Can merging PSUs be considered as reforms?

Jul 28, 2014

In this issue:
» No Acche Din yet for India Inc. in the result season
» The dire condition of PSU fertiliser plants
» Forex reserves near record high, but is it enough?
» Will the govt. breathe life into affordable housing?
» ...and more!

The Modi government, which took charge two months ago, is facing major challenges. The Indian economy is in a mess after ten years of neglect by the UPA. Inflation, government finances, policy bottlenecks and corruption are just some of the big hurdles. However, problems have surfaced in almost every sector which is getting in the way of its big ambitions. The government appears to have realized that the most serious reforms are needed in its own backyard. We are referring to the PSU sector. PSUs were treated very poorly by the previous government. Thus it is not surprising that the NDA government's most ambitious reforms seem to be targeted at this space. If news reports are to be believed, the government is preparing a roadmap to overhaul PSUs in many sectors. Top on the list are Public sector banks and Energy PSUs. The chosen method however, involves mergers of PSUs and this raises the question of investor wealth destruction.

It is no secret that many PSU banks in the country are in a mess. Struggling under the weight of bad loans, tighter regulations and capital needs, this sector is ripe for consolidation. The government has already asked IDBI Bank and United Bank of India to plan a merger. Our readers would recall that United Bank was on the brink of bankruptcy in late 2013. Hence its merger proposal with IDBI raises doubts if this is yet another Oriental Bank of Commerce in the making (merger with GTB sealed its fate!). Also, the top managements at SBI, PNB, BoB and BoI have been asked to select takeover targets. The reasons being given for the mergers are better HR management and larger branch spread among others. However, investors will have to tread carefully we believe. The government may not have investor's best interests at heart. A financially stable bank could run into trouble if it takes over a smaller bank with a serious NPA issue. While nothing has been finalised as yet, we will certainly watch this space carefully.

Over in the power sector, an exercise is underway to shore up India's hydro power capacity. However, the major reform here is taking the form of a mega merger. India's largest hydro power firm NHPC, has been asked to examine an ambitious proposal to merge all four central hydro-power PSUs. Yet again, extracting maximum investor value does not seem to be a reason for this merger. The government is concerned about the falling share of hydro-power in India's energy mix. Currently hydro-power contributes only 16.3% of India's total power capacity. However, it is not clear how a giant hydro-power PSU will change this situation. India's dependence on thermal power has been due to the lack of a long-term vision. We believe the government should come out with a clear vision document for the energy sector. This would help to assuage the concerns of long term investors.

Our main concern here is one that we have stated many times before. The government is known to treat PSUs as its own property. In the name of reform, we have seen quite a few plans go astray. While there is a lot of hidden potential in PSUs, they are never truly allowed a free hand. While merging a few PSUs can certainly be part of a long term solution, we would be happier if the government would give these firms more autonomy. A start can be made by reducing political interference in the boards of these firms. More professionalism and management freedom can be the best reform measures for these firms. This will put PSUs on the path of higher growth and better profitability. However, this will only happen if the government keeps in mind the concerns of minority shareholders while implementing its big ambitions. The previous government certainly did not care too much about this. We hope the Modi government will be different.

Do you think the merging of PSUs is a good long term reform? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
The results for the June 2014 quarter have started pouring in. About 316 companies have filed in their performance during the quarter. Investors would be curious to know how the companies have performed; especially given the fact that the benchmark indices are pretty buoyant close to their all-time high levels. But the results seem anything but encouraging. As per an article in Business Standard, the net profit of the firms that have announced their 1QFY15 results so far was up 9% year-on-year (YoY). If you eliminate the IT exporters from this list, the combined net profit of the remaining 290 companies has risen merely 2.4% YoY. This is the slowest pace of profit growth over the last nine quarters.

The only silver lining has been the topline growth. Firms in the domestic manufacturing and services sectors (excluding IT, financial and oil & gas) have registered higher net sales growth of 9.5% YoY as against 5.8% YoY achieved during the December 2013 quarter. However, it is worth noting that the growth trend is not broad-based and has been largely contributed by a handful of leading companies. So while investors may have enjoyed solid returns in the share markets in India in the year so far; as far as Indian companies are concerned, 'Acche din' (good days) are not here yet.

When will growth pick up?

Here's another example of how social objectives come in the way of profit making. As per a leading daily, as many as 10 fertiliser plants which are owned by the Government out of a total of 23 are not operational. This is not all. Even among the ones that are operational, as many as seven are suffering losses. In other words, only six of a total of 23 plants are making money of some kind. And what is the Government doing to resolve the issue? Well, as is usually the case, it is thinking of throwing good money after bad. To put it simply, it is planning some kind of financial restructuring of at least three sick units in order to sustain their operations. Besides, it is also planning to revive another five units. It should be noted that fertiliser subsidy is one of the biggest areas of concern for the Government and with such demand for revival coming time and again; the going is not going to be easy at all.

Until a few months back, the volatility of the rupee and its impact on India's import cover brought back the demons of 1991. The government and the RBI too were wary of having to face a 1991-like situation. Needless to say, the curbs on gold imports and the RBI embargo on India's foreign exchange dealings were directed towards building reserves. Thankfully, India's forex reserves have swelled in recent months to a near record high. At over US$ 317 bn, India's reserves are 15% higher than the US$ 275 bn that it had plunged to in August 2013, when rupee was at 68 per dollar. However, as per Economic Times, in terms of imports, the country is nowhere near the comfort level of February 2008. Prior to the global meltdown, India was in a position to finance imports of about 15 months. This has come down to just over eight months at present exchange rates. Not just that! Reserves as percentage of external debt have slipped to about 70% from a record high of 140% in March 2008. Now India's forex reserves may not be as vulnerable to foreign fund flows as economies like Brazil. But that does not take away the fact that building a reserve war chest is a necessary step in fortifying the economy. Targeting gold imports may not be an evergreen solution for this!

The much neglected affordable housing segment seems to be getting its due attention finally. As developers stare at slowdown in the luxury segment, they are finally looking at potential in the low and mid income housing segment. The latter has also been a key issue on the agenda of the Modi Government. The Budget this year had some proposals that could revive interest in the segment. Increase in interest deduction on loan for self occupied Indian property market and increase in income tax exemption limit are a few that deserve a mention. However, delivering on the promise will not be so easy. This is because the segment remains a high volume low margin business. It offers limited opportunities to builders as far as scalability is concerned.

On the regulatory front also, things have not been smooth. The delay in clearances has led to delay in construction. The same has translated into increase in cost and margin squeeze for developers. What makes the issue more complicated is that buyers in this segment do not have easy access to bank credit due to the lack of regular income and documents. Because of these challenges, despite the huge demand, the supply in affordable housing segment has been limited. As land remains costly and limited within city limits, delivering on this promise will not be easy. That said, the revival of interest in affordable housing segment is a positive development. Whether it benefits the common man is something time will tell.

What would you rather invest in? In one of the world's oldest metals? Or one of the new age currencies? We are talking about the gold and bitcoins here. The one common factor that is driving investors to both of these is the loose monetary policies of central bankers particularly the US Fed. Indeed, since the 2008 global crisis, the Fed has resorted to a combination of near zero interest rates and a massive bond buying program. All of this has only increased liquidity in the system leading to asset prices inflating. Growth has hardly picked up. Moreover, this has also raised concerns of fiat currencies including the US dollar losing value. And so investors have been looking at alternate options to hedge against this risk. The popularity of the virtual currency Bitcoin saw its price rise to a high of US$ 1,147 in 2013 before there was a collapse. Not surprisingly, gold prices remained less volatile. But the propensity towards fads remains and hence there has emerged a new medium of exchange called Bitgold. This is a combination of Bitcoin and gold and is aimed catering to both Bitcoin enthusiasts and gold believers and thereby achieve a wider audience. But whether that purpose will be served or not remains to be seen. The volatility in Bitcoin in recent times has only highlighted the dangers of fads. And we believe that gold's reputation as a store of value and hedge against inflation remains unmatched whatever permutations and combinations the markets throw up.

In the meanwhile, the Indian stock markets continued to slip deeper into the red. At the time of writing, BSE-Sensex was trading lower by 189 points (-0.7%). Barring consumer durable, all the sectoral indices were trading in the red with realty and metal being the major losers. Asian indices were trading mixed with China and Hong Kong being major gainers, whereas Indonesia and Taiwan were trading weak. European markets opened the day on a weak note.

 Today's investing mantra
"Don't buy a stock just because everyone hates it.". - Warren Buffett

Editor's note: Kindly note that there will be no issue of The 5 Minute Wrapup tomorrow.

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11 Responses to "Can merging PSUs be considered as reforms?"

Ankur Deep Kumar

Jul 29, 2014

It will result in a healthy strategy.

Like (3)


Jul 29, 2014

Merger of loss making PSU banks with other banks are sure to yield lower returns to the public minority share holders as u expressed in your editorial. But in the long run it may do good to the economy provided 1. No other new banks are opened for the next 10 years 2. The Govt should pump more funds to wipe out the NPA,of course again @ the cost fiscal deficit 3. Formation of any mega banks by merger or otherwise has it's own pitfalls 4. It took more than 3 decades to bring down the effective employment soon after introduction of core banking and Basel II reforms etc. There is a news that the banking sector wants to cut the employment by another more than 10000 by this year end,with further recruitments replacing the retired hands at zero level.

AS regards merger various PSU energy corporates into mega Power Corporates on the lines of Hydro Nuclear Solar Thermal etc. also has it's own pitfalls like mega corruption and and unwieldy HR and technical operation, just like FCI Both Fertilizer Corpn and Food Corpn ONGC etc. So the suggestion is that the Govt can think about forming 2 rival corporates in each energy PSU Cos. Coal field necesserily needs reforms,which is already overdue.

However It is sure it will take minimum 3 to 4 years to see the result of any reforms if initiated today by Modi Govt. The Next Govt also must follow the reforms measures without any let up.

Like (3)

sunil nigam

Jul 29, 2014

The mergers will give a good impact but, it requires sensible merger & time to get matured after merger, atleast 2-3 yrs after merger is completely over.

Like (3)


Jul 29, 2014

In case of merger SEBI or government empowered personnel should see the interest of general investors. Which will be highly appreciated.

Like (3)


Jul 28, 2014

PSU's are white elephants. These are being made top survive with govt. interference like getting them orders, special treatment to PSU's, Subsidies to PSU's etc. It is the time to close all the PSU's including the profit making one's for better future of the country.

Like (3)


Jul 28, 2014

This is an excellent study/write up from equity master on the government owned banks/companies.
I request Equity master to send a copy of this to PMO's office. Why not? Let them act accordingly.

Like (3)

Raj Kumar

Jul 28, 2014

In my opinion it is not going to be a productive idea and little except borrowing cost will be reduced. If the Govt is finding difficult to post functional directors and CMDs in these PSUs this is no way to divert the problem. The disease of one company i.e non decision making will be spread and affect performance of all where as at least some companies would be taking decisions. State Govts will have to agree to shed their shares in THDC and SJVNL whereas NEEPCO where DONOR is contributing will have issues. It is felt that decision will be adversely affecting and go towards monopolistic market. The Govt should be going for more and more players in the field to step up generation but sadly merger in no way will increase efficiency and create more HR related issues.

Like (3)


Jul 28, 2014

It is not correct that PSU conditined worsened due to neglect and shabby treatment by only UPA govt.Actually PSU were treated badly by NDA govt during 1998-2004. Even some of the PSU were sold out to pvt business at token amounts.Industrial climate deterioted during last 2yrs when BJP prevented Parliament to work and joined the corus of Arvind Kezeriwal that Ruling party is CHURE(thief).Surprising Supreame court also joined without analysing and going through the matter.They started banning the mining and export of minerals.Administrative machinery came to halt for fear of RTi and afraid of being marked as thieves.Some smart bureocrate developed the bridge with opposition party Ie BJP.At the election times such person were suitably rewarded.Merging of PSU is not solution.Psu should be given free hand and their CEO shall have tenure of atleast 5yrs.IAS shall not be allowed to head PSU.Retired govt officer shall not be allowed to contest election for atleast 4yrs from superannuation.Similarly retiring employing from psu shall not be allowed to joined Pvt sectors after superannuation for atleast 5yrs.

Like (3)


Jul 28, 2014

Is merging of the Public Sector Bank a solution to come out of the mess. NO

Like (3)

H K Prakash

Jul 28, 2014

There is a hydel based giant utility (Columbia River system) in Washington state, north west US. It maintains 14-5(?) dams on the Columbia River flowing in from Canada on its way to the Pacific Ocean. The dams were efficiently planned and are managed to take advantage of every one foot drop in altitude. You need to look twice to make out the dams nestled in greenery. This system not only supplies the entire North West of US but also exports to CA state. Modi, the Power Minister and NHPC execs need to visit this 8th wonder of the world to see how they can improve NHPC's projects in Uttaranchal!

Like (3)
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