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Preface
It is a pleasure to bring out a volume on select papers presented at the 4th International Finance Conference at IES Management College and Research Centre, Mumbai, India on Changing Dynamics of Management through Innovation and CreativityThe Finance Perspective. Around the world, the experiences and lessons emerging from the global financial-market crisis have created awareness among leaders and indeed academicians that crisis prevention requires several things. We need to engage in a fundamental reform of the regulatory framework for financial markets, we need a change in the behaviour of financial market participants and we need to undertake a critical review of some financial instruments. Therefore innovations and creativity have become the centrestone in the financial sector in order to avoid a repitition of the financial apocalypse. Innovation and creativity is seen as the possible solution to overcome any challenge in the corporate business environment. Prevailing business scenario compels managers to be creative themselves and bring creative structural changes in business organization, market segmentation, product specification, as well as tangible and intangible service extensions. Re-examining own processes from different angles opens up doors of innovation and creativity that are ultimately desirable from the view point of cost reduction and cost optimization as an effective tool for corporate sustenance and growth. Instead of cost driven pricing businessmen are compelled to redesign the structure for price driven costing and new credit theories for better financial results and positions. In the light of the above discussion, the edited book provides research concepts by Academicians; Research Scholars and Corporate Delegates that stimulate further thinking and innovative ideas to deal with challenges faced by contemporary practitioners in finance and related fields of management. The research views included in this edited volume encompass a variety of topics in finance like Banking and Insurance, Mergers and Acquisitions, Corporate Governance, Corporate Finance, Money and Capital Markets and many other multidisciplinary topics in finance with sharp focus on creativity and innovation. We hope that this volume fuels your knowledge and creates new directions of research for each of you. We invite your comments and views to improvise the future editions and make this book more user-friendly. You may write to us at mrinal2701@gmail.com or statuskar@gmail.com.
Acknowledgements
The Editors wish to thank Indian Education Societys, Management College and Research Centre, Mumbai, India for having extended their support to organize the academic initiative of the International Finance Conference-2011 and edit this volume of IESMCRC-IFC-2011 research papers. We sincerely thank and acknowledge the inspiration and direction provided by Dr. Dinesh D. Harsolekar, Director, Indian Education Society, Management College and Research Centre, Mumbai, and our Dean, Prof. Parag Mahulikar for their continuous support and encouragement at various stages of conceptualizing and planning the conference. This edited volume of research papers has been possible only due to the enthusiastic response by the authors. Our sincere thanks and regards to the authors who have submitted their research papers for the conference. An overwhelming response from eminent faculty, practicing managers, research scholars, colleagues and students of Management towards the call for papers has been instrumental towards the success of the conference and this edited volume. A large number of colleagues from academia and corporate came forward to accept the task of reviewing the papers received for the conference and offering their suggestions towards modification and alteration of the papers received. It is their critical review process that has added value to the quality of publication and has made it thought provoking and meaningful. We are grateful for their effort. We would like to thank the Finance Conference Committee members comprising Faculty and Students who worked hard round the clock to complete this journey. We would particularly like to thank Mr. N.K. Varun for providing enormous administrative support. We would like to thank all our sponsors for their invaluable support. Last but not the least; we would like to thank Excel India Publishers, New Delhi for their support and cooperation in making the book available in time.
Contents
Preface Acknowledgements v vii
TRACK1:
BANKINGANDINSURANCE 3
1. FinancialInclusionthroughMobileBanking GauriPrabhu 2. RuralInfrastructureDevelopmentFund(RIDF)AnInitiative towardsInclusiveGrowth Dr.GopalK.Kalkoti 3.EffectsofMacroeconomicDynamicsonBSEACaseofBankingStock Dr.NageshwarMarutiRao 4.RoleofFinancialInnovationinMakingBankinganOrganized CompetitiveSector RaginiSingh 5.ProfitabilityPerformanceofIndianScheduledCommercialBanks: AnEmpiricalAnalysis A.N.ShuklaandR.K.Bhardwaj 6.A.C.A.M.E.L.ModelAssessmentofOldPrivateSectorBanksinIndia ShwetaMehtaandDr.NirveshMehta 7.AStudyonApproachandStatusofFinancialInclusion inIndianSubcontinent Dr.SmitaShuklaandDr.AnjaliGokhru 8.CaseStudyonDocumentaryCreditMechanism SonaliDharmadhikariandDr.H.G.Abhyankar 9.BankingontheMobileAStudyofMobileBankinginIndia Dr.SureshChandraBihari 10.ChangingDimensionsofBankingSectorinIndia Dr.T.AswathaNarayanaandShankarReddyP. TRACK2: CORPORATEFINANCE
13 22 34
47 53
68 79 86 107
117
130
x Contents
161
169 178
186
17.PublicPrivatePartnershipisanInstrumentofFasterEconomicGrowth ofIndia:PerspectiveonPoliciesandPracticesinEducationSector MadhaviI.Dhole 18.ReviewofChangesinMonetaryPolicyanditsImpact onIndianGDP&WPI Dr.MrinaliniKohojkar 19.TheGreatInflationandaRecoveringEconomy RashmiandC.A.RishiAhuja 20.MicrofinanceasAPanaceaforDevelopingEconomies MythorRealty Dr.VeenaTewariNandi,S.DasandDr.V.V.R.Raman 21.LeveragingInnovationsforSuccessfulEntrepreneurship VivekanandPawar 22.SocialEntrepreneurship:ChangingFaceofIndia Dr.GulnarSharmaandMithishaAmin TRACK5: FINANCIALCRISIS
199
209 219
Contents xi
313
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32.EconomicValueAdditiontoShareholdersWealth ArvindA.Dhond 33.FundamentalAnalysisofIndianTelecomSector Dr.KeyurM.Nayak 34.MarketAnomaliesintheIndianStockMarket GirijaNandiniandDr.BishnupriyaMishra 35.RecentTrendsinIndianCapitalMarket PoonamDhawale,IndrabhanThubeandShivanandFulari 36.AccountingNumbersasaPredictorofStockReturns: ACaseStudyofBSESensex Dr.NavindraKumarTotala,Dr.IraBapna,VishalSood andHarmenderSinghSaluja 37.InvestigatingtheRoleofPriorInvestmentandGender ontheInvestmentDecisionofaCasualInvestor Dr.SumeetGupta,MeenaksheeSharmaandMahendraKumarIktar
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40.CreativeMultiManifestationsandScopeofOperationalRisk ManagementintheIndianBankingSectorAftermaths ofBaselIIImplications Dr.DeepakTandon,SaurabhAgarwalandShibumiKalita 41.MeasuringInterestRateRiskAssociatedinBonds withtheHelpofPortfolioDurationAStudy Dr.Rekhakala.A.M. andSahilKapoor 42.FactorsAffectingExchangeRateofIndia AStudyofMajorDeterminants Dr.MuniraHabibullah 43.StrategicRiskManagement J.A.Kagal TRACK10: SECURITIZATIONANDRECONSTRUCTION OFFINANCIALASSETS 44.MortgageBackedSecuritiesHowFarSecure AkinchanBuddhodevSinha 45.SecuritizationandReconstructionofFinancialAssets AnAxeforNPAs Dr.RatnaSinha AUTHORINDEX
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Track1
BankingandInsurance
FinancialInclusionthroughMobileBanking
GauriPrabhu*
AbstractAccording to McKinsey Report, March 2010, more than 65% of population of India does not have a bank account. However 80% of population owns a mobile phone. Thus, banking over the mobile phone will play a major role in financial inclusion. With rapid urbanization, when people from rural areas start to adapt to city life, they create demand for goods such as television, refrigerators, and mobile phones. They emerge potential mobile banking customers, a fact that banks have been quick to spot. Mobile banking enables customers to transact on their own confidently and reliably without the need to visit a bank. The aim of the study is to find out whether mobile banking will aid in financial inclusion. This paper uses primary data and secondary data to analyse financial inclusion through mobile banking. Methodology/Approach used is examination of the demographic, attitudinal and behavioural characteristics of the mobile bank users. Keywords: Mobile banking, Financial Inclusion, Aid, Demographic and Attitudinal Characteristics.
INTRODUCTION
We see the popularity of the mobile phone all around us and Mobile Phone has become an order of the day. A comparison between banking and mobile phone penetration in emerging markets is an eye-opener. According to McKinsey report in March 2010, in India, more than 65% of the population has limited or no access to a bank however, one out of two persons owns a mobile The banking penetration remains modest and this can be attributed to some crucial factors. However the integration between banking and telecom technologies will give birth to mass mobile banking. In order to ensure a level playing field and considering that the technology is relatively new, the Government of India has taken the right initiative to set Industry standards for Electronic and Mobile payments to bring about desired effectiveness. The Reserve Bank has brought out a set of operating guidelines for adoption by banks for the Mobile Banking transactions in India. There are in effect guide lines viz. Mobile Banking Guide lines, Prepaid Instruments Guidelines and the Mobile banking for the financial Institutions Mobile phones as a delivery channel for extending banking services have off-late been attaining greater significance. The rapid growth in users and wider coverage of mobile phone networks have made this channel an important platform for extending financial services to customers. With the rapid growth in the number of mobile phone subscribers in Indian, banks have been exploring the feasibility of using mobile phones as an alternative channel of delivery of banking services. Some banks *AISSMS Institute of Management (MBA), Pune
have started offering information based services like balance enquiry, stop payment instruction of cheques, transactions enquiry, and location of the nearest ATM/branch etc. Acceptance of transfer of funds instruction for credit to beneficiaries of same/or another bank in favor of pre-registered beneficiaries have also commenced in a few banks. For the purpose of these Guidelines, mobile banking transactions is undertaking banking transactions using mobile phones by bank customers that involve credit/debit to their accounts. It also covers accessing the bank accounts by customers for non-monetary transactions like balance enquiry etc.
MOBILE BANKING
Mobile banking also known as M-Banking, SMS Banking etc. is a term used for performing balance checks, account transactions, payments, credit applications etc. via a mobile device such as a mobile phone or Personal Digital Assistant (PDA). The earliest mobile banking services were offered via SMS. With the introduction of the first primitive smart phones with WAP support enabling the use of the mobile web in 1999, the first European banks started to offer mobile banking on this platform to their customers. Mobile banking has until recently, most often been performed via SMS or the Mobile Web. Apple's initial success with iPhone and the rapid growth of phones based on Google's Android (operating system) has led to increasing use of special client programs, called apps, downloaded to the mobile device. Mobile Banking offers services which include facilities to conduct bank and stock market transactions, to administer accounts and to access customized information. Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. With mobile technology, banks can offer services to their customers anytime anywhere, receiving online updates of stock price or even performing stock trading while being stuck in traffic. A wide spectrum of Mobile/branchless banking models is evolving. However, no matter what business model, if mobile banking is being used to attract low-income populations in often rural locations, the business model will depend on banking agents, i.e., retail or postal outlets that process financial transactions on behalf mobile service providers or banks. The banking agent is an important part of the mobile banking business model since customer care, service quality, and cash management will depend on them. Many service providers will work through their local airtime resellers. However, banks in Colombia, Brazil, Peru, and other markets use pharmacies, bakeries, etc. Indias mobile phones will reach more than the targeted half billion people by the end of 2010 or 60 per cent of the tele-density, going by the countrys telecom ministry estimates. According to a report, approximately 43 million urban Indians used their mobile phones to access banking services during quarter ending August, 2009, a reach of 15% among urban Indian mobile phone user. Reserve Bank of India (RBI) has taken progressive steps to accelerate the rollout and adoption of mobile banking services. Based on the requests received from the banks, the
Reserve Bank of India has now hiked the daily ceiling for mobile banking transactions to Rs 50,000 per customer for both funds transfer and transactions involving purchase of goods and services. Thirty-two banks have been given approval to provide mobile banking services in India. Of this, 21 banks have already started providing these services to their customers. ICICI Bank now has eight million customers registered for mobile banking services. It is closely followed by HDFC Bank & State Bank of India. In RBI's Vision for Payment Systems in India- 2009-12, Mobile payments settlement network is one of the major projects intended to be pursued by banks. Technology will play a major role in these initiatives and will provide vendors new business opportunities in India. While internet penetration and use in India is relatively low, mobile phone penetration is much higher and growing rapidly. There are over 200 million mobile phone subscribers in India and the number continues to explode. Financial services companies are now working with mobile payment players like mChek to offer innovative mobile phone solutions to urban and rural Indian population. Reserve Bank of India has restrictions on non-bank involvement in money transfer. Therefore, development of mobile financial services application is being sponsored by banks in India.
MobileBankingServices
Mobile banking can offer services such as the following: Account Information Mini-statements and checking of account history Monitoring of term deposits Access to loan statements Access to card statements Mutual funds / equity statements Insurance policy management Pension plan management Status on cheque, stop payment on cheque Ordering cheque books Balance checking in the account and Recent transactions Payments, Deposits, Withdrawals, and Transfers Domestic and international fund transfers Mobile recharging
ChallengesforMobileBankingServices
Key challenges in developing a sophisticated mobile banking application are: Handset operability There are a large number of different mobile phone devices and it is a big challenge for banks to offer mobile banking solution on any type of device. Some of these devices support Java
ME and others support SIM Application Toolkit, a WAP browser or only SMS. Initial interoperability issues however have been localized with countries like India using portals like R-World to enable the limitations of low end java based phones. Security Security of financial transactions, being executed from some remote location and transmission of financial information over the air, are the most complicated challenges that need to be addressed jointly by mobile application developers, wireless network service providers and the banks' IT departments. Security of any thick-client application running on the device In case the device is stolen, the hacker should require at least an ID/Password to access the application and authentication of the device with service provider before initiating a transaction. This would ensure that unauthorized devices are not connected to perform financial transactions. User ID / Password authentication of banks customer, encryption of the data being transmitted over the air, encryption of the data that will be stored in device for later / off-line analysis by the customer, one-time password (OTPs) are the latest tool used by financial and banking service providers in the fight against cyber fraud. Instead of relying on traditional memorized passwords, OTPs are requested by consumers each time they want to perform transactions using the online or mobile banking interface. Scalability & Reliability It would be expected from the mobile application to support personalization such as: Preferred Language Date / Time format Amount format Default transactions Standard Beneficiary list Alerts
Application Distribution & Settings Operator settings are not really meant for critical operations since most of the settings are used for entertainment based activities. For Mobile Banking it is another area where some Banks are facing challenges. While some forward looking Banks are overhauling their gateways and reducing their reliance on Mobile Operators settings to enable customer's phones, Some Banks are actually asking that Customers come with regular Operator settings which in many instances might not be correct configurations settings. Banks that are looking at competing at this sector must look beyond operators settings which might not be correct, delayed in arrival, may not come at all and not regularly updated. Some Mobile operators do update like every three months while some do not at all. For wap and Gprs based Mobile Banking applications, mobile network coverage will also be an issue.
FINANCIAL INCLUSIONS
Definition Financial Inclusions means delivery of financial services at an affordable cost to vast sections of disadvantaged and low income groups Financial Inclusion may also be defined as the process of ensuring access to financial services and timely & adequate credit where needed by vulnerable groups such as weaker sections & low income groups at affordable cost. It mainly includes Savings, Credit, Insurance and Remittance facilities etc. The Reserve Bank of India (RBI) says that financial inclusion is not restricted merely to opening of bank accounts and should imply provision of all financial services like credit, remittance and overdraft facilities for the rural poor. The accounts must be operational to provide benefits beyond deposit of money like availability of credit, remittance facility and overdraft among others. Statistic The one billion number that today represents mobile phone owners in emerging markets without a bank account will grow to 1.7 billion by 2012. Similarly, un-banked users of mobile money will grow almost tenfold to 360 million from 45 million today. Theres an annual business worth $8 billion for the taking: $5 billion to be earned through direct fees for financial services rendered whenever someone uses the mobile phone to make a purchase or P2P payment, and another $3 billion in indirect revenues arising from the usage of voice, network and other services over mobile. With 85% of mobile subscribers being prepaid and a monthly spend over $2 bn, it is the low hanging watermelon. Mobile banking, which is catching up fast in the cities and hinterland, is not only helping the government to take a step forward towards fulfilling its aim of having one bank account for every household, but also saving it crores of rupees by way of reduced transaction costs. While the government incurs a transaction cost of Rs 12-13 for every Rs 100 it shells out, mobile banking helps it reduce the cost to a mere Rs 2. RBI estimates that around 40 per cent of Indians lack access to formal financial services and are largely 'unbanked'
FinancialInclusionsthroughRuralMBanking
Mr. Sam Pitroda, advisor to Prime Minister on public information, the person who brought in the Telecom revolution in India, has said in a seminar on financial inclusion, that over 250,000 panchayats will soon be connected with broadband connections. He is planning to bring fibre cable to majority of them. According to him, financial inclusion cannot be achieved without inclusive growth and every initiative should be directed at the rural poor. He said mobile banking is the next big challenge for government and it will change the nature of banking in India. If merchants, bank and operator can come together, they can develop a platform for mobile banking. Mr. Pitroda said he is trying to set up new platforms for the new generation. For the first time we are a country of 600 million connected people.
Thousands of people from rural areas across 12 states are likely to get their social security pension and wages paid under the National Rural Employment Guarantee Act (NREGA) scheme with the help of mobiles over the coming few months. In Andhra Pradesh alone, for instance, 250,000 people have registered for mobile banking services. The state government is rolling out a programme to enroll three million people by the end of 2008. Mobile banking pilots and full-scale operations has been conducted across 12 states, and the entire ecosystem is being managed by the government with the help of the Reserve Bank of India, banks, leading telecom operators and technology implementation partners. A Little World (ALW), a technology implementation partner, has collaborated with NXP Semiconductors to design a mobile for the AP government that encloses an RFID card, and works with ALW's micro-banking platform ZERO. The mobile acts as a branch of the bank by storing a database of customers. It also has a smartcard, which biometrically stores the identity of the customer such as name, address, photograph, fingerprint templates and relevant details of the savings or loan accounts held by the issuing bank. Customers get a secure electronic identity via phone or smartcard, while agents take deposits and dispense cash. ALW works with the banks on a revenue-sharing basis. Anurag Gupta, founder director & CEO of ALW, says: "We have carried out pilot projects with SBI in villages located in some of the most inaccessible and difficult terrains of the country such as Pithoragarh in Uttarakhand, Mizoram, Meghalaya, and remote villages in Andhra Pradesh." Lokanath Panda, director, ALW, also pointed out that SBI had tied up with the Indian Post to extend banking services especially in unbanked/under-banked areas. "Select post offices will make available to the public SBI's deposit and loan products, and ALW is the technology partner." ALW is also conducting a pilot programme with SKS Microfinance and the Bank of India to provide a mobile banking service that works on BSNL SIM cards. Airtel has already partnered with the Indian Farmers' Fertilizer Cooperative Limited (IFFCO) to set up IFFCO Kisan Sanchar Limited in Rajasthan. Under this initiative, the cooperative department will provide mobile handsets to farmers at marginal price through its outlets in the rural areas. These handsets would be loaded with green SIM cards, which will flash daily updates on agricultural practices and weather forecast free of cost. While he did not provide details, Kapoor hinted that the partnership deal would be extended to mobile banking services too. Kapoor reasons that with 55 per cent of the mobiles being internet-enabled, mobile banking would help bridge the digital divide. ICICI Bank account holders with Reliance handsets (even the low-end Rs 1,000 ones with or without Internet connectivity) to make intra-bank (to ICICI account holders) money transfers. It has already tied up with HDFC to offer Reliance mPay - a virtual credit card.
OtherMBankingBusiness
Mobile Commerce: The Next Wave in Electronic Payments. Not only is the humble mobile a communication device pervasive across all wage earners, but also a Point of Sale (PoS) for the merchant boss. With prohibitive upfront costs and recurring expenses taken care of, the mobile becomes an `anytime, anywhere' device or a wireless PoS.
Clearly, India seems to be one step ahead of Europe and North America in this- more by default perhaps than by design. The second low hanging fruit lies at the other end of the SEC scale-domestic money transfer. Clearly, while all wage earners carry mobiles, not all wage earners will have a bank account or even want to step sideways through the portals of a bank. This informal economy abounds in 80% of India and will continue to do so. NRE Transfers through MBS Corporation Bank and Tata Teleservices have launched the first pan-India mobile-based financial inclusion service called `Green'. Initially, it is for mobile money transfer between migrant workers working in metros and tier-1 cities sending money back to their families in Karnataka and Kerala. This is a simple model where both the sender and the beneficiary open `no frills' accounts at PCOs, and then are able to remit money. The service is powered and the brand is owned by PayMate. The next step will be, only one of the parties needs to have a `no frills' account. And in due course, for the service to be viable and popular, perhaps it will need to evolve into a cash-in and cash-out service at either end, with no need for a mandatory bank account. And in time, perhaps, a UID linked to a job card. This is where NREGA marries with the UID project. Retail Markets in India But all this will come to naught if the `merchant boarding' for a mobile payment is not mature enough to handle these transactions. The retail market is in a constant state of flux. ECommerce broke the stranglehold that brick-and-mortar retail held for over 50 years. Today, e-commerce is well-established and popular for most of our daily needs and aspirations, whether they be ticketing, e-shopping, gifting, entertainment, utility bills, etc. An online retail merchant ecosystem is critical for e-commerce, which has flourished into a $3 bn industry today. Retail in India is a $320 Mn market. Merchant establishments are key to the growth of organized retail and electronic payments. In that respect, we are frightfully low down the chain when it comes to the number of retail outlets, which are electronically enabled even 20 years after the emergence of the credit card and PoS. The conclusion: a penetration of less than 3%. Clearly, that is both a lacuna, yet opportunity. The traditional model is that the EDC has an initial cost, a recurring expense, and a cost to merchant (merchant discount rate), etc. The adoption perhaps has been a problem not only because of these very factors, but the fact is that the local store funds your credit for 30-45 days, depending on your relationship. This huge base of unorganized SME merchants is what has hitherto been untapped and for whom the current model of merchant discount rate, PoS/EDC infrastructure may never seem worthwhile. That is, until the mobile PoS device came along and changed the economics of the industry, or in Internet parlance, dis-intermediated the existing stakeholders. Not only is the humble mobile a communication device pervasive across all wage earners, but also a Point of sale (PoS) for the merchant boss. With prohibitive upfront costs and recurring expenses taken care of, the mobile becomes an `anytime, anywhere' device or a wireless PoS.
OBJECTIVES OF RESEARCH
To study the awareness of mobile banking. To find out whether financial inclusion is possible through mobile banking
RESEARCH METHODOLOGY
The research method used was the structured survey research. A questionnaire was prepared and addressed to the residents of Punes elite area i.e. Deccan Gymkhana which represents the urban population of Pune and the villagers of Khanapur and Donje, Mulshi area which represents the rural population. The sample size selected was 200 people from urban and 150 people from rural areas of Pune.
Fig.1:PercentageofRespondents
Out of the total respondents 95% owned mobile. Rest 5% used their relatives or friends mobile.
MOBILE OWNERSHIP
Owners Non-Owners
Fig.2:MobileOwners
Out of the total urban population 82% had bank account while only 26% of rural population had a bank account. This shows that most of them have a mobile phone but dont have a bank account. It was observed that 42% of people used GPRS facility on their mobile. The rest used mobile only for communicating. Out of the total respondents only 12% were aware that banking service can be availed over the mobile. 40% of the respondents expressed their willingness to use mobile for banking purpose.
WILLINGNESS
Fig.3:WillingnessofMobileUserstoUseMobileBanking
Majority of the above would like to use mobile service for Account balance enquiry, last five transactions statement, Status of cheque clearance. Younger population showed keen interest to use mobile phone for money transfer, bill payments and stock market trading. 17% of respondents were apprehensive to use mobile banking for security purposes. They preferred the traditional methods of banking. People in the income group 3 lakhs and above were more interested in using mobile banking than wasting their time going to the bank or using the computer for account balance enquiry, deposits and payments.
The survey indicates that financial institutions still need to do more to educate consumers about the security of conducting financial activities on their cell phones and other mobile devices. A majority of respondents cited fear of transaction security as a key reason that would prevent them from using mobile banking. Due to lot of bank closures due to bankcruptcy or scams, consumers are monitoring their finances especially bank statements on a regular basis. Thus mobile banking has a greater scope. Nearly two-thirds of the consumers surveyed reported contacting their financial institution once a month or more. Among owners of smart phones and other high-end devices, consumer interest and usage of mobile banking
services was significantly higher than among users of basic cell phones The top three reasons for phone or other high-end device indicating a desire to do more than just talk. The rapid adoption of high-end mobile devices over the next couple of years suggests mobile banking may have a bright future.
CONCLUSION
The Financial inclusion is emerging as a global hot topic. The G-20 has launched an expert group to look into the matter. Mobile banking has come in handy in many parts of the world with little or no Infrastructure development, especially in remote and rural areas. This part of the mobile commerce is also very popular in countries where most of their population is unbanked. In most of these places banks can only be found in big cities and customers have to travel hundreds of miles to the nearest bank. Mobile banking is also seen as the most promising front end technology for broadening the access of banking in the country. Immense potential of mobile banking in the process of financial inclusion and financial growth is now well acknowledged. Its time for banking offerings to make the same evolutionary progress that automobiles, entertainment devices or mobile phones have made. This means offering choice, becoming smarter, better packaged, cheaper and easier to use. Through alliances with the right partners from the device, telecom, network, applications and retail space, Indian banks can turn this vision into reality. With the expectation that the number of deposit account holders will double from its current 400 million to 800 million by 2019, banks need to find innovative ways of onboarding new customers and servicing existing ones. Clearly, there is no shortage of challenges or opportunities. The emergence of mobile telephony and its hi-tech variants such as 3G and BWA, kiosks, ATMs and Internet will ensure that banks get to ride the growth wave like other industries. Parallel to the Internet bank concept, we envisage the rise of the mobile-only bank, where every banking activity from origination and transaction to fulfillment and settlement can be completed using a mobile phone. With the extensive Rural Mobile banking coverage planed by the Govt of India with the RBI & the banking sector, the true financial inclusion will be achieved in near future.
REFERENCES
[1] The Indian Journal of Commerce, Vol 63, April-June 2010. [2] Financial Inclusion, Sameer Kochhar, Eastern Book Corporation, 2009. [3] Promoting Financial Inclusion Through Innovative Policies, John D. Conroy, Julius Caesar Parrenas, Worapot Manupipatpong, 2010 [4] The Hindu Business line, 7 Aug 2010 [5] Financial Inclusion, M/s Taxmann Publications Pvt. Ltd., 2006.
In order to encourage quicker completion of the rural infrastructure projects, the Union Finance Minister had indicated setting up of Rural Infrastructure Development Fund (RIDF) in NABARD from April 1995, with an initial amount of Rs.2000 cr. Made up of contributions by way of deposits from scheduled commercial banks operating in India. Since then, the scheme has been continued and as on date total corpus of RIDF has grown to Rs.86000 crore. RIDF was setup by NABARD for providing loan assistance to the State Government and State owned Corporations for completion of ongoing projects and taking up new projects related to medium and minor irrigation, rural roads, bridges etc. In the Union Budget Speech 1995-96, Hon'ble Finance Minister announced that- "Inadequacy of public investment in *Nagindas Khandwala College, Mumbai
agriculture is today a matter of general concern. This is an area, which is the responsibility of States. But many States have neglected investment in infrastructure for agriculture. There are many rural infrastructure projects, which have been started but are lying incomplete for want of resources. They represent a major loss of potential income and employment to rural population." RIDF-I was launched in 1995-96 with an initial corpus of Rs.2000 crore through contributions both from public and private sector having shortfall in the agricultural lending. Since 1996-97 i.e. RIDF-II, source of deposits from commercial banks has been broad-based by including shortfall in lending to agriculture and/or shortfall in priority sector lending. As a result in 2008-09 the corpus has increased to Rs.14000 crores The tranche-wise size of corpus has been as under:
TABLE1:TRANCHEWISECORPUS RIDF TRANCHE/ YEAR RIDF I RIDF II RIDF III RIDF IV RIDF V RIDF VI RIDF VII RIDF VIII RIDF IX RIDF X RIDF XI RIDF XII RIDF XIII RIDF XIV TOTAL YEAR 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008 2008-2009 CORPUS (RS CRORE) 2000 2500 2500 3000 3500 4500 5000 5500 5500 8000 8000 10000 12000 14000 86000 PERCENTAGE INCREASE OVER PREVIOUS YEAR 25% 20% 17% 29% 11% 10% 64% 25% 20% 17%
The projects pertaining to eligible sectors under each RIDF tranche are submitted by the State Governments through their Finance department to NABARDs Regional Offices. The project proposals are scrutinized and appraised by the Regional Office with the help of Consultants by conducting desk and field appraisal. Appraisal reports submitted by the ROs are then scrutinised by State Projects Department at HO before placing the same to Sanctioning Committee (SC) for consideration of sanction The SC is a committee of the Board of Directors with following Members: Chairman of NABARD; Managing Director of NABARD; Secretary (Banking), MoF, GoI, on the Board of NABARD; Secretary, Ministry of Rural Development, GoI, on the Board of NABARD; Secretary, Ministry of Agriculture, GoI, on the Board of NABARD; Deputy Governor, RBI, on the Board of NABARD;
One Nominee from RBI Board of Directors: and Two State Government Representatives from the Board of NABARD.
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Chart2e
Chart2f
The Charts 2a to Chart 2f which show how there is steady increase in the need for infrastructure. As all sectors expenses are increasing, specially the increase is significant in 1995-96. This clearly indicate how the economy was rearing to move into progress by the year 1995-96. Recognizing this need of a growing economy and the urgent requirements of funds to furnish development of infrastructure RIDF was set up by the Union Finance Minister. The Union Finance Minister also announced that certain other funds will be set up with NABARD/SIDBI/NHB during 2008-09 from the contribution to be made by scheduled commercial banks which failed to achieve their priority sector lending targets. These funds were set up in June 2008 and the corpus allocations were revised in August 2008. The revised allocations were Rs.10,000 crore for RIDF-XIV and Rs.5,000 crore for Short-Term Cooperative Rural Credit [STCRC] [refinance] Fund with NABARD; Rs.1,600 crore for Micro, Small and Medium Enterprises [MSE][refinance] Fund and Rs.1,000 crore for MSE[risk capital] Fund with SIDBI
and Rs.1,000 crore for Rural Housing Fund with NHB. The corpus allocation under the separate window of RIDF-XIV for rural roads component during 2008-09 remains unchanged. During 2008-09, 12 State Governments were sanctioned loans aggregating Rs.2,572 crore under RIDF-XIV which included Rs.277 crore sanctioned to the distressed districts of two States-viz, Andhra Pradesh and Maharashtra identified in the Prime Ministers Relief Package for mitigation of distress farmers. The disbursements under RIDF-XIV during 2008-09 amounted to Rs.58 crore.
RIDFXIINumberofProjects
Chart3a
RIDFItoXIINumberofProjects
Chart3b FiguresinBracketsindicatePercentageofthatItemtotheTotal
The charts 3a and 3b show that in RIDF XII and RIDF I to XII all over India the focus on sanctions is on irrigation projects and the social sector sanction.
As the above table shows the overall disbursed amount is high in the irrigation, rural roads and bridges, power sectors. In the social sector and other sector it is not very good. However when sanctioned amount is compared to the disbursed amounts the diversion is more, this is because the phased amount is much lesser than the sanctioned amounts. This means that the projects are not completed as stipulated by the loans when they are sanctioned, time and cost overruns are the main reasons for non fulfillment of this criterion.
20 Changing Dynamics of Finance TABLE5:CUMULATIVESANCTIONSANDDISBURSEMENTSUNDERRIDFASON31 MARCH08[RS.CRORE] Trench Corpus [Deposits] No. of Projects Sanctioned amount Amount disbursed I 2000 [1586.56] 4168 1906.21 1760.8 [92.4] II 2500 [2225.00] 8193 2636.08 2397.95 [91.0] III 2500 [2308.02] 14345 2732.69 2453.50 [89.8] IV 3000 [1412.53] 6171 2902.55 2482.00 [85.5] V 3500 [3051.88] 12106* 3434.52 3054.96 [88.9] VI 4500 [4073.45] 43168 4488.51 4072.14 [90.7] VII 5000 [4065.77] 24598 4582.32 4038.16 [88.1] VIII 5500 [5031.61] 20964 5996.97 4975.47 [83.0] IX 5500 [4490.24] 19579 5649.09 4513.74 [79.9] X 8000 [5710.05] 17368** 8077.21 5635.52 [69.8] XI 8000 [4302.04] 30305 8412.07 4395.22 [52.2] XII 10000[3171.73] 42299 10460.18 [7959.30]# 3466.62 [43.6] XIII 12000[1656.91] 36964 12795.01[4080.28]# 2348.70 [57.6] Total 72000 280227 74073.41[62857.80]# 45594.85 [72.5] *one lakh STWs sanctioned for Assam treated as single project **42616 construction of primary school structures sanctioned to Madhya Pradesh converted to 213 projects. # Amount phased; figures in parentheses indicate % disbursement to sanctioned/phased amount under XII &XIII Rs.3855.57 crore & Rs.528.85 crore deposits under Bharat Nirman Program The table 5 shows that in the RIDF I, II and VI there is a very good % disbursement to sanctioned/phased amount (92.4%, 91% and 90.7%). As the RIDF plans are advancing further the disbursed percentages are reducing reaching the lowest in RIDF XII (43%.6), it is also low in the RIDF XI and XIII (52.2% and 57.6%). This may be because the number of projects under RIDF and its purview increased due to which the amounts disbursed reduced in percentage. Form RIDF X to XI the number of projects increased by 12937 projects from 17368 to 30305from RIDF XII to XIII it increased by 11994 projects from 30305 to 42299. The functionaries may not have been able to handle the sudden increase in the projects.
ST
CONCLUSION
The studies to examine the relationship between infrastructure and agricultural output showed that Punjab, which has the highest index of infrastructure also has the highest yield of food grains and value of agricultural production per hectare. Tamil Nadu and Haryana, which have the second and third highest index of infrastructure have third and second highest yield per hectare of food grains. Rajasthan and Madhya Pradesh, which have a very low index of infrastructure also have low yield of food grains and total value of agricultural production per hectare [Bhatia, 1999] Fan et al [1999,2000] studied the relationship between government expenditures on agricultural research and development, irrigation, roads, education, power, soil and water conservation, rural development spending on agricultural growth and rural poverty. The study concludes that improved rural infrastructure and technology have all contributed to agricultural growth, but their impacts have varied by settings. Government expenditures on road and R&D have by far the largest impact on poverty reduction and growth in agricultural productivity. The linkages between infrastructure development and sustained output growth have been significantly confirmed by empirical researches. Cross-country analyses have also confirmed strong linkages between infrastructure and agricultural output growth.
Antle in 1983, using cross-sectional data for 47 less developed countries including India, established a strong and positive relationship between infrastructure development and aggregate agricultural productivity. These views have been substantiated by several studies from Asian countries and more importantly Antle [1984] documented evidence of positive linkages between various types of infrastructure and agricultural output growth specifically from studies under Indian settings. Thus it is imperative that policy makers and politicians realize that the only way to success of any country, state, district town or village is heavily dependent on infrastructure available to the common inhabitants of the said locality.
REFERENCES
[1] Gyan Chandra Kar & Mamata Swain, Farmer And Local Participation In Management Commonwealth Publishers, New Delhi, 2005 [2] K.K. Singh, Farmers in the Management of Irrigation System Sterling Publishers Ltd. L-10, Green Park Extension New Delhi.-2006 [3] Dr. M.V.K. Sivamohan, K.B. Satyanarayana, INDIA: Irrigation Management Partnerships, Book links Corporation Narayanaguda, Hyderabad 500 0292007 [4] Norman Uphoff with Priti Ramamurthy and Roy Steiner, Managing Irrigation Analysing and improving the performance of bureaucracies, Sage Publications India Pvt Ltd. -2008 [5] Singh Rudrapratap, NABARD, Deep & Deep Publications, New Delhi, 2004
EffectsofMacroeconomicDynamicsonBSE ACaseofBankingStock
Dr.NageshwarMarutiRao*
AbstractThe relationship between stock prices and macroeconomic dynamics is well documented for the United States and other major economies. It was found that Indian stock market also reacts according to changing macroeconomic dynamics. The risk associated with the stock market is always cause of worry for retail investors. With severe volatility in the stock market due to changing macroeconomic dynamics there is fair degree of inconsistency in returns on investment. However, few studies were conducted to find out what is the relationship between bank stock prices and macroeconomic dynamics in emerging economies like India?. The goal of this study is to investigate the relationship between banking stock prices and the macroeconomic dynamics such as FIIs, crude oil prices, inflation, GDP and gold prices correlation technique. There was a significant relationship was found between macroeconomic dynamics on the bankex and individual stocks, suggesting the bankex exhibit the strong -form of market efficiency. Keywords: Bankex, Gross Domestic Product, Inflation, Crude Oil prices, Foreign Institutional Investment, gold prices.
INTRODUCTION
The relationship between stock prices and macroeconomic dynamics is well documented for the United States and other major economies. It was found that Indian stock market also reacts according to changing macroeconomic dynamics. The risk associated with the stock market is always cause of worry for retail investors. With severe volatility in the stock market due to changing macroeconomic dynamics there is fair degree of inconsistency in returns on investment. However, few studies were conducted to find out what is the relationship between bank stock prices and macroeconomic dynamics in emerging economies like India?. The study has thrown light on correlation between macroeconomic dynamics such as inflation, FII, GDP, FER, gold prices and crude oil prices. The study has taken into effect of aforesaid dynamics on Bankex.
Abbreviation
FER: Foreign Exchange Rate GDP: Gross Domestic Products FII: Foreign Institutional Investment
OBJECTIVES
The present study was undertaken with the following objectives: To find out the effect of macroeconomic dynamics on bank stocks
To find out the correlation between selected macroeconomic dynamics and Bankex. To study the beta of bank stocks.
REVIEW OF LITERATURE
Esen E & Umit O conducted a study on effects of macroeconomic dynamics on Turkish stock market and found that there was varying effect of different macroeconomic variables. Nil Gnsel & Sadk ukur had conducted investigated the performance of the Arbitrage Pricing Theory (APT) in London Stock Exchange for the period of 1980-1993. The study develops seven pre-specified macroeconomic variables such as Interest rate, risk premium, exchange rate, money supply and unanticipated inflation and industry specific variables such as sectoral dividend yield and sectoral unexpected production. They have demonstrated that there are some big differences among industries. Robert D. Gay has investigated the time-series relationship between stock market index prices and the macroeconomic variables of exchange rate and oil price for Brazil, Russia, India, and China (BRIC) using the Box-Jenkins ARIMA model. He found that there is no significant relationship between respective exchange rate and oil price on the stock market index prices of either BRIC country. As noted by Suresh Srivastava (2001), the relationship between bank stock return and interest rates found to be positively correlated. No empirical study was conducted to find out correlation between macroeconomic dynamics such as GDP, Inflation, FER, etc. and their effect on banking stock. This has motivated researchers to take up present study.
METHODOLOGY
For the purpose of the study, five macroeconomic dynamics were selected - inflation, FII, GDP, gold prices and crude oil prices. The data for the study was collected from various secondary sources such as web-site of Finance Ministry, OPEC, RBI, BSE and Business dailies etc. The selection of the macroeconomic dynamics was made based on their impact on stock market in major economics such as USA. The analysis of the data collected was carried out with the help correlation. The study was descriptive and causal in nature. The period of study has been confined to April 2001 to March 2010.
MeaningofKeyWordsused
Inflation Rate: It refers to annual change in Wholesale Price Index or Consumer Price Index. Systematic Risk: Risk which affects all securities can not be diversified or controlled. These risks have to be assumed by investors while entering into the market.
ANALYSIS
The table-1 reveals that there was a strong positive correlation between inflation and bankex as it can be seen from value of correlation which is 0.72. So, increase in inflation has resulted in increase in return on bankex.
24 Changing Dynamics of Finance TABLE1 INFLATION (%) BANKEX X Y 2001-02 3.6 1178.51 2002-03 3.4 1369.42 2003-04 5.5 2992.9 2004-05 6.5 3847.96 2005-06 4.4 5265.24 2006-07 5.4 6542.01 2007-08 4.7 7717.61 2008-09 8.4 4490.97 2009-10 14.2 10652.31 SUMMATION 56.1 44056.93 R 0.723290202 Correlation(r) = NXY - (X)(Y) / Sqrt([NX2 - (X)2][NY2 - (Y)2]) TABLE2 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 SUMMATION
R
YEAR
XY
4242.636 4656.028 16460.95 25011.74 23167.056 35326.854 36272.767 37724.148 151262.8 334124.98
X*X 12.96 11.56 30.25 42.25 19.36 29.16 22.09 70.56 201.64 439.83
Y*Y 1388885.82 1875311.14 8957450.41 14806796.2 27722752.3 42797894.8 59561504.1 20168811.5 113471708 290751115
GDP % X 5.8 3.8 8.5 7.5 9.5 9.7 9 6.2 6.7 66.7 0.45607304
Bankex Y 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.9
XY
6835.36 5203.8 25439.7 28859.7 50019.8 63457.5 69458.5 27844 71370.5 348489
X*X 33.64 14.44 72.25 56.25 90.25 94.09 81 38.44 44.89 525.25
Y* Y 1388885.82 1875311.14 8957450.41 14806796.2 27722752.3 42797894.8 59561504.1 20168811.5 113471708 290751115
The table-2 displays that GDP and bankex has moderate positive correlation as it equals to 0.46. So, the increase in GDP has resulted in increase in Bankex.
TABLE3 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 SUMMATION
R
FII (Rs.crores)
X
1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93 1
Bankex Y 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.9
XY
1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115
X*X 1388885.82 1875311.136 8957450.41 14806796.16 27722752.26 42797894.84 59561504.11 20168811.54 113471708.3 290751114.6
Y* Y 1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115
Effects of Macroeconomic Dynamics on BSE A Case of Banking Stock 25 TABLE4 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 SUMMATION
R
Crude Oil Price X 1116.7421 1150.7013 1367.534 2126.475 2518.9024 2490.318 3974.7864 2548.587 2022.3009 19316.3471 0.629036774
Bankex Y 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93
XY
1316091.7 1575793.4 4092892.5 8182590.7 13262626 16291685 30675851 11445628 21542176 108385334
X*X 1247113 1324113 1870149 4521896 6344869 6201684 1.6E+07 6495296 4089701 4.8E+07
Y* Y 1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115
The table-4 displays that crude oil price and bankex has moderate positive correlation as it equals to 0.63. So, the increase in crude oil price has resulted in increase in Bankex.
TABLE5 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 SUMMATION
R
Gold/Ounce X 15124.12 17271.45 17781.85 19399.56 26841.01 29971.31 34895.84 49463.44 50441.5 261190.08 0.7741632
Bankex Y 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.3 44057
XY 17823926.7 23651869.1 53219298.9 74648730.9 141324359 196072610 269312484 222138825 537318495 1535510598
X*X 228739005.8 298302985.1 316194189.4 376342928.2 720439817.8 898279423.1 1217719649 2446631897 2544344922 9046994818
Y* Y 1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115
We can note from the table-5 that there was strong positive correlation between gold price and bankex.
TABLE6 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R Inflation (%) X 3.6 3.4 5.5 6.5 4.4 5.4 4.7 8.4 14.2 56.1 0.7820536 SBI Y 278.65 642.25 584.85 891.35 1101.9 1781 1291.15 1700.4 2300 10571.6 xy 1003.14 2183.65 3216.675 5793.775 4848.36 9617.4 6068.405 14283.36 32660 79674.77 x*x 12.96 11.56 30.25 42.25 19.36 29.16 22.09 70.56 201.64 439.83 y*y 77645.823 412485.06 342049.52 794504.82 1214183.6 3171961 1667068.3 2891360.2 5290000 15861258
The chart-1 exhibits that there was a strong positive correlation between inflation and stock prices of SBI.
It is worthy to note from chart-2 that there was a strong positive correlation between foreign institutional investment and stock price of SBI.
Chart-1: Inflation v/s SBI
16 14 12 10 8 6 4 2 0 0 500 1000 1500 2000 2500 Stock Price
TABLE7 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R FII (Rs. Crores) X 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93 0.882625375 SBI Y 278.65 642.25 584.85 891.35 1101.9 1781 1291.15 1700.4 2300 10571.55 xy 328391.81 879510 1750397.6 3429879.1 5801768 11651320 9964592.2 7636445.4 24500313 65942617 x*x 1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115 y*y 77645.8225 412485.063 342049.523 794504.823 1214183.61 3171961 1667068.32 2891360.16 5290000 15861258.3
Series1
TABLE8
Effects of Macroeconomic Dynamics on BSE A Case of Banking Stock 27 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R GDP % X 5.8 3.8 8.5 7.5 9.5 9.7 9 6.2 6.7 66.7 2.943885135 SBI Y 278.65 642.25 584.85 891.35 1101.9 1781 1291.15 1700.4 2300 10571.55
XY 1616.17 2440.55 4971.225 6685.125 10468.05 17275.7 11620.35 10542.48 15410 81029.65
x*x 33.64 14.44 72.25 56.25 90.25 94.09 81 38.44 44.89 525.25
y*y 77645.8225 412485.063 342049.523 794504.823 1214183.61 3171961 1667068.32 2891360.16 5290000 15861258.3
Series1
The chart-3 depicts that the GDP and SBI stock price have very strong positive correlation. The chart-4 exhibits that there was a strong positive correlation between gold price and stock prices of SBI.
TABLE9 YEAR 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 SUMMATION
R
GOLD/OUNCE
X
15124.12 17271.45 17781.85 19399.56 26841.01 29971.31 34895.84 49463.44 50441.5 261190.08 0.905140237
SBI Y 278.65 642.25 584.85 891.35 1101.9 1781 1291.15 1700.4 2300 10571.55
XY
4214336 11092589 10399715 17291798 29576109 53378903 45055764 84107633 116015450 371132297
X*X 228739006 298302985 316194189 376342928 720439818 898279423 1217719649 2446631897 2544344922 9046994818
Y* Y 77645.823 412485.06 342049.52 794504.82 1214183.6 3171961 1667068.3 2891360.2 5290000 15861258
Series1
The chart-5 shows that the crude oil price and stock price of SBI have moderate positive correlation.
Effects of Macroeconomic Dynamics on BSE A Case of Banking Stock 29 TABLE11 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation Beta Bankex x 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93 1.56750036 SBI Y 278.65 642.25 584.85 891.35 1101.9 1781 1291.15 1700.4 2300 10571.6 x*x 1388885.82 1875311.14 8957450.41 14806796.2 27722752.3 42797894.8 59561504.1 20168811.5 113471708 290751115 x*y 328391.81 879510 1750397.6 3429879.1 5801768 11651320 9964592.2 7636445.4 24500313 65942617
The table-11 exhibits that the SBI stock is riskier as its beta is 1.57. This stock is meant for those investors who are ready to assume more risk. However, it also signals that the return on SBI stock is more than the Bankex.
TABLE12 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation r Inflation (%) x 3.6 3.4 5.5 6.5 4.4 5.4 4.7 8.4 14.2 56.1 0.4742531 ICICI y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.85 xy 505.98 1005.38 2038.85 3800.55 3917.76 6654.96 2107.245 7355.88 13083.17 40469.78 x*x 12.96 11.56 30.25 42.25 19.36 29.16 22.09 70.56 201.64 439.83 y*y 19754.303 87438.49 137418.49 341874.09 792812.16 1518809.8 201017.72 766850.49 848885.82 4714861.3
Series1
6 stock prices
10
12
The chart-6 exhibits that there was a moderate positive correlation between inflation and stock price of ICICI bank. The increase in inflation will boost the ICICI Banks stock price.
30 Changing Dynamics of Finance TABLE13 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R
FII (crores) 12000 10000 8000 6000 4000 2000 0 0 500 ICICI Bank's stock price 1000 1500 Series1
FII (Rs. crores) X 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93 0.647704584
ICICI y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.85
xy 165639.58 404937.49 1109468 2249902.2 4688169.7 8062373.1 3460190.4 3932742.4 9814505.8 33887929
x*x 1388885.8 1875311.1 8957450.4 14806796 27722752 42797895 59561504 20168812 113471708 290751115
Y*y 19754.3025 87438.49 137418.49 341874.09 792812.16 1518809.76 201017.723 766850.49 848885.823 4714861.33
The chart-7 display that there is moderate positive correlation exists between foreign institutional investment and stock price of ICICI Bank.
TABLE14 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R GDP % X 5.8 3.8 8.5 7.5 9.5 9.7 9 6.2 6.7 66.7 0.503285653 ICICI Y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.9 xy 815.19 1123.66 3150.95 4385.25 8458.8 11954.28 4035.15 5429.34 6173.045 45525.665 x*x 33.64 14.44 72.25 56.25 90.25 94.09 81 38.44 44.89 525.25 y*y 19754.3025 87438.49 137418.49 341874.09 792812.16 1518809.76 201017.723 766850.49 848885.823 4714861.33
500
1500
The chart-8 shows that the GDP and ICICI bank have positive correlation.
TABLE15 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R Gold/Ounce x 15124.12 17271.45 17781.85 19399.56 26841.01 29971.31 34895.84 49463.44 50441.5 261190.08 0.625061903 Bankex y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.85 xy 2125695.1 5107167.8 6591731.8 11342923 23899235 36936642 15645550 43315134 46474276 191438355 x*x 228739006 298302985 316194189 376342928 720439818 898279423 1217719649 2446631897 2544344922 9046994818 y*y 19754.303 87438.49 137418.49 341874.09 792812.16 1518809.8 201017.72 766850.49 848885.82 4714861.3
Chart -9: Gold Price v/s ICICI Bank Gold Price/Ounce 60000 50000 40000 30000 20000 10000 0 0 200 400 600 800 1000 1200 1400 Stock Price
Series1
The chart-9 reveals that the increase in gold price will lead to increase in stock price of ICICI bank.
TABLE16 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation R Crude Oil Price x 1116.7421 1150.7013 1367.534 2126.475 2518.9024 2490.318 3974.7864 2548.587 2022.3009 19316.3471 0.41757525 ICICI Y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.85 xy 156958.1 340262.4 506944.9 1243350 2242831 3069068 1782095 2231798 1863247 13436554 x*x 1247113 1324113 1870149 4521896 6344869 6201684 15798927 6495296 4089701 47893748 y*y 19754.303 87438.49 137418.49 341874.09 792812.16 1518809.8 201017.72 766850.49 848885.82 4714861.3
Crude Oil Price 4500 4000 3500 3000 2500 2000 1500 1000 500 0 0
Series1
200
400
1000
1200
1400
The chart-10 shows that there was a weak positive correlation between crude oil price and stock price of ICICI bank
Effects of Macroeconomic Dynamics on BSE A Case of Banking Stock 33 TABLE17 Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Summation Beta Bankex x 1178.51 1369.42 2992.9 3847.96 5265.24 6542.01 7717.61 4490.97 10652.31 44056.93 0.82686672 ICICI y 140.55 295.7 370.7 584.7 890.4 1232.4 448.35 875.7 921.35 5759.85 x*x 1388885.82 1875311.14 8957450.41 14806796.2 27722752.3 42797894.8 59561504.1 20168811.5 113471708 290751115 x*y 165639.58 404937.49 1109468 2249902.2 4688169.7 8062373.1 3460190.4 3932742.4 9814505.8 33887929
The table-17 reveals that it is safer to invest your money in ICICI Bank as its beta is equal to 0.83.
CONCLUSION
Among the five macroeconomic dynamics used for the purpose of the study it was found that change in inflation rate, gold prices and crude oil prices have very strong impact on bankex. In other words, the increase in these macroeconomic dynamics will results into increase in return as well as risk on bankex. Further, all the five macroeconomic dynamics have very strong correlation with stock price of SBI signaling that SBI stock is very sensitive to macroeconomic dynamics. The study also reveals that all the five macroeconomic dynamics used for the study have a moderate correlation with stock price of ICICI Bank. To conclude the macroeconomic dynamics have affected bankex as well as the individual stocks in bankex. There was a significant relationship was found between macroeconomic dynamics on the bankex and individual stocks, suggesting the bankex exhibit the strong -form of market efficiency.
REFERENCES
[1] Ajay R A and Mougue M, On the dynamic relation between stock price and exchange rate, Journal Financial Research, 1996. [2] Donald E Fisher and Ronald J J, Security analysis and portfolio management, Prentice Hall India, 2004. [3] John Ammer, Inflation, inflation risk and stock returns, International Financial Discussion Paper, No.464, 1994, Board of Governors of Federal Reserve System. [4] Ma C K and Kao G M, On exchange rate changes and stock price reactions, Journal of Business Finance and accounting, 17(3), 1990. [5] Suresh C Srivastava, Interest rate sensitivity of bank stock returns: re-examination since Basel Accords. University of Alaska Anchorage. [6] Business line Newspaper, Various Issues.
Websites
[7] [8] [9] [10] [11] [12] [13] Finance Ministry OPEC RBI Website www.yafinance.com India stats World gold organization www.bseindia.com
RoleofFinancialInnovationinMaking BankinganOrganizedCompetitiveSector
RaginiSingh*
AbstractInnovation is an indispensable part of growth. As financial sector has undergone a complete re-engineering, financial innovation has a major role to play. Financial innovation is a term used to describe new and creative approaches to different financial circumstances. Financial innovation is all about offering an idea or financial instrument that is different from what has gone before, and has the potential to be desirable in long run. A number of innovative financial strategies and instruments have come into being since the decade of the 1980s. One example is the creation of interest rate swaps in the early years of that decade, innovation that allowed many companies and investors to take advantage of the dramatic increase in interest rates that was taking place. In recent years, the development of the credit default swap also allowed businesses to more effectively manage the increasing number of defaults on loans, mortgages, and other forms of credit that took place as the world economy The commercial banking has changed dramatically over 25 years. Commercial banks embedded as part of various innovations like ECS, RTGS, EFT, NEFT, ATM, Retail Banking, Debit & Credit cards, fund transfers, internet banking, mobile banking, selling insurance products, travel cheques and many more value added services. The paper studies how technological change and financial innovation has helped to transform banking from a Government undertaking to competitive corporate institution. We then survey the literature relating to several specific financial innovations, which we define as new products or services, production processes, or organizational forms. Keywords: Financial innovation, Interest rate swaps, Credit default swaps, Retail banking, RTGS, NEFT etc.
OBJECTIVES
This paper discusses the technological changes and financial innovations that commercial banking has experienced during the past twenty-five years. The paper aims to study the various new financial products introduced in the banking sector post liberalization. The level of acceptance of these services by the common customers. Analysis and impact of these innovations on the growth and development of Banking sector in India.
LITERATURE REVIEW
In early study, western scholars searched the original motive of financial innovation through different ways. In earlier time, Greenbaum and Haywood (1973) reviewed the history of * Tirpude Institute of Management Education, Nagpur
American financial market and argued that the growth of wealth is the determinant of demand of financial innovation. In other words, the fast development of economy caused financial innovation to develop at a high speed. Besides, there are four famous theories of the innovation motive, including constraint-induced financial innovation theory of W.L.Silber, transaction cost innovation theory of Hicks and Niehans, regulation innovation theory of Davies and Silla, and circumvention innovation theory of Kane.American economist Silber (1983)]advanced constraint-induced financial innovation theory. This theory pointed out that the purpose of profit maximization of financial institution is the key reason of financial innovation. Constraint-induced innovation theory discussed the financial innovation from microeconomics, so it is originated and representative. But it emphasized innovation in adversity excessively. So it cant express the phenomenon of financial innovation increasing in the trend of liberal finance commendably. Financial institutions deal with the status such as the reduction of profit and the failure of management induced by government regulations in order to reduce the potential loss to the minimum. Therefore, financial innovation is mostly induced by the purpose of earning profit and circumventing government regulations. It comes true through the game between government and microcosmic economic unity. Kanes theory is different from the reality. The regulation innovation he assumed is always towards the direction of reinforcing regulation, however, the regulation innovation in reality is always towards the direction of liberal markets innovation, the result of the game is release of financial regulation and market become more liberal. But his theory is better than constraint-induced financial innovation theory. It not only considered the origin of innovation in the market but also researched the process of regulation innovation and their dynamic relation. Regulation innovation theory was put forward by Scylla etc. in 1982. They argued researching financial innovation from the perspective of economy development history. And they thought financial innovation connects with social regulation closely, and it is a regulation transformation which has mutual influence and is mutual causality with economic regulation. They thought that it is very difficult to have space of financial innovation in the planned economy with strict control and in the pure free-market economy, so any change leaded by regulation reform in financial system can be regarded as financial innovation. The Omni-directional finance innovative activities can only appear in the market economy controlled by government. When government's intervention and the management have hindered the finance activities, there will be many kinds of financial innovation which intend to circumvent or get rid of government controls. The game between the market and government finally form the spiral development process, namely, controlinnovate controls again-innovates again. The transaction cost innovation theorys main pioneers are Hicks and Niehans (1983). They thought that the dominant factor of financial innovation is the reduction of transaction cost, and in fact, financial innovation is the response of the advance in technology which caused the transaction cost to reduce. The reduction of transaction cost can stimulate financial innovation and improvement financial service. This theory studied the financial innovation from the perspective of microscopic economic structure change. It thought that the motive of financial innovation is to reduce the transaction cost. And the theory explained from another
perspective that the radical motive of financial innovation is the financial institutes purpose of earning benefits. Since the late 80s, foreign scholars mainly researched the financial innovation theory in the designing of securities and the direction of general equilibrium, and carried on analyzing the application of financial innovation and the process of diffusion. These theories and viewpoints discussed the motive and the process of financial innovation from different sides. According to the Location Theory, they advanced the financial innovation microscopic economic model. Desai and Low (1987) utilized this theory to confirm and measure the gap in the scope of acquirable product in financial market, which indicates the potential opportunity of the new products innovation and promotion. Chen (1995) built the financial intermediacy model in which new security secured by old security is created. In the period of decomposing the old securities and opening new market, innovators play an influential economical role. For example, investors can obtain the consumption at lower cost; investors can realize a better share of risks. His research indicated that even when introducing the surplus securities which are not distributed yet, the innovators can also play these roles. In other words, although these innovations have not changed the scope of acquirable financial tools, it makes investors trade at lower expected cost. The main focus is on security designing in incomplete financial market. Rahi (1995) used a simple parametric framework for comparing alternative incomplete asset structures in a productive economy, focusing on the role of assets in allocating risk and transmitting private information. Based on an empirical study in the financial services sector, Patrick (2003) first describes how financial companies organize their innovative processes and what barriers to innovation can be identified in banks and insurance companies. The author pointed out that large firms often do have more difficulties with the development of new products than smaller firms. The most important changes that are needed for these organizations to become more innovative are concerned with the organizational structure, the underlying values, beliefs and information technology. Michael and Arnold (2004) studied the Hong Kong banking industry to examine the role of information complementarily and market competition in governing the diffusion of off-balance-sheet (OBS) financial innovations. A simultaneous equation model is devised to estimate the impacts of information complementarily, market competition, and a number of other factors on the diffusion of OBS financial innovations. Therefore, it is very necessary for us to develop our financial innovation. And the research about financial innovation in commercial banks has gradually increased.
The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India. Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money have become the order of the day. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below: Early phase from 1786 to 1969 of Indian Banks Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms. New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.
PHASE
The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority. During those days public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.
PHASE
Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal
agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalized. Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949: Enactment of Banking Regulation Act. 1955: Nationalization of State Bank of India. 1959: Nationalization of SBI subsidiaries. 1961: Insurance cover extended to deposits. 1969: Nationalization of 14 major banks. 1971: Creation of credit guarantee corporation. 1975: Creation of regional rural banks. 1980: Nationalization of seven banks with deposits over 200 crore.
After the nationalization of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.
PHASE
This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices. The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.
Economists use the word innovation in an expansive fashion to describe shocks to the economy (e.g., monetary policy innovations) as well as the responses to these shocks (e.g., Euro deposits). Broadly speaking, financial innovation is the act of creating and then popularizing new financial instruments as well as new financial technologies, institutions and markets. The innovations are sometimes divided into product or process innovation. The primary function of a any banking system is to facilitate the allocation and deployment of funds. History shows that financial innovation has been a critical and persistent part of the economic landscape over the past few centuries In the years since Millers 1986piece, financial markets have continued to produce a multitude of new products, including many new forms of derivatives, alternative risk transfer products, exchange traded funds, and variants of tax-deductible equity. A longer view suggests that financial innovation is an ongoing process whereby private parties experiment to try to differentiate their products and services, responding to both sudden and gradual changes in the economy. The banks have come a long way as far as development and contribution to the economy is concerned. A major factor that has brought banking to such a stage is FINNCIAL INNOVATION. The various innovations in banking and financial sector are ECS, RTGS, EFT, NEFT, ATM, Retail Banking, Debit & Credit cards, free advisory services, core banking services, implementation of standing instructions of customers, payments of utility bills, fund transfers, internet banking, telephone banking, mobile banking, selling insurance products, issue of free cheque books, travel cheques and many more value added services. Some of the popular financial innovative products are as follows: Products Mortgage loans: are one suite of products that have experienced a great deal of change over the past 25 years in the United States. In 1980, long-term fully amortizing fixed-rate mortgages were the norm and this product was offered primarily by thrift institutions. Moreover, these loans required substantial down payments and a good credit history and the accumulated equity was relatively illiquid. These characteristics have markedly evolved. The first big change occurred in the early 1980s with the widespread introduction of various types of adjustable-rate mortgages (ARMs), which had previously been banned by federal regulators. The Tax Reform Act of 1986, which ended federal income tax deductions for non-mortgage consumer debt, spurred substantial growth in home equity lending. One mortgage innovation more directly tied to technological change is subprime lending, which was originally predicated on the use of statistics for better risk measurement and risk-based pricing to compensate for these higher risks. However, the subprime mortgage crisis has uncovered significant shortcomings in the underlying statistical models. Subprime Mortgages: Subprime mortgage lending, broadly defined, and relates to borrowers with poor credit histories or high leverage as measured by either debt/income or loan-to-value. This market grew rapidly in the U.S during the first decade of the twenty-first century averaging about 20% of residential mortgage originations between 2004 and 2006.
At the end of 2007, subprime mortgages outstanding stood at $940 billion; down from over $1.2 trillion outstanding the previous year (Inside Mortgage Finance 2008). Since the onset of the subprime mortgage crisis, research has attempted to identify various sources of the problem. Mayer, Pence and Sherlund (forthcoming) provide an overview of the attributes of subprime mortgages outstanding during this time and investigate why delinquencies and defaults increases so substantially. These authors, as will as Gerarbi, Lehnert, Sherlund, and Willen (forthcoming), point to significant increase in borrower leverage during the mid-2000s, as measured by combined loan-to-value (CLTV) ratios, which was soon followed by falling house prices. Services Recent service innovations primarily relate to enhanced account access and new methods of payment-each of which better meets consumer demands for convenience and ease. Automated Teller Machines (ATMs), which were introduced in the early 1970s and diffused rapidly through the 1980s, significantly enhanced retail bank account access and value by providing customers with around the clock access to funds. ATM cards were then largely replaced through the 1980s and 1990s by debit cards, which bundle ATM access with the ability to make payment from a bank account at the point of sale. Over the past decade, remote access has migrated from the telephone to the personal computer. Online banking, which allows customers to monitor accounts and originate payments using "electronic bill payment," is now widely used. Stored-value, or prepaid, cards have also become ubiquitous. Debit Cards: Debit cards are essentially "pay-now" instruments linked to a checking account whereby transactions can happen either instantaneously using online (PIN based) methods or in the near future The primary line of research relating to online banking has been aimed at understanding the determinants of bank adoption and how the technology has affected bank performance. In terms of online adoption. Furst, Lang, and Nolle (2002) find that U.S. national banks (by the end of the third quarter of 1999) were more likely to offer transactional websites if they were: larger, younger, affiliated with a holding company, located in an urban area, and had higher fixed expenses and non-interested income. Turning to online bank performance, De Young, Lang, and Nolle (2007) report that internet adoption improved U.S. community bank profitability primarily through deposit-related charges. In a related study, Hernando and Nieto (2007) find that, over time, online banking was associated with lower costs and higher profitability for a sample of Spanish banks. Prepaid Cards: As the name implies, prepaid cards are instruments whereby cardholders "pay early" and set aside funds in advance for future purchases of goods and services. (By contrast, debit cards are "pay-now", and credit cards are "pay later"). The monetary value of the prepaid card resides either of the card or at a remote database. According to Mercator Advisory Group, prepaid cards accounted for over $180 billion in transaction volume in 2006.
Prepaid cards can be generally delineated as either "closes" systems (e.g., a retailerspecific gift card, like Macy's or Best Buy) or "open" systems (e.g., a payment-network branded card, like Visa or MasterCard). Closed-system prepaid cards have been effective as a cash substitute on university campuses, as well as for mass transit systems and retailers.
PRODUCTION PROCESSES
The past 25 years have witnessed important changes in banks production processes. The use of electronic transmission of bank-to-bank retail payments, which had modest beginnings in the 1970s, has exploded owing to greater retail acceptance, online banking and check conversion. In terms of intermediation, there has been a steady movement toward a reliance on statistical models. For example, credit scoring has been increasingly used to substitute for manual underwriting and has been extended even into relationship-oriented products like small business loans. Similar credit risk measurement models are also used when creating structured financial products through "securitization". Statistical modeling has also become central in the overall risk management processes at banks through portfolio stress testing and value-at-risk models each of which is geared primarily to evaluating portfolio value in the face of significant changes in financial asset returns. Asset Securitization: Asset securitization refers to the process by which non traded assets are transformed into the U.S., securitization is widely used by large originators of retail credit specifically mortgages, credit cards and automobile loans. As of year-end 2007, federally sponsored mortgage pools and privately arranged ABS issues (including private-label mortgage-backed securities) totalled almost $9.0 trillion in U.S. credit market debt outstanding.
By contrast, as of year-end 1990, these figures were $1.3 trillion, respectively. One recent innovation in the structured finance/securitization area is the introduction of collateralized debt obligations (CDOs). According to Long staff and Rajan (2006) these instruments, which were first introduced in the mid-1990s, are now in excess of $1.5 trillion. Like ABS, CDOs are also liabilities issued by financial-institution-sponsored trusts, which essentially pool and restructure the priority of cash flows associated with other types of risky financial assets, including senior and mezzanine ABS, high-yield corporate bonds and bank loans. Risk Management: Advances in information technology (both hardware and software) and financial theory spurred a revolution in bank risk management over the past two decades. Two popular approaches to measuring and managing financial risks are stress-testing and value-at-risk (VaR). In either case, the idea is to identify the level of capital required for the bank to remain solvent in the face of unlikely adverse environments. Organizational Forms: New bank organizational forms have emerged in the United States over the past few decades. Securities affiliates (so-called "section 20" subsidiaries or the creation of "financial holding companies") for very large banks and Subchapter S status for very small banks, were the by product of regulatory/legal evolution. Indeed, only one new organizational form, the internet-only bank, arose
from technological change. These institutions, which quickly emerged and disappeared, may represent an interesting laboratory for the study of "failed" financial innovations. We believe that understanding such experimental failures may hold important insights for understanding the keys to successful innovations.
RESEARCH ResearchProblem
The paper aims to study the various financial innovations that took in the banking sector in last decade. It will study the level of awareness and the level of acceptance of these innovations among common man. Last but not the least a brief study on the contribution of these innovations on the economic growth.
ResearchMethodology
The research has been done based on both, the primary data as well as the secondary data. Primary Data: A sample of 100 customers was taken randomly to collect the required data for conducting the research. Some data was collected by way of interviewing the bank managers of five banks: State Bank of Indie, Dharampeth, Nagpur ICICI, Ramdespeth , Nagpur Canara Bank, Gandhinagar, Nagpur HDFC, Shankarnagar, Nagpur Axis Bank, Laxminagar, Nagpur
Secondary Data: This data is basically and only used for analyzing the contribution of banking innovations on its growth and revenue towards the country. This data is collected from the internet.
Awareness levels and the number of people availing the services of internet banking
Credit and loan facilities: formalities, procedures, mortgages have become simple and easier.
Inference drawn from interviewing the bank employees of the sample banks.
The awareness levels of people have risen to a considerable extent and also the number of people approaching banks for loans and advances has also risen by 65% as compared to the last decade. The number of customers using internet banking has also improved from 5% to 15% in last five years. Core banking and RTGS though not much popular among individual customers (12%) but is well accepted and exercised by the corporate houses and the employees (68%)
RoleofBankingInnovationstowardsEconomicGrowthandNationalIncome
The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. A few banks have established an outstanding track record of innovation, growth and value creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in the sector remain limited to a small part of it. Summarized data of the adjusted PAT (profit after tax)
( in crores) Adjusted PAT Adjusted PAT Adjusted PAT Adjusted PAT Adjusted PAT mar'10 3,890.47 2,944.68 9,176.51 3,909.62 3,018.65 mar'09 3,740.62 2,240.75 9,124.18 2,893.07 2,071.59 mar'08 4,092.12 1,589.48 6,718.08 1,890.54 1,563.92 mar'07 2,995.00 1,142.50 4,529.18 1,102.46 1,420.32 mar'06 2,532.95 870.51 4,404.73 865.05 1,342.83
From the above we can comprehend that there has been a constant and consistent growth in the profit of the sample banks. A major reason for this success is the increase in the amount and the variety of products offered by the banks. There has been a considerable rise in the turnover of the cash in-flows and the cash out flows. As the services have increased, the earnings have also increased in the form of commissions and the brokerage and other value-added services. As the individual profits have risen, this has also contributed and added to the economic growth and revenue of the nation.
CONCLUSION
Post LPG policy, as the private players entered the Indian economy, the level of competition led to a lot of customization of the services in the banking services. Debit cards, credit cards, core banking, RTGS, interest rate swaps etc. though have been implemented by the banks, yet it is not very popular among common set of customers. From the above we can also conclude that the there is still a lot of unexplored area will is still left to be popularized among India.
Another conclusion that can be drawn from this study is that the corporate houses have benefitted more from the financial innovations in the form of interest rate swaps, credit rate swaps, asset securitization, and mortgage loans as compared to the individual customers. The contribution of service industry has risen from 42% to 54% towards Indias GDP in last five years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.
REFERENCES
[1] Mohd. Arif Pasha, "Financial Markets and Intermediaries", Kalyani Publishers, New Delhi, 2009 [2] Mohan, Rakesh. 2004 a. "Finance for Industrial Growth." RBI Bulletin, March. 2004b. "Ownership and Governance in Private Sector Banks in India." RBI Bulletin, October. [3] 2006. "Financial Sector Reforms and Monetary Policy: The Indian Experience." RBI Bulletin, July. [4] 2007. "India's Financial Sector Reforms: Fostering Growth while Containing Risk [5] Allen, F. and D. Gale (1994), Financial Innovation and Risk Sharing (MIT Press, Cambridge, MA). [6] National income report on Rediff research .com
INTRODUCTION
During the two decades 1971-91 the formal agricultural credit system comprising the National Bank for Agriculture and Rural Development (NABARD) rural and semi urban branches of Scheduled Commercial Banks (SCBs), Co-operatives and Regional Rural Banks (RRBs), has expanded sizably in quantitative terms in response to the increasing need for effective credit support to farmers for the meeting working capital as well as investment needs. However, the benefits of this green revolution have been largely limited to areas having irrigation potential. For the dry land, watershed development programmes have achieved success in some locations but its benefits remain modest as compared to that of green revolution. White revolution, based upon genetic improvement of cow and buffalo, has been relatively better widespread but is perhaps restricted to certain section of farm community. With growing pressures for commercialization and diversification of agriculture in response to growing demands for market and trades need for efficient and effective institutional credit support has accentuated, in addition to other kinds of support such as policy and infrastructure. Credit has been considered not only as one of the critical inputs in agriculture, but also an effective means of economic transformation. A large number of agencies, including cooperatives, regional rural banks, commercial banks, non-banking financial institutions, selfhelp groups and a well spread informal credit outlets together represent Indian rural credit delivery system. These networks apart from working as financial intermediaries also play a key developmental role in the economy. The process of globalization and deregulation of financial institutions have thrown open new challenges and opportunities. The financial institutions need to meet the expanding credit needs of agriculture sector. In an emerging situation agriculture sector in order to enable it to *G.B. Pant University of Agriculture & Technology, Uttarakhand
high value addition and export orientation requires higher credit to strengthen primary production base like land and water, support investment in farm machinery and current inputs. Thus, qualitative dimensions of the credit delivery channel are equally important. The capability of the institutional credit delivery channel will be severely tested in funding farmers at the extremes of the spectrum; small and marginal holdings with more than a third of the production base, and the large and enterprising farmers. As the credit requirements of different sections of producers have specific characteristics of content, scale, timing, mode of payment and back-up services, the quality of credit delivery by various institutions will determine their competitiveness in a deregulated financial regime. The objective of the study is to examine the pattern of profitability of banks and its relationship with rural coverage of banks, share of agricultural credit in total bank credit, and rural credit deposit ratio.
RESEARCH METHODOLOGY
The study is based exclusively on secondary data obtained from various sources. Relevant time series data on profitability of banks, rural coverage of banks, share of agricultural credit in total bank credit, and rural-credit deposit ratio were collected from various publications such as Reserve Bank of India Bulletins, Report on Currency and Finance, Statistical Tables Relating to Banks in India, Economic survey of India, Govt. of India, Economic and Political Weekly Research Foundation etc. Growing participation of commercial banks in financing agriculture sprung up many issues in relation to its functioning and viability functions. Profitability of commercial banks is one such important issue. To examine the issue whether expansion in agricultural financing by banks has resulted in erosion of banks profitability, net profit and earning to expenses ratio were regressed separately upon share of agricultural credit in total bank credit and share of rural offices in total offices of banks. Before taking up regression analysis, zero-order correlation matrix for the above variables was constructed to look for the problem of multicollinearity. The regression equations that was undertaken given below: (i) Linear: Y= a + b1x1 + b2x2 + b3x3 Two different sets of equations was used wherein the dependent variabley in one set represents the net profit of banks in lakh rupees and in other represents the earning to expenses ratio. The independent variables xi, which are common for both the sets of equations, are as under: x1 = Proportion of agricultural credit in total bank credit (%) x2 = Proportion of rural branches in total bank branches (%) x3 = Rural credit deposit ratio a = Constant b1, b2, b3 are regression coefficient for x1, x2, x3 respectively.
Total income, by and large, continued to increase from Rs. 685 crore in 1971-72 to Rs. 220756 crore in 2005-06, except few dips here and there. Similarly, total expenses also continued to rise from Rs. 628 crore in 1971-72 to Rs. 196174 crore in 2005-06. In pre-liberalization period it is seen that income to expenses ratio stagnated around 1.1. In post-liberalization period, the ratio showed signs of improvement after mid-nineties. In first two years of post-liberalization period, the ratio worsened perhaps because of adjustments required to implement measures of banking sector reforms.
TABLE2:RURALCOVERAGEOFBANKS,SHAREOFAGRICULTURECREDITINTOTALCREDITANDRURALCREDITDEPOSIT(CD)RATIO Year Rural Coverage of Banks (%) 36.0 36.6 51.2 55.7 56.9 51.2 48.3 44.48 Share of Agricultural Credit in Total Bank Credit (%) Pre-liberalization Period 7.18 9.2 14.2 18.49 14.22 Post-liberalization Period 10.82 11.01 12.68 Rural C-D Ratio
RelationshipbetweenProfitofBanks,RuralCoverageofBanks, ShareofAgricultureCreditinTotalCreditandRuralCDRatio
Increasing financial assistance by Scheduled Commercial Banks to agriculture and rural branch expansion area undertaken in a massive scale after nationalization has resulted in eroding profitability of banks, as is held out in many circles. To examine this issue three sets of regression analysis was done. Income to expenses ratio (Y1), Income (Y2) and expenses (Y3) were separately regressed upon share of rural offices in total bank offices (X1) and rural C-D ratio (X3) for pre-liberalization period, post-liberalization period and the pooled two
periods separately using linear regression models. Before taking up the regression analysis zero order correlation matrices were constructed. The correlation results showed that share of agriculture credit (X2) has high association with share of rural offices (X1) (0.79) and also with rural C-D ratio (X3) (0.71). Therefore, X2 variable was dropped from regression analysis to avoid the problem of multi-collinearty. Thus, income to expenses ratio was regressed upon the two variables X1 and X3 to examine the empirical relationship.
TABLE3:SIMPLECORRELATIONRESULTS,197172TO200506 Rural Coverage of Banks (X1) 1 Rural Coverage of Banks (X1) Share of Agricultural Credit in total credit (X2) Rural C-D ratio (X3) Total Income (Y2) Total Expenses (Y3) Earning to Expenses ratio (Y1) **Significant at 10 per cent level Share of Agricultural Credit in total credit (X2) .787** 1 Rural C-D ratio (X3) Total Total Income (Y2) Expenses (Y3) Earning to Expenses ratio (Y1)
.317 .709**
.073 -.202
.094 -.200
-.456** -.322
-.567** 1
-.575** .998** 1
The regression results showed that in pre-liberalization period (i.e. 1971-72 to 1990-91), the share of rural offices (X1) and rural C-D ratio (X3) turned out to be non-significant variables in explaining the declining earning to expenses ratio (Y1) of banks. In other words, the share of rural offices in total bank offices and rural C-D ratio (X3) have nothing to do with the falling earning to expenses ratio of banks, the ratio which could be taken as a measure of profitability (ability to make profit) of banks. This kind of result is very obvious when one observes the statistics given in table, which clearly indicates that income to expenses ratio began to fall before the pre-liberalization period. In post-liberalization period (i.e. 1991-92 to 2005-06) the linear regression results show that the share of rural offices (X1) and rural C-D ratio (X3) turned out to be significant variables explaining the increasing income to expense ratio (Y1) of banks. In other words, the share of rural offices in total bank offices and rural C-D ratio explains significantly and positively the increasing income to expenses ratio of banks. However, the overall results for the pooled period 1971-72 to 2005-06 do indicate rural coverage of banks having a significant negative effect on profitability (Y1), but not on total income (Y2) and total expenses (Y3). However, rural C-D ratio is found to have significant negative effect on income-expenses ratio, total income and total expenses. Yet, the total variation explained together by the two variables X1 and X3 in profitability is only 26 per cent, but some what higher at 40 per cent and 42 per cent in total income and total expenses respectively. The table 4 results refute the view (through with weak relationship) that increasing involvement of banks in agriculture sector by way of massive branch expansion in rural areas
has been responsible for erosion in profitability of banks. Commercial banks are involved not only in financing agriculture but in many other sectors of the economy such as small, medium and large industries, services, export sector etc. Therefore, there will be so many determinants of banks profitability.
TABLE4:LINEARREGRESSIONRESULTSONDETERMINANTSOFPROFITOFSCHEDULEDCOMMERCIALBANKS Independent/ Variables Dependent Variables Earning to Expenses Ratio (Y1) Total Income (Y2) Total Expenses (Y3) Dependent variables 1971-72 to 2005-06 (Pooled) Constant (A) 1.52 263830.6 224440.4 Rural Coverage of banks (X1) -.008*** 872.6 1247.2 (.003) (2498.5) (2216.2) Rural C-D ratio (X3) -.003***** -6083.2** -5433.8** (.0024) (1845.6) (1637.1) Coefficient of multiple determination (R) 0.26 0.40 0.42 1971-72 to 1990-91 (Pre-liberalization Period) Constant (A) 1.20 -46158.8 -44413.0 Rural Coverage of banks (X1) -.0009 2573.3* 2397.6* (.0031) (589.1) (520.7) Rural C-D ratio (X3) -.0008 -431.0 -376.0 (.0041) (774.6) (684.7) Coefficient of multiple determination (R) 0.37 0.68 0.71 1991-92 to 2005-06 (Post-liberalization Period) Constant (A) 2.02 740065.3 629418.5 Rural Coverage of banks (X1) -.023*** -15508.4* -12753.9* (.0078) (2858.8) (2892.7) Rural C-D ratio (X3) -.0026 2902.3 2496.6 (.0064) (2358.7) (2386.7) Coefficient of multiple determination (R) 0.51 0.79 0.72 Figures in parentheses indicate standard errors of regression coefficients *Significant at 0.01 per cent **Significant at 0.5 per cent, ***Significant at 2.5 per cent, ****Significant at 5 per cent *****Significant at 10 per cent
These determinants could not be included in the present regression model. However, such excluded determinants might affect the banks profit adversely. That is why the combined variation explained by the two factors together in profitability was found to be only in the range of 26 per cent in profitability and 40 to 42 per cent in total income and total expenses. Therefore, the profitability of bank is adversely affected by increasing share of agricultural credit in total bank credit, increasing rural coverage of banks and increasing rural creditdeposit ratio is accepted but these variables account for small (less than 50 percent) variation in the profitability. This indicates that there are non-agricultural factors also adversely affecting the profitability of banks. Commercial banks have been experiencing high volume of non-performing assets (NPAs) in non-agricultural sector also. Their exclusion, and a relatively less number of observations in the time series period, however, makes the results only indicative and not conclusive in the present study.
REFERENCES
[1] Shukla, A.N. and P.P. Dubey (2008), Performance of Commercial Bank credit to Agriculture in India: An Empirical Analysis. Ph.D., Thesis, Submitted to C.S.J.M University Kanpur, U.P. [2] Reserve Bank of India. Report on Trend and Progress of Banking in India, Various Issues from 197172 to 2006-07. [3] Tewari, S.K. (2007),Rapporteurs Report on Trends in Rural Finance Indian Journal of Agricultural Economics, 62 (3), July-Sep., pp.551561.
A.C.A.M.E.L.ModelAssessmentofOldPrivate SectorBanksinIndia
ShwetaMehta*andDr.NirveshMehta*
AbstractThis study investigates performance and financial health of old sector private scheduled banks of India in the context of new regulations and stiff competition. Performance of 13 banks has been analyzed with reference to CAMEL variables (Capital Adequacy, Asset Quality, Management Efficiency, Earnings Quality and Liquidity Management) for a period of ten years from 1996-97 to 2005-06. Paper analyzes and compares each bank's performance; banks are ranked accordingly. The findings of the study reveal that i) The performance of old generation banking industry is not satisfactory; ii) banks should aim for better performance to cope up the changes and competition. Aggregate performance of Federal bank is the best among all the banks, followed by Karur Vysya bank and South Indian bank. This evaluation of Indian banks performance based on internationally accepted model will be useful to investors, customers, bankers, policy makers and the economy in general.
INTRODUCTION
The financial reforms, initiated in India in the beginning of 1990's, have drastically changed the banking scenario of Indian economy. During the pre-liberalization period, the industry was merely focusing on deposit mobilization and branch expansion. The Narasimhan Committee, appointed by Reserve Bank of India (RBI), recommended efficient, productive and competitive financial system in the country. Governments, irrespective of their political affiliations, adopted these recommendations and reduced reserve requirements, deregulated interest rates and gave more autonomy to banks (Roji 2007). To have global standards. India also joined the Basel accord and urged the banks to adhere to the norms by March 2007. Subsequently, this deadline was extended due to the difficulty of banks to implement the recommendations. The regulator, RBI in its guidelines issued in January 2004, liberalized foreign investment in banking sector by allowing foreign direct investment up to 74%. By the end of 2009, foreign banks will get a free hand to grow and acquire other banks in India on an equal footing with banks incorporated in India. Government in favor of any type of merging either a strong bank with another strong bank, or a week bank with a strong bank etc. The banking sector reforms have improved the profitability, productivity, and efficiency of banks; but in the days ahead, banks will have to prepare themselves to face new challenges and more competition. Old Sector Banks are the scheduled banks, which have been operating in the country for long and are considered as traditional banks. By definition, they are banks, which started before the liberalization initiatives in India. These banks are concentrated in a particular geographical area with limited branch network. Their functions were limited mainly *S.K. Patel Institute of Management and Computer Studies, Gujarat
to lending activities. Typical examples are Federal Bank of Kerala and Jammu & Kashmir, Bank of Jammu & Kashmir, which have been concentrating mainly on their home states for longtime. The changed face of Indian banking compelled these banks to become technologically upgraded, customer oriented and cost effective banks with wider geographical coverage.
Abbeviations: PSB: Public Sector Banks, NB: Nationalised Banks other than SBI group of banks, SBI: State Bank of India and other state banks, Pvt. S.B: Private Sector Banks, O. Pvt S B: Old Private Sector Banks, N. Pvt S B: New private Sector Banks, F. Banks: Foreign Banks.
This paper is organized as follows: Section 2 portrays a conceptual explanation of CAMEL model. Section 3 reviews the previous studies, conducted abroad and in India, and section 4 describes the method of analysis. Findings of the study are explained in section 5 and section 7 concludes this study by giving suggestions for improvement.
C.A.M.E.L. MODEL
Over the past decade, bank regulators introduced a number of measures to link the regulation of commercial banks to the level of risk and financial viability of these banks. Risk-based capital requirements and risk based deposit insurance premia are two prominent examples. Right from the beginning of BASEL accord 1 in 1988, economists discussed warning models, which can predict bank failures. Most recently, the regulators have augmented bank exam CAMEL rating model (early warning, off-site surveillance model) to include explicit examiner's assessment of the banks ability to manage its performance. Due to the nature of banking, the important role that banks play in the economy (i.e. capital formation), banks should be more closely regulated than any other type of economic unit in the economy. In this context, the early warning off-site surveillance CAMEL model reflects the likelihood of both financial distress and regulatory intervention. Bank supervisors use both on-site examination and off-site surveillance to analyze and identify the financial viability of banks. The most useful tool for identifying problem banks is on-site examination, in which the examiners travel to a bank to review all aspects of its safety and soundness. On-site examination is, however, both costly and burdensome: Costly to supervisors because of the intrusion in their day today operations. Consequently, supervisors monitor banks' conditions off-site. Another disadvantage is that, the power can be exercised only by regulatory authorities, who are legally not supported by researches, or investors and even lenders and borrowers. Offsite surveillance also provides banks with incentives to maintain safety and security norms between on-site visits. Now CAMEL is accepted as an internationally recognized tool for measuring bank performance and its financial health, since it covers all functional activates related with banking operations. Padmanabhan Working Group (1995), in its report on on-site supervision, recommended for supervisory interventions and introduction of a rating methodology for banks on the lines of CAMEL model with appropriate modification to suit Indian conditions. The Working Group has recommended six rating factors-Capital Adequacy, Assets Quality, Management, Earnings, Liquidity, Systems and Controls (ie., CAMELS). For Foreign Banks, four rating factors, are Capital Adequacy, Assets Quality, Compliance, Systems and Controls (i.e. CACS). Narasimhan Committee (1998) made several important recommendations like introduction of internationally accepted prudential norms, relating to income recognition, assets classification, provisioning and capital adequacy. Accordingly, a framework for the evaluation of the current strength of the system and of the operations and performance of banks has been provided by Reserve Bank's measuring rod' of "CAMELS", which stands for Capital Adequacy, Assets Quality, Management, Earnings, Liquidity and Internal Control Systems.
The main endeavor of CAMEL system is to detect problems before they manifest themselves. The RBI has instituted this mechanism for critical analysis of the balance sheet of banks by themselves and presentation of such analysis before their boards to provide an internal assessment of the health of the bank. The analysis, which is made available to the RBI, forms a supplement to the system of off-site follow up. The entire cycle of inspection and follow-up action are now completed within a maximum period of 12 months. Monitorable action plan for rectification of irregularities deficiencies, noticed during the inspection within a time frame is drawn up and progress in implementation pursued with the bank concerned.
Thus, the present supervisory system in banking sector is a substantial improvement over the earlier system in terms of frequency, coverage and focus as also the tools employed. Nearly one-half of the Basle Core Principles for Effective Banking Supervision has already been adhered to and the remaining is at a stage of implementation. Two Supervisory Rating Models, based on CAMELS and CACS factors for rating of Indian commercial banks and foreign banks operating in India respectively, have been worked out on the lines recommended by the Padmanabhan Working Group (1995). These ratings would enable the Reserve Bank to identify the banks whose condition warrants special supervisory attention.
AssetQuality
Asset Quality reflects the quantity of existing and potential credit risk, associated with the loan and investment portfolio, other real estate owned assets, as well as off-balance sheet transactions. It a1so reflects the ability of management to identify, measure, monitor and control credit risk.
ManagementEfficiency
The ratio in this segment measures the efficiency and effectiveness of management, which is the most important ingredient that ensures the sound functioning of banks. With increased competition in the Indian banking sector, efficiency and effectiveness have become the rule as banks constantly strive to improve the productivity of their employees.
EarningQuality
Earnings reflect the capacity to grow and the financial health of the bank. High earnings signify high growth prospects and low risk exposure and smooth operations. A high value indicates higher profitability and quality of earnings.
LiquidityManagement
Liquidity implies the cash position of the banks and the ability of the banks to meet customers day-to-day cash needs and to respond to sudden cash withdrawals. Liquidity can be stored or purchased. Stored liquidity like loan or deposit ratio is highly correlated with the capital adequacy ratio. It appears redundant. However, purchased liquidity problem will be forced to purchase funds at higher interest rates.
Robert D Young, Joseph P Hughes and Choon Ceol (1998) stated that, due to the nature of banking (banks have opaque asset quality and a substantial portion of their debt is demandable) and the important part that banks play in the economy (the payment system), banks should be more closely regulated than other types of firms. Such a regulatory process is one, on the basis of which the regulators write debt contracts and covenants on behalf of the bank's demandable debt holders, monitor bank's compliance to safety and soundness regulations, and if necessary, enforce these cost! y covenants (e.g. higher deposit premia, more frequent and rigorous examinations, restrictions on investment activities etc), when banks experience financial distress. In this framework, CAMEL rating reflects the likelihood of both financial distress and regulatory intervention. Reducing the regulatory oversight may adversely affect the market's ability to price bank securities effectively. The bank examination process contributes significantly to the market's understanding of financial problems of the banks (John 1999). Confidential supervisory information, garnered through bank examination, can potentially improve the forecasts of key macroeconomic variables, including bank stock performance in the capital market. De Young, Flannery, Lang, and Sorescu (1998) and Berger, Davies and Flannery (2000) found strong evidence to support that a large portion of information contained in CAMEL ratings remains confidential. Hence, the predictable component of CAMEL should be incorporated in the CDP forecasts, leaving CAMEL to serve as a proxy only for that part of the change in bank's health that is unobservable by the public for publicly traded banks. According to Robert De Young (2001), bank supervisors pay closer attention to newly charted banks than to similarly situated established banks. Federal Reserve supervisors conduct full scope examination for safety and soundness of a newly charted bank at six-monthly intervals (established banks are examined every 12-19 months) and will continue to schedule exams at this frequency until the bank receives a strong composite CAMEL rating of 1 or 2 in two consecutive exams.
IndianStudies
Rao and Datta (1998) attempted to derive rating based on CAMEL. In their study, based on these five groups (C-A-M-E-L), parameters were developed. After deriving separate rating for each parameter, a combined rating was derived for all the nationalized banks (19) for the 1998. The study found that Corporation Bank has the best rating, followed by Oriental Bank of Commerce, Bank of Baroda, Dena Bank, Punjab National Bank, etc. The worst rating was found for Indian Bank, preceded by UCO Bank, United Bank of India, Syndicate Bank and Vijaya Bank. Parsuna (2004) analyzed performance of Indian banks by adopting the CAMEL Model. The performance of 65 banks was studied for the period 2003-04 and the author concluded that the competition was tough and consumers benefited from it. Better service quality, innovative products and better bargains are all greeting the Indian customers. The coming years will prove to be a transition phase for banks, as they will have to align their strategic focus to increasing interest rates, according to the author of this study.
Veni (2004) studied the capital adequacy requirement of banks and the measures adopted by them to strengthen their capital ratios. The author highlighted that the rating agencies give prominence to Capital Adequacy Ratios of banks, while rating the bank's certificate of deposits, fixed deposits, and bonds. They normally adopt CAMEL Model for rating banks. Thus, Capital Adequacy is considered as the key element of bank rating. Satish, Sharath and Surender (2005) adopted CAMEL model to assess the performance of Indian banks. They analyzed the performance of 55 banks for 2004-05, using CAMEL Model. Study concluded that the Indian banking system looks sound and information technology will help the banking system grow in strength in future. The review of the studies, it is clear that the CAMEL Model has been used extensively for ranking/rating of the banks. Researchers have generated various variables that significantly relate to CAMEL components and their rating. All the financial ratios taken in this study are quantitative and adequately represent the CAMEL component.
DataSource
The study is based on secondary data. The main sources of data are Capitaline database of Capital Market Publishers (P) Ltd and database of Reserve Bank of India. The study has also made use of data from the annual reports of the banks and websites of respective banks. This study is based on secondary data. The information are collected from annual report of the bank, capital line database and websites. The present study analyzed for a period of 10 years from 1996-1997 to 2005-2006.
PopulationandSample
Population of this study consists of twenty two banks, which are considered and accepted as old generation banks by RBI during various periods. Study analyses the performance for a period of ten years from the accounting year 1996-1997 to 20052006. Bharat Overseas Bank, Global Trust bank, Lord Krishna Bank and United Western Bank are excluded due to their merger with other old sector or nationalized banks. Five banks - Sangli Bank, Nainital Bank, Tamilnadu Merchantile Bank, SBI Commercial and International Bank and Ganesh Bank of Kurundwad, due to non availability of sufficient data are also not included. This study uses data of thirteen banks, which we consider sufficient for making a general conclusion about old generation private banking Industry.
Variables
Variablesl used for measuring CAMEL are illustrated in table 2. It is expected that, by increasing the number of variables, the extreme as well as non-significant values can be avoided and quality of study can be improved.
TABLE2:CAMLEVARIABLESANDSUBVARIABLES Sr. No Camel Variable 1 Capital Adequacy 2 Asset Quality Sub variables Ratio Capital Adequacy Ratio, Debt Equity Ratio, Advances to Assets Ratio and Government Securities to Total Investment Ratio. Gross NPAs to Net Advances, Gross NPAs to Total assets, Net NPAs to Net Advances, Net NPAs to Total Assets, Total Investments to Total Assets 3 Management Efficiency Total advances to Total Deposits, Business per Employee, Profit per Employee. 4 Earning Quality Operating Profit To Average Working Funds, Percentage Growth in Net Profit, Spread, Net Profit to Total Assets, Interest Income to Total Income, Non-Interest Income to Total Income 5 liquidity Management liquid Assets to Total Assets, Government Securities to Total Assets, liquid Assets to Demand Deposits, liquid Assets to Total Deposits, Approved Securities to Total Assets Note: In asset quality, variables considered are non performing assets and so higher the rate, lower the performance and in all other cases it is reverse.
Analysis
The first part of the study finds value of each variable, which is basically a ratio. Once, these ratios are computed for every bank for all the years, the overall value of each variable (C/A/M/E/L) is found, by giving a weight equal to the value for the particular variable. Based on these values, performance of banks is compared and conclusions are made.
AnalyticalResults
The objective of this study is to analyze the performance of the banks and to assess the old public sector banks in general. First part of this section describes the performance of the banks individually and second part deals with the overall performance.
CatholicSyrianBankLtd.(CSB)
During the beginning of period of analysis, CSB showed an excellent performance in Capital adequacy variable. But it deteriorated with a negative CAGR. Analysis of asset quality variable fluctuates widely with a mean of 0.14 and SD of 0.03. But the quality is increasing. Efficiency of management is found satisfactory, which shows growth rate of 11.46% even though the bank shows a slight fluctuation wi.th the mean of 0.48 and SD of 0.17. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity management shows a slight growth rate of 1.78%. So, it is concluded that performance of the Catholic Syrian Bank is not satisfactory.
CityUnionBankLtd.(CUB)
The capital adequacy figures show that performance is not consistent with a mean of 6.61 and SO of 1.12 (CAGR is 1.70%). Asset quality is not satisfactory and it fluctuates slightly with the mean of 0.11 and SD of 0.03. Management Efficiency has an excellent growth rate of 43.37%. The earnings quality shows a slight fluctuation with the mean of 0.63 and SD of 0.19. It is found that the performance is improving and CAGR is 10.36%. The liquidity variable also shows that the performance of the bank is poor, since the growth rate is negative. It is concluded that performance of the CUB is moderate.
DevelopmentCreditBankLtd.(DCB)
Capital adequacy ratio of the bank is quite satisfactory with little fluctuations (mean of 7.41 and SD of 0.93) and CAGR of 1.11 %. Asset quality of the bank is not satisfactory and it fluctuates slightly with the mean of 0.10 and SD of 0.02. The efficiency of management improves with a CAGR of 24.91 % and it is almost consistent during the study period. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity variable also shows that the performance of the bank is poor. It is concluded that performance of the DCB is not satisfactory.
FederalBankLtd.(FBL)
The capital adequacy position of the FBL is satisfactory (mean of 7.62 and SO of 1.32) and it is growing at 6.91 %. The asset quality is not satisfactory and it fluctuates widely with the mean of 0.11 and SD of 0.03. The management efficiency of the bank shows a slight fluctuation with the mean of 3.83 and SD of 2.77, it shows high growth rate of 11.20%. It is found that earnings quality performance is improving and compound annual growth rate is 18.11%, even though it fluctuates (Mean of 0.85 and SD of 0.92). The liquidity management shows that the performance of bank is good with a growth rate of 3.32%. So it is concluded that performance of the Federal Bank is satisfactory.
INGVYSYABankLtd.(ING)
The capital adequacy position of the bank is not satisfactory and inconsistent with the mean of 7.2.5, SD of 0.53 and a very low CAG rate of 0.52%. Asset quality is found satisfactory; it is improving too with a negative CAGR. Management efficiency factor reveals that the performance of the bank is very poor with negative CAGR. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity variable shows that the performance of the bank is not satisfactory. The performance of the bank is not satisfactory.
JammuandKashmirBankLtd.(JKB)
Capital adequacy figures of the bank show that the performance of the bank is poor with negative CAGR. Asset quality of the bank is satisfactory, even though it shows a slight fluctuation with mean of 0.09 and SD of 0.01. Bank performed efficiently in management efficiency factor, with an impressing growth rate of 67.92%. The earnings quality shows position of the bank was consistent with the mean of 0.64 and SD of 0.20. Performance is improving with CAGR of 4.04%. The liquidity variable shows that the performance of the bank is poor and growth rate is also negative. So overall performance of the Jammu and Kashmir Bank is moderate.
KarnatakaBankLtd.(KBL)
Capital adequacy factor of the bank improves by 5.77% with the value mean of 6.81 and SO of 1.14. Compared to other banks, its quality of assets is not satisfactory and it is deteriorating too (mean of 0.11 and SD ofO.03). The efficiency of the management improved with a CAGR of 44.56% (mean of 2.11 and SD of 1.37). The earnings quality shows some fluctuation with
the mean of 0.61 and standard deviation of 0.19, but it has a growth rate of 8.81 %. The liquidity management of the bank is good (growth rate is 6.26%). Even though KBL does not fall in the list of best five banks, yet its improving performance shows that performance of the Karnataka Bank is satisfactory.
KarurVysyaBankLtd.(KVB)
Capital adequacy ratio of the bank shows that the performance is comparatively good, but compound annual growth rate is negative. Asset quality of the bank is satisfactory; comparing it with its counterparts it is not improving (mean of 0.09 and SO of 0.02). Management efficiency is considered good with compound growth rate of the 12.51 % and with mean of 6.53 and SO of 4.01. In earnings quality, the performance is poor and the growth rate is negative. The liquidity variable also shows that the performance of the bank is poor. So the performance of KYB is rated as moderate.
LakshmiVilasBankLtd.(LVB)
Capital adequacy position of the bank is not satisfactory and CAGR is very low having rate of 0.01 % (mean of 6.95 and SO of 0.23). Asset quality is satisfactory and it is improving (mean of 0.10 and SO of 0.02). In management efficiency, the bank shows growth rate of 10.49% even though fluctuation is high (mean of 2.50 and SO of 1.34). The earnings quality also shows some fluctuation with the Mean of 0.60 and SO of 0.30. The performance is improving as compound annual growth rate is 22.24%. The liquidity variable shows that the performance of the bank is poor and growth rate is negative. So it is concluded that performance of the LVB is moderate.
RatnakarBankLTD.(RBL)
Capital adequacy performance of the bank is poor with a negative CAGR. Analysis of asset quality variable fluctuates slightly with the mean of 0.08 and standard deviation of 0.01. Further the asset quality is not satisfactory. In management efficiency, it shows growth rate of 20.85% with mean of 0.24 and SO of 0.26. Earnings quality shows a slight fluctuation with mean of 0.20 and SO of 0.08. It is found that the performance is improving with compound annual growth rate of 2.05%. The liquidity variable shows that the performance of the bank is poor and growth rate is negative. So it is concluded that performance of the Ratnakar Bank is not satisfactory.
SouthIndianBankLtd.(SIB)
Capital adequacy of the bank is quite satisfactory, even though the growth is negative. Analysis of asset quality variable fluctuates widely with the mean of 0.11 and standard deviation of 0.03. Further the asset quality is satisfactory and it is improving. Efficiency of the bank is very good and it is improving with a CAGR of 39.33%. Similarly, the earnings quality is improving and CAGR is 19.58%. The liquidity variable shows that the performance is satisfactory. It is concluded that performance of the SIB is moderate.
AssetQuality
Asset Quality measures the efficiency of banks in their management of assets to make maximum return. Table 4 depicts the asset quality values of banks for the given period with the ranks of the banks. The average asset quality has been coming down from 1996-97 to 2001-02 (in quantitative terms it is increasing), and thereafter the performance is rising.
TABLE3:CAPITALADEQUACYVALUE:BESTPERFORMINGBANKS
The Karur Vysya is the topmost bank, followed by Ratnakar Bank and ING Vysya Bank.
Rank 1 11 111 IV V 10 years CSB BOR SIB JKB FBL Considering last 5 years CSB BOR FBL SIB DCB 3 Years BOR CSB DCB FBL SIB
Apart from these, Jammu and Kashmir bank and Federal bank showed a consistent performance. ANOV A suggests the rejection of the null hypothesis. It shows that there is a significant difference in performance in asset quality of banks.
TABLE4:ASSETQUALITY:BESTPERFORMINGBANKS Rank 1 11 111 IV V 10 years KVB RBL ING JKB DCB Considering last 5 years ING RBL JKB KVB FBL 3 Years ING KVB FBL JKB RBL
ManagementEfficiency
Management efficiency of banks has shown inconsistent performance during the period. In 1997" 98, the value was 1.32, the lowest in ten years, it rose to 5.04 in 2003-04. But it again came down to 4.4 in 2005-06. Banks like Karur Vysya Bank, Jammu and Kashmir Bank, lNG Vysya Bank, Federal Bank and Lakshmi Vilas bank have a very consistent and superior performance, while the performance of the banks like Catholic Syrian bank, Rathnakar Bank and Development and Credit Bank is very dismal. The statistical test shows that there is a significant difference in the performance of management efficiency between the old generation private sector banks.
TABLE5:MANAGEMENTEFFICIENCY:BESTPERFORMINGBANKS Rank 1 11 111 IV V 10 years KVB ING JKB FBL LVB Considering last 5 years JKB KVB ING FBL KBL 3 years KVB JKB ING FBL LVB
EarningQuality
Like management efficiency, earning quality of banks is also not consistent during the period of the study. The best performance was in 1999-2000, with earnings quality being 0.82. The worst performance was in 2004-05 with value of 0.18. The performance of the best banks is also like that except for Karur Vysya Bank. Statistically there is a significance difference between the performances of old generation banks. It is found that, Federal Bank is the best performing bank in all the years followed by Karur Vysya Bank and South India Bank.
TABLE6:EARNINGSQUALITY:BESTPERFORMINGBANKS Rank 1 11 111 IV V 10 years FBL KVB CSB SIB JKB Considering last 5 years FBL KVB SIB KBL CUB 3 YEARS FBL SIB KVB CUB LVB
LiquidityManagement
TABLE7:LIQUIDITYMANAGEMENT:BESTPERFORMINGBANKS Rank 1 11 111 IV V 10 years SIB RBL DBL KBL FBL Considering last S years CSB SIB RBL PEL KBL 3 years CSB SIB FBL RBL CUB
The following graph shows the fluctuating nature of performance in all the fields. In case of Liquidity, it is found that the banks have enough liquidity and performance is almost consistent during the last seven years of analysis; but the performance in three years is
better than the remaining period. The leading banks are South Indian Bank, Catholic Syrian Bank and Rathnakar liquidity management, it is found that there is a significance difference between the performances of old generation banks.
CONCLUSION
The study analyzed the overall financial performance of 13 old private sector banks. It assessed the performance on the basis of Capital adequacy, Asset quality, Management efficiency, Earnings quality and Liquidity management of these banks for a period of ten years from 19961997 to 2005-2006. Various ratios have been used to find the position of banks. The result of overall ranks of the selected banks indicate that Federal bank is the best bank, followed by Karur Vysya Bank, South Indian bank, Jammu & Kashmir bank and ING Vysya bank in order.
REFERENCES
[1] Altman E.I. (1967) "Managing the Commercial Lending Process". In R.C. Aspinwall & R.A. Eisenbeis Handbook of Banking Strategy, John Wiley & Sons, 1985, pp.473510. [2] Celestine A vinash (2005) "Basel Babel", Business World, 7th March, p.30 [3] Berger, A.N., and S.M. Davies (1994) "The Information Content of Bank Examinations," FiNance and Economics Discussion Series, no. 9420, Federal Reserve System, July. [4] Berger, Allen N., Sally M. Davies, and Mark J. Flannery (2000) "Comparing Market and Supervisory Assessments of Bank Performance: Who Knows What When?" Journal of Money, Credit and Banking, 32, August. [5] Bodla, B.S. and Verma Richa (2006) "Evaluating Performance of Banks through CAMEL Model: A Case Study of SBI and ICICI", The lCFAl Journal of Bank Management, Vol. V 3, pp. 4963. [6] Das, M.R. (2002) "An Objective Method for Ranking Nationalized Banks", Prajnan, Vol.31, 2, pp.111136. [7] Das M.R. (2002) "Risk and Productivity Change of Public Sector Banks", EPW, Vol.37, 5, pp.437448. [8] De, Young, Robert, Mark J. Flannery, William Lang, and $orin, Sorescu (1998) "Could Publication of Bank CAMELS Ratings Improve Market Discipline? Office of the Comptroller of the Currency, November. [9] Economic Times, (2007) "Banking Sector to see more M & As: Moody's" , Chennai, July 13, 2007, p.1 [10] Flannery, Mark J. (1998) Using market information in prudential bank supervision: a review of the U.S. empirical analysis. 30: 273305. [11] Jordan, John S. (1999) "Pricing Bank Stocks: The Contribution of Bank Examinations", New England Economic Review, 3953. [12] Joshy, P. N .(2005) "A National Banking Policy" EPW, July 9, pp 299698 [13] Leeladhar (2005) "Contemporary and future Issues in Indian Banking", BlS Review, 17/2005. [14] Padmanabhan Working Group, Report, from RBI web site, www.rbi.org.in [15] Parsuna (2004) in Bodla B. S. and Richa Verma (2006) [16] Rao and Datta (1998) in Bodla B. S. and Richa Verma (2006) [17] Reserye Bank of India (1991 and 1998) "Report of the Committee on Financial Sector Reforms -1 & II ", Bombay (Chairman - M. Narasimham) [18] Young, Robert D. (2001) in Bodla B. S. and Richa Verma (2006) [19] Roji George (2006) "Consolidation: An inevitable Opportunity for Kerala based Private Banks" National Conference on Global Competitiveness conducted by Indian Institute of Management, Kozhikode, 2006 [20] Roji George (2007) "Merger: Panacea for Tribulations of Kerala Banks" AlMA Journal of Management and Research, Vol. 1, 2 July, pp. 112.
ANNEXURE
HYPOTHESISTESTRESULTANALYSISOFVARIANCE(ANOVA) Sum of Squares Capital Adequacy Between GropuGroups Within Groups Total Asset Quality Between Groups Within Groups Total Management Between Groups Efficiency Within Groups Total Earnings Quality Between Groups Within Groups Total Liquidity Anagement Between Groups Within Groups Total 1535.617 11454.705 12990.321 3.190E-Q2 9.749E-Q2 .129 490.445 601.966 1092.411 5.943 23.177 29.120 .193 .480 .673 df 12 117 129 12 117 129 12 117 129 12 117 129 12 117 129 Mean Square Square 127.968 97.903 2.658E-Q3 8.332E-Q4 40.870 5.145 .495 .198 1.608E-Q2 4.107E-Q3 F 1.307 Sig. .224
3.190
.001
7.944
.000
2.500
.006
3916
.000
ANNEXURE
CAPITALADEQUACYRATIOOFSAMPLEBANKS
Year/ Banks DBL BOR CSB CUB DeB FBL ING JKB KBL KVB LVB RBL SIB 199697 9.75 NA NA 0 23.47 NA 14.21 15.88 NA 12.76 10.64 NA 8.28 199798 11.39 NA NA 11.6 19.79 9.43 12.48 20.48 13.23 14.47 10.35 NA 9.4 199899 10.06 0.83 2.51 0 16.9 10.32 10.63 24.48 10.85 14.53 9.64 NA 10.4 199900 10.02 5.73 NA 13.33 11.34 11.33 12.24 18.82 11.04 15.16 10.45 NA 10.41 200001 9.69 10.57 6.08 13.59 11.28 10.29 12.05 17.44 11.37 15.56 10.21 NA 11.17 200102 11.23 12.07 9.57 13.97 11.49 10.63 11.57 15.46 12.96 16.9 11.54 NA 11.2 200203 10.45 11.29 10.58 13.95 10.08 11.23 9.81 16.48 13.44 17.01 11.35 NA 10.75 200304 13.56 11.18 11.23 13.36 14.26 11.48 11.05 16.88 13.03 17.11 13.79 NA 11.32 2004- 05 10.16 12.75 11.35 12.18 9.88 11.27 9.09 15.15 14.16 16.07 r 11.32 12.03 9.89 200506 9.75 10.6 11.26 12.33 9.66 13.75 10.67 12.14 11.78 14.79 10.79 10.77 13.02
AStudyonApproachandStatusofFinancial InclusioninIndianSubcontinent
Dr.SmitaShukla*andDr.AnjaliGokhru**
AbstractFinancial inclusion of the section of population that does not have access to organized sources of finance is the biggest challenge in front of developing economies in the Indian subcontinent. This paper focuses on current status, practices and approach for financial inclusion in the Indian subcontinent i.e; in countries like Sri Lanka, Pakistan, India etc. The paper also discusses what further changes are required in the current practices to enhance the process of financial inclusion Keywords: Financial Inclusion, Banking, funds, microfinance
INTRODUCTION
Financial Inclusion refers to delivery of Financial Services and Credit at an affordable cost to the vast sections of disadvantaged and low income groups. Various financial services include savings, loans, insurance, payments, remittance facilities and financial counseling / advisory services by formal financial system. According to the Committee for Financial Inclusion in India headed by Dr. C Rangrajan (Former Governor, Reserve Bank of India) financial inclusion may be defined as the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost The basic objectives of Financial Inclusion process is to extend the scope of activities of organized financial system in order to include within its ambit people with low incomes through graduated credit. The basic purpose of Financial Inclusion exercise should be to attempt to lift the poor from one level to another so that they come out of poverty. However financial inclusion scenario worldwide is not very encouraging. According to CGAP Research Report titled Financial Access 2009 (A report based on Survey of financial regulators of 139 countries following result has emerged: Survey indicates that about 70% of adults in developing countries still are excluded from the regulated financial system, despite years of growth in financial sector. The CGAP (Consultative Group to Assist the Poor) is a consortium of 33 public and private development agencies working together to expand access to financial services for the poor in developing countries. CGAP was created in 1995 by these aid agencies and industry leaders to help create permanent financial services for the poor on a large scale (often referred to as microfinance). Reserve Bank of India is actively pushing for the cause of financial inclusion with following aims: To connect people with banking system. The focus is not just on credit * Alkesh Dinesh Modi Institute, Mumbai ** K.S. School of Business Management, Gujarat
dispensation but on long term relation building with the formal banking system. RBI also is aiming at portraying financial inclusion as a viable business model and opportunity while ensuring access to basic banking facilities. The above aims are difficult to achieve in country like India on account of large population spread, social and cultural factors, illiteracy etc. According to NSSO Survey (59th Round), only 27% of total farmer households access formal sources of credit. One third of these groups also borrow from non-formal sources. Overall, 73% of farmer households have no access to formal sources of credit. 51.4 % of farmer households are financially excluded from both formal / informal sources (45.9 million out of 89.3 million). Farm households not accessing credit from formal sources is high in North Eastern ( 96 % ) , Eastern ( 81 % ) and Central Regions ( 78 % ). Exclusion in general is large; it also varies widely across regions, social groups and asset holdings. Poorer the group, the greater is the exclusion. Some idea regarding financial exclusion can also be gathered from basic statistical reports on development and progress of Banking as prepared by Reserve Bank of India. According to RBI reports the population per branch in rural and urban branches in India has changed as following over the years:
POPULATIONPERBRANCH(FIGURESINTHOUSAND) Year 1969 1981 1991 2001 2007 2009 Source: Reserve Bank of India Rural 82 20 14 16 17 17 Urban 33 17 16 15 13 13
According to various reports of RBI on Banking and Finance, by the year 2009 only 48.9 savings bank accounts exist per 100 adults on an all India basis. The coverage in rural areas is only 38.8 accounts per 100 adults. Coverage in urban areas is 75.2 accounts per 100 adults. Coverage in North Eastern (21.2) and Eastern regions (23.3) savings accounts per 100 persons is very low. Here, Eastern includes Bihar, West Bengal, Orissa, Jharkhand, Sikkim & A/N Islands North-Eastern states include Assam, Arunachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland & Tripura Central states are Madhya Pradesh, Chhattisgarh, UP & Uttaranchal Northern States include Haryana, HP, Punjab, Rajasthan, J&K, Delhi & Chhattisgarh. Southern states includes Andhra Pradesh, Karnataka, Kerala, TN, Pondicherry& Lakshadweep, and Western states include Gujarat, Goa, Maharashtra, D& NH,& D& .
70 Changing Dynamics of Finance POSTOFFICESAVINGSBANKACCOUNTS(200708) Circles Andhra Pradesh Assam Bihar (including Jharkhand) Chhatisgarh Delhi Gujarat Haryana Himachal Pradesh Jammu & Kashmir Karnataka Kerala Madhya Pradesh Maharashtra North Eastern Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh Uttarankhand West Bengal Source: India Post Closing Balance of Accounts (Numbers) 6758916 1060231 6016094 568157 901259 1881936 1589198 769235 584051 2980925 2054454 3505423 3354364 510054 2609996 1489937 2735252 8183028 14656722 1043789 5628344 Closing Balance (Amount in Crores) 80.53 316.22 1379.72 241.62 806.03 1198.21 491.13 397.85 212.71 2201.34 212.31 939.88 903.39 494.00 1531.11 282.14 611.83 1106.27 792.09 1408.90 101.39 3066.12
The Government has also taken several other initiatives to strengthen the institutional rural credit system. The rural branch network of commercial banks has been expanded and certain policy prescriptions imposed in order to ensure greater flow of credit to agriculture and other preferred sectors. The commercial banks are required to ensure that 40% of total credit is provided to the priority sectors out of which 18% in the form of direct finance to agriculture and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures supply of credit and subsidies to weaker section beneficiaries. Although these measures have helped in widening the access of rural households to institutional credit, vast majority of the rural poor have still not been covered. Also, such lending done under the poverty alleviation schemes suffered high repayment defaults and left little sustainable impact on the economic condition of the beneficiaries. However in spite of above along with financial inclusion activities of India Post it is being felt that financial exclusion in India is still very high. Thus Reserve Bank of India and government have tried to propose and implement various other formats to provide/ increase the financial inclusion in India. Some of these formats are Banking Correspondent Scheme and development of Micro Finance Institutions in India.
services offered by banking correspondents is enhanced by technology tools like point of sale (POS) devices, mobile phones etc. Such technology devices facilitated by technology vendors help in connecting customer, business correspondent and banks. The Business correspondent and business facilitator scheme is slowly becoming a cost effective medium for financial inclusion during the last few years. However it will also be fair to state that BC and BF scheme has not been able to match the expectation of Reserve Bank of India for furthering the cause of financial inclusion. Nevertheless, the scheme still has been an alternative good medium for achieving following goals: Increasing the outreach of banks, facilitating banks services at lower costs, and bringing even such individuals under the bank net who otherwise would have remained financially excluded. The public sector banks in India that have actively used the business correspondent model are State Bank of India, Indian Bank, Canara Bank, Union Bank of India, Corporation Bank, Oriental Bank of Commerce, Andhra Bank and Punjab National Bank. Among the private sector banks the banks leading in use of business correspondent model have been ICICI Bank, HDFC Bank, and Axis Bank. These banks are generally using non governmental organizations and micro finance institutions as their business correspondents. Business correspondent model is being used by banks to open no frill accounts, to channel payments for programmes like NREGP (National Rural Employment Guarantee Programme) and expanding the microcredit. Some active business correspondent companies/NGO in India are: Eko Aspire Foundation, Fintech Foundation, Zero mass, Basix, Zero Microfinance and saving Support Foundation, Drishtee, Swadhaar Finance ce. The related technology vendors are Eko Financial Services limited, FINO and Little World. India Post has tied up with State Bank of India to act as their banking correspondent. As per data provided by CGAP and RBI HDFC had enrolled 203 banking correspondents and was operating in 13 Indian States and had client reach of over 6, 50, 000 by the end of the year 2008. State Bank of India was using 33 banking correspondents and was operating on all India basis and had reached more than 27, 00, 000 clients by the end of year 2008, ICICI Bank was using 48 banking correspondents and was operating in 13 states in India and had reached over 5, 00, 000 clients by the end of year 2008. The issues and challenges that have emerged under the banking correspondent model are: Problem of dormant accounts according to reports of banking correspondents, more than 80% of the accounts opened by the clients stay inactive because the clients are not financially literate and are not aware of the advantages of banking services. Viability Issues: Under the banking correspondent model the BC cannot charge fees from the client for the services. They are only entitled to commission and service charges paid by the banks. Many banking correspondents are not finding the model viable enough as the current revenue format is not enough to cover their expenses like staff salaries, technology costs etc. Frauds: The banking correspondent staff operates on individual basis with the clients who are illiterate and not familiar with technology. Their have been reports of frauds by banking correspondent staff in handling of cash, incorrect accounting, falsification of records etc.
Shortage of qualified Banking Correspondents It is feeling of the banks that enough qualified vendors are not available that have well trained field agents, are conversant with use of technology and possess management skills of offering financial services.
MICROFINANCE IN INDIA
Indian model of micro-credit is driven by partnership between mainstream credit institutions and indigenous SHGs through intermediaries called micro finance institutions. According to RBI annual report 2005-06, the cumulative number of SHGs linked to banks stood at 2.2 million with total bank credit to theses SHGs at Rs. 11, 398 crores. The Nodal agency for funding the SHGs is NABARD. Today the public and private sector banks such as SBI, ICICI, UTI, ABN Amro etc have also developed impressive micro-finance projects. However activity in micro-finance area is still too little to match the national requirements. Along with above, few of the NGOs engaged in activities related to community mobilisation for their socio-economic development have initiated savings and credit programmes for their target groups. These community based financial systems (CBFS) can broadly be categorised into two models: Group Based Financial Intermediary and the NGO Linked Financial Intermediary. Most of the NGOs like SHARAN in Delhi, Federation of Thrift and Credit Association (FTCA) in Hyderabad or SPARC in Bombay have adopted the first model where they initiate the groups and provide the necessary management support. Others like SEWA in Ahmedabad or BARODA CITIZEN's COUNCIL in Baroda pertain to the second model. Four largest Microfinance Institutions operating in India are SKS Microfinance, Spandana Spoorthy Financials Limited, Share Microfinance Limited, AsmithaMicrofin Limited. As per the data of these above mentioned organizations, they cover more than 8, 00, 000 clients, have loan portfolio of over USD 100 million and asset size of more than USD 170 million by the end of the year 2009. The numbers offered by the microfinance institutions operating in India may seem to be impressive but the real microfinance format under operation in India does not seem to be very satisfactory. The microfinance institutions in India are charging very high rates of interest. This has in recent times, resulted in spate of suicides by individuals on account of their inability to repay MFI loans and interest due on such loans on time and subsequent harassment by collection agents of microfinance institution. In an article published in The Week, (Lalita Iyer, Death by Interest), Vijay Mahajan, founder Chairman of Basix, the first MFI in India, justified high interest rates by saying The basic fact is that providing credit is expensive, difficult and risky. If MFIs have to be sustainable, society will have to get accustomed to the interest rates. Further, unregulated microfinance activity has resulted in multiple financing to same individuals. This has resulted in building up of debt pressure on small borrowers leading to extremes step of suicide by some of them. Microfinance Institutions in India are converting themselves from non profit organizations to profit making entities operating in commercial format. Controversial example of SKS Microfinance is now known to all. A fact finding study conducted by RBI and select banks in 2008 found following:
Some of the microfinance institutions (MFIs) financed by banks or acting as their intermediaries/partners appear to be focusing on relatively better banked areas, including areas covered by the SHG-Bank linkage programme. Competing MFIs were operating in the same area, and trying to reach out to the same set of poor, resulting in multiple lending and overburdening of rural households. Many MFIs supported by banks were not engaging themselves in capacity building and empowerment of the groups to the desired extent. The MFIs were disbursing loans to the newly formed groups within 10-15 days of their formation, in contrast to the practice obtaining in the SHG - Bank linkage programme which takes about 6-7 months for group formation / nurturing / handholding. As a result, cohesiveness and a sense of purpose were not being built up in the groups formed by these MFIs. Banks, as principal financiers of MFIs, do not appear to be engaging them with regard to their systems, practices and lending policies with a view to ensuring better transparency and adherence to best practices. In many cases, no review of MFI operations was undertaken after sanctioning the credit facility.
Grameen Banks branches are located in the rural areas, unlike the branches of conventional banks which try to locate themselves as close as possible to the business districts and urban centers. First principle of Grameen banking is that the clients should not go to the bank, it is the bank which should go to the people instead. Grameen Bank's 21,676 staff meets 7.01 million borrowers at their door-step in 75,950 villages spread out all over Bangladesh, every week, and deliver bank's service. Repayment of Grameen loans is also made very easy by splitting the loan amount in tiny weekly installments. Doing business this way means a lot of work for the bank, but it is a lot convenient for the borrowers. There is no legal instrument between the lender and the borrower in the Grameen methodology. There is no stipulation that a client will be taken to the court of law to recover the loan, unlike in the conventional system. There is no provision in the methodology to enforce a contract by any external intervention. Conventional banks go into 'punishment' mode when a borrower is taking more time in repaying the loan than it was agreed upon. They call these borrowers "defaulters". Grameen methodology allows such borrowers to reschedule their loans without making them feel that they have done anything wrong (indeed, they have not done anything wrong.)When a client gets into difficulty, conventional banks get worried about their money, and make all efforts to recover the money, including taking over the collateral. Grameen system, in such cases, works extra hard to assist the borrower in difficulty, and makes all efforts to help her regain her strength and overcome her difficulties. In conventional banks charging interest does not stop unless specific exception is made to a particular defaulted loan. Interest charged on a loan can be multiple of the principal, depending on the length of the loan period. In Grameen Bank, under no circumstances total interest on a loan can exceed the amount of the loan, no matter how long the loan remains unrepaid. No interest is charged after the interest amount equals the principal. Conventional banks do not pay attention to what happens to the borrowers' families as results of taking loans from the banks. Grameen system pays a lot of attention to monitoring the education of the children (Grameen Bank routinely gives them scholarships and student loans), housing, sanitation, access to clean drinking water, and their coping capacity for meeting disasters and emergency situations. Grameen system helps the borrowers to build their own pension funds, and other types of savings. Interest on conventional bank loans are generally compounded quarterly, while all interests are simple interests in Grameen Bank. There are four interest rates for loans from Grameen Bank: 20% (declining basis) for income generating loans, 8% for housing loans, 5% for student loans, and 0% (interest-free) loans for Struggling Members (beggars). All interests are simple interest, calculated on declining balance method. This means, if a borrower takes an income-generating loan of say, Tk 1,000, and pays back the entire amount within a year in weekly installments, she'll pay a total amount of Tk 1,100, i.e. Tk 1,000 as principal, plus Tk 100 as interest for the year, equivalent to 10% flat rate.In case of death of a borrower, Grameen system does not require the family of the deceased to pay back the loan. There is a built-in insurance programme, which pays off the entire outstanding amount with interest. No liability is transferred to the family.
Grammen bank thus has contributed in a major way in the process of financial inclusion in Bangladesh. Besides Grameen Bank, other institutions that are very active in process of implementation of Financial Inclusion are: Bangladesh Rural Development Board that had 4.7 million active borrowers by the end of the year 2007 and Bangladesh Krishi Bank that had another 521,000 active borrowers by the end of 2007. As per data published in paper titled Financial Inclusion as a tool for Combating Poverty The Bangladesh Approach by Dr. Atiur Rehman, Governor, Bangladesh Bank, the status of financial inclusion in Bangladesh is as follows:
Year Adult# Population in Millions Number of Bank Deposit Accounts (in Million) Number of members in MFI (in millions) 14.63 14.40 18.82 22.89 20.83 20.90 Number of members on Cooperatives (in Million) 7.65 7.67 7.57 7.76 7.92 8.03 8.22 8.44 Financial Inclusion as % of Adult Population 66.21 65.36 71.41 77.33 76.22 78.04
1999 73.16 27.30 2000 75.16 28.40 2001 77.18 30.10 2002 79.59 30.90 2003 80.80 31.30 2004 82.25 31.60 2005 83.80 33.10 2006 84.60 34.50 2007 84.95 35.70 2008 85.78 37.60 # Adult Population here refers to age 15 years and above Source: Bangladesh Bank, 2010
Andhra Pradesh the interest rate charged by microfinance institutions after adding up the hidden charges has been ranging from 25% to 70-75%. The government of Andhra Pradesh promulgated an ordinance recently. This ordinance among other things states and implements the following: [4]
MFIs will now have to specify the area of their operations, the rate of interest and their system of operation and recovery while registering with the Registering Authority.The Registering Authority may, at any time, either suo moto or upon receipt of complaints by Self-Help Groups (SHGs) or the general public can cancel the registration of the MFI after assigning sufficient reasons. The MFIs cannot seek collateral from a borrower by way of pawning or any other security and they will now be required to display the rates of interest rates charged by them in prominent places at their offices. MFIs cannot charge any other amount from the borrower except the charge prescribed in the Rules for submission of an application for grant of a loan.The ordinance also states that the amount of interest should not be in excess of the principal amount. MFIs cannot extend a second loan unless the first loan has been fully paid off. An issue which has become very debatable during recent period has been that microfinance institutions are emerging as profit making bodies. In a public discourse at USA in May 2010, Muhammad Yunus stated that I get very worried when investment funds come to microfinance, said the founder of Bangladeshs Grameen Bank, which pioneered the industry by giving small loans to rural women to start their own businesses. I dont want to excite businessmen that there is profit to be made here, he stated. He appealed that microfinance institutions should not profit from the poor. [5] Further in the zest of financial inclusion it should not happen that bank accounts are created and they then onwards become dormant. Similarly multiple loans should not go to same individual in the microfinance scheme as it increases the debt burden on the poor individuals who are not in position to repay the same. CONCLUSION
The biggest challenge in front of microfinance industry in India and worldwide is to ensure that microfinance and financial inclusion takes place without exploitation of poor in the process. Secondly as microfinance institutions are increasingly looking for profits, it should not happen that they forget that their purpose of existence is financial inclusion at affordable rates. They should not act as loan sharks exploiting the borrower in the process. At the same time the microfinance institutions should be self sustainable in nature. However, this does not mean that they should be able to justify themselves in charging very high interest rates. Instead a cost plus approach is a better approach and basic tenant of this approach should be social objective/service but not charity. Further in the Indian subcontinent, Pakistan and India need to do much more for reduction of financial exclusion.
REFERENCES
[1] D Collins, J Morduch, S Rutherford and O Ruthven (2009). Portfolios of the poor: How the world's poorlive on $2/day (Princeton: Princeton University Press). [2] Rutherford, S (2001). The Poor and their Money (New Delhi: Oxford India Paperbacks). [3] A Chaia, A 3. Dalal, T Goland, MJ Gonzlez, J Morduch and R Schiff (2009). Half the World is Unbanked. [4] T Beck, A Demirguc-Kunt, P Honohan (2007). Finance for All? Policies and Pitfalls in Expanding Access [5] A de la Torre, JC Gozzi and S Schmukler (2007). Innovative Experiences in Access to Finance: Market [6] I Mas (2009). The Economics of Branchless Banking. Innovations, Volume 4, Issue 2 (Boston, MA: MIT Press). [7] T Lyman, D Porteous, and M Pickens (2008). Regulating Transformational Branchless Banking: Mobile Phones and Other Technology to Increase Access to Finance. CGAP Focus Note 43 (Washington, D.C.: CGAP).
Websites
[8] http://www.microfinancefocus.com/news/2010/05/19/state-bank-of-pakistan-devising-strategic-frameworkfor-microfinance/ [9] http://www.sbp.org.pk/MFD/FIP/index.htm [10] http://www.ibtimes.com/articles/72593/20101016/geographic-exclusion-overseas-foreign-workers-from-thephilippines-achieving-financial-inclusion-pan [11] http://indiamicrofinance.com/andhra-pradesh-mfi-ordinance-2010.html [12] http://www.muhammadyunus.org/In-the-Media/dont-profit-from-the-poor-says-grameen-banks-yunus/ [13] http://www.cgap.org/p/site/c/ [14] www.nabard.org/pdf/report_financial/Chap_II.pdfwww.nabard.org/pdf/report_financial/Chap_II.pd [15] www.grameen-info.org
CaseStudyonDocumentaryCredit Mechanism
SonaliDharmadhikari*andDr.H.G.Abhyankar*
AbstractThe buzz word today is Globalization. Due to globalization, volume of cross border trade transactions has considerably increased in the recent past. However, rise in this volume is certainly not without issues related towards settlement of the trade transactions. It is observed that complexities about the trade settlement get accentuated in cross border trading as compared to domestic trading due to various factors differentiating cross border trade from domestic trade. In view of this, there are more than one methods for early settlement like Advance payment, Open Account, Documentary Collection and Documentary Credit etc. of which Documentary Credit also known as Letter of Credit is the most popular and acceptable method being used in international trade settlement. Even though it is considered that Documentary Credit is the most popular and acceptable method assuring payment to the exporter and performance to the importer, errors are likely to creep in the very mechanism of Letter of Credit in case parties to the letter of credit failed in sticking to ICC provisions and guidelines resulting either in non payment or non performance thereby raising doubts about reliability of L/C mechanism itself. Against this background, the hypothetical case based on Documentary Credit method is prepared and presented. The whole case is developed in such a manner that how Exporter may get deprived of payment even though it is assured under L/C and raises a doubt in the mind whether L/C can be treated as a foolproof method amongst all other trade settlement methods. The case progresses by pointing out avoidable errors committed by parties to the L/C while complying UCP provisions and identifies and highlights embarrassing positions to the beneficiaries to the L/C. The case also gives alternative solutions to the problems faced by parties particularly Beneficiary in realizing proceeds of the bill and presents an excellent opportunity to learn principles and practices followed in International Trade Settlements.
INTRODUCTION
In India, the process of globalization started after 1991. Due to globalization, volume of cross border trade transactions has considerably increased in the recent past. However, rise in this volume is certainly not without issues related towards settlement of the trade transactions. It is observed that complexities about the trade settlement get accentuated in cross border trading as compared to domestic trading due to various factors differentiating cross border trade from domestic trade. In view of this, there are more than one methods for early settlement like Advance payment, Open Account, Documentary Collection and Documentary Credit etc. amongst which Documentary Credit also known as Letter of Credit is the most popular and acceptable method being used in international trade settlement. The statistics show that more *Bharati Vidyapeeth Deemed Universitys, Institute of Management and Entrepreneurship Development, Pune
than 85% trade settlement is through Documentary Credit method and hence, it has become an integral part of international trade mainly due to its specific advantages to parties to the letter of credit. The advantages of the Letter of Credit to the Exporter are as follows: Exporter is assured of payment. Exporter gets the facility of discounting his bill i.e. can avail of export finance due to backing of L/C. as compared to bills drawn under collection basis. Exporters do not have to worry about the consignment getting confiscated at the port of destination as L/C opening bank has already verified the relevant provisions of Exchange Control regulations prevalent in the importers country at the time of opening of the L/C.
The advantages of the Letter of Credit to the Importer are as follows: Importer is assured of performance. Importers creditworthiness in the market is established when L/C is opened by the importers banker. Importer is entitled to get finance even though for the short period from the date of payment to the beneficiary till drawing on account of importer.
Due to all above advantages L/C is considered as the most popular and acceptable method assuring payment to the exporter and performance to the importer. In spite of this, the errors are likely to creep in the very mechanism of Letter of Credit resulting either in non payment or non performance thereby raising doubts about reliability of L/C mechanism itself.
OBJECTIVES
To acquaint the reader with statutory basis of cross border trading under documentary credits. To critically analyze ICC provisions pertaining to duties and responsibilities of parties to the letter of credit. To understand the procedure followed in case of amendments and discrepant documents To explore the ways for trade settlement in case L/C mechanism is ineffective. To discuss about efficacy of Documentary Credit.
involved in the case against the backdrop of selected articles of Uniform Customs and Practices for Documentary Credit ICC- 600. The case takes an interesting turn when exporter is really in a fix and dilemma about realizing proceeds of the bill when commitment by the banker becomes ineffective due to avoidable lapses committed by parties to the letter of credit. Before comprehending the case situation, problem, definition and alternative solutions etc. it is necessary to have a conceptual framework of Documentary Credit as a method of international trade settlement.
CONCEPTUAL FRAMEWORK
The mechanism of Documentary Credit popularly called as Letter of Credit is governed as per the provisions of The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 (UCP) however, in order to have more conceptual clarity, the researcher has referred to Clause 2 of earlier version i.e. UCP 500 for the definition part and text of the case, the problem identified and alternate solutions are based on latest version i.e. UCP 600 with reference to Article 16. In the further part, above referred articles are reproduced so as to provide statutory basis. The actual presentation of the case is done later followed by problem identification and alternative solutions. The case concludes with learning principles and gives reader an opportunity to study intricacies involved in cross border trade.
Clause2(UCP500)
Any arrangement however named or described, whereby banker acting at the request of and as per instructions of its own customer or on its own behalf is to make payment to or to the order of third party or authorizes another bank to effect such payment and or to accept and pay such bill of exchanges or authorizes another bank to negotiate provided terms and conditions of the credit are strictly complied with.
Article16(UCP600) DiscrepantDocuments,WaiverandNotice
When a nominated bank acting on its own nomination, a confirming bank, if any, or the issuing bank determines that a presentation does not comply, it may refuse to honor or negotiate. When an issuing bank determines that a presentation does not comply, it may in its sole judgment approach the applicant for a waiver of the discrepancies. This does not, however, extend the period mentioned in sub-article 14(b). When a nominated bank acting on its nomination, a confirming bank, if any; or the issuing bank decides to refuse to honor or negotiate, it must give a single notice to that effect to the presenter.
The notice must state: That the bank is refusing to honor or negotiate; and Each discrepancy in respect of which the bank refuses to honor or negotiate; and that the bank is holding the documents pending further instructions from the presenter; or that the issuing bank is holding the documents until it receives a waiver from the applicant and agrees to accept it, or receives further instructions from the presenter prior to agreeing to accept a waiver ; or that the bank is returning the documents; or that the bank is acting in accordance with instructions previously received from the presenter. o The notice required in sub-article 16(c) must be given by telecommunication or, if that is not possible, by other expeditious means no later than the close of the fifth banking day following the day of presentation. A nominated acting on its nomination, a confirming bank, if any, or the issuing bank may after providing notice required by sub article 16(c) (iii) (a) or (b), return the documents to the presenter at any time. If an issuing bank or confirming bank fails to act in accordance with the provisions of this article, it shall be precluded from claiming that the documents do not constitute a complying presentation. When an issuing bank refuses to honor or a confirming bank refuses to honor or negotiate and has given notice to that effect in accordance with this article, it shall then
CASE
Swastik Co. Ltd., India approached to Bank BK 1 to open a Letter of Credit in favor of Macmilan Co. Ltd. New York. A credit was opened by Bank BK1 for USD 5,30,000/- in favor beneficiary BB. The credit was advised through BK2 who was requested to conform the credit. BK2 accordingly advised the credit and also added its confirmation. The credit was valid up to 31st August 2010. This credit was amended on 23rd May 2010 to increase the value to USD 5,50,000/- On 27 August the beneficiary BB submitted documents for USD 5,50,000 to BK2 and asked BK2 bank to make payment.
th
BK2 refused to make payment stating that its confirmation was only for USD 5,30,000 and the documents tendered were for USD 5,50,000/- BK2 bank offered to forward the documents to the issuing bank BK1. On receipt of documents at the counters of BK1, the issuing bank was unable to effect payment as it was under liquidation and a receiver was appointed.
As described in the case, The Swastik Co. Ltd., India approached BK 1 to open L/C in favor of Macmilan Co. New York for USD 5,30,000. The L/C is advised to the beneficiary through an Advising Bank BK 2 which also is a Confirming Bank. It is pointed out that as per Article 8 of UCP 600, the confirming Bank steps into the shoes of L/C Opening Bank and is also irrevocably committed to pay to the Beneficiary the stipulated amount in the L/C provided documents are strictly in compliance to the terms and conditions of Credit. The case further states that the above, on 23rd May, L/C was amended for value USD 5,50,000 and Beneficiary submitted documents for enhanced value. It is pointed out here that as per Article 10 of UCP 600, the credit being irrevocable in nature any amendment has to be subject to the consent of all parties to the L/C and as per Article 10 b, Confirming Bank may extend conformation and will be irrevocably bound as of the time it advises the amendment. A Confirming Bank may however choose to advise an amendment without its confirmation and if so it must inform the Issuing Bank without delay and inform Beneficiary in its advice. From the description of the Case, it is observed that BK 2, Confirming Bank has neither accepted nor rejected amendment; rather the Case is silent on this issue. The case further states that Beneficiary Macmilan Co. Ltd. presented documents for enhanced value and BK 2 refused to pay stating discrepancy that documents under L/C are overdrawn and simply forwarded documents to Issuing Bank for payment who could not pay due to insolvency. The result was Beneficiary, Macmilan Co. Ltd. though secured his payment through L/C mechanism could neither get payment from Confirming Bank nor from Issuing Bank and goods of enhanced value had already reached to the port of destination. Under the circumstances, when it comes to the fixation of the responsibility and accountability, following points emerged: As per Article 16, it is very clear and states that If an issuing bank or confirming bank fails to act in accordance with the provisions of this article, it shall be precluded from claiming that the documents do not constitute a complying presentation. which clearly means that since the Confirming Bank has failed to follow the discrepant documents
procedure and therefore precluded from refusing payment to the Beneficiary. (It is felt here that in a way, Confirming Banks mistake should have really benefitted the Exporter even though the documents are of enhanced value.) Interestingly, even if it is presumed that BK 2 has adhered to Article 16 f, then Beneficiary would have been required to draw invoice for less amount where goods are of higher value which by all means is impracticable. Hence, it can be said that whether Confirming Bank BK 2 has failed or otherwise, it hardly matters because if discrepancy procedure is followed drawing documents of less amount is impractical and if not followed, the only way out was holding payment and forwarding documents to Issuing Bank as has been done exactly by Confirming Bank. In either case, Exporter is deprived of payment. The fact now remains to be seen that in this typical situation and under the given circumstances, what are the options left so that Exporter would get the payment irrespective of non adherence to the clauses by the parties to the L/C and responsibility and accountability involved in the Case under consideration.
OBSERVATIONS
The researcher is of the view that as per Article 16 d, Five days are given for the scrutiny of the documents and therefore failure on the part of the Confirming Bank is of remote possibility and more possibility is that BK 2 i.e. Confirming Bank will abide by the provisions of Article and may not effect the payment and as described in the case, send the documents to the Issuing Bank and go by options stated above. It is really not understood how Exporter remained unaware of the fact that Confirming Bank has not confirmed the amendment of enhanced value, as such doubt, might have led Exporter to approach the Confirming Bank and all the above problems could easily avoided. In a way, Exporter is also at a fault.
LEARNING PRINCIPLES
The in-depth analysis of the case enables the reader to learn following aspects in cross border trade settlement: The detailed working mechanism of the Documentary Credit operations The roles and responsibilities of parties involved in the Letter of Credit
The procedure to be followed in the event of discrepant documents Irrespective of compliance to relevant UCP provisions, it is ultimately trust between the parties that secured payment and performance in the event of default by either party. The case gave an excellent opportunity to the reader to understand and correctly interpret The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 (UCP) provisions that are being in use from July 2007 superseding earlier ICC 500 version.
REFERENCES
[1] The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 (UCP)UCP 600 [2] The Uniform Customs and Practice for Documentary Credits, ICC Publication No. 500 (UCP)UCP500 [3] Foreign Exchange Dealers Association of India Booklets [4] Cases in International Trade.
BankingontheMobile AStudyofMobileBankinginIndia
Dr.SureshChandraBihari*
AbstractMobile banking is a subset of electronic banking which emphasizes on the banking business as well as the special services of mobile commerce. Electronic banking the execution of financial services via the Internet changed the business of retail banks significantly, at the same time reducing costs and increasing convenience for the customer. The widening spread of Internet-enabled phones and personal digital assistants (PDA) has made the transformation of banking applications to mobile devices as a logical development of electronic banking. This has created a new subset of electronic banking, that is, mobile banking. Mobile banking as that type of execution of financial services in which, within an electronic procedure - the customer uses mobile communication techniques in conjunction with mobile devices. Most relevant is GSM/GPRS, also typical are comparable 2G standards (e.g. IS-136, IS-95) and soon will be evolving 3G-technologies (EDGE, CDMA-2000, and UMTS). While technologies such as e-commerce and payments are limited to computer users with Internet connection and bank account, mobile payments can use technologies as simple as SMS and interactive voice response (IVR) among other things. With mobile penetration of 10 times that of computer and expected to become 1 billion by 2014 (the overall cards market is growing at a 30 per cent compound annual growth rate), it wont be long before India becomes a very large player in the mobile-commerce space. Keywords: Mobile banking, mobile commerce, financial services, mobile payments
INTRODUCTION
Mobile banking is the next frontier in the banking industry, and is expected to dethrone the debit/credit card industry in the future. Electronic banking the execution of financial services via the Internet changed the business of retail banks significantly, at the same time reducing costs and increasing convenience for the customer. The widening spread of Internetenabled phones and personal digital assistants (PDA) has made the transformation of banking applications to mobile devices as a logical development of electronic banking. This has created a new subset of electronic banking, that is, mobile banking. Mobile Banking refers to provision and availment of banking- and financial services with the help of mobile telecommunication devices. The scope of offered services may include facilities to conduct bank and stock market transactions, to administer accounts and to access customized information. As mobile networks are upgraded with WAP, GPRS and UMTS to deliver next-generation multimedia services, the banks are getting ready to unleash services on mobile phones. Customers will be able to view their account statement, transfer funds between accounts, be notified of large payments or get notified of transactions above a predefined threshold, and will have immediate and full control over their finances.
*IBS, Hyderabad
Mobile banking as that type of execution of financial services in which, within an electronic procedure - the customer uses mobile communication techniques in conjunction with mobile devices. Most relevant is GSM/GPRS, also typical are comparable 2G standards (e.g. IS-136, IS-95) and soon will be evolving 3G-technologies (EDGE, CDMA-2000, and UMTS). Mobile banking is divided into two main areas: mobile brokerage which covers securities transactions via mobile devices, especially stock trading, and - mobile banking (in the narrower sense) which covers the account management via mobile devices.
BACKGROUND
Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. Mobile phones have become an essential communication tool for almost every individual. Advent of mCommerce has managed to take mobile VAS to next level, adding tremendous value to telecommunication industry. Mobile banking which is an integral part of mCommerce has become very popular among mobile users ever since its existence in 2007. It creates new, convenient communication and fast financial transactional channel for mobile users which is accessible from anywhere, anytime. Checking account information, balance available, credit/debit card information, cheque status, setting alerts, payment reminders, locating ATMs and bank branches, accessing mini statement, accessing loan and equity statements, insurance policy management, placing orders for cheque books etc via mobile phones are some of the services offered in mobile banking. With multiple access channels such as SMS, downloadable client, mobile Internet (WAP) mobile banking is encouraging mobile users more to explore the service
TOTALMOBILESUBSCRIBERBASEINMAY2010 Indian Telecom Total telephone subscriber base Tele-density Wireless user base (GSM + CDMA + WLL(F)) Monthly additions (Wire line + Wireless) Monthly additions (Wireless) Broadband subscribers Statistics 653.92 55.38% 617.53 15.86 16.30 9.24
MOBILE BANKING-2009 Mobile banking (also known as M-Banking, mbanking, SMS Banking etc.) is a term used for performing balance checks, account transactions, payments etc. via a mobile device such as a mobile phone, pagers etc. To avail this service banks provide with mandatory registration. The registration can be done through visiting the branch, ATM, internet banking sites or through phone call or even SMS in most cases through a JAVA enabled mobile phone. Mobile banking report: Most popular services and income profile (Two month ended March 2009, Urban Indian Mobile Phone Users).
Fig.1:StatisticsonMostPopularMobileBankingServices
Filtering the data further to understand which income groups in urban India use mobile banking more. As depicted in the chart below, mobile banking is most used by subscribers falling in Rs. 1 Lakh to Rs. 2.99 Lakhs income bracket followed by less than Rs 1 Lakh income bracket. Therefore it is observed, mobile banking is more popular among low income group of mobile users than higher income group of mobile users.
Fig.2:MobileBankingusersIncomeProfile
appealing in India today. Various players involved in providing mobile banking services (banks, financial institutions, service providers, operators etc) are therefore expecting a potential growth in mobile banking industry in India.
There are generally two ways to classify mobile banking services. The first method classifies the banking services as 'Push' or 'Pull', depending on the originator of a service session. If the bank sends information as per the already agreed rules, then it is categorized as 'Push'. An example of 'Push' is a minimum balance alert, when the balance goes below a particular amount. On the other hand, when the bank sends information as a response to the request sent by the customers, it is termed as 'Pull'. The second classification of mobile banking services depends on the nature of transactions. So, if a request is send to the bank to for a bank statement, then it is a inquiry-based service, while a request for fund transfer is a transaction-based service. Mobile banking services are not only beneficial for the customers but for the banking institutions as well. These services can significantly lower the operating cost of banking institutions by reducing the dependence on costly call centers. They can also lower the frequency of errors that are usually committed in paper based payments. As mobile banking is a cost effective innovation, it can considerably reduce the financial risk associated with starting a new business initiative. It can also enable banking institutions to closely monitor their new campaigns. Besides this, it can provide a new avenue for selling their products like insurance packages and other banking services. On the other hand, mobile banking helps customers by ensuring the fast processing of their banking transactions. As any kind of financial transaction is immediately reported to the customers, they can easily monitor and detect any error in transactions, or any unauthorized transactions. Today, the mobile and wireless market is one of the fastest growing markets. However, a lack of trust and general awareness has been observed among the people when it comes to mobile banking services. Therefore, it is essential to address issues like security of the banking transactions that are executed from a distant place and transmitted over the air. Besides this, it is also important to ensure the security of financial transactions, if the device is stolen by hackers. If these concerns are properly addressed, then it would help increase the popularity of mobile banking by instilling a sense of trust among the customers. ISSUES IN MOBILE BANKING
The advent of the Internet has enabled new ways to conduct banking business, resulting in the creation of new institutions, such as online banks, online brokers and wealth managers. Such institutions still account for a tiny percentage of the industry.
Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. According to the GSM (mobile based technology) Association and the United Nations the number of mobile subscribers is 4.6 billion in 2010.The mobile technology being improving day by day, banks can offer services to their customers such as doing funds transfer while travelling, receiving online updates of stock price or even performing stock trading while being stuck in traffic. Smart phones and 3G connectivity (now 4G) the advanced technologies in latest mobile phones provide more capabilities, which older text message-phones do not possess. In India however the mobile banking based service is in its budding stages and is mainly based on SMS (Short Message Service)based service, where the customer get details regarding their transactions through SMSes. Other services through mobile internet are evolving but at a faster rate. There are a number of banking models which revolve around the relationship with the end customer. They have been divided into 3 categories: Bank Focused Bank-Led Non Bank-Led.
BankFocusedModel
This can be considered an extension of traditional banking which is branch based. A bank will use low costing new channels to provide banking services such as ATM or internet banking etc to customers. However, the services are largely limited.
BankLedModel
This model gives a very different alternative to conventional banking because the customer can conduct financial transactions with the help of a range of retail agents. This helps the banks to significantly increase the penetration of financial services by using a different delivery channel, a more experienced trade partner etc which can result in significant cost savings for the bank.
NonBankLedModel
This is a model where the bank does not play any part except maybe as a keeper of excess funds and the non-bank has the onus of performing all the functions.
TechnologiesUsedInMobileBanking
Currently, Mobile Banking uses one of the following to provide mobile applications: IVR (Interactive Voice Response) SMS (Short Messaging Service)
IVRInteractiveVoiceResponse
In this, banks have to allot a specific number which customers call to reach an electronic message stored in advance. Customers reach a menu and can choose the options by pressing a number on the keypad and this provides the necessary information. However, this can only be used for enquiry and is relatively more expensive as it involves voice calls. Keeping this in mid, banks should opt for technology based services as one button banking could very well be the future.
SMSShortMessagingService
This is by far the most popular standard to implement mobile banking. The customer can send a SMS to a pre-specified number with the query and the banks can reply with the relevant information. For example the customer can send a SMS regarding the balance available in his account to which the bank generates the appropriate information. However, one of the prime disadvantages is security. Unless password enabled or encrypted, this type of sensitive information should be refrained from sharing as SMS facility and SMS gateway is available on all mobile phones.
WAPWirelessAccessProtocol
Banks can maintain WAP sites which are accessible using a WAP compatible browser on the customers mobile phones. Thus WAP sites can provide significant security which further enables customers to access or carry out transactions, information, trade etc. A WAP based service pre-requires a WAP gateway. Customers use the bank's site through the WAP gateway to carry out transactions, receive information etc.
StandaloneMobileApplicationClients
These are the most promising of the lot as they can be customized to suit the needs of complex banking activities and is secure and reliable. However, this customization can become a major disadvantage of as the applications needs to be customized for each mobile phone. In India, Reliance Infocomm which is the largest CDMA player in the market has 7 million users who have handsets which support J2ME.
While technologies such as e-commerce and payments are limited to computer users with Internet connection and bank account, mobile payments can use technologies as simple as SMS and interactive voice response (IVR) among other things. With mobile penetration of 10 times that of computer and expected to become 1 billion by 2014 (the overall cards market is growing at a 30 per cent compound annual growth rate), it wont be long before India becomes a very large player in the mobile-commerce space. Generally the Mobile banking can offer services such as the following:
AccountInformation
Mini-statements and checking of account history Alerts on account activity or passing of set thresholds Monitoring of term deposits Access to loan statements Access to card statements Mutual funds / equity statements Insurance policy management Pension plan management Status on cheque, stop payment on cheque
Payments,Deposits,Withdrawals,andTransfers
Domestic and international fund transfers Micro-payment handling Mobile recharging Commercial payment processing Bill payment processing Peer to Peer payments Withdrawal at banking agent Deposit at banking agent
Support
Status of requests for credit, including mortgage approval, and insurance coverage Check (cheque) book and card requests Exchange of data messages and email, including complaint submission and tracking ATM Location
ContentServices
General information such as weather updates, news Loyalty-related offers Location-based services
Based on data gathered in April 2009 for Feb/March mobile banking urban Indian customers checking account balance is the most frequently cited reason for using mobile banking. 40 million Urban Indians used their mobile phones to check their bank account balances followed by viewing last three transactions. ICICI bank continues to maintain its leadership extending in mobile space, 42% of all mobile banking users bank with ICICI, followed by HDFC (25.3%).
Filtering the data further to understand which income groups in urban India use mobile banking more. As depicted in the chart below, mobile banking is most used by subscribers falling in Rs. 1 Lakh to Rs. 2.99 Lakhs income bracket followed by less than Rs 1 Lakh income bracket. Therefore it is observed, mobile banking is more popular among low income group of mobile users than higher income group of mobile users.
RBIGuidelines
INTRODUCTION
1.1 Mobile phones as a delivery channel for extending banking services have off-late been attaining greater significance. The rapid growth in users and wider coverage of mobile phone networks have made this channel an important platform for extending banking services to customers. With the rapid growth in the number of mobile phone subscribers in India (about 261 million as at the end of March 2008 and growing at about 8 million a month), banks have been exploring the feasibility of using mobile phones as an alternative channel of delivery of banking services. Some banks have started offering information based services like balance enquiry, stop payment instruction of cheques, transactions enquiry, and location of the nearest ATM/branch etc. Acceptance of transfer of funds instruction for credit to beneficiaries of same/or another bank in favor of pre-registered beneficiaries have also commenced in a few banks. In order to ensure a level playing field and considering that the technology is relatively new, Reserve Bank has brought out a set of operating guidelines for adoption by banks. 1.2 For the purpose of these Guidelines, mobile banking transactions is undertaking banking transactions using mobile phones by bank customers that involve credit/debit to their accounts. It also covers accessing the bank accounts by customers for non-monetary transactions like balance enquiry etc.
http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=1660
Regulatory&SupervisoryIssues
Only banks which are licensed and supervised in India and have a physical presence in India will be permitted to offer mobile banking services. The services shall be restricted only to customers of banks and holders of debit/credit cards issued as per the extant Reserve Bank of India guidelines. Only Indian Rupee based domestic services shall be provided. Use of mobile banking services for cross border transfers is strictly prohibited. Banks may also use the services of Business Correspondent appointed in compliance with RBI guidelines, for extending this facility to their customers. The guidelines issued by the Reserve Bank on Risks and Controls in Computers and Telecommunications vide circular DBS.CO.ITC.BC. 10/ 31.09.001/ 97-98 dated 4th February 1998 will apply mutatis mutandis to mobile banking. The guidelines issued by Reserve Bank on Know Your Customer (KYC), Anti Money Laundering (AML) and combating the Financing of Terrorism (CFT) from time to time would be applicable to mobile based banking services also. Only banks who have implemented core banking solutions would be permitted to provide mobile banking services. Banks shall file Suspected Transaction Report (STR) to Financial Intelligence Unit India (FID-IND) for mobile banking transactions as in the case of normal banking transactions.
RegistrationofCustomersforMobileService
Banks shall put in place a system of document based registration with mandatory physical presence of their customers, before commencing mobile banking service. On registration of the customer, the full details of the Terms and Conditions of the service offered shall be communicated to the customer.
InterOperability
Banks offering mobile banking service must ensure that customers having mobile phones of any network operator is in a position to avail of the service. Restriction, if any, to the customers of particular mobile operator(s) is permissible only during the initial stages of offering the service, up to a maximum period of six months subject to review. The long term goal of mobile banking framework in India would be to enable funds transfer from account in one bank to any other account in the same or any other bank
on a real time basis irrespective of the mobile network a customer has subscribed to. This would require inter-operability between mobile banking service providers and banks and development of a host of message formats. To ensure inter-operability between banks, and between their mobile banking service providers, banks shall adopt the message formats like ISO 8583, with suitable modification to address specific needs.
ClearingandSettlementforInterBankFundsTransferTransactions
To meet the objective of a nation-wide mobile banking framework, facilitating inter-bank settlement, a robust clearing and settlement infrastructure operating on a 24x7 basis would be necessary. Pending creation of such a national infrastructure, banks may enter into bilateral or multilateral arrangement for inter-bank settlements, with express permission from Reserve Bank of India, wherever necessary.
CustomerComplaintsandGrievanceRedressalMechanism
The customer /consumer protection issues assume a special significance in view of the fact that the delivery of banking services through mobile phones is relatively new. Some of the key issues in this regard are given at Annex-II below.
TransactionLimit
8.1 A per transaction limit of Rs. 2500/- shall be imposed on all Mobile Banking transactions. Subject to an overall cap of Rs. 5000/- per day, per customer. 8.2 Banks may also put in place monthly transaction limit depending on the banks own risk perception of the customer.
BoardApproval
9.1 Approval of the Board of Directors (Local Board in case of foreign banks) for the product as also the related security policies must be obtained before launching the scheme.
ApprovalofReserveBankofIndia
10.1 Banks wishing to provide mobile banking services shall seek prior one time approval of the Reserve Bank of India, by furnishing full details of the proposal.
SWOTAnalysisofMobileBanking
Strengths End-users benefit from greater control of their personal finances, as well as time saved by not having to access account details via other channels (Internet, phone, ATM, among others). Bankers are of the opinion that mobile banking gives the banks an opportunity to expand their customer base without incurring additional infrastructure costs. It would also help in financial inclusion as it would provide a large number of unbanked people access to banking services.
Yet another strength is the anywhere/anytime characteristics of mobile services. A mobile is almost always with the customer. As such it can be used over a vast geographical area. The customer does not have to visit the bank ATM or a branch to avail of the banks services. Research indicates that the number of footfalls at a banks branch has fallen down drastically after the installation of ATMs. As such with mobile services, a bank will need to hire even less employees as people will no longer need to visit bank branches apart from certain occasions. Banks would save a huge amount of money on card issuance and merchant acquiring with zero point of sale cost. Mobile banking could be used to make remittances from person to person, banking purposes and to make payments for purchases or services provided. Mobile operators benefit from increased customer stickiness, data usage and, potentially, customer experimentation with other forms of mobile content.
Weaknesses Perception problem. User experience with the Internet on mobile not ideal -- screen size, keypad and slow network speeds. Why not regular HTML browsers like the Safari on the Apple iPhone? Wireless carriers not innovating at faster pace. Lack of standards across platforms and carriers. Many mobile marketing service providers not sophisticated in marketing outreach -don't tell, won't sell. Lack of Trust amongst the users on the new technology
Opportunities Mobile is the future -- no, the present -- of database marketing. Marketers must have mobile loyalty program to complement online and offline. Benefit from marketing dollars pulled from television, print and radio toward more measurable, ROI-driven media, a.k.a., the Internet and mobile. Untapped market potential in The Easy Way Of Marketing Mobile advertising subsidizes content and services for consumers who understand the tradeoff . More SMS text marketing for marketers and retailers targeting offers and alerts to opted-in consumers in database. Make the short code common. More quality content on mobile as publishers launch mobile editions.
Threats Handset Operability: There are a large number of different mobile phone devices and it is a big challenge for banks to offer mobile banking solution on any type of device. Some of these devices support Java Me and others support SIM Application toolkit a
WAP browser, or only SMS. Initial interoperability issues however have been localized, with countries like India using portals like R-World to enable the limitations of low end java based phones. The desire for interoperability is largely dependent on the banks themselves, where installed applications (Java based or native) provide better security, are easier to use and allow development of more complex capabilities similar to those of internet banking while SMS can provide the basics but becomes difficult to operate with more complex transactions. There is a myth that there is a challenge of interoperability between mobile banking applications due to perceived lack of common technology standards for mobile banking. In practice it is too early in the service lifecycle for interoperability to be addressed within an individual country, as very few countries have more than one mobile banking service provider. In practice, banking interfaces are well defined and money movements between banks follow the IS0-8583 standard. As mobile banking matures, money movements between service providers will naturally adopt the same standards as in the banking world. Security: Security of financial transactions, being executed from some remote location and transmission of financial information over the air, are the most complicated challenges that need to be addressed jointly by mobile application developers, wireless network service providers and the banks' IT departments. Scalability & Reliability: Another challenge for the CIOs and CTOs of the banks is to scale-up the mobile banking infrastructure to handle exponential growth of the customer base. With mobile banking, the customer may be sitting in any part of the world (true anytime, anywhere banking) and hence banks need to ensure that the systems are up and running in a true 24 x 7 fashion. As customers will find mobile banking more and more useful, their expectations from the solution will increase. Banks unable to meet the performance and reliability expectations may lose customer confidence. There are systems such as Mobile transaction platform which allow quick and secure mobile enabling of various banking services. Recently in India there has been a phenomenal growth in the use of Mobile Banking applications, with leading banks adopting Mobile Transaction Platform and the Central Bank publishing guidelines for mobile banking operations. Application distribution: Due to the nature of the connectivity between bank and its customers, it would be impractical to expect customers to regularly visit banks or connect to a web site for regular upgrade of their mobile banking application. It will be expected that the mobile application itself check the upgrades and updates and download necessary patches (so called "Over The Air" updates). However, there could be many issues to implement this approach such as upgrade / synchronization of other dependent components. Personalization: It would be expected from the mobile application to support personalization such as : o o Preferred Language Date / Time format
o o o o
MaximizeInnovation
Rapid innovation helps to configure various services from any channel to a mobile. There will be instant delivery of financial services to customers on mobile phones with the new
improved features. Therefore, innovation is the backbone for a mobile banking interface. Growing competition can be tackled by constant up-gradation and innovation.
RobustSecurity
Mobile Banking will require good security with proper encryption and a good referral system in place. This will enable banks to offer complex financial services with a robust security network. A two factor or multi factor encryption with authentication ensures a safe security net enabling banks to protect its customers from the security threats and attacks in mobile transactions.
CostSavings
There is significant cost savings attached for the banks as already discussed. The mobile banking business model is independent of the service provider of the customer, thus reducing the necessity to opt for a revenue sharing model with them. Thus, its attractive for banks to opt for mobile banking.
CustomerDelight
Mobile banking offers convenience and ease of banking to customers using various technologies. Customer convenience has assumed prime importance as it enables customers to make queries regarding account balances, impending loan repayments etc anytime anywhere. Banks can share and disseminate information in a secure framework
IncreaseMarketPenetration
Mobile banking goes a long way in reducing costs and helps increase penetration of services especially in rural areas. Mobiles can now be used as cash and credit cards and enable merchants for faster and safer transactions. It reduces the need to carry plastic money or cash. It also reduces the need to physically access a service point of a bank.
SellMoreServicestoExistingCustomers
Mobile Banking helps understand and address the latent demand among customers. The mobile could then be used as a new functionality or as a different way to interact through the use of technology.
RetentionofMostValuableCustomers
It helps retain the most profitable customers who bring in the most business. This will ensure that they do business with the banks and reduce the chances of them moving to a different bank. Banks can make technology and innovation their core competency as it would be inimitable and difficult for competitors to copy. Banks can thus extend the concept of ease of banking and convenience to all its products through mobile banking technology.
Compatibility
Mobile Banking is not supported in any handset and in India one requires a smart phone or a RIM Blackberry to avail of these services. Some of the handsets have no option of mobile banking at all. Banking application services are available only on RIM and Apple I Phones. Further, the advanced facets of mobile banking are only available on high end sophisticated phones.
Cost
Network service charges are expensive. The costs associated to mobile banking may not be substantial in the presence of an existing compatible device, but charges for data and text messaging are quite high. Some financial institutions charge a premium fee for mobile banking service and for the software. These costs can be very high if there is frequent usage of mobile banking services.
HandsetOperability
A variety of mobile handsets makes it difficult to offer mobile banking services of uniform nature on these devices. They support different application like JAVA ME, SMS or WAP.
CONCLUSION
As far as mobile banking is concerned, its a new type of service offered by the banks to the customers. So its very important for the banks to give due priority to it for its successful implementation. As far as the future scope is considered, it can provide great opportunities for micro financing in the developing countries. Also many technological innovations and researches are required to make the service more effective.
The advantages greatly outnumber the disadvantages and would prove profitable for the banks given the willingness to pay premium by the customers. Banks should invest in up gradation of technology and infrastructure to provide adequate security and ease of transactions etc. With mobile phones becoming a necessity and increasing penetration, banks can tie up with service and handset providers as well. There are lots of people who are aware about the mobile banking but are still rigid to prefer internet banking over mobile banking maybe because of lack of promotional strategies and adequate enthusiasm from the bankers. The customers prefer internet banking over mobile banking and still consider it safer than the mobile banking. There is lack of proper awareness among the customers. They have a wrong risk perception about the mobile banking and consider it insecure and not as reliable as internet and direct banking. They just know that mobile banking exist but are not aware about the services provided. There is a need of deeper penetration for the mobile banking not only in urban areas but also in the rural areas. The banks like Yes bank are moving forward to tap the rural sector by starting its services commercially along with Nokia and Obopay in Chandigarh. Named as Mobile money services by YES Bank, powered by Nokia, it would augment financial inclusion amongst the unbanked and under-banked consumer segments by bringing financial services to the consumer mobile device. This is the first of its kind, providing customers the ability to initiate mobile payments through multiple channels i.e. SMS, IVR, WAP, JAVA and FIRE. This service would eliminate dependence on the physical presence of a branch or availability of internet banking services and will successfully ride on the deep penetration of mobile services in the region. There are about 600 million subscribers in India and 46 per cent of the mobile users dont have any bank account. The bankers must first initiate these people to have bank accounts and then move to the other services like mobile banking and internet banking. The findings also conclude that people are more interested with private sector bank for the mobile banking as they find it more technologically advanced and secure than that of the public sector bank. In a comparative study it can be seen that while private sector bank like HDFC make the mobile banking easy to use and is compatible with any platform while public sector banks like SBI provides a differentiated services depending on the platforms used. So the reputation of the bank also plays an important role. The trust that the customer has with the bank is a key for the expansion of mobile banking. Customers are not much happy about the limit on the transactions as mentioned by RBI. Thus to expand the customer base, the bank can count on mobile banking by targeting a large base of 600 million mobile subscribers and making banking easier and accessible for them. The bankers should create awareness about the various services provided through mobile banking which dont only include account information but also services like stop payment of cheque and enquiries regarding equities. There is a need of building trust among customers and changing their perception towards reliability and riskiness of mobile banking. The bankers must tap on the existing customers and then expand via them. Mobile banking is poised to become the KING of all technologies present in the Banking arena. However, banks going mobile the first time need to tread the path cautiously. The
biggest decision that banks need to make is the set of services that they will allow to prosper to bank upon. Mobile banking through an SMS based service would require the lowest amount of effort, in terms of cost and time, but will not be able to support the full breath of transaction-based services. But, in markets like India, where a bulk of the mobile population users' phones can only support SMS based services, this might be the only option left. Mobile banking has the potential to do to the mobile phone what E-mail did to the Internet. Mobile Application based banking is poised to be a big m-commerce feature. Mobile banking could well be the driving factor to increase sales of high-end mobile phones. Moreover, Bank's need to take a hard and deep look into the mobile usage patterns among their target customers and enable their mobile services on a technology which reaches out to the majority of their customers. Last, but not the least, in a hugely populated country like India, where concepts like Microfinance, SMEs, Self Help Groups etc. are picking up the pace, Mobile Banking can play a fantastic role in bringing about Financial Inclusion in various nations including India by reaching the masses and allowing them to BANK ANYWHERE ANYTIME.
REFERENCES
[1] Roy, P. (2010, June 17). The 4 Rs of mobile banking. Retrieved from http://www.businessstandard.com/india/news/probir-roy4-r\smobile-banking/398434/ [2] Mobile Payment in India Operative guidelines for banks. In RBI Site. Retrieved July 17, 2010, from http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=1365 [3] Multiple Regressions. Retrieved August 3, 2010, from http://www.statisticshell.com/multireg.pdf [4] Tai-Kuei Yu & Kwoting Fang (2009). Measuring the post adoption customer perception of mobile banking services. Journal of cyber psychology & behavior. Doi: 10.1089/cpb.2007.0209 [5] Shi Yu (2009). Factors influencing the use of mobile banking: the case of SMS based mobile banking. [6] Donner, Jonathan & Tellez, Camilo (2008). Mobile banking and economic development: Linking adoption, impact, and use, Asian Journal of Communication, 18(4), 318322. [7] Mobile banking overview (2009). Retrieved from mobile marketing association. [8] Perlman, M. (2008, October 17). Are consumers clamoring for mobile banking? Compete. [9] Editorial (2010, July 15). How to be better banks. In Financial Express. Retrieved from http://in.news.yahoo.com/241/20100714/1273/top-fe-editorial-how-to-be-better-banks_1.html [10] Mobile banking FAQs. Retrieved July 17, 2010, from http://www.hdfcbank.com/personal/access/mobilebanking/mobilebanking_faqs.htm [11] Mobile banking services. Retrieved July 17, 2010, from http://www.statebankofindia.com/user.htm?action=viewsection&lang=0&id=0,1,21,691 [12] A perspective on the history. (2007, November 3). Retrieved from http://mbanking.blogspot.com/2007/11/perspective-on-history.html [13] http://www.hindustantimes.com/StoryPage/Print.aspx?Id=cc3fd5af-37184f70-8ca4-c99e6d399af3 [14] Tiwari, Rajnish and Buse, Stephan (2007): The Mobile Commerce Prospects: A Strategic Analysis of Opportunities in the Banking Sector, Hamburg University Press. [15] Tiwari, Rajnish; Buse, Stephan and Herstatt, Cornelius (2007): Mobile Services in Banking Sector: The Role of Innovative Business Solutions in Generating Competitive Advantage, in: Proceedings of the International Research Conference on Quality, Innovation and Knowledge Management, New Delhi, pp. 886894. [16] Owens, John and Anna Bantug-Herrera (2006): Catching the Technology Wave: Mobile Phone Banking and Text-A-Payment in the Philippines. [17] Pousttchi, Key and Schurig, Martin, Initials. (2004). Assessment of todays mobile banking applications from the view of customer requirements. Retrieved from http://mpra.ub.uni-muenchen.de/2913/ doi: MPRA Paper No. 2913 (Introduction)
[18] Mallat, Niina, Rossi, Matti, & Tuunainen, Virpi Kristiina. (2004). Mobile banking services. 47. [19] Mobile banking: the second wave global mobile banking survey 2008. (2008). Global Mobile Banking Survey 2008, Retrieved from http://www.scribd.com/doc/6409589/Global-Mobile-Banking-Survey-2008 [20] Usman, Tahir, Malik, Abdul, & Kamran, Saif. Emerging trends in it. Mobile Banking, Retrieved from http://www.scribd.com/doc/20616758/Mobile-Banking [21] Padmanabhan, G. (2008). Mobile banking transactions in India - operative guidelines for banks. Retrieved from http://www.scribd.com/doc/6515900/India-RBI-Mobile-Banking-guidelines-20081010-viamedianamacom [22] Mir, Arsalam. (2010). Mobile banking regulatory perspectives. Retrieved from http://telecompk.net/2010/02/28/mobile-banking-regulatory-perspectives/ [23] Alice T. Liu and Michael K. Mithika, Initials. (2009). Mobile banking the key to building credit history for the poor Retrieved from http://docs.docstoc.com/orig/3157267/cf194ada-c71847e4-a70e-a4ab27eb7929.pdf
ANNEX- I TechnologyandSecurityStandards
The security controls/guidelines mentioned in this document are only indicative. However, it must be recognised, the technology deployed is fundamental to safety and soundness of any payment system. Therefore, banks are required to follow the Security Standards appropriate to the complexity of services offered, subject to following the minimum standards set out in this document. The guidelines should be applied in a way that is appropriate to the risk associated with services provided by the bank and the system which supports these services. Banks are required to put in place appropriate risk mitigation measures like transaction limit (per transaction, daily, weekly, monthly), transaction velocity limit, fraud checks, AML checks etc. depending on the banks own risk perception, unless otherwise mandated by the Reserve Bank.
Authentication Banks providing mobile banking services shall comply with the following security principles and practices for the authentication of mobile banking transactions: All mobile banking shall be permitted only by validation through a two factor authentication. One of the factors of authentication shall be mPIN or any higher standard. Where mPIN is used, end to end encryption of the mPIN shall be ensured, i.e. mPIN shall not be in clear text anywhere in the network. The mPIN shall be stored in a secure environment.
Proper level of encryption and security shall be implemented at all stages of the transaction processing. The endeavor shall be to ensure end-to-end encryption of the mobile banking transaction. Adequate safe guards would also be put in place to guard against the use of mobile banking in money laundering, frauds etc. The following guidelines with respect to network and system security shall be adhered to: Implement application level encryption over network and transport layer encryption wherever possible. Establish proper firewalls, intruder detection systems (IDS), data file and system integrity checking, surveillance and incident response procedures and containment procedures. Conduct periodic risk management analysis, security vulnerability assessment of the application and network etc at least once in a year. Maintain proper and full documentation of security practices, guidelines, methods and procedures used in mobile banking and payment systems and keep them up to date based on the periodic risk management, analysis and vulnerability assessment carried out.
Implement appropriate physical security measures to protect the system gateways, network equipments, servers, host computers, and other hardware/software used from unauthorized access and tampering. The Data Centre of the Bank and Service Providers should have proper wired and wireless data network protection mechanisms.
The dependence of banks on mobile banking service providers may place knowledge of bank systems and customers in a public domain. Mobile banking system may also make the banks dependent on small firms (i.e mobile banking service providers) with high employee turnover. It is therefore imperative that sensitive customer data, and security and integrity of transactions are protected. It is necessary that the mobile banking servers at the banks end or at the mobile banking service providers end, if any, should be certified by an, accredited external agency. In addition, banks should conduct regular information security audits on the mobile banking systems to ensure complete security. For channels which do not contain the phone number as identity, a separate login ID and password shall be provided to ensure proper authentication. Internet Banking login IDs and Passwords shall not be allowed to be used for mobile banking.
ANNEX-II CustomerProtectionIssues
Any security procedure adopted by banks for authenticating users needs to be recognized by law as a substitute for signature. In India, the Information Technology Act, 2000, provides for a particular technology as a means of authenticating electronic record. Any other method used by banks for authentication is a source of legal risk. Customers must be made aware of the said legal risk prior to sign up. Banks are required to maintain secrecy and confidentiality of customers' accounts. In the mobile banking scenario, the risk of banks not meeting the above obligation is high. Banks may be exposed to enhanced risk of liability to customers on account of breach of secrecy, denial of service etc., on account of hacking/ other technological failures. The banks should, therefore, institute adequate risk control measures to manage such risks. As in an Internet banking scenario, in the mobile banking scenario too, there is very limited or no stop-payment privileges for mobile banking transactions since it becomes impossible for the banks to stop payment in spite of receipt of stop payment instruction as the transactions are completely instantaneous and are incapable of being reversed. Hence, banks offering mobile banking should notify the customers the timeframe and the circumstances in which any stop-payment instructions could be accepted. The Consumer Protection Act, 1986 defines the rights of consumers in India and is applicable to banking services as well. Currently, the rights and liabilities of customers availing of mobile banking services are being determined by bilateral agreements between the banks and customers. Taking into account the risks arising
out of unauthorized transfer through hacking, denial of service on account of technological failure etc. banks providing mobile banking would need to assess the liabilities arising out of such events and take appropriate counter measures like insuring themselves against such risks, as in the case with internet banking. Bilateral contracts drawn up between the payee and payees bank, the participating banks and service provider should clearly define the rights and obligations of each party. Banks are required to make mandatory disclosures of risks, responsibilities and liabilities of the customers on their websites and/or through printed material. The existing mechanism for handling customer complaints / grievances may be used for mobile banking transactions as well. However, in view of the fact that the technology is relatively new, banks should set up a help desk and disclose the details of the help desk and escalation procedure for lodging the complaints, on their websites. Such details should also be made available to the customer at the time of sign up. In cases where the customer files a complaint with the bank disputing a transaction, it would be the responsibility of the service providing bank, to expeditiously redress the complaint. Banks may put in place procedures for addressing such customer grievances. The grievance handling procedure including the compensation policy should be disclosed. Customers complaints / grievances arising out of mobile banking facility would be covered under the Banking Ombudsman Scheme 2006 (as amended up to May 2007). The jurisdiction of legal settlement would be within India.
ChangingDimensionsofBanking SectorinIndia
Dr.T.AswathaNarayana*andShankarReddyP.*
AbstractThe Indian Banking sector has been the fastest growing in the post liberalization period. The banking industry is undergoing a paradigm shift in scope, content, structure, functions and governance. The information and communication technology revolution were radically and perceptibly changing the operational environment of the banks. But along with this change the banking sector is prone to multiple and concurrent challenges. Increased competition, rising customers' expectations and diminishing customers' loyalty. In such an environment Indian banking sector will have to equip itself to meet the challenges of competition from within the country as well as from abroad. While they more to meet these challenges, they have to ensure that their foundation remains sound and their attention is not distracted from principles of prudent banking. In this background, some of the major challenges and trends which are likely to emerge in future and the strategies to be adopted to combat with these challenges were being covered in this paper. This sort of development, no doubt, would strengthen the banking sector base in particular and Indian economy in general. In view of this, the paper makes an attempt to highlight the changing dimensions of banking sector in India, along with an emphasis on the challenges that the banking sector prone to face, to offer certain strategies for the growth and development of banking sector in India in future.
INTRODUCTION
The service sector has been the fastest growing sector in the post liberatization Period. With the intensification of the pace of ongoing economic and financial sector reference for more liberalization and Globalization of the Indian economy, the Indian Banking industry is undergoing a paradigm shift in scope, content, structure, functions and governance. Their very character, composition, contour and chemistry is changing. The information and communication technology revolution is radically and perceptibly changing the operational environment of the banks. Banking sector is faced with multiple and concurrent challenges, increased competition, rising customer expectations and diminishing customer loyalty. In the complex and fast changing scenario, the only sustainable competitive advantage is to give the customers and optimum blend of technology and personalized service. Banks are in true with each other far introducing sophisticated e-banking facilities to give the customer extra reach and convenience. Banking is the key sector of any economy. Its energy and vitality indicate the health and prosperity of any nation.
OBJECTIVE
The present paper makes an attempt to highlight the changing dimensions of banking sector, to focus on the state of banking sector in the post liberalization period, to make an emphasis on the challenges the sector is facing in India and offer to adopt certain strategies for the growth and development of banking sector in future. *Govt R.C. College of Commerce and Management, Bangalore
StateofBankingSectorinthePostLiberalizationPeriod
After liberalization the Indian banking industry was operating in a highly regulated and protected region. In the changing scenario of liberalization, it was realized that the banking sector would have to play a key role in the economic reforms process. Thus, the Narsimhan Committee was formed to recommend reforms in the banking sector with the objective of granting autonomy and flexibility to the banking industry and improving its efficiency and profitability. The important reform measures recommended by the Narsimhan committee were; Reduction in Statutory Liquidity Ratio (SLR) Reduction in CRR Reduction in priority sector lending Freeing of Interest rates on Deposits and Advances to promote competition in the financial sector. Capital Adequacy Norm. Access to capital markets. Prudential Accounting Norms. Competition through permission to private sector banks.
Most of the measures suggested by the committee have been accepted by the Government. Interest rates have been deregulated over a period of time, branch, licensing procedures have been liberalized and statutory liquidity ratio (SLR) and cash reserve ratio (CRR) have been reduced. The entry barriers for foreign banks and new private sector banks have been rationalized as part of the medium terms strategy to improve the financial and operational health of the banking system by introducing on element of competition into it. In 1994, SEBI for the first time notified regulations to bankers pertaining to public issue. Public sector banks are now allowed to access the capital market to raise funds, leading to a dilution in the shareholding of the govt. Another important dimension of the banking sector reforms was reduction of the non-performing assets. With introduction of securitization Act, 2002, a long felt need has been realized.
ChallengesbeforetheIndianBankingSector
Major challenges which Indian banking sector are facing today and which are likely to be more poignant in the ensuring years in view of the irreversible process of the reforms and resultant verisimilitude of many players entering the banking sector are discussed. Problem of Pressure on Profitability The greatest challenge which Indian banking sector are facing in recent years arises out of pressure on their profitability. With continuous expansion in number of branches and manpower, thrust on social and rural banking, directed sectors lending maintenance of higher research ratios, waiver of loans under ARDR type concessions, repayment default by large industrial corporates and other borrowers, etc, had their telling impact on the profitability of the banks.
Problem of Low Productivity Another ferocious challenges which Indian banking sector are confronting is low productivity. The low productivity has been due to huge surplus manpower, absence of good work culture and absence of employees commitment to the organisation. Problem of Non-Performing Assets (NPA): A Serious threat to the survival and success of Indian banking system is uncomfortably high level of non-performing assets. In its Report on Trend and progress of Banking of India, 1997-98, the RBI reported that gross NPAs as percentage of advances of PSBs was 16 percent as on March 31, 2000 with a colossal amount of about Rs. 52,000 crore being locked up. This might have recently recorded further increase due to default in repayment by the industrial units affected by the two-year old recession. This is much higher than the international level of below 5% Problems from Customers In view of competitive forces, fast changing life style and values of customers who are now better informed, have a wide choice to choose from various banking and non banking intermediaries, become more demanding and their expectation in terms of products, delivery and price are increasing, the PSBs lacking in customers orientation are finding it difficult to even retain their highly valued customers what to talk of attracting the new client particularly when the foreign banks as also the new breed of private sector banks have embarked upon aggressive marketing programmes aiming at niche markets. Competition from Private Banks The commercial banks in India which enjoyed monopoly position until recently are facing perilous challenges particularly on quality, cost and flexibility fronts from the newly emerging players who by dint of their invigorating ambience and work culture supported by pragmatic leadership committed, courteous, affable and friend staff and modern ultra gadgets are offering excellent customer services and marking in roads in the business centers. Competition from Mncs Globalization and integration of Indian financial market with world and the consequent entry of foreign players in domestic market has infused, in its wake, brutal competitive pressure on the Indian commercial banks. Foreign players endowed with robust capital adequacy, high quality assets, world-wide connectivity benefits of economies of scale and stupendous risk management sills are posing serious threats to the existing business of the Indian banks . Problem of Managing Dual of Ownership Managing duality of ownership is a peculiar problem which the PSBs have to encounter because of participation of private shareholders in their share capital. A public sector bank to survive and grow successfully is expected to operate according to the expectations of one of its principal shareholders. In the changed scenario, there would be two major groups of
shareholders, viz., the Government of India and RBI on the one hand and the private shareholders, on the other.Since the expectations of these two categories of owners are not necessarily identical, the bankers will have to manage conflicting interests. Problem of Managing Customers' Diverse Strata Another very important challenge which PSBs are faced with is managing two ends of spectrum of banking services. PSBs, unlike their counterparts in the private sector as also the foreign banks have two faces; a commercial side and non-commercial side, each having various strata. In a country like India with wide disparities in needs, standards and ways of living of the people in various regions, the bankers are expected to manage these different starts in its total expanse equally well without ignoring any of the or even performing one at the expense of the other. Challenge of Qualitative Changes in Banking Paradigm The greatest challenge which Indian banks are facing is to bring about change in the mindsets and attitude of the employees and inculcate. Bank employees in India as noted earlier, are highly cynical and less motivated with decreasing loyalty towards their work life. They are not very much concerned with their productivity and lack cost consciousness. Strong and militant trade unions resisting any organizational change and archaic approach of managing have also been the barriers to bank development.
EvolvingofStrategiesfortheGrowthandDevelopmentofBankingSectorinFuture
Visualizing the scenario in the years ahead, success would crucially depend on strategically effective and intelligent management of marketing and customer relationships. Intensely Competitive Market The market has changed drastically and has become largely customer centric. The key to success in this changed competitive environment will be one's ability to reach the client at his door step and meet his requirements of product and services in a customized manner. This development is indeed welcome as it has immense potential for growth of banking business in future but it has its own draw back as there could be adverse selection of customers. Need-Based Technology Technology is increasingly finding its use in banking by way of conveience in product delivery and access, managing productivity and performance, product design adapting to market and customer needs and access to customer market. For the Indian Banking Sector, these development are of significant interest in the future. The ability to access and share information will contribute in improving efficiency and value additing, moreover; focus on ebanking will open new business potential and opportunities for banking sector. Consolidation through Mergers Globalization has brought severs competitive pressures to bear on Indian banks, from international banks. In order to compete with these entities effectively, Indian commercial
banks need to posses matching financial strength, as fair competition is possible only among equals. Size, therefore assumes criticality even in these days of virtual banking. Mergers and acquisition, route provides a quick step forward in this direction offering opportunities to share synergies and reduce the cost of product development and delivery. Customer Relationship Management The process of relationship banking which has been ushered in on the Indian banking scenario would become sharper and widespread. The competencies required from a banker in the future include expertise in information technology and functional knowledge. This would warrant that the banks have to be careful in selection of personnel as regards to their skills, as the requirement of job would be to take decisions based on risk-reward paradigm rather than process based administration. The training and skills upgradation system is also required to be aligned to desired competencies. Delivering Customer Delight It is a method which can pro-actively monitor customer satisfaction, identifies the areas where most beneficial improvements can be implemented and suggest the uses of web to market measurable improvements to a wider audience. It is a revolutionary and cost effective approach to link customer satisfaction with internal improvements, performance and increased business. Delight results from exceeding the expectations of satisfied, customers. Meeting only current needslocks a firm into the present' but to move beyond the threshold of satisfaction, one must tap into the unmet or even to the domain of unimagined needs of the customer. Hence, the only key that can unlock the door to delight is new ways of thinking and working Imparting Good Governance The road ahead for the banking industry will be entirely different from the track traversed hitherto. Banks will be compelled to concentrate more on how to improve performance with regard to capital adequacy, asset quality, management performance, earnings capacity, liquidity, and systems and controls, while capital adequacy, asset quality and profitability can be ascertained from balance sheet management, systems and controls will involve subjective evaluation. Corporate Social Responsibility Corporate Social Responsibility is the continuing commitment by business to achieve commercial success in ways that honour ethical values, address legal issues and contribute to economic development will improving the quality of experience of the workforce and their families as well as the local community and society at large. Efficient Customer Service In the future competitive pressures will become more intensified in the banking environment in India and the markets will get changed drastically, with the focus on being customer centric. The key to success in the changed environment will be the banks ability to reach the
client at his door step and meet his requirements of product and services in a customized manner leading to customer delight and customer ecstasy. Appropriate HR Policies It has become imperative that for meeting the challenges and opportunities in future, there will be great need for changes in mindset in the human resource available within the Bank. Training and Development in updating the skills is essential to face the emerging challenges. In a service industry like banking, human resources will occupy the pivotal part for making the bank services enduring. With the entry of new private banks and foreign banks, the system of hire and fire will become unavailable. Security and age old practices of conducting traditional banking will undergo revolutionary changes. Management of NPAs In future, the non performing assets will become the major causes of banks concern. Imbibing the credit management skills will become all the more important for improving the bottom line of the banking sector. It becomes essential to master the expertise for monitoring exposure levels, industry scenarios and timely action in respect of troubled industries. Skills of NPA management, which include working out negotiated settlements. Companies, constituting active settlement advisory committees, compromise, constituting active settlement advisory committees. Restructuring and rehabilitation, effective recourse to suitable legal remedies, etc., are to be supplemented with most suitable legal reforms by the banks to recover dues well in time so that the financial soundness of the banking sector will not be undermined. Product Re-Engineering Strategy The growth in disposable incomes, changing lifestyles, global changes and their impact on the economy will result in ever changing and diversified needs of the customers. Banks in future will have to understand the dynamic needs of a changing society through detailed market survey and structure innovative products so as to channelize the savings of the community and also to satisfy the credit requirements of various sectors of the economy.
CONCLUSION
For a successful banking business management and analysis of large data and information play key roles in devising new strategies, products and services, with the cost of technology falling and their capacities increasing day-to-day, datawarehousing has become affordable. Banks should set up their own intranet and extranet, which will be boon to both employees and customers, spread over wide geographic locations. We are in an era where technology is all-pervasive. However, in service like banking due care has to be taken while embracing technology and transforming traditional touch points to electronic ones, so that human touch with customers is not lost. In the end, it can be rightly evolved that productivity and efficiency will be the watch words in the banking industry in the years ahead. Strategizing organizational effectiveness
and operational efficiency will govern the survival and growth of profits changes in the mindset of the employees is imperative with the changing times. Continuous quest for skill upgradation at all levels, development of vision and mission and commitment are some of the aspects which required urgent attention by the banking sector in future.
REFERENCES
[1] Singh, Ranbir (2003), Profitability management in Banks under deregulated environment, published in IBA Bulletin. July. [2] Upinder Dhar, Santosh Dhar, (2005) Strategies of Winning organisation. [3] Dr. Anju Singla, Dr. R.S. Arora (2005) financial performance of public sector banks. Published in Punjab Journal of Business Studies, Vol-I, No.1, September. [4] M. Subramanya Sharma, P. Amaraveni, (2005) CRM in Banks- An analytical approach, published in sedme, Vol. 32, No.3 September. [5] Dr. K.K. Agrawal (2005) Indian Banking Today: Impact of Reforms, Published in Vanijyam Souvenier 58th All India Commerce Conference at Varanasi. [6] www.google.co.in
Track2
CorporateFinance
ImpactofFinancialLeverageonFirms Value:AnEmpiricalAnalysisofFMCGSector
AnshuBhardwaj*andDr.VikasChoudhary**
AbstractIn the analytical and empirical literature on the subject of finance and growth, there is a consensus among economists that development of the financial system contributes to economic growth. The Indian economy is showing resilience and is in the forefront of a worldwide recovery. The key to sustain Indias growth momentum is possible by changing dynamics of management through innovation and creativity. After breezing through the slowdown that cut such a wide swathe across the Indian economy in the past but now manufacturers of FMCG (Fast Moving Consumers Goods) are now up against fresh challenges to their growth. The firms operating in this sector are quite cautious in the choice of sources of funds and thus forming their capital structure to be known as optimal capital structure. De Angelo and Masulis (1980) demonstrated that with the presence of corporate tax shield substitutes for debt, each firm will have a unique interior optimum leverage decisions with or without leverage costs. The firms have realized that attaining overall competitiveness would entail reducing the overall cost of their operations including financial costs. It has compelled the firms to rethink and redesign their financial strategies focusing on global integration and competitiveness. The present study is an attempt to examine the capital structure of the various firms under study and to find out its impact on the firms value. Keywords: Indian economy, financial leverage, firms value, capital structure, competitiveness.
INTRODUCTION
Capital structure is one of the most prolific domains of research in corporate finance. Capital structure has attracted intense debate and scholarly attention in the financial management arena over the last few decades. The capital structure debate has been live for decades, with the key point of contention for many researchers being whether capital structure positively or negatively impacts firms value. Much of the literature on this question takes its departure from the seminal writings of Modigliani and Miller (1958) and their Theorem of Irrelevance. Research is spinning around a few theoretical models of capital structure since over more than fifty years but could not be able to provide the conclusive assistance to managers and practitioners for choosing between debt and equity in financial decisions. Many researchers have subsequently argued their case for and against the optimal value capital structure.Franco Modigliani and Metron Millers (M&M) theory (1958) is considered as fundamental corporate structure model in the modern corporate finance. The theory ascertained the irrelevance of capital structure to firms value in perfect markets, without taxes and transaction costs. MM irrelevance theory was generally accepted and subsequent research focused on relaxing some of its assumptions to develop a more realistic approach. In this sense, MM published another paper considering some of the criticisms or deficiencies of their *BPS Mahila Vishwavidayalaya, Sonipat **National Institute of Technology, Haryana
theory and relaxed the assumption that there were no corporate taxes (Modigliani and Miller, 1963).Thus, one of the central issues in both the theory and practice of financial management is the problem of determining the optimal capital structure of the firm. Given capital market conditions and the array of investment opportunities, is there some optimal composition of liabilities and equity at which the value of the firm will be maximized? The purpose of this research is to evaluate whether in an Indian context an increase in financial leverage positively or negatively impacts firms value in case of FMCG (Fast Moving Consumer Goods). Following the seminal work of Franco Modigliani and Merton Miller (1958, 1963), a substantial amount of effort has been put forward in corporate finance theory to determine the factors that influences a firms choice of capital structure. Many empirical studies have tried to explain the factors that affect on capital structure choice. One of the most renowned initial empirical studies is made by Rajan and Zingales (1995) and they explain the various institutional factors of firms capital structure in the leading industrial countries. Existing empirical research on capital structure has been largely confined to the United States and a few other advanced countries. Myers (1984) holds that the various capital structure theories do not explain actual financing behavior and it is therefore presumptuous to advise firms on optimal capital structure. However various researchers have found evidence in support of a positive relationship between optimal capital structure and a maximized firm value: Ward and Price (2006) indicate that an increased debt/equity ratio in a profitable business increases shareholders returns, but also increases risk. Sharma (2006) concludes that there is a direct correlation between leverage and firm value. Lasher (2003) asserts that increased levels of debt finance can result in increased earnings per share (EPS) and return on Equity (ROE). De Wet (2006) proves that a significant increase in value can be achieved in moving closer to the optimal level of gearing and Fama and French (2002) conclude that there should be a positive relation between debt ratio and firms profitability. Contrary to this, Rajan and Zingales (1995) find a negative relationship between debt and profitability. The purpose of this study is to empirically evaluate the impact of financial leverage on firms value. An optimal debt/equity ratio is achieved when the value of a firm is maximized while the cost of capital is minimized Firer et al.(2004) and Erhardt and Brigham (2003). The literature suggests that leverage is value reducing for high growth firms and value enhancing for low growth firms (Mc Connell & Servaes,1995).These value effects of leverage are related to the ability of debt to mitigate the effects of under and over investment related to manager-shareholder agency costs. However, other studies suggest that there is no such leverage-value relationship(Agrawal&Knoeber,1996).The present study seems to resolve the leverage-value relationship puzzle and may at least partially explain the puzzling phenomenon of debt conservatism documented by Graham(2000). Validity of the pecking order and trade-off theories for the sample companies is also tested. In this paper multiple data regression model i.e., OLS regression for 22 companies listed in index constituent of BSE for the period from 2001 to 2009.The results of the present study reveal that Interest Cover Ratio(ICR) and profitability are negatively correlated with financial leverage. On the
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 119
other hand, Return on Net worth (RONW), Return on Capital Employed (ROCE), Non debt tax shield(NDTS), Profitability(PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH) are positively correlated with financial leverage. This research is grounded in the well-known Theory of Capital structure irrelevance proposition introduced by Modigliani and Miller (1958) which states that in a perfect market, capital structure has no impact on firm value.The modern theory of capital structure is said to have begun with a seminal paper by Franco Modigliani and Merton Miller (1958). Since then, several theories have been proposed to explain the variation in debt ratios across firms. The prior research on the corporate capital structure is based on irrelevancy propositions. The capital structure theory suggests that firms determine what is often referred to as a target debt ratio, which is based on various trade -offs between the costs and benefits of debt versus equity. Assuming perfect and complete capital market structure, Modigliani and Miller (1958) postulate that the leverage of a firm is independent to, and, therefore, uncorrelated with, its market value. Most researchers on capital structure take as their point of departure from the seminal work of Modigliani and Miller (1958), which derived the Leverage Irrelevance Theorem, concluding that capital structure does not impact firm value in an ideal environment. Their assumption of an ideal financial environment excludes the impact of tax, inflation and transaction costs. This theory, known as MM-I received criticism from peers who question the validity of their theory given the fact that the no firm actually operates in an environment without the impact of tax, inflation and transaction costs. This prompted Modigliani and Miller (1963) to issue a correction, which is referred to as MM-II Proposition. They still argue that a change in the debt/equity ratio does not impact on firm value, however when taxes and other transaction costs are considered two factors need to be acknowledged: First, a firms weighted average cost of capital (WACC) decreases as it increases its debt. Second, a firms cost of equity increases as it increases its debt since shareholders bear higher business risk due to the increased possibility of bankruptcy. Given the great debate on capital structure, and adding to the aforementioned Modigliani and Miller models (1958,1963), a number of theories have provided further contributions.
PeckingOrderTheory
Myers and Majluf (1984) propose that the pecking order framework is based on asymmetric information since managers have inside information on the future prospect of the firm and act in the favour of existing shareholders. According to Pecking Order theory firms prefer internal finance (retained earnings) to external finance. And when external finance is required, firms prefer debt before equity. Myers (1984) modifies the strict pecking order hypothesis and suggests that firms with many investment opportunities may decide to issue equity before it is absolutely necessary. The outcome of empirical tests on pecking order theory is mixed. Shyam Sunder and Myers (1999) find support for the pecking order hypothesis utilising data from the New York
Stock Exchange for various sectors, over the period 1971-1989. Frank and Goyal(2003) observed little support for pecking order hypothesis also using American publicly traded firms for the period 1971-1998and argued instead that net equity issues are more closely correlated with financing deficit than are net debt issues. The pecking order hypothesis seems to be more applicable to data prior to 1990 then post 1990.Fama and French (2005) examine the financing decisions of many individual firms and observe that these decisions are in conflict with the pecking order hypothesis. They also find that while equity is supposed to be the last financing alternative, most firms issue some sort of equity every year. Seifert and Gonenc(2008) in their study titled, the international evidence on pecking order hypothesis, find little support for pecking order behaviour in the US,UK and Germany for the period 1980-2004. They indicate that this is largely attributed to the information asymmetry due to widespread ownership of stock where insiders know more than outside investors. They find evidence to support pecking order behaviour in Japan during the 1980s and 1990s. Ni and Yu (2008), also find little support for pecking order theory amongst Chinese listed firms in2004.They indicate that this is largely attributed to the information asymmetry due to widespread ownership of stock where insiders know more than outside investors. They find evidence to support pecking order behaviour in Japan during the 1980s and 1990s. Ni and Yu (2008), also find little support for pecking order theory amongst Chinese listed firms in 2004.They conclude that in China, large companies follow the pecking order hypothesis while small and medium companies do not.
TradeoffTheory
Myers (2001) postulates that debt offers firms a tax shield, and firms therefore pursue higher levels of debt in order to gain the maximum tax benefit and ultimately enhance profitability. However, high levels of debt increase the possibility of bankruptcy. The advantage of this approach include the possibility of deducting interest payments from company tax(Modigliani and Miller, 1963).Kim (1978),states that the disadvantage of debt is the potential cost of financial distress. Jensen and Meckling(1976) add that an additional disadvantage is the agency costs for equity holders and debt holders.To further substantiate this argument DeAngelo and Masulis(1980) predict an inverse relationship between leverage and investment tax shield, while the association between the corporate tax rate and the debt level is expected to be positive. However Nagesh(2002), in his investigation into sixty four JSE listed firms, finds a negative relation between between the tax rate variable and the extent of leverage. He also concludes that the trade off between investment related tax shields and debt related tax shield is unobserved. Myers (1984) asserts that the trade off approach implies that a firms leverage reverts to a target or optimal level. Nagesh(2002) states that Frank and Goyal(2005) break Myers notion of trade off into two parts The first part describes the static trade off theory, where a firms leverage is determined by a single period trade-off. The second part consists of Target adjustment behaviour, where the firms leverage gradually reverts to the target over time. More recently authors have developed a dynamic trade off model in an attempt not only to verify the prediction that leverage reverts to an optimal level, but also to understand how quickly this adjustment is made Hennessy and Whitehead (2005).
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 121
AgencyCostTheory
Capital structure is influenced by firm management, which has a long term impact on the firms capital structure. However, management might be tempted to pursue personal incentives instead of maximising shareholders value Myers (2001). Research in this area was initiated by Jensen and Meckling (1976), building on earlier work by Fama and Miller (1972). They identified two types of conflicts: those between shareholders and managers, and those between debt holders and equity holders. They postulate that conflicts between shareholders and mangers occur since managers hold less than one hundred percent of the residual claim. Managers do not capture the entire gain from these activities, but they do bear the entire cost of these activities by foregoing expenditures that would benefit them personally. Harris and Raviv (1990) share a common concern regarding manager-shareholder conflicts. They postulate that mangers and shareholders may disagree over the firms operating decisions. Managers tend to prefer to continue the firms operations even if liquidation of the firm is preferred by shareholders. Stulz (1990) support the managershareholder conflict argument from a different angle, stating that managers look to invest all available funds even if paying out cash is more suitable for shareholders. All of the aforementioned offer mitigation to manager shareholder conflict by recommending the issuance of debt. Jensen and Meckling (1976) find that this conflict is reduced and even mitigated relative to the percentage of equity the manager holds in the firm. If the managers equity stake in the firm is held constant while the level of debt increases, this result is an increase in the managers share of equity, thereby mitigating the loss from conflict between the manager and shareholder. Jensen (1986) and Stulz(1990) add to the discussion on the mitigation of manager shareholder conflict by stating that since debt commits the firm to pay out cash it reduces the amount of cash available for management to engage in personal pursuits. Therefore, the mitigation of conflicts between managers and equity holders constitutes one benefit of debt financing. Harris and Raviv (1990) assert that debt gives debt holders, who are also investors in the firm, the option of forcing liquidation if cash flows are poor. Grossman and Hart (1982) offer a further benefit of debt financing, stating that bankruptcy is costly for managers who are concerned with losing control and they should therefore focus on efficient utilisation of firm resources to reduce the probability of bankruptcy. Short term debt maturity has the additional benefit of reducing agency costs since in this instance management is more frequently monitored by underwriters and debt holders. Stulz(2000) support this notion and Rajan and Winton (1995)concur that short term debt facilitates effective monitoring with minimum effort. Capital Structure is determined by trading off the benefits of debt against the costs of debt Harris and Raviv (1991). Harris and Raviv(1990) also indicate that investor control through bankruptcy requires additional costs in order to produce information useful in the liquidation decision. Stulz(1990) asserts that debt payments reduce free cash flow, thereby reducing funds available for investment in profitable opportunities.
Several authors have pointed out that agency problems can be reduced by utilising managerial incentive schemes, financial securities or stock ownership. Datta, Iskandar Data and Raman (2005) also prove that managerial stock ownership improves the relationship between credit quality and debt maturity and between growth opportunities and debt maturity. Their findings support Stulzs (2000) findings relating to the use of short term debt as a monitoring tool and are also consistent with Johnsons(2003) finding where that managers with high equity ownership choose a higher proportion of short term debt. The second type of conflict identified by Jensen and Meckling(1976) was the conflict between debt holders and equity holders. They postulate that the debt contracts give equity holders an incentive to invest sub-optimally. If firms are successful and yield a large return above the cost of debt, the equity holders enjoy most of the benefit, however if the firm fails, the debt holders bear most of the loss due to limited liability. Denis and Milov (2002) contend that a firms decision to borrow funds implies that it will be monitored by the debtholder and this constitutes a control mechanism discretionally chosen by the firm.
InformationAsymmetryTheory
The information asymmetry theory of capital structure is credited to the work of Ross (1977).He poists that firm managers possess more information about the future prospects of the firm than the market. Therefore managements choice of capital structure may provide the market with signals of a firms future prospects. Therefore, an increase in leverage would increase the value of the firm since investors would deem this to be a positive signal of the size and stability of future cash flows. Fama and French (1988) disagreed with this notion, arguing that more profitable firms tend to have lower levels of debt. In this case increasing debt would signal poor future prospects for the firm, since future earnings will be impacted negatively due to cash flow being used to service debt, reducing the amount or money available to fund future development. Raju and Roy(2000) establish that the value of available information contributing to firm profitability is higher for larger companies and is higher for larger companies and is higher for industry sectors where there is intense competition. Therefore the release of credible information by managers affects the performance of a firm and has an impact on the perceptions held by the external market about a firm. Finally, Liu(2006) asserts that there is an increase in monitoring of a firm as the size of external financing increases. This serves as a mitigating factor against the challenges of information asymmetry and agency costs as mentioned earlier. Stulz(2000) and Rajan and Winton(1995) also support this notion. Implicitly, this lends support to pecking order theory, where managers prefer internal funds before looking outside of the firm to raise funds in capital markets. Literature Summary The literature reviews above provides a summary of the various views and theories held with regard to capital structure. The theories considered here are as follows:
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 123
Pecking order theory proposes that firms follow a hierarchy in their capital structure choice especially with regard to debt. Trade off theory states that firms endeavor to maximize returns by balancing the benefits of the tax shield that debt can affords the firm against the possibility of bankruptcy brought upon by increased debt. Agency cost theory asserts that the capital structure of a firm is influenced by management personnel who are conflicted by their pursuit of personal enrichment before the maximization of shareholder value. Information asymmetry theory states that since managers have more information on the future of the firm, their decisions on capital structure could provide signals to the market on the firms value.
Hypothesis
The null hypothesis states that an increase in leverage (D/E ratio) for a firm decreases firm value. The alternative hypothesis states that a change in leverage (D/E ratio) for a firm increases firm value.
METHODOLOGY
The research methodology utilized was casual research. The present study is an attempt to be made to identify cause and effect relationships existing between financial leverage and firms value. The research method employed is quantitative analysis of secondary data. Albright (2006) suggested that the sample selected from the total population was stratified by industry sector in order to better understand the characteristics of the homogeneous subsets. Therefore, the FMCG sector firms are considered for the study. The total numbers of 22 companies are included in the sample. The next part of the selection required that all firms in the sample are to be listed on the Bombay Stock Exchange (BSE) for the period 2001-2009. The information relating to the FMCG sector firms financial performance and capital structure provided in the companys annual financial statements to be sourced from the Capitaline Database. The research analysis to be confined to the FMCG sector of manufacturing firms listed on Bombay Stock Exchange (BSE). The study involves impact of financial leverage on firms value and to examine the capital structure of FMCG sector listed on BSE Index. The study also involves determinants of capital structure of FMCG sector from manufacturing sector using pooled data regression analysis. Based on earlier work of (Remmers et al., 1974; Al-Najjar and Taylor, 2007; Mallikarjunappa & Goveas, 2007, Shah
and Hizari, 2004; Buferna et al., 2005; Kakani, 1999; Gropp and Heider, 2008; Saylgan et al., 2008) the dependent variable used in the study is leverage (LEV) which is described as total debt divided by total assets of the firm. The explanatory variables include, Return on Net worth (RONW),Return on Capital Employed (ROCE), Interest Cover Ratio (ICR), Non debt tax shield(NDTS), Profitability(PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH). The variables used in this study are based on book value as per the argument proposed by Myers (1984) that book values are proxies for the value of assets in place. Since variables differ in scales in which their value lies, so data is normalized before conducting statistical analysis. The complete OLS model after incorporating all variables used in our study is: LEVi,t =0 + 1 RONW + 2 ROCE + 3 ICR + 4 NDTS + 5 PROF + 6 TANG it+ 7 SIZEi,t + 8 NDTSi,t + it (1) Where: LEVit , ratio of total debt to total assets for firm i in period t; PROFit, ratio of earnings before interest and tax to total assets of firm i in period t; TANGit, ratio of fixed assets to total assets for firm i in period t SIZEit, log of net sales for firm i in period t; NDTSit, ratio of fixed assets to total assets for firm i in period t.
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 125
RegressionAnalysis
Before analyzing the coefficients, we examine the diagnostics of regression. For detecting the presence of autocorrelation in data, Durbin Watson (D-W) statistics is analyzed. D-W statistics shows the serial correlation of residuals (first order) and ranges in value from 0 to 4 with an ideal value of 2 indicating that errors are not correlated. Analysis of D-W statistics about pooled data reveals that our value (1.903) which is well in range indicating no possible autocorrelation. The table also exhibits R value which is the square root of R-Squared and is the correlation between the observed and predicted values of dependent variable (financial leverage). The present study on FMCG sector concludes that the correlation between dependent variables and predictor is .91 which is considered as a high value. The high value tells that they are positively and significantly correlated with each other. R- Square tell us how much variation is explained by all the independent variables or predictors. This is an overall measure of the strength of association and does not reflect the extent to which any particular independent variable is associated with the dependent variable. Any High value is better. In present study 83.5% variation in financial leverage (dependent variable) is explained by the GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS taken together. The high value shows that the model is constructed well for the study. Adjusted R- Square may be defined as an adjustment of the R-squared that penalizes the addition of extraneous predictors to the model. This is generally used in research for reporting the proportion of variation explained in the dependent by the Independent or predictors. In the present study of FMCG sector 73.4 (.734) percent of variation is explained by all independent variables together. Besides, Durbin Watson (D-W) statistics test the first degree serial correlation among variables and our value is less than the critical range of 2.25. so it is acceptable and concludes that there is no presence of first order serial correlation.
TABLEII:OLSREGRESSION Variables Entered/Removedb Model Variables Entered 1 GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTSa a. All requested variables entered. b. Dependent Variable: FL ( Financial Leverage) Variables Removed . Method Enter
Model Summaryb Model R R Square Adjusted R Square Std. Error of the Estimate 1 .914a .835 .734 .1019761 a. Predictors: (Constant), GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS b. Dependent Variable: FL( Financial Leverage)
Durbin-Watson 1.903
ANOVA
The table III shows the analysis of variance related to financial leverage as dependent variable and predictors are GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS.In the table,F value is calculated which shows that whether the constructed model is significant or not. If sign value is less than 0.05 then (generally less than .010 is also accepted) it is assumed that the model is significant. The present study on FMCG sector reveals that the F value is 8.236 which are associated with p-value of .001, so our model is highly significant and we can
conclude that our model is made correctly. The results of the OLS regression between leverage (dependent variables) and the eight independent variables are reported in Table III. The table reveals that our overall model is significance as F= 8.236 with p value =.001.
TABLEIII:ANOVA ANOVA Model Sum of Squares Df Mean Square 1 Regression .685 8 .086 Residual .135 13 .010 Total .820 21 a. Predictors: (Constant), GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS b. Dependent Variable: FL F 8.236 Sig. .001a
COEFFICIENTS
The table IV represents the dependent variable i.e. financial leverage (constant) in the first column. And after that various independent variables are defined in the table. The second column B represents the values for the regression equation for predicting the dependent variable from the independent variable. The regression equation consisting of various dependent and independent variables are already explained and defined in the methodology section. The b0 is constant and value of b0 is -.090 in case of FMCG manufacturing sector firms. The various independent variables are explained as follows:b1(RONW) the coefficient of RONW is -.141. So for every unit decrease (as it is negative value) in Return on net worth there is a 0.14 unit decrease in financial leverage is predicted, holding all other variables constant, b2(ROCE) the coefficient of RONW is -.085. So for every unit decrease (as its is negative value) in Return on capital employed there is a 0.18 unit decrease in financial leverage is predicted, holding all other variables constant ,b3(ICR) the coefficient of ICR is .074. So for every unit increase (as it is positive value) in interest coverage ratio there is a 0.074 unit increase in financial leverage is predicted, holding all other variables constant,b4(NDTS) the coefficient of NDTS is -.740. So for every unit decrease (as it is negative value) in Non debt tax shield there is a .74 unit decrease in financial leverage is predicted, holding all other variables constant,b5(PROF) the coefficient of Profitability is .223. So for every unit increase (as it is positive value) in profitability there is a .22 unit increase in financial leverage is predicted, holding all other variables constant, b6 (CVA) the coefficient of collateralized value of assets is 1.547. So for every unit increase (as it is positive value) in CVA there is a 1.547 unit increase in financial leverage is predicted, holding all other variables constant,b7 (Size) the coefficient of size is .179. So for every unit increase (as it is positive value) in Size there is a .179 unit increase in financial leverage is predicted, holding all other variables constant and b8 (Growth) the coefficient of growth in investment opportunities is . 151. So for every unit increase (as it is positive value) in growth there is a .151 unit increase in financial leverage is predicted, holding all other variables constant. The next column shows the standard error associated with the coefficients and Beta is also shown as standardized coefficients. It can be concluded from the table that larger betas are associated with the larger t-values and lower p-values. Further, t and Sig. are shown in the table and are the t-statistics and these are associated with 2-tailed p-values used in testing whether a given coefficient is significantly different from zero, using an alpha of (0.01,
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 127
0.05 and 0.010).The findings of the study are, the coefficient for RONW is not significantly different from 0 because its p-value is definitely larger than 0.05,the coefficient for ROCE is not significantly different from 0 because its p-value is definitely larger than 0.05,the coefficient for ICR is significantly different from 0 because its p-value is definitely smaller than 0.010,the coefficient for NDTS is significantly different from 0 because its p-value is definitely smaller than 0.010,the coefficient for PROF is not significantly different from 0 because its p-value is definitely larger than 0.010,the coefficient for CVA is significantly different from 0 because its p-value(.000) is definitely smaller than 0.005,the coefficient for SIZE is significantly different from 0 because its p-value(.068) is definitely smaller than 0.010,the coefficient for GROWTH is significantly different from 0 because its pvalue(.070) is definitely smaller than 0.010. For detecting the multicolinearity in OLS regression analysis, variance inflation factor (VIF statistics) is used and analysed. Highest value of VIF statistics obtained among all variables was 5.802 whereas a commonly given rule of thumb is that VIF's of 10 or higher may be a cause of concern (Chatterjee & Price, 1977; Gujrati & Sangeetha, 2008).Thus, results indicate no presence of autocorrelation and multicollinearity in the data used.
TABLEIV:COEFFICIENTS Unstandardized Coefficients B Std. Error 1 (Constant) .090 .195 RONW -.141 .142 ROCE -.085 .197 ICR .074 .111 NDTS -.740 .255 PROF .223 .211 CVA 1.547 .220 SIZE .179 .132 Growth .151 .115 a. Dependent Variable: FL Model Coefficientsa Standardized Coefficients Beta -.172 -.118 .081 -.889 .211 1.396 .215 .205 t .463 -.990 -.434 2.660 -2.908 1.056 7.026 2.357 2.319 Sig. .651 .340 .671 .072 .052 .310 .000 .068 .070 Collinearity Statistics Tolerance VIF .421 .172 .860 .136 .316 .321 .503 .525 2.376 5.802 1.163 7.370 3.160 3.115 1.987 1.906
CONCLUSION
Debt and equity are the principal source of funding for a business. The proportional distribution of these two sources of funding depends on how a firm decides to divide its cash flow between two broad categories: a fixed component which is utilized for obligations toward debt capital and a residual component which belongs to equity shareholders. Therefore a firms financial leverage affects the firm value, Sharma (2006). The above information could lead to the assumption that all firms should ensure that their capital structure is greatly weighted towards a higher level of debt. However there is a limit to the amount of debt a firm should take on De Wet (2004). In India corporate firms play a significant role in contributing to economic growth. In order to attain their objectives, firms need to efficiently manage their funds. To respond to global competition firms need to make massive capital investment in modern technologies, infrastructure, product development and product promotion and so on. Such investments may promote productivity and efficiency. There are several sources of
financing those investments. Financial leverage is one of them. In its simplest form, financial leverage is the amount of debt used to finance a firm's assets and projects. It is good to note that during the great depression and throughout the 1930s and 1940s, financial leverage was predominantly viewed as a clear evil. It was perceived that huge amount of debt leads to financial distress. However, such a view point is no more universal. Nowadays, financial leverage is seen as important resource for the production of goods and services as well as for their distribution. Financial leverage is an important component in capital structure along with equity and retained earnings. One of the main debates in Corporate Finance is the impact of financial leverage on a firms value. Among the various sources of corporate financing, financial leverage is perceived to have both positive and negative attributes as a debt financing instrument. The issuance of debt commits a firm to pay cash as interest and principal. A firm with significantly more debt than equity is considered to be highly leveraged. Modigliani and Miller (1958) stated that we should not waste our limited worrying capacity on the second-order and largely self-correcting problems like financial leveraging. However, a lot of theoretical and empirical literatures have challenged this point, arguing that financing considerations considerably complicate the investment relation. Myers (1977), for instance, explained how highly levered firms are less likely to exploit valuable growth opportunities as compared to firms with low leverage levels. It is well perceived fact that financial leverage has become the important factors in determining the capital structure decisions of a firm. One of the major issues encountered by fund managers today is not just procurement of funds but also their meaningful deployment to generate maximum returns. Sources of funds are generally the same across all businesses but then why is it that some businesses are able to do better than the rest. If the logic of outstanding performance is a viable business idea, then why is it that some companies still fail to achieve success even with ample funds and the right business idea? The above discussion clearly implies that there is something beyond financial success of business besides great ideas and good geographic presence. Capital structure is one of the important determinants of a firm's success. The research aims to analyze the capital structure of FMCG sector of manufacturing sector industries in India and how this has had an impact on their overall value of the firm. In order to test our hypotheses, we used financial leverage (LEV) as dependent variable and independent variables include Return on Net worth (RONW), Return on Capital Employed (ROCE), Interest Cover Ratio (ICR), Non debt tax shield (NDTS), Profitability (PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH) that are well established and widely used by the researchers in various international studies. There are various theories in corporate finance that propounded the relationship between capital structure and valuation of firm. Validity of the pecking order theory and trade-off theory are also empirically tested using OLS regression model. The various propositions related to optimal capital structure focus more on the theoretical aspect, this study has gathered financial information of selected firms of FMCG sector and attempted to establish a relationship between financial leverage and firms value and its impact on the capital structure.
Impact of Financial Leverage on Firms Value: An Empirical Analysis of FMCG Sector 129
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AnalysisofDividendPayoutPolicyofIndian CompaniesandMultinationalCompanies
Dr.ArchanaSingh*,AbhaTulsian*andBhawna*
AbstractThis paper aims at analyzing the dividend payout policy prevailing in various Indian companies and evaluating them alongside multinational firms, keeping in view certain underlying factors. A sample set of 44 companies which are listed on Bombay Stock Exchange, 29 Indian and 15 multinational companies have been taken (on the basis of the data availability). The past 9 year annual reports have been utilized to study the dividend payout policy. We have examined the determinants of dividend payout for firms and the consequential impact of these factors on dividend payout by performing regression analysis. The result shows that firm's dividend policy will depend upon its past growth rate, future growth rate, systematic risk, profitability, liquidity and size of business. The result of the study indicates that dividend policies of Indian companies were highly influenced by profitability of the firm while the dividend policies of multinational Companies were majorly influenced by growth rate. The result of this study will contribute in assisting other firms to develop a dividend policy which divides the net earnings into dividends and retained earnings in an optimum way so as to achieve the objective of wealth maximization of shareholders. Keywords: Dividend payout, Capital Market, Wealth maximization of shareholders, Earning per share, Dividend yield
INTRODUCTION
Dividend payout policy has been the primary riddle in the economics of corporate finance. Several rationales for a corporate dividend policy have been proposed in the literature, but there is no unanimity among researchers. Dividend policy is the payout policy that managers follow in deciding the size and pattern of cash distribution to shareholders over time. The decision is an important one for the firm as it may influence its capital structure and stock price. The dividend policy of the company should aim at achieving the objective of the company to maximize shareholders wealth. Keeping in view the relationship between dividend policy and the value of the firm, different theories have surfaced. They have been majorly categorized into two categories. The first group consists of theories which consider dividend decisions to be irrelevant. According to Modigliani and Millers Hypothesis (1961), under a perfect market situation, the dividend policy of a firm is irrelevant to the firms value. They argued that the value of the firm depends on the firms earnings which result from its investment policy. The shareholders do not necessarily depend on dividends for obtaining cash. The second group consists of the theories which consider dividend decisions to be an active variable influencing the value of *Delhi School of Management, Delhi Technological University, Delhi
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 131
the firm, supported by Walters Model (1963) proposed by Professor James E. Walter which clearly shows the importance of the relationship between the firms rate of return, its cost of capital in determining the dividend policy. Myron Gordon also developed Gordons Model (1962) which explicitly related the market value of the firm to dividend policy. Gradually, theorists identified a number of factors which play a significant role in making dividend decisions. John Lintner in 1956 conducted his classis study on American companies and stated that dividend policy has two parameters: the target payout ratio and the speed at which current dividends adjust to the target. The extent to which it affects the firm also depends upon other internal and external environment. Extensive studies have been conducted to recognize these factors. The undertaken study captures the different dimensions influencing the dividend policy decisions in BSE listed Indian companies and evaluating them alongside International firms on the same parameters. The independent factors includes profitability, growth rate, liquidity, size of business, systematic risk, and percentage of common stocks held by insiders. Depending upon these factors, the dividend payout ratio has been estimated. The determinants of dividend payout for firms are analyzed and the consequential impact of these factors on dividend payout is studied by performing regression analysis. The study differs from the past survey research. It reveals some interesting results by comprehensively analyzing how Indian firms make dividend decisions. On the other hand, this paper uses several financial variables to explain the possible differences in the dividend policy of both Indian and foreign firms listed in Bombay Stock Exchange. This paper now proceeds as follows: Section-2 provides a brief review of the relevant literature. Section-3 presents the description of the data and the empirical methods used. Section-4 contains the findings, and Section V concludes the paper with a conclusion and summary.
LITERATURE REVIEW
A substantial theoretical literature is accessible on dividend payout behaviour of the firms. Researchers have proposed many different theories about the factors that influence a firms dividend policy. A number of factors have been identified in previous empirical studies to influence the dividend policy decisions of the firm. Setia and Atmaja [2010] provided an explanation whether board independence influences debt and dividend policies of a sample of Australian publicly-listed firms. which have higher levels of leverage and dividend payout ratios than their non-family counterparts.
Najjar et al. [2009] examined that the number of outside directors on the board of directors is indirectly proportional to the dividend payout, applied by UK firms to control agency conflicts of interest within the firm. Pandey and Bhat [2007] suggest that the dividend pay-out ratio in the context of emerging market (India) is influenced by macro-economic policies. Abdulrahman Ali Al-Twaijry [2007] identified the variables with an expected influence on dividend policy and on payout ratio in an emerging market using 300 firms randomly selected from the Kuala Lumpur Stock Exchange. Renneboog [2007] investigated the relationship between the dynamics of earnings payout and the voting power enjoyed by different types of shareholders. Ian D. McManus et al. [2006] has focused on the returns performance of zero dividend stocks in its research paper. It provided link between dividend payment and returns history and firms subsequent stock market performance. It was found that payment history is not a significant determinant of returns, while past returns play a far greater role. Gugler [2003] investigates the relationship between dividends and ownership and control structure of the firm for Austrian firms. Collins and Wansley [1996] compared the dividend payout patterns of a sample of regulated firms with unregulated firms. They did not find that the financial regulators' role is one of agency cost reduction for equity holders. Khigbe et al. [1993] measured the common share price response to dividend increases for both insurance firms and financial institutions relative to unregulated firms. They find that insurance firms stock prices react positively to increases in dividends over a four-day interval surrounding the announcement, but that these reactions differ depending on the insurer's primary line of business. These studies in general tried to explain the dividend behaviour over time with the help of numerous factors. Every research paper considered a single nation and observed the effect of various factors on the dividend pay-out ratio to the stakeholders. But not much work has been done in comparing the dividend policies of Indian firms and the foreign firms. This research study analyzes the dividend payout policy prevailing in various Indian companies and evaluated them alongside International firms keeping in view certain underlying factors like profitability, growth rate, liquidity, size of business, systematic risk, and percentage of common stocks held by insiders. The paper examines the determinants of dividend payout for firms and the consequential impact of these factors on dividend payout by performing regression analysis. An attempt has also been made to calculate estimated dividend payout based on the results. There is a wide gap in literature to address the comparison between Indian and foreign firms on the same platform. This paper expansively tries to fill this gap.
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 133
There is a blend of private and public sector companies in Indian Corporate Sector (which are again a mix-up of firms owned by business houses, privately owned multi-nationals and stand- alone firms), still it has not suffered from the discrimination that has dominated some of the developing economies. Accounting system in India is very well established and it is similar to those followed in most of the advanced economies. This increases our confidence in the reliability of our data.
SampleSelectionandPeriodoftheStudy
This paper studies the dividend payout practices of BSE-listed companies (Indian and foreign firms) which are significant for deciding dividend policy of the Indian corporate sector. The study is an explorative study and is based on secondary data. The firm level panel data for our study has been obtained primarily from the corporate database (PROWESS) maintained by CMIE (Center for Monitoring the Indian Economy). The initial data set includes the universe of 200 companies of Indian Corporate Sector firms. The period of study extends from 1999-2000 to 2008-09. To construct the data sample, we start with all companies listed in Group-A of BSE. We have chosen only group A companies for our analysis, since this group consist of those companies which have the highest growth rate. We have excluded financial firms and utilities because their dividend polices are highly constrained by external forces. The analysis has been restricted to firms which have no missing data for at least 10 consecutive years. Among these remaining listed companies, 29 Indian Companies and 15 Multinational firms having the highest market cap are selected.
ToolofDataAnalysis
Various ratios have been calculated and correlation analysis is used among various variables. In order to identify the factors influencing the dividend payout of Indian and multinational firms, multiple regression analysis has been carried out and based on this model, the best explorative variable influencing DPR has been identified for both of them. The factors influencing on dividend payout policies of Indian and multinational firms have been judged based on the model as depicted below DPR = B0 + B1ROCE +B2RONW + B3DPS + B4EPS + B5 + B6QR + B7CEPS + B8TA + B9P/E + B10 CR
VariablesoftheStudy
This research study analyzes the dividend payout policy prevailing in various Indian companies and evaluated them alongside International firms keeping in view certain underlying factors like profitability, growth rate, liquidity, size of business and systematic risk. These six factors are then evaluated using certain ratios. Profitability is evaluated using ROCE (return on capital employed), RONW (return on net worth), EPS (earning per share) and DPS (dividend per share). Evaluation of growth rate is done using P/E ratio. Liquidity of
firm is calculated by using ratios such as Quick ratio, Cash EPS and Current Ratio( incl mgtl. Securities), Size of business is determined by total assets. Systematic risk is measured through a statistical measure called beta (). These ratios are defined below:
DividendPayoutRatio(DPR)
The ratio reveals that how much profits are distributed as cash dividend. It is computed as follows DPR = DPS X 100 EPS Companies that have high growth rates generally have low payout ratios because they reinvest most of their net income into business.
DividendPerShare(DPS)
This ratio shows that how much income as profit will be received by the investors. It is calculated as follows DPS = Dividend paid to equity shareholders No. Of equity share outstanding
EarningsPerShare(EPS)
It is the net income earned on each share of common stock. The objective of determining this ratio is to measure the profitability of firm on equity shares. It is computed as follows EPS = Earnings available for equity share holders Number of equity shares
ReturnonCapitalEmployed(ROCE)
This ratio is an indicator of the earnings capacity on the capital employed in the business. The objective of calculating this ratio is to determine how efficiently the long term funds supplied by the creditors and shareholders have been used. It is calculated as follows ROCE = Operating net profit before interest and tax Capital employed X 100
ReturnonNetworth(RONW)
This ratio helps the company to discover the return on net worth on the basis of net profit RONW = Net Profit Net worth
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 135
SystematicRisk()
The movement of share prices in relation to movement in stock market is termed as systematic risk, which is measured through a statistical measure called beta ()
QuickRatio(QR)
It is a measure of companys immediate short term liquidity without relying upon realization of stock. It is computed as follows QR = Liquid assets Current Liabilities
CashEPS
It looks at the cash flow generated by a company on a per share basis. This differs from basic EPS, which looks at the net income of the company on a per share basis. The higher a company's cash EPS, the better it is considered to have performed over the period. It is determined as follows Cash EPS = Operating cash flow Diluted outstanding shares
TotalAssets(TA) The sum of current and long-term assets owned by a company. PriceEarningratio(P/Eratio)
This ratio is helpful in predicting the market price of equity shares at some future date and in determining whether the share of a particular firm are undervalued/overvalued. This ratio is determined as P/E Ratio = Market price per equity share Earning per share
FINDINGS
In this section, the multiple regression analysis between the dependent variable DPR and independent variables (Earning Per Share, Current ratio (including marketable securities), cash EPS, P/E ratio, Dividend Per Share, Beta, Quick Ratio, Total Asset, ROCE, RONW is presented to study the relationship between dividend payout policy and liquidity, profitability, systematic risk, growth rate, size of the Indian as well as multinational companies. This is done to find out single most explanatory variable of Dividend policy of the Indian and multinational companies. For this purpose, the regression is run for each year, separately on the sample companies with backward elimination method to select the best predictor. This backward elimination method begins with all independent variables in the model and at each step removes the least predictor out of all of them. Variables are removed until an established
criterion for the F-statistics and adjusted R-square no longer holds. Accordingly under this method, the remaining variable is the best predictor. The significant value of the F indicates that the dependent and the independent variable or the set of independent variables are statistically significant and particularly the independent variables explain the dependent variable in the scientifically accepted fitted model. This section is further divided into two parts. Part one shows the multiple regression analysis for the sample of Indian companies whereas part two depicts the multiple regression analysis for the sample of multinational companies. The year-wise analysis for both Indian as well as multinational companies follows as under:
0.04
0.03
0.2 2 -0.01
TABLE1.B Model 1 2 3 4 5 6 7 8 9 10 11 R 0.49819 0.49651 0.48261 0.45794 0.428 0.39982 0.38835 0.34213 0.22061 2.4E-08 R Square 0.2482 0.24652 0.23292 0.20971 0.18319 0.15986 0.15082 0.11705 0.04867 5.6E-16 Adjusted R Square Model Summary Std. Error of the Estimate 0.298309 0.290675 0.278973 0.276651 0.275072 0.273099 0.269017 0.268987 0.27399 0.275849 Change Statistics R Square Change 0.24819704 -0.0016733 -0.0101302 -0.0232056 -0.0265226 -0.0233306 -0.0090398 -0.0337666 -0.0683831 -0.0486678 F Change 0.594244 0.040063 0.087689 0.267656 0.635286 0.738332 0.656949 0.258237 0.994091 2.013661 1.381254 df1 10 1 1 1 1 1 1 1 1 1 1 df2 18 18 19 20 21 22 23 24 25 26 27
-0.169471 -0.110386 0.492997252 -0.022778 -0.005823 0.0056201 0.0198336 0.0489156 0.0491318 0.0134333 0
It is evident from the regression table (Table 1.b) that the adjusted R-square is going up till 9th model; this shows that DPS and Cash EPS are the best determinant of dividend policy in 2000. The Table 1.c presents the result of ANOVA analysis. The F-statistics shows that the
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 137
value of the residual is lowest in the 9thmodel and the results are supporting the earlier observation in the previous table 1.a. The overall conclusion throws light on two variables that is DPS and Cash EPS. Predictors: (Constant), EPS, log total asset, Beta, Quick ratio, P/E, DPS, RONW, ROCE, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), EPS, log total asset, Beta, Quick ratio, P/E, DPS, RONW, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), log total asset, Beta, Quick ratio, P/E, DPS, RONW, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), log total asset, Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), DPS, Current ratio (incl. mktgl. securities), Cash EPS Predictors: (Constant), DPS, Cash EPS Predictors: (Constant), DPS
TABLE3.C Model 9 Sum of Squares 0.24939 1.8812 2.13059 ANOVA Df 2 26 28 Mean Square 0.124694 0.072354 F 1.72338596 Sig. 0.198227
Year2001
Table 2.a represents the correlation table of the year 2001. It shows that the only ratios which depict some correlation between independent variables and dividend payout ratio are RONW and DPS, which exhibits that dividend payout moves positive with DPS and RONW of the firm.
TABLE2.A dividend payout ratio Pearson Correlation dividend payout ratio 1 Beta Quick ratio -0.08 Correlations log RONW ROCE P/E Cash Current total EPS ratio (incl.mktgl assest securities) -0.21 0.018 -0.12 0.146 0.011 0.028 DPS EPS
-0.04
0.187
-0.21
It is obvious from the regression table (Table 2.b) that the adjusted R-square is moving up till 5th model; this shows that the parameters - Total asset, RONW, DPS, quick ratio, ROCE and Cash EPS are the best determinant of dividend policy in 2001. The Table 2.c presents the
result of ANOVA analysis. The overall conclusion highlights the variables like Total asset, RONW, DPS, Quick ratio, ROCE and Cash EPS.
TABLE2.B Model Summary Model
1 2 3 4 5 6
R
0.812 0.812 0.809 0.804 0.784
R Square
0.659 0.659 0.655 0.646 0.615
Adjusted R Square
0.470 0.498 0.811 0.540 0.550 0.531
Change Statistics
R Square Change 0.659 0.000 -0.003 -0.009 -0.032 F Change 3.480 0.003 0.062 0.156 0.552 1.961 df1 10 1 1 1 1 1 df2 18 18 19 20 21 22
Predictors: (Constant), EPS, log total asset, Beta, Current ratio (incl. mktgl. securities), RONW, DPS, P/E, Quick ratio, Cash EPS, ROCE Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, P/E, Quick ratio, Cash EPS, ROCE Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS, ROC Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS, ROCE Predictors: (Constant), log total asset, RONW, DPS, Quick ratio, Cash EPS, ROCE Predictors: (Constant), log total asset, RONW, DPS, Cash EPS, ROCE
TABLE2.C ANOVA Sum of Squares 0.629247 0.344535 0.973782
Model 5
df 6 22 28
F 6.696666
Sig. 0.000388
Year2002
Table 3.a represents the correlation table of the year 2002. It depict the only ratios that show some correlation are RONW, ROCE, P/E ratio and DPS, which exhibit that dividend payout is directly related to DPS, ROCE, P/E and RONW of the firm.
TABLE3.A
Dividend payout ratio Pearson dividend Correlation payout ratio 1 Beta Quick ratio -0.10 Correlations Cash Current EPS Ratio (incl. mktgl. securities) -0.26 -0.140 Log (total asset) 0.020 RONW ROCE P/E DPS EPS
-0.02
0.209
0.117
The regression table (Table 3.b) shows that the adjusted R-square is going till 5th iteration, this shows that Total asset, RONW, DPS, ROCE and P/E are the best determinant of dividend policy in 2002. The Table 3.c is presenting the ANOVA analysis results.
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 139 TABLE3.B Model 1 2 3 4 5 6 R 0.818 0.817 0.808 0.802 0.784 R Square 0.669 0.668 0.653 0.643 0.615 Adjusted R Square 0.485 0.510 0.815 0.538 0.545 0.531 0.176 0.175 0.178 -0.012 -0.010 -0.028 Std. Error of the Estimate 0.186 0.182 Change Statistics R Square Change 0.669 -0.001 F Change 3.639 0.071 0.157 0.706 0.626 1.731 df1 10 1 1 1 1 1 df2 18 18 19 20 21 22
Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, Beta, DPS, Current ratio (incl. mktgl. securities), ROCE, Cash EPS Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, Current ratio (incl. mktgl. securities), ROCE, Cash EPS Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, Current ratio (incl. mktgl. securities), ROCE Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, ROCE Predictors: (Constant), EPS, log total asset, P/E, RONW, DPS, ROCE Predictors: (Constant), EPS, P/E, RONW, DPS, ROCE
TABLE3.C ANOVA df 6 22 28
Model 5
F 6.59878
Sig. 0.0004267
Year2003
The correlation table (Table 4.a) of the year 2003 shows that the only parameters that shows some correlation are Total asset, RONW, ROCE, P/E ratio and DPS, which shows that dividend payout moves positive with Total asset, DPS, ROCE, P/E and RONW of the firm.
TABLE4.A
Dividend payout ratio 1 Beta -0.03 Quick ratio -0.25 Cash EPS Correlations Current ratio (incl. mktgl. securities) -0.17 -0.213 Log Total RONW Asset 0.136 0.293 ROCE P/E 0.168 DPS EPS
The regression table (Table 4.b) makes it evident that the adjusted R-square is going up till 4th model, this shows that Total asset, RONW, Quick ratio, current ratio, DPS, ROCE and cash EPS are the best determinant of dividend policy in 2003. The Table 4.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in
the 4th model and the results are supporting the earlier observation in the previous table (table 4.a). The overall conclusion throws light on variables like Total asset, RONW, Quick ratio, current ratio, DPS, ROCE and cash EPS.
TABLE4.B Model R R Square Model Summary Adjusted R Square Std. Error of the Estimate 0.53391 0.55465 0.826459933 0.56836 0.11617 0.12072 0.118 Change Statistics R Square Change 0.7003729 - 0.0025748
1 2 3 4
-0.0067628
Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), RONW, Beta, DPS, Quick ratio, ROCE, Cash EPS Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, ROCE, Cash EPS Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, ROCE, Cash EPS Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS
TABLE4.C ANOVA df 7 21 28
Model 4
F 6.2671
Sig. 0.00047
Year2004
Table 5.a presents the correlation table of the year 2004 showing that there is very low correlation between beta, current ratio, total asset and the dependent variable dividend payout ratio. The parameters having some correlation are RONW, ROCE, P/E ratio, cash EPS, EPS and DPS, which shows that dividend payout ratio moves positive with DPS, ROCE,P/E and RONW of the firm out of which the highest correlation is with ROCE(.44 ),P/E(.58) and EPS(.64).
TABLE5.A
Correlations Dividend Beta Quick Ratio Cash EPS Current ratio Log total RONW asset (incl. mktgl. payout securities) ratio 1 -0.4 0.048 0.311 0.048 0.068 0.276 ROCE P/E DPS EPS
Pearson Correlation
0.446
0.587
0.647 0.344
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 141
The adjusted R-square is going till 5th model as evident from table 5.b. This shows that RONW, Quick ratio, DPS, ROCE, P/E and EPS are the best determinant of dividend policy in 2004. The Table 5.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table (table 5.a).
TABLE5.B Model 1 2 3 4 5 6 R 0.896 0.895 0.892 0.887 0.880 R Square Adjusted R Square 0.802 0.800 0.796 0.787 0.774 0.692 0.706 0.728 0.729 0.725 Model Summary Std. Error of the Estimate Change Statistics R Square Change F Change df1 0.095 0.802 7.294 10 0.093 -0.002 0.152 1 0.894 0.061 1 0.089 -0.004 0.359 1 0.089 -0.009 0.918 1 0.090 -0.013 1.382 1
df2 18 18 19 20 21 22
Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE, Cash EPS Predictors: (Constant), EPS, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE, Cash EPS Predictors: (Constant), EPS, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE Predictors: (Constant), EPS, P/E, Beta, RONW, Quick ratio, DPS, ROCE Predictors: (Constant), EPS, P/E, RONW, Quick ratio, DPS, ROCE Predictors: (Constant), EPS, RONW, Quick ratio, DPS, ROCE
TABLE5.C
Model 4
ANOVA Df 7 21 28
F 11.718
Sig. 5.3E- 06
Year2005
The correlation table (Table 6.a) of the year 2005 shows that the parameters that show some correlation are DPS and total asset, which shows that dividend payout moves positive with DPS and total asset.
TABLE6.A
Correlations Current ratio (incl. mktgl. securities) -0.42 0.104 Beta
RONW
ROCE
P/E
DPS
EPS
-0.26
-0.142
0.022
0.434
-0.17
It is evident from the regression table (table 6.b) that the adjusted R-square is going up till 6th model, this shows that Quick ratio, DPS, ROCE, beta and cash EPS are the best determinant of dividend policy in 2005. The Table 6.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 6th model and the results are supporting the earlier observation in the previous table (table 6.a). The overall conclusion throws light on variables like Quick ratio, DPS, ROCE, beta and cash EPS.
TABLE6.B Mode l 1 2 3 4 5 6 7 8 R R Square 0.677 0.677 0.674 0.672 0.669 0.647 0.615 Adjusted R Square Model Summary Std. Error of the Estimate 0.102 0.099 0.822 0.821 0.820 0.818 0.804 0.784 0.565 0.582 0.597 0.588 0.569 0.095 0.093 0.091 0.092 0.094 -0.002 -0.002 -0.003 -0.022 -0.032 Change Statistics R Square Change 0.677 0.000 F Change 3.771 0.012 0.035 0.143 0.120 0.225 1.508 2.168 df1 10 1 1 1 1 1 1 1 df2 18 18 19 20 21 22 23 24
0.823 0.823
0.497 0.524
Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, Current ratio (incl. mktgl. securities), P/E, DPS, ROCE, Quick ratio, EPS Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio, EPS Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio Predictors: (Constant), log total asset, Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio Predictors: (Constant), Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio Predictors: (Constant), Beta, Cash EPS, DPS, ROCE, Quick ratio g. Predictors: (Constant), Beta, Cash EPS, DPS, ROCE Predictors: (Constant), Cash EPS, DPS, ROCE
TABLE6.C ANOVA Sum of Squares df 0.388 5 0.192 23 0.58 28
Model 6
F 9.279328
Sig. 6E- 05
Year2006
Table 7.a represents the correlation table of the year 2006 showing that the parameter that depicts some correlation are P/E, DPS and total asset, out of which the highest correlation is with P/E (.61) which shows that dividend payout moves positive with DPS, P/E and total asset.
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 143 TABLE7.A
dividend Beta payout ratio Pearson Correlation dividend payout ratio 1 - 0.292 Quick ratio Correlations Cash Current EPS ratio (incl. mktgl. securities) -0.063 - 0.153 -0.092 log total asset 0.041 RONW ROCE P/E DPS EPS
-0.266
-0.106
0.615
0.156
- 0.165
Table 7.b shows the regression table .The adjusted R-square is going up till 5th model, this shows that Total Asset, Current ratio, DPS, ROCE, and RONW are the best determinant of dividend policy in 2006. The Table 7.c presents the result of ANOVA analysis. The Fstatistics shows that the value of the residual is lowest in the 5th model and the results are supporting the earlier observation in the previous table (table 7.a). The overall conclusion highlights Total Asset, Current ratio, DPS, ROCE, and RONW.
TABLE7.B Model R R Square Adjusted R Square 0.391 0.423 0.477 0.492 0.485 0.483 Model Summary Std. Change Statistics Error of the Estimate R Square Change 0.245 0.609 0.238 0.000 0.780 0.227 -0.001 0.224 -0.007 0.225 -0.024 0.225 -0.020
1 2 3 4 5 6 7
df2 18 18 19 20 21 22 23
Predictors: (Constant), EPS, log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW, Cash EPS Predictors: (Constant), log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW, Cash EPS Predictors: (Constant), log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, RONW Predictors: (Constant), log total asset, ROCE, P/E, DPS, RONW Predictors: (Constant), log total asset, ROCE, P/E, RONW
TABLE7.C ANOVA Sum of Squares df 1.655624 6 1.09973 22 2.755354 28
Model 5
F 5.5201
Sig. 0.001287
Year2007
The correlation table (Table 8.a) shows that there is very low correlation between all the selected independent variables and the dependent variable dividend payout ratio. The parameters that show some correlation are P/E, DPS and total asset, out of which the highest correlation is with DPS (.20) which shows that dividend payout moves positive with DPS and total asset.
TABLE8.A
divid end payo ut ratio Pearson dividend Correlation payout ratio 1.000 Beta Quick Ratio -0.08 Correlations Cash Curre EPS nt ratio (incl. mktgl . securi ties) -0.19 -0.20 log tota l asse t 0.17 RONW ROCE P/E DPS EPS
-0.35
-0.40
-0.31
0.12
0.20
-0.22
It is evident from the regression table (Table 8.b) that the adjusted R-square is going up till 6th model, this shows that EPS, Beta, DPS, Cash EPS, and RONW are the best determinant of dividend policy in 2007. The Table 8.c presents the result of ANOVA analysis.
TABLE8.B Model 1 2 3 4 5 6 7 8 9 R 0.7308185 0.7308011 0.7095482 0.7002242 0.6896442 0.6709937 0.6275755 0.5702847 R Square 0.5340956 0.5340702 0.5034587 0.490314 0.4756091 0.4502325 0.393851 0.3252246 Adjusted R Square 0.2752598 0.3133667 0.3379449 0.3513087 0.3616111 0.3586046 0.3211132 0.2733188 Model Summary Std. Error of the Estimate 0.1468634 0.1429502 0.1403684 0.1389445 0.1378367 0.1381609 0.1421415 0.1470599 Change Statistics R Square Change 0.5340956 -2.538E- 05 0.729841795 - 0.0292104 - 0.0131447 - 0.0147048 - 0.0253766 - 0.0563815 - 0.0686264 F Change 2.0634537 0.0009807 0.0571385 1.2500945 0.5559228 0.6347161 1.1130297 2.4613227 2.8304276 df1 10 1 1 1 1 1 1 1 1 df2 18 18 19 20 21 22 23 24 25
Predictors: (Constant), EPS, Beta, ROCE, log total asset, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS Predictors: (Constant), EPS, Beta, ROCE, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS Predictors: (Constant), EPS, Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS Predictors: (Constant), EPS, Beta, Quick ratio, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS Predictors: (Constant), EPS, Beta, Quick ratio, DPS, RONW, Cash EPS Predictors: (Constant), EPS, Beta, DPS, RONW, Cash EPS Predictors: (Constant), EPS, Beta, DPS, Cash EPS Predictors: (Constant), EPS, Beta, DPS Predictors: (Constant), EPS, DPS
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 145 TABLE8.C Model 6 Sum of Squares 0.396 0.437 0.833 ANOVA df 5.000 23.000 28.000 Mean Square 0.079 0.019 F 4.172 Sig. 0.008
Year2008
The correlation table (Table 9.a) shows that the parameters that show some correlation are P/E, DPS and total asset, out of which the highest correlation is with DPS (.27) and with total asset it is (.18) which shows that dividend payout moves positive with DPS and total asset.
TABLE9.A dividen d payout ratio Pearson dividend Correlation payout ratio 1.00 Correlations Quic Beta Cash Curren log k ratio EPS t ratio total (incl.mktgl asset . securit ies) `.05 `0.50 -0.17 -0.20 0.19 RON W ROC E P/E DP S EPS
-0.27
-0.10
-0.19
0.27
-0.19
The regression table (Table 9.b) shows that the adjusted R-square is going up till 7th model. The Table 9.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 7th model and the results are supporting the earlier observation in the table 9.a. The overall conclusion throws light on variables like Beta, DPS, Cash EPS, and Quick ratio.
TABLE9.B Model 1 2 3 4 5 6 7 8 R 0.812 0.812 0.811 0.810 0.808 0.799 0.787 Model Summary R Square Adjusted R Square Std. Error of the Estimate Change Statistics R Square Change 0.659 0.469 0.106 0.659 0.659 0.497 0.103 0.000 0.811 0.657 0.543 0.098 -0.001 0.656 0.563 0.096 -0.001 0.653 0.578 0.094 -0.003 0.639 0.578 0.094 -0.015 0.619 0.573 0.095 -0.020
df1 df2 10 18 1 18 1 19 1 20 1 21 1 22 1 23 1 24
Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, RONW, P/E, Quick ratio, DPS, ROCE, Cash EPS Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, P/E, Quick ratio, DPS, ROCE, Cash EPS Prediictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), P/E, Quick ratio, DPS, ROCE, Cash EPS Predictors: (Constant), EPS, Beta, P/E, Quick ratio, DPS, ROCE, Cash EPS Predictors: (Constant), EPS, Beta, P/E, Quick ratio, DPS, Cash EPS
Predictors: (Constant), Beta, P/E, Quick ratio, DPS, Cash EPS Predictors: (Constant), Beta, Quick ratio, DPS, Cash EPS Prediictors: (Constant), Beta, DPS, Cash EPS
TABLE9.C Model 7 ANOVA Sum of Squares 0.376 0.213 0.589 df 4.000 24.000 28.000 Mean Square 0.094 0.009 F 10.601 Sig. 0.000
Year2009
The correlation table (Table 10.a) shows that the parameters that show low correlation are RONW, Cash EPS and EPS while the highest correlation is with DPS (0.47) followed by total asset (0.433) and P/E (0.33) which show that dividend payout moves positive with DPS, total asset and growth rate.
TABLE10.A
divid end payo ut ratio Pearson Correlation dividend payout ratio 1.00 Beta Quic k ratio - 0.10 Correlations Cas Curre h nt ratio EPS (incl. mktgl. securit ies) 0.18 -0.21 Log total RONW ROCE P/E DPS EPS asset 0.43 0.16 0.22 0.33 0.48 0.13
-0.49
It is evident from the regression table (Table 10.b) that the adjusted R-square is going up till 4th model, this shows that Total asset, Beta, ROCE, RONW,DPS, and Cash EPS are the best determinant of dividend policy in 2009. The Table 10.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the table 10.a. The overall conclusion throws light on variables like Total asset, Beta, ROCE, RONW, DPS, and Cash EPS.
TABLE10.B Model 1 2 3 4 5 6 7 R 0.793 0.793 0.789 0.773 0.742 0.711 R Square 0.629 0.629 0.622 0.597 0.551 0.505 Adjusted R Square 0.422 0.453 0.496 0.487 0.454 0.423 Model Summary Std. Error of the Estimate Change Statistics R Square Change F Change df1 df2 0.089 0.629 3.048 10 18 0.086 0.000 0.005 1 18 0.793 0.009 1 19 0.083 -0.006 0.349 1 20 0.083 -0.025 1.377 1 21 0.086 -0.046 2.504 1 22 0.089 -0.046 2.366 1 23
Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, P/E, ROCE, Quick ratio, DPS, RONW, Cash EPS Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, ROCE, Quick ratio, DPS, RONW, Cash EPS
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 147
Predictors: (Constant), Beta, log total asset, ROCE, Quick ratio, DPS, RONW, Cash EPS Predictors: (Constant), Beta, log total asset, ROCE, DPS, RONW, Cash EPS Predictors: (Constant), Beta, log total asset, DPS, RONW, Cash EPS Predictors: (Constant), Beta, log total asset, DPS, Cash EPS
TABLE10.C ANOVA df 7.000 21.000 28.000
Model 4
F 4.935
Sig. 0.002
The table 11 summarizes the regression results for the Indian companies and provide some interesting insights regarding the payout behaviour of these firms. First, it is found that liquidity and profitability in the organization plays a significant role in determining the dividend policy of Indian firms, as indicated by the statistically significant values of ROCE, RONW, cash EPS, DPS and quick ratio. It is evident that the growth, systematic risk and size have the least impact on Indian firms dividend policy.
TABLE11
-0.005 -0.12
It is evident from the regression table (Table 12.b) that the adjusted R-square is going up till 4th model; this shows that current ratio (incl. mktgl. securities), P/E, TA, beta, ronw and roce are the best determinants of dividend policy in 2000. The Table 12.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table 12.a. The overall conclusion throws light on variables like current ratio (incl. mktgl. securities) P/E, TA, beta, ronw and roce.
TABLE12.B Model 1 2 3 4 5 6 7 8 9 10 R 0.713 0.713 0.711 0.611 0.515 0.436 0.352 0.306 0.000 R Square 0.509 0.508 0.505 0.373 0.265 0.190 0.124 0.094 0.000 Adjusted R Square -0.376 -0.148 0.134 0.024 -0.029 -0.031 -0.022 0.024 0.000 Model Summary Std. Error of the Estimate Change Statistics R Square Change F Change df1 df2 302.750 0.509 0.575 9 5 276.576 -0.001 0.007 1 5 0.712 0.017 1 6 240.168 -0.001 0.018 1 7 254.933 -0.132 2.141 1 8 261.810 -0.108 1.547 1 9 262.075 -0.075 1.022 1 10 260.890 -0.066 0.892 1 11 254.986 -0.031 0.418 1 12 258.101 -0.094 1.344 1 13
Predictors: (Constant), dps, curr_ratio, pe, eps, TA, beta, ronw, casheps, roce b. Predictors: (Constant), dps, curr_ratio, pe, TA, beta, ronw, casheps, roce Predictors: (Constant), dps, curr_ratio, pe, TA, beta, ronw, roce d. Predictors: (Constant), curr_ratio, pe, TA, beta, ronw, roce Predictors: (Constant), curr_ratio, pe, TA, beta, roce Predictors: (Constant), curr_ratio, TA, beta, roce g. Predictors: (Constant), curr_ratio, beta, roce Predictors: (Constant), beta, roce i. Predictors: (Constant), roce Predictor: (constant)
TABLE12.C ANOVA
Model 4
df 6 8 14
F 1.361
Sig. 0.334
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 149
Year2001
Table 13.a presents the correlation table of the year 2001. The parameters having correlation are beta, RONW, ROCE and P/E ratio which shows that dividend payout ratio moves positive with beta, RONW, ROCE and P/E of the firm out of which the highest correlation is with P/E (.317)
TABLE13.A DPR 1.000 beta 0.176 eps pe -0.12 0.317 Correlations qr casheps 0.079 -0.062 curr_ratio 0.098 TA 0.046 ronw 0.187 roce 0.236 dps 0.032
Pearson Correlation
DPR
It is evident from the regression table (Table 13.b) that the adjusted R-square is going up till 3th model; this shows that current ratio (incl. mktgl. securities), DPS, total asset, ronw, beta, casheps, quick ratio and roce are the best determinants of dividend policy in 2001. The Table 13.c presents the result of ANOVA analysis.
TABLE13.B Model 1 2 3 R 0.975 0.975 R Square Adjusted R Square 0.951 0.950 0.827 0.860 Model Summary Std. Error of the Estimate 20.093 18.084 Change Statistics R Square Change F Change df1 df2 0.951 7.694 10 4 -0.001 0.050 1 4 0.973 0.333 1 5
Predictors: (Constant), dps, pe, curr_ratio, TA, ronw, beta, casheps, qr, roce, eps b. Predictors: (Constant), dps, pe, curr_ratio, TA, ronw, beta, casheps, qr, roce Predictors: (Constant), dps, curr_ratio, TA, ronw, beta, casheps, qr, roce
TABLE13.C ANOVA df 8 6 14
Model 3
F 13.303
Sig. 0.003
Year2002
Table 14.a represents the correlation table of the year 2002 showing that the only parameter that show some correlation is P/E (0.187) which shows that dividend payout moves positive with P/E.
TABLE14.A DPR 1 beta eps -0.15 pe 0.187 Correlations qr Casheps -0.09 -0.032 Curr_ratio -0.053 TA -0.04 ronw 0.043 roce 0.074 dps -0.02
Pearson Correlation
DPR
0.005
It is evident from the regression table (Table 14.b) that the adjusted R-square is going up till 8th model; this shows that dps, casheps, eps are the best determinants of dividend policy in 2002. The Table 14.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 8th model and the results are supporting the earlier observation in the previous table 14.a. The overall conclusion throws light on variables like dps, casheps, eps
TABLE14.B Model 1 2 3 4 5 6 7 8 9 R 0.864054 0.863882 0.786282 0.774029 0.74057 0.726689 0.709167 0.609172 R Square 0.746589 0.746292 0.61824 0.59912 0.548443 0.528078 0.502918 0.37109 Adjusted R Square 0.113062 0.289618 0.23648 0.298461 0.297578 0.339309 0.367351 0.266272 Model Summary Std. Error of the Estimate 30.32781 27.1419 0.822745393 28.13874 26.97245 26.98941 26.17542 25.61392 27.5843 Change Statistics R Square Change 0.746589 -0.0003 -0.05867 -0.01912 -0.05068 -0.02037 -0.02516 -0.13183 F Change 1.178464 0.004686 1.367365 1.089542 0.350579 1.011319 0.40591 0.533123 2.917249 df1 10 1 1 1 1 1 1 1 1 df2 4 4 5 6 7 8 9 10 11
Predictors: (Constant), dps, pe, ronw, curr_ratio, TA, casheps, beta, qr, eps, roce Predictors: (Constant), dps, pe, curr_ratio, TA, casheps, beta, qr, eps, roce Predictors: (Constant), dps, pe, curr_ratio, casheps, beta, qr, eps, roce d. Predictors: (Constant), dps, curr_ratio, casheps, beta, qr, eps, roce Predictors: (Constant), dps, curr_ratio, casheps, qr, eps, roce f. Predictors: (Constant), dps, casheps, qr, eps, roce Predictors: (Constant), dps, casheps, eps, roce h. Predictors: (Constant), dps, casheps, eps Predictors: (Constant), casheps, eps
TABLE14.C ANOVA df 3 11 14
F 3.709719
Sig. 0.045894
Year2003
The correlation table (Table 15.a) shows that the parameters that depict some correlation are RONW, P/E, ROCE and DPS which demonstrate that dividend payout ratio moves positive with RONW, P/E, ROCE and DPS of the firm.
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 151 TABLE15.A DPR 1.00 beta -0.18 eps -0.11 pe 0.79 Correlations qr casheps -0.24 -0.04 curr_ratio -0.019 TA -0.13 ronw 0.24 roce 0.27 dps 0.167
Pearson Correlation
DP R
It is evident from the regression table (Table 15.b) that the adjusted R-square is going up till 4th model; this shows that dps, TA, curr_ratio, ronw, casheps, roce, eps are the best determinants of dividend policy in 2003. The Table 15.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table 15.a. The overall conclusion throws light on variables like DPS, TA, curr_ratio, ronw, cash EPS, ROCE, EPS
TABLE15.B Model R R Square Adjusted R Square Model Summary Std. Error Change of the Statistics Estimate R Square Change 89.43692 0.949587 80.65013 -0.00083 75.14621 77.84892 76.65699 73.92712 75.9891 -0.00955 -0.01411 -0.00694 -0.00278 -0.01397
df1 10 1 1 1 1 1 1 6 7 8 9 10
df2 4 4
1 2 3 4 5 6 7 8
Predictors: (Constant), dps, TA, pe, curr_ratio, ronw, beta, qr, casheps, roce, eps Predictors: (Constant), dps, TA, curr_ratio, ronw, beta, qr, casheps, roce, eps Predictors: (Constant), dps, TA, curr_ratio, ronw, qr, casheps, roce, eps d. Predictors: (Constant), dps, TA, curr_ratio, ronw, casheps, roce, eps Predictors: (Constant), dps, TA, ronw, casheps, roce, eps f. Predictors: (Constant), dps, TA, casheps, roce, eps Predictors: (Constant), dps, casheps, roce, eps h. Predictors: (Constant), dps, casheps, eps
TABLE15.C Sum of Squares 595141.3 39528.67 634670 ANOVA df 7 7 14 Mean Square 85020.19 5646.952 F 15.05594 Sig. 0.000992
Year2004
The correlation table (Table 16.a) shows that the parameters that show some correlation with DPR are P/E, RONW and ROCE out of which the highest correlation is with P/E (.667). This shows that dividend payout moves positive with P/E, RONW and ROCE.
152 Changing Dynamics of Finance TABLE16.A DPR 1 beta 0.045 eps -0.08 Correlations pe qr casheps 0.667 -0.04 -0.062 curr_ratio -0.089 TA -0.14 ronw 0.174 roce 0.20 dps -0.05
Pearson Correlation
DPR
It is evident from the regression table (Table 16.b) that the adjusted R-square is going up till 5th model; this shows that qr, pe, beta, curr_ratio, casheps, eps are the best determinants of dividend policy in 2004. The Table 16.c presents the result of ANOVA analysis. The Fstatistics shows that the value of the residual is lowest in the 5th model and the results are supporting the earlier observation in the previous table 16.a. The overall conclusion throws light on variables like qr, pe, beta, curr_ratio, casheps, eps.
TABLE16.B Model R R Square Adjusted R Square Model Summary Std. Error Change of the Statistics Estimate R Square Change 59.18214 0.977918 53.03454 -8.4E-05 48.28556 46.34749 47.02594 47.70467 -0.00285 -0.00136 -0.00428 -0.0045
df1 10 1 1 1 1 1 1
df2 4 4 5 6 7 8 9
1 2 3 4 5 6 7
0.977918 0.977834
0.922714 0.937936 0.988496722 0.974277 0.948554 0.972915 0.952601 0.96863 0.951203 0.964131 0.949784
Predictors: (Constant), dps, qr, TA, pe, ronw, beta, curr_ratio, casheps, roce, eps Predictors: (Constant), dps, qr, TA, pe, beta, curr_ratio, casheps, roce, eps Prediictors: (Constant), dps, qr, pe, beta, curr_ratio, casheps, roce, eps Predictors: (Constant), qr, pe, beta, curr_ratio, casheps, roce, eps Predictors: (Constant), qr, pe, beta, curr_ratio, casheps, eps Predictors: (Constant), qr, pe, beta, casheps, eps Predictors: (Constant), qr, pe, casheps, eps
TABLE16.C ANOVA df 6 8 14
F 47.893809
Sig. 0.000007727
Year2005
The correlation table (Table 17.b) shows that the parameters that depict some positive correlation are cash EPS, P/E, RONW and ROCE, which demonstrate that dividend payout moves positive with these profitability ratio but the correlation is weak.
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 153 TABLE17.A DP R Pearson Correlatio n DP R 1 beta 0.01 1 eps 0.23 6 Correlations qr cashep s 0.20 0.11 0.047 8 2 pe curr_rati o -0.134 TA 0.21 5 ronw 0.06 8 roce 0.10 6 dps 0.03 1
It is evident from the regression table (table 17.b) that the adjusted R-square is going up till 5th model, this shows that Total Asset, P/E,RONW,ROCE,EPS and cash EPS are the best determinant of dividend policy in 2005. The Table 17.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 17.a).The overall conclusion throws light on variables like Total Asset, P/E,RONW, EPS and cash EPS.
TABLE17.B
Model R R Square Adjusted R Square Model Summary Std. Error Change of the Statistics Estimate R Square Change 92.741484 0.9457801 83.024215 -9.64E-05 71.3933 67.609903 75.489218 76.871826 81.938309 86.290034 -0.0008677 -0.0014023 -0.0231966 -0.0123008 -0.0232614 -0.0244259
F Change 6.9773613 0.007112 0.0962335 0.0940404 0.174567 3.2199709 1.3696607 2.497763 2.3084825
df1 10 1 1 1 1 1 1 1 1
df2 4 4 5 6 7 8 9 10 11
1 2 3 4 5 6 7 8 9
Predictors: (Constant), dps, TA, pe, casheps, curr_ratio, beta, ronw, qr, eps, roce Predictors: (Constant), dps, TA, pe, casheps, curr_ratio, beta, ronw, eps, roce Predicitors: (Constant), dps, TA, pe, casheps, curr_ratio, ronw, eps, roce Predictors: (Constant), TA, pe, casheps, curr_ratio, ronw, eps, roce Predictors: (Constant), TA, pe, casheps, ronw, eps, roce Predictors: (Constant), pe, casheps, ronw, eps, roce Predictors: (Constant), pe, casheps, eps, roce Predictors: (Constant), pe, casheps, eps Predictors: (Constant), casheps, eps
TABLE17.C
ANOVA df 6 8 14
F 21.80208
Sig. 0.0001506
Year2006
The correlation table (table 18.a) shows that the parameters that depict some positive correlation are Quick ratio, RONW and ROCE, which demonstrate that dividend payout moves positive with these profitability ratio but the correlation is weak.
TABLE18.A
DPR 1 beta 0.044 eps pe -0.26 -0.04 Correlations Qr casheps 0.015 -0.056 curr_ratio 0.006 TA ronw -0.23 0.070 roce 0.094 dps -0.07
Pearson Correlation
DPR
The regression table (table 18.b) shows that the adjusted R-square is going up till 9th model, this shows that EPS and cash EPS are the best determinant of dividend policy in 2006. The Table 18.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 9th model and the results are supporting the earlier observation in the previous table (table 18.a).The overall conclusion throws light on variables like EPS and cash EPS.
TABLE18.B Model R R Square Adjusted R Square Model Summary Change Std. Error Statistics of the Estimate R Square Change 217.96853 0.7005572 195.48888 -0.0016362 178.98828 178.23606 175.08922 173.78559 172.88238 171.33645 0.0456737 -0.0470923 0.0342888 -0.041138 0.0421606 0.0370325
F Change 0.9358144 0.0218561 0.1096749 0.8906646 0.932899 0.6850066 0.8516443 0.8859575 0.7863491
df1 10 1 1 1 1 1 1 1 1
df2 4 4 5 6 7 8 9 10 11
1 2 3 4 5 6 7 8 9
Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, beta, qr, pe, eps, roce Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, qr, pe, eps, roce Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, pe, eps, roce Predictors: (Constant), dps, curr_ratio, casheps, ronw, pe, eps, roce Predictors: (Constant), curr_ratio, casheps, ronw, pe, eps, roce Predictors: (Constant), casheps, ronw, pe, eps, roce Predictors: (Constant), casheps, ronw, eps, roce h. Predictors: (Constant), casheps, eps, roce Predictors: (Constant), casheps, eps
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 155 TABLE18.C Model 9 Sum of Squares 282375.01 352274.14 634649.16 ANOVA df Mean Square 2 141187.51 12 29356.179 14 F 4.8094648 Sig. 0.0292471
Year2007
The correlation table (19.a) shows that the parameters that exhibit some positive correlation are Cash EPS, P/E and Quick ratio which shows that dividend payout moves positive with these profitability ratio but the correlation is weak. With other variables the correlation is negative.
TABLE19.A DPR 1 beta 0.168 eps -0.28 Correlations pe qr casheps 0.004 0.05 0.042 curr_ratio 0.010 TA -0.23 ronw -0.05 roce -0.03 dps -0.07
Pearson Correlation
DPR
It is evident from the regression table (table 19.b) that the adjusted R-square is going up till 2nd model, this shows that besides EPS,P/E, RONW and cash EPS, DPS and Current ratio are also the best determinant of dividend policy in 2007. The Table 19.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 2nd model and the results are supporting the earlier observation in the previous table 19.a. The overall conclusion throws light on variables like DPS, RONW,ROCE,,p/e, EPS, beta, current ratio, total asset and cash EPS.
TABLE19.B Model R R Square Adjusted R Square Model Summary Change Std. Error of the Statistics Estimate R Square Change 0.70291 126.6032 0.915117 0.761402 113.4576 -0.00033 0.733684 119.8668 -0.02892 0.730541 120.5722 -0.02059 0.718733 123.1855 -0.02599
1 2 3 4 5
df1 10 1 1 1 1
df2 4 4 5 6 7
Predictors: (Constant), dps, TA, ronw, pe, casheps, qr, beta, curr_ratio, eps, roce Predictors: (Constant), dps, TA, ronw, pe, casheps, beta, curr_ratio, eps, roce Predictors: (Constant), dps, TA, ronw, pe, casheps, curr_ratio, eps, roce Predictors: (Constant), dps, TA, ronw, pe, casheps, eps, roce Predictors: (Constant), dps, ronw, pe, casheps, eps, roce
156 Changing Dynamics of Finance TABLE19.C Model 2 Sum of Squares 690953.1 64363.15 755316.3 ANOVA df Mean Square 9 76772.57 5 12872.63 14 F 5.964016 Sig. 0.031743
Year2008
The correlation table 20.a shows that the only ratio that shows very high positive correlation is P/E which exhibit that dividend payout moves positive with this profitability ratio
TABLE20.A DPR 1 beta eps pe 0.21 -0.23 0.36 Correlations qr casheps 0.00 0.04 curr_ratio -0.05 TA ronw -0.23 0.07 roce dps 0.09 0.02
arson Correlation
DPR
It is evident from the regression table (table 20.b) that the adjusted R-square is going up till 5th model, this shows that besides EPS,P/E, ROCE and cash EPS, DPS and Current ratio are also the best determinant of dividend policy in 2008. The Table 20.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 20.a). The overall conclusion throws light on variables like DPS, P/E, beta, EPS,current ratio and cash EPS.
TABLE20.B Model Summary Std. Error Change of the Statistics Estimate R Square Change 131.76303 0.9620147 118.14415 -0.0001883 100.4881 94.210319 104.94722 104.20535 103.67254 -0.0002389 -0.0001748 0.0153813 -0.0051756 -0.0052731
Model
R Square
Adjusted R Square
df1 10 1 1 1 1 1 1 1
df2 4 4 5 6 7 8 9 10
1 2 3 4 5 6 7 8
Predictors: (Constant), dps, ronw, TA, pe, casheps, qr, beta, eps, roce, curr_ratio Predictors: (Constant), dps, ronw, pe, casheps, qr, beta, eps, roce, curr_ratio Predictors: (Constant), dps, ronw, pe, casheps, beta, eps, roce, curr_ratio Predictors: (Constant), dps, pe, casheps, beta, eps, roce, curr_ratio Predictors: (Constant), dps, pe, casheps, beta, eps, curr_ratio Predictors: (Constant), dps, casheps, beta, eps, curr_ratio Predictors: (Constant), dps, casheps, eps, curr_ratio Predictors: (Constant), dps, casheps, eps
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 157 TABLE20.C Model 5 Regression Residual Total Sum of Squares 1757228.4 71004.674 1828233 ANOVA df Mean Square 6 292871.39 8 8875.5843 14 F 32.997421 Sig. 0.0000320417
Year2009
The correlation table (table 21.a) of the year 2009 shows that the only ratio that shows very high positive correlation is P/E which demonstrate that dividend payout moves positive with this profitability ratio. Other variables like ROCE, EPS and Quick Ratio show a very weak correlation
TABLE21.A DPR 1 beta 0.23 eps 0.25 pe 0.86 Correlations qr casheps 0.09 1.00 curr_ratio 0.01 TA -0.28 ronw 0.04 roce 0.04 dps 0.02
Pearson Correlation
DPR
It is evident from the regression table (table 21.b) that the adjusted R-square is going up till 4th model, this shows that besides EPS,P/E, ROCE and cash EPS, DPS and Total Assets are also the best determinant of dividend policy in 2008. The Table 21.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 21.a).The overall conclusion throws light on variables like P/E, DPS, total asset, beta, ROCE, EPS and cash EPS.
TABLE21.B Model R R Square Adjusted R Square 0.9999959 0.9999967 0.9999969 0.9999967 0.9999965 0.9999962 Model Summary Std. Error Change of the Statistics Estimate R Square Change 0.7851509 0.9999988 0.7076961 -1.826E-08 0.6773823 -1.186E-07 0.7076432 -3.584E-07 0.7284954 -3.527E-07 0.7578771 -4.401E-07
1 2 3 4 5 6
df1 10 1 1 1 1 1
df2 4 4 5 6 7 8
Predictors: (Constant), dps, casheps, curr_ratio, TA, ronw, eps, beta, pe, qr, roce Predictors: (Constant), dps, casheps, curr_ratio, TA, eps, beta, pe, qr, roce Predictors: (Constant), dps, casheps, curr_ratio, TA, eps, beta, pe, roce Predictors: (Constant), dps, casheps, TA, eps, beta, pe, roce Predictors: (Constant), dps, casheps, TA, eps, beta, roce Predictors: (Constant), dps, casheps, eps, beta, roce
158 Changing Dynamics of Finance TABLE21.C Model 4 Regression Residual Total Sum of Squares 690953.1 64363.15 755316.3 Df 9 5 14 ANOVA Mean Square 76772.57 12872.63 F 5.964016 Sig. 0.031743
The table 22 summarizes the regression results for the multinational companies and provide some interesting insights regarding the payout behaviour of these firms. First, it is found that besides profitability and liquidity playing important role in the case of Indian companies, growth rate and size of business also plays a key role in Multinational companies as indicated by the statistically significant values of ROCE, cash EPS, EPS, P/E ratio, DPS and total asset. It is evident that the systematic risk has the least impact on multinational firms dividend policy.
TABLE22
Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 159
companies are that systematic risk is the least impacting factor in deciding the dividend policy of the companies as indicated by the insignificant value of beta. The main conclusions of the paper are that a firm's dividend policy will depend upon various factors. One of which is that Profitable firms are more likely to support high dividend payments to shareholders. More importantly, however, some of the determinants of dividend policy are different for Indian and multinational firms. It shows that profitability and liquidity of the firm are highly influencing factors in determining the dividend policies of Indian companies whereas in multinational companies size and growth also play a key role in a firm's payout ratio. These can be the guiding factors for other firms framing their dividend policy.
REFERENCES
[1] Akhigbe, Aigbe, Stephen F. Borde, and Jeff Madura, "Dividend Policy and Signaling by Insurance Companies", The Journal of Risk and Insurance, vol. 60, September 1993. [2] Baker, M. and J. Wurgler [2003], Appearing and Disappearing Dividends: The Link to Catering Incentives, NBER Working Paper Series. [3] Bhat, R. and I. M. Pandey [1994], Dividend decision: A Study of Managers' Perceptions, Decision 21. [4] Collins, M. Cary, Atul K. Saxena, and James W. Wansley, "The Role of Insiders and Dividend Policy: A Comparison of Regulated and Unregulated Firms", Journal of Financial and Strategic Decisions. [5] Fama, E. F. [1974], The Empirical Relationship between the Dividend and Investment Decisions of Firms, The American Economic Review. [6] Gorden, M. J. [1959], Dividends, Earnings, and Stock Prices, Review of Economics and Statistics 41. [7] Gugler, K. [2003], Corporate governance, dividend payout policy, and the interrelation between dividends, R&D, and capital investment, The Journal of Banking and Finance. [8] Gugler, K. and B. B. Yurtoglu [2003], Corporate governance and dividend pay-out policy in Germany, European Economic Review. [9] Linter, J. [1956], Distribution of incomes of corporations among dividends, retained earnings and taxes, The American Economic Review. [10] Mahapatra, R. P. and P. K. Sahu [1993], A Note on Determinants of Corporate Dividend Behavior in India An Econometric Analysis. [11] Miller, Merton, and Franco Modigliani [1961], "Dividend Policy, Growth and the aluation of Shares," Journal of Business, vol. 34. [12] Twaijry, Abdulrahman Ali [2007], Dividend policy and payout ratio: evidence from the Kuala Lumpur stock exchange, Journal of Risk Finance, vol. 8. [13] Bebczuk R. (2005)," Corporate governance and ownership: measurement and impact on corporate performance and dividend policies in Argentina", Center for Financial Stability, Working Paper.
ANNEXURE SampleofIndianCompanies
TABLE1 Sr. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 Indian Company Name Reliance Industries Ltd. Oil & Natural Gas Corpn.Ltd. Infosys Technologies Ltd. Bharat Heavy Electricals Ltd. I T C Ltd. Wipro Ltd. Steel Authority Of India Ltd. Indian Oil Corpn. Ltd. Jindal Steel & Power Ltd. G A I L (India) Ltd. Tata Steel Ltd. Hindustan Zinc Ltd. Hindustan Copper Ltd. Tata Motors Ltd. Sun Pharmaceutical Inds.Ltd. Adani Enterprises Ltd. Mahindra & Mahindra Ltd. Tata Power Co. Ltd. Sesa Goa Ltd. Hindalco Industries Ltd. National Aluminium Co.Ltd. Cipla Ltd. Neyveli Lignite Corpn. Ltd. Reliance Infrastructure Ltd. Grasim Industries Ltd. Dr. Reddy'S LaboratoriesLtd. Unitech Ltd. Ranbaxy Laboratories Ltd. Reliance Capital Ltd.
SampleofMultinationalCompanies
TABLE2 Sr. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Multinational Company Name Hindustan Unilever Ltd. Nestle India Ltd. Siemens Ltd. A B B Ltd. Bosch Ltd. Glaxosmithkline Pharmaceuticals Ltd. Cummins India Ltd. Colgate-Palmolive (India) Ltd. Castrol India Ltd. Glenmark Pharmaceuticals Ltd. Areva T & D India Ltd. Glaxosmithkline Consumer Healthcare Ltd. Procter & Gamble Hygiene & Health CareLtd. Alstom Projects India Ltd. Rolta India Ltd.
DividendPolicyofIndianMultinationals
Dr.ManishaPanwala*
AbstractThe companies of the world follow different types of dividend structures. A company's dividends may be declared quarterly, bi-annually or annually. Companies may pay dividends in the form of checks, stocks, property, or in some other form, dependent upon the company's policy. The dividend per share to be paid by the company is determined by the amount of profit earned in that fiscal year. The paper focuses to analyze the influence of various factors on dividend policy of Indian multinational firms. The data for the study is secondary and correlation is used to analyze the data. The analysis reveals that the dividend of the companies mostly dependent on the net income of that company except Mahindra. There is no significant relation between the liquidity position and dividend payment of the company. The macro economic factor, that is, GDP also do not have any significant influence on the companies dividend policy. Keywords: Multinational Companies, Dividend Policy, Net Income, Owners Fund
INTRODUCTION
When a company earns a profit, it pays a certain amount of the profit to its shareholders, in the form of dividends. The companies of the world follow different types of dividend structures. A company's dividends may be declared quarterly, bi-annually or annually. Companies may pay dividends in the form of cheques, stocks, property, or in some other form, dependent upon the company's policy. When a company earns a profit, it has two options for implementing it. They are the following: Re-investment of the profit into business operations, which is also known as, retained earnings paying dividends to the shareholders of the company. A large number of companies keep aside a part of the profits earned by them, the remainder distributed as dividends..
Normally, public companies make the payment of dividends on a specified schedule. Nevertheless, they have the discretion to declare a dividend at any point in time, hence, the special dividend. If a company has suffered a loss, it still has the option to pay dividends out of retained earnings made during earlier years or cancel the dividend.
SEBIGuidelinesonDividendPolicy
SEBI has fine-tuned guidelines on dividend payments, bonus issue, IPOs and preferential allotment of warrants. Mandating that listed companies should declare dividend only on pershare basis. SEBI has also decided to reduce the period for completing a bonus issue to 15 days, where no shareholders approval is required as per Articles of Association of the *Veer Narmad South Gujarat University, Gujarat
company and to 60 days where shareholders approval is required. SEBI has also reduced the timeline for notice period for payment of dividend. The notice period for record date has been reduced to seven working days and for board meetings has been reduced to two working days.
CorporateIncomeTax
Dividend distribution tax: Arguably the most notable fiscal measure for Belgian investors is in relation to the Indian dividend distribution tax. Dividends distributed by Indian companies to their shareholders are in principle subject to a dividend distribution tax of 16.955% (15% tax increased by the 3% education cess and 10% surcharge). The new fiscal measure allows the Indian parent company to offset dividends received from its Indian subsidiary against dividends distributed by the parent when computing the dividend distribution tax liability. This means that the 16.995% dividend distribution tax will solely be due on the difference between the dividends distributed by the parent itself and the dividends received from its subsidiary. However, in order to benefit from the dividend distribution tax credit, there are several conditions to be met: The Indian parent company must hold more than 50% of the nominal value of the equity share capital of the Indian subsidiary; The Indian subsidiary must have paid dividend distribution tax on the dividends distributed to the Indian parent; and The Indian parent may not be a subsidiary of any other company (i.e. any other company may not own more than 50% of the shares of the Indian parent company).
Corporate income tax rate: Indian companies are taxable on their worldwide income at a corporate tax rate of 30% increased by 3% education cess, plus a 10% surcharge if the taxable income exceeds 10 million Indian Rupees (INR). For branches of foreign companies, the corporate tax rate is 40% increased by 3% education cess, while the surcharge is 2.5%.
Effective tax rates for company with Taxable income not exceeding 10 million INR Taxable income exceeding 10 million INR Indian company 30.9% 33.99% Branch of foreign company 41.2% 42.2%
(Using an average approximate exchange rate for 1/1/2008-30/05/2008 of 61.5 INR to the euro, 10 million INR is about 162,600 EUR.) So far, a subsidiary used to pay DDT on the dividend it distributed and on the same dividend, the parent company again paid DDT. This is because the dividend received from a subsidiary company is included in the total dividend income on which a parent firm has to pay DDT. There was no mechanism for getting credit for the DDT already paid.
FactorsAffectingDividendPolicyofIndianMultinationals
The main purpose of this study is to analyze the companies behaviour of dividend payout as a reaction to changes in various factors for emergent markets, with a study case of Indian Multinationals.
In fact, based on dividend payout, the behaviour of listed companies can be distinguished relative to consumption or to investments. Thus, a higher dividend ratio can be translated as a decision oriented to consumption. On the other hand, a lower dividend ratio can be explained by a preference for future economic growth, taking into consideration not only tangible and intangible assets, but also investments in human resources. Dividend Payout Policy remains one of the main issues in Corporate Finance.
ResearchMethodology
Research Question What is the influence of various factors on dividend policy of Indian Multinational Firms?
Research Objectives The purpose of the study is: To analyze the influence of various factors (dividend payment, net income, owners funds, fixed assets turnover ratio, total debt / equity, current ratio and GDP) on dividend policy of Indian multinational firms.
Variables for the Study The key variables for dividend policies of the study are as follows:
Variables Dividend payment Net Income Owners funds Fixed assets turnover ratio Description Dividend Per Share paid by companies Reported net profit before preference dividend payment Owners fund as % of total source
FA Turnover = Total debt/equity TD/Equity = Current Ratio CR = GDP real growth rate (%)
GDP
Data Collection and Analysis The data for the study is secondary and the various ratios are calculated for the study. For the analysis of the data the statistical measures like correlation is used to find out how various variables are related with dividend payment of company. The companies selected are: (1) Asian Paints Ltd. (2) Mahindra & Mahindra Ltd. (3) Infosys Technologies Ltd and (4) Videocon Industries Ltd.
DataAnalysis
Asian Paints Ltd Descriptive Statistics
Dividend Net Income Owners fund as % of total source Fixed Asset turnover Total Debts to Equity Current Ratio GDP Mean 13.9000 273.9740 90.6740 3.6800 .0980 1.1280 8.4800 Std. Deviation 3.34290 94.55729 2.70794 .46519 .03421 .07981 .96540
Correlations
Dividend Dividend Pearson 1 Correlation Sig. (2-tailed) .014 N 5 5 * Correlation is significant at the 0.05 level (2-tailed). Net Income .947(*) Owners fund as Fixed Asset Total Debts % of total source turnover to Equity .740 .947(*) -.735 .153 5 .015 5 .157 5 Current Ratio -.315 .606 5 GDP -.055 .930 5
Dividend payment of Asian Paints is highly related with its net income that is positively related. With increase in net income the dividend also increases. Dividend is also positively related with owners fund and fixed asset turnover. But it is negatively related with total debts to equity, current ratio and GDP. The dividend payment for Asian paints is highly dependent on its net income.
Correlations
Dividend Dividend NI Pearson 1 -.391 Correlation Sig. (2-tailed) .515 N 5 5 **Correlation is significant at the 0.01 level (2-tailed). Owners fund as % Fixed Asset Total Debts of total source turnover to Equity -.063 -.327 -.038 .920 5 .591 5 .952 5 Current Ratio .200 .747 5 GDP -.378 .531 5
For Mahindra the dividend is negatively related with its net income. It is also negatively related with fixed assets turnover and total debts to equity. It is partially related with current ratio.
InfosysTechnologiesLtd.
Descriptive Statistics
Dividend NI Owners fund as % of total source Fixed Asset turnover Total Debts to Equity Current Ratio GDP Mean 24.9500 3677.3580 100.0000 3.3240 . 3.6320 8.4800 Std. Deviation 14.44645 1577.88955 .00000 .12740 . .95910 .96540 N 5 5 5 5 0 5 5
Correlations
Dividend NI Owners fund as Fixed Asset % of total turnover source .(a) -.116 .852 5 Total Debts to Equity .(a) . 0 Current Ratio -.430 .470 5 GDP
Dividend
Pearson 1 .009 Correlation Sig. (2-tailed) .988 . N 5 5 5 *(a)Cannot be computed because at least one of the variables is constant.
.608 .277 5
There is 100% owners fund in Infosys, so the total debt to equity ratio is zero. Dividend is negatively related with fixed asset turnover but it is partially determined from GDP.
VideoconIndustriesLtd.
Descriptive Statistics
Dividend Net Income Owners fund as % of total source Fixed Asset turnover Total Debts to Equity Current Ratio GDP Mean 2.1000 505.8140 39.0620 .8520 .8520 3.8240 8.4800 Std. Deviation 1.55724 371.12338 21.64050 .40071 .49852 1.50264 .96540 N 5 5 5 5 5 5 5
Correlations
Dividend Dividend Pearson Correlation Sig. (2-tailed) N 1 5 Net Income .491 .401 5 Owners fund Fixed Asset as % of total turnover source .769 .703 .129 5 .186 5 Total Debts to Equity .676 .210 5 Current Ratio .316 .604 5 GDP .775 .124 5
Dividend in Videocon is affected by all the factors as it is positively related with all factors.
CONCLUSION
The analysis reveals that dividend payment of Asian Paints is highly related with its net income. With the increase in net income the dividend also increases. Dividend is also positively related with owners fund and fixed asset turnover. But it is negatively related with total debts to equity, current ratio and GDP. The dividend of the companies mostly dependents on the net income of the company except Mahindra. Dividend in Videocon is affected by all the factors as it is positively related with all the factors. There is no significant relation between the liquidity position and dividend payment of the company. The macro economic factor, that is, GDP also do not have any significant influence on the companies dividend policy.
REFERENCES
[1] [2] [3] [4] http://money.rediff.com/companies/videocon-industries-ltd http://money.rediff.com/companies/infosys-technologies-ltd http://money.rediff.com/companies/mahindra-and-mahindra-ltd http://money.rediff.com/companies/asian-paints-ltd
Track3
CorporateGovernance
TaxAvoidanceandEvasion:Issues withinCorporateGovernance
AshutoshSingh*andPankajShah**
AbstractPurpose: Corporate crimes are the planed activates in which some of the smartest minds around the world work to accomplish the malpractices. The intention behind this research to identify relationship among corporate governance and taxation. In corporate crimes around the world organization heads enjoyed the savings and pension funds of the investors. And at the end of the day they were behind the bars and the companies were liquidated. Methodology: Exploratory based laboratory research observation & analysis is used as a method of research. The data is investigated from various books and research publications. Findings: This research work concentrates on one of the burning issues of the corporate governance. Taxation is the issue which is very much ignored and it was known as the matter of technical experts with in the organization. But in the current scenario taxation is not just the matter of board room. As there are various corporate crime cases in which CG rules and regulations are violated by contravening tax regulation. This research introduces readers to role of taxation under practices of CG.
INTRODUCTION
For top managers running a business organization is like formula one car racing where some time drivers take a huge risk to come in the top ranking. In business these risks are the aggressive strategies where one wrong step becomes the question of life and death. The world corporate history is full of biographies of such drivers. Some of them lost everything and some of them become legends. Whether its walking on the street or driving, we expose ourselves to risk. It depends on the personality of the person that how much risk he takes in his life time. Globalization of business has not just provided not just granted a new lot of customers, intellectual staff and global presence. Various kinds of risks in the business were also some of the uninvited guests in the party. Scholars classified the risks in various parts like financial risk, business risk, credit or default risk, country risk, interest rate risk, political risk, market risk, foreign exchange risk and many more. Taxes are the compulsory payments for individuals and multinationals. Taxes play a vital role in the economy. Proper procurement of taxes is the foundation of good governance. Its been a longtime people try to save the money instead of paying taxes. To avoid or evade taxes companies hire lawyers, accountants for that. Anyone can get into serious trouble for avoiding or evading taxes. This becomes a riskier situation when someone caught red-handed while evading taxes. It harms the reputation and various other problems for the accuse person or company. * Amrapali Institute, Haldwani ** GRD Academy, Dehradun
Corrupt practices by the board members make the situations riskier for the investors. Tax evasion is one of the traditional malpractices. Managing or making ourselves safe from risk is there in our subconscious behavior which guides us in searching the best possible options every time (Fiscalis Risk Analysis Project Group, 2006). For sake of protecting stakeholders interest organizations across the world try hard. But when there is one rule there are 100 ways to violate it too. This research discussion about the risk of stakeholders interests from tax evasion and the corporate governance practices with in various organizations to make the work transparent. Legal obligations are essentials for preventing corporate crimes. But this is not enough as we have seen scandals in the recent past. The punishments are not enough for corporate crimes. Self regulations in the companies should be obligatory (Prasad, 2006). The recent financial crisis and the failure of various organizations around the world made it clear the appetite of risk and getting more profit were the main causes behind it. Aggressive tax strategies have made the things worst. Taxes are one of the biggest items on the income statements of organizations. There management and planning is a critical component in terms of corporate governance. But tax risk from an organizational point of view - and the role of tax in good corporate governance - has not featured as prominently as government interventions (Oupa Magashula, September 27, 2010). In the current age of globalization as the technology is changing the world so fast. From needle to yacht everything can be purchased by a simple mouse click and the funds can get transfer from one part of the world to another in a single minute. Tax havens emerged as a favorite destination for corporate managers to save the hard earned money no matter from what way. Tax havens have allowed multinational companies, rich individuals, corrupt leaders, criminals and terrorists to keep their wealth away from the prying eyes of national tax authorities. In the words of one tax expert, I have never come across any reason for people to set up an offshore business in a tax haven other than to avoid tax (The Times, 10 July 2000). This research work is divided in three major parts, the survey of prior research examine the basics of Tax risk, Tax evasion and avoidance, Corporate governance & Relationship between Taxation and Corporate Governance. The analysis part covers the ticks and tactics which the corporations use to avoid and evade the taxes, the tax havens and how Enron used the tax havens for evading the taxes.
The tax risk management involves three aspects Building a suitable tax risk policy and the acceptable level of risk Current risk position. Controlling, communication and monitoring procedures.
TaxEvasionandAvoidance
Corporate managers try to solve the problem of risk via reduction, avoidance, control and transfer of risk. An aggressive tax strategy like avoidance and evasion may lead to risks apart from penalties and other direct consequences like misallocation of corporate resources, loss of auditors independence, (Wolfgang Schn, April 28, 2008). For managing tax instead of
avoidance CFOs prefer evasion. It crafts jeopardy for the institutions goodwill. It is cauterized as reputation risk under tax risk is one which affects the goodwill of an organization. Tax evasion is one of the most common economic crimes from the time when taxation has been started. It is an illegal intentional act by which a taxpayer evades the payment of his statutory dues. Firms evade there taxes by underreporting sales, income and wealth, by overstating deductions, exemptions and credits or by failing to file appropriate tax return (Jorge Martinez-Vazquez and James Alm, May 2003). Some times tax avoidance also termed as same as evasion but both of them are different, the complexity of tax laws makes it difficult to distinguish between fraudulent and aggressive tax planning (David O. Friedrichs, 2010). Avoidance is legitimate while evasion is a fraud activity by falsification in accounts (Sum Yee Loong, 2009). Evading taxes is a corporate crime and have serious consequences for the society and the citizenry because they allow the corporations to raise there profits, lesson their tax burdens and at the same time underpay there employees (Richard D. Hartley, 03/2008).
CorporateGovernance(CG)
Manipulation with accounting records, hiding them from the stakeholders is a serious issue for the corporate governance. The corporate collapse in the year 1970/80 of Rolls Royce, Leyland and corporate scandals questioned the managerial excellence. The stock exchange has commissioned the Adrian Cadbury and his committee to check the financial aspects of the corporate governance. But the companies like WorldCom, Enron, Adelphia who have a well established procurers of CG but these were by passed by them to peruse there personal agenda. The common factor in all these scandals was misuse of power by executives (Adrian Davies, 2006). The term corporate governance is a result of the problems which were arising due to ownership and control of the firm. Corporate governance separates both of them (A. C. Fernando, 2006). Corporate governance is a system by which corporations can be directed and controlled. BODs are responsible for the governance of the company and the role of shareholders is to appoint the directors and auditors and assure themselves that a suitable governance structure is in place (Adrian Cadbury, 2002). It is a system of authoritative directions (John L. Colley, Wallace Stettinius, Jacqueline L. Doyle and George Logan, 6 December, 2004) The reasons for corporate mis-governance in India are: A closed economy, a sheltered market, limited need and access to the global business, lack of competitive sprit and an inefficient regulatory framework. There are major unethical practices in terms of tax evasion. Many large corporations hire tax consultants to get the benefits of loopholes in the tax system and to evade the taxes as much as they can (A. C. Fernando, 2006).
CGandTaxation
BOD plays a vital role in establishing and maintaining a strong CG structure. They have to manage a wide range of priorities. Due to recent economic events BODs are felling necessity of a proper tax risk management system. Various security exchanges around the world
pressurize the listed companies to consider CG principles and recommendations and a sound risk management system. On the international platform, taxation as a concern of CG has gained greater importance due to stricter accounting and financial reporting requirements for better tax governance. The tax administrators have a vital role to play in ensuring boards understand that they are ultimately responsible for their businesss tax strategies and outcomes. At the end it depends on the decisions directors whether tax remains a hidden issue within BOD, with all the barriers to identifying and mitigating risks this entails, or whether management of material tax risk is built into the foundations of your business (Michael DAscenzo, 16 February 2010).Tax law has an impact both on the personal level of shareholders, managers, board members and other stakeholder as well as on the company level. Transparency in the taxation strategies is an essential feature. And it has same relevance in the recording of taxation in the organization. tax rules tend to foster complexity and reduce transparency because they pro-mote in-transparent, tax driven corporate structures. With respect to accounting standards the authors generally support the connection between tax and financial statements, in the belief that the results are a more balanced and realistic picture of companies situation. However, insofar as tax rules influence financial accounts due to a reverse authoritativeness, this results in a risk of in-transparency due to unrealistic tax-driven accounting positions (Arne Friese, Simon Link, Stefan Mayer, 19 January 2006).
TaxHaven
Caribbean/West Indies Tax havens around the world Anguilla, Antigua and Barbuda, Aruba, Bahamas, Barbados, British Virgin Islands, Cayman Islands, Dominica, Grenada, Montserrat, Netherlands Antilles, St. Kitts and Nevis, St. Lucia, St. Vincent and Grenadines, Turks and Caicos, U.S. Virgin Islands Belize, Costa Rica, Panama Hong Kong, Macau, Singapore Andorra, Channel Islands (Guernsey and Jersey), Cyprus, Gibralter, Isle of Man, Ireland, Liechtenstein, Luxembourg, Malta, Monaco, San Marino, Switzerland Maldives, Mauritius, Seychelles, Bahrain, Jordan, Lebanon Bermuda Cook Islands, Marshall Islands, Samoa, Nauru, Niue, Tong Vanuatu Liberia
Indian Ocean Middle East North Atlantic Pacific, South Pacific West Africa
Source: Tax Havens: International Tax Avoidance and Evasion, Jane G. Gravelle, July 9, 2009, CRS Report for Congress.
Tax havens provide the opportunities of tax avoidance and evasion. According to Organization for Economic Co-operation and Development (OECD) these are the areas where the taxes are levied at negligible rate there are no taxes, there is protection of financial information. A high level of secrecy is maintained by the authorities and there are no provisions for the exchange of information about the investment. So the transparency also ignored in the tax havens. For the economies it is easy to track the onshore systems but in the case of offshore operations it is really difficult to track the financial games. In the case of tax
havens it becomes much difficult. In tax havens MNCs evade the taxes by channelizing the various kinds of funds through foreign entities, some individuals evade taxes illegally by not reporting these assets or income on their tax returns (Erek Barsczewski, Oct 10, 2009). Countries become tax haven to attract the business houses to establish the infrastructure on their soil. It happens because the private sector of these countries is not so much powerful to give employment opportunities and the standard of living to the citizens. In this case the foreign multinationals are the ray of hope for these countries. The list of tax havens around the world is as follows: Analysis Tax payments by the corporate houses are the most obvious contributions to the government. But it is a social responsibility of the business to pay tax and it is an ethical topic of discussion too. Corporate governance and taxation is subject matter which is a blend of corporate ethics and corporate social responsibility. The well-known tax consultant, Dinesh Vyas, says that JRD never entered into a debate over tax avoidance, which was permissible, and tax evasion, which was illegal; his sole motto was tax compliance. On one occasion a senior executive of a Tata company tried to save on taxes. Before putting up that case, the Chairman of the company took him to JRD. Mr. Vyas explained to JRD: But sir, it is not illegal. JRD asked, softly: Not illegal, yes. But is it right? Mr. Vyas says that during his decades of professional work no one had ever asked him that question. Mr. Vyas later wrote in an article: JRD would have been the most devoted supporter of the view expressed by Lord Denning: The avoidance of tax may be lawful, but it is not yet a virtue. (R.M. Lala, Friday, Jul 29, 2005). Yes its true that various business icons doesnt feel bad to say that tax evasion is a malpractice.
TaxAvoidanceandEvasioninTaxHavenstheEnronCaseOverview
Enron was the seventh-largest corporation in terms of revenue of United States of America. Its job was to buy natural gas and electrical energy from producers and re-sell those commodities to distributors and consumers. Enron was heavily in debt, but the debt was hidden in various partnerships. (Neal Boortz Friday, Jan. 11, 2002) Enron has paid no income taxes in the last five years. The tax was avoided/evaded by the help of 900 subsidiaries in taxhaven countries. The company was liable for $382 million of tax refunds (David Cay Johnston, January 17, 2002). The company has set up its network in the off-shore tax havens to avoid the taxes. Due to this set up the profit of the company was $2 billion between 19962000.
TricksandTacticsofTaxAvoidanceandEvasion
Tax havens were used for offshore bank account to hide assets and income with the intention unreported income. This is tax evasion. Tax evasion schemes involving tax havens are very sophisticated, and take many twists and turns. Here entities are used as part of aggressive tax strategy to hide critical parts of the transactions. These transactions under the category of aggressive tax planning create foundation of tax evasion. Aggressive tax planning involves
complex arrangement at domestic and international levels. The objective behind such acts is to get those benefits which are not possible in the normal conditions. MNCs manipulate transactions to avoid crossing the line to tax evasion. The following are some of the arrangements involving tax havens that the CRA is reviewing: Tax Shelters In very general terms, a tax shelter could be a gifting arrangement or an acquisition of property for which you are told that the tax benefits and deductions arising from the arrangement or the acquisition will equal or be more than the net costs of entering into the arrangement or acquiring the property. Offshore Investment Funds / Foreign Investment Entities Offshore investment funds and foreign investment entities are generally located in tax havens, and are used to channel investments and delay the taxation of the income earned on them. In India such kind of investments are very popular. Tax Havens and Developing Countries Tax havens affect developing countries also as the taxes from the multinational organizations are one of the biggest sources of the federal earning. According to the tax justice network and global financial integrity study the developing countries are losing $98 billion to $106 billion each year. In 2006 the figure of tax evasion and avoidance was $858.6 billion $1.6 trillion. Indian nationals hold 1.456 trillion US dollars in Swiss banks (Times of India, Aug 24, 2009) it clearly says that Indian are also not way behind in offshore investments. Switzerland is one of favorite destination for Indians because it assures investors that their assets are protected under valid and legal terms. And the most important lawsuits are only applicable within the jurisdiction of a particular country unless there is an agreement between both the countries and authority regarding execution of legal decisions. In Nigeria, the National Economic and Financial Crimes Commission (EFCC) has estimated that during the year 2005 that around $400 billion of foreign aids have been sent to the offshore financial center illegally for the investment purposes. Initiatives for Tax Havens As the situation due to tax havens was becoming worst. Various countries and international organizations have taken measures to control the financial activities the tax havens. The FATF (Financial Action Task Force on Money Laundering) which is an intergovernmental organization founded in 1989 by G7 at that time later G8 has published a blacklist of "NonCooperative Countries or Territories" (NCCTs). These countries were non-cooperative in the global fight against money laundering and terrorist financing. The last list which was published on 25 February 2009 includes 5 countries including Pakistan, Iran, Turkmenistan, Uzbekistan and So Tom and Prncipe. The number of countries is comparatively less than the first list which was including 15 countries
Bahamas, CaymanIslands, CookIslands, Dominica, Israel, Lebanon, Liechtenstein, Nauru, Niue, Panama, Philippines, Russian Federation, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Marshall Islands. However the OECD maintains the black list for the tax crimes. On 22 October 2008, at an OECD meeting in Paris, 17 countries led by France and Germany decided to draw up a new blacklist of tax havens. The OECD has been asked to investigate around 40 new tax havens in the world where undeclared revenue is hidden and which host many of the non-regulated hedge funds that have come under fire during the 2008 financial crisis. Germany, France and other countries called on the OECD to specifically add Switzerland to a blacklist of countries which encourage tax frauds. The representatives of Germany were in the favor to include Switzerland in the blacklist because the country is attracting funds from all over the world. But as Switzerland have the treaties with various countries regarding the discloser of undeclared funds it was not included at the end. (http://www.euronews.net)
REFERENCES
[1] Alm Jorge James, Vazquez Martinez, Bird Richard Miller, May 2003, Public Finance in Developing and Transitional Countries: Essays in Honor of Richard Bird (Studies in Fiscal Federalism and Stated Local Finance Series, Edward Elgar Publishing; illustrated edition edition. Pg. 146. [2] Ascenzo Michael D, 16 February 2010, A speech to the Australian Institute of Company Directors, Sydney. What's tax got to do with it? http://www.ato.gov.au/corporate/content.asp?doc=/content/00231451.htm&page=1#P29_7014, Accessed on 1st September 2010.
[3] Barsczewski Erek, Oct 10, 2009. How Do Tax Havens Work?: A Guide to Understanding International Tax Avoidance and Evasion http://www.suite101.com/content/how-do-tax-havens-worka157779#ixzz14HB3M700 [4] Boortz,Neal Friday, Jan. 11, 2002, Newsmax.com, http://www.papillonsartpalace.com/enrWon.htm [5] Cadbury Adrian, 2002, Corporate Governance and Chairmanship: a personal view, Oxford University Press, pg. 9105. [6] Christensen, John, 14 November 2003, TAX DISTORTIONS, FISCAL DUMPING AND TAX FRAUD, tax justice network, http://www.taxjustice.net/cms/upload/pdf/e_141103_seminar_notes.pdf. [7] Colley John L., Stettinius Wallace, L. Doyle Jacqueline, Logan George, 6 December, 2004, What Is Corporate Governance? McGraw Hill Professional, Pg. 23. [8] Davies Adrian, 2006, Best Practice in Corporate Governance: Building Reputation And Sustainable Success, Gower Publishing Company, Pg. xiii [9] Desai Mihir A., Dharmapala Dhammika, Taxation and Corporate Governance: An Economic Approach, An electronic copy of this paper is available at: http://ssrn.com/abstract=983563, Accessed on 20 August 2010. [10] Death and taxes: the true toll of tax dodging, A Christian Aid report May 2008 [11] Erasmus II Daniel N. October 2009. Tax Planning as Part of a Tax Risk Management Process. Electronic Paper Collection. <http://ssrn.com/abstract=1482423>. [12] Fernado A.C., 2006, Corporate Governance: Principles, Policies and Practices, Pearson Education. Pg. 7, 290. [13] Friedrichs David O., 2010, Trusted Criminals: White Collar Crime in Contemporary Society, Wadsworth Cengage Learning, Belmont, 4th edition, Pg. 83. [14] Friese Arne, Link Simon, Mayer Stefan, 19 January 2006, Taxation and Corporate Governance, Working paper, Max Planck Institute for Intellectual Property, Competition and Tax Law, Munich, Germany. [15] Godman, Robin, The management of tax risk part-1,www.tax.org.uk/attach.pl/4278/4332/004005_TA_0306.PDF [16] Hampton John J., 1994, Financial Decision Making- Concepts, Problems and Cases, Prentice-Hall of India Private Limited, New Delhi, Pg. 22. [17] Hartley Richard D., 03/2008, Corporate crime: a reference handbook, ABC-CLIO, Inc, California, Pg. 21. [18] Johnston, David Cay, January 17, 2002, Enron Avoided Income Taxes in 4 of 5 Years, The New York Times. http://www.papillonsartpalace.com/enrton.htm [19] Lala, R.M., Friday, Jul 29, 2005, The business ethics of J.R.D. Tata, The Hindu Online edition of India's National Newspaper, Accessed on 20 September 2010. [20] Magashula Oupa, September 27, 2010, Good corporate governance includes moral view of tax, http://www.busrep.co.za/index.php?fSectionId=553&fArticleId=5662704. [21] McLaney E.J., 2001. Business Finance Theory & Practices, Pearson Education, Asia & Taxmann India. [22] Minnick Kristina and Noga, Tracy, (September 2009), Do Corporate Governance Characteristics Influence Tax Management?, http://69.175.2.130/~finman/Reno/Papers/paper_tn_1_7_09_km.pdf, Accessed on 15 September 2010. [23] Prasad Kesho, Corporate Governance, 2006, Prentice-Hall of India Pvt. Ltd. New Delhi,Pg.117 [24] Ralf Kirsten and Chatelain Jean-Bernard, (February 16, 2005), Tax Evasion, Investors Protection and Corporate Governance. http://repec.org/mmfc05/paper65.pdf.Accessed on 15 September 2010. [25] Loong Sum Yee, 2009, Singapore Tax Workbook 2009/10 (12th Edition), CCH Asia Pte Limited,Pg. 483. [26] Schn Wolfgang, April 28, 2008, Tax and Corporate Governance, Springer; 1 edition, Pg. 406408. [27] Tax Haven Criteria, http://www.oecd.org/document/63/0,3343,en_2649_33745_30575447_1_1_1_37427,00.html. [28] THE SHIRTS OFF THEIR BACKS How tax policies fleece the poor, September 2005. www.christianaid.org.uk/.../the_shirts_off_their_backs.pdf [29] Tax us if you can, A Tax Justice Network Briefing paper, September 2005. [30] Calls from 17 countries for new tax haven blacklist, 21/10/08 19:37 CET, http://www.euronews.net/2008/10/21/callsfrom-17-countries-for-new-tax-haven-blacklist/
TheMalfunctionofCorporate GovernanceinIndia
Dr.T.SatyanarayanaChary*andP.Sagar**
AbstractEthical behavior is a necessity to gain trust. Trust will be used as an indicator variable of ethics. Basically, trust is three-dimensional, that trust in suppliers relationships, trust in employee relationships and trust in customer relationships. If the company is able to maintain this trust relationship with the internal as well as external stakeholders, then we can call the company an ethical company. Businesses should act ethically to protect their own interest (prudence) and the interests of the business community, keep their commitment to society to act ethically, meet stakeholder expectations, prevent harm to the general public, build trust with key stakeholder groups, protect themselves from abuse from unethical employees and competitors, protect their own reputations, protect their own employees, and create an environment in which workers can act in ways consistent with their values. Indian companies face two types of corrupt practices: political corruption in which money is paid for favors done, and administrative corruption. A study on the ethical attitudes of Indian managers conducted by Arun monappa (1977)reported that business executives listed three major obstacles to ethical behavior, namely, company policies, unethical industry climate and corruption in government. Corporate Governance has become prominent over the last two decades as many countries witnessed corporate succumbing to questionable corporate polices and unethical practices, setting in motion reforms through codes and standards on corporate governance. India too had had its share of corporate scams. The recent fraud in satyam has shattered the dream of various investors, shocked the government and regulators alike and led to questioning the accounting practices of statutory auditors and corporate governance norms. Unethical business conduct, cooking of books of accounts, questionable role of audit committee, flawed ownership structure and other major governance flaws were noticed in the collapse of stayam. As in USA, UK and other countries, in too needs similar kind of corporate governance reforms. Even through corporate governance mechanisms cannot prevent unethical activity by top management completely, but they can at least act as a means of detecting such activity before it is too late The present paper is a modest attempt to discuss on the maladies of corporate governance with a comparison to its counter parts over the Asia. Also dwells on the failures of corporate governance with the help of certain case analysis. The methodology is descriptive and case analysis one.
control. Infarct, the significance of corporate governance for corporate success as well as for social welfare cannot be overstated. Recent examples of massive corporate collapse resulting from weak systems of corporate governance have highlighted the need to improve and reform corporate governance at international level. In the wake of Enron and other similar cases, countries around the world have reacted quickly by pre-empting similar events dramatically. As a speedy response to these corporate failures, USA issued the Sarbanes-OXLEY Act in July 2002(Solomon and Solomon, 2004)
market .This is an important point, because human nature cannot be altered through regulation, checks and balances. Nevertheless, there is growing perception in the financial markets that good corporate governance is associated with prosperous companies. The research of Solomon j and Solomon A. Showed some evidence to support the agenda for corporate governance reform. The findings indicated that the institutional investors welcomed corporate governance reform, viewing the reform process as a help rather than a hindrance .Specifically, towards corporate governance reform.
markets regulator, has made significant efforts to keep-up with changing corporate governance practices in leading equity markets around the world, namely the United Kingdom and the United States. We welcome the actions that the Indian authorities are pursuing. IIF Managing Director Charles Dallara said, it is important that Indian corporate governance standards continue to improve as the country becomes an increasingly important participant in global trade and finance. It is encouraging that, as our new report points out, companies such as Infosys Technologies, the Tata Group, ICICI Bank and the Housing Development Finance Corporation Ltd. (HDFC), are developing sound corporate governance approaches. These can serve as models for the thousands of listed Indian companies that have yet to put in place governance systems that meet the requirements set by the Indian authorities and that can enhance international investor confidence. World bank initiative to work with the Indian government vis-a vis the private sector organization of international market is a good illustration of the efforts of the international body for improving corporate governance as a measure for attracting the badly needed foreign capital into the country. India is among the oldest stock exchanges in the emerging economies. It has nearly 7000 listed companies in the country, which is slightly higher than those in the UK. However, the flow of FDI capital was not high during 2000-2001. The CII (confederation of Indian industries) had taken steps prior to the Asian financial crisis on its own to promote the code of best practices on corporate governance as a measure for attracting FDI. It had issued self-regulatory practices in May 1998 for the business leaders. They were, no doubt, though recommendations, even tougher than those in the UK. These recommendations implied that no director should have more than ten seats and that the board should be constituted with at least 30% external directors. The attendance records of the directors should be an open secret. In case of companies listed in foreign countries, they were required to disclose all the information to the shareholders in India which they did overseas. Seventeen companies s signed the CII code and accepted to implement. The CII was ambitious in its efforts. It aim was not just create local code on governance but to encourage Indian companies achieve international standards in governance. It prime objective is to get the domestic companies listed on the NASDAQ, NEW YORK. Besides, the effort by the CII, the Securities and Exchange Board of India (SEBI) issued another code in draft form towards the late 1999. The code was harsher than the CII code and aimed at compliance by the companies on disclosure of information as part and parcel of the rules on listing. The GCGF was happy with effort of the CII and SEBI because these codes met the objectives of the forum to promote investments through corporate governance based on the best practices.
Theoretically, during the post-world War II period, the structure of governance in japans major organizations known as kabushiki kaisha (stock companies) was comparable to the US corporations. Accordingly, the boards of directors were elected by the shareholders. So, the board was answerable to the shareholders. The board defined nd implemented corporate policy, appointed company executives and was responsible for monitoring and providing direction for business operations. The board represented interest of the shareholders and to some extent interests of the society. In practice, the board of directors of the major organizations represents the interests of the organization and its staff as a collective body and not the interests of the shareholders. There are two factors which account for this kind of practice. The first factor: the constitution of the board: All the directors are ex-employees of the organization and are senior mangers. Around 80% of the corporations in Japan have no external or outside members on the board and 15% have up to two outsiders on the board. In 1990. The second factor: The shareholders are not active owners: Japanese companies usually exchange a small number of stocks with business partners and lenders. This is done as a matter of showing commitment, sincerity and goodwill to the other companies. The numbers of stocks exchanged are small. But they are significant number of share keeping in view the outstanding shares. Institutional investors such as trusts and pension funds or insurance companies also have some stake in most of the major corporations in Japan. The shares held by the business partners or the institutional investors are rarely sold and they constitute 60 to 80% of the total shares. These shares represent the friendly and stable equity owners. Around 20 to 30% of the shares are in general circulation. Relationship with the government: Japanese corporations maintain good relations with the central government. The central government enforces the legal provision through passing informal administrative guidelines. Meetings are held between the Ministry of Finance and the concerned institutions frequently. The relationship is further strengthened with the retiring government officials joining the corporations which fell under their administrative control while in service. Governments role in Japan is that of a protector and promoter of industry. Government sponsors research projects in collaboration with industry. This is an example of state industry cooperation in national interest. Authority of board and the management: Although, theoretically, the board of directors has to look after the interests of the shareholders, it tends to control the business management. Management of the business is answerable to the board whereas control and management are distinctly separate. In Japanese industry, control and management are part of one activity in spite of the business structure being identical to the of the US Information or orientation of directors: In the bottom up consumers approach in decision making, managers are fully aware of the viewpoint of the subordinate staff. Representative Directors know the internal matters through the weekly/ monthly meetings. Directors too are updated on the external environment through many meetings and
interactions. Monthly meetings with the mangers and directors of the industrial groups (keiretu), of which the company may be members, provide the valuable information on group activities in the monthly meeting with mangers and directors of keiretsu organization. Japan also framed its own code on governance. A Japanese corporate governance forum was constituted which defined its guidelines in may 1998.the corporate governance forum consisted of lawyers, academics and executives as well as representatives of shareholders who exhorted the need for improved governance as essential for effective operation of business in the global market. The code took a holistic view of governance compared to the Western nation. In its view, organizations are made up different constituents and shareholders being the equity owners deserve a special status. It underlined the need for corporate solidarity in consonance with social harmony. The forum made significant recommendations which involved a lot of changes in the governance system. One such recommendation was to include more external/outside directors on the board. Japan had just above 4% members outside sources. Another recommendation was to have independent committee. The forum monitors the implementation and has taken help of Tokyo Stock Exchange to include these codes in the exchange rules on listing. These recommendations were widely recognized the world over.
infrastructure Ltd and Maytas Properties Ltd, saying he wanted to deploy the cash available for the benefit of investors. The thumbs down given by investor and the market forced him to retreat within 12 hours. Share prices plunges by 55% on concerns about Satyams corporate governance. In a surprise move on December 23, 2008, the World Bank announced that Satyam has been barred from business with World Bank for eight years for providing bank staff with improper benefits and charged with data theft and bribing the staff. Share prices fell another 14% to the lowest in over 4 years. The lone independent director since 1991, US academician Mangalam Srinivasan, announced resignation followed by the resignation of three other independent directors namely, Vinod K Dham (famously known as father of the pentium and an ex Intel imployee), M Rammohan Rao (Dean of Indian School of Business) and Krishna palepu (professor at Harvard Business school). At last, on January 7, 2009, B. Ramalinga Raju announced confession of over Rs. 7800 crore financial fraud and he resigned as chairman of satyam. He revealed in his letter that his attempt to buy maytas companies was his last attempt to fill fictitious assets with real ones. He admitted in his letter, It was like riding a tiger without knowing how to get off without be being eaten. Satyams promoters, two brother B. ramalinga raju and B.Rama Raju were arrested by the state police and the central government took control of the tainted company. The Raju brothers wer booked for criminal breacdh of trust, cheating, criminal conspiracy and forgery under the Indian Penal Code. The central government reconstituted Satyams board that included three-members.HDFC Chairman Deepak Parekh, EX Nasscom chairman and IT expert KiranKarnik and former SEBI member C Achuthan. The Central Government appointed three more directors to the reconstituted board i.e., CII chief mentor Tarun Das, former president of the Institute for Chartered Accountants (ICAI) TN Manoharan and LICs S Balakrishnan. A week after satyam founded B. Ramalinga rajus scandalous confession, satyams auditiors price Waterhouse finally admitted that its audit report was wrong as it was based on wrong financial statements provided by the Satyams management. Senior partners s. Gopalkrishnan and Srinivas Talluri of the auditing firm pricewaterhousecoopers (PWC) were arrested for their alleged role in the satyam scandal. The states CID police booked them, on charges of fraud (Section 420 of the IPC) and criminal conspiracy (120B). The reconstituted satyam Board appointed former Head, Delivery and Leadership Development Department of Satyam Mr.A.S Murty as the new Chief Executive Officer (CEO) of the beleaguered company.
CONCLUSION
Corporate governance deals with laws, procedures, practices and implicit rules that determine a companys ability to take managerial decisions vis--vis its claimants- in particular, its shareholders, creditors, the State and employees. To most international experts on the subject, corporate governance is interplay between companies, shareholders, creditors, capital markets, financial sector institutions and company law. Therefore, from the information presented it is understood that accounting irregularities occurred in the reporting systems and the internal controls remained ineffective in preventing
them from further occurrence. From the cases reviewed above certain issues can be raised. For instance, issues relating to stakeholders theory and corporate governance, i.e., malfunctions of corporate governance Vs ethical practices of corporate governance, cases like satyam proved that unethical actions of the CEOs, CFO and auditors lead to the firms Bankruptcy and there by the most adversely hit were the employees, creditors, investors and so on. Likewise, issues like Good governance and poor performance and poor governance and good performance can be raised for the further research perusal.
INTRODUCTION
Corporate Governance has been an important issue of enquiry for researchers. The underpinnings of this research area draws from multiple disciplines like accounting, corporate laws, economics, finance, management and sociology. Thanks to the burgeoning empirical work and literature in this area, researchers have made corporate governance highly interdisciplinary. Neophyte researchers thus need to gain an in-depth understanding of the many disciplines as they affect the arena of corporate governance. *Happy Valley Business School, Coimbatore **Anna University of Technology, Coimbatore
Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 187
CorporateGovernanceinIndia:HistoricalPerspective1
The history of Corporate Governance in India is replete with a rich legislative history. At the time of independence, India was one of the poorest economies with its factory sector accounting for one-tenth of the national product, four stock markets with well defined rules for listing, trading and settlement, a sound banking system with prudent lending, recovery norms and public skepticism about investing in equity markets. This section draws heavily from the history of Indian corporate governance in Goswami (2002)The early stages of corporate development in India were marked by the agency system. This system enabled control to be vested in British hands. The lack of indigenous capital and Indian industrial leadership gave British merchants the opportunity. Available British capital seeking investment found among these British merchants the right sort of men who could safely be entrusted with it (Lokanathan 1938). The decade after independence marked by the Industries Development and Regulation Act (IDRA) 1951, and the Industrial Policy Resolution 1956, spelt a regime of licensing, protection and red-tapes. In the absence of a widespread equity culture the onus of corporate funding dwelt on the shoulders of the three Development Financial Institutions (DFIs) of Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI) and the Industrial Finance Corporation of India (IFCI), which were supported by the State Financial Corporations (SFCs).
1.
As the DFIs were evaluated more in terms of quantum of credit dispersed than their quality there was no incentive for proper credit appraisal or monitoring. Nominee directors of such institutions had a nominal role to play on their respective boards. Promoters of businesses thus enjoyed managerial control with very little investments of their own. Such promoters had little incentive to repay the loans and siphoned money to other businesses they controlled. A surge in the bankruptcy caused the government to form its bankruptcy reorganisation measures. The Sick Industrial Companies Act (SICA) and the Board for Industrial and Financial Reconstruction (BIFR) were thus born. However the legal process often took a decade or more eventually leading to the demise of SICA. The Companies Act of 1956 has remained a major piece of legislation governing the functioning of companies registered in India. Several amendments have been made to the Act; however more needs to be done to protect the interests of minority shareholders and creditors in India. The post liberalisation era witnessed landmark changes in the laws driving corporate governance. The establishment of the Securities Exchange Board of India (SEBI) represents a milestone in the history of Indian corporate governance reforms. The SEBI set out to regulate and monitor the stock market trading besides establishing minimum ground rules of corporate conduct in the country. The Harshad Mehta stock scam in 1992 shook the Indian capital market and eroded investor confidence. The scam reflected a failure of the corporate governance mechanism which led to an investigation into ways to fix the corporate governance system in India. This led to the first endevour that led to the Confederation of Indian Industries (CII) Code of Desirable Corporate Governance, developed by a committee chaired by Rahul Bajaj.
TABLE1:INDIANCORPORATEGOVERNANCE:SPECIFICREFORMSTIMELINE Key Reforms Securities and Exchange Board of India (SEBI) Act passed by the parliament. 1992 SEBI instituted as an independent regulator. SEBI institutes four committees (in 1996, 1998, 2000 and 2002) for corporate governance reforms. Government efforts to reform the Bombay Stock Exchange (BSE) face stiff resistance. Government institutes a new stock exchange the National Stock Exchange (NSE) as a competitor to BSE establishing better practices and more standard corporate governance. This eventually leads to reforms in the BSE as 1994 well. 2000 The Institute of Chartered Accountants of India introduces two accounting standards aimed at improving accounting disclosures and transparency related to Related Party Transactions and Segmental Reporting. 2001 The Institute of Chartered Accountants of India issues a Guidance Note on Certificate on to provide guidance to members certifying corporate governance clause 49 of the Listing Agreement. 2003 SEBI made single window approver for FIIs (earlier they had to seek approval from the federal bank also). 2009 CIIs Voluntary Code of Corporate Governance. *Source: Adopted and modified by the authors from Gaur( 2007) Year
Two other committees were formed by SEBI. The Kumar Mangalam Birla Committee that resulted in the adoption of Clause 49 Listing Agreement and the Narayanamurthy committee with focus on improving board practices. The SEBI committee recommendations have had far reaching impact on changing the corporate governance scenario in India. The
Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 189
Advisory Group on Corporate Governance of the Reserve Bank of Indias Standing Committee on International Practices and Codes submitted their recommendations in 2001. These codes and committee recommendations form the basic legislative framework of Indian corporate governance (refer Table-I for the reforms timeline).
We attempt to provide succinct and accurate information of a representative cross-section of selected empirical work spanning a decade (2000-2010). Readers may note that the year of publication mentioned refers to the year in which the article was posted on SSRN website, which may be different from the original date of publication of the article. Where the reviewed paper is not available on SSRN, an indication as to the source is made. The authors consolidate each category of review with a note on the scope for further research. We believe this would serve as a fair indication of the emerging themes in the area of corporate governance. First time researchers in the early stages of their research may use this to understand the direction of future research in this area.
SelectedAnnotatedReviewofCorporateGovernanceResearchinIndia(20002010)
TABLEII:RESEARCHPAPERSONCORPORATEGOVERNANCESYSTEMS&INDICES Reference Disclosures and Corporate Governance in Developing Countries: Evidence from India. (2010) Ruchita Daga & Dr. Dimitrios. N. Koufopoulos Corporate Governance Convergence: Lessons from Indian Experience (2009) Afra Afsharipour Corporate Governance: Regulatory and Cultural Issues (2009) Gurbandini Kaur Richa Mishra Table II Contd Corporate Governance : The Indian Capital Market Law and International Standards (2010) Dr.Tabrez Ahmad Satyajit Surjyakant Sen Nidhi Singh Siddharth Singh Law Enforcement and Stock Market Development : Evidence from India (2009) Vikramaditya Khanna CDDRL Working Paper Corporate Governance in India (2008) Rajesh Chakrabarti W.Meggison P.Yadav Work type, Source discipline ,Data Examines the level of disclosures regarding corporate governance practices of 29 BSE listed companies. Authors use attributes compiled by Standard & Poor to measure corporate governance and disclosure in India. Discussion Almost all companies disclose mandatory information. Some companies disclose additional information which is not mandatory on a voluntary basis.
Indian corporate governance reforms may be seen as a formal convergence towards AngloAmerican practices or a continuing persistence of traditional weak governance reforms. The author contends that greater institutional changes would be necessary for any convergence. A narrative of the regulatory framework of The author argues that the focus of all reforms is corporate governance and its reforms in India. through enforcement and compliance with external laws and regulations. The problems with corporate governance in India are more of execution and there are no easy answers as to what is the best solution for corporate governance. An interesting essay of whether globalization will lead to convergence of Corporate governance laws towards one model of corporate governance or whether regional characteristics will impede convergence. Research Papers on Corporate Governance Systems & Indices This paper enunciates the Indian standards for Corporate governance measures in US and UK corporate governance as spelt in the Clause 49 are outsider systems from where concepts like directors, audit committee, Listing Agreement and compares it with the independent Sarbanes Oxley of USA. International standards CEO/CFO certification and the like emerged. The of corporate governance like the UK Regulations, transplantation of these to Indian businesses Higgs Review and Cadbury Report is also which are insider systems, may not augur well as these differences need to be factored in for discussed. effectiveness of governance.
This paper explores the enforcement of corporate and securities law as a critical feature in determining the health and growth of stock markets. The author attempts to offer explanations as to the surge in FIIs given the weak enforcement of laws in India.
Corporate governance reforms helped FIIs gain access to standardized information thus reducing their information processing costs. Governance lent credibility due to sanctions imposed for inaccurate disclosures.
The authors opine that the Indian legal system offers high levels of investor protection in the world (on paper). In reality our courts are overburdened, share holding is relatively concentrated and evidences of pyramiding and tunneling of resources is rampant. However India ranks high compared to the other BRICs economies and the reforms mooted by the SEBI and BSE are on the right track to steer Indian companies ahead. Firm Level Corporate Provides an overview of Indian corporate The authors opine that large companies have Governance in Emerging governance practices based on a 2006 survey of complied with board independence requirement. Markets: A Case Study of 370 Indian public companies. The authors However the compliance on seeking approval for Describes the Indian corporate governance system and examines how the system has both helped and hampered Indias ascent to the top ranks of the world economy.
Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 191 explore connections between governance and Related Party Transactions is quite weak. The firm value and aspects of overall firm governance authors construct an Indian Corporate that predict a firms market value. Governance Index (ICGI) and posit that a significant correlation exists between ICGI and firm value. Corporate governance reports of different There appears to be no consensus on which Divergent Corporate countries are explored together with salient system of corporate governance is the best one Governance Standards and Need for Universally features of government industry models. Authors and whether legal convergence should be provide different country examples where encouraged on a global basis. Accepted Governance governments play different roles of referees, Practices. managers and coach. Authors raise issues such as (2008) should companies follow the Anglo-American or Syeedun Nisa European model of corporate governance. Is it Khurshid Anwar Warsi possible to have universal corporate governance Asian Social Science norms in a divergent world? Journal Table II Contd Research Papers on Corporate Governance Systems & Indices A qualitative research paper which presents a The authors present a chronological account of Regulatory Norms of Corporate Governance in detailed account of corporate governance model developments in the area of corporate governance in India from the period 1866 to 1998. till 2003. India (2008) Dimple Grover Amulya Khurana Ravi Shankar An essay that outlines important changes in the Key developments related to governance of stock Capital Market and Corporate Governance in Indian capital market and corporate law regimes markets like Regulation of Capital Issues, Issue since the early 1990s. pricing, Repurchase of shares, Sweat equity, India: An Overview of Inter-company loans, Options, Derivatives and Recent Trends. Financial reporting standards are enumerated. (2007) P.M.Vasudev Corporate Governance in The paper is a treatise on central issues in Indian Implementation of corporate governance at the corporate governance. A wide range of issues in ground level represents a formidable challenge. It India: Evolution and corporate governance are addressed. can be widely observed that the influence of Challenges corporate governance reforms is restricted to the ( 2007) top (large) companies and much need be done to Rajesh Chakrabarti ensure adequate corporate governance in the average Indian company. This paper wades through extant corporate The author opines that the existence of transition Understanding the governance literature and identifies the existence and emerging economy models (like India) have Corporate Governance of four different governance models in practice not been extensively discussed by researchers. Quadrilateral An understanding of the governance quadrilateral across the world. (2004) would be a pre-requisite for understanding global Malla Praveen Bhasa corporate governance. Scope for further research: India (2008) N.Balasubramanian Bernard.S.Black Vikramaditya Khanna
A closer examination of research in this area reveals that corporate governance involve a series of codes of practice, policy recommendations and legislations. Much of the corporate governance today falls within a broad comply or explain framework. These frameworks have done little to prevent the global financial crisis, arrest the failure of banks and prevent market collapses. In fact these events are attributed to weak corporate governance. Recent events demonstrate that further work needs to be done in this area. Researchers could examine the possibilities of exploring the best practices in corporate governance on a case to case basis, differentiate the mandatory and voluntary disclosures and construct models based on assigning weights to voluntary disclosures made.
More than emulating standards that have worked well in different contextual scenarios (like the Anglo-American model or the European model meant for outsider oriented systems); Indian researchers could factor in regional characteristics (family controlled firms) and evolve hybrid models that are more relevant for Indian corporate governance. The area of developing indices to measure corporate governance variables is well documented in extant literature. The GIM index, 2003 (Gompers, Ishii and Metrick) and the BCF, 2004(Bebchuk, Cohen and Ferrell) on a global level and India Corporate Governance Index (ICGI), 2008 by Balasubramanian, Black and Khanna are trend setting researches in this area. Further research could attempt to understand how managements attempt to proactively measure and / or mitigate technology / political / economic risks. Helping companies to measure risk by developing a risk management index would benefit both management and investors alike.
TABLEIII:RESEARCHPAPERSONCORPORATEGOVERNANCEANDFIRMVALUE/PERFORMANCE Reference Corporate governance characteristics and company performance of family owned and non-family owned businesses in india. (2009) Palanisamy saravanan Corporate governance, product market competition and firm performance in india: an empirical enquiry (2008) Manoranjan pattanayak Corporate governance and firm performance: evidence from large governance changes ( 2008) N.k.chidambaram Darius palia Yudan zheng Can corporate governance reforms increase firm market value: evidence from india (2007) Bernard.s.black Vikramaditya.s.khanna Work type, source discipline ,data Explores the impact of family control in determining the firm value together with corporate governance variables based on data from 771 firms listed on the bse for the period 2001-05. This paper explores the interaction effort of product market competition and corporate governance variables on firm performance. Discussion The author observes significant differences between family controlled and non family controlled firms in corporate governance factors namely board size.
The author observes a complementary relationship between insider ownership and firm productivity. The relationship becomes stronger when the completion in the firms product market is intense.
Examines the relationship between governance changes and firm performance and attempts to explore the impact of 13 large positive and negative governance changes on the future firm value while controlling for reverse causality. An event study on the adoption of clause 49 listing agreement and its impact on the stock returns of large, medium and small firms over a twoday period i.e., date of announcement plus next trading day.
The authors contend that changes in particular measures of corporate governance alone do not lead to performance improvement. The interplay between governance, observable and non observable characteristics of firm performance are complex and not amenable to a sort of single governance measure or firm characteristic. The authors observe an increase in returns of large firms relative to that of small firms from 4 percent over a two day window to over 10 percent over a two week window. Mid size firms exhibit an intermediate response.
Scope for further research: While most research in this area attempts to demonstrate that improvements in corporate governance adds value to companies reflecting in firm value/performance it would be interesting to ex-ante identify a sample of firms and their characteristics in which good governance leads to better performance so that the link between good corporate governance and corporate financial performance is more forthcoming.
Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 193 TABLEIV:RESEARCHPAPERSONSHAREHOLDINGANDCORPORATEGOVERNANCE Reference Role of institutional investors in corporate governance (2009) Manya srivardhan Work type, source discipline ,data Explores the role of institutional investors like fis, insurance companies, mutual funds, fiis, private equity funds and pension funds in furthering the cause of governance in companies through board representation. Discussion Authors opine that the monitoring role of institutional investors is either missing or marginally visible. The presence of institutional investors is negligible in the case of smaller companies and there is no evidence of a monitoring role being played by such investors in small companies. The need for issuing regulations to facilitate institutional investor activism is addressed. The author reports a curvilinear relationship between insider (family) shareholding and firm value. The author posits that concentrated ownership does not destroy firm value as is generally believed.
Disentangling the performance and entrenchment effect of family shareholding : a study of indian corporate governance (2008) Manoranjan pattanayak Can independent blockholding really play much of a role in indian corporate governance. (2008) George.s.geis Foreign and domestic ownership: business groups and firm performance: evidence from large emerging markets. (2008) Sytse douma Rejie george Rezaul kabir Debt and corporate governance in emerging economies: evidence from a large emerging market (2008) Jayati sarkar Subrata sarkar Equity pattern, corporate governance And performance: a case study of indian corporate sector. (2006) Murali patibandla Elsevier (science direct) Ownership structure and firm value: empirical study on corporate governance Systems of indian firms (2003) Saikat sovan deb C.v. chaturvedula
Examines the relationship between firm performance as measured by tobins q and family shareholding using data of 1833 listed firms from 2001-04.
Explores the role of share block-holders (hedge funds and institutional investors) in guarding against abusive behaviour by monitoring a firms activities.
Many firms currently lack enough of an outside share holder presence to provide meaningful governance counter balance. Reform efforts in this area can create an impact.
This paper explores how property rights (ownership structure), the provision of scarce and inimitable resources by various shareholders and the associated institutional context explains differences in firm performance.
The author observes that foreign corporate ownership, foreign financial institutional ownership and domestic corporate ownership are positively associated with firm performance.
This paper analyses the role of debt in corporate governance, given that debt constitutes a major source of external finance for indian companies. Authors address the question does debt discipline corporations and explore the role of institutional change in supplementing or mitigating expropriation effects of debt. Using panel data for 11 indian industries for the period 1989-99, the author examines empirically whether large investors reduce agency costs of corporate governance by monitoring and disciplining managers (owners). This study breaks outside investors into foreign and government owned local financial institutions. The authors test the monitoring, expropriation, convergence of interests and entrenchment effect hypothesis.
The study posits that during the early years debt did not have a disciplining effort on group/nongroup firms. However debt is observed to have a disciplining effort during the later years. There is limited evidence on debt being used as an expropriating mechanism in group firms.
The author observes that higher the share of government financial institutions in investment, lower is the profitability (efficiency) of the firm and higher the foreign equity higher the profitability. However the author notes that this relationship between foreign equity and profitability is non-monotonic (i.e. Increases at a decreasing rate). The authors find support for all but the expropriation hypothesis. Firm value is observed to increase and after a certain threshold point decrease as ownership concentration increases.
194 Changing Dynamics of Finance Agency theory and firm value in india (2004) Jayesh kumar Capital structure and corporate governance Jayesh kumar (isb website: refer bibliography). An empirical examination of the effects of organization structure on firm performance from an agency perspective using panel data of more than 2000 indian firms for the period 1994-2000. Explores the relationship between corporate firms ownership and capital structure in the context of an emerging market economy-india. Foreign shareholding pattern does not significantly influence firm performance. Directors shareholding beyond a threshold level influences firm performance. Debt structure is non-linearly linked to corporate governance (ownership structure). Firms with weaker corporate governance mechanisms and dispersed shareholding patterns tend to have higher debt levels. Firms with foreign ownership and low institutional ownership have lower debt levels.
Scope for further research: Researchers thus for have invariably considered the independent effect of ownership structure on firm performance. It would be interesting to explore what happens if the interaction effect between ownership structure and firm performance is considered. Such studies would present researchers with the challenging task of dissecting the independent and interaction effects of these variables and establishing how they explain firm value. Another interesting angle of research would be to seek answers for questions like what prompts equity investments in emerging markets like india with weak minority protection. Also there is not much work assessing the impact of trade / tax policy changes and its consequential impact on ownership structure if any. TABLEV:RESEARCHPAPERSONCORPORATEBOARDEFFECTIVENESS Reference Board structure and size: the impact of changes to clause 49 in india. (2010) Helen lange Chinmoy sahu Work type, source discipline ,data Examines the impact of potential country specific factors and the role of individual entrepreneurs and institutional investors in determining the board size and structure. Authors delve on issues like how regulatory changes have impacted corporate governance practices in india and what in addition to regulation has had an effect on the size and composition of boards. Explores the rationale for the emergence of the concept of independent directors by tracing their evolution in us/uk and examines the transplantation of the concept into india with a view to evaluate effectiveness of independent directors. Discussion Country specific factors influence the size of the board however there is little evidence for the determination of board composition.
Evolution and effectiveness of independent director in Indian corporate governance. (2010) Umakanth varottil Corporate governance in an emerging market: what does the market trust? (2010) Rajesh chakrabarti Subrata sarkar
An event study centered on the satyam scam. Authors attempt to answer the question what corporate governance variables have an effect in determining the cross-sectional variation of returns experienced in the stock market following public knowledge of the scam.
Independent directors and firm value: evidence from an emerging market. (2010) Rajesh chakrabarti K.v.subramanian Frederick tung Independent directors :
An event study that follows unique data on the cessation of independent directors across indian companies following the satyam scam. Authors examine cumulative abnormal returns in the stock market for the period succeeding the scam.
Diffused shareholding in the west made it conducive for controls like having independent directors on the board. In india due to concentrated ownership the concept of independent directors is a misnomer. The author addresses the question what does the future hold for independent directors in india and elaborates on measures from a normative view point. There exists a significant difference in markets perception of corporate governance indicators from those frequently listed or discussed in extant literature. More than board and audit independence it is the quality of the board/audit committee, the process of selecting the independent directors, the setting up of an effective board and the audit processes that are important for effective governance. Authors observe that listed firms in which independent directors resigned in jan09 experience negative abnormal stock returns. Such returns were found to be more negative where the independent directors have a monitoring role on the board.
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Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 195 an indian legal perspective (2009) Dipen chatterjee independent directors-clause 49 listing agreement. It presents a theoretical perspective of how an independent director is defined by law, the need for having independent directors and the role played by them. not truly independent because they are handpicked by the promoters. Unlike uk in india there is no public advertisement for the post of independent directors. The author ideates that sebi could regulate the right to nominate independent directors so that there is more transparency in the process.
Scope for further research: In the area of board effectiveness studies, assessing the value of independent directors in varying legal / economic contexts such as developing economy / emerging economy perspective and offering to explain determinants of variations there in present formidable opportunities to researchers
SelectedAnnotatedSourceofIndianCorporateGovernanceWebsites
The World Wide Web (internet) represents a powerful medium that is of use to tech savvy researchers. Some of the most significant sites on the free web offering information to those interested in researching corporate governance is listed below. The authors like to state that the nature of information found on each website would be influenced by the objectives, goals, missions etc., of the authoring body. The emphasis here is to present readers with a compendium of important websites related to corporate governance in India.
http://www.mca.gov.in:
This is a resource offered by the Ministry of Corporate Affairs in India. The website links readers to the Corporate Governance Voluntary Guideline 2009, a set of voluntary guidelines proposed for voluntary adoption by the corporate sector based on the recommendation of the task force set up by CII under the Chairmanship of Naresh Chandra in February 2009. It is expected that these guidelines will progressively converge towards a framework of best corporate governance standards and practices. The guidelines would help first time researchers/readers in the area of corporate governance acquaint themselves with various guidelines concerning board of directors appointment, independent director attributes, remunerations for independent directors, responsibility of the board, audit and remuneration committee and mechanism for whistle blowing.
http://www.academyofcg.org/
The Academy of Corporate Governance, ACG, founded and angel funded by Yaga Consulting Private Limited, Hyderabad, India has as its objectives of being an independent think tank for corporate governance policy, advocacy or knowledge development. The link leading to codes and best practices reports corporate governance of 25 countries and the European continent. For readers interested in India centric information there are links to the CIIs Desirable Code of Corporate Governance, Clause 49 listing agreement, First Principle of Corporate Governance for PEs in India, Kumar Mangalam Committee report on Corporate Governance. This web site also supports an e- journal which features articles on corporate governance (however this feature has been disabled from the third quarter of 2005).
http://www.nfcgindia.org/home.html
The National Foundation for Corporate Governance (NFCG) has an online library of principles, codes, rules and regulations related to corporate governance. These relate to both
the Indian as well as the international context. In addition, the online library also contains few original research papers commissioned by the foundation. The library resources are freely accessible.
http://www.directorsdatabase.com
This website provides a single point access to information on the Board of Directors of listed companies with their age, experience and other directorships they hold. It contains rich data of independent directors of 2618 BSE listed companies. Information on cessation of directors is also available.
www.iodonline.com
Institute of Directors (IOD) is the association of company directors. The site is rather messy, sparse on information, and while it offers links to related sites, quite a few are broken. The Institutes monthly newsletter is online, as well as the Centre for Corporate Governances quarterly journal.
http://www.corpfiling.co.in
www.corpfiling.co.in is the common filing and dissemination portal for all companies listed on the BSE & the NSE. www.corpfiling.co.in has been developed and is being maintained by IRIS Business Services (India) Pvt. Ltd. Readers interested in gaining access to the share holding patterns of BSE/NSE listed companies will find this website very useful.
http://www.corpgov.deloitte.com/site/in/
The Deloitte's Centre for Corporate Governance, aims to promote a dialogue in the critical areas of corporate governance among industry bodies, companies and their boards of directors and senior management, professional services firms, academia, government and others. This site is designed to discuss governance related issues for the Indian boards and their committees. The site contains a diverse collection of resources and thought leadership from Deloitte including third party resources.
CONCLUSION
In more recent years, the area of corporate governance has emerged as a highly relevant and prominent area of business research. The proliferation of the internet has caused a rapid increase in the quantity of information available. This paper is an attempt to provide a good foundation for first time researchers in the area of corporate governance to embark on their research journey. As the field of corporate governance evolves information available on the free web will become more abundant and wide ranging. By attempting to categorize research in this area the authors believe that this paper will benefit new researchers in understanding the direction of research. The papers and the websites reviewed could be bookmarked by new researchers. This paper may constitute a modest, though not insignificant step in furthering the good work done by previous researchers while serving as a compendium for new entrants.
Track4
EconomyandInflation
INTRODUCTION
The Education system that we are following today is the same system the English framed for Indians in the 19th century. They had planned it for us from their point of view as they needed a lot of babus for their offices in India. They never wanted to give Indians the education that would make them something higher than the babu. Now, from their point of view, the system was correct and viable. However, tradegy is that even after 50 years of independence, we still continue to follow the system of education framed by the English for us. We have never bothered to study the application and utility of the education we are imparting to our children. After independence there has been a mushroom growth of schools and colleges but education remained at the level of 50% of the population. Then the moot point now is what has been the utility of these myriads of education homes that have grown in the last 50 years? The growth of these institutions has also been sporadic. Most cities and town have seen growth in the *Sterling Institute of Management Studies, Navi Mumbai
number of schools and colleges but the rural areas which consist of 70 80% of Indias population could not share with this growth. New policy on Education as approved by the Government stresses that a human being is an asset and a precious resource for the whole nation which needs to be cherished. It requires to be developed with dynamism and removal of disparities in a phased manner. For all round development of the society, it is essential to take effective measures in the direction of the implementation of our new education policy and also common school education system as recommended long back. The National system of Education envisages a common educational structure. The common core of national curricular framework has to include contents related to national integrity and identity including our freedom struggle years and constitutional obligations. The new policy envisages promotion of values such as Indias common cultural heritage, democracy and secularism, protection and preservation of our environment, removal of any type of social barriers and follows the message of small family norms. The youth requires being motivated towards peaceful co-existence and international co-operation and making them understand education as a unique investment for present and future The higher education system in India has grown in a remarkable way, particularly in the Post-independence period, to become one of the largest system of its kind in the world.However, the system has many issues of concern at present, like financing and management including access, equity and relevance, reorientation of programmes by laying emphasis on health consciousness, values and ethics and quality of higher education together with the assessment of institutions and their accreditation. These issues are important for the country, as it is now engaged in the use of higher education as a powerful tool to build a knowledge-based information society of the 21st Century.
mobilize resources for their survival and development. At the school level, the dominant thrust of institutional planning has been improvement in operational efficiency rather than resource mobilization. Indian universities need to be dynamic and adoptive to the changing needs and priorities of the society and should provide an arena of freedom to young innovative minds. It is disturbing that the number of students opting for undergraduate courses in basic sciences is declining. The public-private partnerships will have tremendous influence on the development of technologies and how these are managed. There is a need for high level of funding for research, including contractual research. A critical review of activities of higher educational institutions as well as their budgets needs to be conducted to phase out obsolete activities and create necessary space for new activities. The shifting from traditional incremental budgeting to a performance based one is now necessary to arrest the erosion in quality and the resource crunch. The institutes are under-financed and under-staffed. Effort can be made to harness the full potential of trained workforce. Along with the necessary and inevitable quantitative expansion of higher education, it is equally important to improve the quality of higher education. Institutions of higher education would find it difficult to meet the challenges of globalization of higher education if one fails in this front. Emphasis on quality parameters becomes all the more necessary in the light of mushrooming of private institutions with the opening up of the Indian economy.
ObjectivesofStudy
To study the impact of PPP on education sector To analyze the impact of PPP on different aspects of education
LimitationofStudy
India as mixed economy having socialistic pattern and one of the largest democracies in the world. It is difficult to cover every sector of economy. Education sector have been covered for the research purpose.
Methodology
For the purpose of paper different research articles, journals, books magazines, news paper articles Reports are reffered. Data is collected from secondary sources.
EducationandManagementofHigherEducation
The Indian higher education system is one of the largest such systems in the World. The new regime under WTO where competence is the cardinal principle of success in international operations has made it abundantly clear that the country should exploit its excellent potential in higher education and training facilities and prepare itself to export the Indian brand of education to foreign countries. Policy planning and evolving strategies for this task are somewhat new for the country. But, this is an opportunity which cannot be missed by India, as it offers interesting possibilities for strengthening of the nations talent and resourcefulness .Indian higher education system has undergone massive expansion in post-independent. India with a national resolve to establish several Universities, Technical Institutes, Research Institutions and Professional / Non-professional Colleges all over the country to generate and disseminate knowledge coupled with the noble intention of providing easy access to higher education to the common Indian. The Public initiatives played a dominant and controlling role in this phase. Most of the Universities were Public institutions with powers to regulate academic activities on their campuses as well as in their areas of jurisdiction through the affiliating system. Even the private institutions enjoyed large-scale financial support in the form of grants from the public exchequer. Private funds as well as individuals played key roles in the cause of higher education. With the public funding being no more in a position to take-up the challenging task of expansion and diversification of the higher education system in the country to meet the continuously growing demands at present, there is little option other than bringing in private initiatives in a massive way to meet the various challenges. The deregulating mechanism of controls started with the granting of Autonomous Status to identified Colleges in the 1970s. Some of these Colleges have graduated further to receive the Deemed to be University status in later years. Now, the country is on the threshold of the establishment of Private Universities in different States. It is the primary responsibility of the State to provide the eligible with good quality higher education at reasonable cost. There shall be no withdrawal of the State from this responsibility. In fact, the investment in this area by the State shall be stepped-up to 3% of the GDP. This is essential for the intellectual strength of the State to address equity concerns. A huge dedicated fund says, National Human Resource Development Fund, to the tune of at least one- percent of the GDP, may be created to tackle the equity problems. It shall be the accepted principle that no talented person shall be denied access to higher education opportunities on the grounds of economic and social backwardness. This fund may be dedicated to offer direct financial support in the form of scholarships, partial financial assistance and educational loans to students directly, based on the criteria of talent and financial and social backwardness. A welldesigned mechanism to spot talents in different disciplines of knowledge is needed for this purpose. Further, foolproof criteria to determine financial or any other social backwardness is required.
Taxing the individuals, who had the benefit of the State resources in the past for their education, and the industries, which are likely to derive advantage from good human resources, are the options for creating such a fund. While it is difficult to arrive at an ideal solution to the equity problems, the absence of a credible and efficient method of addressing these problems will lead to lowering of the quality of human ware and large-scale discontent. The society may be the ultimate looser. Industries may be encouraged to be partners with educational institutions directly for the development of human resources dedicated to their interests. This could happen in the areas of creating infrastructure, faculty sharing and direct support with funds. The UGC may set-up a High Power Committee to explore these possibilities and to workout the modalities for such a partnership. The industries belonging to a specific discipline or related disciplines shall be encouraged to establish state of the art Research and Training centres to develop the necessary specialized man power. Automobile industry is a case point. Existing Public and Private Institutions and possible new Institutions may generate ample provisions for partnerships in this regard. The areas not capable of attracting private funds shall be supported sufficiently well from public funds. This, as indicated earlier, is essential for the balanced intellectual growth of the society. Industries and individuals may be encouraged to channel a percentage of their profits to the higher education sector, with no strings attached to such contributions. Viable incentives may be offered for attracting such investments from the private resources. Strong quality control measures to assure performance above an acceptable benchmark is essential for the institutions. The various rating agencies shall evolve scientific, transparent and consistent benchmarking techniques for this purpose. A regulatory system to ensure compliance to the set bench marking is needed with sufficient powers to close down non-complying institutions is a need of the hour. The Higher Education Policy needs to incorporate such features in it in the interest of the nation. A Total Quality Management for courses offered, monitoring the achievement of the students at all stages of the course, shall be introduced at all higher education institutions. An accreditation system for individuals in various disciplines may be thought of.Indeed, GATE and NET examinations with limited objectives are forerunners of such a system. The performance of students in such examinations may be made an important parameter for the accreditation of the institution. The idea of allowing students to do Diploma or Certificate courses side by side with their Degrees, recently put forward by the UGC, is a welcome step towards empowering the students to take-up work soon after their Degree courses. This is an area where private initiatives can come up to augment the activities of the Colleges. The Colleges can develop in-house faculty and other facilities for this purpose and make these facilities available at a reasonable cost. Such a measure will turn around many Colleges from the non-performing class to the performing class. There shall be
a mechanism to accredit these courses and facilities to ensure quality. This is an area where public/private partnership has a creative role to play. It is important to realize that we live in a fast changing world, dictated by the developments in technology. Quick access to information has made knowledge creation fast, and the multiplier effect has made it even explosive. It is increasingly difficult to anticipate changes and respond to them with creative purpose. Designing courses with relevance to the future and developing the necessary manpower to deliver them is a challenging task. All this calls for a team of professionals in different areas to come together to develop proactive strategies for higher education to meet the future demands. A Strategy Planning Body and an Institution to design and develop futuristic courses for transferring them to the Universities and Colleges may be created. Good Faculty is a must for any higher education institution aspiring for Quality. It is high time that an Indian Higher Educational Service, along the lines of the IAS, is formed. This has the advantage of quality control of the teaching faculty for higher education. A new Human Resource Development Policy shall be evolved to facilitate this. This could assure that there is continuous infusion of young blood in to the teaching cadre; which is not happening at the moment. With some restrictions on faculty appointments, the present evil of inbreeding can be eliminated. The inbreeding has destroyed many departments at Indian Universities. Private Universities are a reality now and, as such, strong regulatory mechanisms are to be put in place immediately to monitor and control their activities with the objective of ensuring quality and social accountability. Higher education is a Public Good and cannot be left to the market forces to control. Those who venture investment in this area shall be properly scrutinized. Those with commercial interests dominating over the interests and ethics of higher education shall be eliminated. The present archaic administrative practices need a thorough reform. A healthy Public/Private partnership can do much in this regard by way of exchanging good practices. A management system, lean but professional, making use of modern communication and information technologies is required to facilitate quality higher education.
Basic primary education is generally viewed as a public sectors responsibility, which makes any shared involvement of public and private sectors a highly sensitive issue. Transfer of user fees to private sector providers is sensitive, especially in basic education. Even more sensitive is the management of public education institutions by the private sector. PPPs can be used by unions and opposition as pretext to claim that government is abandoning its core task of providing public education.
Fig.1:PPPFormulation:KeySuccessFactorsObstacles
With education in many poor countries provided substantially by the private sector (e.g. 40% in Pakistan), there is often a wide pool of educational and administrative expertise upon which to draw. With regard to accessibility, quality and efficiency, state schools perform poorly for a wide range of reasons. Some of these lie outside the sphere of influence of the individual schools or local educational authorities the effects of HIV/AIDS and violent conflict on the available teacher population; cultural realities that discriminate against educating daughters in favor of domestic work; and resource allocation decisions taken by national governments. Other weaknesses, however, may lie inside the control of the local education system. These include the quality of teaching; relevance of curriculum (e.g. to dropouts); management of buildings and equipment investments; sexual violence among student populations; teacher and student absenteeism; administrative inefficiencies; and lack of accountability. Innovations abound for involving the private education (and corporate) sector in outsourcing, in-sourcing and marketization initiatives in relation to public schools and educational authorities. Many of these examples require, at a minimum, policy reform and, in many cases, legal reform. if we start with direct provision of services we end up working on policy and vice versa. Further, the controversial nature of these PPP arrangements requires winning over public support, which is a function of transparency in the balance of outcomes between social benefits and private sector returns. There is perhaps a role here for development assistance agencies to work with ministries of education and finance to evaluate the available options. Most important, policy-makers and education professionals need to jointly assess the suitability of each option given the specific social, political and infrastructural circumstances of a particular country or region..
PPPArrangementsforMarketingBottomofthePyramidEducationalProducts
A more direct form of private sector participation in basic education is the provision of text books, computers, science and vocational training equipment, and other educational and
teaching aids. There is much discussion in the world of corporate social responsibility at present on the fortune at the bottom of the pyramid (BoP) the notion of marketing lowcost products in high volumes to low-income end-users. Educational department procurement budgets offer one obvious potential source of revenue for companies who manufacture teaching aids for this market.
PresentStatusonTVETProgramsinRelationtoEducationforSustainable Development
Technical and Vocational Education and Training (TVET) programme run from the Ministry have been contracting public and private training institutions to prepare the youth for employment by acquiring skills. TVET system is demand driven, accessible, beneficiary financed and quality assured that meets the needs of society for stability and economic growth, the needs of Enterprise for a skilled and reliable workforce, the need of young people for decent jobs and the needs of workers for continuous mastery of new technology. TVET also prepares learners for employment and then helps them to continue their education and training on flexible mode with courses running part time and fulltime. Since TVET programs are demand driven it is targeted to cater for the labour market through various skills training programs Institution Based training and Employer Based Training are equally recognized pathways or tracks to develop a career based on skills training. Regulatory framework for the higher education sector Regulatory body Ministry of Human Resources Development (MHRD) Profit making Must be run as not-for-profit institutions in the form of a society or trust
Affiliation/accreditation
Higher education institutes must be affiliated to a university and are therefore accredited by the University Grants Commission (UGC) Further, each stream (medicine, management, engineering and law) is monitored by a specific body for instance the .All India Council for Technical Education (AICTE) for engineering and management colleges and affiliation to these is mandatory.Without affiliation in one of these categories, a higher education institute will be considered illegal unless it can be demonstrated that graduating students are successful in the job market (an example is the Indian School of Business in Hyderabad, a proven premier business school with strong industry acceptance) Curriculum As required by affiliated body Typical operating models Greenfield project Public Private Partnership Foreign investment 100% permitted through the automatic approval route Private Sector Participation and corporate social Responsibility Education presents a large opportunity to the private sector, especially corporate India, who need to look at education not just as Corporate Social Responsibility (CSR), but also as a profit venture that will also create trained manpower for their other businesses There is clearly an opportunity for private players to enter the education space. There is a large demand supply gap, which is further exaggerated due to the low quality of education and capacity constraints at the premium colleges / institutions. This opportunity exists in all three segments schooling, higher education and vocational training, and in almost all parts of India. Some success stories are Manipal
University, Amity University and the Indian School of Business. Also, private sector participation is more likely to lead to the creation of thought leadership and centers of excellence in the country. This can then support policy development and at the same time incorporate industry demands in a market based curriculum.Schooling and higher education are not for profit ventures due to the requirements of being registered as a Trust or Society. However, an operate and manage model is now legally accepted and enables a for profit model in education. In such ventures, financial returns are attractive, with EBITDA levels of 30% plus and project IRRs ranging from 20% to 30% levels. Corporate participation is clearly required in building the education landscape of India, as such firms not only bring in project management experience and financial capability, but also the mindset to achieve the right quality. Some examples of corporates in education are:
K12Schooling
Dhirubhai Ambani International School, by Reliance Industries Stonehill International School, by Embassy Group Educomp Millennium Schools, by Knowledge Tree Infrastructure, a subsidiary of Ansal API and Educompssubsidiary, Edu Infra
HigherEducation
Proposed Vedanta University by Mr. Anil Agarwal, Chairman of Vedanta Resources Plc, spread across 6,000 acres with estimated investment of more than US$ 3 billion in Orissa
KeyFindings
The NGO is familiar with the local language, the school administration and the relevant issues We can also think of opening up the FDI for education. Employment opportunities for many unemployed IT trained youth, Computer Education at young age lays a good foundation for the students for higher education Computer has been used by teachers to make their job easy by avoiding the writing hassles (result preparation, notifications etc) Used for school management system software Internet has enabled more GK and basic knowledge Education due to e-content has given good impetus to students ability to retain things for longer duration There are many such PPP cases in Vocational education in university level but none so far in school level as the education system in India is not as similar to US/UK where more stress is on hands on rather than textual. Higher Education should be developed as social economic growth of the country.
Public-private-partnerships, academia-industry partnerships, academia-research laboratories, public- NGOs, public-community etc. will need to be the models rather than working in separate compartments
CONCLUSION
The current trend in the infrastructural development has highlighted the facilitating role played by the Government for increasing private participation in various sectors. The education sector in a state of transformation. There is a lot of money to be made in addition to really adding value and giving back to society. This development whereby a promoter of an infrastructure group takes a big stake in an education company really signals a paradigm shift. That there are difficulties in negotiating and reaching agreement is really the tip of the iceberg; the real issue is the private sector is not part of the education sector policy dialogue in developing countries for reasons on both sides. This has to change. PPPs in education will come out of a strong education policy environment. In the globalized World, the Stateprotected educational system cannot withstand the pressure without making itself competitive. Taking the problem of resource crunch in higher education at face value, research grants from industries, donations for admissions etc. which were found to be inadequate. It was observed that an organized structure for higher-educational fund raising and creating a culture of giving are the only possible solutions.
REFERENCES
[1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] A Technical and Vocational Training (TVET) system for the Briefing Paper (April, 2007) Country Report (2007) Interim Report, Employment Skills Training Project Management of higher education journal Finance and Development Journal Management of higher education in India Whats worth of teaching by Marion Brady 1989 Aggarwal A, Rizvi IA and Popli S (2004) Global branding of business schools: an Indian perspective. Report of UGC (2006) University Grants Commission. Nigavekar A (2005) Ensuring quality higher education for all. Country Report: India Central Advisory Board of Education Report of the CABE committee on Financing of Higher and Technical Education [12] Report Card of Indias education Vol.1
ReviewofChangesinMonetaryPolicy anditsImpactonIndianGDP&WPI
Dr.MrinaliniKohojkar*
AbstractThe Liberalisation Privatisation Globalisation policy of 1991 created waves of changes in India. A decade after the implementation of the policy, Indian economy was placed on high growth trajectory. However, the global meltdown of 2008 09 slowed down the growth process. Benefits of globalization also underlined the risks from the same. Reserve Bank of India (RBI) as the regulatory authority in the banking sector had to adjust the liquidity in the economy to promote the growth and simultaneously had to manage the inflationary pressure. In fact the more challenging job was the withdrawal of the accommodative monetary policy and implementation of monetary tightening without disturbing the growth prospects. This paper tracks down the changes in monetary policy in terms of repo rates, reverse repo rates and CRR since September 2008 and analyses the impact of the policy on growth rates and price levels. Keywords: Repo rates, Reverse repo rates, CRR, Growth (GDP), Inflation (WPI)
OBJECTIVE
The study aims at establishing the impact of the monetary reforms such as changes in repo rates, reverse repo rates and CRR on the major macroeconomic indicators such as GDP & WPI.
METHODOLOGY
Simple technique of matching the reforms with subsequent changes on GDP & WPI is used. The data for the comparison is mainly obtained from RBI website www.rbi.org.in
MainComponentsofthePaper
Basic challenges to emerging market economies in dealing with growth- inflation dilemma in the light of global meltdown. Shifts in Indian monetary policy during September 2008 to October 2010 Impact of policy changes on Indian GDP growth rates and WPI. Analysis of future growth prospects and risk of inflation in India.
The paper aims at a review of changing repo, reverse repo and CRR rates and the impact of the same on Indian GDP and WPI.
Basic Challenges to Emerging Market Economies in Dealing with Growth Inflation DilemmaInTheLightofGlobalMeltdown
The emerging economies have very high growth potentials but they are exposed to the risks like political, monetary and social instability. India is being looked upon as a huge emerging *Thakur Institute of Management Studies & Research, Mumbai
market because of the demographic advantage and Increasing GDP and PCI. The present task for the policy makers is to bring the economy back on the high growth track and to curb the inflationary pressures to avoid overheating of the economy. The real GDP growth rates from 2000 to 2009 are given in Table 1.1.
TABLE1.1:REALGDPGROWTHRATES(%) 2000 2001 2002 YEAR Real GDP 4.4 3.9 4.6 Growth rate Source Global finance www.gfmag.com 2003 6.9 2004 8.1 2005 9.2 2006 9.7 2007 9.9 2008 6.4 2009 5.7
The real GDP growth rate suffered a major setback in the year 2008 and 2009 due to global meltdown. The series of bank failures and collapse of financial institutions created a major economic crisis in the US and subsequently in many European nations. The shrinking global demand adversely affected Indian growth rates and hence there was a slowdown in overall economic progress.
The major concern of the Indian monetary policy one year ago was the significant slowdown in growth in the wake of the financial crisis in the advanced economies. All the policy rates and reserve ratios were tuned to generate the high growth rates. Indian GDP registered a robust recovery since second half of 2009-10 and is continued in the first quarter of 2010-11. The recovery of GDP growth rate is mainly due to strong performance of the services sector. Manufacturing sector exhibited a robust recovery but recently has become very volatile. To achieve and maintain high growth rate of GDP, all the sectors require monetary and fiscal policy support. Business confidence surveys conducted by NCAER and FICCI have shown remarkable improvement over the previous quarter. The forecast of the various agencies for real GDP growth rate for the year 2010-11 is in the range of 8.3 % to 9.7%. The well known measures of inflation are the Consumer Price Index (CPI) which measures consumer prices, and the Wholesale Price Index (WPI) which measures inflation in the wholesale market for the selected commodities. The basic classification of the commodities is done as primary articles, Fuel and power and manufactured products. The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates. Mainstream economist views can be broadly divided into two camps: the "monetarists" who believe that monetary effects dominate all others in setting the rate of inflation, and the "Keynesians" who believe that the interaction of money, interest and output dominate over other effects. Other theories, such as those of the Austrian school of economics, believe that an inflation of overall prices is a result from an increase in the supply of money by central banking authority.
Review of Changes in Monetary Policy and Its Impact on Indian GDP & WPI 211 TABLE1.2:MONTHLYCPIFOR2006TOSEPTEMBER2010 JAN FEB MAR APR MAY JUN YEAR 2010 16.22 14.86 14.86 13.33 13.91 13.73 2009 10.45 9.63 8.03 8.70 8.63 9.29 2008 5.51 5.47 7.87 7.81 7.75 7.69 2007 6.72 7.56 6.72 6.67 6.61 5.69 2006 4.39 5.31 5.31 5.26 6.14 7.89 Source- www.tradingeconomics.com/Economics/Inflation-CPI JUL 11.25 11.89 8.33 6.45 6.90 AUG 9.88 11.72 9.02 7.26 5.98 SEP 9.82 11.64 9.77 6.40 6.84 OCT 11.49 10.45 5.51 7.63 NOV 13.51 10.45 5.51 6.72 DEC 14.97 9.70 5.51 6.72
The inflation rate, which was briefly negative in the middle of 2009, began to accelerate rapidly later in the year. This upward momentum continued into the first half of 2010, with double-digit inflation persisting for a few months. The rapidity of the transition was surprising, given the fact that the recovery in growth was just getting under way and, importantly, the global situation was still very uncertain. The reason for the sharp increase was that all the possible drivers of inflation were simultaneously contributing. Each one by itself may not have resulted in the outcome that we saw, but all three working together resulted in a rather sharp acceleration. Food prices rose sharply because the monsoon of 2009 was deficient in most parts of the country, impacting agricultural production. However, there are longer term forces at work on food prices, which are a matter of concern. Fuel prices also rose as the prospects of a global recovery improved and, particularly, the Emerging Market Economies actually saw a sharp acceleration in growth. The most significant factor from the monetary policy perspective was the growing demand-side pressures. The manufacturing sector overall and without the food processing component the non-food manufacturing inflation, show a tremendous acceleration. The basic challenge for EMEs is to retain the high growth rates, when developed nations are still struggling to regain the economic strength and employment. The dormant demand in advanced countries have adversely affected the prospects of exports and hence affect growth adversely. Rising prices of fuel, power and other materials add to inflationary pressure. Measures adopted to control inflation may affect growth adversely. The protectionist policy of developed nations may also create obstacles in the growth process.
ShiftsinIndianMonetaryPolicyduringOctober2008toSeptmber2010
The focus of the study is to track the changes predominantly in repo and reverse repo rates in response to dual policy objectives i.e. growth and control over inflation. With effect from 29th October 2004 the nomenclature of repo and reverse repo was aligned as per international terminology. As per the new usage of the terms Reverse repo indicates absorption of liquidity and repo indicates injection of the liquidity. Bank rate was almost constant during 2004 to 2008 at 6%. By August 2008 ,Reverse repo was raised from 4.5 to 6.0% , repo was raised from 6% to 9% during 2004 to 2008 and CRR was updated from 4.5% to 9%. Overall the focus was on control over inflation and Indias performance on growth front was satisfactory.
The global crisis that started in September 2008 did not have much impact on India instantly. However international instability and turmoil affected Indian growth rates subsequently and the macroeconomic growth indicators exhibited a slowdown. Industrial production index and exports were the major cause of concern. Hence there was a shift in RBIs policy objective from control over inflation to the concern for growth. From October 2008 to 5th March 2009 reverse repo and repo rate were drastically lowered. The reverse repo was brought to 3.50 from 6 and repo rate to 5.00 from 9%. CRR was also lowered from 9% to 5%. All the measures were focusing on increasing liquidity to boost the declining growth rates. The annual policy statement 2009-2010 on April 2009 underlined the need for Government and Reserve Bank to work in coordination and cooperation to minimize the impact of global economic crisis on India. In order to provide ample liquidity for all productive activities RBI further reduced repo rate from 5.0 to 4.75 and reverse repo from 3.5 to 3.25 on April 21st 2009. The major focus of monetary measures was towards providing growth stimulus to the apparently sluggish economy. The rates almost remained stationary during April 2009 to February 2010.
TABLE2.1:MOVEMENTSINKEYPOLICYRATES(%) Effective since Reverse Repo April 26 2008 6.00 May 10, 2008 6.00 May 24, 2008 6.00 June 12, 2008 6.00 June 25, 2008 6.00 July 05, 2008 6.00 July 19, 2008 6.00 July 30, 2008 6.00 Aug 30, 2008 6.00 Oct 11, 2008 6.00 Oct 20, 2008 6.00 Oct 25, 2008 6.00 Nov 03, 2008 6.00 Nov 08, 2008 6.00 Dec 08,2008 5.00 (-1) January 05, 2009 4.00 (-1) January 17, 2009 4.00 March 04, 2009 3.50 (-0.50) April 21, 2009 3.25 (-0.25) Feb. 13, 2009 3.25 Feb.27, 2009 3.25 March 19, 2009 3.50 (+0.25) April 20, 2009 3.75 (+0.25) April24. 2009 3.75 July 02, 2009 4.00(+0.25) July 27, 2009 4.50 (+0.50) Source Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai) Repo Rate 7.75 7.75 7.75 8.00(+0.25) 8.50(+0.50) 8.50 8.50 9.00(+0.50) 9.00 9.00 8.00(-1.00) 8.00 7.50(-0.50) 7.50 6.50(-1.00) 5.50(-0.50) 5.50 5.00(-0.50) 4.75(-0.25) 4.75 4.75 5.00(+0.25) 5.25(+0.25) 5.25 5.50(+0.25) 5.75(+0.25) CRR 7.75(+0.25) 8.00(+0.25) 8.25(+0.25) 8.25 8.25 8.50(+0.25) 8.75(+0.25) 8.75 9.00(+0.25) 6.50(-2.50) 6.50 6.00(-0.50) 6.00 5.50(-0.50) 5.50 5.50 5.00(-0.50) 5.00 5.00 5.50(+0.50) 5.75(+0.25) 5.75 5.75 6.00(+0.25) 6.00 6.00
Gradual recovery of the growth rates, especially industrial production created an energetic atmosphere on the overall growth front. The early signs of recovery of US and other European countries also created favorable expectations for the future. The baseline projection for GDP
Review of Changes in Monetary Policy and Its Impact on Indian GDP & WPI 213
growth was revised to 7.5%. The food prices in the domestic market started rising and global commodity prices were also soaring. The prices of crude oil and other products increased with the favorable forecast of global demand conditions. The policy stance changed once again from managing recovery to containing the inflation. The dominant factor that shaped monetary policy for 2010-11 was high inflation. The shift in the policy was not a easy task for India. The process of exit from monetary expansion has been relatively smooth because there was no undue expansion of RBIs balance sheet. Monetary intentions were to contain inflation and so the reverse repo rates were brought to 4.50 and repo rates were brought to 5.75 by July 2010. The CRR was raised up to 6% .The major changes in reverse repo, repo and CRR rates are provided in Table number 2.1 The recent global financial crisis triggered a spate of policy responses that differed in their magnitude and coverage.The use of central bank balance sheets, in particular, as a key instrument of monetary policy received unprecedented focus during the recent crisis. In this context, the study of the impact of policy actions taken during the crisis on the balance sheets of central banks, brings out interesting results. It also reveals the fact that the RBIs balance sheet exhibited different trends than the ones exhibited by central banks of advanced countries. The assets of the Fed and the Bank of England more than doubled, that too in a matter of weeks, while that of the European Central Bank (ECB) grew by more than 30 per cent. In the Feds case, this reflected direct lending to banks and dealers through existing and new lending facilities; indirect lending to money market funds; purchases of commercial papers (CP) through special purpose vehicles and drawings by foreign central banks on dollar swap lines. Balance sheet changes with respect to the Bank of Japan ( BoJ) were mainly driven by introduction of measures to facilitate corporate financing, along with the purchase of CPs and corporate bonds. Several challenges emerged from significant changes in the size of central bank balance sheets, such as change to the risk profile of balance sheets with rise in credit. Although several emerging market economies (EMEs) resorted to various measures for expanding liquidity, both in domestic currency and in foreign currency, the size of central bank balance sheets in EMEs increased much less than their counterparts in advanced economies, due to absence of aggressive measures. In India, despite some pressure on financial markets after September 2008, with RBI ensuring ample rupee and forex liquidity in the system, normalcy and orderly conditions were restored in the markets. Unlike other countries, RBIs balance sheet did not expand much as the ample liquidity was injected through CRR operations.
ImpactofPolicyChangesonIndianGDPGrowthRatesandInflationScenario
growth rates in most of the advanced countries have remained sluggish where as the EMEs have regained the robust growth rates in recent times. The prompt and timely measures that RBI has taken to deal with the exceptional global economic crisis have successfully
The
attained the duel goals The economy is back on the high growth track and the inflation is well within the limits. Following table indicates growth rates of GDP at factor cost (2004-05 prices)
TABLE3.1:GROWTHRATEOFGDPATFACTORCOST(200405PRICES) 09-10 09-10 Q1 09-10 Q2 09-10 Q3 7.4 6.0 8.6 6.3 Source: ( CSO as mentioned in Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai) 09-10 Q4 8.6 10-11 8.8
RBIs measures to provide ample liquidity during December 08 to April10 have helped the economy to attain higher growth rates. Of course many more factors such as domestic demand, good monsoon worked as major drivers for the growth. The growth is inward and is happening at the time when EME are getting stronger and advanced economies are struggling to maintain growth and employment. With growing unemployment and sluggish growth rates, the advanced economies are experiencing moderate levels of inflation. IMF has projected 1.4 rate of inflation for advanced economies. Global review indicates that EME are exposed to the dangers of inflation and IMF e projection for the price rise is 6.4 for 2011. Increasing demand from EMEs have led to fuel price hike and thus inflationary pressures. Rising domestic demands add fuel to the fire. Indian economy started feeling the heat of the inflation from March 2010 and then the stance of monetary policy shifted from growth to contain inflation. The repo, reverse repo and CRR rates were raised in from April 2010 and today the indicators reveal that the inflation is well within the control. Table no. 3.2 indicates rates of change in WPI as per the new base i.e. 2004- 05.
TABLE3.2:RATESOFCHANGEINWPIAT200405BASE Mar08 Mar09 June09 Sept09 Dec.09 Mar 10 June10 July 10 Aug10 Sept10 7.7 1.5 -0.7 1.1 6.9 10.2 10.3 10.0 8.5 8.6 Source Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai
The data reveals the fact that the inflation is being brought to the acceptable levels from August 2010 . The supply side of the market has also extended the support in the fight against inflation. Good monsoon, food and nonfood manufacturing and the growth of the service sector together have prevented the WPI to go on spiral rise. Currently Reverse repo rate is 5.5%, repo rate is 6.25% and CRR is 6% . It is an indication of the slow transition from growth orientation to inflation management.
AnalysisofFutureGrowthProspectsandRiskofInflationinIndia
The EMEs have played a strategic role in pulling the global economy out of deep economic crisis. The present position of the EMEs appears to be very promising and strong. Specifically for India, the growth prospects are very high and the inflation is also being managed efficiently without disturbing the growth. In fact, India has a great opportunity to take a leap forward.
Review of Changes in Monetary Policy and Its Impact on Indian GDP & WPI 215
Growth scenario - The factors that will drive the growth in the near future are Demographic Factors Indias sheer size of the population makes it possible to consider inward looking growth strategy. At the time when, all rich and advanced economies are going through tough times, Indian corporate sector has huge domestic market. This provides enormous opportunity to grow and prosper. The age structure of Indian population is rightly described as demographic dividend. With the youth power at the disposal, India can take any challenge successfully. The youth generate demand for anything and everything and hence can give a great boost to the corporate sector. The youth also present themselves as the labour force. The volume of the labour force will provide cheaper labour to the incorporations , reducing their cost of production.
Economic Factors The need for better infrastructure will attract many big players in the market. Currently power generation is one of the most lucrative business and many domestic and foreign players are eagerly waiting to enter the market . The growth may follow the typical path of unbalanced growth strategy. The economy is poised to grow with high rates of Per capita Income, savings and investment. The foreign capital is being invested on a very large scale and this becomes an opportunity for faster economic growth. India has a strong industrial and service sector base.
Political Factors India is being led by a matured leader like Dr. Manmohan Singh. The political impact on economic policy decisions is being minimized. The decisions are based on experience and economic considerations. Social Factors The importance of education is being understood and increasing number of children are pursuing education and higher education.
GovernmentandRegulatoryAuthorities
The government and regulatory authorities design appropriate policy framework to ensure smooth and steady growth. Challenges to Growth EMEs are growing at a time when advanced economies are struggling to maintain the growth rates and employment. Many advanced economies are following protective policies to ensure jobs foe the locals. These policies may hamper the growth of EMEs by reducing the opportunities of outsourced jobs.
Weaker growth and declining job opportunities in the advanced countries may adversely affect the prospects of exports. Capital flows in EMEs are needed to augment their investible resources. However the large volumes of foreign capital with their volatile nature may create instability and severe fluctuations in EMEs. The exchange rate fluctuations, especially the appreciation of exchange rates may adversely affect the demand for the exports. For India in specific , current account deficit on BOP account is cause of concern. Higher growth rate may increase the gap in future. Currently, capital account is in surplus due to heavy flow of FII and FDI. However, foreign capital inflow is not the permanent solution for deficit on current account as capital inflows are volatile in nature.
Future Growth Projections In spite of the challenges India is being considered as the one of the fastest growing economy. Indias performance in terms of growth in 2011 is projected by different institutions separately as follows Economic Advisory Council to PM has revised projection of 8.2 % of February 2010 to 8.5 in July 2010 IMF has revised the projection of 9.4 of July2010 to 9.7 in October 2010 NCAER revised projection of 8.1 July 10 to 8.4 in October 2010 OECD revised the projection of 7.3 of November 2009 to 8.3 in May 2010.
The growth rate projections for 2011 given by the four important sources have some difference. IMF has placed a heavy confidence in Indias growth potentials. All the projections are revised with higher expectations. It is indeed very encouraging to see that Indian economy is poised to move on high growth track. Inflation Scenario Factors affecting inflation are classified as real and monetary. Keynesian explanation and solution for control over business cycle lies in real factors operating in the real market. Aggregate demand and supply need to be in balance to maintain price movements in comfortable limits. Monsoon plays a key role for agricultural production in India and fuel, power supply, labor, infrastructure and other raw material determine the supply side of manufacturing and services sector. Monetary factors, specifically money supply is affected by velocity of money, foreign capital inflow, government borrowings and investment. RBI through monetary measures tries to attain balance between demand for money and supply of money. Liquidity adjustment is the major tool to regulate money supply and price fluctuations. Projections for Inflation Looking at WPI and CPI movements from April 2010 to October 2010, there is moderate rise in price level. Considering the YOY movement of WPI , there is actually a fall in the movement.
Review of Changes in Monetary Policy and Its Impact on Indian GDP & WPI 217
Looking at the current scenario in India, domestic demand is going to remain high in future and challenge is to match the supply side. For augmenting the supply side, special focus should be on the sector specific requirements. The supply can flow smoothly if the financial resources are made available at reasonable cost. The cooperation from other countries in obtaining the materials and for the sell of the products is essential. The control over inflation can be obtained only if government, RBI and governments of our trading partners operate in cooperation. Summary and Conclusion The period from September 2008 is marked by global turmoil and financial instability. RBI had the difficult challenge to steer India through global financial crisis and thereafter to manage inflation effectively. The study was aimed at the review of the monetary policy changes in the area of repo rates, reverse repo rates and CRR and the impact of the same on GDP growth rates and inflation. The period from September 2008 to October 2010 was covered for the study. The success of RBIs monetary policy is beyond doubt and same has been appreciated worldwide. The changes in policy rates were precisely matched with needs and were perfectly calibrated to achieve the required results. In the first phase December 2008 to April 2010 the focus of the monetary policy was restoration of growth. The success of the policy is visible in the upward revision of the growth projections by IMF, NCAER, OECD and economic advisory council to PM. All have projected the growth rate for 2011 well above 8%. In the second phase- April 2010 till date, the challenge is much more complex. The global economy has not yet regained the full strength. India along with other EMEs is registering robust growth. Inflation in double digit is not acceptable. To control inflation in this scenario without hampering growth was truly a very difficult task. The withdrawal of the accommodative policy and reinforcing monetary tightening had a risk of slipping out of high growth trajectory. We must congratulate RBI for establishing control over inflation and maintaining high growth prospects. There are many other factor which have worked in favor of RBI policy without which this success would not have been possible. For e.g. Good monsoon of 2010 has contributed to both growth as well as price stabilization. Even then, we all must appreciate the key role played by RBI in steering the country successfully through the rough weather of financial turmoil. We can also conclude that reverse repo, repo and CRR are the powerful monetary tools, when used in appropriate quantity and time, will give the required results. However, the success of these measures also require support from government policies and other real factors.
The study can be made more technical and elaborate by establishing the lags between the time of introduction of reforms and the subsequent time taken by the objective variables for the necessary response.
REFERENCES
[1] World development indictors2010- The World Bank
Websites
[2] [3] [4] [5] www.rbi.org.in- Monetary policy statements, various reports, publications and reviews. www.tradingeconomics.com/Economics/Inflation-CPI www.gfmag.com The paper is heavily based on facts and figures provided by RBI on the website and the information published in Economic Times on day to day basis.
TheGreatInflationandaRecovering Economy
Rashmi*andC.A.RishiAhuja**
AbstractLaw of inflation: whatever goes up will go up some more Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate. There is a cumulative effect. Inflation and the economy both influence all the major macroeconomic indicators of a country like GDP, Demography, Capital investment, Export-import, Industrial production. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. Inflation would make the heavy debt more manageable as wages rise but the amount owed stays the same. The objective of this paper is two-fold: firstly, to study how the scope of inflation has widened in the form of food inflation, stock market inflation, industrial inflation, etc.and secondly to analyze and study how inflation can help as an aid to boost an ailing economy( In Indian context). Inflation and its effect on economy are enormous. In other words, all events are interlinked and the entire economic cycle gets upset. Very often we hear the word "Inflation", every time we hear some CRR Rates, Price High, Credit Policy and more, and don't understand what exactly it is. Keywords: Inflation, Ailing economy, Food inflation, Stock market inflation, Industrial Inflation
MEANING OF INFLATION
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy.
MismatchofDemandandSupplyLeadstoInflation Inflation is not the rise of prices, but the excess money printing and expansion of the
money supply. For example, lets say, earlier, a product can be bought for Rs.10, but now the same product costs Rs.50. An increase of 400%, If you ask any one why this happened, the answer will be simple the cost of production has gone up so the end value. The reason is right, but the perspective is wrong, the price has not gone up but the value of the money has gone down. *Institute of Productivity and Management, Meerut
Inflation is a self-perpetuating and irreversible upward movement of prices caused by an excess of demand over capacity to supply. Emile James
Relationbetweendemand,supply&costgoingup
People has excess of money holding with them, which forces them to spend it, by which the demand is going up for the respective product but the supply is same/constant, simple rule applies here, demand is high, supply not reaching demand, price is high. Now, why does one spend when the rates are already high? The answer is simple, ask your mother. She says, the prices may go even more up tomorrow, so let me buy and store the stock today itself. Inflation is a state in the economy of a country, when there is a price rise of goods as well as services. To meet the required price rise, individuals have to shell out more than is presumed. With increase in inflation, every sector of the economy is affected. Ranging from unemployment, interest rates, exchange rates, investment, stock markets, there is an aftermath of inflation in every sector. Inflation is bound to impact all sectors, either directly or indirectly.
A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is called inflation. Although inflation is part of the normal economic phenomena of any country, any increase in inflation above a predetermined level is a cause of concern. High levels of inflation distort economic performance, making it mandatory to identify the causing factors. Several internal and external factors, such as the printing of more money by the government, a rise in production and labor costs, high lending levels, a drop in the exchange rate, increased taxes or wars, can cause inflation. Different schools of thought provide different views on what actually causes inflation. However, there is a general agreement amongst economists that economic inflation may be caused by either an increase in the money supply or a decrease in the quantity of goods being supplied. An increase in the quantity of money in circulation relative to the ability of the economy to supply leads to increased demand, thereby fuelling prices. The case is of too much money chasing too few goods. An increase in demand could also be a result of declining interest rates, a cut in tax rates or increased consumer confidence.
Inflation occurs when the cost of producing rises and the increase is passed on to consumers. The cost of production can rise because of rising labor costs or when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange rate changes, and external factors, such as natural calamities or an increase in the economic power of a certain country.
EFFECTS OF INFLATION
Inflation affects the whole of the economy squarely including the taxes and import tariffs. The effect of inflation and economic growth is manifested in the following cases:
Investment
If the prices of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs.
InterestRates
Whenever inflation reigns supreme, it is a well known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods.
ExchangeRates
Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders and value of money also changes.
Unemployment
Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve.
Stocks
The returns a company offer, on investment fully depend on the performance of the company. Past performance, current positions of the company and future trends decide how much (money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted.
EconomicCostsofInflation
The economic costs of inflation are many. They are stated and briefly illustrated below:
Global competitiveness: Inflation initiates competitiveness in the worldwide markets. The higher are the prices of the products of a country, the lesser are the scopes of competition, which subsequently reduces the country's exports. But, this situation may be counterbalanced if there is a fall in the exchange rate. Disorder and improbability: With high inflation, the inhabitants of a country become indecisive about the ways of spending their money, and what to spend their money on. It is under this circumstance that the country's commercial firms become indifferent and less willing towards investment, as they are not sure about their future profits. Boom and Bust economic Cycles: Generally, the high inflationary growth is followed by a collapse; as such constant situation becomes unbearable at times. It is low inflation which initiates a sustained growth in the economy of a country. It is beneficial and harmless in nature, for allowing easy and smooth price adjustments.
Cost of decreasing inflation: High inflation is believed to be unacceptable. Hence the governments of different countries across the world feel that it is best to decrease inflation. This attempt involves high rates of interest. However, a fall in the inflation may lead to decline in the economic growth and development of a nation, and increase in unemployment problems. Re-allocation of income: With redistribution of income, the economic conditions of the borrowers improve and that of the lenders, deteriorate. However, this situation is more dependent on the real interest rates. Shoe leather costs: mean making savings on losing bank interests. As a result, the customers hold less cash amounts and frequent the banks more.
HighInflation
High Inflation is a condition in which the prices of goods and services reach an all time high. The prices of goods and services increase rapidly under such a circumstance, faster than the remuneration of people. Before one can receive his/her paycheck the prices are skyrocketing. The price level during the high inflation period shoots up very high. But the increase in prices does not assure the increase in the production of goods and services. Instead the demand of goods increase and the supply decrease. The supply of money also increases. This is measured against the standard price index. High inflation in an economy can harm the economy by affecting it in a negative way. It casts long-tem effects. High inflation reduces the incentive within the mass to save money hence it reduces the potential for long-term capital formation. The accumulation of money is perturbed by this phenomenon as the value of money hits rock bottom and people lose the spirit of saving. The consumers cannot buy the goods since the price level shots up beyond their reach. However, the high inflation also grants a positive effect to the economy by reducing the spending capability of the mass in the long-term by making goods less affordable. In this way they might be able to save some amount of money in the long run. High inflation is not good for an economy since it dismantles the steadiness of the economy. The rising of the prices take place at an uneven rate and that makes it even more harmful. In the present times none of the economy is free from inflation but reducing the rate of inflation is probably the greatest challenge for the countries.
InflationStatistics
Inflation Statistics gives the record of inflation in different countries depending on the available data of the changes in the purchasing power of the mass. Inflation takes place when the general price of goods and services experience an upward movement. Inflation is measured by placing the altered price against the various price index, the most common being the CPI or the Consumer Price Index. Inflation statistics reveal the impact of inflation on the various economies by recording how much problem an economy suffers due to the hike in
price. The statistical report expresses the inflation rate in terms of figures. This numeric data divulge the situation of an economy during an inflationary period. Contents in Inflation Statistics The inflationary rate is measured against the CPI which takes into account the changes that take place at a daily basis in the market. The CPI again is divided into two groups. They are: CPI for the Urban Consumers CPI for Urban Wage Earners and Clerical Workers A new incorporation is the Chained Consumer Price Index which is a correspondent of the Cost-of Living index.
The Producer Price Indexes is a group of indexes that records alterations brought about changing prices on the part of the seller who sells domicile goods. They were previously referred to as the Wholesale Price Index. Import and Export Prices also form another index against which inflation rate is measured. In this index is recorded the changes in the price of international goods and services. This comparison is done by setting the US price level as a parameter against which the prices of all the other goods and prices of various countries are measured. Consumer spending survey is yet another index which records the spending habits of the consumer and also includes the data on their expenditure and income.
TYPES OF INFLATION
There are three major types of inflation: Demand-pull inflation: is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion. Cost-push inflation: also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Built-in inflation: is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
Some other Categories of Inflation are Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to
increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services. Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn. Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget. Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a countrys monetary system. However, this type of inflation is short-lived.
WhatsCausingGlobalFoodPriceInflation?
New research shows that India, China, and speculators are not the culprits in the food price explosion. Biofuels were a significant element in the 2005-2007 food price surges as they accounted for 60% of the growth in global consumption of cereals and vegetable oils. There cannot be any doubt that Biofuels were a significant element in the rise of food prices. Since new research also shows that Biofuels support policies are disappointingly ineffective on environmental grounds, governments should reconsider them. Global food prices have exploded since early 2007, causing major social, political, and macroeconomic disruption in many poor countries and adding to inflationary pressure in the
richer parts of the world. Concerns about high food prices have been expressed at the highest political level, including during the recent G8 summit. What has caused the explosion of food prices? Several culprits have been blamed. Newspapers have cited an internal World Bank document as having found that 75% of the price increase was due to Biofuels. Several governments and commentators see speculation as a major driving force. A widely held view has it that rapidly growing food demand in the emerging economies is pushing up global food prices.
New evidence on the causes The OECD (Organization for Economic Co-operation and Development) has carefully looked at market developments and analyzed the implications of Biofuels support policies. The analytical framework used is a large-scale partial equilibrium model of agricultural commodity markets in all major countries at the international level, with detailed representation of the multitude of policy instruments affecting these markets, including those targeting Biofuels. Results were published recently in the OECD-FAO Agricultural Outlook, a paper on the causes and consequences of rising food prices, and a report on the economic assessment of Biofuels support policies. The evidence is pretty clear. No Hard Evidence that Speculation Boosted the Spot Price Yet, there is no hard evidence that speculation has added much to the price increase on spot markets. After all, it is only when speculators actually buy produce on the spot market that they can drive up the price, and this would have to be reflected in growing stock levels but stocks appear to have declined throughout the period of rising prices. A different type of panic, though, has without doubt contributed to food price inflation the barriers to exports that some food exporting countries have imposed in order to keep domestic food prices under control. Yet, the precise effect that this form of government panic has had on short-term price movements is very difficult to quantify. OECD analysis clearly shows that two factors external to agriculture and food have had, and will continue to have in the years to come, a significant impact on the rise of global food prices. The rapid increase in crude oil prices and energy prices more generally has significantly raised the costs of producing and shipping agricultural products. The weak dollar has contributed to driving up dollar-denominated commodity prices in international trade.
CausesofRisingFoodPrices
This rise in prices is a consequence of both demand and supply trends. On the demand side, food prices, are rising on a mix of strong consumption growth in emerging markets, which in
turn has been powered those countries impressive income gains. In recent years, the worlds developing countries incomes have been growing about 7 percent a year, an unusually rapid rate by historical standards. China, for example, has accounted for up to 40 per cent of the increase in global consumption of Soya-beans and meat over the past decade.
IndustrialInflation
The JOC-ECRI Industrial Price Index is the brainchild of Geoffrey Moore. Originally created in 1986, the current Index has been in use since 2000. It is designed to give an early "heads-up" to inflationary pressures. Although textiles (-4.28%) and "miscellaneous" (3.33%) are down, the rise of petroleum (+31.46%) and metals (+27.51%) in the last year brings the Industrial inflation rate to a heart-stopping 10.58%. Rising production costs have hit a rate that is the highest since 2004 28.1 percent annually. One of the reasons for it is the raw materials boom on the world market. It should not affect consumer prices in the short term, but production prices will pull consumer prices up eventually, and producers will fell keener competition with imports. According to Rosstat, the state statistics agency, the producer price index rose 4.9 percent in June for a total of 17 percent since the beginning of the year. Minerals rose in price the fastest at 10.6 percent and 18.3 percent for the half year. The main factor driving the price rise is oil prices. The consumer price index rose 9.1 percent from January to mid-July of this year. That is about 15 percent annually. One reason that an increase in the producer price index does not automatically lead to an increase in the consumer index is that export goods are high in the producer index. Petroleum products and coking coal have increased in price by 150 percent in the last year. They are to a significant extent export goods as well. Excluding the raw materials sector, producer prices do not looks as catastrophic. But manufacturing will be affected sooner or later because of rising costs and face lowered profitability, forcing them to raise prices. It will be easiest for producers to raise prices on goods with little import competition. In the long term, there is a threat of slowing down the growth of industrial production and the economy as a whole.
StockMarketInflation
If there is inflation, stock markets are the worst affected. Inflation and Stock Market- the Logistics Prices of stocks are determined by the net earnings of a company. It depends on how much profit, the company is likely to make in the long run or the near future. If it is reckoned that a company is likely to do well in the years to come, the stock prices of the company will escalate. On the other hand, if it is observed from trends that the company may not do well in the long run, the stock prices will not be high. In other words, the prices of stocks are directly proportional to the performance of the company. In the event when inflation increases, the company earnings (worth) will also subside.
This will adversely affect the stock prices and eventually the returns. Effect of inflation on stock market is also evident from the fact that it increases the rates if interest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation and interest rates) being high, the creditor will have a tendency to compensate for the rise in interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant role in prohibiting funds from being invested in stock markets. When the government has enough funds to circulate in the market, the cost of goods, services usually go up. This leads to the decrease in the purchasing power of individuals. The value of money also decreases. In a nut shell, for the economy to flourish, inflation and stock market ought to be more conforming and predictable. There is no one-to-one correlation between the market and inflation. Typically, most investors stay away from the stock market when inflation goes up. This is because prices of shares along with the prices of everything else go up without any corresponding increase in intrinsic value. Such a bull phase soon leads to a market correction due to many investors deciding to realize profits. Debt Market becomes More Attractive One step most governments take to contain inflation is to tighten money supply by raising interest rates. This is because inflation is classically defined as too much money chasing too few goods. Once the money supply is tightened, the prices of commodities come down, thereby bringing down the inflation rate. The increase in interest rates means investors will now find debt instruments such as fixed deposits more attractive than shares. This prompts investors to stay away from the stock market. Export-oriented Companies The tight money supply affects different industries differently. For instance, a company that manufactures automobile parts for the foreign market will be adversely affected by the price hike due to inflation as it will not be able to increase its prices in line with the rise in its costs. This will affect its bottom line and in turn impact its share price negatively. FMCGs However, an FMCG (Fast Moving Consumer Goods) manufacturer will see an increase in revenue growth due to the inflationary prices and, hence, its EPS (earnings per share) and scrip price are likely to go up. However, it must be kept in mind that once prices fall, as they are bound to once inflation is contained, such companies will end up reporting a lower EPS. Luxury Goods Manufacturer A manufacturer of luxury goods for the domestic market (such as the makers of high-end cars) on the other hand might find its market size reduced as its products might find themselves priced out of the market. In this scenario as well the profits of the company and hence its share price is likely to be affected adversely.
An investor should, therefore, not be averse to allocate funds in his portfolio to shares, but instead pick the right company to avoid incurring losses during an inflationary period. Investors can also consider booking profits when the market goes up and wait for the correction to set in before buying shares once again. However, those who have invested for the long term should consider staying invested. Investing solely in debt funds will lead to net erosion in the value of the corpus as the interest rates do not keep pace with inflation in the long term.
VeryImportantquestion:IsInflationGoodorBad?
When the government is trying to decrease the inflation rate at its best means the answer is the inflation is bad. But we say Inflation is absolutely good, why? As we said inflation means excess of demand over supply, so if the demand is more and supply is low there will be a start of new player entry, again advantages of competitive rates, best quality, and latest methods technology comes in, most importantly the Foreign Direct Investment (FDI) goes up. The current economic recovery could suffer if extremely low levels of inflation become the norm. With deflation, consumers and businesses respond to falling prices by sitting on cash, because it will become more valuable in the future as its buying power increases. Hoarding, in turn, weakens the economy further, putting more downward pressure on prices. But that vicious cycle doesn't suddenly kick in only when inflation moves from slightly positive to slightly negative. For example, businesses that forecast a very low rate of inflation would be more inclined to hold onto cash than they would if inflation were higher. Yet without new investment, the jobless rate could remain high, keeping wages - and ultimately prices - from rising. Inflation during recession may not seem like such a good thing, because a recession means money is tight for many, while inflation means higher prices. The fact is though that inflation during recession periods may benefit the economy of the country in some ways. Inflation is better than stagflation, because inflation usually occurs when the economy increases, because there is more spending going on. Right now many parts of the world do not have this problem because consumers are not spending. Instead consumers and even lending institutions are keeping their cash close, and hoarding it instead of spending it. Inflation can
actually help the economy at times, as long as it is a steady rate of inflation. It increases consumer spending, and can stimulate the economy. Right now the economy is stagnant, with employment at an all time high and businesses closing frequently. Usually the gross domestic product and inflation go together, with an increased GDP meaning an increased rate of inflation. Increasing the gross domestic product and having inflation can mean an economy that is expanding, not retracting. Anyone who has stocks in their investment portfolio usually realizes that without an increase in the GDP, companies can not make bigger profits, which is detrimental to their stock performance. An inflation rate of two to three percent, and that is very stable, is critical for a healthy economy. One way that inflation benefits the economy during a recession is that it affects wages. Workers do not take wage cuts usually, but inflation can actually reduce wages once inflation is taken into consideration. Employers usually give raises, sometimes as a cost of living adjustment, or COLA, which takes inflation into consideration and adjusts the real wage to account for it. If a COLA or raise is two percent of a wage, but inflation is five percent, the worker is taking a three percent pay cut even though it appears they are making more money, because the value of a dollar is less. Because of the current lack of inflation, with an interest rate in America as close to zero as it has been in a long time, the stock market is extremely volatile, and many investors have lost most or all of their investment capital. The crisis has hit across almost all sectors of the economy, but it started with the housing and sub prime markets, and spread from there. The stagnant economy and lack of inflation has hurt investors and financial institutions, and a small steady rate of inflation could stimulate the economy so that it starts to grow again, instead of shrinking. This may be one of the few options that can help revive an economy that is falling lower and lower.
CONCLUSION
In reality, low inflation rate and an upward economic growth is never possible. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalates. High inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. It discourages investment and saving. And also increases hidden tax, as it pushes taxpayers into higher income tax rates. With high inflation, purchasing power is redistributed from those on fixed nominal incomes. This redistribution of purchasing power will also occur between international trading partners. It will become more expensive and affect the balance of trade. It also increases instability in prices. People will stores consumer goods and products with their wealth in the absence of resources and thus causing and creating shortages of the hoarded resources. With high inflation, firms must change their prices in order to keep up with economy-wide changes. But often changing prices itself a costly activity. For Example to print new menus, more money is required.
It is always seen that high unemployment occurs in the labor market. As, some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster. Debtors who have debts with a fixed rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. Economic Benefits of Inflation are: Controlled growth of Inflation can become part of business growth, simply because savings are often invested, because of the net loss if they are kept in a Bank. During times of controlled Inflation, people in the past tended to spend, as they feared prices could rise, saving on buying now, rather then paying more lately. Higher Inflation eats away at the real value of a currency. This could mean that the actual value of debts decrease, benefiting indebted businesses and private individuals. Stocks bought at an earlier value, could rise in price and sold off at a higher price bringing higher profitability. Values of fixed assets could rise, making some Companies more financially secure. Traditionally higher Inflation often leads to higher prices; therefore fixed assets in theory should rise in value. The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists. Ernest Hemingway
MicrofinanceasAPanaceaforDeveloping EconomiesMythorRealty
Dr.VeenaTewariNandi*,S.Das**andDr.V.V.R.Raman***
Feed a man fish and you feed him for a day, teach him to catch fish and you feed him for life Chinese Proverb
AbstractMicrofinance as we know it today was first started in 1976 in the Bangladeshi village of Jobra. The concept got shape in the form of Grameen Bank, the brainchild of a Professor of Economics in Chittagong, Dr. Mohammad Yunus. Today it has spawned thousands of other institutions doing similar things: World Bank statistics show that more than 7,000 microfinance institutions serve some 16 million people in developing countries with $7 billion in outstanding loans, 97 percent of which are repaid. Dr. Mohammad Yunus and the institution he founded, Grameen Bank was jointly awarded Nobel Prize in 2006 for the endeavor in this field. The most exciting promise of microfinance is that even without being a panacea it can reduce poverty with a self fulfilling mechanism, once adequately ignited, without requiring continuous donations that often spoil and humiliate the poor, empting the donors pockets. Unsubsidized sustainability and profitability combined with deep outreach to the underserved stands as the most ambitious and difficult goal. In this paper we have highlighted the problems, issues and opportunities of microfinance especially in the developing countries. Some small case studies have been incorporated in the paper from the developing countries. Keywords: Micro Credit, Group Lending, Entrepreneurs, Informals, MFI
INTRODUCTION
The term microfinance as used here refers to financial services for the poor and lower-income sectors of the population. Most microfinance loans range in size from a few dollars up to several thousand dollars, with a standard loan in the $300 to $1,000 range. Loans typically are used for working capital and have maturities of below one year, although longer-term products are also sometimes available. Borrowers vary in size from the self-employed to enterprises with up to five or even 10 employees. Microfinance sometimes generates confusion for non specialists because there are two microfinance models. The model that will be emphasized in this article is based on lending to single borrowers using principles familiar to most lenders. * CBE, Halhale **IPM, Ghaziabad ***College of Health Sciences
The other main microfinance model, and the one that has captured the public imagination, is the group-lending model originated by Grameen Bank of Bangladesh and its charismatic founder, Muhammad Yunus, on the basis of a $27 loan that he made to 42 basket weavers in 1976. The defining characteristic of group lending is that all group members are responsible for the timely repayment of any loan made to any single member of that group. This model therefore internalizes risk diversification and monitoring into the structure of the loan. It also mitigates the difficulties of securing adequate collateral, because the group lending structure provides the secondary source of repayment if collateral fails. One of the great legacies of this model is the fact that the poor can be very reliable borrowers. There is much debate within the microfinance field about the pros and cons of the individual-lending versus the group-lending model. In fact, the models are similar in every way except for the definition of the borrower-that is, a group or an individual.
credit programs were unsuccessful in that they induced local political elites to take advantage of below-market interest rates, leading to rent-seeking activities, insufficient outreach to the rural poor farmers, very low loan repayment rates, and inefficiency in financial markets with excess demand (Adams, Graham, and Von Pischke 1984; Robinson 2001; Zeller and Meyer 2002). As an alternative, microfinance has recently attracted growing attention as a means of overcoming such a situation (Morduch 1999). Most microfinance institutions (MFIs) provide collateral-free small loans to low-income households who have long been deemed to be unbankable. These loans are generally expected to be used for self-employment and incomegenerating activities. Even though many MFIs rely on financial support from the state and donors to expand their outreach, in response to the widespread failure of government programs in the past, financial self-sustainability has also been of major concern, and appropriate pricing of loans is viewed as crucial for sustainability (Zeller and Meyer 2002). Therefore, interest rates are generally set at the market level to cover operational costs, and most microfinance programs across the world have extremely high repayment rates at around 90% to 98%. Although the provision of credit is by far the most important product of financial services, much progress has also been made by many MFIs offering a range of savings and insurance products, which has great potential for alleviating poverty and reducing vulnerability (Nourse 2001; Robinson 2001; Churchill 2002; Zeller and Meyer 2002; Armendriz de Aghion and Morduch 2005).With enthusiasm for their ability to improve the welfare of the poor, the number of MFIs has rapidly grown, from 618 to 3,133 between 1997 and 2005, and, correspondingly, the number of clients who benefitted from microfinance increased from 13.5 million to 113.3 million over the same period (Daley-Harris 2006). Given this growth in the microfinance industry, the United Nations declared 2005 to be the International Year of Microcredit and attempted to link the microfinance movement with the achievement of the MDGs. Furthermore, a leading MFI, the Grameen Bank, and its founder, ProfessorYunus, received the Nobel Peace Prize in 2006 for their efforts to create economic and social development from below. In this way, microfinance is increasingly gaining popularity as an effective tool for poverty reduction, and its evolutionary process is often termed the microfinance revolution. Yet, microfinance is not without controversy. Many studies have examined whether microfinance is as effective as originally expected. For example, although most people have agreed that microfinance is good for the poor, it should be proved in a rigorous way. The recent development of impact evaluation techniques allows us to go in the direction of asking whether microfinance is actually good for the poor. Another strong belief bolstered by the success of the Grameen Bank has been that its lending scheme, characterized by noncollateralized, jointly liable, groupbased lending, is effective in maintaining the high repayment rate. However, recent theoretical as well as empirical studies have cast doubt on this and show there are other mechanisms underlying the high repayment rates. In addition, the belief that the increase in the number of MFIs relaxes credit constraints of the poor has come under challenge. There is also a growing concern that MFIs, often operated by
nongovernmental organizations, should put more effort into becoming regulated for-profit financial institutions that work to enhance financial sustainability instead of primarily pursuing services to the poor. However, there is concern that MFIs might shift away from serving poorer clients in pursuit of commercial viability. This is referred to as mission drift.
CompetitionamongMicrofinanceInstitutions
It is generally thought that an increase in MFIs will expand financial service opportunities for the poor, thereby contributing to the improvement of their welfare. Yet, if there are too many MFIs competing with each other in the same region, borrowers who did not complete repayments to a certain MFI might be able to obtain loans from other MFIs. It is also possible that borrowers of a certain MFI can borrow additional loans from other MFIs in order to repay the loans or to finance everyday needs. We have argued the role of frequent installment as a commitment device to solve saving constraints. If they can obtain loans whenever they want, those who face pressure from their spouse or relatives or face the problem of self-control might decide to repay their weekly installment by borrowing money. In this way, the existence of competing MFIs who generously offer loans will actually render the effectiveness of frequent installment as a commitment device ineffective. The final result will be that some borrow an unrepayable amount of money from multiple sources and enter the multiple debt trap. The rising competition among MFIs will also change their portfolios. Facing such competition (McIntosh and Wydick 2005), MFIs will find their profits reduced and will need to improve their portfolios. Note that clients who generate more profits are usually the non poor, because they are less likely to have repayment problems and they often apply for larger loans than the poor, which will decrease the transaction costs per dollar. Thus, the rising competition will shift the target of MFIs away from the poor and the poors access to financial services will end up declining. Bond and Rai (2009) argue the possibility of borrower runs. Because the effectiveness of dynamic incentives depends on the expectation of future loan availability, if the bank suffers severe losses due to the competition and borrowers expect that the bank may cease to lend, then they have less incentive to repay. If the repayment rate or the market condition for the bank worsens beyond a certain level, then borrower runs occur: borrowers choose not to repay because they expect other borrowers not to repay and the bank then withdraws. Therefore, any increase in default rates or worsening of the bank balance sheet caused by the competition might increase the likelihood of borrower runs.
Microinsurance
Microinsurance is insurance for the poor. It constrains its premium at low levels so that the poor can afford to pay it by limiting the coverage of the insurance. Along with savings and transfers, many large MFIs are considering offering microinsurance services to the poor.
Although poor people insure themselves from income risk to some extent through informal insurance among community members, their consumption is still significantly affected by fluctuations in income (Townsend 1994; Grimard 1997). In addition, this insurance strategy does not function against regional income shocks such as famine and flood, because all the community members suffer from the shocks. Credit can help people protect themselves from negative shocks, but some shocks such as serious disease or the death of cattle are persistent and can reduce income in subsequent years. Large medical expenses and the death of income earners followed by the selling off of productive assets are often the causes of falling into poverty. Given the importance of insuring the poor from negative shocks, some MFIs provide insurance for the poor at low costs. To date, however, microinsurance has suffered from low uptake rates and, in some cases, MFIs have ceased to provide microinsurance due to huge losses incurred by the schemes. The problem with microinsurance is the lack of well designed contract schemes. Although microcredit successfully tackles the problem of asymmetric information through group lending and dynamic incentives, most microinsurance schemes have no effective measures to solve the asymmetric information problems inherent in the insurance market; namely, adverse selection and moral hazard. Below we discuss these problems in health insurance as an example; most of the argument is applicable to life insurance, cattle insurance, and crop insurance. The successful expansion of small-scale financial services to the poor with high repayment records by many microfinance institutions in developing countries is often referred to as the microfinance revolution. A review of the literature demonstrated that, although there is much anecdotal evidence emphasizing the positive effect of microfinance, the empirical results from more rigorous impact evaluations are mixed. Some researchers argue that microfinance has a positive impact on clients (Pitt and Khandker 1998), some point out that when controlling for selection biases (which are caused by such factors as self-selection and program placement), the impacts of microcredit become weaker than nave estimates, which do not take into account selection, although positive and significant impacts still remain (Alexander-Tedeschi 2008). Others find little impact of microcredit when controlling for selection biases (Morduch 1998; Coleman 1999). Moreover, a strand of the published literature shows that near poor or non poor households tend to become the beneficiaries of microcredit. However, in contrast to the widespread failure of subsidized credit programs in the past, many MFIs achieve remarkably high repayment rates, which is a prerequisite for financial self-sustainability. We showed how group lending, which was adopted initially by the Grameen Bank and then by others, theoretically overcomes adverse selection, moral hazard, and strategic default caused by asymmetric information. We also discussed that group lending is not the panacea and showed how other innovative schemes, such as dynamic incentives and frequent installments, work well to increase repayment rates.
Although these new schemes have become emblematic of microcredit, most MFIs have not succeeded in creating any innovative and effective insurance schemes that solve the asymmetric information problems inherent in the insurance market. The emerging scheme of index insurance has the potential to mitigate these problems, but so far it has not significantly increased participation. All in all, the microfinance revolution may be revolutionary with its relatively high repayment rates, which could not be achieved by past subsidized credit programs. In addition, the introduction of insurance products can be labeled as innovative, because virtually no institutions have ever tried this in developing countries. However, judging from the empirical evidence, there is still room to improve the performance of microfinance, especially in terms of impact on and outreach to the poor. With this empirical evidence in mind, we conclude that microfinance is developing in a promising direction but has yet to reach its full potential.
AroundtheWorld
It is important to differentiate at the outset between the microfinance markets in developing countries and the U.S. It would not be an exaggeration to say that microfinance has revolutionized the field of poverty alleviation in developing countries, as demonstrated by the fact that today there are over 68 million microfinance borrowers worldwide--an almost fivefold increase over the past six years. Loans outstanding are estimated to be $16 billion with an average outstanding of $400. Approximately one-third of these loans are made by commercial banks, one-third by cooperative banks and credit unions, and one-third by specialized microfinance institutions. The enormous outreach indicated by this data is a clear testament to microfinance's two great advantages as a development tool: Its resources are reusable, since they are provided in the form of loans, and microfinance offers the poor an opportunity to help themselves. The U.S. microfinance market began its development later than the international market; one of the key dates is 1991. When the Small Business Administration (SBA) Microloan Demonstration project was legislated and the first association of American microfinance intermediaries was created. The potential market for microfinance is smaller in the U.S. and, because of the higher cost of operating a business in a mature economy, the size of microfinance loans tends to be higher--the average loan extended tinder the SBA Microloan Program is $11,670. Operating a micro business is also more complicated in the U.S.; in fact, one of the important lessons learned in microfinance domestically is that training is a significant factor in success. Microfinance in the U.S. has historically been largely the province of nonprofits; the involvement of banks is typically in the form of loans or grants to these nonprofits, often for CRA purposes. Essentially Grameen Bank lends to very poor self employed people a majority of them being women, through Self Help Groups(SHGs).To ensure timely recovery of the loan the amount is disbursed through a SHG. In case of any default the SHG to which the defaulter belongs is held accountable. The system has worked efficiently with almost 97% recovery rates. However the responses in trying to replicate the same model in other parts of the world have been mixed. A prominent reason for Microfinance being so successful in Bangladesh is
having a viable model for delivery and recovery of the loans. The core group of borrowers being women, the socio-cultural aspects became prominent in ensuring success of the model. From Micro Credit, Micro Finance has spawned into Micro Savings and Micro Insurance.
ISSUES
A key problem in developing countries is that there are many poor people who can provide only their work and since complementary assets require outside financing (being savings not existent or not properly stored), the lack of finance (together with lack of education, state aid, infrastructures ) is an obstacle to the birth of entrepreneurship, with negative side effects on employment. (Ashta 2007).Yunus (1999) shows that if the poor are provided access to finance, they might start up micro enterprises, building up a virtuous cycle and transforming underemployed laborers into small entrepreneurs. In the mind of many, microfinance and micro credit are synonymous; however, while micro credit simply deals with the provision of credit for small business development, microfinance - sometimes called banking for the poor - refers to a broader synergic set of financial products, including credit, savings, insurance and sometimes money transfer. MFIs can be classified according to their organizational structure (cooperatives, solidarity groups, rural or village banks, individual contracts and linkage models ) or to their legal status (NGOs, cooperatives, registered banking institutions, government organizations and projects ) or even according to their capital adequacy standards. Microfinance firms are different from traditional banks since they have to use innovative ways of reaching the underserved and poorest clients, not suitable to mainstream institutions, mixing unorthodox techniques such as group lending and monitoring, progressive lending (if repayment records are positive), short repayment installments, deposits or notional collateral, as it will be seen later. Group lending is the most celebrated microfinance innovation, making it different from conventional banking, even if microfinance goes beyond it. Frequent repayments (short term installments, starting immediately after disbursement) is another smart pragmatic device, avoiding balloon payments where the principal is all reimbursed at maturity: given the financial illiteracy of many poor (which find it hard to understand that time is money). The several features of Microfinance which are unique in themselves and need to be addressed separately include: Microfinances attempt to deepen financial markets to serve micro enterprises and poor households; High unit costs of lending; Physically taking banking services to clients who have few other options to receive financial services; Relatively undiversified and sometimes volatile nature of MFI credit portfolios; Cost MFIs began as unregulated credit NGOs, with a focus on social goals rather than financial accountability and sustainability;
Difference in institutional orientation, with some MFIs clearly profit-oriented while others are committed to providing services to the poorer segments of the population on a non-profit basis, creating very different cost structures and funds sources; The fact that MFIs deal in savings and credit transactions with relatively low value in relation to the system as a whole -- and as a result are unlikely to have problems that cause broad systemic instability (Jansson 1997); and The market risk posed within the microfinance sector itself when MFIs (especially large ones) are not properly managed and monitored.
MicrofinanceExperienceinDevelopingCountriesAFewCases
Ethiopia: MFIs Microfinance, as defined by the statute and National Bank of Ethiopia (NBE) directives, consists of extending small credits to rural small farmers or urban entrepreneurs. All MFIs must be 100% Ethiopian-owned, meet minimum capital of approximately $25,000,
Some 16 MFIs operate in Ethiopia, with a mixture of regional government, NGO, and individual ownership. These MFIs reach nearly half a million active clients at a given time with about $34 million in credit outstanding (cumulatively $66.8 million) and hold about $16 million in savings. Repayment rates for most MFIs are close to 100%. However, the prohibition of foreign n ownership and ministerial control on donor funding appear to have deterred involvement in the sector by foreign donors and international NGOs. (Shiferaw and Amha 2001)
Ghana: NBFIs Ghana has several types of organizations engaged in microlending, including informals, NGOs, credit unions, thrifts (savings and loans, and building societies), and rural banks. Informals, including susus (mobile deposit collectors) and moneylenders, as well as NGOs are not regulated by the Bank of Ghana. Incorporated non-bank MFIs (including thrifts) and cooperative credit unions fall under the Financial Institutions (Non-Banking) Law of 1993, while rural banks operate under the Banking Law of 1989, which brings both of these categories of institutions under the authority of the Bank of Ghana. Micro loans backed by group guarantees have a much higher ceiling than individual micro loans ($1,400 vs. $140), but group guarantees are not reflected in the risk-weighting criteria at all nor is moveable collateral for that matter. In each case, the loans are treated as unsecured and given a 100% risk-weighting for capital adequacy purposes. By recent estimates, all rural banks were covered by the supervisors, but only half of those institutions were in full compliance with Bank of Ghana standards, and 8 percent were in distress. Outstanding loans in mid-1999 were approximately $8.9 million. While informals are not included in the law or regulation, they are also not explicitly excluded. A microfinance network called GHAMFIN works with informals, NGOs, and Bank of Ghana on the development of performance standards and monitoring systems.
The first Credit Union in Africa was established in Northern Ghana in 1955 by Canadian Catholic Missionaries. Susu, which is one of the current microfinance methodologies, is thought to have originated in Nigeria and spread to Ghana in the early 1990s. Microfinance has gone through four distinct phases worldwide of which Ghana is no exception; Phase One: The provision of subsidized credit by Governments starting in the 1950s when it was assumed that the lack of money was the ultimate hindrance to the elimination of poverty. Phase Two: Involved the provision of micro credit mainly through NGOs to the poor in the 1960s and 1970s. During this period sustainability and financial self sufficiency were still not considered important. Phase Three: In the 1990s the formalization of Microfinance Institutions (MFIs) began. Phase Four: Since the mid 1990s the commercialization of MFIs has gained importance with the mainstreaming of microfinance and its institutions into the financial sector.
MicrofinanceinPeru
The microfinance sector in Peru represents about 5% of the total financial sector, but during the last ten years average annual rates of growth of the loan portfolios of MFIs has been 32.3% (SBS). While microfinance remains a small percentage of the total financial sector, the picture is altered if the focus on the number of clients rather than portfolio size, and it is estimated that MFIs have 30-40% of the borrowers in the financial system. The majority of the approximately 55 non-bank MFIs operating in Peru are regulated. In terms of portfolio size, the vast majority of the sector is regulated as the non-regulated MFIs tend to have relatively small portfolios. MFIs vary greatly in quality and size. As one commentator remarked, the sector has both ants and elephants. Most of credit provided by the MF sector is directed towards micro-enterprises as opposed to consumer credit. Mortgage lending is an increasing area of focus for many MFIs. By economic sector, most of the micro enterprises tend to operate in the retail sector in urban areas. Rural microfinance is considered both unprofitable and highly risky, as a result only 3.2% of formal MFI lending is for agricultural and livestock
MicrofinanceinthePhilippines
In September 2004 the amount of loans through all microfinance programs in the Philippines had reached 2.5 billion pesos (US$ 50 million). The President has called for an additional 4.5 billion pesos (US$ 90 million), of government money to be distributed over the next ten years, to develop a nationwide network of viable and sustainable microfinance institutions. The government is also working to ensure that the Small Business Guarantee and Finance Corporation (a government financial institution) triples its lending to small and medium enterprises from the present 3 billion pesos (US$ 60 million) to 9 billion pesos (US$ 180 million) in the next 6 years.
Microfinance can be thought of as either (a) a band-aid approach to development, or (b) as a bridge toward a sustainable solution (graduation).The band-aid approach is a way of temporarily stemming the misery that comes with extreme poverty by addressing malnutrition, and increasing caloric intake and financial security. Second approach (graduation) takes a much longer view. It sees microfinance as a stepping stone which leads to graduation. Graduation implies moving from a dependence on informal personal relations to the more impersonal formal dealings taken for granted in developed countries.
CONCLUSION
Microfinance is an enabling, empowering, and bottoms-up tool to poverty alleviation that has provided considerable economic and non-economic externalities to low-income households in developing countries. Microfinance is being hailed as a sustainable tool to combat poverty, combining a for-profit approach that is self-sustaining, and a poverty alleviation focus that empowers low-income households. Microfinance is increasingly becoming a tool to exercise developmental priorities for governments in developing countries. But there has been a gradual realization that microfinance alone is not enough. Microfinance is not a replacement for jobs that are not there, markets that are inaccessible, or education and skills that do not exist. Particularly, the main objective of microfinance institutions - poverty alleviation - requires a holistic and in depth understanding of the interplay between economic, social, cultural extracts of the developmental process. Microfinance has become a viable option only because of a poorly functioning institutional environment, i.e. if the institutional environment was properly functioning; the need for microfinance would be greatly reduced; Microfinance is working reasonably well as a band-aid solution to poverty, i.e. it puts food on the table; Microfinance is not providing a bridge to sustainable development, because it fails to address the root causes of poverty. As such, microfinance borrowers fall short of graduating.
A rich pattern of substitution among the credit alternatives is confirmed, depending on household characteristics. Generally households in self-employed business prefer formal credit for ensuring stable financing sources, but access was sometimes impeded when they were located in rural areas, probably because of high transaction costs. The poorest households have relatively lower probability of exploiting new credit opportunities than middle-income households, even if credit scale was very small. In future work, more detailed credit attributes should be incorporated so that a fuller understanding may be gained concerning the ways in which households choose credit, and how to expand credit outreach to nonparticipants in the market. This line of research will also be valuable for evaluating the effects of policies for encouraging commercial banks to extend credit to smaller business enterprises through the so-called linkage program in Indonesia (Hamada 2010).
Another concern of practical importance is whether or not small amounts of credit indeed help borrowers to improve their economic livelihood. Our companion paper focuses on this issue (Takahashi, Higashikata, and Tsukada 2010), and it reveals that the effect of microcredit is very small after the elimination of possible selection bias. This indicates a need for policy tools to enhance both the abilities and the economic opportunities of poor households, in addition to enhancing their credit access. As elaborated in the present paper, such enhancement will then increase credit demand per se. The future success of microfinance depends on deeper institutional reforms. The path to a modern economy requires secure property rights, trusted mechanisms of enforcement and an absence, or at least a massive reduction, in corruption and predation. Simply put the government and international aid agencies would do best to invest their efforts in the reforms in Financial Policies and goals with inclusive growth as a primary objective of reforms. The lives of millions of people are improved when the right mix of reforms are advocated and enacted. Working to enhance the economic environment in which exchange takes place might not produce the almost instantaneous results many wish to see. However, it will prepare the terrain to enable a greater degree of entrepreneurial activity among the poor.
REFERENCES
[1] Akoten, John E.; Yasuyuki Sawada; and Keijiro Otsuka. 2006. The Determinants of Credit Access and Its Impact on Micro and Small Enterprises: The Case of Garment Producers in Kenya. Economic Development and Cultural Change 54, no. 4: 92744. [2] Andersen, Thomas Barnebeck, and Nikolaj Malchow-Mller. 2006. Strategic Interaction in Undeveloped Credit Markets. Journal of Development Economics 80, no. 2: 27598. [3] Barslund, Mikkel, and Finn Tarp. 2008. Formal and Informal Rural Credit in FourProvinces of Vietnam. Journal of Development Studies 44, no. 4: 485503. [4] Bell, Clive, and T. N. Srinivasan; and Christpher Udry. 1997. Rationing, Spillover and Interlinking in Credit Markets: The Case of Rural Punjab. Oxford Economic Papers 49, no. 4: 55785. [5] Microfinance penetration and credit choice 123 2010 The Authors Journal compilation 2010 Institute of Developing Economies [6] Berry, Steven; James Levinsohn; and Ariel Pakes. 2004. Differentiated Products Demand Systems from a Combination of Micro and Macro Data: The New Car Market. [7] Journal of Political Economy 112, no. 1, part 1:68105. [8] Bose, Pinaki. 1998. Formal-Informal Sector Interaction in Rural Credit Markets. Journal of Development Economics 56, no. 2: 26580. [9] Boucher, Steve, and Catherine Guirkinger. 2007. Risk, Wealth, and Sectoral Choice in Rural Credit Markets. American Journal of Agricultural Economics 89, no. 4: 9911004. [10] BPS Gresik. 2006. Gresik in Figures 2005/2006. Gresik: BPS Gresik. [11] Cappellari, Lorenzo, and Stephen P. Jenkins. 2003. Multivariate Probit Regression Using Simulated Maximum Likelihood. Stata Journal 3, no. 3: 27894. [12] Coleman, Brett E. 1999. The Impact of Group Lending in Northeast Thailand. Journal of Development Economics 60, no. 1: 10541. [13] Conning, Jonathan. 2001. Mixing and Matching Loans: Complementarity and Competition amongst Lenders in a Rural Credit Market in Chile. [14] http://econ.hunter.cuny.edu/~conning/papers/Mixing_0801.pdf (accessed July 1, 2009). [15] Chowdhury, Prabal Roy. 2007. Group-Lending with Sequential Financing, Contingent Renewal and Social Capital. Journal of Development Economics 84, no. 1: 487506. [16] Churchill, Craig. 2002. Trying to Understand the Demand for Microinsurance. Journal of International Development 14, no. 3: 38187.
[17] Coleman, Brett E. 1999. The Impact of Group Lending in Northeast Thailand. Journal of Development Economics 60, no. 1: 10541. [18] Conning, Jonathan, and Christopher Udry. 2007. Rural Financial Markets in Developing Countries. In Handbook of Agricultural Economics Vol. 3, ed. Robert Evenson and Prabhu Pingali. Amsterdam: NorthHolland. [19] Copestake, James; Sonia Bhalotra; and Susan Johnson. 2001. Assessing the Impact of Microcredit: A Zambian Case Study. Journal of Development Studies 37, no. 4:81100. [20] Cull, Robert; Asli Demirguc-Kunt; and Jonathan Morduch. 2007. Financial Performance and Outreach: A Global Analysis of Leading Microbanks. Economic Journal 117, no.1: F107F133. [21] Daley-Harris, Sam. 2006. State of the Microcredit Summit Campaign Report, 2006. Microcredit Summit, Washington D.C.: Mimeo. [22] Drake, Deborah, and Elisabeth Rhyne, eds. 2002. The Commercialization of Microfinance:Balancing Business and Development. Bloomfield, Conn.: Kumarian Press.
LeveragingInnovationsforSuccessful Entrepreneurship
Prof.VivekanandPawar*
AbstractInvention is act of creating or developing a new product or process. Innovation is act of creating a commercial product or process from an invention. Entrepreneurship is any new business or new venture creation - the act of creating new goods or services or serving new markets. Innovation is much more common than invention. Innovations can be classified into two types: process innovation and product innovation. Innovation is investing resources to create wealth or investing wealth to create resources. Innovation is conscious search for opportunity. The innovation entrepreneurship link means either the entrepreneur creates new wealth producing resources or endows existing resources with enhanced potential for creating wealth. Innovations also have two effects on existing firms; they can be either competence enhancing or competence destroying. Competence enhancing innovations help firms further extend their resources and capabilities. Competence destroying innovations undermine existing firm resources and capabilities. More radical the innovation the more competence destroying it is. Most of the new innovations fail as 80% of new products fail and most new product ideas don't even make it to commercial introduction. Organizations today are talking about reaching the bottom of pyramid and setting the business connect between being socially responsible and business-wise innovative and meaningful. The Tata Nano is an ideal example of how empathy towards social needs and connect with the common man can change the rules of the game for a business and eventually make terrific business sense. Big organizations are much better at incremental innovation that they are at radical innovation. Taken together, innovative entrepreneurs rely on their courage to innovate an active bias against the status quo and an unflinching willingness to take risks to transform ideas into powerful impact. This paper attempts to highlight the role of innovation for successful entrepreneurship. It also discusses how any innovation- be it product, process or any ther type- can be converted into a sustainable competitive advantage to make a firm standing in the arena of business. Keywords: Innovation, Entrepreneurship, Sustainable competitive advantage
INTRODUCTION
The economic basis for innovation comes from Joseph Schumpeter and the metaphor of creative destruction. Schumpeter saw industries being reconfigured by the results of invention and innovation. He speculated that only large companies would be able to profitably innovate because only they would have the resources to capture the returns from innovation. However, *PIMSR, New Panvel
Schumpeter was wrong, most innovation comes from small companies or individual entrepreneurs as people, not firms are the ones who engage in creative activity that can lead to invention and innovation. Firms can only enable creative activity by providing incentives and resources. Firms generally require employees to sign intellectual property agreements that state that everything they think up belongs to the firm and non-competing agreements that they will not compete with the firm. Hence most innovation occurs from smaller firms, including groups of people leaving a large firm to start their own. The challenge for existing firms, especially those in a technologically driven industry, is how to encourage their employees to invent and innovate while meeting the challenges from new entrants with superior technology. Innovation is not a technical term. It is an economic and social term. Its criterion is not science or technology, but a change in the economic or social environment, a change in the behavior of people as consumers, producers or as citizens. Innovation is investing of resources to create new wealth or investing of wealth to create new resources. It is measured by assessing its impact on environment, and therefore innovation should always be market focused. Innovation is the responsibility of every executive, and it begins with a conscious search for opportunities. Finding those opportunities and exploiting them with focused, practical solutions requires disciplined work. Innovation is the specific function of entrepreneurship, whether in an existing business, a public service institution, or a new venture started by a lone individual in the family. It is the means by which the entrepreneur either creates new wealth-producing resources or endows existing resources with enhanced potential for creating wealth. There prevails a lot of confusion about the proper definition of Entrepreneurship. Some use the term to refer to all small businesses; others, to all new businesses. In practice, however, a great many well-established businesses engage in highly successful entrepreneurship. The term then refers not to an enterprises size or age but to a kind of activity. At the heart of that activity is Innovation: the effort to create purposeful focused change in an enterprises economic or social potential.
REVIEW OF LITERATURE
Innovations
Innovation has been traditionally defined as the successful implementation of creative ideas (Stein, 1974; Woodman, Sawyer & Griffith, 1993). Contemporary economic theorists have tried to address the concept and related issues with varying success. This is despite widespread recognition of the fact that innovation is crucial to the success of an economy at both the micro and macro levels (Leavy & Jacobson, 1997). Damanpour (1991) has viewed innovation as a continuous and cyclical process involving the stages of awareness, appraisal, adoption, diffusion and implementation. However, it is also possible to view innovation as an outcome, where an innovation is the tangible product.
For conceptual reasons, it is possible to divide this outcome view of innovation into radical and incremental innovations. Pavitt (1991) describes radical innovations as revolutionary or discontinuous changes. On the other hand, incremental innovations are conventional or simple extensions of a line of historical improvements. Moreover, Drucker (1986) has attempted to clarify such discussion by suggesting that innovation is not explicitly the improvement or technical modification of a product. Instead, innovation is the creation of new value and new satisfaction for the customer." Leavy and Jacobson (1997) note that theories of innovation (much like those concerning entrepreneurship) have tended to focus on a single level of analysis. They note the aforementioned work of Drucker (1986) as an example of this at the firm level. The three paradigms that were described above also compete against one other for prominence in research on innovation. Moreover, they even criticise themselves in this regard: Leavy (1997) has previously concerned himself with factors governing innovation at the firm level too, while Jacobson (1994) established an interest in innovation at the regional or national level. Innovation at the sectoral level (Nelson, 1992) and at the global level (Niosi & Bellon, 1996) has also been completed. It is worth considering some basic models of innovation and related innovation paradigms. In this context, the subject of analysis is to establish an understanding on how innovations occur in general. For this purpose, analysis can start with three competing basic explanations of the innovation phenomenon, which are (Sundbo, 1995): An Interface between Entrepreneurship & Innovation Pirich, Knuckey & Campbell DRUID Nelson & Winter Conference 2001 The entrepreneurship paradigm; The technology - economic paradigm; and The strategic innovation paradigm.
The entrepreneurship paradigm (Sundbo, 1995) is frequently used to describe innovation activities that occur at the level of individual firms that have gained favourable market position due to the development of a particular innovation. This happens without any systematic previous approach to the innovation process. Rather, there is a "market forced" effort to introduce a new product, process or service into various markets in order to retain, and possibly enlarge, the volume of activities, or to facilitate new business opportunities. The focal point of this paradigm is the entrepreneur - inventor whose individual and independent actions drive the innovation process. Here innovation per se is seen as a key to obtaining a better position in the market and generation of extra profits, and is often generated in a relatively unstructured manner. However, in recent years, quite a few innovators entrepreneurs have adopted a more formal and systematic view towards innovation activity and long-term business strategy. The technology - economic paradigm (Sundbo, 1995) is usually associated with innovation policies of large companies, which are users of so-called "mass-technologies".
The key feature of this paradigm is the significant involvement of engineers and technicians in the development of new technologies under a company umbrella. Engineers and technicians were not involved directly in defining the companys business development strategies, apart from technical input, but rather were given the task to solve particular technical issues. There are several ways these individuals approach a problem, e.g. in-house R&D, cooperation with other companies who are facing the same issue, buy-in of a solution from someone else, etc. It is important to note that these options require varying levels of internal R&D competencies for utilising, developing, exploring and absorbing new technologies. The strategic innovation paradigm (Sundbo, 1995) is relatively new. Its emphasis is on firm strategy, market conditions and broad firm competencies. An Interface between Entrepreneurship & Innovation Pirich, Knuckey & Campbell DRUID Nelson & Winter Conference 2001 as factors that impact on the innovation process and as such significantly determine the market performance of a firm. This approach to innovation is multifunctional and represents a combination of internal competencies, long term marketing strategies, market developments, the identification of new market opportunities or new market approaches, the creation of technological alliances and partnerships, and the fostering of networks, etc. Innovation is viewed as both technological and non-technological, i.e. it can be an entirely new artefact, process, production activity, or a marketing innovation. The key feature of this paradigm is a strategic manager or management team who are able to recognise new possibilities in the market and exploit them by using internal resources together with other available elements. In this context, the strategic behaviour of enterprises contributes to the economic growth of a country. In addition, innovation activity is often modelled in several different ways for either analysis or policy purposes, and for many years the so-called "linear model" of innovation was widely used to describe the innovation process. Because of the dynamics in the last few decades, the traditional linear model of innovation has become less relevant (Klein & Resenberg, 1986) and, increasingly, the chainlink model of innovation is becoming a more common tool of analysis. This chain-link model suggests that the national innovation system should be examined as an integrated whole and policy developed accordingly. These new insights have important implications for the firm. Innovation is not simply driven from formalised research and development but depends on access to information, to technologies and to the skills needed to implement them effectively. Increasing the capabilities of firms to learn and to be aware of superior technological opportunities is as important as making sure firms have the resources to innovate (Metcalfe, 1998). In this regard, a significant amount of innovation originates through design improvements, "learning by doing" and "learning by using". This process, along with R&D, results in the accumulation of knowledge and experience, i.e. the development of competencies and human capital.
ENTREPRENEURSHIP
The theories of entrepreneurship and knowledge generation have been consistently approached from either one or another perspective. Firstly, an economics perspective Cantillon (1755) described the entrepreneur as one who assumes the risk of buying goods, or parts of goods, at one price and attempts to sell them for profit, either in their original states or as new products. Say (1852) saw the entrepreneur as a person who judges, combines factors of production and survives crises. Knight (1921) views the entrepreneur as an economic pioneer who initiates change or innovation by managing uncertainty and risk. Hayek (1948) noted that the entrepreneur never has the benefit of perfect knowledge and therefore must have the ability to adapt quickly. This concept is elaborated upon later.
Schumpeter (1934) describes the leadership role of the entrepreneur in an economy in his belief that entrepreneurs are continually reorganizing the economic system via evelopment of new products, new processes and new markets etc. He is best known for describing entrepreneurship as a process of creative destruction. Liebenstein (1968) suggests that successful entrepreneurs are those that are able to overcome market inefficiencies. Cassons (1982) entrepreneur is one who can co-ordinate resources without perfect knowledge.
Bolton (1971) gives several economic functions of entrepreneurs in society including market innovation, product and service variety and providing seedbeds from which large companies will grow.
Kirzner (1973) believes that the relationship between entrepreneurship and economic growth is a function of alertness to identification and exploitation of market opportunities. Baumol (1993) concludes this body of work by arguing that entrepreneurship is a vital component of productivity and growth.
A review of the theories surrounding entrepreneurship and innovation reveals an immense amount of material. Researchers in economics, with varying success, have often addressed the issue of interface between entrepreneurship and innovation. Recently, there has been an increased interest in this field, due to the realisation that entrepreneurs and entrepreneurship can contribute to society in various ways, including for example, economic growth (Hayek, 1948), business creation (Gartner, 1985), national identity (Bolton, 1971), and the innovation process (Schumpeter,1934).
RESEARCH METHODOLOGY
The objective of the study was
To understand the strategic benefits of entrepreneurship and innovation. To study the sources of innovation. To highlight the role of innovation in successful entrepreneurship with respect to sustainable competitive advantage.
An in-depth desk research through secondary data was conducted to understand the various aspects that are involved in the success of entrepreneurship through innovation. The study used was mainly Exploratory in nature
ROLE OF AN INNOVATOR
Schumpeter assigns the role of an Innovator to the Entrepreneur. The Entrepreneur in not a man of ordinary managerial ability, but one who introduces something entirely new. The Entrepreneur is motivated by the desire to be the founder of a private commercial kingdom, the will to conquer and prove his superiority and the joy of creating, of netting things done or simply of exercising ones energy and ingenuity. To perform his economic function, the entrepreneur requires two things - the existence of technical knowledge to produce new products and the power of disposal over the factors of production in the form of finances.
ROLE OF PROFITS
An entrepreneur innovates to earn profits. Profits arise due to dynamic changes resulting from innovation. They continue to exist until the Innovation becomes general.
Big Ideas come from small teams: Big organizations command resources but small groups generate camaraderie. Innovative teams within large corporations are inspired to meet stretch goals where they learn to think and act like agile, high energy elites who come out with brilliant innovative ideas. Learning happens away from the desk: Employees with inquiring minds visit experts, see new technology in operation, observe fascinating products in use. Thats how managers find the knowledge needed for bigger ideas. In contrast, many hierarchical organizations assume their employees are only productive when theyre in office. Understand the Products user: Successful innovation depends on cultivating the ability to empathize with the customer. The human side of new product introductions cannot be ignored. Live in the future: Dont think of the past. Construct the future at the work-place, so that the employees and clients can experience what it will be like to live and work in the next century. It is a very effective technique. The secret is to physically mimic revolutionary conceptual break-through affecting the home and office environments. Failure sometimes produces innovation: The most valuable begins to occur when the most elegantly designed apparatus fails. The faster a project flops, the quicker it gets better. Dont just try to reproduce past successes. Real innovation isnt a rabbit you can pull out of the same hat over and over. Join Prototyping to Brainstorming for Fast-Track Innovation Results: Never be scared of trial and error. Dont be embarrassed to play with crude prototypes in round one. A multidisciplinary team will come out with new ideas when you brainstorm with the prototype.
Peter F. Drucker in his book Innovation and Entrepreneurship answers this key question. He says, Innovation can be systematically managed if one knows where and how to look. SOURCES OF INNOVATION DruckerMentionstheDifferentSourcesofInnovation
Innovations can spring from a flash of genius, however, most Innovations result from a conscious, purposeful search for Innovative opportunities, which are found only in a few situations. Within a company or Industry, areas of opportunity can exist in the form of the following: Unexpected occurrences Incongruities Process needs Industry and Market changes
Outside the Company in its Social and Intellectual environment, areas of opportunity can exist in the form of the following:
These sources are different in terms of the nature of risk, difficulty in implementation, complexity, and potential for innovation may lie in more than one area at a time. But together, they account for the great majority of all innovation opportunities. For the purpose of clear understanding, we shall look into these different Sources of innovation with opportunities explored by the entrepreneurs (authorized dealers) in the two wheeler industry.
UNEXPECTED OCCURRENCES
The easiest and simplest source of Innovation opportunitythe unexpected. Bajaj launched sunny for the rural and semi urban markets to up-grade over the mopeds using modern technology (no gears) which made riding more comfortable and hassle free. But the product did not appeal to them. Here market survey revealed that men found the vehicle less macho and hence rejected it, but the vehicle was well accepted by female riders who formed a sizeable portion of riders in these areas. Bajaj smartly started advertising the product targeting females as a vehicle being the new savvy thing in the market, a product that is smart, easy and comfortable especially for the girls. Bajaj accidentally found a new market, which was huge enough, and fill now they treated it as the spillover from the primary target male users.
TheUnexpectedFailureisalsoanImportantInnovationOpportunitySource
When Hero Hondas sales figures were reaching the sky with its 4-stroke economy bike CD100, Bajaj developed its own 4- stroke economy bike 4S, which gave more mileage than CD1 00. Bajaj was confident that its product will beat the competition, launched the bike with great hype with publicity and advertisements comparing the technical superiority against Hero Honda - but the public was not interested. They had already tried and tested the CD100 and were satisfied with its performance. They refused to acknowledge anyone who compared with it. As a result the marketing launch failed. But this was a lesson Bajaj learnt. When they came out with their new, model Caliber (in Jan99), they took utmost care not to repeat the same mistakes of comparing and positioned it in a very unconventional way. They carried out a soft launch. The result - Caliber grabbed 15% of share in sales within 4 months of launch. Unexpected successes and failures are such productive sources of innovation opportunities because most businesses dismiss, disregard, and even resent them. No manufacturer thought of launching a two-wheeler for females thinking that they are not the decision makers in buying, they do not constitute a big enough market, they can use mopeds if they have to, they can not have their separate vehicle etc.. With such ideas in mind no marketer was willing to leap in this market segment. The successes of Bajaj Sunny and TVS Scooty have proved otherwise.
AnIncongruitybetweenEconomicRealitiescanalsoLeadtoInnovations
In the late 80s newer vehicles with Japanese technology bombarded two-wheeler users in India. The problem was that those who already had old model vehicles would not buy a new vehicle until they found buyers for their old vehicles. Here Alibhai Premji (dealers since 1920) found a solution. They started Exchange Schemes where they would appoint an evaluator (Usually a second hand vehicle dealer) who would evaluate the old vehicle and buy it and that amount would be deducted from the price of the new vehicle. This scheme facilitated the old vehicle owners and also pushed the sales of the dealer. Many companies like Bajaj, LML, and also many dealers later adopted this scheme.
PROCESS NEEDS
We saw earlier how two-wheeler sales were promoted through exchange schemes and nhouse financing. Now came a new element - time. Time to wait for the exchange scheme, then finance for the balance amount and then waiting for the bike with the colour chosen. All this took time, which an urban buyer did not have. Auto-riders came in with a new concept: Instant Loan Me/as. They would put up a stall in a convenient location in the city and advertise it. Representatives of their vehicle exchange department, sales department, technicians to aid test rides and inquiries, finance company, insurance, RTO registration agent, stores/delivery all would be present at the same time. Customers are promised that the entire process would take them one hour after which they would be riding back home on a bike of their colour choice.
DEMOGRAPHIC CHANGES
Demographics are the most reliable sources of Innovation opportunity coming from outside the company. Those who watch them can reap great rewards from them. Managers have known for a long time that demographics matter, but they have always believed that population statistics change slowly. However, we have seen that in this century, it has changed very quickly. Innovation opportunities possible due to changes in the numbers of people, their age distribution, education, occupations and geographical location are one of the most rewarding and less risky of entrepreneurial pursuits. In the 80s, the primary target of a bike zi7 as a man, aged 25- 40 years, income Rs.5,000 p.m. and above. In the 90s, the shift was clearly seen. Though this segment was still catered by the economy bikes segment, a new audience was formed; boy, aged 17-21 years, pocket money Rs. 5,000 p.m. and above. The significant part of this change was that this young audience would be the decision-maker. Gemini Motors, Bandra, Mumbai caught on this segment. it launched the TVS Shogun by sponsoring college festivals like Mood Indigo I.I.T, Powai; Malhaar in St. Xaviers, etc. where this young audience was able to test ride the vehicle. So huge was the response and success, that Gemini Motors has since then sponsored many college festivals on a regular basis and launched two other models using this ready audience. All this was supported by TVS (45% financial support for expenses).
CHANGES IN PERCEPTION
The glass is half-empty and the glass is half-full are descriptions of the same phenomenon but have vastly different meanings. Changing a managers perception from half-full to halfempty opens big Innovation opportunities. A change in perception does not alter facts. it changes their meaning. What determines whether people see a glass as half- full or half-empty is the mood rather than fact, and a change in mood defies quantification. It has to be concrete, defined and could be tested. Then it can be exploited for innovation opportunity. We saw earlier how Bajaj Sunny was discounted as a rural small town Scooterette and as replacement for conventional Moped. The dealer in the bigger town however, saw sales picking up by women riders and this finding was passed to the company, which smoothly positioned the vehicle as an easy riding machine and strategically placed it as the right vehicle for female riders. This strategy was then supported by the dealers who provided test rides to these users who were able to get a feel of the vehicle, its driving ease and comfort. The result -Sunnys sales increased 300% within 3 months of the new campaign.
NEW KNOWLEDGE
These are the superstars of entrepreneurship. They earn the publicity and the money. They can be scientific, technical or social. They are what people usually mean when they talk of innovation. Knowledge-based innovations differ from all others in many ways. Like the time they take, their predictability the challenge they pose to entrepreneurs etc. They have the longest lead time of all Innovations, long time span between the emergence of new knowledge and its convergence to usable technology.
Kinetic Honda launched the first gear-less scooter in India. Indians saw this as a technological innovation. To supplement it and to support it Autoriders developed a test track at its workshop. The customers could actually experience the vehicle and also have their queries answered by the engineers at the workshop. No other automobile dealer has yet been able to copy this as they do not have the infrastructural support. Also Kinetic Honda has protected this commitment by huge territory rights to Autorider.
The Role of Innovation in Successful Entrepreneurship With Respect To Sustainable CompetitiveAdvantageinAutomobileIndustry VIP MOTORS
Any inquiry which is made by a prospective customer is recorded in the computer. All details regarding the model preferred, mode of payment, approximate date/ occasion when purchase is intended, the users name, address, profession and even some points the conversation are recorded. The salesman also puts in the date when he should make a follow-up call (usually 810 days later). The computer system is so built that on that particular date the salesman gets a print out on his table reminding him to contact that person. It also gives all details of the last conversation. In addition, in his absence, another salesperson can continue the sale.
ALIBHAI PREMJI
The oldest player in this market (since 1920) and going strong. They have a supermarket for two-wheelers where they offer all brands and surprisingly at a cheaper price than the authorized dealer of the company himself. All through these years have continuously innovated to survive the competition. Presently run high in their exchange scheme, keep in touch with the prospective customers by keeping records of their responses to test rides, etc.
SERVICE MOTORS
They have realized the importance of giving servicing and after sales service. At their showroom at Andheri, they kept their workshop walls of glass so that everyone who visits showroom can see the quality of technical service they offer.
GEMINI MOTORS
They have bought a Delivery cum Breakdown Van. The van is used to deliver bikes, which could be surprise gifts and to help distressed customers who need help at times of breakdown, A unique service offered only by them. The showroom also boasts of a guest lounge for waiting customers whose vehicles are being serviced. It has a carrom board, television etc. The proprietor promises one such Innovation every year.
corporate sales department, which puts stalls at big companies, and offer vehicles to the employees at special price and under a loan scheme.
CONCLUSION
Purposeful, systematic Innovation begins with the analysis of the sources of new opportunities. Depending on the context, sources will have different importance at different times. However, whatever the situation, innovators must analyze all sources of opportunity. Because innovation is both, conceptual and perceptual, would-be innovators must go out and look, ask and listen. They should use both the right and the left side of their brains. They look at figures. They look at people. They work out analytically what the innovation has to be to satisfy an opportunity. Then they go out and look at potential entrepreneuirs to study their expectations, their values, and their needs. Effective innovations start small. They try to do one specific thing. Even innovations that create new entrepreneiurs and new markets should be directed towards a clear, specific and carefully designed application.
REFERENCES
[1] Dr. Amir Pirich et al.An Interface between entrepreneurship and innovation,New Zealand SMEs Perspective Prepared for DRUID Nelson & Winter Conference 2001 ,Aalborg University, Denmark ,12 - 15 June 2001. [2] Brockhaus, R., (1982), The Psychology of the Entrepreneurs, in Kent et al, Encyclopaedia of Entrepreneurship, Englewood, Cliffs: Prentice Hall. [3] Damanpour, F., (1991), Organizational innovation: A meta-analysis of effects of determinants and moderators, Academy of Management Journal, 34: 555-590. [4] Dess, G., Lumpkin, G., McGee, J., (1999), Linking corporate entrepreneurship to strategy, structure, and process: Suggested research directions, [5] Entrepreneurship theory & Practice. 23(3): 85-1-2. [6] Drucker, P.F., (1986), Innovation and Entrepreneurship: Practices and Principles. New York: Harper & Row. Economist, (February 20th 1999), Special Report on Innovation in Industry
SocialEntrepreneurship: ChangingFaceofIndia
Dr.GulnarSharma*andMithishaAmin*
AbstractSocial entrepreneurship in India has successfully grown over the last decade. Every year, more and more people utilize their entrepreneurial skills in building sustainable enterprises for profit and non-profit to effect change in India. Although social entrepreneurship has been practised in India for some time now, social business is a comparatively new phenomenon in the country. Social entrepreneurship, as a practice and a field for scholarly investigation, provides a unique opportunity to challenge, question, and rethink concepts and assumptions from different fields of management and business research. Social entrepreneurship is seen as differing from other forms of entrepreneurship in the relatively higher priority given to promoting social value and development versus capturing economic value. India still has a long way to go compared to the West where governments are funding non-profit organizations by outsourcing social sector services. Though social enterprises are definitely making an impact on Indian society with a population of 1.1 billion, it is very difficult to see that impact on a macro level. This paper titled Social Entrepreneurship: Changing Face Of India tries to understand a view of social entrepreneurship as a process that catalyzes social change and addresses important social needs in India.
INTRODUCTION
Though many may consider Social Entrepreneurship as the buzz word today, the truth of the matter is that it has existed since the 1960s. Whilst it may represent a newly coined term, it is hardly a novel concept. Innovative individuals and enterprising groups have been addressing social issues for centuries But nonetheless, Social Entrepreneurship has become a global phenomenon since and has achieved tremendous success, especially in India. The popularity of Social Entrepreneurship is growing at a very high pace in India over the past few years. With the media having increasingly raised attention to outstanding people who received awards for their social enterprises from a growing range of recognised organisations, like the Schwab Foundation for Social entrepreneurship or Ashoka. The attention to the topic spread to a broader audience when Muhammed Yunus, founded the Grameen Bank to eradicate poverty and empower women in Bangladesh, was awarded the Nobel Peace Prize in 2006. This shed light on the growing number of successful social entrepreneurial initiatives that contribute to solving the worlds most pressing problems. Earlier, the individuals or groups acted as catalysts challenging the status quo by identifying an apparently insoluble social problem and tackling it with tenacity and vision. Their outstanding leadership towards a social end and their ability to see opportunities where *Janaki Devi Bajaj Institute of Management Studies, SNDT University, Mumbai
others only saw hurdles further single out these charismatic figures. Today, the same distinguishing features are also present in a new breed of social entrepreneurs and, therefore, a direct line of descent can be discerned between these extraordinary public change-agents of the past and such modern-day social pioneers as Muhammad Yunus (Grameen Bank, Bangladesh), Fazle Abed (Bangladesh Rural Advancement Committee or BRAC), Chief Fidela Ebuk (Women's Health and Economic Development Association, Nigeria), David Green (Project Impact, USA), Liam Black (Furniture Resource Centre, UK), and Jeroo Billimoria (Childline, India). Social entrepreneurs recognises the parts of society having difficulties, solves the problem by changing the system, spreading the solution, and persuading societies. Social entrepreneurs drive to produce measurable impact to address social and environmental problems that are often deep-seated. However, in comparison with the past, what is notable now is that the number and range of social actors behaving entrepreneurially is far larger than at any previous point in history (Bornstein, 2004, pp.3-6). For example, a recent survey of socially entrepreneurial activity in the UK suggested that new social start-ups are emerging at a faster rate than more conventional, commercial ventures. Social entrepreneurship concept gained importance in today's world where innovativeoriented entrepreneurs are welcomed not only in business world but also within the scope of social world. Thus, companies also try to solve social problems by realizing social entrepreneurship activities and have demonstrated remarkable examples. Social entrepreneurship as an important tool for social transformation have turned NGOs into vital units besides state and private sector in struggling societal matters.
donations to the less fortunate, social entrepreneurship reflects more than the good intentions of its practitioners, who are not merely driven by compassion, but are also compelled by a desire for social change. Oftentimes, charitable organizations survive at the mercy of their donors whose contributions vary with the economic climate. A nonprofit that practices social entrepreneurship, on the other hand, relies less heavily on donor funds because it creates social programs that are meant to be self-sustaining. Social entrepreneurs manage donor contributions in an effective manner, investing in social ventures which can then generate their own revenues to sustain themselves. In other words, while charity uses donor funds to buy food to ease the poors hunger, albeit only temporarily, social entrepreneurship uses its funds to make a lasting social impact, creating instructional programs that teach the poor how to grow their own food so that they can take care of themselves in the long run. In a world of scarce resources, it is no longer enough to simply donate out of good intentions. Rather, Greg Dees emphasizes the need for people to value the social impact that their donations are actually having:
the social safety net. In developing and emerging economies it developed because of a distrust of the NGO community, apathy within the private sector and the impotence of governments to provide services to people. The particular aspects of social entrepreneurship usually follow certain patterns. It begins with the identification of a specific social problem and an attractive opportunity to provide a solution with a promising social impact. Hence, the core process of social entrepreneurship is according to Drayton and the Schwab Foundation the systematic spotting of ideas to solve the worlds most urgent problems and to change their underlying patterns by turning these ideas into transformational solutions. Once a concept for an initiative has been found, to establish and sustain it, frequently resources generated from successful activities are used. This can involve the offering of products and services or the creation of new organisations. Sometimes, part of the income of a social enterprise comes from the beneficiaries when they have to contribute to the specific programme. The creation of economic value is a means to the objective, the condition to ensure financial viability and to achieve sustainability and self-sufficiency. The later is usually more difficult to achieve because the customers that social entrepreneurs are serving often can not afford to pay for the services or products. Social entrepreneurship therefore relies on individuals who are exceptionally skilled at collecting and mobilising human, financial and political resources. The effect of social entrepreneurship as a catalyst for social transformation goes beyond the mere solution of the initially identified problem. The original idea usually grows into a major initiative and spreads in regional and functional scope. The focus of social entrepreneurship, whether for-profit or not, is social change. Hence, the evaluation process should assess the progress made in achieving specific environmental or societal improvements. Clear and well-defined goals greatly simplify measuring the impact of a program on its intended eco-system or recipients. In addition, it seems appropriate to evaluate the leadership performance of the social entrepreneur. After all, that individual is at the heart of social entrepreneurship, acting as the proponent, champion, and steward of a driving vision to improve the environment or society. Thus, assessing the social entrepreneurs leadership, management, and spokesperson capabilities is essential to ensure the sustainability and ultimate success of the enterprise. Finally, as with any startup, the economic performance of the organization should be analyzed using the same methodologies applied to traditional for-profit businesses. Although profit can be a secondary or even nonexistent consideration for some social entrepreneurs, every enterprise must receive or generate sufficient funds to survive, if not thrive.
TypeofOrganization:Society
Website: www.lijjat.com Shri Mahila Griha Udyog Lijjat Papad is a Womens organisation manufacturing various products from Papad, Khakhra, Appalam, Masala, Vadi, Gehu Atta, Bakery Products, Chapati, SASA Detergent Powder, SASA Detergent Cake (Tikia), SASA Nilam Detergent Powder, SASA Liquid Detergent. The organisation is wide-spread, with its Central Office at Mumbai and its 67 Branches and 35 Divisions in different states all over India. The organization started of with a paltry sum of Rs.80 and has achieved sales of over Rs.300 crores with exports itself exceeding Rs. 12 crores. Membership has also expanded from an initial number of 7 sisters from one building to over 40,000 sisters throughout India. The success of the organization stems from the efforts of its member sisters who have withstood several hardships with unshakable belief in the strength of a woman Grameen Bank
are appropriate and reasonable, these millions of small people with their millions of small pursuits can add up to create the biggest development wonder. As of May, 2009, it has 7.86 million borrowers, 97 percent of whom are women. With 2,556 branches, GB provides services in 84,388 villages, covering more than 100 percent of the total villages in Bangladesh. Aravind Eye Hospital & Aurolab
grossly urban and portrayed in the media, the fact remains that Indias urban lifestyle has remained mostly static. Its the rural and semi-urban classes who are spending and spending like never before. Indias meteoric rise as a telecom market is one of innumerable examples. Social Enterprises that are vying to cater to take to the semi-urban consumer have massive scopes for scalability. A major chunk of these will be social enterprises as the India demography is plagued with problems that demand a socio-entrepreneurial approach. Social entrepreneurs and social enterprises share a commitment to furthering a social mission and improving society. Some of the basic definitional issues that remain include the choice of for-profit /non-profit structure, the necessity of earned-income strategies among nonprofits, and the degree to which social entrepreneurs/enterprises can manage the toughest social and environmental issues. A social entrepreneur is someone who identifies a social problem and uses entrepreneurial principles to create, organise, and manage a venture to make social change. A social entrepreneur measures success based on the impact on the society. While social entrepreneurs are often non-profit groups, the aim is to advance the social and environmental goals. Often social entrepreneurs present new ideas that are user friendly and ethical, social and environmental problems. They typically get people support to implement and make a positive impact on the society.
Social entrepreneurs are similar to business entrepreneur in the society with a purpose for a social cause. Often, social entrepreneur need profit but emphasis is on the development of the society and in solving the problems in it. Finding the effects of social or environmental problem, finding root cause, and solving them becomes obvious to social entrepreneur. With focus on positive change:
Social entrepreneur focus on daunting social problems to make a positive change, further motivating common people to persuade the same. Corporate social entrepreneur can reap strategic benefits with a combination of commercial aims and social objectives. Rev up the social team
While social entrepreneurs often work through nonprofits and citizen groups, many work in the private and governmental sectors. Social entrepreneurs work with local groups motivate them to pursue, and develop good solutions for their local communities as well as globally. In innovative and effective community building:
Distinct from business entrepreneurs who seek value in the creation of new markets, social entrepreneurs aim for value in the form of transformational change that will benefit underprivileged group of people and eventually society at large. Social entrepreneur identifies fundamental social and environmental problems in the everchanging society. They guide society through these turbulent times, to help the society. Like any other business venture, social entrepreneurship programmes cannot be isolated exercises. Most entrepreneurs, for instance, promote a non-profit organisation in the hope that other individuals and agencies will move in to support the cause and help multiply its benefits across larger sections of society. The extent of success of such endeavours is often based on the amount of collaboration and grassroots involvement they are able to generate. Furthermore, and just like business ventures, social entrepreneurship projects depend on some degree of risk-taking. Only, in this case, the risk is not limited to financial security but involves social activism and passion. In this context, social entrepreneurship activities may appear to be incredibly perilous, but the risks pay off many times more in terms of their benefits to society. Social entrepreneurship is as important for a growing society as business entrepreneurship is for a developing economy. They are both critical for sustainable development and accelerated inclusive growth. The significance of their impact on societies can be gauged from the contributions of some eminent social entrepreneurs who are feted for positively and permanently impacting our world. In 19th Century United States, Susan B Anthony led the fight for women's suffrage and helped establish equal rights for them. In 20th Century India, Vinoba Bhave founded the Land Gift Movement that caused the redistribution of more than 700,000 acres of land to the country's poorest. Italian physician Maria Montessori (1870 - 1952) determined deficiencies in the early educational system and developed a new approach that continues to be relevant across the world today. Before her, compatriot Florence Nightingale helped establish the first school for nurses and fought to improve hospital conditions. Birth control activist Margaret Sanger encouraged family planning around the world with her Planned Parenthood Federation of America. These and other social entrepreneurs have made extraordinary contributions in shaping the modern world.
In India alone social entrepreneurship space has a countless mixture of models with a one billion thinking structure. One billion thinking requires cost-effective models involving the bottom of the pyramid. The majority of these models are scalable and replicable.
Table1:ProfitabilitybySector
TheProfitableSectorsofSocialEntrepreneurshipinIndia
Education: Sector with a track record of profit: The Education sector has shown a marked degree of financial stability and growth potential. There are two key elements. First, the sector represents the highest number of profit-making enterprises (38%) among others, and also has one of the lowest numbers of loss-making entities (24%). Second, the observation says that there is a good growth potential; 38% of education enterprises are breaking even which means the number of profit-making enterprises in this sector could increase in the coming years. Health: Sector with large growth potential: Although the sector currently produces a very small number of profit-making entities, it has the lowest percentage (13%) of loss-making enterprises. Most importantly, at 73%, the Health sector has the largest segment of break-even businesses. If/when these enterprises begin to turn a profit, the Health sector could sustain a multitude of successful, profit-making enterprises. Rural Development: Sector to watch out for future growth: Despite the fact that the largest number of social enterprises are in this field, it is the biggest loss-making sector at the moment. However, Rural Development demonstrated the largest revenue increases last year, so there could be more surprises in store.
There are more enterprises that are loss-making (34%) than those earning a profit (25%). And 41% percent of enterprises are currently breaking even. If you look at the profitability by
measure of years in operation, you can clearly see that making profit through social enterprise is no easy task. There are more enterprises that are loss-making (34%) than those earning a profit (25%). And 41% percent of enterprises are currently breaking even. If you look at the profitability by measure of years in operation, you can clearly see that making profit through social enterprise is no easy task.
It is true that the percentage of loss-making enterprises steadily goes down as the companies get older. But there is virtually no disparity in the number of profit-making entities across age categories. Many enterprises stop making losses as they grow older but do not begin to turn a profit; they merely start breaking even. Surprisingly, even after 11 years or more of operations, the percentage of profit-making enterprises is only 27%. Social entrepreneurship in India is emerging primarily because of what the government has not been able to do. The government is very keen on promoting social entrepreneurship not necessarily by funding it or by advising on it or enabling it. What they do, is not disable it. For example, in Mumbai alone, non-profit organizations educate more than 250,000 children on a daily basis. The government has not told these organizations not to do it. Whereas in some countries, when someone takes it into their own hands to start a facility for education or healthcare or empowerment, the government often puts in place barriers to prevent this from happening. Our country does not have a homogenous people or geography, so the impact largely remains regional. With the current economic climate, it is very likely that social needs will increase and, consequently, the number of people committed to addressing them will increase. Definition of social entrepreneurship has changed over time. From corporate philanthropy to non-profit and now to self-sustainability, Social Entrepreneurship has evolved and will keep evolving with time and needs of the world.
As per Beyond Profit survey, Forty-five percent of respondents obtained funds from commercial sources whereas 21% of respondents source their funds from personal connections such as family members and friends; another 21% rely on grants and donations from charitable organizations. Arranging finances for a social enterprise in India is still very difficult. And knowing in which sector to finance is even more difficult. In bar diagram mentioned below is a mention of profitable sectors and a trend which clearly states areas to divert funds.
The survey results revealed that there is a clear divide between those that have access to mainstream and/or commercial funds and those that rely on personal connections and grants/donations to raise money. The ratio is about 50/50. Forty-five percent of respondents obtained funds from commercial sources whereas 21% of respondents source their funds from personal connections such as family members and friends; another 21% rely on grants and donations from charitable organizations.
The challenges faced in financing terms included factors like lack of like-minded investors, inappropriate business models, complex fund-raising processes, lack od fundraising investors and so on.
REFERENCES
[1] www.wikipedia /social entrepreneurship/background.org [2] Jean-Baptiste Say, quoted in J. Gregory Dees, The Meaning of Social Entrepreneurship, reformatted and revised, May 30, 2001 [3] http://www.fuqua.duke.edu/centers/case/documents/Dees_SEdef.pdf [4] Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper,1975) [5] Peter F. Drucker, Innovation & Entrepreneurship (New York: Harper Business, 1995) [6] Israel Kirzner, quoted in William J. Baumol, Return of the Invisible Men: The Microeconomic Value Theory of Inventors and Entrepreneurs. [7] http://www.aeaweb.org/annual_mtg_papers/2006/0107_1015_0301.pdf [8] Carl J. Schramm, Entrepreneurial Capitalism and the End of Bureaucracy [9] http://www.aeaweb.org/annual_mtg_papers/2006/0107_1015_0304.pdf
Track5
FinancialCrisis
FinancialCrisisanditsImpactonIndia
RashmiGairola*
AbstractThe Global Financial Crisis which had been brewing for some time really started to show its effects in the middle of 2007 and it is still not over. Triggered by a liquidity shortfall in the United States banking system, it has resulted in the collapse of large financial institutions, bailout of banks by national governments and downturns in stock market around the world. It is often said that when the US sneezes the rest of the world catches a cold. On the contrary, India, unlike most other emerging market economies has not been seriously affected by the recent financial turmoil in developed economies. By and large, India has been spared the panic that followed the collapse of banking institutions such as Lehman Brothers and Merrill Lynch. The relative freedom from the contagion spreading from the global tsunami on the Indian financial system owes much to the wise and judicious policies of the central bank and Government of India. However, the impact of the global crisis has been transmitted to Indian economy through three distinct channels, viz., the financial sector, exports and exchange rates. This can be contrasted against other countries, like Iceland that were hit very severely by the global crisis.
INTRODUCTION
A financial crisis refers to a situation in which the supply of money is outpaced by the demand for money. This mean that liquidity is quickly evaporated because available money is withdrawn from banks, forcing banks to either sell other investments to make for the shortfall or to collapse. It can be also defined as a loss of confidence in a countrys currency or other financial assets causing international investors to withdraw their funds from the country. The term financial crisis is applied broadly to variety of situations in which some financial institution or assets suddenly lose a large part of their value. The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. It contributed to the failure of key business, declines in consumer wealth estimated in the hundreds of trillions of US dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. The Global Financial Crisis which had been brewing for some time really started to show its effects in the middle of 2007 and it is still not over. Triggered by a liquidity shortfall in the United States banking system, it has resulted in the collapse of large financial institutions, bailout of banks by national governments and downturns in stock market around the world. India is not exposed to the new and innovative financial instruments that triggered the meltdown. This is one of the main reasons as to why India has not been severely hit by the crisis, as can be seen from the following discussion. *Pune Institute of Business Management, Pune
Compare with impact on Iceland. What does Indian economy needs to do different financial innovations? Scope of the study: o o o Macro economic indicators used in the study are GDP, Stock Exchange, Export, Import and Foreign Exchange. To study the impact on common man, various parameters are used such as, Unemployment rate, Inflation rate (consumer price), Labour force and Population below poverty line. To study the impact on the Indian corporate sector, a random sample of 1 company, each from the following industries, viz., Banking, Aviation, FMCG; and 2 companies from IT & Outsourcing, will be selected. Secondary data will be used. Websites and other published data.
RESEARCH METHODOLOGY
FINDINGS MacroEconomicImpact
To study the effect of crisis on India, lets take into consideration few important macroeconomic indicators. (Refer to Appendix I) Gross Domestic Product (GDP)
Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 GDP real growth rate (%) 4.3 4.3 8.3 6.2 8.4 9.2 9.0 7.4 *6.5
10.00 9.00 GDP real growth rate(% ) 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 2001 2002 2003 2004 2005 2006 Year 2007 2008 2009 2010 2011
GDP is one of the primary indicators to gauge the health of a countrys economy. It basically indicates a countrys health. As we can see above the GDP of India over a period of time is given. In the year when financial crisis started, it increased to 9.2%. It marginally decreased in 2008 and then further in 2009. Industrial Production Growth Rate
Year Industrial production growth rate (%) 6.0 6.5 7.4 7.9 7.5 8.5 4.8 *7.6
Industrial production growth rate (%) 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 2002 In d u strial p ro d u ctio n g ro w th ra te(% )
2003
2004
2005
2006
2007
2008
2009
2010
2011
Year
As can be seen from the table, the year 2007 and 2009, both showed a negative growth and it was extremely low in 2009. This can be directly related to the decline in the GDP that we described earlier. This could be considered the main indicator showing any traces of financial crisis in India. Exports
Year 2003 2004 2005 2006 2007 2008 2009 2010 Exports ($) 44,500,000,000 57,240,000,000 69,189,000,000 76,230,000,000 112,000,000,000 151,300,000,000 176,400,000,000 *165,000,000,000
200,000,000,000 180,000,000,000 160,000,000,000 140,000,000,000 120,000,000,000 100,000,000,000 80,000,000,000 60,000,000,000 40,000,000,000 20,000,000,000 0 2002 2003 2004 2005 2006 Year 2007 2008 2009 2010 2011
E x po r ts ($ )
Imports
Year 2003 2004 2005 2006 2007 2008 2009 2010 Imports ($) 53,800,000,000 74,150,000,000 89,330,000,000 113,100,000,000 187,900,000,000 230,500,000,000 305,500,000,000 *253,900,000,000
350,000,000,000 300,000,000,000 250,000,000,000 Imports($) 200,000,000,000 150,000,000,000 100,000,000,000 50,000,000,000 0 2002 2003 2004 2005 2006 Year 2007 2008 2009 2010 2011
Imports are also showing an increasing trend for the period taken into consideration except for the year 2010 Stock Exchange (BSE)
Year 11th Feb 2000 9th Dec 2005 5th Dec 2006 29th Oct 2007 17th Oct 2008 18th May 2009 12th Oct 2010 BSE Sensex 6000 9000 14000 20000 9000 12000 20000
25000 20000 B S E S e ns e x 15000 10000 5000 0 0 1 2 3 4 Year 5 6 7 8
The stock market has been quite volatile. But the point to be noted here is that in the year 2007, it reached as high as 20000. Exchange Rate (Indian Rupee to USD)
Year 2000 2004 2007 2008 2009 2010 Indian Rupees to 1 USD 44.952 45.340 41.197 43.814 48.849 *45.857
50.00 49.00 48.00 47.00 46.00 45.00 44.00 43.00 42.00 41.00 40.00 1998 Indian Rupees to 1USD
2000
2002
2004 Year
2006
2008
2010
2012
The above data is quite interesting. In the year 2007, the rupee appreciated with respect to dollar. This was the time when many big companies in the US were going bankrupt.
ImpactontheCommonManinIndia
Let us consider few parameters to study the impact of the crisis on the common man in India. Unemployment Rate
Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 Unemployment rate (%) 8.8 8.8 9.5 9.2 8.9 7.8 7.2 6.8 *10.7
12.00 U n em p lo y m en t rate (% ) 10.00 8.00 6.00 4.00 2.00 2001 2002 2003 2004 2005 2006 Year 2007 2008 2009 2010 2011
It is expressed as the percentage of labour force which is without jobs. Although the rate of unemployment has been increasing leading to substantial unemployment, but in the year 2007 when the crisis started, the rate dropped and it further dropped in the year 2008 and 2009. It should be noted that, this was the period of innumerable lay offs by several big companies in the US. There were lay offs in India also but in comparison it was less which can be confirmed by the data above.
*July 2010.
It shows the annual percentage change in consumer prices compared with the previous years consumer prices As can be seen from the table above, the rate of inflation has been rising. The rate increased by 26.19% in 2007 from 2006. But in the year 2008, it only increased by 20.75% which shows that the government of India was making all the efforts to control the prices. Labour Force
Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 Labour Force 406,000,000 406,000,000 472,000,000 482,200,000 496,400,000 509,300,000 516,400,000 523,500,000 *467,000,000
600,000,000 500,000,000 Labour Force 400,000,000 300,000,000 200,000,000 100,000,000 0 2001
2002
2003
2004
2005
2006 Year
2007
2008
2009
2010
2011
It gives the amount of total labour force. India is number 2 in the world for its labour force. This shows the human capital available with India. It also has been increasing as can be seen. In the year 2007 it went beyond 500 million. Population Below Poverty Line
Year
P o p u l a ti o n b e l o w p o v e rty l i n e (% )
30 25 20 15 10 5 0 2001
2002
2003
2004
2005
2006 Year
2007
2008
2009
2010
2011
The above information shows that the percentage of population below poverty line in India has been quite stable and constant at 25%. This data proves that in spite of the global meltdown, the poverty in India did not increase to enormous levels, which mean the effect of crisis on the common people was not much.
ImpactontheIndianCorporateSector
The failure of Lehman Brothers in mid-September 2008 was followed in quick succession by several other large financial institutions coming under severe stress. This made financial markets around the world uncertain and unsettled. This contagion spread to emerging economies and to India too. Let us take a few sectors to study the impact of the global meltdown on the Indian corporate sector Banking Sector The Indian banking system has had no direct exposure to the sub prime mortgage assets or to the failed institution in the USA. It has very limited off-balance sheet activities or securitized assets. Also the Indian Central Bank relaxed some of its rules in order to help banks. RBI first cut the reserve requirements and then it declined the short-term lending rate. That was the reason the banks in India remained safe and healthy. This can be justified by looking at the financial position of ICICI. (Refer to Appendix II)
Mar ' 10 Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Liquidity ratios Current ratio Quick ratio 16.95 15.06 12.17 1.94 14.70 Mar ' 09 14.13 12.36 9.74 0.78 5.94 Mar ' 08 14.45 12.99 10.51 0.72 6.42 Mar ' 07 13.33 11.41 10.81 0.61 6.04 Mar ' 06 18.66 15.10 14.12 0.62 6.64
The profitability ratios show a consistent rate of profit (gross as well as net) earned through out the period from 2006 to 2010. Also their liquidity condition was quite good as can be seen above. Aviation Sector The aviation industry has been impacted by the global meltdown in the form of oil crisis and strong inflationary trends. The situation in India has been challenging for airlines in the last few years on account of the most expensive aviation turbine fuel (ATF) rates in the world. This is coupled with poor and expensive infrastructure which leads to high fuel wastage and diminished asset utilization. In 2008, late September, the most happening airline company of India, Kingfisher Airlines, decided to go for massive layoffs. Due to volatile fuel prices, they were forced to go for cost cutting measures. The following data is taken from the financial statements of the Kingfisher Airlines. (Refer to Appendix III)
Mar ' 10 Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Liquidity ratios Current ratio Quick ratio -18.73 -21.94 -31.25 1.34 0.57 Mar ' 09 -10.49 -13.02 -27.43 1.09 0.52 Mar ' 08 -22.32 -23.58 -12.50 1.71 0.87 Jun ' 07 -14.57 -15.55 -22.92 2.33 2.20 Jun ' 06 -8.82 -9.86 -26.31 1.27 1.14
As can be seen from the profitability ratios of the company, it has been negative all through the concerned period. IT & Outsourcing Sector The IT Outsourcing boom had really created a buzz in the Indian economy in every which way. More jobs, high salaries leading to increased cost of living and so on. But because of inflation and tight monitory policies, Indian economy had slowed down and as a result IT industry took a downward slope. Due to the global economic slow down, US companies reduced IT outsourcing. As a result of reduced business, Indian outsourcing companies took to reducing the number of employees in order to balance the low demand figures. Wipro Ltd. (Refer to Appendix IV)
Mar ' 10 Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Liquidity ratios Current ratio Quick ratio 24.00 21.47 20.97 2.39 2.29 Mar ' 09 22.12 19.64 13.53 1.83 1.76 Mar ' 08 21.24 18.63 17.19 2.54 2.44 Mar ' 07 23.78 21.15 20.34 1.68 1.61 Mar ' 06 24.28 21.42 19.53 1.46 1.40
In spite of whatever has been said above, the IT and Outsourcing sector of India has not performed very badly as one could have expected. As can be seen from the data above of the two companies, Wipro and Infosys, both the companies have increasing profitability ratios and maintaining sufficient amount of liquidity. One reason can be the declining rate of Indian currency, attracting more western investors to the outsourcing sector. Another reason can be availability of cheap and abundant manpower. FMCG Sector Post liberalization, because of the entry of number of MNCs in India, the FMCG sales went up. But between 2000 and 2004, FMCG sector got hit, attributed to agricultural crisis and industrial slowdown. From 2005, consumers are willing to move to evolved brands (premium products), because of changing lifestyles, rising disposable income etc. In nutshell, consumers are looking for value and not MRP. Also the sales in rural sectors are growing faster. Therefore it can be said that this sector has shown strong volume growth.
As is evident form the data above, which is taken from the financial statements of Dabur India Ltd., there has been steady growth in the profitability of the company. The performance of India during the crisis has been mixed. Although the environment has been volatile and week, there still remain pockets of opportunity. India has been in great shape during the difficult times. The Indian firms have some how tapped the situation intelligently in order to ease out the blows form the financial crisis. Therefore it can be said that the impact of the crisis on India has been limited, specifically because of; Its strong fundamentals Stringent regulations by the Government Untapped growth potential Burgeoning consumer market Availability of cheap workforce
CrisisinIcelandanditsimpactonIndia
In the fall of 2008, Iceland experienced wide-spread financial difficulties. In the wake of the global financial crisis, Icelands three largest private banks, Glintir, Landisbanki and Kaupthing, were taken into government administration due to lack of available credit to finance debts, despite substantial assets. The banks were unable to refinance their debts, which went as high as 50 Billion Euros. Iceland accomplished most of its expansion activities in the new economy by taking loans on the inter-bank lending market. External debt also played a key role in financing the expansion. The fact that household debts were about 200% of the average disposable income of the family fuelled the prices of essential commodities to rise. This resulted in inflation, which got further attested by the Central Bank of Iceland issuing loans on uncovered bonds, to bank. Most banks in Iceland refused to make fresh loans. The larger banks also found it difficult for them to roll over their loans in the inter-bank market, as their creditors asked them for repayment. In such a tough scenario, banks approach the largest bank, which they did, in approaching the Central Bank of Iceland. The problem was the Central Bank refused to take ownership and the government of Iceland couldnt guarantee repayments of debts, as institutionally, the Central Bank of Iceland is much larger than the Government of Iceland. All this resulted in an absolute free-fall for banks, as credit was just not readily available for banks. Basically, the Icelandic financial crisis was a systematic malady though the ultimate reason lies in the failure of the banking sector, unlike the sub-prime crisis which was a joint
effort of real estate and finance. Comparing it with the crisis in India, the Indian banking system was relatively insulated from the factors lending to the turmoil in the global financial market. The tight liquidity in the Indian market was also qualitatively different from the global liquidity crunch. Due to these reasons, the Indian banks global exposure, with respect to sub-prime mortgage lending and investments in complex collateralised debt obligations, was relatively small. Also, the Indian banks had limited vulnerability towards freezing of inter-bank lending market. Mr. Srichand P Hinduja, Chairman and CEO of Hinduja Group had said in one of his interviews, Initially everyone will get because the US is still the leader in the financial market be it in terms of volume, size, or products, and no other country or currency can take the burden of what the US has of the world, particularly in the financial sector. In the long run, India has a great opportunity. It will be able to sustain as the country is not in the same kitty as others. In evaluating the response to the crisis, it is important to remember that although the origins of the crisis are common around the world, the crisis has impacted different economies differently. Most countries have responded to the crisis depending on their specific country circumstances.
WhatdoestheIndianEconomyNeedtodoDifferent?
The world economy went through an unprecedented crisis that started in the financial sector in the US and slowly spread globally. The magnitude of the crisis was such that it affected economies of the world, including India. The question which now arises is that, what the economies can do to secure themselves from such crisis? What are the things that they need to do different? First lets take a look at some of the steps that can be taken and which India took, in order to minimize the impact of the crisis: The crisis should be converted into an opportunity to introspect and find a way within the problem. This can be achieved only if one has strong fundamentals, like India. The first priority should be to protect the financial system, indirectly the investor, from the possible loss of confidence. Banks should be well regulated and also well capitalized. Not only that, they should be well supported by the government so that there is no fear for the safety of deposits. As we saw earlier, the impact of crisis on the Indian banking sector was minimum because: o o o o The Indian banking system had no direct exposure to the sub prime mortgage assets or to the failed institution in the USA. It has very limited off-balance sheet activities or securitized assets The Indian Central Bank relaxed some of its rules in order to help banks. There should be enough liquidity in the system to ensure adequate flow of credit. This step was also taken by the Indian government.
There are also some areas where India can do better to mitigate any risks of being exposed to the global economy, while still benefiting from the upside. The number one scourge in India today is corruption. If there was a single factor that is holding us back from becoming a super power within the global financial world then it is corruption. In the recently released Global Corruption Index, India has the dubious honour of being 87th (where 1 is the least corrupt country) While exports are good for the country, India should look to diversify its export base from the traditional North American and Western European focus. In addition to making political efforts to exporting more goods to China, India should look to developing nations on the African continent. The most critical growth need for India is in Infrastructure. The entire basis for having a strong industrial nation is the infrastructure. The situation should be watched on a day to day basis and corrective actions should be taken immediately as and when required. Required duty cuts should be announced by the government to provide relief to civil aviation sector and iron and steel industry. Government has to closely monitor the evolving macro-economic situation in order to sustain the growth momentum of the economy at a reasonable level.
CONCLUSION
When the financial crisis erupted in a comprehensive manner on Wall Street, it was argued that India would be relatively immune to this crisis, because of the strong fundamentals of the economy and the supposedly well-regulated banking system. However, with the world becoming smaller, it is not possible to insulate the Indian economy completely from what is happening in the financial systems of the world. Effectively speaking, the Indian banks and financial institutions have not experienced the kinds of losses and write downs that even venerable banks and financial institutions in the Western world have faced. Perhaps this is the first time during such crisis period when worlds big economies like US was struggling to overcome this situation when India was able to invest money for launching chandrayaan-1. When big giants in the US were going bankrupt, the companies in India were reporting and still reporting, successes. The major role of the financial crunch has been to expose political, structural and financial weaknesses of an economy. It explores efficiency in the financial market, transparency and accountability of new or reformed organizations, opportunity for creating new jobs and technologies, sufficient fund for investment in R&D innovation and education. During the financial crisis period, the extent of sufferance of an economy shows its weaknesses. One of the most important reasons that India was not affected badly is that India has been reforming very slowly, which proved to be advantageous. By ensuring that the regulatory system is proper, India dealt with the situation quite sophisticatedly. However, once the global economy begins to recover, India will turn around faster than expected because it has strong fundamentals and untapped growth potential. Meanwhile, all we need to do is keep functioning in the present environment with patience. In the end it can be said that although Indias growth of public sector and the narrow reliance on the financial services for growth needs to change, with manufacturer and exporters
having particular attention paid to them, still it is quite evident that India is a safer place in comparison to many developed countries economy. Definitely it is going to come out a stronger India once the whole financial crunch is over.
SUMMARY
The global financial crisis has caused a considerable slowdown in most developed countries. It has accelerated the shift of economic power to emerging economies like India. Stock markets crashed, investment banks collapsed and rescue package were drawn up. In the whole turmoil, few growing economies like India have performed extremely well and are emerging sturdier due to strong fundamentals and untapped potential. The major macro economic indicators show how India has done in the past difficult years. The common man has not been severely affected as it has been in most of the developed countries. Similarly the position of the Indian companies has been far better and progressing. This can be contrasted against other countries, like Iceland that were hit very severely by the global crisis. At the same time it can not be completely ruled out that there was no effect of the global meltdown on India. With the world becoming smaller, it is not possible to insulate the Indian economy completely from what is happening in the financial systems of the world. Especially in the Indian IT and Outsourcing sector, there is huge influence of the Western countries. In order to summarise it can be said that the performance of India during the crisis has been mixed. Although the environment has been volatile and week, there still remain pockets of opportunity.
REFERENCES
[1] Global Financial Crisis and Key Risks : Impact on India and Asia Rakesh Mohan Deputy Governor, RBI [2] The US Financial Crisis : Impact on the Indian IT Sector Manohar M Atreya [3] Global Financial Crisis : Impact on Indias Poor Rajiv Kumar, Bibek Debroy, Jayati Ghosh, Vijay Mahajan, K. Seeta Prabhu [4] How the global financial crisis affects India, Sep 19th 2008, Business Standard [5] Global financial crisis : reflections on its impact on India S. Venkitaramanan, Oct 18th 2008, The Hindu [6] Crisis Will Accelerate the Power Shift to Emerging Economies, CEBR Says Scott Hamilton [7] India Managing the Impact of the Global Crisis1 Duvvuri Subbarao [8] Financial Crises: A Cascading Effect on India Madhuri Malhotra [9] http://www.aboutcorporateindia.com/aci/reports/global%20meltdown.pdf [10] http://www.rbi.org.in [11] http://www.aboutcorporateindia.com/aci/reports/global%20meltdown.pdf [12] http://www.vccircle.com/columns/the-us-financial-crisis-impact-on-the-indian-it-sector [13] http://en.wikipedia.org/wiki/2008%E2%80%932010_Icelandic_financial_crisis [14] http://www.iceland.org/info/iceland-crisis/ [15] http://www.bis.org/review/r100129a.pdf [16] http://www.rediff.com/money/2008/nov/21bcrisis-globalisation-eventually-has-a-positive-impact.htm [17] http://fmcgmarketers.blogspot.com/2008/12/impact-of-slowdown-and-inflation-and.html [18] http://www.nowpublic.com/tech-biz/indias-outsourcing-firms-hit-us-financial-crisis [19] http://www.ezilon.com/articles/articles/12001/1/Impact-Of-US-Financial-Crisis-On-Indian-OutsourcingCompanies [20] http://www.voanews.com/english/news/a-13-2009-06-19-voa18-68802772.html [21] http://www.finance-trading-times.com/2008/09/kingfisher-lay-off-job-cut-kingfisher.html [22] http://money.rediff.com/companies/kingfisher-airlines-ltd/16600017/balance-sheet [23] http://money.rediff.com/companies/wipro-ltd/11060011/profit-and-loss [24] http://money.rediff.com/companies/infosys-technologies-ltd/13020007/balance-sheet [25] http://money.rediff.com/companies/dabur-india-ltd/12540103/balance-sheet [26] http://money.rediff.com/money/jsp/p_l.jsp?companyCode=14030056 [27] http://www.indexmundi.com/ [28] http://www.bseindia.com/
APPENDIX I IndiasMacroeconomicIndicators
INDICATORS GDP (at current prices, US$ bn) GDP Growth (at constant prices, %) Agriculture & allied Industry Services Agriculture & allied Industry Services Inflation rate (WPI, annual avg. %) Gross Fiscal Deficit (% of GDP) Exchange Rate (Rs/US$, avg.) Exchange Rate (Rs/Euro, avg.) Exports (US$ bn) % change Imports (US$ bn) % change Trade Balance (US $ bn) Services Exports (US$ bn) Software Exports (US$ bn) Services Imports (US$ bn) Services Balance (US$ bn) Current Account Balance (US$ bn) CAB as percentage of GDP (%) Forex Reserves (US$ bn) External Debt (US $ bn) External Debt to GDP Ratio (%) Short Term Debt / Total Debt (%) Total Debt Service Ratio (%) Foreign Investment Inflows (US$ bn) FDI (US$ bn) GDRs/ADRs (US$ bn) 2005-06 837.2 9.5 5.2 9.3 11.1 18.1 27.9 53.9 4.4 4.1 44.3 53.9 103.1 23.4 149.2 33.8 -46.1 57.7 23.6 34.5 23.2 -9.9 -1.2 151.6 139.1 17.3 14.1 10.1 21.5 9.0 2.6 2006-07 947.0 9.7 3.7 12.7 10.2 2007-08 1231.0 9.2 2008-09 1222.0 6.7 1.6 3.9 9.8 15.7 28.0 56.3 8.3 6.0e 45.9 65.1 185.3 13.6 303.7 20.7 -118.4 101.7 46.3 52.0 49.6 -28.7 -2.4 252.0 224.5 20.5 19.3 4.6 21.3 35.2 1.2 2009-10 1317.0 7.4e 0.2e 8.5e 9.3e 14.6e 28.5e 56.9e 9.9 (Mar '10) 6.7e 47.4 67.1 178.7 -3.6 286.8 -5.6 -108.2 93.8 49.7 59.6 34.2 -38.4 -2.9 277.0 261.5 18.9 20.1 5.5 69.6 37.2 3.3 2010-11 1529.0# 8.5# 4.5# 9.7# 8.9# 9.97 (Jul '10) 46.81 (Aug 26) 59.45 (Aug 26) 50.8 (Apr-Jun) 32.7 (Apr-Jun)^ 83.0 (Apr-Jun) 34.2 (Apr-Jun)^ -32.3 (Apr-Jun) 282.8 (Aug 13) 10.4 (Apr-Jun) 5.8 (Apr-Jun) 1.0 (Apr-Jun)
4.7 9.5 10.5 Sectoral Share in GDP (%) 17.2 16.4 28.7 28.8 54.2 54.8 5.4 4.7 3.5 45.3 58.1 126.4 22.6 185.7 24.5 -59.3 73.8 31.3 44.3 29.5 -9.6 -1.1 199.2 172.4 18.2 16.3 4.7 29.8 22.8 3.8 2.7 40.2 57.0 163.1 29.0 251.7 35.5 -88.5 90.3 40.3 51.5 38.9 -15.7 -1.3 309.7 224.4 18.1 20.4 4.8 62.1 34.8 6.6
286 Changing Dynamics of Finance FIIs (net) (US$ bn) FDI Outflows (US$ bn) (Actual) Memo Items: Global GDP (% change) World Merch. Trade (Vol., % change) 9.9 6.1 2006 5.1 8.8 3.2 13.1 2007 5.2 6.5 20.3 18.7 2008 3.0 2.4 -15.0 16.2 2009e -0.6 -11.8 29.0 10.3 2010P 4.6 8.0 3.5 (Apr-Jun) 2011P 4.3 6.2
Source: Economic Survey, Various issues; Union Budget, RBI Monthly Bulletin, Annual Report & Weekly Statistical Supplement; Ministry of Finance; Ministry of Commerce & Industry; CSO; Institute of International Finance (IIF); EIU; NASSCOM; WEO, IMF. e estimates; - Not available; ^ Growth over corresponding period of previous year. P Projections. # PM Economic Advisory Council's projections. Note: (a) Debt-service ratio is the proportion of gross debt service payments to External Current Receipts (net of official transfers). (b) Short term debt coverage increased beginning with the quarter ended March 2005, with the inclusion of (i) suppliers' credits up to 180 days and (ii) investment by Foreign Institutional Investors (FII) in short-term debt instruments. Updated on August 26, 2010
APPENDIX II ICICIBankLtd.
Profit Loss Account (Rs crore)
Mar ' 10 Income Operating income Expenses Material consumed Manufacturing expenses Personnel expenses Selling expenses Adminstrative expenses Expenses capitalised Cost of sales Operating profit Other recurring income Adjusted PBDIT Financial expenses Depreciation Other write offs Adjusted PBT Tax charges Adjusted PAT Non recurring items Other non cash adjustments Reported net profit Earnigs before appropriation Equity dividend Preference dividend Dividend tax Retained earnings 32,747.36 1,925.79 236.28 7,440.42 9,602.49 5,552.30 305.36 5,857.66 17,592.57 619.50 -12,354.42 1,600.78 -13,702.10 134.52 -13,567.59 -10,757.94 1,337.95 164.04 -12,259.94 Mar ' 09 38,250.39 1,971.70 669.21 7,475.63 10,116.54 5,407.91 330.64 5,738.55 22,725.93 678.60 5,059.96 1,830.51 3,740.62 17.51 -0.58 3,757.55 6,193.87 1,224.58 151.21 4,818.07 Mar ' 08 39,467.92 2,078.90 1,750.60 6,447.32 10,276.82 5,706.85 65.58 5,772.43 23,484.24 578.35 5,194.08 1,611.73 4,092.12 65.61 4,157.73 5,156.00 1,227.70 149.67 3,778.63 Mar ' 07 28,457.13 1,616.75 1,741.63 4,946.69 8,305.07 3,793.56 309.17 4,102.73 16,358.50 544.78 3,557.95 984.25 2,995.00 115.22 3,110.22 3,403.66 901.17 153.10 2,349.39 Mar ' 06 17,517.83 1,082.29 840.98 2,727.18 4,650.45 3,269.94 466.02 3,735.96 9,597.45 623.79 3,112.17 556.53 2,532.95 7.12 2,540.07 2,728.30 759.33 106.50 1,862.46
Equity share capital Share application money Preference share capital Reserves & surplus Secured loans Unsecured loans Total
Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Current assets, loans & advances Less : current liabilities & provisions Total net current assets Miscellaneous expenses not written Total Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity sharesoutstanding (Lacs)
7,036.00 2,927.11 4,108.90 1,11,454.34 31,129.77 42,895.38 -11,765.62 1,03,797.62 4,01,114.91 11126.87
6,298.56 2,375.14 3,923.42 189.66 91,257.84 23,551.85 38,228.64 -14,676.78 80,694.15 1,99,771.41 8992.67
5,968.57 1,987.85 3,980.71 147.94 71,547.39 15,642.79 25,227.88 -9,585.09 66,090.96 1,34,920.99 8898.24
Ratios
Mar ' 10 Per share ratios Adjusted EPS (Rs) Adjusted cash EPS (Rs) Reported EPS (Rs) Reported cash EPS (Rs) Dividend per share Operating profit per share (Rs) Book value (excl rev res) per share (Rs) Book value (incl rev res) per share (Rs.) Net operating income per share (Rs) Free reserves per share (Rs) Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Adjusted cash margin (%) Adjusted return on net worth (%) Reported return on net worth (%) Return on long term funds (%) Leverage ratios Long term debt / Equity Total debt/equity Owners fund as % of total source Fixed assets turnover ratio -122.91 -117.35 36.10 41.66 12.00 49.80 463.01 463.01 293.74 356.94 16.95 15.06 12.17 -39.58 -26.54 7.79 10.63 3.91 20.35 4.60 Mar ' 09 33.60 39.70 33.76 39.85 11.00 48.58 444.94 444.94 343.59 351.04 14.13 12.36 9.74 11.45 7.55 7.58 56.72 0.01 4.42 18.46 5.14 Mar ' 08 36.78 41.97 37.37 42.56 11.00 51.29 417.64 417.64 354.71 346.21 14.45 12.99 10.51 11.81 8.80 8.94 62.34 0.01 5.27 15.95 5.61 Mar ' 07 33.30 39.36 34.59 40.64 10.00 42.19 270.37 270.37 316.45 199.52 13.33 11.41 10.81 12.30 12.31 12.79 82.46 0.01 9.50 9.52 4.52 Mar ' 06 28.47 35.48 28.55 35.56 8.50 36.75 249.55 249.55 196.87 193.24 18.66 15.10 14.12 17.55 11.40 11.43 56.24 0.01 7.45 11.83 2.94
288 Changing Dynamics of Finance Liquidity ratios Current ratio Current ratio (inc. st loans) Quick ratio Inventory turnover ratio Payout ratios Dividend payout ratio (net profit) Dividend payout ratio (cash profit) Earning retention ratio Cash earnings retention ratio Coverage ratios Adjusted cash flow time total debt Financial charges coverage ratio Fin. charges cov.ratio (post tax) Component ratios Material cost component (% earnings) Selling cost Component Exports as percent of total sales Import comp. in raw mat. consumed Long term assets / total Assets Bonus component in equity capital (%)
1.94 0.13 14.70 37.31 32.33 110.96 66.70 44.79 0.33 1.26 0.72 0.80 -
0.78 0.13 5.94 36.60 31.00 63.23 68.87 49.41 1.25 1.20 1.74 0.75 -
0.72 0.10 6.42 33.12 29.08 66.35 70.51 52.34 1.25 1.20 4.43 0.78 -
0.61 0.08 6.04 33.89 28.84 64.80 70.22 65.12 1.25 1.22 6.12 0.80 -
0.62 0.08 6.64 34.08 27.36 65.82 72.58 52.30 1.39 1.33 4.80 0.82 -
Equity share capital Share application money Preference share capital Reserves & surplus Secured loans Unsecured loans Total
Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Current assets, loans & advances Less : current liabilities & provisions Total net current assets Miscellaneous expenses not written Total Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity sharesoutstanding (Lacs)
1,891.80 316.29 1,575.52 1,630.95 0.05 4,189.37 3,860.18 329.19 4.51 3,540.21 0.05 27,468.70 2659.09
322.33 43.55 278.78 346.25 1,188.41 696.83 491.58 16.64 1,133.26 6,797.11 1357.99
340.77 33.74 307.03 357.62 0.41 1,063.68 456.09 607.59 28.75 1,301.41 0.41 7,485.33 1354.70
247.33 16.40 230.93 286.53 0.41 558.83 439.98 118.85 39.08 675.80 0.41 8,935.97 981.82
Ratios
Mar ' 10 Per share ratios Adjusted EPS (Rs) Adjusted cash EPS (Rs) Reported EPS (Rs) Reported cash EPS (Rs) Dividend per share Operating profit per share (Rs) Book value (excl rev res) per share (Rs) Book value (incl rev res) per share (Rs.) Net operating income per share (Rs) Free reserves per share (Rs) Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Adjusted cash margin (%) Adjusted return on net worth (%) Reported return on net worth (%) Return on long term funds (%) Leverage ratios Long term debt / Equity -48.50 -40.33 -61.95 -53.78 -35.71 -156.01 -156.01 190.59 -167.98 -18.73 -21.94 -31.25 -20.34 -23.99 Mar ' 09 -60.67 -54.22 -60.50 -54.05 -20.80 -84.05 -84.05 198.16 -94.05 -10.49 -13.02 -27.43 -24.58 -7.90 Mar ' 08 -18.64 -15.94 -13.85 -11.16 -23.95 12.68 12.68 107.24 2.68 -22.32 -23.58 -12.50 -14.38 -147.04 -109.29 -36.52 3.54 Jun ' 07 -55.05 -51.81 -30.97 -27.73 -19.37 26.27 26.27 132.89 15.46 -14.57 -15.55 -22.92 -38.34 -209.52 -117.87 -36.27 0.98 Jun ' 06 -39.90 -36.61 -34.69 -31.40 -11.55 18.85 18.85 130.92 8.08 -8.82 -9.86 -26.31 -27.78 -211.67 -184.01 -22.19 1.76
290 Changing Dynamics of Finance Total debt/equity Owners fund as % of total source Fixed assets turnover ratio Liquidity ratios Current ratio Current ratio (inc. st loans) Quick ratio Inventory turnover ratio Payout ratios Dividend payout ratio (net profit) Dividend payout ratio (cash profit) Earning retention ratio Cash earnings retention ratio Coverage ratios Adjusted cash flow time total debt Financial charges coverage ratio Fin. charges cov.ratio (post tax) Component ratios Material cost component (% earnings) Selling cost Component Exports as percent of total sales Import comp. in raw mat. consumed Long term assets / total Assets Bonus component in equity capital (%) -99.65 2.47 1.34 1.34 0.57 30.74 -0.68 -0.30 0.80 13.79 0.32 10.26 -63.14 2.85 1.09 0.64 0.52 5,738.39 0.02 0.29 0.97 12.97 4.54 0.43 10.26 4.95 16.80 4.61 1.71 0.96 0.87 -0.63 0.65 3.00 5.83 3.42 0.34 20.09 2.38 29.56 5.37 2.33 0.79 2.20 28.80 -0.49 0.19 2.55 0.99 18.56 0.38 20.14 2.02 33.16 5.24 1.27 1.01 1.14 21.59 -0.41 -0.22 2.85 1.04 8.65 0.48 27.78
APPENDIX IV WiproLtd
Profit Loss Account (s. crore)
Mar ' 10 Income Operating income Expenses Material consumed Manufacturing expenses Personnel expenses Selling expenses Adminstrative expenses Expenses capitalised Cost of sales Operating profit Other recurring income Adjusted PBDIT Financial expenses Depreciation Other write offs Adjusted PBT Tax charges Adjusted PAT Non recurring items Other non cash adjustments Reported net profit Earnigs before appropriation Equity dividend Preference dividend Dividend tax Retained earnings 22,922.00 4,029.40 2,213.20 9,062.80 378.10 1,737.00 17,420.50 5,501.50 434.20 5,935.70 108.40 579.60 5,247.70 790.80 4,456.90 441.10 4,898.00 4,898.00 880.90 128.30 3,888.80 Mar ' 09 21,507.30 3,442.60 1,841.80 9,249.80 308.40 1,906.00 16,748.60 4,758.70 468.20 5,226.90 196.80 533.60 4,496.50 574.10 3,922.40 -948.60 2,973.80 2,973.80 586.00 99.60 2,288.20 Mar ' 08 17,492.60 2,952.30 299.80 7,409.10 532.10 2,583.70 13,777.00 3,715.60 326.90 4,042.50 116.80 456.00 3,469.70 406.40 3,063.30 3,063.30 3,063.30 876.50 148.90 2,037.90 Mar ' 07 13,683.90 1,889.00 120.50 5,768.20 2,651.70 10,429.40 3,254.50 288.70 3,543.20 7.20 359.80 3,176.20 334.10 2,842.10 2,842.10 2,842.10 873.70 126.80 1,841.60 Mar ' 06 10,227.12 1,367.67 1,020.70 4,279.03 171.05 904.78 7,743.22 2,483.90 113.59 2,597.49 3.13 292.26 2,302.10 286.10 2,016.00 38.33 -33.85 2,020.48 2,020.48 712.88 99.98 1,207.62
Equity share capital Share application money Preference share capital Reserves & surplus Secured loans Unsecured loans Total
Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Current assets, loans & advances Less : current liabilities & provisions Total net current assets Miscellaneous expenses not written Total Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity sharesoutstanding (Lacs)
5,743.30 2,563.70 3,179.60 1,311.80 6,895.30 13,517.20 7,375.00 6,142.20 17,528.90 6,884.50 1,045.40 14649.81
2,282.20 2,282.20 1,335.00 4,500.10 12,058.10 4,742.30 7,315.80 15,433.10 749.90 14615.00
1,645.90 1,645.90 989.50 4,348.70 6,338.40 3,764.10 2,574.30 9,558.40 1,234.10 661.60 14590.00
2,364.53 1,246.27 1,118.25 612.36 3,459.20 4,076.68 2,788.39 1,288.29 6,478.10 514.23 2,956.87 509.18 14257.54
Ratios
Mar ' 10 Per share ratios Adjusted EPS (Rs) Adjusted cash EPS (Rs) Reported EPS (Rs) Reported cash EPS (Rs) Dividend per share Operating profit per share (Rs) Book value (excl rev res) per share (Rs) Book value (incl rev res) per share (Rs.) Net operating income per share (Rs) Free reserves per share (Rs) Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Adjusted cash margin (%) Adjusted return on net worth (%) Reported return on net worth (%) Return on long term funds (%) Leverage ratios Long term debt / Equity Total debt/equity Owners fund as % of total source Fixed assets turnover ratio Liquidity ratios Current ratio Current ratio (inc. st loans) Quick ratio Inventory turnover ratio Payout ratios Dividend payout ratio (net profit) Dividend payout ratio (cash profit) Earning retention ratio Cash earnings retention ratio Coverage ratios Adjusted cash flow time total debt Financial charges coverage ratio Fin. charges cov.ratio (post tax) Component ratios Material cost component (% earnings) Selling cost Component Exports as percent of total sales Import comp. in raw mat. consumed Long term assets / total Assets Bonus component in equity capital (%) 30.36 34.30 33.36 37.31 6.00 37.47 120.49 120.49 156.12 116.54 24.00 21.47 20.97 21.56 25.19 27.68 30.12 0.01 0.31 76.18 3.47 2.39 1.34 2.29 45.40 20.60 18.42 77.36 79.97 1.10 54.76 51.53 18.06 1.64 73.26 36.83 0.44 95.32 Mar ' 09 26.77 30.42 20.30 23.94 4.00 32.48 85.42 85.42 146.81 81.06 22.12 19.64 13.53 20.27 31.34 23.76 37.17 0.01 0.40 71.39 3.85 1.83 1.10 1.76 56.15 23.05 19.54 82.53 84.62 1.13 26.56 18.82 15.98 1.43 77.28 45.00 0.45 95.51 Mar ' 08 20.96 24.08 20.96 24.08 6.00 25.42 79.05 79.05 119.69 21.24 18.63 17.19 19.74 26.51 26.51 23.32 0.33 0.33 75.13 7.81 2.54 2.54 2.44 39.41 33.47 29.13 66.53 70.87 1.09 34.61 31.13 17.94 3.04 73.66 0.40 95.68 Mar ' 07 19.48 21.95 19.48 21.95 6.00 22.31 63.86 63.86 93.79 23.78 21.15 20.34 22.91 30.50 30.50 33.31 0.02 0.02 97.50 8.31 1.68 1.68 1.61 57.23 35.20 31.24 64.80 68.76 0.07 492.11 445.71 14.43 80.05 0.52 95.84 Mar ' 06 14.14 16.19 14.17 16.22 5.00 17.42 45.03 45.03 71.73 42.65 24.28 21.42 19.53 22.32 31.39 31.46 35.87 0.01 99.22 4.35 1.46 1.42 1.40 78.23 40.23 35.14 59.68 64.79 0.02 829.08 739.19 13.60 1.67 69.25 62.12 0.55 98.08
APPENDIX V InfosysTechnologiesLtd.
Profit & Loss Accoun (Rs. crore)
Mar ' 10 Income Operating income Expenses Material consumed Manufacturing expenses Personnel expenses Selling expenses Adminstrative expenses Expenses capitalised Cost of sales Operating profit Other recurring income Adjusted PBDIT Financial expenses Depreciation Other write offs Adjusted PBT Tax charges Adjusted PAT Non recurring items Other non cash adjustments Reported net profit Earnigs before appropriation Equity dividend Preference dividend Dividend tax Retained earnings 21,140.00 2,317.00 10,356.00 215.00 883.00 13,771.00 7,369.00 910.00 8,279.00 807.00 7,472.00 1,717.00 5,755.00 48.00 5,803.00 5,803.00 1,434.00 240.00 4,129.00 Mar ' 09 20,264.00 20.00 1,822.00 9,975.00 83.00 1,456.00 13,356.00 6,908.00 874.00 7,782.00 2.00 694.00 7,086.00 895.00 6,191.00 -372.00 -1.00 5,818.00 12,460.00 1,345.00 228.00 10,887.00 Mar ' 08 15,648.00 18.00 1,549.00 7,771.00 89.00 1,257.00 10,684.00 4,964.00 678.00 5,642.00 1.00 546.00 5,095.00 630.00 4,465.00 5.00 4,470.00 9,314.00 1,902.00 323.00 7,089.00 Mar ' 07 13,149.00 22.00 1,378.00 6,316.00 63.00 1,144.00 8,923.00 4,226.00 333.00 4,559.00 1.00 469.00 4,089.00 352.00 3,737.00 46.00 -5.00 3,778.00 5,973.00 649.00 102.00 5,222.00 Mar ' 06 9,028.00 16.00 854.00 4,274.00 55.00 839.00 6,038.00 2,990.00 221.00 3,211.00 1.00 409.00 2,801.00 303.00 2,498.00 -77.00 2,421.00 3,849.00 1,238.00 174.00 2,437.00
Equity share capital Share application money Preference share capital Reserves & surplus Secured loans Unsecured loans Total Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Current assets, loans & advances Less : current liabilities & provisions
294 Changing Dynamics of Finance Total net current assets Miscellaneous expenses not written Total Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity sharesoutstanding (Lacs) 13,212.00 22,036.00 Notes: 4,636.00 295.00 5728.30 12,390.00 17,809.00 1,005.00 347.00 5728.30 8,595.00 13,490.00 964.00 603.00 5719.96 7,216.00 11,162.00 839.00 670.00 5712.10 3,888.00 6,897.00 876.00 523.00 2755.55
Ratios
Mar ' 10 Per share ratios Adjusted EPS (Rs) Adjusted cash EPS (Rs) Reported EPS (Rs) Reported cash EPS (Rs) Dividend per share Operating profit per share (Rs) Book value (excl rev res) per share (Rs) Book value (incl rev res) per share (Rs.) Net operating income per share (Rs) Free reserves per share (Rs) Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Adjusted cash margin (%) Adjusted return on net worth (%) Reported return on net worth (%) Return on long term funds (%) Leverage ratios Long term debt / Equity Total debt/equity Owners fund as % of total source Fixed assets turnover ratio Liquidity ratios Current ratio Current ratio (inc. st loans) Quick ratio Inventory turnover ratio Payout ratios Dividend payout ratio (net profit) Dividend payout ratio (cash profit) Earning retention ratio Cash earnings retention ratio Coverage ratios Adjusted cash flow time total debt Financial charges coverage ratio Fin. charges cov.ratio (post tax) Component ratios Material cost component (% earnings) Selling cost Component Exports as percent of total sales Import comp. in raw mat. consumed Long term assets / total Assets Bonus component in equity capital (%) 100.47 114.55 101.30 115.39 25.00 128.64 384.69 384.69 369.04 378.73 34.85 31.04 26.31 29.75 26.11 26.33 33.90 100.00 5.59 4.28 4.28 4.20 28.84 25.32 70.92 74.49 1.01 99.69 0.33 93.26 Mar ' 09 108.08 120.19 101.58 113.70 23.50 120.59 310.89 310.89 353.75 305.80 34.09 30.66 27.52 32.57 34.76 32.67 39.80 100.00 3.39 4.71 4.71 4.67 27.03 24.15 74.60 77.16 3,891.00 3,257.50 0.09 0.40 97.88 0.25 93.58 Mar ' 08 78.06 87.61 78.15 87.69 33.25 86.78 235.84 235.84 273.57 230.74 31.72 28.23 27.37 30.69 33.09 33.13 37.77 100.00 3.47 3.30 3.30 3.28 49.77 44.35 50.17 55.60 5,642.00 5,017.00 0.11 0.56 92.59 0.28 93.58 Mar ' 07 65.42 73.63 66.23 74.44 11.50 73.98 195.41 195.41 230.20 190.30 32.13 28.57 28.05 31.19 33.47 33.89 36.64 100.00 3.38 4.96 4.96 4.91 19.85 17.66 79.91 82.15 4,559.00 4,253.00 0.16 0.47 92.44 0.30 93.58 Mar ' 06 90.65 105.50 87.86 102.70 45.00 108.51 26.56 26.56 327.63 245.07 33.11 28.58 26.17 31.43 36.21 35.10 40.62 100.00 3.18 2.75 2.75 2.73 58.32 49.89 43.48 51.43 3,211.00 2,831.00 0.17 0.60 95.86 0.33 93.65
APPENDIX VI DaburIndiaLtd
Profit & Loss Accoun (Rs. crore)
Mar ' 10 Income Operating income Expenses Material consumed Manufacturing expenses Personnel expenses Selling expenses Adminstrative expenses Expenses capitalised Cost of sales Operating profit Other recurring income Adjusted PBDIT Financial expenses Depreciation Other write offs Adjusted PBT Tax charges Adjusted PAT Non recurring items Other non cash adjustments Reported net profit Earnigs before appropriation Equity dividend Preference dividend Dividend tax Retained earnings 2,867.42 1,384.29 58.17 212.34 474.79 187.90 2,317.49 549.93 14.85 564.78 13.28 31.91 5.66 513.93 93.70 420.23 13.10 -0.19 433.14 862.08 173.60 29.50 658.98 Mar ' 09 2,408.33 1,232.85 54.22 167.32 358.75 153.67 1,966.81 441.52 10.72 452.24 14.47 27.42 3.94 406.41 51.44 354.97 18.58 -0.72 372.84 696.07 151.39 25.73 518.95 Mar ' 08 2,093.63 1,023.94 54.02 149.69 337.69 138.69 1,704.03 389.60 9.76 399.36 10.92 25.75 5.67 357.01 48.40 308.61 8.16 -0.86 315.92 545.07 129.60 22.03 393.44 Mar ' 07 1,745.14 778.27 39.24 118.66 403.42 100.90 1,440.48 304.66 3.14 307.80 4.43 21.98 6.49 274.90 32.15 242.76 9.32 -0.13 251.94 426.95 122.13 17.13 287.70 Mar ' 06 1,345.50 582.43 27.10 98.31 316.46 80.24 1,104.55 240.95 1.05 242.01 5.73 19.05 4.26 212.97 25.78 187.19 1.90 0.21 189.29 314.52 100.32 14.07 200.13
Equity share capital Share application money Preference share capital Reserves & surplus Secured loans Unsecured loans Total
Gross block Less : revaluation reserve Less : accumulated depreciation Net block Capital work-in-progress Investments Current assets, loans & advances Less : current liabilities & provisions Total net current assets Miscellaneous expenses not written Total Book value of unquoted investments Market value of quoted investments Contingent liabilities Number of equity sharesoutstanding (Lacs)
518.77 210.45 308.32 51.71 232.05 973.42 696.97 276.45 8.64 877.17 319.12 118.48 174.15 8650.76
467.93 189.77 278.17 16.26 270.37 576.82 610.57 -33.75 13.95 545.01 67.99 205.19 171.24 8640.23
404.30 168.97 235.33 3.71 145.35 397.78 379.27 18.52 19.82 422.73 65.99 80.82 153.25 8628.84
328.23 142.46 185.77 13.07 275.08 285.68 324.12 -38.44 32.87 468.35 234.43 43.43 190.02 5733.03
Ratios
Mar ' 10 Per share ratios Adjusted EPS (Rs) Adjusted cash EPS (Rs) Reported EPS (Rs) Reported cash EPS (Rs) Dividend per share Operating profit per share (Rs) Book value (excl rev res) per share (Rs) Book value (incl rev res) per share (Rs.) Net operating income per share (Rs) Free reserves per share (Rs) Profitability ratios Operating margin (%) Gross profit margin (%) Net profit margin (%) Adjusted cash margin (%) Adjusted return on net worth (%) Reported return on net worth (%) Return on long term funds (%) Leverage ratios Long term debt / Equity 4.84 5.28 4.99 5.43 2.00 6.34 8.60 8.60 33.05 7.14 19.17 18.06 15.03 15.88 56.29 58.04 68.96 0.02 Mar ' 09 4.10 4.47 4.32 4.68 1.75 5.10 8.43 8.43 27.84 6.84 18.33 17.19 15.44 15.97 48.65 51.20 55.29 0.03 Mar ' 08 3.57 3.94 3.67 4.03 1.50 4.51 5.95 5.95 24.23 4.33 18.60 17.37 15.06 16.16 59.99 61.58 68.93 0.01 Mar ' 07 2.81 3.14 2.92 3.25 1.75 3.53 4.44 4.44 20.22 2.80 17.45 16.19 14.41 15.51 63.32 65.75 68.63 0.01 Mar ' 06 3.27 3.67 3.30 3.70 2.50 4.20 7.24 7.24 23.47 5.21 17.90 16.49 14.04 15.63 45.10 45.56 48.02 0.01
Financial Crisis and its Impact on India 297 Total debt/equity Owners fund as % of total source Fixed assets turnover ratio Liquidity ratios Current ratio Current ratio (inc. st loans) Quick ratio Inventory turnover ratio Payout ratios Dividend payout ratio (net profit) Dividend payout ratio (cash profit) Earning retention ratio Cash earnings retention ratio Coverage ratios Adjusted cash flow time total debt Financial charges coverage ratio Fin. charges cov.ratio (post tax) Component ratios Material cost component (% earnings) Selling cost Component Exports as percent of total sales Import comp. in raw mat. consumed Long term assets / total Assets Bonus component in equity capital (%) 0.14 87.59 4.31 1.03 0.92 0.67 11.31 46.86 43.13 51.67 55.64 0.23 42.53 36.46 48.61 16.55 4.31 1.22 0.45 87.10 0.18 84.15 4.84 1.40 1.19 0.98 10.94 47.41 43.74 50.11 54.16 0.35 31.26 28.99 52.80 14.89 4.56 1.06 0.36 87.35 0.03 96.93 4.67 0.94 0.91 0.57 12.52 47.86 43.54 50.87 55.41 0.04 36.56 32.87 49.05 16.12 4.49 0.97 0.48 87.46 0.04 95.37 4.50 1.05 0.96 0.63 13.44 55.24 49.63 42.64 48.66 0.07 69.48 64.33 45.86 23.11 3.96 1.22 0.48 87.58 0.04 95.62 4.24 0.88 0.81 0.52 14.44 60.49 53.85 38.89 45.66 0.09 42.26 38.09 42.97 23.52 1.97 0.72 0.61 81.74
FinancialCrisis
S.V.PradeepKrishnan*
AbstractThe turmoil in the international financial markets of advanced economies, that started around mid-2007, has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies. As this crisis is unfolding, credit markets appear to be drying up in the developed world. The financial sector, especially banks, is subject to prudential regulations, both in regard to capital and liquidity. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity. India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. Indias growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent. The U.S. Federal Reserve and central banks have taken steps to expand money supplies to avoid the risk of a deflationary spiral, in which lower wages and higher unemployment lead to a self-reinforcing decline in global consumption Keywords: exacerbated, evictions, foreclosures, prolonged vacancies, contagion.
The turmoil in the international financial markets of advanced economies that started around mid-2007 has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies.* The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. The collapse of a global housing bubble, which peaked in the U.S. in 2006, caused the values of securities tied to real estate pricing to plummet thereafter, damaging financial institutions globally. Questions regarding bank solvency, declines in credit availability, and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009. The immediate cause or trigger of the crisis was the bursting of the United States Housing bubble which peaked in approximately 20052006. An increase in loan packaging, marketing *Nehru College of Engineering and Research Centre, Kerala
and incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 20062007 in many parts of the U.S., refinancing became more difficult. Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load. As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and Collateralized debt obligation (CDO), which derived their value from mortgage payments and housing prices, greatly increased. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called Financialization. Policymakers did not recognize the increasingly important role played by financial institutions such as investment banks and hedge funds also known as the shadow banking system. The crises culminated on Sept. 15, 2008 with Lehman Brothers filing for bankruptcy.
SUB-PRIME LENDING
The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. The value of U.S.
subprime mortgages was estimated at $1.3 trillion as of March 2007, with over 7.5 million first-lien subprime mortgages outstanding. In addition to easy credit conditions, there is evidence that both government and competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak. A proximate event to this increase was the April 2004 decision by the U.S. Securities and Exchange Commission (SEC) to relax the net capital rule, which permitted the largest five investment banks to dramatically increase their financial leverage and aggressively expand their issuance of mortgage-backed securities. Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-
subsidized corporation may run into trouble in an economic downturn. FINANCIAL GLOBALIZATION: THE INDIAN APPROACH
The Indian economy is now a relatively open economy, despite the capital account not being fully open. The current account, as measured by the sum of current receipts and current payments, amounted to about 53 per cent of GDP up from about 19 per cent of GDP in 1991. Similarly, on the capital account, the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent. With this degree of openness, developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy. The relatively limited impact of the ongoing turmoil in financial markets of the advanced economies in the Indian financial markets, and more generally the Indian economy, needs to be assessed in this context. Whereas the Indian current account has been opened fully, though gradually, over the 1990s, a more calibrated approach has been followed to the opening of the capital account and to opening up of the financial sector. This approach is consistent with the weight of the available empirical evidence with regard to the benefits that may be gained from capital account liberalisation for acceleration of economic growth, particularly in emerging market economies. The evidence suggests that the greatest gains are obtained from the opening to foreign direct investment, followed by portfolio equity investment. Accordingly, in India, while encouraging foreign investment flows, especially direct investment inflows, a more cautious, nuanced approach has been adopted in regard to debt flows. Debt flows in the form of external commercial borrowings are subject to ceilings and some end-use restrictions, which are modulated from time to time taking into account evolving macroeconomic and monetary conditions. Similarly, portfolio investment in government securities and corporate bonds are also subject to macro ceilings, which are also modulated from time to time. Thus, prudential policies have attempted to prevent excessive recourse to foreign borrowings and dollarisation of the economy. In regard to capital outflows, the policy framework has been progressively
liberalised to enable the non-financial corporate sector to invest abroad and to acquire companies in the overseas market. Resident individuals are also permitted outflows subject to reasonable limits. The financial sector, especially banks, is subject to prudential regulations, both in regard to capital and liquidity. As the current global financial crisis has shown, liquidity risks can rise manifold during a crisis and can pose serious downside risks to macroeconomic and financial stability. The Reserve Bank had already put in place steps to mitigate liquidity risks at the very short-end, risks at the systemic level and at the institution level as well. Some of the important measures by the Reserve Bank in this regard include, first, restricting the overnight unsecured market for funds to banks and primary dealers (PD) as well as limits on the borrowing and lending operations of these entities in the overnight inter-bank call money market. Second, large reliance by banks on borrowed funds can exacerbate vulnerability to external shocks. Accordingly, in order to encourage greater reliance on stable sources of funding, the Reserve Bank has imposed prudential limits on banks on their purchased inter-bank liabilities and these limits are linked to their net worth. Furthermore, the incremental credit deposit ratio of banks is also monitored by the Reserve Bank since this ratio indicates the extent to which banks are funding credit with borrowings from wholesale markets (now known as purchased funds). Third, asset liability management guidelines for dealing with overall asset-liability mismatches take into account both on and off balance sheet items. Finally, guidelines on securitization of standard assets have laid down a detailed policy on provision of liquidity support to Special Purpose Vehicles (SPVs). In order to further strengthen capital requirements, the credit conversion factors, risk weights and provisioning requirements for specific off-balance sheet items including derivatives have been reviewed. Furthermore, in India, complex structures like synthetic securitization have not been permitted so far. Introduction of such products, when found appropriate, would be guided by the risk management capabilities of the system. The Reserve Bank has also issued detailed guidelines on implementation of the Basel II framework covering all the three pillars with the guidelines on Pillar II. In tune with RBIs objective to have consistency and harmony with international standards, the Standardised Approach for credit risk and Basic Indicator Approach for operational risk have been prescribed. Minimum capital-to-risk-weighted asset ratio (CRAR) would be 9 per cent, but higher levels under Pillar II could be prescribed on the basis of risk profile and risk management systems. The banks were asked to bring Tier I CRAR to at least 6 per cent before March 31, 2010. After analyzing the global schedule for implementation, it was decided that all foreign banks operating in India and Indian banks having a presence outside India should migrate to Basel II and all other scheduled commercial banks encouraged to migrate to Basel II in alignment with them. In addition to the exercise of normal prudential requirements on banks, the Reserve Bank has also successively imposed additional prudential measures in respect of exposures to particular sectors, akin to a policy of dynamic provisioning. For example, in view of the accelerated exposure observed to the real estate sector, banks were advised to put in place a proper risk management system to contain the risks involved.
Banks were advised to formulate specific policies covering exposure limits, collaterals to be considered, margins to be kept, sanctioning authority/level and sector to be financed. In view of the rapid increase in loans to the real estate sector raising concerns about asset quality and the potential systemic risks posed by such exposure, the risk weight on banks' exposure to commercial real estate was increased from 100 per cent to 125 per cent in July 2005 and further to 150 per cent in April 2006. The risk weight on housing loans extended by banks to individuals against mortgage of housing properties and investments in mortgage backed securities (MBS) of housing finance companies (HFCs) was increased from 50 per cent to 75 per cent in December 2004, though this was later reduced to 50 per cent for lower value loans. Similarly, in light of the strong growth of consumer credit and the volatility in the capital markets, it was felt that the quality of lending could suffer during the phase of rapid expansion. Hence, as a counter cyclical measure, the Reserve Bank increased the risk weight for consumer credit and capital market exposures from 100 per cent to 125 per cent. An additional feature of recent prudential actions by the Reserve Bank relate to the tightening of regulation and supervision of Non-banking Financial Companies (NBFCs), so that regulatory arbitrage between these companies and the banking system is minimized. The overarching principle is that banks should not use an NBFC as a delivery vehicle for seeking regulatory arbitrage opportunities or to circumvent bank regulation(s) and that the activities of NBFCs do not undermine banking regulations. The rate of increase in foreign exchange market turnover was the highest amongst the 54 countries covered in the latest Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements (BIS). According to the survey, daily average turnover in India jumped almost 5-fold from US $ 7 billion in April 2004 to US $ 34 billion in April 2007; the share of India in global foreign exchange market turnover trebled from 0.3 per cent in April 2004 to 0.9 per cent in April 2007. There has been consistent development of well-functioning, relatively deep and liquid markets for government securities, currency and derivatives in India, though much further development needs to be done. However, as large segments of economic agents in India may not have adequate resilience to withstand volatility in currency and money markets, our approach has been to be increasingly vigilant and proactive to any incipient signs of volatility in financial markets. In brief, the Indian approach has focused on gradual, phased and calibrated opening of the domestic financial and external sectors, taking into cognizance reforms in the other sectors of the economy. Financial markets are contributing to efficient channelling of domestic savings into productive uses and, by financing the overwhelming part of domestic investment, are supporting domestic growth. These characteristics of India's external and financial sector management coupled with ample forex reserves coverage and the growing underlying strength of the Indian economy reduce the susceptibility of the Indian economy to global turbulence.
economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from these international developments. The risks arise mainly from the potential reversal of capital flows on a sustained medium-term basis from the projected slow down of the global economy, particularly in advanced economies, and from some elements of potential financial contagion. In India, the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of the Indian corporate sector, and the predominant domestic financing of investment. As might be expected, the main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09. Total net capital flows fell from US$17.3 billion in April-June 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well. While Foreign Direct Investment (FDI) inflows have continued to exhibit accelerated growth (US$ 16.7 billion during April-August 2008 as compared with US$ 8.5 billion in the corresponding period of 2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in AprilSeptember 2008 as compared with a net inflow of US$ 15.5 billion in the corresponding period last year. Similarly, external commercial borrowings of the corporate sector declined from US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in response to policy measures in the face of excess flows in 2007-08, but also due to the current turmoil in advanced economies. With the existence of a merchandise trade deficit of 7.7 per cent of GDP in 2007-08, and a current account deficit of 1.5 per cent, and change in perceptions with respect to capital flows, there has been significant pressure on the Indian exchange rate in recent months. As on October 2008 US $ 1 was equal to Rs.48.74. The following table shows the Trends in Capital Flows for the period 2007-08 to 2008-09.
Table- Trends in Capital Flows (US $ Million) Period April-August April Sept 26 April- June April- June April-August April-September 26 September 26, 2008
Component Foreign Direct Investment to India FIIs (net) External Commercial Borrowings (net) Short-term Trade Credits (net) Memo: ECB Approvals Foreign Exchange Reserves (variation) Foreign Exchange Reserves (end-period)
With the volatility in portfolio flows having been large during 2007 and 2008, the impact of global financial turmoil has been felt particularly in the equity market. The BSE Sensex increased significantly from a level of 13,072 as at end-March 2007 to its peak of 20,873 on January 2008 in the presence of heavy portfolio flows responding to the high growth performance of the Indian corporate sector. However, the corporate sector has, in recent years, mobilized significant resources from global financial markets for funding, both debt
and non-debt, their ambitious investment plans. The current risk aversion in the international financial markets to EMEs could, therefore, have some impact on the Indian corporate sectors ability to raise funds from international sources and thereby impede some investment growth. Such corporates would, therefore, have to rely relatively more on domestic sources of financing, including bank credit. This could, in turn, put some upward pressure on domestic interest rates. Moreover, domestic primary capital market issuances have suffered in the current fiscal year so far in view of the sluggish stock market conditions. The financial crisis in the advanced economies and the likely slowdown in these economies could have some impact on the IT sector. According to the latest assessment by the NASSCOM, the software trade association, the current developments with respect to the US financial markets are very eventful, and may have a direct impact on the IT industry and likely to create a downstream impact on other sectors of the US economy and worldwide markets. In summary, the combined impact of the reversal of portfolio equity flows, the reduced availability of international capital both debt and equity, the perceived increase in the price of equity with lower equity valuations, and pressure on the exchange rate, growth in the Indian corporate sector is likely to feel some impact of the global financial turmoil In short India's financial sector is not deeply integrated with the global financial system, which spared it the first round adverse effects of the global financial crisis and left Indian banks mostly unaffected. However, as the financial crisis morphed in to a full-blown global economic downturn, India could not escape the second round effects. The global crisis has affected India through three distinct channels: financial markets, trade flows, and exchange rates. The reversal in capital inflows, which created a credit crunch in domestic markets along with a severe deterioration in export demand, contributed to the decline of gross domestic product by more than 2 percentage points in the fiscal year 20082009. In line with efforts taken by governments and central banks all over the world, the Government and the Reserve Bank of India took aggressive countercyclical measures, sharply relaxing monetary policy and introducing a fiscal stimulus to boost domestic demand. However, this paper argues that with very limited fiscal maneuverability and the limited traction of monetary policy, policy measures to restore the Indian gross domestic product growth back to its potential rate of 8 9% must focus on addressing the structural constraints that are holding down private investment demand.
2007 and 2008. Concerns that investment bank Bear Stearns would collapse in March 2008 resulted in its fire-sale to JP Morgan Chase. The crisis hit its peak in September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG.
Measures Taken by the Reserve Bank during SeptemberOctober 2008 in Response totheGlobalFinancialMarketDevelopments
CRR cut by 250 basis points to 6.5 per cent, effective fortnight beginning October 11, 2008 Repo rate cut by 100 basis points to 8.0 per cent As a temporary measure, banks permitted to avail of additional liquidity support under the LAF to the extent of up to 1 per cent of their NDTL. The mechanism of Special Market Operations (SMO) for public sector oil marketing companies instituted in June-July 2008 taking into account the extraordinary situation then prevailing in the money and forex markets will be instituted when oil bonds become available. Under the Agricultural Debt Waiver and Debt Relief Scheme Government had agreed to provide to commercial banks, RRBs and co-operative credit institutions a sum of Rs.25,000 crore as the first installment. At the request of the Government, RBI agreed to provide the sum to the lending institutions immediately. Interest rates on FCNR (B) Deposits and NRE(R)A deposits were increased by 100 basis points each to Libor/Euribor/Swap rates plus 25 basis points and to Libor/Euribor/Swap rates plus 100 basis points, respectively.
Banks allowed to borrow funds from their overseas branches and correspondent banks up to a limit of 50 per cent of their unimpaired Tier I capital as at the close of the previous quarter or USD 10 million, whichever is higher, as against the existing limit of 25 per cent. Special 14 days repo to be conducted every day up to a cumulative amount of Rs.20,000 crore with a view to enabling banks to meet the liquidity requirements of Mutual Funds. Purely as a temporary measure, banks allowed to avail of additional liquidity support exclusively for the purpose of meeting the liquidity requirements of mutual funds to the extent of up to 0.5 per cent of their NDTL. Under the existing guidelines, banks and FIs are not permitted to grant loans against certificates of deposits (CDs). Furthermore, they are also not permitted to buy-back their own CDs before maturity. It was decided to relax these restrictions for a period of 15 days effective October 14, 2008, only in respect of the CDs held by mutual funds. For fine-tuning the management of bank reserves on the last day of the maintenance period, a second LAF (SLAF) on reporting Fridays, was introduced with effect from August 1, 2008. It was decided to conduct the SLAF on a daily basis.
Thus we can conclude that India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. Indias growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. It also has a very comfortable level of forex reserves. The credit derivatives market is in an embryonic stage; the originate-to-distribute model in India is not comparable to the ones prevailing in advanced markets; there are restrictions on investments by residents in such products issued abroad; and regulatory guidelines on securitization do not permit immediate profit recognition. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking,
and financial markets from becoming extremely volatile and turbulent. REFERENCES
[1] Daniel Cho Causes of Financial Crisis [2] Williams, Mark T. (March 2010). Uncontrolled Risk: The lessons of Financial Crisis-Tata. Mcgraw-Hill.. [3] The Financial Times Global Financial Crisis
FinancialInnovations:EngineofGrowth orSourceofFinancialCrisis
Dr.VarshaAinapure*
AbstractBoard as a Corporate Governance Mechanism - A Comparative Study of Indian Information Technology Companies The corporate financial scandals of the early 2000s, which brought down Bearings Bank and Enron necessitated a new emphasis on corporate and individual ethics. Corporate governance is about commitment to values and ethical business conduct. It is about how an organization is managed. The literature on corporate governance identifies the board as a prominent corporate governance mechanism. This paper concentrates on various aspects of directors and board structure. It examines the role of directors, and looks at the important areas of independence of the directors, board sub-committees and composition of the board that affect corporate governance. Governance practices of some of the Information Technology companies have been studied for the year 2006-07. This study analyses the following Board characteristics used by the sample companies - Independent Directors' Shareholding in the Companies, Bifurcation of Chairman and CEO Posts, Composition of the Board, Director Tenures, The Presence of Lead Director, The Board Committees and Independence, Number of Directorships of Directors and Frequencies of Board and Committees Meeting. The study concludes by proving that majority companies are concerned about conformance and compliance to the regulatory framework rather than looking at corporate governance from a strategic perspective. Keywords: Corporate Governance, Independent directors, Composition of the Board, Board Sub-committees, Lead Director
INTRODUCTION
For a quarter of a century before 2007 finance basked in a golden age. Financial globalisation spread capital more widely, markets evolved, businesses were able to finance new ventures and ordinary people had unprecedented access to borrowing and foreign exchange. Modern finance improved countless lives. But in 2007 something went awry. Financial services were in ruins first in America and then all over the world. Perhaps half of all hedge funds went out of business. Without government aid, so would many banks. Britain suffered its first bank-run since 1870s. The Wall Street grandees had been humbled. Hundreds of thousands of people in financial services lost their jobs; many millions of their clients lost their savings. When the financial system fails, everyone suffers. Over the years 2007-08 the shock spread from American housing, sector by sector, economy by economy. Some markets were completely seized up; others were being pounded by volatility. Everywhere businesses were going bankrupt and jobs were being destroyed. For the first time since 1991 global average income per head was falling. Even as growth in emerging markets came to a halt, the rich economies looked set to shrink. Alan Greenspan, who as chairman of Americas Federal *Nagindas Khandwala College of Commerce, Mumbai
Reserve oversaw the boom, called the collapse a once-in-a-half-century, probably once-in-acentury type of event. Barry Eichengreen of the University of California at Berkeley and Michael Bordo of Rutgers University identified 139 financial crises between 1973 and 1997, compared with a total of only 38 between 1945 and 1971. Crises are twice as common as they were before 1914, the authors concluded. Financial panics have become almost commonplace; events that are meant to occur once in a millennium now seem to occur every few years. In 2006 Americas current-account deficit peaked at 6% of its GDP. Between 2000 and 2008 the country received over $5.7 trillion from abroad to invest, equivalent to over 40% of its 2007 GDP. Over the same period Britain and Ireland absorbed around a fifth of their 2007 GDPs. The financial system had the job of recycling the money to borrowers. Inevitably, credit became cheaper and savings declined. In America savings fell from around 10% of disposable income in the 1970s to 1% after 2005. The question is why did America, home to the worlds most advanced financial system, turn foreign credit into the worlds most serious post-war bust? Probably the American know-how and talent made the disaster worse. Thanks to financial innovations like credit default swaps, collateralized debt obligations (CDOs), and negatively amortizing mortgages the world experienced enormous explosion of indebtedness. This ultimately led to global financial meltdown.Of all the financial instruments to have failed, CDOs turned out to be the most devastating. Before studying more about causes and effects of financial crisis, some terms used in this paper are explained.
TERMS EXPLAINED
Collateralised-debt obligations (CDOs): CDOs, says Raghuram Rajan, a professor at the University of Chicago, is as a mechanism for converting mortgage securities and corporate bonds from huge, illiquid assets owned by local investors into liquid financial instruments that could be flogged across the world. Innovation: National Knowledge Commission (2007) defines Innovation as: "Innovation is defined as a process by which varying degrees of measurable value enhancement is planned and achieved, in any commercial activity. This process may be breakthrough or incremental, and it may occur systematically in a company or sporadically; it may be achieved by: Introducing new or improved goods or services or Implementing new or improved operational processes or Implementing new or improved organizational/managerial processes in order to improve market share, competitiveness and quality, while reducing costs."
Subprime Lending: means the practice of making loans available to borrowers who do not qualify for normal market interest rate loans due to various risk factors, such as income level, size of the down payment made, credit history and employment status. Subprime Mortgages: are defined as housing loans which do not conform to the criteria for prime mortgages, and also have a lower probability of the full repayment of mortgages.
According to Federal banking and thrift regulatory agencies, subprime mortgages are those made to borrowers who display among other characteristics, (i) a previous record of delinquency, foreclosure or bankruptcy, (ii) a low credit score, and/or (iii) a ratio of debt service to an income of 50% or greater (Office of the Comptroller of the Currency, et al, 2007). Securitization: is a type of structured finance which turns mortgage loans into financial securities by taking existing loans or assets backed by their future cash flows. It involves the pooling of financial assets, particularly assets for which readymade secondary market does not exist. Securities are sold in the market, after separating them into tranches. The main advantage of securitization is that the lender or the originator of the loan gets a lump sum amount, rather than the interest and principal payments over the loan's term and period. In this way, it provides lenders an additional cushion and flexibility to re-lend the capital for new projects. Hence, it provides the capital to investors at the lowest cost, increases liquidity for lenders and helps lenders and investors better manage their financial risk.
During the period of the housing property bubble in the US, when property price was rising, many homeowners used the increased property value to refinance their houses with lower interest rates available in the market. Such second mortgages against the increased value of home ownership were used for personal consumer spending. In 2007, the US household debt was 130% (as a percentage of income), which was considerably higher compared to 100% recorded in the last decade.
Once, the housing bubble burst and prices started dropping sharply, home loan refinancing became more and more difficult. Defaults and foreclosure activity increased steeply as Adjustable Rate Mortgages (ARM) interest rates reset higher, making it even more difficult for borrowers to repay. The US subprime crisis began after the housing bubble burst, which ultimately resulted in high default rates on higher risk borrowers, such as subprime and other ARM. Subprime borrowers were influenced by mortgage loan incentives and the trend of rising home prices to assume large mortgage loans, considering that they would be able to refinance existing mortgage loans with more favorable terms later on.
property loans; excessive speculation in property prices during the strong period of economy; high-level of personal and corporate debt; lack of proper government control and regulation and innovation of structured financial products that concealed the risk of mortgage default for subprime clients. According to a research study conducted by Federal Reserve of US, between 2001 and 2007, the average difference between subprime and prime mortgage interest rates decreased drastically from 280 to 130 basis points. It means that the risk premium considered by lenders or loan issuers to offer a subprime loan to clients, declined. Mortgage underwriting practices, such as automated loan approvals, have also been responsible for subprime crisis, as such approvals were not subjected to appropriate review and documentation. In 2007, 40% of all subprime loans resulted from automated underwriting. The securitization process, which provides a secondary market for mortgage transactions also had a role to play in the crisis. The issuers of mortgages were no longer compelled to hold them to maturity. Pooled assets created by securitization, act as collateral for new financial assets issued by financial institutions. In this way, mortgages with a high risk of default could be derived effectively through Mortgage Backed Securities (MBS) and CDOs, by shifting inherent risks from the mortgage issuer to the investors. The deteriorating situation was further compounded by the failure of the financial markets to recognize the fast changing mortgage scenario and suitably modify their lending and risk management practices. The credit and default risk inherent in the new mortgage structures was not fully recognized. Hence, such risks were not fully reflected in the overall credit ratings of the repackaged financial offerings such as MBS. Credit Rating Models must ensure constant credit monitoring, so that the fast changing environment of the global economy is reflected and accounted in the credit rating processes. Credit rating agencies, such as Moody's, Fitch and Standard & Poor's, gave triple-A ratings to a broad spectrum of subprime mortgage securities -- implying that they were nearly risk-free when, as it soon became clear, they were not.
CORRECTIVE MEASURE
This financial crisis laid bare fundamental weaknesses in the global economy. Confidence in the market as the main mechanism for efficiently allocating resources for economic growth has dropped dramatically, and debate now centers on what new regulations and additional restrictions are needed in the future. As for lessons to be learned, Botn, who worked at Banco Santander beginning in 1988, directing the bank's international expansion in the 1990s with responsibility for the Latin American, corporate banking, asset management and treasury areas; cited the importance of countercyclical measures and liquidity, the risks caused by non-intrusive supervision, and the limitations of local regulators. "We need supervisors who are on top of the situation and see [trends/events] as they happen." In addition, the industry has relied on local regulators and local supervisors "with zero coordination on the global level." There is no way to avoid systemic risk without" the ability to intervene when necessary. "
Corrado Passera, managing director and CEO of Intesa Sanpaolo in Milan, offered his view of the main causes of the financial crisis, including excessive leverage and lack of transparency in the derivatives market. Passera's three priorities for moving forward include first, focusing on limits to total leverage. "The enormous explosion of indebtedness during the last few years has been at the very root of the crisis We need to account not just for onbalance sheet liabilities but off-balance sheet liabilities... all the components of real indebtedness." Second, the new rules must make sure that liquidity management is under control. "You go bankrupt because you get in trouble with your liquidity. If you raise money short-term but lend money long-term, sooner or later you simply blow up." Third, "we need to put derivatives under control by moving towards standardization and in the direction of having these instruments only on regulated exchanges." The U.S. government and Congress have been looking at rating agency reform in an attempt to eliminate conflicts of interest; to set requirements as to how much information ratings agencies should be required to disclose, and to determine whether the agencies should be held liable for their ratings, among other issues. The Senate bill would establish an independent board to assign ratings agencies to securities, so issuers could not shop around for the best ratings. The bill would require the agencies to register with the Securities and Exchange Commission. The most popular reform is the move to centralize trading of derivatives, including hardto-value mortgage-backed securities. These bills would create a centralized exchange and clearinghouse that would make prices public, and assure that each party to a trade gets what it is due -- payment or delivery of securities -- even if the other party defaults
CONCLUSION
Leave it to Wall Street to give innovation a bad name. The world prizes out-of-the-box thinking in technology and culture, but they fear it in financeunderstandably, thanks to innovative disasters like credit default swaps, collateralized debt obligations. The big problem: It's hard to tell the beneficial ideas from the ones that are self-serving or dangerous. Many top economists, including former Federal Reserve Chairman Alan Greenspan, once lauded subprime mortgages as a fantastic innovation. Many free-market economists do acknowledge that some regulation is appropriate in the wake of the crisis. But some economists go further and argue that any financial innovation is guilty until proven innocent. Former International Monetary Fund chief economist Simon Johnson and James Kwak, authors of the popular Baseline Scenario blog, wrote in the summer issue of the journal Democracy that innovation often generates unproductive or even destructive transactions. The debate over innovation is about the Administration's proposed Consumer Financial Protection Agency, which would vet new financial products for safety. Bankers and laissezfaire economists object claiming that government is bad at picking winners and losers. Andrew W. Lo, director of the MIT Laboratory for Financial Engineering, favors letting
markets work: "Financial technology is no different from any other technology. It goes through a maturation process. Version 2.0 is going to be better than version 1.1." In the words of John Lipsky, First Deputy Managing Director, International Monetary Fund, `Despite the unsettling and even dramatic recent global experience with cutting edge finance, I believe that without a renewed effort to foster financial innovation in the global economy, all countriesincluding emerging market economieswill underperform their potential. The principal challenge for policymakers, then, is to strike an appropriate balance between financial openness that supports growth-enhancing innovation while at the same time implementing regulations and effective supervision that limit the potential risk of financial instability. Looking forward from the current conjuncture, financial innovation has three principal tasks. First, it should address the challenge of missing markets, such as those for the longterm financing that is required for creating long-lived assets, or for efficient risk sharing by providing appropriate insurance and hedging products. Second, it should deepen liquidity in existing markets, for example by reducing excessive reliance on a narrow base of depositors for funding. And, third, by raising the quantity and quality of investment, it can increase efficiency in the economy as a whole.
REFERENCES
[1] Knowledge@Wharton (2010), `Ushering in a 'New Financial World' While Avoiding the Excesses of the Old Published : July 14, 2010. [2] Knowledge@Wharton (2010),` Regulating the Unknown: Can Financial Reform Prevent Another Crisis?Published : June 09, 2010. [3] Reena Jana (2009), Business Week `Recession: The Mother of Innovation? [4] Peter Coy (2009), Business Week, ` Financial Innovation Under Fire:Can we protect consumers and still be creative? [5] Saurabh Agarwal, Megha Agarwal, Pankaj Kumar Jain, (2009) Indian Journal of Economics and Business, `Globalization, crisis and financial engineering in India. [6] John Lipsky, Dy. M.D. International Monetary Fund,(2010) Managing Financial Innovation in Emerging Markets at the Reserve Bank of India First International Research Conference [7] The Economist,(Jan. 2009), A special report on the future of finance, `Greedand fear. [8] The Economist (Oct.2010), A special report on the world economy The cost of repair : A battered finance sector means slower growth [9] Panic (2008), Ed. By Michael Lewis, Penguin Books.
GlobalMeltdownandIndianFinancial Market:SomeIssues
Dr.AnilG.Suryavanshi*
Abstract The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world. It is been found that the sub prime crisis as the major cause for the meltdown and as far as India is concerned IT, Real estate, Banking, Insurance, Indian capital market, and infrastructure industries were adversely affected. Rarely in economic history there has been any episode like the cataclysmic global meltdown seen since the second half of 2008. Though there is an impact of global meltdown on international business, it is a need of tomorrow to in introspect Indian business with remedies. The main focus of this research paper is to know the impact of global meltdown on Indian Financial Markets Keywords: global meltdown, financial institutions, impact, remedies.
INTRODUCTION
Meltdown or Recession is nothing but a phase of Business cycle. The term Business cycle in Economics refers to the wave-like fluctuations in the aggregate economics activity, particularly in employment, output and income. There are four phases of Business cycle 1) Prosperity phase 2) Recessionary phase 3) Depressionary phase 4) Revival or recovery phase. It is said that when a nations gross domestic product is affected negatively on account of a decline in the economic activities, the situation is described as an economic recession and when this recession continues for long, it can turn into depression. (Ruddar Datt, 2009). According to National Bureau of Economic Research in US defines an economic recession as, a significant decline in (the) economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales. Though Indian economy is a developing economy and overcome on the various problems in meltdown, Global economic crisis has definitely made an impact on Indian economy but not that extent which was expected. 1
started drying up and this affected investment in the Indian economy. It was; therefore, felt that the Indian economy will grow at about seven per cent in 2008-09 and at six per cent in 2009-10. The lesson of this experience is that India must exercise caution while liberalizing its financial sector. It is been found that the sub prime crisis as the major cause for the meltdown and as far as India is concerned IT, Real estate, Banking, Insurance, Indian capital market, and infrastructure industries were adversely affected. Rarely in economic history there has been any episode like the cataclysmic global meltdown seen since the second half of 2008. Though there is an impact of global meltdown on international business, it is a need of tomorrow to in introspect Indian financial market with remedies.
GlobalMeltdownandImpactonForeignFinancialMarket:SomeIssues
Impacts on Financial Institutions The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The IMF estimated that U.S. banks were about 60% through their losses, but British and Euro zone banks only 40%. 5 Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock, a medium-sized British bank and Countrywide Financial, as they could no longer obtain financing through the credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. The investment bank Bear Stearns was collapsed in March 2008 and resulted in sale to JP Morgan Chase. The financial institution crisis hit its peak in September and October 2008 and resulted in takeover of Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG. Credit Markets and the Shadow Banking System During the crises in September 2008, the equivalent of a bank run on the money market mutual funds, which was frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawals from money markets were $144.5 billion during one week, versus $7.1 billion the week prior. This interrupted the ability of corporations to rollover (replace) their short-term debt
WealthEffects
The New York City headquarters of Lehman Brothers There is a direct relationship between declines in wealth, and declines in consumption and business investment, which along with government spending represent the economic engine. Between June 2007 and November 2008, Americans lost an estimated average of more than a quarter of their collective net worth. By early November 2008, a broad U.S. stock index the S&P 500, was down 45% from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with futures markets signaling a 30-35% potential drop. Total home equity in the United States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total retirement assets, Americans' second-largest household asset, dropped by 22%, from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period, savings and investment assets (apart from retirement savings) lost $1.2 trillion and pension assets lost $1.3 trillion. Taken together, these losses total a staggering $8.3 trillion. Since peaking in the second quarter of 2007, household wealth is down $14 trillion. European Contagion The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and large reductions in the market value of equities and commodities.
ImpactonStockandFOREXMarket
The impact of global meltdown was observed in 2008 on equity market particularly. The withdrawals by foreign investors from Indian stock market have been affected during this period. FIIs had invested over Rs 10, 00,000 crore between January 2006 and January 2008, driving the Sensex 20,000 over the period. But from January, 2008 to January, 2009 this year, FIIs pulled out from the equity market partly as a flight to safety and partly to meet their redemption obligations at home. These withdrawals drove the Sensex down from over 20,000 to less than 9,000 in a year. It has seriously crippled the liquidity in the stock market. The stock prices have tanked to more than 70 per cent from their peaks in January 2008 and some have even lost to around 90 per cent of their value. Equity values are now at very low levels and many established companies are unable to complete their rights issues even after fixing offer prices below related market quotations at the time of announcement. Subsequently, market rates went down below issue prices and shareholders are considering purchases from the cheaper open market or deferring fresh investments. This situation naturally has upset the plans of corporate to raise resources in various forms for their ambitious projects involving heavy outlays. The withdrawals by the foreign investors has made burden on dollar demand and created problems before the domestic, corporate Indian financial system of creating the foreign fund. Because of this initially the impact of global meltdown has been limited to the stock market and the foreign exchange market, but it spreads to all sectors. Dollar purchases by FIIs and Indian corporations, to meet their obligations abroad, have also driven the rupee down to its lowest value in many years. Within the country also there has been a flight to safety. Within this period the Investors have shifted their investments from stocks and mutual
funds to bank deposits and from private to public sector banks. Even though it is observed that highly leveraged mutual funds and non-banking finance companies (NBFCs) have been affected in this situation.
ImpactontheIndianBankingSystem
The Indian banking system is not directly exposed to the sub-prime mortgage assets. According to my opinion, the saving of Indians has made a great help in maintaining the stability in financial transactions with bank. It has very limited indirect exposure to the US mortgage market, or to the failed institutions or stressed assets. As compare to US banking sector, Indian banks as the public sector and the private sector has financially sound, well capitalized and under well regulation. The average capital to risk-weighted assets ratio (CRAR) for the Indian banking system, as at end-March 2008, was 12.6 per cent, as against the regulatory minimum of nine per cent and the Basel norm of eight per cent. However, a few Indian banks had invested in the collateralized debt obligations (CDOs)/ Bonds which had a few underlying entities with sub-prime exposures. Thus it is observed that no direct impact on account of direct exposure to the sub-prime market. As compared to Indian Banking, the US has taken support of shadow banking. During the crises in September 2008, the equivalent of a bank run the money market mutual funds, which was frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawals from money markets were $144.5 billion during one week, versus $7.1 billion the week prior.
ImpactonIndustrialSectorandExportProspect
There is a crucial impact of meltdown over to the real world. If we consider the industrial sector, It has slowed down with industrial growth projected to decline from 8.1 per cent from last year to 4.82 per cent this year. The service sector, which contributes more than 50 per cent share in the GDP and there is slowing down, besides the transport, communication, trade and hotels & restaurants sub-sectors. The growth of manufacturing sector has also come down to 4.0 per cent in April-November, 2008 as compared to 9.8 per cent in the corresponding period last year. The export of gems and jewellery, fabrics and leather etc. is also come down. It is observed that this declining is the first in the last seven years. Export as a percentage of GDP in India is closer to 20 per cent. Therefore, the adverse impact of the global meltdown on our export though it is marginal; we have to take it seriously. Indian exporters are under unexpected pressure as global demand is set to slump frighteningly. The export growth was turn negatively in recent months and the government has scaled down the export target for the current year to $175 billion from $200 billion. For 2009-10, the target has been set at $200 billion.
LiberlisationImpact
With the collapse of Lehman Brothers and other Wall Street icons, there was growing recession which affected the US, the European Union (EU) and Japan. This was the result of large scale defaults in the US housing market as the banks went on providing risky loans without adequate security and the repaying capacity of the borrower. The principal source of transmission of the crisis has been the real sector, generally referred to as the Main Street. This crisis engulfed the United States in the form of creeping recession and this worsened the situation. As a consequence, US demand for imports from other countries indicated a decline. The industries most affected by weakening demand were airlines, hotels, real estate.. Industrial production and manufacturing output declined to five per cent in the last quarter of 2008-09. Consequently, a vicious cycle of weak demand and falling output developed in the Indian economy. A weakening of demand in the US affected our IT and Business Process Outsourcing (BPO) sector and the loss of opportunities for young persons seeking employment at lucrative salaries abroad. Indias famous IT sector, which earned about $ 50 billion as annual revenue, is expected to fall by 50 per cent of its total revenues. This would reduce the cushion to set off the deficit in balance of trade and thus enlarge our balance of payments deficit. It has now been estimated that sluggish demand for exports would result in a loss of 10 million jobs in the export sector alone. To lift the economy out of the recession the Government announced a package of Rs 35,000 crores in the first instance on December 7, 2008. The main areas to benefit were the following: HousingA refinance facility of Rs 4000 crores was provided to the National Housing Bank. Following this, public sector banks announced to provide small home loans seekers loans at reduced rates to step up demand in retail housing sector. o o o o o Loans up to Rs 5 lakhs: Maximum interest rate fixed at 8.5 per cent. Loans from Rs 5-20 lakhs: Maximum interest rate at 9.25 per cent. No processing charges to be levied on borrowers. No penalty to be charged in case of pre-payment. Free life insurance cover for the entire outstanding amount.
This means a borrower can get a loan up to 90 per cent of the value of the house. The government hopes to disburse Rs 15,000 to 20,000 crores under the new package. The housing package is the core of the governments new fiscal policy. It will give a fillip to other sectors such as steel, cement, brick kilns etc. Besides, the small and medium industries (SMEs) too get a boost by manufacturing all kinds of fittings and furnishings. The success of the housing package will, however, depend on the State governments efforts to free up surplus land so that land prices come down and the cost of housing becomes reasonable.
TextilesDue to declining orders from the worlds largest market the United States, the textile sector has been seriously affected. An allocation of Rs 1400 crores has been made to clear the entire backlog in the Technology Upgradation Fund (TUF) scheme. The Apparel Export Promotion Council (AEPC) Chairman, however, said: It is a disappointing package. The allocation of Rs. 1,400 crores has been pending for many years and thus, it is the payment of arrears only. There is nothing new in it. It would have been much better if more concrete measures have been taken to reverse the downturn in the exports of readymade garments and avoid further job losses in the textile sector. InfrastructureThe government has been proclaiming that infrastructure is the engine of growth. To boost the infrastructure, the India Infrastructure Finance Company Ltd. (IIFCL) has been authorized to raise Rs 14,000 crores through tax-free bonds. These funds will be used to finance infrastructure, more especially highways and ports. It may be mentioned that refinance refers to the replacement of an existing debt obligation with a debt obligation bearing better terms, meaning thereby at lower rates or a changed repayment schedule. The IIFCL will be permitted to raise further resources by the issue of such bonds so that a public-private partnership (PPP) programme of Rs 1, 00,000 crores in the highway sector is promoted. ExportsExports which accounted for 22 per cent of the GDP are expected to fall by 12 per cent. The governments fiscal package provides an interest rate subsidy of two per cent on exports for the labourintensive sectors such as textiles, handicrafts, leather, gems and jewellery, but the Federation of Indian Export Organization (FIEO) felt the measures are not enough as they will not make the exports price-competitive and, therefore, will not boost exports. G.K. Pillai, the Commerce Secretary, has estimated a loss of 1.5 million jobs in the export sector alone during 2008-09 on account of the $15 billion decline in the expected exports. Small and Medium Enterprises (SMEs)The government has announced a guarantee cover of 50 per cent for loans between Rs 50 lakhs to Rs 1 crore for SMEs. The lock in period for loans covered under the existing schemes will be reduced from 24 months to 18 months to encourage banks to cover more loans under the scheme. Besides, the government will instruct state-owned companies to ensure prompt payment of bills of SMEs so that they do not suffer on account of delay in the payment of their bills.
In short, the fiscal package is aimed at boosting growth in exports, real estate, auto, textiles and small and medium enterprises. The aim is to encourage growth and boost employment which has been threatened by the recession in the world economy, more especially in the United States. The purpose of the new package announced on January 1, 2009 was to minimize the pain. With this end in view, the new package included the following measures: To boost investment and spending to revive growth, the RBI cut the repo rate, which it charges on short-term loans to banks from 6.5 per cent to 5.5 per cent and also reduced the Cash Reserve Ratio (CRR)the share of deposits which has to be kept with the RBI from 5.5 per cent to five per cent.
To revive exports which has resulted in a contraction of industrial output, drawback benefits have been enhanced for some exporters. Export-Import Bank also gets Rs. 5000 crores as credit from the RBI. To help the realty sector, realty companies have been allowed to borrow from overseas to develop integrated townships. To boost infrastructure, the India Infrastructure Finance Company Ltd. (IIFCL) has been allowed to raise Rs 30,000 crores from tax-free bonds. Besides, Non-Banking Finance Companies (NBFCs) need no government approval to borrow from overseas for infrastructure projects. This will sustain the growth momentum on infrastructure. To make more funds available, ceiling on foreign institutional investments (FIIs) in corporate bonds has been increased to $ 15 billion from $ 6 billion. The purpose is to seek much bigger FII investment. To stimulate the Commercial Vehicles (CVs) sector, depreciation benefit on commercial vehicles has been increased form 15 per cent to 50 per cent on purchases. Besides, the States will get one-time funding from the Centre to buy buses for urban transport. In addition, public sector banks would provide finance firms funds for commercial vehicles. It is hoped that Tata Motors and Ashok Leylands sales would revive.
On February 24, 2009, the government announced a slashing down of excise duty from 10 per cent to eight per centa reduction by two per cent. Since 90 per cent of the manufactured goods attract 10 per cent excise duty, this measure is designed to reduce the prices of colour TV sets, washing machines, refrigerators, soap, detergents, colas, cars and commercial vehicles. Cement prices are likely to drop Rs 4-5 per bag of 50 kg while steel prices may cost Rs 500-600 per tonne less. In addition to this, the government decided to cut service tax form 12 per cent to 10 per centa reduction by two per cent. As a consequence, phone bills, airline tickets, credit card charges, tour packages etc. would cost less. A two per cent reduction in service tax will directly touch the lives of over 500 million persons by reducing monthly expenses. The entire stimulus package of Rs 30,000 crores to boost demand in the economy and thus reduce the impact of recession.
CONCLUSION
The impact of global meltdown is not only on one sector but all economic sectors, but India has not suffered far from high problems. The RBI and government of India have given very good packages to all sectors for survival in future. Finally, The Companies and Management may follow the simple suggestions to protect themselves from the Global Recession i.e. all sectors have to create their own financial stability for overcoming the economic situations. If they believe in Security, protecting, improvement, reshape with technology and sustainability, no doubt they have a bright future.
REFERENCES
[1] R Ruddar Datt: Meltdown and its Impact on the Indian Economy, Mainstream Weekly, Vol XLVII, No 15, March 28, 2009, a well-known economist, is a Visiting Professor, Institute of Human Development, New Delhi. [2] R Report on Indian capital markets By IANS Tuesday, 29 January 2008, 09:48 RHrs, The Economics times of India. [3] R www.nseindia.com, www.bseindia.com, www.google.co.in [4] R Payel Jain, Vinod Kothari & Company, Indian Financial Market: A quick Rintroduction, (payel@vinodkothari.com) [5] "Bloomberg-U.S. European Bank Writedowns & Losses-November 5, 2009". Reuters.com. November 5, 2009. [6] HM Treasury, Bank of England and Financial Services Authority (September 14, 2007). "News Release: Liquidity Support Facility for Northern Rock plc". [7] Roger C. Altman. "Altman - The Great Crash". Foreign Affairs. http://www.foreignaffairs.org/20090101faessay88101/roger-c-altman/the-great-crash-2008.html [8] V. Padmanabhan, July 02, 2009, article on U.S Financial Crisis and ITS Impact on Indian Markets [9] The Global Economic Crisis: Assessing Vulnerability with a Poverty Lens, The World Bank Policy Note, Newsletter n. 5, February 2009 [10] Kum Kum Dasgupta, Less on our plate, The Hindustan Times, December 30, 2008 [11] The Global Financial Turmoil and Challenges for the Indian Economy Speech by Dr. D. Subbarao, Governor, Reserve Bank of India at the Bankers' Club, Kolkata on December 10, 2008 [12] Global Economic Crisis and its Impact on India Rajya Sabha Secretariat, New Delhi, June 2009 [13] Global Financial and Economic Crisis: Impact on India and Policy Response Rajiv Kumar, Director & Chief Executive, Indian Council for Research on International Economic Relations (ICRIER), New Delhi p.p. 9 [14] Global Meltdown and India - Issues, Concerns and Challenges, V. Basil Hans St Aloysius Evening College, Mangalore (INDIA), April 8, 2009.
Track6
InfrastructureFinance
InfrastructureFinanceContrivance forEconomicRipeness
Dr.NavneetJoshi*andKhushbooGupta*
AbstractThe economic advancement of a country critically depends upon availability of adequate physical infrastructure. This includes transportation (roads, ports, railways, and airports), energy (generation and transmission), communications (cable, television, fiber, mobile and satellite) and agriculture (irrigation, processing and warehousing). India, being a fast emerging country, has been the focal destination for such infrastructure development over a decade. Considering the efforts of Indian government, the study critically evaluates the development of Indian infrastructure which says that financing such developments has been the critical factor for the success of the same. Consequently, infrastructure finance is undergoing an unprecedented boom with the sectors stable cash flows, attracting the interests of whole range of structured financiers including both the debt and equity. The study finds that there is a dire need for large and continuing amounts of investment in almost all areas of infrastructure in India. The key issue is, while the need exists, how these projects will get financed. There are certainly issues surrounding the availability of suitable intermediaries with an adequate amount of risk capital for infrastructure financing. While Foreign Direct Investment (FDI) has the potential to provide some of the equity capital, it appears very likely that the Government itself would have to emerge as the provider of the bulk of this risk capital with banks and capital markets providing the bulk of the debt finance. This paper attempts to address these issues: a) Increasing the supply of infrastructure finance b) Facilitating the flow of funds to infrastructure finance sector, c) Enha*ncing the role of banks as intermediaries for infrastructure finance. Keywords: Infrastructure, Developing, Infrastructure Finance, Capital market,Risk
INTRODUCTION
Availability of viable physical infrastructure serves as the corner stone of an economy, whether being developed or developing. Although, the drivers for infrastructural development may vary from country to country, the need and demand for the same are always directed upward. For instance, on one side, developed economies of the world are aggressively indulged in upgrading their infrastructure; the emerging economies are vigorously paying attention on building new infrastructure so as to facilitate economic growth and prosperity. This is largely due to the fact that there remains strong linkage between the economic growth and infrastructure development of a country. The development of physical infrastructure including transportation (roads, ports, railways, and airports), energy (generation and transmission), communications (cable, television, fiber, mobile and satellite) and agriculture (irrigation, processing and warehousing) serves as a barometer of a country economic growth and prosperity. *Jagan Institute of Management Studies, Delhi
Thus, infrastructure development is critical for sustainable growth of India. It has often been noted that the unavailability of sound infrastructure i.e. shoddy roads, irregular energy supply, lack of water and sanitation has been the major constrains restraining the overall economic growth potential of the country. A major area of concern for sustaining the real GDP growth in India has been lack of adequate infrastructure, which can support the growth process. The deplorably low levels of public investment have rendered Indias physical infrastructure incompatible with large increases in the national product and clearly, without improving the rate of infrastructure investment, the overall growth rate at best would remain modest. However, the country continues to witness growing demand for infrastructure over a period of time, mainly since the economic liberalization and industrialization, the time when major MNCs entered into the country. The country reported a GDP growth of more than 8% even during the financial crisis. But, India has not been able to meet the growing demand for infrastructure due to numerous reasons such as lack of funds, sound investment policies, regional disparities, private sector intervention, to name a few. Among all said factor, availability of investment funds has emerged as the most critical element for the successful infrastructural development in India. In this regard, the research paper discusses various aspects of infrastructure finance in India.
DefiningtheInfrastructureFinanceMarketinIndia
In India, Infrastructure financing has a long way to penetrate in order to sustain the uptrend in the cycle of growth. It has critical dimensions and contributes to increased investment and productivity, which is vital for an economy like India. It is thus important to know as what comprises infrastructure financing. Infrastructure projects differ in significant ways from manufacturing projects and expansion and modernization projects undertaken by various companies. To define, infrastructure financing has following characteristics: Infrastructure finance tends to have long term maturities, ranging from around 5 years to 40 years. Infrastructure projects require huge investments. For example a kilometer of road or a mega-watt of power could cost as much as several Crore rupees and consequently large amounts could be required per project. Since large amounts are typically invested for long periods of time, it is not surprising that the underlying risks are also quite high. The risks arise from a variety of factors including demand uncertainty, environmental transformations, technological obsolescence (in some industries such as telecommunications) and very importantly, political and policy related uncertainties. Infrastructure financing results in fixed and low (but positive) real returns. The annual returns here are often near zero in real terms. However, once again as in the case of demand, while real returns could be near zero, they are unlikely to be negative for extended periods of time (which need not be the case for manufactured goods). The infrastructure projects are characterized by non-recourse or limited recourse financing, i.e., lender can only be repaid from the revenues generated by the projects requiring to the large scale of investments.
The official data by the Indian government recently revealed that the investment in infrastructure in the first three years of the 11th Plan (2007-12) had already exceeded the target of Rs 9,81,119 Crore. The actual investment was Rs 10,65,828 Crore, which is 7.1% of the GDP and 109% of the targeted expenditure. Major areas for investment have been the sectors such as electricity, telecommunications, irrigation and oil and gas pipelines. Growth has certainly been driven by various measures undertaken by the Indian Government to enable greater flow of funds into the infrastructure sector such as the "takeout financing" scheme of the India Infrastructure Finance Company Ltd (IIFCL); separate classification of infrastructure non-banking finance companies (NBFCs); and, long-term infrastructure bonds with tax exemption up to Rs 20,000 for individual investors. Moreover, The Union Budget 2010-11 has provided resources amounting to Rs.1,73,552 Crore for upgrading rural and urban infrastructure. Several initiatives have been undertaken to accelerate the pace of project implementation. The policy framework, especially for the PPPs, has been modified by streamlining PPP approvals in the central sector through Public Private Partnership Appraisal Committee (PPPAC), introducing viability gap funding facility, providing finance through India Infrastructure Finance Company Ltd. (IIFCL), standardising contracts to regulate terminologies related to risk, liabilities and performance standards, etc.
SCOPE
The scope of infrastructure financing remains bullish for an emerging economy like India as there remain significant demand supply gaps in availability of infrastructure in the country. The main variants on the demand side are high growth aspirations, burgeoning population, urbanization along with the rapidly changing consumer lifestyle, rapid technological changes and globalization. In order to sustain the economic growth, Infrastructure development serves as a key driver of inclusive growth. It is already identified as one of the serious impediments to high growth in India in the coming years. With fast pace of economic growth and urbanization, availability of adequate facilities as well as upgrading the quality of existing infrastructure would assume paramount importance. Infrastructure development in new townships is a priority to redistribute the influx of growing population. Attention is to be paid to the rural infrastructure provision such as irrigation, electrification, roads, drinking water, sanitation, housing, community IT service, etc. Financial issues are often cited as the key constraint to the availability of provisions in an emerging economy like India.
In industrialized countries, public finance consists of government providing equity financing (seed capital) through general budget reserves, earmarked reserves, self-raised
funds (e.g. licensing fee, and sale, rental or leasing of government assets), and intergovernmental grants and fiscal transfers. Debt financing in the public finance system is through policy loans at concessional rates, supplier credits, and fixed income securities in the form of tax-secured bonds and revenue bonds secured by project-related revenue streams. In some cases, public debt financing is guaranteed by governments either explicitly or implicitly. Corporate finance consists of corporations providing equity financing through retained earnings and shareholders equity. Debt financing takes the form of commercial bank borrowing, subordinated debt (including convertible debentures and preferred stocks), privately-placed borrowing, and issuance of fixed income securities. These securities can be short-term in the form of commercial paper, or of longer durations in the form of corporate bonds. Debt is secured through collateralization of corporate assets and assignments of receivables. Much of the infrastructure-related debt incurred in recent years by State Owned Corporations in China has been through commercial bank borrowings. However, unlike in industrialised countries, much of this debt is implicitly guaranteed by governments, and is not fully collateralised from corporations own assets. Project finance consists of government, corporations and Pubic Private Partnership (PPP) financing investments solely through the revenue stream of the infrastructure projects without taking recourse to government guarantees. Most project finance is made available by projectspecific companies (often called the project company) with equity held by sponsors. Equity takes the form of sponsor investment in share capital of the project company. Debt is fully secured through the revenue stream of the infrastructure project; this stream is assigned to lenders through security agreements with trustees and does not appear on sponsor companies balance sheets. Debt financing usually takes the form of a combination of bank loans (usually syndicated for large projects), sponsor loans, subordinated loans, suppliers credits, and bonds of the project company. Corporate and project finance is clearly applicable only to private and club goods type of infrastructure for which there is sufficient revenue stream that can be legally collateralized to lenders.
PPPEmergingasamostViableSourceofInfrastructureFunding
A PPP refers to a contractual arrangement between a government agency and a private sector entity that allows for greater private sector participation in the delivery of public infrastructure projects through concession agreements which lay down the performance obligations to be discharged by the concessionaire. In comparison with the traditional models, the private sector in the PPP model assumes a greater role in planning, financing, design, construction, operation and maintenance of public facilities. Project risk is transferred to the party best positioned to manage the same. PPP projects have been found to be sources of various efficiencies such as resource allocation efficiency, production efficiency, and economic and social efficiency.
PotentialSourcesofEfficienciesfromPPPs
Type Resource Allocation Efficiencies Examples The private sectors motivation is on the completion of the project to a set of performance standards. Conversely, the public sector will have competing interests for operating resources, which may reduce the performance of the project over its life-cycle. The construction and operation of infrastructure may be Resources for a specific application can also be completed in less time and/or lower overall cost by using used more effectively; The ability to be more productive is developed during the private sector market-tested techniques and incentives for innovation. organizations years of practice delivering similar projects. Access to more capital allows more projects to be More efficient movement of goods and people; Improved funded on a fixed capital budget; Social benefits quality of life resulting from increased access to of infrastructure accrue faster as infrastructure is infrastructure. built sooner. `Definition Efficiencies are gained from the private sectors ability to allocate resources more effectively.
Production Efficiencies
Further, some of the commonly used PPP models are: Build-Transfer (BT): Under this model, the government contracts with a private partner to design and build a facility in accordance with the requirements set by the government. Upon completion, the government assumes responsibility for operating and maintaining the facility. This method of procurement is sometimes called DesignBuild (DB). Build-Lease-Transfer (BLT): This model is similar to Build-Transfer, except that after the facility is completed it is leased to the public sector until the lease is fully paid, at which time the asset is transferred to the public sector at no additional cost. The public sector retains responsibility for operations during the lease period. Build-Transfer-Operate (BTO): Under this model, the private sector designs and builds a facility. Once the facility is completed, the title for the new facility is transferred to the public sector, while the private sector operates the facility for a specified period. This procurement model is also known as Design-Build- Operate (DBO). Build-Operate-Transfer (BOT): This model combines the responsibilities of BuildTransfer with those of facility operations and maintenance by a private sector partner for a specified period. At the end of the period, the public sector assumes operating responsibility. This method of procurement is also referred to as Design-BuildOperate-Maintain (DBOM). Build-Own-Operate-Transfer (BOOT): Here the government grants a private partner a franchise to finance, design, build and operate a facility for a specific period of time. Ownership of the facility goes back to the public sector at the end of that period. Build-Own-Operate (BOO): In this model, the government grants a private entity the right to finance, design, build, operate and maintain a project. This entity retains ownership of the project. Design-Build-Finance-Operate/Maintain (DBFO, DBFM or DBFO/M): Under this model, the private sector designs, builds, finances, operates and/or maintains a new
facility under a long-term lease. At the end of the lease term, the facility is transferred to the public sector.
Fig.1:PublicandPrivateSectorResponsibilitiesinNewProjects Source: Closing the Infrastructunre Gap: The Role of public-Private partnerships, De;potte Researc
Despite its critical role in the development process in India, most of the state and local governments in India would not be in a position to undertake such investments and resultantly our various flagship programs had to depend on central assistance. While funding is understandably a key issue, it is needless to say that much of the success in creating the provision would depend upon some related non-financial factors like project viability, realization of user costs, avoiding time and costs overrun, contract enforcement and efficient utilization of funds. Traditionally the government bore the burden of building up infrastructure in India. However, the strategy of development has been revisited with economic reforms in the 1990s. Accordingly, the infrastructure industry has been opening up to the private players in various sectors. The Electricity (Supply) Act of 1948 was amended in 1991 to promote the entry of Independent Power Producers. Similarly, the National Highways Act of 1956 was amended in June 1995 to allow and attract private investment in road development, maintenance and operation. The telecommunications sector was deregulated and the Telecom Regulatory Authority of India (TRAI) was established in 1997 to oversee the industry. The private sector has exhibited increasing interest in infrastructure investment in India. Resultantly, the relative shares of public and private investment in total infrastructure investment during the Eleventh Plan are projected to be about 70 per cent and 30 per cent, respectively as compared with 80 per cent and 20 per cent, respectively during the Tenth Plan. It is interesting to note that private sector is anticipated to take up projects in telecommunications, ports and airports and private investment is envisaged to constitute more than 60 per cent of total investment in these sectors during the Eleventh Plan. For the power sector, the investment is expected to rise to 28 per cent and for the road sector to 34 per cent. On strength of these arguments, the government has endeavored to create a facilitating environment for large scale involvement of private sector in development of infrastructure. The private sector category includes PPP projects as well as pure private sector projects. While the former must be based on a Model Concession Agreement (MCA) with the government such as for toll roads, ports, and airports; the latter are market-based such as in telephony and merchant power stations.
Overall, there has been some notable progress in attracting private investment in the infrastructure industries. Usually investments from private sources are high in those sectors where user cost is well defined and easily recoverable. For the remaining segment, it is primarily the public investments that have to supplement infrastructure provisions given their importance in the economy. Irrigation, water supply, electricity and gas are the specific cases in point where user charges need to be defined and contract enforcement mechanism need to be strengthened further to ensure an uninterrupted flow of investments from private sources. Overall, the financing requirement from the private sectors during Eleventh Five Year Plan is estimated to be over 30 per cent from a little less than 20 per cent during the Tenth Plan period. The flagship Bharat Nirman Programme of the Government of India focuses on the provision of key rural infrastructure like irrigation, electrification, roads, drinking water supply and sanitation, affordable housing, and connectivity via community IT service centers.
BridgingtheInfrastructureFinancingGap
Considering the importance of infrastructural development in India, there has been evolved various measures and solutions to bridge the gap of what is required and what is available for infrastructure funding. One such measure is the inclusion of private sector funds, banks, and insurance companies in funding the infrastructure projects. Some larger funds globally are beginning to invest in infrastructure via private-equity funds, or, occasionally, even directly such as seen in Australian, Dutch and Canadian pension funds. Further, involvement of private sector investment in infrastructure will largely depend upon the capital market in India. Also it has been found that, there is a dire need to improve the depth and liquidity of the corporate bond market to provide an additional source of funds for infrastructure companies. Industry sources reveal that a number of factors such as limited investor base, limited number of issuers and preference for bank finance over bond finance are the main barriers for development of a deep and liquid corporate bond market in the country. Further, syndication of loans would diversify the risk in infrastructure financing, given the fact that a bank would not like to take upon itself the entire financing given the risks involved and the capital and consequent exposure constraints. One of the recent trends in financing the infrastructure has been the Public-Private Partnership (PPP) model which is being actively pursued in India to meet the gaps in the provision of basic infrastructure services. However, for such partnerships to be successful, the framework of PPP including pricing has to be transparent. The development finance model has to be characterized by good planning, strong commitment of the parties, effective monitoring, regulation and enforcement by the government. A separate Ministry for Infrastructure Development could help immensely in channelising governments efforts. The issue of pricing is crucial in view of the political sensitivities, while also simultaneously ensuring the viability of the project. According to the industry experts, credit enhancement to infrastructure by way of risk transfer and risk reduction could help bridge the gap in the Indian context. Lenders tend to look for credit enhancement from government like policy guarantees, refinancing and
maturity extension guarantees, grants/viability gap funding, etc. Similarly, non-government mechanisms like bond insurance, credit rating, etc. provide risk mitigation to the lenders. Providing credit enhancement by way of insuring the debt payment by insurance companies to banks for the loans extended by them towards infrastructure projects is a concept considered in the North American infrastructure Market. Besides this, the government can also offer various incentives such as issuance of Zero Coupon Bonds for infrastructure with income tax benefits to the individuals so as to increase their participation in infrastructure financing, thus helping India in development of its overall infrastructure. Active participation from the banks can also lead to a successful infrastructure finance market in India. It would ensure ample funding, strong interest, and awareness of a project on a global scale. Managerial incentives could be more aligned with productivity, thus reducing the widespread problems of cost overruns and inefficiency.
CONCLUSION
In India, Infrastructure finance market offers vast potential for growth as the development of sound infrastructure requires huge amounts of rupees to invest in. And, there has been found a large gap between the available funds to the required funds. Till now, it has been observed that traditional forms of government (or public) funding continue to dominate the infrastructure market. However, with the growing demand for infrastructure development, the proportion of public spending on infrastructure in the developed economies has been steadily falling. Government treasuries are being squeezed as they are geared-up close to breaking point, and taxes are at high levels. Major conclusions of the study are: The active participation of private sector funds, banks, and insurance companies in funding the infrastructure projects will pave the growth of the infrastructure financing market in India. Since the government alone cannot provide sufficient funds, the private sector has to complement the governments efforts in financing the development of infrastructure in India. The study vouches for the PPP model for infrastructure financing and the success of such models would require facilitating factors, such as, bureaucratic efficiency, adequacy of returns, efficient market mechanisms, information access, to name a few. The government should regulate the infrastructure financing in a way so as to ensure safety and security to the retail and corporate investors. Banks should also actively participate in providing finance. There should be introduced some innovative means to channelise the individual savings into infrastructure financing, such as offering income tax rebates, etc so as to bridge the required gap of many projects.
REFERENCES
[1] D. Bain, Economics of the Financial System Blackwell Publishing, 1992. ISBN10: 0631181970 [2] Alberto Giovannini (Ed.) Finance and Development: Issues and ExperienceCambridge University Press, 1993. ISBN10: 0521440173 [3] Bharti V.Pathak, The Indian Financial System (markets, institutions and services), Pearson Education, 2009, ISBN 978817758-562-9 [4] Ephraim Clark, Michel Levasseur, Patrick Rousseau, International Finance Thomson Learning, 1993. ISBN10: 1861523823 [5] Franklin Allen, Douglas Gale Understanding Financial Crises (Clarendon Lectures in Finance)Oxford University Press, 2007. ISBN10: 019925141X [6] Ferdinand E. Banks, Global Finance and Financial MarketsWorld Scientific, 2001. ISBN10: 9810243278 [7] Graham Bird, International Finance and the Developing EconomiesPalgrave Macmillan, 2004. ISBN10: 0333733975 [8] Gabrielle Demange, Guy Laroque, The Finance and the Economics of Uncertainty, WileyBlackwell, 2005. ISBN10: 140512139 [9] Henry A Davis Infrastructure Finance: Trends and Techniques ISBN: 978 1 84374 282 1 [10] J.C. Rochet, Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation Princeton University Press, 2008. ISBN10: 0691131465 [11] John R. Boatright (Ed.), Ethics in FinanceBlackwell Publishers, 1999. ISBN10: 0631214275 [12] John Eatwell, Murray Milgate, Peter Newman (Eds.) FinancePalgrave Macmillan, 1989. ISBN10: 0333495357 [13] Keith Pilbeam, International FinancePalgrave Macmillan, 1998. ISBN10: 0333730976 [14] Keith Pilbeam, Finance and Financial MarketsPalgrave Macmillan, 2005. ISBN10: 1403948356 [15] Kern Alexander, Rahul Dhumale, John Eatwell,Global Governance of Financial Systems: The International Regulation of Systemic Risk (Finance and the Economy)Oxford University Press Inc, USA, 2004. ISBN10: 0195166981 [16] L.M.Bhole, Jitendra Mahakud,Financial Institutions and Markets Tata McGraw-Hill Education Private Limited, New Delhi, 2009, ISBN-13987-0-07-008048-5 [17] Mohamed Ariff, Liberalization and Growth in Asia: 21st Century ChallengesEdward Elgar Publishing, 2005. ISBN10: 1843767910 [18] M.Y.Khan, Indian Financial System, Tata McGraw Hill, 2009, ISBN-139780070080492 [19] Mario I. Blejer, Zvi Eckstein, Zvi Hercowitz, Leonardo Leiderman (Eds.), Financial Factors in Economic Stabilization and Growth Cambridge University Press, 1996. ISBN10: 0521480507 [20] P.N.Varshney, Indian Financial System, Sultan Chand & Company, 2009, ISBN 9788180546259 [21] Pierre-Richard Agnor, Marcus Miller, David Vines, Axel Weber (Eds.),The Asian Financial Crisis: Causes, Contagion and Consequences (Global Economic Institutions)Cambridge University Press, 2006. ISBN10: 0521029007 [22] Roy Bailey, The Economics of Financial Markets, Cambridge University Press, 2005. ISBN10: 0521612802 [23] Robert J. Shiller, The New Financial Order: Risk in the 21st CenturyPrinceton University Press, 2004. ISBN10: 0691120110 [24] Roy E. Allen, The Political Economy of Financial Crises Edward Elgar Publishing, 2004. ISBN10: 1843761068
Track7
MergersandAcquisitions
SEBITakeOverCode2010:Assessment andEmergingIssues
C.S.Balasubramaniam*
Abstract Mergers and Acquisitions promote inorganic growth of a business enterprise that can help it to grow faster than the organic route for asset creation. The New Take over Code recommended by Takeover Regulations Advisory Committee (TRAC) headed by Shri Achutan has made a paradigm shift towards international best practices are evident from a number of proposed changes . However, it is also felt that it has not fully taken account of certain tropicalities and so may not automatically translate into a more efficient market for corporate control and greater room within the rules of fair play for all stakeholders. Part I spells out the types of corporate takeovers and benefits of a Takeover Code to the economy. Part II brings out the need for a new takeover code and the Composition of the Takeover Advisory Reforms Committee (TRAC) headed by Shri Achutan . Part III discusses the main recommendations and the comments /suggestions arising from the TRAC Report. The new Takeover code 2010 heralds a refreshing era for the corporates for whom the main drivers of change would be in the form of VET which means takeovers constantly involve scanning the business landscape by the acquirers keeping in mind Valuations, Efficiency and speed in implementation and Transparency in disclosures and information provided to the regulator SEBI and stakeholders alike. The Indian corporate legal system needs to change significantly in consonance with the pace of events in corporate takeover scenario.
INTRODUCTION
Mergers and Acquisitions promote inorganic growth of a business enterprise that can help it to grow faster than the organic route for asset creation. The New Take over Code recommended by Takeover Regulations Advisory Committee (TRAC) headed by Shri Achutan has made a paradigm shift towards international best practices are evident from a number of proposed changes . However, it is also felt that it has not fully taken account of certain tropicalities and so may not automatically translate into a more efficient market for corporate control and greater room within the rules of fair play for all stakeholders. Here it has been attempted to assess the main revisions in the New Take over Code and bring out the emerging issues for further discussion.
TheobjectivesofaTakeover
The Take over assumes significance from corporate management as well as macro economic aspects. In a take over, the management of the acquirer may maintain the legal identity of both the companies and operate them under the direction of separate Boards of Directors (having common directors) or the management may decide that both the companies should merge or amalgamate in a new company or one may amalgamate or merge with the other so that there is only one company, either the new company or the merged or the amalgamated *Allana Institute of Management Studies, Mumbai
company functioning under a unified command of a single Board of Directors. In either case, the object of a successful take over should be economic betterment of the shareholders, the management, staff and all other employees suppliers of raw materials and other consumables, personnel engaged in the marketing network, the ultimate consumer, the public at large and the Government. Besides being advantageous to the concerned companies, takeovers are also beneficial to the economy in a number of ways. Disciplining the capital market: Takeovers help in disciplining the market as inefficient and errant companies get taken over due to their low book value and share prices. This also helps in discovering the potential of the acquired companies. Consolidation of efforts & capacities: During the license era, Government authorised units to function below their minimum economic size .Such units were either incurring losses or earning marginal profits. Also, due to stringent control standards and emergence of MNCs, small units have realized the importance of conservation of resources &reduction of costs. However, due to lack of proper infrastructure and sufficient capacity they are unable to implement their schemes efficiently. Under such circumstances, takeovers can be effective mode for consolidation & efficiency
In the past, due to the restrictive licensing policies, large companies were not allowed to grow and diversify. Rigorous MRTP posed serious obstacles. Recent liberalization environment and FDI amendments have encouraged companies to concentrate on their core competencies. M&A or takeovers offer greener pastures and through these strategies, companies can rationalise their portfolios and enlarge entity value &leverages. Having discussed the pre liberalization scenario, now it is apt to bring out the kinds and modes of takeover:
SEBI Take Over Code 2010: Assessment and Emerging Issues 339
MODES OF TAKEOVERS
A takeover can take place in many ways. Some important ones are: Staged Acquisition: Staged Acquisition occurs in several stages with foreign investor initially acquiring only an equity stake, and gradually increasing their equity stake to 100 %...Staged acquisitions allow continued involvement of previous owners where they are unwilling to sell outright, or favoured to maintain legitimacy with local consumers. The major drawbacks of this mode of takeovers are (a) shared control being a source of conflict and (b) uncertainty over conditions of eventual take over. Multiple Acquisitions: This mode of acquisitions involves entry by acquiring several independent businesses, and subsequently integrating them. Through multiple acquisitions global players can build a nationwide strong market position in a traditionally fragmented market. Indirect Acquisition: This mode of acquisition occurs outside the local market of a company that also owns an affiliate in the same emerging economy. The main objective of the indirect acquisition may be outside the country. The affiliate may be a strategic asset motivating the acquisition, but this is rare. However, locally the local affiliate may or may not with the existing local operations.
Brownfield Acquisition: A Brownfield acquisition is one in which the foreign investor subsequently invests more resources in the operations .such that it almost resembles a Greenfield project. Brownfield acquisitions provide access to crucial local assets under control of local firms that are in many other ways not competitive. The major drawback in this form of acquisition is the post acquisition investments may exceed the price originally paid for the acquired firm.
The terms takeover and merger though used in common parlance as synonymous they are not the same. A merger involves the mutual decision of two companies to combine and become one entity; it can be seen as a decision made by two equals .The combined business, through structural and operational advantages secured by the merger, can result in reduction of costs and increase profits, enhancing values for both groups of shareholders. A typical merger, in other words, involves two relatively equal companies, which combine to become one legal entity with the goal of producing a company that is worth more than the sum of its parts. In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for equal number of shares in the merged entity. The takeover, on the other hand, is characterized by the purchase of a smaller company by a much a larger one. This combination of unequals can produce the same benefits as a merger, but it does not necessarily have to be a mutual decision. A larger company can initiate a hostile takeover of a smaller firm, which essentially amounts to buying the company in the face of resistance from the smaller companys management. Unlike in a merger, in a takeover, the acquiring firm usually offers a cash price per share to the target firms shareholders on the basis of a specified swap ratio.
TheChangesintheScenarioandtheRationale
SEBI introduced a formal takeover code in 1997, which helped set basic rules for mergers and acquisitions in the nascent market scenario for such transactions. However, the rules left scope for interpretation leading to many disputes including Gujarat Ambuja Cements purchase of a near 15% in rival ACC. SEBI did a further review of the takeover code in 2002 when it made greater disclosures at every level of holding mandatory and exempted preferential issues from the purview of the code. The company takeover code in India are set to get egalitarian and move closer to global best practices ,if the new take over code being framed now by the Committee headed by Shri Achutan gets implemented. The basic theme of the SEBI Takeover code 2010 is to provide fair play and transparency in acquisitions and takeovers but at the same time to ensure they are not stifled into extinction. The fair play is provided in terms of stipulation of a public offer to be made whenever there is a substantial acquisition or takeover so that the other shareholders get an equal exit route as well. The transparency is sought to be brought in through mandatory disclosures and guidelines on the conduct of the public offers. These recommendations, if implemented, will replace an archaic takeover rule that was amended 23 times in 13 years and created more confusion than clarifying the regulatory status of the law and SEBI. Average annual takeovers rose to 99 between 2006 and 2009, from an average of 69 a year between 1997 and 2005. The increasing sophistication of the takeover market in India along with rise
SEBI Take Over Code 2010: Assessment and Emerging Issues 341
in the interest of foreign players /MNCs in the takeovers in India .The decade long regulatory experience and various judicial pronouncements have also made it necessary to bring in a new take over code that would create a seamless changeover from the existing takeover code to the new scenario. The reforms in the corporate debt markets and rise in the number of Private equity players have further heralded the context of the new takeover code. Other factors that have compelled the revision in the code include the changes in the threshold level, pricing norm and public offer.
TheNewTakeoverCode2010
Now, we may discuss the Takeover Regulations Advisory Committee (TRAC) and its main recommendations. The composition of the Committee is as follows: Mr. C. Achuthan, Former Presiding Officer, Securities Appellate Tribunal Chairman. Mr. Kumar Desai, Advocate, High Court. Mr. Somasekhar Sundaresan, Advocate; Partner, J. Sagar Associates. Mr. Y.M. Deosthalee, Group Chief Financial Officer, Larsen and Toubro Ltd. Mr. Koushik Chatterjee, Group Chief Financial Officer, Tata Steel Ltd. Mr. A.K. Narayanan, President, Tamil Nadu InvestorsAssociation. Prof N. Venkiteswaran, Professor, Indian Institute of Management, Ahmedabad. Ms. Usha Narayanan, Executive Director, Corporation Finance Department, SEBI. Mr. J. Ranganayakulu, Director, Legal Department, SEBI, and Ms. Neelam Bhardwaj, General Manager, Division of Corporate Restructuring, SEBI
MainRecommendationsoftheTRACareasGivenasUnderAlongwithComments
New threshold of 25 % suggested by the Achutan Panel wields the power to stop special resolutions and acquires negative control : The initial trigger has been raised from 15% to 25% based on two counts, (1)a factual assessment of current shareholding patterns of listed companies which reveal that promoters are capable of exercising de facto control at 25 %and (2) a shareholder holding in excess of 25% has the ability to block special resolutions .Promoters may however be concerned by the mischief that may be caused by the predators holding just less than 25% who may exercise significant voting rights on account of the multiplier effect caused by the absenteeism at general meetings. De facto control as the primary trigger has also been hardwired into the definition of control, which is referenced not just against the right but also the ability to control .As a result, the control trigger continues to be an elusive and subjective determination in each case. The objectivity of control as a positive determination put forth by the Securities Appellate Tribunal (SAT) in the Shubhkam case currently in appeal before the Supreme Court has sadly not found favour with the Committee. There is however no longer a concept of greater control and joint-to-sole control has ceased to be a trigger.
Rise in quality of corporate governance and disclosures are considered to be in line with global best practices and would help in overall administration by SEBI over the capital market. In terms of continuous disclosures, perhaps the most significant point is the parity that it restores between a potential acquirer and the target company. A potential acquirer makes its intentions known though public announcements, but the shareholders of the target company get no information from their own Board as to the future course of action. The draft makes the Board of the target company accountable for making (and publishing) a recommendation to all stakeholders on the offer. That is, the Board should recommend either taking up the offer or dropping it, with adequate background justification. This parity is line with international best practices and will help shareholders to decide. It is hoped that independent directors will exercise jurisprudence with respect to some loose ends, such as the appointment of conflict free advisers. The Board could have taken this step further to include a mechanism for potential bidders to conduct due diligence thereby leveling the potential information advantage with the target companys Board. One item that will be debated for log time is the proposal to increase the trigger level for open offers from the current 15% to 25%. Segments of corporate (especially those with small promoters holdings) will no doubt baulk at the idea, as it increases the risk of hostile acquirers. But such is the reality that PE and other large investors will have to plan to hold larger stakes in companies, even if they do not have any acquisition plans. But before this clause turns into an unbridled license for incumbent promoters to poison-pill their companies, as extreme defensive action, perhaps the New Code could set indicators or markers to flag inappropriate corporate behavior which defeats the central idea of promoting good corporate governance. In a similar vein, the Code recommends that the offer size should be hiked from the current level of a minimum 20 % to all the shares of the target company, subject to the aggregate shareholding not exceeding the maximum permissible non-public shareholding. Though this raises the financing obligations of the potential acquirer and could potentially come in the way of the corporate M&As, it provides a fair mechanism for all shareholders to exit. At this point, the lack of a squeeze out provision becomes glaring. According to clause 7 (4) ,if the bidder acquires 90 % or more though the open offer ,the outstanding public investors have a put option on the bidder for one year post the open offer. But the bidder cannot squeeze out remaining shareholders. This is a somewhat unequal clause and makes capital markets route relatively unattractive for corporate transactions. Potential bidders and the target may seek off- market mechanisms, such as the sale of business operations, to the same end. However, regulatory changes to affect a squeeze out are beyond the purview of SEBI and would require changes in legislation. Given that SEBI and Stock exchanges places a great reliance on timely information flows to iron out arbitrage opportunities ,it seems odd why the draft recommendations of the Takeover code has not put forth a mechanism for forcing bidders/ target to make a public announcements of impending discussions ,in the event of abnormal
SEBI Take Over Code 2010: Assessment and Emerging Issues 343
share price movements. In the UK, for instance, any price movement of more than 5% requires target/ bidder to voluntarily inform the regulator. The regulator then judges if the price movement is on account of normal market movements or if market participants are potentially trading on unequal information creating a false market . In the context of asset stripping in the last few years, the Code states that the acquirer shall not dispose assets of the target company within a period of 2 years, unless the intention has been stated in the offer letter. This can logically be extended to areas beyond alienation of assets. Disclosures on strategic intent should go beyond asset disposals and also cover intent in relation to strategy, employees, facilities ( owned or leased) key contracts,etc.,Basically the Code could incorporate a framework in which the shareholders of the target company should get access to the acquirers intenton,before they evaluate an open offer. A separate regime for voluntary offers consolidation offers by controlling shareholders .In case of unsolicited /hostile offer by a new acquirer does not seem to be permissible. This is not justifiable is that an unsolicited/hostile offer by a new acquirer doesnt hold water. Mandatory exit to all (100 %) shareholders as against the current norm of 20% is a laudable move from shareholders perspective, though not investor friendly However ,public mergers and acquisitions will become more expensive and thereby deter takeovers Mandatory open offer for 100% of outstanding shares and provision for automatic delisting is a positive step .The existing procedures which forces the acquirers to effectively make two open offers one for control and the second for delisting was too cumbersome. A combination of Indian rules against financial assistance by the target company and limitations on acquisition financing by banks results in the creation of an unequal playing field between Indian & foreign players . Non cash payment option though available under the current code has not found favor with Indian corporate .Some stream lining here would be appropriate. The new Codes definition of control also needs to be tightened up significantly .It defines control as either the ability to appoint majority of directors or the ability to control the management or policy decisions . This undermines two scenarios .First is a situation of private equity investor with affirmative rights since by the definition of the Committee such investors would be deemed to be in control. Second is the scenario where the existing management may control 25% or less something that is true of several of Indias largest and most valuable companies .Under these circumstances, hypothetically speaking, if someone was to acquire 24% of the companys shares, that investor would wield dominant influence on management or policy decisions .Yet the current recommendations would not trigger the takeover code. A seamless go private has been made available to the new acquirers who buy out more than 90 % in an offer a route has not been extended to promoters holding above 25 %. Promoters have to necessarily initiate delisting procedures which may become expensive due to higher price offers through reverse book building route ,requisite approvals under SEBI procedures stock exchanges and Company Law Board
The pricing norm revisions would ensure that minority shareholders of the target company would not be cheated out of the price obtained by strategic shareholders Open offer obligation Initial trigger of an aggregate of 25 % or more voting rights in a target company would be required to make an open offer by the acquirer from the present 15%. The trigger for mandatory offer in the UK and Singapore is 30 %. To consider Creeping Acquisition trigger, an acquirer holding 25 % or more in a target company is allowed to acquire additional voting rights in the target company up to 5 % within a financial year, without making an open offer. Indirect acquisitions Acquisition of shares or voting rights in, or control over any entity that would enable the acquirer to exercise or direct the exercise of such percentage voting rights in, or control over the target company, as would attract the obligation to make an open offer would be regarded as an indirect acquisition, requiring the acquirer to make an open offer. If the indirectly acquired target company is a predominant part of the business entity being acquired, the Proposed Takeover Regulations would treat such indirect acquisition as a direct acquisition for all purposes. Voluntary open offer Shareholders holding shares entitling them to exercise 25 per cent or more of the voting rights in the target company may without breaching minimum public shareholding requirements under the listing agreement, voluntarily make an open offer to consolidate their shareholding. The impact of these recommendations would be to raise the cost of acquisitions substantially and only the serious bidders would go for the buyouts. While the proposed code regulations are aimed at creating a level playing field , the number of acquisitions would reduce ,given the buyers may have to invest at least double of what they have to with the Current regulations . Private equity firms would be placed better with the proposed code as they allow them to take a higher stake without having to make an open offer. The recommendations further raise a pointer towards the haziness in extant regulations such as the gap between the minimum public holding threshold for a listed company (75%) and the delisting threshold (90%). The efficiency drivers are largely dependent upon the buy-in by other regulators, in particular in relation to bank financing of take over and the treatment of shares tendered in an open offer as an on-market transaction for tax purposes .Foreign direct investment (FDI) rules may need to be amended to include swaps under the automatic route. Speedy adoption of the new code would raise the overall efficiency levels of the implementation process for corporate takeovers and mergers. Promoters with low holdings may be forced to raise stakes to pre-empt hostile takeovers Minority shareholders will be able to exit fully if the Acquirer cannot acquire shares in target firm for 26 weeks following completion of open offer. This will prevent acquirers from under pricing offers and later buying shares from secondary market. Equal tax treatment on gains due to sale of shares through open offer as well as those sold in the open market would encourage more people to tender shares in open offer Acquirer to accept shares in open offer proportionately, if response exceeds maximum permissible promoter shareholding of 75%, but fails short of delisting threshold of 90%, could affect and dampen the complete acceptance of their shares in
SEBI Take Over Code 2010: Assessment and Emerging Issues 345
open offer. However Indian businesses have become keen to sell their stakes cashing on the recent boom in stock market .Open offer formalities need to be completed within 57 days instead of 95 days as allowed currently will help in reducing unnecessary delays. The new code ensures justice to minority shareholders in the form of the mandatory offer of 100% of outstanding offer of shares has to be the same for all shareholders. Proposed changes would facilitate PE funded promoters/foreign acquirers as they have access to leveraged finance abroad/tax havens at a lower cost than that prevailing in Indian capital market . A combination of PE players or qualified institutional promoters (QIP), acting as concerted minority shareholders can now help in improving corporate governance of listed companies in India. The proposed changes in Takeover code provide a legal framework for orderly acquisition of shares and control and .provides for equitable treatment to all shareholders. The new Code facilitates leveraged buyouts and making the financing of takeovers easier and convenient to corporate rather than facing difficulties in implementing expansion/diversification strategies...Further the new take over code would facilitate strategic alliances and minority investments that can be equity accounted, and promote greater ownership from private equity investors. These changes will help acquisitions by making it simpler to acquire control and delist in one simple step. To conclude, the new Takeover code 2010 heralds a refreshing era for the corporates for whom the main drivers of change would be in the form of VET which means takeovers constantly involve scanning the business landscape by the acquirers keeping in mind Valuations, Efficiency and speed in implementation and Transparency in disclosures and information provided to the regulator SEBI and stakeholders alike. The Indian corporate legal system needs to change significantly in consonance with the pace of events in corporate takeover scenario.
REFERENCES
[1] Report of the Takeover Regulations Advisory Committee under the chairmanship of Mr. C.Achutan, SEBI (2010) [2] Dr. Bhagaban Das, Dr. Debdas Rakshit & Dr. Sathyaswaroop Debashish: Mergers Acquisitions and Corporate Restructuring, Himalaya Publishing House, 2010 [3] Dr. Kamal Ghosh Ray: Mergers and Acquisitions, PHI Learning (P) Ltd.2010 [4] Several articles, comments and editorials in Economic Times, Financial Express and other business dailies.
INTRODUCTION
Growth is always essential for the survival of a business concern. A concern is bound to die if it does not try to enlarge its related activities. Mergers may prove to be beneficial depending on the strategies adopted, but it would not be right to say that all mergers have been successful. The process of mergers and acquisitions has gained substantial importance in today's corporate world. This process is extensively used for restructuring the business organizations. Mergers and acquisitions are prevalent in India right from the post independence period. But Government policies of balanced economic development and to restrain the concentration of economic power through introduction of Industrial Development and Regulation Act-1951, MRTP Act, FERA Act etc. made these actions almost impracticable and a very few mergers and acquisitions took place in India prior to 90s. But the economy liberalization in 1991 had exposed the corporate sector to severe domestic and global competition, which was further emphasized by the reversionary trends, resulted in diminishing demand, which in return result to overcapacity in some sectors of the economy. So companies started to combine themselves in areas of their core competence and strip from that business where they do not have any competitive advantage. It led to an era of corporate reformation through Mergers and Acquisitions in India. In India, the concept of mergers and acquisitions was initiated by the government bodies. The Indian economic reform since 1991 has opened up a whole lot of challenges and *ICFAI University, Jharkhand
Changing Dynamics of Management in Mergers and Acquisitions Through Innovation and Creativity 347
opportunities both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The trends of mergers and acquisitions in India have changed over the years. Mergers and Acquisitions is very imperative tools for corporate to grow. A firm can achieve growth in several ways such as internally or externally. Internal Growth can be achieved if a firm expands its existing activities by upscaling capacities or establishing new firm with fresh investments in existing product markets. However if a firm wants to grow internally it can face certain problems like the size of the existing market may be limited or the existing product may not have enough growth potential in the near future or there may be government restriction on capacity enrichment, they may not have specialized knowledge to enter in to new product/ market and beyond all it takes a longer time to establish own units and capitulate positive return. One alternative way to achieve growth is resort to external arrangements like Mergers and Acquisitions, Takeover or Joint Ventures. External alternatives of corporate growth have convinced advantages. For example a particular company is very good at administration while some other company may be good at marketing strategies or in operations. So if the expertise of both is combined it produces synergy. A new company is shaped in the process, which has a much higher potential and superior to what the individual companies previously had. By apply pertaining the rules of synergy efficiently a merger can be made a success. Several other reasons for mergers are as follows: Enhancing company productivity. There is also a common tendency that the merged companies would monopolize the market, thereby expelling others. Cutting down expenses and increasing revenues. When a company is not self sufficient to operate on its own the subsidiaries may merge with the parent company for better output. Obstacle may be in the form of insufficient investment capacity, excessive competition due to which the company is not able to keep pace with other companies. Political factors. Tax purposes.
Corporate mergers and acquisitions have a great impact on the industry and economy of any country. These events restructure the industry and influence the country's economy as a whole. Corporate mergers and acquisitions also increase the market competition and also work as engines of growth. Corporate mergers and acquisitions involve skill transfer and other sharing activities. Among the various Indian sectors that have resorted to mergers and acquisitions in recent times, telecom, finance, FMCG, banking, automobile and steel industry are worth mentioning. With the increasing number of Indian companies opting, India is now one of the leading nations in the world in terms of mergers and acquisitions. Sectors like pharmaceuticals, IT, ITES, telecommunications, steel, construction, etc, have proved their worth in the international scenario and the rising participation of Indian firms in signing mergers and acquisitions deals has further triggered the acquisition activities in India.
OBJECTIVE
It has been proven theoretically that Mergers and Acquisitions used to improve the performance of the company because of Synergy effect, increased market power, operational economy, financial economy, economies of scales etc. But does it really improve the performance in short run as well as long run? Various studies have previously been done on this matter but related to European countries or US countries. I have not come across with any of such study in Indian context. So I am just trying to have an analysis why the Indian Companies goes for mergers and acquisitions and the impact of mergers and acquisitions on the performance of the companies in Indian context with reference to banking sector?
Changing Dynamics of Management in Mergers and Acquisitions Through Innovation and Creativity 349
From 1965 1970: Most of the mergers from 1965-70 were horizontal mergers and were triggered by elevating stock and interest rates. During this phase the bidding companies were small in size and fiscal strength than the target companies. These kinds of mergers were sponsored by equities, thereby eliminating the roles of banks which they actively played in investment activities earlier. Some of them were INCO merging with ESB, OTIS Elevator with United Technologies and Colt Industries with Garlock Industries. From 1981 1989: This phase saw the acquisition of the companies which were much bigger in size as compared to the firms in previous phases. Industries like oil and gas, pharmaceuticals, banking, aviation combined their business with their national and international counterparts. Cross border buyouts became regular with most of them being unfriendly in nature. This phase came to an end with the introduction of anti acquisition laws, restructuring of fiscal organizations and the Gulf War. From 1992 till present: This period was stimulated by globalization, rise in stock market boom and deregulation policies. Major mergers were seen taking place between telecom and banking giants out of which most were sponsored by equities. There was a change in the attitude of the industrialists, who opted for mergers and acquisitions for long term profitability rather than short lived benefits. Promising economic trends, investments by corporate and revised government policies provoked the participation of many company to contribute in the acquisition trend. Therefore, we can conclude that as long as business entities exist and the economic factors are encouraging the trend of mergers and acquisitions will continue.
SevenBiggestMergersandAcquistionsinIndia
Tata Steel acquired 100% stake in Corus Group on January 30, 2007. It was an all cash deal which cumulatively amounted to $12.2 billion. Vodafone purchased administering interest of 67% owned by Hutch-Essar for a total worth of $11.1 billion on February 11, 2007. India Aluminium and copper giant Hindalco Industries purchased Canada-based firm Novelis Inc in February 2007. The total worth of the deal was $6-billion. Indian pharma industry registered its first biggest in 2008 M&A deal through the acquisition of Japanese pharmaceutical company Daiichi Sankyo by Indian major Ranbaxy for $4.5 billion. The Oil and Natural Gas Corp purchased Imperial Energy Plc in January 2009. The deal amounted to $2.8 billion and was considered as one of the biggest takeovers after 96.8% of London based companies' shareholders acknowledged the buyout proposal. In November 2008 NTT DoCoMo, the Japan based telecom firm acquired 26% stake in Tata Teleservices for USD 2.7 billion. India's financial industry saw the merging of two prominent banks - HDFC Bank and Centurion Bank of Punjab. The deal took place in February 2008 for $2.4 billion.
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circumstances, the company would attempt to downsize the labor force. It is usually seen that the employees those who are being laid off may not have a significant role under the new organizational set up which accounts for their removal. Even though this may not lead to drastic unemployment levels, yet the workers will have to compromise for the same. If not drastically, the mild wave shaped in the local economy cannot be ignored entirely. Impact of mergers and acquisitions on top level management: Impact of mergers and acquisitions on top level management may involve a "clash of the egos". There might be disparity in the cultures of the two organizations. Under the new set up the manager may be asked to implement such policies or strategies, which may not be quite accepted by him. When such a situation arises, the main focus of the organization gets diverted and executives become busy either settling matters among themselves or moving on. Impact of mergers and acquisitions on shareholders: We can further classify the shareholders into two parts: o o o The Shareholders of the acquiring firm The shareholders of the target firm. Shareholders of the acquired firm: The shareholders of the acquired company benefit the most. The reason being, it is seen in majority of the cases that the acquiring company usually pays a little excess price than what it is prevailing in the market. Buying a company at a higher price can actually prove to be beneficial for the local economy. Shareholders of the acquiring firm: They are most affected parties. If we measure the benefits enjoyed by the shareholders of the acquired company in degrees, the degree to which they were benefited, by the same degree, these shareholders are harmed. This can be attributed to debt load, which accompanies an acquisition.
acquired, the decision is typically based on product or market synergies, but cultural differences are repeatedly ignored. It's a mistake to assume that personnel issues may be easily overcome. As the human beings are the more valuable resources for any organization so they should not be ignored. For example, employees at a target company might be habituated to easy access to top management, flexible work schedules or even a relaxed dress code which may not seem to be significant, but if new management removes them, the result can be bitterness and reduction in productivity. Faulty Intention: faulty intentions time and again are becoming the main reason behind the failure of mergers and acquisitions. Companies often go for mergers and acquisitions getting influenced by the booming stock market prevailing which may be risky. Sometimes, organizations also go for mergers just to imitate others. Often the ego of the executive can become the cause of unsuccessful merger. Top executives often tend to go for mergers under the influence of bankers, lawyers and other advisers who earn immense fees from the clients. Mergers can also happen due to global fear. The situation like technological advancement or change in economic scenario can make an organization to go for a change. As a result of which they may end up by going for a merger. Due to mergers, managers often need to concentrate and invest time to the deal for which they often get unfocused from their work and start neglecting their core business. The employees may also get emotionally confused in the new environment after the merger. So their work gets hampered. As the study from McKinsey, a global consultancy states that companies often focus too keenly on cutting costs following mergers, while revenues and profits, suffer. Merging companies focus on integration and cost-cutting so much that they neglect their day-to-day business activities, thereby prompting anxious customers to flee. This loss of revenue momentum is one of the reasons that so many mergers fail to create value for shareholders.
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one can expect that change-management issues will be tackle comprehensively. This merger is on the right track. "The challenge could be that Centurion Bank of Punjab has a workers' union innate from Lord Krishna Bank whereas HDFC Bank has always worked in a union-free environment and Centurion Bank of Punjab is more focused on low-cost operations and distributes more low-cost products while HDFC's products are more universal and sophisticated and higher up the value chain," continues Roy. "How well the Centurion Bank of Punjab team deal with HDFC products and union could be an area of challenge." IDBI Bank to merge IDBI Gilts with itself: IDBI Bank officially said that IDBI Gilts is a loss making subsidiary and it is tough for standalone Primary Dealers to survive. Allowing IDBI Gilts to carry on operations will mean investing extra capital at a time when other subsidiaries like insurance venture needs equity infusion. IDBI Gilts has reported losses for last two years. For 2009-10 its net loss was Rs 18.09 crore as against Rs 19.75 crore in 2008-09. Bank will take up existing staff working at IDBI Gilts United Western Bank (UWB) with Industrial Development Bank of India: Apart from synergies to the participating banks, it is likely to add value to the later in the long run. The merger is likely to help IDBI expand its retail presence, though its size may not increase substantially. There will be an outflow of Rs 150 crore which may appear inexpensive. But if one has to consider the hidden costs in the form of bad loans and the likely slippages in the quality of present assets, the effective cost is likely to climb by another Rs 100 crore. Considering IDBI's size, this may still be a small sum. Post-merger, its level of net non-performing assets is likely to increase to 1.4 per cent from about 1 per cent now. As such, managing and containing the level of bad loans remain a challenge for IDBI.
Management Consulting cited in Tetenbaum, 1999: 3). Just as critical as planning for the management of cultural change is the need for effective communication, in every stage of the merger process. Employee resistance to change can be a massive blockade towards the flourishing implementation of a merger or acquisition. Resistance is a normal part of the change process as change involves going from the known to unknown. Keeping communication channels open will avert nervousness from getting out of hand and providing clarity about expectations will reduce distrust or conflict. Without group effort the process of culture integration may be drastically hampered. In the initial phase of the merger, teaming up to create cross-company task forces and project teams will help problem solving and ensure future collaboration (Kets de Vries, 1995: 47). In addition to that, commitment and patience are very essential. Just as a marriage demands a lot of attention and commitment of resources so does the merger of two often divergent cultures. Mergers and Acquisitions and the resultant changes to the organisational culture often require a collective change of mind but minds cannot be changed they can only be inspired through the right style of leadership (Laurent, cited in Evans, Doz, Laurent, 1989:87). Leaders must be able to communicate the vision of the change and its impact as widely and effectively as possible.
EmploymentChangesintheBankingSector
The reformation process of European and global banking has fetched substantial changes in the nature and quality of employment. In short we can say that international experience and research noticed that the important quantitative and qualitative consequences of mergers and acquisitions in employment are: Reduction of less specialized categories. Imperative changes in the role of senior staff towards more complex and more flexible duties. A relative increase in the employment of specialized and younger staff. Companies are relieved of less specialized or/and older excess staff through early or voluntary retirement programs. Serious incorporation and compatibility problems among the various management systems, industrial relations and organization of work. Another fresh and common technique to reduce production costs in the banking sector is outsourcing, i.e. the decision to assign duties such as maintenance, security, cleaning, movement of titles, transfer of material or money etc. to an outside firm, as well as the development of different distance banking services, like tele banking, phone banking etc. (Kanellopoulos et. al., 1998). Customer service and various sales functions are performed today by call centers, where a great number of tasks are carried out by low skilled and poorly remunerated personnel and with almost no trade union activity.
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CONCLUSION
Most large mergers and acquisitions fall short of achieving the desired synergies. In January 1999, The Economist reported that the study of past merger waves has shown that two of every three deals has not worked. According to a Merrill Lynch study in 2003, not only do most Mergers fail to deliver their promised value, but large deals have tended to perform worse than smaller ones. And at least 50% of major mergers since 1990 have eroded shareholder returns. Reasons for failed mergers are diverse and complex, but most can be attributed to losing something: critical people, customers, market confidence. Uncontrolled costs, hidden losses, unrealized benefits, avoiding decisions, cultural barriers etc. It is generally accepted that through mergers and acquisitions banks manage to better utilize their total human and operational resources, aiming at maintaining and, most of all, expanding their market share, efficiently promoting new products, achieving better customer service, improving their staff operations and achieving capital reforming and raising. Furthermore, by growing their size, banks can benefit from utilizing those synergies that are necessary to develop within modern institutions, thus eliminating all disadvantages and bureaucratic barriers of large business establishments. However, all these positive consequences are not just the result of obtaining an ideal company size; they are mostly the outcome of insightful bank management teams that can define and achieve appropriate goals, while avoiding all wrong and inappropriate choices made in the past. Despite the high failure rate, mergers and acquisitions that succeed can pay large dividends. HSBCs 1992 entry into Europe, when it acquired Britains Midland Bank, is a good example. The successful restructuring resulted in a payback period of less than four years, and operating profits soared by more than 700%. HSBCs success has been attributed to its pre acquisition understanding of Midland and a well-conceived and executed postacquisition integration process, reflecting many of the critical success factors common to mergers and acquisitions. The most successful acquiring firms have clearly established and well-understood acquisition processes, both for ensuring good strategic decisions before the acquisition decision is made and for integrating the acquired firm once the deal is complete. By going through this paper one can conclude that the mergers and acquisitions have failed to contribute positively in the performance of the company. It neither provides Economies of scale nor synergy effect. But still here I would like to add one thing that there are numerous objective that motivate a company to enter in to merger activities. Some times these motives are qualitative and cannot be interpreted in to quantitative figures. Again, a merger may be efficient to deliver the immediate objective but may be failed to deliver all the theoretically defined benefits. So, it will be misleading to assume, on the basis of this paper, that overall mergers do not contribute any thing to the companies and it is an ineffective and hopeless exercise. It would not be correct to say that all mergers and acquisitions fail. There are many examples of mergers that have boosted the performance of a company and addressed the well-being of its shareholders. The primary issue to focus on is how realistic the goals of the prospective merger are.
REFERENCES
[1] A Capgemini Financial Services Point of view (2006), Retail Banking Mergers and Acquisitions: Strategic Choices [2] BS Reporter / Mumbai September 10, 2010, 0:55 IST, IDBI Bank to merge IDBI Gilts with itself [3] India Knowledge@Wharton (March 06, 2008), Are Bank Mergers in India Entering a New Era? [4] John Mylonakis (2006), The Impact of Banks Mergers & Acquisitions on their Staff Employment & Effectiveness, International Research Journal of Finance and Economics Issue 3 [5] K. Ramakrishnan (2006), Mergers & acquisitions in India, the long-term post-merger performance of firms and the strategic factors leading to M&A success [6] Mahesh Kumar Tambi (2006), Impact of Mergers and Amalgamations on the Performance of Indian Companies. [7] Sharma and Gupta, Principles and Practices of Management Accounting, Kalyani Publisher, 2006 Edition.
INTRODUCTION
Merger and acquisition are two terms already identified as one in the business world. Merger and acquisition refers to the combining of separate companies or entities. Merger and acquisitions is a form of a change in ownership and management done through buying and selling of the joining corporations, most of the time retaining the buyers name and omitting the sellers. This is done for different reasons, but mostly to expand business. A strategy of acquisitive growth is by no means a novelty in India. It has been widely practised well before the onset of market liberalization. But there is a fundamental difference between these empires building acquisitions of the past and the wave of mergers and acquisitions that have begun to reshape the structures of several Indian Industries. Mergers and Acquisitions are strategic tools in the hands of management to achieve greater efficiency by exploiting synergies and growth opportunities. Mergers are motivated by desire to grow inorganically at a fast pace, quickly grab market share and achieve economies of scale. India has become a hotbed of telecom mergers and acquisitions in the last decade. Foreign investors and telecom majors look at India as one of the fastest growing telecom markets in the world. Sweeping reforms introduced by successive governments over the last decade have dramatically changed the face of the telecommunication industry. Mergers and * Al-ameer College of Engineering and IT, Vizag
acquisitions in the telecommunications sector have been showing a prosperous trend in the recent past and the economists are advocating that they will continue to do so. The majority of telecommunication services providers have understood that in order to grow globally, strategic alliances and mergers and acquisitions are the principal devices. Telecommunications is among the fastest moving industries in todays economy, with technology as a catalyst. New technologies in the way we access voice, data and video are continually evolving, such as V0IP, IPTV and WiMAX. As a result of Globalization, markets got expanded and the size of the firms also grew. As a result of deregulation, industries which earlier enjoyed monopoly position were exposed to competition from private international players. Indian companies today are buying companies abroad as strategic acquisition and proving their competitiveness. Strategically speaking, Indian companies should acquire various well established companies in overseas markets with commodity prices moving up gradually after feeling the heat of demand from emerging economies. This would give the Indian companies a platform for establishing businesses in international markets. In the late 1990s Merger activities were common in industries where global markets are of particular importance (e.g., automobile and pharmaceutical) and in industries where deregulation and liberalization significantly changed the intensity of competition like Telecommunications and utilities. Going by the historical evidence, in India, the increase in merger and acquisition activity can be seen as a reaction to the changing business environment. Merger, acquisition, Joint Venture, takeover or re- organisation these are not dangers. They are common in the way of an organisation effort to grow and survive. At a time, when companies the world over are discovering that organic growth is hard to come by, the focus is now more on acquisitive growth or inorganic growth. This is all the more true in case of big corporations. Multinational firms such as GE, Johnson and Johnson have for long relied on acquisitions to fuel their growth. Mergers and Acquisitions movement made a beginning in India during 1980s. Wining the race to the future and the rest of the world requires a strong sense of purpose and speed. The idea of racing as a team is somehow uplifting to the human spirit. In the Telecom Industry, since the early 1990s there has been a spurt of mergers, mainly due to deregulation which was characterized by the dismantling of the call rates and the elimination of barriers among the telecom and the mobile operator companies , thereby reducing the entry barriers for both the domestic as well as foreign mobile companies. The other reasons for such surge of merger activities include macro economic pressures, global trends, technology advancements etc. The main motivating factors behind these mergers were cutting down the costs and indirectly benefitting the customers by reduced call rates with better service. These have not only led to domestic mergers, but also included cross border
Mergers and Acquisitions in Indian Corporate CompaniesA Special Reference to Telecom Sector 359
mergers. Today, these mergers and acquisitions have reached unprecedented levels and are expected to further grow in the future as well. Before acquisition the company should go for thorough evaluation of the buying company. They have to take the consideration and suggestions of Merchant Bankers, Consultants, and Corporate planners and so on. Similarly at the same time in the post- acquisition phase they need to be proactive. They should anticipate and solve the problems early. In todays globalized economy, competitiveness and competitive advantage have become buzz words for corporate around the world. Merger and acquisition are being increasingly used the world over, as a strategy for achieving higher size, faster growth in market share and reach, and for becoming more competitive through economies of scale. This research study has attempted to study the mergers among Indian telecom and mobile industry.
Act, 2002; MRTP Act; Indian Telegraph Act; FEMA Regulations; SEBI Takeover regulation; etc. With the speed at which technology advances, telecom companies are scrambling to keep up. One of the fastest and most effective ways for companies to do this is to look into Mergers and Acquisitions. Landline and mobile operators, cable companies, Internet service providers, and even companies in the telecom infrastructure, software and hardware sectors are ripe for consolidation. With the evolution of digital technology, finding companies who use related resources allow them to converge their technologies to become more efficient and diversified. It also allows them to bundle services under one roof driving up their competitive edge. Of course, there is also the aim of grabbing a bigger market share, be it local or transnational market. s The rate at which Mergers and Acquisitions are being transacted in the Telecom industry has also spurred the growth of an industry dedicated to facilitating it. Telecom Mergers and Acquisitions Specialists have responded to the need of both buyers and sellers in the industry. Their market, however, is not limited to telecom companies. There is a whole range of interested parties in this highly dynamic industry, including governments of developing markets who are opening their telecommunications industry to international players. Armed with telecom industry expertise, these telecom mergers and acquisitions specialists offer a wide range of services; from purely advisers, to a full range of service, from valuation, to finance sourcing, to closing the deal. Buyers and sellers can also join listings which act as a venue for networking and eventual business- matching. The Department of Telecommunications issued guidelines on merger of licenses in February 2004. The provisions laid down that prior approval will be necessary for merger of the license from the DoT. The findings of the Department of Telecommunications would normally be given in a period of about four weeks from the date of submission of application. Merger of licences shall be restricted to the same service area. There should be minimum 3 operators in a service area for that service , consequent upon such merger. In addition to M&A guidelines, DoT has also issued guidelines on foreign equity participations and management control of telecom companies. George Bernard Shaw had once said Economists know the price of everything, but the value of nothing. This saying is aptly reflected in case of telecom valuation also. The acquirer pays hefty valuation to acquire an entity and the Business value placed is much higher than Accounting Value. Merged telecom companies are striving hard to capture the potential market.
BenefitsandReasonsforMergerandAcquisitionintelecomandmobileCompanies
As an opportunity to attain greater market share and higher revenue growth. Globalizing in a short span of time. Creating new synergies through product market efficiencies and economies of scale. Acquiring new customers and expanding the market /customer and service portfolio.
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Enhancing infrastructure base through acquisition of under valued infrastructural assets or brands or additional manufacturing capacities from weaker competitors. Building infrastructure for telecommunications is not easy. Moreover it consumes much time. Merger and acquisitions provide access to infrastructure much easily. Benefits of existing network are available much easily through Mergers and Acquisitions. In certain regions there may be restrictions on getting new license. In such a case Mergers and Acquisitions provide an option to run services in that region. Customer base Brand value Spectrum.
The objectives of Merger and acquisitions in between various companies can be for acquisition of licenses or geographical territory, acquisition of spectrum, acquisition of infrastructure and network, acquisition of customer base to achieve an economic base, acquisition of brand value, higher operating profit margin or a combination of above. Mergers and Acquisitions in the telecommunications industry have grown by substantial proportions in India since the mid 1990s. Economic reforms undertaken in the 1990s in India opened up the telecom sector which used to be a predominantly state controlled one. Private investment in the telecom sector in India not only facilitated the rapid expansion of telecom services in the urban, as well as rural parts of India, it also provided the opportunity for mergers and acquisitions in this sector. Acquisitions in the Indian Telecommunication industry have been driven by a few important factors The inclusion of internet (including broadband) and cable services in the telecom sector. New technologies like wireless fixed phone services. Deregulation in the telecom sector.
Mergers and Acquisitions emerged as one of the most effective methods of such corporate restructuring, and have therefore, become an integral part of the long- term business strategy of corporate in India. Since 1996 there was increased activity in consolidation of subsidiaries by telecom companies operating in India, followed by entry of several Multi national companies, into Indian markets, through the acquisition route with liberalized norms in place of foreign direct investments (FDI). After 2002, Indian Telecom and mobile companies started venturing abroad, and making acquisitions in developed markets, for gaining entry into international markets. The opening up of Indian economy and financial sector , huge cash reserves following some years of great profits , and enhanced competitiveness in the global markets, have given greater confidence for Indian mobile companies to venture abroad for market expansion. Changes made in regulations made by the Finance Ministry in India pertaining to overseas investments by Indian companies have also made it easier for the companies to make international acquisitions.
Along with this the acquiring companies should take into consideration regarding certain issues like the price paid for the unit and the procedure for the payment of the price. What should be the exchange ratio between the shares of the parent company and the merger company? What would be the impact on business of the parent company after the take over and the merger, impact of the share prices of the parent company, any new conditions of the financial institutions for the new proposal? The kind of post merger problems that are likely to arise, is the parent company fully prepared to tackle them? Does the merger help both the companies or not. Taking into consideration in regard to the Technical aspects, Commercial aspects, financial aspects, managerial aspects, Human aspects, Legal aspects etc.
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MAJOR M&A DEALS IN INDIAN TELECOM SECTOR Company/Service %Stake Name Sold Orange, Mumbai Command cellular, Kolkata Modi Telestra, Kolkata Reliance CDMA Aircel, Chennai Hutch Essar Idea Cellular 41% 100% 100% Buyer Seller Year Deal size(US$) 560 Min N.A 210 Cr 146 Mln NA 1.5 Bln 1.15Bln 450Mln 225 Mln 750 Mln 178 Mln 873Mn 2Bln 16 Bln NA 9Bln 1.07 Bln 363 Mln NA 570 400 1000 Indicative Enterprise Value(US$) 1.36 Bln 138Mln 160 Mln 10 Bln NA _ Per Sub Value (US$) NA
Hutchison Group, Max Group, Delhi HongKong Hutchison &Indian Group UshaMartin& others Bharti Group, India B.K.Modi &Telestra Qualcomm,San Diego, US Reliance Infocomm RPG Group MaxIndia TataGroup BhartiGroup
1998 2000 2000 2002 2003 2005 2005 2005 2005 2006 2006 2006 2006 NA
79.24% Sterling group,Chennai 3.17% EssarGroup 48.14% Aditya BirlaGroup Vodofone Promoters
BhartiAirtel 10% BPL Mobile and BPL Cellular Hutch Essar, India 5.1% Hutch, India Aircel, TN, Chennai and NE Spice (Punjab and Bangalore) Bharti
HutchSonGroup, HongKong 8.33% Max India 74% Maxis,Malaysia 49% 9.3% Telekom Malaysia,Malaysia Private Investors
NA NA 496 1000
In the years that followed several other mergers and acquisitions took place in the telecommunications sector in India. Important ones among them include Acquisition of Command Cellular Services in Kolkata by Hutchison from Usha Martin in 2000. Acquisition of 79.24 percent stakes of Aircel, Chennai by Sterling group from RPG group for Rs 210 crores in 2003. Acquisition of 48 percent stakes in Idea cellular by Aditya Birla group from the Tata group in 2005. Acquisition of Hutch services in India by Vodofone in 2006. Bharti Airtel acquisition with Zain in 2010.
The Reserve Bank has liberalised the investment norms for Indian telecom companies by allowing them to invest in international submarine cable consortia through the automatic route. In April 2010, RBI issued notification stating As a measure of further liberalisation , it has now been decided... to allow Indian companies to participate in a consortium with other international operators to construct and maintain submarine cable systems on co- ownership basis under the automatic route. The notification further added Accordingly, banks may allow remittances by Indian companies for overseas direct investment. Africa is in the same stage of evolution where India was 5-6 years ago and hence the potential is truly huge. Telecom industry leaders such
as Bharti Airtel swear by Africa and believe the opportunity there is actually bigger than India, where the industry seems to a have passed the phase of hyper growth. While the Ruias promoted Essar and Bharti Airtel have been successful into cracking into this market, others such as Reliance communications, BSNL, and MTNL have not been as lucky. In 2008, the Essar group acquired 49 percent in ECONET wireless international to make Kenya its first overseas bastion for telephony operations. In 2009 November, Essar group entered into a definitive agreement to pick up majority stake in Warid Telecom, the Dhabi Groups subsidiary in Uganda and Republic of congo for around $ 150 million (rupees 692 crores). Infact the Ruias were also in the race to acquire stake in Zamtel, after the Zambian government had invited bids to sell 74 percent stake in the countries only land line operator. Essar is planning to double its investments in Kenya. The company has already invested $ 300 million in the Kenyan markets, and the extra money would go towards data and enhancing network quality. In India the Essar group has a 33 percent stake in vodofone Essar and a minority interest in Loop mobile. BYTE Mobile : Mobile internet service provider BYTE mobile has developed recently research and development centre in the country with an investment of $10 million (about rupees 44 crore) in order to take advantage of the launch of 3G operations in India. Byte mobile has customers such as Bharti Airtel and Vodofone in India. The company is also in talks with other service providers including Tata teleservices and Reliance Communications. Byte mobile was open for acquisition or takeover for growth and ready for any kind of organic or inorganic growth opportunities. The company deployment spans 120 operators in 58 countries, serving nearly two billion subscribers. The company is proactively addressing any potential hang-ups by exploring the possibility of new partnership to create a services alliance for the companys global customer base, which has its operations in countries like China, US, and Greece.
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recorded in the register of transfer of Indian Telecom Company as the same Mauritius SPV continues as shareholder.
Bhartis agreement with the two companies includes network design, project management as well as material and services for the base station sites and microwave transmission. Ericsson will expand and upgrade circuit and packet core network, energy efficient radio access network with evolved EDGE technology, intelligent network, Country wide microwave mobile backhaul and Business Support Systems (BSS). The other network partner, Huawei will swap the existing radio network in the eastern areas of Bangladesh. This is the third deal Bharti had signed with the Chinese vendors, Huawei also manages Airtels network in SriLanka and will be rolling out the operators 3G network in three circles in India. IMI Mobile Vs WIN mobile: The Hyderabad based company IMI mobile has possessed 100 percent of the U.K mobile content and the service provider WIN co. Win is having good business in Europe and having strong agreements with the prime mobile operators.
SUMMARY
As Robert C Higgins of University of Washington points out careful valuation and disciplined negotiation are vital to successful acquisition, but in business as in life, it is sometimes more important to be lucky than smart. Critics claim telecom mergers reduce competition and promote monopoly. In reality, these mergers are part of a healthy competitive process and would foster innovation and bring benefits to consumers. Finally the success of a
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merger hinges on how well the post-merged entity positions itself to achieve cost and profit efficiencies. Merger and Acquisition in the Indian telecom space picking up fastly because on the one hand domestic players are looking at foreign money and expansion plans and on the other international operators are exploring ways to move into emerging markets with their home market reaching saturation. After raising concerns over Black Berry devices and telecom network equipment the Ministry of Home affairs has asked the Department of Telecomm to look at the feasibility of making it mandatory for local manufacturer of Sim Cards used in mobile phones. BSNL was the top operator in terms of subscriber addition with 2.3 million users. BSNL now has 72.7 million subscribers and is ranked fourth among GSM operators. Among the private players, newcomer Uninor ramped up its user base by 2.17 million beating incumbent operators such as Airtel and Vodofone. Market leader Bharti Airtell got just over 2 million new subscribers to take its total user base to 143 million. Vodofone added 1.7 million users in September 2010 against 2.3 million in August 2010. Of course, there is no standard reporting norm and for some of the operators it may be discounted 30 to 40 percent. With profits and market share plunging, privatisation seems to be the best option before BSNL. BSNL can go in the lines of VSNL i.e., Videsh Sanchar Nigam Ltd way. VSNL, now known as Tata communications, has become a global player, acquiring even a government owned company Teleglobe of Canada. BSNL can be privatised likewise, or by a statute as in the case of a British Telecom. Statutory privatisation involves government holding a single golden share. Some shares can be given to employees at less than the market price and the rest to the public as an initial public offer (IPO). The Indian market is highly price sensitive. Easy and cost effective last mile access to the customer is another key issue. The Asian countries especially China now compete with each other in promoting the industry. Alongside low tariffs and low handset prices what is fuelling todays mobile growth is the innovative use of the device. The mobile market is 16 years old in India but has had a dramatic impact in every area. The Indian Telecom Market is possibly the most competitive globally, has excellent self regulation and regulation that works. The vodofone group which holds 67 percent in vodofone Essar plans to launch 3G services early next year. The mobile portability which is going to be implemented in the coming days may encourage more mergers and acquisitions in the country. Indias Telecom industry gets strengthened with the commitment of all the companies for sustaining the industries growth and momentum. One of the key developments is that the amount of data coming into the network is very high. If we look at the US and the European markets, with launch of smart
phones, data is becoming more prominent. How to handle data is becoming a key issue. So from being a commoditised element, networks are becoming very important again. The development and management of the quality of networks to cater to huge upsurge of data is becoming a key issue. It is not just enough to manage the network, we are moving up the value chain to say how we can manage the services and understand subscribers. Operator has a lot of data on subscribers and through the subscriber data management companies can help them create value on network than just offering dumb pipes. If operators spend $100 billion on capital expenditure annually, there is a corresponding spend of $250 billion on the network operational expenditure. Of this 70 percent is done internally by operators. Only 10 percent comes to the vendors. So there is opportunity for vendors to look at improving operators opex by bringing in value like energy solutions. Even as telecom operators get busy with the 3G roll out plan, they are also evaluating various wireless broadband technologies, including those using 4G. Aircel hopes to start rolling out 3G services in the first quarter of the next year. Although the rate havent been decided, it will be affordable, 3G is not about network alone, it is about setting the experience for consumers. With a 5 MHz spectrum, companies have to strike a balance between the consumers and utility of the spectrum. WI-MAX or LTE : Currently the telecom market is debating which is the best technology beyond 3G WiMAX or LTE , akin to the GSM versus CDMA debate. While the fundamentals are similar, the main difference between the two is WI-MAX (wireless interoperability for microwave access) needs a new network to be deployed, while LTE, which uses a radio platform to transmit signals instead of micro waves is an evolution of existing 3G networks. Both promise greater data transfer and download speeds, superior audio / video quality and flexible use of spectrum as India looks to leapfrog to fourth generation networks. While 2G talks of speed upto 0.3 mbit/ second 3G in India is looking at a data rate of upto 42 Mbit/ sec speed. 4G is promising even more- 100 mbit/sec. There is evolution of both wi-max and LTE with trials going on in the country for both technologies. Companies have to make technology affordable. LTE is transformational technology and what is happening in India is concurrent with what is available in the rest of the world. With the 3G services which enables mobile users to enjoy broadband services like video downloads, high speed data services of interest in education, health and entertainment and many other bandwidth hungry applications we can expect more changes in the telecom mergers and acquisitions. The rapid growth of the telecom industry in India was led by a joint effort by operators, regulators and customers. The same three will have to join forces again and redirect their energies to see the sector through to the next phase. A lot has been achieved by the growth of the telecom sector, the most impressive being its ability to bring economic
Mergers and Acquisitions in Indian Corporate CompaniesA Special Reference to Telecom Sector 369
inclusion. With these developments in the telecom sector let us hope that it will pave path for more Mergers and Acquisitions in the coming future.
REFERENCES
[1] Icfai Journals [2] www.economy watch.com
AnalysisofTrendsofMergers andAcquisitionsinIndiaandGrowthofGDP
Dr.SanjayNamdevAswale*
AbstractAs we know that economic reform has opened up new challenge, competition among various sectors of the world. These competitions compelled the Indian companies to go for mergers and acquisitions. Mergers and acquisitions are useful for consolidation of markets as well as for gaining a competitive edge in the various sectors of the economy. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy after 2007. In this context the researcher focuses how the mergers and acquisitions market has experienced an exponential growth. The main objective of this paper is to examine the trends of merger and acquisition in corporate sectors after and before economic reform 1991 in India in the form of mergers and acquisitions deals and also in the GDP The paper recommends that the government may take initiatives for promulgating flexible rules and regulations to avoid the difficulties in the mergers and acquisitions. The financial reforms and convenient rules and regulations have contributed to the growing trends of mergers and acquisitions in India. KeywordFinance - Economic Reform Merger and acquisition Trends GDP GrowthCorporate Sector Purpose-The purpose of this paper is to analyze the trends of Mergers and acquisitions in India after and before global reforms and its impact on GDP.
INTRODUCTION
Mergers and acquisition has a very long history; it has been existed at least since the 1900s.1 However, the saliency of M&A has increased considerably during the past two decades as numerous US firms have adopted M&A as a common corporate strategy to expand their organizational capabilities and to take better competitive market positions.2 This propagation continued during the 1990s, and beyond, including 7,809 M&A transactions with a total value of $1.19 trillion in the United States in 1998 alone.3 In the process of global waves of reforms there are increased competitions, new regulations and financing possibilities etc. Mergers and acquisitions (M&As) have become popular strategy since global reforms in India 1991.Merger and Acquisition is a process of restructuring the business organization. Today, India has become one of the leading nations in the world in terms of mergers and acquisitions. The estimated value of mergers and acquisitions in India for 2007 was greater than $100 billion which became greater than $700 billion in 2009-10. In this context my paper focuses on the issues of Mergers and Acquisitions in India before and after economic reforms in India. The paper also reveals the changes of the trends of mergers and acquisitions in India.
Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP 371
STATEMENT OF PROBLEM
India has accepted the economic reforms in the year 1991. This policy has opened up a lot of challenges both in the domestic and international spheres because it implies free economy and open competition of world economy. These open competitions in the world market have prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy.
REVIEW OF LITERATURE
Nahavandi and Malekzadeh (1993) he has highlighted that despite the popularity of Mergers and acquisitions, the general consensus is that about 80% of M&A do not reach to their financial goals Sally Riad. (2007) he concluded in his study that about 50% simply fail the Mergers and acquisitions in India Lodorfor (2006) - he has studied the cultural clashes between the two merging companies. Simpson (2000) the research shows that the opportunity for mergers fails is greatest during the integrated process. Integration fails because of improper managing and strategy, culture differences, delays in communication and lack of clear vision.
Thus past research on M&A has focused on either the effect of various financial issues, but my paper focuses on trends of Mergers and acquisitions and global reforms
OBJECTIVES
The main objective of my paper is to analyze the trends in mergers and acquisitions before and after economic reforms
HYPOTHESIS
In view of the above objective the following hypothesis formulated and tested. H1 The trend of Mergers and acquisitions of Indian companies in the world markets is an indication of the participation in the overall globalization process.
METHODOLOGY
This study is based in exploratory research method. The study is mainly conducted through the analysis of the available secondary data. The secondary data is collected for the period 1985- 2010 for the purpose of analysis of GDP and mergers and acquisition deals before and after global reforms. The data taken as before global reforms is for ten years (1980-90) and the data taken as after global reforms is 18 years (1992-2010). These data are tabulated and analyzed by using simple statistical technique like averages / mean.
Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP 373
Additional liquidity in the corporate sector Dynamic attitudes of the Indian entrepreneurs
Along with these key factors the increased participation of the Indian companies in the global corporate sector has further facilitated the merger and acquisition activities in India.
Graph9.1:TrendsofMergersandAcquisitionsDeal
It is concluded from the above graph that the mergers and acquisition deals which was very low in the year 2001-02 which increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006. The total M&A deals for the period January-February 2007 have been 102 with a value of US$ 36.8 billion. Of these, the total outbound cross border deals have been 40 with a value of US$ 21 billion. There were 111 M&A deals with a total value of about US$ 6.12 billion in March and April 2007. Of these, the number of outbound cross border deals was 32 with a value of US$ 3.41 billion. There were 74 M&A deals with a total value of about US$ 4.37 billion in May 2007. Of these, the number of outbound cross border deals was 30 with a value of US$ 3.79 billion. The sectors attracting investments by Corporate India include metals, pharmaceuticals, industrial goods, automotive components beverages, cosmetics and energy in manufacturing; and mobile communications, software and financial services in services, with pharmaceuticals, IT and energy being the prominent ones among these.The total number of mergers and acquisitions deals in India was 287 with monetary transaction of US $47.37 billion from the month of January to May in 2007. Out of these 287 merger and acquisition deals, there have been 102 cross country deals with a total valuation of US $28.19 billion. Recently the Indian companies have undertaken some important acquisitions.
There are increasing trends of mergers and acquisitions after global reforms period. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy. India is now one of the leading nations in the world in terms of mergers and acquisitions. The following table shows the average trends and growth of GDP and average trend and growth of mergers and acquisitions deal value before and after global reforms.
Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP 375
The table clearly indicates that the trends and growth of GDP and also mergers and acquisitions deals since global forms (1991-92). The table also shows the average annual trend in case of GDP and deal value is high inspite of world recession.
TABLE11.1:TRENDSANDGROWTHOFGDPBEFOREANDAFTERGLOBALREFORMS Mergers and acquisitions GDP before and after (deal Value) Year Global Reforms before and after Global Reforms 1980-85 5.7 0.10 Before Global reforms Before Global reforms Mergers and Mean GDP = 11.7/10 = acquisitions deal Mean 1985-90 6.0 0.13 1.17 = 0.23/10 = 0.023 After Global reforms 1992-97 6.8 0.21 After Global reforms Mergers and 1997-02 5.3 0.30 Mean GDP = 25.3/18 = acquisitions deal Mean 2002-07 6.5 0.60 1.40 = 19.50 2007-10 6.7 20.61/18 = 1.45 Source: Economic Survey 2001-02, Ministry of Finance, Government of India, 2002. Growth rates for 2001-02 are projections of the Ministry of Finance based on partial information. Average Annual Growth of GDP in (%) Average Trend of Mergers and Acquisitions deal in Billion Dollar
The above data is grouped in two period like before global reform period -1980 -1990 and after reform period of 1992- 2010. The GDP and value of the mergers and acquisition deal for that period is compared by calculating mean value. The period of before global reforms has taken as 10 years; whereas the period of after global reforms has taken as 18 years i.e. full terms since 1991 to 2010. It can be concluded by analyzing the above table that there is continuous increasing trends in the GDP and Mergers and acquisitions. The mean value of average GDP after global reforms is high (1.40 per cent as compare to 1.17 per cent ). The average tends in deal value of mergers and acquisitions is also high (1.45 billion dollars) after global reforms as compare to before reforms ( 0.023 billion dollars)
GDP Growth and trends befroe and after Global reforms
8 6.8 Percentage 6 4 2 0 5.7 6 5.3 6.5 6.7
1980-85
1985-90
1992-97
1997-02
2002-07
2007-10
Year
Graph11.1:TrendsandGrowthofGDPBeforeandAfterGlobalReforms
The above graph shows the trends in GDP. The annual growth of GDP rose from 5.7 per cent in the 1980 85 to 6 per cent in the 1985-90 and again it was increasing trend during 1992-97 i.e. 6.8 per cent making India one of the ten fastest growing countries in the world by accepting global reforms. The economy grew more open, and growing faster than GDP during the period 1997-02 as GDP is fell down as annual average rate was 5.3 per cent.
But the average annual GDP has been increasing since 2002. The mergers and acquisitions deal is also increasing since 2002 as stated in the above graph 9.1. It can be conclude that there is global impact on Mergers and Acquisitions and GDP after reform period inspite of recession in the world.
HYPOTHESIS TESTING
The alternative hypothesis framed in this paper The trend of Mergers and acquisitions of Indian companies in the world markets is an indication of the participation in the overall globalization process is proved and accepted by the researcher as there is increasing trend in mergers and acquisitions as well as average annual rate in GDP
REFERENCES
[1] Gaughan, P. A. (1999). Mergers, Acquisitions, and Corporate Restructuring. New York: John Wiley and Sons, Inc. [2] Buono, A.F., Bowditch, J.L.1989. The Human side of Mergers and Acquisitions San Francisco: JosseyBass. [3] Gaughan, P. A.(1999). Mergers, Acquisitions, and Corporate Restructuring. New York: John Wiley and Sons, Inc. [4] Bijilsma-Frankema, K. (2002), On managing cultural integration and cultural change processes in mergers and acquisitions, Journal of European Industrial Training, Vol. 25, April, pp. 192-207 [5] Covin, T.J., Kolendo, T.A., Sighter, J.W. and Tudor, R.K. (1997), Leadership style and Post-merger satisfaction, Journal of management development [6] Mirvis, P.H. and Marks, M.L. (1992), Rebuilding after the merger: Dealing with survivor sickness, Organizational Dynamics, Vol. 21. No.2, pp. 1823 [7] Appalbaum, S.H., et al (2004), Anatomy of a merger: behaviour of organizational factors and process throughout the pre-during-post-stages, Management decision, Vol.38, No.2, pp.64962 [8] Bartel Robert (2009) - Limited Director Liability in Mergers, Demergers and spin off, Mergers and Acquisitions Report 2009 p 44 [9] www.mergers ans acquisitions .com - Mergers and acquisitions in India, accessed on 20.09.2010
Track8
MoneyandCapitalMarket
EconomicValueAddition toShareholdersWealth
ArvindA.Dhond*
AbstractCorporate firms exist to create wealth and maximize wealth for its shareholders. Most corporates are today geared to understand and act upon the concept of shareholders value creation in order to stay competitive in the dynamic business environment. Maximizing shareholders wealth has thus become the new corporate paradigm. Maximizing the shareholders wealth means maximizing the net worth of the company for its shareholders. This is reflected in the market price of the shares held by them. Therefore wealth maximization means creation of maximum value for companys shareholders which means maximizing the market price of the shares. Shareholders value maximization, which is the heart of economic growth, as a long-term proposition that delivers higher economic output and prosperity through productivity gains, employment growth and higher wages. Managements most important mission is to maximize shareholders wealth. Therefore wealth creation is dependent on managements performance. In order to measure the performance of companys management; accountants, finance managers, investors, analysts and other users use several tools. In the past decade sea changes has been made in the performance and measurement criteria of corporate entities, from the traditional profit based measures like, Earning Per Share (EPS), Return On Capital Employed (ROCE), Return On Net Worth (RONW), Net Operational Profit After Tax (NOPAT) and Earning Before Interest and Tax (EBIT), to the new trendier value based performance measures, like Market Value Added (MVA), Shareholder Value Added (SVA), Cash Value Added (CVA), and Economic Value Added (EVA). Shareholders need some tools, which would enable them to assess and forecast the performance of companys management. Shareholders expect to achieve the required return from their investments. In order to measure the performance of companys management, various users use several tools. Major problem of the shareholders is to understand that among the various tools available in order to measure the performance of companys management, which tool has more relationship with shareholders wealth creation. Among the modern tools, Economic Value Added (EVA) has received attention and recognition in accounting and financial areas as a vital tool to measure corporate performance. Economic Value Added (EVA) concept is a correct criterion in performance management, because it includes all the cost of capital employed
INTRODUCTION
Maximizing shareholders wealth has become the new corporate paradigm. Managers and researchers have traditionally recognized shareholders wealth maximization as the ultimate corporate goal. The owners of the company i.e. the shareholders are more interested in maximizing their wealth. Maximizing the shareholders wealth means maximizing the net worth of the company for its shareholders. This is reflected in the market price of the shares held by them. Therefore wealth maximization means creation of maximum value for *St. Xaviers College, Mumbai
companys shareholders which means maximizing the market price of the shares. Shareholders value maximization, which is the heart of economic growth, as a long-term proposition that delivers higher economic output and prosperity through productivity gains, employment growth and higher wages. Managements most important mission is to maximize shareholders wealth. Therefore wealth creation is dependent on managements performance. In order to measure the performance of companys management; accountants, finance managers, investors, analysts and other users use several tools.
ParameterI:ReturnonNetWorth(RONW)
Rationale: The profits earned by the firm has to be related to Net Worth, which is the actual shareholders investment made in the business.
ParameterII:ReturnonCapitalEmployed(ROCE)
Rationale: The earnings before interest and tax earned by the firm has to be related to the total Capital Employed in the business.
ParameterIII:EarningPerShare(EPS)
Rationale: The total annual profits earned by the firm has to be divided by the total number of equity shares outstanding in order to determine profit per equity share.
ParameterIV:EconomicValueAdded(EVA)
Rationale: The returns earned has to be related to the Cost of Capital Employed while taking investment decisions by the firm. There exists a significant relationship between: Economic Value Added and Earning Per Share, and Economic Value Added and Market Price of share in stock exchange/ markets.
There exists a relationship between two traditional parameters of shareholders wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market and the modern parameter Economic Value Added. Shareholders wealth creation is the ultimate objective of corporate financial management and problem of the shareholders is to understand that among the various tools available in order to measure the performance of companys management, which tool has more relationship with shareholders wealth creation. There is a need to assess the extent of and change in shareholders wealth creation. Has there any change in the shareholders wealth creation and the extent of change in it, if any. Shareholders need some tools, which would enable them to assess and forecast the performance of companys management. Shareholders expect to achieve the required return from their investments. In order to measure the performance of companys management, various users use several tools. Major problem of the shareholders is to understand that among the various tools available in order to measure the performance of companys management, which tool has more relationship with shareholders wealth creation. Among the modern tools, Economic Value Added (EVA) has received attention and recognition in accounting and financial literature as a vital tool to measure corporate performance. Investors, who want to buy stocks, need to know the relationship between returns on their investments and financial information. They have to know measurement tools that help them to buy the stock with higher return; and Economic Value Added (EVA) concept is a correct criterion in performance management, because it includes all the cost of capital employed. There is also a need to study and examine the relationship between Economic Value Added with two parts of shareholders wealth, viz. Earning Per Share and Share Price in stock exchange/ market. There is a need to understand the relationship between two traditional parameters of shareholders wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market and the modern parameter Economic Value Added and finally to compare the performance of the companies applying traditional parameters such as Earning Per Share and Share Price in stock exchange/ market with that of Economic Value Added and assessing and evaluating that whether there is any significant change in the performance of the companies applying traditional parameters such as Earning Per Share and Share Price in stock exchange/ market with that of Economic Value Added. It is believed that, the companies are expected to generate higher wealth for their shareholders over a period of time since generation of higher wealth year after year for their shareholders is the ultimate goal of corporate financial management. In recent years it is believed that, measuring shareholders wealth on the basis of Economic Value Added concept is more meaningful than traditional concept. Economic Value Added being the modern
parameter for measuring shareholders wealth is termed better than traditional parameters of shareholders wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market.
FORMULA
The formula for the calculation is EVA i.e. residual income equals to income earned minus cost of capital on investment. Economic profit = [ROIC Invested Capital] - [WACC Invested Capital] For example, suppose that the cost of capital is 12 percent. Then the cost of capital for the company is 12% on Rs.1,000 Lakhs capital invested = Rs. 120 Lakhs. It the net gain is Rs. 130 Lakhs, therefore Rs.130 Lakhs - Rs. 120 Lakhs = Rs. 10 Lakhs. This is the addition to shareholder wealth due to managements hard work (or good luck). But if the cost of capital were 20 percent, then EVA would be negative by Rs. 70 Lakhs.
According to Stern Stewart, literally dozens of adjustments to earnings and balance sheets - in areas like R&D, inventory, costing, depreciation and amortization of goodwill must be made before the calculation of standard accounting profit can be used to calculate EVA. To protect its trademark, Stern Stewart doesn't fully disclose the adjustments - making the job of using the metric even more difficult. Figuring out the cost of capital (WACC) is even more thorny. WACC is a complex function of the capital structure (proportion of debt and equity on the balance sheet), the stock's volatility measured by its beta, and the market risk premium. Small changes in these inputs can result in big changes in the final WACC calculation. This method calculates a net return to shareholders. It considers the earnings after deducting a charge for the cost of capital. When firms calculate income, they start with revenues and then deduct costs, such as wages, raw material costs, overheads and taxes. But there is one cost that they do not commonly deduct i.e. the cost of capital. They even allow for depreciation of the assets financed by investors capital, but investors also expect a positive return on their investment. A business that achieves the break even point in terms of accounting profits is really making a loss; it is failing to cover the cost of capital. In order to judge the net contribution to value, it is necessary to deduct the cost of capital contributed to the company by its stockholders. Net income after deducting the return required by investors is called residual income or economic value added (EVA). Net return on investment and EVA are focusing on the same question. When return on investment equals the cost of capital, net return and EVA are both zero. But the net return is a percentage and ignores the scale of the company. EVA recognizes the amount of capital employed and the amount of additional wealth created. A growing number of firms now calculate EVA and tie management compensation to it. They believe that a focus on EVA can help managers concentrate on increasing shareholder wealth. The EVA is a registered trademark (EVA) by its developer, Stern Stewart & Company. The term EVA has been popularized by the consulting firm SternStewart. But the concept of residual income has been around for some time, and many companies that are not Stern-Stewart clients use this concept to measure and reward managers performance. Other consulting firms have their own versions of residual income. McKinsey & Company uses Economic Profit (EP), defined as capital invested multiplied by the spread between return on investment and the cost of capital. This is another expression of the concept of residual income.
UTILITY OF EVA
EVAs most important use is in measuring and rewarding performance inside the firm. It is said, if carried out consistently, EVA should help us identify the best investments, that is, the companies that generate more wealth than their rivals. All other things being equal, firms with high EVAs should over time outperform others with lower or negative EVAs. But the actual EVA level matters less than the change in the level. According to research conducted by Stern Stewart, EVA is a critical driver of a company's stock performance. If EVA is positive but is expected to become less positive, it is not giving a very good signal. Conversely, if a company suffers negative EVA but is expected to rise into a positive territory, a good buying signal is given. Of course, Stern Stewart is hardly unbiased in its assessment. New research challenges the close relationship between rising EVA and stock price performance. Still, the growing popularity of the concept reflects the importance of EVA's basic principle: the cost of capital should not be ignored but kept at the forefront of investors' minds. Best of all, EVA gives analysts and anyone else the chance to look skeptically at EPS reports and forecasts. From a commercial standpoint, Economic Value Added (EVA) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor's analysis of a company. Because it relies on invested capital, it is more suitable for analyzing assetintensive firms (those whose value comes largely from tangible assets on the balance sheet) that exhibit somewhat predictable growth trends. The best use of economic profit tends to be in traditional and mature industries. It therefore has less relevance for firms that are valuable largely because of intangible, off-balance-sheet assets; economic profit has shown limited success in high-tech and service-oriented companies.
for explicit monitoring by top management. Instead of telling plant and divisional managers not to waste capital and then trying to figure out whether they are complying, EVA rewards them for careful and thoughtful investment decisions. Of course, if the junior managers compensation is tied to their economic value added, then they must also be given the power over those decisions that affect EVA. Thus the use of EVA implies delegated decisionmaking. EVA makes the cost of capital visible to operating managers. A plant manager can improve EVA by (a) increasing earnings or (b) reducing capital employed. Therefore underutilized assets tend to be flushed out and disposed of. Working capital may be reduced, or atleast not added too casually. Introduction of residual income measures often leads to surprising reductions in assets employed - not from one or two big capital disinvestment decisions, but from many small ones. EVA lets the business managers realize that even assets have a cost and hence stock wont be lying idle. The firm will start using JIT and change the way they connect with their suppliers, and have them deliver raw materials more often.
CRITICISMS OF EVA
EVA could be misleading as a wealth metric because it reflects momentary swings in the capital markets rather than inherent company performance.
EVA is also shareholder-centric and hence of little relevance to the rest of the stake holders. EVA is identical to residual income, which was largely abandoned by companies years ago.
CONCLUSION
In the field of corporate finance, economic value added is a way to determine the value created, above the required return, for the shareholders of a company. Shareholders of the company will receive a positive value added when the return from the capital employed in the business operations is greater than the cost of that capital. On comparison of the traditional and modern parameters of measuring shareholders wealth creation it is identified that the modern parameters are superior over the traditional parameters of measuring shareholders wealth creation. There is a need for revision and reforms required in the parameters of measuring shareholders wealth creation due to the superiority of the modern parameters over the traditional parameters of measuring shareholders wealth creation. The corporates have to view shareholders not merely as a part-owner, who is a supplier of finance and share capital as merely a source of finance but have to shift their paradigm towards shareholders being the true owner of a corporate firm and to run the corporate firm with an ultimate objective of achieving shareholders wealth creation. Today EVA is not a mandatory part of financial reporting and hence it does not form a part of annual reports. Due to the increasing importance of EVA in future it should form a part of mandatory accounting information reported through annual reports.
REFERENCES
[1] James L. Grant, Foundations of Economic Value Added, 2nd Edition. [2] S. David Young & Stephen F. O'Byrne, EVA and Value-Based Management: A Practical Guide to Implementation. [3] Joel M. Stern, John S. Shiely & Irwin Ross, The EVA Challenge: Implementing Value-Added Change in an Organization. [4] Karam Pal Singh and M.C. Garg, Deep and Deep, 2004, Economic Value Added (EVA) in Indian Corporates. [5] Arvind A. Dhond, SFIMAR Research Review, Issue 10, 2010, Shareholders Wealth Creation through Economic Value Added (EVA). [6] Arvind A. Dhond, Economic Value Added (EVA), Special Study in Finance, Vipul Prakashan, 1st Edition, 2010. [7] Craig Savarese, Economic Value Added: The Practitioner's Guide to a Measurement and Management Framework.
FundamentalAnalysisofIndian TelecomSector
Dr.KeyurM.Nayak*
AbstractFundamental analysis on Indian telecom sector was done keeping in mind the fast pace of growth in this sector. This sector has achieved a lot in past few years and has a great potential to grow & flourish. Fundamental analysis tells us about the financial soundness and strong fundamental of the sector. The investment in this sector become a craze among the investors from the investor point of view it is very important to know the fundamental of the company before investing. Whether it is worth investing in company shares or not. Fundamental analysis tells when and where to invest. Intrinsic value of the shares tells us about the future potential growth of the shares. The basis of the study provides us the deep insight into the telecom sector companies. Keywords: Fundamental Analysis, Financial Soundness, Intrinsic Value, Investing
INTRODUCTION
Indian telecom is worlds fastest growing telecom expected to grow three fold by 2012.Tremendous strides in this industry have been facilitated by the supportive and liberal policies of the Government. Especially the telecom policy of 1994 which opened the doors of the sector for private players. Rising demand for a wide range of telecom equipment has provided excellent opportunities for investors in the manufacturing sector. Provision of telecom services to the rural areas in India has been recognized as another thrust area by government which also helps for the enormous opportunities in this sector. Therefore telecom sector in India is one of the fastest growing sectors in the country and has been zooming up the growth curve at a feverish pace in the past few years. Any investor while making investment is concerned with the intrinsic value of the asset, which is determined by the future earning potential of the asset. In case of securities market, an investor has number of securities available for investment in telecom sector. But, he would like to invest in the one, which has good potential for future. In order to ensure the future earnings of any security, an individual has to conduct fundamental analysis of the company. Fundamental analysis of a company involves in-depth examination of all possible factors, which have bearing on the prospects of the company as well as its share price. Fundamental analysis is divided into 3 stages namely economic analysis, industry analysis, company analysis. Therefore fundamental analysis on Indian telecom sector was done keeping in mind the fast pace of growth in this sector.
JPMorganResearchReporton13March2009.
Our new Dec-09 PT is at Rs 600/share based on DCF (including Rs89/share for Indus stake) as opposed to an earlier PT of Rs725/share. The DCF value of Rs570/share with additional Rs89/share from Indus, makes for Rs659/share. we apply a 9% competition risk discount to get a price target of Rs600/share. Our PT implies a one-year forward P/E/EV/EBITDA of 11x/7x, below the historical average. However, Bhartis stock is still ahead of the historical average on growth-adjusted multiples. Key upside risks to our price target are faster-thanexpected subscriber growth and lower-than-expected ramp-up from new operators. Key downside risks are sharper fall in ARPMs due to competition, 3G bids rising irrationally, and regulatory policies (faster roll-out of MNP). DCF valuation (not including Indus) Our Dec-09 DCF fair value estimate is Rs570/share. The DCF estimate assumes 10- year revenue CAGR (2009-2019E) of 7%, long-term EBITDA margin of 34%, and terminal growth of 5.0%. We assume a beta of 0.94, risk-free rate of 9.0%, market risk premium of 6.0%, and cost of debt of 6.1% to arrive at a WACC of 12.53%. We believe that our revenue growth estimates are fair given the stable subscriber growth momentum in spite of increasing competition. The stock, we believe, looks more attractive on a rolling EV/EBITDA basis because growth rates have slowed sharply. Growth adjusted charts still suggest that the stock is overvalued.
EdelweissResearchReportonJanuary2009
Regulations Higher spectrum charges Regulator has proposed one-time levy for over 6 2 MHz besides Proposed reduction in termination Charges Mobile number portability (MNP) Potential impact Higher spectrum charges will negatively impact EBITDA or lead to erosion of scale economies Negative for majority of incumbents who hold spectrum in excess of 6.2 Mhz Will impact net recipients of termination charges primarily GSM operators because of higher proportion of incoming calls on their network Could lead to pricing pressures on LD tariffs No significant impact on existing operators because of low broadband penetration Business case for ISPs not favourable given accompanying regulatory levies and carriage charges Increase in subscriber acquisition costs coupled with higher churn rates Likely to lead to increasing competitive pricing pressures and short-term volatility in earnings and profitability Positive for new entrants as it will allow utilisation of spare capacity Neutral to mild negative for incumbents, as it could lead to further tariff pressures on the voice business
Introduction of IP telephony
ToolsofAnalysis
The analysis methods includes the following Economic Analysis, Industry Analysis and Common Size financial Statement Analysis.
KeyPlayerstobeAnalyzed
This section provides the overview, key facts, financial information, future plans and business strategies of prominent players in the Indian Telecom market like Reliance Communications, Bharti Airtel, Tata Teleservices and Idea cellular.
RisingMiddleClassWillDriveSpending
Economic growth has led to a twofold increase in the number of middle-class households in India from 77m (60% of the total households) as of 1994-1995 to over 150m (74% of total households) today. This increase in the consuming class, coupled with corporate profit growth, has led to strong growth in communication spending in recent years. Yet, despite this increase, communication spending as a percentage of total private expenditure remains significantly low. As incomes rise further, we believe that such spending is only set to rise. Six States Will Together Account For 40% of Net-Adds We highlight below some of the states that we forecast will see stronger growth in the coming quarters. We forecast that these six states (Maharashtra, Gujarat, Andhra Pradesh, Karnataka, Uttar Pradesh - West and Uttar Pradesh -East) will account for about 40% of total net-adds in India in the next four years.
IndiaToHave541.3mnMobileSubscribersByFy2011
We estimate the Indian mobile market hit 541.3mn mobile by FY2011 (excluding BSNL and MTNL CDMA-WLL subscribers). This implies a CAGR growth of 28.3% over FY2008-11E. Thus, the industry in the medium-term is expected to continue to record good subscriber growth rates on as-yet low penetration levels, heightened competitive intensity, a continued fall in minimum subscription costs and tariffs leading to better affordability for lower-income rural users, expansion of coverage area by mobile operators and government support through schemes like the rural infrastructure roll out funded by subsidies from the USO Fund. We expect a majority of this growth to be driven by the 'A' and 'B' circle categories, which have been rapidly growing over the past few years and where tele-density is still relatively low at 21-29% levels.
RuralIndia,TheNextBastionofGrowth
The next phase of growth will undoubtedly be led by rural India. It should be noted that a majority of the Indian population still does not have access to mobile services and has largely remained untouched by the 'mobile revolution' that has swept the country. This has led to a huge 'digital divide', which is reflected in the urban tele-density levels, which stand at over 60%, whereas rural tele-density has barely touched double digits. As many as 800mn people in the country do not own a mobile phone and connection, in spite of the rapid expansion that has been witnessed over the past many years by all mobile operators. Thus, this is clearly the next bastion of growth for mobile operators.
FixedLineSubscriberBase'TriplePlay',ValueAddedServicesProvideHope
India's fixed line subscriber base has dwindled. With mobile telephony proving to be a considerably superior technology, there has been de-growth in the fixed line base, with many people surrendering their landlines in favour of mobile phones. In July 2008, the total number of fixed line subscribers in the country stood at 38.76mn (penetration of just 3.4%). Going forward, to grow the fixed line subscriber base, it is necessary for telecom companies to introduce a greater number of value-added services such as broadband and 'triple play', that is, voice, data and video connectivity through a single line, also known as Internet Protocol Television (IPTV). This could arrest the decline in the fixed line subscriber base. The move towards fully integrated entertainment companies. Major telecom companies are taking initiatives to expand their suite of services and become 'fully integrated entertainment players' rather than remaining merely telephone companies. These companies are making investments in businesses such as DTH and IPTV with a view to tap a greater share of the entertainment spend of consumers. Ball-park calculations suggest an approximate market size of Rs27,000cr for the DTH market, assuming average cable expenditure of Rs300 per household per month and if all C&S households (75mn) were assumed to go for DTH connections. Thus, the market size and growth potential is significant.
SpectrumRemainsTheBiggestConcern
Despite the strong growth prospects of the sector, the biggest concern remains that of spectrum. Spectrum is the lifeblood of the Telecom business, without which growth is likely
to get severely restricted. Even though in the short-term, the issue does seem to have been resolved, going ahead, with the Defence Forces scheduled to release more spectrum for 3G services, any delays on this front could have adverse implications for the sector. The everincreasing competitive intensity in the sector, with licences and spectrum in several circles like Tamil Nadu (including Chennai), Orissa, Kerala and Karnataka allotted to newer operators like Loop Telecom, Swan Telecom, Datacom and Unitech Wireless, is also a concern and could lead to unrealistic pricing levels to grab subscribers.
Announcementof3GandBWAPolicies
The government in August 2008 finally announced the much-awaited 3G and Broadband Wireless Access (BWA) Policies. 3G mobile services are expected to facilitate higher speeds and data throughputs, which enable the delivery of a wide range of multimedia services, including video telephony, e-commerce and television on mobile devices like handsets, smart phones and palm tops.
Net Sales Other Income Total Income Total Expenses Operating Profit PBDIT Interest PBDT Depreciation Profit Before Tax Tax Reported Net Profit Earning Per Share (Rs) Equity Dividend (%) Book Value (Rs) www.moneycontrol.com
100.00 3.14 103.04 60.68 39.22 42.36 0.79 41.56 10.92 30.05 3.30 26.47 0.06 0.05 0.27
100.00 18.11 118.11 83.81 16.18 34.29 9.25 25.04 11.14 13.89 10.36 3.53 0.017 0.12 1.80
100.00 3.23 103.23 72.62 27.37 30.61 8.29 22.32 11.53 9.23 0.97 8.89 0.02 0 0.29
100.00 11.18 111.18 76.67 23.32 34.51 7.80 26.71 17.85 8.85 3.29 15.01 0.52 0 7.93
OperatingProfit
As there is constant upsurge in the operating profit of the companies, which represents the profit of a company made from its actual operations and excludes certain expenses and
revenues that may not be related to its central operations and shows its effective control over costs, or those sales are increasing faster than operating costs. As it is more reliable measure of profitability since it is harder to manipulate with accounting tricks than net earnings. The operating profit margin is the highest in case of Bharti Airtel followed by Idea Cellular, while it is comparatively lower in case of Reliance Communication and TATA Communication.
NetProfitMargin
Due to the high operating profit margin of Bharti Airtel, the net profit margin is also higher as compared to other players. It is interesting to observe that Idea Cellular, Reliance Communication have very low net profit margin while TATA Communication is better than these two players. It indicates that indirect expenses are higher in case of theses two companies.
TABLE2:COMMONSIZEBALANCESHEET Particulars Liabilities Total Share Capital Equity Share Capital Share Application Money Reserves Revaluation Reserves Net worth Secured Loans Unsecured Loans Total Debt Total Liabilities Assets Net Block Capital Work in Progress Investments Total Current Assets Total CL & Provisions Net Current Assets Total Assets www.moneycontrol.com Bharti Airtel Mar 10 % Reliance Comm Mar '10 % Idea Cellular Mar '10 % Tata Comm Mar '10 %
1,898.77 1,898.77 186.09 34,650.19 2.13 36,737.18 39.43 4,999.49 5,038.92 41,776.10 28,024.97 1,594.74 15,773.32 2,187.11 12,842.00 -3,616.91 41,776.12
4.55 4.55 0.45 82.94 0.01 87.94 0.09 11.97 12.06 100.00 67.08 3.817 37.76 5.235 30.74 -8.658 100.00
1,032.01 1,032.01 0.00 49,466.88 0.00 50,498.89 3,000.00 21,478.28 24,478.28 74,977.17 30,612.48 1,683.52 31,898.60 2,118.89 9,223.37 10,782.57 74,977.17
1.38 1.38 0.00 65.98 0.00 67.35 4.00 28.65 32.65 100.00 40.83 2.245 42.54 2.826 12.3 14.38 100.00
3,299.84 3,299.84 44.45 8,112.95 0.00 11,457.24 5,988.61 537.81 6,526.42 17,983.66 14,927.06 462.58 2,755.13 605.95 4,451.52 -161.11 17,983.66
18.35 18.35 0.25 45.11 0.00 63.71 33.30 2.99 36.29 100.00 83.00 2.572 15.32 3.369 24.75 -0.896 100.00
285.00 285.00 0.00 6,995.78 0.00 7,280.78 1,281.76 1,357.15 2,638.91 9,919.69 4,504.80 386.15 2,501.30 736.44 2,259.34 2,527.44 9,919.69
2.87 2.87 0.00 70.52 0.00 73.40 12.92 13.68 26.60 100 45.41 3.89 25.22 7.42 22.78 25.48 100.00
From the above table, it can be concluded that all the companies are having large accumulated reserve, which has been created on the base of less amount of equity capital. The debt equity ratio is also adequate in case of all the companies which indicate that they are able to take the advantage of leverage. However it is interesting to know that the debt portion is relatively lower in case of Bharti Airtel and higher in case of Reliance (32.65%) and Idea Cellular (36.29%) as compared to (12.06%) of Bharti Airtel. However it cab be concluded that TATA Communication has moderate debt policy. We can also conclude that Reliance Communication is having the highest net worth, but return is less on it, while Bharti Airtel has less net worth compared to Reliance, but the return is higher than Reliance. The fixed assets and total asset turnover ratio is very good in case of Bharti Airtel as compared to any other players in the market.
Fundamental Analysis of Indian Telecom Sector 395 TABLE3:INTRINSICVALUEBASEDONEPSANDRISKFREERATEOFRETURN Name of the Company Current Risk Free Rate of EPS Return 4% 4% 4% 4% Value Forecasted Forecasted Currently Traded Price as of EPS Price on dated Shares As on date 58.00 2.55 63.8 130.00 620.50 27.30 682.55 338.00 79.75 3.50 87.72 69.50 423.75 18.64 466.12 258.35 Buy/Sell Decision Sell Buy Buy Buy
2.32 Rcomm 24.82 Bharti Airtel 3.19 Idea Cellular 16.95 Tata Communication www.moneycontrol.com
There are actually a few different ways to calculate the intrinsic value but we'll just go over the most common method. To get started, we must first gather the company's EPS figures for the year ended 2010. We then take this number and divide it by the annual return of the investment we are comparing it with (discount rate). We compare it with Treasury bonds, current rate is 4.00%.we simply divide the EPS by 0.04. We get the intrinsic value of Rs. 58.00 relative to government bonds. If we are interested in finding out what the stock will theoretically be worth next year, we just substitute next year's expected EPS with the increment of 10 % in current years EPS. The stock is expected to 63.80 per share next year (2011), and we get intrinsic value of Rs.58.00, relative to treasury bonds.
SUGGESTION
The company shares are being traded at Rs. 130 (November, 2010) on BSE which is approximately higher to value we get through intrinsic value. Intrinsic value is lesser than current market price, which means that its investing in company shares is not advisable. It is better to sell it in the market to book the profit. In case of remaining three companies the intrinsic value is more than the traded price which means the shares are under priced and really good to invest in such companies to earn a better return in future.
CONCLUSION
Indian telecom is worlds fastest growing telecom expected grow three fold by 2012.Tremendous strides in this industry have been facilitated by the supportive and liberal policies of the Government. Especially the Telecom Policy of 1994 which opened the doors of the sector for private players. Rising demand for a wide range of telecom equipment has provided excellent opportunities for investors in the manufacturing sector. Provision of telecom services to the rural areas in India has been recognized as another thrust area by govt.which also helps for the enormous opportunities in this sector. Therefore telecom sector in India is one of the fastest growing sectors in the country and has been zooming up the growth curve at a feverish pace in the past few years. And even the Indian Wireless Market is booming which has plenty of room for growth. In FY 2010, Bharti Airtel shows strong growth, their sales turnover is very high as well as their operating profit. ROI and leverage ratio is also good for the company. Debt -equity ratio is balanced. Therefore Bharti Airtel is good picks for investment compared any other company in the Indian telecom sector.
MarketAnomaliesintheIndian StockMarket
GirijaNandini*andDr.BishnupriyaMishra**
AbstractNumerous studies have been conducted to find the stock behaviour across the world. The most commonly documented market anomalies are the January effect and the dayof-the-week effect. According to day-of-the-week phenomenon the average daily returns of the market is not equal for all days of the week. Literature available in this area suggests that there is existence of day of the week effect not only in the USA but also in U.K, Canada, Australia, Singapore, Malaysia, Hong Kong, Turkey etc. This paper attempts to investigate the presence of seasonal effects in the Indian stock market through week day effect and month of the year effect .The anomalies in the Indian stock market have been studied by the two major indices, the Bombay Stock Exchange Index and the National Stock Exchange Index. The closing price of SENSEX and NIFTY has been taken for 17 years , from 1993 to 2009.Variety of statistical techniques have been used to see if any seasonality is present in the Indian Stock market. Keywords: Stock market, India, Seasonality, Day of the week effect, month of the year effect
INTRODUCTION
Anomalies in stock-market returns, such as weekend, day of the week, and January effects, have been of considerable interest. Engle (1993) argues that risk-averse investors should reduce their investments in assets with higher return volatilities. Therefore, the investigation of return and volatility patterns is a useful exercise. Most of these patterns are associated with the day-of-the-week (DOW) effects and month of the year effect. Broadly speaking, calendar effects occurs when the returns of financial assets display specific characteristics over specific days, weeks, months or even years. Undoubtedly, this is in contradiction to the efficient market hypothesis where returns should be random and as such, should not be associated with a specific time period. However, a number of studies have documented the presence of calendar effects on several stock markets. For instance, studies by French (1980), Gibbons and Hess (1981), Keim and Stambaugh (1984) found the existence of a Monday effect on the US market. According to the Efficient Market hypothesis, past prices of shares should have no predictive power of future prices. In effect, prices should be random. However, numerous studies have been carried to prove that market inefficiencies do exist and that anomalies may be in terms of seasonal effects over the day of the week, the months of the year or over specific years. For instance, the months of year effect would exist if returns on a particular month are higher than other months. This will negate the notion of efficiency in markets since traders will be able to earn abnormal returns just by examining patterns monthly returns and setting trading strategies accordingly. *Regional College of Management, Bhubaneswar **Academy of Management Studies, Bhubaneshwar
Essentially, this will entail an inefficient market situation where returns are not proportionate with risk. Several studies such as Keim (1983), Ariel (1987) and Jaffe et al. (1989) have pinpointed out the existence of a monthly effect on the US and other developed markets. However, most of the studies reveal the existence of a January effect where returns on January tend to be larger than returns on other months. One must consider the fact that those anomalies may not necessarily mean that these market are inefficient. In fact, it may turn out that gains on a specific time period may be insignificant when transactions costs are taken into account. Also, one must control for risk premium which may be time varying such that high returns on a specific day may be associated with high risk on that same day. Over the last two decades, considerable attention has been paid to estimate and predicting aggregate stock market volatility. Anomaly is defined as the degree to which a market rises or falls in a short period of time .Since the 1970s volatility in the bond and stock markets has increased globally and stock market volatility is not only detrimental to investors but also can be harmful to the stability of national and global economic system. So it needs a brief study of stock market anomaly. A common problem in the low and slow growth of small developing economies is the swallow financial sector. Financial markets play an important role in the process of economic growth and development by facilitating savings and channeling funds from investors to company. Volatility may impair the smooth functioning of the financial system and adversely affect economic performance. Similarly, stock market volatility also has a number of negative implications. A rise in stock market volatility can be interpreted as a rise in risk of equity investment and thus a shift of funds to less risky assets. This move could lead to a rise in cost of funds to firms and thus new firms might bear this effect as investors will turn to purchase of stock in larger, well known firms. While there is a general consensus on what constitutes stock market volatility and, to a lesser extent, on how to measure it, there is far less agreement on the causes of changes in stock market volatility. Some economists see the causes of volatility in the arrival of new, unanticipated information that alters expected returns on a stock . Thus, changes in market volatility would merely reflect changes in the local or global economic environment. Others claim that volatility is caused mainly by changes in trading volume practices or patterns, which in turn are driven by factors such as modifications in macroeconomic policies, shifts in investor tolerance of risk and increased uncertainty. So the study on market anomalies in India can help forecasters and also the investors for the analysis of their investment.
To study the significance of seasonality in returns across different days of the week and different months of the year.
LITERATURE REVIEW
There is undoubtedly an extensive literature on the day of the week effect. In fact, studies on such stock market anomalies started since the late 1930 where Kelly (1930) revealed the existence of a Monday effect on the US markets where the returns turned out to be negative. From thereon, researchers have documented findings in support of the low Monday returns in the US markets. Fields (1931) studied the day of the week effect and was of the opinion that the security prices declined on Saturday and this was because of the unwillingness of traders to carry their holdings over the uncertainties of a week-end which led to liquidation of long accounts. An investigation of the day of the week effect was made by Godfrey, Granger and Morgenstern (1964), who reported that Mondays variance was about 20% greater than other daily returns. Fama (1965) had also reached the same conclusion. Cross (1973) using the standard and poors 500 index showed that the Monday returns were negative and the Friday returns were very high in the U.S stock market. Officer (1975) detected the presence of seasonality in Australian stocks market.French 1980 analysed the day of the week effect for the period 1953 to 1977 by taking the Standard and Poors Composite Portfolio index and found out that the average return for Monday was significantly negative for the entire period . Chaudhury (1991) studied the seasonality in share returns particularly the day of the week effect in the Indian context for the period June 1988 to January 1991. He observed that return on Monday was negative. Broca (1992) also studied the day of the week patterns in the Indian stock market for the period April 1984 to December 1989 using Bombay Stock Exchange National Index of equity price and observed that Wednesday consistently earned the lowest (negative) returns where as Friday exhibited the highest returns in a week. Similarly, Dubois and Louvet (1996) documented the existence of a Monday effect on nine developed markets where as Tong (2000) reported this stock market anomaly in twenty three stock markets which include European, Asian and North American markets. Moreover, Nath and Dalvi (2004) examined the week day effect in the Indian equity market and found evidence of Monday and Friday effects before the rolling settlement in 2002. Nath & Dalvi examines empirically the day of the week effect anomaly in the Indian equity market for the period from 1999 to 2003 using both high frequency and end of day data for the benchmark Indian equity market index S&P CNX NIFTY. Using regression with dummy variables, the study finds that before introduction of rolling settlement in January 2002, Monday and Friday were significant days. Choudhary and Choudhary (2008) studied 20 stock markets of the world using parametric as well as non-parametric tests. He reported that out of twenty, eighteen markets showed significant positive return on various days other than Monday. James and Edmister (1981) had observed that there is existence of the January effect in the stock market. Stoll and Whaley (1983) , Blume and Stambaugh (1983) had studied the month of the year effect and observed that the January effect existed with respect to small firms. Lakonishok and Smidt (1984) had also confirmed the January effect in their study . Berges, Mc Connell and Sclarbaum (1984) investigated the January effect in Canada stock
market for the period 1951-80 and had a strong evidence in favour of January effect. Lamoureux and Sanger (1989) examined the turn of the year effect, the firm size effect and relationship between these two effects for a sample of OTC stocks traded via the NASDAQ reporting system over the period 1973 to 1985. A recent study of Balaban (1995) investigated the month of the year effect on the Turkish stock exchange. His analysis showed that January, June and September had significantly higher returns than other months and among these, January had a compounded return of 22%, about four times greater than the global return if all months are considered.
The most visible and tracked parameter of any stock market is the movement of the stock index. This is just a number that helps to measure the movement of the market against a benchmark index, taken as 100, on a base year. Most stock indices attempt to be proxies for the market they exist in. Each stock exchange has a flagship index like the Sensex of BSE or the Nifty of NSE. An index is calculated daily by tracking the share prices of its constituent member companies. For example, the Sensex is an index comprising 30 component stocks representing a sample of large, well established and leading companies while the Nifty consists of 50 company stocks. Sensex and Nifty are calculated using market capitalization weighted method. Every index is associated with a base year. For example, the base date for Sensex is 1st April 1979 and for the Nifty is 1st April 1995 .This means that the Sensex and Nifty were assumed to be 100 on these respective base dates. It may be interesting to know that Sensex actually came into existence only on 1st January, 1986, when the index was computed at 598.53. In fact, the base date does not have any significance beyond the introduction date, since for all the subsequent days the index is calculated by comparing the previous days value. In addition to the flagship indices, stock exchanges also maintain & publish other indices like BSE-100 Natex, BSE Dollex(BSE Sensex in US Dollar terms), BSE-200, BSE-500, S & P CNX Nifty Junior(Comprises next batch of liquid securities after S&P CNX Nifty) , S&P CNX Defty(measured in US Dollar Terms), S&P CNX Midcap, S&P CNX 500 and many other sector or industry specific indices like ET-Mindex(Comprising 30 companies media and information technology sectors and calculated by the Economic Times). These indices are useful for certain specific purposes. For example, the BSE Dollex or S&P CNX Defty is more relevant for a US citizen investing in India than the Sensex or Nifty.
RESEARCH METHODOLOGY
The data for this study consists of BSE and NSE data that comprise of daily closing price of SENSEX and NIFTY for the period 1993-2009. All the data points where returns are zero have been eliminated. The tests performed are from the parametric group and the various hypothesis tested are listed below. Multiple Regression using dummy variables has been carried out and the P value is used to test the significance. The daily returns are calculated as:
R(t ) =
Ln( I (t )) x100 (t 1)
DayoftheweekEffect
Model: Rt =a1d1 +a2d2 +a3d3 +a4d4 + a5d5 + ut where Rt is the return on day t, I(t) refers to index price on day t; a1 to a5 are the mean return for each day-of-the-week; d1 through d5 are day-of-the-week dummies that are either 0 or 1 (d1 = 1 for Monday and 0 otherwise and so on); ut is the random error term for day t. Hypothesis (Ho): a1 =a2 =a3 = a4 =a5 If this hypothesis is rejected, it would imply that the mean daily returns are significantly different from each other, i.e. there is seasonality in returns across different days of the week.
MonthoftheyearEffect
Model: Rt = b1Djan + b2Dfeb + b3Dmar + b4Dapr + b5Dmay + b6Djun + b7Djuly + b8Daug + b9Dsep+ b10Doct + b11Dnov + b12Ddec + ut where Rt is the monthly return on month t, b1 to b12 are the mean return for each month of the year. Djan through Ddec are month of the year dummies that are either 0 or 1 (Djan = 1 for January and 0 otherwise and so on); ut is the random error term for month t. Hypothesis (Ho): b1=b2=b3=b4=b5=b6=b7=b8=b9=b10=b11=b12 If this hypothesis is rejected, it would imply that the mean monthly returns are significantly different from each other, i.e. there is seasonality in returns across different months of the year.
402 Changing Dynamics of Finance TABLE1:SUMMARYSTATISTICSFORDAILYNSE(50)RETURNS Column 1 Mean Standard Error Median Standard Deviation Variance Kurtosis Skewness Observations Mon -0.050935 0.0327766 0.0109513 0.8879969 0.7885385 5.4021375 -0.899074 826 Tue -0.03481 0.052157 0.032793 1.40726 1.98038 5.210285 -0.2233 830 Wed 0.283498 0.057022 0.181286 1.545922 2.389874 1.890467 0.367184 836 Thus 0.057913 0.056617 0.116295 1.535976 2.359221 2.224008 -0.03057 832 Fri 0.049642 0.060441 0.083227 1.597965 2.553491 3.070398 -0.23293 795
TABLE2:SUMMARYSTATISTICSFORDAILYBSE(30)RETURNS Column 1 Mean Standard Error Median Standard Deviation Sample Variance Kurtosis Skewness Observations Mon 0.009 0.033 0.071 0.918 0.843 3.787 -0.71 821 Tue 0.005 0.0523 0.0558 1.4651 2.1465 3.8186 -0.182 835 Wed 0.112 0.057 0.091 1.596 2.546 1.599 0.255 845 Thus 0.011 0.056 0.08 1.581 2.501 1.777 -0.02 836 Fri -0.009 0.065 0.095 1.792 3.21 4.161 -0.476 797
Table1 & Table 2 reports the preliminary statistics (evidence) for the returns for the each day of the week. Study shows that the Wednesday returns appeared to be higher (0.112) relative to other trading days and Friday return(-0.009) is lowest in BSE. But in NSE the Wednesday returns (0.2834) is higher relative to other trading days and Monday return(0.0509) is lowest. Additionally, the Standard Deviation (SD) is used to measure the risk return tradeoffs across the days. Essentially a high Standard Deviation (SD) can be the result of either higher return or higher risk or even both.. In BSE Wednesday has the highest SD (1.596) and Monday has the lowest (0.918) SD. But in NSE Friday has the highest(1.5979) SD and Monday has the lowest (0.887)SD. In BSE and NSE only Wednesday is positively skewed. This inconsistent pattern may suggest that returns may be random and as such, may reduce support for any strong argument in favour of a day of the week effect.
NSE
TABLE3:TESTINGOFTHEDAYOFWEEKEFFECTS Coefficient P-value Monday 0.132 .361 Tuesday 0.186 .64 Wednesday 0.019 .477 Thursday -0.081 .312 Friday -0.113 .188
BSE
TABLE4 op Coefficient P-value Monday 0.152 .284 0.112 .252 Tuesday Wednesday 0.143 .079 Thursday -0.093 .245 Friday 0.072 .348
Table 3 & table 4 indicate that the variation in returns across different days of the week in both BSE & NSE is not significant at the 5% level, i.e. the null hypothesis is accepted. This suggest that no evidence in favour of the day of the week effect. The results are in sharp
contrasts with the findings of Gibbons and Hess (1981), Mills and Coutts (1995), and Arsad and Coutts (1997) where the significant day of the weeks effects were noted in the US and UK markets.
TABLE5:SUMMARYSTATISTICSFORMONTHLYNSE(50)RETURNS Mean Standard Error Median Standard Deviation Sample Variance Kurtosis Skewness Observations Jan -0.07 2.33 0.21 9.32 86.83 -0.15 -0.11 16 Feb 2.29 1.48 2.05 6.09 37.07 0.47 0.47 17 Mar -2.82 2.04 -2.44 8.39 70.41 -0.83 -0.04 17 Apr 0.72 1.87 -2.02 7.73 59.70 -1.16 0.34 17 May 1.16 2.59 3.13 10.68 114.12 0.60 0.19 17 June 0.87 1.91 1.84 7.87 61.98 1.39 -0.96 17 July 1.70 1.48 3.38 6.10 37.20 -0.27 -0.83 17 Aug 2.17 1.58 0.62 6.50 42.29 -0.22 -0.10 17 Sept 0.39 1.90 3.38 7.82 61.12 -1.03 -0.48 17 Oct -2.73 2.42 -2.37 9.96 99.27 3.47 -0.93 17 Nov 2.79 2.03 3.75 8.38 70.21 -0.24 -0.18 17 Dec 4.65 1.08 5.29 4.47 19.97 1.78 -0.06 17
TABLE6:SUMMARYSTATISTICSFORMONTHLYBSE(30)RETURNS Mean Standard Error Median Standard Deviation Sample Variance Kurtosis Skewness Observations Jan 0.41 2.11 0.39 8.45 71.33 -0.12 0.11 16 Feb 2.02 1.47 2.38 6.05 36.57 0.08 0.31 17 Mar -3.12 2.01 -3.33 8.30 68.84 -0.94 0.08 17 Apr -3.10 2.01 -3.33 8.30 68.84 -0.94 0.08 17 May 0.97 2.59 2.20 10.67 113.80 0.51 0.44 17 June 1.14 1.98 2.01 8.15 66.43 1.87 -1.12 17 July 1.79 1.46 4.21 6.03 36.32 -0.38 -0.87 17 Aug 2.23 1.58 1.44 6.50 42.21 -0.32 -0.31 17 Sept 0.17 2.01 2.84 8.30 68.88 -1.22 -0.35 17 Oct -2.65 2.24 -2.02 9.22 85.03 2.40 -0.79 17 Nov 2.43 2.07 3.92 8.53 72.68 -0.46 -0.13 17 Dec 4.26 1.059 4.495 4.365 19.05 1.486 0.169 17
Table 5 & Table 6 reports the preliminary statistics (evidence) of the returns for the month of the year. Study shows that the December return appeared to be higher relative to other months and March return is lowest in BSE as well as NSE. Standard Deviation (SD) is highest in May and lowest in December in BSE as well as NSE. On overall, the mean returns are positive for nine months except on January, March and October in NSE. But in BSE the mean returns are positive for nine months except on March, April and October. In NSE the month Feb, April and May is positively skewed but in BSE January, February, March, April and May is positively skewed.
NSE
TABLE7:TESTINGOFMONTHOFTHEYEAREFFECTS Coefficient P-value Jan 0.15 0.94 Feb 1.14 0.73 Mar 0.16 0.93 Apr 0.74 0.78 May -.91 0.35 June -1.28 0.54 July 0.77 0.80 Aug 0.84 0.74 Sept 0.14 0.96 Oct 1.07 0.54 Nov 0.78 0.73 Dec 2.68 0.41
BSE
TABLE8 Coefficient P-value Jan -.70 0.77 Feb 2.74 0.46 Mar 1.15 0.59 Apr 0.51 0.86 May 1.74 0.46 June -1.46 0.52 July 0.20 0.95 Aug 0.66 0.79 Sept 0.62 0.82 Oct 1.08 0.57 Nov 1.09 0.66 Dec 3.19 0.35
Table 7 & table 8 indicate that the variation in returns across different month of the year in both BSE & NSE is not significant at the 5% level, i.e. the null hypothesis is accepted. This
suggest that no evidence in favour of the month of the year effect. The results, on overall, do not seem to have a strong support in the month of the year anomaly. It seems that returns are not more or less random, consistent with the efficient market hypothesis.
CONCLUSION
This paper has investigated day of the week effects on the BSE & NSE for 17years from 1993 to 2009.The results, on overall indicate no significant presence of the day of the week effect for the whole period. This paper also investigated there is no existence of the month of the year effect in BSE and NSE. The regression analysis heavily supports the predictions of Efficient Market hypothesis that the returns are not dependent on all the months of the year. These above results undoubtedly call for further research on the presence of a week day effect and month of the year effect based on individual securities.
REFERENCES
[1] Agrawal, A. and Tandon, K. (1994), Anomalies or illusions? Evidence from stock markets in eighteen countries, Journal of International Money and Finance, pp. 83106. [2] Ariel, R. (1987), A monthly effect in stock returns, Journal of Financial Economics, Vol. 18,pp. 16174. [3] Branch, B. (1977), A tax-loss trading rule, Journal of Business, Vol. 50 No. 2, pp. 198207. [4] Brooks, R. and Kim, H. (1997), The individual investor and the weekend effect: a re-examination with intraday data, Quarterly Review of Economics and Finance, Vol. 37 No. 3, pp. 72537. [5] Asian stock markets, Asia-Pacific Journal of Management, Vol. 13 No. 2, pp. 124. [6] Chatterjee, A. and Maniam, B. (1997), Market anomalies revisited, Journal of Applied Business Research, Vol. 13 No. 4, pp. 47-56. [7] Chow, E., Hsiao, P. and Solt, M. (1997), Trading returns for the weekend effect using intraday data, Journal of Business Finance & Accounting, Vol. 24 Nos 3/4, pp. 42544. [8] Draper, P. and Paudyal, K. (2001), Explaining Monday returns, working paper, Centre for Financial Markets, University of Edinburgh, Edinburgh. [9] Dubois, M. and Louvet, P. (1996), The day-of-the-week effect: the international evidence, Journal of Banking & Finance, Vol. 20 No. 9, pp. 146384. [10] Dyl, E. and Maberly, E. (1988), A possible explanation of the weekend effect, Financial Analyst Journal, pp. 83-4. French, K. (1980), [11] Stock returns and the weekend effect, Journal of Financial Economics, Vol. 8, pp. 5569. [12] Gultekin, M. and Gultekin, N. (1983), Stock market seasonality: international evidence, Journal of Financial Economics, Vol. 12, pp. 469-81. [13] Hess, P. (1981), Day of the week effects and asset returns, Journal of Business, Vol. 54 No. 2,pp. 57995. [14] Johnston, K. and Cox, D. (1996), The influence of tax-loss selling by individual investors in explaining the January effect, Quarterly Journal of Business & Economics, Vol. 35 No. 2, pp. 1420. [15] Keim, D. and Stambaugh, R. (1984), A further investigation of the weekend effect in stock market returns, Journal of Finance, Vol. 39 No. 3, pp. 81935. [16] Khaksari, S. and Bubnys, E. (1992), Risk-adjusted day-of-the-week, day-of-the-month, and month-of-theyear effects on stock indexes and stock index futures, Financial Review, Vol. 27, pp. 53152. [17] Lee, I. (1992), Stock market seasonality: some evidence from the Pacific basin countries, Journal of Business Finance & Accounting, Vol. 19 No. 2, pp. 199209. [18] of Financial Research, Vol. 20 No. 1, pp. 1332. [19] Porter, D., Powell, G. and Weaver, D. (1996), Portfolio rebalancing, institutional ownership, and the smallfirm January effect, Review of Financial Economics, Vol. 5 No. 1, pp. 1929. [20] Raj, M. and Thurston, D. (1994), January or April? Tests of the turn-of-the-year effect in the New Zealand stock market, Applied Economic Letters, Vol. 1, pp. 813.
[21] Rogalski, R. (1984), New findings regarding day-of-the-week returns over trading and non-trading periods: a note, Journal of Finance, December, pp. 160314. [22] Star, M. (1996), The January effect: dead or just missing in action, Pensions and Investments, Vol. 24 No. 3, pp. 331. [23] Wang, K., Li, Y. and Erickson, J. (1997), A new look at the Monday effect, Journal of Finance, Vol. 52 No. 5, pp. 217186. [24] Ward, S. (1997), The striking price: warm to the January effect, Barrons, Vol. 77 No. 47, p. 17. Further reading Dyl, E. and Maberly, E. (1986), The weekly pattern in stock index futures: a further note,Journal of Finance, pp. 114952.
RecentTrendsinIndianCapitalMarket
PoonamDhawale*,IndrabhanThube*andShivanandFulari*
AbstractOver the last few years, SEBI has announced several far-reaching reforms to promote the capital market and protect investor interests. Reforms in the secondary market have focused on three main areas: structure and functioning of stock exchanges, automation of trading and post trade systems, and the introduction of surveillance and monitoring systems. Capital market trends can be sub-divided into primary, secondary (short-term), and secular (long-term) trends. Secondary market trends refer to price changes within a primary trend. These price changes are not permanent. A temporary decrease in price during a bull market is a correction and opposite bear. Secular market trends are long-term. They usually remain for a period of five to twenty five years. Many primary trends sequentially arranged result in a secular market trend. * A financial crisis arises in India during 2008 and its effect on capital market and role of SEBI during the financial crises and the role of Government during financial crises. They perform two valuable functions: liquidity and pricing securities. It has two mutually supporting and indivisible segments: the primary market and secondary market. In the primary market, companies issue new securities to raise the funds. The secondary market may also include the over-the-counter (OTC) market and the derivatives market. Keywords: SEBI, Financial Crises, Bulls & Bears, Derivatives, liquidity and pricing securities. Research Methodology The basic feature of Stock Market Trend, and its process was studied based on secondary data collected from the books, journals and related websites regarding Indian Stock Market. Objectives As stated above, the present paper is focused towards the identification of ups and downs in stock indices with respect to Bombay Stock Exchange and National Stock Exchange from financial crises 2008 to July 2010. To be more specific, the present study seeks to attain the following objective. Trends in Indian Capital market with respect to BSE and NSE. Stock Market Trend during the recession. Strategies to battle the recession with respect recovery of Stock Exchange. Recessionary impact on Indian Economy.
INTRODUCTION
Between 1800 and 1970, credit crises, often caused or accompanied by real estate collapses, occurred in the united states on average once every 14 years, according to Prof. James Van Horne of Stanford University. Since 1970, the wave of financial and corporate deregulation *SVPMs Institute of Management, Baramati
that began in the 1970s and accelerated over the past 10 years. One of the biggest changes was affording financial institutions the facility to securitize their loans. Although an important innovation for aiding economic growth, it also gave bankers an incentives to generate large volumes of loan and then move the loans onto somebody else without really worrying about what happens to them after that. Prof. James van Horne compares the recent lack of regulation to the late 1800s. That atmosphere culminated in the bankers panic in 1907, a severe Wall Street crash that prompted the creation of the Federal Reserve and the modern system of financial regulation. The speculative bubbles that caused credit crises in the past included railroads in the late 1800s, electronics and autos in the 1920s and high-tech and internet startups in the late 1990s. At the core of each crisis was real estate. During the panic of 1819, the real estate speculation involved farmland on the Ohio frontier. In the panic of 1837, there was a real estate bubble along the Mississippi. The panics of 1873 and 1893 involved investment in land near rail lines. The crash of 1929 was preceded by the bursting of real estate bubbles in Florida and Southern California.
The response to current crises bears resemblance to past solutions. Most U.S. credit crises have been followed by expansion in credit, tightened trade restrictions, employment-boosting public works projects and, in some cases, direct aid to indebted borrowers. Until the present
crises came to the most prominent example of government intervention was Franklin Roosevelts new deal, which entailed massive infrastructure projects, tight regulation of the financial system and direct support to defaulting homeowners.
CommercialBanksandInvestmentBanks
Commercial banks and investment banks lent vast sums-trillions of dollars- for house purchases and consumer loan to borrowers not really equipped to repay. The easy lending pushed up still higher when speculators bought houses on expectation of further price increases. The prices rose significant because easier access of fund or loans as also historically low interest rates, looser lending and appraisal standards, low documentation (no income proof), speculative fever, low teaser rates, that is low mortgage rates for first year, other creative structures and homeowners seeking extra profit from buying and selling homes. Greater facilitation to the boom was provided by funding the mortgages based securities which were sold to the investment bank, pension funds, insurance companies, foreign banks and other financial institutions, and individuals.
BoomintheHousingSectorandEasyLoan
The boom in the housing sector was taking the economy to a new level. A combination of low interest rates and large inflows of foreign funds helped to create easy credit conditions where it became quite easy for people to take home loans. As more and more people took home loans, the demands for property increased and fueled the home prices further. As there was enough money to lend to potential borrowers, the loan agencies started to widen their loan disbursement reach and relaxed the loan conditions. As a result, many people with low income and bad credit were given housing loans in disregard to all principles of financial prudence. These types of loans were known as subprime loans as those were are not part of prime loan market .With stock markets booming and the system flush with liquidity, many big fund investors like hedge funds and mutual funds saw subprime loan portfolios as attractive investment opportunities.
Hence, they bought such portfolios from the original lenders. Major (American and European) investment banks and institutions heavily bought these loans (known as Mortgage Backed Securities, MBS) to diversify their investment portfolios. Owing to heavy buying of Mortgage Backed Securities (MBS) of subprime loans by major American and European Banks, the problem, which was to remain within the confines of US propagated into the worlds financial markets.
HomePricesStartedDeclining
As the home prices started declining in the US, sub-prime borrowers found themselves in a dirty situation. Their house prices were decreasing and the loan interest on these houses was increased rapidly. As they could not manage a second mortgage on their home, it became very difficult for them to pay the higher interest rate. As a result many of them opted to default on their home loans and vacated the house. However, as the home prices were falling rapidly, the lending companies, which were hoping to sell them and recover the loan amount, found them in a situation where loan amount exceeded the total cost of the house. Eventually, there remained no option but to write off losses on these loans. The problem got worsened as the Mortgage Backed Securities (MBS), which by that time had become parts of CDOs of giant investments banks of US & Europe, lost their value. Falling prices of CDOs bad effect on banks' investment portfolios and these losses destroyed banks' capital.
USFederalBank&LehmanBrothers
Despite efforts by the US Federal Reserve to offer some financial assistance to the in difficulties financial sector, it has led to the collapse of Bear Sterns, one of the world's largest investment banks and securities trading firm. Bear Sterns was bought out by JP Morgan Chase with some help from the US Federal Bank. The crisis has also seen Lehman Brothers the fourth largest investment bank in the US and the one which had survived every major upheaval for the past 158 years - file for bankruptcy. And slowly this recession started to creep into other countries like a contagious disease.
pre-bankruptcy asset (Billion $) 700 600 500 400 300 200 100 0
G Re lo Pa ba fc o lC cif ic ro G ss as in g & El e Un ct ric ite d Ai rli ne s Br ot he rs W or ld co m En ro n Co se co Te xa na co nc ia lC or p. Fi
Le hm
an
company
CollapseofLehmanBrothers
Collapse of Lehman brothers, ranked among the worlds top investment banks, Lehman Brothers expanded aggressively into property related investments including the sub-prime mortgages. The sub-prime crises with the decline in the value of those asset and lead to loss of about U.S. $14 billion, this further leads to Lehmans prime customer pulling out their monies into much safer investments. The collapse of the company put ten thousands of jobs around the world at risk. The impact was also huge in other major economics considering the integration of the financial markets and the global nature of business today. Everything on Wall Street changed.
SpreadingofFinancialcrises
The U.S. financial crises first spread to other rich countries the U.K., Europe and Japan and later to emerging economics, including china and India. The impact, of course, has varied from country to country. The Government has been responding with bail-out packages, through which more and more liquidity is being made available and interest rates are gradually brought down. Countries like Japan, China, and India have put up Bail-out packages to impact of financial crises.
IndianStockmarketTrends
The Indian stock market appears highly promising for the overseas investors as reflected by the inflows in the past few weeks with the high flow in investments in the countrys stocks. The growing FII investments made the BSE index not only cross 17 K points but to get closer to the 20 K points in September 2010.
Recent Trends in Indian Capital Market 411 TABLE1:MONTHLYTRENDSINSTOCKMARKETINDICES(BEGINNINGOFMONTHFIGURES) Date BSE Sensex 1.01.08 20300 1.02.08 18242 3.03.08 16677 1.04.08 15626 2.05.08 17600 2.06.08 16063 1.07.08 12961 1.08.08 14656 1.09.08 14498 1.10.08 13055 3.11.08 10337 1.12.08 8839 26.12.08 9328 30.01.09 9424 02.03.09 8607 31.03.09 9708 29.04.09 11403 01.06.09 14840 01.07.09 14645 03.08.09 15924 01.09.09 15551 01.10.09 17134 03.11.09 15405 01.12.09 17198 04.01.10 17558 01.02.10 16356 02.03.10 16773 01.04.10 17693 03.05.10 17386 01.06.10 16572 01.07.10 17509 Half Year wise Breakup of BSE Sensex First- January 2008- June 2008 Date 1.01.08 1.02.08 3.03.08 1.04.08 2.05.08 2.06.08 BSE Sensex 20300 18242 16677 15626 17600 16063 Date 1.01.08 1.02.08 3.03.08 1.04.08 2.05.08 2.06.08 % Change 4.8 -10.1 -8.5 -6.3 12.6 -8.7 -19.3 13.1 -1.1 -9.9 -20.8 -14.5 5.5 1 -8.7 12.8 17.5 30.1 -1.31 8.7 -2.3 10.2 -10.1 11.6 2.1 -6.8 2.5 5.5 -1.7 -4.7 5.7 S&P CNX NIFTY 6144 5317 4953 4739 5228 4739 3896 4413 4447 3950 3043 2682 2857 2874 2674 3020 3473 4529 4340 4711 4625 5083 4564 5122 5232 4900 5017 5291 5223 4970 5251 % Change 6.6 -13.5 -6.8 -4.3 10.3 -9.3 -17.8 13.3 0.8 -11.1 -23 -11.9 6.5 0.5 -7 12.9 15 30.4 -4.1 8.5 -1.8 9.9 -10.2 12.2 2.1 -6.4 2.4 5.5 -1.3 -4.8 5.7
TABLE3:SECONDFROMJULY2008DECEMBER2008 Date 1.07.08 1.08.08 1.09.08 1.10.08 3.11.08 1.12.08 BSE Sensex 12961 14656 14498 13055 10337 8839 Date 1.07.08 1.08.08 1.09.08 1.10.08 3.11.08 1.12.08 % Change Sensex -19.3 13.1 -1.1 -9.9 -20.8 -14.5 Date 1.07.08 1.08.08 1.09.08 1.10.08 3.11.08 1.12.08 S&P CNX NIFTY 3896 4413 4447 3950 3043 2682 Date 1.07.08 1.08.08 1.09.08 1.10.08 3.11.08 1.12.08 % Change Nifty -17.8 13.3 0.8 -11.1 -23 -11.9
414 Changing Dynamics of Finance TABLE4:THIRDDECEMBER2008JULY2009 Date BSE Sensex 26.12.08 9328 30.01.09 9424 02.03.09 8607 31.03.09 9708 29.04.09 11403 01.06.09 14840 Date 26.12.08 30.01.09 02.03.09 31.03.09 29.04.09 01.06.09 % Change Sensex 5.5 1 -8.7 12.8 17.5 30.1 Date 26.12.08 30.01.09 02.03.09 31.03.09 29.04.09 01.06.09 S&P CNX NIFTY 2857 2874 2674 3020 3473 4529 Date 26.12.08 30.01.09 02.03.09 31.03.09 29.04.09 01.06.09 % Change Nifty 6.5 0.5 -7 12.9 15 30.4
TABLE5:FOURTHJULY2009DECEMBER2009 Date 01.07.09 03.08.09 01.09.09 01.10.09 03.11.09 01.12.09 BSE Sensex 14645 15924 15551 17134 15405 17198 Date 01.07.09 03.08.09 01.09.09 01.10.09 03.11.09 01.12.09 % Change Sensex -1.31 8.7 -2.3 10.2 -10.1 11.6 Date 01.07.09 03.08.09 01.09.09 01.10.09 03.11.09 01.12.09 S&P CNX NIFTY 4340 4711 4625 5083 4564 5122 Date 01.07.09 03.08.09 01.09.09 01.10.09 03.11.09 01.12.09 % Change Nifty -4.1 8.5 -1.8 9.9 -10.2 12.2
TABLE5:FIFTHJANUARY2010JULY2010 Date BSE Sensex 04.01.10 17558 01.02.10 16356 02.03.10 16773 01.04.10 17693 03.05.10 17386 01.06.10 16572 01.07.10 17509 Date 04.01.10 01.02.10 02.03.10 01.04.10 03.05.10 01.06.10 01.07.10 % Change Sensex 2.1 -6.8 2.5 5.5 -1.7 -4.7 5.7 Date 04.01.10 01.02.10 02.03.10 01.04.10 03.05.10 01.06.10 01.07.10 S&P CNX NIFTY 5232 4900 5017 5291 5223 4970 5251 Date 04.01.10 01.02.10 02.03.10 01.04.10 03.05.10 01.06.10 01.07.10
NottoDivertFromCoreBusiness
All companies should focus on their core competencies during disturbed economic times. Companies who did diversify and split focus away from their core competencies often struggled to manage their unrelated businesses whereas companies that remained focused, or
re-focused on their core created opportunities to gain market share more easily from their competitors.
ImprovedProcessandEfficiency
A common theme among the companies is the process by which they implemented their strategy during recessions. It is logical that process efficiencies will be sought to trim costs from budgets during a recession. All the companies should have the flexibility and must be fast action oriented as these are the key to surviving and prospering during recession. Flexibility will allow the business to implement their recession strategies quicker than competitors. In some cases horizontal management structures will also directly attribute to the speed with which companies were able to integrate acquired businesses successfully.
StrategicDivestment
Most companies should divest parts of their business during recessionary periods. At face value these divestments will be a part of a strategy of cutting costs and/or generating short term liquidity, particularly where less profitable divisions were divested. For the companies, divestment is primarily used to raise cash to service debt and fund further investment. However it is important to note that most divestitures to be made must be of divisions that are not in-line with the company's long term strategic view, or differed from the company's corebusiness.
ContingencyPlanning
Companies should actively plan alternative strategies for adverse times well in advance of them occurring. This is important as it demonstrates it is never too late to act, as these companies will survive turbulent times despite having no specific plan for the recession. However, in all cases when the downturn hit, the companies quickly assembled a plan and put in place a strategy for dealing with adverse conditions.
AcquisitionsandStrategicAlliances
There are several reasons why acquisition of competing or allied businesses is seen as a good strategy by some companies in a period of economic downturn. The 'entry price' is likely to be lower than at other times as businesses are sold under stress or to liquidate assets. This means that companies can purchase targets that may otherwise have been out of their reach. There may also be less competition for acquisition targets because few companies make available the resources to make acquisitions during periods of economic stress. Sometimes businesses become available for acquisition that has previously been unattainable, as they struggle to deal with a downturn.
IncreasedAdvertisingandMarketing
One of the biggest mistakes business owners make during periods of economic slowdown is to cut back on marketing and advertising, doing this could be most detrimental to their business .Advertising was used effectively by these companies to help weather downturns and
strengthen demand for their core products. Instead, the marketing needs to be more aggressive and more comprehensive than ever. One should start by contacting past clients and simply touching base. Chances are a good number of them will have projects or assignments for which the company's services may be required.
ResearchandDevelopment
The companies should use Research and development to meet the increasingly diverse needs of their recessionary customers who seek greater value from their spending. Most companies should also try to increase their speed to market with new products to gain advantage over their competition. They must do this by prioritizing development of the most promising products that met the immediate needs of their customers.
HumanFactor
Make sure that one has the right people for the job. As much as possible, the company should get everybody in the team to think lean. Extravagance becomes a luxury, and one can't simply splash advertisements ad infinitum like there is no tomorrow. One should be constantly re-evaluating not just the marketing plan, but all of the business strategies including policies, pricing, and employee performance. The idea is to eventually be as efficient and effective as possible so the company runs smoothly and profitably. Companies should look closely at the competitors. Talking to business leaders will also help. Experiment Solicit feedback from the workers and customers. By doing several of these things one will accumulate a wealth of knowledge and experience crucial to the survival of your business.
CONCLUSION
Recession affect on Indian stock market but immediately recovered after 6 months, so it was not really affect on Indian stock market. In the globalized market scenario, the impact of recession at one place/ industry/ sector percolate down to all the linked industry and this can be truly interpreted from the current market situation which is faced by the world. A global recession occurs or not, there will be people whose businesses go under simply because of the speculation about a recession. Recession was not affected very hard on Indian economy because of strong fiscal and monetary policies of Indian government and RBI. It's incredibly sad but it's a fact and it's happened all throughout history whenever the economy has faltered. These recession strategies won't turn the business around when used independently, but if we combine several of them, they can help to transform one's outlook for the future.
This recession have turned down the growth process and have set the minds of many for finding out the real solution to sustain the economic growth and stability of the market which is desired for the smooth running of the economy.
REFERENCES
[1] A Bank Quest, The Journal Of Indian Institute Of Banking & Finance January-March 2009 (ISSN 0019 4921) Vol: 80 No: 1 P. 5, 6. [2] A Bank Quest, the Journal of Indian Institute of Banking & Finance January-March 2009 (ISSN 0019 4921) Vol: 80 No: 1 P. 8. [3] A Bank Quest, the Journal of Indian Institute of Banking & Finance January-March 2009 (ISSN 0019 4921) Vol: 80 No: 1 P. 15, 16. [4] Corporate India, The corporate Magazine for business and investment 31st October 2008 P. 48. [5] Corporate India, The corporate Magazine for business and investment 15th October 2008 P. 26, 27. [6] Corporate India, The corporate Magazine for business and investment, Mumbai April 2008 P. 54, 55.
AccountingNumbersasaPredictorofStock Returns:ACaseStudyofBSESensex
Dr.NavindraKumarTotala*,Dr.IraBapna**, VishalSood**andHarmenderSinghSaluja**
AbstractCapital Market is a barometer of companys economic and financial condition. The market has witnessed its worst time with the recent global financial crisis that originated from the US sub-prime mortgage market and spread over to the entire world as a contagion. The stringent norms in India made it able to sustain the shock and are able to dictate terms to world capital market. It reflects sustainable growth, developed regulatory mechanism, growing market capitalization with market liquidity and mobilization of resources. It is necessary to know the factors affecting the capital market of the country. In the different informational environment and accounting practices from those of developed market, the research paper aims to evaluate the relevance of accounting numbers for investors in their investment decisions and predict investors return through companys financial analysis. Company analysis is a way of expressing relationship between accounting numbers of the company and their trends over time that analysts use to establish values, evaluate risks and interpret companys past and present financial health and helps in predicting its future. In this framework, the present research is vital to study the performance of Indian capital market by way of company financial analysis. The objective of this study is to examine the value relevance of accounting information in explaining stock returns. The study uses liquidity, profitability, solvency, and leverage ratios as proxies of accounting information. The research is an attempt to analyze the year wise average stock prices of top 26 companies of BSE Sensex on consolidation basis for period of five years from 2006 to 2010 to predict impact of accounting numbers on stock returns. Regression Analysis, t- test, f- test, and Correlation were used. It was concluded that accounting numbers do not predict Stock Returns. Keywords: BSE Senex; Ratio Analysis; Stock Returns; Accounting Numbers; Regression Analysis
INTRODUCTION
Accounting information from financial reports can describe firms condition. The financial reports are affected by two factors, firms activities and accounting system adopted by the firms (Palepu et al, 2004). Some researchers studied accounting information in predicting firms future financial performance, such as earnings and growth (Lev and Trigrajan, 1993), while other researchers measured the effect of accounting information on share prices (Abarbanell and Bushee, 1998). Fundamental analysis is essential for determination of market efficiency. It involves two different approaches in the search of mispriced securities. The first approach involves estimating the intrinsic value and comparing the same with the prevailing *Institute of Management Studies, M.P. **Maharaja Ranjit Singh College of Professional Sciences, M.P.
market price to determine whether the security is underpriced, fairly priced or overpriced. The second approach involves estimating a securitys expected return, given its current price and intrinsic value and then comparing it with the appropriate return of securities with similar characteristics. Analysis of company can be categorized into two parts, a study of financials and other factors. In company analysis, stake holders including investors assimilate several bits of information related to the company and evaluate the present and future values of the stock. Risk and return are associated with the purchase of stock in order to take better investment decisions. The present and future values of a company are affected by a number of factors like, the competitive edge, strength, earnings, capital structure, management, operating efficiency and financial statements of the company.
Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex 423
Assts Turnover, Debt Equity Ratio, Earning per Share, and Price to Book Value; In Automotive Industry are Debt Equity Ratio, Return on Equity, Earning Per Share, and Price to Book Value; While in Pharmacy Industry are Current Ratio, Earning per Share, and Price to Book Value. In overall five industries, the influential financial ratios are Total Assts Turnover, Debt Equity Ratio, Earning per Share, and Price to Book Value. Furthermore, the research showed that the variety of Average Stock Prices can still be explained properly by financial ratios during 1-3 month period after the issuance of Annual Financial Report (Roswati, 2007). The long-term association between Capital Stock Returns and Accounting Numbers i.e., association studies, values the information in financial statements against information in Stock Prices. The association studies do not presume that investors use only accounting data in their investment decisions. If accounting data are good summary measures of the events incorporated in security prices, then they are value relevant because their use might provide a value of the firm that is close to its market value (Dumontier and Raffournier, 2002). Thus, association studies revealed that Accounting Numbers provide a good summary measure of the value relevant events that have been incorporated in stock prices during the reporting period. It tests whether and how quickly accounting measures capture changes in the information set that is reflected in security returns over a given period (Kothari, 2001).
OBJECTIVES
To analyze the significant impact of the Financial Ratios on Stock Returns. To study the linkage between Financial Strength of individual companies and Stock Market Returns.
Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex 425
The study is based on the secondary data. The research has considered only stock price fluctuations taking all other things as constant. The present study is undertaken for the limited period of time i.e., five financial years. The study has used only basic ratios to check the objectives namely, liquidity ratios, profitability ratios, solvency ratios and leverage ratios. Basically the study was aimed at to take all 30 companies forming BSE Sensex but research could be conducted only on 26 companies as the data of four companies were insufficient to carry out the research.
Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex 427 Year 2010 Current Ratio on Stock Returns Quick Ratio on Stock Returns Gross Profit Ratio on Stock Returns Net Profit Ratio on Stock Returns Debt Equity on Stock Returns Return on Assets on Stock Returns EPS Ratio on Stock Returns DPS Ratio on Stock Returns Correlation -0.114 -0.05 0.07 -0.16 -0.07 -0.33 0.38 0.25 f-Value 0.32 0.06 0.62 0.11 0.11 2.9 4.48 1.61 Beta Value -0.114 -0.05 -0.16 0.07 -0.07 -0.33 0.39 0.25 t- Value -0.56 -0.25 -0.79 0.33 -0.33 -1.7 2.12 1.27 Significance 0.58 0.8 0.44 0.75 0.74 0.102 0.04 0.22 Significant / Insignificant Insignificant Insignificant Insignificant Insignificant Insignificant Insignificant Insignificant Insignificant
INTERPRETATION
For the year 2006 correlation of Current Ratio and Quick ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock returns. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns. For the year 2007 correlation of Current Ratio, Quick ratio and Debt Equity Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock returns. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns. For the year 2008 correlation of Current Ratio, Quick Ratio and DPS Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns. For the year 2009 correlation of Current Ratio, Quick ratio and Debt Equity Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns. For the year 2010 correlation of Gross Profit Ratio and DPS Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio with Stock Returns depicts low degree of positive correlation; Current Ratio, Quick Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.
The Beta value for the all years is very low for all the ratios. This implies that the stock prices are low volatile for all the ratios. It reveals that the ratios do not predict volatility and risks themselves and they do not shape the prices in concern with risks. The f value and t value are insignificant for Current Ratio, Quick Ratio, Gross Profit Ratio, Net profit Ratio, Debt Equity Ratio, Return on Assets Ratio, EPS Ratio and DPS Ratio are insignificant to determine Stock Returns.
CONCLUSION
It can be seen that all the ratios during the entire study period have insignificant relationship with the Stock Returns, i.e., there is no significant impact of the ratios on the Stock Returns predictions and determinations. In fact, different financial ratios do not predict Stock Returns. The financial ratios have no influence over Stock Returns. Financial ratios are replica of financial results whereas financial results represents accounting numbers. Thus, this is evident that accounting numbers do not predict Stock Returns.
IMPLICATIONS
The results and conclusion implies that stock market do not take account of accounting numbers, either in the form of financial results declaration or their interpretation in the form of ratio analysis. Market finds its own way ignoring financial results and accounting numbers. This affirms and confirms the Random Walk theory and all forms of Efficient Market Hypotheses. Probably investors are more aware of accounting numbers in the form of quarterly results and they do not wait to take note of it and immediate prevailing prices are the reflection of discounting of the accounting information. In fact it seems that market is driven by sentiments, monetary and fiscal environment of the country and moreover demand supply tug of war or other known and unknown dynamic variants among them accounting numbers seems to be one alone insignificant variable and the rule of impact of discounting one information if another significant information is floated in the market, seems to be playing dominant role in determining Stock Returns. The results of BSE Sensex are independent of financial results of the company results. The BSE Sensex has its own independent and autonomous state. The findings implies that company analysis by way of accounting numbers have a limited role for speculation but has vital role to play in long term perspective as a part of fundamental analysis.
SUGGESTION
In the light of findings and implications, it is suggested that the investors should not overreact to accounting information. They should not either buy or sale investment on decision making based only on accounting numbers. Ratio analysis is multidimensional multiuser instrument which should be used very cautiously in portfolio investment decision. Other variables like, company projects, budgets, plans, market share, marketing strength, company position in the industry may be considered as variables in investment decision. Accounting numbers have their own limitations. They may predict profits or losses but they have lesser role to shape Stock Returns. So, one should use accounting numbers with greater degree of care and
Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex 429
caution in predicting Stock Returns. An investor will have to consider both the financial and non-financial factors so as to form an overall impression about a company. Internal and external strengths and weakness of an industry can also be evaluated.
REFERENCES
[1] Abarbanell, Jeffery S. and Bushee, Brian J. (1998). Abnormal Returns to a Fundamental Analysis Strategy. The Accounting Review,73(1), 1945. [2] Ball and Brown (1969). An Empirical Evaluation of Accounting Income Numbers. The journal of Accounting Research, 39(3), 159-178. [3] Daniati, Nina and Suhairi. (2006). Effect of Information Content: Component of Cash Flows, Gross Profit and Size of the Company to the Return of Shares (Survey on the Textile and Automotive Industries on the BEJ). Padang: National Accounting Symposium, 9. Cited in.. [4] Dumontier, P. and Labelle, R. (1998). Accounting Earnings and Firm Valuation: The French Case. The European Accounting Review, 7 (2), 163183. [5] Hamzah, (2007). Cited in Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 15371506. [6] Kendall, M. (1953). The Analysis of Economic Time Series. Journal of the Royal Statistical Society, 96, 11 25. [7] Kennedy, W.F. (2005). An Empirical Examination on Large Banks Dividend Payout Ratios. Business Economics, 21, 4856. [8] Kothari, S.P. (2001). Capital Markets Research in Accounting. Journal of Accounting and Economics, 31, 105231. [9] Lev, B. (1989). On the Usefulness of Earnings and Earning Research: Lessons and Directions from Two Decades Research. The Journal of Accounting Research, 27, 153192. [10] Lev, B. and Thigarajan, R. (1993). Fundamental Information Analysis. Journal of Accounting Research, 31(2), 190215. [11] Liu, J. and Thomas, J. (2000). Stock Returns and Accounting Numbers. The Journal of Accounting Research, 38(1), 119138. [12] Mais, Gusliana Rimi (2005). Effect of Major Financial Ratios of Companies to the Stock Price: A Company Registered in Jakarta Islamic Index in 2004. STEI Economic Journal, 14(3), 30. [13] Manao, Hekinus and Nur, Deswin (2001). Association with Stock Returns of Financial Ratios: The Consideration of Company Size and Influence of the Economic Crises in Indonesia. Padang: National Accounting Symposium, IV. [14] Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 1537-1506. [15] Meythi, (2006). Effect of Operating Cash Flow to Share Price to Earning Persistence as an Intervening Variable. Padang: National Accounting Symposium, IV. [16] Palepu, G. Krishna; Healy, M. Paul; and Bernart, L.Victor (2004). Business Analysis and Valuation: Using Financial Statements. Paperback Edition, USA. [17] Ritter, J.R.; Constantinides, G.; Harris, M.; and Stutz, R. (2003). Investment and Securities Issuance. Handbook of Economics and Finance, 255306. North-Holland, Amsterdam. [18] Roswati,(2007). Cited in Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 15371506. [19] Sparta, Februaty (2005). Effect of ROE, EPS, OCE on Manufacturing Industry to the Stock Price of the Stock Exchange Jakarta. Journal of Accounting, 9(1). [20] Titman, S.; Wei, K.; and Xie, F. (2004). Capital Investment and Stock Returns. Journal of Financial and Quantitative Analysis, 39, 210240.
SUMMARY
The market has witnessed its worst time with the recent global financial crisis that originated from the US sub-prime mortgage market and spread over to the entire world as a contagion. Accounting information from financial reports can describe firms condition. It is necessary to know the factors affecting the capital market of the country. In the different informational environment and accounting practices from those of developed market, the research paper aims to evaluate the relevance of accounting numbers for investors in their investment decisions and predict investors return through companys financial analysis. In this framework, the present research is vital to study the performance of Indian capital market by way of company financial analysis. The objective of this study is to examine the value relevance of accounting information in explaining stock returns. The study uses liquidity, profitability, solvency, and leverage ratios as proxies of accounting information. The research is an attempt to analyze the year wise average stock prices of top 26 companies of BSE Sensex on consolidation basis for period of five years from 2006 to 2010 to predict impact of accounting numbers on stock returns. Regression Analysis, t- test, f- test, and Correlation were used. It was concluded that accounting numbers do not predict Stock Returns. It can be seen that all the ratios during the entire study period have insignificant relationship with the Stock Returns, i.e., there is no significant impact of the ratios on the Stock Returns predictions and determinations. The results and conclusion implies that stock market do not take account of accounting numbers, either in the form of financial results declaration or their interpretation in the form of ratio analysis. Market finds its own way ignoring financial results and accounting numbers. This affirms and confirms the Random Walk theory and all forms of Efficient Market Hypotheses. Probably investors are more aware of accounting numbers in the form of quarterly results and they do not wait to take note of it and immediate prevailing prices are the reflection of discounting of the accounting information. In the light of findings and implications, it is suggested that the investors should not overreact to accounting information. They should not either buy or sale investment on decision making based only on accounting numbers.
INTRODUCTION
Investment is not a new concept. In ancient times, empires and civilizations invested their savings in land, jewelry and animals just like Horse, Cows, and Buffaloes, which are comparatively riskless. Now-a-days investment instrument and investment behavior of investors have changed. Investors rarely invest their savings in animals. People often want to invest their money in risky instruments such as shares and equities in an attempt to obtain quick returns in short time. However, the dilemma of risk Vs return is always present in front of a small investor. Normally investors want higher return with minimum risk (Thaler, 1985) but they know very well that high returns require high risk. In 2009 share market crashed from 21000 to 16000 in a day. A number of investors lost their huge savings in an attempt to gain higher return. To prevent such shocking events investors hedge their risk by investing in a portfolio of risky and riskless instruments. Since, every instrument has some risk every investor has to include low and high level risky instruments for making an efficient portfolio. A number of portfolio theories have been proposed to develop an efficient portfolio. Prominent among them are Markowitz Portfolio Utility Theory (Markowitz 1952, 1959), Sharpe Single Index Model (Sharpe, 1963) and Capital Asset Pricing Method (Markowitz and Sharpe, 1964). Portfolio theory considers only risk and return as two major factors for developing an optimum portfolio. Identifying the risk level, management of risk and proper * Shri Shankar Acharya College of Engg. & Technology, Bhilai **Shri Shankar Acharya Institute of Technology of Management, Bhilai
diversification of fund in different instruments is primary objective of making efficient portfolio (SLIM, 2007). High dividend payout policy, which should be associated with higher accounting rates of return and higher market to book value ratios, would be consistent with optimization theory (Stanley et al., 2005). However, a casual or a small investor hardly understands these theories and neither has the patience to learn them for identifying an investment portfolio. His investment decision is largely a result of discussion withfriends and experts in the field of investment. Moreover, his prior experience with the investment significantly influences his future decisions. A failure with any investment may put him off for making future investments. Most of the studies in investment behavior examine the role of social factors (Gupta and Sharma, 2009), income level of investors (Morgan et al., 2001), financial advisor recommendation, advertisement (Lee, 2004) and risk and return (Markowitz 1952, 1959). The primary objective of this study is to examine the role of prior investment in the investment decision of casual investor. According to Atkinson et al. (2004), men are more confident than women about their ability to make financial decision. In the ancient times major decisions were taken by male members of the family and female members played a subordinate role in making investment decisions. But time is drastically changing and these days women also earn and make investment decision not only in riskless instruments, but also in risky instruments. Therefore, this study also examines the role of gender in the investment decision of a casual investor.
Investigating the Role of Prior Investment And Gender on the Investment Decision of a Casual Investor 433
Sharma, 2009). If the investor feels regret in his previous investments, then he tries to change his investment strategies. Regret arise when investment instrument are not fulfill the expectation of investors. Anticipated regret also influences investment decision. Lack of proper investment strategy, confusion regarding information and uncertainty influences investor investment decision (Basu et al., 2006; Zhang, 2006).
PortfolioManagementTheories
Return is the primary motivating force that encourages investment. Basically return is reward for understanding investment. If investors are able to understand different investment option and try to make better investment strategy than they can generate higher return. But we know always return comes with risk. We cant talk about investment return without taking risk. Investment decision is nothing but it involves a tradeoff between risk and return. These two factors effect investors investment decision the most. A number of investment theories has been introduced by some financial expert like Markowitz portfolio model (Markowitz 1952, 1959), Arbitrage Pricing Theory (Ross, 1976), Sharpe single index model (Sharpe, 1963), Capital Asset Pricing theory (Sharpe, 1964). Capon, (1992) says that investor can take right decision on the basis of these theories and maintain the risk and return on portfolio. The problem with these theories is that takes into account only risk and return and are not very useful for evaluating multi attributes. These theories are easy to implement, more easy to understand result. Bayesian networks have also been used for making financial forecasts (Ronald et al., 2006). This method is good when investor invests huge amount in market or invest in venture capital. Bayesian network help investors to take unbiased decision. The output of Bayesian network is probability distribution for the value of the portfolio. Network selection behavior is also a new approach for making efficient portfolio (Litman et al., 2002). It is concerned with maximizing returns whereby an investor is willing to take a minimum level of risk. Most of the investors are unaware of even basic financial theories and hardly consider these theories or models for making optimum portfolio. Casual investors are not familiar with different financial tools based upon which they can take good investment decision. Investors experience and friends experience also influence investment decision. Limited liability and level of wealth affect rational investors investment decision. Limited liability can be one reason for minimization of risk (Rochet et al., 1997). Role of Prior Investment in Investment Decision Prior experience can also influence ones investment decision. If past experience is good then the investor feels happy and in future will again try to invest in same instrument. On the contrary, if he / she feels regret (sadness) than he switches to other instruments or stops making investments. On the basis of prior investment, investors try to learn something for future course of action. Regret basically divided in to two parts; Experience and anticipated regret. Counterfactuals (expressing what has not happened but could, would, or might under differing conditions) are more frequently generated when a decision is associated with unfavorable outcomes (Bailey and Kinerson, 2005). For example, suppose an investor has
invested Rs. 100,000 in stocks and founds that after 5 years these stocks have appreciated 3 times in values. When the investor compares this with the situation whereby he would have invested the same amount in a bank (the appreciation would be say 2 times), the possibility of generating counterfactuals is less as the outcome is favorable. However, if he compares this investment with another situation whereby he could have invested in stocks which have appreciated more than 3 times in value, he might generate counterfactual thoughts. According to Inmam (2001) repeat purchasing may cause as much or even more regret than switching. Timing and choice between brand name and price can also influence by asking consumer to imagine how would feel if they made the wrong decision (Simonson, 1992). Sometime people blame other for initial action, it can be one cause of experience regret and experience regret always affects future investment (Fuzikawa, 2009). The study found that prior experienced regret and a complete feedback on the subsequent choice (anticipatory regret) should be both present for a change in behavior in subsequent different choice (Raeva, 2009). Hence, we hypothesize: H1: Prior investment has significant positive impact on Intention to invest Role of Gender in Investment Decision In the modern society both male and female both invest their savings in different avenues but risk taking capacity of investors is different because of gender. Gender influence investor behavior and risk aversion (Arano et al., 2010). Men are considered more knowledgeable and confident about their ability to make financial decision. One study (Pawlowski et al., 2008) showed that brokers were more likely to insist that women go home and discuss their financial choices with a spouse before making any final decisions. Sexual theory (Pawlowski et al., 2008) predicts that males tend to behave in a way that they are more risky than female. Single male pursue a more risky strategy than single female (Pawlowski et al., 2008). Information processing style may account for the lower risk-taking tendencies among female investors as well as the tendency toward lower confidence level. Investment expertise, general knowledge of natural information, and adviser recommendation are also very important factors which affect investment decision of investors. Limited liability is another parameter, which affects risk taking behavior of investors. That is why rational investors take decision after calculating each and every aspect of their decision (Rochet et al., 1997). Opinion of ones social group (family members, peers groups) is also important in determining risk taking capacity of casual investors (Niklas and Weber, 2004). Al-Azmi (2008) argues that men and women as investors should be treated as separate market niches, each with its own needs and requiring targeted marketing strategies. Hence, we hypothesize:
Investigating the Role of Prior Investment And Gender on the Investment Decision of a Casual Investor 435
Fig.1:ResearchModel
DataCollection
The empirical data for the study was collected from casual investors over a period of one month. A total of 150 valid responses were collected for the study. Table 1 shows the demographic characteristics of the respondents.
436 Changing Dynamics of Finance TABLE1:DESCRIPTIVESTATISTICSOFRESPONDENTCHARACTERSTICS Item Age (years) Measure <20 20-29 30-39 >=40 Missing Female Male Missing <1lakh 1-3lakh 3-5lakh >=5lakh Missing <10 lakh 10-20.99 lakh 30-40.99 lakh >50 lakh Missing Total Frequency 67 43 40 0 0 75 75 0 33 68 39 10 0 72 53 21 4 0 150 Percentage 44.66 28.66 26.66 0.00 0 50.00 50.00 0 22.00 45.33 26.00 6.66 0 48 35.55 14 2.66 0 100%
Gender
Annual Income
Net worth
Table 1 shows that about 75 of investors were male and 75 investor were female. They are equally distributed among investors. In India, investment decisions, particularly in middle class families are usually taken by males. Investors were fairly spread over three age groups. The annual income of most of the investors was between 1 and 3 lakh, fairly common among Indian middle class families. Most of the investors had net worth between <10 lakh. The above data fairly represents the characteristics of casual investors.
Investigating the Role of Prior Investment And Gender on the Investment Decision of a Casual Investor 437
HypothesisTesting
The results of the test are shown in Figure 2. Figure 2 shows that gender has a significant influence on intention to invest, thus supporting H2. The surprising finding is that prior investment does not have a significant influence on intention to invest, thus failing to accept H1.
There are several limitations in this study. First, although we sampled casual investors, the sample size could have been greater. Secondly, we did not capture the initial risk level of the investors. By capturing the initial risk level of all investors, we can measure the effect on subsequent decision more accurately. Future studies, may consider measuring the initial risk level of investors and then measuring the effect on subsequent decision. Thirdly, the investment decisions are based on ones beliefs. Therefore, the scenarios presented may not be said to be free from response bias due to extraneous variables. Although scenarios help to some extent in understanding investment behavior, their hypothetical nature precludes one from generalizing the results. The reality may be quite different whereby an individual might have experienced both happiness and regret from investment decision.
REFERENCES
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[19] Morgan, JN, Barlow, R, and Brager, H E (2001), A Survey of Investment Management and Working Behavior Among High Income Individual. [20] Morgen, N S, and Weber M (2004), The Influence of Different Investment Horizons of Risk Behavior, The Journal of Behavioral Finance, 2004, vol, 5. no. 2. 7590. [21] Pawlowski B (2008), Sex Differences in Everyday Risk-Taking Behavior in Humans, www.epjournal.net, 6(1), 2942. [22] Raeva, D, and van Dijk, E (2009). Regret Once, Think Twice: The Impact of Experienced Regret on Risk Choice, CEEL (Computable and Experimental Economics Laboratory) Working Paper 3-09, accessed on 6th May, 2009, available at: http://www-ceel.economia.unitn.it [23] Rochet J C, Koehl P F, Chirstian G (1997), Risk taking Behavior with Limited Liability and risk aversion, The journal of risk and insurance, 64(2), 347370 [24] Ross, S. A. (1976), The Arbitrage Theory of Capital Asset Pricing, Journal of Economic Theory, 13(3), pp. 341360. [25] Samson E.E. (2003), Adjustment of Portfolio Asset to Change in Fundamentals Determination: Evidence from Nigerias Leading Commercial Banks, Journal of Financial Management and Analysis, 16(1),2003, 7783. [26] Sharpe, W F (1963), A simplified model of portfolio analysis, Management Science, 9(2), 425442. [27] Sharpe, W F (1964), Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, The Journal of Finance, 19(3), 425442. [28] Simonson, I (1992), The Influence of Anticipating Regret and Responsibility on Purchase Decisions, Journal of Consumer Research, 19(1), 105-118. [29] Stanley C. W. Salvary, Canisius College, The Underinvestment Problem, Risk Management, and Corporate Earnings Retention,Journal-Journal of Business & Economic Studies, 11( 2), Fall 2005. [30] Thaler, R H (1985), Mental Accounting and Consumer Choice, Marketing Science, 4(3), 199214. [31] Wallace, N D, and Dutia, D, (1989), A Note on the Behavior of Security Returns- A Test of Stock Market Overreaction, The Journal of Financial Research, 12(3). [32] Wilcox, R T (2003), Bargain Hunting or Star Gazing? Investors' Preferences for Stock Mutual Funds, The Journal of Business, 76(4), 645663. [33] Zhang X F (2006), Information Uncertainty and Analyst Forecast Behavior, Contemporary Accounting Research, 23( 2), 565590.
The Study on the Impact of Corporate Action Events on Stock Prices and Volume Behavior
Preeti Sharma* and Mithilesh Kumar*
AbstractThe research examines the impact of major corporate action events on stock prices & volume between 2006 -2010. Corporate Actions are instances where some action is taken by the company as a result of which the share price will react. Common examples are dividends, bonus, rights, stock splits, buy back, mergers and de-mergers. This study examines the impact of right issue on the share price and volume behavior around the event. The sample period consists of growth/boom and slowdown/recession phases of the market. Therefore this study will also attempt to find out the relationship between the frequency of right issue and market cycles. Keywords: Corporate Actions, Bonus issue; growth/slowdown, Share price and volum Summary Corporate actions have potentially strong effects on share prices and trading activity, although these effects depend on the type of corporate action and the particular point in the corporate action processing cycle. For analyzing the impact of stock split announcements on stock returns and volume behavior, our sample consists of stock split announcements of 29 companies during the period 2006 to 2010 with a net-worth of 1500 crore or above as on 10.10.2010. For analyzing the impact of bonus issue announcements on stock returns and volume behavior, our sample consists of bonus announcements of 35 companies during the period 2006 to 2010 with a net-worth of 1500 crore or above as on 10.10.2010. Our findings are summarized as follows: Impact of Stock Split announcements: The chart for Mean Abnormal returns shows the Higher average market adjusted returns(at t = -1, AAR = 2%) just before the announcement day of Stock Split and shows the low average market adjusted returns just after the announcement day of Stock Split (at t = 4, AAR = -1%). However from t = 12 day onwards stock returns shows the high AAR. However the pattern of charts, for mean volume and mean no. of trades does not shows the improvements after the announcement day. In the pre announcement period liquidity is higher in comparison to post announcement period. Impact of Bonus Announcements: The chart for Mean Abnormal returns shows the Higher average market adjusted returns(at t = -2, AAR = 1.5%) just before and on the announcement day (at t = 0, AAR = 2%) of Bonus and shows the low average market adjusted returns just after the announcement day of Bonus (at t = 4, AAR = -0.3%). However from t = 6 day onwards stock returns shows the high AAR.
The Study on the Impact of Corporate Action Events on Stock Prices and Volume Behavior
441
However the pattern of charts, for mean volume and mean no. of trades does not shows the improvements after the announcement day. In the pre announcement period liquidity is higher in comparison to post announcement period. Thus the results for the both the corporate actions shows the similar results and supports the information content of corporate action event announcements but however reflected in stock returns after few days of announcements in the form of high AARs. The lower returns just after the announcement days may be attributed to the phenomenon of market adjustment of new information. However for both the corporate actions the results does not support the hypothesis of increased liquidity in the stocks after the announcement.
With the help of above information it may be concluded that during the growth phase the frequency of stock-split announcements increases. One of the reasons may be to bring the increasing prices in the normal trading range.
With the help of above information it may be concluded that during the growth phase the frequency of Bonus announcements increases. One of the reasons may be the willingness of management to send positive signals supported by good performance during growth
INTRODUCTION
A Corporate action is an event initiated by an issuer that affects the securities (equity or debt) issued by the company. These include, mergers and acquisitions, spin-offs, cash stock mergers, forward and reverse stock splits and name changes. Some corporate actions, such as a dividend (for equity securities) or coupon payment (for debt securities or bonds) may have a directfinancial impact on shareholders or bondholders. Some, such as stock splits, may have an indirect impact on shareholders, as the increased share liquidity may cause the stock price to rise. Others, such as a name change, have no direct financial impact.
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Corporate actions may have significant implications for the financial risks faced by market participant .In particular, such actions often contain new information about the current and expected profitability and growth prospects of firms or they can result in firms operations and financial structure. In our study we analyzed the effects of corporate action associated with bonus issue & Stock Split announcements using the share price returns and volume measure. This study analyses the impact stock split announcement on the stock returns and liquidity on a sample of 29 companies. Further this study analyses the impact of another corporate action event, bonus announcement on the stock returns and liquidity on a sample of 35 companies, spread over a period of year 2006 to year 2010. All the companies in the sample have the net-worth of 1500 Crore or more as on 10.10.2010. Thus the sample comprises of large companies. Announcement Date The date on which a particular action is announced
LITERATURE REVIEW
Several studies have been conducted in advance countries to analyze the announcement effects of corporate action events. However in India only few studies have been conducted. Some of the studies are examined as follows: The paper by Fama, Fisher, Jensen and Roll (FFJR, 1969) that pioneered the event study methodology. FFJR consider the behavior of stock prices around stock splits. They ask the following question: do stock prices behave differently around stock splits than in normal periods? To address this issue, they compare the holding returns on the stock around the event date (i.e. the actual date of the stock split) and the expected return if there had been no event. The difference between the actual return in the event period and the expected returns is referred to as the abnormal return. To study the effects of, in this case, stock splits the observed return series of one single firm is not very informative because returns are stochastic. Therefore, they aggregate abnormal returns over all stock splits in the sample. Statistical tests are then invoked to test the hypothesis that on average, returns around the event date are not different from their expected returns. Ball, Brown & Finn (1977), This study concluded that the observed abnormal returns were due to information concerning anticipated cash flows, and not to the increased number of shares which resulted from the capitalization changes. Emanuel (1977), examines that for the 148 bonus issues 109 (75%) reported excess returns above their control portfolio in the pre announcement period and 82 (56%) reported excess returns above their control portfolio in the post announcement period. The evidence reported strongly supports the view that the New Zeeland stock market is efficient with respect to bonus and right issue announcements. Richard G. Solan (1987), examines Australian share price behavior on and around the exdays of bonus issues and share splits. It employs daily transaction prices for a sample of 89 screened bonus issues and splits made over the period 1974 through 1985. Results for the ex-
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day itself reveal that the null hypothesis of zero abnormal returns can not be rejected. Statistically significant positive abnormal returns are, however documented in the five day prior period to the ex-day. John J. Binder (1998), discusses in his paper the event study methodology, beginning with FFJR (1969), including hypothesis testing, the use of different benchmarks for the normal rate of return, the power of the methodology in different applications and the modeling of abnormal returns as coefficients in a (multivariate) regression framework. Frank de Jong (2007), in his lecture notes, provided an introduction to the methodology of event studies. He discussed the various parametric and non-parametric tests which are popular in the applied literature. Indeed, the statistical methods used in con- ducting event studies are often complicated and confusing. Nevertheless, most extensions of the basic t-tests are designed to deal with serious empirical problems. Neglecting problems such as crosssectional dependence and event-induce variance may easily lead to spurious inference. However, there is also much to gain from a careful selection of the data and an exact determination of the event dates. Pavabutr, Sirodom (2008), This paper explores the impact of stock splits on stock price and various aspects of liquidity using daily and intraday data from the Stock Exchange of Thailand between 2002- 2004. This provides evidence that reductions in trade frictions and increases in split-adjusted price levels are associated with the size of split factors and postsplit trading range. Stocks with high split factors have better post-split adjusted price performance and lower trade bid-ask spreads and price impact. The empirical findings lend support to the trading range hypothesis of stock splits. Shirur (2008), In the case of issue of bonus shares, the first three factors, viz., rate of growth of sales and profit as well as value of beta significantly explain the difference between the companies issuing bonus shares and the Nifty companies. This proves that the capital market is not inherently a semi-strong form of EMH and that the top management has to send signals to make the market efficient. Similarly, the last two factors, viz., stake of promoters and negative companies also significantly explain the difference between the companies issuing bonus shares and the Nifty companies. This shows that the market is not able to inherently depict strong form of EMH. In the case of stock splits, only the rate of increase in share price explains the difference between the companies resorting to stock split and the Nifty companies. This proves that the capital market is not inherently a semi-strong form of EMH and there is a possibility of investors overvaluing the shares of certain companies for an unduly long time. Since the promoters stake in companies resorting to stock split is higher than the Nifty promoters stake, it could be concluded that the promoters stake has a major role to play in the top management taking decisions regarding stock splits. As a defensive measure, promoters resort to stock split in order to restrain the price of stocks from falling. ERaja, Sudhahar & Selvam (2009), empirically examined the informational efficiency of Indian stock market with regards to stock split announcement released by the information
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technology companies. The result of the study showed the fact that the security prices reacted to the announcement of stock splits. The reaction took place for a very few days surrounding day 0, remaining days it was extended up to +15. Thus one can conclude from the forgoing discussion that the Indian stock markets in respect of IT companies in general are efficient, but not perfectly efficient to the announcement of stock split. This can be used by investors for making abnormal returns at any point of the announcement period. Raja & Sudhahar (2010), this study has empirically examined the informational efficiency of capital market with regard to bonus issue announcement released by the IT companies. The results of the study showed that the security prices reacted to the announcement of bonus issue. It concludes that the Indian capital market for the IT sector, in general, is efficient, but not perfectly efficient, to the announcement of bonus issue. This informational inefficiency can be used by the investors for making abnormal returns at any point of the announcement period.
DATA COLLECTION
The data for this research study has been collected from the Capital-line corporate database. The data was collected for all the companies in the sample period for a period of 20days pre announcement period to 20 days post announcement period for each day, for the following parameters: Closing price Volume traded Number of trades BSE-Sensex closing values
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However these data sets belongs to different time periods as all the event announcements were made at different dates during the period 2006 to 2010.
RESEARCH METHODOLOGY
We selected the corporate action announcement date as the event date. The data was collected fore the above discussed period.
Daily Returns
Then we calculated daily returns for all the scrips in our sample for 15 days pre announcement period to 15 days post announcement period, where vent date is characterized as 0 day. Daily returns are calculated using t following formula: Ri, t = [(Pt-Pt-1)/Pt-1]* 100 Where, Ri, t = Returns on Security i on time t. Pt = Price of the security at time t Pt-1 = Price of the security at time t-1 The daily returns on sensex for the similar period were also calculated using the same method.
Abnormal Returns
Abnormal Returns (AR) under market-adjusted abnormal returns are calculated using the equation as below; ARi,t = Ri,t Rm,t Where, ARi,t = Abnormal returns on security i at time t Ri,t = Actual returns on security i at time t Rm,t = Actual returns on market index, which is proxied by BSE Sensex, a weighted average index of 30 companies published by BSE, at time t. We have proxied market returns by BSE Sensex returns because our sample consists the large companies which matches with the chosen benchmark Thus daily actual returns over the announcement period (31days) were adjusted against their corresponding market returns. Analyzing abnormal returns In analyzing abnormal returns, it is conventional to label the event date as time t = 0. Hence, from now on ARi;0 denotes the abnormal return on the event date and, for example, ARi;t denotes the abnormal return t periods after the event. If there is more than one event relating to one .rm or stock price series, they are treated as if they concern separate .rms. We typically
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consider an event period, running from t1 to t2. Assuming there are N firms in the sample, we can construct a matrix of abnormal returns of the following form:
Each column of this matrix is a time series of abnormal returns for firm i, where the time index t is counted from the event date. Each row is a cross section of abnormal returns for time period t. In order to study stock price changes around events, each firms return data could be analyzed separately. However, this is not very informative because a lot of stock price movements are caused by information unrelated to the event under study. The informativeness of the analysis is greatly improved by averaging the information over a number of firms. Typically, the unweighted cross-sectional average of abnormal returns in period t is considered:
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Similarly Average volume and average number of trades are also plotted on the graph for the period t=-15 to t=15 around the event day t=0 to find the liquidity impact of event announcements.
The above data sets when plotted on a graph, shows the following patterns:
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2.00%
1.50%
1.00%
0.50%
0.00% -1 -1 -1 -1 -1 -1 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 5 4 3 2 1 0 -0.50%
9 10 11 12 13 14 15
Days
-1.00%
-1.50%
Fig. 1: Impact OF Stock split Announcement ON Average Abnormal Returns During THE Period T = -15 Days TO T = 15 DAYS
Mean Volume 300,000 Mean Volume
250,000
200,000
150,000
Mean Volume
100,000
50,000
Fig. 2: Impact of Stock split Announcement on Mean Volume during the period t = -15 days to t = 15 days
Mean No. of Trades Mean No. of Trades 8,000 Mean No. of Trades
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Fig. 3: Impact of Stock Split Announcement on Mean no. Of Trades During the Period t = -15 days to t = 15 days
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Our findings for bonus announcements during the period 2006 to 2010, fore a sample of 35 scrips with a net-worth of 1500 Crore as on 10.10.2010, are summarized as follows:
Days -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Mean market adjusted returns -0.24% -0.03% -0.16% -0.54% 0.28% 0.34% -0.35% -0.45% -0.74% -0.15% -0.30% 0.28% 0.95% 1.45% 0.40% 1.93% 1.05% 0.46% -0.03% -0.37% -0.12% 0.84% 0.90% 0.50% 0.75% 0.28% 0.15% 0.47% 0.52% 0.30% 0.27% Mean Volume 278116 262255 276966 333455 353259 350408 384879 321216 312491 297438 287097 320035 309373 412535 597025 782770 303988 194960 311460 242192 277105 270711 372689 348412 243123 223115 215560 244187 206589 208607 255703 Mean number of trades 5641 5298 5381 4957 6289 6920 6413 6101 5816 6284 6321 5899 6433 8375 11998 16086 5450 3598 4939 4223 4843 4529 4805 5169 4386 3679 4109 4159 3888 3495 4245
The above data sets when plotted on a graph, shows the following patterns:
Mean market adjus ted returns
2.50% Mean R eturns
2.00%
1.50%
0.00% -1 -1 -1 -1 -1 -1 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 5 4 3 2 1 0 -0.50%
9 10 11 12 13 14 15
-1.00% D ays
Fig. 4: Impact of Bonus issue Announcement on Average Abnormal Returns During the Period t = -15 days to t = 15 days
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Mean Volume
900000 Mean Volume
800000
700000
600000
400000
300000
200000
100000
Fig. 5: Impact of Bonus issue Announcement on Average Volume During the Period t = -15 days to t = 15 days
Mean number of trades
18000 Mean number of trades
16000
14000
12000
8000
6000
4000
2000
0 -1 -1 -1 -1 -1 -1 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 5 4 3 2 1 0 Days
9 10 11 12 13 14 15
Fig. 6: Impact of Bonus issue Announcement on Average Number of Trades During the Period t = -15 days to t = 15 days
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However the pattern of charts, for mean volume and mean no. of trades does not shows the improvements after the announcement day. In the pre announcement period liquidity is higher in comparison to post announcement period.
With the help of above information it may be concluded that during the growth phase the frequency of stock-split announcements increases. One of the reasons may be to bring the increasing prices in the normal trading range.
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With the help of above information it may be concluded that during the growth phase the frequency of Bonus announcements increases. One of the reasons may be the willingness of management to send positive signals supported by good performance during growth phase.
REFERENCES
[1] Fama, E.F., L. Fisher, M. C. Jensen and R. Roll 1969). The Adjustment of Stock Prices to New Information, International Economic Review, 10, 121 [2] Ball, Brown and Finn (1977). Share Capitalization Changes, Information and the Australian Equity Market, Australian Journal of Management, 2, 10526 [3] D. M. Emanuel (1977),Capitalization Changes and Share Price Movements: New Zealand Evidence [4] Richard G. Sloan (1987). Bonus Issues, Share Splits and Ex-Day Share Price Behaviour: Australian Evidence, Australian Journal of Management, 12, 2, December 1987 [5] John J. Binder (1998). The Event Study Methodology Since 1969, Review of Quantitative Finance and Accounting, 11, 111137 [6] Jijo Lukose P. J. & S N. Rao (2005). Does Bonus Issue Signal Superior Profitability? A Study of the BSE Listed Firms, Decision, Vol. 32, No.1, January - June, 2005 [7] Frank de Jong, 2007, Tilburg University, Event Studies Methodology Lecture notes written for the course Empirical Finance and Investment Cases. [8] Huang, K. Liano, H. Manakyan and M.S. Pan (2008). The Information Content of Multiple Stock Splits, The Financial Review, 43, 543567 [9] P. Pavabutr, K. Sirodom (2008). The Impact of Stock Splits on Price and Liquidity on the Stock [10] Exchange of Thailand, International Research Journal of Finance and Economics, [11] ISSN 1450-2887 Issue 20 (2008) [12] Srinivas Shirur (2008). Dilemma of Corporate Action: Empirical Evidences of Bonus Issue [13] vs. Stock Split, Vikalpa Vol. 33 , No. 3, july september 2008 [14] M.Raja, J.C.Sudhahar, M.Selvam (2009). Testing the Semi-Strong form Efficiency of Indian Stock Market with Respect to Information Content of Stock Split Announcement A study in IT Industry, International Research Journal of Finance and Economics, ISSN 1450-2887 Issue 25 (2009) [15] M. Raja and J.C. Sudhahar(2010). An Empirical Test of Indian Stock Market Efficiency in Respect of Bonus Announcement, Asia Pacific Journal of Finance and Banking Research, Vol. 4. No.4,2010
Comparative Study on the Performance of Mutual Fund Industry of India in Past Five Years
Vidya Shivaji Shinde*
Right from its existence, Banks, whether nationalize or corporate, always dominated others, in case of public investments or retail investments. But in past few years due to various reasons like continuously falling of interest rates, various scams etc. investors will have to look for various other investments avenues that will give them better returns with minimization of risks. Here Mutual Funds Industry has very important role to play in providing alternate investment avenue to entire gamut of investors in scientific and professional manner. Indian Mutual Fund Industry has been definitely maturing over the period. In four decades of its existence in India Mutual Funds have gone through various structural changes and gained prominent position in Financial Industry. Because of ease of investments, professional management and diversification more and more investors are gaining confidence in Mutual Funds. Even government policies like abolishment of long term capital benefit taxes added advantage to growth of Mutual Funds. This is all the way leading to pool of more and more money from retail investors into the Mutual Funds.
Date 2-7-06 1-9-06 3-1-2007 2-4-07 1-7-07 2-9-07 1-1-2008 1-4-08 1-7-08 2-9-08 1-1-2009 1-4-09 1-7-09 3-9-09 1-1-2010 1-4-10 2-7-10 1-9-10 SBI Magnum Contra Fund 28.990 33.430 38.210 34.240 41.970 50.000 40.720 29.680 21.130 22.310 16.990 17.890 22.160 23.850 24.650 25.840 21.180 21.290 UTI Contra Fund 8.380 9.720 9.900 8.720 9.980 11.430 13.980 10.270 8.720 9.100 7.990 7.790 11.080 12.840 13.720 12.840 12.750 13.190
A Mutual Fund is an investment tool that allows small investors access to a welldiversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss o Mutual funds are financial intermediaries, which collect the savings of investors and invest them in a large and well-diversified portfolio of securities such as money market instruments, corporate and government bonds and equity shares of joint stock Companies. The fund's Net Asset Value (NAV) is determined each day. *Vidya Pratishthans Institute of Information Technology, Baramati
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Here I have taken the NAV values of different mutual funds from year 2006 to year 2010 .I have also compared the % returns of these mutual funds, sectorwise allocation of assets.
INTERPRETATION
Above data shows that from year 2006 to 2008 the mutual fund was in growing status. But due to economy meltdown during year 2008 to 2009 it was found that NAV was declining. Currently it is holding its grip in market economy.
Returns of Fund
YEAR OF RETURNS 2008 2009 2010 SBI MAGNUM CONTRA FUND 33.4% 40% 21.4% UTI CONTRA FUND 12.4% 20.2% 20.3%
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INTERPRETATION
From the above data rate of return of SBI Magnum Contra Fund is greater than UTI Contra Fund. UTI Contra fund was launched on 22 feb,2006 .SBI magnum contra fund have high return as compared to UTI contra fund. So SBI is best alternative to invest for high returns.
Comparison of Sectors
Sector Oil & gases Banking & Finance Engineering & Capital goods Utilities Cement & Construction Telecommunication Chemicals Metals & Mining Food & Beverages Services Pharmaceuticals Conglomerates Automotive Information Technology Tobacco Consumer Non-durables Miscellaneous Media & Entertainment Real Estate Manufacturing Debt Cash/Call % of Allocation of SBI 17.04 14.79 9.67 9.04 7.18 6.27 4.25 3.71 3.15 3.02 2.66 2.37 2.35 2.24 2.13 1.39 1.31 1.21 0.94 0.54 0.89 3.84 % of Allocation of UTI 9.83 17.79 12.14 9.90 5.69 6.39 1.70 1.82 0.00 0.00 5.42 0.00 3.77 7.36 4.82 1.68 0.00 1.37 0.00 8.25 0.08 1.93
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INTERPRETATION
Above data shows that different sectors are allocated differently by the SBI & UTI Contra fund. Oil & Gases is largely allocated by SBI whereas Banking & Finance by UTI fund
Comparison of NAVS
Years 1-1-2005 2-4-2005 1-7-2005 3-10-2005 2-1-2006 1-4-2006 1-7-2006 2-10-2006 1-1-2007 1-4-2007 3-7-2007 1-10-2007 2-1-2008 1-4-2008 1-7-2008 1-10-2008 1-1-2009 1-4-2009 2-7-2009 1-10-2009 3-1-2010 2-4-2010 1-7-2010 2-9-2010 SBI Magnum TAXGAIN Scheme 15.620 18.343 22.301 28.550 30.758 36.701 32.351 37.649 44.333 42.420 48.780 56.310 69.520 51.070 40.820 40.870 31.640 32.570 46.360 54.230 57.770 57.800 59.470 61.250 HDFC Taxsaver 62.680 68.669 79.211 99.313 110.305 131.223 115.193 131.676 149.015 129.521 156.535 177.498 205.662 151.451 122.538 131.063 100.472 100.627 148.269 183.457 197.021 208.199 216.660 234.781
We observe, at the year 2005 there was consistency of NAV but for the year 2006-2008 NAV was booming at higher rate. For 2008-2009 it was fallen to rapid rate. Again it grown up for some extent for the year 2009-2010.
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Returns of Fund
Years 2008 2009 2010 SBI Magnum TAXGAIN Scheme -54.8% 82.9% -6.3% HDFC Taxsaver -51.9% 96.1% 16.9%
IAbove data shows that returns of SBI & HDFC in year2008 are in negative due to economy melt down. In year 2009, returns were highly grown. HDFC leads to attract the investors. In current year HDFC is at good return position.
Comparison of Sectors
SECTOR Banking & Financial Services Engineering & Capital Goods Pharmaceuticals Oil & Gases Information Technology Media & Entertainment Automotive Consumer Non-durables Telecommunication Food & Beverages Utilities Services Manufacturing Chemicals Cement & Construction Consumers Durables Conglomerates Miscellaneous Cash & Call Metals & Mining Debt Tobacco Others/Unlisted Real Estate % allocation of SBI 15.67 12.33 7.52 11.99 6.65 2.12 4.93 0.00 2.62 5.13 6.19 1.24 1.56 4.11 3.67 0.25 2.92 0.00 1.73 5.75 1.96 1.15 0.00 0.52 % allocation of HDFC 25.85 12.27 10.86 9.20 7.68 5.19 4.81 4.03 3.58 2.96 2.62 1.83 1.51 1.05 1.00 0.78 0.15 0.04 2.92 0.00 0.00 0.00 1.67 0.00
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INTERPRETATION
We observe in SBI Magnum Tax Gain Scheme Banking & Finance sector have larger allocation of resources. Engineering & capital goods, Pharmaceuticals, oil & gases information technology are followed accordingly. In past few years, there have been ups & downs in the growth of Mutual industry like growing amount of corporate investments; other is that, investors have understood the need for asset allocation, which is why we see high net worth individuals coming to mutual funds. There are good numbers of qualified and educated people who are trying to advice people on how to invest. These key developments are the driving force for industry. While it also have been through weak phase in year 2008 to 2009 due to economy meltdown which loosed many investors but again it accelerated its grip towards the market investment. In all, key challenges will be to reach out to much larger population. The size of market is very large and competition is nothing compared to size of industry. As we know, compared to other avenues, mutual funds are somewhat different. Other investment avenues are more traditional and people are much more comfortable with them. Whereas mutual funds are market related instruments, so one will find that the return will go up and come down and sometimes they will be negative depends upon markets. So there is possibility of very high degree of discomfort with uncertainty, which is major difference between mutual funds and other investment instruments. Currently, mutual funds are very urban focused. It needs to be able to take financial investment culture to much wider market
Track9
RiskAssessmentandRiskManagement
*Lal Bahadur Shastri Institute of Management, New Delhi **Lal Bahadur Shastri Institute of Management, New Delhi ***Lal Bahadur Shastri Institute of Management, New Delhi
INTRODUCTION
Operational Risk has been defined by the Basel Committee on Banking Supervision (BCBS) as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Legal risk includes, but not limited to, exposure to fines, penalties, punitive damages resulting from supervisory actions, as well as private settlements. Unlike market and credit risks, which tend to be in specific areas of business, operational risk is inherent in all banking business processes. Operational risk differs from other banking risks in that it is typically not taken directly for an expected reward, and emanates from internal operational performance factors and has the potential to affect the risk profile. However, it is recognised that in some business lines with minimal credit or market risks, the decision to incur operational risk or compete based on its perceived ability to manage and effectively price this risk, is an integral part of a bank's risk /reward calculus. Operational Risk Management is a continuous systematic process of identifying and controlling operational risks in all activities according to a set of predetermined parameters by applying appropriate management policies and procedures. This process includes detecting hazards, assessing risks, implementing & monitoring risk controls to support better-informed decision-making. The broad Operational Risk Management objectives should encompass the following: To identify operational loss events and analyse their causative factors To build up robust database for operational loss To estimate expected and unexpected losses; allocate capital for operational risk To set up prudential limits To mitigate & control the factors leading to expected losses To protect against unexpected losses To make audit mechanism independent of operation To minimize and eventually eliminate losses and customer dissatisfaction due to failures in processes To identify the flaws in products and their design that can expose the institution to losses due to fraud and similar events
ImplementatonofOperationalRiskManagament
The following diagram illustrates the process of Operational Risk Management as implemented in few of the most successful and operationally efficient banks world over.
Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking Sector 463
One of the most crucial steps to tackle and manage operational risk is through continuous scrutiny of operations for their validity, effectiveness and efficiency. To accomplish this daunting task, the senior management should check all operations for compliance with standards and laid down norms. Moreover, it also becomes quintessential for the Audit and Risk Committee needs to conduct periodic audits, the report of which should be forwarded to the Board of Directors to maintain transparency in operations and prevent excessive risk taking by bank employees.
BenefitsofOperationalRiskManagement(ORM)
The ORM shall ensure adoption of Basel Committees governing principles on Sound Practices for the Management and Supervision of Operational Risk. With the implementation of a robust Operational Risk Management Framework, banks will be able to: Identify the internal & external causative factors leading to operational risk events, Understand the risk drivers Strengthen internal controls to minimize operational risk Find out the extent of Banks OR exposure Integration of OR in decision support system Allocate capital for operational risk Following diagram indicates the board steps involved process of Risk Management, which are explained thereafter:
Risk Identification is of paramount importance for the development of viable operational risk monitoring and control framework. Effective risk identification considers both internal factors (such as complexity of Banks structure, nature of activities, quality of human resources, organisational changes and employee turnover) and external factors (such as changes in the industry and technological advances) that could adversely affect the achievement of Banks objectives. Based on the past experience, the following operational risks have been identified at the Macro level along with their components: People Risk Placement, Competency, Work Environment, Motivation, Turnover/Rotation Process Risk (Transaction Risk) - Transaction guidelines, Errors in execution of transaction, Product Complexity, Competitive Disadvantage Systems Risk (Technology Risk) - System failure, System security, Programming error, Communications failure, MIS Risk Legal and Regulatory Risk Fines, Penalties or Punitive Damages resulting from supervisory actions as well as private settlements. It can also be defined as failing to comply with laws and regulations (e.g. company, industry, environment, data protection, labour, taxation, money laundering) to protect fully organisations legal\rights and to observe contractual commitments.
Risk Assessment Risk assessment allows the Bank to understand its risk profile better and most effectively target risk management resources. Risk assessment shall also identify and evaluate the internal and external factors that could adversely affect the banks performance, information already available and compliance by covering all risks faced by the bank and operate at all
Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking Sector 465
levels within the bank. There are various approaches to the same. A few are considered and elucidated below: Score Card Approach The tools which are proposed to be used for assessing operational risk is Self Risk assessment wherein the operations and activities of the Bank will be assessed against a menu of potential operational risk vulnerabilities and Key Risk Indicators which provide insight into banks risk position. The self risk assessment will be carried out using the score card approach. The process for risk assessment is outlined below Identify all processes, sub-processes of each product line of the Bank List the risk events associated with people, processes, system and legal or external factors Identify existing controls for each risk event and suggest improvements Classify identified risk events in various event types under business lines (as defined by RBI) Identify causes of the identified risk events Assess the severity of the risk events through Risk Severity score card" on a judgemental basis (Insignificant, Minor, Moderate, Major & Catastrophic) with the help of IAD for assessing severity of various risk events. Assess the risk event probability using "Frequency score card analysis on a judgemental basis (Rare, Unlikely, Moderate, Likely and Frequent) with the help of IAD for assessing frequency of various risk events. Classify operational risk events in three risk categories (Insignificant, Minor, Moderate, Major & Catastrophic) based on Severity frequency analysis matrix, identify the audit controls in place and suggest new controls. Finalise the events to be tracked based on the Severity frequency analysis matrix Fine tune events to be tracked using data on bank's historical loss experience Set audit bench marks for high loss events in co-ordination with IAD Develop key risk indicators for events to be tracked which may be quantitative or qualitative with inputs from IAD Develop a mechanism for tracking key risk indicators and risk profile of the bank along with IAD
Risk & Control Self Assessment Process (RCSA) To conduct self-assessment exercise, following steps are undertaken: Identification of activities for the survey, Organizing seminars for the concerned divisions to clarify the concept of RCSA, discuss the methodology of RCSA, Preparation of Risk Description Chart and the questionnaire, which shall involve the following steps: o Identification of the processes in the activity,
o o o o o o
Identification of the sub- processes in the activity, Identification of the Operational Risk Events (ORE) of the activity, Explaining the Risk Description (possible deviations) in the activity, Mapping the OREs to Loss Event Types, Identification of the factors responsible for deviations and Explaining the description of existing controls
Conduct of the survey by the concerned activity owner, Continuous monitoring of the implementation of RCSA surveys, Analysis of the findings of the survey and preparation of the bar/histogram charts, Placing the findings of the survey to the concerned authorities Placing the action take report along-with the findings to Operational Risk Management Committee for deliberation. Consolidation of RCSA findings at entity level and making a central repository. Validation of the process of conducting the survey This process should be repeated for all the activities annually.
Risk Monitoring An effective and regular monitoring process is essential for adequately managing operational risk and offers the advantage of quickly detecting and correcting deficiencies in the policies, processes and procedures for managing operational risk. Promptly detecting and addressing these deficiencies can substantially reduce the potential frequency and/or severity of a loss event. In addition to monitoring operational loss events, banks should identify key risk indicators that provide early warning of an increased risk of future losses and could reflect potential sources of operational risk such as rapid growth, the introduction of new products, employee turnover, transaction breaks, and system downtime. Thresholds directly linked to these key risk indicators should be in place, which shall provide an effective monitoring process and help identify key material risks in a transparent manner and enable the banks to act upon these risks appropriately. The frequency of monitoring should reflect the risks involved and the frequency and nature of changes in the operating environment and shall be decided while finalising the events to be tracked. The reports on these monitoring activities as well as the compliance reviews performed by the internal audit functions shall be included in regular reports to ORMC. The monitoring of Operational Risk should basically focus on the following three areas: Correctly interpreting and observing all the standards and guidelines set out in the operational risk policy and other related documents Monitoring operational risks in a timely manner and in the framework of the defined methods, structure, and processes Pursuing the measures initiated by the concerned HO division for addressing the weaknesses in processes, structures and control, and for limiting the losses.
Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking Sector 467
Risk Event (Hazard) is an incident or a set of incidents that results into actual/potential or direct/indirect or a near-miss loss. Actual or Direct Loss: Actual operational risk losses are those losses, which have actually materialized and have the financial impact associated with the operational event in the financial statement (P&L A/c, Suspense, Protested, Provision, write off etc) and would include the following: o Loss incurred due to: Write downs: Direct reduction in value of assets due to theft, fraud, unauthorized activity or market and credit losses arising as a result of operational events; Loss of recourse: Payments or disbursements made to wrong parties and not recovered; Restitution: Payment to clients of principal and/or interest by way of restitution, or the cost of any other form of compensation paid to clients; Legal liability due to operational risk: Judgments, settlements and other legal costs; Regulatory and compliance including taxation penalties: Fines or any other statutory/regulatory penalties; Loss /damage of assets: Direct reduction in value of physical assets due to some kind of accident (e.g. neglect, accident fire, earthquake etc.) Write off: Write-off means relinquishment of our claims recorded in our books on actual basis and have impact on P&L A/c. Safe, Fixture & Furniture/Motor Car & Cycle Expenditure incurred on repair & maintenance of SFF/MCC/Banks premises damaged due to fire / flood / other calamities /disaster/ accident etc. Expenditure incurred to restore the damaged stationery/records/important documents like loan documents, securities and stamp papers etc. due to fire/ flood/other calamities/disaster etc.