Chapter 36 Privatization of Public Sector Enterprises in India – Indian Economy


Privatization of Public Sector Enterprises in India


Several countries in the world—both the industrial and market-driven economies of the West and the developing countries of Asia, Africa and Latin America, along with the former socialist economies—have launched massive privatization programmes due to their own reasons. The member countries of the Organisation for Economic Co-operation and Development (OECD) and such other industrial and market economies have been privatizing their public sector undertakings (PSUs) on their own volition, whereas developing nations and socialist economies including the Soviet Union have been resorting to privatization at the instance of the International Monetary Fund and World Bank, which stipulated privatization as a prerequisite for financial assistance under their economic stabilization and structural adjustments programmes.

What is Privatization?

Privatization is the anti-thesis of nationalization. When government-owned public sector companies are de-nationalized and the disinvestment process initiated, it is called privatization. Privatization, therefore, refers to a process that envisages the withdrawal of the state in varying degrees from the economic activities of the nation. Privatization is known by different names in different countries of the world; in England it is known as de-nationalization, in Australia as prioritization, in New  Zealand as asset-sales programme, in Mexico as disincorporation, in Thailand as transformation and in Sri Lanka as peoplelization. The process of privatization in economies such as India would include anyone or all of the outcomes of: (i) following private sector industries to enter into the areas which where hitherto reserved exclusively for the public sector or which were once considered exclusive monopolies of the state; (ii) De-nationalization wherein state ownership of productive assets is transferred to the private sector. In this sense, privatization may be considered as the anti-thesis of nationalisation; (iii) Reducing the scope of the public sector or limiting any more diversification of the existing PSUs, and (iv) Transferring the management and control of PSUs and activities, which were hitherto managed by departments of governments such as railways, post and telegraph to private sector or through employees stock ownership plan (ESOP). ESOP can take place through different means such as (i) franchising wherein private players would own the enterprise while the public sector will own the brand name and technical know-how which it may provide to the former for a fee; (ii) contracting out of government service; (iii) leasing out physical facilities to private organizations, and (iv) divesture through equity sales.

The Rationale

Privatization, as an idea and as a process, has both supporters and opponents. Generally, socialists and people of their ilk oppose privatization, while those who favour a free-market economy favour it. According to the supporters of privatization, the rationale for privatization and disinvestment is as follows:

  1. More efficient and superior performance: Privatization brings in profit orientation and a system of incentives in the working of the enterprise. This in turn leads to increase in efficiency and performance. Private ownership of an enterprise brings in both efficiency and better quality of management. It is said with sufficient justification that the magic of private property turns even sand into gold?
  2. Increased responsibility and accountability: In public enterprises, making the top management accountable for any loss is extremely difficult while in the privatized organizations managed by the private sector, various responsibilities are clearly defined, and people are held accountable for their decisions and actions.
  3. Amenable to the discipline of the capital market: Their capacity to raise funds from the capital market depends entirely on their performance. This is not so in PSUs where even when they perform poorly, they have access to credit and budgetary support. Even if they perform exceedingly well, there is no appropriate reward system. Thus, there is no incentive for them to perform well.
  4. No political interference: In PSUs, political interference is very common and oftentimes it is a major cause for their poor show. In PSUs, politicians interfere in every conceivable manner such as in the use of technology, location of projects, recruitment, purchase policies or price preferences of suppliers. Moreover, government also imposes on PSUs non-economic objectives such as maintaining a large pool of unskilled and even undesirable persons.
  5. Succession planning: As we have pointed out earlier, three-fourth to two-third of top management in public sector enterprises (PSEs) are political appointments. With a lot of pulls and pressures, and counter pulls and pressures often the top posts remain vacant. Absence of Chairman and Managing Director in an organization leads to lack of timely decision making which will tell upon the efficiency of the organization. Such a situation generally does not arise in the private sector, as almost all the promoters of companies have a succession plan in place.
  6. Quick response time: In public enterprises, the concept of response time is generally absent and everyone swears by the status quo. But in the private sector, decisions are taken quickly, in the shortest possible time so as to respond to the changing business environment almost immediately.
  7. Quick remedial measures adopted: They are susceptible to a lot of problems such as liquidation, threat of takeover or loss of assets, if stock holders do not respond. With threats looming large, they take immediate remedial measures when things seem to go out of hand.
  8. Better performance due to no political considerations: In many countries including South Korea, Italy, France, India and Pakistan, all efforts to improve managerial efficiency of PSUs through administrative measures have failed to produce any tangible positive results. Sooner or later, political considerations push the commercial or economic considerations to the background. Ultimately, the PSUs are the losers. This kind of situation does not generally arise in private sector companies.
  9. Beneficial to customers: The private sector cannot succeed unless they are able to improve customer satisfaction. But PSUs do not generally care much for their customers, with a few exceptions. However, with privatization, managements would have to ensure customer satisfaction with a view to improving their sales and performance.

Primary Objectives

The primary objectives for privatizing the PSEs are the following:

  • It will enable the PSUs release large amount of public resources locked up in non-strategic PSEs, for use in areas that have much higher social priority, such as primary education, basic health, family welfare, and social and essential infrastructure.
  • It will stop further flow of scarce public resources for sustaining the unviable non-strategic PSEs.
  • It will reduce the public debt incurred for development that is threatening to assume unmanageable proportions.
  • It will help transfer the commercial risk, to which the taxpayers’ money locked up in the public sector is exposed, to the private sector wherever the private sector is willing and able to step in—the money that is deployed in the PSEs is really the public money and is exposed to an entirely avoidable and needless risk, in most cases.
  • It will help release other tangible and intangible resources, such as large manpower currently locked up in managing the PSEs, and their time and energy, and can be re-deployed in high priority social sectors that are short of such resources.

Other Expected Benefits

The following are the other benefits expected to be derived from privatization:

  • Disinvestment would expose the privatized companies to market discipline, thereby forcing them to become more efficient and survive or cease on their own financial and economic strength. They would be able to respond to the market forces much faster and cater to their business needs in a more professional manner. It would also help in freeing such companies from government control and bring in corporate governance in the privatized companies.
  • Disinvestment can ensure wider distribution of wealth through offering of shares of privatized companies to small investors and employees.
  • Disinvestment would have a beneficial impact on the capital market; the increase in floating stock would give the market more depth and liquidity, give investors easier exit options, help in setting up more accurate benchmarks for valuation and pricing, and facilitate raising of funds by the privatized companies for their projects or expansion, in future.
  • Opening up the public sector to appropriate private investment would increase economic activity and have an overall beneficial effect on the economy, employment and tax revenues in the medium to long term.
  • In many high-tech areas, including the telecom and civil aviation sectors, privatization and the end of public sector monopoly has brought greater benefits to consumers by way of more choices, as well as cheaper and better quality products and services.
  • ‘With the quantitative restrictions removed and tariff levels revised owing to opening of world markets WTO agreements, domestic industry has to compete with cheaper imported goods. In the bargain, the common man now has access to a whole range of cheap and quality goods. This would require Indian industries to become more competitive and such restructuring would be easier in a privatized environment.’

Methods of Privatization in India

As we have seen, there are different methods of privatization used by different countries to partially or fully sell the government stakes in PSEs. Governments may use one or a combination of the following methods:

  1. Initial public offering (IPO): It is the first issue of equity shares to the public by an unlisted company. PSUs by offering IPOs can dilute their shareholding when the general public subscribes to the shares.
  2. Strategic sale: Strategic sale means the PSU selling of a large chunk of government holdings to a private enterprise, which would not only acquire substantial equity holdings of up to 51 per cent but also bring in the necessary expertise for making the PSE viable and competitive in the global market. Alternatively, strategic sale includes two elements, one is transfer of a chunk of shares to a strategic partner and the second is transfer of management control to the strategic partner.
  3. Sale to foreign companies: Where a PSU is sold to a company .incorporated in another country.
  4. Auction: Auction is one of the methods for divesting shares under market sale where the sale proceeds are maximized through bidding. It is less time-consuming and involves low transaction cost. It is targeted at the institutional investors. In the initial rounds of disinvestment, government divested its stake in PSUs through this method.
  5. Offer for sale: Offer for sale is offer of shares by existing shareholder(s) of a company to the public for subscription, through an offer document.
  6. Public offer: This model was adopted in the early 1990s. Equity was offered to retail investors through domestic public issues. A lot of blue-chip PSUs also tapped the overseas market by selling global depository receipts (GDRs).

In India, consequent to the advocacy of privatization of PSUs by the new Industrial Policy, 1991 the government has chosen a disinvestment programme which involves the sale of public sector equity to the general public or to the private sector. The objective of the government in adopting this approach is to bring down its equity in all non-strategic PSUs to 26 per cent or lower and to do away totally with those PSUs which are difficult to revive. The programme of disinvestment of PSUs by the government started in 1991–92 and the stakes of the government in different PSUs have been sold in various degrees by 2003–04. The Government of India used to sell minority stakes through domestic or global issue of shares in small portion every year till 1998–99. But after 1999–2000, the stress is on strategic sale of PSEs wherein there will be an effective transfer of control and management to a private company so that the government could get a better price for giving up the total control of the enterprise. In recent times, the following prominent government companies have been divested through strategic sale: Modem Foods, Bharat Aluminium Company Ltd. (BALCO), Computer Maintenance Corporation (CMC), Videsh Sanchar Nigam Limited (VSNL), Indo Burma Petroleum (IBP) Company Limited, India Tourism Development Corporation (ITDC), Indian Petrochemicals Corporation Limited (IPCL), Maruti Udyog Limited, and, Hindustan Zinc Ltd. (HZL).

The Rangarajan Committee

Since there was a lot of confusion among government circles, academia and politicians as to which is the correct method to disinvest shares of PSUs in India, in order to clear the cobweb of confusion, the government appointed in 1993, under the chairmanship of C. Rangarajan, a Committee on Disinvestment in PSEs with the objective of suggesting the correct method of divestiture. In its report, the Rangarajan Committee suggested that the ideal method for disinvestment is to offer shares of PSUs to the general public at a fixed price through the issue of a prospectus. But the problem was that since PSU’s shares have not been traded thus far on the stock market, how to determine the ‘fixed price’? Until such time a regular trading atmosphere was established, it was suggested that an auction method with wide participation could be adopted. The Committee has made some more recommendations as follows:

  1. With regard to the level of divestment in PSUs, it should be based on the desirable level of public ownership in an activity, or unit consistent with industrial policy. The Committee felt that in all those units which are earmarked for the public sector, the percentage of equity to be disinvested should be 49 per cent, so that the government holding the majority of 51 per cent equity would be able to retain control over the management. In all other cases, the percentage of equity to be divested, should be 74 per cent.
  2. The Committee suggested that instead of annual targets of disinvestment, a clear-cut road map of action should be evolved.
  3. The government should initiate a number of measures towards the successful implementation of a policy of privatization, including corporatization, restructuring of finance with an appropriate debts-equity ratio and setting up of an autonomous regulatory commission for the concerned sector.
  4. The method of valuation of the shares of the PSEs should be the one that takes into consideration the special circumstances impacting the PSE’s operations such as its focus on Corporate Social Responsibility and is not based on pure commercial consideration.
  5. A special scheme may be devised to provide preferential shares to the workforce in the PSUs.
  6. While disposing off the disinvestment proceeds, 10 per cent may be set aside by the government for lending to the PSEs on concessional basis to meet their needs for expansion and rationalization.
  7. The committee suggested the setting up of the Standing Committee on Public Enterprises Disinvestment with the view to overseeing the action plan for reform, restructuring, disinvestments, and monitoring the evaluation of progress made so far.

Disinvestment in the Public Sector

Historically, the public sector in India had been assigned an important role in the industrial development of the country. But over the years, in the context of many PSUs incurring huge losses due to low productivity, unsatisfactory quality of goods, excessive manpower utilization, inadequate human resource development and low rate of return on capital, lost the justification for their existence, and in any case, the continued government support they have been enjoying with tax payer’s money. For instance, between 1980 and 2002, the average rate of return on capital employed by PSUs was a measly 3.4 per cent as against the average cost of borrowing at 8.66 per cent. Disinvestment (or divestment) of the PSUs has therefore been recognized as one of the solutions in this context. This recognition resulted in the national economic policy undergoing a radical transformation in the year 1991 under which privatization as a policy component de-emphasized the role of the public sector in the nation’s economy. Privatization was adopted, therefore, as a means of the state withdrawing from commercial activities and consequently from the public sector.

The following have been advanced in favour of privatization by the protagonists of market–driven economic structures:

  • Market-driven economies are more efficient than the state-controlled economies
  • Government must not enter into those areas where the private sector can perform better
  • The state should play the role of a regulator rather than that of a producer
  • Government’s resources locked in commercial ventures owned by them should be released for investing in social welfare activities.

Disinvestment is generally expected to achieve a greater inflow of private capital and the use of private management practices in PSUs, as well as enable more effective monitoring of management discipline by private shareholders. Disinvestment of government equity in public sector began in 1991–92. Till 1999–2000, it was primarily through sale of minority shares in small lots. From 1999– 2000 till 2003–2004, the emphasis of disinvestment changed in favour of strategic sale. Government decided, in principle, on 27 January 2005, to list large, profitable PSEs other than the navaratnas on domestic stock exchanges and to selectively sell a minority stake in them while retaining at least 51 per cent of the shares along with full management control so as not to disturb the public sector character of the companies.

The actual receipts through disinvestment have often fallen far short of their target. During the period 1991–92 to 2002–03, the government had targeted the mobilization of about INR 783 billion through disinvestment, but it could actually mobilize only INR 309.17 billion. The proceeds from disinvestment from April 1991 to November 2005 amounted to INR 476.72 billion.

Establishment of the National Investment Fund

The government has also decided to constitute a National Investment Fund into which the sale proceeds from sale of minority shareholding of the government in profitable PSEs would be placed and used for the following broad investment objectives:

  1. Investment in social sector projects which promote education, health care and employment.
  2. Capital investment in selected profitable and revivable PSUs that yield adequate returns to enlarge their capital base to finance expansion/diversification.

The Disinvestment Commission

The Ministry of Industry (Department of Public Enterprises) constituted a Public Sector Disinvestment Commission under the chairmanship of G. V. Ramakrishna, the former chairman of SEBI for a period of 3 years on 23 August, 1996. The Commission was mandated to draw a long-term disinvestment programme for the PSUs referred to it. The Commission’s terms of reference included such issues as the determination of the extent of disinvestment in each PSU, suggested mode of disinvestment and the sequence in which the process was to be taken up. The Commission had four long-term strategic objectives: (a) to strengthen PSUs, wherever found feasible with a view to facilitating disinvestment; (b) to protect the interests of the workforce; (c) to broaden the pattern of ownership, and (d) to  augment government’s receipts. The term of the Commission was extended till 30 November 1999. The Commission submitted its report on 58 PSEs. The Commission was reconstituted in July 2001 for a period of 2 years, and was subsequently extended till October 2004. The reconstituted Commission submitted its report on 41 PSEs, which comprised the review cases of earlier Commission’s recommendations on 4 PSEs. The term of the Commission expired on 31  October 2004 and it has been wound up.

The Department of Disinvestment

The Department of Disinvestment was set up as a separate department on 10 December, 1999 and was later renamed as Ministry of Disinvestment on 6 September 2001. From 27 May 2004, the Department of Disinvestment is one of the departments under the Ministry of Finance. PSEs have been classified into strategic and non-strategic areas for the purpose of disinvestment. Strategic PSEs would be those in the areas of (a) arms and ammunitions and (b) atomic energy. All other PSEs were to be considered as non-strategic.

The Method and Mechanism of Disinvestment

Disinvestment involves the sale of equity and bond capital invested by the government in PSUs. It also implies the sale of government’s loan capital in PSUs through securitization. Naturally, it is the government and not the PSUs who receive money from disinvestment. The fixation of share/bond price is an important aspect of disinvestment. During its existence, the Disinvestment Commission determined the share/bond price. Disinvested shares are listed, quoted and traded on the stock market. Indian and foreign financial institutions, banks, mutual funds, companies as well as individuals can buy disinvested shares/bonds.

Disinvestment has been suggested as a means of rescuing government from further commitment to PSUs and as a source of revenue. However, the market experience has been otherwise. It has been found that (i) The budgetary deficit on revenue account has been increasing notwithstanding disinvestment; (ii) Since the government has not used the disinvestment proceeds to finance expenditure on capital account, the disinvestment policy has resulted in capital consumption rather than generation, and (iii) Administrative costs of the disinvestment process have also been unduly high.

The UPA Government during its first term between 2004 and 2009 could not progress with its disinvestment programmes because of coalition politics. Though the Prime Minister and the then Finance Minister P. Chidambaram tried to pursue the policy of disinvestment, the Left parties led by Prakash Karat placed stumbling blocks in the government’s efforts. Therefore, disinvestment was stalled considerably. It was only during the UPA’s second term that the government strengthened by its success in the General Election could continue the process started earlier.

Strong Advocacy of Disinvestment in Economic Survey 2009–10

The Economic Survey 2009–10 has called for the revitalizing of the disinvestment policy aimed at generating a minimum of INR 2500 billion annually. According to the Survey, all the unlisted PSUs should sell at least 10 per cent of its equity to the public. It has also called for the completion of the process of off-loading 5–10 per cent equity in the previously profit-making non-navaratna companies.’ The Survey has also stressed the need for revisiting the agenda for pending reforms with a view to renewing the growth momentum. However, the 2009–10 Budget appeared to have played down the importance of disinvestment in as much as the authors of Economic Survey expected much more proactive policy and follow-up on disinvestment.

Problems Associated with Disinvestment

A number of serious problems, both real and perceived, have stalled the disinvestment process. The following are some of the problems of disinvestment:

  1. The number of bidders for equity has been disappointingly small not only in case of financially weak PSUs, but also in that of better-performing PSUs. Further, the government has often forced UTI, other mutual funds and state-owned financial institutions to purchase the disinvested equity. Having bought them, these institutions are not enthusiastic in listing and trading of these shares as they would like to retain their control over PSUs. Insider trading of shares and other malpractices by them has also come to light, all of which have contributed to low valuation or under-pricing of equity.
  2. In many cases, disinvestment has not really changed the ownership pattern of PSUs, as the government has retained a majority stake in them. There has been some fear that disinvestment of PSUs might result in the ‘crowding out’ of private sector companies from the primary capital market, through lowered subscription to their shares.
  3. In the absence of wider national consensus and consequent lack of popular support, a mere government decision to disinvest has not been found enough to carry out the sale of people’s assets. Incomplete information about PSUs has prevented free, competitive and efficient bidding of shares, and a free trading of these shares. Also, since the PSUs do not benefit monetarily from disinvestment, they have shown lukewarm interest in preparing and distributing prospectuses. This has in turn prevented the disinvestment process from being completely open and transparent.
  4. Total disinvestment of PSUs would result in concentration of economic and political power in the hands of the private corporate sector. While the creation of PSUs originally had economic, social welfare and political objectives, their current restructuring through disinvestment is being undertaken primarily out of need of government finances and issues of economic efficiency.
  5. The national wealth has not reduced to such an extent that the government sells its equity in PSUs to the Indian private sector. The sale of such equity to foreign companies will have far more serious repercussions relating to national wealth, control and power, particularly if the equity is sold below the ‘correct’ price!
  6. If the disinvestment policy is to be in wider public interests, it is necessary to examine systematically issues such as the ‘correct’ valuation of shares, the ‘crowding out’ possibility, the appropriate use of disinvestment proceeds and the institutional and other prerequisites.’ Table 36.1 provides a summary of the targets and achievements as well as the methodologies adopted for disinvestment in public sector undertakings in India.

Table 36.1 Summary of Disinvestment Target and Realization Since 1991–92 and the Methodologies Applied

Key Terms

Department of disinvestment 483

Disinvestment commission 482

Disinvestment policy 483, 484

Divesture through equity 477

Initial public offering 479

Market-driven economies 476, 481

Method for disinvestment 480

Minority stakes 480

National Investment Fund 482

Non-economic objectives 477

Private ownership 477, 487

Public offer 480

Strategic sale 480, 482

Discussion Questions

36.1. Critically examine the policy of disinvestment of shares in public sector enterprises.

36.2. Do you think privatization of the economy alone can solve the various problems the economy is facing currently?

36.3. Does disinvestment alone constitute privatization? Is privatization the only answer to all the ailments that the Indian economy is suffering from?

36.4. What decisions have been taken under the Industrial Policy of 1991 to improve the performance of public sector enterprises? Examine the various issues involved in privatization and disinvestment of PSEs in India.

36.5. Examine the role of public sector enterprises in the economic development of India. Evaluate the rationale of the disinvestment policy pursued by the Government of India.

36.6. ‘Public sector disinvestment carried out during the recent years in India is hugely reflective of fiscal pressures rather than designed to address the problems inherent in public sector management’ Examine.

36.7. ‘After the initial exuberance of the public sector entering new areas of industrial and technical competence, a number of problems has begun to manifest themselves in many of the public enterprises.’ Identify these problems. To what extent disinvestment of public sector enterprises and privatization will help in mitigating these problems and how?

36.8. What do you mean by the term ‘Privatization’? Do you think privatization alone can suffice to cure the various ills the Indian economy suffers from?


1. Fernando, A.C. (2009), Corporate Governance, An Indian Perspective (New Delhi: Pearson Education).

2. Dhingra, Ishwar C. (2005), The Indian Economy. Environment and Policy (New Delhi: Sultan Chand and Sons).

3. ‘Genesis and Rationale for Disinvestment in India’,

4. ‘Disinvestment’, Economic Survey 2004–05.

5. Department of Disinvestment, Ministry of Finance, http://www. divest.nic.inl.

6. ‘Economic Survey Calls for Revitalising the Divestment Policy’, http: //, Last Updated: 02-07-2009.

7. Press Trust of India (2009), ‘Economic Survey Raises Hopes for Reformist Budget: India Inc.’, New Delhi, 2 July.

8. Bhole, L. M. (2003), ‘Disinvestment of India’s Public Sector Units’, Department of Humanities & Social Sciences, August_2003/disinvestment html

Suggested Readings

36.1. Adams, C., Cavendish, W. and Mistry, P. (1992), Adjusting Privatization: Case Studies from Developing Countries (London: James Curry).

36.2. Bhaskar, V. (1992), ‘Privatization and the Developing Countries: The Issues and the Evidence’ Discussion Paper No.47, Geneva: UNCfAD.

36.3. Boardman, A. and Vining, A. (1989), ‘Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private Mixed and State-Owned Enterprises,’ Journal of Law and Economics, 32.

36.4. Fare, R., Grosskopf, S. and Logan, J. (1985), ‘The Relative Performance of Publicly Owned and Privately Owned Utilities,’ Journal of Public Economics, 89–106.

36.5. Galal, A., Jones, L., Tandon, P. and Vogelsang, I. (1994), Welfare Consequences of Selling Public Enterprises (New York, NY: Oxford University Press).

36.6. Hemming, R. and Mansoor, A. M. (1987), Privatization and Public Enterprises (Washington DC: IMF).

36.7. Meyer, R. A. (1975), ‘Public Owned Versus Privately Owned Utilities: A  Policy Choice’, Review of Economics and Statistics, 57(1975): 391–399.

36.8. Millward, R. (1988), ‘Measured Sources of Inefficiency in the Performance of Private and Public Enterprises in LDCs,’ in Cook, P. and C. Kirkpatrick (eds), Privatization in Less Developed Countries, pp. 143–161.

36.9. Ram Mohan, T. T. (2005), Privatization in India: Challenging Economic Orthodoxy (New York, NY: Routledge-Curzon).

36.10. Roman, F., Cheryl, G., Marek, H. and Andrzej, R. (1997), ‘Private Ownership and Corporate Performance, Some lessons from Transition Economies’, The World Bank, Policy Research Working Paper 1830.

36.11. Sheshinksi, E. and Lopez-Calva Luis Felipe (1998), Privatization and Its Benefits: Theory and Evidence (Harvard Institute of International Development).

36.12. Shleifer, A. and Vishny, R. (1996), ‘A Theory of Privatization’, Economic Journal, 106(1996): 309–19.

36.13. Stiglitz, J. (1994), Whither Socialism (Cambridge, MA: MIT Press).

36.14. Vickers, J. and Yarrow, G. (1988), Privatization: An Economic Analysis (Cambridge, MA: MIT Press).

36.15. Weiss, J. (1995), ‘Mexico: Comparative Performance of State and Private Industrial Corporations’ in Cook, Paul and Colin Kirkpatrick (eds), Privatization Policy and Performance-International Perspectives (Prentice-Hall), pp. 213–24.

36.16. World Bank (1992), Privatization—the Lessons of Experience (Washington DC: World Bank).

36.17. Wortzel, H. V. and Wortzei, L. H. (1989), ‘Privatization: Not the Only Answer’, World Development, Issue 5: 633–41.