Dear Future PM, PSBs Must be Privatised to Spark Economic Boom

The Modi government blew its opportunity & four years down, India’s public-sector banks have keeled over.

• Rs 772 Cr Loan Scam in the Name of Fishing (Amar Ujala, 29 March, 2018)
• Worried by IDBI Bank’s Poor Health, RBI Writes to Fin Min (The Economic Times, 30 March 2018)
• ICICI-Videocon loan controversy: Did PM ignore whistleblower, twice? (National Herald, 29 March 2018)
• PNB Scam: Why it’s time to change the way fraud cases are handled in India (The Economic Times, 28 March 2018)

These are just a handful of dire headlines from the 200th week of Prime Minister Narendra Modi’s government. All from just one week; all screaming how the government failed to tackle India’s number one economic problem even after 200 weeks of being in absolute power.

Remember how the country had given Prime Minister Modi a single party majority after three decades of relatively weak coalitions? And plain good luck added a massive economic tailwind, as oil dropped to under USD 30 per barrel, giving him a surplus of nearly Rs 1 lakh crore or one percent of the GDP, every year.

Recall how every financial mind thought that Modi would use his awesome mandate and completely unexpected oil bonanza to fix India’s broken banks, which in turn would have ignited an economic boom.

But It’s Been a Deathly Downward Spiral

However, the Modi government blew its fortuitous opportunity. Four years out, India’s public-sector banks (PSBs) have keeled over and are dying (already dead, some would say):

• On Modi’s beat, PSBs’ share of total market capitalisation of Indian banks has crashed from nearly 43 percent (2014) to 26 percent (2018)
• While private banks doubled their value, adding over USD 100 bn in these four years, PSBs wiped out nearly USD 50 bn from their already emasculated valuations
• Through this mayhem, the government put in USD 10 bn, with a promise of another USD 35 bn over the next two years, in additional equity. Clearly, such a destruction of value is mind boggling, despite the infusion of vast quantities of tax-payers’ (yours and mine) hard cash
• PSBs’ share in deposits is down by nearly four percentage points (from 80 percent to 76 percent), but their portion of outstanding loans has fallen by twice that, ie by eight percentage points (from 79 percent to 71 percent). So profitability (or, ‘loss-a-bility’) is in a deathly downward spiral

Band Aid on Cancer!

Six months ago, with its back to the wall, the Modi government announced a “bold plan” of bank recapitalisation bonds. Frankly, this is a statist, un-innovative and old world move.

This instrument was deployed in 1991-1992, when the country was bankrupt and the government was somewhat justified in using a sleight of hand to bail itself out – ie, transferring the liabilities on a bank’s books to the asset side, and shoving the contingent liability (which actually increases the government’s fiscal deficit “invisibly”) off the balance sheet. If any private owner were to do this, he would be in jail for misappropriating public funds. But the government got away with this ploy in 1992 because of the financial emergency.

It’s a shame that the Modi government is reusing a quarter-century-old band aid to try and cure today’s cancer.

It’s Politically Feasible to Privatise PSBs, But There Are Some “NOT TO DOs”

Is it possible to construct a politically feasible plan to begin the arduous process of privatising PSBs? Yes, and it must start by laying down a strict set of “NOT TO DOs”, ie the plan MUST NOT:

• Be seen as selling the family silver to big foreign investors or domestic industrialists (shun crony capitalism at all costs)
• Force a cheap sale of government equity at today’s distressed values; there should be a fair and visible opportunity to recover the taxpayers’ past investments as the asset price rises (eg Maruti and Balco, among other privatisations)
• Work against the interests of the bank’s workforce, who should be incentivised to support the privatisation; their terms of employment should be preserved, unless altered voluntarily
• Be too rapid or disruptive in scale; it must begin with tiny, demonstrative case studies, and build momentum with each success; the full plan could stretch out over half a decade or so
• Be left to the Raisina Hill bureaucrats; it should involve external experts with full political backing, directly from the prime minister and finance minister

How to “Do The Impossible”: India’s First Public-Sector Bank Privatisation

Here’s a typical, illustrative case study to show how to “Do The Impossible”:

• First pick a small public-sector bank, say with a current/distressed market capitalisation of Rs 25,000 crore
• Assume that the state owns 60 percent of this bank; now reclassify its capital structure such that the government’s equity shares are converted into 10-year Compulsorily Convertible Preference Shares (CCPS), which are separately listed; remember that CCPS are equal to “equity” under Indian accounting standards, so the government’s ownership shall stay fully intact after such a conversion, but it will lose its voting rights, thereby allowing a new owner to come in without the government crimping his management
• Transfer 9 percent of these CCPS into an employee stock pool, and liberally grant options to the workforce; the government will continue to own 51 percent of CCPS (ie, equity), but without any voting rights
• Only individual Indian bankers with stellar track records, either singly or in groups, would be eligible to bid for a 10 percent “management stake” in the asset; they should be allowed to tie up with credible private equity investors to transparently fund their bids
• If we assume that the winning bid would be at twice the current/distressed value, then a 10 percent management stake would cost approximately Rs 2,000 crore (at a total market capitalisation of Rs 50,000 crore, but since 60 percent of that would have been converted into CCPS, one would need only Rs 2,000 crore to get a 10 percent voting stake), which is a reasonable sum of money that individual professionals would be able to raise

To the New Prime Minister in 2019: “Give it a Shot, Sir/Ma’am, it’s Doable”

Bingo! The privatisation has been successfully pulled off, and all “NOT TO DOs” have been fully complied with:

• The asset has been acquired by individual Indian banking professionals ( as with the hugely successful RBL Bank), not by any large foreign or domestic business group
• The government has not been forced to sell its equity at today’s throwaway price; in fact, if the asset was to multiply 10 times in value over 10 years, the government’s 51 percent CCPS stake would be worth Rs 1.25 lakh crore (up from the Rs 15,000 crore of current/distressed valuation)!
• ESOP holders, ie the bank’s employees, would see their 9 percent stake go up to Rs 25,000 crore in value

I know what the nay-sayers on Raisina Hill will say. That this is a pipe dream stupidly conceived by a mind utterly inexperienced about how the government works (or frankly, doesn’t work!). To them I will say, thank the sweet Lord for the fact that this mind is unconstrained by bureaucratic thinking.

And to the incoming prime minister and finance minister in 2019, I would say: “give it a shot, sirs/ma’am; it’s doable.”

Once it is successful, others will jump on to the bandwagon, and India would have solved its most intractable economic problem with full political endorsement. Keep the faith!