Arbitrage Magazine - February 2021 - Finance & Investment Club | IIM Rohtak

1|Page

presents

Feburary 2021 Vol 4 Issue 12

Our best read - Reinventing banking for the digital era

Special Mention: Transmission of Monetary Policy in India; and Start-up Funding: The Emergence of Venture Debt Funds

2|Page

INDEX

S.No.

Article

Page No.

1

Reinventing banking for the digital era

3

2

Transmission of Monetary Policy in India

8

3

Start-up Funding: The Emergence of Venture Debt Funds

13

4

Critique of India’s Pandemic Budget

18

5

What’s Special About A Special Purpose Acquisition Vehicle (SPAC)

21

3|Page

Reinventing banking for the digital era By: Rohit Voleti, (International Management Institute, New Delhi) “A crisis is a terrible thing to waste.” - Paul Romer Every crisis brings to us an opportunity to reimagine the way we operate in this dynamic world.

Until yesterday, most of us would have believed that for traditional banking as we know it to embrace digital transformation, it would take a decade at the least. The banking industry over the past few years has witnessed changing customer expectations and growing competition from fintech companies and technology leaders who have forayed into the banking space, leaving banks with no choice but to embrace digital technology. The COVID-19 pandemic has not only catalysed this change but has also depicted that inculcating technological practices is critical to continuity, consistency and resilience. For a world that is recovering from the adverse effects of the pandemic, banks which are at the nerve center of global economies must collaborate with technology providers such as fintechs in shaping the future of economic growth.

Unveiling the potential of technology Banks have sustained desirable levels of stability and continue to command a high level of trust and confidence among customers. This advantage must be leveraged so that banks remain relevant to customers as financial intermediaries in a digital future that will be driven by personalisation, enhanced experience and transparency. It is under this context that technology plays a pivotal role in building upon the inherent strengths of banks in delivering value.

Technology

Potential • • •

Leverage data to derive customer insights Customer centricity through hyper personalisation Smart pricing, product bundling

Blockchain

• • •

Data privacy and security Fraud detection Risk management

5G

• • •

Cross-industry collaborations Cutting-edge analytics Seamless connectivity and services

Internet of things (IoT)

• • •

Customer care automation Voice support, language processing Enhanced experience

Artificial Intelligence & Machine Learning

4|Page

The technology giants of today have forayed into most if not all sectors of the economy and their entry into the banking space has been a question of “when” rather than “if”. These companies have reset the standards of customer experience and offer lessons to traditional banks - to either adopt or collaborate.

• Tech giants command a high level of customer loyalty largely due to the frictionless ecosystems that they have created in effectively mapping sellers with customers and offering one-stop-shop solutions. Banks must rethink their offerings in such that they are tailor-made to the needs of their customers.

• A survey by Bain & Company reports that several people tend to trust tech companies more than banks, which correlates to their increasing preference in seeking banking and financial services offered by fintechs. Traditional banks must prioritise customer experience and service quality by making simple digital interventions in their business models, which will go a long way in not only winning over new customers but also resisting customer churn.

Source: Bain & Company •

Data harnessing capabilities of the tech companies is what differentiates their competitive edge in understanding consumer needs and behaviour. Banks that preside over an ocean of customer data and must leverage it in offering better products and services.

Win-Win The basis for collaboration between traditional banks and fintech companies is that it is a strategic win-win for both. With the ever-increasing digital presence and usage across all major economies in the world, banks can no longer remain aloof to the new realities of the world. Given that the banking and financial services industry is highly regulated, it limits the potential and scope of fintech companies in making significant inroads into the banking space. These factors indicate a “partner or perish” scenario for traditional banks and fintech companies.

5|Page

Source: PwC •

•

•

•

Fintech companies bring innovative offerings to the table but lack the expertise and competence in managing the entire financial life cycle. This is where traditional banks could offer their valuable experience in managing customer relationships across diverse segments and channels. Together, such collaborations can capture a wider market across geographies. For example, Commerzbank of Germany had collaborated with IDnow for a mobile-app offering banking services, which had resulted in a 50% increase in customer conversion for the bank.

Strategic synergies between fintechs and traditional banks provide mutual benefits to both as it facilitates the creation of omnichannel customer offerings that would increase overall profitability. A case in point would be the example of CurrencyCloud providing a payment engine to Fidor Bank, which was incorporated into their service model with no requirement for any extra infrastructure, which resulted in significant forex cost reduction for their customers.

Fintechs have the first mover advantage over traditional banks in prioritising user experience and the overall customer journey, which has led to rapid growth in their customer base and has enabled them capture market share. For example, major global traditional banks such as ANZ and Westpac have made investments in a fintech startup ‘Data Republic’, which provided a data hub for them through which their enterprise customers could save, share and analyse data under a safe and secure environment.

Physical branches could continue to remain critical for the legacy services of the banks but it is important to take note of the declining traffic in these branches, which poses a question on cost-effectiveness for traditional banks. By partnering with fintech companies, banks can create models that deliver both physical as well as digital banking to its customers, which would elevate the customer experience to a whole new level.

6|Page

Source: Deloitte Description: New-age banking ecosystem •

The emergence of open banking and application programme interface (API) based ecosystems provides immense opportunities for collaborations between banks and fintechs in such that they are a step forward in the journey of Banking as a Service (BaaS) ecosystem of third-party service providers accessing data to generate insights and deliver unique products/services. For example, HSBC’s partnership with Tradeshift enables the bank use the Tradeshift platform in automatically generating invoices, thereby reducing the payment cycle.

Source: Fintechweekly Description: Revenue generation of major companies through APIs Challenges Despite the fact that traditional banks and fintech companies are approaching a natural convergence in catering to the needs of the new digital world, there are certain factors that impose a challenge to the success of these collaborations.

7|Page

• •

•

Legacy issues faced by traditional banks are difficult to overcome as there are deep rooted systems and processes that hamper the flexibility of these banks.

Regulatory and compliance norms for the banking industry imposed by governments across different nations poses a challenge on the extent and speed at which new collaborations can be made and brought into action.

Security and privacy management becomes critical to win over the confidence of customers who are otherwise wary of digital transactions. Any threat of data theft or security breaches could impose a significant damage to the reputation of these banks.

On the whole, it can be understood that collaborations between traditional banks and fintech companies would result in enhanced profitability, reduction in costs and offers greater value to users. The coming decade would witness path breaking transformations in the financial industry and the success of banks would depend on their ability to collaborate with strategic partners to adopt emerging technologies. The way ahead for banks to thrive in a digital market context would be to drive innovation through technology, for which they must build a comprehensive ecosystem that benefits all stakeholders.

References https://www.pwc.in/ https://www2.deloitte.com/us/en.html https://www.imf.org/en/Home https://www.fintechweekly.com/ https://www.bain.com/insights/

8|Page

Transmission of Monetary Policy in India By: Ajita Ranade (Jamnalal Bajaj Institute of Management Studies, Mumbai) Monetary policy is like juggling six balls... it is not 'interest rate up, interest rate down.' There is the exchange rate, there are long term yields, there are short term yields, there is credit growth.

– Dr. Raghuram Rajan Role of Monetary Policy Monetary policy is a framework formulated by the Central Bank of every country, which envisages regulating the supply and availability of money and cost of credit in the economy. It is aimed at achieving sustainable economic growth, targeting inflation, regulating growth, liquidity and consumption. In the words of D.C. Rowan, “The monetary policy is defined as discretionary action undertaken by the authorities designed to influence (a) the supply of money, (b) cost of money or rate of interest and (c) the availability of money.”

In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework. Monetary policy of any country, is not an end but means to an end. It is used to achieve certain pre-determined objectives and for aiding the general economic policy adopted by that country.

Monetary Policy Framework The Monetary policy framework in India aims at setting the repo rate based on assessment of the prevailing macro-economic situation. After announcing the repo rate, the operating framework designed by the Reserve Bank envisages liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the operating target – the weighted average call rate (WACR) – around the repo rate. The aforementioned framework is modified, depending on the evolving financial market and monetary conditions, inline with the monetary policy stance.

Instruments of Monetary Policy employed by the RBI The RBI uses several direct and indirect instruments for implementing the monetary policy. They are follows –

9|Page

1. Repo and reverse repo – Repo rate is the rate at which the Reserve Bank of India (RBI) provides overnight liquidity to banks, as a part of the Liquidity Adjustment Facility (LAF) scheme against collateral of government bonds and other approved securities. Reverse repo rate is the rate at which RBI absorbs liquidity from the system against collateral of government bonds and other approved securities as a part of the LAF. The graph below shows movement of Repo and reverse repo rates from January 2015 till date

2.

Liquidity Adjustment Facility (LAF) – LAF was introduced to enable banks to borrow money through repurchase agreements or lend to the RBI using repurchase contracts. LAF can be used by a bank to tide over short term liquidity mismatches by selling G-Secs to the RBI by

10 | P a g e

agreeing to repurchase them at a later date, in lieu of a loan. Conversely, the excess cash of a bank can be deployed in G-Secs in which the RBI agrees to purchase those securities at a later date.

3.

Marginal Standing Facility (MSF) – MSF is the facility extended by RBI, in which scheduled commercial banks (SCBs) borrow overnight funds from the RBI, when interbank liquidity dries up. MSF rate is one percent higher than the repo rate and allows banks to borrow upto 1 per cent of their NDTL. 4.

Bank Rate – It is aligned to the MSF rate and is the rate at which the RBI is rediscounts bills of exchange or other commercial papers.

5.

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)– CRR is a daily balance which a bank is required to maintain with the RBI as a percentage of its Net demand and time liabilities (NDTL). This rate is notified by the RBI from time to time. SLR is the proportion of NDTL that each bank is mandated to maintain in safe assets such as G-Secs, gold and cash. The graph below shows movement of Repo and reverse repo rates from January 2015 till date

6. Open Market Operations (OMO)- OMOs refers to the buying and selling of Government Securities (G-Secs) in the open market to regulate the liquidity in the system. The RBI purchases G-Secs to increase the supply and liquidity in the market and sells to reduce the supply of money and curb the liquidity.

7.

Market Stabilisation Scheme (MSS) – Introduced in 2004, The RBI absorbs excess liquidity from the system under this scheme by selling securities such as Treasury Bills and short term G-Secs.

Types of Monetary Policy Broadly, monetary policy can be described as being contractionary or expansionary.

Contractionary policy is deployed to fight inflation and reduce the economic activity in an economy. The Central Bank increases interest rates, thus increasing cost for capital expenditure for businesses and promoting household savings at the same time. It lowers the money supply in the economy. Expansionary policy is aimed at increasing the economic activity and output. It is usually employed in times of recession and periods of high unemployment. Simply put, the Central Bank often lowers interest rates in this mechanism using measures at hand, which enable

11 | P a g e

businesses to borrow at lower interest rates, thus promoting economic activity and generating employment. Low interest rates also mean lesser return on savings, which encourages consumer spending.

Transmission Mechanism of Monetary Policy in India

Source: https://iasbakra.wordpress.com/2016/08/29/rbi-and-monetary-policy-part-5/

The above chart shows transmission of monetary policy. Transmission of monetary involves altering base rates inline with the broad contours of the monetary policy framework. If the RBI increases the official interest rate, the bond yields increase, directly affecting the cost of borrowing for businesses as a result. An increase in the interest rate will cause the lending rate and rate on savings to increase. As a result, households will notice a decline in the disposable income after the servicing of debt. This, in turn reduces their ability to spend and invest. Thus, other things being equal, increase in interest rates reduces individuals’ and businesses’ spending and consumption.

Similarly, an increase in interest rate increases the cost of financing real estate, which helps to curb demand and the rise in housing prices. Increase in interest rates also increases the firms cost of capital thereby reducing profits. Demand for bonds increases due to higher interest rates, causing valuation of equity to reduce. This makes it expensive to issue new share capital for development projects. Monetary policy interest rates pave the way for expectations and interpretations about how the Central Bank views the economy and the direction it is going in. An increase in the rate would mean that the Central Bank is using interest rate transmission mechanism to bring the inflation down to the desired level. These expectations affect the behavior of financial markets and business decisions w.r.t. fund raising and expansion plans. The effectiveness of the monetary policy largely depends on the expectations of the public and confidence of the financial system in the Central Bank. If the interest rate is increased by the Central Bank, then the domestic securities are more attractive for foreign investors. Increase in interest rates is bound to attract foreign investment, leading to appreciation of the currency. The currency appreciation results in lower import costs, directing demand outside the economy. When this happens, domestic production demand contracts resulting in lower inflation.

12 | P a g e

The reverse, is true in case of decline in interest rates. In a declining interest rate scenario, household savings are discouraged as returns on investments are diminished, thus increasing household spending. Businesses, on the other hand are encouraged to take up capital expansion projects as loans become cheaper, stimulating growth and employment. However, decline in interest rate is likely to make domestic securities are less attractive for foreign investors, resulting in capital flight.

Research has shown that, in general effects of monetary policy actions are felt in six months w.r.t. the domestic demand and majority of the impact is felt after about a year.

References 1. https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2752 2. https://www.bis.org/publ/bppdf/bispap35m.pdf 3. https://www.bankbazaar.com/finance-tools/emi-calculator/current-rbi-bank-interestrates.html

13 | P a g e

Start-up Funding: The Emergence of Venture Debt Funds By: Amrit Mohapatra (Atal Bihari Vajpayee School of Management and Entrepreneurship)

Introduction In recent years, venture debt has emerged as a newer method of start-up funding approaches. It is different from other forms of credit in that it relies more on the relationship of entrepreneurs and the company’s VC investors, rather than depending upon cash flow analysis, inventory levels or accounts receivables (Figure I).

Venture debt financing usually finds applications in financing of capital assets or growth capital.

These debt funds are also used to fund additional marketing and sales teams, R&D investments, etc. Venture debt deals are usually done around the time of a start-up receiving equity capital.

These debts find more application by start-ups who are fast-growing and VC-backed. The major sources of venture debt funds are entrepreneurial-focused banks such as the Silicon Valley Bank and specialized venture debt funds such as “Trinity Capital”, “Western Technology Investment”, and “Triplepoint Capital”. Private equity funds, business development companies (BDC) and hedge fund companies constitute other sources of venture debt finance. In India, there has been a spurt in the number of VD based companies, a few of which are Alteria Capital, InnoVen Capital and Trifecta Capital.

The source of income for venture debt lenders is typically through interests paid on debts, fees for the transaction and warrants. Warrants typically enable a VC to reduce its debt risk by availing options in the business that enables it to exercise the right to convert the instrument into shares during an exit-such as an acquisition or an IPO. Such an approach is uncommon in case of commercial banks, who see growing start-ups as risky investments and are not keen to own part of the company in any manner. The tenure for VDs is typically 24 to 36 months.

Figure I: Comparison of Venture Debt with other forms of credit

Source: Veena Iyer, S. (2020). Venture debt: a catalyst for Indian entrepreneurship. Venture Capital, 22(3), 215-238.

14 | P a g e

Differences from Venture Capital It is essential to differentiate venture debt from venture capital financing. Table 1 enlists these differences.

Table 1: Differences between Venture Debt and Venture Capital Venture Debt Availed by fast growing start-ups that already have VC investments.

Lenders focus on short-term viability.

Low-risk, low return form of investment for lenders as they are likely to be paid back.

Issuers earn warrants that act as options to enable them to own stakes in the future, albeit a small portion.

Pre-fixed interest rates limit the fluctuations in cost of debt.

Sources of income are interest payments, fees and warrants.

A new company valuation is generally not needed.

Source: CB Insights, Corporate Finance Institute

Venture Capital Can be availed by start-ups at different stages of growth.

VCs focus more on the future/long-term growth trajectory.

Higher risk, higher return form of investment.

VC investors own a sizeable stake in the start-up in return for their capital employed.

Equity financing is much more expensive, and it is also prone to dramatic fluctuations.

VCs earn by selling the equity stakes.

Equity investments require company valuation prior to the deals.

Growing Popularity Explained For the past 5-6 years, India has seen a persistent problem of rising non-performing assets (NPA) that put significant stress on the balance sheet of banks. In response, the government brought some significant reforms in the sector to address this issue, one of which was the Insolvency and Bankruptcy Code, 2016. However, one downslide of this move was that the banks and financial institutions began showing greater restraint in lending to young start-ups.

Amidst such developments, these start-ups have started exploring newer methods to fund their working capital and operating requirements which has resulted in the growth of private debt funds in India. This saw a significant jump in the year 2020, with a 100% rise in total venture debt funding from $217 Mn in 2019 to $427 Mn in 2020 (Figure II).

15 | P a g e

Figure II: Trends in Venture Debt Funding and Deals in India (2015-2020)

Source: Inc42 One of the primary reasons for this development was the outbreak of the COVID-19 pandemic that prompted these start-ups to focus on projecting short-term viability and procure debt funds, rather than opt for VC funds that see availability on the condition of long-term sustainability. In addition, it also offered an option to escape from the “downside” impact due to COVID-19 (i.e. start-ups selling more of their stakes at lower prices due to eroded value of their firms and thus losing control). As the economy is coming back to track, many B2C firms are seeing growth again. As the demand for these firms’ products remained, high, these companies had to rebuild their workforce capacity that led to increased spending.

Another reason for this development could be the fact that India’s VC start-up ecosystem is reaching a level of maturity, which is promoting newer start-ups to explore other methods of financing.

In the start-up funding market, times of economic uncertainty play a key role in shifting the choice of funding. If firms do not see their valuations reaching the expectations of VC backers, then they prefer acquiring debt as a form buffer capital and instead try to buy time to improve their financials until they can earn investors’ confidence.

In terms of venture debt funding by sector, Ecommerce (19%), consumer services (19%) and fintech (17%) saw the highest number of deals in 2020. This was followed by TransportTech (10%) and HealthTech (10%). Other sectors contributed less than 10% each to the total number of deals in 2020 (See Figure III)

16 | P a g e

Figure III: Sectoral Breakdown of Number of Venture Debt deals in 2020

Source: Inc42 One of the most interesting observations was the 79% rise in unique investors from 2019 to 2020 for venture debts (Figure IV). This shows that from the supply side, the investors are also willing to support start-ups through venture debt for short term amidst times of uncertainty. In addition, since most of the venture debt investors are also venture capital investors, they feel more comfortable in extending credit to the start-ups who have either procured VC funds recently (shows more promising business model) or enjoy popularity among the network circle of VC and VD investors.

Figure IV: Trends in Unique Investor Count for Venture Debt Deals (2015-2020)

17 | P a g e

Source: Inc42

Conclusion Venture Debt financing has emerged as useful form of start-up financing in these recent times for the simple reason that they enable young, underperforming firms and even those with negative cash flows and lack of tangible assets to access funds. This particularly becomes useful when the start-ups are trying to cross the “valley of death” and reach their breakeven points. Besides limiting equity dilution and loss of ownership, venture debt also allows entrepreneurs and investors to raise equity at the next funding round at a higher valuation. In addition, start-ups can also explore the possibility of using patents as collateral to increase the chances of procuring VDs.

References Veena Iyer, S. (2020). Venture debt: a catalyst for Indian entrepreneurship. Venture Capital, 22(3), 215-238.

De Rassenfosse, G., & Fischer, T. (2016). Venture debt financing: Determinants of the lending decision. Strategic Entrepreneurship Journal, 10(3), 235-256.

The Rise And Rise Of Venture Debt | Forbes India Venture Debt Vs. Venture Capital In One Graphic - CB Insights Research As Venture Debt Becomes The New Norm, Startups Caught In Debt Funding Dilemma - Inc42 Media Behind The Surge Of India's Startup Venture Debt Funding Boom In 2020 (inc42.com) Inside India’s Startup Venture Debt Funding Boom, Report 2021 (inc42.com) What Is Venture Debt? - CB Insights Research India’s Biggest Debt Funding Investors Betting On Startups (inc42.com)

18 | P a g e

Critique of India’s Pandemic Budget By: Pankaj (IIT Madras) Finance Minister, Nirmala Sitharaman, presented India’s first paperless budget amidst the COVID19 pandemic which has disrupted economies across the world. It is a budget which has come during the times of crisis when Indian economy is expected to shrink by 7.7% as per NSO estimates.

However, the budget was well received by the capital markets which saw its highest single day jump ever on the budget day. Though it is difficult to attribute any singular cause to stock market jump but analyst say it is due to consistency that budgets have maintained over the years in its policies and the government did not choose the path of over-taxation to realize its budget deficit.

Instead, the government decided to raise revenues via three main measures which are increasing the tax base, divestment and asset monetization.

The strategy of increasing the tax base seems to be working for the government and as per Laffer’s curve it has been able to increase its revenues while reducing taxes. In last two months, GST collections are on an all-time high even during times of pandemic which is largely attributed to increased tax base, though government has taken other steps as well like plugging in loopholes in input tax credit. Likewise, government has been able to raise more than one lakh crore via its Vivad se Vishwas and Sabka Vishwas scheme which is aimed at reducing government litigation in both indirect and direct taxation. Thus, we can say that government is taking right steps in increasing the tax base. However, divestment has not been very successful in recent years, e.g., government has been unsuccessfully trying to sell Air India since many years. It is only profit-making PSUs which are readily divested whereas loss making entities which adversely impact government balance sheet do not find any takers. Though markets have taken the government’s decision to privatize two public sector banks (PSB) in positive stead, which is also happening first time in history of India. This can improve professionalism in banks as well as reduce monopoly of PSBs in Indian lending space. The third avenue of asset monetization is being undertaken for the first time as a policy where underutilized assets with government entities will be made available in market to raise revenues. This has huge potential as many government entities own prime real estate. Likewise, government will lease constructed infrastructure like highways to private players to operate and monetize whereas it will get freed-up capital which can be invested in new projects like National Infrastructure Pipeline where government will invest over Rs 100 lakh crore in coming 5 years.

In this budget, we find that the government has chosen not to go on the popular path of giving a demand side push to the economy by increasing revenue expenditure which included giving direct benefit transfers and food coupons, and was recommended by renowned economists like Abhijit Banerjee. Instead, it took the more prudent approach of increasing the capital expenditures. It can lead to larger distress for a country which has about 68% people below poverty line as per $1.90 line of World Bank. But choosing the path recommended in this years’ Economic Survey has its own merits as being more market friendly has resulted in greater poverty alleviation in our country than in pre-1990 era when we were more socialist leaning. This is because market friendly policies resulted in a larger pie for the government to tax upon there by increasing the absolute allocation for social welfare. Hence the government has chosen the path of focusing on capital expenditure

19 | P a g e

which saw an increase of 34% in present budget over the last fiscal year. There are other supporting arguments in favor as well like Monetary Policy Report of RBI which found out that revenue expenditure multiplier is between 0.45 to 0.82 whereas capital expenditure multiplier is 3.25 and 2 for central and state government respectively. Hence there is a strong case for government to focus on capital expenditure. However, even now the capital expenditure is only about 15% of total government expenditure and it should increase in the coming future.

Now coming to the areas where the budget could have done better, lets discuss first the financial measures. The FM proposed creation of bad bank which can help banks in reducing their NPA burden and thereby enabling them to support the economic development via expected lending practices. However as pointed out by Raghuram Rajan, Indian banks are largely public sector and bad bank is also expected to be government owned. Thus, it will be merely transferring the NPAs from one government entity to another without bringing in any efficiency or financial prudence and ultimately its cost has to be borne by public. We also saw introduction of Agriculture Infrastructure and Development Cess (AIDC) which is basically just changing a portion of customs duty to cess. While customs duty is shared with states, cess are retained by the central government.

Thus, it is an attack on fiscal federalism as well as against the spirit of simplifying tax structure.

Also, Development Finance Institution (DFI) proposal is welcome as it can solve the problem of long-term financing for development projects. However, here also the financing of the institution was not well defined and FM suggested that will be financed by Foreign Institutional Investors (FIIs) which will not be apt as it is hot money and has no long-term commitment. Instead, the government should look at investment by sovereign funds from other countries as well as investment by institutions like LIC which have long term liabilities.

Second lacunae in the budget were related to social sector, which should have seen some increase in budget allocation in times of pandemic but was largely missing. For example, nutrition levels were already down as per National Family Health Survey-5 between 2016 to 2019 which would have only exacerbated in times of pandemic. Thus, allocation for schemes like mid-day meal, anganwadi and public distribution system should have increased. Also, the 137% increase in health budget is wrongly attributed because it includes allocation for many other ministries like Jal Shakti and not directly associated with healthcare. There has been only 10% increase in allocation for Department of Health in this budget. Likewise, allocation for employment schemes like MGNREGA should have increased because 90% of Indian workforce is employed in informal sector which is badly impacted by pandemic. Instead, we see that allocation for MGNREGA are 34% down from revised estimate of Rs 1.1 lakh crore in last fiscal year. In our view it should have been increased and the scheme even extended to urban areas.

To sum it all, we can say that it was one of the most challenging times for any Finance Minister to present a budget that can revive the economy at the earliest. Many industry experts have given thumbs up to the budget and we are seeing markets at an all-time high. The government is choosing the path of fiscal prudence and higher allocation on capital expenditure instead of the more popular policy of revenue expenditure in times of crisis. We will see in coming times how this strategy pans out. We could also identify that financing the budget will be a challenge for the government especially with strategy of divestment and asset monetization though increasing tax base might bear expected results. Finally, we identified some avenues of improvement in financial measures

20 | P a g e

like financing of DFI and expected more incentives in social sector like increased allocation for MGNREGA. Hopefully the government’s strategy will bear fruit and Indian economy will not only recover fast but emerge stronger. To put it more aptly, in words of our Finance Minister, it is a budget ‘like never before’ which usher us into ‘dawn of a new era, where India is well-poised to be the land of promise and hope.’

21 | P a g e

What’s Special About A Special Purpose Acquisition Vehicle (SPAC) By: Aritra Banerjee (NMIMS Mumbai) Many years from now, when people look back at the year 2020, they would probably describe it as a year that was marked by an unusually high number of unprecedented developments. For, this was the year that witnessed COVID-19 vaccines being developed in record time and oil prices diving below zero for the first time ever in human history. The capital markets too weren’t unaffected and witnessed their fair share of extraordinary trends and events. One such event, was the astronomical rise in the use of Special Purpose Acquisition Vehicles (SPACs). SPACs, which are also often referred to as “blank check” companies, are essentially shell companies that do not have any operations of its own but raise money from investors to acquire another company and take it public. Even though, SPACs have been in existence for some time now, 2020 was the year when their popularity really boomed. To put things in perspective, the number of IPOs through the SPAC route in the US was 201 in 2020, compared to only 59 in 2019 (Exhibit 1). 2020 was also the first time when the number of IPOs through SPACs outnumbered the number of IPOs through traditional methods in the US.

Source: PwC

1

The fact that the SPACs had such a remarkable year begs the question of what were the factors that drove this rise and what lies ahead for SPACs and the IPOs in general. One of the major factors that drove this boom of SPACs was the volatility that was introduced in the markets by the coronavirus. In volatile markets, a company’s value can swing wildly and it can so happen that a company’s value tumbles overnight. In such a scenario, traditional IPOs, which generally take longer than SPACs to be completed, can fall through easily. This is because in traditional IPOs, companies generally have to work in collaboration with one or more investment banks and

22 | P a g e

underwriters and hence the process is a drawn out one which increases the risk of failure in a volatile market. On the other hands, in the case of SPACs, companies have to deal with only a single company instead of a plethora of firms and investors and can even set a locked-in price for the deal as a part of the agreement. To put it succinctly, SPACs provide the cushion of a greater degree of certainty regarding the completion of deals given that the capital has already been raised before and there is a shorter time for execution.

However, like almost everything else in the world of finance, SPACs have their own share of risks and downsides to go with the opportunities that they provide. Arguably, the biggest downside of a SPAC, from an investor’s point of view, is the fact that those who invest in the SPAC don’t really know at the time of investing which exact company is going to be acquired. In other words, investors are, in a way, investing without much clarity. In addition to this, the main task of the SPAC sponsors is to find suitable a company to acquire within a time period of 2 years. In case they fail to do so, the liquidation of the SPAC takes place and those who invested in the SPAC get their invested amount back. Therefore, the SPAC sponsors would try their best to somehow find a company to acquire within 2 years and that company need not be the most financially sound company to acquire. To compound problems, the sponsors are often not incentivised to not overpay for acquiring a company. Therefore, the investors always undertake the risk of being a part of an undesirable acquisition. Finally, the due diligence and transparency of the SPAC deals are much less rigorous compared to the traditional IPOs. This, as one might imagine, has the potential to give rise to manipulations and unethical activities. Evidently, SPACs do carry certain downsides as well but given the spectacular rise of the SPACs last year, it seems for many investors the upsides outweighed the downsides. In fact, many of these investors were vindicated as certain SPACs have performed reasonably well. DraftKings and Virgin Atlantic both have witnessed their stock prices go up since going public through the SPAC route. While the average returns from SPACs between 2015 and 2020 have been below the post-market returns from a traditional IPO, with the growing popularity of SPACs, everyone is keen to know whether the trend would continue going forward or whether 2020 marks the start of a decade that would be in favour of the SPACs. The simple outlook for the future is that there is enough room for both SPACs and traditional IPOs to have a decent run going forward. While better regulations would certainly make SPACs more lucrative, if early trends are a sign of things to come, the party for SPACs is set to continue as big names like SpaceX and Waymo are expected to take the SPAC route in 2020. Additionally, the success of companies like Virgin Atlantic may drive more companies to take the SPAC route.

Additionally, countries like India which as of now have minimal usage of SPACs may also start taking a keen interest in the vehicle. In conclusion, there is enough room for the popularity of the SPACs to be sustained at least in the short term and companies would have to weigh the pros and cons before making a strategic decision about their listing.

23 | P a g e

References

1. https://www.pwc.com/us/en/cfodirect/publications/in-the-loop/spac-tacular-boom2020.html 2. https://www.cnbc.com/2020/12/07/the-2021-outlook-for-the-booming-spac-market-andtraditional-ipos.html 3. https://www.forbes.com/sites/betsyatkins/2020/08/27/the-rise-ofspacs/?sh=2018d6b2337a 4. https://www.livemint.com/opinion/online-views/why-spac-ships-remain-ufos-in-indiabut-should-not-11613405692689.html

24 | P a g e

ALL RIGHTS RESERVED

FINANCE & INVESTMENT CLUB INDIAN INSTITUTE OF MANAGEMENT ROHTAK For any queries/feedback/comments, email to fi@iimrohtak.ac.in

Website: https://fi9522.wixsite.com/home

Follow us on Facebook: https://www.facebook.com/FIclub.IIMRohtak

To Advertise with us: Contact Rashi 9717272044 Bharat 8439143938