By Sumeet Chatterjee and Tony Munroe

India is not making life easy for itself as it looks to sell-off stakes in state companies to help plug a yawning budget gap, with New Delhi's own policies battering sentiment towards government enterprises even as it readies more for market.

This week the government ordered state-run Coal India to sign guaranteed supply pacts with power producers at below-market prices, raising the hackles of British activist investor The Children's Investment Fund Management (TCI).

TCI, which owns 1 percent of Coal India, the world's largest coal miner, plans legal action against it for not protecting minority shareholder interests.

The coal order follows a proposal in last month's budget to lift tax on oil production that will knock $978 million from Oil and Natural Gas Corp's pre-tax profit. That came weeks after a messy government selldown of a $2.5 billion stake in ONGC that ended up mostly in the hands of a state insurer.

"It will be difficult for the government to find buyers of shares in the public sector firms after the recent decisions," said Juergen Maiar, a Vienna-based fund manager with Raiffeisen Euroasien Aktien, which owns Indian shares worth $300 million, including a stake in ONGC.

"The interference by majority shareholders is not new, but how can the government set a very high divestment target and take decisions that will definitely hit companies' profit," said Maiar, who does not plan to add to his state holdings.

The budget made headlines with provisions that could retroactively tax long-completed mergers, potentially putting Vodafone Plc back on the hook for more than $2 billion in tax, despite a win in India's Supreme Court in January.

The British mobile operator had fought a 5-year legal battle against the tax demand over its acquisition of Hutchison Whampoa Ltd's Indian mobile assets in 2007.

Uncertainty over another budget proposal that could tax foreign institutional investors has also spooked overseas funds, which typically buy the majority of large Indian equity sales.

"It's counterintuitive to see the government making life difficult for public sector companies, and foreign investors for that matter, while it is in desperate need for cash and foreign funding," said Michiel van Voorst, a fund manager at Robeco in Hong Kong, which manages $400 million in India.

India, expected to struggle to meet a target to cut its fiscal deficit to 5.1 percent of GDP from 5.9 percent, aims to sell 300 billion rupees ($5.9 billion) of state shares this fiscal year after raising just 140 billion rupees in the year just ended, less than half its 400 billion rupee goal.

The target looks harder to reach after Bharat Heavy Electricals, India's biggest power equipment maker, this week withdraw plans for a share sale expected to raise roughly $1 billion for the government. BHEL has been hard-hit by delays in the construction of power plants due to red tape and a lack of coal.

DUELLING MANDATES

India's cash-strapped government uses state companies both to raise funds and as policy instruments.

"Our hands are tied and feet are shackled, and then we are asked to run and win the Olympics," said a senior executive at a large state company, who declined to be identified given the sensitivity of the matter.

TCI partner Oscar Veldhuijzen said Coal India could earn a further $20 billion in pre-tax profit a year if it priced coal at market rates.

"They are sort of hiding themselves behind the definition of public interest. In our opinion, it is very clear that the government is not acting in the public interest," he said. "They are destroying the appetite in the capital market for PSUs (public sector undertakings)."

Just as Coal India, which raised $3.5 billion in 2010 in India's largest IPO, must sell output at below-market prices, state oil companies carry a heavy and unpredictable burden selling subsidised products.

New Delhi has waited more than a year to sell a chunk of Indian Oil, India's largest oil retailer, which haemorrhages money selling subsidised fuel. It posted a record loss in the September quarter, and its shares are down 33 percent since shortlisting banks for the offering in late 2010.

While petrol prices are deregulated, state refiners are under pressure from an embattled government not to raise prices.

State companies are run for the government's benefit, said David Cornell, managing director in Mumbai for UK-based fund manager Ocean Dial Advisers, which manages about $150 million in Indian assets.

"They just happen to list on the expectation of future improvement in the treatment of minority shareholders, but when the government is short of money it's not going to happen." ALB

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