BREAD Working Paper No. 116, April 2006

Testing Limits to Policy Reversal: Evidence from Indian Privatizations

Siddhartha G. Dastidar, Ray Fisman, Tarun Khanna

Abstract

We examine the effect of regime change on privatization using the 2004 election surprise in India. In that election, the pro-reform BJP was unexpectedly defeated by a less reformist coalition. Stock prices of government-controlled companies that had been slated for definite privatization by the BJP dropped by approximately 3.5 percent relative to private firms. Surprisingly, government-controlled companies that were only under study for possible privatization fell by 7.5 percent relative to private firms. We interpret this as evidence consistent with investor belief of policy irreversibility, where reforms may reach a 'point of no return' beyond which future regimes have difficulty reversing those policies. Further analysis suggests that layoffs, combined with the privatization announcement, served as a credible commitment to the government's privatization agenda.

Keywords: government commitment, layoffs, electoral turnover, government policy credibility

JEL classification codes: G15, G38, H11, L33

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