challenges for indian banks fccbs anal · 2012-11-06 · with the central bank. in reality, the crr...

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Dear Reader,

t gives us immense pleasure to bring to you the inaugural issue of The IGlobal Analyst, the flagship magazine of the Hyderabad-based media start-up, Media Five Publications Pvt. Ltd. We strongly felt that there is a

need for a business publication which could cater to the needs of a wide spectrum of readers – from decision makers to the floor managers, b-school faculties to future managers – and which is also truly global in its coverage. The GA is a result of a long and arduous pursuit. The GA aims to bring cutting edge and well-researched articles, debates, and interviews on contemporary and relevant topics from businesses across the globe, including India, tapping into and talking to global business leaders, thinkers, educators, economists, and entrepreneurs.

The cover story in the inaugural issue aptly deals with the most contemporary issue of why the UPA government needs to press on reforms pedal, notwithstanding a stubborn opposition and hard stance of its alliance partners, what types of key structural reforms are the need of the hour, etc. We spoke to a number of national and international experts to put together an interesting and insightful stuff for you.

The spotlight section features a brilliant piece of work on India’s Microfinance by Dr Milford Bateman, an international expert on Microfinance. He reckons how Microfinance which had once promised to be a panacea for India’s economically weaker section of people is faltering and in fact could be heading towards its end. Shockingly, as works of several researchers establish, he says, nowhere in the world microfinance has succeeded in eradicating poverty or upliftment of those lying at the bottom of the economic pyramid. Given, would the country’s MFIs learn a lesson from the incidents of Andhra Pradesh and do some course correction or is it going to be the end of the road for this once promising sector?

The recent episodes of labour unrest, which even turned violent and led to bloody clashes at Maruti’s Manesar plant, show the flipside of India’s industrial progress. Somewhere corporate India, particularly the manufacturing sector, overlooked the vital aspect of human capital and failed to put in place an effective mechanism to look after the interest of the so-called temps or contractual workforce. Dr. K R Shyam Sundar, a noted industrial expert, dissects what went wrong at Maruti Suzuki, India’s largest car maker, and what kind of corrective measures India Inc needs to take. Labour unrest is not a good sign for any economy and it is hoped that the motown would draw a lesson or two from Maruti’s experience. The issue also contains a number of innovative features such as Economic Indicators, Talking Stock, Technology, etc.

We take this opportunity to thank all the eminent experts, business leaders and academicians who readily agreed to support us, gave their valuable suggestions and insights, and contributed for the inaugural issue.

We would appreciate your valuable feedback.Amit Singh Sisodiya

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Viom Networks Ltd, Gurgaon, India.

Dr David WyssFormer Chief Economist, S&P and visiting fellow,

Watson Institute at Brown University. New York, US

Dean BakerEconomist and co-founder of the Center for

Economic and Policy, Washington, US

William GamblePresident, Emerging Market Strategies, Newport, US

Andrew K P LeungInternational and Independent China Specialist at

Andrew Leung International Consultants, Hong Kong

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“The mother of all bull markets is still ahead of us…It will take something to shake faith in the long term returns that Indian equity will give.”

-Rakesh JhunjhunwalaAce Investor and Founder, Rare Enterprises

“We can't wish away subsidies, but can improve their delivery.”

- P ChidambaramFinance Minister, India

“The disturbing events we have uncovered in the manipulation of Libor (London Interbank Offered Rate) have severely damaged our confidence and our trust - it has torn the very fabric that our financial system is built on.”

- Martin WheatleyManaging Director, Britain's Financial Services Authority

“We estimate that the consumer markets of China and India will triple over the current decade and amount to $10 trillion annually by the year 2020. It is a once-in-a-lifetime prize.”

- The $10 Trillion PrizeCaptivating The Newly Affluent in China and India, BCG

“India's vaccine production sector is likely to expand dramatically to an estimated size of USD 871 million by 2016.”

- GBI Research

“The largest challenge has to do with real estate in large cities where FDI has been opened up. Unfortunately, the availability and cost of real estate in India is very high and we are a low price retailer. If we pay too much of rentals, we cannot offer great prices to our customers.”

- Raj JainWalmart India President and Bharti-Walmart MD & CEO

“India’s top software services companies are offering price discounts of as much as 25% as they battle global rivals to win contracts worth $85 billion (around Rs.4.5 trillion today) that are set to be farmed out by companies such as Pfizer Inc. and Procter and Gamble Co. over the next year.”

- Mint newspaper

“The global economy is not doing well especially with the European debt crisis and the difficult phase would continue for some more time.”

- Kaushik BasuChief Economist, World Bank

Leaders Speak

Volume 1 / Issue 1

Contents

Move over ‘policy paralysis’, the government finally gets back into reforms mode as it launches a slew of policy measures to kick-start the economy.

COVER STORYP.21

Reforms 2.0India’s Mission (Im)possible !

Global Economy Lingering Woes

INTERNATIONAL

ChinaNo More a Beacon of Light?

INDUSTRY

Indian Generic Drug Makers Breaking into the Global Big League

FINANCIAL MARKETS

FCCBs Rising Concerns


HRM

Maruti’s Labor ConflictLessons for India Inc.

SPOTLIGHTMicrofinanceEnd of the Road?

BANKING

Basel IIIHow Geared are Indian Banks?

CORPORATE STRATEGYWockhardt’s TurnaroundTo the Brink and Back

FACE-TO-FACE

Rethinking CRR

PERSPECTIVE

FEATURE

Talking Stock

INDICATORSMaking Sense of Data

TECHNOLOGY

Apple unveils iPad Mini

TRIGGER

Big Data

Starbucks in India

31

35

10

43

5739

51

67

61

MCX-SXThe New Kid on the Block

737

FDI in India 42

50

Management EducationWealth Management

2819

17

13

914

Given the consistent decline in CRR rates over the years, do you think it has lost or is on its way to losing its relevance as a monetary tool?

Generally speaking, CRR is a portion of deposits that banks are required to keep with the central bank. In reality, the CRR is used as a monetary policy tool to control money supply in the economy and hence, to manage the liquidity in the economy. The higher the cash reserve (CRR) required, the lower the money available for lending and the higher the cost of loan.

With the development of money market and monetary instruments in the past two decades, CRR rates declined drastically in many countries, developed and developing as well but with different degree (rates). In fact, some countries have taken a radical decision and they have abolished the CRR policy (Canada, New Zealand, Sweden, and Australia). These countries consider the CRR as an inefficient monetary tool which negatively affect the economic activity and prosperity. These countries, such as many other developed countries, have introduced the inflation targeting regime as a new policy to control liquidity and to ensure financial stability. On the other hand, some other countries have decided to reduce the rates of CRR, but they are still using it as a privileged monetary policy instrument and an inflation-fighting tool. This means that CRR has lost its importance in both cases, but some countries, notably less developed countries, are still relying on it to control money supply.

What is the rationale of non-payment of interest on CRR?

A majority of central banks believe that with a non-payment of any interest rate on CRR, banks would not earn new money coming from their CRR and hence, the liquidity is controlled as it must be. Therefore banks will not lend more like before (especially when CRR increases) and the liquidity will shrink and inflation will be controlled. This policy will widen the spread between deposit and lending rates and will reduce credit expansion by controlling the amount of money that goes out by way of loans. Central banks consider non-payment of interest on CRR as a perfect policy tool to control money in circulation and hence overall money supply.

Given, it looks like a kind of hidden tax for the banks?

As I mentioned above, CRR is a part of deposits that banks are required to keep with central bank instead of circulating it in the economic system. The amount of money is neither remunerated (the interest rates on CRR are too low and even turn negative during rising inflation) nor used by CB. In this case money does not play any role in the economy (passive role); it becomes ‘inefficient money’ or also bad money. With a CRR monetary policy regime, banks are subjected to an opportunity cost, because the deposits held at the central bank through cannot be invested somewhere else. So banks lose, to some extent, part of their profit when deposing money at the CB as CRR. In my opinion, CRR is indubitably a kind of hidden tax on deposits, imposed on banks.

How do you view the growing demand for abolishing of CRR, as raised by some bankers?

In recent times, banks have suffered from several financial constraints notably from different sort of banking regulations at both the national (NPLs, Collateral,

Helmi HamdiSenior Economist at the Central Bank of BahrainSenior Research Fellow, CERGAM-CAE Aix-Marseille University

“I�think�that�the�abolishment�of�CRR�(cash�reserve�ratio)�is�better�because�the�banking�system�would�be�more�stable�and�the�competition�based�on�financial�services�will�improve�between�banks�and�non�banks�alike.”

Rethinking CRR

(The opinions expressed in this article are those o f the au thor and they do no t necessarily represent the official position of the Central Bank of Bahrain.)

Face-to-Face

CRR) and international levels (capital adequacy, Basel I, II. and III). Consequently, some banks were even forced to increase their riskier activities in order to reduce the costs of regulation and the negative effects of globalization (increased competition). However, high risk appetite could harm the banking sector and the economy as a whole. Hence, abolishing CRR could be a good way to help banks avoid taking unduly high risks.

In the last 20 years or so, globalization of financial markets and advancements in technology arena has transformed the banking environment like never before and as a result the banking sector has become contestable. Today, a wide range of enterprises have started to supply traditional banking services such as transactions deposits, savings accounts and a variety of loans. Such enterprises include supermarkets, utility companies, insurance companies, mutual funds and even car manufacturers. While these non-banking entities offer a wide variety of banking services, they, however, are not required to adhere to similar regulations (like CRR). Moreover, they are not obliged to keep any amount of money at the central bank. Given, it’s not difficult to see how banks are subjected to an unfair treatment. Thus, in my view, the CRR should be imposed either for all types of financial institutions or it should better be abolished. In fact, I strongly believe that the abolishment of CRR is better because the banking system would then be more stable while at the same time it would also level the playing between the banks and the non-banking institutions.

Is there prevalence of any such tool in the western world?

To adjust market liquidity, Western central banks rarely manipulate the CRR because it causes an immediate serious problem on the availability of liquidity. Central banks prefer, however, the use of open market operations (OMOs) to control liquidity in the banking system and to implement their monetary policy. Broadly, OMOs consist of buying or selling government bonds by the central bank in the open market. These operations enable central banks to control the supply of reserve balances in the banking system and thereby influence short-term interest rates and reach other monetary policy targets. Hence OMOs indirectly control the total money supply. In western world, CRR rates are fairly low (i.e., 1% in the Euro zone) and they are not considered as a major constraint for banks. Moreover, required reserves earn a positive real interest rate, which hence allows it to play a role in the economic system (non-neutrality of money).

What lessons can be drawn from the experiences of the US and Europe?

The broad aim of CRR in Europe and the US is almost the same (controlling money supply), but the policies are different. In fact, in the beginning of 1960s, US banks were allowed to use both vault cash and deposits at Federal Reserve Banks to satisfy statutory reserve requirements. Vault cash is cash that banks use it for their everyday transactions such as cash withdrawal (ATMs, or at a bank desk). The Fed considers vault cash as a part of a bank’s reserve required.

Hence, banks have the possibility of choosing the amount of their required reserves to be held in the vaults and the amount to be held at the Fed (pure reserve required). With this option, most US banks are satisfying their entire reserve requirement with this vault cash, which they hold to meet the liquidity needs of their customers and would hold even in the absence of reserve requirements. In addition, CRR is remunerated by Fed in order to minimize the effect of the implicit tax that reserve requirements used to impose on depository institutions. In this case, reserve requirement has no impact on the banking system; it cannot be considered as a tax or a financial constraint, it is even non-existent.

In Europe, the weight of the reserve requirement as a monetary instrument gradually declined since the beginning of 1990s. The development of the money market and the adoption of inflation targeting in many countries, have considerably weakened the monetary policy function of the reserve requirement. With the formation of a single currency and a single bank, the European Central Bank requires credit institutions established in the euro area to hold deposits on account (required reserves) with their national central bank and the CRR is remunerated. Thus, banks did not pay the opportunity cost and CRR could not be considered as a financial constraint for European banks.

As we can see from the two experiences cited above, CRR should be flexible and should not hamper the investments and the overall economic activities and it should also be remunerated to remove the negative effects of the implicit tax imposed on depository institutions.

Do you foresee CRR rates coming down further which in turn could give more rooms to banks to lend?

Currently we are facing a severe financial crisis and the near future remains unclear. Despite the efforts taken by European policymakers concerning the financial and economics stability of the Eurozone and the future of its currency the global economy remain fragile and vulnerable. Credit to private sector decreased remarkably in several countries because of the uncertainty. I think that decreasing CRR rates could be an efficient policy to restore confidence between banks and customers and to boost the economic activities through a decrease in spread and hence in lending interest rates. In the medium run, I am convinced that CRR will decrease further and it will be abolished in many countries.

What is your outlook?

Today, we are living in a new globalized economy, but central banks in most countries are still using some old monetary tools (the CRR policy was born in the US in 1913). With the multiplication of crisis during the recent years, central banks have shown their incapacities to respond efficiently to these shocks and to stop the crisis. Their current tools became obsolete. I think that a modernization in the overall monetary policy and tools is needed to be in harmonization with the new era. Adjustments rules need to be updated in parallel with the changing times, technology and society.

Banking / INTERVIEW

November 2012 The Global ANALYST 8/

ctionable Analytics, Personal Cloud, and Big Data are Aamong the top 10 technologies that will be strategic for most organizations, says Gartner, the global IT research

firm. Gartner defines a strategic technology as one with the potential for significant impact on the enterprise in the next three years. Further, a strategic technology may be an existing technology that has matured and/or become suitable for a wider range of uses. It may also be an emerging technology that offers an opportunity for strategic business advantage for early adopters or with potential for significant market disruption in the next five years. These technologies impact the organization's long-term plans, programs and initiatives. According to the Stamford, Connecticut, US-based firm, which advises CIOs and senior IT leaders on technology-related issues, factors that denote significant impact include a high potential for disruption to IT or the business, the need for a major dollar investment, or the risk of being late to adopt. “We have identified the top 10 technologies that will be strategic for most organizations, and that IT leaders should factor into their strategic planning processes over the next two years,” said David Cearley, Vice President and Gartner fellow. According to him, these technologies are emerging amidst a nexus of converging forces - social, mobile, cloud and information. Although these forces are innovative and disruptive on their own, together they are revolutionizing business and society, disrupting old business models and creating new leaders. As such, the Nexus of Forces is the basis of the technology platform of the future.

Mobile Device BattlesGartner predicts that by 2013 mobile phones will overtake PCs as the most common Web access device worldwide and that by 2015 over 80 percent of the handsets sold in mature markets will be smartphones. Enterprises will need to support a greater variety of form factors reducing the ability to standardize PC and tablet hardware.

Mobile Applications and HTML5Six mobile architectures – native, special, hybrid, HTML 5, Message and No Client will remain popular. However, there will be a long term shift away from native apps to Web apps as HTML5 becomes more capable.

Personal CloudThe Gartner forecasts that personal cloud will gradually replace the PC as the location where individuals keep their personal content, access their services and personal preferences and

center their digital lives. The personal cloud will entail the unique collection of services, Web destinations and connectivity that will become the home of their computing and communication activities.

Enterprise App StoresBy 2014, Gartner believes that many organizations will deliver mobile applications to workers through private application stores. With enterprise app stores the role of IT shifts from that of a centralized planner to a market manager providing governance and brokerage services to users and potentially an ecosystem to support ‘apptrepreneurs’.

The Internet of ThingsThe Internet of Things (IoT) is a concept that describes how the Internet will expand as physical items such as consumer devices and physical assets are connected to the Internet. Key elements of the IoT which are being embedded in a variety of mobile devices include embedded sensors, image recognition technologies and NFC payment. The IoT will enable a wide range of new applications and services while raising many new challenges.

Strategic Big DataDealing with data volume, variety, velocity and complexity is forcing changes to many traditional approaches. This realization is leading organizations to abandon the concept of a single enterprise data warehouse containing all information needed for decisions. Instead they are moving towards multiple systems, including content management, data warehouses, data marts and specialized file systems tied together with data services and metadata, which will become the "logical" enterprise data warehouse.

Actionable AnalyticsAnalytics is increasingly delivered to users at the point of action and in context. With the improvement of performance and costs, IT leaders can afford to perform analytics and simulation for every action taken in the business. The mobile client linked to cloud-based analytic engines and big data repositories potentially enables use of optimization and simulation everywhere and every time.

The other four technology trends include Hybrid IT and Cloud Computing, In Memory Computing and Integrated Ecosystems.

Source: Gartner

Big Data, Actionable Analytics among Top 10 ‘Strategic Technology Trends’ for 2013: Gartner

Trigger

9 The Global ANALYST / November 2012

hat i s common among WGlenmark Pharmaceuticals, Dr Reddy's, and Sun Pharma?

Apart from hailing India origin, these three companies now boast of another hallmark – they are among the top 10 fastest growing generic drug manufacturers, globally. According to a recent report by EvaluatePharma, these three companies have successfully broken into the list of generic drug makers, which have logged in growth rates ranging from 25% to more than 106% during the financial year ending March 31, 12. The list which is dominated, though not surprisingly by the American firms, has Glenmark at the number five place with a growth rate of 37%, followed by Dr. Reddy’s at the number 6, which Sun Pharma, which recently acquired Taro is a notch below its Israeli subsidiary at number eight.

So, what does this mean for Indian generic drug makers? Is it just about growing at a healthy growth rate, or has some other connotations as well? Industry observers believe that it signifies Indian generic firms’ new-found confidence to operate in fiercely contested and overtly regulated western markets of the US and Europe. Indian drug makers like Dr. Reddy’s and Glenmark have reaped huge rewards by launching generic versions of a number of blockbuster drugs (those drugs which fetch revenues of over a billion dollar for the company that created them) that have gone off patent in recent times. These companies have painstakingly been building their base in leading generics markets like the US, Africa, Brazil, Russia, etc, and competing and winning exclusivity rights for some of the fast growing drug segments such as cardiovascular, therapeutic etc. Besides, strong growth in domestic market, which remains one of the most promising drug markets, globally, too have boosted sales of these firms.

India, which clocked sales growth of 20% in FY11-12, is one of the few markets in the world to continue growing at such a fast clip.

Commenting on Glenmark’s strategy, CMD Glenn Saldanha says, “The high growth is due to our focus in building a strong emerging markets business in addition to having a significant presence in India and US. The growth from markets, particularly Russia, Brazil and the US, has been exceptional. We have

invested in these markets for the last six-seven years and we are just beginning to make huge inroads in these markets. Glenmark will continue to build its presence in markets like Russia, Brazil and Mexico where it has invested for the last five years and these markets will drive strong growth.” Dr Reddy's launched generic versions of blockbuster drugs Zyprexa and Plavix, while Ranbaxy mopped up huge revenues from sales of generic Lipitor. This shows the growing significance of domestic companies in terms of quality, portfolio strategy and

certain significant first-to-file (FTF) products. Strong revenues from regulated markets are another factor which contributed to the huge growth. Most of the companies have sales of around 50% coming from US, which is the largest market for generics globally. Domestic companies like Dr Reddy's capitalized on key FTF opportunities, while others including Sun Pharma posted gains on account of US sales,” quips Sujay Shetty, India leader for pharma and life sciences at PwC India.

The Indian pharmaceutical industry ranks among the top five countries by volume (production) and accounts for about 10% of global production. The industry’s turnover has grown from a mere US$ 0.3 bn in 1980 to about US$ 21.73 bn in 2009-10. Low cost of skilled manpower and innovation are some of the main factors supporting this growth. According to the Department of Pharmaceuticals, the Indian pharmaceutical industry employs about 340,000 people and an estimated 400,000 doctors and 300,000 chemists.

Signaling their rising g lobal clout, three dom estic generic drug m akers break into the league of the w orld ’s fastest grow ing generic com panies.

Indian Generic Drug MakersBreaking into the Global Big League

Pharma Industry Structure: At a GlanceThe Indian pharmaceutical industry is fragmented with more than 10,000 manufacturers in the organized and unorganized segments. The products manufactured by the Indian pharmaceutical industry can be broadly classified into bulk drugs (active pharmaceutical ingredients - API) and formulations. Of the total number of pharmaceutical manufacturers, about 77% produce formulations, while the remaining 23% manufacture bulk drugs. Bulk drug is an active constituent with medicinal properties, which acts as basic raw material for formulations. Formulations are specific dosage forms of a bulk drug or a combination of bulk drugs. Drugs are sold as syrups, injections, tablets and capsules. Based on the pharmaceutical customer base, the Indian API manufacturing segment can be divided into two sectors – innovative or branded and generic or unbranded. In 2009, the global generic drug market was estimated to be $84 bn, of which the US accounted for 42%. India’s generic drug industry is estimated to be $19 bn and it ranks third globally, contributing about 10% to global pharmaceutical production.

Source: Frost & Sullivan


ABOUT SSIMSiva Sivani Institute of Management (SSIM) is promoted by the Siva Sivani Group of Educational Institutions, which has been running the prestigious and internationally renowned Siva Sivani Public Schools for more than five decades.

SSIM started functioning as an autonomous institute in 1992 and is approved by the All India Council for Technical Education, Ministry of Human Resource Development, Govt.of India, New Delhi. Since its inception SSIM has a rich tradition of pursuing academic excellence and overall personal growth. This is achieved by following innovative pedagogic practices, providing excellent infrastructure and above all, the presence of dedicated and highly qualified faculty members, who strive in ensuring all round development of the future business leaders.

Today SSIM is one of the largest AICTE approved Autonomous Business schools in South India and is consistently ranked amongst the top Business Schools of the country.

• As per Business Barons B-School Survey 2012, SSIM is ranked 30th in the Country.

• Ranked 1st in Placements and Pedagogy amongst B-Schools of AP – Business World B-Schools Survey – 2012.

• Ranked 46th in the country and 7th a m o n g s t t h e To p B - S c h o o l s o f exce l l ence as pe r CSR-GHRDC Survey 2012.

• Received Top Institute of India Award – 2010 from Competition Success Review – April 2011.

• Pan India 22nd Dainik Lakshya B-School Survey 2011.

• Pan India 39th (Tier 1) – Careers 360 - B-School Survey 2011.

• Crisil A* rated for AP and B*** Nationally for the year 2011-2012.

• Business World B-School Survey Ranked SSIM 1st in placements amongst B-Schools in AP for the year 2012.

NH 7, Kompally, Secunderabad - 500014, AP, INDIA.Ph: +91 40 27165450 /51 / 53 / 54 | 65457236 / 37

Fax: +91 40 27165452 | E-mail: [email protected]

EDUCATION

EXPERIENCE

ENLIGHTENMENT

SIVA�SIVANIINST IT UT E OF M A NAGEM ENT

www.ssim.ac.in

IN FOCUS

VISIONTo be a Global centre of

excellence for qualitative and value based education.

MISSIONTo achieve and sustain

reputation for excellence in teaching, learning, research

and consultancy whilst upholding human values.

To become a ‘Deemed University’ par.

Strategically located in Kompally, far from the madding crowd, Siva Sivani Institute of Management has an enviable environment - serene, spacious and stupendous.

It offers an ideal environment for imparting value-based management education. The Institute provides free limited transport facility for day scholars and staff on specified routes. Residential accommodation is available on campus.

It comes as no surprise, that a number of students have been placed in reputed o rgan i za t i ons . The zea l shown by organizations in coming to SSIM for campus recruitment year after year only heightens their commitment to raise the standards, set them even higher than the preceding years.

Training and Consultancy (T&C) at SSIMSiva Sivani Institute of Management has full-fledged Training and Consultancy division headed by Director. This division undertakes assignments in consultancy on various vital i s s u e s r e l a t e d t o m a n a g e m e n t f o r organizations in different sectors, both in India and abroad.

International Tie-Ups and Programs:SSIM has academic collaborations with various educational institutions/ universities in UK, USA and Thailand. The benefits include student exchange, faculty exchange, foreign professors vist to SSIM, joint research and joint seminars etc.

Student of SSIM will have the opportunities to acquire International qualifications post-PGDM in SSIM. This includes:

a) Top-Up MBA from a foreign university.

b) Summer Internship/ Short programs.

c) International Certification Courses.

Corporate Social ResponsibilityStudents of SSIM participate in various ac t i v i t ies o f NGOs, b lood donat ion campaigns, AIDS awareness camps, Old age home service, meeting the physically and mentally challenged people, etc.

They also have adopted a municipal primary school and providing help in running the school including financial support with contributions from faculty and students.In order to support the cause of higher

education, SSIM organizes free Faculty Development Programs for graduate college teachers and also provide free guest lectures/ seminars on important topics to engineering and non-engineering students. Also provide career counseling and general awareness to students in collaboration with The Hindu, Business Line Club.

Distinguished VisitorsDistinguished visitors from various walks of life visit SSIM campus to motivate and invigorate students to help them become great leaders and better citizens.

Apple unveils iPad Mini

Apple Inc, the makers of iPhone, iPod and iMac, has finally unveiled the miniature version of its highly popular tablet PC, the iPad. The iPad Mini, the new

product from the Apple stable, features a stunning 7.9-inch Multi-Touch display, powerful A5 chip, FaceTime HD (high definition) and iSight camera with 1080p HD video recording, ultrafast wireless performance, 10 hours of battery life. And it’s perfectly sized to work with hundreds of thousands of apps made for iPad.

iPad mini has everything that makes an iPad an iPad, but it’s a fraction of the size. At just 7.2 millimeters, it’s pencil thin and unbelievably light. You can easily hold it in your palm. And stash it in your smallest bag without a second thought, so it’s always close at hand, says the company, which surpassed Microsoft to emerge as the wor ld ’s most va luab le technology company and remains one of the few tech firms which have defied worldwide economic slowdown. The iPad mini display uses the same LED backlight technology as iPad to give you plenty of pop per square inch. iPad Mini uses the latest version of its operating system, iOS, which includes all the built-in apps you use every day and all the intuitive technology — like Multi-Touch and Siri — and that makes iPad mini so advanced. The iPad Mini also features the powerful and power-efficient, the dual-core Apple A5 processor, which makes everything you do feel smooth and natural. From the little things like switching from app to app and swiping from page to page, to the big things like editing photos, watching movies, and playing

games, according to the company. With the iPad Mini you can also download over 275,000 apps from the App Store. Also, as the company promises, iPad Mini is not a scaled down version of iPad. “We designed it to be a concentration, rather than a reduction, of the original. A refined unibody consolidates more parts into one. A single-cell battery — the thinnest ever made by

Apple — takes up less space, but lasts just as long. The iSight camera is smaller, yet still takes 5-megapixel photos and shoots full 1080p HD video. And while the display is slimmer and lighter, it’s also incredibly vibrant,” a release from Apple says. iPad mini with Wi-Fi starts at $329 (for the US markets).

The iPad Mini is expected to give tough competition to Google’s Nexus 7 and Amazon’s Kindle Fire HD, which have been received well by the consumers and critics alike, and which have so far dominated the smaller tablet PC segment, which Apple had not targeted earlier. However, iPad Mini does not come cheap when compared to rivals Nexus 7 and Amazon’s Kindle Fire HD, both of which costs much less; while Nexus 7 (16GB) is currently priced at $249, Kindle Fire HD (16GB) comes with a price sticker of just $199.

Notwithstanding the price differential, Apple iPad Mini is expected to stir the competition in the market for sub-10 inch tablet PCs, riding high on iPad’s huge success, Apple’s huge fan following across the globe. So, shall we say, “Cheese”? At least not for now.

Technology

Ending the long wait of its global fans, Apple Inc finally lifts the veil on its iPad Mini, the smaller version of its hugely popular iPad tablet PC.

Team Global Analyst


raving serpentine queues and scorching heat, hundreds Bof coffee enthusiasts waited for hours to grab their cuppa of coffee inside the world’s leading coffee retailer

Starbucks’ first India outlet which opened on October 19th at the posh Horniman circle in south Bombay. Going by the opening day response – it was a full house! – it seems the US coffee giant is leaving no stone unturned in its effort to make India a key market for it. It’s reflected in the fact that right from the welcome sign – which was in six Indian languages -- Hindi, Marathi, Tamil, Gujarati, French and English – to the pricing and flavors, they all have a tinge of localization. The pricing has been aligned with that of Café Coffee Day and Barista, starting at Rs.85 for a cup of brewed coffee excluding taxes, says a report in the Mint daily. There are 42 items on the mixed menu but no pork or beef items. Clearly, they have drawn a leaf or two from the book of fast food MNC giants like McDonald’s, which initially struggled to find a foothold in the tough Indian market in absence of a localized menu. “They have got their pricing similar to the other coffee chains present in India,” noted Devangshu Dutta, Chief Executive, Third Eyesight, a retail consultancy, in an interview to the Mint. A localized menu is a must in India as food is a big part of café culture, he added.

The Starbucks, which had been mulling its India launch for quite some time, makes its foray into the world’s second fastest growing economy in partnership with Tata group company, Tata Global Beverages. “This is the largest market in the world for Starbucks and we will make significant investments here and build a leadership business,” said an exuberant Howard Shultz, Founder and Chief Executive Officer of Starbucks, adding, “India is a complicated and complex market; it has become easier to enter due to Tata”. Starbucks, which seems unlikely to reach its target of reaching 50 stores by the end of December, has said that it will

open its first store in New Delhi early next year. Tata Starbucks Limited is the 50/50 joint venture between Starbucks Coffee Company and Tata Global Beverages Limited.

India’s coffee retailing segment, estimated at $230 million currently, is expected to touch $410-mark by 2017, growing at a CAGR of 14%, according to retail consultancy firm Technopak Advisors. “Consistent growth of consuming class and increasing time-pressured consumer is giving way to convenience-based option, primarily driving the growth of cafes. The market witnessed high growth driven by an addition of 1,250 stores over last 5 years,” highlights its report titled, “Indian Cafe Market". Coffee retailing has emerged as a highly lucrative segment among the fast growing QSR (quick service restaurant) business for a number of reasons. “Coffee retailing doesn't require big supply chain investments; and operating profit margins are huge - at close to 80%. At the store level, profits are not too difficult to achieve as long as the location and brand name works. So even if there's a general slowdown, coffee retailers want a foothold in the Indian market now,” The Economic Times quoted Harminder Sahni, Founder of retail consultancy Wazir Advisors, as saying. Given, it’s no secret why global coffee giants are lining up their India foray plan. What is also attracting both the global biggies as well as domestic firms is the fact that India’s relatively low per capita coffee consumption. According to Indian Coffee Board, India’s per capita coffee consumption is at a miniscule 85 gram every year compares poorly with that of Brazil (4.8 kg) and Finland (12 kg). India has always been a tea-drinking nation. However, with changing lifestyles and rising disposal incomes, the growth of café is only expected to grow from here on. Further, as consumers in the western markets like the US and Europe increasingly shift away from coffee to health drinks like herbal tea, more and more coffee retailers eye the hugely untapped markets like India and China.

Given, Starbucks, which boasts of 18,000 cafes in 60 countries, will have some real tough competition coming its way – right from the existing café chains, which include the market leader Café Coffee Day (which currently has a market share of 60% of the organized café retailing), and others like Costa Coffee, Barista Lavazza, Gloria Jean’s Coffee and Coffee Bean and Tea Leaf to the new and potential entrants like Dunkin’ Donuts and Krispy Kreme. India currently has 1,700 cafes, out of which 1300 cafés are operated by Café Coffee Day. Looks like Indians are slowly but surely warming to the coffee house culture.

Trigger

What’s Brewing!Starbucks Makes it Much Awaited India Debut

Team Global Analyst


On August 7, 2012, Indian equities rose sharply on the back of positive global as well as domestic cues. The announcement of an aggressive bond buying plan by

the European Central Bank (ECB) coupled with expectations of a (upward) revision in fuel prices by the union government saw major stock indices record their best ever gains in the last two months; while the BSE Sensex gained 338 points, the Nifty moved up by 103 points in a single day. Stock prices, in general, remained depressed for most part of the current calendar year as a slew of negative data from both abroad as well as back home hurt investor sentiment. For instance, weak economic data including June’12 quarter GDP growth, which was much below than the near 9% growth achieved in the fiscal 2009-10, negative Index of Industrial Production (IIP) data in June, surge in core inflation, which jumped to 5.44% in July’12 from 4.85% in June’12, which had remained above RBI's comfort levels, persisting debt crisis in euro zone and sluggish economic data from the US, slowdown in China, etc., they all weighed heavily on the investors’ minds. Now investors are keenly awaiting the outcomes of the RBI’s forthcoming monetary policy review meeting. It’s not unusual to find wild market swings in the wake of release of such data. While these could excite someone like a day trader (who could be ready for a wild swings either way, up or down), it could be frightening for an average, risk-averse investor.

One often hears about these terms, but do you know how important they are and whether basing one’s investment decision on some data at a given point in time, or appropriately, one-time data. An understanding of these data, referred to as Economic Indicators, is very important for every one, be it a layman or a stock investor. Simply put, an economic indicator is a statistic about the economy. Economic indicators are also official statistics which are released by the government agencies

from time to time. These indicators enable analysts to get insights into the past and present situation and to forecast about the future direction of the economy. Economic indicators also help in understanding business cycles. Their significance

A firm’s fortune not only hinges on its internal environment, but is also importantly driven/determined by its external environment. That’s why understanding a firm’s business and economic environment is as important as knowing about firm-

s p e c i f i c f a c t o r s s u ch a s i t s management quality, soundness of its business model, its key strengths, etc. The examples are not far to seek. The 2008 financial crisis that originated in the US soon spread to Europe and other parts of the world. The Indian banking system, which had no direct exposure to the crisis, got impacted too as the global liquidity tightened and fears of a systemic or contagion risk became widespread. Banks became reluctant to lend and as a result corporates, even the stronger ones, found it difficult to raise capital, which in turn hurt their growth plans. All these resulted into a worldwide economic recession. Industr ies such as Information Technology, Textiles, Gems and Jewellery, which relied predominantly on exports, got hurt as demand fell. By Mid of 2009, while things started improving and global economy began to find its feet, driven by swift recoveries in China and India, the benefits of recovery were not uniform across the sectors; while some sectors recovered

quickly, others like IT continued to suffer as corporate spending in their key markets like the US and Europe remained sluggish. What it shows is that even if a company is fundamentally sound, poor business or economic environment it operates in could play spoil sport. Further, during a sluggish economic environment, a company in a cyclical business (Cement, Textiles) could found it harder to do well as compared to a firm operating in a non-cyclical or defensive sector (Pharmaceutical,

Economic IndicatorsInsights


FMCG, etc.). Hence it is important for an analyst (and even a commoner) to track relevant/major economic indicators.

Defining an economic indicator An economic indicator (or business indicator) is a statistic about the economy. Simply put, an economic indicator is the official statistical data of a certain economic factor that is published periodically by the government agencies, which an investor can use to gauge the economic situation. It allows investors to analyze the past and current situation and to project the future prospects of the economy. One application of economic indicators is the study of business cycles. Examples of economic indicators include GDP figures, interest rates, foreign currency reserves, trade balance, Foreign Direct Investment, etc.

However, one needs to keep in mind that it’s the trend, and not the data itself, could throw some meaningful insights and provide clues as to where the markets could be heading in the long-term. Also, it always makes sense to use multiple indicators rather than depending on just a single economic data trend.

So, don’t get panicky when you see strong volatility in the market due to strong reactions from market participants to release of an indicator, rather look at the trend(s) to take an informed decision. Some key indicators

Some of the key indicators to watch out for include GDP growth rate, unemployment rate, central bank’s policy rates, balance of payment, inflation, etc. Also, these economic indicators can further be classified as follows:

• Total Output, Income, and Spending (examples include GDP, Corporate Profits, Real Gross Domestic Investment, etc.)

• Employment, Unemployment, and Wages

• Production and Business Activity

• Prices (Producer Prices, Consumer Prices, etc.)

• Money, Credit, and Security Markets

• Federal Finance

• International Statistics (Source: University of Minnesota)

Economic indicators are also classified as leading (signals future trends), lagging (follows an event) and coincident (concurrently happens along with the event it signifies). Leading indicators are those which change before the change in overall economy takes place. Examples of leading indicators include Stock Indices (Sensex, Nifty Fifty), Money Supply (M2), Manufacturer’s New Orders for Consumer Goods, etc. Lagging indicators, as the name suggests, lag the change in the overall economy. In other words, they just confirm the change in the overall economy. Examples include labor cost per unit of output, unemployment rate, corporate profits, etc. Coincident indicators change in sync with the change in the overall economy or in tandem with a related economic trend.

Economic indicators can also be classified as: pro-cyclic, counter-cyclic and acyclic. The accompanying table shows some of the major indicators and their impact on the stock market.

Economic Indicators and their Impact on the Stock Market

Indicators Favorable UnfavorableAgricultural Production High Low

Balance of Payment Positive Negative

Balance of Trade Positive Negative

Deficit Financing Low High

Domestic Savings Rate High Low

Foreign Exchange Position High Low

Freight Movement of Railways High Low

General Employment Position Full or almost full employment Under- and unemployment

GNP High Growth Rate Slow Growth Rate

Industrial Production High Low

Inflation Low High

Interest Rates Low High

New Housing Construction High Low

Power Supply High Low

Tax Rates Low High


Economy / INSIGHTS

Growth Rate of GDP at Constant (2004-05) Prices (%)

Source: Central Statistical Office, PE=provisional estimates, QE=quick estimates, RE= revised estimates.

Industry 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 (PE) (QE) (RE)

I. Agriculture 5.1 4.2 5.8 0.1 1.0 7.0 2.8

II. Industry 9.7 12.2 9.7 4.4 8.4 7.2 3.4

mining & quarrying 1.3 7.5 3.7 2.1 6.3 5.0 -0.9

manufacturing 10.1 14.3 10.3 4.3 9.7 7.6 2.5

electricity, gas & watersupply 7.1 9.3 8.3 4.6 6.3 3.0 7.9

construction 12.8 10.3 10.8 5.3 7.0 8.0 5.3

III. Services 10.9 10.1 10.3 10.0 10.5 9.3 8.9

GDP at factor cost 9.5 9.6 9.3 6.7 8.4 8.4 6.5

As p

er c

ent o

f GDP

10

8

6

4

2

0

-2

-4

-6

-8

-10

-12

-9.7

2006-07 2007-08 2008-09 2009-10 2010-11

Invisiblesbalance

Net�capitalinflows

5.54.7

6.1

8.67.5

0.5

5.9

3.85.0

3.7

-7.8

-4.9

-2.7-2.8

-6.0

-8.7

-1.0

-3.4

-6.5

-1.3

-4.2

-7.4

-2.3

-5.3

Currentaccountbalance

Goods�&servicesbalance

Tradebalance

India’s Trade indicators

Source: RBI

7

6

5

4

3

2

1

02006-07 2007-08 2008-09 2009-10 2010-11 2011-12

(RE)2012-13

(BE)

Revenue Deficit Fiscal Deficit% of GDPLIBOR Rates

Overnight Euro LIBOR 0.01571 %

USD LIBOR - 1 month 0.21850 %

CHF LIBOR - 3 months 0.04000 %

GBP LIBOR - 6 months 0.81000 %

JPY LIBOR - 9 months 0.45157 %

CAD LIBOR - 12 months 1.99600 %

Making Sense of DataKey Indicators

as on October 3, 2012

Source: global-rates.com Source: RBI


*Trading in Currency Futures commenced on August 28, 2008 ** Trading in Interest Rate Futures commenced on August 31,2009

Trading Value of Different market segments (Cr)

Segment/Year 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Capital Market 1,945,287 3,551,038 2,752,023 4,138,024 3,577,412 2,810,893

Equity Futures & Options 7,356,242 13,090,478 11,010,482 17,663,665 29,248,221 31,349,732

Wholesale Debt Market 219,106 282,317 335,952 563,816 559,447 633,179

Currency F&O * -- -- 162,272 1,782,608 3,449,788 4,674,990

Interest Rate Futures ** -- -- -- 2,975 62 3,959

Total 9,520,635 16,923,833 14,260,729 24,151,088 36,834,929 39,472,753

Performance of Core Industries (Growth in %)

Source: Office of the Economic Adviser

Sector Weight 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Jun-2011 Jun-2012

Overall Index 37.903 3.9 8.4 5.2 2.8 6.6 6.6 4.4 5.6 3.6

Coal 4.379 6.6 5.9 6.3 8.0 8.1 -0.2 1.2 -3.0 7.2

Crude Oil 5.216 -5.2 5.6 0.4 -1.8 0.5 11.9 1.0 7.7 -0.8

Natural Gas 1.708 1.4 -1.4 2.1 1.3 44.6 10.0 -8.9 -11.7 -11.1

Refinery Products 5.939 2.1 2.9 6.5 3.0 -0.4 3.0 3.2 4.6 6.1

Fertilizers 1.254 0.6 3.1 -7.9 -3.9 12.7 0.0 0.4 -2.4 -11.7

Steel 6.684 7.0 12.8 6.8 1.9 6.0 13.2 7.0 14.5 -0.5

Cement 2.406 12.4 9.1 8.1 7.2 10.5 4.5 6.7 1.7 10.2

Electricity 10.316 5.1 7.3 6.3 2.7 6.2 5.6 8.1 7.9 8.1

Monetary Indicators (in percent)

* RBI discontinued the PLR and started base rates from July- 10 ** as on 23/08/2012, Source: RBI

2006-07 2007-08 Aug,2008 Nov,2008 Dec-08 Jan-09 Mar-10 April-10 Aug-12

Cash Reserve Ratio 6.50 7.50 9.00 5.50 5.50 5.00 5.75 6.00 4.75

Bank Rate 6.00 6.00 – -- -- -- 6.00 6.00 9.00

Repo rate 6.00 6.00 9.00 7.50 6.50 5.50 5.00 5.25 8.00

Reverse Repo rate 7.75 7.75 6.00 6.00 5.00 4.00 3.50 3.75 7.00

Prime Lending Rate 12.25-50 12.25-75 -- -- -- – 11-12 10.00 -10.50

Call Money rate 0.50-4.90 6.15-9.30 -- – 2.00-4.20 2.50-4.15 – – 7.10-8.10**


Economy / INDICATORS

f you believed the uncertain global economic environment Iwould have hit the world’s super riches as well then think again. As a latest survey of the world’s multi-millionaires by

Citibank and Knight Frank shows, globally, the number of individuals with $100 million or more in assets jumped by 29% between 2006 and 2011. According to the Citi-Knight Frank survey, “The World Wealth Report 2012,” the growth is in fact far more impressive if one looks at regions like Latin America, which outperformed North America (growth of 6%) by a much wider margin. Citing a Ledbury Research, the Citi-Knight Frank survey puts the number of such centa-millionaires at a formidable 63,000 with total net worth of nearly $40 trillion, as of 2011.

The growth in net worth of these HNIs is truly remarkable given the challenging global economic environment: the fragile economic recovery in the US, sovereign debt crisis in the Eurozone, socio-political tensions in the MENA (Middle East & North Africa) region, bearish sentiment across the global equities, sluggish growth in global real estate markets, etc. In terms of region-wise concentration of these super-rich individuals, South-East Asia, China and Japan emerge as the region with the largest population of centa-millionaires at 18,000, as compared to North America, which had 17,000 HNIs and Western Europe with a figure of 14,000. The report predicts this number to grow further, by 37%, to 86,000 by 2016 with the troika of SEA, China and Japan extending their lead over the others (26,000 vs. 21,000 in North America and 15,000

in Western Europe). In terms of individual countries, however, the US is still expected to dominate the league chart with 17,000 HNIs in 2016 followed by China, which is forecast to double its tally of HNIs to 14,000 during the same period. However, fast forward to 2050 and the rankings could dramatically change, or so the Citi-Knight Frank report suggests.

The report cites research by Danny Quah, a London School of Economics professor, who forecasts that the world’s economic centre of gravity, a theoretical measure of the focal point of global economic activity based on GDP, to shift eastwards to lie somewhere between China and India by 2050 from the middle of the Atlantic in 1980. While some individuals have grown wealthy by saving their earnings, a majority of these multi-millionaires are business owners, suggests the report.

“Individuals can become millionaires or multimillionaires through saving their earnings, a trend most commonly seen in more developed and established economies. But, apart from those who inherit wealth, most people who are very wealthy, say with assets of $10m or more, are business owners,” the report cites James Lawson, Director at Ledbury Research, as saying. “To amass this sort of wealth means there must be an alignment between opportunity and ability. For those who make more than $50m, the opportunity usually arises because of a major liquidity event, and these are more common, and can be tapped into more readily, in fast-moving economies,” he reckons, adding that the wealthy investors have benefitted from the growth in sectors such as natural resources, manufacturing and construction. The league table, however, is set to alter if one looks at the long-term. Going by the survey’s forecasts, most of these new HNIs could no longer be found in the traditional markets like the US, Europe and China, but a host of new, emerging wealth hotspots.

The report sounds quite bullish on countries such as Bangladesh, Egypt, Indonesia, Iraq, Mongolia, Nigeria, Philippines, Sri Lanka and Vietnam, which form part of what it calls ‘3G’ or Global Growth Generators. While most of these countries still have a lot of catching up to do, the survey forecasts them to benefit from the large natural resources they enjoy. “All of these countries are poor today and have decades of catch-up growth to look forward to. Some of them, including

The Emerging Wealth HotspotsWealth Management

How HNWI Asset Portfolios are invested All North Latin Europe & Africa & Asia HNWIs America America Russia Mid. East Pacific

Property 23% 20% 13% 16% 29% 31%

Equities 21% 18% 23% 19% 21% 24%Bonds 21% 24% 34% 20% 20% 16%Gold 3% 3% 3% 2% 3% 2%Commodities 2% 4% 2% 2% 1% 2%Currencies 3% 2% 2% 2% 3% 4%Cash 15% 14% 11% 15% 14% 19%Other 12% 15% 12% 24% 9% 2%


Nigeria, Mongolia, Iraq and Indonesia, also have large natural resources that we hope will be more beneficial than they so often have been in the past, says Willem Buiter, Citi’s Chief Economist and one of the writers of the report. Interestingly, the report reckons that acronyms such as BRIC are no longer relevant when discussing the world’s fastest growing economies. Rather, it says, the term 3G, which Citi has created and terms it as a new way of expressing the key drivers of global growth and investment opportunities, is more apt as it more effectively “describes countries, regions, cities, trade corridors, sectors, industries, firms, technologies, products and asset classes that over the next five, 10, 20 and 40 years are expected to deliver high growth and profitable investment opportunities.” But don’t confuse these nations with the Emerging Markets, the report warns. Instead, these nations (which form part of the 3G) are those entities which, Citi considers, are likely to thrive in the globally integrated economy, says the Citi’s Chief Economist. The report contains a section on the real estate and cities of the future (2050), which features cities of the world as ranked by HNIs and which include Indian cities such as Mumbai and New Delhi.

The report also offers useful insights into some other interesting aspects such as what forms part of the portfolios of some of these ultra-rich investors. These include fine wine, sports investment, art and real estate. A comparative analysis of returns from some of these avenues does help to understand how these multi-millionaires have continues to grow and protect their wealth. For instance, investment in fine wine, has delivered relatively superior returns as compared to equities. According to the Citi-Knight Frank report, “Longer term, the value of the Liv-ex Fine Wine 100 has risen 66% over the past five years, which is a far better performance than the FTSE 100. In all but one five-year period since 1988, wine investment has shown a positive return.

By contrast the FTSE has seen 63 negative periods.” According to liv-ex.com, the Liv-ex Fine Wine 100 Index is the industry’s leading benchmark. It represents the price movement of 100 of the most sought-after fine wines for which there is a strong secondary market and is calculated monthly. The majority of the index consists of Bordeaux wines – a reflection of the overall market – although wines from Burgundy, the Rhone, Champagne and Italy are also included.

Finally, the report also highlights some of the key threats which HNIs felt could impact their wealth. For instance, HNIs in India felt inflation as a major threat, while those in Russia pointed out hostile takeovers as a key concern for them. Devaluation of the domestic currency remains a major worry for centa-millionaires of Hong Kong, while nationalization of land is being viewed negatively by HNIs in Zambia.

• South-East Asia, China and Japan now collectively boast more HNWIs worth $100m-plus than North America, a lead that is forecast to widen.

• On an individual country basis, the United States will cont inue to lead the table of centa-mi l l ionaires (individuals with$100mn or more in disposable assets) for some years to come, though China is closing the gap.

• While an equity portfolio can lose its value overnight, investments of passion are more tangible – even if their value falls, they can still be enjoyed

• Wealthy investors remain extremely cautious, with many favoring cash, gold or high-grade government bonds. They are also looking at new ways to spread portfolio risk, as well as investment opportunities that are market neutral.

• At a time of turmoil in the markets, art, wine and sport look like steady investments, routinely outperforming indices such as the FTSE 100. And if times get really hard, investments of passion can still be enjoyed.

• Many HNIs still focused on reducing risk, increasing transparency and improving liquidity. • A l o t o f cash is simply being held on deposit, but there has been some demand for long-duration, mostly five-year, sovereign debt. Unsurprisingly, it is only German bunds, UK gilts and US treasuries that are of real interest.

• Some investors do consider gold something of a relic, but it is still hugely popular in Asia, and quantitative easing measures tend to increase demand.

• High-grade corporate fixed bonds are viewed as a relatively risk-free and liquid asset by a number of clients, but when it comes to investing in the equity of specific companies, few sectors have jumped out as being particularly attractive.

• High-grade corporate fixed bonds are viewed as a relatively risk-free and liquid.

• Currency has attracted some clients who have sold euros aggressively in favour of the dollar.

• Investors ignore falling yields at their peril. Falling yields reflect falling potential growth rates, meaning equities are likely to continue to be downgraded.

• A growing number of investors are discovering that life’s luxuries and pleasures can also make profitable investments.

• Art, wine and sport, so-called “investments of passion”, are enjoying a growing popularity among investors. While collectors are still prepared to spend, the focus is now on “blue-chip” art.

‘The World Wealth Report 2012’Key Highlights


Reforms 2.0India’s Mission (Im)possible !

Cover Story / INDIAN ECONOMY

TWOSOME AWESOME

MOVE over ‘po licy paralysis’, the governm ent f inally gets back in to re fo rm s m ode as it launches a

s le w o f p o l ic y m e a su re s in c lu d in g c a p p in g t h e n u m b e r o f subsid ized LPG cy linders to six a year, h ik ing d iese l p rice b y Rs.5 , and , the b iggest su rp rise o f all, the dec ision to allow FD I in m u lt i-b ran d re ta ilin g a lo n g w ith aviat ion . W h ile it seem s to be a case o f better late than never, the governm ent, however, is facing stiff resistance not on ly from the opposition parties but even from w ith in , w hich saw it lose the crucial support of TM C of fire-brand leader M am ta Banerjee.

Besides, critics also po int out that the recent po licy actions can in no w ay be called refo rm s at all (as key structu ral refo rm s like im p lem entation o f G ood and Services Tax, in frastructure developm ent, land acquisition and labor law s, f u r th e r d e reg u lat io n in a h o st o f o th e r se c to rs su ch as f in an c ia l se rv ice s, energy, cu rb ing red tape and co rrup tion , etc , rem ain unattended to ), and th at th e M an m o h an S in g h -led g o ve rn m en t n eed s to take so m e m o re con cre te ye t tou g h m easu res to f ig h t th e tw in th reats o f su rg in g fiscal deficit and econom ic slow dow n.

G iven, w hile the recent m easures defin itely have helped create a ‘feel-good’ factor, w hich could revive business sentim ent, the real action is yet to beg in . Bu t g iven the k ind o f sticky situation the UPA 2 finds itself in as it gears up to put the econom y back on the fast track o f grow th, reform s 2.0 certain ly appears to be a w hile aw ay. So, can the Singh-PC duo achieve w hat looks like a m ission. im possib le?

by N Janardhan Rao with Amit Singh Sisodiya


of the world’s youngest populations, many felt awesomely optimistic about the economy’s future.

However, the economic jubilation stimulated by apparently inevitable march toward double-digit growth has soured against sagging growth, growing deficit, rising inflation driven by swings in food prices, dwindling rupee value and drying private investment. More importantly, a series of scandals from courts to army called the integrity of a whole range of institutions into question. Looks like scandals have become seasonal which have paralyzed government economic agenda. In short, the economic miracle feels like a mirage and the country is fast losing its economic sparkle.

Sliding downThe economic performance during the fiscal 2011 was marked by slowing growth, high inflation, and widening fiscal and current account deficit. Hencefor th, the macroeconomic situation has remained weak amidst s l ow i n g g r ow t h ; g ove r n m e n t ’s barrowing has remained high, and crowding out of private investment has on ly added to in f l a t ionar y pressure. Slower growth has meant fewer jobs and rise in poverty levels. The economic growth further worsened as GDP could grow at only 5.3% in the last

FTER a decade of rapid Aeconomic growth, the Indian economy today is worth nearly

$2 trillion, which makes it the world’s tenth-largest. India enjoys a rich demographic dividend, rising per capita income rural poverty down, wide spread roads, rapid rising literacy levels and the continual spread of mobile phones and so on. The country is more stable than before. Just a couple of years back, the whole world was going gaga over Indian Economy as it emerged as the second fastest growing economy when most of the western economies were hitting the depress ion . As ia ' s th i rd la rges t economy enjoyed a near double-digit pace of growth during 2004-08 and successfully sailed through the worst global financial crisis in 2008 with GDP growth of 7% annually before reaching to 10.4% in 2010.

The global policy makers labeled the count r y a s an emerg ing g loba l powerhouse. Indian business houses made rapid strides on global business firmament, while Indian managerial and engineering talent underlined its global presence firmly. Economists of all hues even declared that if the growth tempo sustained it could lift millions of people out of poverty quickly and job would be created for all unemployed youth. With the country enjoying one

quarter of 2011-12; hardly creating respectable jobs for all the young Indians coming into the workforce. It was the slowest rate in nine years as sectors like manufacturing, mining and construction dragged growth down. While economic slowdown in 2008 was mainly due to global financial crisis, today it is combination of global as well as domestic factors which have been frightening for a while. In fact, the current crisis is directly correlated with UPA's unproductive public expenditure since 2008 and has less to do with the external world. The slowdown has stabbed once cheerful mood in the business and political circle and brought sharp criticism of the government. Analysts say the economy’s strengths are being undermined by growing political dysfunction and a series of allegations of corruption have undermined the authorities of the policy makers.

And the ongoing troubles in the global economy have only added to India’s miseries. The global economy is shaking once again as the two key regions struggle. The Europe Union is struggling with a sovereign debt crisis while the US is unable to produce enough new jobs; the US unemployment still holds around 8%. Another major blow comes from China, still the world’s fastest growing economy, whose economic growth has weakened with a real estate downturn and stalling exports as the country’s export hub has been hit hard by the global economic slowdown.

In fact, even the other two components of the so-called BRIC nations are not doing well either - both Brazil and Russia is slowing down. All these external factors have acted as serious headwinds to India’s sluggish economic recovery. The feeble demand in the US and EU has hit Indian exports of IT services and manufactured goods.

However, critics believe that India’s woes are more on account of internal than external factors. The last two years marked lack of reforms amidst rising fiscal prof ligacy, which took the heaviest toll on the economy. The stagnant industrial output and falling investment signal India’s worsening economic prospects. The country is

India GDP, Industrial production and export

15

10

5

0

-5

-10

150

100

50

0

-50

-1002008 2009 2010 2011 2012

Industrial production - % Change y-o-y

Exports - % Change y-o-y

GDP - %

Source: Thomson Reuters Datastram



now facing political reckoning. If the political leaders fail to solve the current challenges, the economy may face even deeper problems. Eswar Prasad, an economist at the Brookings Institution echoes, “The key macro numbers reflect not just a loss of economic momentum but, far worse, a loss of confidence in the government’s ability to tackle the enormous short-term and long-term challenges to sustaining growth.” The UPA government’s inability to come out with required economic reforms has pulled down

How do you respond to the government’s measure to cut fuel subsidies? The government's decision to reduce fuel subsidies by increasing prices is a good move. This is essential because the price paid cannot be significantly lower than the market price. Current given that revenue is not increasing due to a slowdown, it is even more important to control the subsidy bill which has a l ready overshot the budgets amount in the first five months of the year.

How significant these measures are as far as the government’s goal of curbing fiscal deficit is concerned?It sends positive signals, though the present price increase will not change the fiscal deficit ratio significantly by more than 0.1 to 0.2 percent of GDP. It has to be realigned more regularly with the market conditions to have an impact. It has to ensure that the other two elements also are under control - food and fertilizer.

Does it also signal the beginning of an auster i ty program on par t o f the government?

economic activity to its slowest pace in nearly a decade. That said, the Indian Inc continues to be puzzled over the long pending economic reforms. All these adverse developments are clouding the economic environment already affected by high public debt and the highest debt-to-GDP ratio among BRICS economies.

Losing competitive edgeAs a consequent to several of these factors, India is losing its competitive advan tag e in cont ra s t to o ther

Not really. We need the government to spend more on projects which hopefully will be done. The trick is to control expenditures within the budgeted numbers and not al low them to overshoot. Austerity means cutting back on expenditure which may not be called for today as we have to keep demand up.

What k ind of o ther measures are needed to rein in the twin deficits – current account deficit (CAD) and the fiscal deficit?For CAD there is little that we can do as trade is free. The import duty on gold imposed earlier this calendar year helped to bring down imports. Otherwise there is not much that can be done when imports grow.

For fiscal the trick is to ensure that all the targets are met. We have to see that the spectrum sale and disinvestment targets are met. Expenses have to be within the budgeted targets. We should have a policy where the government says that once the subsidy level is exhausted, then there will be no further allocations.

Deficit containment is only one part, the government also needs to jumpstart the

economies. According to the World Economic Forum’s latest Global Competitiveness Report, India slid down ten points to 59th place among 144 countries as against its peak position of 49th place in 2009. It clearly reveals how bad governance is holding back the economy from unleashing its real growth potential. Poor infrastructure, for instance, is the single biggest hindrance, especially the power sector where the entire supply chain from digging up coal to the sale of electricity to consumers, is confronted with problems.

economy to achieve a goal of 8% and more , e l se the re cou ld be w ider ramifications. What is your opinion?This can be only by going through with its project expenditure. Right now we should look at 6.5 percent growth and not 8 percent and work towards it. The right policies have been announced on FDI which will help to improve sentiment.

Inflation remains a major concern, and the latest move on fuel front can only worsen the situation? How these twin challenges could be dealt with. Kindly elucidate. This is a tough trade-off which we have to live with. The government has deferred this move be because of this concern. We will have higher inflation, which is the cost for better fiscal management.

What kind of challenges do you foresee for Ind ia as beg ins to take some credible measures on fiscal consoli-dation fronts?The challenge will be on containing inflation, protecting the interests of the poor, managing liquidity for the RBI and spurring growth.

“We should have a policy where the government says that once the subsidy level is exhausted, then there will be no further allocations.” by Madan Sabnavis

Chief Economist, CARE Ratings


Cover Story / INTERVIEW

The macroeconomic concerns raised by S&P and the IMF regarding India are real, alarming and, if unattended, could lead the country into a crisis similar to that witnessed two decades ago. What is your view on the Indian economy and where it is heading?

Deficits in themselves are not bad, and the blunt approach to this issue by the S&P and also the IMF misses a subtle issue. It is not the fiscal deficit, per se, that is the problem, but the reason for the deficit and the reason for the failure to curb it. The reason for a large chunk of the deficit is paralysis of policy due to contradictory pressures of coalition politics. Economic rationale for some of the subsidies cannot be discussed fully for fear of offending coalition partners. This signals policy paralysis, and that is t h e w o r r y i n g a s p e c t o f t h e macroeconomic indicators.

Only a while ago, Indian policy makers seemed convinced that the economy was on the verge of attaining double digit growth. Do you think that India's economic growth s tory has been derailed?

Yes. The first period of growth did not avail of the large population of underemployed and unemployed youngsters. Instead, the service sector-led growth provided jobs for a small percentage of the population. To continue on a fast growth path, the second phase of growth needed to focus on manufacturing. This could not be done due to lack of consensus amongst coalition partners about how to proceed. For example, manufacturing needs access to electricity and a quick increase on the availability could be achieved by focusing on energy theft and those

elements of the energy subsidy which benefit the well off segments in rural and urban India. There is no consensus about how to approach the question of subsidies and theft.

Growth seems to be cooling off around in Emerg ing As ia and Ind ia is no except ion, Wi l l As ia ’s cool down slowdown the world economy?

Emerging Asia could become less dependent on exports to mature economies and resume journey on a fast growth path in the medium term notwithstanding the problems in Europe and the US.

What are the lessons India can draw from Europe’s embattling economies like Spain and Greece?

Lack of internal political consensus about re-distribution of wealth and income entailed in re-structuring a derailed economy is a greater threat to continuing prosperity for a country than external shocks.

Despi te severa l assurances , the government has failed to implement austerity measures it aimed at in order to cut down to rein in fiscal profligacy? What’s your view?

Assurances from a government which is faced with contradictory pulls of a dysfunctional coalition are not credible. There has to a re-configuration of coalition parties if growth is to resume. For example, the railways were better run under an allegedly corrupt leader during the first UPA than they are now run under the direction of an economically illiterate populist street fighter.

What kind of impact do you foresee on the economy and hence fiscal deficit in

the wake of the so-cal led ‘pol icy paralysis’ and poor Monsoon?

Unless the paralysis in policy is addressed, there cannot be much progress. As a starter, Trinamool has to be thrown out of the centre, if necessary by bribing a more rational partner to join the ruling side. However, care must be taken to ensure that the bribes are commensurate with the price of resuming a fast rate of growth.

What is your long-term outlook?

The policy paralysis would not be as much of a worry for the country if there was any prospect of change at the next general election. There is no such prospect as the motley bunch of corrupt opposition politicians have joined or started movements against corruption. If that is the alternative on offer at the next election, there is little hope for the economy until the 2018/19 elections. Certain types of corruptions are more inimical to economic growth than other types. Corruption arising out of populist policies is a greater threat to formulating rational economic policy. Consider, for example, the populist demand to keep passenger fares low. This causes a secondary market that is costly to police and difficult to eradicate. The upshot is that the nominal fare, the money that goes to the railways, remains low but the effective fare paid by the travelling public is greater than it might be if the secondary market provided by touts was weakened by letting the official fares to rise. Then the extra money paid by the travelling public would go to the railways and not to various dubious outfits that now provide the service of equating supply and demand for tickets.

“Corruption arising out of populist policies is a greater threat to formulating rational economic policy.”

Prof. SP ChakravartyProfessor of Economics

The Business School. Bangor University, UK.



I s t h e w o r s t o v e r f o r t h e I n d i a n economy, or is it headed for further fall?GDP growth has bottomed out, but this does not mean that India is on the road to recovery. Inflation may be rising again, g o v e r n m e n t p o l i c y r e m a i n s irresponsible, and there is balance of payments instability. It’s unlikely the economy will continue to weaken as sharply as it has over the past two years but, as a whole, it may not strengthen, either. 6.5 percent growth and 7.5% inflation is all too possible.

What level do you foresee for the Indian rupee from here on, given the slow rate of FDIs and fast shrinking FII in the country?The rupee is probably fairly close to equilibrium now. It was overvalued before. The endless eurozone fiasco is causing a flight to the dollar and could push the rupee toward 60, but that shouldn’t last. The longer-term question is whether consumer price growth slows, which ultimately comes down to the federa l government be ing more responsible than it has been.

Do you think that it is the lopsided policies of the government that has led to the bizarre state the economy is currently in?

Absolutely. Of course there have been external shocks. But I and others warned of exactly this outcome three years ago when the government was patting itself on the back. Indian economic success 1991-2005 was based on market-driven reform. This government has been too weak to implement further reform so it substituted state stimulus and pretended that would work. The pretense has been exposed.

How the government can kick-start the moribund economy?The same way as in the last two round of reforms. Find the area with the least political resistance at that moment and sharply reduce the state’s active role there. Reduce effective taxation of the private sector. Redirect remaining public resources to pure regulatory activity, away from public sector enterprises. India is fortunate to have a private sector that can drive the economy if the state stops warping it with federal borrowing and grandiose infrastructure programs that achieve nothing.

What factors led to the worst ever GDP data in the last 9 years?Primarily, the belief that government spending can drive growth. Government spending does not appear from thin air, either money is printed or it is borrowed.

India tried printing until inflation become intolerable. More recently, borrowing has merely moved money from one sector or the other. What will drive true growth in India – entrepreneurs or the famously incompetent Indian state? Federal borrowing shifts money away from those capable of creating growth to those incapable

What are the key reforms you are looking at which could give fresh lease of life to the India growth story?Do you subscribe the notion that “India need to form sound economic policies rather than becoming directionless.” When economists, especially foreign economists, make specific policy recommendation X, we are immediately told X is politically impossible.

In the long term, the manufacturing labor market must be liberalized or India’s demographic expansion will turn out to be a curse. After this is done, rural property rights must be assigned (to the poor) and strengthened so productivity can rise. In the short term, federal borrowing must be decisively curbed, which makes more capital available to the private sector. The government should choose one major industry it is politically capable of liberalizing, as was done in telecom before the revenue grab. Coal, perhaps.

“India is fortunate to have a private sector that can drive the economy.”

Derek ScissorsSenior Research Fellow Asian Studies Center

The Heritage Foundation Washington, US

about 7%. And as long as inflation remains high, the RBI would remain reluctant to reduce interest rates. However, cutting interest rates may only support growth in the short-term whereas persistent inflationary pressure will harm the economy in the longer term. Nonetheless, the government is desperately trying to cut its fiscal deficit from 5.9% of its GDP to 5.1. To deal

Economists are of the view that it will be harder for policy makers to respond to a slowing economy now than during the global financial crisis. For, during the crisis, the government’s finances were relatively healthier and it was able to spend money to stimulate the economy. Even the central bank has less room to cut short-term interest rates to stimulate lending as inflation remains high, at

with the balance-of-payments crisis in 1991, the first batch of liberalizing reforms precipitated. Are we in a similar situation now? Definitely not. However, it’s still an economy caught in a perfect storm as growth is slowing down, foreign investment is drying up (FDI, which touched a record $47 billion in 2011, has plummeted 67% so far in 2012, and private sector investment is not



forthcoming. With dropping private sector investment, industrial production tapered off in second half of 2012, which prompted the IMF to warn that the fiscal deficit could rise to about 9% of GDP this year!

Structural reforms, and not ‘piecemeal’ ones, need of the hourAfter a slew of scandals, UPA II government surprisingly announced a string of bold, long-pending reforms to prevent the economy from further sliding. To begin with, it reduced the subsidy on diesel, a politically sensitive issue, by raising its prices by 12%, besides capping the number of subsidized LPG cylinders to six. Showing further intent to unleash reforms, the government also announced 51% FDI in controversial areas like multi-brand retail, aviation and broadcasting.

At the time of going to the press, t h e M a n m o h a n S i n g h government in yet another bold decision has decided to set up a system wherein cash subsidies on a c c o u n t o f s ch e m e s l i ke MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) , food and f e r t i l i z e r s u b s i d i e s , p e n s i o n s , scholarships, etc., would be directly transferred into the bank accounts of the actual beneficiaries. These measures would surely renew business sentiment and promote private investments and help foster stronger economic growth and bring unsustainable budget and trade deficits under control.

However, according to a section of economists, these are just piecemeal reforms, and hence miss the big picture. According to most economists, the government needs to look beyond merely slashing some subsidies here and there, and instead focus on pressing the accelerator on a host of other key structural reforms such as archaic land acquisition laws, which if reformed could make it easier for corporates to set up factories, reform labor laws, and bring

transparency in welfare spending, which could help the government put the economy on a fast track of growth once again. Another important reform, which has been waiting in the wings for too long, is the Goods and Services Tax (GST), which aims at bringing in a single, national system to replace a tangle of state levies, which would simplify trade within the country.

Also, rules with respect to foreign investment need to be relaxed to elevate standards in infrastructure such as roads, ports, energy, etc., higher education and financial markets. Also, the supply side constraints continue to be a bane on the economy causing the aam admi much

heart burn and forcing him/her to live with high food and fuel inflation.

Besides, the government also needs to curb its ballooning fiscal deficit, growing current account deficit and a feeble rupee, which many say could aggravate a financial crisis. So, FDI is excellent, but it alone is not going to solve the problem of the f isca l catastrophe. Many economists even warn that Indian economy may face painful years, perhaps beyond 2014. Against this backdrop, the billion dollar question is: can the government act, and faster too?

Biting the bullet To revive the economy, economists reinstate that reduction in subsidies for diesel prices is undeniably a welcome move. Even though it is an unpopulist move in the short term, it is certainly a

necessary step towards bringing the deficits under control and for restoring the economy’s health in the longer term. In fact, the best way for policy makers to respond to slowing growth is further liberalization of the economy, large parts of which are still heavily regulated.

According to Dr Raghuram Rajan, the former chief economist of the IMF and India’s Chief Economic Advisor, “Political parties need to bury the hatchet for paving the way for deregulating diesel prices to rein in runaway fiscal deficit and boost the confidence of overseas investors who are a necessity for India.” He reckons, “India should be kinder to foreign investors as "they are not the

enemy but a necessity in these times”. True. As the adverb goes, g loba l iza t ion can only be prolonged, it can neither be reversed nor be stopped. Can our political leadership pay heed to what other democracies like Brazil, Sweden and Poland, which have pushed through difficult reforms, and have progressed. Those who opposed Pepsi and Coke a few decades ago, could not stop their march.

Today, India is a key market for these global giants. And has India lost anything because of their entry (ask Ramesh Chauhan of Parle who sold off popular Thumps and Limca brands to Coca Cola at astonishing profits). In fact, even MNCs like the Hindustan Unilever, the name behind popular Indian brands such as Lux, Rin and Surf, IBM and Bata are not only India's leading brands, but also leading employers and key contributors to the country's stunning rise as a services sector-driven economy. Do these people who are opposing the reforms also have some credible solutions?

I n d i a n e e d s r e f o r m s , a n d n o t obstructionist politics. The writing is on the wall If you can't create Walmart, McDonald's and United Airlines, invite them. Create an India which is not afraid of the Walmarts, but in fact could accommodate more of them.

The real issue in China is that no one knows

the extent of the problem.



Perspective

Management EducationA ‘Blended’ Approach Needed, Says ISB Professor Arun Pereira

Team Global Analyst

ctivity-based learning might be an ‘in-thing’ at our play Aschools and other innovation-driven high schools, however, it is yet to find an acceptance at the institutions of higher

education such as b-schools, reckons noted b-school professor Arun Pereira of Indian School of Business. According to him, even today, faculties at a majority of b-schools believe in imparting knowledge through the age-old method of ‘lecturing’, a glorified version of telling. However, as the experiences of western b-schools like the Harvard B-School, one of the world’s most revered business schools, show b-schools need to adopt methods that encourage active learning (which is also deep and long lasting) amongst students. For instance, HBS, which became the first b-school to introduce case-based teaching method, spawned similar approaches at other leading business schools across the globe and successfully took management education to a totally different level and probably redefined it forever. Move over passive learning, embrace active learning that promotes debate and interaction, he advises. “Today, the best b-schools are enhancing active learning methods with other initiatives, all of which call for a ‘blended’ approach, leading to learning that is likely to be deeper, and longer lasting,” notes the ISB Professor, who is also its Executive Director at the Centre for Teaching, Learning, and Case Development, in his latest column in India’s leading business daily, The Economic Times. He advocates for a greater need to move away from the old, outdated method of lecturing (which emphasizes of direct delivery of information), which could be better used as the outside classroom learning tool (in the form of webcasts, video-sharing sites, etc) and which allow students to learn at their own pace, while using active learning method to enable and encourage students (the wannabe managers) explore new thoughts/ideas/solutions, and engage in interactive discussions, debating and applying theoretical understanding to solve real-life problems. He also emphasizes on the need to have a blended curriculum for b-school programs. For instance, according to him, there is a greater need to enable students develop interdisciplinary analysis skills.

Indeed, it could not be more timely than in today’s highly complex business world, where there is a greater need than ever to encourage the future managers ‘learn and integrate insights and approaches from multiple disciplines to form a framework of analysis that will lead to a rich understanding of complex questions. In other words, the curricula should encourage multidisciplinary thinking that enables integrated analysis (interdisciplinary thinking). According to Prof. Pereira, “Managers don't face problems that come neatly packaged as a 'finance' problem or a 'marketing' problem; most problems and decisions are complex and touch various functional areas. Given this reality, b-school courses that are taught in a silo-like fashion, reflecting specific functional areas do not help students become effective decision-makers. The best b-schools today are increasingly designing courses that attempt to integrate or 'blend' various functional areas.” He further says that concepts like ‘Innovation and Value Creation’ do not belong to specific functions, but reflect the reality of the needs of today's corporations. However, for such courses to deliver on their promise, instructors must be able to straddle multiple functional areas and appreciate the importance of an integrated view, suggests he. Probably this could also be an effective way to tackle the issue of lack of employability skills amongst students from institutions of higher education including b-schools. In the words of Prof. Pereira, “It is not 'business' as usual in many schools as they attempt to provide a ‘blended’ educational experience through delivery, curricula, and courses.” Given that not many b-schools in India even encourage case-based teaching method (leave aside other tools of active learning), it’s time now for a course correction. Isn’t it? Besides, there are a couple of other issues as well such as: how geared are the faculties at our b-schools to meet the challenges of a changing classroom, and equally importantly, how prepared are the future managers for this ‘blended’ educational experience? No doubt, the challenges are enormous. Given, it would require tremendous efforts, based on a gradual approach, to achieve what looks like mission impossible.

Varying Your Teaching Activities: Nine Alternatives to Lecturing

As long as class sizes continue to increase, it is likely that lecturing will be a dominant teaching method in university class rooms. However, there are many different activities that can be integrated into a lecture-based course to encourage the students to engage with the subject material, to facilitate interaction among the students and between the students and the professor, and to revitalize the course by providing a change of pace.

Activity 1: Questions - Questions are the simplest form of interactive teaching tool. They are useful in any discipline. They can help make students active learners and gauge their level of interest and comprehension.

Activity 2: Pro and con grid - This technique helps students develop analytical and evaluative skills, and encourages them to go beyond initial reactions to complex issues.

Activity 3: Debate - Debates can be formal or informal: what follows is about informal debates (i.e., debating as a method of class discussion).

Activity 4: Guided analysis - This technique helps students develop their analytical skills in any field by observing your analytical skills in action.

Activity 5: Case study - The case-study method was pioneered at the Harvard law and business schools. Applying theory to an instance as described by some source material can demonstrate the applicability of the course material beyond the classroom.

Activity 6: Field trip - If leaving the classroom is not feasible, consider using media such as videos or computer simulations as "virtual" field trips.

Activity 7: Role-play - Role-plays can be used to allow students to experiment with different styles of interaction, practice new communication techniques or explore complex issues. They are generally used in classes dealing with social issues (social sciences, management sciences, etc.) or communication strategies (interviewing techniques, conflict management, etc.).

Activity 8: One-minute paper - The one-minute paper and the ungraded quiz that follows are both examples of ungraded, written, in-class activities.

Activity 9: Ungraded quiz - An ungraded quiz encourages students to pay attention during lectures by presenting them with a short-term, non-threatening learning objective.


producing leader-managers grounded in ‘intellectual humility and ethical profundity’. The college considers its students co-producers in this arduous task. In terms of course curriculum, pedagogic practices, intellectual capital and infrastructure, the college is on par with any ivy-league institution in the country. Eminent management professors and practitioners from across globe bring their aura to the class rooms at Dhruva .

By facilitating active Industry-Institution-Interaction, the college helps bring in the empirical perspective and experiential learning into the academic regimen, which in turn enable the students a smooth transition to corporate life. That’s precisely what makes Dhruva a preferred destination for major corporates. Several reputed national and multinational companies visit the Dhruva campus scouting for its promising talent for recruitment year after year.

Apart from teaching, Dhruva gives primacy to training, research and consulting. Under its unique model of inter-disciplinary research, Dhruva as JNTU-Hyderabad R&D affiliate offers Ph.D. Forging alliances with renowned B-Schools like Wharton, D’Youville and UBDP-Dubai, Dhruva has also carried out significant research and consulting assignments .Case in point is the epoch making GLOBE-Global Leadership and Organizational Behaviour Effectiveness Dhruva did with Wharton.

A B-School with a Difference

orpedoed by the tides of time, today the firmament of Thigher education is in a great ferment. Management education has been no exception. In the wake of

intense shake-up triggered by the hidden fault-lines, many B-Schools have been swept off their feet in the recent times. Even more are expected to follow suit. Proliferation has given way to purgation. Few could come to terms unscathed. Fewer could even think of consolidation like Dhruva College of Management which is acclaimed Asia’s Best Emerging B-School.

Dhruva owes its vision and visage to its founder Dr. S Pratap Reddy – a management professor with four decades of teaching, training and consulting track-record. His disenchantment with the management education as imparted in a constricted environment of a university churning out post graduates rather than competent professionals that provided Dhruva its raison d'être. It is the culmination of a long cherished dream that fructified after 17 years. Located in the lush and picturesque locale of 800-acre reserve Oxygen Forest at Medchal in the suburbs of Hyderabad, the campus of Dhruva presents a most consummate setting for serious scholastic pursuits. Apart from housing academic, administration and living quarters, the campus offers free space for off-campus corporate offices for training & allied activities. The two-year full time residential PGDM-flagship program offered by Dhruva is aimed at

Alongside, Dhruva brings out a half-yearly publication “Vidwat’ – a refereed management journal meant to provide a forum for cross-fertilization and dissemination of topical ideas.

No gainsaying the fact that, Management Education has become too analytical and highly mathematical. In a posthumous article, Sumantra Ghoshal has argued that B-schools have attempted to elevate business management to a science. This has led to simplistic models of human behaviour based on self-maximizing utility, oblivious to the artistic and aesthetic element which is extremely relevant in business and in life. A fallout of this is creation of a moral vacuum in corporate houses, which has led to a proliferation of Enron-type scandals. There are relevant lessons that can be learnt from our ancient literature to curb this menace. For one, Dhruva is venturing out to establish AHIMSA - "@Hyderabad-Indian Management Systems Academy" to resurrect this wisdom for the benefit of "management" per se. Also, privatization and consolidation, inter alia, are

Hon’ble Purandhareswari giving away Indus Award to Dr. Reddy

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impacting the higher education scene in India. With the growing number of private institutes and the depleting number of aspirants ‘coz of the shrinkage of job openings, the scenario presents an ominous future. Consolidation is already in vogue in management education. A number of institutes have closed down shutters as they could no longer confront these challenges. The message is clear – only the fittest will survive. By showcasing resolve, resilience and repertoire, Dhruva is able to stand its ground in these psunamic upheavals and emerge unscathed.

Dhruva intends to use all its resources to drive holistic change in the lives of its main stakeholders – students. Its new logo . “Flying Hamsa... defining excellence”, encapsulating articulation of ingenuity, analytical acumen and Indian mythical values ventures to position its brand on par with global B-Schools The idea rests on the backdrop of positive change, increasing threshold tolerance and redefining excellence. It’s hoped that it’ll scale up to the top 20 B-Schools of India and emerge as “Dhruva Tara” by the time it turns 25.

DHRUVA students adjudged the “best among all Indian B-Schools” in "Business Plan Competitions"by MMA - Chennai, October 2012

AWARDS & RECOGNITIONS

DHRUVA - India's only B-School to win "Award for Educational Excellence"Indus Foundation-USA,September 2012

DHRUVA Chairman Awarded "Visionary in Management Education"MTC Global, June 2011

DHRUVA"Among the Top 10 innovative B-Schools"in India AIMS, August 2010

DHRUVA - "Asia's Best Emerging B-School"CMO Asia with Wall Street Journal as media partnerNovember 2009

Global Bonanza

Estd 1995

[email protected]

Global EconomyLingering Woes

Although China’s economy is struggling against the possibility of a hard landing, this is unlikely as the Chinese state still has a great deal of financial and policy firepower to boost the economy. Bank reserve requirements have been jacked up many times during the bubble phase of the aftermath of the financial crisis. There is a lot of room for these requirements to be relaxed if necessary. The state-owned banks are much better capitalized as they have to comply with newly imposed standards even more stringent than Basel III. The biggest driver of China’s internal growth is the surging demand of China’s middle class. Wages have arisen across the board and their tax burden has been softened, a deliberate policy ploy to expand domestic demand to balance the economy. So I expect the Chinese economy should be able to maintain at least 7.5% growth in 2012.

The black swam out there is a possible euro Armageddon. On 31 August, I listened to a luncheon talk in Hong Kong given by Guido Westerwelle, Federal Minister for Foreign Affairs & former Deputy Chancellor, who accompanied Chancellor Angela Merkel during her late August visit to China. He was very upbeat about strengthening the euro and the EU. The message was one of tough discipline and avoidance of prolonging a moral hazard. Given that Greece only accounts for 2% of the EU’s economy, there does not seem a great deal of European enthusiasm to bend over backwards to save it if it does not deliver on her promises. However, if Greece should exit the euro, some of the other weak members are likely to see their borrowing costs sky-rocket. If there are further cracks appearing in the euro citadel, whether the troika (the EC, the ECB and the IMF) would be able to hold the fort will determine if there is yet another tsunami hitting the shores of the world economy.

C om pared to the 2008 econom ic crisis w hen the w orld econom y m ade a sw ift and quick recovery helped by strong recovery in the two Asian econom ic g iants – Ind ia and C hina – th is tim e around the tw o Asian g iants them selves are struggling w ith dom estic issues.

G iven that, the b illion dollar question is - W here is the g lobal econom y heading in the near term ?

par t f rom the s t r ug g l ing Aeconomies of China and India, so far there simply isn’t any

particularly bright spot anywhere. The whole world’s economy is set for prolonged weakness, if not depression. Any Quantitative Easing (QEs) just print more money for the system and do not generate sufficient jobs to turn things around.

Charles Kindleberger (1978) and Carmen Reinhart and Kenneth Rogoff (2009) argue that recessions associated with financial crises are typically deeper than normal downturns and that the recoveries that follow tend to take longer. History also shows that deleveraging episodes are painful—on average lasting s ix to seven years—and exer t a significant drag on GDP growth in the early stages. (This Time is Different – Eight Centuries of Financial Folly, Reinhart and Rogoff, Princeton University Press, 2009). In McKinsey Quarterly 's January 2010 Report "Deleveraging: Now the hard part", E x h i b i t " A s l o w s t a r t " s h o w s deleveraging can last a total of 6 to 8 years. GDP growth tends to hit bottom after 2-3 years from the start of deleveraging, before climbing slowly back over a period of 4-5 years. So if deleveraging really started in 2008, it is unlikely to end before 2014 and full recovery is unlikely to happen before 2018.

Euro Armageddon – Is it for real? The IMF has lowered China’s growth from 8.2% to 8% for 2012. Its forecast for world growth is for 3.5% in 2012 and 3.9 % in 2013. That’s down 0.1 % for this year and 0.2 % for next year. China’s Premier Wen Jiapao earlier expected China’s economy to register only 7.5% in 2012. Amongst the BRICS, however, the only economy that shows better resilience seems to be China.

by Andrew K P LeungChairman, Andrew Leung InternationalConsultants Ltd, London

International / ECONOMY


Unlike the 2008 economic crisis, when the world economy made a swift and qu ick recover y he lped by s t rong recovery in the two Asian economic giants – India and China – this time around the two Asian giants themselves are struggling with domestic issues. Given that, where do you see the global economy heading in the near term?

The global economy is definitely struggling to reach growth rates which are deemed satisfactory from the point of view of policy makers and business makers. However, with the developed world still in a deleveraging phase, low g r o w t h w i t h m o r e f r e q u e n t recessions/growth scares is probably now the norm. It is a bit different with India and China in my view.

The former has a structural inflation problem and fiscal policy is too loose which recently has outshone the fact that e.g. demographic fundamentals are excellent. My view is that India will be fine and that the economy will rise

to its challenges but perhaps the expectation of 10%-12% GDP growth rates is the main problem here. Indeed in the case of the latter (China), the high expectations represent the real problem here and while China will not sink into the ground, it will probably now move towards a structural growth rate well below 10%. In the near term, the global economy is weakening a synchronized slowdown across the globe, but we have already seen strong policy action and more is likely to come which makes me relatively sanguine on the next 6m-12m.

Do you feel that the situation could only worsen hereon, as the GDP numbers declared by these two nations do not suggest of any improved performance going ahead?

Not so much from India, but further downside surprises are certainly in the cards in China. In India, I think upside surprises are more likely whereas

leading indicators in China point to a very weak growth outcome still.

Can quantitative easing in the US and Europe could offer some respite?Most definitely and I think we have already seen that. My base case scenario is that the Fed will probably do something and the ECB will need to act more aggressively. This will affect asset prices and lead sentiment up. Whether it will add meaningfully to growth is

debatable but it may circumvent a very bad outcome in risk asset prices which would otherwise be very bad for the economy.

Which nations do you think can act as the new engines of growth?

Countries such as China, Brazil and India are still the ones to look for and never write off the US. Other emerging economies such Indonesia and the Philippines are also important to watch.

When do you see the Europe issue resolving to a certain extent?

It will take a while and will require mutualization of sovereign risk and a full fiscal union. Since this is unlikely in the short run, the ECB will likely be forced into much stronger action. Ultimately, we are going to see more sovereign/private debt write-offs in Europe.

Budget Deficits and Government Debt in 2011debt as a% GDP

“We are going to see more sovereign/private debt write-offs in Europe.”by Claus Vistesen

Head of Research Variant Perception, UK

With the developed world still in a deleveraging

phase, low growth with more frequent recessions

is now the norm.


International / ECONOMY

Could quantitative easing in the US and Europe offer some respite?Maybe that would buy some temporary euphoria in the stock market. But printing money does not create jobs, only structural reform, according to Steve Forbes (his new book, Freedom Manifesto). In Europe, the euro crisis also shows clearly that structural reform of the weaklings’ economies is essential to save the euro as it is composed today.

Quest for the new engines of growthThe so-called EAGLE (Emerging and Growth Leading) Economies, including Brazil, China, Egypt, India, Indonesia, South Korea, Mexico, Russia, Taiwan and Turkey, are likely to soar in the coming decade. A BBVA research report "EAGLEs Flash" dated 24 July 2012 outlines how fast the corporations of the so-called EAGLEs (Emerging And Growth Leading Economies) have expanded, especially Chinese enterprises. "EAGLEs are not only the largest contributors to global growth; their corporations are also becoming world-class players.

In this year Fortune Global 500 ranking EAGLEs corporations’ revenue peaked up to 22% of total revenue reported. Their stronger relevance is even more dramatic when considering that in 2005 their share was only 7%". "Among EAGLEs, Chinese companies are the ones with the largest current share of revenues, 14%, followed by Korean, Brazilian and Russian with a share around 2% each. Meanwhile G7’s corporations share decreased to 64% from 80% in 2005. US companies led the decline with a reduction of almost 9 percentage points". "State Owned Enterprises (SOE) in oil business, utilities and finance lead the EAGLEs ranking, with the exception of two electronics private companies in Korea and Taiwan. These sectorial and ownership facts highlight the strategic role of commodities as well as banking in the growth agenda".

Clearly amongst the EAGLEs, China dwarfs the rest. This is reflected not only

in the share of global corporate revenues reported but even more significantly in the overarching role of commodities in their growth, largely driven by China's breakneck resource-intensive demand in recent years. Over much longer horizons, according to Goldman Sachs, by 2050 the top ten economies in the world will be, in descending order, China ($70 trillion), US (about $38 trillion), India (about the same as the US), Brazil (barely over $10 trillion), Mexico (just under $10 trillion), Russia, Indonesia, Japan, United Kingdom, and, lastly, Germany (about $5 trillion each). Only four of the G7 would thus remain on this list. Except the US, the other three G7 countries, Japan, UK, and Germany, would fall to the bottom. The combined economic weight of the EAGLE six, what may be called the E6, would become over two and half times more than the remaining G4. Although it is a bold prediction and many black swans may appear, by 2050 the E6 seem well placed to rise above the G7 to rule the world’s economy.

Europe’s crisis – Hopes float Any crisis focuses the mind. But a crisis will need to come to a real head before fundamental structural reform happens. So far, the can has been serially kicked down the road. A Greek exit may well be a turning. But that can also mean that cracks will be paved over once again for another day. But if some of the big boys like Spain or Italy should crumble, then the whole

edifice could collapse rapidly. As things stand, Spain and Italy seem strong enough to hold on. Hopefully, Europe has woken up to the danger and will embrace the structural reforms to shore up the whole system before the next crisis hits. So what happens from now until the end of 2013 would be crucial.

Can China come to rescue, again?It is instructive that President Morsi of a completely changed Egypt chose China as his first port of call. His visit was shortly followed by Chancellor Angela Merkel of Germany and Secretary Hilary Clinton of the United States. All these show that a rising China is expected to play a more proactive role in such regional as well as global affairs as the changing dynamics of the Middle East, the sovereign debt crisis in Europe and stability in the South China Sea. Meanwhile, the outcome of the U.S presidential election in November and China’s complete next-leadership line-up to be announced around that time are global game-changers. Those outcomes would not only affect how the all-important U.S. and Chinese economies are going to fare but perhaps even more importantly, on how the power dynamics between the world’s existing superpower and its perceived challenger are going to play out in the coming decade. All told, these developments may create an even greater impact on business worldwide compared with the financial crisis.

World GDP growth (% year)


ChinaNo more a Beacon of Light?No more a Beacon of Light?

Other economists also do not see a ‘hard landing’ but for other reasons. The excellent economist Andy Xie points out that economic collapses occur only when creditors fear for their loans and try to collect from defaulting debtors. There is a major difference in different economies depending on their legal infrastructures. In places like the US, when a debt is not paid, the courts will happily enforce the contract. The creditor can satisfy the debt in cash, collect the collateral, foreclose on the real estate or force the debtor into bankruptcy. In other places like Japan, debts are not collected. The difference is between a sharp crash and protracted slowdown.

Hard vs. soft landingAlthough a crash or hard landing may sound worse than a slowdown or a soft landing, in fact the soft landing is worse. Unless creditors can clear the loans and reallocate capital to more efficient enterprises, the economy cannot restart. The country’s economy becomes littered with zombie banks and mispriced assets. Growth comes to a halt, since the market is not a l lowed to function. The stagnation can last for over a decade.

This is what is occurring in China. Their 2008 bankruptcy law is unused. Defaulting debtors usually just leave town. Foreclosures are rare. Banks don’t force developers to repay loans on time, so weak developers see no need to liquidate inventories at lower prices. So prices do not crash, but sales do.

Most of the loans did not go to developers or private businesses. Instead they went to local governments and SOEs. With slowing real estate sales, the main source of income for local governments is drying up. Rather than trying to collect from another branch of government, the state owned banks simply roll the loans over.

Finally the export f igures reveal that the m ain land is far from provid ing a source of stim ulus to the rest of w orld . W orst slow dow n in C hina w ould have far-reaching im plications for the g lobal econom y.

he Chinese economy, like the Teconomies of the rest of the BRICs, is slowing. Despite some

neutral official numbers other numbers l i ke i ndus t r i a l p roduc t i on and electricity consumption indicate that China’s growth rate may have fallen below the target of 7.5%. In May Real estate values have fallen in a record 54 of 70 cities. One of the worst hit is the entrepreneurial Mecca, Wenzhou s o u t h e a s t e r n c o a s t a l Z h e j i a n g province. There price tumbled by 14%. Large cities like Shanghai and Beijing also recorded smaller, but significant losses of 1.6%. In the first five months of 2012, real estate sales volume slowed by 9% compared to a year earlier. The central bank cut interest rates for the first time since l a te 2008 , sug ges t ing a weaker economy than forecast.

With all this bad news, China is still growing at a rate that any other country would envy. Business cycles have been part of every market in history. Have the Chinese found a way to prevent them?

Some people certainly think so. The famous Goldman Sach’s economist, Jim O’Neill, the creator of the term ‘BRIC’, still sees China as a “beacon of light”. O’Neill no longer believes that indicators like electricity consumption and industrial production, which have been so accurate in the past, still ref lect the true level of China’s economic activity. Instead he has s w i t c h e d t o i n d i c a t o r s o f consumption, including monthly retail sales, which seem to support his forecast that China’s economy is in for a “softer” landing. This thesis is quite common among economists and analysts. Any other thesis has probably not been priced in to global equity markets. A different reality could be quite a shock.

by William GambleFounder and President, Emerging Market Strategies Company, Newport, US

International / CHINA


A perfect example of this problem has to do with the Asset Management Companies or AMCs. The AMCs were originally set up in China after the late 1990’s meltdown in emerging markets. They were based on the very successful model of the bad bank used in the US and Sweden. In both countries the government recapitalized the insolvent banks. The shareholders were wiped out. The dud loans on the banks’ books were transferred to bad banks. In the US, the bad bank was called the Resolution Trust Company and in Sweden it was called Securum. Both companies were given the task of administering the assets in preparation for sale at the highest possible price. The object of a bad bank was to eventually liquidate itself. Both were very successful. The Resolution Trust Company reduced the projected cost to the taxpayer of $300 billion to ‘only’ $90 billion in five years. Securum cleaned up Sweden’s mess in the same amount of time and limited the cost to 2% of GDP.

In China they really didn’t quite get the concept. In 1999 like most of the rest of world, the Chinese economy suffered a major recession. The Chinese banks are almost entirely state owned. The four largest include Bank of China, China Construction Bank, Industrial

and Commercial Bank, and Agricultural Bank of China. After the recession these state owned banks were saddled with bad loans estimated to be about $430 billion or as much as 42% of all loans. To do something about it, the Chinese decided to emulate the US’s RTC and Sweden’s Securum. They set up four bad banks. These banks were called asset management companies (AMC). There are four, each one corresponding to one of the big four state owned banks. Bank of China’s AMC is cal led Dongfang. China Construction has Cinda. Industrial and Commercial Bank had Hurong.

The Agriculture Bank of China has Great Wall . The bad loans were transferred to the AMCs in 1999 and 2000 just like what occurred in the US and Sweden. However there was a distinct difference. In the US and Sweden, there was no consideration for the transfer. The RTC just guaranteed the deposits of the defunct S&Ls, nothing more. In China the AMC’s ‘bought’ about $205 billion in bad loans at face value in 2002. Of course no bad loans are worth face value. In return for the bad debts, China’s banks received 10 year bonds paying a taxable 2.25 per cent per annum.

The first transfers to the AMC did not stop the bleeding. So in 2003, the banks transferred another $120 billion to the AMCs in exchange for more bonds. This time at least the bonds were at a discount to face value. Still the AMCs were saddled with an annual interest bill of $3.6 billion.

When they were first set up, the AMCs were supposed to act like the other bad banks. They were supposed to try and get rid of the bad loans and close down. Collateral was to be found and auctioned off. Businesses were to be taken over and reorganized. Firms too far gone were to be put into bankruptcy. This never happened. Without a f i r m legal infrastructure, good public registries for interests in tangible personal property, intangible personal property and real estate, adequate documentation of the loans, it was difficult to determine who owned what, who owed what, where the collateral was and how to get it.

By 2005, the AMC’s stopped trying to sell their bad assets to the outside world a n d j u s t t r a d e d t h e m b e t we e n themselves. In one auction, the largest bidder for distressed assets of Cinda was its rival Great Wall. Rather than winding

Chinese Export GrowthAnnual % change (Rolling12-month sum)

30

20

10

0

-10

-202008 09 10 11 12

Source: Thomson Reuters Data Stream

China’s Monetary Policy

2.0

1.6

1.2

0.8

0.4

0

30

24

18

12

6

02007 08 09 10 11 12

Source : Thomson Reuters

New loans, yuan trn M2,% increase ona year earlier


International / CHINA

down as their assets were liquidated like the RTC and Securum, the AMCs made moves to become permanent. They have now decided to become permanent profit-oriented financial institutions able to compete with investment banks in a wide range of services, but the bad debts remained.

Of course through all of this the AMC’s bonds still remain on the bank’s books. The AMC’s state that they are profitable but their figures are never published. According to one expert, "These AMCs must by now be massively insolvent because all the better assets have been sold and they have used the proceeds to pay the interest on the bonds they issued." According to the Financial Times, “China's own s t a t e aud i to r s a id i t was concerned that the AMCs were no longer able to pay the interest, let alone the principal, on the bonds they had issued to the banks.” When the bonds came due in 2009, rather than trying to collect, the Chinese government just extended the maturity and rolled the debt over.

Can it engineer a soft landing?In 2009 to avoid a recession the Chinese government ordered its banks to open the flood gates. Lending for 2009, 2010 and 2011 more than doubled and one year tripled the amount lent in 2008. No doubt the level of nonperforming loans is enormous. The inefficiency of this lending is a massive drag on the system. It will slow the Chinese economy for years, but if no one bothers to collect these loans, will the Chinese economy crash?

Professor Michael Pettis has pointed out these problems for years. He understands the sclerosis inherent in the system, but believes that Beijing will prevent a slowdown by forcing banks to lend more to local governments for infrastructure projects. While this might be sufficient to stimulate the

economy for a few months, eventually the loans for these projects or the bonds issued to finance them will end up in default as well.

Despite the predictions of these experts, there is a very strong reason to believe that China will not be able to engineer a soft landing. As central banks in the US and Europe are discovering there are limits to the ability of government to manipulate a market. Until quite recently the Chinese government held a tight grip on the banking system. Its control over the deposit and lending rate acted as a support to clean up the bad loans. But things change. Now there is a huge shadow banking system. This system is

not only unregulated, its size and extent are unknown. It is estimated to be at least half the size of the regular banking system.

The concrete business is an excellent example. Families will buy a concrete mixer with vendor financing. But because of poor or unavailable records, the owners will double up on their debt by using the equipment as collateral for new loans. Then the mixing companies sell their ready mixed concrete on credit to developers. This overleveraged pyramid could collapse like a house of cards.

Recently the Chinese have tried financial reform to legalize the system and regulate it. But these reforms could make the problem worse. If government allows competition to the state system

the guaranteed profits of its banking monopoly will disappear. State banks have to offer higher rates to attract d e p o s i t o r s a w a y f r o m p r i v a t e competitors. This is occurring while the demand for loans has fallen, because of restrictions on real estate development and local government borrowing.

The real issue in China is that no one knows the extent of the problem. Europe has gone through about four stress tests to determine the size of their banking issues. Yet the uncertainty always ends up destabilizing the markets. In China infor mat ion i s t ight ly controlled.

There is no independent free press constantly investigating or a s k i n g q u e s t i o n s . T h e government controls most of the financial system and does not have to report to anyone. The size and extent of the shadow b a n k i n g s y s t e m a n d t h e underground economy can only be guessed at. In most emerging markets it is over 50% of the regular economy.

A hard longing in the offing?A l l g o v e r n m e n t s t r y t o

manipulate the market. In the US the central bank, the Federal Reserve, had embarked on a series of ‘stimulus’ programs. These do have an effect at least in the short run, but there are also unintended consequences. By keeping interest rates low, they favor borrowers and more risk, but at the expense of savers and pension funds. The liquidity in one country doesn’t stay there in a globalized world. The perverse effects may have different impacts in different countries which may come back to haunt the experts behind the policy.

The Chinese have the most manipulated economy anywhere. The distortions are massive. It is hard to predict when and in what form they will eventually make themselves known, but when they do, the landing will be very hard indeed.

The real issue in China is that no one knows

the extent of the problem.


Maruti’s Labor ConflictLessons for India Inc.

The vio lent-laden industrial conflict in M aruti Suzuki Ind ia Lim ited (M SIL) conflict is reflective of several system ic m alaises that bedevil the industrial relations system (IRS) in the post-reform period.

he violent eruption that occurred Ton July 18 is not a one-off incident. It is contextualized in

the institutional dynamics not only in MSIL but a lso in the organized manufacturing sector. The aggressive reforms initiated since 1991 relating to the product market led the employers and others to demand reforms concerning the labour market and the IRS. The basic argument has been that the labour institutions such as the labour laws and its complementary institutions like the labour inspectorate, the industrial judiciary, etc. and the collective institutions like the trade unions and collective bargaining introduce “rigidities” which afflict the employers’ capacity to respond to the product market dynamics. They demanded three basic reforms, viz. the freedom to hire contract labour and to dispense with labour services and close business in accordance with the market dynamics and not be restrained by administrative intervention and reform of collective institutions such as trade unions, collective bargaining and industrial actions in a manner conducive to competitive market economy.

The state governments in pursuit of capital “help” the cause of capital as much as it could explicitly or implicitly while keeping the legal framework intact and thus trying to placate both labour and capital. As the trade unions protested and as political parties played “politics of convenience and expediency” on labour reforms, employers responded at the market place with various managerial strategies which sought to achieve labour flexibility at the micro level. The firms dealt with the institutional inadequacies as they perceived in “their ways”, though a pattern can be discerned: natural and coerced a t t r i t ion of per manent employment, r ise in f lexi- labour (contract, casual, trainees, etc.), work reorganization as per new managerial logics, check on union power at best and union busting or avoidance at worst and so

by Prof. K R Shyam SundarAssociate Professor, Head-Department ofEconomics Guru Nanak College of Arts, Science & Commerce, Mumbai University.

on. The workers and the trade unions responded in the ways that they could via strikes, agitations, go-slows, and so on. In the process, a kind of industrial anarchy set in. This is the basic rub of the present IRS.

In the pluralistic industrial relations framework the social actors via their representative institutions negotiate in the given legal framework “rules” to govern the world of work and conduct industrial actions as per the rules of the game to purely exercise pressure on the bargaining parties to secure gains and they also establish mechanisms to settle grievances arising out of functional aspects of work. Institutionalization and public sector labour inspection ensures predictable beahviour of social actors and their respect for “rules”. Collective bargaining is not only an agency to distribute the spoils of growth but an active process to boost growth via order and stability. The post-reform period witnessed cracks in these systems, even willful denial of them.

The employers resorted to contract labour system rather excessively ostensibly to keep down the labour costs which also weakened the trade union coverage and hence their power. While contract labour employment would to some extent enjoy economic legitimacy in that a certain amount of flexible workforce around the core is necessary to cushion the market dynamics, the un-economic managerial strategy of under-payment (wages less than their productivity and the nutritional levels necessary for efficient work) to and poor conditions of work for contract workers has grave implications. The inequities between the union and law-covered workers and those not covered and subject to sub-optimal work conditions stoke discontent. It is not a coincidence that the flexi-category workers have been deprived of “voice security” and legal cover – a vicious circle of employment security deprivation and voice security denial.

HRM / INDUSTRIAL RELATIONS


Ironically, the contract workers’ case becomes less worrisome as the regular workers’ efforts to have a union of their choice, i.e. free and independent (of state and employer) union, are facing resistance if not opposition. The multinational enterprises (MNEs) though subscribing to the OECD’s MNE Code of Conduct which requires them to respect the core labour standards of the ILO and the laws of the origin countries have often not respected them. The firms, especially the MNEs dictate their preferences on the nature of workers’ representation – thus, Hyundai Motors first preferred a workers’ committee and then a non-political union and MSIL resisted successfully the u n i o n f o r m a t i o n h a v i n g affiliation with AITUC at the cost of three strikes in a quarter of an year. These and other instances obviously enjoy[ed] the state support. Eventually a union was formed with the blessings of the management and the state in MSIL which has not been efficient in providing stability at the workplace as expected of a trade union in accordance with the pluralistic theory we noted above.

The Maruti conflict has also highlighted the inadequacies of the managerial strategies and their logic with regard to management of industrial relations. The prolonged conflict for union recognition ended with the exit of leaders of the strike in a controversial manner and a reluctant and a coerced compliance of a good conduct bond by the workers which had more ideological value than shop floor positives. Good conduct arises out of volition and institutional controls and here operates the plural ist ic institutional logic expounded above. Voice security and c o n d u c ive wo r k i n g c o n d i t i o n s “produce” good conduct and not surely via the managerial dictate. The October 2011 work stoppage further signaled to the management that contract workers cannot be left out of the work system at MSIL. So surely conflict did not end but the workstoppage. The boycott by

workers of meetings and morning rituals further reflect the discontent and the management apparently did not respond adequately to this. The union’s demand for extension of long term settlement benefits to contract workers was also ignored.

The post-reform period surely disciplined the trade unions and the regular workers at a cost and made them realize that both (they were synonymous for a long time) could not ignore the interests of the contract workers as insecurity threatens both the regular and the contract workers. The rising solidarity between the two sections could not be read by the management which continued to believe in the virtues of “divide and rule” strategy.

Workers generally are dominated by instrumental orientations but also exhibit normative concerns. The inequities rising in the system as reflected by growing income disparities between the managerial personnel and the working class as a whole and the intra-class inequalities in terms of disparities between the regular and the flexi-category workers disturb the leaders and the rank and file. More importantly, the iniquitous discharge in justice in MSIL as the management sought to punish the guilty worker and leave the equally guilty “other party” (be it supervisor or a manager) has surely angered the workers. In this sense, the insensitive handling of a hurt felt as a result of casteist remark by the workers triggered the unrest. The accumulated discontent exploded thanks to the trigger as workers demanded reinstatement of the worker. The absence of dialogue mechanisms was conspicuous in their absence in a MNE wherein workers could not form a union of their choice. The violence that followed and the

fire engulfing a part of the premise are yet a “mystery” and the war guilt cannot be imposed solely on the workers and the workers of MSIL as a whole. The Maruti conflict has once again exposed the absence of mechanisms to respond to the rising aspirations of the new working class, the failures and the inadequacies of human resource management at the company level and the absence of the labour market governance at the systemic level. The industrial violence may lead to a “police regime of governance” of labour market and the IRS literally as well as metaphorically. While perpetrators of violence ought to be punished to send strong signals, it is time the “other sides” (the management and the government agencies) do some contemplation

to set their houses in order.

A Few More WordsThe industrial conflicts and the unrest in the post-reform period especially in recent years have clearly shown the absence of a labour market governance system. Workers’ complaints include a veritable negative lists: no representation, no voice, no dialogue, ineffective government intervention if there is any, long l e g a l p r o c e e d i n g s , n o n -implementation of awards,

agreements, etc. by the employers, poor penal system for irregularities, weak labour inspection system, and in short poor labour market governance. A sound labour market governance system would raise the confidence of the social actors and ensure order and stability. Hence, the more important labour reforms agenda should concentrate on strengthening of labour market governance.

Wipro’s chairman Azim Premji ’s comments are perceptive. As economic slow-down affects employment creation, rising unemployment will create social unrest. Hence the social actors need to “come together and come to an understanding on how to deal with the environment”. The CII also advocated strongly the holding of discussions and dialogue process to settle any problems between the management and the workers “within the rubric of law.”

The industrial conflicts and the unrest in the post-reform period especially in recent

years have clearly shown the absence of a labour market

governance system.


HRM / INDUSTRIAL RELATIONS

Perspective

FDI in IndiaA Cautious Approach NeededThe FDI per se may not at all be bad for the economy.

Move over policy paralysis, the action begins now as the central government finally pulls up its socks and announces a of a slew of some

rather unpopulist and bold measures. And though the corporate sector has welcomed policy initiatives like FDI in sectors such as aviation and multi-brand retailing (MBR) after dilly dallying by the government for several years, the Manmohan Singh government has h a d t o u g h t i m e s c o n v i n c i n g c r i t i c s including the former key a l l i a n c e p a r t n e r , Trinamul Congress, as well as the opposition par t i e s, wh ich have promised to fight the people-unfriendly moves tooth and nail, of the merit of inviting foreign direct investment into these cash-s t rapped sectors. Why no one seems to have problems with the entry of foreign airlines into the domestic sector, the same is not the case with the multi-brand retailing.

Okay so FDI in MBR would hurt the local kirana or the mom-and-pop stores, similar concerns were raised when organized retail was permitted in the country. The likes of Kishore Biyani and Rajan Raheja amongst other wannabe retailers were opposed by the same critics who had to eat a humble pie as the organized sector created jobs for thousands our country’s youths and shopping turned into a joyful experience for millions of shoppers across the country. If the services sector today accounts for more than half of our GDP, the retailing sector deserves some pat on its back as well for contributing in the stupendous growth our country has achieved during the last decade or so. And importantly, the organized retailing in the country

has not grown at the cost of the traditional kirana stores. Probably, we have not heard any story of closure of a kirana store due to the opening of a mall or supermarket anywhere in the country. Further, the fear that FDI in multi-brand retailing could wipe out mom and pop stores also seems unfounded on the ground that many of these big ticket FDI deals would be in opening giant malls

which could come up only on the outskirts of the cities or at far-off places. It could be any body’s guess how many families would prefer to travel to those far flung areas to buy stuff for their daily needs. Not many. Also, with rising real estate and logistics costs, these big bang malls cannot s imply match the lower prices offered by kirana stores.

Even today, with the presence of so many malls and super markets, people still buy the goods of their daily needs from the neighborhood mom and pop stores. Moreover, at a time when customer is king, let the customer decide where he or she wants to do the shopping. Give them a choice, and not restrict it. Let them decide. Several research has shown that FDI stimulates economic growth in a nation. India too has benefitted from the reforms wave which was unleashed two decades ago. Today the country needs vast capital to spruce up its infrastructure – be it healthcare, education, airports, ports, roadways, etc. In absence of domestic sources of funds, a major alternative seems to be nothing but the FDI. However, the policymakers need to take a cautious approach and take initiatives which are in the best interest of the country.


FCCBsFCCBsRising ConcernsRising Concerns

Redemption Reserve, thus having no fund to redeem the FCCB when the nemesis has hit them hard. The defaults, delays and litigation have severely dented the image of Indian papers in FCCB Market globally as well as the fate of future issuance.

Regu la to r y f r amewor k - Supportive or rigidFCCB guidelines were first issued in 1993 by Ministry of Finance under “ I s s u e o f F o r e i g n C u r r e n c y Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993” and amended from time to time and were prime guiding point alongwith FEMA Notification No.120/RB-2004 dated July 7, 2004. The regulation of FCCBs market was delegated to RBI in 2005 and since then RBI has been regulating FCCB market vide its ECB guidelines which are applicable to FCCB also. The latest ECB guidelines being Master Circular no 12/2012 dated 2nd July, 2012 regulate FCCB issued from India. In addition, issue of FCCBs is also required to adhere to the provisions of Notification FEMA No. 120/RB-2004 dated July 7, 2004, as amended from time to time.

The ECB guidelines issued by RBI define FCCB as “a bond expressed in foreign currency, the principal and interest in respect of which is payable in foreign currency”. The FCCB are primarily bonds or debt instruments issued by an Indian Company and subscribed to by a person who is a resident outside India, in foreign currency and convertible into equity share or Global Depository Shares (GDS) of same company, in any manner, either wholly, or partly or on the basis of any equity related warrants attached to debt instruments. The option to convert the FCCB into equity shares of the issuer is exercised by means of warrants attached to FCCBs.

G iven the current liqu id ity and regulatory scenario and d ism al condition of the C apital m arket, Ind ia Inc has no option but redeem or buy back FC C Bs through fresh borrow ings. It is thus very im portant that the structuring of FC C Bs should be m ade carefu lly. And, FC C Bs m ust be treated as borrow ing and NO T a hedging tool.

ave FCCB become hot potato? HIn the last decade, India has raised over $30bn and as per an

estimate of UK-based KNG securities, the total FCCB liability of India Inc including the redemption premium as of 2011 aggregates to about $14.8bn out of which at least one third i.e. about $6bn is due for redemption by 2013. In the last 2 years, there has been spate of defaults, restructuring, buy back and litigation causing a fear factor among investors, nervousness among CFOs to use FCCB tool and worries for RBI to manage the exchange regime.

The fear of foreign investors to touch Indian papers emanates due to constant rupee depreciation from sub Rs 45 level to Rs 55 level, imprudent practice adopted by India Inc by not hedging the forex liability, insufficient internal accruals to pay back the loans and depressed Indian Stock Markets leading to lower market prices as against conversion price making their profitable exit a distant dream- all causing redemption , restructuring and buy back at discount and even defaults

In retrospect, india Inc seems to have fallen in “FCCB trap” as it is facing challenge to redeem these FCCB on due dates due to stagnant equity market, falling rupee and Eurozone crisis. The conversion prices of FCCB were pegged 25 pc to 150 pc higher than the prevailing market prices in expectat ion of astronomical surge in share prices which did not happen. The stocks of several such FCCB issuers are currently languishing at 70 pc to 90 pc of expected conversion price. The problem has also been compounded by a sharp fall of rupee by almost 11 pc in last few months; as well as non- hedging of FCCB loans. Also taking advantage of lack of stringent guidelines, many companies did not create the FCCB redemption reserve, l i ke t h e m a n d a t o r y D e b e n t u r e

by Sanjay BankaAVP-Finance, Viom Networks Ltd.,NCR, India

Financial Markets / INSTRUMENTS


Under the present ECB guidelines, issuers are permitted to raise ECB or FCCB funds under automatic route up to $750 Mn subject to compliance of other conditions like pricing linked to stock market prices, all in all cost ceiling , minimum average maturity period , expected conversion price, security and charge creation, Issuance of guarantees by promoter group , Call and Put Option, end use restriction , lenders’ profile , parking of funds abroad, e l ig ib i l i t y cr i te r i a of bor rower, permitted lenders etc. The upper borrowing limits vary depending on Industry profile, while lower limits are mandated for Hospital and Real estate sector, NGO in microfinance sector etc. The important guidelines of ECB Policy pertaining to FCCB issuance are as follows:

Eligibility: Corporate ( including those in the hotel, hospital, software sectors ) , Infrastructure Finance Companies (IFCs) except financial intermediaries such as banks, Financial institutions (Fis), Housing Finance Companies (HFCs) and Non-Banking Financial Companies (NBFCs) are eligible to issue FCCB . SEZ Units can raise funds only for their SEZ related business. Micro Finance institutions can also raise FCCB subject to limits stated. However Individuals, Tr u s t s and Non-Pro f i t mak ing organizations are barred from issuing ECB or FCCB.

Borrowing Limits: The ECB rules outline two routes for raising overseas funds- automatic route and approval route along with limits on borrowing . Under automatic route, funds can be raised a) up to $20 million or its equivalent in a financial year with minimum average maturity of three years and b) $20 million and above up to $750 million ( $500 Mn till Sep

2011) wi th a min imum average maturity of five years. The limit for NGO and MFI is pegged to $10 Mn. The limit for Corporate in Hotels, Hospitals and Software sector has been enhanced to $200 Mn per year ( as against $100 Mn till Sep, 2011) . Issuance above these limits and not meeting other conditions fall under “approval route” from RBI.

Call and Put Option: FCCB up to $20 million or equivalent can have call/put option provided the minimum average maturity of three years is complied with before exercising call/put option. All in All Cost: All-in-cost on FCCB includes rate of interest, other fees and expenses in foreign currency except commitment fee, pre-payment fee, and fees payable in Indian Rupees. The payment of withholding tax as well as Hedging cost is excluded .

End use: The ECB policy specifies 8 classifications of end use. The first one being “investments”- in new projects, Capex Impor ts, modernizat ion/ expansion in sectors referred as “real

sector”. This includes industrial sector including small and medium enterprises (SME), infrastructure sector and specified service sectors, namely, hotel, hospital, software in India. The other 7 categories of end use includes ODI in Foreign JV, Investment in divestment programmes of PSU, Spectrum payment for telecom operators, On lending by IFC, Toll ways operations etc.

End Use Restriction: The ECB Policy restricts use of FCCB or ECB funds for a) Real Estate b) Capital market transactions c) Working capital d) general corporate purpose and E) repayment of existing Rupee loans availed from domestic banking system subject to following relaxations-

In f ras t r uc tu r e Sec to r : I nd i an companies in infrastructure sector ( except power sector) as defined under the extant ECB guidelines , are permitted to utilise 25 per cent of the fresh ECB raised towards refinancing of the domestic Rupee loan

subject to :-(i) at least 75 per cent of the fresh ECB proposed to be raised should be utilised for capital expenditure towards a 'new infrastructure' project(s)

(ii) in respect of remaining 25 per cent, the refinance shall only be utilized for repayment of the Rupee loan availed of for 'capital expenditure' of earlier completed infrastructure project(s); and

Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*

Three years and up to fiv years 350 basis points

More than five years 500 basis points

The dilemma of investors, issuers and RBI

Worried about quality of Indian papers- No credit rating, No security, repayment ability. Increase in defaults and delays for recovery; Legal Costs. Huge loss to issuers in case FCCB buy back at discount.

Rupee Depreciation and premium payment on non conversion- double whammy Depressed Equity market and non achievement of pre fixed conversion price Euro zone crisis-fund raising for expansion/redemption difficult expansion

Supporting India Inc by supportive regulatory regime Delegated Rights to Category 1 Auth Dealers No guidelines on FCCB redemption- No back up plans

INVESTORS

INDIA INC

RBI



(iii) the refinance shall be utilized only for the Rupee loans which are outstanding in the books of the financing bank concerned. Manufactur ing and Infra sector companies with forex earnings: Indian companies in the manufacturing and infrastructure sector can avail of ECBs for repayment of Rupee loans availed for capital expenditure from the domestic banking system provided they are consistent foreign exchange earners during the past three financial years and not in the default list/caution list of the Reserve Bank of India. The overall limit for such ECBs is $10 billion and the maximum permissible ECB that can be availed of by an individual company will be limited to 50 per cent of the average annual export earnings realized during the past three financial years. The foreign exchange for repayment of ECB should not be accessed from Indian markets and the liability arising out of ECB should be extinguished only out of the foreign exchange earnings of the borrowing company

End use as working capital: While the ECB policy prohibits end use of ECB funds for working capital. A relaxation has been provided for civil aviation sector on case to case basis under approval route. Airline companies registered under the Companies Act, 1956 and possessing scheduled operator per mit l i cense f rom DGCA for passenger transportation are eligible to avail of ECB for working capital. Such ECBs will be allowed by RBI based on the cash flow, foreign exchange earnings and the capability to service the debt and the ECBs can be raised with a minimum average maturity period of three years.

The overall ECB ceiling for the entire civil aviation sector would be $1 billion and the maximum permissible ECB that can be availed by an individual airline company will be $300 million. This limit can be utilized for working capital as well as refinancing of the outstanding working capital Rupee loan(s) availed of from the domestic banking system. ECB availed for working capital/refinancing

of working capital as above will not be allowed to be rolled over. The foreign exchange for repayment of ECB should not be accessed from Indian markets and the liability should be extinguished only out of the foreign exchange earnings of the borrowing company.

Guarantees: ECB guidelines do not permit Issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by banks, Financial Institutions and Non-Banking Financial Companies (NBFCs) from India relating to FCCB issuance. Applications for providing guarantee/standby letter of credit or letter of comfort by banks, financial institutions relating to ECB in the case of SME are considered on merit subject to prudential norms. With a view to facilitating capacity expansion and technological upgradation in Indian textile industry, issue of guarantees, standby letters of credit, letters of undertaking and letters of comfort by banks in respect of ECB by textile companies for modernization or expansion of textile units are considered by RBI under the Approval Route subject to prudential norms.

Parking of FCCB proceeds: FCCB proceeds can be kept abroad or to remit these funds to India, pending utilization for permissible end-uses. The funds meant for local spending in India should be repatriated immediately while the portion meant for foreign currency expenditure can be retained abroad pending utilization. Funds parked overseas can be invested in the following liquid assets (a) deposits or Certificate of Deposit or other products offered by banks rated not less than AA (-) by Standard and Poor/Fitch IBCA or Aa3 by Moody’s (b) Treasury bills and other monetary instruments of one year maturity having minimum rating as indicated above, and (c) deposits with overseas branches / subsidiaries of Indian banks abroad. The funds should be invested in such a way that the investments can be liquidated as and when funds are required by the borrower in India.

Security: The choice of security to be provided to the lender / supplier is left to the borrower. However, creation of charge over immovable assets and financial securities to secure the FCCB in favour of the overseas lender is subject to FEMA regulations. Necessary powers have been delegated to Authorised Dealer Category I banks to issue necessary NOCs under FEMA.

The major issues faced by bondholders are security and credit rating of FCCB. Since the FCCB are mostly unsecured, the lender carries a huge risk in case of default. The chances of repayment are also subservient to the first charge holders which are primarily the Indian FIs and Bankers and statutory dues.

On a plain reading of the Prospectus of FCCB, prima facie FCCB constitute direct, unsubordinated, unconditional and unsecured obligations of the Issuer and shall generally rank pari passu and without any preference or priority among themselves. The payment obligations and prioritization of debt obligation of the Issuer are limited to mandatory provisions of applicable law and rank at least equally with all of their other present and future direct, unsubordinated, unconditional and unsecured obligations. FCCB sometimes provide “ negative pledge” as a Comfort to Bondholder whereby the issuer gives assurance of non creation of pledge or security on any of its International Securities.

Refinancing of FCCBs to meet Redemption obligationIn order to provide a window to facilitate refinancing of FCCBs in the event of difficulty in meeting the redemption obligations, designated AD Category - I banks have been permitted by RBI to allow Indian companies to refinance the outstanding FCCBs, under the automatic route ( up to $500 Mn) , subject to compl iance wi th the ter ms and conditions .

I. Fresh ECBs/ FCCBs should meet the latest RBI guidelines on average maturity period and all-in-cost ceiling.


borrowers and lenders both are mutually agreeable in conversion price to avoid a default like situation, the same is prohibited due to creation of artificial barriers. The permission to change conversion price was issued only once in 2010 and has been stopped thereafter thus creating artificial and bureaucratic barrier to free play of market forces.

However in some cases of prepayment, the FCCB issuer may have to pay a redemption premium to the FCCB holder (at pre-agreed return rate) to make good the interest loss to FCCB holder as well as notional loss arising due to non conversion.

Buyback guidelinesThe depressed India Capital markets and Eurozone Crisis causing global liquidity crunch has led to Investors dumping Indian FCCB at a discount and encash their investments. This situation offers excellent window to India Inc to buy back their FCCB at

steep discount and reduce the debt liability. Buy back is permitted provided suitable conditions are included in F C C B i s s u e d a n d a g r e e d b y Bondholders.

RBI has permitted buy back several times since 2003 and extending the same as a ritual ; currently the window for prepayment stands extended till Mar 2013 a s pe r l a t e s t c i r cu l a r r e f RBI/2012-13/114; A. P. (DIR Series) Circular No. 1 dated July 5, 2012 and is likely to be extended again and again. In addition, the terms and conditions of RBI Circulars no. A.P. (DIR Series) Circular No. 39 dated December 08, 2008 and A.P. (DIR Series) Circular No.75 dated June 30, 2011 would continue to be valid except as stated hereunder.

The authorisation to approve buyback has been delegated to Category 1 Authorised Dealers under automatic route upto US$ 500 mn while higher amount need RBI approval .

Currently there are two concerns on Buy Pack. First, The minimum discount criteria is artificial and “creation of law”. It purportedly creates an artificial situation of unfair aggrandizement due to regulatory intervention. Ideally, the regulations should not mandate discount criteria rather permit free and fair play of market forces. Second, since change in conversion price is not permitted, corporates are practically left with no option but to resort to fresh borrowings at a much higher rate including the liability to pay redemption premium causing a double whammy. Had a reduction in conversion price been permitted, this would have saved borrowing at higher rates and also a better debt equity ratio. So long as the foreign equity holding of issuer is not likely to breach sectoral FDI limits, change is conversion price should be permitted.

Compliance Loan Registration No (LRN): The borrowers can draw-down the ECB or FCCB only after obtaining

Approval Route

RBI approval is required in case Corporate use internal accruals to buy back the FCCB. The limit is USD 100 Mn per annum per company. In 2008, this was limited to USD 50 Mn.

• The buyback value of the FCCBs shall be at a minimum discount of five per cent on the “accreted value”. (Previously the mandated discount ranged from 10 pc to 20 pc book value, depending on redemption value from USD 50 Mn to USD 100 mn and in 2008 the mandated discount was 25 percent)

• In case, the issuer is to raise a foreign currency borrowing for buyback of the FCCBs, all FEMA rules/ regulations relating to foreign currency borrowing shall be complied with.

• Compliance with other terms and conditions contained in paragraph 5 of Circular No. 39 dated December 8, 2008 mandatory. Valid till March 31, 2013 after which the scheme lapses.

• The existing requirement of submission of ECB 2 return will continue as hitherto. Further, on completion of the buyback, a report giving details of buyback, such as, the outstanding amount of FCCBs, accreted value of FCCBs bought back, rate at which FCCBs bought back, amount involved, and source/s of funds may be submitted, through the designated AD Category - I bank, to the Reserve Bank.

ii. Fresh FCCB issuance cannot exceed the outstanding redemption value.

iii. The fresh FCCB shall not be raised six months prior to the m a t u r i t y date of the outstanding FCCBs

iv. FCCB beyond $500 million will be considered under the approval route

v. Fresh FCCB availed are reckoned as part of the limit of $750 million available under the automatic route as per the extant norms.

vi. Restructuring of FCCBs involving change in the existing conversion price is not permissible. Proposals for restructuring of FCCBs not involving change in conversion price will, however, are considered under the approval route by RBI depending on the merits of the proposal.

The guidelines prohibit change in conversion price, while restructuring of the FCCB like change in maturity period, interest rates etc are permitted under approval route. Thus, even if both

Automatic Route

Automatic route is available to Corporate which use existing Foreign Currency balance or raise fresh ECB Co terminuous with the subject FCCB , compliant in all manner.

AD-Category 1 Banks are permitted to grant approval to Corporate for buy back subject to following conditions:

I) The buyback value of the FCCB shall be at a minimum discount of 8 per cent on the book value (previously the mandated discount was as high as 15 pc under this route in 2008)

ii) The funds used for the buyback shall be out of existing foreign currency funds held either in India ( including funds held in the EEFC account) or abroad and / or out of fresh ECB raised in conformity with the current ECB norms; and

iii) Where the fresh ECB is co-terminus with the outstanding maturity of the original FCCB and is for less than three years the al l- in-cost cei l ing should not exceed 6 months Libor plus 200 bps as applicable to short term borrowings. In other cases, the all-in-cost for the relevant maturity of the ECB, as laid down in A. P. (DIR Series) No .26 da ted Oc tober 22 , 2008 , sha l l apply.

Two Routes for FCCBs Buyback



the LRN from Department of Statistics and Information Management (DSIM), Reserve Bank of India, Bandra-Kurla Complex, Mumbai – 400 051. For allotment of Loan Registration Number (LRN), borrowers are required to submit Form 83, in duplicate to the designated AD bank duly certified by the Company S e c r e t a r y ( C S ) o r a C h a r t e r e d Accountant (CA) One copy is to be forwarded by the designated AD bank to the Director, Balance of Payments Statistics Division. Copies of loan agreement and offer documents for FCCB are not required to be submitted with Form 83.

Monthly return: Borrowers are required to submit ECB-2 R e t u r n c e r t i f i e d b y t h e designated AD bank on monthly basis so as to reach DSIM, Reserve Bank within seven working days from the close of month. Any changes in the terms and conditions of the ECB after obtaining LRN previously required prior RBI approval and many of such powers have been delegated to the designated AD Category-I banks subject to specified conditions.

Case StudiesThe various case studies are pointer to problems and issues faced by India Inc on FCCB arena. The corporate have actively used the window provided by RBI to buy back and reduce their debts. When change in convers ion pr ice was permitted for a very short period, this was used by some including Suzlon. Reliance Communications (Rcom) $1 Bn FCCB issuance of 2007 is historic and laudable as the largest and Zero Coupon Bond. It had a tenor of tenor of 5 years at a conversion price of Rs 661 per share, representing a premium of 30 per cent compared to then prevailing market price. The global paper, sold across Asia, Europe and US, was oversubscribed and well received. RCom has redeemed its May 2011 due tranche of Rs 2,250 crore ($500 million)

at a premium of 25.84 pc. There was no chance that the s tock could be converted at the pre agreed conversion price given the rock bottom price of Rs 90-95 which has now further tested Rs 50 level in Sep 2012.

The $110 Mn FCCB issued by Gitanjali Gems FCCB were “in the money” while majority of other FCCB were “out of money” . Gitanjali Gems FCCB were converted into equity upto 63 pc, while balance 27 pc were redeemed at premium. The conversion price agreed

for Gitanjali Gems was Rs 220 and the Investors raked in moolah when the market price was Rs 345.

Many Corporates have successfully redeemed which include JSW, Suzlon ($360 Mn) , Rolta, Rcom etc . Corporate who did not have enough internal accruals resorted to fresh ECB/ FCCB to redeem their obligation which include JP Associates by raising fresh FCCB at 5.75 pc coupon. Karuturi Global, the flower exporter had to restructure its FCCB obligation of $55 million in 2012 and secured Reserve Bank of India’s approval to pay back the bond holders after a year with an additional 7 per cent interest.

Currently there are two concerns on Buy Pack.

First, the minimum discount criteria is artificial.

Second, change in conversion price is not

permitted.

Since in many cases, FCCB are unsecured, the bondholder carries a risk too. The Bondholders of Pyramid Saimira, i.e. QVT and Linton Funds are saddled with this risk. Pyramid had raised about $90 mn in 2007 and agreed for conversion price of Rs 450. Now that Pyramid has gone into liquidation, bondholders are likely to s u f f e r h u g e l o s s e s s i n c e t h e i r recoverably rights will be subservient to other secured lenders and statutory dues. In case of Venus Remedies, due to invocat ion of “cross default

clause”, their entire FCCB has fal len due for redemption causing a huge stress on the c o m p a n y. O t h e r I n d i a n companies which are facing litigation on FCCB are Cranes Software (€ 42 Mn, litigation by Barclays Bank), Cement Bag Maker Karur KCP Packing ($10 mn, litigation by 3 degrees fund). KSL and Industries , a leading Textile firm was also dragged to Court by Bank of New York Mellon, trustee for the bondholders, by moving a winding-up petition after it defaulted. Finally ,KSL has s e t t l e d a n d b o u g h t b a ck FCCBs worth $90 million. The list of disputes and defaults includes Wockhardt Ltd ($110 Mn) , Tulip ( $150 Mn ). In order to Hedge the exchange

risk in case of non conversion, some issuer like Advanta India of United Phosphorous smar t l y f ixed the conversion rate at the time of issuance itself (Rs 44.94), hedging them from rupee depreciation. This on the other hand exposes the buyer to exchange risk. Also in the current scenario, where rupee is languishing at Historic low, using a fixed conversion price strategy may turn disastrous.

Sensing business opportunity, the PE firms who have already invested in FCCB issuer are making fresh equity investments to bail out their investee firm thus killing two birds with one stone- increasing their stake in the firm


extremely supportive by amending its ECB and FCCB guidelines, but adverse equity market scenario and weak rupee has played havoc. It is thus very important that the structuring of FCCB should be made carefully. FCCB must be treated as borrowing and NOT a hedging tool, as Forex Scholar A.V.Rajwade always preaches.

FCCB holders also need to exercise great caution while investing in risky bonds, and if they do so with full knowledge and risk appetite, they should not later blame India’s tardy legal system. The legal recourse adopted by some FCCB holders may have received a positive response but what will happen in case of failed companies. Thus credit rating of the bond is likely to become more critical in the future days. If the bondholders exercise legal option by going to liquidation processing, it may be inimical to credibility of Indian Bonds.

It is very crucial for Indian Industry to work on a win -win strategy with investors and avoid excessive greed. The game plan of Indian corporate in debt structuring and the support of Indian regulators are being closely watched by Global investors’ community which will set the roadmap for future generations of FCCB.

FCCB bonds are generally listed on Singapore (SGX-ST), Hong Kong, L u xe m b o u r g o r L o n d o n S t o ck Exchanges. The issuer also needs to obtain in principle approval of local Stock exchanges like BSE and NSE due to likely conversion of FCCB into local shares or GDS. As usual with other listed Bonds, in FCCB issuance also, Bond Trustee are to issue are to be appointed to protect the investors’ interest. The issue size of the FCCB varies from $1 Mn to $ 100 Mn, however there have been some large issuance of $300 Mn and mega issuance of $1 Bn by RCOM issued in 2007. There are no guidelines on face value of each FCCB and it may vary from $50,000 to $300,000 depending on local exchanges where they are listed. The funds raised from FCCB route are primarily needed for overseas acquisition and import of Capital Goods in accordance with FCCB (ECB) Policy of RBI.

The Coupon on the FCCB varies from 50 basis point to 500 basis points above LIBOR and on including hedging cost, all in all cost range from 6 pc per annum to 12 pc per annum. While the average minimum maturity was 3-5 years ,the longest tenor FCCB in recent times was issued by Essar Oil which raised $262 in May 2010 for a period of 18 years. Incidentally the FCCB has been issued to a fellow subsidiary called Essar Venture Holding which perhaps explains the unusual tenor. Some CFO’s are loathe to FCCB since it leads to dilution of equity and reduction of EPS.

FCCB emerged as darling for India Inc to harvest cheap ECB funds globally by leveraging on India’s growth story. FCCB are also referred as FCCN (Foreign Currency Convertible Notes) by some issuers and called by various names in international markets. For example in US, overseas bond listed with SEC are called Yankee Bonds, Bulldog Bonds (in U.K.) and Samurai Bonds (in Japan). The liberalization regime unleashed by Reserve Bank of India (RBI) to integrate India with global investors’ community and growing appetite of India Inc for project roll out helped the nascent FCCB to mature. Some companies could even oversell by issuing Zero Coupon Bonds (ZCB) albeit with risk to pay full interest with redemption premium in case of non conversion. The following graph shows the no of FCCB Issued and total amount of FCCB raised from India in last decade as per RBI database.

Trend of FCCB Value ($Mn) and nos issued in last 10 yrs. The issuance which peaked to $7.7 Bn in 2007 has been having a roller coaster ride since then and ebbing to just $835 Mn in 2012 , showing the fear factor among Investors and nervousness of issuers.

1,270835

11 10

Issues

USS / MnI

80

70

60

50

40

30

20

10

0

The author can be contacted at [email protected] The views expressed in this article are his personal views and they do not necessarily represent his official position.

a t m u c h c h e a p e r r a t e s a n d s t r e n g t h e n i n g t h e b o n d w i t h promoters.

The Way ForwardFCCB which till a few years back was a persona grata for CFOs have suddenly become pariah. In its Financial Stability Report issued in June, 2011, RBI had shared fears that many Indian Corporate may face defaults and delays till 2013. In June, 12, Rating agency Standard & Poor's had stated that that around 30 companies whose foreign FCCB are set to mature in 2012 are likely to default because of their inability to raise funds to refinance these instruments and lower market prices Given the current liquidity and regulatory scenario and dismal condition of Indian Capital market, India Inc has no option but redeem or buy back FCCB by fresh borrowing. The credit squeeze globally and In India has led to steep rise in borrowing cost in 11 -12 percent range. The RBI has been

Evolution of the FCCB Market

127

212

2,363

3,920

5,410

7,686

3,817

5324

23

59

72 71

9

19

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000



Talking Stock

Wabco Indiaabco India is a subsidiary of Brussels, Belgium-Wbased $2.8 billion (sales in 2011) WABCO Holdings Inc. (NYSE: WBC), one of the

leading tier-one suppliers to the global commercial vehicle industry. The company, formerly known as WABCO-TVS (INDIA) Limited, founded over 140 years ago, develops technologies and control systems for the safety and efficiency of commercial vehicles across the globe.

It is considered as one of the top pioneering vendors worldwide. To its credit, the Belgian auto giant has pioneered a number of electronic, mechanical and mechatronic technologies for braking, stability and transmission automation systems for the world’s leading commercial truck, bus and trailer manufacturers.

Some of its technological breakthroughs include anti-lock braking system (ABS), collision mitigation system (CMS) with active braking and Adaptive Cruise Control (ACC) on a commercial vehicle. Webco India designs, manufactures and markets conventional braking products, advanced braking systems, and other related

SWOT ANALYSIS

• Leadership in the original equipment manufacturer market as well as the domestic aftermarket• Outstanding engineering and manufacturing capabilities• Global parentage (WABCO INDIA accounts for 7% of the parent’s sales)• Rising value per vehicle • An export hub for the parent• Strong and wide distribution network (more than 7000 outlets and 250 service centers)• Impressive client list that comprises of key players such as Tata Motors and M&M• Nearly zero debt status • High ROE• High free cash flow

Strengths

• Rising competition in domestic market• Uncertain global economic environment, especially in key markets like the US and Euro Zone

Threats

80

60

40

20

0

-20%

Cha

nge

[Pric

e/Po

ints

]

air-assisted products and systems. It also has a significant presence in the aftermarket sector. The company’s client list includes who’s who of India’s Commercial Vehicles (CVs) manufacturers such as Tata Motors, Ashok Leyland, Mahindra & Mahindra and Volvo. The company operates three world-class factories in India located at Ambattur, Chennai; Mahindra World City, Chennai; and Jamshedpur.

Source: Company, Analysts’ Reports

• Growing raw material costs (Rs 630.18 crore in FY12 vs. Rs. 543.73 crore in FY11)• Rising employee costs (rose sharply to Rs.94.29 crore in FY12 from Rs.71.19 crore in FY11 )

Weaknesses

• New products lined up Plans to develop and launch lift-axle control system and foot brake valve with integrated switches in the Indian market• Growing regulatory thrust on safety norms• Expected pick-up in demand for technologically advanced MHCVs in the country • The company’s newly inaugurated plant at Mahindra World City in Chennai, which was completed through the company's investment of over Rs. 50 crore, • With R&D driven new component introduction should take revenue per M&HCV to Rs. 24,000 in FY14. (Source: Motilal Oswal Research Report)

Opportunities

June 11 Sept 11 Dec 11 Mar 12

WABCO

SENSEX

June 12 Sept 12

Stock Price Performance

Source: BSE

Team Global Analyst

MicrofinanceEnd of the Road?

microcredit – often cynically referred to as ‘donna maria stories’ – and then claiming that these positive case studies confirmed that microfinance has been having a positive impact. But these claims were completely disingenuous, since they constitute only a part of the overall picture; and the evidence actually shows that such positive cases have generally been swamped by the m u c h l a r g e r n u m b e r o f p o o r individuals who quickly failed in their tiny microenterprise and actually plunged into deeper poverty, or else used their microcredit for simple consumption purposes and eventually got into life-threatening levels of over-indebtedness. Worst of all, some economis ts now argue that the microcredit model by its very design and nature i s prog rammat ica l l y incapable of promoting sustainable development and poverty reduction in the poorest communities in developing countries. Indeed, as I conclude with my co-author, Professor Ha-Joon Chang of Cambridge University, for a number of reasons microcredit actually constitutes a very powerful ‘poverty trap’.

Experience of Andhra PradeshPerhaps nowhere more than in the Indian state of Andhra Pradesh has the microcredit model resulted in little progress for the poor, if not outright catastrophe. The initial objective of those promoting the microcredit model in the early 1990s appeared to be very laudable; to assist the poorest farmers in the poorest rural communities to carefully reinvest in their tiny plots, and s o h e l p t h e m t o p r o d u c e a n d accumulate their way out of poverty. Indeed, against a background of an I n d i a n g o v e r n m e n t e c o n o m i c liberalisation program in the early 1990s that, among other things, began to phase out all forms of crucial state support for agricultural extension

The evidences, across the g lobe, actually show that the m icrofinance m odel has im pacted very negatively in a large num ber of the poorest com m unities in developing countries. G iven, it raises an im portant question: does

The concept of microcredit (famously called as microfinance) first came to worldwide attention

in the 1990s as a seemingly brilliant way that the global poor could escape their grinding poverty, deprivation and disempowerment. Just advance a microcredit to a poor individual, the argument ran, and he or she can establish an informal microenterprise and thereafter generate a steady income sufficient to make a real difference in their lives. If almost every poor individual could be offered the same opportunity, the thinking went, global poverty would soon be a thing of the past. An extreme faith in the power of self-help and individual entrepreneurship thus lies at the root of the microcredit model, and the ‘faith-healer-in-chief ’ is, of course, Dr Muhammad Yunus, the 2006 Nobel Peace price co-recipient and acknowledged founder of the global microfinance movement following his pioneering work in Bangladesh in the 1970s.

Unfortunately, we now know that Dr Yunus’s supreme faith in the power of microcredi t was a lmost ent i re ly misplaced. The evidence we have to date simply does not back up the case consistently made by Dr Yunus and his g l o b a l b a n d o f a c o l y t e s t h a t ‘microfinance works’. Pointedly, even l o n g - t i m e s u p p o r t e r s o f t h e microcredit concept have now come around to accepting the sour reality that, after more than thirty years of the microcredit movement, we actually have no evidence of a net positive impact from microcredit anywhere a r o u n d t h e g l o b e . T h e m a i n microcredit institutions and their suppor ters in the in te r na t iona l d e ve l o p m e n t c o m m u n i t y w e r e supremely skilled at gaining the world’s attention by pushing out hundreds of uplifting stories of poor individuals who escaped poverty thanks to a

by Milford BatemanVisiting Professor, Croatia and author of the book, Why Doesn’t Microfinance Work

Non-Banking / INDUSTRY


services, marketing outlets, price floors, as well as subsidised (i.e., affordable) credit provision for small-scale farming, microcredit seemed like a very timely and appropriate intervention. However, rather than making things better, the gradually rising tide of microcredit (both formal and informal) began to precipitate a growing list of very serious problems, before eventually culminating in what is to date probably the world’s m o s t d a m a g i n g ‘ m i c r o f i n a n c e meltdown’.

One of the most important of these initial problems with microcredit is bound up with the fact that microloans are only really of any interest to the most tiny and unproductive subsistence farms operating in the rural economy. More than any other state in India, in the 1980s the subsistence farming sector in Andhra Pradesh was in very deep distress. The situation was uniquely summarised in the ‘Report of the Commission on Farmers’ Welfare, Government of Andhra Pradesh’ published in 2003, a report that identified over-indebtedness as the single biggest reason why farmers were in such deep trouble. Poor farmers faced with much less affordable financial support provided by the state became only too willing to tap into this new thing, microcredit, which was being adver t i sed by the in te r na t iona l development community as the ideal replacement for state-subsidised finance.

Much initial impetus for microcredit came from the burgeoning Self-Help Group (SHG) movement, which began to offer women in poverty as much microcredit as they wished for, much of which was recycled into tiny subsistence plots. A new class of entrepreneurs also arose to offer microcredit to the poor, sometimes at high interest rates. A little later, some international and Indian NGOs also began to receive support from the international development community for programs providing farmers with microcredit support through formal

institutions (e.g., NGOs). However, the tiny farming units in Andhra Pradesh could do very little with the tiny sums of money now very widely on offer to them, and so most of those accessing these microloans simply fell into even deeper debt than ever. By 2003, for example, it was estimated that half of India’s small farmers were now in very serious micro-debt, with the highest figure – some 82 per cent of its small farmers – found in Andhra Pradesh.

Meanwhile, those farmers possessing enough good quality land, and so more o p e n t o t e c h n i c a l e x p e r t i s e , mechan i s a t ion and commerc i a l opportunities that might allow them to really raise their productivity and output, actually needed a much larger loan and on more easy conditions than microcredit. But since India’s financial resources were increasingly being channelled into informal and formal mic rocred i t app l i ca t ions, these far mers found fewer and fewer opportunities to access affordable financial support. Effectively the two credit options left open to these family farms was either to ‘bundle up’ with expensive and short-term microcredit, or ‘no credit’. Most chose the ‘no credit’ option in order to avoid any chance of losing their land, as was the case with far too many of the smallest subsistence farmers.

All told, the main outcome of the subsistence farming community’s growing engagement with informal and f o r m a l m i c r o c r e d i t , a n d t h e simultaneous crowding out of its larger and potentially more productive family farms, was the emergence in Andhra Pradesh of what is called ‘the microcredit paradox’: a situation where ‘the poorest people can do little productive with the credit, and the ones who can do the most with it are those who don't really need microcredit, but larger amounts with different (often longer) credit terms.’ With so many tiny subsistence farms failing, while family farms were unable to access capital on affordable terms and maturities, we should not be surprised

that rural incomes fell by 20 per cent in Andhra Pradesh in the decade 1993-2003.

The situation did not improve thereafter, however. Along with a host of other serious problems (e.g., the cotton crop failing), the average rural community in Andhra Pradesh was soon registering even higher levels of micro-debt. And when the massive build-up of micro-debt began to precipitate aggressive lending collection techniques in order to get the most over-indebted to repay at least some of their accumulated debt, the situation began to spiral out of control. One of the worst outcomes was a new w a ve o f s u i c i d e s i n t h e r u r a l communities, as well an acceleration in the transfer of land from the poorest to the rural elites, because farmers were forced to sell their land to repay their micro-debts. The end game was clearly at hand. When in 2006 some rural communities registered their anger by resisting repayment of their accumulated micro-debt, the so-called ‘Krishna Crisis’ began. This was the most dramatic sign in Andhra Pradesh - and in India as a whole - that the microcredit model was actually undermining sustainable development and poverty reduction trajectories in precisely those rural communities in which it was made most readily available and most widely slated to ‘make a positive difference’.

After much prevarication and hand-wringing, the ‘Krishna crisis’ finally forced the Andhra Pradesh government to react. It did so by compelling the main microfinance institutions (MFIs) active in Andhra Pradesh state – known as the ‘big six’ - to sign up to an agreement that it hoped would resolve the crisis: that is, the ‘big six’ would cut their interest rates, eradicate multiple lending, and – very simply - curtail their rapid growth. Within a matter of weeks, however, the ‘big six’ simply tore up this agreement and, among other things, growth in the supply of microcredit actually began to massively accelerate in the wake of the ‘Krishna crisis’. This time, however, the ‘big six’ MFIs took careful aim at the



urban areas and the urban poor in Andhra Pradesh. With already fairly easy access to informal microcredit, disaster soon overtook the urban areas as well, taking the form of massive individual over- indebtedness of the urban population, heightened fear in the community thanks to some very aggressive loan collection techniques, rising numbers of borrower suicides, and the most hapless losing their land and housing as they were forced to repay a microloan unwisely taken out for some unsustainable business idea. It was supremely telling, also, that all of these negative outcomes took place against the backdrop of some stratospheric private enrichment by the owners and senior managers connected to the ‘big six’ MFIs, several of whom vaulted into the category of the highest paid and richest individuals in all of India. The end result was, inevitably, as noted analyst Ramesh Arunachalam brilliantly recounts, a full-scale economic and social disaster.

The entire episode explosively ended in 2010 when the poor could no longer absorb any more microcredit – that is, they could no longer ‘keep dancing’ as Wall Street might have aptly put it. The microcredit sector quickly collapsed. By all accounts, therefore, the ‘big six’ MFIs piloted the Andhra Pradesh economy and the poor into a brick wall.

Effectively leading the way to disaster in Andhra Pradesh was Dr Vikram Akula, the former McKinsey consultant who was in charge of the one-time largest MFI in India – SKS. As Arunachalam recalls once more, much of the blame for the disaster in Andhra Pradesh can be firmly laid at the foot of Dr Akula. Akula returned from the USA proclaiming that he was about to fulfil his life’s vision to resolve poverty through microcredit, and ver y speci f ica l ly through highly commercialised and profit-driven microcredit. But in fact it appears from his actions that he really had in mind the goal, not of really helping poor Indian women, but of getting spectacularly rich himself. To achieve this personal goal, Dr Akula pushed SKS, followed by the other

MFIs, into dumping spectacular amounts of microcredit on to an unsuspecting poor population naively of the opinion that this was their salvation, when it was actually going to prove to be their damnation. Simultaneously, Dr Akula moved to ensure that he was one of India’s top ten highest paid individuals, with a salary and bonus package the envy of many on Wall Street. Later on, the Initial Public offering (IPO) at SKS saw Dr Akula make just under $US13 million for the sale of just 25% of his self-awarded stock options, with the juicy prospect on hold of another healthy financial windfall when the remaining 75% of stock options were offloaded. Who knew that helping the poor into so much damaging individual debt and family disasters could be so rewarding for just one individual!

Not a Poorman’s Friend The most depressing fact in this story is not just the manifest greed and unethical behaviour of the ‘big six’ MFIs, however; it lies in the fact that the poorest in Andhra Pradesh have not benefitted from the microcredit ‘revolution’ to any real extent. For a start, communities artificially propped up on the back off r i s i n g c o n s u m p t i o n f u e l l e d by unsustainable Ponzi-style growth in microcredit, then swiftly collapsed into massive over-indebtedness and deeper poverty. Moreover, many in the poorest communities were gradually sucked into further and further micro-debt in a vain attempt on their part to keep an ill-advised microenterprise project afloat. They finally realised, too late, that the idea that a(ny) local economy can absorb an unlimited number of simple informal businesses is just crazy: every local economy has a limit above which more microcredit-induced entry of informal microenterprises will not find additional demand, but will simply reduce turnover, margins, wages and profits for everyone involved as they all try to tap into existing demand.

Nonetheless, the ‘b ig s ix ’ MFIs continued to charm the poor into taking

out even more microcredit. Individual borrowers hoped that they might become one of the tiny number of lucky individuals able to survive the market chaos and over-supply that the MFIs themselves were directly creating. In fact, most informal microenterprises simply collapsed after a period of time, sending their hapless owners into even deeper poverty and too often forcing them to sell their land, houses, vehicles and so on simply in order to repay their microloan. Even worse, many individuals in the most badly affected regions were forced into an even deeper engagement with the village loan shark as a way of getting the necessary funding to repay their microloan, or else risk losing their land or housing. Some over-indebted individuals that were eventually turned away by the MFIs turned to the loan sharks simply to keep their unprofitable microenterprise afloat for just a little longer. Altogether, we may say that microcredit actually increased the vulnerability of the poor, not ameliorated it.

Those who ventured into a microloan for reasons other than to establish or expand an informal microenterprise – in actual fact, the vast majority – ended up in perhaps the most desperate situation of all. Using microcredit to access needed consumption goods – food, shelter, education, medicines, etc – large numbers of the poorest ended up trapped into paying regular and growing interest payments out of their already meagre, unstable and often declining incomes. All too often, too, other family members, including any children, would be drafted in as free labour to help out an ailing family microenterprise. A gradual descent into more and more micro-debt simply in order to survive is the trademark of a completely failed policy intervention, not that of a successful intervention improving the lives and security of the poor. Moreover, it is also clear that the predations of so many greedy individuals and unethical institutions operating within the microcredit sector in Andhra Pradesh has greatly undermined – probably for very many years to come – any sense of


trust, fairness and social solidarity that are crucially important features of any community if it is to escape its poverty and deprivation.

Finally, we also need to understand that the unsustainable growth of microcredit not just destroyed so many poor communities in Andhra Pradesh and in all of India, it also effectively robbed the average community of funding for alternative interventions that might have had a much better and/or more sustainable positive impact. This is the ‘opportunity cost’ of the microcredit boom, of course, and it stands out as one of the most important failures registered by microcredi t ever ywhere. The uncomfortable fact is that many other financial interventions and programs would have helped the poor much more than simple microcredit, but these interventions and programs went un-funded precisely because the scarce f inancia l resources were instead channelled into microcredit.

I f t h e e a r l i e r e m p h a s i s u p o n microcredit in rural areas disastrously ignored the needs of the most productive family farmers, then the move after 2006 into the urban areas of Andhra Pradesh likewise disastrously ignored the needs of the many small and medium businesses that desperately needed access to affordable and meaningful amounts of capital. As US-based Indian academic, Aneel Karnani, convincingly argues, the urgent need in India is not for yet more ‘no-growth’ subsistence microenterprises, but for a solid raft of growth-oriented small and medium enterprises that can pay decent wages, provide skilled jobs and training, efficiently subcontract to India’s larger enterprises, and export outside of India.

So what has been the reaction to all this bad news by those supporting Andhra Pradesh’s ‘microcredit boom’? Well, rather like the thief that claims the police are responsible for his crime spree because they failed to stop him in time, many embarrassed microcredit

supporters and some major investors in t h e m i c r o c r e d i t i n d u s t r y s e l f -interestedly and, it has to be said, quite s tup id ly (ver y notab ly Legatum Associates ) attempted to blame the Andhra Pradesh government itself for the crisis. Even though the government of Andhra Pradesh, and that of India as a whole, had for years been told to ‘keep well away’ by the microcredit industry and its powerful friends and lobbyists, when it all collapsed ‘the state’ was the obvious and all too ideologically-convenient scapegoat for the major f a i l i n g s o f t h e m a r k e t - d r i v e n microcredit model. It didn’t help when support for this completely false argument came from a group of high-profi le US-based academics and microcredit supporters, including Abhijit Banerjee and Esther Duflo of M.I.T and Dean Karlan of Yale Unversity, who unwisely released a letter to the Financial Times of London stating that ‘it was a crisis born of government intervention’ . Yes, the Andhra Pradesh government can be justifiably accused of being slow to respond, but to hold the Andhra Pradesh and/or Indian government responsible for actually creating the ‘microfinance crisis’ in the first place is a complete inversion of reality.

Will Microfinance Survive?Having inflicted to much damage to date, one obvious question to then ask is, Does the microfinance concept still have any role to play in India? Some say that it does. However, given the nature of past problems, it is important to identify exactly who is saying this. Most often the claim is made those who remain ideologically committed to the microcredit concept, and to the idea that the poor must ‘help themselves’ and not look to the Andhra Pradesh or Indian government for support, or to collective institutions (trade unions, social movements, etc) that might enable them to exploit what one might call their ‘collective capabilities’. Others s t i l l suppor t ive of microcredi t , especially many banks and private investors, simply wish to go back to the

time when they were making fortunes for themselves at the expense of the poor.

This time, however, they claim they will be more careful not to exploit the poor too much. All told, the most reasonable assessment of the likely future of microcredit in India is actually that it will just about survive in a truncated version of its former bloated glory, but that it will be ‘boxed in’ by regulatory structures and so never again be given the opportunity to inflict very serious damage upon the poor. By the same token, the alternative to microcredit, many are now arguing, is fo r commun i t y -ba sed f i nanc i a l institutions to be re-engaged with in a very big way, notably such as credit unions, financial cooperatives and local/regional state development banks. Although not without operational problems in many countries, including in India itself, we are now in a much better position from many experiences around the world (Brazil is almost the ideal case) to understand how such institutions can b e m a d e t o w o r k e f f i c i e n t l y, developmentally and democratically. With the right type of support and friendly advice, these community-based institutions have a far better chance of serving the community, and especially the poor, than the MFIs that have quite unjustifiably hogged the vast bulk of savings, government support, donor funding and policy-maker attention since the 1970s.

The microcredit experiment that took place in Andhra Pradesh in the 2000s now stands as one of the most spectacular setbacks for the poor in recent Indian history. Only now are the poor in Andhra Pradesh coming to terms with the disaster that has befallen them. It is also now clear that microcredit ‘faith-healing’ has come to an end and a failed policy intervention is now being recognised for what it really is. Reality can now return to economic pol icy formulation in Andhra Pradesh, as well as in all of India and in the global economy as a whole, and the better it will be for the poor and for us all.



IN FOCUS

Ethames HR Summit 2012, Hyderabad

The Ethames Graduate School, India campus, Hyderabad,

organized “HR Summit 2012” on 20th October. The main

theme of the summit was ‘Recruitment Strategy’ -

employment as strategy for economic growth. Mr.

Ponnala Laxmaiah, Honorable Minister for IT,

Government of Andhra Pradesh, was the chief guest at

the function, which was also attended by delegates from

four continents along with over 60 corporates.

The international HR Summit on Recruitment Strategy is

a step towards creating best practices at work place by

developing sustainable recruitment strategies which

enable the growth of the organization along with the

overall economy of the nation. The event also focused on

ways to help give opportunities to all sections of the

society, an opportunity to work either part-time, flexi or

better facilities for the disabled. The participants averred

that the employment generation will lead to acceleration

of economic growth which in turn can lead the nation

towards being a welfare state.

The one-day event offered industry participants,

academicians and students, the opportunity to listen to

eminent speakers heading HR domain of the Indian

Corporate as well as from other continents, sharing their

perspectives on the theme.

Ind ian stock m arket has had a rem arkable run for equities in 2012 so far, on the back of positive g lobal as w ell as dom estic cues. Factors like, attractive valuations, notw ithstanding the recent run-up in stock prices, positive investor sentim ent, and the fact that the dow nside risk appears lim ited, augur w ell for the m arket. Though a w ord of caution: don’t throw caution to the w ind.

ver the last decade, India has Ob e e n o n e o f t h e b e s t performing markets in Asia.

The benchmark BSE India Sensitive Index (Sensex) registered more than 700% growth as it peaked in 2010. In tandem with 2008 global meltdown, the index also collapsed, but its sheer recovery of more than 113% until yesterday was more than spectacular. As the fortunes of the markets have taken a turn for even better in the second half of 2012, investors will aggressively star t pumping more money in the market. But the rally has to survive ongoing headline risks as policy paralysis continues be the biggest drag on Indian equities’ va l u a t i o n ; t h o u g h i t h a s b e e n addressed to a certain extent with the recent announcement of a slew of policy measures by the government, the country is yet to see big bang reforms.

From Wall Street to Dalal Street, every global index is scrambling to touch new peak with Dow Jones Industrial Averag e (DIJA) hav ing a l r eady breached the key psychological level of 13,000 while the S&P 500 Index too reached a new 52-week high, the highest level in more than 5 years. Tracking the global bullish tone, there seems to be too much confidence among investors in India that led Sensex to jump 16.5% this year. Bloomberg maintained its target for the Sensex to climb to 18,700 over the next 12 months. With this j ump, the va lua t ion o f Ind i a ' s benchmark index is only 12% away from its 2010 high and is now just 10.5% cheaper than many other Asian markets. In the last five years, Indian markets have traded at a 20.8% discount over Asian peers, which stand corrected to 10.5% now. The Sensex is currently trading at 11.5% discount to its five year average and just 8.6% discount to its 10 year average. Comparing with its

by Rajesh SinghManager Investment ResearchIthraa Capital, Riyadh, Saudi Arabia

historical PE multiple trends, Sensex is still trading at a discount as compared to its own historical levels and any correction will only make the market cheaper to buy. The Index is trading at forward PE of 14.02x against the ten-year average of 18.1x while on a forward P/BV measure; it trades at 2.3x (below the ten year average of 3.5x).

Policy inaction does not bode wellThe Indian stock market, however, faces downside risk from government policy inaction which could spoil the bull party. India’s $1.8 trillion economy grew at 5.5% in the first quarter of FY 2013, sharply down from a robust 8.5% a year ago. Manufacturing expanded at the slowest pace in nine months in August adding to the gloomy signs of slowing growth. Given, India faces gigantic task of rejuvenating the economy as high inflationary environment saps growth and political gridlock undermines investment, with sluggish monsoon and depreciating rupee further dimming the outlook. However, the Indian Finance Minister has promised to take steps for f iscal consol idat ion and tax law clarification to revive investment in the economy. Also, several negatives are now already priced-in. And India assertively is marching ahead and investors seem committed to the rally, as they continued to increase their equity exposure in fundamentally sound stocks. In addition, overseas funds flow have picked up. All these factors suggest that even as the economic sluggishness persists, the Indian markets downside could be limited.

India: Best performing market in 2012India has outperformed major Asia peers in 2012 YTD on improving market sentiment and increased inflows into the market; it was one of the worst

Financial Markets / STOCKS


performing markets in 2011. In fact, there was hardly any emerging market county that had posted positive return during that year as the period marked extreme volatility and investors had a roller coaster ride, oc account of political deadlock witnessed in the US, sovereign debt crisis in the Euro zone and sluggish economic growth in Ch ina . Indeed , 2011 wou ld be remembered as a nerve-wrecking year for the capital markets as it moved with every bit of news.

Remains favorite destinationOne of the key reasons for the tremendous show of Indian stock market has been the overwhelming bullishness of Foreign Institutional Investors (FIIs). Despite gloomy growth prospects, sustained FII flows have f l a r e d - u p I n d i a n e q u i t i e s a n d emboldened bul ls have staged a noteworthy comeback as India Inc’s growth story remains intact even today. In fact, Dalal Street has attracted more FIIs inflows than any other Asian market so far in 2012. As a result, India tops the Asian peers with $12.7 billion overseas fund inflow into Indian equities. MSCI Index plays a huge role in shaping up sentiment of overseas funds for emerging markets including India. Even slight tweak in the weightage of the MSCI emerging market and MSCI India Indices impacts the foreign funds flow as the sheer quantum of funds pumped by foreign investors into Dalal Street is much larger than what domestic institutions and funds allocate to the stocks.

Comparing the performances of various other MSCI Indices, MSCI India Index outperfor med both emerging markets as well as global markets. In 2Q 212, MSCI India reversed the loss and recorded a gain of (+) 14.9%, outclassing MDCI Global (-3.0%) and MSCI Emerging Markets (-11.1%).This clearly highlights strong appetite of enthusiastic investors for taking exposure in India. On 2012 YTD basis, Indian Large, Mid and Small cap Indices outperformed both MSCI

Global and MSCI Emerging Markets Indices. Particularly, India offered a t t r a c t i ve r e t u r n s i n M i d C a p segmentation.

Historically, MSCI has traded at a PE premium as compared with Emerging markets. But the gap has slightly nar rowed down over the recent months, and it is now at around 19% premium to MSCI EM PE currently. Last month, MSCI increased India’s weight to 6.4% from 6.3% in its regularly scheduled quarterly index rebalancing act which resulted in increase of investments from FIIs. Apart from raising India's weight in its Emerging Market Index, MSCI, on stock-specific front, raised HDFC's weight to 7.4% from 6.21% while reducing the weights of TCS, Reliance Industries and Hindustan Unilever. Among As i an pee r s, Ind i a ha s consistently outperformed other emerging markets. As a result of strong performance so far this year, Indian indices are trading at premium to their Asian peers, indicating limited upside potential. But the premium is fully justified given the corporate India’s higher return on equity and return on assets compared to other emerging market peers.

Sector-wise PerformancesFMCG and Healthcare hog the limelight During the current calendar year, all sectors roared back to life after having seen huge setbacks in 2011. Among the major sectors, FMCG and Healthcare have maintained their outperformance, even as both the indices have retreated from their April all-time highs. In the pas t s i x month , e spec i a l l y, the constituents of leading FMCG majors have hit record highs. While BSE FMCG has yielded a strong 28% during the past six month, the healthcare index has given 20% returns. However, valuations of FMCG and Healthcare are not very cheap.

Meta ls, Auto, Banks, Consumer Durables and Capital Goods were beaten down heavily during the past six months due to falling commodity prices, currency fluctuation, and RBI’s unwillingness to cut interest rates and conce r n s ove r po l i c y r e fo r ms. However, the recent change in fuel costs is an encouraging sign for these sectors as it will help the government cut the fiscal deficit. The upward revision in diesel prices will help reduce revenue losses of USD3.7 billion at PSU refiners. Any cut in interest rates will have a positive impact on rate

Pric

e to

Boo

k Va

lue

Indian Markets vs. The Rest

3.0

2.8

2.5

2.3

2.0

1.8

1.5

1.3

1.0

DJIA

India

S&P 500

MSCI World

German

UK

China

Singapore

France

EmergingMarket

Source: Bloomberg

10 12 14 16 18 20Price to Earning Ratio

Financial Markets / STOCKS


sensitive sectors. Still, there are a lot of earnings risks across high rate-sensitive sectors, where leverage is high, such as Real Estate, Metals and Capital Goods. As a result, Indian Auto and Banking, Metal and Real Estate sectors have witnessed sharp earning cuts. FMCG sector stands out for its consistently positive earnings revisions (FY12 and FY13 earnings were revised upwards by 0.26% and 0.02%). India’s automakers’ association had indicated to cut its FY12 domestic car sales forecast. The association lowered its FY12 for car-sales growth to as low as 9% in July, from an earlier estimate of 10-12% growth given in April 2012.

The political gridlock is hurting the growth of Telecom sector as it is suffering from stagnant tariffs. Some investors are also underweight on $100 billion IT sectors on concerns of weakening demand and margins. India’s top three software exporters get 90% of their revenues from outside the country and have developed unhealthy bench strength and the bulge is expected to grow from next quarter.

Small–Caps and Mid-Caps have bounced back After seeing sharp losses in 2011, the BSE's Mid- Caps and Small-Caps indices have rallied smartly so far this year, with several of their stocks giving outstanding returns. The BSE's Mid- Caps and Small-Caps indices have outperformed their large-cap peers so far in 2012 compared to the broader market benchmark Sensex. While the Mid-Cap index of the BSE has given a return of 26.15%, since the beginning of 2012, the small-cap index has gained 23%. In comparison, Sensex could only manage to rise by 16.5%.

E a r n i n g s s e a s o n : b e l ow expectationsThe 2Q 2012 earnings season is essentially coming to a close. Given the global vagaries and domestic self-inflicted policy logjam, expectations for earning season were not very high. As expected, the current 2Q 2012 earnings

season is turning out to be the worst performing quarter in at least last 15 quar ters. Therefore, B loomberg consensus earnings expectations for most of the Sensex companies for FY13 and FY 14 have been revised downward and now consensus expects only 9.61% growth in FY13 Sensex EPS over FY12 and a 13.2% growth in FY14E Sensex EPS over FY13E.

Most of the downsides are coming from negative earnings and sales surprises. An analysis of quarterly earnings declared by 283 BSE-500 companies indicates that more than 66% of the companies have reported negative earnings surprises and more than 40% of the companies have reported negative sales surprises. In terms of earnings, Oil and Gas, Basic Materials, Telecom, Financials were the worst performing sectors. However, Technology and Consumer Services such as Retail were able to outperform the market. In terms sales, Oil and Gas, Consumer Goods, Ut i l i t i e s and Telecom were the worst performing sectors.

However, Healthcare, Technology and Financials were able to beat street’s estimates. Declining sales g r ow t h a n d c o n s i s t e n t m a r g i n pressures have resulted in India Inc reporting the lowest profit margins in 1 2 q u a r t e r s a n d t h e s e v e n t h consecutive quar ter of negat ive earnings growth, though a small jump came in the fourth quarter of 2011. On quarter to quarter basis, sales for the BSE-500 companies declined by 4.8%, the lowest in the last 8 quarters. The earnings declined to 31%, the lowest in the last 17 quarters.

Expectations for the third quarter 2012 earnings season are coming down as the reporting companies have highlighted global growth concerns in their latest analysts’ meets given the tough macro-backdrop all over the world. There is hardly any region across the world that can be described as in good economic shape. Europe is in recession. China,

India and Brazil are slowing down. And the outlook for the US economy too does not look that favorable at the moment.

India Selling Proposition: Strong balance sheet and unparalleled growthIndia stock market bounced back in 2012 primarily due to huge FIIs inflows. One reason for strong inflows of overseas funds is mainly due to stupendous earning growth and quality of balance sheet. Still lot of steam is left in the domestic growth story and India is getting its fair share of global overeats funds inflows. Any improvement in sales, earnings and quality of balance sheet are likely factors that will become crucial for the market performance in medium to long term. Sales per share, EBITDA per share and EPS have recovered more than the levels seen just prior to 2008 pre-recession levels. However, they have almost stagnated from 1Q 2012. In fact, free cash flow per share has deteriorated most dramatica l ly re lat ive to sa les or EDBITDA for the Sensex.

The declining growth of their earnings and free cash flow has impacted the liquid short term investments (cash and cash equivalents) positions in the balance sheet. Yet, over the last eight quarters, cash and cash equivalents of the Sensex companies as a percent of their total current liabilities is above 50%, indicating adequate liquidity to meet any short-term liabilities. Companies have rapidly increased their debt exposure after dip in 2011, as shown by the trend below in net debt to BVPS.

Most of these trends have cheered the investors. But Capex and dividend payout ratio has been drastically reduced in the last few quarters, which can be frustrating for the investors. Even assuming the results of the Q2 continue recent trends of subdued earnings growth and sliming balances of cash and cash equivalents on their balance sheet, investors will expect rewards in terms of higher dividends.


Wockhardt’s TurnaroundWockhardt’s Wockhardt’s TurnaroundTurnaroundTo the Brink and Back

had arisen on account of counter positions advised by the banks. The Company has obtained a legal opinion that these contracts can be disputed, and accordingly no provision for the same has been made,” said Wockhardt’s 2008 Annual Report. Justifying the company’s decision to hedge its forex exposure, Khorakiwala explained, “With 73 per cent of our turnover coming from our international operations, in the normal course of the business, it was prudent to hedge our foreign exchange exposure. But due to the meltdown in the global markets and the consequent currency volatility, we had to make provisions for MTM losses, which had a marked impact on our bottom line.” Wockhardt was not the only domestic firm to enter into such hedging deals. In fact, derivatives-related losses at many domestic firms such as MindTree had triggered a series of lawsuits against the banks that issued them during 2007 and 2008. However, while some companies were lucky to come out with minor blushes, others like Wockhardt got badly bruised.

And from then on it had been literally a journey through the hell as the company got into one trouble after the other. The next year when the company reported its annual report (15-month period ended March 31, 2010), it was staring at a steep loss of Rs.1000 crore. The culprit was once again the Mark-to-Market (MTM) loss, which had piled up to Rs.1295 crore!

Origin of the troubleWockhard's trouble had its origin in the inorganic growth strategy that the company embarked on during the early 2000 which saw it execute a slew of overseas M&A (merger and acquisition) deals besides acquiring a few domestic rivals. The Mumbai-based drug maker was keen on expanding its global footprints which it felt would help it in achieving its ambitious goal of $1bn in sales by the end of fiscal year 2009. A section of analysts, however, said that the

W ockhardt clim bs out of a life-threatening debt quagm ire to script one of the m ost spectacular turnarounds in the h istory of corporate Ind ia.

On December 30, 2008, while for many it could have simply meant wrapping up yet another

year and getting ready to welcome the new one, it was not so for the thousands of tensed shareholders of Wockhardt, the Mumbai-headquartered pharmaceutical and biotechnology firm, which had seen millions of rupees of shareholder wealth evaporate into thin air in what was turning out to be a worst year for it; the stock had lost nearly ¾th of its value from Rs. 419, as on January 1, 2008, to Rs.108 by the end of 2008. The investors’ worst fears came true when a few weeks later the company revealed that it incurred Mark-to-Market (MTM) losses of Rs 581 crore due to its failed hedging strategy; the company entered into several foreign currency derivatives contracts with banks to protect itself from paying higher interest rates on its FCCBs (it had protected 50% of its overseas borrowings) went awry as rupee began reversing its upward movement vis-à-vis dollar towards the beginning of 2008 after having appreciated against the Greenback for most of 2007. According to accounting norms, companies need to show in their books mark-to-market values (including losses) of their financial investments (owned as well as traded). The rupee, which depreciated by 19.1% against dollar during the global financial crisis in 2008, led to losses of Rs.139 crore on account of MTM and derivative losses as well as a provision of Rs. 129.5 crore towards premium on Foreign Currency Convertible Bonds (FCCBs) for the period October 2004 to December 2008.

The company owed dues worth $108.5 million in FCCBs as well as certain other term loans which were due to retire in 2009. In fact, the losses would have been higher had it not been for a dispute related to forex claims of Rs 490 crore as demanded by its lenders who advised it on its hedging strategies. “The forex transactions were unilaterally cancelled by the banks and the mark-to-market losses

by Amit Singh Sisodiya

Corporate / STRATEGY


valuations were exaggerated in a few cases such as the one involving the acquisition of the French drug firm Negma for which Wockhardt paid a premium of 77%.

The spate of acquisitions had swelled the Mumbai-based drug firm’s liabilities from Rs. 808 crore in December 2007 to Rs.1821 crore the very next year. Wockhardt had acquired three firms including CP Pharmaceuticals ($17.7mn), Esparma ($10.9mn), Pinewood Lab ($150mn) and Negma ($265mn). However, the company defended these acquisitions which it says have helped it boost its revenues significantly while also scaling up its overseas operations. “We did acquire three companies in Europe and they form a very important part of our balance sheet. Our UK operation is about USD100 million and German operation is about USD 25 million. So, USD 120 million of our turnover i.e., about one third of turnover has come out of these three acquisitions today,” had then said Khorakiwala, adding, “With this acquisition, we have stepped up our sales and are on a fast track to achieving our corporate strategy of the $1 billion turnover by 2009.” The deal, then the third largest in the histor y of Indian pharmaceutical industry, catapulted Wockhardt as the largest Indian drug maker in Europe with significant presence across the key markets of Germany, the UK, France and Ireland. The all-cash deal marked Wockhardt’s fifth acquisition in Europe after Wallis, CP Pharmaceuticals (both UK-based), Germany's Esparma and Ireland's Pinewood Laboratories. "We have strategically decided to acquire more companies and brands in order to strengthen our presence in both domestic and overseas markets," Wockhardt Ltd chairman and managing director HF Khorakhiwala had said in an interview in August 2000, fresh from the acquisition of the domestic pharma firm Merind Ltd. Wockhardt had then even planned for a US listing. The company had also identified to foray into the promising biotechnology sector and was keen to spruce up its genomic and biotechnology research towards that goal.

While there was nothing wrong in the strategy, a worldwide financial crisis in 2008 punctured corporates which had depended on an overseas debt-led growth strategy. Wockhardt was one among them, which depended on overseas borrowings to fuel their acquisitive growth. As the global liquidity situation tightened and global demand slackened, manufacturers like Wockhardt felt the pinch – their growth tapered off and profits squeezed which severely impacted their ability to meet debt obligations. Wockhardt defaulted on re-payment of its $110 million FCCB (foreign currency convertible bonds) in 2008, and soon landed in trouble, fighting a slew of court and off-court battles with its creditors. The turbulent business environment in its key markets like the US and Europe did not do any well to it as well.

FCCBs – The bitter pills!In October’08, Wockhardt was facing payment obligation of $142.5 billion to its FCCB holders. Just to recap, the drug maker had raised $110 million in overseas convertible bonds in 2004 (at an interest rate of roughly about 6.7%). The bonds were to be convertible at Rs 486 a share, but Wockhardt’s shares, which were trading at Rs 244 in the beginning of 2004, had crashed to Rs.158 by the end

of September 2008. FCCBs became a rage amongst Indian firms which were looking to make overseas acquisitions as they wanted to expand out of their domestic market, though it was lapped up by capital goods importers as well. FCCB, a novel instrument which combine properties of both debt as well as equity, came handy as a low-cost tool to raise funds. With the government also taking appropriate measure to liberalize FCCB norms too boosted demand for this instrument, the market for which grew phenomenally between 2005 and 2008. Indian corporates raised around $25bn in FCCB issuances. In fact, during the last decade, the total amount raised through FCCBs was about USD 30 billion. However, in the hindsight it appears they overlooked the risks or simply underestimated it. While these bonds carried lower interest rates (some of these bonds even carried zero coupon rates!) as compared to the then prevailing rates in the domestic market with the aim to lower their borrowing costs, a major risk which was overlooked was their higher conversion price. “Foreign Currency Convertible Bonds (FCCBs) which were very popular at the time. The conversion price on such bonds was 25 - 150 per cent higher than the prevailing stock price at the time of issuance," said a June 2011 report from the Reserve Bank

FCCBs Redemption profile as of March 2011

3477

3793

2450

627467

25

405262

2011-12 2012-13 2013-14 2014-15 2015-16 2017-18 2025-29

4000

3500

3000

2500

2000

1500

1000

500

0

Source: RBI



of India (RBI). According to the apex bank, FCCBs, which are normally issued for a maturity period of more than five years, worth more than US$ 7 billion are maturing by March 2013. However, citing a Crisil report, it adds, FCCBs worth Rs. 220 – 240 billion may not get converted into equity shares, as the cur rent s tock pr ices of i s su ing companies are significantly below their conversion prices. "Estimates show that a very large proportion of these FCCBs may not get converted into equity, thus requiring their refinancing at the much higher interest rates prevalent today.”

Debt Overdoes! According to industry experts, during late 2007 rupee had appreciated to Rs. 39 vis-à-vis the US dol lar and was threatening to appreciate even further which prompted the jittery exporters to enter into aggressive hedging deals – mainly forward contracts to sell dollars - to protect their export earnings and in many cases also overseas borrowings. According to a report in the Outlook Business, These hedges - mainly forward exchanges contracts to sell dollars - were locked in at Rs 41-42 levels. That seemed safe back then. By March 2008, pharma companies had built substantial forward positions. Biocon had outstanding forward exchange contracts to sell $98 million—up sharply from $13.5 million in the previous year. Similarly, Ranbaxy had an outstanding forward cover of Rs 2,002.8 crore and outstanding option or swaps of Rs 1,555.7 crore. But the tide turned in the currency markets, and the rupee started depreciating against the dollar after April 2008. That has made these hedges go awry. Many of these firms are now left with little option to book mark-to-market losses on their outstanding forex hedges.” The soaring MTM losses in turn hit many such borrowers’ bottom lines hard.

Managing the (debt) mess Wockhardt decided to issue 0.01% non-convertible cumulative preference shares (NCPS), to be redeemed at a 38% premium in September 2018, so as to meet around half of the liability (of

approx. 660 crore) on account of FCCBs. It also decided to issue 0.01% optionally convertible preference shares (OCPS) (to be concerted after October 2015 or redeemed in 2018) to meet the rest of the liabilities. It also decided to convert a part of its annual interest liability - 2% on most loans - into NCPS. To meet its derivative losses also it decided to issue NCPS that will be redeemed at a 20% premium in December 2018 whereas it decided to use a combination of NCPS and OCPS to settle its derivative liabilities.

Wockhardt thus worked out to meet its Rs1441 crore estimated liability during calendar 2009, part of which it expected to meet from sale proceeds of its animal heal th and nutr i t ion businesses, estimated at about Rs790 crore while the rest was to be taken care of by the CDR. By issuing preference shares the company also successfully brought down its debt-equity from a high of 5.5 to less than 2 by the end of Q1FY13. Wockhardt had approached the CDR cell in March 2009. Subsequently, about Rs1,500 crore out of the gross debt of Rs3,400 crore was restructured. With the sale of nutrition business to Danone having now materialized it will greatly reduce the drug maker’s pain.

Seeking CDR support While debts and MTM losses continued to pile up, the creditors were queuing up. Wockhardt needed to buy time to meet the g rowing obl igat ions. Having explored and run out of all the other options, it knocked at the doors of the Corporate Debt Restructuring (CDR) Cell. In April 2009, the Company applied for restructuring of its debts through ICICI Bank, one of its lenders. In July 2009, its proposal was approved by the CDR Empowered Group. As per the terms of the CDR package, the lenders agreed to restructure the drug maker’s debts running into thousands of rupees. As part of the deal, the participating banks led by ICICI Bank, agreed to reduce interest rates as well as reschedule the payment periods. The secured lenders also proposed new terms for the payments to the unsecured creditors (the

FCCB holders), which though was rejected by its foreign lenders; it in turn led to heated debate over the superiority of secured vs. unsecured creditors. The unsecured lenders which dragged the company to the court over the issue won a favorable verdict. Nonetheless, barring the FCCB payment part, the CDR deal went on as planned, thereby giving the company much respite. As per the approved scheme, WL allotted approx. 153mn preference shares to the CDR lenders valued cumulatively at Rs

666.4mn. These Non‐convertible

(NCCRPS) and Optionally convertible (OCCRPS) Cumulative, Redeemable Preference Shares would be convertible in 2015 and redeemable in 2018.

While no one expected the drug maker to be back in the pink of the health so easily, it was, despite faced with all the chaos and mounting challenges, busy scripting a strategy that not only helped it pull itself out of the financial quicksand, but also led it to spring back to normalcy in a much emphatic manner.

Unlocking value through divestituresThe Mumbai-headquartered firm, under attack from all corners, decided to tide over the debt crisis through unlocking of value by divesting its non-core assets. However, its woes further aggravated as a group of foreign investors led by QVT opposed the move and even filed a winding-up petition. This delayed the sale of its nutrition business to the US-based Abbott as bond holders alleged that the company had not consulted them on the issue. The deal with Abbott fell through causing much hardship to Wockhardt.

During October 2011, the company finally got a major relief when the court allowed it to sell the nutrition business after it agreed to pay back the pending amount of Rs 417 crore to the holders FCCBs in five installments ending August 31, 2012. However, the court warned that a default in the payment of any of the installments would trigger the appointment of an official liquidator.


It also cleared the decks for the sale of Wockhardt's nutrition business to French consumer giant Danone. In August’12, Danone finally agreed to acquire Wockhardt's nutrition business and brands as well as its related industrial operations from Carol Info Service (located in Punjab) for approximately €250 million (about Rs 1,600 crore). The acquisition will provide Danone access to a distribution network with nationwide reach. Wockhardt's nutritional business comprises Farex, Dexolac, Nusobee and Protinex, subject, however, to customary closing conditions and various approvals.Cost cutting boosts revival efforts

Besides the debt restructuring and divestitures, the company also looked at areas to trim down costs. "We reduced the operational costs everywhere," according to Khorakiwala. He adds, "Wherever there were inefficiencies, people themselves took action." In fact, they learnt a new way of frugality what Khorakiwala calls the spirit of More & More with Less & Less, i.e., more output at lesser costs. The drug maker was able to bring down manufacturing costs by as much as 10-15%. The company also successfully brought down its marketing and sales costs as well. "If you see my balance sheet of last three years and see the balance sheet before the crisis, you'll see a reduction in expenses today," he said in an interview. What also has helped the company recover from the debt shock is its unrelenting focus on its R&D efforts even amidst the chaos and uncertainty. As a result , the company successful ly strengthened its pipeline of new drugs. "We created inventory in advance before we got the approval.

So when the opportunity came, we took the advantage. It was a risk but the upside was significant," he added. "We took a call, including keeping R&D and drug discovery processes (that cost money) intact. It's a big call. Usually that (R&D spends) is the big casualty," when companies are in trouble, he told. “Fortunately, some of these products in the pipeline have started to materialise. Metoprolol, the cardiac drug got the nod from USFDA. In anticipation of the nod,

Khorakiwala took a huge bet by building an inventory and thus could at once supply to US drugstores when it received a nod from the regulator,” says a report in The Economic Times.

Leadership@workThere is no denying the fact that Wockhardt and its top management has demonstrated exemplary leadership qualities amidst the financial turbulence. While in hindsight, decisions like divestiture of its non-core businesses look easier to execute on paper, believe it, it was not that easy given that the firm was faced with an army of irate bond holders. There is no denying the fact that Wockhardt and its top management demonstrated remarkable leadership amidst the financial crisis. And one man that deserves the accolades is none other than Habi l H Khorak iwa la , the septuagenarian Chairman of the drug maker. “Khorakiwala always maintained his equanimity,” said Shailesh Haribhakti, Head of BDO Haribhakti Group, which has been auditing the books of the drug m a ke r . A c c o r d i n g t o h i m , t h e septuagenarian was calm and composed in our first meeting in early 2009.

Recollecting some of their interactions during the early days when the trouble began, he says, “He (Khorakiwala) clearly understood the problem and told us that the only way to come out of the crisis is by improving operating performance and getting rid of non-core assets. This is what he did and today Wockhardt is a great turn-around story.” He also made sure that his employees did not face any hardship. There was no single instance of delayed payment of salaries to employees. "Not once did any of our employees get their salaries reduced or delayed by even a day," Khorakiwala says. He also took some tough measures like changing his finance team which failed to assess the debt debacle that had brought it to a near-collapse. The company also received tremendous support from its suppliers who readily agreed for extended credit terms as Khorakiwala and his team looked to trim costs. However, his biggest strength was his belief in himself and the future of Wockhardt. It was this

indefatigability that saw him steer Wockhardt from a near-death situation as debt ballooned and share price touched rock bottom and corporate raiders snooped around. “He is also a very tough person, because it is not easy to run a company when you have debtors hounding you every day. He could have cracked up and sold the company, but he didn't. Khorakiwala has taken risks and that has paid,” said Sujay Shetty, head of Life Sciences at PwC.

Sustaining the growth The investors have recognized the fairly-take like turnaround of Wockhardt by pulling its shares from a low of Rs. 76 in 2009 to more than Rs.1200 this year so far. However, the over 10-fold jump in its market cap a lso means g rowing shareholders’ expectations. The question is: can it meet those expectations? "We are becoming more or less a very normal company, " a s su re s a con f iden t Khorakiwala, who transformed the company into a pharma powerhouse after taking over the reins of Worli Chemical Works from his father in 1960s. He is also confident that the company is now well on its way to return to fast track of growth after achieving a stupendous turnaround, helped in part by the unlocking/divestiture of non-core assets such as animal health, nutrition business and hospitals. "We deliberated. We have a large portion of our business coming from overseas. It is neutral for us and we are not managing currencies. You burn your hands once then it takes time to recover," he says. A business runs on its inner core and inner strength, he says and for Wockhardt the only challenge was the "financial challenge", and therefore could be resolved. "We never had a business challenge. We remained very focused," he said. He also has become a bit more risk averse. "We have decided not to touch derivative instruments. Some bankers still come to us with such products. I tell them, I don't want to risk my organization in my lifetime or in my children's lifetime." Surely, these insights would serve the company well as it looks forward to sustain and even better its recent astounding performance.



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Basel IIIHow Geared are Indian Banks?

weighted assets),it is the composition of this capital that is different. The Basel III norms require banks to set aside 6.0% as minimum Tier-I capital of which 4.5% must come from common equity. The minimum requirements for these under Basel II in comparison are 4.0% and 2.0% respectively. The maximum share of Tier-2 capital in the regulatory norm as result goes down from 4.0% under Basel II to 2.0% under Basel III. The norms set by the RBI incidentally are far more stringent not only in terms of the timeline of implementation but also in terms of the magnitude of provisioning. The table 1 summarizes this succinctly.

Reduction in pro-cyclicality and macro-prudential overlay to limit systemic riskThe main charge against Basel II is that the risk sensitive nature of capital regulation under it renders it “pro-cyclical”, exaggerating the impact of an up-cycle or a recession on the system. In good times when banks can raise enough equity from the markets, the rules do not impose additional capital requirements. Conversely, in strained times, when it is difficult to raise capital and risk profiles deteriorate Basel II requires banks to bring in more capital pressing them to e m b a r k o n a v i c i o u s c y c l e o f deleveraging that only exacerbates the downturn. As a result, Basel II keeps capitalization norms constant across an economic cycle instead of adapting them to current conditions.

Basel III on the other hand requires b a n k s t o m a i n t a i n a “ c a p i t a l conservation buffer” in the form of additional common equity totaling 2.5% of risk weighted assets that allows banks to tap into it during a downturn and absorb losses without breaching minimum capital requirements and aggressive deleveraging. The buffer by itself is not part of the regulatory

The Basel III norm s could push dom estic banks to d ivert funding from high cost retail deposits and increasingly look at non-interest revenue stream s to bolster profitab ility.

he August 2012 we marked the Tfour th anniversar y of the collapse of Lehman Brothers and

the global financial crisis. With financial markets remaining somewhat unsettled and global economic growth remaining subdued little has changed over the years. Policy authorities, on their part, continue to do all they can, pumping in large sums of money into the financial system through monetary easing and balance sheet expansion as well as tightening regulatory supervision to prevent a repeat of 2008.This in turn has paved the way for the Basel III nor ms-a s tr ic ter, more nuanced framework than the Basel II norms that are currently in place. Banks are required to comply with the complete set of Basel III norms by January, 2019 but will have to start moving to this in a phased manner by January, 2013. The deadlines for domestic banks, as set by the RBI, are tighter and they are required have the complete framework in place by March, 2018.

To evaluate the impact of the Basel-III framework on Indian banks, it is important to understand how it differs from the Basel-II requirements in the f i r s t p l ace and which of these differences could actually pose a real challenge to domestic banks. The enhancements of Basel III over Basel II come primarily in five areas: ( i) augmentation in the level and quality of capital; i i) reduction in the pro-cyclicality of provisioning norms ;(iii) macro-prudential overlay to limit systemic risk; (iv) an explicit cap on leverage ratio and (v) introduction of liquidity standards. Let’s analyze each of these areas separately:

Augmentation in the level and quality of capitalWhile the minimum total capital requirement is the same across Basel II and Basel III norms (i.e. 8% of risk

by Jyotinder KaurSenior Economist & Assistant Vice PresidentHDFC Bank, Gurgaon, India.

Banking / REGULATIONS


minimum requirements imposed by Basel III but is determines dividend distribution and staff bonuses under the new framework. Shortfall in the bu f f e r am ids t s t ab l e e conomic conditions can therefore impact on a bank’s stock performance and penalize employees and for all practical purposes the buffer is an additional charge on capital during stable times. Along with the buffer, the capital requirement under Basel III is therefore pushed up to 10.5% of risk weighted assets, 7.0% of which must come from common equity.

Apart from the capital conservation buffer, Basel III also introduces a “counter-cyclical” capital buffer over and above the capital conservation buffer to be maintained at 0-2.5% of risk weighted assets in times of excess credit growth. Systemically important banks are also required to make additional provisions-something that is lacking in the Basel II norms.

Restrictions on leverageAnother crucial restriction that is included in the Basel III norms is the guidelines on leverage. At the time of the crisis, major financial institutions in the West ran leverage multiples - the amount of money lent against capital-of as much as 50 times without violating capital adequacy requirements. How was this achieved? By packaging banking book exposures (largely bank loans) into tradable credit derivatives that, under Basel II, required less capital to be set aside against them than is the case for other kinds of assets. The premise was that the trading book exposures were more liquid than other assets and could be easily unwound in the event of extreme stress. Needless to say the crisis in 2008 proved this incorrect forcing policy authorities to not only contemplate an enhancement of capital requirements against trading book exposures but also consider setting a limit on the financial sector leverage multiple to under 33.3 times by January, 2018. The definition of financial sector leverage has also been

modified to include all tangible assets including loan equivalent values of credit derivatives and other off-balance sheet items.

Introduction of global liquidity standardsLastly, Basel III introduces a global liquidity standard comprising a stressed liquidity coverage ratio and a longer-term structural liquidity ratio to prevent long-term liquidity mismatches in the banks’ balance sheets.

Turning my attention now to the impact of these enhancements on the Indian banking system, it becomes imperative to understand which of them are actually binding on domestic banks and how, if they are likely to have considerable impact, they are placed given the current state of the banking system.

Of the additional restrictions placed by Basel III it is the improvement in the level and quality of capital and the introduct ion of the capi ta l conservation buffer and modified provisioning norms that is perhaps the most relevant for domestic banks. G i v e n t h e s t a t u t o r y l i q u i d i t y requirements of SLR (23.00%) and CRR (4.50%) and assuming that the RBI allows these to be reckoned ag a in s t t he Ba se l I I I l i qu id i t y

coverage ratio, tighter international liquidity standards are unlikely to create too much of an additional drag on domestic banks. Neither is the stipulation on leverage ratio likely to be especially restrictive given that domestic banks have traditionally had “moderate” leverage ratios. More importantly, domestic banks have a relatively small exposure to derivatives a n d o f f - b a l a n c e s h e e t a s s e t s , accounting for which is unlikely to create as much of a strain as it is for foreign banks.

However, other Basel III enhancements such as stricter capital adequacy requirements are likely to impact on the s y s t em and t r an s l a t e t o l a r g e r capitalization needs. The problem however is that this drag on the system is likely to come at a time when it is already under considerable strain, reeling from a build of impaired loans that the current downturn has resulted in. Recent data indicates that the gross NPA ratio of the system increased from 2.4% in March 2011 to 2.9% in March 2012. This however belies the extent of stress in the system given that a large po r t i on o f impa i r ed l oans a r e restructured. After accounting for this, stressed assets in the system actually work out to 6.9% which is an increase from 5.4% in Fy11.

Table 1: Minimum Regulatory Capital Requirements (as % of risk weighted assets)

Basel III RBI Preseriptions (as on Jan 1, 2019) Current Basel III (Basel III) (as on Mar, 2018)

A=B=C Min. total capital 8.0 9.0 9.0

B Min. Tier 1 6.0 6.0 7.0

C of which Min. common equity 4.5 3.6 5.5

D Max. Tier 2 2.0 3.0 2.0

E Capital conservation buffer (CCB) 2.5 - 2.5

F=C=E Min. common re equity 7.0 3.6 8.0

G=A+E Min. total capital 10.5 - 11.5

H Leverage ration 3.0 - 4.5

Source: RBI



Further, the restructuring pipeline continues to remain strong with the number of cases referred to the Corporate Debt Restructuring (CDR) cell increasing to 2% of loans in Q1FY13 (calculated on an annualized basis) from a mere 0.5% a year ago. This is not where the problem ends. A large share of infrastructure loans (largely power and roads and highways) are still due for repayment resulting in a step jump in FY14.As a result, the system is likely to face pressure not only from the additional capital requirements of Basel III but also from extra provisioning requirements that deteriorating asset quality entails.

Challenges for PSBsThe good news however is that while a few public sector banks may have to raise additional capital in the near-term the system as a whole remains well capitalized at present even accounting for a possible increase in provisioning from rising stressed assets ( ref. Table 2). Indian banks have historically maintained their core and overall capital well in excess of the regulatory minimum and ratings agency Crisil estimates that the average equity capital ratio and overall capital adequacy ratio of rated banks in India stands well above 9.0% and 14.0% respectively.

NPAs increase due to 40 per cent of res t r uc tured s tandard advances turning NPAs. The trouble is that adequate capital adequacy today may

not sustain going ahead. With the RBI’s financial inclusion drive and a likely bulge in the middle income population of the country it is likely that the credit penetration levels will increase going ahead moving higher from its relatively low level of 75% of GDP at present closer to an average of over 100% for Emerging Asia as whole. This in turn means that cap i ta l iza t ion requirements wi l l accelerate from current levels.

Can these requirements be quantified? There are several estimates doing the rounds but perhaps the most credible of these is the one calculated by the RBI itself. The broad level estimates suggest that in order to achieve full Basel III implementation by March 31, 2018,

public sector banks (PSBs) would require common equity to the tune of Rs 1.4– 1.5 trillion on top of internal accruals, in addition to Rs 2.65–2.75 trillion in the form of non-equity capital. Similarly, major private sector banks would require common equity to the tune of Rs 200-250 billion on top of internal accruals, and Rs 500-600 billion in the form of non-equity capital. These p r o j e c t i o n s a r e b a s e d o n t h e conservative assumption of uniform growth in risk weighted assets of 20 %

p.a. for all banks and individual banks’ assessment of internal accruals (in the range of 1.0-1.2 per cent of risk weighted assets). It is important to mention that banks would have continued to require additional capital to meet Basel II capital ratios had Basel III capi ta l ra t ios not been implemented. In case of PSBs, t h e i n c r e m e n t a l e q u i t y requirement due to enhanced Ba se l I I I c ap i t a l r a t i o s i s expected to be to the tune of Rs 750-800 bn while that in case of private sector banks is Rs. 180-225 bn.

This raises the question-can the market really provide the additional equity requirement of Rs 1.75 trillion? The amount the market will

have to provide will depend on how much of the recapitalization burden of PSBs the Government will meet and could range between Rs 700 billion ( if the government trims its shareholding to 51% in PSBs) to 1

Table 2: Credit risk-Gross credit-Impact on NPAs and capital, March 2012

System Banks with CRAR<9.0%Bank with core CRAR<6.0% level Core % of Total % of Total CRAR CRAR NPA Ratio No. of Banks as Sets No. of Banks % of Total

All banks 14.1 10.3 2.9 - - - -

Shock 1 11.9 7.9 5.8 5 7.0 11 30.0

Shocks 2 11.1 7.2 7.2 12 30.2 18 42.0

Shocks 3 12.7 8.8 4.1 3 1.5 4 6.5

Note: Shock 1 = NPAs increase by 100% Shock 2: NPAs increase by 150%

Source: RBI

In order to achieve full Basel III implementation by

March 31, 2018, public sector banks (PSBs) would require common equity to

the tune of Rs 1.4– 1.5 trillion on top of internal

accruals.


trillion( if the government maintains its current share). Over the last five years, banks have raised equity capital to the tune of Rs 520 billion through primary markets. Raising an additional Rs 700 billion – Rs 1 trillion over the next five years from the market should therefore not be an insurmountable problem. The extended period of full Basel III implementation spread over five years gives sufficient time to banks to plan the time-table of their capital raising over this period.

Stricter capital adequacy norms not only have implications for additional capital infusion that is likely over the next few years but could also depress profit margins and return on equity (RoE). A higher capital charge is likely to increase the cost of capital at a time when credit penetration is likely to increase a n d t h i s c o u l d d e p r e s s profitability if it is not passed on to borrowers. The trouble however is that if it does indeed push up lending costs there is a risk that credit growth itself could suffer. The average return on equity (RoE) on Indian banks is currently close to 15.0% and it is likely that the implementation of Basel-III could depress this in the near-term putting pressure on share valuations and prices.

The flip side to this however is that Basel III norms could also boost banking sector stability, solvency and liquidity and pave the way for a stronger system in the medium-term. The upshot is that while banking sector stock prices could be affected in the near-term the risk attached to these shares could decline considerably actually boosting the risk adjusted return for investors. Further, the Basel III norms could push domestic banks to divert funding from high cost retail deposits and increasingly look at non-interest revenue streams to bolster profitability. Besides, a stable banking system could well end up supporting the return on equity in the medium term by

reducing provisioning requirements that could follow from enhanced risk absorption.

A few more ChallengesAnother facet of the Basel III norms that is likely to prove somewhat challenging for Indian banks is the implementation of the counter-cyclical buffer and the capital conservation buffer that is essentially premised on a “ d y n a m i c ” a s s e t p r o v i s i o n i n g framework. This framework aims to

r e d u c e t h e p r o - c y c l i c a l i t y o f provisioning (increase in provisioning in the event of a downturn and a decline in it during an upturn) by linking annual provisioning to the long run average expected loss during an entire economic cyc le. As a resu l t , the dynamic provisioning (DP) created during a year is the difference between this long-term loss and the incremental specific provisions made during the year to cover fresh non-performing assets.

While this concept is theoretically s o u n d i t s e xe c u t i o n c o u l d b e somewhat tedious. For one, for an economy with a rising credit/GDP ratio that has a large share of loans that are unseasoned and provide little by way of repayment and default

h is tor y, i t becomes d i f f icu l t to ascertain the exact magnitude of expected or long-term average loss on assets. More importantly, dynamic provisioning and counter-cyclical and capital conservation buffers only make sense if the banking system and the central bank has the capability to accura te ly pred ic t tur ns in the economic cycle both at a sectoral and sys temic leve l . Whi le Base l I II prescribes the use of the movement of the credit/GDP ratio from its trend as

the key metric for this purpose, research conducted by the RBI reveals that credit/GDP has not been a good indicator of the build-up of systemic risk in the Indian banking system in the past. As a result, what is needed is both a better database and more refined statistical analysis in analyzing economic cycles. Further, a radical change is required in the domestic banking system’s approach to r i sk management.

Banks are currently operating o n t h e s t a n d a r d i z e d approaches of Basel II and it is important that at least the l a r g e r b a n k s m i g r a t e t o a d v a n c e d a p p r o a c h e s especia l ly as they expand o v e r s e a s p r e s e n c e . O n

b a l a n c e h o w e v e r , w h i l e t h e implementation of the Basel III norms could pose a challenge to Indian banks, there isn’t anything that can’t be tackled with astute risk management and better governance. Despite the drag the Basel III could create on the system, I still believe that Indian banks are amongst the best positioned in the world to tackle international regulatory impediments going ahead, not just because of a more conservative capital ization framework put in place by the RBI but also because of their inherent resilience.

The flip side to this however is that Basel III norms could also boost banking sector stability, solvency and liquidity

and pave the way for a stronger system in the

medium-term.



with the launch of its stock trading platform.

To leverage on technology and goodwillThis new kid on the exchange block has a very high growth potential as MCX already is the most favored exchange for commodities in India. Though a number of exchanges exist (NMCE, ICEX, NCDEX, etc), but they have so far failed to give any tough competition to MCX. It enjoys good relationships with traders and corporate alike which is why they stand a good chance for being successful in equities. Further, given the low market penetration, as far as equity investing is concerned, there is no dearth of new players, punters, investors in the market. It is all about getting their trust. Also, the volumes on BSE and NSE are very high, which means MCX-SX can squeeze some volumes from them as well. We hope that the group would rely on the same marketing strategy it had while

MCX-SXThe New Kid on the BlockM C X-SX becom es the new est addition to the exchange b lock, w hich boasts of such b ig nam es as the m ost techno-logically advanced, NSE (National Stock Exchange) and the BSE, Asia’s o ldest stock exchange) am ongst close to tw o dozen exchanges w hich exist in the country today. But it faces slew of challenges. by Manan Somani

Director, Insignia Commodities and Forex (P) Ltd. New Delhi.

starting MCX. It did not let NCDEX (the only other major commodity exchange) run away and curtailed its wings even before it could fly. We hope it will do the same with MCX-SX, though this time round it is facing competition from stronger and established rivals like NSE and BSE. At the same time, though, this could also be an advantage for the company as prospective customers (brokerages, traders, investors) might be waiting for a change for something new, better, technologically sound and cost effective trading platform. For instance, technology-wise the group has already built a formidable reputation through firms like Financial Technologies and its commodities exchange.

Competitive pricing would be the keyThe company will have to be different in some way from the two giant stock exchanges – NSE and BSE. The best way to do that would be to offer a better trading experience for investors and corporates

he MCX-SX began its journey in T2008 by launching trading in Currency Futures segment,

which has been witnessing a steady and significant growth in average daily turnover and open interest ever since its inception. The exchange, however, had to wait until this year to start trading in stocks as it could not get the necessar y regulator y c learances. Meanwhile, MCX-SX failed to pose any substantial threat to the NSE in the currency trading segment as it could not get the volumes expected. The promoters had given the MCX-SX membership to its original MCX members, which included bullion importers, hedgers, arbitragers and banks. Reason being, the regular equity t raders s t i l l prefer red NSE for currency as they already had accounts with NSE for equities and hence less hassle for account opening. The main drawback they had was availability of less number of future contracts in comparison to the NSE. However, MCX hopes to change the situation


alike. It also won’t be surprising to see if MCX also announces a slew of attractive schemes, free offers along with low brokerage, and better trading facilities. It is also expected they will be providing lower listing fees and a host of other benefits to corporates so as to lure them away. Most of the banks hold stake in the new stock exchange. This will be advantageous to it in marketing itself. Likewise it should go to members and boards of the now dead regional exchanges giving them freebies and making them become members of their exchange. This could in fact be the biggest coup for them if they manage to pull it off. It will be seen in the near future how successful they are. However, they will first have to target big conglomerates and industrial houses as smaller corporate will be more confident to follow suit. It will, however, be a totally different ball game with regards to broking houses. The bigger broking firms will join them almost automatically as they will definitely be getting very high incentives.

The key will be to rope in the smaller players in the equity broking sector. They have to have something unique there. It would also have to differentiate in the indices like the SX-40 (as announced). It could work either way, say they get the major listings first and then the brokers and traders follow… or it could work vice versa also. But one thing is clear: MCX-SX will have to do something like the RCOM Monsoon Hungama Offer which instantaneously made Reliance CDMA as the phone for the common man, selling millions of connections in a very short span of time. The major thing that it has to do is gain the trust of investors and industry alike and to maintain the same in future also.

NSE has around 1500 members whereas BSE has around 1000 whilst MCX-SX has around 700 members already, but the key lies in volumes. NSE had earlier lowered transaction charges by 10% and the volumes shot up in both the cash and the F&O (futures and options) segments. BSE volumes have also picked up after it

offered various schemes to its members. MCX-SX should take heed from this. MCXSX will have to have very strict norms for listing and also see to it that those norms are adhered to. These norms should be made keeping in mind the safety of the retail investors. They should be ensuring that they have made a thorough background check before listing any company. They should have clarity in everything and have proper disclosures for everything. It should appoint regional level marketing teams as it will be the regions other than the metros where it could discover massive growth potential. Give the rural person what he needs to trade and he will also start trading - this should be their motto.

Key concernsGetting acceptance with the corporate sector is the f irst major hurdle. Thereafter, they will have to convince members and then traders and investors to join them. Whether they are lured into trading with them will all depend on their marketing strategies and research. Next, there is question of getting volumes which are generally done by giving members a free hand. The fact is that retail investors do not trade on low volume exchanges. They may have an account with MCX-SX also, but trading on that account is a totally different ball game. For that it would need to ramp up volumes in both the cash as well as futures segments. We sincerely hope that the legal battle is over and that no legal angle crops up later, and that there is also no hurdle put up by the government.

Volumes in the BSE have not been able to keep pace with the phenomenal growth in the NSE. This is despite the fact that we have more companies listed on the BSE than the NSE. It shows that most of the crap companies or junk companies are listed on the BSE. Given, MCX-SX will have to make sure that this does not happen with them. The other challenge will be market platform on which one will trade. Odin has been left behind by DGCX despite MCX and financial Technologies

Disclaimer: Any opinions as to the commentary, market information, and future direction of prices of specific currencies, metals and commodities reflect the views of the individual analyst, In no event shall Insignia Consultants or its employees, Media Five Publications Pvt. Ltd and The Global Analyst have any liability for any losses incurred in connection with any decision made, action or inaction taken by any party in reliance upon the information provided in this material; or in any delays, inaccuracies, errors in, or omissions of Information. Nothing in this article is, or should be construed as, investment advice.

hold around 45% stake. MCX-SX has to reinstate itself in the minds of traders with regards to the trading software. BSE and NSE will not take things lying down. Recently NSE reduced its connectivity charges from one lakh to fifty thousand (for VSAT and leased line customers). MCXSX has to act accordingly as it is A very price sensitive market.

India is the second best performing economy in the world in terms of GDP. Investment interest will continue to be there in Indian equities. There are very few economies which are backed by domestic demand for growth. Taking the above facts into consideration it will not be a problem for MCX-SX to have a steady Volume growth. Small and medium size enterprises are now allowed to list in the stock exchanges which will further boost volumes and turnover. In future tiny industries could also be in with a chance to tap the equity markets for funds, which could further boost trading volumes.

Winning retai l investor ’s confidence would be crucialOne key factor if taken into account can seriously boost chances of MCX-SX ousting, at least, BSE. That is, investor protection, which means ensuring that retail investors are not duped of their hard earned money by r unaway companies (which are there in tons on the BSE). For Example an IPO comes to the market with false claims. It is subscribed to by all on behest of good marketing or underwriting. Shares list at 2 time the IPO price and the same day they crash to very low levels. Investors seeing the high price wait. In a few days or weeks or months, the prices fall to below par…and the situation continues to repeat - even more companies vanish or trade with the lowest possible volumes at 5-10 percent below their listing price. If somehow MCX-SX can address this issue and prevent this sort of events from happening then it could emerge as an attractive trading destination (as a stock exchange) for investors.

Financial Markets / STOCK EXCHANGE


RNI No. APENG03369/01/1/2012-TC

challenges for indian banks fccbs anal · 2012-11-06 · with the central bank. in reality, the crr...

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