People's Democracy

The Murky World Of Disinvestment

C P Chandrasekhar

THE story surrounding the NDA government’s end-of-year   disinvestments rush gets murkier by the day. The latest story is that of an "Error" in allotment, which resulted in High Net Worth Individuals (those investing more than Rs 50,000) being allotted shares in excess of what they were eligible for under the rules that were framed for the purpose. But the story does not end there. No sooner were these allotments made than many of these individuals chose to sell these shares in the market for a huge profit. As a result, by the time the investment bankers realised that a mistake had been made and sought to correct it, the shares had already been traded and were due for delivery to their new owners. Asking the recipients of the extra allotment to return these shares would result in huge losses for them, since they would have to buy these shares to meet their delivery commitments. Hence, they are bound to demand compensation, leaving the question as to who is to pay unanswered.

This, of course, is only the most recent sign of a possible engineered scam involving the sale of equity in some of the most lucrative businesses in India’s public sector. The other sign of anomaly was the ease with which the government could push through its disinvestment scheme even though it was going to market at the end of the year with large volumes of equity. Over a period of around three weeks starting mid-February the government had chosen to put out offers of shares for six companies -  IBP, CMC, IPCL, Dredging Corporation of India, GAIL and ONGC. This would amount to sale of shares worth around Rs 14,000 crore, with Rs 10,000 crore to be raised from sale of ONGC shares alone, amounting to 10 per cent of the equity of that petroleum major.

It is now maintained that this end-of-year sale has been a tremendous success with all issues being oversubscribed. Past experience suggests that this response of the markets was surprising. Through much of the 1990s, governments have set themselves disinvestments targets every year only to find that poor market conditions, democratic opposition or just plain absence of interested investors results in those targets remaining unrealised. But under NDA rule, especially the second half of that rule, there has been a noticeable change. Initially, driven by the need to win friends and legitimacy both within the country and outside, the NDA government was gripped by an almost irrational urgency to push the neo-liberal "Reform" Agenda. One area in which this sense of urgency had been visible was the euphemistically termed "Disinvestments process" Through discounted sales of "Strategic Stakes" the government in recent years has been seeking to put as much of the profit making public sector as
possible under private control.

But strategic disinvestments has not just been controversial and embarrassing (as in the case of the Airport Centaur Hotel Mumbai), but has also run up against the law in the case of companies established under an Act of Parliament. This has meant that the desperation to sell has not been matched always by the ability to do so. This has created an altogether different problem for a government, which sees in disinvestments not just the realisation of its dream of complete privatisation, but also a source of revenues.

Those additional revenues are crucial because they help cover the deficit created by the loss in revenues resulting from customs duty reductions and the huge direct and indirect tax concessions provided as sops to the rich, both of which are adopted as part of the reform agenda.

In the past, the government has on occasion garnered 'disinvestments revenues' even when the privatisation process stalled, by opting to compulsorily force large, cash-rich public sector corporations to acquire government equity in other similar corporations through the cross-holding route. This not only met with opposition from such corporations but also from the media and the public at large, which saw it for what it was -  the misuse of the surpluses earned by successful PSUs to meet profligate budgetary concessions - dress up the budgetary figures on revenues and curtails the fiscal deficit.

Having been deprived of even that option, and emboldened by the buoyancy in stock markets, the government has now chosen to directly divest itself of blocks of shares in public sector enterprises to neutralize the loss in tax revenues that liberalisation results in. These blocks of equity are either a part of the government’s holding in companies it controls or is the residual stake of the government in companies that it has privatised by handing over a strategic stake and managerial control to a private investor.

The first instance of such sale of equity this financial year - that in Maruti Udyog - was driven not just by revenue considerations, but influenced by the lobby that has won out in the push to hand over complete control of the company to Suzuki. But, the substantial revenues garnered from that exercise seems to have persuaded the government that this is a potential means of "Resource mobilisation". This has generated a new "March rush" that of rushing to market with huge lots of public sector shares to be sold through a book-building process involving an auction subject to a floor price specified by the government.

Putting huge amounts of shares on sale in this manner in a short period of time does not make sense in a market that lacks width and depth. It is known that despite the presence of a few small, retail investors, the Indian stock market is dominated by the financial institutions, the foreign institutional investors and large corporates parking their funds to benefit from possible capital gains. On the other hand, there are very few companies whose shares are actively traded on a regular basis in the secondary market. And even in the case of these companies the quantum of shares out of the total issued capital that is traded is small.

If in such a market there is a sudden infusion either of investment funds (from FIIs for example) or shares (from PSUs in this case), the impact on the share price is bound to be significant. If the dumping of PSU shares results in excess supply, investors are bound to chose to hold back purchases in the expectation that share prices would fall. In fact, with such expectations there could be many players who short sell these shares for later delivery in the conviction that these shares can be acquired at a low price and sold even at below the prevailing market price for a profit. This tendency is all the greater because market players expect that in order to attract investors the government would set the floor price for these issues well below the market price that prevails immediately prior to the start of the sale process, imparting some downward pressure on market prices. In sum, large-scale divestment in a short period must involve substantial discounts.

The experience with this round of disinvestments suggests that not only were large discounts being offered on market prices, but those market prices themselves were low leading to huge interest from speculative investors including foreign institutional investors. Even within days of the opening of the issue of shares of some of these PSUs the interest of foreign institutional investors was obvious. For example, they accounted for 75 and 55 per cent respectively of the demand for IPCL and CMC shares by February 26, 2004. Therefore, the government’s real concern was not with these companies but with IBP. In the case of that company the FIIs were not interested at all, accounting for just 2 per cent of total claims. Unfortunately, retail investors, who were important targets of the disinvestments exercise, were not the ones who helped shore up the issue finally, since they accounted for just 6 per cent of demand.

The prime role was played by the financial institutions and mutual funds that had come forward to take up 44 and 36 per cent of the demand, at a time when the issue was still not oversubscribed. Given disinvestments minister Shourie’s alarmist tantrums when the issue was not being responded to, it does appear that the government had "persuaded" the institutions to fill the gap.

Compare this with the performance of the ONGC issue. The sale of 10 per cent of ONGC shares, which was the largest-ever public issue in the country, was fully subscribed within 10 minutes of the opening of the offer. The immediate surge in demand on the first day of the issue came mainly from FIIs who accounted for bids amounting to over Rs 18,000 crore. Retail investors applied for just 13,520 shares, compared with 26.14 crore shares that the FIIs bid for. According to subscription details, FIIs accounted for over 87 per cent of the total bids made on the first day. Finally the issue was oversubscribed six times. There was a further twist to the story. The media has it that Warren Buffet pumped in around $1 billion to acquire a large chunk of shares.

This kind of interest on the part of the FIIs and by investors like Buffet who virtually "lead the herd" suggests that the pricing of the shares was such that they were so lucrative that the offer could not be refused. Associated with the success of the issue may be a substantial loss in terms of the value of the assets that the government has given up. There are bound to be questions regarding the price band in which the shares of the different PSUs were offered. It is widely known that given imperfections, prevailing market prices are no indicator of the true value of a financial asset. But even such comparisons are suggestive. There were very few ONGC shares floating in the market, but evidence from the other firms is telling. Thus IPCL shares were being offered at a floor price of Rs 170, which was well below the Rs 195.70 at which the share was being quoted at the National Stock Exchange just before the offer opened.

The corresponding figures were Rs 475 and Rs 541.50 for CMC and Rs 620 and 717.75 for IBP. According to the government these discounts were unavoidable since the decision to go to market in February-March with a huge bundle of shares was unavoidable. As disinvestments messiah Shourie reportedly put it: “There’s very little that we can do as the disinvestments proceeds are required by North Block by the end of the current fiscal to arrive at that magic figure of the fiscal deficit.” In his view, the strategy to obtain the best deal was to start with the government’s residual shareholding in "privatised" companies like IPCL and CMC and with small issues like that for the Dredging Corporation of India Limited and then move on to the real winners like GAIL and ONGC. The figures also make sense in the light of other evidence. One puzzling feature of the data on mobilisation of capital through the market is that during the period 1998-99 to 2001-02, the share of new (as opposed to existing) companies in total capital mobilised was extremely high. But these were the years when additional mobilisation occurred largely through debentures. There seems to be a reversal in 2003-04, which is clearly a year when mobilisation through equity would overwhelmingly dominate. Interestingly, that also happens to be a year when the sale of equity by existing and highly profitable companies would account for an overwhelming share of the mobilisation.

The message therefore appears clear. The experience of 2003-04 is not one that points to a transformation of India’s stock markets into a cash cow for entrepreneurs with new investment ideas. It is proof that while the capital market remains one in which profit hunters trade risks in secondary markets, there would be periodic primary market booms whenever speculation spills over into a thirst for even new shares or when the government desperate to mobilise budgetary resources and/or shore up its "Reformist" image puts on sale the best PSUs at what are seen as bargain prices.

The presumption that the government has lost out large sums is corroborated by the desperation of many investors to dump their investments at a profit immediately after allotment, as revealed by the ONGC allotment "error". Thus large-scale disinvestments to garner resources for the budget must involve a substantial loss for the government, since it must be made attractive for the investor. Disputing this by pointing to the "small" discrepancy between the offer price and the prevailing market price of the shares involved will not do. Market prices of public sector equity rarely capture the real value of the assets underlying them. A proper evaluation, independent of prevailing stock market values, would have yielded a floor price at which takers for multiple bulk transactions would have been missing. That was something the economist in Shourie must have realised when he went to market with his bulging bundle of goodies. So the discount must have been larger than visible. The moot question therefore is: how much has public equity been discounted to finance the fiscal profligacy that tax concessions imply? Whatever the answer, it is clear that pre-election India is shining for these speculators.