Niveshak July 2012

Niveshak THE INVESTOR

VOLUME 5 ISSUE 7

July 2012

WHEN ENERGY HITS THE BOURSES

the costs of a viperous “coupling”, Pg. 8

consumer credit ratingindian context,pg. 16

FROM EDITOR’S DESK Dear Niveshaks, Niveshak Volume V ISSUE VII July 2012 Faculty Mentor Prof. N. Sivasankaran

THE TEAM Editorial Team Akanksha Behl Akhil Tandon Chandan Gupta Harshali Damle Kailash V. Madan Nilkesh Patra Rakesh Agarwal Creative Team Anuroop Bhanu Venkata Abhiram M.

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

With the major companies declaring their first quarter results, the month of July witnessed various ups and downs in Indian economy. In the IT sector Infosys disappointed the market with a 28.5 per cent increase in revenue and 32.9 per cent increase in net profits lower than the investor’s expectations whereas India’s largest software exporter, Tata Consultancy Services, continued its dream run with a 37.7 per cent growth in revenue and 37.4 per cent growth in net profits. Infosys lowered its dollar revenue FY13 outlook from 8-10% to a dismal 5%, resulting in 8% fall in stock on a single day. Reliance Industries posted a 21% fall in net profit beating the market expectations.

The international agencies also brought both the good and bad news for Indian economy this month. On one hand the Asian Development Bank had lowered its growth forecast for India from 7.0% to 6.5% followed by International Monetary Fund that lowered the growth forecast to 6.1% by a margin of 0.7% for the current fiscal year and on the other hand UNCTAD’s World Investment Report 2012 declared India as the third most preferred FDI destination after China and United States.

Amidst all this, the talks of Indian economy being in stagflation also continue. The news from the political circles brought a pleasant smile on the faces of industry veterans, as CII President Adi Godrej said Pranab Mukherjee, newly elected President of India, is a ‘Man of all seasons’.

On the international front, the biggest shock came from Barclays when its’ CEO Bob Diamond resigned amid an interest rate fixing scandal. The departure of Bob Diamond was followed by the resignation of Jerry del Missier, Barcalys Chief Operating Officer. The Barclays management has been accused by regulators in Britain and US of manipulating the setting of London Interbank Offer Rate, also known as LIBOR. In another major development, Greek Prime Minister Antonis Samaras told former U.S. President Bill Clinton that the country is in great depression and the GDP of the country is expected to shrink by one fifth since 2008 by the end of current fiscal.

The issue brings to you a comprehensive analysis on Power Exchanges in India, covering in detail the issues faced by the Power Exchanges in India and the proposed solutions for the same. The article of the months discusses about the economic crisis being worsened because of the Leadership crisis in India and the possible solutions for the same. The issue also features articles on Asset Restructuring Companies, practice of Consumer Credit Rating in India and unsustainability of widening global imbalances post the financial crisis of 2008. The classroom section explains the concept of technical analysis.

We would also like to thank our readers for their constant support through wonderful articles and appreciation. It is your endless encouragement and enthusiasm that keeps us going.

Kindly send in your suggestions and feedback to niveshak.iims@gmail. com and as always, 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

08

The Costs of a Viperous “Coupling” : The Global Economic Crisis and India’s Leadership Crisis

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When Energy Hits the Bourses

FinGyaan 16 ARCs: A panacea or a

problem in itself?

Finsight

14 Consumer Credit Rating - Indian Context

Perspective 18

Unsustainability of Global Imbalances : A perspetive

CLASSROOM

21 Technical Analysis

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The Month That Was

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The Niveshak Times Team NIVESHAK

IIM, Shillong

Results corner: Infosys disappoints while TCS outperforms The earning season for the first quarter of FY13 began with disappointing news from IT major Infosys. The much talked about transformation in Infosys, Infosys 3.0, has been around for nearly a year; however it has failed to deliver as promised. Infosys did seem to be making some adjustments to suit the current market environment, as evidenced by its volume growth of 2.7%. But pricing declined more than 3%; margins fell despite the company freezing employee pay; it added one less client than in the last quarter. Infosys disappointed investors yet again by lowering its revenue guidance for 2012-13 much below expectations to around 5% and discontinuing the practice of guiding for the next quarter amid volatile economic conditions.

In sharp contrast, the largest Indian IT company by market capitalization, Tata Consultancy Services, positively surprised the market by posting better than expected financial performance. TCS beat street expectations with a 37.7% growth in revenue in the first quarter to 14,869 crore riding high on back of strong, secular growth across all its service lines and industry segments driven by robust volumes from key markets like North America, Europe and the UK. The premium the Infosys stock has enjoyed over the years is beginning to wane and although valuations are expensive for Tata Consultancy Services, investors are willing to give premium for its growth prospects in a challenging environment.

Deficient monsoon may further exacerbate inflation scenario in India It is no secret that the Indian government has failed to control inflation which has shown remarkable resilience over the past year or so.

Although some of the blame for this situation pertains to the macroeconomic environment, lack of political will to implement reforms to alleviate the problems of supply seems to be the main culprit. RBI has done its bit to control inflation by maintaining a hawkish stance in the face of severe criticism from industry groups,

July 2012

all of whom are clamoring for a rate cut to resume high growth path that India had followed before the global financial meltdown.

Adding to the woes of government this time around are the rain gods. The monsoon has disappointed so far and there is increasing possibility that deficient rainfall will push up inflation and the cost of the subsidy further limiting the scope for rate cuts by RBI. According to the India Meteorological Department, rainfall was deficient by 25 percent for the country as a whole, as of July 8, with 22 of 36 regions receiving below-normal rainfall. Regionally, the north-western India was the most affected with deficient rainfall by 43 percent. According to the Department of Agriculture, due to the lack of rain, the production of rice, coarse grains, oilseeds and cotton were at greatest risk. Even the Central Water Commission is concerned that water levels in the 84 reservoirs used for “storage” are below normal which could mean lower availability of energy and/ or use of other more expensive sources. It is still early for the summer monsoon and a recovery in rainfall in the coming weeks could help reduce or even completely eliminate the deficiency and bring relief to all the stakeholders.

Amnesty for HSBC A/c holders who evaded tax from Indian government In a bid to shore up the dwindling financial state of its forex reserves, India has planned to offer amnesty to more than 100 wealthy citizens who evaded taxes by hiding funds in accounts at HSBC Holdings’ Swiss unit. By doing so, India joins UK and the US in cracking down on those who have not disclosed offshore funds amid probes into money laundering and

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tax evasion. On the flip-side, there will be no criminal proceedings or levy of penalty for Indians who repatriate the money and pay the taxes that were earlier evaded. It is estimated that India loses approximately 14 lakh crores ($250 billion) from tax evasion every year, depriving it of funds for investment in major government initiatives like roads, ports and power. Based on similar estimates, such repatriation is expected to double India’s tax revenue to nearly 16 lakh crores. The initiative received further impetus when Supreme Court ordered a team, headed by a judge, to take over the government’s efforts to retrieve as much as $500 billion that Indians have stashed illegally overseas.

IMF Lowers India’s Growth Forecast for ’12 and ‘13 The International Monetary Fund has lowered India’s growth forecast for 2012 and 2013 to 6.1% and 6.5% respectively by a margin of 0.7%.

Deteriorating financial stability in the country because of depreciating rupee and huge fiscal deficit coupled with weakening domestic demand is expected to bring down the growth further. IMF also warned that investors risk aversion has increased because of the growth uncertainty and it is very high time for the policy makers to adjust policies as per the environment. Recently Asian Development had also lowered the country’s growth forecast to 6.5% from 7.0%.

QE3 by Fed, a real possibility after Asian data also reflects slowdown Largest exporters of Asia showed further signs of deceleration in the most recent data published, indicating a new slide in global demand prompting response from two senior officials of the U.S. Federal Reserve that they were in favour of relaxing monetary policy boost growth.

Core machinery orders in Japan fell by 14.8% in May with key indicator of capital spending

falling well below analyst expectations of a decline of 3.3%. The situation warrants appropriate management of growth risk that will likely stall due to reduced investment by companies.

Meanwhile, consumer inflation in China fell more than expected in June resulting in four consecutive months of producer prices deflation.

These numbers signal that demand for goods from industrial sectors across the nation, especially from foreign customers, is declining due to weakening global economy. Consumer prices rose a mere 2.2% over the previous year, a 29-month low and down from 3% in May. Even Taiwan’s exports, one of the world’s largest producers of electronics, fell in annual terms for the fourth consecutive month in June. In light of the weak global scenario, the primary dealers, large financial institutions that deal directly with the Fed, expect a 70% chance of $ 2.3 billion in the QE program through large scale purchases of bonds.

Government set to ease single brand FDI policy in retail in order to increase inflow In order to permit easy access to international brands into the country, the government, as a part of comprehensive review of the FDI policy, is planning to ease local sourcing and brand ownership norms. Around 6 proposals of big and small sized single-brand retailers have been put on hold by the government due to the condition that the investing companies must own the brand. Also, the rule that retailers have to source at least 30% of the sale value from the SMEs whose investment in plant and machinery is less than $1 million will be relaxed. There is a possibility that the retailers will be permitted to meet these norms over a period of time and also the 30% requirement will apply to cost and not sales value. The measures are expected to bring great relief to foreign investors like IKEA.

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Article Market of Snapshot the Month Cover Story

Market Snapshot

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

MARKET CAP (IN RS. CR) BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap

60,15,895 28,28,875 14,27,496

LENDING / DEPOSIT RATES Base rate Deposit rate

10%-10.75% 8.5% - 9.25%

Source: www.bseindia.com

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

56.38 68.05 72.12 87.44

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

4.75% 24%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

Source: www.bseindia.com 23rd June to 25th July 2012 Data as on 25th July 2012

July 2012

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BSE Index Sensex

Open 17038.77

Close 16846.05

% Change -1.13%

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

6033.71 6416.85 9388.36 11643.80 6197.03 9782.89 4872.79 6726.31 5664.70 10431.05 7928.55 1901.00 7124.71 1643.82 3298.09

6066.29 6555.87 8874.29 11784.32 6242.95 9552.48 4990.77 6995.05 5237.37 10131.44 7969.12 1855.43 7153.06 1634.50 3116.50

0.54% 2.17% -5.48% 1.21% 0.74% -2.36% 2.42% 4.00% -7.54% -2.87% 0.51% -2.40% 0.40% -0.57% -5.51%

% CHANGE

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The costs of a viperous “coupling” :

The Global economic crisis and India's Leadership Crisis

Prasenjeet Acharjee

TAPMI

The threat of a double-dip recession in the US, underlined by the Standard & Poor’s downgrade of its economy, resulting later in a global meltdown of stock markets and the never-ending Eurozone crisis poses a real challenge to India’s economic policymakers. S&P has downgraded India’s rating from stable to negative, citing a high debt burden, slowing fiscal reforms, and diminishing growth prospects. India finds itself in the midst of an economic crisis of staggering proportions better coined as stagflation.

The deterioration in the economic situation has been partly attributed to the developments taking place abroad. Talks were going on about endorsing a new currency in the backdrop of a bankrupt Greece and Germany was reluctant to offer Greece more help.

However, the favorable election in Greece has restored new belief and a ray of hope among investors. Eurozone crisis has affected Indian economy to some extent as Indian economy is today more integrated with the global economy and Eurozone accounts for a significant share of the global economy and is also India’s major trade and investment partner.

However, let us not concentrate on situations that are out of our hands. Let us look into some of the

issues plaguing the Indian economy and which can be controlled and handled.

India’s GDP growth rate has hit a rock bottom level of 5.3% as of June, 2012. There has been a steady decrease in the Indian GDP growth rate since 2010.

There are many reasons for this. IMF (International Monetary Fund) is of the view that India’s debt management policy is not as efficient as some of the other BRIC countries.

As can be seen from the graph below, among emerging economies India’s government debt stands highest at 68.05% of its GDP closely followed by the Brazilian government debt at 66.20%. Debt levels in Russia and China are comfortably poised at 9.60% and 25.80% respectively. However, DK Joshi, chief economist at CRISIL, is of the opinion that India’s government debt is on the higher side but the good news is that it has been reducing consistently.

Also, government debt to GDP ratio of other major countries shows that India’s debt scenario is not that bad.

Apart from the debt issue, India’s inflation level is quite high, highlighting that of the Indian Government and RBI’s effort to control inflation have

Fig. 1: India’s GDP growth rate in percentage

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proved to be inadequate so far. However, the good news is that the inflation has been declining by more than 50% since 2010 but it hasn’t yet reached the desired level considering the state that the Indian economy finds itself in.

One of the major pain points in this economic scenario has been India’s high fiscal deficit and high current account deficit. The major reason behind high fiscal deficit is that there has been a 200% increase in subsidies since 2007-08.Current account deficit has swollen up because of high demand for gold among a few other factors.

Another major concern is that Indian Rupee has been falling sharply. There is a 22% drop in rupee against dollar since early 2011. Rupee depreciation has pushed up the rupee cost of imports. The net effect of rupee depreciation will be that profit margins of companies that import commodities or components would shrink which in turn, could result in price increases for the consumer and push up inflation.

This will also increase government’s fiscal burden.

The industrial sector will be one sector which will be majorly hit by this. Also, the Indian government’s borrowing cost will increase because of this rupee depreciation.

Another major problem has been the steady increase in interest rates. The interest rates have increased by 60% since March 2010. The repercussions of this can be manifold. To start with, the cost of borrowing will increase and mortgage interest payments will increase. There will be an increase in incentive to save rather than to spend. High interest rates will affect both consumers and firms and hence, the economy will experience a fall in consumption and investment.

There has been a substantial drop in investments, 29.5% of GDP, gross fixed capital formation, the lowest in 7 years.

Some of the other pain points in the present economic scenario are power sector crisis and decline in portfolio inflows. At present, 30000MW of power amounting to Rs 47,738cr power plant is either idle or underutilized. Also, there has been a decline of more than 50% in portfolio inflows from 2010. The portfolio inflows stand at Rs 47,738cr in 2011-12 against Rs 110,120 crore in previous year.

Some of the above problems can be controlled by taking stringent and brave decisions and policy reforms.

Analysts believe that high fiscal deficit can be controlled by speeding up Adhar pilots, reducing diesel and urea subsidies and decontrolling diesel. Controlling fiscal deficit will curtail current account deficit.

Demand of gold should be curbed and distribution margin on financial products should be restored to further control current account deficit. Inflation can be controlled to a great extent by easing supply side constraints as inflation in India is majorly attributed to supply side. APMC Act should be removed and retail sector should be opened to FDI. High interest rate can be controlled to certain extent if there is strong commitment to fiscal consolidation which in turn will help RBI cut rates. Investments can also be increased in a number of ways. For a start, clarity on coal can kick start power investments. Cash-rich PSUs should be urged and supported to help them fast-track plans which are stuck in some stage or the other. Government should switch from subsidy to investment by stepping-up investment in roads, towns, infrastructure and broadband infrastructure.

Power sector issues can be sorted to a great extent by supplying coal to plants working at sub-optimal

Fig. 3: Government debt to GDP ratio

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Fig. 2: Government debt to GDP ratio of BRIC nations

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Fig. 4: India’s inflation rate in percentage

capacity. Steps should be taken to revamp state electricity boards so as to ensure that power producers can sell to them without payment worries. Portfolio inflows can be increased by allowing employees to migrate from EPF to NPS for long-term savings to be deployed in stocks. Some analysts believe that the dynamics of Indian industry can be altered by the introduction of Goods and Services Tax. Also, if the conditions in the Land Acquisition Bill were to be implemented as it is, India will find it extremely difficult to meet the targets that it has set for investments in infrastructure and manufacturing sectors over the coming years. The consequent impact on job creation will be devastating. There was an expectation that RBI will cut rates. But eventually RBI did not cut rates which sent the stock market tumbling down for some time. However, J P Morgan has estimated that a 10% depreciation of the rupee in nominal (NEER) terms over the past three months is equivalent to 100 basis points of rate cuts, calling it “something that should bring pause to those who still believe substantial rate cuts are warranted debunking the myth that a rate cut will go a long way in improving the current situation. FICCI believes that providing fiscal stimulus for investments across sectors such as allowing accelerated depreciation, re-introducing investment allowance and scrapping MAT for infrastructure projects will increase investment activity without significantly affecting government finances.

But all these solutions require Indian government to take bold decisions and make strong policy reforms which it has been incapable of doing so far.

In fact, one of the major reasons cited for the current state of Indian economy is that the government is in the grips of a policy paralysis, unable to push through reforms that would pave the way for more investment, or flip-flopping on measures that would

do the same. Some analysts and experts think that blaming Europe is only buying time. The root cause of this policy paralysis has been attributed to leadership crisis in the UPA government. There has been a lack of coherent, coordinated and determined behavior from leaders holding top positions in the government. Events since the announcement of the 2012/13 budget in March suggest a deeper dysfunction: a leadership vacuum that has led to empty promises and muddled policy decisions, most notably on tax reforms. Analysts believe that the need of the hour is to change guard in key roles in government. Sonia Gandhi’s backing to tough policy reform measures would be highly desired in these circumstances. The market sentiment can be gauged by the fact that a change of guard at the finance ministry has lifted stock market sentiment noticeably, probably the most in the last 12 months. Probably self-awareness could avert a “macro-economic train wreck” as far as the Indian Economy is concerned.

However, all is not gloomy after all. J P Morgan, in spite of the risk factors facing the economy, has upgraded Indian equities to “overweight” from “neutral” due to encouragement from a number of more positive factors including historic valuations. The bank has predicted a year-end target for BSE index at 19,000 points, a 12% increase from current level.

It expects the broader 50-share NSE index to trade in a 4,800-5,200 range in the near-term. However, the bank is of the opinion that slowing policy reforms remain a hindrance to economic growth and would be a key to recovery.

The problems, analysis and suggestions that have been outlined above are certainly not exhaustive but capture some of the core issues of the current economic scenario.

Fig. 5: India’s interest rate in percentage

July 2012

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Akhil Tandon

BACKGROUND In July 2006, the Central electricity Regulation Commission (CERC) took a major initiative to develop and promote the electricity market in the country and floated a discussion paper on “Developing a Common Platform for Electricity Trading”. Comments were invited from eminent academicians and industrialists, thereby involving all stakeholders in the discussion process. Taking cues from the discussions, CERC finalized the framework and rules for setting up of power exchanges in the country. CERC issued the Guidelines for Establishment of a power exchange in February 2007.

This novel idea was well received by the financial institutions. Within a year or two power exchanges in India, Indian Energy Exchange (IEX), which is promoted by Financial Technologies, and Power Exchange India(PXIL), which is promoted jointly by the National Stock Exchange(NSE) and the National Commodity and Derivative Exchange (NCDEX) came into being, thereby putting CERC’s vision into reality.

WHAT IS A POWER EXCHANGE? Much like the stock exchange, a power exchange provides a trading mechanism wherein utilities, power marketers, and other electricity suppliers come together via an electronic platform, submit price and quantity bids to sell energy or services, and potential customers submit offers to purchase energy or services.

This results in creation of a framework which enables price discovery in the market on the basis of demand and supply, and also equips the traders to look for a suitable deal for themselves.

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The power exchange is effectively a virtual forum where participants come together in different bands to trade according to industry requirements. It receives daily to hourly bids from both the producers of power, i.e. generators and the consumers of power, notably industries and households. The major task is to administer the periodic auctions to ensure that demand meets supply, and the price discounts any discrepancy in the same. Just like the conventional exchanges, the exchange undertakes the responsibility of ensuring transparency in the market clearing and is the counter party in every purchase and sale transaction. All orders are traded, cleared and settled by the exchange.

SALIENT FEATURES OF A POWER EXCHANGE Voluntary Participation: In India, the participation in any of the markets – bilateral or the Power Exchanges is purely voluntary, unlike many countries in the world that have mandated compulsory participation through Power Exchanges. It is the decision of the market participant to choose the market place for buying or selling electricity.

Anonymity: Trading through the Power Exchanges is a non-cooperative game. Both the sellers and the buyers place bids on the electronic platform independent of each other`. No negotiation is involved in the process and the identity of the player (buyer or seller) is not known to the other participants.

Double Sided Auction: Power Exchange as a market place facilitates, without exercising any influence, an auction mechanism where both the buyers and the sellers place bids and offers simultaneously during the bidding session. This gives rise to the aggregated supply – demand curves for price matching

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Fig. 1: Salient features of a power exchange

giving rise to price discovery.

Social Welfare Maximization: The price discovery mechanism in the Power Exchange is based on the principle of Social Welfare Maximization. According to this principle, the algorithm of price discovery ensures that the welfare of all the market participants is maximized simultaneously. In other words, neither the buyer nor the seller receives any preferential treatment over the other, even inadvertently.

Consumer’s Discount: The price discovered on the Power Exchange ensures that the accepted buy bids are those that are more than or equal to the Market clearing price (MCP). In other words, the consumer buys electricity at a price which is guaranteed to be lower than or at most equal to the price bid the consumer (buyer) had placed on the Power Exchange.

This ensures a saving or a discount for the consumer over and above what he was willing to pay.

Generator Surplus: From the seller’s perspective, the price a seller gets is guaranteed to be more than or at best equal to the offer the generator (seller) has placed on the Power Exchange. This ensures a surplus for the seller over and above the expected return.

CURRENT SCENARIO When these exchanges commenced operations, they were laden with very high expectations. They were considered to be the panacea for the supply deficit Indian power market. And, they did not disappoint. To quote an example, the first day response for power on the exchange stood at 13,000MW hour, which crossed 30,000 MW hour mark in mere 20 days.

Currently, IEX dominates the market, with a market share of 85%, followed by PXIL. The total traded volume at IEX alone has crossed 25billion units, with an average of 40 MUs being traded daily. More than 600 participants mark their presence by bidding daily on IEX. IEX has grown from few participants in June 2008 to currently over 1,000 participants in 26 states and 3 Union Territories, thus making a significant presence across the nation.

Similar trends have been observed for PXIL as well.

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The total market clearing volume has increased from 180 MU in May 2009 to approximately 4000 MU in April 2012, with a CAGR of more than 300%.

A major contributor to this manifold increase has been the trading instruments in these exchanges, which are discussed in the following section.

TRADING INTRUMENTS The exchanges traditionally dealt in Day Ahead market and Term Ahead market. Of late, trading of Renewable Energy Certificates has also commenced at these exchanges.

Day-Ahead Market (DAM): DAM refers to a mechanism wherein the Exchange offers a double side closed auction for delivery on the following day. Price discovery is through double side bidding and buyers and suppliers shall pay/receive uniform price.

Term Ahead Market (TAM): Term Ahead Market provides an opportunity to the market participants to trade in contracts with various underlying time durations such as weeks, months, quarters, contingency and intraday etc.

Renewable Energy Certificates: Trade of RECs in the Indian Power Exchange Market commenced in FebruaryMarch 2011. A Renewable Energy Certificate (REC) is a market-based instrument that provides evidence that the generator has sourced a certain amount of electricity from a renewable resource. A Renewable Energy Certificate indicates the environmental attributes of the energy generated or procured. These certificates intend to plug the gap between availability of renewable energy sources and the requirements of various entities, in an effort to meet their renewable energy purchase obligation. At present, two variants of RECs are traded- Solar and Non-Solar.

CHALLENGES Lack of Participation in Electricity Trading on Power Exchanges: One of the most important objectives of setting up power exchanges in India was to introduce competition but the participation from both buyers and sellers has not lived up to the expectations. The current power exchanges operating in India suffer on

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• • •

Prices determined by demand • supply interaction Electricity almost commoditized • Pricing on the basis of risk-reward matrix for quality of planning and • flexibility in supply options •

SHORT TERM CONTRACTS Based on seasonal and diurnal • demand-supply patterns Prices characterized by underly- • ing asset Implicit pricing of transmission and congestion • Pricing on the basis of utility of end-use, bargaining power of counterparties, enforceability of reliability guarantees

LONG TERM CONTRACTS Based on long term demand supply trends Pricing of generation asset, fuel, delivery, specific asset characteristics- such as location, fee, duty Pricing on the basis of fit with long- term demand growth projections, quality of power supply (economies of scale, peaking capability, technology used, risksharing formulae)

Table 1: Types of contracts

both the accounts: • Lack of sufficient participation, especially on the seller side • Strong influence of the top five trading licensees.

Amongst themselves they share 88.80% of the total market.

The tendency of states to procure power jointly has resulted in traders elope the power exchanges. Also, in case of shortage situation, power utilities purchase power from other utilities or captives and sell it to the purchasers. This is another category of activities which has contributed in abandoning the trade from the power exchanges.

Deficit Market: India is growing economy, where the demand for power is growing at a rapid pace which has resulted in an ever increasing overall deficit. In such a scenario, the benefits of trading cannot be sufficiently passed on to the consumers as the generators are in a commanding position to eat a chunk of the consumer’s surplus. Therefore, it goes without saying that generation capacity addition to bridge the demand supply gap is a pre-condition to ensure efficiency of power markets. Besides, in a deficit market the participants face quantity risk in addition to price risk. Deficit market also poses a hindrance to the introduction futures trading, as their delivery on maturity cannot be guaranteed.

Lack of liquidity: At present, the major chunk of trade in the Indian Power Market takes place via Power Purchase Agreements (PPA), which is a long term commitment. This leaves no surplus available for short term trading. Also, it causes price volatility and sends distorted price signals. The PPAs should be freely down-sold by the consumers, who are large scale participants in the exchange markets. Secondly, lack of liquidity provides a great learning and experimentation opportunity. It can be harnessed to introduce products in a relatively shallow and less impactful market Theoretically, at least the idea of exchanges of energy sounds good and will benefit millions of Indians, half of which have no access to power and the others who

do without it most of the time.

CONCLUSION AND SUGGESTIONS Power exchange is not an ‘unknown’ word in the many of the developed countries, and the option to imitate the business model of the organizations operating successfully is always present. However, the Indian markets are substantially different from power markets elsewhere in the world. It’s very nature poses unique challenges in the development of the market and the product as well. In consideration of the issues highlighted above, a lot remains to be done on the part of regulators and power exchange authorities to ensure smooth functioning of the power markets. Some of the suggested measures are • The markets lack participation and liquidity. Appropriate steps, such as introduction of innovative products, must be taken up and financial assistance should be provided to encourage wider participation.

• The operating staff and participants need to be adequately trained • The Power Markets needs to be defined clearly and appropriately, keeping in mind the aspects of tenure and geography.

• Besides, medium term contracts it’s high time to introduce financial products in the markets with power as the underlying asset.

• The products and trading methods need to keep price volatility in check and an open auction methodology is perhaps more apt in the context.

• In view of the varied inherent characteristics of different term contracts, pricing mechanism needs to be developed accordingly. Also, the regulatory jurisdiction over pricing norms needs to be clearly defined • Appropriate Regulation must protect consumer’s interest and lay down norms regarding capital requirements and monitoring. A comprehensive database of power markets information must be developed at the earliest.

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Article Finsight of the Month Cover Story

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Consumer Credit Rating - Indian Context Mahesh Panigrahy & Namratha Vaidya

Great Lakes Institute of Management

Emergence of a Credit Based Economy Right from the 1980s when taking a credit was not less than a crime, Indian economy has evolved into an era of post liberalization, globalization and privatization, where the behavioral pattern and the mindset of consumers have greatly changed.

The other factors contributing to this change in the economy are: the mindset change from a socialist economy to a capitalistic based economy system and the increase in average household income leading to increased consumption. Thus many banks and financial institutions have eased the process of giving credit. A credit card, a bank loan and EMIs are commonplace nowadays. Despite the ease of credit, the marginal propensity to consume in India is still lower than that in the United States. This large chunk of savings helped cushion the Indian Economy from a collapse during the US subprime crisis.

Country (2011) India US

Private Credit/GDP 68.05% 102.94%

Table 1: Country wise Private Credit to GDP

Post 2009, there is an increasing awareness about the importance of credit score among all banks and financial institutions and this has impacted any debt instrument which the consumer is wishing to opt for. If you are one of those individuals who plan to take a home loan a few years down the line and do not have a credit score at all, then CAUTION!! It is time to think of starting a credit score record, which will definitely benefit you in the long run.

What Is a Credit Score and Credit Rating?

Since banks and financial institutions are cautious about lending credit to consumers, this has led to the birth of Consumer Credit Rating Agencies who rate the consumers’ capability of repayment.

Equifax India is one such company, which provides consumer credit services.

When you use credit, you are borrowing money that you promise to pay back within a specified

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period of time. A credit score is a statistical method to determine the likelihood of an individual paying back the money he or she has borrowed.

A credit score is generally a three digit number which ranges from 300 to 900. Higher the score, better the credibility of the individual as perceived by the creditors. This score reflects information from various lenders across various loans and other service providers. Along with the personal identification information, the credit report consists of your repayment history if any, in the case of a loan or a credit card.

Your credit card can be the single most important factor in increasing your credit score. On the other hand it can also sink your score to dark depths if you are negligent.

Credit Score primarily comprises of: • History of Payments - 35% • Amounts Owed - 30% • Duration of Credit History earned - 15% • Number of New Credits - 10% • Types of Credit In Use - 10% Various agencies give different weightages to different components, so it is very much possible to get different scores for the same consumer.

What Isn’t In Your Score?

• Marital status • Age • Receipt of public assistance • Salary • Occupation • Employment history • Rental agreements • Participation in a credit counseling program Things which you can do to improve your Credit Score: • Pay off credit card dues quickly and on time, preferably before due date • Keep a self-imposed credit limit, which is much lower than the actual credit limit • The number of years you hold a credit card ac-

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deposit. The card expires along with the maturity of the fixed deposit (FD). Normally it takes around 6 months for credit scores and account related activities to reach CIBIL or other credit rating agencies. So get a credit card issued from the bank in which you have an account by pledging a FD for one year, use it, pay the bills on time and improve your credit history.

What the future has in store for us?

Perhaps the next time you visit an auto dealer, you may be denied the best deal because your credit score is not good. Your landlord may check your credit score before renting you an apartment. You may have to pay a higher rate of interest for a loan or a higher premium for the insurance policy for not having a good score or no score at all The need of credit is rising day by day.

Buying a property/vehicle was in t h e retirement plans of our forefathers but we consider a house and car as one of the primary objectives as soon as we get a job in order to settle down. The next generation may even consider education as one the credit based activities.

If you have a bad credit score and have a lot of flaws in your credit history, don’t worry. Credit history is something in your own hands. So, start making better choices and you will see gradual improvements in your score as the negative components in your history become older and older. It is in our best interest to keep a check on our credit score and make efforts to improve it.

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Article Finsight of the Month Cover Story

count has a direct bearing on your credit scores.

Hence, if you want to close a card, opt for the most recently issued card • Pay all your loan installments on time. Bargain for a lower interest rate and ensure that the EMIs are paid on time • Credit Utilization Ratio is also checked, so keep your credit utilization slightly lower than the upper credit limit set • Pay off your utility bills (Cellular services, internet connections and electricity services) on time and do not default on any of your bills • Do not close bank accounts without paying the penalty amount as you are charged penalty for not maintaining sufficient balance • Ensure that your PAN is updated in every bank where you hold an account • File income tax returns on time and pay all your taxes on time Things which have a negative impact on your Credit Score: • Missed payments/defaults- This is the single most contributing factor which can plummet your credit scores to deep depths. The number of defaults, frequency and the amount of the default also matters • Having multiple accounts in multiple banks, with each account unable to maintain the minimum balance Ever been denied a Credit Card?

Knowing that the credit score is very important and owning a credit card is the easiest way of building a credit history we should, amongst comparable credit services, choose a credit card.

But what if the bank denies it? Banks generally deny a credit card if the consumer does not have a good credit history and one of the best ways to improve the credit history is a credit card. So, what to do in such a situation?

There are many solutions to this, but one of the simplest ways that can be used by the working middle class is illustrated below.

Banks are skeptical about issuing credit cards to its customers under normal conditions, but many banks issue credit cards along with fixed

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Article FinGyaan of the Month Cover Story

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ARCs: A panacea or a problem in itself?

Amit Sharma & Rahul Goel

NMIMS, Mumbai

ARCs, a term coined for asset reconstruction companies, are a product of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The act provides full right to the lenders to acquire the assets without any judicial intervention. Asset reconstruction business is complimentary to the core banking business of lending. Accumulation of NPAs is a natural phenomenon in the financial sector and only the amount of NPAs varies according to the economic cycle and the external as well as internal factors affecting the financial sector. Removing stressed assets from the balance sheet of the banks will help them focus on their core business and save a lot of intangible assets like human capital, brand and distribution network. The structure of ARCs is win-win situation for both banks and ARCs where the banks get rid of bad loans and ARCs recover them with their expertise, thus bringing benefits to the overall financial system. ARCs can acquire the bad loans for either cash or by issuing security receipts (SR) to the seller.

Net non-performing assets (NPAs) of banks rose by 53.5% during the quarter ended March 2012.

Bank’s gross NPAs are set to increase to 3.2% of advances by March 2013, from 2.9% as at December 2011 and the restructured loan portfolio of banks is set to touch 2 trillion by March 2013, according to CRISIL. The situation seems perfect for the Asset Reconstruction Companies whose objective is the rapid disposal of bad assets owned by the banks to clean up their balance sheets.

But why have they not been able to capitalize on it?

There are four reasons for the under-performance of ARCs. The first and the most important is the price discovery for the acquisition of the stressed asset. Banks tend to demand a higher price due to their limited experience with a small number of bad debts realized and also banking on the expertise of the ARCs whereas ARCs on the hand are not ready to pay such a high price for bad debts. The banks need to realize that recovering a small number of debts does not mean they will be able to realize the same result for the entire pool of assets. The result of not discovering the correct price is that

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the assets continue to be on bank’s balance sheet and their value erodes further with time.

The second is capital requirements of ARCs. Going by RBI norms, an ARC needs to follow 15% capital adequacy till 100 crore of capital. This norm is relaxed once an ARC has Rs100 crore capital, but all ARCs must pick up at least a 5% stake in the SRs that they sell against the bad assets. Also the ARCs make acquisitions for stressed assets in cash and thus have large requirement of capital. There are two solutions to this problem. First is to allow more foreign players in the sector. Currently, qualified institutional buyers, such as banks and insurance firms, are allowed to subscribe to SRs. Foreign investment in such instruments is capped at 49% and no individual foreign institutional investor, or FII, can hold more than 10%.Foreign investors should be allowed to play a larger part at the share capital level as well as at the security receipts level. Also if the foreign investor can bring in expertise for recovery and become actively involved, it’s going to be great for ARCs. The domestic market has less appetite for such an investment considering the risks associated with it and the resultant capital requirements.

FIIs specialized in distressed debt would be the primary source of funding. Second is to let them function as asset managing companies wherein they will be paid management fees and do not require to make their own investments.

The third is the flawed model of the ARCs that operates in India. Internationally ARCs are funded by the government and receive special support and powers from the government to shorten the legal process of recovery of dues. The central idea behind the creation of an ARC is to protect the capital of the banking system as banks need to provision money for bad assets which erodes their capital. In contrast the Indian ARC model doesn’t envisage any fiscal support or tax forbearance from the government. It also does not get any special powers from the government for a shorter path for recovery of stressed assets and has to follow the same route followed by the banks.

The fourth is the practices followed by the banks with regard to NPAs. Banks only sell the stressed assets to the ARCs when no more provisioning is

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required against them. This is because when a bank sells a stressed asset to the ARCs it needs to make a full provision of the difference between book value of the loan and the amount paid by ARCs, thus impacting their profitability whereas if they keep the asset on their balance sheet they can provide provisioning over a period of three to four years. This practise of dressing up the balance sheet is harmful to the system because there is much larger chance of recovering a bad loan in the initial years and the probability of recovery reduces as the time passes. Sometimes the banks have to pay an additional loan amount to a stressed borrower as a last resort to prevent it from becoming an NPA, this is known as “evergreening” and the cost of this is also borne by the bank. Also banks first try to recover the bad loans themselves because the process followed by ARCs is same as them and also try to restructure the loan to help the borrower and when they fail on all fronts the loan is given off to ARCs. What is the point of creating ARCs if anyway the banks are going to put in effort to recover bad loans? This is the job of the ARCs and should be left to them. Also banks use auctions of bad loans to discover the floor price of the stressed asset. After receiving the quotes from the ARCs they start negotiating with the borrower for a settlement using the highest bid as the floor price.

So what key steps need to be taken for a metamorphic change, in making ARCs a panacea for the increasing NPAs? 1) Banks should appreciate the importance of

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Article FinGyaan of the Month Cover Story

Fig 1: ARP : Key features

selling the bad loans to ARCs and focus on their core business. Also the representation of banks in ARCs should be capped so that no bank is able to influence the functioning of an ARC and the way it carries out its business.

2) The investor base for the SRs should be expanded. Currently the banks sell the bad loans and they are the main buyers of SRs. If securitization has to happen in true sense, then investor base has to be expanded.

3) ARCs should get more support from the government. ARCs should get monetary help from the government due to their need of capital, more tax holidays and simplified procedure and more power for recovery of stressed assets, so that banks have an incentive to pass the bad loans to ARCs. IDBI Bank came out with the concept of SASF-Stressed asset stabilization fund to alienate the bad assets from its books .Now how the government helps in such a case is that it allowed IDBI bank to borrow the 20 yr zero coupon government bond and thus as it received the money it transferred it to SASF.The SASF on its part transferred it to IDBI Bank as consideration for transferring NPA to its balance sheet. Thus SASF now has 20 yrs to pay back the money to the government. More such incentives from the government are required for the growth of ARCs. 4) ARCs need to be more efficient in acceleration of resolution of NPA and maximisation of recoveries. This would help in improving the return on capital and generation of more confidence among banks to give stressed assets to them and thus improve the subscriber base of SRs. 5) ARCs is a risky business to operate and the characteristics of the business are very different from other businesses. The major asset with the ARCs is the human capital. ARCs will frequently be involved in negotiating deals with lenders as well as borrowers, so they must have the right balance of soft skills as well as financial knowledge.

Being in existence for the last 8 years and still being able to manage a portfolio of only 15000 crore, in an economy where NPA’s are at an all time high, speaks quantums of the lacklustre growth of the ARCs over the years. Thus, it would require a tripartite partnership between the government, the banks and the ARCs to ensure the ARCs are able to serve the intended purpose of their existence.

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Article of the Month Cover Story Perspective

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Unsustainability of Global Imbalances: A perspetive Ashish Sharma & Divyang Thakur

IIFT

The growth and future prospects of any country is significantly influenced by the current account deficit that it can maintain. In light of this, the growing US current account deficit is analysed to gauge its sustainability. This is important because dollar serves as a major reserve currency for the rest of the world. An estimation of the change in Net International Investment Position of the US clearly supports the unsustainability of the US trade deficit.

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Global current account imbalances, which nearly halved in the aftermath of the global crisis, are widening again on the back of on-going recovery. However, global imbalances are not necessarily undesirable as they represent integrated financial markets and more diverse allocation of global savings across countries. But a widening gap between deficits and surplus countries has raised concern about the sustainability of such imbalances. For the first time we are seeing the flow of capital from developing to developed countries, which is also raising concern that when the unwinding happens, would it be orderly or un-orderly in nature.

In this article, we shed further light on the sustainability of global imbalances and analyse the imbalances in light of their global nature.

What is Sustainability?

Current account deficit is said to be sustainable if the country’s foreign debt does not increase faster than the real interest rate of the debt. Roubini & Wachel (1998) cited in Kee, Wong, & Sek, 2011 (p. 308) suggest that a current account deficit is sustainable if the country maintains a non-increasing foreign debt to GDP ratio. In other words, a country could run a very large current account deficit and it would still be sustainable provided two conditions were satisfied: First, there is an expected surplus in current account in the future. Second, the country’s stock of foreign debt should not increase faster than the real interest rate to maintain the sustainability of current account.

Apart from this, a criterion to achieve sustainability in current account is that

changes in current account do not lead to significant international portfolio reallocations which consequences in a rise in interest rate (Kee, Wong, & Sek, 2011, pp. 308-09).

Global Imbalances: Post the financial crisis of 2008 Gourinchas and Rey (2005) cited in d Mello & Padoan, 2010 (p.3) suggested that widening global imbalances are not necessarily undesirable, to the extent that they reflect increased financial integration and a more efficient allocation of global savings across countries.

However, the continuously growing gap between the external positions of surplus and deficit countries has raised issues about the sustainability of such imbalances, which in turn could pose risk for global growth. That is, in the beginning external imbalances can build up while remaining sustainable for a period of time until a structural break occurs. Post the financial crisis of 2008, the global imbalances have almost halved during the period of 20092010. The US current account deficit has shrunk significantly, from 6.61% of GDP in Q4 2005 to 2.88% of GDP in Q1 2009. Figure 1 shows important variations in many different countries in the size of current account adjustments.

Moreover, figure 2 shows composition of these adjustments between private and government balances. In the US, improvements in private balance were followed by the improvement in the current account. This compensated overall for a reduction in the government balance. In countries such as Spain, Denmark, Iceland and Ireland, there was a significant deleveraging in

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Article of the Month Cover Story Perspective Fig 2: Decomposition of changes in current Fig 3: Decomposition of changes in current accout positions : Private and governement bal- accout positions: Savingd and investment, in ances in % of individual country GDP % of individual GDP Fig 1: Current accout positions in % of individual country GDP

the household as well as corporate area owing to changes in the private balance. On the other hand, in most of the surplus countries, including Germany, the fall in current account could be ascribed to the overall fall in the country’s national savings. As indicated in Figure 3, the improvement seen in current account balance of the US could be attributed to a fall in investment. However, as the global economy is recovering, United States’ deficit is again rising and the global imbalances are again widening (d Mello & Padoan, 2010, pp.

3-12).

Obstfeld & Rogoff (2009) have also proposed a number of considerations indicating that global imbalances remain problematic, both for the US and the world (Obstfeld & Rogoff, 2009, pp. 30-39): (a) The large private foreign purchases of U.S. assets that helped finance the US deficit in past years contracted sharply after the Lehman collapse in 2008. Given the prospect of much larger US public-sector deficits down the road, with no clear and credible timetable for their reduction, US external borrowing will be prolonged and investor faith in the dollar is vulnerable to currency collapses and other forms of crises. (b) In 2008 the US deficit was a little over $500 billion. In addition to this, exchange-rate changes and equity-market losses inflicted an additional loss of over $800 billion on the net international investment position (NIIP). As a result, the US net liabilities to foreigners increased by 10 percent of GDP; see Figure 4. If this continues for long, even a reduced level of US foreign borrowing will raise sustainability concerns. It seems plausible that, in

the future, foreign private investors will become less willing to hold dollar debt in view of the unsettled US fiscal predicament, while official holders of dollar reserves may wish to diversify into other currencies. Also, there is a long-term trend of official reserve diversification away from US dollars, especially among the fast-growing, reservehungry emerging and developing economies, and this trend continues in recent data. (c) China’s current and projected external surpluses remain huge. In its attempt of keeping world real interest rates below their true equilibrium, the Chinese are subsidizing the country’s export of current consumption power in world asset markets. Apart from the implied deflationary pressure on the world economy, the rest of the world’s monetary response to this phenomenon—

Fig 4: NIIP Vs Cumulative External Deficits

in the form of exceptionally low policy interest rates—provides a breeding ground for potential new bubbles. (d) Global imbalances reflect national regulatory systems that still await major reforms. With the

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Article of the Month Cover Story Perspective

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added post-Lehman investor perception that big institutions are operating under a predictable umbrella of government protection, future financial instability could be in store. Large net capital inflows could inflate asset prices and make it easier for policymakers to avoid tough choices, including the politically difficult choice.

Growth of U.S. Foreign Debt Relative to U.S. GDP Looking at the U.S. current account deficit empirically we might be able to support the argument of unsustainability of these deficits. For doing this calculation, we subtract the current account deficits from a country’s net international investment position. The net international investment position of a country is total accumulated claims on rest of the world minus total accumulated foreign claims on it. If we assume the following variables: D = Net International Investment Position Y = GDP r = Net return on D B = Balance of trade in goods and services and unilateral transfers Now the equation for the change in Net International Investment Position by using these variables will be:

ΔD = B + rD If we stabilize D relative to GDP, this implies that the change in the net International investment position divided by D equals the growth in nominal GDP. If we assume that the growth in nominal US GDP in the coming years will be 5 per cent (higher than most of the estimates), then a stable ratio of the net international investment position to GDP i.e. D/Y will require that B/D + r = .05. At the end of 2006, the net international investment position of the United States was - $ 2.2 trillion. This is 16 per cent of U.S. GDP and way above the stabilizing value. Also, current account deficit was around 6 per cent of GDP. Hence, we can say that these numbers do not show any signs of stabilizing the D/Y ratio in the coming years. Even if the interest payments to the foreigners become too low, it will be difficult to return to normalcy. These calculations strongly support the argument that U.S. trade deficits are not sustainable. (Cooper, 2008, pp. 12-13)

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FIN-Q Solutions June 2012 1. European Central Bank 2. Inti & Nuevo Sol Currencies of Peru 3. Casablanca Stock Exchange 4. X= Graff DiamondsIPO called off 5. K Ratio 6. Grants- Others are departments of Ministry of Finance 7. Nigeria 8. Russia 9. FINMA

10. Dirty Price

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Technical Analysis

Sir, finally I have opened a demat account. While searching I came across Technical Analysis. What do we exactly mean by it?

Technical analysis is used for forecasting share prices for short term trading. In stock market short term is generally a period less than 1 year. It involves study of movement of stocks in the market through price and volumes.

Sir, I understand the price, but what are volumes in the stock market?

Volume of a share is the number of shares traded in a market session. Volume is used to access the conviction of buyers and sellers in determining the price. If the volumes are high when the share price are increasing, it indicates more and more people are buying the shares, so prices will continue to rise. Conversely if the volumes are low, the rally in price rise will end soon.

Sir, is the technical analysis applicable to all the stocks traded in the market?

Yes indeed, it’s applicable to all the traded stocks irrespective of the size of the company. But technical analysis assumes that the stock market is a freely traded market, with no manipulation of stocks in the market.

Rishi Gupta IIM Shillong In a market, stock prices are discovered through demand and supply forces. When the number of shares available for sale exceeds the demand, the stock price falls. If the demand is more than the supply the stock prices go up. For manipulating prices, a group of investors deliberately buy or sell shares to artificially increase or decrease the prices. It can be easily done for stocks with low volume in the market. A stock market investor needs to be careful about such manipulation.

Sir, I also read about trends. Why Trend is called `friend’ of the investors?

Trend gives the directional movement of the share price during a time period. By following the trends, investors can make money, until there is a change. An investor can detect the change in trends by keeping track of support and resistance of a stock.

Sir, What is the support and resistance to a stock?

Support and resistance are the most important concepts in technical analysis. Support is the lower price at which demands for shares outstrips the supply, sufficient enough to stop the decline in share price. The converse is resistance, which is the price range at which selling is large enough to stop the rise in prices. There is a famous change in polarity principle according to which once the support level is breached, it becomes resistance. The same holds true for resistance, which once breached become support level.

Sir, thank you for explaining technical analysis to us.

Sir, I have also heard about manipulation. How manipulation is done in the market?

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Article of the Month Cover Story

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FIN-Q 1. Name the first private sector corporate launched Gold fund in India.

2. Connect: “That is the root of all evils” and Pope Benedict XVI. 3. Aconcagua, Cotopaxi, Huascaran, Chimboroza, Siula Grande with “Common Market” 4. X refers to a process of buying a company whose intrinsic value is much higher than its current market price. The major intent is to sell off its assets for a profit. Identify X? 5. Connect: “Capitalism is out of the whack” and “46.8045° N, 9.8367° E”.

6. “X” is one of the largest retail property groups in the world which sold stake in seven non-core shopping centers in June 2012. Name the investment firm which acquired the stake.

7. Explain the phenomenon:

8. Founder of one of the fastest growing MFI’s in India in 2005, “X” was also the Chief Executive of Bank Muscat in India. Name X. 9. “X”, former CEO of “Y” and nicknamed as “Bob”, is one of the accused in LIBOR rate scandal. Name “X” and “Y”.

10. Provide the connect: ES: 34: UEFA: El Caudillo.

All entries should be mailed at niveshak.iims@gmail.com by 5th August, 2012 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-

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WINNERS Article of the Month

Prize - INR 1000/-

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FIN - Q

Prize - INR 500/-

Bindiya Bansal Symbiosis University

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