SEPTEMBER 2013
ARTHNEETI A SIMSREE FINANCE FORUM INITIATIVE
Interview : Mr. Kewal Handa Lessons for Team India Inc ! Rupee on downhill yatra, but for how long? Impact of QE tapering on world growth Dependence of Indian markets on FIIs Sydenham Institute of Management Studies, Research & Entrepreneurship Education
ARTHNEETI SEPTEMBER 2013
Page 2
EDITORIAL
EDITORIAL 6 weeks is a short time, very short indeed, if you are considering the macroeconomic situation in India at least. The last six weeks have demonstrated how from virtually the onset of economic crisis, the macroeconomic situation recovered, so much so that the benchmark SENSEX is close to breaching the highest points recorded in history. There is a sense of confidence in the Finance Ministry and the RBI. Confidence is certainly commendable, but it must not turn into complacency. Let us track the past 2 months and understand what really happened. There was a sense of grim crisis pervading India’s policy making circles and much of the public at large. The under-lying causes were collapse of growth and investor confidence, stagnant infrastructure and energy sector, shrinking job opportunities for the burgeoning young populace, persistently high inflation and large fiscal and current account deficit. However, the real trigger was the hinting of the QE tapering by the Federal Reserve Chief Ben Bernanke. The rupee fell as much as 20% to touch the levels of 69 against the dollar by end August. The SENSEX too dipped to a low of 18,000 points. The tide began to turn in early September, with Raghuram Rajan taking over as the RBI Governor. He began his stint with a slew of positive announcements, one of them being swap facilities to banks for foreign currency non-resident (bank), or FCNR (B), deposits with maturity of three years and over at a rate of 3.5 per cent per year, and the forex swap window for Oil Marketing Companies. Also, the Fed on 18th September announced the postponement of QE tapering, thus encouraging the FIIs back to the Indian markets and helping the emerging economies at large. Also, the trade data in August and September was encouraging. The restrictions on gold import and the aversion of the Syria crisis helped curtail the import bill. Also, the fall in rupee encouraged exports, thus bringing down the trade deficit. Together, these developments ensured a significant recovery in the foreign exchange and capital markets, with the rupee climbing back to the 61-62 range and the SENSEX at the 21,000 mark. These are encouraging positives for sure. However, the sudden shift of macroeconomic conditions, though relieving, is a cause of concern. The fact that the global macro economy is highly dependent on the US is evident, and this is not a good sign. The reason for the SENSEX experiencing the high is more due to inward flows of FIIs. This despite the ever declining India growth forecasts, unnaturally high inflation and mixed quarterly results of organizations. In the backdrop of stable macroeconomic conditions and the announcement of Janet Yellen (who is not in favor of QE tapering) as the next Fed Chief, the policy making bodies in India must work towards strengthening the previously ignored fundamentals. The fact is that India's macroeconomic condition remains quite shaky and certainly does not warrant an iota of complacency. The SIMSREE Finance Forum brings to you the September Arthneeti issue. This issue consists of articles on relevant and contemporary issues such as “Quantitative Easing” and “Impact of the Food Security Bill”. We also have an article from our alumnus Joiel Akilan of the 1994 batch on “Lessons for Team India Inc“.
ARTHNEETI SEPTEMBER 2013
Page 3
Also, in collaboration with the SIMSREE Corporate Relations Committee, we have published an interview with Mr. Kewal Handa who has served as the Managing Director at Wyeth Limited and Pfizer Limited. He shares his immense knowledge and insights on the pharmaceutical sector. To conclude, we have an article on “Dependence of Indian Markets on FIIs“ by the SIMSREE Finance Forum. Happy Reading! Team Arthneeti
ARTHNEETI SEPTEMBER 2013
Page 4
Expert’s Opinion
Mr. Kewal Handa Q: Could you share your experience place. What will be its possible conseon your initial years in the industry? quences?
Mr Kewal Handa Ex Managing Director Pfizer Inc
“The FDI coming into India can influence the GMPs (Goods manufacturing Processes) in a positive way. The professionalism FDI will bring in is what we need.”
A: When I started working, I had an opportunity to work on the field, in factory. That exposed me to the manufacturing operation and how costing is done. I was involved into costing of several project evaluations and funding of mid-sized projects. I also was exposed to several operations related to Govt. That gave me a holistic perspective.
A: The act is aimed at establishing some centralized control, accountability and a sense of responsibility. Here we need to bring an entire different view of looking towards the way things function. The FDI coming into India can influence the GMPs (Goods manufacturing Processes) in a positive way. The professionalism FDI will bring in is what we need. FDA in US does audit of 97% of its manufacturing faQ: Govt. of India is planning to set up cilities every year. a regulatory body on the lines of FDA (Food and Drug Association) in USA. Q: Sir, in 1970s Govt. of India came How do you think will it impact on the up with an act which actually allowed Pharmaceutical Industry? the Indian Pharmaceutical companies A: There is a regulatory body already in place in India. It is known as DCGA (Drug Controller General of India). There are committees like Ethics Committee, a committee looking after approvals of new products, a committee for clinical trials. But through this Drug Regulatory act, bringing all of these activities under the realm of a centralized body is what we are talking about. It is not merely the creation of bodies but the execution is what matters. Shortage of qualified professionals and lack of training facilities to these professionals are some of the most important challenges that need to be addressed. Hence the execution is very critical to the overall Pharmaceutical Industry as a whole.
to use the patents without paying any royalty. Now with GATE agreement, patent law is again coming into picture. So what will be its impact on affordability of medicines?
A: Yes. You are right. In India we recognize only new chemical entities as patentable, products where there is a substantial improvement. Many multinational companies are facing problems because of this as many of their products get challenged under the patentability principle. Few other challenges relate to where to manufacture and at what cost to sell not to forget Govt. intervention in the form of compulsory licensing. Because of this, many global players don’t want to enter into Indian market. The Govt. needs to come up with a clear policy Q: The Govt. is also planning to bring about pricing of patented products up a new Foods and Drugs act in
ARTHNEETI SEPTEMBER 2013
Page 5
and its intervention policy in order to attract these foreign players. Govt. also should consider the price of innovation that goes into manufacturing these products is to be borne by consumers globally and a better mechanism on pricing is essential to maintain the affordability of products. Q: Sir, the reverse engineering approach was widely followed by Indian Pharmaceutical companies. With globalization coming into picture, do you see that the companies will move more into research?
“We need to modify our legal framework in order to lure the foreign players in. “
lenged in India based on the patentability principle. We need to modify our legal framework in order to lure the foreign players in. Q: Sir, what are the challenges for the domestic players? A: The Indian companies have done a good job in spreading their footprint in India and abroad. But we still do not have one generic company in top companies in the world. Indian firms still need to consider how they carry out the front end operations, either through a distributer or through few variants. There are few questions about the manufacturing facilities as well. FDA has set up another office in Hyderabad and is planning to make its audits more stringent. So the Indian firms need to ensure that the quality is never compromised in any way.
A: The Indian firms have a huge market share on global level than local level. But so far there is not much which is done on the research front. We still do not have anything we can Q: Sir, do you think Indian firms will survive if there is a level playing field boast of when it comes to research. created, without any Govt. intervenQ: Sir, what you think are the chal- tion? lenges which global players are facA: See there are two aspects. One is ing in India? patented products. In 2005 it was A: There are quite a few challenges. 0.5% of Indian market. McKinsey surOne is price exclusivity, next is prod- vey says it will be 2% by 2020. I even uct exclusivity. Then there is data ex- challenged that considering the fact clusivity. Globally when you do some that there are very few new products research, the data belongs to you at coming entering market every year. least for five years. In India we don’t The products which are launched behave any such law in place. Add to fore 2005 are generic anyways and the list the concept of patentability I foreign players cannot match Indian mentioned above. There are almost firms in terms of cost. So the 2% prod20 new products launched globally ucts won’t derail the domestic firms’ and many of them have been chal- market.
ARTHNEETI SEPTEMBER 2013
Page 6
Q: Sir, how to approach the careers (The interview is in association with such as financial controller which you Corporate Relations Committee of started your career as? SIMSREE.)
“As a financial controller, you need to have strong basics about the P&L accounts, accounting standards. Most important is to keep yourself updated on topics such as standards and new cases.�
A: As a financial controller, you need to have strong basics about the P&L accounts, accounting standards. Most important is to keep yourself updated on topics such as standards and new cases. There is another function for treasury where you deal with Foreign exchanges, cash flows, controlling working capital. The third area is MIS, decision support system which is heart of business as it provides perspective to decision makers rather than mere numbers. This can enhance their ability to get a better hold of the trend. There is another area for taxation where you need to keep yourself updated, particularly on indirect taxation. Knowledge of Income tax act, its relevant provisions, tax planning and it implementation in company policy are of critical importance. A good hold of legal aspects in general and the laws that are specific to your industry is also very important. Above all, good understanding of your own sector and industry is of prime importance. Q: Sir, what you think the students willing to enter into Pharmaceutical Industry should do to gear themselves up? Those interested in Pharmaceutical industries should try to get industry exposure as much as they can. Through internships and guest lectures such exposure can be attained which is of great help.
ARTHNEETI SEPTEMBER 2013
Page 7
Alumnus Corner
Lessons for Team India Inc!
Mr Joiel Akilan 1994 Batch, Executive Director & Chief Representative –India, BBVA
Fin Quiz:
1.Which is the oldest bank in the world still in existence?
The Indian Rupee has been hit for sixes and fours which has given sleepless nights to treasury managers of Indian multinationals and companies importing huge capital goods or raw materials from overseas. The rupee has added teen’s to its age by going from the 45’s to 60’s with the dollar since mid 2011!
Indian economy has started showing signs of trouble which has been magnified with the negative image of India with overseas investors and currency dealers have turned bearish on the Indian rupee with many global investors pulling their funds from Indian securities as well some multinational biggies declaring their innings even before they can open their batting by cancelling their large value proposed green field investments in India. The image of India has taken a severe beating thanks to the negative coverage by international press. Our authorities are scrambling to find the right cricketing shots to score dollars and stabilize the rupee. The oil, gold and coal import bill too has compounded further to the problem. It has affected the plans of the Indian companies too who had plans to raise funds via ECB’s or Reg-S bonds as well as the Indian traveler who has cancelled his plans to go to exotic destinations or curtailed his holidays or shifted to a cheaper destination.
and thoughts will also be! Banks always make money whichever way the currency moves as the losses are always passed on to the end customer. Banks need to be more vigilant in situations when severe volatility or depreciation of the currencies occur as it could injure their clients and these clients could be retired hurt and land up in the hospital to be injected with medicinal shots like restructuring, CDR’s, OTS etc or some may gasp and become bankrupt. So it is better to keep ready the army of financial forensic experts and analytics team on high alert to figure out who are the companies which could be retired hurt!
Banks can imbibe some batting techniques in their culture to avoid landing in the same hospital bed with broken bones on being hit by the bouncers from their clients:
History: as the saying goes “History merely repeats itself, It has all been done before Nothing under the sun is truly new”. This means if a company has defaulted or restructured its loan in a previous crisis it will have no qualms of defaulting again. Such companies are vulnerable to be caught leg before the wicket every time there is a crisis.
FX Mis Management: “Wealth How should banks bat? Wher- from get-rich-quick schemes quickly ever your treasure is, there your heart disappears; wealth from hard work
ARTHNEETI SEPTEMBER 2013
“Cheaper does not mean it is an attractive buy, companies who are obsessed to buy assets abroad by M&A have to ask two questions a) why will anybody sell their good assets? b) Whether I can find a better investment in India?”
Page 8
grows”. Companies who keep their foreign exchange exposure un hedged could be caught behind the wicket. There is nothing called a natural hedge, every transaction has to be seen on an individual basis and the necessary hedge has to be taken to avoid sleepless fearful nights due to the currency movements. Also unnecessary complex foreign currency derivatives should be avoided unless clearly understood by the client its advantages. Companies should concentrate on making profits by hitting sixes thru their businesses by increasing the profit margins or efficiencies of their operations instead of trying to play with foreign currency googlies and trying to get a high by making margins on it and profit for finance department and earn some leg byes.
over’s of the trade cycle.
Non Core business expansion: When Banks are flush with liquidity they are willing to support their clients expand into new business so that they can deploy these funds and hence we see many companies diversifying in to unrelated businesses like retail, infrastructure, telecom, airline etc. This could be a trap for the banks as in such cases the promoter is willing to take risk as majority of the funds are not his but mostly from the banks thru his innovative financial engineering. Every industry goes thru economic cycles and when the economic cycle turn bad it’s these companies which are most vulnerable to get clean bowled and stop paying the banks. This goes with the saying “The wicked borrows but does not pay back, but the righteous is genBorrowing pattern: The rich erous and gives”; rules over the poor and the borrowers M&A: Cheaper does not mean are the slaves of the lender. Many companies have tendencies to borrow it is an attractive buy, companies who short term for long term projects. are obsessed to buy assets abroad by Some borrow short term buyers’ credit M&A have to ask two questions a) in foreign currency as it’s easily avail- why will anybody sell their good asable and is cheaper than their rupee sets? b) Whether I can find a better working capital funding given by their investment in India? banks. It is better if such borrowings match with the trade cycle of their If they have sufficient answers production, If not then it creates a mismatch which if not well managed could for these two then they could go for land up companies into foreign ex- M&A’s. The point to note is that numerchange losses. There are companies ous empirical studies show high failure who tend to rollover their buyers rates of M&A deals globally like many credit as many times as possible international star studded IPL teams rather than scoring in the power play fail to win the tournament. Companies
ARTHNEETI SEPTEMBER 2013
Page 9
with unwarranted global expansion can be run out even before they get into their batting crease!
Fin Quiz: 2. Which is the largest asset management company in the world based on value of assets under management? Who were its founders?
When business are managed well the companies make profits and create a positive investment climate which will lead global investors to flock in the country in great numbers. This means well managed businesses can create a solid economy with fundamentals and that can revive the sentiments to score well and make the Indian rupee appreciate!
(These are personal views of the author and not those of his organization)
Award Winning Article
ARTHNEETI SEPTEMBER 2013
Page 10
Akshay Gupta
Rupee on downhill yatra, but for how long?
IBS, Hyderabad
“The Rupee sinks to a record prop up rupee are two major reasons low of 65.70, analysts’ fear RBI might for their exit. And with the Fed’s excut rates” pected to announce a partial rollback of gigantic monetary stimulus package These kinds of headlines are known as Quantitative Easing 3 (QE3) rampant in today’s economy. Ever the rupee might just get vulnerable since the market mayhem began in again. May after the US Fed chairman Ben Bernanke outlined a tentative plan to We had it coming. Much of it reduce monetary stimulus – Quantita- has been blamed on the quantitative tive Easing (QE), global investors have easing (QE)- a fancy term for easy been pull- money policy by the US feds which is ing out of overheating the emerging markets speemerging cially BRICS as this can lead to comm a r k e t s . petitive devaluation (currency war) When it and protectionism as their currency is comes to pegged by dollar. However, the truth India, the is that the rupee free fall is more of a g o v e r n - swadeshi crisis rather than a foreign m e n t one. Here’s why. seems to The haemorrhaging started on be in de- heavy selling by foreign institutional nial. Why investor (FII). In order to fund the curin denial? rent account deficit (CAD) which stands It’s be- at $70 billion, Indian authorities, with cause we their infinite wisdom thought they could let our heart rule our brain. The rupee do that with the FII inflows –which in has hit an all-time low against dollar, lucid terms is like paying your monthly rent with the money borrowed from creating long-faced problems for the your landlord and not from your saveconomy already battling multiple ings or capital account. Since the tradheadwinds. The rapid decline threat- ing rules were simplified and foreign ens to undermine the recent gains in investment limit in bonds were raised to current account deficit and inflation attract investors the short term traders and depress badly needed capital were trying to make quick money but this hot money came in fast and left in inflows. India has long been viewed as a hurry. Most of these borrowers boran investor’s dream, 1.2 billion people rowedin dollars and did not hedge so pining for a taste of globalization, so they thought they were borrowing at is it the current rupee acrobats that 2% but the kicker is that they were acare driving the foreign investors tually borrowing at 20% and the first away? The amalgamation of political principle of business is to borrow in dysfunction and ham handed efforts to your currency or else you are a Forex speculator. What FII’s have done now
“The amalgamation of political dysfunction and ham handed efforts to prop up rupee are two major reasons for their exit. And with the Fed’s expected to announce a partial rollback of gigantic monetary stimulus package known as Quantitative Easing 3 (QE3) the rupee might just get vulnerable again.”
ARTHNEETI SEPTEMBER 2013
Fin Quiz:
3. Who was the first governor/inaugural office holder of RBI?
Page 11
is that it has increased the level of external volatility and dependence when our fundamental commercial problems are not fixed. Perception of lack of clarity on policy front has also been fanning speculative demand wherein RBI on one day is tightening liquidity and on other is injecting $1billion in the market. Even the countries forex reserves are not enough to cover imports of $500 billion due to which RBI cannot intervene aggressively and tactfully in the currency market. However, the seeds of rupee devaluation have been planted three to four years back – since 2009, RBI decided not to intervene in the foreign exchange markets to buy foreign currency which releases rupees into domestic banking system which can act as a source of primary liquidity. RBI instead created primary liquidity by purchasing government bonds through Open Market Operation (OMO’s) which monetised the government debt and this is nothing but India’s version of QE only with high inflation the effects of can be devastating. The misconception was that these OMO’s will finance fiscal deficit through monetisation but it backfired accommodating high inflation and a widening current account deficit. The second seed is the persistence of negative real rates for savers. Despite
the tightening policy rates between 2010 and 2012 CPI inflation continued to be at 9% and even the future inflation expectations were in double digits and in such an environment the savers were forced to diversify into assets such as gold to defend their purchasing power. This has implications for the banking system as the deposit growth slowed and liquidity deficit turned structural, while monetary transmission got impaired. Finally, India in the past has been too accommodative when it comes to policy rates. Indian economy went into a tailspin when former finance minister Pranab Mukherjee came out with the retrospective taxation proposal in his budget which brought fear and intimidation in foreign as well as domestic investors. For corporates also it’s that sinking feeling. Biggies like Wipro, Infosys, Reliance, TCSare facing a major predicament due to rupee devaluation which has only increased their overall debt value and has inturn decreased net profit. We are faced with this preconceived notion that the rupee decline will prove to be an egg in an exporter’s beer. However, one should not get all hunky dory – there is high realisation no doubt, but it isn’t translating into higher volumes since the global demand scenario has not been in fine feather. What really can the authorities do? How low can it drop? Is 65 the new normal? The truth is we are all part of it now- Banks, Government, Consumers, we are moving money
ARTHNEETI SEPTEMBER 2013
“If RBI and the monetary authorities don’t figure out a way to attract more dollars, rupee will continue to be under pressure. It may bounce back for a while but long term sustainability of rupee is an issue. The country urgently needs to shift its focus from Finance to Commerce. ”
Page 12
around in circles. If RBI and the monetary authorities don’t figure out a way to attract more dollars, rupee will continue to be under pressure. It may bounce back for a while but long term sustainability of rupee is an issue. The country urgently needs to shift its focus from Finance to Commerce. The problem of 500/300 ($500 Billion – Imports and $300 Billion - Exports) need to be addressed right away. To stabilise the rupee, we need more speculators. Instead of luring more foreign investors there should more of the special deposit schemes or offshore bonds for NRI. A $15-20 billion inflow from such schemes can stabilize the rupee to some extent. However,a better option in the current scenario would be to let the rupee be. Instead of ruminating on what will happen next one should wait and watch the rupee dampen volatility and if it weakens, RBI should continue to hike short-term interest rate which would help correct the negative real interest rates. The government should push through enough growth oriented reforms and structural reforms to stimulate the economy. So does one get a déjà vu of the BOP crisis of ’91 or of the Asian Financial Crisis of ’97? Nobody would want to answer that as the saying goes we let our heart rule our brain and the moment we witness fear, we say to ourselves “all is well”, however in this era of crisis, it’s about time the government steps up, start facing those fears and cure the symptoms of our macroeconomic problems, be patient and brave as the road ahead is
bumpy. For a quick recovery you need steroids and if steroids are being withdrawn then you are back to basics. So I will stick my neck out and say that in short term the rupee is in a free fall given the strength of dollar against major global currencies and the widening of the trade deficit. However, from medium to long term perspective the meltdown of rupee, like all bad things, isn’t going to last forever given the government addresses the basic fundamental problems of the economy or else we might just have to remove the word “emerging” from India.
Award Winning Article
ARTHNEETI SEPTEMBER 2013
Ankit Lahoty Hrishikesh Rahatal SIMSREE
“Many of the investors instead invested in the emerging market funds, stocks, or government bonds. This, without any uncertainty, helped the emerging economies grow. But this led these economies to be more and more dependent on foreign investments which were not irreversible.”
Fin Quiz: 4. Name the company whose share has quoted the highest price ever in the Indian Stock Market, and the price that it quoted.
Page 13
Impact of QE tapering on the World Growth On 22nd May 2013, the US Federal Reserve chairman Ben Bernanke in a testimony stated that the US Fed may cut short its $85 billion bond buying program known as Quantitative Easing to $60-$65 billion giving rise to a new term in the financial dictionary called ‘Tapering’ making it the latest buzzword in the financial world after the ‘sub-prime’ crisis. Quantitative Easing (QE) is the government monetary policy occasionally used to increase the amount of money in circulation in the economy through the buying of financial assets like government securities or other securities from the market. The increased availability of capital promotes increased lending and liquidity. This policy is implemented when the interest rates are near zero levels. Though this policy paves path for growth, there is also a risk associated with it. It may lead to inflation as the amount of goods that can be purchased remains the same. The US Federal Reserve had been pumping $85 billion every month and investing it in the economies since December 2012. Out of the total money 45 billion is invested in Treasuries and $40 billion in mortgage backed securities. Before this, there were two rounds of QE, popularly known as QE1 and QE2. QE1 was initiated post the 2007-08 recession and QE2 during the fourth quarter of 2010. The original purpose of QE was to artificially reduce interest rates and ease the repayment of debts that ac-
cumulated over this time. The unavoidable side effect was that some investors took their money elsewhere in the hope of a better return. The availability of cheap cash allowed banks and other investors to invest in emerging economies like Brazil, Russia, India, Indonesia, South Africa, and Turkey among the many. The sudden influxes of capital in these emerging economies lead to a surge in growth. This flow of capital was not just advantageous for the investors as they were getting higher rates of returns. This flow was also useful for these emerging economies as these investments would soak up the surplus labour and produce goods that can be exported, bringing in more cash in the economy. But this is only the rosy side of the picture. The flow of money is not as free as it is expected to be. Ideally developing economies would like the flow to be in form of hard, irreversible investments, thus, facilitating repatriation of profits. Many of the investors instead invested in the emerging market funds, stocks, or government bonds. This, without any uncertainty, helped the emerging economies grow. But this led these economies to be more and more dependent on foreign investments which were not irreversible. As mentioned earlier, the QE policies were brought into effect by the US government to bring their economy on track of recovery and growth. The situation today has changed. US economy is looking good now. The un-
ARTHNEETI SEPTEMBER 2013
“Again, it is inevitable that the tapering will begin at some point of time. But this has given time to governments of emerging economies to bring their policies into place and plan for a sustainable growth ahead. ”
Page 14
employment rate has dropped to 7.4 per cent from an 8.1 percent rate. Only in the month of July, the US economy added 162,000 jobs and the unemployment rate reduced from 7.6 to 7.4 percent. This led Bernanke to suggest tapering of the government buying. Also foreign investors, seeing that their home economy is back on track and they have good investment opportunities there, the ‘reversible’ factor came in. Foreign investors began pulling out their money leading to huge current account deficit. Back in 1997, it was Alan Greenspan’s decision of pushing up the interest rates giving the investors a safe option rather than investing in the riskier markets which lead to the Asian crisis. This time it isBen Bernanke, coming with a statement on QE Tapering. Though the Asian economies are well prepared now when compared to the Asian Crisis with comparatively much larger foreign exchange reserves, still the growth and stability of these economies is at stake. It was always known that the QE program by US was not to continue forever. But an unplanned announcement led to losses in markets amounting to trillions of local currencies. If there would have been a plan in place, which would have been communicated earlier, may be the markets would have adjusted themselves as they are doing it right now. With the latest statement from
Bernanke on September 18, 2013, the economies have heaved a sigh of relief. The Fed would be delaying the tapering as they want to confirm if the economy is conforming to their positive outlook. Again, it is inevitable that the tapering will begin at some point of time. But this has given time to governments of emerging economies to bring their policies into place and plan for a sustainable growth ahead. The markets have already been correcting themselves but the trend has to be maintained in order to avoid another round of high volatility. This three months period was a wake up alarm to the emerging economies to prepare themselves for the worst. The tapering, if implemented, will not be immediate, but rather a planned one to avoid the market panic in other economies. If the US economy performs well then the Fed may pull back its resources more but if the condition worsens in the economy then the Fed will pump more money in the economy. There is a very important learning for emerging economies from all this fiasco. These economies should go easy on the huge capital inflow. Just because there is an upswing, there should not be an unplanned increase in imports when the prices that govern those imports can change overnight. Consider the way the currencies of the emerging economies have depreciated. And this is all more important when the capital is of reversible nature. There should rather be a buffer
ARTHNEETI SEPTEMBER 2013
Fin Quiz: 5. Identify the person
Page 15
that dictates the ratio of reversible capital that can come into the economy. There can be arguments made that this will hamper investments, but if this situation is watched correctly, it will rather help converting those reversible investments to irreversible investments, or at least bring in some stability. Another Asian Crisis has hopefully been averted.
ARTHNEETI SEPTEMBER 2013
SIMSREE FINANCE FORUM ARTICLE
Graph 1
Page 16
Dependence of Indian markets on FIIs Foreign Institutional Investor (FII) means an institution established or incorporated outside India which proposes to make investment in securities in India. Provided that a domestic asset management company or domestic portfolio manager who manages funds raised or collected or brought from outside India for investment in India on behalf of a sub-account, shall be deemed to be a Foreign Institutional Investor. Foreign Investment refers to investments made by residents of a
Source: www.sebi.gov.in
“When money is injected into a country, the exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of funds. ”
country in financial assets and production process of another country. Entities covered by the term ‘FII’ include overseas pension funds, mutual funds, investment trust, asset Management Company, Nominee Company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies etc. FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI (Foreign direct investment) are insufficient.
A favourable business environment fostered Indian economy 1991 onwards, when the government of India opened the door for foreign capital in the way of direct investment and through foreign institutional investors. The policies drafted to stimulate the flow of foreign capital in to India provided much needed impetus for India to emerge as an attractive destination for foreign investors. The international capital inflows have been increased tremendously during last two decades. Since 1991 foreign investments in the country are allowed to take the form of investments in listed companies referred as FII investments. The effect of FII investment is to increase capital availability in general, rather than availability of capital to a particular enterprise. Translating an FII inflow into increased production depends on production decisions of the enterprise that has to explore and design production plans drawn upon the additional capital made available via FII inflows to augment production. FIIs flows are now mostly ‘Hot money’ refers to funds that are controlled by investors who actively seek short-term returns. These investors scan the market for short-term, high interest rate investment opportunities. ‘Hot money’ can have economic and financial repercussions on countries and banks. When money is injected into a country, the exchange rate for the country gaining the money strengthens, while the exchange rate for the country losing the money weakens. If money is withdrawn on short notice, the banking institution will experience a shortage of
ARTHNEETI SEPTEMBER 2013
“The
most unfortunate part is that the market sentiments follow the FIIs. For example when FIIs pull out their money people think market is going to fall, so they pull out Thus the withdrawal has exposed the absence of support from domestic investors who are willing to take a contrary view when FIIs push the sell button. And eventually the market crashes.”
Page 17
funds. On the other hand huge amounts of FII fund inflow into the country creates a lot of demand for rupee, and the RBI pumps the amount of Rupee in the market as a result of demand created. This situation leads to excess liquidity thereby leading to inflation where too much money chases too few goods. The FIIs profit from investing in emerging financial stock markets. If the cap on FII is high then they can bring in huge amounts of funds in the country’s stock markets and thus have great influence on the way the stock markets behave, going up or down. The FII buying pushes the stocks up and their selling shows the stock market the downward path. This creates problems for the small retail investor, whose fortunes get driven by the actions of the large FIIs. FII flows leading to appreciation of the currency may lead to the exports industry becoming uncompetitive due to the appreciation of the rupee. Foreign institutional investors (FIIs) today own 40 per cent of the value of shares available for trading in Indian exchanges. The impact from the retail investors is not much as they are shying away mostly due to a lacklustre performance from the last 4-5 years. And DIIs (Domestic Institutional Investors) like mutual funds etc are more concerned about profit bookings. So is it a fair assumption that FIIs are only driving stock market now. This makes the market more dependent on FIIs than any other. It is interesting to see how DII and FII play with the markets. Rarely do we see them being on the same side and never have they
both emerged as net seller or net purchaser. So we can safely say whatever is the case euphoria or panic, FII and DII who make major part of daily turnover are against each other. FII withdrawal makes the markets vulnerable. We have had a small taste of this in recent months (Graph I), with FIIs moving out funds in anticipation of an impending tapering of the US Federal Reserve’s monetary stimulus programme as well as asset price erosion on account of the weakening rupee. Because of FIIs moving out SENSEX went down from 19760 in May 2013 to 18620 in Aug 2013. This dependence has to a great extent caused a lot of trouble for the Indian economy. The most unfortunate part is that the market sentiments follow the FIIs. For example when FIIs pull out their money people think market is going to fall, so they pull out. Thus the withdrawal has exposed the absence of support from domestic investors who are willing to take a contrary view when FIIs push the sell button. And eventually the market crashes. Foreign investors have hauled out an astounding Rs 29,191 Cr. (over $5 billion) from the Indian debt and equities in less than a month due to the falling rupee, according to the provisional data on FII activities provided by the Bombay Stock Exchange ( BSE) and the National Stock Exchange ( NSE ).The highest ever impact of FIIs was seen during the time of global crises. What started as profit-booking in early 2008 accelerated into a massive sell-off following the collapse of US
ARTHNEETI SEPTEMBER 2013
Table 1
Source: www.sebi.gov.in
Page 18
investment bank Lehman Brothers Holdings Inc., leading to a severe liquidity crisis. Most FIIs sold as their lenders, facing a cash crunch in their home markets, asked them to bring their money back. If this happens, the Indian companies are certain to incur huge losses, strangely for no apparent fault of theirs. Market factors can hardly be said to be in their control. Some major impact of FII on stock market:• FIIs have increased depth and breadth of the market. • They have played major role in expanding securities business. • Their policy on focusing on fundamentals of share had caused efficient pricing of share. F I I s flows are considered as both cause and effect of stock market reforms. Stock market reforms like automation, dematerialization, and improved market transparency, regulations on reporting and disclosure standards were initiated because of FIIs. Generally FII invest by two ways, one is Equity Investment where 100% investments can be in equity related instruments or up to 30% could be invested in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments) & second is 100% Debt where investment has to
be made in debt securities only. Equity is the thing on which FIIs always have an eye on. FIIs always prefer equity over debt in their asset structure. This can help in enhancing domestic savings which can be further used for development projects like building economic and social infrastructures. In addition it also boosts the production, employment and income of country. FIIs also help in economic development of country by improving capital markets. FIIs have made available riskier long term capital for economic development projects. FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets. FIIs also contribute to firms’ operation and thus improve the corporate governance. Bad corporate governance makes equity finance a costly option. Among the four models of corporate control -takeover or market control via equity, leveraged control or market control via debt, direct control via equity, and direct control via debt or relationship banking-the third model, which is known as corporate governance movement, has institutional investors at its core. In this third model, board representation is supplemented by direct contacts by institutional investors. FIIs also contribute significantly for managing uncertainty and controlling risks in market. FIIs support financial innovation and development of hedging instruments. FIIs not only enhance competition in financial markets, but also improve the alignment of asset prices to fundamentals. FIIs in particu-
ARTHNEETI SEPTEMBER 2013
Page 19
lar are known to have good information and low transaction costs. By aligning asset prices closer to fundamentals, they stabilize markets. In addition, a variety of FIIs with a variety of risk-return preferences also help in dampening volatility. FIIs influencing Microfinance firms: Here let us discuss an example of a microfinance firm in Hyderabad named SKS Microfinance. Since SKS got listed in August 2010, its share price was continuously decreasing. The company was also under debts. But when FII invested in this microfinance firm, it has been successfully able to transfer its debt to securitization and because of this company’s cash flows and credit ratings were improved significantly. Also domestic institutional investors’ stake in SKS climbed to 5.13 per cent for the quarter ended September 30, 2013, from 5.08 per cent in the previous quarter. The number of FIIs in SKS also increased to 48 in July -September 2013 from 42 at the end of the preceding three month. Appointing marketing strategist Jack Trout for its rebranding and repositioning work has helped FIIs to rush towards SKS. This is one of the steps taken by SKS to attract FIIs. And now FIIs which held 35.83 per cent holding in SKS during July-September 2012 raised its stake to 36.90 at the end of September 30, 2013, as per latest information available with the stock exchanges.
Answers of Fin Quiz 1. Monte dei Paschi di Siena , Italy since 1472 2. BlackRock Inc. , $3,560 bn USD, Laurence D. Fink and Robert Kapito 3. Sir Osborne Smith (1935-37) 4. Orissa Mineral Development Company (OMDC), 92,200 (15 Nov 2010) 5. Eugene Fama : Nobel Laureate (Economics) – 2013 for The Efficient Market Hypothesis