February 23, 2017    8 minute read

Building India’s Behemoths

Mega Mergers    February 23, 2017    8 minute read

Building India’s Behemoths

 

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The largest democracy and the second most populous country in the world, India is now the world’s fastest-growing economy. A new government emerged as an agent of change for the country’s masses in 2014, and Prime Minister Narendra Modi has left no stone unturned to glorify the nation, its potential, and the measures taken by his government.

A lot has been happening in India’s economy over the last couple of years. A slew of measures were introduced to curb black money (unaccounted and untaxed money), formalise the informal economy, revive business confidence, revamp sectoral laggards, increase political participation, bring transparency in governance, and so on.

27 The number of India’s banks facing consolidation

The government is also interested in strengthening CPSEs (Central Public Sector Enterprises) by consolidating similar enterprises into large-scale businesses. This integration is aimed at making Indian enterprises globally competitive and at augmenting their operational efficiency, risk management, economies of scale, and stakeholder value. In the Union Budget 2017-18, the finance minister hinted at mergers in the energy, consulting, and construction sectors. The government also proposed integrating all 27 public sector banks to form six large banks.

Building India’s Energy Goliaths

India represents around 17-18% of world’s population, and is the third largest global consumer of oil and petroleum products. This makes India a major crude oil, petroleum and gas importer.

81% India’s import dependency in energy

81% of its energy needs are satisfied by imports. 28.6% of the population depends on LPG (Liquefied Petroleum Gas) for cooking, while 57.9% still rely on firewood and crop residue, paving the way for opportunities in LPG and other non-conventional energy sources. Of total electricity generation, 59.9% is from coal.

Its inelastic demand, a rising population, and a heavy dependency on non-renewable fossil fuels raise perpetual environmental and balance of payments problems. For this reason, Modi intends to reduce the import dependency of his country’s oil needs from 81% to 67% by 2020. Also, the government had set an ambitious target to increase renewable power generation more than fivefold by 2022.

India has 13 state-run energy companies, including Oil and Natural Gas Corporation (ONGC), Indian Oil Corporation Ltd (IOCL), Gas Authority of India Ltd (GAIL), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation (HPCL).

It is estimated that the combined market value of eight such companies would be over $100bn, meaning a consolidated entity would be capable of competing with the international players like BP and Royal Dutch Shell. The 2016 Fortune Global 500 (largest companies by revenue) lists IOCL, BPCL and HPCL at ranks 161, 358 and 367 respectively. ONGC was also part of this list in 2015.

If all 13 energy sector CPSEs were merged, the oil behemoth would occupy a place in the top 30. However, instead of creating just one single oil company, the government intends to explore opportunities to merge various companies into few larger ones.

On February 22nd, the government announced its first step in this regard, involving ONGC taking over BPCL and HPCL. The combined revenue of these three companies would rank the merged entity at 85th or 86th position.

The proposed merger could improve operational efficiency, compete globally for resources, protect India from oil price volatility, provide stronger bargaining power with suppliers and strengthen its financial health. ONGC is the country’s biggest oil producer. The merger would vertically integrate the company from oil and gas exploration to retail sale business. Analysts believe that merging would provide stable profits since exploration business tends to do well as oil prices rise, and distribution business brings in benefits during a price drop.

However, challenges in creating an oil behemoth would include debt and competition. HPCL and BPCL together have debt of more than 250 billion  rupees (as of September 2016) which would burden ONGC’s balance sheet. The other challenge is for the domestic private players. They might face difficulties in competing against the state-owned companies due to lower economies of scale and lower market share.

Building Banking Titans

$432bn The total combined assets of the proposed banking merger

The merger proposal of State Bank of India (SBI) with its five associates announced in May 2016 was finally approved by the Union Cabinet on February 15, 2017. The total combined assets of the merger, as of March 2016 figures is equal to 28,625 trillion rupees (equivalent to $432bn according to the exchange rate at the time). The merger is expected to create the first Indian lender to get a place among the world’s top 50 banks list.

There are 27 public sector and 21 private sector banks in India. The market share occupied by public sector banks is more than 70% as of March 2016. As a part of the mega-mergers process, apart from SBI merger, 16 other PSBs (public sector banks) would be integrated into Punjab National Bank, Canara Bank, Union Bank of India, Bank of India and Bank of Baroda to form final six large PSBs.

Plummeting NPAs (non-performing assets) have been the greatest concern for the banking system in India. Below figure shows a rise of NPAs in banking system along with the disturbing situation of PSBs.

The average ratio of public sector banks in 2016 was 5.75% which is greater than the 4.69% reported by Catholic Syrian Bank, the highest in private sector.

The Return on Assets (RoA) ratio could also be used to compare public and private sector banks. 14 PSBs (i.e. 52% PSBs) have negative RoAs. The rest of the 13 PSBs have positive ratios but do not exceed 1%. Whereas only 2 out of 27 private banks have negative RoAs and 12 banks exceed 1%.

PSBs are lagging behind private players with respect to credit recovery and technological adaptations. They do not have sufficient operational autonomy. However, their reach and trustworthiness are their strengths, which enable financial inclusion, deliver government services, and sustain economic growth. The current situation needs innovative and long-term solutions to get rid of the sector’s problems.

The proposed merger would not solve the sector’s bad loan problems. But it would increase banks’ capital bases which would help them to comply with Basel III norms. It would also create richer coffers to lend to people and corporates. The giant banks could penetrate overseas for geographical diversification alongside strengthening their operational processes in order to provide better services and recover loans more quickly.

S Misra, a Singapore-based banker, believes that “PSB mergers are trickier.” He added: “Modern financial systems need specialisation. Rarely can one institution manage all types of asset classes well.” He suggested creating sector-specific or asset class-specific banks.

The merger has also faced opposition from employee unions. The integration would produce many challenges like job losses, cultural differences, and bumps along the road towards streamlining processes, policies and technologies.

Growing Pains?

Merging is not as easy as it sounds – it is not just an accounting exercise. It involves decisions which might benefit entities financially but might affect millions of people negatively. The procedures should move faster, untouched by politics and controversies.

The merged entities must maintain efficiency and utilise resources optimally. The complete integration of operations and reaching the stage where India’s new behemoths can enjoy merger synergies could possibly take more time to reap the actual benefits.

The next sectors in the consolidation pipeline could be space research and defence. This could be colligated with two latest events regarding India’s world record of launching 104 satellites and the report that stated India as the world’s largest importer of major arms in 2012–16.

The government is struggling very hard to push the idea of ‘Make in India’ to global markets, and stronger Indian businesses (public as well as private) are needed to partner the global giants in this journey. The need to strengthen CPSEs is aimed at increasing global footprint and gain international aid with respect to newer business avenues and technologies.

This could help India in positioning and maintaining its ‘fastest growing economy’ tag and give Indians a new wave of hope by opening the next chapter of development. Would these measures succeed? Would global uncertainties smash India’s hopes? Only time shall unfold the mysteries ahead.

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