SOFIA TIMES NOVEMBER 2019 EDITION
CAN REPO RATE IMPROVE THE CONSUMER SENTIMENTS ?
GOVERNMENTâ€™S BIG MOVE : THE CORPORATE TAX RATE CUT
INTEREST RATE AND INFLATION
IS THIS THE RIGHT TIME TO INVEST IN SMALL AND MID-CAPS?
FINANCIAL MARKETS AND ITS CLASSIFICATION
C O N T E N T S
FROM EDITORIAL'S DESK RAGHAV WADHWA
CAN REPO RATE IMPROVE THE CONSUMER SENTIMENTS ?
GOVERNMENTâ€™S BIG MOVE : THE CORPORATE TAX RATE CUT RUSHABH SHAH
INTEREST RATE AND INFLATION SAKSHI AJMERA
IS THIS THE RIGHT TIME TO INVEST IN SMALL AND MID-CAPS? AKSHAY ARORA
FINANCIAL MARKETS AND ITS CLASSIFICATION GURUBHAI- POST EVENT WRITE-UP
From Editor’s Desk Editors- Akshay, Nikita Senior Editors- Pragyan, Nikita Hello fellow readers, The campus is buzzing around with the placements season on top and everyone getting all prepped up. It’s definitely a good time to brush up your basics (or the definite ones) while as well know what is going around the business world. This edition as usual covers some of the buzzing topics of the market whereas at the same time having the very basics of the finance and its applications in the day to day life covered. The article “Government’s Big Move: The Corporate Tax Rate Cut” elucidates the various aspects of the announcement while at the same time describing the picture at parlance. For the enthusiasts wanting to know about all the buzz that is being created by Inflation and its impact on the economy in general, don’t worry, we have an article covering the same – “Interest Rate and Inflation” stating the facts and reasoning for the same. We also have an article “Is this the right time to invest in small and mid-caps?” to take up all the doubts about the frequently heard about term in the news which we hardly understand its implication and importance while investing or knowing about the share market. Over to the next article we have tried to explain the very basic of the financial market in India- “Financial Markets and its classification” which fairly explains in simple terms about the whole structured and unstructured market. The Indian Economy is currently in doldrums, Diwali has just ended, consumption is still in slump. The Repo Rate has been changed, so we have an article “Can Repo Rate improve the consumer sentiments?” which enumerates the sentiments of the public and how is it going to affect the same. While covering the topics around the world in the Sofia Times, we have not left the occasion of starting our blog for finance snippets bi-monthly. SOFIA is a firm believer of imparting finance knowledge with fun. So, we have also come to an end to our most awaited event “GURUBHAI2019” a commodity floor trading event where 40 teams participated. The game introduces young would be traders to the world of commodity markets by letting them get hands-on experience trading volatile commodities like gold and crude oil. Finance is not all about credit and debit, it’s more about drawing inferences of credit and debit. Driven by Society of Finance, this edition is not only for finance enthusiasts, but also for the people who would like to draw inferences. As usual we hope that this edition will enrich your knowledge benefit in your academic and career decision. Happy Reading!
1. Can Repo Rate Improve the Consumer Sentiments? Reserve Bank of India (RBI), the central bank, was established as an autonomous body in the year 1935. As per the preamble of RBI, the bank is basically entrusted to regulate the issue of bank notes, securing the monetary stability in India and modernizing the monetary policy framework to meet the economic challenges. To carry out these functions the bank acts as an observer of the economy and on the basis of its observations it decides the further course of action. In regards to course of action the bank issues monetary as well as fiscal policies and uses them to control the credit supply in the country. Nowadays, the Indian economy is witnessing a phase where consumers are reluctant to spend as evidenced by reduced number of cars sold, downward trend in realty sector, reduction in the exports since Q4FY19 and so on. The Q4FY19 impacted the overall GDP growth percentage and RBI also reduced the expected numbers from 7.2% to 7% whereas the actual number were 6.8% which was even below what was expected. In such a situation the RBI tries to improve the consumer sentiments by making changes to the abovementioned policies. Recently, as part of its monetary policy, the central bank slashed the repo rate for the fifth consecutive time in the calendar year and maintained the accommodative stance. To know the impact of this move we should first get the basic understanding about the repo rate. The word repo is the short form for repurchase rate which means the rate at which the central bank provides loan to the commercial banks. In other words, whenever a commercial bank requires money it can borrow the same from RBI and the interest rate charged by the lender, RBI, is known as repo-rate. It acts as a measure for the apex bank to control the flow of credit in the country in a way that if RBI raises the rate it means that banks will get the loan at a higher interest, thus, increasing the cost of borrowing. therefore, at a higher rate the borrowings become a non-favorable option which leads to restrict the flow of money from the banks into the economy, hence, helping in arresting inflation and vice-versa. The repo-rate for the Q4FY19 stood at 6.25% which was reduced to 5.15% in the month of Oct FY20, the lowest since March 2010 (Bhuva, 2019). This amounted to an overall decline of 135 bps since Febâ€™19. As per the central bank notification, such decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2% while 2|Page
supporting growth (timesofindia.com, 2019) This is a sweetener for all those who were willing to borrow sometime in future as the RBI mandated for the commercial banks to link all the new floating loans with one of the external benchmarks specified by RBI. Earlier, the banks use to transfer less of the benefit w.r.t the reduced interest rates to the ultimate borrower as was seen during the period of January 2015 to August 2017 where RBI slashed the repo-rate from 8% to 6% amounting to reduction of 200 bps whereas the bankers trimmed their base rates by 75-100 bps, effectively passing on only 50% - 60% of the cut to borrowers, thus, enjoying higher margins. But, at the consumer spending is continuously showing a downward trend the move like linking of floating loans with the external benchmarks will bring joy for for the borrowers. This move is likely to reduce the EMI’s of the borrowers and make it cheaper to take new loans. In this way the RBI is trying to change the consumer sentiments, thus, making an effort to revive the Indian economy. After the abovementioned RBI mandate, several banks including State Bank of India, have launched such home loan products where the interest rates are linked with the repo rate. Such developments can prompt the new buyers to invest in real estate and the existing home loan customers who are still linked with MCLR can also see their interest rates reducing. This can also create a spark in the realty sector which is currently struggling with low sales volume and high inventory (Mishra, 2019). But, not everyone have an optimistic view in regard to the rate cut decision of RBI, in accordance with the Nomura economists, Sonal Verma and Aurodeep Nandi, “considering the weaker-thanexpected growth outlook, we believe a front-load policy action would have been the right approach, as it would have enabled banks to sharply lower their lending rates ahead of the upcoming festive season” (Bhuva, 2019). Similar was the case in regards to the expectation of further action taken by RBI where Mahendra Jajoo-Head Fixed Income, Mirae Asset Global Investments expected the rates to be reduced further in the forthcoming policy reviews whereas Aditi Nayar, Principal Economist, ICRA Ratings was of the view that it was a strong signal of no further rate cuts are off the table (financialexpress.com, 2019). Therefore, getting the mixed 3|Page
reviews as to what is stored for the economy in the further policy review meet. As it is quite evident from the decisions taken by RBI that they are trying their level best to improve the present state of the Indian economy we can just hope that they succeed in their objective at the earliest. References: Bhuva, R. (2019, Oct 4). fortuneindia.com. Retrieved from https://www.fortuneindia.com/macro/rbi-slashes-repo-rate-by-25-bps-to-515/103626 financialexpress.com. (2019, Oct 4). Retrieved from https://www.financialexpress.com/economy/rbi-monetary-policy-live-another-repo-ratecut-on-cards-these-factors-to-weigh-on-mpcs-mind/1726274/?#liveblogstart Mishra, S. (2019, Oct 4). www.proptiger.com. Retrieved from https://www.proptiger.com/guide/post/with-no-change-in-rates-rbi-leavesdemonetisation-hit-real-estate-developers-disappointed timesofindia.com. (2019). https://tradingeconomics.com/india/interest-rate https://www.proptiger.com/guide/post/with-no-change-in-rates-rbi-leaves-demonetisation-hitreal-estate-developers-disappointed
Article submitted by- Raghav Wadhwa (PGP-1)
2. Government’s Big move: The Corporate Tax Rate Cut In his very first Budget 2015-16, Lt Mr Arun Jaitley made a promise of eliminating most tax incentives and putting in place a flat 25 % tax rate to improve the investment climate of the country. This promise was finally fulfilled by our current finance minister, Ms Nirmala Sitharman in her first Budget of 2019-20, when she reduced the corporate tax for domestic companies from 30 % to 22% (effective tax rate from 34.47% to 25.17 %). At 34.47 %, India’s combined effective tax rate was among the highest globally and the key industry bodies had urged the Indian Government to reduce the corporate tax rate especially post ‘Tax Cuts and Jobs Act of 2017’ of US. This US tax reform envisaged a complete exemption in respect of dividends declared by foreign subsidiaries of the US companies and is expected to boost investment and consumption. The India Inc. felt that a similar approach should also be followed by our country.
But will the tax cut really help improve the consumption/demand in our country and reverse the currently ongoing economic slowdown? This looks more like the government’s decision to boost the supply side of the economy instead of demand. As per the Rating agency Fitch, the fiscal impact will be felt much earlier than the growth impact of the decision and the fiscal deficit is likely to increase by 40 basis points (bps) over the budget estimate of 3.3% of gross domestic product (GDP) for 2019-20. Also, unless the demand improves, companies may opt for using tax savings for improving their balance sheets rather than expansion. Since the capacity utilization across many sectors in India is still below optimum levels, companies are unlikely to invest immediately in expansions or reduce prices and hence the benefits will not be passed on to the consumers. The tax cut is likely to boost corporate profits, lead to high foreign inflows into equities and outflows from the debt segment. However, demand conditions are unlikely to see a significant pick-up anytime soon as the income and employment scenario remains grim. Infact, the current rate cut is more likely to impact the distribution of income and increase inequality as the companies will now get a larger share of profits from existing investments, while 5|Page
the economy remains on the downside. Plus, there are better ways to bring prices down- for example, a cut in the Goods and Services Tax (GST). The Corporate investment is currently being withheld because they do not expect any increase in consumption demand. If nobody is going to buy, why produce? Therefore, in the short run, the proposed tax rate would also cause a substantial revenue loss to the government hurting for revenues. If the aggregate demand does not budge, the revenue loss is estimated to be very substantial- Rs. 1.45 trillion and the government has set a fiscal deficit target of 3.3 percent of GDP for 2019-20. Lower tax revenues could upset the fiscal math. The government may fund part of the revenue foregone because of corporate tax cuts through the additional transfer of dividends and surplus from the Reserve Bank of India (RBI). Despite all the negative points, the tax cut is also likely to give us a few benefits in the long run. Nations compete with each other to attract foreign investment and the corporate tax rate is certainly one aspect of this competition. For new manufacturing companies the tax has been slashed even lower at 17.01%. This would provide a great boost for the Make in India Programme for attracting foreign investment. Also, the timing of the cut has been right as the US companies are caught in a war with China and are looking at alternative global manufacturing basis. Therefore, letâ€™s see in which direction this corporate tax takes the economy.
References: https://www.ideasforindia.in/topics/macroeconomics/should-we-do-about-the-indian-economyawide-angled-perspective-iii.html https://qz.com/india/1713944/nirmala-sitharamans-corporate-tax-cut-wont-help-indian-economy/ https://www.livemint.com/politics/policy/india-s-fiscal-deficit-may-shoot-up-to-3-7-in-fy20fitch-ratings-1569489629214.html
Article submitted by: Nikita Mehra (PGP-1)
3. Interest rate and inflation This article is intended to highlight, in the most layman terms, how different factors affecting the Indian economy interact with each other and how RBI controls these factors to regulate growth. Interest rates, inflation and currency prices are three significant factors that have a direct impact on the Indian economy. Interest rates come under the direct control of RBI. It controls the flow of credit in the economy. When RBI increases the interest rate, people tend to curtail their consumption to a future date so as to invest their money at a high rate now. This leads to a drop in current consumption. A dropin interest rate is done to promote consumption. At lower interest rates, people borrow more and the incentive to save reduces. This encourages investment and motivates spending. The five successive repo rate cuts by RBI between February 2019 and present, were aimed to promote consumption and thereby boost the sluggish GDP growth rate.
Inflation refers to a general rise in the prices of goods and services in the economy. It determines the purchasing power of people. In general, an increase in inflation leads to a reduction in purchasing power as goods become more expensive. However, it is important of acknowledge that inflation is not bad for the economy. A moderate level of inflation is needed for economic growth. Increased prices motivate producers to produce more in order to earn higher profits. The higher level of spending in turn boosts the GDP. The Oil and Gas sector contributes about 15% to India's GDP. India imports more than 80% of its crude oil requirement. This leads to more Indian currency being sold to purchase the foreign currency in which payments have to be made. The excess supply of Indian currency in the foreign exchange market leads to a fall in the value of Rupee. Exports lead to an increase in the value of Rupee on the same grounds. 7|Page
RBI uses different monetary instruments to regulate currency prices and inflation. An increase in interest rates make the Indian market attractive to foreign investors. This increases the demand for Rupee which leads to an increase in Rupee value. The same increase in interest rate also leads to a fall in domestic consumption which may have to be compensated by a decrease in the dose of inflation to promote consumption. This is how RBI uses different tools to influence various factors affecting the Indian economy.
Article submitted by- Rushabh Shah (PGP-1)
4. Is this the right time to invest in Small and MidCaps? Which stocks should one start with, large and known companies or smaller companies? Why to invest in a Large- Cap Company? Cons: Because of their broad ownership, shares may become costly. A large number of investors, including the institutional investors, own well known large companies that push demand for their shares. As a result, prices are rising. Most investors hold long-term stakes in large companies, holding demand and, thus, share prices move-up. Pros: The large companies have the potential to provide revenues to investors by way of dividend, which if reinvested by investors would lead to a compounding effect on the overall return. Moreover, large companies have stability, because of which, large cap stocks are at peak business cycle phases, generating established and stable earnings. Not only this, large companies are widely owned plus easy to track. As India is developing, many large companies are growing fast too. This means positive returns over a period of time. Stocks of large companies are also easy to sell due to greater market capitalization.
Why to invest in Small-Cap companies? Cons: Prices are unpredictable as fewer shares are available in the market. Also, a small number of buyers are making it difficult to utilize full potential in the market, thus, the share prices are falling rapidly. And when this happens, people look for safety and tend to avoid smaller companies. In the event of an economic or business downturn, many small-cap companies find it difficult to survive among their competent counterparts, and as a result, the worth of investments in small-
cap funds are rapidly falling. Therefore, one might suggest that they are not a suitable investment for risk-averse investors. Pros: Smaller companies are more agile, light capital structure and high growth potential because of their low base. For example, itâ€™s easier for a company to introduce additional capital from small capital than already having a huge capital in the company, i.e., itâ€™s easy to increase size from Rs.5 crore than for a company to double its size from Rs.1000 crore. There are ample investing opportunities for small cap stocks that is appealing from the perspective of diversification. Moreover, due to bearish market of small cap stocks, investors have an opportunity to go in, buy undervalued stocks and profit from potential valuation expansion later on. Concluding, this can be a good time to invest in small and mid-caps. From here the cycle is towards an uptrend. Prices of these companies are at their base and as an investor, what could be better if you buy them at a base price and make profits at their appreciation. Market is cyclic in nature, what is happening now is bound to recur. For those investors who donâ€™t have a backup in place by structured products in their portfolio, to the scope of 30-40% of their portfolios, this is the time to re-examine it. Structured portfolios are the perfect antidote to these markets. Thus, this can be the perfect time to invest in small cap stocks and seize the advantages underlying it.
Article submitted by- Sakshi Ajmera (PGP-1)
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5. Financial Markets and its Classification: Financial Markets are markets that facilitate the process of buying and selling of financial securities such as bonds, derivatives, equities etc. The financial markets are classified into two major categories: 1. Organized Markets 2. Unorganised Markets
1. Organized Markets: The organized markets consist of standard rules and regulations to be followed which are set by the governing body of the exchange. The financial organizations which follow these rules and regulations of apex institutions while dealing with their financial functions belong to the organized financial market. Hence there is a high degree of institutionalization. The organized markets are further classified into Capital Market and Money Market. I.
Capital Market: Capital Market is a market for financial assets having a maturity period of more than one year or an indefinite maturity period. The capital market deals with any long-term securities which have a maturity period of more than one year. Capital Market is further sub-classified into three broad categories: 11 | P a g e
a. Industrial Securities Market: This type of market is used for industrial securities. It consists of industrial instruments like Equity shares, preference shares, bonds, and debentures. It is further sub-divided into two markets â€“ Primary Market and Secondary Market i.
Primary Market: The primary market also called the New Issue Market, is where issuers raise capital by issuing securities to investors for the first time. Primary market facilitates capital formation as the borrowers in the primary market exchange new financial securities for long-term funds. There are three ways in which a company can raise capital in a Primary Market. Public Issue: This is most common when new companies sell their securities for the first time to raise capital. Right Issue: When a company wants to raise more capital, it first issues its securities to its current shareholder. Private Placement: When a company sells its securities privately to a small selected group of investors
Secondary Market: The secondary market, also is known as Stock Exchange, is a market for securities which were previously issued in the primary market. It facilitates the buying and selling of secondary securities. These securities are already listed on Stock Exchange Trades. b. Government Securities Market: It is a market where financial securities are issued by Government and Semi-Government bodies with a promise of repayment upon maturity, also called as government securities.
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The important feature of the Government Securities is that they are considered to be totally secured financial instruments. c. Long-term loans Market: Development banks and commercial banks comprise the long-term loans market wherein they provide long-term loans to the corporates. The debt is usually paid off over the time period that exceeds one year.
These are further divided into three categories: i.
Term Loan Market: A term loan is a monetary loan that is taken from a bank for a specified amount with a fixed or floating interest rate and is repaid in regular payment over a period of time.
A Market for Mortgages: These markets provide loans mainly to individual customers against a collateral. If the individual fails to repay the specified installment, the lender can seize the mortgage to recover its loss.
A Market for Financial Guarantees: This is a market where financial securities are provided with the guarantee of a reputed person.
Money Market: Money Market is a market for financial assets having a maturity period of less than one year or a definite maturity period. The money market deals with any short-term securities which have a maturity period of less than one year. Money Market is further sub-classified into four broad categories: a. Call Money Market: This is a market for short-term loans having a duration of 1-14 days. The most important feature of this market is that it is highly liquid in nature. This type of loan must be repaid on demand i.e. it does not have to follow a fixed repayment schedule, nor does the lender have to provide any notice of repayment. b. Commercial Bill Market: 13 | P a g e
A Commercial bill is one which is a result of a genuine trade transaction, i.e. credit transaction. A commercial bill of exchange contains a written order from the creditor to the debtor, to pay a particular sum, to a particular person, after a specified amount of time period. The maturity period of the bill may vary from three to six months. Examples of these are Demand and usance bills, Inland and foreign bills, Clean and documentary bills, Indigenous Bills and Accommodation and Supply Bills. c. Treasury Bill Market: This is a market for treasury bills. Treasury bill is a promissory note that is issued by the government. These are zero-coupon securities with an additional feature of no interest payment. d. Short-term loan Market: This is a market where short-term loans are provided to corporate customers. These loans are mainly used to finance the working capital requirements of the firm.
2. UNORGANIZED MARKET: In these markets, many lenders and indigenous bankers, who do not follow any rules and regulations, lend money to the public. These lenders and bankers do not fall under the supervision of any specific apex institute. Many private financial institutions do not fall under the control of the RBI. Such institutions comprise of the unorganized financial markets. Article submitted by- Akshay Arora (BDA-1)
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GURUBHAI- A Recap After a tough battle of negotiation, we are finally out with the results of Gurubhai 2019, our commodity floor trading competition. The game introduces young would-be traders to the world of commodity markets by letting them get hands-on experience trading volatile commodities like gold and oil. The winners for this year are; Team Optimix from PGP1 (Lohith Kumar, Shubham Ahuja, Shinjan Bhattacharya)
and not too far behind are the runners upTeam Igniters from PGP1 (Aditya Mehra, Aman Goyal, Umesh Jhawar).
We thank all our participants for their unending zeal and enthusiasm. We hope all of you had as much fun participating as much as we had organizing it. We would also like to thank our sponsors who made this event happen â€“ Amigoâ€™s Pizza, Ch se Chatpatta & Ice Cream Lab and JK Restaurants.
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