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Niveshak THE INVESTOR

VOLUME 7 ISSUE 1

January 2014

RATIONALIZATION OR REVAMP?

Introducing FinView

‘Niveshak Investment Fund’ comes live on 30th January


FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VII ISSUE I January 2014 Faculty Chairman

Prof. P. Saravanan

THE TEAM Akanksha Gupta Anchal Khaneja Anushri Bansal Apoorva Sharma Gaurav Bhardwaj Gourav Sachdeva Himanshu Arora Ishaan Mohan Jatin Sethi Kaushal Kumar Ghai Kocherlakota Tarun Kritika Nema Mohit Gupta Mohnish Khiani Neha Misra Nirmit Mohan Priyadarshi Agarwal S C Chakravarthi V All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong

With yet another issue of Niveshak, we wish you an ebullient and wonderful year ahead. Amidst relentless cold waves, January has been an eventful month. Starting with social networking, 30 million users were added to the cross platform app, WhatsApp, in January. With 430 million users, it poses direct competition to SMS. Meanwhile, Anand Sharma, India’s Commerce and Industry Minister, said further liberalization of Foreign Direct Investment Policy will ensure India’s endeavour to retain its leadership position in attracting foreign investments. The three-day International Kite Festival (IKF), inaugurated by Gujarat Chief Minister Narendra Modi in Ahmedabad recorded a surge in the Kite market crossing Rs. 500 crores. It also strengthened the tourism sector. Prime Minister Manmohan Singh laid the foundation stone of a nuclear power plant in Fatehabad district of Haryana at Gorakhpur village. While Chief Minister Arvind Kejriwal’s decision to cut tariffs by half through a subsidy may have made Delhi power the cheapest in the country, but doesn’t it threaten to undo all recent reforms in tariff rationalisation across the country? Delhi may have the money to subsidise power; the problem is that many other states do not have the financial wherewithal to follow. In the Common Admission Test 2013, eight engineers scored 100 percentile. It gives us immense pleasure to launch the ‘Niveshak Investment Fund’ wherein we have decided to invest in a diversified portfolio of equities hand-picked by us. Our endeavours are all set to outperform the market. The Article of the month, ‘Will REITs Breathe Life into the Comatose Indian Real Estate Markets?’ dwells into the depth of Indian Real Estate Market and discusses the prospects of REITs in India. Our cover story ‘Rationalization or Revamp: Future of Indian Taxation System?’ analyses the problems with the current taxation system and the nitty-gritties of the proposed taxation on banking transactions. Our next section, FinSight, brings forward the impacts that GST, one of the most awaited reforms, would bring about. Our article on ‘Downfall of Kingfisher Airlines’ gives us insights on how the mighty player came down on its knees. FinGyaan article ‘When the “BRICS” start to fall’ speculates whether the golden era is over for these growing countries. We are introducing a new section ‘FinView’ from this month. It will have excerpts from the conversation with subject matter experts from various domains of finance. Our section on FinView is an interaction with Mr. Puneet Prakash, Associate Professor, Virginia Commonwealth University. He threw light on the future of risk management in India and around the world. He also shared the recent happenings and trends in the field of risk management. ETF is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. Our classroom section gives a clear idea of what ETFs actually are. We would like to thank our readers for their immense support and encouragement. You remain our prime motivation factor which keeps our spirits high and gives us the vigour and vitality to keep working hard. Thank you. Stay invested !

Team Niveshak

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


CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

10 Will REITs Breathe Life into

the Comatose Indian Real Estate Markets?

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Rationalization or Revamp: Future of the Indian Taxation System?

FinGyaan 18 When the “BRICS” Start to Fall

Finsight

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How ‘Impossible’ GST has become ‘Inevitable’ for India?

FinPact 22 The Downfall of Kingfisher Airlines

FINVIEW

29 Mr. Puneet Prakash:

Assoc. Prof., Virginia Commonwealth University

CLASSROOM

33 Exchange Traded Funds


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www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

IIM Shillong POSCO Gets Clearance To Set Up Its Steel Plant In Odisha The government has finally granted environmental clearances for setting up the $12.6-billion steel plant of South Korea’s POSCO in Odisha, after 8 years since it was first proposed. The steel plant got the green signal after it was delinked from the port project that was intend to be constructed to meet the material needs of the steel plant. The POSCO plant will be the single largest foreign direct investment in the country and is expected to churn out some 12 million tons of steel annually. Through this clearance, POSCO has been able to get possession of almost the entire 2,500 acres it needs to start the first phase of the project, but the entire project requires an approximate land area of 4,000 acres. By passing this deal, India is trying to build a strategic relationship with South Korea as part of its Look East policy. Finally, Inflation Drops !!! Atlast, there was something to cheer for the RBI this month. After months of fighting with the inflationary pressures plaguing the Indian economy, the WPI and CPI dropped this month. The WPI dropped to a 6 month low of 6.16% compared to a 7.52% rise in November and the CPI dropped to a 3 month low of 9.87% from 11.16% in November. The main reason behind the fall in the CPI is the softening of vegetable prices. This comes after a string of lending rate increases by the RBI Governor. Had the inflation not fallen this month, the RBI would have been under greater pressure to further increase the rates after a pause in last month’s Policy Review meeting. GDP growth has been sluggish as suggested by November’s IIP number of -2.1%, which could have put Raghuram Rajan in a quandary had the inflation remained sticky. This news even had an impact on the bond market on the day of the announcement. The benchmark 10-year bond yield fell by 5 basis points to 8.63 per cent and the benchmark 5-year swap rate and the 1-year rate each fell 4 basis points. Government Raises Tariff Value Of Gold And Silver To Control Under-Invoicing The government has raised import tariff value of gold and silver to $407 per 10 grams and $663 per

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kg, respectively. Import tariff value is the base price at which customs duty is determined to prevent under-invoicing. The tariff value on imported gold earlier stood at $392 per 10 grams on silver at $638 per kg. Tariff value on imported brass scrap has also been increased to $3,995 per tonne from $3,940 per tonne, while the tariff value on imported poppy seeds remain to $3,195 per tonne. Such steps are continuously being taken by the government to ensure that demand for gold imports is discouraged among gold-hungry consumers and also to ensure the problems relating to underinvoicing to avoid cost attached to government taxes on gold import. World’s First Insured Bitcoin Vault Opens In UK The world’s first Bitcoin storage service that insures deposits of the digital currency against hackers and accidental loss has opened in London. Bitcoin is a virtual currency that can be generated through complex computer software systems with solutions shared on a network. Although, the digital currency is gaining popularity, concerns about its security are on the rise. Online wallets used to store Bitcoins have been subject to a number of cyber-attacks and some users have also suffered from accidental loss. The new Bitcoin storage service offering insurance in UK, named Elliptic Vault, uses “deep cold storage” techniques to secure the digital currency. Bitcoin keys are encrypted and stored offline. There are multiple copies, protected by layers of cryptographic and physical security. Indian Banks Required To Maintain Additional Provisions For Unhedged Forex Exposure Clearly apprehensive of the potential hit to banks’ bottom lines as a result of companies posting losses on account of unhedged forex exposure, the central bank asked lenders to set aside more provisions for such loans starting from April 2014. The Reserve Bank of India (RBI) mandated banks to make additional provisions if the estimated loss from unhedged exposure exceeds 15% of the company’s earnings before tax, interest and depreciation (Ebitda), progressively raising the provision as estimated


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NIVESHAK

losses increase. If the estimated loss is over 75% of Ebitda, banks will have to not just provide 80 basis points more the standard provisioning but also up the risk weight by 25% requiring the bank to set aside more capital. A report put out by Crisil in September 2013 estimated total unhedged forex exposure at about $98 billion — this was arrived at after natural hedges were netted off and active hedges taken into account. Infosys Hits Life Time High Despite the exit of senior management, Infosys has been consistently growing its profits from the past 3 quarters. This Indian IT major has posted a profit of Rs. 2875 crore, recording a 21.4% increase in net profit for the quarter ending in December 31, 2013. On Jan 13 2014, Infosys stock touched an all-time high of Rs. 3674.40, post which most of the brokerage firms raised their 12 month target price. The company also raised its revenue growth forecast for the current year from 11.5-12% to 9-10%. It is suggested to hold the stock, as the stock is likely to move up in the next few quarters because of healthy operating profit margins. This increase in operating profits can be attributed to cost optimization initiatives taken in Q3. The target price has been raised to above Rs. 4000 by brokerage firms such as CLSA, JP Morgan and UBS. On the same day, Sensex rose by 308 points to hit its intra-day high of 21066.08 and as much as 120 stocks hit their 52 week high on Bombay Stock Exchange signifying improving sentiments in the market. Agni-IV Successfully Fired India flexed its military might once again by successfully test-firing the nuclear capable AgniIV missile (range upto 4000 km) from the Wheeler Island off the Odisha coast. This tiny island of less than 2 square km is situated just 10 km off the coast of Odisha on the Bay of Bengal. India has an advance missile testing facility there. This was the third and last testing of this Intermediate-range ballistic missile before induction into the Indian Army. This 3rd successful testing after ones in November 2011 and September 2012 add another feather into the ‘DRDO’ cap - developer of the Agni series. It’s a strategic missile which can carry a nuclear warhead weighing one ton. The fourth missile in the Agni series this is actually a cross between Agni-2 & Agni3. Army will now be able to produce it on the ad-hoc basis. The ambitious Agni series is a family of nuclear

weapons capable surface to surface ballistic missile with range varying from medium to intermediate to intercontinental. They are the mainstay of our “credible deterrence” defense policy against China and Pakistan. AAP Says No To FDI In Multibrand Last year, the central government allowed foreign investors to buy 51 per cent in India’s multi-brand retail chains, but left its implementation on the states. The UPA government opened India’s $500 billion retail industry to foreign investors, allowing companies such as Wal-Mart Stores Inc. and Tesco PLC to own a majority stake in local chains for the first time. Reversing the Sheila Dikshit Government’s decision on FDI in retail, the AAP Government has written to the Centre declaring that it would not allow multi-national companies to set up multibrand retail stores in the Capital. Arvind Kejriwal said that Delhi was not ready for FDI as it would create large-scale unemployment. Delhi is the first State to withdraw permission for FDI in retail sector. Only 11 out of India’s 28 states had agreed to roll out the policy so far. After AAP’s withdrawal, that number has decreased to 10. Reacting to this news, the shares of retail stocks slid downwards. Tata group-promoted Trent in which Britain’s Tesco would buy a 50 per cent stake closed 3.1 per cent lower at Rs.1, 132.20. Future Retail shares fell 1.8 per cent to close at Rs. 82.15, while Future Lifestyle shares declined 2.3 per cent to end at Rs. 68.10. Yahoo’s Marissa Mayer Fires COO More Than A Year After She Wooed Him Away From Google Yahoo’s No. 2 executive, Henrique de Castro, has been fired by his boss, Marissa Mayer, a little more than a year after she wooed him away from Google to help her turn around the struggling Internet company. Mayer, who left Google to become Yahoo’s chief executive in mid-2012, was clearly displeased with de Castro’s performance. Over the past year, Yahoo lost its position as the No. 2 digital ad seller in the United States to Facebook, according to the research firm eMarketer. Clark Fredricksen, a vice president at eMarketer, said that Yahoo had so far failed to transition its advertising from the desktop to mobile, which has contributed to the declines. But de Castro will be walking away with a substantial severance package. The final amount has not yet been determined and will hinge in part on how well he did in reaching performance targets set for 2013.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

The Month That Was

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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

69,02,689.20 Source: www.bseindia.com

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

LENDING / DEPOSIT RATES Base rate Deposit rate

9.80%-10.25% 8.00% - 9.05%

RESERVE RATIOS  62.177 85.0894 60.14 103.38 49.03

CURRENCY MOVEMENTS

CRR SLR

4.00% 23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

Source: www.bseindia.com 25th December 2013 to 24th January 2014 Data as on 25th January 2014

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

Open

Close

% change

21032.71 6619.19 6433.61 12375.58 12937.6 5751.87 10244.24 6498.48 9950.93 8962.53 9819.76 8807.98 1675.48 5834.28 1451.88 4989.32

21133.56 6455.26 6444.46 11953.12 12556.16 5574.77 9624.23 6522.81 10182.79 9529.91 9604.37 8645.61 1568.57 5704.07 1307.17 5216.59

0.48% -2.48% 0.17% -3.41% -2.95% -3.08% -6.05% 0.37% 2.33% 6.33% -2.19% -1.84% -6.38% -2.23% -9.97% 4.56%

% CHANGE

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article Market of Snapshot the Month Cover Story

Market Snapshot

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Will REITs Breathe Life into the Comatose Indian Real Estate Markets?

Rohan Dhall

NMIMS Mumbai In a move to increase the depth of the Indian Real Estate Market, in terms of exit as well as financing options for developers and new avenues for investment, The Securities and Exchange Board of India (SEBI), has decided to allow Real Estate Investment Trusts (REITs) in India. The following article attempts to dissect this seemingly abstruse yet highly innovative investment vehicle from a global perspective where its impact is palpable and attempts to evaluate its suitability in the Indian context. Real Estate Investment Trust (REIT) is a real estate company that offers securities that trade on stock exchanges like equity shares and in turn it invests into income-yielding real estate projects. On a whole similar to any other equity investment, REITs has two unique features – the management of income producing properties remains its main function, and most of its profits have to be distributed as dividends. These dividends, in addition to price appreciation, form the main source of payoffs for investors. Types of REIT i. Equity REIT – These typically invest directly into income-generating real estate projects like Apartments, Malls, and Commercial Complexes etc. They may even be responsible for managing them by virtue of the kind of agreement entered

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into. Sales, rentals and service charges are the revenue streams for the REIT. ii. Mortgage REIT – The REIT invests in existing mortgages, mortgage-backed securities or may even advance money to real-estate owners for mortgages iii. Hybrid REIT – A combination of Equity and Mortgage REIT structures primarily adopted for the mitigation of risks and to seek enhanced returns. More common in the healthcare sector where the trust can advance mortgages to healthcare companies and also buy medical office parks. Global REITs Footprint Since its introduction for the first time in 1960 in the US, it has managed to gain a wide acceptance across the world and currently enjoys a significant market capitalization in most of the global financial markets. Every country has its own policy framework within which different manifestations of REITs have evolved. The US REIT for example has rigorous transparency and mandatory disclosure requirements in addition to strict conditions that ensure 90% of the taxable income is paid out to unit holders as dividend. However, this portion is deductible for tax purposes. Also the US REIT


NIVESHAK

Fig 1: NAREIT Fact Report

Case For Introduction Of REITs In India The following factors make REITs such a compelling investment class world over and the prospect of being able to replicate the success in India seems quite inviting. 1. Superior returns at lower levels of risk: REITs are characterized by a great deal of predictability arising out of stable nature of rentals and occupancy rates. They also have low correlation rates and higher levels of liquidity. On an average, REITs have a Debt/Equity ratio in the range of 0.5 signifying lower leverage. All of these are indicative of lower levels of risk. Figure 2 reflects the historical returns achieved by REITs over four decades juxtaposed with those witnessed by other similar investment avenues. 2.Hedge against inflation – As an asset class, real estate offers an excellent

hedge against inflation. However the huge quantum of investment required, associated illiquidity and lack of transparency deter the small ticket investor from being able to leverage this feature. REITs will provide the same hedge against inflation and owing to its lower entry load would protect the “Average Joe” from increasing inflation by yielding positive and appreciable “real” returns on investment. 3. Infuses a high degree of transparency into a traditionally opaque sector – It would help clear the smokescreen surrounding Indian real estate dealings. Improved reporting and disclosure requirements in addition to stringent regulatory and supervisory oversight by market watchdog SEBI is likely to heighten the extant standards of corporate governance, improve real estate market efficiency by eliminating issues of moral hazard and adverse selection and thereby safeguard the interests of the smaller retail investors. . 4. Opportunities for investors in every business cycle –Most real estate markets witness four discernable phases that constitute the real estate business cycle. One of the foremost reasons that have made REITs a runaway success is their ability to offer lucrative business alternatives in every phase of the cycle. 5. Mobilize financial resources – This is vital to a sector that is currently witnessing a paucity of financial resources in India attributable to high risk perceptions and enhanced regulatory curtailments that makes access to capital expensive and arduous. Figure 3 depicts the cycles in real estate market. Proposed Regulatory Framework Realizing the importance of REITs, a regulatory framework has been proposed under draft SEBI (Real Estate Investment Trusts) Regulations, 2013. Some of the prominent features of proposed framework are as follows: 1. Structure of the REITREIT will be set up as a Trust under provisions of Indian Trusts Act, 1882. It will consists

Fig 2: REITs Measure Up Over Time

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

must be widely held and must derive a major proportion of its income from real estate held for a long term. The Japanese version referred to as J-REIT resurrected the real estate markets in Japan after its introduction in 2000-01. Its management structure is external and hence varies from the US REIT.

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Fig 3: Cycles in Real Estate Markets

ofi. Sponsor- Sponsor should have minimum net worth of Rs 200 million and at least five year of experience in real estate. ii. Manager- Manager should have minimum net worth of Rs 50 million and at least five years of experience in fund management. iii. Trustee- Trustee should be registered with SEBI and 50% should be independent directors. 2.Investment conditions and Dividend Policyi. It has been mandated that at least 90% of the value of REIT assets will be invested in completed revenue generating properties ensuring return for investors and reducing

risk-return. Remaining 10% can be invested in Government Securities, debt of Listed/ Unlisted corporate companies. ii. To ensure regular income to investors, at least 90% of net distributable income after tax of REIT should be distributed among investors. iii. REIT shall not invest in land which is vacant or agricultural land and shall invest only in assets based in India. iv. Investment up to 100% of corpus of REIT can be invested in one project provided minimum size of such asset is more than Rs 1000 crores. v. Leverage of 25% is ordinarily allowed and leverage up to 50% is allowed only after getting positive consent from unit holders and credit rating. vi. All related party transactions by facilities manager will be on arms-length basis and will be in best interest of investors; in line with the investment objective of REITs. vii. Real estate investment trust can invest at least 51% in real estate directly or they can invest in SPV (Special Purpose Vehicles) which in turn holds real estate assets viii. Guidelines related to listing of REITs: - Minimum value of REITs assets - Rs 10 billion - Minimum public float - 25%

Fig 4: EY Research Report on Real Estate Markets – 2012

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exempt from longterm capital gains tax. iv. FDI/FII should be allowed under automatic route by the amendment of FEMA. v. Exemption of Stamp-Duty when asset is purchased or sold by the REIT or rationalization of the Stamp-Duty structure. vi. Inclusion of ports, roads, airports and other completed infrastructure

projects in REITs vii. Explore a relaxation in the minimum 5-years eligibility criterion stipulated for ‘Sponsors’ to enable other entities with prodigious portions of land to act as ‘Sponsors’. Conclusion Globally, REITs have been effective in attracting and managing investments in the Real Estate sector. This, along with an ever increasing demand for quality real estate in India, which REITs can help meet by bringing the required investments in the real estate sector, make the case for implementation of REITs compelling enough to drive policy makers to act fast on the implementation of a similar regime in India with requisite adjustments, keeping in perspective the unique dynamics of its economy.

Real Estate Investment Trust (REIT) is a real estate company that offers securities that trade on stock exchanges like equity shares and in turn it invests into incomeyielding real estate projects © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

- Minimum issue size of lots is Rs 100 thousand and for trading lots it is Rs 200 thousands - Sponsor needs to invest 25% in REITs for three years since inception and continue to invest 15% till lifetime of REIT. - There can be minimum 20 outside unit holders in REITs. 3. Rights of Investorsi. Investors will have the right to remove manager, auditor, and principal valuer and can also apply to SEBI for change in trustee. ii. An annual meeting of all investors needs to be conducted by trustee where information like performance of REIT, appointment of principal valuer, latest annual accounts needs to be disclosed in front of investors. iii. Detailed Disclosures needs to be given in annual and half yearly valuation reports to ensure transparency and protect investor’s money. SEBI has requested comments and opinions from the various stakeholders and public at large on its draft regulations. The following nagging issues often feature as a part of erudite discourses on the topic1i. Single level of corporate taxation (either at REIT or SPV level) or pass through taxation and elimination of all other intermediate taxes including those on distributions received by unit holders ii. Clamour to seek one-time tax exemption when the REIT is created by a sponsor. iii. In the event of payment of STT, the trading of REIT units on the stock exchanges must be

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RATIONALIZATION OR REVAMP? Future of the Indian Taxation System? If we are to create tomorrow’s jobs, we can’t remain frozen in time in yesterday’s tax system. - Bob Taft

Team Niveshak

IIM Shillong In a country like India where taxation system was introduced in the year as deeply rooted in history as 1860, the old laws are not good enough for a developing and modern nation. There have been many reforms time and again but does tinkering with the tax system qualify to be called a reform or rationalization, every time? India has undergone extensive (so called) reforms over the last couple of decades to enhance rationality, simplicity and compliance. But, the endeavours haven’t had the desired results and the four overarching aims of any tax policy - simplicity, fairness, efficiency and revenue sufficiency have not been achieved. The radical proposal, which is being talked about by the Bharatiya Janata Party (BJP), asks for abolition of all direct and indirect taxes for individuals as well as corporates in favour of a nominal banking transaction tax. Let us see the current tax structure in India and then discuss the nitty-gritties of the proposed system. Current Taxation System Unlike many of the developing countries whose tax reforms are guided by multilateral agencies like the International Monetary Fund, Indian tax reforms have mostly been a domestic development for supporting the growth activities and infrastructural developments. India has a

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well-defined tax structure with clear distinction between Central and State Governments and local bodies. The Central Government levies taxes on income (except tax on agricultural income, which the State Governments can levy), customs duties, central excise and service tax. Value Added Tax (VAT), stamp duty, state excise, land revenue and profession tax are levied by the State Governments. Local bodies are empowered to levy tax on properties, octroi and for utilities like water supply, drainage etc. Direct taxes include Income tax, corporate tax, wealth tax and capital gains tax. We follow a progressive rate of taxation. Indirect taxes include Excise duty, Customs duty, Service tax etc. The Indian government is keen on merging taxes like service tax, Excise and VAT into a common goods and services tax (GST) to simplify the current system which is tedious and complicated. All goods and services will be brought into the GST base and if implemented, it is expected to rationalise and simplify the current Indian taxation system. In the budget for FY 2013, the finance minister of India Mr P. Chidambaram had suggested certain policy changes on taxes like imposing a surcharge of 10% on companies with taxable income more than 100 crores and on the super-rich with annual income of over 1 crore.


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Fig 1: Current Tax Slab For A Resident Of India Below 60 Years Of Age

Companies investing over ₹ 100 Crores in plant and machinery could claim a tax deduction of 15% on the actual cost of acquiring new assets. Problems With Current Taxation System Prevailing taxation system in India is still plagued with a number of problems that is preventing the government to realise the full potential of tax revenues that can be generated in India, to support government expenditure on growth and development of the economy. The current system of multiple taxes and lack of clarity in the reforms proposed and implemented for both central and state taxes has made the taxation system in India more opaque. To smartly use the existing system in one’s favour to manage taxes, big corporate houses and HNI’s spend a huge proportion of their incomes as consultation fees to tax consultants and lawyers. This money can be utilised in making investments that would lead to higher returns in terms of future earnings. Some of the major problems with existing taxation system in India are: • Multiplicity of taxes and complex structures to aid tax collection at different government levels has made it difficult for tax payers to efficiently pay their taxes. Also deductions available in various type of incomes has made tax evasion easier. (Do people buy insurance to get a life cover or get tax exemption under provisions of income tax in India?) • Dominance of Indirect taxes (almost 80% in total tax collection) has made our taxation system regressive even after having progressive tax slab rates. The poor have to bear greater burden of Indirect taxes in form of custom duty or excise duty in the final price of the good they purchase for consumption • Some taxes are levied on adhoc basis to cover deficit and are withdrawn once the difficult situation is passed • Due to taxes like VAT, service tax etc., urban youth with lower income have to pay a greater

amount of tax compared to rural rich whose agricultural income is exempted from the income tax • A provoking feature of the Indian tax system is its complexity. Both direct and indirect tax laws are highly complex. This provides enough scope for avoidance and evasion of taxes • Lack of co-ordination: Our federal finance system allows Union and States to levy taxes independently at different rates. There is no coordination between the taxes to allow evolution of a well-organized, planned and coordinated tax system • The tax collected does not increase in the same proportion as income in India because with rising incomes, greater number of people use the loopholes to evade taxes and as a result, government is compelled to increase tax rates or find newer sources to promote tax collection to keep that ratio constant • A huge proportion of government’s nonplanned expenditure, in form of subsidies and populist moves to create vote banks, leads to wastage of the national resources, and thus leads to budgetary deficits in the long run • The amendments made in current system of taxation are very frequent which leads to uncertainty. Every budget adds and deletes provisions in the taxation system making it more complex and uncertain, making long term planning of income management very difficult • Also a huge amount is paid by the government out of its pocket contributing towards the salary of employees monitoring and managing such a complex taxation structure and the huge amount of paper work attached to it Alternatives Proposed For Reform And Revamp Of Current Taxation System Introduction of a tax slab of 35% for super rich (income above 10 crore): The DTC (Direct Tax Code) Bill which UPA government had come up with, last year, kept the IT exemption

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limit unchanged at Rs. 2 lakh for individuals. It suggested a fourth tax slab with a 35% tax rate for people with annual income over Rs. 10 Crores. This invited protests both from industry and business. The UPA government supporting its ideation of implementing a purely regressive taxation system had proposed the additional Slab rate of 35% which is currently being used in countries like USA in their tax structure. Such a system would ensure additional tax inflow to the accounts of exchequer by laying more tax burden on Super-Rich leading to a step towards class equality. Also, introducing a new tax slab would not have an impact on present infrastructure and workforce that support existing tax structure in India and hence there would be no risk arising due to a radical change in the structure. But on the other hand, creation of another slab would lead to more black money as super rich would then try to ensure minimum tax paid through tax management. This system would be more or less similar to the existing t a x a t i o n system and would still face all the problems that is faced by current system in place. Goods and Services Tax (GST): GST will bring about a change on the tax firmament by redistributing the burden of taxation equitably between manufacturing and services. It will lower the tax rate by broadening the tax base and minimising exemptions. It will reduce distortions by completely switching to the destination principle (The destination principle is a concept of international taxation which allows for value added taxes to be retained by the country where the taxed product is being sold). It will foster a common market across the country and reduce compliance costs. It will facilitate investment decisions being made on purely economic concerns, independent of tax considerations. It will promote exports. GST will also promote employment. Most importantly, it will spur growth and simplify the indirect taxation system. Advantages: • It will simplify India’s tax structure, broaden the tax base, and create a common market across

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states. This will lead to increased compliance and increase India’s tax-to-gross domestic product ratio • The average tax burden on companies will fall; thus reducing production costs will make exporters more competitive • The subsuming of major Central and State taxes in GST, complete and comprehensive setoff of input goods and services and phasing out of Central Sales Tax (CST) would reduce the cost of locally manufactured goods and services • Approximately $15 billion a year of profits are predicted by the government with the implementation of GST as it is speculated to bring about raise in employment, promotion of exports and consequently a significant boost in overall economic growth • Countries implementing common GST in their taxation system have seen an increased growth of around 1-2% in their respective GDPs But the problem related to GST would arise in case of distribution of taxes between central and state governments and negotiation between the states to get a larger proportion of the pie. Elimination of existing tax structure (apart from import duties) and simple 2% tax on all inflows into the bank accounts: The proposal was suggested by a Pune based tax – research outfit, ‘Arthakranti Pratishthan’, recommending that the present tax system should be replaced with a single 2 % levy per receipt in bank accounts. For example: A person who earns ₹ 10 Lakh a year, pays ₹ 20, 000 tax every year. He/she won’t be taxed for any other transaction. A person, who earns ₹ 10 crore, pays ₹ 20 lakh a year, if there is no higher bracketing system. The system proposed by Arthakranti also proposes that all currency notes above ₹ 50 must be eliminated from the money supply. Also, it advocates giving no legal protection to cash transactions above ₹ 2000 and making other cash transactions tax free. This taxation system is very simplified in its form and can be easily monitored but it may attract more cash transactions (currently constituting


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Conclusion Now evaluating the current taxation system, we can clearly see that with its small current taxpayer base, rampant tax evasions and increasing budgetary deficits. . As per PwC report, India ranks 158th out of 189 economies in terms of ease of paying taxes. A new or reformed taxation system is required to be put in place to bring back Indian economy to balance. UPA’s suggestion to have a 35% tax slab rate for super rich earning above ₹ 10 crores a year would only lead to a small increase in total tax collected. There are only 42,800 people in the country who earn more than ₹1 crore; those earning over ₹ 10 crore a year would be even fewer. There is a requirement for increasing the current tax base in order to increase total tax collection rather than making the lives of existing tax payers difficult. Also, introduction of an additional tax slab would not have an impact on the limitations in current taxation system; there is a need of a system that can overcome existing problems. Talking about Goods and Services tax, it can be said that it is a great plan that would greatly enhance India’s image as an attractive investment destination. Formalising the structure and simplifying taxation across different states would make doing business easier in India. Also, this would make Indian indirect taxation system in line with international taxation standards. Therefore introduction of GST would increase tax base and total tax collection, increase growth rate of Indian GDP and would not require a complete revamp of existing taxation system in India. Single taxation system on banking transactions would completely simplify the taxation system but it would mean undertaking the huge risk of scrapping the current system altogether. First things first, implementation of the long impending GST is of prime concern. As far as the banking transaction tax is concerned, it may be considered aspirational by many but is India ready to take that risk, given its precarious state of affairs? Does it really have the luxury to experiment with peculiar ideas?

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80% of total business transactions) leading to an unmonitored parallel economy. Also, this system proposes a flat rate of tax i.e. both rich and poor would be taxed on the same flat rate of tax which is not equitable in its true sense. Let us now discuss the feasibility of such a taxation policy in India and evaluate whether it has the potential to make the positive impact that it intends. Advantages: • In India, just around 20% of the transactions are banking transactions; rest are in the form of cash. This system kindles hope that people will do more and more bank transactions and the no. of bank branches will soon surge from the current figure at around 1.5 lakh branches to more than 10 lakh branches • Calculations show that the 2% tax will yield Rs. 1400000 crore, way beyond the total tax revenue of Rs. 0, 38,037 crores in the current financial year. • Also, this system promises to infuse transparency apart from increasing the tax base. It is believed that it may reduce corruption and collusion with the government agencies. • It may lessen the tax burden from individual as well as corporate taxpayers • Supporters of a flat tax system are of the view that it would give taxpayers incentive to earn more because they would not be penalised with a higher tax bracket or conceal the real income. Many of the countries including Estonia, Lithuania and Latvia that have imposed a flat tax rate system on individuals and businesses, have experienced economic growth since adopting flat tax rate policies. The taxpayers will also not indulge into practices like falsification of accounts, money laundering and other illegal ways of tax evasion. It has the capacity to fight the menace of black money. Disadvantages: • India has always followed a progressive system of taxation and introducing a flat tax rate i.e. levying same tax rate on all the tax payers regardless of the income bracket will hurt the very fundamental ethos and fabric of the nation. The question to be addressed here is “Can you tax the rich and the poor at the same rate?” • Some taxes are collected by the centre and others by the states. Hence, a common platform to tax banking transactions would make distribution of total tax collected between states and centre very difficult • There may be legal issues and stiff resistance from a lot of people as the present system has to be totally discarded

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When the “BRICS” Start to Fall FinG-

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“It’s over for the biggies, the golden era of BRICS has just begun” Akshay Gupta

IBS, Hyderabad

After the housing bubble burst in 2008, all of us had formed a preconceived notion that the golden era of the west is over. However the current scenarios have made us realise how counterfactual and ignorant we were. Over the past several years, the most talked-about trend in the global economy has been the rise of the East. The primary drivers of this belief were the four major emerging-market countries, popularly known as the BRIC Countries: Brazil, Russia, India, and China. The world was witnessing a once-in-a-lifetime shift in which the major players in the developing world were catching up to or even surpassing the developed world countries. But little did they know that a mere Quantitative Easing policy by the US Feds would debilitate the financial structure of BRIC, making their surging growth look like a ‘fluke’ which no one seemed to believe in. Why? It’s because we humans live by the famous philosophy of - we let our hearts rule our brains. Quantitative Easing (QE) is an unconventional monetary policy used by US Feds to prevent the

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money supply falling when standard monetary policy has become ineffective. In a nutshell, it’s a fancy term for easy money policy. However, for BRIC, it’s a policy which results in competitive devaluation and protectionism in the economy. Ever since the market mayhem creates due to introduction of QE measures by the US Federal Reserve chairman Ben Bernanke, global investors have been pulling money out of the emerging markets. Here’s the reason why! Brazil’s GDP grew by only 1% and may not grow by more than 2% this year, with its potential growth barely above 3%. The major predicament with the Brazilian economy is that it overheats at slow speed as its investment rate is one of the lowest in the emerging-market countries, at 19%, stagnating the country’s economy. Same is the case with Russia. Despite oil prices being around $100 a barrel, Russian economy minister Alexei Ulyukayev suggests that Russia is likely to grow at 2.5% since the economy is too dependent on oil and gas and at the same time afflicted with corruption and lacking a credible


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Fig 1: Data Comparison of BRICS Countries

legal framework for business. South Africa, a developed market wrapped around an emerging market, grew by only 2.5% and with currency depreciation it would not grow faster than 2% this year. When it comes to India, the economy seems to be in denial. Why are we saying it to be in denial is because the GDP is at a 10 year low (Around 5%) but the government still is optimistic to achieve breakthrough results by the next quarter. The Rupee is at an all-time low, which is approximately 1$=Rs. 62 clearly stating how vulnerable the economy is to any sort of policy measures. We need to focus on Commerce, and not just on Finance. The government is blaming the QE measures by the fed’s, however, the truth is that the rupee free fall is more of a swadeshi crisis than a foreign one. The haemorrhaging started on heavy selling by foreign institutional investor (FII). In order to fund the current account deficit (CAD) which stands at $70 billion, Indian authorities thought they could do that with the FII inflows –which in lucid terms is like paying your monthly rent with the money borrowed from your moneylender and not from your savings or capital account. Since the trading rules were simplified and foreign investment limit in bonds were raised to attract investors the short term traders were trying to make quick money but this hot money came in fast and left in a hurry. Most of these borrowers borrowed in dollars and did not hedge so they

thought they were borrowing at 2% but the kicker is that they were actually borrowing at 20% and the first principle of business is to borrow in your currency or else you are a Forex speculator. What FII’s have done now is that it has increased the level of external volatility and dependence, when our fundamental commercial problems are not yet fixed. Perception of lack of clarity on policy front has also been fanning speculative demand wherein RBI on one day is tightening liquidity and on other is injecting $1billion in the market. People get all hunky dory when it comes to investing in China, however the best way to approach the growth figures of China is by ignoring their GDP rate. Even if we take into account the 7.5% growth rate at face value, its components suggest a more ominous scenario. What’s really the issue in the country is this unhealthy obsession with GDP numbers. Even in the best of times, China’s data can be about as accurate as tossing a dart at a chart on the wall. It’s a structurally imbalanced economy, distorted by top down policies and considerable amount of “gray” activities that are hard to measure. It is like a sprawling shadow of what happened to the banking sector which is currently suffering from the predicament of over investment, seeds of which were planted way back in the housing bubble crisis of 2008. Whereas China appeared to have dodge the global financial meltdown by implementing a huge half a trillion dollar

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Fig 2: Depreciation against the US Dollar

stimulus, misdirected towards wasteful projects such as unneeded steel and aluminium plants. So what is ailing the BRIC? Firstly, what economists called the period of “Golden Era” for the emerging markets, their economies were actually overheating in that period, with growth above potential and inflation rising and exceeding targets due to which, many of them followed the herd of tightening their monetary policies in 2011, which resulted in consequences on their growths in the subsequent years. Secondly, the notion that the BRIC could fully

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decouple from economic weakness in advanced economies, was far-fetched, given the fact that recession in USA and Eurozone were likely to affect emerging market performance via financial links, trade and investor confidence. Thirdly, the BRIC are moving towards a variant state capitalism which implies slowdown in reforms that generally increase the private sector’s productivity and economic share along with the resource allocation, trade protection and imposition of capital control. Fourthly, the commodity super-cycle that helped markets


NIVESHAK

FIN-Q Solutions DECEMBER 2013 1. Prudent Person Rule 2. X=Bretton Woods Conference 1944, Y=IMF, Z=World Bank 3. Black Tuesday 4. Netherlands 5. Snapchat 6. Mphasis (parent company Hewlett Packard) 7. “Wall”, Pink FLoyd “The Wall Album”, Facebook “Wall”, Bull at “Wall Street” 8. BC Partners acquired “Mergermarket” (third image) from Pearson Plc CEO John Fallon (first image), Bureau van Dijk (second image) is also acquired by BC partners. 9. Airpocket Stock

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like Brazil, Russia and South Africa is probably over now. Indeed, a boom would be difficult to sustain, given China’s higher investment in energy-saving technologies and less emphasis on capital and resource-oriented growth models. And lastly, the deficits in countries like South Africa, Brazil and India are being financed in riskier methods: funding the business through more debt than equity, more short term debt than long term debt, more financing from fickle cross-border interbank flows and more foreign currency debt than local currency. Why are dollar holdings not used? Loading up on dollars helps Asia’s exporters by holding down local currencies, but it causes economic control problems. When central bank buys dollars, they need to sell local currency, increasing its availability and boosting the money supply and inflation, so they sell bonds to mop up the excess money. It’s an imprecise science, made more complicated by the US Fed’s QE policies which could sink the emerging markets. We should not forget the example of Japan, where bets against government bonds (Similar to today’s QE policies) ended in grief so dominant that the whole trade came to be known as the “widowmaker” which was a catalyst to the ’97 crisis. The new law in corporate world seems to be, “the survival of the un-fittest”, where government and investors are going bonkers over cheap credit and over react to any sort of policy changes. People seem to have forgotten the economic mantra in crisis which is that the economists shouldn’t try to cushion the blow, they should let their economy hit rock-bottom only then it will be able to purge itself of the structural deficiencies. But as the saying goes, we humans let our hearts rule our brains, when we actually witness fear we say to ourselves “all is well” and try to employ all means to protect the economy by bailing it out to protect and regulate it, which in reality does nothing but only tarnish the chances of BRIC country’s economies from priming themselves in the global economy. For a quick recovery you need steroids and if steroids are being withdrawn then you are back to basics. It’s high time the governments must stand up and take initiatives to stabilize the market or else we might just have to remove the word “emerging” from the description of the BRIC nations’ markets.

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The Downfall of Kingfisher Airlines Heena Motwani

IIM Shillong

Introduction

Key Factors affecting the Aviation Industry

Established in the year 2003, Kingfisher Airlines was founded by the United Breweries Group. The company’s operation were commenced on 2005. The airline had been facing financial issues for many years. Once, Kingfisher Airlines had the second largest share in India’s domestic air travel market, but now due to the severe financial irregulations its operating license were cancelled by DGCA and the airlines’ operation were suspended on 20th October, 2012. Before moving on further to reason the collapse of the airlines, let us first have a look at the Indian Aviation industry.

1. Fuel Prices: It effects the overall increase in the operating cost of airlines in the following way: • Aviation turbine fuel (ATF) costs contributes 30 - 45% of overall operating costs for Full Service Carrier’s (FSC’s) & 40 -55% for Low cost carriers (LCCs) • High central and state governments levies taxes that translates into a 60-70% higher ATF prices in India over the global average 2. Volatility in Global fuel market: Volatility in fuel prices has been the foremost challenge for airlines. IATA estimates that a 1 USD increase in the average price of a barrel requires the industry to recover an additional 1.6 billion USD in revenue. The devaluation of the Rupee, and the resulting higher cost of the dollar, further worsens the situation 3. Aggressive competition by Air India: Air India ticket prices are kept artificially low with periodic inflow of capital and debts that further raises the burden on government and other airlines by

A Snapshot of the Aviation Industry

Air transport currently supports 56 million jobs worldwide and accounts for over US$ 539 billion of the gross domestic product (GDP) per year. It ranks 19th in the world in terms of GDP. Around 1,715 airlines operate a fleet of 23,000 aircraft serving 3,750 airports through a route network of several million km managed by 192 air navigation service providers.

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NIVESHAK

Remedies to the problems in Aviation Industry

1. Operating costs must be lessened for the industry. A start must be made with lowering of abnormally high jet fuel taxes. High taxes on jet fuel makes fuel costs the largest component in an airline’s total operating costs 2. State-run Air India must be stopped from charging below-cost ticket prices. It makes the rules of the game difficult for the entire industry and other airlines find it difficult to compete. The way out is to privatise Air India by the help of FDI norms as in Air India could sell a 51 percent stake to a foreign airline for survival. 3. The airport should also be privatized. Recently, government has announced that it will invite private players to bid for operational handling of

airports. This Public Private Partnership would further help to better the situation of aviation industry. A closer look at the Kingfisher Airlines Timeline of events:

The flow chart below describes the time line of events ranging from airline’s merger with Air Deccan to its suspension by DGCA. Reasons for failure

1. Investment in Airplanes: The 31 March 2011 reports shows that the Kingfisher airlines possessed 66 aircrafts and operated 366 domestic and 28 international flights daily over a route network covering 59 domestic and 8 international destinations. Still, the nett. Loss was Rs.10, 274 million. 2. Also, it took airplanes on lease from GE commercial Aviation Services and DVB Asian Finance Asia Ltd. and was not able to pay off the lease rentals. 3. Merger with Air Deccan: After its merger with Air Deccan the market share occupied by Kingfisher in 2007 was 27.5% and the domestic travel increased by 30%, yet the losses of the airline were increased from Rs. 3405 to Rs. 4196 million. 4. Excessive Debt: The Kingfisher Airlines had accumulated around 7000 crores of debt by early 2012 and had reported a total loss of Rs 23280 million. 5. Non Payment of fuel dues: In the past several years, Kingfisher airlines were troubled on

Fig 1: Timeline of Events

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providing the tickets at price below the incurred cost 4. Lack of skilled staff: Indian airlines are starved of skilled workforce. This leads to hiring foreign pilots and staff adding further to cost pressure 5. Poor Infrastructure: Most Indian airports (leaving Delhi and Mumbai) – are in the ownership of public sector. They need investment and up gradation. But that will further increase the costs for the airline business owing to parking, lending etc. Overall, the industry has been effected by cost inefficiencies and is facing the brunt of high price cuts, rising costs, high interest payments, expensive jet fuel, and therefore the increasing losses.

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paying their fuel bills. Due to non-payment, many Kingfisher’s vendors filed a petition with the High Court. As on Nov 2011, the petition of 7 creditors was pending before the Bangalore High Court. In the past BPCL had also filed the petition against Kingfisher Airlines. Here are some of them: • HPCL : In July 2011, HPCL (Hindustan Petroleum Corporation Limited) stopped the fuel (ATF) supplies for about two hours to Kingfisher airlines owing to the non-payment of dues • BPCL: Bharat Petroleum Corporation in 2009 had filed a case against Kingfisher airlines for nonpayment of dues. The High court in an order said that the entire amount 245 crore had to be paid by Nov 2010 and the airline paid it in instalments later 6. Nonpayment of tax Kingfisher received a notice from the Airports Authority of India on February 2012 regarding accumulated dues of around 255 crore. The airline was operating on a cash and carry basis for the last six months, with daily payments amounting to around Rs. 0.8 crore. Also, the Service Tax Department in Mumbai had impounded an aircraft of the grounded Kingfisher Airlines for defaulting tax dues amounting to Rs.63 crore. The airline owed around Rs.190 crore to the Service Tax Department, of which Rs.127 crore was under litigation. Consequences

1. In April 2011, the company restructured its debt of around 1200 crores to equity. It issued 116.3 million of shares to a consortium of 13 banks led by State Bank of India. • Debt Restructuring: In November 2010, the company adopted the debt restructuring and under that total 18 leading lenders, those have lent total Rs. 8,000 crores, agreed to cut the interest rates and convert a part of loans into equity. As per the contract, lenders have converted Rs. 650 crores debt into preference shares and that would be converted into equity when the company gets listed the on the Luxembourg Stock Exchange by selling global depositary receipts (GDR). Shares will be converted into common shares at the price at which the GDRs are sold to investors. Besides that, the 1,400 crore debt which will be converted into preference shares, the other 800 crore debt was converted into redeemable shares for 12 years. Due to this, the company was able to lower down the average interest rate to 11% and to save Rs. 500 crores each year.

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2. In early 2011, the oil companies put Kingfisher on cash and carry basis and later denied the supply of fuel owing to non-payment of bills 3. In mid-2011, two of its promoting firms, United Breweries Holding Ltd. And Kingfisher Finvest India Ltd. pledged their entire stake 4. Kingfisher was declared as NPA initially by SBI and later by the following banks-Bank of Baroda, Punjab National Bank, IDBI, Central Bank of India and Corporation Bank. • Kingfisher Airlines had not paid some bankers as per the Debt Recast Package (DRP) with lending banks. Till the end of Dec 2011, the loans were estimated to be 260 crore. Lenders hence had told Kingfisher Airlines to clear its dues before they can release more money sought by the airline. Due to the airline’s fail of paying off the debts, SBI, followed by other banks declared its account as an NPA. 5. In 2012, the share prices fell down to 13.1% owing to cancellation of flights and grounded aircrafts. Out of the 64 aircrafts, only 222 were known to be operational by Feb 20, 2012. It was accompanied by a13.5% drop in the stocks of the company on 20 February 2012 6. It also stopped its operation of low cost carrier Kingfisher Lite 7. Denial of Loans by SBI: The State Bank of India, which was the lead lender to Kingfisher airlines said that they would not consider giving any more loans to Kingfisher unless and until it comes up with issuance of new equity. Some of the Political activists also claimed that bailing or helping a private airline would lead to problems within the Government.


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Fig 2: Kingfisher Airlines Share Price: Oct 2009 to Oct-2012

8. Frozen Bank Accounts: Many more accounts were frozen by The Central Board of Excise & Customs of India, as it was unable to pay all the dues as per schedule. Kingfisher was meant to pay 1 crore per working day. Aviation minister Ajit Singh announced that the rest of the airline’s fleet would be grounded and all flights cancelled until the crisis came to an end, which would be only one step from permanently closing the airline. 9. IATA Suspension: On March 7, 2012 IATA had suspended ticket sales of Kingfisher airlines owing to non-payment of dues as the primary reason, and they said that sales services will be restored once Kingfisher settles the ICH account. It also directed all travel agents to stop booking tickets for Kingfisher. This would affect Kingfisher’s business by 30%. Kingfisher claimed that frozen bank accounts were the main cause of being unable to pay back the dues to the IATA, and the airline started making alternate arrangements for the ticket’s sale. It soon became difficult for the airline to follow much of the schedule that it earlier released as more pilots began to go on strike.

10. With pending salaries to be paid off by the airlines, more than 7,000 employees threatened to go on strike if the management does not clear their past dues soon. 11. In April 2012, the International Air Transport Association agreed to open its system to the airline for processing refunds on unused tickets. This provided a little relief to the Kingfisher airlines. 12. Partial Lockout: The employees alleged that the airline has not paid them salary for months. The airlines failed to resolve an impasse with employees over salaries and even after providing assurance to them, the striking employees failed to return to work. Due to which its operations were suspended and there was a partial lock out in Oct 2012. 13. DGCA Suspension: The DGCA had issued the show-cause notice on October 5 to Kingfisher asking why was it not adhering to its flight schedule and why it abruptly cancelling its flights time and again during the last 10 months. It gave a deadline of 15 days to reply back to DGCA. It finally suspended its flying license for failing to come up with a viable plan for its financial and operational revival and resolve the impasse with its employees over payment of their salary dues. And this suspension by DGCA brings us to the end to Kingfisher Airlines.

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How ‘Impossible’ GST has become ‘Inevitable’ for INDIA? SAURABH GUPTA MADHUR GUPTA

NLDIM

WELLINGKAR

During the presentation of Union Budget 2007-08, the Finance Minister P. Chidambaram indicated that an integrated Goods and Service Tax(GST) would be implemented by April 1,2010.Since then, the Finance Ministry and the Government of India have taken steps but have still not managed to implement GST and have postponed the implementation dates twice, firstly from 2010 to 2012 and now from 2012 to 2014. But one thing is certain that it will eventually be implemented, timing being the only area of indefiniteness. Given the importance of this tax legislation, we will go through the key aspects relating to GST, its working, benefits, challenges and its implication on the Indian economy. Before talking about GST, I would like to tell you about the taxes in India. What is the concept of Goods & Service Tax (GST)? Goods and Services Tax (GST) is a comprehensive indirect tax levied on goods and services which are manufactured, sold and consumed at national level. The key features of the proposed plan of the Goods and Services Tax for the Indian economy are: • India will have dual-rate GST i.e. GST will have two components: one levied by the

JANUARY 2014

Centre and would be known as Central GST (CGST) and other by State and would be known as State GST (SGST). • The CGST and the SGST would be applicable to all transactions of goods and services in India except for some exempted goods and services like alcohol, tobacco, petroleum products are likely to be out of the purview of GST regime. • There will be two-rate structure - a lower rate for necessary items and goods of basic importance and a standard one for goods in general. • The CGST & SGST would be levied on import of goods and services into the country. Benefits of Introducing GST GST may be new to India but it has already been implemented in the world successfully. France was the first country to introduce GST system in 1954. Standard rate of GST is 15‐20%. • GST is intended to eliminate multiplicity of taxes, exemptions and rates which are not included in Central VAT (CENVAT) and integrate the indirect tax framework covering manufacture, sale and consumption of goods and services. • CENVAT element is further taxed under state VAT leading to duplicity of tax i.e. ‘tax on tax’. In the proposed GST, such a


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No.

Stages of Supply Chain

Value Value of Input Addition (Rs) (Rs)

1

200

2

Raw material supplier Manufacturer

3 4

sold at Rs.380 in the retail store. The GST on this packet of flour is applied across the flour manufacturing ‘value chain’. By ‘value chain’ we mean, the process of raw materials being supplied to the manufacturer by the raw material supplier, finished and packaged flour supplied to the whole seller and finally to the consumer purchasing the final packed flour from the retail stores. The process in which GST will be calculated are as follows (assuming GST rate=10%): 1. In the first stage the raw material supplier, who supplies the raw material worth Rs.200 to the manufacturer has already paid GST of Rs.20. 2. The manufacturer processes the raw materials and adds value to the extent of Rs.50 and sells the bulk flour to the whole seller at Rs.250.The manufacturer will then pay a GST on output of Rs.250, which is Rs.25 (GST rate of 10% on Rs.250), but will get an exemption of GST input tax credit which is Rs.20 (10% on Rs.200) thus paying a net GST of only Rs.5. 3. Similarly as shown in the table below, the whole seller and the retailer will each have to pay a net GST of Rs.10 and Rs.3 respectively. 4. In total, the entire value chain from the raw material supplier, manufacturer, whole seller to the retailer, all put together will have to pay Rs.38 as GST. Hence, GST is a tax which is levied only on the component of “value addition” at each stage and supplier at each stage is permitted to set-off the early payment through tax credit mechanism.

Value of goods & services at next stage (Rs.)

Rate of GST (%)

GST on Output (Rs)

Input Tax Credit (Rs.)

Net GST= GST on outputInput Tax Credit (Rs.)

-

200

10

20

0

20-0=20

200

50

250

10

25

20

25-20=5

Whole seller

250

100

350

10

35

25

35-25=10

Retailer

350

30

380

10

38

35

38-35=3

Table 1: GST on Output-Input Tax Credit

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Finsight Classroom Cover Story

cascading effect of CENVAT as well as service tax are removed and a continuous chain from original producer/service provider to retailers is established, thus reducing the burden of cascading effect. This is critical improvisation in GST. • As the burden of tax under GST is expected to generally fall it becomes a positive driver for manufacturers, consumers and industry at large and this may lead to increase in revenue both for centre and state, primarily through widening of tax base and possibility of significant improvement in taxcompliance. • GST will ensure the uniformity of taxes across the territory, regardless of place of manufacture or distribution. • General lowering of costs of raw materials and processes will reduce the cost of goods and services in the market. • It will simplify India’s tax structure, create a common market across India and broaden the tax base. According to a report by the National Council of Applied Economic Research, it is expected that GST would increase our economic growth around 0.9% to 1.7%. Exports are expected to increase around 3.2% to 6.3%, while imports are expected to increase between 2.4% and 4.7%. How does the proposed GST system work? The tax burden in GST is applied across the entire ‘value chain’ and tax is levied proportional to the value addition at each point. Let us take an example of a flour manufacturer. Assume a packet of flour is


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At Present under Excise & VAT After implementation of GST In Factory Amount In Factory Amount (Rs) (Rs) Assessable Value 1000 Assessable Value 1000 Add: Excise Duty@10% 100 Add: Excise Duty@10% 100 Sale Value 1100 Sale Value 1100 In Retail Shop Amount (Rs) In Retail Shop Amount (Rs) Cost Price 1100 Cost Price (Rs1100-Rs100) 1000 Add: Expenses & Profit 400 Add: Expenses & Profit 400 Assessable Value 1500 Assessable Value 1400 Add: VAT@12% 180 Add: VAT@12% 140 Sales Price 1680 Sales Price 1540 ANALYSIS Excise Duty Paid by Factory@10% 100 Excise Duty Paid by Facto100 ry@10% VAT paid by Retail Shop@12% 180 VAT paid by Retail Shop@12% 40 Total Taxes Paid 280 Total Taxes Paid 140 Here, Excise Credit of Rs.100/- is not available. Here, GST Credit of Rs.100/- is available. Table 2: The table below shows the advantage of having GST over current taxes

What are the challenges in introducing GST? 1. The Constitutional Amendments: The implementation of GST calls for amendments in the Constitution and the various constitutional entries relating to taxation. For example, the States does not have the powers to levy a tax on supply of services. To give the States this power requires necessary changes in Constitution which is itself a very procedural task. Similarly the centre does not have the power to tax sales of goods and would require necessary changes in Constitution. 2. IT Infrastructure: The Government needs to develop/set up proper IT infrastructure to implement GST. 3. Sharing of resources: Given the current state level VAT variations, there are challenges in securing unanimous consent on the rate of GST, hence this is yet not been finalized. It is not only the matter of rates but the states will have to let go their powers of levying many form of taxes which will henceforth be covered under GST. Such loss of power have turned out to be a major hurdle for securing unanimous approvals from state government in implementing GST. 4. Compensation to States: There is likely to

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be significant loss of revenue to the state governments on account of GST implantation and so there is opposition for implementation of GST. To remove the resistance, the Centre is expected to put in place a mechanism in initial years to compensate the States for any revenue loss due to GST. Every system has its own intricacies embedded at the initial stages and removing these difficulties involve various constitutional, political, technological and procedural barriers and it’s going to be a really big task to design and implement an integrated goods and service tax in line with international best practices and at the same time match with the complexities of the Indian state and central legislation. We have moved forward significantly in this initiative, but, it needs to be seen when we would be in a position to actually implement GST entirely.


MR. PUNEET PRAKASH Associate Professor, Virginia Commonwealth University Ph.D, Georgia State University

How do you think 2008 financial crisis impacted the risk management scenario in the world and what are the important risk management measures adopted by the banks world-wide especially in terms of hedging strategies adopted by the companies? There are two aspects to this question: One is what happened to the risk management in light of 2008 crisis and then what were the measures that were adopted by the banks and the corporates? 2008 actually helped the corporates in bringing risk management to the forefront because prior to 2008, risk management was supposed to be a backend function and people had been hopping about risk management from the past 10 years prior to the crisis. But then what happened was that after the crisis, people realized that the reason why it(crisis) happened was, line officers who were the finance front end people put risk management in the back-seat, and the riskreturn relationship that people ought to follow eventually broke in this process. There is a section of the media that blames one of the metrics for crash in 2008 and that metric is “value at risk”. Value at risk, when it started off as a metric for risk, was touted as the measure, but then everybody jumped on to this measure, look what happened. So, my answer to that question is that it is not really the metric, but the misunderstood metric. So, the measures that banks have taken now essentially after the 2008 crisis are primarily regulation driven. Currently, the emphasis is on SIFIs (Systemically Important Financial Institutions) and all governments across the world identified them, whether they are from banking sector or from insurance sector or from non-banking sector. It has got a lot to do with size and how the banks or financial institutions are networked into the entire economy. So, just to get a historical perspective, in the U.S.

what used to happen was that there were all these local, regional banks and the system worked fine. When an individual demanded loan, somebody from the bank used to come and look at the assets that the individual holds and then loan amounts were decided. However this boring business got exciting in 80s and 90s in the form of investment banking when it (Investment banking) got popular. So, what has happened in this entire process is that the checks and balances usually done by the people prior to loan checking, were kept aside. Now, banks are going back to that old model. They are now realizing that they have their tentacles in many places in terms of products and geographies. Citibank is a prime example. After the crisis, they started winding up a lot of their operations and products. So, I think we will continue to see those measures taken by the banks. Regulations essentially are forcing some of these and some positive role is also being played by the auditing agencies because they are forcing organizations to undertake some kind of enterprise wide risk management. So, now banks are looking at their models differently, keeping aside reserves differently and so on and so forth. In 2009, after 2008 crisis, the GDP growth rate in India was 3.5% and it peaked to 10.5% in 2010 and took a steep fall to a decade low of 3.2% in 2012. Do you think that this paltry growth rate which we have seen in 2012 and the current economic issues are a spillover from 2008 and Eurozone crises or is it that India is fairly insulated from the global catastrophes and it is just due to the internal issues that are there in India? It will be wrong for me to actually say that India is really insulated from the global catastrophes. It is not the case anymore. Is it globally very well integrated? “No” is the answer. When I

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say global integration, it is not just capital flows that we are talking about, it is the kind of instruments that we see, e.g. derivatives market, Credit Default Swap market. These are not very deep, but they are now beginning to come to the Indian market. So, as the process unfolds, India will keep getting more and more integrated. So, the insulation from global catastrophes is not going to happen. In 2012 what you had seen (steep fall of GDP growth rate) is partly because of the spillover effect. But mostly free markets in India don’t really work that much because governments still have a strong role to play. Even today, budget is a big event in India. In the U.S. and the U.K., it is just a government’s statement of accounts (stating the sources and uses of money). The markets that are there in the U.S. and U.K. are not really interested in these events. But for India, this is not the case. So, I think the major part of what we had seen recently in the last 1 or 1.5 years is primarily because of India’s own making and that has been realized by a lot of people. The government’s fiscal deficit and current account deficit have a lot to do with what happened in 2012 rather than blaming it on external sources. Do you think that the liberalization and globalization policies framed in 1991 have a big time effect now? There are two things we have to understand. Research has shown that the liberalization (opening up of economy) by itself doesn’t change anything. It has to be coupled with deregulation. One can say “Welcome capital” but with so many hurdles so that the opening up of economy goes waste. So, I think what had happened was deregulation part got derailed and it is not that we need to finetune what we did in 1991. What we need to do is essentially deregulate. What is your take on increasing NPAs among the Indian banks (since total NPAs of 40 listed Indian banks have zoomed by over 40% - from Rs. 1.25 trillion in December 2011 to Rs. 1.79 trillion in the same month in 2012.). Are the risk management strategies adopted by Indian banks deteriorating which may lead India into another crisis? The reason for increase in NPAs is not the risk

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management practices after the loans have been made. It is the underwriting part that needs to be looked into. Again in India, we know that there is priority sector lending that is dictated by the government. So, what part of these NPAs is formed by these priority sectors also matters in arriving at any conclusion. While disbursing loans, there is a lot of information which is not given weightage. For example, the CIBIL scores for individuals. CIBIL scores is a batch processing system in which someone logs into the banking system and offloads the data on a regular basis. The quality of this data is something which one needs to carefully work upon. So, it is not really the risk management practices of the Indian banks, but prior to making out the loans, the assessment of the risk is the crucial aspect. So, if you start thinking about risk management as a process by itself, you identify the risk and then we take steps to mitigate it. The risk identification part needs to be carefully looked into. With the expectation that the insurance premiums will increase atleast for a decade in the emerging economies, what will be your suggestion to the insurance companies about the longterm opportunities given the recent developments of increasing the FDI limits and on the other hand Berkshire Hathaway leaving India within 2 years of its establishment? Berkshire Hathaway was essentially selling policies for Bajaj – Allianz via its online insurance site. It was not underwriting business in India. That part does not worry me, Berkshire Hathaway leaving India. As far as the insurance sector itself is concerned, I am really gung ho about it because we are at the bottom of the curve and the S-shape curve would actually predict that we are going to grow faster atleast till the point of inflection and then the growth is going to slow down. If we look at not just typical auto insurance and life insurance but at micro-insurance products all across the world, most of the innovations in micro-insurance are taking place in India (there is a micro-insurance academy in Delhi in which these people go from one community to another teaching about Micro-insurance. Tata AIG has got an insurance video teaching villagers about how actually the insurance


works). So, my personal take is that insurance sector is going to grow. What might actually happen is that in the race to grow, some of the insurance companies might take short-cuts. Even if total premiums are to go up, it could come either from volumes or from price hikes. In order to gain volumes, the companies might cut the prices because of which there can be a lot of adverse selection and hence one may end up taking a bad risk which one should not have taken. So, regulators are going to have a key role in looking after this. The future for insurance sector in India looks good. We (our policy makers) always boast about India’s preparedness for any kind of crisis (especially financial crisis) in which they highlight the conservatism and sturdiness of the Indian economy which protected the Indian economy during 2008 crisis. On the other hand, the World Bank’s World Development Report, 2014 has given Risk Preparedness Index value of 31 to India, while the global average is 55. In this situation, do you think India is prepared to face any crisis or risk? RPI constitutes gross public debt as a % of revenues, proportion of households with less than $1,000 in net assets and percentage of the labour force contributing to a pension scheme. We have to delink the two issues. The reason why we have to delink is that there is too much focus on rupee depreciation. When Raghuram Rajan stresses on narrowing CAD, he is saying that they are working to bring down rupee volatility. If we look at World Bank’s Risk Preparedness Index, it is not worried about the volatility of the currency, rather it is concentrating on the entire economy. So, if I were to think about these two issues separately, the policy makers are focusing more on government and financial markets and not on the country as a whole and the World Bank’s Risk Preparedness Index is more on the mark as far as risk preparedness of the country is concerned. We are all really worried because if we look at the demographic profile, a lot of young people are not in jobs, the government has moved over from a defined benefit pension plan to a defined contribution pension plan. When the government says that

it is going to reduce the deficits, it is basically curbing the expenditures, which further leads to a reduction in hiring by the public sector. As a result, the private sector must expand so much that it is able to absorb all the energy (young people). If we have that concern in the mind, then we can say that the risk preparedness of India is not that great because here we are looking at societal risks by moving away from the financial risks and this is what the World Bank report constitutes. What is the future of risk management in debt markets given the recent new fears that were raised out of the U.S. shut down that we have seen and for the first time we are questioning the sanctity of the U.S. T-bills (which is considered as the safest asset). It was said that U.S. could default if debt ceiling is not raised. Recently we have seen that Moody has downgraded France’s government bonds from AAA to AA1. In such scenarios where the safest asset is not safe enough, what is the future of risk management in debt markets? One thing we have to remember is that debt has always been risky. Now the question is whether the closest risk free asset that we can get to (U.S. security) should be scrutinized or not. We have to realize that the debt ceiling issue and so on and so forth are mainly due to political issues and this kind of political upmanship will continue. When we look out farther into the future, the amount of public debt that the U.S. has is a matter of concern. It has started getting discussed within US circles which is a good sign, but we also have to realize that the U.S. is the biggest consumer in the world. Even if it is going to sink, the rest of the economies in the world are not going to let it sink and that is why these things keep on happening i.e. Even if the U.S. goes through a downturn, the rest of the world will buy the bonds that they issue. When there is a perception that the credit quality of a risk free asset has gone down, the markets are going to respond by asking for higher yields. That doesn’t mean that they are close to default. From the risk management perspective, this is exactly what you expect i.e. the credit quality of any asset in general and of a risk free asset in particular is expected to go down. As

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a risk manager, one would like to see these yields. Hence, the risk managers can be happy since the connection is still there and if that connection is not there, then the risk management is broken. The question here is what do people do when a crisis hits? Where do they park their money? If people feel that U.S. is going to default, they will start investing in gold and in other safe assets. At some level, people who are smart enough will take care of their financial risks by switching over to other safe assets and again this points out that the markets will take care of themselves. We need to bother about the people who do not have access to this information. Should the debt ceiling of U.S. be raised? I think it should be raised. This whole issue of rising debt for the U.S. has come up in the past 7-8 years after Clinton left the U.S. economy in surplus. As long as the U.S. keeps on taking steps to curtail its spending, we need not worry about the debt ceiling. The important aspect is the steps that the U.S. government is going to take to bring down the long-term borrowings. In general, the U.S. is very fast in responding to the crisis. Until 2007, the savings rate of the U.S. was actually negative; people were borrowing and consuming and when the crisis hit, their savings rate became significantly positive. If the base also starts growing along with the debts, we need not worry about the ceilings. If we keep raising the ceiling and if we keep hitting it without expanding the base, then there is a problem. Do you think risk management is getting the importance it should be getting for management education? What is your advice for the students of management who are willing to make a career in risk management so that they can meet the industry expectations? I think risk management is getting more and more importance in the corporate world. And if you look at the history of risk management, the career choices were very limited. Earlier, the employees in the field of risk management would rise only to the level of a risk manager. But now, we have Chief Risk Officer and even the boards are talking about risk committees. So, risk management as a profession is going to grow and you also have to think about the best and the brightest. If you look at the

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history of deregulation of the banks, whenever the sectors deregulate, the best and the brightest actually flock to that sector, and risk management is in that takeoff stage. It is a technical area and people are discovering that in India and people are now flocking towards it. Risk management is getting combined with financial engineering and hence you need to be technically competent in order to survive. It is not really a front end job, it is a back-end job. One has to realize that the back-end is all about quantitative modelling and dealing with large data sets. So, the future of risk management is pretty bright. The part that the students need to keep in mind is that the industry standards that have evolved are primarily restricted to the financial sector. There are two industry bodies: one is Global Association of Risk Professionals (GARP) and the other one is Professional Risk Managers International Association (PRMIA). These two certifications prepare you for a career in risk management. But the risk management that these two bodies promote is restricted to the financial sector only. One needs to look at the risk management in a very broad perspective i.e. from the point of view of the entire society. Financial sector is trying to assign a monetary value to these other kinds of risks. So, the modern risk management is now considering all these parameters (human health, chemical and nuclear catastrophes, information security risk etc.). They are trying to get their handle around these risks which were not quantified earlier. Once a link of that sort is formed, then it is very difficult for a profession to go out of business. Since risk management is just taking off, this linkage is slightly missing now. So, for the young professionals who are willing to work in the area of risk-management, it would be better if one looks at making this kind of linkage.


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FinFunda of the Month

Exchange traded Funds priya agarwal IIM Shillong What sort of diversification should the ETF have to ensure that the risk is spread across the portfolio?

Sir, you explained mutual funds, hedge funds. But what are these exchange traded funds (ETF)? Before knowing about ETF you should have a fair knowledge of what indexes are. Investors use indexes to track the performance of the stock market. Any change in the index reflects a weighted change in the stocks that comprise the index. ETF is a financial instrument that tracks an index, a commodity or a basket of stocks which reflects an index, like an index fund, such as the S&P 500 and can be traded like stocks. Unlike mutual funds we don’t have to find out its net asset value. Basically ETF enjoys the pros of index funds and is devoid of the shortcomings of mutual funds. Owing to its similarities with stocks, you can short sell ETFs, buy them on margin with no restrictions on the number of shares you want to purchase; and unlike mutual funds, you can trade them at any point in the day. Sir can you explain what are the major benefits of an ETF portfolio over stocks and mutual funds? Mutual funds are actively managed funds thus, involving high costs whereas, ETFs are passively managed because of the underlying indexes, hence resulting in low cost. ETFs are also more tax-efficient than mutual funds. This is because capital gains from in-kind transfers (by exchanging) do not result in a tax charge. Tax is charged and paid only when ETFs are sold. Therefore, ETFs are an obvious choice over mutual funds. The advantage of ETF over a stock is its diversity. Instead of having stocks of one particular company, ETF tracks a basket of stocks which spreads out the company-specific risk reducing the perils involved thus attracting an investor to consider it as a safe option.

The ETFs can be created broadly focussing on three areas: 1) Sectors: Investors can create portfolios that concentrates on various sectors of the equity markets. For e.g. large cap, small cap, growth, value. 2) Nations: ETFs can track an index that invests in a single country or it could invest in an entire region. ETFs can cover all regions ranging from emerging markets to developed markets. 3) Commodities: ETFs instead of covering a sector or spanning across nations can also focus entirely on one single commodity. However, that does not mitigate the risk faced by an investor to a great level. To summarize, ETFs are a convenient way of asset allocation that enables investors to quickly and easily build a diversified portfolio allowing them to manage the risk for themselves. ETFs seem to be the best financial instrument for any investor. No. It is not the best instrument for any and every investor. One needs to understand when to buy the ETFs and when to trade them along with the price at which it is to be traded. For an illiquid market where much trading of ETFs don’t occur in that case there will be a high bid-ask spread (the difference between the price at which seller wants to sell and the price at which buyer wants to buy) leading to a loss either for the buyer or for the seller. Therefore an investor should carefully observe how the market is performing and should invest in those ETFs that will suit him/her the best. Thank you Sir. I now understand what Exchange traded funds are.

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1. Name the company which built inter-atlantic lines in 1861 and later using the same technology created a revolution in the financial world. 2. Which App has become the number 1 app on iOS, Android and Facebook at the same time? 3. An IIM A pass out, she became a contender for the managing director and CEO’s position. at ICICI Bank in 2009. She was up against the equally high profile and meritorious Chanda Kochhar - and Kochhar was eventually selected. She is now the MD and CEO of one of the major banks in India. Who is “she” and what is the name of the bank ? 4. I invest in your start-up. I am focused on helping the business succeed, rather than earning a huge profit from the investment. I may be your friend or may belong to your family. Who am I? 5. This financial term finds its origin in baseball terminology and was made famous by a prominent American Stock investor in one of his books. It refers to a specific type of stocks that are considered to generate very high returns. Stocks of companies that have small market capitalization have the potential to be in this category. 6. Why Burson Marsteller is in news currently in India and what is its main business ? 7. Identify the person

8. Question (Connect the dots)

9. Question (Connect the dots)

All entries should be mailed at niveshak.iims@gmail.com by 10th February, 2014 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-


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Prize - INR 500/-

Rohan Modi IIM Shillong

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