In conversation with
Mr. Sanjay Bakshi Especially for readers of the 1st Is-
sue
Reliance Industries Ltd. The Heavy Weight of Indian Indices
APRIL—JUNE 2012 | ISSUE 1
Book Review
Ascent of Money Financial History of the World
BLUE CHIP
ISSUE 1
All images, artwork and
design are copyright of
Monetrix
Finance and
Economics club of
MDI, Gurgaon
The Team
Aditya Mittal
Amit Garg
Anupriya Asthana
Keyur Vinchhi
Nihal Mahesh Jham
Sandeep Patil
Uday Das Gupta
Varun Sanghi
For any information or feed-
back, please feel free to write
in to us at
From the Editor’s Desk
Dear reader,
With the monsoons hitting northern India and giv-
ing everyone a pleasant relief from the scorching
heat, I am proud to present the first ever issue of
Blue Chip and hope that it adds to the merriment
around!
We generally associate the word ‘Blue Chip’ with
the companies that make up the broad market indi-
ces such as Sensex & Nifty. To some with a flair for
playing card games such as poker, it has tradition-
ally been a token of prestige. Both the stock market
and the game of poker are based on a combination
of skill and luck – luck dominates in the short run
and skill if you are in it for the long run!
In both these situations, possession of a Blue Chip
has always been equated to having a token of safety
or confidence. Our namesake magazine hopes to
serve its readers with the same goal, of being a
companion of MBA undergrads, like yourself, that
can be banked upon for being there when in-depth
understanding of recent happenings is needed or
simply for the fun of reading it.
Keeping in line with the spirit of a Blue Chip, we
present the cover story on a company that is a phe-
nomenon in itself — Reliance Industries Limited,
traditionally, one of India’s most trusted blue chip
companies.
To make the first quarterly issue of Blue Chip spe-
cial, we present a candid interview of our beloved
and respected professor & revered investor Mr.
Sanjay Bakshi especially for budding investors like
you.
By now, in the game of life you have already been
dealt the cards and now you also have the Blue
Chip in your hands, then what are you waiting for?
Play on and have fun!
~Anupriya
Editor for Blue Chip
CONTENTS
Tutorial ( 8
Active & Passive Investing
Forex Management ( 22
Foreign Exchange Management
An Indian Perspective
Beginner’s Corner ( 15
Stock Markets
A mystery?
Hysteresis Effect ( 32
Hysteresis Effect on the Indian
Economy
Market Update ( 39
Market Movement
Sector Wise Snap Shot
In the News
In Depth ( 36
European Crisis
Still anybody’s guess
Rupee Depreciation ( 18
The Sliding Rupee
Mr. Sanjay Bakshi
In conversation with ( 26
Guru Speak
Cover Article ( 10
Reliance Industries Ltd.
The heavy weight of Indian indices
Book Review ( 35
The Ascent of Money
Financial History of the World
Disinvestement in India ( 4
Disinvestment in CPSEs
Disinvestment in CPSEs
A Haphazard Process Leading to Loss of Value Mansi Batra
PGDM 2011-13, S.P. Jain Institute of Management & Research
Disinvestment – An Overview
The concept of privatisation was born on the
belief that private ownership can result into bet-
ter use of resources and more efficient allocation.
Gradually the concept has gained worldwide ac-
ceptance. Globally, as the economies have ad-
vanced, there has been a rise in preference for a
market economy as the governments could not
efficiently support the high level demand placed
by the booming markets, and effectively manage
the wide-spread enterprises. Hence, we have wit-
ness large-scale disinvestment of government
stakes in state-owned enterprises in different
economies.
Further the gradual transformation of frag-
mented markets worldwide into a global village,
which is ever more technologically advanced and
highly competitive, has fuelled the need for pri-
vatization and forced the governments to off-
load their stakes.
Additionally, the adoption of anti-competitive
polices, birth of regulatory and trade institution
in different sectors and development of compre-
hensive laws and regulation have severely diluted
the need of government intervention to ensure
protection of consumer interests and prohibition
of monopoly development across most sectors.
Disinvestment in India – A Historical Per-
spective
Historically, public sector units (PSUs) have
played a critical role in the development of the
Indian industry and the progress of the economy.
They have not only been instrumental in steering
India towards becoming a self reliant economy
but have also met the rising need for public utili-
ties.
In India, the objectives of Central Public Sector
Enterprises (CPSEs) have been sourced from the
Industrial Policy Resolutions and the Five Year
Plans. At the beginning of the First Five Year
Plan in India, there were five PSEs, which had a
total investment of Rs. 29 crores. By the end of
the Seventh Plan in 1990, the number of PSEs
had reached 244, with the total investment rising
to Rs. 99,329 crores.
However, while the PSEs had been established to
promote economic development and social jus-
tice, over the years, large scale inefficiencies had
crept into them and the financial position of these
companies fell much below the expected levels.
Despite some of the companies being monopo-
lies in their respective sectors, the PSEs lacked
clear visions, strategic direction and suffered from
rampant corruption.
In 1991, when a severe economic crisis led by the
deteriorating condition of the Balance of Pay-
ments was knocking on the doors of the country,
the Indian Government decided to work out a
plan to offload their stake in the PSEs as they
were acting as a drag on the country’s fiscal posi-
tion and were becoming counterproductive to the
economic growth. Additionally, disinvestment
was necessitated by the withdrawal of the budget-
|DISINVESTMENT IN INDIA|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
4
5
ary support of 60% by the Government to the
loss making units.
Hence the Government turned its focus on draw-
ing up a divestiture strategy and the Disinvest-
ment Policy received a major thrust in the Indus-
trial Policy Statement 1991. The policy stated that
the Government would disinvest a part of their
equity in selected PSEs; however, it did not throw
any light on the amount of limits of disinvest-
ment. The policy stated the objectives of disin-
vestment as follows:
To improve performance of units
To reduce budgetary deficits
To overcome the problem of political in-
volvement in PSUs
Enable the government to concentrate on
Social development
In 1993, the Rangarajan Committee was consti-
tuted by the Government. The committee pro-
vided certain important observations, such as:
Disinvested could be made up to any level,
except in defence and atomic energy where
the Government should retain the majority
holding
Disinvestment should be a transparent
process duly protecting the right of the
workers
Suggested setting up of an autonomous
body for the smooth functioning and
monitoring of the disinvestment pro-
gramme
The Committee’s recommendations led to the
formation of the Disinvestment Commission in
1996. The Commission was designed to act as an
advisory body having a full time chairman and
four part-time members. The Commission was
required to advise the Government on details
such as the extent, timing and pricing of disin-
vestment.
The Current Process and the Lost Way
The divestment in CPSEs in India is much
needed to make them more competitive, reduce
the level of political influence on their operations,
generate funds for their expansion plans, improve
their planning and execution capabilities, make
them more competitive and to provide the much
needed cash to the Government for various other
economic activities.
The process not only covers the listing of the new
CPSEs on the bourses, but also includes the dilu-
tion of Government stake in the already listed
enterprises. While the Government aims to offer
a level playing field to the CPSEs to compete
with the private sector, it plans to maintain at
least 51% ownership and management control in
these enterprises.
However, during the course of time, the disin-
vestment process appears to have lost its way,
and the focus has been narrowed down on using
it as a tool to reduce budgetary deficits. Over the
last few years, a key feature of the disinvestment
strategy in India has been to sell minority takes of
5-10% in profitable PSUs in quick successions to
raise money in an environment of low revenue
receipts and to unlock value for investors.
The Government’s short-term focus on raising
the money and failure to adopt a well devised
strategy has made the disinvestment process hap-
hazard and unreliable. This not only indicates at
loss of opportunity and direction but is also re-
sulting into a loss of credibility and high level of
criticism for the Government and the entities in-
volved in different ways.
The ad-hoc approach and the lethargic process
have cast doubts in the minds of Indian corpo-
rate, the business fraternity, the foreign investors
as well the retail investors. The industry and busi-
ness have been put into dilemma of whether to
raise such high amount of funds to buy out and
|DISINVESTMENT IN INDIA|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
acquire PSUs. The foreign investors are also
evaluating the opportunity critically based on the
process and the resulting changes.
Failure of the process to gain traction for
almost two decades
The divestiture of the Government’s stake in
PSUs in India started back in 1991-92, however
the process failed to gain any traction until 2009-
10. This resulted in a tremendous loss of oppor-
tunity and value, especially during the period of
high economic growth in India, which had wit-
nessed multi-scale jump in the Indian stock mar-
kets.
Supported by the recovery in the equity markets
in 2009, the disinvestment drive started to gain
some feet. Over 2009-10 and 2010-11, stake-sale
in CPSEs provided the Government total earn-
ings of INR 45,667.13 crore, accounting for
approx. 40% of the total disinvestment receipts
since 1991-92.
However, despite supportive market conditions,
in 2010-11 the Government failed to achieve its
disinvestment target. While it had planned to raise
an ambitious INR 40,000 crore, it ended-up rais-
ing only INR 22,144.20 crore through partial
stake sales by way of IPOs and FPOs in six PSUs
– SJVN Ltd., Engineers India Ltd., Coal India
Ltd., Power Grid Corporation of India Ltd., Man-
ganese Ore India Ltd. and Shipping Corporation
of India Ltd. The stake sale in Coal India Ltd. was
a new landmark as it was the largest IPO in the
Indian disinvestment history. The Government
raised INR 15,199 crore by selling a 10% stake in
the coal mining giant.
Missing the disinvestment targets more
than 2 out of 3 times
The Government has missed out on the target of
receipts from disinvestments on a large number
of occasions since the year 1991-92. However,
despite the failures, there appears to be no signifi-
cant changes in the approach to the disinvest-
ments process and the Government appears to
continue on its ambitious spree.
In the budget for the fiscal year 2011-12, the Fi-
* Note: 1) In 1993-94, equity of 6 companies was sold by auction method but proceeds were received in
1994-95.; 2) There were no fixed disinvestment targets over 2005-06 to 2009-10. The disinvestment re-
ceipts in these years were 2005-06: Rs. 1,569.68 crore, 2006-07: Nil, 2007-08: Rs. 4,181.39 crore, 2008-09:
Nil and 2009-10: Rs. 23,552.93 crore.
Source: Ministry of Finance, Department of Disinvestment
|DISINVESTMENT IN INDIA|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
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7
nance Minister of India had announced plans to
raise INR 95,000 crore from disinvestment in the
PSUs over the next three fiscal years.
In pursuit of the set target, the Government had
planned to raise INR 40,000 crore in 2011-12.
However, it is yet again on the verge of missing
the target by a wide margin. The adverse condi-
tions in the financial markets on account of the
euro-zone crises and macroeconomic climate in
India have slowed down the disinvestment proc-
ess. The Government is expected to receive
approx. INR 14,000 crore from the divestitures in
the current fiscal.
In the fiscal budget for 2012-13, the Government
has announced plans to raise Rs. 30,000 crore
through disinvestments, a feat that remains unat-
tained till date in the history of the divestment
process in India.
The ONGC FPO Debacle
Nearing the fiscal budget for 2012-13, the Gov-
ernment attempted to take charge of the deterio-
rating fiscal position for the year 2011-12 by di-
vesting a 5% stake in the state-run oil explorer,
ONGC.
However, what appeared to be a hastily planned
issue spilled water over the expectation of the
Government and led to embarrassment. The tim-
ing of the FPO was a severe issue as the an-
nouncement of the auction was made only two
days prior to the process, leaving a large number
of investors unprepared for the process. The
floor price for the ONGC auction was set at Rs.
290, which was at a 2.3% premium to the previ-
ous day's closing price, contrary to the market’s
expectation of a discount. Further, the lack of
clarity on ONGC's share of oil subsidy resulted in
lack of participation from the large foreign insti-
tutional investors. Even the process of the auc-
tion drew high criticism. The websites of the two
main exchanges failed to update the bids after
3:20 p.m., which was 10 minutes before the
scheduled close of the auction process.
The issue was subscribed only to the extent of
98.3%. Against an offer of 42.77 crore shares, the
final demand was for 42.04 crore shares. The
state-owned LIC saved the day by purchasing
around 37.7 crore shares. The process yielded the
Government Rs. 12,766 crores.
Hence, an initiative that was designed to pave way
for disinvestment in other PSEs, ended-up cast-
ing a shadow of doubt on the entire disinvest-
ment process.
In the end
If the disinvestment program has to successfully
see the light of the day and cushion the long-term
fiscal consolidation, the Government needs to
work out a long term strategy supported by a
strong discipline and well planned mechanism. It
has to reduce the focus on short-term funding
needs and allow the program to be guided more
by the market conditions and a long-term strat-
egy.
As part of a successful disinvestment program,
the Government needs to identify the companies
that will be part of the disinvestment process, the
stake it plans to offload in each of them, work
out a clear strategy for disinvestment in every
CPSE, identify the suitable market condition and
other pre-requisites for a successful stake sale and
abide by the plans. Additionally, it needs to create
higher fiscal room during the short-run to reduce
pressure of stake sale in volatile or weak market
condition.
References 1. Department of Disinvestment, Ministry of Finance,
Government of India
2. Union Budget, Ministry of Finance, Government of
India
3. JurisOnline.in
4. Financial Express
5. The Times of India
6. The Economic Times
|DISINVESTMENT IN INDIA|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
|TUTORIAL|
highly efficient, reflecting much of the publically
held information into the prices. The large capitali-
zation stocks particularly in countries with well de-
veloped stock exchanges can be considered as
highly efficient. But other markets like real estate
markets, small capitalizations stocks, many of the
emerging markets are less efficient mainly because
not all information is publically available and so it
leaves a lot of scope for analysis and finding the
intrinsic value.
Standard & Poor’s Indices Versus Active (SPIVA)
has been tracking mutual funds performances for
over a decade and comes out with an annual score-
card on how different styles of investing have fared.
The 2012 report states that “There are no consistent or
useful trends to be found in annual active versus passive fig-
ures. The only consistent data point we have observed over the
five-year horizon is that a majority of active equity and bond
managers in most categories lag comparable benchmark indi-
ces”.
Active Management a negative sum game:
Since the universe of stocks remains the same for
every active investor, for every active investor who
wins, there will be one who loses and so they add to
zero. However, it is costly to actively manage a
portfolio, remove management fees from the zero
sum and we have a negative sum. So the average
returns of all the active investors would be less than
the average returns of the passive investor.
A look at average performance of the small cap and
the mid cap funds in the 2002 and the 2008 bear
markets by SPIVA reveal that the S&P MidCap 400
and S&P SmallCap 600 which can be taken as proxy
for the market, have outperformed more than 70%
of all actively managed small cap and mid cap funds
over the three year period.
Dimensional Fund Advisors have shown that less
than 1% of the actively managed equity funds have
been able to beat the benchmark over the five year
period from 2005 – 2009 as shown in the chart
(please turn over).
ACTIVE & PASSIVE INVESTING Team Blue Chip
Active Portfolio Management or Active Invest-
ing stems from the belief that through thorough
analysis of the investing options, one can always
beat the benchmark index and can attain a positive
Alpha. It however comes at a price, and funds
which follow this approach charge a considerable
amount of management fees because someone has
to pay the portfolio manager and the analysts for
all their brain smashing stock recommendations
and analysis.
Passive Portfolio Management proponents be-
lieve that an investor cannot beat the market in the
long run, and the best way to maximize returns is
therefore to minimize the overheads-the manage-
ment fees. So passive investment invests with a pre
determined strategy and does not entail any fore-
casting.
A concept which needs to be introduced here is
“Efficient Market Hypothesis” (EMH).
"An 'efficient' market is defined as a market where there
are large numbers of rational, profit-maximizers actively
competing, with each trying to predict future market values
of individual securities, and where important current infor-
mation is almost freely available to all participants. In an
efficient market, competition among the many intelligent
participants leads to a situation where, at any point in time,
actual prices of individual securities already reflect the effects
of information based both on events that have already oc-
curred and on events which, as of now, the market expects to
take place in the future. In other words, in an efficient mar-
ket at any point in time the actual price of a security will be
a good estimate of its intrinsic value.” (Eugene F. Fama,
Random Walks in Stock Market Prices Financial
Analysts Journal, September/October 1965).
So according to EMH markets are efficient and so
trying to beat the market is nothing but playing on
luck. The “efficiency” of market has been subject
to thousands of empirical studies. While not going
into the debate of whether markets are efficient or
not, we can safely assume that markets vary with
degrees of efficiency. Some markets like developed
government bond market, bullion market are
© Monetrix, Finance & Economics Club of MDI, Gurgaon
8
9
Figure 1: Benchmark [Source: Dimensional Fund Advisors]
The above graph debunks the myth that active in-
vesting returns are based on skill rather than luck as
just 1% of the funds remained winners for a long
period.
Passive Investing
The most common and synonymous technique
with passive investing is called indexing or index
investing. Indexing aims to replicate the move-
ments of an index by holding all the securities in
the index in same proportions as the index
(tracking). The most popular indexes are the FTSE
100, S&P 500, and Nikkei 225.
The above philosophy aims at minimizing the man-
agement fees and thereby offers higher net return
to investors over a long period.
Another Strategy is “Buy and Hold” where investor
buys stocks and holds them for long periods re-
gardless of market fluctuations, thereby reducing
his tax outgo and transaction costs. A lot of people
confuse indexes with markets. Index is just a repre-
sentation of the universe of stocks in the stock
market. An index may or may not contain some or
all the stocks traded in the exchange.
There are two parts to an index creating-the 2 C’s
of indexes which are Selection (Constitution) &
Weighing (Contribution). These two are exe-
cuted differentiate one index from another.
Selection: At the selection stage you decide which
stocks would be a part of your index. It could range
from all traded stocks in the stock market to as little
as maybe a 5-10 stocks which you feel are an ade-
quate representation of the market. Practically it is
very important to choose a universe of stocks from
which you will choose your stocks because the
sheer number of stocks in an exchange can be un-
wieldy. For example, you can choose your universe
as all stocks that are part of BSE 500 or BSE 200, or
all stocks with average turnover above a certain
minimum level.
Weighing: Weighing means the weight each scrip
has in the index. Although one can use any measure
for weighing, some of the most popular ones are:
Market Capitalization: Each scrip‘s weight is just a repre-
sentation of its market capitalization with respect to other
stocks in the index. So if there are 10 scrips in the index and
their total market cap is 1000 Cr , Stock A’s market cap is 150
Cr. Then stock A would have 15% weight in the index. Al-
though popular initially, this has now been replaced by free
float market capitalization.
Free –Float Market Capitalization: Free Float Methodol-
ogy is similar to Market Capitalization methodology with only
difference being that instead of full market capitalization, free
float market capitalization is taken. The free float market
capitalization takes into consideration, only those stocks
which are available for trading on the exchange. This is the
most popular approach and majority of the indexes of the
national stock exchanges such as Sensex , Nifty , S&P 500,
Nikkei 225 are free float market cap weighed indexes.
Price Weighed: The weight of each scrip is in proportion to
its price relative to other scrips in the index e.g. if there are 10
stocks in the index. Sum of the prices of one share of each
stock is Rs 1000. Stock A’s share is priced at Rs. 250, and
Stock B’s share is priced at Rs. 40 then weight of A would be
25% and weight of B would be 4%. The Dow Jones Indus-
trial Average is the most popular price weighed index.
Equally Weighed: If all the stocks in the index are given an
equal weight irrespective of its price or market cap, then it is
an equally weighed index. The main motive behind this is to
remove the bias of overweight stocks which come up if price
on one of the stock in the index rises sharply in comparison
to others. So if there are 10 stocks in an index, each would
have a 10% weight. Russell Investments has created some of
the more popular equal weighed indexes such as Russell’s
2000 Equal Weight, Russell BRIC Equal Weight.
Fundamentally Weighed: The weight of the scrip is de-
cided by the fundamentals of the company such as sales,
profit, book value, turnover, or a combination of these or any
other parameters. It was pioneered by Research Affiliates
which circulated the methodology in 2005. Fundamental
Indexing blurs the line between passive investment and active
investment as both of them do not consider the market based
price of the stock to be a true estimation of its intrinsic value.
The FTSE RAFI index is a fundamentally weighed index
developed by RAFI for FTSE.
|TUTORIAL|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
ance stock has seen it all and stood the test of
time. Over the last 34 years, RIL has seen its
sales grow from Rs 120 crore (Rs 1.2 billion) to
Rs 339,792 crore (Rs 744.18 billion). This re-
markable performance was reflected in the
stock markets as well. Reliance has always been
hailed as one of the prominent Blue-Chip stock
of the Indian equity markets.
During its initial years following its inception,
RIL mainly followed the organic growth strat-
egy. The sad demise of Dhirubhai Ambani,
more famously
known as Poly-
ester Prince,
ushered the be-
ginning of a
new chapter in
the tale of Reli-
ance Industries.
It marked the
beginning of
succession plan-
ning in the larg-
est private sec-
tor company of
India. The year 2004 went down as a remark-
able year in the history of Reliance Industries.
The company’s net profit crossed the $1 billion
mark. It figured among the top 150 companies
globally in terms of net profit and among the
top 450 in terms of sales. During the same
year, in November 2004, Mukesh Ambani in
an interview, admitted to having differences
with his brother Anil over ownership issues.
Eventually the Reliance Empire was split be-
tween the Ambani brothers, Mukesh Ambani
The Reliance Group, founded by Dhirubhai
H. Ambani, is India's largest private sector
enterprise, with businesses in the energy and
materials value chain. The flagship company,
Reliance Industries Limited, is a Fortune
Global 500 company and is one of the largest
private sector company in India. The Group's
activities span exploration and production of
oil and gas, petroleum refining and marketing,
petrochemicals, textiles, retail and special eco-
nomic zones.
Reliance stock
debuted via an
Initial Public
Offering in
the year of
1977. At the
time when
Reliance went
public, the
Indian Stock
Market was
accessible only
to a handful
of elite inves-
tors. How-
ever, more than 58000 investors from across
India subscribed to the Reliance IPO. Since
its listing on the stock market, the stock has
seen many ups and downs. Be it the rumours
of controlling the stock market in the year
1982, the series of articles published in the
Indian Express alleging Reliance (and Dhirub-
hai) of using unfair trade practices to maxi-
mize the profits or be it the issues of opacity
in corporate governance practices, the Reli-
The heavy weight of the Indian indices
Reliance Industries Ltd.
Cover Article
M o netr i x
Figure 1: Revenue Breakup
© Monetrix, Finance & Economics Club of MDI, Gurgaon
10
11
production. RIL and the government entered
into PSC (Production Sharing Contract) and
the plan was to drill 31 wells and extract
70mmscmd of gas from the wells by 2012.
However, the sweet times did not last long. A
dispute with the Ambani brothers over the
pricing of the gas broke out. How much
should Anil Ambani's firm Reliance Natural
Resources Ltd. (RNRL) pay RIL for the gas?
RNRL says it should be US$2.34 per mmbtu
(million metric British thermal unit). RIL
counters that it should be US$4.21. This is the
price according to the production sharing con-
tract (PSC) signed by the government and RIL.
Soon the government of India became a party
to the dispute as the government will get its
royalty and profit share according to the PSC.
All the parties went to the Supreme Court
which ruled that the price of the gas should be
pegged at US$4.21, as mandated by the PSC.
However the woes of RIL did not end here.
The output from
the gas fields
started falling,
after steadily ris-
ing to 43mmscd
in March 2011.
As per the PSC
the plan was to
drill 31 wells and
extract 70mmscd
of gas from the wells by
2012. The reason cited
by RIL for the fall in output was the shutdown
of one-third of the wells following the ingress
of water and sand. The output from the basin
is expected fall further to 27.6 mmscd in April
2012 and to 22.6 mmscd in the next year. RIL
also went on to slap arbitration against the
govt. to have the company's entitlement to re-
cover its costs related to KG-D6 block, off the
country's east coast. Reliance said in a state-
ment that it was concerned by media reports
getting RIL and IPCL & his younger sibling
Anil Ambani heading Reliance Capital, Reli-
ance Energy and Reliance Infocomm.
During the late nineties and early 2000’s, Reli-
ance went on to diversify into multitude of
businesses including a diversified and inte-
grated biotechnology initiative under Reliance
Life Sciences; transportation, distribution,
warehousing, logistics, and supply chain ser-
vices under Reliance Logistics; development
and operation of cross-country pipelines for
transporting petroleum products under Reli-
ance Industrial Infrastructure Limited and
retails business under Reliance Fresh and Re-
liance Retail.
The fortunes of the company started taking
an ugly turn with the discovery of vast re-
serves of Natural Gas in the Krishna-
Godavari (KG) basin. In a country which had
till then been primarily dependent on imports
for its energy requirements, the discovery of
KG gas was a remarkable
event. However, since the
discovery of the gas the
Reliance group has con-
tinuously been in the news
for all the wrong reasons.
The long standing dispute
between the two brothers
over the pricing of the gas,
the disputes over supply
of KG gas or very re-
cently, the fall in the out-
put of KG D6 output – all this has led to a
beating of once a Blue-Chip stock in the In-
dian equity markets.
RIL began production of natural gas from its
deep sea discovery on Wednesday, April 1,
2009 just after six and a half years from the
discovery. The discovery and production was
considered to be a historic feat and expected
to save India, $9 billion per year, in imports.
Dhirubhai-1 and Dhirubhai-3 were put to
Figure 2: Falling Gas Output, Source: Motilal Oswal
|COVER ARTICLE|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
that kind of crude and RIL has the manufac-
turing reliability, efficiency and technical capa-
bility. It has world-class logical infrastructure
capable of bringing in 2 million barrels in each
shipment and also they possess flexibility of
evacuation infrastructure. The Reliance Jamna-
gar refinery is one of its kind in the world. Re-
c e n t l y ,
RIL re-
p o r t e d
GRMs at
a dis-
count to
t h e
b e n c h -
m a r k
S i n g a -
pore re-
f i n i n g
marg ins
a s
s p r e a d s
on fuel oil were better during the quarter.
While RIL product slate does not contain any
fuel oil, benchmark Singapore margin consid-
ers fuel oil production at 23%. Its gross refin-
ery margin has fallen down to a level of 9 from
the peak levels of 13, a feat for which the Jam-
nagar re-
finery is
k n o w n
for world-
wide. The
company
attributed
the fall to
the fol-
lowing:
Widening spread of Brent over WTI.
Lower spreads of gasoline and naphtha,
which contribute relatively more to RIL
slate than benchmark Singapore slate.
that the oil ministry would seek to restrict the
amount of the costs recovered by the com-
pany from its revenues from sale of gas pro-
duced from the D1 and D3 fields in the KG-
D6 block. Recent developments suggest that
the govt. has agreed to allow RIL to recover
some of the costs involved in the exploration,
devel-
opment and production of hydrocarbons
from KG-D6.
RIL also underperformed on the Oil refining
front. Historically, RIL has beaten Singapore
benchmark consistently. This is because the
c o s t
o f
sourcing crude -
RIL imports sour, heavy, challenged category
crude - is on the cheaper side. Globally, only a
couple of refineries have capability to process
Figure 4: GRM Trend
Figure 3: Comparison of GRMs, Source: Motilal Oswal
|COVER ARTICLE|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
12
13
June 2010. Reliance is looking to invest in new
areas such as shale gas, natural gas exploration
and retail to expand the portfolio of its com-
pany which is currently restricted to petro-
chemicals. Back in April 2010, reliance paid
US$ 1.7 billion to US based Atlas energy and
formed a joint venture. The JV gave Reliance a
40% stake in Atlas’ Marcellus Shale operations
in the eastern United States, giving it around
120,000 acres in net holding. Further in August
2010, reliance again announced acquisition of
Shale gas asset by forming a joint venture with
Texas-based Corrizo Oil and Gas in a deal
worth US$ 392 million. The deal gave Reliance
access to 60 percent stake in 104,400 undevel-
oped acres of the Marcellus Shale natural gas
field in the north-eastern state of Pennsylvania.
Some of the notable achievements of the vari-
ous JVs of Reliance in the shale gas area in-
clude:
Two additional rigs mobilized in the JV
with pioneer
Nine additional wells in the RIL-
Chevron JV with a production rate of 51
million standard cubic ft per day
A total investment of close to US$400 million
in three months ended June 30, 2011. Also the
company is planning raise close to US$ 1 bil-
lion in Foreign Currency Convertible Bonds to
fund its Shale gas ventures in the US and invest
in its refineries.
"The company is entering one of the fastest-growing
opportunities emerging in the US unconventional gas
business." The deals "will materially increase Reliance's
resources base and provide Reliance with an entirely
new platform from which to grow its exploration-and-
production business while simultaneously enhancing its
ability to operate unconventional projects in the future."
- P.M.S. Prasad (Executive Director).
Coal Bed Methane
RIL holds 3 CBM blocks in Sohagpur (East),
Sohagpur (West) and Sonhat. So far, RIL has
So does that mean that the once Blue Chip
stock and a darling of the stock market has
lost its lustre? At least the market reactions to
the RIL stock suggest so. It has received a
severe beating from the market and the com-
pany’s stock price has fallen sharply from Rs.
1039 levels in Apr 2011 to Rs. 737 in June
2012. This poor performance comes against
the backdrop of a dismal performance in
terms of its balance sheet and profit and loss
statement. Therefore a legitimate question
pondering a retail investor’s mind is whether
they should exit the stock or there exists a ray
of hope. It is difficult to figure out, however
our analysis suggests that in future there exists
some opportunities on which the Reliance
can hope to cash upon. In the recently held
AGM, the company has disclosed some long
term investments over the next 3-4 years. Al-
though the investments look promising yet
the shareholders might not realize immediate
benefits of these investments as the new pro-
jects have a high gestation period. We have
identified some of the major investments that
might help turn the fortunes of RIL.
Shale gas is one of the most rapidly growing
forms of natural gas along with other non-
conventional sources of natural gas. The in-
crease in its production is estimated to be
from 42 percent of the total gas production in
2007 in US to 64 percent by 2020. The de-
mand for natural gas is expected to be strong
despite the current decline due to the global
meltdown. Shale gas is produced from Shale
deposits that are found in abundance across
the Gangetic plain, Assam, Rajasthan and
many coastal areas. But most of these sources
are still untapped in India even though many
companies around the world have started
work on Shale gas. In India, ONGC an-
nounced its plans to start a pilot project in
2011 to get gas from shale formations.
Reliance was a quick mover and it acquired a
stake in the Texas Shale gas field as early as
|COVER ARTICLE|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
At the close of offer on 17th February, the total
number of bids received by RIL was 70. The
total demand was in excess of 90 million stan-
dard cubic meters per day. This is several times
more than the peak output of 3.5 mmscd that
is planned to be produced at the end of 2014
from Sohagpur block in Madhya Pradesh.
Reliance-BP Deal
Reliance Industries Ltd (RIL) has signed a joint
venture (JV) with British Petroleum (BP). Ac-
cording to the press statement, British Petro-
leum will get 30% stake in the 23 oil and gas
blocks including the KG-D6 oil fields of Reli-
ance Industries. The total valuation of the deal
is 9 billion dollars. It has also been one of the
biggest Foreign Direct Investments (FDI) in
India. British Petroleum and Reliance Indus-
tries Ltd will also form a 50-50 joint venture
for marketing and sourcing of gas in India. The
expertise of Reliance Industries Limited is in
project management and operations. British
Petroleum brings to the table its expertise in
deep water exploration and development in
which Reliance is a nascent player. The 23 oil
and gas blocks together cover approximately
270,000 square kilometers. The deal is very
significant and is being viewed as positive sign
for the company Reliance Industries Limited.
The strategic part of the deal is that it covers
the entire value chain from sourcing to market-
ing. However, since the signing of the deal,
much has not transpired into actual perform-
ance.
Last words
Our analysis suggests that given the above op-
portunities, the RIL stock may perform better
in the future and once again regain the status
of a Blue-Chip, however in the near term the
stock is expected to continue its dismal per-
formance especially due to the shadow of mul-
tiple controversies surrounding it.
Team Blue Chip
completed the following work in the Sohag-
pur (East) and Sohagpur (West) blocks:
Over 45 core holes drilled, logged and tested for gas content, permeability and coal properties
Drilled over 85 production wells
75 hydraulic fracturing jobs done
5 cavitations completion wells and 2 sets of in-seam horizontal wells
RIL has proposed that the government
should pay not just a price pegged higher than
the price of ordinarily available domestic gas
but RLNG price of about $13/mmbtu for gas
coming out of its Sohagpur blocks, more than
thrice the price at which domestically pro-
duced gas is sold. The formula is the same as
the one at which RasGas of Qatar sells LNG
on a long term contract to India. According
to the formula, RIL wants 12.67% of the pre-
vailing Japanese Crude Cocktail (JCC) plus
0.26/mmbtu as the cost it takes for shipping
the gas in cryogenic ships. If JCC is taken as
$100/bbl, then the price would be $12.67 +
$0.26 per mmbtu totalling $12.93/mmbtu.
Industry gurus however, argue that the price
was unviable on the ground that the Qatari
gas is rich in ethane and propane which are
useful in manufacture of LPG and petro-
chemicals. CMB gas is just methane and
should be priced at least 15-20% below the
price of compound rich gas. Also, LNG pric-
ing cannot be applied for domestic gas as
huge investments go into putting the liquefac-
tion plant that turns natural gas into its liquid
state by cooling it at as sub zero temperature.
Great Eastern Energy Corp (GEECL) sells
CBM produced from its Raniganj block in
West Bengal at USD 6.79 per mmbtu while
Essar Oil has proposed a rate of USD 4.20
per mmbtu for CBM it plans to produce in
the same state. On top of the CBM price set
by the government, RIL will charge USD 0.15
per mmbtu as a marketing margin.
|COVER ARTICLE|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
14
15
Stock Markets– A Mystery?
Mukul Aggarwal, Team Monetrix
Let me begin this
article with some
basic questions re-
garding the stock
markets around the
world- why people
make money in
stock markets (equities, stocks), why peo-
ple like Warren Buffett (popularly known
as god of investors in stock markets),
Charlie Munger (partner at Berkshire
Hathaway Inc.) etc. are so successful and
rich by just trading stocks in the stock
markets despite the fact that less than 2%
of total investors in the stock markets
make money (i.e. more than 98% of the
investors lose money in the stock mar-
kets). Isn’t it really intriguing and interesting?
Let us demystify the core premise behind all
these questions and try to clarify some basic
fundamentals of the stock market. Imagine a
scenario in which there is a company whose
fundamental value (the real worth of a com-
pany depending on the quality and quantity of
its business and its future prospects) is known
to everyone publicly. Then what do you think
are the chances of anyone making
the money by trading that company
stocks in the stock markets – It’s
pretty simple- nil (no one will
make money by selling/buying
stocks of the company in the mar-
ket as everyone has the clear idea
about the real worth of the busi-
ness of the company, the only way
to earn money is to earn divi-
dend on the stocks owned). This
kind of market is known as per-
fectly efficient market where the
market capitalization of the company truly
reflects the fundamental or true value of that
particular company and everyone has the
equal symmetric knowledge.
Fortunately or unfortunately this kind
of situation does not happen in practi-
cal world where public/investor sen-
timents play an important role in de-
ciding the market price of any stock
which leads to inefficiencies in the
market (i.e. market price does not reflect the
true value of the company) and that’s why peo-
ple make money in the stock market. When-
ever there is a positive or bullish sentiment
in the market it leads to excessive buying
of the stock (overvaluation of the stocks as
demand will be much greater than the sup-
ply). In contrast to this whenever there is a
negative sentiment in the stock markets it
leads to undervaluation of the stocks. One
of the recent and relevant examples is the In-
dian stock market in the year 2011 where there
are so much negative sentiments like euro
debt crisis, low IIP numbers, a depreciat-
ing rupee and the foreign investors outflow
because of risk aversion which lead to a plunge
in the stock markets and the stocks were
traded at an undervalued/discounted price. On
the other hand as the quarterly financial num-
bers of the Indian
companies are stabi-
lizing and more policy
reforms are being
initiated by the Indian
government, Indian
stock market is the
best performing mar-
ket in the world in
2012. This is all be-
cause of the investor
sentiments (the real
worth or the funda-
mental value of the companies has not changed
much as compare to the fluctuations in the
market index).
|BEGINNER’S CORNER|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
tries especially the Indian stock market where
there are lot of inefficiencies in the small and
mid-cap stocks.
It is pretty clear that
investors prefer a
stable and certain
environment to in-
vest/trade in the
stock markets. Now
if we know this sim-
ple fundamental
concept behind the
working of stock
markets then the question arises: What one
should do to earn money? What is the key
to earning money in stock markets? To
answer these questions firstly we need to an-
swer why such a large number of people (I
am talking about retail investors- individual
people who buy/sell stocks in stock market)
lose money in stock markets.
The answer is simple- the common and the
most prominent mentality among retail inves-
tors is that stock market is an easy and lucra-
tive platform to earn money. One only needs
to buy stocks, there is no work/time involved
and one will get handsome returns on his in-
vestment. They trade stocks on basis of herd
mentality/ word of mouth (brokers report,
other investors etc.) without knowing what
they are trading which leads to losses in the
long run. This leads to a very important con-
cept called Stock Analysis. Stock analysis is
defined as taking an informed decision
on trading stocks after doing proper
analysis. Therefore the key to earn
money in the stock markets is to do
sound analysis before investing.
There are two very different schools of
thoughts on how to do analysis (these
are completely different to each other).
These are:
Fundamental Analysis
Technical Analysis
Fundamental analysis is related to finding
the true value of any particular stock. The basic
principle behind this approach is that when
you are buying a stock then you
are just not buying a paper
but you are purchasing a
part of a particular business
(becoming an owner of a part
of that business) so it is very
important to find the real
worth of the business depend-
ing on its present state and
future prospects so that you
can decide when to buy/sell
the stocks to earn profits. This
approach assumes that in the long run
markets tend to achieve efficiency i.e. the
market price of any stock reflects its true
value. Fundamental analysis is done in two
stages – Qualitative Analysis and Quantita-
tive analysis.
Qualitative analysis involves studying various
external factors that influences the business/
company i.e. the study of economic environ-
ment, the study of industry/sector in which the
business is operating, the growth potential of
the business etc. The study involves finding
whether these factors are affecting the business
favourably or unfavourably.
Quantitative analysis is about studying the
financial strength and fundamentals of the
company by analysing the financial statements
i.e. Balance sheet, Profit and Loss and Cash
Flow statements and studying various financial
ratios (profitability, lever-
age etc.). The important
thing to keep in mind
while doing the quantita-
tive analysis is that one
should analyse three year
financial statements to
verify the trend and also
negate seasonality factor if
it is present (Hospitality
sector companies during
peak seasons).
Value investing is one of the famous ap-
|BEGINNER’S CORNER|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
16
17
It requires a lot of thorough understanding
and analysis of the business so that one can
properly value the business/company and
find its real worth. It stresses on quality of
stocks rather than quantity. There are lot of
approaches to do valuation of the company
like DCF, Relative valuation etc. which de-
pend on the business and the amount of data
available.
On the other hand, Technical Analysis does
not consider the real worth of the business. It
is all about analyzing the historical price
movements of stocks to take buy/sell deci-
sion. Rather than measuring the true worth of
the stock, it analyses the investors’ sentiments
behind the stock. It has the following as-
sumptions:
1. Investors pattern will be repeated after
a certain time period
2. Market price already reflects the true
worth of the company and it immedi-
ately reflects/discounts any market in-
formation related to the business.
There are many approaches for technical
analysis such as the help of technical charts,
technical patterns, indicators etc. which can
be easily learnt. Apart from this difference
between the two approaches, there is one
more difference which is the time horizon.
Fundamental analysis is generally more
suitable for long term investing while
technical analysis is more suitable for
short term investing.
Now that we have a basic and clear under-
standing of the two approaches that can be
followed while doing the stock analysis, the
next question that arises is what approach
I should follow. Should I follow funda-
mental analysis which involves studying
the underlined value of the business or
follow technical analysis which involves
studying the investors’ sentiments regard-
ing the stock? The ideal scenario for sound
investing is to follow a combination of both
the fundamental analysis and technical analysis.
One should consider both underlying value
and investors’ sentiments while taking any trad-
ing decision.
Lastly a few useful fundamental tips for the
beginners who want to start investing
in the stock markets. These are as follows:
1. In beginning try to identify 2-3 sectors/
industries which you find interesting for
example banking, aviation, real estate etc.
Try to know about basic fundamentals of
that particular sector i.e. how revenue is
generated, key terminologies, external fac-
tors that affect the sector etc.
2. Try to keep yourself updated with all the
latest news related to that particular sector
i.e. what’s happening in the sector, how
various companies are doing etc.
3. Try to study 2-3 companies within that
sector which you think are performing
well and try to look for businesses/
companies which are trading at a discount
to the real worth because of one reason or
another (this is defined as “circle of competence”
by Mohnish Pabrai in his book “The Dhandho
Investor”).
4. Finally try to analyse the historical price
pattern of the stock of these companies to
take a fool proof investing decision.
I hope this article has helped you in under-
standing how stock markets work and how to
approach investing in the stock markets. All
the best for your future investing endeavours.
Happy investing!!!
|BEGINNER’S CORNER|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
|RUPEE DEPRECIATION|
In fiscal year 2012,
India registered a
sharp rise in its Cur-
rent Account Deficit
(CAD) on account of
subdued external de-
mand and relatively
inelastic imports of
POL (Petroleum, Oil
and Lubricants) and
precious metals (gold and silver). The CAD
increased from USD 46.0bn (approx. 2.7% of
the GDP) to USD 78.2bn (4.2% of the GDP).
The deficit in trade balance widened as the
growth in exports declined sharply from
37.5% in 2010-11 to 23.6% in 2011-12 while
the rate of growth in imports increased from
26.7% in 2010-11 to 31.1% in 2011-12.
2. Movement of Investments by Foreign
Institutional Investors (FIIs)
The year 2011 was disappointing for the in-
vestors in the Indian equity markets. After
nearing the 8,000 level in March 2009, SEN-
SEX, the benchmark index of the Bombay
Stock Exchange gained a whopping 81.0% in
2009 and 17.4% in 2010. However, the index
lost almost a quarter of its value until the end
of 2011.
In an environment
of high internation-
alization of the In-
dian economy, the
recent fluctuations in
exchange rate of the
Indian Rupee against
the U.S. Dollar have
exposed the entire
corporate sector to
high levels of risk.
In CY2011 the rupee depreciated against the
dollar by approx 20%, bringing joy to the com-
panies with an export oriented model and exert-
ing high pressure on the importers. In Q1’
CY2012, the momentum turned and the rupee
appreciated by approx. 10% until mid-March
2012. However, the relief for the
importers and companies with
foreign currency loans was only
temporary as the rupee again en-
tered the depreciation mode.
The erratic cycles of rupee appre-
ciation and deprecation are con-
stantly pressurising the risk man-
agement strategies of the Indian
corporates and have put the entire
economy in a cautious mode.
Currently, the rupee is into a depreciation mode
and is hovering around 56.05 (INR/USD) after
hitting an all time low of 57.37 (INR/USD) on
24th June 2012. Owing to the combination of
weak domestic macroeconomic indicators and
uncertainties in the global environment, the ru-
pee is expected to remain under pressure in the
medium term.
Factors behind Rupee Depreciation
1. Deficit in the Balance of Payments
The Sliding Rupee
PGPM 2011-13
Management Development Institute, Gurgaon
Source: Oanda
Note: (P) Preliminary, (PR) Partially revised Source: Reserve Bank of India
Krishna Prem Sharma Shashank Kumar Jha
© Monetrix, Finance & Economics Club of MDI, Gurgaon
18
19
Indian economy have declined. In January
2012, the Reserve Bank of India (RBI) revised
down the baseline projection of GDP growth
for 2011-12 from 7.6% to 7.0% on account of
high global uncertainty, weak industrial
growth, lower investment activity and decline
in resource flow to the commercial sector. In
April 2012, Standard & Poor's cut India's out-
look to negative from stable, quoting large
fiscal deficit and policy paralysis as key rea-
sons. Currently, India’s rating is BBB-, which
is just a notch above the junk
status.
The negative outlook for the Indian
economy has made the foreign in-
vestors cautious of the Indian mar-
kets. The key factors responsible
for the negative sentiments are:
Persistent Inflation
Over the last two years, the Infla-
tion in India has remained around 9
-10%. While, initially the high inflation did not
create a significant impact on the investor sen-
timents, however, the persistence over the last
couple of years has turned it into a structural
issue and has disturbed the investment senti-
ments in the economy. Over the recent past,
the inflation has been relatively easing out;
however it is primarily due to the base-effect.
Persistent Fiscal Deficit
In March 2012, the government announced
that the fiscal deficit for 2011-12 was pegged
at 5.9% of GDP, against the target of 4.6% of
GDP. The government has target by a wide
margin on account of lower tax and disinvest-
ment receipts as well as the rise in expendi-
ture, mainly for subsidies. The government is
targeting to bring down the fiscal deficit to
5.1% of GDP in 2012-13. The high fiscal defi-
cit is leading to an adverse impact on the ex-
change rates.
Policy Paralysis
“Policy Paralysis” has become the new buzz-
word circling the Indian Economy as the UPA
-II government has been unable to success-
A key factor behind the sharp fall in the index
was pull out by the FIIs, largely over August to
November 2011. The FIIs registered a net out-
flow of INR 7,902.5 crore in August 2011, led
by withdrawals from the equity markets, which
were to the tune of Rs.10,833.6 crore. It was the
highest outflow of FII investments in a single
month since October 2008. Over August to No-
vember 2011, there was a net FII outflow of
INR 9,952.6 crore from the equity and debt
markets.
The pessimism among the FIIs which triggered
the outflow was casted by the international fac-
tors such as the ongoing Eurozone crisis and
slow recovery in the U.S., coupled with domes-
tic factors such as high inflation, slower growth
projections and policy paralysis in the country.
The large scale pullout by the FIIs, fuelled the
depreciation of the rupee, which gained momen-
tum in August 2011 and continued until the end
of 2011. The economy was offered some respite
from the deprecating currency by the renewed
optimism of FIIs towards India, which led to
large scale capital inflows over December 2011
to February 2012. The renewed faith was pegged
to relative insulation of the Indian economy
during the global meltdown and steps taken by
the Securities and Exchange Board of India
(SEBI) to attract investments in corporate
bonds and government securities. Investments
in debt accounted for approx. 57% of the FII
inflows over December 2011 to February 2012.
3. Adverse Economic Outlook for India
Over the last fiscal year, the prospects of the
Source: Securities & Exchange Board of India
|RUPEE DEPRECIATION|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
caused due to the debt crisis and in the Euro
zone and concerns over likelihood of default
by a few member nations. Secondly, volatility
in the global markets which has driven inves-
tors to sell off their financial assets and main-
tain cash reserves in dollar. Thirdly, Federal
Bank’s policy measures to contain the supply
of dollar while still increasing liquidity by re-
placing long term bonds with short term
bonds instead of printing additional currency.
Lastly, the ‘safe haven’ status associated with
the US dollar due to which all major central
banks still continue to buy treasury securities.
Measures Available/ Adopted by the
RBI to Stem Rupee Depreciation
Over the recent past the RBI has taken a
number of steps to increase the inflow of for-
eign capital. However, the measures are only
remedial in nature and not really designed to
check the fundamental exchange rate adjust-
ment. The interventions by RBI have been
unable to provide a support to the falling ru-
pee and have just been
able to impact the pace
of currency deprecia-
tion.
Summarised below are
some of the recent steps
taken by the RBI:
1. High Policy Rates
Historically, rise in the
policy rates has been
adopted as a measure
by many nations to pre-
vent sudden capital out-
flows thereby check
meltdown of their re-
spective currencies.
However, RBI has
raised interest rates sev-
eral times since March
2010 to tame inflationary expectations. Thus,
further increasing the policy rates is not the
most attractive proposition for Indian policy
makers, as it has already dented the economic
fully drive home many economic reforms and
improvements in the governance. The failure
has tarnished the Brand Indian image and ad-
versely impacted the long-term foreign invest-
ments. The economy is awaiting reforms in criti-
cal areas such as the Goods and Service Tax
(GST), Direct Tax Code (DTC) and FDI in sec-
tors such as Retail.
4. Global Uncertainty and Appreciation of
the US Dollar
While the US is still struggling with its weak
economy, high debt and downgrade of its long
term debt, the US dollar strengthened against
major currencies in over the last year.
Over July 2011 to June 2012, the EUR has de-
preciated by approx. 14.1% again the USD while
the GBP has deprecated by approx. 2.4%
against the USD. Over the same period, the
INR has deprecated by approx. 24% against the
USD.
This can largely be attributed to four reasons.
Firstly decline in value of Euro which was
Source: Oanda
|RUPEE DEPRECIATION|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
20
21
200 basis points (bps) to 6 months Li-
bor + 350 bps
Increasing the ceilings on interest rates
payable on non-resident deposits – a
move which was later deregulated to
give banks the necessary autonomy in
deciding their own deposit rates
4. Administrative Measures
Since the second half of 2011, the RBI has
undertaken several administrative measures to
curb market speculation. These include:
The RBI withdrew the provisions of
rebooking forward contracts after can-
cellation, thereby ensuring that forward
contracts are booked only by hedgers
and volatility is reduced.
The Board of Directors of Authorized
Dealers was allowed to fix suitable lim-
its for various treasury functions. The
net overnight open exchange position
and aggregate gap limits need to be ap-
proved by the RBI.
All cash as well as spot transactions
executed by authorized dealers on be-
half of clients will be undertaken for
actual remittances and cannot be can-
celled/ cash settled.
References
1. Economic Survey 2011-12, Ministry of Finance, Government of India
2. “Rupee Depreciation: Probable Causes and Outlook” – STCI Primary Dealer Ltd.
3. The Economic Times
4. Reuters
5. The Hindu Business Line
6. Business Standard
7. India Today
8. Oanda
9. The Reserve Bank of India
10. Securities & Exchange Board of India
growth.
Most economists are concerned that current
interest rates in India, which are already higher
than most countries, could not attract capital
flows. However, any decrease in these rates
could potentially lead to further capital outflows
and hence the RBI is adopting a cautious ap-
proach in reducing the rates. In June 2012, the
RBI left its repo rate and cash reserve ratio un-
changed at 8.0% and 4.75%, respectively, against
the expectations of the industry in favour of a
rate cut.
2. Using Forex Reserves
Since November 2011, the RBI has been selec-
tively selling forex reserves and buying the In-
dian Rupee to stabilize demand for the currency.
However these interventions have been limited
as the liquidity in money markets is already con-
strained and any such actions will only tighten it
further.
3. Relaxing Credit Controls
As increasing supply of foreign currency is the
best way to fight domestic currency deprecia-
tion, relaxing credit controls to allow more mar-
ket participation and capital inflows has been
the most favoured approach by RBI to fight the
current crisis.
Various measures adopted by RBI in this direc-
tion include:
The ECB limit under automatic approval
route has been enhanced from USD 500
million to USD 750 million for eligible
corporate. For borrowers in the services
sector, the limit was enhanced from USD
100 million to USD 200 million.
The limits of investments by FIIs in gov-
ernment securities and corporate bonds
has been increased by USD 5 billion each
to USD 15 billion and USD 20 billion,
respectively.
In Trade Credit, the all-in-cost ceiling has
been increased from 6 months Libor +
|RUPEE DEPRECIATION|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
Introduction
Foreign exchange reserves are the foreign cur-
rency deposits and bonds held by the central
banks generally in US dollar, though at times they
can be held in other major currencies such as the
Euro, Pound sterling or the Japanese Yen. For all
purposes in this write up the official gold reserves
of a sovereign will be outside the scope with
which we treat the foreign exchange reserves
(hence forth referred to as forex reserves).
Given below are some of the most important
uses of foreign exchange reserves:
1. Reserves are used to manage external pay-
ment obligations arising out of current ac-
count deficits.
2. They are used for exchange rate manage-
ment. This can help make a country’s ex-
ports competitive in the international mar-
ket especially during times of a financial
crisis.
3. Psychological factor: A depreciating cur-
rency can create a negative outlook about
the economy as a whole which in turn can
lead to lower confidence among foreign
investors.
4. Helps nations, particularly the ones with
relatively large reserves (China, UAE, Sin-
gapore) create a sovereign wealth fund
which can help these countries fund their
overseas investments
Given the importance of the reserves, the duty of
a central bank becomes crucial since it is the only
authority regulating it.
Forex management
The management of reserves by a central bank
depends on a number of factors such as:
Whether a country is CAD positive or runs
a CAD deficit
Whether the currency is market driven,
pegged or partially floating
Whether the country is export driven or not
Whether the country is outward looking in
that it feels the need to make overseas real
estate investments (a case of sovereign
wealth fund)
Based on which of these brackets a country comes
under, the central bank may decide to take up a
particular style of reserves management
For instance the United States holding the world’s
reserve currency never feels the need to indulge in
practices to control its exchange rate. The country
despite running a huge current account deficit (the
highest in the world) never maintains a large forex
reserve because the nation has for years held a
AAA rating which has helped it borrow cheap
internationally and meet its payment obligations.
At the other end of the spectrum is the People’s
Republic of China .The People’s Bank of China
regularly intervened before 2010 to keep the Chi-
|FOREX MANAGEMENT|
Foreign Exchange Management : An Indian Perspective
PGP 2013
IIM Bangalore
Kunal Ashok Abhishek Baid Sudeep Mohapatra
Apart from the traditional roles of a central bank to ensure price stability and growth through its monetary policy,
one of its more important functions particularly in the context developing countries is managing foreign exchange
reserves. This role is critical since the Central Bank is the only national authority which can take any significant
step in times of a foreign exchange crisis. This article talks about the various ways a central bank can intervene to
manage foreign exchange reserves and control exchange rates. A detailed analysis of the foreign exchange concerns in
the current Indian economic scenario is presented.
© Monetrix, Finance & Economics Club of MDI, Gurgaon
22
23
nese Renminbi pegged to the USD. In order to
keep its exports competitive the bank prevented
the Renminbi from appreciating vis-à-vis the dol-
lar by buying the USD and thereby building its
reserves. The Chinese behemoth built up re-
serves up to 2.8 trillion USD becoming the cen-
tral bank with the largest foreign exchange re-
serves and an enviable sovereign wealth fund
carved out of it. That the central bank could
achieve this is commendable, but then in China’s
case this ability was helped by their huge surplus
in trade balances.
Fig1: China’s Foreign Exchange Reserves
India seems to follows the middle path. The RBI
generally allows a floating exchange rate, how-
ever, it does intervene in the currency market to
meet temporary demand-supply imbalances.
What follows below is how India has managed
its exchange rate and reserves and our recom-
mendation as to how it could have been better
managed.
Forex Management in India
From a time in 1991 when the nation had no
more than 600 mn USD to finance its interna-
tional payments and had to, in a major instance
of embarrassment, airlift 67 tons of Gold and
pledge it to the Bank of England and the Union
Bank of Switzerland to serve as collateral for a
2.2bn emergency assistance from the IMF, the
nation has come a long way. Indian forex re-
serves as of 24th Feb 2012 stand at 295 bn USD[1] (Peak of 318 bn USD) enough to finance im-
ports for the next eight and a half months.
While this looks like a formidable amount, ap-
pearances could be deceptive. With a current
account deficit at 3.3% of GDP India has in-
creasingly relied on foreign investments to meet
Fig2: Growth of India’s Foreign Exchange Reserves
its balance of payment requirements. While Janu-
ary’s FII numbers should be encouraging for our
central bank, a 3rd quarter GDP growth of 6.1%
may suggest a future loss of investor confidence in
the economy. This could lead to a subsequent
withdrawal of investments which could lead to a
1991 like crisis taking into account the fact that
our fiscal deficit for the current year is going to be
around 5.6% of GDP. This might get the Moody’s
and the S&P’s interested for a credit rating down-
grade. Given this situation it will be worthwhile
analyzing some questions which the RBI will need
to give a serious thought to – the major one’s be-
ing:
How much reserves should the RBI be comfortable maintaining
Should the RBI intervene (have intervened previously) to prevent a downward slide of the rupee
Should we create a sovereign wealth fund out of our seemingly strong reserves
How much Reserves should the RBI be
comfortable maintaining
India belongs to the twin deficit club i.e., the
country runs both a current account deficit and a
fiscal deficit – the high CAD being attributed pri-
marily to a large trade deficit mainly due to huge
oil imports. For the year 2011, the current account
deficit was 44.3 bn USD [2]. This was balanced by
a capital inflow of 59.8 bn USD allowing approxi-
mately 13 bn USD to flow into the Indian re-
serves. The net change in the previous 2 years has
been an outflow of 20 bn USD in 2008-09 and an
inflow of 13.4 bn USD in 2009-10. While the RBI
can take solace in the fact that reserves are bur-
geoning, a closer look into the BOP shows that
more than 60% of the entire capital account in-
flow is due to foreign investments in the country
|FOREX MANAGEMENT|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
|FOREX MANAGEMENT|
(50% FII and 10% FDI). While the net foreign
infrastructural investments are permanent in na-
ture the portfolio investments are fickle and to a
large extent depend upon the macro-economic
outlook of the nation. This leaves the country at
the mercy of these institutional investments who
may already have started doubting India’s growth
story due to a higher than expected inflation and
a slowing GDP growth (See graph below to see
the impact on reserves when investments dried
up in 2008-09)
Table1: Net foreign investments and impact on foreign
exchange reserved
All other things remaining equal if in the current
fiscal year the portfolio investors turn flat(net
buying and selling being equal), the nation will be
left literally gasping for breath with the RBI hav-
ing to deplete reserves or borrow foreign money
to the extent of an additional 24bn USD a year
to meet its BOP commitments. With fiscal con-
solidation going for a toss this year (even an
ONGC auction having its share of controversy),
India’s international credit rating may itself take a
hit. Borrowing from abroad will be more expen-
sive and India may actually prefer depleting some
of its reserves than taking loans from abroad.
From a doomsday perspective assuming India is
unable to borrow and uses its reserves, our 295bn
USD of reserves will be depleted in about 12
years. Not an immediate problem one might
think but take into account the scenario when the
investors turn net sellers. In such a case the RBI
will have to buy rupee with its dollars to prevent
the depreciation of the rupee which is bound to
happen with an FII pull out. All of a sudden the
RBI does not have the sort of cushion that ac-
companies large reserves. With the foreign ex-
change trading market running into trillions of
dollars in just one afternoon billions of dollars of
fire fighting reserves may be consumed by specu-
lators hell bent on shorting the rupee. Even if we
borrow instead of depleting our reserves, a higher
interest payment (made worse by a falling rupee)
will only worsen the fiscal deficit leading to fur-
ther deterioration of our credit standing thus
sucking India into a downward spiral. One may
call us fierce pessimists especially with the FDI
expected to reach a record high of 35 bn USD
and FIIs have already pumped in a net of 12 bn
USD in the new year alone. One could expect
another positive flow into the reserves this fiscal
year (figures awaited). But the point we are trying
to make should be clear. No central bank of a
country with a twin deficit problem can rest on
its foreign exchange reserves no matter how
large. Our belief is that in India’s case the forex
reserves should be used with the intention of ex-
change rate stability and not for CAD financing.
Long term monetary and government policies
should be framed to strengthen our exports so as
to reduce our trade imbalance. With oil imports
accounting for a third of the country’s imports,
the problem of large imports is going to stay with
us for the foreseeable future unless the country
(and the RBI governor could play a coaxing role
in this) shifts to alternate energy sources.
Should the RBI intervene to prevent a
downward slide of the rupee
While we mentioned that the primary job of RBI
with its reserves should be to maintain a competi-
tive exchange rate, how much intervention is
needed, is a tricky question. The rupee depreci-
ated more than 15 per cent over the last 4
months (see graph below) primarily on account
of FIIs fleeing the Indian markets. Should the
RBI have intervened? The RBI did in fact inter-
vene – selling 845 mn USD last September [3].
But was that too little? With the Indian interest
rates fighting for a spot in the skies, Indian firms
thought it was worth their buck to raise money
from abroad where interest rates were lower.
While this meant lower interest payment in USD,
a falling rupee meant that firms needed to shell
© Monetrix, Finance & Economics Club of MDI, Gurgaon
24
25
|FOREX MANAGEMENT|
out additional Indian money to service their foreign
currency obligations. With their financial statements
being released in rupees, Indian firms were under-
standably disappointed with a rupee fall. Lowered
profitability due to higher interest expense meant a
further pull out of FIIs and further rupee deprecia-
tion. The Indian rupee was being humiliated in the
international market not because of bleak macro
fundamentals but because the portfolio investors
just love to buy and sell at the tiniest signs of
changes. This is where we feel the central bank
should have put its foot down and sold some of its
reserves to back the rupee at least to send a to in-
vestors to check their rampant selling. This would
have let Indian firms be more competitive and FIIs
wouldn’t have fled like they were in an apartment
on fire.
Fig3: Fall of the Indian rupee against the USD in late 2011
Should We Create a Sovereign Wealth Fund
out of our seemingly Strong Reserves
Sovereign wealth funds – are they essentially the
prerogative of the rich? China isn’t essentially rich
yet it has a sovereign wealth fund worth 567bn
USD carved out of its massive foreign exchange
reserves. For a developing country that is indeed an
achievement of sorts. China has used this fund to
buy real estate in Africa and other parts of Asia.
With the next resource battle to be fought in Africa,
should India carve a SWF for itself out of its re-
serves and use it for purposes of investment?
Clearly the central bank should restrain itself from
such an action. To begin we are no Arnold Schwar-
zenegger when it comes to forex reserve muscle
power (China is, see graph below). We are at best a
Tom Cruise – nice and handsome but not powerful
enough. Our entire exchange is not even half of
China’s SWF. If we are indeed to carve a SWF out,
it should be worth atleast 40-60 bn USD – there is
not much point in having an SWF worth 10 bn
USD or around that figure. India will need large
amounts of money for real estate projects outside
and in India. With India being a country with
large twin deficits, we will always need the full
force of our reserve to support a BOP eventual-
ity. Also, the government of the SWF will be a
matter of controversy – who will monitor the use
of the SWF? Will there be a free flow of money
into and out of the SWF. What if the SWF is not
appropriately utilized – that would serve a double
whammy.
Fig 4: Largest Sovereign Wealth Funds
Conclusion
The position of a central banker is riddled with
ambiguous questions. While its primary responsi-
bility is that of price stability and low unemploy-
ment, for a nation having emerged from an em-
barrassing BOP crisis, it has the additional re-
sponsibility of maintaining and monitoring forex
reserves. We opine that the reserve bank carve
out its policies favoring stronger exports to re-
duce CAD since relying on foreign funds for
deficit financing is like riding a tiger. Additionally
while market forces be allowed to play their part
in exchange rate determination the RBI should be
more proactive in saving the day especially when
the nation’s firms are exposed to foreign currency
debt.
References
[1] http://in.reuters.com/article/2012/03/02/india-reserves-idINDEE82109220120302
[2] http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13728
[3] http://www.thehindubusinessline.com/industry-and-economy/banking/article2639510.ece
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
web was yet to dominate the world. I received
the Buffett letters within a week or so and when
I opened them, I could not put them down. I
was hooked to the idea of value investing.
Buffett was heavily influenced by Ben Graham’s
teachings at Columbia who taught him how to
evaluate stocks in 1930s. In his letters, Mr. Buf-
fett talked about Graham and his book, "The
Intelligent Investor," and so I went and bought
the book.
At the end of this book is a transcript of a talk
that Mr. Buffett gave at the University of
Columbia in 1984. The talk was titled “The
Super inves tor s of Graham -and-
Doddsville,” in which he lists the track
record of a bunch of ex-students of Gra-
ham who bought different stocks at differ-
ent times and ended up with astonishing
performance.
One of the best ideas Mr. Buffett gives in that
talk was to do with the relationship between risk
and return. Contrary to what I learnt at LSE,
Buffett said that that to get HIGH returns, you
should take LESS risk. When I read this, I imme-
diately experienced cognitive dissonance. On one
hand my profs at LSE were telling that risk and
return are positively co-related and markets are
efficient and humans are rational, while here was
a man, who had a fabulous track record, and who
said just the opposite. I promptly resolved this
dissonance by dumping the idea of efficient mar-
kets and picking up the teachings of Buffett and
Graham.
I also decided that I wanted to come back to
India and start up an investment partnership just
like the way Buffett did in his early years. So
You are known as an authority on value investing in India. How did you get into
value investing?
I got interested in stock markets in school. Like
many others, I was attracted by hot IPOs. My
friend and I used to pool our money together to
increase the odds of IPO allocation. If we made
any money, we did not keep it, because it went
in the next hot IPO and in the end we had huge
losses. Good early lesson!
I lost interest in the markets when I got into
college because I met this enchanting girl, who
many years later became my wife. So
she kept me more interested in her
than in the markets.
My interests in markets got re-
ignited, when I went to the LSE. I
attended a class called "Security In-
vestment Analysis," where I was
taught that markets are efficient and
that there is no point doing any analysis because
everything that is knowable is already in the
price.
So while I being taught that markets are effi-
cient, I came across an newspaper article which
talked about a fellow called Warren Buffett.
You see this was in 1990 when Mr. Buffett was
not the household name that he now is. Any-
way, the article said Warren Buffett has a fantas-
tic track record in investing and he has a knack
of explaining complex financial and business
topics to people in a wonderful way by writing
amazingly good letters to his shareholders.
I became interested in reading these letters and
I wrote to Mr. Buffett. Berkshire Hathaway did
not have a site then. Indeed, the world wide
Guru Speak
|IN CONVERSATION WITH|
Mr. Sanjay Bakshi A professor at MDI, Gurgaon, where he teaches two
of the most popular courses in Finance. Apart from being elected as the “Best Teacher” by
students year-on-year, he is also the CEO of Tactica Capital Management, a highly
sought after deep value investment boutique. He also writes articles for Outlook Profit
and delivers talks at prestigious institutions.
He blogs at http://fundooprofessor.blogspot.in, Site: http://www.sanjaybakshi.net
“Contrary to what I
learnt at LSE,
Buffett said that
that to get HIGH
returns, you should
take LESS risk.”
© Monetrix, Finance & Economics Club of MDI, Gurgaon
26
27
pany had a billion dollar valuation at one point
of time but it never made any money. If you
look at the cash flow statement and understand
the economics of the business with its need for
constant investment in new plant and machinery
because the old one becomes obsolete rapidly,
you will find that over its life, the company never
made any money for its stockholders. All of the
dividends paid out were funded not from what
Buffett calls "owner earnings," because there
weren't any, but out of new cash injections from
owners and lenders. That's the functional equiva-
lent of pyramid scheme where old speculators
are paid from money brought in by new ones.
This can't last. Today, the stock is worth almost
nothing. As Graham said, market is like a weigh-
ing machine in the long run but in the short run
it’s like a voting machine. So all sensible invest-
ing involves seeking value in excess of price paid.
Deep value is different only by the degree of
cheapness in a situation. Deep value means
"cheap now", not cheap based on "future pros-
pects." One form of "cheap now" would be a
profitable company which is expected to remain
profitable, having zero or very little debt, having
substantial cash on the balance sheet which is
surplus to the needs of the business and having
an aggregate market value less than net cash
alone. That's a cash bargain as an example of
"deep value".
Sounds ridiculous if you think about from the
viewpoint of a businessman. Let's say you walk
into a nice restaurant and approach the owner
and offered to buy his restaurant for less than
the cash in the till. The owner would think you
are insane and yet you get the functional equiva-
lent of such situations in the stock market.
At the beginning of your invest-ment career, how did you iden-tify the first stock to be included
in your portfolio?
My first stocks were IPOs as I men-
tioned. However they were not the beginning of
my investment career but the beginning of my
speculation career which ended very badly and
very quickly. But when I came back to India
after finishing my studies in the UK in 1994,
there were a lot of listed NBFC’s. Some of these
companies had very high dividend yields and
many of them sold well below book value. Some
that's how I got into
value investing.
Why did you select value investing over other
methods of analysis?
In his talk “The Superinvestors of Graham-and-
Doddsville” Buffet said that if somebody ex-
plains value investing to you, two things happen
- either it grabs you immediately or you don’t get
it. In my case it was the former. The idea of get-
ting something for nothing completely grabbed
me. There is a joke about two professors who
are walking down the corridors of their finance
department and one of them spots a hundred
dollar bill lying on the floor. He tries to pick it
up but the other professor stops him and says
well you can’t pick it up because it’s not there. If
it was there, it would have already been picked
up. There is a janitor who sees these two learned
professors walk away leaving hundred dollar bill
on the floor. He picks up the note and enjoys
the money. That’s fascinating because the idea
that you can get something for nothing is a very
seductive idea and to most people if you put it in
that way people will get it. That’s what value
investing really is.
How would you define value investing? How is it different from deep value in-
vesting?
For me, all investing is value investing. Con-
sciously paying more for anything than what it's
worth is speculation. Now, this might work in a
momentum-driven market where somebody else
will buy overpriced merchandise from at an even
higher price, which is what the Greater Fool
Theory says ("I know I am a fool to buy this
stock at this price, but I also know that a bigger
fool will come along and buy it from
me at an even higher price.")
IPOs are a form of the greater fool
theory if you think about it. Buffett
once said that value is destroyed not
created by any business that loses money over its
lifetime no matter how high its interim valuation
might get. In my class I like to cite examples of
companies which never generated any cash over
their life but nevertheless commanded gigantic
valuations for a while.
One example is that of Samtel Color. This com-
|IN CONVERSATION WITH|
“Deep value means
cheap now, not
cheap based on
future prospects.”
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
buying high quality
companies and
holding on to
them for a long
time, and then
there are people
who have done
well by buying
mispriced securities in bankrupt companies un-
dergoing a debt restructuring operation,
and then there are those who have
bought statistical bargains like Tweedy
Brown does now based on the principles
taught by Graham.
I like to give exposure to all these invest-
ment styles to students and it’s for stu-
dent to decide what suits him or her the
most. It’s about trying to fit your personality to a
style, and it isn't necessary that you have only
follow Graham or only follow Fisher. You can
take bits and pieces of things that you like the
best from different role models and try to de-
velop your own investment personality. This will
happen automatically over a period of time pro-
vided you get a variety of exposure to different
styles.
The other thing which I want to tell your readers
is to look out for great businesses by having an
“investment” frame of mind. One favorite exam-
ple to explain this to think about what happens
when you go out for a dinner to a popular restau-
rant.
Let's say you walk into joint like Haldiram’s and
start thinking about Return on Capital in your
current location VS a situation in which you are
dining, let's say, at a much more fancy place like
The Oberoi. Return on Capital is the key ratio to
focus on but that's just a start. So let's break it up
into its two components: margin and turnover.
Which one of the two situations would have a
much more rapid turnover. Obviously that's
Haldiram’s where in a single lunch shift, a table
will turn over maybe five paying customers.
That's just not going to happen in The Oberoi.
So, a Haldiram’s restaurant may have a lower
margin on sales but the very fast turnover should
deliver it a much higher return on capital. This is
a very useful way of thinking about a variety of
businesses, so it makes sense to make a habit of
it.
of them were very conservative in terms of lend-
ing. One of them was Cholamandalam which
was selling at less than 50% of book value. It
was giving you a dividend yield of more than
10%. So it was a classic Ben Graham kind of a
stock.
I enjoyed investing in high yielding stocks. I also
loved the idea of stripping dividends from high
dividend yielding stocks which is an
operation where you buy them on cum
-dividend and then you sell them on ex
-dividend basis at the same or even
higher price, effectively stripping out
the dividend. The annualized return on
such operations can be very good. This
happened at a time when the dividends
were taxable and when dividends became
tax free, such operations became even more
interesting. I think in one of his talks, Charlie
Munger said that when you have very little
amount of money, then you can look at these
obscure bargains in tiny companies. You don’t
find such inefficiencies in large companies be-
cause those are tracked closely by hundreds of
analysts, so there is a lot of competition in that
space.
Identifying stocks for value investing is a difficult process. What would be your advice to young investors looking to get
into value investing?
My advice is to approach value investing with an
open mind and that is an advice that I give to my
students by exposing them to a variety of value
investing styles.
My own investment philosophy has evolved
over the years based on the different styles that I
have adopted, from different role models like
Ben Graham, the partners of Tweedy Brown,
Philip Fisher, Warren Buffett, Seth Klarman,
Martin Whitman, Richard Zeckhauser, Nassim
Taleb and others.
My advice to students is to go into this (or for
that matter anything) with an open mind and if
the idea of value investing grabs at you then
don't decide that you want to only do cash bar-
gains early on in your career. Get exposure to
different styles and see what suits you the best.
There are people who have done extremely well
by adopting the Fisher/Munger/Buffett style of
|IN CONVERSATION WITH|
“It’s about trying to
fit your personality
to a style, and it isn't
necessary that you
have only follow
Graham or only
follow Fisher.”
© Monetrix, Finance & Economics Club of MDI, Gurgaon
28
works.
If you combine these two skills - accounting
and business economics, then you learn to
visualize what the accounting numbers of a
given company might look like under different
scenarios 10-15 years from now. There is a
famous ice hockey quote: "Go where the puck
is going, not where it is." Its quite applicable to
the field of security analysis and the combined
skill of accounting and business analysis would
enable you to go where the puck is going…
The last point I want to make is about under-
standing human nature. It’s important to know
the power of incentives, the power of perverse
incentives. Human nature has not changed
much in the last 1,000 years.
The idea that bad accounting promotes bad
behavior is a very powerful idea. If you have
aggressive accounting - let's say the rules allow
you to recognize revenues faster than you
should - and if you adopt such practices of pre
-poning your revenues and postponing your
expenses, you are not changing anything eco-
nomically but you showing higher current
earnings at the expense of lower future earn-
ings. People would do that because of perverse
incentives e.g. if their own bonus is tied to
reported earnings. That's how it starts. Then it
spreads and when almost everyone is doing it,
everyone else starts to do it too
(social proof) and it get's rational-
ized. Man is not a rational animal,
rather man is a rationalizing animal.
Evil in corporations almost always
starts with bad accounting, and then
human nature takes over and it
spreads. So, understanding human
nature that explains why people are
going to do wrong things and how
the good people end up making bad
judgements, and how that inevitably results in
blowups over time, is something you will learn
by reading a lot of books on financial history.
What readings would you suggest to an
aspiring value investor?
I mentioned some books before. Read up all
the books written by Graham. He wrote two
books for investors, but there are 6 editions of
Security Analysis and each is a bit different
The ideas of return on
capital and how it breaks
into margin and turnover
are not just abstract con-
cepts. These are practical concepts. So
my advice to students who are starting out is to
think in a much more common sense way about
what makes a business a great business and what
makes a business a lousy business and why.
In your opinions what are the virtues/qualities that a value investor should pos-
sess?
The single most important thing in my view is to
have the independence of mind. You can’t get
swayed by what everybody else is doing. In fact,
independence of mind is just one of the attrib-
utes of being "psychologically astute." People
who are not psychologically astute consistently
make errors of judgment, something I talk about
in the early part of my BFBV course.
There are about 15 biases and they are in us for a
reason. So one has to recognize that they were
given to us by evolution for a reason. For exam-
ple, "social proof" which is just a fancy phrase
meaning "herd mentality" was given to us by
evolution because it had survival advantage.
There is "safety in numbers" when you are living
in the caves and in the jungle. But when you are
trying to make a living by buying securities that
very tendency, which gave our ancestors survival
advantage, causes us to make foolish
mistakes in markets. You really have
to fight these automatic tendencies
which are hardwired into us, and there
are specific methods of fighting them.
Another important skill to acquire is
accounting and I realized this late,
despite being a Chartered Accountant
from a great firm, Price Waterhouse.
At PW, I learnt how accounting really
works but I never learnt what the
numbers mean from the viewpoint of business
economics. That's the part I got by reading Gra-
ham's "Security Analysis," Warren Buffett letters
and the books by other authors like Philip Fisher.
Those books really tell you how to determine if a
given business is good, bad, or mediocre, and
why. And its an enormously useful skill to have
answers to those questions and you get better
answers when you know how accounting really
|IN CONVERSATION WITH|
“But when you are
trying to make a living
by buying securities that
very tendency, which
gave our ancestors
survival advantage,
causes us to make
foolish mistakes in
markets. ”
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
29
Euphoria," and
"The Great Crash,
1929." A great
book has come
recently which is
called "This Time
its Different"
which by the way
are the four most dangerous words in investing
according to John Templeton, who is
another role model.
So you have to read these books on his-
tory, and those written by famous inves-
tors but you also must read books on
multiple disciplines. You have to have a
multidisciplinary mindset, and that is a
thing which I like to teach in the early
part of my course. We are trying to buy good
businesses and you won’t understand what a
good business is unless you understand multiple
disciplines. One of them is evolution and you can
pick up any number of great books on the subject
including Dawkins' "The Selfish Gene" and learn
about the remarkable parallels between evolution
and business.
Pick up some of the greatest texts in social psy-
chology like "Influence: Science and Practice" by
Robert Cialdini, and "Social Animal" by Aronson.
I love books on and by Feynman who is one of
my role models. I love his way of thinking - the
scientific way. There are some video lectures that
have been put up on the net by Bill Gates who
bought the rights and gave them to the world.
I also highly recommend a course called "Justice"
by Michael Sandel from Harvard Law School. It's
on the net. See a few lectures and I guarantee you
will be hooked.
You have to know what to read and you have to
read a lot. So one of the things about this profes-
sion is that reading is required and it’s not going
to end just because you finished your business
school. It only begins after that. But you also
must know what not to read, because the world is
full of noise and that is only going to keep on
increasing because of distractions. My advice is to
keep away from television, except for entertain-
ment and not for news. Ignore the front page of
newspapers and do not read the stock market
pages.
with different examples, so read them all. Also
read all editions of The Intelligent Investor.
You should also read letters written by some of
the greatest value investors like the partners of
Tweedy Brown and Warren Buffett, and Seth
Klarman.
Warren Buffett’s letters I think are the best edu-
cation in finance that anybody can get,
and I can’t overemphasize this enough.
The thing is that these letters are free
and that if he had charged a thousand
dollars for them, people would value
them more. But he gives them away
for free and people think that these are
free and can't have much value, which
is completely wrong. My very strong
suggestion to your readers is to drop
everything and just download these letters and
print them out. Don’t read them on the screen.
Read them slowly, read a letter in four days and
try to absorb what he is saying. I think there is no
better place to learn about finance, about busi-
ness economics, about ethics and about a whole
lot of subjects related to the business world than
from the letter of Warren Buffett.
Read Seth Klarman's "Margin of Safety." Martin
Whitman has written a couple of books ("The
Conservative Aggressive Investor" and
"Distressed Investing"), and they are worth read-
ing although his writing style is a lot harder to
understand than that of Buffett.
Read up all the three books by Philip Fisher:
"Common Stocks and Uncommon Profits,"
"Conservative Investors Sleep Well," and
"Developing an Investment Philosophy." Then I
want your readers to read books on history. As I
said earlier that human nature hasn’t changed
much and people have made enormous mistakes
in the past and one can learn from the mistakes
made by our ancestors. There is a book called
"Extraordinary Popular Delusions and the Mad-
ness of Crowds" by Charles Mackay. It is one of
the greatest books on crowd psychology where
you read up on Tulipomania and South Sea Bub-
ble and once you read them you will automati-
cally relate them to recent bubbles and manias
and find that nothing has changed.
Then there are two books written by John Ken-
neth Galbraith: "A Short History of Financial
|IN CONVERSATION WITH|
“Warren Buffett’s
letters I think are the
best education in
finance that anybody
can get, and I can’t
overemphasize this
enough.”
© Monetrix, Finance & Economics Club of MDI, Gurgaon
30
31
with one explanation that answers the question.
That's one hell of a way to think - like the fic-
tional Sherlock Holmes did. I think one should
read Judith Harris and Richard Feynman and
other great thinkers. Even if you don't under-
stand their subjects, you'd understand their
thinking styles.
I think its terribly important to have these role
models from multiple disciplines.
What is your opinion on the current In-dian macroeconomic environment with respect to investments in the equity mar-
kets?
None, I have no macro views. I think it is very
difficult to predict these things. I have read a lot
of studies by the experts who try to predict them
but they don’t do better than a toss of a coin. So
I don’t think it is worth it to try to predict where
the interest rates, GDP growth rates or stock
market levels are going to be in the next year or
two.
The idea that you can buy-well run companies
which are selling at low valuations occasionally in
the stock market is a very powerful idea. If the
business is good, the management is good, the
price you are paying is reasonable and you have
the patience to hold on to that stock for a long
time, then you will do well, particularly if you
have many of them in your portfolio.
Any special words of wisdom for
BlueChip readers?
First, find role models. One inter-
esting thing about role models is
that these are not necessarily the
guys who did the best. The guys
who did the worst, the guys who
messed up, the Nick Leesons, the
founders of LTCM, the Bernie
Madoffs and other people who
are, or until recently, were, in prison for frauds,
can also be good role models. They are great role
models because they are teaching you in a very
vivid way" hey guys look how I screwed up my
life, and I hope you don't end up like me."
An interview with Mr. Sanjay Bakshi
As told to Aditya Mittal & Mukul Aggarwal
Team Monetrix
You have to see how
funny this is. Pick up
newspapers of 5 years
ago and pick up the top
stories of that time and see how ir-
relevant they were in the whole scheme of
things. People think they were terribly important
but in the end they were not too important.
That's recency bias where people overweigh re-
cent but unimportant or irrelevant events.
So you have to know what to read and what not
to read. I like to think a lot about how to elimi-
nate distractions. I use tools to eliminate distrac-
tions like Facebook or Twitter or e-mail or SMS.
Being connected is good but so is being discon-
nected. Depth is also as important, perhaps more
important than breadth.
You are a role model for thousands of young investors/students across India.
Who is your role model?
I get new role models every year; they typically
come from books I read, or columns written by a
journalist. So if I really like a column written by a
journalist I would like to read his or her other
columns, so you have all these people who think
the way you want to think and who think better
than you think and you want to emulate them.
To give you an example, there is a lady by the
name of Judith Rich Harris, she writes on evolu-
tionary psychology which is a combination of
evolution and psychology. She has written two
books and one is called "The Nur-
ture Assumption" and the other
"No Two Alike: Human Nature and
Human Individuality".
When you read these books, you
not only learn about a new fascinat-
ing subject, you also learn how this
remarkable woman thinks, how she
develops her thesis and you really
have to read the book to under-
stand what she is saying, but the algorithm she
uses is a fabulous one, it’s the one which Charlie
Munger refers to as "inversion" or "proof by
contradiction."
Judith Harris has a question and she seeks vari-
ous answers to that question and with extremely
logical way to thinking she starts dismantling one
reason after another and in the end she is left
|IN CONVERSATION WITH|
“I use tools to eliminate
distractions like Facebook or
Twitter or e-mail or SMS.
Being connected is good but
so is being disconnected.
“Depth is also as important,
perhaps more important than
breadth.”
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
The Indian economy has been seeing many
changes over the years owing to both domes-
tic as well as international forces. One of the
key indicators of economic health is the
nominal exchange rate of the country. It is a
well-established fact that India follows a man-
aged floating rate system in which it does not
intervene until there is a significant deviation
from the standard rates. The Central Bank,
Reserve Bank of India in our case does this
by buying or selling currencies. In an increas-
ingly integrated global economy, currency rate
fluctuations affect the economic health of the
country. Hence, almost all governments now
follow the managed floating system to control
sharp deviations in nominal exchange rates.
There are merits as well as demerits of this
system. However, we have attempted to un-
derstand the effect of changes in the net ex-
ports during the last 6-8 months owing to the
exchange rate variation.
Hysteresis effect –
In the aftermath of a large and persistent
overvaluation of the dollar in 1980-85, several
US firms were at a disadvantage in world
trade as dollar prices of imports declined.
These are normal effects of a currency appre-
ciation. However, the hysteresis argument
states that when there is a change is exchange
rate, there is a considerable amount of lag
before the economy reacts to such a change.
Once foreign firms have become established
in the United States and consumers have be-
come accustomed to their goods, even a re-
versal of the exchange rate to the initial level
will not be enough to enable US firms to re-
capture the share of the market. Similarly,
when US markets have lost foreign market
share and even left some foreign markets en-
tirely, going back to the initial level will not be
enough to bring US firms back. To return to
the initial trading pattern, exchange rates will
have to overshoot in the opposite direction,
making it profitable to incur the costs of start-
ing up export operations and competing with
foreign firms that supply imports. The evi-
dence on these hysteresis effects remains tenta-
tive. The hysteresis effect supports the argu-
ment proposed by the J-curve effect where the
net exports fall and later rise whenever the ex-
change rate is devalued.
Figure 1: J-curve effect on net exports due to devalua-
tion
Trend of net exports since July 2011 –
The graph shown below shows the variation in
exports, imports and nominal exchange rate
from November 2010 to Jan 2012. The figures
mentioned in the graph are in $ millions. An
average value has been considered for each
data point for the purpose of analysis. As we
can see from the graph, the exchange rate re-
mains steady at around Rs. 45 per dollar for the
period until July 2011 following which there is
a sharp devaluation in currency. The exports
depend primarily on two factors namely Real
exchange rate (R) and foreign GDP (Yf). On
|HYSTERESIS EFFECT|
Hysteresis Effect on the Indian Economy
Aditya Maira, Nitin Jain
Indian Institute of Management, Indore
© Monetrix, Finance & Economics Club of MDI, Gurgaon
32
33
the other hand, the imports are affected by
Real exchange rate and domestic GDP (Y).
Prior to July 2011, the net exports varied ow-
ing to changes in domestic GDP (Y) and for-
eign GDP (Yf). Since the outlook of the
economy had been good until this period,
both imports and exports rose causing the net
exports to rise. Thus, trade balance improved
during this period. even though there was
trade deficit (X<M). The graph below
shows the trend of rising exports and im-
ports during the period of October 2010 to
July 2011.
Figure 2: Trend of exports, imports & exchange rate
fluctuatin
For the entire period from July 2011 to Jan
2012, net exports has been more or less con-
stant, only varying slightly owing to changes
in domestic GDP, despite a devaluation in
currency. This can be attributed to the steady
& high level of inflation persistent in the In-
dian economy during the period. This has
caused a high domestic demand causing
prices to rise further.
However, from July 2011 to October 2011,
the exports fell from $29344 million to $
19870. Beyond this, the exports rose to $
25347. The J-curve effect can be noticed in
this change. Let us assume Qx to be quantity
exported at an average price of P. If Pf is for-
eign price level, ER is nominal exchange rate
and Qm is the quantity imported, we can see
that
Net Exports NX = Qx.P – Qm.Pf.ER
When the currency is devalued, ER increases.
This causes imports to increase but the exports
remain constant in the short run. Thus Net
export decreases initially. This occurred be-
cause there was a consumer response lag. The
price effect dominated quantity effect causing
consumers to take time to accommo-
date to cheaper domestic goods.
Following this drop in exports for 4
months, the consumers switched to
buying foreign goods. Thus, exports
increased and imports decreased. This
caused the trade balance to improve
subsequently. During this phase, the
quantity effect dominated the price
effect. This effect will now last long as
the lag due to consumer response has now
been surpassed. Thus the hysteresis effect can
be seen to affect the dynamics of net exports
even in the Indian economy but impact in not
so prominent.
Heavy imports of capital goods, fertilizers, pe-
troleum and some other essential commodities
have contributed to the rise of imports in In-
dia. India imports three fourth of its require-
ment for oil and a recent shortfall of coal has
further led to an increase in import figures. For
last few months the confidence of the inves-
tors in the Indian market is at all-time low
which is combined with the recent spurt of
corruption cases on politicians. This has led to
a huge outflow of money from the Indian mar-
ket, which in turn has increased the exchange
rate or the value of the rupee has depreciated.
|HYSTERESIS EFFECT|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
Future of Indian economy, if the recent trend
continues, should see an increase in GDP
figures due to increased exports from Indian
sub-continent. India’s managed floating ex-
change rate system has actually benefitted the
exporters, but the recent increase in the im-
port of oil and coal combined with increase in
exchange rate will only mean further increase
in inflation. This would prove to be a huge set
back since India is already following a con-
tractionary monetary policy.
Since India has a managed floating exchange
rate with free capital flow, fiscal policy will
remain ineffective. In addition, expansionary
fiscal policy would delay the growth further.
In contrast, monetary policy will be highly
effective but again it would hit investments.
Seeing the recent trends, it is clear that India’s
net exports does not increase drastically with
an increase in exchange rate. It only leads to
increase in inflation due to increase import
bills on coal and oil. For a developing econ-
omy like India, a rupee appreciation seems
best for some time to come which can be as-
sured only through positive market senti-
ments. India has been always an attractive
destination for investment but for this the
sentiments of the investors and market need
to be corrected. Foreign investments in the
form of FII’s and FDI’s are needed for the
economy to grow further. This will only be
possible by improving market sentiments.
The composition of government expenditure
needs to lay greater emphasis on increasing
the productive capacity of the economy,
through increased investments in agriculture,
education and infrastructure. This would
make sure that we are less dependent on for-
eign markets for
basic needs. To create fiscal space to invest in
these critical areas, the government will have
to reduce subsidies. Monetary policy will re-
main less effective in inflation control, if fiscal
policy does not focus on improving supply of
key goods and services – agriculture, skilled
labour and infrastructure – but keeps stimulat-
ing consumption demand. Increasing agricul-
tural productivity will require the policy to fos-
ter a supportive environment of better irriga-
tion, better technology and infrastructure. A
developing country has to live with some infla-
tion and using monetary policy to control infla-
tion would only lead to reduced investments.
The only way to fill the demand and supply gap
is to increase productivity.
Linking wages to productivity will be critical
for managing demand pressures. Increasing
productivity will enable the economy to con-
trol inflation and enjoy higher growth. Else, the
economy could lapse again into a phase of
lower growth. We should use innovative tech-
niques, look towards east and west on how to
increase productivity, learn from our mistakes
and try to create an atmosphere for growth.
The hysteresis effect on Indian economy may
not be directly traced due to its over-
dependence on imports. A developing econ-
omy like India should try to decrease trade
deficit and device mechanisms to increase pro-
ductivity, maintain high investor confidence,
eradicate corruption and try to control inflation
by filling the demand supply gap.
References
1. Macroeconomics, 9th editon by Rudiger Dornbusch,
Stanley Fischer and Richard Startz
2. Essentials of Macroeconomics by Peter Jochumzen
- BookBoon , 2010
3. Macroeconomics: Principles and Tools (3rd Edi-
tion) by Arthur O’Sullivan, Steven M. Sheffri
|HYSTERESIS EFFECT|
© Monetrix, Finance & Economics Club of MDI, Gurgaon
34
35
The Ascent of Money: A Financial History of the World
is written by Harvard Professor Niall Ferguson
and it was later adapted into 6-part television
documentary. Logically structured into 6 chap-
ters – banks and banking system, debt and bond
market, equity and stocks, insurance, real estate
and finally Chimerica, which covers a unique
union that has been established between USA
and China, the author investigates right from the
history of credit and debt to the present day top-
ics like globalisation, obsession
with home ownership and
emergence of Chimerica.
Modern finance was born in
Italy in 15th Century. Initially,
Christians did not participate in
the money lending as the Bible
forbids usury. The Jewish
population construed this to
mean that they could not
charge interest to their own
family. This was one of the
first associations of Jewish
people with money. A Chris-
tian by the name of Giovanni
de’ Medici used to give ad-
vance money to a merchant and charge a fee
(Something what we call ‘Interest’ now).
There are lots of fascinating details about finan-
cial events including main innovation that hap-
pened in last few centuries. Perhaps the most
distinct aspect of the book is Ferguson's ability
to link the past events with the present scenario
and cases. For e.g. Spanish found gold and silver
mines in South America while on their explora-
tion. They mined this gold and silver and sent
them back to Spain which made it one of the
wealthiest countries. Whenever they needed
more money, they would mine more gold and
silver (Just like how money is printed nowa-
days). However, there was so much gold in the
market that it lost it value and the Spaniards
drag themselves into financial ruin. Also the
bond market has its origins in the state’s need
for money to finance war.
In Scotland, in the early 1700s, widow and chil-
dren of deceased ministers of Church of Scot-
land faced penury after his death. Robert Wal-
lace and Alexander Webster raised money from
the group of 930 Scottish ministers to profita-
bly invest it and pay out the widows of these
ministers from the profits of these invest-
ments. The keystone behind the success of
this first insurance fund started for Scottish
ministers was the mathematical precision
needed to calculate how much premium to be
paid out every year.
He explicates how China has
become banker to the USA
and until the current global
financial crisis, relationship
which seemed to be pretty reli-
able, now seems unstable.
American consumers over-
purchased goods and over-
borrowed from China and the
China in turn accumulated
huge dollar surpluses by cheap
exports and invested those
dollars back into Wall Street
and US treasury bonds,
thereby providing spendthrift
Americans with the money
they needed to live an American dream and
sustain as the superpower. “For a time it
seemed like a marriage made in heaven,” Fer-
guson writes. “The East Chimericans did the
saving. The West Chimericans did the spend-
ing.”
Mr Ferguson, a historian with a largely busi-
ness oriented interest and research, clearly ex-
plains rationale behind the book by summaris-
ing: “From ancient Mesopotamia to present-
day China…the ascent of money has been one
of the driving forces behind human progress: a
complex process of innovation, intermediation
and integration that has been as vital as the
advance of science or the spread of law in
mankind’s escape from the drudgery of subsis-
tence agriculture and the misery of the Malthu-
sian trap.”
Team Blue Chip
|BOOK REVIEW|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
|IN - DEPTH|
stance from Germany’s exclusive obsession
with Fiscal Austerity. The other notable devel-
opments were that the promised aid of up to
€100 billion ($125 billion) for Spain to recapi-
talise its banks would no longer be senior to
other debt. It is mentionable here that when
Greek debt was restructured earlier this year,
bonds held by the ECB were not subjected to
losses. Spain was also given one year more to
meet the deficit target of 2.8%,
the new deadline being 2014.
Ireland could also expect the
burden of its bank bail-
outs to be eased.
But there are several cave-
ats. Firstly, the Eurozone
members did not
commit to a
b a n k -
i n g
union as such. Al-
though this could
be considered as
the first step to a
“Banking union”
which could end the
deathly cycle of weak governments and weak
central banks trying to stifle each other. Sec-
ondly, before banks can be recapitalised di-
rectly, the euro zone will have to create a strong
central supervisor, centred on the European
Central Bank (ECB). This will take time, with
several issues to settle – among them the ques-
tion of which banks should be supervised. Ger-
many has tried to limit scrutiny to big cross-
border banks. But this will tend to overlook the
smaller regional banks in Spain and Germany
Europe’s 19th crisis summit was held in the last
week of June in Brussels amidst great hope and
global attention. Like the previous 18, this too
was supposed to be a game changer. Did it live
up to its billing? Well partially yes, if you believe
the financial markets and pundits.
Yields on Italian and Spanish bonds fell sharply
as investors interpreted that Europe’s political
leaders had
committed
t h e m -
selves to
the creation of a banking union and to
allowing troubled countries
easier access to Euro-
zone rescue funds.
The heads of
Italy, Spain
and France
were hailed in
their respective
countries for scor-
ing a
v i c -
t o r y
over German Chancellor Angela Merkel, who
came under severe criticism at home for conced-
ing too much at the summit.
Looking at the fine print, the European leaders
have broadly agreed to create a Europe-wide
bank supervisor (involving the European Cen-
tral Bank) before the end of the year. Secondly
and more significantly, by accepting that bail-out
funds can go straight to banks, Mrs. Merkel has
made a big shift from her insistence that help
could go only to governments, with tough con-
ditions attached. This underlines a big change in
European Crisis
Still Anybody’s Guess
Aditya Bansal, Ankur Dikshit
Team Monetrix
36
© Monetrix, Finance & Economics Club of MDI, Gurgaon
37
international experts, and not the Spanish
government that would decide how much
Spain’s banks need. The rescue of Spain is
likely to have more impact on financial mar-
kets than the rest three as its economy is
nearly double the size as the rest three com-
bined.
Coming to Italy, the Italian budget deficit is
now pretty small as a percentage of gross
domestic product – much smaller than Brit-
ain’s, for example. But Italy’s total public
debt has recently hit a new record of €1.95tn
and is well above
120 per cent of
GDP. The country
needs to borrow
hundreds of bil-
lions in the mar-
kets this year, just
to roll over its
debt. However, the
IMF and Euro-
pean Union might
not be able to
cough up the
amount of money
Italy – the country
with third largest
debt stock in the
world, might need
for a bailout. The
borrowing costs
for Italy are creep-
ing up – we might just be approaching the
point where Italy has to look at some place
other than the bond markets because it be-
comes unfeasible.
In the light of these facts, the result of gen-
eral elections in Greece becomes more im-
portant. The newly formed government un-
der Mr. Antonis Samaras makes any confron-
tation with the EU more unlikely. It is very
important that Greece avoids any showdown
with the EU because the indirect effects of a
Greek exit could be enormous. Once inves-
tors see that countries can indeed leave the
where the worst problems lie.
The events of the recent past suggest that the
chances of break-up of the euro precipitated by
Greece are highly unlikely. The EU has enough
firepower to keep Greece in the single currency,
if it wants to. More alarmingly, if both Spain and
Italy are unable to fund themselves through the
markets, the EU may simply be unable to assem-
ble a bailout fund large enough to save them. At
that point, the break-up of the euro does not
look a distant reality.
In this light, the recent
failed attempt at bailout of
the Spanish Banks becomes
more significant. The
Europeans thought they
had exceeded market ex-
pectations by coming up
with €100bn. On the con-
trary, the yield on Spanish
bonds actually rose after
the bailout was announced.
Investors seem to have
concluded that if Spain
cannot borrow directly to
bail out its banks; it is peril-
ously close to losing access
to the markets completely.
The prospect that Spain
might need a full sovereign
bailout seems frightening.
It would need something in
the vicinity of €500 bn -
exhausting almost the entire
financial firewall that the EU has constructed to
contain the crisis.
However, because the new provisions in the Eu-
rozone’s €440bn rescue system were applicable
on Spain, it will avoid the kind of intrusive in-
spection of government books that came along
with Irish, Greek and Portuguese bailouts. But
the new loans, expected to be negotiated before
the end of the month, will not be condition-free.
EU’s top economic officials made clear that it
would be the European Commission and other
Source: The Economist
|IN - DEPTH|
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
June shows a steady decline in the month.
This follows four months after the private
sector shrugged off the region’s debt crisis
and expanded output in January for the first
time in five months. Purchasing managers’
indices for the 17-country bloc showed manu-
facturing and services activity rebounded un-
expectedly sharply in January, driven by ro-
bust output growth in Germany and a modest
expansion in France. January’s improvement
was because of companies running down or-
der backlogs. Exports were helped by a
weaker euro. Another boost to the confidence
might also have been the ECB’s crisis-fighting
measures, which saw it provide €489bn in
three-year loans to Eurozone banks in De-
cember.
As per the current figures,
companies are clearly
short on confidence
and anticipate the
worst, cutting back
on both staff num-
bers and stocks of
raw materials at the
fastest rates for two-and-a
-half years. The situation at the
employment front continues to find a
new low with each passing month. Across the
euro area as a whole, the count of the unem-
ployed topped 17.5m in May, nearly 2m more
than a year ago and more than 5m above the
level in early 2008.
Whatever direction the crisis takes from here,
one thing has become clear, the idea of a cur-
rency union without a fiscal union is essen-
tially flawed. Nations with weak currencies
and high productivity get an unfair advantage.
The current crisis is here to stay and it is only
with concerted apolitical action that the Euro-
pean Union can hope to see a solution in the
foreseeable future.
References
1. The Economist
2. Financial Times
euro, then they will inevitably re-price risk in
other eurozone countries – intensifying the
pressure on Italy and Spain.
It is unlikely that Greece will comply sufficiently
with even “lite” fiscal austerity conditionality, let
alone with structural reform conditionality, in-
cluding privatisation targets, which are unlikely
to be relaxed. Political opposition to both aus-
terity and reform is now stronger in Greece than
ever before. So is the apprehension over bail-
outs in the core. It has already led to one round
of elections that didn’t give any party the man-
date to form a government. The troika of the
European Commission, ECB and the IMF –
may forgive a Greek failure in the September
progress assessment, but is unlikely to tolerate
another failure to comply on all
fronts by the December
assessment.
It would not be the
wisest to assume that
the core Eurozone
would be willing to
take on significant ex-
posures to Spain and
Italy unless it can be estab-
lished unambiguously that a wil-
fully and persistently non-compliant programme
beneficiary will be denied further funding.
Therefore Greek exit would become even more
probable should Spain and Italy require a
broader troika programme and external help,
respectively, which appears likely. The greatest
fear of the core nations is not the collapse of the
euro area but the creation of an open-ended,
uncapped transfer union without a surrender of
national sovereignty to the supranational Euro-
pean level. The exit is likely to create extreme
unrest in Greece, and lead to social and political
instability. In recognition of this, the Greek gov-
ernment is likely to drop its demand to ease bail-
out terms after warnings that it would be re-
jected by international lenders.
The industrial activity front is also gloomy. The
new data on manufacturing activity released in
|IN - DEPTH|
38
© Monetrix, Finance & Economics Club of MDI, Gurgaon
39
|MARKET UPDATE|
Sense
x
Market Movement
Sector-wise Snapshot
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
Currency Rates
1 Dollar – Rs. 54.36
1 Euro – Rs. 68.54
1 Pound – Rs. 85.31
1 Yen – Rs. 0.68
Source: www.bseindia.com Currency rates, policy and reserve ratios as of 3rd July, 2012
Policy Rates and Reserve Ratios
Repo Rate – 8.00 %
Reverse Repo – 7.00%
CRR – 4.75%
SLR – 24%
Bank Rate – 9.00%
|MARKET UPDATE|
In the News
aim of increasing the safety in payments and set-
tlements system. It has invited public comments
on the 'Payments System Vision Document 2012
-15'.
The document proposes the vision of
"proactively encourage electronic payment sys-
tems for ushering in a less-cash society in India"
M3 Money Supply Grows 13.8% June 27, 2012; The Economic Times
According to the Reserve Bank of India, the M3
money supply in India increased 13.8% y-o-y and
stood at INR 76,216.5 billion as on 15th June
2012.
India Targeted M&A Value Decline 26% June 26, 2012; The Economic Times
According to Dealogic, a deals tracking company,
the cumulative value of merger and acquisition
deals targeted towards India this year so far has
registered a decline of 26% over the correspond-
ing period a year ago. The total value of the deals
till 22nd June 2012 was USD 25.5 billion.
The second quarter of 2012 has witnessed a sig-
nificant decline in the M&A activity with approx
USD 3.7 billion worth of transactions announced
during the period. In comparison, deals worth
USD 21.8 billion were announced in the first
quarter of 2012.
RBI Increases Limit on Inward Remit-
tances June 9, 2012; Business Standard
The Reserve Bank of India (RBI) has raised the
limit on the number of foreign remittances an
individual can receive from 12 to 30 per calendar
year. However, there have been no changes in
India's Current Account Gap Reaches 20-
year High June 30, 2012; The Economic Times
India's current account deficit (CAD) has in-
creased to the highest ever level to 4.5% of GDP
at USD 21.7 billion in January-March period of
2011-12. The rise has been on account of higher
imports of oil and gold. During Q1 CY12, India’s
forex reserves decreased by USD 5.7 billion de-
spite inflows of USD 13.8 billion.
A high CAD signals that a country is living be-
yond its means and is only able to fund its con-
sumption with excessive external borrowings. Un-
der the current circumstances in India, if left un-
checked, the rising CAD will lead to a decline in
rupee, and further increase the debt burden.
External Debt Increases 13% in FY12 June 29, 2012; The Economic Times
In FY2012, India’s external debt increased by 13%
to USD 345.8 billion from USD 305.9 billion at
end of March 2011. The rise was on account of
higher commercial borrowings and trade credit.
According to the RBI, almost all the components
of the external debt recorded a rise during the last
fiscal year. The dollar denominated debt was the
largest, accounting for 55% in the total external
debt as at end of FY2012. Loans under external
assistance rose by ~USD 3 billion during 2011-12
in comparison to a rise of USD 8.7 billion during
2010-11.
RBI Promotes Electronic Payments in In-
dia June 27, 2012; The Economic Times
The Reserve Bank of India (RBI) has proposed to
actively promote electronic transactions with the
40
© Monetrix, Finance & Economics Club of MDI, Gurgaon
41
|MARKET UPDATE|
New Format for Reporting Financial Re-
sults April 16, 2012; The Hindu Business Line
The Securities and Exchange Board of India
(SEBI) released a new reporting format for dis-
closing financial results for companies other than
banks. According the SEBI guidelines, the com-
panies will have to adopt the new format for fil-
ing their income statement and balance sheet
starting FY12.
The format follows a February 2012 notification
from the Ministry of Corporate Affairs, India.
Under the new format, companies filing consoli-
dated results need to include details of profit and
loss of associates and minority interest. Addition-
ally, they have to include details of shared pleged
by the promoter/ promoter group.
SEBI Allows Stock Exchanges to List April 2, 2012; The Hindu Business Line
The Securities and Exchange Board of India
(SEBI) has decided to allow stock exchanges and
depositories to list. The move is in contrast to the
recommendations of the Bimal Jalan Committee
on listing of exchanges, which suggested that ex-
changes, depositories and clearing corporations
should not be allowed to list because of their
frontline regulatory role.
However, the SEBI has allowed the listing under
certain restrictions, including that the minimum
net worth for exchanges and depositories should
be INR 100 crore and that no single investor can
hold more than 5% in exchanges.
RBI Relaxes Rules for Foreign Currency
Accounts
April 2, 2012; The Hindu Business Line
The Reserve Bank of India (RBI) has liberalised
the regulations governing the Foreign Currency
Accounts (FCA) with the objective of providing
operational flexibility to Indian entities making
overseas direct investments.
Under the new regulations, Indian entities can
open, hold and maintain FCAs abroad to
smoothen the process of making overseas direct
investments, subject to certain eligibility condi-
tions.
the cap on the amount of each transaction. It has
been retained at USD 2,500 per person.
According to the industry experts, the measure
has been adopted to extend some support to the
falling rupee. It had been a long standing demand
of the money transfer agents to increase the num-
ber of remittances due to such requests flowing in
from the customers.
SEBI to Derecognise Exchanges with Less
than Rs 1,000 crore Turnover May 30, 2012; The Hindu Business Line
The Securities and Exchange Board of India
(SEBI) has announced that it will compulsorily
derecognise exchanges with less than Rs1,000
crore annual turnover and not applying for exit
within two years.
Stock exchanges with an annual turnover of less
than Rs 1,000 crore are eligible to voluntarily exit.
The derecognised exchanges would be required to
file for exit within two months, failing which, they
will have to compulsorily exit.
NRI Deposit Flows Triple in FY12
May 11, 2012; Business Standard
The non-resident Indians (NRIs) deposits inflows
into banks in India increase around three times in
the year 2011-12. THE NRIs sent around USD 11
billion in the last fiscal in comparison to USD 3.23
billion deposited in 2010-11. The increase in the
inflow was on account of higher interest rates and
a weakening rupee.
According to RBI executives, a large amount
moved into NRE deposits after banks raised rates
in the second half of FY12. RBI had raised the
ceiling on these deposits with the objective of at-
tracting foreign fund flows to check the rapid de-
clined in rupee value.
RBI Announces OMO to Ease Liquidity
May 8, 2012; Business Standard
The Reserve Bank of India (RBI) announced plans
to infuse up to INR 12,000 crore through Open
Market Operations (OMO), with the intent of eas-
ing liquidity pressure and creating an appetite for
fresh supply of government bonds.
APRIL—JUNE ‘12 | BLUE CHIP ISSUE 1
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From top left: Nihal Mahesh Jham, Raghav Pandey, Keyur Vinchhi, Uday Das Gupta,
Siddharth Janghu, Aditya Bansal, Rukun Tarachandani, Ankur Dikshit, Shaik Arif Ahmed,
Amit Garg, Anupriya Asthana, Soumya Hundet, Goutam Kumar, Aditya Mittal, Krishna Prem
Sharma, Sandeep Patil, Varun Sanghi, Mukul Aggarwal
The Club
- - - - - - - - - - - - - - - - - - - - - - -
Monetrix is the Finance and Economics club of Management Development
Institute (MDI), Gurgaon. As one of the most active clubs in the campus,
Monetrix continuously strives to contribute to the financial and economic
knowledge of the MDI community by holding events and conducting
knowledge sessions and other interactions.
The magazine, Blue Chip, is an effort in the same direction, of contributing
not just to the MDI community, but to the fraternity of MBA undergrads
throughout India.
Hope this issue of Blue Chip has served as an interesting read. Do watch out
for our next quarter issue to be released in October this year!
More information on Monetrix can be found at http://mdi.ac.in/students-life/academic-
clubs.html. For any other feedback or information, please mail in to us at
Note: You may have noticed that some of the articles in this magazine have been written by team
Blue Chip or team Monetrix. These articles have been kept in the issue only with the purpose of
making the magazine content wholesome and are not considered for the prize money.