Cash rich PSUs funding weak economy - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Cash rich PSUs funding weak economy 

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In this issue:
» India's deficit funding strained
» Rupee woes to hurt gold further
» LIC needs to safeguard its investments
» There is big trouble ahead
» and more....

The Indian economy is growing weak. This is not really news. The twin deficit problem has been eating away into our growth. At the same time the monster of inflation has forced the Reserve Bank of India (RBI) to keep interest rates at higher levels. With interest rates high and gloomy economic numbers, the investor confidence is sinking. As a result not many seem to be interested in investing, which is needed to spur back growth. Net result - the economy is in a mess.

Even in the Union Budget this year, the Finance Minister admitted that this year would be a tough one for us as the government will try to cut back expenses and boost income. Interestingly an avenue being used by the government to boost its income is the PSU cash.

As per an article in The Mint, the combined dividend paid out by 47 PSUs for FY13 increased by 14.12% on a year on year basis. The trigger for this payment was an ultimatum by the Finance Minister. He has told the cash rich PSUs that they should pay out their surplus cash as special dividends or invest it in the form of business expansion. With subdued business conditions and red tapism of the government, the latter was not such an appealing option. In essence the latter translated to losing capital. And as such the companies seem to have chosen the option of paying out dividends.

The question here is whether this is a prudent move or not. The government has not been the best allocator of capital in the past. The deficit problem is the evidence of this. The government has spent more on unrewarding populist measures rather than on avenues that would be beneficial for the economy. And this has led the deficit gap to expand to the level that we see now.

Given that this year is the run up to general elections, it would be natural to expect the government to step up on its populist measures. And we are worried that the special dividends that it is rewarding itself with would be used to the same effect. This is money that could be used by the PSUs for expansion when things take a turn for the better. Wringing out extra cash from the cash rich PSUs is just a short term fix that the government is using. For a long term solution the government officials need to sit down and rethink their expenses. Spend on areas that need investment. Remove red tapism. Amend policies. But is anyone really interested in doing this?

Do you think the government collecting higher dividends from the cash rich PSUs will help the economy? Please share your comments or post them on our Facebook page / Google+ page

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01:10  Chart of the day
The telecom sector was the apple of the investors' eye till 2008. The sector was growing at breakneck pace. Most of this growth was attributable to the explosion in subscriber numbers. But since 2008 the sector has been hit badly by intense competition and adverse regulations. Price wars forced players to accept narrower margins. At the same time costs kept trending up. But the only thing that was working well for the companies was the growth on the subscriber front. However in recent times, this growth driver seems to be drying up as well. As per the recent data released by the COAI (Cellular Operators Association of India), the total net adds in for the top 3 players have come down for the second month in a row. Though this is better than an absolute decline in the number, it is still an indication of things to come. To continue growing the operators will need to rely on new growth drivers. Mere increase in subscriber base may not be a sustainable strategy in the long run.

Source: The Mint

The depreciating rupee has been major concern for the Indian economy over the last couple of years. In fact, the rupee has dropped 8.4% in the current quarter. This has made it the worst performing Asian currency.

The recent fall has been largely driven by fears about the US central bank slowly pulling back its quantitative easing program. How does that affect India? Or for that matter any other emerging economy? Let us explain. The cheap liquidity pumped in by central banks of developed economies was the biggest driver of the current rally in global financial markets. The prospects of liquidity drying up have raised fears of capital outflows. In other words, if foreign investors flee Indian markets, the demand for dollars would go up. And this in turn would weigh heavily on our already steep current account deficit.

Why does India worry so much about foreign capital flows? The reason is that we have a long term structural problem as far as the current account is concerned. In simple words, we import a lot more than we export. As a result, we have to depend on foreign capital flows to fill the gap. Now, there are two ways through which foreign capital comes to India. One is through foreign direct investments (FDI). This is more desirable because it is long term in nature. But India has failed to attract substantial FDI because of regulatory hurdles and slow reforms. So the other alternative is FII flows. But these flows are very volatile and tend to flee during adverse market conditions.

All of this shows how the rupee has been in a very precarious state. And this is the reason why the rupee has been falling against the dollar for several decades. There is no quick-fix solution for the rupee. We need solid improvements in India's global competitiveness, productivity and business environment.

The Indian Rupee has almost become a senior citizen as it approaches the 60 mark to the dollar. Foreign exchange rates have a large bearing on Indian gold prices as the country relies almost entirely on gold imports. Indian investors, quite naturally, measure the gold Price in Rupee. Any fall in the Indian currency makes import of gold costlier. Despite a sharp fall in prices, Indian consumers are not coming and buying because for them, due to the weaker rupee and additional import duty, gold prices are still higher than the international price. At the moment they are standing back from the gold market waiting for prices to fall and even selling gold in the hope to buy back cheaper. Thus gold prices in India might continue to come under pressure.

It has acted as the 'knight in shining armor' on many occasions for the government. Several public sector issuances would have gone belly up had it not been for this financial giant. And the government's disinvestment plans rely more on the investment budget of this company than anything else. Yet, Life Insurance Corporation of India (LIC) seems to be oblivious of its powers! The insurance heavyweight had an investment corpus of Rs 14.8 trillion at the end of December 2012. The gargantuan amount is collected from lacs of Indian policy holders. Many have trusted the insurance company with their life's savings. Yet, the company's investment plan does not get the importance it deserves. In a recent interview to Economic Times, Mr Rajv Takru, secretary of Department of Financial Services, has acknowledged this fact. While LIC is known to act as the government's ATM, it does not even insist on board seats for companies where it has a large holding! There is very little due diligence on the company before the insurance major buys a stake. So it goes without saying that most investments are with the aim of funding the government's need. Whereas the focus should have been maximizing returns for policy holders. We are relieved that at least Mr Takru has acknowledged the shortcomings of LIC. Whether or not the government will allow him to make LIC's investment decisions more independent remains to be seen!

Something very bad and disastrous is about to hit us. If you've been following people like Marc Faber and Jim Rogers recently, this statement may not come as much of a surprise. They've been warning for quite some time now that most economies, especially the US, is being kept alive on the steroids of quantitative easing and once that stops, all hell's is going to break loose. A gentleman named Michael Pento is the latest one we believe to jump onto this bandwagon of predictors of doom.

Taking pot shots at the US Fed Chairman, Pento has opined that Mr Bernanke looks like an utterly confused man. Simply because it was just six months ago that Bernanke was hinting towards more QE because the inflation was low. And now, he is talking about a gradual reversion of QE. Pento foresees the US economy suffering a huge damage emerging out of the unwinding of the QE. As per him, both the real estate as well as stock markets could see significant wealth destruction. Simply because there were no fundamental reasons to justify their rise. They were just a product of the Fed created cheap money. So once the punchbowl is taken away, there will be huge repercussions to bear. Well, we can't help but agree with him.

In the meanwhile after opening the day below the dotted line, Indian equity markets continued to trade in the negative territory. At the time of writing, the Sensex was down by about 208 points (1.1%). Fed's decision to rollback QE combined with worries over China's growth weighed heavily on the other Asian markets. All of the major markets in the region have closed in the red with China and Hong Kong witnessing maximum losses.

04:55  Today's investing mantra
"Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety." - Ben Graham
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6 Responses to "Cash rich PSUs funding weak economy"

R N Padukone

Jun 25, 2013

The PSUs that are cash rich today are those that have got there because of favorable market conditions in the past. To survive in today's market, one needs to reinvent and restructure one's business. One has to innovate and move away from the past. The PSU culture is such that it will not permit them to achieve this transformation. The result is that existing cash reserves are bound to dwindle with a deep negative swing. Gone will be the days of the PSU. BSNL and MTNL are classic examples!


Arun Draviam

Jun 24, 2013

The ill fate met with by NMDC is there for any to judge the fate awaiting LIC and other cash rich PSUs once they abide by the dictates of Finance Minister. From the OFS price of Rs. 148 the present price is around Rs. 103. It dipped even below Rs. 100, the day the FM made this announcement about the cash rich PSUs to go for cross holdings.



Jun 24, 2013

As you have very well pointed out it is a populist measure not going to help economy


R C Sarangi

Jun 24, 2013

The article is excellent and right on dot. The problem is how many of India's population understand the suicidal gimmick the politicians are playing, fooling the country.


Sunny P Pullan

Jun 24, 2013

The cheap money that FEd created caused the sharp rise in the price of asset classes like gold, silver and commodities with out any fundamental reason than the availablity of plenty of cheap money in the market.And with QE unwinding , both real and these fake investors will loose money. Now FED may have to print notes to bail out these speculators and the sufferers are ordinary people.


Ramesh Jaradhara

Jun 24, 2013

No, payment of dividend will not help the dwindling economy to recover. Expansion is the way out there.

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