Niveshak April 2016

FROM EDITORâ&#x20AC;&#x2122;S DESK Niveshak Volume IX ISSUE IV April 2016 Faculty Chairman

Prof. P. Saravanan

THE TEAM Aaron Keith Rego Abhishek Jiaswal Aditya Kumar Jain Anisha Khurana Ankit Singhal Ankur Kumar Anoop Prakash Devansh Sheth Shreyans Jain All images, design and artwork are copyright of IIM Shillong Finance Club ÂŠFinance Club Indian Institute of Management Shillong www.iims-niveshak.com

Dear Niveshaks, Welcome to the FY17. The month created a lot of news but nothing much significant. With the world market and economy relatively stable, the benchmark Sensex rose by 1.19% during the month. There was one important move by the RBI which will have significant impact in the banking industry and it was the applicability of MCLR from April 1st, 2016. The move is aimed to reflect changes in the borrowing rate for the retail consumers whenever RBI changes its policy rate. Also there are chances that after 2 years of drought, the country will have a normal monsoon. This is essential for a country like India where a large number of farmers are dependent on rain for irrigation. The month also saw some moves by the government in the aviation sector. After Civil Aviation Policy is implemented, private players would be able to claim subsidy for regional routes. Also government has eased rules for local airlines to fly abroad. On Magazine front, our article of the month talks about the fall in the economy of Japan. It also analyses the important aspects of the Abeconomics and what went wrong. The article cautions the European economy to learn from the Japanese economy. The cover story analyses the journey of the Insurance sector in India and what are the different channels that have been adopted by the insurance companies. For FinGyaan, the author explains how weather derivatives instrument can be used to protect against possible fallout of the weather. The article explains how the pricing is done and the prospects for weather derivate instrument in India. Our FinRewind section has picked a yet another important event in the Indian economy history, which is LPG (Liberalisation, Privatisation and Globalisation) in India. The author illustrates what led to the decision of opening up of the economy and tries to answer whether we are better off or not. Finally FinSight section talks about the rising gap between the rich and the poor. This time we have an interview of Mr. Nimesh Manger, Regional Head, Agri Business, Gujarat at Ratnakar Bank. He talks about why financial sector has maintained a distance from the agriculture industry and what are the potential areas where there is huge opportunities for the industry to tap the market. The Classroom section explains the concept of Money Market Hedge. It is a simple technique which is used by traders and other players to hedge against the foreign exchange risk. Finally, we would like to thank our readers for their immense support and encouragement. You remain our prime motivation factor that keeps our spirits high and gives us the vigour and vitality to keep working hard. We hope you had a great financial year and wish you the best for the new one. Team Niveshak

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

10 The Lost Decade of Japan

FinGyaan

Insurance Sector in India : Miles to Go

18 Weather Derivatives- Best Way

Finsight

FinRewind

FINVIEW

to Hedge Against Unpredicted 26 Addressing Rising Global Gap Between the Rich and the Poor Weather

22 LPG in India

30 Nimesh Manger

RBL (Formerly: Ratnakar Bank), Regional Head, Agri Business

CLASSROOM

32 Money Market Hedge

Disclaimer: The views presented are the opinion/work of the individual author and the Finance Club of IIM Shillong bears no responsibility whatsoever.

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The Niveshak Times

Team NIVESHAK

IIM Shillong TRAI to Consult for Public Wi-Fi

will earn more on the reserves with the RBI.

TRAI is in the process of consulting with the industry experts regarding the Public Wi-Fi. Considering the surge in data usage, the regulator is actively considering the Public Wi-Fi facility, but the main hindrance is how to make it profitable for the telecom providers. The number of Wi-Fi hotspots is expected to jump to 2 million in two years from about 30,000 now, as per industry estimates.

The most important change is the introduction of the Marginal Cost of Lending Rate (MCLR). It is the benchmark rate for loans to customers with effect from April 1st, 2016. Now the rates at which banks lend to customers will have significant effect, as compared to before, of any rate change by RBI.

Public Wi-Fi was considered a threat to the data services of telecom operators. But that is not the case anymore. With improved technology, it will now be possible for telecom operators to monetise the public Wi-Fi. Loss-Making Regional Routes now can have Private Players as well Till now, only government-owned carrier Air India gets subsidy for providing regional connectivity. But, if the Civil Aviation Policy is implemented, the government will allow private carriers also to provide connectivity in regional areas and claim subsidy as well. This is a part of a plan to improve regional connectivity. The subsidy will be provided till the time a route is making losses. For every route there will be a Break Even Load factor and as soon as the route touches the load, the subsidy will be stopped. Also the Centre will provide 80% of the cost and rest will have to be borne by the respective state governments. Repo Rate Cut by 25 bps Reserve Bank of India cut the repo rate by 25 basis points from 6.75% to 6.50%. The rate cut was on expected lines as the inflation is well under control and is forecasted to fall to 4.2% in Q4 of FY18. In addition to the rate cut, RBI also announced some another measures which would help in bringing down the cost of borrowing. Now, instead of keeping 95% of their deposits, banks would be required to keep 90%. This will increase the amount available for lending. Also, Reverse Repo Rate has been hiked from 5.75% to 6%. Consequently, banks

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“Policy action is greater today than just another 25-basis-points cut,“ Mr. Raghuram Rajan told reporters after the rate-cut announcement. After Banks’ Recapitalisation, Consolidation is on Cards Finance Minister Mr. Arun Jaitley said that the government will push for banks’ consolidation once they are recapitalised. India has 27 public state-run banks. There are many overlap in their areas of operation. By consolidating banks, synergy will earn them more benefits. Mr. Arun Jaitely said that the Bank Board Bureau will be operational in 2016-17 and a plan will be charted for consolidation of the banks. Ease of rules for Local Airlines to Fly Abroad One of the contested rule for domestic airlines to fly abroad is set to change. As per the existing rules, a domestic airline must have been in service for 5 years and maintain a fleet size of at least 20 aircrafts. Now as per the proposal, the government is considering doing away with the 5 years norm. Though the fleet-size rule will remain in place. However, there has been inclusion of an additional rider. Airlines will have to maintain 20% of the total capacity for the domestic sector at all time. Government is also considering providing additional benefits for regional airports like flat 2% excise tax for three years on aviation fuel pumped at those airports and 1.4% service tax on regional flights for one year.

good news.

previous fiscal.

India Meteorological Department expects that La Nina conditions are likely to develop this year. This condition, contrary to El Nino, boosts rainfall. This will ensure that India has normal monsoon. Past data show that in the years of La Nina effect, Indian rainfall has been close to normal or above normal.

With the increase in the CapEx, which will go a long way in lifting up the economy, the government has assured a budgetary support of INR 60,000 for FY17 if Railways is able to keep up the trend. Though the government had earlier announced a Gross Budgetary Support (GBS) of INR 45,000 crore.

Japan Metrological Agency too said the El Nino effect is decaying. Indian Air Force is modernisation action

Planning

10-year

Indian Air Force (IAF) has made plans for modernisation for the next 10 years. Though as per the plan, the detail requirement will be shared by the domestic players as well but only 10-15% of over 2.5 lakh crore projected acquisitions will be sourced from the domestic market. The idea is to give the domestic players an understanding of the actual requirement for the defence sector which will help them in better planning for setting up manufacturing facilities. Eventually, the domestic players would replace the imports. The plan is quite comprehensive and include all types of requirement like from aircraft tyre requirement to the potential of 3D technology. No Restriction on Withdrawal of PF Fund The government has withdrawn the provision of not allowing 100% withdrawn from PF account before the age of retirement of 58 years. This was as per a February 10 notification which was to be implemented by April 30. But due to backlash from various labour unions, the government has deferred the implementation of the proposal by three months.

Ecommerce companies may Face Compliance Issue This Year The government in March legalised the marketplace model of ecommerce companies stating that they strictly would need to remain technology platform for buyers and sellers. However, it also added a rule which some ecommerce companies may find it difficult to comply with this fiscal year. The rule prohibited any seller with more than 25% of total sales on the platform. Since the rule has come in effect on March 29, companies wonder how they would account for the compliance. Smartphones to Get Panic Button Government has notified that all smartphones sold in India from 2017 will have a panic button facility which will help a person in distress to send panic button immediately. No manufacturer will be allowed to sell the smartphones without this facility, and from 2018 all smartphones will compulsorily have GPS location facility. The move is aimed at towards improving women security and the idea is that a woman in distress may not be in a situation to dial 100 and so she should be able to intimidate the police just by a long-press of a button.

The move is a setback for the government as it comes after another withdrawal of a proposal of imposing tax on withdrawal from the Employee Provident Fund (EPF) account. Record Capital expenditure by Indian Railways

Expect Good Monsoon This Year 2-years of drought have made this year’s monsoon more crucial. But, thankfully, now we have some

In the Fiscal Year 2015-16, Indian Railways has recorded highest capital expenditure of INR 94 Lakh crore, a hike of INR 37,000 crore from the

The Month That Was

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Article ofSnapshot the Month Market Cover Story

Market Snapshot BSE Index

BSE

DII

1,200

FII

1,000

26000

800 600

BSE

25500

400 200

25000

0 -200

24500

-400 -600

24000

-800 28-04-2016

27-04-2016

26-04-2016

25-04-2016

22-04-2016

21-04-2016

20-04-2016

18-04-2016

13-04-2016

08-04-2016

06-04-2016

05-04-2016

04-04-2016

01-04-2016

23500

-1,000

FII, DII Net turnover (in Rs. Crores)

26500

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap

97,12,485 Source: www.bseindia.com

LENDING / DEPOSIT RATES Base rate Deposit rate

Sensex MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

9.30%-9.70% 7.00% - 7.50%

Open

% change

25301.7 10631 10552 18039 18360 11517 12854 7686 15168 11376 7538 9120 1778 6104 1227 6100

25603.1 11018 11026 18508 19051 11902 13234 7689 15465 11381 7918 9320 1829 6261 1341 6160

1.19% 3.64% 4.49% 2.60% 3.76% 3.35% 2.95% 0.04% 1.96% 0.04% 5.04% 2.19% 2.88% 2.58% 9.31% 0.99%

% CHANGE

% Change CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling INR/ 1 SGD INR/1 USD 0.00% -0.50% -1.00% -1.50%

Euro/1 USD

GBP/1 USD

66.40 75.42 62.32 96.83 49.31 JPY/1 USD

SGD/1 USD

RESERVE RATIOS CRR SLR

TECK, 0.99%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

7.00% 6.50% 6.00%

-2.00% -2.50% -3.00%

Source: www.bseindia.com

-3.50% -4.00%

Smallcap, 4.49%

4.00% 21.25%

Date as on April 28th

REALTY, 9.31%

PSU, 2.58% POWER, 2.88% OIL&GAS, 2.19% MIDCAP, 3.64% METAL, 5.04% IT, 0.04% Healthcare, 1.96% FMCG, 0.04% CD, 3.35% CG, 2.95% BANKEX, 3.76% AUTO, 2.60% Sensex, 1.19%

-4.50%

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Article Market of Snapshot the Month Cover Story

Market Snapshot

NIVESHAK

Niveshak Investment Fund

Done on 30/6/14

Information Technology(12.79%)

Bank (7.06%)

HCL Tech.

HDFC Bank Wg: 7.06% Gain: 22.83%

Infosys

TCS

Wg: 4.05% Gain : 0.27%

Wg: 4.72% Gain: 48.85%

Wg: 4.38% Gain : 2.89%

FMCG(21.92%) Colgate HUL

Britannia

Wg: 5.48% Gain : 9.92%

Wg: 6.92% Gain: 184.31%

Wg: 4.80% Gain: 23.24%

Amara Raja Wg: 4.95% Gain: 33.04%

Godrej Consm. Wg: 7.32% Gain: 50.80%

Pharmaceuticals (11.52%) Dr Reddyâ&#x20AC;&#x2122;s Labs Wg: 4.28% Gain: 6.96%

Lupin Wg: 7.23% Gain : 39.22%

Midcap Stocks (11.71%) Bharat Forge Wg: 3.86% Gain: -13.44%

Kalpataru Power Wg: 3.63% Gain: -19.90%

As on 29th April 2016

ITC

Wg: 4.72% Gain: -5.44%

Misc. (11.63%)

Auto (9.48%) Tata Motors Wg: 4.53% Gain: -8.94%

Performance Evaluation

Natco Pharma Wg: 4.22% Gain: -4.65%

Titan Company Wg: 4.31% Gain: -5.12%

Chemicals (7.81%) Asian Paints Wg: 7.81% Gain: 37.76%

Textile (6.08%) Page Indus. Wg: 6.08% Gain : 19.69%

Value Scaled to 100

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 15,02,928 Change in Portfolio Value : 50.29% Change in Sensex : 24.92%

Risk Measures: Standard Deviation : 18.71 (Sensex 10.27) Sharpe Ratio : 2.47 (Sensex : 2.04) Cash Remaining: 58,000

Comments on NIFâ&#x20AC;&#x2122;s Performance & Way Ahead: As can be seen, the month of April was an tepid time for the markets. The main events that gave the markets direction were the results which were announced by companies as well a the monetary policy by the RBI. The coming month will see major triggers in the form of Brexit, which has the potential to wreck havoc on markets across the globe. The major movers in the NIF portfolio were the Kalpatru Power and Tata Motors, which saw the highest gains. Conversely, Britannia and Natco Pharma saw marginal losses.

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causes of Japanese stagnation. A second crisis of sorts emerged when a series of large banks and financial institutions started collapsing in a domino effect with the Sanyo Securities in 1997 and Hokkaido Takushoku Bank and Yamaichi Securities following it. By 2007, Japan had largely resolved the non-performing loan problem as well as the issue of battered company balance sheets, but economic growth hardly accelerated, nominal GDP fell from $5.33 trillion in 1995 to $4.36 trillion and real wages fell by about 13% from their peak, resulting in what is now known as the Two Lost Decades. These lost decades have had a major impact on the economic fundamentals. Japan’s market index Nikkei 225 hit an all-time high of 38,916 in December 1989, and then began a nosedive to a low of 7,831in April 2003, a fall by 80%. The official interest rate has remained below

the excessive private savings in the Japanese economy. Savings, being a leakage in the economy, leads to wastage of resources. Despite Japan’s high gross private savings rate as compared to other major economies, it did not face excessive savings till the 1970’s due to heavy investments in technology and other spaces during the high growth era. However, from the beginning of the 70’s, there was large decline in private investment, leading to the problem of chronic excess savings. When a high savings economy cannot effect enough capital exports and an adequate current account surplus, then, under neoclassical conditions, real interest rates will fall as a result of the excess supply of goods. The policy of monetary easing taken up by the Bank of Japan during 1985-1990 gave rise to such a situation, but it also had the adverse effect of giving rise to the Bubble Economy with

1% ever since 1994. The Japanese government has had to run a fiscal deficit since 1991. The government debt to GDP ratio is an appalling 240%, the highest level of debt for any sizeable economy on Earth. Such a situation has contributed to the fact that the suicide rate today in Japan is 60% higher than the world average. The Japanese situation is often held up as a spectre that this is what could happen to Europe if it continues along the same path of deflation. Another major reason for such a crisis was

undesirable consequences such as inefficient capital formation, as became clear through the subsequent NPA crisis. A majority of the country’s private savings surplus had been put into covering for the government deficit, but as the spending measures conducted by the Obuchi administration in the late 1990’s epitomize, government expenditure was not essentially used for efficient purposes. Though the govt. adopted the tried and tested textbook methods of fiscal stimulus and built largely unnecessary bridges and roads, the

The Lost Decades Of Japan UdbhavBhaniramka NMIMS Mumbai Today, Japan’s GDP is about 40 to 50 percent below what the world in 1991 would have estimated it to be. A nation which was expected to surpass USA in the previous millennium itself has been shockingly stagnant for the last 25 years and counting. Ever since the burst of the ‘Asset Price Bubble Economy’ in 1991, Juggernaut Japan, as it was called in its hay day, has not been able to shrug off the deflation and gloom from its financial economy. Stock and property prices that rose steadily from the mid-1980s plunged suddenly in 1991 reacting to increases in inter-bank lending rates by the Bank of Japan (central bank) in 1990.

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These developments in asset prices have not just debilitated aggregate demand through a negative wealth effect but also hampered financial intermediation tasks as firms used land as collateral for business loans and banks held a large amount of common stoc in their balance sheets, leading to a further decline in macroeconomic activity. Japan experienced sluggish growth overall as well as in total factor productivity (TFP). The first ten years of this stagnation – the so called Lost Decade – have been the subject for considerable research and speculation. Studies have focused on financial problems such as bank’s ballooning nonperforming assets (NPA), firm’s dented balance sheets, and negative inflation as the main

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“Quantitative easing is a very risky strategy, and fiscal stimulus hasn’t worked in the last 20 years. All it has done is it has taken Japan from [being] the least indebted major country to the most indebted major country,” says Wharton finance professor Franklin Allen. Japanese economy remained in a slump and long term growth elusive. Like most countries, Japan faced a huge uphill task with the global financial crisis of 2008. However, unlike most other economies, Japan was already facing a demand shortage and a negative GDP Gap before the onset of the crisis. Its GDP Gap fell from 4% in 1990 to -4% in 1998 and -8% in 2009. Almost half a million people lost their jobs in what is known as the Lehmann collapse in Japan. However, such a sad macroeconomic situation has not proved lethal for many baby boomers in Japan. The 60% population in full-time

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employment, and the 45% over 50 years of age are well off as they have a good steady income or a state pension that is two-thirds of the average wage. Since prices are stagnant or falling, at least until recently, it does not matter a lot even if wages rise by only a very meagre amount. In any event, in the jobs for life prevalent in Japan, your salary rises along with your age. The situation is grim for the youth, the minority in an ageing population. This is shown by the fact that those in their twenties are voting half as often as those above sixty. Measures like pre-mortality inheritance have been introduced specifically for this reason.

In the December of 2012, Prime Minister Shinzo Abe took oath and promised to get the Japanese economy stirring again. He proposed a ‘three arrow’ policy popularly known as Abenomics. His policies have been somewhat effective in the short run as we can see in this graph for Real GDP per working age resident. Japan has been performing better than the US and Europe since 2012. However it is the poor Japanese demographics that still keeps the growth rate from improving. The first arrow of Abenomics was a loose

monetary policy of printing currency (quantitative easing) and was started almost immediately. The aim was to cheapen the Japanese Yen against the US Dollar and currencies of export competitors like South Korea, Taiwan and China and thus make its exports more competitive. The Yen depreciated from 75/$ in December 2012 to 120/$ in December 2014. Exports did increase and the first arrow was somewhat effective in the short run. The second arrow related to an expansionary fiscal policy of increasing government spending on infrastructure and providing tax relief to stimulate spending. However, this arrow misfired as Japan raised sales tax, which put the brakes on private spending. The third arrow is structural reforms like immigration of youth, more women in the workforce, greater efficiency in Japan’s retail distribution and cleaning up tonnes of bad debt from bank balance sheets. These reforms are a painfully slow process with long gestation periods. Even the cheap yen strategy

is very short term in nature because oil is the main commodity in Japan’s import bill. If the dollar price of oil were constant, a cheaper yen would make oil more expensive in Japan, even unaffordable for a few as well as adding to the govt. deficit. But oil is priced in dollars and the dollar price of Brent crude in recent times has plunged faster than the yen. As a result, the price of oil in yen has in fact gone down and not up, in the past twelve months, allowing for higher spending and better performance. As the population pyramid of Japan has become more and more mushroom like, cost of social

security and medical has risen exponentially. By 2025, there will be 1.8 working person sustaining one retired person. About 30% of govt. spending is on pensions and other social security benefits. Now the imperative falls on Europe not to go down the Japanese road and learn from history. Japan did not have any system of checks and balances during the years of high growth and only cared about keeping the bicycle running as fast as it could. It was only when the bicycle fell and the bubble burst that they and the world started thinking of the importance of training wheels. The Abe govt. needs to start the painfully slow structural processes and secure the future of the nation’s youth. As the Japanese saying goes, ‘if you catch a fish for a hungry man, you feed him once; but if you teach him how to catch fish, you feed him for life!’

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Cover Story

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Insurance Sector in India: Miles to Go AnkurKumar

Introduction If India is to emerge as a world super power, it needs to empower its people. This empowerment includes not only increase in purchasing-power or income and better education and health services but also the security against unforeseen happenings and thus a well-developed, all-encompassing insurance sector. Despite having a huge population of 1.2 billion people, India currently accounts for less than 1.5% of the worldâ&#x20AC;&#x2122;s total insurance premium(1). Insurance penetration, which is measured as ratio of premium (USD) to GDP (USD), is 3.9%(2) for India, while the world average is 6.3%(3). There is a huge potential in this sector to tap under-insured and un-insured. Historical Perspective: Call it a gift to the people of the country,

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IIM Shillong

the Insurance sector was liberalized in the year 1999-2000. Before liberalization of the industry, LIC (Life Insurance Corporation) had monopoly in the sector. The industry consisted of only two insurers name LIC and GIC (General Insurance Corporation of India) and GIC had four subsidiaries companies. But with the opening up of the sector, it has witnessed influx of private players and continuous growth. At the end of March 2014, the country had 53 insurers. Of which, 24 were in life-insurance (23 private companies), 28 are in non-life insurance (22 private companies) and 1 in the reinsurance which is GIC, as per the IRDA Annual Report 2013-14. Gross domestic premium of the sector also seen continuous growth by a CAGR of 17.6% between FY02 and FY12(4). Also general insurance industry has grown in tandem with the nominal GDP of the country thus Insurance

Penetration remaining fairly constant. The most significant change in the industry after liberalizing the sector came in 2007 when the regulatory pricing was replaced by the pricing-by-market-forces popularly known as Price Detariffication. This move significantly impacted the premium rates and growth in non-life insurance companies. This step has also intensified the competitiveness of the industry with more private players joining the business with 10 new companies entering the general insurance sector between FY06 and FY12. Finding the Right Distribution Model: Due to the sheer population of India, it becomes imperative for the insurance companies to find the right distribution model which must be cost-effective as well as large enough to capture the vast market. After the liberalization in this sector, the private players came in and they found the tied-agent model of the LIC quite good. Under this model an agent was an employee of the company with the fixed salary with some variable components. However the structure of this model was costly. Firstly, the agency is not always activated. A typical agent manager would supervise 10 agents but would source business only from

1-2 agents. Also the business would work on Minimum Business Guarantee where the agent manager needed to provide some agreed business (either in terms of volume or value) to the company. This is accomplished by again a tail of agents employed by the agent manager. This would reduce the margin in the sector. Secondly the companies needed to have more number of branches to grow. Branches in tier-I and tier-II cities would not justify the volume of premium collected as the competition in these cities were very high. And the matter becomes worst when the branches are opened in tier-III and tier-IV cities. Because, though here the competition was low but the market-size was very less limiting the prospect for growth and also putting pressure on margin. Also a lot of mis-selling happens because of improper knowledge of the agents. Moreover, agents needed to build to trust with the client for sustained increase in the business. All these led to the companies adopting bancassurance model. This model became instant hit with the companies with the bank earning fees without any risk and the insurance companies gaining by leveraging upon the established network of bank branches. But this model too had inefficiencies. Insurance is the business of solicitation while the banking need is derived by the customers. The bank also finds conflict of interest as customers start preferring insurance products in place of

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NIVESHAK

typical bank products like saving deposit, fixed deposit etc. Moreover due to the increasing complexity in the insurance products the bank employee finds it difficult in selling the insurance product. Internet-based Model: To mitigate all these hindrances, the sector has adopted internet-based distribution channel. India had 354 internet users in the first-half of 2015, as per Internet and Mobile Association of India. As per RBI Annual Report FY14, electronic transaction by volume grew by CAGR 19.68% from FY12 to FY14 while that in terms of value grew by CAGR 18.56% in the same period.

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imperative for companies. The way banking industry has revolutionized its functioning through app-based services, insurance companies need to tap this opportunity. For the year 2014 the mobile internet user was 159 million which is projected to almost double to 314 million by 2017(5). As mobile users already comply with the KYC, and with the Adhaar-enabled bank accounts the Insurance companies can easily leverage this opportunity to solve the problem of distribution channel. Insurance Sector Product-Mix: The main products of industry comprise Health Insurance, Motor Insurance, Fire Insurance

Also a n

added advantage of this model is that when a customer buys through internet, he takes informed decision and so the chances of misselling gets significantly reduced. Centre-of-Influence Model: But what about rural India where around 70% of the population still lives. With the increased thrust by the new government for financial inclusion combined with the Adhaar, there is a huge scope for growth. Also with the new payments bank coming up, Insurance companies need to join this bandwagon to take advantage. Unlike Urban areas, rural areas lack financial knowledge as well as faith. This can be mitigated by developing rapport with what is called the Centre of Influence like Sarpancha, Head Masters of schools, Post Master etc. Mobile-based Model: Providing mobile-based service has become

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and Marine Insurance. While the overall GDP growth and socio-economic factor will impact the growth of the industry each segment will have their specific growth drivers. Health Insurance: The share of out-of-pocket expenditure for the health related issues continue to be significant compared to the other nations. This provides a big opportunity for the companies to tap the untapped business. Also with the growth in the healthawareness, urbanization, increasing income and substitution of out-of-pocket income with the medical-insurance the sector will see continuous growth. Motor Insurance: With the increase in disposable income and urbanization the automobile industry will see better future. Consequently the Motor Insurance will get fillip. Fire Insurance: With the cost of compensating employees for any mishaps growing substantially and more and more companies becoming conscious about the severity of

Cover Story

the accident, the companies are going for Fire Insurance. Marine Insurance: This segment will see continuous growth with the increase in the international trade. With the implementation of GST, this sector might be impacted with the change in strategy by companies to locate their manufacturing and warehouse. Micro-Insurance: The discussion on the Insurance sector in India would be incomplete without deliberation on Micro-Insurance. Micro-Insurance is defined as providing risk-coverage to the low-income group of people. Generally the product is modulated to meet their requirements and small premiums with flexible time for payment. Micro-insurance sector took its root in India with some NGOs, hospitals and MFI providing such service. However they were outside the ambit of any formal government or regulatory regulations. The micro-insurance sector changed with the law being passed by the government in the year 2002 titled Obligation of Insurers to Rural Social Sector. In the year 2004, RBI allowed regional rural banks to sell insurance as corporate agent. In the next year, IRDA came up with the regulations for the micro-insurance. This step put India among a few countries to have regulations for micro-insurance sector. The distribution channel of the microinsurance is mainly dependent upon trust, relationship and collaboration as providing insurance to the last person in the country like India becomes highly costly. NGOs, MFI, Regional Rural Banks etc. and co-

operations form the core group of the distribution channel. The sector regulator IRDA provides rules which require insurance companies to prescribe certain percentage to the rural and social sector. For Secured Tomorrow: The future lies in bringing the vast underand un-insured population under the ambit of insurance. With the increased focus of the current regime for financial inclusion, the economical social security schemes brought by the government, the increasing e-literacy and internet penetration and the growth of payment banks, the time has never been so alluring for the sector to catapult the number of people insured. With the FDI in the sector being hiked up to the 49%, the sector is poised for more competitions and better products for the customers. The time is not far away when the last man in a small village will have a safe and secured life.

ÂŠ FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

NIVESHAK

FinGyaan

FinGyaan Cover Story

Weather Derivatives: Best Way to Hedge Against Unpredicted Weather ParamRaj & RichaSharma Loyala Institute of Business Administration

Weather derivatives are the newest category in the derivative segment. This type of derivatives are used to hedge against any type of unpredicted weather. Whenever the term weather derivative is introduced, people think of only agricultural sector. But the concept of weather derivatives is not only limited to the field of agriculture. Energy companies, construction companies and any other business whose business can be impacted by weather make extensive use of weather derivatives.

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The concept of weather derivatives originated in the year 1996. The first weather derivative contract was done between Aquila Energy and Consolidated Edison. Then, the concept of weather derivative gained popularity in the year 1997. The trading of weather derivatives started in Over the Counter (OTC) market but become exchange traded in the year 1999. The first weather derivative was introduced on Chicago Mercantile Exchange. As of 2011, weather derivative market covers a total fund of $11.8 Billion. The concept of weather derivatives is very popular in developed

economies like American and European nations but the concept is still in its nascent stage in developing economies like India. Derivative market has many instruments like derivatives on Stocks, Indexes, Currency, etc. But the concept of weather derivatives is completely different from other instruments. All the other instruments has some underlying. For example, an Index derivative has a particular Index as an underlying, Stock derivatives has a particular stock as an underlying and a Currency Index has a particular Currency as an underlying. All these underlying has some value. But in the case of Weather derivatives, the underlying is weather which has no value. This feature completely differentiates Weather derivatives from other derivatives used in the segment. This also means that like other instruments it cannot be used for directly hedging climate but it acts as a proxy to hedge any unpredicted weather. PRICING OF WEATHER DERIVATIVES Like other derivatives, the concept of Black Scholes formula cannot be applied to weather derivatives. Weather derivatives are generally priced by the mechanism of HDD (Heating Degree Days) and CDD (Cooling Degree Days). HDD is a measurement of how much degree is required to heat a building. Similarly, CDD is a measurement of how much degree is required to cool a building. An HDD equals the number of degrees, the average daily temperature is below 65O Fahrenheit. HDD=Max {65-Ti, 0}

Where, Ti denotes temperature on ith day In the same way, a CDD equals the number of

FIG1: HDD- CHICAGO MERCENTILE EXCHANGE

degrees an average daily temperature is above 65O Fahrenheit CDD=Max {Ti-65, 0} Where, Ti denotes the temperature on ith day Average daily temperature is calculated by taking the average of daily maximum and minimum temperature. Average daily temperature= (Tmax+Tmin)/2 After calculating the HDD and CDD on a daily

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basis, the values are culminated for a particular period say a month or a season which is then used in valuation of weather derivatives. Hn=∑HDD Where, Hn is the culminated value of HDD over a particular period And, Cn=∑CDD And , Cn is the culminated value of CDD over a particular period These types of parameters are used only

Where, S=spot rate r= Rate of return And t= Time period of maturity Likewise, options are priced according to the Black Scholes Formula which is given by: Call option = S.N(d1) -X.ertN(d2) Put option= X.e-rt.N(-d2) –S.N(-d1) The figure below shows the pricing of weather derivatives using HDD as the parameter on Chicago Mercantile Exchange.

FIG3: AVERAGE RAINFALL ND STANDARD DEVIATION (ALL INDIA BASIS)

Source: Ramesh Chand and SS Raju in case of Weather derivatives. All other derivative instruments are priced according to the traditional methods like future is priced by the formula F=S*ert

Source: www.investopedia.com As it can be seen from the above figure, the pricing of the contract is done on a daily

FIG 4:RAINFALL RECEIVED ON ALL-INDIA BASIS (in MM)

Source: Ramesh Chand and SS Raju APRIL 2016

basis. For example, on Thursday, the average temperature is 44O Fahrenheit which is 21O below the standard of 65O Fahrenheit. Therefore, the value of HDD equals 21O. After arriving at the HDD value, the HDD is multiplied by the contract price to get the contract value. Here, the contract price is $20, therefore, the value of the contract stood at $420 on Thursday. Similarly, the value of the contract is computed for each day and then all the values are added to get the contract value for a particular month or season. WEATHER DERIVATIVES IN INDIA Indian economy is an agrarian economy in which a large chunk of India’s population is involved. Every year, a large portion of agriculture produce gets destroyed due to unpredicted weather which affects both the farmer as well as the national economy. Because of this very reason, the concept of weather derivative is very feasible in India. Although the concept of crop insurance exists in India but still it is very different from Weather derivatives. Crop insurance covers events in which the chances of occurrence are low like hurricanes, tornados, etc. While a Weather derivative covers the low probability events also like excess heat, excess winter, etc. The table above shows the average rainfall and the variation in rainfall over a particular period. As it can be observed from the data, the variation in rainfall is very high in India. In the period 1950-51 to 1964-65, the variation was 10.7 standard deviation from the mean, which is a very huge variation. The variation increased to 12.5 standard deviation for the period 1967-68 to 1987-88 and then it falls back to 9.6 standard deviation for the period 1988-89 to 2005-06. This table highlights the fact that rainfall pattern cannot be predicted in India and thus Weather derivative represents the best way to hedge the risk.

The graph is an extension of above table. The highs and lows depict the variation in rainfall each year. Looking at the above graph, one can understand the urgent need of weather derivatives in India. But there are certain hurdles which are acting as the bottleneck in implementation of weather derivatives in India. In India, Forward Contract Regulation Act does not consider weather as a commodity. Therefore, Weather cannot be used as an underlying for Weather derivatives. The Act needs to be amended by the Parliament so that active trading can start taking place in this instrument. Also the government should start working on building Weather workstations across the country to measure the temperature at different locations. The government should collaborate with stock exchanges like BSE and NSE to disseminate knowledge about the Weather derivatives. Government can also come up with E-choupal to interact with the farmers directly regarding this instrument and handling all their queries.

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LPG in India Ankur Kumar IIM Shillong Today we have innumerable choices in all walks of life in India. You name it, and we have it. From automobiles to telecom, from pharmaceuticals to IT companies, from FMCG to Healthcare, each sector is bubbling with the companies competing to capture a yet little more pocket share of customers which in the end is benefiting customers. If we were to point out one single event in recent decades that changed the economic landscape of the country and catapulted the country from a chiefly agriculture-led economy to an aggressive contender in the economic super power, that event would be the historic decision in the year 1991 to open up the Indian economy.

knew at that time that the decisions which our policymakers took, more out of compulsion than choice, will become the crowning decision in the Independent India history. The Indian economy was supposed to be a closed economy. The vision of our great nationbuilders was to have a socialist economy where the government will play a major role with the market-economy tightly under its control. So what were the reasons that led to the opening up of the economy? Didn’t we have better options? Could the situation have been better (say more equitable distribution of wealth) if decisions were taken quite contrary to what happened?

In the history of Indian economy the year 1991 will receive a special mentioning. Little did we

The Historic Decision On July 24th 1991, then Finance Minister Manmohan Singh presented the budget in

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parliament where he announced New Industrial Policy (NIP) in which decisions were taken to open up the till now closed economy. Bro adly those decisions were directed to reduce import tariff, to deregulate the market and to encourage more private and foreign players in the market. More specifically the reforms were undertaken under these areas:

was necessary to obtain prior permission from the government for foreign investment. Either the upper limit was capped at very low point which will result in insignificant control over the company or each proposal must be approved by the government for its implementation. Most of these red-tapism was done away with henceforth.

Industrial Licensing: To protect the domestic industry from competition and to allocate the limited resources of the nation, which have very recently come out of the hold of the British rule, Industries (Development & Regulation) Act was passed in the year 1951. The act gave power to the government to regulate almost all of the industries in the country. But the exigencies of the crisis prompted the government to restrict the regulation to 18 sectors. These sectors were related to the security and strategic concerns, social and safety reasons. The proposed relaxation would be helpful to the many dynamic small and medium enterprises.

Foreign Technology Agreement In order to compete on the international forum, the Indian industries needed to be more competitive and technology-savvy. Technology would play a critical role in achieving the same. But since the Indian economy was agricultureled, it was imperative for the policymakers to allow the infusion of the technology from abroad.

Foreign Investment: The maximum level of equity participation was raised to 51% (2) of the total capital structure for industries generally known as “Appendix I Industries”. Prior to this reform it

It was decided that the automatic approval will be provided to the high priority industries and to other industries if that does not result in expenditure of foreign reserves. Indian industries will be free to negotiate the terms of technology transfer with their foreign counterparts. Also the companies will no longer require prior approval for hiring the foreign technicians and foreign testing of

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Public Sector Policy The policy makers gave public sector more power compared to private players after the independence as the motive was to ensure equal distribution of wealth. But lately it was observed that the public sector was suffering from huge losses, inefficient growth, poor management and inadequate attention to the R&D. Now the government decided that it will focus on industries which fall in the reserved areas of operation or are in high priority areas. Now only 8 industries will be reserved for the

Public sector while earlier 17 industries were reserved for the same. For the companies which were constantly making losses, institutions like BIFR (Board of Industrial and Financial Reconstruction) were set up. For better management private participation in the government companies were deemed necessary and so to divest the government stakes in the companies Disinvestment Commission was set up in August 1996.

The growing expenditure by the government could not be handled due to hardening of budget constraint from FY87 because of two main reasons. Firstly, increasing deficit had to be financed by the borrowed capital. In FY87, RBI’s net credit to government reached to its highest level at 5% of GDP. Secondly, due to the recommendations of the Fourth Pay Commission, the States alone were to bear increase in salaries of 18%. Moreover, the drought of 1987-88 added salt to the injury. The

growing

trade

imbalances

could

be attributed to the oil-shocks, growing protectionism and loosing competitiveness in the export market. Between FY71-FY79, Trade Imbalance and Fiscal Deficit remained almost stable. However from FY80, the fiscal deficit rose considerably and so did the Current Account Deficit (CAD).

In early 1991, the CAD rose to unsustainable height from 1.3% of GDP to 2.2% of GDP from first half of 1980s to second half of 1980s). Due Monopolies and Restrictive Trade Practices Act to this, large borrowings were undertaken. (MRTP Act) MRTP Act came into force in June 1970. Under The country started facing strains from 1986 the act large companies which had assets of Rs. with the repayment obligations to IMF started 100 crore or more require prior approval form continuously rising. Also the repayments to MRTP Commission because such companies private creditors saw continuous growth and were allowed to invest only in select industries. were almost equal to the IMF repurchase obligations. But with the reform, the act was amended kjkkunder which prior permission for setting Moreover, the Gulf War accentuated the up of industries and expansion will not be problem with the loss from export revenues, required.Now the focus will be more on remittances and the panic buying of oil from limiting the role of monopolies and unfair and the spot market at higher prices of $30 a barrel. restrictive trade practices. The situation led to impending condition The Reason Behind the Decision of default on loans. India’s debt rose to $72 With the benefit of hindsight we can say billion, third largest in the world after Brazil

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and Mexico. India only had $ 1.1 billion of reserves, enough only for 1 week of imports and it needed anywhere between $5 billion to $7 billion from IMF. With its long-standing ally Soviet Union facing economic and political crisis, India had nowhere to go. In the words of the then PM Mr. Narasimha Rao, India had “no soft options”. So, Are We Better Off? The reforms adopted were painful for the country which used to pride itself on selfreliant. But there is a saying that nothing comes free of cost. So, would the cost India borne at that time bear fruits? Simply, are we better off as compared to before? Chances are high that if one is reading this, then s/he had at least basic resources for sustaining a general life, and so unconsciously might end up concluding that yes we are quite better off. But a better analysis would be comparing the data before and after the reform. The growth in GDP did not show major shift after the reform period. GDP of India grew by an average of 5.7% during 1980-2000. This may be because though the reforms were initiated in the year 1991, it took time for them to fructify and produce results. Also the import increased from 8.57% to 10.65% and exports from 5.54% to 9.08% between 1980s and 1990s. The major reason for this substantial increase in the import and exports could be easily traced backed to the opening up of the economy. Between 1978-79 and 1989-99, India’s manufacturing export basket contained nearly 50% of intermediate and capital goods. Also the proportion in manufacturing shifted towards labor-intensive consumer goods. Combined with this is the data that the share of high-tech exports initially increased from 13% in 1978-79 to 31% in 1991-92 and then fell to 25% in 1996-97. This shows that there is a convergence towards labour - intensive sector away from tech-based sector.

happen. This might be explained that initially the economy was agriculture-based i.e. vast number of labors were involved in that sector. They only needed a better opportunity to be absorbed and then foreign companies came in to tap that opportunity by setting up more labour-based industries. One of the sectors to get most advantage from the reform is the software industry. Also the added advantage for Indians was that they were technically educated in the English language compared to China. In 1990, the IT export of India was about $131 million and this rose to $7.8 billion in FY02. Also one of the greatest advantage that India realized because of the timely opening up of the economy is the internet. If the country would not have opened up at that time chances were quite high that the country would have been left behind in the development of internet which is revolutionizing the whole life of each and every one. With the vast middle class and growing population, India is a cash cow for foreign companies and they got this opportunity in 1991. Conclusion Though there are miles to go, we are certainly better off from what we were before the LPG. Today the mobile-economy could be the answer of many problems plaguing the economy. But mobile revolution is itself is the product of the reforms initiated during 1991. Though there might be concentration of wealth in the market-led economy. But the people are getting benefits in some or other way like more interaction with the outer world. More hospitals, more choices, more competition, more employment opportunities and increasing cohesion with the outside world are all helping to lift the economy and its people out of tatters. The only thing that we need now is to keep that momentum of reforms going.

Though it might seem that because of the opening up of the economy share of the technology sector would increase, it did not

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income inequality, the trend of high income inequality is seen mainly in developing nations. But, there are many exceptions to this trend, the most prominent one being the United States, which has the most unequal distribution of income, with over 30 percent of income in the hands of the richest 10 percent and only 1.8 percent going to the poorest 10 percent.

Addressing the Rising Gap Between the Rich and the Poor SwatiSuravi

XIMB

Introduction Even today, despite all efforts to bridge the economic gap, there exists a huge gap between the rich and the poor. A startling revelation in a study by the World Institute for Development Economics Research at United Nations University reported that the richest 10% of adults accounted for 85% of the world total, while, the bottom half of the world adult population owned barely 1% of global wealth. According to the Organization for Economic Cooperation and Development (OECD), this gap is widening. This can be inferred from the following data:-

a Gini index value of 0 represents absolute equality, and a value of 100 indicates absolute inequality).

(The gap between the rich and the poor or the global economic inequality index is measured by the Gini Coefficient in which

We can see from the above data that while developed nations have low Gini Index i.e. low

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This huge and widening gap between the rich and the poor has severe economic as well as social repercussions and efforts must be made to bridge it as much as possible. Over the past many years several NGOs, Corporate Houses, etc as well as the Government has come up with charitable measures such as free food, clothing, housing, health facilities, sanitation, education etc. This definitely helps lift up the poor and reduce the gap between the poor and the rich. But, charity is not a way to provide a source of long term sustainable livelihood. If the basic needs and necessities of life are provided free of cost to people, they do not have much incentive

to work hard for their living. This adversely affects the economy since there emerges a class of free-riders who act as parasites on other people’s wealth. This also de-motivates people to work hard for a earning. This is most certainly not the way the economy should work. Hence, the market economy must be stimulated in a way to generate more income and employment opportunities so that the not-so-fortunate ones get ample opportunities to rise up the income ladder and be prosperous. This would provide them with a sustainable source of livelihood as well as incentivize them to work harder for a better pay. This can be achieved by taking the following steps:• Changes in work structure Changes in the work policy, environment and structure can take place that are intended to reward, recognize and appreciate hard work and talent and at the same time provide equal

Although most countries are growing in terms of GDP, there is unequal distribution of this income. While the rich get richer, the benefits of a growing economy barely percolate to the poor. This results from lack of financial inclusion, mainly in developing countries, which prevents the tickling down of wealth to the poor. Also, there is a huge disparity in distribution of income and wealth among various countries of the world which can be seen as follows:-

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opportunities to the poor. Such a change would encourage the culture of more work and a healthy competition which would stimulate the economy positively, implying more growth and more production in the economy. This would lead to more employment, better pay which means a greater purchasing power in the hands of people and thus, greater demand. Greater demand would encourage production houses to increase their production, which needs employing more people. Hence, there occurs a virtuous cycle whereby demand fuels supply and vice-versa leading to an overall growth in the economy. In this process, we see a rise in

• Elimination of Black Economy A big hindrance in the path of bridging the richpoor gap is the prevalence of a large amount of black money in the economy. A black economy is a big road block in the path of ensuring equitability in income and wealth. A black economy refers to the part of a country’s economic activity which is unrecorded and untaxed by its government and it is a market in which goods or services are traded illegally. According to the World Bank researchers’ paper: “Shadow economy or black economy also included all market-based legal production of goods and services that are deliberately concealed from public authorities to

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market practices and at the same time detect and confiscate black money in the hands of people. Without such measures being taken, it is impossible to see a world with fair and equitable distribution of income and wealth.

income, employment opportunities as well as enhancement in the standard of living of people. Providing equal opportunities to the poor ensures that they are not left out from reaping the benefits of this virtuous cycle and are given a fair chance to get lifted in the social and economic ladder. • Provision of Micro-Finance and Training Facilities Today, there have emerged many institutions that intend to make the poor people self-sufficient as well as give them ample opportunities to prosper. Micro financing has become a buzz word in developing nations. These aim at providing easy credit to the poor to help set up their business. Also, guidelines and assistance is given to make such businesses profitable. Apart from that, vocational as well as technical training centers are being expanded and upgraded to reach out to a larger number of people and make them employable.

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avoid payment of income, value-added or other taxes or to avoid payment of social security contributions or having to meet certain legal labour market standards, such as minimum wages, maximum working hours, safety standards and to avoid complying with certain administrative procedures, such as completing statistical questionnaires or other administrative forms”. The average size of black economy is estimated to be about 13% in developed nations and about 36% in developing nations. Also, India’s black market economy is estimated to be as high as 30% of the GDP. With a big portion of the world economy being run by illegal and unfair practices it is futile to think of taking any concrete measure to bridge the global poor-rich gap without first attempting to destroy the black economy almost completely. Steps need to be taken to curb black

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• Encouraging flow of FDI and FII to under-developed and developing countries:As seen from statistics of Gini Index of various countries, we came to the conclusion that most developed nations had low Gini Index i.e. lower inequality while the developing and underdeveloped nations had high Gini Index i.e. high inequality. Also, the standard of living of the poor in developed nations is way better that that in developing or under-developed nations where people not only lack the basic needs and necessities of life but live in conditions of abject poverty with minimal or no access to health and education facilities. Hence FDI and FII must be encouraged from the richer countries to the poorer nations. The fact that most underdeveloped countries are rich in natural resources since resources are under-utilized is a major incentive behind such investment but this must be coupled with steps such as minimizing procedural hassles and other barriers like taxes. A larger flow of capital and other resources would boost the under-developed market-economy and also improve the level of technology. This would mean greater employment and improved productivity as well as more purchasing power in the hands of people. Also, many countries need foreign aid and support to boost their marketeconomy.

• Role of International Bodies:International bodies like World Bank and IMF play a great role in removing disparity in availing resources for growth and development among the rich and poor countries. They provide financial as well as advisory support to under-developed nations to help kick-start their economic activity and give them an opportunity to progress and prosper. Also, organizations like WHO and UNICEF provide health and education facilities to the poor, free of cost, thereby enhancing their standard of living. This enhances the quality of manpower in such economies, which indirectly contributes to boosting productivity of the economy. These organizations can work in a more pro-active manner to ensure provision of at least a basic standard of living to each and every individual thereby, bridging the global gap between the rich and the poor.

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From April 2016, Marginal Cost of Funds based lending has come into effect. What are the possible impacts of this change on the banking industry? In general terms which applies to all Industry, Marginal Cost is that fluctuation in relation to the present total cost of fund or a gap or effect which arises in producing the next unit. This can be varying in short term as well long term. As a simple thought process, there are no fixed inputs or fixed cost or average cost of Bank applicable in calculation. Whatever the changes happen with the cost of fund over a period of time that effect has to be passed on to consumers at regular interval. RBI has several times decreased the interest rate and directed to banks to reduce interest rate to consumers, but for banks, as their average cost of funds is on increasing level, it is difficult to manage deposits pricing on immediate bases. Hence, to improve transparency, RBI has directed banks to calculate their card/base rate based on marginal cost of fund and that will help to ensure that interest rate change is passed on to the borrowers. The main concern is the intent of the banks and if it is applied properly in a desired way, it hits on the income of the banks but the borrower will definitely get good benefit. Secondly, due to changes in the formulas applying in last couple of years, the customer is not really able to understand what it is and how it impacts on his/her interest burden. As understood, consumers or borrowers have to understand the MCLR calculation system and negotiate with the Banks. However, the Corporates do it but the retail borrowers are the key consumers in terms of volume as all-

time high in demand. India has been an agriculture-led economy. But even after around seven decades of independence, agriculture sector has not developed much. Why regulated financial sectors have maintained a distance from this sector? India ranks second worldwide in farm output. Agriculture and allied sectors like forestry, logging and fishing accounts for 17% of the GDP. Still we can find good opportunities in terms of methods in low cost of cultivation and better quality produce. What we understand during the last couple of years is that crop yield per unit area of all crops has grown, due to the special emphasis placed on agriculture in the five-year plans and steady improvements in irrigation, technology, application of modern agricultural practices and provisions for agricultural credit and subsidies since the Green Revolution in India. India is the largest producer of milk, jute and pulses in the world, and also has the worldâ&#x20AC;&#x2122;s second largest cattle population. The problem is not going to be in agriculture production or quality, but in farmersâ&#x20AC;&#x2122; incomes, which might slide because of poor harvest and falling prices. In terms of financial sector, as we are aware, financial institutions have to fulfil their PSL and, specifically, agriculture targets and hence, by choice or compulsion, institutions have to take interest in this segment. While checking the subsidies sponsored by State or Central Govt., Capital or Interest subsidy is project specific and has to be financed through banks only. Financial sector tools by way of loans, guarantees etc. can

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support in new projects and beneficiaries for sustainable growth and development in agricultural industries. Agriculture is thought of as a little-less profitable business as it is perceived with high risk and low credit quality. But lately banks are recognizing opportunities in this industry. What are the potential areas for banking industry to venture into agriculture industry? Question on profitability can be addressed by Profit and Loss i.e. investment, Income and Expenses. What is observed in reality is that the investments on land developments, seeds and inputs, fertilizers, pesticides and water are increasing gradually but the return is found to be fluctuating. If I elaborate this issue with some examples : Cotton: The volatility is largely dependent on Asian cotton and on water availability in countries like India, China and Pakistan. Cotton prices continue to remain stable in major markets as there is major stockpile in China’s Govt-controlled market. Farmers have reduced cotton cultivation area in response to high production costs, labour shortages, low cotton prices, higher government subsidies for grains and weak global demand. Other examples include: castor, sugarcane, horticulture etc. Second major factor is the utilization of Bank Finance (end use of fund) and intention on the new initiatives and modern farming. Also there are some opportunities for farmers to earn secondary income like Cattle farming, sell of farm yard manures, consulting to urban farmers etc. Farmers are also advised to use proper natural resources and also divert their focus on renewable energy and fuel generation segment. We can observe some tendencies in farmers like there are some farmers who really want to implement new initiatives and also properly utilise bank’s fund and take Govt. subsidies and policy advantages, and on other hands, there are farmers who take loans just because to avail subsidies and benefits. Currently, parties involved in agribusiness are

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found to make agribusiness profitable with proper utilisation of resources, funds and its marketing arrangements with proper/high grade quality of production. Banking finance or investments are key factors in complete value chain and to bridge the gap between backward and forward integration. Banks can be a partner in all agri-sector industries, say, in agri-processing industries, feed and input industries, infrastructure chains (like cold storages/godown etc.), agriculture marketing franchise, IT etc. which all create bridge to complete agri value chain. Productivity in agriculture industry in an important factor. What are the potential areas the government should focus upon to improve the agriculture productivity? As we all are aware, farming always depends on natural elements. But in earlier years, farmers were doing some practices which would increase their productivity, say, like keeping their land open for at least 3 months, less utilization of chemical fertilizers and pesticides, natural soil treatment to increase fertility, water harvesting to increase water level etc. Day by day, farmers are growing crops throughout the year and using all stuffs to increase their productivity which is eventually affecting the natural elements present in the land. Land fertility and water management are very critical elements to run this industry. As we understand, presently, cost of water is set according to the block area and the cropping pattern but is not related to the volume of water in anyway and attracting to improper utilization of water. Agriculture Factor: Govt. should do more to focus on water management system and its utilization, water conservation projects and its proper implementation, quality control mechanism on seed, fertilizer and pesticides, road and infrastructure, soil and water testing labs at local level, plant protection activities etc. However, in recent days, we have seen good guidelines on crop insurance policy which help farmers in case of crop failure.

Social & Economical Factor: Agriculture is not only about the farming practices but social factors, like community, politics, healthcare, education, employments, wages, investment and finance etc., are also critical elements affecting this industry. Yes, Govt. and other public media/organisations are making policies and working on developments on these factors but effective implementation from both the sides is required. Major factor now a days affecting is global environment rapid changes which directly affecting food security. Its alarming and all stakeholders to address this issue and to act upon to cater food security and sustainable life cycle. Moreover, renewable sources of energy, like solar energy and wind energy, can be better targeted by the government. Instead of having country-wide common policies, area-specific policies should be formulated for better result. What would be your advice to the budding professionals who would want to join banking industry? What are the specific set of skills they need to develop? The Indian Banking is very well capitalised and regulated as per RBI. If we take a snapshot of the banking industry structure, it consists of Public Bank (26), Private Banks (25), Foreign Banks (43), RRBs (56), Urban CoOp Banks (1589), Rural CoOp bank (93550). Also we are expecting the roll out of innovative banking with small finance banks say 11 payments Banks and 10 small finance banks in the coming fiscal year. Banking industry is expected to expand across Urban, Semi-urban and especially in Rural areas. As per RBI and Govt. stipulations, banks are expected to expand in rural areas which are still untapped and can be found huge opportunities. We have seen couple of movements in Public Sector Banks for giving opportunity to young generation and also observed chunk of employee’s retirements. Hence, can expect good opportunities in this segment.

We are observing new technology-driven banking, IT and software based - banking, Relationship and Service based - banking and these are emerging key components to get new customers to the Bank which attract good opportunity for youth of this time. Apart from common skills, some Competencies like team work, problem analysing and solution provider, better executer than planner, empathy, analytical thinking and risk-taking spirit, flexible attitude in high-pressure/keep changing/quick updating, internal-external dealings will help for suitable and sustainable banking life as a profession.

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Money Market Hedge

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Shreyans Jain IIM Shillong

market @ .5% for three months 5. Liquidate the investment after three months and pay off the liability Thus, it ensures certainty of cash flows. The outflow on account of this transaction for ABC Limited will be Rs. 6,61,69,163 (9,95,025*66.50) plus an interest cost on the borrowed money irrespective of Sir, while going through the concepts the exchange rate prevailing at the time of settlement. of Foreign Exchange Market, I came across the term “Money Market Hedge”, could Sir, how would an exporter set up a you please explain to me what it means? money market hedge? Money Market Hedge is a technique used to hedge foreign currency exchange risk. It involves setting up An exporter will undertake the a foreign currency asset against an equivalent amount following steps: of foreign currency liability and vice versa. 1.Borrow the foreign currency equivalent to the of the future Could you please explain how an amount of present value receipt importer uses this technique? 2. Convert the borrowed foreign currency into the domestic currency Consider an Indian company ABC Limited 3. Place the domestic currency on deposit purchased goods worth USD 1 Million from a 4. Settle the foreign currency loan against the US based company, XYZ Inc., payment due after realisation from customer three months. Here, ABC Limited faces the risk of appreciation of US Dollars. ABC Limited can invest in Dollar deposits and receive interest @ 0.50% for Sir, what are the advantages of using three months. Consider spot exchange rate Money Market Hedge over other hedging equal to Rs. 66.50/USD. To perform a techniques? money market hedge, ABC Limited will undertake the following Money Market Hedge is suitable for a small steps: business that does not have access to the currency 1. ABC Limited will determine the forward market. It is an effective way of hedging for present value of the foreign currency currencies where forward, futures or options are not to be paid (i.e. PV (1 Million, .5%) = available. However, it is not widely used because of USD 9,95,025) the complexities and costs involved in it. 2. ABC Limited will borrow an equivalent amount in the domestic currency (i.e. 995025*66.50 = Rs. 6,61,69,163) 3. Convert the amount borrowed in domestic currency (INR) into the foreign currency (USD) in the spot market 4. Invest these US Dollars in the money © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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Ankit Goel XLRI

Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1500/- along with a certificate. Instructions »» Please send your articles before 15th May, 2016 to niveshak.iims@gmail.com »» The subject line of the mail must be “Article for Niveshak_<Article Title>” »» Do mention your name, institute name and batch with your article »» Please ensure that the entire document has a wordcount between 1500- 2000 »» Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 »» Please do NOT send PDF files and kindly stick to the format »» Number of authors is limited to 2 at maximum »» Mention your e-mail id/ blog if you want the readers to contact you for further discussion »» Also certain entries which could not make the cut to the Niveshak will get figured on our Blog in the ‘Specials’ section

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April FinQ Winner 2nd Prize - INR 500/-

Saurav

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XIMB

Finance and Investment Club (PGP14) Thanks a lot for your support and guidance

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