Niveshak July15

Niveshak THE INVESTOR

VOLUME 8 ISSUE 7

July 2015

FROM EDITOR’S DESK Niveshak Volume VIII ISSUE VII July 2015 Faculty Chairman

Prof. P. Saravanan

THE TEAM Abhishek Bansal Bhawana Saraf Maha Singh Gulati Palash jain Prakhar Nagori Ramesh Jaiswal Rahul Bajaj Sandeep Sharma Vishal Khare

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

CONTENTS

Dear Niveshaks,

Taking forward one of his marquee projects, Prime Minister Narendra Modi started the month of July with the launch of ‘Digital India’. Digital India, which talks about taking Internet connectivity to the masses is expected to be officially launched with some of the key components of it such as Digital Locker, National Scholarship Portal and e-health under which people can book online appointments to government hospitals such as AIIMS. The Chinese economy continues to be weak witnessing sharp plunge in stock market.

The People’s Bank of China has cut interest rates to a record low, brokerages have committed to buy billions worth of stocks, and regulators have announced a de-facto suspension of new IPOs. The underlying business sentiment in India during JulySeptember quarter of calendar 2015 is likely to remain subdued amid concerns of weak factory data and potential impact of deficient monsoon. The economic weakness in the domestic market was compounded by lower growth in China and continuing financial woes in Europe that raised doubts about the strength of growth of the world economy. Oil prices rebounded after settling at their lowest in months in the previous session as worries over the demand outlook and continued oversupply weighed on the market. U.S. Treasury long debt yields dropped to two-week lows on Thursday in choppy trading, as investors sought a safe haven from weak U.S. corporate earnings and slumping commodities prices.

India’s central bank said it would reserve the right to inject less funds via term repo auctions than notified, saying ample liquidity in money markets had reduced demand for these short-term debt products.

Driven by an investment friendly government at the centre, overseas investors have pumped in a staggering $6 billion into the Indian securities market in July - taking their overall net inflows since beginning of 2014 to more than $26 billion. According to analysts, the government’s approval of a composite FDI structure, which will result in further capital flowing into the system, has lifted the investors’ confidence and helped revive the inflows. Besides, Greece law makers have passed the austerity laws aimed at paving the way for a bailout by the EU, which has further boosted sentiment.

On the magazine front, the cover story gives interesting insights on the happening in the stock markets of China. It shows how the Chinese markets reached to such highs that a crash was inevitable. The Article of the Month raises concerns on whether the world is going into another great recession and what reasons could be behind it. The Fin Gyaan section explains the current Greek crisis and the Fin Sight section covers the implementation of GST and what impact it may have on our economy. For our FinView section, we have an interview with Mr. K. Biju George, General Manager of IDBI Bank on debt syndication and project financing.

To end this brief note, it’s important that we thank you, our readers, for your constant support and appreciation. Please continue to motivate us so that we can come out with more insightful reads in the issues to come. Keep pouring in.

Stay Invested!

Team Niveshak

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

Cover Story Niveshak Times

04 The Month That Was

Article of the month

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China Stock Market Bubble

Is World Economy Going into Great Depression?

FinGyaan 18 The Greek Debt Crisis: What the fuss is all about!

FinLife

22 Derivatives Market

Finsight

26

Implementation of GST : Impact on Indian Economy

FinVIEW

30

Interview With Mr. K. Biju George ,General Manager, IDBI Bank

CLASSROOM

33 Smart Beta

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The Niveshak Times

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The Niveshak Times

Team NIVESHAK

IIM Shillong India, Large EMs Less Vulnerable To US Fed Rate Hike: Fitch Global ratings agency Fitch today said that so-called “fragile five” emerging economies including India and Brazil are showing “fewer signs of vulnerability” to US Federal Reserve’s rate hike. The large emerging markets (EMs) -Brazil, India, Indonesia, Turkey and South Africa -- are exhibiting fewer signs of vulnerability to a drop in capital inflows than some of their smaller counterparts, Fitch said in a report.

“This suggests these so-called ‘fragile five’ are not necessarily most at risk from Fed tightening, although this will ultimately be determined by a range of factors, some of which are less quantifiable,” Fitch Ratings said.

The ratings agency is expecting US Federal Reserve to start raising interest rates before the end of 2015.

Make In India: Boeing Says It’s Open To Picking Up Stake In Indian Aerospace Firm US aircraft manufacturer Boeing is open to picking up a stake in an Indian aerospace company, its India head said. “We are open to it. The investment environment in India has improved,” said Pratyush Kumar, President, Boeing India.

Kumar added however that a strategic partnership in this space would entail a host of regulatory approvals. He didn’t elaborate on whether Boeing is in talks with any aerospace company in India.

A strategic partnership would considerably expand the manufacturer’s role and involvement in India’s aerospace industry, apart from developing Narendra Modi’s Make in India initiative. Boeing primarily has sourcing or technology sharing relationships with companies in India.

RBI, Central Bank Of Sri Lanka Ink Currency Swap Agreement The Reserve Bank signed a special currency swap agreement with the Central Bank of Sri

JULY 2015

Lanka that will allow the latter to draw up to $1.1 billion.

Under the arrangement, the Sri Lankan bank can draw up to $1.1 billion for a maximum period of six months.

This special arrangement is in addition to the existing Framework on Currency Swap Arrangement for the Saarc member countries.

The proposal to extend the additional currency swap facility of $1.1 billion for a limited period was decided by the government in April based on the recommendation of RBI. It was intended for mitigating the possible currency volatility in the spirit of strengthening India’s bilateral relations and economic ties with Sri Lanka, RBI said.

Posco’s $12 Billion Odisha Project On Hold Posco, South Korea’s biggest steelmaker, has put on hold plans to build a steel plant in India after land acquisition and farmer protests stalled the $12-billion project for a decade.

The project in India’s eastern state of Odisha has been “tentatively postponed,” CEO Kwon Oh Joon said. Until Indian Prime Minister Narendra Modi “offers better deals, we won’t resume and for now we will head to the west and do more downstream work”, he said, referring to a plant the company operates in the state of Maharashtra.

Posco’s 12-million ton-a-year Odisha project, which was the nation’s biggest foreign investment, failed to take off since 2005 because of opposition from local farmers and the failure to secure iron ore mining leases, initially promised for free to the company BRICS Bank To Start Lending In Local Currency By April: Kamath The New Development Bank (NDB), set up by five BRICS nations including India, will start lending in local currency by April next year and member countries will primarily be the focus of

credit facility, its chief and eminent banker KV Kamath said recently.

He said a decision to open membership for other countries will be taken in the next few months by the bank’s Board of Governors.

“I think we will start lending process sometimes early first quarter next year (April). The idea is that by April next year, we will create a state of projects from all the member countries (for lending),” Kamath said.

He also said the NDB, with a capital of USD 100 billion, will look at various instruments of credit to the member countries -- Brazil, Russia, India, China and South Africa -- which require huge resources for development.

India, US Sign Agreement To Share Info On Tax Evasion India and the US signed a tax information sharing agreement under a new US law, Foreign Account Tax Compliance Act (FATCA) that will bolster efforts towards automatic exchange of financial information between the two nations about tax evaders.

The agreement will cover automatic sharing of information on bank accounts as well as financial products like equities, mutual funds and insurance and is aimed at fighting the menace of black money stashed abroad. Coming within months of India becoming a signatory to the OECD pact on automatic information sharing, the government’s efforts at getting names of those with illicit wealth stashed abroad will get a leg up.

With the agreement in palace, from September 30, banks, mutual funds, insurance, pension and stock-broking firms will report their Indian client details to the United States which will be shared with authorities there China Must Learn Lessons From Stock Market Rout, Says Vice Finance Minister Zhu Guangyao China must learn lessons from its stock market rout, the country’s vice finance minister said on Saturday, signalling his intent to focus on

supervision and the development of new frameworks to make it possible to weather any future market turbulence.

China’s stock market plunged by nearly a third at one stage earlier this month from a midJune peak, wiping around $4 trillion from share values as investors were spooked by speculation that China’s central bank was about to end its monetary policy easing.

The slide sparked China’s biggest rescue effort of its equity market, with the government launching a series of moves that included halting flotations and banning companies and their executives from selling shares.

Zhu Guangyao told Reuters Beijing was considering new policies.

Google Shareholders Revel In Record 1-Day Windfall Of $65.1 Billion Google’s stock roared out to produce the biggest shareholder windfall in US history as investors rewarded the Internet Company for promising to curb its spending on risky projects.

A 16 per cent surge in Google’s publicly traded stock translated into an additional $65.1 billion in shareholder wealth, on paper at least.

That barely topped the previous record one-day gain of $65 billion by Cisco Systems Inc. in April 2000 after the computer networking equipment maker had suffered a steep drop in the previous week, according to S&P Dow Jones Indices. More recently, iPhone maker Apple Inc. posted a $46.4 billion one-day gain in April 2012 after its quarterly earnings wowed Wall Street.

Google’s gigantic run-up came after the Mountain View, California, company reported quarterly earnings that topped analyst estimates for the first time since late 2013. The company’s inability to hit the targets that steer investors had raised doubts about Google that had caused its stock to lag the rest of the market since the end of 2013.

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The Month That Was

The Month That Was

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Market Snapshot

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Market Snapshot BSE 1,000

BSE

28400

DII

800

FII

600

28200

400

28000

200

27800

0

27600

-200

BSE

FII, DII Net turnover (in Rs. Crores)

28600

-400

27400

-600

30-07-2015

29-07-2015

27-07-2015

24-07-2015

23-07-2015

22-07-2015

21-07-2015

20-07-2015

17-07-2015

16-07-2015

15-07-2015

14-07-2015

13-07-2015

10-07-2015

09-07-2015

08-07-2015

07-07-2015

06-07-2015

-1,000

03-07-2015

27000

02-07-2015

-800 01-07-2015

27200

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

MARKET CAP (IN RS. CR) BSE Mkt. Cap

10326686 Source: www.bseindia.com

LENDING / DEPOSIT RATES Base rate Deposit rate

9.70%-10.00% 8.00% - 8.50%

Index

Open

Close

% change

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

27665 18607 20915 17477 10545 7635 16222 10537 9177 9839 2016 1408 5940 11055 10653 7586

28115 18769 21145 18011 11028 7991 16715 10927 8523 9929 2077 1348 6142 11724 11158 7610

1.43% 0.87% 1.10% 3.06% 4.57% 4.67% 3.04% 3.70% -7.13% 0.91% 3.05% -4.24% 3.39% 6.05% 4.75% 0.32%

% CHANGE

% Change CURRENCY RATES

RESERVE RATIOS

INR / 1 USD

64.01

INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling INR/ 1 SGD

70.07 51.53 99.83 46.63

CURRENCY MOVEMENTS 2.50%

INR/1 USD

2.00%

Euro/1 USD

GBP/1 USD

JPY/1 USD

SGD/1 USD

CRR SLR

TECK, 3.39% Smallcap, 6.05%

4.00% 21.50% REALTY, -4.24% PSU, 0.32%

POWER, 3.05% OIL&GAS, 0.91% MIDCAP, 4.75%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

8.25% 7.25% 6.25%

1.50%

1.00%

Source: www.bseindia.com 24th June 2015 to 28th July 2015 0.50%

Data as on 28th July 2015

METAL, -7.13%

1

IT, 3.70% Healthcare, 3.04% FMCG, 4.67% CD, 4.57% CG, 3.06% BANKEX, 1.10% AUTO, 0.87% Sensex, 1.63%

0.00%

JULY 2015

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Article Market of Snapshot the Month Cover Story

Article ofSnapshot the Month Market Cover Story

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Niveshak Investment Fund

Done on 30/6/14

CONS NON DURABLE (6.75%)

Information Technology (12.30%)

HCL Tech.

Infosys

Wg: 3.55% Gain : 31.84%

TCS

Wg: 4.77% Gain : 28.01%

GODREJ CONSUMER Wg:6.75% Gain:50.62%

Wg: 3.96% Gain : 0.67%

BANKING (6.39%)

FMCG (22.02%) Britannia Wg:6.86% Gain:204%

Colgate

Wg:6.20% Gain:34%

HUL

Wg:4.71% Gain:30.73%

Wg:4.24% Gain :8.06%

Auto (11.33%)

Pharmaceuticals (11.76%)

Dr Reddy’s Labs Wg:4.58% Gain:35.51%

Lupin Wg:7.89% Gain : 40.92%

HDFC Bank

As on 30th July2015

July Performance of Niveshak Investment Fund 102

Asian Paints Wg:7.12% Gain:36.37%

MISC. (3.79%)

MANUFACTURING (6.15%)

Titan Company Wg:4.12% Gain:-9.68%

Page Industries Wg:6.15% Gain:31.07%

165

Performance of Niveshak Investment Fund since Inception

155

101.5

145

101 100.5

135

100

125

99.5

115

99

105

98.5

95

98 Sensex

NIF

Values Scaled to 100

Wg: 6.39% Gain : 20.47% Opening Portfolio Value : 10,00,000

Chemicals (7.12%) Amara Raja Batt Wg:4.21% Gain :22.46%

Tata Motors Wg:7.12% Gain : 36.37%

ITC

Performance Evaluation

Current Portfolio Value : 15,62,881 Change in Portfolio Value : 56.28% Change in Sensex : 08.03%

Sensex

NIF

Risk Measures: Standard Deviation : 12.15(Sensex 22.35) Sharpe Ratio : 2.91(Sensex : 2.07) Cash Remaining:271897

Comments on NIF’s Performance & Way Ahead : Throughout July 2015, Sensex was seen under swing from the 28500 levels to 27500 levels , mainly on the concern of Chinese crash, weak Asian market cues, the P- notes adversial comments as well as the recommendation of inclusion of MAT, however the market bounced back during the last days of the month led mainly by the banking and auto earnings.

Inside our portfolio major events were seen in Lupin , that went on to acquire speciality and generic businesses in US and Germany. Concerns have been seen in ITC where the cigarette volumes could be expected to fall. Titan posted a disappointing 15 % decline in earnings.

On global front Greece and china occupied the centre stage throughout the month, especially china with the declining index, the fall is mainly attributed to index bubble and impulse of retail investors. We are watchful of business developments and any threat on portfolio’s return would be addressed accordingly.

The portfolio did not witness any re shuffle during this month, however we are watchful of the current fall and corrections in the prices of overvalued stocks , there earnings and the stock’s fundamentals revaluation exercise is underway and therefore reshuffles in the next month would depend upon the momentum of the market and outcome of stock analysis

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Article of the Month Cover Story

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Is World Economy Going into Great Depression?

Ankur Kumar

IIM Shillong Global Scenario A faint and fearful heart is more prone to dreadful situation. So, this may be exactly the case when RBI Governor Dr. Raghuram Rajan cautioned at a London Business School conference about the Great Depression likesituation. The reaction was so sharp that the RBI had to publish a statement clarifying the statement of the Governor. However the alacrity with which his statement was critiqued upon does reveal something about the state of the economy, that there is something that is not working and fearing to collapse.

The Governor, although soaked in the free-market principles of the Chicago School, was reiterating his often-stated position of the possible fallout of the beggar-thy-neighbour policy adopted by many nations. He meant to imply that the world’s economy was behaving in the same fashion a before the longest-lasting and deepest financial crisis i.e. the Great Depression (192939).

JULY 2015

In 2005, Dr. Rajan, in his Jackson Hole speech, had predicted the looming financial market crisis, which very much came out to be true.

Although former US Treasury Secretary Lawrence Summers said he was being ‘Luddite’. So, could Dr. Rajan again be so right in predicating the possible crisis? First of all what makes him say so? Cannot he be wrong this time? We hope so.

Let’s see what major factors could be the reason behind the Governor’s reasoning.

The 2007 Aftermath The world economy dipped into recession after the financial crisis of 2007 which began with the bursting of housing bubble. The resulting loss caused sharp cutbacks by the consumers.

This loss of consumption combined with the financial market chaos led to the collapse in the business environment. This ultimately led to the widespread unemployment in the economy. As per the National Bureau of Economic Research, the official arbiter of US

recession, the unemployment rate in December 2007 was 5.0 percent and it rose to as high as 9.5 percent in June 2009, the official time of the end of recession (1). In 2008 and 2009, the US labour market lost 8.4 million jobs, or 6.1% of all payroll employment (2).

In 2008, the US economy contributed around 20% in the world economy (3). So the reduced consumption in the US economy had a contagion effect around the globe. In the year 2008, the world GDP growth rate fell to 1.5%, which went to -2.07% in 2009.

Now to revive the economy, the most common way adopted by any central banks is to lower the interest rate. But after the financial crisis, even the zero-level interest rate could not spark off the green shoots in the US economy.

This led the Fed (USA Central Bank) to take an unconventional path: Quantitative Easing (QE).

To carry out QE, central banks create money by buying assets, like government securities, bonds, etc. The new money swells the banks’ size thus encouraging them to lend more and more. This in turn is supposed to hike up investment and revive the economy.

So, to spur the stagnant US economy the Fed embarked on QE in November 2008. Its bond buying programme took the Fed’s balance sheet from $870 billion in August 2007 to whopping $4.7 trillion currently. Though now Fed has slowed its bond-buying programme form $85 billion a month to $15 billion a month (4).

The Staggering Japan Japan’s economy continues to be plagued by deflation and continued recession. The reason for continued slow growth is manifold.

But one of the main causes could be that the country continues to be suffering from the 1989-90 crisis of “bubble economy” under which land and stock prices collapsed wiping out assets of banks. Now banks took the charge to revive the economy.

What better than QE to spur the economy. And the Bank of Japan (BoJ) started its QE program in the year 2001. It failed to kick start growth and get the prices rising. Again in April 2013, BoJ started a massive QE program. It promised to pump in around $1.4 trillion by buying close to $50 billion per month. BoJ went even further and announced in October 2014 that they would increase the amount pushed into the system

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from $534-$623 billion a year to $712 billion a year (5). Even then the country’s GDP continues to hover around near-zero percentage growth.

In short, Japan continues to remain a guzzling source of money to the world economy. With no tangible benefits, the country is taking protectionist approach with its depreciating currency which is making its exports competitive.

every six month. The Greece government total debt is around 164% of its GDP for the year 2012, the latest data available with the World Bank.

Portugal total debt to its GDP is 124% while Ireland total debt to the GDP is 121%, again for the year 2012(11).

into being in 1999. The common currency was floated in the year 2002. With only monetary union, without any fiscal union, the group of 19 countries (having common currency) is in precarious situation.

negative interest rate, but it did not help (6). In the end they also went for QE program, again flushing money in already flushed market.

Now here again to make growth engine tick, European Central Bank (ECB), the apex financial decision making The Floundering body in the EU, European Union finally decided on Economics 22nd January, 2015 to pump in $70 Characterized by Table 1: Percent growth in GDP billion per month for burgeoning debt, massive unemployment, persistent low inflation, the at least 19 months. Though the ECB had tried European Union (EU) Economics continues an unconventional method, before agreeing to to act as a hanging sword. The Union came pump money, which was imposing

Today Greece, Portugal, Ireland are having high debt on their government. Greece debt crisis has become a half-yearly show which keeps coming

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The Bank Of England Spree Marred by the dual crisis of financial market collapse in the US and the coming EU debt crisis, Britain’s economy contracted in two consecutive years. The GDP of the UK grew by -0.33% and

-4.31% in the year 2008 and 2009 respectively (7). So to take back the country on the growth trajectory the Bank of England launched the QE programme in March 2009. They initially decided to pump in $82 billion over the month of three months. This programme continued till January 2010.

Then in October 2011, Bank of England decided to pump in another $82 billion as the country was facing warnings of double-dip recession and horrendous Euro-zone debt-crisis.

economy- are adopting beggar-thy-neighbour strategies that were followed in the 1930s.

Instead the Central Bank of these countries should take the greater and moral responsibility of steering the world, and not only their own economy, out of the glut of slow growth. Dr. Rajan had the last laugh after the 2007 crisis.

But we hope he did not have the same this time.

The debate is still on whether the QE was the best method to take the country out of recession.

The Bank has itself said that the richest 10% of households have seen their wealth multiplying substantially due to the QE programme .

So, The Verdict The US, Japan, the EU and the UK has their GDP as a percentage of world’s GDP as 22%, 5%, 24%, 2.5%(9,10) for the year 2014 respectively.

Their combined share of GDP as a percentage of world’s GDP is 53.5%. This is more than half of the world’s economy. These economies are heavily pumping money in the market. Without any substantial benefit, as depicted by the status of the US economy which continues to remain in doldrums even after pumping money for seven years amounting to a whopping sum of around $3830(12) billion, these QE measures have been used a ploy to make the export competitive by depreciating currency. This practice does not give any consideration about the possible impact on the other growing economy.

As said by Dr. Rajan, major economies of the world- comprising more than half of the world’s

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Cover Story

Cover Story

China’s stock market bubble

“This is the slaughter of the middle class.” – Mr. Hao, financial adviser

Abhishek Bansal

the amount of deposits that some banks need to hold in the reserves. However, some investors feel that the central bank has intervened much less by cutting the rates by 25 basis points instead of 50 or 75 basis points. The state run companies have also pledged to invest 120bn yuan to provide support to the market.

How Did The Stocks Get So High?

The rise in the markets has been propelled

country’s communist party, according to Bloomberg – 90m versus 87.7m. Many of the investors are unsophisticated (two thirds lacking even a high school degree) in the sense that they lack proper understanding about the margin trading. The herd mentality can take the market upwards or downwards. And this is what happened when the retail investors received the margin calls, they started selling off which sent

by increasing number of participation from retail investors. There are more stock market members in China than the members of the

the market downwards. The IPO market looked too attractive as the shares often doubled in the opening day of trading. As a result, they were

IIM Shillong While the western world has been glued to the Greece crisis, there has been a bubble bursting in other part of the world. Some people have already started terming it as China 1929 crash.

The Chinese stock markets have lost almost 30% value in the one of the biggest fall that started in June which has wiped off trillions off valuations. And this happened after a five-fold surge in leveraged wagers had helped propel the Shanghai Index to a more than 150% gain in the 12 months through June 12. Half the companies listed on the two main indexes (Shanghai and Shenzhen) were priced ludicrously at 85-times earnings. After a 15% rebound, the shares slipped by 8% on 27th July, its biggest drop since 2007, indicating that the government’s efforts have been insufficient to calm down the jittery investors.

Free Markets At Play? Or Intervention?

The desperate steps that have been taken by the authorities will fuel fears in the mind

JULY 2015

of the investors and it is just postponing the inevitable. The steps taken to curb-off the selloff included banning major stockholders from selling stakes in listed companies. This move saw trading suspensions in almost half of the mainland stocks. The authorities have also blocked the upcoming stock market floats to limit the number of companies that an investor can invest in. The suspension of IPO is a big deal with more than four trillion yuan- worth of floatation estimated to be in the pipeline.

This move can help to support demand for the existing companies.

Policymakers have lowered the interest rates for the fourth time in seven months. The People’s Bank of China has cut the rate on a one-year loan by commercial banks by 0.25 percentage points to 4.85%. The interest rate paid on a oneyear deposit was lowered by 0.25 point to 2%.

Similar rate cuts were made on Nov 22, Mar 1 and then May 11. The central bank has also cut

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Cover Story

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often oversubscribed 60 to 80 times that tied up a lot of investable cash.

The Beijing government wants companies to raise capital through the stock markets instead of taking loans from the state banks. It lined up a string of IPO offerings and to create the

the stock markets. This left the Shanghai and Shenzhen indices soaring and subscriptions flowed into the IPOs. Also, the government is encouraging the boom in the markets by cutting down the interest rates and allowing the pension funds to invest in the

cash and demand made it easier to invest by enlarging access to margin trading. This went on well initially. As the two alternative investment products namely the property market and the shadow banking financial products became less attractive, investors could find respite in

shares. The bubble in the margin lending did ease a little during the recovery of 18% from its trough earlier this month. Official margin lending has dropped to 1.44 trillion yuan ($232 billion) from 2.27 trillion yuan. However, the steep fall of over 8% on July 27 indicates that much more needs to

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be done.

Parallel Drawn With Other Crisis Although it is too early to draw the parallels between the Chinese stock market crash with the Wall Street crash of 1929, it is interesting to observe the similarities between the two.

After more than a decade of frantic growth, extraordinary wealth creation and excess, both economies – America in 1929 and China today – are at roughly same stages of economic development. Moreover, both these booms are in part explained by the rapid credit growth.

Borrowed money, or margin investing played a role in both these outbreaks of speculative excess.

In 1929 crisis, it was only in the final year that the stock markets rose by 50%. The same is seen in China’s crisis in which barring the banking sector everything else has sky rocketed. As in the 1920s America, China’s stock market boom has ridden in tandem with an equally speculative real estate bubble.

Another crisis that comes to the mind is the Japan’s 1989 stock market crash which plunged the Japan’s economy into a two-decade slump.

The government that time had resorted to pumping money into the market in order to prevent the banks from failing. As a result the public debt skyrocketed jeopardizing the Japan’s economic growth. Washington Post has termed the Chinese bubble burst as ‘the greatest stock market bubble since the dotcom boom’.

What Does This Mean For The Chinese Economy ?

The stock market is at stake as the individual investors are nervous over the future and it will erode the consumer confidence amongst the weakest economic growth since 1990. If the markets continue to fall, it will impact the IPOs and other offerings and that is bound to impact the consumption of China’s middle class. The decline in consumption will jeopardise the real economy.

The stock market crash will also have an adverse impact on the China’s aggregate demand for goods and services which will further slowdown the already sluggish economy.

With the economy expanding at a slower pace of 7% as compared to the previous year, the companies are going to have a hard time seeing their top-line grow. Talking about the valuations, they are still high. Over the past four weeks, the analysts have reduced their earnings forecast at Shanghai-listed companies to 10% from 13% for the coming year. Over the long run, the asset prices would match their underlying value. And while that happens, it would be dangerous for the investors to stick around the Chinese stock market.

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FinGyaan

The Greek Debt Crisis: What the fuss is all about!

Rohin Jacob

SIMSREE, Mumbai Fig 1: Greek Creditors

Introduction Greece, a small nation in Southern Europe has lately been in the news for all the wrong reasons.

Greece, the birthplace of democracy and the Olympic Games, famous for its philosophers, leaders and scientists; known for its beautiful beaches, olive oil, honey, wine and a major attraction for tourists world over, has fallen upon bad times. Greece, one among the 28 nations in the European Union, and one among the 19 nations to have adopted the common currency of ‘Euro’, a circa US$ 250 billion economy, with a population of roughly 11 million has rattled global financial markets in the last 6 months.

To give some perspective about the size of the Greek economy, the city of Mumbai alone contributes roughly US$ 200 billion to India’s GDP and has a population of 17 million. So, let’s look at what has transpired till now and why

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such a small economy as Greece has ruffled feathers world over.

The current Greek Turmoil As on 1st July, 2015, the Greek Debt is close to US$ 375 billion. For a US$ 200 billion economy, that translates to roughly Debt-to-GDP of 190%.

For a population of 11 million the public debt is roughly US$ 34,000 per citizen. Its interest payments alone total around US$ 25 billion per year. And ironically, Greece still needs more money.

Fig. 1 shows a major portion of the Greek Debt is with the Troika. The Troika – IMF, EC and ECB are the Senior Debt holders of the Greek Debt as these institutions lent money to Greece as Financial aid at a time when no other institution/ investor was willing to lend to Greece in 2010 and subsequently in 2012.

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History of the Greek Debt Crisis Since a long time, the Greeks have been a notorious customer when it comes to money.

It has defaulted on its sovereign debt 4 times since 1800 (‘A Primer on Greek Crisis’ by Anil Kashyap, Booth School of Business). Rampant tax evasion partly due to ineffective tax collection infrastructure (Greeks owed US$ 86 billion in unpaid taxes to the Greek Government since 2009), a flourishing underground economy which never paid taxes on never-reportedrevenues, early retirement age (57 in 2009 in Greece, compared to 65 in Euro area), huge pension outlays (13.5% of GDP – among the highest in Europe in 2009), an over-staffed public sector, an increasing subsidy burden on the Greek Economy – were clear indicators that Greece was heading towards another default.

But the major reasons for the current Greek Debt crisis began in mid-1990s. Greece had been spending more than it was collecting in revenues and running huge deficits. In 2001, Greece entered the Euro, which gave access to even more credit, Euro being a stronger currency. So, Greece continued to borrow rampantly without observing the fiscal discipline required to maintain the sanctity of a strong currency like the Euro. The bubble burst in the fall of 2009.

In the aftermath of the global credit crisis of 2008, with global financial markets still reeling, the newly-elected Greek Government reported that it was constantly understating its deficit numbers for the past few years. The deficit for 2009 was going to be 13.6% of GDP which was 4 times the EU’s limit of 3%. Fitch, Moody’s and Standard & Poor’s immediately downgraded credit ratings of Greece. This scared off any potential investors and also raised the cost of borrowing funds for Greece to repay its sovereign

Fig.2: Greek Subsidies and other transfers (as a % of expense)

debt. It became imminent by 2010 that Greece would default. The Troika stepped in to bailout Greece with emergency funding in 2010 and in 2012 (hence are the senior creditors to Greek Debt) in exchange for austerity measures.

Austerity Measures The Troika provided US$ 264 billion in emergency funds to Greece but only if Greece were willing to reform. The retirement age had to be increased from 57 years to 65 years, tax collection had to be improved, pensions had to be reduced, subsidies and salaries had to be cut, government jobs had to be reduced and public assets had to be sold off. Basically, the Troika wanted to provide liquidity required to reform Greece so that Greece would become self-sufficient and grow from within and pay off its debts in the long run. Imposing austerity measures for reforms had worked well in the past for Germany, Poland, Czech Republic, Portugal, Ireland and Spain; the Troika felt the same could be emulated by Greece. Initially, Greece did respond positively to the bailout package.

But Greece being a culturally different economy (read lavish and extravagant) than the reformed nations mentioned above, the stinging austerity measures did not go down well with the Greeks and it backfired. Greek economy contracted and businesses suffered and closed down, people lost jobs (25% of Greeks are unemployed, tax collections nose-dived. Angry pensioners who had served for over 30 years were unhappy; this led to riots and fights. Instead of improving the situation, austerity had worsened the situation – now there was debt and public discontent.

In January, 2015, a radical party – Syriza led by Alexis Tsipras came to power under the mandate that he would re-negotiate terms with Greece’s creditors and will put an end to the austerity

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Fig. 3: Greece GDP and Unemployment rates in Europe

measures imposed upon the Greeks. No wonder, the Tsipras-led Syriza came to power.

Implications of Greek Default The referendum on 5th of July where the Greeks voted a resounding ‘No’ to any new bailout package from its creditors and an end to austerity measures implies that Greece is heading towards a default (as Greece used new loans to pay back the old ones). And if Greece defaults, Greece will be forced to leave the Euro, a phenomenon popularly termed ‘Grexit’.

A Grexit would cause lot of unpleasantness for Greeks and other Foreign Institutions alike at least in the short term.

For the Greeks – they will have to revive the old currency Greek Drachma. The Drachma would be a highly devalued currency and in a state of free-fall. A sovereign default would mean it would be an untouchable for global financial markets for some time. It would be able to meet its domestic requirements using the newly printed currency but servicing international debt using a devalued currency would mean continuous printing of the Drachma, which would lead to hyper-inflation (remember Zimbabwe). Besides, Greece is an importer of goods like oil & gas which have to be paid in dollars. A highly devalued Drachma would make imports prohibitively expensive. This may bring a recession in an already depressed economy.

Greeks will have to push exports in order to sustain the domestic economy. The tourism industry has the potential to attract lot of forex from international tourists who would now see Greece as an inexpensive tourist destination.

If not the Greek Drachma, there is the ancient Barter system to fall back on.

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Outside Greece – The Greek Debt crisis has been a phenomenon in the making for the past 5 years now. And somehow everyone knew at the back of their minds that Greece would eventually default. Creditors have sold off their bonds, trimmed exposure, created provisions for bad debts or diversified to other assets or in some cases simply written-off those loans in order to buffer themselves from the Greek Default. However, what follows after the Greek Default is what causes heartburn. The Euro – which is a monetary union, intertwined all European Economies with each other due to seamless trade i.e. each European nation has directly or indirectly lent money to Greece and if Greece defaults, other nations may not receive their loan payments and hence default as well.

Weaker economies like Portugal, Ireland, Italy, Spain (the original PIIGS nations excluding Greece) which have just recovered from their own debt crisis may fall back into debt. And these economies are much bigger than Greece and the financial institutions won’t be able to buffer against these defaults. And if the PIIGS nations default, other European countries would default because they won’t be able to pay off its debt and this domino-effect would trigger a global financial crisis much bigger than that witnessed in 2008 as in this case countries would be defaulting, not companies.

Political Implications of Grexit The Greek default would free the Greeks from the harsh austerity measures – a tempting proposition for many countries including the PIIGS nations who have recovered because of austerity. Syriza-like-minded left-wing political parties like Podemos in Spain have promised an

Fig. 4: Map of Black Sea

end to austerity measures by re-negotiation of terms of debt. If more than handful economies adopt the radical left political parties then Europe would be divided between democratic nations and Leftist nations. Extreme ideology differences can disrupt peace and trade talks in Europe and hence stymie growth.

Many Army chiefs across the globe feel that the geopolitical risks far outweigh the economic ones. For starters, Greece is located centrally between Europe, North Africa and Middle-East.

Greece controls the Aegean which controls the transit between the Black Sea and the Mediterranean (See Fig. 5). Greece is a NATO power and is central to imposing trade sanctions on Russia and US interventions in the Ukraine crisis. What’s worrying is that if Greece does not receive funds from Europe or USA, it would approach China and Russia who would be more than glad to park some military arsenal in this strategic location.

What can be done: Euro an incongruent Union The Euro was put in place to bring the European economies closer, encourage trade within borders cutting barriers and essentially to bring peace to the continent (European nations have been fighting wars with each other since ancient times until the World War-II). However, a unified monetary policy but a different fiscal policy for each country was a fundamentally flawed approach to unifying the continent. As an analogy, consider the Indian Sub-continent – How would it be if India, Pakistan, Sri Lanka,

Nepal, Bhutan, Myanmar, Maldives shared a common currency (say ₹) and each of these countries were able to lend at rates which India can lend with the same credit rating. Other nations being smaller and weaker than India have a higher cost of borrowed funds. Also, having different fiscal policies (expansionary or thrifty) for different economies may make too much public debt unsustainable if the money flow is not controlled well in that economy.

This is what happened in Greece as it had access to huge credit through the Euro; and the Greek Government had a largely expansionary fiscal policy increasing public debt without proportionate increase in public assets till the time the debt became unsustainable. Being in a common currency of Euro, the inability of Greece to devalue its currency during this crisis only made matters worse. The only long term solution to prevent another such a crisis from recurring is to either break up the Euro or to have a single fiscal authority in Europe which would essentially unify all European countries into a United States of Europe i.e. either have both – a single fiscal and monetary authority or neither.

Conclusion Pushing Greece out of the Euro will force them to seek solace in China and Russia which is unacceptable to the West, whereas keeping Greece in the Euro will destroy the Euro from within. It is a fine line and hard decisions have to be made. But Grenter or Grexit; repercussions would be felt across the world.

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Article of the Month FinLife Cover Story

Palash Jain

IIM Shillong

Introduction The Indian financial markets are witnessing a boom run in the recent period. A lot of money is being invested and investor’s confidence is growing exponentially. Also a lot of money from outside the country is flowing in, through FIIs. These are the few reasons for the indexes like SENSEX and NIFTY touching and surpassing their all-time highs. The derivative market also had a contribution in this bull run.

Derivative Instruments Derivative instruments are financial products that derive their value from an underlying financial instrument like stocks, bonds, commodities etc.

These derivative instruments can be traded in the stock markets through exchanges like BSE and NSE or traded directly between two parties like Over the Counter (OTC) derivatives. Since they are derived from an underlying asset, their value fluctuates with the value of the underlying asset. The main purpose of derivative products is to transfer the price risk from one person to

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another. Thus it helps in transferring the risk from a party who wants to mitigate it to a party who is willing to take that risk.

The derivatives market in India has been working since the nineteenth century. However, derivative products as an exchange traded financial instrument was introduced in June, 2000. The derivatives market is well regulated

by Securities and Exchange Board of India (SEBI) and NSE is the largest exchange for derivative products in India.

Participants In The Derivative Markets In India, there are many entities participating in the financial markets like retail investors, institutional investors like mutual funds, banks and foreign investors in the form of FIIs. These use derivative products for different purposes like mitigating or increasing risk, speculation etc. So based on these applications that derivatives are put to use, these investors can be put together in the following categories:

• Forwards • Futures • Options • Swaps Forwards A forward contract is a simple contract between two parties to buy or sell a certain underlying asset on a fixed date in the future at a fixed price. In a forward contract, the two parties are directly involved and there is no exchange in between. Thus a forward contract is an over the counter (OTC) product. Since it is an OTC product, the contract can be directly negotiated between the two parties.

In a forward contract, the buyer of the contract agrees to buy a certain underlying asset from the seller at a predetermined price on a predetermined date in the future. Thus the contract is about making the transaction in future at a price determined today which is unlike spot market where the transactions occur on the spot. The party who agrees to buy the asset is said to have a long position in the contract and the party who agrees to sell the asset is said to have a short position in the contract.

The price agreed by both parties at which the transaction will occur is called the forward price and the date at which the transaction will occur is called expiry date. Since these contracts are not traded on a public platform, they are not regulated by government agencies because of which they carry some amount of counterparty risk. Counterparty risk is the risk of the other party not fulfilling its obligations on the expiry or the termination of the contract. Since it is a private contract, it is difficult to estimate the size of the forward contract market.

Table 1: Comparison - Futures and Forwards

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Article of the Month FinLife Cover Story

Derivatives Market

• Hedgers • Speculators • Arbitrageurs Hedgers are entities that look to mitigate their risk. They are usually the people who have a position in the spot market but are afraid that they may incur losses. So they participate in derivatives market to minimize or eliminate their risk. Thus, they tend to lock their prices to transact in the future to avoid losses in the spot market transactions. Hedgers generally take positions in derivatives market which are opposite to their positions in the spot markets.

A speculator is a person who has an opinion about the potential movement of an underlying asset or index. This movement may be upside or downside. Thus a speculator bets on this opinion in derivatives market. They take a large risk by taking positions based on their opinion on anticipated price movement of the asset in the future. Since it is just an opinion on which they base their decision and the risk involved is large, their profits or losses also tend to be large. They generally trade for short term.

Arbitrageurs are people who tend to make profit from pricing inefficiencies of an underlying asset. There may be a situation where an asset is priced differently on different platforms. So arbitrageurs take two opposite positions in these platforms and earn the price difference which exists. Since there is no risk involved in this form of trading, it is also called riskless profit.

Types Of Derivative Products There are many types of derivative products that are traded all over the world. In its most basic form, these types are:

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Futures A futures contract is similar to a forward contract, that is, it is a contract between two parties to buy or sell a certain underlying asset on a specified date in the future at a specified price.

However, there are some differences between a forward contract and a futures contract. The main difference between them is that forward contract is an OTC product whereas a futures contract is traded on an exchange. Therefore, a futures contract is a standardized contract which is backed by an exchange. Since it is traded on an exchange, there is practically no counterparty risk as even if the counterparty defaults from his obligation, the exchange steps in to prevent the loss.

It is very easy to enter into a futures contract.

The interested party has to just deposit what is called initial margin to enter into a futures contract. Initial margin is a fixed percentage of the contract value which everyone has to pay no matter if he/she is the buyer or the seller and this percentage is determined by the exchange based on the risk and volatility. After they have entered into a futures contract, they have to maintain a margin called maintenance margin or variation margin. Maintenance margin is the minimum amount to be maintained with the exchange in spite of the price fluctuations. If the price falls and the margin balance go below the required level, then the exchange asks to put in more money to make it at the required level.

This is called a margin call. This enables the exchange to keep the mark to market feature in the futures contract. Mark to market feature is an arrangement where the profits and the losses on the positions are settled each day to reduce default risk. The current volume of futures market is around 13 lakh contracts comprising of stock & index futures.

Options Options, like futures, are instruments that give an opportunity to buy or sell an underlying asset. An options contract gives the buyer an option to buy or sell an underlying asset at a predetermined price either at expiry or in some cases before it. Options can be an OTC product as well as an exchange traded product. There are two types of options: 1) American Option: These can be exercised on any day on or before the expiry day.

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2) European Option: These can be exercised only on the expiry date.

Call Option A call option gives the right to the buyer of the option to buy the underlying asset at a specified price. The price at which the buyer gets the right to buy is called the strike price. Since the buyer of the option has the right, he will exercise his right only if the price of the asset in the spot market is more than the strike price and he is not obliged to exercise his right. However, if the buyer decided to exercise his right, the seller has the obligation to make the transaction.

When the spot price is greater than the strike price, the option is in the money. When the spot price is less than the strike price, the option is out of money and when the spot price is equal to the strike price, the option is called at the money.

Put Option A put option gives the right to the buyer of the option to sell the underlying asset at a predetermined price. The price at which the buyer gets the right to sell is called the strike price. Since the buyer has the right to sell, he will exercise his right only if the price of the asset in the spot market is less than the strike price. If he decides to exercise his right, the seller will have to buy the asset at the price.

When the spot price is less than the strike price the option is in the money and when the spot price is equal to the strike price, the option is called at the money. When the spot price is greater than the strike price, the option is said to be out of the money.

There are many option strategies one can use.

Some of them are: 1) Covered Call: In this strategy, you buy in the spot market and sell a call option 2) Protective Put: In this strategy, you buy in the spot market and buy a put option 3) Straddle: In this strategy you buy a call and a put option at the same strike price of the same expiry date 4) Bull Spread: In this strategy you buy an in the money option and sell an out of the money option 5) Bear Spread: In this strategy you buy an out of the money option and sell an in the money

option 6) Collar: In this strategy you buy the asset in the spot market, buy a put option and sell a call option 7) Butterfly: In this strategy you buy one in the money option, one out of the money option and sell two at the money options Entering into an options contract is also very easy. A person can buy the contract by paying upfront an amount to enter. This amount is called the option premium. If the person decided to sell a contract, he will receive the premium. This type of derivative instrument is also very risky as positions can be magnified with the same amount as compared to spot market which can lead to larger gains or losses.

Swaps A swap is an exchange of cash flows between two people. In a swap, one party makes payment to the second party and the second party makes payment to the first party on a specified date.

The cash flows are calculated using a specified formula. Swaps are not listed and are generally traded through dealers. They are also not regulated. There are various types of swaps: • Interest Rate Swap • Currency Swap • Equity Swap • Credit Default Swap Interest Rate Swap is the most commonly used swap in which one party pays on the basis of a fixed rate and the other party pays on the basis of a floating rate like LIBOR, EURIBOR etc. This is used when one wants to convert their fixed rate cash flows to a floating rate cash flow or vice versa. The notional principal may or may not be exchanged at the beginning.

Currency Swap is a swap in which one party promises to make payment in one currency and the other party promises to make payment in another currency. Currency Swaps are often combined with interest rate swaps. Here the notional principal is generally exchanged as there are different currency involved. This swap also has an exchange rate risk, that is, risk arising out of fluctuating exchange rates.

Equity Swap is a swap in which one party promises to pay either on a fixed rate or floating rate basis while the other party pays on the

basis of returns of an equity market index or any other index or stock.

Credit Default Swap is like an insurance policy in which the buyer of the swap pays a premium and the seller of the swap agrees to compensate the buyer for the losses in case a credit event like bankruptcy or downgrading occurs. The condition is that the loss must occur due to a credit event only.

There are also hybrid derivative products where two or more derivative products are put together to make a single product. An example of this is swaptions, which is a combination of swap and options. In this the buyer has the right to enter into a swap at a future date.

Conclusion Derivatives market is a very lucrative and a fast growing market. Today many people like to use derivative instruments in various strategies to increase their profits. But it also magnifies the risk and if this risk is ignored, it can lead to a financial crisis like we saw in the case of subprime crisis where people underestimated the risk of derivative products like Collateralised Debt Obligation (CDOs) which lead to big corporations like Lehman Brothers filing for bankruptcy and other corporations like AIG and Merrill Lynch obtaining government bail-outs.

Thus people should invest in derivative markets only after properly analysing and assessing its risk as they may give you large profits but they also have the capability to wipe out your entire investment.

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Article of the Month Finsight Cover Story

Sumukh Bhardwaj & Vinit Intoliya

TAPMI, Manipal

Implementation Of GST – Impact Indian Economy Chanakya, the architect of taxation under the great Mauryan Empire once said – Tax must be collected from people like a honeybee collects nectar from flowers. This way, both the honeybee (government) and flowers (people) will be happy and prosperous.

Taxation – The Double Edged Sword Taxation is the most effective and time tested method for the government to collect money for administrative purposes. But, the overarching rules and expanding tentacles of the government bureaucracy can create antibusiness environment, thus leading to tax terrorism.

How To Make The Elephant Dance…?

Whether it is Bharatanatyam, Salsa, belly dancing or jazz dancing - the most important aspect is a structured approach. The elephant dance between tax payer and the tax receiver is no different. The absence of a symphonic and symbiotic relationship between dancing partners can be disastrous. The current Indian tax structure depends on both direct and indirect

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tax collections. The direct tax is collected at source of income generation. The Direct tax base is a meager 3% - 4% of the Indian population.

The indirect taxes are too many and prone to leakages. Tightening regulation has only led to harassment of citizens and increased corruption.

The draconian tax regimes of the past have scared away private investment and antagonized the masses. The best way to remedy the situation is to find a new transparent and equitable tax system. The new Goods and Services Taxes Bill, popularly termed as GST, will hopefully be the beginning of the end to the above mentioned problems.

Current Tax Structure Currently, the Indian central government levies indirect taxes through three different medium i.e. Central Excise duty which was established under Central Excise Act and The Central Excise Tariff Act, 1985 it covers taxes on the goods which are manufactured in India and for domestic consumption. Secondly, custom duty which is defined under Customs Act, 1962. It charges on import and export of goods. It charges from 0% to 150% depending

on the goods which is importing or exporting.

And lastly, service tax which is implemented on provision of services, it is currently charged 14%. On similar grounds the State government collects revenue different tax medium like VAT/Sales tax. Entertainment tax, State Excise on Liquor and tobacco products, Stamp duty collection and other taxes which differ from state to state like Octroi, LBT, etc. The main source of revenue collection is through Value Added Tax (VAT). This is levied on sales of goods. If the sales of good is happened intra-state then it is covered under VAT law of that state and if it is inter-state transaction then it is charged under Central Sales Tax Act (CST). From table 1, it is clear that Excise duty contribution is highest to revenue collected by central government.

Budget Estimates of Indirect Taxes (in Rs Crore) YEAR CUSTOMS EXCISE SERVICE 2001 54822 81720 3600 2002 45193 91433 6026 2003 49350 96791 8000 2004 54250 109199 14150 2005 53182 121533 17500 2006 77066 119000 34500 2007 98770 130220 50200 2008 118930 137874 64460 2009 98000 106477 65000 2010 115000 130471 68000 2011 151700 164116 82000 2012 186694 194350 124000 2013 187308 195937 180141 Table 1: Budget Estimates of Indirect Taxes (in Rs Crore)

Problems In Current Tax Structure In India, more and more taxes are levied on products which is consumed by human beings rather than on wealth of individuals. The tax is imposed from ground level of production of goods i.e. from raw material to semi-finished goods and finally to finished goods used by consumer. Due to this complex tax structure it severely impacts the whole supply chain network starting from raw material supplier and ends with consumer. There are various problems associated with the current indirect tax structure.

- Ripple Effect Of Tax It is one of the major concerns for Indian government and tax authorities to curb the

cascade effect of taxes going on with the current system. The most impacted sector because of multiplicity of taxes is manufacturing. India is a country where cost of labor and production is low compare to other countries in the world but due to multi-stage taxation final price of goods becomes very high which takes away the competitive advantage. There are several incidence in our day-to-day life where there are cascading impact of taxation on finished goods.

1) Custom duty and CVD and Cess: The person from India went for shopping to Saudi Arabia for Dubai Shopping Festival. He bought a 3 different models of televisions from Dubai because it cost him very less price compare to India. But while getting clearance form Indian Airport, he not only need to pay custom duty but also Counter Veiling Duty (CVD) and certain percentage of cess on imported goods. In this case there are 2 different taxes has been applied on the same product along with custom duty.

2) Excise duty and VAT or Custom duty: Suppose goods like bike tyres which has been manufactured in Chennai so manufacturer need to pay excise duty on production and then if these tyres ordered has been placed from Bangalore retailor so it need to pay sales tax for transfer of goods between two states. Many times we also need to pay Octroi which differs from state to state.

3) Service tax and VAT: Many times after having dinner at some AC restaurant, when we receive the bill and we are quite shock that around 30% of the bill is charged with taxes only and we find that restaurant has charged separately for service which they have provided and ahead of that there is VAT applied on the consolidated amount. This is simply scenario of tax on tax.

These multiple taxes need to be bear finally by customer who is availing services.

- Disparity Of Tax Rates In India, along with having multi-layer tax problem, there is more complex problem which is state-wise tax rates that plays very crucial role for manufacturer because to gain maximum tax benefits while setting up manufacturing plant or inventory warehouse. Currently, in many particular states there are many warehouses and plants compare to other states. CST plays very important role while transferring goods from one states to another. So states which have less CST rates on goods preferred over other as less amount will be spend.

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Finsight Classroom Cover Story

Implementation of GST Impact on Indian Economy

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increase production at lower cost and finally consumer which will not be heavily tax burden.

- Availability Of Extra Cash The whole tax collection for all CGST and SGST will be done at point of sale (POS). Once tax is collected government will collect taxes from retailers and distributors on quarterly basis. So the money which is collected for tax purposes can be used for flow of day-to-day activities and carry out operations efficiently.

- Incentivize Each Sectors Once the implementation of GST done, all the sectors like manufacturing, retail, IT, Infrastructure, Banking, Hospitality, e-commerce etc. will have greater advantage. The most benefits will be gained by manufacturing sector as it is highest taxed sectors. So charging only one tax instead of having several other taxation like custom, excise, sales etc. will motivate all the manufacturers in the country. The whole tax credit for inter-state transaction will help to decrease the procurement cost. Also it will allow manufacturer to open inventory warehouse or manufacturing plant in any parts of India as there is no state specific rate. And very important is removal of Octroi or entry tax levied by different states which was big burden for companies as they lost majority of time during transportation by doing negotiation at Toll post. The entertainment industry will be more benefited as there is removal of entertainment tax, service tax and VAT so whenever went to watch any movies or any restaurants it will be free from different taxes.

- Increasing Exports And Imports There is no GST on export. So it will motivate all the manufacturer to produce at lower cost and export it. Also with the removal of counter veiling duty (CVD) which is levied along with custom duty so it will encourage manufacturer as goods will be available at comparatively lower cost.

- Common Benefits To Common Men As there is removal of all excise duty, VAT, CST and service tax, hence there will be no cascade of taxation and finally the tax paid by consumers on the end goods will lower. We take small example suppose tyre manufacture in Chennai and from that it went to retailer who is also from same state and retailor finally sold to

2008 Direct Indirect

3338.5 2696.4

Direct Indirect

441.32 2786.7

2009

2010 Central Government 3774.87 4459.94 2438.31 3431.78 State Government 473.87 627.25 3158.63 3981.70

2011

2012

2013

4939.4 3912.3

5658.35 4678.27

6681.09 5629.61

846.92 4802.7

931.48 5729.18

1055.57 6553.57

Table 3: Contribution of taxes to revenues of Central and State Government

end customer. From the given example it is very much clear that once GST is implemented it is helpful to both retailor and consumer and it is because there is removal of excise duty at the first step itself which lowers the cost.

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- Complexity In the past few years there is continuous effort taken by tax officials to simplify the existing tax structure both at state and central level.

As foreign investments are increasing and more business opportunities are opening, the tax system is getting more fractured out. The latest tussle between the American behemoth, Amazon India falls into a regulatory soup with Karnataka tax authorities which believe that Amazon “Fulfillment model” is flouting taxation norm. Hence Karnataka tax officials cancel several merchant’s license and revoke certain electronic goods to be sold by the company.

Another stand-off was held between Kerala State authorities and several e-tailers companies.

Kerala tax officials believe that firms are selling products to localities and so company need to pay regional taxes. In all the above scenarios the issue is not related to tax evasion but to get more clarity of the law – on who is liable to pay for the tax whether the companies or seller.

One Nation, One Policy The proposed model of GST consists of dual structure. It is basically made up of two components i.e.

Central GST (CGST) and State GST (SGST). The proposed structure will be replace existing excise duty, custom duty, service tax and all types of cesses at central level and at state level the different taxes which has merged with SGST are VAT, CST, purchase tax, Octroi, entertainment tax, luxury tax and taxes related to lottery and gambling. There is third components associated with this structure which deals all the transaction between interstates which is called as Inter-state GST (IGST).

The entire supply chain network which occurs from manufacturer to consumer at both Centre and state level and for all taxpayers will have concurrent jurisdiction.

Benefits Of GST Currently, in India there are self-contradicting laws which is required to be change to create more business friendly and investment opportunities. GST will help to bring different taxation under single umbrella and provide streamline and simplify tax regimes in India.

Once GST implemented, the whole economy will be boosted by 1-2%, the corporates will get more tax clarity, the manufacturers will able to

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Without GST (Rs) Manufacturer to Retailor Production cost 10000 Profit Margin 1000 Selling Price 11000 Excise Duty @ 10% 1100 Total Price 12100 VAT @ 12.5% 1512.5 CGST @ 10% SGST @ 10% Invoice generated to 13612.5 Retailor Retailor to Consumer Total Price @ COGS 12100 Profit Margin 1000 Total Price 13100 VAT @ 12.5% 1637.5 CGST @ 10% SGST @ 10% Invoice generated to 14737.5 Consumer

With GST (Rs) 10000 1000 11000

1100 1100 13200

11000 1000 12000 1200 1200 14400

Table 2: Difference in taxes

Challenges To GST Around 140 countries around the world has implemented the GST. At centre level, indirect taxes contributes to around 25% of its revenue and similarly at state level it contributes around 80%. The majority of state’s revenue is coming from indirect taxes. The majority of collection for all states is coming from sales tax and entry tax while having inter-state transaction. So states are generally reluctant to implement GST. The

two biggest challenges in front of both centre and state government which can be biggest failure if not planned properly are as follows: - IT Infrastructure The whole tax collection will be done at point of sale terminal of retailor of wholesaler. Hence this money they will be online transferred from State facilities to centre facilities. According to current structure the centre will be collecting Interstate GST (IGST) and will be crediting to state.

So there is huge requirement of compatibility of both centre and state facilities and hence huge IT framework will be required.

- Revenue Neutral Rate From table 3, we have seen that at both centre and state revenues, collection of indirect tax forms major role. The state is heavily dependent on indirect tax. So GST rate should be such that the revenue generated should be same as it is with current tax structure and if GST rate is higher, than it will put extra burden on consumer and if it is lower, than it will put extra efforts on government shoulders to source funds to fulfil their expenditures and ultimately impact economic development.

Road Ahead Tax clarity is very important and proper formulation of policies helps the country to grow at faster pace. The implementation of GST is in progress stage and the current government is fully supporting ‘One Nation, One Tax’ policy system. Currently, petroleum products, stamp duties on immovable properties, alcoholic and tobacco products does not come under ambit of GST framework. Once the government is able to generate desired revenue by charging right revenue neutral rate (RNR) and able to achieve desired revenue so in the long run government can plan for incorporating above mentioned products. GST framework will incentivize all domestic and foreign investors and helped to receive economic benefits which were untouched by VAT.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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Article of the Month Finsight Cover Story

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Off Late There Has Been Discussions About Having A Presence Of Strong Bond Market In India , That Would Help To Diversify The Risks That Are Related Project Finance In India , We Would Like To Know Your Opinion On This And The Way Forward For India?

• The statement is quite encouraging but seems to be far from reality. However reality might be that country has relatively underdeveloped bond market majorly dominated by Government bonds. A vibrant bond market would definitely support / augment the credit needs of the corporate sector especially for long term asset creation.

• Despite better returns, nearly nil history of defaults, subdued volatility (especially to policy changes), corporate bonds continue to register very low turnover ratios and mostly restricted to private placement (more than 97-98%).

• It is expected that an active & efficient bond market could possibly augment / bridge the perceived gap in the projected fund requirement for the asset creation in the country especially in the infrastructure segment.

• Given the current scenario, market is badly in need of some “Market Makers” who could improve / ensure liquidity. Going forward market also expects to gain momentum with some of the enablers like broader credit enhancement policy, encouragement for public placement & retail investors, transparent secondary market, better turnaround mechanism in placement, reliable robust benchmark for the yields etc.

Banks In India, Especially Those In The Public Sector, Are Stressed, Argues The Reserve Bank Of India In Its Recently Released Financial Stability Report.

The Ratio Of Stressed Assets To Gross Advances Has Risen From Around 6 Per

Cent At The End Of March 2011 To 11.1 Per Cent By March 2015. How Are The Banks Managing The Increasing Bad Debts, Corporate Debt Restructuring And Stressed Assets?

• Stressed assets in the banking system especially with the public sector banks is really a matter of great concern. The bad loans not only affect performance of the banks, hampers its liquidity, which could turn as strong constraint for the economy. This need to be seen as a systemic issue and an early resolution could only could restore health of the financial sector, bring an environment for long term growth of the economy.

• The current situation pauses lot of challenges not only banking system but also to policy makers and regulators. Country has seen certain macro-economic policy initiatives in the recent past which could lay foundation for successful restructuring of viable accounts. With the revised regulatory guidelines lenders are in a better position to fight menace of bad loans. To tie over the current situation, banks are mainly looking at restructuring the viable corporate debts and enforce security / liquidate unviable ones.

• There have been welcoming breathers from RBI for Infrastructure & Core industries in form flexible structuring (5/25) for new and existing projects (post DCCO) has helped the lenders to manage a bit in limited operational projects.

However, major stressed assets / bad debt is in projects which are stuck before DCCO. For such projects, a strong mechanism giving some real relaxations from RBI, permissible sacrifices in terms of NPV from banks which may be or have to be compensated by the promoters in later part of higher yielding curve of the projects is needed.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

FinGyaan

Interview With Mr. K. Biju George General Manager, IDBI Bank

We Have Seen Lot Of Bad Debt In The Road, Power & Steel Sector Over The Last Few Years. Currently We See A Lot Potential And Focus In The Renewable Energy Space (Especially Wind And Solar). What Would Be Approach Of The Bank Towards This Sector For Risk Mitigation And Project Selection?

• Very relevant question reckoning current level of renewed interest in the renewable energy projects. The sector has seen tremendous growth in the last 3-4 years with solar energy generation showing nearly 100 times growth in the past 4 years. Like in other sectors, banks continued to be major source for the long term financing to renewable energy projects as well.

• During the RE-Invest 2015, first Renewable Energy Global Investors Meet & Expo organised by the MNRE, country has seen green energy generation / financing commitment by public / private entities to the extent of more than 275 GW, manufacturing commitment of ¬ 60 GW and financing commitment (largely from public sector banks) to the extent of ¬70 GW amounting to over ₹ 3 trillion in the coming years.

• Sector pauses a lot of challenges to the lenders especially given the fact that it is yet to mature and lenders approach is generally a mix of project & corporate finance wherein lenders expects comfort / commitment from promoters apart from the cash flows.

• The financing challenges could include , relatively nascent stage of the sector with high amount of uncertainty in project parameters, regulatory & policy constraints and its changes ,lack of experience /knowledge by the lenders while apprising, lenders tend to go by the normal bench mark project parameters(DER, DSCR, Tenure , IRR etc), high level of counter party risk due to DICOM’S deteriorating financial health.

• With the experience learned from the past , Lenders tend to choose the projects reckoning the exposure constraints to the sector(reckoned under power), robust PPA’s with payment security mechanisms (supported by revolving LC /BG), better tariff structure & tenure(fixed, escalable with long tenure), volatile project costs(varying AC:DC ratios & falling capital cost), technology, reputed equipment suppliers, realistic projections at dependable CUF levels(limited supply of Class I sights for wind), comfortable service coverage ratios( go with

JULY 2015

lower leverages), sponsor support and counter party guarantees for the performance etc. are some of the mitigants applied for the sector.

Though the market seems to be flooded with large renewable energy proposals, especially in solar power generation, lenders seems to be taking a very cautious approach.

Basel III Increases The Risk Assigned To Funding Of The Long Term Projects By Banks, Thereby Increasing The Provisions Required To Be Set Aside, How Should Banks React To This Important Change That Is Going To Happen Soon?

• When compared earlier guidelines, Basel III focuses mainly on consistency, quality and transparency of capital. Guidelines puts lot of pressure on the requirement of the Tier I capital for the banks.

• Under the Basel III guidelines profitability of the banks could be impacted on account of combination of increased capital requirements, capital buffers and minimum liquidity requirements. Apart from this, increased stress in the portfolio, bad loans could further hurt profitability and in turn could increase their capital needs. This would result in pressure on lowering cost on resources and increase rate of interest on assets to maintain the profitability.

• Though the implementation of Basel III could improve the loss absorbing capacity of the banks due higher risk coverage, presence of capital buffers, constraints in building up assets, it is felt that banks could take a cautious approach in extending loan term loans.

• The recommendation for reducing the leverage could lead to reduced lending and choosy assets, especially in long term. Further in the light of regulatory guidance for reduced leverage exposures in relation to Tier I capital and further reduce the levels to much lower than existing, the banks may impose stricter credit exposure norms and there could be a measured approach to long term loans.

• Banks have been given further one more year by the regulator for implementation of the guidelines reckoning industry-wide concerns on stresses, asset quality and consequential impact on the performance/profitability.

How Do You Expect The Indian Economy Will Perform Over The Next Year (With Global Economies Like China, Greece In

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Turmoil And US Central Bank Expected To Hike Interest Rate)?

• Though every other National, International agencies suggest the Indian economy could grow in excess of 7.5%, the same could be read in conjunction with current developments in China & Greece. Reports suggest that developments in China could be matter of larger concern for India rather than Greece.

• I personally feel that bottlenecks in infrastructure & policies, external challenges could impact growth targets. As far as credit off take is concerned banks are yet to see any major traction especially in Infrastructure and manufacturing sectors.

For Student Readers We Would Like You To Elaborate On The Different Bundle Of Banking Products That Are Currently Provided By The Banks To Fund A Project And The Allocation Of The Same?

• The loan products for projects are tailor made to suit requirement of each project. At IDBI, over the years, the art and science of project funding has evolved and matured in response to the industry experience. The bank’s products for project funding majorly include long term loans for capital expenditure. The loans/ facilities for the projects are generally structured in line with the nature of the industry, economic life of the project, revenue cycles etc.

• Bank also recommends judicious use of nonfund based products for project funding mainly to take advantage of deferred payments from supplier as well as to arbitrage on the lower foreign currency funding in case of imports of capital goods. Depending upon the various requirements of the project performance and project construction/completion/ performance guarantees are provided. The bank also could extend bridge facilities (both Fund & Non Fund based) pending Financial Closure of the project facilities on a selective basis.

• The bank also offers structured products for efficient project financing solutions, pre bid advisory , arrange for assistance from ECA’s, ECB’s, carry out merchant appraisals & project evaluations on standalone basis , develop tailor made products for specific project financing requirements etc.

• IDBI has a very active, dedicated Project Appraisal, Syndication & Structuring desk which

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offers end to end solutions for project financing needs mainly in Core & Infrastructure segments.

Currently IDBI is ranked 2nd in the Bloomberg League table as “Indian Borrower Loans Book Runner” and “Indian Borrower Loans Mandated Lead Arranger” for the H1 of CY15.

What Would Be Your Advice To The Management Students Who Would Like To Make A Career In Debt Syndication And Project Financing?

• Banking is generally perceived as boring and mundane in many ways due to lack creative freedom one could experience in in the desk.

I strongly believe that project financing could be seen as an aberration to that notion and it’s really exciting & fulfilling. Every project financing transaction could throw up many challenges mainly as these are generally “ring fenced” stand alone projects with finite life, depending on purely cashflows and not value of the assets. Most of the project financing structures are without recourse/ partial recourse which needs thorough understanding on the project parameters to establish the cash flows.

It is typically an investment decision which requires deep due diligence of various aspects of the project, viz., industry, technical, market, financial, legal and commercial. In a way a project finance professional need to convince oneself about the viability of the project and then structure the lending structure with necessary covenants reckoning various project participants.

• Syndication should not be misunderstood as selling as it requires deeper understanding of the project and the structures. It calls for stronger relationship with market and sustained efforts for convincing potential participants. The debt market is very competitive and differentiator could be only the quality service. Success of any project finance deal could depend on the structure & deliverability and a successful project finance professional could be somebody who understand the above facts better.

• Overall the career in project finance and debt syndication is enriching, provides innumerable opportunities for learning provided one should be open to fresh ideas ,update regularly & with right attitude and could make boring banking sound like an oxymoron.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

CLASSROOM FinFunda of the Month

SMART BETA BHAWANA SARAF IIM Shillong

Sir, I am planning to invest my savings.

I have come across a term ‘Smart Beta’, could you please explain me the meaning?

Smart Beta refers to an investment style where the manager passively follows an index designed to take advantage of perceived systematic biases or inefficiencies in the market. Smart Beta can also be understood as the returns that can be generated from illiquid or private markets such as real estate and infrastructure which offer attractive risk-return trade-offs and which can provide important diversification benefits when added to a conventional portfolio of equities and bonds.

Sir, there are other investment strategies but why is Smart Beta gaining popularity?

The increased popularity of Smart Beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk-adjusted returns above capweighted indices. One of the key attractions of Smart Beta is that it is less expensive for investors to evaluate the worth of these strategies than to analyse and monitor the performance of active managers.

Sir, what exactly is the approach followed by the Smart Beta investors?

Smart Beta proponents recognize & challenge existing benchmark construction, arguing it has inherent flaws because it’s based on price or capitalization. In other words, the non-smart-beta approach over weights larger components in an index, which then has a disproportionate effect on index returns. Smart Beta proponents say their approach by equally weighting securities, selecting the most undervalued component as measured by P/E, or by some other empirical method—arguably can provide better returns or lower risk and therefore has a value beyond traditional indexing.

Sir, Is Smart Beta related to the beta, which defines the systematic risk, in any way?

In capital asset pricing model, Beta is the sensitivity of an asset to the movement in the market where the beta of the market is one. However, any passive investment strategy that weights individual securities, as defined by its objective or algorithm, different than the traditional market capitalization weighting approach can be understood as a “Smart Beta” strategy. Hence, they are not related to each other in any way.

Sir, currently how do investors perceive ‘Smart Beta’ as an investment strategy and what progress has it made among the investor group across the world and particularly in emerging economies?

In January 2014, Russell Investments conducted a survey of equity investment decision makers at almost 200 asset owners in Europe and the Middle East, and North America. It found that 32% of asset owners currently have Smart Beta allocations, with adoption greatest among the largest asset owners.

Likely future adoption is poised to rise rapidly: 88% of respondents with over $10bn in AUM have evaluated Smart Beta or plan to do so in the next 18 months, falling to 77% among respondents with AUM between $1bn and $10bn.

The financial markets in the emerging economies such as China, India, etc., are still developing. They offer opportunities for active managers to leverage their skills in timing the market. India has also embarked on the journey of “Smart Beta” ETF’s & ETP’s with one offering as of Dec, 2014. As and when these markets become more efficient & developed, the number of passive investments would increase at a higher rate and “Smart Beta” products may become the choice of the investors.

Thank you for the session sir. Now I have understood the intricacies of ‘Smart Beta’ as an investment strategy. I can take an informed decision and plan my investment approach accordingly.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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WINNERS Article of the Month Prize - INR 1500/Ankur Kumar IIM Shillong June FinQ Winners 1 st Prize - INR 1000/Sachin Kumar Sethi SIBM, Pune

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