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Niveshak<br />

TH THE INVESTOR E INVESTOR VOLUME 7 ISSUE 11 November 2014<br />

<strong>Diesel</strong><br />

UNCHAINED<br />

Inside:<br />

Insights by<br />

Prof. Samir K Barua<br />

Ex-Director, IIM Ahmedabad


F R O M E D I T O R ’ S D E S K<br />

Niveshak<br />

Volume VII<br />

ISSUE XI<br />

November 2014<br />

Faculty Chairman<br />

Prof. P. Saravanan<br />

THE TEAM<br />

Abhishek Bansal<br />

Akanksha Gupta<br />

Apoorva Sharma<br />

Bhawana Saraf<br />

Gaurav Bhardwaj<br />

Jatin Sethi<br />

Kocherlakota Tarun<br />

Maha Singh Gulati<br />

Mohit Gupta<br />

Mohnish Khiani<br />

Palash jain<br />

Prakhar Nagori<br />

Priyadarshi Agarwal<br />

Ramesh Jaiswal<br />

Rahul Bajaj<br />

Sandeep Sharma<br />

S C Chakravarthi V<br />

Vishal Khare<br />

Dear Niveshaks,<br />

The month of November saw the GDP growth dropping to 5.3% in the second quarter<br />

as compared to 5.7% in the previous April-June quarter because of the poor performance<br />

of the manufacturing sector with a growth rate of mere 0.1%. The wholesale<br />

inflation has dropped to a five-year low of 1.77% driven by softening prices of fuel and<br />

food items and the retail inflation based on CPI eased to 5.52% at the end of October.<br />

The SENSEX has risen by about 36% so far this year touching an all-time high and<br />

the net investments by overseas investors has reached USD 16 billion so far this year.<br />

The Modi government continued taking some positive steps towards the growth of<br />

Indian economy. The union cabinet approved the proposal to amend the FDI policy<br />

in construction and real estate sector with the minimum capital requirement brought<br />

down to 5 million US dollars from 10 million US dollars. SEBI also revamped the<br />

‘Prohibition of Insider Trading’ regulations with more stringent measures, aligning<br />

its norms with international practices. The PM visited Australia for the 9th G20 summit<br />

where the G20 leaders committed to put in place a mechanism for automatic<br />

exchange of tax information between member countries by 2017. PM Modi made his<br />

debut among the world’s most powerful people after being ranked 15th on the Forbes<br />

list. Government re-launched Kisan Vikas Patra that would help gullible investors to<br />

channelize their savings towards a trusted government scheme instead of some Ponzi<br />

schemes.<br />

Our Cover story for the month of November 2014 edition is on <strong>Diesel</strong> Deregulation<br />

which would familiarize the readers with the concept, its pros & cons, impact on the<br />

various sectors and further what could be done for the improvement of the various<br />

sectors. The article of the month covers the topic of Universal Banking and its future<br />

roadmap in India. On the other hand, FinGyaan covers ‘GDP’s origins, relevance & alternatives<br />

in today’s world, which would take us through the evolvement of GDP. Fin-<br />

Sight section is an insight into the HP Split into two companies HP Inc. and Hewlett-<br />

Packard as well as discussing competitive scenario and growth opportunities of both.<br />

Also, the Editorial Team of Niveshak, is pleased to introduce to you our new team,<br />

which has been selected to carry on the legacy of Niveshak. They are: Abhishek, Bhawana,<br />

Maha, Palash, Prakhar, Rahul, Ramesh, Sandeep and Vishal. Please join us in<br />

welcoming them to team Niveshak. We are confident that the new team will not only<br />

meet but surpass your expectations in this and the coming editions. Keep supporting<br />

them the way you have been doing to us.<br />

All images, design and artwork<br />

are copyright of<br />

IIM Shillong Finance Club<br />

©Finance Club<br />

Indian Institute of Management<br />

Shillong<br />

www.iims-niveshak.com<br />

We are introducing a new column in our magazine ‘FinLife’ which would be covering<br />

the aspects of Financial Decision Making. This section will replace the widely cherished<br />

column, FinPact. This month’s FinView hosted the interview of Prof. Samir K<br />

Barua, Ex-Director, Indian Institute of Management, Ahmedabad. The Classroom<br />

learning section covers the intricacies of ‘Green Shoe Option’. It provides an in-depth<br />

understanding about the concept and the reasons for the exercise of the same.<br />

We would like to thank our readers for their immense support and encouragement.<br />

You remain our prime motivation factor that keeps our spirits high and give us the<br />

vigour and vitality to keep working hard.<br />

Stay invested!<br />

Team Niveshak<br />

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears<br />

no responsibility whatsoever.


Cover Story<br />

C O N T E N T S<br />

Niveshak Times<br />

04 The Month That Was<br />

Article of the month<br />

10 Universal Banking in India<br />

14 <strong>Diesel</strong> Deregulation and<br />

Pricing Issues.<br />

FinGyaan<br />

18 GDP’s origins, relevance and<br />

alternatives in today’s world<br />

FinLife<br />

22 Fundamental or Technical<br />

Analysis: An Amalgamation of<br />

both the perspectives<br />

Finsight<br />

26 Analysis of HP mitosis<br />

FINVIEW<br />

29 Interview Of Ex-Director,<br />

Indian Institute of Management,<br />

Ahmedabad<br />

31 Green Shoe Option<br />

CLASSROOM


4<br />

The Month That Was<br />

NIVESHAK<br />

HDFC’s FII holdings cross 75%<br />

Emerging as one of the sought after stocks for foreign<br />

funds, mortgage giant HDFC has seen overseas<br />

investors raising their stake in the company to a<br />

record-high of nearly 78% during the quarter ended<br />

September 2014. The mortgage financier has also<br />

become the first listed Indian company among 30<br />

Sensex firms to have over 75% shareholding by<br />

foreign institutional investors (FIIs). Cumulative<br />

FII holdings in the company rose to 77.85% in the<br />

July-September quarter this year, according to data<br />

from stock exchanges. Moreover, shareholding of<br />

overseas players or FIIs in HDFC has been steadily<br />

rising since September last year. The rise of<br />

overseas shareholding in the mortgage lender, one<br />

of the highest among the country’s 30 listed bluechip<br />

companies, coincides with overall bullishness<br />

shown by foreign entities in the Indian stock market.<br />

According to market experts, overseas investors<br />

have shown interest in HDFC because of the smart<br />

returns given by the company. In May 2012, HDFC’s<br />

board had approved raising FII limit in the company<br />

to 100%.<br />

Kotak – ING VYSYA bank merger; Kotak to<br />

enter general insurance business<br />

In an all stock amalgamation, ING Vysya Bank decided<br />

to merge with Kotak Mahindra Bank, creating the<br />

fourth largest private sector bank in the country.<br />

ING Vysya shareholders will receive 725 shares in<br />

Kotak for 1,000 shares of ING Vysya. “This exchange<br />

ratio indicates an implied price of Rs.790 for each<br />

ING Vysya share based on the average closing price<br />

of Kotak shares during one month to November<br />

19, 2014, which is a 16 per cent premium to a like<br />

measure of ING Vysya market price,” it added.<br />

The proposed merger would result in issuance of<br />

approximately 15.2 per cent of the equity share<br />

capital of the merged Kotak. One of ING Vysya’s<br />

directors will be joining the Board of Directors of<br />

Kotak. ING Group, which owns 43 per cent in ING<br />

Vysya, has indicated that it supports the proposed<br />

transaction. ING Group will become the largest nonpromoter<br />

shareholder in combined Kotak.<br />

The amalgamation is subject to the approval of the<br />

shareholders of Kotak and ING Vysya respectively,<br />

www.iims-niveshak.com<br />

The Niveshak Times<br />

Team NIVESHAK<br />

IIM Shillong<br />

Reserve Bank of India under the Banking Regulation<br />

Act, the Competition Commission of India and such<br />

other regulatory approvals as may be required. The<br />

last merger to happen in the private sector banking<br />

space was in 2010 when Bank of Rajasthan was<br />

acquired by ICICI Bank.<br />

Kotak also received approval from RBI to form a 100%<br />

subsidiary to enter general insurance industry, which<br />

is currently growing at Rs 77,000 crore premium per<br />

annum.<br />

Kerala and Goa first states to fully provide<br />

one bank account to every household<br />

Kerala and Goa have become the first states in the<br />

country to provide one basic bank account to every<br />

household, achieving the primary goal of the Pradhan<br />

Mantri Jan Dhan Yojana (PMJDY) in two-and-a-half<br />

months of its launch. The finance ministry on Friday<br />

said Kerala and Goa became 100% saturated states<br />

in terms of coverage of all households on November<br />

11. In addition, the Union Territories of Chandigarh,<br />

Puducherry and Lakshadweep, and three districts of<br />

Gujarat — Porbandar, Mehasana and Gandhi Nagar —<br />

have also covered all households under PMJDY with<br />

at least one bank account, it said.<br />

Of the 80 million accounts opened under the scheme<br />

as on November 25, public sector banks have opened<br />

64 million accounts, while regional rural banks and<br />

private sector banks have opened 13 million and<br />

two million accounts, respectively. Jaitley called for<br />

more active participation by private sector banks.<br />

In terms of deposits, only Rs 6,292 crore has been<br />

collected up to November 25, as 60 million accounts<br />

opened have zero balance. However, the growth has<br />

moderated after September 30.<br />

PMJDY, which was launched by Prime Minister<br />

Narendra Modi on August 15, seeks to cover 75<br />

million un-banked households in the country in the<br />

first phase. It provides INR 5,000 overdraft facility<br />

for Aadhar-linked accounts and RuPay debit card,<br />

besides an INR 1 lakh accident insurance cover.<br />

The scheme also envisages channelling all benefits<br />

from the union, state and local governments to the<br />

beneficiaries’ accounts. Finance Minister Arun Jaitley<br />

revised the target for opening bank accounts under<br />

the Pradhan Mantri Jan Dhan Yojana from 75 million<br />

NOVEMBER 2014


www.iims-niveshak.com 5<br />

NIVESHAK<br />

to 100 million by Jan 26, 2015.<br />

RBI new norms on ATM usage charges<br />

According to RBI’s new guidelines that came into<br />

force from 1st November 2014, bank customers<br />

in six metros – Delhi, Mumbai, Chennai, Kolkata,<br />

Hyderabad and Bangalore – are allowed to withdraw<br />

money and/or carry out non-financial transactions<br />

like mini-statements at ATMs of banks, where they<br />

hold saving/current accounts, free of charge only<br />

five times a month. Every transaction beyond this<br />

threshold will be charged Rs 20 per use. Besides, the<br />

number of free transactions at ATMs of non-home<br />

banks have been cut to three times a month from<br />

five times. The RBI, however, clarified that nothing<br />

precludes a bank from offering more than three<br />

free transactions at other bank ATMs to its account<br />

holders if it so desires. The cap in the number of free<br />

ATM transactions will not apply on small/no-frills or<br />

basic savings bank deposit account holders who will<br />

continue to enjoy five free transactions.<br />

The United Bank of India (UBI) on Wednesday<br />

decided to continue with five free ATM transactions<br />

per month (including non-financial ones) at other<br />

bank ATMs for all savings account holders in both<br />

metros and non-metros. HDFC Bank and Axis Bank<br />

will charge their own customers for more than five<br />

transactions at their Automated Teller Machines<br />

starting 1 December. Union Bank will charge own<br />

customers for more than eight transactions per<br />

month at its ATMs and more than five at other banks<br />

ATMs. Punjab National Bank (PNB) on Wednesday<br />

said it will continue giving free transactions to all<br />

saving bank account cardholders using PNB ATMs,<br />

irrespective of the number of transactions.<br />

RBI tightens norms for NBFCs<br />

The Niveshak Times<br />

In a bid to bring non-banking financial company<br />

(NBFC) norms in line with those of banks, the Reserve<br />

Bank of India (RBI) on Monday unleashed tighter<br />

rules for NBFCs. According to the new guidelines,<br />

NBFCs will require higher minimum capital, have less<br />

time to declare bad loans, and a board-approved fit<br />

and proper criteria for director appointments.<br />

The new norms, which will be implemented in a<br />

phased manner, are made applicable for NBFCs that<br />

manage funds worth Rs 500 crore and for those that<br />

accept public deposits. The central bank will also<br />

start granting fresh NBFC licences. At present the Net<br />

Owned Fund (NOF) requirement is at Rs 25 lakh. In<br />

a phased manner, the NBFCs would be required to<br />

raise it to Rs 1 crore by March 2016, and to further<br />

double it to Rs 2 crore by 2017 with an objective to<br />

mitigate risks in the sector.<br />

To harmonise the deposit acceptance regulations<br />

across all deposit-taking NBFCs (NBFCs-D) and<br />

move to a regime of only credit-rated NBFCs-D<br />

accessing public deposits, existing unrated asset<br />

finance companies (AFCs) have been asked to get<br />

themselves rated by March 31, 2016. “Those AFCs<br />

that do not get an investment grade rating by March<br />

31, 2016, will not be allowed to renew existing or<br />

accept fresh deposits thereafter,” RBI noted.<br />

Ratan Tata invests in another e-commerce<br />

firm, Urban Ladder<br />

Tata Group’s Chairman Emeritus Ratan Tata has<br />

invested in online furniture company Urban Ladder,<br />

making it his second personal investment in an<br />

e-commerce firm after Snapdeal. However the<br />

amount and other details about this investment<br />

was not disclosed. This is Tata’s second investment<br />

in Indian e-commerce business, after a previous<br />

investment he made in online marketplace major<br />

Snapdeal earlier in August this year. The latest<br />

investment comes four months after Urban Ladder<br />

raised ‘Series B funding’ from Steadview Capital and<br />

existing investors SAIF Partners and Kalaari Capital.<br />

“Tata understands the furniture space very well,<br />

specially our focus on product design since he has<br />

a lot of knowledge of the subject. His inputs and<br />

guidance will be very valuable for us,” Urban Ladder<br />

CEO and Co-founder Ashish Goel said. Launched in<br />

July 2012, Urban Ladder was co-founded by Ashish<br />

Goel and Rajiv Srivatsa. It offers over 1,000 products<br />

across 25 categories in furniture such as wardrobes,<br />

beds, sofas, dining tables and coffee tables.<br />

The Month That Was<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


6<br />

NIVESHAK<br />

www.iims-niveshak.com<br />

Article Market Cover of Snapshot the Story Month<br />

Market Snapshot<br />

Source: www.bseindia.com<br />

www.nseindia.com<br />

MARKET CAP (IN RS. CR)<br />

BSE Mkt. Cap 9865772.54<br />

Source: www.bseindia.com<br />

LENDING / DEPOSIT RATES<br />

Base rate 10.00%-10.25%<br />

Deposit rate 8.00% - 9.05%<br />

CURRENCY RATES<br />

INR / 1 USD 61.8658<br />

INR / 1 Euro 77.2147<br />

INR / 100 Jap. YEN 52.56<br />

INR / 1 Pound Sterling 97.2283<br />

INR/ 1 SGD 47.5785<br />

CURRENCY MOVEMENTS<br />

RESERVE RATIOS<br />

CRR 4.00%<br />

SLR 22.00%<br />

POLICY RATES<br />

Bank Rate 9.00%<br />

Repo rate 8.00%<br />

Reverse Repo rate 7.00%<br />

Source: www.bseindia.com<br />

23-Oct-2014 to 26-Nov-2014<br />

Data as on 26-Nov-2014<br />

NOVEMBER 2014


www.iims-niveshak.com<br />

NIVESHAK 7<br />

Market Snapshot<br />

BSE<br />

Index Open Close % change<br />

Sensex 26752.9 28386.19 6.11%<br />

MIDCAP 9592.09 10119.95 5.50%<br />

Smallcap 10642.69 11180.24 5.05%<br />

AUTO 17883.04 18787.14 4.81%<br />

BANKEX 18948.89 20586.35 8.64%<br />

CD 9863.16 9630.87 -2.36%<br />

CG 15245.91 16236.26 6.50%<br />

FMCG 7341.74 7696.85 4.84%<br />

Healthcare 13929.77 14809.67 6.32%<br />

IT 10101.5 11094.24 9.83%<br />

METAL 11281.25 11274.31 -0.06%<br />

OIL&GAS 10641.84 10874.72 2.19%<br />

POWER 2092.69 2135.26 2.03%<br />

PSU 8079.62 8228.54 1.84%<br />

REALTY 1432.29 1660.73 15.95%<br />

TECK 5671.73 6125.31 8.00%<br />

Article Market Cover of Snapshot the Story Month<br />

% CHANGE<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


Niveshak Investment Fund<br />

Infosys<br />

Wg: 5.17%<br />

Gain : 34.30%<br />

Britannia<br />

Wg:5.26%<br />

Gain :<br />

63.67%<br />

M&M<br />

Wg:6.64%<br />

Gain : 5.60%<br />

Information Technology<br />

(17.10%)<br />

HCL Tech.<br />

Wg: 5.91%<br />

Gain : 11.08%<br />

Colgate<br />

Wg:7.13%<br />

Gain :<br />

23.79%<br />

FMCG<br />

(26.51%)<br />

Auto<br />

(16.52%)<br />

Tata Motors<br />

Wg:4.77%<br />

Gain : 23.47%<br />

Pharmaceuticals<br />

(17.47%)<br />

TCS<br />

Wg: 6.02%<br />

Gain : 7.25%<br />

HUL<br />

Wg:7.17%<br />

Gain :<br />

11.62%<br />

ITC<br />

Wg:6.95%<br />

Gain :<br />

5.67%<br />

Amara Raja<br />

Batt<br />

Wg:5.11%<br />

Gain : 4.04%<br />

Done on 30/6/14<br />

Utilities<br />

(4.55%)<br />

NTPC<br />

Wg:4.55%<br />

Gain:0.14%<br />

Telecom<br />

(5.23%)<br />

Bharti<br />

Airtel.<br />

Wg: 5.23%<br />

Gain : 4.71%<br />

Auto<br />

(5.07%)<br />

Titan Company<br />

Wg:5.07%<br />

Gain:-2.01%<br />

Chemicals<br />

(7.47%)<br />

Dr Reddy’s<br />

Labs<br />

Wg:3.29%<br />

Gain:37.90%<br />

Lupin<br />

Wg:6.07%<br />

Gain : 41.18%<br />

Ipca Labs<br />

Wg: 8.11%<br />

Gain :-7.71%<br />

Asian Paints<br />

Wg:7.47%<br />

Gain:22.04%


Performance Evaluation<br />

As on 28 th November,2014<br />

104<br />

103.5<br />

103<br />

102.5<br />

102<br />

101.5<br />

101<br />

100.5<br />

100<br />

99.5<br />

99<br />

Oct-14<br />

November Performance of<br />

Niveshak<br />

Investment Fund<br />

Nov-14<br />

Nov-14<br />

Nov-14<br />

Sensex<br />

Opening Portfolio Value : 10,00,000<br />

Current Portfolio Value : 14,03,430.0<br />

% Change in Portfolio Value : 40.34%<br />

Change in Sensex : 39.98%<br />

Nov-14<br />

NIF<br />

Nov-14<br />

Nov-14<br />

Dec-14<br />

Performance of Niveshak<br />

Investment Fund since Inception<br />

145<br />

140<br />

135<br />

130<br />

125<br />

120<br />

115<br />

110<br />

105<br />

100<br />

95<br />

30-Jan<br />

19-Feb<br />

11-Mar<br />

31-Mar<br />

20-Apr<br />

10-May<br />

30-May<br />

Risk Measures:<br />

Standard Deviation : 12.79%(Sensex :<br />

13.05%)<br />

Sharpe Ratio : 2.84 (Sensex : 2.76)<br />

Cash Remaining:2,66,673<br />

19-Jun<br />

09-Jul<br />

29-Jul<br />

18-Aug<br />

07-Sep<br />

27-Sep<br />

17-Oct<br />

06-Nov<br />

26-Nov<br />

Scaled NIF Scaled Sensex Values Scaled to<br />

Comments on NIF’s Performance & Way Ahead : Currently the return of NIF (40.34%) stands inline<br />

with the returns of Sensex at 39.98% owing to our investment strategy of sticking to value<br />

fundamentals in the time of volatility. This month the NIF portfolio witnessed a reshuffle in terms<br />

of value and composition. Cash from Liquid funds were invested in Long Term debt funds where<br />

we expect better capital gains whenever RBI cuts rates and Bond Yields fall. In terms of<br />

composition we have sold expensive stocks where we feel the valuation had fallen out of your<br />

comfort areas and these valuations didn’t justify their growth rates. We moved some money to<br />

stocks with good future potential and relatively comfortable valuations. We have chosen Titan due<br />

to our expectation of a rise in discretionary spend on jeweller items , Amara Raja , is expected to<br />

see good volume growth due to the duopoly market it operates in and a rise in volumes of cars<br />

sold in the country. The 3rd company is M&M, where we expect a revival in their tractor business.<br />

The current P/E of Sensex stands at 19.56. This is considered as overvalued. However, since we<br />

have invested in companies which are fundamentally strong, this will not impact us and so we<br />

have not changed our investment strategy.<br />

The connecting string in all our portfolio has been to lookout for maximizing returns by taking asleast-as-possible<br />

risk.


10 NIVESHAK<br />

Article Cover of the Story Month<br />

Universal Banking in India<br />

Introduction<br />

The financial crisis of 2008 could well be<br />

epochal in the financial history of the world.<br />

Like every crisis that has gripped the world,<br />

it too threatened to derail the good work of<br />

decades, but unlike your run of the mill crisis, it<br />

exposed deep seated fault lines in the so called<br />

sophisticated financial systems of the world.<br />

The investment banking (IB) sector bore the<br />

brunt of the crisis, it was after all one of the<br />

biggest culprits. In the aftermath of the crisis,<br />

the IB sector was in tatters. Some of the<br />

biggest conglomerate banks in America had<br />

failed spectacularly (ironically, they had been<br />

bestowed the Too Big to Fail status). Standalone<br />

IBs hadn’t fared any better.<br />

Universal Banking<br />

There are two pure forms of banking-commercial<br />

and investment. A combination of these two,<br />

in different proportions gives rise to Universal<br />

Banking (UB). For the better part of the twentieth<br />

century, universal banking was disallowed in<br />

the USA due to the perceived conflict of interest<br />

between commercial and investment banking<br />

Sainath Zunjurwada<br />

SIMSREE<br />

arms of the group. However, the world embraced<br />

UB underscoring the economies of scale and<br />

scope so derived. In the US itself, the ban was<br />

lifted in 1999. The USA accepted UB under the<br />

Financial Holding Company (FHC) structure. The<br />

Bank as the Holding Company (BHC) or parent<br />

bank with non-banking subsidiaries model was<br />

employed in countries like India.<br />

UBs were dominant even in the pre-2008 era,<br />

due to monopolistic competition. The standalone<br />

banks were obliterated in the 2008 crisis and<br />

only the universal banks now survive.<br />

Addressing the risks<br />

A flood of regulations came in, such as the<br />

Volcker Rule in the US, Vickers Commission in<br />

the UK and Liikanen report in Europe, aimed<br />

at insulating the important, necessary banking<br />

activities from the riskier, less important.<br />

The Volcker rule was strict and narrow in focus.<br />

It sought to ban proprietary trading by banks,<br />

while distinguishing it from market making<br />

activities on behalf of customers which were<br />

allowed. It proscribes the coexistence of such<br />

trading activities and banking in different<br />

NOVEMBER 2014


NIVESHAK 11<br />

subsidiaries in the same group. However, it<br />

doesn’t constrain intra group funding.<br />

The Liikanen Report was broader in scope,<br />

but less strict. The proprietary trading and<br />

the market making activities (no distinction<br />

made between the two) were required to be in<br />

different subsidiaries if within the same group.<br />

Additional conditions were imposed such as<br />

self-sufficiency in capital and liquidity for the<br />

subsidiaries and intra group lending on market<br />

prices.<br />

The Vickers Commission proposed that the banks<br />

should ‘ring fence’ their retail banking services<br />

from the investment<br />

banking divisions.<br />

This was aimed at<br />

narrowing the activities<br />

encompassed within<br />

the protected entity.<br />

This protected entity<br />

was very narrowly<br />

defined as the retail,<br />

corporate banking and<br />

the strategies to hedge<br />

risks arising from<br />

such activities. This<br />

was to the exclusion<br />

of all underwriting,<br />

secondary market<br />

transactions. Like the Liikanen report, but<br />

unlike the Volcker rule, it allowed room for the<br />

coexistence of protected activities and others in<br />

the same group, albeit in separate subsidiaries.<br />

These recommendations are however stricter<br />

than the Liikanen ones in the sense that the<br />

intragroup lending norms are stringent and the<br />

very interaction of such protected entities with<br />

the wider financial sector is curtailed.<br />

India Story<br />

With this overview of the world regulations, let<br />

us devote some time to the IB sector in India,<br />

and what the events across the world entail for<br />

the domestic industry.<br />

The IB industry is at a nascent stage in India. It<br />

is mostly limited to a few big banks which are<br />

themselves curtailed in their ability to expand<br />

IB activities.<br />

The banking sector in the country is of the UB<br />

type, with no significant presence of standalone<br />

IBs. The UB structure is of the BHC hue, where<br />

big banks lead the conglomerate. The banks<br />

themselves are the holding companies, with<br />

subsidiaries involved in the financial services,<br />

IB activities. The risk emanates from the<br />

balance sheets of these affiliates, as the losses<br />

of such would<br />

be go upstream<br />

to reflect in the<br />

c o n s o l i d a t e d<br />

books of the<br />

banks, posing a<br />

danger to them.<br />

The 2008 crisis was<br />

a wakeup call for<br />

the regulators in<br />

the West. RBI had<br />

foreseen these<br />

risks, and taken<br />

steps to prevent<br />

wide scale failure<br />

of banks. The<br />

first of such measures was the limits on equity<br />

investment by a bank in a subsidiary company;<br />

or a financial services company which is not a<br />

subsidiary. This limit for the subsidiaries was set<br />

at 10% of the bank’s paid up share capital and<br />

reserves, while that on the total investments<br />

made in all subsidiaries and non-subsidiaries<br />

(engaged in financial services) is 20%. However,<br />

this effectively inhibited the expansion of this<br />

industry. So, while the West came up with giant<br />

banking structures, Indian banks were nowhere<br />

in the picture. Standalone banks, which would<br />

come under the purview of the SEBI, were<br />

also largely absent from the Indian theatre.<br />

Article Cover of the Story Month<br />

The investment banking (IB) sector bore the brunt<br />

of the crisis, it was after all one of the biggest<br />

culprits. In the aftermath of the crisis, the IB sector<br />

was in tatters. Some of the biggest conglomerate<br />

banks in America had failed spectacularly.<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


12<br />

NIVESHAK<br />

Article Cover of the Story Month<br />

Interestingly, SEBI has no regulations in place<br />

for IBs. There was no demand for such services<br />

in an essentially underdeveloped economy, and<br />

hence the regulator (which was itself a novice in<br />

this field) felt no need to put up the necessary<br />

regulations.<br />

The need for IB was not really felt because<br />

of the largely embryonic capital markets in<br />

the country. The developing country is now<br />

on the fast track of development and is now<br />

seeing fast development of these sectors. The<br />

manacled and demonized capital markets are<br />

now taking roots.<br />

With this background, the need has never<br />

been more urgent to bring in reforms in the<br />

regulatory framework of the RBI or maybe<br />

even a complete overhaul of the system. SEBI<br />

rules have to be drafted from the scratch for<br />

standalone investment banks.<br />

Future Roadmap<br />

The first question that the RBI needs to answer<br />

is whether to continue with the BHC structure<br />

or to embrace the FHC one. The advantages<br />

of the latter are numerous. The first of which<br />

would be the unshackling of the IB industry,<br />

as the capital constraints would no more be<br />

relevant. In the FHC model, a holding company<br />

has subsidiaries that undertake banking,<br />

non-banking operations. Hence, commercial<br />

banking divisions would be protected from the<br />

risks emanating from the riskier activities. The<br />

risks arising from the losses of subsidiary IBs<br />

would be borne by the FHC. The responsibility of<br />

infusing capital into the subsidiaries would also<br />

lie with the FHC and not the bank. Lastly, the<br />

FHC structure would be beneficial in the event<br />

of winding up, as the resolution of different<br />

entities would be easier. As a clear demarcation<br />

would exist between the different components<br />

of the group. In the past, liquidation of the<br />

parent bank usually meant the liquidation of the<br />

subsidiary also. With a stronger FHC structure,<br />

this wouldn’t be the case anymore. Regulatory<br />

oversight could also be more efficient.<br />

Various studies commissioned by the RBI<br />

indicate a strong shift of the revenue pool from<br />

the traditional banking to investment banking.<br />

The acceptance of the FHC model could see<br />

the IB industry rise manifold, as the equity<br />

investment limits in the IB subsidiaries should<br />

not be as restrictive as the existing regulations.<br />

The first question that the RBI needs to answer is whether<br />

to continue with the BHC structure or to embrace the FHC<br />

one. The advantages of the latter are numerous. The first<br />

of which would be the unshackling of the IB industry,<br />

as the capital constraints would no more be relevant.<br />

Regulatory oversight could also be more efficient.<br />

NOVEMBER 2014


NIVESHAK 13<br />

Article Cover of the Story Month<br />

Studies suggest that the IBs would grow 10<br />

times by 2020.<br />

The lessons from the crises of 2008 will have<br />

to be inculcated. A comprehensive study of<br />

various enactments in Europe, America must<br />

be undertaken. Recommendations of the<br />

Volcker, Liikanen, Vickers committees, aimed<br />

at reducing risks, while not inhibiting growth<br />

should be implemented, suitably tweaked for<br />

Indian environs.<br />

A regime of differentiated banking licenses could<br />

be initiated. A license would be issued to an<br />

entity to undertake a specific, limited activity.<br />

Niche banking players could capitalize on their<br />

specialized knowledge. Clear prescriptions<br />

must be provided for in the event of banking<br />

failures such as closure, restructuring, M&A,<br />

bridge bank.<br />

The objective of this exercise would be to<br />

transfer activities deemed as too risky to<br />

different entities (banning them outright could<br />

be counterproductive). With public guarantees<br />

limited only to the commercial arm to prevent<br />

contagion. A global debate is going on on this<br />

issue. A robust system based on strong checks<br />

and balances should emerge in India, enabling<br />

the expansion of IBs in the country.<br />

Conclusion<br />

Investment banks are a novelty in India. Their<br />

growth has been stunted due to regulatory<br />

restrictions. Changing environs mean investment<br />

banking is going to grow tremendously in the<br />

coming years. Regulatory restrictions could be<br />

lifted. The deepening of capital, wholesale debt<br />

markets could see the explosion of investment<br />

banking activities, as more and more corporates<br />

demand these services. India has the BHC<br />

framework in place, replacing it with the FHC<br />

model could be on the anvil. The future holds<br />

tremendous promise. However recent events<br />

suggest that it won’t be as easy as a walk in<br />

the park. The financial crisis and the ensuing<br />

regulations must be studied and inculcated in<br />

the pursuance of liberalization policies in India.<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


14 NIVESHAK<br />

Cover Story<br />

<strong>Diesel</strong> Deregulation &<br />

Pricing Issues<br />

Prakhar Nagori & Palash Jain<br />

IIM Shillong<br />

Introduction<br />

Over the past decade there has been a tremendous<br />

pressure on India’s fiscal budget because of<br />

the huge subsidy bill. These subsidies majorly<br />

comprised of food and fuel subsidies. India is<br />

the fourth largest consumer of fuel and because<br />

it’s a developing country the demand keeps<br />

rising pushing the fuel subsidy bill higher and<br />

higher. The fuel subsidy has risen exponentially<br />

from 0.6% of GDP in 2004 to almost 2% in 2010.<br />

The subsidy on fuel was estimated at around<br />

INR 1.82 lakh crore for the last two financial<br />

years, that is, 2012-13 and 2013-14. According to<br />

some economists, the diesel subsidy has cost<br />

India around INR 3 lakh crore in the last five<br />

years. With the rupee depreciating drastically<br />

and increase in international crude oil prices,<br />

this bill was increasing in leaps and bounds<br />

and deregulation of fuel prices had become a<br />

necessity.<br />

However, this decision to deregulate the prices<br />

of fuel is not a recent one. The petrol and<br />

diesel prices were deregulated in 2002 by the<br />

Atal Bihari Vajpayee government. But when the<br />

government changed in 2004, this decision was<br />

overturned by the then petroleum minister, Mr.<br />

Mani Shankar Aiyar. As a consequence the fiscal<br />

deficit started shooting up.<br />

In 2010, the government of India then decided<br />

to deregulate the petrol prices to reduce the<br />

pressure it created on fiscal deficit, as a result<br />

of which the fuel subsidy bill started declining.<br />

In continuation to this policy, the government<br />

decided to deregulate the diesel prices which<br />

would reduce the fuel subsidy bill to 0.4% of<br />

GDP in 2014-15 as compared to 0.8% in 2013-14.<br />

NOVEMBER 2014


NIVESHAK<br />

15<br />

What is deregulation?<br />

Freeing the prices i.e. removing the price control<br />

of government over a commodity is called its<br />

deregulation. Prices of fuels like diesel, kerosene<br />

and cooking gas were regulated till now, but<br />

diesel now is the latest entry in deregulated club<br />

who’s another member petrol was deregulated<br />

in June 2010. The diesel deregulation was firstly<br />

done in a partly manner initiated by the UPA<br />

government by increasing the diesel prices<br />

every month by 50 paisa. But now recently on<br />

the onsite of low crude oil prices, Government<br />

of India has taken a decision of full diesel<br />

deregulation. Thus, now the petrol as well as the<br />

diesel prices are totally dependent on supplydemand<br />

and international crude oil prices.<br />

What led the diesel deregulation happen?<br />

<strong>Diesel</strong> deregulation, as discussed above, is<br />

not a recent talk but also being implemented<br />

in a partial way by previous government and<br />

was amongst important agendas of the Modi<br />

government. The combination of state election<br />

being over as well as very low international crude<br />

oil prices could be said as major triggering point<br />

for this deregulation where it had a negative<br />

impact on prices, thus decreasing them by<br />

Rs. 3.37 (Ex-Delhi) and saving the government<br />

from major heat like the one when petrol was<br />

deregulated.<br />

Pros and cons of diesel deregulation<br />

<strong>Diesel</strong> deregulation is a positive step towards<br />

economic growth and expansion. The most<br />

important benefit that can be derived from<br />

it is the reduction in fuel subsidy. This will<br />

reduce our fiscal deficit and make our target<br />

of 3% fiscal deficit in the next three years at<br />

a striking distance. Since India is a developing<br />

economy this amount can be utilised in a more<br />

productive way elsewhere, especially in the<br />

area of infrastructure development which has<br />

become the need of the hour. Also, since the<br />

subsidies are withdrawn and the prices are<br />

linked to the market, eventually it may lead to<br />

increase in diesel prices in future which will not<br />

only encourage reduction in consumption but<br />

also boost our pathway towards sustainable<br />

sources of fuel thereby reducing our reliance<br />

on crude oil. When the price of crude reduces,<br />

it will reduce our import bill which will help<br />

our balance of payments and appreciation of<br />

our currency. It will also increase our foreign<br />

exchange reserves as the payment for crude oil<br />

is made in foreign currencies.<br />

We saw that the diesel prices had reduced when<br />

the prices were deregulated due to decline in<br />

price of crude oil in international markets.<br />

This gave us a boost in our fight against high<br />

inflation. Even though the impact was negligible<br />

on the consumer price index (CPI), it had a<br />

large impact on wholesale price index (WPI).<br />

This would give the RBI more flexibility in its<br />

monetary policy decision. It may also lead to<br />

rate cut in future which will increase investment<br />

and production.<br />

Another benefit of diesel deregulation was<br />

better management and reduction in corruption<br />

due to increase in transparency of pricing policy.<br />

Earlier, the government had a dual method of<br />

price determination. The diesel sold in retail<br />

form was subsidized whereas the diesel sold<br />

in bulk was deregulated. This created arbitrage<br />

opportunities for profit seekers leading to<br />

opacity and corruption in this area. Many small<br />

industries who used to buy diesel in bulk started<br />

buying it from retail outlets to save costs.<br />

However there is a flip side to this step. Since<br />

the prices will be directly linked to the market,<br />

this will lead to more vulnerability. The prices<br />

will fluctuate more causing more volatility.<br />

Earlier the prices were fixed by the government<br />

which gave the consumers price protection to<br />

some extent. With this decision there will be<br />

dissent amongst the population. Also, even<br />

though the price deregulation brought relief<br />

to the consumers in the form of reduction in<br />

prices, in the long run it will increase inflation<br />

to a great extent causing severe problems in the<br />

economy as the demand for diesel is relatively<br />

inelastic. This will have a far reaching impact in<br />

a country like India where still a lot of people lie<br />

below the poverty line. The fluctuation of diesel<br />

prices may also have a huge negative impact on<br />

industries which are directly dependant on it,<br />

like the automobile or the transport sector.<br />

Impact of <strong>Diesel</strong> Deregulation on<br />

OMCs<br />

<strong>Diesel</strong> deregulation comes as a great relief to<br />

OMCs as the prices being market linked, they<br />

won’t be bearing the burden of subsidy which<br />

previously due to delayed subsidy payments by<br />

government was quiet a cost to them. This will<br />

lead to lesser interest charges and better profit<br />

margins.<br />

The deregulation is not only beneficial with<br />

respect to reduction in gross under-recoveries<br />

but will also be a boon to private players who<br />

are back in the game as they were not able to<br />

sell in retail market, as they did not receive<br />

government’s support for selling diesel at<br />

Cover Story<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


16 NIVESHAK<br />

Cover Story<br />

discounted rates; thus increasing the competition<br />

amongst OMCs. A competitive market scenario<br />

will surely lead to process enhancement as well<br />

as product development which would be good<br />

for everyone, a revolution similar to the telecom<br />

revolution.<br />

Auto-Industry’s Take<br />

The auto-industry supported the diesel<br />

deregulation, quoting that things could now be<br />

planned in a better way by the industry with<br />

respect to capacity building as well as by the<br />

consumer with respect to his purchase decision.<br />

Banking Industry’s Take<br />

The banking industry is positive on the diesel<br />

deregulation front as it would benefit economy<br />

leading to a decline in inflation and thus interest<br />

rates which will lead to a low capital cost and an<br />

increased demand for loans.<br />

State’s Says<br />

Apparently the states are not much happy with<br />

this deregulation decision as decrease in the<br />

price of diesel would cost them tax revenue<br />

losses, thus impacting their budgeting and<br />

proposed expenditures.<br />

Way Forward: Pricing still remains an<br />

issue<br />

There is an exigent need for some transparency<br />

in the pricing of diesel and other petroleum<br />

products vis a vis the method followed by the<br />

oil companies. The concept of ‘under-recovery’<br />

has to be given a relook and a better and more<br />

logical price mechanism has to be implemented<br />

so that the benefits of diesel deregulations is<br />

harvested even in the case of volatile and high<br />

crude prices. The concept of under recovery<br />

is very vague and unique in India, it is the<br />

difference between the desired selling price of<br />

the oil companies and the prevailing retail price<br />

in the domestic market.<br />

This ‘desired’ price is calculated on tradeparity<br />

basis that takes into account the landed<br />

cost of imported fuel and the price at which<br />

it is exported by domestic refineries. Presently,<br />

the ratio is 80:20 in favour of landed cost. For<br />

example, if the price on the trade parity basis is<br />

Rs.100 per litre and the domestic selling price is<br />

Rs.80 per litre then the under recovery reflected<br />

in the accounts of these companies is Rs. 20.<br />

But, in India, companies are not directly<br />

importing the refined petroleum products instead<br />

majority of them have developed their own<br />

refineries and they are able to refine products<br />

such as petrol, cooking gas and kerosene from<br />

the imported crude. Given this situation, the<br />

landed cost of imports which includes items<br />

like freight, insurance, custom duties should<br />

not be considered for setting the domestic retail<br />

price. These factors magnify the extent of under<br />

recoveries that the oil companies report.<br />

Therefore, the landed cost of imports inclusive<br />

of above mentioned items and the liveable<br />

should not be considered for fixing the ‘desired<br />

selling price’. The only exception could be a<br />

point where the global crude prices surge to<br />

the abnormal levels and the prices are linked<br />

according to the crude prices. Instead of that,<br />

the below mentioned proposed cost plus<br />

method should be mandated by the government<br />

in order to protect the consumer interest and<br />

promote efficient competition in the sector.<br />

The oil companies harp on “under recoveries”<br />

and always nag about linking the domestic price<br />

with it. The reason being the landed cost which<br />

includes all the duties and liveable actually<br />

serves as a shield to protect their actual losses<br />

from the inefficiencies in their refineries and<br />

NOVEMBER 2014


NIVESHAK<br />

17<br />

Cover Story<br />

other operations. This protection is unnecessary<br />

and unfair to the domestic consumers. It is<br />

very apparent that the public oil companies are<br />

saddled with deployment of larger number of<br />

staffs and with inefficiency in operations resulting<br />

from duplication of works etc. By allowing to<br />

charge liveable through the selling prices and<br />

then consequently recovering it from the under<br />

recoveries reported, these companies pass on<br />

their inefficiency to consumers. Also, the global<br />

prices of crude and the retail prices of petrol<br />

and diesel do not move in tandem. The forces<br />

that drive the markets of these two products<br />

and that adds the costs of these two products<br />

are completely different, like any disruption in<br />

process of petrol refinery can change the price<br />

of petrol or if there is a maintenance shutdown<br />

of any refinery then costing factors change<br />

drastically for each product separately, and it is<br />

nowhere related to the fluctuation in the crude<br />

prices. Therefore by taking into account only the<br />

landed cost of refined fuels rather than crude<br />

oil, the oil companies may be forcing consumers<br />

to pay a higher price when there is really no<br />

supply problem within the country.<br />

The most ideal way to go for any company is<br />

to consider its own cost structure based on the<br />

efficiency of their refinery. The final market price<br />

then could be cost of the crude plus the refining<br />

and the margin of their profit.<br />

The deregulation of diesel would promote<br />

competition by allowing the private players like<br />

Reliance Industries, Essar and Shell to enter into<br />

the retail arena and thus a more systematized<br />

way of marking the price could be followed. As<br />

of now, the PSUs generally tie themselves akin<br />

to a cartel when it comes to the pricing of their<br />

retail petroleum products. Therefore the next<br />

item of improvement in the sector is to push<br />

the oil companies to the arena of cost based<br />

pricing that truly reflects their cost structure.<br />

It could also cause a differentiation in the final<br />

retail price and therefore the consumer would<br />

have wider choices. The real fight would then<br />

reduce to improving the efficiency in buying<br />

crude and refineries.<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


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NIVESHAK<br />

GDP’s origins, relevance<br />

FinGyaan<br />

FinGyaan<br />

& alternatives in<br />

today’s world<br />

Has GDP as a criterion to measure economy’s<br />

progress reached the end of its utility? Today<br />

GDP has become the most important measure<br />

of progress in macroeconomics and almost<br />

every country’s economic policies are designed<br />

keeping in mind the GDP targets. Even the debt,<br />

expenditure, tax collection etc. are measured as a<br />

percentage of GDP. The criticism of GDP started in<br />

1970s due to stagflation in advanced economies<br />

and modern problems like increased commuting<br />

time or lower happiness levels which are not<br />

factored in measuring growth. It is criticized for<br />

multiple reasons: one that it doesn’t measure<br />

the value created by economic activity but<br />

measures only the economic output and second<br />

that it doesn’t take into account non-monetary<br />

costs like pollution, economic inequality or<br />

work life balance. There are also critics of GDP<br />

like economists Michael Green who have also<br />

Ashay S Dalvi<br />

K.J Somaiya Institute of Management Studies<br />

proposed alternative methods to measure<br />

progress. His organisation created the Social<br />

Progress Index for non-economic indicators like<br />

medical care and higher education. The present<br />

day universal standard definition of GDP has<br />

certain assumptions about what to be counted<br />

and what not as an economic activity which<br />

has market price. Although in mass production<br />

economy the amount of goods produced such<br />

as steel, cars, machinery etc. can be measured<br />

but in today’s advanced economy there are<br />

very complicated adjustments made to take<br />

into account quality up-gradation of products<br />

like technology to measure GDP and as a Dallas<br />

Federal Reserve bank report in 1998 put it that<br />

GDP was a measure suitable for measuring<br />

mass production and falls short of measuring<br />

intangible products such as income through<br />

goodwill or patent benefits or innovation for<br />

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NIVESHAK<br />

19<br />

Cover FinGyaan Story<br />

that matter.<br />

Tracing origins of GDP:<br />

Basically the concept of measuring economy<br />

started in the 17th century by William Petty in<br />

England and Wales to ascertain a nation’s capacity<br />

to pay taxes & till 18th and 19th century, tax<br />

revenue and trade remained the sole objective.<br />

However, prior to this, the Arthashastra, written<br />

by Chanakya (350 – 283 B.C) for the Mauryan<br />

empire, had the genesis for the economic policy<br />

of the Mauryan empire. Since the 17th century,<br />

right from the industrialisation to the race for the<br />

domination of Europe during industrialisation<br />

which led to wars among the colonial powers,<br />

the countries needed to know the ability of<br />

people to pay taxes to finance wars.<br />

The need to measure the nation’s economy had<br />

risen during the economic depression after the<br />

First World War when Simon Kuznets, heading the<br />

National Economic Advisory Council, submitted<br />

a report in 1934 to US Congress which contained<br />

estimates of national economy that made a<br />

huge difference to policymaking. It measured<br />

the output of all different industries and amount<br />

consumed by individuals. Kuznets is hence<br />

credited for providing the rough frame work of<br />

what we today measure as national income or<br />

GDP. The Second World War made the latter more<br />

important. So the conventional GDP measure as<br />

we know today was developed by economists<br />

working under John Maynard Keynes in 1941<br />

after the great depression which emphasised on<br />

economic output.<br />

Measuring National Income:<br />

GDP theoretically can be viewed in three<br />

different ways. First is the production approach<br />

which adds the “value-added” at each stage<br />

of production, where value-added is the total<br />

sales subtracted by value of intermediate inputs<br />

into the production process. Second one is the<br />

expenditure approach adds up the value of<br />

purchases made by final users. The third one<br />

is the income approach sums the incomes<br />

generated by production. The international<br />

standard for calculating GDP is contained in the<br />

System of National Accounts 1993, compiled by<br />

the International Monetary Fund, the European<br />

Commission, the Organization for Economic<br />

Cooperation and Development, the United<br />

Nations, and the World Bank. Real GDP is<br />

calculated from nominal GDP by adjusting the<br />

inflation in commodities using price deflator.<br />

Alternatives to GDP:<br />

The alternatives to measure growth in addition<br />

to GDP were UK’s Office for National Statistics<br />

(ONS) & Australian Bureau of Statistics. UK’s<br />

Office for National Statistics (ONS) measures<br />

economic well-being by an annual survey.<br />

However ONS’s data hasn’t changed much since<br />

2012. Certain important things like friendship,<br />

sex, relationships enhance wellbeing but policy<br />

making is difficult for these things. Australian<br />

Bureau of Statistics includes indicators like<br />

income and jobs, quality of the natural and<br />

urban environment, work-life balance, health<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


20<br />

NIVESHAK<br />

Article Cover FinGyaan of the Story Month<br />

&access to education. The only problem here<br />

is most of these figures are based on survey<br />

methodologies and not on quantifiable data<br />

which makes it unsuitable for designing<br />

macroeconomic policies around it.<br />

While Australian model incorporates indicators<br />

like health, education, environment, crime<br />

and social attachment, it is actually used in a<br />

developed nation where growth is not a priority<br />

as per capita income is high and demand is<br />

slowing down. There is also OECD’s System of<br />

Economic Environmental Accounts (SEEA) but<br />

this is also used in addition to GDP and not as<br />

an alternative. The most important alternative<br />

that has emerged in recent years is the genuine<br />

progress indicator. Comparatively GDP and GPI<br />

are like gross profit and net profit. GPI was<br />

developed by Centre for Sustainable Economy<br />

and the Institute for Policy Studies in America.<br />

Such kind of method would tell if we are enjoying<br />

the benefits of economic growth (higher GDP) at<br />

the cost of eating up tomorrow’s resources and<br />

that GDP is not sufficient for this and hence it<br />

needs to be modified or replaced.<br />

Criticism for GDP:<br />

Diane Coyle in her book ‘GDP: A Brief but<br />

Affectionate History’ in which she has studied<br />

GDP from 1940 and analysed in depth its<br />

strengths and weaknesses and how it influences<br />

politics. She concludes from her book that GDP<br />

is a good measure for 20th century and not<br />

for 21st century. The author’s main contention<br />

is that it doesn’t judge anything apart from<br />

economic output. Michael Green another critic,<br />

who has launched his own Social Progressive<br />

Figure 1: World GDP Change (YoY %)<br />

Index at the Skoll World Forum 2013. The Social<br />

Progressive Index is in different context than<br />

what the author sees as a replacement for<br />

GDP to measure growth. So the criticism cited<br />

by Michael Green seems misconstrued and<br />

misinterpreted. Some of the other critics include<br />

Jaret Woodard, a partner at BCG, argued that a<br />

sustainable economy and not a growth oriented<br />

NOVEMBER 2014


NIVESHAK 21<br />

one which is more significant. Robert Kennedy<br />

also is critical to the negative effects of GDP<br />

like producing arms and ammunition leading to<br />

increase in the GDP. Also in 2009, former French<br />

president Nicholas Sarkozy, while addressing<br />

French national statistics agency requested that<br />

the agency give greater consideration to factors<br />

such as quality of life and the environment.<br />

The recent criticism of GDP is mostly<br />

due to the fact that the effects of the industrial<br />

revolution are fading after 200 years in<br />

advanced economies. The Asian tiger economies<br />

post decolonization is also experiencing this<br />

phenomenon. However the emerging nations<br />

especially BRICS have yet to realize the fruits<br />

of a developed economy and hence place more<br />

importance on economic output rather than<br />

on wellbeing. Whether GDP is an appropriate<br />

measure can only the decided on per capita<br />

income levels and purchasing power parity (PPP)<br />

of the economy. However if different nations<br />

try and use different statistics for measuring<br />

growth, it might be difficult to comparatively<br />

analyse the global scenario which would create<br />

confusion.<br />

The solution to this is the inclusion of aspects<br />

from Kuznets theory to present day GDP so as to<br />

measure the wellbeing of people such as gains<br />

to well-being stemming from innovation, new<br />

medicines, and better smartphones which helps<br />

increase standard of living of people.<br />

Modifications and improvements in GDP<br />

measurement:<br />

The debate whether income inequality and<br />

government spending on arms and ammunition<br />

should be incorporated in GDP has been there<br />

for a long time even after World War II after<br />

which the people felt the government spending<br />

on weapons as a wasteful expenditure. There<br />

have been attempts made to factor in economic<br />

inequality and environmental damage inside<br />

GDP measurement. In research paper published<br />

in LSE Growth Commission by Nicholas Oulton,<br />

attempts have been made to factor in economic<br />

inequality by Atkinson’s index of inequality<br />

(1970)<br />

E: Parameter measuring “inequality aversion” if<br />

E=0 then society cares nothing for inequality<br />

To factor in economic welfare the paper suggests<br />

concept of Weitzman’s Net National Product<br />

(Weitzman, 1976 and 2003). It is defined as<br />

consumption plus net investment. It’s given by<br />

Where C: Volume of Consumption<br />

Pi: Price of the ith investment good<br />

Pc: Price of consumption<br />

I: Gross investment<br />

D: Depreciation<br />

Such measures are considered by leading<br />

policy makers as important as they not only<br />

factor in important things in the economy apart<br />

from economic output but also are worldwide<br />

accepted. But difficulties in tinkering with the<br />

present framework of GDP makes it difficult<br />

to incorporate these measures. Also some<br />

other economic indicators like HDI (Human<br />

Development Index), Gini coefficient for<br />

measuring economic inequality gives a fair idea<br />

about the overall economic progress and its<br />

sustainability. But certainly an all-encompassing<br />

criteria to measure growth needs to be created.<br />

Article Cover FinGyaan of the Story Month<br />

where<br />

yi: Income of the ith person (or household)<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


22<br />

Article Cover FinLife of the Story Month<br />

NIVESHAK<br />

Fundamental or Technical Analysis:<br />

An Amalgamation of both the<br />

perspectives<br />

Rahul Bajaj<br />

IIM Shillong<br />

“The best way to have a million is to start with two million and trade<br />

in the financial markets using technical analysis “<br />

A lot of negativity has been built over the years<br />

around technical trading, however this powerful<br />

tool when used in conjunction with fundamental<br />

analysis can help enhance the returns of any<br />

trader. Difference between the two perspectives<br />

is that the technical analyst uses statistics and<br />

assets traded volume and historical prices data<br />

to forecast the prices whereas the fundamental<br />

trader calculates the assets intrinsic value<br />

through current performance and future<br />

projections. Technical analysis relies on patterns,<br />

historical prices to repeat in the future whereas<br />

fundamental analysis relies that the expected<br />

company future performance to reflect in the<br />

prices. However it is possible that history and<br />

market behaviour do not repeat in the former,<br />

and market behaviour/sentiment not being in<br />

sync with the fundamentals in the latter. Traders<br />

who invest in assets with good fundamentals at<br />

the right time can help maximise the returns for<br />

investors. Let us look at both the perspectives<br />

and how they can be used together.<br />

Technical analysis is applicable to stocks,<br />

indices, commodities, futures or any tradable<br />

instrument where the price is influenced by<br />

the forces of supply and demand. Technical<br />

analysts use combination of the open, high,<br />

low, or close for a given security over a specific<br />

time frame. The time frame can be based on<br />

intraday (1-minute, 5-minutes, 10-minutes,<br />

15-minutes, 30-minutes or hourly), daily, weekly<br />

or monthly price data and last a few hours<br />

or many years. As it can be done across time<br />

frames, it is possible to find short-term as well<br />

as long-term trends using technical analysis.<br />

Line chart, Bar chart and Candlestick chart are<br />

three types of charts that are used by investors<br />

to study the chart patterns. Higher the number<br />

of technical traders in the market more linear<br />

will be the price movements in accordance with<br />

the principles of technical analysis. The basis<br />

of widely used algorithmic trading is technical<br />

analysis methods adopted in the system itself<br />

Volume is an important measure for a technical<br />

trader. It helps a technical trader analyse the<br />

intensity of the price movements. When the<br />

trend in an Index/industry/stock is bullish and<br />

the volume traded increases it implies that the<br />

prices are expected to further increase in the<br />

future trading sessions. Similarly bullish trend<br />

with decreasing volumes implies a bearish trend<br />

as the intensity of price rise is decreasing.<br />

Pivot points, resistance and support levels are<br />

tools which are quintessential part of any shortterm<br />

technical trader. For the selected equity<br />

from fundamental analysis, use of such tools<br />

can enable the analyst to enter at the bottom<br />

most price level. Pivot point is the point near<br />

which asset prices are expected to be most<br />

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NIVESHAK 23<br />

Article Cover FinLife of the Story Month<br />

volatile. A support level is a price level where<br />

the price tends to find support as it is going<br />

down. This means the price is more likely to<br />

“bounce” off this level rather than break<br />

through it. A resistance level is the opposite of a<br />

support level. It is where the price tends to find<br />

resistance as it is going up. This means the price<br />

is more likely to “bounce” off this level rather<br />

than break through it. However, once the price<br />

has passed this level, by an amount exceeding<br />

some noise, it is likely that it will continue rising<br />

until it finds another resistance level.<br />

Pivot Point for Current = High (previous period) +<br />

Low (previous period) + Close (previous period)<br />

Resistance 1 = (2 x Pivot Point) – Low (previous<br />

period)<br />

Support 1 = (2 x Pivot Point) – High (previous<br />

period)<br />

Resistance 2 = (Pivot Point – Support 1) +<br />

Resistance 1<br />

Support 2 = Pivot Point – (Resistance 1 – Support<br />

1)<br />

Resistance 3 = (Pivot Point – Support 2) +<br />

Resistance 2<br />

Support 3 = Pivot Point – (Resistance 2 – Support<br />

2)<br />

Various Chart patterns like Head and Shoulders,<br />

Cup and Handle, Double<br />

Tops and Bottom etc.<br />

are used to further<br />

analyse the trends<br />

in the prices. Based<br />

on the time frame of<br />

the charts (Hourly,<br />

Daily, monthly,<br />

Yearly) similar time<br />

Figure 1: Head and Shoulders<br />

frame predictions are made, however charting<br />

is more suitable for short-term patterns.<br />

Head and Shoulders: It is the most popular<br />

and easy to find pattern in technical analysis.<br />

There are two versions of Head and Shoulders –<br />

Upward and Downward. It denotes trend reversal<br />

as the two shoulders and a head is formed. If<br />

the right shoulder is formed it denotes that the<br />

asset is expected to move against the last trend.<br />

When the right shoulder is below the head it is<br />

expected to break down further, otherwise when<br />

the right shoulder is above the head an upward<br />

trend is expected.<br />

Figure 2: Cup and Handle<br />

Cup and Handle: When a bullish trend takes<br />

a bearish breather forming a cup and a handle<br />

as can be seen in the diagram, the asset prices<br />

are expected to continue moving in an upward<br />

trend.<br />

Double Tops and Bottoms: It is another Trend<br />

reversal pattern where the increase/decrease<br />

Figure 3: Double Tops and Bottoms<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


24<br />

NIVESHAK<br />

Article Cover FinLife of the Story Month<br />

in the asset prices is halted at the resistance/<br />

support level. In double top reversal pattern<br />

the asset prices attempt to break the resistance<br />

levels twice after which downward trend in price<br />

movement pushes the prices lower. Similarly<br />

in double bottom reversal pattern prices try to<br />

break down below the support level, however<br />

has sustained in those levels by buying seen at<br />

the support level. After the two bounce-offs the<br />

asset prices starts moving in an upward trend.<br />

Triangle Patterns: There are 3 types of<br />

triangular patterns which are commonly used in<br />

technical analysis. As a triangle pattern is formed<br />

the asset prices breakout into an increasing or<br />

decreasing trend. A symmetrical or an ascending<br />

triangle pattern is a bullish pattern and there is<br />

upward breakdown in such a scenario, however<br />

in a descending pattern breakdown bearish<br />

movement is asset prices is expected.<br />

Leading indicators are those created to proceed<br />

the price movements of a security giving<br />

predictive qualities. The leading indicators will<br />

create many buy and sell signals that make it<br />

better for choppy non-trending markets instead<br />

of trending markets where it is better to have<br />

less entry and exit points. The majority of<br />

leading indicators are oscillators. Oscillators is a<br />

technical analysis tool that is banded between<br />

two extreme values and built with the results<br />

from a trend indicator for discovering short-term<br />

Figure 4: Triangle Patterns<br />

overbought or oversold conditions. As the value<br />

of the oscillator approaches the upper extreme<br />

value the asset is deemed to be overbought,<br />

and as it approaches the lower extreme it is<br />

deemed to be oversold.<br />

Lagging Indicators are those that follows price<br />

movements and has less predictive qualities.<br />

The usefulness of these indicators tends to be<br />

lower during non-trending periods but highly<br />

useful during trending periods. This is due to<br />

the fact that lagging indicators tend to focus<br />

more on the trend and produce fewer buy-andsell<br />

signals. This allows the trader to capture<br />

more of the trend instead of being forced out of<br />

their position based on the volatile nature of the<br />

leading indicators.<br />

Fundamental Analysis: It consists of the<br />

analysis of two factors:<br />

1. Qualitative factors: Various aspects which<br />

look at measures of a company that cannot<br />

be stated numerically but are the key factors<br />

related to the business/commodity are analysed<br />

qualitatively. Companies with intellectual<br />

property and competitive advantage have higher<br />

chances of retaining profits and retaining market<br />

share. Similarly companies with good corporate<br />

governance trade at a premium as it results<br />

in higher transparency and protection to the<br />

shareholders objectives. Capable management<br />

and favourable regulation further boost the<br />

Figure 5: Qualitative Factors<br />

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NIVESHAK 25<br />

Article Cover FinLife of the Story Month<br />

price of the equity.<br />

2. Quantitative Analysis: Ratio analysis and<br />

valuation play a major role in fundamental<br />

analysis. The various ratio that are calculated is<br />

liquidity ratios, leverage ratios, activity ratios,<br />

profitability ratios, Valuation ratios. Valuation<br />

ratios such as P/E, P/BV, EPS (Earnings per<br />

share) and Sales per share are the most widely<br />

used ratios.<br />

Company valuations are done using Gordon<br />

growth model, Discounted Cash flow, Relative<br />

valuation and residual income method.<br />

Gordon growth model is used for determining<br />

the intrinsic value of a stock, based on a future<br />

series of dividends that grow at a constant rate.<br />

Given a dividend per share that is payable in<br />

one year, and the assumption that the dividend<br />

grows at a constant rate in perpetuity, the model<br />

solves for the present value of the infinite series<br />

of future dividends.<br />

Stock value = D/k-g<br />

Where D is the expected dividend one from now,<br />

k is the growth rate in dividend till perpetuity<br />

and k is required rate of return for equity<br />

investor.<br />

Discounted cash flow (DCF) analysis uses future<br />

free cash flow projections and discounts them<br />

(most often using the weighted average cost of<br />

capital) to arrive at a present value, which is used<br />

to evaluate the potential for investment. If the<br />

value arrived at through DCF analysis is higher<br />

than the current cost of the investment, the<br />

Figure 6: Quantitative Analysis<br />

opportunity may be a good one.<br />

Relative valuation is a business valuation<br />

method that compares a firm’s value to that<br />

of its competitors to determine the firm’s<br />

financial worth. Relative valuation models are<br />

an alternative to absolute value models, which<br />

try to determine a company’s intrinsic worth<br />

based on its estimated future free cash flows<br />

discounted to their present value. Like absolute<br />

value models, investors may use relative<br />

valuation models when determining whether a<br />

company’s stock is a good buy.<br />

Fundamental analysis mostly relies on the<br />

financial statements and the business model<br />

of the company whereas technical analysis is<br />

purely a function of price and traded volume<br />

of the asset based on the supply and demand.<br />

Fundamental analysis captures the profits,<br />

assets and future potential of the company<br />

whereas technical analysis focuses on the<br />

price movements and market behaviour. It is<br />

rightly said that fundamental analysis captures<br />

the rational side of traders whereas technical<br />

analysis captures the emotional side of the<br />

traders. Amalgamation of the two methods with<br />

minimum correlation will help us minimize the<br />

risks and maximise our returns.<br />

Would like to end with the last words “In<br />

fundamental analysis if you are good you will<br />

be right six out of ten times, but if you want to<br />

be right nine times you need to have a balance<br />

of both the perspectives”.<br />

© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG


26<br />

NIVESHAK<br />

Article Cover Finsight of the Story Month<br />

Analysis of HP mitosis<br />

Sandeep G Y<br />

IIM LUCKNOW<br />

Introduction<br />

The business world in the US witnessed an<br />

interesting phenomenon in the last few months.<br />

Tech conglomerates like eBay and HP have<br />

split their companies citing reasons such as<br />

sharper focus required in the fast rising cloud<br />

computing and related services. A few experts<br />

received this phenomenon positively saying<br />

that these combined entities are plagued with<br />

‘conglomerate discount’ and hence splitting into<br />

smaller independent chunks will make them<br />

nimble and agile enough to leapfrog in this<br />

competitive tech world. However, few others<br />

brushed this exercise as another attempt by the<br />

top management to cover up their inefficiency<br />

in exploring the growth opportunities and also<br />

as a hurried response to the demands of the<br />

activist investors like Carl Icahn etc.<br />

HP Split: Meg Whitman’s Announcement<br />

On Oct 6 2014, Meg Whitman, the Chairman,<br />

President and Chief Executive Officer of Hewlett-<br />

Packard, announced that Hewlett Packard (HP)<br />

would split itself into two companies: One<br />

focused on PCs and Printers, to be called as<br />

HP Inc, and the other on corporate hardware,<br />

software and services, to be called as Hewlett<br />

Packard Enterprise. The split is going to be<br />

completed by the end of the next year. HP<br />

Figure 1: Independent divisions of HP<br />

NOVEMBER 2014


NIVESHAK 27<br />

Cover Classroom Finsight Story<br />

investors would receive a tax free distribution<br />

of shares in the new company.<br />

This move marks a reversal for Meg Whitman, the<br />

former eBay boss who was roped in three years<br />

ago to turnaround the then ailing technology<br />

conglomerate. One of her first acts was to ditch<br />

the plan to shed the PC division laid out by her<br />

predecessor, Léo Apotheker, though she has<br />

since then left the option open for more radical<br />

actions to deal with HP’s problems.<br />

With growth stuttering in the last few years<br />

post the merger of HP with the then noted PC<br />

manufacturer, Compaq, and the onslaught of<br />

tablet computers leading to the shrinkage of<br />

revenue from PC division, Meg Whitman felt<br />

that this is the best time to divide the company<br />

to prepare the company for the next stage of<br />

growth.<br />

A glimpse of the financials of HP<br />

Based on last year’s revenues, both parts of<br />

HP would have ranked among the 50 largest<br />

US companies. HP’s PC and printer businesses<br />

produced revenues of $55.9bn in its last<br />

financial year, almost identical to the combined<br />

$55.7bn of its enterprise computing, services<br />

and software divisions.<br />

HP’s finances in FY2013:<br />

• Total revenue of $112.3 billion was down 7%<br />

year over year<br />

• Enterprise systems revenue of $28.2 billion fell<br />

5% year over year<br />

• Its operating margin increased from 13.9% to<br />

15.3%<br />

• Enterprise services revenue of $23.5 billion<br />

was down 8% year over year<br />

• Its operating margin fell from 6.9% to 2.9%<br />

Figure 2: HP’s Recent acquisitions<br />

• Printing revenue of $23.9 billion fell 3% year<br />

over year<br />

• Its operating margins increases from 14.6% to<br />

16.3%<br />

• Personal systems revenue of $32 billion fell<br />

10% year over year<br />

• Its operating margin fell from 4.7% to 3.0%<br />

The last three quarters of 2014 are better but not<br />

exciting enough to match the turnaround efforts<br />

by the top management. Enterprise systems<br />

revenue was flat YOY at $20.5 billion and Printer<br />

revenue was down by 3% YOY at $17.2 billion.<br />

However, these divisions have higher margins<br />

at 15% and 18% respectively compared to the<br />

single-digit margins at other divisions of the<br />

company. HP has about $20 billion debt and<br />

$14 billion in cash and other investments. It is<br />

expected that debt would be transferred to HP<br />

Inc and make HP enterprise debt free, although<br />

the decision is yet to be finalized.<br />

Turnaround efforts<br />

The turnaround efforts at HP resulted in<br />

unsuccessful acquisitions notable among them<br />

was that of Autonomy, the UK’s largest software<br />

company by market capitalization. On Aug 28<br />

2011, HP offered to buy Autonomy at 23x EBITDA<br />

valuing the company at $11 billion. However,<br />

within a year of acquisition, HP reported $5<br />

billion write-down after being alerted by a<br />

whistle blower about the serious accounting<br />

improprieties at the software company. It<br />

resulted in a severe dent in the share price of HP<br />

as well as in the confidence of its investors. This<br />

ugly spat occupied the front pages of business<br />

dailies in that year.<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


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NIVESHAK<br />

Article Cover Finsight of the Story Month<br />

Figure 3: Market Share of Worldwide PC Shipments<br />

Is this split an acknowledgment of<br />

failure of oft-repeated synergy story?<br />

An emphatic No.<br />

Companies talk about synergies as the drivers<br />

behind mergers. Executives like to run big and<br />

expanding companies. Mergers are often driven<br />

by vainglorious attitudes of CEOs. Empirical<br />

studies state that 70% of the mergers are<br />

failures. When the companies split up, the<br />

top management often cites lack of growth as<br />

a reason. Lack of growth or divergent growth<br />

among the divisions of a company result in a<br />

discount called as ‘Conglomerate discount’<br />

which has to be eliminated to keep the investors<br />

excited about the growth prospects of the<br />

company.<br />

According to Emilie R.Feldman, a management<br />

professor at Wharton,<br />

“Divestitures and spinoffs are the ugly stepchild<br />

of corporate strategy. They are viewed as<br />

acknowledgements of failures, bowing to<br />

pressure from investors and competitors. In<br />

reality, spinoffs can be used very proactively,<br />

as we are seeing in the HP case, to create value<br />

for shareholders and separate businesses that<br />

don’t belong together anymore.”<br />

So, a spin-off is not necessarily an admission<br />

that a mistake has been made. The prevalence<br />

of acquisition to spin-off only indicates that the<br />

promised synergies are rarely delivered.<br />

In the case of HP split, the move could allow<br />

the two divisions to focus on their core product<br />

offerings and go-to-market strategies that are<br />

decidedly different between consumer products<br />

and the enterprise. The move could signal<br />

renewed focus and commitment by HP with<br />

respect PCs and Printers, while allowing the<br />

Enterprise group more flexibility to react for its<br />

own needs as well.<br />

Figure 4: Worldwide PC Shipments (in millions)<br />

Which division has more steam left?<br />

The Chinese major, Lenovo, has taken over HP<br />

as the company with the highest market share<br />

in the worldwide PC shipments. The worldwide<br />

PC shipment pie has stagnated at 75-85 million<br />

in the last two years. So, HP will have a hard<br />

time in improving the fortunes of its PC division,<br />

absent innovation in its value chain or the<br />

product itself.<br />

The printing business - HP’s most profitable<br />

division, accounting for a third of its profits –<br />

is a cash cow that has been helping the other<br />

divisions of the conglomerate. Its pre-tax profits<br />

have fallen by less than 7% compared to the<br />

other HP divisions where profits have fallen<br />

by half in the last three years. The low growth<br />

hardware business is likely to be valued at<br />

very low multiples compared to the enterprise<br />

division. This group may take most of its debt.<br />

The key investments would largely be organic<br />

to maintain the durability of the cash flow and<br />

the investors would be benefited largely by<br />

dividends. The caveat, of course, is the emerging<br />

PC shipment scenario in the near future.<br />

This leaves the other enterprise division debt<br />

free which may look for acquisitions. Targeted<br />

M&A was explicitly mentioned by Meg Whitman<br />

on the eve of the announcement of the split on<br />

Oct 6. Increased organic investments combined<br />

with targeted M&A are the way ahead for the<br />

enterprise division. The shareholders may be<br />

benefitted by share buybacks in this division as<br />

it gives leeway to the top management given<br />

the investment needs.<br />

Hence, in my opinion, the enterprise division<br />

is a better bet for investment given its healthy<br />

outlook, growth opportunities, and the<br />

competitive scenario in the software and cloud<br />

computing industry.<br />

NOVEMBER 2014


NIVESHAK<br />

29<br />

Interview With Mr. Samir K Barua,<br />

Ex-Director, IIM Ahmedabad<br />

Cover FinView Story<br />

FinGyaan<br />

How would the ‘Jan Dhan Yojana’ affect<br />

the Indian Banking System?<br />

Financial Inclusion is on the agenda of most<br />

emerging economies. In India, efforts at<br />

enhancing financial inclusion were begun<br />

by the previous government. However, the<br />

implementation was not at the scale planned<br />

by the current government. The major concern<br />

would be the number of accounts that are<br />

planned to be opened. By January 15, 2015 it is<br />

planned to open 150 million new accounts with<br />

an overdraft facility of INR 5000 for each account.<br />

While providing access to formal financial system<br />

is a laudable objective, indiscriminate opening<br />

of accounts does not result in true financial<br />

inclusion. A large percentage of accounts opened<br />

by banks under pressure from the government<br />

in the last several years are actually dormant<br />

accounts. The overdraft facility gets used up<br />

almost immediately and after that there are<br />

no transactions. That is not financial inclusion.<br />

The major step which the government needs to<br />

take is to encourage such account holders to<br />

become users of the banking system. The key<br />

step needed to ensure this would be through<br />

routing direct cash subsidies (food, energy)<br />

and other payments (NREGA) through these<br />

accounts. Only then the accounts would remain<br />

active and over a period of time the account<br />

holders would become truly integrated with the<br />

banking system. The other issue that needs to<br />

be addressed is the cost to banks of maintaining<br />

and servicing such accounts. It is estimated that<br />

banks incur a cost of Rs. 100 per month per<br />

account. If the accounts do not generate this<br />

amount of income, banks would be reluctant<br />

to provide requisite quality of service. This<br />

issue needs to be addressed too for ensuring a<br />

voluntary buy-in from banks to the idea.<br />

The proposed Holcim/Lafarge merger<br />

will create the world’s largest cement<br />

producing firm. What are likely to be the<br />

issues the new entity would face from<br />

the proposed merger? According to you,<br />

what would be the likely impact of this<br />

merger on the aggregate market?<br />

Making a success of mergers, particularly<br />

involving large entities is always a challenge.<br />

The issues that are hard to deal with are<br />

the differences in the organization culture,<br />

management styles and processes. Since<br />

cement is not a commodity that is easy to<br />

transport, local prices often may be significantly<br />

different from global prices. Therefore in such<br />

situations regulators do become alert to the<br />

possibility of ‘unfair’ increase in prices due<br />

to greater concentration of capacity. Since<br />

cement is a basic commodity for infrastructure<br />

and housing, I would expect some action from<br />

the government and the regulators to ensure<br />

adequate competition in India. It is possible that<br />

regulators in India and some other countries<br />

too where these entities operate, may require<br />

them to divest some of their assets to ensure<br />

adequate competition.<br />

Recently we have seen a sharp drop in<br />

the price of Brent crude which even fell<br />

below $85 per barrel. One of the reasons<br />

that was attributed to this drop is weak<br />

global demand especially from Europe.<br />

Are there any other supply side or<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


30<br />

NIVESHAK<br />

FinView<br />

demand-side reasons that are affecting<br />

the global oil prices? Does shale gas have<br />

any role to play in this price debacle?<br />

Can we expect that the positive impact<br />

of reduced inflation will outweigh the<br />

negative impact of reduced exports due<br />

to weak global demand?<br />

FinGyaan<br />

There are multiple reasons for the decrease in<br />

the price of crude. US has now become selfsufficient<br />

in energy instead of being an importer.<br />

This is because US government took a decision<br />

to use domestic sources rather than depend<br />

on imports. Withdrawal of US demand from<br />

global markets has fueled reduction in price<br />

of crude. Another reason is currency exchange<br />

rates. Among the large developed economies,<br />

US appears to be the only economy that is doing<br />

well. It is growing at almost 3.5% while Europe<br />

and Japan are stagnating and China is slowing<br />

down. This has resulted in ‘flight to safety’<br />

whereby savings from the rest of the world are<br />

flowing to the US. As a result, the US dollar has<br />

strengthened significantly (the US dollar index<br />

has risen to over 86 against other currencies).<br />

It has always been observed that strength of<br />

US dollar and crude oil prices are negatively<br />

correlated. This is so since crude prices are<br />

quoted in USD. Strengthening of USD implies<br />

higher prices in other currencies (for all other<br />

buyers). To maintain prices in other currencies<br />

so as to sustain demand, the producers are<br />

therefore required to cut price of crude in dollar.<br />

My assessment is that low crude prices may last<br />

for some time, may be another 3-4 quarters. But<br />

crude prices would rise after that above the<br />

levels we are witnessing today. Such low prices<br />

are not sustainable in the long term for the<br />

producers. India being heavily dependent on oil<br />

imports would benefit immensely from the low<br />

crude prices. On balance, I think the benefits<br />

from low crude prices out-weigh the negative<br />

impact on exports from slowing global economy.<br />

This is because India has a large domestic<br />

economy.<br />

no. 22 says, “Regulatory actions should<br />

be subject to appeal to the Financial<br />

Sector Appellate Tribunal, which will be<br />

set up along the lines of, and subsume,<br />

the Securities Appellate Tribunal.” The<br />

recommendation asks for including even<br />

RBI under the ambit of unified Tribunal<br />

but in 2011 he opposed the same idea by<br />

saying that the same recommendation<br />

was ‘schizophrenic’ when Dr. Justice<br />

BN Srikrishna recommended it in FSLRC<br />

recommendations? What are your views?<br />

No regulatory body, be it SEBI, or RBI or IRDA<br />

would want to subject itself to monitoring. It<br />

is therefore not surprising that the view of RBI<br />

governor changed (if it indeed did as quoted<br />

in your question). There is need for an agency<br />

(other than courts of law) to hear appeals against<br />

the primary regulators’ decisions. If the legal<br />

system were more efficient then courts could<br />

have played this role. Unlike SEBI’s decisions<br />

that can be appealed against to SAT, there is<br />

no agency that can be approached against<br />

decisions of RBI. I think such a body is needed<br />

to deal with regulatory excesses and regulatory<br />

over-reach. Else, there could be an element of<br />

recklessness in the decisions of regulators.<br />

In 2007 a high level committee on financial<br />

sector reforms was constituted under<br />

the chairmanship of Dr. Rajan. Proposal<br />

NOVEMBER 2014


NIVESHAK 31<br />

CLASSROOM<br />

FinFunda<br />

of the<br />

Month<br />

GREEN SHOE OPTION<br />

Saket hawelia<br />

IIM Shillong<br />

Cover Classroom Story<br />

Sir, whenever we talk of the process of<br />

listing of shares, more often than not<br />

we end up discussing what underwriting<br />

of shares is. And an in-depth study of<br />

underwriting often leads us to Green Shoe Option.<br />

What exactly is a Green Shoe Option?<br />

Many a times, during the process of<br />

underwriting, there exists a clause that the<br />

underwriters are permitted to allot shares<br />

over and above what was intended to be<br />

allotted by the issuing Company. Legally, it can be<br />

referred to as the option given to the underwriters<br />

to ensure over allotment, in case there is an excess<br />

demand for the proposed issue.<br />

Green Shoe Option is usually exercised by the<br />

company in order to ensure a price stability and<br />

avoid the price fluctuations that may exist because<br />

of demand exceeding the supply.<br />

Sir, in that case why would the company<br />

give this option to the investment banker<br />

as an increased allotment of shares may<br />

lead to dilution of control?<br />

The entire objective of exercising the Green<br />

Shoe Option is to stabilise the pricing of<br />

the shares. So, when after the listing of the<br />

Company, the investors try to book their<br />

profit by selling the shares. As a result of this, there<br />

is an excessive supply of shares, leading to a sharp<br />

fall in the prices. I such a case, the Company shall<br />

intervene by exercising the Green Shoe Option and<br />

purchase the shares to create a “pseudo demand”<br />

leading to price stability.<br />

But Sir, why would the company over allot<br />

the shares? Can you please explain how<br />

this option actually functions using an<br />

example?<br />

Ok, let us assume that a Company ABC<br />

Ltd is planning to issue 200,000 shares.<br />

It exercises the Green House Option<br />

and actually issues 230,000 shares. It is<br />

important to note here that in this case,<br />

the Company does not really issue the “new shares”<br />

but provides the additional shares to the public<br />

by borrowing the same from the promoters of the<br />

company.<br />

Now, after the Company has been listed, it might<br />

so happen that the shares are being traded in the<br />

stock exchange at a price lower than the issue price.<br />

In such a case, the underwriter or the “stabilising<br />

agent” intervenes and starts purchasing the shares<br />

to put a halt on the falling share prices. The shares so<br />

bought are then handed over to the original owners<br />

or the promoters of the Company.<br />

Sir, what if the shares are not being traded<br />

at a price lower than the issue price?<br />

In that case, the company does not<br />

purchase the shares at all for the time<br />

being and waits for an appropriate time to<br />

enter the market.<br />

The concepts are pretty clear now, Sir. But<br />

one last question. Why is the Green Shoe<br />

Option so called?<br />

The name “Green Shoe” Option was coined<br />

in 1919, when Green Shoe Manufacturing<br />

Company, now known as the Stride Rite<br />

Corporation became the first company ever<br />

to exercise this option of over allotment.<br />

Thank you Sir. This explanation makes<br />

things very clear.<br />

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG


32<br />

W I N N E R S<br />

Article of the Month<br />

Prize - INR 1500/-<br />

Sainath Zunjurwad<br />

SIMSREE Mumbai<br />

November FinQ Winners<br />

1 st Prize - INR 1000/-<br />

Swati Pamnani<br />

IIM Shillong<br />

2 ND Prize - INR 500/-<br />

Vishwam Bhattacharjee<br />

IMT Nagpur


33<br />

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