Senior Analyst January 2012

The Senior Analyst 2 FMS Delhi

Rupee Depreciation and its Impact on the Indian 3Economy Downgrading of Credit rating of SBI and Indian 6Banking Sector by Moody’s The Kingfisher debacle – Danger looming large 8on the Indian Airlines Industry World Economic Outlook: Tackling Inflation 12in Asia The rush for “Catastrophe” investing by wealthy 14investors The Rush for Gold – Analysis of the increase in 17Gold prices The Eurozone Crisis and the Role of Monetary 20Union The Dollar Hegemony 24Islamic Banking: Challenges and perspectives 30with a focus on India IPO: It’s the right time to strategize 36Financial Inclusion in the Indian Economy 39Private Equity-A pioneer for Sustainable Growth 42of India Interview with an Alumnus - Nikhil Aggarwal 47Interview with a professor - Dr. Partha Chatterjee 49

Contents


With the rupee shedding over 10 per cent in value since the last week of July, there is a lot of attention on the volatile nature of the Indian Currency vis-a-vis the US dollar. But, the cur-rent free fall in the domestic currency to Rs 49-50 levels is in a way mirroring a historical trend. Two major rupee devalua-tions occurred in 1966 and the early 90s. The reasons for the two devaluations were not too dissimilar; twin deficit (current account and fiscal), soaring inflation, insufficient foreign ex-change reserves, and the developed world demanding decon-trol and liberalization to allow them to do business in India.

India has a managed floating exchange rate system. This means that the Indian government intervenes only if the exchange rate gets out of hand by increasing or reducing the money sup-ply as the circumstances demand.

The reason for the fall

The Indian rupee is under great stress as overseas investors are paring their exposure to Asia’s third-largest economy amid the US and Euro-zone crisis and mounting worries over the do-mestic economy. The global uncertainty and various economy crisis has forced the investors, large banks, investors and fi-nancial institutions to search for safe haven and they have now started selling Euros and buying dollars. Thus, the dollar has appreciated against all major currencies including rupee. These investors are quickly pulling out the money from Indian mar-ket and investing in other safe investments such as Gold or the US dollar.

Rupee Depreciation and its Impact on the Indian Economy

“The Indian rupee is under

great stress as overseas

investors are paring their exposure to Asia’s third-

largest economy amid

the US and Euro-zone cri-sis and mount-

ing worries over the

domestic economy.”


The 3 major factors contributing to the fall are:1. Risk Aversion on part of Currency Investors, which has caused the Demand for the US Dollar to go up world over.2. Uncertain Economic Situation around the globe3. FII’s turning Net-Selle`rs and withdrawing funds from the Indian Market.

Comparisons with a wider basket of 36 currencies also indicate that the rupee has indeed appreciated by al-most 15 per cent in real terms. Hence, purely from an analytical perspective, the depreciation in the rupee is an overdue market adjustment, resulting from the nex-us between exchange rate, inflation and interest rates in the economy.

Impact of Rupee Depreciation on the Indian Economy

Inflation graph and Fiscal deficit to scale up

Currently, India is suffering from a near two digit infla-tionary pressure. A depreciating rupee would only add fuel to this. It would lead to high inflation, as India im-ports around 70 per cent of its crude oil requirement and the government would have to pay more for it in rupee terms. Due to the control on oil prices, the gov-ernment may not easily pass the increased prices to the consumers. Further, this higher import bill will lead to rise in fiscal deficit for the government and will push the inflation.

On November 21 alone, overseas funds sold more than US$500 million worth of Indian-listed shares over the five trading sessions, reducing net inflows for 2011 to under US$300 million. The rupee has lost more than 10 percent of its value this year, making it one of the worst performing currencies in Asia. In the light of uncertainty and fall in global stock market, FII’s are supposed to be pulling out their money from vari-ous EME’s (Emerging Market Economies) and taking them back to their home countries in order to sustain themselves.

A blow to Indian Importers

The Indian import industry would also have to pay more in rupee terms for procuring their raw ma-terials. This would happen despite a drop in global commodity prices, only because of a depreciating rupee against dollar. Corporate India is a net bor-rower of dollars and to that extent a depreciating rupee would impact its balance sheet adversely. Companies with foreign debt on their books would also be impacted. With the rupee depreciating against the dollar, these companies would need more rupees to repay their loans in dollars. This will increase their debt burden and lower their profits. Obviously, investors would do better to stay away from companies with high foreign debt.

The depreciating rupee has pushed up the prices of electronic gadgets and home appliances. Car mak-ers who import 10 to 40 percent of the components are contemplating increasing prices. This is an at-tempt to offset the increased import costs owing to the depreciating rupee. An increase in prices could span from Rs 10,000 for small cars to Rs 50,000 for luxury vehicles. The rising interest rates and fuel hikes have played spoilsport for the car industry that is brimming with a wide array of choice for consumers.

Negative impact on Indian students and travellers abroad

Individually, travelling abroad becomes more ex-pensive as travel cost could go up by around 10 per cent compared to last July figures. Students study-ing abroad too will be hit as more rupees will go out to pay for the courses, stay and other expenses.


Impact on Oil Imports

Oil imports consume the largest part of the FOREX re-serves. A depreciating rupee is bound to offset the de-crease in the international prices of commodities such as oil. As can be seen from the figure below although the oil price per barrel has fallen however the depreci-ating rupee has not given any respite to the importer as they actually have to shell out more money in order to purchase the same quantity of oil. Take for instance crude oil imports. Brent crude oil price was $118.46 per barrel on April 2011 when exchange rate for the rupee was Rs 44.4 to a dollar. On November, oil price had gone down to $109.03 per barrel and exchange rate was Rs 52.7 to a dollar. Thus, because of the rupee depreciation not much benefit can be derived out of the lower oil price. Instead, the increase in price of im-porting oil between April and November is to the tune of Rs. 489.8 per barrel.

Cheerful news for Exporters

When a currency depreciates, the exporters make more profit because they get more of the local cur-rency for every unit of foreign currency though the quantity of trade remains unchanged. The depreciat-ing rupee would be positive for the Indian IT sector which generates more than 85 per cent of their $70 billion revenue from the overseas markets. This kind of appreciation in foreign currency will enhance their actual realisation of revenue in dollar terms.

Role of RBI

RBI will interfere in this area because a steady value of rupee is essential for the orderly growth of the econ-omy. A depreciating rupee will harm oil marketing companies, and other import oriented businesses. This may help the software companies and other exporters, who get their payment in dollars.RBI will be watching the position and interfere to sta-bilize the currency value. In case of depreciation, RBI will sell foreign currency from the reserve and this will help in arresting the fall of rupee to some extent.

Possible Solutions

• Oil import demand could be staggered and purchas-es co-ordinated so that at no point there is undue bun-dling of imports.• The government can take initiatives which encour-age and increase the flow of foreign investments into India. Three recent steps taken by the government be it the pension fund FDI limit or the increase in the investment limit investors in government security and corporate bonds are the steps in the right direction.• The government can make investments attractive and invites long term FDI debt funds in infrastructure sector.• Government can consider temporary import com-pression.• FDI in the aviation industry retail can also attract foreign investors.

By - Bhushan Mahajan (FMS)


Downgrading of Credit rating of SBI and Indian Banking Sector by Moody’s

On October 5th,2011 the share price of SBI came tumbling down to its two-year low level of Rs 1,751.35, a fall of 5.98% from its previous close. The reason ? Moody’s lowering of the credit rating of State Bank of India from ‘C-‘, which signifies ‘adequate intrinsic financial strength’ to ‘D+’, which signifies ‘modest intrinsic financial strength, potentially requiring some outside support at times’. A month later, on 10th November, 2011 Moody’s lowered its outlook for Indian Banking system to negative from stable.

The reasons for the credit rating downgrade of State Bank of India, as stated by Moody’s were inadequate Tier 1 capital and deteriorating asset quality. The rating downgrade puts SBI in the same category as other public sector banks. Private Sector banks like Axis Bank, ICICI Bank and HDFC Bank have rating of “C-”.

Banks Tier I Capi-tal % as on March 2011

Gross NPA % as in March2011

Moody’s stand-alone Ratings

State Bank of India

7.8% 3.3% D+

Punjab Na-tional Bank

8.4% 1.8% --

ICICI Bank 13.2% 4.5% C-Bank of India 8.3% 2.2% --HDFC Bank 12.2& 1.1% C-Axis Bank 9.4% 1.1% C-

Source: Annual Reports, Results of banks, ICRA Research, Moody’s

SBI’s Tier 1 capital ratio as reported in July, 2011 was 7.6% which is lower than the prescribed limit of 8% by Indian gov-ernment for public sector banks. According to Moody’s such a low level of Tier 1 capital is not enough to support growth and to absorb the credit costs from its deteriorating asset quality. Tier 1 capital can be raised through rights issue or a follow-on offer. SBI had been seeking a Rs. 20,000 crore rights issue for which the Indian Government would have been required to infuse capital of Rs 14000 crore to maintain its current 59% ownership or Rs 9000 to maintain 51% ownership. But the cash strapped Indian government with the added pressure of

“The reasons for the credit

rating downgrade of State Bank of

India, as stated by

Moody’s were inadequate Tier

1 capital and deteriorating

asset quality. “


of maintaining a fiscal deficit of 4.6% of GDP had been delaying the infusion. Now the total capital in-fusion has been reduced to Rs 12000 crore, for which the Indian government has agreed to infuse Rs. 3000- Rs 4500 crore, to help SBI achieve a Tier 1 capital of 8%. Though the method has not been finalised as yet, as a rights issue might not be feasible given the mar-ket conditions. However, Moody’s expects it to again fall below 8% in 3 years assuming a loan growth of 15% per annum. SBI has always been plagued by the problem of high NPAs. SBI had to do a high provisioning for the NPAs for the fourth quarter of FY 2010-11, which led to a 99% plunge in the profits. In order to get rid of the NPAs and to prevent such high NPA build up in the future, SBI has recently set up 14 account tracking centres. Moody’s lowered its outlook on Indian banking sys-tem due to concerns regarding the asset quality, capi-talization and profitability because of difficult operat-ing environment.

According to Moody’s the fall in the Indian economy’s growth along with high inflation will have adverse ef-fect on the financial health of the banks. The monetary tightening by Reserve bank of India, which has hiked the repo rate 13 times since March, 2010, will further deteriorate the asset quality leading to higher provi-sioning. Also de-controlling of the saving deposit rates by Reserve Bank of India is expected to put pressure on the net interest margins of the banks. In addition, the European debt crisis and the doubts over the US economic recovery will adversely affect the Indian banking system. Indian government is expected to borrow Rs 528 billion during October-March which will impact the borrowing rates of the corporates.The downgrade is expected to make overseas borrow-ings by Indian Banks costlier. The downgrade led to a 2.62% decline in the BSE Banking Index. State owned banks were badly hit as the shares of Bank of Baroda and IDBI Bank fell by 3.63% each. The downgrading drew a lot of flak from the Indian banks. Many feel that Indian Banks are well-regulated and well-audited. Indian banks have no exposure to exotic assets and have a lesser amount of leveraging and thus, deserve a better rating. Indian government has dismissed the downgrade saying it does not have any significance. On the other hand, rival credit rating agency Stand-ard & Poor’s (S&P) upgraded the sector from ‘group 6’ to ‘group 5’. According to S&P, Indian government is supportive of the banking system and the sector is well-regulated. - By Amarpreet Singh, Ramnik Singh (FMS)

Fin is fun Leveraged Buyout (LBO)

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addi-

tion to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

One of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. The three companies paid around $33 billion for the acquisition.

It can be considered ironic that a company’s success (in the form of assets on the balance sheet) can be used against it as collateral by a hostile company that acquires it. For this reason, some regard LBOs as an especially

ruthless, predatory tactic.


The Kingfisher debacle – Danger looming large on the Indian Airlines In-dustryThe drudges of the Indian aviation sector, in general, and Kingfisher Airlines, in particular, have been in the spotlight over the past fortnight for all the wrong reasons.Compounding the woes for players such as NACIL, Jet Air-ways and Kingfisher Airlines is huge debt and massive accu-mulated losses. Amidst talks of an imminent shakeout, it is noteworthy that Indian aviation is not new to such scenarios.

Industry overview:

The opening up of the aviation sector has facilitated the entry of overseas players following which there has been a consistent growth both in terms of number of players and aircraft. This is depicted by a CAGR (Compounded Annual Growth Rate) of 16%.The reasons for this increase in air travel are:• Presence of multiple low cost carriers with comparatively affordable fares• Increasing disposable income• Establishment of new airports and renovation/restructur-ing of existing airports

Causes of industry worries:

Supply Cuts

Following the rapid expansion in capacity by all listed play-ers during FY06-11, gross debt had gone up 3.7 times to IN-R223bn as of FY11. Kingfisher saw cancelation of ~40% of its daily flights (370 per day) because of cash crunch. The management claims that these routes were not profitable. In the domestic market, Kingfisher’s share is 19%. If it is unable to continue opera-tions in this time of high demand, it could get even worse in the coming months. As a result, the industry supply growth is estimated to limit to 5%-11% CAGR over FY12-14.

“If KFA really wants yet

another chance, it

must be told to bring in at

least Rs 3,000 crore of fresh

equity. “


Price elastic demand

Following the supply cuts by Kingfisher in a busy sea-son, JAL and other airlines have made 20% upward re-vision in their fares. Demand, however, has remained strong so far, growing at nearly 18%-20% over April-October’11. But the price elasticity is high in the sec-tor with cheaper substitutes like train and buses avail-able for the non-business travellers. This implies that a sustained rise in fares can damage demand. Increas-ing fares by more than 5% are not advisable if demand growth is to be maintained in double digits.

High Operating costs

Jet fuel is the biggest contributor to operating costs of airlines with taxes forming a sizeable chunk of it. As a result of heavy national and State taxes, India jet fuel prices are estimated to be 40-50 per cent higher than

global prices. Some of the other costs are high wages for pilots, crew and handling staff. Industry players including JAL are taking cost cutting initiatives including staff rationali-zation to tide over the crisis. With more than 100 pi-lots resigning from Kingfisher it will help them reduce cost and will also help the industry cope up with the shortage of experienced pilots.One more crucial cost is in the choice of aircraft. Air-crafts are available in various sizes and types for the airlines to choose from.It is challenging to decide which planes to use for shorter and which for longer to achieve cost efficien-cies in the long run. Several LCC’s like Indigo have competed effectively by choosing to purchase a single type of aircraft (46 Airbus A320’s) for their entire fleet. This choice enables them to keep maintenance costs as low as possible considering their engineers and ground staff has only one type of plane to service and stock up spares for. Kingfisher Airlines, on the other hand, has eight variants to maintain and Air India maintains ten variants, thereby escalating their operating cost.

Inability to raise fares

Due to stiff competition in the industry the airlines have been unable to raise fares in spite of escalating costs thereby making themselves unprofitable. With the emergence of low-cost (LCC) airlines which cut-back on the frills and sweat their aircraft better by re-ducing turnaround time, it’s even more difficult for full service carriers to maintain their market share.

Impact on Kingfisher Airlines Financials

Kingfisher Airlines have reported consolidated reve-nues of 1,528 crore (up 10.5% YoY, down 18.8% QoQ) that were markedly below the expectations precisely because of the drops in the domestic yields which de-clined 16%. The domestic segment lagged behind the international segment (which is responsible for 25% of the revenues) in performance. The international segment saw a growth of 11.0% on caused by an 8% increase in yields. Fuel cost continued to escalate with a sharp increase of 70%. A net loss of 469 crore was reported by Kingfisher in the quarter triggered by dip-ping revenues and increasing operating costs


Causes of the dipping margins-Lower yields and higher fuel costs

The major reasons for the declining domestic mar-gins during this quarter are the predative pricing strategy followed by major competitors and also an uncalled for increase in the supply (ASKM) which led to a decrease in KFA’s domestic yield of 16% to 4.2 per ASKM. The fuel prices as such rose over 35%YoY in the quarter but the final fuel cost went up by 70% owing to increase in the departure and the depreciation of rupee. The surge of 334 crore in the debt raised the interest cost by 9% and thus further increasing the loss to 469 crore. In spite of a healthy industry pax growth of over 20%, KFA witnessed a drop of 13% in its pax because of a significant 5.5% decrease in the number of flights. But the figures for the international segments are quite encouraging due to the increase in the num-ber of flights. Both the domestic supply (ASKM) and demand (RPKM) declined by 2.1% and 11.5%, re-spectively leading to a steep dip in the domestic load factor by 820 bps to 77%.The load factor in the in-ternational segment has dipped by 536 bps to 73.2% even though the ASKM increased by 4% whereas the RPKM declined by 2.8%.

As a matter of fact, KFA’s’ domestic load factor for the domestic and international segments recorded a sharp drop, courtesy the lean season and reduction in number of flights.

During the last quarter, KFA reported a domestic negative EBITDAR of 10 crore vs. EBITDAR of 289 crore in the same quarter of the previous year. The international EBITDAR also loomed in the negative zone. Some of the factors hitting the airline indus-try hard are rupee depreciation, the lean season, a sharp rise in fuel prices and an irrational pricing environment

The Road Ahead:

The road ahead looks bumpy with an urgent need of some structural and economic reforms. Some of the probable alternatives for the airline industry in general are:

One of the major policy responses could be reduc-tion of state sales tax on fuel from average levels of 24% (average across states) to 4% which is quite possible by giving jet fuel the status of ‘declared goods’ in order to attract uniform state sales tax of 4% across India.

The issue of allowing foreign carriers to pick up stake in Indian carriers has been discussed for quite some time now with the aviation ministry propos-ing a cap of 24% and DIPP 26%. While this will help the cash strapped domestic carriers to raise much needed equity but it will also make them suscepti-ble to hostile takeovers. Not only this, the foreign carriers with deep pockets can artificially lower the prices of air travel to kill domestic competition.


As far as Kingfisher is concerned, it has already been rescued. Banks converted unpaid loans to Kingfisher into equity at a very favourable premium of 62% to the ruling market price. Despite that, the company has sunk deeper into the red. After all these restruc-turing efforts by the government, its debts exceed Rs 7,000 crore. Government concessions to the indus-try may save other airlines, but not Kingfisher. We conclude that that certain airlines must be allowed to perish, giving way to ‘survival of the fittest’.

One way forward is for banks to convert a big chunk of their outstanding loans to Kingfisher into equity at the current market price, giving them a 51% stake in the company. This can then be auctioned to the high-est bidder. This will be clean and quick, free of the crony capitalism that afflicts government handouts to business.

If KFA really wants yet another chance, it must be told to bring in at least Rs 3,000 crore of fresh equi-ty. If it cannot entice the investing public—which is probable—its charismatic CEO, Vijay Mallya must sell his other assets in the likes of Liquor Company UB Holdings, the cricket team Royal Challeng-ers, Bangalore; the Kolkata football teams Mohun Bagan and East Bengal; and the Formula 1 team Force India.

The challenge staring the airline industry in the face is to decide what plane is best suited for which route and can make money for an airline in the long run rather than just on a seasonal basis, thus slowly and steadily heading the way of the good old days.

-By Sonam Gupta, Spreeha Dhama (NITIE)

CEO Profile

Cyrus Mistry

Cyrus Mistry, the next chief of the Tata empire has been labeled as a surprise choice. However, the closer we look into the profile, the more perfect the choice seems to be.

He is the youngest son of construction baron Pallonji Shapoorji Mistry and hails from one of the richest families in India with a net worth of $7.6 bn. His family is also the single-largest shareholder in Tata Sons with a stake of

18%. He holds an Irish nationality and did his graduation from London business school.

He joined the board of Shapoorji Pallonji & Company as director in 1991 and was appointed the managing director three years later. During his reign the business grew from a turnover of $20m to almost $1.5bn. It was under his leadership that the company registered the construction of the tallest residential towers, the longest

rail bridge, the largest dry dock and the largest affordable housing project. In the year 2006 Mr Mistry joined the board of Tata Sons as a director of Tata Power and Tata Elxsi. He is also on the board of the Construction Federa-

tion of India, the Imperial College Advisory Board and is a Fellow of the Institute of Civil Engineers.

On the personal front, Mr Mistry is known to be a soft spoken and a candid individual. In his free time, he is he is known to enjoy playing golf and is a prolific reader.


World Economic Outlook: Tackling In-flation in Asia

Asian economies experienced a moderated growth during the second quarter of 2011. They were affected by uncertainty in global economic environment as investors sold profitable po-sitions in the region to cover losses incurred elsewhere. This resulted in many Asian currency and financial markets expe-riencing reduced liquidity thereby leading to increase in infla-tion. At present, the domestic demand for goods has been on the rise though external demand for Asian goods and services have declined. Credit growth has generally been on the rise but inflation still remains high for the region. The growth rate for Asia is expected to be slightly higher in 2011-12 than in 2010-11 and economic expansion is expected to be healthy due to increased domestic demand for goods. Inflation is ex-pected to decline marginally in the first quarter of 2012.

Domestic demand and Inflation Pressure Demand for domestic goods has risen in Asian econo-mies as employment gains and real wage growth supported private consumption while higher utilization of productive capacity in the region boosted private investment. Increase in interest rates was offset partly by high inflation in some Asian economies (Korea, Malaysia and Thailand) while normaliza-tion of monetary policy along with slowing credit growth have contributed to tighter financial conditions in China and India. Inflationary pressures remained high across Asia with infla-tion increasing in most economies. The average inflation rate of the region was 5.5% in July 2011 in comparison to 4.6% in January 2011. Inflation has primarily been driven by com-modity prices and sustained domestic demand. In contrast Japan’s deflationary pressures due to plunge in output caused by the March 11 disaster persists with core inflation still nega-tive. The inflation rate for developing Asia is expected to av-erage 5.8% (July) which is higher than previous estimate of 5.3% (April) this has led the Asian development Bank (ADB) to cut its growth forecast for developing Asia to 7.5% in 2011 as compared to its earlier estimate of 7.8%.

“Policy makers need

to be careful while changing interest rates

especially in light of United

States’ inability to create jobs

and Europe’s persistent failure to

tackle its debt crisis.”


ConclusionInflation in Asia is primarily due to excess aggregate demand and high inflationary pressures rather than external price shocks and therefore monetary policy remains a powerful tool against inflation in Asia.Pol-icy makers need to be careful while changing interest rates especially in light of United States’ inability to create jobs and Europe’s persistent failure to tackle its debt crisis.Macro-prudential measures remain an im-portant tool for monetary management as many of the measures adopted in Asia since 2010 were designed to minimize risks to financial stability and therefore con-tinue to be relevant. Removal of subsidies/deregula-tion of prices may increase inflation in short term but will rationalize domestic demand and improve market efficiency in long run. The resulting inflationary pres-sure can be used for tightening monetary policy. By: - Ajit Kumar K (FMS)

Fin is FunBarbarians at the Gate

Very few books about the financial world created the kind of impact that Barbarians at the Gate did when it first released. The book, written by two investigative journalists, Bryan Burrough and John Helyar, details the

behind-the-scenes action that took place in the 2 months preceding L Ross Johnson’s $25 billion Leveraged Buyout of RJ Nabisco in 1988. Although “Barbarians” was released in 1990, the story remains relevant even to-day, infact given the recent excesses by Wall Street , the story acquires even greater significance in today’s world.“Barbarians” focuses on the CEO of RJ Nabisco, Ross Johnson and his battle with the takeover of his company

by KKR. Burroughs and Helyar tell the story of the leveraged buyout of RJR Nabisco in gripping fashion, showing how greed and shortsightedness contributed to the biggest and worst-managed corporate takeover in history. The players: Salesman F. Ross Johnson of RJR vs. Henry Kravitz of KKR. Everything from a wild, rip-roaring potboiler novel is here: Secret deals, stock market manipulation, flouting of laws, surprise plot twists.

All of it almost unbelievable, but all of it true.The interesting part of the book is a telling of the history of the companies, main people involved, their

ambitions, their motivations and how they plan and scheme to get ahead. The book has what is called the ‘people’ perspective, and you will get a fair idea of what the personal ambitions of a person as ambitious (and

ruthless) as Ross Johnson will cost many of the other people involved. Also, you get to see something evolving in this book that continues to this day, namely the notion of how executive perks have kept on increasing.

However, the book has its own share of problems as well. While the research on the topic by Burrough and Heylar is meticulous, the book could have done with some better editing. Running into almost 600 pages, the

book is just too long, and the story gets bogged down in a number of places. Secondly, both journalists seem to have eschewed the financial details to make the book read more like a thriller than a serious piece of

investigative journalism. Sadly, the nitty-gritty’s of the deal, which would have made fascinating reading for any student of Finance are lost in the process.

Nevertheless, the book is a gripping read, and a must-read for anyone looking to get a bird’s eye view of the deep, dirty world that lies beneath the moolah that defines the financial world today.


The rush for “Catastrophe” investing by wealthy investors

An entrepreneur who was worth hundreds of millions of dollars recently told a Wealth manager about his new in-vestment philosophy: “I’m not looking for a big return on assets,” he said. “I just want my assets returned.” So it goes for millionaires and billionaires as they look out at careen-ing stock markets, crises in Europe and a slowing Asia. Wealth management has become risk management, and the wealthy are all about preserving their fortunes, rather than making new ones. The world’s wealthiest families are now content with damage limitation rather than seeking to boost their fortunes as financial turmoil erodes their riches, with some so worried they are putting their money in ‘catastrophe’ portfolios. Wealth managers who serve some of the world’s richest individuals are seeing clients pile money into “catastrophe portfolios” and real estate, seeking defensive positions that might help them weather a far-reaching economic storm that has shaken up finan-cial markets worldwide.

The Catastrophe PortfolioThe investment strategy of a “catastrophe portfolio” allo-cates one third of the money to gold, one third to defensive and internationally diversified blue chip company shares, and a third to the debt of ultra-safe developed countries. This model portfolio designed to protect people’s wealth in the face of global catastrophe has attracted more interest as Eurozone has sunk into distress in recent months. With inflation eating away at people’s invested capital and rock-bottom interest rates making living off capital increasing-ly difficult, many rich people are taking new risks just to stand still by investing in Catastrophe portfolios.But interest in the portfolio is still limited to the most “par-anoid” clients but interest is rising, particularly among peo-ple who have seen previous episodes of societal breakdown and financial collapse in Europe.”Its people who have been listening to their grandmother ... They are not necessarily that old. It’s people who are really afraid,” a wealth manager of a multinational bank remarked.

“The world’s wealthiest

families are now content

with damage limitation

rather than seeking to

boost their fortunes as

financial turmoil erodes

their riches


Let us analyse how effective the Catastrophe portfolio can be .First, the move into gold and real estate satis-fies a basic, highly unsophisticated urge: to purchase tangible things that are meant to have lasting value. Tangibility of such assets gives a sense of stability to the investors. Also Gold seems to have a safe haven status now given the erosion of the importance of other safe havens like the Swiss Francs (due to its de-valuation ) and the volatility in dollar .Also it is highly unlikely that the ultra-safe countries will all default at the same time. The investment in internationally di-versified blue-chip shares brings about diversification at two degrees- across counties and across different in-dustry sectors.

Apprehensions

1)This portfolio seems to suffer from recency bias – chasing after assets that have more recently performed well (gold which has risen spectacularly over the past decade, and blue chips which have out-performed oth-er broad riskier asset classes the past few months) - but which will not necessarily fare well in potential future economic scenarios. There are better ways to crash proof a portfolio – build a broadly diversified portfolio and re-balance it regularly. At very low risk portfolio that could be used can consist of eleven asset classes and weighted toward a blend of US bonds, Global Bonds, TIPS(Treasury Inflation Protected Securities) , and Cash - along with exposure to REITs (Real Estate Investment Trusts), commodity funds and equities. And if one is too lazy to re-balance “Lazy Portfolios” (33% inflation protected securities fund, 34% total bond index fund, 33% total international stock index fund) can be used with.

In theory the approach of catastrophe investing is great – investors have their wealth in solid, secure, safe in-vestments – but they still diversify across assets classes to ensure a maximum spread of risk and potential re-turn. However, one has to ask oneself questions like is gold currently overvalued, or are equity shares ever a safe bet? and what on earth is an ultra safe developed country? – the UK, the US – hardly any ! (especial-ly when the credit rating of some of these countries has already been downgraded ).So whether it be cash, bonds, gold or blue chips, all are subject to market or systematic risks which entirely depends on the char-acter of the coming crisis. Hyperinflation would be good for gold and bad for cash, but a systemic defla-tion from a major banking system collapse contagion would likely do the opposite. On the other hand, wars may adversely impact blue chips or transnational com-panies, while “ultra safe government debt” could be a delusion if their social welfare system of the country is running on debt in an economy that consumes more than she produces or earns (a typical case would be the PIGS counties of the eurozone.) Of course there are possible gray areas, such as debt defaults.

Also, since the conventional markets have been greatly influenced by pervasive bubble policies and political interferences so ramifications from the actions of po-litical authorities will remain as major factors in deter-mining the risk environment .This makes taking ac-tion from reading and analyzing the political tea leaves a better and a more flexible approach than a one-size-fit-all portfolio.3) This portfolio does not provide nearly enough protection in the event of a deep crisis because of the following reasons. Firstly the allocation to gold may or may not work out well in a deep global economic crisis. Gold is not a crisis proof investment. Unlike ba-sic necessities needed for survival, the value of gold is artificial. It is desirable because it is scarce.


However think of a financial crisis as basically a peri-od in which everyone is scrambling to raise money to pay their debts. There’s basically no gold-denominated debt (as far as we know). Thus people would rather sell gold to pay-off their debts rather than own more of it. Stocks for traditional defensive plays and internation-ally diversified blue chip companies will get trashed in a deep crisis and do not provide any protection at all. Also one needs to question whether there is really such a thing as “debt of ultra safe developed countries”. De-veloped countries for the most part are carrying high debt loads and a worldwide bout of inflation causing bonds to lose value is a possible consequence of a deep crisis. Thus, while this so called catastrophe portfolio is not terribly risky if the world wide economy continues to muddle along, we should be doubtful that it would perform particularly well in a deep crisis(especially in a case if the Euro-zone disintegrates).

While the “catastrophe portfolio” may be embraced by the most nervous of the wealthy, a 2011 study by Knight Frank and Citi Private Bank reports that the ultra high net worth individuals (UHNWI) still hold investment in property close to their hearts. Accord-ing to their survey, it makes up 35% of the average UHNWI’s investment portfolio (this includes both residential and commercial). Those surveyed in this report had, on average a net worth of $100 million. The report goes on to say, “The factors that encourage the wealthy to seek out and buy the very best prop-erty in cities such as London have, if anything, become even more important.”

Thus real-estate investment seems to be a better option than catastrophe portfolios as seen in the investing be-haviour of the affluent in Europe, the Middle East and China who are investing more of their money abroad, a majority of which ends up in high-end residential real estate. Hence the property booms in London and Vancouver (B.C.). Paris may be next in the growing list of very desirable places to buy luxury homes and con-dos and also promises to be an attractive investment avenue in the times to come.

Conclusion

Therefore the answer to the question whether Ca-tastrophe portfolio investing is effective or not is an absolutely personal one based on risk appetite . i.e., whats a low risk , solid investment approach to one could be too low risk and poorly returning for another person. Since the basic aim is to protect wealth from inflation erosion, the effects of low interest rates and unstable economic factors will of course drive deci-sion making – but as every individual has their own personal perspective in terms of what constitutes safe, the investment decision needs to be in sync with the risk taking ability of the investor. It’s fine to start with a catastrophe investment approach to your portfolio – this would limit the types of assets which need to be considered – but the portfolio still needs to be tailored to the needs and the risk appetite of the investor even in this investment climate. -By Neeraj Rai (FMS)

Fin is funKnow your Economist

Alan GreenspanAlan Greenspan (born March 6, 1926) is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC. First appointed Federal Reserve chairman by President Ronald

Reagan in August 1987, he was reappointed at successive four-year intervals until retiring on January 31, 2006 after the second-longest tenure in the position.

Greenspan came to the Federal Reserve Board from a successful consulting career, holding economic views in-fluenced by Ayn Rand. Although he was subdued in his public appearances, favorable media coverage raised his

profile to a point that several observers likened him to a “rock star”The subprime mortgage crisis occurred within months of his departure from the board, and inquiries into the possible role of his policies in the crisis have tar-

nished his image.


The Rush for Gold – Analysis of the in-crease in Gold prices

As I write this article, gold has touched all time high of Rs. 29440 per 10 grams. A lot of attention and statements has been made on the subject of Gold by leading economists around the world. The madness of buying the gold makes one wonder whether gold price in the market is truly justi-fied or is another bubble.This article tries to identify few reasons for sudden buzz in the demand for gold and whether one should join the band-wagon for buying gold.

Positive correlation between income in China & India and the price of gold

The recent report by World Council of Gold highlights the fact that China and India are the largest consumer of Gold. More than 50% percent of demand for gold is driven by China and India. With income increasing in both the coun-tries, it is expected that gold demand will increase by 30% to 750 tons in China. In recent times China has encouraged its citizens to make investments in gold by offering gold linked checking accounts. The increase in disposable income will certainly act as bullish driver for the price of gold.

Demand by Central Bank Purchase

As the third quarter report of World Council of Gold, the demand for gold increased to 1053 tons, a 6% increase in the demand volume form last year. A closer look at the fig-ures of total demand for gold reveals a startling fact. Net Purchases of Central Banks around the world amounted to 148 tons. This figure represents an astounding increment of 556% from last year during same quarter when Central Bank purchased only 22 tons. China has repeatedly stated its willingness to increase gold holdings in its massive re-serve. Clearly, Central Banks are diversifying their reserves by investing in the gold. The graph depicts the status of gold holding by top 15 Central Reserve Bank around the world. USA holds largest gold reserve with holdings total 8965 tons valuing the reserve $522.16 Billion. India holds Gold reserves of around 615 tons.

“As per Robert R.

McEwen, the Chairman and

CEO of US Gold Corp, gold price

would more than

quadruple and reach $5000 per ounce by end of 2013”


US debt at all time high

The national debt of US is at all time high at $15 trillion. If one remembers, the landmark deal in August had raised the debt ceiling from $14.3 trillion to $15.194 trillion. If the trend of the increment continues the debt may soon hit 100% of US GDP which as per esti-mates is around $15.2 trillion. The recent downgrade by S&P clearly hints that deficit reduction measures agreed by the US Government may not be enough to stop another crisis in US.

Endless money printing by Federal Reserve in US

Federal Reserve has taken various measures to revive the US economy, prominent being Quantitative Easing. However, economists argue that the increase in money supply would lead to hyperinflation. This would erode the value of dollar and increase the price of gold as gold in the only hedge against inflation. Since price of gold is quoted in dollars, devaluation of dollar would

lead to increase in price of gold.

Economic crisis in Europe

The uncertainty in Europe market specifically PIGS economies i.e. Portugal, Italy, Greece & Spain would continue in times to come. The value debts of these economies are on the verge of exceeding 100% of GDP value. The bailout proposals from Germany and France may not be sufficient to prevent default from PIGS nations. Any additional downgrade by rating

agencies would mean increment in cost of debt leading to further aggravation of the situation. Under such cir-cumstances, the investors usually prefer investment in gold and silver rather than risky assets such as equity.

Hedge against inflation

Gold is often regarded as a hedge against inflation. It has been seen that price of gold increases with rise in inflation levels. However, a closer look at things


reveals that gold has not yet reached levels whichwould make it completely hedge against inflation.

For instance, the average inflation as measured by Consumer Price Index has increased by 165% from 1980s level. The price of gold to be completely hedged against inflation needs to be around $2400 ounce. With current price hovering around $1750 ounce, the potential of increase in price of gold is anybody’s guess.

Status as Safe Haven asset

Finally, the most important reason for increase in price of gold is its status as Safe Haven Asset. Historically, during uncertain times investors have always flocked to Gold. It has been argued that unlike other fiat cur-rencies, gold has always held its value. Although there is no method of calculating price of gold, investors ar-gue that unlike other investments, gold can be traded anywhere in the world. Gold is seen as store of value i.e. capital preservation which can be passed from one generation to another.

Conclusion

Economists around the world are generally of the view that the price of gold usually increases in three stages. The process starts with currency devaluation followed by increase in investment demand for gold. The final steps involves unprecedented ascent of gold price also known as mania phase where there is rush for invest-ment in gold. A similar maniac phase was witnessed in 1980s when the gold prices jumped from $60 to $850 per ounce. Economists say that it is very difficult to predict the accuracy of such phase, but recent steps of excessive quantitative easing by Federal Reserve in US points to same direction. As per Robert R. McE-wen, the Chairman and CEO of US Gold Corp, gold price would more than quadruple and reach $5000 per ounce by end of 2013 and the current price of gold would appear extremely cheap in near future.

The Rush for Gold has already started and it seems that Gold will continue to glitter in times to come!!! - By Karan Agrawal (FMS)

Fin is funSome interesting facts

The largest numerical bill ever to circulate in the world was 1,000,000,000,000,000,000,000, and it was the Millard Hungarian Pengo, issued in 1946. At the time, it was only worth $.20 in the U.S.

The first ATM to ever exist was at Barclays Bank in London, in 1967. It was invented by John Shepherd-Barron while bathing in his tub, or so he claimed.

The U.S. “$” sign has long been in use to represent foreign currency prior to the the issue of the first U.S dollar in 1875. Not only that, but the “$” symbol never has, nor does it now, appear on any U.S. currency.

The original two currencies of America was the Sterling Pound, and the Spanish Dollar. In fact, the first type of U.S. currency to ever be issued was a mere $2,000,000. It was issued in 1775 by the Continental Congress. Every

new issue of this currency steadily devalued it against the Sterling Pound, and the Spanish Dollar.

Wall Street gets its name from a defensive wall that was put up to protect New Amsterdam (now New York) from New Englanders

The Founder of Merrill Lynch (Charles Merrill) played semi-pro baseball prior to coming to Wall Street. The Lynch in the name is from Edward Lynch who was a soda fountain salesman


The Eurozone Crisis and the Role of Monetary Union

For the past century, the world has witnessed the US rising to the top. Countries around the world such as the Latin American countries followed its lead. And countries like India entered after some time at a slower pace. But now the global crisis has a created a dent. Countries have stopped following the US and have chosen different paths or are try-ing hard to hold their ground.But even today, the US again leads from the front. Even though it was the originator of the current crisis, its im-portance still remains. As the sub-prime crisis transformed into a financial crisis in US and reached economies world over, the deep lying problems of the financial systems be-came apparent. One of the reasons, as pointed by Belkin and Nelson, was excessive over-lending and over-spending in pre-crisis. They led to a financial bubble, with invest-ments in risky assets, which became unsustainable and re-sulted in a financial crisis. Another reason, by Melitz, was that the debt in the economies is huge, and how they handle it and overcome this crisis depends on their membership of a “monetary union.” The monetary union decides the tra-jectory they follow in these difficult times.

The crisis effects seem to have loosened a bit presently, but are far from over, and in the world of economics, uncom-pleted things have a way to come back even more forcefully. This seems to be the case in Europe. The once mighty force seems to have plunged into depths and is today, desperately trying to maintain itself in top brackets. But how did this happen, and what is there for the future. This hasn’t hap-pened in one shot. In economics every disaster has some history – no matter how small it is.

We can understand this, and the role played by monetary union in recovery, by studying the crisis in Greece and Cali-fornia. California can be considered as a part of US mon-etary union, following the same currency and monetary policies. Greece is the member of the European Monetary Union (EMU). Both experienced a boom in the pre-crisis period. People were borrowing easily as banks were lend-ing freely, and nobody suspected that a fall was near. While California was dominated by internal debt mainly in Mu-nicipal bonds, Greece Sovereign debt was rising.

“As the sub-prime crisis

transformed into a financial crisis in US and

reached economies

world over, the deep lying

problems of the financial

systems became

apparent”


Such over lending and overspending formed a finan-cial bubble which was unsustainable and fragile. This boom in financial and real estate sector was driven by the underlying perverse incentives making the system weak. As said by J. Crotty and H. Minsky, “the deep cause of the financial crisis lies in the flawed institu-tions and practices of the current financial regime of light government regulations.” Thus, the reasons for their bust lay in their boom itself.

Considering Greece, the financial and banking struc-ture was lax. It was easy to borrow capital from inter-national market, especially from the European region, as it was a member of EMU since 2001. There was in-creased investment in risky assets, easy loans and over-lending in general; and was accompanied by govern-ment’s weak revenues. Also, the competitiveness of the economy was extremely low. As there were more fiscal deficits and revenue deficits, Greece’s sovereign debt burden became unsustainable and a crisis was inevi-table. The government also held US bonds, although this was a significantly small proportion, and therefore was affected by the US financial crisis. Initially, it was able to deal with Keynesian measures, but had to again rely on borrowings. This simply added to the burden, which was now even more difficult to repay for and thus by the end of 2009 the signs of crisis were clearly visible. By 2010, the situation got so dire, that Greece had to ask help from EU and IMF. But the measures adopted by them simply helped in delaying the crisis rather than ending it. The optimism showed by them has started to fade, and new measures are required.

Comparing the Greek crisis with California, we see many similarities. There was a housing boom in 2002-06 with low interest rates and easy loans. The bub-ble burst in 2006 and a wave of sub-prime crisis fol-lowed. Consumer spending decreased drastically and many businesses were affected. With high integration of markets, the financial crisis soon transformed to a real economy crisis. Unemployment rose sharply and the revenues of the government declined significantly. The large municipal bonds market also slumped as the rating agencies were questioned. With weak revenues and declining value of bonds, a liquidity crunch was faced in the US economy, adding to the already exist-ing burden of the sub-prime mortgages. The burden increased so much that desperate measures were being

adopted to purchase a part of the debt and keep the economy running.

From 2010 up till now, the US has deliberately kept the interest rates near zero. This is to help the hous-ing market recover, encourage investment, and reduce unemployment. But some have also argued that this would lead to further speculation and instability in long run.

The Fundamentals of a Monetary Union

A monetary union should be attractive and incentive enough for a country to join it. The conditions for a sustainable monetary union are: (Grauwe, May, 2006)

a) Symmetry of shocks between the country and mon-etary union

b) Flexibility in labour market to adjust for asymmet-ric shocks c) Trade integration to benefit a country with one big market and minimum trade barriers

For a monetary union to be stable, it is important to a have a political union. A political union is institu-tional (giving away some sovereignty to form an over-heading institution) and functional (areas where sov-ereignty is parted with). EU states have substantial sovereignty over their taxes, social security, and wage policies (Grauwe, May, 2006). These unilateral deci-sions can create asymmetric shocks, which are difficult to stabilize as the labour mobility is not completely flexible (even after removal of various restrictions) due to language and cultural differences, institutional bar-riers etc. A political union is important to make fiscal transfers possible. A central budget can be created to control asymmetric shocks. Automatic transfer will be made from the surplus to deficit states. This system exists in US monetary union but not in EMU.

Also, the policies by EMU are binding in nature. Greece did enjoy benefits trade and accessibility to credit market. But, there were also constraints. By the Stability and Growth Pact, no country’s deficit/GDP


ratio, and debt/GDP ratio is to exceed 3% and 60% re-spectively. For Greece deficit/GDP ratio always above 3% except in 2006, and debt/GDP ratio was above 90% throughout. Thus the economy was financially over-blown for a long time.There is no proper system to deal with defaults. If a member exceeds limits, it’s asked to maintain them with conditions imposed. Promises are made but im-position of financial sanctions in failure to do so is lacking. The countries have often found it difficult to comply by the limits, and argued for revision.

In addition, a member state is helped when there are “exceptional circumstances beyond its control.” With such policies, Greece couldn’t receive any help. Greece could have also got funds from other individual mem-bers by selling Greek bonds. But with all under the strain of global crisis and low political unity, this pos-sibility was reduced. All these problems in the basic policy framework of EU led to a delay in providing fis-cal aid to Greece.

By 2010, situation was beyond control and Greece had to ask for fiscal help. EU’s policy denied any help as it could be received only if under “certain exceptional cir-cumstances” that have created a financial crisis and are “beyond the control of the member nation.” Greece’s history of dubious financial records went against it. It had to approach the IMF. There was also a fear rising now over contagion in Euro region. IMF came with a package consisting of stabilization mechanism and providing funds, with severe austerity measures. IMF forecasts with the package were too optimistic, as it as-sumed that Greece would be having a primary surplus by 2014. This would be very hard if the desired rate of growth was not achieved, especially with Greece’s history of not able to run primary surpluses, due to lax taxation system and an unfavorable investment cli-mate. Running a primary surplus would require fur-ther austerity cuts. Thus, the steps were for delaying a default rather than ending it.We can see from present trends that optimism was not justifiable.

The fiscal aids provided to other PIIGS countries too seem to have followed a similar pattern. The auster-ity measures have been backfiring. The situation in EU has gone from bad to worse, with all economies in a downturn, investor confidence at an all-time low,

and no domestic demand to grow upon. Thus, simply funding and relaxing policy for time being is not the solution.If a political union had existed, transfer of funds and backing from ECB could have helped a lot in recovery and stabilization. California is in a relatively better po-sition, though there is need to act prudent in its finan-cial regulations and investments. Its municipal bonds are ultimately “backed by the Federal Reserve.” It ben-efits from the presence of fiscal and political union in US. The funds can be diverted from other states to help California.

Conclusion

The European depression is far from over, and all the countries in the region are struggling to remain stable at the same time. An argument often posed to over-come the crisis is to increase the exports. But this is not possible, as many other countries within the EU region are thinking on the same lines and not all of them can have export led growth simultaneously. Also, a huge proportion of Greece’s exports are to other EU countries and these countries are also facing a con-traction in demand. Therefore, the export led growth would not be the solution. In addition, the austerity measures imposed are harming the future prospects of growth in terms of employment and other important services. The multiplier effect would further lower the economic activity for European countries, where the public sector played an important role pre-crisis, and make it even harder to generate a primary surplus to get a positive rate of growth.Hence, the only inevitable solution for PIIGS is to re-structure the debt and the economy. It needs to rede-fine its priorities, role of state, market, financial struc-ture etc. But it is also extremely important, indeed necessary, to reform the European Monetary Union. It has been clearly seen that there is a dire need to have a political union for a stable monetary union. Other-wise, there would be players having an upper hand and moving policies in their favor. Without a political union, the countries would question EMU’s ability to handle crisis. Even ECB’s actions, even though deliv-ered, were with a time lag. This led to further severity of the crisis. It has now finally decided to intervene in a more direct manner. Various discussion, meetings, and forces are taking shape to find a solution. Strong debates are going over ECB buying the Euro debt


of Greece to retain investor’s confidence. For this, the policies would be change, but this is essential to come out of debt trap. Investors did showed some confi-dence when IMF came forward with its stabilization mechanism and funding. But this optimism is short lived, and more is expected and required from ECB side. Thus, the European depression has provided us with important lessons in finance and economics. Both external and internal factors influence such deci-sions, and define the complexity. Restructuring is the way out, as else we would remain trapped in the short term relief rather than long term stability. ECB would

have to intervene in a direct manner to take hold of the European Debt. Also, the coordination and politi-cal unity in the Euro Area would be important for a proper action and implementation. Some major com-panies or investors have realized the importance of in-ward looking approach rather than exports based, but other are yet to come in that line. This is important to be able to create that can of productivity and revenue generation points within the economy for long run. ` -By Sonika Toora (FMS)

Fin is fun The Bombay Stock Exchange : A Brief History

The Bombay Stock Exchange is the oldest exchange in Asia. It traces its history to the 1850s, when four Gujarati and one Parsi stockbroker would gather under banyan trees in front of Mumbai’s Town Hall. The location of

these meetings changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as ‘The Native Share & Stock Brokers Association’. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under

the Securities Contracts Regulation Act.

The Bombay Stock Exchange developed the BSE SENSEX in 1986, giving the BSE a means to measure overall performance of the exchange. In 2000 the BSE used this index to open its derivatives market, trading SENSEX

futures contracts. The development of SENSEX options along with equity derivatives followed in 2001 and 2002, expanding the BSE’s trading platform. Historically an open outcry floor trading exchange, the Bombay Stock Ex-change switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transi-

tion. This automated, screen-based trading platform called BSE On-line trading (BOLT) currently has a capacity of 8 million orders per day.

The BSE has also introduced the world’s first centralized exchange-based internet trading system, BSEWEBx.co.in to enable investors anywhere in the world to trade on the BSE platform.

The BSE is currently housed in Phiroze Jeejeebhoy Towers at Dalal Street, Fort area.

At par with the international standards, BSE Limited has in fact been a pioneer in several areas. It has several firsts to its credit even in an intensely competitive environment.

First in India to introduce Equity Derivatives.First in India to launch a Free Float Index.

First in India to launch US$ version of BSE Limited.First in India to launch Exchange Enabled Internet Trading Platform.

First in India to obtain ISO certification for a stock exchange.First to have an exclusive facility for financial training.

First in India in the financial services sector to launch its website in Hindi and Gujarati.Shifted from Open Outcry to Electronic Trading within just 50 days.

First bell-ringing ceremony in the history of the Indian capital markets (listing ceremony of Bharti Televentures Ltd. on February 18, 2002)


The Dollar Hegemony

100 years ago it was called the dollar diplomacy. After World War II and especially after the fall of the Soviet Union in 1989, the policy evolved into dollar hegemony.The world’s central banks must hold dollar reserves in corre-sponding amounts to their currencies in circulation to prevent speculative attacks on their currencies. The higher market pres-sure to devalue a particular currency causes the central bank to hold more dollars. This creates a built-in support for a strong US dollar which forces the world’s central banks to hold more dollar reserves, making it even stronger. This phenomenon is known as dollar hegemony. What dollar hegemony does is to transform the dollar-denominated payments imbalance of the United States into a dollar-denominated debt bubble in the US economy.Any asset, regardless of location, that is denominated in dollars is a US asset in essence.

U.S. Global Hegemony - The Beginning

The U.S. dollar hegemony has experienced three stages: the confirmation and consolidation, the fluctuation and regula-tion, the revival and strengthen.The Bretton Woods System, established in 1945, a fixed ex-change rate regime based on a gold-backed dollar, was the symbol of the establishment of the dollar hegemony. With the development of the international political and economic situa-tion, the Bretton Woods System winded up eventually in 1971 as the US did not view cross-border flow of funds necessary or desirable for promoting trade or economic development.However, after adjustment, it revived and thrived under the Jamaica system. Oil was denominated in dollars (called petro-dollars) after the 1973 Middle East oil crisis which saw coun-tries earning US Dollars though the same of petroleum.Further, the deregulated global financial markets after the Cold War in 1991 facilitated the cross-border flow of funds. The fi-nance globalization since 1991 has allowed the US to become the world’s biggest debtor nation, with the largest trade and fis-cal deficits.

Concerns over dollar hegemony

“The Dollar Hegemony Fuels the US Twin Deficit

“Any asset, regardless of location, that is denominated in dollars is a

US asset in essence.”


and Produces An Ineffective Federal Reserve”

The recent global turmoil and financial crisis in the U.S threatened to dethrone the dollar. A few of the concerns are:

US Downgrade

The US lost its prized AAA credit rating from S&P on Aug 6, 2011for the first time owing to the “extremely difficult” political conditions in Washington. And now the economists warn that if US politicians fail to make progress to reduce America’s massive defi-cit and rising debt burden, it could result into another downgrade by Moody’s or Fitch .One of the major sticking points facing is what to do with Bush-era tax cuts which would add about $3.7tn to the deficit over the next decade. The Congress needs to come up with a credible long-run plan.

Eroding Superpower Status

The superpower status of the US is also being increas-ingly eroded by the recent precipitous decline of its super economy since mid-2007, both in relative terms and in absolute terms. On one hand, the loss of dollar’s status as a safe ha-ven currency and on another the US ceding leadership of the Libyan operation to The North Atlantic Treaty Organisation, more specifically, France and Germany, and eschewed an invasion of the country are few caus-es.The gradual siphoning of money away from vital pro-grams over the next decade will not lead to security dilemma for America but will certainly lead to a multi polar world and end of American dominance. Defence policy will be increasingly geared toward protecting the homeland, even as globalization makes for a small-er, more intricately connected world.

Increasing US Debt

The U.S. debt of over $14.5 trillion is the largest in the world. The debt is nearly 100% of GDP, up from 51% in 1988. The Government debt is an accumulation of budget deficits and the U.S. also has a debt ceiling, which at-tempts to limit the debt.

However, Congress usually raises the ceiling to prevent the negative consequences of a debt default. The most recent budget forecast from the Office of Management and Budget (OMB) showed the FY 2011 budget deficit at $1.3 trillion, more than the $1.17 trillion deficit for FY 2010, but down from the $1.7 trillion deficit for FY 2009.

The foreign governments worry that the US might consider reducing the real value of debt by allowing for a higher inflation rate and hence effectively reduce the real value of their investments. China which is be-lieved to be holding $ 1.2 trillion of its reserves (out of around $ 2.6 trillion) in dollar assets would lose $1.2 billion for every 1% weakening in the dollar. Thus there exist devaluation risks.Also, with decreasing footprint of United States as the military and economic superpower, increasing US debt and in the uncertain scenario, the US government will definitely have a tough time ensuring its ability to be the world’s greatest creditor.

However, the Irony is that even though the crisis origi-nated in the United States, in the initial phase of the crisis, the dollar actually strengthened, be cause peo-ple thought that the world is collapsing but the safest place in the world is United States and now, the crisis in Europe is deepening and people do think that


compared to Europe, the US still remains a strong economy with a strong currency.

Dollar’s deteriorating role as a reserve cur-rency for international finance

Even though, 85% of all currency transactions across the world involve the US dollar and there are 25 dif-ferent currencies are pegged to the US dollar, a re-cent trend of diversification to other currency assets has been seen.Say, China has recently made investments in yen as-sets (thus $ losing around 8% to the ¥), while both Russia and Brazil have been net sellers of the US treasuries in the past 12 months.Decreasing share of dollars in global forex market

The decreasing share of the USD in the global forex market over the past decade underlines the fact that

market players are gradually increasing transactions in currencies other than dollars and they are set to gain significance in the future.

Dollar’s Reign Is Near an End: Why?

With its current account deficit surpassing $14,000 billion, and the unfunded liabilities of Medicare and social security amounting to $100,000 billion, fur-ther devaluation is inevitable. However, the green-back is not just America’s currency. It’s the worlds.It is on account of the three pillars:• The dollar is the most convenient currency for corporations, central banks and governments alike• The dollar is the world’s safe haven• Other currencies that have achieved stability such as Switzerland or Australia are a tiny fraction of international financial transactionsNow, these seem to be eroding.First, changes in technology such as comparison of prices in different currencies by hand-held devices thus undermining the convenience of pricing in dollars. Second, the dollar is about to have real ri-vals the Euro and China’s Yuan in the international sphere for the first time in 50 years. Finally, there is the danger to its safe haven status as the burden of debt grows heavier.The International Currency System: Is it flawed?

The global economic crisis has ignited concerns over no effective mechanism for bringing about adjust-ments between reserve-issuing and surplus coun-tries and the U.S. being the dominant reserve cur-rency issuer and thereby the future of dollar.In a radical report, the UN Conference on Trade and Development (UNCTAD) calls for a new Bret-ton Woods-style and recently the Fed’s “QE2” risks accelerated the demise of the dollar-based currency system, perhaps leading to an unstable tripod withthe euro and yuan, or a hybrid gold standard, or a multi-metal “bancor” along lines proposed by John Maynard Keynes in the 1940s.


Alternatives: The next most popular currency?

After the dollar, the contenders for the title of the world’s dominant reserve currency are rather limited and obvious.

The Euro

Representing an economic entity roughly the size, complexity, and productivity of the US economy, it has gained acceptance since its inception a decade ago and now makes up about 29.1 % of the $4.4 trillion in global official reserves.However, the euro as the next hegemon was an inter-esting question in the early 2000s but is less interest-ing now because after the Greek crisis people are even wondering now whether Euro currency as a zone can even stand together. Moreover, it is defined by highly fragmented capital markets that can’t offer the size and liquidity of the $600-billion-a-day US bond market. There is no central fiscal authority, the banking system is Balkanized, labor and resource mobility is limited, and reallocation is frightfully slow. Further, Europe suffers from the same dire fiscal outlook as the United States but with lower growth prospects, deeply embed-ded and well-protected national interests, crippling demographics, and without the advantage of substan-tial immigration to support population growth.The only way to come back on a sound footing is to make it grow and get rid of this huge amount of debt that their governments have taken on.

Renminbi

The fundamental shift that has been taking place over the past few years is the emergence of the Chinese economy and the Chinese currency.

Currencies like Renminbi are likely to achieve interna-tional status as it is issued by a large emerging coun-try. However, for this to happen not only the Chinese economy has to grow considerably bigger (which it very likely in the near future) but also it must develop large financial markets, fully integrated in world ex-changes, and the Chinese government must issue top-rated public debt instruments. Currently, Renminbi is plagued by lack of full convertibility and the Chinese markets are not integrated and for various reasons, the financial credibility of local authority is limited. For Renminbi to be a major reserve currency, central banks around the world will have to divest from U.S. assets and Treasury bonds causing USD prices to crash and Renminbi Prices to rise drastically, resulting in pa-per losses, which would cause major loses to the Chi-nese reserve dollar asset. Part of the strategy of China is to make Renminbi a world currency is by making it a regional currency and then a world one through regional and free trade agreements.

IMFs Special Drawing Rights – SDR

The SDR was created by the IMF in 1969. One can think of SDRs as an artificial currency used by the IMF and defined as a “weighted basket of nationalcurrencies” of four major currencies: the Euro, the US dollar, the British pound, and the Japanese yen.


The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the mem-ber countries’ governments.

However, it is only re-weighted every five years and is only based on four currencies and there is scant liquidity available. Also, it operates on a claims basis and supply is determined by special allocation which involves a high level of bureaucracy.There is a far more advanced and apolitical way out : The Wocu.

World Currency Unit – WOCU

The ‘WOCU’ is a synthetic currency, owned and dis-tributed by the WDX Organisation, the WOCU is made up of a basket of the currencies of the world’s strongest 20 economies as determined by IMF measures of GDP. Few of the countries include U.S (U.S. dollar, currently circa 30%), China, India, Russia, Mexico, Japan, South Korea, etc. This could be used to position the dollar as the currency of one of the world‘s most successful economies, but not as the world‘s currency.

The use of Wocu intended to reduce currency fluctua-tions compared to pricing in U.S. dollars. However, the WOCU is complex because it is diversified.

Compared to the SDR, the ‘WOCU’ is better balanced and its constituent currencies are updated every six months compared to 5 years in case of SDR. Since it has no political interference, it is better suited to the conduct of global trade in the 21st century. However problem like lack of financial muscle to safeguard ex-change rate risk remain.

What does the future hold?

While the dollar’s long-standing status as the preemi-nent reserve currency is something of an historical aberration, and the currency faces competitive chal-lenges from Europe and Asia and is vulnerable to un-precedented domestic policy challenges, it’s hard to bet against the dollar retaining a dominate reserve role in 2025.

The following shows the volatility of the exchange rate of the four currencies against the Euro in the period between January 1st, 2010 and July 31st, 2010

There are numerous factors which play in favor of the dollar including its size, liquidity, depth of US capital markets and stability of the dollar asset markets, par-ticularly the short term government securities market where the central banks tend to be the most active. The foreign exchange reserves of central banks around the world are held in treasury bills. The total amount, $4.4 trillion, is about ten times the value of greenbacks held outside the United States with the dollar’s share of foreign exchange reserves currently at 60.2 percent. Another factor which favors the dollar is the natural advantage of its incumbency.


The ingrained habits and institutional rigidities have favored the continued use of the dollar.

But it might be possible for there to be a tipping point when everyone starts migrating directly from the dol-lar to another, it is not necessary for only one interna-tional currency to exist.

In a post dollar world, there are several scenarios pos-sible:

1) The first scenario is a world of multiple polar reserve currency system with dollar (40%), euro (40%) and other leading currencies make up the remainder.

2) The second scenario is a world in which all currencies can only be used locally, and world trade, accounting, invoicing and reserve balances are main-tained in special drawing rights or SDRs issued by the IMF. 3) The third scenario is a return to the gold stand-ard on a global basis as the result of a new Bretton Woods style conference.

4) The last scenario is chaos - resulting from a complete loss of confidence in the dollar.

The sheer size of today’s global market allows enough room for liquid and deep markets in more than one currency. The view of there being only one interna-tional currency is inconsistent with history- there were three international currencies before 1914 (Brit-ish Pound, French Franc and German Marc), the Dol-lar and the Pound shared international primacyin the 1920’sand 1930’s and even today almost 38% of identified reserves are in currencies other than dollars. This would happen as the countries would seek

to optimise the risk-return characteristics of their for-eign exchange reserve portfolios by diversifying them.

Hence while the idea of a switch to another interna-tional currency seems a bit farfetched as even though the United States could still stumble, but it’s unclear whether the dollar rivals will have the capacity and the willingness to take over the lead role. It is more like-ly that the Dollar, the Euro and the Renminbi would share the roles of invoicing, reserve and settlement currencies in the years to come.

Each of these currencies has its own concerns:

1) Dollar: America’s twin fiscal and external deficit may weaken the demand for Dollars.2) Euro: Concerns about the European Union and its ability to hold together its members in the light of the Greece Debt crisis.3) Renminbi: Although China is gaining prominence in the international stage and encouraging the inter-national use of the Renminbi, there is a long way to go before it is an attractive vehicle for international investments and holding reserves due to its currency convertibility norms. Thus, what awaits is a multiple polar reserve currency system in which neither if the currencies would singularly dominate.

Also, the future holds the possibility of the use of IMF’s SDRs. However, for such a transition interna-tional bodies like the IMF may have to come up with can possible come up with norms similar to Basel III norms for Bank Capital Management. These systems would need an international organisation to control its issuance globally in order for them to work.

Whatsoever, future may hold for us a ‘Currency War’. -By Kriti Sondhi (FMS)


Islamic Banking: Challenges and per-spectives with a focus on India

Islamic finance is a trillion dollar plus industry today and is emerging as one of the fastest growing areas of international finance. Islamic banking assets with commercial banks glob-ally will reach $1.1trn in 2012, a jump of 33 percent from their 2010 level of $826bn, Ernst & Young has said. According to Ernst & Young’s World Islamic Banking Competitiveness Report 2011, Islamic banking assets in the Middle East and North Africa (MENA) region increased to $416bn in 2010, representing a five year annual growth of 20 percent com-pared to less than 9 percent for conventional banks. Currently Islamic banking and finance practises has a presence in over 75 countries of the world which include many countries of North America, Europe and South East Asia.

Interest free banking as an idea

Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the ba-sis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposi-tion by Mawdudi in 1950 (1961). Muhammad Hamidullah’s 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognised the need for com-mercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mu-darabha - profit and loss sharing.

Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Ka-rachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, Interna-tional Economic Conference in London in 1977 were the re-sult of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process.

“Currently Islamic

banking and finance

practises has a presence in

over 75 countries of

the world which include

many coun-tries of North

America, Europe and South East

Asia.”


What is Islamic finance?

Islamic finance is finance activity that is consistent with the principles of Islamic law or the Shariah. Is-lamic law is sourced from the text of the Quran, and the sayings and acts (the Sunnah) of the Prophet Mo-hammed. The Shariah explains in detail ethical con-cepts in use of money and capital, the relationship be-tween risk and profit, and the social responsibilities of financial institutions.

There are some key principles underlying the provi-sion of Islamic finance, as listed below.

One key principle is the prohibition of interest (riba). In Islamic finance, rather than interest, a yield from the deployment of money or capital generally arises in the form of profit and loss sharing from an investment activity or a profit or fee from sale of asset or lease of asset.

Other principles include the prohibition of uncertain-ty in contractual terms and conditions, prohibition of investment in or financing of banned products and services such as alcohol, gambling, pork and pornog-raphy, and a requirement that all financial

transactions are underpinned by an identifiabletangible asset.

Financial institutions involved in Islamic finance will normally establish a Shariah supervisory board or committee (Shariah board or committee) which will determine if the institution’s financial products are Sh-ariah-compliant. While designed to meet the specific religious requirements of Muslim customers, Islamic banking and finance is not restricted to Muslims. Is-lamic financial transactions can be undertaken be-tween Muslims and non-Muslims. An Islamic finance product can be attractive to non-Muslim investors for its commercial features as well as its underlying ethical and socially responsible character.

Explosive growth since inception

The massive growth taking place in Islamic institutions is unassailable and is expected to accelerate. The im-portance of institutions with sharia windows is grow-ing as some of the world’s largest financial institutions, such as Citi, HSBC and Standard Char tered Bank, are focusing on Islamic finance in both the wholesale and retail areas.


The growth of Islamic finance is outpacing almost every other business segment of the global banking system. Sharia-compliant banking for Islamic retail clients was introduced only a decade ago (corporate banking has been around a lot longer), yet the past four years have seen exponential growth of the busi-ness, particularly in Saudi Arabia, where 95% of all retail banking transactions are now done through Is-lamic banking institutions.Other markets with a vast potential, such as Malay-sia and Indonesia, are moving dynamically through a development stage. The Malaysian and East Asian markets show a great deal of promise, as they tend to be highly sophisticated with a more developed infra-structure than the Middle East and a more liberal sha-ria interpretation. At the retail end, there is already a flourishing array of products available to Muslim cus-tomers.

The offering includes sharia-compliant home and auto finance, current and savings accounts, debit and credit cards and investment products such as equity funds, property funds and capital-protected funds.

Types of Islamic Financial Products and Ser-vices

Islamic finance covers a range of financial services and markets similar to conventional finance, such as bank-ing, capital markets, insurance, asset management and advisory services. Key Islamic financial products and services are as follows:


1) Murabaha: A form of asset financing where an Is-lamic Finance Institution (IFI) purchases an asset and then sells it to its client at a higher price (ie mark-up sale) with deferred payment terms. The interest that would ordinarily be paid by the client in a convention-al loan – and which would constitute the bank’s profit — is replaced by the difference between the purchase price and the sale price;

2) Mudaraba: A form of limited partnership where an investor (the silent partner) gives money to an entre-preneur for investing in a commercial enterprise. The profits generated by the investment are shared between the partners in a predetermined ratio. The losses are borne only by the investor; 3) Musharaka: Unlike a Mudaraba transaction, both partners in Musharaka must contribute capital to the partnership. While profits may be shared in a pre-de-termined ratio, losses are shared in proportion to the capital contributed;

4) Ijara: Similar to a hire-purchase, the bank purchas-es the asset and allows the customer to use it for an agreed period and for an agreed rent;

5) Sukuk: Shariah-compliant financial certificates of investment that are similar to asset-backed bonds; and

6) Takaful: Similar to a mutual insurance arrangement, a group of individuals pay money into a Takaful fund, which is then used to cover payouts to members of the group when a claim is made.

Factors driving future growth of Islamic fi-nance

Dynamic growth in Islamic finance will be driven by the following.

1) Rising oil revenue and strong economic growth of the Gulf: In the past few years, economic growth in the GCC has been robust on the back of higher oil prices. The substantial petrodollar liquidity in the Gulf econ-omies has meant that petrodollar investors are in

creasingly seeking to invest in offshore assets, a pro-portion of which is sought in the form of Shariah-compliant financial assets.

2) Demand from Muslim and non-Muslim investors: Investors from the Middle East and Asia are increas-ingly seeking to invest in products that are compliant with their religious beliefs. Surveys suggest that half of the Muslims world-wide would opt for Islamic finance if given a competitive alternative to conventional ser-vices.

3) Low penetration levels: In spite of the growth in the Islamic banking and finance industry, there remains a lack of depth across asset classes and products, signify-ing untapped potential. In particular, countries such as Indonesia, India and Pakistan which have the largest Muslim populations in the world are not considered to have well-developed Islamic banking and finance industries.

4) Ethical character and financial stability of products: Islamic finance is attracting attention in a world of in-creasing corporate social responsibility. IFIs have not invested in impaired asset classes that have hampered many conventional banks’ financial profiles and per-formance recently.

International Self-Regulation

IFIs, like conventional financial institutions, are regu-lated by national authorities who are aligned with in-ternational standard-setting bodies such as the Bank for International Settlements. Two international bod-ies have been established to interact with and comple-ment conventional regulation and to establish best practice on issues specific to IFIs.

Islamic Financial Services Board (IFSB) The IFSB was established in 2002 to promote and fa-cilitate the integration of the Islamic finance industry into the global financial system by producing pruden-tial standards for Islamic finance which complement existing international standards for the conventional finance industry. It covers banking, capital markets and insurance. The IFSB is headquartered in Kuala Lumpur, Malaysia. The nine founding members of


the IFSB were the Islamic Development Bank (IDB) and the central banks of Bahrain, Indonesia, Iran, Kuwait, Pakistan, Saudi Arabia, Sudan and Malaysia. As of November 2009 there were 193 members of the IFSB – 49 regulatory and supervisory bodies, six inter-national inter-governmental organisations (including The World Bank, International Monetary Fund, Bank for International Settlements and Asian Development Bank) and 138 industry stakeholders. The IFSB has to date issued 12 standards, guidelines and techni-cal notes in the following Islamic finance areas: risk management, capital adequacy, corporate governance, supervisory review processes, transparency and mar-ket discipline, ratings, money markets, governance for collective investment schemes, governance for Takaful operations, conduct of business for institutions offer-ing Islamic financial services, and Shariah governance systems. The IFSB is also working on a new solvency of Takaful standard. As with other international stand-ard setting organisations, the IFSB does not have the power to enforce the implementation of its standards and guidelines.

Accounting and Auditing Organisation for Islamic Fi-nancial Institutions (AAOIFI)

The AAOIFI was established in 1990 and is headquar-tered in Bahrain. Its main purpose is to issue account-ing and auditing standards and governance norms within the Islamic finance sector. As an independ-ent international organisation, the AAOIFI is sup-ported by institutional members (200 members from 45 countries) including central banks, IFIs and other participants in the international Islamic banking and finance industry. AAOIFI standards have now been adopted by IFIs in many countries such as Bahrain, UAE-Dubai, Jordan, Lebanon, Qatar, Sudan and Syr-ia. The standards cover accounting, auditing, corpo-rate governance, capital adequacy and ethics. Future standards will include corporate social responsibility and presentation and disclosure. While the AAOIFI has introduced a range of accounting standards, many IFIs are required to report to the market in accordance with local Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Stand-ards (IFRS). The treatment of Islamic products under local GAAP or IFRS may well differ from their treat-ment under Islamic principles. An external auditor of IFIs requires skill sets and andexperience that some accounting organisations may

not possess

Indian Perspective

India Inc. has sensed the momentum building up in favour of Islamic Finance and started looking for strategic vantage positions to exploit the niche op-portunity. Many Indian private players have come up with Shariah tolerant products abroad. A few of them have launched products and services in India as well. A leading private sector player has created an entire vertical for delivering Shariah tolerant products. Some financial institutions such as HSBC, Benchmark, TA-TAS, Taurus, UTI, Kotak, Reliance, Bajaj Allianz have some kind of Shariah tolerant products either already in the market or in the pipeline. Government of India too is seriously contemplating various options for al-lowing Islamic finance in the country. Accordingly it has taken certain cautious steps in this direction.

However, comprehensive change is needed in the In-dian banking laws in order to implement interest-free economic system. Indian banks cannot invest capital in trade. At the same time, interest is given to the in-vestors and levied from those who take loans making rupee a good for trade.Money is not a good for trade in the Islamic banking idea. Islamic banks distribute the profit from re-investing the money of the investors in business activities and the like. And experience that some accounting organisations may not possess so, investors are responsible to share chance of loss also along with profit.But, the chance of loss is not shared with investors in the traditional banking system. In Bai’-Mu’ajjal, the bank resorts to purchase and resale of properties, which is not permissible as per the pro-visions of Sections 8 and 9 of Banking Regulation Act, 1949.

The equity participation in the form of joint venture is one of the major forms of financing (Musharaka) whose permissibility will have to be examined in each case in the light of restrictions contained in Section 19 (2) of Banking Regulation Act, 1949. Raghuram Rajan Committee Report

Let us turn towards the report of the Committee on Fi-nancial Sector Reforms (CFSR) of the Planning Com-mission, GOI, headed by Dr. Raghuram G Rajan.


The recommendation of the committee is as follows :

“Another area that falls broadly in the ambit of finan-cial infrastructure for inclusion is the provision of interest-free banking. Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products (where the return to the investor is tied to the bearing of risk, in accordance with the principles of that faith) results in some Indians, including those in the economically disadvantaged strata of society, not being able to ac-cess banking products and services due to reasons of faith. This non-availability also denies India access to substantial sources of savings from other countries in the region.

While interest-free banking is provided in a limited manner through NBFCs and cooperatives, the Com-mittee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system.

This is in consonance with the objectives of inclusion and growth through innovation. The Committee be-lieves that it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact.”

Conclusion

The islamically based system of finance has proven it-self to be entirely feasible and sound.

There are many benefits to the development of full-fledged Islamic banks in India which include a po-tential bettering of the condition of India’s largest minority and better integration of that minority into secular-democratic India. This would also enhance savings across the country and an increase in the na-tional GDP growth rate. Reform, by opening to Is-lamic banks would be beneficial for all entrepreneurs who have profitable proposals but lack collateral. In-creased political involvement, decreased inequality, business ownership and wealth will all serve towards the growth of our economy. All Indians will benefit from the increase in the GDP, the decrease in welfare expenditure, an increase in tax revenues, creation of new savings, employment opportunities and mobili-zation of savings. The increased growth would be the outcome of efficient investment allocation provided by Islamic banks. Islamic banks are on the thresh hold of historic opportunity. Oil prices are rising; banks are flush with funds and are driving growth on the back of strong recent performances. The interpretation of fun-damentals of Islamic financial principles and emer-gence of clear standard and a common framework will help bring about improved management practices at Islamic banks resulting in higher growth and profit margins. - By Prashant Tomar and S. M. Hussain Fatmi (FMS)

Fin is Fun

White KnightA white knight is a friendly savior in the business world who helps a company by purchasing it when it is either

in the midst of an attempted hostile takeover, or when the business is either near bankruptcy or bankrupt due to unpaid debts. The term needs to be contrasted with black knight: a person, group or corporation that initiates

a hostile takeover. Another related term is gray knight: a person, group or corporation that initiates a takeover, which is not what the business in trouble wants, but is perceived as a better alternative than being taken over by a

black knight.

The goal of the white knight is not entirely altruistic. Such knights may perceive profitability in acquiring or merg-ing with a company. For instance, when United Paramount Theaters (UPT) purchased ABC in 1953, they acted as a white knight because ABC was nearly bankrupt. Yet they weren’t simply acting for ABC’s sake, they were hoping

to acquire a company they could turn around to produce greater profits.


IPO: It’s the right time to strategize

The financial crisis, which originated in the autumn of 2007, made the global market for Initial Public Offerings (IPOs) as one of its first victims. The number of companies going public fell even below the depths during the dot-com bust in the early 2000s. The IPO market improved in 2010 and that continued into the first half of 2011. But in the second half of 2011, the failure of the governments to resolve the sovereign debt crisis in Europe and the uncertainties about the strength of the global economy disturbed the trend, leading to doubts over the prospects of the IPOs for the remaining part of 2011 and beyond. The companies that were planning to come up with IPOs were forced to put their plans on hold. Casualties include the likes of Manchester United, the famous football club, Kayak, the hotel and flight search pro-vider and Evonik, the German chemicals manufacturer. Although the present market environment is hostile to IPOs, now is the time when the aspiring companies should plan their IPOs. To have a successful market listing, many months of dedi-cated preparations are required. A company which utilises the hostile market periods to invest in those preparations will be the first ones to gain when the scenarios improve.

The IPO decision

What is a Public Offering?

The first issuance of stock for public sale by a private company is termed as primary public offering. This is the means by which a private company can raise equity capital through the financial markets in order to expand its business operations. A securities sale, in which securities held by the owners of the company are sold, is called a secondary offering.

Why should a company go public?The most important question a company should ask is “Why should it go public?” Some of the significant reasons include:1) To raise money from the capital markets for the expansion of operations2) Mergers and acquisitions purposes3) To attract and retain talented employees4) To move towards an optimal debt/equity structure5) To diversify and reduce investor holdings

“Although the present market

environment is hostile to IPOs, now is

the time when the aspiring

companies should plan their IPOs.”


6) To provide liquidity to the shareholders7) To enhance the company’s reputation

Some other decisions which a company needs to make to check its readiness are:1) Has your company reached the point at which prospects for maintaining a strong sales and earnings growth trend in the future are reasonably good?2)Are your company’s products or services highly vis-ible and of interest to the consuming and investing public?3)Is the leadership capable and committed?4) Do the benefits outweigh the costs of going public?5) Choosing a stock market6)Is the market right?

Planning for a successful IPO

Some critical and strategic decisions need to be taken regarding the issue of an IPO regarding the timing, pricing and scale of the offer. Ensuring a successful IPO is a lengthy process and depends upon the inves-tors’ perception of the company, its corporate strategy, credible financial data, growth and internationalisa-tion prospects, transparent reporting to the investors and the readiness to meet the obligations of a public sector company. Investors seek clarity of strategy based on competi-tive advantage in the market, growing profitability that can be sustained through quantifiable targets for sales growth. An essential requirement of a successful IPO is to present a sturdy business plan especially in today’s turbulent times. Another key element for a successful IPO is that it should determine the potential and fu-ture prospects of a company. The past year reports of a company, its earnings, a proper detailed balance sheet and other transparent financial statements which de-pict a true and clear picture of the health and position of the company vis a vis the markets. Providing an IPO of a business carved out of a large organisation is dif-ficult as the operating and financial details are not eas-ily available. There may be limited data for the carved out business particularly if there has been any recent organisational changes to create it. Operating results can also be distorted by significant accountancy issues such as the allocation

of purchase prices to the business, which can be seen mostly in IPOs being issued by private equity firms. Some other ways of window dressing are adopted by the companies right before their IPO issues to manip-ulate and make their financial statements appear more profitable than they are. Different methods of depre-ciation, valuation of stock etc can be used to window dress the accounts and the investors should be alert and ensure that all the financial statements confirm to the AS & GAAP guidelines and all principles are fol-lowed especially consistency. Hence it is essential to develop and showcase a true picture of the company well ahead of launch of the IPO. For an organisation to be completely ready for the stock markets it requires business functions that are not required in a private firm. These include units for financial reporting, investor relations and corporate communications with the markets. Along with get-ting the infrastructure right for a public listing one also requires competent personnel. Managers must be trained in the responsibilities of running a public company and could also be motivated by appropriate incentives such as stock options. Organizing the align-ment of management and shareholders is of critical importance and can take a long time.

The Right timeInvestors reward a transparent and robust organiza-tional structure that features clear lines of responsi-bility and adequate performance measures. But trans-forming an organisation is no easy feat and needs to begin well ahead of an IPO especially in case of gov-ernment organisations who have been previously not operated as commercial organisations as well as pri-vate companies who need to win over the trust of the public.Timing of an IPO is extremely crucial for companies. The performance of newly launched stocks is signifi-cantly better if they are issued in quarters when shares are rising in the company’s industry as well as when the overall market looks attractive i.e. when market volatility is low and when valuations are attractive. The Initial Public Offerings maximised in 2007 shortly be-fore the financial crisis and fell to a less than one third of that number in 2009 as the global recession gripped the global economy. The numbers strongly improved in 2010


. but fell again in mid-2011 amid concerns over the weakness of the global economy and the European debt crisis. Prospects for an IPO turned negative in the third quarter of 2011 and the outlook for 2012 is uncertain. However this is the right time to plan an IPO and the companies should not delay it waiting for an improved outlook. The past volatility in markets particularly in the summer of 2011, has demonstrat-ed that an opportune moment to launch an IPO can quickly disappear too. Companies still preparing for their public debut after the markets picked up in 2010 were forced to postpone their plans due to turbulent markets.

The companies prefer to launch their IPOs during the times of market stability and economic strength. Coming up with an IPO during volatile times is simi-lar to flying during bad weather conditions. Hence, the companies try to come up with their IPOs when the valuations are high and the volatility is low. Prepara-tion of IPO typically takes a minimum of 9 months to 12 months. An ambitious company should be done with all their preparation by the time markets begin to recover. The opportunity needs to be seized as soon as it materialises and this creates the difference between a successful and failed IPO. Preparation for an IPO dur-ing the bad times is a good strategy to follow so that they can be ready to latch onto the opportunity when the markets recover and enter a booming phase. By - Mridul Gandhi & Shimona Yadav (FMS)

Fin is funThe Boiler Room

“They say money can’t buy happiness? Look at the smile on my face... ear to ear, baby! “

Of the large number of me-too films that sprang up after the success of Wall Street, “The Boiler Room” is perhaps the most compelling. Starring Giovanni Ribsi, Ben Affleck and Vin Diesel , the movie centres around the life of

Seth Davis(Ribsi) , a young stockbroker-in-making and his experiences with JT Marlin, a fly-by-night stock-broking firm. Eager to show his father he can succeed, Seth, a college dropout, lands a job with a small stock-bro-kerage firm, JT Marlin. He is given a job in the company’s “boiler room”, where he cold-calls prospective clients

and sells them fake tips. Wildly successful at his job, Seth soon becomes one of the best new employees at the firm. However as he rises higher in the firm’s pecking order, he grows more and more suspicious of its dealings. His

gradual discovery of the underhand dealings of his firm and the fight between his greed and his ethics play out for the rest of the movie. The strained relationship that Seth has with his father also adds a much needed emo-

tional anchor to the movie.

The movie borrows heavily from its illustrious predecessors; Wall Street and Glengarry Glenn Ross in particular. Ben Affleck in his role as the flashy, competitive and foul-mouthed broker, is highly reminiscent of Alec Baldwin

in Glengarry. For the employees of JT Marlin, greed is not just “good”; it’s a way of life, an ideal they swear by. It’s an insight into the often dirty world of finance and the negative side-effects that unbridled capitalism can have. However, it fails to reach the high standards set by its predecessors, mainly because none of the characters can

match the charisma that Alec Baldwin or Michael Douglas bought to their respective movies. The ending is much too tidy, and the viewer is left wondering whether the conclusion could have been developed in greater detail.

Ribsi does a fine job as a young but street smart stock-broker. Vin Diesel as a co-employee is unexceptional. But a special mention has to be given to Ben Affleck, who plays Seth’s boss, & lights up the screen every time he makes

an appearance. The Boiler Room is thrilling, edgy and most of the time, a utterly entertaining. Watch it, for an interesting view

into the underbelly of the financial world.


According to a recent report published by Goldman Sachs, India is anticipated to be the 3rd largest economy in the world by 2020. As it is explicitly visible from the following table, India has man-aged fine with recession in 2008-09 and Ministry of Statistics and Programming Implementation estimated growth rate for 2010-11 to be 7.7 %. Despite the extra ordinary escape and a bad monsoon, India man-aged to grow close to 7 %. But, as per the records of past 15 years economic growth has led to disparity between rural and urban areas, across states and among rich and poor as well. The follow-ing diagram is grounded on the figures derived by S. Subramanian (Madras Institute of Development Studies) in which it is clearly visible that how the bottom 20% of population is lagging behind in terms of per capita income during rising food inflation.

But, on the contrary Chief Economic Advisor of Indian Govern-ment, Mr. Kaushik Basu was found quoting that for growth to be inclusive it is not sufficient that the income of bottom 20% rise at the same level as average.The table given below shows us the totalgrowth in poverty re-duction in India. The overall poverty has decreased from 54.9% (1973-74) to 26.1% (1999-2000) and the same trend is visible in rural and urban poverty. These estimates claim that poverty has slowed down around 2000-05, it is exactly the same time when In-dian GDP started to shoot up but poverty decline could not keep a check on the trend in GDP. This trend feasibly shows slight neg-ligence on the part of the government as far as poverty lessening is concerned.

Financial Inclusion in the Indian Economy

“ These assessments

show that while India’s

development since 2000 has

been constructive

to the poor, India’s

accomplish-ments are modest as compared

to the other Asian

countries.”


One more point of concern for inclusive growth is Human Development Indicators. The current trend shows no synergism between inclusive growth and hu-man development. Despite high economic growth, In-dia has been ranked very low on Human Development Index. Human Development is a combined measure of human development including health, education and income also.

Roles of Various Sectors - Recommended Steps

Education Sector

“There is in our time no well-educated literate popula-tion that is poor; there is no illiterate population that is other than poor.” (John Kenneth Galbraith)

In order to achieve inclusion in education we need to look at children of poorer segments as citizens with rights instead as objects of assistance. The policies must meet the origin of reasons of children’s problems, not just their insincere exhibitions.Importance has to be given to decentralization, public-private partner-ship, community participation and a drastic change in the thinking of people. Finally, intensive efforts from all must thrive to overcome ennui, cynicism, and abso-lute inertia and reconfigure primacies to put children ahead of all.Thus, a transparent, responsible and sys-tematicmethod without fragmentary inputs is essen-tial.

Healthcare Sector

A rural person seeking healthcare has to travel 10kms which takes a complete day (and as a result a day’s earnings) due to poor physical connectivity. The lack ofinfrastructure, poor monetary reimbursement, and social bigotries result in doctors being hesitant to practice in rural areas and thus further decreasing healthcare accessibility.Emphasis should be on to shieldthe remainingimpor-tant untapped potential in facets, such as the setting up of utilitarian hospitals, drug development and pru-dent innovation in medical technologies along with leveraging economies of scale to lower costs.The private sector can also contribute in a larger role byempowering the weaker sections to afford and ac

cess healthcare by emerging micro health insurance products; also, developing cashless admittance to hos-pitals in rural India. An analogous initiative is already running in Kenya via the Cooperative Insurance Com-pany of Kenya (CICK), which advertises its insurance products through microfinance organizations.

Agriculture Sector

Rural areas have to be integrated with the economic processes to ensure equitable growthTo proceed with, agriculture has received merely 7% of budgetary sharing in the recent past, much low from about 20% in the period 1980s. Bearing in mind the demand-supply imbalances and its significance as a source of living for the rural economy, the budgetary allocation of agriculture should increase. Increase spending on agricultural research and farm expansion practices to enhance yield and production. Over the past decade, wheat production in the country has marginally grown at 0.1% while rice has grown at 1.3% per annum.The last time, our country saw a productionup thrust was way back during the “Green Revolution”and the implementation of hybrid crops. The agricultural re-search should payemphasis on improved farm prac-tices, appropriate use of fertilizers and pesticides, high yielding seed varieties (GM crops), various crops in the same land, etc.The nail in the coffin is the futile distribution system. India’s vegetable productions rose by 5% this fiscal year but vegetable pricesshoot upa lot. A huge quantity of production is lost in the procurement process due to absence of timely action. Insufficient storage systems further pile on the waste.

Financial Sector

There is a need to ensure a fair equilibrium between sustainability of processes through coverage of costs, and interest pressure on the borrower. Reckless lend-ing also focus on the issue of retrieval practices, the use of agents and the need of being sensitive to the needs of the poor people, as in majority of the cases there is no actual intent of defaulting. In this context, the need for reasonable health, accident and life insurance cover as a part of major list of products for financial inclusion, alsothe financial


education and credit advocating, cannot be inflated.

The consequences of various programmes and policy steps get greatly boosted if there is good understand-ing and synchronization between the government gears responsible for development and the banks func-tional in the area. While the Government representa-tives have to appreciate that banks have accountability to their depositors equal to their borrowers, at least, it is equally vital for banks to brace up their operating at the local level for achieving developmental goals of the Government.Looking at the rapid urbanization, the requirements of urban poor have to get a discrete focus. Noteworthy investments will be prerequisite in housing,lighting and power, water and sanitation,education and health

amenities, waste management,and other essential in-frastructure in urban areas - the banking system can play a very significant role in this.

Conclusion

India’s record of attaining inclusive growth was scru-tinized in the background of the familiarities of some of the Asian countries. These assessments show that while India’s development since 2000 has been con-structive to the poor, India’s accomplishments are de-cently modest as compared to the other Asian coun-tries. These demands for anintensive effort to make India’s progressmuch more inclusive in the coming fu-ture. Several actions are sketched to toughen the foun-dations of inclusive growth. - By Tarun Avtar Arya (FMS)

Fin is fun Warren Buffet

Warren Buffett was born in Nebraska, Omaha USA on the 30th of August in 1930. He is one of the worlds richest men, with a fortune that is only surpassed by Bill Gates of Microsoft fame. He is considered one of the most suc-

cessful investors of all time and has picked up the nickname of the “Oracle of Omaha”.

Buffett began studying at the Wharton School of Finance at the University of Pennsylvania, but transferred to the University of Nebraska where he graduated. He then went on to the Columbia University to do a Masters in eco-

nomics. This was where he met the influential value investor Benjamin Graham.

The young investor was very influenced by Benjamin Graham and went to work for him in his company “Graham-Newman”. Warren Buffett’s Berkshire Berkshire Hathaway

After Graham’s retirement, Buffett returned to Omaha and began a limited investing fund partnership with a group of friends, family and associates. The “Buffett Partnerships Ltd” fund racked up amazing returns for its

investors over a ten year period, with returns 10 times higher than the Dow Jones Industrial average for the same time. Buffett liquidated the fund and took control of the textile company Berkshire Hathaway. It was a difficult

time for the textile industry and Buffett eventually wound up Berkshire Hathaway’s textile activities, but kept the name for Buffett’s portfolio of companies and investments. The insurance industry was the first major area of suc-cess that Berkshire Hathaway had, with the funds used to acquire carefully selected investments each year. Major undervalued companies that Buffett took advantage of included “American Express”, “Coca-Cola” “The Washing-

ton Post” and “Gillette”.


Private Equity-A pioneer for Sustainable Growth of India

Introduction & History of Private Equity

The first PE fund was started way back in 1978 in USA by Kohlberg, Kravis and Roberts (KKR) which was based on the venture capital limited partnership model. The innovative PE model of western countries that was introduced to India got cus-tomized with time. The underlying logic on which the western PE model was based is the” inadequate or misallocated capital resulting in underperformance of businesses”. PE funds job is to search for such companies and to buy them with the purpose of providing cheap debt and institutional equity to the business and turn them around by hiving off its unprofitable operations so as to resell the company to public at a higher price either directly (IPO) or indirectly (trade sale).Developing countries like India differ from the developed counterparts in terms of lacking the large, mature capital markets that not only provide PE funds their target firms, but also help them to attract for-eign investors. In addition regulatory barriers in India further raised concerns for easy access to capital in scale resulting in undermined western model results. Indian businesses primarily controlled by families wherein the largest shareholders runs the firms as managers made any kind of disagreement between the two entities over the use of cash flow almost negligible forcing the PE Industry to adapt to Indian landscape by targeting un-listed firms that need capital to grow and expand.A KPMG Survey done in 2008 revealed the unique factor that differentiates India from other countries that is the requirement of overseas equity, corporate governance issues, lower fund size, longer holding periods, above-market risk with higher ex-pected returns.

A Glance at the PE journey in India

Over the past decade PEs have adopted themselves to the Indian economy drawn by excellent growth opportunities in market-oriented environment.They have also been drawn due to the addition of an increased number of entrepreneurs coming up, who have been constrained by lack of capital to expand their businesses as shown in the figure.

“there is a growing

perception among Indian

companies that private equity firms can add

value on several

fronts.”


Figure above provides the snapshot of the perfor-mance of PE Industry in India.India has moved from the sixth position among the largest PE markets in the Asia-Pacific region (including Australia) in 2004 to the top spot by 2007 due to the macro fundamentals that suited the requirements of both PE investors and the Indian economy.PE provided businesses with new source of capital, extensive network of connections and expertise in management. In return, Indian Businesses rewarded PE with exceptional returns with number of PE deals rapidly grew and reached the record levels in 2007 and 2008.The rapid takeoff of PE industry in India came to an end in second half of 2008 with the global financial crisis unfolded after US housing bubble collapsed that led to slowdown in global economy especially US and Europe.

The 2007 Crisis & Impact

The impact of financial crisis started showing from the second half of 2008 when the euphoric results enjoyed by PEs in India have been mirrored by uncertainty in the financial world with the slowdown becoming more pronounced. As a result, PE in India witnessed a change majorly characterised by lower volumes and fewer exits due to the unwillingness of selling stakes at lower prices due to depressed market sentiments. However, India’s medium and long term potential re-mains intact backed by its strong domestic consump-tion that offers superior investment opportunity. By the second half of 2009 Indian economy bounced back. Private Equity in India has not recovered from recent financial downturn.

However, fundraising fell by more than 70 percent in the first half of 2009 from its peak. Moreover, the cred-it crunch has made leveraging cost much more expen-sive. Thus, PE investors have to play a more diligent & critical role.

Post Crisis

In 2010 Indian economy environment stabilized and price expectation become well below the peak in 2007 although comparatively high relative to developed markets, PE space regained strength in India. PE firms made 66 exits valued at US$2.1 billion in 2009 com-pared to 120 exits worth US$5.3 billion in 2010 accord-ing to financial research firm.Following Figure shows trends in PE investments with Deal both in terms of number & value in year 2011 signifying the rise of PE investments both in value & in number of deals from the Q4 of 2009 after the crisis.

Trends: Private Equity as a Pioneer for Sustain-able growth

Sustainable Growth focuses on economic growth which is a necessary and crucial condition for pov-erty reduction. For growth to be sustained in the long run, it should be broad-based across sectors. Issues of structural transformation for economic diversification therefore take a front stage. It should also be inclusive of the large part of the country’s labor force, where in-clusiveness refers to equality of opportunity in terms of access to markets, resources and unbiased regulatory environment for businesses and individuals. Sustain-ability focuses on both the pace and pattern of growth.


PE funds from around the globe are being lured by the enormous opportunities that are on offer in many sec-tors of the Indian economy. Factors that are boosting the inflow of PE funds:

1) Sharp drop in stock market indices that have con-sequently resulted in a significant fall in stock offer-ings.2) Increase in interest rates that are making borrow-ings dearer, and tough Reserve Bank of India norms.

Not surprisingly, most PE funds’ inflow into India has been in sectors that generally have a relatively long ges-tation period. According to IndusView, the real estate and infrastructure sectors accounted for 50 per cent of the total PE inflows in 2009.Still Private Equity has been successful in India, the main reason being dire need of their service much more than their money. Companies in India have different reasons for want-ing private capital depending on the type of company and what stage it is at, i.e. growing, seeking acquisi-tions, family owned, or a large corporate. For an exam-ple, first generation business builders look for private capital because they gain a considerable credibility and governance by having private equity representative on board. This in turn will help them while bidding for international contracts or attracting good talent.The Indian Scenario-Inducing Sustainability

1) Aid the budding Entrepreneurs & act as partners than just fund providers:-In India where the situation

is characterised by family-owned companies, 8000 companies listed on the stock exchanges, abundantly available capital, and yet a relative lack of liquidity in the market means that private equity companies will need to position themselves as partners than just fund providers if they are to become the preferred source of investment capital. These companies expect pri-vate equity firms to be able to add value, as required, in strategic, operational and human capital matters in addition to their financial contribution.

2) Labour Diligence:-Another issue addressed by pri-vate equity firms is due diligence. Much of the time spent on “demand diligence” is mostly irrelevant as companies already know there is enough demand and important question is whether the management can actually deliver or not. And to find out the answer they need to spend time on the shop floor for what can be called “labour diligence”. Most of the family-owned businesses have boards consisted almost exclusively of family members and friends. Private equity firms recognise the importance of finding outside directors who can provide the knowledge, environmental lo-cal expertise and experience necessary to help steer a company through its next stage of growth or towards a public offering. For many companies, the board meet-ing is purely about compliance and the real debate and decision-making happens outside the meeting. Ad-justing to a more rigorous style of board meeting can be extremely difficult for such companies. Private eq-uity firms often play a strong influencing role in help-ing companies attract talent, commissioning search activity, and helping


promoters to interview and assess talent & leadership.help steer a company through its next stage of growth or towards a public offering. For many companies, the board meeting is purely about compliance and the real debate and decision-making happens outside the meeting. Adjusting to a more rigorous style of board meeting can be extremely difficult for such companies. Private equity firms often play a strong influencing role in helping companies attract talent, commission-ing search activity, and helping promoters to interview and assess talent & leadership. 3) Infrastructure/Real Estate & SEZ’z:-The Planning Commission esti-mates that India needs an additional $500bn over the next five years itself to finance infrastructure. Under the growing power and effect of global capitalists over third world nations like India, where the state has be-come an easy tool to facilitate these activities - huge investment for both industrial and non-industrial pur-pose from national and foreign investors are allowed. Land acquisitions are one aspect that draws a lot of controversial aspects related with question of national interest versus community interest. One of the decisive factors of fast growth of corporate sector is the impact of economic policies of liberalisation that have under-gone a sea change in the two decades, starting from 1991. The underlying theory is to have a minimal reli-ability on state and more on market forces. PE has con-tributed by investing in such sectors & making them economically feasible in the interest of the nation .PE plays a key role critical growth driving sectors of the economy, As per Delloitte Report the various sector wise requirements from PE are given on the page.

Road ahead :

The Securities & Exchange Board of India(SEBI) pro-posed new takeover rules that will make acquisitions by Indian companies easy and scrap the non-compete fee. The minimum holding requirement to trigger an offer to minority holders has been increased to 25% from 15% for a company. Once that level is reached, the acquirer must offer to buy 26% up from 20% now.

ImplicationsThis move by the SEBI is in the right direction as it will lead to more participation from PE players both in terms of value and size of the deals and will also give the opportunity to

increase their stakes in existing portfolio companies. This draft, if implemented, will also ease the difficul-ties faced by the listed companies due to 15% barrier for open offer. In Japan, the trigger for an open offer is 33.3 per cent, while in Hong Kong it is 30 per cent and in Singapore it is 29.99 per cent. In all three, the trig-ger requires an acquirer to make an offer for the entire company.

The Achuthan Committee on Takeover Regulations had recommended that an open offer ought to be for all the shares (100 per cent) of the target company to ensure equality of opportunity and fair treatment of all shareholders no matter if they are big and small.On SEBI abolishing non-compete fees, companies woul d split the total pricing consideration (deal size) into a non-compete fee portion too so that the acquirer spent less on the total transaction cost. The fact is very often people with a considerable stake in a company signify some extra value for the acquirer ,that person could be a technology innovator, a progressive leader and/or manager with in depth understanding of the business and the environment, etc. A control premium/non-compete fee is often recognition of this reality. With non-compete fees abolished, what is likely to happen is that promoters may look to issue different classes of shares a practice that is legal in India, but almost never followed – to ensure a premium.The re duction of open offer size from 100 per cent to 26 per cent and scrapping of non-compete fees is a welcome


balancing act.

Conclusion

Private Equity provides a unique edge so as to result in sustainable development of India. As per Delloite sur-vey various parameters that make PE a reliable com-panion for funding are shown on the page. To conclude the discussion, PE investments are not only a source of funds but also play the bigger role of the partner in taking the India’s companies to next

level in terms of good governance, building capableexecutive teams, improving organisational capability, enhancing evaluations, creating liquidity and global competence. Private equity is developing into a major player in the Indian economy and there is a growing perception among Indian companies that private eq-uity firms can add value on several fronts. With more and more companies setting up local offices and teams which work at the ground level, this industry will con-tinue to be successful in the years to come. - By Deepali Sharma, Sanchit Sawhney (FMS)

Did you know ?Recession

A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two con-secutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP); although

the National Bureau of Economic Research (NBER) does not necessarily need to see this occur to call a recession.

Recession is a normal (albeit unpleasant) part of the business cycle; however, one-time crisis events can often trigger the onset of a recession. The global recession of 2008-2009 brought a great amount of attention to

the risky investment strategies used by many large financial institutions, along with the truly global nature of the financial sytem. As a result of such a wide-spread global recession, the economies of virtually all the world’s devel-oped and developing nations suffered extreme set-backs and numerous government policies were implemented to

help prevent a similar future financial crisis.

A recession generally lasts from six to 18 months, and interest rates usually fall in during these months to stimulate the economy by offering cheap rates at which to borrow money.


How do you think the current Euro crisis will pan out? What will India’s role or impact be on the same?

The Euro zone crisis has had a few major impacts

Firstly, when the crisis happened, people who had to lend and gave capital started attaching a higher risk to all their invest-ments. You might have read in the news that a few banks were downgraded just a few days back. A number of countries have seen a major increase in their risk rate. So, as long as the crisis continues, people & companies will continue to downgrade in-vestments across the globe.

Secondly, You have a lot of volatility in markets and people tend to postpone making investment decisions and not only invest-ments in the private equity field but also investments related to the expansion of their companies. So basically you are limiting the growth of your company and of the economy in general. That is bad news for the entire country.

Thirdly, India has been relying to a large extent on the inflow of capital to fund growth as well as to maintain the correct balance If people become risk averse, them there may be a change in the direction of the flow of money.This might result in a limitation of growth in India and at the same time also, inhibit the inflow of foreign capital in IndiaAnd lastly India seems to be facing its own set of problems, and the source of these problems seems to be beyond the Euro zone and its constituents. In a large marketplace like the Indian mar-ket, when you start having domestic problems they become very difficult to solve, because external problems come into play as well. So when it comes to inflation, or currency appreciation, these internal problems become very difficult to solve as they are impacted by the global crisis as a whole.

How has your experience been at investment banking?

When you join an investment bank, it’s a very different experi-ence. You might have read a lot and spoken to a lot of people about it, but until you experience it there, you can never really get a true understanding about the field. I have spent 2 years in this field and there are some good and bad things in it. You have

Interview with an Alumnus - Nikhil Aggarwal

Nikhil Aggarwal

is a passout from the 2009

batch of FMS Delhi. He is currently

working in one of the world’s

leading investment

banks in Mumbai


o be completely committed to your job. You have very little personal time for your family and friends . That’s the negative part.

The positive part is that you get to meet clients and people who are at the very top of their profession. You hear about key business ideas and get to meet people who are the CFO’s of companies, so u can really im-prove your understanding of the industry and how it functions.

What about FMS? And Delhi? What were the two years like?

I graduated from FMS in 2009 and did my speciali-sation in Finance. The two years at FMS were special to me in terms of the kind of people I met, especially because I was one of the youngest guys there. Most people had at least a few years of experience and I de-rived tremendous learning from them. Being from an Economics background, I found a great difference be-tween me and my other classmates in terms of their experiences and different educational qualifications.

The second thing was that FMS gave me a lot of op-portunities to try things out. The curriculum at FMS is extremely flexible and that allowed me to pursue the things that I found most interesting. Being in Delhi, there was an advantage of having a number of corpo-rates around. So along with another batch mate Pawan, we founded Club Beta, a club focused around

Private Equity firms, and how they were structured and how they worked. I also worked on a number of live projects which gave me a lot of exposure. Being in Delhi, the experience that you get there is very different from what you get in a number of B-schools.The last point is that FMS helped me gain experience in a number of different fields and areas. I participated in a number of events. I helped launch ICON for the first time in Fiesta. I was involved Club Beta. I also helped organised the international Sports Meet and thus gained a lot. Along with that, my academics and my corporate experiences really helped me grow as a person

What advice would you give to the B-school student community?

Apart from the academics, I guess students need to realise and take maximum advantage of the fact that they are in Delhi, so you have a number of opportuni-ties outside the campus. Being a part of DU and FMS, you have an excellent reputation, and people do listen to you.

Also I would advise you to make the best possible use of your time. You may have a lot of free time in FMS as compared to other B-schools but that does not mean you waste it. You should try and make the most of 2 of the most fruitful years of your life.


Why do you think the rupee is depreciating to such a large extent for the past few months ?

It’s not only the rupee but a bunch of other currencies which are depreciating recently. If you look at the Indonesian rupiah, you would see that it has depreciated from July onwards. If you look at another emerging economy, Brazil it has depreciated as well. Part of it is because we are weighting it against the US dollar. As you know, in recent times because of the European crisis, there has been a lot of movement away from the Euro, so the dollar has appreciated. So if you look into the Euro-Dollar graph, you see an interesting curve. So post-2009 the dollar ac-tually fell as compared to the Euro. But after this summer, and after the Euro crisis started taking shape, the dollar has appre-ciated significantly as compared to the Euro. So depreciation against the dollar is a global phenomenon.

However, that being said, the depreciation of the rupee has been much greater than that of other currencies. This depre-ciation to some extent has been due to market sentiments. In the past few months there has been a large outflow of Foreign Institutional Investors. There hasn’t been much more new FDI coming in. And India hasn’t been very good at attracting FDI for the past few years. Oil prices have also gone up, although they have moderated recently. So all these oil companies who buy in US dollars , have been spending much more US dollars. So a large number of factors have contributed to the deprecia-tion of the Indian rupee.

But hasn’t the Yen appreciated against the US dollar as well ?

Well, firstly, I wouldn’t call Japan an emerging economy. Also secondly, I would consider the Japanese currency is something of an outlier. If you notice that after the earthquake in Japan, the yen actually appreciated. There are often many counter-intui-tive things that happen with the Japanese currency, partly be-cause the yen is considered as a safe haven. So the Japanese yen is probably not the best currency to compare. Chinese Yuan is another currency that can’t be compared to the US dollar as the Yuan has a sort of crawling peg exchange rate, which is some-where between a fixed and floating. But one point which is very important is that what is happening to the

Interview with a Professor - Dr. Partha Chatterjee

Dr. partha chatterjee is

currently teaching at the faculty of

management studies, Delhi. He

has a phd from min-nesota state

university. Prior to fms, he has

taught for six years at NUS university

in singapore. He has also previously

worked at theindira gandhi institute of

development research.


exchange rate is not a measure of the health of the economy. It is nothing but a price of the Indian rupee with respect to the rest of the currencies. And that has depreciated.

What is your opinion on the frequent repo rate in-creases by the RBI ?

There are two major monetary policies which are fol-lowed around the world. One is the very strict infla-tion targeting. It’s a rule based inflation targeting. They have a fixed rule that if the inflation goes up we will increase the interest rate. The other set of countries which, includes that US as well, they have a very fuzzy set of objectives. For example the US has two primary objectives with respect to its monetary policy. One, to improve employment and the second, to counter infla-tion. In India it hasn’t t been historically very clear as to which of these policy targets is more important to the RBI. But in recent times it has been moving to-wards inflation targeting and that is a very good thing. What RBI has done is probably the only policy option that it was left with. And it has gone after the inflation as hard as it can. The issue about inflation in India is that if you look at the price indices, a large part of the weight on the price index goes on to food and energy. In other banks, such as the Federal Reserve Bank they use a core inflation strategy that basically means that they consider inflation but leave out food and ener-gy. This is because these are the core issues that are not affected by monetary policy. So there is this issue whether monetary policy can affect the food and en-ergy part of the inflation index. But for the sake of its reputation the RBI has to target monetary policy be-cause that would have had worse repercussions across the economy.

What do you think would be the future stance of the RBI on these rate increases ?

In the future, we see that inflation has started falling off. Recently food inflation has dropped drastically. So, there may be some wiggle room. However if you have looked at recent data you would have seen that a number of sectors, particularly manufacturing have declined significantly. And if the interest rates are high, then cost of investment goes up and so invest-ment goes down. There may be some wiggle room for RBI and i don’t think they would increase the repo rate any further based on the numbers that are coming in.

How do you think opening up of FDI in retail could have affected India’s economic growth ?

Well I hope the opening up of the retail sector hasn’t been stalled for good. In some sense both rupee depre-ciation and inflation would be affected by FDI in retail. You would see an immediate rush in investment and that can basically strengthen n the rupee. Secondly there would be an efficiency increase. In supply chain as well as storage. And that can, particularly storage can be extremely useful in dealing with inflation par-ticularly the noncore particularly the food and energy part that we talked about. That part is not going to be that sensitive to monetary policy. That is the structure of things that really control inflation in the noncore part. It is unfortunate that this policy has stalled but I hope that they can allow this measure in retail to go on.


Documents

Senior Analyst January 2012