Bottomline 2017 - Finance Magazine - Networth - IIMB

PAGE 2 OF 66

Bottomline // January 2017

EDITORIAL The Finance Club of IIM Bangalore, Networth,

chief editor, Gaerik Chhabra. It explores the

is pleased to bring to you the 5th edition of its

following questions: What are the various

biannual magazine, Bottomline. Since its first

concepts and how do they interplay to bring

edition in 2011, the magazine has been bringing

about a change in existing transactions? What is

together divergent perspectives on finance and

the role of regulation in emerging technologies

economics from various spheres, including

like block chain? How has the industry evolved

eminent personalities, academia and students

to how it is today and what are some of the

from various reputed universities.

possibilities in future?

This edition focuses on the rapidly evolving

The problem, critics claim, with finance is that

global financial industry and possible future

it sacrifices equity of the nations at the altar

outcomes. We believe that the industry is at

of growth. Our focus on emerging economies

crossroads, witnessing transformation at a pace

explores and questions this idea. We have an

never seen before and moving towards a new

article by Ms. Vidushi on challenges being faced

paradigm. Whether it is the unusually low yields

by Brazil, an article by our Professor Srinivasan

on bonds across the world, the rise of FinTech

Rangan on how successful Foreign Institutional

companies and their increasing influence, the

Investors are in emerging economies and an

unconventional approaches taken by Central

article by Professor Vaidyanathan on what

Banks across the world or changing regulations,

challenges emerging economies like India

the industry is growing by leaps and bounds.

face, particularly those related to security and

Combine all these changes with the evolving

sovereignty.

demographics and politics, and it becomes clear that the finance industry is at the doorstep of a

Meanwhile 2016 has also been marked by highly

revolution.

polarizing debates at home. Demonetization has changed fortunes of many overnight and set

This edition promises you to give an immersion

the economy into tumult, the effects of which

into the world of finance in seven sections. The

still persist. We have an interview regarding

first section views the global finance sector

the same with Mr. Sathya Kumar, a Chartered

from the point of view of an eminent academic,

Accountant, passionate about public policy and

Professor

experienced

knowledgeable about this issue, We also have

bureaucrat, Dr. Karthik Hegdekatti, and our

an article from a trio of Networth members,

Jayanth Varma, an

PAGE 3 OF 66

Bottomline // January 2017

Archana Maganti,

Ayush Agrawal and Rishi

Patnekar for his contribution in the last section.

Vora on high inflation is posing an iniquitous burden on people of India.

We would love to hear from you regarding your views on this magazine. Do send in your

This time we have dedicated a section to startups

comments, feedback & suggestions to

with a special focus on FinTech, which are de

networth@iimb.ernet.in.

rigueur in the current financial landscape.

Following an introduction by Archana Maganti,

The Editorial Team,

we have an in-depth interview with a Venture

Bottomline

Capitalist and IIM B alumnus, Mr. Parag Dhol on the startup ecosystem in India and potential for

Editorial Team

future.

Chief Editors Archana Maganti

We also tried to cover some of the prominent

Gaerik Chhabra

deals that happened during 2016, domestically as well as globally. These deals, we believe, will

Lastly, you may find more interesting reads from

certainly have a significant effect on markets

Networth at our blog. Our team publishes new

and industry structure in future.

articles every fortnight. Please do visit! https://macrohappenings.wordpress.com/

We also look at 2016, review the major happenings by each month and focus on powerful personalities in finance. We thank Bharath Vejendla for his assistance in the compilation of events in 2016.

We express our gratitude to all the members of Networth, the Finance Club of IIM Bangalore. We wish to thank Spriha Saggar, Dinkar Mohta and Madhur Bajpai for all their valuable guidance and advice. We have included a section on the events conducted by our club, which vouch to our enthusiasm. Lastly, we thank Ritwik

Bottomline // January 2017

CONTENTS

THEME: FINANCIAL REVOLUTION 07

FINANCIAL WORLD AT CROSSROADS

12

THE GOVERNMENT BITCOINS: REGULATED AND SOVEREIGN BACKED CRYPTOCURRENCIES

16

THE FOUR NEW FORCES

EMERGING MARKETS VIEW 19

BRAZIL - THE CRISIS PROLONGED

22

FII TRADING AND FUTURE RETURNS – EMERGING ECONOMIES

26

CIBIL - SHOULD OUR CREDIT DATA BE WITH A FOREIGN COMPANY?

MEANWHILE IN INDIA 29

INFLATION - THE INIQUITOUS TAX

34

DEMONETIZATION DEMYSTIFIED: INTERVIEW WITH MR. SATHYA KUMAR

Bottomline // January 2017

THE AGE OF STARTUPS 39

THE BLOOM OF FINTECHS

41

VC PERSPECTIVE OF STARTUPS IN INDIA - INTERVIEW WITH MR. PARAG DHOL

MERGERS & ACQUISITIONS 46

UBER - DIDI : CHINA

48

MARRIOTT & STARWOOD

50

FORTIS & ITC HOLDINGS

LOOKING BACK AT 2016 53

2016 - GLOBAL EVENTS ROUND-UP

56

2016 - PERSONALITIES OF THE YEAR

TEAM NETWORTH 59

TEAM NETWORTH - SENIOR COORDINATORS

60

TEAM NETWORTH - JUNIOR COORDINATORS

61

NETWORTH - 2016 EVENTS ROUND-UP

1 FINANCIAL WORLD AT CROSSROADS

FINANCIAL REVOLUTION

2 THE GOVERNMENT BITCOINS 3 THE FOUR NEW FORCES

PAGE 7 OF 66

Bottomline // January 2017

FINANCIAL WORLD AT CROSSROADS

T

he past two decades represent an interesting phenomenon in the global financial world.

Each decade has a story to tell that in almost all ways contrasts the story of the other. The earlier decade – from the late 1990s to late 2000s – is viewed as the golden era of modern financial world and was marked by increasing global trade, rapid growth of equity and debt markets (probably except for the dotcom bubble) in most stable economies and greater movement of labor and capital across borders. It was the triumph of globalization and few had predicted that there will be challenges or hurdles on this path.

However, a turning point occurred in this narrative in 2008 that left the financial world reeling in shock and probably even turned back the hands of the clock. Post the crisis, global trade has declined and not recovered to its pre-crisis peak, investor confidence has failed to pick up and countries across the world are struggling to push the growth gears of their economies.

In the light of the recent political and financial events, we view the 2008 global financial crisis as the pivot and analyze how the structure of global finance, economy and markets has transformed in the past two decades.

- Gaerik Chhabra

Gaerik Chhabra is a first year student at IIM Bangalore. Prior to joining IIM Bangalore, Gaerik was working in the Private Wealth Management Technology division at Goldman Sachs for 4 years.

At Goldman Sachs, Gaerik has worked on a variety of functions including the lending business, client portfolio ledger and trade order matching.

THE DECADE BEFORE Emergence of the ‘Emerging Economies’ Post World War II, the major economies of the world had been weakened. The United States was the sole capitalist state that drove economic growth and it continued to lead the world until 1970s, when some of the Western European countries started to recover. This was followed by the rise of the Asian economies in the 1980s and the 1990s, primarily lead by Japan and later

by China, after its leader Deng Xiaoping in 1978 liberalized the Chinese accompany. In 1991, after years of following socialist policies and acting as a welfare state with strict regulations

2008 - A PIVOT IN FINANCIAL HISTORY? The Decade Before • Emergence of the ‘Emerging Economies’ • Innovation and globalization in financial markets • The Consumption Era

The Decade After • Central banks: The lone wolves • Bleeding Banks - Regulation and penalties • Rise of populism – End of globalization?

• Growth of alternate finance

PAGE 8 OF 66

Bottomline // January 2017 in the private sectors, the then Indian Finance Minister Manmohan Singh (later Prime Minister), implemented a wave reforms that opened the doors of Indian economy to the private sector and foreign investments.

As a result of these events, during the decade before the 2008 crisis China and India, grew at over 8% annually. A similar wave of growth was being observed in Brazil and Russia. In 2001, the then Chairman of Goldman Sachs Asset Management coined the term BRIC – postulating that these four economies will be the driver of world economic growth. In 1998, the BRIC nations had a combined GDP of 8.31% of the world GDP in current US dollar value (World Bank Data). By 2008, this had increased to 14.47% and it now stands at 21.94%.

Innovation and globalization in financial markets The era before the crisis transformed the financial world in two crucial ways – one, there was innovation in the financial instruments being offered which witnessed exponential growth and two, banks across the world diversified their businesses leveraging globalization.

In the two decades preceding the crisis, there was a growth in new financial instruments being traded such as derivatives and ETFs. Though some of these instruments had existed for decades, some even decades, it was only in the decade before the financial crisis that there was a spurt in the volume of these instruments being traded.

In the decade prior to the crisis, the global daily average turnover in the listed futures and options exchange market increased by almost 8 times from $1.3bn to $9.5bn (based on notional amount, source: BIS). Similarly, the global daily average turnover for OTC foreign exchange derivatives on a ‘net-net’ basis in 2007

“

The growing financial markets provided banks an opportunity to expand their businesses, both geographically and in terms of the services provided.

was $3.3bn, a three-fold increase from a decade earlier (source: BIS). However, the biggest spike was observed in the daily average turnover of OTC interest rate derivatives, which stood at $1.6bn in 2007, up 8 times from a meager $0.2bn in 1998. These numbers are representative of the growth that the derivatives market witnessed in the decade before the financial crisis.

Similarly, the growing financial markets provided banks an opportunity to expand their businesses, both geographically and in terms of the services provided. The fifteen-year period saw a steady increase in the number of foreign banks, from 784 in 1995 to 1,301 in 20071. For the period between 1998 and 2008, the cross-border claims and liabilities tripled from $9.1bn and $8.2bn to $34.4bn and $30.1bn, respectively (source BIS).

Banks also diversified their service lines and grew rapidly in this decade. The strong capital markets allowed banks to earn more income through services such as investment banking and wealth management. The intriguing aspect, however, is the growth of the shadow finance sector during the same period. The graph on next page reveals that the financial assets held by the shadow banking sector had surpassed that held by traditional banking sector.

The Consumption Era In the decade before the crisis, the economies of most of the developed economies were being driven by increased consumer spending. The household savings rate, as a percentage of personal disposable income, was declining in most of the growing economies. The United States has historically had one of the lowest savings rate and lead this decline even in the decade before the crisis. The gross savings as a percentage of GDP in the United States had come down from 21.33% in 1998 to 15.49% in 2008. Since the 1970s, this was the second period with one of the lowest savings rate. However, this trend has seen a reversal since the economic crisis, changing the nature of how consumers allocate their income. Since 2008, the 1 Stijn Claessens and Neeltje van Horen: “The Impact of the Global Financial Crisis on Banking Globalization”.

PAGE 9 OF 66

Bottomline // January 2017

8 years after the crisis, most global economies continue to be plagued by low spending by the larger population despite several efforts by the central banks to ease the availability of credit and to discourage savings through lower interest rates.

THE DECADE AFTER Central Banks: The lone wolves Until the 2008 financial crisis, the Central Banks played a supporting role to the government policies. However, post the crisis, the role of central bank has shifted from a side-actor to the key player.

Financial assets by holding sector (Source: Board of Governors of the Federal Reserve: Financial Accounts of the United States, the author’s own calculations.)

Source: ‘Traditional banks, shadow banks and the US credit boom – credit origination versus financing’ by Robert Unger

gross savings in the US has increased every year and now stands at 19.91%, fast approaching the late 1990s number.

Similarly, the household savings as percentage of the personal disposable income in United States, China, Australia and Switzerland reveals a similar trend. This phenomenon in four different regions of the world clearly indicates that the problem is not limited to the US economy.

While it is true that after every economic crisis, the savings rate tends to increase due to low consumer confidence in the future of the economy, what is surprising in this case is the time period for which this trend has continued. Even

Across the world, the growing importance of the central banks has been attributed to several factors, including the increasing debt of US Government due to the bailout program, and the political and structural weakness of the EU Commission in case of the Eurozone. Similarly, Japan had changed 7 Prime Ministers between 2006 and 2012, as the economy had continued to struggle for over a decade since the Asian financial crisis in 1998. In the given circumstances, Central Banks across the world had to step in to save their economies from a catastrophic collapse.

Most resorted to Quantitative Easing programs, purchasing huge amounts of securities and debts to pump in more money into the economy and reducing interest rates, in some countries lower than 0%.

However, unlike any of the previous financial crisis, these measures failed to lift the economies to the expected level and growth remained tepid years after Central Banks pursued these measures.

“

In the words of Mark Carney, Governor of the Bank of England, “Monetary policy has been keeping the patient alive, creating the possibility of a lasting cure through fiscal and structural operations.”

PAGE 10 OF 66

Bottomline // January 2017

settled $82 billion with 8 banks so far. Deutsche Bank has been the most recent victim, finally settling for an amount of $7.2bn, down from the initial amount of $14bn which was widely believed the bank would not be able to pay. Adding to the DoJ settlements, the various lawsuits against the banks takes up the total amount to over $150bn.

© 2014 Federalreserve, Flickr | GOV Chair Yellen presents the Monetary Policy Report to the Congress.

The lack of fiscal support in many countries with these monetary policies have pushed the Central Banks to a corner, left fire-fighting alone. In the words of Mark Carney, Governor of the Bank of England, “Monetary policy has been keeping the patient alive, creating the possibility of a lasting cure through fiscal and structural operations. It has averted depression and helped advanced economies live to fight another day, so that measures to restore vitality can be taken.”

Bleeding banks - regulations and penalties In the aftermath of the crisis, there was a demand to bring to book those responsible for it and to regulate the financial industry. The US Government responded with a number of regulations under the Dodd-Frank Act. The EU, on the other hand, decided to implement a single rulebook for all its member state banks and has enacted 30 rules since 2012 after it established three supervisory authorities. Compliance with these regulations has greatly impacted the profitability of these banks.

At the same time, inquiries were setup to investigate the role of these banks in the creation of the crisis. The US Justice Department has already

The increased regulations and continuous inquiries have hit the financial systems hard and banks have struggled to stay profitable in the past few years.

Rise of populism – end of globalization?

The greatest driver for economic growth in the past three decades was globalization – borders were opened for trades via free trade agreements, migration rate increased significantly and a number of activities were outsourced from the developed to the developing countries. Until a few years ago, the general perception was that globalization benefits all and just like each of the previous stages of globalization, the common consensus was that this phase, too, will last forever.

However, the prolonged recovery after 2008 crisis caused huge sustained levels of unemployment in the developed economies. There was growing discontentment against movement of jobs and labor from these economies to the

“

Populism is now mainstream.

And this sentiment is affecting the nature of politics in the West as ‘nationalism’ is gaining momentum.

PAGE 11 OF 66

Bottomline // January 2017 emerging world. On the back of these conditions, two major unexpected events happened in 2016 which have probably set in motion the reversal of globalization.

Populism is now mainstream. And this sentiment is affecting the nature of politics in the West as ‘nationalism’ is gaining momentum.

Whether this wave of populism will merely redistribute the jobs and wealth or stall global economic growth is to be seen over time.

Growth of alternate finance While most of the commentary on the last decade has been bleak and pessimistic, there is a knight in the shining armour. The growth of alternate financial systems promises to revolutionize the industry. Finance and technology have blended together to disrupt the old model of banking. There are 4 main areas that have seen phenomenal growth and captured our attention - crowd-funding, peer-to-peer lending, microfinance and invoice trading.

In Europe, the total volume of transactions in this industry experienced a growth of 144% and 92% in 2014 and 2015 respectively2. In the Americas, the industry grew to $36.49bn in 2015, a 212 per cent annual increase from the $11.68bn in 20143.

The leader in this category is peer-to-peer lending, where a number of unsecured personal loans are pooled to support a business venture.

The success of Grameen Bank in Bangladesh has become a model for microfinance across the world. Microfinance involves creating small loans for the impoverished people without any collateral, and is considered vital to kick start economic growth in many economies.

While various industry reports claim that firms that have been funded using alternate finance have performed well, only time will 2 Robert Wardrop, Bryan Zhang, Raghavendra Rau and Mia Gray: “Moving Mainstream - The European Alternative Finance Benchmarking Report “.

3 Robert Wardrop, Robert Rosenberg, Bryan Zhang, Tania Ziegler, Rob Squire, John Burton, Eduardo Arenas Hernadez & Kieran Garvey: “The Americas Alternative Finance Benchmarking Report”.

“

In Europe, the total volume of transactions in alternate finance industry experienced a growth of 144% and 92% in 2014 and 2015, respectively.

tell whether there are flip sides to this growing industry. In that direction, it is imperative that the authorities frame appropriate regulations not only to support these new institutions but also regulate their activities. In the US, conflicts are already emerging between Federal regulators and State regulators on FinTech.

CONCLUSION The global financial crisis has moved the world in a direction different from where it was headed to before the crisis. Almost a decade after the crisis first appeared, we are still seeing the effects on the global financial and political landscape.

In 2017, the outcome of elections in a number of European nations will demystify where we are headed to. On the other hand, the election of Trump has finally set the stage for monetary policy divergence, which will probably help central banks steer out of the spiral of quantitative easing and maintaining low interest rates. In this regard, one cannot discount the role of changing demographics in some of the advanced economies.

A recent paper published by the Federal Reserve4 concluded that with aging demographics, low interest rates is the ‘new normal’.

The question we are left with is - will the coming years see us returning to the pre-crisis era or take us further away from where we were before the crisis?

•••

4 Gagnon, Etienne, Benjamin K. Johannsen, and David Lopez-Salido (2016). “Under- standing the New Normal: The Role of Demographics,” Finance and Economics Discussion Series 2016-080. Washington: Board of Governors of the Federal Reserve System, http://dx.doi.org/10.17016/ FEDS.2016.080.

PAGE 12 OF 66

Bottomline // January 2017

THE GOVERNMENT BITCOINS: REGULATED AND SOVEREIGN BACKED CRYPTOCURRENCIES

S

- Dr. Karthik H. halmali is an Indian student who came to

Dr. Karthik H is a Civil Servant in the Government of India, Ministry of Railways.

the USA a few years ago to study. It was with

great difficulty that her father, a potato farmer in India, made loans to send his daughter to the US to study. Now, Shalmali has graduated and joined a company as a marketing manager.

Shalmali wants to send money to her father.

When her parents used to send her money from the India, a good chunk of the money was gobbled up by the Money Transfer Company and Banks as remittance and transfer charges.

But now, she is standing on her own feet.

She knows that her father will need every rupee of the money, as she has two younger brothers who need to be educated as well.

But how? Can the middlemen and the agents be bypassed? Can the full amount be sent to Shalmali ‘s parents so that her father can pay off the loans and educate her brothers? Is there a solution to Shalmali ‘s conundrum?

Money Systems The world is fast shifting to a cashless economy. But just like before, a centralized banking

He has written 7 internationally acclaimed research papers on Blockchain Technology which were published in more than 45 Journals. They were endorsed by 5 Nobel Laureates, The Deputy Governor of the Bank of England, renowned MIT faculty and many other acclaimed personalities. He is the creator of the K-Y Protocol; The First Protocol for the regulation of cryptocurrencies (like Bitcoin). He has propounded a new concept of money called ‘ENTROPIC MONEY’ to precisely measure the size and influence of parallel economies in Macro-Economic Systems.

A few of his concept creations (amongst others) include-The Canop-E Project, A Rail Tunnel Between India and Sri Lanka, A Fast-Track Credit-based Education System, International Standardization Protocols, and Managerial Index Protocol (MIPs).

Recently, as part of a National Brainstorming exercise - Rail Vikas Shivir, he presented some of his ideas and plans to the Prime Minister of India.

tems.

But Bitcoin and Bitcoin-like currencies (called cryptocurrencies) will change all that.

system still takes its cuts and commissions (to

The present day money system is a central-

the tune of $400 Billion every year!). New tech-

ized paper based money system. It is rapidly

niques of money transfer and schemes are now

transforming into a centralized digital money

in the market which provides better avenues

system. But any centralized digital system is a

for investment vis-a-vis present day money sys-

security risk. It can be hacked and precious fi-

“

The world is fast shifting to a cashless economy. But just like before, a centralized banking system still takes its cuts and commissions (to the tune of $400 Billion every year!).

nancial data can be tampered with. Then, the fate of a nation will depend on a few clicks on a hacker’s computer.

Blockchain technology is a proven, highly secure decentralized digital currency system.

A cryptocurrency (also called cryptocoin) is a

PAGE 13 OF 66

Bottomline // January 2017 medium of exchange based on Blockchain Technology.

By an intricate (yet transparent) procedure, the bitcoin network is able is transfer money with minimal cost from one part of the world to another in very less time (a few seconds to a few minutes depending on the amount). In the process, fresh bitcoins are also ‘minted’.

Bitcoin is a peer-to-peer based cryptocoin which is not backed by any commodity and (unlike fiat money) carries no sovereign guarantee whatsoever.

“

Imagine Bitcoin as a globally accepted digital currency. Bitcoin usage needs no intermediaries.

As such, banks will be completely bypassed. Loans and mortgages will become personal and customized. Anyone willing to loan will become a money lender.

Role of Banks in the Current Landscape A bank, as we all know is a financial institution that accepts deposits from the public and creates credit. One of the important ways by which banks help create money is through the Fractional Reserve Banking system, a book-keeping technique that banks use to create additional money in the system.

The Central Banks tightly control this creation of money by several direct and indirect regulations.

Banks fulfill several other functions too.

One crucial function of banks is that of a verifier. A transaction done through a bank is also supervised, verified and recorded by that bank.

Payment services with verified authentica-

tion and confirmation is done by banks. So banks act as a Trusted Third Party (TTP) between the transactor and the transacted. Basically, the TTP certifies that the transaction is authentic. There is an inbuilt transaction cost, deducted by the banks for their service as a TTP and verifier.

The most vital role of a bank now-a-days is to act as a Trusted Third Party (TTP). Banks act as TTPs in settlements, loan lending, project financing, issuing of banknotes (printed by Central Banks), credit mediation and creating money (through the Fractional Reserve Banking).

Commerce is based on transactions. And to conduct a transaction, there needs to be a supervisor, trusted by both the transacting parties. Banks evolved to fulfill this role of a Trusted Third Party.

Pitfalls of Unregulated Cryptocoin Imagine Bitcoin as a globally accepted digital currency. Bitcoin usage needs no intermediaries. As such, banks will be completely bypassed. Loans and mortgages will become personal and customized. Anyone willing to loan will become a money lender. People will no longer keep money in banks (or prefer to keep) as they will have a competitive market for interest rates throughout the world.

Joe can lend his money to Kate at 10% inter-

PAGE 14 OF 66

Bottomline // January 2017 est rate, wherein his banks provide only 5% on savings. Kate, on the other hand will get money at 10% (from Joe) interest rate instead of 14-18% interest rate loans offered by banks.

RSBCs as a better alternative Bitcoin is unregulated. RSBCs are regulated.

Regulated and Sovereign Backed Cryptocurrencies (RSBC), on the other hand are government

Thus, Kate would rather take loan from Joe

backed cryptocurrency akin to paper currency,

than from banks. And Joe would give loans to

but in digital form. Simply put, RSBCs are Gov-

Kate, rather than keep it in the bank.

ernment Bitcoins.

In the age of Bitcoin, credit–worthiness will

RSBCs are completely managed by the Sov-

become an important issue. In a scenario where

ereign Authority i.e. the Government on its own

Bitcoin becomes a major currency of exchange,

Blockchain. This system is based on the K-Y Pro-

each individual will need to have a credit–rat-

tocol. The K-Y Protocol is a set of rules and in-

ing. Credit–rating agencies will then start to

structions to implement the Regulated and Sov-

take center stage. The banking system will be

ereign Backed Cryptocurrency (RSBC) system.

all but extinguished. Probably banks can take on new roles as credit–rating agencies.

“

In the age of Bitcoin, credit– worthiness will become an important issue. Credit–rating agencies will then start to take center stage. The banking system will be all but extinguished.

Probably banks can take on new roles as credit–rating agencies.

A few banks may successfully transform into Credit-Rating Agencies whereas others will have to bite the dust. It is therefore important to realize that Bitcoin–like currencies (unregulated ones) are heavily disruptive.

Lending money without supervision or control becomes very easy. But so will cheating.

People may lose their lifetime savings to unscrupulous elements with doubtful credentials.

In such a situation, Credit–Rating Agency data may themselves be manipulated. ‘Cartelization’ and insider trading may go on unabated. This system will quickly deteriorate to a point where nobody can trust anybody.

Contrast the bitcoins with a scenario where RSBCs will be the norm in a cashless society.

Along with sovereign backing, there will be a regulated market. Banks can then act as a Trusted Fourth Party (TFP) instead of a TTP (which will be the network itself). They can underwrite or guarantee credit–worthiness of investors, money lenders and loan takers. They will be regulators and insurers merged into one.

What about Fractional Reserve Banking (FRB) in case of RSBCs? FRB’s role in the money supply will be greatly diminished in case of RSBCs. In case of Unregulated Cryptocoins like Bitcoin, FRB will be totally eliminated. Governments will no longer have control over money supply. In fact, money supply will be decided by market forces. This provides a fertile ground for manipulation by cartels and interest groups.

Bitcoin has a 21 million cap on its production. It thus has a constricted money supply regime. This will only lead to a deflationary spiral.

This is detrimental to the world economy as a whole.

In case of RSBCs, governments will have control over the money supply. The role of FRB will indeed be greatly reduced. Banks can still

PAGE 15 OF 66

Bottomline // January 2017 use FRB to increase money supply. But money

can be controlled. The role of FRB in money

supply can be more closely controlled by Cen-

supply will be greatly reduced. But banks will

tral Banks than it is now. A built–in inflation

still have an important role in the economy as

rate will ensure that a constant inflationary sit-

a Trusted Fourth Party (TFP). The economy, as

uation is maintained. Economic expansion is

usual will continue on an expansionary trajec-

thus ensured.

tory. Thus, a government controlled Cryptocur-

Banks lend money not only to private borrowers but also to governments. But in a cashless Blockchain society, Governments can directly borrow from the people at competitive rates. Banks will still exist as TFPs, albeit with a more sophisticated role. One can thus see that Bitcoin–like currencies are heavily disruptive.

rency is better than an unregulated one.

“

The time for a cashless society based on Blockchain technology has come. Demonetization is just the first step.

They have the potential to destroy FRB, eliminate banks, resulting in a deflationary economic outlook.

“

RSBCs are also equally disruptive. But their disruptive power can be controlled. The role of FRB in money supply will be greatly reduced. But banks will still have an important role in the economy as a Trusted Fourth Party (TFP). The economy, as usual will continue on an expansionary trajectory.

The final result will be that the total amount of trust in the system will go down. And an untrustworthy economic system is not good for business or individual growth.

The role of government as the sole issuer of currency will also be side-lined. This is akin to a government surrendering its sovereign author-

A Look at the Future Nations today pay a high price to run a paper currency based economy due to substantial cost of effort, resources, time, maintaining and operating paper money infrastructure, high fees for cash withdrawals, moving and managing cost of paper money etc.

Imagine all the money saved by shifting to a cashless economy. It is estimated that India alone - a $2 Trillion economy now- could save close to $70 Billion by 2025 if it shifts to a cashless economy. The savings world-wide by introduction of RSBCs will be enormous, probably running into hundreds of billions of dollars by 2025. All those savings can be utilized for poverty alleviation or managing the ill-effects of climate change.

The time for a cashless society based on Blockchain technology has come. Demonetization is just the first step.

(The views and opinions expressed in this article are those of the author and do not reflect network goes down, the economy goes down the view of the Networth Bottomline Editorial with it. team.)

On the other hand are RSBCs. They are also ••• ity to the network. The problem is that, if the

equally disruptive. But their disruptive power

Bottomline // January 2017

THE FOUR NEW FORCES

T

his is a wonkish post that links together four concepts that are somewhat slippery even in isolation. So let me begin with a quick primer on each of them 1. Global banking glut refers to the idea that there is an excess lending capacity on the balance sheets primarily of European banks.

Not finding enough outlets in their home markets, this money chases assets elsewhere in Europe and then in the United States. (More details can be found in Hyun Song Shin’s article and paper). I would extend this notion to other institutions – for example Japanese insurance companies chasing US assets.

2. Original sin is the idea that most lenders are willing to lend only in their own currencies and not in the borrower’s currency. Large advanced countries like the US are not subject to this constraint. By holding their foreign exchange reserves in US dollars (invested in US treasury bonds), central banks around the world lend to the US government in the borrower’s currency. But a weakened form of this constraint still exists. Banks will lend in a foreign currency only to the extent to which they themselves can borrow in that currency or can otherwise hedge the exchange rate risk.

A European bank will have dollar liabilities roughly equal to its dollar assets net of hedges so that it does not bear any exchange rate risk.

3. Shadow banking refers to non bank vehicles

“

For much of the last decade, the supply of credit from the banking glut in Europe was matched by the demand for dollar credit emanating from US and emerging market companies.

PAGE 16 OF 66

- Prof. Jayanth Varma Prof. Jayanth Varma did his post-graduation in management from the Indian Institute of Management, Ahmedabad (IIMA), where he was awarded a Gold Medal for scholastic performance. Subsequently, he obtained his doctorate in management from the Indian Institute of Management, Ahmedabad.

He is also a qualified cost accountant.

He is currently a Professor in the Finance and Accounting Area at the Indian Institute of Management, Ahmedabad where he teaches courses in capital markets, fixed income, alternative investments, risk management and corporate finance. He has been the Dean of the Indian Institute of Management, Ahmedabad for three years.

The following articles are published with his permission from his blog at http://www.iimahd.ernet.

for maturity transformation and credit intermediation. The vehicles most relevant to this post are money market mutual funds (MMMFs) in the United States which invested in short term instruments exposed to some (though small) degree of credit risk, but whose units were regarded as completely safe, cash equivalent instruments. Because of their ability to issue and redeem units at par, MMMFs could hide fluctuations in the value of their investments from their investors.

4. In the good old days before the crisis, a bank that could borrow euros at the inter bank euro lending rate (EURIBOR), was able to swap these into dollars to get funding at the dollar inter bank rate (LIBOR). Not any longer. A large cross currency basis has emerged making dollar funding through this route significantly more expensive. The BIS paper by Borio and others has details about this phenomenon. I must add though that while Borio and other

PAGE 17 OF 66

Bottomline // January 2017 economists regard the cross currency basis as a market inefficiency or failure of arbitrage, the post-crisis finance literature, no longer regards the cross currency basis as a market imperfection. Since EURIBOR and LIBOR are no longer seen as risk free, the cross currency basis is just another input to calibrate a multicurve discounting model (See for example, Masaaki Fujii).

Interplay affecting currency behavior For much of the last decade, the supply of credit from the banking glut in Europe was matched by the demand for dollar credit emanating from US and emerging market companies. Some US companies were levering up to fund stock buybacks; some were funding their investment (or losses) in oil fracking and other businesses.

Emerging market companies sought to borrow in dollars because they could not borrow in their home currencies (original sin).

Though the banking glut was in euros and the credit demand was in dollars, the US shadow banking system (particularly, the MMMFs) stepped in to solve the currency mismatch. US MMMFs lent to the European banks in dollars and these banks then lent the funds to dollar borrowers. In this solution, the funding was in some sense coming from the US itself, but the credit risk appetite and the capital required to support this risk came from the European banks.

With the implementation this year of the post crisis reforms of the US MMMF industry (abolition of stable value accounting for MMMFs), this route to matching euro banking glut and dollar credit demand is coming to an end.

Role of derivatives But there was a second solution to the currency mismatch and that was through the derivative market, especially, the cross currency swap. The European banks had abundant access to euros, and they swapped this into dollars to

“

The other rather remote (but frightening) scenario is that an implosion of the European banking system eliminates the banking glut in that continent.

fund credit in dollars. In the good old days before the crisis, a large European bank borrowed euros at EURIBOR, and swapped these into dollars to get funding at dollar LIBOR. The large and rising cross currency basis has made this solution less attractive.

Possible scenarios in future In the long run, this will probably lead to a repricing of credit risk with dollar credit becoming more expensive and euro credit cheaper. The latter process is being accelerated by the ECB’s corporate bond buying program. Borrowers accustomed to borrowing in dollars will at some stage have to accept the currency risk of euro denominated borrowing. The large reverse Yankee bond issuance (US companies borrowing at zero or near zero rates in euros) is the early stage of this process. So far, however, most reverse Yankee issuances have been swapped into dollars. Rising cross currency basis will force at least some of them to leave the borrowing un-hedged thereby taking on euro exchange rate risk, and the US corporate sector will for the first time get a taste of what original sin looks like. For many emerging market companies, who almost instinctively borrow in US dollars, this is an opportunity to rethink their liability management strategy. The other rather remote (but frightening) scenario is that an implosion of the European banking system eliminates the banking glut in that continent.

(The views and opinions expressed in this article are those of the author and do not reflect the view of the Networth Bottomline Editorial team.)

•••

1 BRAZIL - THE CRISIS PROLONGED

EMERGING MARKETS VIEW

2 FII TRADING AND FUTURE RETURNS – EMERGING ECONOMIES 3 CIBIL - SHOULD OUR CREDIT DATA BE WITH A FOREIGN COMPANY?

PAGE 19 OF 66

Bottomline // January 2017

BRAZIL - THE CRISIS PROLONGED - Vidushi Jalota Introduction

B

razil has the ninth largest economy by nominal GDP in the world1. The Brazilian econo-

my is characterized by moderately free markets and an inward-oriented economy.

In the past few years, there has been a shift in the image of Brazil, from an example of an aspirational model in economic growth to a one struggling to develop strongholds of accountability and transparency. Such deficiencies can wreak havoc on the economic and financial standing of

Vidushi is a first year student of MBA (IB) at the Indian Institute of Foreign Trade. She has done her graduation in B.A.(H) Economics from Miranda House, University of Delhi.

She has also been a special invitee to the Godrej LOUD competition and a Campus Finalist for the Citibank Woman Leadership Award. Her interests lie in baking and chocolate making and she has a dedicated Facebook page too.

political inefficiency, to name a few.

a country, like has been the case with Brazil. The following article highlights the factors and areas which have been instrumental in bringing about a political and consequently an economic crisis in the fifth largest country of the world, by land mass and population.

Corruption Brazilian economy has been victim to one of the biggest corruption scandals associated with the state-owned-oil-giant, Petrobras. Its GDP grew at a meager 0.1% in 20142. Petroleo Brasileiro,

Coming to the present bleak economic situa-

widely known as Petrobras, was formed in 1953

tion of Brazil, some major factors are responsible

as Brazil’s national oil company. It is one of Lat-

for the doom. Corruption, trade-restrictions and

in America’s largest companies, with the government holding a majority stake in it. The infamous scandal involves money laundering to the tune of $23 billion, which the executives are accused of awarding to outside companies. Market capitalization of Petrobras has plummeted from $230 billion in 2010 to just $49 billion today. This infamous scandal has caused the economic indicators of Brazil, such as unemployment rate, to nosedive over the years. The Petrobras scandal is one of the main reasons as to why majority of the popu-

1 http://statisticstimes.com/economy/countries-by-projected-gdp.php

2 World Bank Data

PAGE 20 OF 66

Bottomline // January 2017

• 1822-

Brazil

becomes an independent

nation.

Trade

flourished though with regulations;

Britain

was the main trading partner of Brazil.

•

1900s (1st half

of 20th Century) - Until

1930,

Brazil

was

lation is going jobless. The country being heavily

referred to as the ‘Cof-

dependent on the oil company had failed to invest

fee-Economy’ due to immense coffee production

substantially and shrewdly in other sectors, espe-

(close to 60%) and hence largely traded in it. Trade

cially infrastructure development. This resulted

policies were oft undertaken to protect the coffee

in widespread unemployment rates in Brazil.

producers.

Lastly, even though Brazil is a resource rich

• President Fernando Collor de Mello (In of-

nation, but due to difficulty in setting up of busi-

fice: 1990-92) adopted certain radical policies to

nesses, industrial growth has been stymied. As

open up the Brazilian economy . Though these

we can see from the graph above, the ease of

policies were initially beneficial in reigning in

doing business in Brazil deteriorated in the past

the situation and brought industrialization in the

few years on a whole, with the lowest being 129

short run, but later took a toll on the domestic in-

in 2009 to the highest being 111 in 2014. It takes

dustries whose competitiveness nosedived in the

about 83 days to start a business in Brazil3. The

following years.

offshoots of the Petrobras scandal, infested the

Monetary Policies

economy with immense corruption; since then it has become quite difficult for industries to set shop on the Brazilian soil and the growth of the industrial sector has taken a hit.

Trade Protections Economic History of trade in Brazil- If a hawkeye study of Brazil’s trade history with rest of the world is conducted, it would be found out that it depicts quite volatility. A broad timeliness can be constructed for easier analysis: 3 World Bank Data

Here, we discuss about two main monetary policy tools used by the central banks- interest rates and money supply. Using these instruments, the central bank influences the availability of credit in an economy which further influences the growth which takes place over time.

Banco Central do Brasil, the central bank of Brazil, has kept the interest rates at approx.

14.25%. This is quite high as compared to India (6.5%). Due to high interest rates, it gets difficult for households and private investors to borrow

PAGE 21 OF 66

Bottomline // January 2017 from banks. Investment, mainly capital invest-

damage some measures like opening up the econ-

ment gets affected due to this, because it gets

omy, which would increase the competitiveness

costlier to procure funds. As we observe in the

of the indigenous firms, could be adopted. Reduc-

Keynesian equation given by the British econo-

ing restrictions on trade would also help Brazil

mist, John Maynard Keynes (1883-1946),

to leverage its comparative advantage, mainly in

Y = C + I + G + NX where Y=National income or GDP, C=Consumption by households; I=investment; NX=net exports due to fall in investment (I), the overall income/GDP of the decreases and the economy plunges into a bust period and eventually a crisis occurs.

Another major influencer of liquidity in the economy is the Cash Reserve Ratio (CRR). It is percentage of deposit of funds banks are required to keep with the central bank, in the form reserves.

The CRR in India is fixed at 4%, while in Brazil it has been at 45% since the past one year4. Having a high CRR means the banks have to keep a large fraction of their deposits with the central bank, thus it decreases the liquidity in the economy and from the Keynesian equation shown above

“

we can conclude that the GDP (Y) of the country falls due to less Consump-

ufacturing and services. This would be possible because of the reduced costs due to the presence of economies of scale in production.

Another measure could be reducing the oil-dependence of the country, as it can help to make the ailing economy self-reliant, thus pushing the industrial sector towards competitiveness.

Subsidies given by the government need also to be kept in check, as they are often believed to not contribute towards investment purposes. Expenditure on capital investment should be the priority so as to help the economy rise from the debris of a slump.

All this is and much more is achievable by a

If immediate results are not shown by those at the helm, then the outraged public might overthrow the sitting government by a huge mandate.

A policy reform is thus the need of the hour.

tion (C).

Conclusion and Suggestions As has been observed, political imprudence, fueled by excessive corruption and existence of protections on Brazil’s trade have been major contributors to the downfall of the economy.

To bolster growth and to prevent further 4 Trading Economics

natural resources, in industries and even in man-

change in the outlook of the present Rousseff government, which has been tainted

with

corruption

charges associated with Petrobras, the oil-giant of the country. If immediate results are not shown by

those at the helm, then the outraged public might overthrow the sitting government by a huge mandate. A policy reform is thus the need of the hour.

(The views and opinions expressed in this article are those of the author and do not reflect the view of the Networth Bottomline Editorial team.)

•••

PAGE 22 OF 66

Bottomline // January 2017

FOREIGN INSTITUTIONAL INVESTOR TRADING AND FUTURE RETURNS – EMERGING ECONOMIES

- Prof. Murugappa Krishnan & Prof. Srinivasan Rangan

INTRODUCTION AND MOTIVATION

F

oreign Institutional Investors (FII) are institutions established outside India that invest in securities in India. The label “FII” masks considerable heterogeneity. FIIs include large overseas mutual funds and hedge funds, as well as small investment firms. FII participation in the Indian Equity market has grown considerably in the last 15 years, from Rs. 38bn ($1.2bn) at the end of December 1993 to Rs. 8,082bn ($174.8bn) at the end of December 2015 (EquityMaster). In light of this growth, an important question to be addressed is whether FII investments have generated positive abnormal returns. That is how, skilled have FIIs been?

What are the current views of academics and regulators on the expected performance of FIIs? Two broad and opposing views have been offered. Some commentators argue that FIIs are endowed with superior expertise and resources by virtue of being global firms, and are hence likely to be successful portfolio managers. Others contend that FIIs are likely to be disadvantaged in terms of experience and access to information vis-à-vis the incumbent domestic investors (Brennan and Cao (1997)) and hence likely to underperform. Additionally, local governments tend to tightly regulate FIIs in terms of the types of securities that they can trade and thus limit their performance potential.

To evaluate which of the two afore-stated

“

Some argue that FIIs are endowed with superior expertise and resources by virtue of being global firms, and are hence likely to be successful portfolio

Prof. Srinivasan Rangan joined the Finance & Control Area of IIMB in May 2010.

Earlier, he taught at Northwestern University, University of California at Davis, University of Colorado at Boulder, University of Texas at Dallas, Amrita School of Business (Coimbatore), and University of California at Berkeley. His work experience includes two years as a management consultant at Pricewaterhouse Coopers.

His research interests are in the areas of market efficiency, financial analysis and valuation, initial public offerings, and earnings management. He has refereed publications in the Journal of Financial Economics, Accounting Review, Journal of Accounting Research, Review of Accounting Studies, and Financial Management. His work on earnings management and initial public offerings has been cited in The Wall Street Journal.

views dominate, researchers have examined data on investment performance of FIIs. Interestingly, the evidence on the stock-level investment performance in multiple markets (including Finland, Indonesia, Japan, South Korea, and Taiwan) is mixed. While Grinblatt and Keloharju (2000), Huang and Shiu (2009), and Bae, Min, and Jung (2011) conclude that FIIs generate superior performance, Kang and Stulz (1997), Dvorak (2005), and Choe, Kho, and Stulz (2005) report the opposite.

In this study, our research objective is to evaluate the investing skill of FIIs in India, a large emerging market that is relatively unexplored.

While there are many anecdotal references in the Indian financial press of significant FII activity in Indian financial markets, formal evidence of

PAGE 23 OF 66

Bottomline // January 2017 their role, and the consequences of their activity, is limited.

FII trades can be classified into two broad categories: trades on their own account and trades on behalf of foreign investors. To facilitate the latter, FIIs issue derivative instruments known as P-Notes, via investment banks. FIIs initiate trades on behalf of their clients and then P-Notes are issued to the clients to indicate that shares are held by the FII on behalf of the client.

Information on the identity of P-Note holders is typically difficult to establish, at least at the time of the trade. Thus, P-Notes offer foreign investors an opportunity to get exposure to the Indian market without having to register as an FII with SEBI. A frequent claim in the financial press is that P-Note holders are connected to Indian corporate entities and thus help the latter to retain control in the investee firms or even avoid paying taxes in India. Thus, it is possible that FII trades related to P-Notes are motivated

“

A frequent claim in the financial press is that P-Note holders are connected to Indian corporate entities and thus help the latter to retain control in the investee firms or to even avoid paying taxes in India.

by the desire to retain corporate control or avoid taxes, potentially at the expense of a return maximization objective. Hence, whether FIIs are successful portfolio managers, and whether they even care about market performance, are open questions.

FINDINGS Our study employs a database of daily stocklevel trades of FIIs in India for the years 20032014. This firm-level data was not available till

The figure tracks the value of Rs. 1 invested on March 31, 2003 in three portfolios of stocks: stocks in which FIIs are net buyers in a quarter (net buy portfolio), stocks in which they did not trade during the quarter (no trade portfolio), and stocks in which FIIs are net sellers (net sell portfolio).

PAGE 24 OF 66

Bottomline // January 2017 SEBI began releasing masked FII transaction data in a step towards compliance with a promise made in reply to a parliamentary question. We aggregate daily trades over a quarter to construct a measure of quarterly net buying.

Our first finding is that FIIs’ trades are on average unprofitable over the sample period.

For our sample period, portfolios of stocks that are formed based on positive, zero, and negative FII quarterly net buying yield average quarterly returns of 1.6%, 3.8%, and 2.4%, respectively.

This suggests that investing in stocks in which FIIs do not trade yields superior returns to those in which they trade. Further, their sells perform better than their buys.

We also employ regressions that correlate 3-month and 12-month returns with prior quarterly FII trading and find that the latter is negatively associated with subsequent returns. A 10% increase in FII net buying is associated with 3% (6%) decline in returns in the subsequent quarter (year).

“

The study suggests that investing in stocks in which FIIs do not trade yields superior returns to those in which they trade.

Further, their sells perform better than their buys.

To understand the causes of this poor performance, we separate the sample into (a) small/large stocks and (b) stocks that are frequently traded by FIIs and those that are less frequently traded. Fewer analysts follow small firms and these firms face more uncertainty and are hence harder value. Hence, we expect that the relation between FII trading and subsequent returns to be more negative for small firms. Our results, especially for one-year returns, are consistent with this prediction. Researchers in behavioural

“

Fewer analysts follow small firms and these firms face more uncertainty and are hence harder value. Hence, we expect that the relation between FII trading and subsequent returns to be more negative for small firms.

finance have developed theoretical models that posit that traders who are overconfident trade too much and consequently suffer losses (Odean (1998); Barber and Odean (2000); Daniel and Hirshleifer (2015)). Therefore, we predict the FII trading losses will be magnified when they trade more frequently. We divide our sample based on the median number of transactions per quarter (buys + sells) and find that more frequent FII trading magnifies the negative relation between FII trading and subsequent returns. Thus, the poor performance of FIIs in India can be partly attributed to excessive trading.

Next, we examine the relation between FII trading and subsequent earnings surprises and announcement returns. We find that net quarterly FII buying is unrelated to unexpected earnings for the next quarter. In contrast, net buying is significantly negatively related to earnings announcement returns: a 10% increase in lagged net buying is associated with 0.7% decrease in earnings announcement returns.

The inability to predict earnings news and the poor returns around earnings announcements strengthens the conclusion that FIIs in India do not behave like informed traders. This contrasts with a bulk of the U.S. evidence that institutional trades are positively associated with subsequent earnings news (Gompers and Metrick (2001); Yan and Zhang (2009)).

Lastly, we examine whether FIIs exploit a well-known trading anomaly known as the post– earnings-announcement drift, or PEAD. This refers to the tendency for a stock’s cumulative

PAGE 25 OF 66

Bottomline // January 2017 abnormal returns to drift in the direction of an earnings surprise for several weeks following an earnings announcement. Our examination of FII net buying during the earnings announcement suggests that they do not exploit the post-earnings announcement drift. In contrast, we find that FII net buying during the earnings announcement is not related to earnings surprises and is negatively related to subsequent three-month stock returns.

We conclude that FIIs fail to exploit the PEAD strategy.

IMPLICATIONS Our study adds to the evidence on FII performance by examining their medium-term performance in a relatively unexplored economy, India. In a contemporaneous study of Indian FIIs, Acharya, Anshuman, and Kumar (2014) find that abnormal returns associated with unusually low (high) daily FII flow innovations reverse (do not reverse) over the next two weeks, especially when global volatility is high. They interpret the low FII daily innovations leading to price reversals as evidence of limits to arbitrage. Our evidence suggests that reversals occur over longer periods – three months to one year, and are also concentrated around earnings announcements.

Further, we find that both FII buys and sells are associated with poor subsequent performance.

Our evidence that unusually high trading magnifies FII trading losses complements work on trading losses associated with overconfident individuals who trade too frequently (Barber and Odean (2000); Daniel and Hirshleifer (2015)).

“

Many investors in emerging markets tend to mimic FII actions.

This herding in turn could lead to prices overshooting true values and subsequently reversing.

“

The inability to predict earnings news and the poor returns around earnings announcements strengthens the conclusion that FIIs in India do not behave like informed traders.

Our findings lead to the question of why FIIs perform poorly in the Indian market. The first possibility is that FIIs are either not smart or are overconfident. The evidence that their losses are magnified when they trade more frequently suggests that overconfidence is a partial explanation. A second explanation is that other investors perceive FIIs as smart money and follow /mimic their trades. This herding in turn could lead to prices overshooting true values and subsequently reversing.7 A third possibility is that FIIs are global investors who are willing to accept losses in Indian markets some of the time because some of their Indian trades are executed to rebalance global portfolios and thus reduce risk. A fourth possibility is that FIIs might be conduits for Indian funds routed back to India via foreign countries. Because some of these funds may represent income on which taxes have been avoided, FIIs might be willing to accept trading losses as the benefit from tax avoidance exceeds these losses. Lastly, the desire to increase or maintain corporate control might cause some FIIs to behave like long-term investors and accept short-term losses. Disentangling these alternate explanations would be a very interesting subject for future research. This paper only takes the first step in understanding FII flows into India and raises more research possibilities.

(The views and opinions expressed in this article are those of the author and do not reflect the view of the Networth Bottomline Editorial team.)

•••

PAGE 26 OF 66

Bottomline // January 2017

CIBIL - SHOULD OUR CREDIT DATA BE WITH A FOREIGN COMPANY?

- Prof. R Vaidyanathan

Y

ou want a loan for a house or flat from a commercial bank then your CIBIL score is important for the bank. CIBIL’s products, especially the CIBIL Score and the credit information report [CIR] are very important in the loan approval process. The credit score helps loan provider to quickly determine, who they would like to evaluate further to provide credit. . Even though the credit rating is only a decision support system many banks use the score for the decision making. The CIBIL Score ranges from 300 to 900. Data indicates that loan providers prefer credit scores which are greater than 750 Once the loan provider has decided which set of loan applicants to evaluate, it analyzes the CIR in order to determine the applicant’s eligibility.

Eligibility basically means the applicant’s ability to take additional debt and repay additional outflows given their current commitments.

That is the importance of CIBIL. History of CIBIL • Nov 1999: CIBIL is also Report submitted by Siddiqui Committee for setting up India’s first Credit Information Bureau • Aug 2000: CIBIL was Incorporated basis the recommendations made by the Siddiqui Committee • Apr 2004: CIBIL Launched Credit Bureau services in India (Consumer Bureau) • May 2006: Started Commercial Bureau operations • Nov 2007: CIBIL TransUnion Score introduced

“

55% of shareholding of CIBIL is with TransUnion International Inc. This implies that millions of credit data of Indians are held/ controlled by a foreign private company.

Professor R Vaidyanathan has been a professor at IIM Bangalore for 34 years. He has played multiple roles in his illustrious career - as a consultant to various organizations such as HLL, LIC, ITC, BPL, World Bank, Goldman Sachs, Shriram Group, Dalmia Group, Ministry of Finance, IDBI etc. and a number of commercial banks. A graduate of Loyola College, Madras and a post-graduate from the Indian Statistical Institute, Calcutta, he obtained his Fellow in Management (Doctorate) from the Indian Institute of Management Calcutta where he also taught for four years. His book titled India Uninc — about the unincorporated sector in the Indian economy — published by Tata Westland in 2014 has been well received by policy planners and the market. He is working on a book on Black Money & Tax Havens and India’s Wealth Abroad (Tata Westland).

The current article has been taken with permission from his blog https://rvaidya2000.com/ to Banks • Jul 2010: CIBIL Detect – India’s first repository for information on high-risk activity was initiated • Sep 2010: First centralized database on Mortgages in India- CIBIL Mortgage Check was launched • Apr 2011: Individuals were able to avail CIBIL TransUnion Score The diversified shareholding pattern is shown on next page. From the Shareholding pattern it is clear that 55% of shareholding is with TransUnion International Inc. This implies that millions of credit data of Indians are held/controlled by a foreign private company. We also do not know about their sharing arrangement if any with other international security agencies like CIA etc.

PAGE 27 OF 66

Bottomline // January 2017 Problems with TransUnion International Inc. TransUnion was originally formed in 1968 as a holding company for the railroad leasing organization, Union Tank Car Company. TransUnion has evolved its business over the years to offer products and services for both businesses and consumers. For businesses, TransUnion has evolved its traditional credit score offering to include trended data that helps predict consumer repayment and debt behavior. In November 2013, TransUnion merged with TLO LLC, a company that leverages data in support of its investigative and risk management tools. For consumers, TransUnion offers credit monitoring and identity theft protection tools. The company’s app offers a function called CreditLock that allows an individual to unlock and lock their credit to help protect against fraudulent activity.

In 2003, Judy Thomas of Klamath Falls, Oregon, was awarded $5.3 million in a successful lawsuit against TransUnion. The award was made on the grounds that it took her six years to get TransUnion to remove incorrect information in her credit report.

In 2006, after spending two years trying to correct erroneous credit information that resulted from being a victim of identity theft, a fraud victim named Sloan filed suit against all three of

“

Credit data of millions of Indians is too sensitive to be held in HK or London or NY. Let India decide about this important issue.

the USA’s largest credit agencies. TransUnion and Experian settled out of court for an undisclosed amount. TransUnion has also been criticized for concealing charges. Many users complained of not being aware of a $17.95/month charge for holding a TransUnion account.

Pitfalls of CIBIL-TransUnion model This whole scheme has come into existence during UPA time and more so when Chidambaram was Finance Minister. So it is one more albatross on our neck gifted by UPA. Sooner we get rid of this better for us.

Not only that 49% to 74% increase in holding of in ‘credit information companies’ was first proposed by RBI in November 2013 and the recent notification in May 2016 when it was allowed up to 100% It is important that we re-visit this entire CIBIL model of mortgaging our interest before global capital since we are sure we have enough expertise and capability available among our own domestic companies –both in Public sector and private sector.

Credit data of millions of Indians is too sensitive to be held in HK or London or NY. Let India decide about this important issue.

Diversified shareholding pattern of CIBIL Source: CIBIL Website

(The views and opinions expressed in this article are those of the author and do not reflect the view of the Networth Bottomline Editorial team.)

•••

MEANWHILE IN INDIA

1 INFLATION - THE INIQUITOUS TAX 2 DEMONETIZATION DEMYSTIFIED INTERVIEW WITH MR. SATHYA KUMAR

PAGE 29 OF 66

Bottomline // January 2017

INFLATION - THE INIQUITOUS TAX

- Ayush Agrawal, Rishi Vora & Archana Maganti With special thanks to Prof. Ravi Anshuman for his guidance

“One reason inflation is so destructive is because some people benefit greatly while other people suffer; society is divided into winners and losers.”

- Milton Friedman Introduction Inflation can be defined as too much money chasing too few goods. One of the primary reasons of inflation in Indian economy is high government deficit (revenue – expenditure). If the government has a deficit, then this deficit is financed by borrowing from the central bank which has the power to create new money and issue new currency. This leads to a rise in the incomes of the people and hence an increase in the aggregate demand which is given by the formula: ∆Aggregate Demand = 1/(1-mpc)*∆Income We can see that, a change in income can lead to a much high change in aggregate demand (due to multiplier effect). Hence though inflation leads to no increase in the intrinsic value of goods or services, the demand for those goods and services increases thus leading to an increase in nominal prices. Depending on how the newly printed currency has been circulated, some would be able to afford the goods and services at the cost of others.

Inflation - An added tax Inflation is regarded as a case of taxation without representation or legislation. From the government’s point of view, inflation is essentially a monetary seigniorage which acts as a source of revenue for the government. Many articles have shown that the relationship between inflation (money growth) and seigniorage follows the “Laffer curve” pattern i.e. the curve relating tax rates to tax revenues. Thus seigniorage is purported to rise with inflation till certain percentage, and thereafter with increased inflation there

Ayush is a first year MBA student at IIM Bangalore.

Prior to joining IIMB, he has worked on credit risk modeling and mortgage servicing. He has written out two white papers on regulations in mortgage servicing and one on account level modeling methodology for CCAR.

Dr. Archana Maganti is an Indian Railways Accounts Officer (Batch of 2011), currently pursuing PGP (Post Graduate Programme in Management) in IIM Bangalore. Her fields of interest include Public policy, Health, Infrastructure and Finance.

Rishi is a first year / PGP 1 student at IIM Bangalore.

Prior to joining IIMB, he has worked as a Risk Manager in Reliance Industries. He also has a strong experience in trading, as a result of his experience in Futures First as a Commodity Market trader and analyst. Rishi is a certified Chartered Financial Analyst / CFA level 3 professional.

PAGE 30 OF 66

Bottomline // January 2017

Figure 1: Routine Expenditure breakup of different income bracket states

Source: How India Earns, Spends and Saves, Rajesh Shukla

is decreased seigniorage1. As the total value of assets remains constant, the government (currency issuer) is earning revenue at the cost of people (currency holders). Generation of new currency thus decreases the value of the existing currency (purchasing power), redistributes the resources in favor of government and acts as a hidden tax on the existing currency holders. This ‘inflation tax’ is then used by government to finance its debt, lower public expenditure in real terms and inflate GDP figures.

From the consumers’ point of view, prices change faster than wages (due to multiplier effect). Thus, they end up paying more for the same value goods over time which leads to erosion of public’s wealth. Consumers save their money in accounts whose interest rates are less than inflation rates. In a country like India, with dominant saving philosophy, millions of people particularly the poor who have no access to financial markets and pensioners who favor stability over risk, save money in such accounts and thus pay this added 1 Seigniorage in United States, JM Neumann, 1992

Figure 2: Routine expenditure breakup of rural & urban India

Source: How India Earns, Spends and Saves, Rajesh Shukla

tax to government every year. Further, any effort on their part to spend money on purchase of capital assets will come with added risk of erosion of capital value due to inflation tax. Hence it can be concluded that over the long term, inflation tax discourages capital accumulation and promotes instability in the economy.

Inflation - Effect on other taxes Adam Smith laid down equity as the guiding principle of fair taxation: people should pay taxes per their ability to pay and marginal utility. However, inflation tax overrides this canon of taxation. Apart from acting as a tax itself, inflation also has a considerable impact on other

“

Generation of new currency decreases the value of the existing currency, redistributes the resources in favor of government and acts as a hidden tax on the existing currency holders.

PAGE 31 OF 66

Bottomline // January 2017 taxes i.e. if one pays an income tax of 10%, not only is he/she paying greater than that percentage due to the hidden inflation tax but also because of ‘bracket creep’. For example, a year back a person who can purchase a basket of goods at 2 Lakh may not have been qualified as a tax payer, but at the current inflation rates, a person purchasing the same basket of goods at 2.5 Lakh is now falling in the tax bracket, and has to lose his purchasing power in the form of taxes. This effect of inflation on taxes not only limits to direct taxes, but to indirect taxes as well.

INIQUITOUS ‘INFLATION TAX’ Inequity in impact of CPI fluctuations To compare the impact of inflation tax on different sections of the society, the percentage expenditure of these sections on different components of CPI have been compared using data from NSHIE survey2.

As shown below, low and middle income states have a much higher component of food in their total routine expenditure when compared with the high-income states. A similar trend can also be seen in the rural versus urban divide.

Since food forms the biggest component driving

CPI, it can be said that the impact of a higher ‘inflation tax’ is higher on low and middle income states as compared to high income states. Thus, we can safely conclude that inflation as a tax is iniquitous in the economy because not only does it act as an extra tax on the citizens but also because it is unequally distributed across various sections of the society.

However, we believe that CPI cannot be taken as a blanket measure of inflation for all income groups. Instead the government should look to develop different indices for different income groups where the weights would be decided based on sensitivity of that group to different components. This would help in capturing the impact of inflation on each income group better and thereby build policies around it. The overall inflation can be taken as the weighted average of the three indices where weights would correspond to percentage population in each group.

Inequity in generating returns from savings Based on a NCAER household survey, it has been found that the percentage of investors is nearly 20% in urban areas while it is much lower (6%) in rural India3. At an overall level, less than

Total Investor Households

Non-Investor Households

All India

10.74

89.26

Urban

20.75

79.25

Rural

5.99

94.01

Table 1: Investing & saving household distribution Source : How Households Save and Invest: Evidence from NCAER Household Survey, SEBI Report

Post Office Savings

Pension

Life Insurance

Commercial Banks

Regional Banks

INCOME GROUP Lower

11.9

3.74

41.81

39.08

3.47

Middle Lower

17.34

4

37.94

37.27

3.45

Middle

22.18

4.11

33.52

37.81

2.38

Middle Upper

21.98

4.14

32.76

38.65

2.48

Table 2: Saving methods for different income groups

Source : How Households Save and Invest: Evidence from NCAER Household Survey, SEBI

2 How India Earns, Spends and Saves, Rajesh Shukla

3 How Households Save and Invest: Evidence from NCAER Household Survey, SEBI Report

Bottomline // January 2017 11% of the total households invest in the market. This shows that the number of savers form a huge proportion of the total households in India.

From the above tables, we can say that a higher inflation would erode the savings of both rural and urban population. This is because both urban and rural households save majorly through life insurances and savings accounts in commercial banks which provide low/no returns. It can also be seen that the lower and middle lower income groups save much more (in % terms) through life insurance which generate no returns. Thus, the impact of high inflation would be much higher on rural households as compared to urban households.

Recommendations Now that we have established inflation as an iniquitous tax (particularly in high inflation economies) imposed on public, let us look at some of the ways in which the negative tax implications of inflation can be abated.

PAGE 32 OF 66 ciates facilitating the entry of foreign portfolio funds, which reap more benefits than the local producers. Hence, we recommend that a separate credit mechanism be made available to these priority sectors whose borrowing rates should be competitive when compared to other countries. We also recommend to continue with the current financial inclusion schemes. RBI should also make investments in inflation indexed bonds exclusive to low tax bracket population to as to prevent eroding their savings due to inflation.

2. RBI should use the differential between wage growth and inflation index for each income group (as discussed in ‘Inequity in impact of CPI fluctuations’) as a proxy for impact of inflation rather than using inflation index as a standalone measure. The policies (both fiscal and monetary) should be focused around the group that has the lowest value of differential. This will ensure that RBI is focusing on the income group that is most adversely impacted by current inflation.

1. The strategy of RBI is to stabilize it at 4% with tolerance limit of 2%. The usual way for RBI 3. The government’s budget is composed of to achieve it is by changing policy rates (Repo, revenue component and capital component.

Reverse Repo, CRR, SLR) which will translate In revenue budget the government mainly to increased lending rates of the banks and collects money through taxes but revenue credit issue. The defects in expenditure does not lead this mechanism are twoRECOMMENDATIONS to any increase in aggregate fold - (1) lack of financial supply in the economy. Howinclusion which dampens Govt. investment in priority ever capital expenditure inthe effectiveness of these sectors such as agriculture and creases the number of assets instruments (2) these ininfrastructure with a creation and hence leads to increase struments do not make of separate credit mechanism to in aggregate supply in the any distinction between shield them from inflation risks economy. Therefore, if the credit intended for short new money being printed is term consumption and Bringing revenue expenditure used to finance the capital credit intended for long down; Fiscal deficit should expenditure then an increase term productive assets. mainly finance capital in aggregate demand would Moreover, the lending be- expenditure be complemented by an incomes dearer, primarily crease in aggregate supply affecting agriculture and Indexing tax brackets, tax which would lead to lower manufacturing sectors. indexed bonds and finance inflation as compared to revThe exchange rate appre- mechanisms

PAGE 33 OF 66

Bottomline // January 2017 enue expenditure where aggregate supply remains constant. We recommend that the government should look to reduce revenue deficit to zero while financing only capital budget deficit through the money borrowed from RBI. 4. In order to control revenue expenditure through monetary policy, RBI should reduce SLR. On the recommendation of 1991 Narasimham Committee, SLR was reduced from 38.5% to 25%. Since then, our economy has grown by more than six times but SLR has only been reduced to 21.5% which provides government with a higher quantum of money for revenue expenditure. We recommend that a reduction in SLR to around 15% would

result in better asset generation using the same quantum of money thereby controlling inflation.

5. Steps to control food inflation (which constitutes 57% of the CPI) should be taken. Around 40% of the food by value is being wasted in India annually4. The main reasons for these include inadequate supply chain management, few cold storage facilities (10% of the total requirement), inefficient transportation management and negligible incentives to invest in agricultural sector for domestic as well 4 Food Wastage In India A Serious Concern, CSR Journal

“

The government should look to develop different indices for different income groups where the weights would be decided based on sensitivity of that group to different components.

as foreign investors. The government needs to focus on improving agriculture infrastructure by building cold storage facilities across India and by making transportation system faster. The government also needs to focus on improving food processing technology by incentivizing investors to invest in this technology and educate farmer about using this technology.

6. To decrease the effects of inflation on vulnerable classes of people, tax brackets should be indexed to inflation so that people can only be charged what they afford to pay in real terms.

Although the current tax laws provide for indexing, they still lack the full indexing which will mitigate iniquitous effects of inflation. An additional cess or an additional tax bracket on the top 10 percentile of the country may be considered to even out the indexing effects.

Widening the tax base through effective tax reforms and digitization of transactions can also help decrease revenue deficit and thus reduce inflation.

Conclusion It has been touted that inflation is essential to maintain high growth rates of the economy.

However, the question that needs to be asked is - growth of who? At the cost of who? An iniquitous inflation means inequitable growth which is unsustainable. Therefore, to distribute fruits of a nation’s labor there is an urgent need to strike a fine balance between growth and development, making inflation as equitable as possible.

•••

PAGE 34 OF 66

Bottomline // January 2017

“DEMONETIZATION IS THE ECONOMIC FREEDOM OF INDIA“ DEMONETIZATION DEMYSTIFIED INTERVIEW WITH MR. SATHYA KUMAR

O

n 8th Nov 2016, in a swift move against black money and growing corruption, the

Prime Minister of India accounted that India’s two major currency bills, Rs. 500 and Rs. 1000 were no longer valid as legal tender. The two bills, roughly worth $7.50 and $15 respectively, are worth 86% of India’s cash economy.

Since the move, there has been great commentary in the media regarding the move itself and its implementation. Mr. Sathya Kumar, a renowned speaker, has been following the move since its announcement and has deep insights on the implications of the move, beyond what is generally discussed.

Do you think the move was a surprise move?

Yes, and no. Black money eradication was the narrative of this government from its start. When the Prime Minister claimed that he will fight against black money, many viewed it merely as a political statement. But steps were being already taken to lay the ground for the demonetization move. The PM after taking charge

“

I believe most people underestimated the will of this government. It is a majority government with a huge mandate and thus took this bold decision.

”

Mr. Sathya Kumar A Chartered Accountant by profession and a humanitarian, advisor, debater, academician, social activist and mentor to many students, Mr. Kumar is a passionate speaker on Public Policy Matters in India.

Apart from writing in financial dailies and magazines, he is also a regular speaker on Economic, Financial, Taxation, Educational & Start-up matters on reputed TV Channels. He has blessed the audience at a plethora of esteemed places such as IIMK, IIMT, National Ilan University Taiwan, Uganda Revenue Authority, Indian Embassy Muscat, ICAI, ICWAI, ICSI, Malaysian Institute of Accountants (MIA), NRI at Doha, Tibetan Chamber of commerce Nepal, and the list goes on.

established the Ministry of Skill Development and Entrepreneurship. An SIT, comprising of senior IT officers and judges was formed, which travelled to various countries to understand their tax laws.

Subsequently, the Black Money Act was passed and Voluntary disclosure scheme was launched which only managed to collect 4,028 crore, not realizing the dream of 40,000 crore.

In 2016, the government launched another scheme, where people who voluntarily disclosed their income would keep 55% and the rest 45% would be kept by the government. To encourage people to participate in this scheme, the government assured that there will be no

PAGE 35 OF 66

Bottomline // January 2017 prosecution for those who disclose their money as part pf this scheme.

However, by Sep 30th 2016, the total collection was 65,000 crore. The PM had warned that the consequences of non-disclosure are going to be serious and that this is the last opportunity.

I believe most people underestimated the will of this government. It is a majority government with a huge mandate and thus took this bold decision. I consider this as a ‘surgical strike on black money’.

The secretive manner in which the entire decision

was

implemented

surprised

the

public. In Jan 2014, the then Finance Minister, P Chidambaram and then RBI Governor, Raghuram Rajan tried to implement this in a step-by-step manner by phasing out notes issued before 2005.

However, Prime Minister Modi did it in one go and that had huge ramifications for the fight against

“

The cash economy is not bad, per se. However, it is the unaccounted money and the illicit money that is harmful to the economy.

”

crore. If this entire black money is recovered, we can cover our budget deficit. Besides, currently we are spending for defense to protect national security. That spending will also come down.

The RBI has printed around 17.36 lakh crore in 500 and 1000 rupees notes – that is about 86% of the money in circulation. This does not include the fake currency.

Out of the total black money in circulation, I believe 12 lakh crore will come into the banking system and 3 lakh crore will not.

Besides the political gains, why is the fight against black money so critical?

black money. I believe given the boldness of this

There are two economic system running

move, even if the news had been leaked, no one

in India. One, the banking system, the size and

would have found it plausible.

scale of which the government is aware of. The

There are various numbers on the scale of

second system is the cash economy – also referred

black money in circulation. Could you shed some light on what the actual numbers maybe?

How much of this money do you expect to come into the formal system through this move?

There are various estimates. According to a 1978 report by the famed economist, Raja Chelliah, the size of black money is 20% of India’s GDP. We can only make a guess what the size must be now.

Even if we stick to the conservative estimate of 1978, then the black money economy is at least 30 lakh crore, given that the current size of the economy is 150 lakh crore.

Compare that with our annual budget of 19L

to as the parallel economy. Demonetization will formalize this parallel economy.

Now, since it is difficult to estimate the size of the parallel economy, the country’s GDP is measured through the former. The cash economy is not bad, per se. However, it is the unaccounted money and the illicit money that is harmful to the economy. The unaccounted money is the money not declared to the tax authorities. On the other hand, illicit money is legal money used for illegitimate activities and the fake currency in circulation. It is estimated that 55 to 60 thousand crore legal money has been routed for Naxal

PAGE 36 OF 66

Bottomline // January 2017 activities. On the other hand, there is no account

expect 10 to 12 lakh crore of deposit. Assuming an

of the fake currency in circulation.

average tax rate of 20%, this will bring in a gain

It is also important to understand how this

of 2 lakh crore to the exchequer. Combine the

black money is generated. It is through exports of

two, and there will be a 5 lakh crore windfall gain

various goods which are not reported to the tax

to reduce fiscal deficit. We’ll achieve the target

authorities, through bribes, illegal commissions

stipulated in the Fiscal Responsibility and Budget

and lastly through goods supplied to black market

Management (FRBM) Act.

and stock markets. In summary, black Money is

Now, on the remaining deposits in the banks,

anything contrary to economic policy of country.

applying the CRR and SLR of 4.5% and 20%

Do you personally support the move?

respectively and this will translate to a manifold

I support the move because it was long

to the economy.

overdue for at least 10 years and the strong

What are some of the undiscussed benefits of

mandate that the government has helped it

demonetization?

implement this step.

I think there will be huge ramifications in the

The cash economy has increased from 10% in

banking sector itself. Earlier banks were cautious

2002 to 12% in 2015. Credit Suisse says that 50%

about lending to infrastructure projects because

is cash economy. This move is not only a fight

of their NPAs. The Public Private Partnership

against black money but also to transform the

model had been stalled, it never became a Build-

economy to a digital one. I expect more moves in

Operate-Transfer model because of the NPAs.

this direction. For instance, the Jan Dhan Yojana (a government scheme to attract poor people to open bank accounts) has already attracted 25 lakh crore as deposits. The purpose was to bring people to make credit accessible as 86% benefit of any

“

With so much money flowing to banks, I expect that SME & MSME lending will pick up via MUDRA.

transaction goes to the middle men. The scheme takes it to common man. Similarly, demonetization will further cut these commissions.

With so much money flowing to

”

banks, I expect that SME & MSME lending will

This move was also about national security.

pick up via MUDRA. Remember, this sector is

We saw the impact as within 2-3 days of

believed to generate 90% of the employment.

demonetization, extra money came in to J&K

However, there are roadblocks. The MUDRA law

banks, stone throwing in the valley was curtailed

cannot be passed due to stalemate in Parliament.

and Maoist funding also got destructed.

One possible suggestion to overcome this hurdle

Do you believe the move is likely to benefit the exchequer?

Absolutely. Let’s look at the numbers. Around 3 lakh crore of illicit money will be destructed. We

is to register NBFC in branches and route these funds via them.

At the same time, I think the RBI will cut the interest rate because of market pressure and

PAGE 37 OF 66

Bottomline // January 2017 views?

The first impact will be that inflation will go down as lesser disposable income will be available.

The productivity will move to essential commodities. Simultaneously, demand will fall, bringing down the GDP. However, the long run story will be different.

Close to 10 lakh crore is expected to come to the

Image Courtesy: Pixabay make lending rates cheaper. Today MSME and SME borrow on a daily basis. A similar push was done in 1993 by the then Finance Minister Manmohan Singh by infusing 300 crore. But given the current economic scenario, it is more likely to be successful today.

How do you see this impacting Real Estate prices?

For the past 3 decades the real estate prices were spiralling upwards. Not because country has prospered. Not because we don’t earn enough. But because people were involved in illicit activities.

The high land cost can be attributed to blank money.

I believe there will be ripple effects of black money in buying other lands. The real estate price will come by 30-40%. The government has a target to provide affordable housing to 19 lakh people by 2022. The fall in real estate prices will help the government achieve this. It’s true that the construction workers will lose, but it was a bubble waiting to be burst anyways. Sooner, the better.

There are various estimates that GDP will fall to anywhere between 3% and 6%. We have already seen a decline in IIP. What are your

formal economy. This part of the cash economy was not accounted for earlier. But now cash economy will be accounted and 2019-20 we can expect double digit growth.

Do you see any tax benefits to the general public?

The government may increase the basic exemption limit to 5 lakh now that money has come to the system. India has one of the highest tax rates but collection is low. Demonetization might change from an era of deductions to exemption.

We’ve discussed about how demonetization benefits the economy. But how do you view the hardships faced by ‘common man’?

Yes, there are hardships that the common man is facing. However, consider this as the “economic freedom of the country”. Yes, it has affected the common man. It has affected normal life, but given that this is a financial emergency, people have cooperated by and large.

The limit of 2.5 lakh on deposits has been well thought through. Most people will not have more than that.

One way the government can reduce the hardship is by paying 20-30% salary in cash to improve liquidity.

•••

THE AGE OF STARTUPS

1 THE BLOOM OF FINTECH 2 VC PERSPECTIVE OF STARTUPS IN INDIA - INTERVIEW WITH MR. PARAG DHOL

PAGE 39 OF 66

Bottomline // January 2017

THE BLOOM OF FINTECH

I

- Archana Maganti

t is the year 2040. Jonathan is woken up by

micro loans and credit facilities have brought

his robot who hands his coffee over to him

in a tsunami of change in the way we handle

and reminds him it is the day to settle his bills.

money. Banking has shown its dark belly in

Jonathan whips out his phone, settles his debts

the Economic crisis of 2008. Coupled with

through an app, purchases and pays through his

widespread internet use and ‘mobilization’, start-

wallet services. He finds he is short of money

ups like Transferwise, Betterment, Wepay etc.,

and borrows it from his peers. His financial

are waiting to exploit the weakness of banking

advisor aka his artificial intelligence assistant

sector. Cryptocurrencies like bitcoin are waiting

runs the day’s algorithm to help him determine

to substitute the formal currencies. ‘Insurtech’

which stocks to invest in. His wife Martina who is

is similarly waiting to usurp the traditional risk

working in the United States has taken a mortgage

management market. There are various FinTechs

out there through an online service. He transfers

cropping up in investment, wealth management

money through an international money transfer

and other verticals, particularly in the retail

app. All of this has been carried out in a space

segment. The high potential of these start-ups has

of a quarter hour through technologies such as

caught the imagination of Venture Capital funds.

cloud computing, quantum computing, Big data

This is evident by the fact that Fintech funding

analysis and blockchain technology. Jonathan

hitting an all time high of $19.1 billion in 2015

himself works in a financial service startup which

(KPMG).

analyses consumer data to map their preferences

Potential for disruption of banking services

and give out recommendations. The car he drives transmits his behavior (it is part of the IOT network) using telematics to fintech providing his insurance so he can ‘pay as he goes’.

Mushrooming of FinTechs

How do these companies bring about disruption in the finance sector? First, the inefficiency

and costs are quite low when

compared to traditional banks, with customer being the one with the most power in the

FinTechs, as this portfolio of services, are

transaction. The physical distribution costs are

called, are poised to rule the world in a big way.

almost zero. Second, there is a real time settlement

They have already disrupted the traditional

of the transaction with the data points distributed

banking services in a major way. Digital wallets,

in multiple places (“blockchain”), which ensures

peer-to-peer lending, equity and crowd funding,

the security of the data and remote delivery. Third,

“

the data available and mined is really extensive

There is a fear that the story of Fintech might closely follow that of dotcom bubble. 2016 has seen slow down of investment into Fintech compared to 2015.

which facilitates better risk management. Fourth, they avoid pitfalls of leverage and mismatching of maturities. This would also lead to division of monetary and financial functions, each function taken up by a specific fintech which adds an extra layer of seamless service over disintermediation.

PAGE 40 OF 66

Bottomline // January 2017

FinTechs also have a huge potential to explore

to digital payment services, the effect on FinTechs

in areas like social sector financing, financial

still waits to be seen. Moreover FinTechs by and

inclusion, health and environmental finance.

large are operating out of sight of the regulators.

“There are hundreds of startups with a lot of brains and money working on various alternatives to traditional banking… they are very good at reducing pain points.”

- Jamie Dimon, CEO, JP Morgan Sustainability of FinTechs There is a fear that the story of FinTechs might closely follow that of dotcom bubble. 2016 has seen slow down of investment into FinTechs compared to 2015. Customer acquisition costs are still high, with the industry being highly fragmented. So unless they are scalable, their sustainability is questionable. Further, these companies are not entirely without structural problems of their own. Currently the regulations and Banking secrecy act are highly geared in favour of banks. Start up ecosystem in emerging countries like India still remains poor. Although the recent demonetization has given a huge push

There is a high possibility that FinTechs can be used in money laundering and ponzi schemes.

The critics also pose questions of data security and ethics.

The immediate strategy that FinTechs can undertake is enter into partnerships with banks (‘coopetition’) in short run. In fact many banks are developing in-house FinTechs through corporate entrepreneurship or acquiring nascent FinTechs.

The other challenges in front of FinTechs are how to create awareness among the customers, transcend beyond the millenials and establish credibility and trust.

FinTechs do have endless possibilities and a disruptive potential. However caution is always advised as ‘disruption’ has oft become an overused word. Whether it is disruptive or sustainable, one outcome is assured. The world has changed because of FinTechs. Je suis Jonathan.

•••

PAGE 41 OF 66

Bottomline // January 2017

“INCUBATORS AT IIT, IIM AND IISC HAVE TO PLAY THE ROLE OF STANFORD “ VC PERSPECTIVE OF STARTUPS IN INDIA INTERVIEW WITH MR. PARAG DHOL

S

tartups,

including

FinTechs,

are

at

an

interesting point of their evolution in Indian

economy. With huge support in the form of ‘Start up India, Stand up India’ policy by the Government of India and outpouring in form of Venture Capital, the atmosphere has never been better. Mr. Parag Dhol provides us an interesting perspective of a VC in the Indian industry.

Have you always been into investing in companies? How has the industry changed in past 25 years since inception?

Essentially when I got into my job, I thought it

Mr. Parag Dhol An alumnus of Indian Institute of Technology, Delhi and Indian Institute of Management, Bangalore, Mr. Parag Dhol currently is Managing Director at Inventus Advisors India.

Parag made a foray into venture capital after his MBA in 1993. He started off with ICICI Venture (in Bangalore) and followed that up with stints at GE Equity (in Gurgaon) and Intel Capital (in Bangalore).

At Inventus, Parag is a Board Director at FundsIndia, Vizury, Power2SME, PolicyBazaar, eDreams, Avaz, peel-works and Tricog.

was a finance job. It is not. It is a very good place for an MBA as it is a very broad job. You see people

some distinct approach to market. In 1999-2000,

making mistakes, you see people doing right things

first internet boom happened with services like

in marketing side, finance, HR etc., That way it

Netscape. However with bad investments, many

is beautiful. In the initial years it was services

companies went bankrupt, many people left

and more services with a flavor. For example, I

McKinsey, some bit of what we saw last year or

invested in a company called Geometric which

2014 happened that time as well. The fault was

did reasonably well, which was focused on CAD/

even worse than what has happened today,

CAM. So it was verticalisation of services and a

because there was no substance. At the end of the

bit of products thrown in, may be more tools than

day we had 1 million subscribers to Internet, that

products. That was the first 6-7 years of industry

provided big set back till about 2004. 2005 is when

- software services with some verticalisation or

real VC started in India for two reasons: Foreign

“

2005 is when real VC started in India for two reasons. Firstly, foreign experienced VCs started coming in, and secondly, when telecom proved that Indian market is large enough, people started developing products for Indian market.

experienced VCs started coming in, there were India US bridges and second reason was telecom actually which proved that Indian market is large enough, people started developing products

”

for Indian market. Till then almost all the tech investments taking place in companies exporting software services, because Indian market was not strong. 2005 was the starting point, it was more or

PAGE 42 OF 66

Bottomline // January 2017 less continuation of that till the ups and downs of

regime no one liked investing in India, then

2008 due to financial crisis and craziness of 2015.

tech in India is not producing exits irrespective

But otherwise may be it is an oversimplification

of red bus exit. It is quite a hard job, we have 3

to call it more with the same but it has followed

in previous fund contributing 106 millions, for

the same trend line.

our current fund of 150 million, we need about 4

How has the ecosystem changed? The process-

investors.

es? Platforms?

Do you also look into HNI investors, NRIs stay-

Substantially. Way back in 1993-94, when

ing outside?

we used to go out during marketing they used

Yes, substantial chunk of money is from

to ask how much interest you charge, we had to

people who have made money in the past,

tell them it was equity not debt, so that’s where it

typically in US or some other parts of geography,

started. The whole industry managed 50 million

who have invested because they know some of

dollars, it was such a small industry, people didn’t

us. But that money comes through challenges,

know how it worked. It was concept selling at

because individuals go through ups and down in

that point, and slowly because Silicon Valley and

life, you want institutional money because it stays

India have been connected because of techies

longer time. It is a 25 yr long business. You want

going back and forth and all of that, tech industry

someone to back you for a long time, so you prefer

in particular caught on to VC, rest of the sectors

institutions to individuals.

are still catching up, and the ecosystem in all its forms - VCs, Angel ecosystems, lawyers, mentors - everything has grown, it is still no where close to Silicon Valley. Incubators at IIT, IIM or IISC have to play the role of Stanford which is still a distance away. It is an evolving journey.

“

There are lot of tumultuous happenings around the world, like Brexit, BOE’s interest cut or Japan’s negative interest rates, QE etc. Do you think all these affect Indian markets, trickling down to startups?

Obviously they do affect, but as Buffet in

You want someone to back you for a long time, so you prefer institutions to individuals.

”

How difficult it is to pool in funds of other people to your fund to invest?

particular says, there are certain things you can control and certain things you can’t. There is no way I can have better understanding than somebody in CSLA etc., I personally don’t spend a whole lot of time on macro economic factors, because you just react but you can’t predict.

Most people can’t predict. If you see lot of signals coming, e.g. UK during Brexit, you assume the

Entrepreneurs at times make fun of VCs, how

worst, react to it upfront and diversify, but in all

difficult it is to raise funds, how they don’t get it.

probability, I think entrepreneurs should hardly

But what they don’t realise is we have to convince

worry about macroeconomic factors. But if the

10-15 people to pool funds, it is hard because you

investors are from that part of the world it can.

are not just selling yourselves, you are selling tech

Let us say Indian currency depreciated by 15%,

in India, you are also selling India. Each of these

our fund is in India and we will get affected.

has failure points, for example during congress

But I can only hedge or do some amount of risk

PAGE 43 OF 66

Bottomline // January 2017 management. Many of my friends in debt or equity market worry about it on daily basis, but I don’t. Simply because it is uncontrollable.

What is the one challenge you face to convince foreign investors to invest in India?

India has not produced any exits. I think that is the biggest unanswered question of Indian venture ecosystem. Everything said and done, we are putting money, we are not taking it out, proof of the pudding is when you take it out.

Startups like Red bus are few and far between.

Startups like Free charge are all fine, but they are merging into another company, very few people got liquidity. Secondary exits are fine, somebody bought out some stock in Flipkart, but it has not been sold or gone IPO. There are Naukris, Justdials

“

Hence it

India has not produced any exits. We are putting money, we are not taking it out. Proof of the pudding is when you take it out.

”

is ideally placed from that perspective. Another one is Yashish’s DNA. We are very excited about a company called Unbxd based in Bangalore. It enables search for companies which are not e commerce giants like flip kart, Amazon, etc. which have their own internal search engines.

For example when you type in ‘Tintin collection’ on Flipkart, Amazon and Snapdeal, the right product crops up in Flipkart and Amazon, but on Snapdeal what crops up is collection of tiffin boxes and all. Similarly take a brown bag. If brown bag is not there it is better to show a green bag than brown shoe. This intelligence is limited because the underlying search technology is text based. These guys have come up with structured data solution. For example CVS pharma store in US is trying to fight Amazon which is using this technology. It started in India, got customers and

The Government of India has launched a huge campaign, StarupIndia, to promote startups. etc., but they still few and far in between. That has to change, such exits have to happen in 1 in 3 month frequency for Indian ecosystem, but that is not happening. In my opinion that is the biggest problem in India.

In your talk you mentioned you have 40 start ups in your kitty. What are some of the most exciting ones?

Policy bazaar. Indians have love for comparing, for price comparison sites, value for money etc.

relocated on US and grown 10 times in last few months. This time around we believe that it is the time for software products out of India because they are delivered on SAS basis, you could be conceptualizing, executing and delivering over web from anywhere in India.

So do you or VCs in India look into family run business?

Traditionally manufacturing and trading have tended to be family businesses. Technology business, which we do, are not family businesses.

We are skeptical about family businesses, there are too many complexities. There will be conflicts between family members. The good thing in

PAGE 44 OF 66

Bottomline // January 2017 technology business is we don’t have many of

More information is not necessarily good

such companies. Very few companies we see

information. The idea is to narrow it down to

are run by families. We tend to be skeptical, but

trusted sources, at the same time read as much as

although there are exceptions, but it is dangerous.

possible after filtering the data. More information

There are successful me-too companies copy-

does not lead to better decisions. Otherwise Nobel

ing foreign models. Do you believe in looking into innovative albeit risky companies in startups in India?

I feel the so called concept arbitrage or copy and paste business models are very risky. For example, there is a successful company called

winners would be the most successful ones.

Perfect information is not possible. Read as much as possible but the right people.

What do you think about Flipkart reneging on campus recruitments? Is the startup scene in India just a bubble?

PoshMark, whose model involves women trading

People recruited ahead of time, anticipating

closets. Typically the company does 25 - 35 million

growth, but money didn’t come along. I have

GMVs a month. I have seen at least three people

sympathy for them as the cycles are currently

trying to copy that model in India. First thing

short, by the time you go to campuses, recruit

people don’t have iPhones or Instagram quality

them and bring them on board, your market

pictures. The payment escrow system is difficult

reality would have changed. At the same time

here in India. Further, women don’t trust you to

defaulting on your commitments does not look

have dry cleaned others’ closets. The eBay kind of

good. Once you go back on your word you may go

system with seller-buyer comfort does not exist

back again. Some of the crazy unicorns are bound

here. Hence we are gutturally opposed to such

to fail. But fundamentally strong companies like

copy and paste models. The best thing to do is let

Bookmyshow, Freshdesk, Unbxd etc., will always

the entrepreneur come out with his idea and back

stand powerful. You as students have to choose

him up. For example I invested in a company

right start ups, not just choosing investment

called Tagmedia whose idea was to play ads on

banks because everybody is going there. Even

screens inside supermarkets, grocery stores,

some investment banks have become bankrupt.

elevators, airports etc., replicating Focusmedia

How do you think IIM B has added value in

of China. I thought this guy would run it sensibly so I invested but the markets were so different.

Cutting and pasting is a terrible idea.

“

IIM B gives a broad cross functional understanding. I focused too much on finance

IIM B definitely gives you a much broader exposure when compared to our time and multidisciplinary problem solving skills which are very important in today’s world.

”

There is a lot of information out there, how do you keep yourself updated? As students how do you advise us to keep track of it?

your career?

in retrospect. Efforts and grades definitely have a correlation. I did very well in finance, but not as well in others. I wish I had read Kotlers better.

If you have your fundamentals clear, it will help you in every function. IIM B definitely gives you a much broader exposure when compared to our time and multidisciplinary problem solving skills which are very important in today’s world.

•••

1 Uber - Didi : China

MERGERS & ACQUISITIONS

2 Marriott & Starwood 3 Fortis & ITC Holdings

PAGE 46 OF 66

Bottomline // January 2017

UBER - DIDI : CHINA Introduction

C

hina’s dominant ride hailing firm Didi Chuxing acquired Uber China, the regional

Later in 2014, Chinese Internet-search giant Baidu, along with China Life Insurance, agreed to make investment in Uber signaling Uber’s intention

subsidiary Uber that would

to

grow

big

in China. Uber China is

value the combined entity at

a

$35 billion. The $35 billion

separately-held

joint

venture between the main

is made up of Didi’s latest

Uber business, China-based

$28 billion valuation and $7

internet giant Baidu, and

billion value for Uber China.

other outside investors.

Uber and investors in its UberChina unit will take a 20% stake in the company.

After the merger, Uber will become the largest shareholder in Didi. Uber will be given a 5.89 percent stake in the newly merged entity, with preferential equity that is equal to a 17.7 percent economic interest in Didi Chuxing. Existing Uber China investors, which include China’s dominant search firm Baidu, will get 2.3 percent of the new business. (Thus summing to 20% stake).

About Didi Chuxing

Deal Rationale While Didi claimed to be profitable in 200 out of the 400 cities it was operating in, the successive rounds of fund raising by both Uber and Didi indicated that they were burning cash at an unsustainable rate. The unsustainability of the cash burning competition the two giants were involved forced them to rethink their strategy.

Also, with the new regulations brought in just a week before the merger, the operating

Didi Chuxing, a Chinese transportation

environment became much more challenging

network company is the result of the merger of

for Uber and Didi, especially given that they

rival firms Didi Dache and Kuaidi Dache (backed

could no more offer the subsidies. Moreover,

by the two largest Chinese Internet companies,

investors were concerned how much more cash

Tencent and Alibaba respectively.

would be burnt before a winner emerged. By going through the deal, both Uber and Didi have

About Uber Uber’s interest in China first became visible in Apr 2013, when Uber’s executive decided to take a scouting trip to China. Within 6 months, Uber launched its operation in China under the aegis of Uber soft in Shanghai. In Feb 2014, Uber formally launched its operation in three Chinese cities – Shanghai, Shenzhen and Guangzhou.

“

Once Didi becomes operationally profitable in China, it may look to expand to other markets.

It could also possible mean another Uber-Didi face-off in other markets.

PAGE 47 OF 66

Bottomline // January 2017

put a logical end to the costly battle.

Before the deal, Uber was spending most of its raised funding in China, implying that it was investing little in other markets. Uber can now focus on its competition Lyft in US and Ola

threaten its existing operations and expansion to other markets. Last year alone, Uber lost $1bn.

Uber’s graceful exit now gives it an opportunity to focus on other emerging economies where competition is less fierce.

in India. The deal also helped Uber get closer

2. Didi to go international – Closing out

with Didi, which was forming a global anti-Uber

completion, Didi now has the largest market

alliance.

share in China. Since the merger last week, both

Lastly, it is believed that Uber’s expensive battle in China was preventing it from going public. With the deal, Uber has sent a clear signal that it intends to become profitable in the long run, paving the way for an IPO. What next?

1. Uber to focus more on other markets: In the fierce competition in Chine, Uber was burning cash at a rate that was starting to

Uber and Didi have already cut down some of the subsidies and discounts. Didi already claimed to be profitable in 200 out of 400 cities.

Once Didi becomes operationally profitable in China, it may look to expand to other markets.

If Didi choses to do so, it would be interesting to observe which markets Didi aims to capture. It could also possible mean another Uber-Didi faceoff in other markets.

•••

PAGE 48 OF 66

Bottomline // January 2017

MARRIOTT & STARWOOD

M

arriott and Starwood tied knot in April’16 as MarriottInternational signed to acquire

Starwood Hotels for $13.6 billion thus creating the largest Hotel Company in the world. Post this mega merger, the combined entity will boast of 1.1 million rooms spread out over 5,500 hotels and 30 different brands. The deal will impact peers like Hyatt Hotels Corporation, InterContinental Hotels Group (IHG) as well as alternative lodging options like HomeAway and Airbnb.

Deal terms As per the terms, Starwood shareholders will receive 0.8 shares of Marriott common stock and $21 in cash per share of Starwood common stock. The transaction values Starwood at approximately $13.6 billion ($79.53 per share), consisting of $10.0 billion of Marriott International stock, based on the closing price of $73.16 on March 18, 2016, and $3.6 billion of cash, based on approximately 170 million outstanding

97% of Marriott shareholders and 95%

Starwood shares.

of Starwood shareholders approved the deal.

Marriott had originally planned to buy Starwood for $12.2 billion, but a rival bid from Chinese insurance consortium Anbang forced Marriott to increase its bid to $13.6 billion.

Rationale for the deal

Starwood Hotels and Resorts Worldwide Inc.

One of the biggest factors of Marriott’s interest in Starwood was to gain access to its powerful Starwood Loyalty program. The merger will allow Marriott to leverage Starwood’s brand to attract more business from corporate clients.

Starwood’s loyalty program, ‘Starwood Preferred Guest’ is a favorite among business travelers.

Starwood has had a far stronger presence in the

It is one of the leading hotel and leisure

Eastern Hemisphere (Middle East, Asia, Oceania)

companies in the world with more than 1,300

than Marriott -- 653 hotels vs. 206 hotels. This

properties in some 100 countries. Some of its

acquisition should allow Marriott to strengthen

renowned brands include St. Regis, the luxury

its presence in Asia, positioning them as the

collection, W, Westin, Le Meridian, Sheraton etc.

Marriott International Inc. It is an American multinational diversified hospitality

company

that

manages

and

franchises a broad portfolio of hotels and related lodging facilities. Some of its key brands include JW Marriott, Renaissance Hotels, Ritz Carlton, Courtyard.

“

One of the biggest factors of Marriott’s interest in Starwood was to gain access to its powerful Starwood Loyalty program. The merger will allow Marriott to leverage Starwood’s brand to attract more business from corporate clients.

PAGE 49 OF 66

Bottomline // January 2017 Role Financial Advisor Legal Advisor

Acquirer (Marriott) Deutsche Bank Gibson, Dunn & Crutcher

Acquiree (Starwood) Lazard and Citigroup Cravath, Swaine & Moore

Table 1: Advisors in Marriott Starwood deal

dominant brand in that region.

Starwood has been constantly struggling since a couple of years as the company lagged industry growth and investor expectations.

One of the reasons why Starwood has been underperforming is they are lagging when it comes to limited service properties. They mostly have lifestyle brands. Marriott on the other hand does really well in the Limited service market.

Hence the two will complement each other.

Scale is quintessential to succeed in the hotel industry

given

the

high fixed to variable cost

ratio.

Mergers

are viewed as a tool to

monetize

unutilized

capacity.

Annual

savings

~

$200m

save

the of are

expected on account

of the cost synergies by leveraging general, administrative

and

operating

costs.

Both

MarriottRewards and Starwood Preferred Guests have a very loyal following, so what is going is going to how to these two programs for retaining the customer base is something to watch out for?

Also, the extent to which the combined entity will benefit from these synergies is to look out for in this merger!!

•••

PAGE 50 OF 66

Bottomline // January 2017

FORTIS & ITC HOLDINGS

F

ortis Inc. – Canadian electric and gas utility

26% gas), with the remaining 4% comprised

plans to acquire electric power line company

of non-regulated energy infrastructure. The

ITC Holdings (ITC) , for $11.3 billion.

92.51% of the Fortis shareholders voted to

Corporation’s regulated utilities serve more than 3 million customers across Canada, the

approve the issuance of up to 117 million Fortis

United States and the Caribbean.

common shares as partial consideration for

About ITC Holdings

the acquisition of ITC. ITC owns and operates high-voltage transmission facilities in Michigan, Iowa, Minnesota, Illinois, Missouri, Kansas and

Oklahoma.

The

Novi,

Michigan-based

utility serves a combined peak load of more than 26,000 megawatts along approximately 15,600 miles of transmission line. The closing of the acquisition of ITC is expected to occur in late 2016 and is subject to receipt of certain

ITC is the largest independent electric

regulatory approvals, including the approval

transmission company in the United States.

of the Federal Energy Regulatory Commission,

Based

the Committee on Foreign Investment in the

the electric transmission grid to improve

United States, and the United States Federal

reliability, expand access to markets, allow

Trade Commission/Department of Justice under

new

the Hart-Scott-Rodino Antitrust Improvements

to its transmission systems and lower the

Act of 1976, as well as various state approvals,

overall cost of delivered energy. ITC owns and

among others.

operates high-voltage transmission facilities in

About Fortis Inc.

Michigan, Iowa, Minnesota, Illinois, Missouri,

in

Novi,

generating

Michigan,

resources

ITC

to

invests

in

interconnect

Kansas and Oklahoma, serving a combined peak

load

exceeding

26,000

megawatts

along approximately 15,700 circuit miles of transmission line.

Fortis is a leader in the North American

Deal Terms

electric and gas utility business, with total assets

1. ITC shareholders will receive US$22.57

of approximately $28 billion and fiscal 2015

in cash and 0.7520 (a total of US$6.9 billion) of

revenue of $6.7 billion. The Corporation’s asset

a Fortis common share for each ITC common

mix is approximately 96% regulated (70% electric,

share and Fortis will assume approximately

PAGE 51 OF 66

Bottomline // January 2017 Role Financial Advisor Legal Advisor

Acquirer (Fortis Inc.) Goldman Sachs and Scotiabank White & Case LLP and Davies Ward Phillips & Vineberg LLP

Acquiree (ITC Holdings) Barclays and Morgan Stanley Simpson Thacher and Bartlett LLP

Table 1: Advisors in Fortis - ITC Holdings deal US$4.4 billion of consolidated ITC indebtedness 2. Upon completion of the Acquisition,

Corp. for US$2.5 billion in 2014. The acquisition of ITC is a continuation of this growth strategy

ITC will become a subsidiary of Fortis and

2. In terms of accretion, this deal is expected

approximately 27% of the common shares of

to yield 5% accretion to EPS in the first year,

Fortis will be held by ITC shareholders.

following close. In terms of diversification, it

3. Based on the February 8, 2016 closing

dramatically diversifies Fortis’ earnings on a pro

price for Fortis common shares and the US$/

forma basis with Canada contributing 35%, US

C$ exchange rate on that date, the per share

62%, and Caribbean 3%

consideration offered by Fortis represents a

3. ITC’s average rate base and CWIP is

premium of 33% over ITC’s unaffected closing

expected to grow at a compounded average

share price on November 27, 2015 and a 37%

annual rate of approximately 7.5% through 2018

premium to ITC’s unaffected average closing price over the 30-day period prior to November 27, 2015.

4. The Fortis-ITC transaction was valued at approximately US$11.3 billion as of the close of markets on February 8, 2016. The ITC Holdings’ shareholders will see an increased yield to about 3.6% versus the current dividend yield of 1.9%.

“

$2bn bond issuance would be required to fund the acquisition, which would effectively double Fortis Inc.’s debt. However the deal will be transformative for Fortis, with its U.S. business accounting for 62 per cent of revenues.

A US$2 billion bond issuance would be required to fund the acquisition, which would

4. The management team of ITC Holdings

effectively double Fortis Inc.’s debt. However

has a proven track record of delivering

the deal will be transformative for Fortis, with

superior total shareholder return and cash flow

its U.S. business accounting for 62 per cent of

generation. They are execution-oriented with a

revenues.

focus on safety, reliability and managing projects

Rationale for the deal 1. Fortis has been building its asset base in the U.S. with the acquisition of New York-based CH Energy Group Inc. for US$1.5 billion in 2013 and Arizona-based utility company UNS Energy

on time and on budget. Cultural similarities also exist between Fortis Inc. and ITC Holdings with management pursuing operational excellence and regulated focus.

•••

LOOKING BACK AT 2016

1 2016 - GLOBAL EVENTS ROUND-UP 2 PERSONALITIES OF THE YEAR

Bottomline // January 2017

PAGE 53 OF 66

2016 - GLOBAL EVENTS ROUND-UP • China President launched Asian Infrastructure Investment Bank (AIIB) which was formally established in Beijing on December 25, 2015. India and 56 other countries joined

JANUARY

as its founding members. Notably, US and Japan stayed out.

• Reserve Bank of India sought the government an additional Rs 26,000 crore to be injected into state run banks by 2018 as part of implementing Basel-III standards.

• Japan’s central bank, Bank of Japan imposed negative interest rate of -0.1% on its accounts of commercial banks. World market interest rates were subsequently driven down.

• Government revised 2014-15 GDP growth to 7.2% YoY from 7.3% YoY.

FEBRUARY

• Brent crude hit a low of 27.1 dollars which caused selling of energy shares and bonds.

• The Central Statistics Office in India predicted that Indian economy will grow at 7.6% in FY 2015-16, a five year high.

• Employees Provident Fund Organization (EPFO) increased the PF interest rated to 8.8% from 7.75% for FY 2015-16.

• Macro-Economic Survey 2015-16, prepared by Chief Economic Advisor Arvind Subramanian was tabled in parliament by Finance Minister Arun Jaitley.

MARCH

• Market regulator SEBI raised the Foreign Portfolio Investors (FPI) investment limit in govt. securities to Rs. 1,40,000 crore from April 4.

• Current Account Deficit fell to 1.3% of GDP due to lower commodity prices.

• Government permitted 100% FDI in e-commerce through automatic route in marketplace of retailing.

• In its first Bi-Monthly Monetary Policy Statement for FY 2016-17, RBI cut the Repo rate to 6.5%, Reverse Repo rate is 6.0% and CRR was 4%.

APRIL

• India has the world’s largest remittance in 2015 with $69bn in remittances, according to report. Other large remittance recipients in 2015 are China ($64bn), Philippines ($28bn), Mexico ($25bn) and Nigeria ($21bn).

• RBI and National Payments Corporation of India (NPCI) launched Unified Payments Interface (UPI) to promote electronic payments.

• IMF retained its 7.5% GDP expansion forecast for India in 2016 and 2017 in its economic outlook.

Bottomline // January 2017

PAGE 54 OF 66

• Finance Ministry announced that Income Declaration Scheme 2016 for domestic black

MAY

money will commence from June 01 to September 30 for filing of Declarations and Payments towards Taxes, Surcharge and Penalty.

• SBI planned to merge its 5 associate banks and also merge Bharatiya Mahila Bank, a state owned one. This would create a banking behemoth with a balance sheet size of Rs. 37tn.

JUNE

• RBI introduced a “Scheme for Sustainable Structuring of Stressed Assets” to strengthen the banks’ ability to deal with stressed assets.

• United Kingdom has voted to leave European Council in a referendum in which about 52% voted to leave EU. This was widely referred to as “Brexit”.

• Cabinet approved changes to GST Constitutional Amendment Bill, dropping 1% manufacturing tax and promising to compensate states on lost revenue in the first five years

JULY

of rollout.

• HDFC launched India’ s first full-fledged online banking service for Small and Medium Enterprises (SME). It becomes first issuer of ‘Masala Bonds’ in India raising Rs. 3000 Crore.

• Italy’s constitutional referendum and the bad loans plaguing the country’s banks were in spotlight which ultimately led to the resignation of Matteo Renzi as prime minister.

Particularly affected are Italy’s banking sector shares.

• Urjit Patel appointed as Governor General, Reserve Bank of India.

AUGUST

• HDFC, Max, Max life and Max India merge their insurance businesses into HDFC life, a company worth Rs. 67000 Crore.

• Forex reserves reached record high of $365.82bn.

• Japan recorded highest current account surplus (10.63 trillion yen) in first half of 2016, mostly due to its tourism industry.

• By August, globally the universe of negative yielding debt had swollen to $13.4tn. The biggest casualty of some $14tn of global debt trading below zero per cent were the pension and insurance industries.

Bottomline // January 2017

PAGE 55 OF 66

SEPTEMBER

• BSE became first stock exchange and second bourse (after MCX) to file IPO on NSE to raise 1200 to 1300 Crore INR. • World Trade Organization lowered forecast of global trade growth to 1.7 %, slowest since financial crisis signaling anti globalization rhetoric in the world.

• A new Monetary Policy Committee (MPC) was constituted and notified to deal with monetary policy matters in India.

OCTOBER

• Jim Yong Kim took over as the president of World Bank for second term.

• Reserve Bank of India reduced repo rates by 25 basis points from 6.5%to 6.25%.

• ICICI becomes India’s first bank to execute block chain technology in partnership with Emirates NBD. • Department of Industrial Policy and Promotion notified 100% FDI in other Financial services of NBFCs to attract foreign capital in India.

• Prime Minister of India announced that the two largest currency denominations, Rs. 500 and Rs. 1000, are no longer valid as legal tenders.

NOVEMBER

• The shock of Donald Trump winning the vote for markets was short-lived — lasting a matter of hours — as investors rapidly embraced the idea of a Republican-controlled Congress being a game changer by implementing fiscal stimulus, tax cuts and rolling back on regulations for US business.

• Booming share markets after the US election also reflected hopes of an oil production deal that eventually came to pass in late November when OPEC met in Vienna. The big motivation for the deal had been the economic pain inflicted by a falling oil price on the economies of producers, notably Saudi Arabia. As the country looked to line up an equity flotation of state-owned oil company Aramco by 2018, keeping the price firmly above $50 a barrel is a crucial aim.

DECEMBER

• A year after the first rate hike in almost a decade, the Federal Reserve increased the Fed Fund rate by another 25 basis point.

• On the tail of demonetization e-transactions touched 1000 Cr INR mark.

• India crossed $300bn in FDI, biggest contributor of which is Mauritius.

• India overtook UK & becomes 5th largest GDP after USA, China, Japan & Germany.

• The era of ultra-low bond yields was in doubt, with the tally of negative-yielding debt slipping to less than $11tn this month. Wall Street equities moved further into record territory.

PAGE 56 OF 66

Bottomline // January 2017

2016 - PERSONALITIES OF THE YEAR DING XUEDONG Chairman of China Investment Corporation, the country’s largest sovereign wealth fund, Ding steers 810 billion $ sovereign wealth fund. He also chairs China International Capital Corporation, the country’s leading international investment bank. This corporation was in news for being one of the sources of funding China’s One belt, One road initiative. Since he took the helm of CIC in 2013, he has been credited with restructuring CIC, by instilling entrepreneurial spirit and promoting direct investments overseas.

CIC has suffered negative returns on its overseas investments due to volatility in international markets and foreign exchange losses in 2016. CIC’s strategy in 2016 has shifted from global to domestic markets, investing in some of the Internet companies of China.

LLOYD BLANKFEIN Chief Executive Officer of Goldman Sachs, Lloyd Blankfein remains firmly ensorcelled in his position even after the management shuffle post appointment of Gary Cohn as senior economic adviser to the White House. The strategy of Goldman Sachs is expected to remain the same under Lloyd – cautious expansion into new areas with feet firmly in trading and corporate banking. A lawyer from Harvard Law school, Lloyd Blankfein started his career as precious metal salesman before his parent firm J Aron & Co was acquired by Goldman Sachs. Goldman Sachs currently manages 1.35 trillion $ in assets with its shares currently trading at 25% premium to book value.

PAGE 57 OF 66

Bottomline // January 2017

2016 - PERSONALITIES OF THE YEAR STEVE SCHWARZMAN Chief Executive Officer of Blackstone Group, Steve Schwarzman rose through ranks at Lehman Brothers and founded Blackstone with Peter Peterson in 1985 (Schwarz – Black, Peter – Stone). Blackstone currently runs 350 billion $ in assets. Roped in by POTUS Donald Trump as leader of his advisory board, he believes in substantial reduction of regulations for financial sector as contributory to growth of US economy and attracting foreign investment. In 2016, he famously made 250 million $ in five days by selling 25% stake in Hilton Worldwide Holdings to Chinese conglomerate HNA group for $ 6.5 billion.

ABIGAIL JOHNSON Abigail Johnson, CEO of mutual fund giant, Fidelity, has taken full reins of the fourth largest asset manager in the world and assumed its chairmanship from her father, Edward C. Johnson III. Fidelity holds some $2.1 trillion in managed assets, and handles the retirement and savings plans of approximately 25 million Americans and 20,000 companies. While Fidelity is famous for its stock ¬picking (76% of its U.S. stock funds outperformed their peers in 2015), these pricey funds are falling out of favor; investors pulled $18.8 billion from Fidelity’s actively managed equity portfolios last year. So Johnson is slashing fees on Fidelity’s passive funds and targeting a fresh generation of customers with digital tools.

TEAM NETWORTH

Networth is the finance club of IIM Bangalore. The club carries out a number of activities throughout the year, including major events in national fests, weekly financial publications on global finance news, monthly magazines on M&A deals and a blog on macro happenings.

Bottomline // January 2017

PAGE 59 OF 66

TEAM NETWORTH - SENIOR COORDINATORS

Bottomline // January 2017

PAGE 60 OF 66

TEAM NETWORTH - JUNIOR COORDINATORS

PAGE 61 OF 66

Bottomline // January 2017

NETWORTH - 2016 EVENTS ROUND-UP Back to the Futures

winners and 1strunner up position was backed

Networth conducted a new event in Vista

by the team from IIM Lucknow led by Ankit Raj.

2016 themed on Financial Derivatives. Named

Some feedback received from finalists

Back to the Futures, a pun on the movie name and

below:

futures (a popular derivative product), the event

Rahul Rao, NMIMS: “The event was great. A good

was aimed at challenging the participants in their

learning experience!”

understanding of derivatives and formulating strategies

to

maximise

profits

on

their

derivatives portfolio. The event was conducted in two stages. Stage 1 was a time bound quiz on derivatives which saw participation from more

Anirban Kundu, IIMC: “Thoroughly enjoyed the event. Superb Questions!”

Stock 20-20

than 100 teams from top B-Schools of the country.

A client once asked an investor if he makes

13 teams qualified for the final round where the

a trade and earns millions in a matter of time.

finalists battled by taking positions on NIFTY

But, do you really believe that he earned that in

options by analysing a timeline of information

a matter of minutes? No! He spent years after

provided on global macro events, data release

years learning and practicing this art.

and performance of various indices. Teams were

Networth, in association with Aditya Birla

required to provide rationale at each stage for

group provided a unique platform to participants

their positions and

across the country

ultimately predict

to

the NIFTY price and

pitch

RBI policy decision

of

for interest rates.

With

more

All

50+

outstanding

the

teams

come

and

a

their

stock choice. than

t h o r o u g h l y

entries in the first

enjoyed

round, a two-step

the

event and it was

process

a

to narrow down

great

learning

followed

experience for the

the

participants as well

The second round

as the organizers.

did

not

involve

Team

IIM

just

a

buy-sell

led

opinion

from

Ahmedabad

by Ashish Khullar

more

were

as

declared

8

finalists.

but

was

exhaustive each

point

PAGE 62 OF 66

Bottomline // January 2017 was backed by industry and firm analysis.

enter into the niche yet competitive smartwatch

Evaluation of firm’s management, their recent

segment. To build a case for the competition, we

decisions, past performance and total valuation

visited the CEO, Mr. Somnath Meher, at a typical

against comparable firms were the key factors

start-up environment, a co-working space in Bangalore. The experience enabled us to create a realistic case putting forth even the all-important qualitative aspects that go into valuing a startup for the participants to build upon. Mr. Meher agreed to judge the event and asked pointed yet meaningful questions while giving some insightful comments to each team after their presentations.

Convexity calls (Vista) During Vista Networth conducted a unique event based on Asset Liability Management

that

tested

contestants’

skills in Balance Sheet Management. With Financial Markets worldwide recognizing the need for a robust balance sheet, and as rules get ever more stringent, this considered by teams while evaluating it. The panel with years of expertise in fundamental and technical analysis took an account of the overall depth of analysis, clarity of thoughts, quality of the pitch and final recommendation to choose the winners.

event tried to put the contestants straight into the shoes of a Treasurer whose responsibility is to bring his/her bank’s balance sheet inline before the upcoming stringent stress tests. In the first round, a case was provided on the spot containing the balance-sheet information followed by some conceptual questions. The teams will have to solve the problems given in the case in the pre-

Nextup (Eximius) NextUp,

the

allotted time. In the final round, the teams had to startup

valuation

event

dynamically change their balance sheet based on

included a preliminary round that focussed on

the stress scenarios created. The winning team

the fundamentals of valuing a company, after

was from of IIM Bangalore and comprised of M/s

which the top 6 companies were shortlisted for

Jayesh Bhansali, Akshay Soni and Chetan Dixit.

the final round. The NextUp finale was based on a real startup, Witworks, which is planning to

•••

Bottomline // January 2017

PAGE 63 OF 66

Bottomline // January 2017

PAGE 64 OF 66

SO YOU THINK YOU KNOW FINANCE...

PAGE 65 OF 66

Bottomline // January 2017

Across

4. Federal Reserve Chief [6] 5. Popular alternative to paying dividends [7] 6. Oracle of ___: Warren Buffett [5] 7. European country with highest household debt to GDP ratio in the world [7] 9. Statement of financial ___: Balance sheet [8] 10. Four best performing US tech stocks (acronym) [4] 13. Distributed digital ledger of transactions [10] 15. ____ Leverage: A function of operating cost as well as capital structure [8] 16. Black-____ Model for options pricing [7] 17. Beta is a measure of non-diversifiable or ____ risk [10] 21. Assets minus liabilities; IIMB Finance Club [8] 22. South American country facing severe hyperinflation [9] 24. ___ Loan: Short term loan until long term finance is available [6] 25. At the same rate, "equal footing" (Latin) [4,5]

Down

1. Largest Initial Public Offering ever [7] 2. Measure of sensitivity of bond prices to interest rate changes [8] 3. Predominantly used absolute valuation method [3] 7. Brexit, Trump indicate risk of ____ in world economy [15] 8. You lose ___ when a) you are bored; b) when you take a loan [8] 11. Risk-free profit due to market inefficiencies [9] 12. ___ Yield Curve: Long-term debt has lower yield than short-term [8] 14. Commodity that entered a major bull market post Trump [6] 18. Certain European countries facing debt crisis (acronym) [5] 19. What goes out; Deferred payment [6] 20. Failure to repay a loan; Preset value [7] 23. Marketable security that tracks an index, etc (acronym) [3] 26. An ____ of financial statements is required for listed companies [5]

For answers, visit our blog at https://macrohappenings.wordpress.com/

Š 2017 Networth, IIM Bangalore. All rights reserved.

Copyright of the images used rest with the original owners.

Design by Gaerik Chhabra.