Q U A R T E R L Y

INVESTOCRAFT

JULY 2012

NMIMS MBA Capital Markets

IN THIS ISSUE

Importance of Hammer Pattern in Technical Analysis

Poor Companies Rich Multiples

Merger Arbitrage

E-commerce Industry in India – A Look into the Future

Food & Beverages Industry – An Analysis

BASEL III: An Indian Insight

Will INDIA be really first in BRIC to get Junk status?

Glass Industry In India: The Crystal Clear Story

Battle of the Business Model

Yellow Metal, Yellow Fuel causing Economy Blues

Does Weak Currency mean Weak Government

From the Editorial Board

―Light at the end of the tunnel might be another train coming in the opposite direction."

The statement above sums up the action in the Indian Capital Markets in the last six months.

The SENSEX has oscillated from 15,500 levels in start of January this year to 18,400 and then

back to 17,100 in July. Some good news has been followed by series of bad news from all the

fronts.

Government Fails to Delivers

Markets had to suffer on account of an erratic and jittery government on various issues such

as GAAR and FDI in Retail. Inability of the government to push through reforms in critical

areas such as retail, pension funds, insurance and aviation has added to the woes. The

attempt to implement the GAAR in a retrospective manner has created apprehensions

amongst the foreign investors and maligned perceptions of the rule of law in the country. The

Rating agency, Standard and Poor‘s (S&P) raised alarm in April by reducing the rating from

BBB- stable to BBB- negative. A negative outlook would mean country is in danger of getting

reduced to a Junk status in the next one year. The agency has questioned a range of issues

such as lack of political focus, the deadlock in policymaking, the ambiguity on reform, an ―un-

elected‖ Prime Minister with limited power over the cabinet and the duality of power. In spite

of this warning, the government seems to be in state of denial and there seems to be little

action since then. Markets have reacted optimistically when the erstwhile Prime Minister took

over as the Finance Minister, and now it questions Dr. Manmohan Singh‘s prowess to

recreate the magic of the 1991 reforms.

Central Bank Handcuffed

The inaction from the fiscal side, high inflation and depreciating currency has handcuffed the

Reserve Bank of India from taking actions. The high inflation and high fiscal deficit has

ensured that central bank cannot cut the interest rates. The slowing economy, inability to

attract foreign capital and widening current account deficit has lead to weakening of the

Rupee. The 10-year bonds in India are yielding 8.15% as compared to 3-6% for Asian peers

such as Malaysia and Indonesia. In spite of the high yield, the government bond issue met

with cold response from the Foreign Investors. State Bank of India CDS spread on five-year

bonds, which acts as a proxy of Indian sovereign bonds among foreign investors, widened

significantly to 405 basis points on June 1st 2012 from 186 basis points on April 7th 2012.

With foreign investors factoring credit risk into the bond yield, it would be difficult for

government and Indian companies to raise debt from global funds.

Markets “Come Of Age“

One positive development in the Indian markets in the last few

months has been the rise in activism, a good sign of maturing of

the market. Even though India does not boast of any high profile

activists, the charge has been lead by large institutional

shareholders such as Franklin Templeton, The Children's

Investment Fund Management and investor advisory firms such

as Institutional Investor Advisory Services (IIAS) and InGovern

Research Services. India Inc has been confronted with

uncomfortable questions on a range of issues raised for

protection of minority shareholder rights such as sustainability of

its business model, amalgamation of associate entities with itself,

pricing of products and Intra-Group Merger. Rise of activism in

markets would remove skepticism about the Indian market with

regard to corporate governance and attract a host of global

investors. As we witnessed developments on this front in India,

USA raised the bar with the trial of Rajat Gupta for the insider

trading case.

These uncertain times are expected to last for some time before

the the Indian Markets get back to the secular upward trajectory.

These are exciting times to be in the market…

We would like to thank our readers and contributors for their constant support, wonderful articles and critical appreciation. It is this amazing response and encouragement that encourages us to improve. Kindly send in your suggestions and feedback to editorial@investocraft.com.

Team Investocraft

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Magazine/150607915074986

SENIOR EDITORIAL BOARD

MADUSUDANAN RAMANI (Editor-in-Chief)

ANKIT JOHRI

HARISH SV

PRIYA CHHABRIA

SIDDHANT ANTHONY JOHANNES

SNEHA AGARWAL

JUNIOR EDITORIAL BOARD

Deepesh Ganwani

Ishan Agrawal

Khushboo Shah

Pratik Jain

Ravi Srikant

Tanvi Mittal

Tejaswi Kns

Shipra Jha

Shwetketu Veer Jha

LAYOUT & DESIGN

Apeksha Shah

Siddhant Anthony Johannes

Importance of Hammer Pattern

in Technical Analysis

M UPENDRA KUMAR | NMIMS

The Japanese began using technical analysis to trade rice in the 17th century. While this early version of technical

analysis was different from the US version initiated by Charles Dow around 1900, many of the guiding principles

were very similar.

Formation of Candlestick:

To create a candlestick we need Open, High, Low, Close prices of the time period you want to analyse.

For a Hammer or an Inverse Hammer, the body will be smaller than the shadow and generally if one of the tails is

at least two times the body and the other tail is less than or equal to the body size. Hammer can be easily found

on a chart for a single day but a careful observation is required to identify two day and three day hammer or

inverse hammer pattern.

Hammer and Inverse Hammer give important indications regarding new support and resistance lines .The hammer

shown above has a small body when compared to its tail which means that there has been a lot of selling or

buying pressure and when prices were close to their extremes, investors started investing and the prices closed

near the opening prices.

Consider the pattern as shown in the figureb

When we observe the first trend line, we see that at both the ends of the trend line there is either a hammer or

an inverted hammer. It‘s a special case but it need not happen every time .Also formation of a hammer doesn‘t

mean trend reversal is going to happen. It can be seen in the chart that there are few hammers which are in the

trend continuation but not at the trend reversal. To act at a correct point, it is advised to look at the trend line and

next day‘s price movement .It should be kept in mind that trading takes place only if today‘s price movement

breaks the previous periods price range on the day hammer is formed.

Apart from single day hammer, two and three day Hammer can also be formed by using Open, High, Low and

Close Prices of all the three days .Body size will be the difference between opening price of the first day and the

closing price of the third day. The highest price of all two or three days is two or three day high and lowest price

of two or three days is the lowest price for the hammer. The trading strategy adopted for two or three day

hammers will be similar to the trading strategy applied to the single day hammer.

There is a high probability that some of the important candlestick patterns like morning star, Engulfing +, Harami

+ , Morning Doji Star +, Abandoned Baby+, Three Inside Up +,Three Stars in the South can form a 3 day

Hammer or Inverse Hammer .

The stocks traded based on this technique are for short term only and positions should be squared off as and

when the opportunity exists.

Note: If the pattern forms at the bottom of the trend line is known as hammer and if it forms at the peak it is

known as Hanging man. Similarly Inverted Hammer at the peak of the price pattern is known as Shooting Star.

Upendra Kumar is a 2nd year student of the MBA CAPITAL MARKETS programme

at NMIMS, Mumbai.

Email: upendrakumar.maganti@gmail.com

Linkedin - http://www.linkedin.com/pub/upendra-kumar/32/b15/148

POOR COMPANIES RICH MULTIPLES

PREETAM MITTAL | WELINGKAR INSTITUTE OF MANAGEMENT

A premium earning multiple is hard to come to a company and even harder to maintain.

In the recent times when everybody seems to be in a hurry, investors too have discovered a quick short hand for

their investment – P/E ratio.

Countless investors - individuals and professionals alike spend their time seeking out cheap stocks with very low

P/E ratios. Sometimes the stocks are cheap because they are not in favourable industries or have poor

fundamentals hidden within. As a result, the stock prices stay stagnant... sometimes for years.

But investors don‘t understand this fact and companies take advantage and modify the P/E ratio by various means

– the most common being -inclusion of debt in the capital structure. When companies are financially leveraged,

then the one with higher debt in the capital structure has lower P/E ratio and is preferred among its peers.

Exhibit 1

Leverage distorts the P/E ratio (Hypothetical case)

Exhibit1 clearly shows that, though both the company has same EV value, their P/E ratios have substantially

changed due to inclusion of debt. Taking the example of two companies Apache Corp and Anadarko

Petroleum, each of these energy firms in the year 2010 had an EV/EBITDA multiple of just over 5 (source:

investing answers.com) the average EV/EBITDA multiple in their peer group was just under 7. That seems to

indicate APA and APC were relatively undervalued.

But if you looked at Anadarko strictly on a P/E basis, you'd wonder why its shares hold any appeal, trading at

nearly 30 times its net income.

Why PEG is better than P/E ratio?

There are more detailed valuation models available in the market which seldom makes the headline. These are

generally the cause of concern for the senior executives as they claim that their company has great growth

prospects and many investment projects in hand. Actually, they are not necessarily wrong. Even financial theories

suggest that companies which have higher growth prospects should have higher earnings ratios and hence better

market value.

But the problem with the P/E ratio is that it's a retroactive metric. It pits a company's current market cap against

its trailing-12-month profit. But when you buy shares of a company, you are not purchasing its history – you are

purchasing its future cash flows. What matters is what the company is going to do and not what it has done.

So what's the solution?

The solution is to account for the growth rate of the company or expected growth rate if it can be estimated.

Thus, it gives birth to a new and better ratio - PEG ratio, the calculation is as follows:

PEG Ratio = Price-to-Earnings (P/E) Ratio / Annual Earnings per Share Growth

In fact, if one goes back a decade ago, then one may find that Apple's P/E ratio at that time was as high as 297.

So, anyone making investment on the basis of P/E ratios would not have considered it a very profitable

investment but had you bought shares of the company then, you'd be up over 7,300% today.

But, if someone calculated the PEG ratio it would be something closer to 1. A crude analysis suggests that

companies with PEG values between 0 and 1 may provide higher returns (closer to 0 indicates undervalued ).

Common manipulation techniques used by the management

There is another very common form of manipulation used by companies called the "big bath," and this can cause

these stocks to appear undervalued to investors. This happens when the company incurs a big loss to their

bottom line. This method involves the company taking the complete loss in one single period, instead of spreading

these losses over the years. This will cause the earnings per share to drop significantly for the time period

involved, due to the large losses posted. The intention of the company is to foster the idea among investors that

this charge is a once only deal, and that the stock will rise considerably after the loss has been absorbed. This will

cause investors to interpret the stock as one of the undervalued stocks, or as an attractive investment and thus

will cause the demand and the price of the stock to jump up.

One must always keep in mind that using P/E ratios only on a relative basis means that your analysis can be

skewed by the benchmark you are using. After all, there will be periods when entire industry will become

overvalued. In 2000, an Internet stock with a P/E of 75 might have looked cheap when the rest of its peers had

an average P/E of 200. In hindsight, neither the price of the stock nor the benchmark makes sense. Just

remember that being less expensive than a benchmark does not mean something is cheap, because the

benchmark itself may be overpriced.

These ratios are completely ineffective for cyclical firms that go through boom and bust cycles--semiconductor

companies and auto manufacturers and these require a bit more investigation. Although one would typically think

of a firm with a very low trailing P/E as cheap, but that can be the wrong time to buy a cyclical firm because it

means earnings have been very high in the recent past, which in turn means they are likely to fall off soon.

In a similar way, when you're looking at a P/E ratio, also make sure that the "E" part of the equation makes

sense. A few things can distort the P/E ratio. First, the firms that have recently sold off a business can have an

artificially inflated "E" and a lower P/E as a result. The denominator of the ratio can be easily manipulated by

changing the revenue recognition, depreciation and capitalizing cost methods the company have been following.

The company generally projects ―pro forma‖ earnings, which shows the profit the company would make in case

some bad/extraordinary event didn‘t happen. Consider the case of the attack on hotel Taj at Mumbai. It would

have surely affected its current earnings, but long term scenario remaining the same. Using Pro forma in those

cases makes absolute sense to get an overall long term picture. But there are companies which exclude preferred

stock dividends, taxes paid, bad investments, etc., and shows attractive pro forma earnings. Hence in general, it‘s

always better to forget about the pro forma earnings as more companies have come to misuse it, rather than

guiding the stock holders.

Sometimes, companies show an attractive figure as per-share earnings, but in the foot note they may take away

a major part of it as special charges. In such cases investors usually do not pay attention or are ignorant about

these facts but this ultimately affects the total earnings of the company and reduces the per-share earnings.

Sometimes the special charges may not be really so special and it may show all its operating expenses and even

losses as special charges.

Another common mistake made by investors in calculating the EPS is calculating it based on the number of shares

currently available in the market and neglecting the convertible debentures available in the market. Companies

generally issue fully convertible debentures in the market, which the debenture holder converts into equity share

when he/she finds the market lucrative. Here at any condition, one should only take the diluted earnings and also

check if the company has any plans to dilute further, as it may take away another piece from your pie.

Why management manipulates financial statements?

There are three primary reasons why management manipulates financial statements. First, in many cases the

compensation of corporate executives is directly tied to the financial performance of the company. As a result,

management has a direct incentive to paint a rosy picture of the company's financial condition in order to meet

established performance expectations and bolster their personal compensation.

Second, it is relatively easy to manipulate corporate financial statements because GAAP standards afford a

significant amount of flexibility, making it very easy for corporate management to paint a favourable picture of the

financial condition of the company.

Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the

independent auditor and the corporate client. While these entities are touted as independent auditors, the firms

have a direct conflict of interest because they are compensated by the very companies that they audit. As a result,

the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a

manner that will keep their client happy.

Moreover, auditors typically receive a significant amount of money from the companies that they audit. Therefore,

there is implicit pressure to certify the financial statements of the company in order to retain their business.

Conclusion

Are these ratios the ―be all to end all‖ for pricing a share of stock for a company? Of course they aren‘t. There are

a lot of factors that go into pricing shares of stock and so it's important to continually sharpen one's skills and put

new tools in the toolbox. It makes sense to go through and calculate different multiples such as EV multiple

(EV/EBITDA, EV/EBIT), PEG and Dividend yield ratio etc. for all current holdings and for future investments.

Preetam Mittal, the author of this article is a MBA student in Welingkar Institute of

Management specializing in Retail Marketing. He has completed his high school from Delhi

Public School. He is a B.Com graduate from Delhi University and has a work experience of

18 months in a retail firm.

MERGER ARBITRAGE ABHIJIT SINGH | NMIMS

Investment banks are not the only ones cashing in on the increase in merger activity. Well-known investor Warren

Buffet and investment vehicles including Hedge Funds and Mutual funds employ a conservative trading strategy

named ―Merger Arbitrage‖ based on event driven activity. Merger arbitrage involves profiting from the spread

created between two companies that are merging. If a deal is being done in cash, a portfolio manager will only

invest in the target company on the expectation that its stock price will rise to the level of its buyer. However, if

the deal is done for stock, the portfolio manager will still purchase the stock of the target while simultaneously

taking a short position on the buyer for protection. The idea is that the stock prices of the companies involved in

the merger will converge as the completion date of the deal approaches.

Merger arbitrage, or risk arbitrage as it is sometimes referred, is a strategy that attempts to capture a spread

between the price at which a company (target) trades after a transaction is announced, and the price at which an

acquiring company (the acquirer) has announced it will pay for that target firm upon closing of a transaction (at a

date in the future). The spread between these two prices exists due to the uncertainty that the transaction will

close on the same economic terms.

For successful transactions, the spread narrows to virtually zero by the transaction closing date. The size of the

spread itself will depend on the perceived risk of closing the deal as well as the length of time expected until the

deal is completed. In situations where the price of the target stock is higher than the original bid price, this will

indicate an expectation among investors of another bid being expected from the same acquirer, or potentially

from another bidder.

Different Approaches to Merger (Risk) Arbitrage

Depending on different parameters like the timing of the trade (pre-announcement or post announcement) and

whether the offer is cash offer or includes other variables, (e.g. fixed share offer vs. floating, pricing periods, or

collar structures, whereby the amount of stock offered may vary) a merger arbitrage manager will take up

different approaches to reap the benefits of the arbitrage situation.

Some managers will go short on the shares of the target company if they expect the deal to break. In such a case, the price of the target would fall to its pre-announcement level. Many things can cause a deal to break including the financial instability of the potential acquirer, poor

financial results for the target or a decision by regulators to block a deal for antitrust reasons. Other

reasons due to which a deal may not go through might include a material adverse change, a qualified

due diligence audit/review or simply a merger that has conditions that cannot be met. Shareholders may

also block a transaction or vote it down. Market liquidity can also have an impact on the probability of a

deal being a success. Private equity firms for instance, are active acquirers when debt capital is easily

accessible. However, if liquidity in the debt markets were to decrease considerably (i.e. interest rates

increase significantly), the ability of these financial buyers to access debt capital would be constrained

and the success of these deals might be negatively impacted.

Some managers will exploit situations involving acquisitions of bankrupt companies. Typically, these trades involve purchasing the bonds of the target firm, and exchanging them for cash or shares of the acquiring firm. This approach will generally see more activity during recessionary periods with higher bankruptcy rates.

Sources of Return for Merger Arbitrage

In a simple cash transaction where the manager takes a long position in the target firm, all of the returns will be attributed to the increase in the long position (less any borrowing costs, if leverage is used to finance the position).

In situations involving a stock deal, the manager aims to generate returns from both the long position in the target firm, and the short position in the acquiring firm. The sources of return become identical to those of a long-short equity trade, specifically:

Return generated from long position (in target firm)

+ Return generated from short position (in acquiring firm)

+ Dividend income received from long position

- Dividend payments made on short position

+ Interest earned on cash

- Short interest rebate

- Cost of borrowing shares

- Margin costs on short position

- Cost of leverage on long position

= Total Return (i.e. Gross return before fees)

As much of the market risk is hedged away, leading to a lower level of market exposure, leverage may be higher

than most other hedge fund strategies.

Now that we have an understanding of the concepts, it‘s time to put them to the fire. I chose to focus on two

transactions to see what the payout would be if I was running my very own ―Select Merger Arbitrage Fund‖. I

have chosen to focus on the price changes from the deal announcement date to the close of the deal date for

Sprint‘s merger with Nextel and Capital One‘s acquisition of Hibernia.

Transaction #1

Sprint (FON: NYSE) and Nextel (NXTL: NASDAQ) announced their $35 billion dollar merger on December 15,

2004.

Deal Type: Mostly Stock

Expected Recommendation: Buy stock in Sprint and Nextel

On the day of the announcement Sprint shares closed at $24.02, while Nextel‘s shares closed at $30.01(*Average

Price). Since the deal was structured to involve mostly stock, pundits of merger arbitrage would recommend

purchasing the stock of the target company, Nextel, while simultaneously shorting the stock of the buyer, Sprint.

However, since this merger is widely viewed as the marriage of two equals, I argue that arbitragers will haveto

add a page to the rulebook and purchase the shares of both Sprint and Nextel. The merger closed on Friday,

August 12th with Sprint shares up to $26.15 while Nextel shares closed at $33.32 for the final time. Since the

merger, Sprint Nextel have been trading under the former Sears symbol ‗S‘. Buying both stocks would have

yielded an average return of 10% over an 8-month period.

Transaction #2

Capital One (COF: NYSE) and Hibernia (HIB: NYSE) announced their deal for $5.35 billion on March 5, 2005.

Deal Type: 45% Cash & 55% Stock

Expected Recommendation: Buy stock in the target company, Hibernia

On Friday, March 4th, before the acquisition announcement, Capital One shares closed at $78.08, while Hibernia

shares closed at $26.57.

On the day of the announcement Hibernia shares jumped 21% to $32.24. While there is some inherent risk

concerning whether or not a deal will close, paying attention to the regulatory environment and shareholder

sentiment will help an investor identify any showstoppers. On Wednesday, August 3rd shareholders gave approval

for the Capital One acquisition. Shares of Hibernia fell 5 cents to $33.95, while shares of Capital One dipped 39

cents to $83.07 during intraday trading. It is clear that the strategy of buying the target company, Hibernia, in this

case would have generated 28% return over a 5-month period. Since the acquisition was not ―all cash‖ a

merger arbitrager would not have shorted Capital One for protection. In this case the execution plans mentioned

above apply.

Conclusion

The best way to stay on top of a merger arbitrage opportunity is to pay attention to the:

1. Regulatory environment - Will the deal be approved?

2. Interest rate environment - Where are interest rates headed?

3. Benefits derived from the deal - What will the market position of the combined company look like?

Merger Arbitrage is low on risk which means that investors are not likely to receive eye popping results like being

on the inside of the Baidu IPO but for investors seeking steady returns, this is a great place to look for parking

their dollars and cents.

Abhijit Singh is a 2nd year student of the MBA CAPITAL MARKETS Programme at

NMIMS, Mumbai. He has done his B.Tech in Computer Science Engineering from GGS

Indraprastha University, Delhi in 2011 Email: abhijitawake@gmail.com

Ph. No. 9987334257

E-commerce Industry in India:

A Look into the Future

SMITI SASWATI SAHOO |XLRI

Introduction

E-Commerce is a huge domain for conducting business over internet and e-retailing is a part of it. When we discuss digitally/Internet enabled commercial transactions between organizations and individuals using latest web technologies as per the policies of the Organization it takes the form of e-business. Nowadays, 'e' is gaining momentum and most of the things, if not everything, are getting digitally enabled. Thus, it becomes very important to clearly understand different types of commerce or business commonly called as e-Commerce.

E-commerce business model

The Digital Consumer industry in India has made a surprise rebound into the public eye. Over the last few months, reports of internet and mobile start-ups have become a regular feature in all forms of media. Deal activity has been growing at a frantic pace. There is excitement in the entrepreneur and investment community and most importantly, among consumers. If online travel and classifieds were the star performers of the last decade, e-tailing seems to be hogging the limelight this time around. Inevitably, valuations have become the subject of cocktail party conversations. This report is more about consumer oriented e-commerce market in India and the emphasis is on the main investment themes in digital consumer space.

Key Investment Themes Theme 1

E-tail (electronic retail) – a $12 billion opportunity: - E-tailing is the selling of retail goods on the Internet.

It is synonymous to B2C transaction.

By 2016, India‘s E-tailing market is expected to be $ 12 billion (with an expected CAGR of 82%) from the current

$ 590 million (2011); which would still constitute less than 2% of overall retail sales.

Growth of this sector is driven by –

1. Increase in online transacting users (Currently online shoppers including Travel account for only 30% of

internet users – 30 million but increasing @ 1.5 million per month)

2. Shift in buying patterns i.e. online consumption driven by mass marketing by e-commerce players

3. Online adoption of traditional brick-and-mortar retailers

4. Developing trust for online shoppers

Chinese Experience–Through 2005-2010, Chinese e-commerce market grew by 85% annually

E-tailers in India–

Flipkart.com - India‘s Amazon, started with books and now trades in multiple categories(revenue up 20

times in 2 yrs.)

Snapdeal.com – daily deal site, offers group discount, targeting ₹ 5 billion in FY2013

Other e-tailers: Letsbuy.com, Fashionandyou.com & 99labels.com

Theme 2

Classifieds – Emergence of the vertical specific businesses: - In India, though, print media is still growing.

Notwithstanding that, classifieds have moved online at a healthy pace and, at Rs 1,000 Crore ($225 million), it

accounted for 47% of the overall classifieds market in 2010.

India‘s online classifieds market to grow by more than 55% annually for next 5 yrs.

Classified market expected to reach closer to $700 Million by 2016.

Improved content & increasing traffic are the key inflection points for growth in the market.

Verticals in Indian Classified portals –

1. Jobs 2. Local search 3. Matrimony 4. Carsearch 5. C2C classifieds

(Naukri.com) (Justdial.com) (Shaadi.com) (Carwale.com) (Quicker.com)

Jobs and matrimonial services dominate the vertical classifieds market.

Theme 3

Internet advertisements:-

As per Edelweiss research, Internet ads are set to increase to more than three times to $ 800million by

2016 from the current spend (2011) of $255 Million.

Online branding to be the tipping point

Online Ad spend to be increased to 8.5% of the total ad spend by 2016. (Current 3.5%)

Key Drivers of Online Ads-

Increasing reach of online platform

Growing proportion of total advertisement budget

Healthy spend by e-companies to drive higher traffic

Key inflection point – when consumer companies (HUL, P&G) start using this medium for branding

purposes

High mobile penetration as a medium for increasing internet users

India top advertiser

Online advertisement market ‐ Primer

Globally, Internet advertising is a huge market with revenue of over USD63bn (2010) due to large Internet user base of 2billion plus. Further, online advertisement is perceived as best media for direct marketing. It essentially falls in three categories viz., search, display or classified ads. Globally, search is the biggest category followed by display and classified ads.

Social Networking: - Companies have been using this medium for advertisement and to be in direct contact with customers. In India too, social network marketing is on though it has been limited to brand building as of nowFacebook dominates while Orkut is losing market share. Discussions with industry players suggest Facebook is earning revenues to the tune of USD5mn‐USD10mn from India currently.

Online Gaming: - The Indian gaming industry is valued at INR10bn of which mobile and online gamingaccounts for INR4.2bn and console market for INR5.8bn. Mobile and online gaming is expected to increase by six fold to INR24bn by 2015 and overtaking the console market, growing at 40% plus CAGR (CY10‐15).

Online Payment: - Electronic payments in India have been growing at over 60% in the past three years. India has been one of the fastest growing countries for payment cards in the Asia‐Pacific region. India currently has

about 260mn debit and credit cards in circulation and transactions worth USD24billion in FY11

Macro environment analysis / PEST analysis of internet industry: -

Evaluating internet business model -->While evaluating an Indian internet business, relevant metrics under

consideration will change depending on the business phase i.e. early stage, growth stage and mature stage. Since

in the initial years, Internet businesses burn cash, traditional financial metrics like Operating margins and return

ratios may not be the right parameters to evaluate the business. Following are the evaluation criteria that

investors should consider at various stages of a business:

Current state of Indian internet market

Large market, low penetration

o Internet Penetration in India = 7% of population (17% of urban population)

o Global avg. benchmark figures = 31% of total population

Current users – 120 million

PC penetration – 55 million

Current internet penetration rate – 8.5% (India), 74% (US), 32% (china)

User‘s growth in 2010 yty – 23%

Over past 5 yrs. CAGR – 15% (Lowest in BRIC)

Key Inflection points – decreasing cost of 3G, Broadband & Smartphones.

Favourable Demographics- 75% of online population is between 15-35 age

Favourable Structural drivers -

Changing online user lifecycle

Better and cheaper access mode

Buoyant funding environment

Comfort on online payment

Rising income levels

Falling price of access device

E-commerce Market in India-

Currently India‘s B2C market – $10 Billion

75% dominated by Travel industry

Key inflection point in Indian e-commerce market has been Cash On Delivery payment method

Combination of business push and consumer pull factors are driving growth (key catalyst for e-commerce

growth)

Key Issues and concerns in e-tailing:

Order fulfilment issues

Logistics bottlenecks

Enabling infrastructure – low PC & internet penetration

Apprehension of paying online – security issues

Lack of touch and feel of the products while shopping

Major deals & investments in Indian e-commerce sector

Government Initiatives

Announcement of the Information Technology Act 2000 which puts in place a cyber-law regime in the

country

An integrated modern banking law of India is in pipeline

Announcement of National e-governance plan with a total outlay of $7 billion which is to be completed by

2014

Establishment of the cyber law and cyber security due diligence for banks in India

Kerala state government initiated 21 m-governance pilot projects in end 2009,including services like electricity and water bill alerts, filing policy complaints through mobile and audio guides for tourists at hotspots

Kerala government has also just launched a service called ‗Em-power Kerala‘ which enables delivery of all e-governance services on mobile

Himachal Pradesh had awarded contracts for 6 m-governance (mobile governance) services to Spice

Digital, which was to be followed by 6 more services Government initiative to issue Unique Identification numbers (UIDs) to residents through the UID

authority of India (UIDAI) to be helpful in banking & financial inclusion of those who are not able to access it yet

The National Payment Commission rolled out indigenous payment gateway services with the brand name

Rupay in March 2012, which would help save banks in India around 40% of what cost them to process

the payments through Visa & MasterCard

FDI up to 100 per cent is permitted for e-commerce, subject to the condition that such companies divest

26 per cent equity in favour of the Indian public in five years, if these companies are listed in other parts

of the world. However, such companies would engage only in B2B e-commerce, and not in retail trading

E-commerce: e-tail future prospects

Market size to grow 20 times in next five years

BCG study estimates 250 million PCs in India by 2016 which is 55 million as of 2011.

Success of Online travel market (attributed to Indian Railways‘ website - www.irctc.co.in)

Non Travel E-Commerce to grow to $12Billion from the current figure of $600million

4G broadband next game changer

Winners will be those who focus on improving key aspects of customer gratification through User

Interface & Smooth payment systems

Growth will be driven by:

o Increase in online transacting users

o Shift in buying pattern

o Online adoption by retailers

o Developing trust in online shopping

o Challenges exist in logistics and fulfilment issues

Conclusion

IT/ITES industry has consistently proved to be the ‗it‘ industry of the Indian economy driving it through the

moribund of the global economic trials and tribulations. It is high time the E-commerce sector cashed in on this

aspect and boomed big time to thrust the country out of the black shadows of recession enveloping the global

economy and thrust it into the next stage of all-round socio-economic development.

Smiti is a 1st year BM student, XLRI Jamshedpur. She has done her B.Tech in Biotechnology

from IIT Guwahati in 2011. She then joined Deloitte, Mumbai in the role of an Analyst.

She is deeply interested in Finance and intends to pursue Finance as her major in

2nd year at XLRI. She enjoys reading and music apart from following economic news.

Email Address: smiti.sahoo@gmail.com, b12054@astra.xlri.ac.in

Food & Beverages Industry

An Analysis

SOUMYA SARTHAK MISHRA | IIM ROHTAK

Food for Thought

Indians spend nearly INR17 trillion per year on food

Current per capita food expenditure in India is 1/6th of China and 1/16th of US

Only 12% of food is processed, much lower than 40% in China and 80% in Malaysia

Spending on processed food likely to surge by 4 times by 2020 from current INR2 trillion

Salty snack category poised to double over next 3 years

Higher failure rate for new launches in food than non‐food

Healthy + snacks= recipe for failure

Most food companies trade at higher PE multiples compared to non‐food peers

Potatoes corner nearly 75% of existing storage capacity, with meagre 1% for other fruits and vegetables

Introduction

India is one of the world's fastest-growing economies having an average annual GDP growth rate of 5.8% over

the past two decades. Food and Beverages (F&B), the largest category in Indian consumer spending, is expected

to maintain its dominance and have a great impact on the GDP of our country.

Food & Beverage Industry

• Packaged Salt • Wheat Flour • Rice • Spices • Edible Oil • Healthy cooking oils • Instant Food

• Noodle • Pasta

• Breakfast cereal • Oats • Cornflakes

• Salty Snacks • Chips • Ready to eat • Ready to cook • Ketchup • Pickles • Biscuit • Confectionery • Chocolate • Indian dairy industry

• Milk • Whiteners • Ghee • Yogurt • Butter • Cheese • Ice cream • Other

• Restaurant • Non Veg Foods

• Meat • Eggs

• Chyawanprash • Butter Alternatives • Sugar Substitutes

• Baby Food • Energy Drinks

• Powdered • RTD

• Health Drinks • Healthy snack foods • Digestive Biscuits market • Malted Food Drinks • 100% Fruit Juice • Carbonated Drinks • Powdered drinks • Lemonades • Coffee

• Instant coffee • Tea • Packaged drinking water • Natural mineral water

Food to outperform non‐food segments

The Indian food industry is poised to grow by a whopping 63.5% in next 5 years and by 137.8% in

next 10 years, throwing up huge opportunities for investment across the entire value chain.

Food and food products constitute nearly 40% of urban household spending and 36% of the

blended (urban + rural) wallet spent.

In the current share of segments in the FMCG sector food constitutes 46% of the total FMCG sales in

CY10 and is expected to reach to 52% by CY20E

Sales growth of ready meals is highest in India from CY03 to CY08 close to an average growth rate of

27%

The packaged F&B segment zoomed in past five years growing at a CAGR of approximately 18%

and Edelweiss expect growth trajectory to accelerate to 20% CAGR for the next five years.

Edelweiss expects branded products to grow much faster than the total F&B market growth.

For listed player‘s, revenues from Food segment (3‐year CAGR of ~19%) outpaced non‐food (3‐year

CAGR at ~17%).

Also, the profitability profile of food segment has turned superior to non‐food as the competitive intensity

is lesser in food as the penetration level and per capita consumption are extremely low.

Retail sales of ready meals in India and China grew 26.9% and 11.8% respectively from 2003 to 2008

compared to a meagre 2.8% in the US and 2.0% in the UK.

In absence of price increases, a smart product mix + positioning + supply chain efficiencies can help

offset inflation and boost profitability in the longer run.

HUL‘s increased focus on foods category bolsters

the thesis that food will outperform

other Consumer categories. HUL‘s

beverages, foods and ice creams

business accounts for ~18% of sales

while parent Unilever derives ~50%

sales from the same. The management

has stated its intention to expand its

foothold in the fast‐growing food

category.

The evolution and inflection of Indian

packaged F&B market will be driven by

several growth drivers such as

* Urbanisation : Rising urbanisation trend

* Demographics : Over 300mn people in the 25‐50 age bracket - 63% of India‘s population

expected to be in the working population age group by CY15

* Increase in population: India‘s working population (as a % of total population) is below that

of BRICS and G6 countries. By 2025, this would be ~960mn, surpassing similar statistics of

Russia and G6 countries. Increase in nuclear families and education levels led to women

stepping out of homes to work in full time jobs as well.

* Higher disposable income: Per capita income grew at a CAGR of ~14% between 2001 and

2010. According to Hewitt, India will see one of the highest salary hikes.

* Relocation to other parts of country: Market for ‗ready to eat/ready to cook‘ is picking up

(depends extensively on other Industries such as IT)

* Improvement in backend infrastructure : Reasons which have held the evolution of

back‐end supply chain include

High capex

Supply‐demand mismatch

High electricity rates as compared to the rest of the world

Supply Chain Constraints

Contract Farming

New players to expand market, ‘ready‐to‐eat’ may remain small

It is expected that the entry of several new players in packaged foods will expand the market size,

instead of cannibalising existing consumers.

In Nestlé‘s Maggi case where the entry of HUL, ITC and GSK Consumer just helped the noodles market

to expand.

As per ITC Chairman Y C Deveshwar, ITC will eventually enter dairy, tea, coffee and aerated drinks.

Indian women want to retain control over the kitchen

and taste. So while she will use cooking aids,

masalas, she is less likely to buy ―Ready to eat

Meals‖.

Several companies have recently announced the

intention to expand food portfolio in India, including:

* Delmonte, Cargill (I), HUL, Nestle, Mother

Dairy, Amul, ITC, Danone : dairy sector and

GSK : noodles and cookie segments

Opportunities

The Modern trade retail format brings lower prices to the consumers and drives higher consumption.

GST could be a game changer for larger companies: Indian companies use the services of 25 to 50

warehouses at the national level, which is a very high number compared to developed economies (less

than five).

Distribution network emerge as a key entry barrier

Expansion by MNCs turns heat on Indian counterparts

Multinational F&B companies were always fascinated by the Indian growth story, primarily led by the favourable demographic profile as seen by the early entry of PepsiCo, Coke, Nestle and Cadbury.

However, progressively more companies have become aggressive, initiating meaningful investments in the domestic market (Conagra via Agro Tech, Kraft tasting good success post Oreo‘s entry via Cadbury, Nestle investing in capacity addition and HUL savouring its focus on foods segment).

These investments though at nascent stage will eventually set the base for the next leg of growth. Most leading players are adopting a more localised business model, including India specific products (KFC

selling vegetarian products, pizzas selling tandoori variants etc) and a well‐spread out distribution

network. High demand for Food experts Edible oil category, dependent heavily for raw materials on imports, has seen surge of M&A activities with

major MNC companies acquiring regional companies especially at lower end. In March 2011, Cargill Inc bought the premium sunflower brand Sweekar from Marico

in a deal worth over INR2bn. In November 2010, the US‐based firm bought the Rath vanaspati brand from

Agro‐Tech, reportedly for INR1.2bn.

JVs getting more relevant and prompt Jubilant entered into JV with Dunkin Donuts, Tata Global beverages partnering with Starbucks, Godrej with Tyson Foods, Pepsi‘s association with Tata Global Beverages for bottled water and with Unilever for

ice tea

Competitive Analysis in F&B Category

Looking at the competitive analysis of listed players in the F&B segment we can conclude that share of

food as % of sales is the highest for Nestle, GSK Consumer, Britannia, Jubiliant foodworks and Agro Tech

Foods Ltd.

Overall going through different aspects such as Brand Salience, Intensity of Competition, Product Mix,

Distribution, Apetite for ad spend, Innovation and past success Nestle seems to be strongest followed by

Jubiliant Foodworks and then by Britannia.

The weakest amongst them is Pril followed by Tata Chemicals

Health, wellness key differentiators, but taste rules supreme

Most urban youth are getting more and more health conscious and with increasing urbanization this

trend is expected to gain momentum. The key trends are given below: Changing food habits due to rising income, mobility & working women:

Premium biscuits category is growing at a phenomenal annual rate of 25% to 30% compared to 8% in glucose and digestive segments due to higher affordability and changing tastes

India faces contrasting problems of facing one of the highest malnutrition cases and also being the

diabetes capital of the World. As per Edelweiss view, both of these are an opportunity for Food companies. Other issue on focus has been an alarming rise in obesity.

The big challenge is maintaining taste, where consumers clearly do not want to compromise. Taste remains of paramount importance to Indian consumers who would cut down on the frequency of consumption but without giving up on taste.

Companies are ready to experiment in breakfast, but prefer traditional diet for lunch and dinner

Juices, muesli and corn flakes are being steadily warmed to the Indian breakfast tables as seen in the rapid growth in the packaged breakfast market, which has doubled in the last three years, growing at 30% annually.

With the increase in disposable income, there is a marked inclination towards health foods. Some of the recent introductions include:

PepsiCo and Coca‐Cola have introduced ‗0

cal‘ as well as non‐aerated drinks

HUL extended Kissan to Soya Juice in

different fruit flavours (first time extension to a health platform)

Kellogg's launched All Bran, a 100% whole wheat ready‐to‐eat cereal targeted at women.

Britannia extended its health biscuit brand,

NutriChoice, to the Diabetic Friendly Essentials range after establishing it with the Hi Fibre and Multi Grain ranges. In the last three years, health and wellness (H&W) has become a key driver for Britannia and accounts for ~55% of sales.

Indian consumers refuse to compromise in food and health and these have emerged as key categories to register higher spending even in inflationary times, as per Boston Consulting Group (BCG). The study also highlights that the tendency to trade up in developing economies — such as India (34%), China (38%), Brazil (26%) and Russia (22%) — was much higher than that in developed countries such as the US (17%), the EU (15%) and Japan (9%).

What happened in China?

China with demographics, urban‐rural divide similar to that of India will provide good insight into

evolution of food industry in India. Chinese over the time have moved from accepting basic features to demanding value added customized

products, even if it comes at a cost. They are brand conscious but not

brand loyal. In 2011, domestic companies

continued to lead China‘s packaged food sales, with Mengniu and Yili ranked first and second respectively. Multinationals were in a weaker place in packaged food sales with Nestlé and Mars at the 9th and 10th

positions. In China, where diabetes, cancer

and other chronic illnesses are on the rise, people are growing more health conscious creating a fast‐growing market for

companies selling health foods. The extent of food processed is

significantly lower in India than most emerging and developing economies (12% in

India vs. 40% in China and 80% in Malaysia).

Need for supply chain efficiencies to help deliver value proposition

The agri‐supply chain in India faces several constrains. It involves multiple players such as farmer, aggregator,

commission agent, wholesaler and retailer, which results in price rise. Inadequate storage facilities lead to significant wastages (wastage is ~35% for tomatoes, ~30% for mangoes and ~25% for potatoes). High capex requirement for setting up cold storages and shortage of power are major hindrances to a ramp up in supply chains. Supply chain efficiencies will help offset rest of the inflation and deliver packaged foods as a value proposition to consumers. Through mega food parks, the government is creating necessary infrastructure and a viable ecosystem to enable cost efficient manufacturing of Consumer products. The government has already chosen public-private participation (PPP) mode for this scheme and has kept its stake to less than 26%. Future Outlook for India

Two‐three years view

Certain categories in the sector would tend to outperform the rest. Changing consumer habits, low penetration

level, increasing health consciousness among consumers and changing demographics make these categories the

best play within food.

Three‐five years view

In longer run there would be considerable shift in consumer habit and preference with Indian consumer moving

more towards convenience and health related products. A surge in consumption of cooking aids, ready to cook is

expected which would help the consumer reduce cooking time.

Edelweiss expects big opportunities in the following eight food segments

Staples: The almost INR3325bn category is one of the largest categories. Packaged part of this is expected to grow at a healthy rate of almost 18%. It can be further classified into packaged salt, packaged wheat, packaged rice, packaged spices and edible oil.

Snacks: This includes biscuits, namkeen, noodles, pasta, chocolates, confectionaries, Ready to eat (RTE), upma, poha etc. The snack food market in India is estimated to be worth INR409bn and growing at 15‐20% early. INR70bn unorganised sector is growing at 7‐8%. The Ready‐to‐Cook

market is estimated at around INR15bn. As this segment extends shelf‐life, making products

available off the market shelves, demand has been rising at a good pace.

Milk and milk derivatives: India is the world leader in milk production. Indian dairy industry is worth nearly INR3500bn with the unorganized market accounting for ~80%. Contribution from various categories‐

o Liquid milk : INR1610bn, o Ghee : INR426bn o Yogurt : INR245bn

o milk powder : INR123bn o butter : INR228bn o cheese : INR10bn o ice cream : INR35bn and o Other products : INR300bn

Indian dairy industry is still in its infancy and and expected to be the biggest packaged food category in next 10 years (size of almost 7042 bn) thereby benefitting Nestle, Britannia, Amul, Motherdairy and Danone.

Beverages: Total size is approximately INR260bn. India accounts for approximately 10% of the global beverage consumption, being the third largest market in the world after United States and China. Main Categories in the Industry include

Bottled water: The bottled water segment is estimated to be worth INR30bn. There are about 200 bottled mineral water brands in India and nearly 80% of them are local. Three key players who dominate the Indian bottled water market are Parle with Bisleri, Coca‐Cola India with Kinley and PepsiCo India Holdings

with Aquafina.

Health foods: This segment is likely to see one of the highest growth levels in the entire Food segment. It has many sub‐segments like Chyawanprash, Butter alternatives, healthy cooking oils, sugar substitutes,

energy drinks, Health drinks, Healthy snacks and High fibre beverages.

Non‐vegetarian food: The poultry market in India comprises of three main categories: meat, eggs

and processed value added products. Organised sector dominates the poultry market (meat and egg comprise 95% of this segment) with a share of 70%. With INR300bn, meat segment dominates the market while eggs market stands at INR150bn in size.

Restaurants: The total restaurant industry in India is ~INR430bn, comprising two distinct segments: the organized and the unorganized. The industry has shown a growth rate of 5‐6% per

annum with the organized sector estimated at INR85bn and growing at an annual rate of 20‐25%.

Investors have a huge appetite for Food companies

Increasing food consumption and the disposable incomes of Indian consumers have accelerated the growth of food sector making it attractive for PE investors. In the past 3 years more than 20 deals worth INR26bn have

taken place; and two IPO of major food companies which were both oversubscribed and opened at the upper price band. The budding enthusiasm of PE investors will help the sector to proliferate at a higher pace.

According to the report by Ernst & Young, in the last Q4 2011, PE

investors are increasingly focusing on the Indian food and beverage

space, particularly fine-dining or quick-service restaurant (QSR) services.

Consequently, there have been several PE deals in the QSR business

segment in 2011 — e.g., Faaso‘s Food Services received PE investment of

US$5m from Sequoia Capital India Advisors in Q4 2011. Other notable PE

deals in QSRs include an investment of US$55.7m by ICICI Ventures in

Devyani International (Q2 2011) — owner and operator of QSRs including

franchisees of Pizza Hut and KFC — and an investment of US$39.6m in

Sagar Ratna (South Indian cuisine QSR) by India Equity Partners Fund

(Q2 2011).

Moreover, as the QSR sector is expected to grow at a rate of

15%–20% over the next five years, several companies are expected to seek growth capital to increase their scale

of operations. Favourable demographics, including an increase in disposable income, combined with rapid

urbanization and eating out as an entertainment option have been the primary drivers of the growth in QSRs in

India. The QSR business has been growing at a CAGR of 35%–40% annually and is estimated at US$1.4b–

US$1.7b

Conclusion

India‘s burgeoning population is set to go past China, currently the world‘s most populous country by 2015. The

ever-increasing number of mouths to be fed means it is not just the staple food crops, whose productions needs

to stay in sync with the supply; rather for a nourishing and wholesome diet for the common man, it is imperative

that better all-round and nutritious food is produced and supplied equitably. From the above analysis, it is clear

that there is a tremendous potential for the Food and Beverage sector to grow and it needs to overcome the

hurdles impending its path to meet the growing demand of the ever-increasing Indian population at large.

Soumya is a 1st

year PGP student at IIM Rohtak. He has done his B.Tech in Mathematics and

Computing from IIT Guwahati in 2010. He then joined as a Technology Analyst in Finacle

division of Infosys, Hyderabad.

He has a deep interest in following all the economic news and loves reading literary

classics and swimming. Besides he takes a keen interest in writing articles on different

financial and economic aspects and have had had publications in journals, magazines and

websites.

Email Address: pgp02.116@iimrohtak.ac.in, soumyasarthak@gmail.com

BASEL III : An Indian Insight

JUBIN MOHAPATRA | DOMS,IIT-ROORKEE

Introduction

Before embarking on the depiction Basel III norms and their futuristic impact on the Indian Banks and Economy at large, let's start off with a simple question: What is a Venture? It simply means an undertaking which has inherent Risks and Returns . When some capital is invested in a venture; it is expected to yield some returns or benefits out of it. But the buck does not stop here, as along with returns come the rabble-rousers; the different kinds of risks that plague an investment.

Risks entail all potential losses which have detrimental effects on the expected output or the Returns. The risks can be quantified and analysed under many heads namely Market risk, financial risk, Operational risk, Credit risk etc. It is intrinsic to all the ventures from FMCG companies to Automobile giants to Non- banking financial companies to the most reputed of banks.

The 3 Basel Accords: Raison D’être

Basel Accords were created under the aegis of Basel Committee on Banking Supervision to provide various avenues of safety against the various credit, operational, market and liquidity risks vis-a-vis the liquidation of banks. The first round of deliberations was conducted in 1988 in response to the insolvency fiasco of Herstatt Bank of Cologne; which was attended and ratified by the Central Banks of G10 nations. It gave rise to the ―de rigueur‖ guidelines known as Basel I which elucidated the capital requirements to avert credit risks. The number of nations adopting it has since burgeoned to 100 worldwide.

In June 2004 followed the Basel II regulations; which broadened the horizon of Basel I to include banking laws and regulations pertaining to capital adequacy , arbitrage regulation , risk quantification , risk classification and risk sensitive capital allocation. The final version of this dictum entailed three ―Pillars‖ or Concepts namely: Minimum Capital Requirements, Supervisory Review and Market Discipline, catering to the different risks and their repercussions. It also included a framework of tools called Risk Management System to detect and deal with prima facie evidences of risks and fend off residual concerns like systemic, concentration, reputation and legal threats to avoid a financial tailspin.

However, Basel II has been sporadically criticised by a section of economists for having magnified the effects of the credit bubble. Basel II made it imperative for the banks to obtain credit worthiness ratings and loan risk evaluations from unfettered credit rating agencies. However these agencies in lieu of awarding honest ratings, swindled the credits awarded to weak Mortgage based Derivatives on beefy payments from the client bank leading to disastrous consequences. Since then Basel II has been appended and updated many times on the back of numerous financial turmoil and the sequence of reforms eventually culminated in formulation of Basel III regulations. The accord brought into existence during the year 2010-11 aims to plug the deficiencies which led to the late 2000 banking crises.

Base III: An Overview

Apart from bank‘s capital adequacy, stress tolerance and market risk pruning, the third Basel accord also sketches

out well defined contours of bank leverage, capital and liquidity requirements. It tries to reconcile the banking regulations with economic robustness to safeguard against the financial frailties. Some salient features of the latest accord are as follows –

The accord has five broad implications:-

The first dictum tries to improve the quality, eminence, consistency, and transparency of the capital base, by segregating the capital of a bank into 3 heads –

a) Tier I or Core capital( common shares , retainable earnings, disclosed reserves and equity ) ,

b) Tier II or Supplementary capital (Instruments in need of harmonization , Revalued and Undisclosed reserves ) and

c) Tier III capital (needs to be eliminated).

Second change strengthens the risk coverage of the capital framework by trying to marginalize the credit risk.

Third pillar offers a leverage ratio based system to entrench the Basel II risk frameworks.

Fourth point requires building up capital buffers during good times, on which the banks and clients can fall back on; during stress and instability.

Fifth one involves creation of a novel global liquidity standard; involving calculation of de facto liquidity coverage ratio, called Net Stable Funding ratio. It also limits the bad loans.

Indian Banking Sector, Basel III and Growth Scenario

After Reserve Bank of India pronounced final guidelines for Basel III commencing January 1st, 2013, and to be implemented by March 31st, 2018; speculations have been rife about its potential effects on the Indian GDP growth and whether or not the Indian Banks will be able to meet the cumbersome capital requirements. The potential trade off between preventive safeguards and languishing economic growth has been making rounds in the economic debate mills of the country. The cascaded effects of still to be tamed inflation, oil price hike, a free-falling Rupee and sluggish industrial expansion have only escalated the concerns.

So is the Indian Banking Fraternity ready for implementation of Basel III? Will it invigorate the economic and banking standards or will it worsen the already plummeting growth rate as well? Prima facie it seems like a conundrum, but an in-depth analysis reveals that the long term benefits outweigh the imminent shortcomings.

Graph showing spiralling Indian GDP , and Basel III might further accentuate the degrowth.

Source : www.tradingeconomics.com , Indian Central Statistical Organisation

Just like every leap of faith, this step also has both pros and cons. The downside begins with requirement of a massive capital raising by Indian banks, in the tune of Rs 1.67 trillion over the next five years to cater to their growth necessities and boost up their held capital. This figure is churned out from the new Basel III norms requiring a minimum 5.5 per cent in common equity stock by March 31, 2015 against 3.6 per cent now. Moreover creating a capital buffer by March 31, 2018 entails dilution of equity up to 2.5 percent. It has also hiked the minimum overall capital adequacy to 11.5 per cent as opposed to the current level of 9 percent. For now, the private sector banks like ICICI, YES, Kotak Mahindra etc seem to be in a comfortable position to meet the guidelines as compared to the public sector peers like SBI, who need large chunks of funding to mop up the required capital for compliance with Basel III.

Because of such a massive capital structure overhaul, the Indian banks will have to go for stringent loan disbursements which won‘t be helpful for the Indian industrial sector, which is in dire need of banking support to fortify its position. Moreover under the new norms, for every 1% increase in Non-Performing assets the Banks need to gather 25000 crore worth of back up capital. So the banks are expected to go harsh on loan defaulters and tidy up the sectors of economy where NPAs are proliferating rapidly like the critical Power sector and MSME sector; among others. Henceforth, any rate cuts expected from the chests of RBI will aid in boosting up the capital buffers of banks rather than accelerating the economic progress. All these factors might end up in a medium term reduction in growth rates of around .05 to .15 percent as per OECD studies and will most certainly have an adverse impact on the presently effervescent Indian economy.

With that being said, let‘s take a look at the vibrant side of things, the bigger picture.

As far as CAPITAL ADEQUACY is concerned, Indian banks are better placed than most of the foreign foils, to make a transition to the stricter capital regime. The seemingly draconian regulations set by RBI even after liberalisation of monetary policies, will actually work in favour of the Indian banks. The existing RBI norms are more stringent than the international Basel III standards, which mean that the equity capital ratio and capital adequacy ratio of rated Indian banks are pegged well above the required margins of 9% and 14% respectively.

Moreover recently the international credit rating agency Moody‘s and its Indian subsidiary ICRA have gone on records, stating that the conservative return on equity and higher cost of capital on loans adopted by Indian banks will actually be seen in a positive light after the implementation of Basel III and it will be CREDIT POSITIVE for the developing economy of the subcontinent.

A graph showing Bank Credit Requirements Vis- a -Vis held deposits

Source : http://www.thehindubusinessline.com , Article3405002.ece

Further the LEVERAGE RATIO under Basel III needs to be 3% to check derivative counterfeits and takes up cudgels against off the balance sheet trading .But the same ratio for Indian banks lies between 4.3 to 4.5% thus providing a hefty cushion and making it further easier and rudimentary to implement Basel III.

Moving on to the LIQUIDITY COVERAGE RATIO required to provide cash flow for stress period of upto 30 days , here also Indian banks are much well endowed as compared to the foreifgn banks given the traditional saving mentality and conformist practices. The liquidity requirements of Basel III can be comfortably offset from two major sources namely; Cash Reserve Ratio-CRR (4.75%) and Statutory Liquidity Ratio – SLR (24%).

The biggest yet untangible benefit will come in form of HEDGING against cyclic fluctuation in business market. Economic activities progress in form of cycles and banking system which operates in sync with the economy, is universally pro-cyclic . When the economy is zesty and rollicking, carried away by the booms, banks throw caution to the winds and disburse large amounts of loans , thus accumulating unbridled defaulting risks.During a dowturn as seen in case of housing bubble of US , these contraventions impede the very fabric of the banking system hurtling it into a spiral of abyss. The creation of additional capital buffers under Basel III would put some shackles on the unfettered bank-lending as sufficient amount of capital has to be preserved now. This restrain will smoothen the large swings when the business cycles go berserk, thus acting as a shield. India has already witnessed a few moderate tremors in the wake of Eurozone and US slowdown. Hence, for countercyclical measures to be proficient and effective, our banking system has to improve its ability to envisage the business cycles at sectoral , industrial and systemic levels.

Conclusion

There is a famous quote: ―Whatever was on the left-hand side (liabilities) was not right and whatever was on the right-hand side (assets) was not left.‖ This comment came in the context of Lehman Brothers, who foundered so shoddily that their assets were not even worth a fraction of their book value and their entire capital base was worn out. It simply exposed the decay that had crept into the financial machinery, as a result of loose lending, subprime mortgages, shadow financial institutions, speculations, large NPAs and insufficient liquidity buffers, which planted the seeds of the great downturn. In this light, Basel III can prove to be an earnest and triumphant attempt to avoid crises like the late 2000s. Basel III tries to ensconce the balance sheets of banks by enhancing common stocks of equity, creating capital buffers to absorb shocks, increasing liquidity of assets, marginalizing the leverages, improving transparency as well as the market discipline.

The famous adage ―make hay when the sun shines‖ is paramount in the case of Indian Banking fraternity. Given their secure position in contrast with the tumultuous west, coupled with rising diplomatic and economic clout of

India in world map, Indian banks are ever so ready to perk up their banking regulations by embracing Basel III. Yes, in the initial phases it will decelerate the growth fractionally but then again all good things come with a price tag .In the long run it will prove to be a prudent and constructive step as the strong balance sheets will make our banks resilient enough to withstand the financial quakes. Coup -de- Grace!!!

Smaller Banks like the afore mentioned , with limited assets will find it difficult to conform to Basel III norms ,

resulting in dearth of loan disbursal to the smaller industries.

Source : http://www.thehindubusinessline.com , Article 2205002.ece

Jubin is currently pursuing his MBA at DoMS,IIT-Roorkee( batch -2011-13 ) and is an

summer intern at Reserve Bank of India. He is a computer science engineer with a

penchant for issues pertaining to the broader spectrum of economy and finance. He is an

editorial member of IIT-Roorkee’s newsletter.

He also takes keen interest in music , cricket and various entrepreneurial activities. His

social entrepreneurship plan Shabda Shiksha Sansthan , which is meant for the hearing

impaired stratum of the society , has seen immense success and has won the best b-plan

award in multiple national competitions and was ranked among the six top b-plans in

Global Social Venture Competition, Asia-Africa regionals 2012.

Phone – 07417529633

Email-jubin59@gmail.com

Will INDIA be really

first in BRIC to get Junk status? KUSHAL KUMAR|NITIE,MUMBAI

Standard and Poor‘s - the global credit rating agency - has warned in a report to downgrade India‘s investments

grade to Junk status. According to the report, India could be the first fallen angel amongst the BRIC nations. The

warning of a likely downgrade had an immediate impact on the markets; the Sensex ended at 16,668 points,

down by 0.3%. The rupee fell to 55.74 per dollar after having opened at 55.10, up from Friday‘s close of 55.45

(dated 8th June 2012).

Some economists have questioned the content and timing of the S&P report, titled Will India Be The First

BRIC Fallen Angel?, which came some two months after the credit assessor lowered the outlook on India‘s BBB-

rating to ―negative‖ from ―stable‖. The mere speculation of Junk status has given latest blow to the Indian

economy which is already struggling with slower growth, ballooning deficits and political roadblocks to economic

policymaking—precisely the factors the global rating agency says could influence a downgrade. The rating agency

cut India's BBB-minus rating outlook to negative in April, meaning it expects to make a decision within a 6-24

month time frame

Report came on 8th June, by S&P credit analysts Joydeep Mukherji and Takahira Ogawa. As per Joydeep, ―How

India‘s government reacts to potentially slower growth and greater vulnerability to economic shocks may

determine, in large part, whether the country can maintain its investment-grade rating, or become the first ‗fallen

angel‘ among the BRIC nations.‖

The report also said that India had been able to boost investment in infrastructure in recent years, sustaining high

economic growth of around 8-9% during the three years following to the 2008 global slowdown. But a perceived

slowdown in government decision making, failure to implement announced reforms, and growing bottlenecks in

key sectors (including lack of reforms to archaic land acquisition laws that hinder investment) have undermined

business confidence‖, S&P said. ―And infrastructure problems, combined with growing shortfalls in the production

of coal and other fuels, have dampened

investment prospects.‖ As a case in point,

Mukherji cited example of more than a

seven-year delay in the proposed $12

billion investment in the steel sector by

Korean steel maker POSCO because of

―regulatory and other obstacles‖. They

also mentioned ―setbacks in economic

policy‖ because of ―strong opposition

from within the Congress party-led ruling

coalition, as well as from (the)

opposition‖.

BRIC

BRIC, an acronym coined by Goldman Sachs‘s Jim O‘Neill over a decade ago, stands for emerging economies

Brazil, Russia, India and China. The other three economies, which enjoy a ―stable‖ outlook, have higher

investment-grade ratings than India, where economic growth slumped in the March quarter to 5.3%, nine year

low. While India's credit rating is under pressure for a downgrade, fast-rising emerging market Indonesia is on the

up and has just joined the ranks of investment-grade nations. Many see it as the new "I" in the BRIC acronym.

(Image source: http://www.moneycontrol.com/news/features/bric-countries-hitwall_713021.html)

What IF India gets the ‗Junk‘ status?

A rating downgrade to junk status would mean that there would be an increase in the overseas borrowing costs

for Indian companies and the country‘s ability to attract foreign investment would be considerably diminished.

While the cost of borrowing will increase, India‘s borrowing capability will also be materially reduced, as certain

investors who only invest in investment-grade paper will shun India. ―There are certain pools of capital focused

only on investment-grade paper, which will then not be available for India-related paper,‖ said Vikram Limaye,

deputy managing director at the Infrastructure Development Finance Company. ―The other challenge is that after

these rating agencies‘ downgrade, the upgrade, while it is not impossible, always takes a much longer time to

come. According to Dipen Shah, who leads fundamental research at Kotak Securities, ―This could have a major

impact on overall fund flows which relies heavily on international ratings.

Though the impact of a rating downgrade will be contained to a certain degree because of India‘s limited

exposure to external debt, the lack of foreign capital and external funding will hinder growth, Mr. Limaye said. ―As

a country, we are dependent on capital flows,‖ he said. ―If you have to think about the planning commission‘s

estimate that over the next five years there is need for an investment in infrastructure of a trillion dollars, there

will certainly be a requirement of international capital both in the form of debt and equity.‖

Government‘s stand

Prime Minister Manmohan Singh's government has blamed much of the economic slowdown on outside factors

such as Europe's economic crisis. That is the case when about 93% of India‘s debt is locally funded and the

government‘s external debt obligations are only 24.3% of the total external debt. UPA has spent most of its effort

on corruption charges that have lost focus of policy norms.

Finance Minister Pranab Mukherjee, while admitting that Indian economy is struggling on account of global factors

feels the fresh rating action by S&P is unjust. It had rated India‘s long term sovereign credit rating to BBB(-) and

outlook to negative from stable on April 25. But from April 25 to June, no significant events had happened that

suggests that the economy‘s vulnerability to external shocks has increased.

Pranab Mukherjee said that S&P‘s recent report suggests that the main factor that would determine India‘s

investment grade credit rating is the ―government's reaction to potentially slower growth and greater vulnerability

to economic shocks.‖ He cited some positives for the Indian economy—the reversal of the interest rate cycle; a

revival in mining sector growth; progress on fuel linkage for coal-based power projects; a turnaround in the

quarterly investment growth rate, which had been negative in the third quarter of 2011-12; a normal south-west

monsoon being predicted; and a decline in international oil prices in recent weeks.

To have a breeze of relief, Mr Montek Singh Alhuwalia, Deputy Chairman of Planning Commission recently

announced in G20 summit at Los Cabos, Mexico that India has enough forex reserves to withstand a severe

shock.

Industries viewpoint

Amid rising concerns over the country‘s economic growth prospects, many industry leaders have raised their

voices to media and the government. Top business leader NR Narayana Murthy, co-founder of home-grown global

IT giant Infosys, has said, "Over the past 3-4 months, India's image seems to have suffered. As an Indian, I feel

very sad that we have come to this state. Unfortunately, we have created these challenges ourselves. It is self-

inflicted. There is nothing coming from outside. The good news is we can correct it. We have done enough

damage but could end up doing more damage," Another IT major Wipro's Chairman Azim Premji has said that "we

are working without a leader as a country. If we do not change, we would be down for years."

HDFC‘s chairman, Deepak Parekh said that the only thing holding India back at this juncture is ―lack of political

will‖ and investors can no longer be placated by talks of ―long-term fundamentals‖. Parekh, who had previously

also raised concerns over slow pace of economic reforms and lack of required policy measures, however was

optimistic that ―India has always been a country where investors need patience, but the rewards have been

visible. Though there are deepening doubts about India‘s ability to manage its future, companies with a long-term

vision still believe that the risk of not being in India is greater than the risk of being in India,‖

While the government has already rejected the concerns raised by S&P, Congress MP Mani Shankar Aiyar said

Premji and others are "representing a class interest and the Government of India represents a national interest".

Third person viewpoint

A government that knows its stability is not threatened for five years will still be kept under check by the various

signals it will get from time to time. As much Finance Minister Pranab Mukherjee‘s words provide comfort and

hope, there are clear indicators showing the diminishing growth of India. Bad news is that these circumstances

are caused by ourselves due to policy inactions; good news that we can still correct it before it‘s too late.

And on a selfish note, I sincerely hope to market get better by Q2 of fiscal 2013, so that more companies come to

our campus with bigger and better placement figures.

Conclusion

The best way to stay on top of a merger arbitrage opportunity is to pay attention to the:

1. Regulatory environment - Will the deal be approved?

2. Interest rate environment - Where are interest rates headed?

3. Benefits derived from the deal - What will the market position of the combined company look like?

Merger Arbitrage is low on risk which means that investors are not likely to receive eye popping results like being

on the inside of the Baidu IPO, but for investors seeking steady returns, this is a great place to look for parking

your dollars and cents.

Glass Industry in India:

The Crystal Clear Story NIRAJ SATNALIKA | IMT GHAZIABAD

Indian Glass Industry

The Indian Glass industry is primarily divided into four main segments namely-

Container glasses

Specialty glass

Flat glass

Fibre Glass

Container glass, as the term itself says is basically the segment which deals in the manufacturing of containers

which is of prime use in packaging for consumer goods and pharmaceuticals especially. It is the largest segment

in the glass.

Next largest segment is the specialty glass, which is used widely in technical applications such as electronics and

engineering. Flat glass segment comprises of float glass and rolled glass, and are used in architectural and

automotive applications.

The Indian Glass industry has been showing rapid growth across all segments. This growth has been primarily

driven by the growing automotive and construction sectors in which glass is used as a vital component. Likewise

the growth of the container glass industry is owed to the growing awareness about the hygienic packaging

requirement, ever growing population, and obviously due to the increasing per capita income of average Indians

and increase in standard of living. Incidentally, the per capita glass consumption is quiet low and is recorded at

1.2 kg, which offers tremendous scope for rise.

Growth in Container glass industry volumes

The growth of Indian market for glass and glass products in the past few years has been phenomenal. Efforts by

manufactures to create awareness among the users for glass have increased the demand further more. Many

international players are also entering the Indian glass market, thereby paving way for world-class standards of

quality. This is also a factor that is driving growth in this sector.

India's Rs 775 billion packaging industry has been growing at a CAGR of 15%, which is likely to increase to 20%.

The container glass industry constitutes 6-7% of the total packaging industry and has been growing at 7-8%

CAGR. Thus the container glass industry offers a huge growth potential, given the expected acceleration in growth

rate of glass user industries like automobiles, manufacturing, construction, pharmaceutical etc and low threat from

substitutes.

Talking of glass bottles, we can see it accounts for 10% of total packaging industry in India. The Rs 4500 Crore

sector is hopeful of shooting high and recording a double-digit growth. An immense potential is seen in the Indian

market which is untapped as is reflected in the per capita glass consumption of around 1.40 kg when compared

with 5.9 kg in China, 4.8 kg in Brazil, 10.2 kg in Japan and around 27.5 kg in the developed countries of the West.

Thus over a period of time due to the technological advancement and innovation in the industry like that of

flexible packaging, dating in outer packaging, lightweight glass products & also many new varieties of glass which

are much more mouldable then even other materials a rapid growth could be seen. Thus it can be said that with

technological advances along with consumer awareness an exponential growth for this industry is in the cards for

the coming years.The demand for glass containers in India outweighs supply on account of growing downstream

consumer segments like food processing, liquor, beer, construction and pharmaceuticals etc. The growth in

downstream segments, catalyzed by enhanced branding, will accelerate the industry growth in the coming years.

Due to the rising demand and low supply, a rising spree in import is seen and the net difference (export-import) is

going negative. The curve below depicts the trend of export and import along with net difference.

Figure I: Glass Exports (Rs. Crore)

Figure II: Glass Imports (Rs. Crore)

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Figure III: Net Difference (Rs. Crore)

The production of Bottle glass ware has slightly slided down by FY09 as against its production in FY08. The

production observed sharp dip in the month of February 09 but from then a rising spree is seen which has shown

slight improvement on sequential basis and recorded a respectful y-o-y growth.

The graphs below show the trend of production of Glass Bottles, Glass sheets and Toughened glass in India on a

monthly basis. It is clearly seen from the graphs that there is a tremendous rise seen in the production of

glassware in India. A growth of 23%, 39% and whooping 105% was seen in December 2011 as compared to April

2005 in Glass Bottles, Glass Sheet and Toughened glass production respectively.

Figure IV: Glass Bottles Production (in Tonnes)

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Figure V: Glass Sheet Production (in '000 sq. mts)

Figure VI: Toughened Glass Production (in sq mts)

Outlook for the Industry as a whole:

The rising costs i.e., the expense have given a major setback to the booming industry and have dented the

margins of the Indian glass sector. However as a corrective measure the major players have initiated price hikes,

which can help partly in restoring their margins. Also the competition from foreign players, where products are

available at a cheaper rate added fuel to the fire and the PAT margin has gone down largely for the players. The

graphs below clearly depict how the expense in industry has risen.

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Toughened Glass Production

Figure VII: Expense Growth (Percent)

Moreover owing to the rising sales and increase in prices, living standard and disposable income an effect can be

seen in the PAT margin as well. The graph below depicts the PAT margin since the year 1999 when it was as low

as -27.9% and has gradually seen rising trend to current 4.1 percent.

Figure VIII: PAT Margin (Percent)

As a matter of fact, while considering strong demand growth projections for the medium term, the industry is in

the midst of capacity expansions and introducing new advanced technologies which can help them in competing

with the foreign companies. The Glass industry in India is poised to grow rapidly owing to the fact that the

disposable income in the nation is rising, an increase in consumption level is seen and also higher penetration

level.

The slowdown in the demand of glass came due to the sluggishness in key glass user industries like automotive

and construction etc. Now with interest rate hikes over, and India which is again entering the phase of peaceful

growth, interest sensitive sectors like automobile, construction etc will witness acceleration thus leading to the

growth in demand for glass which would add glow to the Indian glass sector. The graph below depicts the sales

growth of Glass and Glassware companies which clearly shows that after the slowdown in sales (falling trend)

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PAT Margin of Glass & Glassware Companies

seen during the period of 2009-2010, the glass Industry once again has started booming and will soon be the talk

of the industry.

Figure IX: Sales Growth (Percent)

Substitutes

Glass has been facing tough competition from its substitutes. Container glass industry has been facing rising

competition from segments like PET Bottles, Tetra packs and Cans due to factors like weight and fragility. But on

the other hand adding to the ray of hope for the industry it is said that the threat is unlikely to impact the demand

potential for container glass industry due to the superior properties of glass as compared to tetra packs and cans.

Being chemically inert material glass provides better storage quality to food, beverages and medicines and helps

in preserving moisture, taste and increases the life duration of products. Glass is suitable for storage in tropical

countries like India and can be easily recycled and reused compared to PET (non biodegradable) and tetra packs

(uses metal and paper). Plastic packaging is banned due to environmental concerns, which augurs well for the

container glass industry.

Also the most important pro for the Container glass is its low cost packaging option. In the beer and soft drinks

segments, reusability is seen as the bottles are re-used multiple times and thus helps in cost reduction.

Statistically it is found that cost per use of a soft drink glass bottle works out to Rs 0.3 as against Rs 1.5-1.8 for a

PET bottle and the glass bottle can be recycled after being used 15-20 times. It is found that recycling by using

old bottles as cullet helps to achieve up to 40% saving in power consumption. Glass bottles still continue to rule in

the soft drinks and beer market.

Industry expectations

The graph clearly shows the kind of expectation one can keep on the glass Industry. The rising trend of Glass

Index since 2008-09 slowdown is an indication of the light at the end of the tunnel. Also the market capitalisation

of the scripts is showing a steep rise. Thus the future of the Industry is seen bright.

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Sales Growth of Glass & Glassware Companies

Figure X: Glassware Index (Numbers)

Figure XI: Market Capitalisation (Rs. Crore)

Government of India which is on the verge of releasing its 12th Five year plan for the year 2012-2017 and also is

going to the release its Union budget for the coming financial year of 2012-2013 All India Glass Manufacturer's

Federation (AIGMF) which is the Apex body of Glass Manufacturers, to sustain the targeted growth rate of the

industry, has put forth its suggestions for the consideration of Government in the Pre Budget memorandum. Some

of the key points are:

To lower the excise duty on various commodities

Abolishment of the customs duty on the important raw material Soda ash, which is the main component

used in glass manufacturing

Uninterrupted quality power supply to be made available and also supply of natural gas at uniform

pressure should be made available from GAIL.

Reusability Ban- Ban on use of old bottles should be strictly enforced. Also it should be ensured that

sanitization procedure of bottles is strictly followed

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Conclusion

The Glass bottle producers can hope for improvement in natural gas availability, as gas production of Reliance

Industries in it KG D6 basin improves. The glass user industries like liquor, food processing, Pharmaceutical too

are witnessing decent growth, and considering low penetration in India, glass bottle producers can reap demand

growth benefit. However, there are attempts to increase use of flexible packaging, even in traditionally bottle

packed segments. The industry is adopting itself to this reality by improving the functional properties and of glass

bottles, not only as a mere packing tool, but also by aiding in marketing / differentiating the product.

Future of the industry Is as clear as a glass

Niraj is pursuing his PGDM-International business (Finance) from IMT Ghaziabad. He is a

Member of the Placement Committee.

+91-8826.890.760

nirajsatnalika@gmail.com

Battle of the Business Model

PRATIK SALIAN, ANKIT JOHRI | NMIMS

For over a decade the poster boy of Indian IT sector, Infosys, led a charmed existence. The Bangalore based IT

firm known as the IT bellwether had built a reputation to under promise and over deliver on the results front. It

now appears that Infosys has hit a roadblock.

Infosys has been struggling since quite some time and things seem to have gotten worse on Friday, April 13th

when the 4th quarter results for FY11-12 were announced. Infosys had delivered a shocker. The company missed

its revenue forecast for the quarter and the year. It said its revenues would grow between 8 and 10 per cent in

FY12-13, significantly lower than the 11-14 % growth that Nasscom had predicted. The market hasn‘t taken this

news kindly and punished the stock relentlessly.

So what has gone wrong with the Infosys story?

Analysts say that Infosys has failed to keep pace with the changes happening outside. It‘s one thing to reach the

top and another thing to stay there. Infosys is clearly struggling to stay there. The thing that had worked in favor

of Infosys now seems to derail its growth story. Strangely enough the reasons for its success in the last decade

seem to be the reason for its current problem.

Throughout the 1990s Infosys had perfected the global delivery model (GDM). It concentrated only on the US and

Europe. It focused on becoming a leader in just a couple of sectors — BFSI (banking and financial services) and

manufacturing, and it delivered excellence in a few areas of IT services — package implementation, application

development and maintenance (ADM in industry parlance) and testing.

Infosys was a pioneer in many of these fields. Also because of its excellence in process and in house systems, it

was able to charge a premium over other Indian IT companies. Even after charging a premium its costs were

much less compared to the global IT service providers like IBM and Accenture. One of the main reasons for this

was the human arbitrage factor that Indian companies enjoyed.

This premium pricing led to Infosys maintaining a higher EBITDA margin than its peers. Infosys has over the years

maintained this high margin of over 30 percent. It would not go in for deals with lower margins and was very rigid

with its pricing.

This model worked for them very well till around 2009. Post 2009 things in its main market, US, changed. Clients

were now looking at getting the maximum out of their IT deals and were looking at reducing costs.

Rise of the mid-cap players

Post 2009 some of the then smaller companies like Cognizant and HCL have caught up with the Big3- TCS, Infosys

and Wipro. In fact Cognizant has replaced Wipro as the third biggest player and very soon will also replace

Infosys.

Ebitda margins of some of the Indian companies

Jun11 Jun10 Jun09 Jun08 Jun 07 Jun06 Jun05

Infosys 36.03 37.67 35.05 34.67 34.16 33.99 35.52

HCL 23.79 29.57 29.27 23.23 32.52 25.84 26.93

TCS 30.93 29.22 24.51 28.79 29.80 29.51 27.71

Source-mvxenius

As you can see from the above figures, Infosys has always been a big margin player operating in the 30 percent

or above region. Companies like HCL and Cognizant have been able to eat into Infosys‘ market share because of

the premium strategy followed by Infosys. These companies are gaining at the cost of Infosys.

Critics feel that Infosys is overly focused on service delivery and not enough on the top line numbers; that it only

focuses on maintaining margins at the expense of getting new deals. Smaller rivals Cognizant and HCL are

winning market share partly due to Infosys‘ reluctance to reduce prices in a difficult market.

―ADM is quickly becoming commoditized. Everyone of a certain scale can deliver services of nearly the same

quality and cost," says Vineet Nayar, CEO, and HCL Tech. As a result of this Infosys is losing its premium position.

The 850 billion IT industry is looking at a smaller growth rate in future. In such a scenario, when clients are

cutting down on the fresh contracts, the big opportunity lies in the churn of existing contracts, which will need a

slightly different business strategy.

As per outsourcing advisory IDG‘s numbers, of the $207 billion worth contracts up for renewal in the next five

years, only 16% are in ADM; 36% is in IT infrastructure services and 48% is in total IT outsourcing.

It seems that companies like HCL and cognizant are chasing this market and Infosys has been left behind.

Is it all about the business model?

Infosys‘s focus on the ADM model has become outdated. If all companies recruit from a similar set of colleges,

work with similar clients and are capable of delivering the same output then there is no scope to charge a

premium. The entire ADM business has become commoditized now.

"This is a battle of business models, not of individual companies," says HCL CEO Nayar. "We are the No. 1 player

in three of the four markets we are in and application development is a must to undertake total IT deals."

In turn, Cognizant has focused on four industries and tried to assimilate service delivery lessons from India based

vendors and also build consulting muscle like IBM. R. Chandrasekaran, President and Managing Director of

Cognizant says, "Our strategy focuses on winning as many customers and broad-basing our range of service

offerings across mature and emerging verticals."

16%

36%

48%

0%

Contracts up for reneval in the next 5 years

ADM

IT infrastructure services

Total IT outsourcing

Strategies used by some of the Indian IT players

Mergers and Acquisitions

Also over the years Infosys has followed a very conservative approach. It has a cash pile of close to 4 billion which

is almost 50 percent more than that of TCS. Yet the company has been very slow in acquisitions. It has preferred

the organic growth method.

At the same time its peers have acquired companies and have gone ahead with Inorganic growth.

1: TCS‘s acquisition of Financial Network Services (FNS), an Australian core banking Solutions Company, led to the

evolution of the ‗TCS BaNCS‘ product, which is used extensively in the industry.

2: HCL acquired Axon in December 2008 for about USD 660 million. The acquisition was directed at blending the

SAP practice of target with existing capabilities of acquirer and come up with productized solutions for large

transformational engagements. The acquisition was able to help the company expand its revenues from this

stream to reach USD 718.0 million in 2011 accounting for 21.3 percent of company‘s revenues.

The other side of the story

Infosys has been in the industry for over 30 years and has arguably been one of the reasons for the tremendous

growth of the sector in the last decade. With so many years of experience in the industry, Infosys would be aware

of its current problems related to its margin strategy. So what is Infosys‘s view regarding their margin strategy?

and why does it persist with this strategy? Infosys CFO, V Balakrishnan believes that Infosys is the pricing

umbrella for the entire industry. According to him, if Infosys reduces its price, then the entire industry will suffer.

Shibulal who is the current CEO also shares similar views. He feels that the easiest thing to do would be to reduce

the price now and reap the benefits. This might work in the near future but as the compensations are increasing

and clients keep on demanding more value for their money, it would be difficult to maintain these low prices in

the long run. Also the reduced pricing will create a price war amongst the top players which cannot be good for

the

HCL

• Early switch to non linear model

• Focus on enterprise apps and remote infrastructure management

• People First -Customers second approach

• Importance given to Market share

Cognizant

• Relationship based approach

• Aggresive sales investment

• Leadership in chosen areas

• Winning market share

• Importance given to acquitions i.e inorganic growth

TCS

• Deals in diversified area

• One Stop shop for all service

• Large geographical footprint

• Capture emerging markets like china,India and latin america

industry. Shibulal believes that Infosys has taken the right route which is not necessarily the easy route.

The way forward: Non Linear Growth

Infosys‘s goal is to migrate to higher value offerings to maintain its ability to charge premium pricing. The

company is planning to achieve this by gradually shifting to products and platform based solutions. The role of

intellectual property is very important here. Also all these solutions would be sold through a consulting led-

approach which will help the company to move on to a higher value chain.

It looks like Infosys is trying to move from a linear growth model to a non-linear model. Over the years the

revenues of IT companies increased proportionally to the number of employees working in the company. This is

called a linear growth model. Given the challenging IT environment, the linear growth model is neither sustainable

nor desirable and companies are shifting to a non-linear model.

In fact, companies like HCL Tech, shifted to this new model quite early. Infosys is beginning to catch up now. The

revenue per employee figures of global companies is currently much higher compared to their Indian

counterparts.

. Source: Non Linear Model, KPMG From a very long term perspective, Infosys might try to match these levels but as of now it looks difficult. For

now, Infosys‘s management is confident that they are on a right track and 2-3 disappointing quarters would not

change their long term strategy. And as they say, the success of your business strategy can only be judged in

hindsight. Let us wait and watch as only time will tell whether Infosys can re-establish itself as the bellwether of

the IT industry.

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

2006 2007 2008 2009 2010 2011 2012

USD

MIl

lion

pe

r e

mp

loye

e

Year

Revenue and employee growth- Global IT vs Indian IT

RPE-Indian Firms

RPE-Global IT Firms

Yellow Metal, Yellow Fuel

causing Economy Blues VIBHU GANGAL | SCMHRD

A significant reason for the recent fall in rupee is attributed to macroeconomic deficiencies of India.

The article below analyses the same and tries to establish a relation between the steep fall of rupee

and the general tendencies, trends and situations prevailing in India that affect the economy

eventually.

The demand equation states that the aggregate demand (and the national income at equilibrium) is

an algebraic sum of consumption demand, investment demand, government expenditure and net

exports. The moment we say 'demand', it is backed by money and indicates a destination where

people roll out the money they possess. If this money is spent to fulfil any of these demands which

add up to the national income, it’s a positive sign. The more this happens, the more the country

grows economically, the more is the national income, the stronger is the home currency. One

scenario, where possession of money with individuals of a nation can harm the economy, is when the

money possessed gets expended big time towards imports, which makes net exports and overall

national income negative, leaving the investment demand of the nation unquenchable. A similar thing

seems to have happened in India. Let’s take a closer look at its causes and implications.

Consider an analogy, where we have a dam constructed with an aim to irrigate fields. It has some

water collected in the reservoir. This water flows to the fields through channels. Thus, it’s the

channels which ensure that the water in the dam gets utilized for growing crops and not for domestic

purposes of farmers' households. Had the channels being broken and had the water been routed to

households instead of fields, crops could never have grown due to lack of water and the production of

the territory could have taken a severe hit. The water is equivalent to liquid rupee with the Indians,

crops to the GDP, and channels to the government regulations and policies. In India, a major part of

money (water) is spent in buying volumes of gold by families (household demand). If gold was

available in India, the tendency of buying gold would have created better circulation of money and

the multiplier effect would have done well to the economy. Unfortunately, out of 902 tonnes of

domestic annual gold demand, India produces only two tonnes and the rest 900 tonnes is imported.

More the demand for gold, more are its imports, more is the payment in dollars, more is the influx of

rupee in forex market, more is the outflow of dollars from forex market, more depreciates the rupee,

more expensive becomes any imported item including gold. This self-feeding spiral continues and

raises ringing-alarm-bells when it reaches a stage where RBI cannot save the rupee by adhoc

workarounds like selling dollars and "trying" (rather struggling) to induce more FII participation.

Indians have imported gold worth $61.5 billion (or around Rs 341,000 crore) in 2011-12, recording a

growth of 44.4 per cent during 2011-12. Same is the case with petrol. A consistent surge in demand

eventually causes the same vicious circle of events. Together, gold and petrol are the biggest burden

on trade deficit and have worsened current account deficit badly, causing the sharp decline in value

of rupee vis-a-vis dollar. The trade deficit during 2011-12 was recorded at $184.9 billion than $118.7

billion during 2010-11 mainly on account of large imports of fuel, gold & silver accounting for 44.4 per

cent of India’s imports. Reports suggest that gold imports contributed to almost one third of the

incremental rise in Current Account Deficit over the 2008-2011 period.

Directly, gold contributes 0.36% to inflation index. Indirectly, it makes all imports including crude oil

costlier fuelling input costs for all industries ranging from plastics to automobiles. If the input costs

rise, so have to be the prices of finished products. Eventually it’s the inflation which kicks off. The

time lags between rise in gold demand, rise in import prices and rise in end product prices make the

three events appear disconnected to the general public and as the "safest" option, we end up blaming

the government without any knowledge of ground level proceedings. Arithmetically, every dollar

reduction in international oil prices translates into a cut in product price by 33 paisa. But every time

the rupee depreciates against the US dollar by one rupee, it translates into a requirement to raise

prices by 77 paisa.

More the demand for gold

More are its imports

More is the payment for imports

More is the influx of rupee in forex market

More depreciates the rupee

More expensive becomes any imported item

including gold

Another aspect is that with booming inflation, with industrial products being costlier than earlier,

why would a buyer in international market prefer buying Indian expensive goods when the same is

available at a lower price in other countries? Together, with imports already being discouraged due to

sharp depreciation of rupee, this fall in exports due to inflation exacerbates the trade deficit causing

further decline in rupee value. It all gets again into the self-feeding loop discussed above.

So, where do we break this infinite-loop of events where every step, every action has a well justified

reason behind it? But somewhere, somehow you need to break this to get things in place. Weakening

or breaking one block might give a temporary relief to figures, but in long run, this would cease

growth. Instead, if every link in the chain is made to melt down in terms of its prominence, it’s just a

matter of time; the whole chain shall cease to be prominent. What I wish to convey is instead of

unplanned adhoc and short-term steps like giving subsidies on fuel prices and making efforts to

attract hot money sources, this nation needs to plan for a durable strategy which would 'subtly' and

'indirectly' bring about relatively stiff and lasting changes in the economy. Here’s what I mean to say…

Whenever individuals hold disposable rupee, government should ensure that substantial part of

rupee either gets invested into banks, corporate bonds, government securities and the share market

or it gets to quench 'domestic' consumption demand of goods and services. Let’s remember in a dam,

it’s the channels which ensure the usage of water in desired way and ultimately govern the

production. Whenever it’s expected to have an enhanced liquidity among individuals, the

government should make capital investment attractive. This would trigger the multiplier to take

effect and eventually translate liquidity into growth. As far as demand for gold is concerned, it can be

discouraged by raising customs duty exorbitantly. Buying gold should be made at least half as tough

as buying a scooter was in late 1980s... Even if the demand for gold reduces partially, this would

mellow down dollar appreciation and prevent further damage.

On the other hand, the consumer who demands gold and oil so excessively, needs to understand that

if he chooses deliberately to intensify imports, he is fuelling inflation to such an extent that he himself

is going to get in trouble. A major reason for S&P indicating to downgrade India in terms of its

investment-grade rating was a drought of investment opportunities in India. With Indian businesses

borrowing big-time from foreign sources, with other events increasing imports and causing rupee to

depreciate, Indian borrowers will now pay more for every dollar borrowed. With every firm

borrowing millions of dollars, the rupee loss is going to be phenomenally huge and shall reflect on a

cost-cutting approach by companies' management which shall also include a cut in salaries.

Eventually, a self-check on surge of gold demand can help prevent a number of significant things.

Recently, after a lot of hue and cry on oil price hike, the government declared a subsidy on petrol

price. I say why? As a long term plan, the government should let the petrol price rise so that vehicular

usage takes a hit, even though the hit is marginal. Towns, where bikes and cars are favorites for

personal transport, should be picked up and transformed into towns with a quality mass public

transport, quality in terms of speed, frequency, availability, ambience, approachability, grievance

handling mechanisms and any and every aspect which makes mass transport well-preferred and

equal in status vis-a-vis individual vehicles. This shall help in fading the rise in demand for crude oil

and so shall prevent the rest of the spiral.

One may say that it’s the gold which facilitates loans and so fosters investment. But one misses to

note that at the time of repaying the same loan taken against gold, the value of the money repaid

plummets so much that the good done by the investment gets offset substantially by severe inflation,

the root cause for the good and the bad being the same. One may say that if investment in India is on

a backseat, why doesn't the government invest? But one misses to note that it would be dumb on the

government's front to do so, as it is already burdened under a budget deficit of 5.19 percent and any

further disbursement of money would widen it more. One may say that subsidies on fuel shall be

continued for some more years as the inflation is cost-pushed and not demand-driven. But one

misses to note that it’s the demand which drives the entire spiral discussed above and it’s the drive of

this demand which ultimately coverts into a cost-push inflation. Thus, it’s high time now that the

administration of the nation gets into a patient and consistent mission of correcting the fundamentals

of economy at a macro-level with an aim to bring about a long-term change.

Vibhu is a student of SCMHRD, Pune and has been writing many analytical

articles related to exchange rates and financial statement analyses of different

companies, published in various finance magazines.

Email id: vibhu711@gmail.com

Does Weak Currency mean

Weak Government? ASHISH AGARWAL NMIMS

Before answering this million dollar question, I would like to give a brief introduction about exchange rates and

how they are determined.

Exchange rate is defined as the value of a country‘s currency in terms of another country‘s currency. Exchange

rates are determined through forces of demand and supply. For example the dollar-rupee exchange rate will

depend upon how the demand-supply forces move. When the demand for dollars in India rises and supply does

not rise correspondingly, each dollar will cost more rupees to buy.

Where does this demand/supply come from?

Sources of Demand: -

Importers who need Dollars (foreign exchange) to buy goods and services.

Another important source of Demand is Companies / Individuals investing abroad.

Companies sending profits back to their home country.

Sources of Supply:-

The Exporters who sell goods and services and earn Dollars (Foreign exchange)

Companies / Individuals investing into Indian markets.

Indian MNCs sending profits back.

We can see that the factors that contribute to the demand for a currency are mirror images of those that add to

their supply.

Rapid increase in value of dollar in recent times

We (India) have witnessed a rapid increase in the value of the Dollars in recent times, which means there is a

change in forces of Demand and supply, obviously demand has outgrown supply of dollars.

There are 2 basic factors that have led to the change in this equation. Firstly, FII‘s (Foreign Institutional investors)

that had been pumping billions and billions of dollars until a few months back, have been desperately pulling

money out of India and putting it into safer havens like USA and Germany.

Secondly, Trade deficit gap i.e. gap between values of our Imports and values of our exports has widened i.e.

exporters are not able to bring in as much dollars as our importers are giving out and hence demand is more than

its supply.

What could the government do to solve the problem?

Solving first problem i.e. of getting FII‘s to put money into India. This problem has two dimensions to it, they are-

First, FII‘s have been pulling money out of India because of financial crisis facing them in their home market. So

they are looking for safe heavens and right now with the Euro zone‘s Euro and the Japan‘s Yen in a mess there is

no other safer and stronger asset than the US Dollars.

Second, FII‘s are pulling out their money from Indian markets because of slowing rate of growth of Indian

economy.

It will be totally unfair to say that government can solve or handle the first dimension of this problem as it is a

global phenomenon and Indian economy still is not big enough to influence world events.

Looking at second dimension, yes image of India has taken a hit due to recent events like

Retrospective amendments

Going back on FDI reforms in Retail and aviation sector

Various corruption charges against ministers of central government

Increasing Fiscal Deficit

Obviously an efficient government would have tackled it better and saved the image of the Indian economy.

Question to ask here is that if the second dimension of problem is taken care of, would it stop FIIs from pulling

their money back from India. The answer is NO, because the global crisis is a phenomenon much bigger than the

few wrong events occurring in the Indian economy. Investors would still chose a safe haven and India is not even

close to be known as a safe haven by any stretch of the imagination. This means money (dollars) would still have

flown out of India.

To make my argument more convincing, I would like to lay stress on fact that India is expected to grow at 6% to

6.5% this year which is better than almost all the countries of the world but still investors are not willing to take

risk in current situation and are running toward safe heavens.

Whenever there is a financial crisis, investors move towards safe heavens as the risk appetite reduces during

financial crisis.

Solving the second problem of Trade deficit gap, which has come up due to the decreasing growth of values of

exports as compared to values of the import. Again this problem can be broken up into two, first lower growth in

exports and second, higher growth in value of Imports.

First part i.e. lower growth in values of export is mainly due to lowering demand in Europe and US, which can

again be attributed to financial crisis in Europe and doubts about growth of US economy.

Second part i.e. higher growth of imports, basically our Imports depend on price of Crude Oil in international

markets and not on the strength of government in India.

Following two charts will illustrate this fact

Chart 1: Value of Oil Imports of India

Chart 2: Value of Crude Oil in international market

Source: - International Monetary Fund – 2011 World Economic Outlook

Let us look at the trend after 2002 because that is when India rapidly industrialized.

During the period 2003 to 2008 there was increase in prices of crude oil from 26$ per barrel to 140$ per barrel

similar trend is visible in value of Oil import by India. Also we can see that slope of both the curves are in

coherence. From 2008 to 2010 we can see that the Crude prices falling from 140$ per barrel to around 75$ per

barrel similar trend is seen in value of Oil import by India.

From this we can easily see that value of our oil imports depend heavily on price of the crude in international

market. Now since 70% of our import bill comprises Oil imports, which mean our imports are heavily dependent

on the price of crude.

Hence the above argument proves that Increase in trade deficit in current conditions in case of India, is due to

global phenomenon and not because of an ineffective government. So far, the discussion put forward has been

India specific; now let‘s talk about various other reasons why we can‘t say that a weak currency is an indicator of

a weak government.

Following are some of the reasons:-

Many strong countries want weak currency: - Two prominent examples of such countries are Japan

and China. This is because they keeps prices of their export lower so that its products and services

become attractive for consumers in other countries. This helps them increase production, which creates

more jobs and wealth that ultimately leads to overall growth of economy of the country.

Role of Speculations: - In any market, expectations and speculation play an important role. For

example, when there is an expectation that the dollar will rise against the rupee, the exporters tend to

hold back their earnings in the hope of getting a higher rate.

Similarly, the importers will try and buy as much as they can today; adding to the current demand and

making the dollar rise even more.

All this skews the supply-demand equation even further and thus setting off a vicious cycle.

Equation Other way around: Does a weak government means a weak

currency?

Again we need to see how can a weak government affect demand supply equations?

Following are some of the adverse effect of weak government: -

Loss of investor’s confidence: - perhaps the most adverse effect of political instability is on the investor

confidence. There may be certain policies that may not be in the interest of business, or government may not be

working in larger interest of the economy, government may not be strong enough to take unpopular but

necessary decision like increasing fares of public transport or increasing in fuel prices, or reduction in subsidies; all

these can lead to lack of investor‘s confidence in future growth of the country making them pull out money from

the market of that country.

Poor business environment: - Poor business environment means high taxes, unclear tax regime, poor law and

order, difficulties in setting up new business, lack of infrastructure like lack of roads, electricity, etc all this results

in lesser production for domestic companies which results in lesser revenues. Also it discourages foreign

companies to invest in the country leading to lesser inflow of foreign exchange in form of foreign direct

investment again adversely affecting demand and supply situation.

Poor Fiscal Management: - Generally it is seen that ineffective governments are unable to keep their

expenditure under check and there is excess of expenditure over revenues. As such governments borrow more

and more money, it increases the borrowing cost and fiscal deficit, and the country needs to pay more for each

dollar it borrows.

Uncontrolled Inflation: - High inflation may persist in such countries because of supply side problems. High

inflation is dangerous for the overall health of economy as it may lead to lack of savings and more of spending

which further increases inflation, as a result Interest rates are higher in such countries leading to increased cost of

borrowing and hampering the growth of business.

All of these may or may not occur simultaneously but all of them are harmful for the growth and the development

of an economy.

Cause effect on Supply of dollar

(Foreign Exchange)

effect on Demand of

Dollar(Foreign exchange)

Effect on currency

(Weakens or

strengthens)

Loss of investor‘s confidence Reduced No Direct impact Weakens

Poor business environment Reduced No Direct impact Weakens

Poor Fiscal Management No Direct impact Increases Weakens

Uncontrolled Inflation Reduced Increased Weakens

The above table summarizes the ill effects of weak and inefficient government. Also we can see that weak

government does leads to weak currency.

Conclusion

From the above argument it can be concluded that weak currency does not necessarily mean a weak government,

we need to carefully analyze the causes for weakness in the currency to determine whether it is due to some

global phenomenon or whether the country has intentionally kept its currency weak or it is due to a weak

government and vice versa, i.e. if we have a weak government, then surely the currency of the country is going

to be weak.

Ashish is currently a student of NMIMS and is pursuing his MBA in Capital Markets.Prior to

this he has worked for Infosys Technologies Limited as System Engineer and has work

experience of 3 years.Other educational qualifications include B.E (Honours).

Email: - ashish012345@gmail.com

Mobile: - 9930270066

QUARTERLY

CENTRE FOR MBA CAPITAL MARKET NMIMS

NMIMS

MBA

CAPITAL

MARKETS

CENTRE FOR MBA CAPITAL MARKET NMIMS

The center for Capital Market studies in NMIMS is an outcome of the synergistic

relationship between The Stock Exchange Education and Research Services (a public trust

established by the Bombay Stock Exchange) and SVKM's NMIMS since March 2005.

With the advent of global capital flows, information and technology, there was an

acute need for trained professionals to man important positions in all spheres of capital

market activity which include stock exchanges, commodity exchanges, regulatory bodies,

policy-making bodies, market intermediaries, asset management companies, corporate

bodies, etc., to name a few. With this objective in mind, a long-duration program called the

MBA (Capital Markets) was custom-designed by the two collaborators.

MBA (Capital Markets) is a two year full time programme offered by NMIMS University to

cater to the needs of requisite intellectual capital to the fast-growing financial world with a

keen focus on capital markets. The program is unique because it aptly integrates conceptual

knowledge, contemporary inputs, technology, information and skill development. The

programme is a blend of traditional core finance subjects along with capital market related

subjects such as Asset Valuation, Treasury and Investment Banking, Asset Management,

Equity Research, Industry Research, Private Equity. Its most striking feature is the Trading

Room facility. In fact it is the first Program in India with such an advanced facility

incorporating Bloomberg and Reuters. It is also the first Program in India to have been visited

by International Financial Centers like Singapore and Hong Kong which was proposed and

supported by BSE.

The design and development of the curriculum for the MBA (Capital Markets) was approved

by the Academic Council and the Board of Management of the Deemed University. It focuses

on all major Financial Markets: Equity, Fixed Income, Forex, Commodity and Derivatives.

NMIMS has played the role of a worthy torchbearer in initiating such a well- designed

specialized course, which is essential as the economy begins to mature. The programme

intends to create capital market experts having managerial expertise; and has been well

received and appreciated by the industry.