Arbitrage Magazine - SEPTEMBER 2018 ISSUE- Finance & Investment Club | IIM Rohtak

ARBITRAGE SEP 2018

VOL. 2 ISSUE 10

ARTICLE OF THE MONTH:

$100 a barrel, again?

FINANCE AND INVESTMENT CLUB

Editor's Note We are pleased to publish the twentieth issue of ‘Arbitrage’ – Finance and Investment Club’s monthly magazine. Arbitrage aims to cover a diverse range of topics under the wide domain of Finance and Economics. Our goal is to ensure that we provide significant value to the readers through informative articles and articles on current affairs. We would like to thank all the authors for contributing their articles for Arbitrage.

In the Article of the Month – ‘$100 a month, again?”, the author Mr. Aditya Singh from Indian Institute of Management Rohtak (IIM-R) has tried to ascertain if the current spike in crude oil prices would hit the global economy as hard as it did back in 2014 and if not, what would be the implications?

We hope for the continuous support of our authors and readers to make this magazine a success.

-Finance and Investment Club, IIM Rohtak Parag Nawani Siddhesh S Salkar Vineeth Harikumar Naveen Kumar Sankalp Jain Pavankumar S Bibekjyoti Roy Nandi Aditi Patil

Index S.No.

Article

Pg. No.

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$100 a barrel, again?

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2

The AI and Banking conundrum

3

3

Valuation of IPL

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4

The INR in free fall and the rising fuel prices

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5

Payments Banks- New Revolution

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6

Sentiment: The real reason for rupee depreciation

12

IL&FS Default Crisis: Causes, Concerns and Corrections

14

China-US trade war: Can India get the extra pie?

16

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8

$100 A BARREL, AGAIN? Aditya Singh IIM Rohtak

ARTICLE OF THE MONTH

After a period of almost 4 years, crude oil prices

oil prices by the time of the election.

in 2014. Brent crude futures, which can very well

b. Saudi Arabia and Russia

percent in the past year. Crude oil prices have

countries and Russia, who together contribute

seem to find their way back to the levels last seen be taken as a benchmark have risen by almost 50 breached the $80-mark, first time since November 2014. There have been forecasts increasingly

hinting at the return of the $100 level mark by the

end of 2018 itself, allaying fears of inflation in crude oil importers and an even more pronounced effect in inflation hit countries, which include even the

UK. The question arises If this rebound in oil prices

Since about last one and a half years, OPEC more than 40% of the total crude oil have

remarkably been consistent with each other in

regard to keeping their production levels almost stagnant, despite the increase in prices. The

outcomes are becoming increasingly apparent now.

would hit the global economy as hard as it did back

c. Venezuela

context of global economies.

has been hit by economic and political crises, both

in 2014 or the impact the same would have in the

The oil-rich South American country Venezuela of which are affecting the country’s crude oil

output. The effect on commodity markets has

been such that Venezuela has cut down on its oil production levels even more than Saudi Arabia, the biggest oil exporter in the world.

Furthermore, the increasingly lesser output from the country’s conventional reserves along with

the job safety and security concerns amongst the

employees in this area are making matters worse.

Reasons behind the rise: a. Donald Trump

It all started with the concerns emanating from the US-China trade war, one which could jeopardize

the energy consumption outlook. The main blow, however, proved to be the US sanctions on Iran.

This is a legitimate concern indeed as the market doesn’t seem to have the capacity to

accommodate for the loss of two million barrels a day of crude oil, Iran exports. The OPEC and a few other major oil producing nations have rebuffed the Trump’s pressure to increase oil production

and with the mid-term elections in the US not faroff, Trump might have to resort to the usage of

US’s strategic oil reserves so as to put a curb on the rallying crude

d. Geopolitics

The recent geopolitical events such as the

increasing tensions between Saudi Arabia and

Iran, the ever-going conflicts and unrests in Iraq, Libya, Nigeria, Syria, and Yemen have further brought in uncertainties regarding future oil prices.

Implications

The concerned analysts, hedge funds and the

markets have been bullish in regard to the crude oil futures. First and foremost, one should give heed to the latest forecast by the Bloomberg

Economics about how the $100 level crude oil mark would imply lesser harm for the global growth as compared to the 2011 spike.

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This is largely because the efficiency in the usage

measure at best, as if the crude prices continue to

most of the high demanding economies have

an even higher cost than they would have

of energy and the share of renewable energy in increased, and shale oil production in the US is witnessing a revolution of late. Hence, it is

rise, the oil companies would have to import at otherwise.

reasonable to assume that the oil prices would

have to go much higher and sustainably at that, so as to make a notable dent to the global growth figures.

Higher levels of crude oil prices tend to have a

varied effect on household incomes, and thereby consumer spending levels across geographies.

Europe, India, and China are large importers of

crude oil and are at the greatest risk of a spike in general price levels. Furthermore, the current account deficits of these nations may suffer in

addition to the increased vulnerability to higher dollar values.

Oil exporting countries are majorly emerging

economies and an uptick in crude oil prices would greatly help the countries such as Saudi Arabia,

Russia, Nigeria, and Colombia. Their governments would be able to impart relief to the current

account deficits and boost their revenues, thereby leading to a rise in the levels of government spending, and consecutively spur up the investments.

Outlook India:

In short term, the markets are expected to be on the toes while on a medium term, the growth is

expected to be impacted. One could expect a rise in crude oil imports to the tune of 30%, implying that the India’s crude oil imports may touch the

USD 100 billion mark. Inflation is expected to set in

Aviation sector in India is already facing a heat

and domestic carriers would surely have to up their sleeves to face the brunt of increased oil prices, depreciating rupee, thanks to the

underlying inability to increase fares in the highly difficult-to-operate domestic market.

Global:

Crude prices had been given a positive push from

the overall global economic activity so far but the prices have been increasing to such levels, that

the demand would most probably be hampered.

The unprecedented rise in the US shale oil

production is a good counterbalance but it might not suffice and the OPEC and Russia ought to think about increasing their output levels,

howsoever constrained, like they had recently promised.

and in addition to rising price levels, depreciating INR may add to the competitiveness of domestic Indian producers and exporters. Indian

government is considering cutting down on

imports of crude and rather rely on the inventories but this is more of a gamble and a short-termÂ

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THE AI AND BANKING CONUNDRUM Yogesh Arora Delhi School of Economics The prima facie for the bank is the evolution of

Chatbots to interact with the customers and solve their problems without any human intervention through the conveneince of a laptop or a

smartphone.TheThe Risk Assessment comes

second in the bucket which will help to analyse “Long Term I think the harnessing of Artificial

Intelligence and Technology will determine the

split between losers and winners”, says Jeroen van Oerle, a prominent European investor. It’s an

exhilarating time for financial services. A veritable cumulation of new, interdependent technologies including blockchain, cloud computing and data

science are making up for a disruptive storm in the financial industry. However, the significant

advancement in the world of Artificial Intelligence

is set to change the dimensions and functioning of financial sector.

According to a recent study by TCS, 86% of banks have already incorporated AI across various sub-

the unidentified risks through the available

unstructured data from customers. AI algorithms can identify the behavior and syntax patterns

through language analysis and work out the future plan of action for the company.

The banks are entitled to use AI in their ‘least-

value processes’. The integration of AI in existing banking system for scanning and parsing the

documents will not only bring down the cost but improve the operational efficiency of the banks.

domains of the financial processes.

According to a study by Consultancy.uk, the banks will experience a significant 12.7%

reduction in their operational cost only after Telecommunication, Retail, High-Tech and UBS Bank has Amazon’s digital assistant Alexa for customer service, JPMorgan is using robots to

execute trades and Morgan Stanley has an AI fraud detection team. Santander Bank launhced red robots to assist their guests in visiting their

Spanish Centre. HSBC said it would follow suit by using AI to detect money laundering, fraud and

terrorist funding. How the banks wish to extract the benefits of Artificial Intelligence to improve their efficiency?

Insurance industries.

The increasing NPAs, frauds, money-laundering have taken a toll at banks working environment.

The difficulty or ignorance in assessing the

anomalies or illegal transactional behavior has

put a question mark on banking processes.AI can spot the unusual patterns which might indicate about frauds or money-laundering through

machine learning algorithms.The ability of AI

systems to parse through each occurrence in the system can

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2ensure transparency and improvised monitoring of the asssets or cash flow in or out of the system.

So, against all this hype, where are banks focusing their AI attentions? According to a FT study, Many

of the banking institutions are finding it difficult to select the right area for implementing AI

technologies. The decision to invest heavily in one particular area such as chatbots and ignoring

other potential areas which can accelerate growth can be crucial as saying goes ‘If you don’t do this,

your competitor will do’.There is a clear difference between banks who focus on altering their existing business models through new

technology and banks who focus on cost

reduction as their primary objective. The premise of increased layoffs and jobs cutting after the introduction of AI has added to the ever-

increasing problems for the banks. Former

Citigroup chief Vikram Pandit predicted 30 percent of banking jobs could be swiped out by AI in

coming few years. Mizuho Financial Group in

Japan says it would replace about one-third of its workforce by 2027.

Amidst all the operational dilemmas, the

effectiveness and impact of AI have raised another question mark. The problems that are currently being solved by AI are very shallow in nature.

There is a misconception that the existing AI can

match the power of the human mind. There is still

.AI is the future for not only the banking sector

but for every sector progressing towards a new era. There are several issues that need to be covered off to ensure a smooth transition period. “We, rather than ‘AI replacing

workforce’, believe in the power of ‘AI

empowered workforce’ says Dutch Bank ING. As the AI is implemented across various

domains, its difficult to evaluate the success as the front-end shows staggering improvement as compared to minimalistic growth in back-

end processes. The marketing story needs to be different from the implementation story as the customers should experience the connection through the adoption of new technology and

feel ensured towards the improvised services.

“The challenge for banks isn’t becoming

‘digital’- it’s providing value that is perceived to be in line with the cost or better yet, providing value that customers are comfortable paying

for” – Ron Shevlin. AI specialised hardware with ever-increasing processing power to enable more robust systems, as well as vastly

improved infrastructure to mine and feed data to such systems for even greater capabilities,

the banking industry has started to realize the extent to which machine intelligence can positively redefine how it operates.

a long forward where AI and humans can be put

on similar levels. Unrealistic expectations at this point of time may push banks deeper into the

tangled vicinity of AI world which has a lot more to offer in the coming years. The things that appear to be ‘bright’ on paper might not be as effective when implemented.

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VALUATION OF IPL Parag Nawani IIM Rohtak (This article is based on Duff and Phelps 2017 IPL

The title sponsorship deals also tell the great

No one would have imagined that the IPL would

initial edition of the league in 2007, the amount per

Report)

become such a huge hit when it was first

conceptualized in 2007. Within just 10 years, it has garnered such success that even the decades-old

sporting leagues across the world would envy. As a Finance enthusiast, when I found this report on

success story of IPL. With DLF sponsoring the year has significantly increased in the later

editions of the league. The graph shows the

companies and the amounts which they had paid for the title sponsorship deals.

the valuation of IPL, I had gone through it, and

have penned it down in the form of this article. The infographic below shows the brand value of IPL,

and also shows the brand values of individual IPL teams.

Brand valuation

Great sporting brands across the globe have

been built over several decades of fan following, successful performance, the ability to attract

great talent, and sustained association with big

companies, associates and sponsors. Teams like the Dallas Cowboys, Manchester United, New The Blue Ocean strategy, as we say in Marketing, is best explained through IPL in the Indian context.

The perfect blend of the sporting religion with

Bollywood and entertainment is welcomed with

extreme enthusiasm by the Indian audience. The huge response can be viewed from the attached

table which shows the growth in the cumulative TV reach of IPL.

York Yankees, Chelsea, Real Madrid, Barcelona FC and Los Angeles Lakers have become much

sought-after brands by advertisers and represent brand values in billions of dollars. The IPL has

also amassed a huge brand value in these years, and one intriguing thing about IPL is how it has

managed to maintain a separate brand value for itself. Most of the EPL brands have become

bigger than the EPL itself, whereas IPL is much more powerful compared to the individual franchises.

The brand value of IPL is derived from a broad variety of factors, keeping in mind the Indian

viewer’s association preference for vernacular

inclinations, cricketing knowledge and celebrity influence. Consequently, drivers of brand value

in the IPL can be categorised under the following broad heads.

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Management strength and On-field

Marketing strategy

The teams performing consistently well across

15-25% of their budgets towards marketing and

performance

editions of IPL are valued more than those not

doing well. Team management plays a vital role in squad selection, talent acquisition,

performance management, and administrative support.

It is estimated that franchisees spend around promotion.

IPL events, merchandising, TV advertisements,

and other such promotional activities driven by the franchise go a long way in gathering

exposure translating into brand value gains.

Geographical location

Valuation approach and methodology

support base, and is an important factor in

calculate the future cash flows for the event. It

This factor determines the population of teams’ assessing the strength of an individual team

brand. However, some teams have seen panIndia support, due to various factors, like the

level of cricket played by those teams, or the

The Relief from Royalty method is used to is premised on the royalty that a company

would have to pay for the use of the brand if they had to license it.

association of players like Sachin Tendulkar and

The 1st step in the valuation of IPL is to

teams. Such teams are valued more than those

these brands. A business model for each of the

Mahendra Singh Dhoni with their respective getting support only on geographical basis.

Social media engagement

The teams that can engage their fans on various social media platforms during IPL have seen an upward trend in their brand values. RCB’s

estimate the future revenues estimated for individual franchises was developed after extensive research. The model was built

considering the various contractual revenue

sharing agreements between the BCCI and the IPL franchises.

PlayBold, MI’s CricketMeriJaan and KKR’s

The 2nd step is the development of the fair

which were a huge success.

number of Brand and Trademark licensing

AmiKKR hastags are some of the campaigns

royalty rate. The company researched a

arrangements across international sporting leagues such as EPL, NFL and NBA. This

estimated royalty rate is applied to forecasted revenues of each franchise to calculate the

royalty savings attributable to the brand owner.

These are then discounted to find out their present values.

Celebrity influence and Marquee players

The teams with more association of celebrities

and having more marquee players are perceived

to have a higher brand value than those bereft of these two factors.

DCF Valuation

The valuation of IPL has been done with the

help of Discounted Cash Flow (DCF) Valuation.

The future cash flows of IPL as a whole, and of individual brands are discounted to come up with the present value of IPL and its teams.

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Conclusion

sporting scene. The value created by the

the novel valuation models are also coming up

to the minimal initial investment by BCCI.

With new business models emerging in the market, which could value these business models

efficiently and correctly. This report helped me

learn some new concepts of financial valuation.

IPL continues to be a cash cow for BCCI. It has

come a long way since its inception in 2008, steadily expanding its foothold in the global

IPL in such a short time is significant due Ten years of IPL has provided us with a

glimpse of what to expect in the next 25 years. It will be safe to say that for the

foreseeable future, the months of April and May will stay demarcated as IPL

territory where nothing else sells. Not even Bollywood!

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THE INR IN FREE FALL AND THE RISING FUEL PRICES Rohit Dudi IIM Lucknow talks and concerns hovering it has a big hand in worsening of situation.

What happened to the Rupee?

The Indian currency Rupee witnessed a heavy fall in its value in last few months. The value as

compared to USD has fallen by more than 10%

What is the potential impact on India?

situation in the last one month. INR is now trading

USD. It worsens as there is a fall in the Rupee’s

since 1st January 2018, and it has worsened the at its weakest value. A reason attributed is that currency of other emerging economies like

Turkey, Argentina, Indonesia and Mexico are also facing depreciation.

Why this situation?

This can be attributed to global factors at play. It is expected that US Federal Reserve is going to

tighten its monetary policy in the coming days by slowing down money supply growth in the US. This affects value of other currencies. First,

interest rates will rise in the US as demand for

different assets begins to drop. Investors hasten in selling their assets in other countries and invest

Buyers have to pay more Rupees to purchase

real purchasing power. A strong USD favours

investors who invested in the US and significantly

affecting the returns of investors who went bullish on emerging markets, initially.

There is a rise in crude oil prices globally and

geopolitical uncertainty has led to a decline in the value of Rupee, leading to steep rise in the prices of fuel. Increased crude oil prices and weakening of Rupees has affected India’s current account deficit and import bill.

The Foreign Institutional Investors (FII) have withdrawn more than 600 billion INR due to speculations of trade wars.

money in the US to earn higher returns. This

What is the way ahead?

economies’ currencies and pressure of buying on

hence have the influence on the value of

increases pressure of selling on developing

the USD. Second, as tightening of money supply

takes place, the availability of USD will turn scarce and so traders buy USD in speculation. This leads to an increased liability on debts dominated by USD, exchange rate appreciation and capital inflows.

A significant fall in the value of Turkish Lira after an economic crisis has deeply impacted currencies of many emerging economies. The US-China trade

Central banks supply national currencies and currencies by regulating the money supply. The Reserve Bank of India can affect domestic

benchmark interest rates by taking a stance on its

monetary policy. The RBI can directly intervene in

the forex market as well. If this situation continues

where Rupee depreciates further, our government

can think about raising funds by issuing NRI bonds in a hope to stabilise the currency.

Inflow of funds expected in the Indian equities

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may provide some respite to a weaker Rupee

of oil in the world and import more than 80% of

record heights.

CAD is a measure of the ratio as a percentage of

Indian equity are performing really well, reaching

Why the steep rise in crude oil price?

Speculations about US sanctions is a threat to oil

supplies which has led to a steep rise in the crude prices.

Disruptions in crude oil supply from Venezuela and Iran is going to squeeze everyone. Even if

Saudi Arabia decides to raise their oil output, it may not be able to square off the decrease in supply from in Libya, Venezuela, and Iran.

How do fuel prices increase impacts the economy?

Inflation: Increased fuel prices bear a direct impact on the non-food component of CPI (Consumer Price Index) and WPI (Wholesale Price Index)

inflation which can further dictate RBI’s to hike

interest rates to control inflation. Speculations are rife that RBI may hike interest rates by at least 25 basis points. This may be a remedy or a

preemptive measure to control high inflation.

The state and central governments can reduce VAT or excise duty reduce the burden of fuel

prices on consumers. Although, this may reduce revenue to the government by INR 7000 to 8000 Crores annually but is the need of the hour to

provide respite to consumers who are reeling under high fuel prices.

our oil requirements.

GDP. This is not the first time INR has taken a blow. In 2011-2013, the INR fell and oil prices

pierced the roof, India’s CAD had a steep hike

from 2.7% in 2010-2011 to 4.2% in 2011-2012 and

later 4.7% in 2012-2013. As international crude oil prices started declining sharply in 2013-2014, the CAD fell to 1.7% in 2013-2014, to 1.3% in 2014-

2015, to 1.1% in 2015-2016 and to 0.6% in 20162017. Again in 2017-18, oil prices increased

leading CAD to increase to 1.9% in 2017-2018.

India’s trade deficit was $113 billion in 2016-2017 which later increased to $160.0 billion in 2017-

2018. When a time came in 2012-2013, the CAD

shot up to 4.7%, consequently, India had to put severe restrictions on gold imports and had to

raise foreign currency deposits at much higher

rates so as to protect the macro-economic health of India.

Final view of many analysts and experts suggest that RBI can let market decide desired level for the INR as it leads to loss of foreign exchange.

This is not a desirable condition.

World is hopeful after fresh dialogue between

the Western and Eastern countries helped in the recovery of few currencies. Euro and Pound are back on track.

With every 5% depreciation in INR, inflation gets pushed up by 20 bps.

Current Account Deficit: It is a measure of any

country’s trade and this term is used when the

value of exports of goods and services are less than value of imports. Net income along with

remittances, interest and dividends, are included in the Current Account. A high Current Account

Deficit can create vulnerability in macro-economic aspects of country’s economy, leading to

instability in currency. This is very reason that

India is vulnerable to any small rise in international crude oil prices. We are the third largest importer

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PAYMENTS BANKS- NEW REVOLUTION Deepak Rawtani KJ SIMSR demerits. PPIs are payment instruments such as e-wallet, smart cards or those having access to prepaid money that facilitates the purchase of

goods and services against the value stored on such instruments.

Aapka Bank, Aapke Dwaar. Sounds familiar? The logo and tagline reflect the very concept that is again in news lately. Take a guess.

Hope, you all guessed it right. The logo and

tagline both represent India Post Payment Bank

(IPPB). Being a Payment Bank, IPPB’s jurisdiction includes savings and current accounts, bill and utility payments, direct benefit transfers, net

transfer, and merchant and enterprise payments.

Billed by Prime Minister Narendra Modi as a game changer for the Indian Banking System, this new poster boy of Central Government would

complement the government’s fight against the

challenge that has become a buzzword these days “Financial Inclusion”. The inclusion of the poorest of the poor or the downtrodden into the Indian

financial system is what defines the term financial

Payment banks are expected to reach customers

mainly through the internet and mobile platforms.

The concept of payment bank was based on the premise that it would be uneconomical for

traditional banks to open branches in every village and flung areas of the country. Thus, the concept of payment banks was promulgated with the

objective to provide secure technology-driven financial services and offer low-income households, small-scale and mid-scale

businesses an alternate method of the banking system.

Currently, there are 6 active payment banks in

India i.e. Airtel Payment Bank (PhonePe), PayTM Payment bank, Indian Post Payment bank, FINO Payment bank, Jio Payments Bank, and Aditya Birla Payments Bank.

inclusion. According to statistics, only 40% of Indians have access to the banking system in India.

So, what are the payment banks? In layman terms, they are non-full service niche banks in India that

undertake limited banking transactions. Payment banks in India were mooted to replace Pre-Paid instrument providers (PPIs) and overcome its

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• Bank as a platform: There can be 4 potential

ways in which payment banks can diversify their customer offerings and revenue model

A) Merchant Acceptance: A holistic merchant acceptance infrastructure is essential for a Opportunities • Market Size: As stated above only, 60% of Indians i.e. 75 crores do not have access to banking

facilities. The problem gets multiplied in rural areas where 68% of India’s population i.e. 85 crore lives.

Also, with the rise of Fintech sector and

government’s initiative of “Cashless India” post

demonetization, there is the increase in demand of digitalization. Thus, this is the opportunity the payment banks should encash in.

cashless society. Thus, a model that would

incentivize customers and merchants like 0% MDR to accept cashless payments and help payment banks in increasing their bank

balances. Also, they can act as a solution for e-

commerce industry to increase the use of online payment.

B) One stop shop for financial services:

Payments banks, with minimum effort, can sell

financial services to their existing and potential customers through digital medium or correspondence network.

C) Microsavings: The concept of Microsaving accounts bodes well for financial inclusion. A Microsaving account is designed around the

smaller amount of money with the concept of minimum balance requirement is very low or

waived off, allowing users not to be charged for services and save a small amount of money.

• Simplification: The current banking processes

are cumbersome and complex both financially and physically. MDR (Merchant discount rate) on debit cards and credit cards are high for small and mid-

Considering the fact that 22% of Indians are

Below Poverty Line and 60% out of banking network, Payment banks can grab this opportunity.

size businesses. RTGS, NEFT is not free and OTP

D) Creating large-scale access to credit:

Mobile banking comes with its own set of

they can act as a platform for credit assessment.

based digital verification is too time-consuming. challenges. Thus, it is imperative for Payment banks to provide simplified solutions and move quickly.

Utilize the payment infrastructure of NPCI (National Payment Corporation of India) and think of

biometrics as a medium of payment transaction to

Though not allowed to offer loan/credit facility, Profile and analyze the customer stability and

transaction which in return could help lending agencies in identifying their potential customers.

gain upper hand.

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SENTIMENT: THE REAL REASON FOR RUPEE DEPRECIATION Guneet Kaur Makan IIM Raipur The rupee has depreciated more than 12% this

Turkey crisis impacted India because both Turkey

trading near 73 against the dollar. First it was

investors start disposing Lira, the rupee gets

year defying all short term targets. It is currently believed that the rupee would stabilize at 68, then

at 69 and finally around 71. But it had hit a high time low of 72.96 after crude oil prices surged to a near four year high. The currency gain has had a

contagion effect on the bond and equity markets.

In the fear of interest rate hikes, the 10 year yield has jumped to 8.22% in the bond market.

As per market veterans, it is tough to say where the rupee momentum will stop in the near term. The fundamental reasons for rupee fall are higher oil prices, gold trade deficit, high imports, capital outflows and global selloff. But the most

prominent reason for the rupee fall is more about

sentiment and the contagion effect more than the fundamentals. The recent fall in rupee has caused panic among importers and corporates with unsecured foreign borrowings. Many of the

importers were forced to take a stop above the 70 mark which is another reason for the increased dollar demand.

It initiated with the Turkish Lira falling to a low of 7

against the US dollar after US imposed trade tariffs on Turkey. This in turn lead to fears of contagion

among all the major Asian currencies including the Indian rupee. The Turkish Lira has fallen almost 30% in August this year. In global financial

markets, bad news spreads faster leading to the

collective damage. This was evident from the 2008 financial crisis which started in the United States

but had spread globally due to financially related instruments. This effect is referred to as financial

contagion and it develops from the time when the investors start avoiding risk by moving to safer

investments. This is comparable to swimmers who prefer swimming to the shore when the sea begins to get rough.

and India are developing nations. So, when

swept along in the wave. Any sort of bankruptcies in Turkey would put a shadow on developing countries like India which has a dollar

denominated debt. This is because as foreign

investors will fear in Indian investments and will

dump the rupee for dollar. Concerns regarding the Lira had not only affected India, but also the South African rand, Russian ruble, and Mexican peso.

Just as the rupee markets appeared to be become stable due to the strong RBI intervention in the

past few days, the fall in Turkish Lira triggered a sharp sell off.

As per economists and RBI, there are no immediate reasons for panic as macro

fundamentals of India are in a much better shape

as compared with 2013-fiscal commitment, stable inflation and better GDP. Retail inflation is at 4%

and CAD is also at sustainable levels, which could be managed well with the forex reserves. The

movement in the rupee should be seen more in

light of the global factors rather than the domestic ones. Â

The government should step in to address the

rupee fall as that might improve the sentiment. As a response to this, the government announced a

variety of measures to bring additional inflows to our country to address the rupee fall. Allowing

manufacturing sector to avail external commercial

borrowings (ECB) up to 50 million with a minimum maturity of one year as compared to three years is one of the steps been taken. The falling rupee has

hampered foreign investments as it could depress their returns in terms of dollar. According to the central bank, a 5% fall in rupee would push up inflation by 10-15 basis points. However, the

impact would be favorable in boosting the net exports.

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The RBI has said nothing officially about the rupee

By removing all restrictions on the free exchange if

entire market. The quantum of reserves gives the

reverse the rupee fall. It would depict the Indian

fall so far. The words of RBI can shift signals in the Central bank the superpower. The former RBI

Governor, YV Reddy, cautioned against letting the market believe that the depreciation is

due. Financial markets react to expectations and conveying the right gestures at the right time is

rupee, foreign investors could be reassured and macroeconomy in a sound position to bear the

risks associated with any such future happenings.

It is vitally important to stop this contagion effect which would help stabilizing the rupee.

critical.

13

IL&FS DEFAULT CRISIS: CAUSES, CONCERNS AND CORRECTIONS Rohit Kumar Choubey IIM Ranchi The Infrastructure Leasing & Financial Services

stake of 25.3 percent, SBI with a stake of 6.42% and

had defaulted on its obligations to holders of

some of the major shareholders in IL&FS.

Company announced on 6th of September that it commercial papers issued by them. This implied

Central Bank of India with a stake of 7.67% are

that the company had a liquidity crisis and didn’t

Impact

shockwaves throughout financial markets.

banking sector, mutual funds, insurance sector

have enough cash to repay its lenders which sent The Infrastructure Leasing & Financial Services (IL&FS) is a non-banking financial company

(NBFC). The company raises money from various sources with the objective of investing in infrastructure related projects.

Probable causes and events leading up to the default

Most of the NBFCs raise financing via issuance of debt instruments such as debentures, bonds,

commercial papers etc. The interest as well as the principal needs to be repaid to lenders at a pre-

determined date which is agreed upon at the time of issuance of these instruments.

The primary source of revenue for IL&FS is the

interest received by them from the loans made to

facilitate various infrastructure projects. Therefore, when such projects are affected for some reason,

IL&FS’s cash inflows are bound to get impacted. In this case, the effects of adoption of measures like demonetization and enforcement of GST regime

has led to slowdown in the infrastructure sector.

Also, subsequent lengthy judicial processes

related to land allocation disputes has delayed, if

Impact of this default is expected to affect the and other indirectly associated sectors which

invest heavily on debt markets. Indian credits rating agencies like CARE have downgraded

IL&FS from investment grade to ‘junk’. Also, other NBFCs and Housing Finance companies who have heavily invested in these debt instruments would be severely affected. The recent plunge in share prices of some of these companies might be an

indication of this domino effect. This major default by an organization as big and strong as IL&FS is bound to have a major impact on the Indian

financial markets unless quick and adequate measures are adopted by the company

management, the board, majority shareholders as

well as the government. If not, the impact is could have devastating effects on the markets as well as

the economy. Subsequent defaults by IL&FS on its obligations would lead to investors losing faith in the NBFC domain. This could lead to a vicious

cycle where affected parties with high leverage

would sell stakes in other entities to cover losses

which could fuel a collapse on an unprecedented scale.

not halted, a number of such projects.

Correctional measures

debt instruments at the time is reported to be a

board of IL&FS has announced a number of

The total amount of debt outstanding via various whopping 91000 crores. This total debt in the form of bank loans amounts to nearly 0.5%-0.7% of the

total loans in the Indian banking system. Up until a few months ago, IL&FS, although a private entity, was considered comparable to a quasi-sovereign entity as a majority of its shareholdings were

public sector entities like LIC and SBI. LIC with a

In an effort to salvage the worsening situation, the measures. In order to infuse much needed capital, the company plans to raise funds of up to Rs 4500 crores via rights issue. Rights issue refers to an

additional issuance of shares at a pre-determined price to existing shareholders of the company in

proportion to the number of shares currently held by them.

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Also, the company intends to sell some part of its

liquidity crisis of the company to the bankruptcy of

In addition to this, the IL&FS has also considered

which severely hit the US economy. The default

assets in order to use the proceeds to repay lenders. short term capital procurement via bridge financing which refers to a financing option intended to

solidify short term capital adequacy situation for the company. A moratorium is also being sought by the board in order to postpone these short term

obligations until the company reinforces its capital position. The government has also asked the

majority shareholders in IL&FS to arrest any further defaults from the entity and its subsidiaries.

Outlook

All things considered, the measures adopted by the management and board seems to be necessary in

order to arrest further defaults and in all probability, stop a chain reaction that could threaten the economy of the country. However, many

financial market experts are already comparing this

the investment bank Lehmann brothers in 2008 announcement has already showed signs of a

selling sentiment in financial markets with stock prices for certain housing finance companies

tumbling sharply. In the absence of long term

corrective measures, these steps being adopted would turn out to be a band aid to an otherwise

fatal wound. The company and its shareholders

need to take a long hard look at its future course of action. A much needed restructuring of the

organization needs to be performed in order to restore faith of the investors in the company’s

ability to meet its obligations. We hope that the remedial measures adopted works for the

betterment of the company and arrests the

detrimental effects from spreading in the financial markets and the economy any further.

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CHINA-US TRADE WAR: CAN INDIA GET THE EXTRA PIE? Peeyush Goyal Sagar Suman IIM Rohtak The US China trade conflict has become an

vehicles and transport parts, chemicals, plastics

Donald Trump, came in power in 2017, US's

in the US market.

everyday news now. After American President, relationship with China has grown acrimonious

and rubber may become more price competitive

and has exacerbated since.

To understand how India can benefit out of trade

$250 billion and has vowed to further the contours

example of items like fresh grapes, cotton linters,

In last 4 years, US has levied tariffs of behemoth

of duty to all the goods and services, and China, thereafter, has retaliated by hiking the tariffs on soya bean and automobile, in the large list of

number of other goods. It will be of no surprise if the trade tension only escalates in years to come and it rightly justifies what the second largest

economy of the world dubs as 'biggest economic fight in the history of the world'.

In the hue of conflict unfolding it is the opportune moment for India to lower its trade deficit and

make itself 'noticeable' in the context of world today or at least even-out its trade with large economies of the world.

With rising trade tension, both US and China will look towards alternative markets which can

provide them with cheaper goods. India has an opportunity here.

These economies will witness a commodity void in form of both consumers good and large industrial

input - India can expand its trade with both US and China as exchange between these two economic

giants will become expensive due to recent tariffs hikes. India has not been exporting several items to US due to the cost disadvantage it faces w.r.t

China. The items like electricity parts, switches,

cables and other small scale industrial production in India can experience a boost. As the US has

imposed 25% tariff on imports from China, Indian products like machinery, electrical equipment,

dis-balance between US and China, let’s take the

tobacco, lubricants, benzene, the value of which is more than $10 million. China has recently

imposed tariffs of 15-20% on imports of these

products from US while the import duty with India is set at much lower at 5-10%, varying with type of product, which makes Indian exports all the more

competitive at present. India has added advantage of being in Asia Pacific Trade Agreement (APTA) under which it has been granted 6-35% duty

concession. Another example to explain the trade dynamics is corn. China imported $600 million

worth of corn in 2017-18, on which American corn

is subjected to duty of 25%. India being a member of APTA can avail 100% concession on the export to any other country in the region.

This is not to say all is hunky-dory here.

Protectionist and inward-looking stand in itself is

detrimental for health of any emerging economy.

India was presumed to replace China in 21st

century as factory of the world given the aging

China and demographic advantage it bears. The world moving towards a Trump-based system

would fend away investors and foreign inflows which is need of the hour. Secondly, nobody would like to expand capacity through fresh

investments, as we don’t know how long these

sanctions will last. India needs to trudge carefully amidst storm all around and strike a balance.

Negotiation, subtlety and astute bargaining are

key to success in approaching fragile new world order.

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