Niveshak Nov15

Niveshak THE INVESTOR

VOLUME 8 ISSUE 11

November 2015

RBI Rate Cut Saga

FROM EDITOR’S DESK Niveshak Volume VIII ISSUE XI November 2015 Faculty Chairman

Prof. P. Saravanan

THE TEAM Aaron Rego Abhishek Bansal Abhishek Jaiswal Aditya Jain Anisha Khurana Ankit Singhal Ankur Kumar Anoop Prakash Bhawana Saraf Devansh Sheth Maha Singh Gulati Palash jain Prakhar Nagori Ramesh Jaiswal Rahul Bajaj Sandeep Sharma Shreyans Jain Vishal Khare

Dear Niveshaks, The month of November saw a volatile movement in the stock market due to rumours with respect to GST Reforms in the country. As well quoting the Finance Minister Mr. Jaitley, GDP growth is expected to exceed 7.3% this fiscal year whereas on other hand we heard the RBI Governor Mr. Raghuram Rajan saying that China’s Economic Slowdown adversely affected India. We hope that these contradicting views of the top leaders of India does not impact the upcoming RBI Monetary Policy. We have seen WPI fall for yet another month, this being the 12th time straight by 3.81% factored in majorly by the fuel prices. Also an active participation from Foreign Investment Promotion Board was witnessed during the month where at first it cleared 6 FDI proposals worth Rs 1810 Crores and later during the month 3 more proposals worth Rs 160 Crores. Whereas on other hand direct investments by Indian firms abroad fell 21% to $2.28 Billion in October 2015 YOY. Our Cover story for the month of November 2015 edition is an Analysis of the rate-cuts initiated by RBI to lower down the interest cost. Various aspects considered by RBI and passed on by commercial banks have been decrypted for our readers in a crisp manner. The article of the month covers the analytics related to Retail Banking. On the other hand, FinGyaan covers BRICS bank and talks about a strong position India withholds amongst its peers. Fin-Sight section is an insight into the depreciating Indian Rupee. This month’s FinView hosted the interview of Prof. S. Shanker, Management Consultant and Adjunct Faculty at IIM-B. Also, the Editorial Team of Niveshak, is pleased to introduce to you our new team, which has been selected to carry on the legacy of Niveshak. They are: Aaron, Abhishek, Aditya, Anisha, Ankit, Ankur, Anoop, Devansh and Shreyans. Please join us in welcoming them to team Niveshak. We are confident that the new team will not only meet but surpass your expectations in this and the coming editions. Keep supporting them the way you have been doing to us. We would like to thank our readers for their immense support and encouragement. You remain our prime motivation factor that keeps our spirits high and give us the vigour and vitality to keep working hard. Stay invested! Team Niveshak

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

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

RBI vs. Commercial Banks: 10 Retail Banking Analytics: The Rate Cut Saga Helping build relations strategically

FinGyaan 18

India : the strongest of the brics

Finsight

26 Indian rupee in the global Financial market

FinLife

22 Options

FINVIEW

Interview With Prof. S.Shanker, Management Consultant and Adjunct Faculty at IIM-B

CLASSROOM

31 Mutual Funds

NIVESHAK

www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

India business confidence at lowest since Feb 2014: MNI Indicators The busy festival season failed to bring cheer to India’s largest companies in November, as business sentiment fell to the lowest level since February 2014. The MNI India Business Sentiment Indicator, a gauge of sentiment among BSE-listed companies, fell to 60.9 in November from 62.3 in October, to stand 11.6% down on the year. The fall in sentiment was observed across both manufacturing and construction companies, while sentiment among service sector companies rose for the first time in five months. According to MNI Indicators, new orders fell slightly between October and November, leaving orders down 11.1% on the year. Export orders fared better, putting in a rise of 5.3% on the month, although were still 9.4% below the same level in November 2014. The production indicator fell for the second consecutive month and was down 14.1% on the year. The only real positive came from an improvement in company’s balance sheets, with the decline in commodity prices and interest rate cuts pushing the Financial Position Indicator higher for the second month in a row. OPEC to stay the course despite fears of $20 oil OPEC is determined to keep pumping oil vigorously despite the resulting financial strain even on the policy’s chief architect, Saudi Arabia, alarming weaker members who fear prices may slump further towards $20. Any policy U-turn would be possible only if large producers outside the exporters’ group, notably Russia, were to join coordinated output cuts. While Moscow may consult OPEC oil ministers before their six-monthly meeting next week, the chances of it helping to halt the price slide remain slim. OPEC’s historic decision in November 2014 – to pump more oil and defend its market share against surging rival suppliers – was working,

NOVEMBER 2015

IIM Shillong they proclaimed as crude traded near $65 per barrel. Six months later, it has hit $45, down from as much as $115 in the middle of last year. Now some member states are talking about a return to twenty-dollar-oil, last seen at the turn of the millennium. They point to Iranian confidence that international sanctions on its economy will be lifted by the end of the year. Goldman Sachs said this year it saw a possibility of crude going even below $20 because of the huge global oversupply, a strong dollar and a slowing Chinese economy. DIPP notifies easing of FDI policy in several sectors The Department of Industrial Policy and Promotion notified the recent liberalisation of FDI policy in several sectors including defence, retail and construction development sector. In a recent decision, the government has permitted a manufacturer to sell products made in India through wholesale, retail including through e-commerce platforms without government approval. Unveiling sweeping liberalisation of foreign investment norms, the government had on November 10 opened up 15 sectors including real estate, defence, civil aviation and news broadcasting in a bid to push up reforms. Foreign investment is now allowed in coffee, rubber, cardamom, palm oil tree and olive oil tree plantations. Earlier FDI was prohibited in these sectors. In defence sector, 49 per cent foreign investment is allowed through automatic route, the press note said. Similarly, FDI cap was increased in teleport, DTH, cable networks and mobile TV besides FDI limit was raised to 49 per cent in up-linking of news and current affairs channels. Foreign investment cap in non-scheduled air transport service was increased to 100 per cent through automatic route. DIPP has also notified easing of the norms in construction development and single brand retail trading.

NIVESHAK

The Niveshak Times Centre announces 3% interest subsidy scheme to boost exports Concerned over the decline in exports for the11th consecutive month, the government announced a 3% interest subsidy scheme for exporters to make the labour-intensive exports sector globally competitive. The CCEA has given its approval for the Interest Equalisation Scheme (earlier called the Interest Subvention Scheme) on Pre and Post Shipment Rupee Export Credit with effect from April 1, 2015 for five years. The scheme will have an annual financial implication of up to Rs 2,700 crore. The rate of interest equalisation would be 3%, which would be evaluated after three years. The scheme would be available to all exports of micro, small and medium enterprises (MSME), and 416 tariff lines, but not to merchant exporters. Under the scheme, exporters get loans at affordable rates, which helps them ship more goods to foreign markets. An earlier interest subsidy scheme for exporters had ended on March 31, 2014. A 52% decline in petroleum products exports to $18.78 billion in April-October attributable to the fall in prices of crude oil was the main culprit behind the shrinking of the country’s exports over the last one year. 7th Pay Commission wants 23.55% salary, pension hike for govt staff Government employees and pensioners at the Centre have received a huge post Diwali gift from the 7th Pay Commission, which recommended to the government a 23.55 per cent increase in their salary, allowances and pension along with a virtual one-rank-one-pension (OROP) for civilians, involving an additional outgo of a whopping Rs 1.02 lakh crore a year. A minimum pay of Rs 18,000 per month and a maximum of Rs 2.5 lakh per month has been recommended by the Seventh Pay Commission, headed by Justice A K Mathur, that presented its 900-page report to Finance Minister Arun Jaitley. The recommendations, which are to be implemented from January 1, 2016, will benefit

47 lakh central government employees and 52 lakh pensioners. The impact the recommendations will be Rs 1.02 lakh crore — Rs 73,650 cr on Central Budget and Rs 28,450 cr on Railway Budget. However, the acceptance of the recommendations will have a significant impact on the government’s wage bill. On its own, the pay rises would increase the central government’s wage bill by around 0.5 per cent of GDP. PE investments in India touch USD 14 bn till Oct Private equity investment in India till October this year soared close to USD 14 billion, registering a steady growth over last year but the average deal size has come down, says a report by Grant Thornton. According to the assurance, tax and advisory firm, there were 863 private equity deals worth USD 13.83 billion during January-October period, as against 497 such transactions worth USD 10 billion in the same period a year ago. The sharp rise in PE transactions was largely driven by sectors like IT & ITES, energy & natural resources, manufacturing, banking & financial services, telecom and pharma, which attracted large investments. Private equity investments are building up but the average deal size has come down by 20 per cent, perhaps as a large chunk of PE money has been invested in early-stage companies or startups. The report noted that the outlook for deal activity looks bullish going forward. With all the macro indicators looking positive, the current traction will continue to grow. Moreover, amidst the visibility of more on ground action around the government’s key policy and reforms, the stage is set to witness a high growth in the deal activity for the next few quarters.

The Month That Was

www.iims-niveshak.com

Market Snapshot

NIVESHAK

Market Snapshot 1,500

26600

BSE

DII

FII

1,000

26400 26200

500

26000 25800

BSE

FII, DII Net turnover (in Rs. Crores)

BSE 26800

25600 -500

25400 25200

-1,000

25000 27-11-2015

26-11-2015

24-11-2015

23-11-2015

20-11-2015

19-11-2015

18-11-2015

17-11-2015

16-11-2015

13-11-2015

11-11-2015

10-11-2015

09-11-2015

06-11-2015

05-11-2015

04-11-2015

03-11-2015

02-11-2015

24800

-1,500

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

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

98,88,227 Source: www.bseindia.com

LENDING / DEPOSIT RATES Base rate Deposit rate

9.70%-10.00% 7.25% - 8.00%

Index

Open

% change

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

26657 18166 19774 14946 11873 7847 18066 11264 7308 9066 1917 1372 6115 11315 10975 6777

26146 18964 19916 14587 12466 7912 16298 10950 7118 9328 1902 1344 5943 11637 10990 6882

-1.92% 4.39% 0.72% -2.40% 5.00% 0.83% -9.79% -2.79% -2.59% 2.90% -0.80% -2.02% -2.82% 2.84% 0.14% 1.55%

% CHANGE

% Change CURRENCY RATES INR/1 USD Euro/1 USD GBP/1 USD JPY/1 USD SGD/1 USD

RESERVE RATIOS 66.44 0.95 0.66 123.22 1.41

CURRENCY MOVEMENTS INR/1 USD 4.50% 4.00% 3.50%

Euro/1 USD

GBP/1 USD

JPY/1 USD

SGD/1 USD

CRR SLR

TECK, -2.82%

4.00% 21.50%

Smallcap, 2.84% REALTY, -2.02% PSU, 1.55% POWER, -0.80% OIL&GAS, 2.90% MIDCAP, 0.14%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

3.00%

7.75% 6.75% 5.75%

0.50%

Healthcare, -9.79% FMCG, 0.83% CG, -2.40%

2.00%

1.00%

CD, 5.00%

2.50%

1.50%

METAL, -2.59% IT, -2.79%

BANKEX, 0.72% AUTO, 4.39%

Source: www.bseindia.com 1st Nov 2015 to 30th Nov 2015 Data as on 30th Nov 2015

Sensex, -1.92%

0.00%

NOVEMBER 2015

Article Market of Snapshot the Month Cover Story

Article ofSnapshot the Month Market Cover Story

NIVESHAK

Performance Evaluation

Niveshak Investment Fund

Done on 30/6/14

Bank (6.49%)

HCL Tech.

HDFC Bank Wg:6.49% Gain: 16.91%

Infosys

TCS

Wg: 4.46% Gain : 16.39%

Wg: 3.87% Gain: 34.04%

Wg: 4.09% Gain : -4.04%

FMCG(22.12%) Colgate HUL

Britannia

Wg:5.89% Gain : 26.91%

Wg:7.42% Gain: 190.3%

Wg:4.20% Gain : 14.80%

Amara Raja Wg:4.45% Gain : 21.74%

Godrej Consm. Wg:6.63% Gain: 40.06%

Lupin Wg:8.23% Gain : 54.79%

Midcap Stocks (12.42%) Bharat Forg Wg:3.95% Gain: -7.75%

Kalpataru Power Wg: 4.27% Gain: 6.44%

Wg:4.61% Gain : -0.32%

Titan Company Wg:4.02% Gain: 1.79%

Chemicals (7.09%)

Pharmaceuticals (13.85%) Dr Reddyâ&#x20AC;&#x2122;s Labs Wg:5.62% Gain: 7.62%

165

105

155 145

103

135

101

ITC

Natco Pharma Wg: 4.20% Gain: 3.02%

Asian Paints Wg:7.09% Gain: 33.34%

Textile (6.46%) Page Indus.

Wg: 6.46% Gain : 23.76%

Performance of Niveshak Investment Fund since Inception 175

107

125 115

105

95 2/11

5/11

8/11 11/11 14/11 17/11 20/11 23/11 26/11 29/11

Misc. (10.65%)

Auto (8.49%) Tata Motors Wg:4.04% Gain: -5.6%

November Performance of Nivehshak Investment Fund

30-Jan-14 28-Feb-14 28-Mar-14 05-May-14 03-Jun-14 03-Jul-14 01/08/2014 02/09/2014 30/09/2014 31/10/2014 12/02/2014 31/12/2014 29/01/2015 27/02/2015 27/03/2015 29/04/2015 28/05/2015 25/06/2015 23/07/2015 20/08/2015 18/09/2015 20/10/2015 19/11/2015

Information Technology(12.42%)

As on 30th Nov 2015

Scaled SENSEX

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 14,89,182 Change in Portfolio Value : 48.90% Change in Sensex : 27.55%

Scaled NIF

Value Scaled to 100

Risk Measures: Standard Deviation : 20.13 (Sensex 11.44) Sharpe Ratio : 2.39 (Sensex : 3.52) Cash Remaining: 58,000

Comments on NIFâ&#x20AC;&#x2122;s Performance & Way Ahead : Throughout November 2015, Sensex was seen under swing from the levels 25482 lowest to 26559 highest and closed the month at 26145 approximately 500 points declining from last months close, the volatility was mainly due to the outcome of GST rumors we have been hearing about. In our portfolio Pharma sector, to which we have highest exposure was seen under pressure due to threat from the regulators. IT was also seen bleeding, however some of the losses were absorbed by premium seen in Tata Companies - Tata Motors and Titan. RBI is widely expected to maintain status quo on upcoming policy rates this week, yet market participants will watch the outcome closely for any clue on probable future rate cuts and thus will drive the stock market henceforth from here. The portfolio returns in new midcap stocks during the month has remained flattish in Bharat Forge whereas Natco Pharma & Kalpataru power surged almost over 3% and 8% respectively during the month

NIVESHAK

Retail Banking Analytics: Helping build relations strategically Richa Agrawal & Dheeraj Lamkhade

WIM,Mumbai The banking industry is going through major disruptions with several new players entering the market and seizing significant market share across the banking value chain. Weaker customer experience levels have opened the doors for many non-bank competitors. Technology companies (like PayUMoney, m-rupee), retail firms (like Paytm) and social/ crowd source fund aggregators (like KickStarter, GoFundMe) are few such entities which have gained significant customers in a short period of time. Let us first understand the main types of bank and its core functions: Commercial Bank: It is also known as business banking, which deals with corporates customers.

NOVEMBER 2015

Investment Bank: It is that division of bank, which is used to assist the ways to create capital to individuals, corporates and the government. Retail Bank: It is a visible face of the bank to the public, which deals which with the retail customers directly. Retail banking is not a new phenomenon in India. It has become synonymous with mainstream banking for many banks in last few years. “It is typically mass market banking where individual customers use local branches of larger commercial banks. Services offered include savings and checking accounts, mortgages, personal loans, debit cards, credit cards and so”. The retail loans constitute less than seven per

cent of GDP in India vis-à- vis about 35 per cent for other Asian economies: South Korea (55 per cent), Taiwan (52 per cent), Malaysia (33 per cent) and Thailand (18 per cent). (Source: International Journal of Recent Scientific Research) Industry Challenges In retail banking industry the customer relationship is core of the business. Due to Hyper-competition in the market the industry is

value added services offered, considering ICICI and PNB data. There has been a significant increase in takers for value added services like ATM banking, internet banking, tele-banking. Post availability of VAS, we can see that customers have decreased their bank visits considerably but still they prefer visiting the physical branch when it comes to decisions regarding investments, processing of loans. Thus a Digical model (Physical + Digital) can give

facing challenges to maintain this relationship. Lost personal touch For Banks, growing cost advantage made the service industry move from a physical model to a digital one. As per BCG analysis an average bank transaction through a branch costs 40-50 INR where as a mobile transaction costs 0.20 INR. For customers, advancements in technology and multichannel service availability, has resulted in customers using PCs and smartphones for interacting with banks. This resulted in reduced stickiness and lower switching costs, which in turn affected the bank’s profitability. A recent report shows a relative study of customer visits to bank with respect to new

banks a small but significant window to build relationship with the customer. Customer Churn Analysis When a customer leaves a bank, not only the future life time value of the customer is lost but also the total marketing spend in acquiring the customer is accounted. With lucrative products in the market and lower switching cost for customer, there is a big challenge for banks to retain the customers. Small changes in customer churn can easily bankrupt the business or can turn a slow moving business into a power house. For Example: Past data showed, a customer is more likely to buy a home loan after 3-4 years of regular income. He/She goes around searching for lowest rates and offers associated with his

Retail banking is not a new phenomenon in India.”It is typically mass market banking where individual customers use local branches of larger commercial banks. Services offered include savings and checking accounts, mortgages, personal loans, debit cards, credit cards and so”

Article of the Month Cover Story

NIVESHAK

employer and the builders. If this customer switches to a new bank there is a high possibility that he/she will move their salary account too. So, banks need to provide right information at right time for making the cross-sell happen. Risk Assessment The total credit off-take has seen the growth side due to the positive economic conditions. Risk based funding still continuous to be a major consideration factor for decision making. It is believed that with years of data in the pocket, we can start developing BI models which can act as a supporting agent for risk assessment.

Analytics the way forward With growing competition it is imperative for banks to offer an interactive and consistent online banking experience coupled with highquality branch banking service. In order to achieve faster time to market, banks need to anticipate the customer needs well in advance. Analytics thus play an important role in developing a base for future banking products. Over the period banks have implemented various reporting and descriptive analytic systems like the CRM, accounting systems, data mining systems which have resulted

into multiple disparate systems. But now the need of the hour is to integrate data from all these systems for providing predictive and prescriptive analytics onto a single dashboard. TBelow are few of the banking segments with significant use of analytics: 1. Customer behavior and marketing: Banks are already analyzing your spending patterns. One of my recent interaction with a telebanking executive revealed that they are tracking my frequent flying patterns and have suggested credit card insurance in case the card is lost in-travel. The concept is backed with a great creative idea of ‘providing travel ticket

and hotel booking assistance in case of credit card theft at nominal premium of 1000 INR per year’. But there is an issue with the data science behind selecting a customer like me who is a student without any regular income, who always pre-books a ticket and haven’t booked a hotel yet. “So it is important to have a balance between creativity and discipline, between art and science.” Some of the predictive and prescriptive analytics techniques for significantly improving the

With growing competition it is imperative for banks to offer an interactive and consistent online banking experience coupled with high-quality branch banking service. In order to achieve faster time to market, banks need to anticipate the customer needs well in advance. NOVEMBER 2015

marketing outcomes without proportionately increasing marketing budget are: • Social media listening and measurement of customer sentiments • Customer segmentation – Identifying profitable customers, profitable cross and up selling products, possible avenues for migrating customers from less profitable relationships to more profitable ones. • Omni Channel Engagement and Campaign management • Trigger based cross selling – Customers are irritated with the telebanking calls for old vanilla products like credit card, insurance. Identifying the triggers in the customer behavior and then selling the product will give higher probabilities of a sell. Some examples for impact analysis are: • Time-to-market reduced by 25% • Operating cost for a new product reduced by 15% • Conversation rate in trigger based selling was 45% higher than usual. • Target customer campaigns helped in increasing the assets by 15% over normal YoY growth

assessment. “Business Analytics can thus help in creating refined customer risk profiles for a better understanding of assets.” 3. Product and portfolio optimization: Multiple product lines spread across the globe, it is very important for the company to find out the key performance indicators to determine the asset pool quality. This can also help in analyzing the effect of pre-payments on the cash-flows and effects of payment defaults. If the mortgage portfolio is used for trading/ investing, analytics can be used to calculate risk of these portfolios. Even though the data is important, the right data is essential. The clear business goals gives the understanding of what’s important to the business and helps analyst to find what data counts or should be counted. “Banking without a bank” is the new trend. It will be interesting to watch how the veterans in banking industry will compete with this new trend.

2. Risk, fraud and KYC: Recently I had attended this Analytics roundtable conference held at Welingkar Institute of Management, Mumbai. The key speaker for the event was from SaaS global who talked about how SaaS helped the Income Tax department in order to detect below 2 types of risks: • Know – Unknown – Tax evasion happens and it is one of the know issues for the IT office, SaaS helped them identify the unknown side – The evaders. • Unknown – Unknown – The same team was able to discover another VAT refund scam which was totally unknown to the IT department. Reducing NPAs has been one of the top challenges for most of the banks. Post 2008 crisis there has been lot of compliance requirements in the banking industry. The introduction of Basil III norms and new regulations in the industry (like credit card accountability, responsibility and disclosure act), has significantly increased the operating cost due to additional activities like record keeping, auditing, portfolio risk © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

NIVESHAK

RBI vs. Commercial Banks: The Rate Cut Saga

Ankur Kumar

IIM Shillong Introduction What a parliament is to democracy, a central bank is to an economy. The importance of central bank in any economy cannot be overstated. Each economy decides the main role its central bank will play with the broad guidelines remaining the same. In India two of the most important mandate of RBI is to control inflation and support growth. But since inflation pinches the poor hardest, RBI tries to keep the inflation within the comfort zone by adjusting Repo rate. But the rate adjustment must be passed on by the commercial banks to the ultimate consumers. RBI does not deal directly with the common people. So the things get mired when the commercial banks do not correspond to the changes propagated by the RBI. RBI has set the inflation target of 6% by January 2016. Since September 2014, there has been continuous decline in the inflation rate. Seeing

the economic scenario RBI was confident that the target will be reached, so, it changed its monetary policy stance and cut Repo rate. But rate-cut transmission is not happening. RBI Governor Raghuram Rajan in its fourth bimonthly policy meeting said “markets have transmitted the Reserve Bank’s past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent.” Since January 2015, RBI has cut repo rate by 125 bps to a four-and-half year low at 6.75(1). Banks have cut lending rate only by 50 bps while deposit rates on an average has fallen by as much as 130 bps. However three-month commercial paper and certificate of deposit rates have fallen by 150 bps(2). Study of 8 banks: To better under understand the rate-cut dynamics by the banks, the further conclusions have been arrived at by study Top-4 PSU (SBI, BOB, PNR and Canara Bank)(3) Banks by Net

Fig 1: Central-bank Base Rates, %

NOVEMBER 2015

Cover Story

Profit and Top-4 Private Banks (ICICI, HDFC, Axis Bank and Yes Bank)(4) by Net Profit. On January 15, 2015 RBI reduced Repo rate by 25 bps for the first time since January 28, 2014. But neither the four Public sector banks nor the four Private Banks reduced their Base rate. The first reduction in Base Rate by commercial banks came when RBI cut Repo rate for second time on March 4, 2015. The third and fourth reduction by RBI came on June 2, 2015 and September 29, 2015 when it cut Repo rate by 25 bps and 50 bps respectively. The average cut in Base Rate by PSU banks in response to the second rate cut by RBI was 0.175% while that by Private Banks was 0.1375%. In absolute terms the reduction by the Private Banks were 115 bps compared to 110 for the PSU Banks in 2015 in response to the second rate cut by RBI. From the Chart-1 we can see that the rate-cut by Private Banks are more in sync with that by RBI while PSU Banks rate reduction policy does not seem to correspond with that of the RBI. This dichotomy can be explained by the fact that there remains more pressure on the PSU Banks from the government to reduce rate while the Private Banks enjoys autonomy. Also the Private Banks are aggressive in passing the rate cut and they are also very much similar in their response while there is wide disparity among PSU Banks in cutting the Base Rate. If we take the number of days between the RBI rate cut and the next first reduction in Base Rate by the banks, the Private Banks also score well on this parameter as compare to that of the PSU Banks. While on an average the PSU Banks took 38.6 days in passing on the reduction, the Private Banks took only 19.1 days in 2015 calendar year. Even one Private Bank HDFC, reduced its Base Rate twice after the June Repo cut but before the September Repo cut. While one of the top-4

PSU Banks, Canara Bank, did not respond to the September Repo cut and on an average has cut its Base Rate only by 0.1% in 2015 compared to the average of 0.1875% for the top-4 PSU Banks. Rate-Cut Effect: In a country of 1.2 billion people where around 2-3% people pay income tax compared to 45% (5) in the US, one might think that the majority of the population are not directly involved in the financial ambit of the country and hence might not be affected by the RBI rate-cut. But the beauty of the rate-cut is that it affects everyone in the country. Following are some of the major effects of the rate-cut: • Bond-Yield Crash: When there is rate-cut by RBI, the money becomes cheap in the economy. Due to more money in the system, people use this extra fund to buy bonds or nonmonetary assets. To buy they bid up the price and consequently the yield (which is measured as the return on the market price) falls. After the 125 bps cut by RBI this year, the NAVs of debt fund have shore up (6), which in the end is pushing down the yields. But will this gains in the fund are here to stay or are momentarily? RBI has said that it is “front-loading” the ratecut i.e. the future rate-cut will depend on the further improvement in the economic condition and mainly inflationary situation. CPI was at 5% in October, while WPI contracted to 3.8% during the month. As per Bank of America Merrill Lynch CPI is expected to remain under-6% (7) in January. Also the fall in commodity prices combined with the government strict stance on the hoarders of commodities in the country, inflation is here to stay down. So we can expect more cut in the coming months. And so it will be good time to enter in these long-term bond funds.

NIVESHAK

Cover Story

Fig 2: Rate Cut

• Low EMI: Rate-cut brings cheer to the loantakers. Not only potential but in some cases existing loan-takers get the benefit of rate-cut. This is a big relief for most of the people who could not pay loan in the one-time and thus take the option of paying in parts over a period of time. On a loan amount of Rs. 50 lakh taken for 20 years with the existing rate as 10.5% pa and if the rate is cut by 50 bps the EMI will reduce by around Rs. 1650. It can be seen that a small fall in the rate can have huge impact on the EMI.

more money. Also another source of fund is deposits from public. So if banks do not reduce their deposit rate also, people will continue to deposit their money in the banks at the same rate i.e. by reducing the deposit rates bank give negative incentive to the people to park their money somewhere else. As also seen in the above analysis, most the banks were proactive in reducing their deposit rates. So do we have any other better options to park our money that can give better return?

• Increase in Money Supply: The rate-cut directly affects the flow of money in the economy. In fact, rate-cut is a powerful tool in the hands of the Central Bank to control the flow of money in the economy. Whenever RBI feels that there is crunch in the money supply in the economy, it frees money in the economy. For example, during the tax-payment season if RBI sees money crunch it tries to pump more money. But there are many other methods which RBI uses to increase money supply. However the efficacy of rate-cut tool is debated i.e. how much does the steps taken by the Central Bank is actually replicated by the commercial banks? • Fall in Deposit Rate: As there is any rate-cut, the funds become cheap for banks to borrow from RBI. This means they now carry

There are host of other options to look for. Like company fixed deposit, tax-free bonds, PostOffice deposits, Sukanya Samriddhi Yojana for the girl child etc. The rates on small saving schemes are linked to the yields on government’s bonds and are revised generally once a year during March-April. The New Base Rate Formula The current practice of Base Rate came into existence on July 1, 2015. At present banks follow different methodologies to calculate their Base Rate. While some uses average cost of funds method, others use marginal cost of funds and the rest uses blended cost of funds method. But it was observed that the Base Rate pegged to the marginal cost of funds are more sensitive to the rate change. So, in its first bi-monthly

NOVEMBER 2015

Monetary Policy statement RBI stated that it would ask banks to move in a time-bound manner to the marginal-cost-of-funds-based determination of Base Rate. On September 1, 2015 RBI published the draft guideline and formula for calculating the Base Rate. This new formula comprises of four components which are as follow: i) Cost of Fund: The marginal cost will be arrived at by taking into account all sources of fund except the equity portion of the capital. Deposit cost will be calculated as the rates payable on current and saving deposits of various maturity. Cost of borrowing will be calculated by averaging the cost in the last one month when the funds were raised. After calculating these, all these cost will be proportioned as per the balance outstanding on the date of review. Finally all the multiplicative results will be added. ii) Negative Carry on CRR and SLR: Negative carry on CRR arises because there is no return on CRR while for SLR it may arise if actual return is less than the cost of fund. iii) Un-allocable overhead cost: This cost should solely comprise of the cost incurred by the bank as a whole and not for any specific business or department. These cost will be fixed for the 3 years. iv) Average Return on Net worth: It is the minimum rate of return on equity determined by the Board and should remain fairly constant. RBI expects to roll-out this formula from April 1, 2016. This will bring transparency and uniformity in the Base Rate calculation by the

banks which is currently abjectly lacking in the system. Moreover it will also give headroom to the investors and public, in general, to calculate what will be the rate cut quantum. Indian economy needs a balanced approach of interest rate so that the growth can be maintained while inflation is also under control. While RBI does its best to calibrate the rate, it must also reflect at the point where the actual consumer borrows. The new formula proposed by the RBI aims to bridge this gap and hopefully the things will turn out for better.

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INDIA : THE STRONGEST OF THE BRICS Sadhvi Chopra

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Abstract This article endeavours to analyse India’s position with respect to other countries of similar standing: the BRIC nations, under various parameters – growth rates, deficits, currencies, inflation, interest rates and political scenarios. While there is still work to do at a socio-economic level, it appears that India is doing better in almost all these aspects. Two years ago – in May 2013 – emerging markets fell into chaos when the Federal Reserves signalled that the American economy had improved enough to end its asset-buying program and investors began pulling out of foreign markets. India was in a vulnerable place then as were its competitors. However, today, while much of the world is in an economically

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dark place, India stands out as a “Star Performer”: the one emerging market perfectly positioned for growth. One of India’s greatest strengths is that it is a vibrant and functioning “democracy”. It also enjoys the advantage of “demographic dividends” as half of India’s 1.2 billion strong population is under the age of 25. By 2020, India will have the world’s youngest population with a median age of 29 years, compared with a median age of 37 in China. The middle class, representing the educated tech-savvy group is rapidly increasing. Despite the economy’s progress, the Indian market still has a relatively low penetration of goods and services, which translates into massive untapped potential. These factors can potentially give India the

biggest labour force and make it the largest consumer market in the world. Acceleration in growth rate With the global economy expected to grow at only 3.4% and the Chinese growth deceleration, (recording a 24 year low growth rate) the IMF Chief, Christine Lagarde said that India has the “opportunity to become one of the world’s most dynamic economies.” The GDP in India expanded by 7.5% in the first quarter of 2015, meaning that Asia’s third largest economy is now outpacing China. With the Brazilian economy contracting in the first half of 2014 and facing 0% growth rate in 2014 and with the Russian economy shrinking by 1.29% in the first quarter of 2015, India seems to be the only ‘BRIC’ standing with an economy of $2.1 trillion (by the new GDP measure). However, sustainment of growth is a question that props up from time to time and requires serious attention. Improvement in fiscal and current account deficit The rivalry between ‘Shale’ and ‘Sheikh’ caused the crude oil prices to crash from 100S to 50$ per barrel within a year. This fall in global oil prices couldn’t have come at a more fortunate time for India, which imports 80% of its crude oil needs. The crash in crude oil prices have helped the Indian Government to cut down its expenditure on oil imports by wiping off the need for subsidised support and thus to contain fiscal deficit to 3.99% of GDP in FY15. Due to favourable macroeconomic, fiscal and

political factors, India id gaining renewed interest as an option for private equity. Foreign investors appear to be back with a bank in Indian markets and are pumping in dollars leading to a massive jump in the country’s foreign exchange reserve. This, combined with the fall in oil prices, has narrowed India’s current account deficit by 0.2% of GDP from 3% of GDP in the same period last year. However, despite relentless efforts of the government, exports – a major component of current account deficit – lack competitiveness and thus create a disadvantage for India. Appreciation of rupee Rupee exchange rate measured against US Dollar has for a large part of 2014 moved in both directions in a narrow range of 60-64. Over the last six months, the Rupee is little changed against the greenback but it has appreciated relative to all major currencies, gaining nearly 17% against the Euro, 15% against the Japanese Yen and 10% against the British Pound. India being an importer of essential commodities, it is to benefit greatly from its strong currency. The major concern of RBI, however, is that this might have adverse effects on exports although India is not highly dependent on exports for growth like many of its Asian neighbours. Fall in inflation rate Most countries in the world, including China have witnessed accelerating inflation rates in 2015, way above the central target of 4.5% and nearly half a percentage point over the government ceiling of 6.5% according to the Central Bank of

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Brazil. The inflation in Russia was recorded to be an alarming rate of 15.30% in June 2015, which caused the Russian markets to be cleared in a day due to the fear of per day rise in prices. However, India is also better off in this respect. In the year 2014-15, India witnessed a substantial decline in inflation. The average Wholesale Price Index(WPI) inflation declined to 3.4% in 2014-15 as compared to an average of 6% during 201314. This decline was caused by low food prices

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due to unexpectedly good monsoons and by the global fall in oil prices(resulting in a fall in transport cost). It seems that India is currently without an inflation problem. However, Indian administration cannot be laid back as Indian agriculture, a major influencing inflation, is still a “gamble of monsoon. Reduction in interest rates In light of the falling inflation rate, the RBI has

reduced interest rates twice in 2015 ending at 7.25% in June, 2015, yielding to the demand of the government for lowering the cost of borrowing. Home loan rates have also dropped below 10% after several years. This can be contrasted with Russia where the key repo rate to 17% was increased to in December, 2014. It was done to support the declining Rouble, but had serious economic repurcussions. Political Stability An important criteria for growth and instilling international confidence in any country, is a stable political framework which is presently missing in various emerging countries. Given the Brazilian g o v e r n m e n t ’s part in the country’s e c o n o m i c weakening and its unpopular austerity measures, public dissatisfaction and unrest seems to be on the rise. Geopolitical issues like recent developments with Ukraine and annexation of Crimea has resulted in a deadlock over the economic policy in Russia, slowing down growth. China is seeing instances of political violence at a time of decelerating economic growth and South Africa is struggling from recurrent strikes. Amidst this international scenario, India has witnessed a majority government in the election of 2014. The stable socio-political conditions in India are conducive to firm policy decisions and quick implementations which means there is less uncertainty and faster economic growth. Challenges Though India has made a place for itself as one of the fastest growing economies in the world, yet it suffers from various socio-economic evils which threaten its growth. As the rich are getting richer and the poor getting poorer, the divide has been expanding more than before, posing a major problem for the government. Poverty is one of the biggest challenges faced by India in the present scenario. With an increasing population of people living below the poverty line (BPL) across the nation, it seems like a never ending issue.

Corruption has adversely affected the economy of India’ which has been marred with a list of scams and scandals, which have crippled the nation from inside. Increasing violence against women across the nation, incidents of terrorism and communal tensions continue to be major concerns. Widespread illiteracy and poor health conditions also restrict the development of India. However, with the government working relentlessly and continuously on making India a better place to live over the years, improvements have been seen. “When you think about India…..it seems the expectations were high and we are not getting there. But when you look outside India, for example Brazil, Turkey, Russia, China or Indonesia all of a sudden India looks like a million roses.” Thus, amongst the fast growing BRICS country, India seems to be running ahead with an economy perfectly structured to handle our delicate and dangerous global market.

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OPTIONS

Kaushal Singh

IIM Shillong Option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or a bond, is a security. It is a type of binding contract with strictly defined terms and properties. Let’s take an example that you have discovered a house that you’d love to purchase but at present you do not have enough cash to buy it for a particular period (let’s take the time to 3 months). Being in desperation to buy the house of your dreams, you talk to the owner and try to negotiate a deal that gives you an option to buy the house in three months for a price of $200,000. The owner also in dire need of money agrees, but for this option, you are needed to pay a price of $3,000. But in the period of three months a lot of things could change like it might happen that close to the house, a multiplex is going to be built. As a result, the market value of the house skyrockets to $1 million. Because the owner sold you the option, he is obliged to sell you the house for $200,000. In the end, you

NOVEMBER 2015

stand to make a profit of $797,000 ($1 million - $200,000 - $3,000) or another case could be that while touring the house, you discover that there is a neighbor who is very irritating and organizes regular party’s and plays loud music in the night, and furthermore, a family of super-intelligent rats have built a fortress in the basement. Though you originally thought that you had found the house of your dreams, but now you consider it worthless. On the upside, because you bought an option, you are under no obligation to go through with the sales. So, in this case, you can decide not to buy the house and ready to lose the $3000 given in the starting. This example demonstrates two very important points. First, when you buy an option, you have a right but not an obligation to do something. You can always let the expiration date go by, at which point the option becomes worthless. If this happens, you lose 100% of your investment, which is the money you used to pay for the option. Second, an option is merely a contract that deals with an underlying asset.

For this reason, options are called derivatives, which means an option derives its value from something else. In our example, the house is the underlying asset. There are two types of options available: Call option and Put option. Call option: A call option gives the buyer the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires Put option: A put option gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires The options market contain 4 types of participants:1. Buyers of calls 2. Sellers of calls 3. Buyers of puts 4. Sellers of puts The person who buy options are called holders and those who sell options are called writers. Furthermore, buyers are said to have long positions, and sellers are said to have short positions. Here is the important distinction between buyers and sellers: • Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose. • Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a seller may be required to make good on a promise to buy or sell.

Don’t worry if this seems confusing. For this reason, we are going to look at options from the point of view of the buyer. Selling options is more complicated and can even be riskier. The Lingo used for options: To trade options, you’ll have to know the terminology associated with the options market. The price at which an underlying stock can be purchased or sold is called the strike price. This is the price, a stock price must go above (for calls) or go below (for puts) before a position can be exercised for a profit. All of this must occur before the expiration date. For call options, the option is said to be in-the-money if the share price is above the strike price. A put option is in-the-money when the share price is below the strike price. The amount by which an option is in-the-money is referred to as intrinsic value. The total cost (the price) of an option is called the premium. The price is determined by many factors including the stock price, strike price, time remaining until expiration (time value) and volatility. Because of all these factors, determining the premium of an option is a complicated task. Now I am going to talk about why to go for options? The reason an investor should go for the options is to speculate and hedge. The speculation is mainly about predicting in which direction the market could move as you are not sure about it. Speculation is the territory in which the big money is made and lost. The use of options in this manner is the reason “why” options have the reputation of being risky. This is because when you buy an option, you have to be correct in determining not only the direction of the stock’s movement but also the magnitude and the timing of this movement. To succeed, you must correctly predict whether a stock will go up or down, and you have to be right about how

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much the price will change as well as the time frame it will take for all this to happen and don’t forget commissions! The combinations of these factors mean the odds are stacked against you. The other function of options is hedging. Think of this as an insurance policy. Just as you insure your house or car, options can be used to insure your investments against a downturn. Critics of options say that if you are so unsure of your stock, that you need a hedge, you shouldn’t make the investment. On the other hand, there is no doubt that hedging strategies can be useful, especially for large institutions. Even the

Now I will explain how you can read the option table: The table is for the IBM stock Column 1 – OpSym: this field designates the underlying stock symbol (IBM) Column 2 – Bid (pts): The “bid” price is the latest price offered by a market maker to buy a particular option Column 3 – Ask (pts): The “ask” price is the latest price offered by a market maker to sell a particular option Column 4 – Extrinsic Bid/Ask (pts): This column

individual investor can benefit from that. Imagine that you wanted to take advantage of technology stocks and their upside, but you also wanted to limit any potential losses. By using options, you would be able to restrict your downside while enjoying the full upside in a cost-effective way.

displays the amount of time premium built into the price of each option (in this example there are two prices, one based on the bid price and the other on the ask price). This is important to note because all the options lose their time premium by the time of option expiration. So

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this value reflects the entire amount of time premium presently built into the price of the option Column 5 – Implied Volatility (IV) Bid/Ask (%): This value is calculated by an option pricing model such as the Black-Scholes model, and represents the level of expected future volatility based on the current price of the option and other known option pricing variables (including the amount of time until expiration, the difference between the strike price and the actual stock price and a risk-free interest rate). The higher the IV Bid/ Ask (%), the more time premium is built into the price of the option and vice versa. If you have access to the historical range of IV values for the security in question you can determine if the current level of extrinsic value is presently on high end (good for writing options) or low end (good for buying options) Column 6 – Delta Bid/Ask (%): Delta is a Greek value derived from an option pricing model and which represents the “stock equivalent position” for an option. The delta for a call option can range from 0 to 100 (and for a put option from 0 to -100). Column 7 – Gamma Bid/Ask (%): Gamma is another Greek value derived from an option pricing model. Gamma tells you how many deltas the option will gain or lose if the underlying stock rises by one full point. So for example, if we bought the March 2010 125 call at $3.50, we would have a delta of 58.20. In other words, if IBM stock rises by a dollar this option should gain roughly $0.5820 in value. Also, if the stock price rises today by one full point, this option will gain 5.65 deltas (the current gamma value) and would then have a delta of 63.85. From there, another one point gain in the price of the stock would result in a price gain for the option of roughly $0.6385. Column 8 – Vega Bid/Ask (pts/% IV): Vega is a Greek value that indicates the amount by which the price of the option would be expected to rise or fall based solely on a one point increase in implied volatility. So looking once again at the March 2010 125 call, if implied volatility rose one point – from 19.04% to 20.04%, the price of this option would gain $0.141. This indicates why it is preferable to buy options when implied volatility is low (you pay relatively

less time premium and a subsequent rise in IV will inflate the price of the option) and to write options when implied volatility is high (as more premium is available and a subsequent decline in IV will deflate the price of the option). Column 9 – Theta Bid/Ask (pts/day): As was noted in the extrinsic value column, all options lose their time premium by expiration. In addition, “time decay” as it is known, accelerates as expiration draws closer. Theta is the Greek value that indicates how much value an option will lose with the passage of one day’s time. At present, the March 2010 125 Call will lose $0.0431 of value due solely to the passage of one day’s time, even if the option and all other Greek values are otherwise unchanged. Column 10 – Volume: This simply tells you how many contracts of a particular option were traded during the latest session. Typically – though not always - options with large volume will have relatively tighter bid/ask spreads as the competition to buy and sell these options is great. Column 11 – Open Interest: This value indicates the total number of contracts of a particular option that have been opened but have not yet been offset. Column 12 – Strike: The “strike price” for the option in question. This is the price that the buyer of that option can purchase the underlying security if he chooses to exercise his option. It is also the price at which the writer of the option must sell the underlying security if the option is exercised against him. To conclude, I see options aren’t for all investors. Options are sophisticated trading tools that can be dangerous if you don’t educate yourself before using them. Please use this article as it was intended - as a starting point to learn more about options.

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INDIAN RUPEE IN THE GLOBAL FINANCIAL MARKET Sadhvi Chopra

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Abstract India is an emerging economy with high growth rate, a rolling equity market and increasing shares in the world trade. But to ensure its steady steady ascent to the top ranks of the economically influential countries of the world, India has to play its trump card – its currency. The steadier the Indian Rupee, greater will be the Indian dominance in international trade. At present there are a lot of obstacles to achieving this end as the INR is not in a strong position as an international currency and the foreign exchange rate has been fluctuating a lot since the past few years. In this article, we will explore the reasons for such fluctuations, their positive and negative impacts on the economy; the INR’s potential as an international currency in the years to come and the policies aimed at achieving its global recognition. Introduction Since 17th century, the world market has been shaped by currencies that come from large, economically advanced nations and these currencies that were vital in international trade came to be known as international currencies. Indian Rupee’s role as an invoicing currency is negligible as trade is mostly carried out in

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Dollars. A fraction of the invoices are also done in Pound, Euro and Yen but since India itself trades in Dollars, the Rupee is not used for invoicing at an International level. Again, the central banks of several countries maintain reserves in stable currencies as a precaution against losses. The Indian Rupee is hardly used as a reserve currency anywhere globally. Moreover, international securities around the globe are rarely denominated in Indian Rupees and its rank in foreign exchange market turnover has slipped lately. Although Indian Rupee is accepted for transactions in some countries like Bhutan, Nepal, Sri Lanka etc. its role in global currency market is eclipsed by the giant economies. Therefore, it is evident that INR is in no position to be classified as an international currency as of now. But this does not mean that the situation cannot change over time. To understand the potential of the Indian Rupee in the present day currency market, we have to first understand what is happening and then explore the options to rectify the situation. Why is the Rupee depreciating ? The principal law governing free market economies is that the Demand and Supply forces interact to determine the price of any

commodity. The same law applies to the price of foreign exchange also, i.e. the exchange rate (price per Rupee) of any other currency with respect to the INR depends on the demand and supply of that currency, assuming a free market for the foreign exchanges. Considering Dollar to be the foreign currency in question, we can explain the fluctuation of the Rupee as follows : The above diagram shows the relation between demand (D), supply(S) and price(P). Q is the number of goods. So if the demand in Dollars

increases (D1 shifts to D2) more than the increase in supply (which is kept constant as we consider a short time span), then the “price” of $ would increase from (P1 to P2). Thus Dollar becomes costlier compared to Rupee as the same Dollar that could be purchased with P1 Rupees initially will now be bought with P2 Rupees (P2>P1). Therefore we say the Rupee has depreciated with respect to the Dollar. The same law is applicable to all foreign currencies like Pound, Sterling, Yen etc. Therefore it may so happen that INR depreciates in comparison to one currency but appreciates with respect to another assuming the exchange rate of Rupee with each currency depends on the demand and supply of that currency only. Apart from the demand-supply mismatch, there are several major factors that contribute to appreciation or depreciation of a currency. Since the US Dollar is the steadiest currency at the moment, we now try to reason why the INR is losing its value when pitted against the USD: (1) India imports more than it exports and hence there is a net deficit in its balance of payments. Although import bills went down in recent times due to falling crude oil prices, Indian exports have decreased significantly and thus deficit gaps have increased further. (2) The Reserve Bank tried to sell Dollars in the

open market to prevent the Rupee from sliding but the plan backfired as currency speculators sensed domestic troubles of the INR and its value further fell under uncertainty. (3) Deficit financing has been increasing the money supply in the economy which, along with global increase in food prices has triggered inflation. When a currency’s purchasing power becomes uncertain due to inflation, there is a tendency to keep the money out of the failing economy till the crisis subsides. This has added to the selling pressure on Rupee. (4) Once the Rupee started showing signs of depreciation, foreign investors pulled money out of India to invest it in more stable locations. This withdrawal of funds weakened the economy further and the Rupee plummeted. Let the Rupee fall ! A common misconception is that a falling currency value is always detrimental to an economy’s welfare. The truth is that in fact, lesser valued currencies can also help the economy grow. The Indian Rupee is costlier than the Japanese Yen even though Japan is a developed country and India is not. In fact, many countries around the world purposefully weaken their currency. This is called “devaluation” and not “depreciation”. In 1991, India had devalued the Rupee as an economic reform; recently China devalued the Yuan Renminbi by a significant margin. A weaker domestic currency indirectly forces consumers to spend more on national products as imports become costlier. Also, capital inflow increases as exported goods become cheaper and create greater demand in the world market. We now analyse the pros and cons of the falling Rupee : Pros (1) It makes export cheaper and thus our products become more competitive in the global market. (2) If Indian debtors have debts denominated in Rupees with some foreign institution or bank then with a falling currency value the real value of the debt falls and the debtors gain. Cons (1) Depreciation makes our imports more expensive. If imports are not restricted it can cause inflation. (2) If Indian creditors have credits denominated in Rupees with some foreign institution or bank then the real value of the credit falls. Basically, India is a net importer and that

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(4) To boost circulation of local currency abroad, India government is trying to introduce local currency trade with its major trade partners. 23 countries with which India has deep commercial ties have been approached to trade in INR. (5) To increase Rupee dominated trade, nonresident exporters and importers are being given incentives such as hedging their currency risk if the trade is invoiced in Rupees. Also, it has been proposed to increase the convertibility of the INR to encourage its use in offshore markets. Such endeavours are already proving successful with Japan recently extending its emergency swap facility with India from 15 billion USD to 50 billion USD and Iran agreeing to 1.54 billion Dollars worth of oil trade payment in Rupees. If all the other policies also worked as planned, then without doubt the Indian Rupee will gradually soar up against all hard currencies. Conclusion The Indian Rupee is plagued by volatility and inflation and that is the root of all problems regarding the currency. But the situation is in no way irreconcilable. INR is performing well against European and East Asian currencies. Middle Eastern countries have petrocurrency which depends totally on their export value and since crude prices are falling rapidly, the Rupee is expected to gain against those as well. The benchmark for growth remains the USD which is gaining steadily. If India can start settling payments through Rupees then the dependence on and subsequent demand for Dollars will go down and hopefully the INR will find its foothold against the dominant USD again.

Interview With Prof. S.SHANKER, Management Consultant and Adjunct Faculty at IIM-B

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is the reason behind the zeal to achieve an appreciation in the currency. But in reality, if we can ensure that with the falling Rupee, import i.e. capital outflow will go down and export i.e. capital inflow will go up then logically, there should be no antagonism towards a depleting currency. If government can manifest its import restriction policies then depreciation should be welcomed and not feared. The Way Ahead “Indian Rupee, Chinese Renminbi and Brazilian Real are likely to become part of a future multipolar currency system along with US Dollar and Euro. As their economies grow and integrate more closely with the world, the developing countries like China and India will perforce have to hasten their reforms to build deep and liquid financial markets. This makes their currency fully convertible to widen their acceptability in the globe.” Klaus Regling, CEO of European Financial Stability Facility(EFSF) made this remark in 2012 after speculating the potential of the INR from a detailed study. Although the Rupee is still a long way from being one of the dominant players in the currency exchange, the RBI and the Government of India are contemplating several structural changes to reduce dependency on Dollar and push the Rupee to the forefront: (1) To counter the drastic fall of INR against USD, the RBI in 2012, made it compulsory for exporters to convert their foreign currency holding into Rupees. Research revealed that exporters were stocking up on foreign exchange as a cushion against further depreciation of the Rupee without realising that this action itself was creating a sudden demand pull for foreign currency and flooring the Rupee. This process might be repeated to increase supply of Dollar and put an end to the crisis temporarily to help INR bounce back up. (2) The GDP growth rate which slumped during 2012-13 was increased to a projected 7.6% in 2014-15and an even higher 8.5% in 2015-16. The GDP, which is being targeted for a large domestic market is indispensable for strengthening the currency. (3)India’s rank both a eral notches over the past few years. To help the Rupee gain dominance, India is aiming at doubling exports which will restore its global importance as well as cut down the huge trade deficits.

The rules related to International Trade are different in various countries. What all things should be kept in mind before entering into a cross-border transaction? The laws, rules and regulations of business in any country have its roots in custom, usage and practice of trade in that country. Subjects such as Sociology, Culture, Language, Religion, History, Geography, Politics, Literacy, Natural Resources, play a vital role in shaping the economic activity and development in that country. Hence we see a lot of difference in trade and commerce amongst countries. To begin with, it is important to have a fair understanding of the above subjects in relation to that country across the border. Secondly, it is important to observe the quality of Human Resource (Skill sets of the population), the level of Industry (Agriculture, Manufacturing & Services), the availability and utilization of Natural Resources. It is evident that these 3 fundamental requirements of economic activity are not evenly distributed in the world. Hence, it is important to select those areas of trade and commerce that become mutually beneficial to neighbors. Thirdly, Political aspirations aside, the people of the world have decided that war is not the answer to economic progress. It is mutual cooperation and co-existence that will decide progress. So countries have come together and formed economic associations. So, we have agreements such as SAFTA, NAFTA, ASEAN, EU (Multilateral Trade) and Free Trade Agreements such as Indo Nepal, Indo Srilanka, Indo Bangladesh Free Trade Agreements (Bilateral Trade). One should read these trade agreements to understand the extent to which and areas of trade and cooperation that neighbors have decided to follow. Fourthly, after World War 2, one big Multilateral Trade Agreement was signed by many countries – GATT, now called WTO. Today there are more than 160 member countries. One should keep in mind the broad frame work of the WTO and other inter-governmental bodies such as WCO, WIPO, which are seeking to standardize and

harmonize National and Regional Trade, so that in due course we have a borderless trade and economic regime. Fifth – Industry and Trade Associations are also working to bring a common platform to business practice, so that economic activity has a uniform understanding of trade and commerce across countries. In this direction, institutions such as ICC and FIDIC have come up with guidelines and models, which are not only illustrative, but also provide for ease of doing business both within the country and across borders. It is very important for one to refer to these guidelines and models and adopt them in the transactions. Thus a 5 step approach to trans-border trade will ensure long term economic relationships. Goods and Services Tax (GST) will harmonize indirect taxes by doing away with multiplicity of taxes. What in your opinion is the major roadblock at present and how should the government try to resolve the conflict? We are a Federal country; the Constitution of India gives powers to the Center and State Governments to legislate on various subjects including taxation. Taxation is a very important and sensitive subject to both the Center and the State Governments for Political, Economic and Social reasons. The road blocks in the introduction of any tax regime are divided into 3 Levels, Legislation - Implementation Administration. We are stuck at the 1st Level – Legislation. Due political incompatibility and arrogance, we are not able to pass a Constitutional Amendment Bill which will allow the introduction of GST and do away with taxes such as Central Excise, Sales Tax and Service Tax. Political parties should set aside their differences at the Central Government (which is easier said than done) and appease the State Governments on their apprehensions of introducing this single tax system. The apprehensions the State Governments are having are two fold, (1) In the event the State Government falls short of its revenue collection from its existing collection – Will the Central Government make good that short fall? For what

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period will the Center make good this short fall? It is important to understand where this apprehension is coming from – Unlike the old tax law which is origin based, the concept of the new tax law is destination based, In other words, wherever the Goods move, the tax will move along with it. This means when Goods move from one state to another state, the tax also will move to that state. The producer state will lose that tax and they fear this will hamper their revenue collection. This fear appears legit. For example, highly industrialized states like Gujarat, when it moves goods to Bihar. Then the state of Bihar is enjoying the tax, why should Gujarat provide for economic activity (Land, Power, Water etc.) and not enjoy anything from it? (2) Implementation and Administration of the tax system will reside with a Council comprising of members from each state and the center. The States and Union Territories combined will have a voting right of 66 two thirds and the Center will have the balance 33 one third. Important decisions must receive 75% of the combined votes. In the event the Center abstains from voting, the decision will not pass. This means the Center is having a Veto Power. The States fear that Center may block key decisions and thereby hamper their development. To overcome these apprehensions and resolve the conflict, (1) The Central Government has agreed to reimburse the State Governments to the extent of shortfall in their tax revenue collections for a period of 5 years. (2) It is proposed that the State Governments should have 75% voting rights and Center 25%. This appears logical and one should see the outcome of political negotiations on this point. Recently the Department of Industrial Policy and Promotion (DIPP) announced easing of FDI norms for 15 sectors including real estate, defense, civil aviation and news broadcasting. Do you think that relaxing FDI norms is the right way of achieving economic growth? What other steps should the government take to boost domestic output? We are still socialist in our behavior and capitalist in thought. We are the 3rd largest economy in the world by PPP (7th by Nominal GDP). We need to keep pace with advancements in Science and Technology. Till 1991 the economic growth of India has been organic to a large extent, nurtured by a protectionist political philosophy. Over the last 25 years, we have made substantial

NOVEMBER 2015

NIVESHAK

and consistent economic growth. This could not have happened if not for FDI. It is important to understand that FDI doesn’t bring just capital, but more of knowhow and technology and in a way we can say that it spurs inorganic economic growth. It allows the existing industry to improve productivity. However we cannot throw caution to the wind and usher in FDI as a means to economic growth. The DIPP is doing a good job by a well thought out process in easing FDI norms. The other steps the Government is taking (the speed at which it is doing things is pushing back economic development) are (1) Harmonization of Indirect Taxes – Introduction of GST (2) Ease of doing business – Reducing licensing and procedural hurdles – Single Window Systems (3) Providing concessions – Land Acquisitions, Tax Holidays (4) Skill Development – Setting up Centers for Training and knowledge dissemination (5) Capital availability – affordable long term interest loans (6) Labour Reforms (7) Export Policy - Implementation. The above mentioned steps will definitely give a boost to economic output. Indian exports have been in the negative zone since December last year and it is even being said that exports may not even touch $300 billion in 2015-16. How can the export decline be arrested? Indian Exports was down since last December as our EXIM policy was delayed. It was expected to happen as the new Government had come into power and well thought out strategy have to be put in place. The Modi Government has done well to bring out 2 new focus areas Merchandize Exports (MEIS) and Service Exports (SEIS). In addition to this, the new policy has ushered in simplified procedures – Online uploading of documents or Self Certification by Manufacturer Status holder etc. It has also brought in better incentives – Reduction in Export Obligation under EPCG or Credit Scrip’s eligible for payment of Customs / Excise or Service Tax. New Establishments such as Business Services, Hotels & Restaurants are being rewarded for foreign currency earnings. This will boost domestic output. Trade and Industry is optimistic with the new FTP in place, India will be a significant player in world trade by 2020 (This is also the intention of the current Government)

CLASSROOM FinFunda of the Month

Mutual Funds nirmit mohan IIM Shillong

Sir, yesterday there was an expert talk being telecasted on the TV discussing SIP, STP and SWP in Mutual Funds. What are these plans all about? As you all know, a mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instrument and other securities. Mutual funds have a fund manager who invests the money on behalf of the investors by buying/selling market securities. Sir, how SIPs can help us in reducing risk associated with price movements in the market? As net asset value fluctuates throughout the year, there is no way the investor can anticipate the maxima or minima. In case of SIP (Systematic Investment Plan), the investor, by deciding to invest say Rs. 3000 regularly each month automatically gets the benefit of the swings. He gets least number of units in the months of high NAVs, whereas he accumulates higher number of units during low NAVs. Thus, SIP helps in averaging cost of acquiring units. Sir, what is STP then? In STP (Systematic Transfer Plan), we invest a lump sum amount in Debt Mutual Fund and then a fixed sum is transferred from this fund to an Equity Mutual fund on mutually agreed dates of a month and denominations. These plans outperform when markets are very volatile and one doesn’t want to take risk with his money in a short span of time. If one invests through STP and markets falls or goes volatile, then this situation is way better than the one time investment option. For that matter, it is still better than keeping money in Bank or a SIP, because

at least the money is earning some returns on debt part in STP. In a way it offers all the advantages of a SIP along with other advantages like growth of money and liquidity. Sir, is there any situation wherein SIP is more advantageous than STP? Yes a situation does exist. Let’s say, in case market is already at the end of a bear market and it can start its upward movement anytime. In that case STP will not deliver the best returns like SIP, because at that time a one-shot investment is a good choice. Sir, can we can say that STP is suited to investors who want to invest lump sum into debt funds and at the same time want some equity exposure in order to gain higher returns on their investment. A big YES!! But vice versa is true as well. STP can also work as a tool to transfer from equity fund to debt scheme giving you the dual advantage of earning profits from your equity investment and preserving capital by moving it into debt. Sir, they also mentioned about SWP. What is that? SWP stands for Systematic Withdrawal Plan. Here the investor invests a lump sum amount and withdraws some money regularly over a period of time. This results in a steady income for the investor while at the same time his principal also gets drawn down gradually. These plans are very well suited for retired people who get a lump sum amount of gratuity after their retirement and want a regular source of income. Sir, thank you for explaining the concepts so clearly.

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