Is this sector the new Kingfisher?

Aug 9, 2012

In this issue:
» Chinese stock market fails to react to reforms
» Mutual fund AUMs concentrated in key metros
» Are the days of CASA led profits over for banks?
» Will Goldman Sachs' MIST replace the BRIC?
» ...and more!

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It took a massive power grid failure last week to help Indian policy makers realize the gravity of power sector problems. Activity in much of India ground to a halt as the outage plunged 20 of the country's 28 states into darkness for nearly two days. The blame game continues between the government, power generators and distributors. But the fact remains that with such an attitude India's growth plans are rapidly taking a back seat. Moreover, the problem no longer remains confined to a grid failure. It has now extended to colossal losses with state distributors and their financers.

The problem of inefficiency and under capacity has seeped into the country's electricity sector since decades. The Electricity Act of 2003 did seek to sort out some problems with State Electricity Boards (SEBs). But after a few years of promising performance the latter are once again defunct entities. To add to the problem, they have also dragged several banks and financial institutions into the mess!

The government's enthusiasm to add power generation and transmission capacity was well placed. But coercing government lenders to lend to SEBs without adequate collateral was completely uncalled for. As per Financial Express, the outstanding loans to state power utilities has grown to a staggering Rs 6 trillion or 6% of India's GDP! The total borrowed funds from banks alone have grown by 56% in the past two years. What is even more appalling is that roughly a third of these are loans were taken to fund past losses. The losses are so massive that they cannot even be serviced through tariff hikes. And as a result the government wants PSU banks and power financers (like Power Finance Corp. and Rural Electrification Corp.) to restructure these loans. In other words, the financers have to take the brunt of these bad loans on their own books!

Despite such gross misuse of funds, states continue to follow a cautious and staggered approach on tariff hikes. For states like Rajasthan, Madhya Pradesh and Tamil Nadu tariff hikes in the range of 65% to 80% will be needed to bridge the revenue gap for the SEBs. Such tariff shocks are, of course, not politically feasible!

Extensive reforms or privatization of the SEBs seems to be the only way to get the sector and its lenders out of the mess. But that is only possible after the stakeholders take some accountability for their misdoings. Meanwhile it will be the PSU banks adding to their restructured loan books. Ones that have already been burdened with aviation sector loans.

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 Chart of the day
As Securities and Exchange Board of India (SEBI) contemplates re-introduction of entry loads for mutual funds to penetrate into newer markets, even the top metro cities seem to be grossly under penetrated. As per data from Economic Times, excluding Mumbai which corners nearly 45% of the share of mutual fund assets under management, the other metros together account for barely 30%. Such gross under penetration of financial products seems to be the key reason for Indian households' low exposure to financial products.

Data source: Economic Times

A change of guard mostly goes hand in hand with change in policies. Thus, when China bought a new person to helm its stock market regulator, people were expecting a strong dose of reforms. And they have certainly not been disappointed. Mr Shuqing, the man at the center of it all, has got some really good long term plans. And if implemented properly, will no doubt put the Chinese stock market on a firm foundation. However, the reaction by the market has been anything but impressive. The Financial Times reports how the Chinese benchmark index is down nearly 13% ever since Shuqing took charge.

Clearly, it will be wrong to put the entire blame on Mr Shuqing. The lacklustre Chinese economy is a bigger reason why stocks are heading nowhere. In the same breath, it will be naive to expect stock market reforms alone to turn Chinese equities into a wealth creating machine. Reforms no doubt are important but the bigger differentiators lie elsewhere. Stock markets flourish in countries where property rights are respected and where there is an efficient dissemination of information. They flourish where there is a strong focus on return on capital and the management works in the interest of all stakeholders. And as long as these qualities keep coming up short in the Chinese economy, no amount of stock market reforms will do the trick we believe.

It takes years to build a reputation and moments to ruin it. Scandal struck companies like Satyam whose fortunes have turned for the worse in matter of hours are testimony to the age old saying. Unfortunately, it is not just one entity that suffers. It is the reputation of entire nation that takes the blow. Not to mention the retail investor that gets dragged along.

The image of India as an investment destination has been tarnished due to a slew of scandals in the recent few years from Satyam to 2G scam. Hence, the need of an institutional reforms and fraud prevention and control mechanism can't be over emphasized. To address this, the Government of India has suggested the need of a watchdog regime to protect investors from the financial frauds. While the possibility of corporate frauds can't be totally ruled out, we believe that a proactive approach will to some extent discourage such practices. However, setting up such practice will just be a beginning. The Government will need to modify it time to time to make sure that offenders don't find a way to get around the loopholes.

A company's profitability is dependent on the uniqueness of its business model. In banking, however, there is little beyond the usual ritual of borrowing and lending. Even then few PSU and private sector banks managed to make a niche over the past decade. The trick was to amass accounts that were stocky but least expensive. Private sector banks like HDFC Bank and Axis Bank earned their superior margins by stocking up CASA. This abbreviation for current and savings accounts later also became the mantra for PSU heavyweights like State Bank of India (SBI) and Punjab National Bank (PNB). That current accounts were almost free and savings accounts interest was capped at 3% made all the difference. However, the RBI's mandate of freeing up interest on savings accounts brought in competition. While the banks with big CASA levels lost some edge, others like Yes Bank managed to garner new accounts by offering higher rates. Critics believe that this could be the norm going forward. And then the banks that boasted of profitability so far will have to look for non CASA avenues. We do not quite agree with this logic.

It is true that as markets mature Indian consumers will look for better returns from their bank balances. However, unlike in the telecom sector, banking sector is unlikely to see a huge customer shift due to interest differential. The new players could initially attract customers with better rates. But getting too aggressive on this count will sound doom for them. As like the aggressive telecom players they will be writing their own obituary.

When Goldman Sachs coined the term BRICs (Brazil, Russia, India, China) almost a decade back, the entire world sat up and took notice. The idea was that these 4 emerging nations would grow at a stupendous rate in the coming years and by 2050 probably match the GDP of some countries in the developed world. The BRIC countries have certainly displayed impressive growth over the last many years. Even when the crisis struck, these countries were able to bounce back at a rapid rate. But now many problems are beginning to crawl out of the woodwork. Slowing growth, high inflation, formation of asset bubbles are some of the concerns that have emerged from those regions. Thus, even though the US and Europe continue to languish in the dumps, these 4 emerging markets are not offering strong returns to investors either. And so Goldman has come out with another fund called N-11 and has coined the term MIST for the four biggest markets of these. These so called MIST nations comprise of Mexico, Indonesia, South Korea and Turkey. The fund has generated 12% in the year so far. The BRIC fund in contrast has gained only 1.5%. That said, whether these MIST nations are just another fad or really have the potential to generate healthy returns in the years ahead remains to be seen.

Taking off from where they left yesterday, the indices in Indian equity markets continued to hover around the dotted line for most part of today's session. The BSE Sensex was trading lower by around 48 points at the time of writing. Telecom, banking and auto stocks were under the maximum pressure. Most other Asian indices closed higher today while Europe opened on a positive note.

 Today's investing mantra
"We have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist" - Warren Buffett

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    8 Responses to "Is this sector the new Kingfisher?"

    Raghvinder Joshi

    Aug 14, 2012

    Calcutta and Bombay have had private power distributers for many years. The consumers in these cities have been enjoying quality service. Country's recent experience with Privatisation of Delhi and Mumbai airport appears to be working against the customers; the airlines as well as the passengers. So even though it is the right thing to do, privatisation should be backed by adequate caution and some effective regulation.



    Aug 10, 2012

    From Government raj to liberalization and now to watchdog raj. Oh what a transition for India. We are incapable of handling any type of freedom. Where have we gone wrong with such great epics and history and what not? Anyway we have become shameless, thick skinned and apathetic with a political class just goes about caring nothing but their vote banks who can be purchased with a locally distilled cheap liquor and a packet of food and may be a big green Ghandhi picture. And then they have the license to loot to such extent that see our various electricity boards, Air India and host of PSUs and Government projects. Either our IAS is incapable to handle the economy or we have become zombies. Hey Ram Bharath ko bechao!!!!!!!!


    Mansoor Haris

    Aug 10, 2012

    Electricity is a utility, essential for every Indian citizen and it falling into the hands of private operators is not desirable.Simply put,let this burden be with the govt, who is otherwise the people, and the financial burden be borne through budgets. Electricity can pass off as an un recovered cost, it doesnt matter anyway as more than half of the budgeted revenues are misutilised.


    Rohan Lawrence D'souza

    Aug 9, 2012

    Privatizing every PSU or Govt. Owned Entity is NOT the answer. We should reduce subsidies which is rocketing forward with NO END IN SIGHT.
    Make them like ONGC or SAIL and see what they do?

    Privatizing will only make a mockery of the PSU.


    Umesh Sharma

    Aug 9, 2012

    The story of SEBs can be described as a fence eating the crop.Prudent demands it that the SEBs should be treated as any other commercial adventure and there should be clear cut demarcation of duties and responsibilities.There should be no room for political interference in the management of SEBs.The so called transmission losses (pilferage in other words)should be totally disallowed.The pricing has to be Practical yet commercially viable.If these steps are initiated there is no reason why the SEB cannot function effectively.If for this reason the SEB is to be privatized then be it.



    Aug 9, 2012

    When the political parties consider gaining and retaining the political power at any cost including the unity and harmony of the country, not only the power sector and even the total economy of the country will be like KING FISHER


    Kersi Mahudawala

    Aug 9, 2012

    The days of CASA led profits are not over for banks.The cost of deposit of funds is very important for banks.The custommers will not simply change the banks just baecause few private sectors bank offer 2% or 3% more interest on saving banks deposits.The private sector banks can attract custommers only when new branches are opened.The minimum balance requirement of private sectors banks is to be kept in mind which is quiet high compared to public secor banks.


    ajay kaul

    Aug 9, 2012

    It would be a good idea to privatise SEBs.But prior to that Tariff reforms to reflect correct Energy Pricing in India akin to Western Economies appears to be extremely urgent since per capita income in India in last 10 years has substantially gone up and cross subsidies norms based on energy consumption would take care of income diversities.

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