Niveshak August 2016

FROM EDITOR’S DESK Niveshak Volume IX ISSUE VIII August 2016 Faculty Chairman

Prof. P. Saravanan

THE TEAM Aaron Keith Rego Abhishek Jaiswal 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 ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

Dear Niveshak We welcome you to our eighth anniversary issue. What was started as a small initiative to keep abreast the readers about the finance and economic issues, has now grown into a full-fledged magazine with different sections, articles, contests, interviews and lots more. All of this has been possible only because of your continued support which has been the fuel for us to continuously try to exceed your expectations. In the run up to the anniversary issue, we organised our anniversary issue contest Celebratio. This time we had two different task. Firstly we invited a model to select stocks based on the principle of Value Investing and for the second task we gave country-specific industry topics and invited the views on those topics. We are very enthusiastic from the huge response from our readers. It was a herculean task for us to select the winner. It would be unfair on our part if we did not thank all the participants who showed their enthusiasm for the events. You could find the top three industry analysis in this issue. From this anniversary issue, we have tried to set the standards high and have introduced a new section in our magazine – Equity Research Report. From now onwards, each month we will select a stock and would publish an ER Report. We hope that it would add to your knowledge. This time, we have brought to you the views of Mr. Rajendra Kalur, Director & Chief Executive Officer, TrustPlutus Wealth Managers (India) Private Limited and Mr. Jay Shah, founder of Ventureforth and President Star Advisory Services, LLC. They gave their views on wealth management and raising capital. Talking about the month, the benchmark Sensex ended with around 1.5% higher than the start of the month. Also the month made some of the important news that would have long-term implication for the Indian economy. One of the most important event for the month was the announcement of the new governor of RBI Mr. Urjit Patel who would replace Mr. Raghuram Rajan when his term ends in September. Mr. Patel is the former deputy of the RBI and brings with him vast experience in the field of banking and economy. Other important event was the introduction of a bill in the parliament that would fast-track the debt recovery process. It is important in the respect that it would fasten the process of debt clearance for the banks. Finally, all of this would not have been possible without your support and enthusiasm. You are our prime motivators and we continue to look up to you. Though we have come so far, but we would not become complacent and would try to continue to provide you with the stimulating ideas and opinions. With all your blessings Stay Invested! Team Niveshak

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

CONTENTS Niveshak Times

04 The Month That Was

Cover Story

Equity Research

10 Lupin Ltd.

Article of the month

14 SBI- Associates’ Mega-Merger

18 A look back with an eye on the road ahead

FinView

33 Rajendra Kalur, Director & CEO

TrustPlutus Wealth Managers (India) Private Limited

FinGyaan 22 The Microfinance Story

FinView

34 Jay Shah, Founder of Ventureforth and President, Star Advisory Industry Analysis

FinRewind

Indian Stock Market Scams 36 Analysis of Banking Sector in – The Harshad Mehta and Ketan Italy Parekh Case

Industry Analysis

FinSight

30 Impact of global turmoil in Commodity markets on Indian economy

41 Automobile Industry in Germany

Industry Analysis

45 Oil and Gas Industry in Russia Classroom

52 Special Purpose Vehicle

The Month That Was

NIVESHAK

www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

IIM Shillong Indian Economy Showing Signs of Recovery Data released by the government department shows that the Indian economy is showing signs of green shoots. Core sector output grew by 5.2% in June and the seasonally adjusted Nikkei India Manufacturing Purchasing Managers Index was at its 4-month high in July at 51.8. The core sector comprises of around 38% of the industries in the Index of Industrial Production (IIP). Regarding Purchasing Managers Index, any sign above 50 shows expansion. Moreover, a private survey showed that the manufacturing activity grew at its fastest pace in four months in July. As per the government data, coal output grew by 12%, cement output grew by 10.3%, electricity production rose by 4.5% and steel output grew by 2.4%. Crude oil and natural gas were the only two sectors where the production declined by 4.3% and 4.5% respectively. In all, the Indian economy is set to rise on a path of growth with expected good monsoon, healthy growth in core sector output and rise in manufacturing PMI. A Bill to Fast-Track Debt Recovery Process Laden with the burden of heavy Non Performing Assets and the inability of quickly recovering the debt through auctioning of collateral, banking sector could not become much worse. But now it could take a sigh of relief. The Lower House of Parliament has passed a bill that would amend four different acts. Through the amendment of these acts, the debt recovery process would be expedited. The bill, The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016, aims to amend the Recovery of Debts due to Banks and Financial Institutions Act of 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act of 2002, the Indian Stamp Act of 1899 and the Depositories Act of 1996. The act proposes to set up a central repository that will have records of transactions related to

AUGUST 2016

secured assets. This will help in determining clear ownership of an asset and thus would expedite settlement. Airwaves Spectrum Auction Coming: Government Could Net in Around INR5.56 lakh crore The government would start its largest auction of 2G, 3G and 4G airwaves in the coming month and would be able to net in a minimum of INR5.56 lakh crore if all spectrums are sold at the base price. The Department of Telecom has released Notice Inviting Application (NIA). This document outlines the process and the various conditions that a telecom operator would need to fulfil before becoming eligible for participation in the process. However, the telecom operator said that because of the high base price, the demand for the spectrum is likely to be low. As per the guidelines stated in NIA, telecom operators could not go for any sort of consolidation in the market until the auction process is completed. This has been done to improve the demand for the spectrum. Indian Government Amending Bilateral Pacts for Investment Clarity In a move towards increasing foreign investor participation in the country by providing more clarity and ensuring fairness to all investors, the Indian government has written to Singapore, Japan and South Korea to revamp the investment treaties. The current treaties treat foreign investors on par with the domestic companies. The loop side of this provision is that this might bring India to the international litigation by potential foreign investors. The planned model would treat the foreign investors on par with the domestic investors once they set up their business in the country. Dabur to Ramp up its Ayurveda Portfolio Increasing health consciousness and rising awareness among people is driving the demand for Ayurvedic products and the home-grown

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NIVESHAK

8000-crore FMCG major Dabur is quick to tap into this opportunity. Dabur is planning to expand its Herb Farms to 3,800 acres by March 2017 from 2,000 acres currently. The development would span across eight states and would involve around 2500 farmers up from now around 1200 farmers. Dabur has a greenhouse at Pantnagar in Uttarakhand where it grows rare herbs and distribute to farmers for cultivation. The company then buys back the produce from the farmers. The move is also to counter the competition from the rising demand for the Baba Ramdev’s Patanjali’s Ayurvedic products. India to Introduce On-Road Emission Test Taking measures to reduce the pollution from the vehicles plying on roads, the country would soon have real time emission test for vehicles running on the road. This is in line with some of the standard global practices to reduce the pollution level. Every vehicle has to go through the mandatory lab testing for pollution level. But the actual emission tends to be much higher than what it shows during a lab testing. All the guidelines have been worked out by the Ministry of Road Transport and Highway and the Ministry of Heavy Industries. The guidelines will include the parameters which could be easily quantifiable and would also include ways to check the use of fraudulent devices which might fudge the actual emission.

Also, the fashion segment is highly profitable as it provides around 1314% commission in terms of revenue to the online marketplace, according the experts. Future Group to Expand its Nilgiris Stores Future Group is planning to add stores in its southern India chain Nilgiris to take the store head count to 1000 in the next three years. Currently, Nilgiris has 160 stores in South India. The Group had acquired 98% stake in Nilgiris in November, 2014. It had entered into the bakery segment through Nilgiris. Also Future Group has tied up with the mobile payment app Paytm. This would enable the users to pay for the Future Group items through the app itself. Kishore Biyani said that the group is working towards omni-channel model by integrating online and offline mode. Credit Enhancement Measures: SBI to Take Initiative Infrastructure companies face a lot of problems when raising funds for their project partly due to the uncertainty regarding whether the companies would be able to pay back the money or not. To mitigate this problem, SBI may partner with LIC and IIFCL to set up a credit enhancement fund that will guarantee the credit ratings of bonds issued by infrastructure companies. IIFCL already has expertise in running its credit enhancement scheme.

Online Giant Amazon Adding to its Tech Team While home grown Flipkart is taking the path of inorganic growth by acquiring Jabong, the international player Amazon is jacking up its tech team in the fashion category to create an experience around the category. Both the rivals are competing heavily for the fashion segment which is going to command around 35% of online marketplace by 2020, according to a report released by Google and AT Kearney. Currently, Flipkart has a market share of around 55% in the online fashion marketplace which Myntra and Jabong under its kitty.

The Month That Was

The Niveshak Times

www.iims-niveshak.com

NIVESHAK

28300

BSE

28200

DII

1,500

FII

1,000

28100

BSE

28000

500

27900 27800

27700 27600

-500

27500 29-08-2016

26-08-2016

25-08-2016

24-08-2016

23-08-2016

22-08-2016

19-08-2016

18-08-2016

17-08-2016

16-08-2016

12-08-2016

11-08-2016

10-08-2016

09-08-2016

08-08-2016

05-08-2016

04-08-2016

03-08-2016

02-08-2016

01-08-2016

27400

-1,000

FII, DII Net turnover (in Rs. Crores)

Article ofSnapshot the Month Market Cover Story

Market Snapshot

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

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

1,10,76,932 Source: www.bseindia.com

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling

1.20%

INR/1 USD

1.00% 0.80% 0.60%

Euro/1 USD

GBP/1 USD

66.98 74.62 64.89 87.69

JPY/1 USD

SGD/1 USD

LENDING / DEPOSIT RATES Base rate Deposit rate

9.30%-9.70% 7.00% - 7.50%

RESERVE RATIOS CRR SLR

4.00% 21.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

7.00% 6.50% 6.00%

0.40% 0.20% 0.00% -0.20%

Source: www.bseindia.com

-0.40% -0.60% -0.80%

AUGUST 2016

Date as on August 31th

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NIVESHAK

BSE Index

Open

% change

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

28083 12734 12355 21148 21626 12430 15523 8750 16370 10822 9469 10676 2083 7232 1610 5959

28452 13217 12649 22008 22657 12458 15212 8822 16162 10439 9940 11073 2098 7506 1542 5753

1.31 3.80 2.38 4.07 4.77 0.45 -2.00 0.82 -1.27 -3.54 4.97 3.71 0.72 3.78 -3.45 -3.45

% CHANGE

% Change TECK, -3.45% Smallcap, 2.38% REALTY, -4.23% PSU, 3.78% POWER, 0.72% OIL&GAS, 3.71% MIDCAP, 3.80% METAL, 4.97%

IT, -3.54% Healthcare, -1.27%

FMCG, 0.82% CD, 0.45% CG, -2.00% BANKEX, 4.77% AUTO, 4.07% Sensex, 1.31%

Article Market of Snapshot the Month Cover Story

Market Snapshot

Niveshak Investment Fund

Done on 30/6/14

Information Technology(11.78%) TCS

HCL Tech.

Infosys

Wg: 3.90% Gain : 2.00%

Wg: 3.72% Gain : 4.81%

Wg: 3.31% Gain: 27.04%

FMCG(21.53%) Colgate HUL

Britannia

Wg: 5.46% Gain : 24.50%

Wg: 7.37% Gain: 233.54%

Wg: 4.53% Gain: 30.61%

Amara Raja Wg: 4.26% Gain: 38.83%

Godrej Consm. Wg: 7.67% Gain: 78.49%

Pharmaceuticals (10.87%) Dr Reddyâ&#x20AC;&#x2122;s Labs Wg: 3.78% Gain: 8.13%

Lupin Wg: 6.03% Gain : 31.32%

Midcap Stocks (12.26%) Bharat Forge Wg: 3.69% Gain: -5.19%

Kalpataru Power Wg: 4.02% Gain: -2.11%

HDFC Bank Wg: 6.99% Gain: 39.33%

ITC

Wg: 4.98% Gain: 14.56%

Misc. (12.90%)

Auto (9.00%) Tata Motors Wg: 5.18% Gain: 22.60%

Bank (6.86%)

Natco Pharma Wg: 5.20% Gain: 31.85%

Titan Company Wg: 4.37% Gain: 11.34%

Chemicals (8.46%) Asian Paints Wg: 9.15% Gain: 85.43%

Textile (6.35%) Page Indus. Wg: 6.38% Gain : 44.77%

Performance Evaluation

As on 31 st Aug 2016

Aug Performance of Nivehshak Investment Fund 175

102 101.5

165

101

155

100.5

145

100

Scaled Sensex Scaled NIF

135

99.5

125

115

98.5

105

98 97.5

Performance of Niveshak Investment Fund since Inception

1/8

4/8

7/8

95 10/8 13/8 16/8 19/8 22/8 25/8 28/8 31/8 30-01-2014 08-08-2014 12-02-2015 13-08-2015 16-02-2016 19-08-2016

Scaled Sensex

Scaled NIF

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 16,92,149 Change in Portfolio Value : 69.21% Change in Sensex : 31.72%

Value Scaled to 100

Risk Measures: Standard Deviation : 18.84 (Sensex 9.87) Sharpe Ratio : 3.46 (Sensex : 3.53) Cash Remaining: 58,000

Comments on NIFâ&#x20AC;&#x2122;s Performance & Way Ahead: The month of August saw a steep rise in the stock markets primarily on account on passage of GST bill by the parliament at the start for the month and positive sentiments from China in the latter half. The coming month will see the focus shift towards the company quarterly results and the Federal Reserve Policy meet whose decision on key interest rates could cause turmoil across the globe. The top performers during the month in the NIF were Britannia and Bharat Forge which saw a gain of 17% and 13% respectively whereas the laggards were Lupin and Titan which fell by nearly 13% and 4% respectively.

Equity Research

NIVESHAK

Equity Research report: Lupin Ltd. EQUITY RESEARCH REPORT – Lupin Ltd.

Date: 31stAugust

Rating Matrix Rating Target Current Market price Target Period Potential Upside (Annualized)

Buy Rs. 1604 Rs. 1484 7-8 months 8% (14%)

Basic Information Ticker (BSE)

500257

Ticker (NSE)

LUPIN

Sector

Pharmaceuticals

M- Cap

₹ 67119 Cr.

Company Background The company was established in 1968 with a vision to fight life threatening diseases using values such as integrity, passion, teamwork, innovation and customer focus. Today, it is the 7th largest generic pharmaceutical company globally in terms of market capitalization. Growing at a CAGR of 20%, the company had revenues of approximately $ 2.06 billion in 2015-16. Lupin’s R&D program headquartered at the Lupin Research Park located near Pune, the company covers the following products: Generics Research – Process & Pharmaceutical, Advanced Drug Delivery Systems, Intellectual Property Management, Novel Drug Discovery and Development, Biotechnology Research.

Business Description In the recent years, the emphasis though has been on the Research and Development of high quality drugs, the company has also focused on strategic acquisitions to gain access to superior technologies and also a wider market base. The company generated approximately 27% of its revenues from the domestic market, 43% from the US market and remaining 30% from rest of the world. The company is likely to see better growth in fiscal 2017 on the back of improved business in the US and the acquisition of New Jersey-based generics firm Gavis for $880 million. It expects Gavis’s sales to triple in three years to about $300 million. AUGUST 2016

NIVESHAK

Date: 31stAugust

Corporate Governance The Company’s philosophy on Corporate Governance lays emphasis on timely disclosures, transparent accounting policies, consistent value systems and integrity with a view to maximize long-term corporate value and preserving shareholders’ trust. The Company has instituted P.L.E.D.G.E. (Preparing Lupin Employees to Demonstrate Governance and Ethical Conduct), which encompasses three important policies viz. Code of Conduct, Whistleblower Policy and Prevention of Workplace Harassment

Shareholding Pattern (As per BSE) Promoter Public Others

Jun - 16’ 46.76 53.24 0.00

Mar – 16’ 46.52 53.48 0.00

Dec – 15’ 46.53 53.47 0.00

Total

100.00

Growth Drivers Generics dominate the pharmaceuticals market, constituting nearly 70 to 80 per cent of the market, with he Indian generics accounting for 20 per cent of global exports in terms of volume. Of late, consolidation has become an important characteristic of the Indian pharmaceutical market as the industry is highly fragmented. One of the key drivers in the industry are research and development, innovation, organic and inorganic growth strategies, managing legal USFDA hurdles, government policies / legislations, however India’s skilled labor, experience in pharma and a market hungry for cheap medicine will could help the pharma industry launch new drugs, explore new markets while expanding the existing ones. The Indian pharmaceutical market size is expected to grow to US$ 100 billion by 2025, driven by increasing consumer spending, rapid urbanization, and raising healthcare insurance among others. Going forward, better growth in domestic sales would also depend on the ability of companies to align their product portfolio towards chronic therapies. In addition, the thrust on rural health programmes, lifesaving drugs and preventive vaccines also augurs well for the pharmaceutical companies. © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Equity CoverResearch Story

EQUITY RESEARCH REPORT – Lupin Ltd.

NIVESHAK

EQUITY RESEARCH REPORT – Lupin Ltd. ROA and ROE

60.0

31.7

16.7

30.0

12.8

20.0 10.0

9.9

20.0%

13.3 13.9

8.2

16.0

27.0%

30.0% 25.0%

22.9

40.0

Date: 31stAugust Revenue & EBIDTA Growth

32.5

50.0

Industry Figure

Equity Research

15.0%

19.2% 26.3% 16.2% 16.5% 27.2% 16.3% 21.6% 18.5%

10.0% 5.0%

11.6%

0.0%

0.0

LUPIN DRREDDY CIPLA ROA

AURO ROE

CADILA Revenue Growth 5 Year EBITDA Growth 5 Year

Comparable Valuation We have calculated the stock’s intrinsic value based on a weighted average of DCF, Residual Income and Relative multiples based valuation. Starting FY17, growth in revenues have been estimated at a gradually declining rate averaging 13% for the first 5-yr and 6% for the next. Due to the non-cyclical nature of business, the sensitivity of Lupin’s stock is below 1, indicating a defensive nature with a WACC of 8.61%. The fundamental value stands at Rs. 1527.01 and given a CMP of Rs. 1483.65 as on 31st Aug, ’16, the stock is undervalued. Execution of Gavis pipeline, key product approvals from Goa, margin growth (US base business, Gavis margin, R&D), big-ticket approval for the US Generic business and growth from Japan exceeding expectations have led to high YoY growth in revenues and EBITDA in 1Q17. The target price by the end of FY17 has been estimated at Rs. 1604.44 using a forward PE of 26x (10% over industry average given superior returns). We recommend a strong BUY with annualized returns of 14.36% over a 7-month period.

Rating Definition BUY: If stock is expected to deliver more than 10% annualized returns over holding period NEUTRAL: If stock is expected to deliver (-)10% - 10% annualized returns over holding period SELL: If stock is expected to deliver less than (-)10% annualized returns over holding period

Valuation Summary Method Discounted Cash Flows Relative Valuation Residual Income Valuation AUGUST 2016

Value/Share 1669.24 1662.11 1249.68

Weight 0.33 0.33 0.33

Fair Value 1527.01

NIVESHAK

Date: 31stAugust

Industry Competition Industry Rivalry- (High)

• Top 5 players account for mere 18% of the market share • High Capital Expenditure & Working Capital

Buyer power – (Low)

• Power in the hands of the influencer (Doctors) • Fragmented Buyers

Threat of New Entry- (Medium)

• Supportive Government Policy but price regulation exists • Economies of Scale Exist • Proprietary Technology

Threat of Substitutes – (Low)

• No real substitutes for medicines • Biotechnology is a threat Industry Rivalry

Supplier Power – (Low)

• Standard inputs available locally • Low Switching Cost • Backward Integration is an option

Threat of… Buyers'…

Threat of New… Suppliers'…

Technical Analysis Using technical analysis we can see that the company has a strong support at 1400 and resistance can be seen at levels of 1650. An RSI of 37 indicates that the stock is oversold and is expected to rise up. Also the stock has historically followed a retracement of 61.8% of a trend and using Fibonacci retracements the levels of 1520 appears to create a support for the stock. Also the stock has recently formed a double bottom chart pattern and hence in the short term the trend for the stock looks positive and the current share price of 1520 would be a good price to enter into the stock for the short term.

Equity CoverResearch Story

EQUITY RESEARCH REPORT – Lupin Ltd.

Article of the Month Cover Story

NIVESHAK

SBI – Associates ‘Mega’ Merger BhavyaRastogi Introduction Consolidation of banks is in the air again, with State Bank of India (SBI) set to merge with five of its associate banks - State Bank of Bikaner & Jaipur (SBBJ), State Bank of Hyderabad (SBH), State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT). The merger of SBI associates is part of an ambitious plan of the Government to set up one large Indian bank in the consortium of global banking colossus. Since, India has a fragmented domestic banking industry, the proposal of the Government is that India needs stronger banks, not scores of banks. The eventual intention of the Indian government is

AUGUST 2016

IIM Shillong

to reduce the number of PSBs from the current 27. In the past too, the SBI has merged two of its former associated banks with it - Bank of Saurashtra in 2008 and the State Bank of Indore in 2010. The latest merger will create an economic behemoth with assets worth Rs. 37 lakh crore ($ 550 billion), including fixed assets of the associate banks worth Rs. 4,000 crore. The associate banks have approximately 5,400 branches and 63,000 employees. Proposition The issue of bank consolidation was projected by the regime in March at a summit of bankers and government officials where various matters

NIVESHAK

NPA (non-performing asset) management and rapid resolution seem to be the reasons operational in favor of consolidation. Long-term benefits The merger is a great move and would strengthen the group. There are certain longterm benefits that SBI can obtain from the merger. For instance, the total market share of SBI is 17-18 per cent while that of the entire group put together is approximately 22-23 percent. The merger could also provide opportunities to cross-sell products. SBI’s aggressive approach to grow its retail products as well as fee income will wipe out the prospects of its associates. Moreover, a merger

with the associates shouldn’t aggravate bad loans problems of SBI. Since the increase in bad loans will be slower than advances, the consolidation will expectedly improve the situation marginally. Besides making SBI more efficient, it will be of enormous value. The group will receive the benefit of all synergies. Also, the total worth of fixed assets of the associate banks is around Rs 4,000 crore, which will escalate the capital. The bank has a balance sheet of Rs 28 lakh crore which is expected to grow to Rs 37 lakh crore after the merger. All in all, the synergies being united in one place are going to be affirmative. Short-term pain The proposal of the Indian Government to consolidate the country’s Public Sector Banks leads to threats that, in the present-day fragile economic environment, could counterbalance

the impending long-term benefits. From a credit perspective, industry consolidation would have certain advantages such as strengthening the bargaining power of the banks, helping save costs and reconstructing administration and corporate governance across the banking system. However, these potential benefits are dwarfed by numerous downside risks. Clearly, the merger will reap long-term benefits, but it will be accompanied by shortterm pain. The move will certainly lead to higher operating costs in the near-term for SBI. Arundhati Bhattacharya, the Chairman

Article of the Month Cover Story

pertaining to banks were debated. In his Budget speech this year, the Finance Minister, Arun Jaitley had said that a structured plan for consolidation of public sector banks (PSBs) would be projected. All bankers sustained the idea of integration among public sector banks and that the state called for a handful of big banks instead of a great bit of little banks. What has bolstered the circumstance for such mergers at this step is the requisite to permeate capital in state-owned banks that are laden by a hefty heap of nonperforming assets—the consequence of an economic decline that made it tough for many over-extended corporate debtors to repay debt. Earlier, the argument that favored consolidation was capital efficiency that is the government would have had to shell out more for several banks from the same group, hence consolidation would support. But today,

Article of the Month Cover Story

NIVESHAK

of SBI, quoted in the media that employee costs are expected to leap by Rs 23 crore a month. Though SBI would have benefits of scale and a larger balance sheet, integration of staff and rationalisation of branches will be a major challenge. The employees at SBI are entitled to a pension, provident fund, and

actually determine the actual incremental employee cost. The varied employee benefit structures and a synchronisation of accounting policies for NPA recognition will have an immediate negative impact. In summation, there is a huge pressure on the asset quality of these banks. While the consolidated valuations

gratuity while those at associate banks do not receive contributory provident finance. Hence, aligning the pay structures will be an important aspect of rationalisation of employees. Internal arrangement and negotiations will

influence the asset quality stress adequately, an essential distress rests on the estimate it pays to merge these banks with it. Branch rationalization will also be a medium- to longterm benefit. But there will be obstacles which

AUGUST 2016

NIVESHAK

fear, and provide them an assurance that if they were getting personalized consideration, they will continue to receive the same. Not only that, SBI will have to instil in the minds of its customers that post-merger they will get far better reach, far better products because stateof-the-art products will be simultaneously rolled out at all of these institutions. The bank will encounter the challenge of restoring the confidence of their customers in their services post the merger. Moody’s Investors Service says, since 2012 the banking system of India has witnessed an upsurge in stressed assets, with the consequence that currently no public sector

marriage. A few weeks ago, workers, labour unions from the related financial institutions carried out a one-day strike and also have threatened to launch a larger demonstration throughout. The biggest challenge in any merger is always integration of human resources, because the employees have a lot of apprehension and trepidation. There is always a concern that impending prospects and opportunities will plummet. Many of these apprehensions are unsubstantiated. Also, the customers will be apprehensive of the merger as they will fear not getting the same kind of personalised attention. The Bank is required to reduce their

bank has the financial strength to undertake a role of the consolidator without putting its own credit standing at risk. As a matter of fact, the banks’ deteriorated metrics and feeble performance mean that they are encountering teething troubles to meet the minimum regulatory requirements without capital assistance from the Centre. Consequently, only a few PSBs have the surplus capital required to procure profoundly sized peers.

Article of the Month Cover Story

SBI and the government will have to overcome, relating to the integration of workforce, restructuring job profiles and remuneration of staff. Challenges The merger of banks presents its own unique challenges.The scale of the task is essential given the total staff strength. SBI offers suggested the desire to comprehend the merger within 201617. While India’s most ascertainable financial institution might cultivate vital things about a more stable equilibrium bed sheet, it will be a serious concern to integrate the personnel and streamline branches. The execution of the merger might be threatened by solid staff

Cover Story

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A Look Back with an Eye on the Road Ahead AnoopPrakash A Brief Introduction

IIM Shillong

bank is most likely to have a change in direction within the economy. Of course, the times that have changed since Mr. Rajan took office and will require a different outlook, uncertainty exists on the road ahead. In one of his recent speeches and one of his last few, he stated his confidence in his successor and said that Mr. Patelâ&#x20AC;&#x2122;s experience on working closely with the monetary policy will ensure the nation is in good hands.

Earlier this month, Mr. Urjit Patel was announced as the new Governor of the Reserve Bank of India (RBI), and is set to take office on this week replacing Mr. Raghuram Rajan, one of the most admired central bankers in the world. Currently, Mr. Patel serves as the Deputy Governor of the central bank. Previously, a panel under his chairmanship had proposed inflationtargeting and the setup of a monetary Mr. Rajan holding the post of the RBI policy committee. A change in the top position of the central Governor brought with it the high image of a world-renowned celebrity economist.

AUGUST 2016

NIVESHAK

has also helped the government reform policies and processes in the appointment of management personnel for public sector banks through the creation of the

many foreign investors began pulling out. Persistent high inflation was another worry for the government as they battled trying to keep inflation growth in single digits. The economy indeed needed the right fix to the monetary policy to bring it back on track. Mr. Rajan has been instrumental in changing the face of the RBI and the Indian banking system putting in place a series of reforms. He implemented the inflation-focused framework (CPI), effected 150 basis points interest rate cuts, improved the balance sheets of public sector banks through asset quality reviews and expanded the horizon for the Indian banking sector by bringing in a number of new players.

Bank Board Bureau (BBB). This would help solve the bureaucratic hurdles and independence issues in the appointment of MDs and CEOs of public sector banks. The bureau will replace the board for appointment of whole time directors as well as nonexecutive chairman of public sector banks. It will also engage with boards of directors of all PSBs to formulate appropriate strategies for their growth and development.

He has been instrumental in making India a part of an elite club of nations with an inflation target in place. The central government has backed the policy suggested by the RBI setting an inflation target of 4 percent with a two percentage price band on either side. He

Mr. Rajan has constantly strived to clean the balance sheet of banks and brought about provisioning under the asset quality review (AQR) system. Banks were postponing bad-loan classification and deferring the inevitable and the RBI believed that banks were resorting to ever-greening of accounts. Reclassification of these accounts led to a havoc on banksâ&#x20AC;&#x2122; profit & loss accounts as many large lenders slipped into losses and some of them reported losses for the full financial year. Although this move has pinched the banking system,

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He took charge when the economy was facing the global turmoil and battling to maintain meagre growth levels. At this time, the rupee saw a steady decline as

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it was one which was long overdue and it would take a lot of guts to pull it off.

of the country, the smart phone model will be the most plausible solution.

With technology changing the way we live our lives, the RBI Governor worked on an enabling a framework for National Payments Corporation of India to roll out the Universal Payment Interface (UPI). As the country moves to a cashless model, UPI would provide a single interface for all

During his term, the rupee has seen drastic movements. He took charge when the rupee was hitting new lows but since then, it has made rebounds owing to the sound monetary policy implemented by the RBI. RBIâ&#x20AC;&#x2122;s foreign exchange reserves have hit a record high to serve as a cushion to drastic

transactions across segments. Payments would be made at the swipe of a finger and without having to identify the bank or account details each time. Further, the platform is also being customized to meet the needs of our multi-lingual country and expand the customer base as wide as possible. Mr. Rajan and his team have led the way towards innovation and have also granted licences to eleven payment banks who would offer the banking system to millions on their smart phones. As it becomes more and more difficult to enable inclusion in person at the most distant parts

movements in trade and capital flows.

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His contributions and achievements including being crowned the Central Banker of the Year for 2016 would leave behind some very big shoes to be filled. Despite that, Mr. Rajan did express confidence and trust in his successor. The two have previously worked closely together on the monetary policy for the last three years and it seems Mr. Patelâ&#x20AC;&#x2122;s experience will definitely help maintain levels of inflation and money supply within target. One of the key aspects that the nation would hope for in this switch is the continuity in the policies that

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22,915 crore. 75 percent of this amount was released immediately to provide liquidity support for lending operations with the remaining 25 percent to be released later. Mr. Patel will be expected to hit the ground Mr. Patel and his team will have to ensure running as he would have several tasks on the funds allocated have been properly utilized, the banks are on the road to recovery and the balance capital to be

the RBIâ&#x20AC;&#x2122;s priority list. One of his important tasks would be to appoint a Reserve Bank nominee on the broad-based Monetary Policy Committee (MPC). The MPC would decide on the interest rate with a view to maintaining inflation at 4 percent. Half of the six-member MPC will come from Reserve Bank and the remaining will be nominated by the government. This appointment would be crucial in ensuring continuity and harmony between the objectives of the RBI and that of the MPC.

diffused in time.

It is said that the world attaches more credibility to the central bank of a country than its political leadership when it comes to matters of financial stability. With the expectations set high, the new leadership will have a lot to prove. India is being highly favoured as the next manufacturing hub for the world and only a stable economy with low levels of inflation will help attract investments, job opportunities and a higher standard of living. The aam aadmi Mr. Patel will also be tasked with ensuring will be impacted more than one can see at the clean-up of balance sheets of public and the surface. private sector banks in India, identifying the true extent of losses and maintain NPAs at a manageable level. Earlier this year, the government agreed to recapitalize public sector banks by injecting a sum of INR ÂŠ FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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have been implemented over the previous regime. This is probably one of the factors considered in the appointment of Mr. Patel with the hope that the continuity exists.

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The Microfinance Story EshanKapoor

What is Microfinance? A major drawback of the formal banking system is that low income households are not able to secure loans from traditional banks as they fail to provide any collateral against the loans, and banks consider such uncollateralized loans as risky. Without this capital, such poor households find it difficult to make their ends meet. Microfinance is the concept of providing financial services to the people at the Bottom of Pyramid (BoP) i.e., low-income poor and extremely poor self-employed individuals. These financial services generally include savings and credit but can also involve insurance and payment services. Therefore, microfinance involves

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the provision of financial services such as savings, loans and insurance to poor people living in both urban and rural settings who are unable to obtain such services from the formal financial sector. Since providing such loans involves risks, microfinanciers use unique contractual methods and organizational forms to mitigate the risk and significantly reduce the costs involved in making these loans. These methodologies include lending to groups instead of providing to just one individual. Some organizations also provide financial education, training, healthcare, and other social services. Another innovative step that microfinance organizations have taken is

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History of microfinance: The journey of microfinancing began in the middle of the 1800s when the theorist Lysander Spooner highlighted that in order to get people out of poverty, entrepreneurs and farmers can be provided with small credits. The terms microcredit and microfinance first came into prominence in the 1970s. Prior to that, from 1950s to the 1970s, donors

and governments usually provided the financial services in the form of subsidised rural credit programmes. However the reach of this credit scheme was abysmal, and it also often resulted in loan defaults and losses. Modern microfinance movement was actually started by Muhammad Yunus in Bangladesh. The concept revolved around

the creation of Joint Liability Groups and lending the money to groups and not to individuals. After this initiative, it became quite clear that microcredit can have a social impact without making any losses. Microcredit Summit of 1997 reinforced the significance of microfinance. This summit aimed to provide credit facilities and other financial services to 175 million of the worldâ&#x20AC;&#x2122;s poorest families, by the end of 2015. Problems with MFIs: In April 2015, the RBI, being forced by the MFI industry to relax the controls, increased the limit of total indebtedness of a microcredit borrower from Rs. 50,000 to Rs. 1,00,000. This kind of shift which was made because RBI had found a substantial amount of improvement in the MFI sector, enabled the MFIs to lend to its clients with more liabilities involving higher risk now. It was observed that many suicides happened in Purshottampur of Bihar, just two months after this particular rule of RBI was implemented. Apart from this, there are two Indian credit bureaus namely Equifax Credit Information Services Pvt Ltd

and CRIF High Mark Credit Information Services Pvt Ltd to find out the credit worthiness of the borrowers and to check whether they have made borrowings from multiple MFIs or not. But the reports generated by these bureaus are not always fool proof as clients can always borrow from multiple MFIs at the same time. Many a times clients manipulate the details in their KYC documents to

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to provide loans to just women. For example, at Grameen Bank, 97% of beneficiaries are women because studies have suggested that when women retain control of microloans, they spend more on the health, security, and welfare of their families. This also increases their self-esteem and self-worth. Some famous microfinance institutions are Grameen Bank, Bandhan, Svasti Microfinance, ASA, Banco do Nordeste, etc. Yet microfinance alone cannot act as a panacea for financial inclusion. In many cases, it has proved to have a detrimental effect on the financial condition of the borrowers. This industry has had its fair share of ups and downs, scandals and losses.

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make their history of multiple borrowing quite ambiguous. In an article, Muhammad Yunus had pointed out that there are two types of microcredit programs: one is designed to serve the poor; and the other aims to maximize the financial returns to the lending institutions. a) Serving the poor: Here the objective is to improve the lives of millions of poor people by making small loans to women to fund incomegenerating microbusinesses. Grameen Bank is the quintessential microfinancing institution of this type where the focus is on the community and its development. In this model, the money including interest payments is continuously circulated locally to facilitate productive local exchange and build

sure that small loans would be profitable for the shareholders of the MFIs, they needed to raise their interest rates and go for aggressive marketing and loan collection. As a result of this, the distinction between socially aimed microcredit programs and profit minded loan sharking began to disappear. Financial programs that had raised funding to improve the socio-economic status of the people at the BoP became a conduit for sucking wealth out of these communities and transferring them to already wealthy investors. It became quite apparent that for most of the MFIs and NBFCs, providing microfinance to the people at the bottom of the pyramid was not so much about alleviating poverty, or improving the socio-economic status of the community

real community wealth. Many MFIs have sprung up which replicate the model of Grameen Bank but fail to incorporate its certain features which are central to its commitment to community wealth building. b) Maximising the returns: To expand their reach, many MFIs started looking for new sources of capital. Around 2005, non-profit MFIs changed their status to for-profit and filed for an Initial Public Offering (IPO). Two such organisations were Compartamos in Mexico, which launched its IPO in 2007. The public offering brought in $458 million, of which $150 million was pocketed by private Mexican investors and the bankâ&#x20AC;&#x2122;s top executives. Another MFI was SKS Microfinance in India, which made its IPO in 2010. It raised $358 million from investors and yielded more than $40 million worth of stock options to its founders. In order to make

or develop grass root level entrepreneurship. It was about unrestrained lending to the clients so as to maximise their profits provided there were no defaults. A study conducted after the SKS microfinance fiasco in Andhra Pradesh highlighted that 70% of microfinance was just consumer lending without a proper evaluation of its pros and cons. Another classis example of the failure of microfinance was in Nicaragua which is one of the poorest countries of Central America. It had a client base of roughly 450,000 people with $400 million in portfolio. However a surge in charitable aid along with an explosive growth of microfinance resulted in a huge number of borrowers being overly indebted. Clients were under such a debt that they refused to pay back their instalments and staged protests on the streets of Nicaragua. At one point of time, government was so supportive

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Other than doing an in depth study of the microfinance sector, there are certain measures that microfinance institutions can take. Firstly, in order to measure the success of the microcredit that is provided to the community, certain indicators need to be clearly defined like – growth of income, school enrolment rate, health and nutrition of the community, quality of housing, sanitation, etc. Secondly, in order to improve the effectiveness and efficiency of the microfinance program, MFIs should support vocational training and financial

could give rise to irresponsible lending, resulting in achieving the target set by the MFIs for themselves. If the clients who have taken this pipelined loan do not default on their repayments, this loan would not show up as delinquency. However, if there is a default, then those several loan accounts that have pipelined the main pipeline loan will show up as delinquency. Remedies: Someone once very aptly said that “Microfinance is like good food. The second you get to the table you really want to eat. But then you have a chance to overindulge”. There is a lot that is still not understood about microfinance even by the experts and hence a lot of research and study is the need of the hour. The four most important areas that need to be studied are as follows: a) Psychology of decision-making by microfinance clients b) Quality and flexibility of the loan terms c) Provision of financial assistance and coaching to clients d) Degree to which easy access to microfinance is creating debt for the community as a whole.

literacy for the clients. They should make the process of starting and growing micro-businesses easier by improving the access to technology that reduces the cost of lending and borrowing. Thirdly, microfinance institutions should look for new opportunities and initiatives to foster the growth of small and medium-size businesses in the regions of interest. Organisations that provide stable, productive, non-exploitative job opportunities and also assist in the overall development & upliftment of the community are the only sustainable businesses which are successfully able to alleviate poverty.

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of the microfinance revolution that it wanted to extend the repayment duration by 10 years. As the number of loan defaults increased substantially, many MFIs of Nicaragua shut shops and the microentrepreneurs were left without any capital to run their respective businesses. Another issue that is concerned with the failure of microfinance is pipelining which is the concept of people lending their names and identities to somebody else who will borrow money from the MFI. As such, the rules are being adhered to on the paper, but this

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Indian stock market scams – The Harshad Mehta and Ketan Parekh Case Abhishek Jaiswal

IIM Shillong Indian stock markets have been the darling of investors for the past few decades. They have given the masses an opportunity to invest in the giant corporates and basically trade risk for return. The first mass participation from the general public took place when Reliance came with its first IPO in 1980. The Bombay Stock Exchange floated index – ‘Sensex’ was a means to measure the performance of the exchange. In 1991, Dr. Manmohan Singh, the then Finance Minister, announced a series of reforms which led to the next surge in mass participation in the stock markets, only to be disillusioned by a single man known as Harshad Mehta. In a kneejerk reaction to this fraud, the Government of India set up the Securities and Exchange Board of India (SEBI) and subsequently the National Stock Exchange (NSE). NSE was an electronic

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clearing system which brought in exceptional transparency, efficiency and professionalism to the system. Hence, the Harshad Mehta scam was a watershed moment in the history of our stock markets and would be discussed in greater detail. In the early 1990s, the banks in India had to maintain an investment of a particular amount of their deposits in government bonds. This ratio was called Statutory Liquidity Ratio (SLR). The condition was such that the banks had to maintain a weekly balance of the threshold amount but the daily balance was not checked. This arrangement can be drawn parallel to the quarterly minimum balance condition for our savings bank account in the present day. Hence, the banks would utilise the money in the earlier part of the week and later bring

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from the banks who had excess and wanted to earn interest on that amount. This agreement is called the ready-forward agreement, which is usually a bank receipt backed by collateral in the form of permitted government securities. As the banking system was still at a nascent stage in terms of sophisticated technology and interface, these banks used to depend on brokers to mediate these weekly deals with fellow banks. This is where Harshad Mehta, who had till then established himself as a top broker, came into the picture. He had great relations with the bankers courtesy regular transactions with them. Moreover, his flamboyant lifestyle was something which the top bankers used to be in awe of. This made his entry within this lending-borrowing arrangement a cakewalk. Mehta’s firm used to broker these transactions between banks. He would approach the buyer bank and make a pitch that they draw the money in his name as he would then pass it on the cheapest lender bank after negotiations. He also had a similar arrangement with the seller banks, wherein he would ask them to release the government securities, say today and provide an extension for the payment by a period in return of a healthy margin. It is said that he took one week (or more) to broker a bank receipt between one bank and another bank, in the meanwhile he asked the second bank one week’s time as well to find a buyer. This circulation went on with several banks and allowed him to always have collateralised backed securities from various banks which were essentially ‘in transit’. In simple words, he handled multiple transactions like these and rotated them all in a way that he

always had liquid funds with him.

Now comes the second part of the story. Bank receipts are backed by government securities so they have intrinsic value. Banks never

moved the security itself, rather the bank receipt acted as the security itself. Now, if there were banks to issue fake bank receipts it would be like conjuring money from thin air. As per sources, it was said that Harshad Mehta had influenced some banks to partner with him for gains by providing him with fake bank receipts. According to Wikipedia, Bank of Karad and Metropolitan Co-operative Bank issued fake bank receipts to Mehta for a fee. With these receipts in hand, Mehta used to garner cash from the buyer banks who had to mandatorily keep a reserve of these government security backed receipts to maintain SLR requirements. The third and final part of the story unfolds with the version of how it impacted the stock markets. The money at his disposal was used to aggressively invest in stock markets. He picked some stocks, such as ACC, Videocon, Sterile, etc. and used to regularly pump in money to stoke up their prices artificially. This led to a massive stock market boom which inspired the masses to invest in these stocks in the greed of quick money. It was a time when the stock market was the discussion in all circles, irrespective of their socio-economic status. The expected reaction was that the market went up like crazy and the bulls went on a rampage. In terms of numbers, the share price of ACC was inflated from 200 to 9000. The Sensex, which had maintained an average PriceEarnings ratio of around 15-16 for 2 decades since liberalisation, breached 40 during that period. Mehta used to book profits when the share prices were sky-rocketing and this is how he used to pay off the banks in time as well to

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the money back to maintain the minimum balance. This minimum balance was supposed to be maintained in the form of investment in government securities. The banks had an unspoken arrangement amongst themselves that banks whose average was below the minimum threshold at the end of the week would buy these government securities

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maintain their trust. The profits were booked at the expense of the masses but they were still hopeful of turnaround gains. This game went on for a fair amount of time until Padmashri Sucheta Dalal, a journalist at Times of India, finally exposed Mehta’s illegal ways and brought to the banks’ notice that they were providing money in lieu of fake bank receipts and the government securities supposed to be backing them never existed. Both the banks and the masses realized that they had been taken for a ride and there was

scam which exposed many loopholes in the banking system and ultimately led to many reforms initiated by the Indian government for creating a transparent and secure financial system. But did the government succeed in creating a full-proof system – No. And this was highlighted in a huge way within the space of a decade by another stock market scam – The Ketan Parekh Scam. Described as the Pied Piper of Dalal Street, the Bombay-Bull, the Pentafour Bull and the likes, Ketan Parekh was again somebody who used

no real money involved and the boom was artificially created out of thin air. The reaction that followed was inevitable, the stock market crashed and hordes of gullible investors went bankrupt as they had put all their savings to have a pie of the giant cake. The incident took a few lives as well, one of them being that of the then Chairman of Vijaya Bank. He committed suicide by jumping off the top of the bank’s office. He knew that when it would become public that he had written cheques in the name of Mehta, he would be dead meat. Harshad Mehta was put behind bars, where he breathed his last. ₹5000 crores – yes that was the scale of the

flamboyance and connections to create an aura around him which called for association with top bankers and policymakers alike. He had the might of bringing politicians, business magnates and film-stars together, which created the brand Ketan Parekh and provided him the opportunity to win the trust of the influential people. A chartered accountant by training, Parekh came from a family of brokers, which helped him create a trading ring of his own. It was a time when the dotcom bubble was at its peak and was inviting involvement from the global audience. The phenomena injected life in the Indian stock markets as well. The modus operandi of this man was not a

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net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. The movement in these stocks made Sensex too volatile to be within the control of any individual. So, what Parekh used to do was to pledge the shares with banks as collateral for funds. Again the banking system was involved in this fraud with Madhavpura Mercantile Cooperative

which had a small capital base but high growth potential. Next, he started artificial trading in these stocks by forming a cartel of his own companies. The stocks he invested in were known as the K-10 stocks. This artificial trading created frequent movement in these stocks and an impression that high activity is a sign of greener pastures pulled the masses towards these stocks as well. This activity is known as price rigging in financial terminology. The buoyant stock markets from January to July 1999 helped the K-10 stocks increase in value substantially. HFCL soared by 57% while Global Telesystems increased by 200%. As a result, brokers and fund managers started investing heavily in these stocks. Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their

Bank being his main partner-in-crime. This bank used to issue pay orders to Parekh which he used to discount at other banks like Bank of India, which never got its money back. This bank also used to offer its own money to Parekh to have an equity market exposure which was way beyond permissible limits. So, the money of banks, mutual funds and the masses was invested when the stocks were at

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work of sheer genius but a cartel which was developed with the sole intention of diverting funds of millions, which it ultimately succeeded at doing. Parekh borrowed money from banks and various companies who had trust in his portrayed superior stock picking skills ; the fact that the stars of Bombay were pooling in their money with him as well was an added incentive. Parekh very smartly selected stocks

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Impact of global turmoil in Commodity markets on Indian economy RajashekarReddyM.&DivyaBharathiG. NMIMS Mumbai Global Economy Slowdown Uncertainty is an uncomfortable position and the world is facing this right now. With most of the developed countries slowing down, subdued economic activity and uncertainty in the air, global commodity prices are falling sharply. IMF has cut down the global economic growth to 3.4% from 3.6% in 2016 and 3.6% from 3.8% in 2017. This subdued growth could be detrimental in any improvement in commodity prices. The gradual slowdown and rebalancing in China could be one of the reasons for slump in major commodities throughout the world. Oil prices have declined from as high as $120 a barrel to $40 which reflects subdued global growth and sustained production increase by OPEC nations. May be the drop in oil prices is more to do with it’s over supply than lower global demand but a supply war between OPEC and US shale companies is presently good for Indian Economy. Impact on Indian Economy RBI Governor Raghuram Rajan recently

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quoted that ‘India is one eyed king in the land of blind’. With most global economies slowing down including china, India is the only bright spot in this uncertain world with a GDP growth rate of 7.6% which is the fastest growing economy in the world. This growth can be attributed to lower crude oil and other commodity prices. Lower price of metals and steel is helping Modi government in their ambitious roads and infrastructure projects. Corporate earning has seen an uptick which brought cheers to Dalal Street. Increase in manufacturing spending would increase the economic activity in the country which would increase employment rate and GDP growth in the long run. A subdued global demand would negatively affect our exporters and farmers as they would be earning less due to lower commodity prices globally. Crude Oil The fall in Crude oil which constitutes 79% of total imports is a welcome for our country’s economy. According to reports India saves 6500 crores for every $1

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inflation by 0.2% and wholesale price inflation by 0.5%. 4. Stable Rupee: A lower current account deficit due to low crude oil prices means India need to sell fewer rupees to buy dollars to pay its bills to the foreign imports. This reduces the pressure on rupee and helps to stabilize it.

be reduced. 2. Increased Government Spending: With more disposable amount government can spend on other schemes and infrastructure projects. Modi government has launched three major infrastructural projects - Atal Mission for Rejuvenation and Urban Transformation (AMRUT), Smart Cities Mission, and Housing for All Mission in Urban Areas and this can be achieved with lower oil prices.

According to media reports these exporters earn $60 billion annually. A fall in oil price may impact India’s trade partners’ economy which would hamper demand for Indian products.

3. Helps to control Inflation: Oil which constitutes around 14% weight in consumer price index is an important factor in determining the inflation of our country. Oil price affects the entire economy, especially because of its use in transportation of goods and services. Lower crude oil would also improve companies’ profits because of lower input costs and higher customer demand. According to a Moneycontrol report, every $10 per barrel fall in crude oil price helps reduce retail

5. Negative Impact for Petroleum Producers: Fall in global oil prices has also its downsides. It affects the exporters of petroleum producers in our country.

Metals and Steel A slump in these commodity prices is attributed more to slowing down of global economy than higher supply. China which has been the largest consumer of these commodities is undergoing a transition in their economy from capital intensive to labor intensive. As this change is large, it would take time for these commodities to stabilize at a lower price. This change is positive for India as it can build huge infrastructure projects with reduced prices of steel, aluminum, copper and other metals. Lower prices would also reduce the cost of building houses and further along with low inflation which would bring down interest rates, it would be possible for lower and middle income Indians to start buying

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decrease in oil prices. With a stable rupee India can save a lot which will have a cascading effect on our macroeconomic situation. These include: 1. To Achieve Fiscal Deficit Target: Indian Government has set an ambitious fiscal deficit target of 3.5% for FY17 and lower crude oil prices would help them achieve this. Due to fall in oil prices there is a huge savings for the government and this could indirectly translate to lower fiscal deficit (Fiscal Deficit is excess of expenses over income for the Central Government). Current account deficit i.e. the amount India owes to foreign countries would also

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homes. Steel, aluminum and other metals which are major raw materials for auto industry would benefit from lower prices as growth, margins and corporate earning of auto industry would improve. Indian government is betting heavily on auto industry for growth and according to IBEF report, Government of India aims to make automobiles manufacturing the main driver of ‘Make in India’ initiative, as it expects passenger vehicles market to triple to 9.4million units by 2026, as part of Auto Mission Plan (2016-26) and steel prices play

is mostly used as hedging against other investments. Gold has increased recently as people turned towards safe havens like gold because of BREXIT but sentiment in the medium run is that it will fall. Government can also save foreign reserves because of low prices which could help in stabilizing a falling rupee. Agricultural Products With a decline in commodity prices around the world, 50 million Indian farmers are the ones who are negatively impacted by this. Prices of sugar, cotton, soya, maize, wheat are declining which would decrease

a very important role in this plan. Telecom sector and especially in development of new 4G towers cost would be reduced substantially. In fact, a Credit Suisse report mentioned that RelianceJio has built 28000-30000 towers. Transport minister‘s Sagarmala project aims to develop the ports with an investment of Rs 70,000 crores. Infrastructure development along the country’s 7500 km long coastline would require metals and steel for sure and all these would benefit from lower prices. New foreign investment in infrastructure and other industrial projects would also increase. Government has started a 20% import duty on steel, mean that government is playing a smart game and protecting the local industry while the sectors for which steel is a raw material enjoy the benefits of its low cost. Gold Gold imports have always been high as far as India is concerned and medium term view of gold is more bearish than bullish. This is good news for many consumers and big players like Titan and PCJewellers. Gold

the profits of farmers as well as exporters. This situation may be here to stay in the medium term unless global economic growth ratchets up. Conclusion All in all those who gain because of low commodity prices are outnumbered by those who will rue this decline. This is a very comfortable situation for India as it aims to achieve a double digit growth and become an economic superpower in the world. This is a perfect tonic for Modi to go out all guns blazing to gain supremacy.

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RAJENDRA KALUR Director & Chief Executive Officer TrustPlutus Wealth Managers (India) Private Limited

What are the prospects of wealth management in the Indian context given that certain asset classes have still not completely developed? With a consistent high GDP growth that India has seen since liberalisation, the number of High Networth Individuals and Affluent Class requiring wealth management services is increasing. As per the latest World Wealth Report published by Cap Gemini, Asia-Pacific region led by China & India is now the region having the largest HNI population & this can only rise in future. The significant acceleration in assets mobilised by the Mutual Fund industry in India is also an indicator of the huge potential that the country has for wealth management. However, it must also be admitted that we are at an early stage of what promises to be a great opportunity for wealth management services. As we evolve we would see opportunities arising across various asset classes. This would come in from both push & pull factors: on the push side we have both regulators & technology giving shape to the industry & on the pull side we shall have the customer preferences & need forcing the industry to evolve & create products / solutions across various asset classes. What are the factors that you consider while designing a portfolio for individuals given their varying risk appetites and return expectations? Designing a portfolio for a client is not just a function of Asset Allocation but it also involves Asset Location. While Asset Allocation at a broader level determines the mix across asset classes, Asset Location involves identifying the right basket / product or bucket for a client. While Asset Allocation depends on the optimum risk adjusted measure, Asset Location looks into cost effectiveness, operational convenience & tax efficiency aspects.

them to client. Regular monitoring at portfolio level along-with identifying changing risk tolerance, market conditions & client preferences help calibrate the portfolio. What are the regulations that one needs to follow while managing a portfolio for a client in India? For a domestic client, the following regulations may apply depending on the product or the nature of services provided. An Investment Advisor needs to be registered under the Securities & Exchange Board of Indiaâ&#x20AC;&#x2122;s Registered Investment Advisor guidelines (RIA) while a distributor of Mutual Funds needs to be registered with Association of Mutual Fund in India. At a product level, Mutual Funds need to be registered with SEBI under MF Regulations, Portfolio Management Services provider needs to be registered under PMS guidelines and Alternate Investment Funds need to be registered under AIF Regulations of SEBI. An NBFC providing loan services needs to be registered with Reserve Bank of India. What is your advice to students who wish to pursue a career in wealth management? Wealth Management Industry is a sun rise industry in India and there is a huge potential for growth. It provides opportunity across the value chain & requires skilled manpower in Front, Mid & Back office. Both technology & regulations are today the biggest disruptors in the industry and this space is likely to see traditional players giving way to newer models. I would recommend this industry as a career path for students who love challenges, willing to learn & adapt to the fast changing business conditions.

At a Product Level, performance & risk based screeners are deployed to identify or recommend

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JAY SHAH Founder of Ventureforth and President, Star Advisory Services, LLC

What are the various factors that a company needs to consider when raising outside capital There are several things that a company needs to consider when raising capital, however, there are a few things that are important – 1) Purpose of the capital – Is the money is being raised to build a product? Or to do a beta testing? Or for growth? Or liquidity. Each of these require different types of investors and achievement of different milestones. It is important to obtain capital for the investors that have a clear understanding of the stage where the company is. The earlier stage of the company, risker the investment, and expectations of returns are higher. The later the stage of the company, expectations of returns are relatively lower. 2) Structure of the security to be issued for raising capital. Pre-money valuation is what most companies focus on when making a decision, however, the terms and conditions attached with the capital are very important, sometimes more critical than just the pre-money valuation. Also, depending upon the stage of the company, different types of debt / equity securities should be considered for issuance. 3) Changes in corporate governance. Once a company takes on outside capital, they have a fiduciary responsibility to outside investors, and that requires a change in mindset, decision making and transparency. The company has to take into account what the investors says in its decision making. The company has to provide information about the company’s performance and defend decisions made. 4) Readiness of the company to withstand due diligence. One can get investors excited to invest, but when due diligence is done documentation issues, verbal promises or legal compliance issues come to the surface. So ensuring that the company is ready for taking in capital is another key consideration. 5) Timing of exit and potential

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buyers (including IPO). Companies need to have a roadmap for exit when raising capital as investors are going to expect liquidity of their capital at some point in the future. Given the current market situation what is your outlook on the M&A activity across industries Within US, I believe that the M&A outlook, outside of the mega-deals, is quite good. Corporations have built up significant cash reserves, family offices are doing direct investments, private equity funds have raised money that they need to deploy, unicorn valuations are coming down, continued lower interest rates keeps debt capital cost low, stock market at the highest level, allowing corporations to use stock as currency. These factors are key ingredients to continued healthy pace of M&A activity. Large corporations have continued to deploy funds through venture arms, and likely buy out those companies once they get to a certain scale. Price discipline is essential for a strategic acquisition to be successful, and I think companies are and will continue to be disciplined. Which industry has the most potential growth in the coming future Within US, there are a few industry sectors that show promise in the short / medium term. Technology sector will continue to grow as technology continues to drive inefficiencies out of the systems based on innovation, analytics and evolving business models. Healthcare is another sector that is undergoing fundamental changes in how procurement decisions of healthcare services are made, requiring changes in basic plumbing to provide more information and transparency. These changes facilitated by EMR, development of quality metrics, formation of ACO’s (Accountable Care organizations), shift from fee for service to fee for outcomes, population health management – are going to have significant impact on how

NIVESHAK

What is your advice to students who wish to pursue a career in consulting and advisory Careers should be viewed and evaluated over the long term. Given that it is very difficult to predict long term, I would suggest that students think about what they want to achieve in 5 year intervals, as one can forsee their professional career for that time period, and then adjust their expectations for next phase. One other thing that I believe is to have the right mindset out of college. Students should focus on learning, and determine which opportunity allows them to learn the most in the shortest amount of time. The professional career trajectory will be steep, if they learn and grow and keep learning at a faster rate, which allows them to contribute at a higher level than their peers, thus allowing them to advance rapidly. Learning how capital works (advisory), how investors think about capital deployment, is critical to any future professional path that one takes. Learning how to solve an organization problem (consulting), allows one to become deep analytical thinker. Depending on one’s affinity, one should decide whether to choose the advisory or consulting path. At a personal level, I have guided my children towards the advisory path.

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healthcare services are delivered and consumed. Demographics of the population (more than 1/3rd baby boomers) favor continued growth in this sector. Governments at all levels have to become more efficient by adoption of technology. Fintech is another sector that has had significant investment in the early stages, which will start having an impact on how banking institutions conduct their business. Several companies are sprung up that eat away at the “fees” banks charge, which enhances returns for the customers. I believe this is another industry that will have significant growth, as inefficiencies are driven out.

NIVESHAK

Industry Analysis Cover Story

Analysis of Banking Sector in Italy SIVA SHANMUGAM.TS

BIM, Trichy Existing Situation It is expected that Italy’s banks could ignite a Eurozone crisis. Italy’s banks are having a very high amount of nonperforming loans. Falling interest rates and flatter yield curves are decreasing the profitability of the banks. Official data shows that the total amount of nonperforming loans, or NPLs is at around 200 billion euros ($220.5 billion), or around 8% of total loans. Italian bank shares have been hammered. The focus is now on Sienabased Banca Monte dei Paschi(BMPS). Shares of the world’s oldest lender have plunged 24% since the end of June and are down nearly 75% in the year to date. Italy’s banking sector is increasingly vulnerable and fears are building up that the euro zone’s third largest economy could go through serious crisis, warning potential bank runs, credit rating downgrades and the threat to the wider European banking system.

What led to this situation? 1) Impaired loans

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A large and growing stock of impaired loans (16% of total loans) is the key weak spot for the Italian banking sector A look at the banks’ loan exposure to both the retail and the corporate banking shows that the Italian banks on an average were exposed more towards the retail segment. But on the contrary the higher NPAs were from corporates. Among the corporate majority of the bad debts is from construction and real estate businesses. 2) Capital shortage: This increasing NPLs has led banks to making commensurate provisions which has thus eroded the capital of these banks. The stress Test conducted

by the ECB gives the following information. Stress tests are normally key component of assessing whether capital (and liquidity) resources are adequate. It helps to decide that additional Pillar 2 required capital is needed, as a new Minimum, where Pillar 1 does not capture the risks adequately. Overall, the 51 banks in the stress test sample increased their capital position on a transitional basis by about €180bn between December 2013 and December

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In the law prior to the existing one the creditors can only file competing proposals if the debtor’s proposal ensures unsecured creditors a payment, as a percentage of the face value of their

the end of 2018. This shows that banks are running short of capital.

claim, that it is not deemed convenient and only if they hold at least 10 percent of the unsecured claims against the debtor. 4) Fragmented banking sector The two biggest players hold approximately 40% of assets (Unicredit, Intesa SanPaolo), and the rest of the sector is divided among a plethora of smaller banks often holding only a regional focus. This has led to a situation

Bankruptcy legislation: There was no strict bankruptcy legislation in place. The new bankruptcy law has been recently changed under

the government of Matteo Renzi, but it has taken time to make itself felt in practice.

in which the entire banking sector is concentrated and even a possibility of default by any one of the majors will shake the entire financial system of the country and hence weak external competitiveness. BMPS one of the oldest and the third largest bank in Italy is now creating such fears as it is at the verge of a default.

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2015 and by more than €260bn since December 2010. The impact of the adverse scenario on the CET1 capital ratio is ‐380bps, bringing the CET1 ratio across the sample from 13.2% to 9.4% at

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NIVESHAK

5) Macroeconomic reasons Very high level of public debt and weak external competitiveness, both ultimately rooted in the protracted sluggish productivity growth. It has a massive stock of public debt (132.7% of GDP at end-2015).This sluggish economic activity has reduced the Gross domestic product of the country and has put Italy in a situation in which Italy wont recover until 2025. This sluggish

economic activity is one important reason for growing NPLs. Near Future Expectations:

them from taking excessive risks. Italian households hold about 29 billion euros ($32.17 billion) worth of bank-issued bonds that are subject to being written down or converted into equity in case those banks need to be rescued. If Italy breaks new EU banking regulations by using state funds to bail out its most troubled lenders then it is in a serious trouble of being ousted out of the European Union. But these type of bailouts have happened in various degrees with Ireland, Greece, Portugal and Spain. However, Italy is seen as “too big to bail out” and its funding needs are too big. If Italy does manage to get a green light for the recapitalization, the funds required to reinforce the Italian banking system may well has to be coming from Italy’s public finances. Potential downgrade of rating: While Italy was widely praised for reforms after the 2008 crisis, most of the measures were relatively modest, Italy failed to restructure its banks in

A Bailout using Public Funds: In the first place, Bondholders are usually professional investors who can handle losses and are also better able to monitor banks and discourage

a meaningful way. Italian ratings are already at ‘BBB-’.Using Public funds to recapitalize the banks will make the credit rating agencies to downgrade the rating for Italy below the investment

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NIVESHAK

grade.

will not majorly affect the rest of the world. The foreign banks exposure on the italian economy is not very high. So the systematic impact on these countries in case of a major default will also not be

very high. But italy is a serious threat to the future of the European Union. A look at the past for similar situations: To look at previous such crisis we will take the example of US and Ireland which were also in a similar situation with a debt more than that of its GDP. When it comes to the US, it is the subprime mortgage crisis of 2008. The US prior to the mortgage crisis had Plentiful Cash/Liquidity. Volatility, risk premiums, investor returns were

proposals were introduced. The proposals were framed to address consumer protection which was made important. b) More stringent Bank financial cushions and capital requirement were made. c) New regulations for shadow Banking were introduced. d) The authority for the Federal Reserve was extended to safely privatize systemically important institutions. e) Housing and economic recovery

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Not a Global systematic risk: The current situation of the Italian banks

unusually low .Return seeking investors used high leverage facilitated by low cost borrowing to enhance yield. Stock market were strong (Dow up 19% in 2006). What caused the problem? The major causes for the banking crisis was • Adverse selection (Lending to subprime category) • Investment banks in the US created opaque securities and improperly marketed them to unsophisticated investors. It is also called as shadow banking. • There was no strict regulation over shadow Banking. Lessons learned a) In 2009 a series of regulatory

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NIVESHAK

act 2008 was passed. f ) Short selling was restricted. A similar case was the 2008 Irish banking

euro .On seeing the bailout taking place many unexpected revelations about the business affairs of some banks

crisis. While the global financial crisis worsened matters, the banking crisis in Ireland was largely a homeâ&#x20AC;?grown phenomenon.

and business people was made. This ultimately added onto the deepening recession in the country, the bank bailout was the primary reason for the Irish government requiring IMF

The crisis stemmed from the collapse of the domestic property sector and that subsequently led to the drop in national output. Its root cause was found in the inadequate risk management practices of the Irish banks and the failure of the financial regulator to supervise these practices effectively. A bank bailout that worsened the situation: Post the crisis - a number of Irish financial institutions faced immediate collapse and insolvency. In response to the situation the Irish government bailed out the banks with a â&#x201A;Ź64 billion AUGUST 2016

assistance in 2010. There can be a clear statement made that the banking regulatory has overlooked the serious trouble that it would face because of the rising bad debt in Italy. The effect of a banking crisis is being felt in Italy, for knowing to what extent this crisis will impact the whole of Europe, we should wait for the situation to unfold.

NIVESHAK

KSHITIJ PRABHU

IIM Udaipur Abstract The paper analyses the intrinsic, as well as extrinsic factors that lead to the dominance of German automobile cluster over other automobile clusters, notably Japan and the United Sates. Few literatures suggest that the primary factor for the developmental of German automobile industry was based on the goal of raising the status and qualification level of production workers, and creating a structure of compromise between management, the workers’ councils and the unions evolved. The paper also sheds some light on the future innovation currently under progress in Germany which include carbon-cutting measures, electric motor vehicles, and automated driving, and the challenges these innovations pose to the current ‘traditional’ automobile manufacturing. Introduction Automobile cluster in Germany consists of the most renowned and premium car brands like BMW, Volkswagen and Mercedes. For the year 2014, the sector had an annual sale of Euro 385 billion which comprised 14% German GDP. Germany is ranked fourth after China, United Sates and Japan and currently the leader in automobile production in Europe. Till date, Germany is considered the first choice for any automobile

location because of the reasons, namely, stable economy, reliable logistics infrastructure, sound and secure legal framework, and a competitive tax system. It is noteworthy to know that the German economy was never so robust and through generations of reforms and cultural sustenance, was able to achieve such a stature in the automobile industry. Analysis Around the world, there are three major automobile clusters which practically define the global supply. They are listed in the order of the revenue each year. a) German cluster (Volkswagen, BMW, Mercedes, etc.) b) American cluster (GM, Ford etc.) c) Japanese Cluster (Toyota, Honda, Hyundai etc.) On an intuitive level, German cluster is inarguably the most advanced in terms of the research and innovation. We evaluate Germany on the following four broad attributes of the diamond framework. (i) Factor Conditions : Factors of production like infrastructure, skilled labour etc. which define the competitiveness (ii) Demand Conditions : The demand within the country (iii) Related And Supporting Industries : The presence of internationally

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Automobile Industry in Germany

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competitive suppliers within the national boundaries (iv) Firm Strategy, Structure and Rivalry : How companies are competing domestically All the four attributes above defines the characteristics of the market as well as the players. The synergies on each point and on the whole framework define the competitiveness of an industry in the international scenario. Factor Conditions (i) Skilled Labor: Automobile Industry has been most vital to Germany’s economic growth and therefore the government has promoted institutes dedicated towards training skilled workers. Germany is known for the engineering excellence around the world and there was always a constant supply of skilled engineers. (ii) Infrastructure: According to Global Competitiveness Report published in 2012, Germany’s extensive infrastructure was singled out for special praise due to its capacity for highly efficient transportation of goods and passengers. This ranking includes high marks for the quality of roads and airports, the rail and port infrastructure, and the country’s outstanding communications and energy infrastructure. In addition to inland connectivity, Germany’s boasts of three major ports (1) Hamburg – Europe’s 2nd largest container port (2) Bremerhaven – Europe’s largest port for cars (3) Duisburg – Largest inland port of Europe. This facilitates the export as well as domestic trade. Similarly, Germany is endowed with world class air transport and rail infrastructure. (iii) Capital market: Germany is the sole supporting economy of the European Union and the German market is viewed quite favourably by

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the foreign investors. Demand Conditions Following facts drives home the point that Germany is having a very healthy demand condition locally as well as globally. • Germany is Europe’s biggest automobile market; it represents 30 percent of passenger cars produced (5.7 million) and approximately 20 percent of the new car registrations (3.2 million). • Around 77% of the cars manufactured in the country were exported to the international market in 2015. Both the facts above justifies that Germany itself is the biggest car market in Europe while it has even far bigger demand internationally. Though the world wars left Germany in shambles, it gave rise to the companies like Volkswagen and BMW in terms of infrastructure. During the world wars, because of the embargo, Germany produced all the components required for Tanks, Ships and Aircrafts locally. This gave rise to many companies which were suppliers to the automotive industry. A simple yet very powerful supporting fact is 21 out of top 100 automotive suppliers are German companies. The examples are, Bosch AG, Continental AG etc. Firm Strategy, Structure and Rivalry German companies usually have a tendency to follow strict organization hierarchies and management practices, with majority of the German CXOs are known to have a technical background. This definitely explains the reason behind the constant pursuit by the German automobile manufacturers towards the engineering excellence.

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due to continuous surge in fossil energy prices and changing climate policy, the Automobile giants have to redesign the cars with better fuel efficiency and less CO2 emission. These developments will certainly trigger innovation and market dynamics, but at the same time, it has its challenges. The major challenges for

Skoda, SEAT and Lamborghini. Similarly BMW also has a horde of brand labels. In between the German firms, the competition was always for the premium segments and over the technological advance. This culminated into the German firms leveraging the R&D infrastructure setup by the government to the fullest. Challenges The global automobile industry is experiencing a phase of great changes and upheavals, and it is becoming important to tap new markets for cars worldwide as the sales in established markets like the European Union, United States of America and Japan (trio) is close to stagnation point. Essential framework conditions have are being changed and the cars redesigned to adapt them. For example,

the automobile industry over next two decades are as follows: (i) Developing Efficient Vehicle with Alternate Propulsion Concepts: The future demands German manufacturers to design and develop products keeping in mind the environment conditions. As a result, stress is laid on developing eco-friendly cars in the Battery Enabled Vehicle (BEV) or PlugIn Hybrid Electric Vehicle (PHEV) sector. Big players like Renault/Nissan have chosen a first-mover strategy in BEV, as have General Motors/Opel and Toyota in PHEV. Entering into these sectors involves benefits of less competition but has its own risk of huge R&D cost with uncertainty as well. Since these vehicles are designed from scratch to achieve targets like light weight, target group city and regional vehicles,

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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There is always an active domestic rivalry between the two major firms (Volkswagen and BMW) as of now. Post the financial crisis of 2008, the cluster has underwent a lot of consolidation giving rise to a giant like Volkswagen. The company owns famous car brands like Audi, Bugatti, Bentley, Porsche,

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German automobile industry can enter the sector and offer more appealing vehicle. (ii) Retaining the position of Technological Leader: The top five OEM namely Audi, BMW, Daimler, Porsche and VW has anchored the image of German automobile industry as the technological leader for years. These giants need to ensure the status quo is maintained in the future as well. (iii) Targeting and Penetrating Emerging Markets of BRICS Countries: Since the developed nation markets have stagnated, German automotive industry needs to tap the developing market like India, Brazil and China which will guarantee significant increase in sales volume. The OEM and system suppliers are already much better positioned in the growth regions with extensive production and development capacities than the downstream suppliers, who mainly focus on business in Germany and Europe and have a much weaker position concerning

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NIVESHAK

RISHABH KISHORE

IIM Udaipur Introduction: Russia is the world’s largest producer of oil and natural gas. Russia was the world’s largest producer of crude oil (currently second largest after Saudi Arabia) and third largest producer of petroleum and other liquids like biofuel, refinery gains (after the USA and Saudi Arabia). Major regions in Russia for oil and gas production (Exhibit 1):  West Siberia: Accounts for more than 60% of Russia’s total production1. Samotlor oil field (under the control of Rosneft) is the oldest and the largest oil field in West Siberia. An average decline of about 5% (much lower than

about 22% of total oil production. Romashkinskoye field (operated by Tatneft) is the largest in the region.  East Siberia: Commencement of Eastern Siberia-Pacific Ocean pipeline and Vankorskoye oil and natural gas field has increased production in the East Siberia region.  Other areas: Yamal Peninsula/ Arctic Circle, North Caucasus, TimanPechora and Barents Sea, Sakhalin Island etcetera. The Russian economy is heavily dependent on energy exports, primarily to Europe and China (Figure 1, Figure 2). Russian and European economies are heavily interdependent. Europe

the standard decline of 10-14%) is maintained.  Urals-Volga: Account for

depends on Russia as a source of supply for both oil and natural gas, and Russia depends on Europe for its market of

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Oil and Gas Industry in Russia

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NIVESHAK

energy products. Moreover, half of the revenues of Russian government depend on Oil Exports

 Increased global supply of hydrocarbon (US shale revolution turning from net importer to exporter)

Status Quo of Russia that affects Oil and Gas sector:  Negative GDP growth: Russian economy displayed negative GDP growth of 1.2% year-on-year in from January 2016 through March of 2016, followed by negative growth of 3.8% drop from April 2016 to June 2016 (Exhibit 2).  High inflation: The inflation rate of about 15% was observed in 2015. The inflation dropped to about 8% in first half of 2016 (Exhibit 3). Various factors have driven Russian oil and gas sector into a new and unfavorable environment, apart from macroeconomic reasons. The major global and domestic challenges faced by the oil and gas companies are: Global Challenges:  Saturation of hydrocarbon demands in export market5

 Aggressive competition with traditional and new suppliers entering global markets like the USA, Iran, Iraq, Australia and East Africa5  Low price of hydrocarbons  Geopolitical tensions in the West including the US and EU sanction introduced against Russia as a consequence of annexation of Crimea. In response to alleged policies and practice of Russia in Ukraine, in 2014, tighter sanctions were levied on Russia by the United States2. These sanctions have: • Limited Russian firm’s access to the US and European markets. • Led to severe financial, technical and operational constraints on oil and gas companies operating in Russia. Limited the supply of imported advanced equipment for oil exploration and drilling

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NIVESHAK

 The increase in global demand: Increase in population and growth in consumer class will support oil demand increase.  Increasing oil production in North America might not trigger major decline global oil price: Most of the production in North America comes from shale oil production. Considerable uncertainty surrounds shale oil production like growing cost of reserve replacement, the mitigating role of OPEC and stagnant US dollar.

 Faster depletion of cheap oil reserves and necessity to explore new oil and gas reserves that are hard-tofind and difficult-to-develop5  Underdeveloped and weak domestic financial markets, reducing access to financing Russian companies should improve production capacity, increase efficiency and drive profitability in upstream production to remain competitive in the long run. A brief overview of opportunities and risks for Russian oil and gas companies are listed below: Opportunities for oil and gas industry in Russia are:

 Systemic Crisis in European Oil Refining: Decreasing US oil imports from Europe and commissioning of new highly efficient oil refineries in the Middle East will result in a likely negative impact on European oil and gas producers. Risks for oil and gas industry in Russia are:  Limited access to new technologies: Increasing sanction and uncertain oil and gas market need to be compensated by new technologies. The current projects do not sufficiently incorporate the large-scale use of new technology, failing which production capacity might start declining from

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• Limited access to long-term loans and lowered the quality of oil field services3. • Led to an adverse impact on Russian government budget since about half of the total revenues of the Russian government depend on oil and gas exports to other nations4. Domestic challenges:  Macroeconomic conditions aggravated by low oil prices  Stagnant domestic industry demand

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2017.  Lack of access to new markets: Competition for global gas markets has been rising continuously. If access

will adversely affect Russian oil and gas industry. Iran has already reached its pre-sanction level of production6.

to more global markets is not reached, Russian oil and gas industry might lose their market share.  Re-emerging Iranian Oil Industry: A consequence of Iran Nuclear deal

Way forward for Russian oil and gas companies:  Regulatory changes: Due to scarce investments and current level

is the removal of sanctions on oil exports. The sizable Iranian Oil industry (approximate production of 3.64 mbpd)

of oil prices, the Russian government is pushing for “General Development

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NIVESHAK

 Efficient Asset Management: The developments in oil and gas industry need efficient asset management as the key initiative in ensuring competitive advantage. High performing core assets should be incorporated (like seismic exploration and drilling), and lowperforming assets should be disposed of.

Moreover, the growing field development costs, stricter environmental regulations are posing challenges in the revival of oil and gas industry. Growth in environmental expenditure and changes in social

 Effective partner management: The oil and gas companies in Russia need to explore better engagement with partners. Mid-stream and downstream costs should not be reduced particularly in the number of filling stations and service offerings9. Potential supply chain risks highlighted were financial risks due to the volatility of commodity prices, and contractual failures by suppliers10.  Process Efficiency: Increasing operating expenses can be curtailed by managing better process automation, enhancing contractor efficiency, adopting energy saving technologies, reducing transportation costs and logistics optimization and outsource contractual staff to reduce operating costs further. Rising costs of imports can be mitigated by substitution of technology and equipment.

spending programs need to be managed carefully to ensure positive environmental and social return on investment.

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Scheme, Oil Industry of the Russian Federation for the Period Until 2020”. The Russian oil and gas industry visualizes it as a major incentive for exploration of oil reserves in Arctic Region7. The regulation is expected to boost investment in oil and gas exploration. Currently, the primary source of capital shall be loans and borrowings8.

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CLASSROOM FinFunda of the Month

Sir, I came across a term called special purpose vehicle in the newspaper wherein the finance ministry proposed to establish an SPV to finance infrastructure projects in specified sectors during the Budget. As far as I know, a vehicle is usually used for transportation. How, we can use it for financing a project? A special purpose vehicle (SPV) is formed for a special purpose. Its powers are limited to what might be required to attain that purpose and it ceases to end when the purpose is attained. SPVs are sometimes referred to as a â&#x20AC;&#x153;bankruptcyremote entityâ&#x20AC;? whose operations are limited to the acquisition and financing of specific assets. The SPV is usually a subsidiary company with an asset/liability structure and legal status that makes its obligations secure even if the parent company goes bankrupt. This arrangement is done with the securitization process in which the loans and future income or receivable (the money that is to become due in future) of a bank/financial institution, are sold to a special purpose vehicle. This allows the financial institution/ bank to get funds upfront, which can be put to more productive use in the business. SPVs are also termed as housing devices since they house the assets transferred by the originating entity in a legal outfit, which is legally distanced from the originator, and yet self-sustained as not to be treated as the part of the originator. This isolation of assets is important for external investors whose interest is backed in these assets but who are not affected by the generic business risks of the entity of the originating entity. . Sir, now I completely understand that

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Special Purpose Vehicle Anisha

IIM Shillong

what is a SPV? But, what are the common uses of SPV? SPVs help in securitization, asset transfer, financing, risk sharing, financial engineering and raising capital. Sir, as a companyâ&#x20AC;&#x2122;s legal structure is same across the globe. Do SPVs follow the same legal structure? An SPV may be structured in different ways, depending on what the originator is trying to achieve through the vehicle and depending on where it is originated geographically. For example:- In Canada, SPVs take the form of charitable trusts. In the United States, a SPV is usually formed as a Limited Liability Corporation. In Europe, a SPV is organised as a limited purpose corporation under domestic (i.e. UK) or offshore (i.e. Jersey) law with charitable trust owner. Other common legal forms used in other jurisdictions include a corporation, partnership, trust, Stitching (i.e. a foundation under Dutch law), unincorporated entity, or a multi-user structure such as protected cell company. Sir, can you please elaborate a little on how a SPV operates in a securitisation process? The most common form of SPV is used in securitisation through asset-backed securities. Under which, originator transfers the underlying assets or loans to SPV. SPV issues ABS to investors using the assets/loans as collateral. Subsequently, SPV completes the circular transaction by transferring the money to the originator.

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