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Gross tax revenues of the government in April were ₹67,557 crore against the backdrop of the covid-19 outbreak, 44.3% lower than in April 2019. There’s not much that the government can do about falling revenues this time, but it can prepare for the next time. Mint explains.
What is the genesis of this idea?
This can be understood through an example. The State Bank of India (SBI), by far the biggest bank in the country, has a market capitalization (m-cap) of ₹1.52 trillion. In comparison, Kotak Mahindra Bank, a much smaller bank than SBI, has a market capitalization of ₹2.39 trillion, which is 57.2% more than that of SBI. As of 31 December 2019, the total advances of SBI stood at ₹23.02 trillion and that of Kotak were at ₹2.17 trillion. The total deposits of SBI were ₹31.11 trillion and that of Kotak were ₹2.39 trillion. SBI clearly is a much bigger bank with a much smaller market capitalization.
Why does SBI have a much lower m-cap?
Clearly, the stock market feels that Kotak Mahindra Bank is much better run than the State Bank of India and has much better prospects and, hence, is willing to pay much more for it. One indicator that Kotak is much better run than SBI is the bad loans rate. As of December 2019, the bad loans rate for Kotak stood at 2.46% and that of SBI was at 6.94%. Bad loans are largely loans that have not been repaid for 90 days or more. When expressed as a percentage of overall loans given by the bank, we get the bad loans rate. The net interest margin of Kotak was 4.69% against 3.59% for SBI as of December 2019.
What does this mean for the central government?
It means significant value destruction for the central government with the state-run SBI having a much a lower market capitalization than Kotak. Other public sector banks (PSBs) have much lower market capitalizations and the overall market capitalization of all public sector banks is lower than that of just HDFC Bank at ₹5.41 trillion.
Any other examples of value destruction?
In January 2018, state-owned Oil and Natural Gas Corp. (ONGC) bought Hindustan Petroleum Corp. Ltd (HPCL), another state-owned company. The m-cap of ONGC in early 2018 was ₹2.53 trillion. However, this has since fallen to ₹1.06 trillion. This fall in m-cap is not only because of the takeover of HPCL by ONGC, it is also because of a massive fall in oil prices globally. The government made an effort to bridge the huge fiscal deficit by getting ONGC to buy HPCL. This has led to a significant destruction of value.
What can the govt do about this?
The Centre needs to run public sector undertakings (PSUs) as proper businesses instead of the current messy manner in which this is done. This will help raise the return on capital employed of these businesses, which has fallen from 10.15% in FY10 to 5.56% in FY19. That will lead to higher dividends from these firms. Well-run firms will mean higher m-cap, thus allowing the Centre to sell few shares in times of trouble, to raise money to bridge the revenue gap.