Blue Chip Issue 2 (July-September 2012)

2
From the Editors Desk

Dear reader, As we bring our second issue to your desk, there seems to be some relief in the economic climate with policy changes like the governments announcement of allowing FDI in multi-brand retail. The way the Manmohan Singh government handled it, seemed like a red herring for distracting the public from the burning issues of corruption. How successful such policies prove at the ground level in uplifting the lowest in the supply chain, is left to be seen. Of course, the news of this bold but long awaited policy change would give relief only for a little while before Team Kejriwal brought out skeletons from closets of political big wigs and put allegations of crony capitalism on one of Indias largest companies, calling for a change. The life of an MBA student, is rife with ups and downs, handling change is a way of life. The previous edition of Blue Chip (July) found you in a much different state than this one. For many first years, the change is a good one, the relief of having gotten a good summer internship for the year 2013. For the second years, those whose placement status has changed to signed out, too, are sitting comfortably. While, for many others, the change might not be such a good one, a time filled with tension and anxiety still waiting for that golden final or summer placement. Some might even fear an outcome similar to the placement season at their undergraduate level during the years of 2008-09. But all hope is not lost, as with policy changes from the government and political activism from the public clubbed with seemingly favourable outcome of US presidential election, there seems to be an atmosphere of constructive change. Keeping in line with the spirit of change - the only constant in life - we have added a new section for exercising your grey cells called Mind Games that features a crossword. We hope you find it to be a change for the better! Retaining popular sections from last issue; this time we feature an interview with the country head of Food & AgriBusiness Strategy & Research (FASAR) for Yes Bank, Mr. Girish Aivalli, who has given his invaluable insights about the food and agri-business scene in India and about Yes Banks future plans. Ending on a festive note, from the entire Blue Chip team, heres wishing all our readers a very Happy Diwali and a prosperous new year 2013!
BLUE CHIP
ISSUE 2
All images, artwork and design are copyright of Monetrix Finance and Economics club of MDI, Gurgaon
Aditya Mittal Amit Garg Aneesha Chandra Anupriya Asthana Keyur Vinchhi Nihal Mahesh Jham Rishabh Gupta Sandeep Patil Sankalp Raghuvanshi Saurabh Saxena Stephen Thomas Uday Das Gupta Varun Sanghi
Manasa Malipeddi
For any information or feedback, please feel free to write in to us at bluechip@mandevian.com
~Anupriya Editor for Blue Chip
CONTENTS
Cover Article ~ 9
Leap of Faith Off the Fiscal Cliff
In conversation with ~ 28
Beginners Corner ~ 40
Mr. Girish Aivalli
Trading Strategies
Policy and Governance ~ 25
Industry Speak Decay Beyond the Billion Dollar Cavity to the National Coffers: Has Coalgate Exposed the Root?
The Bad-Bank Model ~ 19 Fiscal Deficit ~ 43
Fiscal Deficit: The Labyrinth Tale Good Bank, Bad Bank

Carbon Credits ~ 36
Quantitative easing ~ 4
Quantitative Easing: A Blessing or a Curse?

Tutorial ~ 23
Carbon Finance Understanding the Market
Breaking Up of Currencies
Book Review ~ 17 Market Update ~ 46
Breakout Nations Market Movement Economic Indicators World Market Exchanges Sector Wise Snap Shot In the News
Mind Games ~ 50
Crossword
4 |QUANTITATIVE EASING|
QUANTITATIVE EASING
A blessing or a curse
Rini Kothari
Student, MBA 2012-14, SIBM Pune
As another round of Quantitative easing (QE) by the Federal Reserve is making headlines, people are proving skeptical that it would help increase discretionary spending. With continued lackluster growth in the job market and a sluggish economy despite the efforts of the previous two rounds of QE, it is time to raise questions whether this unconventional monetary policy tool is really a blessing or a curse. This article talks about the impact of quantitative easing on US economy, the liquidity in emerging markets and the world economy as a whole and seeks to justify whether the use of QE is warranted in the current economic conditions. Quantitative Easing Quantitative easing (QE) is an unconventional monetary policy tool used by central banks to stimulate the economy when conventional monetary policy has become ineffective. When the nominal interest rate is very low and close to zero, the central bank cannot lower it further. This is called a liquidity trap and it can occur during deflation or when inflation is very low. In such a situation, the central bank may implement quantitative easing by purchasing a predetermined amount of bonds or other assets from financial institutions. This will then increase the demand for the bonds and raise the prices or conversely lower the yield on the bonds issued. The goal of QE is to increase the money supply and stimulate demand rather than to decrease the interest rate, which cannot be decreased further. From the time of the global financial crisis, both the Federal Reserve and the Bank of England and have used the policy of quantitative easing to revive consumer spending and economic growth. For instance, during the financial crisis of 2008, high unemployment and slow growth forced the U.S Federal Reserve to stimulate the economy through its policy of quantitative easing in the interval from November 25, 2008 through June 2010. The program had a little impact initially, so the Fed announced an expansion of the program from $600 billion to $1.25 trillion on March 18, 2009. But soon after the program ended the economy again showed signs of slow growth, & with the rise of the European debt crisis there was a renewed instability in the financial markets. So the Fed introduced a second round of quantitative easing, which came to be known as QE2 and involved the purchase of $600 billion worth of short-term bonds. This program ran from November 2010 through June 2011 and although it sparked a rally in the financial markets, it did little to spur sustainable economic growth. The consequences were the same as those following QE1, which again resulted in weak economic data and poor stock market performance. In September 2012, the Fed said it would spend a further $40bn per month by purchasing mortgage- backed securities until the labor market improves. This is in addition to the $2.3tn that Fed has put into QE since 2008. The Bank of England, on the other hand, has committed a total of 375bn to QE so far.
Monetrix, Finance & Economics Club of MDI, Gurgaon
5 |QUANTITATIVE EASING| During the past 20 years, there have been other instances where QE has been employed by the Bank of Japan and the European Central Bank. The Great Recession and Euro zone debt crisesdrivers of unprecedented QE much lower levels of debt in emerging markets. This also illustrates why emerging markets became a target for excess liquidity. The graph below shows that as compared to emerging markets, debt levels in developed economies are rising sharply.
The need for such aggressive monetary actions Need of QE in the present conditions in recent years can be traced to the U.S. real esSince the second half of 2008 and during tate bubble, which burst in 2007, and to the 2009, spending in the economy has slowed more-recent sovereign debt crisis in the Euro very sharply as the global recession gathered zone. When the toxicity of subprime mortgage pace. This instrus l o w m e n t s growth came to bears the light near threat of the end of a downthe past ward spidecade, r a l the U.S. through equ it y contracmarket tion of p l u m the real meted, output financial combined institutions with price suffered deflation. h u g e losses, and A n Source: Government agencies, as of Dec. 31, 2011 i n v e s t o r Figure: 1 American confidence took a nose-dive. The nightmare of economic recovery is important from the perthis series of events quickly spread to the world, spective of achieving global economic recovand the Great Recession was born. ery. As the Fed has a dual mandate to maintain price stability and full employment, the The central banks in developed countries, which relative lack of inflation at present gives the were faced with task of reviving their flagging Fed room to act on helping the employment economies, responded to the crisis by unprecescenario. dented levels of quantitative easing. Many of these banks were already overleveraged and/or saddling their balance sheets with additional debt in the form of bailouts. This led to a sharp increase in developed-market government debt since the Great Recession, compared to the According to a dismal employment report released in September 2012, the unemployment rate, despite dipping slightly in previous months, remained above 8% and employers
JULY-SEPTEMBER12 | BLUE CHIP ISSUE 2
6 |QUANTITATIVE EASING| could only add 96,000 jobs to payrolls last month. This is well below economists' forecasts of 125,000 jobs. In this scenario where inflation is below the official target of 2 per cent for both the Fed and Bank of England, quantitative easing is expected to jump start the economy through stimulus spending. Currently, the Feds concern is that the sluggish economy would result in deflation which is a bigger threat to economic growth than inflation. Lets take the example of the housing market to see how this works. The housing market has experienced a deflation in Figure: 2 prices of about 30% since the housing bubble burst. Due to this deflation in prices people are hesitant about buying homes until prices start trending up again. The skepticism among home buyers causes the housing prices to fall further in a vicious, depressing trend. In such a setup, the U.S Feds launch of QE3, which will pump $40 billion into the US Economy each month, is aimed at reducing the unemployment levels and reviving the housing sector. Impact on emerging markets QE leads to greater availability of credit in developed markets. But as this supply of money has not been offset by a demand, it results into excess liquidity. This surplus capital from developed countries flows to the emerging markets and has an adverse effect on their currency exchange rates, inflation levels and export competitiveness. There are a number of reasons why emerging markets are a popular target of excess capital. Some of the reasons are: 1. The overall ability of emerging markets to take on debt is strong. 2. Investment yields in these countries are h i g h . 3. As compared to developed markets, they have experienced minimal balance sheet Source: CBS News impairments. 4. As emerging markets have lower debt-toGDP ratios , they have relatively lower levels of pre-existing leverage. The more specific effects of these cash flows on emerging markets are: Global Inflation: Emerging markets like India are already facing a high rate of inflation. An increase in liquidity will further aggravate the inflation to unmanageable levels. Currency depreciation: Increased supply of the dollar will lead to its weakening against major world currencies, and thus improve its export competitiveness. This will have an adverse effect on emerging markets, which are more
4 |QUANTITATIVE EASING| dependent on exports and have less well developed domestic consumer economies. Currency Carry Trade: QE facilitates currency carry trade in which speculators borrow money at low interest rates and invest it in developing countries at a Figure: 3 much higher interest rate. This will have the destabilizing effects of rapid currency appreciation and asset bubbles. place, households and businesses are expected to be more willing to spend, thus improving employment prospects and raising incomes.
In actuality, however, unemployment levels have remained stubSource: U.S Bureau of Labor Statistics bornly high over 9%, the population participation rate in the labor force has constantly decreased and the employment-population ratio has shown Effect on S&P 500 prices no signs of improvement during the last two Quantitative easing tends to pump up the prices years. Figure 3 behind shows that QE has not of financial assets such as stocks and commodibeen very successful in aiding the unemties. This can be seen in the rise of S&P 500 ployed. prices with the expansion of the Feds balance Effect on Mortgage Lending and Housing sheet. But as the money-printing effects start to Markets wear off, the index again shows a downward trend. Thus, by forcing interest rates lower, QE The Federal Reserve has mentioned that QE makes bonds less attractive and therefore stocks has been implemented to support mortgage seem like a better alternative. This effectively lending and housing markets with lower interinflates a false stock market bubble that could est rates. But according to the data released by burst once the intervention ends. The graph S&P Indices for its S&P/Case-Shiller Home given below illustrates how S&P 500 prices Price Indices, the leading measure of U.S. started to rise when QE started and stopped home prices, all three headline composites rising when QE was terminated. the national composite and the 10- and 20Effect on Employment A major motive behind the unprecedented use of quantitative easing has been the high unemployment levels and the sluggish job recovery since the financial crisis in 2008. With the introduction of QE and better nancial conditions in City composites have ended the first quarter of 2012 at new post-crisis lows. This shows that QE has clearly failed to recover the housing sector and at best, it has just reduced the rate by which it is weakening. Figure4 (next page) shows that the Case-Shiller Home Price index is heading downwards.
JULY-SEPTEMBER12 | BLUE CHIP ISSUE 2
8 |QUANTITATIVE EASING| Blessing or Curse these emerging markets, resulting in an overAnalyzing the valuation effects of QE of the policy of the U.S their curFed, we can rencies draw up the foland sublowing points: sequently By the use of damaging quantitative easexports. ing the Fed has A l s o , not been able to further reduce unemQE may ployment in a add to meaningful our probmanner or crel e m s ate a recovery in when the the housing Figure: 4 Source: S&P Indices & FiServ, as of May 29, 2012 Central market. Thus QE does not deal with resolving Bank has to unload all the bonds it has purthe underlying causes of the current economic chased. When the Fed decides to sell all the w e a k n e s s . bonds it bought during the three phases of Another round of QE will add to the already QE, interest rates will be driven up and may enormous national deficit. Even though the install the economic recovery just when it has terest rates are already at historic lows, busifinally taken off. nesses and homeowners are still having trouble borrowing as banks have not taken an aggressive Ultra-easy monetary policies such as QE can stance on lending. So a major risk with more be a threat to the health of financial instituQE is that it may fail to achieve the desired retions and the functioning of financial markets. sult of boosting economic growth because Temporary, higher-than-normal inflation, as a Americans are so indebted they do not want to result of such a policy, causes wage and price borrow more even when the loan is very cheap. adjustments and erodes the real value of Another risk is that the banks and other investors may take the money and invest into assets like shares and commodities, rather than lending it for more productive purposes like business investment. This will further push the asset prices higher. The massive amounts of money flowing into emerging markets as a result of expansionary monetary actions in developed markets will lead to skyrocketing levels of foreign investment into household debts. It should also be noted that when nominal interest rates are close to zero, a higher inflation rate translates to a much lower real interest rate. Thus, we can conclude that, supply of additional liquidity through QE is a questionable solution towards resurrecting todays economy and, not a panacea in creating sustainable demand.
9 |COVER ARTICLE|
Leap of Faith Off the Fiscal Cliff

The fiscal cliff is a term coined by Ben Bernanke, the current chairman of the Federal Reserve, to describe the huge budget deficit reductions slated to go into effect at the turn of the year. It is a combination of tax increases and spending cuts which will be a big negative fiscal shock to the US economy as there will be a fiscal squeeze of roughly USD 500bn in a single year. To have an idea about the size of the cliff, we can look at the GDP growth of the US. As per the data by World Bank, US economy (GDP=USD 15 trillion) grew by 1.7% in 2011 which translates into USD 255 billion. What this means is that if US political heads dont take any action then the tax increases and automatic spending cuts would be triggered leading to a squeeze of USD 500 billion due to the policy changes. On a net basis the US economy would shrink even after considering an optimistic growth of 2% or USD 300 billion. According to a report by Congressional Budget Office (CBO) the total deficit reduction in FY2013 is estimated to be USD 607 billion. So it is high time that US leaders should resolve the issue before it is too late to act.
Components of Fiscal Cliff
If the US congress fails to act before 31st December 2012 then a set of revenue and spending measures are going to expire leading to a fiscal deficit to an estimated 641 billion in fiscal year 2013, almost USD 500 billion less than the deficit in 2012. A large part of
Figure 1 - Deficit Reduction; Source: Congressional Budget Office
the fiscal deficit reduction would be coming from Bush Tax Cuts expiration, Payroll Tax
JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2
10 |COVER ARTICLE|
Cut expiration, Debt Ceiling Deal and the Alternative Minimum Tax patches.
Tax Increases
1. Bush Tax Cuts expiration: In 2001 George W. Bush, the then President of the US, passed Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), a piece of tax legislation to reduce various taxes (individual rates, estate and gift tax), provisions to reduce the marriage penalty, increase per child tax credit and simplify retirement plans over a period of nine years. Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) was passed during the presidency of George Bush in 2003 to accelerate certain tax changes passed in EGTRRA 2001, lower taxes on dividends and capital gains and increase the exemption amount for the individual Alternative Minimum Tax. EGTRRA and JGTRRA are known as Bush Tax Cuts. The provisions made in EGTRRA and JGTRRA were set to expire in 2010 but where extended for two years under the presidency of Barack Obama in 2010. Now the extension period is going to be over in December 2012 costing USD 221 billion to the economy as per the CBO. 2. Payroll Tax Cut expiration: In February 2012, the US Congress extended the temporary 2 percentage point reduction in the tax that funds Social Security pension proArmy Operations & Maintenance Navy
3. Alternative Minimum Tax (AMT): The US congress conceptualised the idea of AMT in 1969 when 155 people with earnings above USD 200,000 took a lot of personal exemptions and didnt pay any taxes. Currently, AMT works as a parallel tax system to limit taxpayers from taking personal tax exemptions. Since the AMT isnt indexed to inflation, the number of people falling under AMT is rising. For the past few years Congress and the President have been enacting legislations to increase the AMT exemptions a.k.a. AMT patch to keep the tax from reaching deep into the middle class. Without the AMT patch, CBO estimates that US households will have to pay USD 98 billion additional income tax in 2012.
Spending Cuts
The Debt Ceiling Deal: Last time when the US was about to reach its debt ceiling in 2011, the US Congress and the White House signed a deal to raise the debt ceiling on the condition of USD 2.4 trillion in spending cuts over the next decade. The spending cuts are supposed to trigger after December 2012 as per the Budget Control Act of 2011. The legal procedure which triggers the automatic spending cuts is known as Sequestration. Considering that economy is still recovering the cuts have been designed to be smaller in the initial few years and then increase with time as economy starts doing well.
6.9 4 2.3 5.8 1.2
Educational achievement & Special- education programs Medicare payments to hospitals Diplomatic programs & Embassy security
Table 1 - USD 109 Billion Spending; all figures mentioned in $billion
gram to support the US economy with a plan to end the tax holiday after December 2012. If the payroll tax holiday isnt extended then it is estimated to suck USD 95 billion in FY2013 from the US households.
The proposed USD 109 Billion Spending Cuts would include :
Fiscal Deficit of US
George W Bush during his tenure had increased the US Fiscal Deficit from USD
11 |COVER ARTICLE|
Figure 2 - US Fiscal Deficit
Green Island Basalt Sea Cliff
144.5 billion to USD 962 billion. He had waged two wars in Iraq and Afghanistan, raised the government spending from 1.8 trillion to 3 trillion whereas the tax revenues
be felt beginning in January 2013, the uncertainty caused by lack of consensus among legislators on a plan to avoid it has led to certain impacts being felt in the present. Al-
Figure 3 - Increase in US spending and tax revenue
were increased minimally. On top of that he had imposed two major tax cut policies which added a 1.6 trillion deficit over the next 10 years. The above two graphs (figure 3) show the major components of spending as well as tax revenue increases during the Bush Administration. After coming to power in November 2008, President Barack Obama tried to reduce the deficit by raising taxes for higher income group and cutting the unnecessary spending. In August 2010 he withdrew US troops from Iraq and is slowly trying to withdraw forces in Afghanistan.
though there are no universally accepted metrics to quantify uncertainty per se, the figure 4 shows a study published in the Economist wherein the number of times the word
Current Impacts of the Fiscal Cliff Uncertainty

While the consequences of the fiscal cliff will
Figure 4 - Uncertainty in US
12 |COVER ARTICLE|
uncertainty appears in the Federal Reserves Beige Book (a report based on interactions with economists, businessmen and other experts) has been used to view the trend over several months of 2011 and 2012. The spike in September 2011 could be attributed to the debt ceiling dispute between Democrats and Republicans whereas increases in June-July 2012 may be a result of the uncertainty over the impending fiscal cliff.
Figure 5 - US Economic Policy Uncertainty Index
Another study conducted on somewhat similar lines has attempted the quantification based on a combination of scanning newspaper reports of economic uncertainty, counting tax provisions slated for expiry and analyzing opinion differences among economists about various possible outcomes. The Economic Policy Uncertainty Index (figure 5) and its calculation were originally proposed by economists from Stanford University. Some of the estimated impacts of this uncertainty that being felt over several months in 2012 are as follows: 1. As per Sylvain Leduc and Zheng Liu of the Federal Reserve Bank of San Francisco, this has contributed at least a percentage point to the unemployment rate (7.9% for October).
2. Although ordinary consumers may not be too worried about the looming cliff, businesses are factoring it into their investment and expenditure decisions. Investments in equipment and office space as well as new hiring are being toned down over fears of the impending fiscal contraction and the subsequent recessionary scenario. 3. An estimation done by the National Association of Manufacturers (NAM), pegs the effect on 2012 GDP at 0.6%. 4. Another interesting trend which is being observed is big dividend payouts under consideration by various companies prior to December 31st in anticipation of dividend tax increases (43% from 15%) in the New Year.
Consequences of Fiscal Cliff

Impact of Tax Increases The added effect of this tax increase on the various income groups is given in figure 6. From this, we can see that the biggest impact would be on low inc o me ho us e ho ld s which will see a tax jump from 1% to 4%. Also, it is interesting to note that the tax in-
Figure 6 - Impact of Tax Increase
13 |COVER ARTICLE|
crease for 2nd quintile is more than that of
that an agreement would be reached during the lame-duck session of Congress set to begin shortly prior to the new year. Republicans Proposal: broadly involves domestic spending cuts keeping the defense spending and tax rates untouched.
Figure 7 - Consequences of Fiscal Cliff
middle quintile. Impact of Spending Cuts Defense is the main sector where most of the spending cuts are planned to be done. It is estimated that expenditure on defense would be reduced by USD 54.7 billion per year. Unemployment benefits to the tune USD 26 billion is planned to be cut. Given the weak labor market, unemployment rate hovering around 8%, and reduction in unemployment benefit - situation can be dismal for the unemployed citizens. On an average the plan is estimated to cost 1.6 million jobs per year. It has been widely accepted that the doctors who treat elderly and disabled on Medicare dont enjoy a handsome compensation from the government. If Doc Fix leads to reducDemocrats Expire tax cuts for the wealthy Allow the USD 500 billion in defense cuts Expand Medicaid & reduce Medicare cost
1. In the past three months, the House of Representatives has voted to extend the Bush tax cuts for all and undo the Pentagon cuts before sequestration begins in January. 2. Spending cuts to the tune of USD 240 billion over a decade have been proposed in welfare programs such as Meals on Wheels and food stamps which could impact nearly 23 million Americans. 3. Republican Presidential candidate Mitt Romney favoured an increase in defense budget to 4% of GDP from the current 3%. 4. Mr. Romney advocated spending cuts in the form of Medicaid (government funded health insurance for the poor) reduction and conversion of the Medicare (health insurance for the old and the disabled) into a voucher based scheme.
Republicans Extend Bush tax cuts to all taxpayers Cut down domestic spending leaving defense untouched Reduce Medicaid & make Medicare voucher based
Table 2 - Democrats vs. Republicans
tion of roughly USD 11 billion p.a. as per the CBO estimate then the doctors compensation will take a further dip, which could lead them to drop Medicare patients.
5. He wanted to retain the 15% gains tax cap for the wealthy while putting an end to the tax for those earning less than USD 200,000. 6. Remove dividend tax on individuals earning below USD 200,000, while retaining the Bush cut rate of 15% on others. 7. Put an end to extension of unemployment benefits. Democrats Proposal: involves letting the
Perspectives on dealing with the Fiscal Cliff

While most of the major stakeholders agree that the fiscal cliff is not in anyones best interests, when it comes to deciding on measures to tackle it there seems to be a difficulty in arriving at a consensus. There is yet hope
14 |COVER ARTICLE|
tax cuts expire for families earning over USD 250,000 and individuals with income exceeding USD 200,000 thereby benefiting about 97% of the taxpayers. Other measures advocated: 1. President Barack Obama has vowed to veto any plan that does not raise taxes for the wealthy. His famous Buffet Rule seeks to impose a minimum effective tax rate of 30% on millionaires. 2. Increase capital gains tax to 20% from 15% for the wealthy. 3. Maintain the 15% dividend rate for most, while increasing it to the 36% - 39.6% rates for the wealthy. 4. The other item on his agenda is expansion of Medicaid and reduction in cost of Medicare. 5. Democrats in Congress are now advocating an extension of the USD 95-120 billion payroll tax relief that both parties had earlier agreed upon to let expire.
groups. This approach would, thus, not conflict with the Republicans no new taxes pledge. The Federal Reserve has no room for lowering interest rates as it is already near zero. It will mostly hold the Fed Funds rate between 0 and 0.25% until mid-2015. The third round of quantitative easing (QE3) which is underway involves purchase of USD 40 billion in mortgage-backed securities per month until the unemployment situation improves. This is aimed at reducing mortgage rates, infusing money into the economy and boosting consumer spending. While this proactive approach is encouraging, it may not be an effective safety net if the economy goes over the cliff. As per projections GDP is expected to rise by around 3% in 2013; however the fiscal cliff may drag it down by as much as 4% thereby leading to recessionary circumstances. A Senate bipartisan group is currently working on a three-point plan to prevent the fiscal cliff.
Figure 8 - Simpson Bowles
Another group christened Cliff-divers which includes some Democrats and economists believe that the immediate consequences of the cliff are overstated. They advocate letting the fiscal cliff occur and then cutting taxes for the middle and lower income
1. Decide on a USD 4 trillion deficit reduction over next decade 2. Work out changes to the tax code, Medicare and Social Security combined with spending cuts to certain federal programs
15 |COVER ARTICLE|
3. Abolishment of the sequestration assuming a substantial reduction in fiscal deficit is feasible by the above plan For step 2, a plan similar to the SimpsonBowles recommendations which were designed to reduce deficit to 2.3% of GDP by 2015 is under consideration (figure 8).
Greece Greeks tax almost everything and huge amount of tax evasion occurs which creates big problem for the government. Greece had a fiscal deficit of 10.5% of GDP in 2010. They had planned a fiscal consolidation of 3.1% of its GDP. However they couldnt get the required tax revenues and the deficit reduced only to 9.1% of GDP. Over the years it has reduced its corporate tax rate from 29% to 20% in order to boost growth in the corporate and has increased VAT from 19% to 23%. Greece is planning a fiscal consolidation of
Effects of Fiscal Consolidation on GDP of Other Economies

Fiscal consolidation has a negative impact on GDP growth of a country. As the growth
Figure 9 - Impact on Other Economies
Figure 11 - Growth rate of Spain
slows, there are stabilisers such as unemployment benefits which start kicking in. So when a country plans to have a fiscal consolidation of 1 unit, actual reduction in the deficit is lesser than one. As we can see in the following figure 9, on an average a one unit of discretionary tightening leads to a 0.7 reduction in the deficit. We can observe that the countries appearing in the right, mainly South Asian countries are in general more effective at consolidating their deficit than the ones on the left, the European countries. Many Countries have had to take drastic measures for fiscal consolidation. Lets see how their strategies have had an impact on their economies.
the tune of 43bn to reduce the deficit from 36bn euro to 17bn euro in 2012. Spain Spain increased VAT from 18% to 21% in September 2012 as a part of its austerity measures. Interestingly, in the past when it had increased its tax rate, the revenue actually contracted by 1% due to weaker economy. This shows how merely increasing tax rates need not increase revenue.
Figure 12 - Growth rate of Japan
Figure 10 - Growth rate of Greece
16 |COVER ARTICLE|
Japan Japan is another country which is on the verge of a fiscal cliff. Even though the Fiscal Deficit is as high as 10.5% of GDP, Japans Government Bond yields are as low as 2% which is unlike the countries of eurozone. Much of the revenue is earned by government bonds and since the inflation is near zero, even 2% yield generates huge volumes. Japan is currently under recession and has curtailed some spending after
spending cuts it is able to maintain its GDP Growth rate. In the mid 1990s Canada started reducing its spending cuts from 18% of GDP to as low as 13% of GDP. We can see that its real GDP growth rate simultaneously increased during that period to as much as 5%. The main reasons why this happened was Canada had huge exports with US at that time and US economy was having a boom-period. As seen above, countries have tried different approaches to tackle their fiscal deficit problem and landed up with unintended results.
What Lies Ahead
Figure 13 - Growth rate and Fiscal Deficit of IrelandSource - www.finance.gov.ie
the Tsunami. Ireland In the case of Ireland we see that the fiscal deficit increased drastically from 2007 to 2009 and the GDP growth declined in a similar mirror image like fashion. It is interesting to note that in 2010 Ireland increased its taxes by 2.5% and cut its spending by 8.3% which resulted in increase in growth rate of about 6.5%.
Will it truly be as drastic as a jump off a cliff or would it be more of a roll down a slope? Will the economy have a soft landing after going over the cliff? Will the biggest economy of the world slide into another recession? While the answers to these questions is anybodys guess as far as the outlook for the near future is concerned, it all boils down to how well President Obama can orchestrate a compromise between the Democrats and Republicans in Congress during the lame-duck session slated to begin from November 13th. However, as often seen, different doctors may prescribe different medicines for the same illness, sometimes with unexpected sideeffects and outcomes. Despite all the heavy forecasting and estimation done by the economists and policy makers, the US will ultimately have to take a leap of faith due to the impending uncertainty.
Figure 13 - Growth rate and Govt. Spending of Canada
Canada The story of Canada shows that despite
17 |BOOK REVIEW|
Breakout Nations - Book Review

Abhishake Dixit, MDI
The past decade has witnessed a gargantuan shift in the world economic landscape. It is hard to imagine that certain nations dubbed as growth engines today, played an almost negligible role in the world economy about fifteen years back. Rather, they were faced with huge economic hurdles and were in constant need of aid from the developing world. When contemplating future economic growth, we have grown used to assuming that the shift of power away from the developed world would be driven by the BRIC Nations - The term coined by Jim ONeill of Goldman Sachs for the four largest emerging economies: Brazil, Russia, China and India. There has even been a BRICS summit with South Africa forming the S. It is projected that in the coming two decades, China will overtake the United States as the worlds largest economy and India will reach the third spot. Numerous books have been written about the changing fortune of the BRICS nations and their extremely bullish future. However, according to Ruchir Sharma (the author of Breakout Nations) one of the most fundamental flaws with such analysis is that economists and analysts invariably cluster all of these countries together which are considerably different from each other. This draws its roots from the uniqueness of the last decade where every country was doing well, everyone was a winner. This was driven by a worldwide flood of easy money that unleashed US consumer spending and sparked more exports from emerging market economies. In 2007, the peak of this golden age, the economies of all but 3 of the worlds 183 economies grew and the growth was more than 5 percent in 114 of them. This was the fastest and most all-encompassing growth spurt the world has ever seen. All the economies grew wings at the same time, especially the BRIC nations which grew bigger and faster than the others. However, post the recession and the eurozone crisis, Ruchir believes that there is minimal probability that we will ever see such a golden age anytime soon. With the world embroiled in a financial mess, the developed nations will consume less which will strangle the spurt of growth in other economies. In his own words, In a world reshaped by a slower global growth, we need to start looking at emerging markets as individual cases. What stands this book apart from the million others that have been written on this subject is that the author has spent two decades travelling around the world and spending one week every month in a particular emerging market which enables him to present the ground reality rather than base his opinions on some external research. He is the head of the emerging markets equity team at Morgan Stanley Investment Management. In the book, he tries to take the reader on his travels around the world in search of the next breakout nation.
18 |BOOK REVIEW|
He cautions the readers against putting too much reliance on economic forecasts, including his own. At the very outset he states, The old rule of forecasting was to make as many forecasts as possible and publicize the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong. The journey starts with the nation that is most touted to be the leader of global growth Peoples Republic of China. He is not overawed by the Chinese growth story which he compares with Japan in the early 1970s, Taiwan in the late 1980s and Korea in the early 1990s. He looks at the economic reality objectively and raises the sustainability issue given the aging population, decline in investment spending, decrease in western demand and higher wages driving inflation, all of which will put the brakes on the near double digit growth rate that the country has managed to achieve in the past few years. Next, he talks about the Great Indian Hope. He attributes Indias recent growth as unleashed by global rather than local forces. He puts the probability of India continuing its journey as a breakout nation in this decade at fifty percent given the bloated government, crony capitalism, lack of recent reform initiatives, falling turnover amongst the rich and a disturbing tendency of farmers to stay on the farm. He also talks about the political elites fondness of welfare state liberalism with schemes like MGNREGA and subsidies on a host of goods. Such excessive government spending was easy in the middle of the global boom but continuing on this path in the current scenario may lead to hyperinflation and crowding out of private investments. He also questions the dynasty rule in Indian politics at the hands of the Indian national Congress. Given the trepidations, many stars are aligned in Indias favour as well. The young population, rising middle class, rising infrastructure spend and a freewheeling democracy give India an equal chance of sustaining its recent success and emerging as the breakout nation but it would require a tremendous amount of hard work and persistence.
The author takes the reader on a similar journey to many other nations like Russia, Brazil, Mexico, Japan, Turkey, Indonesia, South Korea, South Africa etc, all the while trying to understand the economic and political forces at play in each country individually, looking for new trends and trying to discover new sources of growth and highlighting causes for concern. For instance, He praises South Korea for building on its earlier success in the manufacturing industry and Indonesia for a well run machinery of commodity export. He also draws out negatives in countries like the stagnant list of billionaires in Mexico or the complete lack of Small and Medium Enterprises in Russia. As per the author, to identify the economic stars of the future we should abandon the habit of extrapolating from the recent past and lumping wildly diverse countries together. We need to remember that sustained economic success is a rare phenomenon. This is a very interesting book if one wants to understand the dynamics of the emerging world and the changing economic landscape. To conclude the book, the author reemphasizes that not all emerging markets will be breakout nations and their paths would vary substantially. No nation can hope to grow as a free-rider on the tailwinds of fortuitous global circumstances. They will have to propel their own weight, and the breakout nations of the new era will take their mantra from the Latin proverb: If there is no wind, row.
About The Author Ruchir Sharma is head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. He is former contributing editor for Newsweek and a regular contributor to The Wall Street Journal and The Economic Times.
19
|THE BAD-BANK MODEL|
GOOD BANK - BAD BANK

Sachin Pal, IMT Ghaziabad
The world was still on the path of global recovery led by the financial sector post the subprime mortgage crisis when the eurozone crisis caught it midway and stalled its progress and brought the bad banks back in news. This article discusses the concept of Bad Bank. The bad-bank concept has been used with great success in the past and is a valuable solution for banks seeking shelter from the financial crisis and are in news for quite some time now the latest being the creation of socalled bad bank by Spanish government in an effort to revive its dwindling financial economy. This article discusses about the concept of bad bank in detail and takes a look at some retrospect efforts of the economies that implemented this concept.
The Bad-Bank Model ple as the bank wants to keep the dirty fishes out of its pond in an effort to stop the bad assets from contaminating the good ones. Presence of junk and toxic assets on the companys balance sheet impacts the banks financial health and reduces the investors faith and raises concerns on performance, future prospects and money security. All of this directly affects core banking operations of borrowing, lending, trading, and raising capital.
The concept of Bad Bank is quite simple on paper. The bank divides its assets into two asset classes. One asset class includes the assets which have become illiquid, risky and toxic securities that puncture the backbone of the banking system; troubled assets such as nonperforming loans may also be piled up in this stack. The bank may also choose to add nonstrategic assets from businesses which no Implementation of longer fit either in the idea of Bad its portfolio or its Bank is as complibusiness strategy cated as anyone and thus wants to could think of. A exit, and no longer lot of thinking goes wants to keep it on on in the creation its books as it seeks of the new entity to lessen risk and and there are a lot deleverage the balof considerations ance sheet. The involved which ones that get left are typically include the good assets that organizational, represent the ongostructural, and fiFigure 1 - Capitalization of Bad Bank ing business of the core nancial trades-offs. The bank and that shall increase the bottom-line of effect of these choices on the banks liquidity, the bank balance sheet, and profits can be difficult to predict, especially in the current crisis. The reason for segregating the two is again sim-
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Structure The bad bank is structured in a way that it does not appear in the consolidated balance sheet of the good bank. For this purpose the bank can have a minority stake in the new entity with sufficient funding from external sources needed to capitalize the bank. Funding The bad bank must be capitalized in order to function. Typically two options are available for funding a bad bank:
Debt Equity
quality etc. However, in all cases the bad bank pays very less percentage of the nominal value or the book value of the assets and receives the assets at a significant amount of discount or haircut on the initial purchase price. Here in this article we discuss three different types of restructuring that took place in the past. Each of these restructuring were carried out in a different manner. The US TARP was Fed backed Asset Guarantee program, the Irish NAMA was formed as a Special Purpose Vehicle with capital injection from government and private investors in return for equity stakes whereas the RBS was taken over UK government. Asset guarantees differentiates itself from good bank-bad bank model in a way that doesnt involve transfer of assets but just provides asset guarantee. US TARP Program
Private investor, with a focus on distressed situations, may be attracted in investing in order to gain ownership with significant control over the new e n t i t y w h e r e they can exercise control.
U n i t e d States government started the Troubled The reAsset Relief quired Program capitaliza(TARP) in tion will Table 1 - Bank Support Programs an effort to stabitypically depend lize the financial sector at the time of subprime on: mortgage crisis. The Treasury announced their intention to buy senior preferred stock and war Portfolio of assets rants from the nine largest American banks by Valuation of the assets forming an Aggregator Bank. The proposal Anticipated loss levels called for the federal government to buy up to Banks typically formulate this structure as the US$700bn of illiquid move is likely to immortgage-backed seprove the credit ratings curities with the inof the good bank and tent to increase the improve the growth liquidity of the seconoutlook of the bank. dary mortgage marThe biggest challenge kets and reduce pofor bad bank is the tential losses encounvaluation of troubled tered by financial inassets. Different methstitutions owning the ods may be used to securities. Maximum value the assets to be authorized TARP transferred depending disbursements, was on the asset class,
Figure 2 - Troubled Asset Relief Program
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later reduced from US$700bn to US$475bn under various programs. TARP operated as a "revolving purchase facility" with a set spending limit of US$250bn at the start of the program, with which it will purchase the assets and then either sell them or hold the assets and collect the "coupons" from the banks. The maximum limit for facility was kept at US$350bn subject to approval. The participating institutions had to meet certain criteria in order to benefit from the program. According to the terms of agreement, TARP brought warrants and preferred shares that pay annual dividends in the range of 4-6% percent during the first five years which increased to 810% in the following years. According to the latest figures released on the federal government website in July 2012, it has recovered US$351.46bn out of a total of US$467.21bn which it invested under bank support programs, credit market programs and treasury housing programs. Under the bank support programs (a move to support Citi Group, Bank of America among other banks) it disbursed US$245.11bn and has received a total cash back of US$264.73bn. RBS break-up RBS, the 285-year-old UK based bank, reported a loss of 24.1bn in 2008. The bulk of RBS's 24.1bn loss for 2008 stemmed from a 16.2bn write-down of assets, that arose from its purchase of ABN Amro, a bank heavily exposed to the subprime crisis. Its underlying losses totaled 7.9bn. RBS made massive changes to its structure following the loss. It put 325bn of toxic assets into a new government insurance program. UK Governments Asset Protection Scheme provided RBS with a
capital injection of 25.5bn and catastrophe insurance for the riskiest assets. The primary purpose of this equity injection was to make new tier 1 capital available to banks and to restructure their finances. Under the lighter touch terms agreed with the UK Government in November 2009, RBS would bear the first 60bn of losses and the Treasury would bear 90% of losses thereafter. The fee for this insurance will be 700 m for the first three years and then 500 m annually. The new terms allow RBS to exit the APS at any time subject to meeting capital adequacy requirements and repaying the Treasury for any shortfall in fees due. Following placing and open offers in December 2008 and in April 2009, HM Treasury owned c.70.3% of the enlarged ordinary share capital of the company. This new capital took the form of B shares, which did not carry voting rights at general meetings of ordinary shareholders but were convertible into ordinary shares and qualified as core tier one capital. Following the issuance of B shares, HM Treasurys holding of ordinary shares of the company remained at 70.3% although its economic interest rose to 84.4%.Investors welcomed news of the scheme, and its shares were up as a result. According to a news run dated May 2012, RBS was poised to announce that it has repaid emergency funding it received from the British Government after reporting a surge in profits for the first quarter of 2012. Irelands NAMA Bad-Bank
Irish financial crisis stemmed from the financial crisis of 2008 and the country entered into an economic depression in 2009 with the banks bearing the brunt of the ailing economy. In April 2009, the government proposed the formation of NAMA through a Special Purpose Vehicle (SPV) known as
Figure 3 - Structure of NAMA
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National Asset Management Ltd, controlled by the holding company National Asset Management Agency Investment Ltd. The NAMA SPV (Master SPV) structure had a subscribed capital of 100m. 49% of this capital
business plan expects a default rate of 20% on the 77bn of principal, and repayment of 62bn. Taking all adjustments into account it expects a cumulative positive cash flow of 5bn from this entity.
Table 2 Loan Acquisitions
base (i.e. 49m) was advanced by NAMA and 51% by private investors. Three private investors, namely, Irish Life Investment Managers, New Ireland Assurance and a group of clients of Allied Irish Banks Investment Managers, had each invested 17m in the vehicle and took 17% stake each in the SPV. The Master SPV, a separate legal entity, jointly owned by private investors, who together owned 51% of its equity and therefore had the majority vote The remaining and by NAMA, which would hold the remaining 49%. NAMA was then geared up way above typical EU banking limits, taking on debt 35 times its paid-up capital. In its first phase of operation, it acquired a portfolio of c.11,000 loans from the major Irish banks with a nominal value of 71bn from developers at the centre of the property crash in Ireland and paid c.30.4bn for the loans, representing an aggregate 57% discount on the book value of these loans. . In exchange for these loans NAMA issued Government-guaranteed securities to the five participating financial institutions. Although the SPV had its own Board, NAMA retained a veto power over all decisions of the Board that could affect the interests of NAMA or of the Irish government. The Master SPV would be run with the objective of making a profit on the purchase and management of the assets it purchases. The Draft Business plan assumes a life of 11 years for NAMA from 2010 to 2020 with full repayment of the loans issued by NAMA/Irish Government by the end of 2020 along with cumulative interest on the loans. The Draft
Ireland's controversial new "bad bank" (NAMA) thus became one of the biggest property banks in the world after it completed the acquisition of developers' loans worth more than 70bn and gained controls over the loans on hotels, housing estates, shopping centers and development sites across Ireland, the UK, mainland Europe and elsewhere. Conclusion European crisis began over two years ago; market pressure on Europe has boiled up and then eased several times in response to political and economic developments and subsequent policy responses. A permanent solution to Europes problems is unlikely to emerge before year-end, leaving markets vulnerable to the ups and downs of the past two years, as well as the tail risk of a disaster scenario. EU policymakers appear determined to provide the necessary support to avoid disaster, but the crisis continues to intensify. In the present scenario, formation of bad bank looked inevitable and the latest moves by Spanish Banks over bad bank creation hints us that segregation of assets into two asset classes would alleviate the pressures on the financial institutions and financial system. Private players also have an investment opportunity in these distressed assets that meet individualized investment needs. Whether a good bank bad bank structure takes the precedent form like that of NAMA or a novel form is not clear at the moment and will be driven by policy and politics in the months to come.
23
|TUTORIAL|
BREAKING UP OF CURRENCIES
Team Blue Chip
What was the first reaction on reading the title of this article? It sounds quite ominous so I am assuming it would not have been very positive. Something along the lines of a disaster or a catastrophe. The recent discussion on the possible EU break up has added fuel to this negative outlook. However, a simple Google search should be enough to convince you that a currency break is not a novel situation. The world economy has seen sixty-nine currency break-ups just in the past century. And this should be enough to make you question the blanket statement that the break-up of Euro area is surely going to be a debacle. So what exactly is a currency break-up? When two or more regions having the same currency (or a fixed exchange rate) and hence a common monetary policy decide to establish independent currencies, it is known as a currency breakup. These regions can be different countries in a monetary union or can even be a part of the same country. In the latter case, the most common problem leading to a currency break-up is a partition of the country as has been seen in case of India-Pakistan in 1947, PakistanBangladesh in 1971 and Czechoslovakia in 1993. In case of a monetary union, we need to understand some of the issues which can necessitate a currency breakup. While political problems play an important role, there is an economic rationale to it. Along with the monetary policy, it is important for countries in the monetary union to have similar fiscal stance as well. For example, say there are two countries in a monetary union- A and B. Now A decides to take up an expansionary fiscal policy by increasing its borrowings (and hence fiscal deficit of the government increases). However, as As government is appropriating greater funds in the market, the cost of funds for the private sector will increase, leading to an increase in interest rates. If the exchange rates were flexible it would have led to an appreciation of the As currency with respect to Bs currency. However, because of common currency/fixed exchange rate, A ends up with an undervalued currency and thus balance of payments surplus while B ends up with a balance of payments deficit. In such a situation, if A and B had been allowed to take up independent currencies, Bs new currency would have depreciated with respect to As, which would have encouraged exports and hence Bs balance of payments deficits would have corrected. A similar case is being observed in case of the eurozone. To correct the imbalances in the balance of payments, appreciation of Germanys currency and depreciation of the troubled nations currencies is required. However, this can only be possible if the countries decide to exit the monetary union. A country is also a monetary union of the states but having a central government and a central bank permits a common monetary and fiscal policy. This co-ordination becomes difficult in case of countries as they would have different governments which would have different aims, goals and priorities. And this lack of common fiscal and political policy thus becomes an important determinant of a currency break -up. A similar situation is being observed in the eurozone in which the stronger countries like Germany are supporting the weaker coun-
24
|TUTORIAL|
tries like Greece, Spain, Ireland etc. What are the steps involved in a currency break -up? From the various currency break-ups which have occurred in the past, a broad sequence of steps can be listed. It begins with a surprise announcement by the government. The surprise component is essential to avoid any destabilizing speculations. Then as issue of new currency can take time, an ink stamp or physical stamp is put on the old notes and the stamped notes become the legal tender. While this is being done, capital controls are also imposed to prevent the flight of hoarded unstamped currency to areas with stronger currency. (The central principle in these steps is the Impossible Trinity A country can at a time achieve at most two out of the three macroeconomic objectives namely defending exchange rates, free capital movement and an independent monetary policy.) This is followed by the issue of new currency and once this is introduced the old stamped currency is de-monetized (i.e. it loses its status of a legal tender). Once the currency break-up has taken place, the weaker currency depreciates which allows that nation to gain competitive advantage and to correct its balance of payments deficit. The cross-border liabilities and assets of the country will also have to be re-negotiated with the other countries. Now let us try and understand the possible break-up of the Euro area. There are many possible ways in which European Monetary Union (EMU) can break up. Example, Greece or some other weaker peripheral country can leave, all countries can return to their national currencies,
a strong country like Germany can leave the union or the eurozone can be divided into two parts. This would allow the weaker peripheral countries to regain their competitive advantage in terms of exports as their currencies depreciate. However, these countries already have very high debt burdens and the deprecation of currency is only going to further increase the level of foreign-currency denominated. In this regard, one of the solutions being advocated is that these countries should default. Default is essential if the countries wish to recover. On the other hand, there are a few complicating factors as well. The impact of the break-up would be much more serious because of the global importance and scale of the eurozone. The devaluation of currencies would lead to a major reallocation of wealth from the savers to the debtors. Further, currency devaluation would have a limited impact unless further painful steps are taken to bring about the much required structural changes in the economy. Example, the inefficient labour markets of these regions needs to be improved. This break-up would lead to havoc in the global financial market and many countries can go into deep recession. Hence, while breaking up of currency unions has been widely observed in the past years, there is no perfect explanation, mechanism or justification for the same. There is no one-shoefits-all strategy. Every situation needs to be studied separately and the pros, cons and consequences need to be critically examined. In case of the eurozone, we are weighed down further as the impact can vary widely it would either be extremely beneficial and the solution we are looking for; or it would be the biggest catastrophe in the economic history of the world.
25 |POLICY & GOVERNANCE|
Decay beyond the Billion-dollar Cavity to the National Coffers: Has Coalgate exposed the Root?
Pervez N Sethna MBA Core (2nd Year) NMIMS
A loss of Rs.1.87 lakh crore to the public exchequer on allocation of coal blocks, the parliament being paralysed for 13 of the 20 days in the monsoon session due to the standoff between the Government and the Opposition, Rs. 128 crore lost due to the disruption of proceedings in both the Houses, a CBI probe into the coal blocks allocated since 1993 including the six-year NDA rule, the windfall gain to the allocates, the Prime Ministers rebuttal in the Parliament, the CAG Report, the Opposition demanding Prime Minister Manmohan Singhs resignation, the PIL filed in the Supreme Court are we missing something yet???
Energy is the driving force of modern life. Coal, gas and oil are the three indispensable sources of energy. Out of the three, coal is widely used due to its availability and relative affordability . Coalbased power capacity in India is expected to grow from 97 GW in FY10 to 285 GW in FY20: more than five times the pace of growth seen in the last few years. account of de-allocation of coal blocks, strikes and weather conditions. Also, the coal found in the mines is often of inferior quality, characterized by high ash content and low calorific value.
Considering an annual average growth rate of 8.9 per cent during the five-year period, the Plan panel has pegged Indias annual coal demand to go up to 980 million tonnes by 2016-17, the termiAmid the chaos of the Coalgate, the country is nal year of the 12th Plan, against the production
Figure 1: Demand - Supply scenario of coal in India
Year Coal Supply (mt) Coal Demand (mt) Gap to be met through imports (mt)
2009-10 514.50 597.98 83.48
2010-11 536.05 624.78 88.73
2011-12 629.91 713.24 83.33
2012-13 (estimate) 674 763.17 89.17
2016-17 (estimate) 795 980 185
Source: www.coal.nic.in/annrep1011.pdf
grappling with acute coal shortage, hitting various sectors especially power generation. Indias reliance on imported coal is set to rise, given the structural issues affecting domestic supply such as environmental clearances, infrastructural and logistical constraints and production disruptions on
of 795 mt, giving rise to a 185 mt deficit. While India ranks fourth in the world in terms of coal reserves, the growing coal demand has outpaced production levels and has gradually resulted in an increase in imports over the period as highlighted in table 1. JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2
26 |POLICY & GOVERNANCE| As the Coalgate plot thickens, the dependence of IPPs on coal imports is bound to increase and any upward revision in domestic thermal coal prices by CIL so as to realign towards international market prices in the future will result in a significant upward pressure on the cost of power generation. And thats not all. The rising demand for coal calls for improved infrastructure systems across the country. Several coal assets in Jharkhand and Chhattisgarh are lying unutilised for want of a railway line. Poor road transportation facilities are hindering growth. Constraints in coal distribution and coal evacuation infrastructure have restricted the off take and raised inventory levels. The capacity of all major ports as well as non- major and private ports needs to be increased in order to enable efficient handling of cargo without any operational delays. In order to have an efficient and smooth flow of goods at the ports, the total capacity utilised should be not more 70% of the total capacity installed. However, in India, we are handling cargo at levels higher than 80% of the total capacity installed; ports are operating at saturation levels. This leads to delays in unloading of goods, queuing of vessels at the ports and inefficient material handling. The projected capacity expansion and the expected cargo growth would bring down the utilisation levels at the major ports, paving the path for better service. Also, the Indian Railways needs to improve the tonnage on the freight corridor - a major hurdle which could derail the current plans of increased production and distribution of coal and increased power generation. These are enormous outflows that only add to the cost of the energy that lights our homes. The CAG Report kept the coal blocks allocated to government companies mostly owned by the State governments out of the ambit of Coalgate. Theoretically, we can assume that public sector companies will pass on the benefits of the asset allocation to the nation, either in terms of
What those men sitting at the helm of affairs are neglecting is the additional burden to the nations kitty on account of the escalating coal import bill. Coal India Limited (CIL), which accounts for more than 80% of the domestic output, has set a target of producing 464 mt coal in the current fiscal; which is likely to go up to 615 mt by 2016-17. It has agreed to import coal this fiscal and supply 80% of the fuel committed by it to power producers under the long-term fuel supply agreements (FSA), provided they agree to share among themselves the cost of buying coal overseas and shipping it to India. While CIL sells
power-grade thermal coal at about Rs 1,100 per tonne, the imported coal of comparable grade costs about Rs 5,500. To make coal imports viable, CIL plans to mix domestic and international coal and sell the blended consignment at a pooled price to the power producers. Another alternative that lies with CIL is to modernise its processes in order to increase output to meet the ballooning coal demand. Independent Power Producers (IPPs) have increasingly opted for acquisition of overseas mining assets to meet their demand; however, they remain exposed to volatility in coal prices as well as political & regulatory risks. Some of the leading private sector IPPs have acquired substantial coal assets predominantly in the three countries - Indonesia, Australia and South Africa.
27 |POLICY & GOVERNANCE| cheaper electricity, providing coal to smaller consumers at a fair price, or paying handsome dividends to the government. But that was not to be.
the treasure chest that will bring in the valuable carbon credits to our nation. Mining will scar the land, rip apart forests, poison the rivers and disrupt livelihood. The Rs.1.87 lakh crore is only the notional value of the estimated loss; it does not include the value of the loss of biodiversity even if such a valuation was possible. Nature is being asked to sacrifice at the altar of development. A dj vu, not uncommon to the developing world from the days of the industrial development. The finite natural resources are being depleted irreversibly in quantity and quality and cannot be replenished. Even the multitude of Environment Impact Assessments (EIA) and classification of no go zones seem to be fogged by political interests causing slippages and unwarranted delays. Standard resettlement and rehabilitation procedures are conveniently ignored. The question of electricity and power that the country needs is at the heart of all this. The mushrooming population needs a matching step-up in the power generation, non-fulfillment of which would lead to mounting energy prices and spell more trouble for the common man - a perennial battle between preserving nature and economic growth and welfare; most times ending in favour of the latter. What we need today is to look at more sustainable and alternative sources of generating electricity, use suitable long-wall mining methods, increase productivity at the existing mines and take steps to conserve wildlife, natural habitat and the livelihood of the inhabitants. In the noise over the irregularities in allocation of natural resources, the huge environmental and related costs of exploiting these have been forgotten. The Coalgate could well be a blessing in disguise, an eye-opener, but only if we understood the real value.
State-owned companies allowed private miners to tap part of the benefit accruing to them from access to these captive assets allocated to them virtually free of cost. A national loot of unprecedented proportions, skeletons tumbling out of corporate cupboards, allocatees laughing all the way to the bank, the electronic media looking for the slightest bit of information to occupy airtime and newspaper space, burgeoning losses on the import account but let us assume for a moment that the game was played by the book! The State would earn its Rs. 1.87 lakh crore, peace in both houses of Parliament, lesser headaches for the Government, the CAG and the Supreme Court, a Gandhian would have starved a few days less and of course the prospect of selfcontainment in energy needs. Spare a thought for Mother Nature! Over a million hectares of forest is at risk from coal mining in the coalfields in central India. In addition to being home to a substantial percentage of Indias wild tigers and other endangered and threatened species, nearly half of the forestdependent communities in India look to these forests as a way of life and livelihood. They are
28 |IN CONVERSATION WITH|
Industry Speak
Mr. Girish Aivalli
As the Group Executive Vice President & Country Head Food and Agribusiness Strategic Advisory and Research at Yes Bank, he is the key Relationship stakeholder responsible for Origination, Advisory & Execution oversight of Food and Agribusiness Consultancy and Research mandates in the sector. Prior to joining Yes Bank, Mr. Aivalli worked with Dabur, Olam International and Cargill India in various capacities and in various countris, over a span of 16 years. In his previous role at Cargill, he was heading their procurement and operations for the grains and oilseeds business for India. He has an excellent understanding of the global commodity trade flow and had undertaken significant agri-projects in Nigeria, Ghana and India. He is well recognized thought leader in the Food and Agribusiness industry with an excellent mix of operational experience and knowledge of challenges and policy issues in the industry. He is also a member of the CIIs National Council on Agriculture, and member of various sub-committees. An alumnus of MDI, he specialized in marketing and finance.
Firstly, we would like to talk to you about you experience at Yes Bank.
I have worked in Food & AgriBusiness Strategic Advisory and Research (FASAR) which is a very unique offering of Yes Bank. What Yes Bank does is to work on projects where my division prepares the detailed project reports which we give to the bank, which they use for providing funds. So the quality of the project improves and the lending division gets a higher degree of comfort while lending. Because of the rustic nature and rural flavour of AgriBusiness, not many people have an exact idea of what the reality would be like. What people usually do is they look at surrogate projects and look at the returns and look at past experiences in order to get these things. In our kind of work we are able to perhaps have it much closer to reality by actually speaking to lots of clients and by focusing only on this. A regular banker may not be able to do that properly, thats where we come in.
In 2010 version 2.0 of Yes Bank had been introduced, could you tell us about that and how its progress is taking place?
The version 2.0 of Yes Bank is largely on a few parameters - no of branches, ATMS, size of Balance Sheet, the total advances that we expect to have and make and the total deposit size that we wish to have. These would be available on the website as well. So what happens is that in all organisations, be it Yes Bank, or be it banking, aviation or sales. Any industry that you take, you have a 5 year plan which is broken down in year wise basis and further into a quarter wise basis or a month wise basis. So every month end or every quarter end, you have target vs. achievement at a broad level, then each and every division is broken down at a client level. So that is the way you track it. Banking per se is completely dependent on the way your economy does because we are able to lend more if there is a demand for
29 |IN CONVERSATION WITH| money. If there is not much of a demand for money, banking suffers. So Yes Bank has grown at above 35-36% CAGR over the past few years so. Yes Bank over the past 8 years has become the 4th largest private sector bank which is by no means a small achievement by any standards. Our profits have been close to Rs. 1000 Cr. last year, perhaps the only organisation in India which has achieved such a feat within the first 7 years of starting out. I dont see any other industry or any other company in India that has achieved this kind of a success. Perhaps, Yes Bank in that sense or in rather most of the senses is Indias most successful company ever, and when I say that I mean from the start up phase till now. It has a very brief history, but that is the way it has been. ing Food & Agribusiness corporates. Who are the end consumer of the advances that you would be giving? It is not the farmers, so the lending that happens under FASAR advisory is not to the farmers, it happens to AgriBusiness companies and it can be a client as large as Future group, or as small as an upscale dairy. When we go to Yes Bank, the business lines of the bank are divided into Corporate Banking, Retail banking & Treasury, so how does FASAR support the business line, how does it fit into the group as such? Sometimes we get referrals from the banking teams which can be for a company or for an industry. It means that the bank may ask our review on the tea industry or may ask us about our view on, lets say, XYZ chemicals. What we do is, we dont get into the financial part of it because financials the bank would be having adequate talent. We look at it from an operational perspective which let us say in case of XYZ chemicals would be essentially, for most of these organisations, processes related to sales and marketing and business development in new markets. So if one has to analyze XYZ chemicals, we would look at the fertilizer market because it is their main product and then they are also into a few agro chemicals. So once, you will study what is their product portfolio, we would look into the growth rate potential of these products, we would look into the market share in each of these chemicals has gone down or gone up. Then we would speak to few people of XYZ chemicals by telling them that we are doing this for their company. We would speak to competition, distributors and we would try to get as much masala as we can probably to strengthen our case. Once that happens we would
For our readers, could you give us an overview of the FASAR (Food and Agribusiness Advisory and Research) department, which is a part of the Development Banking Group assist the business lines of the bank?
Yes Bank has identified Food & Agribusiness as a focus sector, and has undertaken various thought leadership initiatives through domain specialization besides providing advisory and innovative financial solutions to both public and private sector clients, focusing across segments in the agricultural food value chain, from farm inputs to processing to food retailing. The FASAR group is driven by sector experts who provide insight and knowledge on sector trends and growth prospects in Agribusiness sector. FASAR has been engaging in significant and prestigious assignments with the Central Government and the various State Governments across India. In addition, FASAR has undertaken prestigious projects with International agencies such as UNIDO as well as lead-
30 |IN CONVERSATION WITH| give it serious thought and probably come up with solutions. Is it that FASAR gives the go or no-go for the agribusiness line? FASAR is not really the go/no-go thing. We are not involved in every lending decision. It is probably in specific lending decisions wherein there is lack of comfort, feel or knowledge. E.g. let us say aqua culture products. Not many people would know about it, or for example you may also consider sesame seeds. People would have good knowledge of wheat, rice, soyabean, corn, but people might not be comfortable with something like because it is a very niche thing. Or something like organic farming, the new craze, how do you analyze that? That is when we come into picture. So, what we do therefore is very similar to what the consulting firms do. But again, focused only on food and AgriBusiness and with the bank itself being the client. An extension to the above question, Food and Agri is one of the growth sectors identified by Yes Bank, in this regard could you share with us some of the customized solutions that Yes Bank offers? What we do is, it is a new thing, something called as startup food and agribusiness, we help private sector companies diversify into new businesses or start new businesses. The ten areas where we help them are setting up an Integrated dairy farming, dairy products, mega food park, integrated warehousing project, cold chain, agri supply chain, large scale commercial farming, overseas plantation businesses, other agri ventures and undertaking CSR projects in agriculture. We have given this only to limited people of MD/CEO level based on a background here - the financial and business impact. Yes bank has identified some sunrise sectors, what could be the next sunrise sectors and what challenges do you foresee? First of all, Food and AgriBusiness is at the core of India. India has a large village society and agriculture is the predominant occupation for a large number of people. Politicians and political class have a lot of stake because the voting class in India is essentially the farmers. Therefore, if you position something like this, every politician and most of the business houses, they would have land parcels all over the country and they would have something to do with farming either at the promoter level or at the khaandaani pushtaini zameen jaydaad kind of level. So it helps in opening the door and helps in people listening to what a bank has to say. It also helps in getting a good degree of clientele. E.g. if you go to lets say anyone in the private sector and you tell them you have a business idea on insurance or aviation. People would not know what to do with it and send you back. If you tell them that you have an idea on Agribusiness and this person or politician, a Member of Parliament, has been elected by a constituency, where given the demographics of India it has been the farmers mostly. He will definitely call you up and see what out of this is the idea he can go and replicate in his constituency, as far as politics are concerned. For business houses food and AgriBusiness, again, since it is the prime occupation of the majority of the people of the country, people are open to diversification here. They will hear you out, may not necessarily implement it but they will surely hear you out. If you go to someone saying why dont you diversify into insurance vs. why dont you diversify into AgriBusiness, chances are he will still have an element of curiosity on agribusiness and not the same for any of the other options.
31 |IN CONVERSATION WITH| Next sunrise sector, and this is a personal opinion that in spite of all the things that have gone wrong, I have always believed that in India, currently and for a long time, real estate will be an ever green sector because in India there is a huge and acute shortage of affordable housing. The NPAs are rising because the loans that were restructured in 2008 have not been paid off, especially in the SME segment. You are more focused on SME segment. What will be your future strategy then? Overall, if you look at it, Yes Bank has one of the lowest NPAs, which is extremely less in the entire banking industry. Recently Yes Bank also won The Strongest Bank in India award, which is again a recognition of the way the book is balanced. So there have been many cases where instead of being a Yes Bank we have said No to the client due to the quality of the client not being that strong. In that case our credit and risk department, I think it happens to be one of the strongest in the country and the risk parameters happen to be extremely strong. So, about future strategy, when you have a robust process in place, the chances of going wrong are very less. Without divulging much, what would you say differentiates Yes Banks credit and risk department from the other banks? Even comparing with the public sector banks, it has one of the lowest NPAs, so what is this difference? I cannot possibly comment on other banks, but as far as Yes Bank is concerned, the decision making is participatory consensual and at the same time it is extremely driven by data. So we take into account CRISIL ratings, and put a lot of emphasis on references and feedback from the market, speak to a lot of people in the market and then put that process in. There is a document called as Credit Approval Memorandum which gets signed every time an advance has to be given. So the entire process is extremely strong without any scope for a personal bias or personal view getting into the way, which I think is extremely critical. We have seen the governments intent to improve backend infra in food and Agribusiness as wastage is around 40% in India as compared to 2-3% globally. Would the introduction of FDI in multi-brand retail coupled with the restrictions help? Yes, I think FDI in retail is going to be helpful overall. And it would not be as bad as it has been made out to be. First of all whenever any client comes into India be it Wal-Mart or Carrefour. One, they are not going to be opening their shops in each and every town. Even if they open in all the towns, they are not going to be able to reach each and every mohalla. In smaller towns they would perhaps have one store per town and larger cities they would have multiple stores. As far as the question of existing shop keepers vs. the new store is concerned, at the end of the day it is going to be a function of your conveyance. That is where an operational insight is helpful. E.g. you live in an area which doesnt have space to build a mall, so if Wal-Mart was to come into such a place it can possibly take 3-4 shops and open up a store there but when people have to go shopping, what is it that they will look for? Given the fact that how difficult it is to commute these days. When you travel in cars, a 3-5 km distance can take about 2025mins. What you look for is convenience, which is a walking a distance for me to go and shop and get the essentials for myself. Chances are that you may go
32 |IN CONVERSATION WITH| over the weekend and make bulk purchases and for that you may prefer a better shopping experience. So my own view is that both these formats will survive, I dont see any major challenges coming onto the small shopkeepers. Improvement at the backend will be there wherein they have said that they have to create warehouses and cold storages. As far as India is concerned, there is no shortage of cold storages in India, they have always existed. The capacity utilization of cold storages has been less and whatever has been left has gone largely for potatoes. Now what the government wants is to possibly use the same storage for apples, mangoes, guavas etc. Now there is a challenge there, so now suppose you have two people and one of them uses cold chain and
With Cold Chain Loose Price (Rs.) Storage (Rs.) Cost 1000 300 1300 1350 50 4 Without Cold Chain 1000 100 1100 1200 100 9
the loss in physical weight but the loss in value. So it is a composition of different factors like loss of weight, loss in price, loss in quality and loss in nutritional content and these total up to loss in value.
Out of the 40%, would you be knowing the actual component of loss in weight?
It depends. One of my past companies was Cargill, which is into grains. So when you are moving wheat, we were losing 1-2% max.
Is this proportion higher for fruits?

Government data says that the grains would have 10% weight loss, but where would we get that loss? In fruits you cant have that kind of a weight loss. So lets us take example of apples or mangoes, i.e. if someone has to sell the fruits mentioned above. The cold storage guy needs to sell it at least at Rs. 1350 to make some money and the other guy would sell at Rs. 1200 so he will sell lower and still make more money. And the other one would spend higher and make lesser money. This is the disconnect that exists in the market. Even if cold chain were to come, the cheaper segment would always exist. The shocking part is that as far as the guy without cold storage is that he is putting it somewhere and he is ensuring that he is storing it well because he has some experience in management of the fruits. Chances are that here the quality will go a little bad. As a consumer you would not be able to make out completely that difference in quality. You can hold it in your hand and make out that a certain mango is softer and the other one is more firm, but you will never know that there was a difference in how it was stored for the past 3 months.
Total Cost (Rs.) Selling Price (Rs.) Profit (Rs.) Profit Percent
the other doesnt use cold chain. Lets say the loose price is Rs. 1000. With a cold chain, let us say that the storage charge is Rs. 300 here, whereas without cold chain the charge is going to be Rs. 100, totaling to Rs. 1300 and Rs. 1100 respectively. So eventually, they sell their product at Rs. 1350 and Rs. 1250 respectively, so even though the person with cold chain invests more & provides better quality product, his margins are lesser than those who sell without using cold chain. So as such the wastage is concerned, the 40% that people keep talking about is not
33 |IN CONVERSATION WITH| What they do is, put the mango in the bhoosa and put it in matka which is a very desi way of cold storage. So, therein lies the disconnect. would make that move in the market. So one of the reasons for having a higher interest rate is because that is the way you get the lowest costing funds and easy to get because the competition cannot afford to do that because of the economics that I have shared with you. So you are able to attract money from competition and second it is the only way the bank can increase its physical presence, i.e. number of branches. For a private sector, we are still small, so that is the only avenue left for growth. You can grow in the wholesale banking side as well. You require money to lend there. The cheapest source of funds are going to be from people giving you deposits. You cant offer 4-5% and then try to get people away from other banks, so you need to offer a higher rate of return.
Yes Bank is the only Greenfield licence awarded by the RBI in the last 16 years. Do you see any Greenfield license being given out now or do you expect NBFCs to get the licences?
Cant possibly answer this. It depends on the government.
Keeping in line with the business model of one of your initial promoters/mentors, namely Rabobank, the brand Yes Bank has been associated with knowledge banking since its inception, which has led to it having the highest ROA in the sector. So what has been the motive to shift focus towards retail banking with 7% interest rate?
If you look at various banks - ICICI,. SBI, HDFC, PNB, Canara Bank you will see that their current CASA base is how big, which is around 40% for most banks. So whatever that amount be there, these banks are offering 4%. So a bulk of that money is at 4% (say). Now if you have a new bank which has CASA is at about 10% and has to pay 7%, the bank does two things. One, it ensures that a lot of money from other banks flows into their bank and is able to give that additional 3% because the CASA
Typical Bank (high CASA ratio) 10000 4 400 Yes bank (low CASA ratio) 1000 7 70
So are you as a bank aiming to reach the same level of CASA as other banks, or do you have a lower benchmark?
Sooner or later, by and large it would be around the same ratio. The question is by when do you reach there? To answer your question, we are planning to reach the same levels. But by when, remains to be seen. Rabobank has predominantly been a corporate bank. Yes Bank could be that bank in India and not try moving into retail banking. Is the model on which Yes Bank has been built over the past not sustainable? At the end of the day every person has certain objectives, risk appetite and certain ambitions and therefore to add value to what I am saying, I can give you examples. E.g. lets look at the soap market, you have Reckitt Benckiser which makes Dettol soap and you have HUL which makes
CASA/Base (Rs.) Interest rate (%) Interest (Rs.)
base is less. For the other banks, to give extra 3% is a huge sum of money. Nobody
34 |IN CONVERSATION WITH| many soaps and Godrej makes only Cinthol. When a company knows how to make soaps, making multiple soaps is extremely easy. You change the fragrances, packaging and branding. Not many companies do it, because they have chosen not to do it. Why have they not done it is because of choice, area of interest etc. As far as Yes Bank is considered, what has happened is that most of the top management of the bank was earlier with Rabo and they felt restricted by Rabo that they could only do this and not do anything else. Therefore they ventured out and started Yes Bank. The question is that if you can do something else and get into it, why not do it. have worked in my life. Governments when they come in, the basic criteria is to ensure that they have a say. And when they come in they put certain restrictions so you have to move to them to seek permissions so that does not work out very well for anyone. So as long as the government has to play a role it may perhaps regulate growth but never speed up growth.
A word of advice for students planning to enter the corporate world in general and the banking sector in particular.
Banking sector in particular, which I realized in the last 3 years, probably one of the most interesting jobs one can get into. If you get into a particular industry, e.g. Automobiles or human resources or insurance or real estate or IT, you work only in that industry. It is only in banking that since you are lending to multiple companies in different industries, you are able to get an appreciation of multiple industries. Secondly, finance as a stream is always very interesting because you are dealing with cash, economics, and the economy per se. Third is, over the period of time as you mature and grow older in life and older in the banking system, you come in contact with the promoters of all the companies you are lending to. Therefore, your circle of influence and circle of friends becomes much wider than it would in a non-banking organization. So banks have that advantage. If you are working in any other organization, by 40-45 you will reach a functional head level which has its own charms, you get to run your own business etc. But if you are working with a bank, chances are your exposure level will improve your ability to mix with a different kind of clientele. So banking that way is extremely fruitful and useful. Since bankers deal with money and finances, therefore they also get paid extremely well as com-
Even with the CASA increasing significantly over the past year (which is considered as a source of low cost funds), but this has led to Yes Banks doubling of losses because of the interest rate increase in the retail sector, would you still consider these as low cost funds?
I am not aware of this, I need to educate myself but my own contention is that these losses are part of a banks learning process and certain things that go wrong which are a learning for everyone. Loopholes have to be plugged.
After a really close match, there has been re-election of Barack Obama as US president. Would you like to comment on that and its impact on the banking sector?
As far as the economy is concerned, it works best with as little regulation as possible provided the people who are running businesses believe in self governance and self regulation. Till the time such a situation prevails, it is best for everyone concerned. I have never seen governments adding significant value anywhere where I
35 |IN CONVERSATION WITH| pared to anyone else in the industry. So banking as a career option is excellent. That is one thing one should possibly try to get into. If you are choosing streams within banking, try to avoid agri-banking and lending because in India agri-lending is called Priority Sector Lending, so your entire job becomes one of matching 40% limit and more of structuring the documents, so it becomes a documentation kind of a role. It requires you to apply your brain but not necessarily in the right way. So better way is to get into corporate finance and project funding which I think is more fruitful. Also try to see if you can get into investment banking, which again is a very interesting field. About professional life, one thing you must remember is that once you start your career at the age of 25-26, you are going to be there for the next 35 years or so. Whether you achieve a certain salary at this age or a certain designation at this age, honestly doesnt matter too much because when it doesnt come to you at this age, it will come to you at plus 2 years or plus 3 years. The reason is that people retire at the top. India is not too strong on talent and skill nowadays, there are lot of companies that are yet to enter India, new product categories have to enter. So India is on its path to glory. Managerial talents from good MBA colleges are on their path to glory. Now the question is what you should target. So broadly speaking in 35 years, in the initial years should be falling in love, go find a girlfriend or boyfriend because everything has its age and time in life. So do that for one phase of your life. Once that has been taken care of, second thing you should take care is of making a financial nest for yourself unless you come from very affluent backgrounds. Try to put your money in real estate, there have various studies that have shown that the stock market have given better results than real estate but I dont believe them primarily because of Indias own real estate scenario. Those studies are made in USA. This is an Indian experience. The kind of real estate you invest in always has to be a city specific decision. If you have choice between 2BHK flat in Dwarka or Pune vs 4BHK in Nasik or Kanpur or Aurangabad, please take the 2BHK in Dwarka/Pune because there the appreciation would be much more higher and the market there is more well established. That is the second phase of your life. Professionally keep in mind to always go somewhere where the salary or designation is higher, assuming the company brand value is not much worse. So chase higher salary and designation. Because your industry has not changed at all but your roles and responsibilities have increased which adds more value. So when you seek a shift after taking up this job with higher responsibility, the next shift would be greater than your current salary and there would be someone else in the market who would be looking for someone at a certain salary level and certain designation, so they would like to look at you. So if you are at a certain salary level, that conveys certain things about you. On the flipside, dont chase them so much that you get depressed. They would come to you in due course of time, if not today then tomorrow. Also, never say no to an interview. You never really know which door is going to open and when it is going to open. _________________ Edited excerpts from the Interview of Mr. Girish Aivalli As told to Anupriya Asthana & Nihal Jham from team Blue Chip
36 |CARBON CREDITS|
Carbon Finance: Understanding the Market
PGPM 2011-2013 Management Development Institute, Gurgaon
Prateek Dhingra
Nikhil Sant
Introduction
Carbon Credit is a certificate or a permit that allows the holder to emit one tonne of carbon dioxide or another greenhouse gas with a mass equivalent to one tonne of carbon dioxide. These are tradable instruments and can be bought or sold in the carbon market. Hence we can think of these as tradable tools to help limit the emission of Greenhouse gases. Why do we need these credits? Why did the carbon market come into existence? Greenhouse gas emissions are drastically changing our planet melting glaciers, freak storms are just some of the examples in a wide range of frightening consequences. The level of CO2 gas in the atmosphere increased by around 70% from what it was in the 1870s to the level it reached in 2000. As a result a check was needed to help control the emissions of these gases into the atmosphere. In 1997 the Kyoto Protocol was introduced to set targets to reduce emissions of Greenhouse gases. In 2005 the Kyoto protocol went into effect which set caps on the emissions allowed for different industries and countries. This effectively gave rise to carbon trading and the carbon market came into existence. The carbon market trades under the cap-andtrade schemes or carbon offsets.
Member firms that reduce emissions to under the permissible limit can sell off their extra credits to other firms. Thus this mechanism encourages firms to reduce their carbon emissions and promotes greening of firms practices.
Carbon offsets are a less restrictive method of regulating the carbon emissions. Carbon offsets are a tradable instrument that one can buy to neutralize the emissions that one makes. For example after making a plane journey, one can buy carbon credits to offset the emissions made due the trip. Buying these carbon offsets effectively means that one is funding projects that reduce the greenhouse gas emissions. These projects can be either restoration of forests, or promoting renewable energy etc. Hence what this scheme does is it promotes payment to reduce total global greenhouse gas emissions instead of cutting down ones own emissions. This is a voluntary scheme and is applicable at the individual as well as the business level.
Evolution of the carbon market

The carbon markets have largely been driven by 2 regulations, the Kyoto protocol and the European Union Emissions Trading Scheme (EU ETS). Let us look at each of these regulations: The Kyoto Protocol Formulated in 1997, the Kyoto Protocol sets binding targets for countries to reduce their Greenhouse Gas emissions. These are legally binding targets and must be followed by the countries. This protocol came into force in Feb-
Under the cap and trade scheme the governing body sets a cap, i.e. it defines the maximum possible limit for allowable carbon emissions. Member firms that cannot limit their emissions to under the allowable limit are required to purchase other firms credit to offset their emissions.
37 |CARBON CREDITS| ruary 2005. The targets apply to the four greenhouse gases carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), sulphur hexafluoride (SF6), and two groups of gases, hydro fluorocarbons (HFCs) and per fluorocarbons (PFCs). The above six gases are translated into equivalents of one tonne of CO2 in determining reductions in emissions. Apart from the targets set for the countries the Kyoto Protocol allows three flexible mechanisms which are emissions trading, Clean Development Mechanism (CDM) and Joint Implementation (JI) to meet the targets. These flexible mechanisms allow the countries to offset any excess emissions by buying from countries that have excess emission credits. Emissions trading mechanism: The Protocol has set the targets over the commitment period of 2008-12 and the allowed emissions are divided into Assigned Amount Units (AAUs). The countries with excess AAUs are allowed to sell them to the countries that are exceeding their targets. Clean Development Mechanism: This is a project based mechanism which enables emission reductions through projects in developing countries. Hence countries with emission reduction targets fund an emission reduction project in developing countries to earn Certified Emission Reduction carbon credits (CERs), equivalent to one tonne of CO2 each, which can offset the excess emissions by these countries. We will discuss this mechanism in depth later in the article. Joint Implementation mechanism: This is also a project based mechanism similar to the CDM discussed above; the difference being that Joint Implementation encourages emission reduction projects in other developed countries as opposed to encouraging it in developing countries as per the CDM. The credits earned through such projects are called Emission Reduction Units (ERUs) and are equal to one tonne of CO2 each. European Union Emissions Trading Scheme (EU ETS) The first and the largest international scheme in accordance with the Kyoto Protocol to combat the climate change and reduce the emissions of Greenhouse Gases is the EU ETS scheme. This scheme was launched in 2005 and works on the cap and trade system described earlier in the article. The trading unit is the right to emit one tonne of CO2. Heavy fines are imposed for companies not adhering to the rules. Also the number of allowances in the market is limited and hence the onus is on companies to reduce their emission to within the cap rather than buy allowances in the market. The allowances are to be reduced over time so as to ensure that total emissions will reduce and lead to a greener world. The number of members taking part in this scheme has increased from 15 during the time of creation of the Kyoto Protocol to 30 members at present. This scheme covers more than 11000 factories, power stations and other installations in these 30 member countries. The EU has set a target for the year 2020 of cutting its emissions to 21% below the 2005 levels. Currently the allocation of permits is at a national level administered by the governments of the participating countries. Currently the scheme is in the second phase of operation (2008-2012). From January 2012 onwards the civil aviation sector was also included in this scheme. From January 2013 onwards, the third phase of the EU ETs scheme will commence. There are a number of changes proposed for this third phase. The allocation of allowances will take place via a centralized EU authority and the focus will be on auctioning a greater share of these permits rather than allocating them freely. Also there are plans to include other greenhouse gases such as per fluorocarbons and Nitrous Oxide in the scheme. There is a plan to curb the emissions by 1.74% linearly so as to achieve the target set for the year 2020.
Tradable Instruments
Let us understand in detail the different tradable instruments available in the markets today:
JULYSEPTEMBER12 | BLUE CHIP ISSUE 2
38 |CARBON CREDITS| Certified Emission Reduction (CERs): CERs are the unit of greenhouse reductions from CDM (Clean Development Mechanism) projects. They are verified by external parties which are accredited to United Nations (UN). CERs are issued by CDM Executive Board which is the regulatory body for CERs. Countries can use CERs to comply with the Kyoto Protocol obligations. Verified Emission Reductions (VERs): Also known as Voluntary Emission Reductions, VERs are emerging credits outside the Kyoto Protocol compliance regime. They can either be converted to a CER or can be traded under other regulatory schemes. These credits can also be traded to entities who have adopted VER commitment. These credits are illiquid and they do not have an exchange market which is transparent. This limits their use for short term or speculations. Emission Reductions (ERs): These represent the units of greenhouse emissions which are not verified. These are traded to players who have adopter VER commitment. EU Allowances (EUAs): These are greenhouse gas units which are allocated to parties under EU Emissions Trading Scheme. With these allocated units, the parties can emit an equivalent quantity of CO2. Renewable Energy Certificates (REC): Under Electricity Act, 2003 and National Action Plan for Climate Change (NAPCC), the Government of India framed policies aimed at promoting renewable energy market in India. REC is a market based mechanism to catalyze the renewable energy market development. From the power generation, RECs separates the electricity component and environmental component. Both these components can be traded in the market. This helps in development of the renewable energy as they provide incentives to the states to develop renewable energy more than the Renewable Purchase Obligation (RPO) state limit.
Clean Development Mechanism

As discussed earlier, CDM is a process through which countries can earn CER credits, each equivalent to one tonne of CO2. This is in exchange of reducing greenhouse gas emissions in developing countries. CERs can be used by developed countries to meet the Kyoto Protocol Obligations.
CDM Project Cycle

The CDM project cycle encompasses 7 stages starting from Project Design and ending at CER issuance. The following flow chart shows the 7 stages of the cycle.
Table 1: Parties central to the stages in CDM
Stage Project Design

National Approval Validation Registration Monitoring Verification CER Issuance
Central Party Project Participant

Designated National Authority Designated Operational Entity Executive Board Project Participant Designated Operational Entity Executive Board
Important Characteristic of the stage Project participant prepares project design document, making use of approved emissions baseline and moniProject participant secures letter of approval from Party.
Project design document is validated by accredited designated operational entity, private third-party certifier. Valid project submitted by DOE to CDM Executive Board with request for registration. Project participant responsible for monitoring actual emissions according to approved methodology. Designated operational entity verifies that emission reductions took place, in the amount claimed, according to Designated operational entity submits verification report with request for issuance to CDM Executive Board.
Source: UNFCC website
39 |CARBON CREDITS|
CDM Governance
Figure 1: CDM Governance structure
Source: UNFCC website Table 2: Responsibilities of parties
Party COP/MOP Designated Operational Entity
Responsibility Makes rules of CDM. Decides on recommendations made by the Executive Board. Validates the project request and then seeks registration of the project. Also verifies the emission reduction of an already registered CDM project. If yes, then request the board to issue CERs. Approval from Designated National Authority of each party involved is required before registration of CDM project can take place. Supervises the Kyoto Protocols CDM under the guidance of COP. POC for registration of projects and issuance of CERs. Recommends the board on guidelines used for methodologies for baseline as well as monitoring plans. Prepare decision of the board keeping in mind the procedure for accrediting operational entities. Assists the board in the appraisals of the projects.
Designated National Authority CDM EB Methodologies Panel Accreditation Panel Registration and Issuance Team Small Scale Working Group
Prepare recommendations for baselines and monitoring methodologies for the submitted CDM Small scale projects. Afforestation and Reforestation Prepare recommendations for baselines and monitoring methodologies for the submitted CDM a Working Group forestation/reforestation projects. Supports actions to fight climate change. Also, UNFCCC Secretariat analyses the impact of climate change on ecosystem as a whole.
Source: UNFCC website
40 BEGINNERS CORNER
Trading Strategies
Team Blue Chip
The term trading is often used interchangeably with investing; however despite their similarities there are points of differentiation. The fundamental distinction is that when a trader enters into a stock purchase, he has a strategy in mind which would influence his exit timing. Traders generally use technical analysis and hold stock for shorter periods of time, exiting as soon as they see a prospect for sufficient profits to be made. In contrast investors mostly use fundamental analysis or a mix of both to pick their portfolio and hold on to it for longer periods. They are not too concerned by short-term losses and normally follow a buy and hold approach. Lately, the
Short Selling
When you are confident that a stock is on a downward trend, you can make money by shorting it. A broker checks his stock inventory, clients portfolio or other brokerages for the stock and sells it in the market, crediting the traders margin account. A margin account allows you to borrow funds from the broker at the time of purchase with the security acting as collateral. When the stock price drops in due course, the trader asks the broker to cover his position (buy-back the same number of shares). The broker purchases the stock using the
Figure 1: Short selling process flow
trend shows the market dynamics shifting from an investment to a short-term trading orientation. Analyst Alan Newman mentions in his Crosscurrents newsletter that the average holding period for stocks has fallen to about three months and that for the S&P 500 SPDR (SPY) exchange traded fund to less than five days. Technical analysis involves studying the historical price trends of a stock in order to forecast its future price movements. Fundamental analysis on the other hand is concerned with understanding the intrinsic value of a stock through quantitative and qualitative analysis. The quantitative part is done by studying the companys financial statements and ratios whereas the qualitative part looks at external factors that might affect the company. There are some interesting strategies that are often employed by traders across the globe which include day trading as well as certain longer approaches.
amount available in the traders margin account and returns it to the rightful owner. Interest is charged on the margin account and the broker might be paid a commission for the transaction. Short selling can be done for currency as well. A famous example of shorting was done by George Soros the man who broke the Bank of England. By short selling the British pound to the tune of $10billion on a hunch that it would subsequently be devalued, he made a profit of $1billion. Any dividends paid out on the stock during the period of short selling are due to the lender and not the short seller. There is a lot of inherent risk in short selling. One related consideration is that holding a short position open for long periods may not be prudent as inflation alone could jack up the stocks price to some extent. Mostly we find big traders using shorting as a hedge strategy. The antithetical approach is long trading or
41 BEGINNERS CORNER
Earnings Matrix Maximum Profit Maximum Loss
Short Selling Amount Invested Unlimited
Long Trading
Unlimited Amount Invested
going long which mostly involves using fundamental analysis or a mix of technical and Table 1: Earnings Matrix fundamental analysis to choose stocks that are likely to rise in the future. At that point in time, the trader sells his holding and pockets the difference as his profits.
Swing Trading
In the relative short term, stock prices are normally observed to swing back and forth within certain limits. Swing traders capitalize on this
Support is the average price at which traders were ready to buy the stock in the past. Resistance is the average price at which traders were willing to sell the stock in the past. In short, resistance levels can be viewed as price ceilings whereas support levels can be seen as price floors. Traders often use tools and indicators such as Bollinger Bands and trend lines to identify these levels. A support trend line would be created when a declining stock price rebounds at a pivot point which is in line with two or more previously observed support pivot points. Similarly, a resistance trend line would be created when a rising stock price rebounds at a pivot point which is in line with previously observed resistance pivot points. Bollinger Bands for a certain period primarily consist of a simple moving average, an upper band at k-times standard deviation above the average and a lower band at k-times standard deviation below the average. It has generally been observed that 8085% of the price volatility for a stock occurs within these bands.
Figure 2: Bata India Limited Bollinger Bands Chart
Upper Band: 986.62
Middle Band: 927.51
Lower Band: 868.40
Source: Traders Cockpit
phenomenon by either long trading a stock that is at the trough and about to start climbing or short selling one that is at the crest and about to start declining. Technical analysis of historic trends, in particular the concepts of support and resistance aid a swing trader in taking a call on when to enter and exit.
Scalp Trading
Scalpers follow the proverbial approach of little drops of water make the mighty ocean, engaging in a large number of trades in a day thereby aggregating several minor
42 BEGINNERS CORNER
profits into a worthwhile total. Among traders, it is at times referred to as the quick and the dead. The upside to this strategy is that the risk in terms of losses per trade tends to be relatively small. The underlying principle behind scalping is that a trader can anticipate the directional movement of a stock with reasonable certainty for a very short period of time beyond which it becomes difficult to predict. Technical analysis is carried out by scalp traders to pick stocks and they are generally not concerned with the fundamentals of the stocks in which they are investing. Scalpers sometimes use time-stops which are nothing but stop orders designed to exit their position when a specified time limit is breached regardless of the profit or loss at that stage. Since transaction decisions are taken on an instantaneous basis, scalpers should ideally make use of direct-access brokers who offer swift and dependable execution. Scalp trading has certain inherent advantages such as lower risk due to shorter exposures to the market and ease of finding targets as even stable stocks generally exhibit short periods of minor price movement.
High-frequency trading (HFT) is a type of automated trading that makes use of powerful computers to process large volumes of market data and take split second decisions in order to capitalize on fleeting trading opportunities that would be rather difficult for a human trader to take advantage of. The increasing use of HFT (73% of US equity trading in 2009 as per research carried out by the Aite Group) has got regulators worried about its contribution to speculation and share price volatility. The other concern is that of algorithm malfunctions which was witnessed in February 2010 when a system operated by Infinium Capital Management malfunctioned and the built-in measures for automatic shut-down failed, jolting the markets. EU lawmakers have recently backed curbs on high frequency trading.
Position Trading
Position trading or trend trading involves detecting a price trend, exploiting it and exiting as soon as the trend starts reversing. A trend is nothing but a general direction of price movement. Position trading is a short to medium term trading style where positions may be held open for periods ranging from several days to a couple of months. Such traders normally practice a type of buy and hold approach with less concern for short-term volatilities as they believe that in the long run these will get smoothened out. Though position traders may resemble long-term investors, they are more concerned with the movements of the stock price than the fundamentals of a company. Their primary data source for decision making would be price charts which could consist of daily, weekly or monthly timeframe charts. Position trading thus has more similarities with short-term trading strategies except for the distinction of having longer holding periods. Traders can take both long and short positions in this approach. Happy Trading!
Trading the News

Daily news updates that have economic impacts on certain industries or sectors or more specifically on a listed company can cause short-term trends in the stock markets. Traders can capitalize on such developments through the manual or automatic method, the difference between the two being the use of algorithmic trading in the automatic route. Algorithmic trading or automated trading uses complex programmed mathematical models to evaluate various parameters of stocks including the impact of external factors such as news updates and ascertain the best time to buy or sell. In some situations, the system can even perform the transaction without the help of a human trader. This method is popular among large institutional traders who typically transact large amount of shares in a day.
43 |FISCAL DEFICIT|
FISCAL DEFICIT
The labyrinth tale
Gaurav Kumar and Sakshi Aggarwal
PGDM-BM (2nd year), Xavier Institute of Management, Bhubaneswar
Fiscal Deficit: The Indian perspective When India became a free nation in 1947, we had a vision for our nation. Vision was to live in a country where democracy prevails. People have the right to voice their opinions and protest against injustice. Though we can be proud of living in the biggest democratic nation but there is dark side to it. Economic part of vision has been a failure. For decades, we witnessed sluggish growth in our economy. We were content with selfreliance until 21 years ago. This was the time when the nation faced balance of payment crisis. It forced our leaders to bring in reforms. Doors were opened for private players. Licenses were scrapped. The results were spectacular and our economy never looked back until now. Fiscal deficit is projected by IMF to be 9.5% (included the state deficit) of GDP. India secures 2nd place in the list of emerging economies having high fiscal deficit. The situation is alarming .Rating agency Standard & Poors strongly recommends taking steps to reduce structural fiscal deficits, improve the investment climate and increase growth prospects. It also warns that a downgrade in credit rating is likely if the countrys economic growth prospects slow down or fiscal reforms slow. The main reasons for increased fiscal deficit are weaker than expected tax receipts, high subsidies and the weaker economic growth. Causes of fiscal deficit are:1. Increase in subsidy 2. Payment of interest
3. Defence expenditure 4. Poor performance of public sector 5. Excessive government borrowings 6. Tax evasion 7. Weak revenue mobilisation 8. Huge borrowings Following are some of the consequences of fiscal deficit:a. Debt Trap b. Cut in capital expenditure c. No increase in expenditure on education and health d. High interest rates e. Slow economic growth f. Inflation g. Discouragement to foreign investment h. Additional borrowing by the government to solve fiscal deficit Now, we talk about the measures taken by the government of India to reduce the fiscal deficit and in doing so ultimately to unravel the twisted Indian economy.
FDI In retail In a major reform drive, the government allowed for 51% foreign direct investment in multi-brand retail. There has been a critical assessment of this decision taken by the government and both upside and downsides of this have been evaluated. Let us look at both sides of the picture. On the positive side, with increased foreign participation there will be more competition in
JULY-SEPTEMBER 12 | BLUE CHIP ISSUE 1
44 |FISCAL DEFICIT| the market and thus the consumer will be benefitted with better pricing and more variety of products. Also under the new policy minimum $100 million investment has to be made which is the minimum benchmark, of which $50 million has to be in the back-end .With investments in the back-end, it will lead to creation of much better infrastructure facilities like cold-storage and reduce wastage and rotting of fruits and vegetables. Ultimately, Farmers will get better price realisation and will be benefitted. The small sector would also benefit as 30% sourcing has to be done from the SMEs. Thus this will add further value. With this, we will see the infusion of new technology across the agriculture value chain as well as significant improvements in the backend infrastructure. There will be a multiplier effect in terms of employment generation and domestic manufacturers will benefit as they integrate with supply chain of global retail markets. Looking at the other side, by allowing FDI in retail it will impact the kirana and mom & pop stores. But we can say that it is the same case when multi brand retail stores like Reliance and Spencers opened in India but they still didnt impact much the business of kirana stores. A kirana store is still seen as a nearby convenience store and would continue to be so. On the other hand, a major drawback faced by kirana stores is lack of scale in buying and procurement which puts them at a disadvantage vis-vis the big retailers who buy so much that they can demand a lower cost from their suppliers. To counter this, small kiranas can form a cooperative and then negotiate prices centrally so that they also get same pricing advantage. A few other opinions opposing the FDI decision are that manufacturing sector jobs will be lost in India. As domestic retailers primarily source locally and international structured retail will source internationally, leading to drop in domestic manufacturing. Also international sellers usually rely on the principle to buy cheap and sell costlier. Initially they can offer low prices to customers to attract them and eliminate competition and the raise prices later. Thus, we can see that there are both pros and cons of the decision. But now the way ahead is to find the best possible path which would benefit the consumers and retailers both.
FDI in pension and insurance The government has unveiled its plan to allow 49% FDI in pension and insurance sector. Currently most pension plans are insurance linked. Rapidly growing insurance sector was being hobbled by lack of capital. It needs money which can only come from foreign investment. In the pension sector, it would bring more international players. The government has decided to do that to help the sector which is suffering from expense overrun and is in terrible need of fresh capital infusions. Price hike The Government as part of reforms decided to increase diesel price by Rs. 5 a litre and household will get only six domestic LPG cylinders per annum at subsidized rates. This is an important step in the long run for fiscal consolidation. The Govt. should aim at a complete deregulation of diesel prices. The Kelkar Committee report also has recommended elimination of half of the subsidy on per litre by March 31, 2013 and the remaining half over next fiscal year. If this will be implemented it would mean that
45 |FISCAL DEFICIT| 50% of the losses on every litre of diesel borne by the oil companies will be passed on to the consumers. As subsidy on diesel has been a major contributor to increasing fiscal deficit in the past years. The under-recovery of oil marketing companies in 2011-12 was Rs1, 38,500 crores, nearly double of that in 2010-11. Of this a sizeable amount was borne by the government and the rest by upstream oil companies like ONGC and OIL. This not only resulted in lesser revenues for these companies but also meant 30% corporate tax forgone but more importantly, it will cut their spending and expenditure on exploration and production locally as well as globally. Also, as a result of diesel price hike which will help control fiscal deficit, this will be vital to hold on to credible sovereign credit rating. Subsidy cut The government is mulling over the idea of switching to a system that delivers subsidies by directly transferring cash instead of discounts. The government plans to eliminate subsidy on diesel by the end of 2013-14 fiscal year. Similarly on household cooking gas will also see the removal of subsidy by 2014-15. Subsidy on kerosene will also be reduced by one-third by 201415. There are also proposals on progressive subsidy removals on fertilizers and food products. The government is expecting to bring down the spending on subsidies to 2 per cent of GDP in 2013-14. 25% shares in Tehri Hydro will fetch over 1300 crore rupees. The government is also contemplating disinvestment in Axis bank and ITC. The proceeds from the divestment will be used for capital expenditure in social sector programmes. To that extent, budgetary allocations for the social sector can be reduced. This will naturally help rein in the fiscal deficit. On the down side the planned disinvestment does not happen overnight. Secondly, the fiscal benefits of disinvestment are somewhat illusory. When the government sells its equity in a PSU, it is only realising upfront the value of dividends it would realise over the life of the PSU. Any gain to the fiscal in the shortterm is offset by a loss of the stream of dividends over a longer period. Hence disinvestment can be seen primarily as an instrument for improving performance of PSUs. In the end we can say that all these measures will help us get the environment for growth right. Equally important is that these reforms need to be followed and implemented well. Moreover, a forward movement on GST, introducing greater competition in the mining sector and creating new investment opportunities for Infrastructure development will help us sustain these reforms and put us back on the growth path. With economic condition deteriorating and the future looking bleak, these are the steps which were inevitable. Sooner we realize the seriousness of the situation, the better prepared we will be to prevent our economy to go down the slide way. There may be voices of protests from many political fronts but these are the tough decisions required by the criticality of the situation; though the results will not be visible immediately and will take some time to reflect in the economy.
Disinvestment The government is planning to disinvest its shares in almost 75 PSUs. It has sold 10.82% stake in SAIL which fetched the exchequer over 4000 crore rupees. Similarly disinvestment of
JULY-SEPTEMBER 12 | BLUE CHIP ISSUE 1
46 |MARKET UPDATE|
Market Movement
Economic Indicators
Month June July Aug Sep
Inflation 7.55 7.58 6.87 7.55
CPI 10.05 9.84 10.31 -
IIP 2.5 -1.8 -0.2 2.7
PMI(HSBC) 55 52.9 52.8 52.8
47 |MARKET UPDATE|
World Market Exchanges
Country Brazil Russia India China Japan USA Germany Hong Kong
Indices Bovespa RTSI Sensex SSE Composite Nikkei 225 NASDAQ DAX Hang seng
01-Jul 54,354 1357 17,398 2,604 9,003 2,625 6,496 19,441
30-Sep 59,176 1475 18,763 2,370 8,870 2,799 7,216 20,840
Qtrly Returns 8.87 % 8.72 % 7.84 % -8.99 % -1.48 % 6.63 % 11.08 % 7.20 %
Sector-wise Snapshot
1st July 30th Sept Quarterly returns
Sensex Midcap Small cap CG CD Power Bankex Oil & Gas Auto Metal Realty Healthcare Teck FMCG
17429 6153 6543 10025 6208 1987 11908 8075 9457 10785 1667 6883 3344 4992
18763 6607 7018 10958 6940 2049 13139 8647 10413 10528 1847 7528 3417 5507
7.65 7.38 7.26 9.30 11.79 3.11 10.34 7.09 10.11 -2.38 10.80 9.38 2.19 10.32
48 |MARKET UPDATE|
Policy Rates and Reserve Ratios Repo Rate 8.00 % Reverse Repo 7.00% CRR 4.50% SLR 23% Bank Rate 9.00%
Currency Rates 1 Dollar Rs. 54.78 1 Euro Rs. 67.79 1 Pound Rs. 85.16 1 Yen Rs. 0.68
Source: Reserve Bank of India Currency rates, policy and reserve ratios as of 2nd October, 2012
In the News
Kelkar committee outlines fiscal consolidation roadmap
Sep 30, 2012; Rediff News
The three member Kelkar Committee was instituted by GOI to lay out measures for fiscal consolidation. It has recommended that the government lower its deficit to 5.2% of GDP in FY13, and further to 4.6% and 3.9% in FY14 and FY15, respectively by adopting a fourfold strategy of better tax and administration measures, increment in divestment proceeds, subsidy cuts and reduction in size of plan expenditure. For the required reduction in the fiscal deficit report suggested a reFiscal deficit rises to 65.7% of FY13 target duction of subsidies by 2% in FY14 and 1.8% in Sep 28, 2012; The Economic Times FY15 and moderation in rise of plan expenditure Fiscal deficit is the difference between a country's from 26% to 15%. income and expenditure. Fiscal deficit in Q1 FY 2012-13 stood at 65.7 per cent (INR 3.38tn) of Rupee rises to five month high Sep 29, 2012; Business Standard the budget estimates of INR 5.14tn against 66.3 The rupee rose to a new five-month high of INR per cent in the same period a year ago. 52.86 to a dollar on Friday with an average gain of five per cent in September. The reason for ap- The budget for FY 2012-13 mandates governpreciation is believed to be a combination of for- ment to borrow INR 5.7 lakh crore this fiscal or eign institutional inflow of INR 1,230 Cr in equity 5.1 per cent of the GDP. It has borrowed INR markets as well as positive sentiment driven by the 3.7 lakh crores so far. The finance ministry has spate of reforms announced by the government. reassured that it will keep the fiscal deficit in check by limiting further borrowings to INR 2 Experts believe that the rupee will stabilize at lakh crore. approx. INR 52-53 per dollar in short term and my touch up to INR 50 per dollar by December BSE Sets Limits for Kingfisher, United when the repayments of GOI may cap the cur- Breweries Sep 28, 2012; The Wall Street Journal (India) rency gains. But any sharp appreciation may warrant monetary measures by RBI which aims to NSE and BSE have revised circuit limits of Vijay strengthen the foreign reserves position. Mallya promoted Kingfisher Airlines and United Breweries (Holdings) to 5% and 10% respecApril-June current account deficit narrows tively. Circuit limit is the price band in which a Sep 28, 2012; Reuters stock is allowed to trade in a session. Current account deficit (CAD) is the difference These stocks have rallied in the past after the between a country's total imports and total export
of goods, services and transfers. Indias CAD narrowed to US$16.4bn in Q1 of FY 13 from US$21.7bn in Q4 FY 2012. The CAD figure in the last quarter was equivalent to 3.9% of GDP as compared to 3.8% in Q1 FY12. The CAD had widened to all time high of US$78.2bn (4.2% of GDP) in the fiscal year ended March 2012 compared with the 2.5% benchmark set by RBI. This relative reduction is attributed to a moderation in trade deficit due to sharper decline in imports as compared with exports coupled with improvements in secondary income.
49 |MARKET UPDATE| GOI notified FDI in aviation, a move that is expected to help debt-strapped airline. Also, earlier this week, Diageo said that it was in talks with UB Group company United Spirits and its parent United Breweries Holdings to acquire a stake in the Indian spirits group.
Disinvestment in 4 PSUs allowed

Sep 14, 2012; Hindu Business Line
S&P lowers 2013 growth target to 5.5%

Sep 25, 2012; The Economic Times
Credit rating agency Standard & Poor has slashed India's growth forecast for FY 13 from 6.5% to 5.5% which is equal to its Q1 growth rate on the back of weak monsoon, infrastructure shortcomings and policy paralysis.
The cabinet committee on economic affairs approved the disinvestment of a part of GOI stake in Oil India, MMTC, Nalco and Hindustan Copper. The centre is set to offload 10 per cent of its stake in Oil India, 9.59 per cent in Hindustan Copper. In the case of MMTC the stake offloading will be 9.33 per cent through the OFS (offer for sale) route. The disinvestment will generate INR 15,000 crores according to GOI estimates which is half of the total disinvestment target for current fiscal year.
State power distributors to get INR 2 lakh crore bailout

Sep 24, 2012; Hindu Business Line
Banks will need INR 5 lakh crore to meet Basel III norms
The Cabinet Committee on Economic Affairs on Monday approved the proposal for Financial Restructuring of State Distribution Companies (Discoms). It envisages a scheme for financial turnaround of the discoms whose combined losses have run into approx. INR 2 lakh crores. States have the option to opt into it by 31st Dec, 2012. Under the scheme, 50% of the short term liabilities will be converted into bonds issued by the discoms and backed by the respective state governments. The balance 50% liabilities will be restructured by rescheduling loans and a 3 year moratorium on payments.
Basel III is the latest round of global regulatory standards for banks which India is set to adopt in a phased manner by March, 2018. RBI Governor, D Subbarao has said that banks will require an additional capital of INR 5,00,000 crore to meet the norms. Of the total, INR 1.5 lakh crore will be required as equity capital and the rest as non-equity. The tier I capital requirement comes to about INR 1.75 lakh crore. If the government decides to reduce its shareholding in every bank to 51%, its burden will reduce to INR 70,000 crore.
Coal block allocation scam - 'Coalgate'

Aug 17, 2012; The Hindu
Cabinet Allows FDI in Retail, Aviation, Broadcasting and Power Trading

Government has liberalised FDI norms in aviation, power exchanges, broadcasting and the much talked about retail sector. Now, 51% FDI is allowed in multi brand retail with a minimum investment requirement of US$ 100mn, half of which is mandated to be invested in developing back end infrastructure facilities. The stores can be set up only in the cities with a population of more than 1 million. The FDI in Indian Aviation companies is capped at 49% of the paid up capital. In addition to these, 74% FDI in broadcasting and 49% in power trading exchanges were also approved.
The Comptroller and Auditor General (CAG) report on coal block allocations has estimated the loss at INR 1.86 lakh crore against the draft report which suggested the figure to be INR 10.7 lakh crore. The enormous loss to the exchequer meant windfall gains to the private players as the coal block allocations were done without competitive bidding. The CAG has recommended coal block auction route. The report details the allocation of 194 coal blocks with massive reserves of 44 billion tons at throwaway prices on the basis of recommendations.
50 |MIND GAMES|
CrossWord
Across:
4. BOURNVILLE::CADBURY, What is X?? X::P&G.
later repositioned as a mens brand. In its new avatar, one of the most recognizable figure for X was a cowboy. Name X. 12. The idea for name of this company came from a report on TV about football players taking ballet lessons to improve their balance and co-ordination. Identify the company. 14. The idea for X came to its founder while he was an undergraduate in Yale, in 1965. He wrote an economic paper describing his vi-
7. X secured order to manufacture 900,000 ballot boxes for independent India's first general elections. X also manufactured the first Indian typewriter as well as Indias first refrigerator. Name X. 9. X started out as a brand for women. It was
51 |MIND GAMES| sion, which earned him a C and not feasible remark from the professor. Today, X is a very successful business. What is X? 16. X was set up based on recommendations of Hilton Young Commission. X has sculptures of Yaksha and Yakshini, attendants of Kuber, the God of Wealth. Give the initials of X 17. X made its presence felt at a 1959 Moscow Fair where the product was shared by Soviet Premier Khurshahev and US Vice President Richard Nixon. What is X? 19. Famous hypermarket chain whose name in French means Crossroads 20. X introduced in India, foreign trees and plants which he personally cultivated in his estates in Ooty and Bangalore. He visited Japan in 1890s and invited Japanese to experiment in sericulture in Mysore which helped revive silk industry. Give his first name. Jagans son Mali in Malgudi days 6. X wanted that Y be able to carry two adults and three children, go up to 60 miles per hour, get at least 33 miles per gallon. Who is X (Give the surname) 8. Which famous luxury goods store hired a live Egyptian cobra to guard a pair of haute culture sandals encrusted with ruby sapphire and diamonds 10. X was established before independence in Kolkata. Its idea was conceived during Quit India movement. The idea was to organize a commercial bank with Indian capital and management. Name the bank 11. Though this scheme is named after someone else, it was mentioned for the first time in Charles Dickens 1857 novel little Dorrit. Which scheme? 13. Who said PCs will become niche products like trucks. Give the full name ( 2 words) 15. Connect United Breweries, Trent, Nestle India and Singapore 18. Connect Kodak, PWC and Thomas Edison
Down: 1. When asked to write his own epitaph, this is how X described it, Made more money faster. Lost more money in one day. Led the biggest jailbreak in history. He died. Footnote: The New York Times questioned whether he did the jailbreak or not." Give the full name of X *2 words) 2. The logo of a famous electronic brand is designed in such a way that it represents the integration of analog and digital technology with the first half of the logo representing an analog wave and the second half representing a digital binary code. Which brand? 3. Connect Teen Patti, Rajiv Gandhi and Ashok Leyland 5. The name for X was taken from an American Indian chief X, who led an unsuccessful uprising against British shortly after French and Indian war. X brand of car was driven by
Try not to look at the answers on the next
page!
Happy Quizzing !!!
52 |MIND GAMES|
Solution
53
The Club
-----------------------
From top left: Saurabh Saxena, Anupriya Asthana, Aneesha Chandra, Raghav Pandey, Keyur Vinchhi, Nihal Mahesh Jham, Amit Garg, Ashish Gupta, Goutam Kumar, Rajat Trehan, Rishabh Gupta, Sankalp Raghuvanshi, Vipul Garg, Shaunak Laad, Rishi Maheshwari, Ankur Dikshit, Aditya Bansal, Stephen Thomas, Varun Sanghi, Saurav Kumar Singh, Siddharth Janghu, Swapnil Sheth, Aditya Mittal, Sandeep Patil, Krishna Prem Sharma Not in picture: Mukul Aggarwal, Uday Das Gupta, Shaikh Arif Ahmed, Soumya Hundet, Rohit Agarwal, Syed Fahd Iqbal, Amit Aggarwalla
----------------------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 the new 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 monetrix@mandevian.com 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.

Blue Chip Issue 2 (July-September 2012)

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From the Editors Desk

~Anupriya Editor for Blue Chip

Leap of Faith Off the Fiscal Cliff

Mr. Girish Aivalli

Policy and Governance ~ 25

Fiscal Deficit: The Labyrinth Tale Good Bank, Bad Bank

Quantitative Easing: A Blessing or a Curse?

Carbon Finance Understanding the Market

Monetrix, Finance & Economics Club of MDI, Gurgaon

JULY-SEPTEMBER12 | BLUE CHIP ISSUE 2

Monetrix, Finance & Economics Club of MDI, Gurgaon

JULY-SEPTEMBER12 | BLUE CHIP ISSUE 2

Monetrix, Finance & Economics Club of MDI, Gurgaon

Leap of Faith Off the Fiscal Cliff

Figure 1 - Deficit Reduction; Source: Congressional Budget Office

Table 1 - USD 109 Billion Spending; all figures mentioned in $billion

The proposed USD 109 Billion Spending Cuts would include :

Monetrix, Finance & Economics Club of MDI, Gurgaon

Figure 2 - US Fiscal Deficit

Green Island Basalt Sea Cliff

Figure 3 - Increase in US spending and tax revenue

Current Impacts of the Fiscal Cliff Uncertainty

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

Figure 5 - US Economic Policy Uncertainty Index

Consequences of Fiscal Cliff

Figure 6 - Impact of Tax Increase

Monetrix, Finance & Economics Club of MDI, Gurgaon

crease for 2nd quintile is more than that of

Figure 7 - Consequences of Fiscal Cliff

Table 2 - Democrats vs. Republicans

Perspectives on dealing with the Fiscal Cliff

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

Figure 8 - Simpson Bowles

Monetrix, Finance & Economics Club of MDI, Gurgaon

Effects of Fiscal Consolidation on GDP of Other Economies

Figure 9 - Impact on Other Economies

Figure 11 - Growth rate of Spain

Figure 12 - Growth rate of Japan

Figure 10 - Growth rate of Greece

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

What Lies Ahead

Figure 13 - Growth rate and Fiscal Deficit of IrelandSource - www.finance.gov.ie

Figure 13 - Growth rate and Govt. Spending of Canada

Canada The story of Canada shows that despite

Monetrix, Finance & Economics Club of MDI, Gurgaon

Breakout Nations - Book Review

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

Monetrix, Finance & Economics Club of MDI, Gurgaon

|THE BAD-BANK MODEL|

GOOD BANK - BAD BANK

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

|THE BAD-BANK MODEL|

Monetrix, Finance & Economics Club of MDI, Gurgaon

|THE BAD-BANK MODEL|

Figure 3 - Structure of NAMA

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

|THE BAD-BANK MODEL|

Table 2 Loan Acquisitions

Monetrix, Finance & Economics Club of MDI, Gurgaon

JULYSEPTEMBER 12 | BLUE CHIP ISSUE 2

Monetrix, Finance & Economics Club of MDI, Gurgaon

25 |POLICY & GOVERNANCE|

2009-10 514.50 597.98 83.48