Tuesday, March 02, 2010

The fallacy of public sector disinvestment

In his recent budget, Mr Pranab Mukherjee announced that through disinvestment of public sector undertakings ( PSUs) , he would be able to cut down the fiscal deficit significantly. The Finance Minister has projected that he will raise about Rs 40,000 crores through disinvestment in the coming fiscal year.

Immediately after he made the announcement there was an intense debate in the media about whether the estimate was too optimistic. I would suspect the projection is indeed too optimistic for a government which in the recent past has been tentative when it comes to bold economic reforms.

But I have a more basic objection to the money from disinvestment being used to reduce the fiscal deficit. As I mentioned in an earlier blog, almost 73 % of the fiscal deficit is made up by the revenue deficit. And revenue expenditure items are bad for the economy as they do not create long term income generating assets. So what the finance minister is telling us is that he will sell the family silver to meet current consumption needs.

Let me explain this point with an analogy. When we middle class people sell a property, it is usually to buy another property. if we do not buy another property, we would at least put the money in a long term investment that will yield good returns over a period of time. We don't sell our property to land up in the pub or shopping mall everyday! Nor do we do so to go on an expensive foreign holiday.

Another misleading argument given by a leading business magazine in the country is that disinvestment of PSUs will lead to wealth transfer from the government to the public. That can happen only if the Government starts selling its stake in PSUs at artificially low prices. Why should anyone sell the family silver at distressed prices? When divesting, the Government's concern should not be with wealth transfer. It should be with getting the best possible price. After all, the wealth of the PSUs belongs to the entire nation. if the Government sells off its stake at unrealistically low prices, the people who benefit will be the top 5% of the income group. Whereas if the Government gets a good price, it will have more money available to eliminate unproductive expenses and also deploy in schemes which can help the poor.

What should the Government actually do with the disinvestment proceeds? I think the best thing it could do is to reduce the debt burden which has grown to humongous proportions over time. Reducing the debt burden will bring down the interest outflows which today constitute the biggest expenditure item in the budget.In contrast, using the disinvestment proceeds to fund the revenue deficit would be unethical and bad for the economy. It would violate the basic principles of fiscal discipline.

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