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Optimizing return on equity through treasury operations: Optimizing the instrument mix and deployment geography - EY - India

Optimizing return on equity through treasury operations: Oil and gas E&P

Optimizing the instrument mix and geography of deployment to reduce the drag on return metrics

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As on 31 March 2010, nearly 90% of the investible surplus of the three largest exclusive E&P companies in India was deployed in fixed deposits.

Security of investible surplus generally drives deployment decisions and fixed deposits with banks are generally assumed to be the safest form of deployment

For the same degree of safety as other fixed income instruments, fixed deposits do not always offer the most optimal post-tax return.

As on 31 March 2010, nearly 90% of the investible surplus of the three largest exclusive E&P companies in India was deployed in fixed deposits.

With returns on fixed maturity plans crossing those on fixed deposits and tenor of deployment generally exceeding a year, the post-tax returns on alternative instruments with a similar credit risk profile generally exceeds fixed deposits.

Whereas fixed deposits are subjected to tax at 33.99%, investments in fixed maturity plans held beyond one year are taxed at 11.33% without considering indexation benefit.

Optimizing the instrument mix for surplus deployment and the relevance of investment tenor vis-à-vis the underlying business cash flows after considering the tax implications can help reduce the drag investible surpluses cause on the overall return on equity.

With increasing cross-border activity by Indian E&P players, the geography of deployment can significantly affect return metrics. 

As surpluses are generated from off-shore oil blocks, factors including country risk and domestic interest rates affect deployment decisions. Surpluses held in highly inflationary economies can erode in value even where perceived returns on investible surplus are higher.

Similarly, surpluses held in low-interest bearing currencies can further affect the return on equity.

Integration of dividend/share buy-back decisions with geography of holding, currency of investment and instrument of deployment is critical to preserving the value of overseas investments.

Policy-level questions to address


*Refer to the attached PDF for source information.

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