Why too much cash is not good for you?

By M H Ahssan

The best thing to own during a recession is cash. With everything going crash-bang-thud, hard cash gives you a sense of security, especially when inflation is not denting its value.

But here's the paradox: the only thing worse than not having cash is having too much of it. If cash is at a premium today, it's because we have had too much of it in the recent past. All assets - stocks, real estate, gold - rose in value over 2003-08 because Alan Greenspan, former chief of the US Federal Reserve, made cash dirt cheap after the dotcom bust, and George Bush ran a loose fiscal policy driven by too many tax breaks for the rich. Our own government wasted its tax bonanza in subsidising petro-goods and throwing money at the poor.

Companies raised cheap loans and equity - and blew it up on overambitious projects and overseas acquisitions. Today, you can see the Tatas, Birlas and Wockhardts struggling to pay off their loans. Ordinary people bought houses and sedans they could not afford, and are now being tossed out of their homes and asked to hand over their car keys as they default on EMIs.

The broader point is simple: when you have too much of cash, you seldom do the right thing. You become complacent, and finally lose it. Let's flash back to Bajaj Auto. It was India's No 1 two-wheeler company around the mid-1980s, when Hero Honda was just entering the market. Bajaj had huge cash reserves, and an unassailable position in scooters. It pooh-poohed Hero Honda's attempt to open up the mobike market. The management assumed that if ever Hero Honda became a real threat, it could always use its cash to squash it.

For 15 years, it kept hoping that the market trend would reverse. It didn't. It was only when Hero Honda came very close to pulling off an upset victory that Bajaj started putting big money into building exciting mobikes. That's how the Pulsar became a big hit. But once again, a huge cash hoard blurred its market vision. Even as it was finding traction in mobikes and closing in on Hero Honda, it forgot all about making scooters exciting. Honda came in with advanced, easy-to-ride scooters and clobbered Bajaj in its den.

The explanation for the cash paradox is counterintuitive: far from providing security, it makes you think you have time on your side. It reduces your risk-taking ability. And when you do finally decide to take the plunge, it may already be too late.

Whether you are a company, an individual or a government, too much money is not a good thing. Ask Bill Gates, who has the stuff in sackfuls. When asked by Forbes magazine a decade ago what he would do with his billions, he said his kids won't get too much. "One thing is for sure. I won't leave a lot of money to my heirs, because I don't think it would be good for them." Warren Buffett is giving the bulk of his fortune to the Bill and Melinda Gates Foundation, not his kids.

We should be worrying about the Infosyses of the world. Infosys is oozing so much cash even in this recession that it may be taking few risks. At last count in December, 2008, it had nearly Rs 10,000 crore in liquid assets such as bank deposits and mutual funds. Satyam, too, had excess cash. It proved to be an open invitation to the promoters to rob it.

In Infosys' case, the management has been using its cash to build hotels and restaurants for its staff (it is the country's biggest hotelier, with over 15,000 rooms built with its own money). The logic, of course, is that normal hotel rooms were costly till about a year ago, and it made sense to build your own rooms. This kind of integration into non-related businesses usually leads to disaster.

Let's also see why Infosys is making big money. Its USP is cost, quality arbitrage and scale. Offshoring enables it to use cheap Indian labour. The quality arbitrage comes from using high-value engineers for cheap coding. It's a bit like using airline pilots to drive autorickshaws. It makes engineers costly for the engineering industry, where they are needed more.

The scale advantage is purely linear: expanding the Infosys topline means expanding the manpower, with attendant problems of managing a huge workforce. At over 100,000 employees, Infosys is fast approaching the limits to linear growth. It needs to rework its business model where a rupee in topline does not add proportionate costs in manpower. Moreover, Infosys is highly export-dependent. We know what the recession has done to all export economies in East Asia. What will it do to Indian infotech? Infosys needs to sell more at home.

Against these future threats to growth, is Infosys taking enough risks now to give itself real options? Why is so much money idling in fixed deposits? Should Infosys be focusing on its main business or running hotels? It is today where Bajaj Auto was in 2000 --- too much cash in the bank, too little paranoia about current or future competition. I shudder to think where it will be five to 10 years down the line if it does not change now.