The Financial January 2014, Volume no. IV, issue no. II
Cover Story India 2014 - How will 'GLOCAL' factors play out for India?
The Financial Volume no. IV Issue no. II January 2014
Senior Team Prakash Nishtala Vidhi Shah
Creative, Design, Content Ajit Nayak K V Arghyapriya B. Bhuvanesh Kumar Jeenoy Pandya Sarthak Mohanty
From the Editor’s Desk
Dear Readers, Greetings from Team Finomenon! The year gone by, managed to keep us on our toes with its flurry of capricious unfolding of events; be it a sudden slump in the value of Indian Rupee or the switch-hits played by RBI on hawkish and dovish stances. The story on the global front too was equally intriguing. The year started with a cliffhanger on fiscal cliff before Cyprus crisis could garner the attention amidst some seriously hard landing in China, the world of economics was kept confused by Abenomics and when it appeared the show would Shutdown (read US Shutdown), the game was about to begin. All these events make 2014 a much promising year that would bring even bigger surprises and thrills. At the global level, it is interesting to see how India walks through the ‘taper’ed roads of bringing hot money while at the local level it would be interesting to witness the melodrama of the great Indian political tussle and how India juggles to manage inflation, growth and deficits. The Financial, through the theme for this edition, “India 2014 - How will 'GLOCAL' factors play out for India?”, makes an attempt to know from the budding fin-mavericks what they think about the road ahead for India in 2014. We have aligned our magazine, time and again, to the needs and wants of our reader base. The newly introduced sections like Grassroots received a huge appreciation from all the corners. We promise to bring, in future, even more insightful sections, articles and competitions for our beloved readers. We are happy to bring to you, with this revamped issue, a 360 0 view of the financial world. In this issue, we have delved into the viewpoints on a wide array of contemporary topics. The perspectives put forward by the budding managers from across the Bschools are sure to give a new dimension and importance to this issue. The process of evolution of ‘The Financial’ will see a deliberate attempt from Finomenon, to involve the readers as much as possible. The aim this time is not to have an article end with its last word in the magazine but to take it beyond through comments and discussions. Feel free to contact the writers of each article and discuss their views or to even dispute them! As always, I hope you enjoy this issue! Let us know how you feel about the content. Criticisms, suggestions, requests, and jokes, they are all more than welcome. We thank one and all for their valuable contributions to this magazine and hope you enjoy the articles. ‘The Financial’ is an interactive magazine and, beyond just a magazine, a two-way interactive channel. As we exchange ideas, we will evolve and grow to greater heights. As I sign off, I’ll leave you with this beautiful quote by T. S. Eliot,
Finomenon NMIMS ,Mumbai All design and artwork are copyright work of Finomenon NMIMS Mumbai
“For last year's words belong to last year's language, And next year's words await another voice. And to make an end is to make a beginning." Wishing you a great start to this new beginning! Regards, Prakash Nishtala Editor-in-chief, The Financial
C O N T E N T S
India 2014 - How will 'GLOCAL' factors play out for India? - Part 1
1
China unleashes new Economic Reform
5
India 2014 - How will 'GLOCAL' factors play out for India? - part 2
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REIT’s - will they breathe life into India's comatose real estate sector? Are we on a path to recovery or it is the central banks' effect across the world. Is another crisis looming ? The Rivalry That Turned Goldman Sachs ‘Golden’
Facebook and Twitter going public
Grassroots
15
19
23
25
28
How can India’s growth be recuperated?
30
Top Newsmakers in business –2013
33
Opening the renminbi to the world– currency reform in china
35
C
O India 2014 - How will 'GLOCAL' factors play out for India? - part 1 BY BHUVANESH KUMAR, NMIMS, MUMBAI During the good times of the past bust which came in the form of a US decade, India was one of the most subprime mortgage crisis. This refavoured countries for deploying sulted in major risk aversion, flight capital to achieve best returns ad- of capital to safe havens and slowjusted for risk. India along with down in the global economy. AltBrazil, Russia, China and South hough, India wasn’t affected drastiAfrica were termed as BRICS ow- cally and only ripples were felt by ing to their fast economic growth the Indian economy in the beginning. But ensuing and a policies folbelief lowed by that they the governwould ment and in due the subsetime quent Euroeclipse pean debt the decrisis has veloped seen the econoIndian mies of economy the worsen. Inworld. dia today is The plagued by speed of Figure 1 GDP Growth Rate India 2002-13 policy paralysis which inflow of Foreign Direct Investment (FDI) and For- seems to be slowly receding, high eign Institutional Investment (FII) inflation, unsustainably high level of during 2007-08 was unprecedented fiscal deficit, negative trade balance, and during the period of 2007 to contracting Index of Industrial Pro2013, India recorded its highest duction (IIP), and falling economic growth in annual FDI inflow at growth. A toxic cocktail for any 73.6% in 2008. FDI increased from economy. USD 25 billion in 2007 to USD 43.4 billion in 2008. India during In the period for 2008-13, the Indian this period was also growing at one economy has been growing below its of the fastest rate in the world by potential and economic activity has consistently recording GDP growth been stagnant. A good indicator of rates of above 9% between 2006- economic activity in any country is the stock markets of the country and 08. looking at India’s Nifty-50 and BSEBut like all economic cycles, this Sensex, the markets have given flat boom also had to be followed by a to negative returns during 2008-13 which is a testimony to stagnant
V E Bhuvanesh Kumar is a first year student of MBA at SBM, NMIMS. He holds a B.A. degree in Economics from Hansraj College, Delhi. Email ID: 7bhuvaneshkumar @gmail.com
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S t O R Y
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growth. As the global economy is showing signs of economic recovery, with US leading the charge, India needs to get its act together to reap the benefits of this recovery and regain the status of one of the most attractive investment country in the world. The GDP growth for Q2 FY14 came in at 4.8 per cent and going by the consensus estimate it’s expected that India’s GDP growth for FY 14 would be between 4.5 – 5%. Considering all these factors, 2014 will be a crucial year for India as a country and its economy especially. A lot of factors will determine the direction of the Indian economy. On the global front – the quantitative easing (QE) tapering by the Federal Reserve, stability of the Euro and the policies of European Central Bank, the growing debt concerns in the Chinese economy, money priniting by Japan and the price of commodities especially crude oil. While domestically, the general elections in April-May this year, taming inflationary expectations, reducing the fiscal deficit, clarity on government policies, renewal of investment activity and the stability of the rupee. Though crucial, I have purposely not stated the role of Reserve Bank of India (RBI) in shaping the Indian economy in 2014 because its action will be governed by inflationary and fiscal deficit trends, the stability of the rupee and the dwindling economic growth. To analyze how these factors will affect India, it is important to note that some factors are important than others and will have a commensurate effect. Firstly, a lot of people are betting on the general elections of 2014 to give a mandate which will see a change at the center and the market expects that the next government will be formed by the BJP led National Democratic Alliance (NDA) with Narendra Modi as the PM. Traditionally, BJP is considered to be more pro-business than the Congress. Narendra Modi is believed to be decisive, supports growth of business, believes in minimum government and maximum governance and has a clean track record. His economic model of Gujarat has seen rise in investments, economic activity, development and well being of citizens. This is in complete contrast to the way Congress has ruled over the past five years,
which has seen large scale scams, delay in clearances of corporate projects, rising populism which has led to rise in fiscal deficit and subsequently inflation, and a weak leadership unable to take hard policy decisions. If the script plays out as corporate India expects it to, the business sentiment would improve. We could see an increase in investments giving boost to employment and economic growth. But, even if NDA doesn’t reclaim power from UPA but we see a stable formation, there could be a pickup in the economic cycle. On the other hand, if there is weak formation cobbled up of regional parties which may not be politically sustainable for too long, we may see outflow of capital from the country and further worsening of the economy. Secondly, rising inflation and fiscal deficit need to be checked. The last few CPI inflation readings have not been encouraging for the market with pressure being exerted from mainly food articles. There has also been no respite on the WPI front with WPI inflation rising to 7.52 percent in November. Government has also been running a high fiscal deficit due to rising subsidies and populist schemes such as NREGA and the Food Security Act. A high fiscal deficit has meant greater borrowing by the government thereby leading to crowding out of private investment. High consumption by the government implies a rise in demand and thereby a rise in inflation. Inflation and fiscal deficit together have ensured that interest rates have also remained at elevated levels to control them. In 2014, it would be important to break the back of inflation and reduce inflationary expectations. It is expected that the good monsoon of the previous year will help in a gradual fall in food prices, the major cause of inflation. In addition, some of the measures to directly procure fruits and vegetables from the farmer could also help reduce inflation. A fall in inflation will have multiple benefits for the economy, as it will result in a fall in interest rates which could help boost economic growth, increase investment activity, reduce existing debt costs for most companies which has acted like an Achilles heel on most balance sheets and help build 2
a sustainable foundation for the next growth cycle.
will remain at 0.25% for a considerable period of time. Also, they would want decouple from the Fed’s Thirdly, there is a decision of tapering, instead concern emanating they may increase asset purfrom the QE taper chases to counter worries of of the Fed in the deflation. On the other US. Most of the hand, there is also growing economic indicauneasiness with high debt tors are pointing levels in China, especially towards recovery in regard to shadow bankwith the health of ing. You hear whispers the economy imFigure 2 Headline Inflation y-o-y Courtesy: Crisil about how Chinese banks proving. The unemployment rate has decreased to 6.7% as per the latest figures owned by the state are indulging in various forms of published by the labour department for December debt financing which are not sustainable over the 2013, in addition to the Q3 GDP growth which came long run. Renowned investor George Soros has alin at 4.1%. The Fed has already announced that it ready raised questions about the existing banking system in China. He believes structural reforms and will reduce bond economic growth cannot be purchases by $10 achieved simultaneously, billion starting contrary to what is being January 2014 and claimed by China. In addiprogressively detion, there are the easy cide on the taper money policies being foldepending on the lowed by Japan to reinvigUS economy. This orate their economy. Bank signals the beginof Japan (BoJ) aims to inning of the end of ject $1.4 trillion annually in bond purchases by the Japanese economy the Fed, which Figure 3 Monthly US Unemployment Rate in % Courtesy: Bureau of Labour Statistics which is larger than the will result in decreasing liquidity in the US and the global economy. QE3 program on an annual basis. Some part of this Emerging Markets (EMs) especially those running money will also move into India and other EMs to high CADs are expected to be hit harder due to the make swift returns and gain on the yen carry trade. taper. Although India is much better off today com- Although significant, it’s difficult to predict what pared to the middle of last year, it will be important effect each of these factors will have on the Indian to see how India reacts to the taper going forward. If economy. While the loose monetary policies of ECB there is a pause in the taper, it could be positive for and BoJ is positive for India as it will increase liIndia as it will give her more time to rectify its quidity across the globe looking for avenues of higher returns, the China problem could pose a great risk CAD. to India if it were to come true. The freezing up of the banking system China could have a severe adFourthly, other global factors such as the policy de- verse effect on the global economy which is just cision of the ECB will also affect India. ECB chief starting to stabilize. Fifthly, the price of commodiMario Draghi has signalled that ECB’s lending rate ties especially oil will be significant for the Indian 3
economy in 2014. Currently, Brent Crude has been consistently trading above USD 100/barrel. Given the facts, that the social unrest problem in the Middle-East which for the moment seems to have died down except in Syria. Iran which is the second largest producer of oil in the OPEC has agreed to halt its nuclear enrichment programme, which has in return meant some economic sanctions have been lifted by the West. All these factors including the moderate outlook of global growth and the discovery of alternative source of energy such as Shale Gas have ensured that crude prices don’t move north. 2014 could further see correction in prices if economic sanctions are completely lifted from Iran, leading to Iran restoring oil production to its capacity and selling crude to the West. This could be a major positive for India, as it will reduce the import subsidy bill and thereby the fiscal deficit. As petrol prices have already been deregulated and diesel partially, a fall in
crude prices could mean a fall in petrol and diesel prices. This could reduce manufacturing, transportation and other cost, in effect also reducing inflation. Keeping all these factors in mind and other that may not be significant today but could shape the Indian economy in 2014, it is important to address those factors that are in our control. I also believe that major thrust to the economy would come by working on the local factors such as inflation, fiscal deficit, clarity on governmental policy, creating an investor friendly environment and having a stable government at the center. While India may be bottoming out in terms of growth, there is no room for being complacent in anticipation of future growth. We can’t afford to make the mistakes committed during the past 5 years and the polity needs to realize that economic growth and employment can’t be sacrificed for populism. For India needs to regain its past glory!
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China unleashes new Economic Reform BY ASHITA GUPTA, IMI, DELHI In a view of the government to reach a new stage of development, China's new President, Xi Jinping, along with China’s other leaders have unveiled a series of reforms that aim at overhauling its economy over the next decade. This has signalled a commitment to liberalize the existing economy.
important role in the country's further liberalisation effort.
Mr Xi’s was quoted saying Deng Xiaoping’s warning in 1992 of a “dead end” if the country failed to reform and improve living standards. Mr Xi bluntly said about the challenges that China faces: a mode of development that is “unbalanced, uncoordinated and unsustainable”; an in- Figure 1 crease in “social contradictions”; and a “severe” struggle to contain corruption. These challenges were cited as a need to lead another set of reforms that could set China on a continued growth trajectory.
It is also believed that it will help bolster RMB, the official currency of the People’s Republic of China, convertibility, hold up a path to interest rate liberalisation and increase the volume of cross-border transactions given companies located in the zone will be able to take advantage of both onshore and offshore markets.
The news of China's bold economic reform came as the ANZ- Australia and New Zealand Banking Group, received the green light from the Chinese regulator to open up a subbranch in the Shanghai free trade zone. This is expected to play an
The Shanghai free trade zone initiative is considered to be an important initiative as part of China's reform agenda and is expected to further open up the financial services industry to private and foreign capital.
Ashita Gupta is currently pursuing her MBA from IMI, Delhi. She has completer her engineering in CSE and is a gold medal recipient from the university. She’s a sports enthusiast and loves playing guitar. Email ID: ashita.p13 @imi.edu
China's leaders, in hopes to stimulate growth and curb corruption, have laid out a plan to wrest a bigger chunk of the country's economy from state control and turn it over to the free market. Communist Party leaders in China said that state ownership would continue to play a key role in the economy but more emphasis will be endorsed on private ownership. Though state ownership would remain a pillar 5
of the economy. [Refer exhibit 1] It is believed that the core issue is to straighten out the relationship between government and the market so that the market can be allowed to play a decisive role in allocating resources and improving the government's role.
The reason that the China's leaders changed the onechild policy is because China has aging population and an aging population needed support. Moreover there has been a gender imbalance prevailing with this policy.
Welfare-system reformed Figure 2
Relaxation in the system of household registration known as the hukou system
Under this system migrants give up the public services they are entitled to when they move to urban areas.
Analysts say changing this system is a key step towards liberalizing the labor market that will allow the free movement of labor and encourage urbanization
Xi Jinping is cracking down on corruption which can determine the future of China’s economy. It can be predicted that if Xi seriously works on anticorruption then China's economy will build a base over the next few years based on consumption. This will take China's economy to the largest in the world by 2030. In a meeting of China’s top leaders a 60-point reform plan was seen paving the way for sweeping changes in the world's second largest economy as it tried to steer away from investment-led growth to a consumption-driven economy. Major reforms were as follows:
Relaxation in one-child policy
Was introduced in 1979
Contributed to falling birth rates
Will allow couples to have two children if one the parents is an only child
Baby-product related stocks such as Goodbaby International soared in Hong Kong following the easing of the onechild policy
The urbanization policy change with the relaxation of the hukou policy is considered to be the biggest reform since 1958. The largest cities such as Beijing, Shanghai, Guangzhou and Shenzhen will still have strict rules applied to it though the changes will mean a more mobile labor force and an increase of workers into factories struggling with the demand of work needed. The government will open up rural migration to small cities which will be a boon to the economy as it will boost the wellbeing of migrant workers who will now have more money to spend on goods and services. Still the government is likely to move very slowly on this reform as it will trigger a rush by rural dwellers into the cities—which the cities are unlikely to be able to absorb.
Greater rights for farmers
Farmers will be granted rights to possess, use, benefit from and transfer their land along with the right to use their land ownership as collateral or a guarantee
6
Presently all land in China is
owned by the government with farmers only permitted the right to work the soil in their area
It has become important to encourage urbanization and shift China's economy to a consumer-driven one since it could enable farmers to cash in on the value of their land while investing in new ventures and move to the cities
If farmers are given the right to actually sell their land instead of having it appropriated by the local government then there will be a situation where the right kind of housing development will happen. This “Land reform” is going to be part of a major push towards the right kind of housing in China.
Stepping up financial reforms
Setting up a deposit insurance system by early 2014 that will give the qualified private investors the go ahead to set up banks, loosen controls on the pricing of water, electricity and natural resources and revamp the system for Initial Public Offerings (IPOs)
It is believed that the insurance scheme would protect depositors as China is worried that some smaller
lenders are at risk of going under as banks compete for deposits in a more open regime. China's central bank had removed controls on lending rates.
State-Owned Enterprises (SOEs):
SOEs will be required to pay larger dividends to the government by way of 30 percent of earnings from "state capital" to be paid back to the state and used for social security by 2020
Private firms will be encouraged to play a
greater role in the economy According to a report, China's 113 large SOEs under direct government control typically pay 5 to 20 percent of their profits to the government in dividends. Some people believe that reform of the SOEs is one area where reform could be slow. Of
these
reforms,
the
major
three
viz-a-
viz permission to establish regulated banks by pri-
vate investors to serve small and medium enterprises, payment of larger dividends to government by state-owned lenders and effective replacement of one-child policy with a two-child policy will play a major role. While these three changes aren't sufficient to put China on the path to sustainable growth there will be a significant contribution in solving China’s biggest problem i.e. too much investment and not enough
personal consumption. There has been excessive infrastructure lying around unutilized. China can boost the value of this unutilized capacity by making sure there are more Chinese people around to use it. China’s population is projected to shrink by about one-third before the end of the century at the same time as it rapidly ages under its one-child policy. With this, the result would be a country with about two people of working age for every one person older than 65 by the year 2050 with more old people than young people capable of supporting them in their dotage by the year 2100. This restriction is still too severe to keep the population from shrinking; China still needs to produce at least 2.1 children per mother on average. The government had also decided to work towards
an independent judiciary i.e. the courts would be 7
"appropriately" separated from local govern-
ments.
with vested interests that stand to lose huge power
Figure 4
partic-
Under
ularly
government
re-
form,
re-
the state enter-
laxation on
the
need
for
prises, local
gov-
government
ap-
proval on projects was
real-
ized
and
the performances of local officials would be rated on measures other than just economic growth such as in environmental protection were noted. Xi was facing much resistance in the commitment to abolish re-education through labor camps though they were remarkable. Drawbacks China’s Plenum outlined ambitious reforms however there have been many qualms about the implementation of its policy.
Each of the reforms will have costs for and
might adversely affect powerful players in the Chinese system
The year 2020 is set as a target by the party
leaders for implementing all of this gauging how tough it will be to implement it
These reforms could also be delayed or even
abandoned with the scale of the obstacles ahead becoming more and more apparent
Also, these reforms will come head to head
ernments, banks, well-connected prince lings, security authorities, and ultimately the party it-
self
If these reforms aren’t carried out then China
can’t continue to growthe way it has and risks social and economic fracture
While it pursues these reforms the party is
diluting its control in multiple ways:
Its privileged role controlling the
purse strings if more and more lending is to go through non-state banks
Its leading position guiding the econ-
omy’s development if the private sector starts to move into areas long controlled by state enterprises
Increasingly its sway over the people
as the party loosens the hukou and allows migrants to move more freely where they want while it gives farmers more power
over the land they occupy 8
There is an associated possibility of greater
social unrest if huge new numbers of people flow into the cities and feel less inclined to be quiet when
energy was key to success of other reforms. On the whole, the proposed reforms are part of Chi-
they
na's
feel
grand
the
trans-
state has mis-
Figure 5
treated
them. Having been the factory
to
the world, the Chinese leaders want to avoid the so-called middle-income
formation design: retooling the economy towards
trap- where wealth creation stagnates as market
greater reliance on consumption, services and mov-
share is lost to lower-cost rivals. Chinese leaders are
ing up the manufacturing value chain, while tackling
acutely aware of what is at stake as years of rapid
deepening inequality and discontent, a source of
growth come to an end.
great anxiety for a leadership that prizes stability
The World Bank says China's per capita GDP was
over everything else.
$6,188 last year, compared with $22,590 in South
The past reforms have been good enough for China
Korea, $36,796 in Hong Kong and $51,709 in Singa-
to evolve as a second-largest economy but still it
pore - Asian peers that have succeeded in making
can’t avoid the consequences of its past policy mis-
such a transition.
takes. These new reforms suggest that the leadership
It was believed that significant attempts were towards the powerful state monopolies though many economists argued that loosening the stranglehold of big state-owned firms' on markets from banking to
is willing to take small steps to address the country’s challenges and the only question that remains is whether the pace of reform will be fast enough to allow it to be on the track of continued growth for
China. 9
India 2014 - How will 'GLOCAL' factors play out for India? - part 2 BY PRATIK DAS, NMIMS, MUMBAI Advanced economies improving The story of Indian economy in The gap between emerging mar2014 will be kets like determined by India and Fig 1: GDP Growth % numerous advanced global and econolocal factors. mies To get India such as back to the US and growth trajecUK is tory, various reducing structural issues need to In be corrected terms of by the governgrowth ment keeping and inin mind that it will be impacted by flation. This can be an ominous various ‘glocal’ factors. India regsituation for the financial stability istered a of Fig 2: CPI Inflation growth of emerg4.4% in the ing first quarter of counthe current tries. fiscal, the Most slowest in 4 adyears, before vanced improving in econothe second mies are quarter to facing 4.8%. This low and growth is well falling below the inflation economy’s potential of 7-8% which whereas countries like India and it achieved a couple of years ago. Argentina are facing high inflaLet us analyze the various factors, tionary pressures. both global and local those are going to largely impact the economic This realignment of growth and inflascenario of the country in the fu- tion factors in advanced economies (AEs) can lead to change in direction ture. of capital flows from countries like Global Factors India to AEs. Monetary tightening
Pratik Das is a B.Tech in ECE and he is presently pursuing MBA from NMIMS, Mumbai. Pratik also has a work experience with Infosys Technologies Ltd. Email ID: pratik.das@nmims. edu.in
10
policies by the Reserve Bank of India (RBI)
came as an obvious step to curb the rising inflation in the country which is in turn restricted the growth. Therefore, it is imperative for India to fix the infla-
bond buying program by reducing the amount invested in bond buying by $10 billion. Despite that, the rupee was not seen weakening much as com-
tion issue as soon as
pared
Fig 3: FII Net Purchases/Sales
to
possible in
May
2014
22,
before
Figure 5
easy monin
AEs
are
when the first talk of
wound up.
taper-
QE Tapering - The third edition of the stimulus programme, better known as Quantitative Easing (QE) began in 2012, under which the Fed was
buying $85 billion worth of assets every month created liquidity in the market which ultimately led to easy flow of money to emerging economies like India. India has received $19 billion as foreign institutional investment in 2013, of
2013
levels
etary policies
its
ing happened. The various macro parameters including CAD and Forex reserves have shown healthy revival signs, therefore, the vulnerability has def-
initely come down which clearly shows that the country is now better prepared against the QE tapering that is likely to be complete in 2014. Local Factors
which about $7.5 billion came after September,
1. Lok Sabha Elections – Probably the most im-
when the US Fed decided to postpone the taper
portant factor that is going to decide the fate of the
to 2014. But as pointed out by Dr. Rajan, taper-
Indian Economy in 2014 is going to be the upcom-
ing is imminent in the coming months. To make
ing national elections in May. The general elections
a ‘bullet-proof’ economy, so that India is least
have the potential to reset the system and kick start
affected due to the tapering by Fed, the RBI gov-
the reform process. The entire nation is hoping for a
ernor passed a slew of reforms, mainly structur-
business-friendly government, no matter who is
al, which not only brought more forex reserves
elected eventually. If the Congress-led UPA comes
and stabilised the currency fluctuations, but it
to power, the agenda will be to bring in reforms
also built a strong monetary foundation to pro-
which they already have in pipeline. As put forward
tect the economy in case of a sudden rollback of
by Rahul Gandhi in his speech at FICCI, the UPA
the US stimulus program. Later this year, the
government will look to provide fast track clearanc-
Fed decided to start wrapping up its gradual
es to projects which are stalled due to delays in
11
environmental and social issues. It will also focus on investments in education, R & D and will stress on passing tax reforms such as Goods and Service Tax and Direct Taxes Code. If BJP-led NDA comes to power, the economy may get even more excited due to widespread perception of Narendra Modi seen as a pro-business leader who has constantly boosted both foreign and domestic investments in his native Gujarat. A third front is certainly the least desirable outcome as the stability of the government will be in question. The recent state election defeats by the Congress can also bring about a change in the working mindset of the party. If the party views this defeat as voter dissatisfaction against the rising inflation, then the policy might complement with the central bank’s strategy of controlling inflation. . If the party sees this as the need for more freebies, it will be tempted to pour money into populist schemes to win votes which can dent the fiscal situation of the country even more. Therefore, whatever the country decides in 2014 will certainly pave the way for a change in the business landscape throughout the country. 2. Fiscal worries – The fiscal deficit in the country is a major issue which will largely impact the future policies of the government. Although the finance minister has been stressing on limiting the fiscal deficit to 4.8% of GDP for the current financial year, maintaining that will be a huge challenge and most probably impossible. As per the latest data published by the Controller General of Accounts (CGA), the fiscal deficit of the Union Government in the April-November period was Rs. 5.09 trillion, against a budgeted target of Rs. 5.42 trillion for the year ended 31st March, which is 94% of the full year target. There is very little that the government
can do to contain the fiscal deficit with only 1 quarter left except pushing for some bigticket reforms such as Goods and Service Tax (GST). However, implementation of GST, which aims to rationalize the indirect taxation system in the country, may not be implemented in 2014. The much needed tax reform was tabled in August 2013 by the Standing committee on finance. But the inability of the winter session Figure 5 of parliament to come to a decision on the GST rollout makes it impossible for GST to be a reality before 2016. Therefore, it remains to be seen how the government cuts down on some of its expenditures such as food and fuel subsidies and also focus on collection of non-tax revenues to ensure that the fiscal deficit doesn’t exceed FY14 target, which may negatively affect the economic growth momentum. Therefore, improvement in the fiscal strength of the country through reforms in the indirect taxation system is unlikely in the next year. 3. Inflation – Wholesale Price Inflation (WPI) maintained a consistent 7 percent throughout the year 2013 while retail inflation, measured by Consumer Price Inflation (CPI) rose sharply and crossed the 11% mark in November 2013
Fig 4: Inflation– CPI and WPI
12
To
Fig 5: Deposits after inflation
address the inflationary concerns, the central bank increased the interest rates in September 2013. This is going to be a huge concern for the policy makers in 2014 as unless inflation is addressed, infusing liquidity in the system to accelerate the much needed growth is not possible. Even as some moderation is expected in food inflation going forward, persistence of retail inflation remains a concern. To address the inflationary concerns and to strengthen the environment for sustainable growth by fostering macroeconomic and financial stability, monetary policy was tightened in September 2013 and October 2013 by a cumulative 50 basis points hike in repo rate. As a result of this persistent high inflation, the financial assets of households (money saved as bank deposits and capital market instruments) have fallen from the highs of 2000s. Recent measures such as the re-introduction of inflation indexed bonds (IIBs) and introduction of CPI linked saving certificates for retail customers are part of the strategy to encourage investors to invest in financial assets. These bonds protect the investors against rising inflation. It also gives 1.5% return over and above the inflation. It remains to be seen how the IIBs are able to provide a healthy return against inflation in 2014. Further Securities and Exchange Board of India (SEBI) recently brought out the draft consultation paper on Real Estate Investment Trusts
(REITs). REITs are a positive development in the real estate domain as it will ensure that investing in real estate more accessible, long-term and income-oriented. In 2014, investors will be looking for the rule formulations for REITs. 4. Industrial Production - Manufacturing sector, the key driver of the Indian economy, has witnessed a slowdown leading to a decline in industrial output over the year. The HSBC Purchasing Manager’s Index (PMI) in manufacturing was down at 50.7 points in December 2013 from 51.3 in the previous month. The Index of Industrial Production (IIP) contracted to 1.8% in October 2013. The manufacturing sector declined by 2% in October compared to a growth of 9% in same period last year. The mining sector saw a contraction of 3.5% in October
as against a dip of 0.2% in the same month last fiscal. Power generation, however, posted a growth of 1.3 percent in the month under review compared to 5.5 percent a year ago. Though India is the country with the 5th largest coal reserves, the country is grappling with fiscal deficit due to increased imports of coal. According to the latest International Energy Outlook report of US-based EIA, demand for coal in India is set to double by 2040 while production may stagnate resulting in more than doubling of imports to 281 million tonne by 2040. Coal India
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Limited, which produces 80% of the nation’s coal requirements, is facing internal problems mainly pertaining to technological upgradation needs. This requires restructuring of the coal units which is being strongly protested by the laMonth Mining 2012-13 2013-14 Oct - 0.2 -3.5 Apr - Oct -1.0 -2.7 bour unions. Moreover, several private companies are under CBI scanner after the CAG alleged a scam over the allocation of captive coal mines. The decline in the coal output affected thermal power generation which decelerated to 1.8% during April-August 2013 from 8.6% last year. In 2014, clearing the coal blocks held for environment clearance will be a big challenge. The government should clear the roadblocks as soon as possible and conduct fresh auctions of the disputed mines. The government should attract foreign investments in mining industry and improve coal production to meet the domestic requirements and subsequently reduce fiscal deficit. With improvement in the coal output, more power generation will result which will ultimately lead to a boost in the manufacturing sector.
In the upcoming year, the government in coordination with the central bank has to address various issues. Due to introduction of populist measures such as Food security bill and increased Overall subsi2012-13 2013-14 dies, the 8.4 -1.8 fiscal 1.2 0.0 deficit has widened which needs to be brought under control. To tame that, the government has to decrease spending and increase revenue receipts which are only marginally possible now through non-tax reforms. Due to supply side constraints and infrastructure issues, the food as well as the retail inflation is on the rise. The central bank is not being able to infuse liquidity in the system through a rate cut due to inflation concerns. Without liquidity in the market, the cost of borrowing for businesses is becoming costly, which is holding up more investments and increasing unemployment. Therefore, more foreign infrastructure investments, tax reforms to generate more revenues, power generation through clearing the policy logjam on coal issue, boost in the manufacturing sector and creating an investment friendly government for businessmen are the needs of the hour to bring back the country on a 7-8% growth track.
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REIT’s - will they breathe life into India's comatose real estate sector? BY ROHAN DHALL, SHARMAN MOHITE & TRIDIB PILLAI, NMIMS - MUMBAI
I n K The author is a Computer
n
Engineer from Mumbai University
In a move to increase the depth of the Indian Real Estate Market, in terms of exit as well as financing options for developers and new avenues for investment, The Securities and Exchange Board of India (SEBI), has decided to allow Real Estate Investment Trusts (REITs) in India. The following article attempts to dissect this seemingly abstruse yet highly innovative investment vehicle from a global perspective where its impact is palpa-
and
dividends. These dividends, in addition to price appreciation form the main source of payoffs for investors.
currently
Types of REIT:
NMIMS, Mumbai.
MBA
pursuing
is
O
an
in
Banking
Management
from
W
L
Equity REIT – These typically invest directly into incomegenerating real estate projects like Apartments, Malls, Commercial Complexes etc. They may even be responsible for managing them by virtue of the kind of agreement entered into. Sales,
E D g E The author has done B.Com (Banking and Insurance) and is currently pursuing MBABanking from NMIMS, Mumbai
rentals and service charges are the revenue streams for the REIT.
ble and attempts to evaluate its suitability in the Indian context. Real Estate Investment Trust (REIT) is a real estate company that offers securities that trade on stock exchanges like equity shares and in turn it invests into incomeyielding real estate projects. On a whole similar to any other equity investment, REITs has two unique features – the management of income producing properties remains its main function, and most of its profits have to be distributed as
Mortgage REIT – The REIT invests in existing mortgages, mortgage-backed securities or may even advance money to realestate owners for mortgages Hybrid REIT – A combination of Equity and Mortgage REIT structures primarily adopted for the mitigation of risks and to seek enhanced returns. More common in the healthcare sector where the trust can advance mortgages to
The author is a Mechanical Engineer from Mumbai University and is currently pursuing MBA in Banking Management from NMIMS Mumbai.
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healthcare companies and also buy medical office parks. Dividend yield: Equity REIT < Hybrid REIT < Mortgage REIT Price appreciation: Mortgage REIT < Hybrid REIT < Equity REIT Global REITs Footprint The figure illustrates the various countries that have embraced REITs and those that are still contemplating doing so. Since its introduction for the first time in 1960 in the US, it has managed to gain a wide acceptance across the world and currently enjoys a significant market capitalization in most of the global financial markets. Every country has its own policy framework within which different manifestations of REITs have evolved. The US REIT for example has rigorous transparency and mandatory disclosure requirements in addition to strict conditions that ensure 90% of the taxable income is paid out to unit holders as dividend. However, this portion is deductible for tax purposes. Also the US REIT must be widely held and must derive a major proportion of its income from real estate held for a long term. The Japanese version referred to as JREIT resurrected the real estate markets in Japan after its introduction in 2000-01. Its management structure is external and hence varies from the US REIT. Another popular destination for REITs is Singapore where listing of the REIT is mandatory on the Singapore Stock Exchange. Taxation treatment in Singapore is similar to the US. However, unit holders are taxed on the payouts they receive from
the trust at income tax rates. Despite the myriad structures, one can safely conclude that REITs are an immensely popular channel for portfolio diversification on the markets they operate in. Case for introduction of REITs in India The following factors make REITs such a compelling investment class world over and the prospect of being able to replicate the success in India seems quite inviting. 1. Superior returns at lower levels of risk: REITs are characterized by a great deal of predictability arising out of stable nature of rentals and occupancy rates. They also have low correlation rates and higher levels of liquidity. On an average, REITs have a D/E ratio in the range of 0.5 signifying lower leverage. All of these are indicative of lower levels of risk. Exhibit reflects the historical returns achieved by REITs over 4 decades juxtaposed with those witnessed by other similar investment avenues. Securities that offer such consistent and high rates of returns at lower risks become a natural choice for portfolio diversification. 2. Hedge against inflation – As an asset class, real estate offers an excellent hedge against inflation. However, the huge quantum of investment required, associated illiquidity and lack of transparency deter the small ticket investor from being able to leverage this feature. REITs will provide the same hedge against inflation and owing to its lower entry load would protect the “Average Joe” from increasing inflation by yielding positive and appreciable “real” returns on investment.
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3. Infuse a high degree of transparency into a traditionally opaque sector – It would help clear the smokescreen surrounding Indian real estate dealings. Improved reporting and disclosure requirements in addition to stringent regulatory and supervisory oversight by market watchdog SEBI is likely to heighten the extant standards of corporate governance, improve real estate market efficiency by eliminating issues of moral hazard and adverse selection and thereby safeguard the interests of the smaller retail investors. It will also streamline and institutionalize the process of raising finance and flag several risks associated with clear titles, project viability and minimizing transaction costs. 4. Opportunities for investors in every business cycle – Most real estate markets witness four discernable phases that constitute the real estate business cycle. One of the foremost reasons that have made REITs a runaway success is their ability to offer lucrative business alternatives in every phase of the cycle. 5. Mobilize financial resources – This is vital to a sector that is currently witnessing a paucity of financial resources in India attributable to high risk perceptions and enhanced regulatory curtailments that makes access to capital expensive and arduous. EY estimates peg investments to the tune of US $ 42 billion in Indian real sector fuelled by growing urbanization, shifting demographics and generation of employment opportunities in urban areas. REITs will prove to be a game changer to bridge the vast investment gap and fuel growth in the real estate sector at lower costs of capital. Exhibit depicts the proliferation of REITs in leading Asian markets and is an emphatic assertion of their popularity and success. PROPOSED REGULATORY FRAMEWORK: Realizing the importance of REITs, a regulatory framework has been proposed under draft SEBI
(Real Estate Investment Trusts) Regulations, 2013. Some of the prominent features of proposed framework are as follows: 1. Structure of the REIT: REIT will be set up as a Trust under provisions of Indian Trusts Act, 1882. It will consists of:i. Sponsor: Sponsor should have minimum net worth of Rs 200 million and at least five year of experience in real estate ii. Manager: Manager should have minimum net worth of Rs 50 million and at least five years of experience in fund management iii. Trustee: Trustee should be registered with SEBI and 50% should be independent directors 2.
Investment conditions and Dividend Policy:
i. It has been mandated that at least 90% of the value of REIT assets will be invested in completed revenue generating properties ensuring return for investors and reducing risk-return. Remaining 10% can be invested in Government Securities, debt of Listed/ Unlisted corporate companies ii. To ensure regular income to investors, at least 90% of net distributable income after tax of REIT should be distributed among investors iii. REIT shall not invest in vacant or agricultural land and shall invest only in assets based in India iv. Investment up to 100% of corpus of REIT can be invested in one project provided minimum size of such asset is more than Rs 1000 crores v. Leverage of 25% is ordinarily allowed and leverage up to 50% is allowed only after getting positive consent from unit holders and credit rating vi. All related party transactions by facilities manager will be on arms-length basis and will be in best interest of investors; in line with the investment objective of REITs vii. Real estate investment trust can invest at least 51% in real estate directly or they can invest in SPV (Special Purpose Vehicles) which in turn holds real estate assets viii.Guidelines related to listing of REITs:
Minimum value of REITs assets : Rs 10 billion 17
Minimum public float - 25%
Minimum issue size of lots is Rs 100 thousand and for trading lots it is Rs 200 thousands
FDI/FII should be allowed under automatic route by the amendment of FEMA
Sponsor needs to invest 25% in REITs for three years since inception and continue to invest 15% till lifetime of REIT.
Exemption of Stamp-Duty when asset is purchased or sold by the REIT or rationalization of the Stamp-Duty structure
There can be minimum 20 outside unit holders in REITs.
Inclusion of ports, roads, airports and other completed infrastructure projects in REITs
Explore a relaxation in the minimum 5-years eligibility criterion stipulated for ‘Sponsors’ to enable other entities with prodigious portions of land to act as ‘Sponsors’.
3. Rights of Investors: i. Investors will have the right to remove manager, auditor, and principal valuer and can also apply to SEBI for change in trustee ii. An annual meeting of all investors needs to be conducted by trustee where information like performance of REIT, appointment of principal valuer, latest annual accounts needs to be disclosed in front of investors iii. Detailed Disclosures needs to be given in annual and half yearly valuation reports to ensure transparency and protect investor’s money SEBI has requested comments and opinions from the various stakeholders and public at large on its draft regulations. The following nagging issues often feature as a part of erudite discourses on the topic:
Single level of corporate taxation (either at REIT or SPV level) or pass through taxation and elimination of all other intermediate taxes including those on distributions received by unit holders
Clamor to seek one-time tax exemption when the REIT is created by a sponsor
In the event of payment of STT, the trading of REIT units on the stock exchanges must be ex-
empt from long-term capital gains tax
Industry is seeking a relaxation of sponsor eligibility criteria with regard to requirement of 5 years experience in the realty sector. There is also a feeling that the norm mandating 90% investment in completed projects is too harsh and it should be brought down to 75%. CONCLUSION: Globally, REITs have been effective in attracting and managing investments in the Real Estate sector. This, along with an ever increasing demand for quality real estate in India, which REITs can help meet by bringing the required investments in the real estate sector, make the case for implementation of REITs compelling enough to drive policy makers to act fast on the implementation of a similar regime in India with requisite adjustments, keeping in perspective the unique dynamics of its economy. The issue of draft guidelines by SEBI should provide a fillip to the sentiment in the real estate sector, and help attract capital from overseas markets.
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Are we on a path to recovery or it is the central banks' effect across the world. Is another crisis looming ? BY PUSHPANJALI MITRA, SIMS “Lender of last resort” is what a Central Bank of any country is known as. Central Bank is an institute that can exercise its power of damage control if the economy goes for a toss. From ages, whenever a country undergoes a crisis, the central bank always comes for its rescue by implementing the various financial tools it possesses. No matter how big the crisis is, the Central bank of the respective country always manages to bring the economy back on track. Let us analyse what measures have been adopted by various central banks during the recent period of stagnant economic growth in the world. ROLE OF BANKS 1. US FEDERAL RESERVE Quantitative Easing (QE) – A term which wasn’t even heard 5 years ago has become a general topic of discussion these days and is understandable by anyone who’s a little interested in the world economy. The dual agenda - of maintaining the dollar’s value (i.e. managing inflation) and managing the rate of unemployment - resulted in the Fed’s consecutive 3 cycles of the QE program. With the initial pumping of $1.7 trillion of QE1 ( first cycle of QE) in the economy the process was followed by an infusion of another $ 600 billion during QE2 and eventually QE3 (still going on) at a rate of $75 billion
per month since Nov 2012 (recent tapering by $10 billion in bond purchases). Till now, a total money infusion of $ 5 trillion has been done in the economy. The tapering was an indication of the betterment of the economic situation of the country accompanied with low unemployment rates, a stable home currency (USD), increase in the mortgage value of the houses, gradual inflation, an increase in the GDP figures and an increase in the exports and purchasing ability of the country. But there is a down-side to this process. The monetary stimulus given by the Fed is going to fortify the economy by encouraging banks to lend more hence, leading to increase in borrowing, investment, and spending.
Pushpanjali Mitra is a B.Tech (IT) from West Bengali University of Technology and she is presently pursuing MBA in Finance from Symbiosis Institute of Management Studies. Email ID: pushpanjali.mitra2015 @sims.edu
By lowering the interest rates, the policy of the fed reserve has deprived the depositors from the interests that they would have earned on savings accounts, certificates of deposit, money market funds, short and longterm treasury bills and various interest generating annuities held by the retirees. The process of QE, which is the purchasing of bonds from the commercial banks of the country by the central bank to infuse money into the banks so as to make the currency easily available to spend, invest and trade, has a flip side. Quantitative easing helps in financing a budget deficit since the Fed continuously buys many bonds, but like everything, when the period ends, things 19
turn out to be a little difficult. After the real estate credit crisis bubble, economy slowed down, sales plunged and a recession started setting in and the US treasury came up with what it is known as the bailout bubble that resulted into the introduction of more and more money-stimulus packages in the economy. After the real estate bubble burst, it was time for the world to face the consequences. Fannie Mae and Freddie Mac, the government sponsored enterprises, established to buy up the mortgage backed securities were taken over by the Federal. Lehman Brothers was not bailed out and became bankrupt. Merrill Lynch was on the verge of bankruptcy and underwent an acquisition by BofA for $50billion. Along with these an infusion of $700 billion was done by the US government - the biggest bailout in the history of the US government known as TARP (Troubled Assets Relief Program) - to shore up the common man’s confidence and capital by buying out the toxic assets of the financial institutions . Bear Sterns was bailed out by the Maiden Lane Transactions created by the Federal Reserve of New York and was acquired by JP Morgan Chase along with the AIG bailout where AIG was taken over by the US Companies.
400 trillion Yuan (approximately $600 million in 2009 rate) in order to avoid the downturn of the economy. China suffered an interbank market crash in the first half of 2013.The bank was already having a hard time to keep up the deposit-to-loan ratio (a technique used to check the amount of liquidity available in the banks for the lenders) requirements, even before the liquidity shortage hit the economy. Banks didn’t have money to lend to the people and the loans were kept on hold. The tightened liquidity, which approximately started on June 6, impacted the intermarket, stock market and security refinancing companies. The overnight lending rate (the rate at which the banks lends money to each other overnight) jumped to 25% clearly showing the reluctance of the banks to lend money to each other. The amount of total credit in China’s financial system reached epic proportions reached unsustainable levels. The world had never before seen a debt acceleration of this magnitude in any country ever. This was also knows as the Lehman moment. It has increased eight-fold in the past 10 years and is now around 220% of GDP.
2. PEOPLE’S BANK OF CHINA (PBOC)
The reasons associated with the Credit crunch or ‘SHIBOR Shock’ (Shanghai Interbank Offered Rate, a benchmark interest rate) which contributed to spike the inter-bank rates included the sharp fall in the foreign exchange inflows due to the government crackdown and illicit activities. If this case would have happened in US, the Fed would have infused money instantly but the PBOC (People’s Bank of China) sat on its hands refusing to inject liquidity.
In China the monetary policy and financial institution are controlled by the PBOC, though at times the communist party through its supremacy influences the decisions of PBOC.China is an economy which is semi-intervened by the central bank or the people’s bank of China when suffers from liquidity or credit crisis. During the US recession, China printed
The explanation which the PBOC gave was that it wanted banks to slow the pace of lending money. PBOC wanted to curtail funds that were flowing into the country's vast informal loans market. Generally there is a shortage in liquidity at the end of the year for different banks of China as companies increase their demand for capital. The growing shadow bank 20
ing system of China, which tends to offer higher interest rates to investors, has also been pumping out funds from traditional banks. Investors feared the combination of Fed tapering and the Chinese high interest rates impacting the stock market. The Chinese equities sank to 4 year low. Its tough stance of allowing tightening the cash flow in the economy raised fears of a lasting credit crunch and affected the markets globally. Soon, when the Shanghai stock market started seeing its all-time low since the US recession, PBOC appeared to soften its position slightly. To allay the fear of credit crunch, PBOC pumped in 29 billion Yuan ($4.8 billion) into the economy via open market operations resulting in the fall of the interbank rates almost by half (it surged to almost 18% and fell to 9% after the infusion). 3. BANK OF JAPAN The Bank of Japan has introduced a larger bond buying program in comparison to the Fed, to revive the Japanese economy and break the shackles of deflation that have plagued the Japanese economy for the past two decades. The BoJ is buying ¥7.5-trillion of government bonds (JGB’s) per month, and intervening directly in the equity market, by purchasing ¥1 trillion of exchange-traded funds linked to the Nikkei-225 each year. The BoJ aims to inject $1.4-trillion into the Tokyo money markets by April ‘15, equal to a third of the size of Japan’s $5-trillion economy. These actions have mainly been the result of public mood and the decisive leadership of Japan’s PM Shinzo Abe. These measures to revive the Japanese economy have been termed by some as ‘Abenomics’. This is showing result, as the Nikkei broke its historic highs recently, business sentiment is at a 6 year high and
price have risen slightly. 4. RESERVE BANK OF INDIA In a span of few months, the economic situation of India has become better than what it was during the initial months of this fiscal year. Low GDP, depreciating rupee, high current account deficit (CAD), ineffective reforms and policy paralysis were holding on to the progress of the country. Another event which happened during this time was the Fed reserve chairman Ben Bernanke’s announcement of tapering of the QE. The announcement had repercussions in India resulting in an outflow of capital. The announcement made on 19th June led to the crashing of Sensex by 526 points and only two stocks, Sun Pharma and Ambuja Cement closed in the green among the Nifty 50. Gold tumbled and the foreign investors offloaded Rs 2,094 crore from the equity market. This followed the second quarter in which the dollar exchange rate of rupee touched its lowest value ever of 68.38 on August 28, 2013. All the major sectors were under turmoil and where probably seeing the lowest figures of sales and profits ever.
Every change made by the RBI and finance ministry was having the exact opposite impact on the economy which made people think that India is approaching towards a recession which will shake the financial system. Soon Raghuram Rajan became the governor RBI and gradually things were under control. With the different swap windows opened, new bank, and the various reforms under taken to appreciate the rupee the rupee almost touched 60. The estimated fiscal deficit of this year is expected not to be beyond 4.8% of the GDP which is termed as the “red line” by P.Chidambaram.
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Along with this tool, the other methods adopted by the Reserve Bank is to allow the foreign banks which has commenced the banking services in India before August 2010 to work in their branch mode and were incentivised to be converted into WOS (wholly-owned subsidiaries), but banks which have started their operations after 2010 need to fulfil a bunch of criteria to qualify the test of RBI. The initial minimum paid-up voting equity capital for WOS shall be Rs 5 billion, the bank should be meeting all the BASEL III requirements, and should be maintaining a CAR (Capital Adequacy Ratio) of 10% for the past 3 consecutive years and also the lending requirement for the WOS would be 40% of its net worth. The new policy says that at least 25 percent of the total number of branches (initially proposed by Dr Subbarao) that is opened during the first financial year must be opened in unbanked rural area. CONCLUSION The Fed has always chosen the easy way out usually by infusing money into the economy. The general perception is by giving money into people’s hands, the economy will be the same as the pre-global meltdown era which actually is not possible. Most of the big economists have criticised the usage of quantita-
tive easing since it’s a temporary and short term money producing instrument that affects the economy on a long run. Quantitative easing is meant to benefit the wealthy. The US QE program led to the rise in the stock and home prices that mostly benefits the wealthy. If the central banks try to avert higher inflation and interest rates when the economy starts growing again, it has to drain the money it has pumped into the banks before gradually reduce the money supply. More the money infused, more will be withdrawn to the extent that high money creation has boosted asset prices. In case of PBOC, infusion of money into the economy was a correct decision, in fact, the decision should have been taken earlier else the world wouldn’t have felt the pinch. China is sitting on the largest pile of dollar reserve in the world and the moment it starts releasing the currency the demand of dollars is going to fall. But since China is an export-oriented country, they will think twice before doing that as it will directly hamper the valuation of China’s exports. QE can be an efficient measure if used in a proper way. Using for US and for UK back in 2009 never made the impact but in case of China, it actually helped the economy to come out from a recession. In India also most of the reforms that are taken up by the RBI are long term which directly impacts the micro-economy of the country.
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I
The Rivalry That Turned Goldman sachs ‘GoldEn’ BY JEENOY PANDYA , NMIMS, MUMBAI
This is the tale of the two legends in the field of finance whose rivalry played an instrumental role in conferring the name & fame to a firm who started by marketing paper for commercial use but is now one of the most venerated companies in the field of Investment banking, Goldman Sachs.
Sachs as a janitor’s assistant & went on to become the CEO of Goldman Sachs. Apart from his mettle (a dropout from school who saw meteoric rise to power), it was the liking which Paul J Sachs (the grandson of the founder; firm is named eponymously) took to Weinberg that made his rapid ascension to power possible. To hone Weinberg’s skills, P J Sachs sent him to business school in Brooklyn’s Browne Business College & then after a brief stint in the navy during World War I, when Weinberg joined back the firm, it was as a securities trader.
N L Jeenoy Pandya is a B.E. (Mechanical) from MS University, Baroda & he is presently pursuing MBA from NMIMS, Mumbai.
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Email ID: jeenoypandya @gmail.com
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s
The stalwarts we are talking about are none other than the successive senior partners at the firm, Sidney Weinberg & Gus (Gustave) Levy. The firm not only witnessed unprecedented & unmatched growth rates during the tenures of these Because of his extwo legends but ceptional skills, also diversified Goldman Sachs into the multitude bought Weinberg a of businesses it is seat on NYSE in Sidney Weinberg in now with Sidney 1925. He became a partWeinberg & Gus Levy being the ner in 1927, co-running the division champions for Investment Banking with Waddill Catchings during which & Securities Trading businesses period the market cap of firm shrunk respectively. Here’s an insight in to a meagre $10 million from $500 the lives & careers of these two million. Weinberg rose to the occalegends. sion, wrested Senior Partnership from Catchings & saved the firm Sidney Weinberg from bankruptcy. He held this posiIn a real life rags to riches story, tion until his death in 1969. Sidney Weinberg joined Goldman
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Weinberg championed investment banking which gave a defining direction to the firm’s business & made it one of the most prominent firms around in the field of investment banking, a privilege the firm still enjoys. It was during the later years of his tenure that Weinberg encountered the growing influence of Gus Levy, a force to be reckoned with & who had ideas conflicting with Weinberg’s own regarding the strategy for the future of the firm. The naturally resulting competition proved to be highly beneficial to the firm. Weinberg finally had to give in & appoint Levy as his successor but he formed a supervisory committee to oversee the functioning of Levy which greatly limited the latter’s powers. Weinberg’s story still remains one of the most inspirational ones & he’s remembered even today at Wall Street with love & with respect.
Gus Levy
1969. Gus Levy pioneered several techniques in the field of securities trading such as block trading & amassed great respect for the same. During his tenure as Senior Partner (1969-76), the firm achieved stupendous growth, arguably, even more than that during Weinberg’s Tenure. Despite his remarkable career, the firm got embroiled in some major controversies under his leadership such as “Penn Central bankruptcy commercial paper capital” which tarnished the firm’s reputation for years to come. Levy suffered a major stroke in October 1976 following which he went into a coma, one from which he never recovered. He died at a relatively young age of 66 but till date remains one of the giants of Wall Street.
The rivalry that forged the golden future
No doubt, several great men His story being equally inspirationhave played part in transforming al, Gus Levy too was from a humble Goldman Sachs from what it background. He dropped out of was, a company who marketed Tulane University & plunged into paper for commercial use to the financial sector after spending a what it is today, the company Gus Levy few years in which he joined Goldwhich pioneered the use of commerman Sachs in 1933 where he would work for the rest of his life. People who knew him described him as cial paper (short-term debt instrument used by large very acute, volatile, magnanimous & a powerhouse corporations), but the role that the duo played is special. of energy, He joined the firm as the head of a one-man trading Many a rivalries has destroyed companies but this division, the same division which he championed one is particularly intriguing as despite it being in later in his career. He endeavoured to shift the firm’s the field characterized by cut-throat competition, focus from Investment Banking to Securities Trad- high risks & high rewards, proved to be highly proing which he was able to accomplish to a great ex- ductive for the firm, giving it strategic direction & tent. This & his growing clout at the firm put him at staggering growth. Till date, the verticals that this loggerheads with the then Senior Partner – Sidney duo devoted their lives & careers to (Sidney WeinWeinberg. Weinberg held his own initially but ulti- berg – Investment Banking, Gus Levy – Securities mately had to yield & although begrudgingly, ap- Trading) remain at the heart of multi-billion dollar pointed Levy his successor as Senior Partner in business of Goldman Sachs. 24
Facebook and Twitter going public BY JAY PARIKH, NMIMS, MUMBAI & DHAVAL SHETH, SIMSREE, MUMBAI In December 2011, Facebook was the second most visited website behind Google. At that time, Facebook had almost 845 million monthly subscribers. An investment report valued the company at $50 billion. With huge present profits of $1 billion and high expected growth in future, Facebook decided to file for an IPO with the Securities and Exchange Commission (SEC) on February 1, 2012. The idea was to value the company at about $100 billion. Facebook followed the Silicon Valley tradition to list on NASDAQ.
million shares. The reason behind this high price of $38 was the strong demand despite economic slowdown. Also, investors didnâ&#x20AC;&#x2122;t want to miss out on the massive gains Google and LinkedIn saw. On 8th May, 2012, the trading of Facebook shares was supposed to begin. However, technical glitches with the NASDAQ exchange resulted in a delay of half an hour. Several orders were blocked and even confused investors whether or not their orders successful. As a result the share price fell to $38.23. Although the shares traded at just 0.23 more
Jay has completed his BE in EXTC in 2012. He has worked with Accenture in SAP BOXI before joining NMIMS. Email ID: parikhjay1701@gm ail.com
Dhaval has completed his BE in EXTC in 2012. He has worked with Accenture in CRM before joining SIMSREE. Email ID: dhavalsheth @gmail.com
Figure 1. Facebookâ&#x20AC;&#x2122;s stock price vs the NASDAQ composite
This IPO was led by Morgan Stanley. Initially the company aimed to $28 to $35 per share. Finally it settled for $38 per share. This price valued the company at $104 billion. It even decided to increase the number of shares by 25% to 460
than IPO price, the IPO raised $16 billion. The stock price eventually reduced to as low as $20.011 in August 2012. Today, the share trades at almost $55 eventually lead to a market capitalization of $140 billion.
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NASDAQ had to offer $40 million to investment firms for the technical problems. Also lawsuit was filed against Morgan Stanley for selectively reveal-
in November, one of the year's best months for market gains.
On 7th November, 2013, NYSE got the stock open and trading in 90 minutes. The share Figure 2. Twitter’s stock price vs the NASDAQ composite price rose as high as $50.09 and closed at $44.90 per share. The undering adjusted earnings estimates to some investors. The other underwriters also faced similar litigation. writers did not have to buy stocks to keep it above This has eventually raised eyebrows against finan- IPO price as in the case of Facebook. The share cial companies manipulating to benefit few investors price rose by 75% which is one of the highest on the first trading day. The IPO raised around $1.8 billion to gain loyalty. and gave the company a valuation of $14.4 billion. What was meant to be one of the successful IPO Also the money raised through IPO was to be used turned a bungled and botched one. Twitter, a micro- for general corporate purposes, capital expenditures blogging site, shows almost the same growth pro- while Facebook’s IPO mainly went to early sharespect as Facebook. However there were few notable holders. differences when they registered for IPO. Twitter has only 215 million monthly active users. As com- Twitter released fewer shares as compared to Facepared to Facebook, Twitter is not profitable. While book and thus the demand exceeded than supply. Facebook entered IPO after seeing a lot of growth, Although, Twitter was able to have a successful twitter went public at an early stage in the growth IPO, it did put in further questions. Has Twitter been cycle. The Facebook IPO was a learning experience over cautious and undervalued the company. This for Twitter and it successfully avoided the same fate. seems to be in contrast with Facebook’s overvalued shares. Unlike Facebook, Twitter never revealed its wish to go public until it filed for an IPO. And Twitter didn’t Facebook went for an overpriced I.P.O., and the follow the Silicon Valley tradition. The IPO was led company’s shares lost much of their value as a result by Goldman Sachs. Goldman Sachs worked to keep of it. Twitter avoided that mistake by under-pricing much of the offering of the hands of retail investors its shares. Companies go public to make some monand hedge funds. And it chose to be listed on NYSE. ey that they can invest in their business; an underThus Twitter was committed not to make same mis- priced I.P.O. means the company is bringing in less takes that Facebook made. The firm was generating than it could have for every share it sold. $500 million revenues and thus it aimed to generate $2 billion through IPO. This move was ambitious Just looking at the current valuation, the value per but possible for this 140 character micro-blogging user seems to be the highest for Twitter. website. Initially the share was to be offered at $18$20 per share. However the share was priced to be at $26 per share. And the trading day was decided to be 26
However Valuation ($Bn) in terms of monthly $24.46 Twitter unique $25.25 LinkedIn users as $115.5 Facebook KPI, Table 1: Valuation of Twitter, LinkedIn and Facebook LinkedIn outperforms Twitter. Twitter has something powerful which Facebook and LinkedIn does not have. The power of tweets and this power are not just confined to the platform. Today it extends to TV and even in print media. If such indirect users are counted, possibly the valuation looks very cheap now. Twitter sold 70 million shares for $26 when actually it could have sold at $45. It made less than $2 billion where more than $3 billion was possible. But both Facebook and Twitter successfully reached a valuation remarkably high given their financial fundamentals owing to innovative technology and high anticipated growth. As compared to Facebook, Twitter has an advantage of mobile advertisements. Facebook still will be more of desktop application. This makes twitterâ&#x20AC;&#x2122;s growth after IPO more interesting. The third quarter 2013 financial returns of Facebook show income increased by 100% to $621 million
compared to a loss of $311 million in 2012 230 $106.35 Q3. The 259 $97.49 growth of Fa1190 $97.12 cebook after IPO has tremendously increased from both advertisements and mobile advertisements. The number of daily active users has increased by 27% on y-o-y basis. And this figures reflected back in the share prices which now trades at a range of $50-$55. On the other hand, Twitter underwriters have mixed opinions on the stock where 2 of the 5 companies rating it as a buy, other 2 as a hold and one as a sell option. Twitter also has not made profits for last three years and lost out $133.9 million, 89% increase from same period of 2012. However Twittersâ&#x20AC;&#x2122; stock has been very volatile where it reached $80 and suddenly fell to $60 in 5 days. Although Twitter has played well on the first trading day, will it be able to stabilize? Will the stock grow with such a bright future? And companies with innovative technology and high growth would be able to learn from Twitter and Facebook and launch a successful IPO? Users (Mn)
Value/User
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g
R
Grassroots BY SARTHAK MOHANTY, NMIMS, MUMBAI
As an earnest endeavour on the part of the Finomenon team to apprise our readers of the economic impediments faced by people from the lower strata of our society; the so called "bottom of the pyramid", we focus our attention on a section of the population, which although termed "indigenous", is one of the least developed in terms of the level of income and standard of living. It is indeed an unfortunate fact that these communities, popularly referred to as "Adivasis", primarily concentrated in the eastern and south eastern parts of the country (the states of Jharkhand, Chattisgarh and parts of Odisha and Andhra Pradesh) have been left out of the bandwagon of mainstream economic progress. We take three such examples to drive the point home.
quite candidly. As of Januaryâ&#x20AC;&#x2122;14, his daily routine and the business activities of his shop are as follows:
Sushant (age 27), paan shop owner, Koraput (Odisha)
Manoj(age 32), tea stall owner, Bastar(Chattisgarh)
He inherited the shop at the age of 9 after the death of his father in 1996 and has been running it to sustain himself, his wife, 3 kids and his old mother. His family has been illiterate for as long as he remembers. "No one in my family has ever held a pen or speaks any other language except Oriya and the local tribal tongue", says Sushant
His case a bit different as he has set up the shop quite recently after taking a loan from his brother-in-law in 2012. He hails from a small tribal village 80 kms from bastar. He was a daily wage labourer in a road construction project from Bastar to Raipur. People like Manoj are part of what we refer to as the unorganised labour market. They have no steady
Number of working hours: 14(8 am to 10 pm) on all 7 days. Average daily sales: Rs 300
A Sarthak Mohanty is pursuing his MBA from NMIMS, Mumbai. He has worked for Accenture Services Pvt Ltd. He holds a B.Tech degree from KIIT University, Bhubaneswar. Email ID: 13julys@gmail.com
S S R O O t s
Monthly rent: Rs 1000 Cost of supplies: Rs 4000 He stays at a rented chawl on the outskirts of the town with his family and has to cycle 8 kms daily to the marketplace. His kids study at a government run primary school run under the "Sarvashikshya Abhiyan" which has a mid-day meal facility. Life, in general is quite tough and is a handto-mouth situation considering the additional cost of medicines for his ailing mother.
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employment commitments. Manoj worked as a waiter in a local fast-food restaurant 4 years back. He has also worked as a cycle rickshaw puller and a security guard for a housing colony. He has a family of four (wife and 2 kids) and stays in a relatively decent on the outskirts of the town. Unlike Sushant, he takes a bus daily at 7 in the morning and works at his stall for 10 hours(8 am to 6 pm). His business schedule and earnings are as follows: Average daily sales: Rs 600(around 100 visitors daily and a glass of tea costing Rs 5 or Rs 10). Daily variable cost of supplies(milk, sugar, kerosene, water supply): Rs 150 Fixed cost (stall, kettle, glasses): Rs 4000(invested initially by taking a loan) Daily travel expenses: Rs 50 (to and fro by bus). His wife works as a house maid in the town and earns around Rs 2500 monthly and his kids study at the bastar municipal school. The average monthly income of his family, thus, is around Rs 14,500 which is quite better than the previous case. He pays a house rent of Rs 4000 and spends around Rs 7-8K for food, clothes and his children's books and school fees(a nominal price). He is able to save at least Rs 6 -7K monthly. Kaushalya,(age (Jharkhand)
19),
domestic
help,
Bokaro
She has stayed in Bokaro for the last 5 years. The steel plant in the town established in 1964 has attracted a lot of tribal youngsters from the nearby villages to work as domestic servants, auto-rickshaw drivers, security guards and construction-site workers for decades. Kaushalya works at the house of a senior officer in the steel plant and stays at the servant quarters. She is provided with food 4 times a day
and enjoys a fairly decent life with a salary of Rs 4000 per month. She visits her village once a month and is able to send 1500 per month to her family consisting of her parents and a younger brother who is in high school. Her father is a vegetable vendor back in the village and earns Rs 1800-2000 per month. Her situation is tenuous as she is about to attain marriageable age and is the major contributor to her family's income. She is a school dropout (in class 4) and can barely read Hindi. Conclusion The current tribal population of India is around 84.51 million (around 8.14% of the country's population). Agriculture as an occupation has lost its appeal among the young generation and a lot of the tribal youth are migrating to towns and semi-urban areas in search of a better standard of living. Lack of formal education and skills manifest themselves in the form of a wide disparity in income levels. The vicious cycle of poverty and lack of decent employment opportunities is a major concern. The central and respective state governments have undertaken development plans like the NREGA and the improvised Public Distribution System but a sustained enhancement in the level of economic self-reliance can be achieved by accommodating such people into the organised financial sector by opening up more banks in tribal regions and encouraging them to take advantage of credit facilities. Microfinance initiatives can also be undertaken in villages. Vocational training facilities can be provided in government run schools under various national schemes at the highschool level to equip teenagers with skills required to earn a livelihood in towns and cities. Such measures would go a long way in widening the horizons of our economic policies and transform the lives of thousands of individuals untouched by the boon of economic development.
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how can IndIa’s recuperated?
GRowTh
bE
BY NIBODH SHETTY, SIMSREE, MUMBAI It is often heard now a days that India’s growth story has been deferred till May 2014. The citizens of the country and analyst across the globe believe that only Narendra Modi can revive India’s growth story and the worse scenario would be the same government being voted back to power in 2014. The current government has lost its credibility and is pushing India to pre 1991 era. The incumbent government and its authorities will never accept, but India is currently in a state of stagflation (i.e low growth and high inflation), this fact is rebutted by the latest GDP and inflation numbers which stand at 4.4% and around 10% for CPI respectively. Our fiscal deficit and current account deficit are ballooning at an alarming rate. The fiscal deficit has already reached 94% of budgetary estimate in 2013 and now there is 1 more quarters to go. To widen it further the Government passed the food security bill.
As per popular sentiments the incumbent Government will be voted out of power in 2014 elections. They are trying their best not to lose by a huge margin. This fact is conspicuous by their folly of passing food security bill in this debilitated economic condition, without caring about the catastrophe this bill will bring upon our economy. The UPA blames the opposition for policy paralysis which has led to the current state of economy.
The most important problem is that of ballooning fiscal and current accounting deficit, which is causing a variety of other problems like rupee depreciation, slow growth, inflation, high interest rates, etc. CAD has reduced but only on papers. No one is tracking gold smuggling but gold is being smuggled into India at an alarming rate from our neighbouring countries. The revenues which we could have gained from duties on gold are now being lost.
Nibodh is currently pursuing MMS from SIMSREE, Mumbai. He likes to write analytical articles on varied subjects including finance. Email ID: nibodhshetty @gmail.com
With the same numbers in Parliament there are several steps which the UPA can take to revive the growth. These steps are politically possible and the corresponding policy for those steps can be framed without much arousing acrimony. Whichever the next Government that comes to power in May 2014 or before that in case of early elections, it is imperative that they take these steps. The fiscal deficit can be reduced by reducing number of subsidies, prudent spending by ministries like they did last financial year and suspending the MNEGRA scheme for 2 years in the areas where this employment scheme has failed to deliver. The Food Security bill must be scrapped, as currently the problem in India isn’t hunger its malnutrition. In 1984 27% of population said they were hungry in 2004 just 1% of the population said they were hungry. The poor cannot afford balanced diet due to high prices of dairy products and
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other nutrient rich fruit and vegetables, hence inflation is the main problem not hunger. Commission for Agricultural Cost and Price (CACP) has found a huge correlation between fiscal deficit and inflation in India. Higher the fiscal deficit higher the inflation. The Reserve Bank of India cannot reduce the interest rates as it would further increase the inflation. This is one of the reasons companies are holding back on new investments and their margins are pressure. The high interest rates have hampered the consumer sentiments and the demand for loans to buy car and real estate is hit a low. The automobile and real estate sector which are high dependent on Indian consumers are facing huge liquidity crunch and their inventory are piling up. These 2 sectors are a huge source of indirect employment for other sectors. Fuel subsidy must be reduced. This can be achieved in two ways – one is to increase the fuel price and the other is by reducing consumption. The diesel price must be increased and brought to existing market rates. Cairn India’s Barmer Oil Field in Rajasthan is today supplying 15-18% of India fuel consumption. They are waiting for approval to explore for further in that area. Cairn India estimates that oil reserves in the area surrounding Barmer Oil fields can cater to about 30-35% of India’s oil requirement. They have got the expertise and experience for exploring in that area. Government must speed up the process of giving approval for oil exploration by setting up a body on lines with the Cabinet Committee on Investment CCI which has been setup for infrastructure projects. Several companies are waiting for approvals to explore for oil fields across the country. A higher domestic production will reduce our imports and thus help in bridging the current account deficit. The new resource that has been discovered is Shale gas. US has reduced its dependence on OPEC countries by active exploration of Shale Gas. It is estimated that India has huge reserves of Shale gas, hence a policy must be formulated for shale gas exploration. After railways, telecom sector is the 2nd highest consumer of diesel is telecom sector. They use it to run the diesel generator attached to their network tower in rural areas. The entire consumption of telecom sector could have been obviated with, if we had 24 hours electricity supply. India has coal reserves to suffice our demand for next 50-100 years. Despite this our power plants have shut down due to lack of
coal supply and some are yet to be constructed are stuck waiting for approvals. Government must frame a policy to allot coal blocks either by bidding or revenue sharing basis. Monopoly of Coal India Ltd should be reduced. As they don’t face any competition domestically it is ok if they do not perform as there will always be companies desperate to sign Fuel supply agreement with them due to monopoly. Last year India imported $17.4 Billion worth of coal. Our current account deficit for FY13 stood at $80 Billion. Our FY13 CAD could have been brought down to $63Billion right away, if we had formulated a proper policy to allot coal blocks and rupee wouldn’t have plummeted as witnessed. Iron ore and other mineral mining which has been suspended by the Supreme Court owing to illegal mining. As a result the iron ore exports from these mines have stopped. This is widening our trade imbalance. Environment clearance is today causing most of the delay for companies which have been allotted block to start mining. As most of these illegal mines have already violated the environment criteria and the damage is irrevocable. In the above case of illegal mining, the most pragmatic approach would be to allot the mines without considering the environment factor wherever the damage done, as the damage is irrevocable. The Government must formulate a policy for allotting these mines and also it should formulate stringent policies to curb new illegal mines. As exports from these mines would resume the CAD which is basically difference between the export and imports would reduce as exports would increase. In India the company takes 7 years to obtain all clearance to start mining and it takes 3 years after that to reach optimum capacity. So basically it takes 10 years for mining operation to commence. The company will have to pay interest on the money borrowed for auction and they incur expense without any returns. Who will prefer to invest if in any project if the first cash that would flow in would be after 10 years? Government must reduce the number of unessential licensing and also see to it that the licensing process is completed in a given time frame of few months if not then the concerned department must be made accountable. This a problem the Government can address without having to pass any bills. It is just that the concerned department are too lethargic to work and procrastinate. 31
For the things that have to be done by framing new policy, passing bills for the framing of new policies, it can be achieved even in the current political scenario. Since framing and passing of these bills is imperative for the next Government, BJP will definitely oblige. There is always a fear lurking in their mind that in case they do not reach the required number in May 2014, they would eventually have to depend on tempestuous allies. In that scenario passing the bills for framing these policies would be difficult. Hence the number of votes required for pass these bills in order to formulate these policies is possible.
Congress may have to abdicate Food Security Bill but the Food Security bill is not the game changer for them unlike MNEGRA in 2007-08. In India this year 1/4th of the population would be voting for the first time. For them the main concern is good economy growth and jobs. If the Congress can revive growth they may be able to regain lost ground. And for the next government whoever it may be UPA or NDA or third front, economic growth would be their priority as the people in the coming years will demand it and no government can win the election without delivering on it. Hence BJP will definitely agree to pass these crucial bills.
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Top Newsmakers in Business 2013 Raghuram Rajan: 2013 saw one man take entir e countr y by storm. As Raghuram Rajan took office as the Governor of RBI in September we saw reactions on his academic credentials as well as his looks. He brought stability to the markets and continued to be in spotlight through out the year. Rupee, which was the worst performing currency in Asia was hovering around 68 when he became the Governor, ended the year with 61-62 mark. Never to be pressurized by the North Block or the markets, Dr.Rajan believes in his own style of policymaking. He took the market by surprise by raising the policy rates during September review and keeping rates constant in December review. On being asked by a reporter after one of the policy reviews, ‘Mr.Rajan, the nation was expecting a Volcker but we got a Yellen?’ he replied with his characteristic wit ‘How about a Raghuram Rajan?’
Arundhati Bhattacharya became the fir st woman chairperson in SBI’s 207-year history. Having joined SBI in 1977 as a probationary officer Ms.Bhattacharya has seen it all when it comes to Banking. She has served right from metros, rural areas to the bank’s New York branch handling various assignments spanning credit, forex, treasury and retail operations. Bhattacharya is the first woman to lead a Fortune 500 company in India. She took charge of the bank at the time when its grappling with bad loans, increasing nonperforming assets (NPA) and profits seeing a downward fall. Known as a task master by her peers, she is known for taking tough calls in times of distress.
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Narayana Murthy In what was ter med as the biggest comeback of recent times, Narayana Murthy was shocked India Inc when he announced his return the organization he built after its dismal performance for the past two years. Murthy, however, was not a man with magic wand as warned that the recovery would be time-consuming and painful. Apart from raising the morale of its employees, Mr. Murthy took a slew a measures upon his arrival such as reducing costs, inviting former executives back to the company, hike in pay of employees and hunt for a new CEO. All the Notwithstanding many senior-level exits from the firm the firm has shown promising results with profits beating street estimates. It is to be seen what 2014 has in store for Infosys.
Chanda Kochhar took ICICI to r ural hinter lands in 2013 by exploiting technology that is at the disposal of every bank in today’s world. Banks have been hesitant all these years in setting up bases in rural areas due to high capital costs involved in setting up branches. With ‘Financial Inclusion’ being only on paper for most of the banks, Kochhar cracked the rural code by giving away around 9000 tablets to her staff to open accounts. With its bank on wheels model – one can see her staff walking across villages and towns urging literates to open an account. The bank opened 1.65 crore zero balance savings accounts, the most by any private bank in the country and the second-highest in the industry. It has reached out to over 15,000 villages through its branches and business correspondents.
Jignesh Shah 2013 tur ned out to be annus hor ibilis as he quit from the board of his company Multi Commodity Exchange of India Limited (MCX). Jignesh Shah had became a rage in 90’s due his revolutionary trading software. He started Financial Technologies, the holding company of National Spot Exchange of India (NSEL), an online trading platform for commodity exchange. With the right set of skills, this man created a business empire across the world. All of this success was came crashing down in July this year, when India’s investment community was jolted by a severe payment crisis in NSEL. With a scam estimated to be around Rs 5,600-crore it was considered to be bigger than the Harshad Mehta scam. While thousands of investors were furious with anger, Jignesh Shah tried to prove his innocence before the police. Shah claims that he was unaware that NSEL defaulted on payments to investors.
Compiled by - Ajit Nayak
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OPENING THE RENMINBI TO THE WORLD – CURRENCY REFORM IN CHINA BY RAHUL FERNANDES, SIMSREE, MUMBAI The Chinese currency, the Renminbi (also called the Yuan, represented by ¥) is renowned for being tightly controlled by the Chinese Government. In November 2013, the Government unveiled a list of sixty reforms that signalled sweeping changes in the way the world’s most populous nation functions. While a few reforms – like the relaxation of the one-child policy – are social, a majority of the reforms deal with liberation of the economy of the Asian behemoth. These included allowing private investors to set up banks, allowing private equity into the State Owned Enterprises, giving markets a more decisive role in the allocation of resources and loosening controls on the pricing of necessities like water, electricity and natural resources. The government also signalled its intent to accelerate the process of making the exchange rate of the Chinese currency more market based, which is the latest in a series of steps to reduce government intervention in the currency. The importance of the reforms cannot be fully appreciated without a study of the history of the Renminbi and the Government’s control over the exchange rate. Till the 1970s, the Chinese economy was closed to the world, and the value of the Renminbi was permanently pegged to the US Dollar at ¥2.46 per Dollar. In the 1980s,
the economy gradually opened up, and China began focussing on growth through exports. To increase the competitiveness of their exports, the value of the currency was gradually devalued all the way to ¥8.62 to the USD in 1994. This led to an increase in the inflow of dollars into the country, strengthening the Current Account Deficit (CAD). A massive Current Account Surplus in the latter half of the 90s allowed China to peg the Renminbi to ¥8.27 per USD without further devaluation from 1997 to 2005 after the Asian economic crisis in 1997.
Rahul Fernandes is an MMS Finance student from SIMSREE, Mumbai. He takes keen interest in the macroeconomics of economies around the world and their effect on stock markets. Email ID: rahul.fernandes @simsree.net
At ¥8.27 to the US Dollar, the Chinese currency was highly undervalued considering the Purchasing Power Parity of the United States and China. The World Bank and the International Monetary Fund estimated that a fair price for the Renminbi in 2004 would be close to ¥1.9 to the USD, as opposed to the existing rate of ¥8.27 to the USD. This large difference in the actual and perceived value of the Chinese currency led to difficulties for US companies, which could not compete with the extremely low-priced imports from China. This effect was also seen in many other countries across the globe, leading to the rapid growth of Chinese exports to many nations, which adversely affected the local producers. The United States in particular was at the forefront of international pressure on China to loosen control of the currency and allow it to trade
35
according to the market. Increasing tensions led to the U.S. threatening trade sanctions against China if a more market-based model was not developed for the Chinese currency. In 2005, China finally revalued the Renminbi higher to the US Dollar and announced that it would no longer be tied to a fixed rate against the US Dollar. The Renminbi was instead tied to a basket of international currencies including the Euro, the Japanese Yen and the South Korean Won, besides the existing US Dollar and allowed to fluctuate on the basis of market supply and demand. This represented a small step towards realistic currency valuation, temporarily appeasing the Governments of other nations and alleviating the risk of being slapped with trade sanctions. However, China did not allow the currency to trade freely, setting a narrow trade limit band of 0.3% around the existing price to prevent large corrections in the currency.
many sectors. This development forced China into a rethink on their monetary policy. Since 2005, the Chinese currency was linked to a number of international currencies, of which the Euro was one of the major names. However, the weightage of each currency in the calculation was not disclosed, and China continued to make periodic minor adjustments to deal with various economic situations. After 2008, the Greek and Spanish crises led to a large fall in the value of the Euro. To protect the currency from rapid devaluation and give itself time to consider a means to combat the crisis, the Government increased the weightage of the US dollar, thus unofficially pegging the currency to the USD again. This policy persisted till June 2010, when the Government got rid of the peg once more and allowed the value of the currency to increase based on market supply and demand and the relation to various world currencies. The trade band was also increased from 0.3% to 0.5% and then 1%, which led to a higher rise in the currency value.
One of the major reasons of the Chinese government allowing the value of the currency to start rising was the need to rein in inflation in the economy. Spiralling food costs due to stagnating growth in The chart below production and inshows the Chinese creasing purchasing currency being power were leading to Figure 1: Historical chart of No of CNY to 1 US Dollar. Note: A lower pegged to the USD high inflation, which value of the Yuan to the Dollar represents a stronger currency. before 2005 and could not be curtailed from 2008 to 2010, despite a series of in- Source:XE Charts (www.xe.com/currencycharts terest rate hikes. Also, the cost of keeping the Yuan with a gradual strengthening at other times. It is pegged to the Dollar was rising, without an equiva- worth noting here that the currency never faced a lent rise in the benefits to the nation. With a large large drop due to the narrow trading band imposed Current Account Surplus and huge foreign exchange by the Government. reserves, the Government did not feel the need to keep devaluing the currency. The Yuan gradually The internationalization of the Renminbi has gained strengthened over the next few years, going up from media and political attention recently. An international currency is one that is used to a large extent in ÂĽ8.27 to approximately ÂĽ6.8 to the USD by 2008. world trade, even in the trades of other countries. The crash of 2008 did not affect China directly, For example, if the trades between two nations like however, the sudden drop in demand from devel- India and Turkey are carried out in dollars, it would oped countries involved in trade with China led to show that the dollar is an international currency. The Chinese exports being hit hard. Millions of workers US Dollar and the Euro are the worldâ&#x20AC;&#x2122;s two biggest lost jobs, and exports dipped by as much as 25% in international reserve currencies, since they are
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widely held in foreign exchange reserves of other countries and used for international trade. China is one of the biggest players in the world in international trade, with more than 11% of all trade involving China as either buyer or seller. However, the contribution of the Chinese currency in 2010 was a meagre 0.24%. This was due to tight Government control on all transactions involving Renminbi. Till 2009, no external transactions could be carried out in
with countries like Russia and Japan to carry out all trade in Renminbi instead of the US Dollar. A gradual reduction in Government interference in foreign exchange rates and implementation of Renminbitrading hubs in various major cities of the world like London, Moscow, Paris and Tokyo has also helped the Renminbi move towards being a more globally accepted currency. In 2013, the Renminbi was the 8th most traded currency in the world. However, China still has a long way to go before its currency reflects the stature of the nation in in-
Figure 2: Chart of trade and currency â&#x20AC;&#x201C; 2010
ternational trade. The Renminbi cannot be used as a reserve currency as long as the Government maintains control on the conversion of its currency. The recent economic reforms outlined in November 2013 are a step in the right direction, with the Government pledging to completely quit daily interference in the currency. The speed of implementation of these reforms remains to be seen, but if carried out sooner rather than later, they could prelude the rise of a new truly global currency.
(Source: Society for Worldwide Interbank Financial Telecommunication (SWIFT))
Renminbi. Hence, all payments to Chinese exporters were in dollars, which would pass to the central bank, which in turn would pay the exporters in equivalent Renminbi. Hence, the use of Chinese currency for trade was virtually non-existent. This began to change in 2009, when China agreed on bilateral currency swap deals with various nations. Since then, China has chalked out agreements
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