Friends in need

The RIL-Aramco deal could be the forerunner to further reforms in the PSU refining space

The world’s largest company by profit joining hands with India’s largest company by profit is an event that celebrates scale. The convergence of interest conveys interesting insights about the two partners. Saudi Arabian Oil Company and Reliance Industries are headed by ambitious inheritors. Both are seeking validation from the retail segment. Mohammed bin Salman, the titular head, is firming up plans to take the state-run explorer public. After offering cheapest data downloads in the world, Mukesh Ambani wants to list Reliance Jio in five years.  The effective ruler of the desert kingdom and India’s richest man want to hedge the downside risk of their flagships by looking at other markets. They have tasted blood. A bond offering by Aramaco mopped up US$ 12 billion in April. Besides the US$ 15-billion investment in the oils-and-chemicals business, UK-based BP will pump in Rs 7000 crore to buy a 49% stake in a joint venture with RIL to run a network of retail pumping stations and enter the aviation fuel business. Global investors’ embrace of the crown prince indicates that the overhang of the murder of a dissident journalist last year is fading. Becoming the world’s largest telecom services provider by subscribers has busted the belief that the Ambani family’s success was restricted to the B2B marketplace. Saudi Arabia’s latest overseas investment will expand its downstream footprints and entice investors with the prospect of the declining revenues getting a boost. Assured annual supply of 25 million tonnes of crude oil will insulate RIL from geo-political shocks.

The teaming up is not only because of the opportunities. There are compulsions, too. The fiscal deficit of Saudi Arabai is expected to nearly double than that estimated for the current calendar year as earnings from export of energy falter. The IMF has projected a threshold of US$ 80 a barrel for the world’s largest oil producer to stay afloat. Though doubled since the beginning of 2016, prices have halved in the last eight years as recessionary conditions prevail in the euro region and China’s slowdown looks set to become a trend rather a blip as trade tension with the US is expected to linger well into end 2020, when Donald Trump faces re-election. The slight acquisition premium compared with international peers gets Aramco an operational refiner, thereby circumventing the obstacles created by environmentalists to the US$44-billion proposed green-field partnership with Abu Dhabi National Oil Company in Maharashtra’s Ratnagiri district. High leverage is hampering RIL’s hunger for cash to deploy into emerging areas to compensate for the sluggish growth of the petroleum business as the world shifts from fossil fuels to electric vehicles. Cash EPS is down 40% and the operating profit margins of the group have contracted 226 basis points over three years. The gross refining margins were at an 18-quarter low end June 2019. Net cash-flow from operations halved in the latest financial year over a year ago. Outstanding liabilities of nearly Rs 3 lakh crore are more than double the cash reserves, with most of it going to fuel Reliance Jio’s run. The stock surged 10% in a day on the reckoning that the recent capital infusion will wipe out RIL’s debt by next fiscal year, leaving room for enhanced payouts and borrowings.

Going beyond how the collaboration will help repair the balance sheets of the two companies, the larger message is about the outlook of the global and domestic economy. That Dhirubhai Ambani’s heir is willing to part a chunky stake for the first time to a foreign competitor in the promoter-driven indigenous conglomerate is a reiteration of the recent trend of Indian companies collaborating with or surrendering to external competition. Home-grown Flipkart has been snapped by Walmart, while Idea Cellular has joined hands with Vodafone. It confirms the diminishing role of oil as a lubricant of the global economy. The world’s most valuable company is not a decades-old US onshore or offshore prospector but a relatively young New Economy player. The short-term benefits for India will be narrowing of the current account deficit and stabilizing of the rupee when the dollars flow in. The era of arbitrarily tinkering with central and states taxes on petroleum products to meet expenditure requirement is probably on its last leg as foreign investors will seek stability to avoid disrupting their growth trajectory. India might even be willing to hike the 49% FDI ceiling in processing and marketing PSUs on the road to withdrawal of subsidy support. Freeing the entire value chain from price controls will be the next logical step. If there are any winners or losers of the recent tie-up will depend on how quickly the stakeholders adapt to the changing times.  

-Mohan Sule

Firm but flexible

The concern of the market on some budget proposals can be addressed by learning from the phase-out of PNs

The stock market is supposed to capture local and overseas political shocks and surprises, over and under currents of domestic and global economies, stress and buoyancy in corporate earnings and accidents and incidents in making policies and regulations. Many times equities exhibit irrational exuberance that defies ground reality and underwhelming sluggishness despite optimistic indicators. That there are two views on the direction of the market makes trading exciting and rewarding, uncertain and risky. Hate it or love it but it is hard to ignore it. Three days after the presentation of the budget, when the market mood had turned distinctly dark, Union Finance Minister Nirmala Sitharaman told corporate bigwigs that she does not let the market affect her. In 1992, then Union Finance Minister Manmohan Singh had famously proclaimed that he does not lose sleep over the market. Shortly thereafter the surging stocks tumbled on revelation of manipulators siphoning off funds from banks to rig prices. In contrast, US President Donald Trump makes no secret of his desire for a booming market. Besides exploring the possibility of firing the chair, his own appointee, he has criticised the Federal Reserve for raising the cost of money too soon too often. The tendency is for government to point to the market’s strength as a vindication of the management of the economy but shift the blame to the central bank when the tide is not favourable.  P Chidambaram was not on talking terms with Y V Reddy and shared strained ties with D Subbarao, the two governors he dealt with during his stints as finance minister. 

Paring of lending rates usually points to a pessimistic view on the economy. It is an acknowledgement that the purse strings have to be loosened for consumers to borrow and spend. Yet equities spurt on any hint of a softer rate regime. US indices reached historic highs towards end July in anticipation of the Fed undertaking its first rate cut since the financial meltdown of September 2008 on projections of global trade war tensions shaving off growth after maintaining since late last year that there was no reason to intervene throughout 2019. No sooner did it act, stocks tumbled. More than the action, the disappointment was in the change in the outlook  from accommodative, suggesting an openness to react to any distress signal, to neutral, scotching any room for more snipping in the rest of the year. So here was a situation of the market sulking because the economy is showing resilience. In India, something similar seemed to have happened. The Union Budget for 2019-20 reduced the fiscal deficit target to 3.3% of the GDP, down from 3.4% projected in the interim budget presented in February 2019. Such a scenario should have been ideally very satisfying to investors. There was reiteration of partial or complete divestment from select PSUs and aligning of the FPI limit in stocks to the FDI ceiling of the sector.  Pumping Rs 70000 crore into banks to enable them to start lending, spending Rs 100 lakh crore on infrastructure over the next five years and reducing the corporate tax from peak 30% to 25% on companies with up to Rs 400 crore turnover, thereby covering more than 99% of the corporate sector, have the characteristics of a fiscal stimulus. The market chose to ignore them and obsessed over the higher surcharge on the super rich. Other irritants were the prospect of supply of more paper as companies move to maintain a minimum 35% public float from 25% and 20% tax on buybacks to bring them on par with dividends.  

The question that arises is if monetary or fiscal policies drive the market. Interest rates have been trimmed four times in the current calendar year to encourage private investment and consumption without much success. How much longer the cycle has to continue for risk-taking to make a comeback is uncertain. The goal post keeps shifting. From NBFCs’ liquidity crunch to regulatory overhang on the auto sector, the current crisis of confidence is being attributed to the higher effective tax on foreign investors structured as trusts. Trading had to be halted when Sebi in October 2007 curbed investment by foreign investors through participatory notes. Eventually, a window of 18 months was provided to wind up exposure through PNs, then comprising half of all foreign investment in the Indian market. The share came down to 16% in three years and is now 4% as reporting was made more stringent from 2012 and taking of naked positions in F&O through these instruments banned in September 2017. To resolve the current impasse, the finance minister needs to be firm but flexible to accommodate the concerns without losing sight of meeting the revenue targets.

-Mohan Sule