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Auditing of Privatisation in India - Issues and Problems

K. MUTHUKUMAR
(Director General of Audit, Central Revenues,
New Delhi, India.)

Mr. Nigel Lawson, former Chancellor of the Exchequer in Ms. Thatcher's Government once said that the business of Government was not government of business. But where Government sheds its business by privatisation, it is very much the business of Government to ensure that the chief objectives of privatisation are secured by careful planning of the modalities of sale to realise the best possible price for the exchequer. Even in countries like U.K. which was a forerunner in privatisation under the Conservative Government in the eighties, the process of steering the privatisation programme was a tortuous one, bringing in its wake, adverse audit comments by the National Audit Office, as in the case of British Telecom and British Gas where the Government came under criticism for under-valuation of shares. The programme of privatisation initiated by the Government of India and the issues involved and its audit by the SAI are outlined in this article.

2.    The expansion of Public Sector both in the Central Government and in the State Governments is one of the salient features in the economic development of post independent India. The Public Sector Enterprises (PSEs) in India are mostly in the form, either of Government companies registered under the Companies Act or enterprises set up under separate statutes as statutory corporations. Under the Central Government alone, there are as many as 253 Public Sector Enterprises in different Industrial sectors with the majority ownership directly with the Central Government. Over the years the enterprises have registered a significant growth and the investment of the Government in these enterprises in equity and loan was about 24.768 billion US dollars as on 31st March 1992. Similarly, there is a large number of public enterprises under ownership of respective State Governments. The audit of financial accounts of these enterprises are entrusted to private accounting firms recommended by the Indian Supreme Audit Institution (SAI), but, are however subject to a supplementary audit by the SAI under the provisions of the Companies Act. There are certain statutory corporations for which the SAI is the sole Auditor.

3.    In India, there has been a growing awareness of the need to take some remedial steps to improve the performance of PSEs and to relieve them of some of the common maladies which afflict these enterprises. As many as 102 enterprises have been incurring losses and 57 of them have been incurring cumulative losses. The dividend return on networth was less than 2 per cent, as on 31st March 1992.

4.    Although no concrete programme of privatisation was on the anvil earlier, some policy initiatives were, taken by the Central Government. Briefly these were:

1. emphasis in the Seventh Five Year Plan to introduce market element and develop capital markets to help funding of public enterprises,
2. recognition of the competition as an important element and gradual exposure of the public sector to a competitive market environment as a recognised policy, .
3. Encouraging public enterprises to resort to market borrowings by issue of public sector bonds,
4. contracting out some of the public utility services to private sector.

The partial disinvestment of shareholding in selected publicenterprises has been a recent development in the Central Government although there were instances of privatisation in one or two State Government enterprises some years ago.

5.    The minimal generation of surplus by the PSEs necessitated continuous budgetary support to many of the public enterprises and in the case of some enterprises such support was provided even to meet their cash losses. Such minimal generation of surplus resulted in the inability of these enterprises to regenerate themselves in terms of new investment as well as in technology development. It was in this background that the present Government launched a programme of partial disinvestment of Government's share holdings to raise resources for public sector in a bid to revitalise them, as also to encourage wider public participation.

6.    It appears that the Government has deliberately chosen the policy of partial disinvestment instead of total privatisation. In the context of the fact that the public sector in India has always been considered to be in the commanding heights of the economy, Government's policy is generally in favour of retaining the majority ownership in these enterprises for quite sometime. As things stand today, the policy of the Government in regard to the disinvestment is that the process of disinvestment would be done in stages and level of disinvestment would vary from 5 to 20 per cent of the share holdings so that the total Government share holdings would not fall below 51 per cent. The first stage of the disinvestment programme on 30 public enterprises with the level of disinvestment varying from 0.27 per cent to 20 per cent took place during the fiscal year 1991-92 and the Government realised about US $ 1.013 billion. The issues involved in partial disinvestment of selected Public Enterprises in the Central Government undertaken for the first time in 1991 -92 and thereafter, and the audit thereof, are given in the following paragraphs.

7.    In auditing privatisation programmes SAIs have to generally consider their role in three phases namely (i) adequacy of the pre-privatisation steps undertaken by the Government, (ii) the actual process and modalities of the privatisation and (iii) post privatisation effects on the exchequer with a view to finding whether the programme has been carried out to secure the objectives underlying the programme. For SAI in India, the Government's programme of partial disinvestment launched in 1991-92 provided the necessary opportunities and challenges in the audit of privatisation.

Some of the inhibiting factors and difficult areas for SAIs in other countries in performing their audit role were also experienced in India. These were,

1. inability or conscious avoidance to go into the policy considerations underlying the decision to privatise.
2. the difference in perception between audit and executive on

1. the method and modalities adopted,
2. adequacy of pre-privatisation steps,
3. determination of sale price and
4. fulfillment or otherwise of the objectives underlying the privatisation programme.

3. difficulties in the way of timely and complete access to relevant records and
4. delay and reluctance on the part of the Executive in meeting promptly the preliminary audit enquiries.

8.    Auditing in a new area of Government activity like privatisation (or partial disinvestment as in India) also throws up certain challenges. The processes and modalities of privatisation can certainly be examined in audit with conventional audit standards and approaches on the regularity and efficiency of such programmes. The challenge lies in examining the issues relating to adequacy of the sale price and the technique adopted in valuation of shares in a situation where the usual norms for valuation of securities traded in the capital market may not be fully applicable, as in India. The challenge also lies in a balanced and objective assessment not only of the modalities and valuation norms adopted in the sale of equities but also in the rationality and adequacy of the pre-privatisation steps and the post privatisation results to subserve the objectives of the programme. In the areas of sale price determination some SAIs like NAO, UK had taken the assistance of leading merchant bankers for advice to ascertain whether value for money studies are raising the right Audit questions. In India, the consultation obtained by Government during the disinvestment process in respect of selected public enterprises and their findings and the Government's action thereon, were taken into account while framing the audit findings. Another area of challenge in Audit is the need for proper understanding and appreciation of the performance of financial results of the enterprise in question and its standing in the particular Industrial Sector. This is necessary especially where there could be difference in perception between the Government and the concerned Public Enterprises themselves over the timing of the sale, the sale price that can legitimately be assigned as fair and equitable and also about the steps required to create necessary climate for favourable investor perception of the performance, profitability and growth-potential of the enterprises.

9.    The procedure and the modalities of the partial disinvestment programme launched by the Government of India during 1991-92 was subjected to audit by the SAI India and the Audit Report was presented to.Pahiament in April 1993. Some of the major findings were as follows: , '

1. The disinvestment exercise was not preceded by adequate preparatory study and no efforts were made to generate wide spread investor enthusiasm among certain financial institutions/mutual funds to whom the shares were divested.
2. The sale of shares of different PSEs categorised as' very good','good' and 'average' PSEs and grouped together in different bundles had the effect of depreciating the value realisation in respect of 'very good" and 'good' PSEs. Offers received in the first phase of disinvestment were far below prices for each bundle based on the reserved prices fixed for each share. The criterion adopted for categorisation itself was inadequate.
3. Compqsition of bundles of shares in the first phase was determined even before the fixation of reserve prices with the result that, on a test check, it was found that the bundles on an average ranged far higher than the value per bundle approved by the Government; and the bidding financial institutions quoted even lower rates in the absence of minimum bid price per bundle stipulated in the tender.
4. The reserved prices originally fixed on the accepted criteria were reduced drastically when it was found that the low bids received could not have been accepted otherwise. The reduction was based on certain norms which were rejected earlier as unsuitable as it tended to under value the shares. Such reduction in value ranged between 21 to 86 per cent. The reduction in original reserve prices of shares during the two phases of disinvestment resulted in under-realisation of about US $ 1.147 billion, to the exchequer.
5. Tenders received in the first phase of disinvestment were non-competitive. For 72 per cent of the bundles, there was only one bidder, and only for 4.5 per cent bundles three or more bids were received. In the second phase also the tenders received were non-competitive. Out of 273 bids received, 120 bids were from a single bidder, 4 bidders out of 19, including the single, bidder for 120 bids, constituted 68 per cent of the total bids received.
6. In the first phase of disinvestment Government offered shares valued at about 2666 million US $ on the basis of original reserve prices fixed which was far in excess of perceived investible resources of 666.833 million US $ available with the bidders who were financial institutions/ mutual funds.
7. A claw back provision was not incorporated in the terms and conditions of sale to plough back the profits, if any, in after sale by the financial institutions who were intermediaries since the sale of shares was not made directly in the stock exchanges.
8. Some companies were included in the disinvestment programme against the advice of the concerned administrative Ministries/ Companies themselves on specific grounds. This resulted in gross under realisation of receipts.
9. The disinvestment programme served only to contain the fiscal deficit rather than the main objectives underlying the programme viz. to raise resources for the public sector and to encourage wider public participation.

10.    Apart from the above audit findings certain other issues are also relevant in the audit of this programme. These are outlined
         below:

1. Disinvestment policy and programme in India are essentially executive decisions and it was not felt necessary to give it a legal framework as in the case of French privatisation programme. Besides, in India, this was only a partial disinvestment of certain percentage of shares, majority ownership being retained by the Government. SAI in India have therefore not felt the need to ask questions on the necessity of such a legal framework for this policy/ programme.
2. Despite availability of several methods of privatisation, sale by auction for limited number of public institutions was adopted in India. Audit did not comment on the method of disinvestment chosen by the Government per se and confined its findings only to the deficiencies in the actual operation of the procedure adopted and its financial impact on the exchequer.
3. In India, there are no instances of the privatisation of public enterprises which were originally nationalised as in France where Cour des Comptes could undertake the comparative examination of the prices at which they were privatised and the prices at which they were originally nationalised and could arrive at the overall financial impact of the nationalisation and privatisation operations between certain specified periods after adjustment for inflation. However, such an instance may arise in India also, if the Government decides to privatise some of the Public Sector enterprises say, in the oil sector, which were nationalised in the 70s.
4. Another area of challenge is the scope of audit of objectives of privatisation itself; for instance, whether the objectives of privatisation could be for mobilisation of resources for Exchequer to reduce fiscal deficit or for the redemption of Public Debt as in some countries like Germany or as in the recent case in Argentina. Here again SAI in India did not go into this since the policy of disinvestment and the stated objectives thereof had the necessary Executive sanction. The policy objectives were stated in the Budget Speech of the Finance Minister and the estimated receipts to the exchequer were duly incorporated in the Budget Estimates which were voted by Parliament and thus the objectives had the general Parliamentary backing. The scope of Audit was limited to examining the arrangement made by the Government in the sale of shares and to ascertain whether the procedure was satisfactory and was conducive to benefit the exchequer and whether the objectives underlying the programme were satisfied.
5. The focus in Audit by SAI in India of this partial disinvestment programme was more on the outcome of the sale rather than on the study of various sale options or the policy underlying such options.
6. In the Indian experience on Audit of this partial disinvestment programme, one of the problems faced was lack of proper coordination between the concerned Departments namely the Department of Public Enterprises which was the nodal agency and the Ministry of Finance. The Finance Ministry maintained that it was concerned mainly with the policy, while procedure and the modalities were worked out by the nodal agency. As a result, SAI had the problem of securing complete answers to some of the issues from these agencies.
7. Cost effectiveness of the partial disinvestment programme of the Government could not be specifically looked into as the nodal agency as well as public enterprises had not kept adequate data on the identifiable costs of the programme to the exchequer. However, it was felt that since the Government had taken this as a part of normal activity and the staff costs and other incidental costs were not expected to be of significant magnitude, this study was neither considered feasible nor necessary.
8. Another aspect in the audit of such partial disinvestment programmes is SAI's own evaluation of the fair value of the shares of the enterprises involved. Nodal agency in India engaged some consultants in this behalf and the reserve prices were fixed on the basis of certain approved criteria and on the recommendations of the consultants. SAI's own evaluation of the fair price of the shares was not found practicable in view of the following:-

1. A large number of public enterprises' shares were disinvested at a time i.e. as many as 30 enterprises, and the analysis of their accounts based on the suitable method for fair value determination could involve considerable time and effort.
2. The consultants' professional advice was accepted by the Government. Further the nodal agency, in consultation with the public enterprises concerned, determined the average of the two highest values worked out by 'net asset value method' (NAV), 'price earning capacity value method' (PECV), and 'discounted cash flow method' (DCF). It also took into account the recommended prices of the consultants and adopted the best value. This procedure was found to be generally adequate.
3. Share valuation exercise by Audit would have also involved engagement of professional consultants/leading merchant bankers.

9. One of the significant points noticed in the audit of disinvestment programme in 1991 -92 was the anxiety of the Govemmentto complete the sale by a dead line for adjustment of fiscal deficit. This, besides deviating from the basic objectives virtually had the effect of rendering the sale of shares as something like "distress sale" or "clearance sale" as described by a leading Economic Journal "The Economics Political Weekly".
10. One other aspect emphasised in the Audit Report was the inadequacy in the competition. There was also no attempt at negotiations with prospective buyers, particularly when bids quoted were too much on the lower side as compared to the reserve prices. Although the Government as an after-thought, took the position that they were only indicative or reference prices, Audit stressed the point that negotiations could have been resorted to, for the benefit of the exchequer as the bidders were only public financial institutions and were acting as intermediaries. The nodal agency, however, did "not consider the options of either negotiating the bids or rejecting the bids and inviting fresh bids, as they had the problem of sale by a deadline for containing the fiscal deficit by certain date. These compulsions, however, genuine they might have been, could not by themselves justify the procedures adopted and the prices accepted, which resulted in huge under-realisation of the value to the exchequer, calculated with reference to the reserve prices, originally fixed by the nodal agency. The total under-realisation value as worked out by SAI could be considered somewhat notional, as there was no certainty that the same prices would have been realised in the stock market. To meet this point Audit compared the actual traded prices of shares of 10 PSEs listed in the stock market within a few months after the sale by the Government to the financial institutions and found that the traded prices were even higher than the original reserve prices, in most of the PSE shares, and the gains to the Financial Institutions ranged between 126 to 615 per cent.

11.    The Audit Report of SAI India on the partial disinvestment programme of the Government during 1991-92 was received well in the press and also had a good impact in Parliament. The Government themselves improved some procedures in the later phase of disinvestment during 1992-93. The number of financial institutions including public sector banks which were invited to bid was increased. The minimum bid price for the bundles of shares was also subsequently reduced. However, the Government discontinued the bundling procedure during 1992-93 and the value realisation improved significantly for each company share. The Government also constituted a High Power Committee to suggest proper modalities and procedures for disinvestment in subsequent phases. One of the main recommendations of the Committee is that the auction procedure should be continued for the time being instead of direct sale on the Stock Exchange byway of public issues. The Committee is however against the grouping of shares for sale and has recommended sale of shares of individual companies separately. The Committee has also recommended the constitution of a Standing Committee on Public Enterprises Disinvestment, comprising experts from Government, Public Enterprises, Financial Sector and Professionals and academicians. The Parliament and press showed keen interest in the Audit findings. The Audit Report is presently under the consideration of the Public Accounts Committee.

12.    Auditing of privatisation will be more challenging for the SAIs in the coming years. For one thing, more countries in the Asia, Latin America and in the new republics of erstwhile Soviet Union, are bound to embark on different levels of privatisation programmes more rapidly to raise resources, and SAIs have to gear themselves fully to examine the issues in their correct perspective. For another, the auditing in this field will, in years to come, have to focus not only on the modalities and processes adopted, but also on the rational assessment of the fair valuation of shares which will call for greater access to reliable accounts information relating to the enterprises and a higher degree of professional expertise which will facilitate critical and satisfactory value for money studies in such programmes.