Niveshak March 2009

NIVESHAK THE INVESTOR

VOLUME 2 ISSUE 2

MARCH 2009

Islamic Finance

Niveshak Volume II ISSUE 2 March 2009

Editor Biswadeep Parida Team Niveshak Amit Choudhary Nilesh Bhaiya Sareet Mishra Sarvesh Chowdhury Sujal Kumar Tripurari Prasad

All Images and artwork are copyright of IIM Shillong Finance Club

From Editor's DesK

I

t has often been seen that the world of finance reinvents itself once every decade. During the last five years we saw the world of high street finance pass through one of its highest peaks building a regime of unimaginable optimism before disgracefully fading into the oblivion. We saw the emergence of new economies, evolution of new structured financial products, unprecedented rise of stock markets into stratospheric levels, rise of commodity prices, high growth of international trade and most importantly an air of positive sentiments prevailed all over the world. This fairy tale ended with a catastrophe wiping out the most formidable names of the BFSI sector. In the mean time, the Islamic banking industry was being redefined and reinvented as banks, the world over. Assets of financial institutions offering Islamic products and services have soared by almost 25% year-on-year over the past decade, to about USD 300 billion today and projected to reach USD 1 trillion by 2013. Governments and central banks have taken a lead in supervising Islamic banks, encouraging their growth and have passed Islamic banking and insurance laws in their countries. In our last edition we had covered the emergence of such a new financial institution – The Sovereign Wealth Funds. The current cover story aims to provide a comprehensive overview of the fundamentals on which Islamic Banking works, issues & concerns surrounding it and try to find if it can respond to the opportunities presented by the current downturn with its range of Shariah-compliant products. Today, conventional banks in non-Muslim countries too cannot afford to ignore the growing demand for Shariah-compliant products. We shall try to answer if it will be beneficial to leverage the wisdom of Shariah scholars who have identified financial solutions that conform to Islamic ethics, and the contractual mechanisms that bind them. Apart from this we shall also cover an issue that threatened the credibility of corporate India not so long ago- The Satyam Fiasco. We will try to understand and appreciate the role of Debt financing in corporate structures, leveraged buyouts as well as in running an economy as huge as India at such a fast pace. Our articles will address issues concerning Debt Deflation, the future of leveraged buyouts owing to the current recession and the difficulties faced for the institutionalization of the World Trade Organization. As the world is struggling to find tools & techniques for investing in the current times, we see this as a golden opportunity for picking up gems at throwaway prices. We present to you-“Value Investing”, the tool that has largely been responsible in making Warren Buffet the “Oracle of Omaha” and the most respected investor of the era. Introduced by Prof. Benjamin Graham in the book “The Intelligent Investor” in 1948, the concept of “Value Investing” is, till today, the most successful tool in long term investing. Hope you find this a useful issue. Happy Investing. - Biswadeep Parida (Editor- Niveshak)

©Finance Club Indian Institute of Management, Shillong Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsover.

ContentS

Debt Deflation Liquidation defeats itself- Page 4

Corporate Governance The Satyam fiasco- Page 5

Article of the month Value investing- Page 8

Cover Story Islamic finance- Page 11

Change Economics Obama regime- Page 17

Leverage & Investments Global Recession- Page 18

Institutions WTO- Page 21

Food for thought India’s growth story- Page 23

Perspective Page 24

Finlounge FinToon- Page 7 FinQ- Page 26

© The Finance Club, Indian Institute of Management, Shillong

Debt DeflatioN

«««««««««« here are various reasons and explanations cited for the financial mess that the US economy has turned into. The core of every explanation points to the fact that the US borrowed too much. Now, there are only four ways to wriggle out of this debt: 1. Grow out of debt 2. Inflate the debt away 3. Default on the debt 4. Socialize the debt Debt deflation is #3 and this apparently what the situation seems to be heading towards, if left to itself. This is what is happening. The US government on the other hand, is attempting to switch it to solution #4. In many ways, 2008 has been an odd year. For example, the year began with inflation being the biggest global headache. However, the evil of inflation was replaced with demon of deflation by the time the year ended. Deflation as we all know refers to persistent and generalised fall in prices. Some might argue that lower prices should be good for consumers as they increase their purchasing power. But the situation changes if the falling prices are associated with falling wages, rising unemployment and falling asset prices. In the current environment deflation could cause serious problems because household debt levels are high in many countries. Sustained deflation would increase the real value of debt at a time when asset prices are falling and nominal incomes are weakening. If individuals attempt to reduce their debt burden by cutting spending (which only intensifies deflationary pressures) and selling assets (causing further falls in asset prices), the risk is that a vicious “debt deflation” spiral may take hold. Debt deflation was coined by the economist Irving Fisher way back in 1933. He observed that when highly indebted individuals and businesses get into financial trouble, they usually sell assets and use the proceeds to pay down their debt. Fisher pointed out, however, that such selloffs are self-defeating when everyone does it: if everyone tries to sell assets at the same time, the resulting plunge in market prices undermines debtors’ financial positions faster than debt can be paid off. So deflation in asset prices can turn into a vicious circle. And one consequence of what he called a “stampede to liquidate” is a severe economic slump.

Niveshak

Does the debt deflation theory have any relevance in the current economic crisis? It is very much relevant. In fact what we are seeing in US housing market seems a classic microcosm of debt deflation. Mortgage debt has spiralled out of control and debt deflation made especially ugly by the fact that key financial players are highly leveraged — their assets were mainly bought with borrowed money. Just about every financial institution has been trying to reduce its leverage — but the plunge in asset values has nonetheless left these institutions with more debt relative to their assets than before. The cure of debt deflation is hazy, nobody knows it. The debt deflation of 1930’s was cured with World War II (if you call that a ‘cure’). Japan’s bout with deflation in the 1990’s was never really cured. Although three solutions have been proposed by various economists: 1. Fisher’s solution is simply reflation i.e. an economic policy whereby a government uses fiscal or monetary stimulus in order to expand a country’s output. This is what the Fed is currently implementing. 2. Keynes advocated massive debt-funded public works projects: The General Theory of Employment, Interest and Money (1936). Build pyramids, or bury money in bottles for people to dig up — it does not matter what. 3. Dropping money from helicopters, as described by Nobel-laureate Milton Friedman in The Optimum Quantity of Money (1969). 4. The U.S. government has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at essentially no cost says Bernanke. With all that being said it remains to be seen that will any of it work. Fisher wrote his paper in 1933 and thought that his country was emerging from the Depression then but it took a few more years. There are many years of excesses to be wrung out and there is still a lot of pain to come for the global economy in the near term.

By KaranParmanandka & RajatBrar

Volume 2 Issue 2

XLRI Jamshedpur



March 2009

Page 4

»»»»»»»»»» T

Corporate governancE

«««««««««« * in IT: The Satyam Fiasco Corporate Governance »»»»»»»»»» W

The Great Fall of Satyam Ramalinga Raju resigned as chairman on Jan. 7, revealing profits had been overstated for years and that $1 bn of cash and bank balances on the company’s books did not exist. Satyam fraud is a microcosm of the greed that has infected the world financial system and is the real cause of the current meltdown. The world would never have known about the fraud had a few shareholder activists not been persistent in opposing the unanimously approved resolution of December 16, 2008, acquiring two property

companies (Maytas Properties and Maytas Infra) owned by Raju’s sons at extortionate price of $1.6 bn. It is difficult to comprehend that the accounts have received clean audit reports from auditor (Pricewaterhouse) when assets have been fictitiously included in the accounts. These incidences put question mark over the corporate practices of companies in India and also on the credibility of auditors. Key Events

16 Dec.: Satyam announces plan to buy two building firms part-owned by the outsourcer’s founders for $1.6 billion. It does a rapid U-turn, killing the deal just 12 hours later following a 55% plunge in the company’s share price in a day of hectic US trading. 17 Dec.: Ramalinga Raju says the about-turn reflected negative investor reaction. Satyam shares continue to slide, falling by a third on concerns about corporate governance. 23 Dec: Satyam barred from business with the World Bank for eight years for providing Bank staff with “improper benefits”. Its shares fall another 14% to their lowest in more than 4-years. 26 Dec.: Mangalam Srinivasan, an independent director, resigns. 29 Dec.: Three more directors quit, but Satyam shares rise on hopes for moves to improve shareholder value and corporate governance. 30 Dec.: Shares extend gains on talk of private equity interest and a management change. One of Satyam’s largest investors says it could sell its stake. 02 Jan.: Satyam says its founder’s stake fell by a third to 5.13%. Analysts say this means the company is a more attractive bid target. 05 Jan.: Shares tumble 9% on concerns of corporate governance issues. 06 Jan.: Shares rise more than 7% on a newspaper report Satyam had been approached by smaller rivals Tech Mahindra for an all-share merger. 07 Jan.: CEO and Founder B. Ramalinga Raju resigns. Shares plunged by 77%. (Sources: Reuters) Raju’s predicament has occurred despite Satyam observing all the norms of governance. Evidently it is not rules alone that matter but their implementation. While India Inc. aspires to be benchmarked against world class bodies, it cannot achieve this without streamlining its regulatory process or enhancing its disciplinary provisions.

© The Finance Club, Indian Institute of Management, Shillong

Page 5

here the country is already facing economic crisis, one more bad news came from a very high-profile IT company, Satyam Computer Services Limited (hereinafter referred as ‘Satyam’). Satyam fraud is the latest that has shaken India’s financial foundation by its sheer audacity, tenure and magnitude. Satyam has succumbed to the temptation of stretching earnings to maintain a quarterly growth trend to please short-term investors, resulting in compromising governance norms. The company is out of indices like Sensex, Nifty, Dow Jones as well as derivatives segment. Important learning from this episode is that, in business, survival requires deep commitment to ethics and corporate governance. The Satyam episode has done a lot of damage to the reputation of India Inc. and it has already resulted in greater due diligence from customers as they seek higher level of disclosures from their outsourcing partners and invest more in contingency planning. It may not be surprising if bodies like the Asian Corporate Governance Association, which had put India third out of 11 Asian countries on corporate governance in 2007, downgrade India. Add to this Satyam has received the World Council for Corporate Governance’s Golden Peacock Award for excellence in corporate governance not once but twice. It is a strong case for the World Council for Corporate Governance to consider its own methodology in selecting the winners for their Golden Peacock awards. It requires deeper scrutiny.

Corporate governancE

b) ICAI Accounting Standards Indian accounting standards were to be aligned with the International Financial Reporting Standards by 2008. However, Indian company law must be amended, and full convergence can happen only by 2011. Drawback: ICAI is lenient towards erring auditors. Result: Action against faulting members often gets delayed. The Global Trust Bank case is still pending. c) SEBI Since 1992 Sebi has introduced several stock market reforms, but it has been slow to react on many issues. Drawback: The body is not proactive. Result: Scams every few years; the Ketan Parekh fiasco in 2001, the IPO scandal of 2005-6. Steps Taken Government named a three-member board, including Kiran Karnik, Deepak Parikh and C. Achuthan, to oversee the functioning of scam-tainted Satyam. Larsen & Toubro (L&T), Essar, Spice and the Hindujas have shown their willingness to take over the whole or part of Satyam. A S Murty, a Satyam veteran of 15 years was named the new CEO of satyam on Feb 5. Company has received bank sanctions for Rs 600 crore as a planned fund infusion towards its working capital requirements. Bitten by the Satyam fraud, SEBI is finally waking up to a more proactive role in ensuring corporate governance. Internal audits have been made mandatory and it

Niveshak

must be done by external auditors for listed companies. Following are some important actions taken: a) Share-pledges to be disclosed SEBI has made it mandatory for promoters of companies to disclose details of shares pledged by them. The details of disclosure should be made in two stages: eventbased and periodical. Details of pledge of shares should be made to the company and the company should in turn inform the same to the public through the stock exchanges b) Peer Review To boost investor’s confidence SEBI Committee on Disclosures and Accounting Standards (SCODA) has recommended the peer review of audit of accounts of large companies. Review would be in relation to the last quarterly results and the last audited annual financial results and for this purpose, a panel of auditors would be prepared by SEBI. c) Restatement of accounts A company could reopen and revise its accounts even after their adoption in the annual general meeting and filing with the Registrar of Companies in order to comply with technical requirements of any other law to achieve the object of exhibiting true and fair view. The revised annual accounts would be required to be adopted either in the extraordinary general meeting or in the subsequent annual general meeting and filed with the Registrar of Companies. d) Open-Offer Rule According to SEBI’s current regulation, an investor who acquires 15 per cent of a company needs to make an open offer for another 20 per cent at a price, which is not less than the average share price of the previous six months. But in Satyam’s case, the largest shareholder L&T holds 12 per cent and the six-month rule means that the buyer, who already has acquired 15 per cent stake would have to make an open offer at a much higher price than its current market price. Recognizing the abnormal situation, SEBI has decided to amend the regulation. e) Corporate Governance issues SEBI is likely to come out with a concept paper on revamping Clause 49 of the corporate listing agreement to give independent directors more powers and strengthen disclosure norms. f) Dividends declaration Listed companies must declare dividends on per share basis instead of percentage basis as different practices of declaring dividends create confusion in the minds of investors. The Way Forward: Opportunities in Threat This crisis can be used as an opportunity to learn and implement practices of good governance to add long-term value to an organization. Market has become extremely savvy. The good news is that the market has first time acknowledged the gains from good corporate governance. While some companies lost almost 25% due

Volume 2 Issue 2



March 2009

Page 6

Regulatory Loopholes in India a) Clause 49 In the Listing Agreement between a company and a stock exchange, Clause 49 protects the interests of investors by ensuring good governance practices and disclosures. Here are the provisions of the clause: »» Executive and non-executive directors should make up the board of directors. At least 50% of the board must comprise non-executive directors. »» Independent directors should comprise at least 50% of the board if the chairman is an executive director. If not, the figure should be at least 33%. »» A qualified and independent audit panel should be set up with at least three members. All should be non-executive directors, with the majority being independent. »» The clause defines the responsibilities of the audit panel in all matters of financial reporting and enhances the accountability of top management, especially CEO & CFO. »» The revised Clause 49 clarifies the standards of independence for directors by defining ‘independent’ and excluding any relatives of promoters, senior management, former auditors or consultants. Drawback: Sebi does not have the teeth to penalize firms not complying with its provisions. Result: Clause 49 is practiced in letter, not in spirit.

Corporate governancE to Satyam fall out, a number of companies with good governance like Tatas, Wipro, Infosys either gained or suffered marginal loss. It is an opportunity for India Inc. to enhance transparency, efficient allocation of resources and maximizing stakeholders’ value. Company’s board should adopt the accounting standards as stipulated by the ICAI, a duty to maintain proper books of accounts, prepare final statements that conform to acceptable standards and to exercise due diligence before signing the report. Listed companies must comply with RTI Act. Company’s board should frequently assess and monitor risk across the organization. Corporate need to define and implement properly well defined process of recruitment of independent directors. It should be possible to provide detailed information on accounts including the ledger accounts with individual details of debtors, creditors, Bank accounts, inventory, etc in e-form. Rating agencies and Bankers can do independent analysis of the accounts and the type of frauds that were possible in Satyam can be avoided. Let us hope that the Satyam fraud was a derangement and that the lessons learnt from this pusillanimous

crime will help us put into place new regulatory mechanisms that will prevent such acts of shame and disparage in future. This incidence should not color the contribution of the Indian IT industry, which has been a role model for setting standards in corporate ethics and governance for the country and has also pioneered the fundamentals of meritocracy. This episode may be a good opportunity for all of us: governments, private sectors and individuals, to self-reflect and continue to probe deeper internally about our business depth, governance culture, and sanctity of business.

By Ni lofar

IIM Shillong

© The Finance Club, Indian Institute of Management, Shillong

Page 7

FIN TOON

Article of the montH

«««««««««« »»»»»»»»»» Past Trends and Current Opportunities in India at a big enough discount rate to allow some room for error in your estimation of value. However, this does not imply that value investments are low-risk, low-return ventures. In fact, value investors believe that low risk investments actually result in high returns. This is well demonstrated by the success of value investors like Warren Buffet. In this article, this statement will be tested by evaluating the performance of some value stocks in the Indian market during the previous stock-market boom.

Value Investing in Current Scenario The current slowdown has brought about an interesting scenario for stock markets around the world. The stock market is under a strong hold of the bears and investors are wary of putting their money into stocks. The financial sector crisis in the US has seen stocks around the world What is value investing tumble to levels, which were unthinkable less than a couple alue investing is an investment paradigm which of years ago. Most people would thus argue that the best is based on the ideas of Benjamin Graham & strategy to play the stock market right now is to stay away David Dodd. The ideas of this theory developed from it. Value investors, however, differ from this view. The with Graham and Dodd’s teachings at Columbia Business value investing philosophy suggests that the current condiSchool, USA, in late 1920’s. The ideas were presented by Gra- tion provides an excellent opportunity to pick up shares at ham in his books; “Security analysis” and “The intelligent very cheap prices. Talking in Graham’s language, this could investor”. The theory is based on the philosophy of investing be one of the times when the market is unjustifiably pessiin securities which trade at a deep discount to their intrin- mistic on a large number of stocks. This however, does not imply that we should start picking sic value. Warren Buffet is the most up each and every stock just because famous follower of the principles of “The less prudence with which others it is trading at way below its bull-run value investing in the modern world. highs. What this does suggest is that The core principles of value investconduct their affairs, in every bear run, although there ing are the following: are stocks which fall due to genuine • A stock, or any other secuThe greater the prudence with which falls in their values, there are many rity for that matter, has an intrinsic which decline simply because of the value, and this underlying value does we should conduct our own affairs.” widespread pessimism among invesnot depend upon the market price. tors. Obviously, the intrinsic value of • The market, at times, as-Warren buffett the company does not swing with signs prices to certain stocks which the mood of the investors. A large may be unjustifiably low or high. number of stocks consequently end • An intelligent investor buys up taking a huge beating without any when the market price is unjustifiably low and sells when rational reason and hence trading at huge discounts to their it is unjustifiably high. This is best captured by Buffet’s phiintrinsic value. Thus, every bearish phase brings about some losophy of being “Greedy when others are fearful and fearful excellent opportunities for the value investor to capitalize when others are greedy”. upon. In the later part of this article, performance of op• Investors should be prepared for long-term investportunities provided at the end of the dot-com bust, over ments in a stock. Value investing is not concerned with and the subsequent boom in the Indian stock markets have been cannot predict the short-term movements of the market or evaluated. Some stocks which are good value buys in the of a stock. However, a stock which is genuinely underpriced current bear market and should yield excellent returns in will yield significant results in the long run the long run have been evaluated and presented. Value investing as an investment method, is focused on the curtailment of risk in investments. Value investors Value Investment Themes focus on how not to lose money, rather than how to make The major challenge in value investing is to determine huge amounts of money. In this respect, Benjamin Graham the intrinsic value of the company and hence of its shares, talked about introducing a ‘Margin of Safety’ in the analysis relative to the prevalent market price. Value investing works to minimize the downside risk. This just means that you buy

Niveshak

Volume 2 Issue 2



March 2009

Page 8

V

Article of the montH

Performance evaluation of Value Investing In this section, I have made an attempt to evaluate the performance of the value investing approach over the previous bull phase in the stock markets and compare it with the market’s performance in general. Using this comparison, I aim to test if the results yielded by the value investing approach are truly superior to other approaches. This evaluation consisted of the following steps: • Audited financial results of the companies comprising S&P 500 was obtained from CMIE database Prowess for the year ending March 2003 (beginning of the Bull Run) and March 2008. • Various Price ratios and price data for the similar periods was also obtained. • Stocks worth purchasing in 2003 were identified using various value investing criteria. These criteria are: »» Cash Bargain: Stocks were identified as value stocks, based upon the cash bargain theme if their cash + market value of their investments was more than their market capitalization and outsider’s Liabilities. All the stocks that satisfied the criteria were selected »» Debt Capacity Bargain: The debt-raising capac-

ity is estimated using the PBIT figure in the company’s last annual result. It has been estimated that a company can comfortably raise loans which would keep its interest cover ratio above 5. This has been used to estimate the amount any company can safely pay as an annual interest expense. The interest rate has been taken to be at 14 per cent for the calculation of the debt raised which will result in the interest expense calculated above. Both these assumptions are pretty conservative according to the actual conditions faced by Indian companies to raise debt from the market and thus allow for a margin of safety. »» P/E ratio: A stock with P/E ratio of below 2 has been considered to be a value stock. This translates to an earnings yield of 50%, which is much higher than that available on bonds. »» P/B ratio: All stocks with P/B of less than 0.3 were selected. »» Dividend Yield: All stocks with dividend yield of 9% or more were selected. • Based on each of the above value investment themes, I have come up with portfolios of stocks which were highly undervalued in March 2003. I have evaluated the returns obtained on each of these portfolios and compared it with the average performance of the market or the index itself. All stocks in a portfolio were given equal weights. • The return was calculated for each of these portfolios for the period starting from 31st March 2003 to 1st of January 2008. • For the same period, the return of the Nifty was calculated and was compared with the portfolios’ return.

Conclusion The value stocks thus identified were observed to generate returns which were much superior to those generated by the stock markets in general. Some of these stocks produced absolutely staggering results. For example, Videocon Industries which traded at a P/E of 0.14 and P/B of 0.01 in March 2003 moved from Rs. 12.80 in March 2003 to Rs. 811.50 (as on 1st Jan 2008). This stock was a part of 3 of the 5 value investing portfolios. Walchandnagar Industries, which was a part of 2 portfolios shot up from Rs. 2.73 to Rs. 863.20 over the same period. The returns obtained by the different portfolios and the returns of the Nifty are tabulated below. Table 1. Comparative returns of the portfolios and the Nifty Return

Dividend Yield Portfolio

P/E Portfolio

P/B Portfolio

Cash Bargain Portfolio

Debt Capacity Portfolio

Index (Nifty)

Average Return (in %)

4976.55

10713.82

19932.96

14600.87

2283.65

523.65

Average Return

49.77

107.14

199.33

146.01

22.84

5.24

Annualized Return

2.18

2.55

2.88

2.71

1.87

1.39

Annualized Return (in%)

118.47

154.68

188.35

170.94

86.95

39.25

© The Finance Club, Indian Institute of Management, Shillong

Page 9

on various ratios and themes to determine if a stock is under-valued. Some of these ratios are the price-to-earnings ratio (P/E), price-to-book value (P/B) etc. The principles of value investing have been demonstrated with the use of the following themes: • Cash Bargains: A cash bargain arises when the market value of a company goes below the amount of cash and other liquid assets in its possession, net of all current liabilities and debt. In effect, the market is not giving any valuation to the fixed assets, to the inventories, and to the receivables. • Debt capacity bargains: The value of a debt free company has to be substantially more than the amount of debt it can comfortably service. Thus, a company is highly under-valued if its market capitalisation is less than its debtraising capacity. It’s a principle which was first laid out by Ben Graham in Security Analysis. • Price-to-earnings ratio (P/E ratio): This is the ratio of the company’s market capitalisation and the net profit. According to Benjamin Graham’s principles, the earnings yield of a value pick should be very high, or equivalently, its P/E ratio should be very low. Graham said that a stock with an earnings yield of twice the yield on AAA bonds is a safe value bet • Price-to-book value ratio (P/B ratio): The P/B ratio is a ratio of the market capitalisation of a company and its book value. Theoretically, a P/B of less than 1 shows that the market has valued a company below the book value of its assets, adjusted for all liabilities. However, in accordance with the margin of safety concept, value investment requires the P/B ratio to be much lower. • Dividend yield: The dividend yield is a ratio of the dividend paid by a company to its market capitalisation. To an investor, it signifies the annualised return (in terms of dividend) he can achieve by investing at the current market price, assuming that the dividend remains constant over the years. A high dividend yield shows that a stock is undervalued. Graham has used this parameter extensively in The Intelligent Investor.

Article of the montH As can be seen from the above, supernormal returns can be obtained by following the value investing approach. Nifty provided an annualized yield of 39.25%, from Mar 2003 to Jan 2008, which is less than half of the minimum return provided by any of the portfolios (Debt capacity portfolio provided 86.95%). Therefore, it is observed that the returns obtained upon value investment are much higher than those offered by the market in general.

Since it has been established that the value investing themes discussed in this article can help generate superior returns, I have identified some value stocks based on these themes in the current market and thus present below stocks which are expected to produce excellent returns in the future, based on each of the value themes.

Table 2. Value stocks at current valuations based on different themes

Theme

Stocks to look out for

Cash Bargain

Reliance Infrastructure , Hindalco Industries , Aditya Birla Nuvo ,Bajaj Holdings &Invst. , Tata Investment Corpn. , Jai Corp, Jindal South West Holdings, PTC India, Shaw Wallace& Co., Patni Computer Systems, Cairn India, Subex, JM Financial, Hinduja Ventures, Aftek, Mascon Global, Hexaware Technologies, Kolte Patil Developers, BSEL Infrastructure Realty, IL&FS Investmart, Pheonix Mills, Mahindra Lifespace Developers, Country Club (India), Balaji Telefilms, Sasken Communication Technologies, Tanla Solutions, GSS America Infotech

Debt Capacity Bargain

JM Financial, LIC Housing Finance, DCM Shriram Consolidated, Alok Industries, Orbit Corporation, JK Lakshmi Cement, India Glycols, SREI Infrastructure Finance, Vakrangee Softwares

P/E Ratio

Aftek, Amtek India, Vakrangee Softwares, Prajay Engineers Syndicate, Lok Housing & Constructions, JM Financial, Prithvi Information Solutions, IVR Prime Urban Developers, JK Lakshmi Cement, Orbit Corporation, Kolte Patil Developers, JK Cement, Marg, Sujana Towers, Chennai Petroleum Corpn, Kesoram Industries, Mysore Cements, Country Club (India), India Glycols, Bharati Shipyard, Alok Industries, HDIL, Gujarat State Fertilizers & Chemicals Ltd, KLG Systel, Ruchi Soya Inds, Orient Paper & Inds, Gujarat Fluorochemicals, Nava Bharat Ventures, Kei Industries, Ajmera Realty & Infra India, Unity Infraprojects

P/B Ratio

Aftek, Prajay Engineers Syndicate, Country Club (India), Subex, Prithvi Information Solutions, Amtek India, Mascon Global, Vakrangee Softwares, Alok Industries, Bajaj Auto Finance, IVR Prime Urban Developers, Lok Housing & Constructions, Arvind Ltd, Megasoft, Mukund Ltd, Ansal Properties & Infrastructure, Gitanjali Gems, BSEL Infrastructure Realty, Sujana Towers, Kolte Patil Developers, Sasken Communication Technologies, Bharati Shipyard, JSL Ltd, Kei Industries, Ganesh Housing Corpn, JK Lakshmi Cement, Marg, Ruchi Soya Inds

Dividend Yield

Indiabulls Securities, Monsanto India, Chennai Petroleum Corpn, Prajay Engineers Syndicate, SRF Ltd, Indiabulls Real Estate, JK Cement, IVR Prime Urban Developers, Varun Shipping Co, NIIT Technologies, Bongaigaon Refinery & Petrochemicals, Tata Motors, Ganesh Housing Corpn, Graphite India, Finolex Industries, Ashok Leyland, HCL Infosystems, Deccan Chronicle Holdings, Indiabulls Financial Services, Kalyani Steels, Sasken Communication Technologies, Orbit Corporation

By Ankur Khaitan

Niveshak

Volume 2 Issue 2



March 2009

Page 11

MDI Gurgaon

Cover stror Y

««««««««««

...Islamic Finance...

slamic finance refers to a system of financial activity that is consistent with the principles of Islamic law (Shariah). Shariah prohibits the payment of interest or usury, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam). Islamic banking is becoming increasingly popular, having reached $800 billion by mid2007 and growing annually at a rate of more than 15 percent. This has grabbed the attention of governments as they look to fuel their liquidity-strapped economies with money and deposits from the Islamic world. Wall Street now features an Islamic index and an Islamic mutual fund. In these cash-strapped times Islamic Banking presents another alternative for raising money. The rapid development in the use of Islamic finance over the last few years is partly due to the enormous wealth and accordingly liquidity amongst investors in Islamic countries, who want to structure their investments in a Shariah compliant manner, which is becoming a major movement, as Western banks and investors are seeking wealth from oil profits in the Middle East. The stampede into Islamic finance is mostly an effort to tap an estimated $1.5 trillion of funds floating around the Middle East, largely from higher oil prices. The system of Islamic Finance is also being looked towards as an alternative to the existing system so that the crises like the one financial market are currently experiencing can be avoided. As a consequence, a lot of firms are looking at creating Shariah-compliant products to attract the cash-rich Islamic investor’s community, as well as other non-Islamic investors looking for less-risky alternatives.

Features of Islamic Financial Instruments In order to be considered Halal all the transactions and instruments must meet some minimum criteria. All financial instruments and transactions must be free of at least the following five items: Riba

literally translates to usury is more commonly referred to as the charging of interest. Riba can be in different forms and is prohibited in all its forms. For example, Riba can also occur when one gets a positive return without taking any risk.

Rishwah

It translates to corruption in any form

Maysir

It has been taken to mean unnecessary risk, deception or intentionally induced uncertainty. In the context of financial transactions, gharar could be thought of as looseness of the underlying contract such that one or both parties are uncertain about possible outcomes. Alternatively that the contract could be read in a number of ways such that one party could easily deceive (deception) the other party

Gharar

from a financial instrument viewpoint would be one where the outcome is purely dependent on chance alone- as in gambling

Jahl

It refers to ignorance. From a financial transaction viewpoint, it would be unacceptable if one party to the transactions gains because of the other parties’s ignorance.

© The Finance Club, Indian Institute of Management, Shillong

Page 11

»»»»»»»»»» I

The Islamic Financial Instruments Currently, Islamic finance offers basic products and services but is developing quickly, with some forays into project finance, securitization and private equity. »» Derivative Instruments Among the contracts available within the Islamic Framework, two contracts that could be considered a basis for derivative contracts are: • Bai Salam: Salam is essentially a transaction where two parties agree to carry out a sale/purchase of an underlying asset at a predetermined future date but at a price determined today. The seller agrees to deliver the asset in the agreed quantity and quality to the buyer at the predetermined future date. By definition Bai Salam is pretty close to a conventional forward contract in terms of structure. However the two majorly differ in that in a Bai Salam sale, the buyer is required to pay the entire amount in cash at the time the contract is initiated. The premise, on which this concept of prepayment has been built, has to do with the fact that the objective in a Bai Salam contract is to help needy farmers and small businesses with working capital financing. The buyer in a contract therefore is often an Islamic financial institution. A Salam sale thus, is beneficial to the seller. In case of Bai Salam, the predetermined price is normally lower than the prevailing spot price, unlike normal forward contracts, where the forwards prices are typically higher than the spot price by the amount of the carrying cost. The lower Bai Salam price compared to spot can be explained to be the “compensation” by the seller to the buyer for the privilege given to him. The underlying asset, in case of a Bai Salam contract must be standardizable, easily quantifiable and of determinate quality. It cannot be based on a uniquely identified underlying asset. The underlying asset cannot be based on commodity from a particular farm/field etc as by definition such an underlying asset would not be standardizable. The Quantity, quality, maturity date and place of delivery must be clearly mentioned in the Salam agreement. The underlying asset or commodity should be available and traded in the markets throughout the period of contract. The forward contracts being Over-the-Counter products inherently carry the counterparty risk. This risk exists with Bai Salam contracts as well. However, there is a slight difference here as the counterparty risk would be one sided. Since the buyer has fully paid it is only the buyer who faces the sellers default rink unlike forwards/futures. In order to overcome the threat of default on the part of the seller, the Shariah allows for the buyer to require security. This security may be in the form of a guarantee or mortgage. The contract could also form the basis for the provision of working capital financing by Islamic financial institutions. Since financial institutions would not want possession of the underlying commodity, parallel contracts may be used. • Istijrar Contract: This contract has embedded

Niveshak

options that trigger when the underlying asset’s price exceeds certain bounds. The contract is complex in that it involves a combination of options, average prices and Muharabah or cost plus financing. It involves two parties, buyer which could be a company seeking financing to purchase the underlying asset and a financial institution. A typical Istijrar transaction could be as follows: ɶɶ A company looking for short term working capital to finance the purchase of a commodity approaches a bank. ɶɶ The bank purchases the commodity at a current price (P0), and resells it to the company for payment to be made at a mutually agreed upon date in the future, let us say 2 months. The price at which settlement occurs on maturity is dependent on the underlying assets’ price movement from t0 to t60 where t0 is the day the contract was initiated and t60 maturity day. »» Bond Instruments In the Islamic financial system usury and interest are the first elements to be avoided. This however does not mean that the door of debt financing or the possibility of bonds issuance and trading is closed to Islamic finance. Bond instruments that fit with the framework of Islamic finance are: • Ijarah Bonds: Ijarah is a contract according to which a party purchases and leases out equipment required by the client for a rental fee. The duration of the rental and the fee are agreed in advance and ownership of the asset remains with the lessor. Hence, the relationship between the parties differs from that of a debtorcreditor relationship since it is based on buyer-seller of an asset. Ijarah bonds are securities of equal denomination of each issue, representing physical durable assets that are tied to an Ijarah contract as defined by Shariah. The basic feature of Ijarah bonds is that they represent leased assets, i.e. without relating the bonds holders to any common organisation, company or institution. For instance, a machine leased to a company can be represented in bonds and owned by a thousand different bondholders, each of them, individually and independently, presenting his bonds to the company and collecting the periodic rent without having to have any relation with other

Volume 2 Issue 2



March 2009

Page 11

Cover stror Y

Cover stror Y bondholders(similar to dividend). In other words, the Ijarah bondholders are not owners of a share in a company that owns the leased machine, but simply a sharing owner, who only owns one thousandth or more of the asset itself. • Muqaradah or Mudaraba Bonds: Mudaraba or Muqaradah means an accord between two parties according to which one of the two parties provides the capital for the other to work with on the condition that the profit is to be shared between them according to a decided ratio. Muqaradah is thus regarded as an Islamic way of financing completely different from the Riba mode of financing which is based on a predetermined rate of interest. It is the norm in Islamic financial theory of contract that whatever is allowable for an individual contacting party is also for a group of people not necessarily identified by their number or specified by their qualities. Muqaradah bonds on the other hand are based on the conclusion of a lawful Mudaraba contract with the capital provided by one party and labour by the other, while the shares of profit are determined beforehand by a definite proportion of the total. It should be noted that Mudaraba bond bears close resemblance to revenue bond financing in the conventional system. For example a city wants to build a metro railway facility, believing that the new service will provide an alternate means of conveyance to the people. The local government issues revenue bonds in order to finance the construction of the facility. The money for the periodic dividend payment and retirement of the bonds come from ticket sales and other revenue associated with the service. In other words, only

By Ajay Jain, & Saurav D utta

IIM Bangalore

Islamic banking: Indian way ««««««««««

According to an expert, there are over Rs. 40 billion of funds to be invested by Indian Muslims, who account for 15% of the total nation’s population, annually. Indian Muslims annually lose around Rs. 66,700 crores because Muslims have a credit deposit ratio of 47% against national average of 74%. This loss can be avoided by the provision of Shariah compliant finance products. Besides, there are billions worth properties lying in the form of Awqaf. Zakat potential of the Indian Muslims still largely remains untapped and underutilized. In light of the above mentioned facts this story aims to provide a sneak peek into the attractive upcoming industry. Market potential in India The mutual funds, venture capital and a number of likely instruments based on equity financing are considered to be identical to Islamic principles of profit and loss sharing. Also, 61% of the companies listed on the NSE as well as the BSE, the major indices in India, are Shariah compliant, thus capable of inducing high investments. Add to that, the need for business financing in a commu-

nity which boasts 50% self-employment much of which has very few avenues for financing and loans, which inturn affects their ability to compete and grow. Indians working in Middle East and Middle Eastern companies flush with petrodollars can also be a good source of financial resources for Indian financial institutions offering islamically permissible financial services. Porter’s five forces analysis Porter’s five forces analysis of the Islamic Finance Industry In India 1) Threat of New Entrants-High »» More and more companies are planning to enter the market due to slowdown in the western markets »» General optimism with regards to relaxation of banking regulations for opening up the banking sector to Islamic Banking 2) Competitive rivalry within Industry- Low »» Enough space to accommodate several players, low rivalry at least for now.

© The Finance Club, Indian Institute of Management, Shillong

Page 11

»»»»»»»»»»

revenue generated by the metro facility can be used to service the revenue bonds. If the metro service generates enough revenue to pay off the bonds, then bondholders receive their interest and principal in full and on time. However, if the metro service does not generate enough revenue, bondholders either receive their interest and principal later or nothing at all. Similarly, the muqaradah bonds give its owner the right to receive his capital at the time the bonds are surrendered, and an annual proportion of the realised profits as mentioned in the issuance publication. • Musharakah Bonds: Musharakah bonds based on the musharakah contract are relatively similar to muqaradah bonds. The only major difference is that the intermediary-party will be a partner of the group of subscribers represented by a body of musharakah bondholders in a way similar to a joint stock company while in mudarabah the capital is only from one party. It should be noted that almost all the criteria applied to mudarabah bonds are also applicable to the circulation of musharakah bonds. In the wake of the financial crisis that has gripped the world and the questionable performance of the current financial products; the Shariah compliant products provide alternate solutions. The opportunity for growth in the Islamic finance market is dependent on the ability of practitioners to develop new products which fall within what is permissible under Islamic law.

Cover stror Y

Existing Players • There are several Baitul Mals working in cities as well as in villages, deposits of about Rs. 75 crores. Catering to the local population mostly, their sources of funds are limited and as a result operate on a small scale. • Idafa Investment Private Ltd, caters to over 800 clients • Ahmadabad based, Parsoli Corporation, Corporate Member of the BSE and NSE and a DP with the CSDL • Bearys Properties and Development’s Islamic finance arm, Bearys Amanah Investments • Reliance Money presently offers portfolio management to the Muslim HNI; plans to launch an entire spectrum of financial services the Shariah way. Potential Players »» Shariah compliant Mutual Funds • Reliance Mutual Fund • UTI Asset Management • Way2Wealth • Edelweiss Mutual Fund »» Consumer and Home loan Segment • Doha Brokerage and Financial Services Ltd is all set to enter NBFC operations. »» Suite of Islamic financing solutions • Mumbai-based Taqwa Advisory and Shariah Investment Solutions is in discussions with a UAE-based Shariah advisory firm to offer such services Viable Product Mix »» »» »» »» »»

Provision of equity investment opportunities Mutual Funds based on Shariah guidelines Invest in property development Portfolio Management services to Muslim HNIs Provision of Consumer loans, housing loans and

Niveshak

automobile finance »» Offering venture finance on Mudarabha basis as well as on Musharaka Indian Legal System on Shariah Compliant Finance Indian banks are governed under the Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiating Instruments Act and Co-Operative Society Act. Islamic Banking cannot enter the Indian market as a full fledged bank because many banking services like that of Al Wadiah, Mudarabah, Musharakah, Ijarah and Istisna cannot be provided as they go against the above mentioned acts. The BR Act even disallows an Indian bank from floating a subsidiary abroad to launch such products, or offering these through a special window. Thus, it is amply evident that there is no chance of opening an Islamic bank in India in the conventional sense of the way. Thus that leaves us with the option of tapping the potential market in the form of an NBFC. ISLAMIC BANKS (NON-BANKING FINANCING COMPANIES) IN INDIA AND RBI REGULATIONS Islamic Banks (Non-Banking Financing Companies) in India and RBI Regulations Islamic banks in India do not function under banking regulations. They are licensed under Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997, and operate on profit and loss based on Islamic principles. In so far as accepting public deposits are concerned, NBFCs are akin to banks, except that NBFCs cannot accept deposits payable on demand. But it needs to be recognized that as public deposits are unsecured, the accepted global practice is that only banks which are regulated and supervised should be the main institutions that could be permitted to seek public deposits. This is the underlying element of the regulatory regime presently being put in place in respect of NBFCs in India. Al Wadiah (for saving bank account): • Section 21 of the Banking Regulation Act (BR Act) requires payment of interest on such deposits; thus, interest-free deposit and a simple charging of premium or Hiba is not permissible. Mudarabah (for term deposit or investment): • Section 21 of the BR Act disallows such products where the bank can invest the money in equity funds (in India, equity exposure is determined by a separate set of rules), and the client has complete freedom in the management. Musharakah (for project finance and SME credit): • Sections 5, 6 of the BR Act indicate the forms of business a banking company can undertake, and does not allow any kind of profit-sharing and partnership contract the basis of Islamic banking Ijarah (for home finance): • As against Islamic banking where the banks owns the asset and hold the title, Section 9 of the BR Act prevents the bank from any sort of immovable property

Volume 2 Issue 2



March 2009

Page 11

3) Bargaining power of Buyers/customers »» Till date there is no single company in India which offers a complete range of Islamic finance products, as such one can say that the products offered are differentiated to quite an extent »» There are high switching costs involved. 4) Bargaining power Of Suppliers-Medium »» There are few players »» High number of depositors »» Likelihood of the relaxation of banking regulations could bring in Islamic banking which could later on prove to be an enhancer of the bargaining power of suppliers. 5) Threat Of substitutes-Low »» As the people who opt for these services are those bound by religion to invest as per the Shariah guidelines, and any return is better than no return. As such the offerings of a conventional bank or NBFC can never pose as a threat.

Cover stror Y

other than private use. Istisna (leasing, buyback): • Besides the usual curbs on acquiring immovable property, offering Islamic banking products many not are bankable due to stamp duty, central sales tax and state tax laws that will apply depending on the nature of the transfer. Thus, having analyzed the existing situation in India, I feel that it would be best to enter the Indian market

in the form of an NBFC to reap the benefits of the bustling Indian economy and be in a better position to capture a further share of the possible benefits if and when the banking regulations are further relaxed

By Kirat Rawel, &Ramanvir Sarao FMS Delhi

»»»»»»»»»» Islamic banking: THE Future «««««««««« The immense potential of Islamic banking in India can be judged through its vast Muslim population of about 150 million which accounts for 13% of total population. However, 80% are financially excluded owing to unavailability of interest free banking. Sachar committee claims that Indian Muslims have a share of 7.4% in saving deposits while they get only 4.7% in credit. According to RBI annual report for 2007-08, Indian Muslims annually loose around Rs. 63,700 crores which is 27% of their deposits. The total amount of interest lying suspended is a whopping Rs. 40,000crore. Muslims avail just 4% and 0.48% credits from NABARD and SIDBI respectively. Islamic banking will provide a channel for Muslim investors to be a part of the financial sector. As per Mr. Raqeeb, ICIF even if 15% of the Indian Muslim population invest through Islamic Bank, the amount of Investments generated would be Rs 4000 crores which are enormous. India also has a large proportion of poor population having no access to financial services. As per economic census-2005 there were 51 million non-agricultural enterprises in India which required amounts varying from Rs. 25,000 to Rs. 1 million which is too small for most lenders. Only 4.2% of the poor sections had credit from formal institutions. There is desperate shortage of financing for micro and small enterprises and less than 3% of net bank credit goes to them. The growth of Indian economy at 9% (Economic Advisory Council) also highlights large requirement of capital by India. The infrastructure capital requirement is estimated at 8.5% for 2007-08 by EAC. The increase in disposable income of an average Indian household to Rs 1.2 lakh in 2005 and growth rate of 5.3% has increased credit and discretionary spending. This has increased the requirement of housing & other loans and investment capital. There is also a surge of new ventures. This large requirement of capital dictates a strong growth potential for Islamic banks.

nel for investments from the Gulf Cooperation Council (GCC) Countries not investing under credit method of banking thereby attracting trillion dollars of equity finance. According to Global Investment House, GCC countries have invested around $406.3 million in India which constitutes around 1% of India’s total FDI. With the advent of Islamic banks in India, this number is expected to improve considerably. Companies like Kuwait Finance House, Abu Dhabi Investment Company and Qatar investment authority are willing to invest $50-70 million in Indian companies. McKinsey Quarterly Report-July 06 estimates $1.5 trillion investment from Middle-East owing to rising oil prices and is expected to rise to $9 trillion by 2020. It highlights the transition of about $80 billion from US and Europe towards other regions and shift in asset allocation to Asia by 10-30%. McKinsey also estimates the total funds available for investment in Asian countries involved with Islamic banking over the next five years at $250 billion. Average investment per year comes to $50 billion. If India is able to acquire at least 15% of this amount by adoption of Islamic banking, contribution by them to total FDI Inflow will be $7.5 billion which is about 30% of the total FDI Inflow in India for fiscal year 2008-09 and 22% of the $35 billion target for 2008-09. This will greatly aid in reducing current account deficit of the country. Besides these, after 9/11, trillions of petro-dollars are waiting to be invested in India by Islamic Banks. Private equity players predict investment opportunity of $6 billion petro-dollars in India. Thus, Islamic Banking holds immense potential for attracting huge investments from Gulf countries which is highly important in the light of current global financial crisis when India is looking for alternative sources of capital. Significant investments are also expected from countries involved with Islamic banking like U.K, Singapore, China, Malaysia and Japan.

Contribution of Islamic Banks to Indian Economy

The strict obligations of Islamic banks prevent the financial and economic enterprises from bankruptcy. The Islamic banking mechanism also strengthens the credit rating system to provide security of funds for depositors and investors. The credit rating under Islamic banking evaluates real term business potential and growth trends, instead of manipulated asset values responsible for latest financial turmoil. The very fact that Islamic banks do not compete for extra credit shares, provides stability in the financial market. The principle of Islamic prohibits transfer of public deposits to other banks without the permission of depositors. Thus there is no scope for a liquidity crisis to occur. The insulation of Islamic Banks from the existing financial turmoil justifies

Increased Inflow of Funds Islamic Banking will establish an alternative chan-

© The Finance Club, Indian Institute of Management, Shillong

Page 11

Islamic Banking has the potential to tame liquidity and inflation problems, and promote inclusive growth. Increase in interest component of GDP over past years with public-debt/GDP ratio of 79.5% for March 2006 has increased inflation to about 11%. However, equity finance if extended with far lower costs of credit has potential to restrict inflation. Simultaneously the dividend shared by depositors on equity finance helps equitable distribution of income generated by financial sector.

Stability to Financial markets

Cover stror Y

Inclusive growth of population India’s significant growth of about 9% in the recent years cannot be termed equitable. Major part of the population has remained unexposed from organized financial products. With low collateral strength, farmers and poor workers lack access to loans and credits. Islamic Banking has the potential to provide the desired capital to these sections through its unique method of microfinance called ijara-wa-iktina and morabaha. These schemes do not transfer the total interest risk onto the borrowers but risks are shared. For example, Islamic Bank provides capital to a farmer who provides labour to achieve the output. Profits are then equally shared between the two parties. Islamic banks strongly judge the credibility of borrower based upon the potential of their business proposals and thus promote rational, sound businesses backed by strong fundamentals. Introduction of Islamic banking will aid inclusion of Muslims in financial sector. With 31% Muslims living below poverty line and 40% Muslim workers as own account workers, the financial exclusion is apparently a serious economic disadvantage. Islamic banks will enable them to work with other community members cooperatively towards development of economy.

Growth of SMEs As per International Trade Centre, lending to SMEs is limited because of the relatively high transaction costs and perceived risks. RBI has acknowledged decline in SME credit from 15.1% in 1990-91 to 6.5% in 2006-07. Islamic banking through its scheme of Mudaraba can provide the desired funding to SMEs and also share their financial risk, leaving them with only operational risk. This will ensure sustainable growth of SME’s which is essential for the economic growth of country given the fact that SMEs constitute 80% of the total industrial enterprises and have a 40% share in industrial output.

Growth of Capital markets and Corporate Sector Equity financing being the chief investment tool of Islamic bank, stock market will be the most preferred avenue for investments by future Islamic banks of India. Parsoli Investments estimate that about 50% of Indian stocks are Shariah compliant. Thus trading activity on the stock markets will boom with Islamic banks. All the listed companies will get additional potential investors who genuinely subscribe their shares instead of indulging in speculator trading. This increased growth opportunities to the corporate sector will further fuel the economic growth.

Countering Money Laundering Stringent anti-money laundering measures through Islamic banks have been established in countries like Malaysia, Britain and China. The critical managerial control of the fund desired by Islamic banks may not be available with debt finance under interest-based banking. The universal nature of banking through Islamic Banks prevents surreptitious routes for investments and mutual funds.

Niveshak

Islamic Banking, The road ahead… Concept of Islamic banking in India is still in a very nascent stage. There are many roadblocks towards their development. Following are some of the immediate measures that need to be undertaken. BANKING FOR ALL: Islamic banking has been misunderstood in India as a religious charitable venture restricted to country’s economically downtrodden Muslim community. It is essential to shed these inhibitions about Islamic Banking which has more economic rationality compared to religious rigor. Moreover, there are strong possibilities of Islamic banking becoming a political agenda thereby losing its significance. It is necessary to execute appropriate awareness campaign to convey the purpose and importance of Islamic banking for Indian economy and highlight growth of Islamic banking in non-Muslim countries like Britain, Thailand and Singapore. Islamic banks of Malaysia and Britain have registered non-Muslim customers ranging from 10-40%. PARALLEL TRACK BANKING AND COLLABORATION WITH OTHER BANKS: Government should look forward to implementation of the successful Malaysian model of paralleltrack banking which ensures Islamic banks and traditional banks to work in tandem. A feasible option would be to operate Islamic Banks in India through established public sector institutions like SBI, Bank of Baroda, etc. Many private sector banks like HDFC, HSBC, and Citibank have also shown an interest towards such an initiative. Government should also invite the foreign Islamic banks which have gained sufficient expertise to invest in India. Islamic Banking is a powerful economic instrument capable of creating multi-sectoral impacts and should therefore be invited in India. It will contribute to greater financial stabilization, help real economy significantly, provide significant funds for expansion and more than anything act as a powerful antidote to poverty sans huge subsidies and grants that are making a big dent in our fiscal framework. It would open the doors for financial inclusion faster and quicker. There is vast evidence to support this from across the globe. Today, Islamic banking is the buzzword in the global financial world with all the essential ingredients of modern day banking. Its credibility has been timely acclaimed by various research sources like McKinsey, KPMG, BCG and it has enjoyed the recommendations from various imminent personalities. The latest recommendation from Raghuram Rajan committee Sept 08 including Mr. R Ravi Mohan, MD&CEO CRISIL as a member strongly supports establishment of Islamic banking in India. India has already paid a price for being late in catching the globalization bus in 90’s. It should not repeat the same with Islamic Banking and develop a quick and agile strategy towards its adoption.

Volume 2 Issue 2

By Riyaz Vohra

Great Lakes, Chennai



March 2009

Page 11

the stability of Islamic Banking. This has been acknowledged by the fact that Islamic banks have grown by 20% in the year 2007. Overall, Islamic Banks are less risky than conventional banks.

Change economicS

««««««««««

Protectionist Policy of Obama’s Regime o, people are comforting themselves thinking that this economic recession can’t be as bad as the great depression. They might be bracing themselves for a salary cut but they are kind of confident that it won’t go as far as losing their jobs. Just a small rider to people getting this feeling. If they are thinking that the worst of the financial crisis is over, then well, going by US President Barack Obama’s policy, it just might well be on it’s way. We all think that Smooth – Hawley tariff act was draconian. (The Smoot-Hawley Tariff was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels).It worsened the economic condition of the US general population. Unemployment in the US was at 7.8% in 1930 when the SmootHawley tariff was passed, but it jumped to 16.3% in 1931, 24.9% in 1932, and 25.1% in 1933. But refusal to learn from history is an essential ingredient of politics. Obama is already facing pressure from protectionists over the stimulus package. The congress is arguing about a clause in the stimulus package through which only American materials can be used in public works. If this clause is included then even the Detroit carmakers may have to follow this clause. The ‘Buy American’ clause might prove to be a very costly affair for the US. It’s only natural that following this many European and Asian nations will opt for such clauses in their economic policies. Already in Britain and France, politicians are demanding that whatever money is poured to the ailing banks should be lent at home only. China is continuously alleged with manipulating its currency. And this is where we again come back to the conditions that led to the great depression. Whenever politicians are involved in setting economic policies, practicalities take a backseat and it’s only the short term goals that are looked at. During the great depression it was the extremelyhigh-throughput, continuous-flow mass production and, in agriculture, the widespread efficiency gains brought on by the use of farm tractors that led to the passing of Smoot – Hawley act. But it was realized later that this was only an illusion because although the rated capacity had increased tremendously, actual output, income, and expenditure had not. Their intention was to increase the market share of the American companies. When the crisis deepened, only then it was realized that there is no

direct correlation between an economic downturn and the tariff levels. But it was too late to realize this. In response to this act, many European companies had already introduced similar tariffs on US goods and the US industry was dying a slow death. In the Great Depression US GDP had declined by nearly 30%, Industrial output by 45% and there was deflation. The biggest downfall was of the export industry which was in deep trouble. There is nothing wrong in trying to help one’s own industrial sector. In these times of desperation, every country has taken out packages to help some particular sector or the whole of economy. But in recreating the conditions that led to the Bretton Woods agreement would make no sense. One might argue that effect of this stimulus package with the ‘protection’ clause would result in the multiplier effect and hence would stimulate the whole US economy and thus creating approximately 5 million jobs. But the effect it would have on export industry would not very different from what happened during the great depression era. Maybe now the US economy is not under a very severe problem of overcapacity but by killing competition the problems of overcapacity will be created and this would lead to deflation. I am sure the US would not want to have its own ‘lost’ decade, the way Japan had in the 1990’s!!! One can’t overemphasize the effect this would have on the developing nations which work on outsourcing contracts from US giants like Dell, Nike etc. The export sector would be crippled and the economy would be affected drastically. And even these US firms would lose their cost advantage which would lead further cooling of the economy. Barack Obama’s honeymoon with the presidency is over .It’s time for him to think hard over these matters and veto any ‘protectionist’ clause which might jeopardize the US in the long term.

By Yogender Chhibber

© The Finance Club, Indian Institute of Management, Shillong

SIMS Pune

Page 11

»»»»»»»»»» S

Leverage &investmentS

««««««««««

GLOBAL RECESSION

»»»»»»»»»» A

Is this the end oF LBO model?

What is LBO?

leveraged buyout, or LBO, is the acquisition of a company or division of a company with a substantial portion of borrowed funds. It started becoming more popular since 1980’s, with LBO funds raised over around $385 billion till 2000. As increasing amounts of capital competed for the same number of deals, it became more and more difficult for LBO firms to acquire businesses at attractive prices. In addition, senior lenders have become increasingly wary of highly levered transactions, forcing LBO firms to increase the level of equity. In the beginning, the average equity contribution to leveraged buyouts was 9.7% while it reached around 40% in the beginning of 21st century. As a result of these developments, generating target returns (typically 25% to 30%) have become more difficult. Where once they could rely on leverage to generate returns, LBO firms today are seeking to build value in acquired companies »» By improving profitability »» Pursuing growth including roll-up strategies (in which an acquired company serves as a “platform” for additional acquisitions of related businesses to achieve critical mass and generate economies of scale). »» Improving corporate governance to better align management incentives with those of shareholders. LBO funds generally use the following two methods for the valuation of established companies that can be targeted for acquisition: »» Market Comparisons: These are metrics such as multiples of revenue, net earnings and EBITDA which can be compared among the private and public companies. Usually a discount of 10% to 40% is applied to private companies due to the lack of liquidity in their shares. »» Discounted cash flow (DCF) analysis: This is based on the concept that the value of a company is based on cashflows that can be produced in future. An appropriate discount rate should be used to find out net present value.

tal structure of an LBO is summarized as below:

(Source : Centre for PE -Tuck school of business)

This structure varies from company-to-company and also between industries in most of the cases. To determine the optimal debt capacity for a potential Leverage Buyout target, factors like the outlook for the company’s industry and the economy as a whole, seasonality, expansion rates, market swings and sustainability of operating margins should all be considered. There are many advantages for using leverage in acquisitions which can be discussed as below: • Large interest and principal payments can guide management to improve performance and operating efficiency. This “discipline of debt” can cause management to focus on certain initiatives such as »» Divesting non-core businesses, »» Downsizing, cost cutting or investing in technological upgrades that might otherwise be postponed or rejected outright. In this manner, the use of debt serves not just as a financing technique, but also as a tool to force changes in managerial behavior and focus of company towards various operational activities.

Transaction structure of LBO

Niveshak

Volume 2 Issue 2



March 2009

Page 11

The major part of an LBO consists of Debt component with the debt-to-equity ratio of around 2:1. So, in order to meet the huge requirement of debt, an LBO will often have more than one type of Debt. The capi-

Leverage &investmentS

ing Mezzanine funding will demand extra premium in terms of high interest rate and also beneficial Warrants to convert the debt to equivalent equity shares. Both of these factors are unfavorable for the PE firm using LBO model. Scene of LBO in India DIFFICULTIES DUE TO RESTRICTIONS ON FOREIGN INVESTMENTS IN INDIA Only 2 routes for Foreign Capital to be directed towards India: a) Foreign Institutional Investors (FII): They have the ability to buy and sell securities freely on a stock exchange. However, their investments in an Indian Company cannot exceed more than 24% of the total paid up capital. Moreover, they are heavily regulated by SEBI with cumbersome registration processes and are not permitted to hold more than 10% of the share capital of any publicly listed company. b) Foreign Direct Investors (FDI): FDI route is used when the foreign investment is more than 10%. Off-market or Non-stock exchange purchases can be executed through FDI and it is the only route available for investing in unlisted companies in India. However, the restrictions include FDI sector caps in different sectors as set by the Govt. Of India. UNDERDEVELOPED CORPORATE DEBT MARKET India still has a bank-dominated financial system, with bank-dominated loans measuring 36% proportionate to GDP and corporate debt only 4%.State-owned public sector undertakings (‘PSU’) which started issuing bonds in financial year 1985-86 account for nearly 80% of the primary market. Compared with the government securities market, the growth of the corporate debt market has been much less. Also, a bulk of the debt has been

© The Finance Club, Indian Institute of Management, Shillong

Page 11

Effects of recession on various debt component To finance their transaction, the LBO private equity company makes use of tranches of debt. In reality, the LBO transaction is financed mainly by two tranches – Senior & Junior. Now we will analyze the effect of Recession on these financial components. 1. Bank Debt: It is usually provided by the Commercial bank. In case of defaults or liquidation of the company, Banks have the most senior claim in the business cash flows. Bank debt usually comprised of two components: a) Revolving credit facility: It serves as a line of credit that allows the firm to make certain capital investments, deal with unforeseen costs, thus providing a lot of flexibility to the bought-out firm. In the period of recession the credit policies are very strict and even if loan interests are relaxed, there is a big uncertainty regarding the availability of the Credit. Hence to finance their transaction, private equity players make use of other costly debt instruments. b) Term Debt: It is often secured by the assets of the bought-out firm, is also provided by the banks and insurance companies in the form of private placement investments. It is usually priced with a spread above treasury notes and has maturities of five to ten years. In the period of recession, the initial amount of Term Debt from the bank will not be sufficient for the deal. Term debt amount and rate depends upon the Interest coverage ratio & stable cash flow of the firm over the loan period. During recession, stable cash flows & profits are not very lucrative so the banks will be reluctant to give loan. 2. Mezannine Financing: It is junior to the bank debt incurred in financing the leveraged buyout and can take the form of subordinated notes from the private placement market or high-yield bonds from the public markets, depending on the size and attractiveness of the deal. During the recession phase, the availability of cheap debt funding is not easy. Moreover the company provid-

Leverage &investmentS raised through private placements.

(Source : KPMG India. 2007. “India Budget 2007 Highlights)

The overwhelming dominance of private placements can be attributed to the following factors: a) Ease of issuance b) Cost efficiency, and c) Primarily Institutional demand.

FOCUS AREAS The Service-Sector companies are the most soughtafter for LBO in India, with the outsourcing and hightechnology companies leading the pack. Recent acquisitions of Flextronics Software Systems and GECIS are prime examples. These companies are labor-intensive and their costs are globally competitive due to a low-cost, highly educated English workforce in India. With a phase of consolidation looming large in these sectors, there is a very good chance of these companies changing ownership through LBO in recent future.

vestor. Most of the equity returns are generated from growth by scaling and ramping up the operations of the portfolio company through hiring and training employees, expanding capacity and adding additional customer contracts. This sort of rapid scaling up of operations requires high quality management talent, robust internal processes and a large pool of skilled human resources. FUTURE OF LBO IN INDIA The Future of LBO in India depends on a large number of Factors. There is no dearth of companies that can be acquired, with the service-sector booming, but until the regulations by SEBI are relaxed, it will be very difficult for the LBO funds to source the money to acquire their targets. The risks that come along with the high-growth companies have to be kept in consideration, as also the risks involved in giving more allowances to FII’s and FDI’s by SEBI. On the whole, the prospect looks bright if all the factors fall in place.

By Arpit So lanki Avik Roy Ankit Agar w al

IIM Kozhikode

HIGH GDP GROWTH IN INDIA With the Indian economy registering a consistent over 9% growth rate during 2005-07 and an expected creditable 7.5% in FY08, the Indian companies have a huge chance to grow. This makes them all the more attractive to the LBO funds as they can get the acquired company’s revenues pay for the debt taken by the LBO funds. Indian companies face large capital requirements and despite the ample availability of capital in the international markets and in India for portfolio investments, there is a shortage of capital for funding operations and growth. The NASSCOM-McKinsey report estimates that the offshore business process outsourcing industry will grow at a 37.0% compound annual growth rate, from $11.4 billion in fiscal 2005 to $55.0 billion in fiscal 2010. The NASSCOM-McKinsey report estimates that India-based players accounted for 46% of offshore business process outsourcing revenue in fiscal 2005 and India will retain its dominant position as the most favored offshore business process outsourcing destination for the foreseeable future. Also, retail banking, insurance, travel and hospitality and automobile manufacturing have been identified as the industries with the greatest promise for offshore outsourcing and being targeted by LBO.

Niveshak

Volume 2 Issue 2



March 2009

Page 22

RISK FROM HIGH-GROWTH CHARACTERISTICS The High-Growth characteristics of Indian Companies bring with them a greater execution risk for the management of the target company and the financial in-

InstitutionS

Concerns with n the last two editions of this series we have seen the role that needs to be played by International Monetary Fund (IMF) and World Bank in the current crisis. The third in the series is the role that can be played by World Trade Organization (WTO).

The World Trade Organization is a major player in the field of global governance. Since its creation in January 1995, it has expanded the reach of trade rules deep into the regulatory structure of almost 150 sovereign states, affecting the daily lives of all citizens. As a result, it has found itself at the centre of controversy in areas that are well outside the domain of traditional trade policy. The ree trade policy is found to be benefitting the developed countries more than the developing countries. The financial crisis in the US is now converting into a contraction in real demand for goods and services globally. This is mainly because the US by itself accounts for about 30 percent of world demand. The latest International Monetary Fund (IMF) forecast sees world trade contracting by 2.8 percent this year after growing 4.1 percent in 2008 and 7.2 percent in 2007, a particularly worrying trend as slowing trade growth is now the main depressing factor on world output. Although this recession is the worst since 1930s, there is a crucial difference: the level of coordination among countries in financial and other markets is quite significant today. Lack of this coordination (both domestically and internationally) was a major lacuna in the 1930s. The main problem with this lack of coordination is that the required demand corrections rely entirely on markets which are typically known (a la Keynes) to fail in such times. The main difference today as compared to the 1930s is the existence of international coordinating institutions. For trade we today have the WTO, which coordinates tariff concessions between countries. However, the failure to close the Doha round of trade negotiations during the past seven years or so has made many observers doubt the efficacy of the WTO in fairly regulating world trade. Yet, paradoxically, the role of the WTO is far more critical today in preventing tariff wars. It is, therefore, essential for the WTO to use the

current world economic crisis to try t o obtain final closure of the Doha round. It is unfortunate that the Doha closure was postponed recently mainly because of a rather silly US stand on what import surge in agriculture constitutes a reasonable trigger for safeguard action by developing countries. Again, the recent draft which brings in sectoral level negotiations in NAMA is likely to muddy the waters. That trade and global commerce is the first casualty of world recessions is well known. As unemployment drops in countries there are increasing political demands (more so in democracies) to ‘keep jobs at home’. The US which had taken the lead role in liberalization through the 1980’s and 1990’s has taken a U-turn in its policy. One has already seen this in some of Barack Obama’s statements in the US. The bill to tax outsourcing heavily is already underway. Obama’s intent to insert labor and environmental standards into the NAFTA Treaty is seen as more mercantile, to America’s benefit, than favoring global free trade. One of the emerging trends of this recession is the emerging protectionism. Although the exact details of the measures taken by various countries are not available, there is clearly a move in that direction. Erecting trade barriers to defend jobs may deepen the global recession by making it harder for other countries to sell their goods abroad, as occurred during the 1930s Great Depression. World bodies must ensure multilateralism as unilateral actions, in such circumstances, are irrational. The WTO has shown its resilience by keeping markets open during periods of financial and external payments crisis, the multilateral trading system has shown that it can give a chance to crisis-stricken countries to recover through trade. However, to do so, access to trade finance at affordable rates must be maintained in such critical times to ensure that international trade can continue to play its shockabsorbing role. The global financial crisis has put pressure on the system of trade credit that underpins world trade, making exporters and

© The Finance Club, Indian Institute of Management, Shillong

Page 22

»»»»»»»»»» I

««««««««««

InstitutionS

importers pay far higher prices for the loans that allow them to transport goods globally. Important players like banks either lack funds or are too risk-averse to extend export credit in times of economic uncertainty. The primary role of the WTO at this moment is to serve as an insurance policy against protectionism; especially for developing countries, whose expansion relies very much on trade. Many developing countries rely on trade finance - loans tied directly to cross-border trade transactions - to help fund their participation in the global market. But with many banks short on cash, such loans are now hard to come by. Affordable access to trade financing in such crises is crucial to ensure that international trade can help absorb the shock of a global economic crisis. However the point in favor of trade financing is that trade finance is widely considered one of the most secure modes of finance. The loans have a short maturity, their execution is relatively routine, and the traded goods themselves can serve as collaterals. The priority task is to enhance capacity to mitigate the effects of the increased perception of risks and to provide the market with earmarked liquidity for trade finance.

vestment restrictions) in coming months. WTO members could agree to a new system of surveillance that would track and report all new national trade restrictions. The WTO must also shift focus from the traditional role of reducing trade barriers at the borders, such as tariffs and quotas and more recently regional and bilateral free trade agreements. The challenges of the current times call for a more up-to-date understanding in an interdependent world. In areas such as climate change, the challenge is to coordinate or reconcile domestic policies to promote a common global objective while also avoiding trade barriers. The WTO should also move beyond the straitjacket of the “grand bargain” negotiating round, in which progress cannot be achieved unless all countries reach agreement on all subjects. Instead, certain negotiating subjects could proceed separately or in clusters, expediting agreement and making the WTO more responsive to rapid changes in the global economy. The challenge is not to rebuild the WTO from scratch, but to rethink how the WTO can better address emerging global issues.

The stimulus package and the financial bailouts are also seen as a more insidious form of protectionism because they favor domestic producers and poor countries cannot afford the cash. They are also expected to distort the competition between the institutions.

By Manjunath M

IIM Shillong

Niveshak

Volume 2 Issue 2



March 2009

Page 22

A drastic action is needed in the immediate future to revive the fortunes of the WTO and the multilateral system. WTO trade ministers should formally agree to a “stand still” pact, by which all member states would pledge not to introduce new protectionist measures (increased tariff rates, a surge of safeguard actions, in-

Food for thoughT

««««««««««

Is India’s growth story mostly debt driven?

General definition of GDP is :GDP = C + I + E + G where, C - Consumption I - Investment E -Exports over Imports G - Government Spending

L

et us first take the “E” part of it. Given that India has a trade deficit, this should be a negative contributor to the equation but let’s have a look at the following: Over the last 5 years the imports have risen by around $180 bn. But about $115 bn dollars of these imports were supported by incremental external debt taken during the same time. During this time frame, fertilizer imports jumped from $6 bn to $54 bn. I think it is fair to assume that this has been exclusively financed by government through additional debt issuance. Petroleum imports have jumped from $17 bn dollars to $80 bn. Some part of it is financed by the government. If we add up all these, all the incremental imports in the country in the last 5 years have been financed by debt, mostly external. Thus essentially all the earnings from exports ended up supporting incremental consumption/capex/savings in the country, since our import liabilities were handled by debt. (This is on a overall balance sheet basis, not oneto-one correspondence between imports and debt) Thus, even though the “E” part in the above equation was negative, still the debt driven financing gave a big boost to the “C” and “I” part of the equation. Given that the exports have gone up by $105 bn in this time, that is the amount of stimulus the economy would have received and these numbers do not include the software exports or the remittances. To put that into context, in the last 5 years the GDP has roughly gone up from $700 bn to $1000 bn @ around 8.5% p.a. Thus a big chunk of the incremental $300bn GDP was from export earnings coming through as consumption and capex. If the above theory is reasonably sound then - the savings rate (%) of the country is inflated. We should probably subtract the incremental external debt for the year before coming to the number. (The savings in the country is like taking loan from Bank A and keeping it in Bank B and calling it savings). And if this conclusion is correct, savings rate should fall this year given the problems in getting exter-

nal finance. The Indian consumption story has also been debt driven rather than earnings driven. It’s just that the individuals are not saddled with big debt, but big corporate houses and government are. And to that extent I also think that the so called domestic consumption story was overestimated and is now unraveling. (As can be seen from falling vehicle sales and even falling consumer nondurables!!!). In fact I think it will be quite a while before we are able to sell 1.4 mn passenger vehicles again in a year. It is always argued that India’s internal domestic structure will ensure minimal impact of external environment. But as we have seen above, exports have a huge part to play in the growth seen in the period and consequently we would see a more than marginal impact of the deteriorating global environment. It was ironical but for a country with a current account deficit, we were piling on forex reserves. But as we saw above, it was majorly driven by debt and not earnings. Of course, FII and FDI money also came in hoping to cash in on the “India growth story”. Since exports are now de-growing and domestic consumption also tapering off, I would think capex would come to a grinding halt. What happens next year, given that oil prices have collapsed and there would be much lesser pressure on the current account. Given the exports are falling, how much help would be given is a question mark. We might even end up having small current account surplus next year, but that is at the cost of huge slowdown in growth. I am not sure if it is a positive signal. To conclude while adding roughly $300bn to GDP in the last 5 years, our external debt has gone up by $ 110 bn dollars and Central government’s debt has gone up by around 13.5 lac cr (roughly $250bn, excluding government’s share of external debt). Is India’s growth mostly debt driven? I don’t think this is sustainable kind of a growth model...then how do we build one?

By P uja Kasat

© The Finance Club, Indian Institute of Management, Shillong

FMS Delhi

Page 22

»»»»»»»»»»

PerspectivE

««««««««««

A Different Perspective!

T

he year 2008 was an unprecedented year in many ways. As a consequence of the financial crisis and the number of external shocks financial markets had to deal with, extreme volatility, record high risk aversion, and a wave of de-leveraging that caused a deflationary shock, 2008 will certainly get its place in the history books. Also with the fundamentals of companies facing dire crises all over the world and fundamental accounting standards going for a toss with the Satyam fiasco, let us look towards history and statistics to provide us with a fresh and rational perspective. If we look back over the past year, with a -38.4% the S&P-500 posted its 3rd worst year since 1800 and the sensex shed a whopping 52.86 % (source: Bloomberg). But next if we look at the market reflexes after such an extremely negative year, we had in most cases substantial bounces if not even the start of a new bull market in the following year. Since 1800, the S&P-500 experienced 20 years with a loss of 15% and higher. The record down year was 1931, where the US market lost 47% of its value. In 14 out of 20 cases the market managed a bullish following year with an average performance of some 22.3%. So, one key message for this year is that from a statistical standpoint alone we have a 70% likelihood that 2009 will end up as a positive year for the markets. And if there is a positive bias in the chance of developed markets ending the year in green, then it is safe to say that the chances of emerging markets giving substantially higher gains is much more. Now that we have probability on our side and little optimism behind our backs, let’s move on to a term which has been literally ignored since after the market crash last January: Decoupling. Decoupling was what was rumored to happen between the developed and the developing economies before Wall Street debacles took down the world with it. Let’s now look at it again in a new light. The world is one leveraged bet on the US consumer. But as the US consumer cuts back on his spending, export growth of Asian countries plumbs new depths. So, in this cycle, there is no decoupling, or there was no decoupling. What about future cycles? There is scope for hope.

Niveshak

Asian banks and financial institutions—on t h e whole—are in better shape. Bloomberg produced a nice chart showing the superior relative performance of stocks of Asian financial institutions in the Morgan Stanley Asian financial index, compared with those in the indices for American and European financials. The contrast has been more noticeable since the collapse of Lehman Brothers in mid-September last year. This is grounded in fundamentals. Fifty-six per cent of the global write-offs and write-downs by financial institutions have come from the US, 36% from Europe and only 8% from Asia. And these are very encouraging statistics. Perhaps Chinese banks are slightly more vulnerable, for the country was high on confidence, had institutional structure that facilitated directed lending and had enough global cheerleaders to take them down that path. Korean institutions and households are genetically hardcoded to assume leverage of Western proportions. Indian banks would have walked down that path gladly but the RBI effectively forbade them from doing so. So, Asian banks are in considerably better shape. Their credit intermediation has been disrupted not by the state of (ill) health of their and their clients’ balance sheets, but by the economic cycle. Further, a survey conducted by the Duke University on the cash levels of financially constrained and unconstrained non-financial firms, their credit availability and their investment plans for the future shows that Asian firms are much better placed than their Western counterparts. Also according to another study, India fares better than some developed countries in terms of M&As. The size of “completed” M&A deals for India had declined by 25%, according to an 9 October Thomson Reuters report— exactly in line with the global average and significantly better than a 28% decline for the US, 57% for France and 32% for the UK. This suggests that economic growth will be both relatively and absolutely better in Asia. A few days ago Merrill Lynch and Co.’s North American economist, David Rosenberg gave the following advice to investors: “Investors looking for growth should look beyond the American consumer and housing market. These areas of the econo-

Volume 2 Issue 2



March 2009

Page 22

»»»»»»»»»»

PerspectivE my, even after they stabilize, are unlikely to be the leaders in the next economic expansion or bull market. Investors are advised to seek out the countries, most of them in the emerging market world, which have the cash, the surpluses and the savings rates that can liberate consumers on the other side of the ocean. The global economy has relied for far too long on the American consumer for growth, but that well has run dry—and this time, for good.”

FinQ January’09 Issue Answers

1. Bretton Woods Institutions(1) Bretton Woods Hotel, (2) Logo of International Bank of Reconstruction & Development (IBRD) and (3) Logo of The International Monetary There are two points that emerge from this quote Fund (IMF) . — one, the decline of the US; and the second is the rise of 2. X- Franco Modigliani the emerging markets. Y- Merton Miller American state at present continues to be the Z-M & M theorem big hope, not only for its citizens, but for international 3. (1) Business Week Cover Page – 21st capital. But if, as more and more voices are arguing, the September’ 1998: After the LTCM outcome of the crisis is a depression and if it leads to a collapse fundamental change in the way the global economy has (2) Price Waterhouse LLP- Auditors been arranged for the last quarter of a century, there for LTCM could be huge tensions building up within the US. The (3) When Genius Failed: The Rise and impact has been one where Wall Street makes huge prof Fall of Long-Term Capital Manage its from financial activities, its companies increasingly ment by Roger Lowenstein offshore their operations in places such as China and In(4) Myron Scholes-Member of Board of dia, while Main Street prosperity is fuelled by debt and Directors at LTCM; Nobel Price rising asset values. This system revived growth, but also Economics Winner in 1997 had the added advantage of disciplining labor, as a result (5). Robert Merton-Member of Board of of which the share of labor in national income in the US Directors at LTCM; Nobel Price went down strikingly. Economics Winner in 1997 The problem is that it is not possible to get back to 4. Carol Bartz, New CEO of Yahoo! the world of the 1950s, a world in which there was no 5. Life Insurance Corporation of India, ICICI global production system. As for investors putting their Prudential, Unit Trust of India, General money in emerging markets, it would be best to sum Insurance Corporation of India and Asian up by quoting investment guru Jeremy Grantham’s word Development Bank.Connect: Credit Rat “We’re simply getting more mature, and all the other deing and Information Services of India veloped countries are doing the same thing. But emerging Limited (CRISIL) was established by UTI, has not fallen off its trend line, and has a lot of people ICICI, LIC, GIC and the Asian Develop coming into the workforce and a huge savings rate. I ment Bank in January 1988. think it will do very well. Put it this way, it will appeal to 6. Nick Leeson investors. It may not make any more earnings per share, 7. Syndicate Bank in other words. I’m not talking about true fundamental 8. Rothschild Family value. I’m talking about how people buy stocks. They love 9. Phenomenon is known as the “Mark top line growth. If they’re going to grow at four-and-aTwain Effect” or “October Effect”. The half and we’re going to slow down to two-and-a-half, it’s quote is by Mark Twain in his book going to look like a no-brainer. So, I think the next big titled, “Pudd’nhead Wilson”. event in emerging will be that they will sell it at a big P/E (price to earnings) premium over us developed countries, 10. Diners Club Credit Card. who are suffering from a terminal case of middle-aged spread, I think.”

By Subhada

© The Finance Club, Indian Institute of Management, Shillong

Page 22

NMIMS, Mumbai

FinloungE

FinQ 1. Identify the advertisement of the institution which moves your money from there to here.



2. Identify the Company?

3. He used to earn money by repairing toy trains at the age of 13. After escaping from British Police, his father landed in USA in 1920 with $20 in his pocket and later married an American school teacher and settled in Philadelphia. His corporate headquarters is known as “The Mountain”. Identify him. 4. Identify this Coat of Arms

5. Identify the logo.

6. In which country’s coins you can see the following lines imprinted, ‘This is the root of all evils’. 7. What term became popular after the newspaper report of Watergate Scandal in the year 1973? 8. What term in Oxford Advanced learner’s Dictionary latest edition describes “a person who lost his job owing to heavy outsourcing in his company” 9. X laid the foundations of the New Delhi based Y Group in the 1970s with a small bicycle-parts business. In 1985, he entered the telecom business by establishing Z that manufactured telephonic equipment. In the same year, Z entered into technical collaboration with Siemens AG (Germany) for manufacturing electronic push button telephones. Z also signed an agreement with Takacom Corporation (Japan) for manufacturing telephone answering machines. Identify X, Y and Z 10. What is the name given to banks that have no physical presence and conducts business over the phone, through the mail, by fax, or over the Internet.

Niveshak

Volume 2 Issue 2



March 2009

Page 22

All Enteries should be mailed at [email protected] by 30th March 23:59 hours One lucky winner will receive cash prize of Rs 500/-

Team niveshaK

ARTICLE OF THE MONTH

The article of the month for March 2009 goes to Mr. Ankur Khaitan of MDI Gurgaon. He recieves a cash prize of Rs.1000/-. CONGRATULATIONS!!

Fin-Q Winner for Last issue

Mr. Manas Jain of NMIMS University, Mumbai. He receives a cash prize of Rs.500/-. CONGRATULATIONS!!

All Are INVITED!!

The team Niveshak invites article from B Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month.” and would be awarded cash prize of Rs.1000/Please send your articles before 31st March 2009 to [email protected]. Do mention your name, institute name and batch with your article. Format: Font:- Times New Roman, Size:- 12, Length <= 5 Pages in word doc/docx. Please DO NOT send PDF files and Kindly stick to the format.

Number of authors 3 at max.

SUBSCRIBE!! Get YOUR OWN COPY DELIVERED TO INBOX Drop a mail at [email protected]

© The Finance Club, Indian Institute of Management, Shillong

Page 22

Thanks Team Niveshak

COMMENTS/FEEDBACK MAIL TO [email protected] www.iimshillong.in ALL RIGHTS RESERVED Finance Club Indian Institute of Management, Shillong Mayurbhanj Complex,Nongthymmai Shillong- 793014