Finly February 2019 by FINLY

From the Editor’s Desk

FINLY| January 2019 | Finstreet | SIMSR

Dear Readers, We at Finstreet are proud to unveil the February edition of our monthly magazine FINLY for the academic year 2018-19. Our Cover Story helps us understand the process of Brexit and what is its relevance from the Indian context. Next in line, the Eco Section analyses the Euro as a currency and the benefits of a single currency system. In the Sector Analysis, the authors inspect the Capital Goods sector, with an in-depth analysis of the latest disruptions in the industry, along with covering the leading industry players. This month's Fintech Funda covers the emerging trends in InsurTech and how it may impact the future of the Insurance Industry in India. In the end, we have introduced a new section called “Know Your Finance”, which contains information, breaking down some useful concepts in Finance, which would help any aspiring finance student to take baby steps in building the concepts as well as confidence in the subject. I am thankful to Prof. (Dr.) Pankaj Trivedi (Course Coordinator, PGDM Core, and Faculty Coordinator, Finstreet) for providing the much required mentoring, support and backing to the Finly team. I would also like to thank our New Sponsors, White Knight Ventures, for an enriching collaboration. We hope to continue the partnership for a very long time. We have received an overwhelming response for this month's call for article competition, with some high-quality content from some of the best management colleges of the country and I thank each and every participant for their sincere efforts and participation. This month's winner's and runner-up articles are a recommended read. I thank all our readers and faculty members for their constant love and support. Your reviews and feedback are much appreciated. Team FINLY has always been a strong set of focussed individuals who put in a lot of efforts and dedication to stitch together this magazine and I can't thank them enough for their constant support and initiative. HAPPY READING!!!

R Prasanth, PGDM-FINANCE, 2017-2019,

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Faculty Incharge

Editor-in-Chief

Team Finly February 2019 Dr.(Prof) Pankaj Trivedi

Indresh Naithani

R Prasanth

Shubham Patel

Conceptualization & Design Sudarshan Daga

Rohan Thombre

Content Team Ankit Nimbajiya

Swapnil Ghose

Radhika Goyal

Yash Gore

Sambhabi Chanda

Shraddha Joshi

Shreyash Vaidya

Isha Koolwal

Kunal Mirchandani

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FINLY| JULY 2018 | Finstreet | SIMSR

INDEX

Editorial Team Finly

Cover Story

15 Article of the

Month-Winner

Article of the Month-Runner Up

Eco Section

Fintech Funda

Sector Analysis

Know your ď&#x20AC; nance

A COMPLICATED DIVORCE

As 29th March 2019 approaches the world awaits to see the conclusion of Brexit, one of the most complicated divorces that were started between the United Kingdom & European Union by the referendum held back in 2016. The referendum conducted on Thursday 23rd June 2016, UK choose to leave the EU by a mere margin of 3.8%. Around 30 million people, i.e., around 71.8% of the people voted and arrived at the conclusion to Leave. Subsequent to the decision countless debates have been held to argue the pros & cons of the Brexit process owing to its complexity which was not foreseen by officials who intended to deliver a smooth and crisp Brexit.

primarily focussed on the issues that were related to sovereignty and immigration while the other campaign stressed the economic repercussions of leaving the EU. The hardline Brexiteers thought that they were losing position as most of the decisions were carried out in Brussels, the capital of the European Union. The principle that the decisions in the UK should be carried out in the UK emerged as the strongest contributor. They wanted the trade and other rules and regulations to be framed in their own terms. The trading patterns followed by British, capital flows and the emigration patterns were least Europeanized. The favour of domination in the membership of the EU was missing in one way or the other. The leave voters wanted to reverse the process and gain the advantage.

Britain's relationship with EU was on and off type. The country had different opt clauses which dominated the Leave factor. The Leave campaign was

The political scenario also paved the way, where the politicians were able to convince the common man. The admittance of increase in the

Cover Story

INTRODUCTION

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employment opportunities brought the people together and the factor that the UK economy will become more buoyant was an added factor. They wanted to end the privilege being experienced by the European citizens to come to the UK to staff their offices, filling in the gaps in different professional sectors and enjoying the agricultural yield. The department from EU was also governed by the immigration. The UK wanted to regain control over the immigration and its own boundaries. In the decade before the Brexit referendum, there was a significant increase in the migration from European Union countries. As per the reports, the inflow of citizens of EU migrating to the UK stood at around 201,000 in 2013 followed by 268,000 in 2014. EU inflows were mainly flat for the 1991-2003 period, averaging close to 61,000 per year. The research also investigated that the exit vote was larger in the areas which witnessed the l a rg e r i s e i n t h e p ro p o r t i o n o f immigrants. The rejection of neoliberalism and globalization were also major influencers. There was a sense of economic insecurity that was propagating among the UK people. Additionally, Britain was reluctant to integrate itself with Europe as their distinctive identity was undermined by EU. The other factors that influenced the decision were the potential nostalgia of the older people who have experienced the life in the UK prior to 1973. Additionally, the higher turnout of the older people dominated the younger ones. The older generation was in much favour leaving whereas younger ones wanted to stay.

PRO-BREXIT AND ANTI-BREXIT GROUPS Once the referendum was passed, there was the emergence of two groups one being pro-Brexit and other anti-Brexit. A pro-Brexit group was associated with the UK Independence Party (UKIP). It was founded to oppose and challenge the EU membership. The pro-Brexit labour group consisting of a group of economists forecasted that there will be a 7% boost to the annual GDP. The people with earning the least will be benefited the most. Additionally, they mocked EU politicians and stated that the politicians and the respective officials will go on banging down, door to door for achieving a trade d e a l a n d w i l l t r y to gat h e r t h e i r commercial interests. “Vote Leave” is the official pro-Brexit campaign which was founded in October 2015. It was supported by political strategists as a cross-party campaign and involved members of Parliament from the Conservative Party, Labour Party, and UKIP. They secured the top rank in “Why Vote Leave” page on its website and claimed that the UK economy could save £350 million per week. While Vote Leave has focused on the economic arguments against the EU, there was another proBrexit group “Leave EU”, which focussed more on the immigration-related issues. Pro-Brexit campaign as found now has been marred with a lot of fake news & unfounded facts propagated via social media & the famous red bus. There were a number of anti-Brexit groups that carried out campaigns to support remain in the UK EU membership referendum. It was initially led by Britain stronger in Europe in 2016. In April 2018,

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people's Vote campaign was launched. It was a British campaign group which called for a public vote on the final Brexit deal and stressed for the second Brexit referendum. It tried to improve relations with the official opposition and has developed a close working relationship with the anti-racism group, Hope Not Hate. The campaign is gaining momentum amid increasing uncertainty over Brexit. UNCERTAINTY OVER BREXIT HAS IMPACTED BUSINESSES With just a few days to go until the UK leaves the EU, and with the growing uncertainty, many employers continue to be in the worried state. Brexit has impacted the UK business and the labour market adversely. Around 25% of the UK businesses employ staff from EU but now they are putting off employing someone from EU due to changes in the immigration laws of laws. This has impaired their talent pool significantly. This is particularly seen in the healthcare sector where there is anticipated to be a heavy shortage of nurses which would directly impact the quality of delivery of healthcare. Once the Brexit is accomplished in March 2019, all 3.8 million EU nationals living in the UK or those who wish to enter will need to get registered themselves with the settled status to continue to work a n d l i v e . A d d i t i o n a l l y, w i t h t h e uncertainty, the rights of citizens of Norway, Switzerland, Iceland, and Liechtenstein living in the UK can still be negotiated. In May 2018, as per the reports of LinkedIn, 96% of hiring strategies are already affected and 44%

of recruiters believed that the UK is becoming less attractive to EU citizens and 39% international candidates are now reluctant to move to the UK. Supply chains are affected by tariffs which would come into effect on the exit of the UK from the EU single market & c u sto m s u n i o n fo r ra w m ate r i a l procurement. The goods or services offered contain raw materials sourced from multiple EU countries. Thus the supply chains would require time to reformulate and stabilize due to policy uncertainty. The automobile sector in the UK has been impacted severely, where British carmaker Aston Martin is outlining contingency plans to combat the uncertainty and have warned against higher costs & lower output levels on pulling out of EU with no deal. The cost rise may be attributed to the increased logistics time due to border checks & tariffs. Also, the financial sectors have seen major shifts like the plans of banks like JP Morgan to shift assets worth $ 235 bn to Frankfurt, with many banks that may follow trend causing heavy damage to the lucrative position that London holds in the financial markets. Moreover, primary sector activities like fishing & fish processing would fall into heavy trouble due to the exit from the trade block, where territorial waters will need to be redrawn. The UK currently enjoys free movement of products within the trading block which is not subjected to any border checks or tariffs. Brexit will also result in the UK paying EU settlements in the tune of 35-45 billion pounds to cover the outstanding obligations to EU which will be paid out in

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a phased manner. Brexit has been touted to cause damage to the UK GDP in the medium term. The damage estimated has varied considerably among the

estimators, with PwC (2016) report touting a loss of -3.5% to the GDP by 2030.

Forecasted short-term effects of Brexit on real GDP in UK in 2018-2023

Source: Statista

Region wise impact of Brexit

Source: Confederation of British Industry

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FINLY| February 2019 | Finstreet | SIMSR

Source: infographic.statista.com

SCOTLAND & NORTHERN IRELAND In 2014, Scotland had held its own referendum on independence from the UK. The results, however, showed that majority of the people were against separating from the UK citing EU membership as the main cause to remain. If Scotland separated from the UK, it would have to again apply for the EU which may take years hence Scotland voted to remain. SO, WHY DOES SCOTLAND & NORTHERN IRELAND VALUE THIS EU MEMBERSHIP? During the 1975 referendum, the people of Scotland and Northern Ireland observed the EC i.e European Commission as a threat that was holding the British regional development. This was due to the fact

that the European Commission had no development policies on a regional basis. However, in today's conditions, EU now has deep pockets to ensure that there are enough regional development funds. It has been investing around the entire island of Ireland as well as in most deprived parts of Scotland. Another factor is that during the 1970s the autonomy and the right to have their own national parliaments in the UK structure was not obtained as compared to today. Now they have a better autonomous & equal relationship with their other counterparts. This has been due to the EU's process of devolution. Also, Scotland probably considers that being in the UK does not fit their purpose anymore, and an independent Scotland which is rich in oil can function and prosper. Also, the political

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FINLY| February 2019 | Finstreet | SIMSR

legitimacy, which both the Scotland & Northern Ireland parties have obtained thanks to EU's deliberate engagement with regional political parties. Now, one of the most important factors influencing the Brexit call by the UK is immigration control. However, this is not an issue in Scotland and Northern Ireland. This is because historically, the people of these countries have been forced to seek work abroad. Thus, their approach towards immigrants is more filled with empathy than the rest of the UK. Moreover, unlike any other, the UK country, Northern Ireland shares an approximate of a 350-mile border with the Republic of Ireland. There were many conflicts occurring among them prior to the Good Friday Agreement based on how Northern Ireland was a part of Ireland and not the UK. The Good Friday Agreement was signed on 10th April 1998 after intense negotiations between the governments of the UK, Republic of Ireland & Northern Ireland political parties. The agreement was focused on areas like culture and civil rights, as well as justice and policing. It included setting up of a separate parliament for Northern Ireland assembly, council for farming, health and other areas which will benefit both Northern Ireland & Republic of Ireland, British-Irish council to strengthen the relations between British and Ireland and also dual British-Irish citizenship. The backstop agreement proposed by the EU in May's deal binds the UK perpetually with EU in the event of a no deal that would in effect beat the purpose of Brexit.

SCOTLAND AND IRELAND'S VOTE TO REMAIN In 2016, the UK as a whole voted to leave the EU with 52% of the people voting to leave. It was later observed that the voting results varied in the country to country basis. Majority of Scotland and Northern Ireland voted to remain. Thus, considering the various benefits, after t h e U K ' s B rex i t vo te , S co t l a n d ' s Government started making moves to hold a new referendum on Independence from the UK. Scotland clearly stated that it is facing the Brexit decision i.e the decision of being taken out of the European Union against its will. Now, regardless of whether Scotland separates from the UK or not, it is going to lose its membership. However even breaking up of the UK is not that easy. This is because it will be a lengthy process like establishing a new referendum and again taking the votes. Plus, Scotland relies on theUK for Defense purposes. Leaving the UK will make the trade even more complicated provided that it will take time to again become a member of the EU. BREXIT & INDIA London is one of the most important financial hubs of the world. The Brexit decision that the UK is heading out of the EU, caused large volatility in the stock markets. The markets were expecting a “No-Brexit” result with the help of various opinion polls like “What UK Thinks: EU”, Financial Times, the Telegraph etc. However, the shocking news caused the British pound to experience its largest one-day sell-off. The Sterling dropped in London, from

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$1.50 to just $1.33 & closed at $1.368 against the US dollar. About $2 trillion were wiped off from the world market just due to the Brexit panic. The world

stock markets took a dive with a drop in sterling. Thus, this fact is sufficient to prove that the Brexit decision's impact will be felt in the whole world.

Coming to India, the BSE Sensex crashed by some 1090 points following the Brexit decision on 24th June 2016. There are many Indian companies which have their operations in the UK. Currently, about 800 companies function in the UK. M o r e o v e r, I n d i a h a s a t ra d e o f approximately $14 billion with the UK with imports worth $8.5 billion. The UK is the third largest source of FDI in India. The falling value of the pound could render several existing contracts lossmaking. This will thus eventually affect India's GDP growth. The IT, Pharma and automobile sector will be affected the most. India has a huge IT sector of about $107 billion and thus there may be large amounts of renegotiations required by various Indian IT companies.

Many Indian companies also have their European headquarters in London like Rolta India LTD, Bajaj Holdings & Investment etc. and are also listed in the London stock exchange. However, this advantage may no longer benefit India. These effects will be for short term until the further arrangements and policies and made by the UK. There are also certain positives regarding the trade that can be seen as a possible outcome; like the fall in pounds will act in favour for the importers as the price will be reduced and also for exporters as their profits will increase. Coming to the education sector, the UK is one of the most preferred destinations for the Indian students to pursue their

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FINLY| February 2019 | Finstreet | SIMSR

further education. Earlier, UK was forced to provide scholarships to not just the students of the UK but also to other members of the EU. Thus, if the UK is freed from this compulsion it may provide some better plans for the other students including Indians. The EU rules state that the member countries should not hire immigrants from non-members unless there is a shortage of talent. This provides a great opportunity for Indian professionals provided that India's large number of working-age population, as well as good growth rate, will be of attraction for the UK. Also, the reduction in value of UK's pound may even make it cheaper & better to travel to the UK. The falling currency also presents cheaper real estate options for Indian citizens and companies seeking property in the UK's notoriously expensive property market. Moreover, after leaving the EU, the UK wanting to improve its trade and India being a huge emerging market may provide certain better trade opportunities for India. WHAT MAY HAPPEN? We have thus observed that India, as well as the rest of the world, will be seeing the effects of Brexit. The effects can be of both positive as well as negative nature. Theresa May had given the notification to European Council regarding the intention of the UK to leave EU on 29 March 2017. Thus, 29th of March 2019 is going to be a historical day due to the possible departure of the UK from EU. However, the recent events and debates have proved that the matter is not as easy as it seems. The Brexit decision is

undergoing lots of fluctuations making the entire deal very messy. Looking at the current situations, there is a certain number of possible outcomes. The first possible outcome is The NO DEAL. It means that if UK exits the EU without a withdrawal agreement with respect to Article 50, all the regulatory links, as well as the current trading links with EU, would end immediately. As a part of Brexit deal, UK has agreed to continue to pay into EU budget in the year 2019 and 2020. It will also have negative effects like it will result in breaking the trade links which will eventually lead to a shortage of food or drugs that are usually imported. Also after this, UK will have to follow the rules of WTO and the free trade flow between EU countries will immediately cease. The next possible outcome is to REVOKE ARTICLE 50. This article gives the right to a member to withdraw from. This will result in cancelling the decision of leaving EU and continuing to be its member. However, UK will have to make this decision before the due date i.e 29th March 2019. Once it has exited it would again have to reapply like a normal country applying for membership. Cancelling Brexit will act as a betrayal to the people who voted to leave, & would undermine further referendums. The next possible outcome is an EXTENSION. Article 50 provides for an extension where the UK would have to notify it to EU and would need approval from all the other members. Though EU officials may consider the extension proposal, Theresa May would have to convince the EU that the extension will

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definitely help them in coming up with a better and fruitful agreement. Theresa May correctly said that â&#x20AC;&#x153;the EU is very unlikely to simply agree to extend Article 50 without a plan for how we are going to approve a dealâ&#x20AC;?. Though providing extension will allow the officials more time and better chance to revisit the deal, there are certain other complications if the extension is provided. The complications like how would UK be allowed to exercise its rights as a member state, how the European Parliament elections in May 2019 will be affected by it, how will the parliament still contain members from the UK, how the reallocation of seats will not take place. Also delaying of the exit will cause delaying of further trade negotiations. Another possible outcome consists of a THE SECOND REFERENDUM. The UK would repeat the vote of 2016 with complete cognizance of the repercussions of the Brexit vote. However, the standard process of conducting a referendum requires 10 weeks time with campaigns in each region for the same. Looking at the time limit this option looks highly unlikely. Moreover, Theresa May has said that a second referendum could have significant implications for how the UK government handles referendums in the country would damage the social cohesion by undermining faith in democracy. CONCLUSION Overall, Brexit has from its start seen a lot of complications in political, financial & economic terms. There are certain outcomes which will prove beneficial to

the UK. However, all these are coming at a cost of conflicts among the citizens, breaking up of the UK, requirements of a large number of trade renegotiations with the trading partners, negative effect on the companies, time etc. Moreover, the Brexit decision has not been finalized yet and even though the chances of the UK continuing the EU membership are very less they certainly cannot be completely ignored. This raises the question of whether this exit of Britain was necessary in the first place. One thing that can be surely stated is that no matter what the decision is made, every stakeholder will not be satisfied. As we move towards the final stages of Britain officially leaving the European Union, political pundits have expressed their opinions full of concerns. 'Brexit' has even been dubbed as the worst political situation that the UK has faced in modern times. Given the scenario, life hasn't been easy for Theresa May who is in the epicentre of the situation. Her l e a d e rs h i p h a s b e e n c o n s t a n t l y questioned since she was given the top job in 2016 after the referendum. She suffered a heavy setback in the snap elections & even the biggest parliamentary defeat for her version of Brexit Deal, which kicked the can down the lane so that issues regarding Brexit may be discussed at a later date. She lacked cooperation from her own Conservative party as well from the European Union. So the only conclusion we can draw with utmost certainty is that the Conservative party will face heavy anti-incumbency and may well be out of power in the upcoming election. In this event of the UK leaving the EU,

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much focus has been on the future prospects of the UK. Taking a cursory glance at the situation in the rest of the European Union, we come to understand that not everything is great. The newly elected coalition government in Italy hasn't performed significantly to reduce its debt and ignored the advice of the European Central Bank. It is uncertain whether ECB will buy any more Italian debt. Spain's rigid monetary policy has been constantly criticized. As many countries are relatively underperforming, the EU relied heavily on the economic powerhouses of Germany, France, and the UK. Now with the UK gone, the responsibility rests on the other 2 countries to lead the EU and discourage any other country from taking an exit from EU. Brexit if not smooth would cause immediate short to medium term damage to the UK. Thus Prime Minister May has urged in Parliament to arrive at a holistic solution by engaging with all stakeholders more effectively, thereby crafting a more flexible & comprehensive deal. The UK has pledged itself to address concerns over hard borders, protection of labour rights & immigration. The government would have to actively assuage the market and alleviate concerns over trade policies to bring about stability & certainty in both domestic & international markets as the external environment becomes more protectionist & slows down growth. The current situation demands firm corrective pragmatic action that must be taken by the government, as ticking clock fast approaches 29th March 2019.

A NEW TAX BRACKET? Vishal Mahajan IMI, New Delhi

Article of the Month - Winner

“No matter how bad a child is; he is still good for a Tax Deduction” - Anonymous With a few days left for the next budget, this would be the best time to highlight a significant issue which presents a new dimension of Indian taxation system. Even though the preparations for the budget starts months before the actual date, still this issue will be relevant for the current budget as well as the upcoming budgets. TERMS USED Ÿ Assessee: Person paying income tax Ÿ IT Act: Income Tax Act, 1961 Ÿ TDS: Tax deductible at source Ÿ AOP: Association of persons Ÿ BOI: Body of Individuals

Ÿ HUF: Hindu Undivided Family Ÿ AY: Assessment Year Ÿ GTI: Gross Total Income

TAX BRACKETS OR TAX SLABS Tax slab or a tax bracket is a range of income which is taxed at a given rate. Indian system of taxation is governed by Income Tax Act 1961. India introduced the Income Tax Act in 1961 which regulates the taxation system in India along with the Finance Act passed in the parliament each year, in the budget session. The tax slabs in 1961 were as follows:

Article of the Month - Winner

FINLY| February 2019 | Finstreet | SIMSR

Source: https://www.incometaxindia.gov.in/Pages/acts/finance-acts.aspx

57 years after the introduction of the IT Act, currently, the tax slabs for Individual (resident or non-resident), HUF, AOP, and BOI are:

increases with an increase in income, thereby ensuring that the poor and rich are taxed accordingly. WHY A NEW TAX BRACKET? Many tax experts have given conflicting views regarding the fact that a new tax bracket should be introduced for Individuals or HUF's. The focus has been on these two categories because progressive system of tax is applicable to mostly these categories of taxpayers and not firms or companies.

Source: https://www.incometaxindia.gov.in /Pages/charts-and-tables.aspx

W H Y T H E R E A R E TA X S L A B S O R BRACKETS? India has a progressive system of taxation just like many other countries, which entails that the burden of tax

F o r m e r f i n a n c e m i n i s t e r M r. P Chidambaram had once raised this concern in 2013. When the economy and the government requires more resources, taxing the very rich â&#x20AC;&#x153;a little moreâ&#x20AC;? should be considered. But the statement never took the shape of reality because of the then 2014 general elections.

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FINLY| February 2019 | Finstreet | SIMSR

Considering the current economic situation of the country, even after introduction of the much talked about GST, government seems to be far away from achieving its pegged target to keep the fiscal deficit at 3.3 percent of the GDP by March 2019. The government budgeted a fiscal deficit of INR 6.24 lakh crores for FY19, or 3.3% of the GDP. Fiscal deficit at the end of October was INR 6.49 lakh crores.

Therefore, a new tax bracket for Individuals and HUF's might be a prospect in curbing this situation but only after considering all its pros and cons. COUNTRY BY COUNTRY COMPARISON Let us understand how individuals are taxed in the other countries.

Source: https://www.hrone.com/chinas-new-individual-income-iit-tax-reform-2018/

Source:https://www.gov.uk/income-tax-rates

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Source: https://www.irs.com/articles/2018-federal-tax-rates-personal-exemptions-and-standard-deductions

To conclude, In USA, an individual has to give up 35% as tax amount, with income ranging from INR 1.5 crore to 3.5 crores INR, and above that the remaining income is charged at 37%. In China, similarly an income between 5.5 Crores INR and 8 crores INR will attract a 35% tax rate and above that, 45% tax rate. In UK, income above INR 40 lacs will invite a tax bracket of 40% and a 45% tax rate for income exceeding 1.4 crores INR. Talking about the Scandinavian countries, Denmark's top marginal effective income tax rate is 60.4 percent. Sweden's is 56.4 percent. Norway's top marginal tax rate is 39 percent. WHAT DOES POPULATION AND INCOME FIGURES SAY? India's population was 44 crores as of

1961 and around 128 crores in 2017. Per capita GDP was 81 USD in 1961 which increased to 1940 USD in 2017. It implies that there has been an increase of 191% in the population figure and approximately 2300% increase in the per capita income figures in the said period. IMPORTANCE OF DIRECT TAXES The direct tax collected contributes to more than 50% of the total tax revenues for the Indian government. Around 5 crore individuals filed tax returns in 2017 whereas the number of individual taxpayers was around 7 crores in 2017. Let us understand how the segmentation of Taxpayers is significant for our hypothesis using some data from the official website of the Income Tax department of India.

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Source: https://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Income-tax-sta tistics-i-t-return-ay-2017-18-v1.pdf

For the above calculations, tax slabs of more than 10 lacs have been considered because, below that, the tax rates are different depending upon the types of assessees and their age groups. S e c o n d l y, A O P/ B O I h a v e b e e n considered separate because a flat rate of tax is applicable on those assessees. PROBLEMS WITH THE INDIAN TAX REGIME Currently, the Indian Taxpayers believe that they are exploited when they pay a hefty portion of their hard earned income by way of taxes. The point of concern here is that majority of the taxpayers belong to the salaried class, who don't have a choice to file a return but are instead automatically taxed under TDS system. The burden therefore shifts to the small segment of actual taxpayers. The returns filed during AY 2017-18 were 5, 08, 74,369 (5 crores approximately) out of a population of 128 crores which accounts for only 4 % of the total crowd.

If we look at other countries, majority of the population is subject to payment of taxes leaving very little scope of tax evasion or tax avoidance, which is why some countries can afford to keep the tax rates low. But the reality is even after a tight control over their taxation regimes, these countries have kept the tax rates very high indeed. THE NEW TAX BRACKET If the Indian government introduces a new tax bracket for Individuals or HUF, it will certainly have many implications, both positive and negative. Considering the tax slabs of other countries, and the wealth of individuals in India, the new tax bracket can be aptly applied with an upper threshold of 5 crores. Hence, if we make a tax slab of Rs. 10 lacs to Rs. 5 crores with an effective tax rate of 30% and remaining income over and above 5 crores being charged at 40%, the results obtained would be as follows:

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Source: https://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/time-series-dat a-2017-18.pdf

The difference of 4200 crores INR would significantly cover the deficit of INR 25000 crores to meet the target, not only for the short term, but in the future as well. THE WAY AHEAD The proposed tax bracket might appear difficult to some because of the current situation, but if the government is able to fix the loopholes in its taxation system at the earliest, even the contradicting parties would find that the solution is feasible, because then, the burden of tax would be considerably shifted to the untaxed population, bringing in more transparency. The need is not to focus on just one part of the taxation regime i.e., GST (the best source of indirect taxes right now) but also consider other ways to boost revenues for the government in the long run.

Article of the Month - Runner Up

NBFC crisis and the way forward Tushar Garg PGP-2019 ISB

India experienced its near-Lehman moment in 2018 when IL&FS was on the verge of collapsing, if not for the disaster management intervention by the Government. Its aftermath was the liquidity crunch faced by India in 2018. Beginning from the early 2000s – NBFCs sta r te d a s a l i n k to atte n d t h e geographies, where either the banks had no reach, or they remained underserved – making NBFCs undeniable in India. While NBFCs were filling in the shoes of banks in unreached turfs, in the regulator's lingua banks and NBFCs were treated differently. NBFCs started with a single-digit share in the Indian credit market and were thus regulated lightly, however, now with nearly 20% share, the old rules won't suffice for these shadow banks – IL&FS saga was a jolty realization. The banking industry's primary job is the management of interest spread. First principles advocate that duration

of both assets and liabilities should match; otherwise, it may lead to an asset-liabilitymismatch (ALM). While ALM management is thrust upon banks by the regulatory norms, NBFCs were not under its purview – leading to durationmismatch of assets and liabilities, making it contingently vulnerable on the inflows from its assets (i.e. the repayment of loans that NBFC has lent). Difference between lending and collections leads to the dreaded non-performing-assets (NPAs). Following example elucidates ALM:

Imagine in the above case that the depositors want their money back after two years, but the assets being long term will not provide enough cash flows to meet demand in two years. In such a case, the entity may either sell off its assets at a discounted value to arrange for funds to pay its depositors or may default

FINLY| February 2019 | Finstreet | SIMSR

Article of the Month - Runner Up

altogether. In both these cases, credit-worthiness of the entity is compromised as either it will not earn enough returns when the assets are short-sold, or if it defaults to pay, then creditors will not provide future funding. Something analogous happened in the IL&FS case, as it was not able to pay off the creditors on time since its assets were long-term and illiquid in the short-run. WHAT LED TO THE NBFC CRISIS? The Modern age has made businesses interdependent and is indeed introducing a world of crossdependence. While it brings along its numerous benefits, it also means that the whole matrix may collapse if one node malfunctions. Even worse, if that node is well entrenched and has many business lines to its disposal. IL&FS, with 347 entities as direct/ indirect subsidiaries in infrastructure, finance etc. turned out to be that feared evil node IL&FS held ~INR 91,000 crores as debt, and with that humongous amount being feared to be added to the pool of NPAs, lenders (mainly via Commercial Papers) became cautious. Nobody wants to bet on uncertain businesses, and this risk aversion led to a chain of events, lesser lending to shadow banks leading to smaller lending by them to the general masses. The repercussions of the NBFC crisis were felt across sectors, (viz. Real

Estate, MSME and Automobile etc.). This chapter led to two realizations â&#x20AC;&#x201C; First, if not for NBFCs, significant sections of the Indian population will remain deprived of credit. Second, it was time for some substantive actions to be undertaken at both the regulator's and the NBFC's ends to adjudge NBFC the status of a fullyorganised key sector. HOW CAN NBFCS HAVE A BETTER FUTURE? The issue of NBFC is akin to an adolescent who has not realized that childhood is over, and adulthood is around the corner. The actions needed are two-fold from the parents' perspective to start treating the adolescent as an adult and on the adolescent's end to start behaving responsibly. Analogically, the road ahead has been presented underneath from the regulator's and NBFC's perspective. A. REGULATOR'S PERSPECTIVE Regulators need to shift focus from NBFC's asset side (loans provided by NBFCs) to its liability side â&#x20AC;&#x201C; from where NBFCs get their funds. 1. Liquidity coverage The systematically relevant NBFCs must be mandated to maintain a minimum liquidity reserve, just as Banks are required to maintain CRR/SLR. This will help in avoiding a sudden need of liquidity to pay-off lenders if the situation arises. 2. Securitization Just as banks are required to meet a target of preferred-sector lending, so should NBFCs be required to have a part of their portfolio be mandatorily

Article of the Month - Runner Up

FINLY| February 2019 | Finstreet | SIMSR

securitized, leading to Ÿ Liquidity to NBFCs Ÿ Fulfilment of Bank's preferred-sector lending targets B. NBFC'S PERSPECTIVES Recommendatory points to help NBFCs improve operations: 1. Short-term to long-term funding A shift from short-term to long-term would stabilise the associated volatility with ALM and will also lead to squeezed interest spread (higher borrowing rate for NBFCs). Though it may lower NBFC's profitability, it will relieve NBFCs from its existential crisis of illiquidity; perhaps insolvency. 2. Resorting to foreign borrowing and bonds External commercial borrowing and rupee-denominated bonds issued to a foreign investor (Masala Bond, et.c) will help diversify the funding pool for NBFCs & enhance liabilities' duration.

the augmentation of Blockchain, etc. NBFCs can collaborate with fintech players to conjointly devise an enhanced mechanism for: Ÿ Credit scoring Ÿ Peer-to-Peer lending and crowd funding Ÿ Introducing invoice trading Ÿ Profiling by accessing client's e-footprint While the suggestions are speculative and holistic sectoral changes may take longer, but the wait is worth the effort. Both Regulators and NBFCs need to contribute in reshaping the NBFC industry. Risks and returns go together, and the focus should be on managing risks, not eliminating them. No risks = No returns

3. One size does not fit all Tra d i t i o n a l l y, N B F C s e v a l u a t e d borrowers against a common credit policy, resulting in the exclusion of a potent credit-worthy customer base. NBFCs can now adopt a personalized approach to underwrite customer profile by incorporating segmentspecific policies that leverage alternative data sources and apply scorecard-based credit decisions. This will ensure expanding the good assetpie for NBFCs assuring cash inflows. 4. Synergistic alliances with Fintech players Fintech is creating ripples in BFSI with

20 years of Euro: Is it still going strong?

ECO Section

Two decades ago, on 1st January 1999, 11 European Countries gave up their currency and adopted a single currency, the Euro. The currency which initially existed in accounting terms became tangible in the lives of Europeans, three years later in 2002, when the notes and coins came into circulation. Since then it can be found in the wallets of 340 million people in 19 European countries and is the second most used currency in the world. The continent which reeled under the disruptions of two world wars finally decided to move beyond the needs of an individual nation towards a peaceful future through integration in political and economic terms. Euro is perhaps the biggest symbol of the European project that was seen as a tool which will ensure European integration to be truly

irreversible. However, it also contributed to cleavages and asymmetries that marked the roller-coaster ride for the monetary union in the last two decades. In this context,the article gives an analysis on the account of euro in 20 years. EURO: THE ECONOMIC PROJECT The Eurozone manifests itself as a monetary union which strives to achieve the prospects of the Economic Project started by EU (European Union) entailing higher standards of living by increasing the efficiency of resource allocations, pursuing the principles of comparative advantage, enhancing competition, taking advantage of economies of scale and strengthening economic stability across the region. Inherent lies the idea of a single currency

ECO Section

FINLY| JULY 2018 | Finstreet | SIMSR

and a single market structured by Jacques Delors, whose vision was to reap the benefits of open markets, at the same time protecting the people of Europe from its vulnerabilities. Hence, it m e a nt a c h i e v i n g m o n e ta r y a n d economic union through the convergence of policies across the nations pitching in for the Euro.

mechanism wherein the monetary union adjusts to the divergent demands among countries (weakening of aggregate demand in one country while strengthening in other at the same time) by deepening cross border capital flows through bonds and stock markets and cross-country fiscal transfers, such as unemployment insurance.

TESTING THE MONETARY UNION OPTIMUM CURRENCY AREA

EURO BENEFITS

The benefits of monetary union stem from the theory of optimal currency area that similar business cycles, price and wage flexibility, and labour mobility a c ro s s b o rd e rs l e s s e n t h e c o s t associated with having to give up an independent monetary policy and make it more likely for a currency area to be optimal for its members. Also, it stresses u p o n d e ve l o p i n g a r i s k- s h a r i n g

Euro was benefited largely from the expanding trade, lowering transaction costs and facilitating cross-border flows of labour, capital, and information. In fact, the first eight years of euro saw a remarkable degree of nominal convergence in the form of long-term interest rates on government debt which was cited as indicative of a successful monetary union.

Euro-Area Long-Term Borrowing Costs Converge Before 2008 (10-year government bond yields)

ECO Section

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Similarly, countries such as Italy has been able to take the advantage of economies of scale, with around half a million of its workers involved in the production process of companies located in other EU countries which export to the rest of the world. This positive association of their labour productivity makes them an integral part of the global value chain.

The nominal convergence (closer interest rates and inflation rates) could not hold for long which was apparent during the 2008-09 recession period when domestic economic conditions diverged significantly. While Germany was hit hard during the recession, it outperformed Eurozone during the recovery period. Spain and Ireland, on the other hand, were underperforming and was going through a deep recession. Hence, they required an expansionary monetary policy at that time. The restrictive stance towards them gripped these nations further into severe economic contraction and high unemployment eventually leading them to fall under a sovereign debt crisis and threatening the very existence of the euro.

WHAT WENT WRONG? In reality, the Eurozone was far from optimal currency area due to reasons such as diverging business cycles across member countries, wage (and price) rigidities and limited mobility of labour and capital between euro economies. The design of Economic and Monetary Union (EMU) was incomplete which was clearly reflected by the crisis originated in the latter half of the two-decade period. Euro-Area Conditions Diverge After 2008-09 Global Recession (Cumulative growth of real GDP since 2008)

LABOUR MARKETS: COMPETITIVENESS THROUGH INTERNAL DEVALUATION Internal Devaluation means reducing the cost of production by reducing wages and to increase labour

LACK OF CYCLICAL SYNCHRONIZATION

productivity thereby, improving export competitiveness. This measure is resorted to by the countries which have limited ability to adjust their monetary policy or have limited or no recourse to currency devaluation.

ECO Section

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Reducing government spending on wa ge s a n d p e n s i o n s wo u l d p u t downward pressure on prices of goods due to a decrease in overall demand and reduce inflation, even leading to deflation. A noticeable aspect is that to seek increased competitiveness the benefit of lower wages should be passed on to consumers and not just higher profit margins for the firms, which will ensure rapid GDP growth and make the process less painful for the general population. The problem with Europe was its limited ability to implement internal devaluation due to

the rigidity of labour markets and was subject to national wage setting. Hence, they were slow to adjust to the changing economic conditions. Also, unlike the US, the labour mobility across European nations for better opportunities due to structural barriers such as cultural, linguistic remains restrictive. For instance, Spain went through a prolonged period of negative growth and unemployment through internal devaluation. The severe recession reduced the size of the workingage population in Spain during the 201215 period as mentioned below.

Spain's Costly Change since 2008:Lower Labour Cost, Higher Out-Migration

The UK, on the other hand, was able to achieve significant depreciation in its

exchange rate and restore its export competitiveness.

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ECO Section

FISCAL IMBALANCES – THE DEBT CRISIS

The architects of Maastricht Treaty tried to cap the budget deficit of the countries at 3 percent of the GDP including a “nobailout” clause, however, their fiscal rules proved un-enforceable and almost all the Eurozone members (including Germany) breached the 3 percent deficit ceiling. The E u ro p e a n C e n t ra l B a n k fa i l e d t o incorporate the missing elements of EMU such as common banking regulations, fiscal risk-sharing mechanism, economic governance, etc.

national level to provide the necessary recourse and moreover, the willingness of the nations to do was felt. The blame should be equally accorded to the reckless lending of the banks, mainly German and French banks, which held large quantities of Greek sovereign and private sector debt. These situations could have been avoided had there been common banking regulations, risk pooling mechanism or much talked about common deposit insurance as a sovereign backstop (guarantee). CONCLUSION

The consequences of this were heavily weighed down on the Southern European Nations, of which Greece was most severely affected. Much of the narrative of debt crisis focuses on the “profligacy” of the peripheral nations. These nations were maintaining large current account deficit and were able to borrow at almost similar rates as Germany which brought innet capital inflows from central Europe to these peripheral nations. Lowered interest rates also gave them the leeway – most noticeably Greece - to run large fiscal deficits and high debt levels during the booming period (most of its creditors include German Banks and other Euro Area Banks). However, the situation reversed when the 2008 crisis hit and the flight of capital triggered by recession plunged them into a mountain of debt. The structural divergence (ability to generate revenue through taxes and maintain pension funds) between the north and the south also became apparent when the austerity measures imposed turned disastrous for these nations and further shrank their economy. The lack of fiscal authority at the supra-

The future path requires greater convergence of policies and structural reforms which has been recognised by the European Leaders but much of it depends on the political will of the member nations. For starters, the monetary union should be completed by incorporating the union of two institutions – Banks and Capital Markets. The banking union would entail common banking regulations restricting capital flight during the time of crisis and regulating cross border lending practices across the Eurozone and the capital markets union would ensure private-risk sharing helpful in absorbing and mitigating such shocks. A further step involves creating fiscal space which would involve creating a fiscal budget at the euro-level to ensure countercyclical measures during the adverse period. For what it's worth, Euro still remains the choice of 74 percent of the population residing in the European Union, with 64 percent believing it to be good for their country including Portugal and to some extent, even Italy. This was found by the recent pan-European survey conducted

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by Eurobarometer. The benefits of a single market which eased travelling and doing business across euro borders won the hearts and minds of many. However, not much thought was given to sharing responsibility which renders the monetary union incomplete. The c o n s e q u e n c e s w e re s i g n i f i c a n t resulting in the make or break crisis for the union.

2.0

Fintech Funda

What is InsurTech 2.0?

The InsurTech landscape has been experiencing a flurry of activities in the last few years, disrupting and challenging the traditional business models. The phase one of the InsurTech focussed on trying to capitalize on points of customer friction having huge profit potential. So, the first wave was dedicated to transforming insurance distribution, identifying the needs through the lens of the customer and providing solutions.

understand InsurTech and how it will add value to their businesses. So now InsurTech is less about disruption and more about additional opportunities to add value to their customers and increase their value proposition. It is now less about the challenge and more about collaboration and partnership leading to a meaningful insurance ecosystem. This is InsurTech 2.0.

Technologies energizing InsurTech 2.0 I) IoT and Telematics

While the phase one has been more about InsurTech companies challenging the incumbent insurance companies and their business model, the last few years have also been a learning period for insurance companies, trying to

The internet of things (IoT) is a network of interrelated computing devices, sensors, living creatures or other objects that have unique identifiers and can communicate with other devices on the network.

FINLY| JULY 2018 | Finstreet | SIMSR

Fintech Funda

The data streams and sources for IOT are likely to include: a) Wearable or Personal TechnologyThe technology of â&#x20AC;&#x153;fit-techâ&#x20AC;? often used in the context of monitoring heart rate, steps walked and other health-related metrics is rapidly developing with prototype patches already performing blood work and ECGs and monitoring drug doses. b) Sensors on objects - These include personal, commercial vehicles and shipping containers that measure distances travelled, speeds and frequency of braking. c) Location-based sensors- such as those in factories, warehouses or offices, security technologies, such as alarms and cameras, and industrial control systems. All of these data types are useful for the full range of products and lines of businesses, from commercial to life, property & casualty, and health. Creative solutions made possible by Integrating IOT with Insurance.

InsurTech is all about connecting the technology in the insurance sector with clients and their risks. 1) Connected Car Data for InsuranceConnected car and mobile technology can enable the next generation of insurance products but the challenge lies in the penetration and adoption of connected cars. This can be solved by mobile phones which are enabled with accelerometers, gyroscopes, GPS and more sensors to provide data on consumer driving habits. 2) Smart Home Insurance- Smart home devices provides an opportunity for insurance companies to reinvent their business models and to move from simply ensuring against the risk to helping customers protect their properties. The combination of home insurance and home monitoring technology would reduce the probability of damage and lower the overall risk for homeowners and their insurers. 3) IOT increases Health and PreventionConnected wearable devices can be used in more interesting ways, one such example is that of someone with diabetes who is probable to pay more insurance. But as part of a program, if they can use a wearable to track activity and if they meet certain goals such as reduction in diabetes level and maintaining a good track record, then they can get a discount on the following year's premium. II) Analytics

Source: iteveryone.com/internet-of-things

Data has always been the premise for almost all decisions and functioning of the i n s u ra n c e b u s i n e s s â&#x20AC;&#x201C; r i g h t f r o m underwriting and pricing decisions driven

Fintech Funda

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by risk profiles to analysing customer specific data in order to recommend the right product. Increased adoption of connected devices is making customer profile available at a personal level, leading to a boom in data availability, and making it imperative to leverage next-generation technologies such as Artificial Intelligence and Big Data systems. These technologies have become all the more important, given the need to understand customers at a personal level.With the availability of a large amount of data, artificial intelligence systems are being trained to employ Predictive Analytics. It allows insurance companies to obtain valuable insights into different segments of business such as customers, agents, and markets.

3) Providing customized experiences â&#x20AC;&#x201C; Delivering customized experiences to different customer segments

III) Blockchain B l o c kc h a i n te c h n o l o g y, a cryptographically secured form of shared record-keeping, has the potential to disrupt the interactions within an industry l i ke i n s u ra n c e w h i c h re q u i re t h e coordination and cooperation between many intermediaries. The following possible applications have a lot of active Proof-of-Concepts(POC) research: a) Fraud Detection and Risk Prevention: Since blockchain provides the feature of an immutable ledger, moving insurance claims into such a ledger can help in avoiding common sources of frauds. b) Property & Casualty Insurance: Blockchain provides the use case of Smart Contracts that have the ability to improve the efficiency in P&C Insurance by a large magnitude.

Source: edkentmedia.com

This will help in developing effective, fact-based strategies such as: 1) Building meaningful differentiation â&#x20AC;&#x201C; Allowing the insurers to perform at a higher level, enabling them to provide differentiated customer experiences 2) Focusing on customer responsiveness â&#x20AC;&#x201C; Key d river o f investment decisions are customer needs and channel preferences

c) Health Insurance: Medical records can be cryptographically secured and shared by the health providers in a secured manner within an interoperable health insurance ecosystem. T h e s h a re d i nf ra st r u c t u re , s m a r t contracts and non-repudiation capabilities of the blockchain, make it a shared source of truth, opening up opportunities for insurers to collaborate and implement automation in requesting, exchanging and entering data.

Fintech Funda

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O n e s u c h a c t i v e p ro j e c t i s b y a consortium of leading Indian Life insurers â&#x20AC;&#x201C; comprising SBI Life Insurance, Max Life Insurance, Canara HSBC OBC Life Insurance, Edelweiss Tokyo Life, IDBI Federal Life Insurance, Birla Sun Life Insurance, HDFC Life, Kotak Life, Tata AIA Life, PNB MetLife, IndiaFirst Life Insurance, ICICI Prudential Life Insurance, Bharti AXA, Aegon Life, and SUD (Star Union Dai-ichi) Life Insurance â&#x20AC;&#x201C;who have banded together to develop a collaborative blockchain program. Te c h n o l o g y g i a n t C o g n i za n t h a s partnered with the consortium to develop the blockchain solution to facilitate cross-company data-sharing. This collaboration is aimed at reducing the risk of data breaches, fraud and money-laundering by reducing their reliance on data intermediaries and aggregators. The system also holds the potential to improve customer experience through better recordkeeping and improved turnaround time. The solution will be developed on Corda, a distributed ledger platform provided by R3 and will be hosted on Microsoft's Azure infrastructure. The Rise of a Digital Ecosystem While newer technologies are acting as a source of disruption, they are also an opportunity to acquire a competitive advantage. Digitalisation is radically reordering the traditional industry boundaries. Insurance companies have to now replace their traditional business model with a new paradigm based on a Digital Ecosystem. Like any ecosystem, a digital ecosystem is a complex network of

interconnected businesses, that depend on each other to deliver value to all stakeholders. This ecosystem is based on new partnerships between disparate companies that create combined services and innovation in their value chains. This adoption ofan ecosystem will require to do away with traditional industry borders, enabling a world of sectors without borders. Such an ecosystem will shift the value pools and change the nature of risk. Currently, the primary role of an insurer is that of a risk aggregator, having a passive and limited relationship with the customers. By doing so, it is putting itself on a weak footing in an industry facing commoditization risks. Adopting an ecosystem perspective will enable insurers to look beyond their standardised offerings and offer valueadded services, a combination of products to address broader consumer and business-partner needs. This would require positioning themselves at the center of the interconnected ecosystem that could include non-insurance offerings such as reward programmes for s afe d r i v i n g p ra c t i c e s t h ro u g h a partnership with telematics companies, health diagnostics and promotion of good health practices through wearables, monitoring devices for homes and other allied solutions. This helps in reinventing customer relationships, improving revenues and reducing costs, as it could boost loyalty, attract new customers and by reducing commoditization prospects, decrease theprice sensitivity risks.

Fintech Funda

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The global insurance players have started developing partnerships to leverage the digital ecosystem. USbased Progressive Insurance has partnered with Zubie, a vehicletracking, and engine-diagnostic device, to help their customers provide visibility on the effect of driving habits on their premiums. Liberty Mutual Insurance has partnered with Nest Protect, a smoke detector solutions provider, helping the customers offset the smoke detector price through a discount on their home insurance premium. But changes to the business model also entail changes to the nature of risks. With the adoption of this model, risk to be insured changes significantly due to two primary reasons:

1) Reduction in uncertainty: Improvement in tracking and predictive t e c h n o l o g i e s , w i l l re d u c e f u t u re uncertainties as real-time inputs make it possible to avoid these risks. For example, wearables make it possible to monitor the human health actively ensuring a healthy lifestyle. Telematics in connected cars reduces the chances of accidents and breakdowns. 2) Changes in risk distribution: The purpose of insurance has always been pooling of risk, but personalisation will now lead to the de-pooling of risks. Due to increased understanding of the customer at a personal level, the focus would shift to predicting and managing the risk of i n d i v i d u a l s ra t h e r t h a n a g ro u p . Consequently, premiums could be

Fintech Funda

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affected, disrupting the revenue stream in return. This disruption can be offset by the new businesses from complementary services. The Near Future The development of an insurance ecosystem is not onlyone of the greatest opportunities, but also one of the most daunting challenges of the insurance industry today. Technology investments alone won't ensure success. As an ecosystem player, the insurer must have a 360-degree view of the organisation, ensuring that their efforts and investments are aligned with their requirements. Also, corporate competencies to develop partnerships will be essential for continued success in the future. Companies that are able to deliver a differentiated and disruptive value proposition, drive for scale quickly, carve out clear routes to profitability and embrace the power of data, will be in a position to build and sustain loyalty and fend off the threat of commoditization.It is not the strongest species that survive, but the ones most responsive to change.

Sector Analysis

The Engineering and Capital Goods Sector is a bellwether for the Indian Economy. Capital goods are primarily goods and ser vices used in the production of consumable goods. Our focus here is a subset of the sector involving companies associated with

railways and the constructionindustry. This sector's performance is a key driver of the GDP output of the Indian Economy. The sector is represented by the BSE Capital Goods Index -Bombay Stock Exchange.

Source: BSE and World Bank Data

Sector Analysis

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As one can clearly observe, the representative index's P/E has a strong correlation with the GDP growth across the decade as shown in the graph above. The primary driver behind the growth of the sector is the continuous push by the Government to boost the infrastructure spending. In the year's post-2012, there has been a steady rise in public expenditure with the figure touching 67.56% in March 2017.

As per the CARE ratings report in November 2018, the number of projects under implementation had increased to 1347 in August 2018 from 1247 in April 2017. But, this growth is accompanied by cost overruns of over 20% in some cases. Projects being the whole and sole of this industry face continuous challenges on the fronts such as land acquisition, financing delays, engineering delays, and environment clearances.

Source: RBI

COMPONENTS OF THE SECTOR 1. ELECTRICAL EQUIPMENT MANUFACTURING The EXIM (Export-Import) Bank of India supposes that the market for the electrical power transmission industry can swell up to $100 billion in FY 202122. The sector has been witnessing capex tuning to doubling and even tripling capacities. The prime buyers of the outputs have been central and state governments. Electrical equipment contributes to over 10% of overall imports. The de-licensing has led to increased competition from foreign players. Although the sector has shown a growth of over 12.8%, it is still plagued by imports. The industry's record performance is a result of government schemes like DDUJGY (Deendayal

Upadhyaya Gram Jyoti Yojana), IPDS ( I n t e g ra t e d Po w e r D e v e l o p m e n t Scheme)and Saubhagya (Pradhan Mantri Sahaj Bijli Har Ghar Yojana)where the government is taking up rural electrification at an incredible pace. 2. RAILWAYS The industry also covers the orders from the monopolistic buyer- Indian Railways, which has been in the limelight for a while due to the introduction of the high-speed rail network in India. But if you compare with the capex occurring in roadway development (Over 660 INR Billion to lower than330 INR billion in 2015) it's lagging far behind. Under the make in India initiative, innovations in railway network is at forefront which were developed under the British regime.

Sector Analysis

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Table 1(Source: Budget Documents and Indian Railways)

1. POWER TRANSMISSION With the government aiming for over 40 million electricity connections under Saubhagya Scheme, transmission is playing a pivotal role in the implementation. Similarly, on the renewables front, a target of 175 GW through renewables has been set, making transmission companies an attractive opportunity. The Indian government has been focussing on generation, leading to high leakages. The recent focus on the transmission to lower the overall cost has led to spur in demand of transmission companies. This has led to a propelling demand for power conductors, transmission units, switchgears, and substation equipment. Government's bias towards public sector units and to dissuade competition has led to slowing capex by the private sector. Although, a recent proposal of competitive bidding could lead to a resurgence in the private sector investment. TRENDS ACROSS THE COMPONENTS

A potential opportunity of over $500 billion over the next 5 years is in the sight, with growth being spurred by

segments like railways and roads. These are being accompanied by sectors like renewables, defence, and manufacturing. Before understanding the drivers of this sector, we must focus on challenges, which are as follows: 1. Illiquidity in Debt Market due to the IL& FS Debacle: The industry is driven by working capital requirements being fulfilled through short term borrowings. But the continuous default in Project SPVs is causing investors exercising excessive caution 2. The Red-tapism has been marring the sector growth. It has recently come down due to government intervention in speeding up the work on projects which are underway 3. Competition is getting limited due to continuous underperformance by companies leading to only large players being able to survive in the sector. The subdued capacity utilization at 72% has led to a challenge on the asset turnover fronts. Although recently, it has started to show signs of improvement across the industries.

Sector Analysis

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Source: RBI

DRIVERS OFTHE SECTOR ELECTRICAL EQUIPMENT MANUFACTURING 1. Increase in import duty has been a stimulant for the segment being driven by a Y-o-Y growth of over 12%. The FTA (Free-Trade Area) agreement with China was pulling the growth downwards 2. The adoption of higher voltage technology of 765 KV has led to upgradation by electrical distribution companies, leading to a new segment altogether 3. At the time of renewable power generation being a costly affair, the electrical generation and transmission equipment demand has fewer chances of fading RAILWAYS 1. A dedicated freight corridor has been on the cards of the government and its implementation on the western front is a stimulant for companies

manufacturing rolling stock, EPC c o n t ra c t o r s a n d m e t a l - c e m e n t suppliers to the Indian Railways. The freight segment is contributing higher to revenues since the passenger segment is bearing the social cost 2. Creation of logistic parks in the hinterland will create vast opportunities for logistics based enterprises 3. A focus on electrification, leading to an increase in competitiveness with road transport brings opportunities for the power and transmission companies 4. Financing in railways is seeing a turnaround, with the Indian railways opting for extra-budgetary resources, such as the institutional investment being tapped from firms like LIC (5.1 Trillion INR) 5. New avenues of revenue boost for Indian Railways under the Nav-Arjan which brings in opportunities for advertisement and land monetization. Stations are being re-developed under joint ventures with EPC companies

Sector Analysis

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POWER TRANSMISSION 1. States are seen as driving the momentum, with the annual market inflating to INR 500 billion. Discom programmes like UDAY (Ujjwal DISCOM Assurance Yojana) are focusing on deleveraging state electrical grids leading to a room for Capex in the segment. Aggregate technical and commercial losses have come down to 20.74% as on 30th September 2018 2. Renewables are gaining traction and hence creating opportunities for transmission companies 3. Power oversupply has started shrinking due to capacity additions and accelerated withdrawals. Peak Load Factor (PLF) is an important indicator, which had seen correction and is anticipated to touch 56% in FY22. As investments are drying up in the sector, soon power prices will see a rise, due to a shift from overcapacity to a shortage in a very short span INDIA STORY Ÿ Growth in the power industry is

expected to drive growth in the electrical equipment industry Ÿ Electrical equipment market size is

forecasted to reach U.S. $100 billion by FY22 from U.S. $21 billion in Fy17 Ÿ Engineering research and design

segment revenues to increase fourfold by 2020 Ÿ The Construction equipment market

is also projected to triple in size by 2020

Ÿ Government investment is the main

driver, as the private sector remains cautious Capacity creation in sectors such as mining, power, oil &gas, infrastructure, refinery, steel, automotive, etc. will drive demand in the capital goods s e c t o r. T h e a d v a n t a g e I n d i a n companies have over their foreign peers is the lower manufacturing costs, market knowledge, technical expertise, and vast human and labour capital. Delicensing and 100 percent FDI in the engineering sector has helped to increase competition. It is a highly organized sector in India with mainly large players dominating and employing more than 4 million skilled and unskilled labour. CURRENT SCENARIO Major brokerage houses and investment firms in their reports have argued that the infrastructure recovery kick-start is happening now and is beginning to show through. One can see it in the bullish commentary of major companies in the sector such as ABB, L&T, Siemens, BHEL and their large order book. Increased government spending in Railways, Defence and Oil &Gas is a major indicator of the revival of the engineering and capital goods sector. It is the best time to buy infra stocks. This time the cycle has been kick-started by the public sector and hopefully, it will be a much large cycle and sustainable for a longer time period than previous cycles, once the private sector also gets on board.

Sector Analysis

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In the September quarter, sales were affected due to a delay in the delivery of materials and components, and also due to the uncertainty in applicable GST rates and complexity in the new tax re g i m e . T h e o p e rat i n g m a rg i n s increased mainly due to contributions from higher margin products such as graphite electrodes and abrasives and also due to better order book and execution.

BHEL, which contribute almost 50 percent of the aggregate revenues to the BSE Capital Goods Index and considered worthy proxies for the sector, registered better revenues and growth in the bottom line as compared to previous years. The just-released results of L&T for the December quarter have been above expectations and better than street estimates, largely driven by engineering and construction, IT and financial services segments.

The two major companies L&T and INDEX PERFORMANCE COMPARISON

STOCK COMPARISON WITH INDEX

Source: Bombay Stock Exchange (BSE)

Sector Analysis

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There is a positive correlation between the S&P BSE Capital Good Index and the S&P BSE Sensex index performance, which means that both have shown similar movements over the last 3 years. But it can be observed that when Sensex was at its all-time high during mid-2018, the Capital goods index started to fall due to changes in GST implications which affected the sector heavily. Later, when the government allowed 100% FDI investments, the index started to follow the trend with Sensex. Stock comparison (scaled to 100) for each stock shows the individual stock performance of each stock compared to its benchmark S&P BSE Capital Goods index. It can be observed that over the past 3 years only Larsen & Toubro has managed to outperform its benchmark index. ABB India Ltd is the only other company which has shown an increase

in stock price over the three years. But there are also other parameters to judge the performance of a company, which is given below. LARSEN & TOUBRO Larsen & Toubro Ltd.'s profit rose for the twelfth straight quarter, beating estimates. Net profit rose 37 percent year-on-year to Rs. 2,042 crores in the three months ended December 2018. Revenue rose 24 percent on a yearly basis to Rs. 35,709 crores. The company bagged orders worth Rs. 42,233 crores at the group level during the quarter. Its consolidated order book stood at Rs. 2.84 lakh crores. L&T's earnings before interest, tax, depreciation, and amortization rose 27 percent to Rs. 3,997 crores compared with the estimated Rs. 3,653 crores. The operating margin expanded 30 basis points to 11.

MARKET CAP OF TOP COMPANIES

Source: MoneyControl

Sector Analysis

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Source: MoneyControl

BHARAT HEAVY ELECTRICALS LTD. (BHEL) Government-owned Bharat Heavy Electricals Limited (BHEL) is India's largest power generation equipment manufacturer based in New Delhi. BHEL is an engineering and manufacturing company. It is the only one amongst the top companies in the capital goods industry to have its share price less than its book value, which is a sign of having strong fundamentals for a company.

BHEL has recently bagged orders worth Rs. 565 crores for power plants in Telangana. BHEL is reportedly forming a Joint Venture with US-firm Libcoin, for manufacturing Lithium-ion batteries in India. Also, its consolidated FY19 Q3 profit has increased by 65.9% to Rs. 258.60 Cr. Even though the stock price has decreased over the recent years, the company's EPS (Earnings per share)& revenue has shown stability over the same period.

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CUMMINS INDIA LIMITED

INVESTMENT OUTLOOK

Cummins India Ltd. is one of the seven legal entities of the Cummins India gro u p . I t is o n e o f t h e lea d in g manufacturers of engines, generators and related products in India. It is principally engaged in the business of manufacturing, trading, and selling of engines and allied activities. Rajiv Batra, CFO of Cummins India said that they are expecting a 5-10% domestic growth in FY19. He further said that tailwinds of government expenditure can be seen in the industrial segment. This indicates that revival of the power generation industry may be 2-3 quarters away. Moreover, Cummins India has the highest net profit margin as compared to its peer companies in the industry, as can be seen in the graph above.

Investment by the private sector continues to remain cautious. While the Modi government is focusing on propelling public infrastructure which will drive industrial growth, the private sector remains subdued. The order book is expected to be robust in sectors such as Oil & Gas, railways, defence andTransmission and Distribution, the private sector revival will also happen gradually due to a protracted revival in demand and high leverage levels.The previous cycle of the sector was led by the public and the private sector, with the power sector providing the muchneeded driver. This time around the cycle is expected to be staggered and supported by public investments to start with and complemented by the private sector much later.

SIEMENS INDIA LTD Siemens India Ltd. is engaged in manufacturing of electric motors, generators, transformers, and electric distribution & control apparatus. The company's prime area of focus is on electrification, automation, and digitalization. It is known for being the leading producers of energy-efficient and resource-saving technologies, combined cycle turbines for power generation and power transmission solutions. Siemens India Ltd. ranks second in terms of market capitalization, as seen in the graph above. It has shown positive growth in its sales for the past few years, combined with low debt ratios and high ROCE %, which makes it a key player in the market.

Recovery in private capex (Capital Expenditure) to be gradual this time: Aggressive capacity build-up coupled with dismal demand in the past 3-4 years had seen sub-optimal utilization for corporates. High corporate leverage may also mar the capex recovery, which is more likely to be gradual this time around versus the sharp pick up in the previous cycle (FY04-08). There has been momentum in select infra verticals where companies have been gaining strong ordering m o m e nt u m l e d b y t h e fo c u s e d approach of the PSUs/government. Also, after a gap of 4 years, meaningful growth is apparent in exports (for past 6 months exports growth pegged at ~10%), which has a strong correlation with the top-line growth of corporates.

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Rohan Thombare | PGDM FS | 2018-20 Shraddha Joshi | MMS | 2018-20 Ankit Nimbajiya | MMS | 2018-20

STOCK MARKET FCFE – FREE CASH FLOW TO EQUITY INTRODUCTION Free cash flow to equity is the cash remaining to equity investors which is free from all other claims. This means it is the cash that remains after taking care of every other need of the business including investments in fixed capital and working capital. This is because we want to come up with free cash flow assuming that the company will sustain and to sustain company needs to make investments in fixed & working capital. While collecting financial data for the computation of FCFE, things that must be kept in mind: 1. The numbers should be as recent as possible

2. If there are fluctuations in the earnings, one may take normalized earnings over a period FCFE = Net Income – Net Capital Expenditure – Change in Non-cash Working Capital - Net Debt Repayment – Preferred Dividend Ÿ Net Capital Expenditure = Capital

Expenditure – Depreciation Net capital expenditure is the amount reinvested in long-term assets. The depreciation is subtracted from capital expenditure because it is an accounting expense and a non-cash expense. Here, though the earnings went down due to depreciation, the actual cash remains the same. Thus, this cash equivalent of depreciation can be used to cover some part of the capital expenditure and the total capital expenditure is a cash amount

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over and above the depreciation. That's why depreciation needs to be subtracted.

FCFE are projected over a future period based on fundamental analysis of the company which includes both qualitative & quantitative measures.

ŸThe net capital expenditure is a

function of how fast a firm is growing or expecting to grow. Thus, assumptions about net capital expenditure are associated with assumptions about growth in the future. Ÿ Change in Non-cash Working Capital =

Non-cash Working Capital in Current Year - Non-cash Working Capital in Previous Year Change in non-cash working capital is the difference between non-cash current assets like inventory & accounts receivables and non-cash current liabilities like accounts payable. The difference between non-cash items is considered because they take time to convert into cash & there is a time lag between the receipts & payments. The firm needs to reinvest to fill this time lag. Negative working capital has a positive impact on cash flows as it gives the firm an opportunity to grow the business on supplier credit.

The company is assumed to be operating indefinitely unless mentioned otherwise. Thus, the projection is divided into two phases: Forecast phase & Perpetuity phase. The forecast phase is for a certain period and is dependent on a company's ability to sustain. For a company making continuous losses, having a highly competitive environment and no regulatory support, the forecasting period is around 3 months to 2 years. This is because the possibility of survival of the company is less and the cash flows cannot be clearly projected. A start-up is a good example of this type. A company with good products or services, brand value, strong marketing & distribution channels and regulatory support, having the limitation of a competitive environment can have a forecasting period of 2 to 5 years. Forecasting period for a company having excellent products & services with very low competition can be from 5 to 10 years.

Ÿ Net Debt Repayment = Principal

Repaid – New Debt Issues

TERMINAL VALUE

The new debt issue is a cash inflow whereas principal repaid is an outflow. So, if the debt goes up during the year then net cash flow due to borrowing is positive.

The perpetuity phase is different from the forecasting phase, in the sense that it cannot have annualized FCFE components. Thus, the Gordon growth model is used to find the summation of all the FCFE components in perpetuity at the end of the forecasting period.The Gordon growth model is a mathematical model used to determine the present value of

GROWTH PROJECTIONS The changes in all the components of

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infinite series of future cash flows that grow at a constant rate in perpetuity.

GENERAL AWARENESS ANTI-PROFITEERING

Terminal Value= FCFEn * (1 + g)/ (Kepp-g)

WHAT DOES IT MEAN? Where, FCFEn = Free cash flow for last period of the forecasting phase g = Growth rate for the perpetuity phase Kepp = Cost of equity for the perpetuity phase The growth rate and cost of equity for perpetuity phase can be same or different than the forecasting phase depending on the progress of the company. EV = FCFE1/(1 + r)1 + FCFE2/(1 + r)2 + FCFE3/(1 + r)3+..... + (FCFEn + TV)/ (1 + r) n When the enterprise value is divided by a total number of outstanding shares, we get an intrinsic value per share of the company. It can be compared with the market price per share to determine whether the stock is undervalued or overvalued and accordingly investment decision can be made.

Anti-profiteering is defined under section 171 of the CGST/SGST Act which says any reduction in tax rate on any supply of goods or services, or any benefit of input tax credit(Basically means the credit you get for tax paid on purchases for e.g. if a manufacturer has to pay an output tax of Rs. 450 on the final product and an input tax of Rs. 300 on purchases, you need to deposit only Rs. 150 as tax and you get input tax credit of Rs. 300), must be passed on to the recipient(for e.g., customer) by the registered person(e.g. t ra d e r ) t h ro u g h a co m m e n s u rate reduction in prices. So if a trader is paying, say, Rs. 100 less in the new tax rate on a certain item, he has to compulsorily sell that item for Rs. 100 cheaper, so the customer benefits proportionally. Failure to do so would mean the trader is indulging in â&#x20AC;&#x153;profiteeringâ&#x20AC;?. N AT I O N A L A N T I - P R O F I T E E R I N G AUTHORITY The National Anti-Profiteering Authority ( N A A ) i s a 5 - m e m b e r c o m m i tte e consisting of a chairman and 4 technical members constituted by the Central Government under the GST Law to check the unfair profit-making activities by the trading community. The formation of NAA comes on the background of the ratereduction of a large number of items by the GST Council in its 22nd meeting. At the meeting, the Council reduced rates of

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more than 200 items including goods and services. This has made a tremendous price reduction effect and the consumers will be benefited only if the traders are making a quick reduction of prices of respective items. Traders should not be realizing an unfair profit by charging high price from consumers in the name of GST. The responsibility of NAA is to examine and check such profiteering activities and recommend punitive actions, including cancellation of registration.

HUL ANTI-PROFITEERING CASE The Directorate General of Antiprofiteering has charged one of the country's top consumer products maker Hindustan Unilever Limited (HUL), with profiteering from a cut in goods and services tax by not passing on the benefits to consumers. HUL came under the scanner when the company showed undue profits of more than Rs. 330 crores, more than the double of the Rs. 160 crores that the company had deposited with the Consumer Welfare

Fund of the Government. Since the rollout of GST in July 2017, most companies including HUL have said that they have passed on the benefit of lower taxes by: Ĺ¸ Lowering Prices

OR Ĺ¸ Increasing Weight of the Items Price reduction efforts gained pace when the GST council cut tax rates on 200 products including chocolates, toothpaste, shampoo, washing powder, and shaving creams to 18% from 28%, to ease the burden on consumers, the government wanted to ensure that the intent is translated into action. Since November 2017, companies were allowed to affix an additional sticker or stamping or online printing for declaring the reduced MRP (maximum retail price) on the pre-packaged commodity in view of the revision in GST rates. The additional sticker had to be pasted alongside the earlier labelling to show the difference in price and was allowed until December. This was done to allow for a transition period of about 2-4 weeks before packs with new price labels reach the stores. HUL was of the opinion that during this transition period, the company had suo moto offered to pay the government the benefits accrued to it but which could not be passed on to the consumers. This amount aggregated to Rs.160 crores, including Rs. 36 crores on behalf of their redistribution stockists, had since been deposited with the Consumer Welfare Fund of the Government. HUL said that

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they kept the Government informed of the approach and the manner that they had adopted in passing on the GST benefits to the consumers. The question that arises here is, since there is no prescribed method in the GST Law to calculate the profit earned, co m p a n i e s a re f re e to a d o p t a reasonable strategy to pass the benefit of GST rate reduction based on industry practice. The law indeed requires to pass the profit by a commensurate reduction in price, but nowhere has it mentioned that increasing the quantity for the same price does not meet the requirements of the law. The case still goes on and looks like the final verdict by the court may decide to leave things ultimately to the Competition Commission of India to handle any unfair trade practice.

PERSONAL FINANCE WHY KNOWING YOUR NET WORTH IS IMPORTANT? Net worth is one of the most important measures to calculate personal wealth. It shows how strong or weak an individual's financial condition is. It can be calculated by reducing liabilities from assets. Assets include your house, car, property, savings, bonds, stocks, other investments, retirement accounts, etc. Liabilities include all your debt like a mortgage, car loan, personal loans, student loans, medical debt, and any other debts you have. Subtracting your liabilities from your assets would fetch you your net worth. NEGATIVE NET WORTH In layman's language, it is the difference between what you own and what you owe. The result can be a positive or a negative number; a positive value determines how wealthy you are and a negative value determines how much you are in debt. For example: If you own a house worth Rs. 20,00,000, but you have a mortgage on it for Rs. 15,00,000, then your net worth would be the remaining Rs. 5,00,000. If you had another education loan of say Rs. 7, 00,000, then your net worth would have been a negative Rs. 2, 00,000. It is only a number; it need not always necessarily mean that a positive figure is better than a negative one. For example, you might have a negative net worth because you got an expensive professional degree that will significantly increase your income over the course of your life. That doesn't mean your financial health is bad. It only means that your

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investment in yourself hasn't yet paid off in a way that's easily accountable. Identifying your liabilities or your cash or cash equivalent assets can be easy, but it's quite a task to calculate your net worth as it involves defining current market values to all your fixed assets like car, house, land, etc. Many a time's people assign inflated values to all their assets which can give a false net worth. For example: If you were to value your house, you should take the price which the market is willing to pay to buy your house and not what you think is the value of the house. It can be found out by the price of a similar house sold in that area recently. IS THERE A MEASURE FOR IDLE NET WORTH? Net worth can be calculated on a regular basis or from time to time to evaluate one's performance. The increasing net worth is the best sign of moving forward while a declining net worth means you have work to do. Work to improve your financial stability by reducing your debts, which can be done only if you keep a track of your net worth. It will help you establish both short term and long term financial goals by helping you make an idle forecast. An idle net worth of an individual can vary from person to person, some might have bigger dreams to own a sea facing bungalow, a yacht and a well setup business, while some may be satisfied with a 2BHK flat, a small car, and a permanent job. In both the situations, the net worth should be increasing but at different paces.

WHY IS NET WORTH IMPORTANT? To reach your desired goals, it is important to know where you stand and what steps you will have to take to attain them to ensure moving in the right direction. It wakes you up where you're lacking, making you aware of your current position and providing an opportunity to improve on it by taking necessary decisions like how to increase your assets and/or how to decrease your debts in time. Net worth is important when you need a loan to expand your business, to complete your education, to buy a house or a car. Along with your regular income what banks or lenders will be more concerned about is your ability to pay back in case of no income by knowing your net worth. Higher your net worth, higher would be your credibility to receive money to rotate.

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