Disinvestment Processes in India


Investment refers to conversion of money or cash into securities, debentures, bonds or any other claims on money. At the same time, disinvestment involves the conversion of money claims or securities into money or cash.

Disinvestment is a wider term extending from dilution of the stake of the government to a level where there is no change in the control to dilution that results in the transfer of management. The transfer of ownership may occur when in an enterprise the dilution of government ownership is beyond 51 percent. The disinvestment implies that the government will sell to public or private enterprises / public institutes part of its holding in public sector enterprises.

Reasons for disinvestment

The public sector in India at present is at cross roads. The new economic policy initiated in July – 1991, clearly indicated that the public sector undertakings have shown a very negative rate of return on capital employed. On account of this phenomenon many public sector undertakings have become burden to the government. They are infact turning out to be liabilities to the government rather than being assets.

This is a sector which the government clearly wants to get rid off. In this direction the government has adopted a new approach to reform and improve the public sector undertakings performance i.e 'Disinvestment policy'. This has gained lot of importance especially in latter part of 90s. At present the government seriously perceives the disinvestment policy as an active tool to reduce the burden to financing the public sector undertakings.

Problems of Public sector undertakings

The most important criticism levied against public sector undertakings has been that in relation to the capital employed, the level of profits has been too low. Even the government has crticised the public sector undertakings on this count. Of the various factors responsible for low profits in the public sector undertakings, the following are particularly important :-

i. Price policy of public sector undertakings
ii. Under – utilization of capacity
iii. Problem related to planning and construction of projects
iv. Problems of labour, personnel and management
v. Lack of autonomy

The government in order to put an end to these problems, decided to disinvest its stake in the PSUs. The companies traditionally established as pillars of growth have now become a burden on the economy. Except few mighty oil and petroleum companies, almost all other PSUs are incurring losses. The national gross domestic product and gross national savings are also adversely effected by low returns from PSUs. About 10 to 15 % of the total gross domestic savings are reduced on account of low savings from PSUs.

Objectives of Disinvestment

The following are the main objectives of disinvestment policy of the government.

i. To reduce the financial burden on government.
ii. To improve public finances.
iii. To introduce, competition and market discipline.
iv. To find growth.
v. To encourage wider share of ownership.
vi. To depoliticise essential services.

The Disinvestment process in India

The following are the three methods adopted by the Government of India for disinvesting the Public sector undertakings. There are three broad methods involved, which are used in valuation of shares.

1. Net Asset Method: This will indicate the net assets of the enterprise as shown in the books of accounts. It shows the historical value of the assets. It is the cost price less depreciation provided so far on assets. It does not reflect the true position of profitability of the firm as it overlooks the value of intangibles such as goodwill, brands, distribution network and customer relationships which are important to determine the intrinsic value of the enterprise. This model is more suitable in case of liquidation than in case of disinvestment. 

2. Profit Earning Capacity Value Method: The profit earning capacity is generally based on the profits actually earned or anticipated. It values a company on the basis of the underlying assets. This method does not consider or project the future cash flow.

3. Discounted Cash Flow Method: In this method the future incremental cash flows are forecasted and discounted into present value by applying cost of capital rate. The method indicates the intrinsic value of the firm and this method is considered as superior than other methods as it projects future cash flows and the earning potential of the firm, takes into account intangibles such as brand equity, marketing & distribution network, the level of competition likely to be faced in future, risk factors to which enterprises are exposed as well as value of its core assets. Out of these three methods the Discounted cash flow method is used widely though it is the most difficult.

Sunday, 03rd Apr 2016, 08:20:02 PM

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