## wpiea2022165-print-pdf ## Source details **Canonical URL:** [wpiea2022165-print-pdf](https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022165-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2022/english/wpiea2022165-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2022/english/wpiea2022165-print-pdf.pdf.json) --- ### Executive summary: overview and purpose - India’s recently announced privatization strategy can facilitate a change in the composition of the public sector balance sheet toward high-return public sector investments in infrastructure and human capital, leaving commercially viable companies for the private sector. - The paper: - Describes the SOE sector in India. - Considers criteria to inform the scope and rationale for privatization. - Develops a framework for evaluating SOE policy options that can be used in other countries. ### Key facts on central government SOEs (FY2019/20; market data as of end-October 2021) - Counts and status: - Central government owned 366 SOEs. - 256 SOEs were operational (reporting operational income). - 96 SOEs were under construction (reporting no operational income). - 14 SOEs were under closure or liquidation. - As of March 2020, 58 SOEs were listed firms. - Size and economic footprint (as of FY2019/20; excludes public sector banks and insurance companies): - Total assets: 22 percent of GDP. - Fixed assets: 12 percent of GDP. - Gross turnover: 12 percent of GDP. - Value added: 2.6 percent of GDP. - Employment and market capitalization: - Employed about 1.5 million workers (about 0.3 percent of the labor force). - Market capitalization of the government share was around 14 trillion Rs or about 7 percent of GDP (as of end-October 2021, Department of Investment and Public Asset Management). - Profitability and dividends: - Aggregate profits of profit making SOEs declined from about 1.4 percent of GDP in 2009/10 to about 0.7 percent of GDP in 2019/20. - About 40 percent of operating SOEs paid dividends in FY2019/20. - Total dividends paid declined from close to 0.5 percent of GDP to around 0.35 percent of GDP. - Net worth of SOEs declined from 10 percent of GDP to about 6 percent of GDP since 2009/10. - Fiscal transfers and support: - Budget support to SOEs in the form of loans and equity over the past five years have averaged about 0.95 percent of GDP. - Dividends received from SOEs have averaged about 0.25 percent of GDP. ### Rationale for privatization and potential benefits - Core rationales: - If the private sector can run a commercial business as well as the government, government ownership is not warranted. - Loss-making, low-productivity enterprises may drain public finances and expose the government’s balance sheet to risks. - Opportunity cost of ownership: may preclude higher-return public investments (examples include health, social safety nets and public infrastructure). - Potential benefits: - Make the use of public resources more efficient. - Facilitate financing of priority spending on health, social safety nets and infrastructure. - The authorities’ new SOE policy—privatization or closure of all SOEs in non-strategic sectors while keeping a bare minimum presence in strategic sectors—can improve efficiency and shift government assets toward higher-return investments if implemented. ### Strategic sectors (definition used in the paper) - Strategic sectors are defined as: - atomic energy, space, and defense; - transport and telecommunication; - power, petroleum, coal, and other minerals; - banking, insurance, and financial services. - Note: the authorities’ published SOE strategy does not provide further details on the sectors. ### Heterogeneity, performance patterns, and concentration of losses - Sectoral and firm patterns: - About half of SOEs operate in the services sectors, about 40 percent in manufacturing and the remaining mainly in mining and exploration. - Within manufacturing, largest sub-sectors by number are heavy and medium engineering and chemicals and pharmaceuticals. - In terms of gross revenues, petroleum (refinery and marketing) sub-sector under manufacturing accounts for about 53 percent of total gross revenue from operations as of March-2020. - Profitability concentration: - One-third of SOEs were loss-making in FY2019/20. - Top-10 loss-making SOEs accounted for 91 percent of total losses in FY2019/20. - Sub-sectors with more than half of SOEs loss-making include chemicals and pharmaceuticals; transport and logistic services; industrial and consumer goods; hotel and touristic services. - Loss-making SOEs are particularly prevalent in contract and construction, heavy and medium engineering, and trading and marketing sectors. - Listed firms: - About 18 percent of SOEs are listed and they constitute about 14 percent of total SOE assets. - Listed SOEs are typically more profitable, account for a large share of SOE assets, and operate across diverse sectors. ### Management, governance, and institutional arrangements - Institutional responsibilities and reforms: - Management of India’s SOEs is under the Department of Public Enterprises (DPE); in 2021 the Department was moved to be under the Ministry of Finance. - DPE formulates policy guidelines on performance improvement and evaluation, autonomy, financial delegation and personnel management. - Autonomy enhancement via Navratna/Miniratna/Maharatna status: 14 Navratnas, 73 Miniratnas and 10 Maharatnas. - Performance monitoring: - Memorandum of Understanding (MoU) mechanism (introduced 1986) sets targets and benchmarks; MoU ratings: “excellent”, “very good”, “good”, “fair”, and “poor”. - Reported increase in share of SOEs with a “poor” or “fair” ranking from 16.5 percent of all SOEs with an MoU evaluation in FY2014/15 to 22 percent in FY2018/19. - Tools and oversight recommendations: - Ex-ante monitoring by the Ministry of Finance of key fiscal risk indicators for strategic companies could highlight SOEs at risk and enable earlier intervention. - The paper showcases the IMF’s SOE Health Check Tool and SOE Stress Test Tool (benchmarking function used) to identify financially weak SOEs and associated risks. - Strengthening specialized units with dedicated skills for SOE oversight is recommended. ### Framework for analyzing policy options and categorization - SOE categorization dimensions: - (1) social mandate, - (2) strategic vs. non-strategic sector, - (3) commercial viability. - Policy options by category: - SOEs with a social mandate: - Typically not commercial; provide quasi-fiscal services (example: Food Corporation of India). - Recommendation: ensure transparent budget treatment and fully compensate the SOE for the cost of the social mandate. - SOEs in strategic sectors: - Maintain state ownership for some SOEs; consider privatization for others with greater care where competition is limited or externalities are large. - Commercial viability: - Commercially viable SOEs: consider privatization. - Non-commercially viable SOEs: consider closure. - Cross-cutting priority: improve management and governance of SOEs. ### Privatization policy, prioritization, and sequencing - Empirical grouping and findings (based on FY2018/19 Public Enterprises Survey; profitability proxy: profit in both FY2018/19 and FY2017/18): - About half of all SOEs are in non-strategic sectors where there is no rationale for government presence. - About 40 percent of SOEs operating in non-strategic sectors are loss making and can be prioritized in the privatization/closure process. - Loss-making SOEs account for a large share of assets in the trading and marketing sector. - Prioritization criteria: - SOE profitability: prioritize loss-making SOEs from an intertemporal net worth perspective. - Ease of privatization: depends on industry, size, listing status, and financial position; strategic sectors may require longer pre-conditions. - Sequencing considerations: - Some SOEs can be privatized quickly; others require preparatory reforms. - Political economy: there will be losers from privatization; linking receipts to priority investments and compensating losers may increase public support. ### Preconditions, risks, and international lessons for privatization - Preconditions frequently highlighted: - A medium-term privatization plan. - A solid regulatory framework for good governance and transparency during privatization. - Competitive markets. - Equitable redistribution of privatization rents (e.g., compensate affected workers). - Risks in network sectors: - Privatization in network sectors is more difficult due to tensions between affordable provision and adequate profit; weak regulatory frameworks and lack of competition can lead to renegotiations, higher prices, or excessive rents. - International evidence and experience: - No consistent evidence for all emerging markets; several studies on India find positive effects (examples include Baird et al. (2019); Chhibber and Gupta (2017a, 2017b)). - Benefits of successful privatizations: more efficient firms, contribution to healthy public finances, positive macroeconomic effects via higher aggregate productivity. - Typical durations: across countries, privatizations (from decision to completion) often take about two years; can be as fast as one to two months or take more than one decade in phased approaches. - Safeguards against reversion: - Avoid tariff hikes that create public disaffection. - Avoid significant underestimation of losses due to inaccurate operational data that could lead to unsustainable bids. - Pre-conditions and proper governance and oversight of SOEs are critical. ### Fiscal management, transparency, and reporting recommendations - Medium-term perspective on fiscal support to SOEs/PSUs: - SOEs should provide ex-ante medium-term financial plans/budget estimates including revenue, expenditure, guarantees and borrowing requirements for the medium term. - The Government of India does not yet have a medium-term budget framework at the union, state or SOE level. - Ministry of Finance to consider introducing a policy to charge risk-based guarantee fees in line with international good practice. - Guarantees should not be extended to non-viable SOEs with a history of default; support could focus on tariff policies, subsidies, or transfers. - Identification and compensation for quasi-fiscal activities (QFAs): - Fiscal impact of QFAs should be quantified and government should compensate SOEs for QFAs. - Compensation could be considered part of medium-term support to SOEs. - Transparent reporting of fiscal impact: - All extrabudgetary resources and off-budget operations undertaken through SOEs/PSUs should be disclosed in budget documents with multi-year fiscal impact estimates. - Fiscal risks from SOEs/PSUs, including guarantee-related contingent liabilities, should be disclosed in a fiscal risk statement. - Institutional coverage of India’s fiscal reports should be extended to include SOEs/PSUs; a first step could be consolidation of the public sector at the Union level and states. - Prepare a fiscal risk statement including likelihood of risks materializing and associated cost. - Comprehensive fiscal reporting: - IMF’s Fiscal Transparency Code requires fiscal reports to consolidate all public sector entities and report by subsector using GFS and IPSAS. - To be comparable to G20 peers, India should extend coverage of fiscal reports to include at least SOEs controlled directly by central and state governments and prepare GFS-compliant fiscal reports. - In future, prepare a comprehensive balance sheet for the government of India—including SOEs with a social mandate. ### State government enterprises: exposure, risks, and good practices - Exposure and fiscal risks: - State-owned enterprises operate in power, mining, transport, housing, and the financial sector. - Electricity distribution companies (DISCOMs) present the highest exposure risk for many state governments. - Under UDAY bailout scheme (FY2015-17) many states took on DISCOM debt. - Example: Tamil Nadu lent 228 billion Rs interest-free to TANGEDCO to cover operating losses in 2016/17. - The 15th Finance Commission estimates UDAY increased state government deficit by 1.5 percent of GDP during FY2015-17. - RBI (2020) finds UDAY has not delivered improvement and DISCOM losses have continued to increase since implementation. - Example: Gridco in Odisha incurred losses of 4.1 billion INR in 2017 due to purchasing at higher prices than regulated sale price; losses absorbed through commercial borrowing guaranteed by central government. - Loss drivers include uncompetitive tariffs and inadequate subsidies. - Non-commercial activities and inadequate compensation: - State PSUs often perform non-commercial activities without adequate compensation (examples in Tamil Nadu: tariffs not adjusted since 2014; inadequate electricity subsidies; inadequate compensation for subsidized bus routes; reduced rail tariffs for students). - International good practice: quantify QFAs and compensate SOEs to avoid worsening financial positions and to set correct incentives. - Good state-level practices (Odisha example): - Placed a ceiling on stock of guarantees to PSUs. - Established a guarantee redemption fund financed from guarantee fees. - Finance department established an oversight unit applying the SOE health check tool. - Published an initial fiscal risk statement including priority risks and cost estimates. - Reporting and institutional weaknesses: - SOE reporting is not comprehensive; reports have lags (example: Tamil Nadu consolidated report average lag about 15 months). - No in-year report to proactively identify, quantify and mitigate fiscal risks. - Institutional gaps: no state-level department responsible for preparing analytical reports identifying PSUs at risk; Comptroller and Auditor-General issues annual compliance-focused reports. - International good practice: Ministry of Finance should conduct ex-ante assessment of PSU portfolios to identify greatest risks. - The SOE Health Check Tool can identify PSUs representing highest risk. ### Conclusions and transferability - India’s SOE strategy can help reallocate the public sector balance sheet toward higher-return public investment in infrastructure and human capital. - There is significant scope to rationalize government ownership of enterprises in India. - Implementation is key: prerequisites for successful privatization include a medium-term privatization plan, solid regulatory framework, competitive markets, and policies addressing political economy considerations. - Improving governance and management of SOEs can increase efficiency, reduce cost to governments, and facilitate future privatization. - The framework in the paper (SOE Health Check Tool; SOE Fiscal Risks and Stress Test Tool; Framework for Analyzing Policy Options) is transferable and can be applied using standard publicly available SOE data in other countries. *Source: wpiea2022165-print-pdf.* ### Executive Summary....................................................................................................... ### Executive Summary ### Overview and purpose - India’s recently announced privatization strategy can facilitate a change in the composition of the public sector balance sheet toward high-return public sector investments in infrastructure and human capital where there is a clear role for government, leaving commercially viable companies for the private sector. - This paper provides a description of the SOE sector in India, considers different criteria which can inform the scope and rationale for privatization, and develops a framework for evaluating SOE policy options that can be used in other countries. ### Key facts on India’s SOEs (central government) - As of end-FY2019/20, central government owned 366 SOEs, out of which 256 SOEs were operational (or reporting operational income), 96 SOEs were under construction (or reporting no operational income) and 14 SOEs were under closure or liquidation. - India’s central government owned SOEs account for 22 percent of GDP in total asset, 12 percent of GDP in fixed assets, 12 percent of GDP in terms of gross turnover and 2.6 percent in terms of value added. (These figures are as of FY2019/20 and include SOEs covered in the Public Enterprise Survey and therefore exclude public sector banks and insurance companies.) - India’s SOEs employed about 1.5 million workers (about 0.3 percent of the labor force). - As of March 2020, 58 SOEs were listed firms. - According to Department of Investment and Public Asset Management, as of end-October 2021, market capitalization of the government share was around 14 trillion Rs or about 7 percent of GDP. - Aggregate profits of profit making SOEs have declined from about 1.4 percent of GDP in 2009/10 to about 0.7 percent of GDP in 2019/20. ### Rationale for privatization and potential benefits - Privatization can make the use of public resources more efficient and facilitate the financing of priority spending on health, social safety nets and infrastructure. - Standard arguments: - If the private sector can run a commercial business as well as the government, government ownership is not warranted. - Loss-making, low-productivity enterprises may drain public finances and expose the government’s balance sheet to risks. - Opportunity cost: owning SOEs may preclude higher-return public investments (examples for India include health, social safety nets and public infrastructure). - The government’s new SOE policy—privatization or closure of all SOEs in non-strategic sectors while keeping a bare minimum presence in strategic sectors—can, if implemented, go a long way to improve efficiency and shift government assets toward higher-return investments. ### Strategic sectors (as defined in the paper) - Strategic sectors are defined as atomic energy, space, and defense; transport and telecommunication; power, petroleum, coal, and other minerals; and banking, insurance, and financial services. (The authorities’ published SOE strategy does not provide further details on the sectors.) ### Implementation considerations and prerequisites - International experience highlights several prerequisites for reaping the benefits of privatization: - A medium-term privatization plan. - A solid regulatory framework for good governance and transparency during privatization. - Competitive markets. - Ensuring an equitable distribution of privatization rents, for example by compensating affected workers. - Because privatization often takes time, governments should invest in governance and oversight of SOEs to increase efficiency, reduce cost to governments, and facilitate future privatization. - A multi-year strategic plan for privatization is recommended to ensure a concrete timeline and well-designed sequencing and strategy. - Political economy considerations matter: there will be losers from privatization and potential push-back from interest groups. Linking privatization receipts to investment in priority areas and compensating losers may help increase public support. - The privatization process should be open, transparent, and inclusive and generate the best value for the government. - For some SOEs, pre-requisites may be needed before privatization; some can be privatized quickly while others require preparatory reforms. ### Governance, management, and monitoring of SOEs - Improving governance and management of SOEs is critical to increase efficiency, reduce cost to government, and facilitate future privatization. - Ex-ante monitoring by the Ministry of Finance of key fiscal risk indicators for strategic companies could highlight SOEs at risk and enable earlier intervention. - Improving financial performance and efficiency of SOEs could lead to fiscal savings in the short-to-medium term and limit government support through transfers, subsidies, guarantees and financial bailouts. - The paper showcases the SOE Health Check Tool applied to selected SOEs in India to help identify financially weak SOEs and associated risks. The SOE Stress Test Tool’s benchmarking function is used given data requirements. ### Heterogeneity and performance patterns - SOEs are significant in number and highly heterogeneous in terms of size, profitability, and industry. - About half of SOEs operate in the services sectors, about 40 percent in manufacturing and the remaining mainly in mining and exploration. - Within manufacturing, the largest sub-sectors by number of SOEs are heavy and medium engineering and chemicals and pharmaceuticals. - In terms of gross revenues, petroleum (refinery and marketing) sub-sector under manufacturing accounts for about 53 percent of total gross revenue from operations as of March-2020. - One-third of SOEs are loss-making, posing a drain on limited public resources. ### Literature and evidence on privatization effects - There is no consistent evidence on the impact of privatizations on firm performance in emerging market and low-income countries, but several studies on India find positive effects. - Examples: - Baird et al. (2019) find that following privatization of SOEs in India over 1991-2005, there was a reallocation of labor away from the public sector with a substantial improvement in aggregate productivity and output. - Chhibber and Gupta (2017a, 2017b) find that disinvestment policies have significant positive effects on firm performance; MOUs had positive impacts mainly driven by non-service sector SOEs; for service sector firms, partial privatization (share sales) had a more significant impact on performance. - IMF (2020) highlights challenges: SOEs often pursue multiple uncosted policy mandates weakening financial positions and limited transparency around SOEs’ operations and financial relationships with government leading to weak governance and oversight. ### Scope of analysis and limitations - Analysis focuses on enterprises owned by the central government due to lack of comprehensive data on state-level public sector enterprises. - There are many enterprises owned by state governments—more than 1000 according to some estimates—and their management and fiscal impact is important; a brief discussion of key issues related to state-government owned enterprises is included, while detailed state-level analysis is left for future work. *Source: Executive Summary (wpiea2022165-print-pdf).* ### 0.25 percent of GDP on average over the past decade. While total losses are typically concentrated ### India’s State-Owned Enterprises ### Overview and Fiscal Footprint - Total losses concentrated: top-10 loss-making SOEs accounted for 91 percent of total losses in FY2019/20. - Aggregate indicators: - Loss-making SOEs: about one-third of all SOEs were loss-making in FY2019/20. - Sub-sectors with more than half of SOEs loss-making: chemicals and pharmaceuticals; transport and logistic services; industrial and consumer goods; hotel and touristic services. - Dividend payments and net worth: - About 40 percent of operating SOEs paid dividends in FY2019/20. - Total dividends paid have declined from close to 0.5 percent of GDP to around 0.35 percent of GDP. - Net worth of SOEs declined from 10 to about 6 percent of GDP since 2009/10. - Financial flows between SOEs and the central government: - Budget support to SOEs in the form of loans and equity over the past five years have averaged about 0.95 percent of GDP. - Dividends received from SOEs have averaged about 0.25 percent of GDP. - Sectoral presence: loss-making SOEs present in almost all sub-sectors; transportation vehicle and equipment sector noted as an exception in FY2019/20. ### Management and Institutional Arrangements - Institutional home: Management of India’s SOEs is under the Department of Public Enterprises; in 2021 the Department was moved to be under the Ministry of Finance. - Department functions: formulates policy guidelines for CPSEs on performance improvement and evaluation, autonomy and financial delegation and personnel management. - Performance monitoring: - Memorandum of Understanding (MoU) mechanism introduced in 1986 to set targets and benchmarks between SOE management and administrative ministry/department. - MoU ratings: “excellent”, “very good”, “good”, “fair”, and “poor”. - Reported trend: an increase in the share of SOEs with a “poor” or “fair” ranking from 16.5 percent of all SOEs with an MoU evaluation in FY2014/15 to and 22 percent in FY2018/19. - Board and autonomy reforms: measures to improve corporate governance and professionalization of Boards; autonomy enhanced for some profit-making CPSEs via Navratna/Miniratna/Maharatna status. - Current counts: 14 Navratnas, 73 Miniratnas and 10 Maharatnas. ### Privatization History and Fiscal Receipts - Early 2000s: active privatization/disinvestment from over 30 SOEs, including BALCO, Hindustan Zinc Limited, CMC and Maruti Udyog Limited. - Late 2000s onward: privatization less aggressive; partial divestments continued. - National Investment Fund: created to collect disinvestment receipts for strategic use; criteria for using receipts relaxed after the 2009 crisis until the fund became part of the budget. - Disinvestment receipts: - Historically hovered around 0.3-0.4 percent of GDP. - Recent disinvestment receipts mainly reflect partial divestment in publicly listed SOEs with the government maintaining majority stake. - Note: some disinvestment receipts reported in the budget do not constitute disinvestment per se (e.g., one SOE buying another SOE). ### Framework for Analyzing Policy Options - SOE categorization dimensions: (1) social mandate, (2) strategic vs. non-strategic sector, (3) commercial viability. - Policy options by category: - SOEs with a social mandate: - Typically not commercial; provide quasi-fiscal services (example: Food Corporation of India). - Recommendation: ensure transparent budget treatment and fully compensate the SOE for the cost of the social mandate. - SOEs in strategic sectors: - Sectors include defense, transportation, telecommunication, utilities. - Recommendation: maintain state ownership for some SOEs; consider privatization for others with greater care where competition is limited or externalities are large. - Commercial viability: - For commercially viable SOEs, consider privatization. - For non-commercially viable SOEs, consider closure. - Important cross-cutting priority: improve management and governance of SOEs. ### Privatization Policy, Prioritization, and Sequencing - Key considerations for prioritization and sequencing: - SOE profitability: prioritize loss-making SOEs from an intertemporal net worth perspective. - Ease of privatization: depends on industry, size, listing status, and financial position; strategic sectors may require longer pre-conditions. - Empirical grouping used in analysis: - Data from FY2018/19 Public Enterprises Survey; SOEs split on a 2x2 dimension: strategic vs. non-strategic sectors and profitable vs. nonprofitable. - Profitability proxy: SOE had a profit in both FY2018/19 and FY2017/18. - Strategic sectors defined as: atomic energy, space, and defense; transport and telecommunication; power, petroleum, coal, and other minerals; and banking, insurance, and financial services. - Findings from classification: - About half of all SOEs are in non-strategic sectors where there is no rationale for government presence. - About 18 percent of SOEs are listed and they constitute about 14 percent of total SOE assets. - About 40 percent of SOEs operating in non-strategic sectors are loss making and can be prioritized in the privatization/closure process. - Loss-making SOEs account for a large share of assets in the trading and marketing sector; in terms of number of firms, loss-making SOEs are more prevalent in contract and construction, heavy and medium engineering, and trading and marketing sectors. - Among strategic sectors, many SOEs are non-profitable, especially in transport and logistic services, and chemicals and pharmaceutical sectors. - Listed SOEs are typically more profitable, account for a large share of SOE assets, and operate across diverse sectors. ### Preconditions and Risks for Successful Privatization - International experience identifies key prerequisites for successful privatization: - A medium-term privatization plan. - A solid regulatory framework. - Competitive markets. - Equitable redistribution of privatization rents, including compensating affected workers. - Additional considerations: - In network sectors (e.g., energy, utilities, public transportation), privatization is more difficult due to tensions between affordable provision and adequate profit; weak regulatory frameworks and lack of competition can lead to renegotiations, higher prices, or excessive rents for private owners. - Political economy: compensating losers and linking privatization receipts to priority investments can increase public support. ### Lessons from International Experience (Box 1) - Benefits of successful privatizations: - More efficient firms. - Contribution to healthy public finances. - Positive macroeconomic effects via higher aggregate productivity. - Preconditions reiterated: - Medium-term privatization plan: helps plan and implement privatization which takes time and resources. - Solid regulatory framework: governance and transparency in privatization; attract private participation; ensure effective implementation. - Competitive markets: incentivize firms to operate on commercial principles and deliver high-quality, affordable services. - Equitable redistribution of privatization rents: compensate affected workers through social safety nets, unemployment insurance, and labor market measures. - Contextual experiences: - Western Europe: privatization accompanied by vigorous financial market development. - Central and Eastern Europe: transition strategies included private sector development. - Africa: positive privatization effects when accompanied by better regulation and enhanced competition. - Risks and adverse experiences: - In network sectors, lack of competition and weak regulation led to renegotiations and higher prices in several Latin American countries. - Employee and union opposition frequently arises due to layoff risks; however, privatization can sometimes lead to employment gains in competitive markets. ### Governance and Management Priorities - Improving financial performance and governance of SOEs/PSUs is a prerequisite for sound public financial management and can yield fiscal savings in the short- to medium-term. - Governance issues apply to both central government SOEs and state government PSUs. - Key priorities include financial oversight of SOEs/PSUs based on international good practice and strengthening specialized units with dedicated skills. *IMF WORKING PAPERS — India’s State-Owned Enterprises* ### Box 1: Lessons from international experience with privatization (continued) ### Box 1: Lessons from international experience with privatization (continued) ### Conditions that improve privatization outcomes - Private sector participation is more likely to succeed when: - information about the operating performance of the utility and the condition of its assets are more accurate; - retail tariffs are close to full cost recovery; - the regulator is competent in adjusting tariffs and monitoring quality of service (Rana and Foster 2020). - Strong governance and oversight of SOEs help nurture the above conditions and generate favorable conditions for successful privatization. - Based on India’s own experience, profitable firms and firms with lower wage bill are likely to be privatized early in India (Dinc and Gupta, 2011). ### Risks and safeguards for privatization - The government should safeguard privatization success by avoiding privatization reversions. Common causes of reversions include: - tariff hikes associated with privatization leading to public disaffection; - significant underestimation of losses due to inaccurate operational data leading to unsustainable bids. - Pre-conditions and proper governance and oversight of SOEs are critical to prevent reversion. ### Timeline and sequencing of privatizations - The privatization process can take time depending on type of privatization and economic, social, and political context; a medium-term plan is important. - Across countries, it is common to see privatizations (starting from decisions made to the completion of privatization) taking about two years. - Examples of multi-tranche or phased privatizations: - SAFRAN France: four tranches of public offerings of the State’s shares during 2013-2015. - ENGIE SA France: share sales mainly to institutional investors during 2015-2017. - DONG Energy Denmark: privatization through IPO during 2015-2016 (although the decisions were initiated in 2004). - Siarkopol S.A. Poland: block sales of 85% shares during 2012-2013. - Deutsche Post AG Germany: process of privatization since November 2000 (gradual, to allow stock market absorption and better price). - Türk Telekom Turkey: sequenced sell-off with first phase block sale of 55% shares to Oger Telecom in 2005 and second phase through IPO in 2007. - Privatizations can also proceed very fast (one to two months), while some phased/sequential approaches have lasted for more than one decade. Governments choose durations to achieve goals such as optimizing prices. ### Institutional capacity and reporting in India - The Ministry of Finance in India has strengthened institutional capacity for SOE oversight through movement of the Department of Public Enterprises (DPE) under the Ministry of Finance. - The DPE produces an annual public enterprises survey on the financial performance of central government SOEs: - the report includes useful financial ratios and SMART measurable performance indicators based on a memorandum of understanding (MOU) between the administrative department and SOE management; - the report is produced ex-post with a one-year time lag; - the MOU contains mandatory and optional indicators on financial and service delivery parameters. - The DPE could consider producing an ex-ante report focusing on key financial ratios showing SOEs at risk and that may require fiscal support. - Analytical tools like the IMF’s SOE Health Check and Fiscal Stress Test Tools (discussed in Box 2) are cited as good examples of potential tools to utilize. ### Policy recommendations for fiscal management of SOEs - Medium-term perspective on fiscal support to SOEs/PSUs: - SOEs should provide ex-ante their medium-term financial plans/budget estimates to determine government fiscal support and limit unplanned bailouts (transfers, subsidies, guarantees, capital injections). - The Government of India does not yet have a medium-term budget framework at the union government, state government or SOE level, which limits anticipation and mitigation of future financing needs. - The Department of Public Enterprises could prescribe the format for SOE financial plans to include revenue, expenditure, guarantees and borrowing requirements for the medium term to be submitted to administrative departments. - This information would enable the Ministry of Finance to include estimates of multi-year budget support in fiscal projections. - The Ministry of Finance should consider introducing a policy to charge risk-based guarantee fees in line with international good practice to incentivize SOEs to borrow on the strength of their balance sheet. - Guarantees should not be extended to non-viable SOEs with a history of default—instead support could focus on tariff policies, subsidies, or transfers. - Identification and quantification of quasi-fiscal activities (QFAs): - Some SOEs perform activities on behalf of government not aligned with profit objectives (e.g., transport or electricity subsidies)—QFAs. - The fiscal impact of QFAs should be quantified and government should compensate for QFAs to avoid worsening SOE financial positions, set correct incentives, and evaluate true financial cost and performance of commercial activities. - Such compensation could be considered part of medium-term support to SOEs. - Transparent reporting of fiscal impact of SOEs/PSUs: - All extrabudgetary resources and off-budget operations undertaken through SOEs/PSUs should be disclosed in budget documents and their multi-year fiscal impact estimated. - Fiscal risks from SOEs/PSUs, including guarantee-related contingent liabilities, should be disclosed in a fiscal risk statement. - Institutional coverage of India’s fiscal reports should be extended to include SOEs/PSUs; a first step could be consolidation of the public sector at the Union level (Union Government plus central PSUs) and states (respective state government and State level PSUs). - Examples of international practices in SOE financial reporting (e.g., Australia or Sweden) could be provided. - Fiscal transparency could be strengthened by preparing a fiscal risk statement including likelihood of risks materializing and associated cost. - Comprehensive fiscal reporting for the public sector: - Fiscal reporting in India is incomplete and excludes SOEs and their operations—a significant portion of public funds. - The IMF’s Fiscal Transparency Code requires fiscal reports to consolidate all public sector entities and report on each subsector according to international standards including Government Finance Statistics (GFS) and International Public Sector Accounting Standards (IPSAS). - To be comparable to its G20 peer group, India should extend coverage of fiscal reports to include at least those SOEs controlled directly by central and state governments and prepare GFS-compliant fiscal reports. - In future, a comprehensive balance sheet for the government of India could be prepared—including SOEs with a social mandate. ### Application and transferability of the framework - The framework developed in this paper can be applied to evaluate policy options for SOEs in other countries by combining: - the SOE Health Check Tool; - the SOE Fiscal Risks and Stress Test Tool; - the ‘Framework for Analyzing Policy Options’ developed in the paper (Figure 2). - The approach allows assessment of the SOE sector based on considerations important to authorities (economic, strategic, fiscal risks). - The framework can be applied using standard publicly available data on SOEs, making it feasible for a broad range of countries. *Italic: IMF WORKING PAPERS — Box 1: Lessons from international experience with privatization (continued).* ### Box 3: State Government Enterprises ### Box 3: State Government Enterprises ### Exposure and fiscal risks from state-owned enterprises (SOEs) - State-owned enterprises operate in power, mining, transport, housing, and the financial sector. - Electricity distribution companies (DISCOMs) present the highest exposure risk for many state governments. - Under the Ujwal DISCOM Assurance Yojana (UDAY) bailout scheme (FY2015-17) many states took on the debt of DISCOMs with the objective to improve financial and operational performance. - Example: Tamil Nadu lent 228 billion Rs interest-free to Tamil Nadu Generation and Distribution Company (TANGEDCO) to cover operating losses in 2016/17. - The 15th Finance Commission estimates that the UDAY scheme increased state government deficit by 1.5 percent of GDP during FY2015-17. - According to RBI (2020), the UDAY scheme has not delivered an improvement in financial performance and DISCOM losses have continued to increase since its implementation. - Example: Grid Company (Gridco) in Odisha incurred losses of 4.1 billion INR in 2017 due to a requirement to purchase electricity at higher prices than the regulated sale price; these losses were absorbed through commercial borrowing guaranteed by central government. - Loss drivers for state-owned electricity distribution companies include uncompetitive tariffs and inadequate subsidies to compensate for categories of domestic consumers. - Without energy sector tariff reform to address the gap between cost of supply and regulated tariffs, losses are likely to continue and may contribute to the State’s growing debt burden. ### Non-commercial activities and inadequate compensation - State government owned enterprises provide substantial non-commercial activities on behalf of states but are not adequately compensated. - In Tamil Nadu, non-commercial activities contributing to PSU losses include: - Electricity tariffs which have not been adjusted since 2014. - Inadequate electricity subsidies to compensate for free electricity to categories of domestic consumers. - Inadequate compensation for subsidized bus routes to rural communities. - Reduced rail tariffs for students. - International good practice requires governments to quantify noncommercial activities—also known as quasi-fiscal activities—and to compensate SOEs for their losses. ### Good practices at the state level - Odisha has implemented measures to mitigate the fiscal cost of guarantees: - Placed a ceiling on the stock of guarantees to PSUs. - Established a guarantee redemption fund financed from guarantee fees. - Finance department established an oversight unit to monitor SOE fiscal risks by applying the SOE health check tool. - Published an initial fiscal risk statement including priority risks along with an estimate of their cost. - These policies comply with international best practice and could be adopted by other states. ### SOE reporting, oversight, and institutional weaknesses - SOE reporting is not comprehensive; financial reports, where available, are produced annually with some lag. - Example: The Finance Department of Tamil Nadu produces a consolidated Review of the Performance of PSU report with an average lag of about 15 months after the end of the fiscal year. - The report provides aggregate performance but contains no assessment of strong or weak performance or discussions on improving performance. - No in-year report is produced to proactively identify, quantify and mitigate fiscal risks to inform future fiscal decisions. - Good international practice requires that the likelihood and impact of potential fiscal risks be quantified and presented in a fiscal risk statement alongside the budget documents. - Odisha has made progress by conducting qualitative and quantitative analysis of PSU annual reports; this practice could be replicated by other states. - Institutional framework gaps: - Each state has a department of public enterprises responsible for staffing levels and new capital investments or disinvestments. - The administering department reviews business plans, provides operational oversight, and participates on SOE boards. - There is no department responsible for preparing analytical reports on SOE performance and highlighting those at risk. - The Comptroller and Auditor-General issues an annual report on SOEs focused on compliance against financial standards and performs selected ex-post performance audits. - International good practice requires the Ministry of Finance to conduct an ex-ante assessment of the financial performance of the overall PSU portfolio and to identify PSUs presenting the greatest risks to government—particularly in the energy and transport sectors. - The SOE Health Check Tool (described in Box 2) could be useful in identifying SOEs that represent the highest risk. ### Conclusions and policy implications - India’s recently announced SOE strategy can facilitate a change in the composition of the public sector balance sheet toward high-return public sector investments in infrastructure and human capital. - There is significant scope to rationalize government ownership of enterprises in India. - SOEs are significant in number and highly heterogeneous in size, profitability, and industry. - One-third of SOEs are loss-making which poses a drain on limited public resources. - Implementation is key to reaping benefits from privatization. International experience highlights prerequisites for success: - A medium-term privatization plan. - A solid regulatory framework for good governance and transparency during privatization. - Competitive markets. - Addressing political economy considerations, as there will be losers from privatization. - Linking privatization receipts to investment in priority areas and compensating losers may help increase public support. - Improving governance and management of SOEs can increase efficiency, reduce cost to governments, and facilitate future privatization. - Ex-ante monitoring of key fiscal risk indicators could highlight SOEs at risk and enable earlier intervention. - Improving financial performance and efficiency of SOEs could lead to more fiscal savings in the short-to medium term and limit government support through transfers, subsidies, guarantees and financial bailouts. *Source: Box 3, "State Government Enterprises", wpiea2022165-print-pdf.* --- _Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022165-print-pdf.pdf_