Why take a loan if you have the cash?

Dec 5, 2011

In this issue:
» Indian CEOs are pessimistic
» India Inc frets but MNCs do not fume
» Austerity will kill the Euro: Krugman
» Will advance pay boost labour productivity?
» ...and more!
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In a scenario where loans are getting more and more expensive, it is normal to state that it is better to build your cash reserves rather than taking a loan. And is you already have a huge cash balance, then common sense would state that save it and use that rather than taking a loan. Why? Because taking a loan would only increase your expenses in the form of heavy interest payments. When something is so blatantly obvious to a layman, shouldn't the same be true for a company? Then why would a company that already has a huge cash balance go on to take more debt?

This was the question that haunted us when we picked up a leading daily and read that Reliance Industries Ltd (RIL) plans to raise debt the daily has reported that the company has appointed three foreign banks to raise US$ 1 bn through a 10 year dollar denominated bond issue. But the company already has a huge cash corpus of US$ 12.6 bn (cash and cash equivalents as on September 30, 2011). To add to this would be the US$ 5.2 bn that it has received from British petroleum company BP for a stake sale. So the question is why does RIL more cash?

One possible explanation for this could be the company's capex plans? But this amounts to only US$ 12-14 bn over the next three years. This could easily be taken care of by the company's existing cash reserves plus its internal accruals. So obviously the additional cash is not for that. Another possible explanation could be that it is increasing its reserves to take care of the additional business streams that it plans to get into. These business ventures include interests in telecom, financial services and retail. Then again the question that comes up is would it not be better to raise funds when the business plans are concrete and in place?

Apparently RIL does not think so. It appears to be more interested in acquiring debt at the lower overseas interest rates. It does not matter to the company that it does not have any concrete plans to utilize its own cash reserves let alone the additional cash that will come in the form of debt. In our opinion, investors should delve more into companies like these. Raising debt when it is available rather than taking it at the moment of dire need maybe a good option at times. This is because the company would have more flexibility to negotiate favourable terms. However, at the same time, it would be good to keep in mind the company's debt to equity ratio. If this gets stretched by the additional debt then it could cause worries for the company.

Do you think that it is prudent for companies to raise debt despite having huge cash reserves? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
The Indian IT industry has witnessed several headwinds in recent times. The industry has been touted as one that would suffer the adverse impact of the global financial crisis. The reason being that people expect order inflows for the industry to decline as client industries come under pressure. Though there is no evidence of this as of now, even stalwarts of the industry have stated that the global demand environment continues to be uncertain and this may have an adverse impact on the industry. But even then, as per a recent study done by The Mint, the IT industry still continues to witness the maximum number of start ups in India. As shown in today's chart of the day, entrepreneurial interest in India is maximum in IT (Information Technology). The other sectors which see high level of start ups are education, retail and media.

Data source: The Mint

We don't worry too much about volatility in stock markets. That's a part and parcel of the game. Nor do we bother much about what economists are saying. They keep doling out new projections every few days. But when the people who run businesses have something to say, we are all ears. The Confederation of Indian Industry (CII) conducted a survey of CEOs (chief executive officers) of some leading companies to gauge their investment outlook for 2012. The result was a unanimous somberness. Close to 70% CEOs expect domestic and outbound investments to either grow by less than 10% or decline in 2012. Moreover, a majority of them believe that the gloom in the developed economies and an overall sense of risk and uncertainty in the global environment will impact India on several fronts such as exports, foreign direct investment (FDI), foreign institutional investor (FII) inflows and external commercial borrowings (ECB).

On the domestic front, the most pertinent issues affecting investment are land availability issues, rising cost of power, environmental hurdles and high interest rates. So the coming times are really going to put the Indian economy to test. However, investors should take this as good news. The best buying opportunities unfold during such times of distress and uncertainty. Be a disciplined value investor and you will certainly be well-rewarded.

Even as the economies in Europe and America continue to sneeze, the ones in emerging markets, including India, have caught the cold. The September quarter results showed most Indian corporate bearing the brunt of slower economic growth, loss of purchasing power and muted consumer demand. Not surprisingly, many have opted to or have been forced to shelve or defer their expansion plans. Others have tried their hands at cutting costs or repaying expensive debt.

Banks that have seen corporate credit demand dry up and NPAs (non performing assets) move up, have given a very muted guidance for the next couple of quarters. Overall, when it comes to near term outlook, India Inc seems to share the consensus that there is more pain left. Interestingly, most MNCs (multinational corporations) are ignoring such facts. Probably because these entities, which are looking for lucrative growth potential in the long term, are not bothered about near term prospects. The likes of FMCG majors Kraft Foods and Coca Cola and engineering major Siemens have readied their cash war chest to invest more in India. However, when it comes to regulated sectors or those entailing land acquisitions and government clearances, the mood is still cautious. It is for India to prove her ability to offer reasonable returns over the long term through effective policy making and reform execution.

The European debt crisis simply refuses to go away and while the overall consensus is that European countries need to put the brakes on spending and control their rising debt levels, noted economist Paul Krugman believes otherwise. He is of the view that the real problem is too little spending in Europe as a whole and the efforts to fix matters by demanding austerity measures is only making the situation worse. Krugman contends that after the crisis, when private spending plummeted, European leaders should have focused on how to prevent spending cuts from causing a recession. Instead, what they did was to demand that all governments (and not just the indebted ones) slash spending and raise taxes. Krugman also advocates that the gap between the indebted southern Europe and the northern Europe needs to be bridged. This can be done by either bringing prices down in the South which will only stagnate the economies more and worsen their debt situation or by raising prices in the North. The latter would involve contending with inflation for a period of time but which to Krugman seems acceptable given that recession in the region has kept prices low anyway. The crux of the matter is that Krugman supports expansionary monetary policies; something that we do not necessarily agree with. Throwing more debt to solve problems of debt is hardly a long term meaningful solution to the crisis. And three years of stimulus measures in the US and Europe so far have hardly done much in kick starting their respective economies.

You may have heard of prepaid smart cards, mobile recharges and advance tax. But how about getting paid in advance without a day of work? The government is soon likely to allow advance part payment of wages to restore faith in its rural jobs scheme. Many beneficiaries of NREGS (National Rural Employment Guarantee Scheme) complain of delayed wages due to various administrative hassles. Inadequate bank penetration in rural areas, postal network and a shortage of human resources are chief among these. A pilot project for this will take place in areas currently suffering from a staff shortage. Based on the feedback, it may get implemented on a larger scale. But whether this will actually have the desired results or if it will just be money down the drain is the question.

In the meanwhile, the stock markets are trading below the dotted line after opening weak. At the time of writing, the BSE Sensex was down by 52 points (0.3%). Stocks in the FMCG and metal space were witnessing maximum losses. However, stocks in the capital goods and power sectors were witnessing buying interest. Other stock markets in Asia closed on a mixed note with indices in Japan and Indonesia closing in the green while those in China and Hong Kong ended in the red.

 Today's Investing Mantra
"No one ever made a dime by panicking." - Jim Cramer

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5 Responses to "Why take a loan if you have the cash?"


Dec 5, 2011

the company may be trying to bet on the recovery of INR/$ as the exchange rate has deteriorated too fast, too much....They might gain 5-10% in case $ rate comes back to 46-47 range again (which is likely in medium term)...


Gandhi Balagani

Dec 5, 2011

It is very Unwiseand as it erodes the profits on share unless otherwise the debt is absored at the earliest into expantion Utility.



Dec 5, 2011

Because overseas rates are at historic lows and have only one way to go... up. So now is a good time to lock-in these low rates especially when you consider the current dollar-rupee conversion rate and the long-term fundamentals of the dollar, which look bleak at best. If nothing else, borrowing at 5% overseas and investing at 10% in the domestic market makes perfect sense.



Dec 5, 2011

Could this be a exchange rate speculation?
RIL may be betting that going forward, the rupee can only go up.


Subrahmanya Raju

Dec 5, 2011

I think Reliance is trying to use the the current market conditions and profit from it.
1) Since the Rupee value is down, they might be expecting it to strengthen soon. They can mop up the money during this period and benefit if the rupee strengthens
2) Since the interests rates are very low in the US and high in India they will be well off parking the existing reserves in fixed deposits in India.
Thus profiting in either case.

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