The government may face fresh problems for its mammoth borrowing programme, with several major banks, especially public sector players, expressing difficulty in buying more long-tenure bonds during the auctions owing to growing mark-to-market risks to their balance sheet.
One indication of this was the fact that many large bond buyers stayed away from the Rs 12,000 crore auction conducted on August 7 when Reserve Bank of India (RBI) rejected all bids.
Treasury executives at some of the largest bond buyers said their bank had little headroom to buy government securities and hold these in the held-to-maturity (HTM) category.
Banks can keep securities in the HTM category only up to 25 per cent of net demand and time deposits. These securities remain in their portfolio till maturity, so banks do not have to follow mark- to-market accounting and make provisions if the value of the security drops below its face value.
When banks buy a government bond, they classify them into three categories — trading, available for sale (AFS) or HTM. If a security in the trading portfolio is not traded for 90 days it has to be shifted to AFS. But the RBI expects banks to shift securities from AFS to HTM, or vice versa, at the start of the year and that too with prior permission of the bank’s board or the investment or the asset-liability committees.
With HTM capacity virtually exhausted, any bonds banks buy now have to be classified as available for sale (AFS), for which mark-to-market provisions would be required. Fearing a mark-to-market hit, banks have become reluctant to put the securities in this category since yields are projected to rise. Bond prices and yields have an inverse relationship. So, when bond yields harden, there is price erosion for which banks have to set aside funds and take a knock on their profits.
Many of the treasury heads at the public sector players confirmed that they stayed away from the August 7 auction and at least one of them has also written to the central bank, pointing to its inability to make large purchases.
Bankers said one option for the RBI was to raise the ceiling on HTM classification from the present level of 25 per cent of the net demand and time liabilities. “Even if it is 27 or 28 per cent, we will be able to come back to the auctions,” said a bank executive.
The government and RBI have taken several steps to ensure that the Centre’s gross market borrowing, which has jumped from the second half of the last financial year, to fund the stimulus packages, did not upset the financial sector and loan flow. During the current financial year, the Centre has budgeted to borrow a record Rs 4,51,000 crore, of which Rs 2,99,000 crore is to be borrowed by the end of September.
With lower demand for credit, banks have stepped up investment in government securities, which rose to Rs 1,63,000 crore during April-July 2009 against Rs 31,259 crore in corresponding period last year.
A treasury executive with private sector bank said that while banks had the option not to participate in bond auctions, the public sector players had practically no choice but “to pick up” bonds to support the borrowing programme.
“A higher level of the investment portfolio is exposed to ups and downs in interest rates, making the balance sheet volatile for no fault of ours,” said a public sector bank executive.
The company’s net sales dropped 9.5 per cent to $10.18 billion in the same period.
Hindalco was also able to bargain with banks and revised the terms of its $982 million bank loan for the Novelis acquisition.
The Birla group’s other overseas acquisitions, including Canadian BPO firm Minacs ($125 million) and mines in Australia, also dented the group’s bottom-line. So Aditya Birla Minacs, the group’s business process outsourcing (BPO) arm, closed three centres, with a capacity to house 1,200 people, in Canada. The company also downed the shutters of units at Pickering, Saskatoon and Chatham in Canada. The company has 12 centres in Canada.
Faced with high costs and falling demand, the firm is now shifting part of its back-office operations from Canada to India, said a company official. “To consolidate and rationalise costs, we have shifted close to 250 of the 1,200 jobs to India,” he added.
The slump in copper prices and demand forced Aditya Birla Minerals, the Hindalco subsidiary, to close its Mount Gordon copper mine at Queensland in Australia. Mount Gordon produced 17,815 tonne of contained copper in the last financial year against 23,886 tonne last year. “Due to the global financial crisis and significant drop in copper prices, mammoth underground mine operations were put into care and maintenance,” Australia-listed AB Minerals said in its annual report.
The group has few other options. Prasad Baji, senior vice president of Edelweiss, said the costly operating structure of the acquired entities definitely required pruning, mainly to bring them under the low-cost and high operating margin format of Indian companies. “Overhead costs in India are lower than the developed and developing countries. Through rationalisation, the companies are rightly aiming to align costs with their Indian operations,” Baji added.
Although analysts dispute synergies between Tata Motors and Jaguar and Land Rover (JLR), the Indian auto maker is taking steps to save the sinking premium European models. The country’s largest auto house, which took over JLR from Ford Motor Company in June last year, has cut more than 2,000 jobs so far with about 500 more jobs also on the line. Employee strength at the three major manufacturing facilities and two advanced design and engineering centres in UK totalled more than 16,000.
The company appointed KPMG and Roland Berger Strategy Consultants a couple of months back to advise it on cost cutting and cash management. A special team at JLR is also looking at expanding the vendor base in India, east Europe and China to source low-cost components. JLR has already implemented significant cost reduction initiative across the business. Fixed marketing and selling costs have been reduced in line with sales volumes, in addition to headcount reductions.
The Ruias have also joined the queue. Essar Steel’s acquired entity Algoma is also rationalising operations in Canada during downturn. It has, however, taken back most of the 2,500 workers laid off earlier on the assumption that it would require more workers because it is increasing capacity, said J Mehra, chief executive officer of Essar Steel. “Algoma’s annual capacity will be increased to four million tonne from the current 3 MTPA by year-end and later it will to go up to five million tonnes,” Mehra recently said.
Sajjan Jindal-controlled JSW Steel is keen to revive its US mills, which is utilising just 15 per cent of its 1.7 million tonne annual production capacity because it expects higher demand soon. In the June-ended quarter, JSW Steel’s consolidated numbers were marred by demand contraction and low capacity utilisation at the US mills. Later, the company took cost-cutting measures such as lowering fuel consumption and reducing procurement costs.
JSW Group's Chief Financial Officer M V S Seshagiri Rao said the mills will run at 30 per cent capacity within three months as the market recovers slowly. As part of the revival efforts, JSW plans to sell the products from mills in Texas at the African and Latin American markets in addition to the existing markets. Mexico and Chile are next targeted markets for the products.
