secondary offering. The authors are inclined to ascribe the limited improvement in performance post-privatisation to the fact of continued government control over bank decisions. Anther study involves a comprehensive survey of government ownership of banks and an examination of its implications for financial development and economic growth (La Porta, Lopez de-Silanes and Shleifer (2000)). Surveying 92 countries around the world, the authors find that government ownership of banks is still common. In 1995, 42 per cent of the equity of the top ten banks was owned by government in an average country. The authors also find that higher government ownership is associated with slower subsequent development of the financial system, lower efficiency in the financial sector and lower economic growth. Further, they find that government ownership of banks tends to be more prevalent in less-developed countries. Whatever the authors’ results for developing countries in general, it would be hard to argue that government ownership of banks has not contributed to financial development in India. Indeed, as highlighted earlier, the fact of financial deepening is, perhaps, among the least-contested propositions about government ownership of banks in India. This would hold even if we went by some of the measures that the authors employ: growth of private credit/GDP, growth of liquid liabilities/GDP, growth of commercial bank assets/total bank assets, and growth of stock market capitalisation/GDP. Moreover, this study also finds that state ownership need not always be bad for growth. The World Bank (2001) notes that the above study does show that ‘at higher per capita income levels, the negative effect diminishes to become insignificant’. Barth, Caprio and Levine (2001) show that greater state ownership is associated with higher interest-rate spreads, lower levels of private credit, lower stock-market activity and less non-bank credit. They also find that state ownership tends to heighten the probability of crises, although this finding was not statistically significant. Reviewing further evidence on the subject of government ownership, the World Bank concludes there is a strong case for moving to sell government banks, but, for reasons that are clear, it qualifies its recommendation with the comment that ‘the findings do not demand elimination of all state ownership’. The World Bank study also examines the experience of bank privatisation in several countries and documents the gains from privatisation. However, it does warn that ‘privatisation can also be badly designed and lead to crises’. The comparisons made on the gains from ownership, it underlines, are for ‘other things equal’, such as the ‘quality of financial infrastructure and the regulatory environment’. It cites the examples of Chile and Mexico, where there were major banking crises (inflicting costs of 42 per cent and 20 per cent

Performance of banks 127 of GDP respectively) following privatisation. This happened because of an underdeveloped supervisory and regulatory framework. The Bank concludes that there must be a ‘deliberate and credible’ phasing out of state ownership, going hand-in-hand with a strengthening of the environment. As regards studies on bank efficiency and profitability in the Indian context, perhaps because profitability was not the objective of Indian banks, there have not been many attempts to compare profitability in the various categories of banks. Many of the studies (Swamy and Subrahmanyam (1993) for instance) have attempted to focus on profitability within public sector banks in attempt to set benchmarks for laggards. Bhattacharyya et al. (1997) studied the impact of the limited liberalisation initiated before the deregulation of the 1990s on the performance of the different categories of banks, using DEA. Their study covered 70 banks in the period 1986–91. They constructed one grand frontier for the entire period and measured technical efficiency of the banks under study. The authors use advances, investments and deposits as outputs, and interest expenses and operating expenses as inputs. They found public-sector banks had the highest efficiency among the three categories, with foreign and private banks having much lower efficiencies. However, public-sector banks stated showing a decline in efficiency after 1987, private banks showed no change and foreign banks showed a sharp rise in efficiency. The main results accord with the general perception that in the nationalised era, public-sector banks were successful in achieving deposit and loan expansion. It should be noted, however, that the use of one grand frontier for the entire period implies that technical change is not separately accounted for. In a study that covers a more recent period, Das (1999) compares performance among public-sector banks for three years in the post-reform period, 1992, 1995 and 1998. He finds a certain convergence in performance. He also notes that while there is a welcome increase in emphasis on non-interest income, banks have tended to show risk-averse behaviour by opting for risk-free investments over risky loans. Sarker and Das (1997) compare performance at public, private and foreign banks for the year 1994–5 by using measures of profitability, productivity and financial management. They found public-sector banks compared poorly with the other two categories. However, they caution that no firm inference can be derived from a comparison done for a single year. Das (1997) analyses overall efficiency – technical, allocative and scale – at PSBs. In the period 1990–6, the study found a decline in overall efficiency. This occurred because there was a decline in technical efficiency, both pure and scale, which was not offset by an improvement in allocative efficiency. However, the study pointed out that the deterioration in technical efficiency was mainly on account of four nationalised banks. Sarkar and Bhaumik (1998) compared performance across the three categories of banks in India, public, private and foreign, using two measures of profitability: return on assets and operating profit ratio, and four efficiency

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measures: net interest margin, operating profit to staff expenses, operating cost ratio, and staff expense ratio (all ratios except operating profit to staff expenses having average total assets in the denominator). The authors attempted these comparisons after controlling for a variety of non-ownership factors that might impact on performance: asset size, the proportion of investment in government securities, the proportion of directed credit, the proportion of rural and semi-urban branches, and the proportion of noninterest income to total income. They found that, in the comparison between private banks and PSBs, there was only a weak ownership effect. Traded private banks were superior to PSBs with respect to profitability measures but not with respect to efficiency measures. Non-traded private banks did not significantly differ from PSBs in respect of either profitability or efficiency. There was, however, a strong ownership effect between foreign banks and private banks, with the former outperforming the latter with respect to all indicators. The authors conclude that the results showed that private enterprises may not be unambiguously superior to public enterprises in a developing economy. They ascribe the particular ordering that they found – foreign, traded private, non-traded private, and public – to the link between performance and the market for corporate control. The stronger the link, they suggest, the better the performance. We believe, however, that this study suffers from an important shortcoming. It is confined to just two years after financial sector reform, 1993–4 and 1994–5. In one of these, 1993–4, the performance of PSBs was adversely impacted by the introduction of new prudential and accounting norms. Any comparison using the performance parameters for these two years is unlikely to fully reflect differences in managerial performance. As noted earlier in this chapter, it is more appropriate to attempt comparisons in the period subsequent to 1995–6 as indeed the RBI (2002) has done in its own analysis. We address this shortcoming in our own analysis.

5.3 Methodology We compare performance using both financial ratios and input–output quantities. We attempt the following: (i) Comparison of performance using financial ratios. (ii) Comparison of Tornquist total factor productivity growth, Malmquist total factor productivity growth and revenue maximisation efficiency. (iii) Comparison of pre- and post-privatisation performance of listed PSBs. Comparison of performance using financial ratios We chose four financial ratios for comparison: net profit/ total assets, net interest income (interest income interest expense)/ total assets, inter-

Performance of banks 129 mediation costs/total assets, and non-performing assets/total assets. The period covered is 1994–5 to 1999–2000. We leave out the first two years after deregulation because in these years, PSBs’ balance sheets were adversely impacted by new prudential and accounting norms, so the various measures we use would not reflect operational performance in these years. Data were obtained from the Reserve Bank of India’s Report on Trend and Progress in Banking (RBI, 2000). Given the opacity of accounting data in the banking sector, the quality of financial data is always an important issue. It is fair to suggest that the RBI, the country’s central bank, has, perhaps, greater credibility than most emerging-market banks and that its monitoring of banks should make data on Indian banks reasonably reliable, especially in the recent years when the RBI has attempted to push the banking system towards accounting norms consistent with international standards. The RBI provides separate data on three categories: public sector banks, private sector banks and foreign banks. We, therefore, separately compare the public sector’s performance with private banks and with foreign banks. The data relates to a total of 27 PSBs, 34 private sector banks (25 old and nine new), and 45 foreign banks. Table 5.11 provides key statistics for each category. However, two caveats are necessary with respect to the comparisons made. The private sector banks include the ‘new private-sector banks’ that have been in operation for six years or less. As non-performing assets tend to show up over a longer time horizon, the NPAs of private-sector banks may be under-stated and hence profitability overstated. As for foreign banks, this is a highly disparate category in terms of operating characteristics with wide variations in performance. Moreover, in size and scope of operations, they are not at all comparable to PSBs. It is a moot point, therefore, whether a comparison of PSBs with foreign banks can lead to any meaningful inferences. Nevertheless, as foreign banks as a category are routinely included in the literature in any examination of the ownership effect, we include this category in our comparisons as well. With these two caveats in mind, we attempt, first, a comparison between PSBs and old private-sector banks. However, instead of comparing averages, we shall hereafter compare medians, using the Wilcoxon rank sum test. The

Table 5.11 Profile of banks by category in 1999–2000

Public Private Foreign

Mean Assets (Rs bn)

Standard deviation (Rs bn)

335 47 21

491 37 38

Source: Prowess database, CMIE

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reason is that, while the RBI provides ratios for individual banks and bank categories, it does not provide the relevant figures in the numerator and the denominator. So it is not possible to compute averages within a given category after omitting particular banks, as we shall be doing later. Using the ratios provided for the individual banks, however, it is possible to compare median scores between different categories. But even this comparison is inapt because the PSBs include the three weak banks whose operations have been hobbled for several years now pending recapitalisation by government. We attempt, therefore, two further comparisons. We compare the PSBs minus the three weak banks with the old private-sector banks. Next, we compare the nationalised banks minus the three weak banks with the old private sector banks. Comparison of performance using input–output quantities We use three measures: Tornquist total factor productivity growth (TFP), Malmquist TFP growth and revenue maximisation efficiency. For the comparison based on quantities, it is necessary to be clear about what we should regard as outputs and inputs. As Mukherjee et al. (2001) point out, there is no consensus on what best measures these in the case of banks. In the production approach, banks produce loans and deposit account services, using labour and capital as inputs. (Berger and Humphrey (1992) refer to this as the ‘value-added approach’.) The number of accounts measures outputs and production costs include operating costs only (although in the literature there are instances of the dollar value of accounts being used as outputs in the production approach). In the intermediation approach, banks collect funds and, using labour and capital, transform these into loans and other assets. This approach treats the dollar value of accounts as outputs, and production costs include both operating and interest costs. As Wykoff (1992) points out, the issue of whether deposits are to be regarded as inputs or outputs remains unresolved. If bank deposits are regarded as inputs and there are no associated outputs, then it is not clear why depositors spend so much time and effort travelling to banks to give them these free inputs. If deposits are outputs, then it has to be explained why their nominal prices have been comparatively stable and even falling in real terms over the years. This would imply that banks have undertaken to make these outputs cheap – but it is not clear why. Mukherjee et al. (2001), adopting the intermediation approach, use as outputs the following: consumer loans, real estate loans, investments, total non-interest income. As inputs they use transaction deposits, non-transaction deposits, equity, labour, and capital (measured by non-labour, non-interest expense). In the Indian context, we need to be clear about which approach is most appropriate. Using deposits and loans as outputs would have been appro-

Performance of banks 131 priate in the nationalised era, when maximising these was indeed the objective of banks, but they are, perhaps, less appropriate in the reforms era. Banks are not simply maximising deposits and loans, they are in the business of maximising profit. Maximising loans and deposits may not necessarily be consistent with profit maximisation because the quality of bank loans, not just quantity, is crucial to profit. Keeping in mind the above considerations, we compute Tornquist and Malmquist total factor productivity growth for the three categories of banks – public-sector, domestic private-sector and foreign – using as outputs the following: loan income, investment income and non-interest income. For inputs, we use interest cost and operating cost (which includes labour and non-labour, non-interest costs). Thus, both outputs and inputs will comprise flow items. Both inputs and outputs are deflated by the price index. (We also compute Tornquist TFP growth using loans, investments and other income as outputs, and deposits and operating costs as inputs.) The period covered is 1992–2000. For the Tornquist TFP computation, we have data for 27 PSBs, 21 old private-sector banks and 14 foreign banks (Where data for some banks was available for most of the period, data for the relevant years was included in the computation.) For the Malmquist TFP computation, we have a slightly smaller sample of banks: 27 PSBs, 20 private-sector banks and 11 foreign banks, as we used a DEA software that required a balanced panel over the period. Further, we compute revenue maximisation efficiency for the three categories of banks (for which we have the same data set as in the Tornquist TFP computation). Profit maximisation might seem the logical objective to focus on, except that Indian banks have thus far not had much freedom in trimming costs, especially the cost of labour. Closing branches and retrenching staff remains an emotive issue, although very recently there have been moves towards reducing staff through voluntary retirement schemes. It would seem that revenue maximisation best describes the objective that banks have been focusing on in recent years, and this is what we use in our study. In order to validate our preference for revenue maximisation as the objective function, we looked at the variability in revenues and costs at PSBs over the period under study. We use interest spread and interest spread net of provisions (both as proportions of total assets) as measures for revenue. For costs, we use the intermediation cost to total assets ratio. Table 5.12 gives the results for variability, measured as standard deviation and coefficient of variation. The variability in revenue measures is seen to be greater on both measures. Thus, for instance, in the case of one revenue measure, interest spread minus provisions, the standard deviation is 0.69 per cent and the coefficient of variation 0.46. In contrast, the variability in costs is 0.15 per cent in terms of standard deviation and 0.06 in terms of coefficient of variation. Over the period, therefore, it would have made more sense to improve revenues than to attempt to control costs.

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Table 5.12 Variability in revenues and costs (as % of total assets) 91– 92 Interest spread Intermediation cost Provisions and Contingencies Spreadprovisions

92– 93

93– 94

94– 95

95– 96

96– 97

97– 98

98– 99

99– 00

SD

Coeff. of Var.

3.22 2.39 2.36 2.92 3.08 3.16 2.91 2.8 2.7 0.31 0.11 2.61 2.63 2.65 2.83 2.99 2.88 2.66 2.66 2.52 0.15 0.06 1.57 1.92 2.14 1.16 1.56 1.03 0.81 0.95 0.89 0.48 0.36 1.65 0.47 0.22 1.76 1.52 2.13 2.1

1.85 1.81 0.69 0.46

For the purpose of computing revenue maximisation efficiency, loans, investments and other income are outputs, and deposits and operating costs are inputs. Revenues are then the sum of two products: the product of loans and the prices of loans, and the product of investments and investment prices. Similarly, costs are the product of deposits and deposit prices. In Chapter 4, we outlined our approach to profit maximisation, using the DEA approach. Here, we briefly touch upon the approach to revenue maximisation. Suppose that the competitive output and input price vectors are P (P1, P2, . . . Pn) and W (W1, W2 . . . Wn). Then, the profit maximisation problem of a firm in this industry is: Maximise p’y w’x, such that (x, y) ∈ T. Here, both input and output price bundles are choice variables and the only constraint is that the selected input–output bundle must be in T. In many cases, the output bundle y0 may be a pre-assigned task. The objective of the firm is to select the input bundle that minimises the cost of producing y0. Here, the problem is: Minimise C (w, y0) w’x, such that x ∈ V(y0). In some other situations, the input bundles x0 is exogenously determined and the firm seeks to produce the output that maximises the revenue. Now the problem is:

Performance of banks 133 Table 5.13 Descriptive statistics of privatised banks

Bank

Year of privatisation

Govt equity share post issue (%)

Total Assets (Rs billion)

State Bank of India Oriental Bank of Commerce Bank of India Dena Bank Bank of Baroda Corporation Bank State Bank of Bikaner and Jaipur State Bank of Travancore Syndicate Bank

1994–95 1994–95 1995–96 1996–97 1996–97 1997–98 1997–98 1997–98 1998–99

59.74 66.48 52.59 NA 66.21 68.34 NA NA 73.52

2615 245 564 169 586 168 125 124 272

Maximise R (p, x0) p’y such that y ∈ P(x0). The DEA linear programming problem for revenue maximisation is: Maximise p’y such that N

jyj 0 j1 N

jxj x0 j1 j 1, j 0. Comparison of pre- and post-disinvestment performance Comparison using financial ratios We compute the average ratios in the period prior to and after disinvestment, for each of the nine listed public-sector banks. In each instance the government has sold fresh equity, resulting in a lowering of its equity holding, although this remains well above 51 per cent. The statistics for the nine privatised banks are provided in Table 5.13.

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We compare pre- and post-privatisation performance, looking at three ratios: profit after tax/total assets, net interest income/total assets and intermediation cost/total assets. We subject the means of each ratio before and after privatisation to a t-test and we also use the Wilcoxon ranked sign test. The period covered is the post-reform period, 1991–2 to 1999–2000. As the nine banks were privatised in different years, the periods prior to and after privatisation vary. We take the average for each bank prior to and after privatisation, leaving out the year in which the bank was privatised. Post-privatisation stock performance We estimate holding period returns for a total of 24 banks: nine PSBs, eight old private-sector banks and seven new private-sector banks. We excluded PSB stocks that have been listed over the past year, as there are not enough data points to make for a meaningful analysis. We also excluded ICICI Bank, as data for the most recent period relates to the entity created by the merger of ICICI, a financial institution, with its erstwhile banking subsidiary. We compute returns over a period starting from the first trading date on the Bombay Stock Exchange up to 30 November 2002. We do not include initial returns to these stocks in our computations; as is well known, several studies have documented the high positive returns to initial public offerings in a variety of contexts. Stock prices and trading dates are drawn from the Prowess database of the Centre for Monitoring the Indian Economy. Table 5.14 lists the banks in each category, and the first and last trading dates for each bank. (As mentioned, the latter is the same for all banks.) The period over which returns are computed varies from one bank to another, as the banks have been listed at different times and the first date of trading accordingly differs from bank to bank. The longest trading period we have is for Nedungadi Bank, 2472 days, and the shortest is for Syndicate Bank, 732 days. However, in each instance, the stock return is compared with return to a reference index over the same period. This index is the Sensex, which comprises 30 stocks at the Bombay Stock Exchange. We compare returns with the Sensex both on an unadjusted and risk-adjusted basis. (i) Unadjusted return comparisons For computing returns over a given period, we use the daily stock return data for the banks. Prowess provides daily returns duly adjusted for dividends. For computing the daily return for the Sensex, we use Sensex closing prices over the same trading period. Typically, the number of trading days for the Sensex would be greater than that for any bank stock over the relevant time period. We take the returns to the bank stock on non-traded days to be zero. We compute the holding period return for the stock as: N

Rt (1 rt), t1

Performance of banks 135 Table 5.14 Bank stocks and first and last dates of trading New private sector banks

First trading date

Last trading date

Bank of Punjab Ltd. Centurion Bank Ltd. Global Trust Bank Ltd. HDFC Bank Ltd. IDBI Bank Ltd. Indusind Bank Ltd. UTI Bank Ltd.

19 May 1995 6 December 1999 8 November 1994 26 May 1995 12 April 1999 4 March 1998 27 November 1998

30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002

15 December 1994 7 September 1998 3 June 1994 3 August 1998 16 July 1992 17 December 1998 27 November 1995 18 June 1996

30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002

4 March 1997 5 May 1997 5 December 1997 4 March 1997 19 December 1994 20 May 1996 4 March 1994 11 March 1998 27 December 1999

30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002 30 November 2002

Old private sector banks Bank of Rajasthan Ltd. City Union Bank Ltd. Federal Bank Ltd. Jammu & Kashmir Bank Ltd. Nedungadi Bank Ltd. South Indian Bank Ltd. United Western Bank Ltd. Vysya Bank Ltd. Public sector banks Bank Of Baroda Bank Of India Corporation Bank Dena Bank Oriental Bank of Commerce State Bank of Bikaner & Jaipur State Bank of India State Bank of Travancore Syndicate Bank

where Rt is the holding period return, rt is the return on a given trading day, and n the total number of trading days since listing. Similarly, the holding period return to the Sensex is: N

St (1 st), t1

where St is the holding period return, st is the return to the Sensex on a given trading day. Thus, the unadjusted relative return for a stock Rt/St. (Strictly speaking, this is not a comparison of returns per se; it compares the wealth that would have been earned by investing one rupee in a stock over a given period with what could have been earned by investing a rupee in the Sensex over the same period. Nevertheless, it is indeed a measure of relative returns and is widely used as such.)

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(ii) Risk-adjusted return comparisons We also compute risk-adjusted returns for the stocks. We do so using the Capital Asset Pricing model (CAPM): Ri Rf i (Rm Rf), where Ri return on stock i Rf risk-free rate of return

the measure of the market risk of stock i Rm rate of return on market portfolio. We compute the average risk-free rate for the period 1996–2002, based on the weekly data on the yield on 364-day Treasury bills provided by Prowess. We translate this annual yield into a daily risk-free rate, using an average of 247 trading days a year. We then proceed to estimate the value for each stock by regressing the daily return on the stock against the daily return on the Sensex over the trading period for the stock. Using the risk-free rate, the estimated for a stock and the market return, we compute the predicted return for a stock on a given day using CAPM. The excess risk-adjusted return, et , on a given day is the difference between the actual daily return, available in Prowess, and the predicted daily return using the CAPM. Over the entire period, we compute the risk-adjusted return relative to the Sensex as n

(1 e1), t1

where et is the excess return on a given day and n the total number of trading days.

5.4 Results Comparison of performance using financial ratios Comparison of financial performance in the three broad categories Comparing the performance of public-sector banks with private-sector banks (Table 5.15), we find the latter doing better on three out of four parameters. The only parameter on which the public sector does better is the net interest income/total assets, or what is called the ‘spread’. The public sector’s performance is also inferior to that of foreign banks

Performance of banks 137 Table 5.15 Comparison of performance of public, private-sector and foreign banks in the period 1994–5 to 1999–2000 Ratio

Public sector 1

Private sector 2

Foreign 3

t-statistic (1&2)

t-statistic (1&3)

NP/TA NII/TA IntCost/TA NPA/TA

0.42 2.93 2.76 3.25

1.00 2.56 2.15 2.5

1.21 3.89 3.05 1.01

4.09 2.06 5.23 3.86

4.12 7.2 1.95 14.52

Key: NP/TA Profit after tax/total assets; Intcost/TA – Intermediation cost/Total assets; NII/TA net interest income/Total assets; NPA/T non-performing assets/total assets Note: figures in bold indicate significance at 5% level of confidence

Table 5.16 Comparison of performance between PSBs and old privatesector banks in the period 1994–5 to 1999–2000 Ratio

PSBs

Private sector (old)

z-statistic


0.54 3.28 2.78 3.44

0.78 2.67 2.49 3.2

2.3 1.8 1.54 0.23

Key: NP/TA Profit after tax/total assets; Intcost/TA – Intermediation cost/Total assets; NII/TA net interest income/Total assets; NPA/TA non-performing assets/total assets Note: figures in bold indicate significance at 5% or 10% level of confidence

on three out of four parameters. In this comparison, the public sector does better on the ratio of intermediation costs to total assets. Comparison of PSBs and old private-sector banks The results of the above comparison are presented in Table 5.16. Table 5.16 shows that the old private-sector banks score over the PSBs on two out of four parameters: they have higher profitability and lower intermediation costs. But the PSBs do better on one parameter, interest spread. Thus, in this comparison, the gap between PSBs and private-sector banks is narrower than in the earlier one, where the latter category included the new private-sector banks. (There, the score was 3–1 in favour of private-sector banks.) Adjusted comparison of PSBs with old private-sector banks Table 5.17 presents the results of the comparison of PSBs minus ‘weak’ banks with the old private-sector banks. The results do not change with respect to Table 5.16: PSBs are seen to have inferior performance in respect of two

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Privatisation in India Table 5.17 Comparison of performance between PSBs (other than weak banks) and old private-sector banks in the period 1994–5 to 1999–2000 Ratio

PSBs*

Pvt sector (old)

z-statistic


0.55 3.14 2.8 3.23

0.78 2.67 2.49 3.2

1.82 2.58 1.50 0.03

Key: NP/TA Profit after tax/total assets; Intcost/TA – Intermediation cost/Total assets; NII/TA net interest income/Total assets; NPA/T non-performing assets/total assets Note: figures in bold indicate significance at 5% level of confidence *Excluding three weak banks

Table 5.18 Comparison of performance between nationalised banks (other than weak banks) and old private-sector banks in the period 1994–5 to 1999–2000 Ratio

PSBs*

Pvt sector (old)

z-statistic


0.47 2.96 2.79 3.03

0.78 2.67 2.49 3.2

1.87 1.5 0.92 0.64

*Excluding three weak banks

parameters – profitability and intermediation cost – but they do better on one parameter, interest spread. However, we do find the median value of interest spread going up at PSBs with respect to the previous computation. We also find that the median scores for non-performing assets for PSBs and private-sector banks become almost identical, which suggests a further narrowing of the gap in this comparison. Comparison of nationalised banks other than ‘weak banks’ and old private-sector banks Table 5.18 presents the results of the comparison of nationalised banks (minus the ‘weak banks’) with the old private-sector banks. Nationalised banks do better on one parameter, interest spread, worse on profitability and there is no significant difference in respect of the two other parameters. In other words, we have a draw of sorts. To summarise the results of the different comparisons attempted above: •

When we compare the performance of PSBs as a whole with respect to private-sector banks and foreign banks over the period 1994–5 to

Performance of banks 139 Table 5.19 Comparison of Tornquist TFP growth, using income as outputs Year

Growth rate – PSU (%)

Growth rate – Pvt (%)

Growth rate– Foreign (%)

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 Average

8.16 5.69 5.79 0.16 2.22 1.58 3.00 2.99 0.77

3.63 6.76 4.89 1.71 0.70 0.99 8.78 7.18 0.49

1.90 11.27 1.90 20.19 1.00 2.62 14.24 4.06 3.07

Note: Figures in the three columns represent the average for each category for a given year.

•

•

1999–2000, we find PSBs’ performance to be clearly inferior. This is probably the basis for the criticism of PSBs’ performance that is often heard in public discourse However, when we fine-tune the comparison, for the reasons we have adduced, we find the picture changing. A comparison of PSBs with old private-sector banks shows the gap in performance narrowing. The gap becomes narrower still when we leave the three ‘weak banks’ out of the PSB category. Finally, comparing nationalised banks with old privatesector banks, we again find no clear difference in performance. Juxtaposing the above with the improvement in performance of PSBs over the deregulation period that we documented earlier, it is fair to suggest that PSBs are catching up with private-sector banks when an appropriate comparison is attempted. In short, in the wake of deregulation, PSBs have improved their performance in both absolute and relative terms.

Comparison of performance using input–output quantities Tornquist total factor productivity growth Table 5.19 presents the results for Tornquist TFP growth in the three categories of banks – public-sector, domestic private-sector and foreign – using interest income, investment income and other income as outputs, and interest cost and operating cost as inputs. Table 5.20 compares growth in the three categories, while Table 5.21 provides the average frequency distribution of the TFP growth over the period for the different categories. It can be seen from Table 5.19 that there is no significant difference in Tornquist TFP growth either between public- and private-sector banks or between public-sector and foreign banks. We computed but do not report here the results for private-sector banks after including new private-sector

140


Table 5.20 Comparison of Tornquist TFP growth in Indian banking

Public sector Private sector Foreign

Sample size

Mean growth rate

27 21 14

0.77% 0.49% 3.07%

t-statistic (Public and Private)

t-statistic (Public and Foreign)

0.11 (0.46)

0.94 (0.18)

Note: 1. Means are for the period 1991–92 to 1999–00 2. Figures in brackets indicate levels of significance

Table 5.21 Average distribution of banks in the Tornquist TFP growth range 20% 20–15% 15–0% 0–10% 10–20% 20%

PSB

% of total

Private

% of total

Foreign

% of total

0 0.75 10.125 14.25 1.75 0.125

0.00% 2.78% 37.50% 52.78% 6.48% 0.46%

0 0.5 9.875 7.5 2.75 0.375

0.00% 2.38% 47.02% 35.71% 13.10% 1.79%

2 0.75 5.75 3.875 3.375 1.25

11.76% 4.41% 33.82% 22.79% 19.85% 7.35%

Table 5.22 Growth rates of Tornquist TFP growth, using alternative method Year

Growth rate (PSU)

Growth rate (Pvt)

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 Average

3.49% 1.16% 1.31% 4.61% 0.56% 0.61% 0.69% 2.75% 0.58%

1.96% 2.13% 5.82% 0.13% 1.33% 2.51% 0.79% 2.98% 0.72%

Growth rate (Foreign) 14.35% 8.96% 1.47% 10.19% 10.25% 2.64% 0.22% 0.17% 0.11%

Note: figures in the three columns represent the average for each category for a given year

banks for the limited period for which the latter have been in existence. The comparison remains unaffected although the growth rate for private-sector banks rises slightly with the inclusion of new banks. Table 5.22 presents the Tornquist TFP growth for three categories of banks – public-sector, domestic private-sector and foreign – using loan, investment and other income as output, and deposit and operating cost as output. Once again, as can be seen from Table 5.23, there is no significant difference in Tornquist TFP growth either between public- and private-sector banks or between public-sector and foreign banks. This also applies when the results for private-sector banks are computed after including new private-sector banks.

Performance of banks 141 Table 5.23 Comparison of Tornquist TFP growth in Indian banks Mean Public sector Private sector Foreign

0.58% 0.72% 0.11%

t-statistic (Public and pvt)

t-statistic (Public and foreign)

0.99 (0.17)

0.34 (0.37)


Table 5.24 Averages for Malmquist TFP growth for bank categories, by year

1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 Average

Growth (PSB)

Growth (Private)

5.14% 1.02% 1.05% 3.92% 5.20% 0.35% 2.71% 2.10% 0.80%

6.59% 3.26% 2.86% 0.83% 0.25% 7.13% 5.99% 1.11% 1.76%

Growth (Foreign) 1.97% 13.65% 4.59% 14.06% 13.03% 1.80% 15.97% 38.37% 9.22%

However, it will be noticed that the public sector shows the highest growth in TFP among the three categories in the first approach and the lowest growth in the second approach. This accords with the fact that, in the period since deregulation, PSBs’ focus has been on asset quality rather than asset growth. Not surprisingly, TFP growth turns out to be low when we use loans and investments as output. However, as we have seen, PSBs have managed to improve profitability, which means they have seen growth in revenues relative to costs. This shows up in a positive TFP growth when loan income and investment income are treated as output. Malmquist TFP growth Table 5.24 gives the results of Malmquist TFP growth for the bank categories for each year. Table 5.25 compares growth among the categories, while Table 5.26 provides the frequency distribution. As can be seen from Table 5.25, PSBs are seen to do better than private banks at a 10 per cent level of significance and worse than foreign banks at an 8 per cent level of significance. The foreign bank category’s average productivity growth rate has been boosted by an unusually high increase in productivity at one bank in 2000. We would, therefore, interpret our results as pointing to no significant differences in Malmquist TFP among the three categories.

142


Table 5.25 Comparison of Malmquist TFP growth in Indian banks Sample size


Mean growth rate

Public sector

27

0.80%

Private sector Foreign

20 11

1.76% 9.22%

t-statistic (Public and Foreign

1.35 (0.1) 1.45 (0.08)


Table 5.26 Distribution of banks by Malmquist TFP growth ranges 20% 20–15% 15–0% 0–10% 10–20% 20%

PSB

% of total

Private

% of total

Foreign

% of total

0.5 0.625 12.75 9 2.75 1.375

1.85% 2.31% 47.22% 33.33% 10.19% 5.09%

1.5 1.375 8.875 5 2 1.25

7.50% 6.88% 44.38% 25.00% 10.00% 6.25%

2 0.75 2.625 1.75 1 2.875

18.18% 6.82% 23.86% 15.91% 9.09% 26.14%

Table 5.27 Revenue maximisation efficiency for bank categories, by year

1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00

PSB

Private

Foreign

0.74 0.69 0.81 0.72 0.82 0.76 0.80 0.86 0.33

0.36 0.25 0.44 0.52 0.54 0.49 0.52 0.64 0.24

0.71 0.46 0.73 0.70 0.73 0.66 0.65 0.87 0.49

Revenue maximisation efficiency Table 5.27 gives the results for revenue maximisation efficiency. Table 5.28 presents the comparison among the three bank categories and Table 5.29 summarises the frequency distribution across the three categories. PSBs are clearly superior to private-sector banks but there is no difference between them and foreign banks. The results accord with known facts about

Performance of banks 143 Table 5.28 Comparison of banks on revenue maximisation efficiency

Sample size

Mean

Public sector

27

0.73

Private sector Foreign

22 17

0.44 0.67


t-statistic (Public and Foreign)

4.05 (0.00) 0.88 (0.19)

Note: 1. Means are for the period 1991–92 to 1999–02. 2. Figures in parentheses indicate levels of significance

Table 5.29 Average distribution of banks in efficiency range in 1992–2000 Efficiency range

PSBs

% of total

Private

% of total

Foreign

% of total

0–0.25 0.25–0.5 0.5–0.75 0.75–1.0

1.67 1.22 10.33 13.67

6.20 4.55 38.43 50.83

2.78 7.00 5.67 1.44

16.45 41.45 33.55 8.55

2.33 2.22 3.11 7.11

15.79 15.04 21.05 48.12

the financial performance of PSBs. PSBs have higher costs than private-sector banks but they do better on a key revenue parameter such as spread. The question we ask in revenue maximisation is: how well is a bank doing, given its cost base? Not surprisingly, PSBs are seen to do better than private-sector banks. However, as we have seen earlier, foreign banks do better than PSBs on spread. So, we would not expect to see PSBs fare better on revenue maximisation than foreign banks. The interesting result, though, is that PSBs have a better score than foreign banks although this is not significantly superior. Summary of comparisons between bank categories We are now in a position to summarise the results obtained in the comparison of the three categories of banks using both financial measures and input– output quantities. These are summarised in Table 5.30. Out of a total of ten comparisons we have made, there are no differences in four cases, PSBs do better in two, private banks in two, and foreign banks in two. To put it differently, PSBs are seen to be at a disadvantage in only four out of ten comparisons. It is difficult, therefore, to sustain the proposition that efficiency is lower in public sector banks.

144


Table 5.30 Summary of comparison of performance of bank categories Measure/comparison Financial performance i. PSBs and private banks ii. PSBs and foreign banks

Result Private better on 3 out of 4 parameters; PSBs better on one Foreign better on 3 out of 4 parameters; PSBs better on one Private better on 2 out of 3 parameters; PSBs better on one Private better on 1 parameters; PSBs better on one; no difference on two parameters

iii. PSBs and old private sector banks iv. Nationalised banks (minus three ‘weak banks’ and old private sector banks) Tornquist TFP growth i. PSBs and old private No difference sector banks ii. PSBs and foreign banks No difference Malmquist TFP growth iii. PSBs and old private PSB better at 10 per cent level of significance sector banks iv. PSBs and foreign banks Foreign better at 8 per cent level Revenue maximisation efficiency v. PSBs and old private PSB better at 5 per cent level sector banks vi. PSBs and foreign banks No difference

Pre- and post-privatisation performance of listed PSBs Comparison of financial performance before and after privatisation Table 5.31 shows the results of the comparison of public-sector banks before and after privatisation. In four out of six results obtained, we see an improvement after privatisation. This is not surprising because public sector banks took a big hit in the years 1992–3 and 1993–4, consequent to the introduction of new norms for non-performing assets. They were able to tide over the consequent impact on their balance sheets thanks to an infusion of capital of Rs 200 bn provided by the government. With some of the baggage of the past removed from their balance sheets and with the new emphasis on profit orientation, public-sector banks have been able to improve their performance in recent years. This has happened despite the inevitable decline in spreads that has followed deregulation. To the extent that performance was depressed by non-operational factors in the first two years, the comparison between preand post-disinvestment performance is not as meaningful as the trend towards improvement in all PSBs since 1996–7 alluded to in Section 4.2 of Chapter 4.

Performance of banks 145 Table 5.31 Comparison of public-sector banks before and after privatisation Parameter

PrePrivatisation

PostPrivatisation

tstatistic

Significance

zstatistic

Significance

NP/TA IntCost/TA NII/TA

0.01 2.74 3.03

1.12 2.55 2.89

2.81 2.01 1.02

0.01 0.04 0.17

2.67 1.84 0.98

0.00 0.03 0.16

Improvement in performance in four out of six instances Key: NP/TA Profit after tax/total assets; Intcost/TA – Intermediation cost/Total assets; NII/TA net interest income/Total assets

Table 5.32 Unadjusted relative returns of listed banks Public sector banks Bank of Baroda Bank of India Corporation Bank Dena Bank Oriental Bank of Commerce State Bank of Bikaner and Jaipur State Bank of India State Bank of Travancore Syndicate Bank

0.81 0.79 1.44 0.53 0.92 1.22 1.45 0.75 2.19

New private sector banks Bank Of Punjab Ltd. Centurion Bank Ltd. Global Trust Bank Ltd. HDFC Bank Ltd. IDBI Bank Ltd. Indusind Bank Ltd. UTI Bank Ltd.

0.78 0.86 0.42 5.07 1.53 0.62 2.27

Old private sector banks Bank Of Rajasthan Ltd. City Union Bank Ltd. Federal Bank Ltd. Jammu & Kashmir Bank Ltd. Nedungadi Bank Ltd. South Indian Bank Ltd. United Western Bank Ltd. Vysya Bank Ltd.

0.03 1.57 0.50 3.57 0.23 1.66 0.86 1.00

Comparison of stock returns with benchmark (i) Unadjusted return comparisons The unadjusted returns for bank stocks relative to the Sensex return for the comparable period are reported in Table 5.32.

146


On an unadjusted basis, four out of nine PSBs – Corporation Bank, SBI, State Bank of Bikaner and Jaipur and Syndicate Bank – outperformed the Sensex. Three underperformed the Sensex by less than 20 per cent. The mean relative return for listed PSBs was 1.12, which means this category outperformed the Sensex. However, using a t-test, we found that the difference in performance with respect to the Sensex is not statistically significant. Among the old private banks, three out of seven outperformed the Sensex: HDFC Bank, IDBI Bank and UTI Bank. As for the old private-sector banks, three out of eight outperformed the Sensex: City Union Bank, Jammu and Kashmir Bank, and South Indian Bank. In both categories, the mean returns were higher than those for the Sensex, although here again the difference with respect to the Sensex is not statistically significant. As the Sensex returns have not been adjusted for dividends, these comparisons overstate bank stock performance somewhat. But we do not believe they would change the picture in terms of the number of outperformers when we make reasonable assumptions about Sensex dividend yields for the period covered. The average price–earnings multiple for 2002 is the lowest in the period: 13.8. This would translate into a dividend yield of the order of 3 per cent. For the other years, the yield would be lower and we estimate the yield on the Sensex to have ranged between 1–3 per cent. On this basis, we would expect the yield on the Sensex to have added around 20 per cent to the Sensex return over a nine- or ten-year period and, of course, a lesser figure in the smaller periods over which most bank stock returns have been computed. Thus, a relative score of 1.2 for a bank stock with respect to the Sensex can be safely taken to connote outperformance even with respect to a dividend-adjusted Sensex return. We compared the mean and median relative returns for the sample of PSBs with the sample of old and new private-sector banks, using the t-test and the Table 5.33 Comparison of returns in different bank categories Mean return PSB New pvt sector Old pvt sector

1.12 1.65 1.18

Median return PSB New pvt sector Old pvt sector

0.92 0.86 0.94

t-statistic (PSB & New) 0.92 (0.18)

z-statistic (PSB & New) 0.1588 (0.43)

Note: figures in parentheses indicate level of signficance.

t-statistic (PSB & Old)

0.14 (0.44) z-statistic (PSB & Old)

0.1925 0.42

Performance of banks 147 Table 5.34 Risk-adjusted relative returns of listed banks Public sector banks Bank of Baroda Bank of India Corporation Bank Dena Bank Oriental Bank of Commerce State Bank of Bikaner and Jaipur State Bank of India State Bank of Travancore Syndicate Bank

0.73 0.70 1.37 0.34 0.71 0.67 1.67 0.44 1.44

New private sector banks Bank of Punjab Ltd. Centurion Bank Ltd. Global Trust Bank Ltd. HDFC Bank Ltd. IDBI Bank Ltd. Indusind Bank Ltd. UTI Bank Ltd.

0.52 0.70 0.48 4.03 1.28 0.53 2.07

Old private sector banks Bank of Rajasthan Ltd. City Union Bank Ltd. Federal Bank Ltd. Jammu & Kashmir Bank Ltd. Nedungadi Bank Ltd. South Indian Bank Ltd. United Western Bank Ltd. Vysya Bank Ltd.

0.03 1.22 0.48 2.93 0.15 1.42 0.54 0.66

Wilcoxon rank-sum test respectively. We find that the mean and median return for the PSB group are not significantly lower than those of either of the other two categories. The results are reported in Table 5.33. (ii) Risk-adjusted return comparisons The risk-adjusted returns for the banks are as in Table 5.34. On a risk-adjusted basis, three banks outperformed the Sensex in each of the three categories. The mean returns for the PSB, new private banks and old private banks were 0.90, 1.37 and 0.93 respectively. None of these pointed to a difference in performance with respect to the Sensex that was statistically significant. As before, we compared mean- and median-adjusted returns in the three categories, using the t-statistic and the Wilcoxon rank sum test. The results are reported in Table 5.35. In this comparison too, the mean and median returns for the PSB group are not significantly different from those in the other two categories.

148


Table 5.35 Comparison of adjusted returns in different categories of banks Bank categories

Mean return

PSB New pvt sector Old pvt sector

0.9 1.37 0.92

Median return PSB New pvt sector Old pvt sector

0.92 0.86 0.94

t-statistic (PSB & New) 1.02 (0.16)

z-statistic (PSB & New) 0.16 (0.41)

t-statistic (PSB & Old)

0.1 (0.46) z-statistic (PSB & Old)

0.77 (0.24)

Note: figures in parentheses indicate level of signficance.

5.5 Conclusion Our results show that it is hard to sustain the view that efficiency in PSBs is inferior to that in domestic private and foreign banks. We arrive at this conclusion by comparing PSBs with the other two categories using our different measures: financial rations, Tornquist total factor productivity growth, Malmquist total factor productivity growth, and revenue maximisation efficiency. We are unable to find evidence of clear superiority in private-sector performance. The results point to an improvement in the performance of PSBs that have been privatised through minority sales of government equity. While the pre- and post-privatisation comparisons using financial ratios may not amount to much because pre-privatisation performance was depressed by the introduction of new prudential and accounting norms, the post-privatisation stock performance of PSBs is noteworthy because stock prices are forwardlooking in nature. Consequent to disinvestment, the nine listed PSBs studied here delivered a mean nominal return that was superior to that of the Sensex over the corresponding period. On a risk-adjusted basis, they delivered a lower return with respect to the Sensex. In neither case was the difference in performance with respect to the Sensex statistically significant. That listed PSBs as a category could return such a performance (even when initial returns are excluded) is not something that many critics of public ownership of banks would have bargained for. Equally significant, the listed PSBs as a group have delivered stock performance comparable not only to that of the old private-sector banks but also of the much-vaunted new private-sector banks. This does undermine the proposition that disinvestment, the mere dilution of government equity in PSBs, cannot possibly contribute to any improve-

Performance of banks 149 ment in performance and that government control must cease altogether. Consequent to disinvestment, PSBs have performed as well as the Sensex and the private-sector banks. This suggests that listing on the exchanges, a profitorientation and a measure of autonomy can together produce improvements in performance. Those who advocate full privatisation will, of course, put forward the counterfactual claim that had PSBs been privatised, they would have done even better. But this is quite different from contending that PSBs are a doomed lot under government ownership, which is what we were hearing until recently. As remarkable is the fact that, seven years after financial liberalisation, the banking sector has remained stable, while showing an improvement in efficiency as measured by the decline in spreads. This is remarkable because the literature on financial liberalisation points to a high probability of a financial crisis in the aftermath of deregulation, say, within five to seven years of deregulation (Demirguc-Kunt and Detragiache,1998). This happens typically because banks, finding their returns squeezed by deregulation, tend to take on higher risks. Capital-account liberalisation that has accompanied financial liberalisation exposes banking systems to a sudden rush of foreign capital, which in turn triggers a lending boom and a subsequent collapse (World Bank, 1997). In India, thanks partly to regulatory norms, government-owned banks have had minimal exposures to risky assets such as real estate and the stock market. India has not joined the movement towards full-blown capital convertibility. More importantly, government ownership facilitated recapitalisation of banks at the onset of reforms and this has arguably pre-empted costlier bail-outs down the road. (Incidentally, Verbrugge et al. (1999) cite effective treatment of bad loans prior to or during the privatisation process as an essential condition for the success of bank privatisation.) Concern has been expressed in recent years as to how far the quest for higher shareholder returns in privately owned banks is compatible with the goal of financial stability. Further, as Beim and Calomiris (2001) note, there is a heightened recognition now that financial liberalisation, of which privatisation is generally regarded as a key component, ‘is most likely to succeed when strong foundations have been laid in law and regulation’. While regulation of banking in India is of better quality than in many other emerging markets, law enforcement, including proceedings against wilful defaulters and perpetrators of fraud, remains unsatisfactory. Finally, Beim and Calomiris also observe that financial liberalisation ‘works best when preceded by fiscal reform’, an area in which Indian economic reforms have failed to deliver results so far. Viewed against this background, the Indian experience thus far does provide some ground for the proposition that government ownership can conduce to a meaningful tradeoff between stability and efficiency in banking, even while helping to meet social objectives.

6

Method of sale: is strategic sale the best option? 1

6.1 Introduction How to sell is, perhaps, the most vexed question in privatisation. Even those who claim to know the answers to the other two questions – why to sell and what to sell – may not be as confident when it comes to specifying the method of sale in privatisation. Much of the controversy regarding Indian privatisation is centred today on the method of sale. Even steadfast believers in the virtues of public ownership would not contest the need to broaden ownership by bringing in the general public. Many of them may even be willing to let government shed majority ownership, i.e., they may not be averse to government ownership falling below 50 per cent and letting the public own the majority of shares in state-owned enterprises (SOEs). What raises hackles all round is the outright transfer of control in SOEs to private management through what is called ‘strategic sale’. This would involve the sale of 26 per cent or more of government equity to a private party. In other words, the central issue in Indian privatisation today is disinvestment – the offloading of government’s equity stakes to the public in stages – versus strategic sale. Many would regard the latter as true privatisation. The former is referred to in the literature on privatisation as share issue privatisation (SIP) and the latter as asset sales. Asset sales, strictly speaking, refer to the sale of government equity in unlisted firms. In India, some strategic sales have occurred in listed firms but would, nevertheless, fall in the broad category of asset sales. This chapter reviews the claim that strategic sale ought to be the preferred mode of sale in the generality of cases of privatisation in the light of what we know from the literature on auctions. It also reviews the empirical evidence on privatisation around the world to see whether a similar presumption has driven privatisation attempts elsewhere: have other countries indeed preferred strategic sales to public offers?

1 This chapter draws on Ram Mohan, T. T. (2003b).

Method of sale

151

The chapter is organised as follows. In Section 2, we recapitulate briefly the shift towards strategic sale in Indian privatisation recounted earlier in Chapter 1, and consider the arguments in favour of it cited in official circles. In section 3, drawing upon important results in auction theory, we ask whether strategic sale can be counted upon to meet the objectives of maximising revenues and efficiency. Section 4 reviews the empirical evidence on the method of sale in privatisation. Section 5 looks at arguments advanced for strategic sale by policy-makers and often heard in the media. Section 6 concludes.

6.2 From disinvestment to strategic sale The emphasis on strategic sale in Indian privatisation is relatively recent in origin. From 1992 until 2000, the general policy was to sell minority shares in state-owned enterprises (SOEs). It was in March 2000 that the Finance Minister’s budget speech spoke of a ‘fresh impetus to this [privatisation] programme that will emphasise increasingly on strategic sales of identified PSUs’. This new approach was practised with considerable vigour by Arun Shourie, the Minister for Disinvestment in the recently ousted government of Prime Minister Vajpayee. Prior to Shourie’s taking over, there had been one important strategic sale, that of Modern Foods to the multinational subsidiary, Hindustan Lever. This sale did not evoke major criticism from political parties, although there were loud protests from the workers’ union. Since Shourie took over, every single disinvestment has followed the strategic sale route. Table 6.1 lists the strategic sales that have taken place to date. The second big strategic sale, after Modern Foods, that of Bharat Aluminium Company (Balco), proved more controversial, with the Chief Minister of Chattisgarh, Ajit Jogi, joining battle with the central government. The sale was challenged in the country’s Supreme Court by the workers’ unions but the Court dismissed their plea, holding that workers could not decide who the owners of their firm might be. Following this judgement, the government was quick to proceed with strategic sales in important firms such as Computer Maintenance Corporation, a software firm; Videsh Sanchar Nigam Limited (VSNL), the international call carrier; and Indian Petrochemicals Limited. The controversy over strategic sales flared up again with the proposal initiated in 2002 to take the strategic sale route in the cases of the petroleum majors, Bharat Petroleum Company Limited (BPCL) and Hindustan Petroleum Company Limited (HPCL). These sales have since been mired in bitter controversy, with deep divisions not only between the ruling coalition and the opposition in parliament but also within the coalition and the cabinet itself. In early 2003, a compromise was agreed upon in the cabinet whereby BPCL would be sold through a public offer while HPCL would be offered for

152


Table 6.1 Strategic sales of SOEs in India

Sr. No.

Name of PSE

Date

Modern Foods

Jan-00

2 3 4 5 6 7 8 9 10 11 12 13 14–16

LJMC BALCO* CMC HTL VSNL* IBP PPL Jessop‡ HZL IPCL Maruti Udyog† ICVL§ HCI (3 Hotels)

17–35

ITDC (19 Hotels)

Jul-00 Mar-01 Oct-01 Oct-01 Feb-02 Feb-02 Feb-02 Feb-02 Apr-02 May-02 May-02 Apr-02 2001–02 various dates 2001–02 various dates

1

Total

Ratio of paid up Equity Sold %

Face Value of Equity Sold (Rs mn)

Realisation Rs mn

(i) 74 (ii) 26 74 51 51 74 25 33.6 74 74 26 26 23 51 100

96.30 33.80 7.00 1125.20 77.30 111.00 712.00 74.00 3201.00

1050.00 440.00 25.30 8265.00 1520.00 550.00 36890.00 11537.00 1517.00

681.00 1098.00 645.00 660.00 62.10

182.00 4450.00 14908.00 24240.00 160.00

100

147.00

2425.00

271.00

4441.00

* Including dividend & dividend tax/withdrawal of surplus cash prior to disinvestment. † (Minimum amount to be received over 3 tranches; could go up to Rs 31.58 bn). ‡ Subject to court order. § Subject to BIFR approval. Source: Department of Disinvestment website

strategic sale. But the controversy continues, with the opposition questioning the right to proceed with the sales of the companies, acquired under an act of parliament, without seeking parliamentary approval. The thrust on strategic sale stems from the perception in the Ministry of Disinvestment that this method best serves the principal objectives of privatisation, namely, improvement in firm efficiency and revenue maximisation for the government. As Pradip Baijal (2002), who oversaw much of the privatisation process as Secretary of the Ministry of Disinvestment, puts it, ‘The adoption of a strategy of block sale of government stock in identified PSEs [public sector enterprises] to a strategic partner, along with transfer of management control, as opposed to market sale of shares in small lots, has enhanced the value received by the government through disinvestment. It also ensures that these assets are put to productive use in the most optimum time frame and with the maximum benefit.’ These claims are accepted uncritically in the media and by large sections of the public. We begin by reviewing the claims made on behalf of strategic sales.

Method of sale

153

6.3 Does strategic sale maximise efficiency and revenues? Reserve prices The process of strategic sale involves inviting expressions of interest from interested parties, followed by a short-listing based on certain eligibility criteria and invitation of bids from those short-listed. The highest bidder wins out provided his offer is higher than a reserve price set by the government (which is not known to bidders). Advocates of strategic sale argue that this method must lead to superior efficiency because an asset is being transferred to a buyer who clearly places a higher valuation on it compared to its value under government ownership. Moreover, government would realise a higher value from a firm through such a sale than what it could hope to realise if it continued to run it itself. (There are some who do not regard revenue maximisation as an important objective where the buyer is of domestic origin, as the sum paid out as purchase price only constitutes an internal transfer. However, since we are dealing with governments that face budgetary problems and the buyer could be a foreigner, it makes sense to posit revenue maximisation as an objective.) Indeed, it is argued that since government has a propensity to destroy value in enterprises, the sooner a transfer to private hands is effected the better. In public discourse on the subject, and especially in media comments, these contentions recur with monotonous regularity. Self-evident as these propositions might sound, it is not true that strategic sales will by itself conduce to either improved efficiency or to revenue maximisation. Take, for instance, the claim that it ensures that a firm passes into the hands of a party that values it more. This presumes that the firm is correctly valued in the first place. This is by no means axiomatic. The valuation is entrusted to ‘independent advisers’, such as investment bankers, who have an obvious interest in seeing sales go through because their fee is linked to a sale being consummated and have, therefore, every incentive to undervalue government assets. The incentive would be even stronger where the government is keen to ensure that the transaction goes through, whether for ideological or revenue considerations. Moreover, many investment banks have close business associations with the bidding parties in the private sector and this too could be expected to create a bias towards undervaluation. A further problem is that even if investment bankers are indeed objective in their approach, valuation may be based on the incorrect premise that no further improvement is possible under government ownership. For instance, if it is supposed that the workforce will remain unchanged, that would yield a lower valuation than one in which reductions in workforce are factored in. Such a premise would be incorrect because we do know for a fact that SOEs have been successful in trimming their workforce in recent years. There is a trend towards improvement in efficiency in SOEs in recent years, but there is every likelihood that this improving trend is ignored in valuations

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carried out for purposes of strategic sale. Whatever the reason for undervaluation, if firm value is not correctly determined and the reserve price is therefore set incorrectly, the very basis for strategic sale may be undermined. Incorrect reserve prices may not matter if the winning bid is higher than even the correct reserve price. If, however, the winning bid is lower than a reserve price that is accurately set, a transfer to private hands would not constitute an efficient allocation. There are several instances internationally of reserve prices being incorrectly set. An astonishing example cited by Klemperer (2002) is that of the Swiss government’s sale of fourth-generation mobile phone licences, where the ascending auction method was employed. The sale went through at a reserve price that was set, quite incredibly, at one-thirtieth of the UK and German per capita revenues. The problem of setting reserve prices could be especially acute in the case of unlisted firms but it does not go away in the case of listed firms. The stock price at a given point or the average of stock prices over the past year –benchmarks that are used for setting reserve prices – may be misleading in times when stock markets are depressed and undervalued as a whole, as has been the case with the Indian stock market for several years now. That a bid is higher than the reserve price is thus no assurance that the auction is either efficient or has maximised revenues. It may, therefore, be useful to have a mechanism for vetting reserve prices set by investment bankers – say, the creation of an independent committee on valuation that includes academics. Auctions, efficiency and revenue maximisation Suppose these problems can be taken care of and we arrive at reserve prices that reflect valuation under government ownership with reasonable accuracy. Can we then be confident that strategic sale will conduce to superior efficiency and revenue maximisation? A vast literature on auctions has developed, although it has only recently begun to be applied to the area of privatisation. Drawing on this literature, it is possible to identify the conditions under which we might expect the objectives of privatisation, spelt out above, to be met through strategic sale. We turn now to a brief summary of important propositions in this literature in so far as these have a bearing on the design of privatisation. The auctions literature focuses on three standard auctions: the English auction, the second-price sealed-bid auction and the first-price sealed bid auction. (There is a fourth, the descending-bid or Dutch auction, but this has been established to be equivalent to a first-price sealed-bid auction.) In the English auction, bidding is done in public and the auction ends when no one wishes to bid higher. In a variant of this method, an auctioneer keeps raising the price from zero until only one bidder is left, who will win the bid at the price at which the second-highest bidder dropped out.

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In the second-price sealed-bid auction, bidders submit sealed bids. The highest bidder wins but he pays only the bid of the second-highest bidder. In the first-price sealed-bid auction, again bidders submit their bids and the firm is awarded to the highest bidder, but the winner pays his own bid, not that of the second-highest bidder. This is the method the Ministry of Disinvestment has followed in effecting strategic sales. In the simplest case, all three auctions are efficient, i.e., they allocate the firm to the bidder with the highest evaluation. They also generate the same expected revenues – this the famous Revenue Equivalence Theorem. So, it would seem that it does not matter which of the three methods is used. This theorem is seen to hold, however, only under certain stringent assumptions. First, all bidders are risk-neutral, which in this case means their bids will not be influenced by the likelihood of their winning or losing the bid. Second, the bidders are symmetric, i.e., there are no publicly known differences according to which one bidder is likely to have a higher valuation than any other bidder. Third, all bidders have ‘independent private values’ for the firm, i.e. a bidder’s valuation is statistically independent of any other bidder’s valuation. When the above assumptions hold we can expect the auction process to be efficient, i.e., the asset will land up in the hands of the bidder who values it most. From the standpoint of a seller wishing to maximise revenues, a result in auction theory is relevant: the more bidders there are, the higher on average is the valuation of the second-highest bidder. Hence, increasing the number of bidders tends to maximise the seller’s revenues. Thus, while the three standard auctions may all be expected to lead to efficient allocations under the assumptions stated above, they will conduce to revenue maximisation only if there is a large number of bidders. The vital importance of having a large number of bidders has, however, not been reflected in the government’s approach to strategic sales. In the case of CMC, eventually there was only one bidder left in the fray, the Tata group. In other cases, the number of bidders has turned out to be rather small. At least in part, this smallness appears to have been built into the process by the government’s own predilections. There has not been sufficient effort to attract foreign buyers, probably because the government felt that such sales might prove controversial in the early days of strategic sales. But the downside to this approach is that the government may well have lost out in terms of valuations. The claim that strategic sales effected in such circumstances nevertheless helped maximise government revenues is thus ill-founded. No less restrictive from the point of view maximising revenues is the government’s decision to bar SOEs from bidding for other SOEs put up for sale except through special Cabinet approval. This too has the effect of narrowing the number of bidders and driving down the government’s realisations. If an SOE’s bid is higher than that of private bidders, it

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simply means that the objective of both efficiency and revenue maximisation would be better met if the SOE were allowed to acquire the firm in question. However, critics argue that SOEs, acting under the direction of ministers eager to expand their empires, would place wildly high bids: in other words, their bids would not reflect their true valuation of the firm. Thus, if their bids are successful, it is their shareholders who stand to lose. Whether this holds true for some of the better-managed SOEs is open to doubt. Such SOEs not only enjoy a high degree of autonomy but also delegate valuation to specialised committees that include independent directors. These mechanisms can be reinforced through parliamentary oversight, so that SOEs are free to bid in strategic sales and the condition of a large number of buyers is met. We have so far remained in a world in which the three assumptions of standard auctions hold and have been looking only at how best revenue maximisation can be met achieved in this world. When we begin to drop the three assumptions one by one, life begins to get more complicated. First-price sealed bids We will now examine whether first-price sealed bids, which is the method used in strategic sales in India, can meet the twin objectives of efficiency and revenue maximisation when the three assumptions of standard auctions do not hold. Suppose the first assumption does not hold, i.e., bidders are risk-averse and not risk-neutral, and the other two assumptions do hold. The results in respect of both efficiency and revenue remain the same as before with the English auction and the second-price auction. In the English auction, it makes sense for bidders to remain in the fray as long the price is less than their value; in the second-price auction, it is still the dominant strategy for each bidder to bid his true valuation. However, the first-price auction will produce a higher expected revenue than the other two methods. This is because the bidder gets nothing if he loses. If, however, he is willing to settle for a lower profit by raising his bid, he will win. The seller gains from bidders’ risk-aversion. All three methods are efficient but the first-price auction yields a higher expected revenue. If bidders are risk-averse but differ in their risk-aversion, that has its own implications. The outcomes in the English and second-price auction remain the same. However, in the first-price auction, a bidder who is more risk-averse may win the auction even if his valuation is less than that of another bidder who happens to be less risk-averse. It is just that the more risk-averse bidder is more eager to win. In this case, the auction would not be efficient and one of the two objectives of sale would be compromised. Next, consider what happens when we drop the assumption of symmetry, i.e., that there are no publicly known differences among bidders. It could be

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that one bidder has an advantage over another because he has specialist knowledge of the business that the auctioned firm is in. There could be different classes of bidders who differ from each other – say, domestic and foreign firms bidding for a government firm, with known differences in their cost structures. In the presence of such asymmetries, nothing changes in the English and second-price auction: each bidder will bid his true valuation. In the first-price auction, however, it has been shown that the bidder with the highest valuation does not necessarily win. In other words, the first-price auction may be inefficient when the bidders are asymmetric. It has also been shown that expected revenues in this case are the same in the English and second-price auctions, but may be higher or lower in the first-price auction relative to the other two methods. So far we have considered only the case of independent private-value auctions, where each bidder’s valuation is statistically independent of others’. There is also a set of results for the case known as ‘correlated values’, where there is interaction among bidders’ valuations. If the assumptions of riskneutrality and symmetric information are satisfied, then all the three standard auctions yield an efficient outcome (Maskin, 1992). As for expected revenues, Milgrom and Weber (1982) show that the English auction yields a higher expected revenue as compared to the other two auctions. The intuition behind this is that, in an English auction, every bidder gets a chance to observe when other bidders drop out and hence to update his own valuation in light of the information about others’ valuations. To summarise the above, the English auction and the second-price auction are efficient under a wide variety of circumstances. In at least two instances, varying degrees of risk-aversion and information asymmetries, the first-price sealed-bid auction is inefficient or has the potential to be inefficient. So far as revenue maximisation is concerned, under risk-aversion the firstprice auction produces higher expected revenue. With asymmetric bidders, the first-price auction may produce higher or lower revenue compared to the other two methods. With correlated values, the English auction produces the highest revenue. The various cases discussed here and the corresponding results are summarised in Table 6.2. The preceding discussion should place the claims made on behalf of the first-price sealed-bid method followed thus far in India in perspective. Contrary to the belief voiced or implied in public discourse in the country, we cannot expect this method to be efficient or to maximise revenue in all instances. Indeed, from the point of view of both efficiency and revenue maximisation, the English auction is seen to fare better across a variety of circumstances. What is more, given the variety of possible cases, of which some important ones have been cited here, the suggestion that the first-price method is in some sense the best method appears hopelessly naïve.

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Table 6.2 Comparison of auction methods under different assumptions Assumption 1. Risk aversion, with equal risk-aversion for all bidders 2. Differing risk aversion 3. Information asymmetries

4. Correlated values (with risk neutrality and symmetric information)

Efficiency

Revenue

All three methods same

Higher revenue in first price auction

First price auction may be inefficient First price auction may be inefficient

Higher revenue in first price auction Higher or lower revenue in first price compared to other two methods. Higher revenue in English auction

All three efficient

Collusion in auctions The discussion so far might suggest that it is the particular method of strategic sale the Indian government has adopted that is at fault and that, perhaps, the use of the English auction might deliver better results. However, the English auction, while more attractive than the other methods once the assumptions underlying the Revenue Equivalence Theorem are relaxed, is vulnerable on other counts: collusion, entry deterrence and predation. Indeed, Klemperer (2002) believes these considerations to be more important in the practical world than, say, risk-aversion or correlated values, whose effects, he contends, are of second-order importance. Klemperer cites several examples to make the point that collusion is all too common in ascending auctions such as the English auction, one of which is worth mentioning here. In 1999, Germany sold ten blocks of Spectrum by a simultaneous ascending auction, with the rule that any new bid on a block must exceed the previous high bid by 10 per cent. Mannessman bid 18.18 DM per megahertz on blocks 1–5 and 20 million on blocks 6–10. It would not have been difficult for the only other credible bidder, T-Mobil, to calculate that 18.18 plus 10 per cent amounted to approximately 20. Accordingly, T-Mobil bid 20 million on blocks 1–5 and did not mount a bid on the other half, thus facilitating a live-and-let-live policy between the two rivals. The auction closed with each of the bidders duly acquiring half the blocks for the same low price. The ascending auction is also weak when it comes to encouraging the entry of bidders in the face of even modest costs of bidding. Everybody knows that the bidder who values the asset the most will win, so many potential bidders lack the incentive to enter the fray. One example Klemperer mentions is Glaxo’s 1995 takeover of the Wellcome drugs company. Glaxo entered a bid of £9 bn, while Zeneca and

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159

Roche considered bids of £10 and 11 bn respectively. However, Glaxo had an advantage in terms of certain synergies with Wellcome, and the costs of bidding ran into tens of millions of pounds. Eventually, neither Zeneca nor Roche entered the bidding and Glaxo walked away with the prize at £9 bn pounds, at last one or two billion less than what Wellcome’s shareholders might have received. The auction might have been efficient in this instance but it failed to maximise revenues. The objective of revenue maximisation may also be hindered in the case of the English auction by the ‘winner’s curse’ problem. This problem arises in the ‘common values’ case, when bidders have the same value for an asset but differ in the information they have about that actual value. There is always the danger that the winning bidder has over-estimated the value and ends up a loser after winning the auction. Knowing that this problem exists, bidders will bid cautiously. Weaker firms will be especially cautious. while advantaged firms can bid less cautiously as they know that beating the weaker firms’ bids need not mean over-estimating the value. The advantaged firm thus wins at a relatively low price. Klemperer illustrates the point by referring to the 1995 auction for mobilephone broadband licences in Los Angeles. Pacific Telephone, the local telephone provider, which had distinct advantages over other bidders, won the auction for the licence at a price of $26 per capita. In Chicago, where the local telephone provider was not eligible to compete, the auction yielded $31 per capital even though Chicago was thought less valuable than Los Angeles. Thus ascending auctions, such as the English auction, while they conduce to efficiency and revenue maximisation even when the assumptions of standard auctions are relaxed, are vulnerable to collusion and entry deterrence. It may be argued that since the Indian government has used the sealed-bid auction, the discussion about collusion is only of academic importance. Be it noted, however, that the sealed-bid auction is not immune to collusion through signaling when there is a series of such auctions, although the problem may be less acute than in the case of ascending auctions. To rule out collusion in the closed club in which Indian businesses operate is rather disingenuous, to say the least. Where the first-price sealed-bid method scores is in encouraging entry of bidders. There is always a chance for a weak bidder to win because the stronger bid did not bid aggressively enough. So the first-price sealed-bid method may encourage more bidders to enter. This, of course, assumes that the government does not create barriers of its own of the sort discussed earlier – keeping out foreign bidders or other SOEs. If such barriers continue to be erected, the principal advantage of the first-price sealed-bid method relative to other auction methods would be lost. To sum up the discussion on auctions, when we move away from the simple world of standard auctions and factor in the realities of the practical world, we find that the objectives of efficiency and revenue maximisation are met only when the most stringent conditions are satisfied.

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6.4 Empirical evidence We now turn to the empirical evidence on the method of sale. Advocates of strategic sale in India are apt to give the impression that this is the method of sale to be adopted. They contend that this method alone can contribute to improvement in SOEs’ performance as it involves an immediate change of control from government to private hands. This gives rise to two separate questions. What is the empirical evidence on the method of sale used in privatisations worldwide? And where the principal alternative to strategic sales, share issue privatisation (SIP), has been employed, what do we know about the efficacy of such sales? The first question has been addressed by Megginson, Nash, Netter, and Poulsen (2002). Using a sample of 2477 sales of SOEs from 108 countries that raised $1.2 trillion between 1977 and 2000, the authors analysed the choice between raising funds in public versus private capital markets (the latter involving asset sales to private buyers). The larger proportion of proceeds was accounted for SIPs, $745 bn (62.6 per cent), with asset sales accounting for $445 bn (37.4 per cent). The authors’ key findings may be highlighted. First, SIPs tend to be larger in size than asset sales. The average SIP was found to generate $794 m (median of $105 m), whereas asset sales have average proceeds of $289 m (median of $31 m). Second, the portion of an SOE privatised tends to be smaller in an SIP than in an asset sale. In the average SIP, governments sell 35 per cent of the SOE’s capital. The average asset sale involves sale of 74 per cent of the government’s equity in the SOE, with a median value of 90 per cent, which suggests that governments are more likely to use asset sales in order to relinquish majority ownership. Third, the proportion of government equity sold is smaller in an SIP because the enterprises concerned are very large: the average enterprise value is more than $4.6 bn in SIPs compared to $641 m in asset sales. Table 6.3 shows the distribution of SIPs and asset sales in different geographical regions. SIPs have been the preferred route to privatisation in Western Europe, Asia/Australia and Mid-East/North Africa. Asset sales have been preferred in South America, North America and Africa. The presumption among Indian policy makers today that privatisation through asset sale alone makes sense is thus not grounded in empirical evidence. The only region with large privatisation sales where asset sales has been the dominant mode of sale is South America where 85 per cent of privatisation sales took place through the asset sale route. It is also not true that there is genuine privatisation only when majority control is ceded at one go. As mentioned above, governments typically have only sold a third of their equity in SIPs that account for the larger proportion by value of privatisation sales. Why or under what circumstances would one method of sale be preferred to the other? Megginson and others use three types of variables to explain

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Table 6.3 SIPs and asset sales, by region ($ million)

SIPs

%

Asset sales

%

Total

Western Europe Asia/Australia Md-East/North Africa Africa North America South America Total

437552 253161 10379 2998 19433 21271 744794

66.49% 83.27% 52.70% 36.96% 35.33% 14.72% 62.62%

220568 50850 9317 5114 35575 123262 444686

33.51% 16.73% 47.30% 63.04% 64.67% 85.28% 37.38%

658120 304011 19696 8112 55008 144533 1189480

Source: Megginson et al. (2002)

the choice of the means of privatisation: market characteristics, political and legal characteristics, and firm-specific characteristics. They find that governments of countries with less-developed capital markets are more likely to use SIPs, possibly as a means for developing capital markets. A more equal income distribution better conduces to SIPs because it makes for a broader base of potential investors and reduces the need for substantial underpricing. The less the state control of the economy and the more stable the government, the greater are the chances that asset sales would be used, as investors who need to make substantial commitments would be more confident about doing so. SIPs are, however, more frequent when there are stronger protections in place for minority interests. As for the last determinant, firm-specific characteristics, the authors find that the larger and more profitable the enterprise, the greater the likelihood that SIPs would be used – a point that is worth noting when sales of large firms such as the oil majors is considered in India. In India, although state control over the economy is still strong, the risk of expropriation of private owners must be reckoned to be low and hence investors need not be wary of taking part in asset sales. But, having regard to the objectives of capital-market development, one would expect that SIPs would be the preferred route for the larger SOEs. It is often contended in public debate in India that SIPs that involve only the sale of minority government equity in SOEs cannot possibly result in improvement in firm performance. After all, government continues to call the shots and management would be answerable to bureaucrats and politicians, so little changes at the firm level. But this, as we have seen, would not be a uniquely Indian problem. In the first round, only about a third of equity in SOEs tends to be sold in the SIP route. So what has been the experience with firm performance in SIPs the world over? The short answer is that the better-known privatisation studies indeed pertain to SIPs. The improvements in firm performance documented by these studies relate to firms that were, in fact, privatised through the SIP route and in which majority ownership was not ceded by governments at one go.

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One of the best known in this genre of studies on privatisation is that of Megginson, Nash and Randenborgh (1994). This study, which has been extensively cited in favour of the case for privatisation, focused exclusively on firms privatised through the public offer route; it did not consider firms privatised through asset sales at all. Further – and this is something that not many who cited this study seem to have noted – in all the parameters that were used to evaluate post-privatisation performance, the number of partially privatised firms (or disinvested firms, to use our terminology) exceeded the number of fully privatised firms. Now comes the punchline: on most parameters, partially privatised firms too showed improvement in performance. The notion that privatisation is effective only when a controlling stake is transferred to a private buyer through the asset (or strategic) sale route or when majority ownership by government is shed, is thus not supported by the enormous empirical literature on privatisation. Another strand in the literature on the impact of privatisation looks at long-run stock performance in SIPs. This literature is somewhat scanty and is briefly reviewed in Megginson, Nash, Netter, and Schwartz (2000). The findings of this paper itself, which looks at a large sample of SIPs across several countries, are more interesting and may be summarised here. The authors examine the returns to domestic, international and US investors who purchased shares at the first open-market price in 158 SIPs from 33 countries during the period 1981–97. They calculate buy-and-hold returns over a one-, three- and five-year period. They find that SIP investors earn higher returns than do investors who buy on the local, world or US market, or who buy a portfolio of industry-matched returns. The results are striking because the authors look at SIP returns for three different groups of investors. They consider domestic investors who purchase SIP shares in the local market and compare the returns they earn with the return they could have earned on the national market index. They look at international investors’ returns on an SIP and compare these with what they could have earned on a world market index. Finally, they examine returns to a US investor from a SIP and compare these with what the investor could have earned by investing either in the S&P 500 index or the stock of an American company in the same industry as that of the firm being privatised. The authors validate the results obtained above by using three other measures of relative performance. One is a wealth relative, which says how much money would have to be invested in the reference index or matched-firm portfolio to provide the same total return as investing one dollar (or one unit of local currency) in the SIP sample. Another is the percentage of SIP issues with holding period returns in excess of the reference index or matching-firm portfolio. The third is one-, three- and five-year compound annual returns for the SIPs compared to the country index, world index, the S&P 500, and industry-matched firms. In all cases, the SIPs outperform the reference indices and matching portfolios over all three time horizons considered.

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163

The paper by Megginson et al. thus reinforces the conclusion of studies that use measures of financial performance: SIPs do work, no matter that governments may be retaining majority control. Or, to put it differently, it is not necessary that governments transfer control to a private party through an asset sale in order to secure improvement in firm performance. Why do SIPs work? If governments retain majority control at least after the first tranche of equity sale, what explains the performance improvement? In the transition economies, this is seen to be the result of new managers being brought into SOEs but, as Megginson and Netter (2001) note, ‘no study explicitly documents systematic evidence of this occurring in non-transition economies’. One would imagine that, in industrial economies, this is the result of managers being accountable to institutional investors. However, many, if not most, SIPs have targeted retail investors and this has resulted in extremely atomistic ownership structures, not large holdings concentrated in institutional investors. Moreover, the evidence of post-privatisation improvement in SIPs is not confined to industrial economies; SIPs in developing economies exhibit performance improvements too. It would appear that performance improvement in SIPs is the result of a number of factors. Listing on exchanges, with its concomitant of a share price that is monitored closely by investors, seems to concentrate managerial minds wonderfully. Governments are wary of interfering in commercial decisions for fear of upsetting large numbers of retail investors and are inclined to grant greater autonomy to managers. These two factors together contribute to a focus on profit maximisation in SOEs that is absent when government has 100 per cent ownership and pursues multiple objectives. While we have cited the literature on SIP performance elsewhere, we do not have to look very far to see what SIPs can achieve. When financial-sector reforms were implemented a little over a decade ago, few could have thought that India’s public sector banks (PSBs) would be capable of performing well. Yet, as Ram Mohan (2003) shows, nine listed PSBs delivered a mean nominal return that was superior to that of the Sensex in the period from the start of trading up to November 2002. On a risk-adjusted basis, their return was lower but the difference was not statistically significant. Equally significant, listed PSBs as a group delivered performance that was comparable to that not only of the old private-sector banks but also the much-vaunted new private-sector banks. The performance of PSBs serves to reinforce the point that SIPs can lead to significant improvement in performance – and, perhaps, also that a transfer of control to a private buyer is not a sine qua non for improvement in performance at an SOE.

6.5 Popular misconceptions about strategic sales Misconceptions about strategic sales abound and are often evidenced in comments made in the media or by politicians and bureaucrats. These have

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mostly to do with the favourable impact on share prices of strategic sales or such sale announcements, and with valuations in strategic sales. In this section we address some of these. Share-price movements and market structure A basic prerequisite for an auction to deliver on the underlying objectives is free competition. It is easy to forget that auctions are socially efficient only when we have competitive conditions in the marketplace. This may not, of course, require that markets are not concentrated; it suffices if markets are contestable. But, where competitive conditions are missing, improvements in profitability or market capitalisation of privatised firms may merely reflect a greater willingness on the part of private owners to exploit market power. This fact is all too often overlooked in public discourse. The popular press often points to increases in share prices of firms on announcement of privatisation, or when privatisation appears imminent, as proof that the market perceives private ownership to be more efficient. In fact, such increases are often attributable to the perception that private owners would not be inhibited in using market power to increase profitability. It is very easy, for instance, for the oil majors to pass on increases in international costs of crude oil to their customers. But ministers who run the petroleum ministry tend to exercise a restraining influence on these companies and as a result such increases are passed on to consumers only gradually or partially. Private owners are unlikely to practise self-denial in similar circumstances, and this would be duly reflected in valuations. Hence share price increases do not necessarily have to do with improvements in operating efficiency. So, an increase in the share price of BPCL or HPCL on announcement that strategic sale is imminent or a fall in the share price when the sale decision is put off – both headline-grabbing news in the business press – do not necessarily point to increased efficiency under private ownership. They may merely reflect the market’s perception that private owners would be less inhibited in the use of market power enjoyed by the oil majors. Superior valuations in strategic sales Yet another argument advanced for strategic sale is that the government stands to realise better prices via this method than through a public offer. As Baijal (2002) puts it: The experience gained so far seems to justify the assumption that the strategic sale ‘discovers’ the fundamental, long-term value of the company, as opposed to the sale of small lots of shares in the market which get valued on short-term considerations linked to the current expectations of the market. The higher sales realisations through

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165

strategic sale reflect the control premium, which the investor is willing to pay for managing the company. Elaborating on these propositions, Baijal notes that from 1991 to 1999, when the government sold minority shares in public-sector companies, the price–earnings ratio in blue-chip companies such as IOC, BPCL, HPCL, GAIL, and VSNL was in the range 4–6. The price–earnings ratio through the strategic sale route, he contends, has been higher: 11–89. The comparisons are inappropriate. In the majority of cases with price– earnings multiples of 4–6 that Baijal refers to, shares were disinvested in ‘bundles’ by the government and bought by government-owned financial institutions. With a few exceptions such as GAIL, VSNL and MTNL, there were no offers to retail or international institutional investors. International offers were made in the cases of GAIL, VSNL and MTNL through GDR issues. As Table 6.4 below shows, in the cases of VSNL and MTNL, the price–earnings multiples were quite high – 18.8 and 13.9 respectively. Only in the case of GAIL was the multiple around 6. Baijal’s contention that offers of minority shares tend to yield low price–earnings multiples is thus factually incorrect. Further, there is always a problem with comparing price–earnings multiples at widely separated points in time, which is what Baijal does. Lower multiples at one point relative to another could simply reflect conditions in the market, with the market multiple itself being lower at the first point. Not least, disinvestment of SOE shares in bundles took place in the initial years of reform, 1991–2 and 1992–3, whereas strategic sales are largely a post-2000 phenomenon. With deregulation and competition being ushered in and an increased focus on profitability, the performance of SOEs has improved dramatically in the period. This again undermines comparisons of disinvestment at different points in time. There is the problem, finally, of comparing valuations of companies that are not comparable to each other. For all these reasons, Baijal’s contention that the strategic sale route has produced superior valuations – and the corollary that offer of minority shares through public offers can only yield low price–earnings multiples – is untenable.

Table 6.4 Price–earnings multiples in public offers Issue

Date of issue

P/E

VSNL GDR MTNL GDR GAIL GDR

24/03/97 3/12/97 5/11/99

18.81 13.90 5.57

Note: P/E multiples were computed in the month closest to date of issue Source: Prowess database, CMIE

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Market impact of strategic sales There is a more fundamental point that is often heard in the business press. This is that the shift in emphasis towards strategic sale has lifted values of SOEs as a category in the stock market. That is to say, not only are valuations superior in individual strategic sales but the ‘halo effect’, so to speak, of these is felt by SOEs that are yet to be sold by this route. The perception that full-blooded privatisation as represented by strategic sales will soon happen in SOEs where only disinvestment has taken place so far, we are told, is causing stock prices of disinvested SOEs to rise too. (While making the familiar point about the increase in market capitalisation of listed SOEs – he cites a 73.5 per cent increase between 31 January and 16 May 2002 – Baijal does not couch the argument in quite those terms. He ascribes the rise in share prices, erroneously, to the ‘increase in levels of available PSE stock’.) What to make of this argument? We examine the change in market capitalisation of 25 listed SOEs in the period 31 January to 16 May 2002, the period to which Baijal alludes (Table 6.5). (We exclude SOEs that were privatised in this period, also SOEs that were not traded on either or both of the first and last trading days considered.) The market capitalisation of the listed companies rose by 84 per cent in the period considered. Of the increase, 56 per cent was accounted for by one firm, ONGC, which is not a candidate for privatisation through strategic sale. If we include four other companies that are also not candidates for strategic sale, i.e., where no transfer of ownership is contemplated in the foreseeable future, these five companies together accounted for 67 per cent of the increase in market capitalisation in the period. The data thus turns on its head the received wisdom that it is the prospect of strategic sale that has caused a phenomenal rise in market capitalisation in listed SOEs as a category. It is the SOEs that have seen disinvestment through public offer and that are not likely to be sold through the strategic route that have caused the steep increase in market capitalisation. If anything, the rise

Table 6.5 Change in market capitalisation in SOEs (Rs bn)

BHEL GAIL SAIL IOC ONGC TOTAL MARKET CAP ONGC/TOTAL (23456)/7 Source: Prowess database, CMIE

31/01/02

16/05/02

36.18 57.34 20.45 105.35 208.97 743.04

42.44 62.96 24.99 156.75 559.89 1368.34

Increase in Mkt Cap 6.27 5.62 4.54 51.39 350.92 625.30 56.12% 66.97%

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in market capitalisation thus constitutes an argument for disinvestment, not privatisation! It should be apparent that attempts to read into the behaviour of SOE stock prices proof of the virtues of strategic sale are far too glib. The rise in market capitalisation of the petroleum companies that has driven in the rise in market capitalisation is more likely a response to deregulation in the oil sector, which impacts favourably on the bottom lines of oil companies, than to the prospect of privatisation. But the self-serving interpretation of SOE stock-price behaviour should not come as a surprise. The bane of many studies on privatisation has been their inability to disentangle the ownership effect from that of deregulation. Privatisation is very often one component of a larger deregulation package that tends to stimulate economies and improve firm performance. However, very few studies separate the two effects, and advocates of privatisation have been only too eager to ascribe all improvement to withdrawal of state ownership. A false comparison It remains for us to tackle head-on one of the arguments for strategic sales mentioned earlier. A private investor will pay a premium to acquire control over and above the current market price or the valuation of the firm under government control. This is said to explain why share prices rise more in response to announcements of strategic sales than in cases where sale of minority shares is proposed. The argument overlooks a critical fact: the two mechanisms of sale are not strictly comparable at the first point. In a strategic sale, a big chunk, 26 per cent or more, of the government’s equity is sold at one go. Public offers will follow the Initial Public Offer (IPO) route where a small share is first offered, followed by further tranches. We do know from the IPO literature that there is under-pricing in IPOs. One explanation that has been put forward is that such under-pricing is necessary in order to attract a body of investors to an offering. Once this is done and information is disseminated about the firm over time, share prices will rise and further tranches can be priced at higher levels. In other words, the value of the firm is realised over several tranches, starting off with calculated underpricing at the start. Hence a comparison between the price for an offer of a 26 per cent stake in a strategic sale and the price for, say, an offer of 5 per cent in an IPO is inapt. What we need to do is to compare the average price realisation over the cumulative sale of 26 per cent or more through successive rounds of public offers. The empirical evidence on the preponderance of public offers in privatisation suggests there is an expectation that, over time, the former method will do better, given the acute information asymmetries in the first sale in either method. It is worth noting that the public-offer route offers scope for

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correcting acute under-pricing in the early stages as better information about the firm becomes available. So even if a small lot is under-priced in the first offer, that need not materially impact on the realisation over several tranches. In contrast, in a strategic sale, there is the danger of a large stake being sold cheaply – and the probability of this happening must be deemed to be high given the imperfections in auctions alluded to earlier. There is thus an element of irretrievability in strategic sale; and the larger the stake sold at one go, the greater is the risk of loss from under-pricing. The relative movements on share prices on announcement of strategic sale and public offer must, therefore, not blind us to the potential for greater revenue loss in strategic sales over the long haul in a world in which auctions are riddled with imperfections. The closest we could get to comparing valuations in the two methods might be to offer roughly the same stakes in a given company through both the methods. Something along these lines was contemplated in the case of Nalco, the aluminium producer, before the process was stalled by protests in the state of Orissa. If the proposal had gone through, the strategic offer could have been completed and bids kept under wraps. The government could then have gone ahead with the planned IPO in the domestic and/or international market. We would then, perhaps, have had an opportunity to make a better comparison of valuations in the two methods than the rather shallow comparisons attempted in public discourse so far.

6.6 Conclusion To advocates of strategic sale, the merits of this method are so transparent as to place it above reproach. It makes for efficiency by transferring control of SOEs from government to private owners who can add value to them. It maximises revenues for government because the valuations obtained through this method are superior to those that can be obtained through minority sale of shares through public offers. Hence, strategic sales must be the preferred mode of privatisation. However, the findings of auction theory suggest that the first-price sealedbid method used in strategic sales cannot be counted upon always to meet the objectives of efficiency and revenue maximisation. More importantly, the empirical evidence on privatisation points to the use of share issue privatisation (SIP) as the preferred method of privatisation worldwide. The preference for SIPs is consistent with post-privatisation improvement in performance in firms privatised through this route. Such improvement has been documented using both financial measures and long-term performance of shares of firms privatised through the SIP route. Judging the relative merits of the two methods using short-term share price movements can be deceptive. For one thing, auctions are socially efficient only when competitive conditions exist in the marketplace. This is not true of cases where strategic sales have been effected or planned. Hence share price movements on announcements of strategic sales may only reflect greater use

Method of sale

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of market power under private ownership, not necessarily any improvement in firm efficiency. It is also not true that it is the drive towards strategic sales that has caused share prices of SOEs to rise. Most of the increase in share prices is accounted for by SOEs that are not candidates for strategic sale. Finally, comparisons of the immediate impact on share prices of the two methods are inapt. This is because in strategic sale, a large proportion of government shareholding – say, upwards of 26 per cent – is sold at one go. In SIPs, small lots are sold over time with deliberate under-pricing in the initial offer. As a result, the realisation of value will take place only over several tranches. Hence comparing the impact on share prices at the first point of sale of equity in the two methods is not terribly meaningful.

7

Governance and privatisation

7.1 Institutions and governance The literature on privatisation does suggest that the private sector – or privatisation – delivers when certain pre-conditions are met. We need competition, to be sure, but we also need strong institutions: law enforcement, regulation, corporate governance, a market for corporate control, and efficient bankruptcy procedures. Yet, votaries of privatisation are unwilling to buy this contention. In their view, the markets will ensure that assets are efficiently allocated once privatisation is effected. This view is, of course, rooted in the propositions of Ronald Coase, who argued that, no matter what the law was, firms and individuals could always write contracts that achieved efficiency. In other words, markets would find a way, however ineffective the law might be. Johnson and Shleifer (2001), while reviewing the literature on the link between legal institutions and the effectiveness of privatisation, show that the empirical evidence is weighed against these propositions. Legal rules and investor protection do matter. Corporate governance is thus material to postprivatisation performance. They write, Privatised firms with weak corporate governance have repeatedly demonstrated weak performance and have frequently been ‘tunneled’ by their management. . . . The lesson from post-communist countries is that effective investor protection needs to accompany privatisation. They go on to say: The implication is that unless privatisation is accompanied by enforceable investor protection, it will not improve firm performance and will likely be accompanied by severe agency problems, including various forms of expropriation or ‘tunneling’ – the diversion of company funds for personal gain – by management.


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We would add that this holds not just for privatisation but for the performance of the private sector wherever it already exists. Why do legal institutions and governance matter? Because they have an important impact on economic outcomes. The evidence in this regard is formidable and we shall summarise here the salient points made in the Johnson and Shleifer survey (2001) and some of the papers cited therein. The first point to note is that countries differ in the extent of legal protection accorded to investors and that these difference can be traced to differences in the origin of the legal system. This is captured in La Porta, Lopaz-de-Silanes, Shleifer, and Vishny (LLSV, 1998). The authors use six dimensions to measure the extent of protection of minority shareholders against expropriation by insiders. These are: whether proxy voting is allowed by mail; whether shares are blocked for a period prior to a general meeting of shareholders; facility for cumulative voting; ability of shareholders to sue the board or otherwise get relief from the board decision; pre-emptive right to new issues for minority shareholders; whether an extraordinary shareholder meeting can be called with relatively few shares. Where shareholders possess all the rights or facilities mentioned above, the antidirector rights index is strongest – a score of 1 is accorded for each one of the six dimensions. The authors find that investor protection is significantly higher in commonlaw countries (average score: 4) than in French-origin civil-law countries (average score: 2.33). LLSV (1998 and 1999) find further that the legal enforcement of contracts is weaker in countries with a civil-law tradition. For example, the efficiency of the judicial system is on average 8.15 in Englishorigin countries (on a scale of 1–10) but only 6.56 in French-origin countries. The authors conclude that legal origin affects investor protection, both through the rights available in the laws and the ease of enforcement of these rights. It turns out that the degree of investor protection has important economic implications. For one thing, both stock and debt markets are less developed in French-origin countries. When we add the abundant evidence on the correlation between financial development and growth (Levine and Zervos, 1998, Beck, Levine and Loayza, 2000 and Rajan and Zingales 1998), we can see how investor protection can have important economic outcomes. Another finding that is relevant is that economies that have weak legal institutions for corporate governance tend to suffer more when hit by a shock – as, for instance, the economies affected by the East Asian crisis (Johnson, Boone, Breach, and Friedman, 2000). An important point made by Johnson and Shleifer (2000) is that the Coasian principle that private institutions will adapt in ways that will protect investors also does not hold. For instance, concentrated ownership, which is one adaptation that one finds in emerging markets, does not protect small shareholders from expropriation – a point that is very relevant to the

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Indian situation, as we shall see. A glaring example is that of the Czech Republic, where privatisation and concentrated ownership led to ‘tunnelling’, but similar deficiencies have been noticed in Germany and Switzerland as well. The Coasian argument about private parties being able to write efficient contracts, it would seem, rests on the premise that there are courts that can enforce such contracts. But this is not true of many countries. Either the judicial system needs to be strengthened or, alternatively, an efficient financemarket regulator is required. In the absence of these, investor protection will remain weak and privatisation will be fraught with peril. How does Indian situation relate to the above discussion? India has moved some distance towards exposing its economy to competition but the supporting institutions remains underdeveloped. In particular, the legal system and law enforcement are rather weak in India. In their study of the legal environment and shareholder and credit rights, for instance, LLSV (1998) rank India quite low on five dimensions: rule of law, corruption, risk of expropriation, risk of contract repudiation, and accounting standards. India gets a decent ranking on only one dimension, efficiency of judicial system, but this is defined rather narrowly as the integrity of the system in relation to foreign investors (Table 7.1). Demirguc-Kunt and Maksimovic (1998) also give India a low rating on law and order, defined as the efficiency of the state in enforcing property rights within the country. This measure, prepared by the International Country Risk Guide, aggregate reports by a panel of more than one hundred analysis on a scale of 0–6. India rated a low score of 2. (The US, Sweden, Norway, and Australia are among countries that rate a score of 6.) India does better in terms of shareholder rights, with above-average scores on four out of six dimensions (Table 7.2). Yet, as we shall see in the next section, there are other factors that militate against shareholder interests, the relative absence of hostile takeovers, the dominance of owner-managers with a poor record of corporate governance, and the absence of activism on the part of institutional investors.

Table 7.1 Legal institutions in India Efficiency Rule Risk of of judicial of Risk of contract Accounting system law Corruption Expropriation repudiation standards India 8.00 Average for 7.67 49 countries

4.17 6.85

4.58 6.90

Note: Higher score indicates better performance Source: La Porta et al. (1998)

7.75 8.05

6.11 7.58

57.00 60.93


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Table 7.2 Protection of shareholder rights One share Proxy – one by mail vote allowed India 0 Average for 0.22 49 countries

0 0.18

Shares not blocked before meeting

Cumulative Prevoting/ emptive proportional right AntirepresenOppressed to new Director tion minority issues rights

1 0.71

1 0.27

1 0.53

1 0.53

5 3

Note: 1 investor protection is in the law Source: La Porta (1998)

Against this backdrop, it is useful to review the state of governance in the public and private sectors, and to judge how far conditions are conducive to privatisation in India.

7.2 Governance in the public sector The problem of corporate governance at SOEs is seen to be very different from that in the private sector in that there we do not have one set of agents, the managers, accountable to one set of principals, the shareholders. There are at least two sets of principals and agents in the picture. There are the voters, the primary owners of the SOEs, to whom the politicians are accountable. Then there are the politicians and bureaucrats, to whom the managers of SOEs are accountable. Where the SOEs happen to be listed, we have an additional complication in that there are both institutional and individual shareholders to whom the managers are also accountable. This adds a third layer to the principal–agent problem at SOEs. These multiple layers of the principal–agent structure are seen to complicate the problem of governance at SOEs. However, the most fundamental problem, in the popular perception, is political and bureaucratic interference with the day-to-day operations of SOEs, which renders difficult the pursuit of shareholder wealth maximisation. Such interference takes many forms in the Indian context. Decisions at SOEs, it is said, are often taken on non-commercial considerations, for instance excess employees are hired or project locations are not chosen strictly on commercial grounds. Decision-making is slowed down because several decisions require the approval of parent ministries. A big problem is that many SOEs remain without a CEO for long periods of time as the government process of selection is necessarily slow and cumbersome. Not least, oversight of SOEs by parliamentary committees, the Controller and Auditor General as well as the Central Vigilance Commission, not only slows down decision-making – as decisions are referred to committees

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instead of individuals being able to decide – but also creates a culture of riskaversion that does not conduce to performance. As R. H. Patil (2003) points out, one of the striking facts about SOEs in India is that the government chose the corporate form of organisation for carrying out a variety of activities when it could easily have set up these organisations as departmental undertakings. The motivation for doing so was not ease in raising capital but the ‘administrative convenience and flexibility that a corporate entity confers’. It is not necessary for government to seek parliamentary approval for the budgets of SOEs; it needs approval only for funds provided to an SOE out of the Consolidated Fund of India. Having opted for the corporate form, however, the government failed to put in place mechanisms of governance appropriate to the corporate organisation. For many years, SOEs functioned without a minimal complement of full-time directors. As Patil (2003) points out, it was only in 1984 that the Bureau of Public Enterprises issued guidelines to SOEs asking for the creation of the posts of Director (finance) and Director (personnel). While the guidelines also referred to the need to have board representation for other disciplines such as production, marketing, etc., these guidelines were largely ignored. In 1992, a fresh set of guidelines was issued regarding the composition of SOE boards. Full-time functional directors should not be less than 50 per cent of the strength of the board; the number of government directors should not exceed one-sixth the actual strength of the board, with not more than one official nominee of the concerned administrative ministry; the total number of government directors, in any case, should not exceed two; and non-official part-time directors should not be less than one-third the strength of the board. Then in 1997, as we outlined in Chapter 1, SOE boards were conferred varying degrees of autonomy in respect of decisions relating to capital expenditure, creation of joint ventures or strategic alliances, organisational restructuring, creation of posts, raising of debt in the domestic and international markets, etc. However, all these improvements sidestep the crucial issue in the governance of SOEs: the empowerment of the board itself. The CEO of an SOE is neither appointed by the board nor removed by him. Moreover, key decisions are still taken by the parent ministries of SOEs and the board is reduced to ratifying these decisions. So what is to be done? Nobody would dispute that the government, as the owner of SOEs, would have a say in their running. But ideally this must take place through the boards of the concerned enterprises, with governmentappointed directors putting forward the government’s viewpoint and carrying the rest of the board, including full-time directors and independent directors, along. The government has shown little inclination to carry autonomy at SOEs that far. R. H. Patil, who has held top positions in several government-owned organisations and is currently chairman of the Disinvestment Commission,


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makes several suggestions for reform of governance in the public sector (Patil, 2003). He argues in favour of the strengthening of the Public Enterprise Selection Board (PESB). The PESB makes recommendations for the posts of Chairman, Managing Director and functional directors in SOEs, as well as posts at other levels. It is also supposed to advise the government on overall HRD policies at SOEs, including performance appraisal, training and development, creation of a data bank on managerial personnel, etc. A problem that Patil sees in the present PESB system is that its recommendations are not final: they are subject to further scrutiny. This, he suggests, should change, with the PESB being the sole decision-maker. Further, the job of selecting independent directors should also be transferred to the PESB. Not least, the boards of many SOEs need to be reconstituted with induction of independent directors as required and a panel of qualified, independent directors needs to be drawn up from which the Appointment Boards of SOEs can select directors as required. Patil suggests that the role of the administrative ministries should be confined to two areas: the appointment of directors, based on the recommendations of an expert body; and the issuing of transparent guidelines to SOEs under their jurisdiction. The latter is important because of the tendency on the bureaucrats to issue by telephone instructions to top management of SOEs. Both these recommendations involve a substantial shift of authority from the administrative ministries to the respective boards of SOEs. As mentioned earlier, this would not mean that the government, as owner, would not have a say in the running of SOEs. It is just that government would have its nominees on boards and these nominees would work with full-time and independent directors in formulating the SOE’s policies. The first Disinvestment Commission, headed by G. V. Ramakrishna, made a number of recommendations for strengthening the governance structure at SOEs (Disinvestment Commission, 1998). Again, a key recommendation was to professionalise the boards by inducting non-executive directors chosen by the PESB. The government responded by announcing that in the case of 97 SOEs, the boards would have at least three non-official part-time directors, with such directors constituting at least one-third of the total strength of the board. The nomination of such directors would be decided, not just by the PESB as recommended by the Commission, but by a Search Committee that would comprise the Chairman, PESB, Secretary, Department of Public Enterprises, Secretary of the administrative ministry concerned, and some eminent persons. Clearly, the bureaucracy is loath to entirely cede control over board appointments. Other recommendations made by the Disinvestment Commission include conferment of greater autonomy, depending on whether the SOEs are strong performers or moderate performers, autonomy in fixing prices and superior

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compensation structures for top management, none of which has found acceptance with the government. There are many who believe that the political and bureaucratic class will never let go of their stranglehold on SOEs, and that is why privatisation remains the only route to improved governance at these enterprises. A more radical route to greater autonomy for SOEs proposed by the Disinvestment Commission was the creation of a National Shareholding Trust that would hold government shares in blue chip SOEs. First, there would be sale of shares to the general public. Once the government’s shareholding came down to 26 per cent, these shares would be transferred to the Trust, which would be managed by six or seven eminent professionals, including the Finance Secretary to the government of India. The Commission said that there was a precedent for such an arrangement in Singapore, where the government’s shares in SOEs were vested in an organisation called Temasek. The argument for creating such a Trust, the Commission argued, was particularly compelling once government’s shareholding in SOEs dropped to something like 26 per cent with the rest of the shares being dispersed among the public. The companies would then technically cease to be in the public sector but the government, meaning the politicians and bureaucrats, would still have control. Not being in the public sector would mean that the companies would not be under the purview of parliament, the Comptroller and Auditor General, the Central Vigilance Commission, and other watchdogs. The potential for mischief would thus be immense. This seems rather alarmist as SOEs with public shareholding would still have to comply with listing requirements of the stock exchanges and would be subject to the governance code applicable to listed companies. The broader point, however, is that, in listed SOEs, the dominant shareholder, the government, can always be pitted against the interests of other shareholders. (As we shall see in the next section, this problem is by no means confined to the SOEs; it is to be found in the private sector as well.) Indeed, this problem has come to fore at some listed SOEs, including public-sector banks, where it has been noticed that the interests of minority shareholders are sometimes compromised by the majority shareholder, the government. One episode that highlights this problem relates to the State Bank of India, the nation’s largest bank. On two occasions, the bank was saddled with the task of mobilising funds from overseas Indians in order to shore up the country’s foreign-exchange resources. As the interest rates offered were higher than what SBI would pay domestically and there were also significant transaction costs, analysts decried the move as inimical to the interests of minority shareholders. But this also highlights the positive side to bringing in public and institutional shareholders, namely that decisions taken by SOEs on noncommercial grounds are at once highlighted, discussed, criticised. To that extent, it becomes difficult for politicians and bureaucrats to foist decisions on


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management of SOEs. The greater the non-government shareholding, the more difficult government interference becomes. That is why disinvestment, the listing of shares of SOEs, may be expected to have a salutary impact on SOEs and has indeed contributed to an improvement in the functioning of many SOEs, as we have seen in earlier chapters.

7.3 Governance in the private sector While these ills at SOEs are well-recognised and are highlighted ad nauseam in the media, there are grave shortcomings in the realm of governance in the Indian private sector as well. This should not, of course, come as news in light of the steady stream of disclosures about abuses in the American corporate sector ever since the technology bubble burst in 2000. Indeed, given that law enforcement and judicial mechanisms are weaker in India than in the industrial economies, as borne out by some of the findings presented earlier in Section 7.1, one would expect that the governance problem in the Indian private sector would be far more acute than in the industrial economies. It is important to recognise that the governance problem in the Indian private sector is rather different from what obtains in the Anglo-Saxon model and that is sought to be addressed by the current wave of reforms in corporate governance. The central problem in the Anglo-Saxon model is making managers, whose ownership of the firm is low or negligible, accountable to the owners. In India, the dominant shareholder constitutes the management and the governance problem is one of ensuring that the other shareholders, whether institutions or individuals, are not expropriated by the dominant shareholder. Thus, the problem of governance in the private sector, it turns out, is not very different from that in listed SOEs with the public and institutions holding a minority of the shares. One of the criticisms of governance at SOEs, we saw, has been that the board lacks the power to appoint or remove CEOs, the power to do so being vested with the government alone. But the situation is not very different in the private sector, given that the CEO happens to be from the group with a dominant shareholding and given also that institutional activism is largely missing in India. It is virtually unheard of for CEOs in companies run by industrial houses to be removed by the board or by shareholders. If anything, the problem of CEO accountability is more acute in the private sector. In the public sector, CEOs at least have fixed tenures, even if they may not be removed during their tenures on grounds of performance. In the Indian private sector in contrast, barring a handful of professionally managed companies, the CEO (or the Chairman if he has executive powers) goes on forever, no matter how poor the performance of the firm. In ‘sick’ or chronically loss-making companies, there could be drastic financial restructuring as well as downsizing of the workforce but the CEO responsible for the mess carries on regardless. Rightly is it said that in India

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there are ‘sick’ companies but no ‘sick’ businessmen: the latter flourish and prosper irrespective of their companies’ fortunes. In the literature, a high shareholding by a group is seen as mitigating the principal–agency problem. If management happens to have a substantial ownership stake, its interests are said to be aligned with those of other shareholders. This, however, is strictly true only when opportunities for ‘tunnelling’ are not available. Where such opportunities are not available, the dominant owner lacks incentive to maximise shareholder value by improving firm performance. The interests of the dominant owner may thus not be aligned with those of other shareholders. The simpler option for management is to transfer funds to Swiss banks – or American banks, as happened in Russian privatisation. As India’s financial institutions and banks have discovered to their cost, the bane of project financing in India is that the promoter can recover most of his investment at the very outset through ‘tunnelling’. The danger with privatising some of India’s best companies in the public sector is that they then become exposed to the prospect of such ‘tunnelling’. Where there is an active market for corporate control, the firm’s share price would fall with ‘tunnelling’ and the firm would be acquired by somebody who could deliver better value to the shareholder. Such a market is missing here and is weak even in the industrial economies where large firms are concerned. The ‘private benefits of control’ resulting from a dominant shareholder would thus be considerable. It is the existence of ‘private benefits of control’ that must explain the single-mindedness with which industrial groups have been striving to raise their already high equity holdings in group companies. Businessmen contend that their companies would otherwise become easy targets for takeover by foreign companies with deep pockets. But this should not be such a big concern for groups that are confident of delivering shareholder value. A case in point is Infosys Technologies, one of India’s leading software firms that is regarded as a model of corporate governance. At this firm, the promoter-directors together own less than 25 per cent of equity. They have not sought to increase it through market acquisitions, nor do they award themselves stock options for performance that could lead to an increase in their shareholding in future. It is hard to resist the conclusion that, at Infosys Technologies, the promoters’ lack of interest in a higher shareholding reflects as much their indifference to the ‘private benefits of control’ as their confidence that performance would confer them immunity from takeovers. Institutional shareholding is large in Infosys. Which institutional shareholder would want to replace the existing management? Lacking the confidence of the promoters of Infosys, most industrial houses in India take refuge in high shareholding in the companies they manage. We referred in Chapter 1 to the phenomenon of ‘vanishing companies’, firms whose promoters have simply disappeared after raising funds from


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the stock market and have yet to be prosecuted. Whatever the governance problem in the public sector, the prospects of ‘tunnelling’ must be reckoned to be far lower than in the private sector – the controls are much too strong to permit it. Even if we grant that the upside to returns at SOEs is not as high in the private sector, they do have the advantage in the Indian context of having a rather limited downside to their returns! It is worth mentioning, incidentally, that foreign institutional investors are often quoted in the press as saying that corporate governance, and especially accounting standards, at SOEs are superior to those in the private sector. In sum, the governance problem in the Indian private sector is not materially different from that in SOEs: both suffer from the problem of a dominant owner whose actions may work to the detriment of minority shareholders. While ministerial or bureaucratic interference in SOEs gets much play in the media – including such relatively minor matters such as the abuse of cars or accommodation available at SOEs – it is somehow blithely assumed that, in the private sector, the very fact of private ownership would somehow take care of the agency problems. We do know that the reality is very different. Two arguments could be put forward as to why the governance problem at SOEs would nevertheless be more acute. One is the familiar ‘soft-budget’ argument about SOEs. Failed enterprises in the public sector are not closed down because governments are willing to throw money at them. This is not wholly true in India in the post-reform period, because governments have indeed cut back on support to SOEs as a whole, including loss-making SOEs. Further, it is not as if loss-making private firms lose access to funds. In several large firms, the financial institutions and banks have been obliged to write off portions of loans as part of restructuring, and often to make funds available in order to safeguard their exposures. In restructuring of this sort that occurs elsewhere, management tends to be replaced. In India, this is so rare as to be virtually unknown, given that management is the dominant owner. The ‘hard-budget’ constraint that is said to operate in the private sector is eased at least in the larger firms because banks and financial institutions find it difficult to replace management or to find a suitable buyer for their equity stakes. The second argument as to why the corporate governance problem in the private sector, while broadly similar to that in the public sector, might be more tractable relates to the market for corporate control. As mentioned earlier, this market is weak even in the industrial firms where large economies are concerned. In India, even smaller firms are relatively immune to this threat for a variety of reasons: the high shareholding of the controlling group; lack of takeover finance; the ban on foreign firms investing in the secondary market. (Such investment is open only to foreign institutional investors (FIIs), a category that comprises investment funds of various kinds, not foreign firms.) There have been serious attempts at reforming corporate governance in the country in recent years. Several committees have deliberated the reforms

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needed and come up with recommendations – notably the Confederation of Indian Industry, one of the leading all-India organisations of businessmen, the Kumar Mangalam Birla and Naryana Murthy committees set up by the Securities and Exchange Board of India, and the Naresh Chandra committee constituted by the government of India. As a result, there has been much progress towards instituting the forms of governance. In particular, norms have been laid down for the induction of independent directors on boards, disclosure norms have been tightened, audit, compensation and nomination committees have been mandated, and so on along the lines of what obtains in the Anglo-Saxon model. However, these norms amount to very little in a situation in which the board cannot remove the CEO. The CEO, typically a member of the industrial house, can always command sufficient votes, if not the majority of votes, in a shareholders’ meeting and is, therefore, not really subject to the will of the board. True, in many companies, the financial institutions, including FIIs, acting together could dislodge the CEO if they got together. However, institutional activism is sadly missing in India and this again detracts seriously from the quality of governance. FIIs have been passive investors thus far, perhaps because their holdings in India are small in relation to their overall portfolios but also, perhaps, because they are fearful of the political fall-out of any activism they may practise. The Indian institutional shareholders are overwhelmingly governmentowned and their actions are always suspect in the eyes of the business community as well as the general public as being politically motivated. This problem can be addressed only if the Indian institutions are perceived to have a large degree of autonomy or if they are privatised. Thus, those who view privatisation across the board as inevitable must recognise that privatisation of financial institutions must come first; without this, neither corporate governance nor the market for corporate control can be improved to a level where privatisation of industrial firms can be effective. Yet, the political reality on the ground ensures that the financial sector will be the last to be privatised. There is thus a serious constraint on the pace of privatisation that is ignored by most advocates of privatisation. The immediate and more practical solution is to inject a greater degree of professionalism and autonomy into such large government-owned institutions such as the Unit Trust of India, insurance companies and banks so that they are enabled to take a more active role in ensuring performance by the companies in which they have invested. This could mean that institutional investors appoint nominees on the boards of companies in which they have investment, but this move has been stoutly opposed by Indian businessmen on the ground that it could lead to insider trading. (It is not clear why the owners, industrial houses who constitute the management, should be exempt from criticism on the same grounds.) Businessmen would prefer to have as ‘independent’ directors individuals they choose rather than ones nominated by financial institutions.


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It is not just the quality of governance that inhibits superior performance in the private sector. A wide swathe of Indian business, accustomed to profits in a sheltered economy, has only recently been exposed to international competition – in some products, competition from imports is still inadequate – and hence lacks the capacity for risk-taking and innovation that drive typically performance in private enterprises. It is true that in some areas, notably software and pharmaceuticals, India has produced firms that can compete in the world market. (Many of the successful firms in these sectors are run by first-generation entrepreneurs who do not belong to the older business houses.) But these sectors still represent too small a proportion of Indian industry to impact significantly on aggregate performance in the private sector. Moreover, the conditions under which these sectors have demonstrated performance – exposure to global markets and standards of governance – are precisely the ones that are missing where most of Indian industry is concerned. The inability of the private sector to demonstrate performance that is superior to that of the public sector that we have documented in earlier chapters must be viewed in the context of these limitations to private-sector performance in India.

7.4 Conclusion Privatisation cannot be expected to deliver results under any circumstances. Privatisation works only if certain pre-conditions are satisfied, notably an efficient judicial system and law-enforcement machinery and strong corporate governance. As our brief survey of the literature shows, the legal framework for investor protection varies widely and such variation has important economic outcomes. Where investor protection is weak, capital markets tend to be underdeveloped and this inhibits growth. Moreover, economies with weak legal systems tend to be hit more by adverse shocks. As India ranks low in terms of the quality of its legal system, this should prompt concerns about the likely effectiveness of privatisation. The Coasian dictum that law does not matter and that private institutions will adapt is contradicted by the empirical evidence. For instance, one form of adaptation, concentrated ownership of shareholdings, does not protect minority shareholders from expropriation; indeed, it is part of the problem in emerging markets. Governance at SOEs is complicated by the fact that there are multiple layers of principals and agents. Politicians are accountable to the electorate and managers are accountable to bureaucrats and politicians. Political interference, the imposition of non-commercial objectives, the absence of adequate empowerment of the board, particularly in respect of appointment and removal of CEOs, are among the problems that beset governance at SOEs.

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In the Indian private sector, the problem of governance is that of protecting minority shareholders from the dominant shareholder, the industrial house, that holds the reins of management. In this respect, the problem in the private sector is not different from that of listed SOEs. Lack of institutional activism and a weak market for corporate control together mean that the dominant shareholder is difficult to dislodge. A weak judicial system and poor law enforcement leave open possibilities for ‘tunnelling’ and other forms of expropriation of minority shareholders. An important requirement for more effective governance in the private sector is greater activism on the part of both domestic and foreign institutional investors. As domestic institutions are, for the most part, government-owned, their actions against management are suspect as being politically motivated. They need to be given a credible degree of autonomy or they need to be privatised. Privatisation of industrial firms is thus constrained by the pace of privatisation of the financial sector.

8

China’s privatisation: a synoptic view

8.1 SOE reform in China: an overview India’s economic reforms and its performance cannot escape comparison with that of China – and India often suffers in the comparison. This is true of privatisation as well. In pronouncements made by politicians favourably disposed towards privatisation, and also in the business press in general, China is shown as having proceeded vigorously with privatisation, in stark contrast to India’s own bumbling efforts in that direction. It is worth looking at the Chinese privatisation experience, therefore, not only because, as in India, SOEs are a big part of the economy but also to see whether there are any lessons that could be drawn from China’s privatisation policies. Like most other economic reforms, China’s substantive reform of SOEs, culminating in privatisation in recent years, precedes India’s by more than a decade. It is worth emphasising at the very outset that this process, which commenced in the late 1970s, has for most of the period largely involved SOE reform rather than privatisation. Privatisation in the sense of sale of SOEs to private parties is a relatively recent development. State ownership of enterprises, we have seen in Chapter 2, is said to have two fundamental flaws. First, there is a ‘soft-budget’ constraint, meaning funds are available regardless of whether the businesses are profitable; and, second, there is a lack of autonomy, or rather, there is political interference that makes it difficult for firms to pursue commercial objectives wholeheartedly. These problems may be magnified further if the state sets prices instead of leaving it to markets to do so. China’s reform of SOEs has been aimed at addressing each of these problems. Hay et al. (1994) have chronicled in detail the progress of such reforms up to the mid 1990s. They identify four stages in the reform process up to the early 1990s. From 1978–80, the focus was on increasing enterprise autonomy; in the second stage, 1981–2, reform focused on contract profit delivered to the state; in 1983–6, profit delivery was sought to be replaced by taxes; and from 1987 onwards, the focus changed to the institution of a contract-responsibility system. Then, in 1992, a new stage began, namely the share system. Alongside these reforms aimed at improving enterprise

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autonomy, price reforms were also carried out. There was also a certain hardening of hard-budget constraints, and greater competition in product and factor markets was encouraged. To take up price reforms first, meaningful price reform commenced only in May 1984 when a dual-price system was adopted for the inputs and outputs of SOEs. Inputs and outputs that were part of state plans would be covered by state-determined prices; inputs and outputs that were outside the plan quotas could be sold at market prices, with an upper limit of 20 per cent over the mandatory prices. Over time, the number of products governed by state-plan quotas was reduced: the number had fallen from 256 to 23 by 1986. As Hay et al. (1994) point out, the dual-track system could be faulted on a number of counts. For instance, since output and input quotas were determined on the basis of past performance, this tended to penalise efficient enterprises: they would get a larger output quota and a smaller input quota. Further, it created incentives for enterprises to understate their capacity, so that they were allotted a lower output quota and a greater surplus was available for sale at market prices. Not least, there were multiple prices for different transactions. Thus, the dual-track system, while useful up to a point, was limited in its ability to deliver higher levels of efficiency in the system. The enterprise-level reforms, including the conferment of greater autonomy, had a greater impact on performance. As mentioned earlier, China started off with contracts between the state and SOEs regarding delivery of profit, switched to a profit-tax system in 1983 and reverted to a modified form of the contract-profit system in 1986. At the same time, through the 1980s, responsibility for enterprises was gradually transferred from the Party to the enterprises themselves. Further, as the World Bank (1997) notes, there was substantial decentralisation of government authority, with all but about 2000–3000 industrial enterprises being placed under the supervision of local governments rather than under the central government. Under the profit-delivery arrangement introduced in 1979, firms contracted to deliver a certain quota of profit to the state. As this allowed room for bargaining over the share of the state, this was replaced in 1983 by a flat rate of profit tax on medium and large enterprises. The modified form of the contract-profit system introduced in 1986 was tougher than the one that had existed earlier. First, firms were obliged to deliver a minimum of profit. If a firm did not generate profit equal to the quota in a given year, it was obliged to make up the quota from its own funds or savings deposits. Second, the contract period was lengthened from one year to three years or more, with yearly targets for quotas being subject to revision based on economic conditions. In the case of small SOEs, lease contracts began to be encouraged by the end of the 1980s. Further, by 1984, the practice of awarding performancerelated bonuses had become widespread. However, as Yao (2004) notes, the system was asymmetric: the manager would be rewarded for his successes but

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not punished credibly for failure. As a result, collaterals began to be required of managers. The combination of greater autonomy, tougher constraints and better incentives in the new contract-responsibility system is generally perceived to have resulted in improved enterprise performance. Hay et al. (1994) note that Chinese GDP grew at an impressive annual rate of 10.6 per cent during the 1980s, with the state-owned industrial sector growing at over 8 per cent per annum and at nearly 12 per cent per annum in the main reform years 1983–8. However, the authors are quick to add that faster growth in productivity in private enterprises as well as in collectively owned enterprises suggests that ownership reform must remain a priority for China. The 1990s saw a fresh burst of enterprise reform (World Bank, 1997). In early 1994, the government embarked on a programme of corporatising, i.e. converting into companies, 100 large and medium SOEs at the central level and 2500 at the local level. By 1997, 414,400 companies had been formed (Yao, 2004). Of the 2500 local SOEs, 1080 had been transformed into either limited-liability or shareholding companies with diversified equity ownership by the end of 1997. Another initiative involved reduction of SOE debts and raising of asset– liability ratios through fiscal incentives. A third programme related to the re-invigoration of 1000 large SOEs through technical renovation, interestpayment exemptions, debt forgiveness, and redundancy payments for idle workers. A process of transferring social responsibilities of SOEs, such as housing, hospitals, schools, etc. to municipal or regional governments also commenced. Divestitures of small firms to private hands took place. Partial disinvestment in SOEs was, however, more common, a process that received a boost with the opening of the Shenzhen Stock Exchange in 1990 and the Shanghai Stock Exchange in 1991. Further, the management of SOEs was gradually taken away from ministries and vested in State Asset Operating Companies at various levels – national, provincial, municipal, and district. Until the first half of the 1990s, only about 2–5 per cent of the 118,000 Chinese industrial SOEs had been divested to the non-state sector and virtually all of these had been small firms. For the rest, shares were sold to employees, the public and to financial institutions. In the case of the latter, the government imposed restrictions intended to prevent the state from losing control of the listed SOEs. Five categories of shares were created. First, there were state shares, which referred to shares held by the central government, local governments or solely government-owned enterprises; these were not tradeable. Another category of shares was ‘legal entity shares’, which were shares held by domestic institutions partially owned by the central or local government. These were only partially tradeable. Similarly, shares issued to employees could be traded only among employees. Then, there were A, B and H categories of shares. A category shares were similar to ordinary equity shares except that they were meant exclusively for

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Chinese citizens and domestic institutions. A shares were required to be no less than 25 per cent of total outstanding shares when a company made its initial offering. B category shares were intended for foreign portfolio investors and generally accounted for less than 5 per cent of the total shares of a company. H shares were shares of mainland Chinese enterprises listed on the Hong Kong Stock Exchange. The process of disinvestment was thus carefully designed to maintain state control. The overall policy was ‘keep the larger and let the smaller go’ under which the state would retain control over the top 500–1000 large firms. As Yao notes, this meant that state control over a large proportion of industrial assets would remain strong: in 1997, the 500 largest state firms had 37 per cent of the assets of state industrial firms, contributing 46 percent of the tax collected on all state firms and 63 per cent of total profit in the state sector. This should help place in perspective the talk in India of the ‘hundreds’ of SOEs that have been privatised in China. Chinese privatisation has, for the most part, involved transfer of ownership only in the case of the smaller SOEs that account for a relatively small proportion of industrial assets and profit. It has not involved a significant diminishing of state ownership or control over business enterprise. The larger, corporatised SOEs are run either by the concerned supervisory departments as before or by state-owned asset management companies. As Yao (2004) points out such privatisation that has taken place has stemmed from pressures on scarce state resources arising from large numbers of SOEs. China’s tax reforms in the 1990s has not progressed rapidly enough to create sources of revenue that could substitute for the state’s pre-emption of profits from SOEs. At the same time, SOEs’ profits have fallen with the ending of monopolies and this pushed SOEs towards increased reliance on bank credit and high gearing ratios. There was little alternative to privatising the smaller SOEs and also allowing the injection of private capital into the larger ones. While enterprise reform did yield results, as the World Bank (1997) noted, profitability at SOEs in the aggregate remained an area of concern. In 1996, about 50 percent of industrial SOEs incurred net losses, amounting to 1.3 per cent of GDP. SOEs absorbed more than 75 per cent of domestic credit and produced a lower rate of return on assets (6 percent) compared to the return of 8.4 per cent and 9.9 per cent earned by collectives and foreign-funded firms respectively.

8.2 Disinvestment and performance of Chinese enterprises Here, we briefly review the evidence on post-disinvestment performance of Chinese SOEs. Sun, Tong and Tong (2002) review the performance of all companies listed in the Shanghai and Shenzhen stock exchanges over the period 1994–7. They choose 1994 as the starting period because that is when China started to


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adopt an accounting system that was closer to international standards. They measure performance as the ratio of market to book value of equity (a proxy for Tobin’s q), controlling for the effects of foreign ownership, firm size, the firm’s leverage, location, and industry. The authors find that government ownership of shares, whether as state shares or as legal entity shares, has a positive and significant relationship. This, of course, raises the question why the Chinese government would go in for disinvestment in the first place. They hypothesise that the relationship between ownership and performance might be non-linear: it might have an inverted U-shape, i.e., 100 per cent government ownership might not be good but neither would no government ownership at all. In other words, there is an optimal relationship between government ownership and performance. Their results supported this hypothesis. Why would this be so? The authors suggest that too much government holding might mean too much interference, while too little holding might mean lack of adequate support from government. They also speculate that floating some of an SOE’s stock might have a signalling effect: it signals the government’s confidence in the partially privatised firm’s ability to perform well, so that the government can eventually privatise the firm completely. High equity retention by the state might thus lower the ex-ante uncertainty for investors. Moreover, where markets are underdeveloped, high government ownership might make for a monitoring role by government where monitoring by other parties, such as the investing public, is weak or inadequate. Finally, government ownership has positive effects where SOE reform is a priority: as noted earlier, the Chinese government has moved to strengthen SOEs through debt restructuring, reduction in tax, infusion of fresh equity, etc. Legal entity ownership might also contribute through business connections. Xu and Wang (1997) investigate whether ownership structure has significant effects on the performance of publicly listed companies in China and in what way, if at all. Using pooled data for listed companies on the Shanghai and Shenzhen stock exchanges over three years (1993–5), they first run regressions of performance variables on concentration ratios without distinguishing between different types of shares. Next, they examine the effects of different types of ownership – state, legal person and individual – on firm performance. The authors use three ratios to measure firm performance: the market-to-book value ratio (MBR), return on equity and return on assets. Ownership concentration is measured by the percentage of shares controlled by the top 10 shareholders and by the Herfindahl index of ownership concentration, the sum of the squared percentage of shares controlled by each top 10 shareholder. The authors control for a variety of factors such as firm size, industry, location, firm leverage, and firm growth. The authors find that the market value and profitability of firms increase with ownership concentration. As regards ownership mix, firms’ performance is found to be positively correlated with the fraction of legal person shares but

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either negatively correlated or uncorrelated with the proportion of state shares and tradeable A shares. The authors conclude that, while market-oriented reform measures have helped improve the economic efficiency of China’s SOEs, diversification of state ownership through the introduction of other large stakeholders is crucial to improved performance. The answer to ownership diversification, however, is not dispersed private ownership: as mentioned, the results point to individual shareholdings being insignificantly related to firm performance or having a significant negative effect. Large institutional shareholders seem to hold the key to firm performance, no matter whether these shareholders are state-owned. This finding has important implications for Indian privatisation, for in India too, disinvestment has led to transfer of government-owned shares to government-owned financial institutions, although institutional shareholding is quite small in most cases. Groves et al. (1994) examine the impact of autonomy and incentives on productivity in Chinese SOEs. They do so by looking at annual data for 769 enterprises in four provinces over the period 1980–9. Large firms were overrepresented in the sample. The sample thus covered firms for which it was believed that progress in reforms had been modest compared to the small, non-state sector. The firms had benefited from the moves towards greater autonomy described earlier, such as the right to retain a share of profits, to sell some output outside state delivery quotas, and the freedom to give bonuses to workers and to hire workers on fixed contracts. The authors ask three questions. Did managers respond to autonomy by strengthening workers’ incentives? Did stronger incentives translate into higher productivity? Did autonomy result in higher returns to the stakeholders – workers, management and the state? To test for worker incentives, they used as independent variables the real bonus per worker and the number of contract workers as a fraction of the total number of workers, and dummy variables for the presence of autonomy and the enterprise’s ex-ante marginal profit-retention rate. They found some evidence that worker incentives had indeed been strengthened consequent to greater output autonomy and an increase in the profit-retention rate. The authors also found evidence that in the five industries into which they had broken up the data, at least one of the two incentive variables generated increased productivity. As for returns to various stakeholders, the authors found only weak evidence that the reforms had a positive effect on profits. Much of the benefits of autonomy seemed to have gone to the workers, with significant increases in real average employee wages in several industries. Interestingly, managerial wages did not rise with autonomy. The authors suggest this might be due to the emergence of a managerial labour market in China in the 1980s and hence the greater competition for managerial jobs, a hypothesis for which Groves et al. (1995) find evidence. The authors’ broad conclusion is that industrial reforms in China met with considerable success in terms of


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inducing behavioural changes at the firm level. SOE reform is by no means a forlorn cause, going by China’s experience. In the same vein as the above paper, Li (1997) examined the impact on economic reform on Chinese SOEs in the period 1980–9, using a panel data set of 272 enterprises drawn from the same data pool as the above paper. The paper addressed the following questions: did reform increase enterprise productivity? If so, how much of the productivity gain was attributed to improved factor allocation between enterprises, to improved incentives within enterprises, and to intensified competition in product markets? The study found market improvements on every count. The marginal productivity of labour increased by over 54 per cent between 1980 and 1989. Total factor productivity (TFP) growth was 4.68 per cent per year in the period and accounted for over 73 per cent of output growth, which was 6.37 per cent. The remaining 27 per cent of output growth was attributable to increases in factor inputs. Improved factor allocation, i.e. shifts in resources from less productive enterprises to more productive ones increased output growth by 1.79 percentage points per year during the period and accounted for 28 per cent of output growth and 38 per cent of TFP growth. Growth in bonus per worker and market competition contributed 2.29 percentage points to TFP growth, accounting for 49 per cent of TFP growth and 36 per cent of output growth. As for the impact of competition, the study found that the market power of state enterprises, measured by market price compared to marginal cost markup, eroded by 15 per cent between 1980 and 1989. The authors’ conclusion reinforces that arrived at by many others: enterprise restructuring can improve enterprise performance even without formal privatisation and . . . the marginal economic liberalisation as practiced in China can improve resource allocation when entry barriers to the state-monopolised industries are also lowered to foster competition. Wei et al. (2003) attempt an analysis that is along more conventional lines, using financial measures of performance instead of productivity. They come up with conclusions that are somewhat contrary to the ones mentioned so far. In keeping with standard studies on privatisation, they ask whether performance, as measured by profitability, real output, real assets, leverage, and employment, improve following privatisation. Their analysis is based on data on 208 firms that completed public share offerings in China in the period 1990–7. They find that real output, real assets and sales efficiency improve while leverage declines significantly following privatisation. Contrary to the results of other studies, profitability does not change significantly postprivatisation; employment declines significantly in the long run. Out of the sample of 208 firms, 46 were fully privatised, meaning that state shares were zero; 76 firms had more than 50 per cent state ownership. The authors divide the sample into two sub-samples, one comprising firms in the

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first category and the other firms in the second category. They find that firms where voting control had passed to private investors experienced significant relative gains in profitability, efficiency and employment over those with majority shares following privatisation. The authors explore the issue of profitability post-privatisation further. Since profitability of enterprises in general has been declining, they suggest this could bias their results. So they compare profitability and net income over the period 1994–9 for 41 firms from their sample with 41 fully state-owned firms. They find that privatised firms outperform fully state-owned firms. They conclude that privatisation works in China, especially when control passes to private investors.

8.3 SOE reform versus privatisation The empirical evidence cited in the earlier section leaves little room for doubt as to the effectiveness of SOE reforms in China. But the last paper cited also raises the question: would full-blooded privatisation have worked even better? There is, of course, a political-economy argument to be made in favour of SOE reform in China, one that is applicable to India as well. SOE reform, which can be seen as a gradual approach to privatisation, can ensure that job losses, if not eliminated, are contained at a level at which social discontent does not become unmanageable. This is especially so when social security nets are not available. Huang (2003) comes up with strong arguments against the political economy line of thinking. It is worth examining these arguments at some length because they constitute the strongest possible repudiation of SOE reform as an alternative to privatisation. Huang argues that SOE employment has been maintained at the expense of the quality of assets in the Chinese banking system. If SOEs are allowed to go bankrupt, the costs will be borne by depositors. If the government decides to recapitalise the banks, the burden will fall on taxpayers. If there is a financial crisis, the entire population will be losers. Moreover, continued support to SOEs, Huang contends, has stifled growth in China’s private sector: it has resulted in China’s failure to create globally competitive firms, despite a fast-growing domestic market and export opportunities. Huang suggests that China’s ruling class has accepted these economic costs because politically it was more palatable to forgo losses in the future than to suffer losses in the present. Huang is thus dismissive of the notion that China’s privatisation policy is a vindication of the gradualist approach to reform. Gradualism, according to him, would have argued in favour of a faster process of privatisation because some of the essential conditions for success in privatisation were in place, such as the emergence of a private sector and price liberalisation. Yet, China’s rulers have set their face against privatisation of large SOEs.


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The SOE reforms of the mid 1990s, as we have seen earlier, did not constitute privatisation in the sense of transferring control to private hands. They involved two things. First, they re-assigned ownership rights among the different government agencies. Second, they entailed listing of shares of SOEs on the exchanges with only a small portion of these going into private hands. He cites Xu and Wang (1997), who found that individual shareholders controlled only 0.3 per cent of the board seats while owning 30 per cent of the shares. The state retained 50 per cent of board seats while owning 30 per cent of the shares. Control remained firmly in government hands in this phase of SOE reforms. Moreover, the proceeds of privatisation were used to fund investments in the larger SOEs, so that the aggregate ownership role of the state was not reduced. What of the contention that the ‘big bang’ approach to privatisation is fraught with risk? Huang argues that the Russian privatisation disaster is no argument against a stronger thrust towards privatisation in China in the 1990s. Genuine privatisation would not have caused major political and economic disruption in China for two reasons. China had developed a large entrepreneurial class and it was also not leery of foreign investment. The absence of private entrepreneurs and wariness of foreign investment had led Russia to opt for insider privatisation – sale to firm managers – which is what had created problems. Huang does not subscribe to the view that rational and pragmatic considerations – the need to manage the process in ways that did not create economic and political instability – at all dictated the course of Chinese privatisation. He believes China’s leadership moved slowly on privatisation entirely on ideological grounds: it wanted to preserve socialism. Private capitalists were seen as a threat to the socialist state, so their growth had to be curbed. It is worth quoting Huang: a doctrinal commitment to state ownership remains a first among equal governing principles in today’s China. The primacy of state ownership can be circumvented and even shortchanged but cannot be openly and explicitly challenged. . . . The Chinese state is pragmatic, but up to a point. The famous aphorism by Deng Xiaoping – ‘it does not matter whether the cat is white or black, as long as it catches mice’ – has not yet been applied to privatisation of large SOEs. The colour of the cat apparently matters, and matters a great deal. It is possible, of course, that ideological considerations have dictated the nature of privatisation in China. At the same time, we cannot ignore the considerable accommodations of principle and departures from doctrinaire socialism that have marked China’s move towards a market economy. As in India, so also in China, it is possible that the political establishment was sensitive to the dangers of a monitoring vacuum that might arise when

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state control is withdrawn without adequate governance mechanisms being put in place. China’s capital markets are, if anything, even more underdeveloped than India’s and the governance framework also, perhaps, lags behind. China’s rulers would have good reason to be wary of placing enormous assets in the hands of private owners accountable only to dispersed shareholders. An effective alternative to state control, as we have seen in Chapter 7, is the existence of large institutional shareholders. In China, as in India, this would require that government-owned financial institutions be privatised before SOEs are. But this is an even more contentious issue than privatisation of SOEs, given that the financial sector is perceived as a strategic sector that must be the last to be privatised. Academics are entitled to take the view that, no matter whether SOE reform works, privatisation would work even better. But the bottom line is that, where SOE reform works as well as it has in China and contributes to extraordinary economic growth, the impulse to go in for full-blooded privatisation is bound to be weak. Huang’s contention that the fiscal costs of maintaining state control over SOEs have thus far been buried in the banking system is valid. Sooner or later, the fiscal costs will materialise and will show up as government debt. But, if China’s economic growth continues at the present rate, surely these are costs the economy can live with?

8.4 Conclusion For more than two decades now, China has pursued SOE reform with considerable success. There have been moves to induce greater competition, to make inputs and outputs of SOEs more and more market-determined, the provision of greater autonomy, and the introduction of incentives for employees. Privatisation has occurred extensively only in the case of small firms. Such privatisation that has taken place in the larger firms has taken the form of issue of equity to the public and to domestic and foreign institutions, with the state still owning a large equity stake in the firms and retaining control. Several studies have documented the positive impact of SOE reforms, including limited privatisation, on firm productivity and financial performance. Critics of the programme, however, argue that complete privatisation, the transfer of control to private owners, could have produced even better results in the 1990s. Some conditions for the success of privatisation at least existed, such as the emergence of an entrepreneurial class and openness to foreign investment. Hence, the Chinese establishment’s reluctance to privatise reflected a doctrinaire opposition to any meaningful withdrawal of the state from commercial activity. On the other hand, the absence of satisfactory governance mechanisms and the relatively underdeveloped nature of China’s capital markets might well have justified China’s gradualist approach to privatisation, especially when


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enterprise reform was producing impressive results. The parallel with the Indian context is very strong indeed. In both countries, a political establishment, responsive to popular perceptions and wary of the risks involved in selling off the biggest SOEs to private firms, has chosen caution as its watchword in its approach to privatisation. It is certainly not true, as is commonly believed in India, that the Chinese have been a lot bolder in their privatisation drive than India.

9

Summary and implications for privatisation policy

9.1 Comparing public- and private-sector performance This book set out to address an important question in the current policy debate in India: is the private sector indeed more efficient than the public sector? It also addresses a corollary question: has disinvestment – the limited privatisation undertaken so far – been followed by any improvement in performance? These questions assume importance in the context of the ongoing programme of economic reforms in India, one of whose tenets is that privatisation is necessary in order to improve firm-level performance and hence that of the overall economy. We posed these questions in respect of performance in Indian industry as well as in banking. And we attempted to answer them by comparing performance based on both financial ratios and input–output quantities, using Data Envelopment Analysis in the latter case. Here, we summarise our main findings and spell out their implications for privatisation policy.

9.2 Comparing financial performance (3.3) We used six financial ratios for comparing performance in industry. For the purpose of comparison, we focused on 227 public enterprises and on all private enterprises other than those in the financial services. We compared performance over three different periods. The first, 1989–2000, covers a period that includes three years in the pre-reform era and eight in the postreform era; the second, 1992–2000, covers eight years in the post-reform era; the third, 1995–2000, covers the last six years following reforms. We analysed performance both at the aggregate level and at the sectoral level, that is, by comparing performance in seven different sectors. Aggregate level results At the aggregate level, we find that the private sector’s performance was clearly superior over the entire period, 1989–2000: it did better on four out

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of six indicators used. However, this not true of the most recent period, namely 1995–2000: on five out of six indicators of performance, there was no significant difference between the private and public sectors. It is only when we exclude the petroleum monopolies from the public sector and compare performance with the private sector that we find the latter doing uniformly better across all the three periods. It is interesting, however, that even in this comparison, the public sector is seen to catch up on profitability in the most recent four-year period. Sectoral level results At the sectoral level we compared performance on six parameters in seven sectors, giving us a total of 42 results. We made one change in our methodology with respect to the approach adopted at the aggregate level. We eliminated negative net worth companies from the sample available to us. The logic of this is that, first, negative net worth companies can show high figures for particular ratios because both the numerator and the denominator are negative. Second, the existence of such companies in the sample reflects tardy bankruptcy processes and is not a reliable indicator of managerial capability, which is what we are seeking to capture in measures of performance. Over the entire period 1988–9 to 1999–2000, we get significantly higher scores for the private sector in 23 out of 42 instances, in 20 of these at the 5 per cent level of confidence. In the post-reform period, 1991–2 to 1999–2000, the private sector has better scores in 20 out of 42 instances; and in the most recent period 1995–6 to 1999–2000, the private sector is superior in 16 instances or 38 per cent of cases. The number of ties between the public and private sectors rises modestly from 17 in the aggregate period and 18 and 19 respectively in the two abbreviated periods. Further, whereas there are only two instances of superior performance in the public sector in the full period under review, we get four and seven instances respectively of superior performance in the two shorter periods. Thus, the data at the sectoral level reinforces our finding at the crude, aggregate level: the advent of reforms has led to a convergence in performance between the public and private sectors. The public sector’s superior performance is not confined to the petroleum monopolies. Among the seven sectors considered, private enterprises are seen to fare better in two sectors in the most-recent period (three sectors over longer periods) and not in the other five. While in two of these five sectors, public firms may be said to have had the advantage of a degree of monopolistic presence in certain sub-sectors, this is not true of the other three sectors. In some industries, such as petroleum (subsumed in the sector ‘minerals’) and in telecommunication (covered by the sector ‘services’), the public sector may have reaped the benefits of a monopolistic position. But it is worth noting

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that even these industries have been opened to competition and deregulation in recent years (for instance, petroleum refining and cellular services). The evidence thus shows that the perception that the private sector is uniformly superior to the public sector, which informs much public discourse in India, rests on weak evidential foundations. Post-privatisation performance We also evaluated the results of the limited privatisation that has taken place so far in the form of selling a portion of the government’s shareholding to other shareholders (although many of these new shareholders are government-owned entities themselves). We find that, on the average, there has been no improvement in performance in the sample of 36 firms studied. However, while there is no improvement on average, we do find improvement in profitability in 21 out of 36 firms. In the 15 firms where performance worsened post-privatisation, in some instances this was because the firms simply lost their rationale in the deregulated environment, as they had been created solely in order to meet the government’s requirements. In other instances, factors such as a reduction in tariffs or international movements in prices resulted in an adverse shock. The firms in question needed to modernise or expand in order to cope but the government was in no position to provide capital, given its fiscal constraints. Nor had the firms been prepared for such a shock by being listed ahead of deregulation, so that they could have accessed capital when they were in better shape. As regards firms that saw an improvement in performance after disinvestment, we document in some detail improvement at three strong public-sector firms, based on our interactions with company executives. It does appear that intrinsically strong firms were able to take advantage of the freedoms conferred by deregulation and do better than before even though there was no change in ownership. They were able to raise resources from the domestic and international markets, they took advantage of freedom of pricing and many were conferred greater autonomy in decision-making by the government. The government itself contributed to a greater profitability orientation by progressively increasing the weight accorded to profitability in the objectives it agreed with management of public-sector firms. Not least, listing on the stock exchanges brought these firms under the scrutiny of investors, including international investors in some cases. This served to focus management attention on the impact on profitability and stock prices of important decisions, and was thus a factor contributing to improved performance at many firms. The professionalisation of boards, through the induction of independent directors, has also been a factor making for improved performance. In other words, public-sector firms were given an assortment of objectives prior to deregulation: nobody told them that profitability or value maxi-


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misation was the central objective. Their objectives included asset growth, employment creation, self-sufficiency, backward-area development, creation of positions for disadvantaged groups, etc. Post-deregulation, public sector firms were told to focus on profits and given a measure of freedom to do so. They delivered profits. There is little evidence here that public-sector firms suffer from a congenital inability or aversion to making profit.

9.3 Comparison based on input–output quantities (4.4) We sought to validate the conclusions drawn from our comparison of financial performance by comparing the public and private sectors on the basis on physical quantities of inputs and outputs. For our analysis of performance based on input–output quantities, we compared balanced panels of public and private enterprises in eight industrial sectors over the period 1992–2000. We used four measures for comparison: technical efficiency; growth in the Malmquist total factor productivity index; cost efficiency; and growth in the Tornquist index of total factor productivity. The first two were estimated using Data Envelopment Analysis. We have a total of 32 results across the eight sectors The overall results corroborate those obtained from analysis of financial ratios, namely, that there is no indication of a clear superiority in private sector performance. Out of the 32 results, 10 show superior performance in the private sector, 5 show superior performance in the public sector and 17 show no difference between the two. Looking at individual sectors, only in three sectors out of eight is the private sector seen to do better. The public sector fares better in two sectors.

9.4 Banking sector (5.4) Comparison of financial performance Turning to the banking sector, we compared performance between PSBs and private banks in the period 1995–2000, using four financial ratios. The PSBs’ performance is inferior to that of domestic private-sector banks as well as foreign banks: the latter do better on three out of four parameters. When we compare PSBs with old private-sector banks, the gap narrows: the latter do better on two parameters, with the PSBs doing better on one parameter and no difference in respect of the fourth. The gap gets narrower when we exclude the three ‘weak banks’ – loss-making banks that had been rendered dysfunctional for some of the period covered – from the PSB category. Between nationalised banks (minus the three ‘weak banks’) and the old private-sector banks, there is no clear difference in performance. In the period since 2000, PSBs have improved their performance dramatically, so the story of convergence in performance between them and private banks in the preceding years captured here is quite authentic.

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Comparison of bank performance based on input–output quantities We compared the performance of the three categories of banks – PSBs, private banks and foreign banks – using three measures: Tornquist total factor productivity growth; Malmquist total factor productivity growth; and revenue maximisation efficiency. Along with the comparisons of financial performance, we have a total of ten comparisons. There are no differences in four cases, PSBs do better in two, private banks in two, foreign banks in two. In other words, PSBs are seen to be at a disadvantage in only four out of ten comparisons. It is difficult, therefore, to sustain the proposition that efficiency is lower in PSBs compared to the other two categories. Post-privatisation performance When we compare pre- and post-privatisation performance in banking based on financial parameters, we find that there has indeed been improvement consequent to the limited privatisation that has taken place. However, since performance in the first two years in the pre-privatisation period was depressed for non-operational reasons (there was a write-off of bad assets from the past), this result is less compelling than the broader point about the general improvement in performance of public-sector banks. On an unadjusted basis, four out of nine PSBs outperformed the Sensex. Three underperformed the Sensex by less than 20 per cent. The mean relative return for listed PSBs was 1.12, which means this category outperformed the Sensex. We compared the mean and median relative returns for the sample of PSBs with the sample of old and new private sector banks, using the t-test and the Wilcoxon rank-sum test respectively. We find that the mean and median return for the PSB group are not significantly different from those of either of the other two categories. No public-sector bank enjoys a monopolistic position, so the performance of PSBs as a category cannot be ascribed to this factor. The improvement in PSBs’ performance since deregulation and the narrowing of the gap between their performance and those of private-sector banks parallels what we saw earlier in industry. Here again, the focus on asset quality and profitability since deregulation have helped as has listing wherever it has occurred. State ownership in banking versus state ownership in industry In banking, there have been two other helpful factors. Following the decision to adopt Basle norms of capital adequacy and to move towards international accounting norms, the government was constrained to infuse Rs 200 bn by way of recapitalising the banking sector.


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By contrast, in industry there have been cuts in public spending following attempts to curb the fiscal deficit, a key item on the reform agenda. At the same time, the government has not taken steps that could enable public enterprises to source capital from the markets on their own. This does suggest that lack of capital, rather than lack of a decisive change in ownership, might have hindered post-privatisation performance in several public-sector firms in the industrial sector. Second, the banking sector is overseen very substantially by the Reserve Bank of India (although there is also a Ministry of Banking), unlike industrial enterprises, which are controlled entirely by their parent ministries. It is fair to suggest that the existence of a credible agency independent of the government bureaucracy has contributed to the improvement in performance of PSBs. In the period since deregulation, not only has efficiency of the banking system, as measured by the spread, improved but so have various measures of performance. This throws up the interesting proposition as to whether the Indian banking system has been able to strike that balance between stability and efficiency that has eluded banking systems elsewhere. It also raises the interesting proposition whether government ownership, widely seen as contributing to bank failures, might not have been a force for good in India. Government ownership made recapitalisation of major banks possible at the advent of deregulation, and arguably this kept banks from taking the sort of risks that led to bank failures elsewhere in the wake of deregulation. Regulation in India has also ensured that banks steered clear of investments in real estate and stock markets on a scale that could cause them to overturn. This apart, a certain degree of risk-aversion goes with government ownership and, in the banking context, this may not be a bad thing at all.

9.5 Privatisation and the fiscal deficit India’s drive towards privatisation is said to be driven substantially by ideology, the belief that the state must vacate commercial activities and focus its energies instead on physical, social and legal infrastructure. But investment in infrastructure requires resources. The necessary resources, the argument goes, can be freed from SOEs and diverted towards infrastructure. The ground reality, however, is that privatisation is being primarily driven by fiscal pressures. The government is unable to reduce unproductive expenditure (interest payments and subsidies consume 64 per cent of total government expenditure) nor is it able to raise tax revenues (the tax–GDP ratio is 7.1 per cent, which is way below the levels in developed countries). The fiscal deficit has been running at over 5 per cent of GDP for years now, and domestic debt–GDP ratio has shown a rising trend since 1998–9. Unfortunately, it not clear how privatisation will improve matters. In the first place, privatisation proceeds are not being used to reduce public debt.

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(The government has not heeded the suggestion that privatisation proceeds be kept out of the federal budget.) To the extent that privatisation proceeds are used to bridge the fiscal deficit, it reduces pressure on government to cut expenditure or raise taxes. This merely defers the fiscal problem, it does not mitigate it. (The benefit in terms of a lower interest rate as a result of a lower fiscal deficit is small, as the amounts raised through privatisation have been paltry.) More importantly, under the strategic-sale route that has become the preferred mode of privatisation lately, there is a presumption that efficiency would improve under private ownership and, therefore, that government would realise through sales of SOEs a value that is higher than what the SOEs are worth under government ownership. This is how privatisation through the strategic-sale route would contribute to a lowering of the fiscal deficit. However, the results we have obtained in our study, as well as the limitation to governance in the private sector we have highlighted in Chapter 7, must, at the very least, raise doubts as to whether this presumption is well-founded where the better-run SOEs are concerned. But even if we were to accept that private ownership would indeed make for greater efficiency, it does not follow that the values realised by the government in sales of SOEs would reflect the higher valuation that the private sector places on the firms being sold. As we saw in Chapter 6, strategic sales of the sort pursued thus far – with limited bidders and little or no foreign participation – may not conduce to the best valuations being realised by the government. In the event that the government does not realise values higher than what the SOEs are worth under government ownership, privatisation of SOEs cannot be expected to contribute to an improvement in the fiscal situation. Thus, the argument that SOEs are a drain on the fisc and, therefore must be privatised, would not wash unless efficiency in auctions was ensured. It has been observed that since privatisation tends to occur under fiscal duress and against the background of a depressed stock market, there is every likelihood that prices being obtained do not reflect intrinsic value. The pursuit of privatisation as a magic cure for fiscal problems will thus prove chimerical unless greater care is taken to ensure that the best prices are realised in SOE sales. At the same time, there can be no quarrel with the contention that the fiscal situation requires that SOEs contribute to the government exchequer more than the dividend yield, which is typically around 3–4 per cent in India. An increase in market capitalisation of SOEs of the sort that has occurred in recent years does improve the government’s balance sheet. It should mean an improvement in the fiscal deficit, as measured by a change in the net worth of government. But the fiscal deficit is measured in cash terms, not in relation to the government’s balance sheet. To help improve the fiscal deficit, as measured conventionally, SOEs need to stump up more cash than what they contribute


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by way of dividends. But to do so, it is not necessary to effect strategic sales. The sale of tranches of government shareholdings in SOEs in both the domestic and international markets can meet the fiscal needs of the government. Public offers of government equity, as distinct from strategic sales, would not make sense only if it could be shown that continuing government control would lead to declines in efficiency and loss of value in the enterprises in question. Given the trend towards improvement in performance documented by our results, this condition does not hold and therefore this argument does not hold water. Second, public offers of equity would not be preferable if strategic sales produced higher realisations of value, but this again is an assumption that we have questioned in Chapter 6. Thus, it is possible to address the government’s fiscal problem through disinvestment, the sale of small portions of the government’s shareholding – that is to say, without a loss of government control over SOEs. It must also be understood that it is easy enough for private acquirers of SOEs to show improvements in efficiency by downsizing the workforce, given that SOEs have historically tended to employ excess workers in order to meet the government’s objective of employment generation. Private bidders can thus offer the government a higher value for an SOE than what it is worth under government ownership. However, some of the higher value realised by the government would, in any humane society, go towards providing a security net for displaced workers and for expenditure on retraining. Hence the fiscal impact – and indeed the net gain to the economy as a whole – would be negligible unless efficiency gains accrue from improved operations and not merely through downsizing. In assessing the impact of privatisation, therefore, it is important to know where the efficiency gains are coming from: is it through transfers from workers to shareholders, or through higher operational efficiency, or simply through higher prices? In sum, whatever the merits of the case for a change of ownership at SOEs, the argument that such a change is necessary in order to deal with the government’s pressing fiscal problems is, perhaps, the least compelling.

9.6 Implications for privatisation policy and role of SOEs in India Limitations imposed by weak governance Our survey of theoretical and empirical research on privatisation ought to induce a measure of caution in statements about the likely efficacy of privatisation. While agency problems may tend to be more acute under public ownership, this need not be true in all contexts. Where law enforcement and corporate governance are weak and capital markets underdeveloped –

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and we must expect all of these in most emerging markets – there is every likelihood of agency problems under private ownership being as bad as or even worse than under public ownership. Likewise, the mixed empirical evidence on privatisation is warning against sweeping generalisations about the impact of privatisation. In general, where privatisation is claimed to have delivered improvements, the methodological shortcomings of many of the studies to which we have drawn attention must cause many of these conclusions to be viewed with a measure of scepticism. Even if we were to live with these methodological infirmities, the evidence about the impact of privatisation in emerging markets is less emphatic than in developed markets. Similarly, regulated or monopolistic industries are less susceptible to the vaunted effects of private ownership than are competitive businesses. The weaknesses of the legal system and of corporate governance in India are constraints on privatisation that cannot be easily wished away. The problem of governance in the Indian private sector, we saw in Chapter 7, is not very different from that in listed SOEs: in both, there is a dominant shareholder pitted against the interests of minority shareholders. The choice in the Indian context is thus not between firms that are controlled by government and firms that, after privatisation, would be accountable to financial institutions that are privately owned. If the latter were the alternative to government ownership, we could contemplate privatisation with a measure of equanimity. Rather the choice is between state-controlled firms and firms that would be controlled by a dominant private owner, typically an industrial house. This problem cannot be addressed through the sort of reform of the boardroom that is contemplated under the improvements in governance initiated in the country. Both listed SOEs and private firms face, in varying degrees, the problem of making the CEO accountable to the board. In SOEs, lack of accountability to the board arises from the fact that it is the government that calls the shots when it comes to appointing and removing CEOs. In the private sector, lack of accountability to the board results from the fact that the CEO happens to be from the industrial house that has a dominant shareholding. The improvements in governance wrought through boardroom reforms in the private sector are no more substantive than the improvements effected in the public sector through appointments of independent directors and conferment of greater autonomy. Before it can embark on full-blooded privatisation, India needs not only an improvement in the quality of its judicial system but also a more radical overhaul of governance, a more active market for corporate control and even greater openness to competition. Better governance requires greater activism on the part of institutional investors, Indian and foreign; we have not seen much of this so far. A problem with greater activism on the part of Indian institutions is that, because they happen to be government-owned, any attempt on their part


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to destabilise management tends to be seen as politically motivated. This problem can be addressed either by conferring a greater degree of autonomy on Indian institutions or by privatising them. Yet, privatisation in the financial sector meets with the most strident opposition. Thus, privatisation of industrial firms is inhibited by the inability of governments to proceed rapidly with privatisation of the financial sector. This is a constraint on the pace of privatisation that is not easily wished away. A role for SOEs The trend towards convergence in performance in the public and private sectors in recent years that our results point to argues against any simplistic approach to the question of public ownership or privatisation policy in India. As we have seen in the case of several SOEs in which disinvestment occurred, the mere fact of listing, a heightened emphasis on profitability and exposure to competition have by themselves contributed to improved performance. But the fact of convergence also, perhaps, suggests that the Indian private sector has not been able to lift itself up sufficiently because the forces that make for superior private-sector performance – competition, better governance, a market for corporate control – are not as strong as they should be. It could be contended that many SOEs do well because they have the advantages of scale and of depreciated costs, and to posit a counterfactual: if the same SOEs were handed over to the private sector, they would do even better. This is a proposition that many in India will view with caution because there is also a downside to it: the SOEs could end up doing a lot worse because of asset stripping and ‘tunnelling’. As mentioned earlier, in India today we have SOEs that enjoy a measure of autonomy, are listed and hence accountable to investors, and are managed by professionals of very high quality. As more and more government equity is sold to private and institutional investors, it is possible to visualise a gradual movement towards the Anglo-Saxon model of governance, whereby professional managers are accountable to large institutional shareholders. This is why strategic sales of highly profitable SOEs raise hackles and are seen as an act of retrogression. They threaten to hand over well-run enterprises, with a record of improving performance in the deregulated era, to precisely the narrow set of family-managed groups that are themselves in need of radical overhaul. Understandably, this is a prospect that does not seem particularly appetising not just to a large section of the political classes and the bureaucracy but also to the public at large. (There is, of course, the option of selling SOEs to foreign firms but this does not appear politically feasible at the moment, at least where the largest firms are concerned.) The above discussion points to two reasons why at least the betterperforming SOEs might be retained as government-controlled entities. First, there is potential for attaining a level of performance that can enable the SOEs

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to compete effectively in the domestic marketplace, if not in the international arena. Second, it is not clear that handing these over to family-managed businesses with little accountability to investors makes for better governance There is a third reason why the SOE as a business model might continue to be of relevance in the Indian milieu. SOEs offer lower wages, at least at the managerial and supervisory level, and employ larger numbers of people relative to their private-sector counterparts. In return, they offer job security, housing, and generous medical and retirement benefits. This is a package that is still able to attract and retain talent of very high quality, given the large pool of technical and managerial talent that India possesses. Astonishing at it may seem, there are managers of the highest calibre, including many at the top management level, who will not be lured by a compensation package in the private sector that, in cash terms, is a significant multiple of what they earn in the public sector. This suggests that SOEs offer a whole lifestyle, comprising job security, richness of job content and a certain professional freedom that strikes many as a worthy alternative to the hire-and-fire, family-driven culture of the Indian private sector, no matter how lucrative positions in the latter might be. For the Indian middle class, newly exposed to the uncertainties that go with competition and globalisation, a secure job still remains a prized possession – and many are willing to settle for lower wages in return. There is no reason why this preference cannot be used to create a business model wherein lower managerial costs are a source of competitive advantage. If a State Bank of India (SBI) or a Bharat Heavy Electricals Limited (BHEL) can attract and retain some of the best talent in the country and compete successfully in the marketplace, that begs the question whether the business model needs to be disturbed at all. If cultural, ethnic and gender diversity are all seen as virtues, organisational diversity, the existence of diverse business models in the corporate milieu, needs to be welcomed too. If this proposition is accepted, privatisation for the large, well-run SOEs must involve the sale in tranches of government equity to the public. Over time, the government’s stake could fall below 51 per cent, resulting in institutional and retail shareholders constituting the majority. Government could nominate directors on the boards of these SOEs in proportion to its shareholding and generally facilitate the creation of a board-driven culture at these firms. These SOEs could thus become beacons of a new era of large, professionally managed Indian firms. Further, the government must commit itself to submitting SOEs to the market for corporate control. Let SBI, the biggest public -sector bank and ICICI, the biggest private bank, compete under the discipline of the capital market. Let IOC, the public-sector oil refiner, compete with Reliance, the private conglomerate with interests in petroleum. Let BSNL, the publicsector telecom giant, slug it out with the numerous private telecommunication companies. Let the SOEs take over their private-sector counterparts or be taken over.


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In other words, the fate of the large SOEs does not need to be decided now on ideological grounds. Once a superior culture of governance has evolved in both the public and private sectors, the market can decide which business model is superior in a given context and needs to survive. If SOEs as a breed cannot survive and are taken over, so be it. Votaries of market discipline should not baulk at the prospect of the future of SOEs being decided by the market rather than by government decree. In retrospect, it would seem that not listing more SOEs on stock exchanges has been an important failure in the management of such firms. Had this been done, especially when the firms were doing well, many could have raised capital on their own instead of being dependent on the budget, and would have been better prepared to face competition ushered in by economic liberalisation. The liberalisation program was a sudden event, a response to an economic crisis. Hence the generality of SOEs were not prepared for that event. The position now is that many of them cannot raise capital on their own, nor is the government in a position to support them. They may have to be closed down or sold at give-away prices.

9.7 Implications for privatisation policy In light of the results thrown up by our study and against the background of the discussion we have had above, it is possible to spell out some principles that could guide privatisation policy in Indian. First, privatisation is seen to work best when allied with competition or deregulation. As we have highlighted in our survey of the literature, all too often, the improvements in efficiency wrought by competition tend to be ascribed to privatisation. Second, strong institutional and regulatory capacity are preconditions for privatisation to work. We need effective law enforcement and swift judicial processes, developed capital markets and strong mechanisms of corporate governance. Third, it would be unwise to presume superior performance on the part of the private sector. Where the public sector co-exists with the private sector, the assumption that the private sector does better needs to be subjected to rigorous empirical tests. It is the under-performing public-sector firms that should be the prime candidates for privatisation, as this would conduce to the twin objectives of firm efficiency and fiscal stabilisation. Fourth, in privatising a given entity, it is important to have some prior idea as to where superior financial results are going to come from: is it higher prices of a firm’s products, transfers from workers to shareholders or higher operational efficiency? Needless to say, the economy gains most when efficiency gains drive superior performance consequent to privatisation. Fifth, as privatisation of a whole range of firms is likely to be a long drawnout affair, it is important to monitor post-privatisation performance and to

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assess whether improvements in performance have actually materialised in the privatised firms. Such monitoring can have a bearing on the decision to privatise the remaining firms, as also on the design of privatisation for these firms. Sixth, in the case of SOEs that are doing well, a mechanism for selling portions of the equity from time to time needs to be devised so that the exchequer reaps capital gains from these firms and not just dividend yields. It will then be possible to ensure that privatisation is driven, not by short-term budgetary pressures, but by the primary objective of improving firm efficiency. In conclusion, one cannot resist observing that in hastening slowly with privatisation, and especially in being wary of adopting the strategic sale as the universal norm for privatising SOEs, India’s democratic polity has shown a measure of wisdom for which it has not received due credit. The Indian approach to privatisation has not been very different from that of China, documented in Chapter 8. In both countries, the political establishment has put its faith in the benefits of SOE reform – and its faith has been substantially vindicated by SOE performance. This does serve to debunk the popular notion that the political class has been patently self-serving in holding up privatisation. Ministers who are opposed to strategic sale in well-run SOEs tend to be portrayed in the media as venal politicians who do not want let go of the perquisites that go with holding on to SOEs in their domain. But such a view does scant justice to the basic intelligence of politicians. As rational utility-maximisers, politicians must know that they can easily capitalise the future stream of perquisites as one-off kickbacks for parting with the SOEs they lord over, instead of nibbling away over time at SOEs under their control. At the risk of seeming too kind to the Indian political classes, one might suggest that if it has not opted for a transfer of ownership in the better-run SOEs, it is because it has good reason to be wary of big-ticket privatisation. With their instinctual understanding of the polity, politicians would have a pretty good sense of the agency problems inherent in privatisation, more so than the cerebral types who are forever running them down. Knowing how the system works, they would be alive to the risks involved in handing over large SOEs to the private sector. They would sense that, outside a small elite class, businessmen are not seen as lesser crooks than politicians or as more accountable. Like the lay public, they can judge that if businessmen, who have otherwise been reluctant to invest in recent years, are willing to put money into SOEs, it must be because there are easy returns to be had from undervalued assets. For these reasons, the sale of large, well-run SOEs to private parties would not make either economic or electoral sense. Not to grasp this is to betray a tragic lack of understanding of the political economy of privatisation in the Indian context.

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Index

ABB 72 Adams, C. 32 Aditya Birla group 76, 77 Ahluwalia, I. 44 Ahuja, G. 93, 93 Air India Ltd 19 Ajit Jogi 151 Alcatel 69 Aluminium Products Ltd 77 Andrew Yule & Co. Ltd 67, 69, 70, 82 Arun Shourie 19, 151 Associated British Ports 34 auctions 17, 40, 150; collusion in 158–9; efficiency in 154–9, 164, 200; methods of 154–9 Baijal, P. 152, 164, 165, 166 BALCO 18, 77, 151, 152 Bank of Baroda 133, 135, 145, 147 Bank of India 133, 135, 145, 147 Bank of Punjab Ltd 135, 145, 147 Bank of Rajasthan Ltd 135, 145, 147 Banker, R. 85 banks foreign: 115, 117, 127–8,131; intermediation costs in 119–20; profile of 129; share of Indian banking assets 116; spreads in, 118, 120 Indian (including Indian banking, see also public sector banks): concentration ratios 119; disintermediation in 124–5; efficiency in (see public sector banks); financial deregulation 115, 121, 124; financial sector reforms 117, 119, 163; foreign ownership 118; government ownership 126, 149; interest spread 121–4, 131–2, 13–8, 213; intermediation cost ratios

115, 118–24, 131–2, 134, 137–8, 145; nationalised 5, 21, 115, 117, 122–3, 127, 130, 138–9, 144, 197; net interest income ratio (see also spread) 118–20, 128, 134, 136–8, 145; non-performing assets 117, 118, 121–4, 129, 137–8, 144; private (see private banks, Indian); profitability 120, 122–5, 127–9, 137–38, 141; weak 122, 130, 137–9, 144, 197 input and output in 128, 130–2, 139, 198 public sector (see public sector banks, PSBs) X-inefficiency 125 Barth, J. R. 126 Beck, T. 171, Beim, D. O. 149 Berger, A. N. 125, 130 Bharat Breaks & Valves Ltd 19 Bharat Earth Movers Ltd 67, 69, 70, 82 Bharat Electronics 67, 68, 70, 82 Bharat Heavy Electricals Ltd 67, 70, 71, 72, 73, 74, 75, 82, 166, 204 Bharat Heavy Plates & Vessels Ltd 19 Bharat Petroleum Corpn Ltd 19, 20, 67, 70, 82, 151–2, 164, 165 Bharat Pumps & Compressors Ltd 19 Bhattacharyya, A. 127 Bhaumik, S. K. 127 Bhaya, H. 44 Bishop, M. R. 32 Boardman, A. E. 35 Bombay Stock Exchange 134 Bongaigaon Refinery & Petrochemicals Ltd 67, 70, 82 Boone, P. 171 Boubakri, Narjess 41

214

Index

Breach, A. 171 British Aerospace 34 British Airports Authority 34 British Airways 34 British Gas 34 British Steel 34 British Telecom 33, 34 Britoil 34 BSNL 205 Calomiris, C. W. 149 Caprio 126 Cavendish, W. 32 Caves, D.W. 36, 89 Centurion Bank Ltd 135, 145, 147 Chandrashekhar 11 Charnes, A 85 Chennai Petroleum Corpn Ltd 67, 70 China governance in 192 privatisation in 183, 186, 189–93 SOEs: autonomy in 183–5, 188, 192; disinvestment and performance 186–7; efficiency of 188–90; government ownership of shares 183, 186–9, 191; incentives in 29, 42, 184–5, 188–9, 192; institutional shareholders 188, 192; listing of 191; privatisation and performance 189–90, 192; reform of 183–93 Christensen, L. R. 36, 89 City Union Bank Ltd 135, 145, 146, 147 CMC Ltd 19, 67, 82, 151–2, 155 CMIE 45, 45, 93, 95, 113, 114, 134, 165, 166 Cochin Refineries Ltd 82 CONCOR 18 Container Corpn of India Ltd 67, 70, 83 Cooper, W. 85 corporate governance and privatisation performance 170–1, 181 in India’s private sector firms 173, 176–7, 179, 181–2, 200, 202–3, 205 in SOEs in India 173–7, 179, 181–2 Corporation Bank 133, 135, 145, 146, 147 Cosset, J.-C. 41 Das, A. 127 Data Envelopment Analysis (DEA) 85, 93, 95–6, 103, 113, 127, 131–3, 194, 197

Demirguc-Kunt, A. 149, 172 Dena Bank 133, 135, 145, 147 Desli, E. 90 Detragiache, E. 149 Deve Gowda 14 Dewenter, K. 36 Diewert, W. E. 89 Disinvestment in banking 20, 21 case studies 71–78 in China 185–8 criticisms of 17–19 evolution of policy in India 11–15 fiscal impact 181 ministry of (see Ministry of Disinvestment) pre- and post-disinvestment performance: in Indian industry (see also SOEs in India) 65–71, 78, 101; in India’s public sector banks (see PSBs) and privatisation 2, 15–16, 150 proceeds from 17 and strategic sale (see strategic sale) Djankov, S. 32 Dredging Corpn of India Ltd 67, 70, 82 efficiency aggregate efficiency 49; comparison between SOEs and private firms 37–40; comparison between Indian SOEs and private firms 44–6, 48–9, 51–3, 58–65; pre- and postdisinvestment comparison in Indian SOEs 66, 78, 80 allocative 84, 93, 96, 109, 111, 125, 127 cost 93, 96, 109–12; comparison between Indian SOEs and private firms 51, 53, 58–61, 93, 107–12 financial sector reforms and 119–20 in financial institutions 125 in Indian banking (see public sector banks) in public sector banks in 119–20, 122, 124, 127, 148–9, 199 operational 7, 9, 40, 47, 122, 125, 202, 206 strategic sale and (see strategic sale) technical (see technical efficiency) Elyasiani, E. 85 Engineering Projects (India) Ltd 19 Engineers India Ltd 67, 70, 83

Index Fama, E. F. 30 Färe, R. 89 Federal Bank Ltd 135, 145, 147 Fertilisers & Chemicals, Travancore Ltd 67, 70, 82 Finsinger, J. 36 foreign banks (see banks, foreign) Foreman-Peck, J. 33 Friedman, E. 171 Frydman, R. 38 Galal, A. 33, 35, 37 Gandhi, Rajiv 5, 6 Gas Authority Of India Ltd 18, 67, 70, 83, 165, 166 GE 72 Glaxo 158, 159 Global Trust Bank Ltd 135, 145, 147 Gray, C. 38 Grosskopf, S. 36, 89 Groves, T. 188 Hay, D. 29, 183, 184, 185 HCI 152 HDFC Bank Ltd 135, 145, 146, 147 Heavy Engineering Corporation 8, 9 Hessel, M. 38 Hindalco 77 Hindustan Cables Ltd 19, 82 Hindustan Copper Ltd 19, 67, 68, 70, 82 Hindustan Insecticides Ltd 19 Hindustan Lever 151 Hindustan Organic Chemicals Ltd 19, 67, 68, 70, 82 Hindustan Pertoleum Corpn Ltd 19, 20, 67, 70, 75, 76, 82, 151, 164, 165 Hindustan Photofilms Mfg. Co Ltd 82 Hindustan Salts Ltd 19 Hindustan Zinc Ltd 19, 67, 69, 70, 82 HMT Ltd 82 Hong Kong Stock Exchange 186 HTL 152 Huang, D. 190 Humphrey, D. B. 130 Hunter, C. W. 125 HZL 152 IBP Ltd 19, 152 ICICI Bank 134, 205 ICVL 152 IDBI 18 IDBI Bank Ltd 135, 145, 146, 147

215

India Tourism Devp. Corpn Ltd 67, 70 Indian Airlines 19 Indian Oil Corpn Ltd 18, 67, 70, 83, 165, 166, 205 Indian Petrochemicals Corpn Ltd 19, 67, 70, 82, 151–2 Indian Railway Const. Co. Ltd 82 Indian Telephone Industries Ltd 69, 82 Indian Tourism & Dev. Corpn 19, 83 Indira Gandhi 5, 6, 7 Indusind Bank Ltd 135, 145, 147 Industrial Dev. Bank of India 83 Instrumentation Ltd 19 investor protection and privatisation 170, 172, differences in legal systems 171, 181 in India 172–3, 181 measures of 171–3 Ircon International Ltd. 67, 70 ITDC 152 ITI Ltd 67, 69, 70 Jaguar 34 Jammu & Kashmir Bank Ltd 135, 145, 146 Jawaharlal Nehru 3, 4, 5, 24 Jensen, M. C. 26, 29 Jessop & Company Ltd 19 Jessop 152 Jha, L. K. 5 Jha, R. 44 John Nellis 38 Johnson, S. 170, 171 Jones, L. 33 Kaufman, T. 36 Kay, J. A. 32 Kelkar, V. 15 Khilnani, S. 4 Klemperer, P. 154, 158, 159 Kochi Refineries Ltd 67, 70 Kornai, J. 28 KRL(CRL) 18 Kudremukh Iron Ore Co. Ltd 67, 68, 70, 83 Kumar Mangalam Birla 180 La Porta, R. 40, 126, 171, 172, 173 Lal Bahadur Shastri 5 Levine, R. 126, 171 Li, W. 189 Lindgren, B. 89 LJMC 152

216

Index

Loayza, N. 171 Logan 36 Lopez-De-Silanes, F. 40, 126, 171 Madras Fertilizers Ltd 19 Madras Refineries Ltd 83 Mahanagar Telephone Nigam Ltd 18, 67, 70, 83, 165 Majumdar, S. K. 93, 94, 95 Maksimovic, V. 172 Malatesta, P. H. 36 Mangalore Refineries and Petrochemicals Ltd 76 Manning. D. 33 market for corporate control 28, 30–1, 128, 170, 178–80, 182, 203, 205 Martin, R. 30 Martin, S. 28, 29, 33, 36 Maruti Udyog Ltd 19, 152 Maskin, E. 157 Meckling, W. H. 26 Megginson, W. L. 31, 33, 37, 39, 42, 125, 160, 161, 162,163 Mehdian, S. 85 Memorandum of Association 21 rationale for 7–8 short comings in 8–10, 13 Meyer, R. A. 36 Milgrom, P. 157 Millward, R. 39 Minerals and Metal Trading Corporation of India Ltd 19, 69–70, 83 Mini-Ratna 15 autonomy of 69–70 conditions of 14 Ministry of Disinvestment 11, 13, 18–19, 152, 155 Mistry, P. 32 Modern Foods 151, 152 Mohan, R. 13 MRL 18 MSTC Ltd 19 Mukherjee, K. 130 Murphy, K. J. 29 Murrell, P. 32 Narasimha Rao 11 Narasimham, M. 117 Naresh Chandra 180 Naryana Murthy 180 Nash, R. C. 37, 160, 162 National Aluminium Co. Ltd 19, 67, 70, 76–8, 83, 168

National Fertilizers Ltd 19, 67, 70, 83 National Freight Corpn 34 National Mineral Dev. Corpn Ltd 67, 70, 83 Navratna 13–15, 69–70, 74 Freedom to 14 Nayar, B. R. 4 Nayar, R. J. 3, Nedungadi Bank Ltd. 134, 135, 145, 147 Nellis, J. 41, 41 NEPA Ltd 19 Netter, J. M. 163 Netter, J. M. 31, 33, 39, 42, 160, 162 Neyveli Lignite Corpn Ltd 67, 70, 83 Norris 89 Oil & Natural Gas Corpn 18, 67, 70, 76, 83, 166 Oriental Bank of Commerce 133, 135, 145, 147 Owens, W. L. 125 Paradeep Phosphates Ltd 19 Parker, D. 28, 29, 33, 36 Patil, R. H. 174, 175 Picot, A. 36 Poulsen, A. B. 160 PPL 152 Praga Tools Ltd 19 private banks, Indian 115, 117, 121, 127–8, 131, 149 new 118, 129, 134–5, 148; intermediation cost 120; spread 120 old 129–30, 134–5, 148; intermediation cost 120; spread 120 profile of 129 share of Indian banking assets 116 Private ownership superior incentives 29–30 privatisation (see also disinvestment) case studies 32–5 categorization 17 cross-sectional comparisons 35–7 and disinvestment 2, 11–13 efficiency (see efficiency) empirical evidence 25, 32, 43, 150–1, 160, 167–8, 202; in UK 34–5 incomplete contracts approach 27 in India (see SOEs in India, public sector banks, efficiency) in less-developed countries 39–42; capitalism 41; conditions to 42 objectives 25–6, 152, 154

Index productivity: definition 87; index 87–8 public choice theory 26–8 pre- and post-privatisation performance 37–9 steps towards 16, 17 technical efficiency (see efficiency) theory of property rights school 26–8 total factor productivity (see SOEs, public sector banks) in UK 34–5 public sector, Indian banks (PSBs) 115, 117–19, 122,129, 149, 163, 197–9, 205 categories of 21, 22 changes in policy towards 5, 6 comparison of performance with private and foreign banks: summary 143–4; using financial measures 136–9; using Malmquist total factor productivity growth 128, 130–1, 141–2, 144, 148, 198; using revenue maximisation efficiency 128, 130–2, 142–4, 148,198; using technical efficiency 128, 197; using Tornquist total factor productivity growth 128, 130–1, 139–41, 144, 148, 198 comparison of pre and post disinvestment performance: using stock performance 134–5, 145, 148–9, 198; using financial ratios 133, 144–5 efficiency (see efficiency) post-deregulation performance 119, 121, 123–5 origins of 3–5 pre and post-privatisation stock performance 144–6 technical efficiency in 127 Rajan, R. G. 171 Ram Mohan , T. T. 84, 115, 150, 163 Ramakrishna, G. V. 15, 175 Ramaswamy, R. 44 Rangarajan, C. 12 Rapaczynski, A. 38 Rashtriya Chemicals & Fertilizers Ltd 67, 70, 83 Ray, S. C. 84, 90 Renworth, W. 44 Reserve Bank of India 20, 116, 117, 118, 119, 120, 121, 122, 125, 128, 129, 199 reserve price 17, 153–4 Rezvanian, R. 85 Rhodes, E. 85 Roche 159

217

Rolls-Royce 34 Ronald Coase 170 Roos, P. 89 Sahni, B. S. 44 Sarkar, J. 127 Sarker, P. C. 127 Sarkar, S. 127 SBI Capital Markets 29 Schwartz, A. L. 162 Scooters India Ltd 19 Sengupta, A. 6, 7 Shipping Corpn Of India Ltd 67, 70, 83 Shleifer. A, 27, 31, 126, 170, 171 Singh Manmohan 11 South Indian Bank Ltd 135, 145, 146, 147 Sponge Iron India Ltd 19 State Bank of Bikaner & Jaipur 133, 135, 145, 146, 147 State Bank of India 29, 115, 133, 135, 145, 146, 147, 176, 204, 205 State Bank of Travancore 133, 135, 145, 147 state-owned enterprises (SOEs) accountability 14 in China (see China) and deregulation 10, 24, 33, 38, 40, 43, 71, 79, 81, 165, 195–6 incentives in 28–30, 38, 42 multiplicity of objectives in 27, 76 performance of 9–10 politicians and 15, 27, 29–30, 161, 163–4, 173, 176, 181, 206–7 social objectives of 6, 9, 11 soft budget constraint in 28, 179, 183 supervise of 14, 15 types of 28 State Trading Corpn of India Ltd 19, 67, 69, 70, 83 state-owned enterprises (SOEs) in India comparison with private firms in industrial sector based on input–output quantities: cost efficiency 93–6, 109–12; Malmquist total factor productivity growth 95, 103–6; technical efficiency (see technical efficiency); Tornquist total factor productivity growth 95, 107–9 financial performance: aggregate level 45–6, 49–53, 79; sectoral level 46–7, 54–65, 80

218

Index

SOEs in India (cont.) pre- and post-disinvestment performance (see disinvestment) studies of financial performance 44–5 Steel Authority Of India Ltd 67, 69, 70, 83, 166 Stiglitz, J. 29, 41 strategic sale and efficiency 151–4, 156–9, 164, 168–9 empirical evidence on 150–1, 160, 167–8 market impact of 166 misconceptions about 163, and revenue maximisation 152–7, 159, 168 valuations in 164, 168 Subrahmanyam, G. 127 Sun, Q. 186 Swamy, S. B. 127 Syndicate Bank 133, 134, 135, 145, 146, 147 Tandon, P. 33 Tata group 154 technical efficiency comparison: between Indian SOEs and private firms 94–5, 97–102, 110, 112; in Indian banks (see Indian banks, comparison of performance); in international firms 36, 39 definition 85, 91 input-oriented measure of 93 output-oriented measures of 84, 86, 91, 93 Timme, S. G. 125 Tong 186

Tong, J. 186 Trivedi 8 Tungbhadra Steel Product Ltd 19 Unit Trust of India 180 United Western Bank Ltd 135, 145, 147 UTI Bank Ltd 135, 145, 146, 147 Vajpayee, A. B. 16 Van Randenborgh, M. 37, 162 Varian, H.86 Verbrugge, J. A. 125, 149 Videsh Sanchar Nigam Ltd 18, 19, 67, 70, 83, 151, 152, 165 Vining, A. R. 35 Vishny 171 Vishny, R. W. 27, 171 Vogelsang, I. 33 Vysya Bank Ltd 135, 145, 147 Wang, Y. 187, 191 Weber, R. 157 Wei, Z. 189 Weiss, J. 39 World Bank 39, 126, 149, 184, 185, 186 Wykoff, F. C. 130 Xiaoping, D. 191 Xu, X. 187, 191 Yao, Y. 184, 185, 186 Yunker, J. A. 36 Zeneca 158, 159 Zervos, S. 171 Zhang, P. 89 Zingales, L. 171

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