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Volume 2, Issue 5

October 17, 2011

Vinod gupta school of management, IIT KHARAGPUR THE EUROZONE CRISIS

About Fin-o-Menal Fin-o-Menal is the Fortnightly Financial News Letter of VGSoM which is published by Finte`est, the Finance Club. Come, Take Interest in Finte`est!

Editors Rahul Ravi Mouli Ghatak

The Euro zone, a 17 member ‗Monetary Union‘ of Europe is facing an acute debt crisis today. Enormous Government debts of several nations under their common currency Euro, has led to stock market plunges, utter panic and chances of Sovereign Governments defaulting. Such a sense of haplessness was last seen in the sub-prime crisis of 2008. A currency which was created to fight the dollar has now shown dependency on the same to survive this debacle. Ever since its inception, Euro zone members have been aware that a potential conflict is on the cards as monetary policies are set by the European Central Bank whereas fiscal policies are determined by the Sovereign Governments of the member nations. Today, the truth of the pudding is in the eating. WHAT LED TO THE CRISIS

Rates As On Oct 17th

48.95

67.44

77.16

7.68

Editors’ Note Look out for our first issue of “Mark2Market” magazine in November.

The Euro crisis originated partly as an outcome of the housing market collapse of the U.S and partly as a result of the fiscal policies of its member nations. The ‗Too Big To Fall‘ American banks are not yet in a mood to lend out money as the U.S Government has not yet made up for their losses which coupled with the subprime crisis has resulted in several European Banks being woefully undercapitalized as the dollar is still a stronger currency than the Euro. Poor fiscal policies of the so called ‗weaker‘

Euro zone members like Greece, Ireland and Portugal in particular has led to large bailouts of these sovereigns by the stronger economies like Germany and France. The fallacy of the ‗monetary union‘ lies in weak economies like Greece sharing a common currency with an economically strong nation like Germany. Some economists argue that politics had the better of economics in the 2001 decision to allow Greece to join the EU. Greece had allegedly given false figures to not only sell its bonds but also to get into the EU. It ran out of money to pay off its debts. The debt problem of Greece is compounded by the fact that a good part of the government debt is held by foreign institutions, particularly foreign banks. It is estimated that 106 billion Euro of government bonds may be held by foreign banks. The EU came up with money to lend it but the Greek fiscal management was disastrous. Competitiveness deteriorated and structural reforms were missing. The underlying rate of GDP growth, which was driven excessively by domestic activities, was not sustainable, and the fiscal problems escalated. Its debt to GDP ratio rose to 12.6% when EU rules stipulated 3% at most. The situation was not very different with most EU countries. Very recently Italy has raised serious concerns on the Global forums

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Volume 2, Issue 5

Markets This Week Index

BSE

NSE

Opening Value (Oct 3)

16151

4849

Closing Value (Oct 17)

17025

5118

Change

5.41%

+5.54%

(As on October 17, 2011)

Commodities This Week Commodity

`

Unit

GOLD

26740

10 gm

SILVER

53585

1 Kg

OIL

4250

Barrel

(As on October 17, 2011)

Sectors This Week Indices

Last close

BSE IT

5670

AUTO

8988

BANKEX

11075

BSE PSU

7408

METAL

11238

(As on October 17, 2011)

with a Government debt six times the amount of Greece. It so has happened that the Euro zone countries have lent out enormous sums to each other to pull fellow nations out of debt as illustrated in figure shown above. The fear is that if they don't help Greece out, other PIGS countries could default on their debt as well. The 2011 debt crisis now looks more likely to be a banking crisis with major European banks being severely undercapitalized. The stock prices of large European banks like Société Générale, Credit Agricole, and BNP Paribas have tumbled by as much as 50 percent in September. For the first time, the ECB has considered taking the help of other central banks like the Fed Reserve to pour dollars (not Euros) into the stumbling European banks, as dollar is still the stronger currency. In a crisis that called for fiscal and monetary stimulus, European Governments have raised taxes and strategized on monetary contraction which has neither driven growth nor reduced deficits. THE IMPENDING DANGER FOR ITALY The question on the minds of many is will Italy be next on the list? Italy's debt is even more colossal, standing at approximately 1,800 billion euro (Italy National Debt 115% of GDP), the fourth highest public debt in the world after the US, Japan and Germany and has been projected at 122.4% for next year. Importantly, Standard & Poor's (S&P) downgraded Italy's credit rating outlook from stable to negative (by one notch to ‗A‘) a few weeks ago (a move some describe as hitting the start button on the default stopwatch !). A Greek default, with the nation having a public debt of 330 billion euro, has already caused a lot of unrest in the international markets. With Italy's public debt being almost six times that of Greece, an Italian default, would be extremely difficult to address with a bailout plan and could possibly have catastrophic consequences on the world economy. Many have considered Germany‘s backing of Italy as the root cause to the crisis. Italian growth, 0.8 percent in the second quarter, is less than the Euro region average for the past decade. Italy‘s sovereign debt is rather being taken as a ‗toxic asset‘ in the panic driven market and no one is ready to buy their bonds which makes the largest bond-market in Europe. Mario Draghi, the head of the Bank of Italy said on Oct. 12 that Italy's austerity plan won't be sufficient. He believes that interest rates on the country's debt could rise and create ―a spiral that may end up being ungovernable.‖

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He promised constitutional and judicial reforms along with tax cuts to boost the economy. In all probability, the ECB needs to back Italy the way the Fed Reserve backs the U.S. WHAT‘S THE RESCUE PLAN? It‘s imperative that the affected banks recover and default of sovereign states is averted to avoid another global economic crisis. Many economists have considered bank recapitalization to be the way out and German political figures are pushing for nationalization of banks hit by the crisis instead of bailing them out. Policymakers backed by Germany are now considering a haircut of 50% for Greece instead of the original 21% figure which the French still want to go with. The knock-on impact on Irish or Portuguese debt is to be avoided and the European Banking Authority is proposing that Euro area banks raise their capital ratios to around 9% or 10% of their risk-weighted assets. Some economists have advocated retaining the Euro for all external payments, but issue non-convertible local currency which can be used for domestic financial transactions. This would sharply increase the government holdings of Euros, resulting in a scarcity of Euros in the private sector – hence devalue the local currency and boost competitiveness. Minting of money and escaping debt via inflation is difficult as the ECB would not approve of that. Raising taxes and cutting consumption hasn‘t benefitted and instead can lead to Keynes' paradox of thrift which is declining economic output and rising debt as a share of GDP. An option suggested is for Bondholders to exchange existing bonds for GDP linked bonds, which offer payouts pegged to future economic growth. In effect, these instruments turn creditors into shareholders in a country's economy, entitling them to a portion of its future profits while temporarily reducing its debt burden. Reducing bank bonds and converting those into equity would both avert a government takeover of banks and also prevent socialization of bank losses from causing a sovereign debt crisis. Most importantly economic and fiscal stimuli are necessary to bring growth into the Euro zone. It‘s imperative that Europe responds well to the debacle and the policymakers find out a plausible solution to the crisis as danger and uncertainty is looming at large over the global financial market. The recent ‗Occupy Wall Street Protest‘ represent growing public angst over government failure to take decisive stand on implementing tougher regulation on financial market. The world awaits a move which would thwart the chances of another global economic crisis. (Contributed by Sauvik Seal, MBA, 1st year)

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Did You Know? Goldman Sachs was founded in New York in 1869 by the German-born Marcus Goldman. In 1928,Goldman Sachs Trading Corp. launched a closed-end fund with characteristics similar to that of a Ponzi scheme. The fund failed as a result of the Stock Market Crash of 1929, hurting the firm‘s reputation for several years afterward.

International Markets this week

US Dow Jones

11644

Japan Nikkei 225

8879

London FTSE 100

5436

HongKong Hang Seng

18873

(As on October 17, 2011)

October 17, 2011

Islamic Equity Funds An equity fund is simply an investment vehicle that allows investors to take advantage of investing in a diversified group of stocks which manages risk and exposure to one or a few stocks. It also offers the opportunity to participate in the long-term performance of the stock market. The profits are mainly achieved through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also achieved by the dividends distributed by the relevant companies. Islamic Equity Funds (IEFs), however, add two other elements to these well-known stock market funds. They add a screening process to remove stocks of companies deemed to be inappropriate for Muslim investors. They also perform cleansing of a company‘s profits, a technique used to remove any income derived from non-Shariah compliant sources, such as interest a company would earn on its bank accounts. It is obvious that if the main business of a company is not lawful in terms of Shariah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business. Similarly the contemporary Shariah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with the Shariah (which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account), its shares can

be purchased, held and sold without any hindrance from the Shariah side. But evidently, such companies are very rare in the contemporary stock markets. Almost all the companies quoted in the stock market are in some way involved in an activity which violates the injunctions of Shariah. Even if the main business of a company is halal, its borrowings are based on interest. On the other hand, they keep their surplus money in an interest bearing account or purchase interest bearing bonds or securities. Subject to these conditions, the purchase and sale of shares is permissible in Shariah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in Shariah as partners "inter se." All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends‘ distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits are earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given to charity. Background and History Prior to the growth of equity funds, Muslim investors had little alternatives in which to invest their money. Much of what was available to them during the 1980s and early 1990s consisted of short -term saving deposits, murabaha accounts, and a limited number of local real estate funds. (Continued on page 4)

Quote Un-Quote "I'd rather be in the arena trying than not doing what I can to help," - General Electric Co. Chief Executive Jeff Immelt while urging empathy for the Occupy Wall Street protest.

Toon of the week

Q u i c k Q u o t e : " Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed‖ —- Mahatma Gandhi

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(Continued) The first known Islamic equity fund, ironically, did not emerge from the Gulf or even from the Middle East.It was the Amana Income Fund, established in June 1986 by members of the North American Islamic Trust (NAIT), an organization based in Indiana which oversees the funding of mosques in America among other things. The fund is still in existence today and has been one of the better performing Islamic funds. Saturna Capital Corp., a small asset management company based in Washington, manages the Amana Income Fund as well as the Amana Growth Fund. Other Early Islamic Funds are:  Dana Al-Aiman - Mara Unit Trust, Malaysia  Tabung Amanah Bakti - Tabung Amanah Bakti, Malaysia  Mendaki Growth Fund - Mendaki Holdings Pte. Ltd., Singapore  Pure Specialist Fund - Futuregrowth Unit Trust Mgmt., South Africa  Al Rajhi Local Share Fund - Al Rajhi Banking & Investment, Saudi Arabia  Al-Ahli US Trading Equity - National Commercial Bank, Saudi ArabiaFund How big is this market? The Islamic Equity Fund has grown from just $800 million in total assets in 1996 to over $6.3 billion in 2005. That‘s an annual growth rate of over 60 percent during the same period. The biggest boost to fund managers and the industry at large came when Dow Jones and FTSE launched their Islamic indices in 1999. By 2000, the industry reached its first peak. Currently, there are nearly 300 Islamic banks and financial financial institutions all over the world with assets‘ predicted to reach nearly $1 trillion by 2013. The Islamic Funds available today offer an increasingly wide range of investment styles and objectives. Many major U.S and European fund managers are active in the field, including AXA, Brown Brothers Herriman, Citibank, Deutsche

October 17, 2011

Bank, HSBC, Merrill Lynch, Permal, Pictet & Cie, UBS and Wellington Management. This rapid growth is expected to continue as new players enter the market and new products are developed. Advantages of Islamic Equity Funds These funds have obvious advantages to Muslims, who can invest their money safely in the knowledge that the fund will not compromise any of their religious beliefs. Many funds have been around for a long time and have a good track record of generating healthy returns for their investors.It can be argued that, over the long term, IEFs will tend to perform better than conventional funds, since the former avoid investing in heavily leveraged companies. Issues/Concerns regarding Islamic Equity Funds The restricted ability of IEFs to invest in certain market sectors limits opportunities and may increase the risk of losses during economic downturns.Since Islamic principles preclude the use of interest-paying instruments, the IEFs do not maximize current income because reserves remain in cash.Most of the funds target high net-worth individuals and corporate institutions, rather than the small investor. Minimum investments range from US$50,000 to as high as US$1 million. Recent Developments Putting Australia on the path to join the booming Islamic finance, a Muslim wealth manager is planning to establish the country‘s first Shariah-compliant equity fund. The Crescent Australian Equity Fund (CAEF) is aimed at allowing Australians to tap into the $1.4 billion Islamic investment market. It is believed that there is a lot of ―pent-up demand‖ for Islamic investment opportunities and the Shariah compliant fund will help to put Australia on the right path to get a share of the booming Islamic banking. (Contributed by Sohini Banerjee, MBA, 1st year)

Impact of Steve Jobs death ―Apple has lost a visionary and a creative genius, and the world has lost an amazing human being. Those of us who have been fortunate enough to know and work with Steve have lost a dear friend and an inspiring mentor. Steve leaves behind a company that only he could have built, and his spirit will forever be the foundation of Apple‖ says the Apple homepage after the founder, chairman and CEO of Apple died on Oct 5, 2011. Steve‘s brilliance, passion and energy were a source of many great innovations, but since he is no longer with us, let us try to figure out the impact of his death. The stock price of Apple has shown no negative trend upon his death. Apple Inc.‘s stock, listed in NASDAQ, has gone up by 14% since his death. Moreover, the latest release of the Apple iPhone 4S looks all set to create the best selling records ever for the company up till now. Skeptics say this is because of people feeling more sympathetic towards the brand and are therefore more inclined to buy Apple‘s product but there is much more to it. To analyze the impact on Apple we need to first identify the level of involvement that Jobs had in the creative process of Apple‘s

innovative products. It would be wise to believe that Jobs had a vision and concept which was converted into reality by Apple‘s engineering masterminds. These masterminds are still available to Apple. As far as the vision and concept is concerned, it could be assumed that, Jobs, being the visionary he was, has left blueprints for future products of Apple. In that case, Apple should not be held back by this loss. The Stock markets certainly have thought in this direction. The social media impact of Job‘s death has been tremendous. Social Networking sites like Facebook, Twitter etc. have been flooded with condolences for Jobs. Celebrities, politicians, sports personalities and ordinary people across the country turned to these to mourn the death of Steve Jobs. Others praised and thanked Jobs for introducing the iconic iPhone, iPod, iPad and other devices that changed the daily habits of millions across the globe. This social media effect is expected to push Apple‘s products even further. (Contributed by Pallav Maheshwari, MBA, 2nd year)

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Come, Take Interest in Finte`est! Fin-o-Menal is the Fortnightly Financial News Letter of VGSoM which is published by Finte`est, the Finance...