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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 />
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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 />
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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 />
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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 />
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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 />
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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 />
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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 />
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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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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 />
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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
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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 />
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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 />
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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 />
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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 />
A N N O U N C E M E N T S<br />
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