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Breathing DeepVolume 41 / April 2010

FINANCIAL ADVISOR

PPPRRRAAACCCTTTIIICCCEEE JJJOOOUUURRRNNNAAALLLJOURNAL OF THE SECURITY ACEDEMY AND FACULTY OF e-EDUCATION

SAFE UPDATES KEEP INFORMEDThe Securities Academy and Faculty of e-Education

Editor: CA Lalit Mohan Agrawal

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Breathing DeepEditorial preamble:1.1 BREATHING DEEP

The Concept of New Normal

Wellness is not just the presence of healing it is a return to normalcy. With many parts of the globaleconomy still operating below full capacity, the anguish continues even though the downturn is well pastus. In the developed world at least, the concept of a new normal is gaining traction amid a growing

realisation that economic activity will not return to its pre-crisis trend any time soon.

That outcome will be consistent with historical analysis, which shows that big crises cause big timedamage. Financial accidents leave a lasting imprint on growth due to tighter credit conditions, lower productivity on account of cutbacks in research and development spending while a structural rise inunemployment hobbles consumption.

Aggressive fiscal and monetary stimulus measures have of course reduced theduration of a downturn in the past but the problem this time around is that debtlevels in much of the developed world are at a point where further spendingwill be counterproductive.

The IMF reckons that when debt levels exceed about 60% of GDP, the impact of any governmentspending turns negative as doubts regarding debt sustainability result in lower consumer spending andhigher long-term interest rates.

Economists Kenneth Rogoff and Carmen Reinhart write in their paper Growth in a time of debt thatwhen government debt as share of the economy exceeds 90%, median growth rates fall by 1% and themean levels of growth decline by an even more substantial 4%.

At 180%, Japan has the worlds highest level of public debt as a share of GDP whereas in countries such

as Greece and Italy, the ratio is around 120%. The bad news is that public debt in the US will be at 90%of GDP by the end of this year the threshold point after which debt begins to seriously drag down long-term growth. No surprise then that the economic recovery in the developed world has been sub par andthat the prospects for medium-term growth do not look too bright.

Given the debt overhang, the potential growth rate for the US economy this decade is likely to be atleast a full percentage point lower than the average 3% of the past few decades.

Europe and Japan, which typically tend to grow at a slower pace than the US due to weakerdemographics and lower productivity, now face the same drags to growth as the US post the financialcrisis. As a result, trend growth in those regions is likely to be around 1.5% in the foreseeable future.

What does all this mean for the growth outlook for developing economies?

Emerging markets expanded at an average 3.6% from 1980-2002 but their growthtrajectory doubled to 7.2% from 2003 till the economic meltdown of 2008.Structural factors such as benefits of globalisation, the demographic dividend and better macroeconomic policy management were hailed as the main drivers of thestep function increase.

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Breathing Deep

However, easy access to cheap money and strong export growth directed to the freely spending USconsumer were significant factors behind the growth leap. It was no coincidence that the levitation act ofemerging markets began in earnest from mid-2003, once the US economy started to recover stronglyfollowing aggressive interest rate cuts by the US Fed. Capital gushed into many developing countries.Corporates in the developing world raised huge amounts of debt and equity capital to fund their ambitiousgrowth plans, largely from western financial institutions.

The turning off of the global liquidity tap in 2008 left many emerging marketcompanies high and dry, resulting in a broad slump in investment-led growth.Policymakers in developing economies then joined their counterparts in thedeveloped world in implementing sizeable fiscal and monetary stimulus measures.

Now with growth rates in several leading emerging markets once again near pre-crisis levels, a consensusis fast building around the view that the golden era of high economic growth that spanned from 2003 to

2007 is back. But that consensus ignores the role that fiscal expansion has played in boosting emergingmarket growth. Fiscal deficits in developing countries widened by five percentage points from 2007 to2009, just a bit less than the near six percentage points increase in the deficits of the developed world. Nearly half the expansion was specifically directed towards countering the crisis. A major part of thestimulus will begin to wear off this year. Although the private sector in emerging markets is in muchbetter shape than that in the developed countries to pick up the load from reduced government spending,many factors will prevent it from growing at the breakneck speed of 2003-07.

For one, its dependence on exports is too large and domestic demand cannot

quickly offset the consumption slowdown in the developed world. The relativedeterioration in trade balances may contribute at least one percentage point less togrowth than was the case between 2003 and 2007.

Furthermore, a major part of the surge in capital flows to several emerging marketslast year was a reversal of the panic outflows in 2008. On a trend basis, capitalinflows will be lower than during 2003-07 due to the reluctance of westernfinancial institutions to lend as aggressively. A less appreciated point about capitalinflows is their tendency to be pro-cyclical: investors tend to invest more in

emerging markets when risk appetite is rising and not just because capital isfleeing the beleaguered western economies.

The high domestic savings rates of many emerging markets cannot provide thenecessary risk capital to local businesses either as local credit systems areinadequate to effectively use those savings. The global boom-bust credit cycle hasdented banks in emerging markets too.

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While most did not get caught up in any systemic troubles like the US and European financial sector, thesudden stop in global growth in 2008 has made them more cautious. Credit growth consequently has beenslow to revive in emerging markets, except in China where the state-owned banking system wasinstructed to go on a lending spree. These arguments are also relevant to India where the growth rate roseby a similar magnitude as other emerging markets in the 2003-07 period; Indias economy expanded by8.5% on an annual basis during that phase compared to 5.5% in the preceding two decades.

The global growth boom lifted Indias export growth to 24% in those five years from an average 10% inthe 1990s. More importantly, the surge in capital inflows from 2003 onwards meaningfully boosted thecountrys investment rate. Foreign savings are an important driver of Indias investment rate becausecapital inflows tend to stir the animal spirits of the private sector.

Indias investment growth rates started declining sharply in the aftermath of the 2008 crisis and had it notbeen for the sizeable fiscal expansion, overall GDP growth rate would have been much lower than the6.5% recorded in calendar year 2009. Government consumption accounted for more than a third of Indiasincremental growth rate last year and the private sector will have to fill in the void caused by reducedgovernment spending in 2010.

A pick up in investment and export growth will undoubtedly help continue Indias economic recovery thisyear. Still, GDP growth wont be able to return to the 8.5% growth path of the 2003-07 period on asustained basis in the absence of another global economic boom or a fresh round of major productivity-enhancing reforms. Also, Indian banks are unlikely to extend credit at the frenetic 25-30 % annual pacethat helped facilitate the 2003-07 boom, as they too are likely to be more restrained following theharrowing 2008 experience.

Emerging markets such as India cannot charge on at a pace similar to that of the 2003-07 era while thedeveloped world moves to a new normal of lower growth rates.

The trend growth rate of emerging markets probably lies somewhere between the1980s and 1990s crisis-marred rate and the global credit bubble fuelled ratewitnessed between 2003 and 2007. This implies that the potential growth rate foremerging markets is around 5% and 7% for India, which still makes thesecountries exciting growth stories.

However, any attempt to engineer even higher growth rates through just loose monetary and fiscal

policies will prove to be unsustainable and lead to higher inflation.

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Breathing Deep1.2 STOCK MARKETS

Control Emotions, Greed & Fear

Anywhere in the world a SALE announcement is always associated with throngingcrowds in a rush to grab their purchase. Whether it is apparel, electronics or whitegoods, a sale is seen as a brief window of opportunity before prices rise again.Strangely, when a similar window of opportunity opens in the stock market, there is no

stampede among investors to buy stocks. On the contrary, when prices move up, thereis a flurry of buyers who come to buy stocks.

But even the most pessimistic investor would acknowledge that the Indian economy will continue togrow. Moreover, since agricultural growth is largely flat, any growth will have to come out ofmanufacturing and services and will have to be reflected in corporate performance. In other words,equities can only go up in the long term.

One may argue that selling ahead of downturn provides an opportunity to buy later at lower prices. But asthe most-seasoned investors would tell you, it is impossible to time the market. So the ideal strategy is toinvest more in equity when markets fall rather than liquidate your portfolio. This tendency of investors to

stay away from a good deal is a fallout of what psychologists call the herd instinct. A crash in prices isusually triggered by a large investor selling, which in turn prompts others to follow suit.

Behavioural investing is aimed at taking advantage of this trend rather than falling victim to it. Emotions,greed and fear, over which investors have no control are the major reasons for irrational exuberance byinvestors. Veterans in the field of finance say controlling greed and fear is the most difficult aspect whenit comes to managing your money. It is a slow process and does not happen overnight. There are someaspects that you need to keep in mind in order to have control over greed and fear: -

Mental accounting

Investors do not want to sell shares or mutual funds in which they are losing or restructure their portfoliosas per advice from experts. Mental accounting contradicts the benefits of diversification as investors tendto meet goals of each mental account separately leading to subdued returns despite higher risk.

Do not follow the crowd

Investors need to be self-disciplined and not follow a herd mentality. A lot of times, investors merely endup selling stocks, because they hear bad news. When you have bought a stock or a mutual fund for a 3-year time frame, be patient. Do not start checking prices every hour or every day and start questioningyour investment. At times when markets are bad, investments are bound to go down in value. That is justhow the markets work. If you refuse to accept this, then fear creeps in and causes you to bail out marketdeclines. If you sell and keep making losses, you may never reach your goals. Remember, wealth is built

patiently over a period of time and often you need to wait and watch your investments.

Stay diversified

Spread your investments across equities, bonds, real estate and gold. So when times are good, you will gethigher returns from stock markets. When times are choppy and bad, investment in bonds will preserveyour wealth. So while equities will satisfy your greed for higher returns, bonds will keep your fears undercheck. So while greed and fear cannot be simply eliminated from investing, having control over the sameis essential for successful investing.

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1st week of March 2010 Sensex gained 3.44% to cheer fiscal prudence in budget

Daily review 26/02/10 01/03/10 02/03/10 03/03/10 04/03/10 05/03/10 06/03/10Sensex 16,429.55 343.01 227.45 (28.31) 22.79

Nifty 4,922.30 Holi 94.70 71.10 (7.85) 8.45 Saturday

Weekly review 26/02/10 05/03/10 Points %Sensex 16,429.55 16,994.49 564.94 3.44%

Nifty 4,922.30 5,088.70 166.40 3.38%

The week ended March 5 gave enough time to investors to realign their positions in the market. The positive undertone provided by the finance minister against the backdrop of commitment to fiscal prudence was cheered by markets. Despite the decision to withdraw the fiscal stimulus, the financeministers Budget came out as a positive, since there were no great expectations. The pre-Budgetweakness gave way to bullishness.

At a time the government is defending on the fuel price hike, the price of fossil fuels made their way up.

Black gold crude oil moved up despite a fall in inventory. From $77.92 a barrel to $80.62 a barrelover the week a development that will ensure that the fuels will remain costly if the pricing is freed.This will surely influence inflation in the economy. At a time when equity markets were taking off, thedebt market continued their southward journey despite government borrowing targets being in line withexpectation. The finance ministers steps to control the fiscal deficit could not cheer bond traders. 8.24%GoI bond maturing on April 22 2018 closed at Rs 102.80 compared with Rs 102.99. Had one put Rs 1lakh in the bond a week ago, he would have left with only Rs 99,812.

Rates at longer ends through are expected to remain range bound; short-term rates are expected to climbas they track the inflation. With a fall in liquidity towards the end of the financial year, short-term ratesare expected to climb. If the central bank goes ahead with a rate hike prior to the monetary policy review

in April, it may reward those in liquid-plus schemes of mutual funds.

The yellow metal remained a preferred spot after equities. Though, experts have preferred silver to gold inthe precious metals for some time now, there is still shine left in the Gold. The price of gold moved fromRs 16,755, to 16,940, a gain of 1.16%. Gold prices will be governed by sovereign default risks loomingover Europe in the short term. Going forward, investors will be better off if they remain watchful ofinflation. Though there is an expectation that due to the base effect and arrival of rabi crops, prices areexpected to cool down, any adverse news on monsoons arrival can spook hopes.

2nd week of March 2010 Sensex gained 1%

Daily review 05/02/10 08/03/10 09/03/10 10/03/10 11/03/10 12/03/10 13/03/10Sensex 16,994.49 108.11 (50.06) 45.79 69.63 (1.34)

Nifty 5,088.70 35.30 (22.50) 14.75 17.15 3.60 Saturday

Weekly review 05/02/10 12/03/10 Points %

Sensex 16,994.49 17,166.62 172.13 1.01%Nifty 5,088.70 5137.00 48.30 0.95%

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3rd week of March 2010 Sensex gained 2.40%

Daily review 12/03/10 15/03/10 16/03/10 17/03/10 18/03/10 19/03/10 20/03/10Sensex 17,166.62 (1.63) 218.19 106.90 29.18 58.97

Nifty 5137.00 (8.10) 69.20 33.80 14.00 16.90 Saturday

Weekly review 12/03/10 19/03/10 Points %Sensex 17,166.62 17,578.23 411.61 2.40%

Nifty 5137.00 5,262.80 125.80 2.45%

4th week of March 2010 Sensex gained 0.38%

Daily review 19/03/10 22/03/10 23/03/10 24/03/10 25/03/10 26/03/10 27/03/10Sensex 17,578.23 (167.66) 40.45 107.83 85.91

Nifty 5,262.80 (57.60) 20.10 Ram Navmi 35.10 21.60 Saturday

March 24, 2010 (Wednesday) - Wall Street rally, Japan data lift Asian stocks - A strong showing on WallStreet and a massive jump in Japan's trade surplus boosted Asian markets Wednesday. The upbeat figuresstoked hopes that, with the world's two biggest economies growing stronger, a global recovery was wellon track. Japan released data showed a 651.0 billion yen (7.2 billion dollars) trade surplus in February,soaring from 70.8 billion yen the year before. The figure was helped by a 45.3 per cent jump in exports onhigher shipments of automobiles, auto parts and microchips.

The gains in New York were spurred by better-than-expected data showing existing home sales fell to5.02 million units in February. Analysts had forecast the figure to drop to 5.0 million.

Weekly review 19/03/10 26/03/10 Points %

Sensex 17,578.23 17,644.76 66.53 0.38%

Nifty 5,262.80 5,282.00 19.20 0.37%

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Breathing DeepMonthly Review

Month December 2007 December 2008 December 2009 January 2010 February 2010

Sensex 20,206.95 9,647.31 17,464.81 16,357.96 16,429.55

Points Base (10,559.64) 7,817.50 (1,106.88) 71.59

% Base (52.26%) 81.03% (6.34%) 0.44%

Small investors appetite for stocks on the wane

Retail investors appetite for equities has not kept pace with rising per capita income,

as is evident from the trend in retail shareholding over the past few years. Thepercentage of retail holding to the combined equity capital of the listed companieshas fallen from 13% to 12% between 2006 and 2009.

Brokers say only a small part of household savings continues to find its way into thestock market, because of heavy losses incurred periodically by retail investors duringsharp market corrections. Brokers attribute the biggest stock market crash of 2008 as

a key reason for retail investor apathy. From its peak of 20,873 points recorded on January 8, 2008, theSensex crashed 60% in just 10 months, causing unprecedented capital loss to many retail investors.

They also blame aggressive pricing of new issues for keeping retail investors away from the primary

markets; Of the 22 IPOs listed between 2009 and now, 13 have returned between 4% and 27% while therest have led to losses between 3% and 20%. This is in sharp contrast to the trend in 2007 when all thelistings, about 100, returned between 82% and 175% on debut.

An analysis of the change in retail shareholding in about 3,200 listed companies between 2006 and 2009shows that the percentage of individuals holding shares worth up to Rs 1 lakh (face value of the sharemultiplied by number of shares) fell gradually to 12.2% as on December 31, 2009 from 13.1% as onDecember 31, 2006. The analysis considered this period as the data relating to retail holding is availableonly since June 2006. It is now mandatory for all the listed companies to separately disclose details aboutindividual holdings having a nominal capital of Rs 1 lakh and below. The period spans the two extremephases of the stock market, the bull run of 2007-08 and the downtrend in 2008-09.

Lack of understanding of the risks involved with equity investments and volatility in the markets haveresulted in retail investors staying away from equities. There is an inclination towards safer investmentavenues like bank deposits among retail investors. The presence of financial intermediaries is mostlyconcentrated in metros and even the focus of marketing of IPOs is restricted to a few major cities in India.

According to Analysts, there has been a sharp growth in market capitalisation of listed companies over thepast 5-6 years, due to the contribution of fresh capital by promoters and institutional investors.

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Breathing DeepGood leaders buy low, sell high

Common sense tells us that we should buy when times are bad andsell when times are good. However, people find comforting to buyduring good times and sell during bad times. Partly because we lovebeing in the comfort of a herd. If all are buying, then there should besome logic to it. Seldom do we make the effort to look beyond what is

in the immediate horizon. But then, that is exactly what good leadersare all about being contrarians, seeing what is distant and doingwhat is right rather than what others are doing.

Hence, in a way a good leader is more like a good investor: he buys low and sells high.

An investor practises this in the world of finance to make a profit, while a leader practises this forconceptualising and developing his idea.

Initially, though his idea is perceived like an undervalued stock, perhaps because it is before its time orbecause the times are bad, he still supports it, adds value to it until the time has come for fruition.

He sees what is not obvious and strives to create what is not there by betting on hidden potential. Heundertakes the act of converting something worthless in the present to what is precious in the future.

So, what does buying low mean?

Buying low means looking into the future: True leadership is about committing your present to a futurethat appears to be on the lower side currently, but which you believe can be high.

Visionary leaders see the potential in things before they become obvious. They look for what is not there,what has not been said, what has not been done and imagine how things should be or could be.

Buying low means defying the crowd: If we were to ask George Bernard Shaw, he would brand a trueleader as an unreasonable man. While a reasonable man adapts himself to the world, an unreasonable mantries to adapt the world to himself.

He takes the big decision to defy the crowd.

He produces and supports ideas that go against the crowd, that are like buying low and doing the oppositeof what the world is doing, even while those ideas are viewed as bizarre, useless and even foolish.

However, as Shaw would conclude: All progress depends upon the unreasonable man.

Leadership Takeaway: Leadership is the art of buying low and selling high. There is no better time to buyinto an idea than when times are bad.

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Breathing Deep2.1 INDIAN ECONOMY

Can India be the next safe haven for investors?

The first decade of the 21st century has been lost for the global equityinvestors with MSCI World Index and Dow Jones yielding close to 0%returns. In contrast, India and other emerging markets (EMs) deliveredreturns of 13.2% and 7.3% respectively. In the next 2-3 decades, this

return differential is likely to persist as growth in EMs will outpace thatof the developed world. The legacies of the crisis are likely to weigh onthe recovery in the developed world.

During the financial crisis, EMs proved more resilient than thedeveloped world. Yet, they have failed to meaningfully shatter the

perception that the US and other developed economies are safe havens. With every rise in risk aversion,we see investors shunning EM equities and fleeing to US treasuries.

It is true that the risk gap between India and developed countries is reducing. However, we are yet to seeits impact on portfolio flows. India is the second-fastest growing economy with well-regulated and

capitalised financial system, stable political scenario, attractive demographic profile, low debt-to-GDPratio, high savings rate and domestic consumption-driven growth. Despite these, foreign portfolio flowshave shown diverging trends in India and due to capital linkages, Indian markets remain vulnerable to thedirection of FII flows, which results in huge impact cost.

The Feds balance sheet has ballooned to $2.3 trillion; more than double that of pre-crisis levels. A record$329 billion of corporate debt worldwide defaulted in 2009. Of this, North America accounted for $291 billion, a whopping 88% of total defaults. Public debt-to-GDP ratio in 20 EMs stands at around 40%against 80% in 20 developed economies, which is further expected to rise to 120% by 2014.

While the US remains worlds largest consumer market (16.6% of global GDP), consumption in EMs isgrowing at a faster pace. Emerging economies share of global GDP (on PPP basis) has grown from 37%in 1999 to 46% in 2009, and is poised to grow further as, incrementally; global growth will be led byEMs. India and China will together contribute ~45% of the worlds growth in 2010 or 2011.

In the last decade, India has outscored US in many ways: investment returns, regulatory supervision,recapitalisation of banks, better balance sheet management, number of corporate failures and dealing withsuch cases. Also, India required a modest stimulus (~2% of GDP) to recover from the crisis compared tothe US while Fed had to expand its balance sheet to arrest the downturn. This is a testament of Indiasstructural strength and effectiveness of regulations.

Even within EMs, India remained internally-focused with growth led by domestic consumption. In China,the share of household consumption in GDP has been constantly falling while that of net exports was

rising in the last decade. Indias export-to-GDP ratio stands at 21% against 41% for China.

Indias middle class is estimated at 170 million, half of the US population. It is important to note thatIndias working population as a percentage of total population is still expanding, whereas in China, it hasalready begun to shrink. It is far worse in Europe where the dependency ratio will increase rapidly andbecome a burden for the state budgets.

This coupled with the fact that India also has among the youngest population half of its 1.1 billionpeople are below 25 years old compared to 42% in Brazil, 36% in China and less than 30% in developednations consumption will undoubtedly continue to soar in the years to come.

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Going forward, India will continue to strengthen its global footprint led by strong economic growth,structurally-appreciating currency, massive infrastructure development and attractive demographicdividend. There is a need to take concrete reforms that will help attract long-term growth capital.

The huge infrastructure development need makes the case to develop a deep and liquid corporate bondmarket for global investors. At the same time, emphasis should be on ensuring long-term holdings with

commensurate incentives and tax benefits. It is equally important for the economy to develop expertise inabsorbing such foreign capital flows without creating the vicious circle of currency appreciation, loosemoney supply, credit growth and inflation.

India today offers most promising growth prospects and one of the finest opportunities for long-termwealth creation. Given Indias economic potential, global investors should invest with a longer-term viewin the country. India should take steps to raise its visibility and position itself well among the globalinvestment community along with delivering on its promises.

This would go a long way in increasing investor confidence, resulting in long-term portfolio flows that donot get fettered by short-term global worries.

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Breathing Deep2.2 INDIAN INC

India Incs Billion-Dollar Sales Club

Close to two dozen Indian companies joined the billion-dollar revenueclub over the last two years, reflecting the strength of Asias third-largesteconomy that came out unscathed from the most severe global economiccrisis since the Great Depression.

According to an ETIG study, which analysed the projected net sales forthe 12 months ending March 31 using data available for the first nine

months of the fiscal year, the number of companies in the billion-dollar club went up to 124 comparedwith 104 in the year ended March 2008.

Cipla, Lupin, Tata Tea, Tech Mahindra, Lanco Infratech, IVRCL Infrastructures and Bharat Electronicsare among the firms that joined the billion-dollar revenue league in the last two years. Some likeMotherson Sumi Systems and Apollo Tyres, which gained size through global acquisitions, also figureamong the entrants.

The study used Rs 45.5 as the rupee-dollar exchange rate for both the years to factor out currencymovement impact on dollar revenues.

The comparison has been made with FY08, which was the last year to record 9%-plus economic growth.Indias economy expanded 9.1% in FY08, before the global economic downturn pulled down growth rateto 6.7% in the next year. The government expects a growth rate of 7.2% for the current fiscal year.

Billion-dollar revenue is considered as an important benchmark by many investors who use it to shortlistthe pool of companies to invest in.

Institutions prefer the big companies by revenue due to consistency in financial terms. The increase in the

number of companies in the billion-dollar club will act as a catalyst for market growth.

Infrastructure and agriculture firms dominated the list of new entrants to the billion-dollar revenue club,as these sectors remained more-or-less unaffected by the economic downturn. This trend is reflected inthe entry of agri-related firms such as United Phosphorus and National Fertilizer into the club.

There is a lot of autonomous demand due to consumption from rural and semi-urban India which was lessaffected by the slowdown allowing companies to grow revenues. The financial slowdown impacted theurban economy much more.

While the big revenue league grew by nearly a fifth in the last two years, the group of firms with billion-

dollar market value shrank by the same ratio.

A large number of companies from the real estate and financial services sectors fell down the valuationcharts while others from FMCG, pharma, healthcare representing domestic consumption demand joinedthe list. Apollo Hospitals, Fortis Healthcare, Gillette, P&G Hygiene, Glaxo Consumer, Emami, Marico,Godrej Consumer, Aurobindo Pharma, Cadila Healthcare among others have joined the club.

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Breathing Deep2.3 INDIAN

You work hard for your money; does it do the same for you?

As a nation we have amongst the highest saving rates in the world (our grossdomestic savings as a percentage of GDP at current market prices is around 30%).The same, however, is not true of us as investors. While we do manage to put asidemore than others can, we are not really good at putting our money to work. We

could be broadly classified in two groups - the discerning and the undiscerning!

The discerning type of investor is a growing breed. He is characterised by having aclearer idea of his financial goals and objectives. He is someone who knows whathe wants and how to go about getting it. This kind of investor has a distinct idea ofhis short term and long term requirements, a fair understanding of market dynamics

and is able to understand complex products and debate upon their features. Most importantly, heapproaches investments with discipline.

The undiscerning type is the investor who often believes he is too caught up to take time out forinvestments. He has a vague idea of his short-term and long-term financial goals, has superficial

knowledge of markets and products. He is the kind who often invests on tips and follows a herdmentality when entering or exiting investments.

Most investors in India often share their relationship with more than a couple of wealth managers(relationship managers) managing independent and separate portfolios. This action results in no singlewealth manager having a holistic knowledge of the investors portfolio which is the first step towards asound financial plan. During the course of these interactions with the investors we would classify theirinteraction with the wealth managers as positive and otherwise. Let us share some of these with you:

My wealth manager is always interested in pushing a product whenever he/she meets me. Most of thetimes I think he is trying to sell refrigerators to Eskimos. Products are often recommended on the basis of

past returns with little regard for other relevant factors. Products are recommended without any regard tomy risk appetite and there is no consideration of suitability. The approach is one size fits all and I amsure he would recommend the same product to my grandmother as well.

Products that were good a few months ago suddenly turn bad without any apparent reason! This is done toget me out of existing investments so that funds can be routed to wherever he desires.

The discerning investor, however, attracts the right people to work with. We have heard some very goodthings about wealth managers and we have listed some of the feedback below. These can be construed asdesirable traits or qualities in a good wealth manager: My wealth manager is more like a member of thefamily. He/she has been with me for many years and understands me and my requirements well. He/she

meets me regularly and does regular portfolio reviews. The decision to invest is based on my risk appetiteand portfolio suitability and I am informed in detail about all costs and associated risks.

Amongst the many factors, a simple litmus test is to check if the institution: Lays particular emphasis onrisk profiling and financial planning; has a transparent advisory and product recommendation process thatminimises human bias in investment decisions; has a pre-mandated portfolio review frequency and; has aclient centric approach that emphasizes the human element. Therefore, the first step in making yourmoney work starts with you. Be informed. Be demanding. Be discerning.

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Breathing Deep2.4 CORPORATE WORLD

India Inc lines up warrant issues for promoters

In a move thats expected to boost shareholder confidence, many companies mostly mid-caps are rushing to issue convertible warrants to their promoters at asubstantial premium to the current market price. Investment bankers say thisreflects the promoters conviction in the growth prospects of their companies.

Convertible warrants are instruments which give the holder an option to subscribeto an equivalent number of shares within 18 months, at a conversion price decided at the time of theallotment. If the warrant holder doesnt exercise this option, the warrants lapse and the person will have toforego upfront margin of 25%. Mahindra Forgings, Bartronics, Filatex India, Vardhman Polytex, D&HWelding Electrodes and Agro Dutch Inds are among the companies offering warrants to their promotersand other investors at a conversion price higher than the current market price.

Investment bankers feel such moves, particularly those taken by the companies with a good track record,could boost the morale of minority shareholders, something much needed in volatile market conditions. Inan EGM, the shareholders of Mahindra Forgings approved a proposal to issue nearly 73 lakh warrants to

the promoters M&M, at a price of Rs 137 per warrant, around 28% higher than the current market price.

In the past, promoters of many companies had hiked their stake through conversion of warrants, whichhas been one of the preferred routes, because of the convenience of payment. They need to pay only 25%upfront and exercise the conversion option any time during the 18-month conversion period by investingthe balance funds, thus enjoying flexibility in payment. Experts advise prospective investors to verifysuch a possibility before taking any investment call on the companies issuing warrants at a premium.

Spurt In buy-backs fuels recovery hopes

NEW YORK: Judging by the recent flurry of share buyback announcements,

Corporate America is increasingly confident the worst of the economic slump has passed. After two years of belt tightening, stock buybacks are running at theirhighest level in two years, as companies start to look for ways to deploy therecord levels of cash on their balance sheets.

The hoards of cash for buybacks also spell good news for the broader equity market. JP Morgan estimatesthat S&P 500 companies currently have $3.2 trillion of cash sitting on their balance sheets. Excluding thefinancial sector, the cash pile is $1.1 trillion, or 11% of assets, a 60-year high and well above the long-term average of 8%. This makes it likely 2010 will mark a big turnaround in share repurchases, and therevival in capital expenditures and M&A should follow after a muted 2009.

Buybacks are viewed as sort of a way-station to the more aggressive ways to spend: acquisitions andcapital expenditures. Those expenses imply a long-term strategic bet by a company on earnings potentialand growth. Buyback authorisations are cyclical and do tend to move with recessions and expansions.New stock buybacks have been particularly robust in the latest earnings reporting season, averaging $1.6billion daily, the highest level in almost two years.

Buybacks reward shareholders by reducing outstanding shares, driving up the price of existing stock, andimproving earnings-per-share figures. But they can be cancelled more easily than a big acquisition.Investors tend to be forgiving if companies suspend buybacks when the going suddenly gets tough, unlikecutting a dividend or abandoning capital expansion plans.

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Breathing Deep2.5 INTERNATIONAL

Currency Manipulator

Don't politicise yuan,

China tells Obama:

BEIJING: The United States should not make a political issue out of the

yuan, a Chinese central banker said, as the two countries lurched towardsa potential bust-up over Beijings currency regime.

The latest rhetorical salvoes underlined how long-running friction causedby the yuans de facto dollar peg could come to a head next month when US president Barack Obamasadministration decides whether to brand China as a currency manipulator.

Peoples Bank of China vice Governor Su Ning said the United States should look to itself to boostexports and not cast blame on other countries, when asked to comment on remarks by Obama, who calledon China to move to a more market-oriented exchange rate.

Ning said, We always refuse to politicise the yuan exchange rate issue, and we never think that onecountry should ask another country for help in solving its own problems.

Obamas rare comment about the currency comes as his administration mulls whether to use thecurrency manipulator label in a semi-annual Treasury Department report due on April 15, which couldset in train punitive actions against China.

With Obama facing domestic pressure to take a tough line against China and Beijing clinging to its dollarpeg, the report could act as a tipping point.

If China flinches, it may soon resume the yuan appreciation halted in mid-2008 to cushion the countryfrom the global credit crunch.

But if China keeps the yuan locked in place, then scattered trade spats between the two giants couldescalate into a full-fledged dispute, with Washington even considering across-the board tariffs againstChinese products.

Stephen Green, China economist for Standard Chartered Bank in Shanghai said, The chances of acollision have never been higher.

Asked whether it might be counter-productive for Washington to ratchet up pressure over the yuan, Greensaid: Thats the $64-billion question to which no one really knows the answer.

Li Jianwei, a director in Development Research Centre, a think-tank under Chinas cabinet, wasunequivocal: demands for aggressive yuan appreciation will harm not only China but also the UnitedStates and others.

A stronger yuan will hit exports and lead to a double dip in the Chinese economy, which in turn willhamper the global economic recovery.

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Breathing DeepYuan not undervalued: Wen Jiabao

Chinese Premier Wen Jiabao rejected foreign calls for the yuan to rise andshowed no let up in scolding the United States over recent bilateraltensions. Wen said calls from the United States and other big economiesfor China to lift the value of its yuan currency were unhelpful, evenprotectionist, and vowed that Beijing will steer its own way on currency

reform through a risk-filled economic landscape.

Wen told in a news conference at the end of China's annual parliament meeting, "We oppose mutualaccusations between countries, and even using coercion to force a country to raise its exchange rate, because that's of no help to reforming the yuan exchange rate," "We don't believe that the yuan isundervalued." Wen used the keynote event to both cast China as a benign political and economic powerand as the victim of unfair international demands.

Rebuffs external pressures: Without directly mentioning the United States, Wen made clear that Beijingwas in no mood to surrender to any demands from Washington and might even be girding for a fight. "Ican understand some countries' desire to raise exports, but what I do not understand is depreciating one's

own currency and attempting to pressure others to appreciate, for the purpose of increasing exports. In myview, that is protectionism."

However Wen pressed Beijing's own worries about Washington policy, as he did at last year's newsconference, "We are very concerned about the lack of stability in the U.S. dollar. If I said I was worriedlast year, I must say I am still worried this year." China is the world's biggest holder of U.S. Treasurydebt, holding $894.8 billion worth, "We cannot afford any misstep, no matter how slight, in ourinvestments. U.S. debt is guaranteed by the U.S. government, so I hope that the United States will takeconcrete steps to reassure international investors."

Beijing and Washington have also recently been at odds over new U.S. arms sales to Taiwan, the self-

ruled island China claims as its own territory, and Obama's meeting in the White House with the DalaiLama, the exiled Tibetan leader reviled by Beijing. Wen said about their ties that the responsibility for theserious disruption in U.S. - China ties does not lie with the Chinese side but with the U.S.

Domestic worries weigh: Wen also stressed that domestic worries weighed on policy, "I have said that ifthere is inflation, plus unfair income distribution and corruption, they will be strong enough to affectsocial stability and even the stability of the state's power. It will be an extremely difficult task for us to promote steady and fast economic growth, adjust our economic structure and manage inflationexpectations all at the same time."

China escaped the worst of the global slump by ramping up credit, slashing interest rates and launching a

4 trillion yuan ($585 billion) infrastructure stimulus program in late 2008. Its economy grew 8.7 percentlast year as a result, by far the fastest pace of any major country. But price increases have followed in thewake of that burst of spending and easy credit. Consumer price inflation rose to 2.7 percent in the year toFebruary from 1.5 percent in the year to January, spurting to a 16-month high. Rising housing prices havealso stoked domestic disquiet. The government wants to limit inflation for the whole year to 3 percent.

Wen unveiled rises of 8.8% on social spending and 12.8% on rural outlays, more than the rise of 7.5% inthe military budget, to narrow the wealth gap economists blame for dampening domestic consumption.

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Breathing DeepChina faces the 'greatest bubble' in history

James Rickards, former general counsel of hedge fund Long-Term Capital Managementsaid, China is in the midst of the greatest bubble in history.

The Chinese central banks balance sheet resembles that of a hedge fund buying dollarsand short-selling the yuan.

Rickards, now the senior managing director for market intelligence at consulting firmOmnis said, As I see it, it is the greatest bubble in history with the most massive misallocation ofwealth.

At the Asset Allocation Summit Asia 2010 organised by Terrapinn in Hong Kong, Rickards said, Chinais a bubble waiting to burst.

Rickards joins hedge fund manager Jim Chanos, Gloom, Boom & Doom publisher Marc Faber andHarvard University professor Kenneth Rogoff in warning of a potential crash in Chinas economy.

China has pegged the yuan to the dollar since July 2008 to help exporters weather the global recession.The central bank buys dollars and sells its own currency to prevent the yuan strengthening, drivingforeign-exchange reserves to a world-record $2.4 trillion as of December.

The Shanghai Composite Index of stocks jumped 80% last year and property prices rose at the fastestpace in almost 2-years in February, helped by a record 9.59 trillion yuan ($1.4 trillion) of new loans in2009.

Rickards said leveraged speculation in the stock market, wasteful allocation of resources by state-ownedenterprises, off-balance-sheet debt through regional governments and the countrys human rights recordare concerns.

Rickards also disputed an argument that China could hold US policies hostage through its Treasuriesholdings. The nation remained the largest overseas owner of US debt after trimming its holdings by $5.8billion in January to $889 billion. China will suffer massive losses if the debt was dumped, reducing thefunds available in the US securities market and forcing the prices lower, he said.

Take Russia and China together, neither of them is really deserving any investment except for short-term speculation. India and Brazil are two of the real economies among the developing countries.

The World Bank has indicated in a quarterly report on China released in Beijing, that

China should raise interest rates to help contain the risk of a property bubble and allowa stronger yuan to help damp inflation expectations. The nations massive monetarystimulus risks triggering large asset-price increases, a housing bubble, and bad debtsfrom the financing of local-government projects.

China is poised to overtake Japan as the worlds second-largest economy this year, according to the IMF,and Nomura Holdings forecasts it will contribute more than a third to global growth. The nation hassurpassed the US as the worlds largest auto market and Germany as the No. 1 exporter.

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Breathing Deep2.6 WARNING SIGNALS

Greece Cabinet Passes Euro 4.8-Bllion Austerity

ATHENS - Greece's cabinet approved a sweeping new austerityprogramme on Mar 3, 2010, the third in as many months, intended torein in a bulging budget deficit and secure European financial support.

A government spokesman said the package of public sector pay cutsand tax increases would save an extra 4.8 billion euros ($ 6.5 billion),equivalent to 2 percent of gross domestic product. Prime MinisterGeorge Papandreou said, "Additional steps were necessary for the

country's survival. The measures included an increase of value added tax by 2% to 21%, cutting publicsector salary bonuses by 30%, increases in tax on fuel, tobacco and alcohol, as well as freezing state-funded pensions this year.

Greece is under pressure from the European Union and financial markets to fulfil a promise to cut thebudget deficit to 8.7 percent of GDP this year from 12.7 percent in 2009. But EU inspectors estimated theausterity plans announced so far would only go half-way due to a deeper than forecast recession.

Papandreou told the cabinet that if the EU did not provide financial support now, Greece had the option ofturning to the International Monetary Fund. Speaking to members of his PASOK party, he compared hiscountry's fiscal crisis to a war and said he would have to take harsh and possibly unfair measures. All ofEurope would be threatened, he said, if Greece failed to take brave decisions to cut a 300 billion euro debtmountain, equivalent to 125 percent of the country's annual output.

The euro rose on foreign exchange markets on the news and Greece's borrowing costs fell further, withthe risk premium on Greek 10-year bonds over benchmark German bunds at 289 basis points, the lowestsince early February. The relief was evident in the money markets once Greece announced its additionalausterity measures. This increases their chance of navigating through these troubles.

In a first reaction, Germany's economy minister, who has accused Greece of endangering the euro,welcomed the latest measures, adding it was essential that they be implemented. European governmentsources have said Germany and France are working on contingency plans under which state-ownedfinancial institutions would directly purchase billions of euros in Greek bonds or offer guarantees tocommercial banks that bought them.

Although market pressure on Greece has eased in recent days, a Reuters poll of economists showed thatscepticism about the government's ability to meet a goal to slash its deficit by four percentage points thisyear still runs deep. Only 18 of 47 respondents said they believed Athens would meet that target, withmost predicting a "slow burn" scenario through 2010 in which the government makes only limited

progress in reducing the deficit.

Social Explosion

The main public sector trade union, which has called another one-day strike for March 16, vowed to fightthe new measures. General secretary Ilias Iliopoulos said "We will be on the streets with all our might. Iam afraid there will be a social explosion. People will start going hungry soon." About 500 pensionersrallied in central Athens and marched to the finance ministry in a first protest against the new measures.Civil servants also planned an anti-austerity demonstration outside the ministry. However, opinion pollssuggest the government retains majority support for its austerity plans.

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Breathing Deep3.1 MUTUAL FUNDS

Let fund managers guide you

There are many investors who after witnessing sensational stock marketcrashes in the past have a mortal fear of investing in equities. However, withreturns from traditional fixed income products turning unattractive, investing inequities is perhaps the only way to beat inflation. In such a scenario, what are

the choices that such an investor has? Fund managers have come out withinnovative schemes as the answer to the dilemmas faced by such investors.

Capital protection strategy:

If you desire better return on capital and at the same time you are concerned about the return of capital,this is the scheme for you. These are close-ended debt mutual funds. The fund invests a part of yoursubscription into high-quality fixed income instruments that by the end of the term of the scheme reachesat least the original sum. Rest of the money is invested in equity with the sole objective to enhancereturns. However, one must remember that such products are generally illiquid and one may have toremain invested for the full tenure of the product to reap its benefits. For example, if you invest Rs 1 lakh

in such a scheme with 3-year tenure, the fund manager will put approximately Rs 85,000 in fixed incomeinstruments which will grow to Rs 1 lakh. The rest of the money, Rs 15,000, will be invested in equities.Rs 85,000 invested in debts for a period of 3 years will give you interest income sufficient to protect yourcapital while extra returns could come in from equities.

Structured products:

Over the past couple of years, structured products have guaranteed success of your capital in the market.Investors in such schemes can get to earn a return linked to the returns generated by underlying stockindex or a stock. You are offered higher part of the fixed coupon and the returns generated by theunderlying. There are two versions of products, one that offers a capital protection and another that does

not. Risk-averse investors can look at the former. However, a point to note is the minimum ticket size is atad higher and typically stands above Rs 20 lakh. The products are available only through the privatebanking channels that cater to high net worth individuals.

Monthly income plans:

MIPs launched by MFs deploy money into a mix of equities and fixed income instruments. The onlydifference between an MIP and balanced fund is that in the case of MIP, the fixed income weight ishigher. In some cases, it is as high as 95%. MIPs though are aimed to generate regular returns that takecare of income needs; there is no guarantee that there will be regular payouts to the investors. Investorsrun the risk of losing money. MIPs work better than capital-oriented products for investors with a 3-year

time frame, since the fund manager has the flexibility to alter the duration of the portfolio depending onthe interest rate scenario.

Combination of debt and equity funds:

If you are willing to take some efforts, you can choose to invest into a combination of equity and debtfunds. Depending on your risk appetite, you may choose to put 10-20% of your money into equity funds.This helps you ensure you will earn good risk-adjusted returns over 3-5 years. When you choose equityfunds, you will be better off picking funds from dividend yield funds, index funds or diversified equityfunds with long-term track record.

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Breathing Deep3.2 CORPORATE BOND MARKET

Let Corporate Bonds Take Over

With India recovering smartly from the economic crisis, the government is settingits sights on achieving its target growth of 9%. The policy debate also needs toshift to the reforms to sustain rapid growth over the long run. Enabling Indiasfinancial system to serve the needs of its increasingly-dynamic economy is a

critical element of this policy agenda. And now is an opportune time to makestrides towards a domestic corporate bond market.

A deep and liquid corporate bond market is the financial equivalent of motherhood and apple pie something worthy and desirable. Bond markets play a fundamentally different role from banks byproviding long-term finance for investment and allowing firms to diversify their sources of funding.

The need to develop this market has long been recognised in India. The Patil, Mistry, and Rajan reportspoint to it as a critical missing link in the Indian financial system. More recently, at the India EconomicSummit in November 2009, Prime Minister Manmohan Singh himself emphasised the importance to Indiaof a vibrant corporate bond market when he said, We need to ensure that the financial system can

provide the finance needed for our development, and especially for infrastructure development Weneed to develop long-term debt markets and to deepen corporate bond markets.

With the Indian government set on a big push for infrastructure investment, a strong corporate bondmarket is vital. Examples of Asian countries that have relied on the development of corporate bondmarket for infrastructure building are South Korea, Thailand and Malaysia.

The domestic bank-centred system is ill-equipped to provide financing for infrastructure projects. Banksliabilities are short term, while infrastructure projects have long gestation periods. Too many of theseprojects on banks books could expose them to large asset-liability mismatches and high concentrationrisks, undermining financial stability.

A deep bond market would serve useful functions other than for infrastructure finance, such as to broadenaccess to credit by allowing banks to reduce their corporate exposure as blue-chip companies may shiftto issuing bonds and provide funds to under-served sectors, such as SMEs and households.

Yet, Indias corporate bond market remains stunted. So what needs to be done? In many emergingmarkets, the takeoff of the corporate bond market has been linked to the development of their domesticinstitutional investor base: these are institutions with long-term liabilities and, hence, are ideally suited totake on long-term assets. For example, in Mexico, the pension fund industry was key and, in Malaysia,the easing of investment restriction on insurance companies served the same purpose. In India, insurancecompanies and pension/provident funds are growing rapidly, but they invest most of their assets in

government securities.

Liquidity is the sine qua non of any vibrant financial market; a high volume of transactions is the pre-requisite for price formation and discovery. Domestic institutional investors are typically buy-and-holdinvestors, so a liquid market requires other players, usually foreigners. For this reason, the IMF hassuggested increasing the limits for foreign investors in local bond markets. Critics fear that increased participation by foreign investors will bring volatility. This may happen initially, but once the marketbecomes deep and liquid, prices should become less volatile for any given shock. With the governmentsrenewed commitment to fiscal consolidation and fiscal discipline, this could be an opportune juncture tomake the push to develop a deep corporate bond market in earnest.

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Breathing Deep3.3 GOLD ETFs

Cut in Charges to Boost Trading

The National Stock Exchanges (NSE) move to slash transaction charges on goldexchange-traded funds (ETFs) will benefit trading members who take proprietary bets,

more than their retail clients, feel market watchers. Theexchanges move is expected to boost trading volumes in

gold ETFs, but will not result in any meaningful costreduction for retail investors, they say.

Gold ETFs are units representing physical gold held in dematerialised form and normally quoted in priceper gram of gold. A client wanting to invest in the ETF can buy and sell one unit, representing a gram,whose current price is around Rs 1,650 levels.

For the period from March 1 to September 30, NSE has reduced transaction charges for gold ETFs to Re1 per lakh of the traded value (each side) against the earlier slabs, from Rs 3 a lakh to a maximum of Rs3.25. Brokers charge their clients between 0.2% and 0.5% on delivery-based transactions in gold ETFs,excluding exchange charges and stamp duty. An investor putting Rs 4 lakh into a gold ETF would save

around Rs 9 after the reduced charge is passed on, which really wont make much of a difference. Itcould, however, make a difference where the prop book size is large.

At present, there are seven gold ETFs listed on the NSE, managed by fund houses Benchmark, Kotak,Quantum, Reliance, SBI, UTI and Religare. Industry experts peg the total holding of gold with six of theexchange-traded funds as of end-February at around 9-tonne, with Benchmarks holding alone at around4.5 tonne.

There has been a perceptible shift from buying bars and coins to investing in goldETFs. While the consumption of gold has been on the decline, investment intogold ETFs has been going up steadily.

Globally, some gold ETFs buy and physically hold gold bars while others invest infutures contracts. Physically-backed gold ETFs track the spot price of gold moreaccurately, since the value of the underlying holdings depends solely on themarket price of bullion.

The exchange has also waived transaction charges for all trades in ETFs based on money marketinstruments. Currently, Liquid BeES (Liquid Benchmark Exchange Traded Scheme) is the only moneymarket ETF listed on the NSE. It invests in a basket of call money, short-term government securities andmoney market instruments of short and medium maturities.

It is settled on a T+2 rolling basis. Benchmark isawaiting the green signal from capital market regulatorSebi to launch the first-ever Gilt ETF on NSE.

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Breathing Deep4.0 FINANCIAL SECTOR: TRANSFORMING TOMORROW

Breathing Deep

The financial sector received considerable attention in Budget 2010. The mostsignificant aspect from a broader economic context but that also has a material

bearing on the financial sector was the governments stance on budget deficit.

In the context of spiralling fiscal deficits run by governments in matureeconomies and mounting levels of government debt as a proportion of GDP inthose economies, India had to seize the moment as well as the economic

momentum that it is experiencing to rein in deficits and present a differentiated level of financialdiscipline that would sustain the confidence of investors and lenders to continue funding Indias growth.The Budget addresses this concern satisfactorily.

4.1 FINANCIAL ADVISORS:Weigh impact on investors: What budget holds out for financial services?

Fiscal Reform

Borrowing programme: At Rs 3.8-lakh crore, the governments borrowing programme for next year ispegged at levels below that for the current year. This should allay concerns of investments being crowdedout by government borrowings along with adverse inflationary and interest rate expectations.

Deficit levels and government debt: By committing to progressively contain deficit levels and bringgovernment debt down to 68% of GDP over the next few years consistent with the 13 th FinanceCommission recommendations, and to bring out a paper on how this will be done in 6-months, thegovernment sets out an agenda for fiscal reform.

Disinvestments: At Rs 40,000 crore, the governments target for raising funds from disinvestments

represents about 80% of funds raised from capital markets during 2009. This will permit investmentbanks to bolster their credentials, and, if successful, ensure that the capital markets will see a substantialsupply of equity paper.

Funding of the infrastructure sector: The India Infrastructure Finance Co (IIFCL) is expected to increaseits funding of the infrastructure sector. Importantly, from a banking sector perspective, the FM expectsIIFCL to develop a framework under which it will take out financing extended by commercial banks toinfrastructure projects; a working arrangement , if devised, would permit commercial banks to lend toinfrastructure projects without creating material asset-liability mismatches.

Government ownership in public sector banks: Tier-I capital of public sector banks is sought to be shored

up to 8% by the end of next year, with the government injecting Rs 16,500 crore of additional equity.Working on an average government ownership in public sector banks at 60%, this would imply that themarkets will see follow-on public offers for Rs 11,000 crore from this segment of the banking sector.

Banking licences to private sector: While details are limited, the FM indicated that banking licences will be issued to private sector organisations, including NBFCs. Yes Bank was the last private bank to begranted a licence, and that was over five years ago. Given the conservative stance of the RBI on banklicensing, the number of private banks in the country is unlikely to swell materially in a hurry.

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Breathing Deep

Overhaul of outdated legislation: An overhaul of outdated legislation governing the financial sector isproposed to be undertaken by the Financial Sector Legislative Reforms Commission. Indias insurancelegislation dates back to 1938, the Securities Contracts Regulation Act was enacted in 1956, and theBanking Regulation Act was introduced in 1949.

Also, there are provisions relating to the financial sector contained in the Companies Act and the Income-

Tax Act, all of which could do with a review to make provisions contemporary. A proposal to amend thepermitted level of foreign ownership in insurance companies has been with the government for severalyears, as have proposals to amend many provisions in the Banking Regulations Act. One can only hopethat the reforms commissions efforts meet greater success.

Financial Stability and Development Council: The government proposes to establish a Financial Stabilityand Development Council to monitor macro prudential supervision of the economy. The council, intendedto strengthen and institutionalise the mechanism for maintaining financial stability, is meant to operatewithout derogating powers of existing regulators.

Tax proposals: Specific tax proposals did little for the financial services sector. However, a proposal to

subject transactions in securities between unrelated parties to a fair market value test has the potential to become a nuisance for such transactions. Although being introduced to plug abusive transactions, theabsence of safe harbours in the broadly-worded provisions could have unintended consequences. Beyondthis, the financial services sector will need to await the Direct Taxes Code and the Goods and ServicesAct, both of which are intended to be introduced effective April 1, 2011.

In summary, Budget 2010 contains a combination of near-term actions and policy initiatives that couldtake longer to implement. As always, actual action will count for more than announced intentions.

4.2 WEALTH MANAGERS

Map out the details to translate into benefits:

Fiscal stimulus

Fiscal stimulus in the Keynesian framework consists of extreme affirmativegovernment action through the Budget to boost economic activity. Traditionally,this concept would refer to increasing fiscal deficits wherein the governmentspends, through high borrowings or printing of currency, to provide purchasingpower to the people so that demand is sustained. Therefore, the pre-requisite of afiscal stimulus is a high fiscal deficit. Such deficits are brought about by eitherhigher expenditure or lower tax rates. In India, stimulus exhibited big increase in

fiscal deficit by 166% in 2008-09. Subsequently, the increase in 2009-10 wasmoderate at 23% and has been largely withdrawn in 2010-11.

The interesting observation is that the total expenditure had actually increased sharply before the financialcrisis in 2007-08, when the deficit was at 2.7% of GDP. The increase in 2008-09 was actually more due tohigher inflation. Even in case of nominal expenditure, the increase in 2008-09 was on revenue account the typical Keynesian variety of NREGA, where income was provided for the poor to spend money andgot reflected in Plan expenditure. But the government did not spend on projects as seen in the decline incapital expenditure in 2008-09, which was subsequently brought back to the 2007-08 level in 2009-10.

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Breathing Deep

The view evidently was the short run where the thrust was on reviving consumption by addressing issuesof poverty. Further, the government spent more on the three critical components of non-developmentexpenditure, i.e., subsidies, interest and defence, in 2008-09. However, subsidies were just aboutmaintained in 2009-10 at 2008-09 level. The conclusion is that there was nominal increase in expenditurein 2008-09 and 2009-10, and a gradual withdrawal in 2010-11.

How effective were these expenditures? It must be realised that the countrys GDP growth had slid to6.7% in 2008-09 from two successive years of over 9%. This was so as both, growth in privateconsumption expenditure and capital formation, had slowed down to 6.8% and 4.0% respectively in 2008-09 from 9.6% and 16.9% in 2007-08. Further, in 2009-10, growth in consumption and capital formationwas tardy at 4.1% and 5.2%.

The higher spending invoked by the government, gets reflected in the social services and governmentadministration component of GDP, displayed a high growth rate of 13.9% in 2008-09 and 8.2% in 2009-10. This was a classic Keynesian stimulus of higher government expenditure compensating for the loss ofdemand generated by the private sector. However, government expenditure of the non-projects varietycannot lead to sustained growth and can, at best, compensate for any shortfall in private sector activity.

How has the private sector been affected by the Budget? The government has taken a major hit in itstax collection in 2008-09 and 2009-10 by reduction in excise and Customs duty rates. Indirect taxcollections declined in the two crisis years and the effective tax rates have come down quite drastically by3.7% in the case of Customs and 5.6% for excise duties. This was the stimulus provided on the productionside to industry in particular that will be reversed in the coming year.

What are the takeaways from this analysis? The first is that the expenditure was directed not atcreating capital but more at providing relief to the poor. The second was that it helped to compensatetardy growth in private consumption and capital formation. Third, the lowering of tax rates provided animpetus for sure. Therefore, it was Keynes at both the ends.

4.3 FINANCIAL PLANNERSValue unlocking for all stakeholders: The dangers of deficit reduction

Deficit reduction

A wave of fiscal austerity is rushing over Europe and America. The magnitude of budget deficits like the magnitude of the downturn has taken many bysurprise. But despite protests by the yesterdays proponents of deregulation, whowould like the government to remain passive, most economists believe that

government spending has made a difference, helping avert another GreatDepression. Most economists also agree that it is a mistake to look at only one

side of a balance sheet (whether for the public or private sector).

One has to look not only at what a country or firm owes, but also at its assets. This should help answerthose financial sector hawks, who are raising alarms about government spending. After all, even deficithawks acknowledge that we should be focusing not on todays deficit, but on the long-term national debt.Spending, especially on investments in education, technology, and infrastructure, can actually lead tolower long-term deficits. Faster growth and returns on public investment yield higher tax revenues, and a5% to 6% return is more than enough to offset temporary increases in the national debt.

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Breathing Deep

A social cost-benefit analysis (taking into account impacts other than on the budget) makes suchexpenditures, even when debt-financed, even more attractive.

Finally, most economists agree that, apart from these considerations, the appropriate size of a deficitdepends in part on the state of the economy. A weaker economy calls for a larger deficit, and theappropriate size of the deficit in the face of a recession depends on the precise circumstances. Forecasting

is always difficult, but especially so in troubled times. What has happened is (fortunately) not an everydayoccurrence; it would be foolish to look at past recoveries to predict this one.

In America, for instance, bad debt and foreclosures are at levels not seen for three-quarters of a century;the decline in credit in 2009 was the largest since 1942. Comparisons to the Great Depression are alsodeceptive, because the economy today is so different in so many ways. And nearly all experts have provenhighly fallible - witness the U.S. Federal Reserves dismal forecasting record before the crisis.

Yet, even with large deficits, economic growth in the US and Europe is anaemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continuedstagnation - of growth too weak to return unemployment to normal levels anytime soon.

The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, ofcourse, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then apremature exit from deficit spending risks pushing the economy back into recession. This is one of thelessons we should have learnt from Americas experience in the Great Depression; it is also one of thelessons to emerge from Japans experience in the late 1990s.

These points are particularly germane for the hardest-hit economies. The UK, for example, has had aharder time than other countries for an obvious reason: it had a real-estate bubble (though of lessconsequence than in Spain), and finance, which was at the epicentre of the crisis, played a more importantrole in its economy than it does in other countries. The UKs weaker performance is not the result of

worse policies; indeed, compared to the US, its bank bailouts and labour-market policies were, in manyways, far better. It avoided the massive waste of human resources associated with high unemployment inAmerica, where almost one out of five people who would like a full-time job cannot find one.

As the global economy returns to growth, governments should, of course, have plans on the drawingboard to raise taxes and cut expenditures. Principles like it is better to tax bad things than good thingsmight suggest imposing environmental taxes. The financial sector has imposed huge externalities on therest of society. Americas financial industry polluted the world with toxic mortgages, and, in line with thewell established polluter pays principle, taxes should be imposed on it. Besides, well-designed taxes onthe financial sector might help alleviate problems caused by excessive leverage and banks that are too bigto fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their

key societal role of providing credit.

Over the longer term, most economists agree that governments, especially in advanced industrialcountries with ageing populations, should be concerned about the sustainability of their policies. But wemust be wary of deficit fetishism. Deficits to finance wars or giveaways to the financial sector (ashappened on a massive scale in the US) lead to liabilities without corresponding assets, imposing a burdenon future generations. But high-return public investments that more than pay for themselves can actuallyimprove the wellbeing of future generations. These are questions for a later day - at least in manycountries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear:reducing government spending is a risk not worth taking.

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Breathing Deep4.4 INCLUSIVE CEOsInnovative responses to problems: fewer bangs for US stimulus buck

Counter-cyclical policy

The run-up to the economic crisis in the United States wascharacterised by excessive leverage in financial institutions and the

household sector, inflating an asset bubble that eventually collapsedand left balance sheets damaged to varying degrees. The aftermathinvolves resetting asset values, deleveraging, and rehabilitating balancesheets resulting in today's higher saving rate, significant shortfall in

domestic demand, and sharp up tick in unemployment.

So the most important question the US now faces is whether continued fiscal and monetary stimulus can,as some believe, help to right the economy. To be sure, at the height of the crisis, the combined effect offiscal stimulus and massive monetary easing had a big impact in preventing a credit freeze and limitingthe downward spiral in asset prices and real economic activity. But that period is over.

The reason is simple: the pre-crisis period of consuming capital gains that turned out to be at least partlyephemeral inevitably led to a post-crisis period of inhibited spending, diminished demand, and higherunemployment. Counter-cyclical policy can moderate these negative effects, but it cannot undo thedamage or accelerate the recovery beyond fairly strict limits.

As a result, the benefits associated with deficit-financed boosts to household income are now beingdiminished by the propensity to save and rebuild net worth. On the business side, investment andemployment follows demand once the inventory cycle has run its course. Until demand returns, businesswill remain in a cost-cutting mode.

The bottom line is that deficit spending is now fighting a losing battle with an

economy that is deleveraging and restructuring its balance sheets, its exports, andits microeconomic composition in short, its future growth potential. Thatrestructuring will occur, deficit spending or no deficit spending.

So policy needs to acknowledge the fact that there are limits to how fast thisrestructuring can be accomplished. Attempting to exceed these speed limits notonly risks damaging the fiscal balance and the dollar's stability and resilience, butalso may leave the economy and government finances highly vulnerable to futureshocks that outweigh the quite modest short-term benefits of acceleratedinvestment and employment. Demand will revive, but only slowly.

True, asset prices have recovered enough to help balance sheets, but probably not enough to helpconsumption. The impact on consumption will largely have to wait until balance sheets, for bothhouseholds and businesses, are more fully repaired.

Higher foreign demand from today's trade-surplus countries (China, Germany, and Japan, among others)could help restore some of the missing demand. But that involves structural change in those economies aswell, and thus will take time. Moreover, responding to expanded foreign demand will require structuralchanges in the US economy, which will also take time.

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Breathing Deep

This is not to say that rebalancing global demand is unimportant. Quite the contrary. But achieving thatgoal has more to do with restoring the underpinnings of global growth over three-to-five years than it doeswith a short-term restoration of balance and employment in the advanced economies, especially the US.

Today, the best way to use deficits and government debt is to focuson distributional issues, particularly the unemployed, both actual and

potential. In an extended balance-sheet recession of this type,unemployment benefits need to be substantial and prolonged. Theargument that this would discourage the unemployed from seekingwork has merit in normal times, but not now. Today's unemployment,after all, is structural, rather than the result of perverse incentives.Benefits should be expanded and extended for a limited, discretionary

period. When structural barriers to employment have diminished, unemployment benefits should revert totheir old norms. Doing this would not only reduce the unequal burden now being carried by theunemployed; it would also help to sustain consumption, and perhaps reduce some precautionary savingsamong those who fear losing their jobs in the future.

Monetary policy is a more complex and difficult balancing act. Amore aggressive interest-rate policy would likely reduce asset prices(or at least slow the rate of appreciation), increase adjustable-ratedebt-service burdens, and trigger additional balance-sheet distress anddisorderly deleveraging, such as foreclosures. All of this would slowthe recovery, perhaps even causing it to stall. But there areconsequences to abjuring this approach as well. Low-cost credit isunlikely to have a significant impact on consumption in the short run,

but it can produce asset inflation and misallocations.

Much of the rest of the world would prefer a stronger dollar, fewer capital inflows with a carry-trade

flavour, and less need to manage their own currencies' appreciation to avoid adverse consequences fortheir economies' competitiveness. In short, the sort of monetary policy now being practised for a fragileeconomy like the US will cause distortions in the global economy that require policy responses in manyother countries.

From a political point of view, the crisis has been portrayed as afailure of financial regulation, with irresponsible lending fuelling arapid rise in systemic risk. That leaves the rest of the real economy populated with people who feel like victims albeit victims who,prior to the crisis, bought a lot of houses, vacations, TVs, and cars.

Unfortunately, that perception pushes the policy response in thedirection of too much remedial action, even when the marginal returnsare low. What we most need now is support for the unemployed,

stable government finances with a clearly communicated deficit-reduction plan, some truth-telling aboutmedium-term growth prospects, and an orderly healing process in which balance sheets are restoredmostly without government intervention.

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Breathing Deep4.5 ONE-STOP-SHOPSDedicated to offer related services under a roof;

Careful with lessons

Trade unions are confusing financial markets with free markets. Thefinancial crisis has shown that free markets and free trade cannot correct

themselves. The International Trade Union Federation saying, Wewarned business and politicians of dangerous instability in the globaleconomy. Business and governments created this crisis on their own, butthey wont be able to solve it unless they work with unions to stop theglobal jobs haemorrhage, kick start the world economy and put a properregulatory framework in place.

Trade union prescriptions confuse financial markets with free marketsand mirror image the error of market fundamentalist in recommending

that the state should substitute for markets or reduce their volatility. This misunderstands the sources ofprosperity and job creation.

Finance is valuable, and drunk driving is not an argument against cars. The debate is whether centralbanks should lean into asset bubbles. But even if they should, how does a central bank know when?

Professor Robert Lucas at the University of Chicago quips that if an economist had a formula that couldreliably forecast crises a week in advance, then the prices would fall a week earlier.

The problems of modern finance are not an argument against the 200-year spectacular track record of freemarkets and entrepreneurship in poverty reduction. The modern free market economies are now 20 timesbetter off than the 1800 AD average. Even in India, more people have been brought out of poverty sincewe stopped asphyxiating markets 18 years ago than the four decades before that; the Planning

Commissions recent proposal to redefine poverty reinforce that garibi hatao needs amiri banao.

At best, the crisis validates distinction between good entrepreneurship which creates jobs, innovation,wealth, etc and bad entrepreneurship financial engineering, money from money, etc. But should wecreate regulatory mechanisms that act as an antibiotic to these animal spirits and force people to live lifeat the mean? Entrepreneurs, by definition, have dreams larger than wallets. High tide allows them tochallenge incumbents by opening windows where belonging to the lucky sperm club is not as importantas the courage in your heart, the strength of your back and or the sweat of your brow.

Behavioural Economics professor Dan Ariely says, A society in which no one is overly optimistic and noone takes too much risk wouldnt advance. There is utility in over optimism; Individuals often suffer

because of an overly bright outlook and end up dead, poor or bankrupt because they underestimated thedownside. But society as whole often benefits from behaviour spurred by upbeat outlooks. So, beinghighly positive can lead to disaster for individuals but benefit society as a whole.

The magnificent ruins at Halibut in Karnataka have three animal carvings holding up the building;elephants for stability, horses for speed and lions for courage. Wise societies need all three. India has justbegun a Cambrian explosion that is making a million statistically independent tries in creating jobs andcompanies. It would be a tragedy if the global financial crisis becomes an alibi for trade unions tosabotage our march of entrepreneurship and poverty reduction.

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Breathing Deep4.6 CREDIT COUNSELORSResolve convertibility and recompensation issue:

Expose the fallacy of specious arguments

It is a little over two years to the day investment bank Bear Stearns collapsed,triggering one of the most painful economic recessions the world has witnessed

since the Great Depression. A great many lessons have been learnt though thelearning process is not yet complete in many areas: the need to rein in ratingagencies, clean up the regulatory mess in the US, rejig capital adequacy norms,address underlying macro-economic imbalances and so on.

But what is truly amazing is how quickly some of the lessons of history arebeing unlearnt in the search for ways to deal with the fallout of the emergency

measures taken earlier to keep the global economy afloat. The most egregious of these is contained in arecent International Monetary Fund (IMF) paper co-authored by Olivier Blanchard, Giovanni DellAriccia and Paolo Mauro.

Amazingly, the paper argues that a higher inflation rate would have given monetary authorities moreleeway to cut interest rates during the crisis. A low and stable rate of inflation in the range of 1-2% inmost of the developed world during the pre-crisis years meant monetary authorities could at best bringreal interest rates down to 1% or 2% even if they cut nominal rates to zero.

Had inflation been higher, say 3-5%, the effect of a zero nominal rate of interest would have been a muchhigher negative rate of interest and, hence, it would have been possible to give an even bigger push toeconomic activity, say the trio.

Had (central banks) been able to, they would have decreased the rate further... But the zero nominalinterest rate bound prevented them from doing so.

The paper adds, It is clear that the zero nominal interest rate bound has proven costly. Higher averageinflation and thus higher nominal interest rates to start with, would have made it possible to cut interestrates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.

Had the suggestion come from any other organisation, it would have been dismissed out of hand. Butwhen it comes from the IMF, even if it is a vastly discredited IMF, there is the very real danger that manygovernments, faced with a looming debt burden, may find it a seductive argument to justify a higher rateof inflation. And there lies the danger. It would destroy the hard-won gains from the battle againstinflation in the 1980s that laid the foundation for the subsequent period of prolonged growth. Worse, itwould penalise the savers at the cost of borrowers, including the biggest borrower of all, governments.

Clearly most of the Western world has had such a long period of low and stable inflation that memories ofthe hard-won battle against inflation have been all but forgotten, save in Germany, where the worstravages were felt in the post-war years. Such a lapse might have been forgiven had the argument comefrom lay folk; but when you have people who are supposed to be experts making such speciousarguments, it is time for the rest of the world to expose the fallacy of their argument.

After all, once this view is allowed to gain ground, what is to stop its proponents from taking the next stepand arguing that well, even 4% inflation is too low, we need 10%, because then the next time there is acrisis, we can get real interest rates down to 10%?

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Breathing Deep4.7 RISK MANAGEMENT CONSULTANTSEducate Engineer and Enforce:

Overhaul the way of staffing in regulatory agencies

Lehman Brothers bankruptcy examiner released a report showing that theinvestment firm went to great lengths to hide its shaky finances. In fact, it

even managed to evade a team of investigators from the Securities andExchange Commission and the Federal Reserve who were embedded atLehman headquarters with the sole purpose of ferreting out accountingsleight-of-hand.

How could they miss it? Its possible that someone convinced them to look the other way. But its morelikely that they werent qualified to be there in the first place.

Indeed, as Congress debates financial reform, it is ignoring the obvious Achilles heel in any newregulatory scheme: the inability of regulatory agencies to enforce and put in place the new rules, thanks inlarge part to their failure to recruit, train and retain effective staff.

Thats why, alongside thorough reform, we need to overhaul the way regulatory agencies are staffed. Itstrue that some agencies, including the SEC, have already taken small steps to raise pay, add a few trainingcourses and recruit industry professionals on temporary contracts. But as long as the agencies are plaguedby high