FineTune 2011 MDI Gurgaon

Contents MDI PGPM 2010-12

Rohith Potti

Kriti Jain

Utkarsh Vikram Singh

7 THE TELECOM SCAM Of the many intriguing scams that have occurred in the Indian industry till date, the 2G spectrum scam has made the most noise owing to its magnitude and the status of people involved. The scam has made national headlines and gone to the extent of disrupting parliamentary procedures on several occasions.

14 SECTORS TO DRIVE INDIA’S NEXT GROWTH At present manufacturing and banking sectors are bullish and prospects of sectors such as Information Technology (IT), Telecommunication (Telecom), Retail and Healthcare are also attracting global attention..

MDI PGPM 2010-12

Rahul Aggarwal

NITIE, Mumbai 2010-12

Rohit Lakhotia

Pratibha Malik

Apurva Agarwal

20 CURRENCY WARS - RACE TO THE BOTTOM The modern day warfare has shifted from the traditional battle field to the corporate boardrooms. The decisions on who survives and who does not, are taken by those who stroll the corridors of power. The battle is gauged, not by the number of soldiers felled but by the points the currency has fallen.

Contents PGDIM-17,NITIE, MUMBAI

24 THE EURO CRISIS The recession that began in 2008 triggered a phenomenon which has repeatedly come to haunt various segments of the world economy. If the collapse of Lehmann Brothers marked the concept of behemoth conglomerates that were “too big to fail”, the Euro crisis of 2010 has brought sovereign defaults into the picture.

NOOR MAINI

28 INDIAN M&A MARKET With the increasing confidence in Indian economy the capital markets gained significantly. India Inc’s appetite for strategic M&A has more than quadrupled over 2009 clocking US$ 49.78 billion in 2010.

Rachna Agrawal

Nilesh Anandpara

Saichand Musunuru

33 CHINA’S ECONOMY: IS IT A BUBBLE ?

MDI PGPM 2010-12

Ashwin Nair

SBM, NMIMS2010-12 batch

Shalabh Arora

The story of superlatives in China is not just restricted to its population numbers, highest GDP growth in the world in 2009 of 8.7 per cent and the third largest economy of the world set to overtake Japan, clearly it couldn’t have been a better time to be celebrating the year of the Tiger for the Chinese.

Contents 36 IMPACT OF NEW BANKING LICENSES IN INDIA The proposal by the Reserve Bank of India to open up the Indian banking sector through issuance of banking licenses to Non banking finance corporations (NBFCs) met with unparalleled interest by industry representatives. In what ways can the launch affect financial inclusion and rural banking growth in India and what other benefits can be realized through this move?

39 FUTURE OF INDIAN DEBT MARKET Generally in any developed country the debt market is many times larger than the equity market. But compared to India’s world class equity markets, India’s corporate bond market is still in an embryonic stage, both in terms of the market participation and infrastructure.

IIM, Shillong 2010-12

PGDM 2010-2012, SPJIMR

Rohan Rambhia

Mansi Mahajan

Nitish Sanadhya

Pritha Sharma

Sushant Gupta

FROM THE EDITOR’S DESK Dear Readers,

finetune October 2011 The Team Editor Danish Arif

Sub-Editor Shishir Srivastava

New Team Anupriya Asthana Ankur Dixit

Creative Team Prateek Bhatnagar Anant Garg

I wonder when we are going to see the end of the vicious circle. The Global Downturn in 2008, which was followed by the multifarious crises across the globe from Ireland to Greece to Dubai has brought the global economy on the brink. And with the indecision plaguing the people who call the shots in Europe, we may see more nations joining the list of ailing economies – Italy , Spain or maybe even France, who knows. Action, in the near future, will shift to individual member states, such as Germany, which would take its support for the Greek bailout plan to its elected representatives for their approval.

Now the critical question is whether the jittery financial markets have the same faith in governments as they have in themselves, or, their panic will precipitate a crisis. The financial markets will in all probability wait out the action that is going to begin in individual elected assemblies, before heading in any single direction. But there is a fear and anticipation of a fresh contagion , which may push the world into the abyss.

Another global contagion at this stage can be catastrophic for emerging economies like India. We have already used up most of our fire-power dealing with the 2008 crisis, moreover, there are worrying signals on the macroeconomic front, what with the inflation approaching double digits, growth slowing to under 8% and ,most worryingly, the fiscal deficit target which is surely going to be missed. There is no quick and easy fix available, although the Reserve Bank of India has done all it can to contain inflation, but it must understand that trying to continuously hammer down inflation by increasing the interest rates wouldn’t be much of help in cases where there are supply-side constraints involved. All that will happen is a slowdown in growth and a marginal, if any, decrease in inflation , moreover a slowing down growth would make it all the more harder for the government to meet its fiscal deficit targets.

This edition of Finetune brings to you the 8 best articles ( out of more than 100 articles ) that we received from different B-Schools across the country, on diverse topics such as ―Impact of 2G Scam‖ , ―Euro - Is it too big to fail?‖ and many others. I congratulate the authors of the top 3 entries who are entitled to prizes as we had mentioned in our previous communications. But you cannot takeaway anything from the other 5 entries, which were almost as good. One special mention here, I’d like to thank Prateek Bhatnagar, for redesigning the ―finetune‖ logo. We hope that this endeavor of ours would be an interesting read for our readers. Looking forward to your valuable feedback and suggestions.

Peace Out

Danish Arif

Editor-Finetune

MDI PGPM 2010-12

Rahul Aggarwal

NITIE, Mumbai 2010-12

Rohit Lakhotia

Pratibha Malik

Apurva Agarwal

MDI PGPM 2010-12

Rohith Potti

Kriti Jain

Utkarsh Vikram Singh

Monetrix

Finetune OCTOBER 2011

THE TELECOM SCAM AND ITS IMPLICATIONS

EXECUTIVE SUMMARY Of the many intriguing scams that have occurred in the Indian industry till date, the 2G spectrum scam has made the most noise owing to its magnitude and the status of people involved.

The scam has made national headlines and gone to the extent of disrupting parliamentary procedures on several occasions.

There have been allegations that DoT manipulated its own policies to selectively favor a few firms while issuing new cellular licenses in September 2007, resulting into a Rs. 1.76 lakh crore loss to the exchequer.

The scam brought to light the four major groups who were engaged in the illegal allocation of the 2G spectrum – 1. Politicians who had the authority to sell licenses 2. Bureaucrats who implemented and influenced policy decisions

3. Corporations who bought licenses 4. Media professionals who mediated between the politicians and the corporations on behalf of one or the other interest group.

Issuance of licenses happened on a first come first serve basis, no auction process took place, no bids were invited and even the cut-off date for applications was advanced by a week.

Several recommendations by TRAI, Law Ministry, and Finance Ministry for the auctions of spectrum to be done at market rates were ignored and A. Raja went ahead with the undercharged frequency allocation.

Through this article, we have analyzed the intricacies of the scam and assessed the impact of it on all major stakeholders in the industry, namely, the consumers, industry players and the

government and also offered recommendations on the regulatory scenario in the industry, going forward.

OVERVIEW The telecom services sector has grown rapidly over the past 5 years on the back of a meteoric rise in the mobile services space.

The mobile subscriber base soared from 99 Mn in FY05 to 584 Mn in FY10, making it the second-largest wireless market in the world, next only to China.

Increased affordability (due to continuous decline in tariffs, handset prices and reduction in initial subscription costs) and greater availability (with rapid expansion in coverage and wider distribution network) of mobile services has fuelled this buoyant growth.

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(In Millions)

Total mobile subscribers base 600 500 400 300 200 100 0

584 392 261

7

14

36

57

99

166

2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 200902 03 04 05 06 07 08 09 10

Mobile subscribers

Source: COAI, AUSPI and TRAI The industry has witnessed phenomenal growth in the past eight years at a CAGR of 73.8% as is reflected in the graph above. As of December 2010, mobile subscribers in India had reached 752 million translating into an overall teledensity of 66.2%.

Industry wide ARPU witnesses significant fall

The Telecom Scam and its Implications

While there has been significant subscriber growth, Average Revenue Per User (ARPU) has plummeted due to intensifying competition between service providers in the sector. Fall in call tariffs, initial subscription costs as well as SMS and non voice services rates, has led to a reduction in the average ARPU of the industry.

Over the past 18-24 months, the mobile services sector has evolved considerably as operators expanded their services, which led to tariffs declining sharply and subscriber growth moving along an altogether different tangent.

3G to be the game changer in the industry However, with the advent of 3G services, Industry ARPU is expected to stabilize going forward. Global examples indicate that with the onset of 3G services, data and application usage rises substantially, generating higher ARPU levels.

With MTNL, BSNL, Tata Teleservices, Reliance Communications and Bharti Airtel having already begun the roll out of 3G services, industry can be expected to grow, going forward.

Rural areas yet to witness the telecom boom In urban areas, Teledensity (Number of mobile connections per person as a percentage) has crossed 100%. On the other hand in the rural areas, there is still tremendous potential for growth. As of September 2010, there were 236 million rural subscribers translating to just 28% Rural Teledensity.

The fall in ARPU has led to a reduction in the Revenue Per Minute (RPM) of service providers. With RPM for several players falling below the operating cost that the service provider is incurring per minute, survival in the industry has become tough.

OCTOBER 2011

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Spectrum pricing strategies employed by DoT Key Selection parameter

1994

Metros: Lowest Rental proposed to be charged from subscribers Non Metro circles: Highest license fee quoted by the bidders

1999

Shift from license fee to revenue sharing

2004 2008 2010

Additional spectrum issued on the basis of number of subscribers New licensees selected on arbitrary FCFS basis 3G & BWA spectrum alotted through auctions

Source: TRAI recommendations on spectrum allocation

HISTORICAL SPECTRUM PRICING STRATEGIES

In August 1995, Mobile services were launched for the first time in India in the city of Kolkata. Under the National Telecom Policy, 1994, the policy‘s key objectives included: 1. Universal service with complete coverage of urban and rural areas 2. Availability of a wide range of services at reasonable prices In the first phase in 1994, 2G spectrum was allotted to four service providers per circle on the basis of the lowest rental proposed in metros (to increase affordability) and the highest fee quoted by service providers in Non metro circles (to maximize revenues). This was later extended in 2001 to accommodate more players in order to increase competition leading to a reduction in prices.

Moreover, the excess spectrum allocation from 2004 onwards had been done by DoT in proportion to the number of subscribers that a service provider had in the respective circle.

3G pricing strategy employed by DoT In the case of the 3G spectrum allocation, government conducted an auction between interested parties for three-four slots of spectrum in the 2.1 Ghz range for service providers. As against a budgeted Rs. 35,000 crores from 3G and BWA auction made in the Finance Minister‘s speech for the 2010-11 budget, the exchequer collected Rs. 107,000 crores from the two auctions.

The opponents of the auction process being employed to sell spectrum argue that the economic and the social benefits which can be raised from the sale of spectrum should be a determining criteria for the pricing of spectrum with India being a highly competitive price sensitive market having high price elasticity.

Hence, if mobile services were made affordable then an exponential growth in users could be expected.

However, if the spectrum is offered at exorbitant prices, then the service providers will pass on the cost to the subscribers, making it less affordable.

International pricing strategies Varied spectrum allocation strategies have been employed in various countries with reasonable success.

The beauty contest plus fixed fee pricing strategy have been employed on most occasions. Some of the international pricing strategies employed in various countries are given below

The Telecom Scam and its Implications

Large untapped population coupled with relatively lower penetration has prompted the telecom companies to fine-tune their focus on rural areas. Service Providers had been reluctant to expand their services in the rural areas owing to the low quality of subscribers and the high power and fuel cost incurred in these areas. However, with the urban regions getting saturated, rural India will be the prominent contributor to the industry growth going forward.

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International pricing strategies for spectrum

Country Australia

Pricing strategy Auction

Korea

Beauty content plus fixed fee Beauty content plus fixed fee Beauty contest plus fixed fee

UK

Auction

Malaysia Singapore

2G/ 3G 3G Both 2G & 3G Both 2G & 3G 3G 3G

Source:TRAI consultation paper issued 12th June 2006

Having considered historic as well as international pricing strategies, the following criteria can be used for determining spectrum price,

4. Opaque & uncertain delivery system due to UAS licenses barely being issued from 2004-05 to October 2007.

5. Change in the method for applying FCFS criteria from the date of receipt of application to date of compliance of LoIs. The Prime Minister, Minister of Law and justice, Finance Secretary and the DoT Secretary were against the hasty allotment of spectrum at 2001 prices and believed that DoT had lost an opportunity to discover the real economic value of a scarce national resourcespectrum.

2G Scam : Timeline 24th Sep, 2007

DoT conveys no application to be accepted after 1st Oct, 2007

1.

Demand supply situation reflective of scarcity

19th Oct, 2007

2.

Economic and social benefits emanating from 3G services

Policy for dual technology announced, LoIs issued to Rcom & 2other companies

2nd Nov, 2007

DoT decides that only 232 applications till 25th Sep, 2007 will be considered

3.

Maximizing government revenue THE 2G SPECTRUM SCAM

2nd Nov, 2007 2nd Nov, 2007 31st Dec, 2007

PM writes to Telecom Minister to consider auction of spectrum in fair transparent manner Telecom minister writes back saying that sufficient 2G spectrum is available Secretary DoT and Member (Finance) DoT retired.

Out of 232 applications received up to cut off date 121 LoIs were issued to applicants found eligible

The Telecom Scam and its Implications

Salient features of these recommendations were:

10th Jan, 2008

No cap to be placed on the number of access service providers in any service areas

Criteria for allocation not met by new entrants

No additional spectrum to be allocated to licensees without fulfilling the rollout obligations and failure of the same would lead to termination of license.

Later that year, DoT accepted all the recommendations made by the regulator. However, despite the recommendation, DoT issued a press release accepting applications only till 1st October, 2007. DoT further accepted applications only till 25th September, 2007.

Irregularities in FCFS strategy adopted by DoT 1. Arbitrary dates fixed as cut off for receiving applications in September 2007.

2. Selectively leaking out information to benefit a few players who were ready with pre-dated demand drafts prior to the date of issue of application asking for Demand drafts.

3. Out of 232 applications received from 21 applicant companies till the changed cut-off date, 121 applications from 16 applicant Companies were found eligible.

Even ignoring the arbitrary FCFS methodology adopted by DoT in the issuance of articles, the real issue lies in the type of companies that were allotted spectrum to roll out 2G services. Most of the new entrants who won spectrum were novices in the telecom field having no background in the industry, existing only on paper.

Additionally, most of the new entrants did not meet several criteria for the allocation of spectrum. In the table below, the irregularities with respect to the new licensees have been mentioned.

OCTOBER 2011

Page 11

Company

Irregularities in the new licenses

Shipping stop dot com now Loop Telecom

Suppressed non - registration of alteration in the main object clause of MOA by ROC Authorised share capital only Rs. 5.20 crore against requirement of 128 crore

Request for Registration of increase in authorised share capital submitted 24 Oct. Suppressed non - registration of the resolution effecting alteration in the MOA

Datacom Solutions Pvt. Ltd. (Now Videocon Telecom Ltd.)

Authorised share capital only Rs. 1 lakh against requirement of Rs. 138 crore Submitted false certificate from Company Secretary

S Tel

Suppressed non - registration of alteration in the MOA/AOA Authorised share capital only Rs. 10 lakh against requirement of Rs. 18 crors; Submitted false certificate from Company Secretary

Equity sales by new entrants to foreign players Seller Swan Telecom S Tel Unitech

Buyer Etisalat Mauritius BMIC, Mauritius Telenor, Norway

% Stake In Rs. Crores 50%

3,598

5%

239

67%

6,120

Source: Media releases on company websites

Little impact on competition in the sector While the allotment of 2G spectrum was expected to usher in a new wave of competition leading to a further reduction in tariffs, most of the new entrants failed to meet their roll out obligation norms.

Source: Various public releases on the website

IMPACT ON INDUSTRY Incumbents: In an already competitive environment, number of service providers was raised from 6-7 to 11-12 in various circles, resulting in a hyper competitive scenario.

Preferential treatment for new entrants While established players were waiting in line to gain spectrum, new players were offered spectrum within a few months of applying for the letter of intent. Idea Cellular had been in queue for more than 2 years for spectrum in the Punjab circle, while new entrant Unitech Wireless was issued spectrum in just 2 months, despite being much lower than Idea in the priority list for the Punjab circle.

Spectrum issued at throwaway prices The spectrum issued to new entrants was offered in the range of Rs. 1,500 to Rs.1,600 crores which was the same price at which most of the incumbent players had received startup spectrum post the implementation of the National Telecom Policy, 1999. In eight years, the industry had undergone major changes and from its infancy stage had zoomed forward. To realize the true value of spectrum, we can consider the equity sales made by the following companies, most of whom did not possess any assets on their books, but a piece of paper – The 2G license.

Moreover, the new entrants have failed to garner a significant amount of market share since their roll out.

Infact the top six players of the industry have remained unchanged in the past several years.

As of December 2010, six new entrants (Etisalat, Uninor, Sistema Shyam, S-Tel, Loop Telecom and Videocon) had managed just 4 per cent market share translating into just one per cent revenue market share.

Therefore, the objective of DoT to increase competition leading to higher affordability has not been met.

The Telecom Scam and its Implications

2G spectrum scam: New licenses

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Burgeoning fiscal deficit

IMPACT ON GOVERNMENT Non fulfillment of roll out obligation norms As per the roll out norms, new licensees were required to roll out services in 90% of metro service area and 10% District Headquarters in other service areas within 12 months of being allotted spectrum. Although, startup spectrum of 4.4 Mhz was made available to all players in 2008, none of them had rolled out services as per the earlier stated provisions till January 2010. Therefore,

In the year 2007-08, India ran a fiscal deficit of Rs. 1,509 billion representing 3.1% of the country‘s GDP. While in the union budget for 2009-10, this fiscal deficit had risen to 6.7 % of the country‘s GDP.

1. DoT did not earn any spectrum fee from these operators in 2008-09 and 2009-10 2. Hoarding and wastage of the spectrum which could have been utilized by other players.

3. DoT has also not recovered penalties amounting to Rs. 700 crores from these new entrants.

Huge loss of revenue The notional -loss suffered by the exchequer due to the 2G spectrum scam can be calculated in two ways,

The Telecom Scam and its Implications

1. On the basis of S-Tel‘s offer to DoT of Rs. 13,751 crores for 6.2 Mhz of spectrum for 10 years, leading to Rs. 47,964 crores for 122 licenses.

2. On the basis of the 3G spectrum auction price, which works out to Rs. 111,512 crores.

Estimates of loss due to 2G scamon Based Based on S 3G auction Tel's offer prices Revenue expected Revenue through auctions Loss

47,964

111,512

9,014

9,014

38,950

102,498

In addition, if losses due to dual technology specific losses and excess spectrum issued over and above 6.2 Mhz is considered, then the figures in the two cases amount to Rs. 67,634 crores and Rs.1,76,645 crores respectively.

However, support was lent by the auctions conducted for 3G and BWA spectrum in 2010-11. Against a budgeted Rs. 35,000 crores expectation by the government for 3G and BWA auction, the exchequer made Rs. 107,000 crores through the sale of spectrum. This helped in fiscal consolidation as fiscal deficit came down to 5.1 %.

If a similar auction system were used for the allocation of 2G spectrum to new licensees in 2007-08, then India would not have had fiscal deficit concerns of such a large magnitude IMPACT ON CONSUMERS

When the Telecom Minister wrote to the Prime Minister on 2nd November 2007, explaining the rationale behind issuance of spectrum on 2001 prices, he mentioned the following points, 1. More number of operators per circle will bring down the tariff 2. In order to increase affordability, if a high cost was imposed on the spectrum, service providers would have no option but to pass on the costs The roll out of new licensees has led to competition further intensifying in the domestic mobile services space with the HHI falling from 1,590 to 1,394 as of December 2010

(Considering subscriber market share). However, it is imperative to note that the new licensees do not have a substantial amount of revenue market share in the industry with the incumbents still being the dominators

ew entrants launched services in a hyper competitive scenario having no option but to align their schemes with the prevalent market prices. With mobile services increasingly getting commoditized, most of the new entrants are currently making losses at an operating level itself.

N

Moreover, a high proportion of the subscriber additions that have been achieved in the past three years have been due to attractive schemes rolled out by the incumbents.

1. Airtel brought down lifetime prepaid scheme from Rs. 199 to Rs. 99 2. Simply Reliance plan offering competitive tariffs to subscribers 3. Tata DoCoMo‘s launch characterized by per second billing Subscriber additions in the past three years (In Millions) 20

18 16 14 12 10

Sustained growth due to incumbents perfroming well & new entrants chiping in

RCom’s GSM launch and Vodafone and Idea’s new circle launches

Lifetime prepaid scheme reduced to Rs 199,

Tata DoCoMo's GSM launch characterised by per second billing

8

Apr-10

Jun-10

Feb-10

Oct-09

Dec-09

Aug-09

Apr-09

Jun-09

Feb-09

Oct-08

Dec-08

Aug-08

Apr-08

Jun-08

Feb-08

Oct-07

Dec-07

Jun-07

Aug-07

6

Source: TRAI, COAI and internal research

Lifetime subscription costs plummet When we talk about reduction in tariffs, the initial lifetime subscription cost is an apt indicator of the tariff levels. Over the past few years, this initial subscription cost has been on a downward trajectory. But the noticeable point is that the lifetime subscription cost has always been lowered by the incumbent players such as Reliance Communications, Tata Teleservices and Bharti Airtel.

In a nutshell, the impact on the consumers due to overcrowding of 11-12 players in each circle has been marginally positive, however, the new entrants have had little profits to show in this period.

NEED FOR REGULATIONS Telecom Regulatory Authority of India (TRAI) was established in 1997 to regulate telecom services and for fixation/revision of tariffs, and also to fulfill the commitments made when India joined the World Trade Organisation (WTO) in 1995. The formation of TRAI separated the regulatory function from policy making and operations which remained under DoT. With reference to the 2G Telecom Scam, several issues have come to light.

1) Disagreement in opinions of the regulator TRAI and the Department of Telecom (DoT) 2) Uniform decisions need to be taken by the DoT, Ministry of Finance & Prime Minister‘s office.

3) Level of corruption and non transparency in the Telecom Ministry 4) Nexus between media representatives, lobbyists, politicians, bureaucrats as well as industrialists.

The regulator needs to be offered independent authority and a larger responsibility in framing policies for

The Telecom Scam and its Implications

OCTOBER 2011

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FINETUNE

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The regulator can go a long way in increasing transparency and accountability in the system and offering recommendations for the designing of policies to DoT. With reference to the current industry scenario, the regulator needs to design a uniform pricing strategy for future 2G as well as 3G spectrum allocations.

Also, issues such as Spectrum trading, Mobile Virtual Network Operator, change in merger and acquisition norms need to be studied in detail and relevant policies need to be designed in order to ensure the smooth functioning of the sector for all major stakeholders.

RECOMMENDATIONS The 2G scam has tarnished the reputation of Indian politicians and bureaucrats and in the aftermath a lot has changed. Despite the resignation of A. Raja from the post of the Telecom Minister, questions of corruption have also been raised against the Prime Minister and other members of the UPA government.

On the other hand, the scam has resulted in a gargantuan financial loss to the exchequer amounting to the

than Rs. 60,000 crores atleast. Irrespective of the exact financial loss made due to the 2G scam, transparency.

Moreover, there has been a substantial loss due to the new entrants not rolling out operations on time leading to lower revenue collections for the DoT. Going forward, DoT in accordance with the Telecom Regulatory Authority of India needs to arrive at a uniform spectrum pricing policy to avoid similar discrepancies in the future. Also, in order to make the sector sustainable for service providers and to promote expansion into the hitherto neglected rural hinterlands, DoT needs to relook at the Merger and Acquisition norms currently prevalent in the industry.

With consolidation imminent in the sector, the next phase of growth is expected to stem from the expansion into the rural areas and revenue generated from 3G services. The Indian telecom sector has witnessed a honeymoon period till now and the good times can last going forward, if the Telecom Ministry, can tinker the M & A norms and make the industry environment more favorable for industry players.

Department of Telecom lost accountability and more

The Telecom Scam and its Implications

SECTORS TO DRIVE INDIA’S NEXT GROWTH INTRODUCTION

GDP Growth of various countries; Source: IMF World Economic Outlook IMF World Economic Outlook

India is the world's second fastest-growing economy with a four year growth average of 8.6 percent. The key drivers for growth have been favorable policies and increase in investment, both domestic and foreign.

Moreover, past decade has witnessed fundamental changes in the Indian economy, outlook of business, industry and most importantly Indian mindset.

GDP Growth of various countries; Source: IMF World Economic Outlook IMF World Economic Outlook

12

9.4

8 6.2

6

3.8

4

3.5

2 0

China

India

Singapore

80% 59 60% 40%

70

Service Industry

22

20% 0%

62

19 2007

24 14

Agriculture 20 10

2015 2025

2007 – US$800 bn; 2015 – US$1411 bn; 2025 – US$3174

However, inflationary pressures are the prime concern area for the government. Reserve bank of India has a great responsibility to bring about price stability and sustain the growth momentum.

10.9

10

100%

USA

Australia

Foreign direct investments (FDI) into India went up from USD 4,029 million in 2000-2001 to USD 33,053 million in 2009-2010 (up to Feb ’10), one of the highest among emerging economies.

OCTOBER 2011

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As evident from the figure 1, India is second only to China when GDP growth as an indicator is concerned.

It is higher as compared to other developed countries.

Moreover, the contribution of different sectors to the GDP and their respective growth are shown. The projected data indicates a shift from the agricultural mindset of the Indian economy.

Consumption of GDP by Industries for FY 2009-10

Manufacturing

Electricity, Gas & Water Construction

Minning Quarrying

Agriculture, Forestry & Fishing

Electricity, Gas & Water Construction

Financing, Insurance, Real State & Bus Services Community, Social & Personal Services

Aggregate consumption in India is expected to grow four-fold in real terms from US$ 420.7 billion in 2006 to US$ 1.73 trillion in 2025.

Financing, Insurance, Real State & Bus Services Community, Social & Personal Services Agriculture, Forestry & Fishing Minning Quarrying Manufacturing

This article analyses the existing scenarios of promising sector and also highlights their strengths and opportunities.

These stress tests for credit, market and liquidity risk show that Indian banks are by and large resilient.

Credit growth of Indian banks stood at 19 percent during the one-year period ending June 4 2010, up from 15.1 percent a year ago. Total assets of all scheduled commercial banks by end-March 2010 is estimated at INR 40,90,000 crores. This comprises about 65 percent of GDP at current market prices as compared to 67 percent in 2002-03. Bank assets have grown at an annual composite rate of 13.4 percent during the rest of the decade as against the growth rate of 16.7 percent that existed between 1994-95 and 2002-03.

THE INDIAN BANKING SECTOR

STRENGTHS

There has been a great shift in the conventional image of India from low labor to a high caliber pool of human capital. At present manufacturing and banking sectors are bullish and prospects of sectors such as Information Technology (IT), Telecommunication (Telecom), Retail and Healthcare are also attracting global attention.

Indian banking industry has been growing tremendously over the past decade. As the world reels from a global financial meltdown, India‘s banking sector has been one of the very few to maintain resilience and continue to provide growth opportunities.

The single-factor stress tests undertaken by the Committee on Financial Sector Assessment (CFSA) divulge that the banking system can endure considerable shocks arising from large possible changes in credit quality, interest rate and liquidity conditions.



Extensive services provided by banks: Demat, Lockers, Cash management, insurance product, mutual fund project, loans, and Electronic Clearance system.



Banking sector is the largest user of IT as a tool for better performance and overall system efficiency. Major developments are Core banking system, Internet banking, and Mobile banking



Contribution of Banking Sector in GDP is expected to increase from 35 percent to 50 percent

Sectors driving India’s Next growth cycle

Cumulative amount of FDI inflows from April 2000 to March 2009 amount to USD 89, 840 million.

FINETUNE 

Improvement in Cost Income Ratio: Cost to income ratio of public sector banks declined from 58.4 percent in 1992 to 45 percent in 2004. For all scheduled commercial banks taken together, decline was from 55.3 percent to 45.1 percent. Foreign banks, however, showed an increase in the ratio from 30.9 percent to 42.8 percent.

OPPORTUNITIES





Accelerating the creation of world class supporting infrastructure (e.g.: payments, asset reconstruction companies (ARCs), credit bureaus, back -office utilities) to help the banking sector focus on core activities.

Hybrid capital: In an attempt to relieve banks of capital crunch, RBI has allowed them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If new instruments find takers, it will help PSU banks, left with little headroom, for raising equity.

GOVERNMENT POLICIES

Sectors driving India’s Next growth cycle









Shape a superior industry structure in a phased manner through ―managed consolidation‖ and by enabling capital availability. This would create 34 global sized banks controlling 35-45 percent of the market; 6-8 national banks controlling 20-25 percent; 4-6 foreign banks with 15-20 percent share and the rest being specialist players (geographical or product/segment focused).

Create a unified regulator, distinct from the central bank of the country, in a phased manner to overcome supervisory difficulties and reduce compliance costs.

Improve corporate governance primarily by increasing board independence and its accountability. Accelerate the creation of world class supporting infrastructure (e.g., payments, asset reconstruction companies (ARCs), credit bureaus, back-office utilities) to help the banking sector focus on core activities.

Enable labor reforms focusing on enriching human capital, to help public sector and old private banks become more competitive.

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FUTURE OUTLOOK  Competition from Global banks  Rural Banking & Microfinance Assets Under Management (AUM) are expected to grow by 15 percent till 2010; Retail finance is expected to grow at an annual rate of 18 percent, from US$27.6 billion in 2003-04 to US$75 billion by 2010.

Demand for credit is likely to grow at 25 percent per annum with rapid GDP growth.

Indian Retail banking is totally isolated from the rural parts and only SBI has its presence in rural India. This leaves a lot of room for expansion. Currently microfinance is able to cater the needs of the rural poor and few who aren‗t able to get micro credit resort to local money lenders on astronomical interest rate. In order to get more money to expand their operations rural India offers good opportunity.

Other features of India that prompt a high growth for banking sector are:  Demographic profile favors higher retail off take - 54 percent of the population is in the 15-35 years age group.  Capital expenditure by the government and private industry is expected to grow at a high rate.  Economic growth of about 14 percent per annum in nominal terms.  Regulatory and technological enablers leading to high growth.  Improved asset management practices - Gross Non Performing Assets (NPAs) to Advances ratio reduced from 24-25 percent in 1993 to 2.5 percent in 2006-07  Investment opportunity across all segments in banking and financial services sector.  Low penetration in the pension market making it a lucrative business segment  Foreign banks likely to be allowed to acquire local banks after March 2009 when the next stage of banking begins.

In totality, we see that there are many pros for Indian banking industry to prosper but Government and regulators must be vigilant about malpractices.

Banking

Insurance

Asset management Companies

Size

Total Assets US$ 1105.35 bn in FY10

Life insurance – US$ 56.1 bn in FY10

US$ 157.6 bn in FY10

Size(projected)

13 percent

14.2 percent

Projected CAGR

16 percent during FY10FY14

15 percent (Life insurance) during FY10FY14

17 percent during FY10FY14

Regulatory

Foreign ownership in private banks allowed up to 74 percent (including FII ownership), with a 5 percent cap on ownership by any one entity

• FDI up to 26 percent • Allowed under automatic • Route subject obtaining • License from IRDA

Up to 100 percent investment in Indian Asser management companies is allowed, subject to regulatory approvals

Volume Wise

Bank credit expected to grow at a CAGR of 18 percent between FY10FY14 to reach US$ 1823.8 bn

Penetration levels expected to touch 4.4 percent from the current level of 4 percent by FY10

AUM as a percentage of GDP is expected to rise from 13 percent in FY09 to 20 percent by FY20

THE INDIAN IT SECTOR The Indian IT sector had seen a tough time in the year 2009. But, the growth of the sector in the year 2010 was even more remarkable, running into double digits.

Going by analyst predictions the year 2011 is going to be even better. Focus of the industry is on innovation and certain upcoming technologies like Cloud Computing and mobile technologies.

Companies planning to revamp their IT spending are increasingly looking at India as their favored destina-

-tion. The sector is poised to cross the $72 billion mark by the end of this year. So, what can be the reasons that can contribute to this rapid growth?

As per the current market scenario the IT/ITES sector is expected to contribute about 6.1 percent of India‘s GDP for FY10. Also IT BPO is expected to reach US$ 73.1 billion, depicting a growth rate of 5.1 percent.

This surge in growth can be attributed to the following key growth drivers:  Inorganic Growth Route: The sector is looking at new geographical locations to widen its markets.

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FINETUNE



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

Sectors driving India’s Next growth cycle



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

This shift towards new emerging markets like Mexico, Philippines, Ireland, Netherlands and Brazil is expected to drive growth in the future.

Several third party and captive BPO units are likely to acquire small size companies to ramp up revenue, acquire clients, and expand business segments and geographical reach. Consolidation will also be driven by international M&A deals, propelled by robustness of the Indian players.

Strategic shift towards Small and Medium Businesses (SMB): During 2009, expenditure on IT by SMB segment was around 30 percent of the total spend of over INR 300 billion which is expected to rise further.

Emergence of new technologies like cloud computing: In the words of Microsoft CEO, Steve Ballmer – ―It's the next step, it's the next phase, it's the next transition, and depending on who you are, and how you think, you could say the cloud started five years ago, ten years ago.‖ According to recent reports even TCS has adopted the use of this technology to advance its grip on SMB in India.

The emergence of Remote Infrastructure Management Services (RIMS): This allows the delivery of services from low cost locations. According to the Nasscom-McKinsey study, the global RIMS market is estimated to be US$96-104 billion, out of which nearly 70-75 percent of the infrastructure management roles can be off shored. India, given its strength in offshore delivery of services, in poised to seize this big opportunity.

Emergence of new avenues for IT spending: With booming economic scenario in the country, government initiatives like e-governance are expected to rise. Unique Identification Project (UID) is a good example in this direction.

Coming of age of the rural BPOs: According to a Nasscom study, about 35 rural BPO centers had employed more than 5,000 people, as on February 2010. Their contribution towards the value chain is also improving, with a shift from data management tasks to content creation.

OPPORTUNITIES

Government policies and actions can make India the largest software exporting country. Significant oppor-

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-tunities exist in new verticals like Retail, healthcare, travel and tourism. Moreover India being a low cost delivery location offers a great advantage.

The worldwide KPO market is expected to be around US$ 16.7 billion in revenues by 2010 of which US$ 12 billion (70 percent) will be outsourced to India.

Services and software segments are estimated to cross US$ 1.2 trillion by 2012. This is more than the 5.2 percent growth expected in the total IT spending.

Worldwide BPO market is expected to grow at a CAGR of 11.9 percent to reach US$ 181 billion by 2012, while ITO market is expected to grow at a CAGR of 6.9 per cent and reach US$ 275 billion by 2012.

Table 2: Snapshot of Indian IT Industry

Size (2010E)

US$ 73.1 bn

Size (2011E)

US$ 77.3 bn

CAGR 2007-2010

15 percent

Exports (2010E)

US$ 50.1 bn

Exports Growth Rate

5.4 percent per annum

Source: Investing in India, KPMG, October 2010

MANUFACTURING SECTOR Even though India relies heavily on Service sector for its growth, importance of Manufacturing Sector can‘t be ignored. Manufacturing fuels growth, productivity and employment, and strengthens agriculture and service sectors. Moreover in the backdrop of recent economic crises it is getting overt that dependence on Services alone which has its roots outside may not be able to help us maintain the growth trajectory.

WHAT LIES AHEAD? India is fast emerging as a global manufacturing hub.

From automobiles to computer hardware, consumer durables and engineering products, all are being manufactured by multinationals here as India offers a distinct advantage in terms of low waged – skilled work force for all the facets of manufacturing i.e. product, process and capital engineering.

According to the Federation of Indian Chambers of Commerce and Industry (FICCI) and Yes Bank, India is poised to become the global manufacturing hub for luxury brands over the next five years with manufacturing of luxury items becoming a US$ 500 million industry during this period.

INDIA’S ADVANTAGE Size of Indian market: According to a study by McKinsey Global Institute, India will be fifth largest consumer market by 2025. Also Indian consumer spending is likewise estimated to more than quadruple to approximately US$ 1.5 trillion by 2025, on the back of a ten-fold increase in middle class population and a three-fold jump in household income. This sheer size of Indian market is instrumental in attracting multinationals to make investments in India for the benefit of their own.

Government Policies: Since 1991, FDI policy have been liberalized with opening of new sectors for investment, raising FDI caps, liberalizing Industrial Licensing, reducing area reserved for public sector, amendment of the Monopolies and the Restrictive Trade Practices Act and market determined exchange rates.

THE GROWTH TRAJECTORY 

The Index of Industrial Production (IIP) quick estimates data for October 2010 shows a growth of 11.3 percent in the manufacturing sector as compared to October 2009.  Cumulative growth during April-October 2009-10 over the corresponding period of 2008-09 is 11 percent, according to Ministry of Statistics and Programme Implementation.  India is ranked second in terms of manufacturing competence, according to report '2010 Global Manufacturing Competitiveness Index', by Deloitte Touche Tohmatsu and the US Council on Competitiveness. The report states that the country's talent pool of scientists, researchers, and engineers, together with its English-speaking workforce and democratic regime make it an attractive destination for manufacturers.

Finally, development of manufacturing sector is crucial for inclusive and long term growth in India. India had a leapfrog jump from agricultural based to pre-

-dominantly service based economy whereas the industrial growth has been sporadic and opportunistic without any definite plans. This has widened the urban rural gap and leaving a large population of India further behind. In this respect India could learn a lesson or two from China who, with its focus on manufacturing, has achieved a growth pattern that is more robust and balanced that of India.

Growth in manufacturing sector is sine qua non to make Developed India dream come true but several improvements like increased investments in R&D, supportive measures, easy credit and quality improvements in vocational and higher education.

CONCLUSION The Indian growth story is a function of the above mentioned sectors. All of them have been instrumental in their own ways to contribute to our economic growth.

On one hand where the IT/ ITES sector has helped in job creation, with about 4.5 lakh jobs created per annum, the banking sector has remained firm during the sub-prime crisis acting as a shield. The manufacturing sector has emerged as a new area for investment activity, and the government has realized its importance when it comes to competing with its aggressive neighbor.

It is therefore, hard to pin point one specific sector which will lead the Indian growth trajectory. For our country to progress, it is imperative that all three of these sectors move in tandem.

SOURCES Investing in India 2010, KPMG, October, 2010 Indian Banking Industry, Business maps of India, accessed on February 10, 2011 Strengths and weaknesses of Indian banking, Business Line, April 24, 2006 Opportunities in the world's largest democracy, HC-India, accessed on February 10, 2010 IT-BPO Sector in India: Strategic Review 2010, Nasscom, February 15, 2010 Investing in India 2010, KPMG, October, 2010 IT Opportunity in Indian SMB, Zinnov LLC, February, 2008 Steve Ballmer: Cloud Computing, Microsoft, March 4, 2010 IT-BPO Sector in India: Strategic Review 2010, Nasscom, February 15, 2010 Investing in India 2010, KPMG, October, 2010 Indian IT-BPO Industry 2009: NASSCOM Analysis, Nasscom, March 2009 Manufacturing Sector in India Growth Rate of Manufacturing Sector, Winentrance, accessed on February 10, 2010 Manufacturing, IBEF, January 2010

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FINETUNE

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CURRENCY WARS - RACE TO THE BOTTOM INTRODUCTION The modern day warfare has shifted from the traditional battle field to the corporate boardrooms. The decisions on who survives and who does not, are taken by those who stroll the corridors of power. The battle is gauged, not by the number of soldiers felled but by the points the currency has fallen. Today the currency symbol and not the armoury is the sign of strength. Today boundaries can be transcended virtually thus shifting the focus of protection from the national boundaries to the central exchequer. The war is definitely on, but there will not be a single drop of blood; red will only be the spilt ink.This is the new world order; this is the new way of life. ‗Currency War‘ was the term coined by the Brazilian Finance Minister Guido Mantega. It has attracted the same level of trauma as the financial meltdown of 2008 and has threatened to weaken global cooperation on economic recovery. It started as a duel between China and the USbut has now developed into an allout currency war.

Currency Wars—Race to the bottom

DEFINING CURRENCY WAR It is an economic warfare where countries competing against each other try to achieve a relatively low exchange rate for their home currency so as to protect their domestic economy to preserve jobs and growth at home. It is better known as ‗Competitive Devaluation’.

MECHANISM OF DEVALUATION Generally a country‘s exchange rate is set by market forces. However the central bank can intervene in the market to effect devaluation by selling its own currency to buy other currencies causing a fall in the value of its own currency. This method is practised by China. US, to the contrary,devalue its currency through Quantitative Easing (QE). QE is the process of infusing money into the system by creating ‗new money‘ for buying financial assets in the country. It spurs consumption demand in the economy. It also lowers the domestic interest rate in comparison to

interest rates of other countries where QE is not being practised causing appreciation of the other country‘s currency.

EFFECT OF DEVALUATION A country suffering from high unemployment rate may devalue its home exchange rate to follow a policy of export-led growth of its economy, thus encouraging increased domestic production, creating newer jobs for employment and protecting itself from future economic crisis. But it may lower the standard of living of its citizens by lowering their purchasing power. It may also discourage foreign investment.Devaluation is a tempting solution to unemployment when other alternatives like increased public spending are ruled out due to high public debt and also when a country has a balance of payments imbalance which devaluation would help correct.

CURRENT SCENARIO CHINA China pegged its currency yuan to the US dollar in 2007 and stuck with it throughout the crisis. China constantly buys billions and billions of dollars-worth of US assets (usually Treasury bills), which increases the supply of yuan relative to dollars in currency markets, and thus keeps the price of yuan artificially low.

This then makes Chinese exports artificially cheaper, while making foreign goods artificially expensive to the Chinese. That is, it‘s as if China were simultaneously subsidizing its exports and placing a protective tariff on its imports.

Various estimates are that the yuan is currently between 25 and 40% undervalued against the dollar.China is adopting export-led growth (exports make nearly 25% of its GDP) since long and has posted a trade surplus of $13.91 billion in December. Hence China has resisted pressure from IMF and other advanced countries to allow for a sharp appreciation of its currency.A big change of its exchange rate could cut down China‘s growth rate to half thus jeopardising its economy. China said in June‘10 that it would allow

its currency to rise gradually, but so far, it's risen less than 3% (Figure 1), indicating China is more interested in cosmetic changes than real appreciation.

Figure 1: Change in price of Yuan

US US economy posted anenormous budget deficit to the tune of $1.3 trillion in 2010.It is suffering from Trffin dilemma, observed when a domestic currency also serves as the international reserve currency. It causes fundamental conflict of interest between short term domestic and long term international economic objectives. It states that US must be prepared to run huge trade deficits in order to supply the world with dollar to placateworld demand for foreign exchange reserves.

countries to defend their currencies from being appreciated.

JAPAN In 1985, Japan bowed down to US pressure and agreed to increase its exchange rate against the dollar as per the Plaza Accord. Within one year, the value of the yen had increased by some 60 percent which hurt its export industries badly. Bank of Japan (BoJ) lowered interest rates to nearly zero but Japan has still not recovered from the prolonged crisis that followed.

China recently invested heavily in Japanese government bonds forcing Japan to publicly intervene in the foreign exchange market. Japan lowered its benchmark interest rate to ―virtually zero‖ and its bold 12 billion dollar move to push down the value of the yen proved ineffective.

OTHER COUNTRIES In October 2010, to disallow huge inflow of foreign capital, Brazil increased the Tobin tax on foreign capital from 2% to 6%. Some other countries in Latin American like Chile, Columbia and Costa Rica have initiated programmes to buy dollars to check currency gains. Chile will buy $12 billion in the exchange market to stop peso from appreciating.

Most Asian currencies are also appreciating against dollar with a surge in inflows. Indian rupee has appreciated little over 6% but India has so far stayed away from intervention. Other Asian countries like Korea and Thailand have imposed taxes to curb the flows.

The threat in all this is obvious: everyone may start

Figure 2: Exchange rate

US can solve this dilemma by cutting the deficit and raising interest rates to attract dollars back into the country. But Federal Reserve has reduced the dollar‘s exchange rate by providing nearly free credit to banks at only 0.25% interest. This aims at inhibiting U.S. real estate, stocks and bonds from dwindling further in price. Low U.S. interest rates and easy credit motivate investors to lend overseas or buy foreign assets yielding more than 1%. This dollar outflow coerces other

Figure 3: Loss in competitiveness

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FINETUNE intervening in currency markets, erecting tariff walls,passing anti-dumping legislation and quotas to protect powerful domestic lobbies.This could lead to deflationary spiral, the kind of protectionism that was one cause of the Great Depression.

HOW SEVERE IS IT? Currency war is severe because of its size.Some $3.2 trillion worth of currencies are traded each day. To put that number in perspective, the entire world stock market is about $36 trillion in market capitalization.

The currency markets trade this amount every week and a half.Contrastingfrom trade, it is a “zero-sum” game. If one country‘s currency rises, another country‘s currency must fall. Hence there are winners and losers and no economy wants to be on the losing side with a "winning" strong currency.

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undervalued yuan. But China holds nearly a trillion dollar worth of US Treasuries and has leverage over the US. Today, the United States spends approximately $3.90 on Chinese goods for every $1 that the Chinese spend on goods from the United States. Last month, the monthly tradedeficit with China was approximately $26 billion. For the year, the trade deficit with China will be somewhere in the neighborhood of $300 billion as shown in the following chart.

Figure 5: Trade Imbalance

Currency Wars—Race to the bottom

Moreover China has almost a complete and total monopoly on rare earth elements. If China totally cut off the supply of rare earth elements, US would have no hybrid car batteries, flat screen televisions, cell phones or iPods.

Figure 4: Movement of gold prices

This is an absolute disaster waiting to happen and hence everyone is turning back to the safe haven: Gold.

Gold has catapulted to an all-time high of $1400 an ounce. Nations such as China and India have been buying gold and other precious metals every time there is a little dip. They are trying to diversify into something safer and have stopped hoarding endless amounts of U.S. dollars.

DEALING WITH CURRENCY WAR In October 2010, the US House of Representatives approved a bill that would allow America to levy taxes on imported Chinese goods. In other words, this bill would allow America to put a 40% tariff on a Chinese good that is enjoying 40% subsidy on account of

Figure 6: Unequal competition

Concurrently, China is also losing from its currency policy. The undervalued yuancreates inflationary burdens (Figure 8) and diverts a huge portion of China‘s national income into the acquisition of foreign assets with a very low rate of return.

Consequently, Sensex has already shed more than 3000 points since the beginning of 2011 causing a loss of more than Rs11 lakh crores.

If Chinese decide to de-ped the yuan Indian rupee is expected to be one of the majorbeneficiaries of this move.It will help ease India‘s trade deficit with China ($19.2 billion in 2010) and help exporters to compete better in textiles, leather products and handicrafts market.

SHORT TERM SOLUTION

Figure 7: Inflation in China

Both the U.S. and China have abundant reasons to avoid a serious breakdown in relations. The monetary and political consequences would be overwhelming for both countries and the rest of the world.

RUPEE’S OPPORTUNITY Foreign institutional investors bought Indian stocks and bonds worth $221.43 billion in 2010 causing the rupee to appreciate over 6% since September. While an appreciated currency would be harmful for country‘s exporters, RBI has not intervened in the exchange rate and is looking at this as a two pronged strategy. Firstly, as an aid to curbinflation which RBI has been struggling to constrain. An appreciated rupee will reduce the imported goods prices thereby curbing inflation. Secondly, RBI is permitting capital inflows to fund the current account deficit which has reached 3.5% of the GDP in 2010-11 fiscal. In the last quarter, the current account deficit was $13.7 billion while capital account surplus was $17.5 billion. With the imports growing faster than exports, RBI is trying to make sure there‘s sufficient money to fund state‘s current-account deficit, but at the same time avoiding any majorloss to exporters‘ competitiveness.

But RBI may soon decide to intervene in the currency markets to halt further appreciation of rupee becausethe hot money that came to India in 2010-11 is already starting to reverse its direction.

There has to be a reversal of fiscal and monetary policies that the world is witnessing now. Nations should focus on more coordination rather than adopting ‗beggar thy neighbor‘ policy.

Appreciating the currency is in the interest of the Chinese government because they need to build their domestic consumption market and not be long-term dependent on the whims and fancies of the American consumers. Hence China should gradually raise its currency (if not rapidly) to increase the purchasing power of the Chinese consumers.US should also shed its hypocrisy and stop printing dollars to finance its skyrocketing government debt.

Alternatively, US and Japan can stopThe People Bank of China from carrying on its intervention policy without violating any international agreement. They only requireenforcing the principle of reciprocity,announcing that in futurethey will allow the sale of their public debt only to the official institutions from nations in which they themselves are permitted to acquire and hold public debt.Hence if the Chinese want to buy more US Treasury bills and Japanese bonds, they can do only if they permit foreigners to buy domesticChinese debt. It is equivalent to a very specific form of controls on capital flows. The Chinese Central Bank would no longer be able to intervene in the exchange market and face problem of reinvesting the flow of T-bills coming due.

LONG TERM SOLUTION We are beginning to see dollar as something like a beached whale, basically in trouble. We are dealing with the consequences of being it in trouble. All this frictionamong nations marks the end of the process by which the US Dollar has been the undisputed world reserve currency. The world is changing and the institutions that surround the world will have to change

Currency Wars—Race to the bottom

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FINETUNE with it; one of the institutions being the dollar itself.

The last two years, particularly in the repercussion of the global financial meltdown, have seen mounting concerns around the validity of US dollar as the dominant currency. This has originated from a horde of reasons, chief amongst them being the weak fundamen-tals of the United States as highlighted by its huge federal debt that reached 93% of the GDP in the fiscal year 2010, mounting unemployment (9.8% in November 2010) and enormous budget deficit of the order of $1.3 trillion in 2010.

The strongest contender to replace dollar is Special Drawing Rights (SDR) of the International Monetary Fund (IMF). The nominal value of an SDR is formulated from a basket of currencies – precisely, a fixed aggregate of Japanese Yen, US Dollars, British Pounds and Euros. The share each of these four currencies contributes to the nominal value of a SDR is re -evaluated every five years. After the onset of the global economic crisis in 2008, the BRIC countries – Brazil, Russia, India and China – led largely by Russia and China, have called for abandoning the dollar and moving into a global currency scheme.

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There have also been dialogues to expand SDR‘s reference basket to embrace all major international currencies which will be a better representative of the forthcoming multi polar world.

Globalist organizations such as the IMF believe that devising a true global currency would assist world trade; it would make currency wars unlikely, it would soothe the global economy and it would make the rest of the world less dependent on what is going on in the United States.

CONCLUSION So far world finance leaders have failed to find an appropriate solution to the on-going currency tussle and the dialogue has remained at the diplomatic level only. The finance leaders should put the interests of the global economy ahead of those of their national economies during negotiations. Otherwise global tensions will further rise over currency rates as emerging markets try to repel off a torrent of investment funds pursuing higher returns, and countries struggle to keep the prices of their exports competitive, leading to a virtual trade war.

THE EURO CRISIS Currency Wars—Race to the bottom

THE EURO CRISIS: A GLOBAL MALAISE AND NATIONAL TROUBLES The recession that began in 2008 triggered a phenomenon which has repeatedly come to haunt various segments of the world economy. If the collapse of Lehmann Brothers marked the concept of behemoth conglomerates that were ―too big to fail‖, the Euro crisis of 2010 has brought sovereign defaults into the picture.

While an extensive analysis of the crisis has been the subject matter of many economists, and a variety of solutions suggested; some implemented, it is without fail noticed that the original problem that led to the crisis- a running away from risk without addressing the inherent causes of the risk- is a part of the very solution designed for the crisis.

To begin with we address the following questions: How did economies that supposedly joined a stable currency union fail? What were the risks that were

ignored? Are the current recovery measures sufficient? What are the risks that are being ignored today?

And what lies in store?

THE THEORY OF RISKS My emphasis on risks is a cautious approach towards an interpretation of the mess that many economies find themselves in.

To quote from John Kemeth Gabriel‘s ―A short story of Financial Euphemism‖, financial markets are prone to recurrent bouts of speculation.

It is when a new product or new market seems risk free to investors that they jump into it no-holds barred.

This leads to an speculation based investment rather than fundamentals based. The incentive of maintaining the growth story/risk free image of the investment is too high for the financial markets, the investors and the new product/market. This brings risk aversion/ distribution measures like hedging (as in the US), currency unions (The EU) or a refusal to accept risks

(Greece‘s fake deficit ratio figures). This ignorance invariably leads to a bubble and a bust.

OCTOBER 2011 governments made hay while the sun shone- the approval rates of governments in the ―Euro Kids‖ were at an all time high in the years after joining the Euro zone.

Poor fiscal policies- It was however the saving for a rainy day part that they missed out on. Poor fiscal policies accompanied by the high debt ratio of these countries resulted into huge deficits which could not be refinanced once the market broke loose.

Bound hands ( monetary policy) – Once the bubble burst, the option before the ― Euro Kids‖ would have been a devaluation of the currency as was done by Argentina in 1999 and Mexico in 1982.

However, the Impossible Trinity made this impossible.

HOW DID THE “EURO KIDS” END UP THIS WAY? The incentive in joining a much stable currency union was the additional stability attributed to your economy. Also the ease of trade; and movement of goods and labour made joining the Euro a highly convincing proposition for the ―Euro Kids‖ (the sick countries of the euro zone). The resulting opening up of these economies to foreign capital flow led to higher liquidity and making assets sell like hot pancakes. And hence, the high growth rates.

The Asset Bubble- After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank, and regulators treated government bonds as riskless. This caused interest rate differentials between various Euro zone countries to shrink, which generated real-estate and asset booms in the weaker ―Euro kids‖ economies and reduced their competitiveness. (The short term 3 month inter-bank rate reduced from 12.5% in Aug ‘99 to 8.5% in Aug 2000 when Greece was about to adopt the Euro)## The increase in wages and prices in these economies however, gradually resulted into production being costly than other countries, and hence less competitive exports than other countries.

Complacent governments- The newly rich

The Impossible Trinity allows economies to enjoy only two out of the three comforts: Free Capital flows, Fixed Exchange rate, and an Independent monetary policy.

The Euro countries agreed to free capital flows and a fixed exchange rate in the euro, thus doing away with an independent monetary policy wherein they could influence interest rates and currency exchange rates as a stimulus to their economies.

NOT JUST ECONOMICS The proponents of the Euro often cited the US dollar as an example of currency union amongst different states. The proposed, and at those times convincing, argument was that if the US could run with a common currency for different states with independent fiscal policies, why couldn‘t the Euro zone? The answer

The Euro Crisis

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FINETUNE well, had to come in the form of a crisis that shook the foundations of the world economy.

POLITICAL INTEGRITY WITH ECONOMIC INTEGRITY An important difference was that the US has one federal government for all states in contrast to the euro zone. To quote the ex-RBI governer, Mr. Y.V. Reddy in his book ― Global Crisis, recession and an Uneven recovery‖, ― If a central bank were to take the initiative to provide liquidity against assets whose solvency is in doubt at the time of crisis, such a central bank would be bearing a solvency risk. Solvency risk in times of crisis implies a drawing on resources of the government and hence involves substantial or extraordinary quasi-fiscal impact. In these circumstances, a central bank needs some form of approval from the fiscal authority, namely, the government. In other words, the actions of central banks that may result in serious losses would require the approval of the government. Hence, though central banks are the first line of defence in crisis, they have to depend on government approval for any large scale discretionary intervention to manage the crisis.‖ The European Central Bank sadly, did not have one government to take this approval from.

Different governments with different political and economic goals and agendas would always find it difficult to face such a crisis.

THE CONSPICUOUS ABSENCE OF A COMMON TREASURY

The Euro Crisis

A common treasury would have been missed the most by the ―Euro Kids‖- a cash source to fall back upon when things go bad. But it was not meant to be, because the Maastricht treaty was meant to bring about a monetary union without a political union.

While the ECB, after much delay and political bickering across Europe, did work out a rescue package in the form of an emergency fund, the uncertainty and delay of actions has put a question mark on the viability and sustainability of the euro.

IS IT REALLY ONE EURO-ZONE? As a placard during one of the innumerable protests in Greece during the peak of the crisis said, ―Angela was my best friend, until I needed a friend‖ (the reference being to the German Chancellor, Angela Merkel).

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When Angela Merkel refused to agree to a bailout package for Greece financed from German pockets, and insisted that each country should guarantee its own institutions, the concept of the euro zone went into the drain. It was very apparent that none of the countries was interested in the other‘s interests, thus refuting the common growth agenda of the Euro proponents. In fact, the much delayed emergency fund that has been agreed for bailouts is more of an effort to save the Euro rather than the ―Euro Kids‖- a weaker Euro having much larger potential costs on Germany than a bailout package.

AUSTERITY V/S DEFAULT At the verge of default, Greece was faced with two options:  An ECB bailout package wherein ECB would guarantee Greece bonds and institutions in return for fiscal austerity measures by Greece.  Defaulting on its commitments and doing away with the Euro as its currency.

Both would have entailed a lot of suffering for Greece and its people. Whether it be austerity measures, or a default, both would entail many years of slow growth, unemployment and suffering. But would it not have been better had Greece chosen the latter option to maintain its own sovereignty would remain a point of contention.

THE POLITICAL ECONOMIC IMPOSSIBLE TRINITY A very intelligent insight into the effects of globalisation on emerging nations is given by Dani Rodrik, Professor of Political Economy at Harvard University‘s John F. Kennedy School of Government. The essential trillium for an emerging economy opened to globalisation is:

In a democratic country open to globalization, the high capital flows make growth dependent on imported capital. Under such a situation, the country compromises its national sovereignty. As the influence of foreign investments on an economy increases, the domestic and foreign policies need to be aligned accordingly. This invariably has a bearing on a democratic sovereign nation.

Under such a regime, the main focus of the government moves to maintaining the economy as a favourable destination for foreign investments. Thus, the demands and whims of foreign investors start playing an increasing important role in the policy framework.

Policy shifts in this direction may not necessarily align with the domestic population‘s interests.

Increased investments in an economy give other nations leverage on its policies. Thus, the effects of the decision to stick in the euro zone would be interesting to see.

Thus we can sum up a review of the crisis as:

OCTOBER 2011 The taxpayer‘s resentment can trigger a political crisis in many countries.  Second, high interest rates charged on the rescue packages make it impossible for the affected countries to improve their competitiveness. The gap between the strong and weak countries would continue to widen.

Mutual discontent among debtors and creditors would increase and there is a real danger that the euro might destroy the EU‘s political and social cohesion.

THE ALTERNATES Emergency funds need to be used instead of taxpayers‘ money to refinance banks and sovereign debt.

This would lead to lower deficits and a quicker recovery.

Also, the interest rates on rescue packages should be reduced to the rates at which the EU can borrow from the market. This would also lead to an active Euro bond market.

Private holders of sovereign debt need not be reimbursed fully for their holdings of sovereign debt. The rescue package‘s financing would enable them to share burden.

THE ROLE OF GERMANY Germany being the strongest of all Euro members needs to take the leader‘s role and ensure that the weak countries can recover from the crisis without their economies having to undergo long years of stagnation and people suffering. Investments into these economies and technology transfers would go a long way in helping their cause.

LESSONS FOR THE WORLD

THE SOLUTION AND ITS PROBLEMS The ECB has formulated a rescue package for Greece and an emergency fund facility eventually to be made into a permanent institution. This is supposed to meet the requirement of a Central common treasury. However, the rescue package has other shortcomings that need immediate attention.  One is that bondholders of insolvent banks are being protected at the expense of taxpayers for fear of provoking a financial crisis.

The Euro crisis along with the troubles in US, Dubai and other regions does present some useful lessons for the world:  Boom and bust are a part of the capitalist cycle. It is better to identify risks and work to correct them rather than run away from them.  Global markets need global regulation. With the extent of globalization, national regulators would be inept at foreseeing and controlling any predicaments. The role of the ECB, World bank, IMF is highly critical.

The Euro Crisis

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It is wrong to depend only on imported capital for growth. Domestic strengths need to be developed and domestic consumption needs to form an important component. ―Euro Kids‖ is a term used by the author to refer to the countries affected by the Euro crisis-Portugal, Italy, Greece, Spain and Ireland instead of the PIGS used commonly, out of respect for these countries and the concerns expressed by these countries on the usage of this acronym.

REFERENCES 

Exchange rate policy during transition to the European Union

by Fabrizio Coricelli (xmlservices.unisi.it/depfid/joomla/ docente.asp?id=2320)

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

George Soros‘ ―Making the Euro Whole‖ www.projectsyndicate.org



(http://www.project-syndicate.org/commentary/soros63/ English) has influenced this writing



Dani Rodrik‘s blog on Project Syndicate (www.projectsyndicate.org/commentary/rodrik43/English) has influenced this writing.



Dr. Y.V. Reddy‘s book ―Global Crisis, recession and Uneven recovery‖ has influenced this writing.



The views expressed by Mr.C.P.Chandrashekhar and Ms. Jayati Ghosh in various write ups in the biweekly magazine ―Frontline‖ of ―The Hindu‖ group have also influenced this writing.



The views expressed by the Nobel-Prize winning economist Paul Krugman on various platforms have influenced this writing.

INDIAN M&A MARKET: PROSPECTS & CHALLENGES India's economy has grown at a faster pace in 2010/11 than earlier expected, supported by a global recovery, domestic demand, a good monsoon and a double-digit expansion in factory output. With the economic growth back on track, Indian companies have shifted

The Euro Crisis

With the increasing confidence in Indian economy the capital markets gained significantly. India Inc‘s appetite for strategic M&A has more than quadrupled over 2009 clocking US$ 49.78 billion in 2010. With corporate debt raisings, IPOs and QIP funding helping

their focus back to growth opportunities. After couple of years of weak activity, Indian M&A and private equity investments have risen to 2007 levels. Also due to the financial crisis, Indian companies are finding overseas acquisitions at cheaper valuations.

companies fund their acquisition plans, India Inc proceeded to make some of the largest deals ever in 2010.

Telecom, Oil & Gas and Pharma sectors lead the M&A charts in terms of value.

As Indian companies continue to expand and hunt for overseas targets with the intent to compete in the global markets, there could be record outbound M&A activity in 2011. Access to cheap and easy finance for large buyers, a need to expand in new markets, and the rush to tap natural resources are expected to be the main triggers for driving deal volume.

As Indian companies continue to look abroad for large acquisitions and Indian promoters continue to be willing to let go of their stakes, there would be more consolidation in the coming months coupled with many more large deal announcements.

SECTOR-WISE ANALYSIS Banking sector Post financial crisis, RBI is willing to convert foreign banks into wholly-owned subsidiaries for systemic safety, instead of functioning as parents‘ branches, leaving room for instability. These subsidiaries will be allowed to spread their operations in India. An RBI Report on Currency and Finance presents the view that mergers are the only way to face competition from these foreign banks.

Indian banks are not able to compete globally in terms of fund mobilization, credit disbursal, investment and rendering of financial services due to the size of the industry. SBI, India‘s largest bank, is globally ranked 70th in terms of assets. Another recent study released by the RBI reveals that the combined assets of the five largest Indian banks - SBI, ICICI Bank, Punjab National Bank, Canara Bank and Bank of Baroda are just about half the asset size of the largest Chinese bank, Bank of China. The time required to expand inorganically may be less than that of an organic route.

Basel II requires banks to meet tougher and higher capital adequacy norms such as capital allocation towards operational risk, in addition to credit and market risks. Many Indian banks, especially public sector banks, cooperative banks and regional rural banks are unprepared for this implementation due to capital inadequacy. Consolidation is a route for these smaller banks to infuse funds to strengthen their capital base.

Many branches and ATMs of various banks are congregated in the same areas leading to pointless outlay on premises, manpower and maintenance facilities.

Consolidation may lead to redeployment and rationalization of such infrastructure, human resources and other administrative facilities thereby undercutting the

cost factor and enhancing profitability.

Financial inclusion has been a key focus area for RBI since 2005. Ever since, it has exhorted banks to extend their operations into rural areas. Most of these projects are not financially viable for the banks. In case of a merger, the combined customer base increases the volume of business. The enhanced rural branch network may lead to increase in microfinance activities and lending to the agriculture sector.

Even though traditional issues like technology alignment and people integration are hindrances to M&A in banking sector, due to the aforementioned reasons, there would be an increase in M&A deals in the Indian banking sector.

Presently, SBI has proposed to merge its five remaining subsidiaries with itself over the next 12-18 months. The consolidation exercise has been systemically planned to bring in economies of scale, reduce administrative overheads, redeploy and channelize trained manpower to business development and reduce avoidable competition amongst arms.

Telecom Sector The Indian telecom industry, with a rapidly increasing subscriber base and approximately 10 million new subscriber additions a month, is now one of the fastest growing wireless markets in the world. [See M&A sector-wise table] The tariff war amongst incumbents and the price difference between incumbents and the new players will most likely decrease further. This would force the big players to look for attractive growth opportunities outside the country. In 2010, India‘s largest Telco by both customers and revenues, Bharti Airtel closed a $10.7 billion deal to buy out Kuwaiti telecom Zain‘s African operations.

The total available spectrum in India is not aligned to a market structure of 11-12 players. These spectrum constraints would also drive consolidation. Moreover, all new players have spectrum in the 1800MHz band, which seriously impairs their viability [High CAPEX] and scale even in the long term.

The ultracompetitive market and uncertainty over the impact of mobile number portability (MNP) have eroded the confidence of institutional investors. Institutional investors are likely to invest in this sector only after assessing the kind of impact MNP will have on the sector. The telecom companies have spent over US$7.6 billion for buying 3G spectrum. The telecom

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Indian M&A market

companies have raised debt from foreign sources as well to fund this auction.

Though reducing profit margins, attractive growth

activities in foreign markets favor inorganic activity, the current financial position of the telecom companies doesn‘t encourage M&A activity.

Pharma, Healthcare & Biotech The pharmaceutical industry in India and globally, is highly fragmented. Till 2000, pharma MNCs were not interested in domestic pharma market. During 2000s, focus shifted to contract manufacturing thereby leveraging India as a low-cost destination. Owing to the slump in the sales growth, many MNCs, such as Pfizer, GSK and Merck , have announced massive cost-cutting measures, including expenses in R&D. Due to India‘s continuing competitive strength in research services backed by low cost skilled doctors and scientists, Contract manufacturing and research (CRAMS) is expected to gain momentum going forward.

Since 2007, globally the acquisition of the generics business [table above] has been driven due to concerns of revenue losses arising as drugs [e.g. Lipitor and Zyprexa] go off patent. Research firm Evaluate Pharma Ltd. estimates medicines now generating $133 billion in annual U.S. sales could become exposed to generic competition by 2016. Indian pharma market is set to double by 2015 owing to increase in healthcare spending, rising middle class incomes, and deeper penetration in rural areas. This also explains why MNCs are looking at the inorganic route to build a presence in India. Valuations commanded by Indian firms have also gone up from 4 sales multiple of 4 for Ranbaxy to 9 for Piramal.

Government policy change concern still remains. The government is presently considering if at all it is viable to impose a 49% FDI cap, currently the sector is 100% automatic FDI. This could have real implications on the Indian pharma industry.

The outlook for Indian Pharma in 2011 and beyond looks bright with Dr Reddy's, Cadila, Torrent and Divi's Labs being on the radar of MNCs such as Merck, Pfizer and GlaxoSmithKline (GSK). The consolidation will continue to be the key in next few years as it brings economies of scale, growth opportunities for MNCs and money to firms to carry and sustain R&D expenditure.

Oil – Gas and Metal – Ores Energy and power deals [77 deals worth $23 bn] tripled compared with 2009. India‘s 11th position on the global M&A list and 1.52% share of the total value of deals will not deter companies within to be major acquirers of the oil and gas assets located overseas. The rational being the limited avenues for domestic M&A and the need to expand its global footprint for achieving energy security.

BP's confidence in India is evident from the fact that the transaction constitutes one of the largest foreign direct investments into India. Shale gas acquisitions are turning out to be best bet against volatile oil prices, as companies across the globe try to diversify their energy sources. RIL has been an aggressive

OCTOBER 2011

Indian M&A market

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buyer in this category. Globally, ExxonMobil Corp.‘s $41 billion deal to buy XTO Energy shows shale gas is a better hedge to secure energy needs.

On the government front, China, with $2.4 trillion of reserves and a $300-billion sovereign fund, has outpaced India, as Chinese companies spent a record $32 billion last year buying oil, coal and metal assets abroad, while a $2.1-billion OVL-Imperial deal was India's sole energy acquisition. To address this, the government is drawing up ambitious plans to set up a ‗Sovereign Fund' that would help its state-run companies pursue acquisition of oil, gas, coal, LNG and other raw material in other countries in order to compete with China.

The 2011 prospects of this sector continue to be bullish on M&A, as State-run and private companies globe-trot to acquire energy assets.

IT/Software Sector As companies go through cautious phase of restructuring following the financial crisis, barring iGate-Patni US $1.2 Bn [83% stake] acquisition, no major big ticket IT M&A were seen so far. In 2011, we are more likely to witness mid-size IT firms buying out US and European IT firm selectively. Top 10 domestic IT players are holding out, and are in no mood of consolidation. In fact, as evidenced by their Q3 2010-11 performance, [barring Wipro] all have entered into the post-crisis growth phase. Though there might be some acquisitions if cloud computing picks

up in a big way in India, as established players look to enter into this new phenomenon through inorganic route.

Auto Sector Apart from Mahindra-Ssangyong US $470 mn and Hero acquiring its partner Honda‘s 26% Stake for US $1 Bn, no major activity to be seen in auto sector. A report by KPMG on the Evolving Dynamics of the Indian Automotive Industry confirms this.

According to the report, low car penetration, rising incomes and strong rural demand make a good case for growth. Depending on the need to access technology, manufacturing facilities, services and distribution networks, some consolidation could be expected in future but anything big in the form of brands being bought or sold or companies exiting the market are more likely to be exceptions, it adds.

Retail Sector In 2010, there were a few small ticket domestic deals – Shriram - Vishal Retail US $21.3 mn, PantaloonHome Solutions retail, and hardly any outbound acquisitions.

India does not allow foreign investment in multi-brand retail, but the government in July revived the debate by seeking feedback from various stakeholders about allowing FDI in multi-brand retail. It is more likely to be deferred this year again. Global retail giants such as Tesco, Carrefour, Wal-Mart are keen to have a

FINETUNE presence in India despite regulatory obstacles, hoping that the laws would be eased as it happened in the telecom and other sectors. If laws do change, which experts caution – should be done in a judicious manner taking social repercussions into factor, we might see fierce M&A activity in the retail sector.

Private Equity PE Investments in India increased from US$ 3.45 Bn in 2009 to US$ 6.23 Bn in 2010, an 81% increase as per Grant Thornton report. Power & Energy – US$ 1.5 Bn and Realty & Infrastructure – US$ 945 mn accounted for major chunk of PE. Some of the major PE deals were Blackstone-Moser Baer US$ 300 [Power & Energy], Quadrangle Capital-Tower Vision US$ 300 [Telecom], 3i India Infra Fund-GVK Energy US$ 255 [Power & Energy], KKR-Dalmia Cement US$ 160 [Cement]. PE prospects for 2011 continue to look bright for Power & Energy, Realty & Infrastructure, BFSI, Telecom, IT & ITES, Pharma and Education.

Indian M&A market

M&A value creation or destruction ‗Strategic intent opens the door, financial considerations close the deal‘. Wish it were true. More often than not, deals are closed by quoting ―Synergies‖.

Synergies, per se, are not wrong. When managers fail to put a number on it, quantify the synergy, it leads to failure. US statistics from 1990s and 2000s show that 70% of M&As end up destroying net value.

For the Indian scenario, M&A activities pre 1990s was done mostly on industry multiples of sales and ebitda. Not much attention was paid to valuation. Post economic liberalization, corporate methods have changed, still herd mentality persists in some sectors.

One of the concerns in many Indian companies is they do not use acquiree‘s cost of capital to value the firm, but their own [acquirer] and end up overpaying. Other important concern, is the Agency Cost – as the CEOs who do not have stake in the company, end up overpaying in acquisitions due to their inflated egos and lack of accountability. CEOs who are paid major part of their compensation in stock options, are more likely to exercise prudence.

Of the M&As done since 2007, Tata‘s Corus and JLR & Land Rover, and Aditya Birla Group‘s Novelis seem to have turned the corner and started making profits. Here, one must look into Post-MergerIntegration [PEI] process, which determines whether

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the acquisition will succeed. Tata‘s executed the PEI exceptionally well, given the myriad difficulties they faced immediately after acquiring them as the world plunged into financial turmoil. Of particular importance is the case of Suzlon, where Tulsi Tanti [58% stake] built his empire through inorganic growth, buying everything on the horizon. a] Lack of attention to finances – short term as well as long term, b] coupled with lack of industry demand due to crisis, c] order rejection due to faulty windmill blades, d] overpaying for acquisitions [REpower & Hansen] his empire is undergoing massive restructuring. For the acquisitions, post 2008, the elapsed time period is too short to judge their performance.

CONCLUSION To sum it up - Banking, Pharma, Oil & Gas and Metal Ores, and Power Energy will see major M&A activity.

Telecom and Auto sectors are less likely to have any major M&As. IT/ITES will not see big ticket M&As but many mid-sized deals, whose cumulative size would be large. A lot depends on government policy, especially in banking and retail sectors. IFRS [3R-IAS 27] would not impact the M&A deal calculations, as the government has heeded to the calls from industry to defer its implementation. Economic recovery and steady growth of US and European economies would play a crucial role in both Inbound and Outbound acquisitions. Overall, Indian firms and MNCs would continue globe-trotting in search of value for money acquisitions, growth, entry to new markets and energy security.

REFERENCES 

Grant Thornton Deal Tracker Annual Edition 2008, 2009, 2010

        

KPMG, Deloitte and PWC reports available online IRJFE reports www.reuters.com www.business-standard.com www.deccanherald.com www.ft.com Damodaran on Valuation – Book http://economictimes.indiatimes.com www.moneycontrol.com

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INTRODUCTION The story of superlatives in China is not just restricted to its population numbers, highest GDP growth in the world in 2009 of 8.7 per cent and the third largest economy of the world set to overtake Japan, clearly it couldn‘t have been a better time to be celebrating the year of the Tiger for the Chinese. Also, with the IMF recently raising their GDP 2010 forecast for China from 9.9 per cent to 10.5 per cent, there is a buoyant feeling about China‘s growth potentials doing the rounds.

Consumer expenditure witnessed moderate growth despite the ongoing recession in 2009 at $1.7 trillion as compared to $1.6 trillion in 2008.

China GDP at constant prices 20% 10.1%

10%

12%

13%

10%

10,000

15% (per cent)

(In RMB billions)

15,000

10% 5%

5,000

0% 2004

2005 GDP (LHS)

2006

2007

2008

YoY Growth in % (RHS)

Source: IMF

However, its objective should be to sustain this growth over the long term. To achieve this, the Chinese policy makers will have to rethink their growth strategy. Rebalancing will include a managed floating exchange rate regime, increased dependence on domestic consumption as compared to exports and policies to curb inflation and reduce the gap between income inequalities present in the country.

WHY REBALANCING IS THE WAY FORWARD FOR THE CHINESE ECONOMY Low private consumption, a cause for concern: China‘s private consumption was barely half of its total demand in 2008. However, Government tax rebates and the subsidies contributed to a sharp rise in the sales of cars and household appliances in 2009.

Source: National Bureau of Statistics, China 2009

With the rebates and subsidies continuing in 2010 and labor market conditions set to improve. Historically, China has been a savings based economy with almost 32 per cent of the disposable income being saved by the Chinese household. (US savings measure upto 3-4 per cent) Fear of a real estate bubble: A major cause for concern for the Chinese officials is the feverish growth in the real estate markets, raising the financial risk associated with China. The phenomenal rise in the real estate prices can be attributed to the excessive easing of credit brought about by the RMB 4 trillion stimulus package. During this period, total financing for property developers rose to almost RMB 9 trillion in 2009, leading to a spurt in property prices.

Rising energy consumption: Investment led growth has led to a rise in machinery generated output which has translated into higher energy consumption. China‘s energy elasticity of GDP growth averaged a moderate 0.6 in the 1980‘s and 1990‘s but this ratio has more than doubled in the

Indian M&A market

CHINA’S ECONOMY: IS IT A BUBBLE IN THE MAKING?

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2000s (Source: National bureau of statistics, China).

Lack of coal resources, rising environmental concerns and increasing air pollution in most Chinese cities has forced China to consider other ways of achieving growth.

Exports -The major contributor to revenues: The Chinese economy revolves around the exports segment. Exports as a per cent of GDP have constantly been rising but during 2008, the year of the global meltdown, they fell significantly attributable to the overdependence of China on exports to the western nations.

Chinese exports (as a per cent of GDP) 39.9

40

39.7

39 38

37.4

37

Unfavourable age demographics: The one child policy implemented by the Chinese authorities has had its own set of drawbacks. China is now a rapidly ageing society, with citizens above 60 making up about 12-15 per cent of its total population.

The need of the hour is an urgent investment in people rather than in infrastructure to cater to the immediate needs of this aged population.

REBALANCING: THE WAY FORWARD In December 2004, at the annual central economic work conference, Chinese leadership had commented on the unsustainability of their growth path and expressed their desire to make the growth more broad based. Sustainable growth could be attained by increasing domestic consumption and reducing reliance on investments and a burgeoning trade and current account surplus.

36.6

36

Current account balance as percent of GDP 15

2005

2006

2007

2008

12

9.6

9

Source: World Bank

Indian M&A market

Unemployment rate, still rising: Unemployment is also one of the major factors which has proved to be an impediment to appreciation of Renminbi, especially since June 2008. The global economic meltdown had a severe impact on the employment in the manufacturing sector. The country also has to deal with the problem of youth unemployment, especially among university graduates. According to government estimates 16% of the university graduates were unemployed as of end 2009.

Widening gap in income inequality: The main cause of the increase in the gap in income inequality has been an unbalanced regional economic growth. The high income differential between the coastal regions of China and the national average is quiet evident. Hence there is a need to bridge the gap in income inequality between the coastal and the inner hinterland regions which can be made possible through a transition from an export led economy to a more harmonious consumption led one.

6

11.0 9.4

7.0 3.5

3 0

2004

2005

2006

2007

2008

Source: IMF

Increase in share of private consumption in GDP as compared to exports and investments: Increasing domestic demand can be achieved through household consumption as well as government consumption. A flexible floating currency rate will benefit China by allowing them to vary their interest rates and will lead to appreciation of the Chinese currency thereby reducing the value of the exports. Also, it will aid in curbing inflation which has been on an upward trend in the 2000s.

Also, the Chinese government has to have an effective tax structure in place which reduces taxes on the income levels of households thereby leading to higher consumption. The Chinese have historically had high savings rates as compared to other developed as well as developing economies. The motive for the Chinese

households towards savings has been to cater to emergencies such as illnesses or unemployment. In the longer run, if the Chinese policy makers can help reduce the fear of Chinese people over these two factors, expenditure of the Chinese household towards domestic consumption will surely rise.

Consumer price Inflation (Index 2000=100) 130

121 120

114

110

105

107

108

CONCLUSION

100

90 2004

2005

2006

2007

2008

Source: IMF

Move towards a managed floating currency rate regime: Observing the long trend of the movement of the Chinese yuan with respect to the dollar, the currency has been on the downward trajectory. However, In June 2010, after approximately two years, the Chinese government announced that it would allow greater flexibility in its currency. An undervalued Renminbi has contributed to a large current account surplus, dampened consumption in the domestic market as well as created pressure due to high domestic liquidity. A stronger currency would decrease prices of local and domestic goods/services, and subsequently boost local demand with the hope that the appreciation will change the country‘s exchange rate regime extensively, despite close monitoring by the Chinese government.

10

Movement of Chinese yuan with respect to Dollar

8 (In times)

China is moving towards a managed float exchange rate regime in the long run. However, this can be achieved only though decreasing the current account surplus as well as liberalization of capital accounts. To achieve the requisite benefits, China should also maintain a low inflation monetary policy. Additionally, China‘s implementation of the logic behind the Bretton Woods 2 suggests that China should depart to a floating exchange regime once its financial systems are structurally prepared to do so.

6 4 2 0 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992

Yuan Dollar fluctuations

Source: Chinability

Despite the concerns over the Chinese economy, and indicators towards expected Chinese growth being as volatile as the financial markets, China is set to remerge as one of the top two global economies of the world. However, China will find it getting increasingly difficult to maintain its high pace of growth as the gap between its average income and those of the developed economies reduces.

On the other hand, the optimists are envisaging a ‗G2‘ era, in which China and the United States of America will be the pivots around which the global economy would revolve. Projections from PriceWaterhouse Coopers and a few international banks expect China to overtake the US in the next couple of decades. The way towards fast yet sustainable growth ahead is definitely rebalancing and tweaking the economic strategy by the Chinese government. If the reforms relating to floating the currency, increasing domestic consumption as well as curbing inflation through a well executed monetary policy are implemented soon, then China, may well meet the optimists‘ forecasts, going forward.

REFERENCES      

National bureau of statistics, China 2005-2009 reports IMF Organisation for economic cooperation and development Standard and Poors World Bank Chinability report

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IMPACT OF NEW BANKING LICENSES IN INDIA ABSTRACT The proposal by the Reserve Bank of India to open up the Indian banking sector through issuance of banking licenses to Non banking finance corporations (NBFCs) met with unparalleled interest by industry representatives. In what ways can the launch affect financial inclusion and rural banking growth in India and what other benefits can be realized through this move?

INTRODUCTION Friday 26th February, 2010: The finance minister Pranab Mukherjee announced that the government is looking at issuing higher number of banking licenses in the coming year and that NBFCs that meet the regulatory requirements and criteria as laid down certainly stand a chance to get them.

Following this announcement, the positive impact on NBFCs was certainly evident in the immediate upswing of their stock prices. Now what needs to be seen is what it means for NBFCs and on a broader view, India as whole?

WHAT IT MEANS FOR NBFCs?

Impact of new banking licenses

There are many advantages that NBFCs will enjoy once they get converted into banks, as is evident from Kotak Mahindra‘s example. The advantages are highlighted on the following basis:

access to lower-cost deposits and improved leverage.

Currently only 310 NBFCs are allowed to access public deposits and thus Banks continue to be largest source of finance for NBFCs. This explains why the loans provided by the NBFCs are at higher rates than those offered by the banks.This also exerts pressure on their margins, thus leading to lesser profitability. So, conversion to banks is certainly a lucrative option for, once converted into a bank, these institutions will definitely enjoy more profits.

Improvement in Customer Base: Currently, many NBFCs focus on lucrative niches and earn exceptional spreads. For example, infrastructure NBFCs like Srei Infrastructure lend money between 10 per cent and 14 per cent to the infrastructure. Once converted into Banks, these NBFCs will have access to a broad market i.e. across the sectors and the lending rates will be competitive to the market rates due to availability of cheap credit.

Improvement in reach-ability: As far as penetration of the NBFCs is concerned, many new branches will have to be opened up, especially in the tier II and tier III cities. Thus, this conversion into banks will necessitate re-jig of the branch networks of NBFCs. In this case, some NBFCs like Religare Enterprises Limited will have an operational advantage because of their existing widespread network in tier II and tier III cities.

WHAT IT MEANS FOR INDIA?

Fig:Comparison of bank rate, repo rate and borrowing rates of NBFC

Improvement in Profitability: The biggest advantage is that the NBFCs will have

Existing Scenario: The existing scenario in India shows a negative picture of Financial Inclusion. The concept of Financial Inclusion as proposed by Rangarajan Committee in 2008 was ―The process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost.‖ Reports suggest at present only 50,000 of India‘s 600,000 villages have access to organized bank branches.3 As per NSSO data, 52% of farm households do not have access to credit. Of the remaining

48%, only 27% have access to credit from formal sources.

A 2010 IFMR study found that the people from rural areas spend an average of 40 minutes in travelling and 50 minutes in waiting for their transactions at nearest bank branches.

India currently has an abysmally small ratio of just one bank branch per 16,000 people. As seen from the graph below, developed countries (like Germany and Japan) generally have a ratio which is around 5-10 times better than the developing countries (like India and Brazil).

The reasons for the same are not hard to state:  The reluctance of banks to serve the financially excluded as is evident from the constant decrease













in number of banks in rural areas.

The poor financial histories of rural India, the lack of collateral, the high rate of default in terms of payment of credit are all the factors which act as major deterrent for the banks‘ plans to expand into rural areas.

FINANCIAL INCLUSION: THE TARGETED FUTURE

Mr Pranab Mukherjee, has announced that banks will have to meet their target of spreading financial inclusion to 20,000 unbanked areas with a population of less than 2,000 by the end of this fiscal.4  Financial Inclusion is being considered an important tool in aiding the development of the economy essentially for the following reasons –  Financial Inclusion will help in channelizing the population into the formal sector and hence enabling better record-keeping of transactions.

A more sustainable model of lending/borrowing will be established which is crucial to the development of rural sector.  Rural Population will be saved from the debt trap

of moneylenders who usually lend money easily but at exorbitant rates.

Better access to banking services which will include access to more credit and insurance facilities will aid in enlarging the livelihood opportunities for the rural Indians.

The increase in bank transactions will help in cutting money laundering and fraud that negatively impacts country‘s GDP and hence help in boosting tax collections.

Better facilities for credit availability will increase uptake of the government‘s various social welfare programs such as NREGS, Sarva Shiksha Abhiyan, and Janani Suraksha Yojana.

More sources of credit will bring down the lending rates, thus driving the growth of SMEs as well as more financing facilities for other sectors of economy.

Rural India is being considered as the driver of future growth of companies in FMCG, IT, education and all other major sectors. Thus, financial inclusion will directly aid in upliftment of rural Indians and indirectly help in making the economy self-sustainable by driving the growth.

IMPACT ON BANKING SECTOR

After the issue of new Banking licenses, there will be considerable change in the Banking industry as a whole. This industry, though has lot of potential to expand, seems to have reached a maturity stage with not much expansion taking place both organically as well as inorganically. In the recent past we have seen a few consolidation phase deals with ICICI Bank taking over the troubled Bank of Rajastan. Overall, this industry seems to have reached a near stagnant phase post the recession in India.

According to HDFC Chairman, Deepak Parekh (source: interview to CNBC-TV18) RBI‘s decision to issue more Banking licenses will open up banking sector to rural areas and fetch in whiff of fresh air in the sector.

The immediate effects of these new banks on existing banks:  The new banks, mainly catering to Tier 2 and Tier 3 cities, will be posing a big threat to the organic growth plans of banks like ICICI, HDFC, Axis and SBI.

Impact of new banking licenses

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The impact may not be much on existing banking operations as these licenses may be given over a period of time and not at once.  Also, many of the NBFCs are currently catering to niche sectors, where they enjoy huge benefits and recognition. To make a mark as a bank catering to all the sectors equally and mainly to the general public may take considerable amount of time.  Customer retention will be a problem for the relatively inefficient banks like SBI because of the technological advance which would be used by the NBFCs of the business houses. These business houses have already gone global and understood the importance of customer satisfaction in customer retention.  Shrinking margins in operations because of stiff competition could be another problem which can affect the banks.

Overall, new banking licenses will give the existing banking industry a new launching pad to take off from.

RECOMMENDATIONS

Impact of new banking licenses

The existing NBFCs, Rural Regional Banks (RRBs), Micro-financing Institutes (MFIs) and the big business houses will be the strong contenders for the new banking licenses. However, the following recommendations must be considered for extending the licenses: 1. More focus should be laid on feasibility of converting RRBs into banks because of the following advantages that RRBs have over other contenders:  They are better placed to achieve the target of Financial Inclusion.  The recent mergers in RRBs have brought their number to 82 and have resulted in healthier banks which have the ability of sustainably expanding the branch network.  RRBs and the refinancing agency National Bank for Rural Development have been around for decades and they have to answer for the glaring hiatus in the formal banking system's presence in rural India.  NABARD has set up financial inclusion funds to support them.

2. A partnership with a business house can be looked at as they are resource houses of huge amount of funds as well as corporate expertise.

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3. NBFCs like IFCI and Religare Enterprise must be granted banking license only after strict audits and without any compromise in financial regulations.

4. To achieve Financial Inclusion, a criterion of minimum number of centers in Tier II and Tier III cities should be laid down.

COUNTER VIEW Even though the whole plan of having more banks seems rosy at first, but then there are a few issues which need to be taken care of:  Minimum capital requirement: Getting the initial minimum capital requirement is simple but sustaining it over a period of time could be an issue. RBI has experienced this with the earlier banks like Centurion Bank and Bank of Rajastan.  Allowing Business houses to set up a bank from NBFC: There is always a threat that the NBFCs of business houses could be biased towards their group companies. So a strict vigilance system has to be in place for them.  Extent of Promoter shareholding: This point again affects the extent to which the promoter can influence the decisions of the Banks because the promoter has any vested interests.

It rightly said that ―Good things come at a price‖, NBFCs will also have to get used to working in the highly regulated Banking sector as against enjoying the advantages of operating in an unregulated turf and that too in specific sectors. This includes compliance with CRR and SLR norms as well as the mandatory priority sector lending norms. Thus, even after the conversion from NBFC to bank, sustenance is going to be a challenge.

COMPARISON OF TOP NBFCs Finally let‘s compare some of the leading NBFCs on the basis of the criteria laid down by RBI: (on next page) Now what needs to be seen which of these actually beats the competitions and gets the first new Banking license.

REFERENCES    

http://findarticles.com/p/news-articles/times-of-india-the/mi_8012/ is_20100302/nbfcs-rush-banks-india-business/ai_n50700913/ http://www.indianexpress.com/news/expanding-inclusion/749306/4 ht t p :/ / w w w . mo ne yc o nt ro l. c o m/ ne w s / fe a t ure s / c is c os -ind ia solution_522964.html ht tp :// www.t he hind ub us iness line. co m/op inio n/ed itor ia l/

OCTOBER 2011

Impact of new banking licenses

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Legend:

FUTURE OF INDIAN DEBT MARKET INTRODUCTION & HISTORY ABOUT INDIAN DEBT MARKET Indian economy has expanded with an average of about 8.5% annually for the past 4 years and one of the major contributors of this is the economy‘s rising productivity and investment. India‘s bright prospects have attracted record capital inflows, even amid heightened global uncertainty and slowing growth in the United States.

INDIAN DEBT MARKET Generally in any developed country the debt market is many times larger than the equity market. But compared to India‘s world class equity markets, India‘s corporate bond market is still in an embryonic stage, both in terms of the market participation and infrastructure. From 1996 to 2008 the ratio of equity market market capitalization to GDP has more than trebled to 108% from 32.1% the debt market grew to a more modest 40.0% of GDP, from 21.3%.

FINETUNE The Indian bond market is predominately dominated by the government bonds which hold around 90% of the total Indian Bond Market which was triggered and grew to finance a large fiscal deficit of the government. The government bonds are around 36% to the size of India‘s GDP while the corporate bonds hold just a meager 3.6% of the share.

In the economic survey done in 2011 the survey has reported that in 2009-10, private placements of corporate bonds listed on the BSE and NSE had raised Rs. 212,635 crore, in contrast till November 2010, only Rs. 147, 400 crore were raised through this route. The number of issues were also fewer, from 1,278 issues in 2009-10 to 929 issues till November 2010 Among the emerging markets, India ranks among the lowest for money raised through bond issuances which tells us about the dire conditions of the bond market. In 2009, Brazil raised $10.1 billion, Russia $10.8 billion, China $3.3 billion and India $2.2 billion.

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Source: Asian Bonds Online, Reserve Bank of India

1.

2.

India has developed world-class markets for equities and for equity derivatives supported by highquality infrastructure.

The infrastructure for the bond market, particularly the government bond market, is similarly of high quality.

WHY INDIAN DEBT MARKET IS UNDER-DEVELOPED

Future of Indian debt market

I. Regulatory restriction on institutional investors Banks - Majority of public sector bank's investments are held in public sector debt & Banks can invest in bonds of investment grade only.

Insurance companies- Permitted to hold a maximum of 25% of their portfolio in bonds rated less than AA. EPFO & PPF – Investments by them is subject to stringent regulatory restrictions.

Source: Asian Bonds Online, Reserve Bank of India

Though as far as Asian countries are concerned the Indian government bonds are adequate in volume in the market but generally most of them are illiquid.

The turnover ratio for Indian government bonds, in 2007 was 104% which means than in a financial year the government bonds don‘t change more than one hand which is way below any acceptable percentage of a good bond market country. The corporate bond market is restricted to participants and it‘s largely arbitrage-driven and is also highly illiquid but still less than the government bonds. This liquidity is the concern which makes the Indian debt market sluggish and unattractive and demands improvement.

The lack of development in the debt market can be anomalous to two reasons:

II. Inadequate liquidity Secondary Market for Corporate Debt lacks liquidity in India. Poor liquidity is attributable to inadequate number of good papers and lack of sufficient investor base in terms of quantity as well as diversity.

III. Incomplete access to information Lack of sufficient, timely and reliable information on bonds and on bond markets to the investors is a deterrent for investment in Debt markets. Information on bond issue, size, coupon, latest credit rating, trade statistics are sparsely available.

IV. Anomalous Interest rate structures Corporate bonds with ―AAA‖ rating offer lower coupon than sovereign rate offered on certain instruments

such as PPF, National Saving Certificates. Individual investors, therefore, have no incentive to invest in Corporate Bond market, unless they are accompanied by some fiscal concessions.

V. Absence of Bond derivative market While equity market derivatives are active, India has no bond related derivative market. Without derivatives it is difficult for primary dealers to manage risk exposure.

In the absence of such instruments primary dealers provide liquidity at higher transaction cost. Also currently Credit Default Swaps (CDS) are not allowed by RBI. MARKET REFORMS The chief reforms that have been made are as follows: I. One of the chief characteristics of the Indian bond market is that it consists of a large number of small issues thus hampering the liquidity of large issues. To address this problem the RBI followed policy of passive consolidation in the fiscal years 2007-2008 and 2008-2009 that reduced the number of bonds—retiring 14 separate bonds for the addition of four new bonds reducing the number of bonds outstanding by 10 to 95.

II. Interest Rate Derivative Market – India has no exchange traded - bond-related derivative market and the interest-derivative trade is over the counter. The RBI tried to introduce interest rate futures. This is because banks were permitted to use the market for specific hedging transactions only unlike other countries where banks use interest rate futures for hedging and optimal use of capital. Thus a similar futures market in India shall provide greater flexibility to the primary dealers and more liquidity to the bonds market.

III. Primary Dealers – Primary Dealers were introduced in India in 1996 as independent or bank- linked entities. Later in 2006, banks were allowed to participate directly as primary dealers. Today India has 6 primary bank dealers and 11 independent primary dealers. Primary dealers have previliges in the form of preferential finance at the RBI, access to RBI‘s open market operations, permission to borrow and lend in the money market, issue commercial papers and raise finance from commercial banks like corporate borrowers.

IV. Issuance – Most of the issuers preannounce the forthcoming issues and since September 2006, the RBI has also published a yearly issuance timetable for dated bonds. This all happened after the introduction of ―when-issued (grey) market‖ in May 2006 which was then relaxed to allow when-issues trading in selected new issuances. This tool helped issuers of government bonds to realize that transparency of issuance allows investors to plan their cash flows and investments more accurately.

The RBI is now working to develop a market for Separate Trading of Registered Interest and Principal of Securities (STRIPS) V. Short – Selling – In April, 2006 RBI allowed intraday short selling for primary dealers and scheduled commercial banks and in January, 2007 the permission was extended to 5 day short selling. The purpose of allowing short selling was to enable the primary dealers in supporting the secondary market and maintaining its liquidity. However there are still significant restrictions on short selling that restricts the capability of the primary dealers to provide liquidity.

VI. Repo Market – The primary dealers and the scheduled commercial banks are permitted to raise funds through repo of their non – SLR holdings of government securities, T- Bills and state government bonds. Gilt repos are almost exclusively between the market and the RBI and there are few third-party repos. The RBI also uses repo and reverse-repo to conduct money market operations. Daily rates are announced, and set a corridor between the repo and reverse-repo rates where the call money market operates. A major hindrance to the development of the repo market was the double regulation – regulated by SEBI as a part of the debt market and regulated by RBI on account of being a money market instrument.

The regulatory jurisdiction of RBI and SEBI with respect to regulation of corporate bond market has been clarified. SEBI is responsible for primary and secondary debt market while RBI is responsible for the market for repo/reverse repo transactions in corporate debt.

VII. Collateralised Borrowing and Lending Operations – CBLOs are tradable money market instruments developed by RBI and the Clearing Corporation

Future of Indian debt market

OCTOBER 2011

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FINETUNE of India Limited (CCIL) and managed by CCIL. CBLOs are the fastest growing debt instruments in India due to their advantages. The lenders are assured because borrowers make collateralised deposits with the CCIL and risk management is done by the CCIL. Borrowers are benefitted because the interest rates are lower than repos due to collateral deposits and anonymity of the borrower is maintained thus guaranteeing better access to certain borrowers who otherwise could not have obtained such funds. Banks have limited exemption from CRR and SLR requirements for their CBLO transactions and thus they can borrow cheaply. As of July, 2008, the CBLO market of India had 169 players with mutual funds and insurance companies being the largest lenders and public sector, private sector and foreign banks being the largest borrowers.

CORPORATE BONDS MARKET As already mentioned the corporate bond market in India is very small and undeveloped. It has a high turnover ratio of but that due to the small size of the market and not due to its efficiency. Thus the market is relatively illiquid. The RBI has taken initiatives to drive the bond markets towards accessibility, transparency and efficiency. Some of the major problems tackled and changes brought about are as follows:

Future of Indian debt market

I. Most of the corporate bonds are issued as private placements instead of public issue. Public issues require the disclosure of a very large amount of data publicly which is largely considered excessive. Both listed and unlisted companies have to disclose similar information and there is no provision for shelf registration. Besides, the issue process is very slow making the issues very risky due to their fixed price and expensive with the high costs of marketing etc. being borne throughout the long period. This makes the private issues which require much less documentation and time and offer greater flexibility – more attractive.

Thus in order to promote public issues, the Patil Committee made certain recommendations – Companies publicly-listed on an Indian exchange would be required to make only minimal additional disclosures for a public issue or a private placement and unlisted companies would be required to make more substantial disclosures, though less than those required for an equity issue. SEBI (Issue and Listing of Debt

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Securities) Regulations, 2008 simplifies disclosures and listing requirements. Amendments in the Companies Act to enable shelf registration are also in progress. And documentation requirements for private placements have been increased.

II. Stamp Duty – The stamp duty on corporate bonds is very high, as much as 0.375% for debentures. These duties are ad-valorem with no volume discounts and vary across state to state and across issuers. The high duties discourage corporate bonds and instead encourage an arbitragebased, tax-driven approach to corporate finance. To overcome this, the Patil Report recommended a lower and uniform stamp duty across all states. However the RBI is still considering its implementation.

III. Securitisation –India began securitization in 1990s and now the market is around INR580 billion in the year 2008 which is around 1.25% of India‘s GDP. Of the various types, Collateralized Debt Obligation and Collateralized Debt Obligation issues represent around 54% of the total market while Asset Backed Securities another 45%. This means that there is a large scope of other forms of securitization. Credit card securitization has been very limited, partly because of stamp duty costs, but also because the credit card market in India which is very small but with the current growth in the credit card usage this is one area which offers huge prospect. Bank and Insurance companies are the predominant investors of in securitized notes. Until recently, securitizations with subordinated tranches were not offered in India and remain a rarity.

This is because there is little investor demand for such lower-rated notes and there was no capital penalty for originating banks retaining the first-loss tranche RBI guidelines have removed the latter reason and the market is now seeing some use of subordinated tranches.

Reforms –The Securitization and Reconstruction of Financial Assets & Enforcement of Security Interest Act, which clarifies the status of securitization but still it has not come in full effect. RBI regulations have encouraged more direct assignments (cash flow transfers without SPVs) but it‘s still a very hazy area. The Patil report also made recommendations on securitization relating to the stamp duty and taxation as stamp duty is one of the major development to the

development of securitization. Like for bonds in securitization also there are different rates in different states giving rise to arbitrage.

IV. Foreign Investors – Foreign fund managers wishing to invest in Indian debt securities have to apply SEBI and gain Foreign Institutional Investor (FII) certificate, which is valid for 3 years and is renewable.

FIIs register as individual sub-accounts to trade in the market. The various reforms introduced by SEBI to enhance foreign investment are: a) FIIs can now undertake short-selling and stock borrowing/lending on par with domestic investors b) Registration has been simplified c) FII status has been opened to non-resident Indians (NRIs) FUTURE OF DEBT MARKET IN INDIA According to Planning Commission estimates India is projected to grow at least by 7-8 per cent per year for the next decade. India needs to invest around $500 billion between now and 2015 for infrastructure expansion. Infrastructure companies would need money for long term infrastructure projects with high gestation periods. Traditional sources of financing like commercial banks, External commercial borrowing or Foreign Currency Convertible Bonds are not easily accessible & also present the danger of exposing such projects to events like Global credit crisis. Hence it is important to have a Non-banking funding channel in the form of Government/corporate bond market. In India, credit from banks is largely available to big private sector companies, essentially squeezing small borrowers, SMEs etc. out of the bank lending market.

If the domestic corporate bond market becomes vibrant then it could become an attractive source of financing for these large corporations and free up resources of the banks to support smaller companies Due to growing fiscal concerns, Government is favouring defined contributory schemes in the short run.

This along with the entry of private pension funds requires more risky investment avenues to enhance their returns. This is likely to create greater demand for corporate bonds.

OCTOBER 2011 WHAT NEEDS TO BE DONE? Investor base needs to be broadened: Banks‘ investments in corporate bonds can be encouraged by bringing changes in the regulatory mechanism which treats loans portfolio on par with investment portfolio. Also FII‘s can be given higher limits for investments in corporate bonds since this will bring volumes to the corporate bond markets. To encourage small investors, the bond market structure should emulate the equity market structure in the sense that a retail investor should be able to buy and sell bonds without any restriction on the minimum market lot.

Widening the issuer base The guidelines for issuance, disclosure and listing of corporate bonds should be made simpler. Banks should be allowed to issue bonds of maturities over 5 years subject to their asset liability matching norms.

The development of an interest rate derivatives markets is a major prerequisite to facilitate this.

Listing norms to be eased For entities which are already listed, listing norms should be made simpler and they should be allowed an abridged version of disclosure. For unlisted companies issuing bonds to institutional investors and QIBs, rating should form the basis for placement Developing a market for debt securitization Government should try to resolve the uncertainty in taxation issues pertaining to securitized paper. To remove any ambiguity in this regard, the Central Government should notify pass through certificates and other securities issued by securitization trust as securities under Securities Contract Regulation Act. Developing a robust trade reporting system There is an urgent need to put in place a framework by which we can capture all the information related to trades in corporate bonds, disseminate the same and keep a data base of trade history. Regulators should direct the bond market participants to report all the transactions done by them to the trade reporting system.

Development of derivatives market The derivatives market for hedging interest rate risk is not fully developed in India. Developing derivatives and swap markets is critical for broadening the investor base & increasing liquidity in both bond markets.

It is also crucial to funding massive infrastructure investment needs and providing tools to Indian banks to

Future of Indian debt market

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FINETUNE assess risks associated with India‘s financial globalization.

WHAT IS THE FUTURE AGENDA THEN? We need to ensure that the financial system can provide the finance needed for India‘s development, especially for infrastructure. We need to develop longterm debt markets and to deepen corporate bond markets. This also requires long pending reforms in insurance and pension sectors .We need to improve futures markets for better price discovery and regulation & remove institutional hurdles to facilitate better intermediation.

REFERENCES 1) Ministry of Finance, Govt. of India: http://finmin.nic.in/ the_ministry/dept_eco_affairs/capital_market_div/Recent% 20Developments.asp?pageid=1 2) Reserve Bank of India: http://finmin.nic.in/the_ministry/ dept_eco_affairs/capital_market_div/Recent%20Developments.asp? pageid=1 3)AsianBondsOnline: http://asianbondsonline.adb.org/ 4) SEB I: http://www.s ebi.gov.in/commreport/corpor ate_bond_market.html 5) International Finance Corporation http://www.ifc.org/ifcext/ publications.nsf/AttachmentsByTitle/ Builing_Local_Bonds_Chp.9/ $FILE/Building_Local_Bonds_Chp.9.pdf

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Future of Indian debt market

COMMENTS/FEEDBACK MAIL TO monetrix@mandevian.com http://mandevian.com/monetrix/ ALL RIGHTS RESERVED Monetrix, The Economics & Finance Club Management Development Institute Gurgaon