Should investors be wary of the best PSUs? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should investors be wary of the best PSUs? 

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In this issue:
» Major fluctuations in public and private debt since 1990
» Nobel laureate Joseph Stiglitz's take on QE
» Can gold reach new high by end of 2013?
» China's lower growth rate may be the 'new normal'
» and more....

For a while now, the Prime Minister's office (PMO) has been monitoring the capital investment plans of some major public sector units (PSUs). This it has been doing, to gauge the utilisation of surplus funds. A few weeks ago, the PMO has suggested that these cash rich PSUs pay out higher dividends if they are not being deployed back within the firm. The government has also been working out norms on how the PSUs can utilize their surplus funds, which are believed to amount to as much as Rs 2.8 trillion. The panel constituted to review guidelines on investment of these surplus funds, is looking at coming out with a set of guidelines to provide more flexibility to the PSUs to invest the sums.

Given these developments, can one expect PSUs to improve their efficiencies over the medium term? As you would know, we have always been fans of companies that allocate capital wisely. For a profitable company - those that are able to generate returns that exceed their cost of capital, it would only make sense for it to reinvest capital back into the business. This would benefit shareholders over the long run due to the power of compounding. On the other hand, as and when companies accumulate more and more cash on to their books - without deploying the same back into the business - it tends to impact their overall returns.

Given that the high fiscal deficit limits the government's ability to spend more on budgeted expenditures, it seems to be relying on the dividends from cash rich PSUs to play its role. Particularly that of driving growth and creating jobs.

We, nevertheless, believe investors should be wary of the government coercing cash rich PSUs. Pressure from the government could lead to such PSUs making non required acquisitions or investments into projects which could potentially deteriorate shareholder return ratios. At the same time, paying out excess dividends also does not seem to be the most prudent option as majority stake in the PSUs is held by the government itself. Given the government's capital allocation history, we believe it could turn out to be an indirect misuse of cash!

Do you think it would be right for the government to put pressure on the cash rich PSUs? Please share your comments or post them on our Facebook page / Google+ page

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01:35  Chart of the day
Today's chart of the day displays the debt to GDP ratio of major global economies. This ratio indicates the health of a country's balance sheet. The higher the debt level, the more difficult it would be for the sector (public or private in this case) to repay and service the debts. Evidently, over the years, the debt to GDP ratios have worsened for US, UK and Japan.

Data Source: Wall Street Journal

Looking at the chart, it is clear at first sight that since 1990 there have been major fluctuations in debt to GDP across the world. Emerging markets particularly have seen a major change, more so in private debt figures. From having access to cheap capital in the early 90s, the latter half of the decade saw the debt levels going down post the 1997 financial crisis. However, the boom period post the millennium, led the private players to continue taking on more debt given the access to cheap capital. As for developed markets, majority of this period saw an increase in private debt on the back of the housing boom. Public debt of these economies continues to be an area of concern. This has increased all the more over the past few years as governments have been making attempts to fuel growth in their respective regions.

It's now Nobel laureate Joseph Stiglitz's turn to jump onto the bandwagon of economists who are warning it would be too premature to reduce monetary stimulus in the US. He sees no signs of the economy coming back to normal. And hence, the stimulus should continue as per him. However, he is aware that there are no solid grounds on which to base his argument. The stimulus has given hardly any impetus to the economy and may have contributed to asset bubbles and also a little bit to the weaker dollar as per him. However, the latter is not so much a problem because it actually helps US exports. So, there we are. An economist not willing to change his original framework despite evidence to the contrary. And this has been the problem with most economists supporting monetary stimulus, Fed Chairman Ben Bernanke notwithstanding. But we believe markets will eventually make this people aware of what monetary stimulus ends up doing to the economy. We just hope it isn't too late by then.

High inflation has been one of the biggest hindrances to India's growth in recent years. It tends to keep interest rates at high levels. This affects demand and investment in the economy. The ongoing economic slowdown is nothing but a result of this.

Apart from the high fiscal deficit, India has been facing a high current account deficit as well. This is because our economy relies heavily on imports of essential commodities such as crude oil. Another big item on our import bill is gold. Now, gold is largely a keeper of value and is used as a hedge against inflation. But it has negligible productive value. This irks Indian policymakers. This is the reason why it has been trying various ways to curb gold imports.

So, why not introduce bonds that would take care of inflation? The RBI announced that it would launch Inflation Indexed Bonds (IIB) on June 04, 2013. On the positive side, the principal will be adjusted to the prevailing inflation rate. If the face value of the bond is Rs 100 and inflation is 8%, the principal amount will be Rs 108. So, the interest rate will be calculated on this adjusted principal amount. In other words, the returns will be higher than the inflation rate. Theoretically, this may sound compelling. But a closer look raises some questions.

For one, the IIBs will be linked to the wholesale price index (WPI) and not the consumer price index (CPI). The inflation index that is most relevant to consumers is the CPI. As such, this bond may not cover the inflation that consumers face. In April 2013 for instance, while the WPI declined to 4.89%, CPI inflation stood firmly at 9.8%. As such, the bond may not be lucrative for retail investors unless it is linked to CPI.

Gold may have lost steam in the past several months, but the case for the precious metal in the longer term as a store of value still remains strong. And Nick Barisheff, CEO of Bullion Management Group, in an article on Firstpost, reinforces this view. Two of the major reasons why gold will not lose its appeal is the fall in the value of paper currencies and rising inflation. The unprecedented money printing measures adopted by the governments in Europe, Japan and the US means that the value of fiat currencies has been called into question. Barisheff maintains that in all of this, gold has maintained its purchasing power. This is because gold is not really rising in value. Rather it is the currencies that are losing their power against gold. Further, all these quantitative easing programs are only likely to raise the risk of a much higher inflation in the future. Rising prices of oil would only pile on the inflation pressure. All of which has led Mr. Barisheff to opine that gold will rise against the US dollar and probably reach a new high by the end of 2013. It would not be possible for us to determine what the price of gold will be by the end of this calendar year. But we agree with Mr. Barisheff on the strength of gold in the longer run and believe that it should certainly form a small portion of an investor's overall investment portfolio.

The only yardstick that the Chinese policy makers have looked at for several decades now is the economy's GDP growth rate. The country's economic policies have had a legendary disregard for environment, labour well being and private entrepreneurship. Factories and construction sites have hardly taken environmental concerns into account. The recent air pollution crisis in Shanghai was a testament to that. Labour strikes, suicides in factories have been commonplace in China over last few years. Also, foreign entities have flourished by off shoring manufacturing to China. But private enterprise has hardly been encouraged due the preference given to government owned entities. All of that is set to change! As per Bloomberg, the new government in China wants to take lower GDP growth rate as the 'new normal'. It also wants to focus on encouraging private enterprise. Taking environmental and labour concerns more seriously is something that China can no longer keep in the backburner. Thus, with China's growth rate no longer being the focus, the world will have to realign the demand supply dynamics of commodities.

The Indian equity markets traded well above the dotted line for most part of the day. At the time of writing, the BSE-Sensex was trading higher by about 170 points or 0.84%. Barring stocks from the automobile and capital goods spaces, interest was seen across the board. oil and gas, consumer durables and healthcare stocks were amongst the most favored today. Stocks from the midcap and smallcap spaces were also finding investor interest as the BSE-Midcap and BSE-Smallcap indices were up by about 0.6% each. Stock markets in rest of Asia ended the day on a mixed note with Japan down by 3.2%, while Hong Kong and China were up by 0.3% and 0.2% respectively.

04:50  Today's investing mantra
"Sir John Templeton had one of the best methods for keeping emotion out of the process. He used to do his calculations of intrinsic value when there wasn't a lot going on in the market. He'd then place a margin of safety on those intrinsic values and place buy orders with his broker at, say, 40% below the current market price." - James Montier
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7 Responses to "Should investors be wary of the best PSUs?"

c v krishnakumar

May 30, 2013

such surpluses should be invested wisely. on the one hand we cite resources crunch as a limiting factor for developing infrastructure. government is the major shareholder and as such it is very legitimate for it to direct cash rich PSUs to invest money where it is needed. At present they are parked with banks and that too mostly in new generation private sector banks giving them a stable cheap source of funds. It also breeds certain unhealthy trends with banks vying with each other to woo the decision makers in such PSUs. It is high time this sorry state of affairs is remedied.

Like (1)


May 28, 2013

Govt expecting high dividend is not a bad idea.

Like (1)

parimal shah

May 28, 2013

They can issue bonus shares instead

Like (1)

Govind Ved

May 27, 2013

Recently GOI is using PSU money to increase cross holding in companies. Even recently concluded OFS of Hind Copper ,NMDC and other PSU major chunk was captured by LIC at the request by govt. It means government is using public money to balance the deficit. But how far it will continue. There will be limit. At that time what will happen!

Like (1)

m. ram mohan rao

May 27, 2013

you are critical about psus not investing their surplus cash.why is r i l accumulating its cash surplus? in the back ground of expost facto criticism by audit and other authorities in govt do you expect conservative beuracrats who invariably head psus to be venturesome? i epect the govt to press the psus to declare larger dividends. ram mohan rao

Like (2)

asit ganguly

May 27, 2013

Cash rich PSUs are in catch 22 situation.One option is to give away dividends which Govt is interested in view of deficits. Other option is investments in projects, in the name of modernization and capacity enhancements. It is common knowledge that bosses in ministries take keen interests in such investments for obvious reasons.
It will be interesting to know how many PSUs are engaged in large capex investments and for what value.What is the time and cost over-run of such projects! By the time CAG takes up such cases, money has already vanished in thin air.

Like (2)

Balakrishnan R

May 27, 2013

Our country is starving for power. The government can request the PSUs with surplus funds to invest in new power plants through NTPC or in solar power plants / wind Mills so that our country can become self sufficient in power. This shall help further in coming out of low industrial growth of recent years.

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