Thinking Strategically About Privatisation
Air India privatisation is paramount, but the central challenge for the Modi government will be to rapidly reduce its control over the banking system.
There is an old story that needs to be retold at a time when the privatisation of public sector companies such as Air India is once again being avidly discussed. A young parliamentarian named Atal Behari Vajpayee asked during a debate why the government was building hotels rather than hospitals. Prime Minister Jawaharlal Nehru explained that the government was building hotels so that it could then use the profits to build hospitals.
I am not sure whether this story is apocryphal or not—but it does provide an interesting insight into one of the reasons why public investment was directed towards the creation of new enterprises in Nehruvian India. The most commonly cited reason is that the government had to take on the role of entrepreneur because India did not have deep financial markets to fund private sector investment in the heavy industries that were central to the planned structural transformation of the Indian economy. Even the Bombay Plan, representing the view of large business houses, had argued for active state participation in industrialisation.
The other reason for public sector enterprises is not that well-known. The profits from public sector enterprises would be used to fund further investments. I have recently been going through the old five-year plans in detail. The profits of public enterprises are an important element in every discussion about plan finance. For example, the third plan assumed that public sector enterprises that were built during the second plan would generate Rs 450 crore of profits for funding the next round of industrial investment. The railways would contribute another Rs100 crore. These profits were one of the major components of plan finance, if one takes away additional taxation, deficit financing and external assistance.
It is no secret that the public sector has been a drain on national resources rather than a source of profits for future investment. A fine piece published in The Economist earlier this month provided a stark view of the performance of public sector enterprises. One in three made losses in the year ending March 2016. One in five reported losses for three years in a row. Most of the profits made by these firms come from a handful of firms in oligopolistic areas such as energy. The financial ratios of these enterprises are awful.
In a speech he gave a few years ago in memory of Purshottamdas Thakurdas, economist Vijay Kelkar framed the issue with typical clarity: what should the composition of assets owned by the government be? He added that the answer should change with the times. “So there is a spectrum of assets, ranging from airlines to rural roads, where government ownership is inadvisable for airlines but required for rural roads or public health infrastructure… In short, I am proposing that it makes a lot of sense for India to undertake this portfolio adjustment of public sector assets to switch from owning Air India to owning highways or public health infrastructure or augmenting environmental capital.”
This is a sharp strategic approach to the problem rather than a grand ideological argument. Privatisation will be more politically palatable if the money raised from the sale of assets is used to create new assets that are under-supplied by the market right now. It should not be myopically seen as a way to bridge the annual fiscal deficit.
Aggressive privatisation has never been tried in India. What we have seen is privatisation by stealth—and new companies in the private sector have made many of the old public sector monopolies irrelevant. Has this failure to privatise quite accidentally been a catalyst for entrepreneurial companies that could take on the inefficient public sector monopolies?
Now, here is another anecdote. In Half Lion: How P. V. Narasimha Rao Transformed India, Vinay Sitapati writes about an unsigned letter written to Rao, in all probability by Dhirubhai Ambani, in the days before the reformist 1991 budget. The letter did not focus on either industrial or trade reforms, but on the sale of Rs16,000 crore of government stake in public sector companies to fund the fiscal deficit. “Such a suggestion would soon be implemented elsewhere. After the disintegration of the Soviet Union in 1991, the newly-formed Russian republic would opt for the large-scale privatization of public sector enterprises. Many of these state assets were purchased at throwaway prices by business with connections to the new government. This Russian-style privatization was more crony capitalism than genuine liberalization, and Narasimha Rao was being pressured to adopt a similar approach.”
The lack of rapid privatisation may have serendipitously acted as a check on crony capitalism, but this under-appreciated positive has been more than balanced by the drag on the Indian economy because of public sector enterprises that have operated under a soft budget constraint thanks to government backing. The Vajpayee government found the political courage to sell state assets only in the last two years of its tenure. The Narendra Modi government could learn a thing or two from the previous National Democratic Alliance, which was a more messy coalition.
Air India is obviously a prime candidate for a sale, but the central challenge for the Modi government will be to rapidly reduce its control over the banking system that seems to be getting into deeper trouble by the day, posing the most significant risk to economic stability right now. Privatisation may begin with Air India but the most meaningful challenge right now are the banks owned by the government.
This article was first published in the Mint, and has been republished here with permission.
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