How can the PSU recap help revive capex?
The recent decision by the Government of India to breathe life into the country's capital-starved public sector banks (PSBs) over a short span of the next two years is seen as a game-changing measure to revive the flagging economy. The jury is still out on how much of the proposed INR 2.11trn capital will ultimately fuel the growth, after PSBs' balance sheets are cleaned. But, whatever be the quantum of capital left over, it can still have a multiplier effect on the economy since a bank's equity lays the foundation for its lending growth. Further, the positive relationship between credit and real output implies that the first-order positive impact of a faster clean-up of PSBs' balance sheets is higher credit growth for the larger PSBs and private financials, and hence growth in output. A second-order impact and a necessary condition for a faster output growth could be a revival in capex driven by improvement in the economics of the sectors that house the stressed assets. Our internal estimates indicate that the four large PSBs (constituting 53.7% of loan market share) will need around 59% of the promised INR 2.11trn infusion to conform to the Basel III norms by March 2019. However, this is expected to translate to merely 100bps of higher growth capital. For achieving growth higher than 11% CAGR in loans, additional growth capital will have to be generated internally. This would mean that as the smaller and weaker PSBs struggle with asset quality and capital deficiencies, the larger ones and private financials will gain from better-managed balance sheets and product-specific moats. Further, improved bank capital would ultimately increase competitive intensity in segments such as mortgages, Loan Against Property, SME and infra. Since these weaker PSBs are relatively inefficient vis-a-vis private financial institutions (the Return-on-Assets for PSBs has never exceeded 1% versus 1.5% for private financials even during bad times), we expect the private financials to be better placed to navigate through such competition. A necessary and second-order condition for a sustainable increase in output is revival in capex which in turn is dependent on the improvement in the fundamentals of the infrastructure and metals sectors (accounting for c.49% of industrial credit and 63% of stressed assets within industries). Focussing on steel and power specifically, we analyse what a 50% hair-cut to outstanding bank loans (one can run with other scenarios as well but this is close to sustainable debt in many of the stressed assets) can mean for them. In power, for ex., the tariffs for stressed power plants could drop to as low as INR 3/kWh, making them more attractive for merchant power and long-term contracts. However, low plant load factors (estimated at 60%-65% by FY20E) and inadequate Power Purchase Agreements (PPAs) could mean that the earliest revival of capex could happen only by FY20 by when the thermal power capacity addition drops to a third (7GW p.a.) from 21GW in FY15. For the steel sector, though, the availability of stressed secondary steel players for purchase, combined with the robust capacity expansion plans of India's steel majors, has engendered a fruitful opportunity for consolidation. These will augment prevailing strong industry fundamentals with capacity utilisation set to touch 85% in two years, amid prevailing strong global steel prices. We expect the resolution of stressed assets in steel to pave the way for capex revival from FY19, with power following a year or two later. All in all, we believe that the recapitalisation of India's PSBs is a much needed move and pre-requisite to reviving capex and hence triggering growth in the economy. By Suhas Harinarayanan, Head-Institutional Equity Research, JM Financial Institutional Securities Ltd.