When oil and oil don’t mix

Indian Express, 22 November 2004

Mergers may not be the answer to problems of PSU banks, oil companies

The Finance Minister wants PSU banks and PSU insurance companies to merge. The Petroleum Minister wants PSU oil companies to merge. But is bigger better?

As an example, will Bank of Baroda become a better bank if a small PSU bank is merged into it? Is scale of essence in strengthening the bank? Bank of Baroda is already bigger than HDFC Bank. It is not as if there is some minimum size which is presently lacking. Yet, Bank of Baroda does only Rs 2.53 crore of business per employee, while HDFC Bank does Rs 8.66 crore. Bank of Baroda’s assets are twice that of HDFC Bank’s, but its market value is one-third. The Ministry of Finance should certainly worry about how Bank of Baroda can be brought up to HDFC Bank standards. But if size was of essence, Bank of Baroda has that already.

When do mergers make sense? In the private sector, when mergers take place, they lead to cost cutting because excess staff is sacked. This channel is inherently limited when mergers take place in the public sector. We should be wary about transplanting the successful stories of mergers in the private sector to the public sector given the rigidities of PSU labour practices.

In speeches, P Chidambaram has rightly commented on the absence of Indian finance in world markets, while Indian manufacturing has achieved world standards in many areas. If size were of essence in global competitiveness, then SBI and IDBI would have been exporters of financial services. The path to a globally competitive finance does not lie in bigger PSU banks, but in asking questions about why Bank of Baroda and IDBI are so far behind the well-run banks of India.

To make an analogy with India’s experience in manufacturing, the global attack by Indian auto companies came through the foreign Hyundai, the private TELCO, and the privatised Maruti. It did not come through Scooters India Ltd. Making Scooters India bigger through mergers would not have matched Bajaj Auto or Hero Honda. It would have merely given a bigger Scooters India.

The path to global banks springing up in India lies through the energies of HDFC Bank, ICICI Bank and UTI Bank, which can mount an assault on global markets if backed by a modern policy and regulatory framework. If a Dena Bank is merged into IDBI, we won’t get a globally competitive bank. We’ll just get a bigger IDBI.

Another aspect to consider is that of competition in the economy. Both banking and oil suffer from a severe lack of competition. Upholding competition is perhaps the single most important tenet of sound economic policy. The interests of the citizen will be ill served by more concentrated banking or more concentrated oil. The powerful big firms will merely gang up on the citizen. When the Competition Commission comes about, it will need to urgently tackle the anti-competitive aspects of both industries: such as the price fixing for petroleum products by the PSU cartel, and the barriers against foreign banks operated by RBI. It will need to take on the combined might of the industry and the government advocate of the industry (the RBI for banks and the Ministry of Petroleum for oil companies). If mergers are done, the task of the Competition Commission will become harder.

The next aspect is that of ‘‘too big to fail’’. When a PSU gets really big, there are a unique set of problems that come from it being so big that no government can accept bankruptcy. SBI has assets of Rs 409,771 crore, and it is the Ministry of Finance that has to worry about SBI going bankrupt. The threat of bankruptcy is a central device through which a firm is kept honest. A policy of mergers will diminish this pressure on the PSUs and detract from efficiency.

Finally, there are two successful paths to privatisation. There is the Arun Shourie way: auctioning off VSNL or CMC to a business house. There is the Deepak Parekh / K V Kamath way, where shares of HDFC or ICICI were steadily sold and the company became a board-managed, professionally-run company, without being controlled by any family.

Privatisation is inevitable; the only question is about how it will be done. Both ministers know about the damage that India has suffered from having PSUs, and the benefits from privatisation. The Deepak Parekh / K V Kamath path to privatisation can be applied to (say) Bank of Baroda. But if Bank of Baroda bloats through mergers, then privatising it will become harder. Mergers today should be avoided, even if they appear expedient in the short run.

Ila Patnaik