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
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.
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.
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.
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
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.
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.
Government should choose the first set of public sector
units for privatization using the following criteria:
Degree of demand for these assets (e.g. petroleum,
Influence that the efficient operation of this sector
will have on the rest of the Indian economy (e.g. telecom, infrastructure)
Degree of capital intensity and size of investment
required in this sector to be globally competitive (e.g. mines, shipping,
The goal should be to attain early successes, rapidly improve the competitiveness
of Indian industry (not jus the public sector) and accelerate resource
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.
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:
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.
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
Non -core businesses may be offered as a Management
Buyout option to its current managers and associates, or divested.
The Board may seek any external assistance in determining
their actions and timetable.
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.
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.
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.
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.
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.
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.
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.
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
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.
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.
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.