Vijay Kumar Gaba

Friday, January 31, 2020

Dilemma of the CFO of a stressed company

This morning I see the finance minister as CFO of a financially stressed company. She faces all the problems a highly stressed business could in bad times. For example—

The business of the company has witnessed considerable slow down in past few years. The revenue has shrinked and losses have increased.
The ability to modernize and expand has been constricted as stressed balance sheet and poor cash flows are hindering capital expenditure.
The investors are reluctant to commit more capital as the return on past tranches of investments has been poor.
The company is not able to sell non-core businesses and assets to mobilize the resources needed to sustain the ongoing capex as well as the current repayment obligations.
The competitors have snatched market share with competitive pricing and better delivery.
The ability to retain talent has been hampered due to a variety of constraints.
The rating agencies have put the company on watch list for a possible down grade.
The top management of the company is struggling with allegations of misgovernance and failing to deliver on promises.
To make the matter worst, the new accounting system put in place a couple of years ago has still not stabilized. Many claims have been overpaid and many have been rejected erroneously.

Given these circumstances, you imagine the plight to the CFO (here minister), if -

Most debtors are unable to discharge their obligations and are seeking debt waiver or substantial concessions.
Employees are threatening strike if salaries are not hiked and non-core assets are sold.
Raising prices of goods and services is mostly out of question due to already precarious competitive positioning.
Shareholders are seeking higher dividend.
Creditors want equity to be diluted materially and debts be discharged to deleverage the balance sheet. Any increase in leverage ratios is strictly no-go zone.
The media has already declared that the CFO is going to lose her job in a month. They have also declared a retired banker as her successor. The management has neither confirmed nor denied these viral media posts.

I would never wish anyone to be in her shoes. Nonetheless, I would not refrain myself from offering my five cents to the finance ministers:

(1) Avoid jingoism.

(2) Don't try to please all, because you cannot.

(3) Incremetalism will not help anyone at this stage. Do some zero based thinking.

(4) We need ship loads of foreign capital and technology to survive and grow. Respect them for what they have.

(5) Focus on your strengths not weaknesses. Give euthanasia to the people who have been already declared brain dead.

Thursday, January 30, 2020

Time for Gurdas Mann to sing again

The Union Budget in India usually has five objectives:

(i) Presenting the annual accounts of the previous year Union Government for consideration and approval of the Parliament.

(ii) Presenting the policy roadmap for the future. This usually is a political statement.

(iii) Presenting the budget of the Union government for the following year. This includes the budget for various revenue and capital expenditure of the union government, allocation of resources to states and union territories, and sources of revenue to meet the budgeted expenditure and allocations.

The key monitorable in this exercise usually is the difference between the revenue and expenditure. The excess of budgeted expenditure over budgeted revenue is termed as fiscal deficit.

This deficit is met by the union government through borrowings from various sources. Changes in provisions of various tax laws are also monitored closely as it impacts the tax liability and compliance requirement for the tax payers.

(iv) Presenting an action taken report for the previous budget proposals.

(v) Presenting a medium term fiscal road map in terms of the Fiscal Responsibility and Budget Management Act 2003 (FRBM Act).

Various stakeholders in the economy look forward to the budget with a great sense of anticipation. However, their interest is usually limited to the third objective listed above.

The rich eagerly wait for the budget to get fiscal incentives to make investments and find loopholes for evading taxes. The middle classes wait for some duty concessions on items of common use and lower taxes on salary etc. The poor would anticipate more subsidies and welfare schemes.

The scope and importance of Union Budget has diminished materially over the past two decades.

Initially the changes in tax rates were made only through the Finance Bill which is part of the budget exercise. However, many springs ago the government assumed the power to change the rates of excise etc through notification outside the budget. Subsequently, the GST subsumed most of the indirect taxes and the power to alter GST rates has been exclusively vested in the GST Council. The Union Budget has no role to play in GST rates now.
The boundaries for rates of customs duty are now mostly set in accordance with the WTO agreements. The union government can change these rates to safeguard domestic industry from unfair pricing by overseas suppliers or to stabilize the domestic prices in times of abnormal supply shocks. These changes could be done whenever a need arises. The union budget has little role to play in this.
Post implementation of the 14th Finance Commission recommendations, the onus to implement a large number of welfare schemes has been transferred to the respective state government.
The petroleum products' pricing has been mostly deregulated and the budget provides no subsidies for the transportation fuel now.
Most of the public sector enterprises, like NHAI, Railway Subsidiaries, Oil & Marketing companies now raise resources directly rather than through the budgetary support.

This year particularly, the importance of budget is even lesser, because -

(a) The corporate tax rates were restructured materially in August 2019 and therefore no further change in corporate tax is anticipated.

(b) The government has announced a National Infrastructure Pipeline (NIP) of Rs1.02trn in December. This obviously takes out almost all major projects from the union budget.

The budget anticipations are therefore mostly focused on the following three points:

(1) What tax concessions the finance minister would provide to individual tax payers to spur the consumption demand in the economy. Remember, the personal tax revenue is less than 1/6th of the total budget revenue.

(2) How the finance minister will manage resources to meet the requirements for higher capital expenditure to stimulate the investment demand. Raising tax rates or imposing additional levies may not be preferred options this time. The condition of telecom sector also does not augur well for raising meaningful revenue from sale of spectrum. Therefore, aggressive disinvestment, market borrowings, overseas borrowing and higher tax revenue through stricter compliance may be some of the preferred sources of additional revenue.

(3) How much relaxation on FRBM fiscal deficit is availed. The general view is that the finance minister may choose to aggressively breach the fiscal deficit limits and allow higher spending by the government alongside lower taxes.

After listening to a lot of market experts, industry captains and reading many reports outlining market expectations from the budget, I am reminded of the anticipation and excitement the New Year Eve entertainment program of the national telecaster Doordarshan (DD) used to stimulate amongst middle class households during 1980s.

While the elite (there were only a few back then) partied the whole night and poor shivered in bitter cold, the middle classes would usher the New Year sitting in front of their TV sets, listening to the famous Punjabi singer Gurdas Mann and watching some sundry comedians trying hard to make people laugh.

Tax on long term capital gain (LTCG) arising from sale of publicly traded equities is one such stories (like Gurdas Mann's performance) that is served almost every year. If my message box is a benchmark, at least half the market participants are discussing and worrying about it, once again.

Insofar as I am concerned, I shall hear the finance minister for objectives (ii) and (iv) mentioned at beginning of this post.

I am keeping no expectations for tax concessions, as I am convinced that the effective tax rates for me have bottomed few years ago, and these should continue to rise for next many years. Any concession, if at all, allowed this year will be ad hoc and perhaps misleading.

Wednesday, January 29, 2020

Indian railways on the slippery tracks

Earlier this month, the National Institution for Transforming India (NITI Aayog) issued a discussion paper on Private Participation in Passenger Trains (see here). The discussion paper proposes engagement of private players for running passenger trains on 100 train routes. The routes proposed include some of the most popular routes from Delhi, Mumbai, Patna, Chennai, Hyderabad and Kolkata.

The objectives of the proposal to engage private operators for running passenger train are stated as follows:

Introduction of modern technology rolling stock with reduced maintenance
Significantly Reduce Transit Time
World Class Service – Improved User Experience
Capacity Augmentation
Reduce Supply Demand Deficit

I would not like to delve into the mundane issue of whether this proposal is a tacit admission by the Indian Railway that it is not possible for it to provide global standard services in the present format.

I want to raise a rather meaningful and certainly relevant issue.

With over 1.3million employees, Indian Railways is one of the largest civilian employers in the world. With an annual budget of over Rs2trn, it plays a significant role in the Indian economy.

As per the latest data released by the CAG, Indian Railways could be one of the most inefficient rail operators in the world with an operating ratio of 98.44% in FY18. This implies that Indian Railways spends Rs98.44 for every Rs100 of revenue it earns. Excluding the advances received from NTPC and IRCON, the operating ratio for FY18 would be 102.66%, implying operating loss in operations of Indian Railways.

The primary argument behind the privatization of passenger services in my view may be to relieve the Railways from the burden of huge subsidy it provides for carrying appx 8.5bn passengers every year. As per the CAG report, almost 95% of the profits from freight haulage services was utilized towards the loss on operation of passenger and other coaching services.

Besides, the share of internal resources in total capital expenditure also fell to 3.01% in FY18, resulting in higher dependence on the gross budgetary support and extra budgetary resources for capital expenditure. The growth and modernization plans of Railways is obviously suffering.

Keeping the current conditions of the Railways in mind, the points to ponder are as follows:

(a) Once the dedicated rail freight corridors and Sagarmala (sea route for non export cargo movement) projects are completed the share of Indian Railways in freight movement may come down.

(b) Development of highways shall continue to challenge the Railways dominance in the freight movement business.

(c) GST has changed the trade paradigm in the country. There are high chances that henceforth most large projects will be set up close to raw material sources minimizing the movement of bulk materials like coal, iron ore etc.

(d) Engagement of private operators in the passenger freight business may not result in any meaningful reduction in fixed off track (administrative) costs of Indian Railways.

This would essentially mean that the Indian Railways shall be treading on the same path as the public telecom operators (MTNL & BSNL), public air carrier (Air India), Public Power Equipment Manufacturer (BHEL), and Public Coal Producer (Coal India) have treaded in past 2 decades.

With the inbuilt operating inefficiencies and largely inflexible cost structure, running the Indian Railways as a business venture may no longer be viable.

Tuesday, January 28, 2020

India Energy Policy Review

In a recently published report "India 2020 - Energy Policy Review", the International Energy Agency (IEA) highly appreciated the efforts of Indian government in achieving energy efficiency, energy security and sustainability, and robust data and policy governance. IEA also made significant recommendations for further enhancing the efforts and achieving greater results. The recommendations assume further significance as these could have material impact on the investments in the Indian energy sector.

The key points highlighted in the report could be listed as follows:

India vital for future of global energy market

With a population of 1.4 billion and one of the world’s fastest-growing major economies, India will be vital for the future of the global energy markets. The Government of India has made impressive progress in recent years in increasing citizens’ access to electricity and clean cooking. It has also successfully implemented a range of energy market reforms and carried out a huge amount of renewable electricity deployment, notably in solar energy.

Progress towards affordable, secure and cleaner energy

Around 750 million people in India gained access to electricity between 2000 and 2019, reflecting strong and effective policy implementation. The IEA highly commends the Government of India for this outstanding result and supports its efforts to shift the focus towards reaching isolated areas and ensuring round-the-clock reliability of electricity supply.

The government of India has also made significant progress in reducing the use of traditional biomass in cooking, the chief cause of indoor air pollution that particularly affects women and children.

Energy security improving

India’s electricity security has improved markedly through the creation of a single national power system and major investments in thermal and renewable capacity. India’s power system is currently experiencing a major shift to higher shares of variable renewable energy, which is making system integration and flexibility priority issues. The Government of India has supported greater interconnections across the country and now requires the existing coal fleet to operate more flexibly. It is also promoting affordable battery storage.

India’s coal supply has increased rapidly since the early 2000s, and coal continues to be the largest domestic source of energy supply and electricity generation. Amid more stringent air pollution regulations, new coal power plants that are more efficient, flexible and relatively lower in emissions will be better positioned for their economic viability. By contrast, old and inefficient plants, which require expensive retrofits to comply with environmental standards, are in a difficult position.

The government aims to increase the share of natural gas in the country’s energy mix to 15% by 2030, from 6% today. The role of gas has grown in India’s residential and transport sectors but fallen in power generation, where imported natural gas remains squeezed by cheap renewables and coal.

Reforms to achieve greater energy efficiency

The creation of functioning energy markets will ensure economic efficiency in the management of the coal, gas and power sectors, which is critical to achieving energy security and supporting the country’s economic growth. This will be increasingly important in the future, as energy demand and investment needs increase in line with India’s economic expansion.

Reform of India’s electricity sector will need to be comprehensive to achieve these goals. A country-wide wholesale market is very much needed as a backbone for the national grid.

India also faces the challenge of ensuring the financial health of its power sector which is dealing with surplus capacity, lower utilization of coal and natural gas plants, and increasing shares of variable renewable energy.

Sustainability

India has made important progress towards meeting the United Nations Sustainable Development Goals, notably Goal 7 on delivering energy access. Both the energy and emission intensities of India’s gross domestic product (GDP) have decreased by more than 20% over the past decade. This represents commendable progress even as total energyrelated carbon dioxide (CO2) emissions continue to rise. India’s per capita emissions today are 1.6 tonnes of CO2, well below the global average of 4.4 tonnes, while its share of global total CO2 emissions is some 6.4%.

Energy data and policy governance

Good quality and timely energy data are vital for monitoring, reviewing progress and enforcing the implementation of energy policies. The government has identified the critical importance of energy data and is taking action to improve their collection and dissemination.

Key recommendations

Establish permanent energy policy co-ordination in the central government, with an overarching national energy policy framework to support the development of a secure, sustainable and affordable energy system.
Continue to encourage investment in India’s energy sector by

(i) Ensuring full non-discriminatory access to energy transport networks

(ii) Working with the states to implement power sector and tariff policy reforms with a focus on smooth integration of variable renewable energy and power system flexibility

(iii) Moving from government allocation of energy supplies to allocation by market pricing

(iv) Further rationalising subsidies and cross-subsidies.

Prioritise actions to foster greater energy security by:

(i) Reinforcing oil emergency response measures with larger dedicated emergency stocks and improved procedures, including demand-restraint action and proper analysis of risks by using oil disruption scenarios and capitalising on international engagement

(ii) Strengthening the resilience of India’s energy infrastructure, based on a robust analysis of the water–energy nexus and cooling demand, notably when planning future investment.

Improve the collection, consistency, transparency and availability of energy data across the energy system at central and state government levels.
Adopt a co-ordinated cross-government strategy for energy RDo&D, which enables impact-oriented measurement and dissemination of results.
Ensure India’s international energy collaboration continues to be strong and mutually beneficial, highlighting the country’s energy successes and supporting continued opportunities to learn from international best practices.

You can read the full report here.

Friday, January 24, 2020

Market and economy are moving in tandem

In the discussions about the present market conditions and likely emerging scenarios in next few months with some seasoned investors and money managers earlier this week, an cliché but still interesting point was raised. A large majority of the participants felt that the equity markets have diverged a long way from the real economy in past couple of years; and this is matter of grave concern since this kind of divergences in the past have not ended in a pleasant market scenario.

I however was on the side of small minority which felt that the market movement in the past two years has actually been in total congruence with the conditions in the real economy; and that is a cause of even more serious concern.

In past couple of years while the overall economic growth has slipped, a comparatively smaller section of the economy has done extremely well. The number of billionaires in India has risen at a faster pace. The number of Unicorns (start ups ventures valued more than a billion USD) have risen rapidly. The sale of luxury vehicles has sustained while the sale of entry level vehicles, two wheelers and commercial vehicles has collapsed. The salary of CEOs has recorded rise of high two digits while the salary of lower level workers has stagnated or even fallen. The wealth of top 1% has recorded sharp jump while the bottom 70% have hardly grown. The air travel has recorded much higher growth than railway and road transport passengers. The telecom ARPU has recorded increase after many years.

Similarly, if we analyze the price performance of the companies traded on the National Stock Exchange (NSE) during the two year period from 1 January 2018 to 31 December 2019, we get a very similar picture.

~50% of the companies have lost between 50.1% and 99.4% of their value in past two years. These companies include some really large names likes Reliance Infra (-95%), Reliance Power (-94%), Jain Irrigation (-94%), Jet Airways (-97%), DHFL (-97%), Reliance Communication (-98%), Yes Bank (-85%).
~36% of the companies have lost between 0.1% and 50% of their value in past two years.
Only 9% companies have gained between 0.1% and 50% in value during past two years.
Just 5% companies have gained over 50% in value during past two years, with just 1.5% gaining more than 100% in value.

While on one hand more than 75% of the population has suffered some sort of stress in the past two year, 86% of the companies traded on stock exchanges have given negative return.