Niveshak Sep14

Niveshak THE INVESTOR

VOLUME 7 ISSUE 9

September 2014

Interest rate distress

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VII ISSUE IX September 2014 Faculty Chairman

Prof. P. Saravanan

THE TEAM Akanksha Gupta Apoorva Sharma Gaurav Bhardwaj Jatin Sethi Kocherlakota Tarun Mohit Gupta Mohnish Khiani Priyadarshi Agarwal S C Chakravarthi V All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

The month of September 2014 has seen the Prime Minister of India, Narendra Modi concluding a successful visit to Japan in which investments of USD 35 billion were promised by Japan over the next five years in development projects. During the fiveday visit, his first outside the subcontinent since becoming PM in May, Modi invited Japanese investments while hard-selling India as a conducive destination for business particularly for the manufacturing sector. The two countries also decided to enhance cooperation in defense and other strategic areas and also signed five pacts covering defense exchanges, cooperation in clean energy, roads and highways, healthcare and women while vowing to take their relationship to newer level. Then came the launch of ‘Make in India’ campaign which aims at investments in the 25 identified growth sectors and as a consequence, generate employment. But the highlight of the month was, definitely, Mr. Modi’s US visit. Enthralling Americans and the Indian-American community, his visit marked a new direction in strengthening of Indo-US ties. In the four-day visit, Modi not only met the US President Barack Obama, but also sought to invite investment from prominent CEOs and urged the Indian-American community to take up a greater role in the development of India. India and the US issued a vision statement “Chalein Saath Saath: Forward Together We Go.” The vision statement said that US-India strategic partnership is a joint endeavor for prosperity and peace, and through intense consultations, joint exercises and shared technology, their security cooperation will make the region and world safe and secure. On the whole, the entire investor community is upbeat about India after Modi’s successful foreign consultations and business pitches. Even the business community around the world is extremely optimistic about investing in India and is waiting for an opportunity to open up in the country. With S&P also upgrading the rating from negative to stable, India is only set on a path of positive economic reforms and consistent growth. On the magazine front, the cover story deals with low interest rates that are prevailing globally. It essentially analyzes the interest rates across the globe, in major economies, and their impact on Indian economy. The Article of the Month (AOM) discusses about de-allocation of the 214 coal blocks. The article talks about how the decision infused fear in the minds of investors who were benefitting from the surge in the markets since the new government has taken over the center. It also talks about how the mid-cap companies are affected by this verdict and that whether there is enough cushion for them to pull back. FinSight discusses about the MSME sector and how it has been the backbone of Indian economy their financing needs through CGTMSE. FinGyaan article on ‘Impact of regulation on Indian economy,’ talks about how the ‘over-regulation’ is crippling investor sentiments and has become a bone of contention in India’s growth. FinView has the excerpts from the discussions with a senior level executive from India’s leading E-Commerce firm. Classroom section shares knowledge on Letter of Credit. 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 vigor and vitality to keep working hard. Thank you. Stay invested! Team Niveshak

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

14 The

Interest Rate Distress: 10 COAL BLOCK DE ALLOCA- Are we creating a bubble and its TION: Is the devil lurking around? potential Impacts on India

FinGyaan 18 Impact of Regulation on Indian Economy

FinPact

Finsight

26 Financing the CGTMSE way:

A deep insight to growth driver of Indian Economy

FINVIEW

22 Creation of the Steel Giant: 29 Interview By A Senior Arcelor-Mittal Merger

Executive From Indiaâ&#x20AC;&#x2122;s Leading E-Commerce Firm

CLASSROOM

31 Letter of Credit

The Month That Was

NIVESHAK

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The Niveshak Times Team NIVESHAK

IIM Shillong SEBI Grants Conditional Renewal To MCX-SX For One Year SEBI has renewed the licence of MCX STOCK Exchange (MCX-SX) for a period of one year till 15 September 2015, subject to conditions related to net worth and a long-term business sustainability plan. However, SEBI has barred the exchange from launching any new contract before fulfilling the net worth requirements. The conditions have been necessitated due to the recent action of MCX-SX wherein it extinguished warrants worth Rs. 56.24 crore held by FINANCIAL Technologies India Ltd (FTIL) and transferred the non-refundable deposit against the warrants to the capital reserve to boost net worth. Sebi also wants the exchange to submit a business plan about its own long-term sustainability. MCX-SX was also asked to comply with its directions with regard to entities, which have been declared not “fit and proper” person and take immediate steps to rectify the deficiencies pointed out in the systems audit. FTIL, which continues to hold 5% stake in MCX-SX, was declared unfit by Sebi in March. The order followed the Rs 5,574.35 crore fraud at the Shah-promoted National Spot Exchange Ltd (NSEL). FTIL appealed the Sebi order before the Securities Appellate Tribunal (SAT), which upheld the ruling and gave the company and its affiliates four weeks to comply but FTIL has failed to sell its stake in MCS-SX. Standard And Poor’s Revised The Ratings Outlooks On 11 Indian Banks And Financial Institutions To Stable From Negative After upgrading India’s credit rating outlook from ‘Negative’ to ‘Stable’ credit rating agency Standard and Poor’s has revised the rating outlooks on 11 Indian banks and financial institutions to ‘Stable’ from ‘Negative’. These banks include ICICI Bank, HDFC Bank, Axis Bank, Kotak Mahindra Bank, State Bank of India, Bank of India, IDBI Bank Ltd., Indian Bank, Union Bank of India, IDFC and Kotak Mahindra Prime. S&P said the revision follows a similar move in terms of the sovereign as financial institutions from India cannot be viewed above the sovereign since policy changes have substantial impact on them. S&P said the rating downgrade for these banks/financial institutions is unlikely since the individual finances of the institutions are unlikely to

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deteriorate sharply. PVR Ltd To Raise Rs 500 Crore Through Qualified Institutional Placement Multiplex operator PVR Ltd. announced that it’s board has approve plans to raise Rs 500 crore through qualified institutional placement (QIP). The board in its Annual General Meeting authorized PVR to raise the fund, PVR informed the BSE. It also approved management services agreement with its JV firm PVR bluO Entertainment. PVR had said that it would raise Rs 500 crore through QIP for any inorganic growth or acquisition and to support future growth plans. Moreover, Ajay Bijli along with five independent directors has been appointed. The independent directors are -- Sanjay Kapoor, Sanjay Khanna, Vikram Bakshi, Sanjai Vohra and Amit Burmam. RBI Keeps Key Rates Unchanged In Monetary Policy Review In line with market expectations, Reserve Bank of India on Tuesday kept the repo rate unchanged at 8%. The central bank also kept CRR, SLR unchanged. The reverse repo rate was also maintained at status quo of 7%. However, it said it would cut the ceiling on bonds that must be held-to-maturity from the current 24 percent to 22 percent in stages starting in the biweekly cycle beginning in Jan. 10, 2015. It expects to complete the process by September 2015. “For the near-term objective, the risks around the baseline path of inflation are broadly balanced, though with a slant to the downside. However, the undershooting of the objective may be temporary because of base effects. Turning to the medium-term objective (6 per cent by January 2016) the balance of risks is still to the upside, though somewhat lower than in the last policy statement,” said Raghuram Rajan. Morgan Stanley Picks Up 26.7 Lakh Shares Of Pantaloons Foreign fund house Morgan Stanley Asia (Singapore) picked up nearly 26.7 lakh shares of clothing retail firm Pantaloons for a little over Rs 32 crore through the open market route. A total of 26,68,655 shares of Pantaloons were acquired by Morgan Stanley at an

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average price of Rs 120.18 apiece, according to bulk deal information with the bourses. In a separate transaction, Macquarie Bank has offloaded 16.12 lakh shares of Pantaloons for about Rs 19.17 crore. At present, there are about 83 Pantaloons stores operational in the country and for the quarter ended June 30 Pantaloons reported revenue of Rs 386 crore. In 2012, Aditya Birla Nuvo Ltd had entered into an agreement with the Future Group to infuse Rs 1,600 crore into Pantaloons and had acquired a majority stake in the store chain. Also, shares of Pantaloons dipped 2.34 per cent to settle for the day at Rs 121.10 apiece on the BSE. Tamil Nadu CM Jayalalithaa Held Guilty In Disproportionate Assets Case J Jayalalithaa, the Chief Minister of Tamil Nadu on 27 September 2014 was found guilty in the disproportionate assets case by the Special Court in Bangalore. The Court pronounced a jail term of 4 years and fined 100 crore rupees to her. The judgment of the 18-year-old 66.65 crore rupees disproportionate assets case against Jayalalitha was pronounced by the special court in Bangalore amid tight security. Apart from Jayalalithaa, the court also accused three others in the case, namely Sasikala Natarajan, Ilavarasi and Jayalalithaa’s disowned foster son V N Sudhakaran. With this conviction, she became the first incumbent chief minister in India to be disqualified from holding office due to conviction in a disproportionate assets case. Mr. Pannerselvam has been appointed as the new Chief Minister of the state. Cognizant Into Health Industry The recent acquisition of Cognizant marks its entry and diversification into vastly growing Health industry. US-based Trizetto was acquired by Cognizant for $2.7 billion in cash. It is expected that both the companies together will serve nearly 245000 healthcare providers. With the healthcare industry undergoing structural shifts due to reform, cost pressure and shifting responsibilities, there is a significant growth opportunity which both the companies together can grab. Integrated portfolio of capabilities across technology and operations will uniquely position both the companies in helping the clients in improving their operational efficiency. This way, Cognizant could start delivering innovative healthcare software and solutions to a wide range

of healthcare clients. Cognizant intends to finance this transaction through a combination of cash on hand and debt and it has also secured $1 billion of committed financing in support of the transaction. Trizetto’s 3700 employees will now be a part of Cognizant’s existing healthcare business, which currently serves more than 200 clients. On a whole, this acquisition is expected to see a good synergy in the coming future. Kaizen to invest $75 million in Indian education sector Mumbai-based Kaizen Management Advisors Pvt Ltd will raise another $150 million next year, 50 per cent of which will be placed as equity investment in India’s education sector, a top official said here. The technology-focused equity investor has already invested $55 million in India from its first fund raised in 2012, its managing director and founder Sandeep Aneja said. Another $10 to 12 million from the remainder of $70 million first fund will be placed within the next five months. All of the investment would be for the Indian educational sector, especially in technology-oriented projects. Kaizen raised its first fund for equity investment from IFC, Swiss Fund for Emerging Markets, HDFC India, UBS Fund of Funds and Bartelsmann. Aneja said his second round of fund raising would increase the number of equity investors including ADB and CDC, formerly called Commonwealth Development Corp, of the United Kingdom. An average of $200 million a year was being invested in the Indian educational sector, which offers an attractive return on investment, about 22 per cent to 25 per cent a year, according to Aneja. Having established in India, Kaizen would also be expanding into South East Asian markets, and would soon set up offices in Singapore and Manila. Out of the $150 million to be raised next year, Kaizen would place $75 million in equity investment in India’s education sector during 2015-2019 and the remaining $75 million would be invested as equity investment in educational projects in Singapore, Sri Lanka, Myanmar and the Philippines. The investments, to be made from next year, would be in partnership with local investors in these countries. India would need Rs 800,000 crore investment in educational sector over the next 15 years through to 2030.

The Month That Was

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Article ofSnapshot the Month Market Cover Story

Market Snapshot

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

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

9339175.91 Source: www.bseindia.com

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

LENDING / DEPOSIT RATES Base rate Deposit rate

10.00%-10.25% 8.00% - 9.05%

RESERVE RATIOS 61.57 78.45 56.45 100.42 48.05

CURRENCY MOVEMENTS

CRR SLR

4.00% 22.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

Source: www.bseindia.com 24th July 2014 to 28th Sep 2014 Data as on 28th Sep 2014

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

Open

% change

26210.09 9237.86 10133.94 15752.39 17719.01 8525.58 15630.09 7131.05 12028.73 9727.99 13360.86 10939.63 2174.16 8197.00 1954.62 5463.51

26626.32 9421.40 10510.99 17835.70 17859.88 9510.42 14385.53 7651.37 13855.85 10522.02 11649.26 10646.92 2000.26 7838.25 1628.49 5835.75

1.59% 1.99% 3.72% 13.23% 0.80% 11.55% -7.96% 7.30% 15.19% 8.16% -12.81% -2.68% -8.00% -4.38% -16.69% 6.81%

% CHANGE

Article Market of Snapshot the Month Cover Story

Market Snapshot

Article of the Month Cover Story

NIVESHAK

COAL BLOCK DE ALLOCATION: Is the devil lurking around? Ansuman Mishra

IIM Shillong Wednesday morning, the 24th of September, 2014, a date many of the analysts and investors would not really appreciate worth remembering. A date that witnessed one of the incidents that was sufficiently capable enough to single handedly cripple and retard the booming stock market , thus infusing the usual scare in the minds of the ever enthusiastic investors who were benefitting from a rock and roll trend the market was going through. Post NDA assuming power at the centre, Federal Reserve’s decision of an unchanged interest rate and a series of other events gave the investor’s sentiment a positive kick that assured him of a brilliant market growth that was waiting in the future until the 24th of September brought to us the news of “De allocation of the Coal Blocks”.

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Dissecting details into the facts “The Honorable Supreme Court of India” declared 214 out of the 218 coal blocks allotted since 1993 as illegal. Further to add to the woes the message came with a negative incentive of a fine worth 295 INR per ton of coal mined since the allocation to be paid by the companies who are a direct sufferer to this verdict. The consequence of which was but a sense of urgency and scare that settled deep in the minds of the people directly and indirectly affected by this . To simplify further the companies who are a direct sufferer to the above verdict are Metal Plants and Power Plants, in a broader sense however the list can unassumingly be endless as to the present day, every thermal process directly or indirectly involves usage of coal. Similarly the

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attracted investors in huge numbers owing to their phenomenal growth potential and relative stagnation in Blue Chip stock returns owing to their maturity and a phase where the ceiling was not too far. To this, the subprime mortgage crisis, 2008 was a huge supplementor which stagnated the Indian service industry which had positive correlations with the west. These chain of event s brought about a paradigm and a trending shift for the investor where the attention was on the new kid in the block “The Mid Cap Stock”. Money flowed in, the firms grew, made greater profits and took more money. This cyclic process made the bigger players more attracted towards these companies and came the FII’s who unhesitatingly got allured by the growth figures, however not to be blamed because the market was ripe for these investments. In the wake of the recent budget, 2014 where manufacturing sector has been paid due attention to, with the declaration of hundred smart cities and a huge infrastructure ordeal in the form of metro connectivity, the stage was but set for investors to rely a lot on the manufacturing industries with special focus on Metals and Power as these two envisage a major chunk of the total infrastructural requirements. However somewhere the plan has been rendered short sighted as the investor could never foresee this facet of the systematic risk in the form of “de allocation of coal blocks”, being hurled at him. The biggest question that stays unanswered now is what next? Are these Mid Cap industries capable enough to cushion themselves from

Select Metal stocks and power stocks witnessed a dip in their prices as the news shrugged of demand for the same with a huge supply of stocks that every investor was eager to sell on account of a possible downside, which might just take longer than usual time to recover. © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

tier of the indirect sufferers includes the banks, investors and the retail and B2B consumer in general. Let’s try and fathom how each of these direct and indirect factors affected the money market, the short term as well as the long term purview of the same. Select Metal stocks and power stocks witnessed a dip in their prices as the news shrugged of demand for the same with a huge supply of stocks that every investor was eager to sell on account of a possible downside, which might just take longer than usual time to recover. In this context the major disappointment was the pulling back of Foreign Institutional Investors Funds worth rupees 194million $ in the current week, a fair chunk of the funds supplied by these enthusiastic investors in the backdrop of the “Make In India” campaign successfully propagated by the ever dynamic Mr. Narendra Modi, which had accrued over the past four weeks. The direct implication of the same being a jolt to the manufacturing sector of which metal and power plants form an integral component. Investors would certainly want to pull back money on apprehensions of rising costs and falling EBIDTA margins of these firms. A fresh evidence of the instance being a 25% reduction in the EBIDTA margins of JSPL a leading steel and power producer with its own captive power plant. To amplify the same the biggest fear to be realized is the huge amount of money locked in the Small and Medium Sector Companies relevant to the suffered industries being spoken of. Come 2006, mid cap stocks were the new revelation that

Article of the Month Cover Story

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this risk to reassure the investors and pull back the ones who have retreated? Well the answer to this is a prosaic reflection of some facets that either have been ignored or are still not in perfect compliance to. The facet that we term as “Risk Hedging”. It is heartening to ascertain that majority of these medium sized metal plants have just piled on and increased capacity owing to a brilliant market sentiment and huge stock piles of investment. Supply risk was never so much touched upon, the reason might plainly be attributed to the fact that these industries are relatively new and have not experienced the crests and troughs of the full economic cycle to make themselves i m m u n e o f fluctuations o w i n g to past

experience a n d expertise. The second and the foremost reason may be attributed to the fact that the recent surge in demand for manufacturing goods and capital goods just made the investment horizon a lot greener to veil them from seeing the unforeseen. With improved and increased capacity risk hedging and mitigation should also have been looked upon. To further shed light on the bone of contention, it is but true that on account of the de-allocation the two major aspects that shall infuse

impairment in the system shall be “Shortage of Raw Materials” and the “fees to be paid as fines”. The former shall take a huge dig at the companies as the immediate source of raw materials has been disrupted and on account of poor risk hedged supply chain, there shall be a colossal deficit of raw material leading to production halts and rising costs and loss of opportunity in the wake of an increased demand which is still there intact at the consumer’s end. Production halts are typically cancerous for metal industries. The remnant solution being imports which would again come with its Halloween share of scares. With the stock market slipping, rupee depreciation shall follow and import under this climate is certainly not a favorable taste to possess, moreover imported raw materials always come with a premium. Books of accounts are certainly going to see a dip in the net worth and investors would not really wait to bear any more brunt that has already been inflicted upon them. The other aspect however has been untouched. What about d e b t ? where do the banks feature in this context?. Leverage has not yet been spoken of, but a very crucial aspect to touch upon. Majority of the mid cap companies took higher leverage positions in light of a growing tomorrow, just to amplify and multiply their growth and with a desire to reach for the sweet fruit at the quickest. Moreover debt

Production halts are typically cancerous for metal industries. The remnant solution being imports which would again come with its Halloween share of scares. With the stock market slipping, rupee depreciation shall follow and import under this climate is certainly not a favorable taste to possess. SEPTEMBER 2014

NIVESHAK

and companies concerned with manufacturing and infrastructure must indoctrinate several parameters of risk hedging to shield themselves from uncertainties of several accords. Typically pervasive in nature supply risks are the biggest that these companies can be exposed to under the scenario that the end demand from the consumer is intact on account of news and announcements. Thus capital being invested apart from being focused on growth must also be invested in hedging the above mentioned risks by investing in tie ups with riskless or relatively less risky resources. To reiterate facts a fine of 295 rupees per tonne would certainly give the government a windfall benefit of 7905 crores from the fines generated. This however doesn’t compensate for the bigger crisis that stands at hand. Facts pertain to the reality that West Bengal shall be the worst affected state, as it envisages six operating blocks which previously allocated stand cancelled, in addition to an operating block that has been allotted to a state- government company from Karnataka, Madhya Pradesh, Punjab, Arunachal Pradesh and Rajasthan. As investors and responsible consumers we certainly do not want the Bull Run to dissipate which has witnessed a 26% increase in the BSE index, in the last couple of months. It’s this growth which certainly shows us a promising figure of the dream GDP growth of 8% which at present is pegged at 5.7% rising from a below 5% mark. The future looks promising, let’s not allow impediments to cost us in this Bull Run.

Article of the Month Cover Story

is a relatively easy way to raise money with a promising scope and efficient financials. However this can now prove counterproductive when the Income statement might just register continually falling values. Loss shall equally be multiplied. Can these companies furnish back their debt or shall it yet be another NPA saga for the banks to ponder over. Majority of these mid cap firms have collateralized their fixed assets and machineries, but are these sufficient to answer for the cause? Is recovering the debt by selling off the fixed assets actually answer the impeding growth. It shall just be a localized relief, not for the long term. Nevertheless the consumers shall also not be spared; severe power deficit and reduced supply of infrastructure raw material shall render the demand to soar up. This shall give a suitable vector to perpetrate in lines of inflation. Tariffs and prices shall soar and large scale projects involving B2B clients shall overshoot their stipulated, spending, and again leading to a vicious chain of lending and default. Thus there is an air of risk associated with this issue which has been triggered, however timely intervention is the panacea. The short term equity price shall however not see a huge dip on account of positive sentiments prevailing in the market regarding transparency and reduction in corruption leading to efficient money utilization and prevention of scams. The previous scams have certainly triggered a heavy dose of negativity in the minds of the common man which ultimately paved way to a set of new reforms. May be the evidence to this can be attributed to the formation of the new government where people wanted to witness and go for a change. A shift towards transparency and moves to reduce loss of information and corruption might just go well with the retail investors who if contribute in numbers can certainly match to the gap created by the pulling out of institutional investors, nevertheless the contribution of an institutional investor is of pinnacle importance and the current day stock quotes at an upsurge of 26% in the last couple of months stand as a deliberate evidence to the same. They have to be retained at any cost. However the stocks might plummet in the medium term if government intervention is not catered to. Amidst the splurge of negativities the positive sentiment might not stand out that strong enough to survive for long. As a heads up for the future, industries

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The Interest Rate Distress: Are we creating a bubble and its potential Impacts on India

Mohnish Khiani & SC Vellanki

IIM Shillong Introduction Never in the history of interest rates, were the global interest rates so low for so long a period. Except for the US, it is a safe bet to assume that the central banks of Britain, Euro zone, Japan and Switzerland will not be increasing their short-term interest rates. In the recent policy statement by the US Fed, it highlighted that the interest rates are expected to be at near zero for a â&#x20AC;&#x153;considerable timeâ&#x20AC;?. It would be hardly surprising to anyone if the interest rates persisted at the current levels in the western countries. When the rates were initially reduced in 2008-09, it was thought to be a temporary phenomenon, now it looks like a normality. Investors and businesses throughout the world are still in the process of adjusting to these rates. Some companies have benefited by borrowing at cheaper rates. Although these low rates are supposed to encourage the businesses and thereby to enhance growth, it has not led to growth-igniting investment spree. From the past 2 years or so, India has seen an increase

in interest rates in order to control inflation and it seems that in the recent months the interest rates and also the inflation have calmed down. In this article, we will analyse the interest rates across the globe (major economies) and assess the impact of these different rates on the functioning of Indian economy. Analysis Of Interest Rates In US It is clear that low interest rates have some positive impact on the economy. By buying mortgage backed bonds, Fed is trying to lower the yields and thus reducing the cost of home ownership. The average 30-year mortgage rate was lying around 3.5% during the initial half of 2013, which was almost near its alltime lowest value of 3.31% and later now it is around 4.2%. Because of this lower yields, there was a lot money that went inside the pockets of homeowners which led to sharp spike in mortgage origination. Although there is a significant improvement in the home sales that reached an annual rate of 5.05 million in July of 2014, the growth rate has been faltering due

Fig 1: Central-bank Base Rates, %

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stock market movements are heavily controlled by the FIIs, was no exception. Experts are of the opinion that this news of gradual QE tapering is already discounted into the markets. Hence, ideally there shouldn’t be any surprise element for the investors. But if the US Fed chooses to increase the interest rates at a faster pace than expected, then there could definitely be a negative impact on the markets. Even this impact is expected to be short-lived. This is because of the measures taken by RBI and Finance ministry after both came under criticism for what was seen as a shaky initial response for the fears of Fed tapering. Measures such as curbing the gold imports, building up the foreign exchange reserves and also aiming at lower CAD in the current fiscal are helping the markets to be strong enough to hold to any negative external factors. Raghuram Rajan has repeatedly assured that India has the ability to withstand any Fed taper. Negative Interest Rates In Japan Earlier, Recently, the Bank of Japan (BOJ) has pushed the short-term interest rates to below zero in order to stroke inflation. The central bank’s intention to buy the bonds at any price shows its determination to reflate the economy. The current massive asset purchase programme is aimed at ending 15 years of deflation by doubling the money base in the economy. Hence it cannot be concluded that Bank of Japan needs to change its policy of going below zero. To meet the target, BOJ is ready to buy the assets at whatever cost. It is also acknowledged by BOJ officials that at some point of time they have to take some extreme steps of selling their Japanese government bond holdings at some point of time in the future, when the required inflation rate is achieved. By the end of this year, BOJ targeted a monetary base of ¥270 trillion. Because of the low interest rates, there was a continuous decline of Yen. Currently, it is hovering around 109 (for 1 USD), setting new lows that were not seen since 2008. In the foreign exchange market, there was selling pressure on Yen and an increased demand for dollars because of the growing confidence of American economic recovery and a possible increase in interest rates by Fed. It can also be observed that there is a significant rise in INR in comparison to Yen from the past 1 year. This had a positive impact on Indian economy as it led to decrease in the prices of automotive and electronic goods which are mostly imported into India. But the rupee’s rise is of concern

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to increased concern about possible increase in interest rates in the future. Higher home sales prompted the homebuilders and hence the real estate sector to get busy. More constructions led to more jobs and also more demand for timber yards and brick factories. It is worthwhile to notice that when there is a decline in interest rates, consumers spend their disposable income not only on houses, but also on other items such as consumer durables, automobiles (cars in the case of US) etc. According to Equifax National Consumer Credit Trends Report, total outstanding car loans as of July 2014 have hit an all-time high of $902.2 billion, an increase of 10% from the same time a year earlier. A growth of 10% employment was observed for three consecutive years from 2010, which only happened during 1970s. The number of people employed for credit card transactions is the highest for almost 4 years. All this led to increase in house prices and an overall increase in demand, which encouraged the people to feel wealthier. Low interest rates have also triggered a raise in share prices, with both Dow Jones Industrial Average and S&P 500 reaching their all-time high. It has to be kept in mind that excessively low rates create bubbles because it makes people to forget about their cost of financing and rather to concentrate more on capital gains. Chances are that the situation may become similar to that of 2007, where the stance of the people gets changed from risk-free return to return-free risk, which is a quite dangerous situation to get into. It is observed that the investors are careful this time in showing the appetite for higher returns. After the recent FOMC meet, it was clarified that Fed is not going to increase the interest rates and the record low interest rates are going to stay the way they are. It is expected that by mid-2015 Fed would abandon the 6-year old policy of keeping the short-term interest rates at record low and hence interest rates are to eventually go up. This makes the mortgages more costly and also the car loans. Increasing the interest rates could mean that economy is in a strong position which could result in inflation. The investors may dump the stocks and could send the prices tumbling. Of course, this is not to say that there would be another recessionary situation, but only to highlight the possible situations. On the eve of this FOMC meeting, all the global financial markets were eager to know the outcome of this meeting and India, whose

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Fig 2: Exchange Rates

to that exporters where the center is planning to increase the bilateral trade to $25 billion. Because of the lowering of interest rates, Yen is depreciating faster with respect to other global currencies. Having a weak currency is good, but at the same time it should be remembered that if currency weakens too fast, that might lead to a crisis kind of situation. And Europe Too Follow Japan! Negative Interest Rates By ECB Too Earlier this month the European Central Bank went further than the US Federal Reserve or Bank of England ever dared and pushed an important policy interest rate deeper into negative territory. The Swiss central bank, battling to cap the Swiss franc’s appreciation, may not be far behind, although it stopped short of breaking the zero bound. As a consequence, interest rates have turned negative not just on very short-term lending, for instance between banks. Yields on two-year government bonds, which move inversely with prices, are negative in Ireland and Belgium as well as Germany. German and Swiss three-year yields have also dropped below zero. In this upside-down world, finance ministers earn money borrowing from markets. The change raises lots of questions. Will negative interest rates encourage borrowers – and not just finance ministers – to act recklessly? Will markets continue to function if lenders lose money on transactions? Or alternatively, and more benignly, has the ECB discovered an exciting new way for central banks to deliver a positive demand shock that perks up sluggish economies? If holding money erodes its nominal value, there is a big incentive to spend fast. The ECB is not thinking of sending interest rates so negative that they are imposed on consumer or business accounts. If it did, there might be a run on banks – the costs of keeping money in accounts would justify spending on safes and security guards to protect piles of bank notes. At

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minus 0.2 per cent, the interest rate on the ECB’s overnight deposit facility – which sets the floor for market rates – is only just below zero. The objective was to ensure ECB liquidity pumped into the financial system – including via the “targeted longer term refinancing operations” – flowed into the real economy, rather than simply landing back in its electronic vaults. Having imposed a cost on banks for parking funds overnight, Mario Draghi, president of ECB, said this month’s interest rate cuts would be the last. The worry about negative interest rates – which perhaps stopped the Fed going so far – was that lending and borrowing would grind to a halt as profitable trading opportunities vanished. Worst affected would be money market funds, which act as alternatives to bank accounts and provide liquidity to the financial system. When short-term interest rates turn negative, it is harder for them to deliver attractive returns while remaining safe and liquid. But the ECB has shown that interest rates can be pushed into shadow negative territory without the financial system seizing up. That could encourage their use elsewhere or in future crises. What was maybe overlooked was that absolute interest rate levels are not so critical for intermediaries. As long as there is a positive “spread”, or difference between the rates at which they lend and borrow, they can still make profits. Similarly, terms offered by money market funds should be compared with the costs of alternative instruments. The full impact of Europe’s adventure below zero is not yet known. The process of adjustment will take time. Yields on a larger pool of assets could turn negative; markets have not yet priced in full deflation or the “Japanification” of the Eurozone. But so far volumes in overnight money markets have been unaffected. While money market funds saw sharp outflows in June, there were stronger inflows in July, according

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investors-FII flows) dominate over the prevailing domestic factors,” it said. As of FY13, India’s exports to the European Union were about 17%20% of the total export basket. In the event of any growth in the Euro zone, exports from India would tend to get affected, though the impact will not be too severe. Emerging economies are likely to remain the favored destination for FIIs for investments. Firstly, given the macro economic situation in the Euro zone with low growth and low inflation, it is unlikely that the Fig 3: Core Inflation in Euro Area Euro area will offer competition to the emerging to the European Fund and Asset Management economies as regards FII inflows. Extremely Association. low interest rates will be a deterrent to foreign The Swiss National Bank (SNB) also does not rule out the use of negative interest rates to defend its cap on the Swiss franc and ward off deflation, proclaimed the SNB chairman Thomas Jordan. The central bank imposed a ceiling on the value of the franc in September 2011, after investors fleeing the eurozone crisis bid the safe-haven currency up to record levels, threatening to snuff out inflation. Mr Jordan also reiterated the SNB’s quarterly statement and said the central bank was ready to take additional action immediately, if necessary, to defend its lid on the franc at 1.20 per euro. Mr Jordan also cautioned the risks of deflation have grown in Switzerland, citing the SNB’s 2016 inflation forecast of 0.5%, even with Fig 4: Annual GDP Forecast rates at zero for the next three years. However, India may not be affected much, though slow growth in Euro region will affect our investment inflows in the region. exports in a limited manner, says CARE Ratings Secondly, the Eurozone contributes to only 12%in a report. It said, “The crisis in Europe is to 13% of the total foreign currency inflows in India a large extent driven by low consumption and as majority foreign currency inflows come from investment, which cannot be reversed easily the US. Hence, this scenario is unlikely to be by lowering interest rates, especially when the changed going ahead. longer term refinancing operations (LTRO), which injected a lot of liquidity, did not quite succeed to turn the economy around.” CARE Ratings also said, as a fallout of ECB moves, the US dollar is expected to rise, which may put slight pressure on the Indian rupee. “When juxtaposed with the continued stimulus by the ECB and thereby higher Euro flows in the market, the US dollar is imminently expected to rise against the Euro. The rise in the dollar in international markets will impose pressure on rupee to a slight extent. Indian rupee may witness volatility with slight risks of depreciation against the US dollar, if international forces (foreign institutional

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ON INDIAN ECONOMY

FinGyaan

IMPACT OF REGULATION Abhishek Mathur

MICA

Today, the largest democracy in the world has become one of the biggest dilemmas for the world. Only a few years back India seemed to have arrived on the world stage on the back of high GDP growth, booming markets, abundant employment opportunities and low fiscal deficit. However, the years that followed marked an era of unexpected pessimism. In the recent years, the rosy picture has come crashing down with the country strangled by policy paralysis and shoddy governance. With a new government at the helm of the affairs, countries all over the world are watching India with expectant eyes in the hope that India revs up its growth engine and makes the subcontinent a favorable destination to do trade and business. The quest for answers has already begun for questions: How long will it take the country to march out of the economic mess it is in today? Will doing business in India be made any easier? Will the rising commodity prices have any cooling effect in the near future?

SEPTEMBER 2014

Will the unemployment rate see a turnaround in the times ahead? Will problems of poverty and malnourishment be tackled head on? India of the 21st century has been described by many catchy phrases: ‘a potential superpower’, ‘Asian giant’, ‘untapped market’, ‘IT hub’, ‘poverty stricken land’, ‘crime capital of the world’ etc. Sadly, there is another notorious phrase attached to India’s identity: ‘overregulated market’. Regulation refers to the tool for controlling societal or human behavior by imposing rules or orders having the force of law. The concept of regulation was introduced in India for three main reasons: prevention of market failures, promotion of public interest and restriction or removal of anti-competitive practices. In violation of the definition, regulation has become a tool frequently abused by babus, inspectors and officials at different levels of the government

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machinery for vested interests. Inspectors and government officials exercise discretionary powers and nail businesses at every stage of the life cycle for minor procedural lapses. It is perhaps one of the primary reasons that India ranks a dismal 134 in the list of ‘Ease of Doing Business’ ranking and holds 177th position in the ‘ease of starting a business’ ranking among the 189 countries around the world. Also, ‘babudom’ is a phrase that has become synonymous with the government’s high-handedness in running the nation. There are many hurdles that stand in the way of an investor seeking to start and establish a venture in India. First, he needs to apply to the Centre and seek for numerous approvals and clearances. After getting the Centre’s nod, he then has to approach the State for seeking its help in acquiring land, getting building plan approvals, facilitating release of electricity and water connections etc. In addition to it, red tape, bureaucracy, lack of fair access to resources and discrimination are other pain points that make the journey of any investor an unpleasant one. Business sentiments have remained at an all-time low since 2012 when the Income Tax Act of 1961 was amended

with retrospective effect. The biggest victim of such a step has been the British telecom major Vodafone, slapped with a capital gains tax of Rs.20000 crore retrospectively after its acquisition of Hutch-Essar in 2007. Some have termed it as ‘tax terrorism’ as it has not only negatively impacted business sentiments but also dented the image of the country. Other firms such as Shell India Markets, Nokia, IBM and WNS Holdings too have been caught in similar tax issues. Such an act has evoked sharp criticism from domestic and foreign investors alike amid rising voices to repeal the dreadful Act. But the question is whether the government will risk foregoing Rs.30000 crore by doing away with retrospective law and see beyond political compulsions? The suggested course of action is to do away with the legislative amendment done in the Finance Act, 2012 which deals with retrospective taxation and avoid making retrospective amendments in the future. Further, policy makers should assure investors by making it clear that starting this year all taxation would be done prospectively only. Small business enterprises’ are another victim of complex Indian regulatory regime.

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Presence of multiple channels of compliance for a relatively small unit of business not only incurs high financial cost but also strains the bandwidth of the lean management that such entities can afford. Thus, it is in the best interest of the tax payer to have a single window of compliance so that hassles of tax payment are eliminated. While the filing of income tax has become easier due to electronic filing system, still a lot of time and cost is consumed in litigation matters. Rulings already pronounced by higher authorities often fail to be taken up by the tax officers. These authorities neglect taking note of such proceedings, their prime focus being to increase the annual tax collection. Due to such negligence, the system is clogged and crowded with matters that should have been resolved much earlier. The situation needs rectification. To correct this, a circular should be issued that obliges assessing authorities to take cognizance of proceedings of higher authorities (e.g. Appellate Tribunal) in identical matters to avoid backlogs in the post-filing period. Finance regulatory structure is one of the oldest regulations in place. Outdated legislations still exist and find their place in the Indian constitution despite outliving their utility. As many as 60 Acts with myriad rules and regulations govern the sector today in addition to the many ad hoc changes made from time to time. This highlights the maze of regulations that finance sector finds itself in. It faces serious inconsistencies, overlaps and regulatory gaps and suffers from lack of inter-ministerial coordination. The drawbacks are also exemplified by the row seen in the past between capital

SEPTEMBER 2014

markets regulator SEBI and insurance watchdog IRDA over the issue of unit-linked insurance plans (ULIPs). The resolution lies in finance sector legislative reforms through rolling out of Indian Finance Code. The code proposes carving out seven financial agencies with clearly defined objectives, power and accountability. All these financial agencies would also be responsible for making rules as per the process laid out in the code. Further, a unified financial agency is proposed to oversee organized financial trading, consumer protection and micro-prudential law for all financial companies except those of banking and payments. Clear definitions for relevant financial terms will help in reducing ambiguity and warding off battles between parties. For instance, the battle between Sahara and SEBI waged for a long time over the term â&#x20AC;&#x2DC;securityâ&#x20AC;&#x2122; proposed in the code. Power sector is another sector suffering from regulatory hurdles. In the first decade of the 21st century, it grew at a healthy rate before slipping into a period of skepticism. Long standing problems of fuel shortages, financial health of discoms (state-owned distribution companies), land and environmental issues remain. Further, tight regulatory controls over pricing, production and fuel allocation have resulted in distorting market prices and crippling the energy sector. Subsidies continue to be a major drain on countryâ&#x20AC;&#x2122;s resources with half of the energy consumption subsidized, be it in areas of power, process heat requirements or transportation. Consumers continue to enjoy doles on LPG, CNG, diesel and piped natural gas through administered price mechanism (APM) together with cross subsidization of

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Thus we see huge scope for government to reduce its intervention and minimize regulations wherever possible. Regulation problems in India range from child labor laws, intellectual property, export goods barriers to mandatory local sourcing in electronics and IT, SEZs and FDI among others. Overregulated market gives rise to public and private corruption which impedes social as well as economic development. Removing cumbersome regulation increases the opportunity for officials to interact with individuals and businesses and gives them summary control of the resources. Today the balance between social welfare and self-interest is highly tilted towards the latter. While the self-interest of politics gets an upper hand and politicians perform keeping their political agendas in mind, the bureaucrat has little reason to fear the law, taking full advantage of the creaky regulatory framework to use it to his own advantage. The need of the hour is to bring a simple and transparent regulatory regime into effect. This includes simpler drafting of rules that are not open to varied interpretations, giving greater autonomy to regulators, incentivizing states for adopting key reforms, pushing for a transparent process for selecting heads of regulatory bodies and speedier resolution of disputes through arbitration and consent mechanisms. Besides, before setting up of regulatory organizations, enough thought should go in deciding whether or not there is a need for such an organization; if such a body does come into existence it should be given the freedom to self-evaluate and selfregulate. To help give a boost to MSMEs and provide a hassle free tax payment regime, an overarching body should be set up to ensure process and policy coordination. Moreover, strong political will is required to keep party and personal agendas aside and work for the economic and social welfare of the people. The hopes of people are higher than ever before and they have expressed it by giving a clear mandate to the government this time. If the government and policy makers come together and take steps to liberate the economy from the current economic mess, there is little doubt that they will take India to an inclusive double digit growth from the sub 5% level seen in the last two years.

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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agriculture and power segments by commercial and industrial segments. As problems of fuel and subsidies become untenable by the day, the sole way out is ushering in reforms in the energy sector. These include implementation of market-driven pricing and letting market dynamics decide the fuel supplies, accelerating development of coal and gas and separating roles of producer, regulator and policy maker to ensure smoother governance. Regulatory reforms offer opportunity to attract private players to enter fuel production segment making it more competitive. Moreover, generators will have more options for sourcing fuel giving a boost to sourcing capabilities. The Indian drug industry faces tough regulatory challenges in the present times. The latest move by the Finance Minister to revoke 12.3% exemption of service tax on clinical research will up the trialsâ&#x20AC;&#x2122; cost in India. This will negatively affect drug companies as they are likely to shift their base for clinical research out of India to maintain their quality integrity. Last summer, the Supreme Court stepped in and demanded health secretaries of state governments to come up with ways to tighten regulations in clinical trials. Previously CDSCO (Central Drugs Standard Control Organization) had also sought to beef up trial regulations through new rules of trial participant compensation and use of ethics committees. The biggest roadblocks for project takeoff in India are the land and environment regulatory delays. Today, projects worth Rs.200000 crore remain stalled and mired in red tape. Further, 20 new coal-mine projects could not be started because of the difficulty of getting land and green clearances. Such instances leave sufficient room for the Environment Ministry to engage with other ministries and speed up decision making at different levels. The same hurriedness is also required for setting up a single Green Regulator so that a single window is created for all environment related approvals. Deregulating the economy can help fill government coffers and solve thorny problems of fiscal deficit and current account deficit by creating revenue streams through investments and giving impetus to local manufacturing by checking supply side issues. Significant steps in this direction will boost growth prospects, create jobs, bring transparency in the system and in due course of time give its neighbor, China a run for its money.

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Creation of the Steel Giant: Arcelor-Mittal Merger Prakhar Agrawal

IIM Shillong

Overview On 26th June, Mittal Steel and Arcelor announced the merger of the two giants of the steel industry to form the world’s largest steel company. This ended over five months of manoeuvring by both the entities resulting in acquisition of Arcelor by larger rival Mittal Steel Co. for $33.8 billion in cash and stock. This takeover battle was one of the most acrimonious in recent European Union history. It all started in January, 2006. After having been refused by Arcelor’s president for a friendly merger, Mittal launched an offer of EUR 18.6 billion to acquire all outstanding shares of Arcelor. This offer valued each Arcelor share at EUR 28.21 which represents a 27% premium over the closing price of Arcelor shares on January 26, 2006. The reaction from Arcelor’s management, government officials and the European unions was swift and furious. Arcelor engaged in one of the most aggressive takeover defences in recent corporate history. Arcelor announced buy back plans and doubled its dividend. It tried to persuade the Luxembourg government to change the takeover laws. It also approached Russian

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steel maker OAO Severstal for a possible merger between the two entities which would render it too big to be acquired by Mittal Steel. This logjam was broken when the shareholders of Arcelor forced the management to consider the offer of Mittal. Mittal raised its offer which values each Arcelor share at EUR 40.40 and represents an 82% premium over the closing price of Arcelor on January 26, 2006, the last trading day before the announcement of the initial offer. After the completion of the transaction, current Arcelor shareholders own collectively 50.5% of the combined group. The Mittal family owns 43.6% of the capital and voting rights of the combined group. Synergy between the two companies Arcelor was a product of integration of three European steel companies - Arbed from Luxembourg, Aceralia from Spain, and Usinor from France. Most of its 90 plants were in Europe. In contrast, most of Mittal’s plants were outside Europe in areas with lower labour costs. Lakshmi Mittal, Mittal’s CEO started the firm and built it into a powerhouse through two decades

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end of 2008, the combined firms had realized their goal of an annualized cost savings of $1.6 billion. The combined entity is the world’s largest steel company and more than three times larger than its closest rival, Nippon Steel Corp. of Japan. It shipped 100 million tons of steel per year. After the takeover, the company has embarked on a global buying spree by acquiring several steel companies around the world in countries such as Italy, Austria, Turkey, Mexico, Estonia, Slovakia, Uruguay and the UK. Impact on Finances and Operations of the merged entity The combined operations and financial statements showed a significant change in the sales and profit margins for the company. Steel markets Year 2005 World steel production 1,129.60 (millions of metric tonnes) Change year/year HRC price – US (US 600 dollars per metric tonnes)

Fig 1: Arcellor Mittal Locations

Year 2006 1239.50 9.7% 642

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of acquisitions in emerging nations such as Trinidad & Tobago, Mexico, Kazakhstan and Macedonia. The company was headquartered in the Netherlands for tax reasons. ArcelorMittal reported revenues of $105 billion and its steel production accounted for about 10% of global output. After the merger, the behemoth had 320,000 employees in 60 countries, and it is a global leader in all its target markets. The two firms’ downstream (raw material) and upstream (distribution) operations proved to be highly complementary. Mittal owned vast deposits of iron ore and coal reserves while Arcelor had extensive distribution and service centre operations. ArcelorMittal faced the challenge of integrating management teams in various functions. The acquisition also gave Mittal a significantly enhanced presence in Western Europe which was one of its weaker markets, and helped it in strengthening its product range in the long steel end of the market where Arcelor was the leading producer. It also gave it access to Arcelor’s technical know-how and R&D centres. In some cases, the synergy potential was larger than anticipated while it was smaller in other situations. The integration objectives were included in the 2007 annual budget plan. At the

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HRC price – German 561 (US dollars per metric tonnes) HRC price – Far East 449 (US dollars per metric tonnes)

583

478

ArcelorMittal ratios EBITDA margin Operating margin Interest cover

18.70% 14.50% 9.3

17.20% 13.30% 8.9

Table 1: Combined Financial Statements

ArcelorMittal operations (thousands of metric tonnes) Shipments of steel products Change year/year ArcelorMittal financials (millions of US dollars) Sales Change year/year EBITDA Operating income Financing costs – net Net income Change year/year Net cash provided by operating activities Net cash used in investing activities Cash and Short-term investments Property, plant and equipment Total assets Short-term debt Long-term debt – net of current portion Shareholders’ equity

102866

7.4%

80171

88576 10.50%

14959 11648 -1257 8263

15272 11824 -1328 7973 -3.5% 10825

ArcelorMittal financials per share (US dollars) ArcelorMittal average 29.32 share price Book value per share Basic earnings per 5.97 share Change year/year

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110504

-4775 6146 54696 112166 4922 21645 42127

35.45 30.42 5.76 -3.5%

Impact on Global Steel Industry The steel industry was reeling under high prices demanded by the iron ore suppliers especially after a round of consolidation in the mining industry. The steel industry also had to face geographical and logistical constraints forcing them to depend on select iron ore suppliers. The industry was very fragmented with major steel producers lacking access to sufficient iron ore reserves while those having enough reserves suffering from inefficiencies and market access. The sector also suffered from excess capacity and being dependent on big consumers like auto manufacturers, industry faced steel price cycles. Mittal acquired Arcelor to accelerate steel industry consolidation and thus reduce industry overcapacity. The combined firms have more leverage in setting prices and negotiating contracts with major customers from other industries, such as auto and white goods manufacturers, as well as suppliers, such as coal and iron ore vendors, and they eventually realized $1 billion annually in pre-tax cost savings. The merger is also supposed to help contain the volatility of prices in the steel industry by many. The merger has set many precedents for the global steel industry by suggesting new ways for optimization of operations. Excessive manufacturing capacity, which has been a major problem in recent times, in one country can be redirected to fulfil the demands of another area. ArcelorMittal has done this to some extent though they faced strong opposition from the regional governments. Successful innovation from one factory can be implemented worldwide resulting in elimination of redundant research and development work and engineering costs are lowered as resources are shared. The presence of steel plants all over the world has been a major boost for the company as slowdown in one market, as is the case with China right now, can be offset by supplying to other emerging nations such as Brazil and Indonesia. The merger affected the financial markets all

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indebtedness and limit its flexibility in managing its business. Conclusion ArcelorMittal has emerged as a supergiant with almost no competition from others for many years to come and has the economies of scale which will help it buck the general trend of losses in steel industry. This merger is expected to reshape the global steel industry and the financial strength of the entity will support continued investment and growth initiatives.

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over the world with sharp price rises seen in stocks of all major steel producers. There was widespread speculation that the new behemoth may result in pressure for more transnational consolidation activities. Present Situation of ArcelorMittal ArcelorMittal is a leader in all the major global steel markets across the world, including industries like automobiles, construction, electronic household appliances, and packaging. It possesses leading research and development capabilities, as well as substantial captive supplies of raw materials and extensive distribution networks for the finished products. Enjoying an industrial presence in more than 20 countries covering four continents, the company is existent in all of the key steel markets, right from emerging to mature economies. ArcelorMittal is the world’s largest steel producer and a significant producer of iron ore and coal, with production of 91.2 million tonnes of crude steel and, from own mines and strategic contracts, 70.1 million tonnes of iron ore and 8.84 million tonnes of coal in 2013. ArcelorMittal had sales of $79.4 billion and steel shipments of 84.3 million tonnes for the year ended December 31, 2013. ArcelorMittal is the largest steel producer in Europe, North and South America, and Africa, a significant steel producer in the CIS and has a smaller but growing presence in Asia. As of December 31, 2013, ArcelorMittal had approximately 232,000 employees. ArcelorMittal currently has coal mining activities in Kazakhstan, Russia, and the US. ArcelorMittal’s main mining products include iron ore lump, fines, concentrate, pellets, sinter feed, coking, PCI, and thermal coal. As of December 31, 2012, ArcelorMittal’s iron ore reserves are estimated at 4.3 billion tons run of mine and its total coking coal reserves are estimated at 318 million tons run of mine or 170 wet recoverable million tons. But there are certain worries for the company. The group has built up significant debt in the last few years. In FY2012, ArcelorMittal had a total debt outstanding of $26.3 billion, consisting of $4.3 billion of short-term indebtedness (including payables to banks and the current portion of long-term debt) and $22.0 billion of long-term indebtedness. Substantial amounts of indebtedness mature in FY2013 ($4.3 billion), FY2014 ($3.9 billion), FY2015 ($2.6 billion), and FY2016 ($2.5 billion). High debt could significantly harm the group’s financial condition, results of operations, and profitability. Further, it could harm the group’s ability to refinance its existing

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Financing the CGTMSE way: A deep insight to growth driver of Indian Economy Avnish Kumar & Abhinandan Huddar

TAPMI

Since few decades, MSME sector has been the backbone of Indian Economy. Employing close to 40% of India’s workforce which is next only to Agriculture and contributing approximately 45% to national manufacturing output, it undoubtedly play a vital role in balancing the socio-economic aspect of the country by generating millions of job and therefore divesting the economic power and dependence to larger section of the society. According to Small & Medium Business Development Chamber of India, MSME’s in India produces more than 10000 products ranging from low end domestic goods to edible items to high end finished products and largely contribute to 17% of nation’s GDP. Owing to the increased exposure and government aid to this particular sector, Ministry of Micro, Small and Medium Enterprises (MSME) is eying 22% contribution to GDP by 2020. India has close to 48 million MSMEs which is next only to China with 50 million. However the difference in their GDP contribution is not that neck to neck. China enjoys a healthy 60 % contribution to their GDP through MSMEs. The obvious question: Why is there such a stark

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difference despite of comparable units of SME’s? Where do our entrepreneurial skills fall short?

SME Financing: A complicated Process Every small or medium enterprise needs financial stability for its sustainable growth. Access to adequate and regular capital is very essential at the inception as well to support their expansion plan. Unfortunately it is not as simple as it sounds. Getting properly funded is among the major hindrance faced by any SME. It is observed that most firms fall short on the projection offered to the lending bank and consequently the bank minimises or denies the credit. Most of the micro and small enterprises are not registered. Coupled with inadequate infrastructure, technological obsolescence and operational efficiency, maintaining transparency in the book of record remains a problem for most of the unit. All these impediments cloud the guiding principal of any lending bank, the principle of “Going Concern of any firm” and bank remains reluctant towards such lending proposals. Many banks and private lending

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institutions therefore demands for collateral or third party guarantee against the credit as a security. Under such strict circumstances Financing remains the biggest challenge and the lack of it is the prime reason for any SME going out of business.

CGTMSE: A boon for small businesses In August 2000, Ministry of Micro, Small & Medium Enterprises (MSME), Government of India in collaboration with Small Industries Development Bank of India (SIDBI) launched a credit guarantee scheme Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) which would ensure the much needed credit flow to the firm. The corpus of CGTMSE is contributed by the Government and SIDBI in the ratio of 4:1. At present the corpus is around 3300 crores. It would relieve the owner of the firm from the hassles of collateral/ third party guarantee and facilitate the disbursement of loan against the primary security of the financed assets. It proved to be a magical wand for all those micro and small firms whose project is technically viable and profitable yet found it almost impossible to take loan against collateral. For a very small cottage industry let’s say one manufacturing incense sticks (agarbatti), managing collateral would be a herculean task failing which it would probably cease to exist. CGTMSE scheme strengthen such firms and make sure that the business access bank loan and their business remains intact. Under this scheme, any new or existing firm can apply for a working capital or term loan up to

100 lakh without any collateral or third party guarantee. The maximum guarantee cover for small industries is 62.5 lakh – 65 lakh i.e. 75%80% of the sanctioned credit cap whereas for the micro level industries the cover is up to 5 lakh. The government is using this scheme as an effective instrument to encourage young entrepreneurs with sound business acumen and viable idea to start up their own venture without any financing constraints. The guarantee cover starts from the day the loan is disbursed to the party and is valid through the contracted tenure in case of term loan. The duration of guarantee cover in case of working capital loan is till 5 years or lesser if specified by the trust. Provided the financial projections, KYC compliances and other legal formalities are proper and well structured, any major bank is obliged to consider the loan request under CGTMSE scheme and hence let the dream materialise into a reality. In case of an existing business vouching for loan under this scheme, the pre-requisite is that the dues to the lending institution must not be bad or doubtful from recovery aspect. Another relief for SMEs out of this scheme is the sanctioning of both working capital and term loan from a single lending institution thereby reducing the overall toil. Over the years a significant number of small level entrepreneurs have accessed the benefits. As per SIDBI records, about 1 million accounts have been facilitated with CGTMSE scheme with guarantee cover for an aggregate loan amount of over Rs 48,000 crore as on January 31, 2013. CGTMSE has been the true catalyst for MSMEs. Well, if lending under CGTMSE is so easy and risk free for a borrowing party, it must be equally riskier for the lender, isn’t it?

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CGTMSE in addition to providing economic support to small and medium industries, also safeguards the business and profitability of lending banks. In the event of default by any lender, it guarantees to settle the claim up to 75% or even 85% (for selected category) of borrower’s credit facility extended by the lending institution. This cover includes principal amount and the interest as on the date of account declared bad or on the date of filing of suit, whichever comes first. As per the provision the lending institution is paid back the 75% of credited amount within 30 days of the event of default. Any delay from this period fetches additional penalty charged at the bank lending rate. As a result Banks are also safety netted against any large loss and thus are not shy sanctioning loans to promising and credible enterprise based on their prudent judgement. SIDBI in association with the Indian government is ensuring that maximum number of banks is involved in funding to MSME’s under CGTMSE scheme. SIDBI is capitalising on its refinance assistance to commercial banks and aiming to reach out to maximum number of Indian MSMEs.

Way Forward for CGTSME: CGTMSE has been the key driver for the growth and expansion of MSME’s sector in India. It is considered to one of the best tool for ensuring financial inclusion in the society. It has lived up to its objective of providing wings to a promising but economically impaired firm. CGTMSE has received international recognition and has been made a member of the Asian Credit Supplementation Institutions Confederation (ACSIC), which is responsible for promoting the sound development of the credit financing for Micro and Small Enterprises in Asian countries. The ministry of MSME has left no stone unturned in spreading the awareness about this scheme among the small industries owner, especially the rural community. Several financial institutions ex. Banks, trust, MSE associations, public are made aware through all possible mode of advertisement which includes workshops, print media ad, annual seminars etc. CGTMSE organises awareness programme on Credit Guarantee Scheme in association with the state industrial corporation to penetrate its reach. Year on year the guaranteed cover is increasing manifold. It has come a great distance so far still it needs to go a long way in bringing more and more innovation to Indian MSMEs by helping innovative minds to convert their ideas into reality. All said the story isn’t

SEPTEMBER 2014

over yet. Despite of increase in the guarantee covered, the total coverage of the scheme doesn’t present a rosy picture. Most of the micro industries doesn’t have access to internet and other media which literates them about this scheme. In villages and remote areas, a major section of unemployed youth are not utilising the facility, also the existing ailing business are wrapping up because they have no idea about this scheme. GTMSE scheme is indeed a blessing and therefore every stakeholder involved be it Central or state govt. or SIDBI or commercial banks should work in tandem and make sure that the blessing is spread across miles and Indian society emerges out to be more financially balanced and cohesive.

Interview By A Senior Executive From India’s Leading E-Commerce Firm E-commerce being known to fast growing sector which has still not got onto its own legs through internal cash flows and are still growing on PE money. But the issue at hand is all-over the world large diversified players like Amazon, Groupon are still loss making. On the other hand there are some niche players who have got their revenue model right and have started reporting profits. At the end of the day, profits are all that matters, and we believe your PE investors would also be of the same view. So by when do you hope to start making profits? Profits and high growth are highly –vely correlated. Currently ecommerce Industry in India is in a high growth trajectory and any company that seeks to capture disproportionate share of the same will be in the red. Also, profitability is an equation of economies of scale and hence most of the companies in India are eyeing for a higher growth rate even at a cost of losses. However, most of the ecommerce companies are taking a long term view on profitability and market share. Again, the niche players that you are referring to have a very different business models and are concentrating only on few categories of the business and not operating as a horizontal players so comparing our organization with them may not be an apple to apple comparison. Lastly, Amazon is not in losses. You can refer to their financial statements herehttp://www. gurufocus.com/financials/AMZN. They had some mis-investment leading to –ve profitability in 2012.

are expanding on the same strategy of revenue growth, discounting their products and providing better and better customer service. So how does an Indian ecommerce company create a differentiating offering for its customer that would compel the Indian customer to leave aside International Players like Amazon, even if it offers high discounts and similar customer service, to shop on the website. Also do you see any Indian ecommerce company getting any kind of pricing power in the next 10 years also? I am aware that most of the big e-commerce companies are expanding on providing better customer service but the question here is how many of them are able to successfully create them. Majority of the companies primarily thrive on providing competitive pricing along with efficient product delivery model and friendly customer service. Pricing has not and will never be a long term growth strategy for any company across the globe. Similarly for any Indian company as well I don’t think pricing will be a key lever in long term.

Many companies already started a lifestyle products division. Amazon has also spiced up the competition by starting a similar division. So what should be long term strategy for any Indian ecommerce player with regards to this thought. Also, recently Flipkart has also acquired Myntra, so how do you expect to Indian ecommerce players will ward off competition from International players like Amazon and many other emerging Almost all big e-commerce companies niche players in fashion space. © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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Lifestyle being a very high margin business segment, has to play a very important portfolio role in the success of any e-commerce company. Therefore, most of the e-commerce companies will be focusing a great deal on lifestyle business and will surely be ready to up the ante with International players like Amazon.

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Generally, companies prefer to have growth in an asset light model and outsource their peripheral functionalities. But many of the Indian ecommerce players have recently started its own delivery service and also started offering their own private labels. All this has been done to provide better customer service. But at the same time, these initiatives require a lot of investments which would increase the costs. So how do you think this would impact the bottom-line in the long run? Not at all. Every company and industry has to develop some core-competencies and has to continuously invest into the same. Similarly, logistic service and vast & deep operations are going to be the core competencies of the e-commerce industry and every company will continue focus on the same. Going by your experience in both the brick and mortar retail stores and online stores, what is the difference in the financial strategy followed in both these business models and which are the different focus points unique to both of these models? As explained in Q1, the growth and profit tradeoff in both the businesses are completely different. Ecommerce is more about selection and delivery and Brick and Mortar retailing is about store location and distribution system.

SEPTEMBER 2014

NIVESHAK

Letter of Credit

FinFunda of the Month

S C Chakravarthi IIM Shillong

Sir, this time what confuses me is a term called ‘Letter of Credit’. Is this some statement showing the credit balance of my bank account? No, but the name surely misleads many people, especially for beginners of Finance & Accounting, who are thrown into a deep confusion between credit and debit. Fortunately, this is not related to credit or debit of Accounting. Letter of credit is a mechanism which is used by the people involved in foreign trade (i.e. export or import business to another country) as a mode of guarantee for the payments to the seller towards the goods exported to the buyer.

‘Letter of Credit’ is issued by the importer’s bank on producing appropriate invoices, insurance etc. Initially, the buyer and seller agree upon the business and then it is the seller who requests for ‘Letter of credit’ from the buyer. Then the buyer approaches his bank for applying a letter of credit in favor of the seller (Exporter). After verifying the buyer’s credit history, the buyer’s bank issues and forwards the credit to its correspondent bank that is located at seller’s location. This correspondent bank will authenticate this credit and forward the same to the seller. After shipping the goods to buyer, the seller will submit the required documents to the advising (correspondent) bank and the advising bank on verifying the documents claims for funds from issuing bank. Again the issuing bank checks these documents and credit the seller’s bank immediately. Finally, the issuing bank debits the buyer and releases the documents so that the buyer can claim the goods shipped.

Why do we need a bank guarantee when there can be other legal contractual agreements that are possible between buyer and seller (without involving a 3rd party banker)? Firstly, banks are considered the most reliable for any kind of financial transactions because the risk involved is very minimal. When you are doing business with an international company, chances are that you may not be fully aware of the buyer’s credentials (Especially when you are doing business with that buyer for the first time). In such a case, ‘Letter of Credit’ or ‘Documentary Credit’ acts as secured mode of payment for the sellers (Exporters) whose risk of non-payment gets transferred to the bank.

Very well explained Sir. What is the advantage that buyer is going to get by issuing a ‘Letter of credit’? It is understood that the seller is assured of full payment on time. Similarly, the buyer is also assured that the seller will honor the deal. One should also be aware of the costs involved with ‘Letter of credit’, because banks usually charge the seller for providing guarantee of payment and the exporter should provide the necessary documentary proofs. Sometimes, this verification process may take longer time than expected. So, the exporter should properly weigh the costs to the risk of non-payment for the shipped goods and then take an informed decision. Thank you Sir. This explanation makes So, who will issue this Letter of Credit and things very clear. what is the mechanism of working of ‘Letter of Credit’?

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WINNERS Article of the Month

Prize - INR 1500/-

Ansuman Mishra IIM Shillong

ANNOUNCEMENTS ALL ARE INVITED Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1500/- along with a certificate. Instructions »» Please send your articles before 15th Oct, 2014 to niveshak.iims@gmail.com »» The subject line of the mail must be “Article for Niveshak_<Article Title>” »» Do mention your name, institute name and batch with your article »» Please ensure that the entire document has a wordcount between 1500- 2000 »» Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 »» Please do NOT send PDF files and kindly stick to the format »» Number of authors is limited to 2 at maximum »» Mention your e-mail id/ blog if you want the readers to contact you for further discussion »» Also certain entries which could not make the cut to the Niveshak will get figured on our Blog in the ‘Specials’ section

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