PSU sell-off through ETFs can energise comatose equity market

The finance ministry is toying with the idea of using Exchange Traded Funds to partly divest its holdings in public sector units. If handled with intelligence, this can energise the stock market, which has largely been shunned by Indian retail investors. Even the hair-brained Rajiv Gandhi scheme can be made to work this way

The Indian government is apparently toying with the idea of selling public sector units (PSUs) through an Exchange Traded Fund (ETF). This could be a game changer, not only for the beleaguered government which had failed to meet its divestment target of Rs30,000 crore (having raised less than half the amount), but also the for the retail investors and the way financial markets are run in this country.

Under this idea, a bunch of PSU shares will be transferred to the ETF. The investor would be investing in a fairly diversified portfolio of government stocks, without worrying too much about one or two underperformers. The ETF manager will then issue shares to the Indian public the same way mutual funds’ New Fund Offers (NFO) are launched. An exchange traded fund is a basket of shares that can be bundled together and traded just like any other share, on an exchange. Its valuation would be decided by underlying value of the basket.

However, this route by itself will not be very useful unless it is used intelligently. Very simply, the shares have to transferred to the ETF not with the purpose of maximising the take of a greedy government, but to leave a lot on the table for ETF investors so that they make some money and from the process start believing in investment in blue chip equities as a solid investment option.

After all, valuation has been the bane of the government’s divestment process. With unrealistic valuations, mostly benefiting merchant bankers, investors in past PSU initial public offerings have lost money—and have been put off further by the Indian stock market. The market has essentially shown that some of the initial public offers (IPOs) were overpriced, favouring the government and the merchant banker instead of the investor. The National Buildings Construction Corporation (NBCC) is down nearly 10% from its issue price of Rs106 and MOIL is down 29% from its issue price. This was also the reason behind the Oil and Natural Gas Corporation (ONGC) fiasco and other PSUs which are faring poorly. The government and merchant bankers did a poor job of valuing the company. The poor performance has put off many retail investors from investing in future offers.

ONGC’s follow-on issue was originally planned in the 2010-11, but was deferred as the company could not meet Securities Exchange Board of India’s (SEBI) norms. Once again, adverse market conditions put off its listing in 2011. And presently, the government had embarrassed itself when it priced ONGC at a premium instead of a discount. This prompted Life Insurance Corporation of India (LIC) to buy almost half of the shares on offer, with some sources saying it bought as much as 90% of the auction, as there were virtually no retail subscribers. Even Indian Oil Corporation (IOC) had to put out its follow-on offer, for similar reasons.

The current ETF idea seems to be on the lines of the way the Hong Kong government changed its financial markets.  In August 1998, the Hong Kong government acquired a substantial portfolio of Hong Kong shares during a market operation. The Exchange Fund Investment (EFIL) was established in October 1998 by the Hong Kong government to advise it on the disposal of this portfolio in an orderly manner. When seeking to dispose of these shares, the Hong Kong government chose a stock neutral solution that would create minimal disruption to the market. An Exchange Traded Fund, the Tracker Fund of Hong Kong (TraHK), which met these requirements and added depth to Hong Kong's capital markets, was launched in November 1999 as the first step in the government's disposal programme. It has been a success since then. With an issue size of HK$33.3 billion (approximately $ 4.3 billion), TraHK's Initial Public Offering (IPO) was the largest IPO ever in Asia, ex-Japan, at the time of its launch. Since the IPO, approximately HK$ 140.4 billion (by 15 October 2002) in Hang Seng Index constituent stocks has been returned to the market through TraHK's unique tap mechanism, without market disruption. By taking a page out of TraHK, the Indian government will find it easier to not only find buyers, but also involve a large swath of the Indian investor population.

The benefit of adopting this route is that the government does not have to fear of disrupting the market the way it did for the ONGC auction. The Indian government could make it available only for domestic institutions and retail investors—n other words, the Indian tax payers. The government could just announce all the PSUs it wants to divest, well in advance by announcing a fair price. By garnering enough subscribers, it will not only manage to divest each PSU, but it will be able to divest all of them (or whatever it wants to) in just one single shot. In case of oversubscription, additional shares of ETF can be launched, thus make it more accessible than ever.

The mood of the country favours this as well. Moneylife has a direct evidence of this (neither the ministry of finance nor the market regulators engages with the savers). In a meeting of 300 people organised by Sanjay Nirupam, in 2010, for Moneylife Foundation, all hardcore investors demanded that this PSU share sell-off at a reasonable valuation is a great idea.

However, it will work only if the government allows more room for valuation, especially at the lower end of the spectrum, which will “guarantee” some returns and attract investors. After all, the owners of the PSUs are not the government, but the Indian taxpayers. In essence, the Indian taxpayers are keeping them afloat and therefore entitled to it at a fair valuation. Otherwise the ETF will not work for the same reasons the ONGC failed. The government could also club this ETF with the Rajiv Gandhi Equity Scheme, thereby giving first time investors a chance to enter the market profitably instead of being eaten up alive by the stockbrokers, aided by the TV channels.

Companies which are lined up for disinvestment in the current fiscal include Steel Authority of India (SAIL), Bharat Heavy Electricals (BHEL), Hindustan Copper, Oil India and Hindustan Aeronautics.



Krishnaswami CVR

5 years ago

Seems to be an wonderful idea. Of course, the article speaks of providing space to the investors. But then who will provide the space to the deficit of the Government. Valuation is a key factor. Once again the hungry merchant bankers will offer for their services. Will it not be better if the merchant bankers or some of the cash rich institutions bid for the shares and then bundled as ETF and listed in the market. Valuation , in that case,may satisfy both the parties- Government and Investors.


Moneylife Digital Team

In Reply to Krishnaswami CVR 5 years ago

Investment bankers must be kept out of this. The ETF managers and PSU officials know how to value more sensibly than IBs

Krishnaswami CVR

In Reply to Moneylife Digital Team 5 years ago

Every big financial group has a merchant banking arm. I feel that you can not do away with them. Whom do you suggest to be the ETF manager.

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RBI to set up committee to look into fixed rate loan products

RBI is planning to set up a committee to look into the issue of facilitating the development of fixed rate loan products in the banking system

Mumbai: The Reserve Bank of India (RBI) is planning to set up a committee to look into the issue of facilitating the development of fixed rate loan products in the banking system, RBI deputy governor, Anand Sinha said, reports PTI.

“We will set up a committee soon to facilitate the development of fixed rate loan products in the market, which are presently absent in the system,” Mr Sinha told reporters on the sidelines of an Assocham event.

Explaining the rationale behind the move, he said it is the question of market development as consumer should get a range of products to make a choice.

In its last credit policy review in April, the central bank had announced to set up a committee to look into the issue.

Referring to the issue of hedging, Mr Sinha said the central bank has asked banks to have a board mandated hedging policy to protect corporate clients from currency fluctuations.

“We know that the corporates take a view on the exchange rate movement based on the currency movement and then decide whether to hedge or not to hedge. Point is that if we are looking for a safer system then we will have to gear up on our hedging in a better way...,” Mr Sinha said.

He also said the central bank doesn't have any fixed level for rupee and will only intervene to check excess volatility.

“RBI doesn't look for a fixed level of rupee. We will only intervene if there is excess volatility,” he said adding that it is closely watching the liquidity situation.

Presently, banks are borrowing around Rs1 lakh crore from the liquid adjustment facility (LAF) route, which is above RBI's comfort level of around Rs60,000 crore.


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