Investors are often told that they should be aware of regulatory risks. A surprise change in laws and regulations that materially impacts a business, sector or market can be devastating for shareholders and investors. It is never a good idea to own a stake in a business where the pricing power is with somebody outside. Imagine an idli seller whose prices are not set by him, but by the person who sells paan next door!
Well, investors got a taste of this in the week ended October 6 when the Indian government while announcing Rs 2.50 per litre cut in the price of fuel said that Re 1/litre will be borne by the Oil Marketing Companies (OMCs) as a subsidy. Government intervention risks are real. These risks can be related to how companies will price their products, which company will merge with whom and even asking financial institutions to take retail investor money and pump in it a failed institution.
The fuel price subsidy is likely to wipe out nearly 50 per cent of the profit margins of downstream OMCs and some of these stocks lost nearly 50 per cent of their value in just two days flat. Investor wealth worth over Rs 1.3 lakh crore in two days was eroded as investors dumped shares of HPCL, IOCL, BPCL, and ONGC like there was no tomorrow. There are concerns that some of this subsidy burden will also fall on the back of upstream firms like ONGC, Oil India and GAIL as has been the case in the past.
So, what is wrong with the government directing OMCs at present to bear a part of this subsidy? Well, OMCs price their fuel as per market dynamics i.e. rates are market-linked. What the government did was to bring back regulation of fuel prices. The government could not have simply let fuel prices rise at the rate which it has done and couldn’t risk ire of the public just ahead of key state elections in Rajasthan, Madhya Pradesh, Chhattisgarh and Telangana. This intervention deserves a big thumbs-down. Investors in PSU oil stocks have understood this and hence they offloaded their shares in such a hurry. With global oil prices expected to rise to $100 per barrel and the US dollar now at 74 levels versus Indian rupee, more such interventions will mean that OMCs and upstream firms will pay a heavy price.
The government’s controversial decision, which has already cost a lot of money to shareholders including the government itself since it controls these PSUs, almost looked like an unwinding of the entire oil sector reforms process. Markets had anticipated that for quite some time but did not price the risk in. But oil is not the only sector where the intervention risk has been realised.
A few days ago, stock markets were shocked when the proposed merger of financially-strong Bank of Baroda (BoB) and Vijaya Bank with a weak Dena Bank was announced. Since September 17 when the deal was announced, the BoB stock fell from Rs 135 level to Rs 98 now. Vijaya Bank shares declined from Rs 60 level to Rs 44 on October 5. The key rationale behind selecting these banks for amalgamation was not justified in any case, other than better Tier I for the merged entity. Minority interest, many feel, was compromised over the lower need of capital infusion in future.
All benefits, material operational efficiency, lower funding cost and better risk management, that are expected to accrue to the merged entity for saving a poor bank by joining it with two goods banks are only in the long term. In the short term, the slippages could increase as recognition of non-performing assets is harmonised and accelerated. There are operational aspects such as business growth and resolution of large stock of delinquent assets continue receiving adequate attention. Would BoB and Vijaya Bank minority investors want to merge with such a poor bank like Dena? Nobody would know, because nobody waited to ask them. There is the talk of more such strong-weak banks being considered for mergers. So, investors who carefully selected good banks for investments would be compelled to pay a price for the mistakes of a bad bank.
We have also recently seen how IDBI Bank, the worst PSU bank in terms of bad loans, has been passed on to LIC. The insurance giant LIC is not government property. LIC had a big stake in IDBI Bank and that stake was bought by policyholder money that LIC collects from premiums that you or I pay. The government nudged LIC towards IDBI Bank. The IDBI Bank board has already approved the proposal for issuance of preferential shares in favour of LIC with a view to increasing the share of the insurer in the bank to 51 per cent. LIC’s open offer is triggered after the government transferred 43 per cent of its stake in IDBI Bank to the insurance company, which resulted in LIC’s holding rising to 51 per cent. Now, LIC wants to spend more for an open offer to buy up to 26 per cent stake in IDBI Bank.
LIC has been a white knight for government-owned institutions. As a steward of insurance money that belongs to common men and women, LIC is accountable to them. But the government, not just the current one, have virtually used LIC as an ATM and a lender of the last resort. Be it PSU company IPOs, follow-on offers, financial loans and rescue acts, LIC over the years has had to come forward every single time to bail out others. While it can be argued that LIC with over Rs 22 lakh crore assets is too big and the government intervention risk has played out without any failure, it may not always to do so. LIC may not always taste success, and that is something its policyholders must mentally prepare for.
These types of developments make the government regulation risk extremely unpredictable. Stock markets are fine with taking a risk, but uncertainty is something that is giving them shivers. Government related sectors and companies will always be at intervention risk. We have seen how HAL was replaced as a partner in a big defence deal. It was replaced by a private sector company. There are more such defence related PSUs and other companies that are controlled by the government. If private sector defence manufacturing is promoted in a big way, many defence PSUs may lose orders, which would hurt their earnings. As the majority stakeholder, the government may want to take any decisions that suits it, but for the common minority investor, such interventions are a financial cost, that are often big.
The problem with even a well-intentioned intervention is that it has an impact. For direct equity investors and even the indirect investors who buy stock related instruments like MFs, ULIPs or insurance cum investment plans, the cloud of an intervention-happy government is not an ideal situation. Companies and their management may be gearing their businesses to cash in on some opportunity, but a surprise government intervention can easily create a distraction and impact the business in a definitive way. So, should you avoid government-owned and controlled companies and sectors? Your guess is as good as mine.
The author is a financial journalist with over 13 years of experience