The Financial NMIMS December Issue

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DECEMBER 2012

THE FINANCIAL


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Senior Team

Komal Poddar

Achal Mittal

Dear Readers,

Coexistence. This is what the world is all about. Good cannot exist without evil.The cover page, Yin Yang, signifies the same. Therefore, for the world towork smoothly, there has to be a balance between the coexisting entities. Simi-

larly, inflation and growth coexist; for any economy to develop, there has to be aperfect balance between them. This issue of The Financial tries to instigate a

similar line of thought. The Financial continues to evolve and it has received anoverwhelming response this time. We are happy to bring to you, with this issue, amagazine with several new sections that will grow into a repository of originalcontent and opinion from the Finance Cell at NMIMS. Keeping with this themeof change, The Financial, in this issue, explores the highs and lows that theeconomy seems to have confronted in its journey.

In this issue, we have delved into the issue of Growth versus Inflation. The per-

spectives put forward by the budding managers from across the B-schools are

sure to give a new dimension and importance to this issue. We have also tried toenlighten the readers about the implications of the fiscal cliff. In addition, the is-sue also captures many other financial goodies for you to discover!

The process of evolution of The Financial will see a deliberate attempt from Fi-

nomenon, the finance cell to involve the readers as much as possible. The aim thistime is not to have an article end with its last word in the magazine but to take itbeyond through comments and discussions. Feel free to contact the writers ofeach article and discuss their views or to even dispute them! Let us keep it inter-esting this way. As always, I hope you enjoy this issue! Let us know how you feelabout the content. Feel free to contact anyone from the Finance Cell regarding

any aspect about the magazine and I promise we will get back to you. Critics,suggestions, requests, and jokes, they are all more than welcome.

We thank one and all for their valuable contributions to this magazine and hopeyou enjoy the articles and also, write back to us. The Financial an interactivemagazine and, beyond just a magazine, a two way interactive channel. As we ex-change ideas we will evolve and grow to greater heights.

So until we meet again next time and while you wait to see what is in store for thenext issue, take care and enjoy reading!

Komal Poddar

FROM THE EDITORS DESK

The Financial

December 2012

Finomenon

NMIMS Mumbai

All design and artwork are

copyright work of Finomenon

NMIMS Mumbai

Creative and Design

Srijan Srivastava

Prakash Nishtala

Junior Team

Akshay Goyal

Anirudh Kowtha

Debottama Sharma

Ellina Rath


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Table of contents


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Debottama Das Sharma

is a 1st year student of

NMIMS,Mumbai (MBA

Banking Management).

She has graduated in

Economics Honours

from St.Xaviers college,

Kolkata in the year 2012.

Email ID:

[email protected]

1

Akshay Goyal is a 1st

year MBA student at

NMIMS. He has an

engineering background

and loves to write and

sketch in his free time.Email ID:

akshaygoyalonline@gma

il.com

BY DEBOTTAMA SHARMA AND AKSHAY GOYAL, NMIMS MUMBAI

The controversial inflation-growthtrade-off has been widely re-searched upon, both theoreticallyand empirically since the concep-tion of the Phillips Curve elucidat-ing the negative relation betweeninflation and the level of unem-ployment. This was one of the rag-

ing debates between the structural-ists and monetarists. While thestructuralists believed that inflationwas a harmless accompaniment ofgrowth, the monetarists saw infla-tion as a deterrent of economic pro-gress and well-being of a country.The subsequent hypothesis byFriedman and Phelps asserted theabsence of a long run Phillips curverelation between the two variables

under consideration-growth andinflation.

In the present Indian scenario theInflation Vs Growth debate has as-sumed renewed importance andsignificance. In light of the eventsin the recent past and the visibledifference in opinion between thegovernment and the central bank ithas become important to take an-

other look at this age old debate.Traditionally, growth has been fa-cilitated by an amalgamation ofrising consumption and increasingfiscal deficit. Needless to reiterate,containing the inflation resultingfrom rising consumption and in-come levels is one of the mainchallenges the government is fac-ing today.

The first quarter of the year saw the

Reserve bank hike interest rates to

curb investments thereby temporar-

ily curbing inflation. However this

move by the RBI has dampened

growth projections for the year

2012-13.More importantly in an

economy experiencing a down-swing induced by global recession-

ary factors, the relevance of em-

ployment cannot be superseded.

According to various sources every

percentage fall in economic growth

reduces the number of new jobs

created by ten million. The severe

consequence of this is unemploy-

ment of a large section of skilled,

educated and trained youth. The

socio-political repercussions of

such a scenario may be compre-

hended with further understanding

of the social structure established

by the constitution of the country.

Since the constitution of India as-

serts the ideology of democratic

government and the establishment

of a country characterized by thesignificance of the individuals

voice, these repercussions cannot

be ignored.

The global recession though little

late did have a severe impact on the

Indian economy, particularly in the

then booming information

The Growth-Inflation Paradox

Revisited


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2

technology sector which operated majorly in col-laboration with giant Multinational Corporationsheadquartered in the Western countries. The feed-back effect of this situation was a huge number oflay-offs and a decline in the pay-rolls of the employ-ees. A large section of unsatisfied youth may proveto be a deterrent in the social well-being of a coun-

try. Internal security problems triggered by the pre-ponderance of a Maoist ideology may be a matter ofconcern in such a scenario. The thriving of anti-government entities may be a probable consequencethat the government would want to avoid at any cost.Even for the well being of the country the possibilityof civil strife should be completely mitigated.

The concept of inflation has traditionally been as-sumed as a major reason for instability in a countrys

economy. The plausible reason behind this is the fur-

ther disparity it creates in the purchasing power ofgoods. The relevance of this issue is heightened inan economy like that of India which is characterizedby widespread economic inequity and disparity. Theworst sufferers in an economy characterized by highinflation are the poorest in the society. The twelfthfive year plan has stressed the importance of inclu-sive growth in the present scenario. In such a back-drop the costs of inflation seem to be magnified fur-ther. Allowing rising inflation would be hypocriticalon part of the government post the endorsement of

the idea of financial inclusion.

The RBIs recent step of keeping the reserve ratios

and interest rates largely unchanged indicates the

Central Banks concern to curb inflation. The deci-

sion was received with skepticism by the finance

ministry and the banks as it wouldnt help the invest-

ment climate in any way. The reasons for this can be

easily comprehended. The Indian economy has suf-

fered recently due to the Euro crisis and the down-

swing in the American economy curbing exports andinflow of capital for investments. The encourage-

ment of growth has therefore assumed great rele-

vance at this point. The difficulty remains in solving

the paradox where growth can be facilitated with

minimum rise in inflation.

The financial reforms implemented in the early

1990s introduced the idea of growth stemmed from

trade liberalization. The change in the FDI policies

created a thriving environment for growth. More im-

portantly, the experience of that period showed that

the resultant effect on inflation was minimal as com-

pared to growth triggered from increased consump-

tion or investment. The exhibit indicates that growth

and lowering of inflation took place hand in handpost the implementation of the reforms in the early

nineties. Paul Krugman, in an influential paper in

1990 stressed the relevance of trade liberalization for

developing countries like India, Bangladesh and Sri

Lanka. Firstly, developing countries have production

patterns that are skewed towards labor intensive ser-

vice, agriculture and manufacturing. People have

low per capita incomes and markets in such coun-

tries are usually small. A liberalized trade regime

allows low-cost producers to expand their output

well beyond that demanded in the domestic market.

Secondly, the open trade regime permits enjoyment

of constant returns to scale over a much wider range

and finally import substitution regimes normally

give bureaucrats considerable discretion either in

determining which industries should be encouraged

or in allocating scarce foreign exchange in a regime

of quantitative restrictions, leading to serious effi-

ciency losses. Another important effect is the stabili-

zation of prices according to the demand of products

in the world markets. This is one of the main reasons

why growth triggered from an increase in net ex-

ports actually results in a lower rise in inflation. Un-

derstanding the requirements of the present


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3

situation and the consequences of rising inflation,export liberalization is probably going to be one ofthe best inducers of growth. Encouragement to poli-cies like welcoming of foreign investment in Multibrand retail is going to assist growth with a lowerinflationary impact.

The present scenario necessitates the encouragementof growth of the economy initiated by immediatereform measures introduced by the government. It isimportant to minimize the inflationary repercussionsresulting from the growth. The government of Indiahas recently thought of a new measure to deal withthe problem of increased economic disparity as aresult of inflation. It has conceptualized the idea ofdirect cash transfers to the lowest strata of the econ-omy. This would enable the benefits of growth toundergo what is popularly known in economic ter-

minology as the trickle-down effect where thepositive impact of economic growth is transferred tothe grassroots of the economy. The facilitation ofsuch a measure will be a challenge to the govern-ment given the infrastructural requirements that arebrought forward by such a policy. Also, the faults inthe Indian administrative setup will be a major bar-rier to such a policy. The idea of direct cash transfersbeing carried out without leakages stemmed fromcorruption is Utopian indeed. The political backlashthat may result from unsuccessful or faulty imple-

mentation of such a policy is unwarranted.

Comprehending the primary focus of the govern-ment in the twelfth five year plan as financial inclu-sion and lowered social and economic inequity, thesocial implications of inflation should be clearly un-derstood. The impact of inflation is most on the low-

est strata of the society thus defeating the basic ideaof financial inclusion. In this regard it becomes im-portant to focus on the significance of mobilizationof financial resources at every level of society. Thisbrings us to the widely discussed concept of microfi-nance. A study conducted in Pakistan in the year2009(when the country was grappling under infla-

tionary pressure) indicated that inflation could actu-ally prove to be beneficial if there was a sound andstrong micro financial structure in place. Accordingto the survey, when the funds obtained from microfi-nance institutions are used for business or profitmaking purposes, inflation could actually be usedpositively by the economically downtrodden. Thesmall scale farmers, manufacturers seem to be thebiggest gainers. The small scale handicrafts indus-tries, although may be adversely affected in a situa-tion characterized by high inflation as they cannot

fully benefit from the advantages of price rise.

Apart from that fast-tracking of infrastructure pro-

jects and pending regulatory clearances, with a focus

on removing supply-side bottlenecks in areas such as

power, transportation and agriculture would boost

the growth potential of the Indian economy and con-

tribute towards easing inflationary pressures. The

government should ideally focus on the holistic

growth and development of the country and allow

the Central Bank to take its course of action in termsof monetary policies. It may try and work in har-

mony with the Central Bank to understand the ideal

mix of fiscal and monetary policies that would result

in all encompassing growth.


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Deependra Kumar is a

first year PGPM student

at MDI Gurgaon. Heholds a B.E degree in

EEE from BIT Mesra and

has worked with Oracle

India for three years.

Email ID:

pg12deependra_k@mand

evian.com

4

Ashish Khare is a first

year PGPM student atMDI Gurgaon. He is a

fresher and holds a B.E

degree in ECE from

Delh i Co l lege of

Engineering.

Email ID:

pg12ashish_k@mandevia

n.com

BY ASHISH KHARE AND DEEPENDRA KUMAR, MDI

Introduction

The nature of functions dischargedby the central bank and their rela-tion with the functions dischargedby the central government has beendebated for a long time. Together

the central bank and the centralgovernment of a country are re-sponsible for putting the economyon the path of prosperity and suc-cess. However, due to the complexnature of the relations between thefunctions performed by these twoentities, there could be instanceswhen central bank and the govern-ment are at odds against each other.Since the time India gained free-

dom, socialist ideas were promotedand the role of government andRBI was to guide the stressed econ-omy. The objective was to promotebalanced growth in general andalso to take initiatives for the wel-fare of the people. However, it wasnot until 1991 that effective eco-nomic reforms were introduced inthe country which placed India onthe path of high economic growth.It is since then that the role of thecentral bank, that is, the ReserveBank of India has widened inscope. It is in the light of the devel-opments in the Indian economyafter 1991 economic reforms andthe major economic events such asthe 2008 recession and the Eurozone crisis that we will analyze therelationship of the Reserve Bank of

India with the central governmentwith a focus on their existing rela-tionship.

Role of Government

The role of government in the

economy is to maintain growth andgenerate employment for the citi-zens of the country. The govern-ment in order to achieve its objec-tives tries to mould the overall paceof economic activity by maintain-ing steady growth, high levels ofemployment and price stability.

Role of Central Bank

In developing countries central

banks play a very important role innot only regulation but also devel-opment. RBI in addition to per-forming the traditional roles of cen-tral bank also plays a very impor-tant role of development of thecountry by manipulating monetarypolicies. The central bank of thecountry establishes a suitable inter-est rate structure to manage the in-vestment in the country. The rates

also decide the money supply in themarket so by changing the rates thecentral bank manages inflation andgrowth.

Conflict of Monetary policy and

Fiscal Policy

The conflict between monetary pol-

icy and fiscal policy arises because

Government of India and

RBI: An Evolving

Relationship


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of difference in the goal of Government and the cen-tral bank. While the aim of Government is highgrowth and low unemployment, the main aim of thecentral bank is economic and price stability.

The core issue of the conflict of interest between

monetary policy and public debt management lies inthe fact that while the objective of minimizing mar-ket borrowing cost for the Government generatespressures for keeping interest rates low, compulsionsof monetary policy amidst rising inflation expecta-tions may necessitate a tighter monetary policystance. Therefore, the argument in favour of separat-ing debt management from monetary policy rests onthe availability of effective autonomy of the centralbank, so that it is able to conduct a completely inde-pendent monetary policy even in the face of an ex-

pansionary fiscal stance of the government.

Sometimes the conflict between the two also ariseson using the foreign reserve of the country. Whilethe Government intends to use the reserve to financeits 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

The role of government after the independence wasto guide the economy which was highly stressed.The function of RBI also became diversified as ithad to take part in national building. Post independ-ence government triggered the economic growththrough large public investment which was facili-tated by accommodative monetary and conducivedebt management policies. RBI played a crucial roleof financing the government debt by monetising andmaintaining interest rates artificially low levels so

that the cost of borrowing for government remainscheap.

By the end of the 1980s a fiscal-monetary-inflationnexus was increasingly becoming evident wherebyexcessive monetary expansion on account of moneti-

zation of fiscal deficit fuelled inflation.

Post 1991

After 1991 despite the fact that fiscal compressionwas on its way and efforts were made by RBI inmoderating money supply during the early part ofthe1990, the continuance of the ad hoc Treasury billimplied that there could not be an immediate checkon the monetized deficit. In order to keep check on

the unbridled monetisation of fiscal deficit, the firstsupplement argument between RBI and the Govern-ment of India was started in 1994 to set out a systemof limit for creation of ad hoc Treasury bill duringthree years. Later the second supplemental agree-ment was done in 1997 to completely phase out thetreasury ad hoc bills. By 2006, under the provisionof FRBM, participation of RBI in primary auctionsof government has also been stopped.

Post 2008 Recessionthe relationship

Post 2008 recession, Indian economy struggled tokeep inflation low, and there were fears that the cur-rent high levels of inflation may become the new

normal for the Indian economy. To deal with theinflationary pressures, the RBI raised the repo rateby 375 basis points and the CRR ratio by 100 basis

points between 2010 and 2011.

Figure 1-Inflation and repo ratetrend

Despite these actions the inflation continued to re-main high. Analysis of the sector composition ofgrowth reveals that the growth moderation during2008-12 has been driven largely by manufacturing

and agriculture sectors. The sources of inflation


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during post-crisis period suggest that the increase ininflation was contributed by more than doubling offood price inflation to 11.8 per cent during 2008-12.A major factor from the demand side contributing tothe persistence of food price inflation, which causedgeneralization of inflation and fuelled inflationaryexpectations, was the sharp increase in rural wages.

While RBI was trying to tame the inflation, govern-ment on the other hand was trying to prevent thecountry from recession by giving many benefits tothe mass to increase consumption and hence increasethe growth. The difference in the goal of the two en-tities has recently become public when Governmentasked RBI to reduce the interest rates so that the

growth is not hampered due to the monetary policy.

Figure 2- Growth and repo ratetrend

A look at the US Economy: Relation of Government

and Federal Reserve

The low growth in USA is the major concern forboth government and the central bank. The graveproblem of liquidity trap is on the verge and a goodmix of fiscal and monetary policy is what is neededin this case. While the central bank has kept the in-terest rates low the growth targets are still notachieved. Central bank needs to ensure that the ratewill be kept low past the crisis. On the other hand

fiscal policy is more effective during such times be-cause government doesnt need to promise anythingpast the crisis but it becomes difficult for the govern-ment to sell such an idea. There are limitations toboth kind of policies and hence it became all themore important for both government and centralbank to hold hand in hand. The strategy best suited

was to campaign on both the fronts of the policiesand that is what is implemented in US. While thegovernment is ensuring that austerity is bad, the fedis ensuring the investors that the rates will not behiked 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 fiscalsituation ensures that inflation is contained . A coun-try which has strong fiscal fundamentals hardly findsitself struggling to keep inflation low.

What also needs to be realized that even if the mone-tary policy framed by the Reserve bank of India isset to keep the current levels of inflation low and thefiscal policy aims to reduce revenue collection frompeople through reduced tax collections, money fi-nancing will eventually be required by the centralgovernment. This will mean a dependence on bor-rowing and hence an upward push on the borrowingcosts for the government leading to higher inflationonce again. Hence it is of great importance for theboth the monetary and fiscal policy to be in tandem

with each other.

It is in this context today that the RBI and the centralgovernment are in a conflict with each other. Thereare concerns about the lower expected GDP growthrate by the GOI and the RBI is concerned about the

persistently higher inflation.

An important area of focus today thus has been thecontainment of the fiscal deficit. If we look at theRBI claims, it wants the government to reduce itsexpenses on subsidies rather than increasing thetaxes so as to contain the fiscal deficit. A deteriorat-ing fiscal situation has also posed dangers of creditrating downgrade from the credit rating agencies.

This will have direct implications on the investor


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confidence and will pose a big threat to putting theeconomy back on the trajectory of higher growth.The government has responded to this situation byshowing firm resolve to improve the fiscal situationthrough a number of policy initiatives. However thegovernment blames RBI for playing it safe by notreducing the lending rates and only altering the CRR

rate in the some of the recent monetary policy re-views.

However, RBI has its own problems which haveforced it to maintain a tighter monetary policy. Thedepreciating rupee, euro zone crisis, rising oil priceshave forced RBI to keep the interest rates high. Asmuch as it appears that It will help to contain the in-flation we see that the food inflation has remainedmore or less the same level. This is because of the

fact that RBI is trying to control inflation by focus-ing on demand push inflation whereas the currentinflation levels have a lot to do with the cost pushinflation. Thus RBI policy is going wrong here andhence needs corrective actions. However the fact

that the rupee has undergone serious devaluationover the course of past one year and the oil priceshave remained stubbornly high, lowering interestrates poses risks of worsening this situation.

It is thus important for both the RBI and the centralgovernment to work in accordance with each other.

Rule based fiscal policy by the central governmentwill become increasingly important to afford thespace for monetary policy to contribute to macroeco-nomic stability. Fiscal prudence by the central gov-ernment to alleviate resource constraints by boostingdomestic saving will be crucial for raising domesticinvestment rate. In addition to this RBI will alsohave to take certain strong measures to infuse moreliquidity into the system by lowering the interestrates keeping in mind the fact that the major causefor high inflation has not been the demand push in-

flation. The quicker this important realization occursto both the central and the Reserve Bank of India;quicker will be the improvement in the Indiasgrowth prospects and between the relationships of

the central government with the RBI.

Courtesy: Akshay Goyal

NMIMS, Mumbai


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Chaitanya Gandhi is afinance enthusiast. Along

with working at Ernst and

Young, he has completed

his Masters in Commerce

from Mumbai University

and is a qualified

Chartered Accountant. He

is currently pursuing his

first year of MMS at

JBIMS.

Email ID:

chaitanyagandhi14@jbims.

edu

8

BY CHAITANYA GANDHI, JBIMS MUMBAI

Higher the Risk, Higher the Re-

turn has been the motto of all thebusiness across the globe sincetime immemorial. The Equity Mar-kets have been the personified ver-sion of this motto. Various strate-gies have been developed by the

most elite and erudite of the inves-tors to succeed in this high riskavenue. The most popular and wellaccepted is the Buy and Hold strat-egy or the Long-term InvestmentStrategy.

Choosing a good company for theportfolio will make a difference tothe profits but holding the same fordecades shall make the profitsmammoth sized as compared totrading it every day. Even the un-crowned emperor of stock markets,Warren Buffett relies on a Buy andHold strategy for investments andit can be said that as an investmentstrategy, its one of the most opti-

mum options one has for increasingthe wealth over the long term, inalmost every situation. WarrenBuffett is listed on the Forbes 2012Worlds Billionaire List as the third-richest man in the entire world.However, as per John Melloy in hisblog at CNBC, the Buy and HoldStrategy has taken a fair amount ofbeating in the recent times. As perthe blog, it is the mainly the highfrequency traders that make themoney in the world. As per theanalyst Alan Newmans Crosscur-

rents newsletter, the average hold-ing period of stocks has fallen fromfour years in the period 1926 1999 to 3.2 months now and thesame for S&P 500 SPDR (SPY),the ETF which tracks the bench-mark for U.S. stocks, is less than

five days!Given recent average volume, the

SPY trades its entire capitalizationand then some each and everyweek, wrote the analyst. Doesanyone really wish to argue wherevaluationm i g h tenter thepicture inthis sce-

n a r i o ?V a l u edoes notmatter int h eslightest.This dis-sertationaims tohave ane x p r e s -

sion on whether the annulment ofthe Buy and Hold Strategy has

really taken place? It is done vide:1. Understanding the Buy and

Hold Strategy, its advantagesand disadvantages.

2. Analysing the top indicesacross the world for the last tenyears

Does the 'Buy and Hold'

strategy really work amid the

current high volatility in equity

markets?


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3. Concluding on the invalidity of the long terminvestment strategy in such volatile times or oth-erwise.

What is Buy and Hold?

Investment Strategies are the various rules, behav-

iours or procedures designed and used by variousinvestors for stock selection and forming a portfolio.The investors design strategies as per their risk appe-tite and try to achieve a risk-return trade-off.Buy and Hold is a long-term investment strategybased on the view that in the long run, financial mar-kets give a good rate of return irrespective of periodsof volatility or decline. Also, it advocates that short-term market timing, i.e. the phenomenon that onecan enter the market on the lows and exit on thehighs, doesnt work. Moreover, attempting market

timing gives adverse results, at least for small-sizedor unsophisticated investors. Hence, it is far betterfor them to follow the Buy and Hold Strategy.The theory behind the Buy and Hold strategy is It'simpossible to consistently achieve above average

returns, on a risk-adjusted basis, according to theefficient market hypothesis (EMH). Investors have

access to information that will fairly value a securityat all times. Therefore, it is pointless to make deci-

sions that might result in the active trading of a se-curity.Hence the disciples of Buy and Hold find no

reason to trade in stocks on a day-to-day basis. Theonly area of focus is that the long term trend in themarket should be a positive. The antithesis of buy-and-hold is the concept of intra-day trading, inwhich money can be made in the short-term takingadvantage of greater volatility.Choosing good companies makes a difference toyour profits, but holding stock for decades will offerbetter results on an average rather than attempting today trade without in-depth knowledge and analysisof the market.

There are several advantages of Buy and Hold Strat-egy:

1. Easily Comprehendible and Implementable2. Supported by Investment Theory3. Reinforces the Minimum Emotions Maximum

Discipline approach4. 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 losses2. Test of Risk Appetite Investors may lose if

they dont have sufficient risk appetite3. Buy and Hold Approach may not provide Maxi-

mum Possible Returns as much as in Minute toMinute approach

Performance of various indices across world

The best way to take a call on the effectiveness ofthe strategy is to look at the historical results. Forthis, a sample of the top ten indices of the world istaken into consideration. Following are the perform-ances of the various top indices of the world.


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10

As can be seen from the above chart, most of the topindices have shown a low return over the ten yearperiod with spikes in between. In fact the Tokyo In-dex - Nikkei 225 has given a negative return of 17%,which means that a person invested in Nikkei keep-ing a Buy and Hold Strategy in mind for ten yearswould have lost 17% of his investment instead of

gaining anything.The mean return (arithmetic mean) and standard de-viation of the yearly returns achieved by these indi-ces are shows in the adjacent table. The mean returnsof the samples taken into consideration show that theaverage yearly return is below 10% in most of thecases. Also, the high rate of standard deviationshows that there is a lot of volatility in the marketand this makes the investments high on risk factor aswell.

Table 2 enlists the five-year and ten-year returns ofthe indices. As can be seen from the table, there is adisparity in the performance of the indices. Some ofthe indices have given exceptional returns over theyears as high as 534% over ten years, whereas others

have others have given a return of around 20% forthe same period. The negative returns in the five-year period 2007-Nov, 2012 has offset the gainsearned in the five-year period 2001-2006 due towhich the ten-year returns are not very impressive

(other than BSE 30 Index and Mexican IPC Index).

To gain a better understanding of the long-term re-turns, the year on year returns for the period 2001 to

November, 2012 (current) need to be analysed.Table 3 shows that the returns on various indices ofthe 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 byindices over a period of time which is subject to cer-tain steep falls owing to occurrence of certain bigticket events. As can be seen, there has been a fall in

2002 (Dot-Com Bubble Burst), 2008 (Sub-Prime


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Crisis) and 2011 (Curb of Quantitative Easing). Bar-ring these years, the indices have earned a good re-turn of investment considerably higher than the gilt-edged investments.This proves that the Buy and Hold strategy stillholds true provided its tweaked a little. One needsto decide the period for which the investments need

to be held as the Long in the long-term investmentsis not a thumb rule figure. For this it is suggested tointroduce periodic review of investments along withthe strategy. The review need not be on a daily basiswhich makes it as good as trading but over a longerperiod sufficient to detect any event which is affect-ing or may affect the investment in a hugely adverseway.The periodicity of review is basically dependant onthe risk of the portfolio. Higher the risk, more oftenshould it be reviewed. There are two types of risks,

namely the systematic risk and the unsystematicrisks. An unsystematic risk is a company specificrisk and it is inherent in every different investment ata varying level. It is a company specific risk andhence can be minimised using proper diversification,

whereas the systematic risks cannot be reduced inthe same way. The systematic risks are the ones ex-ternal to the company like inflation, high unemploy-ment, political turmoil, wars, natural disasters, andso on. The systematic risks are the events which cancause excessive volatility in the markets and hencethe investor should keep a keen watch on them. Sys-

tematic risks are measured using the Beta Factor(CAPM Theory) for a particular investment. Thisfactor is available in various investment journals.Portfolio beta must be used in order to determine theperiodicity of monitoring the investment while fol-lowing this strategy. This will ensure that the inves-tor assesses the investment as and when required andtake a sound strategic decision when the time de-mands.The traditional Buy and Hold strategy has tradition-ally given returns shall hold for the years to come,

but as time progresses and volatility increases newerways shall have to be discovered to keep tweakingthe strategy to the right curve so that the investorprofitability continues.

11


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Mr. Aviral Gupta has

over 10 years of

extensive performance

oriented experience in

funds management &

equity research for

Indian Equity Markets

with domestic as well as

foreign institutionalinvestors. Besides, he

has also set up

domestic as well as

offshore investment

s t r u c t u r e s a n d

mandates for Indian

Equities.

Mr. Aviral Gupta is

currently the fund

manager of Indiabulls

Mutual Fund. He is a B.E

from IIT Kanpur and a

CFA.

ANALYSIS OF FISCAL CLIFF

BY AVIRAL GUPTA, INDIABULLS FUNDS MANAGER

Hundreds of billions in tax increasesand automatic spending cuts comeinto effect in the United States assoon as the final moments of 2012tick away. Lawmakers in the US arescrambling to reach an accord onthis 'fiscal cliff', which if doesn'thappen is expected to drag theworld's largest economy into reces-sion, taking along with it severalother major economies around theworld. Tonight, on December 28, USPresident Barack Obama and Con-gressional leaders will be meetingfor the first time since Novemberwith no sign of progress in resolvingtheir differences. Will the US goover the fiscal cliff? That's the bigquestion staring at economists evenas the stock markets around theworld trade with caution on cuesfrom the US Congress.

Here are five facts on what 'fiscal

cliff' means for the US and the

world economy, and how it can be

averted:

1. The low tax rate regime enactedunder Republican PresidentGeorge W Bush on a temporarybasis and extended in 2010 under

the Obama administration ex-pires starting January 1. This willhave an impact on ordinaryworking Americans who willhave to pay about 2 per centmore in income tax. The taxes onan individual's investment willalso get increased, which in-cludes capital gains and divi-

dends. The New Year will seethe return of caps on personalexemptions and itemized deduc-tions for upper-income taxpay-ers. All this had come to an endduring Bush era.

2. More than two million unem-ployed Americans won't be re-ceiving the US government's un-employment insurance. Figuressuggest that about two lakhs ofthese unemployed reside in NewYork. The US unemploymentrate stood at 7.7 per cent in No-vember, according to Labor De-partment figures, and if the econ-omy slips into a recession, therate is expected to stand at a veryworrying 9.1 per cent.

3. Avoiding a fiscal cliff will meanextending the Bush-era tax cuts.Mr. Obama is not expected tobudge on this as far as imposingof higher taxes on rich Ameri-cans is concerned. Even if therich are taxed more, fiscal can beavoided by just extending Bush-era tax cuts for some months, ifnot all through 2013.

4. Americans blame the Republi-cans, who are the opposition in

the US Congress, more than De-mocrats (led by President BarackObama) for the "fiscal cliff" cri-sis, a recent Reuters poll hasshown. When asked who theybelieved to be more responsiblefor the fiscal cliff situation, 27per cent blamed Republicans inCongress, 16 per cent blamed

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Obama and 6 per cent pointed to Democratsin Congress. The largest percentage - 31 percent - blamed "all of the above". On the posi-tive side, 67 per cent of Americans polled inthe online survey said the impending fiscalcliff was not affecting their holiday spending.

5. Lawmakers are now looking at the period imme-

diately after the December 31 deadline to come

up with a retroactive fix to alleviate the impact

of the return to higher tax regime. If Friday's

meeting fails to arrive at a deal, lawmakers

would come back in January and take a more

politically palatable vote on cutting some of the

tax rates.

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Vibhu Gangal student of

SCMHRD, Pune and has

been writing many

analytical ar ticles, related

to Macroeconomics,

exchange rates and

f inanc ia l s ta tement

analyses of different

companies, published in

v a r i o u s f i n a n c e

magazines.

Email ID:

[email protected]

Quantitative Easing- Not That Easy!

BY VIBHU GANGAL, SCMHRD PUNE

With growing inability of traditionalmonetary tools, QE has been a pre-ferred weapon to fight out dryeconomies. However, whether pour-ing in billions of dollars into themarket via indirect measures spursthe economy in desired direction inlong run is indeed a billion dollarquestion! Is it sufficient just to havemore money into the system? Isnt italso necessary for the central-banksto route money so that it gets utilizedfor the intended purposes specifi-cally? The critique looks at scenar-ios, frequency, ways and the after-effects when QE has been imple-mented in different economies.Since the use of these unconven-tional monetary tools has been re-cent and infrequent, not many in-stances proving the degree of effec-tiveness of QE are available. How-ever, in consonance with the pastconsequences of easing events andrecent economic developments, theexposition tries to extrapolate theimplications of easing process to ac-complish a stand on whether QE is aboon or a curse for an economy.

The prime reason behind enforcing

easing is to make the institutions and

banks available with sufficient liquid

money which can be used for lend-

ing purposes, thereby prompting

more investments and a higher

growth in production eventually.

drilling the concept down to its root,

observe that under QE, no new

money is printed here. This means

that easing is a means just to divert

the flow of liquid money in the

economy from one destination to the

other. Thus, the main concern here is

to decide:

1. What is the current base of this

liquid money from where it

needs to be hived off?

2. Where this money needs to be

routed to?

3. How shall the diversion of this

money be carried out?

A miss on any of the three tabs iscapable enough to ruin the whole

plot of digressing money to the rightfront. For instance, if the idea is todivert the investment of money fromrisk less assets like government/treasury bonds to risky assets likeshares then the central bank creditsthe bond holders account withequivalent money for the bonds pur-chased.

The investors who sell securities to

the central bank then take the pro-

ceeds and buy other assets, raising

their prices. Lower bond yields en-

courage borrowing; higher equity

prices raise consumption; both help

investment and boost demand. De-

pending on the degree that investors

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add foreign assets, portfolio rebalancing also weak-ens the domestic currency, helping exports to gener-ate more returns. Unfortunately the timing of thissort of easing in India has not been escorted withchanges which could make the most of the easingeffect. For example, given the fact that about 70% ofIndian exports is un-hedged, OMOs in India could

be scheduled around the time when seasonal exportsare at peak and foreign assets appear attractive toinvestors than risky assets in India. Finding a junc-ture of these three events is not a rare event in pre-sent time. This shall serve two purposes at the sametime - narrowing down the current account deficit(though temporarily), and the main purpose of di-verting money away from the risk-less securities.These consequences, even if have a hideous nega-tive; shall not impact the economy in long run sincethe laws of demand and supply shall take effect and

bring it back to its original state.

Another rationale behind Quantitative easing mightbe the requirement to boost investment by loweringthe interest rates especially when credit channels arebunged. This, as the Federal Reserve was doing as apart of its earlier rounds of Quantitative easing, com-prised of purchasing mortgage-backed securities,demand for which had weakened sharply during thefinancial crisis. To meet the reduced demand withreduced supply, increasing prices and lowering inter-

est rates was a short-term technique, which found norelevance in present times since the credit channelshave eased to quite an extent. If the idea is to routethe liquid money to productive assets and long terminvestments then an anticipated spoke in the wheeland a major challenge is the glittering yellow metalwhich has seen substantial increases whenever QEhas been launched. In the course of the first round ofquantitative easing in the US, which ran from No-vember 2008 to March 2010, gold prices rallied by athird. During QE2, between November 2010 and

March 2011, they rose by another 17 percent. With ahigh volatility in currency markets, investors arelikely to seek shelter in gold. This effect, if seen inIndia, shall be devastating for imports as India beingthe largest importer of Gold, will experience theworst of the implications related to rupee deprecia-tion.

In light of this important concern of routing the

money released to an appropriate base, its interesting

to see what US and India have been doing for thepast few months at different deemed necessary lev-els. This is mainly due to two highlights of the QEprocess:

First and foremost, in case of India where the WPI(whole sale price index) is at 7.55%, CPI (consumer

price index) at 10.36% and entrench spraying mone-tary gasoline on an incipient inflation fire. This isbecause; the added one-year forward inflation expec-tations at 12.5%, OMOs or quantitative easing isakin to additional money influx in the economyshould flow to quench investment demand ratherthan fuelling consumer spending. So, how does thecentral bank ensure that the water in the village isused in the farms and not for domestic house-holdusage?

Secondly, an observation worth noting is that in In-dia, during 2011-12, of the Rs 1,27,000crore bondspurchased Rs 1,02,000 crore was of 7-13 year ma-turity. In FY 2012-13, of the Rs 55,000 crore ofbonds purchased Rs 42,000 crore is in the 7-13 yearmaturity.

If the reason for buying these bonds is to create pri-

mary liquidity the same could have been met

through buying bonds of short maturity or conduct-

ing term repos of 3-6 month maturity with the mar-

ket. Then why is it that the government is infusing

liquidity only through long term securities?

The answer to these two questions lies in the third

round of QE by the US. This phase comprises of two

parts. Under the first part, the government shall con-

tinue to purchase mortgage backed securities for $40

billion per month with no clear timeline when it will

end. As discussed, this shall most probably cause

prices to inflate. The current inflation rate in the US

is around 2%. Just as a higher inflation rate indicates

problems for an economy, a lower inflation rate can

also be a sign of danger because if the inflation if

primarily demand driven and not the one pushed by

costs, an excessively stumped inflation indicates a

drought of demand, i.e. a low purchasing power

which in turn means a narrowed scope for growth.

Why would not the Fed in US want this equation to

15


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invert? As it appears to me, this leg of the thirdround of QE corresponds to routing more moneytowards consumption demand than it is right now.Under the second part, famously known as operationtwist, is an initiative of buying longer-term treasuriesand simultaneously selling some of the shorter-datedissues the central bank already holds in order to

bring down long-term interest rates. The idea is thatby purchasing longer-term bonds, the Fed can helpdrive prices up and yields down (since prices andyields move in opposite directions). At the sametime, selling shorter-term bonds should cause theiryields to go up (since their prices would fall).

The program gets its name from the fact that in com-

bination, these two actions twist the shape of the

yield curve. A same phenomenon is apparent in the

Indian case too. The fact that the government has

been infusing

liquidity only

through long

term securities

is evident from

this figure of

Yield curve.

Observe that in

the figure, the

10 year bond

yields have low-

ered by about

2%. The ration-

ale behind do-

ing this is that lower longer-term yields would goose

the economy by making loans less expensive for

those looking to

buy homes

purchase cars

finance projects.

This leg of the QE phase three in US is to route the

money to satisfy the investment demandof the econ-

omy. Together this two-pronged strategy has been

framed by the Fed to fortify the flow of money to the

pillar components of economy i.e. consumption and

investment demands. A point to be noted here is that

India, on the other hand cannot go for the first part

of the QE program since inflation in India is high

and secondly is mainly pushed by costs. So, at its

own deemed necessary level, India plays the game

only with the second leg of QE, i.e. a program on

similar lines of operation twist, though not exactlysame as that.

Having seen the different implications and variousways in which QE can be executed, the billion dollarquestion is that does pouring in billions of dollarsinto the market via these indirect measures reallyspurs the economy in the desired direction in longrun? How long can we bank upon these ancillarymeasures? The need of the hour in both Indian and

the American

economies is toovercome the struc-tural deficienciesimpeding invest-ments. By easingcredits, one canpush investmentsonly when the fun-damental platformfor investing ispaved with a strong

foundation. Bureau-cratic hurdles inIndia, a dense spiralof corruption andlong sanctioningprocedures are

faced by an aspirant businessman before he/sheraises money. So, how much ever low are the inter-est rates, if a person is entangled in these steeple-chases, how does it make investments easy? Howdoes it create jobs? And how does it prompt growth?

So, the answer to the question, whether quantitativeeasing is a key step to an economys success is a bit

difficult to be answered up-front. Quantitative easing

is surely a blessing, a boon when the structure in the

economy is at place. It can create leverage effects

where a gentle turn-around of just a few purchases

of bonds can makeover the face of the economy.

However, easing in isolation, not being completed

Source: ET

16


20/47

with appropriate channels to settle the money di-verted shall end the whole effort in smoke.

Easing is not a means to create additional money,

easing is not a means to absorb; easing is just a

means to re-route the money from one base to the

other, and so along with this re-routing, if the econ-

omy is architecturally and structurally incapable to

create money and operationally incompetent to ab-

sorb money at the right time, easing alone cannot

create wonders.

17

crossword


21/47

An M. Phil & PhD inEconomics from Jadavpur

University, Kolkata, she

started her career as a

faculty (Economics) with

BES col lege under

Calcutta University. She

has been faculty with

reputed business schools

across India since 2004.

Alongside teaching she

has been a full time

researcher. She is expert

in trade modeling and has

b e e n w o r k i n g o n

international trade issues

since 1997. Dr. Sikdar

completed several studies

on behalf of Ministry of

Commerce, Govt. of India

and for United Nations

Asia- Pacific Researchand Training Network on

Trade (ARTNeT).

Impact of India-ASEAN Free Trade

Agreement

While India at present has been talk-

ing ad infinitum about FDI in vari-ous sectors, another event of utmost

importance, the 1oth ASEAN-Indiasummit held on November 19, 2012,

failed to catch attention of hoi pol-loi.

In the wake of such a time, TeamFinomenon makes an attempt to

bring forth this hugely forgottenphenomenon through our Faculty

Speaks section.

The following is a summarized ver-sion of the research paper published

by Dr. Chandrima Sikdar, AssociateProfessor, NMIMS, Mumbai along

with Dr. Biswajit Nag, AssociateProfessor, IIFT Delhi.

India announced its Look Eastpolicy in 1991 in an attempt to in-crease its engagement with the EastAsian countries. Consequently, in1992, it became a sectoral dialoguepartner of the Association of South-east Asian Nations (ASEAN).ASEAN, which is a geo-political andeconomic organization with 10member countries, was formed in

August 1967 by Indonesia, Malay-sia, the Philippines, Singapore andThailand. Since then, the member-ship has expanded to include Brunei,Darussalam, Cambodia, the LaoPeoples Democratic Republic,

Myanmar and Vietnam. ASEANsobjectives are to accelerate eco-nomic growth, social progress and

cultural development among itsmembers, protect the peace and sta-bility of the region, and provide op-portunities for the member countriesto discuss their differences peace-fully.

Negotiations on a trade in goods

agreement between India andASEAN were started in March 2004.

The negotiations continued for six

years and finally the India-ASEAN

Free Trade Agreement (AIFTA) was

signed on 13 August 2009 in Bang-

kok. AIFTA promises to boost bilat-

eral trade between the two regions.

ASEAN is a major trading partner of

India. The FTA will lead to the

elimination of tariffs on some 4,000products including electronics,

chemicals, machinery and textiles.

Of these 4,000 products, 3,200 prod-

ucts will have duties reduced by the

end of 2013, while duties on the re-

maining 800 products will be low-

ered to zero or almost zero by the

end of 2016. The net effect of the

trade agreement crucially depends

on the ability of the Government of

India to redistribute some of the in-

creased wealth gained from this

trade agreement to those industries

negatively affected by the agree-

ment.

BY DR. CHANDRIMA SIKDAR, ASSOCIATE PROFESSOR AT NMIMS

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Impact on select macroeconomic and trade vari-

ables of India and ASEAN region

As far as the selected macroeconomic indicators ofGDP, employment and average prices are concerned,Indias gains are virtually none whether there iscomplete tariff elimination (full liberalization) or

tariff changes as per tariff commitments of the coun-tries (as in the current or ultimate scenarios). Underfull liberalization, Malaysia, Singapore, Thailandand the rest of ASEAN are better off. Singapore andMalaysia gain the maximum benefit. Among thesmaller countries, Cambodia is the most adverselyaffected while Myanmar, Vietnam and Indonesiaexperience considerable positive impact. In the cur-rent scenario, the same three ASEAN countriesbenefit substantially, with Singapore and Malaysiagaining the most. In the ultimate scenario, Singapore

still gains notably among all the ASEAN countries.

Welfare implications of the FTA for India and the

ASEAN region

FTA implementation under both the current and ulti-mate scenarios will result in India and some of thesmaller ASEAN countries (i.e., Cambodia, the LaoPeoples Democratic Republic and the Philippines)

incurring welfare losses.While the loss for India is due to negative terms of

trade, for Cambodia and the Lao Peoples Democ-ratic Republic the loss is due to both allocative inef-ficiency and the negative terms of trade effect. ThePhilippines experiences some gain from increasedallocative efficiency but the negative terms of tradeeffect is relatively stronger. For other ASEAN coun-tries, the terms of trade effect is positive andstronger, resulting in large welfare gains. For India,the welfare position improves with the expansion ofthe trade liberalization process, both with regard tothe number of ASEAN countries with which its

trade is liberalized as well as the number of productsfor which tariffs are lowered or eliminated. How-ever, although total welfare improves, the terms oftrade for India continue to be negative, resulting inthe lowering of its GDP in all three trade liberaliza-tion scenarios. Therefore, the import and exportprices of India following FTA implementation needto be given more attention.

Impact on bilateral trade between India and ASEAN

In summary, following implementation of the FTA,bilateral trade between India and ASEAN increasesphenomenally. While Cambodia, Indonesia, the LaoPeoples Democratic Republic, the Philippines andViet Nam provide additional markets for almost all

Indian exports, Malaysia, Singapore and Thailandprovide markets for some of the fastest growing ex-ports from India. Malaysia, Thailand and Viet Nambecome major importers of Indian goods in terms oftotal exports by that country to ASEAN. They alsoprovide markets for the fastest growing items ex-ported by India. In particular, Thailand consistentlyprovides a large market for Indian products under allthree scenarios. The increase in Indias imports fromASEAN is due to increased exports by Indonesia,Malaysia, the Philippines, Singapore, Thailand and

Viet Nam, plus the rest of ASEAN. These countriesalso supply the items that register the largest in-creases in Indias imports from ASEAN following

the implementation of the FTA.

Impact on India

Indias welfare gain appears to be negative at theinitial stage due to both negative allocative effi-ciency and negative terms of trade. The loss in allo-cative efficiency is due to a loss of import tax result-

ing from tariff reduction/elimination, while the nega-tive terms of trade is explained by a larger fall in In-dias export prices relative to its import prices. How-ever, the country's welfare improves as liberalizationexpands and the markets of the rest of ASEAN openup substantially.

Impact on ASEAN countries

Malaysia, Singapore and Thailand experience posi-tive welfare gains, with the largest gain accruing to

Singapore. This is due to the fact that Singaporesschedule of tariff commitments only comprises sixitems; as such, the FTA is tantamount to a unilateralliberalization by India for Singapore. These coun-tries gain substantial market access in India, withThailand experiencing the largest increase. Malaysiaenjoys the largest welfare gain if there is full liber-alization. The other countries, except Cambodia, theLao Peoples Democratic Republic and the Philip-

pines, enjoy positive welfare. The gains accruing to

19


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all these countries are due to large positive terms oftrade gain. This is because the prices of their exportsto India fall much less than Indias export prices to

their markets. This is explained by their relativelysmaller market sizes compared to the Indian market.The welfare losses experienced by Cambodia, thethe Lao Peoples Democratic Republic and the Phil-

ippines are also due to large negative terms of trade.

Trade impact on other countries of the world

In general, the India-ASEAN FTA is likely to pro-vide many of the desired results for the countriesinvolved, i.e., improved welfare for most of thecountries, increased trade engagement, better marketaccess in the partner country and, to a large extent,trade diversion in the India-ASEAN region. How-ever, the relatively larger ASEAN members will de-

rive more benefits in terms of GDP and welfaregrowth. India is expected to enjoy higher benefitsonly when the agreement has been fully imple-mented. Indias exports to smaller ASEAN markets

are expected to grow faster as the agreement entersits final stage.

ASEAN members will gain from a higher Terms-of-Trade (ToT) effect while Indias gain will mainly be

from resource reallocation and change in domesticproduction activities reflected through allocative ef-

ficiency. Indias import demand for several interme-diate goods will remain high and ASEAN will havethe advantage of supplying such goods at higherprices that are still lower than the average prevailingimport prices in India.

(This article is an excerpt of the original researchpaper Impact of India-ASEAN Free Trade Agree-

ment: A cross-country analysis using applied gen-

eral equilibrium modellingby Dr. Chandrima Sik-

dar and Dr. Biswajit Nag. This research paper is

Asia-Pacific research & training Network on Tradeand Finance ARTNet Working paper series No. 107,November 2011.)

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Vishal Pingale is a first

year student of PGDM at

Institute for Financial

M a n a g e m e n t &

R e s e arc h ( I F MR ) ,

Chennai.

Email ID:

[email protected].

in

Tushar Sharma is a

first year student of

PGDM-FE at Institute for

Financial Management &

R e s e arc h ( I F MR ) ,

Chennai.

Email ID:

[email protected].

in

"In The Business World, The Rear-view Mirror Is Always ClearerThan The Windshield."

- Warren Buffett

Predicting the movements of stockmarket has never been easy. Asmuch as we try to analyze and

theorize to understand and predictwhere it is heading, we are alwaysbeaten by the vagaries of the game.This is particularly true in Indiancontext, where the financial mar-kets are more chaotic and the in-vestors come from extremely var-ied rational and intellectual back-grounds.

Nevertheless, an informed observa-

tion of the historic trends and theprevailing macroeconomic environ-ment can help in gauging how theSensex can shape up in the comingyear 2013.

The SENSEX is an acronym forSensitivity Index. It was com-

piled in 1986and is based on the'Market Capitalization-Weighted'method. It comprises of 30 stocks

representing large, well-establishedand financially sound companiesacross varied key sectors. The baseyear of SENSEX is 1978-79 and itsbase value is set at 100 as on April1, 1978. Owing to its scientific de-sign, it widely accepted and pub-lished barometer of the health ofIndian financial markets.

Over the past one year, the Sensexhas been operating in the 16,000 -19,000 range. The year has beencharacterized by 2 small-term bullruns with a correction thrown in themiddle. As on Dec 10,2012 theSensex is passing through the sec-ond upswing which appears in a

mood to take the Index above20,000.

In the coming year, we can bet onthe Sensex to breach its all-timepeak of 21,078 (which it made onJan 08, 2008). Whether it happensas part of the current Bull Run orthe subsequent one is debatable.All the indicators that we considerare pointing towards a bullish year

ahead for the Sensex. Some of thekey factors which are contributingtowards this bullish outlook are: Anewfound Political will in the Gov-ernment to push through reforms.Increased cases of CDRs passingthrough.

Percolating effects of QE3

A major contributing factor to the

feel-good factor of Sensex is theinvestor sentiment. And the inves-tor sentiment is now on a high withhopes that the reforms agenda willfinally see the much needed pushfrom the political masters. Thesereforms saw an inception sometimein September, 2012 in the form ofproposals to allow foreign

Sensex in 2013

BY VISHAL PINGALE AND TUSHAR SHARMA, IFMR CHENNAI

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participation in retail, aviation and broadcast to-gether with some fiscal tightening measures such asreducing fuel subsidies.The spate of restructuring of debts of SECs andwaiver of import duties on broadcast together withsome fiscal tightening measures such as reducing

fuel subsidies.

The spate of restructuring of debts of SECs andwaiver of import duties on import of machinery forpower generation will doubtlessly have a positiveimpact on power sectora crucial but troubled sup-ply side ingredient of the Indian economy. But con-cerns still remain over the workability and consis-tency of the Power Purchase Agreements. Alreadythere have been concerns over another major compo-nent of the mix fuel. With mining sector passingthrough regulatory hurdles, many power plants are

facing an artificial fuel shortage. The long gestationperiods for Power plants and subsequent delays posea challenge for the sectoras these only make the

sector more unviable.

The reforms in Pensions and Insurance sectors willincrease the liquidity in the marketsthus contribut-ing positively to the growth in the coming year. Thetroubled sectors remain the Airlines, PSU Banks andReal Estate/Infrastructure sectors. With eroding assetqualities and increasing exposure to troubled sectors,PSU banks will face tremendous stress on their op-

erations. Debt restructuring will constantly keep thebanks on the run for their money. However, the sil-ver line remains their strong fundamentals andstrong adherence to tight regulatory mechanisms,which will ensure no crisis, breaks out in the sector.The allowing of FDI in Airlines sector is still beingdebatedif it will do any good. Intense competitionand low margins means that the sector remains lowon the radar for global players and foreign investors and with existing players burdened already, theoutlook remains bleak for the sector. It is expected

however, that the Land Acquisition Bill passed thisyear will contribute to removing the one biggest bot-tle-neck associated with the sector and hopefully

provide an impetus to fresh investment in the sector.

In spite of being a NOT SO BAD YEAR for themarkets, a lot of pessimism has still prevailed in the

atmosphere. This has been due to:

Threats and instances of credit rating down-

grades

Poor monsoons

Ballooning fiscal deficit

Weak IIP growth numbers

Global pessimism

Uncertainty about FDI in retail

There is now a growing realization among investorsthat the worst phase of Indian economy is over andeconomic growth, which had slowed down to a lowof 5.5% this year, has started to bottom out. Econo-mies are slowly limping to normalcy globally andthere is an expected pick-up in external demand in2013. With a weakened Rupee Dollar exchange re-

gime, the exports would be perked up. Another ma-jor sector, IT, which depends greatly on exports ofits services, would be buoyed by such a scenario.There is increasing pressure on Reserve Bank of In-dia (RBI) to cut rates next year, which would go along way in stimulating economic growth and con-sumption. Credit Suisse has predicted that a 125 bpscut in interest rates by the RBI will likely push In-dia's growth rate above 7 percent by late-2013.

Fig1. FII Inflows in India Data Source: Hindu Business LineDt. Nov 30, 2012

Analysts believe that a confluence of liquidity, senti-ment, reforms, global cues and geopolitical situationin the Middle East will drive the Sensex further upin the coming year. Indian equities and currencyboth got a boost from recent measures. The rupee,which had plunged to an all-time low of more than

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57 vis a vis the U.S. dollar on June 22, has since re-covered by more than 8 percent, helped partly bythese initiated reforms. Also, if everything goes wellwith the Euro zone, its possible to see the Sensexabove 23,000 as compared to the movement shownin 2011. The Index line touches the uptrend line atseveral points confirming the long term uptrend in

the Index. Due to all these reasons, it can be techni-cally inferred that if Sensex continues to move at thesame pace we can see the Sensex breaching at leastthe 22,500 mark if not the target of 23,069 set by

Morgan Stanley in their recent report.

The lines shown in orange color show the supportsand resistances that the Index may have in the nearfuture. The earlier support levels will act as verystrong supports in the future. In the near term themarket will get a support at 18,200 and a very strong

support at 17,300.The chances of the market goingbelow 17,300 (without any economic adversity) arevery marginal. On the other hand, the upside poten-tial of the Index is to climb over23,000. Therefore,the downside risk is just of 1,800 to 2,000 points ascompared to 3,500-3,700 points of upside potential.

The market may face resistances at the earlier resis-tance levels of 2011 i.e. at levels of 19,800 and20,550.Once these resistances are broken, these re-sistance levels will act as supports to the Index.However, there could be a few stumbling blocksahead too. With disappointing FY13 numbers seenin top-line growth of companies in the BSE, a carry-over of weakened earnings in the next year can im-

pede any growth of Sensex. The biggest stumblingblock could still be the supply side constraintsplaguing the Indian economy, which are holdingback India from unleashing its true potential. Prob-lems like a rickety infrastructure, delays in clear-ances for crucial projects, delays in land acquisitionand power and supply-chain woes have had a very

bad effect on the companies often affecting theirbottom lines too. Any amount of upswing in con-sumer demand will be unable to perk up the Indianeconomy unless these constraints are not tided over.Nearing of elections in year 2014 could also temptthe Government to increase its spending on subsidiesand finance its other populist measures. These stepscan put pressure on the Sensex and bring it back tosquare onea classic case of one step forwards, andtwo steps backwards. Many other things still need tobe done to assuage the investor sentiment and fire up

the Animal Spirits.The reforms so far are just thebeginning of a long and painful process. Economicgrowth, which has slowed to around 5.5% this year,is not going to return to the 9% growth rate experi-enced a few years back. But the long-term Indiastory stays intact, as long as politics doesnt trumpeconomics.

The below figure shows the FII investments into theIndian markets since 2008. FIIs have the financialmuscle to move the markets. We saw a recession in

2008, when the FII outflows (coupled with DII andretail investor panic) were to the tune of Rs. 41,216cr. This was the time when the Sensex tasted levelsof 8,000. But, just after experiencing few sluggish

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months in 2009, the Index fired up to reach back tolevels of 17,500 by Dec 2009.This was backed by aninflux from the FIIs to the tune of RS. 83,424. In

the next year i.e. in 2010, the 94,335 cr. investmentby the FIIs pulled the Index above the 21,000 level.

2011 saw the Sensex slithering to 15500 levels,when the FII investment was merely Rs. 225 Cr.

And, in 2012 the Index has again grasped 19400 lev-els with a very high cash inflow to the tune of Rs.101316 cr. (till Nov 30) from the FIIs. This is thesecond highest inflow since 1993, when Indiaopened the doors to this class of investors. Thisshows the confidence of the FIIs into the Indianeconomy, even when the Indian experts werent con-fident about our economy. FIIs usually invest for

long term. So it can be anticipated that the moneythat has come in will stay in, for at least one moreyear i.e. until 2013.Also, if the economy does well

assisted with the reforms recently initiated by theIndian Government, we can expect the foreign in-flows to continue. So, there are very high chances ofSensex breaching 23,000 levels in 2013.

We will now have a look at the Index from the tech-nical perspective. From the historical chart of Sen-sex (in the previous page) ranging from Jan 2011 toDecember 2012, we can find two strong trendsemerging in the Index. The first trend was a down-trend which had started in Jan 11 and lasted for the

entire year. During the month of December 2011,just when the markets were at the lowest point of theyear, the stock market experts were self-confidentlypredicting that the markets would fall further to13,500-14,000. But, fortunately this didnt happen.

The Index then picked up in a dramatic fashionbacked by the huge FII investment pouring into In-dia in the months of January, February and March.The green color uptrend line shown in the graphmakes it pretty evident that the Bull Run of Sensex

has started with very strong supports. This uptrend issteered by the huge FII investments coming into theIndian markets. Also, the behavior of the Index inthis uptrend is pretty simple without much volatilityas compared to the movement shown in 2011. TheIndex line touches the uptrend line at several pointsconfirming the long term uptrend in the Index. Dueto all these reasons, we can infer that if Sensex con-

tinues to move at the same pace we can see the Sen-sex breaching at least the 22,500 mark if not the tar-get of 23,069 set by Morgan Stanley in their recentreport.

The lines shown in orange color show the supportsand resistances that the Index may have in the near

future. The earlier support levels will act as verystrong supports in the future. In the near term themarket will get a support at 18,200 and a very strongsupport at 17,300.The chances of the market goingbelow 17,300 (without any economic adversity) arevery marginal. On the other hand, the upside poten-tial of the Index is to climb over23,000. Therefore,the downside risk is just of 1,800 to 2,000 points ascompared to 3,500-3,700 points of upside potential.The market may face resistances at the earlier resis-tance levels of 2011 i.e. at levels of 19,800 and

20,550.Once these resistances are broken, these re-sistance levels will act as supports to the Index.

However, there could be a few stumbling blocksahead too. With disappointing FY13 numbers seenin top-line growth of companies in the BSE, a carry-over of weakened earnings in the next year can im-pede any growth of Sensex. The biggest stumblingblock could still be the supply side constraintsplaguing the Indian economy, which are holdingback India from unleashing its true potential. Prob-

lems like a rickety infrastructure, delays in clear-ances for crucial projects, delays in land acquisitionand power and supply-chain woes have had a verybad effect on the companies often affecting theirbottom lines too. Any amount of upswing in con-sumer demand will be unable to perk up the Indianeconomy unless these constraints are not tided over.Nearing of elections in year 2014 could also temptthe Government to increase its spending on subsidiesand finance its other populist measures. These stepscan put pressure on the Sensex and bring it back to

square onea classic case of one step forwards, andtwo steps backwards. Many other things still need tobe done to assuage the investor sentiment and fire upthe Animal Spirits.The reforms so far are just thebeginning of a long and painful process. But thelong-term India story stays intact, as long as politicsdoesnt trump economics.

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Ellina Rath is currently

a first year student of

MBA at SBM,NMIMS. She

is a graduate in

E c o n o m i c s f r o m

Miranda House, Delhi

University. She has also

completed a PG diploma

in International Trade

Law from the Indian Law

Institute, New Delhi.Email ID:

[email protected]

Prakash Nishtala is a

first year student of

MBA at SBM, NMIMS,

Mumbai. He holds a

B.Tech degree and has 2

y e a r s o f w o r k

experience in IT andStock Exchange (F & O

Segment)

Email ID :

[email protected]

A term that loosely signifies avoluntary investigation refers toan audit carried out of a potentialinvestment. In other words, it is away of assessing a business oppor-tunity. The very notion behind it isto save any unnecessary harm toboth parties involved in a transac-

tion by examining all material as-pects to a sale. This includes anexamination of the past record, pre-sent and a forecast of the businessin consideration. In the era of glob-alization, every Business strives toposition itself strategically. This isdone through either cross borderalliances or mergers & acquisi-tions. In order to tackle the indis-pensable uncertainties arising in

business, as companies make anattempt to diversify their risks,functionally as well as globally,informed decision becomes an im-perative.

Peeking into the background, it hasits origin in the United States Se-

curities Act of 1933 that followedthe Stock market crash of 1929.The law aimed at regulating the

sale and offer of securities. Section11 of the law referred to a clause ofDue Diligence that could be re-

ferred to in a situation where bro-ker dealers did not practise ade-quate disclosure of relevant infor-mation to the investors or purchas-ers of securities. Originally prac-tised only for the equity invest-ments through public offerings by

broker dealers, it is associated withpractically all forums of investmentfor a business. These range fromdisinvestments, private equity fundinvestments, mergers and acquisi-tions as well as listing of securitiesin overseas markets.

The Process of Due diligence is amultidimensional exercise basedbroadly on three parameters:Evaluation, Interpretation andCommunication. The evaluationand interpretation is not an analysisof accounting nature but a businessoriented analysis i.e. includes infor-mation on tax, legal and other busi-ness aspects of the issuer. Thiscomprises understanding the indus-

try of the target, the business andthe environment it operates in. ITalso attempts to locate the deal de-stroyer defects and aim to findmitigating options to them. It canbe carried out as per the specifica-tions of the party interested in theinformation.

The classification of the due dili-gence types can be broadly on twobases. It is largely dependent on thenature of the Transaction and whatthe entire process of Due Diligenceaims to achieve. Nature of Client according to

the specifications of the inves-tor or the seller.

Nature Of work LimitedScope Vs Full scale i.e. eitherstrictly deals with the part of

Due Diligence and the Foreign

Corrupt Practices Act

BY ELLINA RATH & PRAKASH NISHTALA, NMIMS MUMBAI

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the business concerned in the transaction or a com-prehensive study of the entire business is under-taken.

Process

The process of Due Diligence broadly covers the

following steps: Presentation/background information by the is-suer Sending the issuer a questionnaire Organizing a due diligence team Issuer to create a data room (virtual or physical) Review of documentation/ discussion with man-agement Bring down due diligence questionnaires/callsprior to closing of the transaction

Due Diligence in India

Due Diligence in India has been brought by the for-eign investors and advisers only after the economicreforms took place in 1999. Hence the practice ofDue Diligence investigation is relatively recent.However, SEBI guidelines mandate certain parties tocarry out Due Diligence when it comes to issuanceof securities by a company. Some of the major regu-lation in the context of Due Diligence is: Regulation 64 of chapter VI of the ICDR regula-

tions The Book running Lead manager ( BRLM)to exercise due diligence in the pre issue of securi-ties and can also call upon the issuer to oblige as perthe disclosure made by the latter in the offer docu-ment. Regulation 65 -the BRLM is required to submitthe post issue document to SEBI along with a duediligence certificate along the prescribed format. Regulation 83- a qualified institutions placementis to be managed by BRLMs registered with SEBIwho shall exercise Due Diligence. A Due Diligence

certificate by the BRLM is to be furnished to eachstock exchange the securities is listed on to certifythat the securities are eligible for issue under Quali-fied Issuers placement.

A greater degree of caution is practised and exten-sive review of compliances is undertaken in case ofthe listed companies in India. The provisions ofSEBI (Prohibition of Insider Trading) Regulations1992 are applicable in case of the listed company.

This is in regard to the care that has to be taken toavoid any violation of insider trading regulationswhile practising due diligence.

Due Diligence Vs Audit

There are some fundamental differences between the

practice of due diligence and Audit. While the scopeand procedures of Due diligence are agreed upon bythe Client, that of the latter is often specific to theGAAS defines procedures in each country. Due dili-gence does not test the underlying accuracy of theinformation and includes forecasting about the busi-ness. It uses the Audit output and limited accessalong with a time constraint. The material aspectshave to be accordingly taken into account as per theClients needs.

Audit however is backward looking and does notcover the future. It is a financial statement focusesapproach and the report is prepared as per theGAAP. It has scheduled time tables and at the sametime tests the accuracy of the information given.

There are some limitations inherent in the Due Dili-gence Practice when compared to Auditing. Since itis not an examination of internal controls and is notattested as per the ICAI standards. As is apparent, ithas dependency on the target Company in terms of

the information and documents provided beinggenuine.

While it seems to be a process that is negative i n

approach i.e. raising hurdles to transactions, on the

contrary it facilitates transactions by identifying

problems and risks associated. It also devises solu-

tions that help in mitigating risks and manage the

problems in investments.

With the increasing number of penalties being im-posed on companies, it becomes imperative for busi-nesses to look at Due Diligence with substantial seri-ousness. The lack of due diligence by many institu-tions can lead to transactions that are perceived to beviolating the compliance requirements of certain leg-islations. The Foreign Corrupt Practices Act is onesuch legislation that needs to be understood as duediligence is closely associated with it.

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Foreign Corrupt Practices Act

The Foreign Corrupt Practices Act of 1977 (FCPA)

is a United States federal law known primarily for

two of its main provisions, one that addresses ac-

counting transparency requirements under

the Securities Exchange Act of 1934 and anotherconcerning bribery of foreign officials. The Act is

implemented into two parts. The first is generally

enforced by the Department of Justice (DOJ) which

prohibits U.S. citizens and U.S. firms, or those listed

on a U.S. stock exchange, from making and offering

to make payments to foreign government officials to

obtain, or retain, business or a business advantage.

The second is enforced by the Securities and Ex-

change Commission (SEC) that requires that compa-

nies maintain accurate books and records.

There is practically no threshold limit to the amount

of infractions and even a small bribe monetarily can

be termed as a big crime, especially if FCPA prob-

lems are systemic. The FCPA makes an attempt to

unearth the systemic flaws and often the depth or

breadth to which corruption is prevalent within a

company is more pertinent under FCPA.

Backdrop

The U.S. Securities and Exchange Commis-

sion carried out investigations in the mid-1970s

which resulted in admittance of making questionable

or illegal payments in excess of $300 million to for-

eign government officials, politicians, and political

parties by over 400 U.S. companies. The ambit of

abuses ranged from bribery of foreign officials to

secure favorable action by a foreign government tofacilitating payments that were made to ensure that

government functionaries discharged certain minis-

terial or clerical duties. Lockheed scandal was such a

case in point in which officials of Lockheed, an

aerospace company, bribed foreign officials to pro-

mote their company's products. Next in line was

the Bananagate scandal in which Chiquita

Brands bribed the President of Honduras to lower

taxes. FCPA was enacted to bring a full stop to the

bribery of foreign officials and to restore public trust

and belief in the integrity of the business system in

US.

On December 19, 1977, FCPA was signed into lawby President Jimmy Carter and amended in 1998 by

the International Anti-Bribery Act of 1998 which

was designed to implement the anti-bribery conven-

tions of the Organization for Economic Co-operation

and Development.

India & FCPA

India has never been more attractive as a land of

business opportunities as it is now. For businesses

eager to enter India, compliance with the Foreign

Corrupt Practices Act (FCPA) becomes an increas-

ingly important priority as corruption in the country

continues to rise and government doing a little to

curb the corruption. Moreover, it has now become a

regulatory prerequisite to set up businesses in India.

Indias propensity for corruption is unmistakable as

measured by Transparency Internationals (TI) Cor-

ruption Perceptions Index (CPI), which ranks coun-

tries from highly clean (10) to highly corrupt (0).

Indias 3.4 score makes it prime territory for FCPA

violations, not much safer than Russia (2.1) or Nige-

ria (2.7).

When it comes to India, clearly the risk is higher

which means that special care should be taken. In-

dias vast, poorly paid government bureaucracy ap-

pears to leverage its power over granting licenses

and permits by demanding bribes from those seekingto speed up what can be a long and drawn out proc-

ess.

FCPA Violations in India

US company: Dow Chemical Company

Indian affiliate- De-Nocil Corporation

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Offence: Paid Indian government officials $200,000

(Rs 1 crore) between 1996 and 2001; one particular

officer was given $39,700 (Rs 19.85 lakh) through

contractors working for the company who got the

extra cash via fictitious bills.

Penalty: Dow Chemical was found guilty of violat-

ing book-keeping norms related to the above in2007; Dow agreed to a penalty of $325,000 (Rs 1.62

crore).

US company: AT Kearney

Indian affiliate: AT Kearney India (ATKI)

Offence: Between 2001 and 2003 ATKI paid

$720,000 (Rs 3.6 crore) to Indian government-

owned companies on directions of founding Presi-

dent Chandramouli Srinivasan.

Penalty: In 2007, ATKI parent EDS was fined

$490,902 and Srinivasan $70,000 after the SEC

brought in prosecution against them for violating the

FCPA.

US company: Xerox Corporation

Indian affiliate: Xerox Modi Corp (now Xerox In-

dia)

Offence: Xerox voluntarily disclosed in 2003 im-

proper payments (related to sales to gov

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