International Treasurer The Corporate Treasurer's Guide to Global Financial Management

October 31, 1 994

Country profile

India Eases Lending Restrictions

October 17 Reserve Bank of India Meeting eases lending restrictions.

In our last issue, we mentioned how fin ancial controls on interest rates were forc ing Indi a's b lue-chi p compani es to off-sho re f in anc ial markets. Eu roissues and other fo rms of exter­nal fund ing are still cheaper, but progress is being made to lower loca l funding costs. On October 1 7, th e Reserve Bank of Indi a announ ced the eas ing of contro ls on large loans of RS200,000 or more. The cost of bank lines will hereby be reduced by 50-200 basi s points from current levels of 14-15%.

Th e extent o f th e dec line w ill depend to some degree on the financial hea lth of each ind ividual bank. Wi th fixed deposit rates (now 4 .5%) most ba nks, esp ec iall y go vernm ent­owned Indian ones, cannot afford to narrow their lendin g spreads mu c h more. Fallin g interest rates and competition, however, w ill pressure them to do so. Counterparty ri sk in the current environment is a huge concern .

Many banks in trouble

Indi a' s banking system 1s m poor shape and many of its most f in anc iall y strained ba nks belong to the public sector. Thus, the govern­ment must seek to manage the pace of f inan­cial sector reforms, as it moves to conso lidate, moderni ze, and pr iva ti ze the banking system. Most importantly, it mu st c ut banks loose fro m pu b li c co ffers before marke t- d ri ve n insolvencies bust any semblance of a budget.

Meanwh ile, large corporati ons are press ing ahead with their ow n finance arms to funnel fun ds sou rced off-sho re. Th ese corpo rate banks are jo ining foreign banks, the IM F, and Indian industry to press for reform to free-up credit. This competition means th at, even w ith government paternal ism, each new reform measure, including this one on lending con-

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Financial risk management

JP Morgan's RiskMetrics By joseph Neu

Understanding the methodology behind Risk Metrics is an important first step for corporate risk managers.

Whil e or iginall y intended primaril y fo r finan­c ia l in sti t utio ns and fund m anage rs, th e release of jP M organ's Ri skMetri cs data and its accompany ing risk methodo logy comes at a tim e w hen many co rporates are looking to move up the ri sk management lea rning curve. "Th at was our biggest surpri se," notes jacques Lo nge rstaey, w ho hea ds th e M ark et Ri sk Research team that created Ri skMetri cs, "we expected commercial banks to be the biggest users and we ended up f inding as much if not more corpora te in terest. "

Th e fact th at co rpo rates a re eage r to improve their ri sk management is good new s for m any reaso ns. H oweve r, as good as Ri skMetri cs is, it is does not prov ide a com­pl ete ri sk management so lution, nor should corporates seek to use it w ithout f irst under­standing the methodology behind it.

Highlights from the "Technical Document"

JP Morga n has done a laudab le job of present­ing its methodology for quanti fying market ri sk and ge nerall y exp laining Ri skM etrics in its 1 00-page "Technica l Document" (soon to be posted on-line). The Ri skMetri cs methodology is a nea r equiva lent of the class ic portfo lio the­ory app roach (what academi cs ca ll a mean cova ri ance tec hniqu e), w hi c h i s w id e l y accepted as a standard for prudent ri sk man­agement. The fo llow ing are question s w hich summari ze the methodology and prompt gen­eral considerations for corporate risk manage­ment frameworks.

• What is our definition of risk? M organ defines ri sk as " the degree of uncertainty of

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India Eases Lending Restrictions Banks in India are being pressured to cope with market rea li ties.

page 7

JP Morgan's RiskMetrics Use the Morgan methodology to improve your under­standing of financial ri sk management.

page 7

PW's Financial Risk System A new PC application from Price Waterhouse makes use of RiskMetri cs .

page3

New UK Tax Regime for FX Pl anning advice to get book and tax trea tment for all FX ga ins and losses to match.

page4

FX Forecasting Fundamentals (Ill) A survey of empirica l evidence from acade­mia showing how forecasting works.

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Brazil Under the Real What Cardoso must do to keep in flation down.

pageB

The Back Page

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trois, wi ll be pushed to the limit. Thi s process will create a great dea l of volatility in rupee interest rates and increase the level of f inan­c ial innovation.

Unfortunately many banks in India, already at their limits financially, have little margin for error. Hence, corporates should consider the financial health of banks and its impact on credit line availability and counterparty risk.

Get credit assessments

Fo r a cu rrent road m ap of the best rated sources (and users) of loca l funds in Indi a, readers may w ish to refer to the Credit Rating Information Services of India Ltd . (CRISIL)[ Mr. G.F.R.K. Rao, executive director, phone: (9 1 22) 4939-445, fax: (9 1 22) 4939-441]. CRISIL offers debt rating services, credit advisory ser­vices, company reports, and micro-economic data, according to Managing Di rector Reav i Mohan . One of three rating services in India, CRISIL has been at it the longest-since 1987.

Credit rating services look to be a growth industry. Especia lly, if as Mr. Mohan predicts, partial convertibility of the rupee extends from the cu rrent account to the capital account, "prompti ng more interplay between the Indian and internationa l debt markets." This increased interplay w ill add further vo latility to interest rates and rupee/dollar parity, stoking market risk in add ition to cred it risk . •

The Best Banks in India CRISIL last ranked India's commercial banks fo r Business Toda y, a local magazine. The results, published in its December 22, 1993- january 6, 1994 issue li st banks accord ing to a weighted average score comprised of financial resul ts, operationa l ratios, phys ical parameters, and pro­ductivity ratios. The top ten were all foreign:

1. Bank of America 2. Bank of Tokyo

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3. ABN-AMRO Bank 4. American Express Bank 5. Citibank 6. Credit Lyonnais 7. HongKong Bank 8. Sakura Bank 9. Societe Generale

10. BNP

Correction: Branch coverage for the State Bank of India listed in the last issue as 11 should have read 8,69 1.

Country briefing

Brazil Under the Real How long can Cardoso keep inflation at bay?

Cardoso was elected to pres identia l office this month thanks to initi al success of the strong currency/anti- infl ation pl an he introduced as Brazil's finance minister. The introd uction of a new currency, th e Rea l, ha s succeeded in bringing infl ation down from a rate of 50% a month to 5%. Can this low inflation last?

Yes, say treasurers in Braz il , infl ation will be tame for until year end, but in 1995 it will sta rt to creep up. How quickly it returns " to nor­mal ," will depend on how we ll Cardoso makes use of hi s current political leve rage. Though unlikely, if Cardoso can move within the next six months to solve structural fiscal problems, he may end chroni c defic its and spira ling inf lati on for good. Th ree things are worth watching for:

• Fiscal reform. Government spendin g needs to be shifted to new sectors of the econ­omy and away from the loca l pork projects.

• Tax reform. About 80-85% of the taxes co ll ected in Brazil are pre-allocated to specific programs, making fiscal reform impossibl e without an overhaul of the tax regime.

• Acceleration of privatization. Tax reform, w ill not help until next year, so to pay for this yea r's budget the government needs to sell $7-1 0 bi II ion worth of assets .

Stay short and keep the flexibility to move as fast as possibl e as in f l atio n grows , say Brazilians, w hose in flation expectations have not fallen with nea r-term inf lation rates. .a

Masthead Changes: Several changes are taking place on our masthead at right. First, In ternationa l Treasurer is pleased to welcome two new corporate advisors: juanita Hinshaw, vi ce pres ident and treasurer at Monsanto and Hans Poh!schroeder, ass istant treasurer at Colgate-Palmolive. These two advisors replace Jean-Pierre Bourtin, who is now a fund manager with Bridges Capita l (an emerging markets bou­tique, in Greenwich, Connecticut) and no longer with Xerox, and M ichael O'Donnell, who is moving from his reg ional cash management post in Singapore to head a broader effort for Citibank in Korea. We wish to take this opportu­nity to thank Messrs. Bourtin and O'Donnell for their va luable support in launchi ng th is publica­tion.

Editor & Publisher joseph Neu

Associate Editor Donald Dunn

Professiona l Contributors Robert Herz

Associate National Director of Accounting and SEC Services

Coopers & Lybrand

Peter Connors

Director, Tax Services International Capital Market·s

Ernst & Young

Jeffrey Wallace Managing Director

Greenw ich Treasury Advisors

David Veres Partner

Rogers & Wells

Corporate Advisors Hans Poh lschroeder Ass istant Treasurer Colgate-Palmolive

David Rusate Assistant Treasurer

General Electri c

Arvind Sodhani Vice President and Treasurer

Intel Corp.

A. john Kearney Assistant Treasurer

M erck & Co.

Juanita Hinshaw V ice President and Treasurer

Monsa nto

Academic Advisors Lee Remmers

Professor INSEAD

Donald Lessard Professor

Massachusetts Institute ofT echnology

Richard Levich Professor

Stern School o f Business New York Universi ty

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International Treasurer/October 31 , 1994