Niveshak

THE INVESTOR VOLUME 4 ISSUE 10 October 2011

OCCUPY WALL STREET

ENTRY OF PRIVATE SECTOR PLAYERS IN INDIAN BANKING Pg. 14

iNFRASTRUCTURE FINANCING IN INDIA - EXPLORING ALTERNATIVES Pg. 19

FROM EDITORS DESK

Niveshak Volume IV ISSUE X October 2011
Faculty Mentor Prof. N. Sivasankaran

Dear Niveshaks, The current financial crisis has illustrated how the world markets have moved closer to each other and have become so interconnected that every move in every economy is now being catapulted to the global arena. Every piece of information is being analysed for signs of economic conditions. In fact, if we go by what is being written in press, right from high inflation, dismal growth numbers, hiring freeze and poor earning guidance by corporates, we can fall into a false sense of belief that our economy is already in midst of a recession. The Indian economy today is seen as so interconnected and dependent on the western economy that any problem in the western economy is automatically seen as trouble for the Indian economy as well. However, if we analyse the situation carefully, the Indian economy is surely slowing down, but is not in the same mess as developed economies. The Reserve Bank of India has forecast a GDP growth rate of 7.7 per cent in FY 2011 while the UNCTAD has pegged the figure a shade lower at 7.6 per cent and the broad consensus among most economists is that it is unlikely to be lower than 7 per cent. Four years ago, if anyone had said the country would grow at 7 per cent, we would have taken it with glee, but three years of 9 per cent growth and talk of touching double-digit expansion had spoilt us. The fact of the matter, that Indian growth story is still intact and what we are seeing now is probably only a temporary phenomenon. The inflation rate is declining; overall domestic demand is growing, though not at the feverish pace of the last five years and jobs are being created, albeit at a slower pace than before though cost pressures have increased. Under the circumstances, the mood of despondency that has set in is unwarranted. The currency space around us is on the verge of major transformation. The last time something big happened in currency space was in 1971, when the gold standard was abandoned by the then US President Richard Nixon. The move resulted in huge trade imbalances and a massive build-up of foreign currency reserves by countries like China. Something big is all set to happen again in the currency space with the new proposed currency bill by US. The bill is essentially a form of trade protectionism that intends to penalize China for keeping its currency at artificially low levels to boost its exports. The bill not only in violates a series WTO rules, but would also potentially dampen the global economic activity and increase the probability of a double dip recession. This issue brings to you some more interesting and insightful topics. The cover story this month focuses on the Occupy Wall Street Protest and its implications for the US as well as global economy. The issue also features an article on the Private Equity Industry in India and the road ahead for it. Other articles in this issue focus on infrastructure financing and entry of private players in the Indian banking sector. The Classroom this month explains various types of Fixed Income Securities. We would like to thank all those who have contributed articles to this issue and sent entries for Fin Q. Hope you find this issue an interesting read. Stay invested. Rajat Sethia (Editor - Niveshak)

THE TEAM
Editor Rajat Sethia Sub-Editors Alok Agrawal Deep Mehta Jayant Kejriwal Mrityunjay Choudhary Sawan Singamsetty Shashank Jain Tejas Vijay Pradhan Creative Team Vishal Goel Vivek Priyadarshi

All images, design and artwork are copyright of IIM Shillong Finance Club Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS
Cover Story
Niveshak Times

04 The Month That Was

Article of the month

08 Profit Equity: Shackled?

11 Occupy Wall Street

Perspective
17
Where is inflation in India headed?

14 Entry of private sector

players in Indian banking

Finsight

19

Infrastructure financing in India - Exploring alternatives

23 Bonds

CLASSROOM

NIVESHAK

www.iims-niveshak.com

The Month That Was

The Niveshak Times

Team NIVESHAK

IIM, Shillong

Mining bill approved by cabinet The union cabinet has given its nod to the new mining bill which requires the coal miners to share 26% of their profit and also proposes to double the royalty burden for non coal miners. This would generate INR 10000 crore annually which will be used for the social welfare and development activities in 60 tribal dominated districts in Jharkhand, Chhattisgarh, Orissa, Madhya Pradesh and Karnataka. In addition to the royalty being paid by the non coal miners they may also have to make an equal contribution to an infrastructure development fund. This effectively doubles the royalty payment for the non coal miners placing on them an additional burden of INR 4500 crore. Implementation of this bill will raise the effective tax incidence on coal and iron ore to 61% and 55% respectively. Coal India will be worst hit by this new mining bill as it will required to shell out INR 1000 crore annually under the proposed profit sharing scheme. The bill also entails the setting up of a regulator that will have the powers to investigate and prosecute the offenders. The new mining bill would simplify the land acquisition problems being faced by miners as land owners now will be more willing to give up their land in exchange for the recurring revenue source assured by the new bill. SBI subjected to downgrade by Moody Global rating agency Moody downgraded State Bank of India (SBI)s Bank Financial Strength Rating (BFSR) by one notch from C- to D+ on account of low Tier I capital ratio and deteriorating asset quality. As per Moodys, a D rating suggest modest intrinsic financial strength, potentially requiring some outside support at times, while a C rating denotes adequate intrinsic financial strength. Moody explained expectations of increase in non-performing assets (NPAs) of SBI due to rising interest rates and slower economic growth as one of the major reasons behind the downgrade. India has expressed its displeasure over the downgrade

and has pointed out that the agency has failed to account for the government backing of the public sector banks while arriving at its downgrade decision. Government officials also quoted substantiating facts that at the end of June 2011 SBIs gross NPAs were to the tune of 3.5% of its assets while its capital adequacy ratio was 11.6%, both parameters satisfying regulatory requirements. Goldman Sachs shocked by USD 428 million losses Goldman Sachs reported a loss of $428 million in the third quarter, the second instance in the banking behemoths history since going public in 1999. This event has raised questions about a temporary or a more fundamental erosion of the much admired earning power of Goldman Sachs. Chief Executive, Lloyd Blankfein expressed his disappointment over the reporting of quarterly losses and attributed this anomaly to lower confidence among corporate clients and investors and downward pressure on asset prices around the world. The majority of these losses were incurred by the lending and investment business as revenues plunged from $8.9 billion in the third quarter last year to $3.6 billion for the corresponding quarter this year. The business model of Goldman Sachs has been hit by the Volcker Rule that bans proprietary trading to new restrictions on derivatives trading. Draft National Telecomm policy unveiled by the government The draft telecomm policy framed by the government envisaged a one nation one tariff regime for the country with a proposal to do away with roaming charges and introduce free inter-circle MNP. This proposal if and when put into practice will dissolve the distinction between local and STD calls. As a part of this policy the telecomm operators will be required to maintain just one license for all the circles in which they are operating as opposed to the current requirement of separate licenses for different circles. The absolution of roaming charges will cause the telecomm operators to suffer losses of

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The Niveshak Times

USD 400 million. Currently GSM and CDMA operators generate 9% and 5% of their revenues from roaming charges respectively. Further Spectrum occupied by existing government agencies will be vacated and a roadmap for providing additional spectrum will be reviewed every five years. NRIs allowed holding accounts in any fully convertible currency RBI has allowed Indians with nonresident accounts in India to hold to hold them in any fully convertible currency. This move will provide flexibility to NRIs in holding accounts and reduce their exposure to fluctuations in major currencies. Previously FCNR accounts could only be held in certain currencies like Pound Sterling, US dollar, Japanese yen, Euro, Canadian dollar and Australian dollar. Moreover the central bank has also permitted any citizen who was earlier residing in a foreign country to own or transfer property or other assets in that nation if it was acquired during the time of his residence there. INR 900 crore relief package for exporters The government has decided to provide INR 900 crore relief package to the exporters to combat the sluggish demand in developed markets and escalation in input costs. Engineering goods, pharmaceuticals and chemicals, apparels are some of the expected major beneficiaries from this succor. The Commerce ministry also introduced a special market focus scheme to help diversify the countrys exports to new markets. Under the scheme, an additional 1% duty credit would be provided to exporters, who ship their goods to markets in Latin America, Africa and CIS countries. Another move is to provide a special bonus of additional 1% of export value between October and March in the current fiscal year to fifty products in engineering, pharmaceuticals and chemicals. The government expected the relief package to help it in achieving its $300 million export target for financial year 2011-12. Yield on 10 year gilts at a 3 year peak The yields on 10 year government bonds attained a 3 year peak at 8.82% per annum owing to oversupply and lack of appetite. Limited buyer interest by also observed for 7 year government securities. The subdued investor demand resulted in a development as around 40% of the INR 10000 core put up for auction left with primary dealers. The uptrend in interest rates on government securities has been attributed to market expectations of another policy rate hike by RBI. Rise in freight rates and unseasonal rains are expected to stroke inflation further putting upward pressure on interest rates. Chinas GDP down to a two year low China registered a GDP growth rate of 9.1% y-o-y in the third quarter of 2011, the slowest growth rate since the third quarter of 2009. The GDP growth rate slowed down from 9.5% in second quarter and 9.7% in first quarter of 2011. The overall GDP growth rate for the first nine months of this year is 9.4% y-o-y. The slowing down of growth rate may be attributed to the macroeconomic policy regulation of Chinese government which is making continuous efforts to keep soaring property prices and inflation under check. 8 billion euro lifeline given to Greece The Euro zone finance ministers have agreed to give another lifeline to Greece giving their approval to 8 billion euro loan tranche that the debt laden country may need next month to pay its bills. However the troika of IMF, ECB and EU presented an overall gloomy picture of economic scenario in Greece expressing serious concerns over the country ability to repay sovereign debt. The most positive scenario analyzed by the trio involved reducing the debt level of Greece to 110% of GDP which is still considered very high by global levels. However this will require private bondholders to accept up to 60% of haircuts which is a highly unlikely scenario. The assessment also revealed that the debt level may further rise to 186% of GDP up from 160% currently. The 8 billion euro tranche the sixth installment in the 110 billion bailout fund will be released in first week of November this year.

The Month That Was

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

NIVESHAK

www.iims-niveshak.com

Market Snapshot Cover Story

Market Snapshot

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR)

BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap 62,64,794 29,40,420 1,463,899

LENDING / DEPOSIT RATES

Base rate Savings Bank rate Deposit rate 10%-10.75% 4.00% 8.5% - 9.25%

Source: www.bseindia.com

CURRENCY RATES
INR/1USD INR/1Euro INR/100Jap.YEN INR/1PoundSterling 48.82 69.28 64.36 78.56

RESERVE RATIOS
CRR SLR 6% 24%

POLICY RATES
Bank Rate Repo rate Reverse Repo rate 6% 8.50% 7.50%

Source: www.bseindia.com 3rd to 28th October 2011

Data as on 28th October 2011

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Market Snapshot
BSE
Index Sensex MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECk Open Close % change 16,256 17,805 9.53 6,128 6,879 8,469 10,739 6,361 10,628 3,888 5,851 5,195 10,887 8,397 2,105 7,361 1,751 3,212 6,275 6,960 9,571 11,372 6,633 11,036 4,153 6,171 5,830 12,143 9,179 2,217 7,616 1,923 3,522 2.39 1.17 13.02 5.90 4.28 3.83 6.82 5.47 12.23 11.54 9.31 5.35 3.47 9.81 9.65

Market Snapshot Cover Story

FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Article of the Month Cover Story Article of theMonth

PRIVATE EQUITY: SHACKLED?

Prateek Ahuja, Varun Salwan

nmims, mumbai

Introduction India is riding high on its expanding corporate sector and has also witnessed unprecedented increase in entrepreneurial activities across the country. 64,990 limited companies with authorised capital of Rs. 47,161.75 Crore were registered under the Companies Act, 1956 during the period from 1st April, 2010 to 31st December, 2010. Out of these, 36 were Government companies with authorized capital of Rs. 23,697.22 Crore and 64,954 were Non Government companies with authorized capital of Rs. 23,464.53 Crore.

This growth wave is supported by the emergence of new ventures in the form of Medium and Small Scale Industries. Traditional financing resources have failed to keep pace with increasing demand for capital. These new ventures require extensive capital infusion especially from the private sector. No wonder corporate houses have started scouting for unconventional financing options. This has helped private equity culture to take roots in India. Also, over the time promoters in India have realized the importance of private equity capital and are willing to give stake in their businesses.

Fig 1: Number of PE Investments (Source: Venture Intelligence)

Figure

2:

Value

of

PE

Investments

(In

million

USD)

(Source: Venture Intelligence)

.. The uptrend in PE investment is in sharp contrast to the sluggish stock markets.

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Article of theMonth Article of the Month Cover Story

Although the number of PE investments was reduced post the 2008 financial crisis, it is again showing signs of growth. The PE industry in 2011 has witnessed 44 deals till June, which is about 70% of total deals struck in full calendar year 2010. The amount invested by PE investors till June this year had already crossed last years figures for the whole calendar year. According to Grant Thorntons Dealtracker Oct11 report, private equity investment in India touched $1.91 billion in July-September this year, which was 18 percent higher than that in the same period last year. The uptrend in PE investment is in sharp contrast to the sluggish stock markets. In comparison to $1.91 billion of PE investments in the third quarter this year, the capital raised through the initial public offer route during the period stood at $455.92 million through 11 IPOs, the report said. Under performance of capital markets globally as well as in India, is expected to give rise to interesting deal making in PE. Dawn of a new era: SEBI Guidelines on Alternate Investment Funds SEBI has come up with a draft proposal for Alternate Investment Funds on August 01, 2011, which has the potential to dramatically alter the scenario of PE industry in India. SEBI in its draft guidelines has proposed regulations on higher sponsor contributions, caps on investments and restrictions on the use of funds among other things to reduce systematic risk and channelize private equity investments in specified sectors. Current Framework The current SEBI (Venture Capital Funds) regulations of 1996 were framed to promote start ups/ early stage ventures by VCFs (Venture Capital Funds), but there are no separate regulations for PE Funds. VCF regulations are being used as a one point solution for all private investments. The rationale behind a VCF and a PE Fund is very different; while VCFs are set up with an aim to provide private capital to start up/early stage ventures, PE is used to provide private capital to ventures in their later stages. Concessions and sops given to VCFs are not needed for PE invest-

ments and similarly restrictions put on VCFs are not required for latter. Investors in a VCF or a PEF are either institutions or HNIs (High Net worth Individuals). These are very sophisticated and well informed investors and bring good governance along with good quality money. If everything is so hunky dory, then one might wonder-Do we really need stringent regulations for private funds? Lessons from the recent financial turmoil in the western countries coupled with the exponential growth of the private fund industry domestically and their influence on the stability of the financial markets have impelled regulators to formulate stringent regulations for private equity funds. Draft Guidelines on AIFs Mandatory Registration Under the current regulations it is not mandatory for VFCs or PE Funds to register with SEBI, but the new proposal makes it mandatory for every private investment fund to be registered with SEBI. This mandate is proposed to give a level playing field to similar funds. This proposal also seeks to recognize Alternate Investment Funds such as PE or VCF as different asset class from promoter holdings, creditors and public holdings. SEBI has proposed to categorise private equity into nine formats, such as venture capital funds (VCF), private investment in public equity, or PIPE funds, private equity funds, infrastructure equity funds, debt funds, small and medium enterprise funds, social venture funds and strategy funds. Also the proposed regulations are confusing and conflicting in nature. Multiple registrations are required for fund managers who are involved in managing different vehicles. Multiple regulations mean multiple compliance this would only harm the prospects of PE industry in India. Investment Caps The proposed regulations put restrictions on the investments that a VC or a PE fund can make. The regulator has proposed that investments should be largely based on the funds theme. So a VCF, set up to promote businesses using new technology at an early stage, would be required to invest 66.66% of its corpus in the specified

.. SEBIs rules adversely affects the growth prospects of PE firms as well as businesses that are seeking capital for growth and expansion. FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Article of the Month Cover Story Article of theMonth

category only. Similarly, a debt fund should invest the entire corpus in unlisted debt instruments, while a PIPE fund should invest in shares of small-sized listed firms. It prohibits PE funds from investing more than half their corpus in a pre-IPO company. It also stipulates that 50 per cent of their corpus should be invested in unlisted companies. Although, the motive behind the draft proposal by SEBI is commendable (To channelize PE funds to specific sectors), it does curtail the flexibility of PE and VC funds. Flexibility is the key to survival of this industry, option to invest in a mix of ventures in their early stages and some in their later stages is what attracts these investors. PE Investors look to diversify their portfolio; such restrictions can drive away potential investors as the risk cannot be minimised with diversification. Ambiguity Regarding Foreign Funds In PE investment almost 80% capital is foreign capital hence government needs to form favourable rules to promote foreign investment. The proposed regulations are also not clear on foreign private funds with foreign investors and foreign fund managers. It is not clear whether or not they will have to register as an AIF. Takeover Regulations Capital markets regulator, Securities Exchange Board of India came up with a new set of takeover regulations in the month of July, 2011 to alter Indias mergers and acquisitions scenario. The change in the regulations was on cards from July, 2010 when Takeover Regulation Advisory Committee (TRAC) headed by Mr. C. Achuthan proposed revamping of the then existing Takeover Regulations. The new takeover rules have different entails for diversified class of stakeholders. For institutional investors, mainly private equity firms these new rules ring a favourable bell as they will now be able to acquire up to 24.99% stake in a company without triggering an open offer. Retail participantsd will also gain as the

non-compete fees is removed and they will get exposed to a larger share during an open offer. SEBI has amended the 13 year old takeover rules and augmented the first trigger limit for an open offer to 25% which was earlier at 15%. The offer size too is increased to 26% which was at 20% earlier providing an exit option for more investors. The change has aligned Indian M&A landscape closer to the global platform. The first trigger point for an open offer while acquiring a company in UK is 30%, similarly in Japan it is 33.33% and in South Africa it is 35%. Fig shows first trigger limit for different countries. The increased threshold limit and effort to be in line with the global best practices will provide an additional flexibility to organizations to raise capital by exploiting PE firms which on the other hand is an opportunity for PE investors to increase their investment base . The fact is that in eighties also the open offer trigger limit was 25% as per the listing agreement. Later, it was trimmed down to 10% and then increased to 15 %. Since 1998, PE funds have invested around $11 billion in listed firms. According to the experts if a PE firm acquires 24.99% which is usually more than 25% of public present and voting at an Extraordinary or Annual General Meeting, it can have substantial control over important matters of special resolution and better minority protection rights and hence can create an efficient impel against poorly run and mismanaged companies. Conclusion Though it is essential to rein in the financial system in order to avoid the repeat of 2008 financial turmoil, we feel that considering the growth stage India is in, it is essential to provide the access to capital in order to promote the businesses in India. At one hand SEBI has provided flexibility through New Takeover Regulations while on the other hand it has put in stringent measures through Alternative Investment Funds. Our analysis shows that SEBI needs to reconsider the classification of investment funds and specified minimum investment limits. It adversely affects the growth prospects of PE firms as well as businesses that are seeking capital for growth and expansion.

Figure 3: First Trigger Limit (Source: www.indiape.com)

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Cover Story Article of the Month Cover Story

Occupy Wall Street

Sawan Singamsetty & Shashank Jain

Team niveshak
The Occupy Wall Street (OWS) protests are in- test spread across the world. In fact, by the 3nd tended and aimed at drawing attention towards week of October, similar protests were being the economic disparity, injustice and political held in around 900 cities worldwide, all being corruption. The slogan We are 99% being used modelled according to the original OWS protest. by the protesters to refer to the difference in What is the Revolution all about? wealth between them, i.e. common citizens of As mentioned earlier, the protests are aimed US and top 1%, who supposedly run the Wall at the growing economic inequality between street. The protests come in the wake of intoler- the 99% (ordinary citizens of US) and the top ance towards the greed and corruption of top 1% (who run Wall Street). The increasing greed 1%. and corruption by the top 1% has led them to A Revolution Begins! take a share of more than 20% of the total US The protest began on a small scale when Ad- income in 2007-08 as compared to a share of busters, a Canadian based anti less that 10% in the 1980s (Figure consumerist magazine, initi2). The movement intends to bring ated a peaceful occupation of about a real change in the society Wall Street to protest against the from the bottom up by empowerinfluence of corporates on deing the 99%, minimizing the influmocracy and the absence of any ence of top 1% (big corporates) on mechanisms post the global ecothe US laws and policies and thus nomic crisis. The protest was furreducing the inequality in the disther promoted with the famous tribution of wealth. However, a lot poster of a dance over the Wall of people classify the protests as Streets Bull (Figure1). a revolution against capitalism. In short, the primary demand of The revolution started on SeptemOWS is that Barack Obama ordain ber 17 with more than thousand a Presidential Commission tasked protesters marching through the with ending the influence money streets and eventually the proFigure 1 FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Article of the Month Cover Story Cover Story

Figure 2

has over our representatives in Washington. Who constitute the top 1%? A fundamental question that has been raised all along this time during protests was that who constitute the top 1%? who are seemingly greedy, corrupt and are responsible for the economic disparity in the United States. While the general opinion is that, majority of them are the Wall Street Executives or top corporate honchos, it is not actually completely true. Following is the distribution of the occupation of the taxpayers in top 1% of the income (Figure 3). Will India join this Movement? We believe it is very unlikely that India will join in this protest. India happens to be a developing nation wherein the aspiring middle class seldom relate themselves to the urban working class and urban working class to the rural India. Hence, there is a lot of disconnect between such strata of the society unlike the West where they are digitally connected among each other. However, this doesnt mean that the middle class or the common man is not fighting for its growth. A point to be observed in the Indian scenario is that the root cause for the hindrance of growth is corruption and the major culprit is The Central Government. And, as we all know, thousands of Indians have recently protested against corruption through the Anna Hazare Movement that was an eye opener for the Indian Government Effect of crisis on the Luxury Market Luxury store owners as well as real estate agents are having a Jaundice eye effect when it comes to evaluating the business prospect of their industry. Even in the year 2008 various luxury market products suffered a hit. Eg: Saks saw a double digit

decline in sales and had to go in for discounts to clear the stock from the shelves. New York alone contributes nearly 33% of the $65 Billion luxury retail market of United States. Any sign of deepening protests will definitively affect this market. This protest is also coupled with job cuts that were announced by Bank of America, JPMorgan Chase , UBS AG and Goldman, which will again put a curb on demand of these products. Goldman which registered its 2nd loss from the time of going public has also commented on putting 59% less money towards the compensation of employees in the 3rd Quarter. The Funding behind the Protest Lately there have been many speculations recently as to who is actually behind the funding of the Occupy Wall-Street Protests. One name that comes into picture while talking about the same is George Soros, the name that appeared in the list of wealthiest 10 Americans. Conservative say that this movement is a Trojan Horse for the Soros Agenda. One possible link is the indirect financial relationship of George Soros and Adbusters, an anticapitalist group in Canada. This group started the protests with inventive marketing strategies. Second reason is that George Soros was against the 2008 bailout and also government repurchases of the toxic sub-mortgaged assets that were involved in property bubble. Vox Populi For many casual observers and news consumers, the fledgling Occupy Wall Street movement appears to have come out of nowhere-a spontaneous, loosely knit gathering of protesters who feel disaffection and anger over the financial crisis and

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Article of the Month Cover Story Cover Story

Figure 3

dismay over the outlook for the American middle class. Much of the criticism against these protests has come in the form that they are leaderless and that the demands and goals are unclear. During a hearing before the Joint Economic Committee October 4, 2011, the Federal Reserve Chairman Ben Bernanke empathised with the protests stating that People are quite unhappy with the state of the economy and whats happening. They blame, with some justification, the problems in the financial sector for getting us into this mess, and theyre dissatisfied with the policy response here in Washington and at some level, I cant blame them. Certainly, 9% unemployment and very slow growth is not a good situation. Former Soviet president Mikael Gorbachev stated that the reasons of protest seem justified and significant. Further, he also stated that though he respected the movement he feared that it might get diluted or affected due to some extremist elements. He also went on to compare this movement with perestroika, the period of reform in the 1980s he ushered in that culminated in the collapse of the communist superpower and end of the Cold War. The protests may be leaderless or without any proper goals. But one thing for sure is that this has been a wakeup call for the leaders of all major economies. It has made them realise that they cannot be complacent in any way possible and that the growth of 99% is of paramount importance when it comes to the overall growth of the country or economy.

End to these protests The protestors, in actuality, have not mentioned their end goals or anything that would allow them to declare victory and end their protests. Given this, it is of paramount importance that the politicians and leaders start tacking the larger problems and causes that lead to these protests. Providing a feasible, long term sustainable solution to the euro crisis problem would surely impress the protesters to some extent. Further, focus on taking steps and actions and developing policies that would boost economic growth in respective economies would add to the betterment of the masses. Rather than going for austerity, making the top 1% or the rich pay their taxes in an appropriate manner, boosting the taxes for the wealthy would lead to better solutions that make economic sense. The other major steps that can be taken by all the leading economies, one of them being is to maintain transparency. Lack of transparency has always led to major problems in several nations, especially this being a major reason for Greece crisis. Further, identifying the correct reasons for the global turndown in 2008 and building or developing suitable mechanisms to tackle such problems in future would assure the protestors of some safety or security in future. Announcement of such measures or steps by the governments may not lead to end of these protests on an immediate basis. However, this would lead to slow realisation among the protestors that the leaders are truly worried about the condition of the economy and the 99% which would eventually culminate to a slow die-down of the protests.

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Finsight Cover Story

ENTRY OF PRIVATE SECTOR PLAYERS IN INDIAN BANKING

Pooja N Joukani and A.N.V Mallika

nmims, mumbai

Banking industry is the backbone of any economy and hence has always attracted the attention of policy makers, industrialists as well as of academicians. It acts as a catalyst to build the economy. Historically, banking industry in India has been dominated by a handful of public sector banks. Post-independence Government has tried to increase the reach of banks through measures like nationalization initially and later on through liberalization but unfortunately banking industry has remained concentrated only in urban areas leaving poor people outside the system. Almost 65% of population does not have access to the banking system. The present government in its election manifesto had promised to increase the pace of financial inclusion and since then has taken measures like the Unique Identification Number (UID) initiative, which would do away with the hassles of KYC (Know Your Customers) norms. RBI has also taken a crucial step to achieve this objective. It has come up with a proposal of issuing banking licenses to big industrial houses in India. It intends to provide an opportunity not only to the NBFCs but also, for very first time, to industrial houses to participate in banking sector. RBI has been extremely cautious, taking more than a year in carving out guidelines which would provide directions for selection or rejection of a particular private player for assigning banking license. KEY GUIDELINES AND RATIONALE The following are the major guidelines issued by RBI (September 2011) for new banking licenses followed by the rationale for each: (as per RBIs draft on guidelines for banking licenses) It is proposed that the initial minimum paidup capital for a new bank shall be Rs 500 crore and that a wholly-owned non-operative holding company (NOHC) will hold the existing businesses and the newly created bank within itself. Only non-financial companies can have a shareholding in the NOHC.

The minimum capital requirement of Rs 500 crore is laid down such that the capital requirement is not significantly high or not meager. A very low minimum capital requirement (of Rs 200 crore) could attract non-serious entities without inadequate financial resources to seek for licenses. On such small scale, there is always a risk of an early wiping off of the initial capital. Such small scale banks would also not be able to invest in technology. While a low minimum capital requirement has these disadvantages, a very high minimum cap requirement (say Rs 1000 crore) would evince only those with high funds. Such entities would be profit oriented and could divert funds to big-ticket corporates thereby diluting the purpose of financial inclusion. Thus the requirement of high enough entry capital can be fulfilled only by entities with large surplus of funds that are readily available with the industrial houses. It could also act as contingent capital for banks in case of financial shocks. The creation of an NOHC would enable in separating the activities of each of the subsidiary companies from another and help in greater regulation by separate regulators in each of the segmented spheres. The NOHC will only act as a vehicle to hold the investments on behalf of the promoter/promoter group and will not be allowed to accept deposits. This would cause a fall in the Return on Assets (RoA) and Return on Equities (RoE) of the NBFCs. Excepting promoters/promoter groups that generate more than 10% of revenues or have more than 10% of assets in real estate or broking services, all private sector players are eligible to promote banks. The exposure of the bank to any entity in the promoter group shall not exceed 10 per cent and the aggregate exposure to all the entities in the group shall not exceed 20 per cent of the paid-up capital and reserves of the bank. A clear NO to the businesses in broking services comes from lessons from international experience. The recent financial crises have led to closure of not only the broking companies but also the banking company associated with them. The crises have also

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LIC Housing Finance Shareholding Pattern Promoter FII DII 36.54% 39.86% 7.81% Others 15.79% N/W 4169Cr Key Financials R&S Cash CAR 4074.11Cr 415.41Cr 15% NNPA 0.12%

Article of the Month Finsight Cover Story Cover Story

shown that banking industry was not completely shielded from real estate businesses. This relation could be attributed to fact that the recent crisis was due to asset bubbles in the real estate sector. However, because the cause has been specific to a particular industry (in this case, real estate) the lessons from recent past cannot be undermined. The cap on the holding limit of 10% by banks in the promoter group company is to prevent the sub-version of Chinese wall between the bank and the rest of the group. Groups with diversified ownership, sound credentials and integrity that have a successful track record for at least 10 years shall be eligible to promote banks and RBI may seek feedback on applicants from other regulators and agencies like Income Tax, CBI, Enforcement Directorate, etc. This, in effect, rules out a first-generation entrepreneur setting up a new bank. The newly formed banks must have 25 % of their branches in unbanked rural areas. This is mainly so as to ensure financial inclusion. Major considerations for Allowing/Disallowing Industry houses to run banking services are: SELF-DEALING: Self-dealing means that the parent industrial company that set up the bank can route funds to its own purposes not considering the depositors interests. There exists a possibility that a bank affiliated to a commercial firm may deny loans to its competitors. CONNECTED LENDING: Also, the risk of connected lending to companies or suppliers within the group cannot be ruled out. Such rotation of funds among related parties can make it difficult for the regulator to trace sources and utilization of funds. However when the existing NBFCs of industrial houses and their clients were questioned about the financing services by their corporate houses, it was revealed that the loans that were sanctioned to the existing customers, vendors, channel partners- dealers and distributors- of the industrial unit were processed 40-45% times
Shareholding Pattern FII DII Others 19.45% 29.31% 51.23%

faster than that done by the banks. The improved turnaround times of sanctioning and disbursing loans was made possible because of quicker duediligence of the clients through information available with the group firm that had business links to the borrower. Not only that, another advantage could be that the existing industrial houses can extend their management expertise and strategic direction of their existing experience in the nonbanking and financial services domain to their affiliated banks. Analysis of the major companies planning to apply for the banking license: LIC HOUSING FINANCE: The company has 21 years of work experience in Financial Services and has more than 200 offices across the country. It provides long term finance to individuals for purchase, construction, repair and renovation of new / existing flats / houses, on existing property for business / personal needs and gives loans to professionals for purchase / construction of Clinics / Nursing Homes / Diagnostic Centers and also for purchase of equipments, thus having a diversified business. It has robust financials in terms of substantial cash balances and low Net Non-Performig Assets but its exposure to real estate loans as on January 2011 was 10-11% which could be a red signal to the license issuers. Also it has future prospects of launching venture capital fund to invest in real estate in upcoming 3-4 months. This could again increase its exposure to the prohibited sector. Probable Outcome: Its exposure to realty sector could hinder its chance in bagging the license. IFCI: The company has 63 years of experience in Financial Services. It is involved in a diversified industrial portfolio comprising of Public Sector Undertakings, Manufacturing industry, Infrastructure projects, NBFCs, Participation in Private Equity and Promoter funding. It is currently facing a litigation wherein Supreme Court has issued a notice to the company questioning its appointment of IES officer Atul Kumar Rai as CEO and MD of the IFCI in breach of all norms. Apart from
IFCI Key Financials R&S Cash CAR 4000 cr 500 cr 17.9%

N/W 5000 cr

NNPA <1%

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Finsight Cover Story

Mahindra & Mahindra Financial Services Limited Shareholding Pattern Key Financials Promoter FII DII Others N/W R&S Cash 57.44% 34.49% 3.54% 4.53% 2490 cr 2385.56 cr 297.62 cr Reliance Capital Shareholding Pattern Promoter FII DII 54.14% 21.48% 4.86% Others 18.52% Key Financials N/W R&S Cash 7027.69 cr 6781.53 cr 1171.16 cr

CAR 20.3%

NNPA 1%

CAR N.A.

NNPA N.A.

this IFCI has been accused of behaving as an independent company, over which the government has no control, in spite of the center bailing them out with a package of Rs. 5220 crore. IFCI also declares itself to be out of the purview of the RTI Act. Probable Outcome: Despite a few litigations IFCI has a fair chance of bagging the license mainly due to its enormous experience and its exposure to RBIs favourite sector.

MAHINDRA & MAHINDRA FINANCIAL SERVICES LIMITED: The companys major revenue driver is the business of financing (for vehicles) since 1993 through its NBFC. It is also into fixed deposits, personal loans, mutual funds and insurance business. It shows a diversified business by financing utility vehicles, tractors and cars, focusing on the rural and semi-urban sector. Thus it has a huge presence in the rural areas as financial services. It has around 540 branches and majority of them are in rural areas where it has set a strong foothold. Also its CAR is quite high thus depicting a thick cushion for economic downturns. Probable Outcome: High chances of bagging the license mainly because of their rural presence. RELIANCE CAPITAL: The company has 25 years of experience in Financial Services. It has diversified holdings into life insurance, mutual funds, general insurance, securities and commercial finance. The company however belongs to Reliance

ADAG promoter group, top officials of which are a suspect in the 2G Scam. Reliance capital recently completed the 26% stake sale of Reliance to NIPPON Life in Reliance Life Insurance. Its key financials seem quite appropriate i.e. huge amount of cash and bank balances, high net worth etc. Probable Outcome: High chances because it satisfies all the criteria. Promoters track record is questionable only after he is proved guilty by court. SHRIRAM GROUP: The company, since 1974, has diversified its business in Commercial vehicles Financing, Consumer & Enterprise Finance, Retail Stock Broking, Life Insurance, Chit Funds and Distribution of Investment & Insurance Products, EPC and Real Estate. The company underwent a capital infusion of Rs 67 crore Investments for expanding their operations in - Shriram Fortune and Shriram Insight. ShriRam Fortune in Insurance and ShriRam Insight in Broking. This infusion of capital might increase revenues from broking business in excess of 10%. Also the FII stake is huge (42.41%) thus introducing uncertainty and financial instabity. The company currently has a substantial presence in financial services business and is known for sound track record of its promoters. Probable Outcome: It would be difficult to come to any fair conclusion based on the given data. If the revenue structure of the company remains under the limits as mentioned in the

Shriram Group Shareholding Pattern Promoter FII DII 41.28% 42.41% 2.18% Others 14.13% Key Financials N/W R&S Cash 4904.39 cr 4674.66 cr 914.26 cr SREI Shareholding Pattern Promoter FII DII 46.22% 14.17% 0.26% Others 39.35% Key Financials N/W R&S Cash 2553.13 cr 2049.89cr 1.71 cr CAR 29.36% NNPA 0.6% CAR 24.85% NNPA 0.4%

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L&T Finance Shareholding Pattern Promoter FII DII 82.64% 2.62% 2.64% Others 12.10% N/W NA Key Financials R&S Cash NA NA

Finsight Cover Story

CAR NA

NNPA NA

guidelines the company might have a chance to get a license. SREI: This Infrastructure Financing Company has been in existence since the last 20 years. They have a well-established rural presence in the form of SREI Sahaj e-village. They have been setting up IT centers under e-governance, e-commerce and elearning in those villages. They already have 16000 centers and are planning to set up 30000 more. An alarming figure is their low cash balances. Also the promoters of the company are accused of misappropriating funds of around Rs. 300 crore to some private institutions. Probable Outcome: Its chances of winning the license are bleak. L&T FINANCE: L&T Finance Holdings is into the business of lending to infrastructure projects, selling insurance, financing small and medium businesses, among other financial services. The companys combined asset base grew to Rs 188 billion at the end of the financial year 2010-11, up 57% from a year ago. L&T Finance has a tie up with National Collateral Management Services (NCMSL) to provide receipt financing, which involves collateral management and warehousing services, to farmers and small businesses. The major objective is to assist industrialists, traders and farmers in financing their working capital requirements at all stages of the supply chain, right from pre-harvest to marketing and export. NCMSL plans to build its own warehouses at 40 locations across 12 states, and this partnership will facilitate secured post-harvest lending on large scale to farmers , processors and other agribusiness clients. Probable Outcome: Based on their reach in rural areas the company has fair chances of bagging the license. ADITYA BIRLA GROUP: Aditya Birla Group has a highly diversified business structure. It is involved into apparels, agri business, cement, carbon black, insulators, textiles, viscose filament yarn, BPO and IT services, telecom and financial services. It reaches across 3000 villages. The group is known for its corporate governance. Its initiative of Center for Community Initiatives and Rural Development focuses on the complete development of the communities around the plants of this group usually located in remote rural areas and tribal belts.

Probable Outcome: The group has a bright chance of securing the license owing to its rural reach, corporate governance and sound management BAJAJ FINSERV: Bajaj Finserv has a 20 year old experience in financial services namely life insurance; general insurance and consumer finance (mainly auto finance) businesses. Apart from financial services, Bajaj Finserv Service is also involved in wind-energy generation. They have an option of either converting their NBFC Bajaj Finance into a bank or can have a wholly owned subsidiary under Bajaj Finserv. They have a record of age old sound management. Probable Outcome: With their experience and excellent promoter track record they have a fair chance of bagging the banking license. TATA GROUP: The Tata group is involved with IT services, chemicals, consumer goods, automobiles, energy, telecom, steel and engineering products. Tata group has taken several initiatives like Tata Chemicals Society for Rural Development, Rallilove ACTS, and Voltas for Women etc. for social reforms, rural welfare and womens development. Probable Outcome: Tatas like Birlas with their highly diversified business and sound promoter track stand a good chance of securing the banking license. Some other companies like India Bulls are completely out of the race of receiving the banking licenses owing to their major revenue contribution by brokerage. Religare enterprises might still stand a chance if its promoters plan to apply for the license since the revenue contribution of Religare Enterprises might be less than 10 %. Conclusion: The guidelines incorporate a lot of subjectivity in terms of diversified ownership, soundtrack record of promoters. This suggests that the guidelines are merely a signpost for issuance of the banking licenses; the final say still rests at the discretion of RBI. The detailed study of the guidelines and of the various companies applying for the banking licenses indicates that this step would be instrumental towards achieving Financial Inclusion, provided appropriate regulations are in place.

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Perspective Cover Story

G.S.N. Aditya

iim shillong
Introduction While the rest of the world is in awe of Indias stability during the turbulent times of 2008s recession and while the international press is abuzz with speculation of Indias high growth rate and its chances of overtaking China, there has been one problem plaguing India all the while, runaway Inflation. Until the early nineties, Inflation was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly. Inflation today is caused by an amalgam of global and domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of inflation too have undergone tectonic changes. Today a trident of higher inflation, interest rates and slower growth is now plunging deep into Indias economy. As of August 2011, Inflation rate was at 8.99 %. Although inflation today is much lower compared to the first quarter of 2010, it is still at a level that would leave the people at the lower income level in an uncomfortable position. proper irrigation facilities lead to over dependency on an uncertain monsoon. What actually compounds the problem for India is the fact that lower harvest worldwide, specifically in Australia and Brazil, has led to an increase in the price being offered for Indian agricultural produce. Not so recently there was a situation where the price of one kilo of onions was more expensive than the price of one litre of petrol or a bottle of beer. As per recent reports, Food inflation has reached 10.6% for the week ending October 8th 2011. Inflation has been largely driven by soaring vegetable inflation (17.6%) and fruit inflation (12%). In addition people have started consuming more protein rich food which in turn has driven up the price of protein food products. Also, other commodity prices have been increasing continuously further adding to the inflation. Global crude oil prices have stagnated over the $100/barrel psychological level. Continued de-subsidization has resulted in continuous price hikes in Petrol and Diesel prices. There is speculation that LPG prices will be increased as well. The rise in crude oil prices trickles down to an increase in the price of all other commodities. Lately, the rupee has been constantly depreciating against the dollar, reaching its lowest value since April 2009 (50.32 rupees per dollar). As a result our exports are fetching more money than usual. This has led to an increase in the wages of the people which in turn has boosted the buying power and affordability of the middle class and upper class.

Factors driving inflation India has struggled to maintain control over rising consumer good prices while stagnated developed countries are facing low inflation rates. A large portion of the consumers income is spent on food in poorer countries. Inflation in India stems from Food inflation which is basically a supply side issue. India for example spends 46% of its income on food. Im-

.. Inflation has been largely driven by soaring vegetable inflation and fruit inflation.

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Lastly, housing prices have also been rising constantly raising the cost of living. What RBI is doing As it can be seen from the chart, RBI has resorted to continuous hikes in interest rates in an attempt to curb inflation. It has raised interest rates 11 times in the last 18 months. It has primarily controlled the Repo and reverse repo rate as a means to control the money in circulation which in turn would control the demand. By increasing the Repo rate and bank rates, the banks would have to pay a higher interest rate to the RBI to borrow money. This increase in interest is transferred completely or partially to the end consumer. As the interest that the consumer now has to pay has increased, it is believed that the consumer would spend lesser than normal, thereby curbing his buying potential which in turn would bring down demand and curb inflation. However, Inflation is largely due to food inflation where most of the commodities are essential and the consumer is forced to buy them even at exorbitant prices. Hence, the demand for food products falls gradually as compared to other luxury products. Why is it failing? RBI can only control the monetary policy. But the crux of the problem lies on the supply side. We arent

Hence just merely raising the Interest rates will not be enough as interest rate hikes will only help to temporarily curb demand. Also, there will be certain essential goods like petrol and rice grains where people will have to pay the high prices being demanded. Therefore to curb inflation we will also need certain policies and measures in place to eliminate the supply side problems and increase production in general.

Perspective Cover Story

supplying enough to meet our demand. And suppliers in our country are inclined towards exporting their produce to other countries due to the greater margins being offered. Although the government has been taking steps to discourage exports by imposing heavier duties and by restricting export of certain commodities, the policies are still not holistic and comprehensive in nature.

Where is inflation heading Analysts predict that inflation would dip to 7.5 to 8 % by the second quarter of 2012. The current measures in place would ensure that inflation is contained at least temporarily. Food inflation is projected to stabilize and decline over the near future given a good healthy monsoon and the policies in place to encourage imports and discourage exports. However the reason to worry now is that the latest hike in inflation has been led by manufacturing products. Manufacturing products form the largest weightage in the Wholesale Price Index (WPI). With price hikes of fuels such as diesel being very much in the offing in the near future, the pressure will only get worse.

.. With price hikes of fuels such as diesel being very much in the offing in the near future, the pressure will only get worse

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Cover Story Perspective

INFRASTRUCTURE FINANCING IN INDIA - EXPLORING ALTERNATIVES

Ankur Bhardwaj & Sounak Debnath

mDi gurgaon
Infrastructure
It is the backbone of economic activity in any country, but unfortunately, India suffers from osteoporosis. Time and again various policy measures have been taken to boost infrastructure, but no major progress has taken place barring on telecom infrastructure front. To fuel Indias ambitious growth rate and meet distant targets, a major restructuring is required on governance, legal, administrative and financial front. According to Global Competitiveness Report (GCR) 2009-10, India ranks very low at 76 in infrastructure domain. Also India spends only about 6-7% of its GDP on infrastructure. Financing is one of the most basic requirements for carrying out infrastructure projects, which are capital intensive and are in risky domains. The low levels of public investment have made Indias physical infrastructure incompatible with large increases in growth. Any further growth will be moderate without adequate investment in social, urban and physical infrastructure. In 11th 5 Yr plan, 30% of total infra investment is expected to be from private sector & 48.1% of total infra investment is expected to be from Debt sources. It emphasises the need for availability of cheap and easy finance options for private sector. easy financing for infra projects in India 1. SAVINGS NOT CHANNELIZED: Although Indias saving rate may be as high as 37%, almost one-third of savings are in physical assets. Also, financial savings are not properly channelized towards infra due to lack of long term savings in form of pension and insurance. 2. ASSET-LIABILITY MISMATCH: Most of the banks face this issue due to long term nature of infra loans and short term nature of deposits. 3. REGULATED EARNINGS: Earnings from projects like power and toll (annuity) may be regulated leading to limited lucrative options for private sector and difficulty for lenders. Also, any increase in input cost over the operational life is very difficult to pass on to customers due to political pressures. 4. LIMITED BUDGETARY RESOURCES: With widening fiscal deficit and passing of FRBM act, government has limited resources left to meet the gap in infra financing. Rest of funds have to be met by equity / debt financing from private parties and PSUs. 5. UNDERDEVELOPED DEBT MARKETS: Indian debt market is largely comprised of Government securities, short term and long term bank papers and corporate bonds. The government securities are the largest market and it has expanded to a great amount since 1991. However, the policymakers face many challenges in terms of development of debt markets.

Read on to understand the challenges involved in carrying out one of the most important function that directly impacts large number of developmental projects in our country - Infrastructure Financing. The article also gives a diverse set of alternatives to make finance easily available and overcome the obstacles

Challenges in Infra Financing

There a lot of hindrances in achieving

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Cover Story Perspective

Effective market mechanism Robust trading platform Simple listing norms of corporate bonds Development of market for debt securitization 6. RISK CONCENTRATION: In India, many lenders have reached their exposure limits for sector lending and lending to single borrower (15% of capital funds). This mandates need for better risk diversification and distribution 7. REGULATORY CONSTRAINTS: There are lot of exposure norms on pension funds, insurance funds and PF funds while investing in infrastructure sector in form of debt or equity. Their traditional preference is to invest in public sector of government securities.

However, much progress is sought is this domain like minimizing multiplicity of regulators, removing TDS on corporate bonds, stamp duty uniformity, etc.

2. PRIORITY SECTOR STATUS TO INFRA

Hitherto, infrastructure financing doesnt come under the ambit of priority sector like agriculture, small scale industries, education, etc. For every Rs 100 lent to non-priority sectors, banks have to lend Rs 140 to priority sectors. Giving priority status will help banks to lend more to this sector.

3. TAKE OUT FINANCING AND LOAN BUYOUTS

One major problem faced by banks while disbursing loans to infrastructure projects is the asset liability mismatch inherent with these projects. Therefore, many such projects are denied financing by banks. One way out from this predicament will be the takAlternatives ing over of loans by institutions like IDFC after the To overcome these challenges and find a way for medium term. This will allow banks to finance these easy availability of funds for infra financing, we can projects for a medium term by sharing some of the explore following alternatives: risks with institutions like IDFC. This reduced risk 1. DEVELOPING DOMESTIC BOND MARKET, CREDIT exposure will allow banks to increase their financing DEFAULT SWAPS & DERIVATIVES of infrastructure projects. India receives substantial amount of FII investment 4. RATIONALIZING THE CAP ON INSTITUTIONAL INin debt instruments. But most of this investment VESTORS is concentrated in government securities and corpo- Rationalizing the cap on investment in infra bonds by rate bonds institutional investors like pension funds, PF funds FII investment limit in infrastructure bonds has been and life insurance companies will lead to more inincreased from USD 5 billion to USD 25 billion. How- vestment in this sector. Currently, insurance compaever, investments of only USD 109 million material- nies face a cap of 10% of their investible funds for ized till August, 2011. This deficit in target invest- infra sector. ment levels need to be reduced. 5. TAX FREE INFRASTRUCTURE BONDS BY BANKS Just like a well-developed equity market, India needs Currently only NBFCs can float tax free infrastrucefficient bond market so that long term debt instru- ture bonds. If banks are also allowed to float these ments are available for infrastructure. Currently, bonds, they can raise long-term resources for infraFIIs can trade Infra bonds only among themselves. structure projects, thus reducing the asset liability Also, if credit derivatives are allowed, then FIIs will mismatch. be encouraged to invest more in these infrastruc6. FISCAL RECOMMENDATIONS ture bonds due to the presence of credit insurance and better management of credit risk. RBI is in the The following fiscal policy medications can allow process of introducing CDS on corporate bonds and more funding of infrastructure projects. unlisted rated infrastructure bonds by Oct 24 2011.

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i. Reducing withholding tax Currently, foreign investors pay withholding tax as high as 20% depending on the kind of tax treaty. It increases borrowing cost as the current market practice is to gross up the withholding tax. So, this recommendation would reduce the borrowing cost. ii.Tax treatment on unlisted equity shares Unlisted equity shares attract larger capital gains tax than listed ones. Currently, capital gains on unlisted equity shares are taxed at 20% instead of 10% for listed equity shares. Most private players in the infrastructure sector are not able to raise capital through public issues. Therefore, for these players unlisted equity will be their dominant source of

Cover Story Perspective

Singapore. After accounting for liquidity purposes, external shocks, high rate of domestic monetary expansion & real risks of disruptive reversals of capital

flows; some of funds can be used for infra.

9. FUTURE CASH FLOWS AS TANGIBLE SECURITY

The loans given to infrastructure project consortiums by banks are not secured & fall under the unsecured loans asset class for banks. Currently, RBI mandates that provisioning of such unsecured loans is kept at 15% (additional 10% for substandard unsecured loans). Therefore, total amount of loans to infrastructure projects are constrained because of the substandard unsecured nature of these loans. The primary source of repayment of these loans is

equity capital. They are adversely affected because of the tax treatment meted out to unlisted equity shares. Hence, special consideration should be given to private players in the infrastructure sector to encourage investments.

7. FOREIGN BORROWINGS
With respect to foreign borrowings, several options are there like increasing the cap rate for longer tenure loans, relaxing refinancing criteria for existing ECBs/FCCBs; allow Indian banks for credit enhance ECBs (which is currently allowed only for foreign banks), etc.

8. UTILISING FOREIGN EXCHANGE RESERVES

Indias foreign exchange reserves stand at USD 311.5 bn (Sep 2011). These reserves are primarily meant to provide a buffer against adverse external developments. But they do not add value to any real sector as they are invested in foreign currency assets such as government bonds. So, the returns on these reserves are quite small. The Deepak Parekh committee on infra financing is also in favour of allocating a small fraction of total reserves for infra purpose. This method of funding is already being used in some Asian countries like

the future cash flows accrued from the project once they are completed and ready for public use. These cash flows can act as a security under certain conditions and debt covenants. For instance, in case of road/highway development projects, RBI passed an order that a) annuities under build-operate-transfer (BOT) model and b) toll collection rights where there are provisions to compensate the project sponsor if a certain level of traffic is not achieved, be treated as tangible securities

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CLASSROOM FinFunda of the Month

Bonds

Classroom Cover Story

jayant kejriwal

IIM Shillong

rates as compared to normal bonds, which do not carry such options. Sir, what is the difference between yield and interest rates or coupon rates? Yield is a return on investment. It is a function of the market value of the bond, whereas coupon rates are always calculated on the face value. Sir, I am not getting. Market Value! Face Value! How is market value calculated, and how does it change with interest rates? Always remember that bond prices and interest rates are inversely proportional. If the interest rates in the market are above the coupon rate of the bond, the bond would trade at a discount, and if the coupon rate offered is above market rates of similar securities, the bond would trade at a premium. Hence, the yield would vary accordingly. The market value of a bond is calculated by discounting the future cash flows from the investment at the market interest rate at that time. Sir, can we do this with an example.

Sir, we have heard a lot about bonds or fixed income securities and yield. But they are very confusing. Could you please explain them properly? Yes, an important topic indeed. Bond is a debt instrument in which an investor lends money to an entity (corporate or governmental) that borrows funds for a defined period of time at a fixed interest rate. This rate is also called the coupon rate, and is usually paid semi-annually. So, is the interest rate and the period always fixed? Not always. Interest rate for floating rate securities is variable and may depend on the market interest rates or the interest rates of bank treasuries. Also one can easily exit investments in bonds by selling them in the open market. Then there is a class of bonds, called Zero-coupon Bonds which do not pay any interest. They are sold at a discount and are redeemed at par when they mature. The difference in price is the profit on the investment. Sir, could you explain what factors lead to different interest rates being offered by different bonds? There are several factors, risk being the primary one. Different firms have varying risks based on the industry it operates in, leverage on its balance sheet, its management etc. Also the rates reflect the ratings that the bond gets when they are introduced. Usually higher the risk higher is the interest rate offered. Also there are other factors like Callable options, which give the issuer the right to call back the bond in case market interest rates reduce, and hence they offer a higher return compared to normal bond. Similarly in Puttable bonds the bondholder has the right to sell the bond to the issuer at a specified price prior to maturity. They do so if the interest rates rise or the credit worthiness of the issuer deteriorates. Hence, they offer lower interest

Sure. Suppose XYZ Company issues a 2 year bond with a face value of Rs.100 and a coupon rate of 8% annually. The market interest rate for a similar security is 6.5%. Hence the market value of the bond would be calculated as: 8/1.065 + 108/ (1.065^2) = Rs.102.73/Sir, could you talk about one of the most important risk which is the Reinvestment Risk. Yes. Reinvestment risk is associated with the redeployment of capital obtained as interest or principle from fixedincome securities. If market interest rates reduce, these funds need to be invested at lower interest rates. Risk usually increases with call or prepayment feature or if the coupon is higher.

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FIN-Q
1. Which type of Bond Auction is followed by Government in India? 2. When a stock market seems highly oversold and there is a sudden spike the next day as people cover positions, this is called a _______ 3. What will be the effect on interest rate given the tax collected by Govt. exceeds the expectation? 4. Which type of risk is involved while trading Govt. Bond? 5. You are a trader. The stock market is going up and you figured out that FIIs are buying stocks. What should be your trading strategy in Forex in terms of Dollar? 6. Spot Date: Jul 7, Spot - 46.70/73, Sp Jul - 18/21.A customer wants to sell dollars forward for July15, 2011. What will be the rate if the bank charges a 2 paisa margin? 7. A floating rate bond where the principal is repaid over time is called_______ 8. Given that the closing Market Price of Wipro is Rs 400, if Wipro were to announce a bonus of 1:1, what will be the stock price of Wipro in the market, all other factors remaining constant? 9. Which part of the office (back, middle or front) is concerned with giving buy or sell recommendations? 10. Monitoring the corporate actions and collecting results of the same is the activity done by Custodians. (True or False)

All entries should be mailed at niveshak.iims@gmail.com by 15th November, 2011 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-

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WINNERS
Prize - INR 1000/-

Article of the Month

NMIMS, MUMBAI

Prateek Ahuja & Varun Salwan

Prize - INR 500/-

FIN - Q

Diptiranjan Panda
IIM INDORE

ANNOUNCEMENTS
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