By Priyanka Venkat
The ailing health of India’s public sector is widely known. However, the government has often tried to make services more profitable and efficient by consolidating public sector undertakings (PSUs). Simply put, consolidation refers to the merging or acquiring of smaller companies such that they become a part of fewer larger ones, in an attempt to achieve economies of scale.
Consolidation offers economies of scale
For instance, the government plans to merge the group companies of Power Finance Corporation and Rural Electrification Corporation—two state-owned companies in the power sector. The hope is to leverage the combined synergy of these enterprises by consolidating the subsidiaries into one unit. This could improve efficiency by reducing the costs, which would allow these state-owned companies to work on par with private ones, at least in terms of cost. Other PSUs in the power sector, like National Thermal Power Corporation (NTPC), Coal India and National Mineral Development Corporation (NMDC) may soon follow suit.
Many state-owned firms struggle to take advantage of economies of scale because their numerous subsidiaries possess similar business objectives and perform similar tasks. In response, public sector companies are also considering the possibility of shutting down entities that are redundant. An accounting expert in an interview with the Economic Times has said, “Now managing so many subsidiaries has become very complicated for the management. Compliance is also costly and consequences of non-compliance are huge.”
Is merging PSBs the best way forward?
PSUs are not the only entities attracting the government’s attention. The government also has its eyes set on public sector banks (PSBs) and has proposed the merging of small and medium-sized PSBs with larger ones. However, the idea of consolidation of PSBs has received mixed reactions.
The existence of numerous poorly performing state-owned banks raises the question of whether their function could be performed by a few larger and stronger banks. The burden of Non-Performing Assets (NPAs) impedes the ability of banks to contribute to credit creation. This drastically impacts their position in the market and makes a turnaround less likely. Their weakened position makes it hard for them to raise capital on their own. By merging them with larger banks, the increase in capital availability and resources could put them in better stead. In this sense, consolidation could solve the credit problem.
The repercussions of the State Bank merger
Last year in April, the State Bank of India (SBI) undertook a massive merger with five associate banks and the Bharatiya Mahila Bank. This merger launched SBI into the global sphere, and it found its place among the top 50 banks in the world in terms of assets. While the government initially lauded the merger, the outcome was not as positive as expected. SBI reported huge losses at the end of the March quarter of the financial year (FY) 2017. A major reason for this was the poor asset quality of its subsidiaries.
While SBI reported a net profit of Rs. 2814.82 crore, the merged enterprise ran a net loss of close to Rs. 3000 crore. This was largely due to the associate banks reporting about Rs. 6,000 crore of losses. When a large bank like SBI has the benefit of commonality in terms of information technology, human resources, and basic systems in such a merger, one would expect the outcome to be a lot more favourable than this. This makes the outcome of mergers by other government banks, which have fewer systems in common, look bleak. This also demonstrates the high stakes involved in such mergers, where a lot of variables need to align for the merger to be successful and the outcome needs to be worth the large input of resources involved.
The benefits of privatisation
It is therefore imperative that the government explore alternative avenues to alleviate inefficiency in the sector, as consolidation and recapitalisation may have a serious impact on the economy. One such avenue is privatisation through disinvestment.
The International Monetary Fund (IMF) has highlighted the various challenges faced by the banking sector. The poor asset quality of PSBs severely affects the sector as they contribute to 71% of credit creation. The IMF has strongly recommended that weak PSBs be privatised. This is because weak banks, when merged with stronger ones, often gradually weaken the strength of the banking system.
While the pursuit of privatisation is likely to receive strong political opposition, it has tangible benefits that need to be considered, such as improvements in efficiency. By privatising some loss-making PSBs, other PSBs may be driven to re-evaluate and fix their strategies in order to maintain control. This would also reduce the repeated injections of cash by the government to keep such PSBs afloat, thereby inculcating fiscal discipline in the sector.
There is also the moral hazard problem. State ownership in PSBs often influence the trajectory of lending, with banks having to lend towards projects that fulfill political goals. When these projects go bad and the money lent is irrecoverable, a bailout is required from the government, creating a vicious cycle.
The problem faced by the sector is a persistent and a complex one. It will require a multitude of approaches to be effectively tackled. It is therefore imperative that the government learns from past mistakes.
Featured Image Source: Pixabay
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