Niveshak - The Investment Report

RALLYING STOCK MARKETS DUE THE IMPACT OF RISE IN CRUDE OIL PRICES to HOT MONEY INFLOWS PG.08 ON THE INDIAN ECONOMY pg.20

THE INVESTOR VOLUME 3 ISSUE 11 November 2010

Niveshak

Q2Results

The G

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Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

F R O M E D I T O R ’ S D E S K

NiveshakVolume IIIISSUE XI

November 2010

Faculty MentorProf. N. Sivasankaran

EditorBhavit Sharma

Sub-EditorsDurgesh Nandini Mohanty

Hitesh GulatiSumit KediaTanvi Arora

Upasna Agarwal

New TeamAlok AgrawalDeep Mehta

Jayant KejriwalMrityunjay Choudhary

Rajat Sethia Sawan Singamsetty

Shashank JainTejas Vijay Pradhan

Creative TeamBhavya Aggarwal

Swarnabha MukherjeeVishal Goel

Vivek Priyadarshi

All images, design and artwork are copyright of

IIM Shillong Finance Club

©Finance ClubIndian Institute of Management

Shillong

www.iims-niveshak.com

Dear Niveshaks

I wonder when we are going to see this vicious circle coming to an end. The whole world witnessed the global downturn in 2008 followed by debt crisis in Dubai and Greece. And now we see Ireland joining the league. While the US economy faced the repercussions due to reckless securitising of subprime mortgages and Greece collapsed under the burden of mis-represented government spending, the Irish took an easier path to ruin: by taking out enormous, unregulated loans. While the Irish government might have underestimated the severity of the crisis in the last two years and have still not asked for assistance, but, given the kind of interconnected framework i.e. Euro Zone in which they operate, its neighbouring countries might not let this continue for a longer period of time. Although European countries don’t affect our economy directly but they do affect sentiments, capital flows, gold prices, and commodity prices and so on. Thus, it makes all the more important for a recovering economy like ours to maintain the growth momentum through timely and appropriate reforms.

The waves of concerns that Ireland and few other countries of Europe may find it difficult to meet their debt commitments couldn’t prevent them-selves from reaching Indian bourses and dragged it below the psychologi-cal levels of 20,000 and 6,000, of Sensex and Nifty respectively. This really makes me (and many of us) believe that we are truly an integral part of so called Global village. Moving forward we can expect to see more down-side movement owing to the slowly building Asian cues specifically on con-cerns that China may further tighten their monetary policy to curb inflation. But with the strong capital inflows from FIIs looking for greater returns and sound Indian economy backed by solid fundamentals, our benchmark in-dices can surprise us by breaking its greatest achieved heights by the end of this year.

Last month’s cover story gave you a detailed analysis of the Coal In-dia’s IPO and its future outlook. The stock, when listed on 4th November 2010, actually met all its expectations and got listed at Rs. 314 which was at approximately 30% above of what investors had paid. Truly a windfall for all investors. I so wish I too had invested in it. In this month’s cover story, we are going to look, analyse and understand the second quarter results of differ-ent key sectors operating in India and their implications. At a time when In-dian Financial services landscape is undergoing big time consolidation with the likes of Axis-Enam deal, we, in this edition, also present to you an article on mergers and acquisitions. We are pleased to inform you that we have introduced a new section in Niveshak called “Classroom” for your reading pleasure. In this section, we will explain and elaborate a financial term with the help of a conversation. We hope that this endeavour of ours will prove to be an interesting read for our readers and will help them understand new terms in a much easier way with fun. Looking forward to your valuable feedback and suggestions.

Stay Invested.

Bhavit Sharma(Editor -Niveshak)

THE TEAM

C O N T E N T SNiveshak Times04 The Month That Was

PERSPECTIVE20 The Impact Of Rise In Crude Oil Prices On The Indian Economy

Cover Story11 Q2 Results – The Good, the Bad and the Ugly!

Fingyaan16 Mergers and Acquisitions in a Recession

CLASSROOM

23 Arbitrage

Article of the month08 Rallying Stock Markets due to Hot Money Inflows

FINLOUNGE24 Crossword

finsight

19 Axis Enam Merger

4 NIVESHAK VOLUME 3 ISSUE 11 november 2010

DOMESTIC BUSINESSPower Grid FPO garners 14.88 times oversub-scription

The FPO offer from Power Grid Corporation of India for its 84.17 crore shares in the price band of Rs. 85-90 per share attracted a 14.88 times over-subscription of 1252.96 crore shares. The oversub-scription reflects the continuing investor enthusiasm

in stocks of state run entities which was also evident during the big-gest Indian IPO by Coal India Lim-ited. This FPO, which is estimated to generate about Rs.7500 crore, is a part of the government plan to raise Rs. 40,000 crores in the current fiscal year through stake

sale in state owned firms. After this FPO, the gov-ernment’s stake in Power Grid will come down from 86.36% to 69.40%.

RBI hikes interest rates by 25 basis points

To tame the rising inflation, RBI pushed up its interest rates by 25 basis points with repo and re-verse repo rate being 6.25% and 5.25% respectively. Though the WPI based inflation fell down marginally from 8.62% in September to 8.58% in October, the latter figure is still considered to be above “comfort level” by central bank, thus triggering its decision to continue with its trend of increasing lending rates. It also tightened its norms on high value property loans as it increased the risk weight on property loans exceeding Rs. 75 lakhs from 100% to 125% ir-respective of its LTV (Loan to Asset Value) which also has been subjected to an upper limit of 80%. This is likely to increase the difficulty of access to these loans as the banks are likely to reciprocate with a hike in lending rates for such loans.

IDBI goes for a rise in interest rates

In view of policy rate hike by RBI, public sector bank IDBI pushed up its interest rates by 50 basis points. The benchmark prime lending rate has been raised by 25 basis points to 13.50% with effect from 4th November. It also raised its retail term deposit rates by 10-50 basis points for its various maturity schemes. With RBI increasing risk weight for prop-

erty loans above Rs. 75 lakhs, IDBI also increased its interest rate for same by 25 basis points.

SEBI raises retail investor cap to Rs. 2 lakhs

SEBI has doubled the upper limit for retail in-vestment in public offers from Rs. 1 lakhs to Rs. 2 lakhs to encourage greater investor participation in share market through retail route. Now an inves-tor applying for shares up to Rs. 2 lakhs in an IPO or FPO will be treated as retail investor which will make him/her eligible for 5% discount on subscrip-tion’s face value. It is relatively easier to buy shares through retail investment due to relatively lower share subscription by this category as compared to HNI and institutional investor community. The total shares at the disposal of retail investors shares in a public offer has remained unchanged at 35% and the corresponding allotments for HNI and institutional investors has also remain fixed at 15% and 50% re-spectively.

India and China ranked higher in IMF’s quo-ta

G-20‘s decision to increase the quota for emerg-ing economies by 6% in its meeting in South Korea has resulted in India and China being elevated to 8th and 3rd positions in quota status respectively. Now India’s quota in this 187 nation body has increased from earlier 2.44% to 2.75% signaling its emergence as a major player in new world econom-ic order. Emerging economies contrib-ute about 47.5% to world economy in terms of PPP (Pur-chasing Power Par-ity) whereas their corresponding share in IMF prior to this decision stood at 39.5%.

India and Malaysia sign a free trade pact for next year

India and Malaysia finalized a Comprehensive Economic Co-operation Agreement, CECA that is like-ly to increase annual bilateral trade to $15 billion by year 2015. Malaysia exports electrical and electronic

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IIM, ShillongTEAM NIVESHAK

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IRELAND TO SEEK EU-LED BAILOUT AS FINANCE MINISTER BRIAN LENIHAN WORKS TO AVERT BANK COLLAPSE

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 5

THE BIGGEST OPPORTUNITY FOR US IS NOT NECESSARILY TO DO MORETHINGS, BUT TO BE GOLDMAN SACHS IN MORE PLACES: LLOYD BLANKFEIN

products, crude petroleum, palm oil and chemi-cal goods to India. Further, India has also invested around $1.11 billion in nearly 100 manufacturing projects in Malaysia. The deal expected to promote free movement of goods, services and investment will be signed by leaders of both the countries by 31st January, 2011. This deal is more comprehen-sive than India-ASEAN one which came into effect at beginning of this year as it also covers services, investment and technical barriers to trade and other areas.

Cross Border Mergers embroiled in capital gains tax tangle

Two cross border mergers, one involving tele-com giant Vodafone’s acquisition of Hutchison and the other involving major drug maker, Sanofi –Aven-tis’ pick up of majority stake in Shanta Biotechnics, have come under the scanner of IT department for payment of capital gains tax. In Vodafone’s case, it has been asked by a three judge bench of Supreme Court headed by chief justice S.H. Kapadia to de-posit Rs. 2500 crore by first week of December and a bank guarantee of Rs. 8500 crore by second week of January,2011. The total sum of Rs. 11ooo crore is the capital gain tax which Vodafone has to pay for its acquisition of Hutchison shares. In other case, Sanofi-Aventis has been asked by IT department to pay Rs. 700 crore as capital gain tax for its buying of majority stake in Hyderabad based pharmaceutical firm, Shanta Biotechnics valued at Rs. 3770 crore.

Mutual Funds to go for quarterly basis dis-closure of assets

Association of Mutual Funds in India (AMFI) has decided to end the practice of monthly disclo-sure of Assets Under Management (AUM) for mutual funds in India from October and adopt a quarterly basis disclosure for period thereafter.”The average AUM (AAUM) for each quarter (90-day average) will be computed and uploaded on the Amfi website on the first working day of the following month of every quarter, effective from quarter ending December 31, 2010,” Amfi said. The move is an attempt to placate prevalent feeling among mutual fund companies about monthly disclosure of AUM putting too much pressure on business.

INTERNATIONAL BUSINESSUS to go for second round of Quantitative Easing:

Federal Reserve of US has announced its sec-ond round of Quantitative Easing (QE) of $600 bil-lion to provide succor to languish-ing US economy. QE 2 action plan involves buying of trea-sury bonds of $75 billion per month over the next 8 months to infuse $600 bil-lion into the economy. The objective is to increase the excess reserves with the bank-ing system so as to keep the inter-est rates low and thereby stimulate borrow-ing and spending activities in the economy.

AIA’s $17.9 billion IPO is the 3rd biggest in world

The Hong Kong IPO of AIA, the Asian insurance unit of AIG was a huge hit among investors looking to invest in one of world’s most attractive financial markets as it amassed $17.9 billion to become the third biggest IPO in the world. A part of the proceeds will be used by AIG to pay back a portion of the $182.3 billion bailout that it received from US.

Steve Ballmer sells $1.3 billion shares of Mi-crosoft

Microsoft CEO, Steve Ballmer has laid off $1.3 billion worth of shares in the company, a first in his tenure of seven years with the company. After this sale the CEO still holds 350 million shares in company valued at $9 billion approxi-mately. To avoid any negative specula-tion that this chunk sale of shares by the CEO may trigger, the company issued a statement on Steve’s behalf in which personal investment diversification and bet-ter year end tax planning were given as the reasons behind his move.

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NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010

BSEIndex Open Close % ChangeSENSEX 20,272.49 19585.44 -3.39MIDCAP 8302.56 8077.36 -2.71SMALLCAP 10597.59 10237.29 -3.40AUTO 9964.35 9940.93 -0.24BANKEX 14165.91 13705.09 -3.25Consumer Durables 6544.48 6455.92 -1.35Capital Goods 15889.74 15625.49 -1.66FMCG 3620.89 3595.08 -0.71Healthcare 6462.61 6579.76 1.81IT 6023.54 5889.87 -2.22Metal 16923.31 16461.15 -2.73OIL & GAS 11137.96 10227.47 -8.17POWER 3138.99 2981.36 -5.02PSU 10199.39 9647.79 -5.41REALTY 3653.32 3173.57 -13.13TECk 3702.60 3617.55 -2.30

MARKET CAP (IN RS. CR)BSE Mkt. Cap 72,21,148.40Index Full Mkt. Cap 29,13,700.51Index Free Float Mkt. Cap 15,45,165.99

CURRENCY RATESINR / 1 USD 45.26INR / 1 Euro 61.78INR / 100 Jap. YEN 54.25INR / 1 Pound Sterling 72.60

Market Snapshotwww.iims-niveshak.com

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Source: www.bseindia.com 1st to 19th November 2010

Source: www.bseindia.com

Source: www.bseindia.com www.nseindia.com

Data as on 19th November 2010

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POLICY RATESBank rate 6%Repo rate 6.25%Reverse Repo rate 5.25%

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Market Snapshot

GLOBAL INFLATION RATESAmerican inflation CPI 1.17 % Oct-10English inflation CPI 3.13% Oct-10Dutch inflation CPI 1.56% Oct-10German inflation CPI 1.31% Oct-10Japanese inflation CPI 0.60% Sep-10

GLOBAL INTEREST RATESName of Interest Rate Current Rate Previous Rate Last Date of Change American interest rate FED 0.25 % 1.00% 16-Dec-08 Brazilian interest rate BACEN 10.75 % 10.25% 21-Jul-10 British interest rate BoE 0.50 % 1.00% 5-Mar-09 Canadian interest rate BOC 1.00% 0.75% 8-Sep-10

Chinese interest rate PBC 5.56% 5.31% 19-Oct-10 European interest rate ECB 1.00% 1.25% 7-May-09 Indian interest rate RBI 6.25% 6.00% 2-Nov-10 Japanese interest rate BoJ 0.10% 0.10% 5-Oct-10 Russian interest rate CBR 7.75% 8.00% 31-May-10 South African interest rate SARB 5.50% 6.00% 19-Nov-10 Swedish interest rate Riksbank 1.00% 0.75% 26-Oct-10 Swiss interest rate SNB 0.25% 0.50% 12-Mar-09

RESERVE RATIOSCRR 6%SLR 25%

LENDING / DEPOSIT RATESBase rate 7.5% - 8%Savings Bank rate 3.50%Deposit rate 6% - 7.5%

KEY INDICESCPI (Sep. 2010) 9.81%WPI 8.58%IIP (Sep. 2010) 4.4%

Source: www.global-rates.com

Source: www.global-rates.com

Source: www.rbi.org.in Source: www.rbi.org.in

Source: www.rbi.org.in

Source: www.mospi.gov.in

Data as on 19th November 2010

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So far, FIIs have poured in nearly $4.3 billion into the

Indian markets in November and almost $28.64 billion since the start of this year

Since January of this year, there has been a surge in equity value across almost all the emerging mar-kets and India is no exception. Last month, the Bombay Stock Exchange (BSE) Index (Sensex) closed at over 20000 points, while National Stock Exchange’s index, the Nifty, closed at over 6000. Sensex jumped over 15 per cent since January, due to huge capi-tal inflows, making the Indian stock market as one of the best performers.

Where did the capital inflows come from?

Usually, the capital inflows come from both the retail domestic investors and the off shore investors in the form of foreign Institutional Investments (FII’s) and Foreign Di-rect Investments (FDI’s). This had been the case earlier during the mar-ket rise of 2007 or before, but this time it’s different. One of the major concerns that India is facing is that this ‘hot money’ is going into the stock market rather than new proj-ects and startup companies in the form of long term fund- i n g . The investment in the stock market has more than doubled this year, foreign direct invest-ment (FDI) into India fell more than 25 per-cent, com-pared to the same period a year earlier. So far, FIIs have poured

in nearly $4.3 billion into the In-dian markets in November and al-most $28.64 billion since the start of this year. The domestic institutions have been a net seller which has helped in meeting the FII demands.

”Hot money” refers to funds that are controlled by investors who actively seek short-term returns (mostly FII’s). These investors scan the market for short-term, high inter-est rate investment opportunities and move their money from one invest-ment asset to another very quickly.

Higher FII inflows to India may be attributed to the unclear growth prospects in the west (US has slowed down while Germany and UK are up-beat) and unchanged interest rates signifying lower returns with the Fed-eral Reserve, European Central Bank (ECB), Bank of England (BOE) keep-ing rates unchanged. Funds seeking better returns moved to the Asian emerging markets and in particular,

India has received large por-tion of the in-

v e s t m e n t .

Overall Impact of hot money inflows

FIIs are usually not concerned about the issues of devel-

opment of the developing economies, whether or not this is ethical is another debate. Though there are obvious positive out-comes for an economy due to the incoming FIIs, these are also accom-

The Indian stock market has been on the rise on account of the “hot money” inflows from the FIIs. Currently, a lot of investments are happening in the emerging econo-mies. While FIIs have certain positive im-pacts on the econ-omy, on the other hand they can also affect the economy in a negative man-ner if they are in excess.

XLRI JamshedpurAkash Agarwal & Abhishek Dassani

Rallying stock markets due to

HOT money Inflows


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Funds seeking better returns have moved to the Asian emerging markets and in

particular, India has received large portion of the investment

panied with a host of other negative aspects. The only reason for an FII to invest in a company is the motive of profit. FIIs are usually very selective in their investment. They select companies that show good results or have potential for future profitabil-ity thus raising these companies’ stock prices and hence their market capitalization. The firm, now with financial clout can even acquire other firms and grow even more. Apart from that, another posi-tive impact of FIIs is that it leads to a competition among firms, all of them vying for the attention of the FIIs which leads to greater efficiency, higher transparency and improved corporate governance.

Macroeconomic impact

Due to these capital inflows, enormous inflows of foreign exchange occur, which exerts an upward pressure on the Rupee. It soared up 9 percent against the dollar in the last 16 months. The appreciation of the Rupee will obviously make the imports com-ing into India cheap and exports more expensive. Thus, importers stand to gain from cheaper imports, which in turn, lead to lower prices of these imported goods in the country leading to a deflationary trend.

Fig 1: Monthly Trade deficit in million dollars On the flip side, the appreciation of the Ru-

pee makes Indian exports less competitive in the international markets. The major commodities that are exported are gems and jewelry, chemical and related products, engineering goods and textiles among others. If the Rupee appreciates, these sec-tors would become less competitive due to exports becoming expensive and thus possibly would expe-rience a slowdown in growth. Earlier, exports would have led to the growth of these sectors. Thus, with the fall in exports the possibilities of layoffs and slower growth rates in these highly labor intensive sectors have increased. On the other side, a positive

outcome of losing competitiveness in exports is that it would force the organizations to become more in-novative and increase the productivity and quality.

Effect of Foreign institutional investors on other emerging economies

FIIs have had many positive affects in other countries too like in OECD countries, where institu-tional investors have contributed significantly to the development of their financial markets and overall economic growth. In China, for instance, when the Qualified Foreign Institutional Investor (QFII) scheme came into effect (it essentially allowed licensed for-eign investors to buy and sell yuan denominated “A” shares in China’s stock exchanges which was closed to foreign investors till then), the domestic markets was opened up for the foreign investment. This strat-egy of QFIIs was also implemented in other places like Taiwan to ensure a stable flow of currency so that the economic stability of the economy was maintained.

In Mexico too, significant changes in its eco-nomic and political scenario have taken place making it a preferred investment destination.

Negative effects of excess FIIs in markets

The Foreign Institutional Investors usually bring with them a lot more volatility into the fi-nancial markets of the country than what may have been experienced before. According to some Indian analysts, the increasing bullishness in the developing nations is leading the stocks in these countries to become overvalued that may not be justified even under country’s high growth rate. There are also fears that some of the lessons from the recent financial crisis have been forgotten.

According to Eswar S Prasad, Professor of Eco-nomics at Cornell University, there can be fairly serious risks associated with the escalating equity market if the hot money keeps pouring in India. He fears that this might just be the boom phase of a boom-bust cycle, with all the given risks.

Mr. Prasad worries that one day or the oth-er most of the FIIs could suddenly withdraw their invested money, as was done in early 2008, if they saw any signs of a slow down in the In-dian economy. The outflow of money from the market could then decrease the real economic growth in India, and hurt it tremendously, by de-

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“There can be fairly seri-ous risks associated with the

escalating equity market if the hot money keeps pouring in

India” - Eswar S Prasad, Professor of Economics,Cornell University

priving the country of the short term capital.

For example, in 2008 India was growing at the rate of 9.2% but its growth fell to 6.7 percent, partly because the foreign investors took out bil-lions of dollars from Indian stock and the bonds market. The decreased supply of capital severely hit the companies with large capital requirements.

Thus, when the economy opens to the short term capital in the form of ‘hot mon-ey’ by the FII, the risk of the capital sud-denly moving out of the country increases.

Conclusion

It will not be wrong however, if we say that FIIs have played a big role in the formation of capital in the country. Some academicians even say that the overall liquidity in the capital market can be at-tributed to the hot money poured in the country by institutional investors. The surge in the rupee due to steady flow of dollars in the country also has its own implications for the economy. However, on the downside there are some severe implications in terms of increased volatility in financial markets. This volatility significantly impacts the small local investors in these markets. If we look at the over-all trend in the stock market today, many Indians have become wary of the stock market. Individual investors, for instance, did not jump at the recent IPO of SKS Microfinance. The Coal India offering was also subscribed only 2.1 X times by the retail in-vestors in contrast to the overall subscription of 15.3 times. In early 2008, however they clamored to buy public offerings such as Reliance Power.

Another significant development that has been observed is that the Indian markets are now no longer insulated from the world mar-kets due to the international flow of goods and services and international flow of capital.

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CROSSWORD SOLUTIONS

OCTOBER 2010

Across

4. Petrobras

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6. CBOT

7. Cairn

9. Peter Lynch

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2. Sarbox

3. UTI AMC

4. Plowback

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With the economy growing at 8-9%, and robust de-mand of goods and services, the quarterly results of Q2 FY-11 were mostly in line with estimates. The Sensex hit an all-time closing high of 21004.96 points on 5th No-vember 2010, mainly fuelled by FII inflows. The average growth of capital goods production remains healthy at over 28% in 2010-11, though the growth of IIP index in September at 4.4% fell short of expectations. Data for the first six months of the fiscal year presents a trend of declining growth of capital goods over the course of both Q1 and Q2 of 2010-11. The pace of growth of con-sumer durables, although healthy at 10.9% in September 2010, was considerably slower than the growth rates in excess of 20% registered since April 2010. The healthy growth in the production of consumer durables during the previous months may have partly reflected building up of inventory prior to the festival season in India. With interest rates expected to climb following the lagged transmission of monetary tightening, and the US Federal Reserve announcing the second round of quantitative easing (QE2) of USD 600 billion, it would be interesting to see how the economy unfolds in the coming months.

Auto

The top-line performance in Q2FY11 for the in-dustry, on the whole, has either been in line with the estimates or has exceeded the estimates. The industry is expected to grow at a CAGR of 13-15% for FY10-12E aided by boisterous economic activity, favourable demo-graphics and higher income levels. The major concerns, however, are steep raw material prices and untoward forex volatility, which could cause serious concern to the whole of the value chain, going forward, as margins and bottom-line, could shrink to a certain extent. How-ever, commodity prices could see some slowdown from Q4FY11 with the easing of the demand-supply mismatch.

Hero Honda Motors’ Q2FY11 net profit, down 15% Y-o-Y, was below market expectations. The vari-

ance was on account of higher-than-expected increase in raw material costs which were up 150bps Q-o-Q, after having risen 400bps in Q1FY11.

Going forward, the major concerns are like-lihood of a split in the joint venture of Hero and Honda, with Hero group to acquire Honda’s 26% stake, around Rs. 9000 Crore at current mar-ket prices. Also the Production at the Haridwar plant is 1.4 million units annually which can be stretched to 1.8 million. Hence, the possibil-ity of further benefits from this plant is limited.

Mahindra and Mahindra (M&M) reported a

strong set of results in Q2FY11 with revenues of the automotive segment growing 23.7% YoY driven by strong volume growth of three wheeler/small trucks. Also, the segment’s revenues were boost-ed by robust exports volume growth. The PAT grew by 7.9% YoY to Rs 758 crore further supported by lower interest expenses. Since the successful in-troduction of Gio and Maximo the company is ag-gressively planning to expand its product portfolio in the Heavy Commercial Vehicle segment (~25-50 tonnes category) with the Navistar vehicles.

M&M with its proposed buy-out of South-Korea

Cover Story

Team NiveshakJayant kejriwal & deep mehta

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With Chinese and Irish con-cerns along with US Federal Reserve’s QE2, it would be interesting to see how the

economy unfolds in the coming months

based SUV maker, SsangYong Motor Co (SMC) can lever-age SMC’s strong R&D capabilities and global footprint.

Tata Motors Q2FY11 net sales were up 36% YoY led by strong performance from core busi-ness and significantly better performance from Jaguar Land Rover. Luxury car demand remains ro-bust particularly in China, Russia and the US. This was on the back of a strong response to the newly launched Indigo Manza. The latest launch of Aria in the mid-premium UV segment is expected to fur-ther improve market share in this growing segment.

Maruti Suzuki for 2QFY2011 registered 27% yoy growth in net sales while net profit at 598cr re-corded a 5% yoy jump. The production capacity has been increased to 1.3mn units (from 1.2mn) through de-bottlenecking exercise. The current production rate is 110,000units/month. In October’2010 with sales of 1, 18,908 units the company crossed the one-lakh mark in domestic sales for the first time.

Company Revenue Net Profit EPS

Hero Honda 4551.95 505.6 25.32

M&M 5434.36 758.49 13.36

Tata Motors 28782 2222.99 38.91

Maruti Suzuki 9147.27 598.24 20.71

Revenue and Net Profit in Rs. Crores

Oil & Gas

Oil and gas industry in India is almost US$110 billion and oil accounts for almost 44% of India’s primary energy consumption. Demand for oil and gas is likely to increase from 186 million tonnes of oil equivalent (mmtoe) to 233 (mmtoe) in the year 2011-12. India is net importer of oil and its dependence on imports is 80% which is likely to go up in near future which might also bring do-mestic oil price equivalent to international price.

RIL’s Q2 FY11 net profit was up 27.80 % YoY largely driven by high operating rates and improved refining margins at US$ 7.9 per barrel as against US$ 6 per barrel in the corresponding period of the previ-ous year. Its net sales were up 22.69% (YoY) helped by higher gas output from its KG D6 block where it aims to reach peak gas output of 80 million stan-dard cubic metres. Growth in the refining segment was driven by the increase in throughput and high-er oil prices. The company has struck three shale-gas joint ventures with US firms so far this year.

ONGC’s Q2 net profit was up 5.87% YoY and net sales were up 20.64% YoY, mainly due to in-crease in crude oil sales volume by 11.3% and lower subsidies(Due to increase in retail price of auto fuels, overall subsidies declined as a result subsidy burden shared by the ONGC fell 45% QoQ to Rs 1480 crore). Gas business revenues improved 41%. Other income almost doubled QoQ to Rs 906 crore, mainly on account of dividend income from subsidiaries and higher interest income. Miscella-neous also accounted for a large part of the rise.

OMCs: Post the deregulation of petrol prices in June 2010 and price increases in LPG/ kerosene, the three oil marketing companies (OMCs; IOC, BPCL and HPCL) have delivered significant outperfor-

mance (14-23%) against the Sensex since July 2010.

IOC net sales for Q2FY11 increased 26.8% YoY due to higher crude prices and strong refin-ing margin of US$6.6/bbl compared with US$2.7/bbl for HPCL and US$2.8/bbl for BPCL. With com-pensation of Rs. 7220 Crore from the govern-ment its net profit stood at Rs. 5293.95 crore.

HPCL’s revenue increased 25.3% YoY primarily due to higher subsidy pay out of Rs.2830 crore from the government.

BPCL reported impressive earnings of Rs.2142.22 crore supported by government subsidy of Rs.2950 crore and forex gain of Rs. 300 crore.


RIL 57479 4923 15.05

ONGC 18430 5388.77 25.19

IOC 77335.75 5293.95 21.8

HPCL 30870.23 2089.61 61.71

BPCL 35434.77 2142.22 59.25



Cover Story

IT

IT sector companies reported stron-gest quarter in the last four years. The growth was visible across all segments and verticals.

TCS, the largest software exporter from India, showed Q2 US GAAP consolidated net profit up 14% at Rs 1813 crore. The stock markets reacted posi-tively with share price touching a 52-week high of Rs 1030.5. 53.7% of the revenue comes from North America, with UK and India contributing 15.3%, 9.9% resp. BFSI contributes to 44% of its revenue, followed by Telecom (12.8%) and Retail and Distri-bution (10.9%).The streamlining in operations dur-ing slowdown was the major reason for expanded margins. TCS added 19,923 employees in the quar-ter which was the largest ever. The superior per-formance was driven by volume growth of 11%.

For Infosys, 16% QoQ PAT growth was assist-ed by addition of 27 clients in the quarter. North America is even more significant with 65.8% con-tribution. Europe with 21.8% and India just 2.1%.Onsite revenues contributed 50.2% for this quarter. Company was conservative on its guidance and so stock prices took a minor beating. On the innovation front, Infosys applied for 18 patent applications in India and US taking the aggregate to 256 and it has been granted 15 by US Patent and trademark office.

The third biggie Wipro announced IT services revenue growth of 5.7% QoQ. Volume growth of 6.6% was highest in 12 quarters. Strength of the ru-pee did cause margin squeeze by 2.5%. Americas with 56% contribution, Europe with 27% and India 9% formed the revenue dynamics for the quarter. Financial services and Technology, Telecom and Me-dia contribute 27%, 25% resp. to the revenue. Wipro

announced a decrease in margins due to salary hikes. It won a key project from the UID authority for the critical enrolment process for 2 states in In-dia. It was particularly a disappointing quarter for Wipro, when its peers showed double digit growth.

Overall, expect the volume growth to con-tinue on account of stable pricing through-out the industry. Attrition remains a major con-cern due to increase in demand of the laterals. Also, currency fluctuations can take a toll on the

bottom-line due to lesser realization of dollars.


TCS 7267.45 1812.65 9.24

Infosys 6425 1641 28.59

Wipro 6556.9 1172.1 4.81


Banking

Banking sector showed very good growth in this quarter with increase in focus on CASA (Current and Savings Account) which reduces the cost of de-posits (interest on savings account=3.5%,interest on current account=0%,lending rate= approx. 10%) and helps banks to increase NIM (Net Interest Margin).

SBI, the country’s leading lender, showed a 22% decline in consolidated profit on YoY basis, and a marginal 0.5% growth YoY on a standalone basis. It was a 14.2% decline QoQ. Probable reason could be higher provisions for bad loans which were partly due to acquisition of State Bank of Indore in August.

Bank’s loan portfolio is well diversified with no segment accounting for more than 21% of the loan book. There was a healthy growth in Non-Interest income on account of growth in loan pro-cessing, cross selling, commission from increase in government business. Higher slippages impacted the asset quality of the bank. Mainly this was due to defaults in Dubai and Agri-loan waiver scheme.

ICICI Bank, top private sector lender, showed results that beat street estimates that were driven by good credit growth and drop in provisions for bad loans. Here, Net slippages were lower and NPA’s declined. A concern was increase in operating expenses, which will increase due to integration of Bank of Rajasthan.

For HDFC Bank, 33% rise in Net profit (YoY) was driven by increase in NII (Net Investment Income - dif-ference between interest earned and paid). Again, the growth was due to stable margins, robust loan growth and good CASA ratio. Retail loans which constitute 52% of the total, grows when GDP slows down. Depos-its increased by 30%, out of which half are low cost.

Andhra and Axis bank showed 27%, 26% growth on the basis of interest earned due to good loan approval and disbursement.

14

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With economy expected to grow robustly and good monsoons, it looks good for the bank-ing industry with credit growth bound to improve. But, with RBI planning to give licence to NBFC’s to open banks, competition will increase and de-celerate the pace of expansion. Also, focus on le-veraging branches, promotional activities to at-tract customers will be the broad theme so as to increase market share. Also, rising NPA’s will also be a challenge, especially in retail and SME seg-ment where loans are provided without adequate securities. RBI’s recent increase in Repo, Reverse Repo rates will influence the banks other income.


SBI 19808.09 2501.37 39.39

ICICI 6309.1 1236.27 10.91

HDFC 4810 912.14 19.8

Axis 3624.25 735.14 18.01


FMCG

Talking of the FMCG sector, it was a mixed bag. It has been a story of declining margins due to rising raw materials cost across the sector.

Hindustan Unilever Ltd. reported Q2FY11 net profit of Rs. 566.12 crores versus Rs. 420 crores in Q2FY10 i.e. gain of 34.76% YoY.

After adjustments, PAT stood at Rs.533.65 vs. 499 crores i.e. a growth of 6.8%. All the three ma-jor segments viz. soaps and detergents, personal products, and beverages showed growths of 6.3%, 14.7% and 9.3% resp. But again, due to increasing ad-spend the EBIT margins have slipped, by 190bp, 330bp and 160bp respectively. Costs of basic raw materials like palm oil, benzene have increased by 46% and 100% resp. Company had to hike prices in certain products so as to protect margins. Pre-launch of brands like Rin, Lifebuoy did help to im-prove the bottom-line. It was 6th successive quarter of double digit growth for personal care products.

For Marico, there was a volume growth across businesses with PAT growing 15% over Q2FY10. The main contributor was Parachute Coconut oil at 10%, Saffola Oil at 18%. Revenues from Kaya Skin Clin-

ics grew by 28%. This was boosted by acquisition of Derma Rx in May 2010. Rise in copra prices by 26% attributed to 100bps reduction in EBITDA. Volume growth has been good. So, due to rising costs, vol-ume growth may be prioritized over margin growth.

Moving onto Dabur, margins expanded by 29bps to 22.4% despite increased inflation and tax-ation. Hair care, its largest category grew at 5.8%.Reduction in employee costs (% of sales) and ef-ficient operations were main reasons for increase in margins. But, on the negative was 2nd succes-sive quarter of de-growth in Shampoo business.

ITC showed good performance in ciga-rettes despite hike in prices. For its FMCG space, margins have improved with person-al-care products and biscuits gaining stability.

Overall, high inflation will prevent companies from raising prices significantly in order to preserve market share. But, good monsoons augur well for the FMCG sector. While competitive intensity will remain high, focus will be on cost and cash management.


HUL 4764.67 566.12 2.59

MARICO 540 59.66 0.98

DABUR 800.5 126.18 0.72

ITC 5147.18 1246.74 1.63


Conclusion

India Inc. is set forth for a good second half going by the Q2 numbers. But it remains to be seen if they can reduce the impact of higher input costs.

Also, with increasing recruitment, salary costs will also tend to reduce margins.With selling pres-sure seen in domestic markets due to Chinese and Irish concerns, it will be interesting to see the impact it will have on different sectors.Good demand was seen in Auto and IT sectors, but 2G spectrum scam will definitely impact telecom companies which are already struggling due to competitive pressures. For banking, second half of the year usually sees an in-crese in credit growth - which is good news. FMCG space will continue to see rising product costs as the companies will pass on the load to customers so as to protect margins. Also, incresing participation by FMCG companies in international territories is some-thing to look forward to. With promising recruitment figures from Wipro, TCS and Infosys and good growth guidance from HCL, IT is likely to take off. So, overall India Inc, looks set to continue their growth story and tackle the competetive dynamics and international pressures so that we continue to report many such success stories in the issues ahead.

..

16 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010

FinG

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IIM BangaloreAnkit Sinha

Mergers and

Acquisitions in a

Introduction

Mergers and Acquisitions (M&A) are an important activity for the growth of any organization. M&A activity can have significant ramifi-cations for the management as well as the investors. While this may seem a natural mode of expansion in a booming economy, the reasons for pursuing M&A activity in reces-sionary times may not be apparent. Pursuing deals in recession seems risky and impractical. Credit markets and equity markets are depressed. Historically, M&A’s have eroded shareholder value rather than cre-ating it. However, strategic M&As in recession can add value leading to significant advantage for companies.

Pros and Cons of M&A Activity

The pros and cons are primar-ily decided by taking into account the short term and long term ef-fects of M&As. This depends on internal factors like nature and strategic outlook of concerned

firms, as well as external factors such as global economic environ-ment and government regulations.

The major positive effects can be increased market share and lower cost of operations due to economies of scale. The emerging company may be more competitive, with improved profitability and enhanced EPS. Also, there can be an increase in the indus-try knowledge of the organizations.

On the other hand, the con-cerned companies may face signifi-cant legal expenses and takeover costs, both tangible and intan-gible. There can be potential de-valuation of equity and lowered industry innovation. The merger of two large firms can also sup-press competition, and may lead to increased costs to customers.

Whether a merger or an acqui-sition is successful depends on how the positive and negative effects weigh against each other. This is highly subjective to individual M&As.

“Going downhill, everybody picks up speed.”-Business

Proverb

Name Period Characteristics Outcome Sources of Financing

Wave 1

1890s-1903 Horizontal Mergers Formation of Monopolies

Cash

Wave 2

1910s-1929 Vertical Mergers Formation of Oligopolies

Equity

Wave 3

1950s-1973 Conglomerate Mergers

Growth through diversification

Equity

Wave 4

1981-1989 Hostile Takeovers, Corporate Raiding

Elimination of inefficiencies

Debt Financed/ Cash Paid

Wave 5

1993-2001 Cross Borders Mergers

Adjustment to globalization processes

Equity

While M&A may seem a natural mode of expansion in a booming econ-omy, the reasons for pursuing M&A activity in recession-ary times may not be apparent as pursu-ing deals in reces-sion seems risky and impractical. How-ever, strategic M&As in recession can add value leading to sig-nificant advantage for companies.


FinG

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Mergers and

Acquisitions in a

M&A activity has been his-torically clustered in distinct waves originating in periods

marked by economic recovery.

M&A Waves and their common characteris-tics

M&A activity has been historically clustered in distinct waves. The waves have been summarized in the above table.

The waves comprise of some common charac-teristics. They originate in periods marked by eco-nomic recovery. Wave 2 started during economic recovery after market crash and First World War. Similarly, Wave 3 started after economic recovery after Second World War. The waves also occur in periods of rapid credit expansion and burgeoning credit markets. Industrial and technological shocks often precede takeover waves. For example, Wave 1 was preceded by development of trading on NYSE while wave 4 was preceded by development of junk bonds and technological innovations in electronics. Changes in regulatory mechanisms also lead to take-overs. This is illustrated by the fact that changes in antitrust policy and deregulation of financial sector preceded Wave 4.

M&A Activity in recent years

In the aftermath of the worldwide cri-sis, M&A activity took a sharp hit. This is evi-dent from Exhibit 1. Both the number of deals and deal value decreased greatly after 2007.

Exhibit 1: Deal Value, $ billion and volumeYear 2008 saw a reversal of trends in previ-

ous years. Some of the key changes observed were:

• Cross border M&A activity decreased from 41% in 2007 to 35% in 2008.

• Therewasashift infocusfrommegadeals(>$10 bn).

• Hostile activity, generally resulting from

strong markets, remained strong in first 3 quarters of 2008 ($50 bn a quarter).

• PE Activity has bottomed out and is likely to rise in future. The volumes of PE deals fell by 72% from 2007 levels and there was negligible PE activity in megadeals

• Proportion of overpaid deals rose to 61%.

Exhibit 2: Share of global M&A by geography of target

M&A Activity in 2009M&A activity was stable in 2009. Corporate M&A

activity was in line with 2008 levels. PE accounted for just 4% of global M&A, compared to 20% in 2006 and 2007. Also, there was a significant decrease in cross border activity as a share of total M&A value. It experienced a 10% decrease from total 41% in 2007. However, M&A activity spread around the globe with companies in Asia-Pacific accounting for 26% of global M&A in 2009. In 2008, this share was only 19%. (Exhibit 2) More value was created for targets as compared to acquirers. Total deal value added was just below the long term average. (Exhibit 3)

Exhibit 3: Average annual deal value added


FinG

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Companies that are strategi-cally and financially superior

will find rare opportunities in recession to improve their

competitive position.

Advantages of M&A in recession

Contrary to the popular beliefs, M&A activ-ity in recessionary times can lead to significant benefits. Companies that are strategically and fi-nancially superior will find rare opportunities in recession to improve their competitive position.

For buyers, strong companies with short term risk may be available cheaply. For sellers, reces-sion provides opportunity for strategic divestures and portfolio rebalancing. As seen from exhibit 4, Acquisitions completed during and right after the last recession (2001-02) generated almost triple the excess returns (“Excess returns” is defined as shareholder returns from four weeks before to four weeks after the deal, compared to peers) of ac-quisitions made during the preceding boom years. According to Bob Filek, partner with PwC Transac-tion Services, “M&A activity in 2010 will be driv-en by strategic buyers who have access to capi-tal and the strategic vision to capitalize on some of the best values we have seen in recent times.”

Strategies for M&As during recession

From the previous discussion, it can be in-ferred that M&A activity in recession can lead to significant benefits, and separate the leaders from the laggards. Organizations that proceed carefully can generate significant returns for their sharehold-

ers. Several strategies can help the companies to successfully carry out M&A activity in recessions.

Firstly, organizations should define a corporate strategy which is at the core of the company and allows it to invest with a clear thesis. Danaher Cor-poration can be a suitable example in this regard. It engages in M&A to strengthen its base of real as-sets. It made 10 acquisitions in last downturn, in-cluding Gilbarco. Gilbarco turned out to be the part of the third most profitable product line in 2008.

Secondly, companies should also buy and di-vest frequently and consistently through cycles. They should always keep in mind a list of po-tential targets. For example, Cintas maintains a pipeline of priority targets and cultivates strong relationships with them. Thus, it can often ap-proach a target long before other acquirers. Cin-tas has sustained its sales growth for 39 years.

Thirdly, companies should tailor merger in-tegration efforts to deal thesis and the sources of value. This can be accomplished by increased due diligence from the M&A team. Often, buyers in the same industry overlook the details as they believe that they know the industry. They con-duct cursory reviews of the target company and are often surprised to find out the actual valua-tions to be much cheaper than they anticipated.

Exhibit 4: Average acquirer excess return during various years


FinSigh

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“For us to build a balance-sheet, we thought that combin-ing forces would be an extraor-dinary opportunity.” Vallabh

Bhansali, co- founder and chairman of Enam

Weeks after lead-managing the successful Rs 15,000-crore Coal India IPO, Enam Securities sold off its investment banking, corporate advisory and equity distri-bution divisions to India’s fourth-largest bank, Axis Bank. The deal will combine capital at Axis bank with the clients and distribution network managed by Enam.

Team NiveshakRajat Sethia

Axis Bank Ltd., India’s top-ranked lending institution, strength-ened its equity underwriting op-erations by merging with Enam Securities Pvt. Ltd in a transaction valued at $455 million. The trans-action would combine Axis’s invest-ment bank with Enam’s advisory ser-vice, as well as its institutional and retail equities units. It won’t include Enam’s portfolio management ser-vice and asset management units. The acquired businesses of Enam complement the strong corporate banking and debt capital market franchise of Axis Bank. Macquarie Group acted as the advisor to Axis Bank on the transaction.

Axis will swap 5.7 shares for each one of closely held Enam. Enam shareholders will get a 3.3 percent stake in Axis following the transac-tion, and Enam’s Manish Chokhani, will act as the CEO and MD of the entity to be created by the combi-nation. Axis’s first financial-services acquisition will combine capital at India’s fourth-largest bank with the clients and distribution network managed by Enam. The deal is a win-win for both Axis and Enam. While Axis gets the back-end distribution which will bolster its front-end bank-ing segment, Enam will be able to build its balance-sheet using a bank base. Rankings

Enam Securities is ranked third among equity-underwriters in India, with equity sales of Rs. 1.02 tril-lion rupees this year. In M&A space, Enam Securities is ranked No. 9. Axis is ranked at No. 16 in the equity

underwriting business while in M&A, Axis isn’t in the top 20. Axis is top ranked in the debt sales and loan syndication business. The merger will help Axis to gain significant presence even in the equities and M&A advisory business.

Comparison with other deals

The Axis Enam transaction is the second-largest involving India’s investment banks and securities firms.

Merrill Lynch & Co. spent $500 million in December 2005 to buy con-trol of its Indian venture DSP Merrill Lynch Ltd. from its local partners, valuing that business at $1 billion.

Morgan Stanley paid $445 mil-lion in February 2007 for Mumbai-based JM Financial Ltd.’s stake in a business that traded in stocks for local and foreign institutions. At the same time, JM Financial paid $20 million to buy out Morgan Stanley’s share of that venture’s investment-bank, fixed-income and retail units.

Axis Bank’s rivals have made acquisitions in recent years to add clients and outlets. ICICI Bank Ltd., ranked No. 2 among the nation’s lenders, bought smaller rival Bank of Rajasthan Ltd., based in northwest India, in August through a share swap in a transaction worth as much as 23 billion rupees.

HDFC Bank Ltd. bought regional lender Centurion Bank of Punjab Ltd. in July 2008 for 71.2 billion rupees in India’s biggest banking acquisition.

AXIS ENAM merger

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In 2009, with a consumption of 3 million barrels per day, India was the 4th largest oil consumer in the world after

the United States, China, and Japan

INDIA’S CRUDE OIL REQUIRE-MENTS

India is emerging as an eco-nomic powerhouse of the 21st cen-tury & a large consumer of energy resources. Despite the global finan-cial crisis, India’s demand for energy continues to rise. But India still faces tremendous challenges in meeting its energy requirements. In order to sustain the rate of growth, In-dia needs to develop a reliable pool of energy resources which can be tapped in the long run.

Oil meets about 24% of India’s commercial energy requirements. In 2009, with a consumption of 3 mil-lion barrels per day, India was the 4th largest oil consumer in the world after the United States, China, and Japan.

India’s proven reserves of crude oil and oil production have not witnessed any significant improve-ment in the last few decades. As a result, India largely relies on im-ported crude oil to meet its energy requirements.

In 2009, India was the 6th larg-est net importer of oil in the world, importing nearly 2.1 million barrels per day, or about 70 %, of its oil

needs. The Energy Information Ad-ministration (EIA) expects India to become the 4th largest net importer of oil in the world by 2025, behind the United States, China, and Japan.

OIL UNDER-RECOVERIES

The dependence on crude oil imports is chronic for a developing country like India as the current re-source utilisation pattern does not contain alternatives to imported crude oil. Further, in a situation of unabated rise in oil prices the prob-lem tends to get compounded.

Government Owned Oil Market-ing Companies (OMCs) in India sell petroleum products (excluding Pet-rol) at a subsidized rate. The losses incurred by these companies are called “Under Recoveries”. The Gov-ernment of India compensates the OMCs for these under recoveries ei-ther through cash payment or issue of bonds.

Under recoveries of OMCs for FY 2008-09 were Rs. 1,03,292 Crores. The Government issued oil bonds to the tune of Rs. 71,292 Crores whereas the remaining burden of Rs. 32,000 Crores was shared by Upstream Oil Companies.

ECONOMIC IMPACT OF RISE IN OIL PRICES

India’s huge dependence on Imported Crude Oil makes it vulner-able to the shocks & disruptions in the Global Oil Market. Any sharp spike in oil prices in the global mar-ket results in an unfavorable eco-nomic situation in India. The reasons

Crude oil is one of the most essential commodity. A slight fluctuation in crude oil prices can have both direct and indirect influence on Indian economy, and will continue to affect, considering the fact that India is 6th largest importer of oil in the world.

THE IMPACT OF RISE IN CRUDE OIL PRICES ON THE INDIAN ECONOMY

Welingkar Institute of Management, MumbaiAMITKUMAR RAJANI


Perspective

The dependence on crude oil imports is chronic for a devel-oping country like India as

the current resource utilization pattern does not contain alter-natives to imported crude oil.

for the same are outlined below.

a) RISE IN COST OF IMPORTS: The first victim of rise in crude oil prices is the state exchequer. Ev-ery increase of $1 per barrel in Indian crude basket prices pushes up the annual oil import bill by $1.2 billion. It also leads to a faster depletion of India’s Foreign Exchange (FOREX) Reserves.

b) WIDENING OF TRADE DEFICIT: India’s trade deficit for 2009-10 was $117.3 billion. The steep in-crease in imports due to high oil prices leads to a further widening of the trade deficit.

c) INCREASE IN OIL UNDER RECOVERIES: As the pricing of Diesel, LPG & Kerosene is still under gov-ernment control, any rise in international oil prices is not reflected in the domestic market. The inability of OMCs to sell fuel at the market defined rate re-sults in higher under recoveries.

d) MOUNTING FUEL SUBSIDY BURDEN: Any hike in price of imported crude oil is absorbed by the OMCs along with the Upstream Oil Companies & the federal government. The fuel subsidy bill has witnessed a continuous rise for the past few years. From FY 2005-06 to FY 2008-09, Government’s fuel subsidy bill amounts to Rs. 1,42,203 Crores.

e) WORSENING FISCAL DEFICIT: India’s Fiscal Deficit for 2009-10 stood at 6.6 % of Gross Domestic Product (GDP). Rise in crude oil prices would worsen the situation as Government has to shell out more money in the form of fuel subsidy to OMCs.

f) REDUCED AMOUNT FOR INFRASTRUCTURE IN-VESTMENT: India aims to invest $1 Trillion in infra-structure development during the 12th Five Year Plan (2012-17). High prices of crude oil (leading to higher fuel subsidy & increase in fiscal deficit) have the potential to derail the government’s plans as they eat into the amount of disbursal available with the government for infrastructure & social develop-ment schemes.

A continuous rise in the subsidy bill & worsen-ing fiscal deficit has forced the federal government to deregulate the petrol prices in the domestic mar-ket while in-principle approval has been given for deregulation of diesel prices.

IMPACT OF HIKE IN FUEL PRICES IN THE DO-MESTIC MARKET

The hike in fuel prices in the domestic market has a cascading effect on the Indian Economy. The same is explained below.

a) INFLATION: Rise in fuel prices has a direct impact on the prevailing inflation rate in the econ-omy. Higher fuel prices (in particular Diesel) lead to increase in transportation costs across the coun-try. As a result, the price of essential commodi-ties (such as food items, cement etc) shoots up. An inflationary expectation among traders leads to hoarding which pushes the spiraling inflation rate further up.

b) EROSION OF PROFIT MARGINS: Rise in infla-tion rate in turn leads to erosion of profit margins of business enterprises as the key inputs for busi-ness become costlier & consumers reduce their

22

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The fuel subsidy bill has witnessed a continuous rise for the past few years. From FY 2005-06 to FY 2008-09,

Government’s fuel subsidy bill amounts to Rs. 1,42,203 Crores

spending budget. Inevitably, the earnings growth of corporate India slows down.

c) HIKE IN INTEREST RATES: The Reserve Bank of India (RBI) is entrusted with the responsibility of containing inflation in the Indian economy through periodic Monetary Policy review. It does so by in-creasing the Cash Reserve Ratio (a portion of depos-its which banks have to keep with the RBI), Repo Rate (the rate at which banks borrow funds from the RBI) & Reverse Repo Rate (the rate at which RBI borrows money from the banks). As a consequence of rise in these key rates, banks are left with lesser funds to lend to their customers thereby sucking out the excess liquidity from the system. Banks are forced to fol-low suit & increase the cost of loans to their customers.

d) CAPEX POSTPONEMENT: Cor-porate India largely relies on bor-rowings from banks for business ex-pansion. In view of inflationary trends & dearer cost of funds, corporate India puts it Capital Expenditure (CAPEX) plans in the cold storage. The idea is to wait for the inflation & interest rates to come down before initiating any new projects.

e) REDUCTION IN CREDIT GROWTH: A reduced level of investment in the economy due to increase in interest rates leads to a slowdown in the credit growth of banks, the lubricant of every economy.

f) FALL IN EMPLOYMENT OPPORTUNITIES: As business activity in the economy takes a hit, gen-eration of employment opportunity also suffers a

setback.

g) SLOWDOWN IN ECONOMIC GROWTH: A sus-tained rise in interest rates in the economy begins to hurt the economic growth. Reduced investment, lower spending on infrastructure & fall in domestic consumption of goods & services puts a brake on the fast rate of growth of the economy.

IMPACT ON KEY SECTORS

The performance of business enterprises across India is adversely affected due to increase in fuel prices in the domestic economy. But some sectors

suffer a greater loss as compared to the others.

They include the Automobile Industry (dear-er personal loans leading to fall in sales), FMCG

Sector (erosion of profit mar-gins due to rise in cost of raw materials), Banking Industry

(slow down in credit growth), Civil Aviation Industry (rise in

price of Aviation Turbine Fuel), Oil Refining Industry (higher under recoveries), Paint Industry (crude oil is a major input for solvent based paints) and many others.

NEED FOR REFORMS

It is imperative that the Indian government brings about the necessary reforms to strengthen the domestic oil market. The key reforms include:

1) Rational pricing of petroleum products

2) Reducing the rate of taxes levied on petro-leum products

3) Tapping alternative sources of revenue to compensate the loss due to reduced taxation.

As the Indian Economy treads the path of growth, its appetite for crude oil as a crucial source of energy will only increase. Given India’s chronic dependence on imported crude oil, the Indian Econ-omy will continue to remain vulnerable & sensitive to fluctuations in world oil prices.


It is said that risk and return go hand in hand. But there are fleeting mo-ments, when high return can be achieved with low risks. Welcome to the world of Arbitrage.

That sounds interesting. But isn’t it contrary to what we read in finance that higher risk leads to higher return?

First of all, higher risk doesn’t lead to higher return. There is only a possi-bility of higher return just as there is a possibility of higher returns with lower risk which is what happens in the case of arbitrage. Arbitrage involves buying

and selling of same or closely related securities at the same time. Buying and selling correlated or same assets at same time creates a natural hedge and hence the risk is less.

Sir, I have watched a movie called the “Rogue Trader” in which the pro-tagonist makes millions arbitraging the Nikkei Index between the Singapore and UK exchanges.

Yes, that’s a nice movie which inci-dentally made arbitrage famous. In that movie, the arbitrageur takes advantage of price differences between interna-tional markets to make huge money. In a

similar manner, arbitrageur can also take advantage of price differences between two national exchanges where similar securities are traded. Lastly, the price differences between the spot and futures market can also be tapped to make money.

Sir, but isn’t it true that with ad-vent of algorithmic trading, it is difficult for people not equipped with computer trading system to actually spot arbitrage opportunities.

Well, it has definitely become dif-ficult for manual arbitrageurs to make money in developed markets, but in the fledgling markets like the commodity markets of India, one can find a lot of

arbitraging opportunities even without computers. It is not unusual to spot price differences on similar contracts on MCX and NCDEX. This is because vol-umes at NCDEX are not that high and prices react sharply on trades made by few buyers and sellers.

From what you are saying, it seems that arbitrage can make you money without any risk, only you need to spot the right opportunity.

I wish it were that simple. In real life situation, there is always some risk and so even in arbitrage. There are various risks involved in arbitrage transactions viz. execution risk, counterparty risk and

liquidity risk. While counterparty and liquidity risks are rare, the execution risk is more common and one should be wary of execution failures while closing a large transaction.

Having discussed the very basics of arbitrage trading, as a closing com-ment, I would like to point out that some of the most exciting things in finance such as options arbitrage and calendar spread arbitrage happen to

be related to arbitrage. We will discuss more on these in the coming lectures.

Arbitrage

Team NiveshakRajat Sethia

Classroom

CLASSROOMFinFunda

of the Month

It's risk free...


FinLo

unge

Down

1. The process of monitoring managers and aligning their interests and incentives with shareholders is called

2. A leading security Firm which acted as the Lead manager for Coal India Limited in its IPO and was acquired by a famous bank recently is

3. What is black scholes formu-la used for?

5. Graph representing a set of portfolios that maximize ex-pected return at each level of portfolio risk is called

8. The excess of purchase price over the sum of the fair market values of the individuals assets acquired

Across

4. Who is the Chief Economic adviser to Government of India? (person)

6. Retirement income paid by the company is called

7. The total amount of credit issued to the user determined by the credit card company is called

9. The basic measure of risk is

10. The Japan Stock Market Index is called

(Note: All the clues given refer to Financial terms and not personalities unless explicitly mentioned)

All entries should be mailed at [email protected] by 7th December,2010 23:59 hrsOne lucky winner will receive cash prize of Rs. 500/-

C R O S S W O R D

A N N O U N C E M E N T SARTICLE OF THE MONTH

The Article of the Month winners for November 2010 are Akash Agarwal and Abhishek Dassani

of XLRI, JamshedpurThey receive a cash prize of Rs.1000/-

Crossword WinnerThe Crossword Winner for the month October 2010 is

Ankit Bansalof SJMSOM, IIT Bombay

He receives a cash prize of Rs.500/-CONGRATULATIONS!!

ALL ARE INVITEDTeam Niveshak invite articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contrib-ute 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/-

Instructions » Please email your article with the file name and the subject as <Title of the

Article>_<Institute Name>_<Author’s name/Group’s name> by 07 December 2010. » Article must be sent in Microsoft Word Document (doc/docx), Font: Times New

Roman, Font Size: 12, Line spacing: 1.5 » Please ensure that the entire document has maximum 1500 words » The cover page of the article should only contain the Title of the Article, the

Author’s Name and the Institute’s Name » Mention your e-mail id/ blog if you want the readers to contact you for further

discussion » Also certain entries which could not make the cut to the Niveshak will get

figured on our Blog in the ‘Specials’ section

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Drop a mail at [email protected] Niveshakwww.iims-niveshak.com

COMMENTS/FEEDBACK MAIL TO [email protected]://iims-niveshak.comALL RIGHTS RESERVED

Finance ClubIndian Institute of Management, Shillong

Mayurbhanj Complex,NongthymmaiShillong- 793014

Date post:	29-Nov-2014
Category:	Education
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