Niveshak December 2012

Niveshak THE INVESTOR

VOLUME 5 ISSUE 12

CASH

economic Impact of Mega Events in Brazil, pG. 08

New Private Sector Banks in India, PG. 21

December 2012

FROM EDITOR’S DESK Dear Niveshasks, Niveshak Volume V ISSUE XII December 2012 Faculty Mentor Prof. P. Saravanan

THE TEAM Editorial Team Akanksha Behl Akhil Tandon Chandan Gupta Harshali Damle Kailash V. Madan Nilkesh Patra Rakesh Agarwal New Team Anchal Khaneja Anushri Bansal Gourav Sachdeva Himanshu Arora Ishaan Mohan Kaushal Kumar Ghai Nirmit Mohan Creative Team Anuroop Bhanu Kritika Nema Neha Misra Venkata Abhiram M.

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong

The latest fad to make inroads in the Indian economy from the global arena is FDI in multi brand retail. It was passed by both houses in the just concluded winter session of the parliament. But come January 1st and we witness the rollout of undoubtedly the biggest scheme in the history of independent India.

Our cover story focuses on the same and we evaluate the suitability of cash transfer schemes for India of today. We also portray the India where cash transfers can be extremely successful. Is India ready to embrace this latest offering from the West? Turn on the pages to find out.

The success (failure?) of the cash transfers will be something to watch out for and we sure will keep a tab on that; but are the 2014 FIFA World Cup and the 2016 Olympics not something to watch out for as well? Agreed that it’s a little too early to foresee these events but isn’t Niveshak all about keeping you ahead of the times! This issue’s Article of the Month analyses the effects of these events on the Brazilian economy. While this article takes you years ahead, our Finistory article takes you about a century back to the era of World War I and analyzes the transformation of the US economy in that period.

This month, our Finance Minister, Mr. P. Chidambaram, advised RBI to proceed ahead with issuing of new banking licenses without waiting for amendment of the Banking Regulation Act of 1949. Is this the beginning of a new chapter in the ever-dynamic relationship of the Government of India with its central bank? Explore the same in the FinGyaan section of this issue.

We continue to receive your support in the form of articles and FinQ entries and our sincere thanks goes out to all our esteemed readers for the same. We would also like to thank all the participants for an overwhelming response to our intercollege first-of-its-kind event ‘FinDrishti’. Please continue to motivate us so that we can come out with more insightful reads in the issues to come. And as always, Stay Invested!

Team Niveshak

www.iims-niveshak.com Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

08

Economic Impact of the Mega Events in Brazil

11 All that Glitters is not Cash

FinGyaan

14 Government of India and

RBI: An Evolving Relationship

Finsight

21

New Private Sector Banks in India: An Industry Analysis

Finistory

17 Transformation of US

Economy during World War I

CLASSROOM

25 Bond Laddering

The Month That Was

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www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

IIM Shillong

Gujarat votes for Modi Narendra Modi has once again been chosen as the leader of the state on December 20, when BJP recorded a staggering victory over the arch rival Congress. BJP captured 115 seats in the state assembly where Congress could only secure 61 out of 182 seats.

With this, Narendra Modi completed a hat-trick in the state elections. This victory has assured the Bhartiya Janata Party of the popularity this assertive man enjoys in the state. It also raises the prospects of him becoming the BJP’s prime ministerial candidate in the upcoming general elections. Meanwhile, it was not a great show by the BJP in the northern hill state of Himachal Pradesh, where the saffron party was ousted from power by the Congress which secured 36 out of 68 seats in the state assembly.

Obama proposes to cut Social Security As an attempt to avoid the possibility of fiscal cliff, the White House has indicated that significant cuts will be made to the social security and health programs for the poor and the elderly of the nation. The Bush tax cuts that benefit some of the wealthiest of the country are on the way to become permanent, whereas the payroll tax cuts that were hailed by many economists might be allowed to lapse. The White House calls this cut in social securities and other programs as adjustments and calculates it by changing the way in which cost of living adjustments are calculated. The proposed change in the policy would be known as ‘Chained CPI’. These indications have invited wrath of the public which is outraged by such a

December 2012

move. It remains to be seen whether the Senate approves of these changes.

FDI in Multi-Brand Retail becomes a reality The Upper House of the Indian Parliament on December 6 put its stamp of approval on the government’s decision to allow Foreign Direct Investment in multi-brand retail. This brings to an end the protests, the debates and the opposition that the country had now witnessed for months. The votes in Rajya Sabha paved way for the International chains in Multi-brand retail to enter the lucrative Indian market. Now, retailers like Wal-Mart, Tesco and Carrefour are free to deal directly with the state governments.

It would take another 18-24 months before any of these chains can possibly set up their stores in India. The problem now is that many of these states will see transition in their governments in this period. It remains to be seen whether this transition will bring additional problems for these ‘eager to enter Indian markets’ firms.

The legacy of Ratan Tata The TATA group is set to witness transition at the top with the legendary Mr. Ratan Tata stepping down as the Chairman of the largest Indian conglomerate with annual revenues of over USD 100 billion. Mr. Cyrus Pallonji Mistry (44) takes over from Mr. Tata, who has served at the helm of the affairs for 21 years, on December 28, 2012. The nomination of young Mr. Mistry is in line with the group’s objective of infusing young blood in the group’s leadership. Mr. Tata leaves behind him a strong legacy of aggressive but ethical leadership. He is the name behind the conceptualization of Nano, the ‘car of the century’ according to many. Other feathers in his cap include Corus, Jaguar Land Rover and

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Starbucks etc. A lot is now expected from the young enthusiast who will move in to lead an organization that in the last few years has represented India on the world stage. The country wishes him luck and hopes that he continues the good work the Group is known for.

Japanese Firms Look towards India Japan’s two biggest corporations, Hitachi and Panasonic, have identified India as one of the growth centers and a base to expand in Africa and Middle East Markets. Hitachi, Japan’s largest industrial power and electronics conglomerate has formulated a ‘India business strategy 2015’ plan to make the country one of its top markets and targets a three-fold jump in its India revenues to Rs. 20,000 crore by 2015-16 with an investment of Rs. 4700 crores in form of 5 manufacturing plants across India. Similarly, Panasonic has lined up more than Rs. 1,000 crore investments in a new plant at Haryana and targets Rs 20,000-crore revenues by 2014-15, a year earlier than Hitachi. Yorihisa Shiokawa, Panasonic’s managing executive officer and chief of the APMEA operations, said the firm wants to set up more such plants and become the country’s largest appliances maker by 2018.

RBI keeps policy rates unchanged The Reserve Bank of India (RBI), during its monthly monetary policy review preferred to keep the key policy rates including the cash reserve ratio (CRR) unchanged. While the repo rate was maintained at 8%, CRR was also maintained at status quo of 4.25%. Describing it as a strategic move to control inflation, RBI hinted at easing rates in January (scheduled on 29th January, 2013) in order to shift focus towards growth from inflation.

The central bank has been under enormous pressure to cut rates from industry and the Finance Ministry,

both of which believe a monetary easing at this stage will lift spirits and ultimately aid in growth reviving.

NIB shapes up as Cabinet Committee of Investment National Investment Board (NIB), one of the recommendations from the CAG report which was released in May this year on allocation of coal blocks, ultimately has been shaped up as a Cabinet Committee on Investment (CCI). This committee will reside in the cabinet secretariat, will be chaired by prime minister and comprise members from various ministries. In line with the operations of Foreign Invest Promotion Board (FIPB), this committee will acts as a single window clearance for large infrastructure projects worth Rs. 1,000 crores or above. It will also monitor the progress of decision making and implementation of projects of such magnitude.

In India, there are as many as 90 such projects over Rs. 1,000 crore pending clearances in various ministries.

ETF for CPSE to formalize soon After the success of Rs.15,000 crores disinvestment programs approved in September, Government is likely to soon set up an Exchange Traded Fund (ETF) comprising stocks of listed Central Public Sector Enterprises (CPSEs). It is being treated as a move to create an additional mechanism to meet the disinvestment target of Rs. 30,000 crore for this fiscal.

ETFs were introduced in India in 2001. Currently, there are 33 ETFs having AUM (Assets under Management) of close to Rs. 11,500 crore and held by 6.2 lakh investors. Owing to the weak correlation between Gold and Share Markets, Gold ETFs dominate the ETF market in the country.

Globally, ETFs have been growing at a rapid pace with an annual growth rate of over 34% in the last decade, with Assets under Management of $1.5 trillion at present.

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The Month That Was

The Niveshak Times

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Article Market of Snapshot the Month Cover Story

Market Snapshot

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap

6,864,893 3,166,830 1,652,684

LENDING / DEPOSIT RATES Base rate Deposit rate

9.75%-10.50% 8.50% - 9.00%

Source: www.bseindia.com

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling

54.84 72.47 65.31 89.11

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

4.25% 23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

Source: www.bseindia.com 23rd November to 20th December 2012 Data as on 20th December 2012

December 2012

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BSE Index Sensex

Open 18506.57

Close 19453.92

% change 5.12%

MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

6597.42 7057.11 10558.86 13178.67 7476.93 10630.36 5815.39 7703.04 5733.43 9801.24 7987.56 1920.10 7003.98 1869.11 3399.91

7101.79 7434.86 11406.99 14343.78 7723.79 10916.42 5949.40 8198.73 5637.90 11241.04 8469.24 1981.27 7276.75 2123.08 3405.37

7.64% 5.35% 8.03% 8.84% 3.30% 2.69% 2.30% 6.43% -1.67% 14.69% 6.03% 3.19% 3.89% 13.59% 0.16%

% CHANGE

IT

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Market Snapshot

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Economic impact of the mega events IN Brazil 2014 FIFA World Cup and 2016 Olympic Games Ganesh Sumant Tamboli

IIT BOMBAY

The term BRIC was coined by Jim O’Neill in his paper “Building Better Global Economic BRICs” published in 2001. The term is an acronym that refers to Brazil, Russia, India and China and is widely used to symbolize the growing shift of economic power from the G7 economies.

Though the growth of these countries has been outstanding during the last decade, the recession arising out of the 2008 crisis and the global economic downturn due to the Euro-zone crisis has cast some doubts on the ability of the BRIC nations to maintain the growth rate. Many things have changed after the housing bubble, which led to a global recession in 2008. Russia has been engulfed in corruption and has not been able to find a solution to break the business-politics nexus. India with its coalition government is finding it hard to balance the power at centre due to multiple scams that are being exposed.

China is faltering and the falling growth rate casts doubt on its ability to handle the present downturn.

Brazil, on the other hand, has been steady during this tough time. Unemployment is low, wages are rising and the foreign direct investment is pouring in. Many economists are of the view that Brazil should be able to grow at 3.5% in this decade. It is one of the few countries where democracy has brought political continuity and economic stability. But, not all is hunky-dory and Brazil has its own set of challenges. The growth witnessed during the past two decades was a result of opening up the economy in 1990 and a boost in trade caused due to China’s demand of commodities. However, the Chinese economy is slowing down and this has resulted in a negative impact on trade. The cost of doing business is very high and the complex tax structure acts as a deterrent to MNCs. Amidst all this, there are two important events that will happen in Brazil. It will host the FIFA World Cup in 2014 and Olympics in 2016. Only Mexico, Germany and U.S. had such an opportunity to

December 2012

host two mega events back-to-back. While these events will present organizational and logistics challenges, they will also offer a unique opportunity to showcase a modern and globally integrated Brazil. The events will have a deep impact on the financial and economic climate of Brazil. The financial effect refers to the budgetary balance of the host city’s organizing committee and whether the financial costs of hosting the Games can be met by the revenues directly generated from the Games events. The economic impacts will include the overall effect on the economy arising out of the increase in tourism and improved infrastructure.

Economic Benefits The growing tourism industry results in increase of revenue for the host nation. But, this can be termed as short-term effect and no country would want to invest billions to promote tourism alone. The more important effect is the increase in exports. Hosting a mega event can be linked to trade liberalization. In 1955, when Rome won the bid to host the 1960 Olympics, Italy started moving towards currency convertibility, joined the United Nations and started negotiations on treaty of Rome which led to the formation of European Economic Community (EEC). Japan joined International Monetary Fund (IMF) in 1964 when it hosted the Olympics. Spain joined EEC in 1986 when it won the bid for 1992 Games.

Mexico hosted the FIFA World Cup in 1986 which coincides with its trade liberalization and entry into the General Agreement on Tariff and Trade (GATT). Thus, it appears that hosting a mega event leads to a boost in infrastructure that amounts to trade liberalization.

The economic impact caused by such mega events begins from the time the nation wins the bid to host and extends to a few years after the event. This impact can be classified into three groups: • Pre-Games impact: This includes investment and other preparatory activities and tourism

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2000

2001

2002

2003

2004

2005

2006

6.2

10.6

10.5

9.7

12.8

17.7

14.5

15.1

Source: National Bureau of Statistics of China, China Statistical Year book 2006 Fig 1: Growth Rate of GDP in China

• Games impact: With tourism, the infrastructure gets a boost. Temporary jobs are created and revenue is earned through tickets • Post-Games impact: Urban regeneration and international reputation are some of the long term effects of hosting a mega event Since hosting a mega event entails huge costs, financing the event forms the most critical challenge to the host nation. How does a nation finance such a huge event? How can it ensure to recover these costs? Till the Games of 1976 Montreal, Olympics was sponsored through public funds. But things changed after 1976 Games. This event was financed through public funds and a considerable amount was spent on improving infrastructure. However, a significant financial debt was declared from the event. The Montreal Games showed that hosting the event through public funds alone was not a good idea. As a result, in 1984, when the Games were to be organized in Los Angeles, the citizens voted against the use of public funds. This was the first time that an Olympics was organized through sponsorship which later on led to the commercialization of the Games. Though the Los Angeles Games resulted in budgetary surplus, the expenditure on infrastructure was quite low. Thus, the economic benefits associated with the Games were not per the expectations expected. The Games of Seoul 1988 and Barcelona 1992 proved that a nation can have huge expenditure on the infrastructure and yet can recover the costs. By this time, people started laying down more importance on the economic benefits rather than concentrating only on the financial viability.

To consider the economic effects of hosting a mega event, it would not be appropriate to study these effects on the developed nations.

Instead the effects on similar countries which include China (Olympic 2008), South Africa (FIFA World Cup 2010) and India (2010 Commonwealth Games) would present a better picture. The effects of these events are discussed below: Beijing 2008 Olympics China hosted the Olympic Games in Beijing from 8th – 24th August, 2008. Beijing was selected to

the 2008 Olympics on July 13, 2001. The games had a profound impact on the GDP of China. In 1999, the growth rate of GDP was 6.2 % which rose to 10.5% in 2001 Before the Games the average growth rate was 8.4% which rose to 13.3% during 2001 to 2006. The growth rate of GDP over the years is given in Figure 1 above.

The average growth rate of GDP during the Pregames years, Games year and Post-Games was 13.4%, 13.8% and 13.9% respectively. The growth of per capita GDP in China increased from 5.3% in 1999 to 13.8% in 2005. The growth rate of investment increased from 10.2% to 23.7% in 2006.

Huge amount of employment was created owing to increase in investment. The Games generated direct employment for 2,788 thousand workers.

Figure 2 shows the employment figures of past Games.

The profit that China earned from hosting this mega event was 16 million dollars. However, this figure should not be considered as the actual benefit from hosting the event. This figure gives only the difference between revenue in the form of ticket sales, broadcasting rights, etc. and expenditure on infrastructure. The long term benefits arising out of the improved infrastructure and international reputation are not evident from this figure. To conclude, the Olympic Games helped China show its ability to manage a mega event and opened up new avenues for growth and investments.

South Africa, 2010, FIFA World Cup The FIFA World Cup took place in South Africa from 11th June to 11th July 2010. This was the first time that a World Cup was being hosted by an African country. The total amount spent on tourism due to this event is estimated to have boosted the economy by USD 475 million. However, the event posted a loss of USD 6.6 billion to the national budget. Thus, a question that needs to be asked is whether the economic benefits justify this immense loss or not?

The total number of tourists that visited during the event was 309,554. It is likely that the tourism in South Africa will get a boost as 90% of the visitors interviewed in a survey may visit the place

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Growth rate of GDP (%)

1999

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Los Angeles 1984 Increased Employment (in thousands)

25

Seoul 1988

Barcelona 1992

Atlanta 1996

Sydney 2000

Beijing 2008

336

120

90

1577

2788

Source: National Employment Bureau of China, China Statistics year book 2010 Fig 2: Employment figures for past Olympic games

again. Though the event boosted the economic growth by 0.5%, much of it was caused due to the Government expenditure. Thus, the event led to redirection of national wealth and not creation of wealth. Employment was also impacted by the event. Almost 695,000 jobs were created in the year 2009 and most of them sustained through 2010. However, not many of these jobs were permanent and hence the surge in employment did not last long after the event.

Though the event was successfully organized, the huge loss has raised many questions. Given the loss, was it practical to organize such an event in a developing country like South Africa?

How much should the economic benefits be to offset this loss? Was this loss created due to operational and financial inefficiencies?

Only time will tell if the economic benefits are as expected.

India 2010 Common Wealth Games The Common Wealth Games were held in Delhi from 3rd - 14th October, 2010. India is the third developing country to host this event after Jamaica in 1966 and Malaysia in 1998. Like other mega events, this event too had an impact on the social and economic dynamics of the nation.

The Organising Committee claimed that the economic contribution to India’s GDP is USD 4.94 billion during a four year period (2009-2012). It is estimated that close to 2.47 million job opportunities were created during this period. A profound impact was seen on the economy of Delhi which witnessed a high growth rate of around 9% during this period. The Government of India

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took additional efforts to promote tourism by liberalisation of visa-on arrival and permitting 100% FDI in tourism. One of the major bottlenecks for this event was the accuracy of the revenue projection. The projected revenue in July 2008 was USD 410 million. However, out of the total committed revenue of USD 157 million by Organising Committee, only USD 101.5 million was the net revenue generated. After deducting the revenue generation cost, the total revenue amounted to only USD 40 million.

The event was also scarred by the massive corruption which resulted in the arrest of a senior politician.

The long term benefits of hosting this event on India and particularly Delhi which hosted this event remains to be seen.

Conclusion The global economic climate is gloomy due to the Euro-zone crisis and a slow U.S. recovery. The investment in the developing countries has dried up and countries are trying to woo the investors by going an extra mile. These events will serve as a platform to boost the economy of Brazil. An efficient execution of events, check on financial viability of investments, judicious use of public resources and public policy reforms will help boosting the trade and tourism. Thereafter, it will depend on how Brazil uses this opportunity and creates a sustainable growth and development model.

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Anchal Khaneja & Gourav Sachdeva

Team Niveshak “All men can see these tactics whereby I conquer, but what none can see is the strategy out of which victory is evolved.”

-Sun Tzu The apparent swiftness with which the Indian government has acted on the introduction of Cash Transfers (CT) in India is perhaps unparalleled, definitely very rarely observed to say the least.

Are the minds at helm of affairs at present so overwhelmingly sure of the results of the new policy that they couldn’t resist delaying it anymore, is something else at stake here or are they just following what has undoubtedly become the latest fad of the international development industry, as the preferred strategy for poverty reduction (They are now being cited in many places as the solution to the problem of poverty)? In this cover story of Niveshak, we take a holistic view at this rather much-debated topic of Cash transfers in India.

We begin by having a look at the present scenario of the welfare schemes, go on to establish the need for CT in the country and then look at the advantages and disadvantages of the same. We will also critically examine some of the very ‘successful’ implementations of Cash transfers around the globe.

Where we stand today?

In the fiscal year 2010-11, Government of India’s expenditure in subsidizing the retail prices of diesel, kerosene, LPG and gasoline amounted to a whopping Rs. 43904 crore (USD 9.6 billion) and it grew by 26.7% in the year 2011-12. Food subsidies provided by the central government increased by over 300% in a period of six years between 20062007 and 2011-12. The same has seen a 25-fold increase in a span of 21 years.

The Union Budget 2012-13 attributed the deterioration of fiscal balance in 2011-12 to this steep increase in subsidies and pointed out that such a high level of growth in subsidies is not sustainable in the long run. The Budget also pointed out the Government’s intention to maintain the level of subsidies under

2% of GDP in the year 2012-13 and bring it down to less than 1.75% over the next three years. Figure 1 shows the trend of various subsidies for 5 years.

The food subsidy bill of India in the fiscal year 201213 has already swelled to over Rs.101879 crore in the first six months, around 36% more than the budgeted estimate. This could seriously jeopardize government’s plan to rein the fiscal deficit at 5.1% of GDP. As far as the efficiency of present measures against poverty alleviation is concerned, it can be said with reasonable confidence that they aren’t serving their purpose well. Hence, the recent proposal is the culmination of several factors: (a) ballooning fiscal costs, (b) the manifold distortions resulting from the subsidies, (c) the successful examples of Cash transfer programs around the world, particularly in Latin America, as a means to address poverty and improve social welfare of the poor, and (d) institutional and technological changes within India, particularly the on- set and rapid expansion of the Aadhar program which aims to give every Indian a biomarker-based unique identity and Swabhiman, under which every Indian is` expected to have access to a bank account, bringing, for the first time, half of India’s population access to financial inclusion.

Cash Transfer Schemes: A Boon for India?

Cash transfers will replace forty two different welfare schemes and cover the entire country. The advantages of Cash transfers are quite evident.

Direct Cash transfers will eliminate the long chain of intermediaries and subsequently reduce the cost of distribution to a substantial extent. This will prove beneficial for both the people as well the government.

According to P. Chidambaram, the cost of transferring one rupee to the pockets of the beneficiaries is presently three rupees for the government. The rest is spent on administrative expenses, waste and corruption. Cash transfers will eliminate the intermediaries, hence reducing the corruption and

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ALL THAT GLITTERS IS NOT CASH

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administrative burdens. The Direct Cash transfer Scheme will have the potential to phase out the tremendous paperwork and consolidate them under one identification requirement of Aadhaar UID.

Fig 1: Subsidies trend in India in 5 years

To illustrate, the rationale for subsidised kerosene was to provide cheap fuel where electrification was not prevalent. But, it is available at subsidised prices even in states where electrification is widespread.

Kerosene is hardly used for cooking purposes now-a-days both in rural as well as urban areas.

However, it has become a more important fuel source for lighting. There are presently 70million households (mostly rural) in India that use kerosene for lighting purposes. While the subsidy is intended to shield the poor households from the volatile nature of prices and provide a stable supply of fuel, it has created a large black market wherein cheap kerosene is diverted and mixed with petrol and diesel. In such a scenario, if the government can successfully execute a Cash transfer program that provides cash equivalent of the subsidy while simultaneously raising the prices of kerosene, it will have considerable effects on reduction of pollution levels and criminality. The cost to the government will substantially reduce due to better targeting.

India requires completely different infrastructure in order to make Cash transfer schemes successful in India. The ration shops that deliver subsidies by means of low priced essential goods would no longer be relevant and a cash equivalent of the subsidies will have to be distributed by a proper network of banks. But the requisite banking facilities do not exist in the Indian villages, majority of beneficiaries are illiterate and, in spite of “Aadhaar”, may not have been properly identified. Obviously, it is not possible to have a perfect system in place right from the start. The system will get refined once the schemes come into operation.

Where Cash transfers can work?

The Indian initiative is more or less influenced by

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similar programs existing in the South American countries. These countries are among the highly urbanized countries in the world with more than 70% of the population living in cities. Corruption is comparatively low, as is gender discrimination.

They have highly stable welfare services. On the other hand, in India, the basic infrastructure for welfare services is collapsing and hence any cash transfer policy can have disastrous results.

The CT schemes of Brazil and Mexico are quoted as examples by the government. But it should be kept in mind that only 5% of the population of these two countries is below the poverty line and the Indian figure stands at a whopping 46%. Thus, their system which caters to only a small number of beneficiaries is unlikely to be viable in India.

The consequences should, therefore, be taken into account before deciding to operationalize any system of Cash Transfers.

It is important to note that the Supreme Court of India has defined social security, food and nutrition as the basic human rights and these cannot be curtailed by below poverty line (BPL) eligibility conditions. Cash Transfers limit these basic rights.

They can be successful only in places where the government bodies are capable and influential.

Whereas in India, the political system is weak and hence the Cash Transfer schemes might prove completely incapable of meeting their objectives. …or a Bane?

However benevolent be the intentions behind the new scheme, there are two pressing questions that demand urgent answers. They are – If cash transfers are put in place, consumers will be on the mercy of highly competitive markets alone; who then, will ensure that any price increase will be suitably compensated for in the new deregulated markets for all goods? And how will the government make sure that the transfers actually happen to those who are the intended beneficiaries? To worsen the matter, is the fact that Cash Transfers are not new to India. There are already a number of Cash Transfer programs ranging from targeted unconditional social security programs to the ones designed to change societal behavior towards girl child. Indeed, while its proponents may not like the designation, India’s flagship National Rural Employment Guarantee Scheme is at heart a conditional Cash Transfer program. The hiccups experienced in these programs are not a matter to be explained here.

Situations can only get worse if scales increase.

To answer the first of the two concerns, it can be argued that Cash Transfer systems can simply be indexed to price indices (for example, in the case

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Bolsa Família in Brazil, both types of errors remain high. An evaluation by the International Poverty Centre of the United Nations Development Program (UNDP) showed that 70% of the poor were excluded from the benefits of Oportunidades, and 59% of the poor were excluded in Bolsa Família. In contrast, Bolsa Família was found to have a higher inclusion error than Oportunidades: 49% of all beneficiaries are non-poor in the former program but only 36% are non-poor in the latter. India is already infamous for its leakages in PDS and other schemes. It is illogical in the very first place to imagine that cash transfers will solve this problem; how simpler and easier it will be for those who benefit from such leakages to divert cash, rather than goods that have to be stored and resold.

Another important facet of the cash transfer schemes that seems to be missing from the government’s current point of view is the sunset or the exit clause. In every case, cash transfer proposals must have a well-worked out temporal dimension. We must carefully consider possible exit options under which cash transfers might wane or cease, as beneficiaries’ status changes, program objectives are met, or critical effects urge a rethink of the direction of the strategy and its interaction with other priorities. Therefore, unless sunset clauses or incentives are built into the cash transfer programs that incentivize beneficiaries to move out of them, there will be a natural lock-in effect. Are we witnessing another reservation system in the making?

The Verdict All said and done, cash transfers are definitely an effective tool in poverty alleviation and bringing social equality in an economy. What is probably wrong with them in the Indian context at this point of time-is the time itself. India still needs to overcome a number of challenges and do a lot of groundwork before it can embrace cash transfers in its system.

It is imperative that the government focusses on other pressing issues at hand and plug in the loopholes existing in the system prior to embarking on the journey to cash transfer schemes. If the results of the Cash transfer Pilot Project in Rajasthan are anything to go by, we believe that this is the right way to go for India.

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of food items, to the price index for the foods in question). But anyone familiar with the lags in public response to price changes – for example in the setting of minimum wages, and in the determination of the national wages under the the Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGS) – will immediately understand that this is an excessively optimistic, even utopian, assumption in the Indian context. To revert to the food example once again, in context of the high food inflation rates of between 15% and 20% per year experienced in India in the past, even within half-yearly revisions to the amount of a predefined transfer, there would be considerable effective loss to the designated beneficiaries.

Let us get this straight from the horse’s mouth. A survey, conducted by a group of NGOs including the Right to Food Campaign in Delhi threw up this rather audacious fact – 99% of slum women prefer food rations rather than cash transfers or coupons specified for a specific value. The 593 women from 14 slums interviewed in this survey also feared that cash receipts could get spent on other household priorities or immediate needs of the moment, be it for a health emergency or a celebration, if not on liquor, etc. They therefore wanted a strengthened PDS that functions well, preferably run by self-help groups or co-operatives. To support their view, a statement from Nilekani interim report reads, “The Task Force does not recommend substitution of public provisioning by the State. Instead it recommends a solution whereby the subsidies that are being provided by the State now can be more efficiently provided to the intended beneficiaries directly. It complements public provisioning by the State, rather than supplanting it.”

Moving on to the second question – that of identification of target beneficiaries – gives us some more insights about potential flaws of the proposal. The very process of identification can generate some well-known errors - Type I errors of unjustified exclusion of the genuinely poor and Type II errors of unwarranted inclusion of the nonpoor. Moreover, the possibility of such errors is inherently higher for a cash transfer program than delivery of food or other goods because of lack of any incentive to opt out of such a program. For example, in the most widely quoted success stories of cash transfers, Oportunidades in Mexico and

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Government of India and RBI: An Evolving Relationship Ashish Khare & Deependra Kumar

MDI

The nature of functions discharged by the central bank and its relations with the functions discharged by the central government has been debated for a long time. Together the central bank and the central government of a country are responsible for putting the economy on the path of prosperity and success.

However, due to the complexity of the relations between the functions performed by these two entities, there can be instances when central bank and the government are at odds against each other.

Since the time India gained freedom, socialist ideas were promoted and the role of government in guiding the economy was stressed upon. The objective was to promote balanced growth and also to take initiatives for the welfare of the people. India being a country with a huge size, vast amount of natural resources promised a huge scope for development. However, it was not until 1991 that effective economic reforms were introduced in the country which placed India on the path of high economic growth. Since then, the role of the central bank, that is, the Reserve Bank of India has widened in scope. In the lights of the developments in the Indian economy after 1991 economic reforms and the major economic events such as the 2008 recession and the Euro zone crisis, we will analyse the relationship of the Reserve Bank of India with the central government, with a focus on their existing relationship.

Role of Government The role of government in the economy is to maintain growth and generate employment for the citizens of the country. The government in order to achieve its objectives tries to mould the following in an economy: 1) Pace of economic activity 2) Maintain steady growth 3) Maintain high levels of employment 4) Maintain price stability Role of Central Bank In developing countries, central banks play a very important role in not only regulation but also

December 2012

development. In addition to the traditional roles, RBI also plays a very critical role in development of the country by revising Monetary Policies. The central bank of the country establishes a suitable interest rate structure to manage the investments in the country. The rates also decide the money supply in the market, so, by changing the rates the central bank manages inflation and growth.

Conflict of Monetary policy and Fiscal Policy The conflict between monetary policy and fiscal policy arises because of the difference in the goals of the Government and the central bank. While the aim of the Government is high growth and low unemployment, the main aim of the Central Bank is to regulate money money supply and thus stabilize prices.

The conflict of interest between monetary policy and public debt management lies in the fact that while the objective of minimizing market borrowing cost for the Government generates pressure for keeping interest rates low, compulsions of monetary policy amidst rising inflation may necessitate a tighter monetary policy stance. Therefore, the argument in favour of separating debt management from monetary policy rests on the availability of the effective autonomy of the central bank, so that it is able to conduct a completely independent monetary policy even in the face of an expansionary fiscal stance of the government.

Sometimes the conflict between the two arises over the usage of the foreign reserves of the country.

While the Government intends to use the reserve to finance its projects, the central bank wants to keep it as a reserve for safety and liquidity purposes.

Relation between the RBI and the Government of India: History Post-Independence The role of government after the independence was to guide the economy which was highly stressed.

The functions of RBI also became diversified as it had

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basis points between 2010 and 2011. Figure 1 shows the variation in Repo rate & Inflation over the last 3 years.

Despite these actions, inflation continued to remain high. Analysis of the sector composition of growth reveals that the growth moderation during 2008-12

Fig 1: Variation of Repo rate & Inflation over hte last 3 years

was driven largely by manufacturing and agriculture sectors. The sources of inflation during post-crisis period suggest that the increase in inflation was contributed by more than doubling of food price inflation to 11.8 per cent during 2008-12. A major factor from the demand side contributing to the persistence of food price inflation, which caused generalization of inflation and fuelled inflationary expectations, was the sharp rise in rural wages.

While RBI was trying to tame the inflation, government on the other hand was trying to prevent the country from recession by giving many benefits to the mass to increase consumption and hence

Fig 2: Relation between Repo Rate and the economic growth rate for the last 4 years.

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to take part in nation building. Post-independence, government triggered the economic growth through large public investment which was facilitated by accommodative monetary and conducive debt management policies. RBI played a crucial role of financing the government debt by monetising and maintaining interest rates artificially low, so that the cost of borrowing for the government remains cheap.

By the end of the 1980s, a fiscal-monetary-inflation nexus was increasingly becoming evident whereby excessive monetary expansion on account of monetization of fiscal deficit fuelled inflation.

Post 1991 After 1991, despite the fact that fiscal compression was on its way and efforts were made by RBI in moderating money supply during the early 1990s, the continuance of the ad hoc Treasury bill implied that there could not be an immediate check on the monetized deficit. In order to keep a check on the unbridled monetisation of fiscal deficit, the first argument between RBI and the Government of India started in 1994 to set out a system of limit for the creation of an ad hoc Treasury bill within three years.

Later a supplemental agreement was made in 1997 to completely phase out the treasury ad hoc bills.

In 2006, under the provisions of FRBM, participation of RBI in primary auctions of government was also stopped.

Post 2008 recession, Indian economy struggled to keep inflation low, and there were fears that the current high levels of inflation may become the “new norm” for the Indian economy. To deal with the inflationary pressures, the RBI raised the repo rate by 375 basis points and the CRR ratio by 100

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increase the growth. The difference in the goals of the two entities has recently become public when Government asked the RBI to reduce the interest rates so that the growth is not hampered due to the monetary policy. Figure 2 shows the relation between Repo Rate and the economic growth rate for the last 4 years.

A look at the US Economy: Relation between the Government and the Federal Reserve The low growth in the US is a major concern for both government and the central bank. The grave problem of liquidity trap is on the verge and a good mix of fiscal and monetary policy is what is needed in this case. While the central bank has kept all the rates low, the growth targets are still not achieved.

Central bank also needs to ensure that the rate will be kept low past the crisis. On the other hand, fiscal policy is more effective during these times because it doesn’t promise anything past the crisis, but it is difficult to sell the stimulus packages. There are limitations to both kind of policies which make it all the more important for both the government and the central bank to hold hands. The best strategy is to campaign on both the fronts of the policies and that is what has been implemented in the US. While the government is ensuring that austerity measures are avoided, the Fed has made clear that the rates will not be hiked until inflation attains high levels.

Conclusion As much as we try to blame the “cost push “ as being the prime factor behind this persistent inflation , there is a growing need to realize the fact that a sound fiscal situation ensures that inflation is contained . A country which has strong fiscal fundamentals hardly finds itself struggling to keep inflation low.

What also needs to be realized is that, even if the monetary policy framed by the Reserve Bank of India is set to keep the current levels of inflation low and the fiscal policy aims to reduce revenue collection from people through reduced tax collections, money financing will eventually be required by the central government. This will mean a dependence on borrowing and hence an upward push to the costs for the government leading to higher inflation once again. Hence it is of great importance for both the monetary and fiscal policy to be in tandem with each other.

It is in this context today that the RBI and the central government are in a conflict with each other. There are concerns about the lower expected GDP growth rate by the GOI and the RBI is concerned about the persistent high inflation.

An important area of focus today thus has been the

December 2012

containment of the fiscal deficit. If we look at the RBI claims, it wants the government to reduce its expenses on subsidies rather than increasing the taxes so as to contain the fiscal deficit. A deteriorating fiscal situation has also posed dangers of credit rating downgrade from the credit rating agencies.

This will have direct implications on the investor confidence and will pose a big threat to putting the economy back on the trajectory of higher growth.

The government has responded to this situation by showing firm resolve to improve the fiscal situation through a number of policy initiatives. However the government blames RBI for playing it safe by not reducing the lending rates and only altering the CRR rate in some of the recent monetary policy reviews.

However, RBI has its own problems which have forced it to maintain a tighter monetary policy. The depreciating rupee, euro zone crisis, rising oil prices have forced RBI to keep the interest rates high. As much as it appears that it will help to contain the inflation we see that the food inflation has remained more or less at the same level. This is because of the fact that RBI is trying to control inflation by focusing on demand push inflation whereas the current inflation levels have a lot to do with the cost push inflation. Thus RBI policy is going wrong here and hence needs corrective actions. However the fact that the rupee has undergone serious devaluation over the course of past one year and the oil prices have remained stubbornly high, lowering interest rates poses risks of worsening this situation.

It is thus important for both the RBI and the central government to work in accordance with each other. Rule based fiscal policy by the central government will become increasingly important to afford the space for monetary policy to contribute to macroeconomic stability. Fiscal prudence by the central government to alleviate resource constraints by boosting domestic saving will be crucial for raising domestic investment rate. In addition to this, RBI will also have to take certain strong measures to infuse more liquidity into the system by lowering the interest rates keeping in mind the fact that the major cause for high inflation has not been the demand push inflation. The quicker this important realization occurs to both the central and the Reserve Bank of India, quicker will be the improvement in India’s growth prospects and in the relationship between the central government and the RBI.

1914-1918

NIVESHAK

Nirmit Mohan

TEAM NIVESHAK

The United States was actively involved in World War I for only 19 months i.e. from April 1917 to November 1918. During this period, their mobilization of the economy was extraordinary. An estimated 4 million Americans served in the armed forces, and thus the U.S. economy had to turn out a vast supply of ammunitions and raw materials. While entering the war, Americans knew that the price of victory would be extraordinary. What, then, encouraged the United States to enter? What economic forces were responsible in bringing about this development?

Why did United States enter the World War I? One social factor which has always been pointed out is that Americans had stronger ties with France and Britain (Allies), than with Austria and Germany. By 1917, it became clear that France and Britain were nearing exhaustion and there was considerable sentiment in the United States for saving the traditional allies. However, the main trigger was the bombing on US trade vessels by the German submarines. The loss of several American trade vessels and 155 Americans on board was a key factor in President Wilson’s verdict to break diplomatic relations with Germany and declare a war.

Effect on Economic Trades Looking at the economic trades with Europe, the United States exports to Europe reached $4.06 billion in 1917 from $1.48 billion dollars in 1913. If U.S. had stayed out of the war, all trade with Europe would have been cut off. Assuming the resources engaged in the lost trades would have been reallocated to other purposes such as producing goods for exports for non-European countries or for domestic market, the calculated loss in output would have been $2.03 billion in 1917 which was 3.7 percent of GNP in 1917, and only about 6.3 percent of the total U.S. cost of the war.

Armed forces of United States The area of paramount importance before the entry into the war was the mobilization of the armed forces. When the U.S. entered the war, the army stood at 0.2 million, which was hardly enough to have an influential impact in Europe. However, by May, 1917, a regulation was imposed and the numbers were enlarged rapidly. Initially, a figure of 1 million was under discussion in the corridors of U.S. government but soon it touched a new high. Overall the size of army grew to 4.7 million. The increased size of the

Fig 1: GNP Growth of US Economy during World War I

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Finistory Article of the Month Cover Story

Transformation of U$ Economy during World War I

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Fig 2: Comparison of Total Industrial production and Steel during 1914-1920

army demanded: guns and ammunition, means of by 6% or 7% , and this increase accompanied with the ease of finding work was adequate to draw many transport, training schools, food and clothing etc.

The U.S Naval forces also had to be expanded to more workers into the labor force. Although, the protect the American shipping and the troop agricultural labour did drop slightly to 10.3 million transports. Tenders were immediately floated farmers in 1918 from 10.5 million farmers in 1916 but, demanding these facilities from the private sector. it was felt that agricultural farming included many This resulted in an exponential rise in the Federal low-productivity workers which became evident by a Spending from 0.47 billion in 1916 to 8.45 billion in sustained output of the agricultural sector. Instead, the all-important category of food grains showed 1918. The latter figure accounted to over 12% of GNP. robust increase from the year 1918 onwards.

The above amount excludes spending by allies and other wartime agencies most of which was funded Figure 2 shows the total industrial production (an index of steel, copper, rubber, petroleum etc.) and by loans from the United States. the monthly production of Steel from 1914 to 1920. It Industrial Growth during World War I can be inferred that the U.S. had built up its capacity It is evident that the increase in the armed forces did to turn out these quintessential raw materials during not prove to be an unmanageable burden for the U.S the years of American neutrality when British and economy as the total labor force rose to 44 million French Governments were buying its supplies. The in 1918 from about 40 million in 1916. The real wages U.S. then merely maintained the production of these rose in the industrial sector during the war, perhaps materials during the years of active U.S. involvement

The Stock Market, 1913-1920

100 90 80 70 60 50 40

Outbreak of War

30

US Entry

Armistice

20 10 1913

1914

1915 Nominal Prices

1916

1917

1918

Real Prices

Fig 3: Performance of NYSE during World War I

December 2012

1919

1920

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Fig 4: Revenue and Expenditure of US Government during 1916-1920

and concentrated on turning these materials into much thought to printing money due to sacrosanct gold standards. Thus, the real choices available were munitions.

Performance of Stock Market during World either raising the taxes or borrowing from the public.

Most economists at the time of World War I believed War I that raising taxes was the best option with the U.S. Figure 3 provides some insight into what investors Government. Thus, in October 1917 Congress came perceived about the performance of the U.S. economy up with War Revenue Act to call for higher taxes. during the war era. The dark line shows the S&P/Cowles This act established new excise, excess-profit, and Commission Index, while the dotted line shows the luxury taxes in addition to increase in personal real price of stocks (adjusted by the consumer price and corporate income tax rates. The tax rate for an index). When the war started, the New York Stock income of $10,000 with four exemptions was raised Exchange was shut down in anticipation of panic to 7.8% from 1.2%. For higher incomes of $1 million selling for about 6 months. After the market reopened the tax was raised to 70.3% from 10.3%. These in January 1915, it followed an upper trajectory as taxes increased revenue receipts to $4.3 billion in investors anticipated that the United States neutrality 1918 from $0.93 billion in 1916 whereas the Federal would profit. But later, it followed a long downslide expenditures increased to $15.5 billion in 1918 from when tensions built up between the United States $1.33 billion in 1916. Thus, a huge gap had opened and Germany (in 1916). The rally continued after the up calling for public borrowings too.

United States entered the war in 1917. A second rise Short-term borrowing was introduced as a stopgap was witnessed at the start of the year 1918, when arrangement to reduce the pressure on the Treasury an Allied victory began to appear conceivable. This and the danger of a surge in short-term rate. rise continued and picked up momentum after the However, long-term bonds were later pitched in by Armistice in 1919. But in real terms, this rise was the Treasury under the name of “Liberty Bonds”. not sufficient to counterbalance the rise in consumer These bonds were made attractive for people falling prices. Thus, though many economists say that the in high tax bracket by tax-exemptions. The 1st issue war is good for the stock market, but the records for was a 3.5% coupon 30 year bond callable after 15 years. In all, there were three issues of Liberty Bonds World War I narrate a more complex story. and one issue of short-term Victory Bonds after the Financing the War peace agreement, thereby raising over $20 billion A question which will arise in everyone’s mind is from public for the war effort.

‘Where did the funds come from to manufacture all Once the money began flowing and contracts for the ammunition and other requirements?’ ammunition were issued, the government mobilized The possible options during the World War I to raise a gamut of agencies to control the economy during money were; raising taxes, borrowing from the public, the World War I. and printing money. The U.S government did not give • A Food Administration board was appointed to

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control the agricultural production and ensure a fair distribution among the U.S. civilians, Armed forces, and the Allies at a fair price.

• A Fuel Administration board was constituted to look into the distribution of Bituminous Coal, as a variety of factors led to Coal Shortage in 1918. This board reacted by setting the price of coal, margins of dealers, mediated disputes in the coalfields, and worked with the transporters to reduce lengthy hauls of stocks.

• A Railroad Administration was appointed by nationalizing the railroad as severe congestions in the network were stalling the movement of war goods and coal.

• Other boards included the War Labor Board to settle labor disputes; War Shipping Board to build noncombatant ships; the New Issues Committee to vet private issues of stocks and bonds etc.

Long-run Economic Impacts The war left a number of long run economic legacies.

• Firstly, the finances of the U.S Federal government were perpetually transformed by the war. Though tax increases were scaled back by the year 1920, the rates were still kept high to pay for higher capital expenditures, mainly due to interest on the national debt.

• Internationally, economic position of the United States was transformed dramatically from a debtor to

FIN-Q Solutions NOVEMBER 2012 1. Liquidity Preference 2. Marginal Standing Facility 3. Nanjing Motor Company, China 4. Bill S. 2059, known as the “Paying a Fair Share Act of 2012” 5. K.C.Pant 6. X-John J. Mack Y-Morgan Stanley

a net creditor. In 1914, U.S investments abroad stood at $5.0 billion against the total foreign investments of $7.2 billion Thus, Americans being a net debtor of $2.2 billion. But by 1919, U.S investments abroad had risen to $9.7 billion against the total foreign investments of $3.3 billion leading to being a net creditor to the tune of $6.4 billion. This eventually led to the shifting of the center of the world capital markets from London (Bank of England) to New York after the war.

December 2012

7. X -Citigroup, Y -American International Group(AIG) and reverse stock split 8. Kagi Chart 9. Game Theory

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Cover Story

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Sinjana Ghosh

VGSOM, IIT Kharagpur Banking in India The Indian banking system started with the Government of India establishing three presidency banks in India, namely, Bank of Calcutta (1806), Bank of Bombay (1840) and Bank of Madras (1843). These three Presidency banks were subsequently merged into the Imperial Bank of India in 1921- which is now the State Bank of India. Towards the late 19th Century some banks like Allahabad Bank Ltd., Punjab National Bank, Bank of India Ltd. and other came into picture. These, along with some other major banks were nationalized in 1969 and 1980.

Banks which were not nationalized in these years for instance, Bank of Punjab, City Union Bank, ING Vyasa Bank etc were called Private Sector Banks (PSBs), which later came to known as “old private sector banks” after some new banks (now known as new private sector banks) like HDFC, ICICI, Axis bank etc came into foray, following the economic reforms of 1990s.

Private Sector banks The Private Sector Banks of India are the most lucrative target for domestic as well as foreign investors owing to their remarkable progress in recent years. More aggressive by nature, these banks have been able to outperform their Public Sector counterparts with respect to most key ratios like Net Interest Margin, Credit/Deposit ratio, return on assets (RoA) while maintaining better credit quality.

Asset Quality Adding to the slow economic growth and growing food inflation, are the global concerns of fiscal cliff outstanding at the end of the year that is likely to have a strong impact on the performance of the banks, anticipation of the analysts and decisions of investors. While aggressiveness is important from the credit growth perspective, credit quality is what, according to most equity analysts, separates the winners from the losers in these testing macroeconomic conditions of Indian Economy. While RBI

Fig 1: Substandard Asset Percentage (2007-2012)

Fig 2: Gross NPA percentage (2007-2012)

statistics over the past 3 years show significant improvement in the net NPA of new private sector banks, including the “most aggressive” ICICI bank which saw its NPA coming down from 1.7 in FY2010 to 0.73 in FY2012, the NPA of PSU banks showed an increasing trend, with the current average of 1.53. Increasing percentage of sub-standard assets, relatively higher exposure to Gross NPA ‘heavy’ sectors, as revealed by their loan portfolio, high debt restructuring, low NPA coverage, and thinning capital cushion (Tier-1 Capital, less stressed assets) are some of the major reasons supporting the assumption that the asset quality headwinds will persist in the PSU sector. Exposure of PSU banks to sensitive sectors as a percentage of overall exposure

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NIVESHAK

Fig 3: Loan Portfolio of Different Banks

declined marginally to 28.7% v/s 29.2% in FY11.

Capital Ratios are the indicators of how risky a bank’s balance sheet is and the degree to which the bank is vulnerable to an increase in bad loans.

Banks with a higher share of Tier I Capital are likely to outperform those with a lesser share. Here, the new private banks like Yes Bank; HDFC shows a consistently increasing trend while PSUs are on the decline.

Profitability and Effciency Macro-economic factors largely determine the profitability of various sectors forming a part of the bank’s loan portfolio. New private sector banks have been able to maintain their credit growth despite slowing corporate spending cycle. On the other hand, larger exposure to priority sector and low-interest student loans has led to a decrease in profitability of PSU banks. Asset quality dominates interest rate declines in driving banks’ stock performances.

Statistics suggest that the new private sector banks

Bank Group

CAR (Tier I) 2011 8.71 9.01 15.35 12.27

SBI & Associates Nationalized Banks Old Private Banks New Private Banks

have not only been able to maintain a better NIM but also increased their non-interest income through other business like Credit Cards, Trade Finance, and other fee based services.

The private sector banks show strikingly stronger growth in the average spends by their credit card customers compared with the PSU banks.

Another interesting ratio is the term loan to total advances. Term loans, unlike demand loans are of long term, high value, and chargeable at floating interest rates, hence are more profitable and sustainable assets than latter. These loans are usually done in conjunction with specialized financial institutions which have greater contribution, hence greater charge on the security. Some new private sector banks like ICICI Bank, Kotak Bank, have taken full advantage of their presence across all sectors of financial services, to grant more term loans, thus increasing their profitability. Though the old private

CAR (Tier I) 2012 9.38 9.05 12.46 12.08

CAR (Tier II) 2011 4.23 4.45 1.73 4.01

CAR (Tier II) 2012 3.88 3.85 1.73 4.12

Table 1: Capital Adequacy Ratio of different Banks 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

Jul-12

Private

May-12

Apr-12

Feb-12

PSU

Dec-11

Nov-11

Sep-11

Jul-11

Jun-11

Apr-11

Feb-11

Aggregate

Fig 4: Average spend by credit-card customers bank-group wise

December 2012

banks have performed remarkably well in terms of return on advances, given the smaller share of term loans and their limited reach across the country, sustaining the margin over the quarters has been a challenge.

Indicators of different groups Valuation Ratios Strong core operations and robust asset quality of Private Banks is evident in their premium valuations relative to the state-owned banks.

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SBI & its Associates Nationalised Bank Old Private Bank New Private Sector Banks

2011

2012

2011

2012

2011

2012

2.96

2.90

2.17

2.08

1.05

0.92

55.29

52.20

0.58

0.55

2.75

2.58

1.95

1.88

0.83

0.78

56.77

56.45

0.7

0.7

3.08

2.96

1.89

1.88

1.02

1.01

47.88

47.36

0.52

0.58

3.32

3.19

2.56

2.42

1.73

1.67

70.68

71.28

0.99

1.04

Operating Profits/ Total

Non-Interest Income/ Total

Profit per employee 2011

2012

Finsight Article of the Month Cover Story

Bank Groups

Term Loan/ Total Advances 2012 2011

Net Interest Margin

Table 2: Key Profitability Key Valuation Metrics

SBI

ICICI

HDFC

AXIS

YES

PNB

ING VYSYA

2011

2012

2011

2012

2011

2012

2011

2012

2011

2012

2011

2012

2011

2012

Book Value per share(INR)

1014

1215

481.3

527

118

128.7

452.8

541

109.3

132.5

632.5

779.4

208.4

258.1

EPS(INR)

130.2

174.5

25.2

24.2

23.8

27.18

82.5

102.7

20.9

27.7

139.9

144

26.34

30.4

P/E

16.4

9.9

20.3

16.4

26.5

23.9

16.8

11.7

14.8

13.3

7.6

6.7

13.6

10.7

P/BV

2.1

1.4

1.9

1.7

5.9

5.2

3

2.2

2.8

2.8

1.5

1.2

1.6

1.2

Return on assets

0.99

0.88

1.35

1.5

1.55

1.77

1.68

1.68

1.58

1.57

1.34

1.19

0.89

1.09

Return on equity

18.9

16.3

9.65

11.2

16.74

18.69

19.34

20.29

21.13

23.07

22.6

19.8

14.37

12.86

No. of issued shares (in mn)

671

635

1151

1153

465

2346

410

413

347

352

316

339

120

150

Table 3: Key Valuation Metrics of some of the most preferred banks of mutual funds

Analysts foresee that slowing credit growth and degrading asset quality is likely to persist in the coming quarters for public sector banks, while retail assets focus, improving asset quality and robust fundamentals would be the key driving factors for Private Bank Stocks in the capital markets. Despite fluctuations post US elections, mutual funds across the nation, are showing their preference towards the large-cap and mid-cap private banks over giants like SBI.

Success Strategy of the new private banks The historical decision of liberalization of banking sector coupled with a steady economic growth of India, paved way for the new generation “techsavvy” banks which leveraged on their superior technology and promotional expertise to build a strong foothold in India.

Marketing Promotion of banks were limited to newspaper ads

Table 4: Promotional Strategies of Banks

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NIVESHAK

Fig 5: No of Banks ATMS group wise

Fig 6: Average Spending of debit card cuustomers at POS

before the advent of the New Private Sector Banks headed by HDFC and ICICI bank that changed the way banks did business in India. They introduced the concept of branding in the banking Industry, a trend followed by Axis, Kotak Mahindra and Yes Bank, while DCB and IndusInd was left behind in the race of aggressive campaigning. Recent years have seen PSBs like SBI, PNB etc developing their promotional strategy as well to stay in the competition.

Increasing accessibility through ATMs and POS The private banks extended their reach not only through branches but also through huge number of ATMs. RBI statistics of 2012 reveal that Axis, HDFC and ICICI, along with SBI comprise of 52% ATMs all over India, among 53 SCBs recognized by RBI. The data summarized below suggests only 9 new private banks have surpassed all other bank groups in number of ATMs. Another way through which banks increase their accessibility these days is through POS transactions by debit card customers.

Innovations in banking The banking sector in India has undergone a remarkable metamorphosis in the last decade through innovative strategies. Needless to mention the new private banks not only pioneered these changes but also continue to surprise the consumers with new moves. Way back in 1998, HDFC Bank joined the Cirrus interbank network so that MasterCard holders worldwide could use its ATMs. In 2001, it became the

December 2012

first bank in India to launch an International Debit Card, in association with VISA. ICICI, the bank that unleashed the power of Internet in Indian Banking, launched e-Locker facility to wealth customers and initiated a 24x7 electronic branch this year. On 6 September 2012, it announced the launch of its services on social media platform ‘Facebook’, an initiative taken under the tagline “Khayal Aapka”.

Axis Bank came up with this innovative homeloan product: if you pay all your equated monthly installments (EMIs) in time, it will fully waive the last 12 payments-a move seen as the bank’s strategy to break the stranglehold the HDFC and SBI have on the home loan business. Yes Bank, the youngest and fastest growing bank in India, outsourced technology and used innovation as the key engine to their growth. Not only has it used innovations for profitability, but also came up with various initiatives like Honey Farming and Responsible Banking to evolve as a socially responsible, futuristic brand in the industry. The most striking feature of these banks is flexibility, the way they adapt to changing regulations and consumer demands. While HDFC’s strategy of increasing the provision cover for its loans helped them to stick to their 30% profit growth even in the difficult phases, ICICI showed nimbleness in changing their loan mix to focus on retail sector, particularly mortgages and auto loans.

The way forward The Indian banking industry, strongly regulated

by RBI, has shown great resistance to volatility, particularly in the wake of the global financial crisis, which pushed its global counterparts to the brink of collapse. From the above analysis it would be safe to conclude that the new private banks are better placed to face the economic turmoil anticipated in near future, although a large section of Indians will continue to trust only the PSBs. The tough competition posed by these late entrants has been extremely beneficial to the Indian Banking Sector. Though macro-economic conditions have made many analysts pessimistic about this sector, the new generation banks continue to deliver unexpected results quarter by quarter and mutual funds continue to bank on these banks when it comes to Asset Portfolio.

NIVESHAK

Bond laddering

Sir, I recently came across a share market trader who told me that with ongoing fluctuations in interest rates, it might be time to use a bond ladder in one’s portfolio. What does this bond ladder mean?

Well, we all know that bond prices move to the rhythm of the interest rates and one often does not have any control over them. Thus, familiarity with the concept of bond laddering will help in reducing the risk related with different interest rates while ensuring a regular flow of money for the bond holder.Bond laddering is actually a very simple investment strategy. A bond portfolio that uses the concept of laddering consists of many bonds with different maturity dates spaced at regular intervals.

Neha misra IIM Shillong often connected to the future movements of interest rates and in this volatile economic environment, fluctuations in interest rates have become a very common feature. Thus, it has become imperative for every investor to guard oneself from such fluctuations.

Let’s say you have a bond portfolio that returns you an interest of 7.5% till the maturity date. Meanwhile interest rates keep changing. If you hold all your bonds till the date of maturity then all your bonds will mature on the same date. This means that you can reinvest your cash on some future rate of interest which may be lower or higher than the previous interest rate. If lower, you stand to lose; if higher you stand to gain.

This is what we call reinvestment risk. Thus, spreading out the bond maturity dates over a period of time helps in spreading out the reinvestment risk.

So is bond laddering a complete winwin situation?

No, not necessarily. Spreading out your reinvestment risk may actually lower your returns. Look, a basic principle of So does the face value of bonds having life is when you gain some, you also lose different maturity dates also have to be some. Incorporating bond laddering in your different or can it be the same? portfolio can actually make you bear extra costs.

The face value of each bond may be the What kind of extra costs, Sir? same or different. Let’s take an example, say you have invested a sum of Rs. 20 lakhs in See, in bond laddering you will have five different bonds with a face value of Rs. different bonds with different maturity 4 lakhs each. The first of these bonds has a maturity dates as well as different rates of return. period of one year; the second one has a maturity Usually bonds with a longer maturity date period of two years and so on. This ensures that you give you a higher return while bonds with a have a consistent flow of cash every year which can lower maturity date give you a lower return. Investing be further invested. all your money in bonds with a longer maturity date may seem profitable. However, bond laddering in the Ok, it sounds quite simple but how current situation also has bright prospects. As I said, does laddering actually help in reducing risk? with bond laddering, every year you will have one bond maturing which means every year you will have It is good to see that you want to get money to make new investments. into the depths of this investment strategy.

A bond laddering technique helps you handle Thank you sir for explaining Bond one of the most common risks bond portfolio Laddering in such a lucid manner! owner faces – reinvestment. Reinvestment is

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1945 2 . An investment gala held for the first time in 1979 by Drexel Burnham Lambert has become increasingly popular today 3. A part of the Bloomsbury Intellectual Group, this radical thinker was involved in one of the greatest intellectual battles of the 20th century. The Indian Prime Minister praised his philosophy at a recent G-20 Summit. Identify the personality.

4. Connect the following pictures:

5. Central Bank of Germany uses this rate to charge other banks for collateralized loan obligations, it is generally 50 basis points higher than the German Central Bank’s Discount rate 6. Company X, a NBFC, has been restructured to form a Non-Operative Holding Company Y, which later will be converted to a bank once new banking licenses are issued by RBI 7. This company is promoted by SEWA Bank and also an affiliate of WWB, a global network created to focus on the need for women’s direct access to Financial services 8. What inference do you draw from the picture below?

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