Niveshak July 2016

Niveshak

THE INVESTOR

VOLUME IX ISSUE VII

July 2016

Trans Pacific Partnership: EXPLAINED

FROM EDITOR’S DESK Niveshak Volume IX ISSUE VII July 2016 Faculty Chairman

Prof. P. Saravanan

THE TEAM Aaron Keith Rego Abhishek Jaiswal Aditya Kumar Jain Anisha Khurana Ankit Singhal Ankur Kumar Anoop Prakash Devansh Sheth Shreyans Jain All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

Dear Niveshak The month made news mainly centred around the monsoon and the GST Bill. The benchmark Sensex index showed optimism for the month with the index up by around 2.92% during the month.

The Indian monsoon and the GST Bill attracted the maximum eyeballs in the month of July. The benchmark Sensex index showed optimism for the month with the index up by around 2.92%.

The two most discussed issues for the month for the Indian economy were the prospect of good monsoon and the push by the government to pass the GST Bill. As has been predicted by the IMD, India would have above normal monsoon after a gap of two years. This is a very important factor for a country heavily dependent on the rainfall for the agriculture sector. Also, one of the most awaited reforms in the Indian economy, the GST Bill, is all set to come into force. The Rajya Sabha has finally cleared the bill after struggling to form a consensus over it for years. Also some of the other events that made news this month was India tryig to host G20 summit in 2018 rather than the scheduled 2019, and some news in FMCG sector where the companies like Dabur and HUL are venturing into new sectors.

On the magazine front this time, July’s article of the month talks about the bankruptcy code. The author asserts the importance of bankruptcy code in making the system more resilient. Our cover story is on the Trans-Pacific Partnership among the nations. The article talks about the recent development where the nations have signed a deal on the final proposal, though it is yet to be ratified. The article focuses on how it would affect India. In the FinGyaan section, the author talks about the GST Bill and its effects on the Indian economy. The author talks about what benefits India could derive through the implementation of the bill and how it could be a panacea for the Indian economy. The FinRewind section covers the Enron scandal which had rocked the financial world. The author describes the event and provides his insight as to how this scandal made financial systems more robust. FinSight talks about the financial technology companies and their dynamics with the banks. The author supports the perspective that the banks should view the tech firms more as a partner in their growth journey rather than a parallel competing industry. This is based on the paradigm shift being observed in the way people bank, with major functionalities being transformed for the mobile platform. This time we have brought to you an article on Personal Finance authored by Mr. P. Saravana, Associate Professor of IIM Shillong, and published in Financial Express. The articles talks about how one should do Industry Analysis.The Classroom section explains the concept of ‘The Big Mac Index’.

It is one of the popular indices to measure the purchasing power parity of nations.

Finally, we would like to thank our readers for their immense support and encouragement. You remain our prime motivating factor that keeps our spirits high and gives us the vigour and vitality to keep working hard.

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.

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

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Trans-Pacific Partnership - A 10 Importance of Bankruptcy Harbinger of Change in Global Code Against the Backdrop of the Trade Existing Legal Framework

FinGyaan 18 GST Bill and Indian Economy

FinRewind

22 Enron - The Accounting Scandal that Rocked the World

Finsight

26 Bank vs Fin Techs Personal Finance

29 The Sum of All Peers Classroom

32 The Big Mac Index

The Month That Was

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The Niveshak Times Team NIVESHAK

IIM Shillong Dabur to Roll Out Fruit Drinks Catering to the growing acceptance of people for carbonated fruits drinks, home-grown FMCG company, Dabur, is planning to roll out a fruitbased carbonated drinks. The company had earlier introduced a similar product in 2011. But the product was withdrawn from the market after test marketing.

As per the rule, a drink must have a minimum of 10% fruit juice or pulp to be qualified as a -carbonated fruit beverage. Some of the other companies are targeting this growing market where consumers are becoming more health conscious and at the same time they want the fizziness of a carbonated drink.

Coca Cola is also testing Fanta Green Mango, a carbonated fruit drink. Both of these products would bring competition to the Parle Agro’s Appy Fizzy which is the leader in the segment.

Car Companies Need to Add Pedestrian Safety Features Taking into account the growing pedestrian deaths due to road accidents, government has asked all car companies to change their front portion of the car so that it can absorb more force during collision. As per a recent report, most pedestrian death happen due to the head injuries resulting from accidents.

October 2017 has been set as the deadline by the government for the new models to pass the crash test. Every new model of the car companies will be tested for its force absorbing capacity and a rating would be provided to them out of a total of five.

Recently, in a car safety test organised by Global National Car Assessment Programme (GNCAP), many cars selling in India got a ration of zero.

Also taking into account that almost 14,000 pedestrians are killed and around 50,000 get serious injuries every year due to road accidents, the government is planning to improve safety for the pedestrians.

Supreme Court Tightening Norms in Conflict of Interest in Awarding Government Contracts

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The founder of Lok Prahari, S N Sukhla has urged the SC to make changes in the law to make it mandatory for the elected representatives to disclose their source of earnings. As the rule stands today, the representatives are only needed to declare their amount of assets but they need not declare their source of incomes.

He also pointed out that while most of the representatives show themselves as social activist, their asset becomes four-five times after they hold the office.

Earlier, the Representation of Peoples Act, 1951, had this provision that an elected member would be disqualified from holding the office even if s/he had one percent share in a government contract.

But that provision of the act was repealed in the year 1951.

This has come in the wake of Vijay Mallya’s case where he has a debt of around INR9,400 crore and when India sought his extradition from London, he resigned from the Upper House in May. India Pushing for Hosting G20 Presidency in 2018 Rather than 2019 With the national elections due in 2019, the government has started talks to host the G20 summit in 2018 before its turn. As the situation stands today, India would host the talk in 2019.

But the government would like to distract itself from the national election due in that year, as the platform provides a place where countries comprising around 90% of world’s GDP come together.

The G20 nations of 19 members have been divided into five groups. First group has Australia, the US, Canada and Saudi Arabia; second group has India, Russia, Turkey and South Africa; third group has Brazil, Mexico and Argentina; group four has Italy, Germany, France and the UK and the last group has China, Japan, Indonesia and South Korea.

India needs the support of South Africa as it is also a contender for 2019. Currently, South American group has turn to host the summit and Argentina is looking to host it.

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Ease of Norms for Public Banks to Issue AT1 Bonds in the Pipeline

FMCG Major HUL Planning to Extend Brand Dove into Baby – Care Segment

Government is planning to make it easier for public sector banks to raise money by issuing AT1 bonds. The proposal is being considered because government sees that it would not be possible for the public sector banks to raise their capital base to the required limit given the current scenario of asset quality they have.

HUL is planning to make a serious entry in the baby-care market which till now has largely been dominated by Johnson & Johnson. The company is planning to launch its Dove brand in the babycare market. After the brand was transformed just from being a soap, the company is capitalizing on it to make an entry into a segment where winning loyalty is very hard.

Till now insurance companies were taking large stakes in such bonds issued by public sector banks.

But the issue with such bonds is that they can be written off by the banks at the time of distress. This could adversely impact the policyholders’ safety.

Given this situation, Insurance Regulatory and Development Authority is not convinced that the insurance companies should take large stakes in such type of issues.

As per experts, the baby-care category has huge potential in India not only because there is no serious competitor of Johnson & Johnson but also the market is huge given around 25 million children are born in India every year.

Public sector banks need to raise around INR1.8 lakh crore as additional capital. Of these amount, INR1.1 lakh crore would have to be raised from the market.

Of the INR25,000 crore that the government would pump in, INR15,000 has been allotted and the remaining would be based on the performance of the banks.

Reliance to Add Retail Business to its Petrol Pump As Reliance Industries is planning to restart its around 1500 petrol pumps, it has something bigger to offer. The company is hiving off its petrol business which it owns and merging it with the other group company, its retail unit. The move is aimed to increase its revenue from the petrol pumps when the revenues are falling from each petrol pumps due to increase in the number of petrol pumps in the country.

In the western world the model is quite popular where the petrol pumps apart from selling petrol also act as a small retail store.

The company was planning to restart its retail petrol pumps from March 2016. But due to the change in its strategy to club the petrol business under the retail arm, the pumps will be reopened by the end of this fiscal. The retail arm, which operates under the name Reliance Retail, contributes around 10% to the conglomerate’s turnover.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

The Month That Was

The Niveshak Times

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28400

BSE

28200

DII

2,000

FII

1,500

28000

1,000

27800

BSE

27600

500

27400 0

27200 27000

-500

26800

-1,000

26600 29-07-2016

28-07-2016

27-07-2016

26-07-2016

25-07-2016

22-07-2016

21-07-2016

20-07-2016

19-07-2016

18-07-2016

15-07-2016

14-07-2016

13-07-2016

12-07-2016

11-07-2016

08-07-2016

07-07-2016

05-07-2016

04-07-2016

01-07-2016

26400

-1,500

FII, DII Net turnover (in Rs. Crores)

Personal Finance Market CoverSnapshot Story

Market Snapshot

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

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

1,09,06,754 Source: www.bseindia.com

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

INR/1 USD 12.00% 10.00% 8.00%

Euro/1 USD

GBP/1 USD

67.03 74.27 64.69 88.30 49.72

JPY/1 USD

SGD/1 USD

LENDING / DEPOSIT RATES Base rate Deposit rate

9.30%-9.70% 7.00% - 7.50%

RESERVE RATIOS CRR SLR

4.00% 21.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

7.00% 6.50% 6.00%

6.00% 4.00% 2.00%

Source: www.bseindia.com

0.00% -2.00% -4.00%

JULY 2016

Date as on July 31th

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NIVESHAK

BSE Index

Open

Close

% change

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

27064 11752 11824 19816 20606 12047 14902 8457 15542 11248 8568 9750 1994 6724 1541 6094

28052 12661 12310 21091 21679 12405 15478 8725 16299 10813 9406 10595 2077 7186 1607 5951

3.65 7.74 4.11 6.43 6.43 2.97 3.86 3.17 4.87 -3.87 9.78 8.67 4.16 6.87 4.27 -2.34

% CHANGE

% Change TECK, -2.34%

IT, -3.87%

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Smallcap, 4.11% REALTY, 4.27% PSU, 6.87% POWER, 4.16% OIL&GAS, 8.67% MIDCAP, 7.74% METAL, 9.78% Healthcare, 4.87% FMCG, 3.17% CD, 2.97% CG, 3.86% BANKEX, 5.20% AUTO, 6.43% Sensex, 3.65%

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Market Personal Finance CoverSnapshot Story

Market Snapshot

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Done on 30/6/14

Information Technology(11.23%)

Bank (7.00%)

HCL Tech.

HDFC Bank Wg: 7.00% Gain: 35.49%

Infosys

TCS

Wg: 3.66% Gain : 9.79%

Wg: 3.48% Gain: 31.52%

Wg: 4.08% Gain : 7.49%

FMCG(21.42%) Colgate HUL

Britannia

Wg: 5.47% Gain : 25.12%

Wg: 6.39% Gain: 186.20%

Wg: 4.60% Gain: 31.18%

Amara Raja Wg: 4.38% Gain: 25.53%

Godrej Consm.

Wg: 7.94% Gain: 81.33%

Pharmaceuticals (10.72%) Dr Reddy’s Labs Wg: 3.66% Gain: 3.95%

Lupin Wg: 7.06% Gain : 45.05%

Midcap Stocks (12.44%) Bharat Forge Wg: 3.31% Gain: -11.71%

Kalpataru Power Wg: 4.22% Gain: -1.02%

Wg: 4.96% Gain: 9.76%

Misc. (12.51%)

Auto (9.40%) Tata Motors Wg: 5.02% Gain: 15.14%

ITC

Natco Pharma Wg: 4.90% Gain: 22.38%

Titan Company Wg: 4.57% Gain: 11.01%

Chemicals (9.04%) Asian Paints Wg: 9.04% Gain: 81.76%

Textile (6.25%) Page Indus.

Wg: 6.25% Gain : 22.38%

Performance Evaluation

As on 31 st July 2016

July Performance of Nivehshak Investment Fund 105 104 103 102 101 100 99 98 97

1/7

4/7

7/7

10/7

13/7

Scaled Sensex

16/7

19/7

22/7

25/7

28/7

Scaled NIF

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 16,61,968 Change in Portfolio Value : 66.20% Change in Sensex : 36.85%

Value Scaled to 100

Risk Measures: Standard Deviation : 18.55 (Sensex 9.88) Sharpe Ratio : 3.35 (Sensex : 3.32) Cash Remaining: 58,000

Comments on NIF’s Performance & Way Ahead: The markets were seen slowly rebounding after a tumultuous start in the month of July. With the results of many companies being released, wayward movements were seen in the markets.

However, with GST on the horizon the markets continue to remain upbeat.

In the coming month GST and other news coming out of the monsoon session of parliament will play a major role in deciding the market trends. Also, the likely successor to the incumbent RBI Governor is expected to be announced later this month and the markets would be keeping a close eye on who would replace him come September.

The top performers in the NIF for July were Lupin and Asian paints which rose by 13% and 11% respectively. Whereas, DrReddys and Infosys were the laggards falling by 13% and 8% respectively.

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Importance of Bankruptcy Code Against the Backdrop of the Existing Legal Framework Introduction The robustness of the banking system is very crucial for the economic growth and prosperity of any country. This fact was clearly evident during the Global Financial Crisis when every major world economy and their banking system had collapsed and are still struggling to recover since then. But the Indian banking system had successfully sailed through the stormy waters of GFC and came out as robust.

But in recent time, this robustness has been questioned due to the rise in NPAs. The Indian government and regulators have implemented many loan recovery processes

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NayanSaraf &AsthaMehta TAPMI

like SICA, Lok Adalat, DRT, SARFAESI Act, but none of them have proved to be efficient enough to handle this situation. Subsequently, the banks are running in huge losses. But recently the government has passed a historic bill: Insolvency and Bankruptcy Code (IBC) to amend and consolidate existing laws on bankruptcy, and to create a unified legal framework.

But before we discuss the details of IBC and analyze its impact, let’s examine the current scenario of NPA across banks and the different loan recovery processes, in order to build the

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Woes of Indian Commercial Banks The non-performing assets have shown an increasing trend for both public and private sector banks in the last few years. The rise in gross NPA from domestic lending, in both absolute and percentage terms, for public sector banks, private sector banks and all scheduled commercial banks (excluding foreign banks) is shown in Figure 1.

The contribution of priority sector in total NPAs is more for Public Sector Banks than Private Sector Banks. Although, the private banks have relatively lesser gross NPAs but the increasing trend poses a challenge for them also. Furthermore, the huge sum of more than one trillion of non-performing assets

highlights the pressure on commercial banks.

Loan Recovery Processes The government started taking actions towards the increasing problem of NPA in the 1980s.

The first major step taken was Sick Industrial Companies Act (SICA). It aimed at timely detection of sick companies and required quick action for either revival or liquidation.

But SICA had many drawbacks. Firstly, any firm was regarded sick only after its net worth had eroded by at least 50%. This worked against the foremost objective of quick detection.

Also, there was a possibility that companies proclaiming to be sick to avail financial help

and to prevent an unsecured creditor from making claims.

Soon after SICA, Lok Adalats or Peoples Courts were introduced, with a focus to solve debt recovery cases with an amount up to INR 5 lakh. However, in order to ease the system from pending bad loan cases, this limit was increased to INR 20 lakhs in 2004. The limitation of Lok Adalats was the ceiling set on the amount involved.

The government then proposed the construction of Debt Recovery Tribunals or DRT. These tribunals enabled loan recovery in around 1 years’ time span. However, as the number of cases being filed with DRT rose, the time is taken to resolve cases increased.

Currently, there are 33 debt recovery tribunals in India with a huge backlog of pending cases.

The 33 debt recovery tribunals receive more

than 70,000 loan recovery cases along with more than 25,000 securitization cases in one month but are able to resolve less than 2% of the cases.

All these processes required the involvement of a legal intermediary, example: Peoples court, DRT, for resolution. The government realized the need for prompt recovery and presented the SARFAESI Act. The SARFAESI Act allowed banks to take possession of the defaulter’s assets and sell them to recover the debt. As the court’s intervention in this process was eliminated, the process could be accelerated.

The SARFAESI Act also overcame the issue of

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Personal Finance Cover Story

ground for the bankruptcy code.

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debtor fraudulently using SICA as a mode to prevent/delay repayments to creditors.

Presently, Lok Adalats, DRT, and SARFAESI are the common methods sought for credit recovery. Even though SARFAESI comes out as the best mode, it provides the recovery of only ~25% of the total loan amount. The statistics regarding the total cases referred and the amount of recovery during 2012-15 is shown in Table 3.

Although the mentioned organizations and developments were made to reduce the existing pressure, they also complicate the legal procedure that can, in turn, have a negative effect. The different channels available are not exclusive and different creditors can approach any of the legal bodies for either filing for liquidation or recovery. This can lead to sideby-side processing of more than one case against a single company. The ambiguity can result in confusion for both the company and the lenders, and consequently, in the failure of timely resolution.

Comparison with other World Economies The World Bank data ranks India at 183rd among 196 countries in terms of loan recovery time and 149th in terms of loan recovery percentage. India’s insolvency and recovery process are so corroded that it affects its ease of doing business also. Currently, India’s ranking is 136 out of 189 countries in ease of resolving insolvencies.

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The comparison of India with other BRICS countries on various parameters is shown in Table 4. India, when compared to the BRICS nations, lists itself at the bottom in the rank of insolvency resolving index, time taken for recovery of credit, and strength of insolvency framework. Each of the parameters being far lower than the other nations. The recovery rate in India (25.7%) is marginally higher than that of Brazil (22.4%).

Further analysis of the World Bank data reveals that India takes 7 times more time in recovery and recovers less than 1/3rd the amount as against Japan. The comparison of recovery time and rate between the top five countries in insolvency resolving index, and G7 and BRICS countries is graphically shown in Figure 2.

Now, we can clearly understand that the strong bankruptcy law was the need of the hour. And the current bankruptcy code is designed to overcome the inefficiencies of all past legal framework whether it is SARFAESI act, DRT, or Lok Adalat. The process is designed uniquely to reduce the time taken for completing the insolvency process and arriving at the resolution quickly.

Bankruptcy Code The Insolvency and Bankruptcy Code (IBC) involves the Insolvency Resolution Process (IRP) which can be initiated by any creditor i.e. a financial firm or an operational creditor like non-financial firm or an employee when an individual or a firm default on their credit contracts. During IRP, creditors asses the

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involves taking decision-related to bringing fresh finance in the business by inviting bids for commercial contracts to keep the business running. This is a unique aspect as in the countries like U.S., China, where the power remains in the hands of only defaulter’s management while bankruptcy professionals oversee business in order to prevent asset stripping.

Speedy Resolution The most crucial aspect of IRP is its definite time limit of 180 days to make a consensus on the business viability. If in 180 days, 75% majority of Committee of Creditors do not approve a resolution plan, then the debtor is declared bankrupt. Though in certain cases, NCLT could also provide extended 90 days period on the request of Committee of Creditors.

This speedy resolution is helpful in two ways.

Firstly, it prevents the decline in the value of the underlying assets. Secondly, it incentivizes creditors to make a rational decision on whether to revive or liquidate the business, since, on liquidation, creditors usually wouldn’t be able to recover the complete amount. In the case of liquidation, bankruptcy code also gives the clarity about the priority of claims by different category of creditors over the liquidated assets.

Conclusion The enactment of Insolvency and Bankruptcy Code (IBC) is one of the major milestones in the Indian financial system. But its effective implementation is the biggest challenge owing to requirement of judicial infrastructure, dearth of qualified Resolutions Professionals, the lack of data privacy and authenticity about the present and past financial situations of the debtors and creditors, and the synergy and

synchronization between bankruptcy code and other existing laws such as SICA, Companies Act, SARFAESI act etc.

The Bankruptcy Code has its own flaws or the areas where it needs improvement, but it will certainly improve India’s current ranking in ease of resolving insolvencies which are at 136.

But we should not be overwhelmed with this index. The crucial point is not to hamper the current economic activity in terms of borrowing like a leveraging firm without a reduction in risk taking, the share of borrowing from NBFC, unsecured borrowing in total debt etc. Because the very purpose of the bankruptcy code is to bring the efficiency in the system not to hinder economic activities.

It’s only time will show whether Bankruptcy Code is effective enough or not but we must admit that it is far better and robust in comparison with existing bankruptcy laws which are neither effective in time to recovery nor in terms of amount recovery.

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Personal Finance Cover Story

viability of defaulter’s business, whether it can be rescued and revived or it should liquidate immediately.

The request for IRP is initiated by the National Company Law Tribunal (NCLT) which appoints Resolution Professionals to administer IRP. During IRP, Resolution Professionals take over the management of the firm and operate the business as a going concern under the broad direction of a Committee of Creditors. This

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Trans-Pacific Partnership - A Harbinger of Change in Global Trade ShreyansJain A Brief Introduction Trans-Pacific Partnership (TPP) Agreement is a trade pact among 12 Pacific Rim countries.

The signatories to the agreement are Australia, Brunei, Canada, Chile, Japan, Mexico, Malaysia, New Zealand, Peru, Singapore, United States of America and Vietnam. The TPP is an expansion of the Trans-Pacific Strategic Economic Partnership (TPSEP) Agreement signed by Chile, New Zealand, Brunei and Singapore in 2005.

The trade deal is aimed at dismantling tariff as well as non-tariff barriers to investment and trade between the member countries.

It also hopes to streamline regulations and to implement common standards for the protection of intellectual property rights and

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IIM Shillong

foreign investments. Apart from eliminating barriers to trade, to creating a level playing field for competing businesses, all countries involved will have to meet the negotiated standards on environmental protection and labour standards amongst others.

The finalised proposal of the TPP was signed on 4th February, 2016. However it has not come into force yet and will have to be ratified over the next couple of years. During this time period at least six participating nations must approve the final text of the deal for the TPP to be implemented. The TPP is expected to serve as a model for future trade deals in other regions once it comes into force. The agreement will supersede the past trade agreement like North America Free Trade Agreement (NAFTA) signed

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The twelve countries involved are looking to strengthen their economy by linking themselves together. The agreement will promote economic integration to liberalise trade and investment, create new opportunities for workers and businesses, benefit consumers, contribute to raising standards of living, reduce poverty and promote sustainable growth. The agreement seeks to establish a predictable legal framework for trade and investments.

Domination Ovet the Global Economy China, the world’s second largest economy is not a signatory to the pact. The Obama administration asserts that the Trans-Pacific Partnership is needed to counter China’s growing power, saying “if we don’t write the rules, China will write the rules for the global economy.” Through TPP, United States wants to ensure that it retains its domination over the global economy, especially in the AsiaPacific area where China has emerged as a big competitor. Thus the agreement is aimed at offsetting the power of China by strengthening

North America’s connections with several trading partners of China.

IPR Norms Under TPP The TPP seeks to boost IPR protections beyond the current WTO provisions contained in the TRIPS agreement. Most of the standards in the TPP negotiations are to converge to the US standards. The TPP provides for seventy years of copyrights. It also provides for discipline

on the use of geographical indications and seizure of in-transit goods due to suspected trademark violations. The stiffer IPR regime is expected to be enforced more vigorously.

Investor State Dispute Mechanism Investor State Dispute Mechanism allows private foreign companies to seek international arbitration against host governments to settle claims over alleged violations of the investment provisions. The TPP Agreement provides for more expeditious resolution of disputes and closes various potential loopholes in the existing Free Trade Agreements. The TPP dispute settlement mechanism will give a member country, the tools to be able to enforce the strong, high-standard obligations that have been negotiated.

United States of America And TPP Of the 30 chapters in the agreement, only five chapters are related to trade while the remaining chapters are focussing on rules and

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among Canada, Mexico and the USA. Trans-Pacific Partnership Agreement is potentially the largest trade pact in history.

The participating countries involved make up nearly 40% of the world’s economic output and 26% of the world trade. The combined GDP of these countries is $28 trillion and comprises the market of 870 million people. The TPP is going to be the most comprehensive free trade agreement because the standards set in it are much higher than even WTO standards.

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pushing forward the governance model which is expected to work in the best interest of the US corporations. The agreement will enhance USA’s leadership in economically dynamic Asia-Pacific region by setting and modernizing the rules of commerce consistent with its interest and commercial realities.

Impact of TPP on Indian Economy While the Trans-Pacific Partnership seeks to

liberalise the rules for trade and investments, critics are worried about the provisions on dispute settlement and intellectual property.

Even a non-participating country like India could stand to lose.

The total trade between India and the TPP countries is $155.3 billion with $79.5 billion worth of exports and around $75.8 billion imports, making a trade surplus with these countries. India’s export to these countries will have an impact in future. According to an estimate, trade worth $2.7 billion will be diverted away from India. This amount could increase to $3.8 billion if South Korea becomes a party to the agreement. These countries are also a major source of foreign direct investment in India.

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India’s leadership position and potential in textiles, outsourcing, services and digital trade might come under pressure. This might potentially reduce the attractiveness of the country for foreign capital.

The United States accounts for 30-35% of India’s readymade garments exports. TPP is expected to affect India’s clothing and textile sector in two ways leading to decrease in exports. First, TPP member countries will get a preferential

access in the US market vis-à-vis exporters such as India. Secondly, the ‘Yarn Forward Rule’ an important feature of the TPP makes it mandatory to source fabric, yarn and other inputs from any or a combination of TPP partner countries to avail duty preference.

There will be different period of patent protection in different countries in the TPP, meaning that Indian companies which are suppliers of generic drugs to the international market would be unable to make investment decisions. Moreover IPR norms will delay the launch of generic drugs and extend the monopoly of innovators. India is the largest provider of generic medicines globally, accounting for 20% of the global exports. Thus the IPR norms might lead to lower exports of

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because the domestic economic norms on labour and environment are not at par with TPP clauses.

India will have to significantly lower down the tariff rates leading to severe import competition among the domestic industries. India may have to compromise with its “Make in India” policy.

It will also prevent the government from using state owned enterprises for achieving socioeconomic objectives like food security and employment generation.

Way Forward for India India must urgently adopt the reforms needed to integrate its domestic economy, making it a more responsive partner in the momentum for a more integrated global economic and financial environment.

On the domestic front, India should expedite the process of making its products more costcompetitive. There is no denying that India’s infrastructural deficiency is one of the main hurdles in attaining the cost competitiveness.

through appropriate conformity-assessment procedures.

India needs to ensure that its pending Free Trade Agreements (FTA) are concluded expeditiously.

India’s bilateral FTA with some of the TPP members like Japan, Malaysia and Singapore along with FTAs which are underway with Australia, New Zealand and Canada may dilute the impact of trade diversion caused due to TPP to some extent.

India can also strengthen the regional forums of which it is a part of, especially the BRICS and Regional Comprehensive Economic Partnership (RCEP). This would give India a greater strategic space to assert leadership and cultivate a geopolitical and geo-economic order that is conducive to its unique development.

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medicines in future.

Addressing these issues will have the dual effect Vietnam and Philippines might eat India’s share of making India’s exports cost-competitive of service exports. as well as making them more attractive for international firms to integrate India in global value chains.

Should India Join TPP? At present it is not possible for India to join TPP The government should launch a comprehensive initiative to enable Indian exporters to comply with the standards existing in the importing markets as well as demonstrate the compliance

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GST Bill and Indian Economy SwapnilDeshmukh

Introduction The GST stands for “Goods and Services Tax”. It is proposed to be a comprehensive indirect tax levy on manufacture, sale and consumption of goods as well as services at the national level.

It will replace all indirect taxes levied on goods and services by the Central Government and State Governments. In India the proposed GST would be implemented from 1st April 2016. For this purpose 122nd constitution amendment bill is passed in the Lok Sabha, but still pending for approval in the Rajya Sabha. The GST is a

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tax reform that has been on the cards for more than a decade. In principle, it is the same as the Value-added Tax (VAT) already adopted by all Indian States but with a wider base. While the VAT which replaced the sales tax was imposed only on goods, the GST will be a VAT on goods and services. In the current tax regime, States tax sale of goods but not services. The Centre taxes manufacturing and services but not wholesale or retail trade. The GST is expected to usher in a uniform tax regime across India through an expansion of the base of each into the other’s territory.

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on inter-state supply of goods and services.

Despite the success with the VAT, there is still certain shortcoming in the structure of VAT both at the Central and at the State level.

However, in countries like Brazil and Canada there is dual system wherein GST is levied

GST has been designed to overcome from all shortcomings of VAT because GST is not simply

both by the Central Government and the State Governments. In India due to federal structure there shall be dual GST system. This will comprise of Central GST (CGST) which is levied by the Centre, State GST (SGST) which is levied by the State, Integrated GST (IGST) which is levied by the Central Government

VAT plus service tax but an improvement over the previous system of VAT and disjointed service tax. The mechanics of applying VAT and GST are basically the same. But there are some fundamental differences between them like VAT is levied on goods, whereas GST on both goods and services as it is evident from the

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GST was first introduced in France in 1954. Today it has spread over 150 countries.

GST is of two types: (a) Single GST and (b) Dual GST. Many countries have unified GST.

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name, GST would have a uniform rate in all the states which VAT lacks as each state levies its own rate of duty for each goods, input credit can be set-off only against the goods sold within the state in case of VAT, whereas in case of GST not only you can set-off input credit against goods sold within the country but also against the services.

Advantages

Like every coin has two sides, even GST will probably have its own positives and negative impacts. Let us first look at the possible positive impacts of GST. The GST, by

subsuming an array of indirect taxes under one rubric, will simplify tax administration, improve compliance and eliminate economic distortions in production, trade and consumption. Second, by giving credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer avoids the ‘cascading’ of taxes, thereby cutting production cost and making exports more competitive. In the other words the GST is designed as a value-added tax, which means starting from the manufacturer to the wholesaler and then retailer, each person will pay tax only on the value addition done by him. So, suppose a manufacturer purchases inputs worth Rs. 40 and then produces a good worth Rs. 100, then with a 10 % GST rate, his

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tax liability will turn out to be only Rs. 6 (10 % of 60). This is because he gets to set-off the tax paid on the inputs against the tax he pays on the final goods produced. This will reduce final price for consumer. Consider another example to understand this positive impact on final price of product: IGST, the combination of CGST and SGST will make efficient logistic tax system. It will solve warehousing obsession problem of previous tax system. Also in present tax system to reduce burden of cascading, companies try in-house production of components required for final

product. But after implementing GST, credit on input will be given and cascading effect of tax will be reduced. So outsourcing and subcontracting will increase. It will help in increasing employment. This will indirectly help to increase tax collection. In GST due to same base computation overall price of the product will be reduced due to overall reduction in tax.

Export will be zero rated, because exporters will get credit for GST paid on inputs. But they have to sell product with bill else no credit will be given. This will prevent tax evasion.

Challenges and recommendations

But there are still some challenges in

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Conclusion Coming to conclusion, GST is structured to simplify the current indirect system. It is a long term strategy leading to a higher output, more employment opportunities and economy boom. According to experts, by implementing GST, India will gain $ 15 Billion a year. This is because it will promote more exports, create more employment opportunities and boost

state collection. So states will lose their tax collection in significant manner. Union have decided to compensate effected states for first five years. Finance Commission recommended GST compensation fund with tapering effect for the same. Data base management for GSTN ltd. (Goods and service tax network) is also challenging task. According to IMF dual rate taxation will be complex system since union have to coordinate with twenty nine states.

India will have not a single federal GST but a dual GST, levied and managed by different administration. The Centre will administer the CGST and the States will administer SGST. The monitoring of compliance will also be done independently at the two levels. The rates for both, the CGST and the SGST will be fixed by the GST Council, whose members will be State finance ministers and chairman will be the Union finance minister. Once the rates are set by the GST Council, individual States will lose their right to tax whichever commodities they want at the rates they want.

growth. Individuals will be benefited as prices are likely to come down. Lower price mean more consumption, more consumption means more production and thereby helping in the growth of the companies. Overall introduction of Goods and Services Tax (GST) will be panacea for Indian economy.

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implementing GST. First is high revenue neutral rate (RNR). Because it will combine CGST (13%) and SGST (14%). Due to high RNR domestic industries will be ruined, also purchasing power will be reduced. To avoid this problem exempted items such as petroleum, electricity, stamps must be included in GST. Direct tax is the source of center’s major collection whereas VAT, cess and surcharge are major sources of

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Enron - The Accounting Scandal that Rocked the World Aaron Keith Rego

IIM Shillong During the course of history, one can find a number of events that go on to have a profound impact on the way business gets done. However, few can match the scale and complexity that involved the accounting scandal of Enron. The aftermath of the scandal shook the entire corporate community and had significant collateral damage with auditing giant Arthur Andersen being forced to end its practice.

The making of a corporate giant.

Enron was primarily an American company incorporated in Houston, Texas that primarily dealt with energy, commodities and services. It was one of the world’s largest companies and derived revenues of nearly $111 billion from its

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business in the field of electricity, natural gas, communications, and pulp and paper.

Enron was initially called the Northern Natural Gas Company which was formed in 1932, in Omaha, Nebraska. It was reorganised through a series of mergers in 1979 to form “InterNorth.” In 1985, the CEO of InterNorth Kenneth Lay, decided to rename the company to “EnterOn”, but changed it to “Enron’’ after being informed that the former referred to ‘intestines’ in Greek. He soon relocated the company’s headquarters to Houston, Texas from Omaha, Nebraska. Immediately after relocating, Enron (which by then had become a hugely diversified business due to its M&A activities) began selling a number of its prime assets such as its chemicals division, etc. and became a less diversified company. Analysts

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accounting malpractices in the fine details of the statements.

Attempts by Analysts to get access to more information or probe further into the accounts of Enron were met with severe backlash and criticism from the company’s management.

One such instance in 2001 involved Bethany

1999 Enron launched the “EnronOnline” trading website, which allowed the company to manage better its contract trading business. It was hugely popular and was soon used by virtually every energy company in the United States of America.

Enron’s stock price grew 311% from 1990-1998, this was modestly higher than the growth rate of the S&P500. However, the stock would go on to increase by 56% in 1999 and 87% in 2000, this was in stark contrast to the performance of the S&P 500 which had barely grown during that period.

McLean from Fortune, who while analysing Enron’s 10-K filing (equivalent to annual report) found strange transactions, erratic cash flows and huge debt. On attempting to clarify the same with Skilling, she was admonished and labelled “unethical” for not doing her research properly. Another case involved Wall Street analyst Richard Grubman, who in a conference call with Skilling, questioned why the company did not release a balance sheet and statement of cash flows along with its income statement.

Skilling reply to Grubman was, “Well, thank you very much, we appreciate that … asshole.”

Events such as these led to unease and distrust of Enron in the financial markets. The stock price of Enron, which until then had been providing exceptional result, began to falter.

What further ruffled feathers was when Jeffrey Skilling, who had been made CEO in February 2001 after Kenneth Lay had stepped aside, abruptly resigned in August 2001 forcing Kenneth Lay to take over as CEO again. What caught everyone’s attention was the fact that Skilling had sold nearly 450,000 shares (valued at nearly $33 million). Despite Kenneth Lay’s attempts to assure investors, there was deep discontent among the investors following Skilling’s resignation and his admission that the falling stock price was a very significant reason for his decision.

On 16th October 2001 Enron announced that it would have restated its accounts from 1997 to 2000 in order to correct accounting violations. This led to a reduction of $613 million in earnings and increased liabilities by $628 Million, the company’s equity also

Events that led to Uncovering of the Scam The accounting scandal that would go on to consume Enron took root in the early 1990s. The then Chief Operating Officer (COO) Jeffery Skilling hired Andrew Fastow, who was acquainted with the deregulated energy market to exploit the prevailing market conditions. In 1993, Fastow began establishing a number of special purpose entities, this was a common practice in the energy sector. These special purpose entities (SPE) were of a limited liability and would not appear on the balance sheet of Enron despite Enron having guaranteed and funded all of the SPE’s liabilities and assets. Fastow would go on to become the Chief Financial Officer (CFO) of Enron in 1998.

The financial statements of Enron were extremely complex, making it difficult for investors and analysts to understand the business model completely. This enabled the management at Enron to cleverly conceal any

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early on noted that Enron had accumulated a lot of debts and selling off its assets would not be sufficient. This was one of the earliest signs of the corporate fraud that would soon unravel.

By 1992, Enron had become the largest producer of natural gas in North America. Trading of gas contracts earned Enron nearly $122 million, the second largest contributor to its net income. In

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reduced by $1.2 Billion. This was the first time that Enron had posted a loss in a quarter in the past 4 years.

The company also changed pension plan administrators and forbade employees from selling their shares for at least 30 days.

Shortly the SEC announced that it would be investigating Enron and the SPEs that had been created by him. On 25 October 2001 Fastow was fired by the company.

The Scam Finally Unravels What followed was a series of revelations about how Enron manipulated and took advantage of certain accounting loopholes to portray a larger than life picture of the company’s performance. Some of the major accounting

malpractices that would unravel in the time that was to follow were as follows: • Revenue Recognition: The normal practice of revenue recognition was such that companies that accepted the risk of buying and selling the product were allowed to report the entire selling price as revenue and the cost of the product as a cost of goods sold. However, companies that were providing agency services and did not take on the same risk as merchants would report only the trading and brokerage fees as revenue and not the entire value of the transaction. This was followed by trading companies such as Goldman Sachs and Merrill Lynch. However, Enron chose to report the entire transaction value as revenue, which ended up inflating the revenues of the company despite not undertaking the inherent risk of trading the product.

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• Mark-to-Market Accounting: Initially the accounting practice of Enron was fairly straightforward, the company would record the actual cost of supplying the gas and actual revenue received from it. However, Skilling demanded that the business adopts the practice of mark-to-market accounting. The practice of mark-to-market accounting dictates that once a long-term contract is signed, income from that contract is estimated at the present value of future cash flows. This resulted in a lot of subjectivity in revenue recognition, as the future revenue was extremely uncertain and there was no surety of actually receiving the amount. This led to large discrepancies in trying to match revenues and costs and in many cases the revenues were never really realised. Utilising this method of accounting

meant that Enron relied heavily on revenues from new contracts in order to mask the losses from previous contracts.

One such deal was when Enron and Blockbuster Videos signed a 20-year agreement to provide on-demand entertainment to cities in the US. After initial pilot projects, Enron recognised revenue of $110 Million. After the deal had fallen through, Enron continued to recognise profits, even though the deal resulted in a loss.

• Special Purpose Entities (SPEs): Enron used special purpose entities i.e. limited liability partnerships or companies that were created to fulfil a specific purpose. These companies would be used to transfer liabilities or loss making assets in order to hide these entries from the books of Enron. By 2001, Enron had hundreds of SPE’s which were used

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• Insider Trading: Enron reached a peak of $90.56 during August 2000. During this time executives of Enron and their associates who had knowledge of the company’s malpractices began selling shares of the company while at the same time encouraging the public to buy more of its shares. By August 15 2001, the company’s stock had halved in value to $42 and by October 2001 had reached $15.

Many investors were duped into thinking that the stock was extremely undervalued based on selective appearance by Kenneth Lay encouraging them to buy the stock. At the same time, Lay was accused of selling more than $70 million of shares Enron. Also Lay’s wife Linda sold 500,000 shares of Enron amounting to $1.2 million between 10-10.20 am on 28 November. The very same day, at 10.30 am news of Enron’s malpractices, including the millions of Dollars they hid became public driving the price of the stock to less than one dollar. In all 29 executives of Enron made approximately $1.1 Billion trading on insider information.

Impact of the Revelations By the end of October 2001, the facts about the malpractices carried out by Enron had eroded most of the trust placed upon Enron.

The Company was literally hanging by a thread with a credit downgrade on the cards. Such a downgrade would result in the company being forced to issue millions of shares to cover the debt that it had guaranteed. On October 29, news had spread that Enron had insufficient cash on hand and was looking for an additional $1-2 Billion in financing. This immediately prompted a rating downgrade with Moodys lowering the credit rating to Baa2 and S&P lowering their ratings to BBB+, two notches above the junk rating. The only thing that kept the company’s rating from being downgraded to junk was an impending buyout of Enron by Dynegy.

The final nail in the coffin was struck on 28th

November 2001 when Dynegy called off the proposed acquisition of the company, which immediately resulted in the credit rating of the company being downgraded to junk.

Enron’s European operations filed for bankruptcy on 30 November 2001 and 2 days later on 2nd December sought Chapter 11 (Bankruptcy in the US) protection. Enron became the largest bankruptcy in US history (it would later be surpassed by Worldcom).

Subsequent Legal action The Executive of Enron was tried on multiple counts of fraud, money laundering, insider trading and conspiracy. Andrew Fastow pleaded guilty to the charges and was sentenced to 10 years in prison without parole.

Fastow’s wife Lea was sentenced to one year in prison for helping her husband hide income from the government.

Lay and Skilling both pleaded not guilty to the crimes. Skilling was found guilty and convicted in 19 of the 28 counts of securities fraud earning him a sentence of 24 years and 4 months.

Lay was also convicted on all 6 charges of securities fraud that would have earned him a maximum of 45 years in prison. However, Lay passed away in July 2006 before the sentencing.

Since Lay passed away prior to exhausting his appeals, his conviction was vacated.

Arthur Andersen the accounting firm (formerly part of the big 5 audit firms) which audited Enron’s accounts was found guilty of shredding and deleting thousands of documents pertaining to Enron. The company had to surrender its CPA license on 31st August 2002 resulting in loss of nearly 85000 jobs.

Aftermath The Enron scandal had a profound impact on the US markets. This led to Senate passing the Sarbanes-Oxley Act in July 2002, aimed at preventing companies like Enron and Arthur Andersen from manipulating accounting practices at the cost of the public.

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to hide the debt of Enron. These SPE’s were however backed by the equity of Enron, which meant that Enron was ultimately liable to pay off these debts despite not showing them on its books. Some of the most prominent SPEs of Enron included the likes of JEDI, Chewco, Whitewig, LJM and Raptors.

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Banks vs Fin Techs MihirMorbia&RiddhiBaid The The recent superhero movie, “Batman vs. Superman: Dawn of Justice”, typically shows the relationship of financial technology executives and bankers because while both of them started the movie arguing and fighting with each other, they came to a truce to overcome the common challenge – a same scenario that banks and FinTech firms are facing. Banks will have to begin to see FinTech firms less as a rivals and more as strategic partners.

FinTechs can provide entrepreneurial agility and digital innovation while banks often have superior distribution and regulatory expertise.

The rise of FinTechs has emerged as a fundamental challenge to well-established banks. Particularly in areas like payments and wealth management, banks are seeing their competitive advantages being eroded and market share being squeezed. But we expect that there will be more cooperation between banks and FinTech firms because of many synergies that are hard to ignore

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although there will be some rivalry over some products and services that overlaps.

A study shows that more and more FinTechs want to collaborate with banks as they have realized that they can gain more working with banks. So in the coming years we will see more FinTechs coming out of the collaboration models rather than disruption model.

Disruption by FinTechs A Citi report stated that international investment in private FinTechs has increased more than ten-fold in the last 5 years. According to Traxcn, as of 31st December, 2015, there were over 750 FinTech startups in India, out of which about 175 were launched in 2015. The next generation of tech-savvy customers are eager to take advantages like lower fees, more transparency, easy-to-use and fast mobile interfaces and banks cannot turn their back on them.

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FinTechs have worked towards developing new products and building an ecosystem to broaden their acceptance. They can be divided into mainly three parts – Payments, Lending and Personal Finance.

Payments Companies who are in the payments and transaction space, worked towards building an ecosystem to boost acceptance of non-cash transactions like m-wallets.

These wallets are accepted at multiple platforms like e-commerce sites, large retail stores and small merchant shops. Paytm has more than 120,000 merchants and 10 million users. These wallets have enabled one-touch solution for faster transactions, which was one the main reasons for their acceptance.

Lending Lending can be categorized into 4 types – P2P Lending, crowdfunding, digital credit to merchants and loans to individuals.

Benefits for customers are from fast and paperless processing system.

Personal Finance In this category, they can be further divided into three segments – insurance, investment and money management.

These companies are working towards different ways to cut down manual intervention and make robo advisory as a key focus area.

Competitive Collaboration The FinTech sector is becoming more competitive with number of startups satisfying same needs in a better way. But banks have something that FinTechs need – Customers. So what this mean? There is innovation and technology that FinTechs

FinTechs are likely to stall without resources and experience of banks, while banks also require innovation, technology and entrepreneurial skills of FinTechs. So both of them collaborate for the greater good. The benefits of collaboration include reduced costs, improved customer satisfaction, new opportunities for growth and ticket to long-term survival.

The new emerging status quo between banks and FinTechs is called competitive collaboration and will be one of the keys to success in the industry. The rise of FinTechs present both a challenge and an opportunity for Indian Banks. The challenge is that FinTechs have distinctive advantages in terms of speed in action and decision making, organizational agility, transparency and customer experience.

The opportunity is that banks have an edge over these challenges related to cost of capital, data, distribution and regulatory certainty. Both of these have their own strengths and weaknesses and both can gain more by combining the best they offer and covering each other’s weaknesses.

Banks will take a hit when well-capitalized, technology-driven FinTechs will begin to eat traditional banking profits in retail and commercial loans, cross-border payments and foreign exchange transactions. They will be forced to change their products and services, resulting in operational changes and decline in profits. But banks can do better if they collaborate with FinTechs. These startups are incumbents and collaboration can serve as an efficient means for knowledge of new technologies like blockchain.

We can have example of number of foreign banks who have realized the importance of FinTechs and have collaborated in various ways. Some of the findings are given in the following chart.

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According to KPMG India, global investment in FinTech startups tripled to US$ 12.21 billion in 2015 from US$ 4.05 billion in 2014. More than 50% of investments were in areas of P2P (peer-to-peer) funding, m-wallets and online lending.

can offer while there is a demand that banks can drive. In short, banks have an ability to scale up what FinTechs have.

Source: Min Research, Traxcn

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Importance of Big Data One of the most important areas of collaboration is ‘Big Data’. In the lending space, for decades, banks have relied upon conventional indicators of credit risk. They are out-of-date and sluggish compared to innovative measures used by FinTechs.

There are many indicators like education, work history, utility bills and social media.

FinTechs also check online reviews posted on social media to make lending decisions.

By collaborating with such FinTechs and Using Big Data and other performance metrics (profitability, management strength, etc.) banks can more accurately access their risk profiles. Banks can develop such analytics in-house or they can use expertise of startup for this.

Data Security Cooperation Banks and FinTechs cooperate in challenging areas that are interest of both like data security. In India, markets lack a reliable third-party credit-scoring system. The security of such data is very important for FinTechs. Banks have high security updates because of their size and regulatory requirements. While startups are more focused on speed and customer experience may give little importance to the regulatory environment in which they operate. So when it comes to balancing between security and customer experience, banks and FinTechs can benefit from increased collaboration and strategic partnerships.

Investments by Indian Banks in FinTechs The country’s largest bank, State Bank of India, has planned to invest Rs. 200 crore fund for startups in the FinTech space. It will assist up to Rs. 3 crores to an Indian registered company for promoting innovations using IT for banking and related technology in India. It will guide them and help them in various areas including additional funding requirements, external legal and financial assistance. Arundhati Bhattacharya said that bank is seeing great opportunity in FinTechs and is looking for cross-selling through collaboration with FinTech startups.

Axis Bank through its innovation lab –

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“Thought Factory” aims at accelerating development of innovative solutions in banking sector. They have tied-up with American financial services company – Wells Fargo and two banks from UK for collaboration on technologies like artificial intelligence, block-chain, cloud and mobility.

Conclusion There is no doubt that FinTechs have brought some disruptions to traditional banking. These disruptions were in the areas of payments, loans and personal financial advice. With advances in technology, change in customer preferences and with investments from venture capitalists and corporates we will see even more radical transformation. Now next is the FinTech 2.0, which will be “seamless specialization” across the value chain where service providers will combine to deliver cheaper and easier-to-use value propositions for customers.

Banks will also have to continue on their journey of digital transformation, but they need not to go through alone.

By understanding core strengths and weaknesses of their own, banks need to look for FinTechs that can fill gaps. FinTechs are also no exception. They may have efficiency and cutting edge technology, but there is more work to be done as brand name, image, assets, market expertise and licensing required in this sector are a cruel necessity.

So there is only a single message for both FinTechs and Banks – collaboration is the key.

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The Sum of All Peers P.Saravanan Associate Professor, IIM Shillong Published in Financial Express Industry analysis is a tool that facilitates a company’s understanding of its position relative to other companies that produce similar products or services. Understanding the forces at work in the overall industry is an important component of effective strategic planning.

Let’s discuss industry analysis in depth and see how it is useful in identifying investment opportunities.

What is an industry?

Industry is defined as a group of companies offering similar products and/or services.

For instance, major companies in the global heavy truck industry include Volvo, Tata Motors, Ashok Leyland, Daimler AG, Paccar, and Navistar, all of which make large commercial vehicles for the on-highway

truck market. Similarly, some of the large players in the global automobile industry are Toyota, General Motors, Volkswagen, Maruti Suzuki, Ford, Honda, Nissan and Hyundai, all of which produce light vehicles that are close substitutes for one another.

What is a sector?

The term sector is often used to refer to a group of related industries. The healthcare sector, for example, consists of a number of related industries, including pharmaceutical, biotechnology, medical device, medical supply, hospital and managed care industries. These classification schemes typically place a company in an industry on the basis of a determination of its principal business

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activity. A company’s major business for investment returns on a risk-adjusted activity is the source from which the basis. The investment time horizon can be company derives a majority of its revenues either long or short. and/ or earnings.

Identifying correct sector For example, companies that derive a An industry has sub-parts. For instance, majority of their revenues from the sale if you look at the chemical industry, you of pharmaceuticals include Cipla, Pfizer, will find many sectors such as fertilisers, Dr Reddy’s Lab, Lupin, Aurobindo Pharma, pharmaceuticals, petrochemicals, dyes, Glaxo SmithKline, etc., all of which could polymer, paint and varnishes, etc. Therefore,

be grouped together as part of the global pharmaceutical industry. Companies that engage in more than one significant business activity usually report the revenues of the different business segments in their financial statements.

Industry analysis Investors needs to study statistical relationships between industry trends and a range of economic and business variables and they need to develop practical, reliable industry forecasts by using various approaches to forecasting. One needs to check the chosen industry’s past trends, demand-supply mechanics and future outlook. Investors also need to examine industry performance (a) in relation to other industries to identify industries with superior/inferior returns and b) over time to determine the degree of consistency, stability, and risk in the returns in the industry.

it is necessary to focus on the relevant sector.

Without this, it will be impossible to make an accurate industry analysis. So, take up an industry and find out the sectors. Select the particular sector that is doing well and its prospects are good. Moreover, it is worthwhile to look at the different market segments in a particular sector.

Review existing literature One should start with reading all the available but relevant industry reports and statistics to check whether it is worth reading further on the specific industry. Some of the existing reports might have an in-depth information and detailed analysis so that the need for new industry analysis is eliminated. However, it is not always advisable to depend on the existing industry analysis reports as the market is always volatile and industry factors keep on changing constantly. Therefore, it is essential to check for the most recent report and, on that basis, envisage its relevance in the current market.

The objective of this analysis is to identify Demand & supply analysis industries that offer the highest potential

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One can do comparative analysis with other companies competing in the same manner to find out the economic health of the company under consideration. Future demand and supply forecasting helps investors to understand the viability of future investments in companies those sector.

Five forces analysis Michael Porter propounded the concept of five forces analysis, which is an integral part of any industry analysis.

Under this model, one needs to study the competitive scenario of a company using five parameters to see the competitive landscape.

The five forces are (i) barriers to entry (ii) supplier power (iii) threat of substitutes (iv) buyer power and (v) degree of rivalry. All these forces are extensively used while analysing any industry.

An industry analysis is not only just about studying the particular industry on a micro level; it is important to incorporate factors that are influencing the industry at the macro level. The macro-level factors include recent industrial developments, innovation in the industry, legal and regulatory frame work, etc.

To conclude, though there are many approaches to industry analysis, the above steps are essential and industry analysis is

industry trends and a range of economic and business variables * Develop practical, reliable industry forecasts by using various approaches to forecasting * Check the chosen industry’s past trends, demand-supply mechanics and future outlook * Examine industry performance (a) in relation to other industries to identify industries with superior/inferior returns and b) over time to determine the degree of consistency, stability, and risk in the returns in the industry * The objective of this analysis is to identify industries that offer the highest potential for investment returns on a risk-adjusted basis.

The investment time horizon can be either long or short * Take up an industry and find out the sectors.

Select the particular sector that is doing well and its prospects are good. Moreover, it is worthwhile to look at the different market segments in a particular sector

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useful for understanding a company’s business As we all know, demand and supply are the and business environment and identifying primary factors governing any market. So, it active equity investment opportunities. becomes relevant to look into the demand- Step-by-step approach supply scenario for a particular product or industry by studying its past trends and * Study statistical relationships between also reasonably forecasting future outlook.

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CLASSROOM FinFunda of the Month

Sir, all I knew about the Big Mac is that it’s a lip-smacking burger by McDonalds.

But recently, in a news article, I read about the Big Mac index. What is that?

The Big Mac index, also known as Big Mac PPP, is a survey done by The Economist magazine that is used to measure the purchasing power parity (PPP) between nations, using the price of a Big Mac as the benchmark. It is a light-hearted guide to whether currencies are at their “correct” level. Using the idea of PPP from economics, any changes in exchange rates between nations would be seen in the change in price of a basket of goods which remains constant across borders. The Big Mac index replaces the “basket” with the popular hamburger. It suggests that, in theory, changes in exchange rates between currencies should affect the price that consumers pay for a Big Mac in a particular nation.

Sir, can you give an example to simplify the concept further?

For example, if the price of a Big Mac is $4.00 in the U.S. as compared to 2.5 pounds sterling in Britain, we would expect that the exchange rate would be 1.60 (4/2.5 = 1.60). If the exchange rate of dollars to pounds is any greater, the Big Mac Index would state that the pound was over-valued, any lower and it would be under-valued.

Sir, is there a real life significance of the Big Mac Index?

The Big Mac Index is pretty cleverly chosen. The ingredients used cover meat, bread, dairy and vegetables. The preparation requires capital and labour involvement. So, it includes various cost baskets.

For the common man, it can be used for

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The Big Mac Index Abhishek Jaiswal IIM Shillong planning vacations. One can look up the US Dollar to Euro exchange rate but it won’t tell if one can eat better or stay in nicer hotels in Paris, Madrid, Athens or Rome. On the other hand, knowing the Big Mac Index for France, Spain, Greece or Italy might help.

However, it’s probably more useful to compare prices of vacations offered by tours and travel operators.

For amateur economists, of course it’s not a formal measure as there are many factors that make it imperfect but it is valuable to get a sense of trends. It is remarkably informative and very easy to generate.

Sir, what are the drawbacks in assigning higher weights to this measure while doing economic analysis?

The index is imperfect at best. First, the Big Mac’s price is decided by the McDonalds Corporation and can greatly affect the Big Mac index. Also, the Big Mac differs across the world in size, ingredients and availability. Social status of eating at fast food restaurants such as McDonald’s in a local market, proportion of sales to expatriates, local taxes, levels of competition, and import duties on selected items may not be representative of the country’s economy as a whole. That being said, the index is meant to be lighthearted and is a great example of PPP and is used by many schools and universities to teach students about PPP.

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