Indian Public Sector Undertakings (PSUs): Pride or Prejudice- Updates

In the recent post on PSUs (click here for the post), I wanted to explain the impact of Govt/PSU investments on the economic growth which is much deeper and complex than checking their profit & loss account statement. PSUs mobilize resources and channelize investments in an economy differently so their performance shall be judged from macro level of socio-economic impact rather than micro level of linear net profits. But I left this segment in that post as I had decided to explain the same in the next post on development of semiconductor industry in India. But now I have decided to put a brief note on this in the blog post on PSUs. I have added the same under para A(c) of the post. I am putting the same here also:

Net profit is a wrong measure to evaluate the contribution of PSUs to economic growth

I have seen many attempts to evaluate PSUs by comparing their performances (Profit & Loss account) with private sector counterparts and straightforward conclusions are derived fairly easily just on the basis of profit & loss statement. But great thing about life is that it is multidimensional (not just 3D). Net profit is just one dimension of multi-dimensional growth matrix and this growth matrix becomes more complex when we raise the platform from micro level (Firm level) to macro level (Economy level).

Growth (profit) for a corporate firm is an individual (linear) phenomenon while for the economy the same is a comprehensive (inclusive) phenomenon. Actually GDP is a composition phenomenon but GDP growth is a distribution phenomenon. Economic growth occurs when wealth is distributed. That’s why when a private bank like ICICI decides to close a loss making remote town branch (or decides not to open a branch) then this will increase their profits but when SBI does the same then it does hit their profits but it results in economic growth (wealth creation). Another way to see this opening of a bank branch by SBI is that it distributes income (wealth) from SBI to village in the form of investments in Branch (assets/employees) which results in further growth of wealth (Because village as a whole also grows due to availability of banking... result is the higher production and so economic growth). So loss to SBI is an investment for the economy. Hence, net profit is a very inefficient barometer to measure growth at macro level (economy) just like GDP which is good enough to measure “Income generated in an economy” but not “wealth” created.

I have seen SBI branches in remotest places in India and so it is not appropriate to compare SBI to other private sector banks just on the basis of net profit. Once I was posted in a small town in MP (Sarni) and there was no other mobile services working properly (no tower) except BSNL and BSNL broadband internet was a pleasant surprise for me when dongles of other providers were too slow. So value of PSUs can’t be judged on the basis of net profits but their contribution to economic growth which I think is massive. Like PSUs are required to procure around 25% of their procurements from MSME vendors so this process may result in higher costs and execution delays but the impact of economic growth is much higher in the form of development of these MSMEs and employment generated through these MSMEs. We can see PSUs are distributing their wealth more comprehensively. Concentration of wealth in the hands of few is not good for an economy. It has to be distributed. Socio-economic impact of PSUs is very high.

Like, the role and importance of Indian railway can’t be gauged from profit and loss account alone. Now, as private players will be allowed to run passenger trains so they can choose profitable routes thus maximizing profits. So there is a much higher purpose behind PSUs and if these can be made better then they can provide massive boost to economic growth. As they are dealing with public money so there are processes, checks and control measures to avoid any willful mishap like fraud etc. So there are tendering norms (against selective buying), L1 norms for awarding contracts, regulatory agencies like CAG, CBI and CVC etc. This is to ensure the fulfillment of objectives and to stop the misuse of power and public money. So these checks and controls can make PSUs bulky and slow moving at times but safeguarding of public money is also equally important. The need is to choose a midway to allow more freedom.

That’s why private firms are more nimble and a firm like Reliance can source crude oil at spot market to get the benefit of big temporary fall in prices but state owned refineries like IOCL are required to issue tenders for the same. This is one of the reason for Reliance to have high GRM (It has highest Nelson Complexity Index for its refineries; Recently IOCL’s Paradip refinery is having high NCI. Then Reliance’s refineries are near coast saving money, big size). But now as controls/managements are getting better so state owned refineries are also allowed to source crude at spot prices. Recently IOCL has set up a trading desk in Delhi to source cheap crude at spot prices just like Reliance. IOCL/HPCL/BPCL are setting up a massive refinery (60MT almost double of Reliance’s biggest) at west coast.

But there is a risk with the concentration of power/agility in a thundering juggernaut like Reliance. Fraudulent managements can siphon off the shareholder’s wealth by taking dubious decisions thus leaking out the money. We have seen many examples recently in the cases of Vijay Mallaya, Yes bank, DHFL, Videocon, IL&FS. So there was a purpose behind CAG and CVC to have an eye on the working of PSUs and this acts as a check against these destructive frauds though this has a cost on PSUs in the form of bulkiness. We can’t afford a Videocon, Satyam in a critical sector like defense. But still there are better ways to ensure more freedom for better agility (which I’ll discuss in a separate post in more details) by empowering their managements…like Singapore’s Temasek Holdings which acts as Investment company where portfolio companies are managed by their independent boards. Tamasek can independent business decisions and Singapore govt has no role in it. . However, in any case the RISKS of existence threatening frauds are much lower in PSUs.

And if you ask me then these lesser risks should lower the cost of equity capital of a PSU just like bulkiness may raise the cost of equity (At times I find calculations of cost of equity somewhat funny and not much worthy in practical life…but still a fair theoretical concept to understand the factors making a firm more risky than the other.)

PSU is not an Indian concept and they are still used globally for achieving socio-economic goals. In fact, State owned enterprises (SOE) have played major role in the stunning economic growth of China. Government is required to invest in sectors which are strategic for the nation long term growth and safety like Defence, Energy, Mining etc. Government is required to play a major role in high risk sectors where private sector has lesser appetite for risk like take for example Semiconductor, AI, advanced telecommunication tech etc. Govt. has access to cheap capital and it can afford to take risks much better. Indian private sector has failed to capture and develop the massive opportunities in sectors like Solar power, Electronics goods, Semiconductor, telecom equipment and so now it is better if Govt. (through PSUs) invests in creating these capacities in India. I’ll discuss more on Govt. investments in these sectors in a separate post on development of semiconductor industry in India.