Niveshak Oct15

Niveshak THE INVESTOR

VOLUME 8 ISSUE 10

October

FROM EDITOR’S DESK Niveshak Volume VIII ISSUE X October 2015 Faculty Chairman

Prof. P. Saravanan

THE TEAM Abhishek Bansal Bhawana Saraf Maha Singh Gulati Palash Jain Prakhar Nagori Rahul Bajaj Ramesh Jaiswal Sandeep Sharma Vishal Khare

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

Dear Niveshaks, The month of October has generated a lot of news from the government side with the Indian African Forum Summit 2015 taking place in New Delhi. Prime Minister Narendra Modi spoke to heads of states and delegates from all 54 African nations kick-starting the summit which also included various bilateral trade talks and Indian investment in the continent. PM Modi announced concessional credit of USD 10 million over the next five years for Africa. He also announced grant assistance of USD 600 million which will include India-Africa Development Fund of USD 100 million. The fiscal deficit of India from April to September was released. The Centre’s fiscal deficit for the period remained well within control at INR 3,78,563 crore or 68.1 per cent of the Budget Estimate on the back of a strong growth in revenue collections. The revenue deficit amounted to INR 2,69,008 crore or 68.2 per cent of the Budget estimate by September 30, according to data released by the Controller General of Accounts. The government cleared 16 foreign investment proposals amounting to INR 4,722 crore. The investment proposals were approved following the recommendation for the same by the Foreign Investment Promotion Board (FIPB). However, it rejected 8 proposals including that of Cipla Health Limited and Apollo Hospitals Enterprise Limited. The government also released the New Aviation Policy Draft. Incentives to fly to small towns at affordable costs and easing the norms for domestic carriers to operate services abroad are some of the highlights of the new draft aviation policy. The primary aim of the policy is to ensure a tariff of no more than INR 2,500 per ticket for each flying-hour with a host of incentives and other benefits to both airport developers and operators to make that happen. The mergers and acquisitions market had seen one of the largest deal in the recent times and among the top 5 deals in the history with the acquisition of SABMiller by AB Inbev in a deal worth approximately USD 104 billion. However, to execute the deal, the firms may have to sell some of their assets to comply with various antitrust regulations On the magazine front, the cover story of the month is on our very own Niveshak Investment Fund’s foray into the midcap segment. We, the fund managers of the NIF have decided to take the NIF one step ahead into the midcap arena. The cover story gives an analysis on some of the stocks we have shortlisted for the same. The Article of the Month is an interesting read on obtaining debt finance for start-up organisations. The FinGyaan section gives us some interesting facts on India’s FDI ecosystem. The FinSight section of the magazine covers an insight into the impact of global turmoil on Indian capital markets. Our FinView section is an interview with Prof. Anuj Puri, a visiting faculty at IIM Shillong and a practising lawyer in the Supreme Court. He gives us an interesting view on the current business scenario for a legal point of view. To end this brief note, it’s important that we thank you, our readers, for your constant support and appreciation. Please continue to motivate us so that we can come out with more insightful reads in the issues to come. Keep pouring in. Stay Invested!

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

10 The first step is always the

14 Economy screening & selection of sectors

toughest

FinGyaan 18 India - The hub of FDI

Finsight

26 Impact of global turmoil on Indian capital markets

FinLife

22 Market risk classification

FINVIEW

29 Interview By A Independent Legal Practitioner and Visiting Faculty at IIMs

CLASSROOM

31 Credit Default Swap

NIVESHAK

www.iims-niveshak.com

The Niveshak Times

Team NIVESHAK National Pension System opened for NRI To enable Indians living abroad to access old age income security, the Reserve Bank of India on Thursday, 29th October, 2015 allowed non-resident Indians (NRIs) to subscribe to the National Pension System (NPS). NRIs may subscribe to the NPS governed and administered by the Pension Fund Regulatory and Development Authority (PFRDA), provided such subscriptions are made through normal banking channels and the person is eligible to invest according to the provisions of the PFRDA Act, it said. The subscription amounts shall be paid by the NRIs either by inward remittance through normal banking channels or out of funds held in their NRE/FCNR/NRO account. RBI, however, said there would be no restriction on repatriation of the annuity/ accumulated savings. ICICI Bank to sell 9% stake in ICICI Lombard to Fairfax ICICI Bank today said it plans to sell additional 9 per cent stake in its general insurance arm for about Rs 1,550 crore to Prem Watsa run Fairfax Financial Holdings of Canada. Upon completion of the transaction, ICICI Bank will hold about 64 per cent in ICICI Lombard General Insurance Company Ltd, while Fairfax have 35 per cent. Earlier, foreign partners were only allowed to hold 26 per cent stake in an insurance venture which has now been increased to 49 per cent after the passage of the Insurance Laws (Amendment) Act earlier this year. The proposed transaction values the company at Rs 17,225 crore, it said. The transaction is subject to governmental and regulatory approvals Bank of Japan keeps it QE programme on hold in hopes of recovery The Bank of Japan has held off expanding its massive monetary stimulus programme, preferring to keep its powder dry in the hope that the economy can overcome the drag from China’s slowdown without extra support. But the central bank is likely to remain under pressure to expand its asset-buying or quantitative easing programme as slumping energy costs, weak exports and a fragile recovery in household spending kept inflation well short of its

OCTOBER 2015

NIVESHAK

IIM Shillong 2% target. Consumer prices fell 0.1% in the year to September, a second monthly decline, while household spending slid 1.3 percent from a year earlier, official figures released on Friday said. The BOJ maintained its pledge to increase base money, or cash and deposits at the central bank, at an annual pace of 80 trillion yen ($662bn) through aggressive asset purchases. The US dollar fell 0.5% against the yen and the Nikkei share average lost 0.6% before recovering into positive territory despite disappointment that the BOJ had backed away from another increase in liquidity for equity markets. Funds raised via corporate bonds at a record high With lending rates of banks higher than those at which funds are available for companies, private placement of corporate bonds were at a record high in AprilSeptember (first six months of this financial year). The bank credit data on a fortnightly basis shows a rise below 10 per cent. Data from the Securities and Exchange Board of India show companies raised Rs 2.43 lakh crore in April-September, the highest since 2007. Year-on-year, the growth was 67.1 per cent, from Rs 1.45 lakh crore. According to issue arrangers, some of the recent ones include bonds of Can Fine Homes of a 39-month tenure at 8.41 per cent and Reliance Jio’s 10-year bonds at 8.27 per cent. Beside corporate bonds, companies have also borrowed through issuance of commercial paper. Here, too, rates had dropped sharply, compared with the lending rates of banks. AB InBev, SAB Miller agree to merge in a deal worth $104 billion Anheuser-Busch InBev SA and SABMiller PLC, the world’s top two beer companies, have reached an agreement to merge, after Budweiser’s BelgianBrazilian owner extended an offer of 44 British pounds ($67.48) per share to SABMiller creating a global beer behemoth. Various reports valued the deal to be worth between $104 billion to $107 billion. The final agreement, came after multiple,

unsuccessful takeover attempts. Under the terms of the deal, Anheuser-Busch InBev said it will pay 44 pounds ($67.48) a share in cash for SABMiller. That is a 50 percent premium to the closing price in mid-September, before Anheuser-Busch InBev confirmed it had approached SABMiller about a combination. Together, the two companies could create a mega global brewing giant, and the deal is the biggest takeover of a British company in history. The combined company will control 31 percent of the global beer market, topping Heineken, the next biggest brewer, which has 9 percent of the market. The deal could also help Anheuser-Busch, which has had success in Europe, North Africa and Asia, expand into the African and Australian markets, according to the Associated Press. The pairing of these two giants still faces multiple regulatory headwinds, including antitrust hurdles spanning the globe from the U.S. to China.

Republicans. The 64-35 Senate vote early Friday, following House passage two days earlier, sends President Barack Obama a bill that will extend U.S. borrowing authority until March 2017, after he leaves office. The agreement likely frees Obama of protracted fiscal battles with congressional Republicans for the rest of his term. The measure, H.R. 1314, includes a two-year deal to increase defense and non-defense spending levels by $80 billion in 2016 and 2017, paid for with future savings and revenue. The agreement diminishes, but doesn’t eliminate, the odds of a government shutdown because lawmakers still must work out details before current funds expire Dec. 11. Obama said the agreement should help avoid future “manufactured crises” and government shutdowns.

World Bank retains India’s growth forecast at 7.5% for 2015-16 The World Bank on Thursday retained its India’s growth forecast for 2015-16 saying it will continue to grow, but the catch is the acceleration year-on-year will be gradual. “The latest India Development Update expects India’s economic growth to be at 7.5% in 2015-16, followed by a further acceleration to 7.8% in 201617 and 7.9% in 2017-18,” the multilateral lending agency said in a report released. Speaking at the launch of the report, World Bank India’s Senior Country Economist Frederico Gil Sander said India has taken advantage of the sharp decline in global oil and commodity prices to eliminate petrol and diesel subsidies and increase excise taxes. The most significant risks to the outlook, he further said, stem from the banking sector and financing requirements of infrastructure companies. US avoids debt defaults as Congress passes Fiscal Plan Congress passed a two-year bipartisan budget plan that avoids a catastrophic default on U.S. debt, increases spending on domestic and defense programs and ends months of turmoil among House

The Month That Was

www.iims-niveshak.com

Market Snapshot

NIVESHAK

Market Snapshot

26500

4,000

BSE

DII

FII

3,000

26000

2,000 25500

BSE

FII, DII Net turnover (in Rs. Crores)

BSE

1,000 25000 0 24500

29/09/15

28/09/15

24/09/15

23/09/15

22/09/15

21/09/15

18/09/15

16/09/15

15/09/15

14/09/15

11/09/15

10/09/15

09/09/15

08/09/15

07/09/15

04/09/15

03/09/15

02/09/15

24000

-1,000 -2,000

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

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

98,33,358.74 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

26155 17391 19682 15111 10810 7752 17779 11578 6834 8695 1842 1397 6256 11020 10799 6695

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

1.92% 4.46% 0.47% -1.09% 9.83% 1.23% 1.62% -2.71% 6.94% 4.27% 4.09% -1.79% -2.25% 2.68% 1.63% 1.23%

% CHANGE

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

RESERVE RATIOS 65.22 71.67 53.92 99.93 46.69

CURRENCY MOVEMENTS INR/1 USD 2.00% 1.50% 1.00%

Euro/1 USD

GBP/1 USD

JPY/1 USD

SGD/1 USD

CRR SLR

TECK, -2.25%

4.00% 21.50%

Smallcap, 2.68% REALTY, -1.79% PSU, 1.23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

0.50%

7.75% 6.75% 5.75%

-2.00%

Healthcare, 1.62% FMCG, 1.23% CG, -1.09%

-0.50%

-1.50%

CD, 9.83%

0.00%

-1.00%

IT, -2.71%

POWER, 4.09% OIL&GAS, 4.27% MIDCAP, 1.63% METAL, 6.94%

Source: www.bseindia.com 2nd October 2015 to 29th Oct 2015 Data as on 29th Oct 2015

BANKEX, 0.47% AUTO, 4.46% Sensex, 1.92%

-2.50%

OCTOBER 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

Information Technology(12.42%)

Bank (6.49%)

HCL Tech.

HDFC Bank Wg:6.49% Gain:18.06%

Amara Raja Wg:4.45% Gain : 26.66%

Godrej Consm. Wg:6.63% Gain: 43.08%

Lupin Wg:8.23% Gain : 63.45%

Midcap Stocks (12.42%) Bharat Forg Wg:3.95% Gain:-6.80%

Kalpataru Power Wg: 4.27% Gain: 0.06%

Titan Company Wg:4.02% Gain: -6.61%

Natco Pharma Wg: 4.20% Gain: -1.71%

Asian Paints Wg:7.09% Gain:32.47%

Textile (6.46%) Page Indus. Wg: 6.46% Gain : 32.79%

125 115

NIF

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 15,82,671 Change in Portfolio Value : 58.27% Change in Sensex : 29.69%

Sensex

20-10-2015

18-09-2015

20-08-2015

23-07-2015

25-06-2015

28-05-2015

29-04-2015

27-03-2015

27-02-2015

29-01-2015

1/10 4/10 7/10 10/10 13/10 16/10 19/10 22/10 25/10 28/10

31-12-2014

12-02-2014

31-10-2014

105

30-09-2014

Wg:4.61% Gain : -2.28%

Chemicals (7.09%)

Pharmaceuticals (13.85%) Dr Reddy’s Labs Wg:5.62% Gain:47.20%

ITC

Misc. (10.65%)

Auto (8.49%) Tata Motors Wg:4.04% Gain : -13.1%

135 101

02-09-2014

Wg:4.20% Gain : 13.04%

145

103

03-Jul-14

Wg:5.89% Gain : 24.05%

Wg:7.42% Gain : 219.9%

155

01-08-2014

Britannia

105

03-Jun-14

FMCG(22.12%) Colgate HUL

165

28-Mar-14

Wg: 4.09% Gain : 1.24%

175

107

05-May-14

Wg: 4.46% Gain : 17.26%

Wg: 3.87% Gain : 37.89%

Performance of Niveshak Investment Fund since Inception

30-Jan-14

TCS

October Performance of Nivehshak Investment Fund

28-Feb-14

Infosys

As on 30th Oct 2015

Value Scaled to 100

Risk Measures: Standard Deviation : 20.28 (Sensex 11.68) Sharpe Ratio : 2.38 (Sensex : 3.44) Cash Remaining: 58,000

Comments on NIF’s Performance & Way Ahead : Throughout October 2015, Sensex was seen under swing from the levels 26168 lowest to 27421 highest, the surge was mainly due to FPI Net Inflows of Rs 22350 Crores which touched a 7 month high . In our portfolio IT and Banking were two heavily impacted sectors along whereas Pharma and FMCG made some recovery led by Lupin , Dr. Reddy’s and Britannia. On global front the emerging markets performed better than the India marketsChina's Shanghai Composite recovered about 12% during the month while Jakarta Stock Exchange gained 10% The portfolio witnessed investments in new stocks during this month, we have delved into midcap stocks on the recommendations of Vishleshan teams; full coverage of the stocks bought and rationale is covered in the cover story .

NIVESHAK

while raising funds. The foremost reason for low penetration of institutionalized credit among startups is their poor creditworthiness. Financial institutions, unlike angel investors and venture capitalists or for that matter family and friends, do not extend loans on the basis of a gem of an idea or lucrative income projections. A bank would ordinarily require at least three years of business operations, a minimum turnover and cash profit and a demonstrated growth in turnover before it sanctions a loan. Naturally, a start-up in need of seed capital can rarely meet

Third-party Guarantee (guarantee to repay the loan amount out of the personal assets of the borrower or a third party in case of default). Any bank would require security that is at least 1.25 times the loan amount, even more for borrowers with less creditworthiness. The primary security is almost always not enough to secure the loan, thus requiring the borrower to bring in collateral security or provide personal guarantee to meet the bank’s requirements. This directly increases the financial risk for the borrower and the absence of adequate collateral often becomes a stumbling block to

these criteria. Secondly, what distinguishes equity from debt is that the latter’s repayment has to be secured. There are three kinds of securities – Primary security (charge on the assets created out of the loan proceeds), Collateral security (charge on the borrower’s assets, existing prior to the loan being sanctioned) and Personal or

availing a loan. Thirdly, raising money through debt brings the additional burden of interest payments. The early stages of a startup are characterized by low revenues and significant expenditure on capacity building. Debt servicing increases the recurring fixed cost, thereby putting added pressure on cash flows.

The First Step is always the Toughest Siddharth Gupta

XIMJ An entrepreneur needs two primary resources to start up – a business idea and adequate seed capital. While the idea is an intrinsic resource which no one other than the entrepreneur can generate, capital is an extrinsic resource for which the entrepreneur has to fall back on an external source, sooner or later. The good news is that angel investors and venture capitalists are slowly warming up to indigenous start-ups. According to a report by Venture Intelligence, a research firm focused on venture capital and private equity deals in India, there are 43 angel networks, 111 venture capital investors and 37 incubators in the country, giving a much needed boost to the Indian startup ecosystem. To add to these, crowdfunding has found its own place among

OCTOBER 2015

the new generation entrepreneurs. The bad news is a very small fraction of entrepreneurs are able to garner funds from these sources, the others being forced to bootstrap - rely on personal savings or funds from family and friends. And the more money the entrepreneur infuses into the startup, the more risk he assumes. This is where loans come in. Loans allow us to buy assets with borrowed funds, with the belief that the income from the asset will be more than the cost of borrowing. This excess adds to the profits from the business, thereby having a multiplier effect on the Return on Equity (ROE). This is what we call ‘leveraging’ or ‘gearing’. However, historically, it has always been difficult for entrepreneurs to obtain loans

But what if a startup could avail a loan based on its future viability rather than its business history, without the entrepreneur having to submit collateral security or personal guarantee, all this at a comparatively lower rate of interest? Seems impossible? Not now… © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

NIVESHAK

The above points do present a strong case as to why startups are unable to avail bank loans. But, what if a startup could avail a loan based on its future viability rather than its business history, without the entrepreneur having to submit collateral security or personal guarantee. All this at a comparatively lower rate of interest? Seems impossible? Not now. The answer lies in a scheme operated by the Ministry of Micro, Small and Medium Enterprises (MSME), Government of India, called the Credit Guarantee Scheme (CGS). The Credit Guarantee Scheme allows entrepreneurs to avail credit up to Rs. 1 crore

entrepreneurs) of the outstanding amount subject to a maximum limit of Rs. 62.50 lakhs (Rs. 65 lakhs for women entrepreneurs). For this purpose, the Ministry of MSME and the Small Industries Development Bank of India (SIDBI) have jointly set up a trust called the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). Besides the guarantee cover, banks also have the incentive of assigning zero weight to the portion of the loan guaranteed by CGTMSE while calculating capital adequacy ratio. In simpler words, greater the quantum

(Yes, 1 crore!) Without providing any collateral security or personal guarantee. The scheme mandates that the lender gives high importance to project viability and secures the credit only through primary security. In case the borrower fails to discharge his liabilities to the lender, the Government make good the loss of the lender up to 75% (80% for women

of loans sanctioned under this scheme by a bank, lesser will be its requirement for capital, thereby reducing its total cost of acquiring capital. On account of these incentives, banks are required to provide differential rates of interest to MSE borrowers. This implies that borrowers under the scheme can avail loans

All Scheduled Commercial Banks (either PSU, Private or Foreign Banks), select Regional Rural Banks and such of those institutions as may be directed by GOI are covered under CGTMSE. Small Industries Development Bank of India (SIDBI), National Small Industries Corporation Ltd (NSIC) and North Eastern Development Finance Corporation Ltd (NEDFI) have also been included as eligible institutions. OCTOBER 2015

at comparatively lower rates of interest. Prime Minister’s Employment Guarantee Programme (PMEGP) is another scheme under which entrepreneurs can startup by contributing only 10% (5% for women entrepreneurs) of the project cost from their own funds, the government providing 15% (25% for women entrepreneurs) of the project cost. However, this scheme is applicable only to startups whose investment does not exceed Rs 25 lakhs for manufacturing sector or Rs. 10 lakhs for service sector. The above schemes directly address the aforementioned apprehensions of an entrepreneur. Firstly, he is not required to put his personal property at stake so as to secure the loan and his exposure in the business is limited to the initial equity that he has to bring. While under PMEGP, the entrepreneur’s equity contribution is very low on account of the Government subsidy, under CGTMSE banks would ordinarily require a debt-equity ratio of 2:1 implying that he would have to bring only around one-third of the total project cost. Secondly, he can avail loans at relatively lower rates of interest. Besides, the Credit Information Bureau (India) Ltd. (CIBIL) maintains records of the credit history of every person on the basis of which it assigns a credit score ranging from 300 to 900. This credit score is considered by all lenders before sanctioning a loan. Borrowers with a credit score of more than 700 can negotiate for even better interest rates. Also, the interest expense, unlike dividend on equity, is deductible from income for tax purposes, leading to tax savings and further reducing the cost of capital. Thirdly, banks often allow an initial moratorium, allowing the business to start the repayment process only after 18-24 months. The borrower can also negotiate for a step-up repayment schedule where the instalment amount keeps increasing with the passage of time, thus reducing the pressure on cash flows in the initial stages of the business. Fourthly and most importantly, for loans under these schemes, banks shall pay heed to the project feasibility and sustainability rather than depending on previous financial statements while sanctioning the loan. Thus, a few months old startup with low revenues can also obtain a loan provided he can convince the banker of a promising future for the company. But how easy is it to convince the

banker? Well, not easy. The thought of NPAs (NonPerforming Assets) sends a chill down the spines of bankers. Loans to start-ups carry a higher degree of risk and the government guarantees only 75% of the outstanding amount in default; the remaining amount turns into losses for the bank. Naturally, banks are wary in sanctioning such loans. Convincing the banker that a loan to the business is a safe investment, requiring good homework on the part of the borrower. He must back his business plan with detailed pro-forma income statements, cash flow statements and balance sheets for the next five years. Moreover, the worth of a startup depends greatly on the vision, sincerity and determination of the entrepreneur, of which the banker must be convinced. Besides, it is important to be acquainted with every detail of the loan scheme; otherwise the banker might easily take the borrower for a ride. It is also advisable to approach at who says, “Yes, I will”. Just keep looking and the startup least three banks at least three banks at once, preferably those with the borrower has exciting relationship. Even then, getting a proposal sanctioned might take some time. But if the idea is worthy, there will surely be a banker who says, “Yes, I will”. Just keep looking and the startup might soon be up and running!

Article of the Month Cover Story

NIVESHAK

ECONOMY SCREENING & SELECTION OF SECTORS

Ramesh Jaiswal

IIM Shillong Introduction Power is the facilitator in the growth of an economy. And with the allocation of the coal blocks under the Modi Government, power companies are determined to transfer the benefits under their belt with the cheap source of raw material for them. Also Narendra Modi with his ambitious nature has announced a deadline of a thousand days to power up Indian villages, 18500 being in his list. These factors not only will uplift India but also improve the balance sheet of the power companies bringing an end to the aged struggling phase. Another important contributor to the economy would be the auto industry. With the increase in ambition and the disposable income of the household, both in the urban as well as the rural ladder, the auto industry is going to blast the furnace in the years to come. Also the freight carry in India, with the acceptance of GST will increase drastically contributing directly to the GDP as well as the growth in the commercial vehicles in India. According to Marketline, the commercial vehicle is expected to grow at 19.8% CAGR till 2018. When it comes to pharmaceutical industry, people tend to think it as an evergreen industry, but with the advancement in the FDI cap to 100% and with advent of diseases in this fast paced life, pharmaceuticals are being all more important. The cost-effective technological advancement in the pharmaceutical industry is helping in short time to market for new

OCTOBER 2015

drugs. The Indian pharmaceutical industry is expected to grow at a staggering 20% CAGR in the next five years according to India Ratings, a Fitch company with Biopharma being the maximum contributor in the growth. ‘Pharma Vision 2020’, the Government of India’s focus towards making India a global leader in end to end drug manufacture will drive the growth in the Indian pharmaceutical industry to a large extent. NATCO PHARMA

Natco Pharma wants to make it big in discovery research, and the management has guided to develop and bring to market an indigenous drug. For the Indian pharmaceutical industry as well as for the company, the next big thing is discovery research. If we see, India has already arrived on the global pharmaceutical map. It has made a huge impact in generics and in bringing down costs to affordable levels. India is very much active in the discovery research front. Selecting the right drug and target disease to develop molecules assumes great significance. Lucrative opportunities in the category has actually led to immense scope for entrepreneurship in new drug discovery, especially for start-ups that can focus on specific areas to develop basic molecules. The

main precondition is that the government has to foster the movement, and private investors and Big Pharma should also support various stages of drug discovery. COST IMPROVEMENT The cost of drug development can be significantly brought down using advanced technology. The company has forged research collaborations with various universities and other institutions. For example, a tie-up with the University of Illinois in the US has led to significant strides in the development of a molecule to cure brain tumours. The management has also put in their guidance that there iss positive progress on the drug, which is at pre-clinical stage now Natco Pharma, which introduced novel sustained released technology for drug delivery in the mid-1980s, has made several strides forward. The previous track of the company states that it has been engaged in patent challenges against Big Pharma on oncology drugs it scored win in the case of Glivec, Novartis’ in blood cancer drug category. INVESTMENTS Natco, which has lined up about ₹300 crore to invest in new units and to enhance existing capacities, is trying to leverage its existing strength in oncology. It has pipeline of molecules in phase II of drug development, and these are likely to bear fruit in two-three years. These are being developed in house entirely, the management has guided. The main reason that the company choose the oncology niche for discovery research is the regulatory requirements and time frames associated with the diseases are relatively easier to handle. Also the company registered better success rates in the segment in the past. BHARAT FORGE

• Benefit from cyclical uptick in domestic economy • Recent alliances with Safran and Boeing could enhance its capabilities • BFL’s FY18 EPS estimated to be 2.2x over FY15 EPS. • Opportunity to grow – despite being one of the largest forging manufacturers globally, its volume market share is below 1% SECTOR STRENGTH • Favourable demand for CV demand in India and North America Passenger car and LCV sales in Europe mainly depends on growth in Germany, Spain and U.K. • Outlook for Class 8 truck in US continues to be robust • Recovery of Indian automobile segment DRIVERS BFL’s automotive revenues will be driven by cyclical recovery in domestic CVs, steady demand in the North American truck market Gain traction in lucrative segments such as defense, aerospace and locomotives Make in India – Localization of components would expand its domestic opportunity size significantly RISKS • Declining dependence on the cyclical CV segment • Exposure to CVs in automotive segment is 86% towards CVs • Higher raw material prices • INR appreciation against USD • Slowdown in China

COMPANY STRENGTH • Ability to improve margins (600bps in the last 5 years) • BFL’s management has displayed exemplary fiscal prudence – Exited investments that do not offer meaningful long-term upsides © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

Cover Story

NIVESHAK

PREVIOUS RETURNS

KALPATRU POWER

COMPANY STRENGTH • Leading Global EPC player in power transmission and distribution sector • Also operates in oil and gas pipeline, railways, infrastructure development, civil contracting and post-harvest value chain of agri-commodities • Footprint across 40 nations across Africa, Middle East, South-East Asia, North America and Europe • Has an order book of Rs. 10,800 cr on a consolidated basis • Has subsidiaries JMC Projects and Shree Shubham Logistics • Diversified into international markets post slowdown in domestic market • Order inflow at Rs. 8100 cr is above estimates • Power deficit India to focus on improving its transmission capacity • Strong execution is expected to lead to revenue CAGR of 12% • Subsidiaries like JMC Projects boasts a strong order book of Rs. 5500 cr EBITDA margins to move back to double digits SECTOR OUTLOOK • Need to provide access to electricity will

OCTOBER 2015

NIVESHAK

drive in transmission sector in growing economies • Uptick in prospects of T&D, as India looks to fast-track growth • World Bank estimates global T&D spending at $900bn over 2010-2020 • Wants to increase International revenues (currently to 50%) • Tripled its revenues from infrastructure due to higher execution in pipeline and railway business HIGH GROWTH SUBSIDIARY High growth business Shree Shubham Logistics (SSL) is 70% subsidiary of KPTL. SSL is in the business of Agro-Logistics Services and is one of the largest private warehousing and agrologistics players in the India. Major services provided by the company includes storage and preservation (Dry and Cold), Weighing facilities, testing and certification, fumigation and pest management, collateral management, commodity procurement etc. In FY13, Private Equity fund Tano India Invested Rs 800 mn in SSL, which were used by the company in capacity expansion. Inline with capacity addition, SSL revenue has increased by CAGR ~39% in FY11-14 with healthy EBITDA margin of 12-15%. Current capacity of the company stands at 1.7 mnt and company is planning to add 0.15-0.2 mnt in next financial year which will give further boost to its topline growth. STRONG DIVERSIFICATION Infra business pain likely to get over: Company has railway and pipeline businesses in Infrastructure segment (~10% of standalone order book). Company being new entrant in these businesses had to face high fixed cost and low margin initially. However as legacy orders in this segments (especially Railways) are in the process of completion in next few quarters, company is on path of stabilising its infrastructure business and profitable growth. To counter the cyclical nature of EPC business KPTL has entered into transmission BOT business. KPTL currently has two transmission BOT projects on annuity model. The first transmission project

was commissioned in FY12 at Jhajjar (Haryana). Second transmission project Kalpataru Satpura is likely to commence operation in Q4FY15. Both projects have concession period of 25 years which is extendable by 10 years. PREVIOUS RETURNS

year horizon the stock has a good entry point with the Slow Stochastics being in the oversold region. KALPATRU POWER

TECHNICAL CALL

The stock has been in an uptrend since 2009. A couple of weeks back it has seen correction of approximately 18% and found support at its 20 week SMA indicating the strength in the stock. Since then it has bounced to the upside confirming the uptrend. At near support level of the 50 week SMA with the Stochastics showing oversold level on the daily chart, it is a good entry point.

The Stock has corrected by 15% in AugustSeptember. It found support at its long term trendline (white) which has been in force since the beginning of 2014 indicating the optimistic sentiment of the market towards the stock. 20 week SMA is above the 52 week SMA. Moreover, it has recently found support at its 20 week SMA (yellow) with imminent upside bounce indicating a good buying opportunity for

BHARAT FORGE investors with a medium to long term horizon. The Stock has seen some heavy selling from March 2015 till date. From the highs of 1350 level it has corrected to 850. On the long term charts(monthly) the Stock has found support at the 20 SMA level as well as the 38.2% Fib Retracement level. For investors with a 1.5 - 2

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India – The hub for Foreign Direct Investment Ankit Jain & Fatema Ru-

NLDIMSR

Globalization has opened doors for foreign trade, cross- border financial flows and boundary-less business. At the end of 20th century, the world economy has seen a rapid increase in FDI flows. This is because multinational companies get access to new markets and cheap production opportunities. The supporters of FDI believe that FDI inflows will help the economy to grow by reducing poverty and by improving unemployment. However, the opponents believe that it will lead to a higher interdependence thereby increasing risk and inequality. Also, the huge influx of capital through FDI increases the risk of foreign investors out-competing the domestic investors. The host country may not be technically prepared for the same. Prior to liberalization the FDI inflows were negligible. However, the balance of payment crisis in 1991 forced the government to

OCTOBER 2015

form a comprehensive structural reforms for improvement in the economy, including steps to attract FDI. Some of the direct efforts by the government to attract FDI includes- raising foreign-equity caps in many sectors, diluting provisions of the Foreign Exchange Regulation Act (FERA) and revamping Foreign Exchange Management Act (FEMA). Also, deregulating interest rates, opening up capital markets, and conducting trade reforms paved the way to increase investment and capital formation. Thus, government has changed its role from a regulator to a facilitator creating a business conducive environment. Role of FDI in Indian Economy Investors find a huge business opportunity in India due to flexible investment regimes and policy. FDI has helped increase the foreign

reserves by providing shield against external debt and it also provides security against any probable currency crisis. The financial position of the country is improved by enhancing the economic growth which has helped to boost the exports. Reasons behind FDI inflows in India. As on 30th September 2015, India ($31 billion) has surpassed China ($28 billion) and USA ($27 billion) in terms of FDI inflows. Singapore and Mauritius form major source of FDI inflows followed by Netherlands, US and Germany. The major FDI inflows are in IT sector followed by automobile, trade and financial sector. The overall increase in FDI inflows is almost 4% from 2005 to 2015. 1) Political ties The current government has adopted a proactive foreign policy and has successfully established closer ties with its strategic trading partners. This efforts includes foreign visit by Prime Minister Modi to various countries such as Nepal, Bhutan, USA, Germany, Russia, Canada, Japan, China etc. Various commitments and agreements have been signed during the meeting. Over the next five years Japan plans to invest USD 34 billion. The motive of building India’s image in the international arena as an economy having huge potential to grow is successfully accomplished.

2) BRICS economy The net FDI inflows to India has increased from $8.8 billion to $19 billion as the incoming FDI has increased about 16% in 2015 and outgoing FDI has declined due to weakening of other competitive nations. Among the BRICS nations India is favoured as the hot destination for FDI because Brazil and Russia are in the grip of recession, China is slowing down as being an export oriented country its exports are falling which reduced their growth rate from double digit to single digit and South Africa’s economy is contracting. On the other hand India is offering growth and stability as its fiscal deficit is manageable, current account deficit is low, currency is relatively stable because of low inflation and there has been a rate cut in the interest rates as well. 3) Initiatives by the government The ‘Make in India’ campaign aims to raise India’s international profile and promote it as an attractive destination for manufacturing. Launch of ‘Make in India initiative’ has led to more than 48% growth in FDI equity inflows. The reforms initiated by the government towards ease of doing business and ‘Make in India’ have created a positive investment climate. The ease of doing business initiative by Government of India and World Bank has encourage FDI inflows and India is scaled at 141 nation among 189 in terms of ease of

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doing business. Rate of Corporate Tax to remain the same for Assessment Year 2016-17 (i.e. Financial Year 2015-16), however it is proposed to reduce the Corporate Tax from 30% to 25% over the next four years starting from next financial year. Although the reduction will be accompanied by rationalization and removal of various kinds of tax exemptions and incentives for corporate taxpayers. In the following sectors the cap of FDI inflows has been increased in the 2015-16 budget a) Health sector 100% FDI in this sector is allowed by the Department of Industrial Policy and Promotion (DIPP). It focusses on production of indigenous medical products and reduce imports. b) Real estate FDI in reality is allowed to be 100%, experts are of the opinion that the demand from foreign property buyers will increase. The growth in this sector is expected to be twofold as currently it is $1.5 billion and is expected to grow at $3billion. c) Railways In railways-related infrastructure FDI is allowed to be 100% focusing on developing highspeed train and bullet trains. d) Infrastructure A National Investment and Infrastructure Fund (NIIF) to be setup with an annual flow of INR 200 billion to invest in equity of infrastructure finance companies. Proposal to introduce E-Biz platform, which will aim at making all business

OCTOBER 2015

and investment related clearances and compliances available on a 24x7 single portal. E-Biz portal would integrate 14 regulatory permission at one source. The FDI inflows in this sector is allowed to be 49% (earlier 26%). 4) Increase in the number of start-ups The start-up phenomenon has been a game changer for the Indian economy. India has the third highest number of starts-up in the world. The number of starts-up in India is estimated to be 4200-4400 are reported by Nasscom and Zinnov consulting. The estimated total funding for starts-up in 2015 is $ 5 billion. The rapid growth of start-ups has grabbed the attention of investors globally. The Indian government has framed many schemes to encourage the start-up firms. This is done by allowing the foreign investors to venture into Indian startup ecosystem. 5) Bureaucratic procedures The budget of 2015 has simplified the procedures of doing business to attract more FDI. Currently, the number of mandatory documents required for import and export of goods is reduced to three from ten. This will reduce the transaction cost and time. In construction sector government has relaxed restrictions by reducing minimum built-up area as well as capital requirement. Exit norms has been liberalised. 6) Manufacturing sector India is offering low cost manufacturing, skilled man power and raw material to biggest marketers of FDI. Indiaâ&#x20AC;&#x2122;s manufacturing environment has been improved greatly. The

proposed change aims to limit the discretion of labour inspectors which was earlier used by corrupt officials to harass businesses. The single window compliance process is adopted for resolving issues of labour. For skill development of Labours, the Labour Ministry of India will finance the training of apprentices in manufacturing units. Also, the government has instituted reforms to allow workers to legally work more. Areas where more action is needed 1) FDI in insurance needs to be increased 2) Land acquisition act is a major barrier to investment, it needs to be looked upon. 3) Need for uniform Goods and Service tax. Conclusion: The reforms has taken pace since the BJP government came into power and their prime focus has been on the micro level policy i.e. trying to improve the efficiency and reduce the logjams. The changes have taken place in a number of areas such as reducing bureaucratic red tape, providing increased transparency on laws and regulations, introducing large scale digitization of government functions, and easing environmental and labour norms. Reforms have been implemented in infrastructure and manufacturing sectors in order to facilitate conducive business environment. These are the reasons that there is a positive correlation between increase in FDI inflows and GDP growth rate.

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Market Risk Classification

Satish Rath & Vin-

XIMB Market Risk Classification Market Risk can be defined as the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets. Market Risk is also termed as “systematic risk” as it cannot be eliminated by diversifying the cause, however it can be hedged against. Very prominent examples of market risk can be a major natural disaster or an impending election in a state. Other forms of market risk include the any political turmoil, terror attacks, fluctuations in interest rates etc. The various categories of market risk are as follows:1. Interest Risks 2. Equity Price Risk 3. Foreign Exchange Risk 4. Commodity Price Risk Interest Rate Risk This type of risk is defined as the risk that the value of a security will fall owing to the increase in interest rates. In other words it can be stated as the risk to the earnings of the market value of a portfolio due to fluctuations in the interest rates. Fundamentally interest rate risks can be understood from two different perspectives.

OCTOBER 2015

Book value perspective: • This perspective of risk is valued in terms of its effect on accounting earnings. • It is generally typical in insurance and corporate treasuries where book value system of accounting prevails. • The book value of an asset = the asset’s cost - the asset’s accumulated depreciation. • Market Value perspective: • From this perspective risk is perceived in terms of its effect on market value of a portfolio. It is also known as the economic perspective. • It is generally used in context of investment management or trading Interest risk can be again categorized into following: a.) Basis Risk: The risk that defines the value of the future contract does not move in line with that of the underlying exposure. Basis Risk in finance can be defined as the difference between the price of the asset to be hedged and the price of the asset serving as the hedge. The difference can also arise due to the mismatch between the actual selling date of the asset and the expiration date of the hedge asset. . The difference between the two

quantities measures the value of the basis risk Basis = Spot price of hedged asset - Future price of contract b.) Yield Curve Risk: It is the risk due to changes in fixed income term structure. Its occurrence is due to difference in interest rates on liabilities for periods which differ from those of offsetting assets. Of the many reasons one reason could be attributed to the difference in maturity In money terms yield curve is defined as a curve showing a number of yields or interest rates across dissimilar contract lengths for similar debt contract. The curve shows the link between the extent of rate of interest or the cost of borrowing and therefore the time duration for maturity. The maturity time is also known as the term of the debt for a given debt in a given currency. For Ex: The U.S. dollar rate of interest paid on the U.S. Treasury securities for different maturities are closely watched by several traders and is plotted on a ‘the yield curve’ graph.. c.) Options Risk: This type of risk arises due to the optionality embedded in some aspects and liabilities. This can be seen in the prepayment speeds of the real estate loans, due to varying interest rates. Declining rate of interest can cause the borrowers to refinance and repay their loans which will leave the banks with un-invested cash with the fall in the interest rates. On the other hand a rise in interest rate can cause the borrower to repay at a slower pace, thus leaving the banks with more number of loans based on prior lower interest rates. This type of risk is relatively difficult to measure and control 2. Equity Price Risk This type of risk arises due to the volatility in the stock prices. In this type of risk it is important

to differentiate between the systematic and the unsystematic risk. Systematic risk refers to the risk due to the general market factors and it is responsible for affecting the entire industry. It is quite not possible to diversify it. Whereas on the contrary the Unsystematic risk is specific to particular company and arises due to the company’s certain characteristics. As per the portfolio theory, this type of risk can be eliminated by the help of diversification. The basic idea behind this is that if one stock experiences a sudden and considerable decline then, the portfolio will be less affected if more stocks or equities are involved. Another way to avoid this risk is by creating more specific diversification. For ex: Investors holding stocks in different sectors help decreasing the risk involved in it. Reduction of risk can also be achieved by buying stocks at a global level, contrary to holding all the stocks of the same country. These are some certain methods that help the investor lower the equity risk that their total holdings will experience owing to sudden price fluctuation. 3. Foreign exchange risk Foreign exchange risk is about the risk to the value of one’s assets when it is valued in another currency. The exchange rate of conversion standard for currency to an alternate may be unstable. The variation of cash estimation offers a chance for remote trade hazard in the future. Devaluation in the money you own, in which you get designated advantages, brings about a lower estimation of the benefits, which is measured as alternate cash, in contrast to the before the deterioration period. Assets or Transactions which are exposed to foreign exchange risk

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Finsight Ownership of assets overseas, International trade, overseas remittances, Foreign currency loans, Overseas payments and receipts, foreign stock dividends, Pension funds, Payment to a foreign supplier, foreign holiday expenses Parties exposed to foreign exchange risks Importers and exporters, international students, companies with overseas branches, companies whose income/cash transactions are in foreign currency. There are various types of foreign exchange risks, which are mentioned below: Transaction risk: This is the risk when exchange rate changes between the transaction date and the settlement date for the subsequent period, i.e. it is the profit or loss which arises on conversion. This type of risk is primarily associated with import and export sector. Economic risk: Transaction exposures focuses on short-term cash flow; economic exposure encompasses this in addition to the long term effect of changes in the rate of exchange on the market value of a company. So this means there is a change in the present value of the future after cash flows of taxes due to changes in rate of exchange. Translation risk: The foreign subsidiaries translated their foreign statements into the home currency in order to be consolidated into the financial statement of the group companies. This exercise is purely paper-based - it is the

OCTOBER 2015

translation of real cash from one currency to another 4. Commodity Price Risk Commodity Price Risk is risk due to unexpected changes in the price of the commodity, such as the oil price. It is a threat of an adverse impact due to the change in price to the producer. Eg. of commodities : grains(wheat, rice, sugar, corn), cash crops(cotton , cofee) , metals(copper, aluminium, steel), fuel(petrol, gasoline) etc Commodity risk affects these sections of people: • Producers : Farmers, companies in agricultural & mining sectors) • Buyers : Cooperatives , traders , end consumers) • Exporters : Suffer pricing issues , duty costs ) Governments: Instances of farmer suicides, strikes by farmers & related agencies cause not only a problem of policy making & governance , but also a bad name to the country at an international stage

Impact of global turmoil on Indian capital markets Vaghul Ramanujam

SIBM Pune

The Indian capital market has witnessed a paradigm shift to be at par with the advanced markets of the world in the last couple of decades. The 1990s might probably go down as the most important decade for the Indian capital market, with the emergence of SEBI, participation of Foreign Institutional Investors (FIIs), new industrial policy, entry of private sector banks and mutual funds, etc. It was also known for some not-so-good reasons like scams by Harshad Mehta and Ketan Parekh etc. which led to reform of equity markets. These helped to strengthen the market to avoid any such misdeeds in future. For a long time, debt markets have been anticipated to make significant developments but are still at a nascent stage. The bond market is not customized and is illiquid which acts as a key deterrent for investors to participate. Nearly 98% of the bond market in India is through private placement and there is a lack of competitive intermediaries. Corporate bonds are not actively supported by FIIs and pension funds. The government should actively focus on these issues to generate interest amongst investors to hold these asset classes. Hence, there has been lukewarm interest in debt markets of India, among global as well as domestic investors, and de-facto equity markets have always run the show in India. Peek into the past During the Asian crisis, Indian markets were quite resilient. In the 2000-01 dot-com crash, only the stocks in the technology domain

suffered mostly; the rest of the market actually did quite well, including the industrial stocks. But during the 2008 global financial crisis, the Sensex almost crashed more than 50%, from 20,000 to 9,000 odd levels. FIIs had been withdrawing heavily from Indian equity as they moved their capital to safety. This seriously crippled the liquidity of our stock market. It led to no appetite from retail and institutional investors and the primary and secondary markets were in a deep abyss. Despite the great fall in the popular stock market indices, few quarters later, our stock markets provided strong resistance to the global financial contagion. The turnover of the NSE rose by 50.2% in 2009-10 compared with 2008-09 and by 2010 the markets consolidated, thanks to better macro fundamentals. Role of FIIs and retail investors in equity markets One of the key reasons for the recovery was investment by FIIs, to which the market is very sensitive. RBI, in 2010, has estimated that a 10% fluctuation in FII investment results in a 35% variation in stock prices. Thus, capital markets have always reacted to the decisions of FIIs, and hence play a key role in the performance of capital markets. Retail participation in capital markets has always been muted. Less than 1.5% of the population invests in securities, compared with almost 18% in the U.S and 10% in China. Just 2% of India’s household savings are exposed to equity while in the U.S. it averages around

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45%. If retail investors show more excitement in channeling their investments towards capital markets, it will help our capital markets generate more funds for their investments. The chart shows the holdings of different class of investors in equities in India. In the last 20 years, since they have been allowed to invest, they have poured in over Rs. 13,000 billion in India’s equity market. India needs lot of investment in the coming years to pick up its growth trajectory. Hence it’s important that FIIs show keen interest in investing in Indian equities, which can fuel our growth story. The chart below shows the net monthly investment of FIIs in equity and debt markets of India. Earlier, among foreign investors, only FIIs were allowed to invest in Indian stocks. Now, even retail investors from abroad can invest in markets. Chinese Downturn After rising by 150% in the last one year, Chinese stocks have dramatically nose-dived in the last few months. The rapid decline has sparked fears that Chinese stocks may be entering a long-term bear run. This fear can be attributed to the slowing Chinese economy and its high debt-to-GDP ratio levels. Indian stocks have managed to stay relatively resilient

OCTOBER 2015

to the turmoil in Chinese stocks of late. While the Shanghai Index has dropped 40% since June 12, 2015, the Sensex has lost only 5% in the same, even though it touched 25,000 levels in this period. It implies that though Indian equities got affected by the Chinese drop, they have managed to recoup and are currently nicely placed. Understanding the Impact of Fed Hike Starting from 2004 till 2006, Fed has raised interest rates 17 times, i.e. from 1% to 5.25%. This has resulted in a sharp outflow from Indian debt markets as FIIs pulled out significantly and their cumulative holding went down by 70% by June 2006. On the contrary, Indian equities witnessed a strong inflow, thanks to FIIs pumping in their investments. But this was the period when most asset classes were doing well and there were few uncertainties. aAs the US economy slowly gets back on track, there is an impending rate hike which might happen by the end of the year. The US dollar has appreciated against most emerging market currencies and has damaged carry trade and liquidity in emerging countries’ capital markets. The aftereffects of “taper announcement” of 2013 are unlikely to be repeated when the Fed hikes rates, as the markets are already correcting itself in anticipation of it. Although

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OCTOBER 2015

is on an average 11% and falling whereas in India, it is 16% and expected to rise. In this scenario, FIIs will continue to invest in India. Thus Indian markets will be resilient and better prepared to face minor external shocks. Impact on Indian debt markets The same rosy picture cannot be painted for debt markets as well. There is a greater threat of volatility in debt markets as foreign investors are more short-term in their investment horizon and are very sensitive to yields and currency movements. They have poured $53 billion in debt since the beginning of 2009. While $13 billion was pulled out in 2013 due to Fed taper announcement, $32 billion has been pumped in since the beginning of 2014. As the bond market in India is relatively less liquid, as pointed out by the IMF’s Financial Stability Report, money tends to flee from illiquid assets such as EM bonds when riskaversion rises. Hence, Indian bonds face greater risk when compared to equity. Also the performance of debentures has been disappointing. The recent credit downgrades of Amtek Auto, Jaiprakash Associates, Jindal Steel and Power, Bhushan Power and Steel, etc. have created fear amongst investors, and hence might be difficult for the market to repose faith in the investors that these assets are safe investments. For all the above cited factors that might induce capital flight, the debt markets still have one big advantage. India has a 6% advantage on bond yields (Indian 10-year yield is at 7.8% while the US 10-year bond yields are at 2.2%). This yield differential is highly attractive for investors and hence might mitigate the capital outflows from debt market. Markets will be resilient Hence, for any major global happenings, we expect the markets to be strong enough to withstand downturns, even though there might be some short term volatility. The macros are strong enough to support these markets, which would repose the faith in both domestic and foreign investors. It is expected that Indian markets would be the favorite among global investors in comparison to its EM peers and hence “where else but India the money would flow into”.

Interview With Anuj Puri, Independent Legal Practitioner and Visiting Facuty at IIM

As per the World Bank’s ‘Doing Business 2016’ report India has jumped to 130th spot. But in absolute terms it is still low. What should the GOI do in the short and long term to enhance the future rankings?

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some short-term volatility is expected to happen, the effects might not be substantial. Taper Tantrums During the announcement of taper, the initial selling happened in the Indian debt markets. The selling created some panic and the rupee depreciated sharply touching 68.85 to the US dollar on 28 August 2013. It was this unexpected crash in the rupee that created more panic among FIIs forcing them to pull out funds from equities as well. Another major factor that can explain why markets went crashing was India’s poor fundamentals. India’s twin deficits—fiscal and current account—were in dangerous territory, it was classified as one among the Fragile Five economies and its inflation was spiking with falling GDP growth. The situation is very different now. Advantage India The crash in oil prices have helped to limit the import bill, hence the CAD is tamed. Inflation and interest rates are trending down, which is a good sign for the economy, which wants to invest more to stimulate growth. India is best placed in comparison with its other emerging market peers, which are still struggling to get its macros in good shape. This puts India in a sweet spot and will hold it in good stead when the Fed starts increasing its interest rates. The present stability of the rupee, as against the sharp depreciation in the Brazilian Rial and Turkish Lira is testimony to the strength of the Indian economy and an indication of the shape of things to come. Forex reserves have swelled to a great extent, which puts India in a relatively better fiscal position, providing cushion against volatility. It can be attributed to the RBI’s continuous buying of dollars in the last couple of years. The country’s foreign exchange reserves now stand at $350.8 billion, making India one of the top 10 holders of Forex reserves in the world. It is true that the Indian market is presently trading at premium valuations. But it is important to note that India has the best structural growth story among its emerging market peers. Therefore, considering the expected recovery in growth and earnings, the stocks might provide greater returns even though they might currently be expensive buys. The return on equity (RoE) in emerging markets

First of all, the ranking by itself does not really reveal the complete picture. For last few years, India was steadily slipping in these rankings and it was affecting investor sentiments and was not something that was on governance agenda. The present government rode in on promise of economic reform and as such it made a credible promise that we want to be within the top 50. And then it started taking initiatives towards that. Two initiatives that are highlighted in the report are; first was abolishment of minimum paid-up capital and commencement certificates and in terms of ease of getting electricity connections. More than the ranking, what is impressive according to me is that now ease of business has become a center focus of governance. Regardless of the ranking, this is a paradigm shift. We are no longer focusing on what may be electorally relevant issues, but on core governance issues. And if we move in this direction, I feel that the rankings will only improve henceforth. So, the key takeaways would be in terms of firstly arresting the fall in rankings, which was previously there and secondly that the rise in rankings has been a result of a mix of legislative initiatives like the amendment in the Companies Act and series of initiative in executive domain. It’s a job well begun but nowhere close to be done. One thing that industry still complains is in terms of harassment of petty bureaucracy.

Even if there is a parliamentary standoff or the government doesn’t enjoy the majority in Rajya Sabha, it can still regulate the interference from authorities like Excise, Customs, etc. that happens on a day-to-day basis. The interface between the government and industry should be as minimalistic as possible. The regulation should be effective but not interfering. That is a balance that the government should strive for the future of the country. Some of the legislative reforms, which can help us in this regard, are in the three areas of labor reforms, land acquisition reforms and the GST. The last parliamentary session was washed out. If the parliamentary standoff continues, then the onus of driving two of the aforestated reforms would fall back upon the state. States like Rajasthan, Tamil Nadu, Madhya Pradesh and Gujarat have taken lead in various reforms. Rankings are not only a certificate in terms of good governance but they would also help the government get the country’s political narrative back on track. By that what I mean is that headlines today are plagued with issues that should be at the periphery of the governance agenda. The noncore issues have hijacked the entire governance agenda. This ranking could not have come at a better time as it helps us as a country to focus back on issues of development and growth. From the global perspective, the investor community’s faith has been re-affirmed as lots of investments are sentiment driven. Also, it makes the case for the credit rating agencies to revise the country’s ratings. Talking about some key legislative reforms like GST, Environmental Laws & Land Acquisition Laws etc. Some of these

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bills could not be passed because of the parliament deadlock. Is it the deadlock that has stalled the process or the bills actually need some changes? I think the reason that these reforms are at a standstill is because of political considerations and not on account of their respective lack of merits. No matter how good or bad a legislation is, it can and should always be further improved by amendments. Let us look at the issue of land acquisition, where we previously had the 1894 law that was ambiguous on various terms. Comes the 2013 Law, which sort of over-corrects. The consent and compensation part are laudable but some of the objectionable portions in terms of Social Impact Assessment have deterred investments. The 2015 Amendment was a step in the right direction but it unfortunately failed to pass muster as a result of Parliamentary Standoff. Now states like Tamil Nadu and Rajasthan are taking a lead in this regard. There is a great fallacy, which every party in opposition keeps reiterating that the onus of running the parliament is on the government. No, that is incorrect. The onus is on all the political parties concerned. Derailing the democratic process undermines the legitimacy of the great institution. Can you throw some light on the ecommerce industry with a legal point of view? There are two ways of looking at regulation of ecommerce. First is in terms of growth and innovation in core areas of technology where law is still playing catch up with the fast evolving technology and various business ideas that are spinning off on a daily basis. Another way to look at it is that the commerce aspect of the transactions still takes place in the real life; it is just that the facilitating media has changed and has gone online. In this regard, we can look at the IT Act 2000 to make sure that the e-contracts are in accordance with law. From a contrarian perspective it is well understood that one of the biggest reasons the e-commerce industry has been able to takeoff is because of lack of stifling regulations which some of the entrenched traditional industries suffer from like labor, environment etc. It is a widely recognized phenomenon that the IT/

OCTOBER 2015

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Ecommerce industry has been doing so well is because of the lack of stringent regulations. But one must also acknowledge the positive role played by law. You cannot have such a thriving ecosystem in a country where the rule of law does not exist. India’s robust legal and democratic processes are twin drivers of investment. At the same time law is also providing a platform for dispute resolution between traditional modes of commerce and ecommerce. For instance, India’s strong Competition Law ensures that the entrenched players do not simply drive away the small players by way of predatory pricing. One legal challenge that the ecommerce industry would in the future face from their real life brick and mortar counterparts is in terms of litigations on account of erosion of the market share. However in my opinion, this is not a very well founded concern. It is just that the market has evolved and moved on. Having an understanding of legal aspects of business is important for any management graduate. At what level should a graduate have an understanding of this subject? Well this field can be looked at from two angles. One is legal aspects of business and second is managerial aspects of law. I think the latter is better. Knowledge of law is quintessential for any modern day manager because it will help the manager spot opportunities, understand operational risks and avoid liabilities. In this fast evolving business environment, it is imperative to have understanding of law. From the teaching perspective, the study should not be focused on an in-depth knowledge of the law. An MBA student cannot be a substitute for a lawyer. The aim should be to makes students aware of the legal environment so that they can take informed strategic decisions.

CLASSROOM

CREDIT DEFAULT SWAP

FinFunda of the Month

Palash Jain IIM Shillong

Sir, while reading an article on sub-prime crisis, I came across with a term called “Credit Default Swap”. What is it? A credit default swap is a particular type of swap designed to transfer the credit exposure of fixed income products between two or more parties. In a credit default swap, the buyer of the swap makes payments to the swap’s seller up until the maturity date of a contract. In return, the seller agrees that, in the event that the debt issuer defaults or experiences another credit event, the seller will pay the buyer for his losses Sir, how does this provide protection to the investors? Many bonds and other securities that are sold have a fair amount of risk associated with them. While institutions that issue these forms of debt may have a relatively high degree of confidence in the security of their position, they have no way of guaranteeing that they will be able to make good on their debt. Because these kinds of debt securities will often have lengthy terms to maturity, like ten years or more, it will often be difficult for the issuer to know with certainty that in ten years’ time or more, they will be in a sound financial position. If the security in question is not well-rated, a default on the part of the issuer may be more likely.

against non-payment. Through a CDS, the buyer can mitigate the risk of their investment by shifting all or a portion of that risk onto an insurance company or other CDS seller in exchange for a periodic fee. In this way, the buyer of a credit default swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the debt security. For example, the buyer of a credit default swap will be entitled to the par value of the contract by the seller of the swap, should the issuer default on payments. Sir, but if the issuer of the bond does not default then the buyer will stand to lose money on the premium he pays for CDS That is true that if the debt issuer does not default and if all goes well the CDS buyer will end up losing some money, but the buyer stands to lose a much greater proportion of their investment if the issuer defaults and if they have not bought a CDS. As such, the more the holder of a security thinks its issuer is likely to default, the more desirable a CDS is and the more the premium is worth it.

Thank you Sir. This explanation makes things very clear.

Sir, so is this like an insurance on fixed income securities? Yes, a credit default swap is, in effect, insurance

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