Why the disinvestment process is getting messier

This song from the 1968 Hindi movie Teen Bahuraniyan best explains the state of the Congress party-led United Progressive Alliance government. As the lines from the song go, “A_amdani atthani, kharcha rupaiya, bhaiya, na poocho na poocho haal, nateeja than than gopal”._ Loosely translated this means that when you keep spending more than what you earn, you are bound to end up in a mess sooner rather than later.

One area where the mess is getting more obvious by the day is disinvestment of public sector shares. The idea was that by selling these shares the government would be able to reduce a part of its fiscal deficit, the difference between what a government earns and what it spends.

During the course of this financial year (ending 31 March), the government had expected to earn Rs 30,000 crore by selling shares of public sector companies to the public. This number has since been revised to Rs 24,000 crore.

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This has been a tad better than the last financial year when the government had targeted to raise Rs 40,000 crore through the disinvestment of shares but finally managed to raise only Rs 13,894 crore. And that too by selling ONGC shares to Life Insurance Corporation (LIC).

It may be a similar story this year. Of the Rs 24,000 crore being raised this year from disinvestment, the LIC has again played a role.

The insurance major is supposed to have bought 46 percent of the 69 million shares of RCF that were disinvested last week. LIC, as expected, has denied the report. “We have not bailed out anyone. We have examined this (RCF) issue by its own strength and then taken a decision to participate. We will examine the future issues in a similar manner and then take a call,” DK Mehrotra, Chairman of LIC, told Business Standard on 13 March 2013. In November 2012, LIC had come to the rescue of the government by picking up 43.6 percent of the nearly 52 million shares of Hindustan Copper that were being sold.

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[caption id=“attachment_661308” align=“alignleft” width=“380”] The point is that the government is being greedy here. But that ‘greed’, of course, comes with the confidence that LIC can always be made to buy these shares. Reuters[/caption]

In March 2012, LIC had picked up 88.3 percent of the 427 million shares of ONGC that were being sold. When a government-owned insurance company has to pick up 88 percent of the shares being sold, what it clearly tells you is that there was no real demand for the share in the stock market. The government thus raised around Rs 11,275 crore from LIC.

The government was also expected to sell shares in Minerals and Metals Trading Corporation(MMTC) of India, but that has been postponed. The government and the merchant bankers could not agree on the price at which the shares of MMTC would be sold. The merchant bankers seem to have told the government that Rs 75 per share was a fair price for an MMTC share. The trouble though is that currently one MMTC share is worth around Rs 302 (as I write this) in the stock market.

But there is a simple explanation for this huge difference. As an editorial in Business Standard points out, “rather than getting carried away with the wide gap between the market price and the fair value assigned to the company’s shares by merchant bankers, the government should note that the current stock price of MMTC is produced by market dynamics - but with constrained supply. Only 0.6 per cent of the stock is freely floating.”

The point is that the government is being greedy here. But that ‘greed’, of course, comes with the confidence that LIC can always be made to buy these shares. The MMTC situation is similar to that of ONGC, where the shares were priced so high that investors were simply not interested in buying it - at least at that stage. As Business Standard points out, “The government may have deferred the proposed stake sale in…MMTC Ltd over valuation differences with merchant bankers, but it would do well to recall the debacle associated with the share sale of the state-controlled oil company ONGC last March. On that occasion, the government priced ONGC’s shares at Rs 290 each; institutional investors saw little value in bidding for them at that price - higher than the market price that was prevailing then. The government had to ask the Life Insurance Corporation of India to bail out the issue.”

The disinvestment of other companies like Steel Authority of India Ltd (SAIL) and National Aluminium Company Ltd (NALCO) also seems to be in trouble. The share prices of both these companies are currently more or less at their one year lows. The same stands true for MMTC as well.

What the ONGC experience hopefully must have taught the government is that while selling shares of a company that is already listed, it cannot demand a price that is higher than what the market is willing to pay. So if a share is selling at a price of Rs 100, the government cannot demand Rs 120, simply because the investor has the option of buying the share from the stock market.

Given this, it means that if the government wants to sell the shares of SAIL, MMTC and Nalco, it will have to sell them at a price which is lower than their market price to make it an attractive proposition for investors. And since the market price is at one-year lows, the government will be unable to raise as much money from these stake sales as it had expected to.

There are several points that stand out here. If the government is having so much trouble achieving a scaled down disinvestment target of Rs 24,000 crore for this year, how will it achieve the target of Rs 54,000 crore which it has set for itself in the next financial year? It also raises the question as to whether the figure of Rs 54,000 crore was just assumed to project a lower fiscal deficit for next year?

The second point is that at Rs 54,000 crore, disinvestment receipts are expected to bring in 6 percent of the total revenues of the government during the next financial year. This a huge number to be left to the vagaries of something as moody as the stock market. The government is only doing this because it is confident that it can get LIC to pick up the tab if the stock market is not interested.

In fact that is why it has passed a special regulation allowing LIC to own upto 30 percent of shares in a company against the earlier 10 percent. This in a scenario where the other insurance companies can own only upto 10 percent of a listed company. How can there be two separate rules for companies in the same line of business?

Also what happens in a situation when LIC ends up investing in a company which turns out to be a dud? Imagine what would happen when LIC decides to get out of the shares of such a company. The stock price of the company will fall, impacting returns of investors who have bought insurance plans from LIC. As the old saying goes, “putting all eggs in one basket” is a pretty risky proposition and goes against the basic principles of investing. What makes the situation even more dangerous is the fact that it is public money that is at stake.

Also when LIC has to anyway pick up these shares why go through this entire charade of disinvestment in the first place? The government can simply sell these shares directly to LIC and get done with it.

There is another basic issue here. Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management point this out in a report titled Connecting the Dots: “As trained Accountants, we have learnt that sale of assets from the balance-sheet are one-off or non-recurring items.”

In simple English what this means is that shares once sold cannot be resold. By selling shares the government is raising one-time revenues. On the other hand, using this revenue it is committing itself to huge expenditures which are more or less permanent. And that really can’t be a good thing in the long run.

But politicians really don’t live for the long run. They survive election by election. And there is one due next year.

Vivek Kaul is a writer. He tweets @kaul_vivek