India Signals Intentions to Drive Divestment Program; Why Global Buyers Should Take Note

Nandini Chopra

Vikram Utamsingh

Sai Chaitanya

By Nandini Chopra, Head of Corporate Finance with Alvarez & Marsal India.
Vikram Utamsingh, Head of Transaction Advisory with Alvarez & Marsal India.
Sai Chaitanya, Senior Manager, Corporate Finance with Alvarez & Marsal India.

Central Public Sector Enterprises (CPSEs) have dominated Indian economic policies since 1950s as they were initially set up with the socialist ideology of the state being the best allocator of resources. While the balance of payment crisis in the 1990s and the poor performance of CPSEs relative to private sector compelled the government to undertake disinvestment of CPSEs, the successive governments, with the exception of the period between 1999-03, have generally shown faith in retaining majority control in CPSEs until the recent emphasis on strategic sales by the government of Narendra Modi.

Given political sensitivities, the disinvestment policy has faced strong opposition from various stakeholders. The government was able disinvest, on an average, less than 10% of its stake in certain select CPSEs till the late 1990s. The National Democratic Alliance (NDA) government led by Atal Bihari Vajpayee which assumed power between 1999-03 had pursued wholesale privatization of non-strategic CPSEs for the first time and had set up a dedicated department for divestment (Department of Disinvestment (DOD) under the Ministry of Finance) to streamline the process. This was the only period that witnessed strategic sales to private parties until the recent strategic sale of Air India to Tata Group in 2022.

The strategic sales to private parties during this period faced several controversies, litigations, and labour unrest. Under these circumstances, the newly elected government of the United Progressive Alliance (UPA) led by Manmohan Singh in 2004-05 renewed its focus on retaining the public character of CPSEs. The UPA government pursued minority stake sales mainly to raise resources to meet budgetary requirements. Several new methods were employed by the government for minority stake sales such as buybacks, offers for sale (OFS), and exchange-traded funds (ETFs).

The return of the NDA government to power in 2014-15 led by Narendra Modi brought back the focus on strategic sales. While the government continued minority stake sales, several measures were undertaken to encourage strategic sales to private parties. The government issued a new policy in February 2021[1] which classifies all CPSEs into strategic (atomic energy, space and defence, transport, telecommunications, power, petroleum, coal and other minerals, banking, insurance, and financial services) and non-strategic sectors. The aim is to move out of non-strategic CPSEs while retaining a minimal presence in strategic sectors where not more than one CPSE will operate.

Although majority of the strategic sales by the government of Narendra Modi to date are CPSE to CPSE sales[2], the strategic sale of Air India to Tata Group, which involved transfer of control to a private entity, is expected to provide major impetus to strategic sales in India. The success of this transaction is more pronounced in the context that it involved sale of a large company with widely reported losses of approximately USD 2-3 mn a day[3].

Learnings from past experiences

In 2016, DOD was rechristened as Department of Investment and Public Asset Management (DIPAM) with the extended scope of, in addition to disinvestment, advising the government in the matters related to financial restructuring and to attract investment[4]. From 2019, the role of DIPAM was further expanded to give recommendations on selection of entities for strategic sales[5]. A new body called Alternative Mechanism (AM), headed by the Finance Minister was created to take crucial decisions on the firms which have received in-principle approval for strategic sale[6]. The AM includes the Finance Minister, the Road Transport and Highways Minister, and the minister of administrative department whose CPSE has been identified for sale.

Many of the CPSEs have certain surplus assets apart from their core business such as land and real estate properties. Non-separation of such surplus assets from core businesses could be a hurdle for private parties that are only interested in the core business. For instance, the stake in Videsh Sanchar Nigam Ltd. (VSNL) was disinvested in 2002 with a condition that surplus land would be demerged post disinvestment. However, the buyer was not ready to bear the capital gain tax and stamp duty arising from such a demerger. Only after the Income Tax Act was amended to exempt such cases was the demerger completed in 2019, after a long gap of 17 years[7],[8]. With this experience, the government has mandated to hive-off surplus assets such as land of all CPSEs into a separate entity before disinvesting[9].

Removing barriers and expanding the stake

Disinvestment of certain CPSEs may require repealing or amending certain acts. For instance:

• The majority stake in Hindustan Zinc Ltd. (HZL) was disinvested by 2003 with an option to the buyer to acquire the residual stake. However, when the option was exercised by the buyer, the government could not sell the residual stake due to potential legal hurdles that could arise from the acts under which HZL was incorporated[10].
• The proposed disinvestment in state-owned oil companies viz. Hindustan Petroleum Corporation Ltd. (HPCL) and Bharat Petroleum Corporation Ltd. (BPCL) in 2003 could not go ahead as the acts under which these companies were nationalized required oil business to be under the government[11].

Learning from these experiences, the present government has been making efforts to repeal such obsolete and redundant acts to remove legal barriers towards the strategic sale of several other CPSEs[12].

The present government seems to consider selling 100 percent of its stake as a more practical approach. In the case of Air India, the government initially intended to sell 76 percent stake but could not find any interest from buyers. Eventually, the government offered a 100 percent stake along with certain relaxations to make the sale more attractive for the buyers[13].

The government is also changing its approach to setting disinvestment targets. Traditionally, the targets were set according to the budgetary requirements and then CPSEs were identified according to the target. However, this approach is fraught with inadequate preparation, missing hidden assets, and overlooking potential legal, and administrative hurdles. Additionally, it seems to have discouraged prospective investors with inadequate disclosures and ever-changing conditions. Factoring such complexities associated with strategic deals, the government has been taking a more realistic approach towards the targets for FY22 and FY23[14].

Making strategic sales attractive to foreign investors

Historically the participation of foreign investors in disinvestment deals has been predominantly through public offers, auction of shares, and in sporadic cases, through Global Depository Receipts (GDR)[15] issues such as for VSNL, Mahanagar Telephone Nigam Ltd. (MTNL) in the 1990s. As such, the role of foreign investors has been primarily limited to that of a minority shareholder in publicly listed CPSEs. Due to political sensitivities surrounding strategic sales, prior governments were wary of ceding controlling stake to foreign investors. However, the current government has been taking several measures to encourage the participation of foreign investors in strategic sales.

The easing of foreign direct investment (FDI) limits occurring across various sectors is a welcome move towards encouraging strategic sales to foreign investors. In June 2021, the government has increased FDI limit in insurance companies from 49 percent to 74 percent under automatic route[16]. In July 2021, 100 percent FDI was permitted under the automatic route for such CPSEs in oil & natural gas sectors which have received in-principle approval for strategic disinvestment[17].

This move facilitates the participation of foreign investors to acquire a controlling stake in CPSEs such as Bharat Petroleum Corporation Ltd. (BPCL) which is currently undergoing the strategic sale process. The government may follow a similar approach for the proposed disinvestment of few public sector banks where the FDI investment is currently capped at only 20 percent.

On the taxation front, the government amended tax laws in August 2021 to scrap the controversial retrospective tax provisions[18] which frequently resulted in prolonged litigations with foreign investors in India. This is a positive signal from the government to build confidence amongst foreign investors.

In September 2021, the government allowed CPSEs to carry forward losses to be set off against future profits post its strategic sale[19]. This was aimed to make underperforming CPSEs more attractive to the prospective strategic buyers.

The environment is now exceedingly hospitable for foreign investors acquiring controlling stakes in a variety of CPSEs from niche players to market leaders in their respective areas of operations. As the government pursues its goal of identifying more such CPSEs for disinvestment, foreign investors can leverage their technical know-how and introduce best global practices for restructuring the operations of underperforming CPSEs to revive growth. Given the inefficient practices in most of these underperforming CPSEs, ‘low-hanging fruit’ initiatives by the buyers requiring little investment are likely to turnaround performance and maximize value.

The government may also make it the norm to allow buyers to identify and absorb optimal levels of debt for reviving loss-making CPSEs. For instance, in the case of the strategic sale of Air India, the government has allowed the buyers to decide the level of debt they could absorb instead of insisting on absorbing pre-decided debt levels[20].

With continuous reforms that have eased bureaucratic and legal hurdles, relaxed FDI limits in identified sectors, and moved towards setting practical disinvestment targets to avoid unpreparedness, the government has clearly signaled its intentions in making strategic sales more attractive to foreign investors.

[1]https://dpe.gov.in/sites/default/files/DPE_OM_DTD_13.12.21_Guidelines_on_New_PSE_Policy_0.pdf

[2]http://www.bsepsu.com/master_disinvestment1.asp?ord=comp_name

[3]https://www.livemint.com/news/india/air-india-was-facing-daily-losses-of-rs-20-cr-had-to-sell-centre-tells-delhi-hc-11641285580093.html

[4]https://www.financialexpress.com/economy/department-of-disinvestment-renamed-as-dipam/240340/

[5]https://www.moneylife.in/article/consultative-group-formed-to-select-psus-for-strategic-sale/58425.html

[6]https://pib.gov.in/PressReleseDetail.aspx?PRID=1567764

[7] https://www.bloombergquint.com/business/over-14-year-wait-for-vsnl-shareholders-nears-closure

[8]https://timesofindia.indiatimes.com/business/india-business/demerger-of-tata-communications-surplus-land-to-hpil-gets-mca-nod/articleshow/70577166.cms

[9]https://www.business-standard.com/article/current-affairs/cabinet-nod-to-spv-for-monetisation-of-surplus-land-of-cpses-122030900693_1.html

[10]https://economictimes.indiatimes.com/news/economy/policy/mines-ministry-adds-rider-to-hindustan-zincs-29-5-selloff/articleshow/23755687.cms?from=mdr

[11]https://www.financialexpress.com/economy/bharat-petroleum-legal-hurdles-cleared-for-sale/1723945/

[12]https://www.livelaw.in/news-updates/law-ministry-obsolete-redundant-laws-repealed-gov-of-india-195695?from-login=114090

[13]https://www.business-standard.com/article/companies/air-india-govt-puts-entire-stake-on-the-block-sets-terms-of-sale-120012700586_1.html

[14]https://www.business-standard.com/article/economy-policy/fy23-divestment-target-more-realistic-not-underestimation-sitharaman-122020600796_1.html

[15]https://documents1.worldbank.org/curated/en/887021468763785576/pdf/17754-Replacement-file-140MUSTA.pdf

[16]https://www.livemint.com/insurance/news/finance-ministry-notifies-rules-for-increased-fdi-in-the-insurance-sector-11621528712819.html

[17] https://mybs.in/2Zg2fXR

[18][18]https://www.livemint.com/companies/news/government-introduces-bill-in-lok-sabha-for-settlement-with-cairn-vodafone-11628171653995.html

[19]https://economictimes.indiatimes.com/news/economy/policy/psus-to-be-allowed-to-carry-forward-losses-accumulated-prior-to-divestment-cbdt/articleshow/86100229.cms?from=mdr

[20]https://www.pib.gov.in/PressReleasePage.aspx?PRID=1762146