Finetheus - January 2013

FINETHEUS | January 2013 FinNiche - IMT Ghaziabad

1. From the Editor’s Desk 1

2. Policies in the Insurance Sector 2

3. General Anti Avoidance Rules (GAAR) 7

4. US Fiscal Cliff - What Lies Ahead 11

5. Government of India and RBI 16

6. Does the Buy and Hold Strategy Really Work Amid 21

the Current High Volatility in Equity Market ?

7. Golden Rules : Gold Rules 26

8. New Private Sector Banks in India 31

9. Crossword 36

Contents


Globalization and investment form an integral part of most of the developed as well as

developing economies. These components equip any nation with new skills and provide

smooth access to markets & technology. Today, every nation across the globe is looking for

foreign and overseas investors be it India, China or even US. But in the absence of signs of

global recovery, will the current domestic policies be able to boost demand and investment

in India is the question.

FinNiche, the Finance Club of IMT Ghaziabad, brings to you the January 2013 edition of

Finetheus focusing on the impact of government‟s policies on FDI, subsidies, forex

management, insurance etc, on the investment sentiment in our country and the economy as

a whole.

We are very grateful to Dr S.C.Jain (Ex-ED, LIC) and Dr Amit Agarwal (Tax Director,

Ernst & Young Pvt. Ltd.) for the highly informative articles on „Policies in Insurance Sector‟

and „GAAR‟ respectively.

This issue also features articles from the entries we received in the article-writing

competition.

Below are the winning entries:

1. Shilpa Sardar and Prajata Das Chowdhury from FMS, Delhi for “US Fiscal Cliff :

What lies ahead”

2. Deependra Kumar and Ashish Khare from MDI, Gurgaon for “Government of India

and RBI: An Evolving Relationship”

3. Chaitanya Gandhi from JBIMS, Mumbai for “Does the 'Buy and Hold' strategy really

work amid the current high volatility in equity markets?”

4. Sinjana Ghosh from VGSOM, IIT Kharagpur for “New Private Sector Banks in India:

Industry Analysis”

5. Raghav Agrawal from SIBM, Bangalore for “Golden Rule: Gold Rules”

Heartiest Congratulations to all the winners!

We would appreciate feedback and suggestions for improvement. We hope to bring you

more information in the future thus keeping you updated and adding to your knowledge base. Till then, Happy Reading!

Team FinNiche

Finetheus

January 2013

Faculty Mentor

Dr. N.L. Ahuja

Team FinNiche

Ajay Krishnaraj

Akshay Kansal

Bhavya Agarwal

Deepak Garg

Divya Satsangi

Himika Chaudhary

Jack Ruzario

Mayank Swarup

Rishabh Jain

Sutapa Mishra

Vikram Jain

Vinita Deswal

Yash Asthana

From the Editors’ Desk

Disclaimer: The views presented are the opinion/work of the individual author and Team FinNiche, IMT Ghaziabad bears

no responsibility whatsoever

1

Dr. S .C. Jain

EX—ED LIC &

CEO LIC Housing

Faculty - National

Insurance Academy

He retired as an

Executive Director

cum CEO LIC

Housing Finance

Ltd in Feb 2004. He

was also called for

interview for the

position of

Chairman of LIC

by Ministry of

Finance.

FINETHEUS | January 2013 FinNiche - IMT Ghaziabad 2

Introduction

Indian insurance industry is one of the premium sectors showing upward growth trend. The world insurance industry is a $400 trillion industry. Globally, India is the fifth largest life insurance market in the emerging insurance economies and is growing at 32-34 percent annually.

The economic reforms initiated in the early 90s paved the way for the growth and the opening up of the financial sector, which led to a sustained period of economic growth. The insurance industry was opened up for private players in 2000, and has seen tremendous growth over the past decade with the entry of global insurance majors. India is fast emerging as one of the world‟s most dynamic insurance markets with significant untapped potential.

The insurance sector plays a critical role in a country‟s economic development. (1) It acts as a mobiliser of savings, a financial intermediary, a promoter of investment activities, a stabilizer of financial markets and a risk manager. (2) The life insurance sector plays an important role in providing risk cover, investment and tax planning for individuals; the non-life insurance industry provides a risk cover for assets. (3) Health insurance and pension systems are fundamental to protecting individuals against the hazards of life, and India, as the second-most populous nation in the world, offers significant potential for that type of cover. (4) Furthermore, fire and liability insurance are essential for corporations to safeguard infrastructure projects and investment risks. Private insurance systems complement social security systems and add value by matching risk with price.

By the nature of its business, insurance is closely related to savings and investing. Life insurance, funded pension systems, and to a lesser extent, non-life insurance, will accumulate a significant amount of capital over time, which can be invested productively in the economy.

Insurance

Insurance is a contract between two parties whereby one party called insurer undertakes in exchange for a fixed sum called premium, to pay the other party called insured a fixed amount of money on the happening of certain event. Every asset (living and non-living) has a value and it generates income to its owner. The income has been created through the expenditure of effort, time and money. Every asset has expected lifetime during which it may depreciate and at the end of life period it may not be useful, till then it is expected to function. Sometimes it may cease to exist or may not be able to function partially or fully before the expected life period due to accidental occurrences like burglary, collisions, earthquakes, fire, flood, theft, etc. These types of possible occurrences are “risks”.

Future is uncertain; nobody knows what is going to happen? It may or may not? Insurance is the concept of risk management – the need to manage uncertainty on account of above stated risks. Insurance is a way of financing these risks either fully or partially. Insurance industry has both economic and social purpose and relevance. Insurance business in India can be broadly divided into two categories: Life Insurance and General Insurance or Non-life insurance.

Policies in the Insurance Sector

By S C Jain, Ex - Executive Director, LIC


Evolution of the Insurance Industry

The growing demand for insurance around the world continues to have a positive effect on the insurance industry across all economies. The insurance industry in India has come a long way since the time when businesses were tightly regulated and concentrated in the hands of a few public sector insurers. Shown in the table below is the chronological order of the evolution of the industry.

Year Significant Regulatory Event

1818 Oriental Life Insurance Co. was established in Calcutta

1870 The first insurance company, Bombay Mutual Life Insurance Society, was formed

1907 The Indian Mercantile Insurance Limited was formed

1912 The Indian Life Insurance Company Act

1928 Indian Insurance Companies Act

1938 The Insurance Act: Comprehensive Act to regulate insurance business in India

1956 Nationalization of life insurance business in India with a monopoly awarded to the

Life Insurance Corporation of India (LIC)

1972 Nationalization of general insurance business in India with the formation of a holding

company General Insurance Corporation

1996 Setting up of (interim) Insurance Regulatory Authority (IRA) Recommendations of the

IRA

1998 The cabinet decides to allow 40% foreign equity in private insurance companies - 26%

to foreign companies and 14% to Non-resident Indians and Foreign Institutional

Investors

1999 The IRA bill is renamed the Insurance Regulatory and Development Authority Bill

2006 Relaxation of foreign equity norms, thus facilitating the entry of new players


Country No. Of Policies per 100

persons

Indonesia 2

Philippines 5.6

India 12.4

Thailand 14.7

South Korea 70.5

Taiwan 75.2

Singapore 112.6

Japan 198

On Going Scenario

The major market share of the insurance sector is with LIC. Above shown pie chart gives us the

insight of the market shares which the public as well as private companies are sharing.

Reforms in Insurance Sector

The Government introduced reforms in the insurance sector in 1990s, primarily to encourage

more domestic investments to increase insurance coverage and create an efficient and

competitive insurance industry. The Government‟s monopoly came to an end in 1991 when

Year Reform

1957 Framing of a code of conduct by the general insurance

Council to ensure fair conduct and ethical business practices

1991 Beginning of economic liberalization

1993 Malhotra committee set up to complement the reforms

initiated in the financial sector

1994 Detariffication of aviation, liability, personal accidents and

health and Marine cargo products

1999 IRDA bill passed in Parliament

2000 IRDA incorporated as the statutory body to regulate and

register private sector insurance companies

GIC and its four subsidiaries made India‟s national reinsurer

2005 Detariffication of marine hull

2007 Detariffication of all general insurance products except of

the auto third-party liability segment


The effect of insurance reforms has been positive on the insurance industry. There has been

positive growth in all the segments, with investments flowing in the right direction. Reforms have

helped to achieve rapid growth in critical areas and sustain them over a period of time through

channelized strategies. Post reforms, the number of players have increased from four in life

insurance and eight in general insurance in 2000 to 21 life players and 20 general insurance

players, including one reinsurer, in 2008.

Critical Factors for market development of insurance sector

Distribution channels

The effectiveness and cost of diverse distribution strategies of different players is crucial in

ensuring the success of players in the insurance business, particularly in the retail lines of

business. The low differentiation among retail insurance products suggests the criticality of

distribution reach and efficiency for success in this business.

The factors that determine the choice of the distribution channel of an insurance company are:

• Where are the customers?

• What is target customer profile?

• Which product (linked, traditional, term, etc.) can be sold through distribution channel?

• Which channel provides best buying experience and value to target customer segment?

• What is the operational cost involved in each type of channel?

The customer preferences vary by market segment vis-à-vis geography, age, income, life style,

etc., and market characteristics change over time. The figure below provides an estimate of the

current market share of the various distribution channels used by life insurers, and gives a view of

how these channels could develop in the future.


Challenges with the existing distribution model are:

• Building faith about the company in the minds of clients.

• Intermediaries being able to build personal credibility with clients.

• Controlling operating expenses by reducing distribution costs.

• Coping with IRDA norms on their commission.

Increasing Financial Inclusion

There are various measures that have been taken to increase insurance penetration in India. Some

of these are listed below:

1.Increase financial literacy.

2.Motivating Indian households transfer savings from physical assets to financial assets.

3.Improve access and reach vast sections of the underprivileged and low-income groups.

4.Insurance as a tax saving instrument.

Consumer needs and preferences

The growth in insurance industry has been spurred by product innovation, vibrant distribution

channels, coupled with targeted publicity and promotional campaigns by the insurers.

One of the crucial areas in the insurance sector is the adoption of new technology in the industry.

E-commerce will be increasingly used in all the sectors, including banks & insurance and products

will be sold on the internet more often. Project insurance is another area, which is increasingly

gaining significant traction.

Insurance plans for children are fast becoming popular, as they not only offer payouts that can be

timed to coincide with certain milestones in a child‟s life, but also financial security if the parent

dies.

Emerging lifestyle trends amid a changing fabric of the Indian society have also modified social

and financial behavior. For instance, an increase in the number of working women has led to a

demand for life insurance policies, which in turn has helped women through a

micro-entrepreneurship initiative.

Dr. Amit Agarwal

Director, Tax &

Regulatory services

Ernst & Young

He is a fellow member

of the Institute of

Charter Accountants

of India and is also a

certified Public

Accountant from

Delaware (USA). He

has considerable

experience in advising

clients on FDI and

exchange controlled

regulation


Definition

GAAR is a concept which generally empowers the Revenue Authorities in a country to deny the tax benefits of transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit. Whenever such transactions are being questioned by the revenue authorities, there is a conflict with the tax payers. Thus, different countries started making rules so that tax cannot be avoided by such transactions. Australia introduced such rules way back in 1981. Later on countries like Germany, France, Canada, New Zealand, South Africa etc too opted for GAAR. However, countries like USA and UK have adopted a cautious approach and have not been aggressive in this regard.

Thus, in nutshell we can say that GAAR usually consists of a set of broad rules which are based on general principles to check the potential avoidance of the tax in general, in a form which cannot be predicted and thus cannot be provided at the time when it is legislated.

Difference between GAAR and SAAR

Anti Avoidance Rules are broadly divided into two categories namely "General" and "Specific". Thus, legislation dealing with „General‟ rules is termed as GAAR, whereas legislation dealing with „Specific‟ avoidance is termed as SAAR. In India till recently SAAR was in vogue i.e. laws were amended to plug specific loopholes as and when they were noticed or were misused en-masse. However, now Indian tax authorities wants to move towards GAAR but are facing severe opposition as tax payers fear that these will be misused by tax authorities by giving arbitrary and wide interpretations.

We can say that SAAR being more specific

provides certainty to taxpayers where as

GAAR being general in nature can be

misused and is subject to arbitrary

interpretation by tax authorities.

GAAR in India

In India, the real discussions on GAAR came to light with the release of draft Direct Taxes Code Bill (known as DTC 2009) on 12th Aug,2009. It contained the provisions for GAAR. Later on the revised Discussion Paper was released in June 2010, followed by tabling in the Parliament on 30th Aug, 2010, a formal Bill to enact the law known as the DTC 2010. The same was to be made applicable w.e.f. 1st Apr,2012. However, owing to negative publicity and pressures from various groups, GAAR was postponed to at least 2013, and was likely to be introduced along with the DTC from 1st April 2013.

General Anti Avoidance Rules (GAAR)

By Dr. Amit Agarwal, Ernst & Young


It was likely to be introduced along with the Direct Tax Code (DTC) from 1st April 2013.

Moreover, an Expert Committee has been set by Prime Minister (Manmohan Singh) in July

2012 to vet and rework the GAAR guidelines issued in June 2012. The latest reports

(September 2012) indicates, it may not be implemented even for 3 years i.e. this will be postponed for 3 years (2016-17).

Implications

It empowers officials to deny the tax benefits on transactions or arrangements which do not

have any commercial substance or consideration other than achieving tax

benefit. It contains a provision allowing the government to retroactively tax overseas deals involving local assets (like Vodafone).

Will P-Notes be targeted?

Investments into Indian stock markets through participatory notes might slow after the

introduction of GAAR. According to data from market regulator SEBI, P-notes issuance

reached Rs. 1.83 trillion at the end of February, about 16.4% of total assets under the foreign investor inflow scheme. P-Notes are

instruments used by investors or hedge funds that are not registered with the SEBI to invest

in Indian securities and they offer the buyer anonymity. The tax would be imposed on the

registered financial firm buying the security on behalf of the client, meaning the brokerage would then pass on the taxes to the end

investor.

To avoid tax altogether under GAAR, an

investor may now have to prove the P-note was not set up specifically to avoid paying taxes or

to prove that the deal has commercial substance.


What happens to the Mauritius route?

GAAR could allow the tax dept to deny double taxation treaty benefits to foreign funds based out of tax-havens like Mauritius. India

has a Double Taxation Avoidance Agreement with Mauritius. Overseas portfolio investors,

routing their investments via countries like Mauritius, currently do not pay any tax on

short-term capital gains. If GAAR is implemented, FIIs domiciled in such treaty locations may have to prove that they have

created this structure for genuine business purposes and not just for avoidance of tax.

Recent developments regarding GAAR

16th March,2012: Finance Minister announces that the govt will crack down

on tax avoidance effective from fiscal year 2012-13.

7th May, 2012: Finance Minister forced to eat his words and agreed to defer GAAR by a year as his announcements

spooked overseas investors.

28th June, 2012: Finance Ministry

releases first draft on GAAR; there is wide criticism of the provisions.

14th July, 2012: Manmohan Singh, forms review committee under Parthasarathi Shome, for preparing a second draft and

final guidelines by 30th Sept, 2012.

1st Sept, 2012: Shome Committee

recommends deferring GAAR by three years. It also recommends some more

investor friendly measures.

1st October 2012: Finance Ministry says the final guidelines for GAAR to be

issued by October 2012 end.

17th November 2012: Finance Ministry says the final amendments to GAAR has

been finalised.

What is the Basic Criticism of GAAR?

The basic criticism of GAAR provisions is

that it is considered to be too sweeping in nature and there was a fear that Assessing

Officers will apply these provisions in a routine manner and harass the general honest tax payer too. There is only a fine distinction

between Tax Avoidance and Tax Mitigation, as any arrangement to obtain a tax benefit can

be considered as an impermissible avoidance arrangement by the assessing officer. Thus,

there was a hue and cry to put checks and balances in place to avoid arbitrary application of the provisions by the assessing authorities.

It was felt that there is a need for further legislative and administrative safeguards and

at least a minimum threshold limit for invoking GAAR should be introduced so that

small time tax payers are not harassed.


Examples to Understand GAAR provisions

Example 1:

Fact: A business sets up an undertaking in an

under developed area by putting in substantial

investment of capital, carries out manufacturing activities therein and

claims a tax deduction on sale of such production/manufacturing. Is GAAR

applicable in such a case?

Interpretation: There is an arrangement and

one of the main purposes is a tax benefit.

However, this is a case of tax mitigation where the tax payer is taking advantage of a

fiscal incentive offered to him by submitting to the conditions and economic consequences

of the provisions in the legislation e.g., setting up the business only in the under developed area. Revenue would not invoke GAAR as

regards this arrangement.

Example 2:

Fact: A business sets up a factory for

manufacturing in an under developed tax exempt area. It then diverts its production

from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of

packaging there). Is GAAR applicable in such a case?

Interpretation: There is an arrangement and

there is a tax benefit. The transaction lacks

commercial substance and there is misuse of the tax provisions. Revenue would invoke GAAR as regards this arrangement.

Shome Committee: Deferment of GAAR by

3 years and more investor friendly measures

By recommending that it should apply only to cases where tax benefit is the main objective of

an arrangement or transaction and not one of the main objectives, the Committee has taken the sting out of GAAR as originally envisaged.

Rarely, if ever, can tax authorities prove conclusively that obtaining tax benefit was the

main objective of an arrangement or transaction. The Committee‟s report should

also warm the hearts of foreign investors routing funds into India through sham companies based in Mauritius - it has

explicitly stated that “GAAR provisions shall not apply to examine the genuineness of the

residency of an entity set up in Mauritius”. In other words, a Tax Residency Certificate from

Mauritius is enough to override GAAR provisions. This kills one of the most laudable objectives of the rules as envisaged in the

Budget - that of plugging a loophole which foreign institutional investors exploited to

avoid paying capital gains tax in India.

Shilpa Sardar

(FMS Delhi)

Email :

[email protected]

Prajata Das

Chowdhury

(FMS Delhi)

Email : Prajata.c14

@fms.edu


The United States fiscal cliff can be referred to the economic effects that could result

from the tax increases and spending cuts that will be in practice from 2013 if existing

laws are not changed. These laws on one hand will reduce fiscal deficit to a great

extent but also has the potential to hinder economic growth pushing the country to recession. Hence there are arguments and

counter-arguments for and against for fiscal adjustment. This article will discuss the

following aspects of the fiscal cliff:

Alternatives put forward by CBO

Components of the fiscal cliff

Need for the fiscal adjustment

Limits and targets to fiscal restructuring

Effect on world economy

Our outlook and conclusion

Alternatives put forward by CBO

Congressional Budget Office (CBO) is responsible for providing economic data to the US government. It is a federal agency

under the legislative branch of the US government.

The fiscal cliff and the steps taken to mitigate it will have effects on the fiscal

deficit i.e. the debt and tax revenues. The CBO has put forward two scenarios for the coming 10 years.

* The baseline scenario: This scenario will

result if current laws are not altered. This

will result in lower deficits and debt combined with spending cuts and higher

taxes.

* The alternate scenario: This scenario

will result when some specific laws are

changed to reverse or stall the effects of the fiscal cliff.

The following graph obtained from a CBO report shows the pronounced

difference between the two scenarios. If no action is taken to alter the current

laws, the economic scenario closely resembles the baseline projection. On the

other hand if the fiscal cliff is not succumbed to and some tax cuts and spending patterns are continued we will

have a scenario resembling the alternate scenario.

Baseline Projection :

The CBO since 1985 has been publishing

baseline predictions for the coming fiscal

years.

The positives:

The estimate they have come up

with shows that fiscal deficit will be

reduced from an estimated 8.5% of

GDP in 2011 to 1.2% by 2012.

US Fiscal Cliff - What Lies Ahead

By Shilpa Sardar and Prajata Das Chowdhury


Revenues would rise from 18% (historical average) to 24% of GDP.

Debt reduction of about 7 billion USD vs increase in debt by 10-11 billion USD if current policies are extended.

The negatives:

The GDP growth is likely to be reduced from 1.1% to 0.5% in the short run.

High chance of recession in the initial part of the year followed by 2.3% in the second half.

Alternate fiscal scenario:

The positives: Short-term impact on the economy is

avoided at the time of high unemployment

The negatives:

Revenues will remain on and around the historical average of 18% GDP.

Public debt rises from 69% of GDP in 2011 to 190% of GDP by 2035

Components of the fiscal cliff

Economic Growth and Tax Relief

Reconciliation Act (EGTRRA) and

Jobs and Growth Tax Relief

Reconciliation Act (JGTRRA): These

laws combined have cut government

revenue by about 2.6 percentage points of the GDP. A large permanent tax cut may have looked feasible a decade ago after

the budget surpluses of the late 1990s, but it looks far less feasible today, after

three years of fiscal deficits close to 10 percent of GDP and a surge in debt held

by the public from about 40 to about 70 percent of GDP.

Expiration of temporary payroll tax cut: This tax cut has temporarily eliminated 2 percentage points out of the employee‟s 6.2 percent Social Security tax on the first $110,000 of salary.

The compromise budget control act: This act provided that if a super committee could not agree on fiscal cuts, an automatic mechanism beginning in 2013 would cut spending by $109 billion annually, divided evenly between defense and nondefense non-entitlement spending.

Expiration of emergency unemployment benefits and surge of collection of alternate minimum tax (AMT): The two components of the monetary budget repeatedly dealt with annual „fixes‟.

The following table put forward by a CBO report

lists down the major components of the fiscal cliff and their respective sizes. The first column

reports the impact of the fiscal cliff for FY2013 before December 2012, a nine-month period. The final column annualizes these amounts to

obtain an approximation of the full effect for calendar year 2013. On an annual basis the total

impact of the fiscal cliff amounts to a reduction in the federal budget deficit of about $800 billion.


The need for fiscal adjustment

The US fiscal history can be divided into two parts:

1. From 1990-2007: Government revenues were

around 18% of GDP while spending was

about 20%

2. From 2007-2011: Government revenues went

down to 15.8% of GDP while spending rose to

23.5%

Thus the government fiscal deficit also rose during

the second phase. The fiscal cliff hence seems to be

a necessary evil.

However there will be a loss of 1.6% of GDP in the short term on submitting

passively to the current scenario. This sacrifice on GDP will mean loss of demand

and will result in higher unemployment. Again reduction in demand would mean a

sacrifice in potential output rather than a redeployment of resources from use in government purposes to use in private

purposes. If instead there were no excess capacity and unemployment were at, say, 4

to 5 percent, a case could be made to simply allow the fiscal cliff effects to

happen.

Category FY2013 CY2013

Revenue Increases

Expiration of certain provisions in income tax,

estate tax, and AMT indexation at end-2012

221 294

Expiration of employee‟s payroll tax reduction 95 126

Other expiring provisions 65 86

Taxes in the Affordable Care Act 18 24

Subtotal 399 531

Spending reductions

Automatic cuts, Budget Control Act 65 86

Expiration of emergency unemployment benefits 26 35

Reduction in Medicare payment rate for physicians 11 15

Subtotal 103 137

Other revenue and spending changes 105 140

Total reduction in deficit: Direct (percent of GDP

in parentheses)

607(3.7) 807(4.9)

Effect of economic feedback -47 -62

Total change (percent of GDP in parentheses) 560(3.4) 745(4.5)


Hence any fall in US markets due to a fiscal

cliff could cause a fall in all emerging stock

markets including India.

Effect on other economies

According to a CNN report the failure of the US political class to deal with the fiscal

emergency correctly can affect economies world over. The following are pointed out as possible outcomes:

The GDP of China might take a direct hit from the fiscal cliff baseline scenario. The major reasons will be decrease in trade with the US. There would also be an impact due to changes in inflation and interest rates.

Countries like Singapore and Switzerland which are dependent on exports will also face slowing down of economy. The projected fall of growth in Singapore will be about 0.2%.

The model proposed by UN estimates decline in both direct and indirect trade.

Our Outlook

The fiscal cliff scenario requires pragmatism.

The importance of balancing long-term deficit reduction with actions that would not slow the

economy in the short-run cannot be over emphasized.

In general the US government has to look back at the components of the cliff objectively and decide on the elements that are desirable and

the ones that can be avoided. A complete submission to the scenario may be just as bad

as taking steps to stall the change altogether. A time phased implementation of the changes is

what is desirable. A focused approach we believe will be a much better way to go about things rather than taking the route of across the

board tax increases and spending cuts.

Limits and targets to fiscal restructuring

The fiscal restructuring should look at the

following targets. These targets are formulated

keeping in mind the long term as well as short

term requirements in the economy.

Overall, in the medium term federal spending needs to be held down to a range of 20 to 22 percent of GDP and federal revenue needs to recover to a range of 18 to 19 percent of GDP.

For the financial year of 2013 CBO has projected govt spending to be at 23.5% of GDP which will result in a deficit of 7.2% in the alternate scenario. Thus the basic target will be to raise revenue by 1.5 to 3 percent and cut spending to around 1.5 to 3.5 %.

Suppose for simplicity one were to adopt the averages of these ranges as the targets, placing the spending cut at 2.5 percent of GDP (to 21 percent of GDP) and the revenue increase at 2.2 percent of GDP (to 18.5 percent of GDP). The medium-term deficit would then be 2.5 percent of GDP.

Effect on Indian Economy

Since the India is not one of the countries that

exports manufacturing outputs to the United States the only sector that can be affected is

the services sector. Again services industry will not be affected much as it is majorly a cost cutting measure to outsource for the US

companies.

The US indices are currently trading very close

to an all time highs. So it is natural for them to fall at the beginning of 2013 when the US

economy finally falls off the cliff. Some experts are of the opinion that the equity markets of countries like India might be a safe bet for

investments. However these markets share a positive correlation with market performance

of the west.


Conclusion

As discussed in the article succumbing to fiscal

cliff will not be right due to the current state of

the economy and the levels of unemployment.

There has been a lot of procrastination

involved in the process given the presidential

elections. But now the situation is ominous

and steps need to be taken proactively.

Targeted relaxation of taxes and spending cuts

as suggested by a lot of experts may be the way

to go forward and possibly only way to protect

small and midcap enterprises.

As far as the common man is considered, these

are some suggestions for him:

Play it safe: It is suggested to move to

investments which have low risk and

regular returns. It is also advised to take

into consideration the exit options while

making an investment.

Go high on savings and cut down

expenses: Cut down on debts especially

avoidable ones like credit cards. Plan to

make healthy savings and move towards

value with your purchases rather than

going for flashy.

Be opportunistic: The fiscal cliff will

bring with itself lower interest rates which

will be a good opportunity for purchase

of useful assets. The opportunities need

to taken with both hands.

Deependra Kumar

(MDI Gurgaon)

Email :

pg12deependra_k

@mandevian.com

Ashish Khare

(MDI Gurgaon)

Email:pg12ashish_k

@mandevian.com


The nature of functions discharged by the central bank and their relation with the

functions discharged by the central government has been debated for a long

time. Together the central bank and the central government of a country are

responsible for putting the economy on the path of prosperity and success. However, due to the complex nature of

the relations between the functions performed by these two entities, there

could be instances when central bank and the government are at odds against each

other. Since the time India gained freedom, socialist ideas were promoted and the role of government and RBI was

to guide the stressed economy. The objective was to promote balanced

growth in general and also to take initiatives for the welfare of the people.

However, it was not until 1991 that

effective economic reforms were

introduced in the country which placed India on the path of high economic

growth. It is since then that the role of the central bank, that is, the Reserve Bank of

India has widened in scope. It is in the light of the developments in the Indian economy after 1991 economic reforms

and the major economic events such as the 2008 recession and the Euro zone

crisis that we will analyze the relationship of the Reserve Bank of India with the

central government with a focus on their existing relationship.

Role of Government

The role of government in the economy is to maintain growth and generate

employment for the citizens of the country. The government in order to achieve its objectives tries to mould the

overall pace of economic activity by maintaining steady growth, high levels of

employment and price stability.

Role of Central Bank

In developing countries central banks play a very important role in not only

regulation but also development. RBI in addition to performing the traditional roles of central bank also plays a very

important role of development of the country by manipulating monetary

policies. The central bank of the country establishes a suitable interest rate

structure to manage the investment in the country. The rates also decide the money supply in the market so by changing the

rates the central bank manages inflation and growth.

Government of India and RBI

- An Evolving Relationship

By Deependra Kumar and Ashish Khare, MDI


Conflict of Monetary Policy & Fiscal Policy

The conflict between monetary policy and

fiscal policy arises because of difference in the

goal of Government and the central bank.

While the aim of Government is high growth

and low unemployment, the main aim of the

central bank is economic and price stability.

The core issue of the conflict of interest

between monetary policy and public debt

management lies in the fact that while the

objective of minimizing market borrowing cost

for the Government generates pressures for

keeping interest rates low, compulsions of

monetary policy amidst rising inflation

expectations may necessitate a tighter

monetary policy stance. Therefore, the

argument in favour of separating debt

management from monetary policy rests on

the availability of effective autonomy of the

central bank, so that it is able to conduct a

completely independent monetary policy even

in the face of an expansionary fiscal stance of

the government.

Sometimes the conflict between the two also

arises on using the foreign reserve of the

country. While the Government intends to use

the reserve to finance its projects, the central

bank wants to keep it for the reserve purpose

to improve the safety and liquidity.

Relation of RBI and Government of India :

History

Post Independence

Post independence government triggered the

economic growth through large public

investment which was facilitated by

accommodative monetary and conducive debt management policies. RBI played a crucial role of financing the government debt

by monetizing and maintaining interest rates at artificially low levels so that the cost of

borrowing for government remains cheap.

By the end of the 1980s a fiscal-monetary-

inflation nexus was increasingly becoming

evident whereby excessive monetary

expansion on account of monetization of

fiscal deficit fuelled inflation.

Post 1991

After 1991 despite the fact that fiscal compression was on its way and efforts were

made by RBI in moderating money supply during the early part of the1990, the

continuance of the adhoc Treasury bill implied that there could not be an immediate

check on the monetized deficit. In order to keep check on the unbridled monetization of fiscal deficit, the first supplement argument

between RBI and the Government of India was started in 1994 to set out a system of

limit for creation of ad hoc Treasury bill during three years. Later the second

supplemental agreement was done in 1997 to completely phase out the treasury ad hoc bills. By 2006, under the provision of FRBM,

participation of RBI in primary auctions of government has also been stopped.


Post 2008 Recession- The relationship

Post 2008 recession, Indian economy struggled to keep inflation low, and there were fears that the current high levels of inflation may

become the “new normal” for the Indian

economy. To deal with the inflationary

pressures, the RBI raised the repo rate by 375 basis points and the CRR ratio by 100 basis

points between 2010 and 2011.

Inflation and repo rate trend

Despite these actions the inflation continued

to remain high. Analysis of the sector

composition of growth reveals that the growth

moderation during 2008-12 has been driven

largely by manufacturing and agriculture

sectors. The sources of inflation during

post-crisis period suggest that the increase in

inflation was contributed by more than

doubling of food price inflation to 11.8 per

cent during 2008-12.

A major factor from the demand side

contributing to the persistence of food price

inflation, which caused generalization of

inflation and fuelled inflationary

expectations, was the sharp increase in rural

wages.

While RBI was trying to tame the inflation,

government on the other hand was trying to

prevent the country from recession by giving

many benefits to the mass to increase

consumption and hence increase the growth.

The difference in the goal of the two entities

has recently become public when

Government asked RBI to reduce the interest

rates so that the growth is not hampered due

to the monetary policy.


A look at the US Economy: Relation of

Government and Federal Reserve

The low growth in USA is the major concern

for both government and the central bank.

The grave problem of liquidity trap is on the

verge and a good mix of fiscal and monetary

policy is what is needed in this case. While

the central bank has kept the interest rates low

the growth targets are still not achieved.

Central bank needs to ensure that the rate will

be kept low past the crisis. On the other hand

fiscal policy is more effective during such

times because government doesn‟t need to

promise anything past the crisis but it

becomes difficult for the government to sell

such an idea. There are limitations to both

kind of policies and hence it became all the

more important for both government and

central bank to hold hand in hand. The

strategy best suited was to campaign on both

the fronts of the policies and that is what is

implemented in US. While the government is

ensuring that austerity is bad, the fed is

ensuring the investors that the rates will not

be hiked until they see high level of inflation.

Conclusion

As much as we try to blame “cost push“

being the prime factor behind this persistent

inflation , there is a growing need to realize

the fact that a sound fiscal situation ensures

that inflation is contained . A country which

has strong fiscal fundamentals hardly finds

itself struggling to keep inflation low.

What also needs to be realized that even if

the monetary policy framed by the Reserve

bank of India is set to keep the current levels

of inflation low and the fiscal policy aims to

reduce revenue collection from people

through reduced tax collections, money

financing will eventually be required by the

central government. This will mean a

dependence on borrowing and hence an

upward push on the borrowing costs for the

government leading to higher inflation once

again. Hence it is of great importance for the

both the monetary and fiscal policy to be in

tandem with each other.

Growth and repo rate trend


It is in this context today that the RBI and the

central government are in a conflict with each

other. There are concerns about the lower

expected GDP growth rate by the GOI and

the RBI is concerned about the persistently

higher inflation.

An important area of focus today thus has

been the containment of the fiscal deficit. If

we look at the RBI claims, it wants the

government to reduce its expenses on

subsidies rather than increasing the taxes so

as to contain the fiscal deficit. A deteriorating

fiscal situation has also posed dangers of

credit rating downgrade from the credit

rating agencies. This will have direct

implications on the investor confidence and

will pose a big threat to putting the economy

back on the trajectory of higher growth. The

government has responded to this situation

by showing firm resolve to improve the fiscal

situation through a number of policy

initiatives. However the government blames

RBI for playing it safe by not reducing the

lending rates and only altering the CRR rate

in the some of the recent monetary policy

reviews. However, RBI has its own problems

which have forced it to maintain a tighter

monetary policy. The depreciating rupee,

euro zone crisis, rising oil prices have forced

RBI to keep the interest rates high. As much

as it appears that it will help to contain the

inflation we see that the food inflation has

remained more or less the same level. This is

because of the fact that RBI is trying to

control inflation by focusing on demand push

inflation whereas the current inflation levels

have a lot to do with the cost push inflation.

Thus RBI policy is going wrong here and

hence needs corrective actions. However the

fact that the rupee has undergone serious

devaluation over the course of past one year

and the oil prices have remained stubbornly

high, lowering interest rates poses risks of

worsening this situation.

It is thus important for both the RBI and the

central government to work in accordance

with each other. Rule based fiscal policy by

the central government will become

increasingly important to afford the space for

monetary policy to contribute to

macroeconomic stability. Fiscal prudence by

the central government to alleviate resource

constraints by boosting domestic saving will

be crucial for raising domestic investment

rate. In addition to this RBI will also have to

take certain strong measures to infuse more

liquidity into the system by lowering the

interest rates keeping in mind the fact that the

major cause for high inflation has not been

the demand push inflation. The quicker this

important realization occurs to both the

central and the Reserve Bank of India;

quicker will be the improvement in the

India‟s growth prospects and between the

relationships of the central government with

the RBI.

Chaitanya Gandhi

(JBIMS )

Email :

chaitanyagandhi14

@jbims.edu


“Higher the Risk, Higher the Return” has been the motto of all the business

across the globe since time immemorial. The Equity Markets have been the

personified version of this motto. Various strategies have been developed

by the most elite and erudite of the investors to succeed in this high risk avenue. The most popular and well

accepted is the Buy and Hold strategy or the Long-term Investment Strategy.

Choosing a good company for the portfolio will make a difference to the

profits but holding the same for decades shall make the profits mammoth sized as

compared to trading it every day. Even the uncrowned emperor of stock

markets, Warren Buffett relies on a Buy and Hold strategy for investments and it can be said that as an investment

strategy, it‟s one of the most optimum options one has for increasing the wealth

over the long term, in almost every situation. Warren Buffett is listed on the

Forbes 2012 World‟s Billionaire List as the third-richest man in the entire world.

However, as per John Melloy in his blog at CNBC, the Buy and Hold Strategy

has taken a fair amount of beating in the recent times. As per the blog, it is the

mainly the high frequency traders that make the money in the world. As per the analyst Alan Newman‟s Crosscurrents

newsletter, the average holding period of stocks has fallen from four years in the

period 1926 – 1999 to 3.2 months now and the same for S&P 500 SPDR (SPY),

the ETF which tracks the benchmark for U.S. stocks, is less than five days!

„Given recent average volume, the SPY

trades its entire capitalization and then

some each and every week,‟ wrote the

analyst. „Does anyone really wish to

argue where valuation might enter the

picture in this scenario? Value does not

matter in the slightest.‟

This dissertation aims to have an

expression on whether the annulment of

the “Buy and Hold” Strategy has really

taken place? It is done vide:

Understanding the Buy and Hold

Strategy, its advantages and

disadvantages.

Analysing the top indices across the

world for the last ten years

Concluding on the invalidity of the

long term investment strategy in

such volatile times or otherwise.

Does the Buy and Hold Strategy Really

Work Amid the Current High Volatility

in Equity Market ?

- By Chaitanya Gandhi, JBIMS


What is Buy and Hold?

Investment Strategies are the various rules,

behaviours or procedures designed and used

by various investors for stock selection and

forming a portfolio. The investors design

strategies as per their risk appetite and try to

achieve a risk-return trade-off.

Buy and Hold is a long-term investment

strategy based on the view that in the long

run, financial markets give a good rate of

return irrespective of periods of volatility or

decline. Also, it advocates that short-term

market timing, i.e. the phenomenon that one

can enter the market on the lows and exit on

the highs, doesn‟t work. Moreover,

attempting market timing gives adverse

results, at least for small-sized or

unsophisticated investors. Hence, it is far

better for them to follow the Buy and Hold

Strategy.

The theory behind the Buy and Hold strategy

is ‘It's impossible to consistently achieve above

average returns, on a risk-adjusted basis, according

to the efficient market hypothesis (EMH). Investors

have access to information that will fairly value a

security at all times. Therefore, it is pointless to

make decisions that might result in the active

trading of a security.’ Hence the disciples of Buy

and Hold find no reason to trade in stocks on

a day-to-day basis. The only area of focus is

that the long term trend in the market should

be a positive. The antithesis of buy-and-hold

is the concept of intra-day trading, in which

money can be made in the short-term taking

advantage of greater volatility.

There are several advantages of Buy and

Hold Strategy:

1. E a s i l y C o m p re h e nd i b l e a nd Implementable

2. Supported by Investment Theory

3. Reinforces the „Minimum Emotions – Maximum Discipline‟ approach

4. Outperformance of the Passive Investing over Active Investing

5. Cost-Effective as compared to Active Trading

The Disadvantages of Buy and Hold

Strategy:

1. No upper limit to losses

2. Test of Risk Appetite – Investors may lose if they don‟t have sufficient risk appetite

3. Buy and Hold Approach may not provide Maximum Possible Returns as much as in Minute to Minute approach

Performance of various indices across world

The best way to take a call on the

effectiveness of the strategy is to look at the

historical results. For this, a sample of the top

ten indices of the world is taken into

consideration. Following are the

performances of the various top indices of the

world.

As can be seen from the below chart, most of

the top indices have shown a low return over

the ten year period with spikes in between.

Infact the Tokyo Index - Nikkei 225 has

given a negative return of 17%, which means

that a person invested in Nikkei keeping a

Buy and Hold Strategy in mind for ten years

would have lost 17% of his investment

instead of gaining anything.


The mean return (arithmetic mean) and

standard deviation of the yearly returns

achieved by these indices are shows in the

adjacent table. The mean returns of the

samples taken into consideration show that the

average yearly return is below 10% in most of

the cases. Also, the high rate of standard

deviation shows that there is a lot of volatility

in the market and this makes the investments

high on risk factor as well.

As can be seen from the above table, there is

a disparity in the performance of the indices.

Some of the indices have given exceptional

returns over the years as high as 534% over

ten years, whereas others have others have

given a return of around 20% for the same

period. The negative returns in the five-year

period 2007-Nov, 2012 has offset the gains

earned in the five-year period 2001-2006 due

to which the ten-year returns are not very

impressive (other than BSE 30 Index and

Mexican IPC Index).


As can be seen from the above table, there is a disparity in the performance of the indices. Some

of the indices have given exceptional returns over the years as high as 534% over ten years,

whereas others have others have given a return of around 20% for the same period. The negative

returns in the five-year period 2007-Nov, 2012 has offset the gains earned in the five-year period

2001-2006 due to which the ten-year returns are not very impressive (other than BSE 30 Index

and Mexican IPC Index).

The above table shows that the returns on various indices of the world have been more or less on

a positive trend; the only exceptions are the massive fall in the years 2002, 2008 and 2011.


Conclusion

As can be inferred from the above chart and

tables, there is a consistent amount of

returns offered by indices over a period of

time which is subject to certain steep falls

owing to occurrence of certain big ticket

events. As can be seen, there has been a fall

in 2002 (Dot-Com Bubble Burst), 2008

(Sub-Prime Crisis) and 2011 (Curb of

Quantitative Easing). Barring these years,

the indices have earned a good return of

investment considerably higher than the

gilt-edged investments.

This proves that the Buy and Hold strategy

still holds true provided it‟s tweaked a little.

One needs to decide the period for which the

investments need to be held as the „Long‟ in

the long-term investments is not a thumb rule

figure. For this it is suggested to introduce

periodic review of investments along with the

strategy. The review need not be on a daily

basis which makes it as good as trading but

over a longer period sufficient to detect any

event which is affecting or may affect the

investment in a hugely adverse way.

The periodicity of review is basically

dependant on the risk of the portfolio. Higher

the risk, more often should it be reviewed.

There are two types of risks, namely the

systematic risk and the unsystematic risks.

An unsystematic risk is a company specific

risk and it is inherent in every different

investment at a varying level.

It is a company specific risk and hence can be

minimised using proper diversification,

whereas the systematic risks cannot be

reduced in the same way. The systematic

risks are the ones external to the company

like inflation, high unemployment, political

turmoil, wars, natural disasters, and so on.

The systematic risks are the events which can

cause excessive volatility in the markets and

hence the investor should keep a keen watch

on them. Systematic risks are measured

using the Beta Factor (CAPM Theory) for a

particular investment. This factor is available

in various investment journals. Portfolio beta

must be used in order to determine the

periodicity of monitoring the investment

while following this strategy. This will ensure

that the investor assesses the investment as

and when required and take a sound

strategic decision when the time demands.

The traditional Buy and Hold strategy has

traditionally given returns shall hold for the

years to come, but as time progresses and

volatility increases newer ways shall have to

be discovered to keep tweaking the strategy to

the right curve so that the investor

profitability continues.

Raghav Agrawal

(SIBM Bangalore)

Email :

Raghav.agrawal14 @sibm.edu.in


There is only one Golden Rule in the market: Those who have “THE GOLD”

rules. India`s unquenched thirst of gold is

impregnable. India imports 1/3rd of

Worlds Gold output making it world largest importer of gold. According to the

survey, value of the gold held in Indian Household is 18,000 Tonns values at $950bn that could wipe out India`s

current account deficit of $80bn with a whisker.

Facts about Indian Gold import and its

import:

* Gold‟s share in total import bill of

the country has gone up from 8.1

percent in 2001-02 to 9.6 per cent in

2010-11.

* Indian consumer demand for gold is

37.6 per cent more than that of China.

* Whereas in terms of GDP,

India‟s GDP is just 27.7 percent of

China and a meager 11.0 percent of

USA.

* India‟s forex reserves are 8.81

percent of China‟s forex reserves

yet its gold demand is more than

that of China by 37.6 percent.

* Despite of huge demand, India

only keeps 9.2% of its reserves in

Gold compared to US (75%). That

is Indian gold is not with the

government, but lying in coffers in

Indian Household.

* 85% of the total gold imports are

used to make jewellery while the

rest 15% is used in industry and

investment.

Golden Rules : Gold Rules

- By Raghav Agrawal, SIBM Bangalore


Why Indians are mad about Gold ?

Emotional Quotient : Gold no doubt has unconditional emotional value attached. From the day

daughters get their ear pierced continuing till the time of their marriage, Indians want their wife

and daughters bejeweled. And rising aspirations of men for gold is also not questionable. 80% of

gold demand in India comes from wedding season because gold in eternal of any wedding

ceremonies in India.

Gold as investment : Gold is the symbol of wealth, prosperity and fortune in India. Saving rate

in India is 30% which is maximum in the world. 10% savings are in Gold. Gold is foundation of

saving in every Indian household. It is evident from the fact that net retail addition of gold has

increased by 264% to 93 tonnes in 2010.

Gold as hedging instrument : Only one thing is certain in the market that is uncertainty. And

gold is the best possible hedging tool because more is the uncertainty in the market; more will be

the demand of gold. Gold also hedges against depreciation of dollar and other currencies. Gold

hedges against inflation too. With real interest rate (interest rate after inflation) turning negative,

CAGR of 37% over 5 years on Gold seems to be the silver bullet.


Liquidity of gold : Gold is one of most liquid instruments that can be sold across any counter

almost immediately which is not possible for other asset like land, commodities etc.

Gold as No-Frills investment : Unlike fixed deposits, equities, mutual funds and other securities

which require financial acumen, gold is no frills investment. India, where 70% population is

rural, there is high availability of gold contrary to low reach of banks. It is for this reason that

good monsoon season adds to the gold demand.

What is the problem with Indian buying too much gold ?

India produces only 0.5% of its gold demand from its own mine and is thus hugely dependant on

imports. It is for this very reason that Gold is second most import quantity after crude.

Gold as Non-Productive Asset

Buying gold may be good for the people but not good for the economy. When we buy gold, it sits

idle in our coffers contrary to other securities like FD, Equities where investor‟s money rotates in

the market and multiplies.


Gold imports burdens already bleeding Current account Deficit

Chart below depicts the impact of gold imports on the current account balance position. The

chart clearly shows that due to the high value of gold imports the current account deficit gets

accentuated , whereas had there been no gold imports then in that case not only would have

been the current account balance been much better but also there would have been current

account surpluses for year 2004-05 right until 2007-08.

What is the alternative ?

One thing for sure that India`s hunger for gold cannot be curbed. However the way people

invest in gold may be changed.

Gold ETF

Gold ETF is the virtual form of storing gold. They sit in investors Demat Account as like any

equity and can be traded in the market. No entry and exit load and expense ratio in mostly less

than 1%. Gold ETF has an advantage as no premiums and making charge, no worries of thefts,

tax benefits like no Sales Tax, VAT, STT and Wealth Tax.Custodian appointed by AMC is

responsible for safe keeping of gold on investor‟s behalf. Benefits of ETF is liquidity, purity,

safety, tax efficiency etc.

Gold Fund of Funds

This fund invests in underlying Gold ETFs of different companies. Demat account is not

necessary to invest in these funds thereby saving account brokerage. But cannot be traded on

exchange and will be redeemed by the fund house itself. However it is attractive as offers SIP

facility contrary to ETFs.


What is the way forward ?

Last year our Gold import bill was enough to feed the country‟s entire population. By just

doubling the excise duty on gold to 4%, gold has left the issue of staggering imports to the back

burner. Even the additional excise duty on 1% on gold had seen lakhs of jewelllers protests. Last

year, high gold prices crushed jewellery demand by 14% but ignited investment demand by 5%.

Moreover RBI imposed to reduce to grant loan against gold up to 60% of its value from

85-90%.Loan against purchase of gold is already banned by RBI.

Though these steps are only tightening the screw rather than repairing the whole machine. No

doubt it is very difficult to regulate and monitor the gold market as 95% of the market is

unorganized to small and medium retailers.

With imparting financial prudence and high availability of other financial instruments apart

from gold in the rural markets, we can curb the problem. According to the RBI out of $60bn

imports last year, $15-$20bn were for hedging against inflation. Therefore lowing inflation will

also decrease demand of gold as the hedging tool. However we should also consider the fact

that too much restrain on import may lead to gold smuggling.

Conclusively, as far as possible, the demand of gold as an investment tool should be converted

to electronic form from than physical form. This conundrum is difficult to solve because of deep

emotional value physical gold has. Let us see how the government plays with the psyche of the

people.

Sinjana Ghosh

VGSOM, IIT

Kharagpur

Email : [email protected]


Banking in India

The Indian banking system started with

the Government of India establishing

three presidency banks in India, namely,

Bank of Calcutta (1806), Bank of

Bombay (1840) and Bank of Madras

(1843). These three Presidency banks

were subsequently merged into the

Imperial Bank of India in 1921- which is

now the State Bank of India. Towards the

late 19th Century some banks like

Allahabad Bank Ltd., Punjab National

Bank, Bank of

India Ltd. and

other came into

picture. These,

along with some

other major banks

were nationalized

in 1969 and 1980.

Banks which

were not nation-

alized in these

years for instance,

bank of Punjab,

City Union Bank,

ING Vyasa Bank

etc were called

private sector

banks, which

later came to known as “old private

sector banks” after some new banks (now

known as new private sector banks) like

HDFC, ICICI, Axis bank etc came into

foray, following the economic reforms

of 1990s.

Private Sector banks

The private sector banks of India are the

most lucrative target for domestic as well

as foreign investors owing to their

remarkable progress in recent years. More

aggressive by nature these banks have

been able to outperform their public

sector counterparts with respect to most

key ratios like Net Interest Margin,

Credit/Deposit ratio, return on assets

(R0A) while maintaining better credit

quality.

Asset Quality

Adding to the slow

economic growth and growing food

inflation, are the global concerns of

f i s c a l c l i f f outstanding at the end of the year that

is likely to have a strong impact on the

performance of the banks, anticipation

of the analysts and d e c i s i o n s o f investors. While

aggressiveness is important from the

c r e d i t g r o w t h perspective, credit

quality is what, according to most

equity analysts, separates the winners

from the losers in these testing macro-economic conditions of India.

While RBI statistics over the past 3 years show significant improvement in the net

"NPA of new private sector banks, including the “most aggressive” ICICI bank which saw its NPA coming down

from 1.7 in FY2010 to 0.73 in FY2012.

New Private Sector Banks in India - Industry Analysis By Sinjana Ghosh, VGSOM IIT Kharagpur


Loan portfolio

Capital Adequacy Ratio of different bank groups

Capital Ratios are the indicators of how risky a bank‟s balance sheet is and the degree to which the

bank is vulnerable to an increase in bad loans. Banks with a higher share of Tier1 Capital are

likely to outperform those with a lesser share. Here, the new private banks like Yes Bank; HDFC

shows a consistently increasing trend while PSUs are on the decline.

Bank Group CAR(Tier1) 2011 CAR(Tier1)

2012

CAR(Tier2) 2011 CAR(Tier2) 2012

SBI & Associates 8.71 9.38 4.23 3.88

Nationalized

Banks

9.01 9.05 4.45 3.85

Old Private Banks 15.35 12.46 1.73 1.73

New Private

Banks

12.27 12.08 4.01 4.12

NPA of PSU banks shows an increasing trend, with the current average net NPA of 1.53.

Increasing percentage of sub-standard assets, relatively higher exposure to GNPA ‘heavy’ sectors, as

revealed by their loan portfolio, high debt restructuring, low NPA coverage, and thinning capital

cushion (Tier-1 Capital, less stressed assets) are some of the many reasons supporting the

assumption that the asset quality headwinds will persist in the PSU sector. Exposure of PSU

banks to sensitive sectors as a percentage of overall exposure declined marginally to 28.7% v/s

29.2% in FY11.


Profitability and Efficiency

Macro-economic factors largely determine the profitability of various sectors forming a part of the

bank‟s loan portfolio. Retail-driven portfolio, new private sector banks have been able to maintain

their credit growth despite slowing corporate spending cycle. On the other hand, larger exposure

to priority sector and low-interest student loans has led to a decrease in profitability of PSU banks.

Asset quality dominates interest rate declines in driving banks‟ stock performances. Statistics

suggest that the new private sector banks have not only been able to maintain a better NIM but

also increased their non-interest income through other business like credit cards, trade finance,

and other fees and charges.

The private sector banks show strikingly

stronger growth in the average spends by

their credit card customers compared

with the PSU banks.

Another interesting ratio is the term loan

to total advances. Term loans, unlike

demand loans are of long term, high

value, and chargeable at floating interest

rates, hence are more profitable and

sustainable assets than latter. These loans

are usually done in conjunction with

specialized financial institutions which

have greater contribution, hence greater charge on the security. Some new private sector banks

like ICICI, Kotak, have taken full advantage of their presence across all sectors of financial

services, to grant more term loans, thus increasing their profitability. Though the old private banks

have performed remarkably well in terms of return on advances, given the smaller share of term

loans and their limited reach across the country, sustaining the margin over the quarters would be

a challenge.

Few ratios that can determine the profitability banks


Valuation Ratios

Strong core operations and robust asset quality of Private Banks is reflecting in their premium

valuations relative to state-owned banks. Analysts foresee slowing credit growth and degrading asset quality is likely to persist in the coming quarters for public sector banks, while retail assets focus, improving asset quality and robust fundamentals would be the key driving factors for private

bank stocks in the capital markets. Despite fluctuations post US elections, mutual funds across the

nation, are showing their preference towards the large-cap and mid-cap private banks over giants

like SBI.

Success Strategy of the new private banks

The historical decision of liberalization of banking sector coupled with a steady economic growth

of India, paved way for the new generation “tech-savvy” banks which leveraged on their superior technology and promotional expertise to create a demand in the Indian market that had never been

experienced before.

Marketing

Promotion of banks were limited to newspaper ads before the advent of the new private sector

banks headed by HDFC and ICICI bank that changed the way banks did business in India. They introduced the concept of branding in the banking Industry, a trend followed by Axis, Kotak Mahindra and Yes, while DCB and IndusInd was left behind in the race of aggressive

campaigning. Recent years have seen PSBs like SBI, PNB etc developing their promotional strategy as well to stay in the competition.

Promotional Strategies of Banks

Increasing accessibility through ATMs and POS

The private banks extended their reach not only through branches but also through huge number of

ATMs. RBI statistics of 2012 reveal that Axis, HDFC and ICICI, along with SBI comprise of 52% ATMs all over India, among 53 SCBs recognized by RBI. The data summarized below suggests

only 9 new private banks have surpassed all other bank groups in number of ATMs.

Promotional activities Public sector bank Private Sector

bank

Advertising on TV and newspaper Fairly used Fairly used

Personal Selling/Personal Contact Hardly used Frequently used

Tele Calling by Sales Persons Hardly used Frequently used

Schemes/Gifts/Prizes for Customers Hardly used Frequently used

Public Relations/ Events/Program Less frequently used Frequently used

Online Marketing/ E-Mail Less frequently used Frequently used

Pamphlets/Propaganda Fairly used Fairly used

Letter/Mails with CASA statement and other rele-

vant status

Hardly used Frequently used

Publishing News in Newspapers Less frequently used Frequently used


Number of banks in each group

Number of ATMs bank-group wise

Innovations in banking

The banking sector in India has undergone a

remarkable metamorphosis in the last

decade through innovative strategies.

Needless to mention the new private banks

not only pioneered these changes but also

continue to surprise the consumers with new

moves. Way back in 1998, HDFC Bank

joined the Cirrus interbank network so that

MasterCard holders worldwide could use its

ATMS.

In 2001, it became the first bank in India to

launch an international Debit Card, in

association with Visa. ICICI, the bank that

unleashed the power of Internet in Indian

Banking, launched e-Locker facility to wealth

customers and initiated a 24*7 electronic

branch this year. On 6 September 2012, it

announced the launch of its services on social

media platform „Facebook‟, an initiative taken

under the tagline “Khayal Aapka”. Axis Bank

came up with this innovative home-loan

product: if you pay all your equated monthly

installments (EMIs) in time, it will fully waive

the last 12 payments-a move seen as the bank‟s

strategy to break the stranglehold the HDFC

and SBI have on the home loan business.

The way forward

The Indian banking industry, strongly regulated

by RBI, has shown great resistance to volatility,

particularly in the wake of the global financial

crisis, which pushed its global counterparts to

the brink of collapse. From the above analysis it

would be safe to conclude that the new private

banks are better placed to face the economic

turmoil anticipated in near future, although a

large section of Indians are and will continue to

trust only the public sector banks. The tough

competition posed by these late entrants has

been extremely beneficial to the Indian Banking

Sector. Though macro-economic conditions

have made many analysts pessimistic about this

sector, the new generation banks continue to

deliver unexpected results quarter by quarter

and mutual funds continue to bank on banks

when it comes to asset portfolio.

Bank group Number of banks

Nationalized PSB 19

SBI group 6

Old Private sector

banks 12

New Private Sector

Banks 7

Foreign Banks in India 8

Other Public Sector

Banks 1


CROSSWORD

H4 Meeting place of the world’s top economic minds since 1978

C8 A friendly takeover to prevent a hostile one

A10 If u have it, uncertainty can be rewarding

P7 Different asset classes in a structured product

Q11 Enables buyer to buy a security at a specific price in a given time frame

ACROSS

DOWN

F6 Buzz about a new economy characterized by the internet until it all fell apart

I3 Target company takes the bidding company over

M1 Based in the country of tulips, formed the first global exchange

Q2 Limits the interest rate on a loan to a range

W2 Change in number of shares without change in capital

Across Down

JACKSONHOLE DOTCON

WHITEKNIGHT PACMAN

BULLION EURONEXT

TRANCHES COLLAR

WARRANT STOCKSPLIT


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