Liberalisation/Privatization in India

Disinvestment Revenue and Market Structures

Parashar Kulkarni
parashark@hotmail.com
LSS Bhopal 2003

Since the decade of the 90s, liberalisation has been the guiding star for India’s policy
framework. International institutions, consulting firms and national government have
pushed liberalization in India by advocating policy measures such as privatisation1,
disinvestment2, commercialisation, deregulation and international integration. A review
through the vast literature on the reform process takes us through the journey of India’s
movement from a socialist closed economy to a pro market open economy. The
following represents a broad summary of the liberalization agenda
1) Steady reduction in the number of strategic3 sectors (Today there are three
strategic sectors: Defence, Atomic Energy and Railway Transport) and selling
equity stakes in public sector units
2) Liberalization of financial markets.
3) Decontrol of price regimes.
4) International integration
5) Promotion of pro market reforms and move towards a market economy.

An important and ongoing component of the reform process consists of privatisation and
disinvestment. With growing acceptance of libertarianism, the government is increasingly
cautious of its burgeoning size and its unnecessary involvement in commercial activities.
The government is changing its role in markets; from that of a market participant to that
of a market regulator. In this constructive deconstruction it is trying to attain several
objectives such as government efficiency, revenue generation, promotion of market
mechanism and economic development. Sometimes objectives contradict each other
and have to be balanced.

In this essay we shall focus on the relation between two such contradicting objectives

Revenue Generation and Efficient market structure

Disinvestment plays an important role in revenue generation. Disinvestment receipts can
help the government reduce fiscal deficit not only by way of equity sale in PSUs (public
sector units) but also by the subsequent cap in government transfers to bleeding PSUs.
But has the government been successful in its disinvestment endeavor? Trends in the
past few years present an abysmal picture. There are wide differences in disinvestment
targets and actual receipts. (Refer Table 1.1)
Table 1.1
Year Targeted Receipts Actual Receipts
1999-2000 10,000 1829
2000-2001 10,000 1870
2001-2002 12,000 5632

1
Privatization is defined as the exit of the government as a producer in a given market, and complete
transfer of the government ownership to the private player..
2
Disinvestment is defined as the reduction in government equity in public sector enterprises..
3
Strategic sectors are those industries that are reserved for public sector enterprises.
Political hurdles in disinvestment, intervention of stakeholders and poor financial state of
sold PSUs have all contributed to this performance.

Apart from revenue generation, creating an Efficient Market Structure is also one of the
important goals of the disinvestment/privatization process. The government seeks to
establish a competitive market that would result in driving down consumer prices (e.g.
Privatization and Deregulation in the Telecom Sector in India has reduced prices and
increased consumer base dramatically)
On the other hand the government would try to maximize revenue by divesting in a
pseudo monopoly environment and using regulation to control rent seeking behavior
(e.g. When Reliance acquired IPCL a pseudo monopoly was formed in the
petrochemical market. But government control on crude prices as well as its control on
petrol prices led to some form of price regulation) The government cannot try to
maximize both, revenue and market structure. The following example will explain the
contradiction in the two objectives.

Consider the case of the Domestic Airline industry in India, an oligopoly dominated by
three players: Jet, Sahara and Indian Airlines. Consider a hypothetical case of
privatization of Indian Airlines, the government owned airline company.
How should the government privatize Indian Airlines? Should the government encourage
more players by offering investment incentives and subsequently divest in a competitive
market or should the government sell Indian Airlines to a third new entrant say Tata
Airlines or should it permit a current player to buy Indian Airlines and increase the
possibility of monopoly creation. Table 1.2 depicts the given situation objectively.

Table 1.2
Government Payoff to the Government Post sale market No of players
Strategy (Additional Revenues:Premium) structure after sale
Sell to existing High Pseudo 02
player monopoly
Sell to new player Medium Oligopoly 03
Increase players & Low Competitive Over 5
then sell in
competitive mkt.

Diagram 1.1 explains the inverse relation between objectives of competitive market
structure and revenue maximization. Competitive structure is plotted on Y axis and
Disinvestment receipts on X axis

Diagram 1.1

Perfect
Competitio
MARKET
COMPETITIVENESS

Monopoly
 DISINVESTMENT RECEIPTS
(Company Value)

As the number of players in the market increase the value of the government entity to be
divested decreases. In this situation how should the government balance its objectives
The government can look at three components to arrive at the solution
1) Different privatization strategies on the basis of the nature of goods i.e.
commercial, social, public utilities etc
2) Establishing a regulatory framework to lay down the rules of the market.
3) Withholding the sale, until the required market structure is created with the help
of entry incentives.

Solutions are not simple, especially where stakeholders are many and come from all
sections of the society. The government should study international best practices,
customize them to the Indian landscape and arrive at the right direction of the
liberalization process.