Niveshak Jan15

Niveshak THE INVESTOR

VOLUME 8 ISSUE 1

January 2015

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VIII ISSUE 1 January 2015 Faculty Chairman

Prof. P. Saravanan

THE TEAM Abhishek Bansal Akanksha Gupta Apoorva Sharma Bhawana Saraf Gaurav Bhardwaj Jatin Sethi Kocherlakota Tarun Maha Singh Gulati Mohit Gupta Mohnish Khiani Palash jain Prakhar Nagori Priyadarshi Agarwal Ramesh Jaiswal Rahul Bajaj Sandeep Sharma S C Chakravarthi V Vishal Khare All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

With this first issue of 2015, we wish our readers a very happy and prosperous new year. The month of January saw SENSEX increase by 7.5% from the 2014 year end. This shows that the investors are continually looking towards Indian economic growth in future with positive sentiments. Also the International Monetary Fund recently updated its World Economic Outlook report predicting that India’s GDP growth will overtake China’s in 2016 making it the fastest growing economy in the world. Our Finance Minister Mr. Arun Jaitley led the Indian delegation to the Davos Summit with a motto to showcase the ‘Make in India’ programme to the world leaders. The Crude Oil is daily touching its new lows making the conditions worse for Oil producing countries. The first big effect was seen with S&P cutting Russia’s rating to Junk. However, falling prices come as a boon for India as it’s helping to achieve fiscal deficit target pegged at 4.1% of the GDP for the current fiscal year. Lower than expected inflation enabled the first rate cut post Raghuram Rajan’s taking over the office of RBI. This long awaited rate cut would lead to a reduction in the financial costs, thus increasing profitability and adding on to the confidence of the industry as well amongst the investors. Our Prime Minister inaugurated the Vibrant Gujarat Global Summit, 2015 in the presence of US Secretary of State – John Kerry and U.N. Secretary General Ban Ki-moon where we saw a huge number of MOUs being signed and Reliance coming up with a plan of investing Rs 1 lakh crore in the next 12- 18 months. With more and more focus on Financial Inclusion and Pradhan Mantri Jan Dhan Yojana by our government, our cover story for the month of January 2015 edition “Is Jandhan making PSBs Nirdhan?” would give readers an outlook with respect to the banking scenario in India and how PMJDY would impact the banks. The article of the month covers the topic Falling Oil Prices and its implications on Indian economy. On the other hand FinGyaan covers a deep insight into Euro Zone – Economic Crisis. FinSight column of the magazine try to highlight Retail Investment, a hot topic these days as markets are trading at all-time highs. In keeping in line with the current Bull Run our FinLife portion of the magazine would guide you towards making investments through Mutual Funds. This month’s FinView hosted the interview of Prof. Maram Srikanth who discussed with us about the banking sector as well about the expectancy from Union Budget 2015-16. The Classroom learning section covers the intricacies of ‘Value Investing’ which is a well-known investment strategy, the one also backed up by none other than Warren Buffet. We would like to thank our readers for their immense support and encouragement. You remain our prime motivation factor that keeps our spirits high and give us the vigour and vitality to keep working hard. 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 Cover Story Niveshak Times

04 The Month That Was

Article of the month

Falling oil prices and its implications on Indian Economy

Is Jan Dhan making PSBs Nir Dhan?

FinGyaan

Finsight EURO-ZONE : ECONOMIC CRISIS : Is European Integration 26 Importance of Retail reason for frequent European Investment recessions

FinLife

FINVIEW

Interview With Dr. Maram 22 Want to be part of the Bull Srikanth Run? Guide to Mutual Fund In- Professor - IIM Shillong vestments

CLASSROOM

Value investing

The Month That Was

NIVESHAK

www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

IIM Shillong ‘NITI Aayog’: New Name For Restructured Planning Commission India’s Planning Commission will be renamed “NITI Aayog” as part of a restructuring plan announced by Prime Minister Narendra Modi in his Independence Day speech. ‘NITI’ is an acronym for “National Institution for Transforming India,” said officials. The new plan body, sources say, will have up to five full time members and four union ministers. The permanent members are expected to be experts from various fields. The panel reported directly to the Prime Minister, who was its chairman. The change comes almost 65 years after India’s first Prime Minister Jawaharlal Nehru, a socialist who admired Joseph Stalin’s drive to industrialize the Soviet Union, set up and chaired the Commission to map out a development path for India’s agrarian economy. The Aayog will recommend a national agenda, including strategic and technical advice on elements of policy and economic matters. It will also develop mechanisms for village-level plans and aggregate these progressively at higher levels of government Obama Pledges $4 Billion Of Investment In India U.S. President Barack Obama pledged $4 billion in investment and loans to India, soon after attending the South Asian nation’s 66th annual Republic Day celebrations as the guest of honor. Obama told a gathering of business leaders from India and the U.S. that both countries have “got to do better” in furthering an economic relationship “defined by so much untapped potential,” Reuters reports. The $4-billion deals include $2 billion of leveraged financing for renewable energy investments in India through the US Trade & Development Agency and $1 billion in loans for small and medium businesses across India through the Overseas Private Investment Corporation, or OPIC. Separately, the US Export Import Bank would finance a billion dollars to support ‘Made in America’ exports to India over the next two years. Obama also

JANUARY 2015

announced that two US trade missions will be in India this year with a specific focus on infrastructure development in rail, roads, ports and airports. World Economic Forum Publishes 14-Point Plan To Tackle Global Inequality The 45th World Economic Forum kick started in Davos,Switzerland on 20th Jan, 2015. Ahead of the start of its annual meeting in Davos on Tuesday, the WEF published 14 measures of inclusive growth as it responded to criticism that the gathering of 2,500 business leaders, academic and policymakers has become an exercise in hand-wringing about the gap between rich and poor. Christine Lagarde, the managing director of the IMF, Pope Francis, Jim Kim, the president of the World Bank and Mark Carney, the governor of the Bank of England, are among those who have stressed the need to ensure that the fruits of economic progress are shared more equally. Carney will be taking part in a panel in Davos this week titled: “A richer world but for whom”. The WEF paper says governments should assess 14 yardsticks of progress under six pillars: education and skills; employment and labour compensation; asset building and business investment; corruption and rents; fiscal transfers; and basic services and infrastructure. Raghuram Rajan Serves Up 25 BPS Repo Rate Cut To 7.75% Raghuram Rajan announced his first rate cut since being appointed Reserve Bank of India (RBI) Governor in August 2013. The move prompted a nearunanimous opinion that this could be the beginning of a new easing cycle. “It’s not just a rate cut; it also signals a shift in the stance of monetary policy,” Arvind Subramanian, chief economic advisor to the finance ministry, told reporters. The central bank also hinted as much, saying inflationary pressures had ebbed since July last year and on current policy settings, inflation was likely to be below six per cent by January 2016. “These developments have provided headroom for a shift in the monetary policy stance,” RBI said, before delivering a surprise Makar Sankranti and Pongal gift

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by cutting the repo rate, its key lending rate, by 25 basis points (bps) to 7.75 per cent. Consequently, the reverse repo rate, at which the central bank drains excess liquidity from the banking system, also fell 25 bps to 6.75 per cent. Over 9 Crore Consumers Sign Up For LPG Cash-Subsidy Scheme More than 60 per cent of LPG customers in the country have joined the ambitious PAHAL scheme for receiving cash subsidy so that they can buy cooking gas (LPG) at market price. Over 9 crore consumers, out of a total customer base of 15.33 crore, have joined the Direct Benefit Transfer for LPG (DBTL) scheme and Rs 2,262 crore in cash has been transferred to them as per official record. “The DBTL Scheme for LPG consumers (PAHAL) was launched on November 15, 2014 in 54 districts and in the rest of the country on January 1, 2015. The Scheme aims to transfer the subsidy on LPG directly into the bank accounts of over 15 crore LPG consumers”. LPG consumers have time till March 31 to join the scheme, failing which they will not get any subsidy and will be forced to buy LPG at market rate. Record Coal India Privatisation Drive

Sale

Boosts

India has raised about $3.6 billion by selling a 10 percent stake in state-run Coal India Ltd in the largest ever equity deal in the local market, giving a welcome boost to the government’s faltering divestment drive. The share sale will move the government closer to the still distant target of raising $10 billion by selling minority stakes in state-owned companies to trim the fiscal deficit to a seven-year low by the end of March. The strong investor response to the Coal India issue is expected to bolster New Delhi’s plans to offload shares in other state firms including Oil and Natural Gas Corp and Power Finance Corp Ltd. Coal India, the largest coal miner in the world, is the biggest supplier of coal domestically, sheltering it to a degree from tumbling global prices, as it feeds India’s power stations. Coal fuels 60 percent of India’s power production.

European Central Bank Unveils Stimulus Plan Of 60 Billion Euros A Month The European Central Bank launched its most aggressive effort to date to revive the region’s ailing economy - a program to buy 1.1 trillion euros in government and private bonds starting in March. The long-awaited program was an emphatic statement of the central bank’s willingness to do all it can to rejuvenate the economy shared by the 19-nation euro currency alliance. And it showed the multinational ECB’s readiness to assert its independence against critics in Germany, the eurozone’s largest and most politically influential country. The ECB said it would combine purchases of government bonds with an existing smaller program of private bond purchases, to total 60 billion euros a month through September 2016. All told, the program will amount to 1.1 trillion euros ($1.16 trillion). The size of the program exceeded investors’ expectations, and ECB President Mario Draghi pledged to keep it going until the central bank sees a “sustained adjustment” in lifting inflation above dangerously low levels - in other words, for as long as it takes. S&P Cuts Russia’s Rating To Junk Russia’s foreign-currency credit rating was cut to junk by Standard & Poor’s, putting it below investment grade for the first time in a decade as policy makers struggle to keep economic growth alive amid sanctions and falling oil prices. S&P, which last downgraded Russia in April, cut the sovereign one step to BB+, the same level as countries including Bulgaria and Indonesia. The ratings firm said the outlook is “negative.” Russian stocks declined and bonds fell for a second day following the announcement, which came after the close of equity trading in Moscow. The world’s biggest energy exporter is on the brink of a recession after oil prices fell to the lowest since 2009 and the U.S. and its allies imposed sanctions over President Vladimir Putin’s actions in Ukraine. The penalties have locked Russian corporate borrowers out of international debt markets and curbed investor appetite for the ruble, stocks and bonds.

The Month That Was

The Niveshak Times

www.iims-niveshak.com

Market Snapshot 35,000.00

2,500

30,000.00

2,000

25,000.00

1,500 1,000

20,000.00

500

15,000.00

10,000.00

BSE

FII, DII Net turnover (in Rs. Crores)

Article ofSnapshot the Month Market Cover Story

NIVESHAK

-‐500

5,000.00

-‐1,000

0.00

-‐1,500 28/01/15

27/01/15

26/01/15

25/01/15

24/01/15

23/01/15

22/01/15

21/01/15

20/01/15

19/01/15

18/01/15

17/01/15

16/01/15

15/01/15

FII

14/01/15

13/01/15

DII

12/01/15

11/01/15

BSE

10/01/15

09/01/15

08/01/15

07/01/15

06/01/15

05/01/15

04/01/15

03/01/15

02/01/15

01/01/15

31/12/14

30/12/14

29/12/14

-‐5,000.00

-‐2,000

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

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

10431645.44 Source: www.bseindia.com

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

61.41 69.82 52.06 93.18 45.67

CURRENCY MOVEMENTS 8.00%

INR/1 USD

6.00%

Euro/1 USD

GBP/1 USD

JPY/1 USD

SGD/1 USD

LENDING / DEPOSIT RATES Base rate Deposit rate

10.00%-10.25% 8.00% - 9.00%

RESERVE RATIOS CRR SLR

4.00% 22.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

8.75% 7.75% 6.75%

4.00% 2.00% 0.00% -‐2.00%

Source: www.bseindia.com 29th Dec 2014 to 28th Jan 2015

-‐4.00%

Data as on 28th Jan 2015 -‐6.00%

JANUARY 2015

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NIVESHAK

Article Market of Snapshot the Month Cover Story

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

Open

% change

27241.78 10115.85 10894.89 18455.13 21253.3 9359.5 15113.05 7686.06 14409.51 10422.16 10562.54 9878.81 2032.64 8121.33 1533.94 5762.49

29559.18 10808.44 11369.11 20209.63 23439.08 10786.9 17077.58 8233.2 15581.27 11152.77 10298.15 10053.06 2201.68 8406.28 1718.83 6154.08

8.51% 6.85% 4.35% 9.51% 10.28% 15.25% 13.00% 7.12% 8.13% 7.01% -2.50% 1.76% 8.32% 3.51% 12.05% 6.80%

% CHANGE TECK

6.80% 12.05%

REALTY PSU

3.51%

POWER

8.32%

OIL&GAS METAL

1.76% -‐2.50%

7.01% 8.13%

Healthcare FMCG

7.12%

13.00%

15.25%

BANKEX

10.28%

AUTO

9.51% 4.35%

Smallcap MIDCAP

6.85%

Sensex -‐4.00%

-‐2.00%

0.00%

8.51% 2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

Niveshak Investment Fund

on 30/6/14 As on 2Done 8th January,2015

Informa(on Technology

CONS NON DURABLE (5.85%)

HCL Tech.

GODREJ CONSUMER Wg:5.85% Gain:26.99%

(12.08%)

Infosys

Wg: 4.25% Gain : 10.88%

Wg: 3.66% Gain : 32.12%

Britannia Wg:4.40% Gain : 90.07%

TCS

Wg: 4.17% Gain : 3.06%

FMCG (20.24%) Colgate HUL

Wg:5.93% Gain : 25.65%

ITC

Wg:4.90% Wg:4.99% Gain:32.60% Gain :5.43%

HDFC Bank

Wg: 6.25% Gain : 14.81%

Auto (10.72%)

Chemicals (7.77%) Amara Raja BaT Wg:4.53% Gain : 28.00%

Tata Motors Wg:6.19% Gain : 31.39%

Pharmaceu(cals (10.72%)

Dr Reddy’s Labs Wg:4.25% Gain:12.17%

BANKING (6.25%)

Lupin Wg:6.47% Gain : 31.27%

Asian Paints Wg:7.77% Gain:44.75%

MISC. (4.98%)

MANUFACTURING

Titan Company Wg:4.98% Gain:-‐15.50%

Page Industries

(5.45%)

Wg:5.45% Gain:13.07%

Performance Evaluation

As on 28th January,2015

January Performance of Niveshak Investment Fund

Performance of Niveshak Investment Fund since IncepDon

165 155

110 145

108 106

135

104

125

102 100

115

98 96

4 ug 18 -‐14 -‐S ep -‐ 1 17 4 -‐O ct 18 -‐14 -‐N ov -‐ 15 14 -‐D ec -‐ 12 14 -‐Ja n-‐ 15 -‐A

-‐Ju

Scaled NIF

l-‐1

-‐Ju

n-‐

4 -‐1

ay -‐

-‐M 27

-‐A

ar -‐1

-‐M

-‐1

-‐F

Values Scaled to 100

-‐Ja n-‐

NIF

Sensex

/0 2

/1 5

/0 1

/1 5

/1 5 16

/0 1

/1 5 /0 1 06

/1 2

/1 4

105

Scaled Sensex

Values Scaled to 100

Risk Measures: Opening Por+olio Value : 10,00,000 Standard DeviaDon : 15.02%(Sensex : Current Por+olio Value : 15,21,883 14.96%) % Change in Por+olio Value : 52.18% Sharpe RaDo : 3.20 (Sensex : 2.68) Change in Sensex : 44.20% Cash Remaining:268869

Comments on NIF’s Performance & Way Ahead : This month the financial market in India cheered the much needed rate cut by the Reserve Bank of India on 15th January. The market in the second half of the month traded on improved senDments and touched new highs. The BSE Sensex recorded a posiDve change of 7.47%, the por+olio performed in line with the benchmark index to record a posiDve change of 7.75%. On internaDonal front, the European central bank unleashed 1.1 trillion euro bond buying sDmulus to rejuvenate the Eurozone economy, the Indian market is expected to benefit the most out of the emerging peers, as the economy rebounds and more reforms sets in from the government side, the Indian markets could see more chunk of por+olio in flows from this increased global liquidity. This would also help the Indian markets to meet the concerns over increasing rate by Fed and could bring some stability in rupee exchange rate. The por+olio did not witness any re shuffle during this month, however we expect some sell offs of overvalued stocks and other reshuffles in the next month owing to budget, crude prices and other domesDc and internaDonal developments. This month also marks the compleDon of one year of NIF, over this period our funds net worth has changed (+52.18%) where as the market index has changed (+44.20%).

Article of the Month Cover Story

NIVESHAK

Falling oil prices and its implications on Indian economy Avishek Bhattacharyya & Shubharthi Ghosh

SIBM Bangalore Introduction The year 2014 witnessed a steep drop in the price of the Brent crude when the prices decreased by 55.42% from the mid-June price of 112.36 USD per barrel to 50.08 USD per barrel. This trend of drop in oil prices has been primarily been due to the demand shock of crude oil, led to the increase in global oil supply through the production of shale oil by horizontal drill and hydraulic fracturing technology by the US which has become the largest exporter of dirty oil. This has contributed to a price war among the Middle East exporters of “clean oil” to defend their market share. The falling oil prices have raised concerned that countries such as Venezuela, Russia might default on their debt obligations, and this has given rise to the Russian rouble

JANUARY 2015

crisis. Origin Of The Crisis There are several reasons that led to the oil crisis: • Because of weak economic activity of different countries, demand is low. This is evident from the sluggish economic outlook for Eurozone and Japan for fiscal year 2015 and also concerns over full recovery of US economy. • Geopolitical risk that can be seen from the fact that Iraq and Libya, two of the largest oil producers (combined 4 million barrels a day) had no slowdown effect on the output. • America has become the world’s largest oil producer. In spite of the fact that the US does not export crude oil, it now imports much less,

NIVESHAK

Article of the Month Cover Story

Fig 1: Impact of falling oil price on Russian Rouble

so that generating a lot of surplus supply. With the popular choice of the shale oil, a new more efficient substitute has arrived. â&#x20AC;˘ To restore the price the Gulf Allies and the Saudis were not ready to give up their market share. They could have curb production sharply, but they did not want Iran and Russia to get the benefits. Also, the lower oil prices have not affected countries like Saudi Arabia much as its Brent crude fiscal price break even price for its exporters is 89 USD per barrel, which is much lower than its competitors. Its oil costs a meagre $5-6 per barrel to get out of the ground and also it has $900 billion in reserves. This has led to the OPEC nations decide to let the market decide the price. Now breakeven for each barrel of oil vary from country to country, because the break even for Shale oil is said to $40. The International Energy Agency estimates

most of the drilling will be around the Bakken formation, the shale producers whom OPEC is trying to drive out of business return a cash of $42 a barrel. In theory, production can continue to flow until prices fall below the day-to-day costs of existing wells. So they were gradually poised to face the decline in the price of oil. Impact In India The sharp price drop will of course favour India somehow. This will lead to the opening of multiple growth boosters. India imports more than 70 percent of its oil consumption. According to Nomura, the $40 fall can potentially push growth by up to 0.4 percentage points to 6 percent in the current financial year. The subsidy savings and extra revenue will come in very handy for the Centre in keeping its fiscal deficit for this year within the proposed target of 4.1 per cent of the GDP.

The sharp price drop will of course favour India somehow. This will lead to the opening of multiple growth boosters. India imports more than 70 percent of its oil consumption. This will come in very handy for the Centre in keeping its fiscal deficit for this year within the proposed target of 4.1 per cent of the ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

NIVESHAK

Effect On Various Indian Stocks: Falling oil prices also provide a significant opportunity for investors as many companies are expected to make huge gains. The following stocks get impacted because of the slump in crude oil prices: 1) Oil marketing companies (HPCL, BPCL, IOCL): These will face pressure because of the immediate inventory loss but will later get stabilised once lower oil price negate subsidy concerns 2) Auto companies (TVS, Hero MotoCorp, etc.) should benefit as the ownership cost of vehicles will come down because of falling oil prices. 3) Tyre companies (Apollo Tyres, MRF, Ceat and JK Tyres) will benefit from higher margins as 3040 per cent of their raw material costs are linked to crude oil prices. 4) Industrials (Cummins, Concor): Demand for diesel general set could rise in the near term. Lower diesel prices will lead to a cutback in railway freight rates.

5) Consumer: The biggest gainer will be Asian Paints as a huge chunk of raw materials is linked to crude derivatives. Godrej Consumers, HUL and Emami would benefit from the reduction in prices of packaging materials since these are direct derivatives of crude. 6) Power utilities such as Tata Power, Adani Enterprise and JSW Steel will benefit if benchmark thermal coal prices fall because of a drop in diesel prices. Drop in price of diesel is again a positive for mining companies (Coal India). 7) Finally, upstream companies like Cairn India, which are pure crude oil play will be adversely affected due to the slump in oil prices. This will also adversely affect companies such as ONGC, Oil India and Reliance Industries. Subsidies on LPG and kerosene are heavily subsidized, so the source of relief from fewer grants can be the crude oil. The total subsidy on petroleum products in 2013-14 was 854 billion rupees, and it will be reduced to the extent the international price of crude declines. The main

The main problem is that on one side India is going to gain from its current account balance due to less import rate, but on the flip side India will also lose several of its FIIs. Due to lower income , the corpus of the sovereign wealth fund would automatically shrink which they usually invest in the equity market of countries like India for higher returns JANUARY 2015

NIVESHAK

Article of the Month Cover Story

problem is that on one side India is going to gain from its current account balance due to less import rate, but on the flip side India will also lose several of its FIIs. Due to lower income from falling oil prices for Middle East countries, the corpus of the sovereign wealth fund would automatically shrink which they usually invest in the equity market of countries like India for higher returns. Effects In Folds GDP growth: Reduction in prices of oil should boost growth through multiple channels: • Lower inflation will increase the household’s real disposable incomes, which should positively impact the consumer discretionary demand • Better corporate profit margins because of reduced input costs will act as an additional impetus for reviving business investment • Improvement in macro fundamentals (inflation, fiscal and current account deficits) will play a significant role to balance the space for macro (monetary and fiscal) policies for positive impact on growth. Every USD 10/bbl. fall in oil price can increase GDP growth by approximately 0.1 % points. Inflation: The impact of lower commodity prices is much higher on WPI inflation than CPI inflation. Lower oil price directly affects 8.6 percent of the WPI basket. This is because every USD 10 per barrel fall in crude oil price drops WPI by approximately 0.5% and CPI by approximately 0.2%. Current account balance: Every USD10 per barrel fall in crude oil price improves India’s annual

current account balance by around USD 9 billion or 0.5 percent of GDP. Fiscal balance: Petrol pricing is already a market determined, and oil marketing companies (OMC) are currently generating over-recoveries (profits) on diesel. Conclusion The major question for oil markets right now is whether Saudi Arabia, the world’s one of the major oil producer, will cut production in order to boost global prices. So there is a possibility of crude oil going to a price level of $30, which is much lower than the present price level of $50/bbl. However, it is expected to rebound and stabilize in $70 - $75 a barrel later. OECD estimates a $20 drop in price will add 0.4% point towards the growth of its members after two years. By narrowing down inflation by 0.5 point during the same period, cheaper oil might also persuade central banks to either keep interest rates low or even add stimulus. As for India’s perspective, contrary to wide belief there is no inverse correlation when an analysis of the year to year study of average global crude oil prices versus India’s GDP is done. However, the country’s GDP Growth has risen every time oil prices have gone up and vice versa. A drop in global commodity prices which has a high positive correlation with global crude oil prices would lead to lower growths for both exports and imports. Hence, a decline in the CAD might occur during times of lower commodity prices, mostly due to lower growth. So it’s debatable that whether falling price oil price growth will boost India’s economy.

Cover Story

NIVESHAK

Is Jan Dhan making PSBs Nir Dhan? Abhishek Bansal & Ramesh Jaiswal

IIM Shillong

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” – Henry Ford Introduction Be it the Pradhan Mantri Jan Dhan Yojana (PMJDY) launched by PM Narendra Modi on 28th August or the acquisition of ING Vysya Bank Ltd by Kotak Mahindra Bank Ltd or the RBI allowing IDFC Ltd and Bandhan Financial Services Ltd to set up shop within the next 18 months, the year 2014 was quite an eventful one for the Indian banking sector. Banks are very different from the normal corporate entities, which are generally answerable to its shareholders as they have an added responsibility to answer to the deposit holders who have entrusted them with their funds for safe keeping. So when assets go

JANUARY 2015

bad or banks fail, deposit holders are the first hand sufferers. Schemes like Jan Dhan increases this risk significantly. About The Pradhan Mantri Jan Dhan Yojana Jan Dhan Yojana was in news throughout the year since its launch. The financial inclusion scheme seeks to cover 75 million un-banked households in the country in the first phase to eradicate the ‘financial untouchability’. FM Arun Jaitley revised the target for opening bank accounts from 75 million to 100 million by Jan 26, 2015. The scheme provides INR 5,000 overdraft facility for Aadhar-linked accounts and RuPay debit

NIVESHAK

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card besides an INR 1 lakh accident insurance cover. The scheme also envisages channelling all benefits from the union, state and local governments to the beneficiaries’ accounts. The phase one target of opening 100 million accounts under PMJDY was achieved much before the target date of Jan 26, 2015. As on January 27, 122.1 million new bank accounts have been opened with a deposit of Rs 10,155 crore and only 28% accounts under the scheme are active. The interesting thing is that Private Banks contribution to the scheme is only 4%. Private Banks have opened 5.1 million accounts under PMJDY, and they account for 21% in terms of advances in the banking system. In the same period, public sector banks have opened 95.7 million accounts and regional rural banks have opened 21.31 million accounts. Is PMJDY A Burden? Ever since the nationalisation of banks in 1969, multiple schemes have been launched in order to achieve financial inclusion in our economy. But most of them have failed, even the Swabhiman campaign launched in 2011 which aimed at bringing the banking services in the rural areas turned out to be an account-opening exercise as people did not channel their savings in those accounts. Same thing can happen with the PMJDY. The concern with PMJDY is the large number of zero balance dormant accounts. And how the public sector banks will maintain active status in these accounts would be a challenge. As of now, only one-third accounts are linked with the Aadhaar numbers and this again will pose a challenge in the Direct Benefit Transfer (DBT) scheme. Though Aadhaar has not been made mandatory for the DBT, the government has been pushing banks to maximise the linking

of Aadhaar with the bank account. Another challenge in the PMJDY is the opening of multiple saving accounts by individuals who already have a saving account with other banks. Such a practice is being adopted to benefit from the INR 1 lakh accident insurance and overdraft which can be availed in six months’ time. Liberalised KYC norms not only increase the security threat to the nation (both internally and externally) but also hamper the risk check mechanism that is there in place for the effective tracking of credits granted to the customers. Even though the Aadhaar numbers will be linked to these accounts at a later stage, the duplication of accounts will be difficult to handle and rectify for an operational account. Another problem that the government would face is the financial burden of these accounts once they qualify for freebies after some transactions are made in these accounts. About Rs 60,000 crore will be the overdraft liability of these 12 crore accounts once they qualify for the freebie. And if it is not repaid, the banks will lose this money, which will further deteriorate the asset quality at a time when PJ Nayak committee has estimated that the banks in the coming years would need to raise Rs 5.8 lakh crores to meet the Basel capital adequacy requirements. RBI had also started a financial inclusion scheme in villages across the country with population above 2000 in the year 2009-10. The banks had opened banking outlets in 74,199 villages under the first phase and the second phase began in 2013. Under this scheme, banks opened about six crore basic banking accounts in the whole of the fiscal year 2014. Compare this with PMJDY, where banks have already opened more than 12 crore accounts since the launch of the scheme. The difference being the KYC norms which were diluted for PMJDY.

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Human Resource Challenges Well, it is not only the financial brunt that these PSBs will have to bear. They will have to deal with various HR and productivity issues. Let us look at some of the statistics; According to the RBI, employee productivity is the lowest in nationalised banks with profit per employee of Rs 0.65 million. In contrast, foreign banks score Rs 4.5 million on this metric. Nationalised banks employ around 8 lakh staff, accounting for more than 70 percent of the banking workforce. The over 12 crore new accounts opened under this scheme will make life tough for bank employees. Prime Minister Narendra Modi, on January 24 sent an email to the bankers urging all the banks to seed the Aadhaar in all the bank accounts that have been opened so far. “I want you to work to ensure that each account holder enrols for Aadhaar and seeds it in the bank account. This needs to be done for all accounts. I am sure you will do this seeding with the same zeal you showed in driving bank account opening,” he said. Well this clearly shows the haphazard approach the government took to open the bank accounts. It is very evident that it will be very tough to rectify the mistake because it will be a time consuming exercise and by then the system will have millions of non-operative accounts. Financial Challenges Banks have been trying to shut down the nonprofitable branches where there is minimum business in terms of deposits and where there are lesser business in terms of credits. Having millions of additional accounts in the scheme could put an additional burden of margin

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reduction which could deteriorate the valuation parameters of PSBs when they go to public for raising additional capital in the equity markets. Ideally, depositors who are not maintaining minimum balances in their accounts should be penalized with various hidden charges. Now for the scheme related accounts which won’t be regularly active, the cost of operations could be very high if the hidden charges penalties are waived off because cost of opening a bank account could be as high as Rs.80-100 (Source: Business Standard publication) with an addition of Rs.100 for the debit card which has already been waived off. The administrative costs to maintain the desired accounts under the Jan Dhan scheme requires opening charges and staffing charges. The major proponents argue that technology would come as the saviour but are we really prepared in terms of the infrastructure or technology front to implement the schemes at one go? Banks have already been told to start charging for excess ATM usage in metro cities. RBI data shows that on an average in a month an ATM card rolls over just 1.4-1.5 times, which means that the usage is very low and there are several machines in non-metro cities that are hardly used (If the RBI is opening up charges for more than three ‘other bank’ ATM transactions, evidently the consumption is very high in these centres). The financial challenge is that out of every Rs 1000 that the banks receive, around Rs 260 has to be kept aside as pre-emption, Rs 400 has to be lent to the priority sectors and the remaining balance is for the purpose of lending. So, in qualitative & cost terms it drains away much of the resources in terms of branches and

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Fig 1: Percentage of Zero Balance Accounts of the Total Accounts opened under PMJDY

manpower. For the PSBs there is an additional burden to be aggressive on inclusive banking and few bankers admit it to be a strain as it is held to be sacrosanct. Taking this logically, if it were at all profitable then the overall business in these sections would have witnessed significant growth but corporate and RBI targets are generally not met. Now with this additional task of the PMJDY, there will be several compromises that have to be made. According to the RBI, the PSBs need Rs 2.34 Lakh crores of equity capital (tier 1 Capital) to meet the Basel III prescriptions. The government has made it very clear that it is not going to fund the PSBs with its contribution towards equity but it is ready to dilute its stake to 52% in the PSBs, which implies that the PSBs on their merit have to go to the market to raise the equity capital (through FPOs). The timing is also crucial for the PSBs, as the timings for corporate loan demand revival and the commitment towards government welfare schemes are clashing at the same period. PSBs need to be focussed towards converting these schemes into a profitable business since its inception, otherwise they could lose to private lenders and the NBFCs in the race to fund the corporate loan demand. Conclusion Well, the government could have taken a much more structured and systematic approach in opening ‘fit’ accounts and then ensuring the flow of subsidies through them. That would have taken time off course but it would have been much easier for PSBs who are already reeling under so much pressure on the asset quality

front. While over 70% accounts are zero balance, the money will begin to flow in once the direct cash transfer scheme for government payments starts rolling out. According to statistics, LPG subsidy payments – estimated currently in the range of Rs 25,000-30,000 crore annually – are getting routed compulsorily through bank accounts. Some 50 percent of the 16 crore LPG consumers are already linked through bank accounts, and by 1st April 100 percent coverage is expected. The Economic Times says that “the government has already disbursed Rs 6,688.98 crore to 8.03 crore LPG customers up to 14 January and the figure could go up to Rs 25,000Rs 30,000 crore annually.” Also, the overdraft facility of Rs 5,000 might help the banks to meet the priority sector lending obligation. The banks have already requested the RBI to treat the ODs as loans to weaker sections. The government should set up a credit guarantee fund to cover possible delinquencies in overdrafts. While it is true that the government has to address social issues, for a country like India the first priority should be the infrastructure creation through spending. Banks especially the PSBs and the other Indian banks who aspire to achieve the global platform of banking should be released from compulsive pressures like these. Let’s move a step further in this context and do the performance evaluation including the maintenance issue of every ‘blockbuster’ social scheme with primary focus on implementation and infrastructure creation. So that when we talk of small cities the existing ones should not continue to decay.

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EURO-ZONE : ECONOMIC CRISIS Is European Integration reason for frequent European recessions FinGyaan

FinGyaan

Prashant Choudhary & Debangshu Bhattacherjee

XIMB

Introduction The European Union comprises of 28 member states which was established in 1993 with the signing of “Maastricht treaty”. The European Union which accounts for €12945402 million as combined GDP in 2012 is an important global player. Its main objective is to develop Economic and Monetary Union by virtue of a single currency. It does not consider a state for membership for 2 years post currency devaluation and also nominal long term interest rates should not be greater than three lowest inflation member states. The Euro is the common currency of the European Union. It was introduced in 1999 as an accounting currency for cashless payment and accounting purposes. In 2002 it was circulated in the physical form as banknotes and coins.

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Currently, 18 out of 28 EU members are using the Euro as currency, whereas Denmark and UK have ‘opt-out’ clause in the Treaty which exempts them. While several remaining countries will be adopting the Euro on set deadlines, others don’t have any obligation till date. Is Euro Adding To The Injury The single currency eliminates exchange rate fluctuations and provides a stable trade friendly environment. The Euro is the second strongest currency in terms of its demand. It has been costlier than US dollar for the most part till date. The Euro was doing well till 2008 global recession after which the countries started feeling the heat due to dependence on Euro whose circulation is controlled by the European Central Bank rather than their local central bank. Certain loop holes were highlighted by economists in this model as

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One more interesting pattern observed after the introduction of the Euro is the varying inflation which is not a good indication. Moreover the inflation rate became negative during 2009 due to euro-zone crisis when things were becoming stagnant. But after grants of worth 110 billion Euro flowing in the market, the economy as well as inflation rate recovered a bit as a result of Keynesian dynamics. But now it has again started declining in 2014.

3% of GDP by 2015 due to weak growth (0.3% for 3Q 2104) and very weak inflation (0.32% CPI inflation) rate. Now they will meet it by 2017. The government debt has topped 2 trillion euro (i.e. 95% of the GDP) due to more welfare spending globally, a violation of the 60% rule. Even though a framework has been created but it cannot be followed due to other political and non-political factors like electoral spending. If we take a look at Greece, they have 163.3% Debt as a percentage of GDP and in the past three years it has been hovering over 100%. This led to the signing of the European Fiscal Compact on 2nd March 2012, a stricter version of SGP. It requires member countries to introduce laws to limit their structural government budget deficit to less than 0.5% of GDP. This means that the government can run above the limit, if the target is cyclically adjusted. The fiscal instability was also caused due to the failure of running sufficiently large surplus during prosperity by increasing tax and decreasing spending. The balancing of budget cyclically due to the European Fiscal Compact could have a lot of impact on Europe’s long term fiscal problem as long as politicians do not find a way to manipulate it. Possible Causes Of Recession In Euro Zone

Requirement Of Proper Debt Regulation

Reduction in Public Expenditure

The various national fiscal policies in the European Union are coordinated using the Stability and Growth Pact (SGP). SGP was developed to safeguard sound public finances. SGP has two arms – corrective and preventive. The preventive arm assess annually the medium term budgetary objectives for each member submitted by them. The corrective arm makes sure that Government debt must not exceed 60% of GDP and the deficit must not exceed 3% of GDP.

Most of the member states were engaged in reducing the government deficit to be a part of the Euro Zone and this was indirectly brought about by reduction in the public expenditure between 1995 and 2002. The reduction in public expenditure is mainly due to the decreased public investments towards goods and services. This led to decrease in the budget deficits. Consequently it can be said that the reduction in public investments would have led to a fall in inflation levels as per Keynesian Model. Decline in inflation conveys the message to the public that prices would further fall and so majority of the population would avoid spending and indulge in more and more savings leading to a phenomenon called “Paradox of Thrift”. Such an economy is most likely to enter recession phase.

Deadlines are given to various members by the corrective arm for fixing their deficits. Malta fixed its deficit in 2011, much before the deadline 2014. This might paint a rosy picture but not every country is able to meet its deadline. France recently announced that it will not be able to meet the target of deficit being less than

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countries failed to print more money in case of need which a sovereign state would have done easily in case of monetary independence. According to a paper written by Dr. Thieb Petersen, Dr. Michael Böhmer and Henning vom Stein, “If Germany had a separate currency of its own then its GDP would be about 0.5% points lower which amounts to 1.2 trillion Euro between the years 2013-2025.” So such are the benefits of the Euro that Germany is enjoying. But the German economy is also slowing down. The GDP growth rate has been close to 0% in 2012 and 2013. In 2014 also there is a decline in the output for two consecutive quarters, which is fuelling the chances of recession in the biggest economy of the European Union. Greece, Portugal and Spain already had nightmares in 2009-2013 in terms of economic crisis.

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Fig 1: Long Term Interest Rates (%)

Fig 2: Growth in Bank Credit (%)

Increased accessibility to debt for low credit worthy nations Another aspect which holds a lot of significance is the lower nominal interest rates in the member states after adoption of a single currency. Due to lower interest rates many of the member states resorted to private credits and selling of bonds in order to raise money. This in turn increased the debt levels. After the introduction of the Euro in 1999 the interest rates fell between 2000-2001. The graphs clearly illustrate the fact that there had been a drastic decrease in the long term interest rates and an increase in the bank credits. Due to this many of the countries which had different credit worthiness ended up on very low interest rates for their bonds and private credits. This in turn resulted in a higher government and private investment which lead to increased money circulation due to investment multiplier effect. This made markets more competitive leading to a reduction in price of goods in order to attract consumer demand. This had compelled the firms and institutions to cut back on production, which in turn lead to unemployment thus reducing total personal income earned by people of that nation. Thus a single monetary policy across Europe had resulted in a huge amount of bad debt due to excessive investments and ultimately led a phase of recession. Differences between Fiscal and Monetary Policy

the common monetary policy across the member states, but there was an absence of parity between the independent fiscal policies of the member states and the unified monetary policy. Since bad debt had already accumulated in the European Union during 2007-2012, reducing the lending rate did not encourage investors for borrowing. However money supply could have been brought in the economy if the member states had the authority to print and circulate new currency notes. The European Central bank was solely responsible for the circulation of the common currency Euro. Circulation of fresh currency is a prescription to revive an economy as it will lead to enhanced circulation of money and people will spend more due to inflationary expectations. But the lack of currency printing power further soared the situation thus leading to comparatively powerless governments which leads to recession. Conclusion

The formation of European Union however led to adoption of a common currency or a unified monetary policy but there was an absence of unified fiscal policy between the member states. The ECB was mainly responsible in implementing

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The ECB approach of â&#x20AC;&#x153;One size fits allâ&#x20AC;? common monetary policy that is binding on all the Euro zone countries is against diverse financial and macroeconomic ecosystem of different countries. e.g. ECB targeted inflation rate of about 2% which was suitable for countries like Germany, which had relatively low unemployment levels. But for countries like Greece, Portugal, Spain, who experienced higher levels of inflation and unemployment, such a policy caused more harm than help. It lowered the real interest rates in these countries and hampered their price competitiveness, making them susceptible to current account deficits. The ECB rate was nearly close to Taylor recommended rate for Germany during the first

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Fig 3: ECB Rate vs Taylor Rate for Germany

Fig 4: ECB Rate vs Taylor Rate for Greece

seven years of Euro zone formation (1999-2007). Thus, Germany displayed a strong and stable economy with low inflation level and high output level. If we look at the graphs of Greece; the Taylor rate is higher than the ECB interest rate throughout.

by the same stick by the ECB. There is a dire need for focussing on differential policies and rates rather than a general policy for the whole European Union. So we can conclude that there is certainly a significant link between the formation of the European Union and the recession in the member states. The ECB is learning from past mistakes and improving economic framework but still it is susceptible to external factors and diverse economies of member states. The European nations are falling prey to recession one by one while others like France are in heavy debts. So the future looks grim and the use of quantitative easing methods by the European Union is yet to be seen.

This means that to address the economic issues of Greece, a higher interest rate than what was set by ECB was required. Similar is the case with Portugal. Both of these countries are rumoured to be considering leaving the Euro-zone due to the negligible growth potential. The case of United Kingdom further exemplifies the above analysis. UK chose not to be part of the monetary union and its actual rate of interest was higher than the ECB rate from 1999-2007. So UK used independent measures like higher inflation to reduce the debt burden, depreciating the currency to promote exports etc., which the Euro zone countries couldnâ&#x20AC;&#x2122;t use as they are bound by common monetary policy Moreover adoption of the Euro has been beneficial to most of the nations as we have seen in case of Germany. But it curbs one of the powers of the member states to print fresh currencies to meet their contingent demands as only ECB can print fresh Euro. Printing more currency by ECB for bailing out one nation can soar up inflationary pressures on other nations. So this is acting as a trap as it was seen in case of debt crisis of Greece. Moreover due to complex and variable economic challenges of each country the European Central Bank has failed to address individual issues. Certain nations having varying issues like Inflation and others having deflation cannot be tamed

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Want to be part of the Bull Run? Guide to Mutual Fund Investments Abhishek Bansal

IIM Shillong

Overview In the third Article of the series ‘FinLife’, we will look into the Mutual Fund Investments, the various types of mutual funds available in the Indian Mutual Fund Industry, the risks and benefits of each of them, the current trends prevalent in the industry, and some recommendations on the various offerings by the financial instruments. Market Rally Let us begin by analyzing the recent trends in the Indian stock market. The market has rallied to breach the psychologically important 29,000-point mark for the very first time in the history. The BSE Sensex has surged over 47% since September 2013 to reach at its all-time high. The market capitalization of listed companies on the BSE has surpassed Rs 100 lakh crore for the first time. The trend is likely to continue as per the various analysts of the market and the various reasons for bullish expectations are: Rate cut by RBI – The continuous slide in global crude oil prices and diesel decontrol eased the inflation to a very low level. The RBI cut its benchmark interest rate by 25 basis points to 7.75%. Although, this move was much anticipated, the timing was a surprise. The BSE

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Sensex has gained over 8% since the rate cut was announced. 2) Bank of Japan’s stimulus – According to the analysts BOJ’s move will attract foreign investment in the Indian equity market and this will be helpful especially when US Federal Reserve has finished its six year old monetary stimulus. Also, European Central Bank announced a better than expected stimulus program. These are some of the factors that have contributed to the stock market rally for the short term. 3) Reform Measures – The recent reform measures like decontrolling the diesel prices, opening up of the coal sector, reforms in the railway and insurance sector and relaxed norms for foreign direct investment in the construction sector have brought in positive sentiments in the market. The foreign investors poured in $16.4 billion in the equities market last year. What Is A Mutual Fund? Mutual Funds are one of the most popular ways for new investors to build wealth. It is a type of professionally managed collective investment scheme where many investors pool together their money to buy stocks, bonds, or any other investments. As an investor you own units, which basically represent the portion of the fund

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Fig 1: Working of Mutual Funds

Key Terms Net Asset Value – NAV represents the market value of one unit of fund or the price at which investors can buy or sell units. The NAV is generally calculated on a daily basis, reflecting the combined market value of the shares and bonds held by a fund on a given day. Expense Ratio – Asset Management Companies charge an annual fee to cover the administrative expenses, salaries, brokerage fees etc. A 1% expense ratio means the AMC charges Rs 1 for every Rs 100 in Assets under Management

(AUM). More the assets in the fund, lower should be its expense ratio. As a general rule, 1% towards management fees and 0.6% towards other expenses should be acceptable. Types Of Mutual Funds There are various types of mutual funds available in the market depending upon your plans to invest for short-term or long-term and also the risk factors. Some of the prominent types have been discussed below: 1) Debt Mutual Funds – As the name suggests, a debt mutual fund works on borrowing. Companies and governments require money to run their operations and for this purpose they offer various debt based instruments like Treasury Bills, Debentures, Government Securities etc., and Mutual Funds buy the debt issued by them. AIM – To generate steady returns, Capital preservation RISK – Lower in risk as compared to Equity Funds DECISION – Invest if you are looking at a safer investment opportunity for medium term between 3 months to 2 years 2) Equity Mutual Funds – When you invest in equity, you are considered as an owner of that particular company. So, your profit is linked to the performance of the company. The higher the profits of the company, the better are your gains. AIM – To deliver high returns and act as a guard against inflation in the long term RISK – No assurance whatsoever on the principal, rate of interest or tenure, however MF’s diversify by investing in multiple companies thereby reducing the risk to some extent DECISION – Invest if you have the risk appetite and if you are looking for long term investment as a guard against inflation and capital appreciation 3) Liquid Funds – Liquid mutual funds have the least amount of risk and they invest in short-term debt securities (money market instruments), therefore making them less risky. The concept here is that the shorter is the investment duration, the higher are the chances and surety of you obtaining the principal and the interest. AIM – To provide the investors with greater liquidity and option to park their funds that are excess of emergency funds RISK – These involve the least amount of risk as

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that you hold, based on the amount you have invested. Therefore, an investor is also known as a unit holder. Most mutual funds are openended, meaning unit holders can buy or sell units of the fund at any time by redeeming them from the fund itself, rather than on an exchange. The increase in value of the investments along with other incomes earned from it is then passed on to the investors in proportion with the number of units owned after deducting applicable expenses and taxes. Regulation All mutual funds in India are regulated by SEBI (Securities and Exchange Board of India). The Association of Mutual Funds of India (AMFI) is a self-governing association of Indian Mutual Funds that regulates its members’ sales, distribution and communication practices. Investors can invest in Indian mutual funds directly or through distributors under codes of practice developed by AMFI.

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they are short-term funds and highly liquid Systematic Investment Plan (SIP) DECISION – Invest if you have excess funds over An SIP is a vehicle offered by mutual funds and above your emergency funds for investments which allows you to invest a certain amount at a ranging from a day up to a month or even two regular interval. It is just like a recurring deposit account where you deposit a certain amount of 4) Hybrid Funds - As the name suggests, Hybrid money every month, the only difference being Funds are those funds which have a combination that here the amount is invested in a mutual of asset classes such as debt and equity in the fund. It is a systematic approach towards portfolio. That is, they invest in a blend of debt, investment which helps in inculcating the habit money market instruments and equity. The risk of saving in an investor. factor would also depend upon the mix of debt and equity in the portfolio. Rupee-Cost Averaging Benefits Of Investing In Mutual Funds In an SIP, an investor commits to a fixed amount which is used to buy the mutual fund units There are various benefits of investing in mutual every month at the market rate (NAV). Therefore, funds, some of which are mentioned below: during the period of volatility different units a) Increased Diversification – Like the old saying, are brought with fixed amount of money which “Don’t keep all your eggs in one basket”, a fund means that you will add more units in your holds various securities which reduces the risk portfolio when the prices are low and vice-versa. as compared to investing in a single stock. Power Of Compounding - Long-Term b) Liquidity and Flexibility – Open-ended funds Investing are generally liquid as you can trade your Compounding means re-investing the interest holding with the fund manager at the close of the that you gain, back in the fund. In the words trading day based on the closing net asset value of Albert Einstein, (NAV) of the “Compound fund’s holdings. interest is the Invested funds eighth wonder of are generally the world. He who received back understands it, within 3 to 5 earns it. He who working days. doesn’t, pays it.” The asset The compounding management rule is simple company is the sooner you imposed a start investing, penalty of 15% the more time if you don’t get your money has Fig 2: Example of Compounding of Savings at 8 percent your money to grow. within 10 working days. Monthly Income Plans (MIP) c) Professional Investment Management – Are you looking for an instrument that offer Actively managed funds generally have large you regular income with decent returns with staffs of analysts who actively trade the fund moderate or low risk? If yes, then monthly holdings, thus providing your investments the income plans are exactly for you. An MIP is a best opportunities. Mutual Funds also publish debt-oriented mutual fund that gives you income a monthly fact sheet which lists out all the in the form of dividends. Generally, 70-80% of important facts about the scheme you’re invested the amount is invested in debt instruments in, thus increasing the transparency. like corporate bonds, debentures, government d) Reduces the transaction cost – As per prevalent securities etc. and the rest amount in equity tax laws, under provisions of Section 10 (23D) of and cash. Also you have the option to receive the Income Tax Act, any income received by the income quarterly, half-yearly or annually. Mutual Fund is exempt from tax; which simply Growth Option Or Dividend Option? means that funds don’t pay any tax on the gains obtained from selling securities that they buy on Growth Option – In this option, the dividend is behalf of the investors. ploughed back in the fund and all the benefits

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are reaped net purchase at the time amounting to of redeeming $5.25 billion the fund. This ever since option is more the BJP-led suitable for government investors that came to are looking power. Net for long term inflows into investments equity funds because there have surged is no capital to a new high Fig 3: Inflows Vs Deployment gains tax on of Rs 6,651 the returns and mutual funds give good return crore in December increasing total inflows in over the long term because of the power of . 2014 to Rs 49,458 crore. The primary reason for such positivity is that domestic investors look Dividend Option – This option offers regular at equity as a favorable class because of the income for the investors in the form of dividend improvement in the macro-economic conditions, as it repays a part of the investment each year. fall in commodity prices and inflation. The Example – You hold 1000 units of a mutual fund benchmark indices Sensex and Nifty have and the fund declares a dividend of Rs 5 per increased by 24% each in the last six months unit. You will get Rs 5000 as dividend but the with midcap and smallcap stocks increasing at NAV will also be offset proportionately. a much faster pace. Taxation Impact – Taxation structure can play an CRISIL Report important role when you are deciding whether The equity mutual funds in India have to go for Growth or Dividend Option. In case of outperformed CNX Nifty by 10% on the basis equity fund, any profit on sale of units within of annualized returns over the last 17.5 years, one year is taxed at 10% and if it is sold after according to Crisil-AMFI equity performance one year holding period, then there is no tax on index. Equity funds have given an annualized the gains. On the other hand, the dividend paid return of around 23 per cent as against 13 per cent out by MF companies is tax free in the hand of the investors. However, the mutual fund needs to pay dividend distribution tax before giving out the dividend to the investors. Choosing A Mutual Fund Scheme The mutual fund schemes should be selected on the basis of the following criteria: a) Long term and Short term performance b) Consistency in returns c) Performance during bullish and bearish phases d) Fund managers’ performance with the fund’s Table 1: Average Assets under Management for the quarter operations ended Dec-14 (Source – AMFI) e) Ratings from agencies like ICRA, CRISIL, Value Research Online, Moneycontrol etc. by CNX Nifty between April 1997 and September Current Scenario 2014. During the same period, Reliance MF’s equity funds have given annualized return of Net investments by Equity Mutual Funds was 24.27 per cent on an average, rating agency around $1.2 billion (Rs 7,037 crores) for the Crisil said in a report. month of December. Various fund houses have made net investments of around $3 billion in shares in the last three months alone with their

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Importance of Retail Investment Kunal Vora & Fatema Tinwala

KJSIMSR

the Indian markets have. The FIIs have been Introduction Finance essentially involves the transfer of a major contributor to the investments during funds in exchange for goods and services on this period. Hence, they earned exorbitant promise of a future return. Financial markets profits which the retail investors missed out like security market and financial intermediaries on. Individual investment may be small, but are a critical element for functioning of the collectively it will be a huge amount leading economy that facilitates the transfer of funds to capital mobilization facilitating avenues of growth. for economic growth. Sensex has been the official tracker for the Need For Study growth of Indian markets. Currently the markets It has been observed that in 2013, the are at an â&#x20AC;&#x153;all time highâ&#x20AC;? and facilitate a bull- participation of retail investors had come down market type scenario. A rise in the middle class to a 10-year low. This suggests that investors still have not recovered has been observed from the 2008 crisis which can fuel which had resulted in further growth in major losses in the form of for many of them. investments from The mounting this segment. corruption and The Sensex has scams have gained almost added on to their 600% over the last apprehension. A 20 years, from declining trend has 3000 to 27000. In been observed in the past 8 months, the retail turnover Sensex has moved over a period of significantly; shot last 10 years. up by almost 40%. Hence the These facts suggest movement of the massive market is not potential which Fig 1: Retail turnover over a period of 10 years: A declining trend

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academic background, income, or information about the market. Awareness is needed while carrying out trading activities, else the investors can incur massive losses. Economic reforms have aided several foreign players to enter the Indian market. These investors are called ‘Foreign Institutional Investors’ (FIIs). It has become more complex to understand the stock market for retail investors due to the foreign entrants. Stock Market volatility: Stock markets are highly unpredictable. This was felt especially after the US mortgage crisis in 2008 which left a long lasting impact all over the world due to the losses made by individual investors. A massive drop in indices sometimes creates a bearish sentiment which creates a pessimistic investment scenario. Scams like Harshad Mehatha, Khethan Parekh etc., have also created negative sentiments. Protection of interest of retail investors: Many IPOs have been fraudulent and have disrupted investor confidence. Retail investors need to be protected from such frauds. Moreover, some investors have multiple demat accounts and can mobilize more shares through them. Regulatory bodies should protect investors from these issues. Intermediaries: Retail investors find it hard to purchase shares on their own accord. They need expert guidance to make an accurate decision for them. But this decision comes at a cost called floatation cost. In general, intermediaries such as stock brokers and sub-brokers influence their decisions. Stock brokers or sub-broker firms act as intermediaries and influence the decision. But sometimes these intermediaries tend to fool the customer through faulty balance sheets and incorrect valuation of corporate capital structure. Alternative investment avenues: Gold and Real Estate are lucrative options for many Indians due to low risk and low default rate. The Indian mentality of having gold because of association to the culture and wealth has also strengthened this fact. Capital markets have sprung up only in the recent years and have had their own flip sides. This leads to the investment flux diverting to alternate avenues. Technological problems: Timely and rapid information is very essential for stock market trading. Gaps in information can lead to heavy losses. Hence, traders need robust infrastructure that can deliver the best efficiency possible. As recent as 27th December 2014, several hundred retail investors who bid for shares in the offer for sale (OFS) of Steel Authority of India (SAIL)

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because of retail investors but due to the Foreign Institutional Investors (FIIs). The participation of FIIs has shot up to 47% in stark contrast with retail investors at less than 22%. The FIIs are considered highly fickle and dividends earned by them will lead to a drain of wealth from India and not necessarily be reinvested. Discussion And Analysis Current trends: Low growth rate, high inflation, high fiscal deficit, depreciating rupee and lack of faith in government policies are few reasons due to which there is a lack of investor participation. Today sensex is rallying aggressively and the commodity market is undergoing a decline. Hence, Equity can be a lucrative investment option. Several stocks in infrastructure, oil & gas, power, manufacturing, capital goods etc. can be seen as an investment options. IRB Infrastructure, HPCL, IL&FS, BHEL, DLF, Coal India, JP Power, Reliance Industries Ltd., ONGC, and Indian Oil can be examples of these stocks. In India, the retail investor participation is very low at 2% of the total population. A fund raised by the retail investors is the only way to generate risk capital. This injected risk capital facilitates the pumping of money for upcoming enterprises to function and diversify their businesses. It is a retail investor who provides capital directly through equity market. 2% of the Indian population which contributes to investments raise $0.5 billion. If this percentage increases to 30%-40% (as in United States), funds worth $7.5$10 billion can be raised. Market characteristics: Indian markets are well equipped with a technical interface. The incorporation of dematerialization wherein physical shares are converted into electronic form led to reduction of default risk and increase in liquidity. There are a large number of companies listed in stock exchange in the Indian markets. This is actually a drawback because shares of most of them are not traded on a regular basis. Capital valuation of these companies needs to be done and appropriate measures to be taken so as to induce investor confidence in them. Various charting softwares are available which depict trends. These trends can provide an understanding of stock movement and provide insights for its price discovery. This data can aid investors for their decisions. Causes of low retail participation: Lack of awareness: Majority of the Indian population is unaware about the functioning of Capital Markets. This may be due to their

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have not received their promised discount due to technical glitches that happened during the trading. Strategies to overcome problems: There are several measures taken by Reserve Bank Of India (RBI) and Security and Exchange Board (SEBI) to attract investors. Awareness creation: The most important thing is to create awareness among the masses. This could attract them to invest in the capital markets rather than other investments. It is necessary to establish training institutes to train the professionals who are dealing/working in the stock market related fields. For this, the regulatory bodies may take the help of other professional bodies like Institute of Chartered Accountants of India (ICAI), Institute of Cost and Works Accountants of India (ICWAI), Institute of Company Secretaries of India (ICSI) and others. Through awareness one can attract the retail investors easily. The regulatory authorities also have to organize workshops, seminars, and campaigns etc. to make people aware about the practicalities of the capital markets. As per the Disclosure and Investment Practices (DIP) guidelines, the shareholders are entitled to the following rights. Some of them are as follows: 1. To receive the share certificates, on allotment or transfer (if opted for transaction in physical mode) as the case may be, in due time 2. To receive copies of the Annual Report containing the Balance Sheet, the Profit & Loss account and the Auditorâ&#x20AC;&#x2122;s Report 3. To participate and vote in general meetings either personally or through proxy 4. To receive dividends in due time once approved in general meetings 5. To receive corporate benefits like rights, bonus, etc. once approved 6. To apply to Company Law Board (CLB) to call or direct the Annual General Meeting 7. To inspect the minute books of the general meetings and to receive copies thereof Besides the above rights, which you enjoy as an individual shareholder, you also enjoy the following rights as a group: a) To requisite an Extra-ordinary General meeting b) To demand a poll on any resolution c) To apply to CLB to investigate the affairs of the company d) To apply to CLB for relief in cases of oppression and/or mismanagement

JANUARY 2015

Regulation of Intermediaries: In this regard the regulatory bodies have to act strictly. The intermediaries being the key players in the market, it is necessary to govern them. The practice of client registration with brokers or sub-brokers, depository participantsâ&#x20AC;&#x2122; activities should be examined at regular intervals. The commission charges and service charges are needed to be reviewed and necessary measures are to be taken wherever necessary. Priority to the retail investors: In the recent past, we have seen the exponential growth of Foreign Institutional Investors (FIIs), Qualified Institutional Buyers (QIBs) that growth may be because of the Government policies, rules and regulations. It is desirable to give priority to the retail investors also. Every time when the stock market crashes generally the retail investors become the victims. It can be avoided by concentrating equally on the retail investors. Corporate Governance Practices: The regulating authorities have to ensure that all the corporate organizations are practicing good corporate governance practices. This in turn will improve the confidence of the retail investors. Many violations are taking place in the global financial markets in this regard. In all the scams retail investors are losing huge amount. The incidents like Global Trust Bank, the recent issue of Satyam computers etc. are preventing the retail investors from investing in the capital market. Technology improvement: The technology plays vital role in selling/purchasing the financial instruments. The on-line terminal system should be improved. Many retail investors are not able to sell/purchase during volatile situations. Stock exchanges should provide the best quality technology service to the investors.[2] Conclusion It is clear from the above facts that an increase in participation of retail investor will help India progress as it will help provide the much needed liquidity to the markets. Moreover, equity will generally perform better than other asset classes in terms of returns (albeit their volatility). When making investment decisions, one should not invest based on whims of other individuals. Investment decisions should be pragmatic and made after spending time reviewing all the available information. Equities should be viewed as a mechanism to gain long term wealth and not as a short term shortcut to mint money.

Interview With Dr. Maram Srikanth Professor - IIM Shillong

Banking Sector has been the top performing industry in financial markets in 2014. Axis Bank was the top gainer, almost doubling with gains of 93.10 per cent, followed by State Bank, up 76.59 per cent at the third spot, and ICICI Bank ranking fifth with gains of 60.75 per cent. However when we look at the nonperforming assets (NPAs), in many cases, gross NPAs of a few PSU banks are almost touching double digits, while the net NPAs hover between 4-6 per cent. State Bank of India has NPAs of approx. 31096 crore. What is the reason for diversion between returns and high NPAs? If you observe the Indian banking sector, total gross NPAs stood at 4.5% as on September 30, 2014. Restructured standard advances are around 6.2%. Put together, stressed assets of Indian banks are around 10.7% as at the end of Q2 2014-15. Some of the credit rating agencies estimated that this ratio may touch 15% if the course correction does not take place. If you analyse the NPAs in the banking sector, there are 5 sectors which contributed the most namely infrastructure, iron and steel, mining, textiles and civil aviation. They hold around 52% of total stressed assets as on June 30, 2014. Infrastructure sector has a lion’s share of stressed assets (i.e., 15.6%) mainly because the banks in India could not appraise the projects properly at the time of sanctioning these term loans and did not factor in the downturns in their models. Further, hike in interest rates as well as critical inputs during implementation period of these projects, availability of raw material like coal, issues related to Right of Way, delay in obtaining clearances from Ministry of Environment & Forests, etc. are the main reasons for higher NPAs in the infra segment. With regard to sector wise stressed assets, majority of stressed assets/NPAs are in Public Sector space. The reasons are obvious: directed lending to certain projects and political pressures/ issues of corporate governance on the part of PSBs. Besides, delay in timely disbursements,

lack of follow up by lending officers resulted in the stressed assets. Such pressures or compulsions are relatively less in the private sector and they have better follow up systems which help in reducing their NPAs. Nevertheless, some of the PSBs like SBI, BoB, etc. managed to do well in terms of their returns mainly due to their wide presence in the nook and corner of the country. As they have access to low cost funds/float funds from the Government, their Net Interest Margins are at satisfactory level which is reflected in performance of Bankex. What are the key challenges of Indian banking sector and how to rectify them? In a lighter vein, I can say that Global financial crisis was a blessing in disguise for the Indian banking sector. A key takeaway of the crisis is that a lot of focus has been given to capital adequacy, leverage and liquidity of banking institutions. The question arises as to why to follow capital adequacy norms of advanced nations when we can’t achieve financial inclusion in our country. The reason for this is simple. Even though per capita income of India is around $1600, our country has a lot of rich people alongside the below poverty line population. Besides, India is the 4th largest economy in terms of purchasing power parity. On one side there are advanced financial systems and institutions and on the other side, most of the people have no access to basic banking facilities. The reason for the fall of Lehman Brothers was excessive leverage (i.e., around 26:1 during September, 2008). Some of the Indian Corporates, on an average, are having higher leverage (gearing ratio) around 3 times mainly in infrastructure, iron & steel, mining, textiles, etc. As some of the corporates have double leverage’’, on their balance sheets (i.e., holding company is investing in Special Purpose Vehicles on one hand and the promoters are pledging their shares on the other hand), which put heavy strain on interest servicing capacity of these firms. This needs to be corrected since banks are at the receiving end. The third challenge is of course liquidity. Most of the banks fail

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NIVESHAK

to manage their liquidity requirements during the crisis times. This can be addressed by development of our corporate bond market and participation of pension / insurance funds in infra segment so as to reduce heavy reliance of corporates on banks. With a view to strengthening their credit risk management as part of conservation of capital, banks should have sound credit appraisal systems, strong due diligence, proper credit monitoring/follow-up and impeccable legal documentation in place. It is a proven fact that target-oriented lending leads to NPAs in the banking industry. Hence, banks should be cautious while taking an aggressive stance of lending, especially during boom periods. Further, Indian banks should upgrade their human resource skills, technology and data warehousing capabilities further to maintain their financial health as well as the economy. The budget 2014-15 has set aside 11,200 crore rupees to help the banking sector meet minimal capital ratios mandated by Basel III norms, but it is believed that more would be required in the budget this year. Global ratings agency Moodyâ&#x20AC;&#x2122;s Investors Service estimates the state-run banks would need anything between Rs 1.5 lakh crore and Rs 2.2 lakh crore to comply with Basel-III by 2019. How, as per your opinion, should the government tackle this issue? What are the alternatives? Should we go for privatisation? Between 2011 and 2014, Government infused around Rs. 58,600 crore in PSBs. Now it plans for 11,200 crore during 2014-15. This is a very huge amount given our high fiscal deficit of 4.1% and limited head room for fund raising ability of the Government. Now, the Government is holding between 56-84% equity stakes in PSBs and wants to reduce the same to 52% level so that public and institutional investors can participate in this disinvestments process. Even SEBI directed that the public shareholding in the listed companies / PSUs should not be less than 25% by June, 2017. So in order to comply with this and to meet the capital adequacy norms of Basel-III, going forward, Government of India has no other option but to decrease its stake in PSBs. Even if the Govt. wants to decrease its stake to less than 51% in PSBs, it may not be able to do so due to various political compulsions. Instead, the government may go for issue of shares with non-voting rights, a practice prevalent in developed nations. Also, the government may push for consolidation in the banking industry by way of mergers as per the Narasimham

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JANUARY 2015

Committee Report, 1998. This may partly solve the problem of capital adequacy of banks. For the time being, privatisation of PSBs may not happen in India say during the next 5-10 years down the line. The reason for this is that Public Sector banks have certain social objectives to be met. If they are privatised, it will be very difficult for the Government to meet these social objectives and achieve financial inclusion as envisaged by the policy makers. Recently top officials of all Indian banks participated in Gyan Sangam, Pune to discuss burning issues and key challenges faced by the Indian banking industry. Most of the senior bankers opined that the individual banks should be given enough autonomy at the board level for key decisions such as mergers, inducting fresh talent at the top level (drawn from the market), introduction of performance related remuneration, splitting Chairman and Managing Director posts, etc. So, we can expect some path breaking reforms in the Indian banking sector in the near future. What, in your opinion, should be the focus of Union Budget 2015-16? One is consolidation of the banking industry and the second one is capital adequacy. Other issue is controlling fiscal deficit of the Government to reduce from the present estimated level of 4.1% of our GDP. Deregulation of oil prices and Fiscal austerity may be given further impetus to reduce fiscal deficit of the Government. Another area of focus will be financial inclusion. Even after 68 years of our independence, a huge section of the society (around 40%) are outside the purview of regular, organised Indian banking system. And these rural masses are literally at the mercy of money lenders and contracting high interest bearing loans. Hence the government is very eager to bring them under banking system. So that the Government can transfer cash subsidies directly into their savings bank accounts. PMJDY is a right step in this direction, which may be given further boost in the days to come. Apart from the above, revival of stalled infrastructure projects by way of single window clearances, land acquisition issues, special asset class status to infrastructure segment are some of the top priorities of the Government. Exports will be the major focus of the present government to contain Current Account Deficit as well as to earn the precious foreign exchange. The government is looking forward to revive the investment climate thereby increasing the investorsâ&#x20AC;&#x2122; confidence through various industry friendly measures.

NIVESHAK

Value investing

FinFunda of the Month

Mohnish Khiani IIM Shillong

Sir, Yesterday I was watching a news channel which aired a famous interview of the legendary investor Warren Buffett, where he spoke about value investing. I couldn’t understand the meaning behind this term, can you please explain it to me? Value investing is an investment paradigm that derives from the ideas on investment philosophy that Ben Graham explained in his famous book Security Analysis. Value investing has taken many meanings since its explanation by Ben Graham, it basically means buying securities that appear under priced by some form of fundamental analysis. Warren Buffett has taken the value investing concept even further with a focus on “finding an outstanding company at a sensible price” rather than generic companies at a bargain price. Okay, I have understood the concept but how does one apply this in real life? As examples, such securities may be stock in public companies that trade at discounts to book value, are high dividend paying companies, and have low priceto-earning multiples. The discount of the market price of the stock to the intrinsic value is what Benjamin Graham called the “margin of safety”. The intrinsic value of a security is calculated as the discounted value of all future cash distributions by it. The most notable contribution of this strategy is to emphasize on the quantifiable aspects of security analysis such as the evaluations of earnings and book value while minimizing the importance of more qualitative factors such as the quality of a company’s management. Oh, if this is Value Investing, are there any other strategies that investors follow? Yes, there are multiple strategies that an investor may follow. A famous contrasting strategy to value investing is

growth investing. Those who follow this style, are known as growth investors who invest in companies that exhibit signs of above industry average growth rate, even if the share price appears expensive in terms of metrics such as price-to-earnings or priceto-book ratios. This concept seems fine, so why doesn’t everyone apply it? Are there any short comings in its approach? The concept of value or book value has evolved significantly since the 1970s. Book value, which is the acquiring price of fixed assets of a company subtracted by its accumulated depreciation, is most useful in industries where most assets are tangible. Intangible assets like patents, software, brands, or goodwill are difficult to quantify. When an industry is going through fast technological changes, the value of its assets cannot be easily estimated. Sometimes, the productive power of an asset can be significantly reduced due to competitive disruptive innovation and therefore its value could suffer a permanent impairment loss. But how can one be sure that the price of a lowly valued stock doesn’t fall more, because most of the times there are fundamental reasons as to why the stock is priced low, doesn’t it mean there is inefficiency in the operations of the markets? Yes, one cannot always be sure about the movement of prices and a value investing strategy can also turn into a value trap by selecting a fundamentally bad business. But markets are sometimes driven by sentiments or news that have short term implications and do not affect the business directly. In such grim scenarios, when the entire market crashes, all kinds of stocks fall. This is the right time for bargain hunting and selecting good quality businesses which are reasonably undervalued. Sir, Thank you for explaining me the concept of Value Investing. I am sure it will help me to understand investing in the markets in a better manner now.

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