The financial Bulltin- August issue,2012,

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Issue 1, volume 15 Dated: 30 August, 2012

The Financial Bulletin From The Editorial Board

What’s Inside?

1.

LIBOR’s Labor lost.

2.

Rebooting Indian economy with liberalization 2.0

3.

Should Central Bank also be a lender of Last resort to the Government?

4.

Investments Drying-Up in India

5.

Transfer pricing

6.

Investment In Banking Sector - Is it still a safe haven?

7.

Where does the Buck Stop? - The Euro zone Crisis.

Warm welcome to all our readers!

In this edition, we present you fresh insights on financial issues from the bright minds of various B schools in India.

With India emerging amidst the global crisis, we often ask if India is lagging behind in investments?

Or is Banking sector a safe haven for the investors? Indian economy has changed since the liberalization of 1991 but what is the need of the hour? With many more questions like these and different insights, we hope to keep you engaged and informed.

Happy Reading!

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The Team: Advisor: 

Dr. V. Narendra

Faculty Co-ordinator: 

Dr. S. Vijaylakshmi

Student Co-ordinator: 

Roshni nair

Edited and designed by: 

Hemanta Poudyal

Contributors:         

Prakash Nishtala Anuj Narula Meeta Sharma Rahul Bakshi Rishi Gupta Shivani Ghildiyal Anju Maurya Aditi Ghosh Vaibhavi Sharma

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LIBOR’s labor's lost In 1598, William Shakespeare scripted the rib-tickling comedy “Love’s Labour’s Lost”.

The world has seen an unprecedented paradigm shift by then. But, now, the history seems to repeat itself. This time around, Barclays comes up with an ad nauseam thriller, “LIBOR’s Labor's Lost”.

Prelude

The rate at which each bank submits

LIBOR is the average interest rate

must be formed from that bank’s

estimated by leading banks in London.

perception of its cost of funds in the

The Banks charge this rate for lending

interbank market.

credit to other banks in the London Interbank

Market.

For

instance,

a

Plot (LIBOR… Lie More?)

multi-national corporation (MNC) with a

So far the LIBOR’s journey was a dream

very good credit rating may be able to

run. But, all was not rosy as it appeared.

borrow money for one year at LIBOR

To obliterate gloomy economic scenario,

plus four to five points. LIBOR is

banks showed lower than actual interest

calculated and published by Thomson

rates. The lower interest rates resulted in

Reuters on behalf of the British Banker’s

lower LIBOR and heaved up confidence

Association (BBA) on a daily basis

and increased lending. As LIBOR is

wherein they survey interbank interest

average of the interest quotes by different

rate quotes by 16 large banks. The

banks, so rigging of LIBOR involved

submitted rates are, then, ranked and the

many banks.

mean is calculated using only the two middle quartiles of the ranking. So, if 16 rates are submitted, the middle 8 rates are used

to

calculate

the

mean.

The

calculated mean becomes the London Inter-bank

Offered

Rate

for

that

Why rigging? A close examination into the issue transpired that Barclays was itself facing rising interest rates; had it provided the same rates to BBA, it would

particular currency, maturity, and fixing date.

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have created an unhealthy picture on the bank’s financial stability and liquidity issues it was facing would have surfaced. So, to protect its own interest Barclays resented on reporting (read rigging) lower rates so as to present a merrier outlook to the outer world.

The rigging happened between 2005 and 2009, as often as daily.

A fast-paced turns of events ranging from staunch investigations into the conversations of Barclays’ CEO Bob Diamond and the Deputy Governor of Bank of England to the Barclays’ public admittance of the rigging, the world witnessed abdication of three stalwarts of Barclays from the throne. Barclays Bank was fined a total of £290 million (US$450 million) for attempting to manipulate the daily settings of LIBOR.

What’s the big deal?

Upshots on proletarian: If LIBOR is very high that means one needs to dish out more to avail the credit. If it’s maneuvered towards a lower rate, it implies that your interest earnings on savings account would be subdued. Hence, in either ways, a manipulation would lead to common man’s loss.

As it is used as a benchmark for deciding various rates across numerous banks including central banks or even EURIBOR, so at a macroeconomic scale, it has the potential to create many ripples in financial assets worth $500 trillion.

Mumbai Inter-Bank Offered Rate (MIBOR) - The Younger Brother In India, as the financial markets started developing, the need for a reference rate in the debt market was felt. The National Stock Exchange (NSE) on 15 June 1998, developed the Mumbai Inter-Bank Offered Rate, referred to as MIBOR, on the lines of LIBOR. These rates are calculated by a combination of two methods—polling and bootstrapping.

In the polling method, like in the case of LIBOR, the data is collected from the panel of 30 banks which has a mix of public sector banks, private sector banks, foreign banks and primary dealers.

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How safe is MIBOR?

Learning from LIBOR scandal

As MIBOR shares a similar DNA as that

Prior

of its elder brother LIBOR, it might also

proponents of LIBOR were too confident

have a little room to get manipulated. But,

about its piousness. Promoters of MIBOR

MIBOR has its own merits over LIBOR

such as Reserve Bank of India (RBI)

which makes it a bit safer.

should act proactively to tighten the

Firstly, instead of omitting 2 highest and 2

possible loose links and to cover the

lowest rates as is done in case of LIBOR,

undiscovered loopholes. The case in point

NSE separates the outliers and determine

is the possible switching over of MIBOR

the mean rate. It is expected to help

calculation to actual dealt rates on a

against any attempt by the market

trading platform. As India has online,

participants

screen-based trading of money market

to

come

together

and

influence rates.

Secondly, though in a less extent, the very fact of Indian banking system being largely dominated by public sector banks makes one to believe that MIBOR could

to

the

exposure

instruments such as

of

scandal,

call money, unlike

voice-based markets in many countries, it makes sense to move to a transparent, actual screen based traded rate system which could capture actual MIBOR levels.

not be affected by private players to satiate their own interests.

Source:

Exhibit 1: http://chasvoice.blogspot.com/2012/08/the-libor-cartel.html This newsletter is for internal use at IBS, Hyderabad only and not for sale.

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Epilogue As Shakespeare’s classic had not only the King of Navarre involved in the promiscuity, he had an unflinching support from his three noble companions as well, on a similar line, even in this story Barclays is not forlorn, they reportedly, have support from many other players (refer to Exhibit ) of the game. The immediate action in the current context should be to identify the hidden miscreants and subject them to serious punishments. What we require today from regulators is not merely whipping fines on the perpetrators rather a system that should evolve wherein there is no scope for manipulation at all. The time must come sooner when we could say, “LIBOR’s LABOUR’s WON!”

CONTRIBUTED BY:-

PRAKASH NISHTALA NMIMS MUMBAI prnishtala@gmail.com

ANUJ NARULA NMIMS MUMBAI anuj.narula@gmail.com

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Rebooting Indian economy with liberalization 2.0

The year 1991 was nothing short of revolutionary for the Indian economy. Neo-liberal policies ‘clapped’ the clapperboard for the very first take of India as a matured, freshly liberalised economy, and the phase ahead beamed with promises and exciting economic prospects. Back then, for the economy, breaking away from the

outlines of a controlled socialist form in

favor of a market economy meant easing in the many dormant yet maverick aspirations of individuals and sectors, and re-adjusting the rheostat to start pumping out ‘glocal’ (global-local) efforts instead of roiling under nation’s own inconsistencies and limitations. The promise of economic liberalisation was that of new people-driven developments that along with political will and support could steer the course for India towards becoming a developed, empowered nation.

The prospect bore fruits. Opening up for international trade, tax reforms, deregulation policies and ingressive investments from people and institutions from across the world helped boot up Indian economy to level-up to the likes of developed and other developing nations, and an exposure as this did what it set out to build confidence in the idea of India as an economic and trade hub, and reciprocally configure the same confidence in India as a nation that can deliver global standards to global audiences. The fruits of liberalisation peeked between the years 2007-2008 when India accounted close to double digit growth in GDP and a vast influx of wealth creating and wealth generating opportunities. However, somewhere in this picture, we forgot one crucial thing: How to sustain such vortex of growth and the need to reformat growth parameters with changing and maturing times. As much anticipated the realizations of liberalisation of ’91 were

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congruently enough, no one seemed to know how to keep it going once the efforts reached their pinnacle.

Presently, problems for the economy of India are relative. We have produced wealth creators but we do not know how to retain and develop the influx of wealth; we have opened up to new sectors and vocational avenues but we are unable to generate substantial outcomes from the same, let alone expect global standard in the same. As much wealth and power economic liberalisation has endowed India with, it has also fuelled elitist interests and unsustainable patterns of growth and governance. We are environmentally inconsiderate and social welfare is a lost cause. Governance wise, things like inconsistencies in political will, rampant corruption, lack of scalable social programs and inadequate infrastructure are dampening efforts from individuals as well as organizations who are willing enough to work against such socio-economic and political digressions. It is hard to justify a lot of things, from why the government is funneling in billions of dollars into loss making SOEs like Air India while the thriving private sector entities in the fields of education and healthcare are crying out for capital support and infrastructural concessions. Our fiscal deficits stand at nearly 6% and government debt’s eat about 70% of India’s GDP. Today, we offer the world a promise of ‘incredible India’, more so because we have no tangible things to promise as such. We are only able to sell to the world the “idea” of a better investment opportunity that can be India, a new market for sophisticated products that can be India or an outsourcing destination that is India, and even then political unwillingness and inhibitions harpoon the prospects before they are given the opportunity to perform. There is paisley assurance or insurance in one’s invested efforts and yet we retain in our positing statement the words ‘incredible India’. At the heart of it, our promises are hollow and politically as well as economically are crippled by our indiscipline, policy paralysis, political polarization, sheer lack of leadership to do anything differently.

Liberalisation ’91 opened India to the world and vice-versa but the need of the hour is of a variant economic structure that seeks growth for the long-run and not just for short-haul goals to be met by the next elections. Our economy is currently

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circumventing around policies framed 20 year ago, under the governance of people who are way past their retirement age, led by a dogmatic outlook which glues itself to the notion of culturally and historically rich India and inhibits thinking above and beyond known paradigms and conventions. The need of the hour is to break away from such a cognitive bottle-neck.

In a day and age when technology becomes obsolete in a matter of hours our economy continues to strain under archaic policies framed two decades ago. Rebooting Indian economy with Liberalisation 2.0 is about moving out of this cocooned way of function to push a new kind of economic development, achievable through empowerment of economic clusters. Liberalisation ’91 has come a full circle and it is time to up the ante by vesting faith individual sectors like insurance, banking, retail, healthcare and education and freeing them to explore growth on their own terms. Ours being an aspirational democracy that it is, encourages freedom of thought and action. And so our representative, control cherishing democracy just doesn’t seem to cut it anymore, especially when it comes to doing things differently. The impetus to do things differently is there, but the governance framework needs to bend its rules to accommodate the growing aspirations and expectations that one has come to don from various economic bands and the nation as a whole. Whether we choose to erect Direct Democracy like the Swiss nationals or individually choose to pursue lateral thinking and break away from the constraints of a paralytic economy, there is a need to transfer decision making power directly to the source – be it the people, corporations or sectors.

The idea of liberalisation 2.0 seeks to expedite sustainable growth through inclusive and invested efforts, and the revolution needs to happen now!

CONTRIBUTED BY: MEETA SHARMA SIESCOMS , MUMBAI Misha_287@yahoo.co.in

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Should Central Bank also be a lender of last resort to the Government?

Central banks around the world are responsible for running the monetary policy of the nation. In many countries the central bank is run by technocrats and academicians in an autonomous and independent manner while it is run by government officials as a part of government machinery.

Central bank mostly target two important goals: Unemployment and Inflation. But as the Phillip’s curve shows that if we try to lower unemployment below its natural rate, the inflation rises. So there is a tradeoff. The central bank tries to achieve its goals mainly by targeting interest rates and money supply. Also since the central banks holds the authority to print infinite amount of money it can be source of funds both for financial institutions as well as the government both in normal as well as distressed times. But as we know that increased money supply in the economy without any productive capacity increase leads to inflation which if not controlled can lead to hyperinflation and loss of confidence in the currency and in the government. The Central banks acts as the lender of the last resort but this can resorted only for short term imbalances and not for structural issues for e.g. If there is a Bank run and the banks don’t have enough money to pay the depositors then the central bank can lend money to the bank since this is a temporary issue but if most of the bank’s loans have turned NPAs (non performing assets) then there is a structural issue and it is quite possible that bank will not be able to pay its depositors even in the long run. Similar is the case with Governments, every country is expected to maintain a level of Fiscal deficit, debt/GDP ratio depending upon its GDP growth rate but if the government stretches these values to unsustainable values then markets will punish them by raising the yields on the government bonds. The Government might try to get its way out of the debt by devaluing the currency but this may lead to inflation in the economy and loss of confidence in the Government Bond market thus raising yields further for the new debt issued.

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We will now discuss how Central banks around the words have turned lender of the last resort to their unsustainable Governments in order to stabilize the markets in economy in the short run. 

Reserve Bank Of India- RBI has acted as a lender of last resort to Government directly up to 1990s mostly by buying Government bonds and indirectly now by conducting OMOs (Open market operations). Indian Government has run a deficit for most part of history after independence and has to raise resources by selling bonds to pubic and Financial institutions, since public has limited savings Government started funding its deficit by selling newly issued bonds to RBI amounting to printing of currency by the process of deficit financing. For the last few years Government annual borrowings have risen to $100 billion in the FY 2011-13 since such the market does not have the capacity to finance such huge borrowings without leading to substantial rise in yields leading to huge interest cost for the Government. So the indirect process is Government selling bonds to Financial Institutions and RBI then conducting OMOs (Open market operations) to buy these bonds from these institutions thus indirectly financing the deficit.

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

Federal reserve (U.S.A)-Since dollar is a Global reserve currency, the U.S treasury does not have any issue selling U.S treasuries when the global growth is slow and economies are in slowdown or recession and there is a move towards non-risky assets. Also since the most important commodities like gold and oil are priced in $ most countries maintain a $ reserve leading to sustained demand for treasuries. But when times are good money flows towards risky assets in emerging markets leading to low demand for low yielding U.S treasuries. Since the U.S does not want the yields to rise on its bonds, Fed finances it in such cases. Also with a Fiscal deficit of 10% and declining status of $ as well as U.S sovereign rating Fed financing of the deficit is expected to increase in the future.

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

European Central Bank (ECB)-The constitution of ECB says it can buy sovereign bonds only in grave emergencies. In the beginning of European crisis ECB didn’t aggressively come in the market but with investors losing confidence in countries PIGS, ECB entered the market in a limited manner since it didn’t want to be seen as financing sovereign deficits. But now ECB has an innovative method, LTRO (Long term refinancing operation) where ECB started lending banks for 3 years at ECB funds rate and banks found attractive yields on the sovereign bonds.

So there was a carry trade with the Banks borrowing from ECB and the investing in sovereign bonds and pocketing differential 2-3%. The method points out to indirect funding of sovereign fiscal deficit by ECB but such methods can be short term solution but not long term panacea. They are inflationary and lower the confidence in the Central bank as well as the currency and are not sustainable in the long term. In case of LTRO it is difficult to understand how these deficits will be funded when LTRO expires?

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

Bank of Japan (BOJ)-With a debt of 225% of GDP and a deficit of 7%, slow growth for many years and interest levels close to zero it is difficult to understand how Japan funds its fiscal deficit. Since the interest rates are quite low in the domestic market even the domestic people find it unattractive to invest in Government bonds and with Japan being a welfare state the Government runs a huge fiscal deficit. The government expenditure is increasing because of the changing demographics but with slow economic activity and low tax collection it is difficult to increase revenues. Hence the Government has resorted to deficit financing by issuing “deficit financing bonds� to the bank of Japan. Such direct funding is possible because risk of inflation and yields (close to 1% for 10 year bond) rising is low. But such deficit financing is unsustainable and Japan must try to reduce its fiscal deficit and national debt.

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The above examples show how Central Banks around the World have resorted to funding their Government debt but it can also be observed that these are only band-aid solutions and are not sustainable in the long term. Government must try to remove structural flaws in the economy, increase taxation base and also plan expenditure properly keeping populist policies in check.

This will help in maintaining the credibility of the Government, central bank and the currency which will lead to sustainable growth in the economy.

CONTRIBUTED BY:RAHUL BAKSHI IIM INDORE p11rahulb@iimidr.ac.in

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Investments Drying-Up in India In the last one year, there has been a sharp decline in the inbound FDI routed to India. Even, large domestic business houses have shied away from announcing any big ticket investments. Though India is stated to witness significant capacity additions in power and metal processing, it may be only because it takes years to get a plant running after the plans are finalised. Therefore India will only end up in being benefitted by the euphoria around Indian growth story built in the past. Indeed there are pockets of FIIs investing in India, but FII investments essentially remain hot money, looking only for superior returns. They fail to have long term commitment and funds can be easily pulled out for greener pastures.

There is not even an iota of doubt that rate of expansion of Indian economy is coming down. Domestic economy is marred with inflation and till the time inflation is not brought under control very little can be done to the prevailing high interest rate regime. It can also be argued that debt crisis in Europe and sluggish growth in US can be detrimental for FDI, as most of the FDI comes from large corporations housed in these economies. But, the crisis in developed world will result in increase in demand of products and services at lower cost. In-spite of India being a established low cost destination, negligible investments have been committed.

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Looking more closely into the issue, the heart of the problem exists in lack of policy reforms and few incorrect decisions which have the potential to spoil the image of India as an attractive investment destination.

UPA government has been unable to take forward policy reforms initiated by the NDA regime. . The only step taken by the UPA government was signing of the Indo-US Nuclear deal, which was supposed to ensure fuel supply to the nuclear plants in India.

The deal was expected to result in large investments in the nuclear power generation.

Almost 3 years have passed, but not even a single dollar of investment has been planned.

Even UPA had put their government at centre on stake to ensure that the deal passes through, but post the deal it has shown no interest in adding any new nuclear power projects. Even, the regulation to allow private sector participation in the sector has not been relaxed, leaving NPCIL the only company in India to pursue nuclear power generation. Though ideas like FDI in multi-brand retail, GST, pension sector reforms and others have made to top news of major dailies, but no concrete action has been taken.

Even, the Supreme Court ruling in 2G scam case has been a very big setback for FDI. After the verdict, three large telecom companies Etisalat, Sistema Telecom and Telenor are forced to book billions of dollars of write-off. There only mistake being was to buy stake into Indian companies which had pan India 2G telecom spectrum along with investments of close to a billion dollar to roll out telecom services. It seemed to make perfect business sense at the time of acquisition. Indian players had spectrum to roll out services, and foreign players had expertise to run telecom operations. After the 2G scam was detected, Supreme Court ruling changed the telecom landscape as they no more had cheap spectrum to operate. If they bid for spectrum, the cost of spectrum will make their

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business unviable. Investments are based on assumptions and the prevailing law of the land. If one ruling or policy can completely change the business environment, it will be difficult for any business house to plan returns on their investment. The central government can pass a resolution to do away with the judgments. But UPA government with a tarnished image after the scam, decided against it. This is only set a precedent where India will be projected as a hostile destination for FDI. Vodafone tax case is another case which will result in big thumbs down by the foreign investors. Vodafone had bought 67% stake in Hutch India, with the deal involving parties which were not headquartered on India Soil. The deal was routed through Mauritius; therefore none of the party was liable to pay capital gains tax. After the deal, notice was sent to Vodafone to pay taxes, when globally taxes are paid by the sellers. When the notice was challenged, even the apex court upheld the Vodafone’s case. After losing the case, Indian Government changed the law to retrospectively tax similar deals, essentially over-ruling Supreme Court order. It gave power to the tax department to retrospectively tax similar transaction involving Indian assets for capital gains. But the larger questions arises, how the Corporate which have made investments in India account for such retrospective change in policy. If Government of India continues to pursue such abrupt policy changes, it can jeopardize billions of dollars already invested in the country. For corporate it may turn out to be safer bet not to invest in India, rather than lose their assets before monetization.

Another notable point remains that only foreign multi-nationals investing in India will end up paying the heavy price for the policy changes. None of the Indian companies are significantly affected by them. Though it seems that Indian counterparts will also loose the precious spectrum, but in reality they have been more than compensated by selling their stake in telecom business at market prices. Differential treatment by the Government to the Indian and foreign business houses can drive away FDI for years.

There are no surprises, when FDI in civil aviation was increased to 49%, none of the foreign players were looking to buy stake in capital starved Indian airlines.

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The depreciated rupee would improve

It is advisable to put their money in

their returns on their investments, but it

other developing geographies where

failed to impress investors from abroad.

acceptable returns on investment can

Domestic business houses have also played the price especially in the power sector.

Inaction

on

the

part

of

Government to provide timely clearances for coal mines, is putting tremendous pressure

power

producer.

Almost

8000MW of capacity is idle due to unavailability of natural gas. Though India is stated to add nearly 15000 MW of power capacity in the current financial year, fuel is not available to service them.

Private players who have invested money in these projects have been left with no choices than to import coal from abroad

be achieved.

India remains a capital starved nation.

Our honorable Prime Minister

sited requirements to the tune of $ 1000 billion to fund infrastructure like roads, ports, power and others in the next 5 years. Relying on the domestic savings may turn out to be insufficient to fuel the anticipated economic growth. In-spite of it, policy makers

removed

the tax

exemption on infrastructure bonds. It may do little good to simplify tax

to run their plants .Power producers will import coal to the tune of 160 MT in the current financial year, when reserves within

the

nation

remain

has

unused.

Profitability of these players is under stress and they have little room to service the debt. If anyone of these players default, banking system and shareholders will end-up paying the price. If domestic players investing in India end up making losses, in future they will prefer to invest abroad rather than in India.

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structure, but can pose significant challenges to infrastructure financing. The high interest rate would make PPP (Public Private Partnership) projects financially unviable. Most of the built operate and transfer (BOT) and PPP projects have only resulted debt ridden private players. Instead of making fortunes out of these projects, private players like Lanco Infrastructure and others are forced to sell-off there assets to bring down their leverage.

Clearly the bar was set very high, when UPA came into power under the leadership of Dr. Manmohan Singh. UPA in its first tenure could ride on the economic boom created by the good work of NDA government. It was essential to take the process of reforms forward. Huge demand aided by large population and low cost of operations would have kept the economy on the fast growth track. On the contrary, UPA either choose for inaction or policy measures which are detrimental to investments in India.

Indian economy has just started to feel the tremors; if timely corrective actions are not taken, Government may end-up driving away investments from the nations for the coming decade.

CONTRIBUTED BY:RISHI GUPTA IIM SHILLONG rishi11@iimshillong.in

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Transfer pricing According to UNCTAD’s World Investment Report 1996, one third of the world trade is Intra firm trade. Also due to mergers and acquisition, this proportion is continuously increasing. When intra firm trade occurs, the problem of transfer pricing has a huge presence. Transfer Pricing, according to Wikipedia.org is defined as “setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property (including intangible property)”.

The recent upheaval of this issue was noticed when data about certain IT industries came out. The Indian branch of Multi-national companies sells their IT solutions to related companies at a very cheap rate. Here “related parties” stand for the parent companies of the related IT Company .The solutions are provided to them at a very cheap rate, when compared to unrelated companies. However, the expenses for the IT Companies is the same for parent as well as unrelated companies. In order to save tax, they report smaller profits. Transfer pricing is something that IT Indian branches of multinational companies are resorting to, to underreport the company revenues. In the year 2010-11, this amount was as huge as Rs 22,900 Crores. This discrepancy was first noticed when certain data came to picture. (Refer table below) Revenue

Net Profit

No of employees Net profit per employee

Infosys

30000 crore

7569 crore

190000

4 lacs

Accenture’s Indian IT branch

5270 crore

855 crore

59100

1.44 lacs

Company

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These 2 companies have clients which

The parent company of Accenture is in

are largely similar and the projects are

Ireland, a tax haven. Accenture India

similar till a great extent. The net profit

sells the IT solutions to its parent

per employee is vastly different in the 2

company which in turn sells it to client

companies. Why?

at a premium. This way MNC’s evade

The reason is Transfer pricing. The

tax. And this is one big reason that the

Indian arm of the IT Giant Accenture,

pressure of tax falls on ordinary

didn’t report the profits properly in India.

citizens. In order to check such

It reported its major revenue as coming

practices,

from

pushes

parent

companies

or

other

India’s

these

Tax

Indian

department branches

of

subsidiaries of its parent companies

Multinational companies to increase

situated in other countries that provide

their revenues and hence provide

tax haven.

additional tax.

Over past few years, various Indian branches had to forcibly increase their revenues.

So broadly, this situation can be described as – A company opens its branch in another country, manufactures it there and they are imported. Now the question is what price should be paid by parent company to buy it from the subsidiary.

This problem is prominent not only in India but in almost every other country. The investigations carried out by the Internal Revenue Service’s (IRS) in US found that the American subsidiary of Glaxo Smith Kline overpaid its UK parent company for drug supplies. The rule says that any transaction between 2 entities of same company should be carried out as if it was being conducted between 2 unrelated parties.

The transfer price may be based on product or technology (called the transactional method) or it may depend on profitability.

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Inappropriate reporting of transfer pricing leads to loss of foreign exchange and leads to incorrect reporting of profit and loss. Transfer pricing guidelines are now quite strict in developed countries, thanks to Organization for Economic Co-operation and Development. However, developing countries still lag behind in implementing the guidelines to put a check on misuse of transfer pricing

CONTRIBUTED BY :SHIVANI GHILDIYAL KJ SOMIAY INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH ghildiyal@gmail.com

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Investment In Banking Sector - Is it still a safe haven?

The banking sector of any country is not only the backbone of its economy but also it is a financial intermediary which gives a clear picture of its health. What makes this sector different from other sectors is the positive correlation with other sectors in the economy.

In a report of Indian Banks’ Association( IBA), it is stated that India’s gross domestic product (GDP) will make the Indian Banking Industry the third largest industry in the world by 2025. GDP and banking sector are interrelated as in when monetary policies do change and stimulate the economy, GDP rises and vice versa.

These estimates depict an exponential growth of banking sector in coming years with the increase in asset size of more than 20%.

Index of leading banking sector stocks has shown a compounded annual growth rate of 31% from last 5 years and considering the future prospects, economists say that in next five years from now, banking sector will be at least two and half times what it is currently while in western countries, this scenario will not prevail because people don’t save there rather they spend their future earnings as well. So growth rate will be lesser there.

Investments in banking sector are growing day by day as it is considered to one of the most reliable sectors for investment (others being power sector, infrastructure, oil and gas and food processing industry). Following are few reasons which are responsible for making this sector so attractive: 1. RBI has increased interest rates from 3.5% to 4% which will stimulate more liquidity as people will deposit more.

2. By increase in disposable income, people save more. Deposits in bank give lesser return in comparison to other investments but they are risk free investments.

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3. With the increase in information technology , banking services have also enhanced like introduction of ATMs, mobile banking, internet banking, online payments of bills. This is a good sign of growth of this industry 4. The large untapped market of about 41% adults who don’t own any bank account gives the assurance of flourishing in future.

There are some facts which may change an investors mind. Recently , banks were hit by many adverse situations like increased interest rate on saving deposits, tight monetary policies, increased government deficit, unamortized pension/gratuity liability and implementation of basal norms III. Other facts are as follows: 

With the advent of foreign banks after liberalisation, competition has increased which led to aggressive lending. Consequently, net NPA has risen very much.

In 2011, net NPA of public banks was higher than private banks which indicates poor asset quality of public sector banks.



In last 5 years, private sector banks have shown an increasing trend of return on assets (ROA), foreign banks have shown decreasing trend while public sector banks have shown almost stagnate growth. This clearly indicates that not all players in the industry are moving further.



Banking sector in responsible for many bubble bursts in the history e.g. sub prime crises. IF any commodity is misjudged (over valued or undervalued), the results can be beyond imagination and very destructive which will no doubt influence very badly other sectors of the economy.



Huge credit by Indian banks to various loss incurring industries like aviation and power sectors which incurring huge losses indicates that banking industry may run into fiscal deficit if any of these companies default (ex. Huge lending of SBI to Kingfisher Airlines).



There is huge exposure of credit towards the power sector and it is increasing very rapidly ( increase of 347% in last five years). This part of credit forms a major chunk of the total credit ( about 7%). In the view of the poor financial health of power sector especially State power utilities, it is doubtful the servicing of the debt and danger of default arises.

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

Cost of deposits have grown up with the increase in interest rate from 3.5 % to 4%. This difference could be around 13 basis points. In order to maintain the profitability , banks will pass on this cost to borrowers .Otherwise their NIM will be diluted by around 10 basis points. Consequently , return on equity will be lowered by 1%. The banks with high deposits ( like SBI and PNB ) will be hit more than other banks having lesser deposits( like UCO bank and OBC).

The foreign banks which are operating are responsible for stimulating the sector as they impose a large competition to PSUs. Private sector banks are advanced in technology and have presence in global market which gives them lot of exposure.

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Ultimately, public sector banks have to improve themselves to avoid lagging behind.

Till now , investments in financial sector especially , banking has proved profitable but the above mentioned facts are a few concerns which cannot be ignored while planning to investment in it. Implementation of Basel norms III is meant to protect the industry from any adverse effects but it does not make risk free investment at all.

CONTRIBUTED BY :ANJU MAURYA IBS, HYDERABAD Maurya.anju03@gmail.com

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Where does the Buck stop?

- The Euro zone Crises.

Who is to be blamed for the mess.

Euro zone crisis- The blame game While the World plays its favorite real-time rendition of the game of Global Monopoly, separating the Heroes from the Villains has always been very difficult and only subjective. Rich was synonymous with powerful and the powerful is always right .The poor are the borrowers and they must always comply. Recently there has been a major role reversal, the Powerful emerged the borrower. The Weak turned out to be the secret lender. And so, quite understandably, the world has gone in a quandary trying to figure out who can shoulder the blame of the world.

Let us look at the most glamorous contenders. It takes two to transact. One lends and the other borrows. So if someone can be blamed for borrowing imprudently, it is because there exists someone who is more than willing; sometimes almost forcefully, to lending.

Let’s explain this with an example: If Switzerland’s currency goes up (appreciates) and the euro, down (depreciates) it is more a translation of demand for Swiss goods over European goods to more demand for Swiss Francs ,lesser supply, leading to an inevitable Swiss Franc Appreciation. But that’s no good news because Swiss Franc appreciation means Swiss goods become dearer and demand for them dwindles and industries in France come to a halt because no one really wants expensive goods anymore when they can get cheap substitutes.

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Obviously, if both the nations don’t work at balancing of trade together, the outcome can only be narrow. This is where theories such as those of Competitive Advantage, Free Trade and Product Life Cycle Theory have been proposed to herald an era global world-well-being.

However we all have the ‘truth’ glaring in our face. All our well laid plans have gone up in flames. The crisis at euro zone is a ticking time bomb that if not detonated in time, will blow up Europe with significant repercussions across the world. So where did we go wrong? Who broke the code?

Let us trace how the buck passes.

The euro team has to chosen the (in) famous Greece as the star contender villain or the one responsible for the whole mess. Those with a soft corner for Greece pass the baton back in time to none other than U.S.A and its Sept, 2007 sub-prime mortgage fiasco. U.S.A is quick to respond .They’ve already chosen China and the Eastern Economies (special mention to Japan)

Who is the Villain? Contender 1: GREECE In 2000 Greece joined the euro group and decided to adopt the common currency ‘Euro’. Its borrowing cost dropped drastically. Investors believed that there would be widespread convergence among countries in the Euro zone. This belief was reinforced by the policy targets, called convergence criteria that countries had to meet in order to be eligible to join the Euro zone, that limits government deficits (3% of GDP) and public debt levels (60% of GDP). These limits were to be enforceable through fines of up to 0.5% of GDP. All of these factors created new investor confidence in Greece. But all this did not result in the policy change in Greece. They took the advantage of cheap credit and also borrowed to pay for imports but these funds were not channeled into productive investments.

The Governments’ dependence on global financial market to pay for twin deficits (see figure 1) left it vulnerable to shifts in investor’s confidence.

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Figure1: Greece’s “Twin” Deficits: Budget and Current Account Deficits, 1999-2009 Source: International Monetary Fund, World Economic Outlook, April 2011.

In 2009, investor’s confidence dropped significantly as the debt level was too high so, they started demanding higher interest rates for buying and holding Greek bonds (see figure 2). But this raised Greece’s borrowing costs, exacerbated its debt levels, and caused Greece to veer towards default.

Figure 2. Greek Bond Spreads, 1993-2011 Spreads on 10-year Greek bonds relative to 10-year German bonds (%) Source: Global Financial Data 2011.

This is when Angela Merkel, Chancellor Germany, suggested Greece abstain from its excessiveness and that loans to Greece from ECB should be halted and asked for rescheduling of the payments, whereas the President of France and others favored

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granting loans to Greece as France (which also has the pressure of the double deficits, and many other European countries were also under pressure.) Europe’s debt crisis was deepening, affecting others as well.

Who is the Villain? Contender 2: PIIGS (Portugal, Ireland, Italy, Greece, and Spain) PIIGS are the weaker of the European economies who were lured by their sudden access to greater purchasing power due to stronger currency they got access to Euros.

They borrowed with no care for the future consequences and obligations.

Who is the Villain? Contender 3: U.S.A A little further walk more down memory lane might lead us to the U.S.A of September 2008.

So let us look at the US banking system, where the regulators horribly failed to enforce rules, US banks ruined everything and caused a huge damage to the economic system of US and all the foreign investors who got carried away with the promises of the new Collateralized Debt Obligations, Mortgage Backed Securities and Credit Default Swaps. The extensive financial inter-connections between US and European banks in the NON-transparent derivatives market, the US housing bubble burst triggering off a chain of potential defaults in Europe.

So have we correctly identified the culprits- the Americans?

Who is the Villain? Contender 5: CHINA China and the Eastern Economies specifically Japan strategically and compulsively saves and forcefully lend to the U.S. And how does China defend itself? Throw up its hands saying what should justify keeping 1.36 billion stomachs hungry.

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The answer to the world’s problems lies in reaching economic moderation between over borrowers and over suppliers. This is where the buck must stop.

CONTRIBUTED BY :-

ADITI GHOSH IBS, HYDERABAD

VAIBHAVI SHARMA IBS,HYDERABAD Vaibhavi.frendz@gmail.com

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