Journal of FInance Vol 20

8/9/2019 Journal of FInance Vol 20

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Editorial Preamble

1 REGULATORY INDEPENDENCEMisunderstood & muddled

In a democratic mode of governance no agency is independent. If one is independent, it cannot be a partof any system. A system delivers best only if all its parts have harmonious co-existence and no part seeksindependence of others. In fact, dependence on one another is a strength, rather than weakness. Besides,

vigilance by others keeps one always on toes and prevents its failure.

To some, independence is a misnomer. It certainly does not mean independence from the laws of the land.Nor does it mean independence from standard checks and balances evolved over time for the exercise ofpowers. As much as one may wish, a public agency has to discharge its responsibilities within the frameof the law and be accountable for its performance. Hence accountability and independence go hand inhand and the mechanism to ensure this need to be provided together.

Independence is not free of cost: it has to be earned. In a system, only those who can shoulder

accountability deserve to be independent. A related issue would be credibility. An organisation createdcannot legitimately achieve the credibility overnight to claim real independence. Even central banking

independence the world over has been earned over decades.

Even after a few decades of experimenting with independent regulators, the debate on regulatoryindependence is far from over. It has rather engulfed the independence of neo-government, theinstitutions created by government for governance (customer protection, development and regulation) ofmarkets on its behalf. To protagonists of the regulatory mode of governance believe that neo-governmentsneed to be independent to enable them to discharge their responsibilities professionally.

The neo-governments seek functional independence in respect of regulatory activities to facilitateobjective decisions without being encumbered by socio-political legacy constraints. Efficiency and speedof decision making are the watch words which no political decision making process could dispense.Independence in this functional sense means adequate powers, enough resources and capacity to carry onregulatory activities.

However, the neo-governments discharge non-regulatory functions as well where perhaps the degree ofindependence sought is different. Here, the neo- governments are just one of the players (government mayhave multiple arms performing these tasks) while in the regulatory space they are the umpires. Theumpires must be independent but armed with knowledge; including the knowledge that theirindependence is restricted to the game on the field. Non-regulatory activities are not the exclusiveprerogative of the neo-governments.

Discharging the responsibilities of the neo-governments requires legislative, executive and judicialmeasures a reason why their powers, including the self-image, sometimes get magnifies. But given theexalted position of legislature and judiciary in the Indian Constitution, independence is not sought inrespect of legislative and judicial activities. It is considered normal if the regulations/orders of neo-governments are modified/set aside by the legislature/judiciary. Thus, independence of neo-governmentsessentially boils down to independence from the executive branch of the State.

The Constitution assigns a particular subject to the government. The business allocation rules assign it toan executive unit. However, the legislature, by a statute, has assigned regulation, development andcustomer protection matters related to the subject to a neo-government, without actually curtailing theresponsibilities of the executives. The said statute, however, empowers the executive to constitute theneo-government and supersede if it is failing to discharge its duties to its satisfaction. It also empowers


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the executive to give direction on policy matters to neo-government. The executive places the activityreports annual report, the annual accounts, regulations, etc. of neo-governments before the legislaturefor scrutiny. It responds to legislature on all matters relating to the subject for and on behalf of the neo-government. This is de facto an agency mode of governance. Further, the executive is accountable topeople through legislature on all matters relating to the subject. In exercise of these responsibilities, theexecutive engages in constant interaction with the neo-government. The interaction, if not properlycalibrated, is construed as interference.

Let us look at regulatory domain of a neo-government. Under the statute, a neo-government makessubordinate legislation dealing with market related matters. It issues various kinds of directions in theinterest of market and/or customers. It determines and initiates enforcement action appropriate in thecircumstances. It has powers to raise resources to support its regulatory functions. Its staff enjoysimmunity from suit, prosecution or other legal proceedings in respect of actions taken by them in goodfaith. Once appointed, the chairman and members of the neo-government cannot be removed, exceptunder extreme circumstances. These statutory provisions promote independence of neo-governments andhardly leave any scope for the executive to interfere in the regulatory arena. Viewed in this context, everyneo-government in India is independent.

There are few agencies within government who need independence for their effectiveness. These includethe Election Commission, Comptroller and Auditor General of India and Union Public ServiceCommission. All of them respond to Parliament through the executive. They are subject to legislative andjudicial scrutiny. They do not enjoy any higher level of independence than the neo-governments do. Theyare rather worse off in certain respects. For example, none of them has an independent source of finance.Even the Supreme Court, which is independent in every sense, does not have its own source of funding.

There are general regulators and special regulators. While one deal with a particular market, another dealwith one aspect of every market. For example, the Competition Commissioner of India deals withcompetition issues in all markets while Sebi deals with all aspects of securities market. Both theseregulators may wish to have independence to determine competitive structure of securities markets. Doessuch determination by one amount to interference in the domain of the others?

There are comparable bodies in other countries. A case in point is the Securities and ExchangeCommission in the USA. It appears twice before the Congress in a year and gives testimony beforecongressional oversight committees as often as required. The fees levied by it are turned over to generaltreasury. The Congress approves its budgets as well as important rules proposed by it. It is required tohold its proceedings in public. Its programmes and expenditure are studied by the governmentaccountability office. It seeks administrative sanction from an administrative law judge. It refers thematter to the justice department for launching prosecution before the district criminal court. Viewed inthis context, the neo-governments in India appear comparatively more independent.

Governance through neo-governments is still evolving. The Constitution of India does not explicitlyrecognise neo-governments as recognised mechanism for delivering of governance. When governancethrough panchayats was considered necessary, the Constitution was amended to explicitly recognise themand specify their responsibilities, including their autonomy and accountability arrangements. So, it maybe appropriate that a clear Constitutional provision be made to explicitly recognise neo-governments andprovide for an appropriate autonomy-accountability framework for them. While deciding their space inthe constitution schema, it would be ideal to define the autonomy arrangements of the neo-governments tothe three organs of the State legislative, judiciary and executive. This is necessary to remove bothconceptual ambiguity and the cobweb on the practical aspects of independence.


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2.1 SECURITY MARKETStay flexible, open minded and skeptical

Volatility is an inherent part of stock market investing and investors need to keep in mind that marketgyrations tend to be more pronounced over the short-term. Thus, during times of negative sentiments,often quality asset prices are available at attractive bargains and you can benefit from them.

There is an important lesson never adopt permanently any type of asset or any selection method. Alwaystry to stay flexible, open minded and skeptical. Long-term top results are achieved only by changing frompopular to unpopular types of securities you favour and your methods of selection.

The starting point of investing is to have a point of view of the future of economy and then the sector andthen the company; or it can be individual stock picking if there are compelling reasons. In this changingworld the view of the future can change rapidly and the original assumptions of investment may undergoa change. It is crucial to have an open mind about being wrong and to do course correction.

1st week of July 08 Sensex closed flat

Daily review 30/06/08 01/07/2008 01/07/08 02/07/08 03/07/08 04/07/08Sensex 13,461.60 12,961.68 (499.92) 702.94 (570.51) 359.89

Nifty 4040.55 3896.75 (143.80) 196.60 (167.60) 90.25

Weekly review 30/06/08 04/07/08 Points PercentageSensex 13,461.60 13,454.00 (7.60) (0.06%)

Nifty 4040.55 4,016.00 (24.55) (0.61%)

At these levels, the market is facing an acid test - the toughest since the start of the bull-run. The Nifty

levels of 3890-3870 will prove to be a very important support level for the market. In past few tradingsession, the Nifty breached 3890-3870, but never gave closing below the 3890-mark. Recent marketconditions have certainly tested the patience of many investors. The most frustrating part is that themarket has been drifting steadily lower and intra-day moves have been choppy and sudden, making ithard to chase trades. We are not seeing smooth moves followed by small pullbacks that offer multiplechances, but rather quick whooshes followed by complete reversals on a dime.

2nd week of July 08 Sensex closed flat again

Daily review 04/07/08 07/07/08 08/07/08 09/07/08 10/07/08 11/07/08

Sensex 13,454.00 71.99 (176.34) 614.61 (38.02) (456.39)Nifty 4,016.00 14.00 (41.45) 168.55 5.10 (113.20)

Weekly review 04/07/08 11/07/08 Points PercentageSensex 13,454.00 13,469.85 15.85 0.12%

Nifty 4,016.00 4.049.00 33.00 0.82%


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SECURITY MARKET

The stock market managed to snap seven week long losing streakas both the indices Sensex and Niftyended the week in the green amid a host of negative factors. Abysmal industrial data, spiraling inflation aswell as global crude oil prices and muted business outlook indicated by Infosys Tech weighed on themarket sentiments on the Friday, wiping out major part of the weeks gains. The BSE 30-share barometercrossed 14K-mark at mid-week, but failed to maintain the level due to fluid political conditions.

3rd week of July 08 Sensex in a recovery mode, closed up by 1%

Daily review 11/07/08 14/07/08 15/07/08 16/07/08 17/07/08 18/07/08Sensex 13,469.85 (139.34) (654.32) (100.39) 536.05 523.55

Nifty 4.049.00 (9.30) (178.60) (44.40) 130.50 145.05


Nifty 4.049.00 4,092.25 43.25 1.06%

The markets seem to be consolidating around 3,800 levels of Nifty; however negative developmentson political front may change the market scenario completely. On the political front, the ground is finallyset for the UPA to face a vote of confidence in parliament on July 22. This event will be watched withgreat interest by the markets and will decide the direction, as any negative surprise can give a nasty jolt tothe markets once again. On the positive side if the UPA cruises comfortably the markets will definitelywitness a big spurt which coupled with the nuke deal will physiologically boost the market sentiments.This may confirm the bottom formation for near term.

4th week of July 08 Sensex up 5%

Daily review 18/07/08 21/07/08 22/07/08 23/07/08 24/07/08 25/07/08Sensex 13,635.40 214.64 254.16 838.08 (165.27) (502.07)

Nifty 4,092.25 67.25 80.60 236.70 (43.25) (121.70)

Market gives thumbs up to UPA government


Nifty 4,092.25 4,311.85 219.60 5.36%

5th week of July 08 Sensex up 3%

Daily review 25/07/08 28/07/08 29/07/08 30/07/08 31/07/08 01/08/08Sensex 14,274.94 74.17 (557.57) 495.67 68.54 300.94Nifty 4,311.85 20.25 (142.25) 123.70 19.40 80.60


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SECURITY MARKET


Nifty 4,311.85 4,413.55 101.70 2.36%

Market gains despite RBIs hawkish policy: The markets showed greater resilience despite the RBIshawkish monetary policy and extended their weekly winning streak. According to analysts, the marketsdrew support largely from high expectation that the reforms process would get a boost following astatement by Finance Minister P Chidambaram. Investors morale was also uplifted as the government onFriday introduced norms for 3G mobile services, an indication of its willingness to put reforms on a fasttrack. They said there are positive factors ruling in the market fueled by easing of crude oil prices, whichstayed around $ 123 a barrel mark. The inflation, which almost touched the 12% mark seems to bediscounted by market conditions.

Monthly review

Month March 08 April 08 May 08 June 08 July 08

Date 31.03.08 30.04.08 30.05.08 30.06.08 31/07//08

Sensex 15,644.44 17,287.31 16,415.57 13,461.60 14,355.75

Points Base 1,642.87 (871.74) (2,953.97) 894.15

Percentage Base 10.50% (5.04%) (18.00%) 6.23%

Going ahead, the market are expected to hold the recent lows, although there could be further globalshocks since most of the negatives in the domestic arena have been fully discounted in the market prices.

F&O data suggests that the August 08 series is starting on a lighter note which is the lowest since

December 07 series. This leaves less room for any further downside. The recent lows on Nifty of 3,800 is

likely to hold for the near term and in short term, the markets may see further extension of gains. Anypositive move from the government on market liberalisation may provide necessary impetus for a rally.


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SECURITY MARKET

JUST CHILLIs the choppy stock market making your heart skip a beat or two?

Put your fear aside

Greed (bull) and fear (bear); these are two words investors often here and think of, but are unable tocontrol their emotions when it comes to investing. In fact, when stock markets are north-bound, theirconfidence in buying increases considerably. They buy stocks irrespective of their high P/E ratio and are

sure to make good money. If, the markets enter a bearish phase, their confidence goes down, leaving themwondering where did they go wrong? The chaotic bear market environment then sets the stage for fear tocreep into their minds, thus impacting investment decisions. To make sure that you successfully weatherthe market storms, here are ways to drive out your fears of losing money in a bear market.

Stay calm and act prudently

Easy to say than follow; It is true that bear markets spread panic among investors, often causing them tosell all the stocks they hold. But a smart investor is one who gets on with the job of picking up valuestocks, notwithstanding where the tide of the market is moving. Such an investor is rightly rewarded withgreat profits once the market turns. Since we fail to control our emotions, we forget that investment in

equity is not for short term. So for long-term benefits, it is important to stay calm and act prudently.

Review your stock rationally

You may have earlier doubled your money in a short span, by investing in a particular stock during a bullrun, but you must remember that stock investing is not about speculating or making easy money. It is anart and science of buying good businesses at cheaper valuations. It is important to set realistic goals foryour portfolios long term return, and buy only good companies with strong fundamentals and goodmanagement. To nip your fears in a bearish market, you should avoid selling just because stock priceshave dropped. You must review your stock portfolio rationally. Then only you should arrive at a decisionto sell losers whose future prospects look weak, and hold on to winners with prospects that remain solid.

Avoid tracking the market

Another way you can calm your nerves in a bear market is by not following the stock markets on a dailybasis. Every investor knows that you should buy low and sell high. Bull markets provide you a chance tosell high. Bear markets, however, offer you a chance to buy low. Unfortunately, too many investors arelulled into complacency during bull markets and scared out of their wits in bear markets. So they do justthe opposite, buying high and selling low. Thus you should avoid tracking the stock markets daily duringa bearish phase. This way you will save yourself from unnecessary anxiety and fear.

Set aside emergency funds

Investors have the tendency to over-invest during a bull run, which becomes a reason for fear when themarkets turn choppy. To counter such a situation, you should have sufficient liquidity in hand foremergencies. This will make sure that you arent forced to sell equity holdings before the time and priceare right. To emerge as a winner, all you need to do is recognise the fact that your portfolio will declinefrom time to time, but take solace in knowing that short-term pain is required for long-term gain.


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SECURITY MARKET

See the positive side

To make money in equities, it is important to be rational, not emotional. You should always try to look atthe positive side in a bad market. A bear market provides an excellent opportunity to buy strongbusinesses at rock bottom prices. And no one can tell you when the next bull market will begin, how long

will it last, or how high the market will ultimately go. That should be the key point to drive out your fearsin the bear market. So even if the markets are down, you should be convinced that your business ismaking money. The stock price may not generate great returns due to the bearish phase, but in the long-term, your portfolios returns will be unmatchable.

Study behavioural finance

Last but not the least; you can study behavioural finance to calm your fears in a bear market. For theuninitiated, behavioural finance pairs emotions with investments and shows how emotions and cognitiveerrors can cause disasters in investing decisions. Individual behaviour, temperament and psychology playan important role in determining investment success.

Even experienced investors are susceptible to making judgment errors identified by behavioural financeresearch. It can help you to be watchful of your behaviour and, in turn, avoid mistakes that will decreaseyour personal wealth. It provides a platform to learn from peoples mistakes, to modify and improve youroverall investment strategies and actually profit from identifying these mistakes. As for the bottomline,just as it is important to know when to exercise caution, the same way it is important to comprehend whento abstain from fear. Happy investing!


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2.2 INDIAN ECONOMYLeft pullout may help push economic reforms

The decision of Left parties to withdraw support to the government could give lease of life to a largenumber measures including disinvestment and reforms in the banking, insurance and pension sectors. TheSamaijJwadi Party (SP), which has come to the rescue of the UPA government, is not expected to havesuch reservations. The trust motion moved by Prime Minister Manmohan Singh in the Lok Sabha on

Monday, 21

st

July 2008 was just a sideshow. The trust motions fate was settled not over the weight of thearguments put forth by either side during the two-day debate, but by the outcome of the intense andbrazen bargaining outside Parliament.

After a day of high drama, backstage deals and frayed nerves, the Manmohan Singh government onTuesday, 22nd July 2008 evening won the trust vote in Lok Sabha. The government won comfortably 275 against 256 votes. Looking forward, the principal concern of the Congress will be to aid MrManmohan Singh quest for legacy. The Leftists were consistently frustrating his effort on the nuclear dealfront. Mr Singh has made the nuclear agreement an issue of personal prestige. But a forward movementon policy issues will dependent on the support from new allies.

The Left parties were also vehemently opposed to raising the FDI limit in insurance to 49% from thepresent 26%. On banking side, Banking Regulation (Amendment) Bill, 2005 that proposed to make thevoting rights of shareholders in private sector banks equal to their voting shares, did not find favour withthe Left. Currently, voting rights of the shareholders are capped at 10%, irrespective of their actualholding. The Pension Fund Regulatory and Development Authority (PFRDA) Bill, 2005, was also held up preventing reform in the pension sector. The government also wanted to bring changes in LIC Act of1956 in order to raise resources. The proposal, however, got halted because of the Lefts opposition.

With the coming in of SP, theres some hope for these key measures besides some crucial disinvestmentdecisions. Divestment of 10% each in BHEL and BSNL could see green light. Further, the Department ofdisinvestment is already, in the process of carrying due diligence on the listing of about two dozencompanies and the process is likely to get accelerated in the present political circumstances. Thegovernment plans to piggyback on IPOs of these companies to offload up to 5% of its own stake.

Instant punditry concludes that the Lefts separation from the UPA is good news for reforms. But thosefamiliar with the reflexes of the parties that would sustain the government in power for another fewmonths are not so sanguine. This assessment is not off the mark for two reasons. Firstly, with price riseand related issues, the new alliance would like the government to fix these problems first rather thantrying out any ambitious economic agenda. Secondly, the government just does not have the comfort-level to put contentious piece of legislation such as pension reform or higher FDI in the insurance sectoron the policy table. In any case, the Congress will also not like the government to take up issues thatwould complicate inter-party relations at this juncture.

Chidambaram puts reforms on fast track

The UPA government is gearing up to fast-forward economic liberalisation with finance minister toppriority to reforms in banking, pension sector and capital markets, besides streamlining the commoditiesmarket and merger of SBIs subsidiaries with the parent bank. Disinvestment and hike in FDI ceiling inthe insurance sector are other areas shortlisted by the FM. Apart from financial sector reforms; theManmohan Singh government is also likely to take up labour reforms. Liberalisation of labour norms is along-standing demand of India Inc.


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INDIAN ECONOMY

Among the areas of focus identified by Mr Chidambaram include: The Pension Fund Regulatory &Development Authority (PFRDA) Bill; The Forward Contracts (Regulation) Amendment Bill; BankingRegulation (Amendment) Bill, and SBI (Amendment) Bill.

A parliamentary committee has vetted the PFRDA legislation and it might be easy to get Parliaments

approval for the Bill with the support of UPAs new allies. In case of Forward Contracts (Regulation)Amendment Bill, which seeks to streamline the commodities market, the government has already issuedan Ordinance. Now, the UPA regime has to obtain approval from the Parliament to effect these changes.

Cabinet approval for merger of SBS with SBI

Proposed merger of SBI received a go ahead from the Cabinet. The move would make way for the mergerof other six associate banks of SBI with itself. The Union Cabinet has also approved the proposal toredefine powers of the RBI nominee director on the board of SBI. Centre is now expected to bring inlegislation in the monsoon session to effect the merger.

The word disinvestment be replaced by listing

Since the UPA came to power in 2004, the disinvestment ministry has been functioning with out a full-fledged minister. The department now comes under the finance minister. The Prime Minister is looking atthe coming eight months to carry out economic reforms. With the backing of new allies, the UPAgovernment would push through PSU disinvestments to improve the fiscal health of the country. It cantbe possible unless a full-fledged minister overseas the process.

Meanwhile, minister of state for commerce, industry and power Jairam Ramesh has been lobbying thatthe word disinvestment be replaced by listing and all PSUs be listed on the bourses. Investment is apositive word, but disinvestment is not. We should junk the word disinvestment and call it listing. What

we need now is to list all our PSUs in stock market. The process will not only unlock value but will bringin a corporate mind-set to our public sector undertakings.

The government may now undertake the process of diluting stakes of many PSUs through initial publicofferings (IPOs) because unlike many other reforms, listing in the market does not require any approval ofthe Parliament. Mr Ramesh said some power PSUs such as NHPC, North Eastern Electric PowerCorporation (NEEPCO) and Tehri Hydro Development Corporation should be taken up for divestment.We should list all these PSUs. We should not debate on whether we should list a particular PSU or not.The debate should be on how much we should offload. Should it be 5%, 10% or 15%. In fact, we cannotrule out the importance of PSUs in sectors such as power, coal, oil etc. But until they are listed, ourpolitical system will not allow them to function as corporate entities.


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2.3 INDIA INCRedefining the reform agenda

The post-mortem of the trust vote has been a rush of commentaries that economic reform issues pending can and must be addressed. Sadly, only a very limited agenda has been listed: FDI liberalisation inbanking, insurance and retail plus financial sector reforms. These are, of course, important but there ismuch else pending to be completed. There are 10 reforms issues which are pending and which could raise

growth as well as help contain inflation. These are the public sector, urban development, highways,power, water, sanitation, housing, transport, rural infrastructure and food/agriculture.

The public sector needs priority attention. It is rich in assets, physical and human resources but ishamstrung by procedures. Autonomy non-existent: CEO travel needs to be cleared by government and the boards of directors are subservient to government. Government controls emoluments. Investmentdecisions and pricing policies are subject to government approval. If government were to free the publicsector, it could add 1% of GDP growth. One way is certainly to continue the stalled disinvestmentprocess. It will automatically help free PSUs, especially if government shareholding is below 50%. Theonly issue at this point of time is the decline in share prices in the stock market. But freedom for PSUswill help government coffers in the medium and long term.

Second, urban development; Todays congested and crowded cities need to be redeveloped, redesigned,reconstructed; And new cities need to be built with simple, good quality infrastructure. Urbandevelopment reform, which extends from legal changes to procedures becoming transparent, could alsoadd 1% to GDP, concurrently addressing major concerns regarding corruption, a cancer in the system.

Third, highways; they have a transformational role both for development and growth. But constructionof highways is moving at a slow speed; far, far slower than the country can afford. Allocation of resourcesexists. Plan exists. There are no real policy issues. Only implementation is lacking. A push for fastesthighway construction could do great benefit to India. A part of this land is land acquisition reform.

Fourth, power the last frontier of infrastructure reform. We are slowly, painfully, moving from anational culture and belief that power is free to a new paradigm where people have to pay for power.NTPC excels as a PSU of quality and, gradually, private sector power projects are happening, but, all tooslowly. The use of renewables needs to be speeded up as well as the use of local resources to generatepower in a decentralised manner. Indias power needs a mix of policies and practices large plants, smallunits, traditional technologies, and newer technologies. Power shortages can be resolved even in the shortterm. And conservation and saving can be a powerful vehicle. Today, power is a huge cost pusher and itsshortage is surely reducing GDP growth.

Fifth, water; Real reform is yet to happen. Water supply, generally, is a huge problem. Drinking watersupply is a bigger challenge. Water conservation methods are only slowly gaining attention. If the problem of water management and conservation is addressed, it could make a huge difference to thepeople. A nation-wide creative initiative is needed. Water reform is critical to quality of life.

Sixth, sanitation; It is a major issue in India, urban, semi-urban and rural. Perhaps, a PSU corporation orAuthority with funds to work in a PPP mode and implement one million sanitation facilities 650,000 inthe villages and 350,000 in urban centres is the need of the hour. It is simple to do. It can be done. Thereis no great innovation needed - Only simple, clean construction and maintenance arrangements.


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INDIA INC

Seventh, housing; the country needs economic housing in the millions to provide shelter, to enhancequality of life, to provide security and stability, to raise productivity and also for so many other reasons. Itis a national need. It is a national priority. It can be done in a variety of ways - through a combination ofcentral initiative and decentralised implementation. Technology exists to get things done very quickly.

Eighth, transport; Public transport; More and better buses; Also small aircraft for short distances tocarry food grains, fruit, vegetables, speedily, from small rural airports to urban market centres. It will cutdown the huge waste of food, fruits and vegetables, and add productivity and efficiency. A simple systemof road and air transportation can transform the food and agriculture industry.

Ninth, rural infrastructure - All weather roads to be completed; small kuccha airports to be built; ITconnectivity to be completed; and TV and telecom connections to be provided. Even if some of these aretaken care of quickly, the 600 million people living in the rural areas will experience dramaticimprovement in their living standards.

Finally, the food and agriculture, which is still beset with controls and restrictions. What are needed are

specific strategies for specific products and different approaches for different geographical areas. A grandvision combined with a deeply autonomous, decentralised approach and action plan is a must to achieveanother Green Revolution.

Indias reform agenda has to be broad, wide and deep. Its mostly about management, organisation andimplementation. Its not the what. Its the how. The next few six months should and can take thereform agenda ahead. A critical element will be a strong, clear, communication plan, which sets out thesteps being taken, the rationale and reasons, the benefits, the risks (if any) so that the public understandswhat the reform agenda aims to do and achieve. Without this, actions can be seen as ad hoc. This will be areal challenge because governments are best known for poor communication!

Too often, economic reforms are related to opening the economy in terms of trade and investment ortax cuts. This limited coverage may well suit some other countries, but not India. Economic reform inIndia has to extend too many other areas, some of which have been covered here. There is a need for newthought leadership to redefine economic reform as it is applicable to India. And the sooner action istaken, the faster will India be able to sustain 10% GDP growth per annum.


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2.4 INDIANSIndia to have 737m mobile users by 2012

Global consultancy and research firm Gartner said in a report: The revenues of Indian cellular operatorswill grow at compound annual growth rate (CAGR) of 18% to the tune of $ 37 billion by 2012. And Indiawill continue to hold its position as worlds second-largest wireless market after China in terms of mobileconnections during this period. Gartner has also predicted that the Indian mobile subscriber base is likely

to grow at a CAGR of 21% to reach 737-million connections by 2012. India currently has about 280million mobile customers.

India telecommunication sector is witnessing an explosive growth, as falling tariffs and rising incomes arebringing mobile phones within the reach of millions of new customers. With the urban mobile servicesmarket reaching its saturation, operators are training their eyes on the rural market.

The Indian telecom industry is expected to see some level of M&A activity in 2009. Given the high levelof competition different business models will emerge that could push tariffs further down, with Indiamobile service consumers set to emerge as the biggest beneficiaries.

The Gartner report also predicts that the cellular market penetration will increase by 40.9% to reach60.7% in 2012 compared to 19.8% in 2007. Gartner analysts attributed the growth to the increasing focuson the rural market, and lower handset prices, as operators would continue to focus on sub- $ 25 handsetsto increase their market share. According to the study, Indian mobile market will continue to bedominated by prepaid subscriber. Prepaid connections in the country are expected to grow to more than92% by 2012 compared to 89% in 2007.

The next big mobile wave

Indian mobile industry is poised for the next big wave, thanks to Trais recent initiative on releasing aconsultation paper recently on value-added services (VAS). VAS adds value to services, enabling themobile phone for a host of purposes such as messaging, playing games, listening to music, gettingnews/sports and other host of information, getting location-based information, seeing real-time video andso on. The VAS providers are neither regulated nor licensed as of now and they mainly act as channelpartners to mobile network operators (MNOs).

The VAS market is still in its nascent stages in India with revenue contribution of less than 15%.However, it is expected that it will boom in to a substantial business in the coming years. Though we seenew models of handsets with functionalities such as global positioning system, rich media capabilities,enhances email and search engines, being released by handset vendors every day, these can be of use tosubscribers only if services using these functionalities are made available. This requires activecollaboration between MNOs and VAS providers. Hope our regulatory reforms pave way for a betterfuture for VAS in the country.

As indicated in Trais consultation paper there is non-transparency in payment settlement, selling prices,and sharing of management information between MNOs and VAS providers. To enforce transparency,accounting separation for VAS service shall be implemented at MNOs. The VAS providers, especiallycontent aggregators also should have revenue-sharing arrangements with the content authors, contentowners and application developers who are at the end of the VAS value chain. This shall augur well forgrowth of VAS in the country by fostering healthy and fair competition.


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INDIANS

Mobile learning opens a new chapter in education

If you find classroom teaching boring or computer session a little too tiring then its time to break themould and switch over to learning on the go! Now, you can take lessons in maths, English and scienceand also do your training on your mobile and PDAs. And what more, you can also take your preparatory

tests, such as CAT and IIT-JEE, on your handset. Some firms, such as EnableM, Tata Interactive, 24X7Learning, Airtel, IMS and NIIT, are working overtime to make this possible. While companies areoffering small training modules for employees, coaching and content development institutes in theeducation space are tying up with mobile operators to offer such services.

India is witnessing rapid growth in mobile and Internet penetration. Analysts believe convergence ofmobile, internet, and TV services on a single gadget will lead to increased awareness and popularity ofthis form of education in the next few years. Such a medium has multiple benefits. One, it offers aninteractive learning experience; two, accessibility of mobile device in remote areas. The platform can beused anywhere, anytime, including schools, home or when in transit.

Bharti net rises 34% in Q1, adds 7.5 m users

Bharti Airtel, Indias largest wireless operator, beat street forecasts and posted a 34% jump in net profit toRs 2,025 crore for the quarter ended June 30, 2008, against Rs 1,512 crore in corresponding period lastyear. Robust subscriber growth coupled with expansion of network to remote areas and lower tariffs sawthe companys revenue surge 44% to Rs 8,483 crore.

Bharti added a record 7.5 million subscribers during the period the highest by any telco in any quarter.This improved the companys market share in the countrys fiercely competitive wireless subscribersspace to 24.2% as on June 30, 2008, compared to 23.1% in the year-ago period. Bharti also accounted forclose to 30% of the countrys wireless subscriber additions during the period. EBITDA climbed 44% to

Rs 3,522 crore. The Q1 net profit also factors in a forex loss of Rs 148 crore.

But there were some blips too:

Bhartis net income margin dropped to 23.9% in Q1, from 25.6% in the same period last year,following cut in tariffs.

The margins for the mobile business declined to 30.7% compared to 35.4% in the in the quarterended March.

Average revenue per user (ARPU) too fell 2% (Q-o-Q) to Rs 350 from Rs 357 in January-March

08. On a year-on-year basis ARPU shrank 10%.

The Bharti management was upbeat about the Q1 performance and was confident the telco could sustainthe growth momentum. The slowdown in some sectors has had no impact on us telecom is immune tothis. We only see the situation improving as we expand our operations. We are close to rolling out ourDTH operations. The launch of our GSM services in Sri Lanka will also happen by before the year-end.


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2.5 FOREIGN INSTITUTIONAL INVESTORSRe-ordering of the league tables within BRIC economies

In 2000, when Goldman Sachs clubbed Brazil and Russia together with India and China as the BRICeconomies they collectively represented the emerging world economic order, China and India wereclearly the poster boys. Brazil and Russia were seen as also-rans. Both had a history of economicinstability, and in the case of Russia at least, dodgy politics.

Today things could not be more different. While the broad picture presented by Goldman Sachs, that theBRIC economies will together be more than half the size of the G6 economies (US, Japan, UK, France,Germany and Canada) by 2025 and overtake them by 2040 is unchanged, there has been a re-ordering ofthe league tables within BRIC economies.

The Asian tigers have lost their allure. And while growth in both China and India is still expected to beamong the highest in the world, the sharp decline in their stock markets China has fallen a whopping41% since December 2007 with India a close second at 38% - is a measure of the seachange. Once thedarling of investors worldwide, they have now been forsaken for more attractive alternatives. In contrastBrazil and Russia have come from almost nowhere to become the new poster boys. True, their growthrates of 5.8% and 8.5%, respectively, for the first quarter of 2008 may still trail Chindias (as China andIndia are often referred to collectively). But even as stock markets around the world have collapsed, bothRussia and Brazil are up in dollar terms Russia by 1% and Brazil by almost 15% during the periodDecember 2007 to June 25, 2008.

What has changed? The worlds unsatiable appetite for commodities and the vantage position of these twoeconomies as major commodity producers - while Russias energy resources both oil and gas put it inan enviable position in a world where energy has become the lynchpin in which everything else revolves.

Brazil with its unique dominance in both food as well as energy is even better placed. And thoughinflation stood at 5.6% in May 2008, above central bank target of 4%, most of this was food inflation andshould not pose a problem for a country that is among the worlds largest exporters of wheat and soya. Asfor energy, if initial reports are correct, Brazil may well be sitting on reserves of between 40bn and 50bnbarrels of oil in recently discovered field off its coast in South Atlantic. If proven these could transformBrazil from a minor player in the global industry into one of the worlds big oil powers.

Its much a same story with Russia, but with one vital difference. Unlike Brazil where democracy seemsfirmly entrenched, Russian democracy is still suspect. Nonetheless, on the economic front, the picture isas rosy. The countrys reserves of oil, gas (it supplies a quarter of Western Europes natural gas),industrial metals and potash means it is safely riding the global commodity price boom. Russia now hasthe third largest forex reserves in the world and runs both budget as well as current account surplus.

But anyone, who has tracked commodity markets will tell you, these tend to be highly cyclical nature. Oncesupply catches up with demand or demand shrinks in response to higher prices, the commodity cycle willreverse. Today, with oil almost pushing $ 150 a barrel and food prices remaining high, that might seemwishful thinking. But ten years ago a sharp fall in commodity prices oil fell $ 13 a barrel had seen growthin these same countries plummet. GDP actually declined in both Brazil and Russia even as the Russianfinancial crisis saw the ruble collapse. The bottom line, then, is that it is too early for new BRIC stars tocelebrate or for Chindia to be despondent. As the Goldman Sachs report points out, growth is never linear.The only constant is change. The final pecking order will depend on which country manages to smoothenout the peak and trough (since peaks are invariably followed by trough) through sound economic policies.


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2.6 WARNING SIGNALSIMF chief gloomy on growth

International Monetary Funds managing director Dominique Strauss- Kahn said: It is hard to know how far the global financial crisis still has to run, with the extent of further credit losses hinging on what

happens to the US hosing sector. With sky-high food and oil prices adding to the economic pain caused

by financial strains, he said the IMF was fairly pessimistic about global growth prospects this year and,

especially, in 2009. But he told softening growth was less of a threat than inflation, which he said wasrampant in some countries. In emerging countries and some low-income countries, in some of them at

least, inflation is out of control. He added that the lesson from 1970s and 1980s was that inflation can last

for years, or over decades, if central banks and government choose the wrong policy settings. Thats whyits very important today, and thats what the IMF is doing, to draw attention to this question.

Dooms here: Houses in US still overvalued

The downward spiral of the US housing prices still has a way to go and homes were overvalued bybetween 8% and 20% in the first quarter of this year, according to research by International MonetaryFund (IMF). In his report What goes up must come down? House price dynamics in the US, IMFeconomist Vladimir Klyuev used several economic techniques to determine by how much US homeprices are overvalued. His research showed that home prices become considerably overvalued from 2001and while the housing market has started to correct itself, there is still a long way to go. US policy-makerare now trying to guide the housing market into a soft-landing after a five-year run-up in home values thatended in 2006. The report said that it is likely that the home prices will swing well below theirequilibrium level before that start to recover.

US economy needs time to recovery: Henry Paulson

Treasury secretary Henry Paulson said: The US economy needs months to recover from its slowdown,but the banking system remains sound despite a home mortgage crisis that could cause more problems. Iam optimistic that Congress would approve the Bush Administrations request for authority to shore upthe troubled mortgage giants Fannie Mae and Freddie Mac. He added high-energy prices would prolongthe slowdown, but the key to recovery was stablising the housing market.

He said that US banking problems were manageable despite this months highly publicised failure ofmortgage lender IndyMac bank. The list of troubled would grow. But this is a very manageablesituation our regulators are focused on it. Our banking system is a safe and sound one. Only 5 USbanks have failed this year, compared with an annual average of about 250 during the US saving-and-loanindustry crisis in the 1980s. He added: about 99% of the 8,500 US banks fell into the highest category ofcapitalisation, a measure of financial health.

Ensuring confidence in US financial markets was crucial to reviving the housing industry and the broader

economy. To that end it was essential that Congress approve the stability plan for Fannie Mae and FreddieMac, which are responsible for 70% of US home loans. Treasury asked Congress for unlimited authorityto lend money to troubled mortgage companies and to buy their stock if necessary to inject fresh capital.Some Republican lawmakers have walked at the prospect of a blank check that could cost US taxpayersbillions of dollars. But Paulson was very optimistic were going get what we need from Congress.


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WARNING SIGNALS

Private profits, public losses

Market economics is a big casualty in times of crisis. One tenet that has taken a beating in recent monthsis that inefficient firms must be allowed to fail and shareholders must bear the loss. Banks, especiallylarge banks have always an exception to the tenet because the failure of banks imposes huge costs in theeconomy. So, when the British government rescued Northern Rock, it was not a big surprise.

The subprime crisis has thrown up newer exceptions. The Fed stepped into presents failure of aninvestment bank. It not only organised the sale of Bear Sterns to JP Morgan but went so far as to take abig slice of its assets on its own book. The Fed then went further. It offered liquiditory support to otherinvestment banks. And the new development that really takes the cake is the US governments decision toissue a blank cheque in favour of two private home loan institutions.

Fannie Mae and Freddie Mac (both short name), together hold or guarantee home loans worth $ 5-trillionor more than half the national debt of the US. They are both in the trouble consequent to the debacle inthe US housing market over the past year. A failure of the two institutions is unthinkable it would spelldisaster for the US economy. So, the US Treasury has found itself obliged to throw these two privateinstitutions a lifeline. It has sought approval from the US Congress for an increase in the credit line to the

two companies and for injection of equity capital if needed. The Fed has allowed them to borrow from itsdiscount window, a facility meant only for banks and primary dealers.

Fannie Mae and Freddie Mac are secondary market vehicles for home loans. They buy loans fromlenders, keep some on their books and sell the rest by packaging them into mortgage-backed securities.The rationale for such vehicles is simple enough. Banks have largely short-term liabilities, so they have aproblem making home loans with maturities of as long as 30 years. In the jargon, home loans expose banks to both interest rate and liquidity risks. But we need banks to make home loans so that largenumbers of people can buy houses. The American answer to this problem in 1938 was to create FannieMac as a federal agency. With government support, Fannie Mae could issue securities at lower-thanmarket yields. This funding advantage was passed on to consumers. So, home loans became more

affordable, banks could get some of their home loan off their books and Fannie Mae itself was viable.

In 1968, the US government decided to privatise Fannie Mae so that its debt would not be recorded aspart of government debt. Fannie Mae continued as a government supported institution (GSE), subject tovarious special dispensations. To prevent a private monopoly, another GSE was promoted in 1970,Freddie Mac. The crisis Fannie Mae and Freddie Mac face today can be directly ascribed to the originalsin of privatisation. Two highly leveraged institutions operated under government support, withoutadequate regulation and with all the pressures to reward executives and shareholders that go with privateownership. At the end of the first quarter of 08, their leverage (including guaranteed liabilities) wasestimated at 65 times of regulatory capital. Fannie Mae and Freddie Mac illustrate the perils that go withpublic-private partnership: profits are private; losses are public.

How do we prevent this dichotomy in the financial sector?

Well, if a subsidy is required or if other social objectives are to be met, it is best done through publicinstitutions, adequately capitalised and regulated. The argument against public ownership has been that itis inefficient. There is political interference and hence a higher proneness to failure; less managementaccountability because of the absence of private shareholder pressure; poor risk management because ofthe inability to attract managerial talent; and, very often, monopoly and bigness, with all its dangers.Every one of these contentions has been shown to be hollow in the subprime crisis. Failure is not theprerogative of public ownership. Private monopolies can be as bad as public monopolies.


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3.1 MUTUAL FUND INDUSTRYBorderline products

In recent months, the mutual fund (MF) industry has become increasingly vocal about its distress overinsurance companies stepping into their turf with unit-linked insurance plans (Ulips). The MF industryblames high commissions and the lack of transparency in Ulips for their dominance.

However, the charge, cannot take credit away from the life companies for building a nationwidedistribution network. They set up thousands of branches and employ over two million agents. The money

flowing into Ulips is not coming from metros alone, but also from tier II and tier III cities.

Besides, insurers are quick to point out that commission on single premium policies match those paid on

MFs. They add that the seemingly high commissions are quite low when amortised over the term of the

policy. Indeed, the commissions are low when compared to what insurers pay worldwide.

But what life insurance companies fail to mention is that there is mis-selling happening where regular

premium policies (where commission rates are up to 35% in one year) are mis-sold as single premiumpolicies. The mis-selling is negative both for the insured and the industry. The insured fails to renew the

policy and loses half his investment on account of high year charges. For the company, it is not good as

the policy lapses and does not really bring them income. In the past two years, exceptional returns inequity have helped cover up hidden charges and mis-selling. But with the tide turning in the equity

markets, some of the mis-sold policies may come home to roost for insurers.

Mutual Funds have been around much longer than Ulips. If the mutual fund industry has not been able toachieve the level of retail penetration managed by life insurers, it is because they do not own a dedicateddistribution network similar to insurance companies. Even after nearly two decades of their existence,Mutual Funds rely on new fund offerings to generate retail interest.

The tussle between MF industry and the life insurers is a bit peculiar to India. Indeed it is peculiar thatsuch a dispute should exist. Every insurer has an associated company in the mutual fund business andvice-versa. So while there is Reliance Mutual Funds selling units, its sister firm Reliance Life sells Ulips.Similar sibling rivalry exists among companies by ICICI Prudential, HDFC Standard Life, Birla Sun Lifeand State Bank of India.

Elsewhere, such duplications are considered rare and even wasteful. Most insurance groups hand overtheir funds to a group asset management company. In India, the regulation does not allow suchoutsourcing out of suspicion of thinly capitalised fund managers.

While the regulations may be well intended, it goes against the universal truth insurance is always adomestic business while fund management is becoming increasingly global.

For instance: Retirement funds of senior citizens in developed markets, which are mobilised by localinsurers, get invested in emerging markets by global fund management companies.

While consolidation of fund management may be inevitable in future, India offers immense opportunities both in accumulating and investing savings. A decade ago, mutual funds made a feeble attempt to tapretail investors through small-ticket investments of as low as Rs 500. Such schemes were unfeasible thenbecause of the inefficiencies of the system. Now, with advances in cash management and fund transfers itis possible for both mutual funds and insurers to reach out to the smallest investor.


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3.2 GOLD ETFsIts the glitter of the yellow metal on paper

Gold ETFs have made an entry into Indian mutual fund market only for about two years or so. Only fivefund houses have offered this product and going by the assets under management (AUM) of these fundhouses in terms of absolute values, these products are not yet popular.

But there can be little doubt these products are destined to come into their own. All five gold ETFs inIndia showed a rise in collections with the total corpus up by over 10% compared to April 2008. The totalgold collection was 4.57 tonnes at May-end, boosted by Akshaya Tritiya.

Are gold ETFs investments in gold?

In the traditional sense: No. An investor in ETF is neither entitled to receive gold nor does he sell ETFs toget gold, nor can he exchange ETFs for gold. The investor merely has a paper investment in theequivalent of gold. They are listed on the NSE and can be purchased and sold on the NSE as though youare dealing in the gold bullion market, but without trading physically in gold. The fund house would buygold in the bullion market to the extent of his investment at the spot price and when he sells it would sellthat quantity in the bullion market and give him the proceeds calculated at the spot price. Therefore, theinvestor invests indirectly in gold but never gets to possess the metal physically. Because he never gets tohave it physically, the hassles of physical possession are not there.

Gold ETF buyer are pure investor who seek a return out of their investment without any other motivationsuch as beautification or social status or love of possessing physical gold.

It is as specialised an investment as an investment in sectoral mutual funds such as in Infotech. In fact, itis even more specialised because an investor in Infotech holds a basket of investments in different ITcompanies and is driven by the desire to invest in the IT industry.

In case of gold ETFs, the investor is not only, not in the industry, it is not in a basket of products; it is only inone single product gold. The commodity gold is the standard gold bullion 0.995-purity.

Taken as a pure investment instrument, what would the investment objective for the investor be?

The returns from investing in gold have been considered for a period of 10-years (Jan 1998 to May 2008)and are based on the daily London prices. These are then compared with the Sensex. Daily returns havebeen taken using continuous compounding. Gold Annualised return (%) comes to 16.4 as compared to22.6% of Sensex. Next, the volatility as measured by standard deviation for gold is 1.05% as comparedwith Sensex of 1.70%. The gold has fairly high volatility, but it is less than the Sensex.

There are, however, points uniquely in favour of Gold ETFs - Tracking errors are expected to be low.

Another special reason: How gold units score over physical gold is from the wealth tax angle. If you havewealth in excess of Rs 15 lakh, you are liable to wealth tax. Gold held in physical form is countedtowards this figure. But when you hold it as units of mutual funds, you are outside the ambit of wealthtax. Capital gain on units sold of such MFs, if held for more than a year, being of long-term nature isexempt. The same exemption applies to gold only if you hold for three years. This adds to the uniquenessfor MFs. Further, STT will not be leviable on sale as this is classified as a non-equity scheme.


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COMMODITY MARKRT

Myth 3: Delivery of commodities

This is something that gives nightmares to many investors but you really dont need to worry about it.Only the commodity players are involved in taking and making delivery on commodities. If you closeyour futures contract before the first delivery notice day, which usually occurs a five-six days before the

contract expires, you should have absolutely no worries about this. If for some reason you forget about thefirst notice day, your broker will certainly monitor it and contact you, preventing you from enteringdelivery process.

Myth 4: Not enough money

You do not need fortunes to enter commodity trading, it can be started with a bare minimum amount ofRs 1,000 also which you can trade in gold guinea (8 gms gold coin). This money should be risk capital ascommodities can be a risky investment. The problem with accounts of this size is that investors take ontoo much risk for their account size. They tend to roll the dice and bet it all on one trade. Dont fall intothat trap. If you are looking for a respectable return of 25 percent a year, you will do much letter in the

long run as opposed to trying to hit a home run.

Myth 5: Nobody makes money

The fact is that many people do lose when trading commodities. However, the losers are usually ill prepared investors who jump into the commodity markets and lose within six months, never to returnagain. Others get addicted to the markets, while trying again and again to make a killing with the samestrategies and just keep losing.

So, who makes all the money?

It is normally the professional commodity traders and money managers that consistently make moneyyear after year. Also, disciplined commodity traders learn how to trade commodities properly and theyfollow a strict trading discipline, which most losing traders never adopt. Even you can make money fromtrading commodities whether you are a novice or very experienced investor. We will not say it is easy, butif you do your research and use a good trading strategy with sound money management skills, you stand amuch better chance of success.

So, mind the gaps before investing in commodities

An investor should be properly equipped with modern tools before entering the market arena. In allprobability, an investor not having proper skillsets to play with fire will burn his fingers. If, however, he

sharpens his skillsets, he can tame the fire and use it to his advantage. Trading with proper strategies notonly results in wealth creation, but also helps the market to grow on a sustained basis.

In the absence of successful trading skills, there is widespread value erosion for most of the participants,which results in more people deserting the market after operating for a few months and damaging themarket sustenance in the long run. Hence, in order to ensure their own long-term survival, the markets areduty-bound to impart knowledge among the participants, caution them against possible pitfalls and helpthem mature in their trading skills.


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COMMODITY MARKRT

Such a requirement is particularly significant in commodity exchanges, which attract millions of tradersand investors. However, in order to sustain the pace of growth in the year to come, it is important to studythe nature of trades, identify deficiencies in strategies which cause loss of capital, and suggest possiblesolutions to such matters.

Volatility factor of a commodity

Interestingly, a survey of some small traders in commodity exchanges has found that many traders/speculators still do not analyse the volatility factor of a commodity while planning their strategies.Volatility can be defined as the range within which the price of a commodity generally moves during agiven period of time. When we say average volatility, we should not consider the extreme volatilityexhibited by different commodities at certain points of time due to certain special events. The volatility indifferent commodities is a function of:

Historic price behaviour Liquidity of the commodity: Volatility tends to be lower if a commodity has a high liquidity and the

impact cost of putting in a position is lower. It will be higher if the liquidity is low.

The number and nature of participants in the commodity: Usually volatility in the price of acommodity is lower if a large number of people from different backgrounds participate in trading fordifferent objectives. For instance, if a large number of speculators trade in a commodity, it will bemore volatile. But if investors, jobbers, arbitrageurs, hedgers, physical market traders, short and longterm position traders and others mainly do the trading, it will be less volatile.

It is important for you to understand this aspect while determining the size of the position you should put in.The common mistake many people do is to determine the position size based on the margin requirement ofthe commodity exchange. In fact, two different commodities may attract the same margin, but the risk

involved may not be same vis--vis the same position value. Therefore, it is important that you understandthe inherent volatility of each commodity and accordingly determine the position size. In an ideal situation, atrader should:

Take smaller positions in those commodities, which have got higher volatility so that he can allow thecommodity price to oscillate over a larger span of price movement.

Take bigger bets in those commodities, which have lower volatility so that he can take advantage ofsmaller movements and lock-in the profit.


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COMMODITY MARKRT

CRUDE OIL PRICESTheres more to oil spike than speculation

The world seems to be perplexed as to why crude oil prices are cruising upwards. The global leaders alsofailed to come to a conclusion in their meet in Jeddah on June 22 as to how to tame the galloping price-baby back to its cradle. Interestingly, albeit rather unfortunately, the influx of speculative element in oilprices and a slump in dollar rate have been used as excuses by Opec to shrug off its stake in oil price

determination. But is that the real reason that OPEC has lost its control on crude oil prices?

Let me just go back to the fundamental economic principle that simply the equilibrating market forces ofsupply and demand determine the global crude oil prices.

Call on OPEC

There are two suppliers OPEC and non-OPEC. Let me toe the line of conventional energy modelingsystem as followed byInternational Energy Agency (IEA), Paris andDepartment of Energy (DOE), USAwhere OPEC is assumed to perform the function of a residual supplier in order to equilibrate thedemand and supply in the world crude oil market. Thus, OPEC is supposed to supply precisely the

shortfall in world demand (often referred to as Call on OPEC) after accounting for supply from non-OPEC and adjusting for stocks of crude oil being held by the importing countries.

However, if one goes by the history of OPECs response to the Call, it could be observed that it seldomcomplied with what had actually been demanded from it, especially when oil was dearer, although itrepeatedly claimed to have consistently oversupplied. So, at the first instance, it claim should be acceptedwith a pinch of salt. OPEC has been defending its inadequate supply in response to Call by mentioningthat it has lost its excess crude capacity buffer owing to abnormal rise in demand and persistentinadequate investment in capacity enhancement on account of financial and geopolitical uncertainty. Butdoes this argument hold good uniformly for all the member of OPEC?

Among the 13-member cartel, Saudi Arabia has the highest daily production capacity of nearly 8.80million barrels/day (b/d); Kuwait and UAE, each with 2.50 million b/d; Venezuela 2.34 million b/d; andNigeria 2.25 million b/d. However, with the exception of Saudi Arabia, that has promised to pump inmore crudes if need be, other producers, especially, Iran, Iraq, Libya and Venezuela, are fully contentwith the spikes in crude prices and are opposing any increase in their crude output. The reason is abnormal windfall profit and not lack of spare capacity.

Clearly, the moot question at this juncture is is it actually profitable and rational for them to increaseproduction and comply with the Call on OPEC when they can silently continue to enjoy the windfallgains from spiraling crude prices for some more time? The outright rejection by OPEC of restoring themechanism of price-band suggested by the Indian Finance Minister during the Jeddah meet, such

intention becomes crystal clear.

Thus, contrary to its claim of lack of control, OPEC as a whole still has perceptible monopolisticinfluence on world crude oil prices and it is exercising the same at this crucial hour through a wait andwatch policy when the entire world is reeling under the dual bout of oil price shock and rising inflation.So, it may not be wise to pass the buck entirely on speculation and slump in dollar rate. It deserves to beunderscored that these monopolistic rational producers are consistent self-interest maximisers, even if weaccount for the uncertainties shrouded in geopolitical element that often seem to be OPECs escape route.


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COMMODITY MARKRT

COMMODITY TRADEHas the bubble popped?

If you were long silver, wheat and base metals at the start of 2008, you have my deepest sympathy. Allthese counters have become substantially cheaper in the last three months. Any bets you placed last yearwould have certainly made you richer. But things havent been quite simple from 2008 onwards. Withcrude oil hogging the headlines, one tends to forget that metals have been especially pathetic performers

in the last three months. Natural gas has fallen more than twice the distance that oil has. Wheat is 7%cheaper than 2007. The unusual price signals last year have stimulated an equally amazing supplyresponse. Wheat is bearish due to record global production and wide availability of high quality wheat.

Now, the big question is has the commodity bubble deflated? And most important, who do you blame foryour pain? The answer lies mired in a confusing slush of demand-supply fundamentals, market sentimentsand threats from regulators.

The threats of investigation, tighter rules, and a very public hounding of so-called speculators by US sarkari busybodies and Commodity Futures Trading Commission (CFTC) have scared off the largerhedge funds and index traders. The House of Representatives voted 402 to 19 to approve legislation

directing to curb immediately what was termed excessive speculation in energy markets. The bill has togo the Senate before it becomes law.

Independent Senator Joe Lieberman, chairman of the Homeland Security and Government AffairsCommittee, wants greater regulation of pension funds investment. He has proposed prohibiting privateand public pension funds with more than $ 500m in assets from picking up agriculture and energycommodities traded on a US exchange, foreign exchange or over-the-counter. Second, the CFTC wouldhave the right to set limits on the market share that speculator can hold in any one commodity. Plus, hewants to close the swaps loophole which allows individual speculator limits to be exceeded by swapdealers (who tend to be acting on behalf of investment funds linked to commodity indices). If hisproposals are implemented, commodity investment would be dead in the water.

Crude oil prices:They are finally falls in line with market fundamentals

Higher oil prices are their own enemy: demand destruction caused by spiking energy costs will fell globalcrude prices. Crude oil prices, which are now on down trend, may soften further unless spooked by adisruptive geopolitical development. Increased OPEC production, led by Saudi Arabia, coupled with adecline in demand in the developed world, especially the US, is set to ease the tight demand-supplyequation in the global oil market. Demand is also expected to moderate in developing economies likeChins, India and Thailand, among others because of lower subsidies and some moderation in economic

activities. This year thus expected to see prices soften as the tight market condition ease.


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4. FINANCIAL SECTOR: TRANSFORMING TOMORROWRegulatory overlap in the financial sector

The haphazard pace at which new financial products are being launched is constantly adding newdimensions to the issue of regulatory overlap in the financial sector. Some of the new/exotic products,because of their hybrid or borderline character, make a case for being treated under different regulatoryjurisdictions. Though the issue has a global nature, it has become more multifarious in India due to the

lackadaisical approach to finding expedient solutions. The ground realty is that this policy deficit isincreasingly creating problems (and losses) for the investors and taxpayers.

The other view is that Indias retail financial products market is still rather immature with very lowcustomer penetration level, and so regulatory convergence is not an immediate issue to be addressed.

1. FINANCIAL ADVISORS:Weigh impact on investors

Borderline products

Unit linked insurance plans and mutual fund products which directly compete (as both offer securitiesmarket-linked investment avenues); even while under different regulatory jurisdictions (Ulips under Irdaand MFs under Sebi) have co-existence in the market. Being under different regulatory domains, thesellers of these products get disparate rewards for their services. (What asset management companies areallowed by Sebi to give as commission to the distributors appears minuscule when compared with whatinsurance companies offer to agents for selling Ulips). So there is obviously a lack of level playing fieldhere. A related issue is that the extra incentive is practically a lure for the insurance agents to mis-sell (itis alleged that many Ulip buyers bought it without fully understanding its risk profile).

Another possibility of regulatory tussle has come to be noticed in the area ofgold exchange traded funds.Sebi regulates these funds even as gold, being a commodity, is under Forward Contracts Regulation Act

(FCRA) and so, under the regulatory purview of Forward Markets Commission (FMC).

It may be recalled that RBI and Sebi had been at variance over the regulation ofcorporate bonds market,before the latter virtually took over the regulation of this growing, high-potential segment.

2. FINANCIAL PLANNERSValue unlocking for all stakeholders

Harmonised regulations

The proposal for harmonised regulation ofsecurities and commodity derivatives market has also beenhanging fire. An inter-ministerial task force headed by Wajahat Habibullah had proposed that at leastFMC and SEBI could embark on a programme of closer co-ordination of their activities. Again, noconcrete action has been taken.

Besides, the development of commodity derivatives market is impeded by existing market-distortion

policies related to cash market such as minimum support price, monopoly procurement scheme,

differential rates of taxes, APMC Act etc., the task force had proposed corrective policies. This, again, isnot being acted upon.


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FINANCIAL SECTOR: TRANSFORMING TOMORROW

3. CREDIT COUNSELORSResolve convertibility and recompensation issue

Multiple tasks

For quite some time, policymakers and their advisors in India have been discussing handling ofpublicdebt, with the central question being who should do it the central bank or the government? Though, thepoint that central bank will be somewhat distracted from its core function (managing a key short-term base rate to maintain price stability) as it is given multiple tasks is fairly acknowledged, no earnestattempts is being made to fix the issue.

4. ONE-STOP-SHOPSDedicated to offer related services under a roof

Regulatory convergence

It is true that even globally; regulatory convergence in the financial sector is not perfect. But manycountries, especially UK, Australia, New Zealand and Singapore have traversed some distance in thedirection of harmonisation. FSA, financial watchdog of UK, does almost all the financial regulation(including regulatory part of debt management) in that country. Only the function of monetarymanagement is left with Bank of England.

In the US, the SEC regulates the spot market for securities but CFTC regulates all derivatives marketsincluding the commodity derivatives market. So, one agency regulates the equity spot market and anotherone, the equity derivatives market. Similarly, the spot market regulator would regulate the bond market, but derivatives market regulator would regulate interest rate futures. SEC and CFTC have jointjurisdiction for single stock futures and narrow stock indices.

5TECH SAVVY PROFESSIONALSTake first step to ensure efficient and reliable system

An informed and alert system

According to some analysts, the more pertinent issue than absence of regulatory convergence in India isthat not only customers but also even other stakeholders here are clueless about the hidden risks of manyfinancial products and this leads to mis-selling.

Its important all stakeholders regulators, entities in financial business like banks, insurance companies,AMCs, bond houses, distributors, and customers are fully aware of the risks involved in particularproducts and possible remedial actions they can take.

It may be recalled that even leading banks mis-sold complex derivative products to corporates and the

issue was mainly of lack of adequate information. So, it is an essential prerequisite for ensuring that the

whole system is sufficiently informed and alert.


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6. MICRO-FINANCE PROFESSIONALSDeveloping alternative credit delivery models

Investor protection

Recently, the head of Indias securities market regulator C B Bhave made it clear to the mutual fundindustry that when it comes to upholding the mandate of Sebi, he would place protection of investorsahead of development of the market. His remarks appear to have jolted the industry which had made apitch to him seeking approval for offering higher incentives to take on the insurance industry whos Ulipscompete in a way with their offerings.

The Sebi chiefs message is important for two reasons.

One, it signals to the mutual fund companies that if they have to grow their assets, they cannot do it byfattening themselves at the expense of the investor. India mutual fund industry which has had animpressive growth over the last three years now manages assets of over Rs 6,00,000 crore. But the

bulk of these assets have been built through investments made by individuals in the metros and a fewtop tier towns.

Bhaves remark also helps draw attention to another regulator Irda, which has the mandate foroversight of the insurance industry.

The Acts that govern almost all regulators mandate them to protect the interests of investors and fostercompetition and help develop the market.

IRDA is a relatively new regulator in the financial sector, compared to the RBI and SEBI. But it doesmerit the question as to whether the insurance watchdog is perceived as protecting the interests ofinvestors. The insurance industry has had a good run over the last few years, especially by selling Ulips.Mis-selling has been a big issue and sharp practices prevail among a few players but the regulatorsability to protect may be constrained due to the limited staff it has to supervise the industry.

Ashwin Parekh, national leader, financial services, of consulting firm E&Y, who has watched the industryfor long says that the first five years of opening up of the industry was good but in the next phase whenconsolidation and stability was called for, there were hardly any reforms. The time is opportune forcarrying out changes in areas such as reinsurance, intermediaries like broking besides beefing upsupervisory capacity. Ensuring level playing field also ought to be on the agenda.

The Financial Services Authority (FSA), which regulates the financial services industry in the UK says in itscharter that its aim besides promoting orderly, efficient and fair markets is to help retail financial serviceconsumers get a fair deal. The FSA does provide links to help consumers compare the feature and cost ofproducts and helpline numbers. The Indian insurance regulator can perhaps take a cue. Otherwise it doesrun the risk of encouraging the perception that players protection counts more than investor protection.


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7. WEALTH MANAGERSMap out the details to translate into benefits

Currency futures

Currency futures are once more the flavour of the season. They are needed to enable price discovery for

hedging operations, as there are a large number of players involved who would be looking at them. Moreso because the rupee, which was appreciating sometime back creating problems of monetisation for RBIhas suddenly started depreciating. The outlook continues to be hazy as is the case with all markets. Thepresence of OTC set-up, though efficient, is opaque. But, there is an alternative that exists.

Besides, there is another thought, which has to be addressed in the light of the Abhijit Sen Committeereport on futures trading in commodities. The report provokes further debate on whether futures tradingcan be effective in a commodity where there is a lot of government intervention. In case of commodities,the reference was to wheat where the minimum support price (MSP) causes a distortion. If one looks atthe forex market, then traces of familiarity can be seen in the behaviour of the RBI.

Today, market forces determine the exchange rate, but there is substantial intervention by the RBI asprudential monetary policy also entails keeping an eye on the exchange rate.

This means that the market principles guiding price movements is susceptible to intervention byregulatory authority. Hence, as in the case with the commodity market, when there is a MSP or itsequivalent of a maximum tolerable change in exchange rate, which is notionally held by RBI, there,would tend to be distortions in prices.

The players would have to conjecture what the RBI has in mind when bidding on the future rate. But, unlikethe MSP, the RBIs vision is a variable that changes more frequently 4 times a year when the monetarypolicy is announced and also an equivalent number of times in between. But, the task becomes tedious, as

RBI is known to intervene even on a daily basis in case of large swings in the exchange rate.

Therefore, one solution that could be advocated here is that the RBI will have to be actively involved inthe contract design and also specify its level of comfort with currency rate swings, which should be takenas the daily price band beyond which the market could also expect intervention from RBI. But, this is notefficient. Besides, the RBI can never tell what would be the tolerable limit and when it would intervene.Therefore, there would always be an issue of regulatory intervention making the market jittery. Besidesconjecturing moves of the Fed and ECB, market layers have to continuously read the RBIs mind whichis not an easy job to do.

Currency trades set get a future in India:

A clutch of banks from both public and private sectors are planning to join hands to float a newexchange for trading exclusively in currency futures. The Chicago Mercantile Exchange (CME), theworlds largest diversified financial derivatives exchange, has approached some of the banks involved inthe venture to partner them. The group, which plans to promote a new exchange, includes large publicsector banks such as SBI, UBI, and Canara Bank, besides leading private banks Axis and HDFC Bank.SEBI and RBI are working on the regulations and the norms for potential players. Trading in currencyfutures is expected to be kicked off a couple of months down the line. The NSE is reckoned to be a strongcandidate for offering a trading platform in currency futures.


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8. INCLUSIVE CEOsInnovative responses to problems

Shift currency-risk to foreign investors

The finance ministry has made out a case for a major revision in the policy on foreign borrowings to

allow an investment of over $ 15 billion by foreign portfolio investors in rupee-denominated bonds issued by Indian corporates. The finance ministry has sounded out the RBI on the proposal. The finmin hasargued that allowing higher investment by foreign portfolio investors in local corporate bonds wouldmake better economic sense rather than repeatedly raising the limit for Indian firms to borrow overseas.Increasing the allocation for investment in local corporate bonds and cutting down on the entitlements forIndian firms to borrow abroad would mean shifting the currency-risk to foreign investors.

The ministry has suggested that instead of an annual ceiling of over $ 20 billion for borrowings abroad,foreign portfolio investors should be allowed to invest $ 15-20 billion in corporate bonds in India. Thiswould mean carving out a substantial share for investment in local corporate bonds from the annualceiling on overseas borrowings, while paring the limit for foreign currency borrowings. The ministry has

also suggested the bonds ought to be traded on domestic exchange and that they may be of an averagematurity of five to seven years to allay concerns on short-term debt. The finance ministry and RBI jointlyfix the annual limit for Indian corporates to raise debt abroad. The cap has progressively been raised, andduring last fiscal, local firms are reckoned to have raised over $ 20 billion.

9. RISK MANAGEMENT CONSULTANTSEducate Engineer and Enforce

Credit derivatives

Credit derivatives are financial instruments whose value is derived from the creditworthiness of a thirdparty. The RBI had serious reservations about credit derivatives. After issuing draft guidelines in March2003, it decided the time was not appropriate to take the plunge. Subsequently, as part of the process offinancial sector liberalisation in India, it decided to introduce credit derivatives in a phased manner andissued modified draft guidelines on credit default swaps in May 2007.

These guidelines were again revised based on the feedback received and a second draft was issued inOctober 2007 for further discussion. But with the subprime crisis hitting the financial world and the roleof derivatives under intense scrutiny of regulators globally, there is now little pressure even from foreignand private banks to introduce these products in India. The central bank has, therefore, seized thisopportunity to reassert its traditional suspicion of innovation and keep credit derivatives on hold.

The decision fits in with the RBIs slow and steadyapproach to financial sector liberalisation. Havingsaid the time is not considered opportune to introduce the credit derivatives in India should not be takenas an excuse to defer derivatives indefinitely.

Innovation is an integral part of business, be it banking or anything else. What is important is not to frownupon it because it poses risks but to frame suitable prudential guidelines and back this with competentsupervision and market intelligence so that misdeeds are promptly bought to light.


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10. CONTINUING LEARNING CENTRESTake informed decisions

Assessing Customers Role in Derivatives

There has been quite a deal of excitement on the derivatives front in the last few months. Banks and

customers are busy pointing fingers at each other and things have gone to the extent where somecustomers have taken banks to court.

Unfortunately, most of the criticism is aimed at banks, labeling them the guilty party who operated withthe sole motive of ripping off their customers, in an unscrupulous effort to make huge amounts of money.In fact, some customers naively believe that their loss is the banks gain. This is far from the truth, asbanks profits are actually only the spreads they make on these transactions.

In the melee, the role customers have played in this sorry mess has been totally forgotten. Granted, somecompanies have less than the minimum knowledge needed to handle sophisticated products. Having noclue whatsoever about cross-currency movements and attendant risks, they chose to buy these products,

often carried away by the excitement of entering into derivatives contract just like the big boys.

How did companies that are so careful and conservative in other aspects of their business became soadventurous when it came to derivatives? We know that common sense is not so common but the nave waysome people have entered into these transactions makes one wonder.

While we can forgive innocence in a small-town small company, we cannot do so to those professionalswith qualifications and experience manning the finance department. They read the financial journals andatten

Documents

Journal of FInance Vol 20