Bailout lunacy: ONGC, oil cos, banks, power, aviation...and LIC?

LIC's bailout is by no means the last in a series of bailouts seen as an alternative to reform. At some point, LIC too may need a bailout or capital infusion, too.

R Jagannathan March 05, 2012 14:23:00 IST
Bailout lunacy: ONGC, oil cos, banks, power, aviation...and LIC?

With egg all over its face in the ONGC share sale imbroglio last Thursday, when the Life Insurance Corporation (LIC) was roped in at the last minute to rescue the Rs 12,000 crore issue, the government is looking for explanations everywhere but in the right place: the mirror.

The department of disinvestment (DoD) is sifting through the garbage to see why Rs 3,693 crore worth of bids (out of a total Rs 16,460 crore bids received, Rs 12,767 crore were deemed valid) were rejected by the auction system. The finance minister wants to "analyse" what happened with the ONGC case, since it was the first one sold through the newly-created auction process.

Bailout lunacy ONGC oil cos banks power aviationand LIC

The real worrisome issue is the cycle of circular bailouts we are now seeing happen.

DoD Secretary Haleem Khan is pissed off that everyone is talking about LIC bailing out the issue, when he claims LIC was keen on buying up the whole issue at even higher prices.

In an interview to The Economic Times, he asked: "Are we saying LIC was not interested in buying ONGC? Or we are feeling bad that LIC bid so aggressively that FIIs could not outbid it? Do we mean LIC putting bids earlier in the day would have been optically more desirable? Are we saying that if FIIs are not able to invest in ONGC in a big way, the local institutional purchase becomes a non-professional decision?"

These rhetorical questions have guilty conscience written all over them.

The answer is simple: No, we are not saying LIC should not have invested in ONGC, but trying to rescue the whole issue with help from the insurer sends the wrong message. After all, LIC ended up with 95 percent of the ONGC issue despite the "technical glitch."

No, we are not saying the FIIs should not have been outbid, but the reason why they were outbid is important: they are worried about poor corporate governance at ONGC, where government arbitrarily issues diktats on subsidy payments to loss-making oil marketing companies (OMCs), and denting profits.

And yes, LIC putting in bids earlier in the day - if it was really keen on ONGC shares - would have been more transparent. It might even have helped create excitement around the issue and pushed up the real bidding process.

The real worrisome issue is the cycle of circular bailouts we are now seeing happen: first, due to a flawed energy subsidy policy, ONGC bails out a government that is unwilling to directly subsidise the OMCs from the budget. Next, when government wants to sell ONGC shares to reduce the fiscal deficit, it needs the LIC to bail out the issue.

When banks develop a huge portfolio of bad loans by lending to all favoured sectors - aviation, textiles, power, you name it - they need more capital. But government does not have the money - and guess who has to bail them out? LIC.

The cycle will be complete when LIC finds it needs its own infusion of capital as its solvency ratio sinks close to the minimum (1.5 times). As at the end of March 2011, LIC had the lowest solvency margin of 1.54 times its insured liabilities. (The solvency ratio is the sum of capital and market value of assets that insurers have to maintain over their insured liabilities.)

To bail out LIC or banks (SBI, for example), the government will issue bonds which will again be bought by banks and the LIC? Perfect?

Can LIC continue with bailouts indefinitely? Four days after the ONGC issue mess, LIC has already incurred a notional loss on its ONGC holdings as the market price fell well below its bid prices.

A Business Standard report explains how using the LIC as bailouter-in-chief for the government's disinvestment programme has cost the insurer pots of money. According to the newspaper, the insurer invested Rs 12,400 crore (excluding ONGC) as part of its support for the disinvestment programme in seven government companies since 2009. But the market value of these investments is down to 9,379 crore. That's a Rs 3,000 crore paper loss.

Of course, all will be forgiven if the markets zoom and LIC makes a neat packet on its investment.

However, the real issue is this: all through 2011-12 till February, LIC has been selling largely private sector shares worth around Rs 35,000 crore, according to The Economic Times. Quoting a source, the newspaper says it has sold ITC, Bharti Airtel and Mahindra & Mahindra, and has been replacing them with public sector stocks - especially banks.

Now you know one contributing factor to the market's volatility in 20011-12.

The market will, of course, find its own level, and one can't complain if the LIC thinks bank shares are better than Bharti Airtel or ITC.

But, as Firstpost asked last month: "Is it healthy for one institution to be holding so many bank shares?"

The short point is this: Insurance is about risk, and so is banking. If one risk-taker is bailing out several other risk-taking institutions, and that too by getting rules waived in its favour, the overall systemic risk is compounded.

LIC is able to buy bank shares only because the government has encroached on the insurance regulator's domain by allowing the state insurer to buy beyond the legally permissible limit.

The Times of India says "LIC has received regulatory forbearance from the government, allowing it to breach investment limits set by the insurance regulator." The Insurance Regulatory and Development Authority (Irda) says no insurer can invest more than 10 percent of a company's net worth.

But who cares for norms when it's the government that is looking for a bailout from LIC? Irda can complain about corporate governance issues at LIC, but who can bell the cat when it is the cat's owner who is encouraging this?

The government is setting a bad precedent by allowing its own institutions to think they are beyond the law. It makes for bad corporate governance and undercutting the regulator's authority.

Whether it is ONGC or LIC, the finance ministry is essentially saying it will change to rules when it suits it.

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