Scientia Potestas Est Dear Niveshaks, This month, we focus the lens on the recent IL&FS banking crisis. As the world marks the 10th year of collapse of Lehman Brothers, the default of India’s leading infrastructure finance company to make payments to lenders triggered panic in the financial markets. These defaults have put the interest of hundreds of investors, banks and mutual funds associated with the company in jeopardy.. The company is
left at the mercy of the shareholders that include Life Insurance Corporation of India, Housing Development Finance Corp, Japan’s Orix Corp and Abu Dhabi Investment Authority - who are yet to sign off on the Rs 4,500 crore rights share sale. The past month was also marked by the loosening up of foreign acquiring standards for state-run Oil Marketing Companies (OMCs) as rupee keeps on sliding to new lows. The Article of the Month by
Aditi Sharma & Neeraj Aggarwal, of NMIMS University, Mumbai tries to understand the impact of Global Debt, of both public and private sector on the world economy. Following up on its intent to consolidate the Public Sector Banking space as mentioned in the last budget and happening at a time when the market suffers shock waves due to the IL&FS crises, widening of the current account deficit and depreciating rupee; the
announcement regarding the merger of Dena Bank and Vijaya Bank with Bank of Baroda brings in new hopes. The Cover story in fact tries to understand the impact of synergies created through this merger. The FinFails section covers the famous Bernie Madoff case of 2008, when the former NASDAQ Chairman & founder of the Wall Street firm, Bernard L. Madoff Investment Securities LLC admitted that the wealth management arm of his business was an elaborate Ponzi Scheme. The Fingyaan section of this month’s edition, contributed by Aravind Shankar, PGPX, 2018-19 participant at IIM Ahmedabad, takes a closer look at the depreciation of Indian Rupee, its ramifications and implications. The Finview section presents to you views of CA. Deepak Mulchandani, who is a Chartered Accountant by profession and a teacher and trainer by passion, on recent happenings in the financial markets including the proposed merger of Bank of Baroda, Vijaya Bank and Dena Bank and his opinion on RBI’s purchase of 8.4 tonnes of gold for the first time in 9 years amongst others. The classroom section of this month attempts to enlighten the readers about the subtle & lesser known differences between Private Equity Capital and Venture capital funds. Book Review features, New York Times Bestseller, “Barbarians at the Gate: The Fall of RJR Nabisco” which is a real story on the leveraged buyout of RJR Nabisco, written by investigative journalists Bryan Burrough and John Helyar. Stay Invested, Team Niveshak
THE TEAM Aayushi Abhishek Soni Arpit Murarka Bhushan Bavishkar Mahesh M Priyanshu Gupta Samprit Shah Sheshav Dosi Sriya Gupta Aman Jain Harsh Jain Rajat Magotra Rohit Garg Shreyansh Parakh Suchitra Mandal Trisha Waghela Vinti Singla Yukti Rajpal All images, design and artwork are copyright of IIM Shillong Finance Club
© Finance Club Indian Institute of Management, Shillong
Disclaimer: The views presented are the opinion/work of the individual author and the Finance Club of IIM Shillong bears no responsibility whatsoever.
Contents NIVESHAK: SEPTEMBER 2018
06 08 10 . . . The Month That Was
Niveshak Investment Fund
Article of the Month: The Risk Of Global Debt
13 17 20 . . .
Cover Story: The 3 Bank Merger
FinFail: The Madoff Case
FinGyaan: Depreciation of Indian Rupee
24 26 28 . . .
FinView: Mr. Deepak Mulchandani
Classroom: Private Equity vs Venture Capital
Book Review: Barbarians at the Gate
THE MONTH THAT WAS
NIVESHAK | SEPTEMBER 2018
THE MONTH THAT WAS IL&FS and the shadow banking sector crisis With debt standing at INR 91,000 crore and 7 defaults in half a month, Infrastructure Leasing and Finance Services (IL&FS) is more than just cash strapped. Be it bank loans, interest obligations, term deposits or commercial papers, the company has defaults in all of these areas and with fresh defaults worth INR 395.6 Crores. With this, the limelight is suddenly on the Credit Rating Agencies, their accountability and methodologies, who have been providing investment grade ratings to the various debts issued by the company and its subsidiaries even when the company started showing signs of trouble from July.
Source: The Week
Another matter of concern is the shadow banking sector which has seen a growth of around 21% in the past financial year and whose growth can be stuck due to this and which can possibly lead to revocation of licenses of 1500 smaller NBFCs and stricter regulation and norms for the sector. Currently comprising of 11,400 firms, the sector has balance-sheet worth of around INR 22.1 Lakh Crore. In the Line of Fire India seems to be the collateral damage of the current global trade tensions including the oil price surge, the US China trade war, etc., which has led to FPI withdrawal of around INR 610 Billion. However, all is not well at the home front as well, with low tax collection as well as widening CAD which stood at 2.4% for the quarter ending June’18. Hitting a 4 month high, September alone saw a pull out of INR 210 billion from the capital market with equities just a tad bit higher than debt. All of this gave indication towards the current risk averseness present among foreign investors particularly in emerging markets like India on the back of the Trade War with two of the major economies in the world. The Cost of a Tweet Despite clocking in a $4 Billion revenue, Tesla still logged in a loss of $717.5 Million loss for the second quarter of the year and only a tweet was enough to create a market disruption such that it further created more troubles for the company such as Penalty Payment of [6]
THE MONTH THAT WAS
NIVESHAK | SEPTEMBER 2018 $40 Million to investors who suffered a loss due to the sudden stock price rise as a result of the tweet.
Source: Wall Street Journal
Secondly a $20 Million Fine to SEC who considered the tweet by Elon Musk regarding taking the company private as Fraud due to lack of any concrete financial aspects to the deal and which created market disturbance. The tweet which stated that Mr. Musk had funding secured to take the company private at $420 a share, now risks him stepping down as Chairman as well as Chief Executive Officer of the company after the board rejected the settlement proposal suggested by the SEC.
The Stake of Bandhan Bandhan Bank which has seen its share price stumble down by more than 20% in the last few days is now struggling to cut its promoter’s stake which currently stands at 82%. According to the mandate by RBI, Banks are allowed to maintain a promoters stake of 40% which Bandhan bank has failed to comply with. Bandhan bank which got its banking
banking license back in 2014 when it was operating just as a micro finance company was expected to cut its promoter’s stake within three years of this establishment. As a consequence, RBI has followed stringent measures such as freezing the salary of CEO, Chandra Shekhar Ghosh as well as stopping the opening up of any new branches by Bandhan unless the shareholding pattern of the Bank is sorted out. RBI facilitates abroad acquiring standards for OMCs The Reserve Bank India (RBI) loosened up foreign acquiring standards for state-run Oil Marketing Companies (OMCs) as rupee keeps on sliding to new lows for over many months now especially when rupee contacted a new low and shut at its unequaled low of INR 73.34 for every US dollar and Brent unrefined petroleum cost went over $84 a barrel. Open division OMCs, require gigantic measure of outside cash to import raw petroleum, and would now be able to raise ECBs for working capital purposes with a base normal development of three to five years from all moneylenders under the programmed course. The RBI loosened up the standard that requires raising External Commercial Borrowings (ECBs) for working capital purposes from immediate and backhanded value holders or from a gathering organization with a base normal development of five years.
[7]
NIF PERFORMACE EVALUATION th, 2018 As on September As on 31th30July 2017
September Month's Performance of NIF 120 100 80 60 40 20
Scaled Sensex
27-Sep-18
25-Sep-18
23-Sep-18
21-Sep-18
19-Sep-18
17-Sep-18
15-Sep-18
13-Sep-18
11-Sep-18
09-Sep-18
07-Sep-18
05-Sep-18
03-Sep-18
0
265 255 245 235 225 215 205 195 185 175 165 155 145 135 125 115 105 95
Performance of Niveshak Investment Fund since Inception
Scaled Portfolio Sensex Scaled values
Portfolio Scaled Values Value Scaled to 100
Total Investment Value: 10, 00,000 Current Portfolio Value: 20,14,414 Change in Portfolio Value: 101.44% Change in Sensex: 76..77%
Risk Measures: Standard Deviation NIF: 35.44 Standard Deviation Sensex: 18.13 Sharpe Ratio: 2.75 (Sensex: 4.01) Cash Remaining: 37,788
Comments on the Equity market and NIF’s Performance: Equity market witnessed a bloodbath in the month of September when both the index lost more than 6% due rise in rupee volatility, higher crude oil prices and liquidity crisis fears in NBFC. BSE Midcap index crashed 12.55 percent and smallcap lost 16 percent. IL&FS defaulted on several interest payments to bondholders due to the cash crunch which made rating agencies downgrade its rating to “D”. There was a spillover effect and DSP sold the bonds of DHFL at a steep discount. This triggered the NBFC stocks and they had fallen drastically. NIF portfolio performed worse than Sensex where the fund value was eroded by around 17.6% as compared to 6% for the benchmark. NIF is bullish on the Indian markets as a whole and sees the fall in the month of September as a market correction where people booked profits and funds pulled out the money because of the fear from NBFC defaulting which would have a spillover effect on other companies. Rana Kapoor had to step down as the CEO of Yes Bank this had led fall in the price of Yes Bank share from Rs.381 to Rs.180 washing away half the market capitalization of the company. NIF is bullish on YES Bank and estimates that it will recover its lost market capitalization by March’2019. The top sector which will see high growth will be retail, auto and IT. IT will continue to benefit from the depreciation of rupee.
NIVESHAK INVESTMENT FUND INDIVIDUAL STOCK WEIGHT AND MONTHLY PERFORMANCE Monthly Performance Portfolio Weight
NIF Sectoral Weights
7.74%
14.26%
7.35%
1.43% 1.57% 6.75%
12.70% 12.58%
5.69%
29.94%
Auto Infrastructure Chemical Media Financial Services FMCG Pharma Telecommunication Misc
TOP LOSERS FOR THE MONTH • • • • • • •
Godrej Consumer (-46.33%) IndiaBulls Housing (-32.22%) Nelco (-29.94%) Specialty Rest (-26.77%) Mannapuram Finance (-26.72%) Paramount Comm (-25.25%) PPAP Automotive (-22.63%)
ARTICLE OF THE MONTH
NIVESHAK | SEPTEMBER 2018
THE RISK OF GLOBAL DEBT -Aditi Sharma & Neeraj Aggarwal NMIMS University, Mumbai It is a known fact that any economy under recession would require a fiscal stimulus package i.e. increased levels of government spending and decreased tax levels. Such a package can only be managed if the government restricts its fiscal spending during the times of growth, which helps in the creation of a buffer for a strong fiscal policy response during the times of downturn.
Public Debt As per recent IMF estimates, governments around the world have accumulated a total of $63 trillion of debt, with the US owing 31.8% of that! The table below shows the top 5 countries in terms of their share in the total global debt.
Global Debt ($Trillion) 300
60.63 55.64
150
66.51
57.62 56.46
100 50 0
36.85 29.67 57.76
73.5
23.37
46.4
26.38 20.37
36.87
39.54
46.51
2003 Q1
2008 Q1
2013 Q1
2018 Q1
Households
Non-Financial Corporations
Government
Financial
Country
Debt ($B)
% of global debt
Debt-toGDP
1
United States
$19,947
31.8%
107.1%
2
Japan
$11,813
18.8%
239.3%
3
China
$4,976
7.9%
44.3%
4
Italy
$2,454
3.9%
132.6%
5
France
$2,375
3.8%
96.3%
Private Sector Debt Not just government borrowings but the private sector borrowings have also witnessed massive increases. Global corporate debt has increased by around $29 trillion in the past decade! Between 2018 and 2022, almost $1.5-$2 trillion of corporate bonds will mature per year.
250 200
Rank
However, currently the world economy is on a rough road with the global debt reaching a record $247 trillion in the first quarter of 2018, marking an 11.1% rise over the previous year. Consolidated debt-to-GDP ratio of major developed and emerging economies has increased to around 318 percent!
A key trend that has emerged is the shift of corporate borrowings from bank borrowings to the bond market. As bank lending reduced post the 2008 financial crisis, corporates resorted to borrowing in the bond market to raise capital. Since 2007, the value of corporate bonds outstanding from nonfinancial companies has nearly tripled – to $11.7 trillion. A worrying problem, however, is the increasing number of noninvestment grade bonds being issued. In the US, 22% of non-financial corporate debt outstanding is made up of speculative
[10]
ARTICLE OF THE MONTH
NIVESHAK | SEPTEMBER 2018 grade bonds and 40% are rated BBB, just one notch above junk. This implies that almost 67% of bonds face a high risk of default. Another key trend emerging is the rising use of bond financing by corporates in the emerging markets, led by China, Brazil, Mexico, and Chile. In the past bond financing was extensively used by US corporates and not so much by emerging market companies. Around $1 trillion of dollar-denominated emerging market debt is going to mature by 2019. How are the global giants faring? The current levels of the global debt-toGDP ratio are around 12 percentage points higher than the previous high of 2009 when the governments were on a deficit spending spree following the global financial crisis. The accumulation of debt has occurred differently in advanced and emerging economies. The advanced economies saw the level of debt rise before the crisis began and has remained relatively constant in the subsequent decade. On the other hand, emerging economies had relatively lower debt levels, which increased post the financial crisis. Among the emerging economies, the debt situation in China is particularly alarming considering the debt issuance done to help achieve the high levels of growth target. In addition, China’s banking sector holds assets, which are valued at 3.1 times the country’s annual output. Considering the deep connection of China with the world
economy, any efforts by the local authorities to stabilise the financial system and slowing domestic growth could have a huge impact on the global demand. The situation in an advanced economy like the US is also not encouraging considering that it is already having one of the longest economic expansion in the post-war era assisted by tax cuts. IMF projects that the US government debt will increase from 108 percent of GDP in 2018 to 111 percent in 2020. The largest contributor to the US fiscal deficit is the mandatory spending for entitlement programs such as Medicare, Social Security etc. The likelihood of any action to curb the government expenditure is less considering the approaching elections Implications of high debt 1.
2.
3.
[11]
A very high public debt not just hampers private investment, but also limits the ability of countries to borrow cheaply, which is reflected through the rating downgrade of highly leveraged countries A highly leveraged corporate sector is very vulnerable to rising interest rates, which is now the case in most developed economies. Firms had borrowed heavily till now owing to low global interest rates in response to the 2008 crisis. However, with the Fed raising rates continuously since 2015 and the trend expected to continue, cost of capital will go north If debt growth is unsustainable then most of the cash flows will go into
ARTICLE OF THE MONTH
NIVESHAK | SEPTEMBER 2018 iiiiiiiiiservicing the debt rather than iiiiiiiiibeing reinvested. Add to that the iiiiiiiiipressure of rising interest rates 4. Rising debt coupled with the looming trade war threat could worsen matters as such wars can have a negative impact on corporate earnings and incomes, affecting the ability of corporates to finance debt The case for stringent policy actions It won’t take long for the negative impact of a major default to spill-over on a global scale and across sectors, given the linkages across countries and sectors. Economists Christina D. Romer and David H. Romer in their 2017 paper Why Some Times Are Different: Macroeconomic Policy And The Aftermath of Financial Crises, have shown the effectiveness of the available fiscal and monetary policy space after looking at 24 advanced economies in the post-war period. The paper states that the decline in output is less than 1% after a crisis if a country has both monetary and fiscal policy space. However, the output declines by around 10% when it does not have the policy space to respond. Given the state of fiscal and monetary policy, especially in advanced economies, an unknown shock to the financial system could be difficult to handle and lead to severe output loss. A case in point being the Greece economic crisis. Greece had taken massive amounts of loans from the European Union, which it was unable to service. To prevent default, the EU
further loaned Greece enough to continue making payments. It had received almost 295 billion euros of assistance since 2015, the payments of which run up to 2059! However, along with the rescue package came a host of austerity measures, which led the economy into a recession and created unrest. The impact of such a crisis on the Euro and European Union would be much more disastrous than the 2008 crisis. Banks might have collapsed, the European Central Bank, which held a lot of this debt would be in a jeopardy. Just the thought of default sent investors exiting stock markets. The Dow Jones industrial average fell 2%, S&P’s 500 fell 2.1% and Nasdaq fell 2.4% the day news of a possible default broke. The losses were so massive that they wiped out all gains accumulated that year on DJIA and the S&P 500 Index. Large levels of debt are a potential source of risk and demand policy attention. Therefore, it is critical for the policymakers to carve out a policy space when the economy is performing well, instead of what the US government is doing. The lack of macro policy space will lead to a higher loss of output in the case of a financial distress, and sustaining the cyclical recovery in the global economy will be far more difficult. As Thomas Jefferson, former US President summarised it: “It is incumbent on every generation to pay its own debts as it goes. A principle which if acted on would save one-half the wars of the world.”
[12]
COVER STORY BANK OF BARODA DENA BANK VIJAYA BANK MERGER
COVER STORY
NIVESHAK | SEPTEMBER 2018 Amidst the growing concerns relating to the increasing NPAs, negative sentiments in the stock market due to the recent IL&FS crises, widening of the current account deficit and depreciating rupee; the announcement regarding the merger of Dena Bank and Vijaya Bank with Bank of Baroda perhaps brings in hopes. To improve the public sector banking industry, the government had put in place an Alternative Mechanism on bank mergers. This mechanism is basically a group of senior ministers led by the Finance Minister to approve mergers. The merger of the three banks is the first proposal under this mechanism. There have been numerous discussions regarding the consolidation of public sector banks in India. In the previous budget, the government had announced that consolidating the PSB space was their prime agenda. Restructuring of Indian banks was first proposed in 1991, by a committee appointed by Mr Manmohan Singh, the then finance minister. The committee recommended reducing the number of banks to three, or maximum five large banks which would include State bank of India. This set of banks would be positioned as global banks, and would be at par with their international peers. Next would be a set of eight to ten banks, and would have a national presence with multiple branches all over the country. This was a better proposal than having
over a two dozen PSBs, catering to the same set of customers by utilizing the same resources. With the proposed merger, and the merger of SBI with its five subsidiaries, the number of PSBs have come down to 19. Earlier, the decision to consolidate the banks was left to the board of directors of the respective banks. In this case, however, the government itself proposed the merger. The board of the three banks, being publicly listed, will meet and get approval for the proposal. Since government has a dominant shareholding in all the three, getting the approval will not be difficult.
Image source: Business Standard
The amalgamation of these three banks will create the third largest bank and the second largest public sector bank in India. Looking at the numbers, the combined entity will have a total business of Rs. 14.25 trillion. The total deposits would be at Rs 8.4 trillion.
[14]
COVER STORY
NIVESHAK | SEPTEMBER 2018 The positivity around the merger is due to the expected synergies that the combined entity would generate. The idea behind choosing these banks is simple, two financially strong banks will absorb a weak one, thus creating a mega bank which will be sustainable, and the lending capacity will be much higher. In this case, Dena bank is a laggard. It is also under RBI’s prompt corrective action (PCA) framework.
As against this, the combined entity would have a CET1 ratio of 9.32%. This is closer to the Basel III requirement of minimum tier 1 capital, which is 10.5%; The merged entity will also have a net NPA ratio of 5.71%, and the capital adequacy ratio is estimated to be at 12.25%. This clearly shows that Dena bank is bound to benefit from the merger, thus validating the purpose of selecting the three banks.
Delving into Dena bank’s financials, it has a net performing asset ratio (NPA) of 11.01%, which is significantly higher than the other two banks (Bob – 5.40%, Vijaya bank – 4.10%). A very high proportion of debt has eroded its tier-I capital, which is a core metric to measure the strength of a bank from a regulator's point of view. The core equity ratio (CET1) of Dena bank stands at 8.15% of the risk weighted assets.
Due to an increase in bad debts, it becomes imperative to study another important metric – the provision coverage ratio (PCR). The PCR for the merged entity will be 67.5%, higher than the PSB average of 63.7%, this would to cater to the rising NPA issue. The table below compares the metrics of individual banks and shows the expected synergies resulting from the amalgamation.
Image Source: Economic Times
[15]
COVER STORY
NIVESHAK | SEPTEMBER 2018 Besides the financial synergies, the combined entity would benefit from the economies of scale and cost rationalization by reducing the number of branches. It would also have a geographical advantage. Vijaya bank has a strong presence in South India, while Dena bank and BOB have a stronger base in Western India. Together, the merged entity will have access to new potential customers, greater market reach, increased operational efficiency and a wider bouquet of products to offer to its customers. Another interesting fact to be noted here is that all the three banks operate on the same core banking platform – Finacle of Infosys, thus making the technological integration easier. While this merger brings hope, the presumed benefits might not materialize. As pointed out by TT Ram Mohan, professor at IIM Ahemdabad, there are human resource and cultural challenges posed by the merger. The new management will have to deal with the complexity of the workforce, sort out the HR issues by establishing new reporting relationships, assign portfolios to executive directors etc. The branch rationalization, as mentioned above, has its own problems; branch rationalization would lead to layoffs. Also, India still has a low level of bank penetration, as was seen during demonetization, the most affected were the rural households.
Reducing the bank branches will only worsen the access to financial infrastructure for the low income groups. The number game, on the basis of which this merger was proposed, might not yield results. Reducing the number of PSBs to 19 would only consolidate the PSB space. Looking at other statistics, the U.S. has over 7000 banks, Germany has 1800 and Spain has some 300, most of them are financially stable. Perhaps, there is no ‘right number of banks’ that an economy should have.
Government’s move of merging SBI with its five subsidiaries was also appreciated, however, the benefits of the merger are yet to be seen. In fact the performance of SBI has deteriorated post-merger. Though comparing the proposed merger with the former one would not be correct, one can still draw an analogy for the purpose of analysis. All said and done, any move toward bank reforms is a good move. Privatizing the PSBs is also on the cards, but strengthening the existing management by the way of consolidation can prove fruitful in the long run. This merger should be judged only on the basis of its consolidated performance in terms of earnings, growth, asset quality etc. rather than focusing on individual metrics of the banks being merged together.
[16]
FIN FAILS – THE MADOFF CASE
FINFAILS
NIVESHAK | SEPTEMBER 2018 Ponzi schemes have not been something new to have been substantiated in this world, off recently. The legacy has been going on since the 19th century. One of the earliest Ponzi schemes to have made its mark in the modern world is the one mentioned by author Wendy Gamber in her book “The notorious Mrs Clem”. Be it MMM, the Russian giant perpetrating one of the world’s largest Ponzi schemes making almost $10 billion in losses or be it a scheme maintained by Dona Branca, in Portugal receiving nearly $120 million. The world has seen it all. Ponzi schemes run in a centrally coordinated system, wherein the operator keeps using money from new investors to pay off the promised returns to older ones, creating an inevitable trap for the operator which falls off in a few years. Usually, the schemes are short-lived as they are unveiled after all the customers start to pull out their money realising something unusual is going on somewhere. One might wonder that there should be no profit made subsequently, but the investor keeps using the money to expand the operations for personal reasons. But, one name that needs a special mention in this discussion is the Madoff case of 2008. The case was exclusive in many ways. Ten years ago, Bernie Madoff was sentenced to a 150 years jail in prison for running the biggest fraudulent scheme in U.S history which ran for over 40 years. [18]
Madoff was accused of convincing thousands of investors, handing over their savings and conning his investors of $65 billion by guaranteeing them unusually high returns and being undetected for many decades. On the 25th of November Ruth Madoff withdrew $5.5 million from a Madoff linked brokerage firm, followed by another $10 million on the 10th of December. At one point clients requested a total of $7 billion in returns, but the firm fortunately or unfortunately only had $200 million to $300 million left to give. The scam was hidden from the eyes of his sons too and was disclosed later by Bernie as a “one big lie”, and they were the ones who turned Bernie into FBI. Bernie basically took client’s assets, transferred them to his account and later mailing them to fictitious account statement to hide the ruse, selling products to clients in the line of a hedge fund. Markopolos highlighted that Madoff's fund earned about 16 per cent average annual returns over 14.5 per cent by using the split-strike strategy. Markopolos identified three possible sources of returns 1) Dividend income from stocks owned 2) Premium Income from the sale of index call options 3) Capital gains. For the strategy mentioned above to make a mark in the market, Madoff would have required a return of over 20% per year, and to achieve this success, Madoff must have been a legend in the field of investing. But what made the
FINFAILS
NIVESHAK | SEPTEMBER 2018 case so special as to make Madoff invincible for decades at a stretch despite multiple reports to SEC, or despite the frequent whistleblowing by Harry Markopolos trying to alert the regulators of the fraud in a series of letters which he believed to be a serious scam at BLIMS beginning in 2000, is the fact that Madoff himself was an active member of financial industry. He had his market maker firm which had established its roots in 1960 helping Nasdaq to launch the stock market. He was also in the board of National Association of Securities Dealers advising SEC on trading, and this made everyone believe that the old man knows what he is trying to do. Madoff made off with just $20 billion while cheating clients out of $65 billion. Bernie tried to make a ghastly presence in the eyes of the investors by refusing to divulge any information about the company’s practices & using
[19]
a split-strike conversion investment strategy. Even after so many years, questions persist in the Madoff case, nevertheless, critical lessons for investors and investment managers are : 1) Realistic standards for evaluating investments 2) Due diligence 3) Diversification. In making an important decisions on investments, people fall prey to physical cues of respectability and jump off of the cliff by assuming that if others have come to a safe conclusion they are well off in expecting the same way. Madoff was a master con artist; he did not just play with the greed but rather substantiated it with scarcity and ego along with the plausible high returns and low risk associated with the fund and making the product exclusive creating a high aspiration of the product.
FINGYAAN
NIVESHAK | SEPTEMBER 2018
Depreciation of Indian Rupee - Ramifications & Implications - Aravind Shankar PGPX 2018-19 IIM Ahmedabad Introduction India has been operating on a managed floating exchange rate regime from March 1993, marking the start of an era of a market-determined exchange rate regime of the rupee with provision for timely intervention by the central bank. This means that generally, free market forces determine the exchange rate of the rupee, though the RBI leaves itself the discretion to intervene at times when it has reason to believe that the rupee is over- or under-valued. Pullbacks after years of quantitative easing have resulted in a steady increase in US bond yields, and hence, coupled with the next year being the year of general elections in India, there has been a dramatic flight of capital from the country. This has caused a high demand for dollars and a consequent weakening of the rupee. The rupee has depreciated sharply in the preceding 12 months from September 2017 onwards, with the exchange rate to the US dollar falling over 12.4% from about 64 in September 2017 to over 72 in September 2018. A significant part of the fall has been seen from August 2018 onwards. This article attempts to
evaluate some of the implications of this sharp fall. Economic implications India’s biggest import is crude oil, with over 80% of the nation’s needs being addressed by imports. This extreme reliance on importing crude oil for meeting the country’s consumption needs put India in a vulnerable position with respect to currency fluctuations. The sharp rise in oil prices per barrel from an average around $43.5 in 2016 to $56.1 in September 2017 to $77 in May 2018 has dramatically increased India’s import bill. This, coupled with the steep depreciation in the rupee has led to a significant upward pressure on fuel prices in the country, which in turn has resulted in an inflationary situation in the Indian economy. In order to curb these inflationary pressures and to rein in the runaway depreciation of the rupee, the RBI has raised the repo rates and is more than likely to continue with the same strategy. When the rupee started depreciating from January 2018 onwards, the RBI took a watchful stance until April 2018 and allowed the gradual depreciation while allowing its foreign exchanges reserves to build up. After that point in April, the depreciation of the rupee accelerated, which has forced the RBI to intervene and mitigate the depreciation. The RBI has needed to make use of the country’s foreign exchange reserves to sell US dollars to stabilize the exchange rate of the rupee. Built using values published by the RBI, Figure 1 indicates that over
[20]
FINGYAAN
NIVESHAK | SEPTEMBER 2018 $25 billion of India’s foreign exchange reserves were used over 4 months from April to August 2018, which helped cushion the fall in the value of the rupee. When the RBI stopped intervening from August onwards, the rupee depreciated sharply to hit a lifetime low of over 72 in September 2018. Clearly, the RBI has now minimized its market interventions and has allowed free market forces to determine the true value of the rupee over the past 2 months. Industry implications Traditionally, a depreciating currency would spell bad news for import-based industries since it would push up the prices of the imports, while having the opposite effect on export-oriented industries. However, many exportoriented industries in India rely on importing basic goods before reexporting them, where this structure acts as a natural hedge against currency fluctuations. Consequently,
gains through exports are counteracted by the adverse impact on imports, and hence a depreciation of the rupee may not necessarily translate into supernormal profits for such firms. Additionally, the Indian rupee is not depreciating in isolation. Any potential advantage accrued to the exportoriented industries could have been considered likely had the depreciation been limited to the Indian rupee alone. However, most of the currencies of emerging economies have depreciated sharply over the past year, with the rupee falling the most. Hence, despite the depreciation offering the possibility of a benefit, the extent is tempered by the corresponding depreciation in the other currencies as well, thus partially negating the advantages enjoyed by Indian exporters due to the depreciating rupee. As a domino effect of the depreciation in the rupee resulting in an inflationary
Figure 1 India's reserves vs. exchange rate
[21]
FINGYAAN
NIVESHAK | SEPTEMBER 2018 environment, which in turns prompts the RBI to take actions to arrest this through measures described earlier, the industry output is expected to dip in the near future. Consequently, the GDP growth rate of the country which had hit a high of 8.2% in Q1 FY18-19, before the depreciation of the rupee occurred in Q2, is now forecast to dip to 7.4% over the entire 2018-19, i.e. the RBI forecasts lower than 7.4% GDP growth rate over Q3 and Q4 of the current financial year. Geopolitical considerations In 2013, India had an agreement with Iran to pay for crude oil in Indian rupees rather than US dollars, which had been a hedge against currency fluctuations. By early 2018, India had again reverted to paying for the oil imported from Iran in Euros. However, with the US pressurizing the world to restrict or terminate business with Iran as part of its sanctions on that country
which take effect from 4th November, India can no longer rely on the Euro payment channel to service its oil import bill. One option for India would have been to rely on more expensive imports from other nations with the payments required to be done in US dollars. The other option would have been to renegotiate the deal with Iran to pay in Indian rupees, which Iran can then use for importing goods and services from India back into Iran, thus bypassing all payment mechanisms through Euros or US dollars. This is a feasible option given the significant trade relationship between the countries, and indications are that the talks are already underway to operationalize such an arrangement.
Additionally, the trade war between the USA and China and increasing protectionist behavior by major economies globally puts India’s export growth at risk. The “Make in America” push by the Trump administration in The
Figure 2 Visualizing China's One Belt One Road (OBOR)
[22]
FINGYAAN
NIVESHAK | SEPTEMBER 2018 USA is a headwind for Indian exports into that country. China’s stated goal of “Made in China” by 2025 aims to achieve 70% self-sufficiency in components in manufacturing for hightech industries and reduce its dependence on imports from other countries. Additionally, the One Belt One Road (OBOR) project by China aims to promote Chinese trade with several countries Central and Western Asia, Europe, Africa and the IndoPacific region as shown in Figure 2 below. The success of such an initiative will only be detrimental to India’s trade position vis-à-vis those countries. Apart from the challenges to Indian exports from the push towards selfreliance by the two largest economies of the world as described above, India’s import bill itself would increase due to rising international prices as protectionist tariffs and WTO disputes such as India’s subsidies to agriculture begin to play out. Since India runs a trade deficit, the losses incurred on more expensive imports does not get offset in its entirety by the increased profitability of its exports.
Image credits: Creator Isadmin
[23]
Conclusion The depreciation of the rupee coupled with rising oil prices and geopolitical tensions, especially in an election year has led to a “perfect storm” situation for India. An unavoidable fuel import bill causing an increase in imports which may not be offset due to potentially stifled exports is pushing India towards a high-inflation environment. A shift towards renewable energy would address the single biggest cost to India by significantly cutting the oil imports, while diplomatic and infrastructure partnerships are needed to counteract the other challenges. However, it would take significant investment and policy support for this to happen, which would take years to play out in its entirety. Consequently, it is likely that the rupee stabilizes in the current range for a significant duration of time moving forward, rather than being a temporary fall in the recent months alone. Hence, it is probable that rather than being a temporary aberration, the depreciation of the rupee to its current levels is a new normal moving forward.
FINVIEW
NIVESHAK | SEPTEMBER 2018
CA. DEEPAK S MULCHANDANI
is a Chartered Accountant by profession and a teacher & trainer by passion in the field of Economics and Strategic Management. He provides Risk Advisory & Assurance Services to midsize & large clients
Q-1) Your examination of the proposed merger of Bank of Baroda, Vijaya Bank & Dena Bank? Ans.) A good move in the direction of a structured solution for the country's banking system. Lending money and managing the lent money is a very qualitative aspect when brought down to the last point. The banking system lacks the consistency of a standardized way to lend money to borrowers. The introduction of CIBIL has been able to check the fraud and the tendency of individual borrowers but corporate lending is still judgemental & based on a set of assumptions. Moreover individual can be traced with CIBIL score but if the entity itself changes, then the CIBIL score of the earlier entity doesn't matter. In the present scenario most of the banks have been bleeding not because of [24]
individual borrowers but because of Corporate lending. Merging the three banks will bring standardization in the process of the banks that will give the bank a more holistic view of the business ,the entity, as well as the borrowers calibre. More consolidation will come in the days. Q-2) Taking a cue from global uncertainties and market volatility, RBI bought 8.46 tonnes of gold for the first time in 9 years. How do you view this investment? Ans.) If we connect the dots globally and try to make some sense out of it we can see that this move in the long run is a better version of increasing the backup of the Indian currency and security. 60% of the funds of RBI were parked in bonds. Also the gold redemption scheme timeline is on the horizon now. With dynamic business scenarios trade war, rising strength of Russia etc., it makes more sense for economies like India to back themselves up on their own rather than depending on the yields of the foreign bonds. Because despite of Fiat money in circulation these days the final backup is still gold in the world. Q-3) How do you see the future prospects for India Post Payments Bank, given that it is backed by ambitious plans of the government? Ans.) Indian Postal department has 1.55 lakh post offices (PO), of which 90% are in rural areas and every 21.21 sq km area is served by a P.O. i.e. 7174 per PO (2011 census). This is one
FINVIEW
NIVESHAK | SEPTEMBER 2018 capability which nobody identified in India but Amazon came down and identified that Indian Postal Services has got the highest reach into the remotest part of the country after election commission and initially tied up with Indian Postal Services Department to deliver their products till the time they could develop their own logistics team. But now the GoI has understood its potential and has tried to utilise the existing postal network which has been lying idle. This will help them leapfrog from obstacle of infrastructure creation for banks in remote areas. The fact that postal department is able to understand and micromanage individual saving issues is a good prospect for JAM (Jan Dhan Aadhar and mobile) which is the main thrust of this government for financial inclusion. Q-4) Your views on the statement ‘We should not see a strong rupee as strength but target a fairly priced rupee for restoring our competitiveness. Ans.) Childhood dream of watching 1 Dollar equal to 1 Rupee cannot be possible & should not be done. Most of the countries buy products from India because the currency of India is weak against Dollar so they can purchase more from India as compared from their own country. If the Rupee gets too much stronger the exports will take a hit & India will loose on outsourcing front will lead to unemployment of skilled workers. A stronger rupee is a distant possibility unless India develops capabilities where [25]
the world has to compulsorily buy certain products from us with help of state of the art facilities and innovation at its epicentre. We need to have our own Intel Microsoft SanDisk HP Lenovo as well as our own automobiles so that we can have a situation where we don't need dollars to pay for our imports except for oil which is a necessity and we don't have it in sufficient quantity for our self. Q-5) Nearly 9200 crore worth of investor wealth in Infibeam Ltd was eroded just by WhatsApp messages circulated among traders which has adversely affected small retail investors. What is your view on the role of SEBI to prevent such situations? Ans.) The unauthorised fake news has been biting the political and social scenario. There have been instances where the details have been leaked out due to WhatsApp messages before the board meetings. The sensitivity of information along with urge to share rather than understand the source is a sense of evolution which the regulator. investor as well as the broker has to understand. This is ethical responsibility which needs to be sensitized among the stakeholders, employees and the people who are in possession of information which is material and can influence the decision of the investor. The stock market needs Rajat Gupta moment in India and after that they would be aware of it because as a country we are reactive to learn rather than proactive.
CLASSROOM
NIVESHAK | SEPTEMBER 2018
PRIVATE EQUITY vs VENTURE CAPITAL
Private Equity and Venture Capital are both capital related assistance given to the organizations and ventures at different stages in their lifecycle. Because of the comparability in their concept, they are normally taken as a similar thing. But, there is an extensive refinement between the two terms and many people do not know much about it. Private Equity includes significant interests in developed organizations whereas venture capital is one in which moderately little measured speculations are made in the organizations going through their underlying phases of improvement. Private Equity fund is generally an unregistered investment vehicle, wherein numerous investors combine their money for investing in companies. On the contrary, venture capitalists majorly finance startups and ventures which possess high risk and promoted by new entrepreneurs. [26]
Private Equity- These firms generally alludes to capital investments made by investors or organizations in the privately owned businesses that are not cited on the stock exchange. These funds also invest in a public company with the motive of buyout, through, which the public company gets delisted. These investments are mostly made in a mature company, having a substantial operating history. Capital infusion includes both equity and debt financing. Private Equity firms purchase an officially existing organization with the motive of rebuilding, extending and improving it to grow further with new management team. Fundamental procedures of private equity includes leveraged buyout, growth buyout venture capital, and mezzanine capital. Over the span of past two decades, private equity has become an important part of the financial services across the world.
CLASSROOM
NIVESHAK | SEPTEMBER 2018
Venture Capital funding is portrayed as the capital contributed by the financial specialists to people with infant endeavors or startup firms which have a crisp idea and promising prospects. Startups which aren't able to raise required capital from other sources take the route of venture capital funding as venture capitalists ask for a big chunk of equity in company they are investing. This sort of financing may include a high level of risk as 90% of the startups fail and hence are normally favored by those organizations whose promoters are qualified business visionaries. New companies require capital for expanding the operations and molding their thoughts. Investment firms bolster these developing companies in their beginning times. The financer is known as Venture Capitalist, and the capital is provided as equity capital. In a funding bargain, huge proprietorship pieces of an organization are made and sold to venture capitalists. Any business searching for funding needs to present a strategy to the investment firm or individuals with high net worth. If interested in the proposal, venture capitalist moves ahead and invests in the companies on the basis of their business plan. [27]
Key Differences Between Private Equity and Venture Capital are• The investments made in the privately owned businesses or open organizations with a goal to take them private is known as Private Equity, whereas, Venture Capital on the other hand refers to the capital contribution made by the investors with high risk and return potential • Private Equity investments are mostly made in developed organizations, whereas in Venture Capital funding investments are made at the early stage, i.e., seed stage or startup stage • Private Equity firms make interests in just few organizations while Venture Capital firms make their interests in an extensive number of organizations • Private Equity funds are provided to develop organizations that have a decent record but Venture Capital funds are provided to small business which do/might not have the desired track record • Private Equity firms make investments in any industry on the other hand Venture Capital investments are made in high growth potential industries
BOOK REVIEW
NIVESHAK | SEPTEMBER 2018
Barbarians at the Gate: The Fall of RJR Nabisco “Ross was the only man who could be given an infinite budget and he would still exceed it".
This book is a business classic which was once ranked as #1 in New York Times Bestseller, and core reading for any form of business training worthy of the name.
As his tenure as a CEO advanced, he ended up disappointed due to RJR's offer cost and its stagnating valuation. He looked for approaches to get more valuation for his investors and was ultimately induced by his investment banking advisers to undertake a LBO where he would lead a takeover of the organization financed with debt obligations by the banks.
The LBO (leveraged buyout- It is the acquisition of a company using a significant amount of borrowed money) of RJR Nabisco at its time was considered to be the preeminent example of corporate greed. Bryan Burrough and John Helyar wrote Barbarians at the Gate: The Fall of RJR Nabisco, one of the most famous books ever written about investment banking. It is the real story about the $25B war to gain control over the American biscuit and tobacco co. - RJR Nabsico Oreo cookie and RJ Reynolds cigarettes.
RJR appreciated steady & copious money streams. Additionally, it was underestimated by the stock exchange. Its valuation was less than the sum of its part and suffered from the effect of “the conglomerate discount”.
It is a story about the immense greed of corporate managers, private equity investors, investment bankers, shareholders, lawyers and PR advisers.
The writers have managed to make it comprehensible which was nothing less than a chaotic tale with given the high number of parties to the contract.
At the focal point of Barbarians is the-then CEO of RJR Nabisco-F. Ross Johnson, who the book paints as an exceptionally brilliant character:
In our opinion, it’s a good read. It explains very well about how the deals of this size were funded and executed. [28]
Fin.
ANNOUNCEMENTS ALL ARE INVITED Team Niveshak invites articles from participants from all B-Schools across India. We are looking for original articles related to finance and economics. Participants can also contribute puzzles and jokes related to finance and economics. References should be cited wherever necessary. The best article will be featured as ”Article Of The Month” and would be awarded cash prize of Rs. 2000/- along with a certificate.
Instructions: • Send in your articles before 28th October, 2018 to niveshak.iims@gmail.com • The subject line of the mail must be ”Article For Niveshak_<Title>” • Do mention your name, your batch and institute name along with the article • Please ensure that the article has a word count between 1500—2000 • Format: Microsoft Word; Font: Times New Roman; Size: 12; Line Spacing: 1.5 • Please DO NOT send PDF Files and stick to the format • Number of authors is limited to 2 for each article • Mention your mail id/blog if you want readers to contact you for further discussion • Also certain entries which could not make the cut to the magazine will get featured on our website.
SUBSCRIBE Get your own copy delivered to your inbox Drop a mail at niveshak.iims@gmail.com Thanks, Team Niveshak