Proposal on Privatization in India: Ideas on Implementation

January 15, 2000

The following proposal on how to implement privatization of public sector companies in India is prepared by a committee consisting of the following individuals:

K. Palepu, Harvard Business School; C.K. Prahalad, University of Michigan; R. Rajan, University of Chicago; H. Raghava, Merrill Lynch; Marti Subrahmanyam, Stern School of Business (NYU); Abraham George, The George Foundation; V. Gandhi, Morgan Stanley; N. Vaghul, ICICI Ltd.


The millennium offers a vantage point from which to reexamine the priorities of the Government of India (GOI). The new government and the opposition parties are united in their determination to increase the spending on human development and welfare in primary and secondary education and basic health care for all. The target is to increase the current spending which is at 1% of GDP to 6% of GDP over a period of five years. Simultaneously, GOI is interested in privatization of public sector to improve the efficiency and productivity of the Indian economy. Subsidies for the public sector units is expected to rise significantly in the coming years. We believe that more than $100 billion can be raised (in potential market capitalization) over the next three years by a workable privatization initiative. We see the two goals -- enabling investment in human capital and unlocking the value of past public sector investments -- as two sides of the same coin. We suggest that GOI see the task as one of shifting priorities from owning, managing and subsidizing commercial ventures which mostly benefit the few to investments in human infrastructure that benefits all, especially the poor and the needy.


We believe that a task of this magnitude cannot be managed without a clear framework of principles. Ad hoc, partial or expediency-driven actions will not do. We outline below the broad principles that should govern the privatization initiative. We believe that these principles address not only the economic but political and social issues arising out of privatization of the public sector in India.

1.      The goal of privatization should be improve the competitiveness of India's industrial infrastructure and enable it to become world class. Privatization should not be motivated only by our current account deficits.

2.      All commercial public sector units should be privatized over a five-year period. Speed is the essence. The longer we wait, the lower will be the market value of public sector assets in today's terms. Also quicker privatization will allow for faster investment in healthcare and education of the current generation.

3.      The social implications of privatization, namely, unemployment and the need for a social safety net must be dealt with openly and fairly. We should strive for a process of privatization that represents a "win-win" for all. To this end, current employees of public sector units should be allowed to share in the benefits of privatization. Further, part of the proceeds of privatization should be earmarked to provide for unemployment compensation, retraining, and reemployment of employees displaced by privatization. In particular, privatization can provide more prosperity and stability for employees whose human capital is currently locked up in over-manned and under-performing units with an uncertain future.

4.      There should be a nodal point for the privatization effort. Accountability must be fixed in one senior minister reporting to the Prime Minister. This minister should have the authority to expedite and approve all privatization efforts. Responsibility for the effort will be focused. The multiplicity of ministries and authorities currently involved should be disassociated with the initiative.

In sectors that are natural monopolies or involve public safety, privatization will require some regulatory infrastructure. Independent regulatory authority is critical to regain the trust of the public, create transparency, and for the market to function effectively.

5.      Implementation should be decentralized. The Board of individual units should be responsible for implementation of privatization within the broad framework of principles laid down by the Privatization Ministry. If necessary, Boards of public sector units should be strengthened so that they are well equipped to perform this function.

6.      Government should choose the first set of public sector units for privatization using the following criteria:

1.      Degree of demand for these assets (e.g. petroleum, hotels)

2.      Influence that the efficient operation of this sector will have on the rest of the Indian economy (e.g. telecom, infrastructure)

3.      Degree of capital intensity and size of investment required in this sector to be globally competitive (e.g. mines, shipping, steel)

The goal should be to attain early successes, rapidly improve the competitiveness of Indian industry (not jus the public sector) and accelerate resource realization.

7.      To make sure that employees will benefit from privatization, and also have the incentive to improve value so as to fetch the best price to the nation, all public sector units should be allowed to allocate up to 20 % of the stock, free of charge, to the entire workforce as of a target date; say march 31st., 2000. All employees of record on that day should become co-owners of the company along with GOI.

8.      Once a unit is chosen for privatization, its Board should be expected to submit, to the Privatization Minister, within a period of 6 months, its plan to restructure and revitalize the unit. Each unit should examine its portfolio to identify its core and non-core businesses, as well as the general approach to revitalizing the unit will be as follows:

1.      Identify the portfolio of businesses, products and services, which the Board and management feel can propel the company into an efficient operation that can sustain itself without any help from the GOI. Each unit must retain only the minimum complement of employees needed to make that unit very efficient. For this unit all subsidies in all forms will be cut off from the date of completion of its privatization.

2.      The Board should identify and group all surplus employees. Preferably, they will be housed in a different location. These employees should be provided a safety net of up to two years. Their current salaries and benefits should be protected for that period. During that time, they should be retrained and encouraged to seek other opportunities. They may choose to receive their benefits as a lump sum. Each unit should be encouraged to offer outplacement services. The private sector should be given tax incentives to retrain and employ displaced public sector workers.

3.      Non -core businesses may be offered as a Management Buyout option to its current managers and associates, or divested.

4.      The Board may seek any external assistance in determining their actions and timetable.

9.      A portion of the shares of the privatized firm, say 25%, will be available to the Indian investing public. Public participation, at the time of privatization, may be a way of allowing the upside to be widely shared.

10.  The Board should be free to form alliances, JVs or seek domestic and foreign investment subject to the current laws of the country. If a substantial stake is to be sold to a strategic investor, earn out arrangements should be used to alleviate potential concerns regarding the sale price. Also, wherever possible, attempts should be made to establish a market price for shares before a strategic sale.

The Boards should be required to abide by governance procedures that protect the interests of minority shareholders.

11.  The Privatization Ministry should review all plans before they are put in motion. The Ministry will be supported, in its judgments, by a group of 12 eminent individuals who prescribe to the basic principles of privatization and fervently believe in making India a preeminent industrial power. The Ministry can take up to a maximum of two months to respond. If the Ministry does not raise any objections to proposals from the Board of the public sector unit, within this time period, the unit should have the authority to proceed with the proposal.

12.  These proposals must be seen as an integrated package. If the policy makers "pick and choose", the benefits of the privatization initiative will not be fully realized.

What is Different about this Proposal?

We believe that our proposal addresses several important issues that stymied past privatization efforts in India.

1.      It clearly addresses the potential benefits of privatization to the Indian public - redirecting public investments to education and healthcare, and creating an economy that is concerned about creating efficiency and jobs. Such articulation is likely to increase public support for privatization.

2.      It addresses the concern of public sector employees. It makes them stakeholders in the privatization process, and it provides for a safety net for displaced workers.

3.      We recommend separating people from assets in the privatization process. This allows us to create a very efficient public sector enterprise, before it is privatized, increasing its market capitalization significantly. All benefit from this process - GOI, current employees, and the Indian public. Secondly, we protect the interests of the employees - by protecting their wages for two years and retraining and out placing them.

4.      It deals with the potential concern that he sale prices may be too low in two ways. First, we require 25% of the shares to be sold to the Indian public, so that they benefit from subsequent price appreciation if the share price at sale is too low. Second, we recommend earn-out provisions that will help GOI receive a portion of the post sale profits.

5.      Our proposal recommends centralized supervision and decentralized implementation. As a result, we think that the privatization process is likely to be quick and transparent. It is also likely to encourage experimentation and learning.

6.      Because our proposal is geared toward increasing the efficiency of the current public sector units, rather than as a mere fiscal exercise in bridging the budget gap, it will reduce the overall cost of doing business in India and increase the competitiveness of the Indian industry as a whole. Therefore, our proposal is likely to get the support of the private sector as well.

7.      Since the proposal focuses on the creation of an efficient and profitable industrial sector, rather than merely balancing the budget, it creates a favorable climate for foreign investment. The long- term effects of this process go beyond the benefits of privatization.



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