Privatizatio

CONTENTS

ASSIGNMENT ON

SUBMITTED TO
Prof. M.M.GUPTA

PREPARED BY
Mr.BAHUBALI.T.KHANAPURE
MBA-I (sem)

NATIONAL SCHOOL OF BUSINESS

BANGALORE

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CONTENTS

1. History of Privatization

2. Nature of Privatization

3. Meaning of Privatization

4 Definition of Privatization

5. Objectives of Privatization
HISTORY: 6. Privatization Routes
The 7. Techniques of Privatization
history of
privatization is 8. Arguments for Privatization
very short-just 10
to 15 years old to 9. Arguments against Privatization
be precise.
Though real 10. Advantages of Privatization
disinvestment
started in the 11. Disadvantages of Privatization
1980s, the word
‘Privatization’ 12. Sins of Privatization
first made its
appearance way 13. Privatization in INDIA
back in the late
60s. The credit 14. Conclusion
for inventing the
word goes to Peter .F.Drucker, who used the term first in his famous book,
The Age of Discontinuity in 1969. Ten years later, Margaret Thatcher
became Prime Minister of Great Britain and it was she who gave practical
shape to privatization. Later, country after country fell in line with Great
Britain in the move towards privatization.

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NATURE:

Privatization may be understood as the process whereby activities

or enterprises that were once owned and operated by government and its
employees are now performed, managed by private business and
individuals, often with much better results in terms of cost and quality
service.

MEANING:

Privatization is the process whereby activities or enterprises that

were once owned and operated by government are now transferred to
private. Privatization achieves these results by replacing government
monopolies with the competitive pressure of the market place to encourage
efficiency, quality and innovation in the delivery of goods and services.

Arrangements between government and private sector entities for

the purpose of providing public infrastructure, community facilities and
related services. Such partnerships are characterized by the sharing of
investment, risk, responsibility and reward between the partners. The
reasons for establishing such partnerships vary but generally involve the
financing, design, construction, operation and maintenance of public
infrastructure and services.

DEFINITION:

According to D.R.Pendse “Any process which reduces the involvem-

ent of the state or the government sector in the nation’s economic affair is a
privatization process”.

Privatization is the incidence or process of transferring ownership of

business from the public sector (government) to the private sector
(business). In a broader sense, privatization refers to transfer of any
government function to the private sector including governmental functions
like revenue collection and law enforcement.

Objectives of Privatization:

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 To improve the performance of the PSU’s so as to lessen the financial

burden on tax payers.

 To reduce government interference in the economy.

 To promote greater private initiative.

 To promote wider share ownership.

 To development of the capital market.

 To promote competition and reward efficiency.

 To reduce the administrative burden on the state.

 To increase the size and dynamism of the private sector.

 To promote increased efficiency.

 To encourage and facilitating private sector investments from both

domestic and foreign sources.

 To reduce the threat of the losses.

 To provide improved quality and services to the custmers.

Privatization routes:

Privatization is sought to be achieved through any or more of the four

important routes: sale to outsiders, management employee buy-out, equal-
access voucher privatization, and spontaneous privatization.

1. Sale to outsiders:

This involves the sale of state enterprises, case by case, as going

concerns to outsiders. Sale to outsiders has been favored as it fetches

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revenue and turns the firm to the real owners who possess the expertise and
incentives to govern the company efficiently.

Sale to outsiders has largely fulfilled expectations about performance

improvements. But the route is costly and slow and far more difficult to
implement.

Lack of adequate domestic capital, resistance from managers and

employees and difficulty of evaluating and negotiating deals make this route
difficult to follow.

2. Management Employee Buy-Out:

Management employee buy-out is a widely used alternative to sale.

Buy-out is relatively fast and easy to implement, both politically and
technically. The route may lead to better corporate governance as insiders
have better access than outsiders to to information needed to monitor
managers.

The disadvantage of this is the insiders do not bring in new skills

and new capital. Here the government charges low prices to insiders and
thus realize little revenue.

3. Equal- access voucher privatization:

A third form of privatization distributes vouchers across the

population and attempts to allocate assets approximately evenly among
voucher holders. Such programmes excel in speed and fairness. But they
raise no revenue for government and they have unclear implications for
corporate governance. Mongolia, Lithuania and the former Czechoslovakia
were the first to implement this route to privatization.

4. Spontaneous privatization:

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This route to privatization is easy, obstacle-free, with no revenue

generation for the government and has doubtful impact on governance.
Small firms lend themselves to this type of privatization.

Techniques of privatization

• Contracting Out (also called "outsourcing"). The government

competitively contracts with a private organization, for-profit or non-
profit, to provide a service or part of a service.

• Management Contracts. The operation of a facility is contracted out

to a private company. Facilities where the management is frequently
contracted out include airports, wastewater plants, arenas and
convention centers.

• Public-Private Competition (also called "managed competition," or

"market testing"). When public services are opened up to competition,
in-house public organizations are allowed to participate in the bidding
process.

• Commercialization (also referred to as "service shedding").

Government stops providing a service and lets the private sector
assume the function.

• Asset Sale or Long-Term Lease. Government sells or enters into

long-term leases for assets such as airports, gas utilities or real estate
to private firms, thus turning physical capital into financial capital. In
a sale-leaseback arrangement, government sells the asset to a private
sector entity and then leases it back.

Arguments for privatization:

1. Government run industries cost more because they have larger burea-
ucracies.

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2. Government run industries leave people with little choice in the mark-
et place.

3. Privatizing an industry fosters competition in the market place, which

transfers to lower prices and greater choice for the consumer.

4. Governments should not be in the business of controlling industries or

services since this gives them too much control over the people.

Arguments against privatization include the following:

1. A privatized industry is most concerned with profit, so while initial

benefits to the consumer may occur, the industry may not be induced to
keep prices low unless government controls are exerted.

2. The competition fostered in privatized industries may result in dirty

or unsavory business practices.

3. Privatization may limit access to certain industries for people who

cannot afford them.

4. The public has little control over a private industry, and decisions in
that industry may adversely affect those in the public sector.

Advantages of privatization

1. Improved Efficiency.

The main argument for privatization is that private companies have a profit
incentive to cut costs and be more efficient. If you work for a government firm, managers
do not usually share in any profits. However, a private firm is interested in making profit
and so it is more likely to cut costs.

2. Lack of Political Interference.

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It is argued governments make poor economic managers. They are motivated by
political pressures rather than sound economics. For example a state enterprise may
employ surplus workers which are inefficient. However, they may be reluctant to get rid
of the workers because of the negative publicity. Therefore, state owned enterprises often
employ too many workers.

3. Short Term View.

A government many think only in terms of next election. Therefore, they may be
unwilling to invest in infrastructure improvements which will benefit the firm in the long
term.

4. Shareholders.

It is argued that a private firm has pressure from shareholders to perform. If the
firm is inefficient then the firm could be subject to a takeover. A state owned firm doesn’t
have this.

5. Increased Competition.

Often privatization of state owned monopolies occurs alongside deregulation - i.e.

policies to increase the competitiveness of the market. It is this increase in competition
that can be the greatest spur to improvements in efficiency.

Disadvantages of Privatization:

1. Privatization is expensive and generates a lot of income in fees for

specialist advisers such as banks.

2. Public monopolies have been turned into private monopolies with too
little competition, so consumers have not benefited as much as had been
hoped. This is the main reason why it has been necessary to create
regulators. This is an important point. It partly depends on how the
privatization took place. For example, the railways were privatized in bit of
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a rush and there might have been other ways to do it so that more
competition was created. It partly depends on the market. Some markets are
'natural monopolies' where competition is difficult. For example, it would be
very wasteful and expensive to build two sets of track into Liverpool Street
just to create some competition. Natural monopolies create a special
justification for public ownership in the general public interest.

3. The nationalized industries were sold off too quickly and too cheaply.
With patience a better price could have been had with more beneficial
results on the government's revenue. In almost all cases the share prices rose
sharply as soon as dealing began after privatisation.

4. The privatized businesses have sold off or closed down unprofitable parts
of the business (as businesses normally do) and so services eg transport in
rural areas have got worse.

5. Wider share ownership did not really happen as many small investors
took their profits and didn't buy anything else.

Sins of privatization:

1. For the wrong reason:

Privatization strategies have aimed at maximasing short-term revenue

rather than markets for long-term.

2. In the wrong environment:

Privatization makes sense only if enterprises are related in an

environment that allows them to become competitive and efficient. Where
the market functions poorly and entrpeises are still vulnerable to arbitrary
government edicts, transferring ownership to the private sector is unlikely to
achieve much.

3. With non-transparent procedure:

Privatization has sometimes been accompanied by allegations of

corruption and claims that the process has enriched a few privileged cronies
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of the government. The disposal of assets should be so open and public that
such allegation cannot arise.

4. Only to finance budget deficits.

Harassed finance ministers are often tempted to sell state assets to

cover their current budget deficits.

5. With unrealistic labor strategies.

Employment is one of the most sensitive area of Privatization. But

experiences show that it is better to have an open and free dialogue in
advance. This should cover the possibilities of workers ownership and
retaining schemes, as well as the inevitable job losses.

6. With political consensus.

Privatization is not merely a technocratic exercise. It is also a political

process. A hasty Privatization forced through executive orders, risks
immediate conflict-and reversal after a change in governments.

Privatization in India

In many ways, India provides an excellent testing ground for

hypotheses about privatization and its impact, except that so far privatization
has not been attempted on a scale that researchers would like to see. The
country has a large, well diversified public sector. Unlike many of the
transition economies, it also has a long tradition of private enterprise,
including big companies in the private sector, although there are certain
sectors in which private sector participation is quite new, these sectors
having been reserved until recently for the public sector. Privatization in
India generally goes by the name of ‘disinvestment’ or ‘divestment’ of
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equity. This is because privatization has thus far not meant transfer of
control or even of controlling interest from government to anybody else. The
government has sold stakes ranging from one per cent to 40% in 40 PSUs,
but in no company has its stake fallen below the magic figure of 51% which
is seen as conferring controlling interest.
The privatization program is itself relatively new to the country. It is
part of an ambitious process of economic reforms covering industry, trade,
the financial sector and agriculture and also involving a program of macro-
economic stabilization focused on the federal budget, which commenced in
1991. Privatization is seen as a necessary concomitant of deregulation of
industry, necessary in order to enable firms in the public sector to compete
and survive in the new environment. The major element in industrial
deregulation has been the Industrial Policy Statement of June 1991 which,
among other things, drastically reduced the number of sectors of industry
reserved for the public sector from 17 to 8. This list has since been truncated
to four: defense, atomic energy, specified minerals and railway
transport. Moreover, all the areas earlier reserved for the public sector have
also been exempted from the system of industrial licensing under which the
private sector was required to obtain a license from the government in order
to start a business. This has naturally exposed the hitherto cosseted public
sector to competition on a scale to which it has not been accustomed.
Disinvestment, while raising revenues for the government, has been
perceived as necessary in order to subject PSUs to market discipline and to
ensure that they raise their standards of performance. Disinvestment of
equity in 40 PSUs has risen about Rs12 billion ($ 2.8 bn) so far. Only profit-
making enterprises have been offered for sale. In the first round of
disinvestment, the government offered “bundles” of shares of various PSUs

(each bundle carrying a notional reserve price) to local institutions. Later,

the bidding process was opened to foreign institutional investors and the
public at large. The overwhelming chunk of funds raised through
disinvestment (Rs9.9 bn) has been through the auction route. The method of
disinvestment was widened in 1996-97.

Conclusion:

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The foregoing arguments do not in any way constitute uncritical

support for our PSUs. Undeniably, there is an urgent need to restructure
them to improve their performance. But privatization is not only the way
to put the PSEs on the right track because the private sector is not rosy
and glory.

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