Infineeti IIFT Finance Magazine

July 2011

The Monthly Finance Magazine from IIFT Diesel price deregulation The Road Ahead

The story of internet IPOs Feeling of Déjà vu

Enterprise Risk Management

Its Macro Level Implications

SPECIAL FEATURE - Revealed Comparative Advantage : An index of efficiency

Contents

From the Editor’s Desk

BANKING

12 Finance for the Poor – Where are we?

COVER STORY

MONEy&POLICY

Team INFINEETI

10 Funding India’s Infrastructure

growth 6 Effect of Diesel deregulation on the Indian economy 14 Impact of changes in DTAA with Mauritius

Editor-in-Chief Arjit Jain Editorial Board Archie Gangarade Nishtha Anand Sunandan Sridharan Shivaji Yadav Vineet Bakshi

Summer Internship

22 Enterprise Risk Management

CROWDSOURCING

Design Arjit Jain

24 Version 1.0

GLobal economy

Feedback/ Queries infineeti@iift.ac.in infineeti@gmail.com

4 The story of internet IPOs

Readers can now express their views on our blog www.cashonova.blogspot.com

16 Deregulation On Savings Interest Rate: A Boon Or A Bane:

Interest calculation methodology has been shifted from minimum balance between 10th and last day to the daily product basis with effect from 1st April, 2010. Recently, the savings deposit rate has also been increased by 50 basis points to 4%.

SPECIAL FEATURE 8 Revealed comparitive advantage: An index of efficiency

REGULARS 20 Monthly Chronicles 27 Campus to Corpoate 4.0 28 Market Watch 30Fun With Fin- Presented by Vedvyas Bhattacharya 31 Book Mark-Games Indians Play INFINEETI| July 2011

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GLOBAL ECONOMY

GLOBAL ECONOMY

The story of internet IPOs By- Ramanathan.B (The Author is a student IIFT-D)

Going public: It’s the ultimate rite of passage for a young company, marking the transformation from startup adolescence to corporate adulthood. And, it is a sure path to easy riches. Atleast that is why companies float IPOs in the first place. As far as internet companies are concerned, IPOs provide the surest way to remain in the public eye in more than one sense. And recent times have thrown up a whole lot of internet companies willing to go public for varied reasons. LinkedIn was the biggest US internet IPO next to Google in 2004. According to data provider Capital IQ, the amount of money LinkedIn has raised makes it the fifth-biggest-ever U.S. IPO in the Internet software and services sector. Other companies to join LinkedIn in going public during recent times include Zynga, Groupon, The Mountain View, Pandora

and more. Companies, not only in the US but in other countries like china are also showing a willingness to go public and with US investors keen on entering the Chinese market, it seems to be a win-win situation for all parties. Some prominent IPOs include 21 Vianet, which followed on the heels of impressive debut of Qihoo technologies. Other recent high-flying Chinese internet IPOs include leading online bookseller E-Commerce China Dangdang and China’s #1 online video portal Youku.com, dubbed the Chinese Amazon.com and Youtube.com, respectively. Both companies went public in December 2010. Two additional Chinese Internet companies are scheduled to complete IPOs over the next two weeks: mobile Internet security provider NetQin and the

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highly-anticipated offering from China’s leading social network Renren.

Let us get down to what really happens during an IPO? How does the IPO affect the market share(the most important!) of the company? How do companies go about improving their business models? What role does the media play during an IPO? What determines the survival of internet IPOs? Let us also examine the skepticism of some market gurus who contend that such frantic activity in going public is not beneficial and it will ultimately reach a period of bust which may even be reminiscent of the famous dot com burst.

When a company goes public for the first time, the executives of the company are involved in frantic work pitching their company to potential investors and the local public in general. This is true of most of the smaller company that go public for the sole purpose of raising capital whereas the investors and stock traders go in search of investing in the more prominent ones. There was quite a bit of buzz leading up to LinkedIn’s IPO given their eye-popping debut last month with shares rising as much as 172% at one point in the first day of trading.

Pandora’s IPO didn’t generate quite the same excitement, but still gained 62.5% at one point before closing the day 8.9% higher.

Mostly during the first day a company goes public, there is frantic selling and buying of its stocks.Each share is traded more than once on an average, as all the investors want to make the maximum profit on the first day. After a few days the dust settles and the company begins trading in its proper value. For example, LinkedIn floated 7.8 million shares in its initial offering, but over 30 million shares traded hands in the first day. In other words, each share of LinkedIn stock changed hands 3.85 times in the first day of trading. Pandora’s ratio of shares offered to shares traded was 2.86. To put that level of activity in perspective, that ratio for Google’s (GOOG) IPO in 2004 was 1.14 and Visa’s (V) wa s 0.44 in 2008.

The influence on the market share of the company depends upon the brand name of the firm. For small and medium enterprises it depends upon the effect of • 4

pitching done by the execs of the company and the reach they have achieved in doing so. Needless to say, it is boom time initially for biggies. Take for example LinkedIn.The stock was initially offered at $45 – a price the company’s management and advisors thought was fair – but on the first day of public trading the stock closed at $94 and traded as high as $122. Today the stock trades at about $75, so the investors that rushed out to buy LinkedIn that first day overpaid and have already suffered a loss.

The losses may get even greater considering that the company’s managers were willing to sell the stock for $45.

The Mountain View, a Californiabased firm ended its first day as a public company with its shares worth US$94.25 apiece. When Instant Contact, a provider of services for creating and managing email newsletters, debuted on the NASDAQ, its share price was by up an impressive 65% at around $26 per share. The company raised more than $100 million in the IPO.

What determines the survival of an IPO? Two factors primarily stand out: First, there is no significant relationship between the age of the IPO firm and its survival rate. This may be attributed to the fact that non-internet related activities prior to becoming an internet firm areless relevant.

Second, the financial ratios regarding the internet firms’ performance prior to IPO only have a limited effect on firm survival and acquisition. An explanation is that internet firms have been far from steady state at the time of offering. Another explanation could be that the internet IPO market was ‘hot’. Irrespective of a firm’s economic fundamentals investors were willing to buy the shares the offering. As a consequence, accounting variables played a minor role in determining the share price. .

But all is not wellwith the internet IPOs: This year could yield the most initial public offerings of tech-

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nology stocks since 2000. But the venture capitalists who bankroll high-tech startups aren’t pouring money into the Internet like they once did. And even rapidly growing Internet companies LinkedIn and Pandora Media have lost some of their lustre after the initial blockbuster performance. All those factors signal that cooler heads are prevailing, especially with the global economy on shaky ground.

So far this year, 28 of the 74 IPOs completed in the U.S. have been by technology companies, according to IPO investment advisory firm Renaissance Capital. If, as expected, another 31 tech IPOs are completed by the end this year, it will be the most from the sector since 2000.

LinkedIn was minted with a market value of $9 billion, the highest for an Internet company since Google went public in 2004. Then Pandora Media doubled the target price for its IPO because of such intense demand. At the end of its first day of trading Wednesday, Pandora had a market value of $2.8 billion, more than AOL, which had a market value of more than $160 billion in early 2000.

Pandora stock fell below its IPO price of $16 in its second day on the market, suggesting that investors were having second thoughts about a company that still hasn’t turned a profit despite building an audience of 94 million.

In another indication of sobriety, LinkedIn’s stock has lost more than a quarter of its value since its first day of trading. The caution may be short-lived though. Online coupon seller Groupon has filed plans for an IPO that has analysts wondering whether its market value will exceed $25 billion, even higher than Google on the day it went public. All in all, IPOs are here to live and just a bit of caution amidst all the frantic activity while investing in internet IPOs would surely go a long way in great returns.

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MONEY& POLICY

MONEY& POLICY

Effect of Diesel deregulation on the Indian economy By- Jayanth Renatheus Raj (The author is student of IIFT-K) In India, diesel is used primarily by transport vehicles such as trucks and buses, other commercial vehicles, and to a smaller extent, by the railways and passenger cars.

There have also been increasing instances where power companies are switching to diesel from fuel oil because the former is less than the later by Rs. 4-6 per litre. And in my opinion, the usage of diesel is bound to go high in the near future because of the increased production of diesel engine cars.

Diesel accounts for a third of total fuel demand in the country and price pressures from a hike in diesel costs are typically transmitted to the broader economy through the transportation sector.

reportedly Rs. 1,36,000 crore and to the state governments about Rs 80,000 crore. The subsidy provided by the government is Rs 40,000 crore, i.e., 20 per cent of petroleum sector’s contribution in taxes and duties.

Hence, the steps taken to deregulate the diesel prices are not to save the petroleum industry which is already profitable (the investment of the FII being witness to this fact) but to reduce the fiscal deficit and curb inflation. Taking these factors into account lets analyse what effect changes in regulation have over the Indian economy.

Diesel subsidy and the government’s role:

When diesel prices are deregulated, B = 0.

1. This implies that the government has increased profits C. This will lead to increased indirect taxes which will in turn reduce the fiscal deficit and reduce inflation though inflation being affected by fiscal deficit is of minor magnitude.

2. The normal people will be paying Rs. B higher than they are paying now. This will increase the overall transport cost of trucks and other vehicles and this will have a direct bearing on the food and commodity prices which will again increase inflation. Now increase in C will be around 40% of the increase in A. So this clearly implies that the consumer pays an additional amount which is much more than the additional tax generated. Added to this is the multiplying factor of the transport cost which will have a cascading effect on inflation.

Thus, we are facing a situation in which the balance will be tilted towards the later side (2) and inflation is bound to rise to some extent because of deregulated diesel prices.

So if the diesel prices climb high in the future then we will face a situation in which inflation will climb to greater and uncontrollable heights. This will make the RBI hike interest rates which will in turn result in the lowering of investments by companies which will again affect the economy of India. So safeguards should be put

In order to make an informed decision about the regulation or deregulation of diesel it is important that we need to know the concept of subsidies, taxes and under recoveries.

Let’s make the following assumption for easy analysis of the deregulation concept. All assumptions are for per litre of diesel.

Cost price per litre of diesel = A Subsidy per litre diesel = B (Subsidy is the amount that the government gives to the OMCs) So pre-tax price = A – B Tax on Diesel = C (This includes both state and central tax) So the post-tax price = A-B+C (market price) Governments profit = C- B *B is a variable factor which is the difference between the market price in India and the international cost price. *Profit C is the factor of pre-tax price A-B *According to statistics C is greater than B and this implies that the government is already making profits with respect to the diesel prices. During the year 2010-2011 (data taken from Editorial, Peoples’ Democracy, July 03, 2011), the central tax from the petroleum sector is

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to stop this outburst of economy.

I admit that the diesel should be deregulated. That is the best step forward which also reduces the confusing and unwanted under recoveries by the government. Added to this is the increased future chance of international diesel prices coming down which will lead to reduced market diesel prices as well as leading to reduced inflation. But currently the international prices are high and we should question the timing of deregulating the prices of diesel.

Effects of Deregulation of diesel prices:

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Curbing inflation during deregulation:

Deregulating the diesel prices will result in increased diesel prices and hence inflation. In order to avoid this we should be focusing on the taxes that are levied on diesel. The taxes that are levied on diesel are about 40 % of its cost and we should aim to reduce this cost for a short time so that inflation is within control.

India is one of the countries wherein the taxes are over rated. This can be ascertained from the following tables and charts. Table 1 clearly shows that the prices in India are greater than that of other countries and this is because of the high taxes

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The above table illustrates that 11.88 Rs tax (which is around 40 % of the initial cost) is levied on each litre of Diesel sold, an amount which is quite higher when compared to countries like US.

So in order to deregulate the diesel prices and also control inflation at the same time the only way is to reduce the tax for an intermittent period. This will reduce the amount of indirect taxes for a while and this would also have a bearing on the fiscal deficit. The government can raise the taxes in the future according to its plans but the taxes should be reduced now if it is to deregulate the prices.

Plans for the future: 1. Diesel demand can equally compete with petrol demand and there is every chance that diesel prices will increase due to the high demand. India is one country which majorly depends on road for transport of commodities and passengers. The high dependency of these food commodities on diesel will result in increased price of the commodities resulting in inflation.

So we should focus on reducing these dependencies. Improving the railway infrastructure and making them as the primary means of commodity transport within the country will reduce dependency.

2. Steps should be taken that diesel cars and power companies do not use diesel to the maximum because this will result in depletion of the resource as well as increase pollution as compared to petrol. Special taxes on diesel cars should be raised to discourage their use.

3. The government should be able to increase the direct tax collection for reducing the fiscal deficit. Solving the black money issue is one step forward. Bringing in improved measures to track taxes and facilitating higher collections will automatically reduce the fiscal deficit. Even in spite of this, if the government thinks that it should raise taxes then let it do so in the future.

Bottom line: Diesel market should be deregulated but the taxes should be reduced in the short run to curtail inflation.

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SPECIAL FEATURE

SPECIAL FEATURE

Revealed comaparitive advantage-As an Index of efficiency: By- Dr. Tamal Dutta Chaudhuri (The Author is CGM of Industrial Investment Bank of India. He

hold PHD from John Hopkins University, USA. He has 36 years of teaching experience and 21 years experience of working in Banking & Financial sector. He has over 40 publication to his credit and also manages website on share market-www.fin-insight.com ) Bela Balassa (1965) in his paper titled “Trade Liberalization and Revealed Comparative Advantage”, The Manchester School of Economic and Social Studies 33, 99-123, introduced the concept Revealed Comparative Advantage (RCA) to empirically determine the areas of export competitiveness of an economy vis a vis its trading partners. He defined RCA as (Xij/jXij) / (jXij/ijXij)

Where : Xij – exports of the ith good by the jth country iXij – total exports of the jth country jXij – total world exports of the ith commodity ijXij – total world exports The index can be rewritten as (Xij/j Xij) / ( iXij/ijXij) or the ratio between share of exports of commodity i by country j in total world exports of commodity i and the share in total world exports of country j. This looks at RCA in terms of world market share in commodity i of country j vis a vis the overall competitive position of country j.

The theory of comparative advantage stems from the Heckscer-Ohlin-Samuelson hypothesis that a country would export that commodity which uses intensively that factor that is relatively abundant in the country. Thus factor endowments determine the pattern of trade. As factor endowments cannot be empirically measured, Balassa’s index was a useful proxy. As per RCA, an economy is said to have revealed comparative advantage in commodity i if RCA is greater than one.

That is if the share in exports of a commodity to total exports of a country exceeds the share of total world exports of that commodity to total world exports, then the country is said to have revealed comparative advantage in the production of that commodity.

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The purpose of this paper is to extend the application of the concept of RCA beyond international trade and examine whether it provides a meaningful tool of analysis in measuring competitive efficiency. In particular, we choose the banking sector. There is no notion of trade in our application. Endowment of resources is a vector.

For a country it consists of skilled and unskilled labour, underground resources, demographic features etc.

Similarly, for a bank it denotes the amount and quality of manpower, the ownership pattern, the size of equity capital relative to its assets, the technology platform etc. It is true that in physical terms, if a country does not possess oil underground, it can never have oil in future. Whereas a bank always changes its manpower pattern, its technology platform, its equity base etc. In that sense, endowment of resources changes for a bank.

However, our presumption is that, such changes take a lot of time. It is a time consuming process to upgrade the skills of the employees, to link all bank branches and fully computerize them – that is adjustment is not instantaneous. So for a short time period, we can take endowment of resources as given.

As per theory of comparative advantage, if endowment of resources determines competitive efficiency, and if RCA is a measure - if we can design some indices like RCA for the banking sector, then we should be able to arrive at the reasons behind competitive efficiency of Indian banks. We usually use parameters like Returns on Equity (ROE) or Net Interest Margin (NIM) to measure competitive efficiency. Our contention is that, with indices like RCA, it may be possible to analyse the reasons behind differences in ROE or NIM among banks.

We define the following indices for measuring competitive efficiency. a. NPA Index (NI) (NPAi/Total Assets i)/ (ΣiNPAi/ΣiTotal Assets) • 8

OR (NPAi/ ΣiNPAi)/ (Total Assets i /ΣiTotal Assets) The NPA index reflects the ratio between the share of Non Performing Assets (NPAs) to Total Assets of bank i and the share of NPAs of the banking system as a whole to Total Assets of the banking system. Alternatively, this ratio can be written as the ratio of share of NPAs of bank i in total NPAs of the banking system and the share of assets of bank i in total assets of the banking system, the latter being the competitive share of the bank. We stipulate that if NPA Index > 1, then the bank is revealed inefficient.

indicators may be a function of the ownership pattern.

This, a researcher may like to explore.

b. Operational Efficiency Index (OEI) (OEi/ TotalIncome i)/ (ΣiOEi/ΣiTotalIncome) The intuition behind OEI is straightforward. If a bank’s operational expenses (OE) to total income is higher than the industry average, its profitability should be adversely affected and hence if OEI > 1, then the bank is revealed inefficient. c. Risk Aversion Index (RAI) (GSECi/Total Assets i)/ ( ΣiGSECi/ΣjTotal Assets i) RAI indicates the risk appetite of a bank. It indicates the ratio of investments of bank i in Government Securities (GSECS) to total assets. As GSECs carry lower default risk being sovereign, returns would also be lower. If RAI > 1, then the bank is said to be risk averse. This would affect adversely its total income and hence NIM. d. Growth Orientation Index (GOI) (LAi/Total Assets i)/ (ΣiLAi/ΣjTotal Assets i) where LA stands for loans and advances. It indicates the preference for long term loans rather than short term investments aimed at liquidity protection. If GOI > 1, then the bank is growth oriented as it looks beyond the short run. As loans and advances are riskier, returns are also expected to be higher.

Table 1 provides information on fundamentals of a sample set of banks. Except for SBI, clearly the market perception of the private sector banks is better than the public sector banks. As a matter of fact, the public sector banks are underpriced. The reason may lie in the difference in the indicators mentioned above, or in the ownership pattern as given in Figures 1 & 2

The figures show two distinct ownership patterns.

Whereas for ICICI Bank ownership is in the hands of FIIS, the public at large, DIIs and Corporates , for SBI the government is the promoter. It is possible that the

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Figure 1: ICICI Bank ownership pattern

Figure 2: SBI ownership pattern

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MONEY&POLICY

MONEY&POLICY

Funding India’s Infrastructure growth By-Vipul Agarwal (The author is a student of IIFT-D)

26 Feb 2010 Budget Speech by Finance Minister: “To promote savings as well as to ensure their utilization for the thrust area of infrastructure, I propose to allow a deduction of an additional amount of Rs.20,000 for investment in long-term infrastructure bonds as notified by the Central Government. This would be over and above the existing limit of Rs.1 lakh on tax savings. I am sure that these reliefs will put more money in the hands of individual taxpayers for both consumption as well as saving.”

Irrespective of any smile this announcement may have brought on the tax-payers face, it also

brought forth the government’s desperation on how to fuel India’s colossal infrastructural funding requirements for furthering the high growth rate since the post-liberalization era.

“Accelerated development of high quality physical infrastructure, such as roads, ports, airports and railways is essential to sustain economic growth. While addressing the policy gaps in this sector, I propose to maintain the thrust for upgrading infrastructure in both rural and urban areas. In the Budget for 2010-11, I have provided Rs.1,73,552 crore, which accounts for over 46 per cent of the total plan allocations, for infrastructure development in the country”

Government Reports in the National Economic

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Survey and findings made by other organizations have envisaged India’s infrastructure funding requirements at around $500 billion to $1 trillion with a major chunk of this is in the transport and core-utility sectors as power and energy. Against this total requirement the total allocation was just above $40 billion. This might look as a fallacious comparison but even if this amount grows at 10% per annum it will require more than 10 years to generate these funds through conventional sources such as tax collections and other sources.

Around 25% of this investment and the subsequent funding has through the Public-Private Partnerships (PPP’s). In view of the massive funding required, ambitious planning along with a careful vision is required. The success of such an ambitious plan depends on a lot of factors such as creation of adequate projects, facilitating the uptake of such projects by private contractors, ensuring a financial system which provides the necessary funding , subsequent final closure, completion of projects on time (so as to prevent cost over-runs).

Looking from a historical perspective the government has exercised strict control over infrastructure projects and the funding was always done from the government treasury and this was done through external debt.

This was also done through massive foreign aid which came from the US or the erstwhile USSR. The reasons that this large aid was generously available were purely political and post-Cold War such aid has dried out. Japan through a international aid programme provided aid for large development projects but the long financial crisis there has also impeded any chances of easily available foreign help. Thus the government is now faced with a huge requirement of massive fund to the tune of over $1 trillion. Post-liberalization the PPP’s model came up and a large chunk of mega projects was done through this model where the profits or other tangible benefits were shared with the private sector. But the infrastructural re• 10

quirements are so huge that a single model would find it impossible to cater to.

But assuming that all bottlenecks are tackled well still we fall short of around $200 billion to $ 300 billion in financing core infrastructure factors. Structural impediments in the financial system and the volatility in the international credit system will keep on constraining the inflows to this sector. In order to tackle this critical bottleneck a complete restructuring of the entire infrastructure funding system becomes a foremost requirement.

In fact there is a huge incentive for the financial sector to invest in infrastructure development projects due to the huge amount of revenues it will generate. A McKinsey report points out that the revenues for the financial sector could be in the range of $10 - $12 billion in the years from 2010-2014 and above $25 billion in the years after.

In fact India’s infrastructure spending has fallen short in the past few years when compared to the economic growth and has been far behind China in terms of ratio of investment. According to Government data the investment ratio has fallen from 55 between 1988 to 1997 to 38 between 1998 to 2007. Although data for China is not easily available but experts peg the figure between 60 to 70. This is quite self-evident from the level of projects such as the Three Gorges Dam ($22.5 billion) and the recently completed Danyang–Kunshan Grand Bridge.

In the Eleventh Five Year Plan the government envisages to invest an amount to the tune that it will amount to 28% of the total investment in infrastructure projects by all developing countries. This is second only to China. Much of this investment will happen through the private sector. Easier access to internal and external funding is one of the primary reasons that there is such a boost in the private sector. But there are still a lot of issues which impede the investment of private sector investment in infrastructure projects with some of them being exposure limit of banks, high pre-emption of funds from the banking system, strict regulation on usage of provident and pension funds, shallowness of the bond market and most importantly limitations on External Commercial Borrowings.

As already stated these factors will result in a shortfall of around $200 billion in the system. Although these factors threaten to hamper the growth of the debt system but equity flows to the PPP model projects will also be strained.

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India is in the midst of a very critical phase of growth and any impediment coming out of lack of infrastructure is not affordable at the moment. It is not that the government quarters are ignorant of this fact.

For instance in the budget speech for 2005-06 erstwhile Finance Minister P. Chidambaram stated :’

“The importance of infrastructure for rapid development cannot be overstated. The most glaring deficit in India is the infrastructure deficit. Investment in infrastructure will continue to be funded through the Budget. However, there are many infrastructure projects that are financially viable but, in the current situation, face difficulties in raising resources”.

But instead of relying on conventional thinking which usually comes out of the North Block circles, the government could consider some breakthrough policy reforms which will open floodgates of funding to the private sector and hence the infrastructure projects whether mega or medium scale can be pursued wuth enthusiasm.

The major bottlenecks from the system needed to be removed include - allowing banks to invest in infrastructure projects. Apart from this a new system framework for the participation of NBFC’s in the infrastructure development projects will be a major boost to the sector.

Easing of commercial borrowings from external sources is a much needed reform which will also indirectly aid FDI into this sector. Some steps such as the setting up of the IIFCL (India Infrastructure Financing Corporation Ltd.) and providing IDFC (Infrastructure Development Finance Corp.) with a new lease of life are some novel steps taken by the government in the right direction.

While it may be too early to judge IIFCL’s success in this sector, IDFC had lent only Rs 35,021 crore so far against the bank lending of Rs 4,86,132 crore until midDecember 2010.

The combination of the above stated reforms may surely accelerate the funding for infrastructure but other basic reforms such as expedition of the land acquisition process, risk allocation and contract enforceability need to be ensured so that the financial risks of the private players need are mitigated and the bidding for such projects becomes viable.

As previously stated we cannot afford to lose out on the pace which we have picked up after over 43 years of economic drudgery. The leadership at the helm of the Indian financial and economic system needs to be pragmatic with their approach towards this huge funding requirement.

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BANKING

BANKING

Finance for the Poor – Where are we?

By- Dr. BR Chaudhary

(The author is a Asst.Professor of economics at IIFT-K. His research projects include Indo-Thai FTA and has many publications to his credit. He has also served as a consultant to NCAER-Industry Div.)

Credit availability is one of the important factors identified to contribute to reduction in poverty of masses. It is an important means to alleviate poverty when combined with other policies like strengthening property rights over land, developing human capital, ensuring gender equality, introducing proper regulatory structure and increasing political accountability. In rural areas credit non-availability is one of the major constraints for people who have little to offer in terms of collateral.

Majority of the rural poor remains un-touched by the formal banking system and is forced to resort to moneylenders, friends or relatives for finances. Innovation in credit delivery mechanisms which had its roots in the cooperative credit systems in Europe especially in Germany came into vogue from 1970s to tackle the scarcity of credit in rural areas. The modern microfinance movement started in early seventies in Bangladesh due to initiatives of Prof. Muhammad Younus. It quickly spread to other countries buoyed by patronage received from the World Bank. Microfinance tried to address the problem of lack of credit faced by poor people through credit delivery innovations. Giving small (on average $100) loans to individuals as part of groups (Joint Liability Groups, JLGs) or to groups to be disbursed to members by the leader (Self-Help Groups, SHGs) or even to individuals with increasing future loan commitments if borrowed amounts repaid on time, regular repayments (weekly/ fortnightly) are new mechanisms through which the information asymmetry problems were sought to be mitigated. One of the major objectives of this programme was to reduce the dependence of the poor people on moneylenders who charge exorbitantly high interest rates.

In India the microfinance movement started with the pilot project initiated by NABARD in 198687. During 1988-89, in collaboration with some of the member institutions of the Asia-Pacific Rural and Agricultural Credit Association (APRACA), NABARD undertook a survey of 43 NGOs in 11 states in India, to study the functioning of microfinance SHGs and their collaboration possibilities with the formal banking sys-

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tem. Both these research projects threw up encouraging possibilities and NABARD initiated a pilot project called SHG linkage project. In this model groups of 15-20 people (predominantly women) are nurtured by NGOs and then linked to banks. Evidence of financial discipline has to be demonstrated by the group through regular savings for at least six months before such linkage is possible. An account is then opened in the bank in the group’s name where the accumulated savings is deposited. The bank then lends in multiples of this accumulated savings. More than 90% of the members of SHGs are women and most of them are poor and asset-less.

The SHG movement has been instrumental in mainstreaming women by-passed by the banking system. In 2009-10 the growth in number of SHGs linked to banks increased by 11.8% whereas same figure for the annual growth rate of loans stood at 17.9%.

After RBI allowed banks to lend to MFIs under their priority sector requirements microfinance through MFIs grew rapidly in India. MFIs are a wide range of organizations, such as Trusts, Societies, NGOs or even Companies, which vary in their legal structure, mission, and methodology, but share the common function of providing financial services to clients who are poorer and more vulnerable than traditional banking clients. In 2009-10 the growth in the number of MFIs being financed by banks was 116% over the previous year and in terms of amount lent the growth figure read 102.6%.

Thus the rapid growth of MFI-based lending in recent years has been possible due to funds provided by the commercial banks to this sector. Despite this spectacular growth of MFI-based lending, SHG-Bank Linkage still provides around 70% of microfinance loans in our country.

The question that can be asked at this juncture is whether after almost two decades of existence of a variety of microfinance organizations applying innovative lending methodologies, have access to finance improved in our country. Has it reduced the dependence of borrowers on informal sources of finance especially money lenders? Recent National Sample Survey Organization • 12

(NSSO) data reveals that still 51.4% of total number of households in our country has no access to either formal or informal finance. Moreover, only 27% of total farm households are indebted to the formal institutions out of which one-third are also indebted to informal sources.

Regional disparity in proportion of farm households indebted to formal sources is high with North-eastern, Eastern and Central region on an average having 80% of farm households not accessing credit from formal sources. At the rural household level the rich-poor divide in incidence of indebtedness is astounding. Debt to Asset ratio is 27% for the poorest households whereas it is only 2% for the richest households. The same ratio for debt from non-institutional sources stood at 23% for the poorest households and only 0.2% for the richest ones .

have been largely bypassed by the microfinance and other financial institutions in the rural areas. How can one bridge this gap between regions and people in terms of access to credit? Before answering this question

one must look at the causes for such divide. Causes for such exclusion can be segregated into demand and supply side factors. On the demand-side credit absorption capacity of the borrowers has been emphasized. Lack of skills, low health standards, weak infrastructure reduces the probability of success of projects which may limit the requirement for loans. Thus policies must be taken to improve human and physical resource endowments and productivity, reduce risks and strengthening market extension services. This would improve credit absorptive capacity of the poor borrowers and increase their demand for productive loans. On the supply-side NGOs should be encouraged to nurture poor people in backward areas where banks cannot reach, by providing information on the kind of services available for them.

Business Facilitator/Business Correspondence model as emphasized by RBI should be adopted by banks and MFIs where latest technology like hand-held devices may be used to provide door-step banking to rural poor in a cost-effective manner. The recent (May, 2011) RBI Guidelines on microfinance lending based on the Malegam Committee Report tries to address the issue of noninclusion of poor borrowers and financial sustainability

This makes rural poor more vulnerable to shocks of MFIs. Ceiling on effective rate of interest charged to their income generating activities. They may confront (26%), amount of household indebtedness at any point perpetual debt trap which leads to loss of little assets they in time (Rs. 50,000), annual household income above may have and result in working as bonded laborers in which MFIs would not be allowed to lend (Rs. 60,000) moneylenders’ business activities both agricultural and etc. are in the right direction. A balance has to be achieved otherwise. Overtime it has been observed that incidence between outreach and efficiency objectives though outof debt from formal sources increased from 29% in 1971 reach to non-included poor borrowers should be the to 64% in 1991 but it came to 57% in 2002 in rural over-riding concern of these organizations. A medium areas. So still a substantial proportion of credit in rural term objective of reaching at least 50% of the financially areas is provided by informal sources especially agriculexcluded households by 2012 has been proposed through tural and professional money lenders (29.6%). launching of the National Rural Financial Inclusion

The above mentioned facts show that there is Plan. Thus proper policies to enhance demand for and still a long way to go before all rural poor have access to supply of credit along with right regulation can be credit. If we consider outreach of microfinance by sheer thought of as viable strategies to substantially reduce the number of people reached it is quite substantial but subnumber of financially excluded households in our counstantial disparity is observed across regions and people. try.

Many Studies in this area shows that poorest of the poor

INFINEETI| July 2011

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MONEY&POLICY

MONEY&POLICY

Impact of changes in DTAA with Mauritius By- Sourav Dutta (The author is a student of IIFT-K) “Double Taxation

Double taxation is the imposition of two or more taxes on the same income, assets or financial transaction.

It is a taxation principle referring to income taxes that are paid twice on the same source of earned income.

Double Tax Avoidance Agreement (DTAA) and India

Double tax avoidance treaties are signed to avoid profits from the same source being taxed twice. As far as India is concerned, India has entered into Double Taxation Avoidance Agreements (DTAA) with 65 countries including countries like U.S.A., U.K., Japan, France, Germany, Singapore etc. These agreements provide for relief from double taxation in respect of incomes by providing exemption and also by providing credits for taxes paid in one of the countries. These treaties are based on the general principles laid down in the model draft of the Organization for Economic Cooperation and Development (OECD).

DTAA with Mauritius

India signed a Convention in 1983 with Mauritius for the avoidance of double taxation, prevention of tax evasion and to encourage mutual trade and investment. According to the DTAA, capital gains from sale

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of shares by residents of Mauritius in India would be liable to tax only in that country. Mauritius is a leading offshore financial centre (OFC) with all the characteristics of a typical OFC such as very low taxes, relatively light financial regulation, banking secrecy and no requirement for a substantive local presence. As Mauritius does not have capital gain tax, it leads to zero taxation and there is no burden on investors routing money to India through circuitous route. Thus, a Mauritius-based investor does not pay capital gains tax either in India or in Mauritius. Currently, nearly 42 per cent of FDI into India is routed through Mauritius. Of the $132 billion FDI flows received by India between April 2000 and 2011, $55 billion was routed through Mauritius.

Likewise about 40 per cent of the FII fund flow into the country is believed to be routed through the island nation. A large majority of them are third country investors, who use the DTAA for saving capital gains tax.

Why the DTAA needs a change

The government is losing out on huge tax revenue of at least Rs 2,000 crore per year because of the Indo-Mauritius tax treaty according to the Minister of State for Finance. India is currently facing 3 major problems.

• Treaty shopping: Treaty shopping is when a resident of a third country takes advantage of the provisions of the DTAA between two countries to reduce tax liability • Round tripping: It means that domestic funds come back into India as FDI money without any incremental flow of funds into the country.

• Loss of revenue: Indian Government is losing revenue since users of this route are evading tax that should have flowed into the Government’s coffers. There is an extensive use of the Mauritian route to pump in black money into India especially in the telecom and real estate sectors.

India plans to review the Double Taxation Avoidance Agreement (DTAA) with Mauritius to pre• 14

vent tax evasion and strengthen the exchange of information. It also aims to plug loopholes and revenue leakages.

Impact of DTAA with Mauritius on Foreign Inflows

Review of India’s three-decade old double tax avoidance agreement (DTAA) with Mauritius will not impact foreign direct investment inflows to the country in the long run. Genuine investors will continue investing in India. In the short term it may affect the FDI. FII investments into country would be impacted if capital gains tax is imposed. Even if the Indian Government takes the unnecessary step of revoking the DTAA, investors in the stock markets need to understand that this is not a catastrophe. Such an event would affect only prospective FII flows and not money that is already invested. There could be a temporary outflow as FIIs book short-term capital gains before a given date, but this money will flow back, through other routes. Some FIIs might prefer to cut back on short-term trading and turn in to long-term investors and that would be good for our market.

Big Business, which operates across countries, dodges taxes and transfers profits to low-tax jurisdictions. But, in my personal opinion, there is no need to make amendments to the DTAA treaty. Firstly, treaty shopping is a widely accepted form of tax planning. And the concept is flawed in the sense that if Mauritius charged a low rate of Capital Gains Tax (CGT), India would still not have made any money since the revenue in that case would have gone to the Mauritian government.

Current Scenario and Prediction of Future

FDI flows from Mauritius and Cyprus have also been declining of late. In April 2011, India received more FDI from Singapore (Rs 5,214 crores) than from Mauritius (Rs 4,332 crores). Incremental FII flows into equity markets are more from other jurisdictions such as Singapore, Dubai, Luxembourg. The Mauritian government is reluctant to bring about changes in the DTAA treaty since it earns substantial sum from these offshore entities.

India is taking up measures to tighten the screws on inflow of funds from tax havens. Government is already under pressure to go after black money. Black money isn’t generated only from political bribery and kickbacks. It is generated on a rather bigger scale when

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The final reason why scrapping of Indo-Mauritius tax treaty is unnecessary is because the Direct Taxes Code that will come into effect from April 2012 has a modified GAAR (general anti-avoidance rule) that lays down that income-tax officers can determine the tax consequence for the assessee by disregarding any arrangement such as DTAA. The Singapore alternative that the Indian Government has provided to overseas investors by amending the DTAA with that country in 2005 could prove to be a serious competitor to Mauritius in the years ahead.

Indian Government has made Singapore waive capital gains tax of its residents on sale of equity in India. Since many FIIs are already head-quartered in Singapore, they can easily channel their funds from there. What is more important is that the DTAA with Singapore includes clauses that prevent misuse which can be done with Mauritius.

India being a growing economy, business and investment will continue to come in the long term

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COVER STORY

COVER STORY

Regulation On Savings Interest Rate: A Boon Or A Bane By- Shubham Singhal, Nimit Varshney, Siddhartha Arora (The authors are students of NITIE-Mumabai)

In India, banks have complete freedom in fixing domestic interest rates. However, the savings deposit rate is still regulated by Reserve Bank of India [RBI] and acts as a source of low cost funds for the banks. The interest calculation methodology has been shifted from minimum balance between 10th and last day to the daily product basis with effect from 1st April, 2010. Recently, the savings deposit rate has also been increased by 50 basis points to 4%. In simple words, deregulation is removing RBI’s control over the prevalent interest rates for banks’ savings accounts.

The issue of complete deregulation of savings deposit rate has risen from time to time and acts as our point of discussion in this article Banker’s Point of view

With the soaring inflation, the real rate of interest on savings is negative and hence deregulation seems inevitable. However, banks hold a mixed opinion on the same. While the state-owned banks are more in favor of the regulated savings deposit rate, the private banks are mostly in favor of deregulation. Many banks affirm that if interest rates are to be deregulated then RBI should also deregulate the maintenance charges. The private banks feel that deregulation is a win-win situation for both the retail depositor as well as the banking system due to the reasons given in the next section.

Pros of Deregulated Savings Deposit Rate • De-regulation of interest rates will lead to stiff competition. Thus, banks will have to come up with innovative products to attract consumers resulting in increased focus on technology and customer support, thus benefitting the consumers.

• Inflation in India has averaged to about 5%+ in the last five years. Thereby the existing savings deposit rate is even lower than the inflation rate effectively yielding negative returns for the consumer.

• Currently the deposit base is about 22% of the total deposits of scheduled commercial banks and 13% of the financial savings of the household sector. Deregulation will lead to increase in savings deposit base for the bank.

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Fig:Interest Rates For Different Deposits

Table Savings Bank Deposits: Annual Growth

Cons of Deregulated Savings deposit Rate

The process of deregulation of deposit interest rates began in 1980. However, the Indian Banks’ Association [IBA] still remains in favor of a regulated savings interest rate due to several reasons: • At a time when new banking licenses are to be issued, deregulation may lead to unhealthy competition thus leading to uncertainty in the markets.

• In our country, the account maintenance charges are among the lowest in the world. Today several services are clubbed with the savings accounts which are provided to the consumer free of cost like issuance of a new cheque book, ATM services etc. However if savings deposit rates are deregulated and goes up, the banks in order to maintain their margins will thereby be charging these services which will thereby be an overhead to the consumer.

• Although deregulation will lead to product innovation which should generally be benefitting the consumers, but it may also lead to complex product schemes which may be difficult for the users to comprehend. This may result in mis-selling and thereby larger number of complaints by the consumer.

• Depositors will take benefit of high interest rates for short term and this can lead to high volatility in transactions. Large part of deposits is used as core deposits (Tier 1 capital) by banks and is further utilized for giving long term loans. Any volatility can lead to Asset Liability Mismatch (ALM) for banks.

Our Viewpoint

Regulated savings deposit rates are providing cheap funds for banks to operate and hence have huge profit margins. Do they really have huge profits?

Banks need to maintain 6% of their deposits with RBI in form of CRR [cash reserve ratio] and 24% in the form of SLR [statutory liquidity ratio] and at the same time need to provide cheap loans to priority sector which constitutes about 40% of their total loan advances. This leads to low availability of cheap funds thereby hampering their margins. One of the bankers quoted that it’s quite difficult to break even at current rates with minimum balance of Rs. 7500, thus, if rates go up, the minimum balance could be almost double[5]. This emphasizes on the low operating margins on which the banks sustain.

In India, banks lure customers in terms of the services being offered to the consumers rather than having a price oriented competition. Even if the consumers may not be enjoying the market driven interest rate but they

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INFINEETI| July 2011

enjoy a lot of free services like ATM facilities, free cheque books, online banking, phone banking, etc. which has substantial costs for the bank. This can be referred to as irrelevance hypothesis which holds that any subsidies banks might receive from restricting price competitions are fully dissipated through non-price competitions.

We look at deregulation as a tool for the customer to reap benefits of market driven competition. But will it really be useful for the consumers and our economy?

De-regulation could be a major setback for the process of financial inclusion. With stiff competition due to deregulated savings deposit rate, banks might not entertain maintaining savings deposit account with small amounts due to high maintenance costs incurred.

This will discourage banks from focusing on rural and semi-urban areas which constitute around 36% of our total banking population.

Table:Saving deposit rate.

As observed in other countries like Singapore and Hong Kong, the banks have come up with slab based interest rates, depending on the amount deposited.

Little or no priority is given to the first slab as the bank considers accounts of the individuals falling under this slab as high cost incurring accounts. In India, where major population lives in the rural and semi-urban areas this may be a major setback. As for low amounts deposited, the rate may even be lower than the current regulated rate i.e. 4% thus, leading to loss in savings for a major chunk of India’s population

Another issue which we could be facing is that an increase in the savings deposit rate will further push the lending rates upwards as this will be a necessary action for the banks to maintain their margins.

(Figure Country wise savings deposit rates offered by HSBC Bank) • 17

COVER STORY

COVER STORY

Provided appropriate measures are taken, the banking sector can account for over 7.7% of GDP with over Rs. 7500 billion in market capitalization as compared to 3.3% of GDP with market cap. of Rs. 2400 billion. This growth will require high amount of capital to the tune of Rs. 600 billion over the next few years .

This will lead to an offset in wealth distribution since only few high deposit holders will be able to reap benefits of the higher interest slabs with the rest being burdened with higher lending rates.

the account maintenance charges are still regulated by RBI in this phase. The banks are operating at marginal operating margins and thus, would not be able to offer higher interest rates to low saving accounts. Higher interest rates offered to select customers will attract more savings. The banks can choose to keep their QAB [Quarterly Average Balance] to a higher limit for these selective customers thus mitigating the loss in revenue incurred due to higher interest rate. Thereby the savings interest rates become more competitive without affecting the common man.

Since banks still have access to cheap funds, thus, lending rates will not be impacted significantly.

Higher interest rates on selective accounts should not hurt profits of the banks since higher deposit base will be available which could be utilized for revenue generation through loans or investments. Phase 1 allows us to monitor the impact of deregulation on the market value of commercial banks.

Table : Savings Bank Deposits: Number of accounts and per capita savings bank deposits

Our Proposed Approach

For comprehensive growth of our economy, the expansion of banking sector is of utmost importance.

To cover maximum proportion of the population, it is important that the banks should go ahead with their expansion plans of opening as many branches as possible covering all the regions. Referring to the table 5, we can see that the number of people having access to banking facilities is quite low being around 36.20 per 100 persons

We would like to state ‘Producer Protection Hypothesis’ which proposes that although regulators are originally established to regulate the regulatees, they can be subsequently captured by the regulatees due to the alignment of self- interests between the two i.e. both RBI and IBA have the same incentive to maximize the size of the banking industry

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In India, where a significant portion of household savings (particularly in semi-urban and rural areas) is still held in the form of cash, attractive interest rates on savings bank deposits will bring into the banking system a part of the Rs 9.5 lakh crore that households keep with themselves as cash [2]. To increase the attractiveness of deposits, we need to deregulate the interest rates.

But at the same time, we need to safeguard the interests of the senior citizens, pensioners, small savers, particularly in rural and semi-urban areas by not exposing them to the volatility of the market driven rates. We propose that deregulation should take place in a 3-phased manner.

Phase 1:

RBI should set 4% as the base rate for all the savings deposits giving flexibility to banks to compete for customers having high saving deposits i.e. RBI should fix only the floor rate with flexible ceiling rate. However, • 18

Phase 2:

During phase 1, banks were able to increase their share of deposits from urban areas. However, due to high operating costs, banks were not able to focus on the rural and semi-urban areas. In phase 2, the maintenance charges accrued by the banks should be deregulated continuing with the same savings deposit base rate i.e.

4%. This gives them incentive to target the large rural sector population which still remains untapped. The banks will have flexibility to decide their impositions of maintenance charges. For example, to attract the rural population, banks may not charge them for maintenance of their accounts. However, they may levy charges on other customers.

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Phase 3:

During phase 1 and phase 2, we tried to focus on maximizing the reach of the banks without bringing in unhealthy competition. Phase 1 concentrated on maximizing the urban reach of the customers increasing the deposit base and phase 2 focused on maximizing the rural reach of the customers. In this phase we propose to completely deregulate the deposit savings rate. This should be done at a time when banks have a significant reach to the customers within the country. Also, during this stage certain economic conditions like inflation should be under permissible limits to yield positive real return.

Execution of each phase is dependent on the success of the previous phase and constant monitoring of each phase is important as any deviation from the expected outcomes will have to be tackled sensitively.

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REGULARS

Monthly Chronical By- vineet

bakshi

(Author is student of IIFT-K) Cabinet okays BP picking 30% stake in 21 Reliance blocks In February, Reliance had agreed to sell 30 per cent stake in 23 blocks won under various licensing rounds in part to benefit from BP’s deepwater exploration expertise. Reliance will retain operatorship of all blocks. The two have been holding divergent views on the exploration phase of these non-producing blocks.

According to the RIL-BP announcement, BP will pay RIL an aggregate $7.2 billion. Future performance payments of up to $1.8 billion could be made on exploration success that results in development of commercial discoveries. The deal size may rise to $20 billion with future performance payments and investments

Apple surprises with smashing Q3 Results

USA, based Apple Inc announced financial results for its third quarter of the fiscal year 2011, ended June 25,2011. The company reported a record net profit of $7.31 billion, a growth of 125% compared to profits of $3.25 billion, in the year-ago quarter. The company’s quarterly revenue rose to $28.57 billion in the quarter, an increase of 82% compared to $15.70 billion that it reported in the same quarter, last year. International sales accounted for 62 percent of the quarter’s revenue. Gross margin was 41.7 percent compared to 39.1 percent in the year-ago quarter

Italy and the euro: On the edge

For more than a year the euro zone’s debt drama has l urched from one nail-biting scene to another. First Greece took centre stage; then Ireland; then Portugal; then Greece again. Each time European policymakers reacted

INFINEETI| July 2011

similarly: with denial and dithering, followed at the eleventh hour with a half-baked rescue plan to buy time.

Financial markets turned on Italy, the euro zone’s third-biggest economy, with alarming speed. Yields on ten-year Italian bonds jumped by almost a percentage point in two trading days: on July 12th they breached 6%, their highest since the euro was created. The Milan stockmarket slumped to its lowest in two years. Though bond yields subsequently fell back, the debt crisis has clearly entered a new phase. No longer confined to the small peripheral economies of Greece, Ireland and Portugal, it has hurdled over Spain, supposedly next in line, and reached one of the euro zone’s giants. All its members, but especially Germany, face a stark choice.

Italy has the biggest sovereign-debt market in Europe and the third-biggest in the world. It has €1.9 trillion ($2.6 trillion) of sovereign debt outstanding, 120% of its GDP, three times as much as Greece, Ireland and Portugal combined—and far more than the €250 billion or so left in the European Financial Stability Facility (EFSF), the currency club’s rescue kitty

Eight banks fail EU stress test with 16 in danger zone

The European Banking Authority (EBA), which carried out the healthcheck, said another 16 banks were in the danger zone. The EBA called on national financial regulators to ensure that capital shortfalls would be quickly resolved. Five Spanish banks failed, as well as one in Austria and two in Greece.

A key benchmark for passing the test was whether the banks have at least 5% “core tier 1” capital, which describes the best form of capital a bank can hold to make up any losses.

he tests are a key element in fighting Europe’s debt crisis, intended to identify weak banks and ensure they are made robust enough to survive a possible default on government bonds by heavily indebted countries such as Greece.

CASHONOVA

Equity Research Cell at IIFT, Delhi – A Cashonova Initiative

(The Equity research Cell at IIFT is a initiative of students to give a new dynamism to the stock market following and investing. The articles discusses the scope and activities of the Cell) Cashonova – the Finance & Investments Club recently launched the Equity Research Cell with the objective of enhancing the understanding of equity markets among IIFTians. Largely, it is the endeavor of the ERC to equip students with the skills required to prepare professional Equity Research reports, but it does not restrict itself to just this. The ERC will provide the necessary tools to formulate investment thesis on publicly-traded companies, make sound judgments and communicate opinions through equity research reports. The scope of the Cell’s Knowledge Transfer sessions would cover all aspects of preparation of equity research reports, namely: • Gathering Relevant Information • Forecasting Financial Estimates • Developing Valuation Models • Formulating investment thesis and Producing Effective

Research Reports

The members of ERC would have the opportunity to interact and seek guidance from professionals in the Indian Equity Research Industry. As mentioned earlier the ERC would also focus on other challenging initiatives such as • In House Mutual Fund • Paid Equity Research Initiatives

Scope of ERC:

• Introducing students to Fundamental and Technical Analysis.

• Appreciating the factors affecting Equity Market movements.

• Financial Statement Analysis • Preparation of Sector Analysis reports • Building Valuation Models • Building Dynamic Models to factor changes in business scenarios • Launching Mutual Funds and Actively Managing them • Prepare students to represent IIFT at CFA Global Investment Research Challenge (GIRC)

• Reuters India • Ace Equity • INTERNATIONAL FINANCIAL STATISTICS (IMF) • INSIDE US TRADE • CMIE Database ERC would be making best use of the information provided by these databases, to arrive at sound judgments and make informed recommendations.

In house Mutual Fund:

The ERC plans to launch an in house Mutual fund in the coming few weeks. The fund would be actively managed based on the research reports by the ERC members and Bloomberg consensus estimates. NAV’s would be published on a weekly basis in our website and Monthly Performance reports in Infineeti. Students would be maintaining ghost accounts with the sole intention of academic learning.

Paid Equity Research Initiative:

The ERC understands that there are numerous small cap stocks that are not actively tracked and hence provides an opportunity to produce first hand reports.

The reports would be based on company annual reports, management inputs and ERC estimates on the industry and the company. These research reports would be provided to the concerned companies to facilitate their business transactions. They would also be published on our website and ‘Infineeti’ - the monthly finance magazine.

Corporate Partnership:

ERC looks forward to engage corporates as knowledge partners in its journey. The corporate would mentor and guide the cell in its initiatives. The idea behind the partnership is to imbibe the best practices of the industry in the learning process. The Cell endeavors to bring knowledge partners on board in the near future.

Resources

IIFT provides its students with wide range of databases as follows: • Capital Line Plus

(Continued at page 31)

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• 21

SUMMER INTERNSHIP

SUMMER INTERNSHIP

Internship Experience: Enterprise Risk Management By- Mary Brinda (The author is a student of IIFT-K. The article highlights her

Assets.

experience & learnings as an intern at Wipro )

As a part of the course curriculum of IIFT, it is compulsory for every student to get hands on experience in the corporate world before they enter their final year.

I was one of the 5 students from IIFT who did their internship with Wipro Ltd. I worked in the Enterprise Risk Management which directly comes under the purview of Wipro Corporate. The two months in the ERM team has been a great learning experience.

Today’s managers face a variety of complexities in addressing the dynamic business needs. The risk associated with business is also changing. Risk is defined as the probability of an unforeseen incident and its penalty.

It becomes important for a company to understand the risks involved in business. An effective risk management is essential to safeguard and increase the profitability of a business.

ERM (Enterprise Risk Management) wing of Wipro Corporate address risk in a holistic way that includes strategic, financial, operational and compliance risk components. The Wipro Enterprise Risk Management focus group has built deep expertise and key insights into the Risk Management arena. The COE (Centre of Excellence) is a recently established wing of ERM, which specializes in providing risk assessments to the different Business Units.

The first project that I worked on was the “Country Risk Assessment”, where I was required to understand the framework for country risk assessment and deploy it on selected countries. The fundamental underlying of the framework is the PESTEL analysis. A detailed study was made on the country in the lines of the current political scenario, the economic growth, the regulations in terms of taxes and work visa norms, etc.

A comprehensive summary of the key challenges and the mitigation plan was developed. This report serves as an early warning signal for the challenges Wipro might face when it enters a particular country.

INFINEETI| July 2011

“Customer Credit Risk Assessment” was the second project in line. This was further subdivided into 4 parts. The first part deals with the determination of the risk associated with the Wipro Clients. The turmoil happening in the financial world makes it necessary for Wipro to determine the riskiness of their clients to ensure that they get back their receivables. The Customer Credit Rating (CCR) model is an in house model used to determine the credit worthiness of Wipro clients.

I had to run the model on the Top 100 customers of Wipro. This process involved in looking at the financial statements of these 100 companies and calculating the required financial ratios, based on which the rank was assigned.

The core part of my project was involved in stress testing the CCR model with other existing bankruptcy prediction models. The CCR model was tested against models like Altman Z score, Springate and Fulmer.

Altman Z score is a score used to predict the probability that a firm will go into bankruptcy within two years. The Bloomberg terminal has details of the Z score.

The model was developed by Edward I. Altman in the year 1968 who was, at the time, an Assistant Professor of Finance at New York University. Altman used a sample of 66 companies; 33 failed and 33 successful companies.

Z = 0.012T1 + 0.014T2 + 0.033T3 + 0.006T4 + 0.999T5.

Where

T1 = Working Capital / Total Assets.

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T2 = Retained Earnings / Total Assets.

T3 = Earnings before Interest and Taxes / Total

T4 = Market Value of Equity / Book Value of Total Liabilities.

T5 = Sales/ Total Assets.

Based on the Z score the companies are classified into the following zones: Z > 2.6 -“Safe” Zone 1.1 < Z < 2. 6 -“Grey” Zone Z < 1.1 -“Distress” Zone Altman’s model is reported to have achieved an accuracy rate of 95.0%.

Springate model is used to predict the probability that a firm will go bankrupt. Gordon L.V. Springate a Canadian scientist on the basis of Altman developed own coefficient in 1978. He selected 4 major ratios from 19. The main criteria for this selection were independency between ratios and also highest correlation and predictiveness of company’s bankruptcy.

Z = 1.03A + 3.07B + 0.66C + 0.4D Where A = Working Capital / Total Assets B = Net profit before interest and taxes/ total assets C = Net profit before taxes/ current liabilities D = Sales / total assets If Z < 0.862; then the firm is classified as “failed”

This model achieved an accuracy rate of 92.5% using the 40 companies tested by Springate. Botheras (1979) tested the Springate Model on 50 companies with an average asset size of $2.5 million and found an 88.0% accuracy rate.

Fulmer model is used to give the probability of a company becoming insolvent. The model was developed by using step-wise multiple discriminate analyses to evaluate 40 financial ratios to arrive at the final 9 ratios. It was developed in 1984 by John G Fulmer. It is designed specifically for small retail manufactures and service companies that are generally smaller in size.

H = 5.528 (V1) + 0.212 (V2) + 0.073 (V3) + 1.270 (V4) - 0.120 (V5) + 2.335 (V6) + 0.575 (V7) + 1.083 (V8) + 0.894 (V9) - 6.075 Where

V1 = Retained Earning/Total Assets

V2 = Sales/Total Assets

V3 = EBT/Equity

V4 = Cash Flow/Total Debt

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V5 V6 V7 V8 V9

= = = = =

Debt/Total Assets Current Liabilities/Total Assets Log Tangible Total Assets Working Capital/Total Debt Log EBIT/Interest

If H < 0; then the firm is classified as “failed”

Fulmer reported a 98% accuracy rate in classifying prior to bankruptcy, the test companies one year prior to failure and an 81% accuracy rate more than one year.

A sample of 24 Bankrupt companies (which have filed Chapter 7 or Chapter 11) within the period of 20092010 with annual revenue of more than $250M were chosen for analysis. The financials of these companies were obtained from the SEC filings filed one year prior to the date of bankruptcy. The Credit Worthiness score as per Wipro’s CCR methodology was computed for the fourth quarter before the date of filing the bankruptcy.

Altman Z score’s was obtained from the Bloomberg report; the Springate Score and Fulmer Score were computed for the same period. I had the opportunity to work on the Bloomberg terminal, in order to get the Altman Z score. The resulting comparison showed that the CCR model had an accuracy rate of 88.88% while the Springate model had an accuracy rate of 94.44%.

The reason behind the greater success of Springate was analyzed and action plan was recommended to the team.

The third part of the project was involved in determining the risk associated with the Euro billing customers. The Euro Sovereign Debt crisis has an impact on the companies working in these countries, especially the high risk countries of PIIGS(Portugal, Ireland, Italy, Greece and Spain). The CCR model was used in collaboration of the country risk ratings to come up with the final risk score.

The final part of this project was involved in evolving a framework for the financial sector. The different dynamics associated with the financial Service sector makes it necessary to develop a modified framework to determine the credit risk associated with the clients from the FS sector. The financial statements of financial firms are a tad different from the other companies; the same financial parameters used in the CCR model cannot be applied to the firms under the Financial Services sector.

The Basel norms and other regulations were studied before the financial parameters were determined. The design of the framework was completed and it has been handed over to the ERM team.

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CROWDSOURCING

CROWDSOURCING

Crowdsourcing 1.0: By- Arjit Jain (The author is a student of IIFT-K. The article high-

highest levels of participation. Howe cites the 1:10:89 Rule, which states that out of 100 people • 1% will create something valuable • 10% will vote and rate submissions (crowd creation) • 89% will consume creation For example, Google’s search engine is built upon the principle of Crowd Voting. Reality TV shows offer another example of Crowd Voting.

lights his experience & learnings as an intern at M&M) Introduction Some depend upon active collaboration within virtual

Many of you might have heard about community of individuals, while others benefit from the crowdsourcing and for many this might be the first opposite. For example, prediction markets maximize time. It is not a rocket science to understand it but if value not through collaboration, but from minimal successfully implemented in business it definitely holds interaction between participants.

Rocket profits.

Jeff Howe describes the four primary types of The term “crowdsourcing” is a portmanteau of “crowd” crowdsourcing – and “outsourcing”, first coined by Jeff Howe in a June 2006 Wired magazine 1. Crowd Creation article “The Rise of Crowdsourcing”. Crowdsourcing= Crowd creation implies that the creativity The basic premise is that a task normally and labour of the crowd is employed to CROWD + OUTperformed by a regular paid employee solve the problems of the crowdsourcer.

SOURCING would get “outsourced” to a large group Perhaps, the best known forms of of people by harnessing the internet to crowdsourcing are “creation” activities bring them together. But this definition and tasks change such as asking individuals to film TV commercials, based on the criterion for selection of the crowd. Off perform language translation or solve challenging late, in some projects it has been generalized and can also scientific problems. mean that the burden of a large endeavor doesn’t fall to For example : just one person, but is distributed among • MTV Roadies and Big Boss – Cast of many people. the show is crowdsourced C rowdsourcing • Android – Google backed operating What is Crowdsourcing? system for smart phones is a way to tap the

Crowdsourcing is a distributed • StockPhoto – Amateur photographers problem-solving and production model. power of masses. contribute high quality stock In the classic use of the term, problems Rather than get- photography images are broadcast to an unknown group of ting a task done • Innocentive – Connects research solvers in the form of an open call for by your employees organizations with a global community solutions. The crowd also sorts through or getting it out- of scientists. the solutions, finding the best ones.

• Linux – Open source operating sourced These best solutions are then owned by system developed by community of the entity that broadcast the problem in avid programmers the first place—the crowdsourcer—and It changes the perception of the industry the winning individuals in the crowd are sometimes in many ways and changes the industry economics. For rewarded. In some cases, this labor is well compensated, example; iStockPhoto helped in reducing the cost of either monetarily, with prizes, or with recognition. In portfolio of photographs in a significant way. other cases, the only rewards may be kudos or intellectual satisfaction. Crowdsourcing may produce solutions from 2. Crowd Voting amateurs or volunteers working in their spare time, or

Crowd Voting leverages the community’s from experts or small businesses which were unknown judgment to organize, filter and stack-rank content such to the initiating organization. as newspaper articles, music and movies. It is the most

There are multiple approaches to crowdsourcing. popular form of crowdsourcing, which generates the

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3. Hassle free –

No need to envisage tasks to be done. Get the finished forms and then pay for the best option. No need to maintain those employees and no need to track the whole process in development.

4. Great Marketing Tool–

As of now more than the benefits out of the design that LG crowdsourced, LG drew more attention through the news that went viral about LG crowd 3. Crowd Wisdom sourcing. I don’t see great phone models coming but I

The “Wisdom of Crowds” principle attempts do see good links going back to the news on Google. to harness many people’s knowledge in order to solve 5. Talent comes searching for you – problems or predict future outcomes or help direct

Case study competitions organized by companies corporate strategy. in association with various B-schools is a classic example.

For example; P&G crowdsources 60% The top prize usually is a pre-placement Ideating of its annual R&D from laboratories offer along with cash incentives. through crowd in universities and research centers 6. Stop that futile R&D – throughout the world.

This is an application which has multiple benefits. The success rate increases immensely, new 4. Crowd Funding product development program is focused on customer

Crowd-Funding circumvents the traditional requirements and it saves a lot of shareholders money. corporate establishment to offer financing to individuals Example; Procter and Gamble crowdsources 60% of its or groups that might otherwise be denied credit or annual R&D catalogue from various universities and opportunity. The crowd funding approach has long research centres across the globe. precedents in the sphere of charity. But, various 7. Good tool for head hunting or outsourcing – applications developed by entrepreneurs

That’s where I see a long term today use Crowdfunding to create benefit of crowdsourcing. In case yours Raising capital capital for business. Applications of this is a web design company and you from the crowd kind evolve everyday depending upon frequently crowdsource your job to for a purpose the Area of implementation. couple of people who are the same all For example; French entrepreneurs and times, you know this relationship can be producers Guillaume Colboc and Benjamin Pommeraud converted into a contractual outsourcing. Furthermore, from company Guyom Corp. when they launched a this can be even utilized incase if you are looking for public internet donation campaign in August 2004 to polished professionals to recruit. fund their film, Demain la Veille (Waiting for Yesterday).

Disadvantages of Crowdsourcing Advantages of Crowdsourcing 1. Crowdsourcing the wrong thing – 1. Cost effective way to complete the task –

Seeking solution from the crowd requires the

iStockPhoto.com sold a photograph for 1$ . At idea to be made public. This may result in competitors that time, professional photographers charged close to using the same idea to their advantage.

100$ per photograph (depending on the kind of snap 2. Authenticity and source of content – required).

A major issue is that of copy rights. For example; 2. Provides more value for your money – If Nokia claims that the artwork that LG has used by

With large number of choices to choose from, crowsourcing is a Nokia copyright, then what? It’s true even though the cost is high, we get lot many options. that LG need not pay the royalties but would have to at Example, LG crowdsourcing competition had users least withdraw that phone off the market. What if while designing the future phone. Even if the winning design the crowdsourcee participates in the contest he also is not used to develop a model, the entries can be used provides the same design to Nokia and before LG comes for idea generation of hundreds of phones to come. up, Nokia throws a similar piece in the market.

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REGULARS-C2C

CROWDSOURCING 3. Wrong Marketing –

At times Crowdsourcing can result in wrong marketing by passing the bad word of mouth publicity.

Example; an automobile company tries to crowdsource its next model design. In case if the end product is proved not good from the comfort aspect and not good in aesthetics, who is to be blamed? People will simply say that the company does not take quality seriously and rather tries to crowdsource

Campus to corporate: By- Nitin Bakshi

(The author is MBA from NITIE-Mumbai. He is currently working in AirTel. The article gives the glimpse of what it is to work with the Co. and the responcibilities at entery level)

In R&D, the challenges for application of Crowdsourcing to product development are unique. But the results far outweigh the limitations. FMCG major P&G is the biggest example.

In Operations, crowdsourcing facilitates the sharing of best practices. It also assists in identifying the future partners in development and production.

Some of the biggest companies of the world have successfully employed crowdsourcing to their advantage and have reaped in the desired results. to get the work done in pennies.

4. Can become costlier –

Example,launching competition to write an article for college magazine sees 50 entries on 5 different topics. The purpose of the competition was to get quality entries and save time of the editing team. But the team ends up spending more time in reviewing 50 entries and the quality may not be good (opportunity cost).

Where to use crowdsourcing?

Crowdsourcing is the new kid on the block.

It has vast applications from Marketing, Research and Development to Finance. The applications vary to suit the requirement of the crowdsourcer. Crowdsourcing is an alternative technology acquisition model whose costs can be closely managed.

In Marketing, Crowdsourcing can be applied to all the 5Ps of Marketing. “People”, the latest P is the driving force behind crowdsourcing.

In Finance, Crowdsourcing can be used to raise capital, find the best fit capital structure and design innovative products for ever changing world.

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I have joined Bharti Airtel in the Finance division. In Airtel, all the Management Trainees are addressed as Young Leaders. But before being deployed into the Finance division, I would be a part of the 6 months Bharti Airtel Young Leaders Program (BYLP).

Started as an initiative to inject the freshest, most innovative, talented and energetic blood into the organization, the Bharti Airtel Young Leaders Program (BYLP) helps in grooming young leaders (YL) into future core members of the Bharti Airtel family.

Structure of the Program

A healthy mix of project based training, interpersonal mentoring as well as on-the-job assignments, makes BYLP a unique and productive initiative.

fit and ready to take up functional roles and challenges.

On the Job Training: Once the YL is ready to be part of the core structure, functional duties are assigned and he/she is made familiar with exemplified procedures of work.

• Facebook used crowdsourcing to develop interface and applications for different countries.

• L’Oreal used viewer created advertising messages of Current TV to pool new and fresh advertising ideas.

Requirements

For any crowdsourcing project to be successful, it requires the crowdsourcer to prevent the occurrence of a phenomenon called Madness of the Crowd. This refers to the difficulties that the crowdsourcer faces in employing the strengths of the crowd to the advantage.

One of the main reasons for the occurrence of this madness is that the problem statement is not clearly defined, in other words, the needs are not clearly defined.

The only option to define a need for crowdsourcing is to first identify the problem statement which has resulted in the creation of that need.

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Focus on Development

A series of initiatives have been taken to focus on individual development of YL’s: The Mentoring Program aims to create interpersonal interaction between accomplished senior mentors (from within the organization) and Young Leaders and helps them channelize their career aspirations by instilling knowledge, skill, wisdom and inspiration through these interactions.

Cross Functional Training: During this phase, the YLs receive holistic exposure to the working and products & services of the organization. Every YL would be doing a mandatory 20 weeks on- the- job training in 3 core functions i.e. Sales, Network and CSD. Apart from this there would also be 4 weeks of non-core functions such as Finance, Regulatory, SCM and IT. Comfortable adapting to the daily operations through this 6 month training, the fresh pass-outs from campus then becomes

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The Buddy Program enables the Young Leaders (YL) to not only ‘feel’ the organization through the eyes of an old timer, but also accelerates their ability to deal with early disconcerting issues. The buddy is the ‘confidante’ on whom YLs can fall back on in the new environment.

Training Programs: Residential Programs are conducted for YLs to facilitate movement from “Campus to Corporate.”

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INFINEETI

REGULAR-MW

Market Watch By- KUSHAL MASAND (Author is student of IIFT-K)

In the last month or so, the equities markets around the world have been in uptrend despite the concerns about the Greek debt crisis. The reason for this is the fall in the commodity prices, due to the conscious efforts by Chinese administrators to bring down the inflation, and thus owing to the fact that the profit margins if the firm won’t take a beating. It has been more of a relief rally Let’s have a look at the run up by the major stock exchange

Moreover, with the Greek crisis near mid-term solution one can expect this rally to continue with the only deterrent seen are high commodity prises and US debt-ceiling problems. 2nd August after which US economy won’t be able to service its debt, and which might also lead to downgrade in its AAA rating. The industrial production in the US advanced only by 0.2% but the jobless claim fell by 22,000 to 405,000. Also the pending home sale index rose by 8.2%, giving enough reasons that the US economy is getting out of its slumber, albeit a tad slowly then initially expected.

Now lets take a look at the Indian bourses. Here also the sectoral indices are positive, leading to a short but smart rally by the Nifty. The major contributor has been the FMCG stocks, which have a PE of 32, significantly higher then any other index, most of which are below PE of 25.

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Banking stocks have also started to move up, amid the hope that the interest rate cycle has peaked up. Among the heavyweights Reliance has been an utter disappointment amid various reports questioning the integrity and falling output from KG-6 basin. The only microfinance scrip listed on the exchange, SKS Microfinance, has run up by more then 50%, after the Microfinance bill, where the jurisdiction of the microfinance companies has been given to RBI. Many PSU’s like Power Finance Corporation, REC, and IDFC has increased by more then 15% or so

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REGULARS-BM

REGULARS-FWF

Games Indians Play By- Rajesh Jaddu (The author is a student of IIFT-D)

Fun With Fin: By-Vedvyas Bhattacharya (The author is a student of IIFT-K) 1. A company, to avoid being taken over, issues a large number of bonds with the condition they must be redeemed at a high price if the company is taken over. What is the specific name of this tactic?

2. Named one of Time Magazine’s 100 Most Influential People in the World in 2010. In the aftermath of the 2008 financial crisis, she has been tasked to build a new government agency to crack down on abusive practices in financial products like mortgages and credit cards in US. Identify her and the agency.

“Games Indians Play” primarily deals with explaining the behaviour of Indians at times of intense competition using Game Theory and what we could do to rectify it.

Who among us, as Indians, have not heard of or experienced or ourselves played a role in, jumping the Traffic light, breaking the Queue or corruption in the

3. Which credit rating agency in India launched ‘Real Estate Star Ratings’, assigning city-specific ratings to a particular project on an eight point scale?

4. The General Insurance Corporation of India, NABARD, National Insurance Company Limited, The New India Assurance Company Limited, The Oriental Insurance Company Limited and United India Insurance Company Limited together are together stakeholders in which insurance company?

5. X, a figure of speech was invented by Y to indicate the price fluctuations in the stock market. X forgets what happened the previous day and has extreme mood swings. This made Y propose theory Z based on the extreme behavior of X. What are X, Y, Z? 6. Connect: Harry Markopoulos, Sherron Watkins, and Cynthia Cooper. (Hint: illegal activities) 7 This bank was founded on June 2, 1806, mainly to fund General Wellesley’s wars against Tipu Sultan and the Marathas. It was renamed for the first time on January 2, 1809. How is this bank best known?

8. The word X is derived from the ancient language word which means “silver”. Many languages use this root, however, in some places, X is officially known by names derived from the same ancient language word Y which means money. Y is also a currency of another country. Identify X & Y 9. Connect these four images to a company

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system. All of these are unfortunately a part of the system we live in. We as Indians need to acknowledge this and take appropriate measures.

The author, as a build up, brilliantly uses Prisoners Dilemma (2 prisoners) and Veerapan’s dilemma to explain the basic nature of humans. Prisoner’s dilemma is the age old Good Cop- Bad Cop Strategy used on prisoners, in which they are given an option to rat out, so that one gets a lesser sentence and the other gets the bulk of it. It is fun to read both the cases, and even better is the beauty of Game Theory in solving these dilemmas. The author thus tries to convey that real life is nothing but Prisoners dilemma taking place repeatedly. The solution suggested by the author is the Tit-for-Tat strategy, where, if anyone cheats (rats out) you use the tit-for-tat strategy.

In the land of Gandhi this might seem a little off beat, but in the dog-eat-dog world we live in today, the author says, we unfortunately are left with no option.

The beauty of this book lies in the fact that, it is not just boring mathematical theories the author talks

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about but also real life experiences that the author has been through. He uses the payoff matrix to explain each example to give the readers a better perspective.

Lastly the author interestingly links Bhagavad Gita and Game theory. He links “You have right only to your actions, and not to their result” teaching of the Bhagavad Gita to the utility-maximizing choice of the Game Theory.

The author was a professor at IIM Ahemadabad for about 20 years, a chief executive at a private firm and is a specialist in Game Theory and Behavioural Economics.

(Continued from page 20) Takeover Makeover

India announced a complete makeover of its takeover rules. SEBI has accepted most of the recommendations made by the Takeover Regulations Advisory Committee (TRAC) last year. India’s new takeover regulations will raise the substantial acquisition trigger to 25% followed by a 26% open offer. SEBI rejected the TRAC proposal of a 100% mandatory open offer. But agreed to do away with the up to 25% noncompete fee to promoters- thereby giving all shareholders the opportunity to exit at the same price. That price will now be determined via a longer look-back period and a more current volume-weighted market price.

As proposed by TRAC, shareholders with a more than 25% stake will be allowed to creep at 5% per fiscal all the way to 75% or use a minimum 10% voluntary offer to consolidate their position.

US House passes debt bill, likely to die in Senate

The House of Representatives Friday passed a Republican bill to end the bruising standoff over raising the US debt limit, but the measure was nearly sure to die in the Democratic-led Senate. Defying a White House veto, lawmakers voted 218-210 in favor of Republican House Speaker John Boehner’s measure to avert a disastrous US debt default, setting up a Senate vote within hours to set aside the bill and begin crafting a compromise acceptable to Democrats • 31

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