Private equity firms use a concept called dividend recapitalisation, as a means of generating returns earlier than the original investment horizon. In India, we have seen a smattering of cases where bonus debentures have been issued, essentially meeting objectives similar to that of a dividend recapitalisation exercise.

An issuance of bonus debentures has the following aspects:

A. Capitalises reserves on a balance sheet — i.e. reduces reserves and increases debt of a like amount — by distribution of those debentures to shareholders of the company; the traditional bonus issue meant the capitalisation of reserves to issue equity shares, for free, to existing shareholders; this involves the issuance of debentures, for free.

B. Bonus debentures, being debt on a company balance sheet, will carry annual interest and get repaid over a medium to long term, depending on the business visibility of the issuing company.

C. Bonus debentures, for greater marketability, will be listed on various stock exchanges and rated; typically, low leverage companies are ideal candidates, with the proviso that the rating of the corporate, after the issue of debentures, remains at the pre-issue level of close to triple A and stable.

D. Effectively, the issuing company is making a statement about cash flow and profit visibility over the life of the debt. This payout to shareholders usually is a meaningful percentage of the market cap and certainly, of the net worth.

E. The payment of interest on the debentures to be issued, can be seen as a surrogate for the dividend that the company would have given — a material difference being that dividend is out of tax paid profits, while interest payments are tax deductible. This is a massive benefit for the company issuing the instrument.

F. This issuance, though termed a bonus debenture, is treated as deemed dividend. Hence, taxable in the hands of the recipient, while the issuer has no dividend distribution tax since the last Budget.

G. Presence of debt in low leverage companies also enhances return on equity. Enterprise value, calculated as a sum of market cap and net debt of the company, should theoretically be unaffected — since the increase in debt should get compensated by a reduction in market cap. That’s theoretical — in reality, a payout as large as what’s being envisaged in these public sector units (PSUs), should actually help in a massive rerating.

Plain common sense and empirical evidence show us that the indiscriminate sell-off / divestment of PSU entities by the government has only eroded their value and most of them are languishing at multi-year or lifetime lows. Their extremely high dividend yields bear further testimony to the wealth destruction that investors and the majority shareholder, the government, have had to endure.

What’s being proposed is a massive dividend recap of PSUs, through issuance of bonus debentures in a clutch of entities as shown in the table below. Using a sample list of about 13 entities, an amount of about Rs 2.5 trillion can be raised through these entities, for all shareholders combined, with the Government of India getting about Rs 1.45 trillion. The government stands to get an additional Rs 26,300 crore as tax collection, on the non-government portion of bonus debentures.

The current process envisages a referral to the National Company Law Tribunal for approvals, with its attendant delays — a fast-track, two- to four-week process for companies seeking issuance of bonus debentures, may well be in order. This would enable achievement of most fiscal targets and, more importantly, the funds required for the stimulus to be available within the current fiscal.

So, without putting further pressure on an already beleaguered PSU space, without disturbing the cash position of some of these companies, without any dilution of government stake at absurdly low levels, the government becomes the recipient of a large basket of diversified, triple A, PSU debentures. That can then be wrapped in a Bharat Bond ETF structure and sold down to everyone from retail individuals to mutual funds, Employees’ Provident Fund Organisation and hugely cash-surplus banks, sitting on about  Rs 8 trillion of liquidity parked with the Reserve Bank of India (RBI) at around 3.4 per cent.

This PSU basket, carrying a coupon of 6 per cent, should massively galvanise the corporate debt market, a stated objective of the government and the RBI, since the late 1980s! In fact, at a 6 per cent coupon, this basket will get lapped up, given the competing options of yield and liquidity. It is quite possible that the secondary market for corporate debt, with increasing participation and diversified issuers, could become extremely efficient, with narrowing bid-offer spreads, as other private sector issuers too could join this bandwagon. The irrational phobia for debt that corporate India has been exhibiting, when interest rates are as low as they are, should get replaced by a sensible strategy of taking on long-term debt at current rates, especially for well-capitalised and highly-rated companies.

About Rs 1.45 trillion of government receipt plus about Rs 26,300 crore of tax collection on the non-government payout, would mean an effective income generation of about Rs 1.7 trillion. It’s worth noting that no tinkering of tax rates was needed to generate these additional resources. This is income, not debt for the government and hence a massive, positive impact on the fiscal deficit. Seen differently, ceteris paribus, this amount could be the fiscal stimulus that the economy so badly hankers for. It dovetails into the divestment target, which through equity sell-off can certainly not be met this year — the dividend recap of PSUs may well be the solution to exceed divestment targets and pump-prime the economy.


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