It is welcome news that the Narendra Modi government has chosen to move forward with the disinvestment programme, although it is clear that adverse fiscal arithmetic has forced its hand. However, in what is a repeat of mistakes made by the previous regime, it has bunched up big-ticket share sales in the last quarter, thus putting unnecessary pressure on institutional investors and the secondary market. They are now supposed to somehow summon a huge amount of liquidity in the remaining two months of the current financial year. Given the amount targeted - Rs 42,000 crore through sales of shares in four companies - the success of the issues will require the large participation of foreign institutional investors.
In the absence of adequate foreign participation, government-owned institutions such as Life Insurance Corporation (LIC) could once again have to bail out the issues on the last day. LIC is already the single largest non-promoter shareholder in both Coal India as well as Oil and Natural Gas Corporation (ONGC). In the latter, it holds nearly a third of all non-government equity. In Coal India, it has doubled its stake in the last two years to 2.6 per cent now - a quarter of all its freely floating shares. Fortunately, market sentiment is much better than any time during the disinvestment programme rolled out by the United Progressive Alliance in its second term, and the present government is wise to use this to its advantage. However, even if all the four issues are successful, some collateral damage may not be ruled out. They will soak up a substantial amount of incremental liquidity flow, and put pressure on the secondary market. After all, the government would be competing with equally large equity issuances from top-rated companies, such as HDFC Bank, Tata Motors, Torrent Pharma and State Bank of India. Many institutional investors are fully invested in the market right now and have little cash. If they decide to participate in such large issues, they will have to either book profits on a few of their existing investments or divert incremental inflows to these issues.
There is another problem, too. The biggest drag on the divestments of Coal India and ONGC could be the collapse of the international commodity cycle, which means low revenue growth and poor profitability for the PSU (public sector undertaking) behemoths in the near to middle term. A steep fall in international crude oil prices in the last seven months has dampened the earning prospects of oil producing companies, including ONGC. The valuation issue is most pertinent for Coal India, the world's largest pure-play coal miner. The company's fortunes are tied up with the global coal cycle that is on a downward trajectory after a decade-long bull-run that ended in 2012. Coal prices at Richard Bay, South Africa, are down nearly a third since late October, and could fall further as the Chinese economy slows. This has worsened the outlook for Coal India. The coal miner is already one of the most expensive commodity producers in the world; it is more than twice as expensive as its global mining peers on valuation metrics, such as the price-to-earnings multiple and the price-to-book value. At this level, long-only institutional investors - sovereign wealth funds and pension funds - may be the only ones to find the issue attractive. The government's job would have been much easier had it offloaded the shares in these companies in tranches spread over the entire year.