LIC IPO: Desperation or masterstroke?
LIC Divestment: Much ado about not nothing?
The decision to divest from the life insurance behemoth Life Insurance Corporation of India (LIC) might have come as desperate last move by the government, which has been staring at the gaping hole in its fiscal position -- partially due to contraction in the direct tax mop-up and partially because of the haywire fiscal math. Even as the government reduced its revenue targets in this year's budget by 3%, but still expects its annual mop-up to jump by 16.6% for the full year, even it has grown by paltry 4.2% in the first four months of this year. However, the government has toned down its high revenue projections for the next year and expected its total receipts to jump by just 12% next year.
Overall, this is much in line with the maximum governance and minimum government mantra or the business of government is not to be in business. Set up under the LIC Act of 1956, the insurance giant is a statutory corporation owned by the government and may need to be converted into an independent commercial company before getting ready for a public issue. LIC and the way policies / investments are administered is largely a black box and investors / insured have little or no easy access to information.
The culture of ‘bonus’ is largely at the whims and fancies of the company (which grew in the protectionist era). 30 crore policyholders of the life insurer currently enjoy a sovereign guarantee on policy benefits. Issues with policy/investment and information dissemination were palatable for several reasons: for one there was no choice for life insurance (should there be a felt need), Tax breaks and the sovereign guarantee.
The issue of the continuance of state guarantee to policyholders may occur if a part is being privatised. But the world has changed; for 14 years, pensions have moved to a defined contribution universe along with EPFO (Employees provident fund organisation) diversifying away from government debt into equity markets. As such, the government too has little interest in holding onto stakes in larger (or even smaller Public Sector Undertakings and itself heading to pubic (and foreign) markets – with aggressive divestment targets and larger signal towards public market fundraising through instruments like Sovereign Bond ETFs.
Implications for the Government:
Leaving aside the timing (this is again in the issuers hands and the government appears to be in no tearing hurry to file for the IPO), these companies which have either a legal mandate or have significant competitive advantage, have been a small but important source of fundraising. Several tranches down and the CPSE ETF itself is a well-entrenched investment instrument with a well-oiled machinery backing it. Such public holdings (along with the Bharat Bond ETF - the jury is still out on this one) have a significant role in easing the government finances (out of business) by diluting equity and providing these firms with access to public debt markets to directly raise monies.
And once that cat is out of the bag, there is little future government can do to overtly influence its functioning, the exception being re-nationalising LIC which, for the foreseeable future, appears highly unlikely and quite likely will see incremental dilution through direct share sale or, more likely, through new ETFs and tranches of existing ones.
As the ETFs starts to trade well, there will be a better price discovery. With better pricing and liquidity, PSUs as well as LIC may be in a far better position to manage their balance sheet and more importantly, without the need for wither government assistance or bail out should the need arise.
In addition, given the state of the treasury, the stated focus has been on economy and development with any freed-up resources going a long way in achieving said objectives. The government therefore would benefit both from the divestment itself as well from making the organisation self-sustaining which in turn would add value to residual government holding. There are larger issues around transparency for a government owned organisation.
Corporate Governance: sooner or later this will come to fore as investors, customers and indeed vendors start to demand periodic updates. Today, especially for LIC customers, other than the pure term insurance buyers, there is no way of discovering what they stand to gain (or even a formula thereof) on maturity, for the annual/ periodic/ one-time premium payment. Furthermore, there aren’t clear options for shifting to more secure pools or anything else. Going public, with greater scrutiny on risk management (at the organisational level) and service, all stakeholder, the government (and shareholders), policy holders, vendors all stand to gain and not just with in the existing scheme of thing.
Financial & Equity Markets have a peculiar problem. When EPFO investment limits were hiked (to 15% of additional flows into Equity ETFs), and with India’s growing GDP, there has been a dearth of large sinks for investment.
The result of that has been zooming headline indices with astronomical valuations, with the rest of the cap table languishing in the shallows. The addition of a large company releases some of this pressure and provides both institutional and individual investors with another avenue. Not just by enhancing the diversity in existing indices, debut of a significant firm will spawn a series of passives, offering different slices of stock market to suit their preferences and improving areas directly connected with LIC’s business of retirement planning, regular saving as well as developing core technologies for more efficient management and is ideal for passive investors or those looking at India allocations.
The implication for a well-managed publicly owned LIC are far greater than merely corporate accountability, domestic public ownership also serves to open the company for stripping some functions and aligning itself with the global model of asset as well as asset manager diversification. It opens the asset management business to institutional mandates which are all currently handled in-house.
Benefits accrue near shore in the overseas markets. With the advent of a large firm on the stock market, most of the indices, which are India centric or with an India component, will reset to account for additional weight. Indirectly, those companies at the lower end of the indices, which, by virtue of relative size, move to other indices, impact the flow in those as well – these indirectly driver capital flows to India. Such or other direct / indirect foreign ownership of companies also results in compliance with other financial market regulators.
The government, RBI and Money markets.
While Indian rates remain high, and cutting rates is an option, inflation has put paid to that party. There now needs to be a balancing act for generating revenues which staving off dreaded stagflation. Instead of multiple divestments (for example CPSE tranches), which add a $1bn or two to the kitty, a larger offering serves to increase government spending without necessarily upsetting the interest/inflation balance.
While this and other initiatives by successive governments as well as DIPAM are great overall, they do face hurdles in terms of existing staffing contracts and agreements etc. Then come the process of valuing the company and setting the terms for its IPO -- which, any investment bank, would take at least four to five months. And even when this is done, the government will have to wait for right market condition to put this behemoth on sale.
If these processes weren't enough, the government will have to counter mass rhetoric of 'jewel being sold', which has gripped the country after LIC divestment was announced. It would also have to carefully negotiate will the employees of the LIC, who are already on roads opposing the divestment plan.
Doing away with exemptions may also impact the sale but broadly, these, like any other sale, are merely problems to solve if the nation is to realise real value for public supported assets. But there is a catch: Finance Ministry expects its mop-up from the investments to surge three times next year to Rs 2.1 lakh crore -- mostly on the back of LIC divestment plan. This comes even though the government was forced to revise downwards it's divestment targets for this year by 38% -- primarily because of two big-ticket investments (Air India and BPCL) not likely to take off soon.
But this announcement might take more than a year to materialise in all probability as there are legal hurdles to cross before testing the market As a parallel step, the government may also wish to look at offloading up to 75% of the stake not just from LIC but all other such holdings. LIC being roughly the size of SBI can easily become another HDFC / ICICI and their respective Banks. If levered well, these can easily fix several years of budget deficit while providing a significant jump in valuation for each incremental divestment
With inputs from Furqan Moharkan
Originally published in the Deccan Herald at https://www.deccanherald.com/specials/sunday-spotlight/central-vista-a-waste-of-money-violation-of-norms-841221.html