BSE PSU Index up 92% in past year: Decoding India's divestment opportunity

A well-executed PSU divestment strategy could attract foreign investment, raise corporate governance standards, and generate funds for further infrastructure development

Indian equities are one of the brighter corners of sunshine in the global markets. Over the past year, key indices like the Nifty 50, Nifty Midcap 100, and Nifty Smallcap have surged by significant margins of 29%, 60%, and 70%, respectively. However, the standout performer amidst this surge has been the BSE PSU Index, which has seen an astounding 92 per cent increase, marking a remarkable turnaround from its lackluster performance over the past decade, said Axis Asset Management in a note. 

This vibrant market environment has triggered a surge in Initial Public Offerings (IPOs) and presents a golden opportunity for the Indian government to offload its stakes in public sector companies (PSUs).

"This robust equity market has spurred a wave of activity in the capital markets, with 57 initial public offerings (IPOs) raising a total of Rs 53,000 cr in 2023 alone. The momentum has continued into 2024, with 13 more IPOs already hitting the market. In total, 2024 could see 60+ companies hitting the market and are likely to raise upwards of Rs 70,000 crore," said Ashish Gupta, CIO at Axis Asset Mamangement. 

The secondary market has been even more active, with private equity firms and company promoters offloading nearly Rs 2 lakh crore worth of shares in 2023, 4x the average from 2019 to 2021. Even the parent companies of several multinational corporations operating in India, such as Whirlpool (24.7%), GMM Pfaudler (13.6%), and Timken (10% stake), have taken advantage of the favorable market conditions to reduce their stakes over the past year.

Between January and March 2024 so far, Rs 68,000 crore worth shares have been sold already

"This robust market environment presents a compelling opportunity for the government to strike while the iron is hot," added Gupta. 

Government Divestment: A Golden Opportunity

This buoyant market environment presents a golden opportunity for the Indian government to accelerate its divestment program of PSUs.  In recent years, the government has fallen short of its divestment targets. However, the combined market capitalization of the 84 PSUs has surged by an impressive 79% since early 2023, reaching a staggering Rs 67 trillion. February. In 36 ofthese firms, share prices have doubled since 2022,yet the government’s offers for sale have remained consistent at Rs 0.1 lakh annualy. This presents a unique window to capture premium valuations for these companies, said the report. 

PSU Stocks Shine

The robust performance of PSU stocks is attributed to several factors:

1. Strong financial resilience during the COVID-19 pandemic showcased the stability of these traditional economy sectors
2.  Government policies promoting sectors like defense indigenization have boosted specific PSUs
3. Improved corporate governance  including formalized payout policies, balance sheet restructuring in public sector
4. Attractive valuations, with many firms reaching decade-low valuations and offering dividend yields surpassing those of debt instruments. As a result, the PSU market capitalization now accounts for nearly 17% of India's total market cap, compared to Rs 37 lakh crore at the beginning of 2023.

"This vigorous performance has propelled the aggregate market capitalization of PSU stocks to Rs 67 trillion, accounting for approximately 17% of India’s total market capitalization, up from Rs 37 lakh at the beginning of 2023. Despite this sharp uptick, the valuation discount of the PSU Index relative to the Nifty has merely returned to its long-term averages," noted the report.

Opportune Time for Growth Capital

Credit growth refers to the increase in the amount of loans given out by banks over time. In India, credit growth typically needs to be higher than the country's Gross Domestic Product (GDP) growth. This is because a growing economy requires more loans to fuel businesses and investments. To meet this demand, PSU banks (Public Sector Undertaking banks) need additional capital. Gupta's estimates suggest they might need Rs 2 lakh crore over the next five years to maintain current loan growth rates. Successful capital raising efforts by several PSU banks in the public markets in recent months have strengthened their balance sheets.

The Market Opportunity:

1. The current strong stock market provides a golden opportunity for PSU banks to raise capital.
2. By issuing new shares in the public market (capital raising efforts), banks can bolster their financial strength and meet their growth needs.
3. Recent successful fundraising by some PSU banks demonstrates the viability of this approach.

Government Divestment Opportunity:

"While PSUs are often exempt from the minimum public shareholding norms applicable to other companies, the average government holding in PSUs remains high. In 22 of the 84 PSUs, the government owns more than 75% of the shareholding. This market upswing presents the government with an ideal opportunity to reduce its holdings. If the government were to reduce its holdings to 51% across companies, it could divest a quarter of its stake, potentially raising Rs 11 lakh cr in the process. A significant portion of this amount, one-fourth, would come from its holdings in the Life Insurance Corporation of India (LIC) alone," added the report. 

By divesting in a staggered manner, reducing their holdings by 300 basis points each year, the government could generate over Rs 2 lakh cr (0.6% of GDP) in capital receipts. This would help bridge the fiscal deficit and reduce net market borrowing.

"A well-executed PSU divestment strategy could have far-reaching benefits for the Indian economy. It could attract foreign investment, raise corporate governance standards, and generate funds for further infrastructure development and social welfare programs, thereby enhancing the dynamism and competitiveness of the economy," said Gupta.