Niveshak October 13

Niveshak THE INVESTOR

VOLUME 6 ISSUE 10

October 2013

In for a TAILSPIN? NEW BANKING ENTRANTS: THE ROAD AHEAD , Pg. 24

US SHUTDOWN: A BATTLE OF PUBLIC FUNDiNG AND ITS DEBT, pg. 08

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VI ISSUE X October 2013 Faculty Chairman

Prof. P. Saravanan

THE TEAM Editorial Team Anchal Khaneja Anushri Bansal Gourav Sachdeva Himanshu Arora Ishaan Mohan Kaushal Kumar Ghai Kritika Nema Neha Misra Nirmit Mohan

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

After a bloody month of September where Rupee witnessed nothing but free-fall, the month of October brought some respite for the Indians and specifically Mr Raghuram Rajan. The Rupee has revived (though only just) to the levels of 61-62 and has stayed there for most part of the month. But, what is better is the run of the Sensex this month. The value briefly touched 21000 mark and is all set to make history come Diwali. Speaking of Diwali, no one would be happier than perhaps the most discriminated section of our society, the people with HIV. The IRDA has issued draft guidelines to make life insurance for people with HIV/AIDS a reality in the time to come. Niveshak will be keep an intent eye on the developments in this sector and will update you with the latest happenings. The Forex reserves for India were also up at the $281.12 billion mark for the week ended Oct 18. The figure gained $1.88 billion in the week ending on Oct 18 and $1.51 billion in the week before that.

The Diwali might not be so cheerful for people in the states of Odhisa, Andhra Pradesh & West Bengal where rains have caused havoc after cyclone Phailin hit the Eastern Coast of the country on October 12. Our disaster management system deserves a special mention which saved the lives of millions of people, but the after effects still continue to wreak havoc in the aforementioned states. The losses to the economy will run into billions of dollars. The month of October also witnessed the announcement by the Little Mater to retire from the game of cricket after he has played his 200th test match in the forthcoming series against the West Indies. This development isn’t good news for the economy either. Cricket might lose some of its devotees and brands many potential customers.

Talking about the contents of this month’s Niveshak, The Article of the Month for October discusses the US Shutdown and its impact on the global and Indian economy. The 16 day long shutdown was the third longest in the history of the States and forced more than 80,000 employees to go on unpaid leave. The cover Story for the Month takes a bird’s eye view at the aviation sector of our country and how the entry of Tata’s might be a game-changer. Niveshak also brings some more good reads for you in this issue – the FinGyaan of the issue throws some light on the new proposed SEBI guidelines for the Mutual Funds in India. Fin-Sight for the month of October debates whether and how the new banks that will be formed from the new banking licences from the RBI, will be able to compete with the established banks in the country. Then there is the story of the Stock Market Crash on October 19, 1987, more popularly known as the Black Monday. The Dow Jones fell by 22.6% in a single day and couldn’t recover for years. The issue also explains the commonly talked about Hedge Funds and its nitty-gritties through our much cherished Classroom Section.

To end this brief note, it’s important that we thank you, our readers, for your constant support and appreciation. Thank you! It is your endless encouragement and enthusiasm that keeps us going. Kindly keep pouring in your suggestions and feedback to niveshak.iims@gmail.com and as always,

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

08 US Shutdown: A Battle of Public Funding and its Debt

12

Planes of Different Feather Flock Together

FinGyaan

16 SEBI: MF Advisory Guidelines

24

Finsight

New Banking Entrants: The Road Ahead

Finistory

20 Stock Market Crash: 1987 Black Monday

27 Hedge Funds

CLASSROOM

The Month That Was

4

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The Niveshak Times Team NIVESHAK

IIM Shillong India Looks to import Onions from Pakistan and China

Reliance to enter into chicken business in direct competition with KFC

India issued an import tender for onions to surge over a crippling shortage of the vegetable staple that has contributed to stubborn food inflation and brought scathing political criticism about the government’s food management. State-run National Agricultural Cooperative Marketing Federation of India (NAFED) issued a statement which said that it was interested in buying onions from Pakistan, Iran, China and Egypt. However, no quantity or purchase price was mentioned in the same. The federation expected to complete the procurement by 29th October. India is one of the largest producers of onions in the world and is usually a net exporter but heavy rains during the recent monsoons washed out large portions of the crop in northern and western India and to cover up for the losses, some imports of the vegetable have already been made from China, Egypt and Pakistan in the last three to four months. Notwithstanding any of the measures taken by GOI, the price of a kilogram of onions has more than quadrupled from last year to a record 90 rupees-100 rupees this year.

Mukesh Ambani-controlled Reliance Industries plans to run an exclusive chicken restaurant chain in India in partnership with a UK-based company as he seeks a bite of the quick service restaurant (QSR) pie, which is pegged to grow at 30% per annum. The chain, to be called ‘Chicken came First’ will directly compete with KFC.

Twitter Ipo Conservatively Valued At $11 Billion Twitter’s initial public offering would raise up to $1.6 billion and value the company at up to about $11 billion, amidst widespread comments that the company was treading the path carefully and is avoiding going overboard with its plan in the light of Facebook IPO debacle last year. The company has revealed that 70 million shares of it will be sold between $17 and $20 apiece, raking in up to $1.4 billion for the company. If underwriters choose to sell an additional allotment of 10.5 million shares, the offer could raise as much as $1.6 billion. At a roughly $11 billion valuation, Twitter would be worth more than Yelp Inc and AOL Inc combined, but only a fraction of tech giants like Google Inc and Apple Inc, worth $342 billion and $483 billion respectively.

Facebook’s market value is now around $128 billion.

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RIL has picked up a 45% equity stake in Two Sisters Foods India (TSFI), which belongs to 2 Sisters Food Group (2SFG), the third largest food company in UK. The group supplies poultry, red meat, fish, and bakery and chilled/frozen products to the retail, food service and food manufacturing sectors in UK. The stake has been picked through Reliance retail for an undisclosed sum. What is known, however, is that Reliance Retail has already invested in a state-ofthe-art food innovation lab to support new products.

Uk Gdp: Fastest Growth For Three Years The UK’s economic output grew by 0.8 per cent between July and September, the fastest quarterly growth in three years, according to official GDP figures from the Office for National Statistics. The figures, which were in line with expectations, saw all sectors of the economy grow, including a 2.5 per cent surge in construction - a sector bolstered by Government initiatives such as Help to Buy. Overall GDP was 1.5 per cent ahead of the same period last year. However, the economy remains 2.5 per cent off its pre-recession peak at the start of 2008 with construction remaining 12.5 per cent off its pre-crisis peak. Production grew by 0.5 per cent, though this remains 12.8 per cent off its 2008 level, while within this manufacturing improved 0.9% in the third quarter. It is 8.9 per cent off the level five years ago.

Meanwhile, the powerhouse services sector, which represents three-quarters of economic output, grew by 0.7 per cent and is now 0.6 per cent above its pre-crisis peak. The largest contributions here came from business services and finance, followed by distribution, hotels and restaurants. The UK economy is now larger than the Bank of England expected it to be at the end of the year.

Rising Global Cocoa Prices To Hurt Indian

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Chocolate Buyers With demand for confections going to peaks due to the festival of Diwali arriving, biting cocoa prices have left a bitter taste in the mouths of chocolate makers such as Nestle SA and Cadbury in India. More than half of the input costs for making chocolates is accounted by cocoa and its prices has risen 21.5% since March, which has seized the margins of chocolate makers. To make matters worse, the prices of other raw materials such as milk have also risen.

It is feared that rising prices might lead to dampening of demand, making consumers to go for traditional sweets and nuts instead of chocolates during Diwali.

Estimated by a market researcher, chocolate sales, at INR 6007 crore in 2013, usually receive a boost during the festival season. It is expected that sales will rise 22.24% in 2013 from INR 4,914 crore in 2012.

Chocolate prices are estimated to rise 9.84% to Rs.574.70 per kg in 2013 from an average of Rs.523.20 per kg in 2012. According to data portal Index Mundi, the monthly price of cocoa beans remained around $2,275 per ton in January and rose to $2,616 per ton in September. For chocolate makers, rising cocoa prices are not the only concern. It is also expected that inflationary pressure on milk is likely to continue.

The cost of milk production has grown at an average annual pace of 14%. Due to Diwali being early this year, it is expected that global cocoa prices hike may not effect sales.

Small Firms, Start-Ups Can List Without Ipos In order to help small firms and start-ups, India’s capital market regulator announced that these companies will be able to raise public money and trade their shares on exchanges without an initial public offering (IPO). They will be able to list & trade their shares on a special platform that is to be called the Institutional Trading Platform (ITP) in SME exchanges. This move will also bring relief to private equity & venture capital funds which usually fund such firms and have been looking for easier exit options.

It is believed that the ITP platform will offer exit routes to early-stage investors but it will not open a floodgate of start-ups and SMEs looking to list. The biggest advantage of listing on the ITP is that an investor can take the benefit of not paying capital gains tax on a transaction. Short-term gains on

transactions on a non-market platform attract such levies of as much as 20%. According to Sebi, only those companies can list on the ITP that are younger than ten years and whose revenues haven’t exceeded INR 100 crore in any year. The paid-up capital of such SMEs and start-up firms must be below INR 25 crore. There would be difference between ITP and the usual share-trading platforms. Individuals and institutions that can trade in a minimum lot of INR 10 lakh will be able to access the platform. Small firms that have received money from a scheduled bank for their project financing or working capital needs can also opt for listing on the ITP after three years of such financing and full utilization of such funds. Companies which are listed on the ITP can exit the platform and choose to be listed on any of the main bourses only after receiving approval to do so from at least 90% of their shareholders.

Bcci Terminates Pune Warriors From Ipl The BCCI has terminated Pune Warriors from the IPL when the Sahara-owned franchise defaulted on its payments and refused to furnish the bank guarantee for the next season. Sahara Group mentioned that it was forces to take this decision as the board “has always acted in betrayal of trust and not fulfilled its part of obligations”. It also said that the reduction in the number of IPL matches by the BCCI from the number stipulated in the franchise agreement was at the center of the whole dispute. As per Sahara group, reduction in the number of matches has had a substantial financial impact due to the reduction in the central revenues under the Franchise Agreement.

Sahara Group has been demanding the completion of the arbitration proceedings on the issue of franchise fee, which, it feels, should be lowered since the BCCI did not deliver on its promised number of IPL matches for the team. Sahara had bought Pune Warriors for $370 million in 2010. It was the most expensive franchise on the IPL roster and its termination would cause substantial financial loss to the BCCI.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

The Month That Was

The Niveshak Times

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Article ofSnapshot the Month Market Cover Story

Market Snapshot

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

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

6,700,678 3,298,771 1,696,202

LENDING / DEPOSIT RATES Base rate Deposit rate

9.80%-10.25% 8.00% - 9.00%

Source: www.bseindia.com

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

61.63 85.14 63.48 99.94

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

4.00% 23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.50% 7.50% 6.50%

Source: www.bseindia.com 28th September to 25th October 2013 Data as on 25th October 2013

OCTOBER 2013

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NIVESHAK

BSE Index Sensex

Open 19893.85

Close 20683.52

% change 3.97%

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

5627.58 5479.62 11192.48 11494.65 5890.02 8052.67 6896.44 9475.89 7829.4 8720.76 8349.93 1565.00 5586.99 1213.23 4471.09

5965.48 5825.75 11794.35 12445.26 5945.84 8886.59 6860.19 9573.3 8443.43 8975.44 8692.63 1567.66 5615.44 1323.91 4769.11

6.00% 6.32% 5.38% 8.27% 0.95% 10.36% -0.53% 1.03% 7.84% 2.92% 4.10% 0.17% 0.51% 9.12% 6.67%

% CHANGE

IT

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article Market of Snapshot the Month Cover Story

Market Snapshot

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US SHUTDOWN

A battle between public funding and its debt Paridhi Gupta

IEHE, Bhopal What is ObamaCare?

ObamaCare is the unofficial name for The Patient Protection and Affordable Care Act which was signed into law on March 23, 2010. ObamaCare’s health care reform does a number of important things including setting up a Health Insurance Marketplace where Americans can purchase federally regulated and subsidized health insurance.

A few highlights about ObamaCare are as follows: • The proposed system contains over a thousand pages of reforms for the insurance and healthcare industry of US in order to cut government health care costs and to provide affordable health insurance to all Americans • Earlier a citizen could be denied of Insurance coverage or treatment because he/she had been sick in the past or be charged more or be dropped mid-treatment for making a simple mistake in the application, and had limited options to fight insurance related grievances As per estimates, there are around 44 million Americans who currently are unable to access health insurance. One of the major things ObamaCare does is help individuals to get health insurance through expanding “Medicaid” and “Medicare” and offering cost assistance to Americans who cannot currently afford health care

OCTOBER 2013

Terming the present debt crisis in America as “mission-critical”, the IMF Managing Director Christine Lagarde said, “The current political uncertainty over the budget and the debt ceiling does not help. The government shutdown is bad enough, but failure to raise the debt limit would be far worse, and could terribly damage not only the US economy, but the entire international economy,” What led to this shutdown?

The Patient Protection and Affordable Care Act continues to be very controversial for a variety of reasons. Republican party (also referred to as the Tea party) after failing to stop passage of the original act in 2010, failing to pass myriad repeals between 2010 and 2013, losing the case at Supreme Court in 2012, and failing to win the 2012 U.S. Presidential Election which could have led to repeal of that act attached a provision to a spending bill that required eliminating funding for the implementation of the ObamaCare in order to fund the rest of the U.S. Federal Government.The ongoing shutdown is due to this budget standoff between President Barack Obama and Congress.

They are unable to come to a consensus as to how the country should be funded for the next fiscal year.

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Article of the Month Cover Story

Fig 1: Debt Ceiling of US over the years

Under ObamaCare, President Obama and the Democrats wanted to introduce a new healthcare system into the United States, which they believed will make healthcare more affordable for most Americans.

The GOP continued to fight against the Affordable Care Act, saying it costs too much government cash. They believe that it’s not right for US citizens to be forced to pay insurance money, and that passing of this bill could take US economy into ICU as the law imposes too many costs on business and with many describing it as a “job-killer”. They have also described it as an unwarranted intrusion into the affairs of private businesses and individuals. And because of this, the Republicans didn’t want to sign the budget plan for the next year, as it included the Affordable Care Act - which is something they

don’t want. The shutdown has left more than seven lakh employees on unpaid leave and closed national parks, tourist sites, government websites, offices and more. It’s the first shutdown since 1995 when Bill Clinton and the House of Representatives (and its spokesperson Newt Gingrich) also failed to agree on a plan to fund federal services. That row ran for 28 days (over two stages). But it was a more regular event in the eighties, usually for a couple of days at a time. In total, the federal government has partially shut down on 17 occasions before this one.

So what’s next?

If this shut down continues US will run out of money as the borrowing limit cannot be raised since the president alone cannot raise the ceiling, it requires the permission of House of

Under ObamaCare, a new healthcare system will be introduced in the United States, which they believe will make healthcare more affordable © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Senate and Representatives and then they set the law on how much treasury department can borrow and as Republicans and Democrats are at a tiff it is impossible to pass the budget.

Consequences, can lead to a debt default of 2008 or worse and its effect are going to be catastrophic. According to Congressional Budget Office US debt is 73% of GDP which is twice as much as that of 2007. If the debt limit is not raised it would cause delays in payments including benefits and government employees’ salaries and result in default on government liability. President Obama urged Congress to raise the debt limit without conditions to avoid a default by the US on government debt. Raising the debt limit is also supported by Bernanke, chairman of the Fed. But Republican Speaker , John Boehner and the Senate Republican minority leader, Mitch McConnell as well as other Republicans argue that the debt limit should not be raised unless outlays are cut by an amount equal to or greater than the debt limit increase.

What defaults mean to the rest of the world?

A default would send a shock through the financial markets. US bonds, known as treasuries, have always been seen as a safe investment and trillions of dollars are invested in them. Analysts say it is hard to know what would happen and a lot would depend on how long the default lasts. Investors may be prepared to wait out a short disruption. But a lengthy default might see money switch into other perceived havens, such as German and Swiss debt. There might also be a rush into gold, which is seen as a safe investment.

Effects: If it lasts for 10-14 days then the impact will be very limited but then there is another risk as well of debt ceiling. If it lasts a month then it could lead to 1-2 % decrease in the fourth quarter GDP growth in the US, which could impact the demand for Asia. Asian economies like Singapore, Malaysia, Taiwan and South Korea are mostly export intensive and

have biggest share of exports going directly to US would be most affected.

Partial shutdown of the federal govt. would cost the US at least $300 million a day in lost economic output at the start, according to IHS Inc. While that is a very less part of the country’s $15.7 trillion economy, the daily impact of the closure is likely to accelerate if it continues because it decreases investors’ confidence and spending by businesses and consumers.

Massachusetts-based IHS estimates that its expected 2.2 percent annualized growth in the fourth quarter will be reduced by 20 basis points in a week-long shutdown. A 21-day closing like the one in 1995 could cut growth by 0.9 to 1.4 % point, according to Guy LeBas, CFIS (Chief Fixed Income Strategist) at Janney Montgomery Scott.

South Korea’s economy could face some adverse impact if the shutdown is prolonged, it will effect American consumption and the US economic recovery. Internationally, America’s fiscal shenanigans might be particularly harmful for Euro zone countries trying to get their own debt problems under control and strengthen their economic recovery. Instability in the world of financial markets is the last thing that the likes of Greece, Ireland and even France need. And with the UK economy excessively dependent on its financial sector, the storms in Washington DC could turn into a tempest for the City of London.

If the U.S. imbroglio results in a debt default next month, it will serve as a very bad example to EU countries which are undergoing austerity measures to cure their indebtedness.

What it means to India?

1. On macroeconomic front, a prolonged shutdown will affect US growth as well as consumption. This will lead to decrease in Indian exports in the coming months.

2. Closure of non-emergency functions of US government will delay many approvals. To count a few a. Visa issuance and renewals will get

A lengthy default might see money switch into other perceived havens, such as German and Swiss debt

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NIVESHAK

FIN-Q Solutions SEPTEMBER 2013 1. Unit Trust of India -UTI 2. Connaught Plaza Restaurants Pvt. Ltd. CPRL 3. X - Sahara India Y - Optionally Fully Convertible Debentures OFCD 4. IRCTC, maximum number of tickets 5.72 lakh were booked on a single day through IRTCVeto Switch Gears and Cables Ltd. 5. Fast market rule 6. PFRDA 7. LG Electronics 8. Margin Call

A delay in tapering of the plan would raise uncertainty for the US economy and inflows into emerging market would continue including India.

Š FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

accumulated at Embassies. This would impact current deliverables of Indian IT/ITeS companies. b. The commercial harbors do not come under essential services category. So harbor services like unloading of goods, custom clearances etc. would be delayed due to staff shortage.

This may result in huge losses for exporters on economic cost. c. Raising capital in US could take time as processing and approving applications will be discontinued during the shutdown. d. Pharma companies could lose some business as the drug company waiting for a decision from FDA could see delays.Though Indian IT companies have very less exposure to Government backed IT projects, but the shutdown would effects these billings too.

But this shutdown has a positive side too for the Indian market A delay in tapering of the plan would raise uncertainty for the US economy and inflows into emerging market would continue including India.

1. A delayed Fed tapering and higher risk aversion in dollar assets could particularly benefit India with global investors likely to increase their allocation to Indian markets 2. The rupee may gain as the US dollar weakens against the basket of global currencies.

3. The more likely situation is that a default will be avoided, but the fear that is imminent and will keep worrying the investors is that it could easily happen again this time next year.

Foreign creditors willingly lend to the U.S. as they consider it a safe bet in an uncertain world. But if its dysfunctional politics makes it look unsafe, they will look elsewhere.

4. Right now nothing can be said for how long the shutdown will last, it will all depend on how Republicans and Democrats negotiate on the issue. As of now it appears that no one wants to do the talking but Obama will have to do some walking otherwise the consequences will be horrendous.

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Planes of different Feather Flock together Gourav Sachdeva

Do you have an unfinished agenda still?

“Oh yes. I would be a hypocrite if I said I did not.”

So what is it that remains to be accomplished?

“I think it would not be correct at this point in time to talk about what one would have liked to do; it would not be fair to my successor for me to say. I think he has to have his arena to perform in.”

These are the excerpts from an interview that Ratan Tata, the former chairman of the Tata Group gave around three weeks before he retired in December 2012. Today, when the group is moving ahead with not one, but two airline companies, it can be confidently deciphered what he meant when he wrapped his ‘unfinished agenda’ under that “would not be fair to my successor…” blanket. One of their ventures is with Singapore Airlines (SIA) to set up a new full-service carrier (FSC) based out of New Delhi with an initial investment of $100 million of which Tata Sons will own 51% and another is with Malaysia-based AirAsia Bhd and Telestra Tradeplace Pvt. Ltd to form a local low-cost carrier (LCC)—AirAsia India. The latter is still awaiting the Indian aviation regulator’s final go-ahead and has 49% ownership held by AirAsia Bhd, 30% by Tata Sons, and rest by Arun Bhatia of Telestra.

Yet, if we just go a few weeks further into the past, Ratan Tata, in another interview, had said that it was unlikely that the salt-to-software conglomerate is ever going to venture into an airline. He had said, “It (aviation) is a different sector today than it was at that time (1998). It is somewhat like telecom. It is proliferated by many operators, some of them in financial trouble. I would hesitate to go into the

OCTOBER 2013

Team Niveshak sector today in the sense that the chances are that you would have a great deal of competition which would be unhealthy competition.” ‘Destructive Competition’ was the reason he quoted when he added, “Overseas, people go bankrupt or companies go bankrupt. Here they never do, they continue to be sick and still operate. Then they are operating to kill you.”

Do not both the aforementioned ventures run counter to this statement of Mr. Tata? What changed within months in the Indian skies that they suddenly became so attractive to foreign players and domestic giants alike? For the case of Tata alone, it could be two prominent reasons, recalling that the FDI norms were relaxed in September 2012, months before the interviews of Tata – one, Kingfisher was too broke to really offer a competition and was in its deathbed, leaving in its stir injured contenders and creating an opening for aspirants and two, Jet Airways, once the master of Indian skies, was now a shadow of its old self. As a newspaper put it nicely, “There was no Harvard textbook kind of strategizing (in deciding to enter into aviation by Tata). Rather, they were purely opportunistic, made possible by deregulation in Indian aviation.”

Introduction Frank Zappa once said, “A country’s worth something if it has its own beer and airline.” India fits the bill rather too perfectly: it has four privately owned airlines and a national carrier. Till recently, it even had an airline named after a beer!

Before we take off with aviation in India in a broader perspective, one thing remains clear – if there is one

NIVESHAK

Net Revenue, Profit/(Loss), Aircrafts Destinations Flight per day Load Factor, % Market Share, %

Indigo SpiceJet 9,458 5,715 787 -191 70 55 34 54 447 370 80.8 74.31 29.1 17.2

Jet Airways 17,070 -480 120 75 620 78.8 25.1

Air India 16,130 -5,198 108 95 400 64 19.9

Table 1 Relative Position of Various Airlines of India (Figures in INR Crore)

international airlines operate to India and 5 Indian carriers connect over 40 countries. Air passenger traffic in India is increasing on a tremendous pace. The sub-continent’s airport infrastructure is undergoing tremendous overhauling with the introduction of most advanced facilities. It includes setting up of new Greenfield airports and installation of security, surveillance and air traffic navigation systems. Still, the airline seat per capita in India is only 0.07 compared with 3.35 of Australia, 2.49 for the US, 1.38 for Canada and 1.05 for Japan, according to aviation consultancy Centre for Aviation (CAPA).

The Indigo Story – Only Airline Still Flying!

The IndiGo brand of austerity is the hallmark of every successful global low-cost airline. The airline has shunned frequent flier programmes, airport lounges, special check-in counters for a particular class of passengers and TV screens on board. It is, perhaps, to silence their critics that the otherwise subtle Indigo Airlines publicly announced its net profit to the tune of INR 787 crore for the year ending March 2013. Not being listed on the bourse does not compel the company from going public with its numbers. To put things into right perspective, Jet Airways, SpiceJet and Air India, in the same period, posted a collective loss of INR 5,869 crore. The traffic for Indigo increased by 27% while it fell by around 5% for the industry. The depreciated rupee and increased fuel prices could not deter the airlines to

post a six-fold increase in its numbers.

Enough of the Indigo praises already? What about the critics who remain unconvinced by Indigo numbers and claim that the company generates profit by entering a sale and lease back deal with aircraft manufacturers? Well, the company released its operating profit data at INR 1,758 crore on an operating margin of 18.6% (For newbies, this number is calculated before taking sale and lease back benefit). Compare that with Jet Airways’ reported operating margin of 7%, or with SpiceJet which is barely profitable at operating levels.

There are a slew of measures behind this exceptional performance of Indigo which stands as the sole soldier in a Warfield when all its foes and friends alike are falling apart. The airline did not enter into price war when every other airline was rooting on Kingfisher’s fall to earn numbers and it continues to stick to its operating format. Indigo, in cricket parlance, has stuck to its basics by taking singles.

To be precise, Indigo has stuck to its low-cost model rather than moving onto low-fare model. It operates just one type of aircraft which facilitates interchangeability of crew members, thereby cutting on hiring, training, and upgradation cost of staff.

Indigo carries more passengers per plane (indicated by higher PLF) and its planes make more trips per day. This is possible since the airline has one of the best turn-around times (time taken between landing and the next take-off) of 30 minutes. And how is that made possible? Indigo is probably the only airline in the world to use sloping ramps to enable passengers enter and exit its planes instead of staircases. Stairs cause delay especially when children, older people or those with luggage are using them. Low sloping ramps are not only fun, but also result in a smooth flow of customers. So, there are smaller details being taken care of behind that stellar performance is delivered quarter after quarter. And there are more!

Indigo’s pilots switch off an engine when taxing the runway, thus reducing fuel cost. They plan the flight and airplane speed in such a way that fuel is not wasted in circling over airports, especially busy ones like Mumbai. Even their sale and lease back policy is valid for six years, after which the aircraft is changed. This means lower maintenance because of a younger fleet.

The Jet-Etihad Deal Etihad airlines, national airlines of UAE, purchased a significant minority stake in only private FSC of India around September this year. Under the said deal, Etihad will invest USD 600 million in Jet Airways including an equity investment of USD 379 million, giving Etihad Airways 24% of an enlarged share capital of Jet Airways. Etihad’s investment was made possible since India recently, after much delay,

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sector that probably makes more news than any other in India, it has to be the one we are talking of here. Marred by heavy losses on one hand and elated by entry of new players on the other, this is a sector that sends out contradictory vibes like no other! There is no doubt about the fact that aviation brings about enormous benefits with itself to communities and economies around the globe and that it is a vital catalyst of economic growth, social benefit and tourism.

India is currently the 9th largest aviation market handling 121 million domestic and 41 million international passengers. Today, more than 85

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moved to allow expanded foreign airline ownership of Indian carriers. Ironically, the long delay in introducing the change was mostly due to Jet Airways’ influential opposition, as it feared that its own position would be eroded if other airlines like Kingfisher were strengthened by receiving foreign airline support.

Now, in the current circumstances, with Kingfisher out of the picture, the impact of the Etihad-Jet combination will be devastating for the country’s largest international carrier, Air India, just as it was starting to show signs of improvement.

To sweeten the Etihad and Jet partnership, the UAE and India signed a bilateral agreement to increase the number of seats available each week on flights between India and the Emirates to 50,000 from 13,330 over the next couple of years.

With now the largest FSC effectively establishing its base at Abu-Dhabi, Kingfisher long since grounded and Air India struggling, there is no longer an Indian carrier with the ambition and capability to support the development of hubs at Delhi and Mumbai Airports. This surely has implications for the private operators of India’s gateway airports and for future airport investment.

Air Costa takes off This no-noise domestic airline flew its first (of the just two that it currently has while it waits for the third one) Embraer jets on 15th October 2013.

Claiming to be India’s first regional airline, Air Costa, promoted by a little known infrastructure company LEPL Group Ltd, plans to invest $150 million in the next two years. It plans to go pan-India by 2015 and global by 2018. Given that the annual growth rate of air travel stands at 20 per cent and air traffic expected to cross 70 million by 2014, the company believes that the underserved and lesser competitive routes between bigger and smaller cities have higher demand in terms of revenues per kilometer and has based its business model on the same philosophy. It will initially serve Vijayawada, Hyderabad, Chennai, Jaipur, Bengaluru and Ahmedabad.

No matter, how humble the beginning, it will be interesting to watch the growth of this regional airline, in the hands of an aviation first timer.

New Giants on the block!

The role of Tata in entire aviation business is still mysterious in ways more than one. The group already holds small minority stake in Spicejet and is now coming up with two new airlines altogether! As shown in the info-gram alongside, the airlines fill in the missing link in the Tata’s aviation business. And it is not for the first time that Tata is trying to enter into an airline business. Not even counting the Tata Aviation Service (a forerunner to Tata Airlines which

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became Air India in 1946 when it went public and was later nationalized against the wishes of JRD in 1953) that marked the birth of civil aviation in India in 1932 when JRD Tata himself flew from Karachi to Mumbai, there were at least two other occasions when the house of Tatas seemed eager to enter the skies – once in 1990s when it partnered with same Singapore airlines to start a new airline but its application could not move beyond foreign investment promotion board and then in 2001, when its bid to buy 40 per cent in the state-owned Indian Airlines was thwarted. Indeed, Ratan Tata’s enthusiasm for aviation is no lesser renowned — FlightSafety, the Warren Buffet-owned aviation training company, uses Tata’s endorsement as the first testimonial on its website — but the airline business remained elusive while he held the group’s reins. The closest he ever got to the business was when he briefly led Air India as nonexecutive chairman in the eighties.

His dreams are finally taking shape now when he can only smile from behind the curtains!

The Tata-SIA and Tata-AirAsia partnerships,

Table 2 The Tatas in Aviation; Source – Economic Times

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five years as mandated by current regulations (which do not permit an airline to fly internationally till it has met two primary conditions: five years of domestic operations, and a fleet of 20 aircraft). Let us not forget that LCCs -- IndiGo, SpiceJet, Jet Konnect and GoAir - enjoy over 60 per cent market share, while the legacy carriers Air India and Jet Airways account for just the rest 40%. It is, but natural then, to question the profitability of Tata-SIA new airline which will be serving only a part of the under-40 per cent segment of the domestic market. If the rule of not going international before 5 years of domestic flying is relaxed (which may actually be the case seeing the excitement government seems to be in promoting aviation business), Tata-SIA may get a much needed boost. Also, the same skeptics concede that Tatas have the advantage of managerial expertise of SIA, one of the world’s most respected airlines, as well as its own financial strength. Taina Erajuuri, a Helsinkibased portfolio manager at FIM India, which owns shares in Tata Consultancy Services and Tata Motors, said, “Tata is famously called the salt-to-software conglomerate. They manufacture Jaguars and Land Rovers and the cheapest car globally — Nano. The execution in all these businesses has been spot on.

Hence, creating a new vertical through airlines is unlikely to be an execution challenge. They believe in creating a strong layer of management.”

The Last Word The Indian skies are unforgiving. But as a group, none other than Tata commands the same respect and dignity. The employee friendly perception, amazing management understanding, a knowledge power-house about the sector in the form of Ratan Tata (few in India can boast of such knowledge about aviation as him) and deep pockets give them unmatched head start in this business. However, it would be nothing short of utopian to imagine that the sailing will be smooth, especially after what the history books show us about various players. Indian consumers can be toughest in the world to woo, if they show their true colors!

According to Consulting firm CAPA, India’s aviation industry would have to eventually move to a hybrid business model, combining low costs and premium services given the country’s limited market for fullservice airlines.

In the light of all that’s happening, would we be wrong to think that situations could actually dramatically improve for everybody if, instead of all these new airlines cropping up and Air India going down, Air India was handed back to Tatas to run and turn profitable?

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mentioned in the opening remarks of this story, have the potential to be the game-changers for Indian aviation. Important questions first – What are the chances that the two proposed airlines will be a success, especially since (a) Indian aviation is usually considered an unattractive industry, (b) ATF is considered the only cash cow for oil companies which pass-on all price increases plus more to the airlines regularly, (c) airports, driven by huge investments in new infrastructure are constantly trying to raise airline and passenger user charges, and (d) buyers in India are extremely price conscious and offer no respite to full service carriers? Add to it the perishable nature of offering (the seats) and perceived lack of differentiation and you have an extremely tough environment to steer your business through.

With the exception of Indigo, any other LCC has not really succeeded in India. The pioneer Deccan was sold off to Kingfisher which later became grounded and Spicejet’s southbound fortunes have made auditors question its ability to be treated as a going concern already.

All the above facts make us suspect that, contrary to what Tony Fernandes would like us to believe, AirAsia would make a stormy entry into Indian market. It will take quite some years before it is at same footing with home-grown Indigo in terms of operational excellence and hence, operating profits.

What remains to be seen, then, is what happens with Tony’s comment regarding making profits the very first year in India.

Talking about the Tata-SIA FSC, the only plausible reason that can be offered is the increasing influence of Etihad and Emirates in India which threatens Singapore airport’s aspirations of becoming entry hub for south-east Asia (it is an altogether separate issue that India also once shared the same aspiration and was perhaps more strategically located to become that hub as well but for the series of wrong steps that it can’t even be considered in that race anymore). It remains to be seen in this case if the proposed airline leads to a grant of additional seats on the India-Singapore sector for Singapore Airlines in a manner similar to what has been done for Etihad airlines.

Some analysts have also raised questions about the viability of two airlines being run by same business house. Their fears are not misplaced as evidenced by the frequent objections raised by erstwhile Indian Airlines about Air India’s domestic operations; and Air India did the same with regard to Indian Airlines’ international flights on the grounds that it was hurting its commercial interests by charging lower fares. More so when the full-service Tata-SIA airline will also fly only in domestic skies at least for coming

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SEBI: MF Advisory GUIDELINES

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A. Sindhuja & Bhairav Mehta

IIM Raipur Introduction World over, Mutual Funds (MFs) have played a remarkable role in defining the financial topography of the investors. Myriad changes are taking place with respect to the mutual funds settings in India. In spite of being one of the safest investing avenues, MFs have failed at the doorstep of the Security and Exchange Board of India. It has now come up with a proposal for the amendment of the regulatory framework (Mutual Fund Regulations, 1996) concerning mutual funds in India. These amendments are based on the recommendations given by the Mutual Fund Advisory Council.

Current Scenario

Fig 2: AUM based on Geography as on Dec’12

Fig 3: Net flow of assets per year

Fig 1: shows that the Asset under Management (AUM) in India has been steadily increasing.

AUM saw a drop in the year 2010 and 2011, it has been on the rise again since 2012. This is a healthy sign for the mutual fund industry.

Another important observation which can be observed in Figure 2 is that a major chunk (almost 85%) of the AUM is being contributed by the top 15 cities. Low penetration has marred the growth of the mutual fund industry for a long time now. One of the major aims of SEBI with its new set of guidelines is to reach out to the smaller investors in the Tier III, IV and V cities.

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Also to be noted is the AUM/GDP ratio for India (Figure 4) which is very low when compared to the rest of the world. The ratio for India is a mere 4.7% while for US it’s a staggering 77%.

So there lies a huge scope for investments in mutual funds. SEBI with its newer guidelines would be hoping that it will be able to provide a major boost to the mutual funds industry in India.

Fig 4: Country wise rate of AUM vs GDP

GUIDELINES- WHAT’S NEW? Total Expense Ratio (Ter) Under the new advisory guidelines of SEBI for the mutual fund industry, the Asset Management Companies (AMC) will be allowed to charge an additional expense ratio of up to 0.3% if 30 % of the net sales or 15% of the AUM (higher of the two) comes from beyond the top 15 cities (based on the Association of Mutual Fund in India’s data about the AUM under geography).

If the net inflow from cities other than these 15 cities is lesser than 30%, then the proportional amount can be charged as an additional TER (on the whole corpus) by the AMC’s. However, if the amount invested is redeemed within a year then additional TER can be reclaimed.

Service tax of 12.37% on advisory fees and investments which was previously borne by the AMC’s now has to be borne by the investors.

This is in congruence with SEBI’s move to bring the mutual fund industry at par with other sectors.

IMPACT A point of concern is that it will be difficult to put the proposal to practice, as certain distributors in order to take advantage, might give address of the investor (who actually belongs to one of the fifteen big cities) as cities which might not be a part of the 15 big ones. Also the burden of increasing the penetration will go down on the existing investors.

The additional TER of 0.3% and the service tax will result in overall increase in the cost by around 0.4%. This may not be a burden on the schemes which have been continually performing well and giving returns of around 10%, but for the schemes which have not been doing well.

Additional TER will further hurt the investors of MF for whom the returns are already low but it will encourage the AMC’s to better their distribution network and further expand their reach geographically.

Concentration in certain major cities and low penetration has been pain points for the industry for a long time now. So the new guidelines will come as a breath of fresh air for the AMC’s and it will serve as an incentive for them to reach out to the Tier II and Tier III cities. Though the investors will be hurt by the increase in TER in short run, they will be benefited by the increase in AUM in long run.

Single Plan Structure For bringing all the investors under the same expense structure, SEBI has made it compulsory for all AMC’s to have a single plan structure for both the existing as well as new schemes.

The present schemes which have been issued with multiple plans based on the amount invested (retail, institutional or super-institutional) will have to accept payments under one plan only.

IMPACT Equity funds are rarely offered under multiple plan schemes. It’s the debt funds that are offered under multiple plans. So the single plan structure will affect the debt funds more.

Some funds have chosen to continue with the retail plans whereas some have gone for the institutional plan. In case of the latter, the minimum investment amount has been reduced.

The discontinuation of any plan will not affect the already existing investment as people can redeem their investments anytime they want. Also, where the investors have chosen Systematic Transfer Plan (STP) or Systematic Withdrawal plan (SWP), such schemes will be continued till they have sufficient balance under the plan.

The single plan structure won’t have any major impact on the retail investors. Also various categories of investors will not be differentially

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treated anymore. The role of a fund manager will become crucial.

Direct Plan To encourage direct investments in the mutual funds, SEBI has mandated that each scheme in mutual funds will also have an equivalent direct plan. This direct plan shall eliminate the distributor and shall also have a lower expense ratio as no commissions will be included in the expenses. As a result it will have a separate NAV compared to the normal scheme. Also the direct plan will be implemented on both the new as well as the existing schemes.

IMPACT A direct plan without the commissions will definitely reduce the costs and will make for a better return to the investors. It might lower the expense ratio by about 0.75%. A direct plan with its lower costs will definitely attract investments from self-investors.

Even though the MFs are relatively simple investment medium, investing in them is a bit tricky. So if an investor chooses to go for a direct plan then it might not be all that easy.

The investors have multiple plans and schemes to choose from. Also, maintaining a balanced portfolio is not that easy. So the entire process might be cumbersome. Investors may also require help to handle a variety of service requests throughout the investment time. In a normal scheme, all these activities are taken care of by the advisors.

The distributors might not be too happy with the direct plan as they feel that many investors will go for the Direct Plan and as a result they will be losing a sufficient amount of business.

So if one is confident to invest on his own then Direct Plan definitely offers an attractive route as costs involved will be much lower. But it is a double edged sword as it might prove to be costly in the long run. Therefore, it is important for the investors to find out the actual involvement of their advisor before choosing the Direct Plan.

Product Labeling & Focus On Investor Education SEBI has mandated that from now on the Fund houses will have to label their products based on their risk and return. All the products will come with a color code signifying the amount of risk associated with them. Mutual funds will also have to include a statement of objective for the scheme followed by the type of product.

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The different color indicators will be blue for low risk, yellow for medium risk and brown for very high risk. There will also be a disclaimer stating that investors need to consult their advisors in case they are not clear on the suitability of the product.

Also, financial literacy ratio and lower awareness have hindered the inflow of household savings into mutual funds. SEBI has made it compulsory for the AMC’s to keep at least two basis points of their daily net assets for the campaign to spread awareness among the investors. The AMC’s are also required to make disclosures regarding the awareness campaign.

IMPACT The product labeling will help the investors to choose the fund according to their risk profile.

It will also help to determine the suitability of products to different customer classes and objective of the scheme whether it is intended for wealth creation or providing regular income depending on the timeline. All this, in turn, will help in reducing the chances of miss-selling by the agent.

If the amount to be kept aside for the investor education is spent in a careful and well thought out manner, it will not only lead to expansion of the customer base but will also help the investors to take informed decisions and thus reap in greater profits from their investments.

Exit Loads Before the investors were charged with exit load, if the amount of investment was redeemed before one year, then this exit load payment was used by the AMCs for marketing and distribution.

But now SEBI has mandated that the whole of exit load will have to be added back to the corpus. However, the guidelines allow the AMCs the liberty to include a maximum of 20 bps in the expense ratio to overcome the loss due to exiting investors.

IMPACT This move will be beneficial to the continuing investors as they won’t have to feel the brunt of the outgoing customers. The NAV of the scheme will rise due to the amount going back to the corpus. But at the same time the guidelines have also allowed the AMC’s to recover the amount by giving them the choice of increasing the expense ratio by about 2 bps. So overall the effect remains the same. The part coming to the distributors from the exit load will no longer be

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products.

IMPACT This easing of registration and allowance to transact in cash up to INR 20,000 per financial year will no doubt help the mutual fund companies to attract smaller investors. In India there exists a sizeable population with lower income levels. So the new guidelines will definitely help the mutual fund companies to tap into the market of smaller investors. One caution with this regulation is that chances of miss-selling might increase as the investors might not have the sufficient knowledge and awareness of the different schemes.

Steps To Improve Regulations One of the major reforms required in the mutual industry is in relation to the regulation so that the whole industry can become more transparent and efficient. In congruence with the requirements SEBI has mandated that the AMC’s are required to upload their half-yearly results along with monthly portfolio disclosures on their websites. AMCs also need to provide the details of the net inflow and gross inflow based on the distribution. Along with it, SEBI has asked its panel to look into the regulatory framework in other countries like US and UK so that the whole mutual fund industry can expand and at the same time become more efficient.

Conclusion In short term the investors will be hit with the increase in expense ratio and their returns will be marginalized. This will definitely create a big impact on the investors as the costs will increase.

In spite of the expense ratio increasing, there are some definite positives for the long term.

The amendments such as exit load, single plan structure, cost-effective direct plan, introduction of product labeling and improvements in regulation will give the investors something to cheer about. Also, steps to expand the network, easing of the KYC norms, relaxed distribution registration process might go a long way to increase the geographical footprint of the mutual fund industry in India.

Mutual funds for long have been waiting for reforms that will increase the inflow of funds and make them most preferred investment avenue and SEBI with its new set of guidelines might just have given the boost required for the industry to prosper.

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available and hence distributors have a reason to feel dejected.

Smaller investors who were previously affected due to the moving out of the bigger investors will welcome this amendment in the exit load rule as now they won’t be as vulnerable as before due to the exit load going back to the corpus.

Role Of Advisors The advisors will now need to have a minimum qualification without which they won’t be eligible to provide their services. The role of the advisors will be defined by SEBI. All advisors need to register with SEBI and conform to all the rules and responsibilities defined for them. The advisors will be free to charge their fee from their client but will no longer be eligible for the commissions from the AMC’s for the sale of their products.

IMPACT This will come as a relief for the investors.

Since the advisors won’t be able to receive any commissions on the products sold, so there is a high probability that miss-selling will come down to some extent. Also it will help the investors in distinguishing genuine advisors and will bring in a certain amount of transparency in the advisory system. Quality of service is also expected to improve due to the minimum qualification clause. The new guidelines aim to develop sound advisors instead of mere product pusher. But it will be interesting to see as to how many investors would be opting to go for advisors as in general investors do not pay advisory fees for financial products. It will be sometime before the whole advisory models takes shape becomes effective.

Encouraging Smaller Investors The compulsory requirement of having a PAN or a bank account has been relaxed and the smaller investors can have transactions in mutual funds up to INR 20000 in cash per financial year. This has been done so that the MF companies can target the Tier IV and Tier V cities to increase their geographical footprint and expand their customer base.

Also to make the distribution network wider and more efficient and to ease the distribution registration process, the distributors will include personnel such as retired government official, bankers, teachers and other people from similar profession for the distribution of simple

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1987

Article of the Month Finistory Cover Story

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STOCK MARKET

CRASH

1987 BLACK MONDAY Ashish Singla

IIM Shillong

Stock market is a world of fluctuations and speculations in which value of a stock rises or falls multiple times during a span of a day. One of the major instances when stock market around the world crashed within a short span of time was on Monday, October 19th, 1987. Its impact was much larger than the one which happened in 1929 and it sent the world into a great depression which lasted for a decade. This day is memorized as a Black Monday in history of the world. The crash began in Hong Kong and then spread west to London, Paris, and then hitting the United States after other markets had declined by a substantial margin.

One of the key market indicators was drop of Dow Jones Industrial Average (DJIA) by 508.32 points to 1738.74 (22.61%). In the Wall Street history, it was the worst week and in the aftereffects many people wondered anxiously if a global economic catastrophe would follow. According to Facts on

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File, which is an authoritative source of currentevents information, the crash in 1987 marked the end of a 5-year ‘bull’ market which had seen the Dow rise from 776 points (August 1982) to a high of 2,722.42 points (August 1987).

Contrasting with the happenings in 1929, the market recovered partially after the crash. Very next day, it posted a record one-day gain of 102.27 and gain of 186.64 points on Thursday.

It took two years for the Dow index to recover completely. By September 1989, the market had recovered most of its value that it had lost in the ‘87 crash.

Timeline & Impact of The Crash • Wednesday, October 14 – Friday, October 16, 1987 Wednesday: Two events that happened on Wednesday morning can be thought upon as starting of the decline in the stock market which continued for the rest of the week: 1. Ways and Means Committee of the U.S. House

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of Representatives filed a legislation to eliminate the tax benefits associated with mergers and acquisitions. Stocks’ values were re-examined as investors reduced the odds that certain companies would be take-over targets.

2. Commerce department announced trade deficit which was above expectations. Due to this, dollar declined and expectations of tightening of policy by Federal Reserve increased. Downward pressure on equity prices increased due to rise in interest rates.

Thursday: On Thursday, October 15th, 1987, equity markets declined continually. Some of this decrease was due to anxiety among the institutions, especially towards pension funds, and among individual investors, which led to the movement of funds from the stocks into relative safety investments, bonds. There was heavier selling of the stocks during the last half an hour of the day.

Friday: Due to the anxiety created in the market and high selling of the stocks, markets continued to decline on Friday too. Lot of stock index options expired and investors started to invest more into the futures market where they sold futures contracts as a hedge against falling stocks. Due to the increase in the sales of futures contracts, price discrepancy was created between the value of the stock index in the futures market and the value of the stocks on the NYSE. By the end of the day on Friday, with the S&P 500 down over 9 per cent for the week, markets had fallen considerably. These were

signs of huge market fall for the next week.

On Monday morning, there was huge selling pressure and there was large mismatch in the number of selling orders as compared to the buy orders. Due to this, many stocks did not open for trading during the initial hours. According to the Wall Street Journal, around 11 of the 30 stocks in the Dow Jones Industrial Average opened late.

With some of the stocks not trading, the quotes used to construct market indexes were fusty, so the values of these indexes did not decline as much as they might have. On the other hand, the futures market opened on time with heavy selling.

With stale quotes in the cash market and declining prices in the futures market, a gap was created between the value of stock indexes in the futures market and in the cash market.

Due to huge selling, equity prices started to drop during the latter half of the trading. The Dow Jones Industrial Average, Wilshire 5000 and S&P 500 declined between 18 and 23 per cent on the day amid deteriorating trading conditions while the S&P 500 futures contract declined 29 per cent.

• Tuesday, October 20, 1987 Before the financial market got opened on Tuesday, Federal Reserve issued a statement stating that National Central Bank will try to maintain liquidity in the market in order to support the economic and financial system. This was issued to support the market sentiments which was not in favour of the then current conditions. On Tuesday, around 7% of the stocks

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Fig 1:Other Impacts

were closed for trading. Before the trading got started, the NYSE moved to prevent index arbitrage program traders from using DOT system to execute trades, which might have affected the depth of the market.

On October 20, two CME clearinghouse members had not received margin payments due to them by noon, which started buzzes about the solvency of the CME and its capability to make these payments. These rumours proved baseless, but nevertheless reportedly discouraged some investors from trading on the CME. Bid-ask spreads broadened, and trading was characterized as disorderly.

Due to number of trading halts on the NYSE for individual stocks and also due to the possibility that the exchange might close, trading of many stock-index derivative products was adjourned on the Chicago Board Options Exchange (CBOE) at 11:45 am and on the CME at 12:15pm. These closures completed de-linkage between the futures and cash markets and stocks on the NYSE began to rebound.

However, the stock market declined again once the futures markets re-opened just after 1:00 pm.

Later in the afternoon, there was a sustained rise in financial markets as corporations announced stock buyback programs to support demand for their stocks.

Causes of Stock Market Crash • Computer Trading/Program Trading Many of the investors think that computer

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trading (also known as program trading) was one the main reasons for the stock market crash. In program/Computer trading, computers are programmed to order large stocks in case certain market trend follows. Many people blamed trading strategies for blindly selling of the stocks when market fell, which further exacerbated the decline. Some economists also think that the speculative boom leading up to October was also caused by program trading. • Illiquidity During the Crash, there was a large flow of sell orders and the trading mechanisms in financial markets were not able to deal with these flows.

Most of the common stocks were not traded until late in morning of Monday, October 19, because the investors were not able to find enough buyers to purchase the amount of stocks that sellers wanted to sell at certain prices.

As a result of this, trading was terminated in many listed stocks. Due to this, price quotes for stock and stock indexes were not reliable.

This insufficient liquidity had a significant effect on the size of the price drop, as investors had overestimated the amount of liquidity. • Derivative securities Another cause of stock market crash was the failure of the synchronization between index options and future markets and the stock markets. In case of stock markets, people actually buy shares but in case of derivatives

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prevent further crashes like this, following steps were taken: • Margin Requirements: The SEC modified the margin requirements in order to lower the volatility of common stocks, stock options, and the futures market.

• Circuit Breakers: The New York Stock Exchange and the Chicago Mercantile Exchange (CME) presented the concept of a circuit breaker. The circuit breaker halts trading on both of these exchanges for one hour if the Dow fall more than 250 points in a day, and for 2 hours, if Dow fall more than 400 points.

• New Computer Systems: Stock exchanges were changed to adopt new computer systems which increase data management effectiveness, accuracy, efficiency, and productivity.

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people only purchase rights to sell or buy the stocks at a particular price in future.

• U.S. Trade and Budget Deficits Another possible cause of stock market crash is the announcement of U.S. trade deficit on 14th October. It led to the fear that dollar will fall on foreign exchange markets. Thus the fear of a dollar loosing value led the foreigners to pull out of dollar-denominated assets, leading to a sharp rise in interest rates.

• Overvaluation Many analysts agree that stock prices were overvalued in September, 1987. Price/Dividend and Price/Earnings ratio were too high during that period.

Factors Responsible For Stabilization Of Crash According to some of the analysts, crash could trigger a recession. But fallout from the crash turned out not to be much large. There were multiple stabilizing factors which helped to minimize the effect of crash on economy: • Federal Deposit insurance: In 1929, people had made a run on the financial banks. But this time, banks seemed a far safer repository for savings than the stock market.

• Quick response of Federal Reserve – In 1929, Federal Reserve was strongly criticized for shrinking supply of money and credit into the market which exacerbated the financial debacle.

But this time reserve made money available as much as required. It pumped enough money into the banks which led in the drop of the interest rates.

• Government response: After denying for few days that the crash was anything worse than a correction, President acknowledged that federal deficits were one reason for market crash, and indicated that he would go for a modest tax increase as part of a deficit-reduction package.

Conclusion The stock market crash of 1987 was a blow to the stability of the financial system, not just because of the size of the drop in price, but importantly because market functioning was significantly impaired. Though stock market crash of 1987 was severe in nature, but due to government policies and interventions at right time, the world was saved from falling into the great recession. The market began a slow and steady ascent almost immediately following the crash. In effect, before the end of 1989, the Dow Jones Industrials was once again setting new record highs. In order to

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New Banking Entrants The Road Ahead Rohit G. Mehboobani & Kartik Sharma

IBS, Hyderabad

The Reserve Bank of India is once again poised to give banking licenses and has already received 26 applications in June 2013 for the same. The RBI has been issuing new licenses from time to time since 1993.

But the question to be asked is will the new banks preparing to enter the market be as successful as their predecessors like HDFC Bank, ICICI Bank, etc.?

Who are the New-Generation Banks?

The New-Generation banks referred here are the banks which have come into existence after 1992-1993 up to 2003-04. Some of these banks were merged with other banks either voluntarily or compulsorily. The prominent new generation banks are HDFC Bank, ICICI Bank, Axis Bank, IndusInd Bank, Kotak Mahindra Bank and Yes Bank.

Success of existing New-Generation Banks: To look how successful these New-Generation banks have been we need to see how they have captured around 14.5% of total bank credit in 2012 from next to nothing in 1993. To put that in perspective, the total credit of the New-Generation banks is at Rs.736300 crore as in 2012. The New Generation banks had a phenomenal rate of growth over the years.

These banks expanded both organically as

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well as inorganically, absorbing banks and other financial institutions, and setting up new branches across the country. They provide end to end services and solutions to their customers. These banks are also among the most profitable banks in the industry today.

Challenges in matching the success of New Generation Banks The new banks will have a herculean task of meeting the same kind of success of the likes of HDFC Bank, ICICI Bank etc. This is partly because of the different conditions put forward by RBI this time, increased regulation, and also prevailing market conditions and competition. Some of the difficulties which the new banks will be facing are as follows: RBI rules on opening branches in unbanked rural areas: The new banks would have to compulsorily open 25% of their branches in unbanked rural areas with population of less than 10,000. This would be a drag on these banks profitability. RBI in the past required New-Generation banks to have 25% of their branches in Semi-Urban areas, with population up to 100,000 persons. Also these places need not have been unbanked,

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with respect to the existing banks at that time. This would be hard to replicate for new banks today because of the presence of high service quality offered by private banks and improved service offerings by public sector banks as well.

Public Sector Banks better equipped to handle competition: Another important thing to consider is that the public sector banks in the early 1990s were not used to competition. The new generation banks were able to out manoeuvre the slower and more bureaucratic public banks, enabling them to eat into their market share. Today the PSU banks are more competitive and have learnt to live with competition. They have upgraded their technology and have reduced employee costs. With the presence of private banks, the market has become highly competitive.

It will be difficult for the new banks to handle the competition.

Difficulty in raising CASA and high cost of funds: The new banks would also find it more difficult to raise low cost funds in the form of Current account and Savings Accounts (CASA). After the deregulation of savings bank interest rates, many banks have substantially increased the interest rates on savings bank accounts. Some potential exists in rural areas which still have low amount of deposits but achieving a large scale would be difficult. It would take time for these banks to create a large enough branch network to attract large amount of CASA. Hence, the new aspirants would face higher cost of funds in the initial years because of both more costly CASA as well as lower levels of CASA. Promoter shareholding requirements: RBI has directed that new banks should bring down promoter stake to 40% within 3 years, 20 % in 10 years and 15% within 12 years from getting a license. Considering the condition put on financial inclusion and lower CASA, promoters may not be able to get attractive valuation for the bank in this time frame. On the flip side this may lead to promoters’ not following best industry

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so the private sector could open branches in lucrative semi urban areas too. This enabled the older new generation banks to open in suburban parts of large cities and still fulfil their financial inclusion obligations, which will not be the case for the upcoming new banks.

No concession on CRR, SLR, etc.: RBI also said in a circular to the new aspirants that no relaxations would be provided with regard to CRR, SLR or other conditions. These banks would need to conform to CRR, SLR, and Branch presence from day one. While in the past the RBI allowed the new generation banks some relaxations regarding to CRR, SLR, promoters shareholding requirements etc. With these conditions, new aspirants may find it difficult to be profitable in the initial years.

Conditions on conversion of NBFCs: Existing NBFCs would find it difficult to convert to banks because of CRR, SLR, branch & other requirements, without relaxations from RBI. RBI also said that different banking groups would have to maintain all lending activities of the group within the bank itself (except for those activities that banks are not allowed to do). These conditions were not present or were relaxed for banks like ICICI Bank, HDFC Bank, Kotak Mahindra Bank.. This would make it difficult for the new banks to attain a large scale as large NBFCs will find it difficult to convert to a bank.

Saturation of Urban Markets: Today majority of bank’s lending is in metropolitan and urban areas. These markets are already saturated with both private and public banks, increasing their branch presence in these areas over the years. Banks have increased their quality of service over the years.

Private Banks initially attracted large number of customers because of the difference in their service quality

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NIVESHAK

practices and follow strategies which are riskier to improve performance in the short term.

Large corporates already well banked: Large corporates form a major part of loans for banks like Axis Bank, Yes Bank, ICICI Bank, HDFC Bank. These banks provide various solutions like Cash Management Services, treasury services etc. Also the new banks would not be able to match the cost of funds of other banks that have much larger branch networks. With long established relations present, new banks would find it hard to attract large corporates.

Advantages new banking aspirants have The new banks do have some things going in their favour. There are still opportunities for them to grow. Some of the factors favouring the new banks are: Large economy & favourable macro factors: There is still plenty of room for growth of banks in India. Credit penetration in India is still quite low. There are many regional imbalances in credit growth. With the growth of GDP and money supply in the country there is a large scope for banks in general to increase their presence. This is especially true for suburban and rural areas where credit levels are very low. This presents an opportunity for all banks in general to grow in the country.

Large NPAs in the banking system at present: Considering the slowdown in the economy, NPAs or non-performing assets at existing banks are set to rise. At this time new banks would have a clean balance sheet. These banks would be more cautious in giving loans and grow their books with better quality assets. This would enable them to enjoy clean growth in the initial years.

PSU banks under-capitalized: Considering tighter norms prescribed by RBI regarding restructured loans, increasing pressure on asset quality, increase in capital requirements, etc., several public sector banks would become undercapitalized and require equity infusion from the government.

In the interim, they would have to slow their balance sheet growth till capital is infused.

This could create a gap in credit which could

OCTOBER 2013

be exploited by the new banks.

Migration to Advanced approach in risk management: The new banks would also find it much easier to migrate to advanced approaches in risk management. This would enable them to increase their leverage and increase the size of their balance sheet. Existing banks would take a longer time to implement this because of technology, cost and implementation issues. Advanced approach would also give banks a better understanding of the risk they are taking. Thus the new banks could have a slight advantage in this regard.

Latest Technology: The new banks would also have superior technology compared to existing players which could help them manage costs. Like Private Banks entry forced PSU banks to upgrade technology, so will new banks force existing banks to upgrade technology. This difference would not be as sharp as what was witnessed in the past but the new banks would still have a technological edge.

Mergers & Acquisitions: Mergers and acquisitions by new banks of some of the old private banks could help them achieve substantial scale. Acquisitions and mergers might make more sense for these banks rather than older players.

However, this is something which is hard to predict and would depend on a host of different factors. But the new banks’ success would strongly depend on their success in the M&A game.

Conclusion In the end considering all factors, new banks could be quite successful, probably not as successful as their predecessors.

Their prowess in mergers & acquisitions and technology could play an important role in their success. But even more important would be their ability to make rural banking viable. If these banks could tap the rural markets they could be extremely successful on multiple fronts. Financial inclusion is probably the biggest challenge but also an opportunity for the new banks. Even so the success of the existing new generation banks would be difficult to match.

NIVESHAK

Hedge Funds JoAnne FernAndes.

IIM Shillong

Sir, recently a friend of mine was appointed as a hedge fund manager with XYZ Securities Ltd. Can you explain what is hedging and what are hedge funds?

Hedging can be thought of as an insurance. It means controlling or reducing risk by using instruments to offset the risk of price fluctuations. However, a hedge fund involves varied investment techniques such as long and short positions, use of arbitrage, buying and selling of undervalued securities, trading in options or bonds, and investing in almost in any market opportunity where it foresees impressive gains at reduced risk.

Some hedge funds focus on maximizing returns on investment with an aggressively managed portfolio of investments.

Then, why is it called a “hedge” fund?

The idea was conceived in order to generate positive returns without taking into account the market movement. As the name implies, these funds often try to hedge their investments in the principal markets they invest in by using different methods. Over the years, it has been applied to many funds that actually do not hedge their investment and in fact use hedging that increases the risk instead of reducing it, while at the same time increasing the expected returns. Eventually these funds have become more and more varied in style Sir, the hedge fund sounds similar to the mutual fund. What is the difference between the two?

Hedge funds focus mainly on absolute returns whereas mutual funds focus on relative returns. Unlike mutual funds which are setup in a risk controlled environment, hedge funds are unregulated. Hedge funds can invest in any asset class such as stocks, bonds, real estate,

commodities, and private partnerships, or even in exotic debt products. Also, hedge funds are open only to accredited investors.

Sir, who qualifies as an accredited investor?

Presently, if you can meet one of the following criteria, you are an accredited investor: • Earnings of an individual income exceeding $200,000 per year, or cumulative income of $300,000 in last two years and expect to reasonably maintain the same level of income • Have a net worth exceeding $1 million, either individually or jointly with his or her spouse • Be a general partner, executive officer, director or a related combination thereof for the issuer of a security being offered Sir, if I may interrupt, could you explain what do you mean by general partner?

The general/limited partnership model is the most common structure for the pool of investment funds that make up a hedge fund. In this structure, the general partner assumes responsibility for the fund operations, while limited partners can make investments into the partnership and are liable only for their paid-in amounts. It is common for new hedge funds to open up with minimum investments of $250,000 or $500,000. Established funds can have much higher limit which can go up to $10,000,000. The GP can also waive this limit. This is done for investors who do not want to start with large investment but rather intend to make an investment equal to or greater than the stated limit over the time.

Thank you Sir for this session. Now I fully understand which field my friend is getting into.

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CLASSROOM FinFunda of the Month

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FIN-Q 1. Find the missing link:

2. X is a Euro-American multinational financial services corporation and is responsible for operating multiple securities exchanges. In June 2013, the European Commission approved X’s proposed takeover by the Inter Continental Exchange. Identify X. 3. An average of high, low & closing prices from the previous trading day is used to determine the market trend over different time frames. Trading above this level indicates ongoing bullish sentiment and vice-versa. What is this level called?

4. Company X has risen close to $540 million in the last six years out of which $360 million of funds have come this year itself. Founders of Company X are alumni of IIT. Identify X. 5.This merger left many Germans unhappy as, such a large German Company was never acquired by any foreign owner. This is still the largest merger that has ever been undertaken with the deal size crossing $200 billion. Identify the two companies involved in the deal.

6. The airline XYZ had Q2 (July-September, 2013) net loss which crossed its highest ever net quarterly loss of more than INR 700 crores. This was mainly due to slowdown in air travel and also due to high fuel cost. Identify XYZ. 7. Which Indian financial Institution has Dog in its Logo?

8. He is the pioneer in mutual fund industry and often referred as the Father of Index Fund investing. He created the first S&P 500 Index fund. Identify this famous person.

9. Identify a term that describes a stock resembling a sinking battleship that goes down fast until it hits the bottom.

All entries should be mailed at niveshak.iims@gmail.com by 10th November, 2013 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-

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WINNERS Article of the Month

Prize - INR 1000/-

Paridhi Gupta IEHE, Bhopal

FIN - Q

Prize - INR 500/-

Ayush Agarwal IIM Shillong

ANNOUNCEMENTS ALL ARE INVITED Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1000/- along with a certificate.

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