blue chip issue 2 (july-september 2012)

2

From the Editor’s Desk

Dear reader,

As we bring our second issue to your desk, there seems to be some relief in the economic climate with policy changes like the government‘s announcement of allowing FDI in multi-brand retail. The way the Manmohan Singh govern-ment handled it, seemed like a red herring for distracting the public from the burning issues of corruption. How success-ful such policies prove at the ground level in uplifting the lowest in the supply chain, is left to be seen.

Of course, the news of this bold but long awaited policy change would give relief only for a little while before Team Kejriwal brought out skeletons from closets of political big wigs and put allegations of crony capitalism on one of In-dia‘s largest companies, calling for a change.

The life of an MBA student, is rife with ups and downs, handling change is a way of life. The previous edition of Blue Chip (July) found you in a much different state than this one. For many first years, the change is a good one, the relief of having gotten a good summer internship for the year 2013. For the second years, those whose placement status has changed to ‗signed out‘, too, are sitting comforta-bly. While, for many others, the change might not be such a good one, a time filled with tension and anxiety still waiting for that golden final or summer placement. Some might even fear an outcome similar to the placement season at their undergraduate level during the years of 2008-09.

But all hope is not lost, as with policy changes from the gov-ernment and political activism from the public clubbed with seemingly favourable outcome of US presidential election, there seems to be an atmosphere of constructive change.

Keeping in line with the spirit of change - the only constant in life - we have added a new section for exercising your grey cells called ‗Mind Games‘ that features a crossword. We hope you find it to be a change for the better!

Retaining popular sections from last issue; this time we fea-ture an interview with the country head of Food & Agri-Business Strategy & Research (FASAR) for Yes Bank, Mr. Girish Aivalli, who has given his invaluable insights about the food and agri-business scene in India and about Yes Bank‘s future plans.

Ending on a festive note, from the entire Blue Chip team, here‘s wishing all our readers a very Happy Diwali and a prosperous new year 2013!

~Anupriya Editor for Blue Chip

BLUE CHIP

ISSUE 2

All images, artwork and design

are copyright of

Monetrix

Finance and

Economics club of

MDI, Gurgaon

Aditya Mittal

Amit Garg

Aneesha Chandra

Anupriya Asthana

Keyur Vinchhi

Nihal Mahesh Jham

Rishabh Gupta

Sandeep Patil

Sankalp Raghuvanshi

Saurabh Saxena

Stephen Thomas

Uday Das Gupta

Varun Sanghi

Manasa Malipeddi

For any information or feedback, please

feel free to write in to us at

[email protected]

3

CONTENTS

Tutorial ~ 23

Breaking Up of Currencies

Fiscal Deficit ~ 43

Fiscal Deficit: The Labyrinth Tale

The Bad-Bank Model ~ 19

Good Bank, Bad Bank

Market Update ~ 46

Market Movement

Economic Indicators

World Market Exchanges

Sector Wise Snap Shot

In the News

Quantitative easing ~ 4

Quantitative Easing:

A Blessing or a Curse?

Policy and Governance ~ 25

Decay Beyond the Billion Dollar

Cavity to the National Coffers: Has

Coalgate Exposed the Root?

Mr. Girish Aivalli

In conversation with ~ 28

Industry Speak

Cover Article ~ 9

Leap of Faith Off the

Fiscal Cliff

Book Review ~ 17

Breakout Nations

Carbon Credits ~ 36

Carbon Finance

Understanding the Market

Mind Games ~ 50

Crossword

Beginner’s Corner ~ 40

Trading Strategies

4

|QUANTITATIVE EASING|

through its policy of quantitative easing in the

interval from November 25, 2008 through

June 2010. The program had a little impact

initially, so the Fed announced an expansion

of the program from $600 billion to $1.25

trillion on March 18, 2009.

But soon after the program ended the econ-

omy again showed signs of slow growth, &

with the rise of the European debt crisis there

was a renewed instability in the financial mar-

kets. So the Fed introduced a second round of

quantitative easing, which came to be known

as QE2 and involved the purchase of $600

billion worth of short-term bonds. This pro-

gram ran from November 2010 through June

2011 and although it sparked a rally in the fi-

nancial markets, it did little to spur sustainable

economic growth. The consequences were the

same as those following QE1, which again

resulted in weak economic data and poor

stock market performance.

In September 2012, the Fed said it would

spend a further $40bn per month by purchas-

ing mortgage- backed securities until the labor

market improves. This is in addition to the

$2.3tn that Fed has put into QE since 2008.

The Bank of England, on the other hand, has

committed a total of £375bn to QE so far.

Quantitative Easing

Quantitative easing (QE) is an unconventional

monetary policy tool used by central banks to

stimulate the economy when conventional

monetary policy has become ineffective.

When the nominal interest rate is very low and

close to zero, the central bank cannot lower it

further. This is called a liquidity trap and it can

occur during deflation or when inflation is very

low. In such a situation, the central bank may

implement quantitative easing by purchasing a

predetermined amount of bonds or other assets

from financial institutions. This will then in-

crease the demand for the bonds and raise the

prices or conversely lower the yield on the

bonds issued. The goal of QE is to increase the

money supply and stimulate demand rather than

to decrease the interest rate, which cannot be

decreased further.

From the time of the global financial crisis, both

the Federal Reserve and the Bank of England

and have used the policy of quantitative easing

to revive consumer spending and economic

growth.

For instance, during the financial crisis of 2008,

high unemployment and slow growth forced the

U.S Federal Reserve to stimulate the economy

QUANTITATIVE EASING

A blessing or a curse

Rini Kothari

Student, MBA 2012-14, SIBM Pune

© Monetrix, Finance & Economics Club of MDI, Gurgaon

As another round of Quantitative easing (QE) by the Federal Reserve is making headlines, people are proving skep-

tical that it would help increase discretionary spending. With continued lackluster growth in the job market and a

sluggish economy despite the efforts of the previous two rounds of QE, it is time to raise questions whether this uncon-

ventional monetary policy tool is really a blessing or a curse. This article talks about the impact of quantitative easing

on US economy, the liquidity in emerging markets and the world economy as a whole and seeks to justify whether the

use of QE is warranted in the current economic conditions.

5

much lower levels of debt in emerging mar-

kets. This also illustrates why emerging mar-

kets became a target for excess liquidity. The

graph below shows that as compared to

emerging markets, debt levels in developed

economies are rising sharply.

Need of QE in the present conditions

Since the second half of 2008 and during

2009, spending in the economy has slowed

very sharply as the global recession gathered

pace. This

s l o w

g r o w t h

bears the

threat of

a down-

ward spi-

r a l

t h r o u g h

contrac -

tion of

the real

o u t p u t

combined

with price

deflation.

A n

American

economic recovery is important from the per-

spective of achieving global economic recov-

ery. As the Fed has a dual mandate to main-

tain price stability and full employment, the

relative lack of inflation at present gives the

Fed room to act on helping the employment

scenario.

According to a dismal employment report

released in September 2012, the unemploy-

ment rate, despite dipping slightly in previous

months, remained above 8% and employers

During the past 20 years, there have been other

instances where QE has been employed by the

Bank of Japan and the European Central Bank.

The Great Recession and Euro zone debt

crises—drivers of unprecedented QE

The need for such aggressive monetary actions

in recent years can be traced to the U.S. real es-

tate bubble, which burst in 2007, and to the

more-recent sovereign debt crisis in the Euro

zone. When the toxicity of subprime mortgage

i n s t r u -

m e n t s

came to

light near

the end of

the past

d e c a d e ,

the U.S.

e q u i t y

m a r k e t

p l u m -

m e t e d ,

f i n a nc i a l

institutions

s u f f e r e d

h u g e

losses, and

i n v e s t o r

confidence took a nose-dive. The nightmare of

this series of events quickly spread to the world,

and the Great Recession was born.

The central banks in developed countries, which

were faced with task of reviving their flagging

economies, responded to the crisis by unprece-

dented levels of quantitative easing. Many of

these banks were already overleveraged and/or

saddling their balance sheets with additional

debt in the form of bailouts. This led to a sharp

increase in developed-market government debt

since the Great Recession, compared to the


JULY-SEPTEMBER‘12 | BLUE CHIP ISSUE 2

Figure: 1 Source: Government agencies, as of Dec. 31, 2011

6

has not been offset by a demand, it results

into excess liquidity. This surplus capital from

developed countries flows to the emerging

markets and has an adverse effect on their

currency exchange rates, inflation levels and

export competitiveness.

There are a number of reasons why emerging

markets are a popular target of excess capital.

Some of the reasons are:

1. The overall

ability of emerg-

ing markets to

take on debt is

strong.

2. Investment

yields in these

countries are

h i g h .

3. As compared

to developed

markets, they

have experi-

enced minimal

balance sheet

impairments.

4. As emerging markets have lower debt-to-

GDP ratios , they have relatively lower levels

of pre-existing leverage.

The more specific effects of these cash flows

on emerging markets are:

Global Inflation: Emerging markets like India

are already facing a high rate of inflation. An

increase in liquidity will further aggravate the

inflation to unmanageable levels.

Currency depreciation: Increased supply of the

dollar will lead to its weakening against major

world currencies, and thus improve its export

competitiveness. This will have an adverse

effect on emerging markets, which are more

could only add 96,000 jobs to payrolls last

month. This is well below economists' forecasts

of 125,000 jobs.

In this scenario where inflation is below the of-

ficial target of 2 per cent for both the Fed and

Bank of England, quantitative easing is expected

to jump start the economy through stimulus

spending.

Currently, the Fed‘s concern is that the sluggish

economy would

result in defla-

tion which is a

bigger threat to

e c o n o m i c

growth than

inflation. Let‘s

take the exam-

ple of the hous-

ing market to

see how this

works. The

housing market

has experienced

a deflation in

prices of about

30% since the housing bubble burst. Due to this

deflation in prices people are hesitant about

buying homes until prices start trending up

again. The skepticism among home buyers

causes the housing prices to fall further in a vi-

cious, depressing trend.

In such a setup, the U.S Fed‘s launch of QE3,

which will pump $40 billion into the US Econ-

omy each month, is aimed at reducing the un-

employment levels and reviving the housing sec-

tor.

Impact on emerging markets

QE leads to greater availability of credit in de-

veloped markets. But as this supply of money



Figure: 2 Source: CBS News

7

place, households and businesses are expected

to be more

willing to

spend, thus

i m p r o v i n g

employment

p r o s p e c t s

and raising

incomes.

In actuality,

h o w e v e r ,

u ne m p l oy -

ment levels

have re-

mained stub-

bornly high

over 9%, the population participation rate in

the labor force has constantly decreased and

the employment-population ratio has shown

no signs of improvement during the last two

years. Figure 3 behind shows that QE has not

been very successful in aiding the unem-

ployed.

Effect on Mortgage Lending and Housing

Markets

The Federal Reserve has mentioned that QE

has been implemented to support mortgage

lending and housing markets with lower inter-

est rates. But according to the data released by

S&P Indices for its S&P/Case-Shiller Home

Price Indices, the leading measure of U.S.

home prices, all three headline composites –

the national composite and the 10- and 20-

City composites have ended the first quarter

of 2012 at new post-crisis lows. This shows

that QE has clearly failed to recover the hous-

ing sector and at best, it has just reduced the

rate by which it is weakening. Figure4 (next

page) shows that the Case-Shiller Home Price

index is heading downwards.

dependent on exports and have less well devel-

oped domes-

tic consumer

economies.

Currency Carry

Trade: QE

f a c i l i t a t e s

‗ c u r r e n c y

carry trade‘ in

which specu-

lators borrow

money at low

interest rates

and invest it

in developing

countries at a

much higher interest rate. This will have the de-

stabilizing effects of rapid currency appreciation

and asset bubbles.

Effect on S&P 500 prices

Quantitative easing tends to pump up the prices

of financial assets such as stocks and commodi-

ties. This can be seen in the rise of S&P 500

prices with the expansion of the Fed‘s balance

sheet. But as the money-printing effects start to

wear off, the index again shows a downward

trend. Thus, by forcing interest rates lower, QE

makes bonds less attractive and therefore stocks

seem like a better alternative. This effectively

inflates a false stock market bubble that could

burst once the intervention ends. The graph

given below illustrates how S&P 500 prices

started to rise when QE started and stopped

rising when QE was terminated.

Effect on Employment

A major motive behind the unprecedented use

of quantitative easing has been the high unem-

ployment levels and the sluggish job recovery

since the financial crisis in 2008. With the intro-

duction of QE and better financial conditions in


JULY-SEPTEMBER‘12 | BLUE CHIP ISSUE 2

Figure: 3 Source: U.S Bureau of Labor Statistics

4

8

these emerging markets, resulting in an over-

valuation

of the

their cur-

r e n c i e s

and sub-

sequently

damaging

exports.

A l s o ,

f u r t h e r

QE may

add to

our prob-

l e m s

when the

C e n t r a l

Bank has to unload all the bonds it has pur-

chased. When the Fed decides to sell all the

bonds it bought during the three phases of

QE, interest rates will be driven up and may

stall the economic recovery just when it has

finally taken off.

Ultra-easy monetary policies such as QE can

be a threat to the health of financial institu-

tions and the functioning of financial markets.

Temporary, higher-than-normal inflation, as a

result of such a policy, causes wage and price

adjustments and erodes the real value of

household debts. It should also be noted that

when nominal interest rates are close to zero,

a higher inflation rate translates to a much

lower real interest rate.

Thus, we can conclude that, supply of addi-

tional liquidity through QE is a questionable

solution towards resurrecting today‘s econ-

omy and, not a panacea in creating sustainable

demand.

Blessing or Curse

Analyzing the

effects of QE

policy of the U.S

Fed, we can

draw up the fol-

lowing points:

By the use of

quantitative eas-

ing the Fed has

not been able to

reduce unem-

ployment in a

m e a n i n g f u l

manner or cre-

ate a recovery in

the housing

market. Thus QE does not deal with resolving

the underlying causes of the current economic

w e a k n e s s .

Another round of QE will add to the already

enormous national deficit. Even though the in-

terest rates are already at historic lows, busi-

nesses and homeowners are still having trouble

borrowing as banks have not taken an aggressive

stance on lending. So a major risk with more

QE is that it may fail to achieve the desired re-

sult of boosting economic growth because

Americans are so indebted they do not want to

borrow more even when the loan is very cheap.

Another risk is that the banks and other inves-

tors may take the money and invest into assets

like shares and commodities, rather than lending

it for more productive purposes like business

investment. This will further push the asset

prices higher.

The massive amounts of money flowing into

emerging markets as a result of expansionary

monetary actions in developed markets will lead

to skyrocketing levels of foreign investment into



Figure: 4 Source: S&P Indices & FiServ, as of May 29, 2012

9

Leap of Faith Off the Fiscal Cliff

|COVER ARTICLE|

The fiscal cliff is a term coined by Ben Bernanke, the current chairman of the Federal Reserve, to

describe the huge budget deficit reductions slated to go into effect at the turn of the year. It is a

combination of tax increases and spending cuts which will be a big negative fiscal shock to the

US economy as there will be a fiscal squeeze of roughly USD 500bn in a single year. To have

an idea about the size of the cliff, we can look at the GDP growth of the US. As per the data by

World Bank, US economy (GDP=USD 15 trillion) grew by 1.7% in 2011 which translates

into USD 255 billion. What this means is that if US political heads don’t take any action then

the tax increases and automatic spending cuts would be triggered leading to a squeeze of USD

500 billion due to the policy changes. On a net basis the US economy would shrink even after

considering an optimistic growth of 2% or USD 300

billion. According to a report by Congressional Budget

Office (CBO) the total deficit reduction in FY2013 is

estimated to be USD 607 billion. So it is high time that

US leaders should resolve the issue before it is too late to

act.

Components of Fiscal Cliff

If the US congress fails to act before 31st December

2012 then a set of revenue and spending measures

are going to expire leading to a fiscal deficit to an

estimated 641 billion in fiscal year 2013, almost USD

500 billion less than the deficit in 2012. A large part

o f

the fiscal deficit reduction would be coming from Bush Tax Cuts expiration, Payroll Tax

Figure 1 - Deficit Reduction; Source: Congressional Budget Office

JULY—SEPTEMBER ‘12 | BLUE CHIP ISSUE 2

9

10

Cut expiration, Debt Ceiling Deal and the

Alternative Minimum Tax patches.

Tax Increases

1. Bush Tax Cuts expiration: In 2001

George W. Bush, the then President of the

US, passed Economic Growth and Tax

Relief Reconciliation Act of 2001

(EGTRRA), a piece of tax legislation to

reduce various taxes (individual rates, es-

tate and gift tax), provisions to reduce the

marriage penalty, increase per child tax

credit and simplify retirement plans over a

period of nine years. Jobs and Growth Tax

Relief Reconciliation Act of 2003

(JGTRRA) was passed during the presi-

dency of George Bush in 2003 to acceler-

ate certain tax changes passed in EG-

TRRA 2001, lower taxes on dividends and

capital gains and increase the exemption

amount for the individual Alternative

Minimum Tax. EGTRRA and JGTRRA

are known as Bush Tax Cuts. The provi-

sions made in EGTRRA and JGTRRA

were set to expire in 2010 but where ex-

tended for two years under the presidency

of Barack Obama in 2010. Now the exten-

sion period is going to be over in Decem-

ber 2012 costing USD 221 billion to the

economy as per the CBO.

2. Payroll Tax Cut expiration: In February

2012, the US Congress extended the tem-

porary 2 percentage point reduction in the

tax that funds Social Security pension pro-

gram to support the US economy with a

plan to end the tax holiday after December

2012. If the payroll tax holiday isn‘t ex-

tended then it is estimated to suck USD 95

billion in FY2013 from the US house-

holds.

|COVER ARTICLE|

3. Alternative Minimum Tax (AMT): The

US congress conceptualised the idea of

AMT in 1969 when 155 people with earn-

ings above USD 200,000 took a lot of per-

sonal exemptions and didn‘t pay any taxes.

Currently, AMT works as a parallel tax

system to limit taxpayers from taking per-

sonal tax exemptions. Since the AMT isn‘t

indexed to inflation, the number of people

falling under AMT is rising. For the past

few years Congress and the President have

been enacting legislations to increase the

AMT exemptions a.k.a. AMT patch to

keep the tax from reaching deep into the

middle class. Without the AMT patch,

CBO estimates that US households will

have to pay USD 98 billion additional in-

come tax in 2012.

Spending Cuts

The Debt Ceiling Deal: Last time when the

US was about to reach its debt ceiling in

2011, the US Congress and the White House

signed a deal to raise the debt ceiling on the

condition of USD 2.4 trillion in spending

cuts over the next decade. The spending cuts

are supposed to trigger after December 2012

as per the Budget Control Act of 2011. The

legal procedure which triggers the automatic

spending cuts is known as Sequestration.

Considering that economy is still recovering

the cuts have been designed to be smaller in

the initial few years and then increase with

time as economy starts doing well.

The proposed USD 109 Billion Spending

Cuts would include :

Fiscal Deficit of US

George W Bush during his tenure had in-

creased the US Fiscal Deficit from USD


Army Operations & Maintenance 6.9

Navy 4

Educational achievement & Special- education programs 2.3

Medicare payments to hospitals 5.8

Diplomatic programs & Embassy security 1.2

Table 1 - USD 109 Billion Spending; all figures mentioned in $billion

11

144.5 billion to USD 962 billion. He had

waged two wars in Iraq and Afghanistan,

raised the government spending from 1.8 tril-

lion to 3 trillion whereas the tax revenues

were increased minimally. On top of that he

had imposed two major tax cut policies which

added a 1.6 trillion deficit over the next 10

years. The above two graphs (figure 3) show

the major components of spending as well as

tax revenue increases during the Bush Ad-

ministration.

After coming to power in November 2008,

President Barack Obama tried to reduce the

deficit by raising taxes for higher income

group and cutting the unnecessary spending.

In August 2010 he withdrew US troops from

Iraq and is slowly trying to withdraw forces in

Afghanistan.

Current Impacts of the Fiscal Cliff Un-

certainty

While the consequences of the fiscal cliff will

be felt beginning in January 2013, the uncer-

tainty caused by lack of consensus among

legislators on a plan to avoid it has led to cer-

tain impacts being felt in the present. Al-

though there are no universally accepted met-

rics to quantify uncertainty per se, the figure 4

shows a study published in the Economist

wherein the number of times the word


Figure 3 - Increase in US spending and tax revenue

Figure 4 - Uncertainty in US

Figure 2 - US Fiscal Deficit Green Island — Basalt Sea Cliff

|COVER ARTICLE|

12

―uncertainty‖ appears in the

Federal Reserve‘s Beige

Book (a report based on

interactions with econo-

mists, businessmen and

other experts) has been

used to view the trend over

several months of 2011 and

2012. The spike in Septem-

ber 2011 could be attrib-

uted to the debt ceiling dis-

pute between Democrats

and Republicans whereas

increases in June-July 2012

may be a result of the un-

certainty over the impending

fiscal cliff.

Another study conducted on somewhat simi-

lar lines has attempted the quantification

based on a combination of scanning newspa-

per reports of economic uncertainty, counting

tax provisions slated for expiry and analyzing

opinion differences among economists about

various possible outcomes. The Economic

Policy Uncertainty Index (figure 5) and its

calculation were originally proposed by

economists from Stanford University.

Some of the estimated impacts of this un-

certainty that being felt over several months

in 2012 are as follows:

1. As per Sylvain Leduc and Zheng Liu of

the Federal Reserve Bank of San Fran-

cisco, this has contributed at least a per-

centage point to the unemployment rate

(7.9% for October).

|COVER ARTICLE|

2. Although ordinary consumers may not be

too worried about the looming cliff, busi-

nesses are factoring it into their invest-

ment and expenditure decisions. Invest-

ments in equipment and office space as

well as new hiring are being toned down

over fears of the impending fiscal contrac-

tion and the subsequent recessionary sce-

nario.

3. An estimation done by the National Asso-

ciation of Manufacturers (NAM), pegs the

effect on 2012 GDP at 0.6%.

4. Another interesting trend which is being

observed is big dividend payouts under

consideration by various companies prior

to December 31st in anticipation of divi-

dend tax increases (43% from 15%) in the

New Year.

Consequences of Fiscal Cliff

Impact of Tax In-

creases

The added effect of

this tax increase on the

various income groups

is given in figure 6.

From this, we can see

that the biggest impact

would be on low in-

come households

which will see a tax

jump from 1% to 4%.

Also, it is interesting to note that the tax in-


Figure 5 - US Economic Policy Uncertainty Index

Figure 6 - Impact of Tax Increase

13

crease for 2nd quintile is more than that of

middle quintile.

Impact of Spending Cuts

Defense is the main sector where most of the

spending cuts are planned to be done. It is

estimated that expenditure on defense would

be reduced by USD 54.7 billion per year.

Unemployment benefits to the tune USD 26

billion is planned to be cut. Given the weak

labor market, unemployment rate hovering

around 8%, and reduction in unemployment

benefit - situation can be dismal for the un-

employed citizens. On an average the plan is

estimated to cost 1.6 million jobs per year. It

has been widely accepted that the doctors

who treat elderly and disabled on Medicare

don‘t enjoy a handsome compensation from

the government. If ―Doc Fix‖ leads to reduc-

tion of roughly USD 11 billion p.a. as per the

CBO estimate then the doctors compensation

will take a further dip, which could lead them

to drop Medicare patients.

Perspectives on dealing with the Fiscal

Cliff

While most of the major stakeholders agree

that the fiscal cliff is not in anyone‘s best in-

terests, when it comes to deciding on meas-

ures to tackle it there seems to be a difficulty

in arriving at a consensus. There is yet hope

|COVER ARTICLE|

that an agreement would be reached during

the lame-duck session of Congress set to be-

gin shortly prior to the new year.

Republicans’ Proposal: broadly involves

domestic spending cuts keeping the defense

spending and tax rates untouched.

1. In the past three months, the House of

Representatives has voted to extend the

Bush tax cuts for all and undo the Penta-

gon cuts before sequestration begins in

January.

2. Spending cuts to the tune of USD 240 bil-

lion over a decade have been proposed in

welfare programs such as Meals on Wheels

and food stamps which could impact

nearly 23 million Americans.

3. Republican Presidential candidate Mitt

Romney favoured an increase in defense

budget to 4% of GDP from the current

3%.

4. Mr. Romney advocated spending cuts in

the form of Medicaid (government funded

health insurance for the poor) reduction

and conversion of the Medicare (health

insurance for the old and the disabled)

into a voucher based scheme.

5. He wanted to retain the 15% gains tax cap

for the wealthy while putting an end to the

tax for those earning less than USD

200,000.

6. Remove dividend tax on individuals earn-

ing below USD 200,000, while retaining

the Bush cut rate of 15% on others.

7. Put an end to extension of unemployment

benefits.

Democrats’ Proposal: involves letting the


Democrats Republicans

Expire tax cuts for the wealthy Extend Bush tax cuts to all taxpayers

Allow the USD 500 billion in defense cuts Cut down domestic spending leaving defense untouched

Expand Medicaid & reduce Medicare cost Reduce Medicaid & make Medicare voucher based

Table 2 - Democrats vs. Republicans

Figure 7 - Consequences of Fiscal Cliff

14

tax cuts expire for families earning over USD

250,000 and individuals with income exceed-

ing USD 200,000 thereby benefiting about

97% of the taxpayers. Other measures advo-

cated:

1. President Barack Obama has vowed to

veto any plan that does not raise taxes for

the wealthy. His famous ―Buffet Rule‖

seeks to impose a minimum effective tax

rate of 30% on millionaires.

2. Increase capital gains tax to 20% from

15% for the wealthy.

3. Maintain the 15% dividend rate for most,

while increasing it to the 36% - 39.6%

rates for the wealthy.

4. The other item on his agenda is expansion

of Medicaid and reduction in cost of Medi-

care.

5. Democrats in Congress are now advocat-

ing an extension of the USD 95-120 billion

payroll tax relief that both parties had ear-

lier agreed upon to let expire.

Another group christened ―Cliff-divers‖

which includes some Democrats and econo-

mists believe that the immediate conse-

quences of the cliff are overstated. They ad-

vocate letting the fiscal cliff occur and then

cutting taxes for the middle and lower income

|COVER ARTICLE|

groups. This approach would, thus, not con-

flict with the Republicans‘ ―no new taxes‖

pledge.

The Federal Reserve has no room for lower-

ing interest rates as it is already near zero. It

will mostly hold the Fed Funds rate between

0 and 0.25% until mid-2015. The third round

of quantitative easing (QE3) which is under-

way involves purchase of USD 40 billion in

mortgage-backed securities per month until

the unemployment situation improves. This is

aimed at reducing mortgage rates, infusing

money into the economy and boosting con-

sumer spending. While this proactive ap-

proach is encouraging, it may not be an effec-

tive safety net if the economy goes over the

cliff. As per projections GDP is expected to

rise by around 3% in 2013; however the fiscal

cliff may drag it down by as much as 4%

thereby leading to recessionary circumstances.

A Senate bipartisan group is currently

working on a three-point plan to prevent the

fiscal cliff.

1. Decide on a USD 4 trillion deficit reduc-

tion over next decade

2. Work out changes to the tax code, Medi-

care and Social Security combined with

spending cuts to certain federal programs


Figure 8 - Simpson Bowles

15

3. Abolishment of the sequestration assum-

ing a substantial reduction in fiscal deficit

is feasible by the above plan

For step 2, a plan similar to the Simpson-

Bowles recommendations which were de-

signed to reduce deficit to 2.3% of GDP by

2015 is under consideration (figure 8).

Effects of Fiscal Consolidation on GDP

of Other Economies

Fiscal consolidation has a negative impact on

GDP growth of a country. As the growth

slows, there are stabilisers such as unemploy-

ment benefits which start kicking in. So when

a country plans to have a fiscal consolidation

of 1 unit, actual reduction in the deficit is

lesser than one. As we can see in the follow-

ing figure 9, on an average a one unit of dis-

cretionary tightening leads to a 0.7 reduction

in the deficit. We can observe that the coun-

tries appearing in the right, mainly South

Asian countries are in general more effective

at consolidating their deficit than the ones on

the left, the European countries.

Many Countries have had to take drastic

measures for fiscal consolidation. Let‘s see

how their strategies have had an impact on

their economies.

|COVER ARTICLE|

Greece

Greeks tax almost everything and huge

amount of tax evasion occurs which creates

big problem for the government. Greece had

a fiscal deficit of 10.5% of GDP in 2010.

They had planned a fiscal consolidation of

3.1% of its GDP. However they couldn‘t get

the required tax revenues and the deficit re-

duced only to 9.1% of GDP.

Over the years it has reduced its corporate tax

rate from 29% to 20% in order to boost

growth in the corporate and has increased

VAT from 19% to 23%.

Greece is planning a fiscal consolidation of

the tune of 43bn to reduce the deficit from

36bn euro to 17bn euro in 2012.

Spain

Spain increased VAT from 18% to 21% in

September 2012 as a part of its austerity

measures. Interestingly, in the past when it

had increased its tax rate, the revenue actually

contracted by 1% due to weaker economy.

This shows how merely increasing tax rates

need not increase revenue.


Figure 9 - Impact on Other Economies

Figure 10 - Growth rate of Greece

Figure 11 - Growth rate of Spain

Figure 12 - Growth rate of Japan

16

Japan

Japan is another country which is on the

verge of a fiscal cliff.

Even though the Fiscal Deficit is as high as

10.5% of GDP, Japan‘s Government Bond

yields are as low as 2% which is unlike the

countries of eurozone. Much of the revenue

is earned by government bonds and since the

inflation is near zero, even 2% yield generates

huge volumes. Japan is currently under reces-

sion and has curtailed some spending after

the Tsunami.

Ireland

In the case of Ireland we see that the fiscal

deficit increased drastically from 2007 to 2009

and the GDP growth declined in a similar

mirror image like fashion. It is interesting to

note that in 2010 Ireland increased its taxes

by 2.5% and cut its spending by 8.3% which

resulted in increase in growth rate of about

6.5%.

Canada

The story of Canada shows that despite

|COVER ARTICLE|

spending cuts it is able to maintain its GDP

Growth rate. In the mid 1990s Canada started

reducing its spending cuts from 18% of GDP

to as low as 13% of GDP. We can see that its

real GDP growth rate simultaneously in-

creased during that period to as much as 5%.

The main reasons why this happened was

Canada had huge exports with US at that time

and US economy was having a boom-period.

As seen above, countries have tried different

approaches to tackle their fiscal deficit prob-

lem and landed up with unintended results.

What Lies Ahead

Will it truly be as drastic as a jump off a cliff

or would it be more of a roll down a slope?

Will the economy have a soft landing after

going over the cliff? Will the biggest economy

of the world slide into another recession?

While the answers to these questions is any-

body‘s guess as far as the outlook for the near

future is concerned, it all boils down to how

well President Obama can orchestrate a com-

promise between the Democrats and Republi-

cans in Congress during the ―lame-duck‖ ses-

sion slated to begin from November 13th.

However, as often seen, different doctors

may prescribe different medicines for the

same illness, sometimes with unexpected side-

effects and outcomes. Despite all the heavy

forecasting and estimation done by the

economists and policy makers, the US will

ultimately have to take a leap of faith due to

the impending uncertainty.


Figure 13 - Growth rate and Govt. Spending of Canada

Figure 13 - Growth rate and Fiscal Deficit of Ireland-

Source - www.finance.gov.ie

17

|BOOK REVIEW|

Breakout Nations - Book Review

Abhishake Dixit, MDI

The past decade has witnessed a gargantuan shift in the world economic landscape. It is hard to imagine that certain nations dubbed as ‗growth engines‘ today, played an almost negli-gible role in the world economy about fifteen years back. Rather, they were faced with huge economic hurdles and were in constant need of aid from the developing world.

When contemplating future economic growth, we have grown used to assuming that the shift of power away from the developed world would be driven by the ―BRIC Nations‖ - The term coined by Jim O‘Neill of Goldman Sachs for the four largest emerging economies: Brazil, Russia, China and India. There has even been a BRICS summit with South Africa form-ing the ‗S‘. It is projected that in the coming two decades, China will over-take the United States as the world‘s largest econ-omy and India will reach the third spot.

Numerous books have been written about the changing fortune of the BRICS nations and their extremely bullish future. However, according to Ruchir Sharma (the au-thor of Breakout Na-tions) one of the most fundamental flaws with such analysis is that economists and analysts invariably cluster all of these countries together which are considerably different from each other.

This draws its roots from the uniqueness of the last decade where every country was doing well, everyone was a winner. This was driven by a ‗worldwide flood of easy money‘ that unleashed

US consumer spending and sparked more ex-ports from emerging market economies.

In 2007, the peak of this golden age, the econo-mies of all but 3 of the world‘s 183 economies grew and the growth was more than 5 percent in 114 of them. This was the fastest and most all-encompassing growth spurt the world has ever seen. All the economies grew wings at the same time, especially the BRIC nations which grew bigger and faster than the others.

However, post the recession and the eurozone crisis, Ruchir believes that there is minimal probability that we will ever see such a golden age anytime soon. With the world embroiled in a financial mess, the devel-oped nations will con-sume less which will strangle the spurt of growth in other econo-mies. In his own words, “In a world reshaped by a slower global growth, we need to start looking at emerging markets as individual cases”.

What stands this book apart from the million others that have been written on this subject is that the author has spent two decades travelling around the world and spending one week every

month in a particular emerging market which enables him to present the ground reality rather than base his opinions on some external re-search. He is the head of the emerging markets equity team at Morgan Stanley Investment Management. In the book, he tries to take the reader on his travels around the world in search of the next breakout nation.

17


18

|BOOK REVIEW|

He cautions the readers against putting too much reliance on economic forecasts, including his own. At the very outset he states, “The old rule of forecasting was to make as many forecasts as possible and publicize the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong.”

The journey starts with the nation that is most touted to be the leader of global growth – Peo-ple‘s Republic of China. He is not overawed by the Chinese growth story which he compares with Japan in the early 1970s, Taiwan in the late 1980s and Korea in the early 1990s. He looks at the economic reality objectively and raises the sustainability issue given the aging popula-tion, decline in investment spending, decrease in western demand and higher wages driving inflation, all of which will put the brakes on the near double digit growth rate that the country has managed to achieve in the past few years.

Next, he talks about the Great Indian Hope. He attributes India‘s recent growth as unleashed by global rather than local forces. He puts the probability of India continuing its journey as a breakout nation in this decade at fifty percent given the bloated government, crony capitalism, lack of recent reform initia-tives, falling turnover amongst the rich and a disturbing tendency of farmers to stay on the farm.

He also talks about the political elite‘s fondness of welfare state liberalism with schemes like MGNREGA and subsidies on a host of goods. Such excessive government spending was easy in the middle of the global boom but continu-ing on this path in the current scenario may lead to hyperinflation and crowding out of pri-vate investments.

He also questions the dynasty rule in Indian politics at the hands of the Indian national Congress. Given the trepidations, many stars are aligned in India‘s favour as well. The young population, rising middle class, rising infra-structure spend and a freewheeling democracy give India an equal chance of sustaining its re-cent success and emerging as the breakout na-tion but it would require a tremendous amount of hard work and persistence.

The author takes the reader on a similar jour-ney to many other nations like Russia, Brazil, Mexico, Japan, Turkey, Indonesia, South Ko-rea, South Africa etc, all the while trying to un-derstand the economic and political forces at play in each country individually, looking for new trends and trying to discover new sources of growth and highlighting causes for concern.

For instance, He praises South Korea for build-ing on its earlier success in the manufacturing industry and Indonesia for a well run machin-ery of commodity export. He also draws out negatives in countries like the stagnant list of billionaires in Mexico or the complete lack of Small and Medium Enterprises in Russia.

As per the author, “to identify the economic stars of the future we should abandon the habit of extrapolating from the recent past and lumping wildly diverse countries together. We need to remember that sustained economic success is a rare phenomenon.”

This is a very interesting book if one wants to understand the dynamics of the emerging world and the changing economic landscape.

To conclude the book, the author re-emphasizes that not all emerging markets will be breakout nations and their paths would vary substantially. No nation can hope to grow as a free-rider on the tailwinds of fortuitous global circumstances. They will have to propel their own weight, and the breakout nations of the new era will take their mantra from the Latin proverb: “If there is no wind, row”.

About The Author

Ruchir Sharma is head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Manage-ment. He generally spends one week per month in a develop-

ing country somewhere in the world. He is for-mer contributing editor for Newsweek and a regular contributor to The Wall Street Journal and The Economic Times.


19

GOOD BANK - BAD BANK

Sachin Pal, IMT Ghaziabad

The Bad-Bank Model

The concept of Bad Bank is quite simple on paper. The bank divides its assets into two asset classes. One asset class includes the assets which have become illiquid, risky and toxic se-curities that puncture the backbone of the banking system; troubled assets such as nonper-forming loans may also be piled up in this stack. The bank may also choose to add non-strategic assets from businesses which no longer fit either in its portfolio or its business strategy and thus wants to exit, and no longer wants to keep it on its books as it seeks to lessen risk and deleverage the bal-ance sheet. The ones that get left are the good assets that represent the ongo-ing business of the core bank and that shall increase the bottom-line of the bank

The reason for segregating the two is again sim-

ple as the bank wants to keep the dirty fishes out of its pond in an effort to stop the bad as-sets from contaminating the good ones. Pres-ence of junk and toxic assets on the company‘s balance sheet impacts the bank‘s financial health and reduces the investor‘s faith and raises concerns on performance, future pros-pects and money security. All of this directly affects core banking operations of borrowing,

lending, trading, and raising capital.

Implementation of the idea of Bad Bank is as compli-cated as anyone could think of. A lot of thinking goes on in the creation of the new entity and there are a lot of considerations involved which typically include o r g a n i z a t i o n a l , structural, and fi-

nancial trades-offs. The effect of these choices on the bank‘s liquidity, balance sheet, and profits can be difficult to predict, especially in the current crisis.

|THE BAD-BANK MODEL|

The world was still on the path of global recovery led by the financial sector post the subprime mortgage crisis when the eurozone crisis caught it midway and stalled its progress and brought the bad banks back in news. This article discusses the concept of Bad Bank. The bad-bank concept has been used with great success in the past and is a valuable solution for banks seeking shelter from the financial crisis and are in news for quite some time now the latest being the creation of so-called bad bank by Spanish government in an effort to revive its dwindling financial economy. This article discusses about the concept of bad bank in detail and takes a look at some retrospect efforts of the economies that implemented this concept.

Figure 1 - Capitalization of Bad Bank


19

20

Structure

The bad bank is structured in a way that it does not appear in the consolidated balance sheet of the good bank. For this purpose the bank can have a minority stake in the new entity with sufficient funding from external sources needed to capitalize the bank.

Funding

The bad bank must be capitalized in order to function. Typically two options are available for funding a bad bank:

Debt

Equity

Private investor, with a focus on distressed situations, may be attracted in investing in order to gain ownership with significant control over the new e n t i t y w h e r e they can e x e r c i s e control.

The re-q u i r e d capitaliza-tion will typically depend on:

Portfolio of assets

Valuation of the assets

Anticipated loss levels

Banks typically formulate this structure as the move is likely to im-prove the credit ratings of the good bank and improve the growth outlook of the bank. The biggest challenge for bad bank is the valuation of troubled assets. Different meth-ods may be used to value the assets to be transferred depending on the asset class,

quality etc. However, in all cases the bad bank pays very less percentage of the nominal value or the book value of the assets and receives the assets at a significant amount of discount or haircut on the initial purchase price.

Here in this article we discuss three different types of restructuring that took place in the past. Each of these restructuring were carried out in a different manner. The US TARP was Fed backed Asset Guarantee program, the Irish NAMA was formed as a Special Purpose Vehi-cle with capital injection from government and private investors in return for equity stakes whereas the RBS was taken over UK govern-ment. Asset guarantees differentiates itself from good bank-bad bank model in a way that does-n‘t involve transfer of assets but just provides asset guarantee.

US TARP Program

U n i t e d States gov-e r n m e n t started the T r o u b l e d Asset Relief P r o g r a m (TARP) in

an effort to stabi-lize the financial sector at the time of subprime mortgage crisis. The Treasury announced their intention to buy senior preferred stock and war-rants from the nine largest American banks by forming an Aggregator Bank. The proposal called for the federal government to buy up to

US$700bn of illiquid mortgage-backed se-curities with the in-tent to increase the liquidity of the secon-dary mortgage mar-kets and reduce po-tential losses encoun-tered by financial in-stitutions owning the securities. Maximum authorized TARP disbursements, was



Figure 2 - Troubled Asset Relief Program

Table 1 - Bank Support Programs

21

later reduced from US$700bn to US$475bn under various programs.

TARP operated as a "revolving purchase facil-ity" with a set spending limit of US$250bn at the start of the program, with which it will pur-chase the assets and then either sell them or hold the assets and collect the "coupons" from the banks. The maximum limit for facility was kept at US$350bn subject to approval. The par-ticipating institutions had to meet certain crite-ria in order to benefit from the program. Ac-cording to the terms of agreement, TARP brought warrants and preferred shares that pay annual dividends in the range of 4-6% percent during the first five years which increased to 8-10% in the following years.

According to the latest figures released on the federal government website in July 2012, it has recovered US$351.46bn out of a total of US$467.21bn which it invested under bank sup-port programs, credit market programs and treasury housing programs. Under the bank support programs (a move to support Citi Group, Bank of America among other banks) it disbursed US$245.11bn and has received a total cash back of US$264.73bn.

RBS break-up

RBS, the 285-year-old UK based bank, reported a loss of £24.1bn in 2008. The bulk of RBS's £24.1bn loss for 2008 stemmed from a £16.2bn write-down of assets, that arose from its pur-chase of ABN Amro, a bank heavily ex-posed to the sub-prime crisis. Its un-derlying losses totaled £7.9bn.

RBS made massive changes to its struc-ture following the loss. It put £325bn of toxic assets into a new government in-surance program. UK Government‘s Asset Protection Scheme provided RBS with a

capital injection of £25.5bn and catastrophe insurance for the riskiest assets. The primary purpose of this equity injection was to make new tier 1 capital available to banks and to re-structure their finances.

Under the lighter touch terms agreed with the UK Government in November 2009, RBS would bear the first £60bn of losses and the Treasury would bear 90% of losses thereafter. The fee for this insurance will be £700 m for the first three years and then £500 m annually. The new terms allow RBS to exit the APS at any time subject to meeting capital adequacy requirements and repaying the Treasury for any shortfall in fees due.

Following placing and open offers in December 2008 and in April 2009, HM Treasury owned c.70.3% of the enlarged ordinary share capital of the company. This new capital took the form of B shares, which did not carry voting rights at general meetings of ordinary shareholders but were convertible into ordinary shares and quali-fied as core tier one capital. Following the issu-ance of B shares, HM Treasury‘s holding of ordinary shares of the company remained at 70.3% although its economic interest rose to 84.4%.Investors welcomed news of the scheme, and its shares were up as a result.

According to a news run dated May 2012, RBS was poised to announce that it has repaid emer-gency funding it received from the British Gov-ernment after reporting a surge in profits for

the first quarter of 2012.

Irelands Bad-Bank NAMA

Irish financial crisis stemmed from the finan-cial crisis of 2008 and the country entered into an economic depression in 2009 with the banks bear-ing the brunt of the ailing economy. In April 2009, the government proposed the formation of NAMA through a Special Purpose Vehicle (SPV) known as



Figure 3 - Structure of NAMA

22

National Asset Management Ltd, controlled by the holding company National Asset Manage-ment Agency Investment Ltd.

The NAMA SPV (Master SPV) structure had a

subscribed capital of €100m. 49% of this capital

base (i.e. €49m) was advanced by NAMA and 51% by private investors. Three private inves-tors, namely, Irish Life Investment Managers, New Ireland Assurance and a group of clients of Allied Irish Banks Investment Managers, had

each invested €17m in the vehicle and took 17% stake each in the SPV. The Master SPV, a separate legal entity, jointly owned by private investors, who together owned 51% of its eq-uity and therefore had the majority vote The remaining and by NAMA, which would hold the remaining 49%. NAMA was then geared up way above typical EU banking limits, taking on debt 35 times its paid-up capital. In its first phase of operation, it acquired a portfolio of c.11,000 loans from the major Irish banks with

a nominal value of €71bn from developers at the centre of the property crash in Ireland and

paid c.€30.4bn for the loans, representing an aggregate 57% discount on the book value of these loans. . In exchange for these loans NAMA issued Government-guaranteed securi-ties to the five participating financial institu-tions.

Although the SPV had its own Board, NAMA retained a veto power over all decisions of the Board that could affect the interests of NAMA or of the Irish government. The Master SPV would be run with the objective of making a profit on the purchase and management of the assets it purchases.

The Draft Business plan assumes a life of 11 years for NAMA from 2010 to 2020 with full repayment of the loans issued by NAMA/Irish Government by the end of 2020 along with cumulative interest on the loans. The Draft

business plan expects a default rate of 20% on

the €77bn of principal, and repayment of

€62bn. Taking all adjustments into account it

expects a cumulative positive cash flow of €5bn from this entity.

I re land ' s con trovers ia l new "bad bank" (NAMA) thus became one of the biggest property banks in the world after it completed the acquisition of developers' loans worth more

than €70bn and gained controls over the loans on hotels, housing estates, shopping centers and development sites across Ireland, the UK, mainland Europe and elsewhere.

Conclusion

European crisis began over two years ago; mar-ket pressure on Europe has boiled up and then eased several times in response to political and economic developments and subsequent policy responses. A permanent solution to Europe‘s problems is unlikely to emerge before year-end, leaving markets vulnerable to the ups and downs of the past two years, as well as the tail risk of a disaster scenario. EU policymakers appear determined to provide the necessary support to avoid disaster, but the crisis contin-ues to intensify. In the present scenario, forma-tion of bad bank looked inevitable and the lat-est moves by Spanish Banks over bad bank creation hints us that segregation of assets into two asset classes would alleviate the pressures on the financial institutions and financial sys-tem. Private players also have an investment opportunity in these distressed assets that meet individualized investment needs. Whether a good bank– bad bank structure takes the prece-dent form like that of NAMA or a novel form is not clear at the moment and will be driven by policy and politics in the months to come.


Table 2 –Loan Acquisitions


23

What was the first reaction on reading the title of this article? It sounds quite ominous so I am assuming it would not have been very positive. Something along the lines of a disaster or a ca-tastrophe. The recent discussion on the possi-ble EU break up has added fuel to this negative outlook. However, a simple Google search should be enough to convince you that a currency break is not a novel situation. The world economy has seen sixty-nine currency break-ups just in the past century. And this should be enough to make you question the blanket statement that the break-up of Euro area is surely going to be a debacle.

So what exactly is a currency break-up? When two or more regions having the same currency (or a fixed exchange rate) and hence a common monetary policy decide to establish independ-ent currencies, it is known as a currency break-up. These regions can be different countries in a monetary union or can even be a part of the same country. In the latter case, the most com-mon problem leading to a currency break-up is a partition of the country as has been seen in case of India-Pakistan in 1947, Pakistan-Bangladesh in 1971 and Czechoslovakia in 1993.

In case of a monetary union, we need to under-stand some of the is-sues which can necessi-tate a currency break-up. While political problems play an im-portant role, there is an economic rationale to it. Along with the monetary policy, it is important for countries in the monetary union to have similar fiscal stance as well. For exam-ple, say there are two countries in a monetary

union- A and B. Now A decides to take up an expansionary fiscal policy by increasing its bor-rowings (and hence fiscal deficit of the govern-

ment increases). However, as A‘s government is appropri-ating greater funds in the market, the cost of funds for

the private sector will in-crease, leading to an in-

crease in interest rates. If the exchange rates

were flexible it would have led to an appreciation of the A‘s currency with respect to B‘s currency. How-ever, because of common currency/fixed ex-change rate, A ends up with an undervalued currency and thus balance of payments surplus while B ends up with a balance of payments deficit. In such a situation, if A and B had been allowed to take up independent currencies, B‘s new currency would have depreciated with re-spect to A‘s, which would have encouraged ex-ports and hence B‘s balance of payments defi-cits would have corrected. A similar case is be-ing observed in case of the eurozone. To cor-rect the imbalances in the balance of payments, appreciation of Germany‘s currency and depre-ciation of the troubled nations‘ currencies is required. However, this can only be possible if the countries decide to exit the monetary union.

A country is also a monetary union of the states but having a central government and a central bank permits a common mone-tary and fiscal policy. This co-ordination becomes difficult in case of countries as they would have different governments which would have different aims, goals and priorities. And this lack of common fiscal and political policy thus becomes an important determinant of a currency break-up. A similar situation is being observed

in the eurozone in which the stronger countries like Germany are supporting the weaker coun-

BREAKING UP OF CURRENCIES Team Blue Chip

|TUTORIAL|

23


24

tries like Greece, Spain, Ireland etc.

What are the steps involved in a currency break-up? From the various currency break-ups which have occurred in the past, a broad se-quence of steps can be listed. It begins with a surprise announcement by the government. The surprise component is essential to avoid any destabilizing speculations. Then as issue of new currency can take time, an ink stamp or physical stamp is put on the old notes and the stamped notes become the legal tender. While this is being done, capital controls are also imposed to prevent the flight of hoarded un-stamped currency to areas with stronger currency. (The central prin-ciple in these steps is the Impossible Trinity – A coun-try can at a time achieve at most two out of the three macroeconomic objectives namely de-fending exchange rates, free capital movement and an independent monetary policy.) This is followed by the issue of new currency and once this is introduced the old stamped currency is de-monetized (i.e. it loses its status of a legal tender).

Once the currency break-up has taken place, the weaker currency depreciates which allows that nation to gain competitive advantage and to correct its balance of payments deficit. The cross-border liabilities and assets of the country will also have to be re-negotiated with the other countries.

Now let us try and understand the possible break-up of the Euro area. There are many pos-sible ways in which European Monetary Union (EMU) can break up. Example, Greece or some other weaker peripheral country can leave, all countries can return to their national currencies,

a strong country like Germany can leave the union or the eurozone can be divided into two parts.

This would allow the weaker peripheral coun-tries to regain their competitive advantage in terms of exports as their currencies depreciate. However, these countries already have very high debt burdens and the deprecation of cur-rency is only going to further increase the level

of foreign-currency denomi-nated. In this regard, one of the solutions being ad-

vocated is that these countries should default. Default is essential if the countries wish to recover.

On the other hand, there are a few complicating factors as well. The im-

pact of the break-up would be much more serious because of the global im-

portance and scale of the eurozone. The devaluation of currencies would lead to a major reallocation of wealth from the savers to the debtors. Further, cur-rency devaluation would

have a limited impact unless further painful steps are taken to bring about the much re-quired structural changes in the economy. Ex-ample, the inefficient labour markets of these regions needs to be improved. This break-up would lead to havoc in the global financial mar-ket and many countries can go into deep reces-sion.

Hence, while breaking up of currency unions has been widely observed in the past years, there is no perfect explanation, mechanism or justification for the same. There is no one-shoe-fits-all strategy. Every situation needs to be studied separately and the pros, cons and con-sequences need to be critically examined. In case of the eurozone, we are weighed down further as the impact can vary widely – it would either be extremely beneficial and the solution we are looking for; or it would be the biggest catastrophe in the economic history of the world.

|TUTORIAL|


25

Energy is the driving force of modern life. Coal,

gas and oil are the three indispensable sources of

energy. Out of the three, coal is widely used due

to its availability and relative affordability . Coal-

based power capacity in India is expected to grow

from 97 GW in FY10 to 285 GW in FY20: more

than five times the pace of growth seen in the last

few years.

Amid the chaos of the Coalgate, the country is

grappling with acute coal shortage, hitting various

sectors especially power generation. India‘s reli-

ance on imported coal is set to rise, given the

structural issues affecting domestic supply such as

environmental clearances, infrastructural and lo-

gistical constraints and production disruptions on

account of de-allocation of coal blocks, strikes and

weather conditions. Also, the coal found in the

mines is often of inferior quality, characterized by

high ash content and low calorific value.

Considering an annual average growth rate of 8.9

per cent during the five-year period, the Plan

panel has pegged India‘s annual coal demand to

go up to 980 million tonnes by 2016-17, the termi-

nal year of the 12th Plan, against the production

of 795 mt, giving rise to a 185 mt deficit. While

India ranks fourth in the world in terms of coal

reserves, the growing coal demand has outpaced

production levels and has gradually resulted in an

increase in imports over the period as highlighted

in table 1.

|POLICY & GOVERNANCE|

Decay beyond the Billion-dollar Cavity to the National

Coffers: Has Coalgate exposed the Root?

Pervez N Sethna

MBA Core (2nd Year)

NMIMS

A loss of Rs.1.87 lakh crore to the public exchequer on allocation of coal blocks, the parliament being paralysed for

13 of the 20 days in the monsoon session due to the standoff between the Government and the Opposition, Rs. 128

crore lost due to the disruption of proceedings in both the Houses, a CBI probe into the coal blocks allocated since

1993 including the six-year NDA rule, the windfall gain to the allocates, the Prime Minister’s rebuttal in the

Parliament, the CAG Report, the Opposition demanding Prime Minister Manmohan Singh’s resignation, the

PIL filed in the Supreme Court……… are we missing something yet???

Figure 1: Demand - Supply scenario of coal in India

Year 2009-10 2010-11 2011-12 2012-13

(estimate)

2016-17

(estimate)

Coal Supply (mt)

514.50 536.05 629.91 674 795

Coal Demand

(mt) 597.98 624.78 713.24 763.17

980

Gap to be met

through imports

(mt)

83.48 88.73 83.33 89.17 185

Source: www.coal.nic.in/annrep1011.pdf

25


26

What those men sitting at the helm of affairs are

neglecting is the additional burden to the nation‘s

kitty on account of the escalating coal import

bill. Coal India Limited (CIL), which accounts

for more than 80% of the domestic output, has

set a target of producing 464 mt coal in the cur-

rent fiscal; which is likely to go up to 615 mt by

2016-17. It has agreed to import coal this fiscal

and supply 80% of the fuel committed by it to

power producers under the long-term fuel supply

agreements (FSA), provided they agree to share

among themselves the cost of buying coal over-

seas and shipping it to India. While CIL sells

power-grade thermal coal at about Rs 1,100 per

tonne, the imported coal of comparable grade

costs about Rs 5,500. To make coal imports vi-

able, CIL plans to mix domestic and interna-

tional coal and sell the blended consignment at a

pooled price to the power producers. Another

alternative that lies with CIL is to modernise its

processes in order to increase output to meet the

ballooning coal demand.

Independent Power Producers (IPPs) have in-

creasingly opted for acquisition of overseas min-

ing assets to meet their demand; however, they

remain exposed to volatility in coal prices as well

as political & regulatory risks. Some of the lead-

ing private sector IPPs have acquired sub-

stantial coal assets predominantly in the three

countries - Indonesia, Australia and South Africa.

As the Coalgate plot thickens, the dependence of

IPPs on coal imports is bound to increase and any

upward revision in domestic thermal coal prices

by CIL so as to realign towards international mar-

ket prices in the future will result in a significant

upward pressure on the cost of power generation.

And that‘s not all. The rising demand for coal calls

for improved infrastructure systems across the

country. Several coal assets in Jharkhand and

Chhattisgarh are lying unutilised for want of a rail-

way line. Poor road transportation facilities are

hindering growth. Constraints in coal distribution

and coal evacuation infrastructure have restricted

the off take and raised inventory levels. The ca-

pacity of all major ports as well as non- major and

private ports needs to be increased in order to

enable efficient handling of cargo without any op-

erational delays. In order to have an efficient and

smooth flow of goods at the ports, the total ca-

pacity utilised should be not more 70% of the to-

tal capacity installed. However, in India, we are

handling cargo at levels higher than 80% of the

total capacity installed; ports are operating at satu-

ration levels. This leads to delays in unloading of

goods, queuing of vessels at the ports and ineffi-

cient material handling. The projected capacity

expansion and the expected cargo growth would

bring down the utilisation levels at the major

ports, paving the path for better service. Also, the

Indian Railways needs to improve the tonnage on

the freight corridor - a major hurdle which could

derail the current plans of increased produc-

tion and distribution of coal and increased power

generation. These are enormous outflows that

only add to the cost of the energy that lights our

homes.

The CAG Report kept the coal blocks allocated to

government companies — mostly owned by the

State governments — out of the ambit of Coal-

gate. Theoretically, we can assume that public sec-

tor companies will pass on the benefits of the as-

set allocation to the nation, either in terms of



27

cheaper electricity, providing coal to smaller con-

sumers at a fair price, or paying handsome divi-

dends to the government. But that was not to be.

State-owned companies allowed private miners to

tap part of the benefit accruing to them from

access to these captive assets allocated to them

virtually free of cost.

A national loot of unprecedented proportions,

skeletons tumbling out of corporate cupboards,

allocatees laughing all the way to the bank, the

electronic media looking for the slightest bit of

information to occupy airtime and newspaper

space, burgeoning losses on the import ac-

count… but let us assume for a moment that the

game was played by the book!

The State would earn its Rs. 1.87 lakh crore,

peace in both houses of Parliament, lesser head-

aches for the Government, the CAG and the Su-

preme Court, a Gandhian would have starved a

few days less and of course the prospect of self-

containment in energy needs.… Spare a thought

for Mother Nature!

Over a million hectares of forest is at risk from

coal mining in the coalfields in central India. In

addition to being home to a substantial percent-

age of India‘s wild tigers and other endangered

and threatened species, nearly half of the forest-

dependent communities in India look to these

forests as a way of life and livelihood. They are

the treasure chest that will bring in the valuable

carbon credits to our nation. Mining will scar the

land, rip apart forests, poison the rivers and dis-

rupt livelihood. The Rs.1.87 lakh crore is only

the notional value of the estimated loss; it does

not include the value of the loss of biodiversity

even if such a valuation was possible.

Nature is being asked to sacrifice at the altar of

development. A déjà vu, not uncommon to the

developing world from the days of the industrial

development. The finite natural resources are

being depleted irreversibly in quantity and quality

and cannot be replenished. Even the multitude of

Environment Impact Assessments (EIA) and

classification of ‗no go‘ zones seem to be fogged

by political interests causing slippages and unwar-

ranted delays. Standard resettlement and rehabili-

tation procedures are conveniently ignored. The

question of electricity and power that the country

needs is at the heart of all this. The mushrooming

population needs a matching step-up in the

power generation, non-fulfillment of which

would lead to mounting energy prices and spell

more trouble for the common man - a perennial

battle between preserving nature and economic

growth and welfare; most times ending in favour

of the latter. What we need today is to look at

more sustainable and alternative sources of gen-

erating electricity, use suitable long-wall mining

methods, increase productivity at the existing

mines and take steps to conserve wildlife, natural

habitat and the livelihood of the inhabitants.

In the noise over the irregularities in allocation of

natural resources, the huge environmental and

related costs of exploiting these have been for-

gotten. The Coalgate could well be a blessing in

disguise, an eye-opener, but only if we under-

stood the real value.



28

In 2010 version 2.0 of Yes Bank had

been introduced, could you tell us

about that and how its progress is

taking place?

The version 2.0 of Yes Bank is largely on a

few parameters - no of branches, ATMS,

size of Balance Sheet, the total advances

that we expect to have and make and the

total deposit size that we wish to have.

These would be available on the website as

well. So what happens is that in all organi-

sations, be it Yes Bank, or be it banking,

aviation or sales. Any industry that you

take, you have a 5 year plan which is bro-

ken down in year wise basis and further

into a quarter wise basis or a month wise

basis. So every month end or every quarter

end, you have target vs. achievement at a

broad level, then each and every division is

broken down at a client level. So that is the

way you track it.

Banking per se is completely dependent on

the way your economy does because we are

able to lend more if there is a demand for

Firstly, we would like to talk to you

about you experience at Yes Bank.

I have worked in Food & AgriBusiness

Strategic Advisory and Research (FASAR)

which is a very unique offering of Yes

Bank. What Yes Bank does is to work on

projects where my division prepares the

detailed project reports which we give to

the bank, which they use for providing

funds. So the quality of the project im-

proves and the lending division gets a

higher degree of comfort while lending.

Because of the rustic nature and rural fla-

vour of AgriBusiness, not many people

have an exact idea of what the reality

would be like. What people usually do is

they look at surrogate projects and look at

the returns and look at past experiences in

order to get these things. In our kind of

work we are able to perhaps have it much

closer to reality by actually speaking to

lots of clients and by focusing only on

this. A regular banker may not be able to

do that properly, that‘s where we come in.

Industry Speak

|IN CONVERSATION WITH|

Mr. Girish Aivalli As the Group Executive Vice President & Country Head – Food and

Agribusiness Strategic Advisory and Research at Yes Bank, he is the

key Relationship stakeholder responsible for Origination, Advisory &

Execution oversight of Food and Agribusiness Consultancy and Re-

search mandates in the sector. Prior to joining Yes Bank, Mr. Aivalli

worked with Dabur, Olam International and Cargill India in various

capacities and in various countris, over a span of 16 years. In his previ-

ous role at Cargill, he was heading their procurement and operations

for the grains and oilseeds business for India. He has an excellent un-

derstanding of the global commodity trade flow and had undertaken

significant agri-projects in Nigeria, Ghana and India. He is well recog-

nized thought leader in the Food and Agribusiness industry with an

excellent mix of operational experience and knowledge of challenges

and policy issues in the industry. He is also a member of the CII’s Na-

tional Council on Agriculture, and member of various sub-committees.

An alumnus of MDI, he specialized in marketing and finance.


29

ing Food & Agribusiness corporates.

Who are the end consumer of the ad-

vances that you would be giving?

It is not the farmers, so the lending that

happens under FASAR advisory is not to

the farmers, it happens to AgriBusiness

companies and it can be a client as large as

Future group, or as small as an upscale

dairy.

When we go to Yes Bank, the business

lines of the bank are divided into Cor-

porate Banking, Retail banking &

Treasury, so how does FASAR support

the business line, how does it fit into

the group as such?

Sometimes we get referrals from the bank-

ing teams which can be for a company or

for an industry. It means that the bank

may ask our review on the tea industry or

may ask us about our view on, let‘s say,

XYZ chemicals. What we do is, we don‘t

get into the financial part of it because fi-

nancials the bank would be having ade-

quate talent. We look at it from an opera-

tional perspective which let us say in case

of XYZ chemicals would be essentially, for

most of these organisations, processes re-

lated to sales and marketing and business

development in new markets. So if one has

to analyze XYZ chemicals, we would look

at the fertilizer market because it is their

main product and then they are also into a

few agro chemicals. So once, you will study

what is their product portfolio, we would

look into the growth rate potential of these

products, we would look into the market

share in each of these chemicals has gone

down or gone up. Then we would speak to

few people of XYZ chemicals by telling

them that we are doing this for their com-

pany. We would speak to competition, dis-

tributors and we would try to get as much

‗masala‘ as we can probably to strengthen

our case. Once that happens we would

money. If there is not much of a demand

for money, banking suffers. So Yes Bank

has grown at above 35-36% CAGR over

the past few years so. Yes Bank over the

past 8 years has become the 4th largest pri-

vate sector bank which is by no means a

small achievement by any standards. Our

profits have been close to Rs. 1000 Cr. last

year, perhaps the only organisation in In-

dia which has achieved such a feat within

the first 7 years of starting out. I don‘t see

any other industry or any other company

in India that has achieved this kind of a

success. Perhaps, Yes Bank in that sense

or in rather most of the senses is India‘s

most successful company ever, and when I

say that I mean from the start up phase till

now. It has a very brief history, but that is

the way it has been.

For our readers, could you give us an

overview of the FASAR (Food and

Agribusiness Advisory and Research)

department, which is a part of the

Development Banking Group assist

the business lines of the bank?

Yes Bank has identified Food & Agribusi-

ness as a focus sector, and has undertaken

various thought leadership initiatives

through domain specialization besides

providing advisory and innovative finan-

cial solutions to both public and private

sector clients, focusing across segments in

the agricultural food value chain, from

farm inputs to processing to food retailing.

The FASAR group is driven by sector ex-

perts who provide insight and knowledge

on sector trends and growth prospects in

Agribusiness sector. FASAR has been en-

gaging in significant and prestigious as-

signments with the Central Government

and the various State Governments across

India. In addition, FASAR has undertaken

prestigious projects with International

agencies such as UNIDO as well as lead-



30

Yes bank has identified some sunrise

sectors, what could be the next sunrise

sectors and what challenges do you

foresee?

First of all, Food and AgriBusiness is at the

core of India. India has a large village soci-

ety and agriculture is the predominant oc-

cupation for a large number of people.

Politicians and political class have a lot of

stake because the voting class in India is

essentially the farmers. Therefore, if you

position something like this, every politi-

cian and most of the business houses, they

would have land parcels all over the coun-

try and they would have something to do

with farming either at the promoter level or

at the khaandaani pushtaini zameen jaydaad

kind of level. So it helps in opening the

door and helps in people listening to what a

bank has to say. It also helps in getting a

good degree of clientele. E.g. if you go to

let‘s say anyone in the private sector and

you tell them you have a business idea on

insurance or aviation. People would not

know what to do with it and send you back.

If you tell them that you have an idea on

Agribusiness and this person or politician, a

Member of Parliament, has been elected by

a constituency, where given the demo-

graphics of India it has been the farmers

mostly. He will definitely call you up and

see what out of this is the idea he can go

and replicate in his constituency, as far as

politics are concerned.

For business houses food and AgriBusi-

ness, again, since it is the prime occupation

of the majority of the people of the coun-

try, people are open to diversification here.

They will hear you out, may not necessarily

implement it but they will surely hear you

out. If you go to someone saying why don‘t

you diversify into insurance vs. why don‘t

you diversify into AgriBusiness, chances are

he will still have an element of curiosity on

agribusiness and not the same for any of

the other options.

give it serious thought and probably come

up with solutions.

Is it that FASAR gives the go or no-go

for the agribusiness line?

FASAR is not really the go/no-go thing.

We are not involved in every lending deci-

sion. It is probably in specific lending deci-

sions wherein there is lack of comfort, feel

or knowledge. E.g. let us say aqua culture

products. Not many people would know

about it, or for example you may also con-

sider sesame seeds. People would have

good knowledge of wheat, rice, soyabean,

corn, but people might not be comfortable

with something like because it is a very

niche thing. Or something like organic

farming, the new craze, how do you ana-

lyze that? That is when we come into pic-

ture. So, what we do therefore is very simi-

lar to what the consulting firms do. But

again, focused only on food and AgriBusi-

ness and with the bank itself being the cli-

ent.

An extension to the above question,

Food and Agri is one of the growth

sectors identified by Yes Bank, in this

regard could you share with us some of

the customized solutions that Yes

Bank offers?

What we do is, it is a new thing, something

called as startup food and agribusiness, we

help private sector companies diversify

into new businesses or start new busi-

nesses. The ten areas where we help them

are setting up an Integrated dairy farming,

dairy products, mega food park, integrated

warehousing project, cold chain, agri sup-

ply chain, large scale commercial farming,

overseas plantation businesses, other agri

ventures and undertaking CSR projects in

agriculture.

We have given this only to limited people

of MD/CEO level based on a background

here - the financial and business impact.



31

put that process in. There is a document

called as Credit Approval Memorandum

which gets signed every time an advance

has to be given. So the entire process is

extremely strong without any scope for a

personal bias or personal view getting

into the way, which I think is extremely

critical.

We have seen the government’s intent

to improve backend infra in food and

Agribusiness as wastage is around

40% in India as compared to 2-3%

globally. Would the introduction of

FDI in multi-brand retail coupled

with the restrictions help?

Yes, I think FDI in retail is going to be

helpful overall. And it would not be as

bad as it has been made out to be. First

of all whenever any client comes into

India be it Wal-Mart or Carrefour. One,

they are not going to be opening their

shops in each and every town. Even if

they open in all the towns, they are not

going to be able to reach each and every

mohalla. In smaller towns they would per-

haps have one store per town and larger

cities they would have multiple stores. As

far as the question of existing shop keep-

ers vs. the new store is concerned, at the

end of the day it is going to be a function

of your conveyance. That is where an

operational insight is helpful. E.g. you

live in an area which doesn‘t have space

to build a mall, so if Wal-Mart was to

come into such a place it can possibly

take 3-4 shops and open up a store there

but when people have to go shopping,

what is it that they will look for? Given

the fact that how difficult it is to com-

mute these days. When you travel in cars,

a 3-5 km distance can take about 20-

25mins. What you look for is conven-

ience, which is a walking a distance for

me to go and shop and get the essentials

for myself. Chances are that you may go

Next sunrise sector, and this is a personal

opinion that in spite of all the things that

have gone wrong, I have always believed

that in India, currently and for a long time,

real estate will be an ever green sector be-

cause in India there is a huge and acute

shortage of affordable housing.

The NPA’s are rising because the loans

that were restructured in 2008 have not

been paid off, especially in the SME

segment. You are more focused on

SME segment. What will be your future

strategy then?

Overall, if you look at it, Yes Bank has one

of the lowest NPAs, which is extremely

less in the entire banking industry. Recently

Yes Bank also won ―The Strongest Bank

in India‖ award, which is again a recogni-

tion of the way the book is balanced. So

there have been many cases where instead

of being a ‗Yes‘ Bank we have said ‗No‘ to

the client due to the quality of the client

not being that strong. In that case our

credit and risk department, I think it hap-

pens to be one of the strongest in the

country and the risk parameters happen to

be extremely strong. So, about future strat-

egy, when you have a robust process in

place, the chances of going wrong are very

less.

Without divulging much, what would

you say differentiates Yes Bank’s credit

and risk department from the other

banks? Even comparing with the public

sector banks, it has one of the lowest

NPAs, so what is this difference?

I cannot possibly comment on other banks,

but as far as Yes Bank is concerned, the

decision making is participatory consensual

and at the same time it is extremely driven

by data. So we take into account CRISIL

ratings, and put a lot of emphasis on refer-

ences and feedback from the market, speak

to a lot of people in the market and then



32

the loss in physical weight but the loss in

value. So it is a composition of different

factors like loss of weight, loss in price, loss

in quality and loss in nutritional content

and these total up to loss in value.

Out of the 40%, would you be know-

ing the actual component of loss in

weight?

It depends. One of my past companies was

Cargill, which is into grains. So when you

are moving wheat, we were losing 1-2%

max.

Is this proportion higher for fruits?

Government data says that the grains

would have 10% weight loss, but where

would we get that loss?

In fruits you can‘t have that kind of a

weight loss. So lets us take example of ap-

ples or mangoes, i.e. if someone has to sell

the fruits mentioned above. The cold stor-

age guy needs to sell it at least at Rs. 1350

to make some money and the other guy

would sell at Rs. 1200 so he will sell lower

and still make more money. And the other

one would spend higher and make lesser

money. This is the disconnect that exists in

the market. Even if cold chain were to

come, the cheaper segment would always

exist.

The shocking part is that as far as the guy

without cold storage is that he is putting it

somewhere and he is ensuring that he is

storing it well because he has some experi-

ence in management of the fruits. Chances

are that here the quality will go a little bad.

As a consumer you would not be able to

make out completely that difference in

quality. You can hold it in your hand and

make out that a certain mango is softer and

the other one is more firm, but you will

never know that there was a difference in

how it was stored for the past 3 months.

over the weekend and make bulk purchases

and for that you may prefer a better shop-

ping experience. So my own view is that

both these formats will survive, I don‘t see

any major challenges coming onto the

small shopkeepers.

Improvement at the backend will be there

wherein they have said that they have to

create warehouses and cold storages. As far

as India is concerned, there is no shortage

of cold storages in India, they have always

existed. The capacity utilization of cold

storages has been less and whatever has

been left has gone largely for potatoes.

Now what the government wants is to pos-

sibly use the same storage for apples, man-

goes, guavas etc. Now there is a challenge

there, so now suppose you have two peo-

ple and one of them uses cold chain and

the other doesn‘t use cold chain. Let‘s say

the loose price is Rs. 1000. With a cold

chain, let us say that the storage charge is

Rs. 300 here, whereas without cold chain

the charge is going to be Rs. 100, totaling

to Rs. 1300 and Rs. 1100 respectively. So

eventually, they sell their product at Rs.

1350 and Rs. 1250 respectively, so even

though the person with cold chain invests

more & provides better quality product, his

margins are lesser than those who sell with-

out using cold chain.

So as such the wastage is concerned, the

40% that people keep talking about is not



With Cold Chain

Without Cold Chain

Loose Price (Rs.) 1000 1000

Storage Cost (Rs.)

300 100

Total Cost (Rs.) 1300 1100

Selling Price (Rs.) 1350 1200

Profit (Rs.) 50 100

Profit Percent 4 9

33

would make that move in the market. So

one of the reasons for having a higher in-

terest rate is because that is the way you

get the lowest costing funds and easy to

get because the competition cannot afford

to do that because of the economics that I

have shared with you. So you are able to

attract money from competition and sec-

ond it is the only way the bank can in-

crease its physical presence, i.e. number of

branches. For a private sector, we are still

small, so that is the only avenue left for

growth. You can grow in the wholesale

banking side as well. You require money to

lend there. The cheapest source of funds

are going to be from people giving you

deposits. You can‘t offer 4-5% and then

try to get people away from other banks,

so you need to offer a higher rate of re-

turn.

So are you as a bank aiming to reach

the same level of CASA as other

banks, or do you have a lower bench-

mark?

Sooner or later, by and large it would be

around the same ratio. The question is by

when do you reach there? To answer your

question, we are planning to reach the

same levels. But by when, remains to be

seen.

Rabobank has predominantly been a

corporate bank. Yes Bank could be that

bank in India and not try moving into

retail banking. Is the model on which

Yes Bank has been built over the past

not sustainable?

At the end of the day every person has

certain objectives, risk appetite and certain

ambitions and therefore to add value to

what I am saying, I can give you examples.

E.g. let‘s look at the soap market, you have

Reckitt Benckiser which makes Dettol

soap and you have HUL which makes

What they do is, put the mango in the

bhoosa and put it in matka which is a very

desi way of cold storage. So, therein lies the

disconnect.

Yes Bank is the only Greenfield li-

cence awarded by the RBI in the last

16 years. Do you see any Greenfield

license being given out now or do you

expect NBFC’s to get the licences?

Can‘t possibly answer this. It depends on

the government.

Keeping in line with the business

model of one of your initial promot-

ers/mentors, namely Rabobank, the

brand Yes Bank has been associated

with knowledge banking since its in-

ception, which has led to it having

the highest ROA in the sector. So

what has been the motive to shift fo-

cus towards retail banking with 7%

interest rate?

If you look at various banks - ICICI,. SBI,

HDFC, PNB, Canara Bank you will see

that their current CASA base is how big,

which is around 40% for most banks. So

whatever that amount be there, these banks

are offering 4%. So a bulk of that money is

at 4% (say). Now if you have a new bank

which has CASA is at about 10% and has

to pay 7%, the bank does two things. One,

it ensures that a lot of money from other

banks flows into their bank and is able to

give that additional 3% because the CASA

base is less. For the other banks, to give

extra 3% is a huge sum of money. Nobody


Typical Bank (high CASA

ratio)

Yes bank (low CASA

ratio)

C A SA / Ba se (Rs.)

10000 1000

Interest rate (%)

4 7

Interest (Rs.) 400 70


34

have worked in my life. Governments

when they come in, the basic criteria is to

ensure that they have a say. And when they

come in they put certain restrictions so you

have to move to them to seek permissions

so that does not work out very well for

anyone. So as long as the government has

to play a role it may perhaps regulate

growth but never speed up growth.

A word of advice for students plan-

ning to enter the corporate world in

general and the banking sector in par-

ticular.

Banking sector in particular, which I real-

ized in the last 3 years, probably one of the

most interesting jobs one can get into. If

you get into a particular industry, e.g. Auto-

mobiles or human resources or insurance

or real estate or IT, you work only in that

industry. It is only in banking that since you

are lending to multiple companies in differ-

ent industries, you are able to get an appre-

ciation of multiple industries. Secondly,

finance as a stream is always very interest-

ing because you are dealing with cash, eco-

nomics, and the economy per se. Third is,

over the period of time as you mature and

grow older in life and older in the banking

system, you come in contact with the pro-

moters of all the companies you are lending

to. Therefore, your circle of influence and

circle of friends becomes much wider than

it would in a non-banking organization. So

banks have that advantage. If you are work-

ing in any other organization, by 40-45 you

will reach a functional head level which has

its own charms, you get to run your own

business etc. But if you are working with a

bank, chances are your exposure level will

improve your ability to mix with a different

kind of clientele. So banking that way is

extremely fruitful and useful. Since bankers

deal with money and finances, therefore

they also get paid extremely well as com-

many soaps and Godrej makes only Cin-

thol. When a company knows how to make

soaps, making multiple soaps is extremely

easy. You change the fragrances, packaging

and branding. Not many companies do it,

because they have chosen not to do it. Why

have they not done it is because of choice,

area of interest etc. As far as Yes Bank is

considered, what has happened is that most

of the top management of the bank was

earlier with Rabo and they felt restricted by

Rabo that they could only do this and not

do anything else. Therefore they ventured

out and started Yes Bank. The question is

that if you can do something else and get

into it, why not do it.

Even with the CASA increasing sig-

nificantly over the past year (which is

considered as a source of low cost

funds), but this has led to Yes Bank’s

doubling of losses because of the in-

terest rate increase in the retail sector,

would you still consider these as low

cost funds?

I am not aware of this, I need to educate

myself but my own contention is that these

losses are part of a bank‘s learning process

and certain things that go wrong which are

a learning for everyone. Loopholes have to

be plugged.

After a really close match, there has

been re-election of Barack Obama as

US president. Would you like to com-

ment on that and it’s impact on the

banking sector?

As far as the economy is concerned, it

works best with as little regulation as possi-

ble provided the people who are running

businesses believe in self governance and

self regulation. Till the time such a situa-

tion prevails, it is best for everyone con-

cerned. I have never seen governments

adding significant value anywhere where I



35

believe them primarily because of India‘s

own real estate scenario. Those studies are

made in USA. This is an Indian experi-

ence. The kind of real estate you invest in

always has to be a city specific decision. If

you have choice between 2BHK flat in

Dwarka or Pune vs 4BHK in Nasik or

Kanpur or Aurangabad, please take the

2BHK in Dwarka/Pune because there the

appreciation would be much more higher

and the market there is more well estab-

lished. That is the second phase of your

life.

Professionally keep in mind to always go

somewhere where the salary or designation

is higher, assuming the company brand

value is not much worse. So chase higher

salary and designation. Because your in-

dustry has not changed at all but your roles

and responsibilities have increased which

adds more value. So when you seek a shift

after taking up this job with higher respon-

sibility, the next shift would be greater

than your current salary and there would

be someone else in the market who would

be looking for someone at a certain salary

level and certain designation, so they

would like to look at you. So if you are at a

certain salary level, that conveys certain

things about you. On the flipside, don‘t

chase them so much that you get de-

pressed. They would come to you in due

course of time, if not today then tomor-

row.

Also, never say no to an interview. You

never really know which door is going to

open and when it is going to open.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Edited excerpts from the Interview of

Mr. Girish Aivalli

As told to Anupriya Asthana & Nihal

Jham from team Blue Chip

pared to anyone else in the industry. So

banking as a career option is excellent.

That is one thing one should possibly try to

get into. If you are choosing streams within

banking, try to avoid agri-banking and

lending because in India agri-lending is

called Priority Sector Lending, so your en-

tire job becomes one of matching 40%

limit and more of structuring the docu-

ments, so it becomes a documentation kind

of a role. It requires you to apply your

brain but not necessarily in the right way.

So better way is to get into corporate fi-

nance and project funding which I think is

more fruitful. Also try to see if you can get

into investment banking, which again is a

very interesting field.

About professional life, one thing you must

remember is that once you start your career

at the age of 25-26, you are going to be

there for the next 35 years or so. Whether

you achieve a certain salary at this age or a

certain designation at this age, honestly

doesn‘t matter too much because when it

doesn‘t come to you at this age, it will

come to you at plus 2 years or plus 3 years.

The reason is that people retire at the top.

India is not too strong on talent and skill

nowadays, there are lot of companies that

are yet to enter India, new product catego-

ries have to enter. So India is on its path to

glory. Managerial talents from good MBA

colleges are on their path to glory. Now the

question is what you should target. So

broadly speaking in 35 years, in the initial

years should be falling in love, go find a

girlfriend or boyfriend because everything

has its age and time in life. So do that for

one phase of your life. Once that has been

taken care of, second thing you should take

care is of making a financial nest for your-

self unless you come from very affluent

backgrounds. Try to put your money in real

estate, there have various studies that have

shown that the stock market have given

better results than real estate but I don‘t



36

Carbon Finance: Understanding the Market

PGPM 2011-2013

Management Development Institute, Gurgaon

Introduction

Carbon Credit is a certificate or a permit that

allows the holder to emit one tonne of carbon

dioxide or another greenhouse gas with a mass

equivalent to one tonne of carbon dioxide. These

are tradable instruments and can be bought or

sold in the carbon market. Hence we can think

of these as tradable tools to help limit the emis-

sion of Greenhouse gases.

Why do we need these credits? Why did the car-

bon market come into existence?

Greenhouse gas emissions are drastically chang-

ing our planet – melting glaciers, freak storms are

just some of the examples in a wide range of

frightening consequences. The level of CO2 gas

in the atmosphere increased by around 70%

from what it was in the 1870‘s to the level it

reached in 2000. As a result a check was needed

to help control the emissions of these gases into

the atmosphere. In 1997 the Kyoto Protocol was

introduced to set targets to reduce emissions of

Greenhouse gases. In 2005 the Kyoto protocol

went into effect which set caps on the emissions

allowed for different industries and countries.

This effectively gave rise to carbon trading and

the carbon market came into existence.

The carbon market trades under the cap-and-

trade schemes or carbon offsets.

Under the cap and trade scheme the gov-

erning body sets a cap, i.e. it defines the

maximum possible limit for allowable car-

bon emissions. Member firms that cannot

limit their emissions to under the allow-

able limit are required to purchase other

firms‘ credit to offset their emissions.

Member firms that reduce emissions to

under the permissible limit can sell off their

extra credits to other firms. Thus this

mechanism encourages firms to reduce

their carbon emissions and promotes

greening of firm‘s practices.

Carbon offsets are a less restrictive method

of regulating the carbon emissions. Carbon

offsets are a tradable instrument that one

can buy to neutralize the emissions that

one makes. For example after making a

plane journey, one can buy carbon credits

to offset the emissions made due the trip.

Buying these carbon offsets effectively

means that one is funding projects that

reduce the greenhouse gas emissions.

These projects can be either restoration of

forests, or promoting renewable energy etc.

Hence what this scheme does is it pro-

motes payment to reduce total global

greenhouse gas emissions instead of cutting

down one‘s own emissions. This is a volun-

tary scheme and is applicable at the individ-

ual as well as the business level.

Evolution of the carbon market

The carbon markets have largely been driven by 2

regulations, the Kyoto protocol and the Euro-

pean Union Emissions Trading Scheme (EU

ETS). Let us look at each of these regulations:

The Kyoto Protocol

Formulated in 1997, the Kyoto Protocol sets

binding targets for countries to reduce their

Greenhouse Gas emissions. These are legally

binding targets and must be followed by the

countries. This protocol came into force in Feb-

|CARBON CREDITS|


Prateek Dhingra Nikhil Sant

37

ruary 2005. The targets apply to the four green-

house gases carbon dioxide (CO2), methane

(CH4), nitrous oxide (N2O), sulphur hexafluoride

(SF6), and two groups of gases, hydro fluorocar-

bons (HFCs) and per fluorocarbons (PFCs). The

above six gases are translated into equivalents of

one tonne of CO2 in determining reductions in

emissions.

Apart from the targets set for the countries the

Kyoto Protocol allows three flexible mechanisms

which are emissions trading, Clean Development

Mechanism (CDM) and Joint Implementation (JI)

to meet the targets. These flexible mechanisms

allow the countries to offset any excess emissions

by buying from countries that have excess emis-

sion credits.

Emissions trading mechanism: The Protocol

has set the targets over the commitment period of

2008-12 and the allowed emissions are divided

into Assigned Amount Units (AAUs). The coun-

tries with excess AAUs are allowed to sell them

to the countries that are exceeding their targets.

Clean Development Mechanism: This is a pro-

ject based mechanism which enables emission

reductions through projects in developing coun-

tries. Hence countries with emission reduction

targets fund an emission reduction project in de-

veloping countries to earn Certified Emission

Reduction carbon credits (CERs), equivalent to

one tonne of CO2 each, which can offset the ex-

cess emissions by these countries. We will discuss

this mechanism in depth later in the article.

Joint Implementation mechanism: This is also

a project based mechanism similar to the CDM

discussed above; the difference being that Joint

Implementation encourages emission reduction

projects in other developed countries as opposed

to encouraging it in developing countries as per

the CDM. The credits earned through such pro-

jects are called Emission Reduction Units (ERUs)

and are equal to one tonne of CO2 each.

European Union Emissions Trading Scheme

(EU ETS)

The first and the largest international scheme in

accordance with the Kyoto Protocol to combat

the climate change and reduce the emissions of

Greenhouse Gases is the EU ETS scheme. This

scheme was launched in 2005 and works on the

‗cap and trade‘ system described earlier in the arti-

cle. The trading unit is the right to emit one tonne

of CO2. Heavy fines are imposed for companies

not adhering to the rules. Also the number of

allowances in the market is limited and hence the

onus is on companies to reduce their emission to

within the cap rather than buy allowances in the

market. The allowances are to be reduced over

time so as to ensure that total emissions will re-

duce and lead to a greener world. The number of

members taking part in this scheme has increased

from 15 during the time of creation of the Kyoto

Protocol to 30 members at present. This scheme

covers more than 11000 factories, power stations

and other installations in these 30 member coun-

tries.

The EU has set a target for the year 2020 of cut-

ting its emissions to 21% below the 2005 levels.

Currently the allocation of permits is at a national

level administered by the governments of the par-

ticipating countries. Currently the scheme is in

the second phase of operation (2008-2012). From

January 2012 onwards the civil aviation sector

was also included in this scheme.

From January 2013 onwards, the third phase of

the EU ETs scheme will commence. There are a

number of changes proposed for this third phase.

The allocation of allowances will take place via a

centralized EU authority and the focus will be on

auctioning a greater share of these permits rather

than allocating them freely. Also there are plans

to include other greenhouse gases such as per

fluorocarbons and Nitrous Oxide in the scheme.

There is a plan to curb the emissions by 1.74%

linearly so as to achieve the target set for the year

2020.

Tradable Instruments

Let us understand in detail the different tradable

instruments available in the markets today:

|CARBON CREDITS|

JULY—SEPTEMBER‘12 | BLUE CHIP ISSUE 2

38

Certified Emission Reduction (CERs): CERs

are the unit of greenhouse reductions from CDM

(Clean Development Mechanism) projects. They

are verified by external parties which are accred-

ited to United Nations (UN). CERs are issued by

CDM Executive Board which is the regulatory

body for CERs. Countries can use CERs to com-

ply with the Kyoto Protocol obligations.

Verified Emission Reductions (VERs): Also

known as Voluntary Emission Reductions, VERs

are emerging credits outside the Kyoto Protocol

compliance regime. They can either be converted

to a CER or can be traded under other regulatory

schemes. These credits can also be traded to enti-

ties who have adopted VER commitment. These

credits are illiquid and they do not have an ex-

change market which is transparent. This limits

their use for short term or speculations.

Emission Reductions (ERs): These represent

the units of greenhouse emissions which are not

verified. These are traded to players who have

adopter VER commitment.

EU Allowances (EUAs): These are greenhouse

gas units which are allocated to parties under EU

Emissions Trading Scheme. With these allocated

units, the parties can emit an equivalent quantity

of CO2.

Renewable Energy Certificates (REC): Under

Electricity Act, 2003 and National Action Plan

for Climate Change (NAPCC), the Government

of India framed policies aimed at promoting re-

newable energy market in India. REC is a market

based mechanism to catalyze the renewable en-

ergy market development. From the power gen-

eration, RECs separates the electricity component

and environmental component. Both these com-

ponents can be traded in the market. This helps

in development of the renewable energy as they

provide incentives to the states to develop renew-

able energy more than the Renewable Purchase

Obligation (RPO) state limit.

Clean Development Mechanism

As discussed earlier, CDM is a process through

which countries can earn CER credits, each

equivalent to one tonne of CO2. This is in ex-

change of reducing greenhouse gas emissions in

developing countries. CERs can be used by de-

veloped countries to meet the Kyoto Protocol

Obligations.

CDM Project Cycle

The CDM project cycle encompasses 7 stages

starting from Project Design and ending at CER

issuance. The following flow chart shows the 7

stages of the cycle.

|CARBON CREDITS|


Stage Central Party Important Characteristic of the stage

Project Design Project Participant Project participant prepares project design document,

making use of approved emissions baseline and moni-

National Ap-

proval

Designated National

Authority

Project participant secures letter of approval from Party.

Validation Designated Opera-

tional Entity

Project design document is validated by accredited des-

ignated operational entity, private third-party certifier.

Registration Executive Board Valid project submitted by DOE to CDM Executive

Board with request for registration.

Monitoring Project Participant Project participant responsible for monitoring actual

emissions according to approved methodology.

Verification Designated Opera-

tional Entity

Designated operational entity verifies that emission re-

ductions took place, in the amount claimed, according to

CER Issuance Executive Board Designated operational entity submits verification report

with request for issuance to CDM Executive Board.

Table 1: Parties central to the stages in CDM

Source: UNFCC website

39

CDM Governance

|CARBON CREDITS|



Figure 1: CDM Governance structure

Party Responsibility

COP/MOP Makes rules of CDM. Decides on recommenda-

tions made by the Executive Board.

Designated Operational Entity Validates the project request and then seeks regis-

tration of the project. Also verifies the emission

reduction of an already registered CDM project. If

yes, then request the board to issue CERs.

Designated National Authority Approval from Designated National Authority of

each party involved is required before registration

of CDM project can take place.

CDM EB Supervises the Kyoto Protocol’s CDM under the

guidance of COP. POC for registration of projects

and issuance of CERs.

Methodologies Panel Recommends the board on guidelines used for

methodologies for baseline as well as monitoring

plans.

Accreditation Panel Prepare decision of the board keeping in mind the

procedure for accrediting operational entities.

Registration and Issuance Team Assists the board in the appraisals of the projects.

Small Scale Working Group Prepare recommendations for baselines and moni-

toring methodologies for the submitted CDM

Small scale projects.

Afforestation and Reforestation

Working Group

Prepare recommendations for baselines and moni-

toring methodologies for the submitted CDM a

forestation/reforestation projects.

UNFCCC Secretariat Supports actions to fight climate change. Also,

analyses the impact of climate change on ecosys-

tem as a whole.

Table 2: Responsibilities of parties


40

│BEGINNERS’ CORNER│

Short Selling

When you are confident that a stock is on a

downward trend, you can make money by

shorting it. A broker checks his stock inventory,

clients‘ portfolio or other brokerages for the

stock and sells it in the market, crediting the

trader‘s margin account. A margin account al-

lows you to borrow funds from the broker at

the time of purchase with the security acting as

collateral. When the stock price drops in due

course, the trader asks the broker to cover his

position (buy-back the same number of shares).

The broker purchases the stock using the

amount available in the trader‘s margin account

and returns it to the rightful owner. Interest is

charged on the margin account and the broker

might be paid a commission for the transaction.

Short selling can be done for currency as well.

A famous example of shorting was done by

George Soros ‗the man who broke the Bank of

England‘. By short selling the British pound to

the tune of $10billion on a hunch that it would

subsequently be devalued, he made a profit of

$1billion.

Any dividends paid out on the stock during the

period of short selling are due to the lender and

not the short seller. There is a lot of inherent

risk in short selling. One related consideration

is that holding a short position open for long

periods may not be prudent as inflation alone

could jack up the stock‘s price to some extent.

Mostly we find big traders using shorting as a

hedge strategy.

The antithetical approach is long trading or

The term trading is often used interchangeably

with investing; however despite their similarities

there are points of differentiation. The funda-

mental distinction is that when a trader enters

into a stock purchase, he has a strategy in mind

which would influence his exit timing. Traders

generally use technical analysis and hold stock for

shorter periods of time, exiting as soon as they

see a prospect for sufficient profits to be made.

In contrast investors mostly use fundamental

analysis or a mix of both to pick their portfolio

and hold on to it for longer periods. They are

not too concerned by short-term losses and nor-

mally follow a buy and hold approach. Lately, the

trend shows the market dynamics shifting from

an investment to a short-term trading orienta-

tion. Analyst Alan Newman mentions in his

Crosscurrents newsletter that the average hold-

ing period for stocks has fallen to about three

months and that for the S&P 500 SPDR (SPY)

exchange traded fund to less than five days.

Technical analysis involves studying the his-

torical price trends of a stock in order to fore-

cast its future price movements. Fundamental

analysis on the other hand is concerned with

understanding the intrinsic value of a stock

through quantitative and qualitative analysis. The

quantitative part is done by studying the com-

pany‘s financial statements and ratios whereas

the qualitative part looks at external factors that

might affect the company.

There are some interesting strategies that are

often employed by traders across the globe

which include day trading as well as certain

longer approaches.

Trading Strategies Team Blue Chip


Figure 1: Short selling process flow

41

Support is the average price at which traders

were ready to buy the stock in the past. Re-

sistance is the average price at which traders

were willing to sell the stock in the past. In

short, resistance levels can be viewed as price

ceilings whereas support levels can be seen as

price floors. Traders often use tools and indi-

cators such as Bollinger Bands and trend

lines to identify these levels. A support trend

line would be created when a declining stock

price rebounds at a pivot point which is in

line with two or more previously observed

support pivot points. Similarly, a resistance

trend line would be created when a rising

stock price rebounds at a pivot point which

is in line with previously observed resistance

pivot points. Bollinger Bands for a certain

period primarily consist of a simple moving

average, an upper band at k-times standard

deviation above the average and a lower band

at k-times standard deviation below the aver-

age. It has generally been observed that 80-

85% of the price volatility for a stock occurs

within these bands.

Scalp Trading

Scalpers follow the proverbial approach of

―little drops of water make the mighty

ocean‖, engaging in a large number of trades

in a day thereby aggregating several minor

going long which mostly involves using fundamen-

tal analysis or a mix of technical and

Table 1: Earnings Matrix

fundamental analysis to choose stocks that are

likely to rise in the future. At that point in time,

the trader sells his holding and pockets the dif-

ference as his profits.

Swing Trading

In the relative short term, stock prices are nor-

mally observed to swing back and forth within

certain limits. Swing traders capitalize on this

phenomenon by either long trading a stock that

is at the trough and about to start climbing or

short selling one that is at the crest and about to

start declining. Technical analysis of historic

trends, in particular the concepts of support and

resistance aid a swing trader in taking a call on

when to enter and exit.



Earnings Matrix

Short Selling

Long Trading

Maximum Profit

Amount Invested

Unlimited

Maximum Loss

Unlimited Amount Invested

Figure 2: Bata India Limited Bollinger Bands Chart

Upper Band: 986.62 Middle Band: 927.51 Lower Band: 868.40

Source: Traders Cockpit

42


High-frequency trading (HFT) is a type of

automated trading that makes use of powerful

computers to process large volumes of market

data and take split second decisions in order

to capitalize on fleeting trading opportunities

that would be rather difficult for a human

trader to take advantage of. The increasing use

of HFT (73% of US equity trading in 2009 as

per research carried out by the Aite Group)

has got regulators worried about its contribu-

tion to speculation and share price volatility.

The other concern is that of algorithm mal-

functions which was witnessed in February

2010 when a system operated by Infinium

Capital Management malfunctioned and the

built-in measures for automatic shut-down

failed, jolting the markets. EU lawmakers have

recently backed curbs on high frequency trad-

ing.

Position Trading

Position trading or trend trading involves detect-

ing a price trend, exploiting it and exiting as

soon as the trend starts reversing. A trend is

nothing but a general direction of price move-

ment. Position trading is a short to medium

term trading style where positions may be

held open for periods ranging from several

days to a couple of months. Such traders nor-

mally practice a type of buy and hold ap-

proach with less concern for short-term vola-

tilities as they believe that in the long run

these will get smoothened out. Though posi-

tion traders may resemble long-term inves-

tors, they are more concerned with the move-

ments of the stock price than the fundamen-

tals of a company. Their primary data source

for decision making would be price charts

which could consist of daily, weekly or

monthly timeframe charts. Position trading

thus has more similarities with short-term

trading strategies except for the distinction of

having longer holding periods. Traders can

take both long and short positions in this ap-

proach.

Happy Trading!

profits into a worthwhile total. Among traders, it

is at times referred to as ‗the quick and the

dead‘. The upside to this strategy is that the risk

in terms of losses per trade tends to be relatively

small. The underlying principle behind scalping

is that a trader can anticipate the directional

movement of a stock with reasonable certainty

for a very short period of time beyond which it

becomes difficult to predict. Technical analysis

is carried out by scalp traders to pick stocks and

they are generally not concerned with the funda-

mentals of the stocks in which they are invest-

ing.

Scalpers sometimes use time-stops which are

nothing but stop orders designed to exit their

position when a specified time limit is breached

regardless of the profit or loss at that stage.

Since transaction decisions are taken on an in-

stantaneous basis, scalpers should ideally make

use of direct-access brokers who offer swift and

dependable execution. Scalp trading has certain

inherent advantages such as lower risk due to

shorter exposures to the market and ease of

finding targets as even stable stocks generally

exhibit short periods of minor price movement.

Trading the News

Daily news updates that have economic impacts

on certain industries or sectors or more specifi-

cally on a listed company can cause short-term

trends in the stock markets. Traders can capital-

ize on such developments through the manual or

automatic method, the difference between the

two being the use of algorithmic trading in the

automatic route.

Algorithmic trading or automated trading uses

complex programmed mathematical models to

evaluate various parameters of stocks including

the impact of external factors such as news up-

dates and ascertain the best time to buy or sell.

In some situations, the system can even perform

the transaction without the help of a human

trader. This method is popular among large in-

stitutional traders who typically transact large

amount of shares in a day.


43

|FISCAL DEFICIT|

3. Defence expenditure

4. Poor performance of public sector

5. Excessive government borrowings

6. Tax evasion

7. Weak revenue mobilisation

8. Huge borrowings

Following are some of the consequences of

fiscal deficit:-

a. Debt Trap

b. Cut in capital expenditure

c. No increase in expenditure on education

and health

d. High interest rates

e. Slow economic growth

f. Inflation

g. Discouragement to foreign investment

h. Additional borrowing by the government to

solve fiscal deficit

Now, we talk about the measures taken by the

government of India to reduce the fiscal defi-

cit and in doing so ultimately to unravel the

twisted Indian economy.

FDI In retail

In a major reform drive, the government al-

lowed for 51% foreign direct investment in

multi-brand retail. There has been a critical

assessment of this decision taken by the gov-

ernment and both upside and downsides of

this have been evaluated.

Let us look at both sides of the picture. On

the positive side, with increased foreign par-

ticipation there will be more competition in

Fiscal Deficit: The Indian perspective

When India became a free nation in 1947, we

had a vision for our nation. Vision was to live in

a country where democracy prevails. People

have the right to voice their opinions and pro-

test against injustice. Though we can be proud

of living in the biggest democratic nation but

there is dark side to it. Economic part of vision

has been a failure.

For decades, we witnessed sluggish growth in

our economy. We were content with self-

reliance until 21 years ago. This was the time

when the nation faced balance of payment crisis.

It forced our leaders to bring in reforms. Doors

were opened for private players. Licenses were

scrapped. The results were spectacular and our

economy never looked back until now.

Fiscal deficit is projected by IMF to be 9.5%

(included the state deficit) of GDP. India se-

cures 2nd place in the list of emerging economies

having high fiscal deficit. The situation is alarm-

ing .Rating agency Standard & Poor‘s strongly

recommends taking steps to reduce structural

fiscal deficits, improve the investment climate

and increase growth prospects. It also warns

that a downgrade in credit rating is likely if the

country‘s economic growth prospects slow

down or fiscal reforms slow. The main reasons

for increased fiscal deficit are weaker than ex-

pected tax receipts, high subsidies and the

weaker economic growth.

Causes of fiscal deficit are:-

1. Increase in subsidy

2. Payment of interest

FISCAL DEFICIT The labyrinth tale

Gaurav Kumar and Sakshi Aggarwal PGDM-BM (2nd year), Xavier Institute of Management, Bhubaneswar

43

JULY-SEPTEMBER ‘12 | BLUE CHIP ISSUE 1

44

source locally and international structured re-

tail will source internationally, leading to drop

in domestic manufacturing. Also international

sellers usually rely on the principle to buy

cheap and sell costlier. Initially they can offer

low prices to customers to attract them and

eliminate competition and the raise prices

later.

Thus, we can see that there are both pros and

cons of the decision. But now the way ahead

is to find the best possible path which would

benefit the consumers and retailers both.

FDI in pension and insurance

The government has unveiled its plan to allow

49% FDI in pension and insurance sector.

Currently most pension plans are insurance

linked. Rapidly growing insurance sector was

being hobbled by lack of capital. It needs

money which can only come from foreign

investment.

In the pension sector, it would bring more

international players. The government has

decided to do that to help the sector which is

suffering from expense overrun and is in terri-

ble need of fresh capital infusions.

Price hike

The Government as part of reforms decided

to increase diesel price by Rs. 5 a litre and

household will get only six domestic LPG cyl-

inders per annum at subsidized rates.

This is an important step in the long run for

fiscal consolidation. The Govt. should aim at

a complete deregulation of diesel prices. The

Kelkar Committee report also has recom-

mended elimination of half of the subsidy on

per litre by March 31, 2013 and the remaining

half over next fiscal year.

If this will be implemented it would mean that

the market and thus the consumer will be bene-

fitted with better pricing and more variety of

products.

Also under the new policy minimum $100 mil-

lion investment has to be made which is the

minimum benchmark, of which $50 million has

to be in the back-end .With investments in the

back-end, it will lead to creation of much better

infrastructure facilities like cold-storage and re-

duce wastage and rotting of fruits and vegeta-

bles. Ultimately, Farmers will get better price

realisation and will be benefitted. The small sec-

tor would also benefit as 30% sourcing has to be

done from the SME‘s. Thus this will add further

value. With this, we will see the infusion of new

technology across the agriculture value chain as

well as significant improvements in the back-

end infrastructure.

There will be a multiplier effect in terms of em-

ployment generation and domestic manufactur-

ers will benefit as they integrate with supply

chain of global retail markets.

Looking at the other side, by allowing FDI in

retail it will impact the kirana and mom & pop

stores. But we can say that it is the same case

when multi brand retail stores like Reliance and

Spencers opened in India but they still didn‘t

impact much the business of kirana stores. A

kirana store is still seen as a nearby convenience

store and would continue to be so.

On the other hand, a major drawback faced by

kirana stores is lack of scale in buying and pro-

curement which puts them at a disadvantage vis-

à-vis the big retailers who buy so much that they

can demand a lower cost from their suppliers.

To counter this, small kiranas can form a coop-

erative and then negotiate prices centrally so

that they also get same pricing advantage.

A few other opinions opposing the FDI deci-

sion are that manufacturing sector jobs will be

lost in India. As domestic retailers primarily

|FISCAL DEFICIT|


45

25% shares in Tehri Hydro will fetch over

1300 crore rupees. The government is also

contemplating disinvestment in Axis bank and

ITC.

The proceeds from the divestment will be

used for capital expenditure in social sector

programmes. To that extent, budgetary alloca-

tions for the social sector can be reduced.

This will naturally help rein in the fiscal defi-

cit.

On the down side the planned disinvestment

does not happen overnight. Secondly, the fis-

cal benefits of disinvestment are somewhat

illusory. When the government sells its equity

in a PSU, it is only realising upfront the value

of dividends it would realise over the life of

the PSU. Any gain to the fiscal in the short-

term is offset by a loss of the stream of divi-

dends over a longer period. Hence disinvest-

ment can be seen primarily as an instrument

for improving performance of PSUs.

In the end we can say that all these measures

will help us get the environment for growth

right. Equally important is that these reforms

need to be followed and implemented well.

Moreover, a forward movement on GST, in-

troducing greater competition in the mining

sector and creating new investment opportu-

nities for Infrastructure development will help

us sustain these reforms and put us back on

the growth path. With economic condition

deteriorating and the future looking bleak,

these are the steps which were inevitable.

Sooner we realize the seriousness of the situa-

tion, the better prepared we will be to prevent

our economy to go down the slide way. There

may be voices of protests from many political

fronts but these are the tough decisions re-

quired by the criticality of the situation;

though the results will not be visible immedi-

ately and will take some time to reflect in the

economy.

50% of the losses on every litre of diesel borne

by the oil companies will be passed on to the

consumers. As subsidy on diesel has been a ma-

jor contributor to increasing fiscal deficit in the

past years.

The under-recovery of oil marketing companies

in 2011-12 was Rs1, 38,500 crores, nearly double

of that in 2010-11. Of this a sizeable amount

was borne by the government and the rest by

upstream oil companies like ONGC and OIL.

This not only resulted in lesser revenues for

these companies but also meant 30% corporate

tax forgone but more importantly, it will cut

their spending and expenditure on exploration

and production locally as well as globally.

Also, as a result of diesel price hike which will

help control fiscal deficit, this will be vital to

hold on to credible sovereign credit rating.

Subsidy cut

The government is mulling over the idea of

switching to a system that delivers subsidies by

directly transferring cash instead of discounts.

The government plans to eliminate subsidy on

diesel by the end of 2013-14 fiscal year. Similarly

on household cooking gas will also see the re-

moval of subsidy by 2014-15. Subsidy on kero-

sene will also be reduced by one-third by 2014-

15. There are also proposals on progressive sub-

sidy removals on fertilizers and food products.

The government is expecting to bring down the

spending on subsidies to 2 per cent of GDP in

2013-14.

Disinvestment

The government is planning to disinvest its

shares in almost 75 PSUs. It has sold 10.82%

stake in SAIL which fetched the exchequer over

4000 crore rupees. Similarly disinvestment of

|FISCAL DEFICIT|

JULY-SEPTEMBER ‘12 | BLUE CHIP ISSUE 1

46

Market Movement

Economic Indicators

Month Inflation CPI IIP PMI(HSBC)

June 7.55 10.05 2.5 55

July 7.58 9.84 -1.8 52.9

Aug 6.87 10.31 -0.2 52.8

Sep 7.55 - 2.7 52.8


|MARKET UPDATE|

47

World Market Exchanges

Sector-wise Snapshot

1st July 30th Sept Quarterly returns

Sensex 17429 18763 7.65

Midcap 6153 6607 7.38

Small cap 6543 7018 7.26

CG 10025 10958 9.30

CD 6208 6940 11.79

Power 1987 2049 3.11

Bankex 11908 13139 10.34

Oil & Gas 8075 8647 7.09

Auto 9457 10413 10.11

Metal 10785 10528 -2.38

Realty 1667 1847 10.80

Healthcare 6883 7528 9.38

Teck 3344 3417 2.19

FMCG 4992 5507 10.32

Country Indices 01-Jul 30-Sep Qtrly Returns

Brazil Bovespa 54,354 59,176 8.87 %

Russia RTSI 1357 1475 8.72 %

India Sensex 17,398 18,763 7.84 %

China SSE Composite 2,604 2,370 -8.99 %

Japan Nikkei 225 9,003 8,870 -1.48 %

USA NASDAQ 2,625 2,799 6.63 %

Germany DAX 6,496 7,216 11.08 %

Hong Kong Hang seng 19,441 20,840 7.20 %


|MARKET UPDATE|

48

Currency Rates

1 Dollar – Rs. 54.78

1 Euro – Rs. 67.79

1 Pound – Rs. 85.16

1 Yen – Rs. 0.68

Source: Reserve Bank of India Currency rates, policy and reserve ratios as of 2nd October, 2012

Policy Rates and Reserve Ratios

Repo Rate – 8.00 %

Reverse Repo – 7.00%

CRR – 4.50%

SLR – 23%

Bank Rate – 9.00%

|MARKET UPDATE|

In the News

of goods, services and transfers. India‘s CAD

narrowed to US$16.4bn in Q1 of FY 13 from

US$21.7bn in Q4 FY 2012. The CAD figure in

the last quarter was equivalent to 3.9% of GDP

as compared to 3.8% in Q1 FY12. The CAD had

widened to all time high of US$78.2bn (4.2% of

GDP) in the fiscal year ended March 2012 com-

pared with the 2.5% benchmark set by RBI. This

relative reduction is attributed to a moderation in

trade deficit due to sharper decline in imports as

compared with exports coupled with improve-

ments in secondary income.

Fiscal deficit rises to 65.7% of FY13 target Sep 28, 2012; The Economic Times

Fiscal deficit is the difference between a country's

income and expenditure. Fiscal deficit in Q1 FY

2012-13 stood at 65.7 per cent (INR 3.38tn) of

the budget estimates of INR 5.14tn against 66.3

per cent in the same period a year ago.

The budget for FY 2012-13 mandates govern-

ment to borrow INR 5.7 lakh crore this fiscal or

5.1 per cent of the GDP. It has borrowed INR

3.7 lakh crores so far. The finance ministry has

reassured that it will keep the fiscal deficit in

check by limiting further borrowings to INR 2

lakh crore.

BSE Sets Limits for Kingfisher, United

Breweries Sep 28, 2012; The Wall Street Journal (India)

NSE and BSE have revised circuit limits of Vijay

Mallya promoted Kingfisher Airlines and United

Breweries (Holdings) to 5% and 10% respec-

tively. Circuit limit is the price band in which a

stock is allowed to trade in a session.

These stocks have rallied in the past after the

Kelkar committee outlines fiscal consolida-

tion roadmap Sep 30, 2012; Rediff News

The three member Kelkar Committee was insti-

tuted by GOI to lay out measures for fiscal con-

solidation. It has recommended that the govern-

ment lower its deficit to 5.2% of GDP in FY13,

and further to 4.6% and 3.9% in FY14 and FY15,

respectively by adopting a fourfold strategy of bet-

ter tax and administration measures, increment in

divestment proceeds, subsidy cuts and reduction

in size of plan expenditure. For the required re-

duction in the fiscal deficit report suggested a re-

duction of subsidies by 2% in FY14 and 1.8% in

FY15 and moderation in rise of plan expenditure

from 26% to 15%.

Rupee rises to five month high Sep 29, 2012; Business Standard

The rupee rose to a new five-month high of INR

52.86 to a dollar on Friday with an average gain

of five per cent in September. The reason for ap-

preciation is believed to be a combination of for-

eign institutional inflow of INR 1,230 Cr in equity

markets as well as positive sentiment driven by the

spate of reforms announced by the government.

Experts believe that the rupee will stabilize at

approx. INR 52-53 per dollar in short term and

my touch up to INR 50 per dollar by December

when the repayments of GOI may cap the cur-

rency gains. But any sharp appreciation may war-

rant monetary measures by RBI which aims to

strengthen the foreign reserves position.

April-June current account deficit narrows Sep 28, 2012; Reuters

Current account deficit (CAD) is the difference

between a country's total imports and total export


http://www.rbi.org.in/home.aspx

http://articles.economictimes.indiatimes.com/2012-09-28/news/34148206_1_fiscal-deficit-net-tax-receipts-arvind-mayaram

http://online.wsj.com/article/SB10000872396390443843904578023520271453596.html

http://www.rediff.com/business/slide-show/slide-show-1-special-kelkar-committee-report-on-indian-economy/20121001.htm

http://www.business-standard.com/india/news/rupee-rises-to-5-month-high/487977/

http://in.reuters.com/article/2012/09/28/india-currentaccount-takealook-idINDEE88R0AV20120928

49

|MARKET UPDATE|

Disinvestment in 4 PSUs allowed Sep 14, 2012; Hindu Business Line

The cabinet committee on economic affairs ap-

proved the disinvestment of a part of GOI stake

in Oil India, MMTC, Nalco and Hindustan Cop-

per. The centre is set to offload 10 per cent of its

stake in Oil India, 9.59 per cent in Hindustan

Copper. In the case of MMTC the stake offload-

ing will be 9.33 per cent through the OFS (offer

for sale) route. The disinvestment will generate

INR 15,000 crores according to GOI estimates

which is half of the total disinvestment target for

current fiscal year.

Banks will need INR 5 lakh crore to meet

Basel III norms Sep 4, 2012; The Economic Times

Basel III is the latest round of global regulatory

standards for banks which India is set to adopt in

a phased manner by March, 2018. RBI Governor,

D Subbarao has said that banks will require an

additional capital of INR 5,00,000 crore to meet

the norms.

Of the total, INR 1.5 lakh crore will be required

as equity capital and the rest as non-equity. The

tier I capital requirement comes to about INR

1.75 lakh crore. If the government decides to

reduce its shareholding in every bank to 51%, its

burden will reduce to INR 70,000 crore.

Coal block allocation scam - 'Coalgate' Aug 17, 2012; The Hindu

The Comptroller and Auditor General (CAG)

report on coal block allocations has estimated the

loss at INR 1.86 lakh crore against the draft re-

port which suggested the figure to be INR 10.7

lakh crore. The enormous loss to the exchequer

meant windfall gains to the private players as the

coal block allocations were done without com-

petitive bidding. The CAG has recommended

coal block auction route. The report details the

allocation of 194 coal blocks with massive re-

serves of 44 billion tons at throwaway prices on

the basis of recommendations.

GOI notified FDI in aviation, a move that is ex-

pected to help debt-strapped airline. Also, earlier

this week, Diageo said that it was in talks with UB

Group company United Spirits and its parent

United Breweries Holdings to acquire a stake in

the Indian spirits group.

S&P lowers 2013 growth target to 5.5% Sep 25, 2012; The Economic Times

Credit rating agency Standard & Poor has slashed

India's growth forecast for FY 13 from 6.5% to

5.5% which is equal to its Q1 growth rate on the

back of weak monsoon, infrastructure shortcom-

ings and policy paralysis.

State power distributors to get INR 2 lakh

crore bailout Sep 24, 2012; Hindu Business Line

The Cabinet Committee on Economic Affairs on

Monday approved the proposal for Financial Re-

structuring of State Distribution Companies

(Discoms). It envisages a scheme for financial

turnaround of the discoms whose combined

losses have run into approx. INR 2 lakh crores.

States have the option to opt into it by 31st Dec,

2012. Under the scheme, 50% of the short term

liabilities will be converted into bonds issued by

the discoms and backed by the respective state

governments. The balance 50% liabilities will be

restructured by rescheduling loans and a 3 year

moratorium on payments.

Cabinet Allows FDI in Retail, Aviation,

Broadcasting and Power Trading Sep 15, 2012; The Economic Times

Government has liberalised FDI norms in avia-

tion, power exchanges, broadcasting and the much

talked about retail sector. Now, 51% FDI is al-

lowed in multi brand retail with a minimum in-

vestment requirement of US$ 100mn, half of

which is mandated to be invested in developing

back end infrastructure facilities. The stores can be

set up only in the cities with a population of more

than 1 million.

The FDI in Indian Aviation companies is capped

at 49% of the paid up capital. In addition to these,

74% FDI in broadcasting and 49% in power trad-

ing exchanges were also approved.


http://business-standard.com/india/news/disinvestment-in-4-psus-allowed-to-raise-rs-15000-cr/186888/on

http://articles.economictimes.indiatimes.com/2012-09-04/news/33582154_1_basel-iii-d-subbarao-public-sector-banks

http://www.thehindu.com/news/national/article3784709.ece

http://www.google.com/news/url?sr=1&sa=t&ct2=in%2F0_0_s_1_0_t&usg=AFQjCNEwaTjUnUWz5FeE-fIdZTJ7DFr7kg&did=43ad4f31628d706a&cid=26389780301851&ei=PM1qUKDIHM2ZiAeglgE&rt=STORY&vm=STANDARD&url=http%3A%2F%2Farticles.economictimes.indiatimes.com%2F2012-09-25%2Fnews

http://articles.economictimes.indiatimes.com/2012-09-25/news/34082647_1_fiscal-deficit-growth-target-growth-forecast

http://www.thehindubusinessline.com/industry-and-economy/article3932537.ece

http://articles.economictimes.indiatimes.com/2012-09-15/news/33862902_1_multi-brand-policy-paralysis-single-brand

50

|MIND GAMES|


later repositioned as a men‘s brand. In its new

avatar, one of the most recognizable figure

for X was a cowboy. Name X.

12. The idea for name of this company came

from a report on TV about football players

taking ballet lessons to improve their balance

and co-ordination. Identify the company.

14. The idea for X came to its founder while

he was an undergraduate in Yale, in 1965. He

wrote an economic paper describing his vi-

Across:

4. BOURNVILLE::CADBURY, X::P&G.

What is X??

7. X secured order to manufacture 900,000

ballot boxes for independent India's first gen-

eral elections. X also manufactured the first

Indian typewriter as well as India‘s first refrig-

erator. Name X.

9. X started out as a brand for women. It was

CrossWord

51

|MIND GAMES|

Jagan‘s son Mali in Malgudi days

6. X wanted that Y be able to carry two

adults and three children, go up to 60 miles

per hour, get at least 33 miles per gallon. Who

is X (Give the surname)

8. Which famous luxury goods store hired a

live Egyptian cobra to guard a pair of haute

culture sandals encrusted with ruby sapphire

and diamonds

10. X was established before independence in

Kolkata. Its idea was conceived during Quit

India movement. The idea was to organize a

commercial bank with Indian capital and

management. Name the bank

11. Though this scheme is named after some-

one else, it was mentioned for the first time in

Charles Dickens 1857 novel ―little Dorrit‖.

Which scheme?

13. Who said PCs will become niche products

like trucks. Give the full name ( 2 words)

15. Connect United Breweries, Trent, Nestle

India and Singapore

18. Connect Kodak, PWC and Thomas Edi-

son

Try not to look at the answers on the next

page!

Happy Quizzing !!!

sion, which earned him a C and ―not feasible‖

remark from the professor. Today, X is a very

successful business. What is X?

16. X was set up based on recommendations

of Hilton Young Commission. X has sculp-

tures of Yaksha and Yakshini, attendants of

Kuber, the God of Wealth. Give the initials of

X

17. X made its presence felt at a 1959 Moscow

Fair where the product was shared by Soviet

Premier Khurshahev and US Vice President

Richard Nixon. What is X?

19. Famous hypermarket chain whose name in

French means ―Crossroads‖

20. X introduced in India, foreign trees and

plants which he personally cultivated in his

estates in Ooty and Bangalore. He visited Ja-

pan in 1890s and invited Japanese to experi-

ment in sericulture in Mysore which helped

revive silk industry. Give his first name.

Down:

1. When asked to write his own epitaph, this is

how X described it, ―Made more money faster.

Lost more money in one day. Led the biggest

jailbreak in history. He died. Footnote: The

New York Times questioned whether he did

the jailbreak or not." Give the full name of X

*2 words)

2. The logo of a famous electronic brand is

designed in such a way that it represents the

integration of analog and digital technology

with the first half of the logo representing an

analog wave and the second half representing a

digital binary code. Which brand?

3. Connect Teen Patti, Rajiv Gandhi and

Ashok Leyland

5. The name for X was taken from an Ameri-

can Indian chief X, who led an unsuccessful

uprising against British shortly after French

and Indian war. X brand of car was driven by


52

|MIND GAMES|


Solution

53

- - - - - - - - - - - - - - - - - - - - - - -

From top left: Saurabh Saxena, Anupriya Asthana, Aneesha Chandra, Raghav Pandey, Keyur Vinchhi,

Nihal Mahesh Jham, Amit Garg, Ashish Gupta, Goutam Kumar, Rajat Trehan, Rishabh Gupta, Sankalp

Raghuvanshi, Vipul Garg, Shaunak Laad, Rishi Maheshwari, Ankur Dikshit, Aditya Bansal, Stephen

Thomas, Varun Sanghi, Saurav Kumar Singh, Siddharth Janghu, Swapnil Sheth, Aditya Mittal, Sandeep

Patil, Krishna Prem Sharma

Not in picture: Mukul Aggarwal, Uday Das Gupta, Shaikh Arif Ahmed, Soumya Hundet, Rohit Agarwal,

Syed Fahd Iqbal, Amit Aggarwalla

The Club

- - - - - - - - - - - - - - - - - - - - - - -

Monetrix is the Finance and Economics club of Management Development Institute

(MDI), Gurgaon. As one of the most active clubs in the campus, Monetrix continuously

strives to contribute to the financial and economic knowledge of the MDI community by

holding events and conducting knowledge sessions and other interactions.

The magazine, Blue Chip, is an effort in the same direction, of contributing not just to the

MDI community, but to the fraternity of MBA undergrads throughout India.

Hope this issue of Blue Chip has served as an interesting read. Do watch out for our next

quarter issue to be released in the new year!

More information on Monetrix can be found at http://mdi.ac.in/students-life/academic-clubs.html. For any other feed-

back or information, please mail in to us at [email protected]

Note: You may have noticed that some of the articles in this magazine have been written by team Blue Chip or team

Monetrix. These articles have been kept in the issue only with the purpose of making the magazine content wholesome

and are not considered for the prize money.

blue chip issue 2 (july-september 2012)

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