The government's failure to sell all of the shares in its $2.5 billion auction of a five per cent stake in Oil and Natural Gas Corp is an embarrassing setback in its effort to revive stock sales and trim a yawning fiscal deficit.

ONGC shares fell more than 2 per cent on Friday, a day after a glitch-ridden auction saw just 98.3 per cent of the shares taken up. Media reports said state-run Life Insurance Corp of India (LIC) had bought a huge chunk of the shares.

LIC officials could not be reached for comment. New Delhi hoped to follow up the ONGC sale by unloading shares in companies including Bharat Heavy Electricals Ltd, Steel Authority of India Ltd and Oil India but will need to rethink how it manages and prices those deals.

It will also need to address the concerns of overseas institutional investors about regulatory risk associated with investing in state-run companies.

A lack of clarity on how much of India's hefty oil subsidies would be borne by ONGC was a key deterrent to more interest from foreign institutions.

"Perhaps the fatal misunderstanding was, I think, the government banked on a couple of large investors to come in as anchors so to speak and lift a lot of that stock," said Saurabh Mukherjea, head of equities at Ambit Capital in Mumbai.

"Those guys failed to materialise, perhaps without assurances from the government on subsidy sharing," he said.

The floor price for the auction was set at 290 rupees late on Tuesday, a 2.3 percent premium to the day's closing price, prompting widespread criticism that it should have been priced at a discount.

Shares of ONGC, India's second most valuable company, were trading at 281.95 rupees on Friday.

AUCTION MESS
The auction itself drew wide criticism. The websites of the two main exchanges failed to update bid activity after 3:20 pm, 10 minutes before the close of the auction, leaving investors in the dark about the outcome of bidding.

Soon, TV stations reported that two-thirds of the shares had been bid for, but there were no official confirmations.

The result was finally announced about seven hours later by the exchanges, which said some buy orders had been erroneously rejected by custodians and that their own systems 'operated normally and smoothly and there were no glitches'.

Government officials went into a crisis meeting on Thursday night, emerging six hours later.

"The merchant bankers and the stock exchanges are clearly at fault for all the mess that has been created and for keeping things under wrap without keeping people posted about the same," Arun Kejriwal, an independent market analyst, wrote on his website on Friday.

The government, which is widely expected to miss its target to trim its deficit this fiscal year to 4.6 per cent of GDP by a percentage point or more, is desperate to pare stakes in state firms but has been thwarted by weak markets.

The ONGC deal would bring its total share sale haul for the fiscal year that ends this month to about $2.75 billion, far short of its rough target of $8 billion.

The government's direct holding in ONGC will fall to about 69 percent with the sale of the five percent stake.

"Had this ONGC issue got a healthy response, it would have added a positive flair to market sentiment and future disinvestment proposals," said Jagannadham Thunuguntla, head of research at SMC Capital.

In a move that expands its options, New Delhi on Thursday allowed cash-rich state companies to buy back shares, with the cash proceeds going to the government.

Citigroup, Bank of America Merrill Lynch, HSBC, Morgan Stanley, Nomura and India's JM Financial advised on the ONGC deal.