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Investocraft Annual EditionTRANSCRIPT
INVESTOCRAFT 2013
INVESTOCRAFT 2013
INVESTOCRAFT 2013
2012 was a good year for the equity markets after a lacklustre
performance in 2011. The issues that mired the markets in 2012
were homemade issues unlike in 2011 which was mired by
Sovereign Debt Crisis in the Developed Countries. The government
moved from the state of “Policy Paralysis” to a state of “Policy
Impotence” and stayed in the same state for most part of the year.
By last quarter of 2012, the government woke up from the long
slumber. There was some action on the policy front such as allowing
FDI in sector such as Retail and Insurance. With the elections
approaching in 2014, the compulsions of keep the Growth story
alive and kicking would be key driver to keep the reform process on
and to be active in the policy front. Even in these times, states with
good policies and encouraging governments such as Gujarat have
been able to receive huge investments.
The benchmarks returned more than 20 percent in the year 2012.
The bond markets and flow of foreign funds indicate that equities
could be headed for newer peaks in 2013 and a few years to come.
The rate sensitive sectors such as Banks, Real Estate and
Infrastructure could be the next big movers in the markets. However,
the risks on account of effects of fiscal cliff and rating downgrade
still exist.
Other than equities, another asset class that is expected to witness
good action would be the Real Estate Sector. The primary driver for
the sector would be the faster GDP growth and softening interest
rates. The sector has grown significantly in the last decade, but the
growth in the next few years would be sustainable one with
structural changes. There are significant policy reforms that are in
pipeline such as the Real Estate Regulation Bill and Land Acquisition
and Rehabilitation and Resettlement Bill. The Low Cost Housing is
also expected to get a boost, with the Reserve Bank of India (RBI)
allowing the real estate developers and housing finance companies
to raise upto $1 Billion through external commercial borrowing
(ECBs) for this purpose.
The 10-year bonds in India are yielding less than 8% for the first time
in close to two years. Little effort from the government has brought a
lot of confidence in the markets. State Bank of India CDS spread on
its five-year bonds, which acts as a proxy of Indian sovereign bonds
SENIOR EDITORIAL
BOARD
MADUSUDANAN RAMANI (Editor-in-Chief)
ANKIT JOHRI
HARISH SV
PRIYA CHHABRIA
SNEHA AGARWAL
SIDDHANT ANTHONY
JOHANNES (Layout &
Design)
Letter from the Editor
INVESTOCRAFT 2013
among foreign investors, has fallen from close to 400 basis points on June 1st 2012 to
close to 200 basis points by end of the year. With foreign investors perceiving lower
default risk, it would be easier for corporates and the government to raise debt.
The year of 2013 promises to be year of Structural Reforms that would provide us with a
good financial system for the Indian Growth Story to sustain for years to come.
The magazine brings along a set of articles that provide in-depth analysis of the issue
that the capital markets are facing and some potential solutions to them. We would like
to thank our readers and contributors for their constant support, wonderful articles and
critical appreciation. It is this amazing response and encouragement that encourages us
to improve.
Kindly send in your suggestions and feedback to [email protected].
Investocraft Editorial Team
Team Investocraft
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JUNIOR EDITORIAL BOARD
Deepesh Ganwani
Khushboo Shah
Pratik Jain
Ravi Srikant
Tanvi Mittal
Tejaswi Kns
Chakshu Aggarwal
Apeksha Shah
(LAYOUT & DESIGN)
INVESTOCRAFT 2013
Index
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Long Term Corporate Debt Market in India
Rajeswari Sengupta, Assistant Professor, IFMR & Vaibhav Anand, IFMR Capital
Why do we need a Long Term Debt Market?
At the current time, when India is endeavoring to sustain its high growth rate, it is
imperative that financing constraints in any form be removed and alternative financing
channels be developed in a systematic manner for supplementing traditional bank credit.
In this context, the development of long-term debt markets – corporate debt and
municipal debt – is critical in the mobilization of the huge magnitude of funding required
to finance potential business expansion and infrastructure development.
Before we discuss the evolution and current state of the Indian corporate debt market, it
may be useful to discuss the rationale and need for long-term debt markets, in general
as well as in context of the Indian economy.
The critical role played by long-term debt markets in supporting economic development,
especially in emerging economies are listed below.
Ensuring financial system stability
A liquid corporate bond market can play a critical role because it supplements the
banking system to meet the requirements of the corporate sector for long-term
capital investment and asset creation. Banking systems cannot be the sole source of
long-term investment capital without making an economy vulnerable to external
shocks. Historical and cross-sectional experience has shown that systemic problems
in the banking sector can interrupt the flow of funds from savers to investors for a
dangerously long period of time.
Indeed, one of the lessons from the 1997 Asian financial crisis has been the
importance of having non-bank funding channels open. In the aftermath of this crisis,
a number of countries in the region, including Korea, Malaysia, Singapore and Hong
Kong, have made progress in building their own corporate debt markets. Spreading
credit risk from banks balance sheets more broadly through the financial system
would lower the risks to financial stability. Bond financing reduces macroeconomic
vulnerability to shocks and systemic risk through diversification of credit and
investment risk.
Enabling meaningful coverage of real sector needs
The financial sector in India is much too small to cater to the needs of the real
economy. A comparison of the asset size of the top ten corporates and that of the top
ten banks (as shown in Figure 1 below) reveals that banks in India are unable to
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meet the scale or sophistication of the needs of corporate India. Needless to say, the
financial system is not big enough to meet the needs of small and medium-sized
enterprises either. While these are pointers to the fact that the banking sector in
India needs to be larger than its current size, they are also clear indicators that debt
markets need to grow manifold to ensure that the financial sector becomes adequate
for an economy as large and as ambitious as India’s.
Figure 1 - Comparison of the Asset Size of the top ten corporates and exposure limits of
the top ten banks above reveals the disparity in credit demand and supply
Panel A: Assets of top 10 corporates (2011) Panel B: Capital funds and exposure
limits of top 10 banks (2011)
Creating new classes of investors
Commercial banks face asset-liability mismatch issues in providing longer-maturity
credit. Development of a corporate debt market will enable participation from
institutions that have the capacity as well as aptitude for longer maturity exposures.
Financial institutions like insurance companies and provident funds have long-term
liabilities and do not have access to adequate high quality long-term assets to match
them. Creation of a deep corporate bond market can enable them to invest in long-
term corporate debt, thus serving the twin goals of diversifying corporate risk across
the financial sector and enabling these institutions to access high quality long-term
assets. Thus, access to long-term debt opens up the market to new classes of
investors with an appetite for longer maturity assets and thereby helps prevent
maturity mismatches.
Reduced currency mismatches
The development of local currency bond markets has been seen as a way to avoid
crisis, not only by supplementing bank credit but also because these markets help
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reduce potential currency mismatches in the financial system. Currency mismatches
can be avoided by issuing local currency bonds.
Thus, well-developed and liquid bond markets can help firms reduce their overall cost
of capital by allowing them to tailor their asset and liability profiles to reduce the risk
of both maturity and currency mismatches.
Term structure and effective transmission of monetary policy
The creation of long-term debt markets will also enable the generation of market
interest rates at the long end of the yield curve – thus facilitating the development of
a more complete term structure of interest rates. A deeper, more responsive interest
rate market would in turn provide the central bank with a mechanism for effective
transmission of monetary policy.
Indian Corporate Debt Market : Current Status
India has been distinctly lagging behind other emerging economies in developing its long-
term debt market (LTDM), be it corporate or municipal bonds. The equity market has
been more active, developed and at the centre of media and investor attention.
Traditionally, larger corporates have used bank finance, equity markets and external
borrowings to finance their needs. Small and medium enterprises face significant
challenges in raising funds for growth.
Comparison with other countries
In India, the proportion of
bank loans to GDP is
approximately 36%, while
that of corporate debt to
GDP is only 4% or so. In
contrast, corporate bond
outstanding is 70% of GDP
in USA, 147% in Germany,
41% in Japan, & 49% in
South Korea. The size of the
Indian corporate debt
market is very small in
comparison to both
developed markets, as well as some of the major emerging market economies. For a
sample of eight Indian corporates that featured in Forbes 2000, corporate bonds
account for only 21% of total long term financing. In contrast, corporate bonds account
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for nearly 80% of total long term debt financing by corporates in the four developed
economies of USA, Germany, Japan and South Korea. In these countries, the share of
corporate bonds is close to 87% for corporates graded above BBB and 66% for the rest.
Corresponding figures in major emerging economies such as South Africa, Brazil, China
and Singapore, are 57% and 33% for corporates rated above BBB and those rated at
BBB or below respectively.
Drawing on the cross sectional experience of G7 countries since the 1970s, it is
estimated that the overall capitalization of the Indian debt market (including public-
sector debt) could grow nearly four-fold over the next decade. This would bring it from
roughly USD 400 billion, or around 45% of GDP, in 2006, to USD 1.5 trillion, or about
55% of GDP, by 2016. This growth, if not crowded out by public sector debt, could result
in increased access to debt markets for Indian corporates.
Comparison with the G-Sec Market and Equity Market
In India the long-term debt market largely consists of government securities. The market
for corporate debt papers in India primarily trades in short term instruments such as
commercial papers and certificate of deposits issued by Banks and long term
instruments such as debentures, bonds, zero coupon bonds, step up bonds etc. In 2011,
the outstanding issue size of Government securities (Central and State) was close to Rs.
29 lakh crores (USD 644.31 billion) with a secondary market turnover of around Rs. 53
lakh crores (USD 1.18 trillion). In contrast, the outstanding issue size of corporate bonds
was close to Rs. 9 lakh crores
(USD 200 billion). Moreover, the
turnover in corporate debt in 2011
was roughly Rs. 6 lakh crores (USD
133 billion) whereas in 2011, the
Indian equity market turnover was
roughly Rs. 47 lakh crores (USD
1.04 trillion).
Some challenges in the Indian market
The total corporate bond issuance in India is highly fragmented because bulk of the debt
raised is through private placements. Small and medium-size enterprises are unable to
access the debt markets. Furthermore, trading is concentrated in a few securities, with
the top five to ten traded issues accounting for the bulk of total turnover. The secondary
market is also minuscule, accounting for only 0.03% of the total trading.
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Development of the
domestic corporate
debt market in India is
constrained by a
number of factors viz:
low issuance leading to
illiquidity in the
secondary market,
narrow investor base,
high costs of issuance,
lack of transparency in
trades and so on. The
market suffers from
deficiencies in products, participants and institutional framework.
All this is despite the fact that India is fairly well placed insofar as pre-requisites for the
development of the corporate debt market are concerned. There is a reasonably well-
developed government securities market, which generally precedes the development of
the market for corporate debt securities. Another emerging economy, South Africa for
instance, witnessed nearly a decade long public sector debt market reform before the
market for corporate debt securities began to develop. The major stock exchanges in
India have trading platforms for transactions in debt securities. Infrastructure also exists
for clearing and settlement in the form of the Clearing Corporation of India Limited (CCIL).
Finally, the presence of multiple rating agencies meets the requirement of an
assessment framework for bond quality.
Indian Corporate Debt Markets – The Supply-Side Issues
The peculiar issue with the Indian corporate debt market is not that it faces challenges
due to a lack of adequate infrastructure. In fact, India is fairly well-placed insofar as the
pre-requisites for the development of a corporate debt market are concerned. In spite of
this, Indian corporate debt markets are yet to witness the level of activity that an
organized financial market should. Some of the issues are structural and a few are
regulatory road-blocks. These issues have been categorized into supply-side, demand-
side, secondary-market issues and risk & hedging related issues.
The total corporate bond issuance in India is highly fragmented because bulk of debt
raised is through private placements. The private placement route requires that the
issuer makes an offer to select a group of investors, no more than 50, to invest in the
debt securities for issue. However, corporates are known to circumvent the 49 investor
cap in private issuances by making multiple bond issuances for many groups of 49
investors or satisfying the greater demand through immediate secondary market
transfers upon the completion of the primary issue, thus diffusing the issue among a
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greater number of subscribers. Therefore there is a clear need to remove impediments
that hinder the development of the institutional side of the market.
The dominance of private placements has been attributed to several factors, including
ease of issuance, cost efficiency and primarily institutional demand. Furthermore, trading
is concentrated in few securities, with the top five to ten traded issues accounting for
bulk of the total turnover. The SEBI Issue and Listing of Debt Securities Regulations
2008, in Ch III, Sec 20 lays out conditions for private placement which include, requiring
compliance with The Companies Act of 1956, obtaining credit rating, listing of securities,
mandating disclosure standards as per Sec 21 that stipulates the documentation and
disclosure requirements (detailed in Schedule I of the Regulations ).
The private placement disclosure and documentation requirements are viewed by the
market to be comprehensive yet not being too onerous in terms of compliance. On the
other hand, the disclosure and documentation requirements for public placement of
securities are viewed by the market as being extremely onerous and difficult to comply
with. In addition to the Schedule I requirements for private placements, public
placements also have to comply with additional disclosure requirements , as specified in
Schedule II of The Companies Act of 1956. These are an exhaustive set of disclosures in
three parts. The first part contains general information, capital structure information,
terms and issue particulars, information on company, management and project as well
as information on all companies under the same management, and finally management
perception of risk factors. The second part contains additional general, financial,
statutory and other informational disclosures.
With such an extensive set of disclosure requirements for public issues, it seems to us
that the market has been avoiding this route for issuing bonds. For instance, The Patil
Committee Report lays out the following statistic that highlights corporates’ preference
for the private placement route as against the public:
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The figures above are consistent with findings of the Patil Committee.
Analysis of the Private Placement Market
Table 2 above indicates that over the years, number of issuances by the private sector
has been much more than that of the public sector. However, the volumes of the private
sector have been lower than public sector. This indicates that the average size of issue
by private sector corporations has been close to INR 1 billion as against the larger size of
public sector issuances amounting to INR 4 to 5.5 billion over the years. As shown in
Table 2, resources mobilised through private placements in private sector spiked in
2009-10 but came down in 2010-11. There was close to 120% hike in issues placed
during 2009-10 by the private sector. Comparatively, public sector issues increased
marginally by around 1% during the same period. What is also evident from Table 2, is
the tremendous cost differential, with public issuances on average seven times as
expensive as private issuances. This could have further driven market participants to
favour the private route.
Analysis of issues and volumes of private placements by financial and non-financial
corporates reveals that the financial corporates dominate. However, in terms of growth,
volumes placed by financial institutions grew by 71% while the same by non-financial
institutions grew by 62% from 2008-09 to 2009-10.
The pie chart below corroborates the finding that financial institutions have dominated
the number and volume of issues over the years.
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In the winter of 2005, the High Powered Expert Committee (HPEC) on Corporate Bonds &
Securitisation led by Dr. R.H. Patil made a variety of recommendations to address the
prevailing issues in the corporate bond market. The recommendations were spread
across three broad areas – (i) Primary Market, (ii) Secondary Market and (iii)
Securitisation. One of the primary recommendations to address supply-side issues was
enhancement of the issuer base.
The Patil Committee recommended that in order to reduce the time and cost of public
issuance, the disclosure norms and listing requirements be reduced. The Committee also
recommended that in the case of issuers that are already listed, these requirements be
reduced even further.
In December 2007, SEBI vide circular dated December 03, 2007 amended the
provisions pertaining to issuances of Corporate Bonds under the SEBI (Disclosure and
Investor Protection) Guidelines, 2000. The changes to the guidelines were as below:
(a) For public issues of debt instruments, issuers now need to obtain rating from only
one credit rating agency instead of from two. This was done with a view to reduce
the cost of issuances.
(b) In order to facilitate issuance of below-investment grade bonds to suit the risk
appetite of investors, the stipulation that debt instruments issued publicly shall be
of at least investment grade has been removed.
(c) Further, in order to provide issuers with desired flexibility in structuring of debt
instruments, structural restrictions such as those on maturity, put/call option,
conversion, etc have been done away with.
In May 2009, SEBI issued a Listing Agreement for Debt Securities that provided for a
simplified regulatory framework for the issuance and listing of Non-Convertible
Debentures (NCDs). The circular released by SEBI was split in two parts. The first part
prescribed incremental disclosures for issuers that were already listed and the second
part pertained to issuers who were unlisted and prescribed detailed disclosures for them.
To conclude, the supply-side issues in the Indian corporate debt market remain primarily
cost related and to some extent related to heavy disclosure norms, some of which have
recently been simplified through regulatory changes. Hopefully the steps taken by
regulators to address these issues will help deepen the bond market development
further, by promoting more public issuances in multiple categories.
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Indian Corporate Debt Markets – The Demand-Side issues
A study of the investment norms for banks, insurance companies, pension funds, and
provident funds helps to understand specifics of the investment bottlenecks that may
have prevented the development of a well-functioning corporate debt market in India.
According to the eligible Statutory Liquidity Ratio (SLR) investments (as per Master
Circular – Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) issued on July
01, 2011), banks are required to hold 24% of their liabilities in cash, gold, central and
state government investments, thereby leaving non-government bond market
instruments completely out of the picture.
For a life insurer it is very important to generate high returns while maintaining asset
quality to avoid credit risk. In India, the norms for insurance company investments are
made in the Insurance Regulatory and Development Authority (IRDA) Investment
Amendment Regulations, 2001, and cover the following businesses: life insurance,
pension and general annuities, unit linked life insurance, general insurance and re-
insurance. The only section of the Act that allows for long-term, non-government
investments are the infrastructure and social sector investments of 15+% and
unapproved investments of 15%. Further, according to this Act, the pensions and
annuities businesses cannot have any portion of their funds invested in non-government
linked investments. Investment regulations governing life businesses require that at
least 65% of assets be held in various types of public sector bonds. Funds are permitted
to invest in corporate bonds, but the category of “approved investments” only includes
bonds rated AA or above. Bonds below AA (which are rare in India), can be held in
unapproved assets. Then again, total unapproved assets cannot exceed 15% of the
portfolio and are subject to exposure norms limiting exposure to any company or sector.
In practice, insurance companies hold less than 7% in unapproved assets. For instance,
according to the ICRA, SBI Life’s exposure to equity and unapproved investments has
been around 6% only.
A major part of investments (approx. 47%) for life and pension businesses is thus being
held in G-Secs and other government approved securities which are relatively safe
instruments. Poor appetite for corporate bonds is also on account of the lack of a
secondary market – thereby making such an investment a buy and hold play which,
considering the long tenor, is decidedly a sub-optimal investment. In other words, the
investment norms of insurance companies, banks, pension funds in India are heavily
skewed towards investment in government and public sector bonds which acts as a
detriment to the corporate bond market development. Without long-term investors like
pension funds and insurance companies investing in corporate debt, it is difficult to see
how the corporate debt market will take off.
The adverse effect of this legal/regulatory lacuna on corporate debt market is further
aggravated by the fact that the high fiscal deficit of the Government of India (GoI) is
financed by the issue of GoI bonds or government securities (G-Secs). The fact that the
Fiscal Responsibility and Budget Management (FRBM) Act – that required the GoI to
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reduce its deficit to sub-3% levels by 2009 – has been put in abeyance in the wake of
the financial crisis of 2008, implies that the fiscal deficit has been going up and
government bond issuances continue to finance this deficit. This has effectively served to
further crowd out private corporate debt issuance.
The highlights a few major issues:
The high level of G-Sec issuances in the Indian debt market,
The low level of corporate bond issues; both these issues are inter-related since
large government debt issuance on account of high fiscal deficit has a crowding
out effect on corporate debt,
Market preference for very safe AA+ assets with no market for issuances below
AA thus creating a very thin debt market; As shown in the following graph, the
volume of bonds rated below A is around 5% of the total issue.
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The High Powered Expert Committee (HPEC) on corporate bonds and securitization also
popularly known as the Patil Committee made a few recommendations on enhancing
the investor base-an important demand-side issue that was subsequently addressed in
part by the SEBI. We detail here the recommendations of the Committee and actions
taken thereafter by the SEBI.
In order to enhance the investor base and diversify its profile, the Committee
recommended that the investment guidelines of Provident/Pension Funds be directed
by the risk profile of instruments rather than the nature of instruments. The Committee
also recommended an increase in investment limits for Foreign Institutional Investors
(FIIs). In the “Plan for a unified exchange traded corporate bond market” – a report of
the internal committee of SEBI in 2006, it is mentioned that the point it to be taken up
with the Government and Reserve Bank of India (RBI) wherever relevant – “So as to
encourage the widest possible participation for domestic financial institutions, IRDA, the
Central Board of Trustees of the Employee Provident Fund Organisation (EPFO) and the
Pension Fund Regulatory and Development Authority (PFRDA) should modify their
respective investment guidelines to permit insurance companies, provident and gratuity
funds, and pension funds respectively to invest/ commit contributions to SEBI
registered Infrastructure Debt Funds.”
In July 2011, the EPFO put out requests for proposal while appointing custodians of
Securities of EPFO. The document listed the investment guidelines for EPFO fund
managers alongside terms and conditions and duties of custodians. Though the
prescribed pattern of investment for EPFO favours investments in central and state
government securities, it allows upto 30% to be invested in any central government
securities, state government securities or securities of public financial institutions
(public sector companies) at the discretion of the Trustees. Of this, 1/3rd is permitted to
be invested in private sector bonds/securities which have an investment grade rating
from at least two credit rating agencies, subject to the Trustees’ assessment of the risk-
return prospects.
Demand-side issues remain trickier to resolve as they are tied to a variety of other
regulations on investment and an over-arching prescription for “safe investments” i.e.
for instruments rated AA and above. Understandably, demand exists only for such
instruments and the market caters to this demand, creating in turn a thin-market. A
market for high-yield bonds is practically non-existent, suggesting that risk-return
profiles are uniform throughout the market, which need not necessarily be the case.
Moreover, much of this lack of appetite is also linked to the lacklustre secondary market
in corporate bonds. Investors in any market would require an active platform where they
would be able to liquidate their assets or square off positions if need be, especially in a
high-yield market. In the case of India’s fledgling secondary market in corporate bonds,
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market activity is highly bunched up at one end of the market at all times, making
holding fixed-income securities riskier unless they are being held till maturity.
In keeping with the Patil Committee’s recommendations, investment guidelines that are
directed by risk/return profile of investments and investor appetite rather than the
nature of investments will help boost demand for a wider range of debt securities and
hopefully help in building a deeper, more active market with varied investor profiles. Our
next post in this series will aim to uncover a few pertinent secondary-market issues, and
their effects on corporate bond market development or lack thereof.
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Gujarat: A Template for the Rest of the States
Tanvi Mittal, NMIMS
The State of Gujarat is classified as one of the leading industrialized states in India and
has earned itself the sobriquet of being the “Growth Engine of India”. The state houses
several private companies, public enterprises, multi-national corporations and is the host
of small-and medium-scale business units. The state has become one of the best places
in India for the manufacturing of textiles, pharmaceuticals, and agro-based and
petrochemical products and is also popular for its physical and social infrastructure
facilities. Gujarat is also one of the states in India where there is an excellent
environment and is aptly supported by a responsible and proactive bureaucratic system.
Even though Gujarat has been known for entrepreneurial spirit, it has made good policies
and taken good decisions in the last decade that has facilitated high level of growth at a
high base.
With a share of about 12.5%, Gujarat has the highest share of the total outstanding
private sector investments (including both domestic and foreign private sectors) across
India as of June 2012, according to a study by Associated Chambers of Commerce and
Industry of India (Assocham). Of the total outstanding investments in Gujarat worth over
Rs 14.8 lakh crores, private sector accounted for over Rs 10.3 lakh crore thereby
registering a share of about 70% in the overall investments across the state. Out of the
20 emerging industrial States in India, Gujarat tops in terms of investments, followed by
Maharashtra, Andhra Pradesh, Odisha and Karnataka which, together, attracted 54 per
cent of all investments in India during the last seven years, according to an Assocham
report.
Source: Retaining the edge, Mckinsey, CII
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Gujarat
Haryana
Bihar
India
Karnataka
Kerala
Uttarakhand
Tamil Nadu
AP
Growth Rate(%)
Stat
es
INVESTOCRAFT 2013
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Flow of private investments is decided by the attractiveness of investment opportunities
as the ultimate consideration of any investment is profitability. That is a reason why big
corporate houses of the nation such as Essar, Torrent, Reliance, Shell, Tata, Adani and
many others have chosen Gujarat over other states.
Gujarat offers Bureaucratic efficiency through its acts such as Single Window Clearance
Act, infrastructure facilities, and ease of land acquisition, tax concessions, product
market conditions and exit policies which make it a private investment haven. The
investor-friendly policies in Gujarat along with state-wide gas grid, rich gas reserves,
round-the-clock power supply, tremendous rail and road connectivity within the state and
to other parts of the country, large consumer base, easy availability of hardworking and
skilled manpower and simple and transparent procedures for investment, all these
combined factors make Gujarat a business-friendly state and an ideal destination for
making an investment.
The role of Gujarat in ancient trade and commerce goes back to Indus Valley Civilization.
It has a long and ancient history of maritime trade across the world. Gujarat since time
immemorial has been renowned for its entrepreneurial spirit. Gujarat also has the
advantage of having a strategic location in terms of having the Longest Coastline of
1600 km with 18 active ports across the State. Today, Gujarat handles 35% of the cargo
of India. All these are the indicators on the basis of which India's ascendance is
recognized. And it's clear that Gujarat's contribution in them is substantial.
Gujarat is one state that has evolved constantly and has diversified its industrial base
substantially. In the year 1960-61, textiles and auxiliaries were the major contributor to
the economy of the state. In the span of over 49 years, the industrial spectrum has
completely transformed and refined petroleum products has emerged as one of the
largest industrial groups having 33% share, followed by chemicals having 21% share.
Other important groups include agro and food products (8.5%), textiles and apparel
(6.9%), basic metals (6.2%), machinery and equipment (2.7%), non-metallic mineral
based products (2.5%), plastic and rubber products (1.8%), furniture industry (1.4%),
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fabricated metal products (1.4%), electrical machinery (1.2%) and paper and paper
products (1.1%). The industries in Gujarat produce a wide variety of products. The
sectors that keep attracting investments are petrochemicals, chemicals, drugs and
pharmaceuticals, minerals, ceramics, gems and jewellery, textiles, automobile
engineering, IT, power and ports.
Over a period of time, Gujarat has also succeeded in widening its industrial base. At the
time of its inception in 1960, the industrial development was confined only to four major
cities namely Ahmedabad, Baroda, Surat and Rajkot and some isolated locations such as
Mithapur and Valsad. Today, almost all the districts of the state have witnessed industrial
development .Such a massive scale of industrial development has been possible on
account of judicious exploitation of natural resources, such as minerals, oil and gas,
marine, agriculture and animal wealth. The discovery of oil and gas in Gujarat in the
decade of 60s has played an important role in setting up of petroleum refineries,
fertilizer plants and petrochemical complexes. During the same period, the state
government has also established a strong institutional network.
Gujarat Industrial Development Corporation (GIDC) established industrial estates
providing developed plots and ready built-up sheds to industries all across the state.
Institutions were also set up to provide term finance, assistance for purchase of raw
materials, plant and equipment and marketing of products. Later, District Industries
Centers (DICs) were set up in all the districts to provide assistance in setting up industrial
units in the form of support services. All these initiatives have made Gujarat to emerge
as the highly industrialized state in the country today.
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The state government in Gujarat has made constant efforts to attract investments by
formulating acts such as Single Window Clearance Act which aims to cut down the
phenomenon of red-tape in the state. Through this act, project proposals can be made
online and all the necessary permissions can be obtained under a single window, making
procedures easier and reducing the time required for clearance of a project and this has
further motivated the entrepreneurs to invest in the state.
The state also organizes the prestigious Vibrant Gujarat Global Investors
Summit (VGGIS), an initiative of Gujarat state government to attract foreign
investment for the development of Gujarat. It aims at bringing together the business
leaders, investors, corporations, thought leaders, policy and opinion makers. VGGIS
organized in 2003, 2005, 2007 and 2009 attracted investment proposals of
Rs.18,72,437 Crores and the 2011 summit resulted into inking 8380 MOUs and getting
investment proposals of over Rs.20.83 lakh Crores. Till March 2012 the State has
received acknowledgement of 10,537 Industrial Entrepreneurs Memorandum, with an
estimated investment of Rs.10,33,314 Crores which is approximately 11.86 percent of
total investment in the country. The event has also been successful in creating
employment opportunities for people in tourism, handicrafts and knowledge sectors. The
summit has been able to put Gujarat’s mark on the Global map and has become an
epitome of success for attracting futuristic projects and investments in the State.
At a time when the whole nation is plagued by policy paralysis, scams and everyone is
talking about lack of macro-economic management, the model of development in Gujarat
can be seen as the silver lining. When it comes to Gujarat one constantly hears of clean
administration, responsible bureaucracy and a progressive government which has its
focus on long term development of the state. Gujarat’s success story could very much be
used as a template by the rest of the nation.
INVESTOCRAFT 2013
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Banking Amendment Bill: Licensing all the way
Pratik Jain, NMIMS & Chakshu Aggarwal, NMIMS
"Since the bill is too important for me to pass, therefore I am bringing the Bill dropping
the controversial clauses," Finance Minister P Chidambaram said, and this paved the way
for the Banking Laws (Amendment) Bill, 2011.
The seeds of the Banking Amendment bill were sown by the former finance Minister Mr.
Pranab Mukherjee while presenting the budget for the financial year 2010-2011. Indian
Banking Industry has come a long way since the nationalization of banks in 1969. Now
the banking system needs to grow in size to meet the demands of modern economy.
Besides this, there is also a need to extend the geographic coverage of banks and make
the banking services more accessible. The new banking bill will cater to these
requirements and will lead to financial inclusion
The salient features of the Banking bill and its possible implications on banking sector
are:
a) To Enable banking companies to issue preference shares, rights issue (increase
the authorized capital) without being limited by the previous ceiling of maximum
of Rs. 3000 crores
Implication- This provision would be helpful to banks in raising capital as and
when required without approaching the RBI for these approvals. Besides, this
provision would also aid the Banks to comply with the tier-1 capital and capital
adequacy requirements in accordance with the Basel-III norms that the banking
sector is expected to comply with starting from 1st April, 2013
b) Increase in voting rights of investors in private sector banks subject to maximum
of 26% while in case of state run banks to 10%
Implication- The increase in voting rights may lead to higher interest from
investors (both domestic and foreign) in the scrip of various public and private
banks. A change in the shareholding patterns of banks in the short term can be
expected
c) To empower RBI to collect information and inspect associate enterprises of
banking companies
Implication- This gives RBI the power to investigate the books of the other
associates of the banking companies and will lead to more transparency and
regular checks in the lending process of these banks
d) To provide for primary cooperative societies to carry on the business of banking
only after obtaining a license from RBI
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Implication- Earlier, the cooperative credit societies had to register with the
Registrar of Co-operative societies whereas the credit societies with paid-up
capital of more than 1 Lac came under ambit of RBI. Most of these co-operative
societies kept their paid-up capital below this level to avoid the regulatory purview
of RBI over them. With this amendment, RBI will issue new guidelines regarding
the capital requirements necessary to register as a cooperative credit society.
These societies will have to comply with the norms specified by the RBI within one
year or face suspension of their operations.
e) Competition commission of India will have powers to regulate anti-competitive
practices and would also have powers to approve mergers
“We must create at least 2 or 3 world-size banks. China has done it. And if India wants to
be and as it will be the third largest economy in the world…we must also have one or two
world size banks and some consolidation is inevitable” said PC
Implication: This provision will pave way for mergers and acquisitions of banks in
India and it will be win – win for both acquirer and target bank. Smaller target
banks will benefit from the high class banking services and lower transaction
costs of larger banks whereas large acquirer banks will benefit from the larger
penetration of smaller banks and will thus help in consolidation of banking sector.
On the other hand, there is no reason to abandon the current practice of
consortium (syndicate) financing as it spreads the risk among many banks.
Concentration of risk in a single bank entity can also have serious implications on
the bank’s balance sheet and asset quality. Also merging the weak public sector
banks with the ones performing well can render the stronger PSU banks weak.
f) To empower RBI to issue new banking licenses to eligible entities
Draft Guidelines for eligibility: The initial draft guidelines to be eligible for license
are as follows:
Eligible promoters: The entities should be owned and controlled by
residents having successful track record along with sound credentials and
integrity for more than 10 years. Entities\groups with income or assets of
10 percent or more from real estate of broking activities are not eligible.
Corporate structure: The new banks will be set-up through a wholly owned
Non-operative Holding company registered with RBI as NBFC
Minimum capital requirement: The minimum capital requirement as per
the guidelines is Rs.5 billion dollars.
Foreign shareholding: The non-resident shareholding in the entity should
not exceed 49 percent for the first 5 years.
Corporate governance: At least 50 per cent of the directors of the NOHC
should be independent directors.
Implication: This provision of bill will lead to revamp of the banking sector. The increase
in number of banks will extend the geographic coverage of banking sector as well as will
lead to the credit growth.
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The Licensing Thump to The Stock Markets
The reform drive started by UPA-II in September of 2012 also consisted of initiating the
process of issuing banking licenses. On back of expected banking amendment bill
authorizing RBI to issue new banking licenses, stocks of many NBFCs expected to be
front runners in getting new banking licenses rallied. It was observed that this rally had
enough fuel to beat the banking Index. Statistics quoted below justifies the veracity of
statement. On one hand where BSE_BANKEX rallied 16% in this period, rally in the below
NBFCs expected of getting banking license was higher. One of the reasons behind this
rally is the earnings potential which investors feel that would increase once these
institutions get the banking license.
Name of The Company
Market price
on
9/18/2012
Market
Price on
1/1/2013 Return %
L&T Finance 46.15 89 92.84%
M&M Finance 785 1126.55 43.50%
Bajaj Finance Ltd 1,100 1357.05 23.36%
Shriram Transport and
Finance 620.5 757.2 22.03%
But historical data available suggests otherwise. There is more to this rally than what
meets the eye. It has been observed that those financial institutions which were earlier
beating banking index on back of being top contenders for getting banking license
actually fail to beat the BANKEX once they are established as banks. Instead of increase
in their earnings, earnings of these new banks start to decline and so does the stock
price. Table below sheds more light on this fact. As it can be seen, most of NBFCs after
getting the banking licenses have failed to beat the bankex. One of the reasons behind
this decline in earnings and stock price is the regulatory restrictions that these banks are
subjected to once they get the banking license. CRR and SLR requirement takes toll on
the profits of these banks as it brings down the amount of credit that they can offer to
borrowers. Though the cheaply available CASA deposits is one of the positives of being a
bank, it takes a lot of time for a new bank to garner sufficient CASA deposits to actually
benefit them. The newly formed banks also have to invest in technology, people and
branch network expansion which have its own cost. The newly formed banks will also be
mandated to open 25% of their branches in the rural unbanked regions (population of up
to 9,999, according to 2001 census). These rural branches may severely affect the
profitability of the NBFCs. A peek into the historical returns data tells that the NBFCs
srcips have rallied significantly a year prior to announcement of the license and have
generally underperformed the benchmark Bankex after the announcement of License
and commencement of bank operations. Hence with the RBI expected to dole out new
license in the coming 12-18 months it could be a good opportunity to buy into the some
of the expected NBFCs and sell at the time of announcement.
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The performance of various Holding companies after the issuing of licence vis-à-vis BSE
BANKEX
The bill is an effort of the government to boost the banking sector and also achieve its
goal of financial inclusion. But there are some fronts on which government need to be
careful so that the bill does not reap any negative results. The increase in number of
banks in the country will lead to increased competition in the banks, the impact of which
could be there on the margins of the banks as they will reduce their rates to allure more
customers. RBI will have to keep a strong check on these type of anti – competitive
practices which was one of the reason for 2008 U.S financial crisis. Although
fundamentals of Indian banking industry are strong but one thing that should be kept in
mind is that bankers are made of same cloth. Another front where RBI has to be careful
is in the selection of entities to which licenses will be issued. Many NBFCs in order to
comply with clause of having 25% of branches in under banked areas open the branches
in these area but do not put them to use and also to comply with the provision of having
capital requirement of 5 billion will fulfill it through other arms of the corporate house
Bank The parent that
received the
banking license
Share price of
the parent
before the
announcement
of banking
license/ or
listing price (Rs)
The delisting
price /
existing Price
Share price
CAGR during
the
investment
period
Returns
given by
benchmark
during the
same
period
Kotak
Mahindra
Bank
Kotak Mahindra
Finance Ltd
17.2 649 45% 26%
Yes Bank 66 382 28% 14%
Axis Bank
Ltd
UTI Ltd 16 1,015 36% 22%
HDFC
Bank Ltd
HDFC Ltd 33 653 18% 13%
IndusInd
Bank
IndusInd Bank 32 355 21% 17%
ICICI Bank
Ltd
ICICI Ltd 149 61 -10% -1%
Centurion
Bank
Centurion Bank 16 41 12% 22%
Bank of
Punjab
Bank of Punjab 10 48.6 16% 16%
Global
Trust
Bank
Global Trust
Bank
10 0 -10% 5%
DCB Bank DCB Bank 57 44 -4% 11%
IDBI Bank IDBI Ltd 41 100 11 23%
Times
Bank
Times Bank 10 9.4 -11 -11%
INVESTOCRAFT 2013
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they are part of and in the process the aim of financial inclusion will not be achieved. So
in order to safeguard the banking sector against this RBI should restrict the amount of
deposits that can be raised from other arms of same corporate house and should also
make sure that all the branches are functional. If these fronts are taken care of , then
only the bill will serve the purpose for which bill is framed.
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Bonded to Equities!
Sudeep Mallya, NMIMS
The world of Finance has divided into silos of equities market and debt market. The
events of one market are assumed not to impact other market. But in reality the events
of one market impacts the other market in a significant manner. These two instruments
are used to finance any venture and it is imperative to look at both the markets to
determine the funding mix to optimize value. The article attempts to study the various
indicators from the debt market and what they indicate about the returns of equity
markets for present and forward returns.
The risk in equities as an asset class is measured as Equity Risk Premium and the risk in
Debt is measured as a Bond Default Spreads. These two indicators along with the ratio
between these two parameters can be used to determine the kind of financing mix.
The graph below depicts the Implied ERPs, Default Spreads for a Baa Rated securities
and ratio of ERP to Baa Spread. It can be noticed in the graph that in the 15 years when
the ratio of ERP to Baa Spread was close to 1, a ratio of less than 1 indicates that the
equity as instrument is cheaper than debt adjusted for risk. First time this happened was
during the dotcom bubble when it was quite easy to raise equity and the second time this
happened was 2008 after the crisis when debt defaults spreads widened significantly.
The ratio was been highest in 2006 in the last 15 years at 3, it would have been
appropriate to raise more debt than equity.
Such an analysis in the Indian context might not be great value as the thin debt markets
would make it difficult for the Indian Companies especially the ones with lower rating to
raise debt. These companies typically raise debt from banks and who have their own
proprietary method of pricing credit.
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Predicting Equity Returns using Bond Market
Even though bond markets in India are not developed the way they are in the west, but
there are still enough indicators to understand the Indian Equity Markets. The Indian
yield curve has a lot of information embedded about market views on future growth in
various terms, inflation estimates and liquidity position. All these are key factors that
drive sentiments in the market and key factors to forecast equity returns.
Indicators used for prediction of Equity Returns
Value Assigned to Future Growth
Yield Curve
Modified Yield Curve (derived using Local Short Term Rate)
Modified Yield Curve (derived using US Long Yields)
Value Assigned to Future Growth
In the industry, the long term
government bond yield is used
as the Risk Free Rate.
However, professionals from
the Damodaran’s school of
thought would argue that it
should be the government
bond yield minus default
spread that should be used as
the Risk Free Rate. But let us
keep this difference of opinion
apart from this article and use the government bond yield as the risk free rate as used
widely in the industry.
When the economy is doing
well, the bond yields would
increase. The bond yields
would also increase if there is
high level of inflation due to
the action of the central bank.
In the first case the negative
impact of higher rate is far less
than the positive impact on the
cash flows of the companies
due to a better economy, which leads to a better performance of the equities as an asset
INVESTOCRAFT 2013
24
class. But if there is a high inflation, the impact of higher risk free rate is more negative
on the value.
Value Assigned to Future Growth (VAFG) is calculated by capitalizing the Trailing Earnings
capitalized at the cost of equity using a constant Equity Risk Premium (ERP) and the 10
year bond yield as the Risk Free Rate. It tries to measure the relative attractiveness of
bonds and equities. Using a constant ERP of 6 percent and the 10 year bond yield, the
current level of VAFG is 48 percent, as against the long term average of 51%. Currently,
VAGF indicate more value in equities than bonds on a relative basis and indicate a 15.7
percent CAGR return from the equities on a 10 year horizon.
Yield Curve
Yield Curve is the curve of rates of
the government bonds/bills of
different maturities plotted across
time. Difference/spread between the
10 year bond Yield and the 91-Day
bill indicates the future economic
growth and can be used as a good
indicator for long term equity returns.
If the short term rates are falling
faster than the longer term, then the
growth in the economy is expected to
pick-up. When the inflationary
pressures fall, the short term rates
also fall. If the inflation pressures fall,
short term rates tend to fall and
leading to an economic recovery.
The spreads are not increasing,
implying that the inflationary
pressures are receding. This means
that equity markets are past the worst.
Modified Yield Curve (derived using Local Short Term Rate)
It is liquidity that drives the equity market returns in the short run. The modified yield
curve, difference between trailing earning yield and 91-day treasury yield, is used
primarily used to measure liquidity. This spread and three year forward equity returns
have shown a strong correlation in past.
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The Modified Yield Curve
indicates domestic liquidity
in relation to share prices
and can be used to predict
the medium term (3 years)
equity returns. Medium term
equity returns are likely to be
lower than the long term
growth predicted other
parameters at 10 percent
CAGR. The short term returns
could increase to the long
term average if the short term rates could decrease by 75-100 basis points (BPs).
Modified Yield Curve
(derived using US Long
Yields)
The other Modified Yield
Curve is derived from
spread between the
earning yield and the US
10 year Bond yield. Since
1991, the correlation of
the Indian markets and
equity returns with the
world markets has been increasing on account of higher economic integration. The bull
rally in the Indian markets has been primarily fuelled by the Foreign Institutional (FII)
funding. The liquidity in the foreign equity markets is instrumental in driving the returns
INVESTOCRAFT 2013
26
of from Indian Markets. This modified yield curve is meant to capture the effect of short
term liquidity and indicate the one year forward returns from the equity markets.
This modified yield curve measure the global liquidity positions and its impact on Indian
equity markets. This can be used to predict the short term (1 Year) equity returns. This
indicator predicts a strong performance in the short term. This indicator predicts that the
equity markets could give a return of 49 percent for the one year period Oct’2012-
Sept’2013.
Conclusion
If the indicators of the bond markets are anything to go by then, the equities as an asset
class scores over the GILTs for long term. The average equity returns from the longer
tenure is far more than from the shorter tenure. The bright outlook for equity market
stems from global liquidity positions. To have a sustained bull market, the domestic
liquidity must improve and short term interest rates should fall if the bond market
indicators are considered.
Note – Data points for this article were from Morgan Stanley – India Strategy and Aswath
Damodaran’s Website.
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Is that Gold Loan Really Shining?
Ishan Agarwal, NMIMS
Gold and Black Gold (Crude Oil as it is sometimes referred to) have been giving sleepless
nights to our Finance minister since a very long time. Black Gold for obvious reasons,
since it accounts for one-third of India's total import bills; but why is gold pestering our
finance ministry?
Well there are two issues here; one that, after Crude Oil, Gold is the second highest
contributor to India's import bill and that most of the gold that gets imported lies idle in
homes in the form of coins, biscuits and jewellery, thus drawing money out of productive
resources of the economy.
So do Gold loan companies have a role to play for the Indian Economy?
BACKGROUND
Gold loan companies have been in focus ever since the R.B.I tightened regulatory norms
on them in March 2012. These new norms were considered by some experts as a slow
killer which could hamper the rapid growth of such organisations by limiting the value of
loans given on pledged gold, increasing the capital requirements of such NBFCs and
capping the interest rates chargeable on such loans. Such regulatory interference was
expected from the R.B.I to check the rapid growth of the sector which many experts
believed was another bubble in the making. Another issue was the mushrooming of many
small ticket-size gold loan companies in different parts of the country. Many experts
predicted this regulatory action by the R.B.I as a dampener for one of the fastest growing
industries.
Barely 9 months into the regulation, has the RBI seemed to have changed its thoughts
on gold loan companies from being a threat to the economy to the one which could
actually channelize savings in to the economy. The R.B.I working group in the first week
of January 2013 has proposed changes in its report which aim to encourage Gold loans
by such companies and increase the loan to value from 60% to 75%.
So, what makes the Central Bank of the country change its stance on Gold loan
companies? Let us probe into this, going deeper into issues related to gold and gold loan
companies.
The Concept of Gold Loans and History
Historically, Gold has been a valued commodity, especially in India where it is
considered auspicious and has been kept as an asset in an average Indian
INVESTOCRAFT 2013
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household in the form of coins, jewellery and other forms. The issue with such
kind of asset is that it is bad for the economy. How?
Firstly, take into account the fact that India is a net importer of gold. So, whenever
an average Indian purchases gold in any form, it ultimately adds to the import bills
of the country, thus resulting in depleting foreign reserves. Secondly, assume that
if a person purchases gold worth Rs. 10,000 and keeps it in the locker of his
house, this means that this Rs. 10,000 kept in the form of gold is drained out of
productive resources in the country. Now this is where Gold loan companies step
in.
These companies provide loans by taking gold as collateral. Now this money,
obtained by the borrower by pledging gold can be used by him in his business, for
his emergency needs or some other productive purpose. Compared to the other
markets in the world, the gold loan business in India is a big one. Until a decade
back, most of the gold loan financing was done in the unorganised sector by
pawnbrokers and money lenders. However this scenario has changed with the
entry of organized players such as NBFCs and banks. These players now
command around 30% of the total gold loan market.
The organized gold loan market in the country has grown at a rate of 40% CAGR
from 2002-2012. At just 1.5% of the total stock of gold in the country at present,
gold loans have a huge potential to grow.
Add to the fact that India is one of the largest markets for gold accounting for
about 10% of the total stock of gold in the world. Rural India accounts for 65% of
this gold stock. The demand for gold in the country follows the regional trends,
where south India accounts for 40% of the gold stock, west accounts for 25%, and
north around 20-25% and east around 10-15%.
Role played by Gold Loan companies in India
Driving Financial Inclusion:
One of the main roles played by gold loan companies is financial inclusion
for the untapped population of the country. Financial inclusion is now a
national priority and gold loan companies can be a useful tool to attain this
objective.
Encouraging Monetisation:
In India, only a small part of the total gold stocks held by its citizens is
monetised, depriving the economy of the much-needed liquidity. Borrowing
against gold facilitates economic activity thus contributing to the economy.
INVESTOCRAFT 2013
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Tapping the Multiplier Effect:
Gold loans in India are typically small ticket loans falling within the
definition of micro-credit in the country. In gold loans, delinquency rates
are well below 1% and any productive activity can be financed year after
year without need for periodic replenishment. In contrast, in micro-credit
models where recovery rates are low, a significant portion of the funds is
lost in each disbursement cycle. In the long run, this cumulative
compounded cost to the economy is heavy.
Extending Efficiency Gains:
Gold loans have become a form of immediate borrowing to the ,average
person similar to the way a credit card is for the well-off common man.
These small-ticket loans disbursed promptly help kick-start and keep alive
micro-entrepreneurship.
Discouraging Usury:
As organised gold loan companies are expanding their foot print in India,
they are slowly eating in to the unorganized gold loan market mainly
operated by pawnbrokers or money lenders. This type of reduction of
dominance of the unorganised market is good for the country and the
common man. Last, but not the least, these companies also contribute to
the national exchequer in the form of corporate taxes.
The future of Gold Loan companies
There are many factors which will determine the future of Gold loan companies in
India. Some of the factors can be explained with the figure below:
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Source: Muthoot Finance Annual Report, 2011-2012
Challenges for the sector:
The major challenges faced by Gold loan companies today are:
Stringent Loan-to-Value Norms:
Capping the loan-to-value of gold loan companies is a welcome move by
the R.B.I, however capping it to very low levels can have an adverse effect
on the sector because this may make it unattractive for borrowers who do
not have additional gold holdings to make up for the shortage. This may
drive them to the unorganised sector, to which these norms don't apply.
The R.B.I in its regulation in March 2012 had capped the L.T.V at 60%
which was considered too stringent by industry experts. The R.B.I working
group report in January 2013 proposes to increase it to 75%.
Negative perception of the Sector:
The regulatory measures introduced by the R.B.I were intended to
standardize the Gold loan sector and prevent a growing bubble, too many
regulatory announcements in a short span of time and adverse media
comments have created a negative perception of Gold loan companies in
India.
Other challenges faced by the gold loan sector in the country are
o Very volatile gold prices in the global commodity market
o Access to cheaper sources of funding
o Changing common man's perception about gold loans.
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Conclusion:
With the Government of India now determined to monetise gold savings of its citizens to
increase money in productive resources of the country, gold loan companies offer one of
the best platforms for the activity. The Government can leverage on the strong local
reach and distribution channels formed by these organisations to tap gold into the
economy even in far-flung villages of the country. Total Gold stock in the country is
estimated at 18000 tonnes and only around 1000 tonnes of it is estimated to be lying
with gold loan companies and banks. Also, India's organised gold loan sector could grow
substantially in the coming years by tapping the unorganised part of the sector. An
effective L.T.V of around 75%, coupled with strong business focus and customised
products, this sector can potentially attract small borrowers, self-employed professionals,
agriculturalists and artisans. These factors when catalysed by the right policies of the
R.B.I can be beneficial to both, the overall Indian economy as well as the gold loan
sector.
So yes, we conclude that gold loan players are here to stay. Not only stay but grow too.
So it really won't be a bad idea investing in a Muthoot or a Manappuram!!
Oh Wait, do your analysis before hitting the trade!!
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Fiscal Cliff-Hanger
Chakshu Aggarwal, NMIMS & Ravi Srikant, NMIMS
The phenomenon that had been giving nightmares to economists of the biggest economy
of the world is “Fiscal Cliff”. It has been termed as the biggest event in US economy
since 2008 financial crisis that has the potential of pushing US economy back into
recession. Let us have a look at what lead to formation of this cliff and how did the US
economy go about resolving it.
BACKGROUND
George .W. Bush during his tenure as US president in 2000 had brought some changes
to the tax code popularly known as Bush Tax cuts. Before the tax cuts, the highest
marginal income tax rate was 39.6 %. After the cuts, the highest rate was 35%. These
tax cuts lowered the marginal tax rates for almost all US tax payers. Owing to the sunset
provisions of Bush Tax cuts that were to expire in 2010, these tax cuts were extended
during the presidency of Barack Obama through a series of acts: EGTRRA, JGTRRA and
tax relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The
extension was for 2 years. Owing to the increasing Budget deficit and debt of the US
government, the Budget Control Act was passed in 2011 in which the US congress
agreed to increase the debt ceiling under the provision that the US has to reduce the
expenditure by $1.2 trillion in the 10 years following the expiry of the Bush tax cuts on
31st December 2012.The Budget Control Act was a poison-pill deal designed to force
them to find a less austere compromise. If no deal was reached, then the spending cuts
would have come into effect from 1st January2013 that has been termed as fiscal cliff by
Federal Reserve Chairman, Ben Bernanke.
WHAT IS FISCAL CLIFF?
“Fiscal cliff “ refers to the effect of expiring Bush tax cuts and spending cuts by the U.S
government that would have come into effect from midnight of December 31, 2012 if
republicans and Democrats had not been able to agree on how to reduce the nation’s
budget deficit and debt.
IMPLICATIONS OF FISCAL CLIFF
The combined effect of the tax increases and spending cuts would have reduced the
deficit by around $600 billion. Over the long run there would be a reduction in the U.S
public debt by around $7 trillion as compared to an increase of around $10 trillion if the
INVESTOCRAFT 2013
33
present policies were allowed to continue. The risk, however was that the U.S economy
would contract next year sending the economy into a recession again.
The table below shows how the Fiscal cliff would have impacted the US economy:
Fiscal or Economic Measure CBO
Baseline
Alternative
Scenario
Federal deficit in FY2013 $641 billion $1037 billion
Economic growth in FY2013 −0.5% of GDP 1.7% of GDP
Unemployment rate for October thru December 2013 9.1% 8.0%
Public debt in 2022 58% of GDP 90% of GDP
The baseline scenario represents a scenario in which the tax cuts expire and spending
cuts take place. The alternative scenario represents a scenario in which present policies
continue and neither the tax cuts expire nor the spending cuts take place. The
enactment of fiscal cliff would have reduced the public debt of US to 58% of GDP but
would have sent the economy into a recession.
Out of a deficit increase of $10-11 trillion in the 10 years from 2013-2022, $7 trillion
could have been saved had the existing policies been allowed to expire under the Fiscal
cliff. The deficit for FY13 would have reduced to $600 billion as opposed to $1.2 trillion
the previous year.
THE FISCAL DEAL IN THE ELEVENTH HOUR ON 31st DECEMBER 2012
The Senate passed the American Taxpayer Relief Act on January 1 as a compromise
solution. Some of the provisions of the act were
1. Taxes on individuals earning more than $400,000 and couples earning more than
$450,000 was increased from 35% to 39.6%.
2. The capital gains tax was increased from 15% TO 20%
3. Removal of tax deductions and credits for incomes over $250,000 for individuals
and $300,000 for couples
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4. Estate taxes would be set at 40% of the value above $5,000,000, an increase
from the 2012 rate of 35% of the value over $5,120,000.
5. Payroll tax cuts would expire
The bill provided for $600 billion in tax revenue over ten years, about 1/5th of the
revenue that would have been raised had the Fiscal cliff occurred. The total deficit from
2013-2022 would increase by $4 trillion compared to the baseline projections. Add in
the financing costs and the deficit would increase by $4.5 trillion over the 10 years. The
deficit for FY 13 is now projected to be $1 trillion compared to $1.2 trillion the previous
year
The Budget Control Act contained Spending cuts of $110 billion per year split evenly
between defence and non-defence discretionary spending. If the US Congress could not
come up with other spending cuts of similar size, the spending would have to be reduced
by sequestration. For FY11 discretionary spending was $1.3 trillion and defence
spending was $700 billion. It is estimated that defence spending will be around 2.7% of
GDP as compared to 3.5% at the moment.
The spending cuts, which would have kicked in on January 1 2013, have been delayed by
2 months.
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The Petersburg Paradox
Harish Srigiriraju, NMIMS
“Price is what you pay and value is what you get” –Warren Buffet
Everything in this world has a price and not paying the right price will always create
problems. Warren Buffet waited for about 30 years before he bought Coca-Cola. He
waited for that long only to get the right price which will then give him the necessary
returns. Many of the M&A deals have failed only because of paying more than what was
necessary. It is essential not only to select good assets for investments, but also to pay
the right price to acquire them, and this brings us to the concept of St. Peterburg Paradox
Petersburg Paradox is a paradox related to probability and decision theory. It is an
essential theory to understand the behaviour of an investor and pricing decision. The
problem and its solution were first presented by Daniel Bernoulli in 1738. Assume that a
casino offers a play where there is an unbiased coin which is tossed at each stage. The
prize money starts with one rupee and doubles every time a tail appears. At any point of
time if the head appears, the game ends and the player can take away the money earned
so far.
Now think about how much would you be willing to play for this game? As per the
probability theory since there is a payoff which is unlimited, it would suggest that a player
should ideally be willing to put any amount of money to play this. However, people would
not be willing to pay a high price for this. In a survey conducted in 2004 on an average,
people were ready to play it by paying up around 25 Rs. Now what is the reason behind
people paying up so less despite the possibility of unlimited payoff?
Few theories can be used to explain this phenomenon. The “Expected Utility Theory”
explains this on the basis of diminishing marginal utility of money but this might not be
true in most of cases. The “Probability Weighting theory” gives less weight to unlikely
events but contrary to this it was observed that people give more weight to unlikely
events. Can it be explained based on the fact that the casino cannot have infinite
resources? How much ever finite the resource are, this does not explain the low amount
the players are willing to pay.
This paradox can be explained in two ways. One with the help of the “von Neumann and
Morganstern axioms” where it can be explained that the investor does not take decisions
only based on the expected payoff but always on the basis of the risk taking ability and
the payoffs are thus risk adjusted. As per the “Erodig Theory” the time averages maybe
different from space averages and the probability theory should only be used when the
systems are erodig in nature. To make things simple, it implies that the expected gains
increase with the increase in number of games. So if only one game is played, the
probability theory will not hold true. These two theories explain that there is a rationale
behind the paradox which is based on risk aversion.
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Similar to this paradox are real life situations which investors face in order to decide the
price for a particular stock. For high growth companies, it is often assumed that the
payoffs are unlimited and any price paid can be justified. However this is absurd as the
payoffs even if unlimited, has to be risk adjusted and hence there is always a right price
for everything. In my recent encounter with Ashwath Damodaran, someone asked him if
he was willing to invest in a company with very good growth prospects but corporate
governance issues. His answer was a bit surprising but logical when he said he would
definitely invest but only at the right price.
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About NMIMS
The School of Business Management (SBM) is the torchbearer of NMIMS, University
Mumbai. SVKM's Narsee Monjee Institute of Management Studies (NMIMS) has, ever
since its inception in 1981, been a leader in management education in the country. It
offers more than 50 programs across various disciplines, such as Management,
Technology, Science, Pharmacy, Architecture and Commerce. The NMIMS Deemed-to-be
University has over 6000 students and more than 300 faculty members who represent
an eclectic mix of rich industry and academic experience.
MBA CAPITAL MARKETS Program Introduction
Human life began with evolution. Thus, to change for the better, to improve, to innovate,
and to evolve is inherent to mankind. A disciplined way of innovation – sorting,
stabilizing, standardizing and finally sustaining is of utmost importance or business
conglomerates to effectively cater to wants, especially in the dynamic world of finance.
As human wants get more complex, the idea of Capital in the financial world gains
further importance. With this in mind, identifying and seizing new opportunities to sustain
the growth of these complex businesses entails a completely different skill set.
The Bombay Stock Exchange (BSE) along with NMIMS started the MBA (Capital Markets)
program in 2006, specifically to address this demand.
MBA Capital Markets is a specialized course in capital markets, which is offered only
at NMIMS Mumbai. The
curriculum offered as part of this program is prepared in consultation with BSE,
industry experts and senior faculty members of the institute. The Agreement entered
into between The Stock Exchange Education and Research Services, a public trust
established by the Bombay Stock Exchange and NMIMS in March 2005 became the
platform for the setting up of the
BSE-NMIMS
Centre for Capital Market Studies to further research and studies in the field of Capital
Markets. The program strives to train students into becoming decision makers along with
exercising social sensitivity, keep a broad strategic vision, and become responsible to
assume higher corporate responsibility. All this is being enhanced through a superior
degree of skill in interpersonal relationships. A great deal of emphasis is also placed on
experiential learning. Students are required to work on a number of corporate and
academic research projects during their two years on campus.
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