Themes > Current Issues
01.06.2000
Airlines:
The Specious Logic of Privatisation
C.P.
Chandrasekhar
The
focus of the government's privatisation drive has shifted to the civil
aviation sector. In a move aimed at scorching rumours of dissension
within the cabinet regarding its "big ticket" privatisation
drive, the Prime Minister reportedly convened, towards the end of
May, a meeting of the Cabinet Committee on Disinvestment. That meeting
arrived at what amounts to the most far-reaching decision as yet with
regard to the nature and thrust of the privatisation process under
the BJP-led regime. The government, it was decided, would offload
up to 60 percent of its stake in India¹s national flag carrier, Air
India. Of this 26 per cent would be offered to a strategic partner
who could be from abroad, another 14 per cent to a domestic strategic
partner, 10 per cent to the financial institutions and other domestic
investors and the remaining10 per cent to employees of the company.
Strategic sales of public assets, as defined by the government, are aimed at handing over the management of the company to the private sector. Thus, the move clearly expects an alliance of some kind between interested foreign investors and domestic private investors who, together, would control 40 per cent of the equity in the company after privatisation. Needless to say, in such a tie-up, the foreign investor, who controls the largest block of equity, other than for the government divesting managerial responsibility, would be the determining influence on the operations of the privatised company. A shareholders agreement, to be negotiated as part of the sale, would ostensibly define the relative roles of the strategic investors and the government, which through its own shareholding and that of the financial institutions would still be in control of 50 per cent of equity in the company. As if to allay fears that the government had set the scheme up for a take over of management by foreign investors, the Minister for Disinvestment, Arun Jaitley, issued a clarification. The scheme, he said, allows for the possibility of a domestic investor acquiring up to 40 per cent of equity, provided it had the resources and the technical skills to run the company along competitive lines..
The decision on Air India comes in the wake of an earlier decision to divest 51 per cent in the dominantly domestic carrier Indian Airlines, with 26 per cent being offered to a single buyer who, once again, would be handed over the management of the company. The somewhat delayed appointment of a global advisor in the case of Indian Airlines and the appointment of a similar advisor in the case of Air India are to occur soon. This would allow the government to complete the process and garner a part of the Rs. 10,000 crore from disinvestment targeted for in the Budget for 2000-01, well before the March-end deadline.
These decisions are indeed surprising for a number of reasons. Most nations have sought to create, and still maintain, a state-owned national carrier (or carriers) flying international and domestic routes on strong economic and social grounds. Principal among these are the need to ensure adequate flights connecting the country concerned to the major airline hubs of the world and the need to connect different centres within the country, even if operating such connections are not in the first instance profitable. International connnectivity and ease of access is crucial especially when a country is attempting to engage international markets and build commercial bridges with the rest of the world. And integration and development without excessive regional inequality very often requires ensuring transportation and communication networks, which in themselves may not be profitable but yield substantial external benefits. In sum, state ownership in the airline industry may be essential from the Œdevelopmental¹ point of view of ensuring connectivity across points between which traffic is low. This is achieved by cross-subsidising unprofitable operations with revenues from more lucrative routes and even accepting an overall deficit which is financed through taxation. A form of support for such cross-subsidisation is the provision of a captive market. Since the various arms of government are themselves major clients on international and domestic routes, diverting that traffic to the state-owned carrier ensures a minimum of revenue along profitable routes, besides reducing foreign exchange outgo from the country. Thus, privatisation of the airline sector, which does away with state control and state support and leaves the decision of which points to connect and at what frequency to be determined purely by the profit motive, can result in economically and socially damaging results in the long run.
It need not be true at all that the indifferent financial performance of India¹s publicly owned airline companies arises purely from the social role they have hitherto been called upon to play on these grounds. Part of the reason their financial bottom line is disappointing may indeed be a combination of poor management and excessive governmental intervention. But privatisation as a means to trim the fat is by no means the best answer. To start with, instances where privately-owned firms make erroneous investments decisions or manage companies poorly are legion. The recent experience with private entry into the domestic airlines sector itself is indicative, with many players such as Modiluft and NEPC having burnt their fingers and exited at considerable private and social loss. Further, it is yet unclear how much fat there is to trim in the existing operation of the two airlines.
But private acquirers of Indian Airlines and Air India need not rely just on improvements in productivity in existing routes to improve profitability. They can exploit the opportunity to eat into the "social routes" when either there is not enough fat to trim or when they are new unable to cut the existing fat in the state-owned airlines. That is privatisation may just be a process of transforming what where social gains or benefits into private profits. The latter may be inevitable given the high returns which are expected by private investors based on hypothetical calculations of profits foregone by choosing this rather then some other lucrative area of investment.
It should be obvious that any effort by the government to use the its own residual shareholding and the shareholders agreement with the likely private investors as a means of preventing the transformation of social benefits into private profits would be subverted. Given the logic of private calculations of the opportunity costs of investing in the airlines sector, any attempt at restricting profit maximising tendencies would make the exercise of privatising airlines one more instance of the failed experiments with privatisation in recent years.
It is this aspect of the privatisation process that makes the motivation behind the choice of the "strategic sale" route suspect. The remarkable feature of this method of privatisation is that management control is handed over to a private investor in return for acquisition of a minority stake. In the case of the airlines sector, by handing over management control in return for purchases varying between 26 and 40 per cent of equity, the government is allowing one or a combination of two or more minority private shareholders to transform the objectives of the company. The implied willingness to trade social gains for private profits could be traced to a desire to achieve either one or a combination of two objectives. That of wanting to make the privatisation offer unusually attractive, or that of wanting to use private management as the hatchet with which to close "unprofitable" routes and slash cross-subsidisation to improve profitability in return for a share in those profits. That is, privatisation becomes a means of cutting social expenditures, which are given a bad name by treating them as "implicit subsidies" that in government parlance has come to mean populist "give aways".
But even this is not easily achieved. The current performance of the airlines sector is not merely the result of the adverse impact of cross-subsidisation on financial profitability but of the beneficial impact of offering a captive client to the operator in the form of the many arms of government. Once social objectives are dropped and competition and market principles made the rule, there is no logic to the provision of such a captive market. If the government pursues logic and allows full freedom to official travellers to choose their airline on all routes, the expected gains from privatisation may remain unrealised, especially since ownership change per se does not necessarily improve profitability. If it does the value of the 50 per cent equity, which the government has chosen to continue to hold in order to facilitate privatisation, would collapse, making the whole exercise a financially disastrous one.
It is not surprising therefore that the decision to privatise the airline industry has been mired in controversy not just outside but also within the government. According to reports, Civil Aviation Minister Sharad Yadav has been a staunch opponent of the disinvestment move, and it has taken some persuasion by Mr Jaitley and intervention by the Prime Minister for the decision to go through the Cabinet Committee on Disinvestment. This rather stubborn insistence on going ahead with "strategic sales" in an area where there still remain strong arguments for control by the state stems from many sources. Primarily it comes from the ideological and political moorings of the BJP. First, the BJP and the Jana Sangh out of which it evolved is the most economically conservative and pro-business political formation in the country, which has recently given up even the nationalist rhetoric that made it appear as favouring domestic rather than international capital. Second, in keeping with this transformation, the BJP under Prime Minister Vajpayee has decided to virtually steal the "reform" agenda from the Congress and make it its own, necessitating an acceleration and intensification of the liberalisation process. Third, the BJP has clearly decided to use this liberalisation process and the "modernity" it is claimed to symbolise to divert attention from its deeply conservative, retrogade and divisive social and cultural ideology.
These fundamental influences driving the BJP¹s reform agenda in general and the privatisation plank in particular have been supported by more immediate factors. One of these is the need to appease the G-7 in general and the US in particular, by offering "big-ticket" liberalisation as a sop for not overreacting to the BJP¹s "nuclear natioinalism". The other is the need to deal with the contradiction involved in placating domestic business with low tax rates, while satisfying the demands from the IMF and the international financial interests it represents, to rein in the fiscal deficit. The resources garnered from privatisation help at least temporarily resolve this conflict and provide the government with some additional resources to go about its routine activities, even if at the expense of substantial future revenues.
The fact that such a range of motives govern the process of privatisation through strategic sale does, however, send out a damaging signal. The desperation to sell potentially lucrative assets to the private sector gives the "strategic buyer" a negotiating advantage. A host of reasons can be found to undervalue assets and sell them cheap. In the event, in the event of failure to ensure that the opposition wins, reason prevails and indiscriminate privatisation halted, the least that should be secured is transparency in the valuation process. If not, a group of private investors are bound to take over the market for airborne traffic at bargain prices, even though the process involves considerable social cost.
Strategic sales of public assets, as defined by the government, are aimed at handing over the management of the company to the private sector. Thus, the move clearly expects an alliance of some kind between interested foreign investors and domestic private investors who, together, would control 40 per cent of the equity in the company after privatisation. Needless to say, in such a tie-up, the foreign investor, who controls the largest block of equity, other than for the government divesting managerial responsibility, would be the determining influence on the operations of the privatised company. A shareholders agreement, to be negotiated as part of the sale, would ostensibly define the relative roles of the strategic investors and the government, which through its own shareholding and that of the financial institutions would still be in control of 50 per cent of equity in the company. As if to allay fears that the government had set the scheme up for a take over of management by foreign investors, the Minister for Disinvestment, Arun Jaitley, issued a clarification. The scheme, he said, allows for the possibility of a domestic investor acquiring up to 40 per cent of equity, provided it had the resources and the technical skills to run the company along competitive lines..
The decision on Air India comes in the wake of an earlier decision to divest 51 per cent in the dominantly domestic carrier Indian Airlines, with 26 per cent being offered to a single buyer who, once again, would be handed over the management of the company. The somewhat delayed appointment of a global advisor in the case of Indian Airlines and the appointment of a similar advisor in the case of Air India are to occur soon. This would allow the government to complete the process and garner a part of the Rs. 10,000 crore from disinvestment targeted for in the Budget for 2000-01, well before the March-end deadline.
These decisions are indeed surprising for a number of reasons. Most nations have sought to create, and still maintain, a state-owned national carrier (or carriers) flying international and domestic routes on strong economic and social grounds. Principal among these are the need to ensure adequate flights connecting the country concerned to the major airline hubs of the world and the need to connect different centres within the country, even if operating such connections are not in the first instance profitable. International connnectivity and ease of access is crucial especially when a country is attempting to engage international markets and build commercial bridges with the rest of the world. And integration and development without excessive regional inequality very often requires ensuring transportation and communication networks, which in themselves may not be profitable but yield substantial external benefits. In sum, state ownership in the airline industry may be essential from the Œdevelopmental¹ point of view of ensuring connectivity across points between which traffic is low. This is achieved by cross-subsidising unprofitable operations with revenues from more lucrative routes and even accepting an overall deficit which is financed through taxation. A form of support for such cross-subsidisation is the provision of a captive market. Since the various arms of government are themselves major clients on international and domestic routes, diverting that traffic to the state-owned carrier ensures a minimum of revenue along profitable routes, besides reducing foreign exchange outgo from the country. Thus, privatisation of the airline sector, which does away with state control and state support and leaves the decision of which points to connect and at what frequency to be determined purely by the profit motive, can result in economically and socially damaging results in the long run.
It need not be true at all that the indifferent financial performance of India¹s publicly owned airline companies arises purely from the social role they have hitherto been called upon to play on these grounds. Part of the reason their financial bottom line is disappointing may indeed be a combination of poor management and excessive governmental intervention. But privatisation as a means to trim the fat is by no means the best answer. To start with, instances where privately-owned firms make erroneous investments decisions or manage companies poorly are legion. The recent experience with private entry into the domestic airlines sector itself is indicative, with many players such as Modiluft and NEPC having burnt their fingers and exited at considerable private and social loss. Further, it is yet unclear how much fat there is to trim in the existing operation of the two airlines.
But private acquirers of Indian Airlines and Air India need not rely just on improvements in productivity in existing routes to improve profitability. They can exploit the opportunity to eat into the "social routes" when either there is not enough fat to trim or when they are new unable to cut the existing fat in the state-owned airlines. That is privatisation may just be a process of transforming what where social gains or benefits into private profits. The latter may be inevitable given the high returns which are expected by private investors based on hypothetical calculations of profits foregone by choosing this rather then some other lucrative area of investment.
It should be obvious that any effort by the government to use the its own residual shareholding and the shareholders agreement with the likely private investors as a means of preventing the transformation of social benefits into private profits would be subverted. Given the logic of private calculations of the opportunity costs of investing in the airlines sector, any attempt at restricting profit maximising tendencies would make the exercise of privatising airlines one more instance of the failed experiments with privatisation in recent years.
It is this aspect of the privatisation process that makes the motivation behind the choice of the "strategic sale" route suspect. The remarkable feature of this method of privatisation is that management control is handed over to a private investor in return for acquisition of a minority stake. In the case of the airlines sector, by handing over management control in return for purchases varying between 26 and 40 per cent of equity, the government is allowing one or a combination of two or more minority private shareholders to transform the objectives of the company. The implied willingness to trade social gains for private profits could be traced to a desire to achieve either one or a combination of two objectives. That of wanting to make the privatisation offer unusually attractive, or that of wanting to use private management as the hatchet with which to close "unprofitable" routes and slash cross-subsidisation to improve profitability in return for a share in those profits. That is, privatisation becomes a means of cutting social expenditures, which are given a bad name by treating them as "implicit subsidies" that in government parlance has come to mean populist "give aways".
But even this is not easily achieved. The current performance of the airlines sector is not merely the result of the adverse impact of cross-subsidisation on financial profitability but of the beneficial impact of offering a captive client to the operator in the form of the many arms of government. Once social objectives are dropped and competition and market principles made the rule, there is no logic to the provision of such a captive market. If the government pursues logic and allows full freedom to official travellers to choose their airline on all routes, the expected gains from privatisation may remain unrealised, especially since ownership change per se does not necessarily improve profitability. If it does the value of the 50 per cent equity, which the government has chosen to continue to hold in order to facilitate privatisation, would collapse, making the whole exercise a financially disastrous one.
It is not surprising therefore that the decision to privatise the airline industry has been mired in controversy not just outside but also within the government. According to reports, Civil Aviation Minister Sharad Yadav has been a staunch opponent of the disinvestment move, and it has taken some persuasion by Mr Jaitley and intervention by the Prime Minister for the decision to go through the Cabinet Committee on Disinvestment. This rather stubborn insistence on going ahead with "strategic sales" in an area where there still remain strong arguments for control by the state stems from many sources. Primarily it comes from the ideological and political moorings of the BJP. First, the BJP and the Jana Sangh out of which it evolved is the most economically conservative and pro-business political formation in the country, which has recently given up even the nationalist rhetoric that made it appear as favouring domestic rather than international capital. Second, in keeping with this transformation, the BJP under Prime Minister Vajpayee has decided to virtually steal the "reform" agenda from the Congress and make it its own, necessitating an acceleration and intensification of the liberalisation process. Third, the BJP has clearly decided to use this liberalisation process and the "modernity" it is claimed to symbolise to divert attention from its deeply conservative, retrogade and divisive social and cultural ideology.
These fundamental influences driving the BJP¹s reform agenda in general and the privatisation plank in particular have been supported by more immediate factors. One of these is the need to appease the G-7 in general and the US in particular, by offering "big-ticket" liberalisation as a sop for not overreacting to the BJP¹s "nuclear natioinalism". The other is the need to deal with the contradiction involved in placating domestic business with low tax rates, while satisfying the demands from the IMF and the international financial interests it represents, to rein in the fiscal deficit. The resources garnered from privatisation help at least temporarily resolve this conflict and provide the government with some additional resources to go about its routine activities, even if at the expense of substantial future revenues.
The fact that such a range of motives govern the process of privatisation through strategic sale does, however, send out a damaging signal. The desperation to sell potentially lucrative assets to the private sector gives the "strategic buyer" a negotiating advantage. A host of reasons can be found to undervalue assets and sell them cheap. In the event, in the event of failure to ensure that the opposition wins, reason prevails and indiscriminate privatisation halted, the least that should be secured is transparency in the valuation process. If not, a group of private investors are bound to take over the market for airborne traffic at bargain prices, even though the process involves considerable social cost.
© MACROSCAN 2003