PUBLIC SECTOR REVISITED
- The trouble is not government ownership, but interference
Commentarao
S.L. Rao

In the last six months, there has been a sea-change in views about government ownership. Privatization is no longer seen as a universal panacea for the inefficiencies of ownership by the government. It is the interference by the government in management that has to go, not necessarily the ownership.

The financial meltdown in the United States of America and the revival measures required have transformed opinions. Many banks and financial institutions are now owned by the US government (as they have been in India for over 40 years). The regulatory system for the financial sector that was created during the Great Depression by Roosevelt is in shambles.

The Federal Reserve could not foresee the overextended situations of much of the financial sector. Finance products became like currency, no longer representing intrinsic value of the assets they represented as confidence in the system. Housing loans were given with little checking because the lenders thought they were risk-free, with the property market on a constant high. Merchant banks, venture capitalists, brokers and banks, bundled housing mortgages into packages (‘products’) that were the sub-prime mortgages. No one knew what value and quality they actually represented. Similarly, the securitization of debts from credit cards, mortgages, foreign exchange futures, created ‘products’ whose intrinsic values no one knew. These were also rated by rating agencies, which are unregulated for their judgments. These ‘products’ were traded and insured. The insurers did not know their real values.

The stock market regulator, the Securities and Exchange Commission, had little idea of the risks being taken because of computerized ‘programme trading’ in stock market arbitrage and portfolio insurance. Similarly with foreign exchange-based products, with options and futures that were increasingly speculative and with little capital backing from the trading or lending institution. Brokers and many other institutions were into speculative trading, basing themselves on complex mathematical models of markets that assumed normal curves for their risk and values, but did not take account of the volatility at the ‘tails’ of the normal curve. The regulatory system (Federal Reserve, SEC, rating agencies, the self-regulated accounting profession) could not keep pace with the flow of money, the new products created at dazzling speed and becoming huge, and the entry of non-banking institutions with low capitalization into large volumes of financial trading. These products were beyond the ken of regulators accustomed to a slower and less complex environment. A regulatory system that worked for 70 years was unable to understand or regulate this new situation. The federal government was ‘hands-off’ under the Republicans and, under Clinton towards his closing years, relied on Alan Greenspan. He is responsible for the housing bubble, with rising house prices due to the constant lowering of interest rates, destroying savings habits and pushing up asset values. Public ownership of failing financial institutions was the only way to save the American economy.

Transparency, regulation that is tough and up-to-date on market developments, ensuring that every stakeholder knows the score, can deter private owners or representatives of the government as owner. They can be made to perform and to behave.

In India, the complexity of financial markets is yet not there. The regulators (the Reserve Bank of India, the Securities and Exchange Board of India) have got stronger, because of personalities and the transparency of regulated entities. Over the 1990s, recapitalization of nationalized banks helped their ability to lend. Service improved. The “loan melas” of past years, allowed by compliant RBI governors, could not happen. Venugopal Reddy, a strong RBI governor, made inflation control his priority despite government pressures to reduce interest rates and go for growth. He used relatively high interest rates to keep inflation down despite rising government fiscal deficits. But the government’s desperation to increase foreign exchange reserves through foreign institutional investment inflows led to the “irrational exuberance” of stock markets, as funds ebbed and flowed, and then were recently withdrawn to shore up the head offices of foreign banks and FIIs. This led to sudden declines in rupee values. Government ownership of banks and strong financial regulation by the RBI countered the policies of the government. But government policy created volatility in stock markets and pushed down the rupee’s foreign exchange value.

Public sector enterprises did not have the backing of a powerful regulator like the RBI to keep predatory hands of government representatives from meddling with their operations. Ministers and their bureaucrats continue to exert “ownership”. The excuse is that they have to report to Parliament; though it is rare for Parliament to discuss the performance of PSEs. The excuse of parliamentary reporting gave these government representatives a free hand to interfere in staff appointments, investments, purchases, and competitive strategies.

The problem with PSEs is not ownership but the behaviour of the government representatives with the enterprise. Politicians and bureaucrats treat a PSE as their personal fiefdom and use it to benefit themselves, promote their ideology, promote lackeys, and prevent the enterprise manager from functioning autonomously. The plight of Air India and Bharat Heavy Electricals Limited are good examples. Air India was prevented from replacing old aeroplanes for over 10 years, while private competitors were licensed to take over the domestic market and foreign airlines the overseas market. Some of the ‘owners’ must have personally benefited. Even ‘good’ PSEs like BHEL have been failing to deliver equipment on time and to keep pace with technology because of government interference. Expansion of power supply was a casualty.

Privatization removes financial burdens from the government (except when they fail, and the government has to pump in huge amounts to prevent the economy from collapsing). For example, the public-private partnership running the earlier fully government-owned Delhi electricity distribution has significantly improved performance while removing a major financial burden from the Delhi administration. The Gujarat electricity system is under full government ownership and under a proactive chief minister; it has achieved similar results under government ownership. Not ownership, but the autonomy of managements and their accountability are what matters.

Preventing ministerial and bureaucratic interference in PSEs, putting them under independent regulatory surveillance, appointing the best people to run them, and paying them well, can make PSEs perform well even under government ownership. Changing legislature rules so that only reports have to be placed on the table of the legislature concerned but not discussed, and creating an independent regulatory commission to oversee PSEs to ensure accountability of their managers, are essential.

All enterprises must work within a framework of regulations and overall control by a board with a majority of independent directors. The directors must be courageous enough to ask questions. This is ‘corporate governance’. Regulators — the RBI, Sebi, the Institute of Chartered Accountants of India, the registrar of companies, the Central electricity regulatory commission, the telecommunications regulatory authority of India and others to come, and a new regulator for PSEs — and subservience to the shareholders, must be the mantra for public and private enterprises. Experiments to distance the government from the management of PSEs have failed. The annual MoU between the government and the PSE, and navaratnas with more autonomy, failed. The holding company did not insulate the subsidiaries from the government. The joint sector worked well in Maruti, Delhi electricity distribution and other instances.

Privatization was a desperate solution to distance government from managements of public enterprises. It is not the only way to improve public enterprise performance.
The author is former director- general, National Council for Applied Economic Research