Breathing Deep

Volume 41 / April 2010

FINANCIAL ADVISOR
P R A C T IC E J O U R N A L
JOURNAL OF THE SECURITY ACEDEMY AND FACULTY OF e-EDUCATION

SAFE UPDATES – KEEP INFORMED

The Securities Academy and Faculty of e-Education
Editor: CA Lalit Mohan Agrawal
 Breathing Deep
Editorial preamble:
1.1 BREATHING DEEP
The Concept of New Normal

Wellness is not just the presence of healing – it is a return to normalcy. With many parts of the global
economy still operating below full capacity, the anguish continues even though the downturn is well past
us. In the developed world at least, the concept of a ‘new normal’ is gaining traction amid a growing
realisation that economic activity will not return to its pre-crisis trend any time soon.

That outcome will be consistent with historical analysis, which shows that big crises cause big time
damage. Financial accidents leave a lasting imprint on growth due to tighter credit conditions, lower
productivity on account of cutbacks in research and development spending while a structural rise in
unemployment hobbles consumption.

Aggressive fiscal and monetary stimulus measures have of course reduced the
duration of a downturn in the past but the problem this time around is that debt
levels in much of the developed world are at a point where further spending
will be counterproductive.

The IMF reckons that when debt levels exceed about 60% of GDP, the impact of any government
spending turns negative as doubts regarding debt sustainability result in lower consumer spending and
higher long-term interest rates.

Economists Kenneth Rogoff and Carmen Reinhart write in their paper ‘Growth in a time of debt’ that
when government debt as share of the economy exceeds 90%, median growth rates fall by 1% and the
mean levels of growth decline by an even more substantial 4%.

At 180%, Japan has the world’s highest level of public debt as a share of GDP whereas in countries such
as Greece and Italy, the ratio is around 120%. The bad news is that public debt in the US will be at 90%
of GDP by the end of this year – the threshold point after which debt begins to seriously drag down long-
term growth. No surprise then that the economic recovery in the developed world has been sub par and
that the prospects for medium-term growth do not look too bright.

• Given the debt overhang, the potential growth rate for the US economy this decade is likely to be at
least a full percentage point lower than the average 3% of the past few decades.

• Europe and Japan, which typically tend to grow at a slower pace than the US due to weaker
demographics and lower productivity, now face the same drags to growth as the US post the financial
crisis. As a result, trend growth in those regions is likely to be around 1.5% in the foreseeable future.

What does all this mean for the growth outlook for developing economies?

Emerging markets expanded at an average 3.6% from 1980-2002 but their growth
trajectory doubled to 7.2% from 2003 till the economic meltdown of 2008.
Structural factors such as benefits of globalisation, the demographic dividend and
better macroeconomic policy management were hailed as the main drivers of the
step function increase.
 Breathing Deep

However, easy access to cheap money and strong export growth directed to the freely spending US
consumer were significant factors behind the growth leap. It was no coincidence that the levitation act of
emerging markets began in earnest from mid-2003, once the US economy started to recover strongly
following aggressive interest rate cuts by the US Fed. Capital gushed into many developing countries.
Corporates in the developing world raised huge amounts of debt and equity capital to fund their ambitious
growth plans, largely from western financial institutions.

The turning off of the global liquidity tap in 2008 left many emerging market
companies high and dry, resulting in a broad slump in investment-led growth.
Policymakers in developing economies then joined their counterparts in the
developed world in implementing sizeable fiscal and monetary stimulus measures.

Now with growth rates in several leading emerging markets once again near pre-crisis levels, a consensus
is fast building around the view that the golden era of high economic growth that spanned from 2003 to
2007 is back. But that consensus ignores the role that fiscal expansion has played in boosting emerging
market growth. Fiscal deficits in developing countries widened by five percentage points from 2007 to
2009, just a bit less than the near six percentage points increase in the deficits of the developed world.
Nearly half the expansion was specifically directed towards countering the crisis. A major part of the
stimulus will begin to wear off this year. Although the private sector in emerging markets is in much
better shape than that in the developed countries to pick up the load from reduced government spending,
many factors will prevent it from growing at the breakneck speed of 2003-07.

For one, its dependence on exports is too large and domestic demand cannot
quickly offset the consumption slowdown in the developed world. The relative
deterioration in trade balances may contribute at least one percentage point less to
growth than was the case between 2003 and 2007.

Furthermore, a major part of the surge in capital flows to several emerging markets
last year was a reversal of the panic outflows in 2008. On a trend basis, capital
inflows will be lower than during 2003-07 due to the reluctance of western
financial institutions to lend as aggressively. A less appreciated point about capital
inflows is their tendency to be pro-cyclical: investors tend to invest more in
emerging markets when risk appetite is rising and not just because capital is
fleeing the beleaguered western economies.

The high domestic savings rates of many emerging markets cannot provide the
necessary risk capital to local businesses either as local credit systems are
inadequate to effectively use those savings. The global boom-bust credit cycle has
dented banks in emerging markets too.
 Breathing Deep

While most did not get caught up in any systemic troubles like the US and European financial sector, the
sudden stop in global growth in 2008 has made them more cautious. Credit growth consequently has been
slow to revive in emerging markets, except in China where the state-owned banking system was
instructed to go on a lending spree. These arguments are also relevant to India where the growth rate rose
by a similar magnitude as other emerging markets in the 2003-07 period; India’s economy expanded by
8.5% on an annual basis during that phase compared to 5.5% in the preceding two decades.

The global growth boom lifted India’s export growth to 24% in those five years from an average 10% in
the 1990s. More importantly, the surge in capital inflows from 2003 onwards meaningfully boosted the
country’s investment rate. Foreign savings are an important driver of India’s investment rate because
capital inflows tend to stir the animal spirits of the private sector.

India’s investment growth rates started declining sharply in the aftermath of the 2008 crisis and had it not
been for the sizeable fiscal expansion, overall GDP growth rate would have been much lower than the
6.5% recorded in calendar year 2009. Government consumption accounted for more than a third of India’s
incremental growth rate last year and the private sector will have to fill in the void caused by reduced
government spending in 2010.

A pick up in investment and export growth will undoubtedly help continue India’s economic recovery this
year. Still, GDP growth won’t be able to return to the 8.5% growth path of the 2003-07 period on a
sustained basis in the absence of another global economic boom or a fresh round of major productivity-
enhancing reforms. Also, Indian banks are unlikely to extend credit at the frenetic 25-30 % annual pace
that helped facilitate the 2003-07 boom, as they too are likely to be more restrained following the
harrowing 2008 experience.

Emerging markets such as India cannot charge on at a pace similar to that of the 2003-07 era while the
developed world moves to a ‘new normal’ of lower growth rates.

The trend growth rate of emerging markets probably lies somewhere between the
1980s and 1990s crisis-marred rate and the global credit bubble fuelled rate
witnessed between 2003 and 2007. This implies that the potential growth rate for
emerging markets is around 5% and 7% for India, which still makes these
countries exciting growth stories.

However, any attempt to engineer even higher growth rates through just loose monetary and fiscal
policies will prove to be unsustainable and lead to higher inflation.
 Breathing Deep
1.2 STOCK MARKETS
Control Emotions, Greed & Fear

Anywhere in the world a ‘SALE’ announcement is always associated with thronging

crowds in a rush to grab their purchase. Whether it is apparel, electronics or white
goods, a sale is seen as a brief window of opportunity before prices rise again.
Strangely, when a similar window of opportunity opens in the stock market, there is no
stampede among investors to buy stocks. On the contrary, when prices move up, there
is a flurry of buyers who come to buy stocks.

But even the most pessimistic investor would acknowledge that the Indian economy will continue to
grow. Moreover, since agricultural growth is largely flat, any growth will have to come out of
manufacturing and services and will have to be reflected in corporate performance. In other words,
equities can only go up in the long term.

One may argue that selling ahead of downturn provides an opportunity to buy later at lower prices. But as
the most-seasoned investors would tell you, it is impossible to time the market. So the ideal strategy is to
invest more in equity when markets fall rather than liquidate your portfolio. This tendency of investors to
stay away from a good deal is a fallout of what psychologists call the herd instinct. A crash in prices is
usually triggered by a large investor selling, which in turn prompts others to follow suit.

Behavioural investing is aimed at taking advantage of this trend rather than falling victim to it. Emotions,
greed and fear, over which investors have no control are the major reasons for irrational exuberance by
investors. Veterans in the field of finance say controlling greed and fear is the most difficult aspect when
it comes to managing your money. It is a slow process and does not happen overnight. There are some
aspects that you need to keep in mind in order to have control over greed and fear: -

Mental accounting
Investors do not want to sell shares or mutual funds in which they are losing or restructure their portfolios
as per advice from experts. “Mental accounting contradicts the benefits of diversification as investors tend
to meet goals of each mental account separately leading to subdued returns despite higher risk.”

Do not follow the crowd

Investors need to be self-disciplined and not follow a herd mentality. A lot of times, investors merely end
up selling stocks, because they hear bad news. When you have bought a stock or a mutual fund for a 3-
year time frame, be patient. Do not start checking prices every hour or every day and start questioning
your investment. At times when markets are bad, investments are bound to go down in value. That is just
how the markets work. If you refuse to accept this, then fear creeps in and causes you to bail out market
declines. If you sell and keep making losses, you may never reach your goals. Remember, wealth is built
patiently over a period of time and often you need to wait and watch your investments.

Stay diversified

Spread your investments across equities, bonds, real estate and gold. So when times are good, you will get
higher returns from stock markets. When times are choppy and bad, investment in bonds will preserve
your wealth. So while equities will satisfy your greed for higher returns, bonds will keep your fears under
check. So while greed and fear cannot be simply eliminated from investing, having control over the same
is essential for successful investing.
 Breathing Deep

1st week of March 2010 – Sensex gained 3.44% to cheer fiscal prudence in budget

Daily review 26/02/10 01/03/10 02/03/10 03/03/10 04/03/10 05/03/10 06/03/10

Sensex 16,429.55 343.01 227.45 (28.31) 22.79
Nifty 4,922.30 Holi 94.70 71.10 (7.85) 8.45 Saturday

Weekly review 26/02/10 05/03/10 Points %

Sensex 16,429.55 16,994.49 564.94 3.44%
Nifty 4,922.30 5,088.70 166.40 3.38%

The week ended March 5 gave enough time to investors to realign their positions in the market. The
positive undertone provided by the finance minister against the backdrop of commitment to fiscal
prudence was cheered by markets. Despite the decision to withdraw the fiscal stimulus, the finance
minister’s Budget came out as a positive, since there were no great expectations. The pre-Budget
weakness gave way to bullishness.

At a time the government is defending on the fuel price hike, the price of fossil fuels made their way up.
Black gold – crude oil – moved up despite a fall in inventory. From $77.92 a barrel to $80.62 a barrel
over the week – a development that will ensure that the fuels will remain costly if the pricing is freed.
This will surely influence inflation in the economy. At a time when equity markets were taking off, the
debt market continued their southward journey despite government borrowing targets being in line with
expectation. The finance minister’s steps to control the fiscal deficit could not cheer bond traders. 8.24%
GoI bond maturing on April 22 2018 closed at Rs 102.80 compared with Rs 102.99. Had one put Rs 1
lakh in the bond a week ago, he would have left with only Rs 99,812.

Rates at longer ends through are expected to remain range bound; short-term rates are expected to climb
as they track the inflation. With a fall in liquidity towards the end of the financial year, short-term rates
are expected to climb. If the central bank goes ahead with a rate hike prior to the monetary policy review
in April, it may reward those in liquid-plus schemes of mutual funds.

The yellow metal remained a preferred spot after equities. Though, experts have preferred silver to gold in
the precious metals for some time now, there is still shine left in the Gold. The price of gold moved from
Rs 16,755, to 16,940, a gain of 1.16%. Gold prices will be governed by sovereign default risks looming
over Europe in the short term. Going forward, investors will be better off if they remain watchful of
inflation. Though there is an expectation that due to the base effect and arrival of rabi crops, prices are
expected to cool down, any adverse news on monsoon’s arrival can spook hopes.

2nd week of March 2010 – Sensex gained 1%

Daily review 05/02/10 08/03/10 09/03/10 10/03/10 11/03/10 12/03/10 13/03/10

Sensex 16,994.49 108.11 (50.06) 45.79 69.63 (1.34)
Nifty 5,088.70 35.30 (22.50) 14.75 17.15 3.60 Saturday

Weekly review 05/02/10 12/03/10 Points %

Sensex 16,994.49 17,166.62 172.13 1.01%
Nifty 5,088.70 5137.00 48.30 0.95%
 Breathing Deep

3rd week of March 2010 – Sensex gained 2.40%

Daily review 12/03/10 15/03/10 16/03/10 17/03/10 18/03/10 19/03/10 20/03/10

Sensex 17,166.62 (1.63) 218.19 106.90 29.18 58.97
Nifty 5137.00 (8.10) 69.20 33.80 14.00 16.90 Saturday

Weekly review 12/03/10 19/03/10 Points %

Sensex 17,166.62 17,578.23 411.61 2.40%
Nifty 5137.00 5,262.80 125.80 2.45%

4th week of March 2010 – Sensex gained 0.38%

Daily review 19/03/10 22/03/10 23/03/10 24/03/10 25/03/10 26/03/10 27/03/10

Sensex 17,578.23 (167.66) 40.45 107.83 85.91
Nifty 5,262.80 (57.60) 20.10 Ram Navmi 35.10 21.60 Saturday

March 24, 2010 (Wednesday) - Wall Street rally, Japan data lift Asian stocks - A strong showing on Wall
Street and a massive jump in Japan's trade surplus boosted Asian markets Wednesday. The upbeat figures
stoked hopes that, with the world's two biggest economies growing stronger, a global recovery was well
on track. Japan released data showed a 651.0 billion yen (7.2 billion dollars) trade surplus in February,
soaring from 70.8 billion yen the year before. The figure was helped by a 45.3 per cent jump in exports on
higher shipments of automobiles, auto parts and microchips.

The gains in New York were spurred by better-than-expected data showing existing home sales fell to
5.02 million units in February. Analysts had forecast the figure to drop to 5.0 million.

Weekly review 19/03/10 26/03/10 Points %

Sensex 17,578.23 17,644.76 66.53 0.38%
Nifty 5,262.80 5,282.00 19.20 0.37%
 Breathing Deep
Monthly Review

Month December 2007 December 2008 December 2009 January 2010 February 2010

Sensex 20,206.95 9,647.31 17,464.81 16,357.96 16,429.55

Points Base (10,559.64) 7,817.50 (1,106.88) 71.59

% Base (52.26%) 81.03% (6.34%) 0.44%

Small investors’ appetite for stocks on the wane

Retail investors’ appetite for equities has not kept pace with rising per capita income,
as is evident from the trend in retail shareholding over the past few years. The
percentage of retail holding to the combined equity capital of the listed companies
has fallen from 13% to 12% between 2006 and 2009.

Brokers say only a small part of household savings continues to find its way into the
stock market, because of heavy losses incurred periodically by retail investors during
sharp market corrections. Brokers attribute the biggest stock market crash of 2008 as
a key reason for retail investor apathy. From its peak of 20,873 points recorded on January 8, 2008, the
Sensex crashed 60% in just 10 months, causing unprecedented capital loss to many retail investors.

They also blame aggressive pricing of new issues for keeping retail investors away from the primary
markets; Of the 22 IPOs listed between 2009 and now, 13 have returned between 4% and 27% while the
rest have led to losses between 3% and 20%. This is in sharp contrast to the trend in 2007 when all the
listings, about 100, returned between 82% and 175% on debut.

An analysis of the change in retail shareholding in about 3,200 listed companies between 2006 and 2009
shows that the percentage of individuals holding shares worth up to Rs 1 lakh (face value of the share
multiplied by number of shares) fell gradually to 12.2% as on December 31, 2009 from 13.1% as on
December 31, 2006. The analysis considered this period as the data relating to retail holding is available
only since June 2006. It is now mandatory for all the listed companies to separately disclose details about
individual holdings having a nominal capital of Rs 1 lakh and below. The period spans the two extreme
phases of the stock market, the bull run of 2007-08 and the downtrend in 2008-09.

Lack of understanding of the risks involved with equity investments and volatility in the markets have
resulted in retail investors staying away from equities. There is an inclination towards safer investment
avenues like bank deposits among retail investors. The presence of financial intermediaries is mostly
concentrated in metros and even the focus of marketing of IPOs is restricted to a few major cities in India.

According to Analysts, there has been a sharp growth in market capitalisation of listed companies over the
past 5-6 years, due to the contribution of fresh capital by promoters and institutional investors.
 Breathing Deep
Good leaders buy low, sell high

Common sense tells us that we should buy when times are bad and
sell when times are good. However, people find comforting to buy
during good times and sell during bad times. Partly because we love
being in the comfort of a herd. If all are buying, then there should be
some logic to it. Seldom do we make the effort to look beyond what is
in the immediate horizon. But then, that is exactly what good leaders
are all about – being contrarians, seeing what is distant and doing
what is right rather than what others are doing.

Hence, in a way a good leader is more like a good investor: he buys low and sells high.

An investor practises this in the world of finance to make a profit, while a leader practises this for
conceptualising and developing his idea.

Initially, though his idea is perceived like an undervalued stock, perhaps because it is before its time or
because the times are bad, he still supports it, adds value to it until the time has come for fruition.

He sees what is not obvious and strives to create what is not there by betting on hidden potential. He
undertakes the act of converting something worthless in the present to what is precious in the future.

So, what does buying low mean?

Buying low means looking into the future: True leadership is about committing your present to a future
that appears to be on the lower side currently, but which you believe can be high.

Visionary leaders see the potential in things before they become obvious. They look for what is not there,
what has not been said, what has not been done and imagine how things should be or could be.

Buying low means defying the crowd: If we were to ask George Bernard Shaw, he would brand a true
leader as an unreasonable man. While a reasonable man adapts himself to the world, an unreasonable man
tries to adapt the world to himself.

He takes the big decision to defy the crowd.

He produces and supports ideas that go against the crowd, that are like buying low and doing the opposite
of what the world is doing, even while those ideas are viewed as bizarre, useless and even foolish.

However, as Shaw would conclude: “All progress depends upon the unreasonable man.”

Leadership Takeaway: Leadership is the art of buying low and selling high. There is no better time to buy
into an idea than when times are bad.
 Breathing Deep
2.1 INDIAN ECONOMY
Can India be the next safe haven for investors?

The first decade of the 21st century has been lost for the global equity
investors with MSCI World Index and Dow Jones yielding close to 0%
returns. In contrast, India and other emerging markets (EMs) delivered
returns of 13.2% and 7.3% respectively. In the next 2-3 decades, this
return differential is likely to persist as growth in EMs will outpace that
of the developed world. The legacies of the crisis are likely to weigh on
the recovery in the developed world.

During the financial crisis, EMs proved more resilient than the
developed world. Yet, they have failed to meaningfully shatter the
perception that the US and other developed economies are ‘safe havens’. With every rise in risk aversion,
we see investors shunning EM equities and fleeing to US treasuries.

It is true that the risk gap between India and developed countries is reducing. However, we are yet to see
its impact on portfolio flows. India is the second-fastest growing economy with well-regulated and
capitalised financial system, stable political scenario, attractive demographic profile, low debt-to-GDP
ratio, high savings rate and domestic consumption-driven growth. Despite these, foreign portfolio flows
have shown diverging trends in India and due to capital linkages, Indian markets remain vulnerable to the
direction of FII flows, which results in huge impact cost.

The Fed’s balance sheet has ballooned to $2.3 trillion; more than double that of pre-crisis levels. A record
$329 billion of corporate debt worldwide defaulted in 2009. Of this, North America accounted for $291
billion, a whopping 88% of total defaults. Public debt-to-GDP ratio in 20 EMs stands at around 40%
against 80% in 20 developed economies, which is further expected to rise to 120% by 2014.

While the US remains world’s largest consumer market (16.6% of global GDP), consumption in EMs is
growing at a faster pace. Emerging economies’ share of global GDP (on PPP basis) has grown from 37%
in 1999 to 46% in 2009, and is poised to grow further as, incrementally; global growth will be led by
EMs. India and China will together contribute ~45% of the world’s growth in 2010 or 2011.

In the last decade, India has outscored US in many ways: investment returns, regulatory supervision,
recapitalisation of banks, better balance sheet management, number of corporate failures and dealing with
such cases. Also, India required a modest stimulus (~2% of GDP) to recover from the crisis compared to
the US while Fed had to expand its balance sheet to arrest the downturn. This is a testament of India’s
structural strength and effectiveness of regulations.

Even within EMs, India remained internally-focused with growth led by domestic consumption. In China,
the share of household consumption in GDP has been constantly falling while that of net exports was
rising in the last decade. India’s export-to-GDP ratio stands at 21% against 41% for China.

India’s middle class is estimated at 170 million, half of the US population. It is important to note that
India’s working population as a percentage of total population is still expanding, whereas in China, it has
already begun to shrink. It is far worse in Europe where the dependency ratio will increase rapidly and
become a burden for the state budgets.

This coupled with the fact that India also has among the youngest population – half of its 1.1 billion
people are below 25 years old compared to 42% in Brazil, 36% in China and less than 30% in developed
nations – consumption will undoubtedly continue to soar in the years to come.
 Breathing Deep

Going forward, India will continue to strengthen its global footprint led by strong economic growth,
structurally-appreciating currency, massive infrastructure development and attractive demographic
dividend. There is a need to take concrete reforms that will help attract long-term growth capital.

The huge infrastructure development need makes the case to develop a deep and liquid corporate bond
market for global investors. At the same time, emphasis should be on ensuring long-term holdings with
commensurate incentives and tax benefits. It is equally important for the economy to develop expertise in
absorbing such foreign capital flows without creating the vicious circle of currency appreciation, loose
money supply, credit growth and inflation.

India today offers most promising growth prospects and one of the finest opportunities for long-term
wealth creation. Given India’s economic potential, global investors should invest with a longer-term view
in the country. India should take steps to raise its visibility and position itself well among the global
investment community along with delivering on its promises.

This would go a long way in increasing investor confidence, resulting in long-term portfolio flows that do
not get fettered by short-term global worries.
 Breathing Deep
2.2 INDIAN INC
India Inc’s Billion-Dollar Sales Club

Close to two dozen Indian companies joined the billion-dollar revenue

club over the last two years, reflecting the strength of Asia’s third-largest
economy that came out unscathed from the most severe global economic
crisis since the Great Depression.

According to an ETIG study, which analysed the projected net sales for
the 12 months ending March 31 using data available for the first nine
months of the fiscal year, the number of companies in the billion-dollar club went up to 124 compared
with 104 in the year ended March 2008.

Cipla, Lupin, Tata Tea, Tech Mahindra, Lanco Infratech, IVRCL Infrastructures and Bharat Electronics
are among the firms that joined the billion-dollar revenue league in the last two years. Some like
Motherson Sumi Systems and Apollo Tyres, which gained size through global acquisitions, also figure
among the entrants.

The study used Rs 45.5 as the rupee-dollar exchange rate for both the years to factor out currency
movement impact on dollar revenues.

The comparison has been made with FY08, which was the last year to record 9%-plus economic growth.
India’s economy expanded 9.1% in FY08, before the global economic downturn pulled down growth rate
to 6.7% in the next year. The government expects a growth rate of 7.2% for the current fiscal year.

Billion-dollar revenue is considered as an important benchmark by many investors who use it to shortlist
the pool of companies to invest in.

Institutions prefer the big companies by revenue due to consistency in financial terms. The increase in the
number of companies in the billion-dollar club will act as a catalyst for market growth.

Infrastructure and agriculture firms dominated the list of new entrants to the billion-dollar revenue club,
as these sectors remained more-or-less unaffected by the economic downturn. This trend is reflected in
the entry of agri-related firms such as United Phosphorus and National Fertilizer into the club.

There is a lot of autonomous demand due to consumption from rural and semi-urban India which was less
affected by the slowdown allowing companies to grow revenues. The financial slowdown impacted the
urban economy much more.

While the big revenue league grew by nearly a fifth in the last two years, the group of firms with billion-
dollar market value shrank by the same ratio.

A large number of companies from the real estate and financial services sectors fell down the valuation
charts while others from FMCG, pharma, healthcare representing domestic consumption demand joined
the list. Apollo Hospitals, Fortis Healthcare, Gillette, P&G Hygiene, Glaxo Consumer, Emami, Marico,
Godrej Consumer, Aurobindo Pharma, Cadila Healthcare among others have joined the club.
 Breathing Deep
2.3 INDIAN
You work hard for your money; does it do the same for you?

As a nation we have amongst the highest saving rates in the world (our gross
domestic savings as a percentage of GDP at current market prices is around 30%).
The same, however, is not true of us as investors. While we do manage to put aside
more than others can, we are not really good at putting our money to work. We
could be broadly classified in two groups - the discerning and the undiscerning!

The discerning type of investor is a growing breed. He is characterised by having a

clearer idea of his financial goals and objectives. He is someone who knows what
he wants and how to go about getting it. This kind of investor has a distinct idea of
his short term and long term requirements, a fair understanding of market dynamics
and is able to understand complex products and debate upon their features. Most importantly, he
approaches investments with discipline.

The undiscerning type is the investor who often believes he is too caught up to take time out for
investments. He has a vague idea of his short-term and long-term financial goals, has superficial
knowledge of markets and products. He is the kind who often invests on tips and follows a ‘herd
mentality’ when entering or exiting investments.

Most investors in India often share their relationship with more than a couple of wealth managers
(relationship managers) managing independent and separate portfolios. This action results in no single
wealth manager having a holistic knowledge of the investor’s portfolio which is the first step towards a
sound financial plan. During the course of these interactions with the investors we would classify their
interaction with the wealth managers as positive and otherwise. Let us share some of these with you:

My wealth manager is always interested in pushing a product whenever he/she meets me. Most of the
times I think he is trying to sell refrigerators to Eskimos. Products are often recommended on the basis of
past returns with little regard for other relevant factors. Products are recommended without any regard to
my risk appetite and there is no consideration of suitability. The approach is ‘one size fits all’ and I am
sure he would recommend the same product to my grandmother as well.

Products that were good a few months ago suddenly turn bad without any apparent reason! This is done to
get me out of existing investments so that funds can be routed to wherever he desires.

The discerning investor, however, attracts the right people to work with. We have heard some very good
things about wealth managers and we have listed some of the feedback below. These can be construed as
desirable traits or qualities in a good wealth manager: My wealth manager is more like a member of the
family. He/she has been with me for many years and understands me and my requirements well. He/she
meets me regularly and does regular portfolio reviews. The decision to invest is based on my risk appetite
and portfolio suitability and I am informed in detail about all costs and associated risks.

Amongst the many factors, a simple litmus test is to check if the institution: Lays particular emphasis on
risk profiling and financial planning; has a transparent advisory and product recommendation process that
minimises human bias in investment decisions; has a pre-mandated portfolio review frequency and; has a
client centric approach that emphasizes the human element. Therefore, the first step in making your
money work starts with you. Be informed. Be demanding. Be discerning.
 Breathing Deep
2.4 CORPORATE WORLD
India Inc lines up warrant issues for promoters

In a move that’s expected to boost shareholder confidence, many companies –

mostly mid-caps – are rushing to issue convertible warrants to their promoters at a
substantial premium to the current market price. Investment bankers say this
reflects the promoters’ conviction in the growth prospects of their companies.

Convertible warrants are instruments which give the holder an option to subscribe
to an equivalent number of shares within 18 months, at a conversion price decided at the time of the
allotment. If the warrant holder doesn’t exercise this option, the warrants lapse and the person will have to
forego upfront margin of 25%. Mahindra Forgings, Bartronics, Filatex India, Vardhman Polytex, D&H
Welding Electrodes and Agro Dutch Inds are among the companies offering warrants to their promoters
and other investors at a conversion price higher than the current market price.

Investment bankers feel such moves, particularly those taken by the companies with a good track record,
could boost the morale of minority shareholders, something much needed in volatile market conditions. In
an EGM, the shareholders of Mahindra Forgings approved a proposal to issue nearly 73 lakh warrants to
the promoters M&M, at a price of Rs 137 per warrant, around 28% higher than the current market price.

In the past, promoters of many companies had hiked their stake through conversion of warrants, which
has been one of the preferred routes, because of the convenience of payment. They need to pay only 25%
upfront and exercise the conversion option any time during the 18-month conversion period by investing
the balance funds, thus enjoying flexibility in payment. Experts advise prospective investors to verify
such a possibility before taking any investment call on the companies issuing warrants at a premium.

Spurt In buy-backs fuels recovery hopes

NEW YORK: Judging by the recent flurry of share buyback announcements,

Corporate America is increasingly confident the worst of the economic slump has
passed. After two years of belt tightening, stock buybacks are running at their
highest level in two years, as companies start to look for ways to deploy the
record levels of cash on their balance sheets.

The hoards of cash for buybacks also spell good news for the broader equity market. JP Morgan estimates
that S&P 500 companies currently have $3.2 trillion of cash sitting on their balance sheets. Excluding the
financial sector, the cash pile is $1.1 trillion, or 11% of assets, a 60-year high and well above the long-
term average of 8%. This makes it likely 2010 will mark a big turnaround in share repurchases, and the
revival in capital expenditures and M&A should follow after a muted 2009.

Buybacks are viewed as sort of a way-station to the more aggressive ways to spend: acquisitions and
capital expenditures. Those expenses imply a long-term strategic bet by a company on earnings potential
and growth. Buyback authorisations are cyclical and do tend to move with recessions and expansions.
New stock buybacks have been particularly robust in the latest earnings reporting season, averaging $1.6
billion daily, the highest level in almost two years.

Buybacks reward shareholders by reducing outstanding shares, driving up the price of existing stock, and
improving earnings-per-share figures. But they can be cancelled more easily than a big acquisition.
Investors tend to be forgiving if companies suspend buybacks when the going suddenly gets tough, unlike
cutting a dividend or abandoning capital expansion plans.
 Breathing Deep
2.5 INTERNATIONAL
Currency Manipulator

Don't politicise yuan,

China tells Obama:

BEIJING: The United States should not make a political issue out of the
yuan, a Chinese central banker said, as the two countries lurched towards
a potential bust-up over Beijing’s currency regime.

The latest rhetorical salvoes underlined how long-running friction caused

by the yuan’s de facto dollar peg could come to a head next month when US president Barack Obama’s
administration decides whether to brand China as a “currency manipulator”.

People’s Bank of China vice Governor Su Ning said the United States should look to itself to boost
exports and not cast blame on other countries, when asked to comment on remarks by Obama, who called
on China to move to a “more market-oriented exchange rate”.

Ning said, “We always refuse to politicise the yuan exchange rate issue, and we never think that one
country should ask another country for help in solving its own problems”.

Obama’s rare comment about the currency comes as his administration mulls whether to use the
“currency manipulator” label in a semi-annual Treasury Department report due on April 15, which could
set in train punitive actions against China.

With Obama facing domestic pressure to take a tough line against China and Beijing clinging to its dollar
peg, the report could act as a tipping point.

• If China flinches, it may soon resume the yuan appreciation halted in mid-2008 to cushion the country
from the global credit crunch.

• But if China keeps the yuan locked in place, then scattered trade spats between the two giants could
escalate into a full-fledged dispute, with Washington even considering across-the board tariffs against
Chinese products.

Stephen Green, China economist for Standard Chartered Bank in Shanghai said, “The chances of a
collision have never been higher”.

Asked whether it might be counter-productive for Washington to ratchet up pressure over the yuan, Green
said: “That’s the $64-billion question to which no one really knows the answer.”

Li Jianwei, a director in Development Research Centre, a think-tank under China’s cabinet, was
unequivocal: demands for aggressive yuan appreciation will harm not only China but also the United
States and others.

“A stronger yuan will hit exports and lead to a double dip in the Chinese economy, which in turn will
hamper the global economic recovery.”
 Breathing Deep
Yuan not undervalued: Wen Jiabao

Chinese Premier Wen Jiabao rejected foreign calls for the yuan to rise and
showed no let up in scolding the United States over recent bilateral
tensions. Wen said calls from the United States and other big economies
for China to lift the value of its yuan currency were unhelpful, even
protectionist, and vowed that Beijing will steer its own way on currency
reform through a risk-filled economic landscape.

Wen told in a news conference at the end of China's annual parliament meeting, "We oppose mutual
accusations between countries, and even using coercion to force a country to raise its exchange rate,
because that's of no help to reforming the yuan exchange rate," "We don't believe that the yuan is
undervalued." Wen used the keynote event to both cast China as a benign political and economic power
and as the victim of unfair international demands.

Rebuffs external pressures: Without directly mentioning the United States, Wen made clear that Beijing
was in no mood to surrender to any demands from Washington and might even be girding for a fight. "I
can understand some countries' desire to raise exports, but what I do not understand is depreciating one's
own currency and attempting to pressure others to appreciate, for the purpose of increasing exports. In my
view, that is protectionism."

However Wen pressed Beijing's own worries about Washington policy, as he did at last year's news
conference, "We are very concerned about the lack of stability in the U.S. dollar. If I said I was worried
last year, I must say I am still worried this year." China is the world's biggest holder of U.S. Treasury
debt, holding $894.8 billion worth, "We cannot afford any misstep, no matter how slight, in our
investments. U.S. debt is guaranteed by the U.S. government, so I hope that the United States will take
concrete steps to reassure international investors."

Beijing and Washington have also recently been at odds over new U.S. arms sales to Taiwan, the self-
ruled island China claims as its own territory, and Obama's meeting in the White House with the Dalai
Lama, the exiled Tibetan leader reviled by Beijing. Wen said about their ties that the responsibility for the
serious disruption in U.S. - China ties does not lie with the Chinese side but with the U.S.

Domestic worries weigh: Wen also stressed that domestic worries weighed on policy, "I have said that if
there is inflation, plus unfair income distribution and corruption, they will be strong enough to affect
social stability and even the stability of the state's power. It will be an extremely difficult task for us to
promote steady and fast economic growth, adjust our economic structure and manage inflation
expectations all at the same time."

China escaped the worst of the global slump by ramping up credit, slashing interest rates and launching a
4 trillion yuan ($585 billion) infrastructure stimulus program in late 2008. Its economy grew 8.7 percent
last year as a result, by far the fastest pace of any major country. But price increases have followed in the
wake of that burst of spending and easy credit. Consumer price inflation rose to 2.7 percent in the year to
February from 1.5 percent in the year to January, spurting to a 16-month high. Rising housing prices have
also stoked domestic disquiet. The government wants to limit inflation for the whole year to 3 percent.

Wen unveiled rises of 8.8% on social spending and 12.8% on rural outlays, more than the rise of 7.5% in
the military budget, to narrow the wealth gap economists blame for dampening domestic consumption.
 Breathing Deep
China faces the 'greatest bubble' in history

James Rickards, former general counsel of hedge fund Long-Term Capital Management
said, “China is in the midst of “the greatest bubble in history.”

The Chinese central bank’s balance sheet resembles that of a hedge fund buying dollars
and short-selling the yuan.

Rickards, now the senior managing director for market intelligence at consulting firm
Omnis said, “As I see it, it is the greatest bubble in history with the most massive misallocation of
wealth.”

At the Asset Allocation Summit Asia 2010 organised by Terrapinn in Hong Kong, Rickards said, “China
“is a bubble waiting to burst.”

Rickards joins hedge fund manager Jim Chanos, Gloom, Boom & Doom publisher Marc Faber and
Harvard University professor Kenneth Rogoff in warning of a potential crash in China’s economy.

China has pegged the yuan to the dollar since July 2008 to help exporters weather the global recession.
The central bank buys dollars and sells its own currency to prevent the yuan strengthening, driving
foreign-exchange reserves to a world-record $2.4 trillion as of December.

The Shanghai Composite Index of stocks jumped 80% last year and property prices rose at the fastest
pace in almost 2-years in February, helped by a record 9.59 trillion yuan ($1.4 trillion) of new loans in
2009.

Rickards said leveraged speculation in the stock market, wasteful allocation of resources by state-owned
enterprises, off-balance-sheet debt through regional governments and the country’s human rights record
are concerns.

Rickards also disputed an argument that China could hold US policies hostage through its Treasuries
holdings. The nation remained the largest overseas owner of US debt after trimming its holdings by $5.8
billion in January to $889 billion. China will suffer massive losses if the debt was dumped, reducing the
funds available in the US securities market and forcing the prices lower, he said.

“Take Russia and China together, neither of them is really deserving any investment” except for short-
term speculation. India and Brazil are two of the “real economies” among the developing countries.

The World Bank has indicated in a quarterly report on China released in Beijing, that
China should raise interest rates to help contain the risk of a property bubble and allow
a stronger yuan to help damp inflation expectations. The nation’s “massive monetary
stimulus” risks triggering large asset-price increases, a housing bubble, and bad debts
from the financing of local-government projects.

China is poised to overtake Japan as the world’s second-largest economy this year, according to the IMF,
and Nomura Holdings forecasts it will contribute more than a third to global growth. The nation has
surpassed the US as the world’s largest auto market and Germany as the No. 1 exporter.
 Breathing Deep
2.6 WARNING SIGNALS
Greece Cabinet Passes Euro 4.8-Bllion Austerity

ATHENS - Greece's cabinet approved a sweeping new austerity

programme on Mar 3, 2010, the third in as many months, intended to
rein in a bulging budget deficit and secure European financial support.

A government spokesman said the package of public sector pay cuts

and tax increases would save an extra 4.8 billion euros ($ 6.5 billion),
equivalent to 2 percent of gross domestic product. Prime Minister
George Papandreou said, "Additional steps were necessary for the
country's survival”. The measures included an increase of value added tax by 2% to 21%, cutting public
sector salary bonuses by 30%, increases in tax on fuel, tobacco and alcohol, as well as freezing state-
funded pensions this year.

Greece is under pressure from the European Union and financial markets to fulfil a promise to cut the
budget deficit to 8.7 percent of GDP this year from 12.7 percent in 2009. But EU inspectors estimated the
austerity plans announced so far would only go half-way due to a deeper than forecast recession.

Papandreou told the cabinet that if the EU did not provide financial support now, Greece had the option of
turning to the International Monetary Fund. Speaking to members of his PASOK party, he compared his
country's fiscal crisis to a war and said he would have to take harsh and possibly unfair measures. All of
Europe would be threatened, he said, if Greece failed to take brave decisions to cut a 300 billion euro debt
mountain, equivalent to 125 percent of the country's annual output.

The euro rose on foreign exchange markets on the news and Greece's borrowing costs fell further, with
the risk premium on Greek 10-year bonds over benchmark German bunds at 289 basis points, the lowest
since early February. The relief was evident in the money markets once Greece announced its additional
austerity measures. This increases their chance of navigating through these troubles.

In a first reaction, Germany's economy minister, who has accused Greece of endangering the euro,
welcomed the latest measures, adding it was essential that they be implemented. European government
sources have said Germany and France are working on contingency plans under which state-owned
financial institutions would directly purchase billions of euros in Greek bonds or offer guarantees to
commercial banks that bought them.

Although market pressure on Greece has eased in recent days, a Reuters poll of economists showed that
scepticism about the government's ability to meet a goal to slash its deficit by four percentage points this
year still runs deep. Only 18 of 47 respondents said they believed Athens would meet that target, with
most predicting a "slow burn" scenario through 2010 in which the government makes only limited
progress in reducing the deficit.

Social Explosion

The main public sector trade union, which has called another one-day strike for March 16, vowed to fight
the new measures. General secretary Ilias Iliopoulos said "We will be on the streets with all our might. I
am afraid there will be a social explosion. People will start going hungry soon." About 500 pensioners
rallied in central Athens and marched to the finance ministry in a first protest against the new measures.
Civil servants also planned an anti-austerity demonstration outside the ministry. However, opinion polls
suggest the government retains majority support for its austerity plans.
 Breathing Deep
3.1 MUTUAL FUNDS
Let fund managers guide you

There are many investors who after witnessing sensational stock market
crashes in the past have a mortal fear of investing in equities. However, with
returns from traditional fixed income products turning unattractive, investing in
equities is perhaps the only way to beat inflation. In such a scenario, what are
the choices that such an investor has? Fund managers have come out with
innovative schemes as the answer to the dilemmas faced by such investors.

Capital protection strategy:

If you desire better return on capital and at the same time you are concerned about the return of capital,
this is the scheme for you. These are close-ended debt mutual funds. The fund invests a part of your
subscription into high-quality fixed income instruments that by the end of the term of the scheme reaches
at least the original sum. Rest of the money is invested in equity with the sole objective to enhance
returns. However, one must remember that such products are generally illiquid and one may have to
remain invested for the full tenure of the product to reap its benefits. For example, if you invest Rs 1 lakh
in such a scheme with 3-year tenure, the fund manager will put approximately Rs 85,000 in fixed income
instruments which will grow to Rs 1 lakh. The rest of the money, Rs 15,000, will be invested in equities.
Rs 85,000 invested in debts for a period of 3 years will give you interest income sufficient to protect your
capital while extra returns could come in from equities.

Structured products:

Over the past couple of years, structured products have guaranteed success of your capital in the market.
Investors in such schemes can get to earn a return linked to the returns generated by underlying stock
index or a stock. You are offered higher part of the fixed coupon and the returns generated by the
underlying. There are two versions of products, one that offers a capital protection and another that does
not. Risk-averse investors can look at the former. However, a point to note is the minimum ticket size is a
tad higher and typically stands above Rs 20 lakh. The products are available only through the private
banking channels that cater to high net worth individuals.

Monthly income plans:

MIPs launched by MFs deploy money into a mix of equities and fixed income instruments. The only
difference between an MIP and balanced fund is that in the case of MIP, the fixed income weight is
higher. In some cases, it is as high as 95%. MIPs though are aimed to generate regular returns that take
care of income needs; there is no guarantee that there will be regular payouts to the investors. Investors
run the risk of losing money. MIPs work better than capital-oriented products for investors with a 3-year
time frame, since the fund manager has the flexibility to alter the duration of the portfolio depending on
the interest rate scenario.

Combination of debt and equity funds:

If you are willing to take some efforts, you can choose to invest into a combination of equity and debt
funds. Depending on your risk appetite, you may choose to put 10-20% of your money into equity funds.
This helps you ensure you will earn good risk-adjusted returns over 3-5 years. When you choose equity
funds, you will be better off picking funds from dividend yield funds, index funds or diversified equity
funds with long-term track record.
 Breathing Deep
3.2 CORPORATE BOND MARKET
Let Corporate Bonds Take Over

With India recovering smartly from the economic crisis, the government is setting
its sights on achieving its target growth of 9%. The policy debate also needs to
shift to the reforms to sustain rapid growth over the long run. Enabling India’s
financial system to serve the needs of its increasingly-dynamic economy is a
critical element of this policy agenda. And now is an opportune time to make
strides towards a domestic corporate bond market.

A deep and liquid corporate bond market is the financial equivalent of motherhood and apple pie –
something worthy and desirable. Bond markets play a fundamentally different role from banks by
providing long-term finance for investment and allowing firms to diversify their sources of funding.

The need to develop this market has long been recognised in India. The Patil, Mistry, and Rajan reports
point to it as a critical missing link in the Indian financial system. More recently, at the India Economic
Summit in November 2009, Prime Minister Manmohan Singh himself emphasised the importance to India
of a vibrant corporate bond market when he said, “We need to ensure that the financial system can
provide the finance needed for our development, and especially for infrastructure development… We
need to develop long-term debt markets and to deepen corporate bond markets.”

With the Indian government set on a big push for infrastructure investment, a strong corporate bond
market is vital. Examples of Asian countries that have relied on the development of corporate bond
market for infrastructure building are South Korea, Thailand and Malaysia.

The domestic bank-centred system is ill-equipped to provide financing for infrastructure projects. Banks’
liabilities are short term, while infrastructure projects have long gestation periods. Too many of these
projects on banks’ books could expose them to large asset-liability mismatches and high concentration
risks, undermining financial stability.

A deep bond market would serve useful functions other than for infrastructure finance, such as to broaden
access to credit by allowing banks to reduce their corporate exposure – as blue-chip companies may shift
to issuing bonds – and provide funds to under-served sectors, such as SMEs and households.

Yet, India’s corporate bond market remains stunted. So what needs to be done? In many emerging
markets, the takeoff of the corporate bond market has been linked to the development of their domestic
institutional investor base: these are institutions with long-term liabilities and, hence, are ideally suited to
take on long-term assets. For example, in Mexico, the pension fund industry was key and, in Malaysia,
the easing of investment restriction on insurance companies served the same purpose. In India, insurance
companies and pension/provident funds are growing rapidly, but they invest most of their assets in
government securities.

Liquidity is the sine qua non of any vibrant financial market; a high volume of transactions is the pre-
requisite for price formation and discovery. Domestic institutional investors are typically buy-and-hold
investors, so a liquid market requires other players, usually foreigners. For this reason, the IMF has
suggested increasing the limits for foreign investors in local bond markets. Critics fear that increased
participation by foreign investors will bring volatility. This may happen initially, but once the market
becomes deep and liquid, prices should become less volatile for any given shock. With the government’s
renewed commitment to fiscal consolidation and fiscal discipline, this could be an opportune juncture to
make the push to develop a deep corporate bond market in earnest.
 Breathing Deep
3.3 GOLD ETFs
Cut in Charges to Boost Trading

The National Stock Exchange’s (NSE) move to slash transaction charges on gold
exchange-traded funds (ETFs) will benefit trading members who take proprietary bets,
more than their retail clients, feel market watchers. The
exchange’s move is expected to boost trading volumes in
gold ETFs, but will not result in any meaningful cost
reduction for retail investors, they say.

Gold ETFs are units representing physical gold held in dematerialised form and normally quoted in price
per gram of gold. A client wanting to invest in the ETF can buy and sell one unit, representing a gram,
whose current price is around Rs 1,650 levels.

For the period from March 1 to September 30, NSE has reduced transaction charges for gold ETFs to Re
1 per lakh of the traded value (each side) against the earlier slabs, from Rs 3 a lakh to a maximum of Rs
3.25. Brokers charge their clients between 0.2% and 0.5% on delivery-based transactions in gold ETFs,
excluding exchange charges and stamp duty. An investor putting Rs 4 lakh into a gold ETF would save
around Rs 9 after the reduced charge is passed on, which really won’t make much of a difference. It
could, however, make a difference where the prop book size is large.

At present, there are seven gold ETFs listed on the NSE, managed by fund houses Benchmark, Kotak,
Quantum, Reliance, SBI, UTI and Religare. Industry experts peg the total holding of gold with six of the
exchange-traded funds as of end-February at around 9-tonne, with Benchmark’s holding alone at around
4.5 tonne.

There has been a perceptible shift from buying bars and coins to investing in gold
ETFs. While the consumption of gold has been on the decline, investment into
gold ETFs has been going up steadily.

Globally, some gold ETFs buy and physically hold gold bars while others invest in
futures contracts. Physically-backed gold ETFs track the spot price of gold more
accurately, since the value of the underlying holdings depends solely on the
market price of bullion.

The exchange has also waived transaction charges for all trades in ETFs based on money market
instruments. Currently, Liquid BeES (Liquid Benchmark Exchange Traded Scheme) is the only money
market ETF listed on the NSE. It invests in a basket of call money, short-term government securities and
money market instruments of short and medium maturities.

It is settled on a T+2 rolling basis. Benchmark is

awaiting the green signal from capital market regulator
Sebi to launch the first-ever Gilt ETF on NSE.
 Breathing Deep
4.0 FINANCIAL SECTOR: TRANSFORMING TOMORROW
Breathing Deep

The financial sector received considerable attention in Budget 2010. The most
significant aspect from a broader economic context – but that also has a material
bearing on the financial sector – was the government’s stance on budget deficit.

In the context of spiralling fiscal deficits run by governments in mature

economies and mounting levels of government debt as a proportion of GDP in
those economies, India had to seize the moment as well as the economic
momentum that it is experiencing to rein in deficits and present a differentiated level of financial
discipline that would sustain the confidence of investors and lenders to continue funding India’s growth.
The Budget addresses this concern satisfactorily.

4.1 FINANCIAL ADVISORS:

Weigh impact on investors: What budget holds out for financial services?

Fiscal Reform

Borrowing programme: At Rs 3.8-lakh crore, the government’s borrowing programme for next year is
pegged at levels below that for the current year. This should allay concerns of investments being crowded
out by government borrowings along with adverse inflationary and interest rate expectations.

Deficit levels and government debt: By committing to progressively contain deficit levels and bring
government debt down to 68% of GDP over the next few years consistent with the 13th Finance
Commission recommendations, and to bring out a paper on how this will be done in 6-months, the
government sets out an agenda for fiscal reform.

Disinvestments: At Rs 40,000 crore, the government’s target for raising funds from disinvestments
represents about 80% of funds raised from capital markets during 2009. This will permit investment
banks to bolster their credentials, and, if successful, ensure that the capital markets will see a substantial
supply of equity paper.

Funding of the infrastructure sector: The India Infrastructure Finance Co (IIFCL) is expected to increase
its funding of the infrastructure sector. Importantly, from a banking sector perspective, the FM expects
IIFCL to develop a framework under which it will ‘take out’ financing extended by commercial banks to
infrastructure projects; a working arrangement , if devised, would permit commercial banks to lend to
infrastructure projects without creating material asset-liability mismatches.

Government ownership in public sector banks: Tier-I capital of public sector banks is sought to be shored
up to 8% by the end of next year, with the government injecting Rs 16,500 crore of additional equity.
Working on an average government ownership in public sector banks at 60%, this would imply that the
markets will see follow-on public offers for Rs 11,000 crore from this segment of the banking sector.

Banking licences to private sector: While details are limited, the FM indicated that banking licences will
be issued to private sector organisations, including NBFCs. Yes Bank was the last private bank to be
granted a licence, and that was over five years ago. Given the conservative stance of the RBI on bank
licensing, the number of private banks in the country is unlikely to swell materially in a hurry.
 Breathing Deep

Overhaul of outdated legislation: An overhaul of outdated legislation governing the financial sector is
proposed to be undertaken by the Financial Sector Legislative Reforms Commission. India’s insurance
legislation dates back to 1938, the Securities Contracts Regulation Act was enacted in 1956, and the
Banking Regulation Act was introduced in 1949.

Also, there are provisions relating to the financial sector contained in the Companies Act and the Income-
Tax Act, all of which could do with a review to make provisions contemporary. A proposal to amend the
permitted level of foreign ownership in insurance companies has been with the government for several
years, as have proposals to amend many provisions in the Banking Regulations Act. One can only hope
that the reforms commission’s efforts meet greater success.

Financial Stability and Development Council: The government proposes to establish a Financial Stability
and Development Council to monitor macro prudential supervision of the economy. The council, intended
to strengthen and institutionalise the mechanism for maintaining financial stability, is meant to operate
without derogating powers of existing regulators.

Tax proposals: Specific tax proposals did little for the financial services sector. However, a proposal to
subject transactions in securities between unrelated parties to a fair market value test has the potential to
become a nuisance for such transactions. Although being introduced to plug abusive transactions, the
absence of safe harbours in the broadly-worded provisions could have unintended consequences. Beyond
this, the financial services sector will need to await the Direct Taxes Code and the Goods and Services
Act, both of which are intended to be introduced effective April 1, 2011.

In summary, Budget 2010 contains a combination of near-term actions and policy initiatives that could
take longer to implement. As always, actual action will count for more than announced intentions.

4.2 WEALTH MANAGERS

Map out the details to translate into benefits:

Fiscal stimulus

Fiscal stimulus in the Keynesian framework consists of extreme affirmative

government action through the Budget to boost economic activity. Traditionally,
this concept would refer to increasing fiscal deficits wherein the government
spends, through high borrowings or printing of currency, to provide purchasing
power to the people so that demand is sustained. Therefore, the pre-requisite of a
fiscal stimulus is a high fiscal deficit. Such deficits are brought about by either
higher expenditure or lower tax rates. In India, stimulus exhibited big increase in
fiscal deficit by 166% in 2008-09. Subsequently, the increase in 2009-10 was
moderate at 23% and has been largely withdrawn in 2010-11.

The interesting observation is that the total expenditure had actually increased sharply before the financial
crisis in 2007-08, when the deficit was at 2.7% of GDP. The increase in 2008-09 was actually more due to
higher inflation. Even in case of nominal expenditure, the increase in 2008-09 was on revenue account –
the typical Keynesian variety of NREGA, where income was provided for the poor to spend money and
got reflected in Plan expenditure. But the government did not spend on projects as seen in the decline in
capital expenditure in 2008-09, which was subsequently brought back to the 2007-08 level in 2009-10.
 Breathing Deep

The view evidently was the short run where the thrust was on reviving consumption by addressing issues
of poverty. Further, the government spent more on the three critical components of non-development
expenditure, i.e., subsidies, interest and defence, in 2008-09. However, subsidies were just about
maintained in 2009-10 at 2008-09 level. The conclusion is that there was nominal increase in expenditure
in 2008-09 and 2009-10, and a gradual withdrawal in 2010-11.

How effective were these expenditures? It must be realised that the country’s GDP growth had slid to
6.7% in 2008-09 from two successive years of over 9%. This was so as both, growth in private
consumption expenditure and capital formation, had slowed down to 6.8% and 4.0% respectively in 2008-
09 from 9.6% and 16.9% in 2007-08. Further, in 2009-10, growth in consumption and capital formation
was tardy at 4.1% and 5.2%.

The higher spending invoked by the government, gets reflected in the social services and government
administration component of GDP, displayed a high growth rate of 13.9% in 2008-09 and 8.2% in 2009-
10. This was a classic Keynesian stimulus of higher government expenditure compensating for the loss of
demand generated by the private sector. However, government expenditure of the non-projects variety
cannot lead to sustained growth and can, at best, compensate for any shortfall in private sector activity.

How has the private sector been affected by the Budget? The government has taken a major hit in its
tax collection in 2008-09 and 2009-10 by reduction in excise and Customs duty rates. Indirect tax
collections declined in the two crisis years and the effective tax rates have come down quite drastically by
3.7% in the case of Customs and 5.6% for excise duties. This was the stimulus provided on the production
side to industry in particular that will be reversed in the coming year.

What are the takeaways from this analysis? The first is that the expenditure was directed not at
creating capital but more at providing relief to the poor. The second was that it helped to compensate
tardy growth in private consumption and capital formation. Third, the lowering of tax rates provided an
impetus for sure. Therefore, it was Keynes at both the ends.

4.3 FINANCIAL PLANNERS

Value unlocking for all stakeholders: The dangers of deficit reduction

Deficit reduction

A wave of fiscal austerity is rushing over Europe and America. The magnitude of
budget deficits – like the magnitude of the downturn – has taken many by
surprise. But despite protests by the yesterday’s proponents of deregulation, who
would like the government to remain passive, most economists believe that
government spending has made a difference, helping avert another Great
Depression. Most economists also agree that it is a mistake to look at only one
side of a balance sheet (whether for the public or private sector).

One has to look not only at what a country or firm owes, but also at its assets. This should help answer
those financial sector hawks, who are raising alarms about government spending. After all, even deficit
hawks acknowledge that we should be focusing not on today’s deficit, but on the long-term national debt.
Spending, especially on investments in education, technology, and infrastructure, can actually lead to
lower long-term deficits. Faster growth and returns on public investment yield higher tax revenues, and a
5% to 6% return is more than enough to offset temporary increases in the national debt.
 Breathing Deep

A social cost-benefit analysis (taking into account impacts other than on the budget) makes such
expenditures, even when debt-financed, even more attractive.

Finally, most economists agree that, apart from these considerations, the appropriate size of a deficit
depends in part on the state of the economy. A weaker economy calls for a larger deficit, and the
appropriate size of the deficit in the face of a recession depends on the precise circumstances. Forecasting
is always difficult, but especially so in troubled times. What has happened is (fortunately) not an everyday
occurrence; it would be foolish to look at past recoveries to predict this one.

In America, for instance, bad debt and foreclosures are at levels not seen for three-quarters of a century;
the decline in credit in 2009 was the largest since 1942. Comparisons to the Great Depression are also
deceptive, because the economy today is so different in so many ways. And nearly all experts have proven
highly fallible - witness the U.S. Federal Reserve’s dismal forecasting record before the crisis.

Yet, even with large deficits, economic growth in the US and Europe is anaemic, and forecasts of private-
sector growth suggest that in the absence of continued government support, there is risk of continued
stagnation - of growth too weak to return unemployment to normal levels anytime soon.

The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, of
course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a
premature “exit” from deficit spending risks pushing the economy back into recession. This is one of the
lessons we should have learnt from America’s experience in the Great Depression; it is also one of the
lessons to emerge from Japan’s experience in the late 1990s.

These points are particularly germane for the hardest-hit economies. The UK, for example, has had a
harder time than other countries for an obvious reason: it had a real-estate bubble (though of less
consequence than in Spain), and finance, which was at the epicentre of the crisis, played a more important
role in its economy than it does in other countries. The UK’s weaker performance is not the result of
worse policies; indeed, compared to the US, its bank bailouts and labour-market policies were, in many
ways, far better. It avoided the massive waste of human resources associated with high unemployment in
America, where almost one out of five people who would like a full-time job cannot find one.

As the global economy returns to growth, governments should, of course, have plans on the drawing
board to raise taxes and cut expenditures. Principles like “it is better to tax bad things than good things”
might suggest imposing environmental taxes. The financial sector has imposed huge externalities on the
rest of society. America’s financial industry polluted the world with toxic mortgages, and, in line with the
well established “polluter pays” principle, taxes should be imposed on it. Besides, well-designed taxes on
the financial sector might help alleviate problems caused by excessive leverage and banks that are too big
to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their
key societal role of providing credit.

Over the longer term, most economists agree that governments, especially in advanced industrial
countries with ageing populations, should be concerned about the sustainability of their policies. But we
must be wary of deficit fetishism. Deficits to finance wars or giveaways to the financial sector (as
happened on a massive scale in the US) lead to liabilities without corresponding assets, imposing a burden
on future generations. But high-return public investments that more than pay for themselves can actually
improve the wellbeing of future generations. These are questions for a later day - at least in many
countries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear:
reducing government spending is a risk not worth taking.
 Breathing Deep
4.4 INCLUSIVE CEOs
Innovative responses to problems: fewer bangs for US stimulus buck

Counter-cyclical policy

The run-up to the economic crisis in the United States was

characterised by excessive leverage in financial institutions and the
household sector, inflating an asset bubble that eventually collapsed
and left balance sheets damaged to varying degrees. The aftermath
involves resetting asset values, deleveraging, and rehabilitating balance
sheets – resulting in today's higher saving rate, significant shortfall in
domestic demand, and sharp up tick in unemployment.

So the most important question the US now faces is whether continued fiscal and monetary stimulus can,
as some believe, help to right the economy. To be sure, at the height of the crisis, the combined effect of
fiscal stimulus and massive monetary easing had a big impact in preventing a credit freeze and limiting
the downward spiral in asset prices and real economic activity. But that period is over.

The reason is simple: the pre-crisis period of consuming capital gains that turned out to be at least partly
ephemeral inevitably led to a post-crisis period of inhibited spending, diminished demand, and higher
unemployment. Counter-cyclical policy can moderate these negative effects, but it cannot undo the
damage or accelerate the recovery beyond fairly strict limits.

As a result, the benefits associated with deficit-financed boosts to household income are now being
diminished by the propensity to save and rebuild net worth. On the business side, investment and
employment follows demand once the inventory cycle has run its course. Until demand returns, business
will remain in a cost-cutting mode.

The bottom line is that deficit spending is now fighting a losing battle with an
economy that is deleveraging and restructuring its balance sheets, its exports, and
its microeconomic composition – in short, its future growth potential. That
restructuring will occur, deficit spending or no deficit spending.

So policy needs to acknowledge the fact that there are limits to how fast this
restructuring can be accomplished. Attempting to exceed these speed limits not
only risks damaging the fiscal balance and the dollar's stability and resilience, but
also may leave the economy and government finances highly vulnerable to future
shocks that outweigh the quite modest short-term benefits of accelerated
investment and employment. Demand will revive, but only slowly.

True, asset prices have recovered enough to help balance sheets, but probably not enough to help
consumption. The impact on consumption will largely have to wait until balance sheets, for both
households and businesses, are more fully repaired.

Higher foreign demand from today's trade-surplus countries (China, Germany, and Japan, among others)
could help restore some of the missing demand. But that involves structural change in those economies as
well, and thus will take time. Moreover, responding to expanded foreign demand will require structural
changes in the US economy, which will also take time.
 Breathing Deep

This is not to say that rebalancing global demand is unimportant. Quite the contrary. But achieving that
goal has more to do with restoring the underpinnings of global growth over three-to-five years than it does
with a short-term restoration of balance and employment in the advanced economies, especially the US.

Today, the best way to use deficits and government debt is to focus
on distributional issues, particularly the unemployed, both actual and
potential. In an extended balance-sheet recession of this type,
unemployment benefits need to be substantial and prolonged. The
argument that this would discourage the unemployed from seeking
work has merit in normal times, but not now. Today's unemployment,
after all, is structural, rather than the result of perverse incentives.
Benefits should be expanded and extended for a limited, discretionary
period. When structural barriers to employment have diminished, unemployment benefits should revert to
their old norms. Doing this would not only reduce the unequal burden now being carried by the
unemployed; it would also help to sustain consumption, and perhaps reduce some precautionary savings
among those who fear losing their jobs in the future.

Monetary policy is a more complex and difficult balancing act. A

more aggressive interest-rate policy would likely reduce asset prices
(or at least slow the rate of appreciation), increase adjustable-rate
debt-service burdens, and trigger additional balance-sheet distress and
disorderly deleveraging, such as foreclosures. All of this would slow
the recovery, perhaps even causing it to stall. But there are
consequences to abjuring this approach as well. Low-cost credit is
unlikely to have a significant impact on consumption in the short run,
but it can produce asset inflation and misallocations.

Much of the rest of the world would prefer a stronger dollar, fewer capital inflows with a carry-trade
flavour, and less need to manage their own currencies' appreciation to avoid adverse consequences for
their economies' competitiveness. In short, the sort of monetary policy now being practised for a fragile
economy like the US will cause distortions in the global economy that require policy responses in many
other countries.

From a political point of view, the crisis has been portrayed as a

failure of financial regulation, with irresponsible lending fuelling a
rapid rise in systemic risk. That leaves the rest of the real economy
populated with people who feel like victims – albeit victims who,
prior to the crisis, bought a lot of houses, vacations, TVs, and cars.

Unfortunately, that perception pushes the policy response in the

direction of too much remedial action, even when the marginal returns
are low. What we most need now is support for the unemployed,
stable government finances with a clearly communicated deficit-reduction plan, some truth-telling about
medium-term growth prospects, and an orderly healing process in which balance sheets are restored
mostly without government intervention.
 Breathing Deep
4.5 ONE-STOP-SHOPS
Dedicated to offer related services under a roof;

Careful with lessons

Trade unions are confusing financial markets with free markets. The
financial crisis has shown that free markets and free trade cannot correct
themselves. The International Trade Union Federation saying, “We
warned business and politicians of dangerous instability in the global
economy. Business and governments created this crisis on their own, but
they won’t be able to solve it unless they work with unions to stop the
global jobs haemorrhage, kick start the world economy and put a proper
regulatory framework in place.”

Trade union prescriptions confuse financial markets with free markets

and mirror image the error of market fundamentalist in recommending
that the state should substitute for markets or reduce their volatility. This misunderstands the sources of
prosperity and job creation.

Finance is valuable, and drunk driving is not an argument against cars. The debate is whether central
banks should lean into asset bubbles. But even if they should, how does a central bank know when?

Professor Robert Lucas at the University of Chicago quips that “if an economist had a formula that could
reliably forecast crises a week in advance, then the prices would fall a week earlier.

The problems of modern finance are not an argument against the 200-year spectacular track record of free
markets and entrepreneurship in poverty reduction. The modern free market economies are now 20 times
better off than the 1800 AD average. Even in India, more people have been brought out of poverty since
we stopped asphyxiating markets 18 years ago than the four decades before that; the Planning
Commission’s recent proposal to redefine poverty reinforce that garibi hatao needs amiri banao.

At best, the crisis validates distinction between good entrepreneurship – which creates jobs, innovation,
wealth, etc – and bad entrepreneurship – financial engineering, money from money, etc. But should we
create regulatory mechanisms that act as an antibiotic to these ‘animal spirits’ and force people to live life
at the mean? Entrepreneurs, by definition, have dreams larger than wallets. High tide allows them to
challenge incumbents by opening windows where belonging to the lucky sperm club is not as important
as the courage in your heart, the strength of your back and or the sweat of your brow.

Behavioural Economics professor Dan Ariely says, “A society in which no one is overly optimistic and no
one takes too much risk wouldn’t advance. There is utility in over optimism; Individuals often suffer
because of an overly bright outlook and end up dead, poor or bankrupt because they underestimated the
downside. But society as whole often benefits from behaviour spurred by upbeat outlooks. So, being
highly positive can lead to disaster for individuals but benefit society as a whole.”

The magnificent ruins at Halibut in Karnataka have three animal carvings holding up the building;
elephants for stability, horses for speed and lions for courage. Wise societies need all three. India has just
begun a Cambrian explosion that is making a million statistically independent tries in creating jobs and
companies. It would be a tragedy if the global financial crisis becomes an alibi for trade unions to
sabotage our march of entrepreneurship and poverty reduction.
 Breathing Deep
4.6 CREDIT COUNSELORS
Resolve convertibility and recompensation issue:

Expose the fallacy of specious arguments

It is a little over two years to the day investment bank Bear Stearns collapsed,
triggering one of the most painful economic recessions the world has witnessed
since the Great Depression. A great many lessons have been learnt though the
learning process is not yet complete in many areas: the need to rein in rating
agencies, clean up the regulatory mess in the US, rejig capital adequacy norms,
address underlying macro-economic imbalances and so on.

But what is truly amazing is how quickly some of the lessons of history are
being unlearnt in the search for ways to deal with the fallout of the emergency
measures taken earlier to keep the global economy afloat. The most egregious of these is contained in a
recent International Monetary Fund (IMF) paper co-authored by Olivier Blanchard, Giovanni Dell’
Ariccia and Paolo Mauro.

Amazingly, the paper argues that a higher inflation rate would have given monetary authorities more
leeway to cut interest rates during the crisis. A low and stable rate of inflation in the range of 1-2% in
most of the developed world during the pre-crisis years meant monetary authorities could at best bring
real interest rates down to –1% or –2% even if they cut nominal rates to zero.

Had inflation been higher, say 3-5%, the effect of a zero nominal rate of interest would have been a much
higher negative rate of interest and, hence, it would have been possible to give an even bigger push to
economic activity, say the trio.

‘Had (central banks) been able to, they would have decreased the rate further... But the zero nominal
interest rate bound prevented them from doing so.’

The paper adds, ‘It is clear that the zero nominal interest rate bound has proven costly. Higher average
inflation and thus higher nominal interest rates to start with, would have made it possible to cut interest
rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions.’

Had the suggestion come from any other organisation, it would have been dismissed out of hand. But
when it comes from the IMF, even if it is a vastly discredited IMF, there is the very real danger that many
governments, faced with a looming debt burden, may find it a seductive argument to justify a higher rate
of inflation. And there lies the danger. It would destroy the hard-won gains from the battle against
inflation in the 1980s that laid the foundation for the subsequent period of prolonged growth. Worse, it
would penalise the savers at the cost of borrowers, including the biggest borrower of all, governments.

Clearly most of the Western world has had such a long period of low and stable inflation that memories of
the hard-won battle against inflation have been all but forgotten, save in Germany, where the worst
ravages were felt in the post-war years. Such a lapse might have been forgiven had the argument come
from lay folk; but when you have people who are supposed to be experts making such specious
arguments, it is time for the rest of the world to expose the fallacy of their argument.

After all, once this view is allowed to gain ground, what is to stop its proponents from taking the next step
and arguing that well, even 4% inflation is too low, we need 10%, because then the next time there is a
crisis, we can get real interest rates down to –10%?
 Breathing Deep
4.7 RISK MANAGEMENT CONSULTANTS
Educate – Engineer and Enforce:

Overhaul the way of staffing in regulatory agencies

Lehman Brothers’ bankruptcy examiner released a report showing that the

investment firm went to great lengths to hide its shaky finances. In fact, it
even managed to evade a team of investigators from the Securities and
Exchange Commission and the Federal Reserve who were embedded at
Lehman headquarters with the sole purpose of ferreting out accounting
sleight-of-hand.

How could they miss it? It’s possible that someone convinced them to look the other way. But it’s more
likely that they weren’t qualified to be there in the first place.

Indeed, as Congress debates financial reform, it is ignoring the obvious Achilles’ heel in any new
regulatory scheme: the inability of regulatory agencies to enforce and put in place the new rules, thanks in
large part to their failure to recruit, train and retain effective staff.

That’s why, alongside thorough reform, we need to overhaul the way regulatory agencies are staffed. It’s
true that some agencies, including the SEC, have already taken small steps to raise pay, add a few training
courses and recruit industry professionals on temporary contracts. But as long as the agencies are plagued
by high turnover rates, increasing their training budgets. So, the key is retention. Federal agencies can
never match private-sector salaries, and so the incentives need to come in other forms.

Fortunately, there’s a well-established model: the Foreign Service, which is set up to build career
professionals, not to be a way station for future law firm partners. It has a specialised training institute,
early pension eligibility and a separate career system that places officers on long-term job tracks tied to
specific diplomatic disciplines. Like Foreign Service officers, financial regulation service officers should
receive long-term training in professional tracks like consumer protection, systemic risk and examinations
and investigations, and they should accumulate progressive responsibility within specialised fields. Most
important, they should become eligible for a pension after as little as 20 years on the job.

By managing the career progression and development of a stable pool of rising professionals, regulatory
agencies would also be able to identify and plan for future needs, rather than merely plug gaps as they
occur. A specialized cadre of federal regulators should also reflect a diversity of backgrounds. An
important weakness of the SEC has been its over-reliance on inexperienced lawyers, often straight out of
school, to conduct investigations and other core tasks – a notion contrary to the practices of more highly
regarded investigative agencies like the F.B.I., which draws on a range of professions and experience
levels to fill its ranks of special agents.

This reliance on inexpensive but inexperienced staffers has deprived the commission of crucial private-
sector expertise and other critical skills; the result is an insulated and often gullible investigative team. Is
it any wonder the bankruptcy examiner says that Lehman was able to dupe federal regulators?

An important benefit of similar federal training institutes has been the establishment of lasting ties among
attendees, as well as the cross-pollination of experience among colleagues from different agencies. A
financial regulation service and associated institute would be neither radical nor prohibitively costly
compared to the new agencies and other proposals already being considered. And they would be a lot
cheaper than another financial crisis.
 Breathing Deep
4.8 MICRO-FINANCE PROFESSIONALS
Developing alternative credit delivery models:

Weakness in Governance

In his Budget speech, finance minister Pranab Mukherjee noted three

challenges. The first, widely noted and highly praised by corporate India,
concerned finding means to cross the ‘double-digit growth barrier’. The second,
less glamorous and hence less discussed, is in harnessing economic growth to
make development more inclusive. The third, which attracted little notice,
relates to ‘weaknesses in government systems/structures/institutions’ that he
recognised as a ‘bottleneck of our public delivery mechanisms’.

The Budget is not really the vehicle to address the last concern. However, it is noteworthy that with
regard to governance too, the Budget had two significant initiatives. The first is the creation of a
technology advisory group for unique projects, which will handle technological and systemic issues
connected with various IT projects of the finance ministry. The second is an independent evaluation
office, which will evaluate the impact of flagship programmes. The minister also mentioned progress
regarding implementation of the Administrative Reforms Commission’s recommendations.

Yet, he looked on these as measures to support transparency and accountability, rather than steps to
radically change systems and structures of implementation. The fact is that without radical improvements
in governance, delivery of public goods will be inadequate, inefficient and ineffective. So far, the
government has sought to increase the impact by pumping in disproportionate amounts of money. Even
this often does not work. Marginal improvement at best in outcomes can be brought about by pumping in
more money into the rusted and leaky pipeline, but beyond a point, the leak will only haemorrhage further
and there will be decreasing returns.

There are many examples of dysfunctional government structures and inefficient processes. A recent one
is the launch of 3G telecom services. Where we had a chance to leapfrog into a global leadership position,
the delay in allocation has put us behind by many years. All this because of wrangling within and between
ministries, possibly instigated by vested commercial interests. Rather than such an ad hoc mechanism, it’s
time to institutionalise a permanent way to deal with these matters.

There is also an urgent need for new systems, structures and professionalism especially in the social
sector, now receiving very large funding. This Budget has provided massive allocations for rural
employment, education and rural infrastructure. Managing these schemes efficiently is going to be key to
whether development is truly inclusive or whether we become a schizophrenic society with unsustainable
inequities. Yet, there is little attention on the appropriate people, systems or organisational forms.

Private-public partnership is often a good solution, but is not always the best solution – especially because
it is increasingly interpreted as privatisation through the back door. A genuine partnership would use the
domain expertise of the government organisations in areas like education and rural development. In
addition, it is necessary to tap civil society organisations to understand user needs. This would mean
evolving new systems that permit local variations and responsiveness to specific needs, in place of the
present bureaucratic and rigid one-size-fits-all framework. A pilot project in one state would prove the
efficacy or otherwise of this approach. This could be a path-breaking initiative that could synergise rural
employment guarantees with skills development and social entrepreneurship and provides a flying start to
the National Rural Livelihoods Mission.
 Breathing Deep
4.9 TECH SAVVY PROFESSIONALS
Take first step to ensure efficient and reliable system:

The Next Greece

Is Spain the next Greece? Or Italy? Or Portugal? Even as Greece pledged

anew on Mar 3, 2010 to rein in its runaway budget deficit, briefly easing
the anxiety over its perilous finances, traders on both sides of the Atlantic
weighed the risks – and potential rewards – posed by the groaning debts
of other European governments. While investors welcomed news that
Athens would raise taxes and cut spending by $6.5 billion this year,
analysts warned the moves might not be enough to avert a bailout for
Greece or to contain the crisis shaking Europe and its common currency, the euro.

Indeed, some banks and hedge funds have already begun to turn their attention to other indebted nations,
particularly Portugal, Spain, Italy and, to a lesser degree, Ireland. The role of such traders has become
increasingly controversial in Europe and the US. The Justice Department’s anti-trust division is now
examining whether at least four hedge funds colluded on a bet against the euro last month.

Jim Caron, global head of interest rate strategy at Morgan Stanley said, “If the problems of Greece aren’t
addressed now, there is a risk the market will focus on the next weakest link in the chain.” Whatever the
outcome in Athens, the debt crisis in Europe threatens to tip the financial, as well as political, balance of
power across the continent. With Germany and France emerging as the most likely rescuers, leaders in
Berlin and Paris could end up dictating fiscal policy in Portugal, Ireland, Italy, Greece and Spain.

And in the months ahead, fears about the growing debt burden elsewhere in Europe are likely to return,
according to investors and strategists. That is particularly worrying given that Western European
countries must raise more than half a trillion dollars this year to refinance existing debts and cover their
widening budget gaps. The way fear can spread from capital to capital reminds Jim Caron of how the
American financial crisis played out. He said, “What people are doing in the markets is no different from
what they did with the banks. First, it was Bear Sterns, then it was Lehman Brothers and so on. That’s
what people are worried about.”

Spain: The most vulnerable country after Greece, some analysts say, is Spain, which has been mired in a
deep recession. Facing an unemployment rate of 20%, a budget gap of more than 10% of GDP and an
economy expected to shrink by 0.4% this year. Madrid has little wiggle room if investors shun an
expected E85 billion in new bond offering this year.

Portugal: Spain’s neighbour Portugal is also vulnerable. Large budget and trade deficits, combined with a
shortage of domestic savings, leave Portugal dependent on foreign investors. And, as in Greece, there may
be little political will to slash spending or raise taxes.

That’s in sharp contrast to Ireland, which had been a source of anxiety last year. New austerity measures,
including a government hiring freeze and public sector wage cut, have put it in a stronger position as it
raises E19 billion this year.

The Italian government is also heavily indebted – it has more than $2trillion in total exposure – but it is
also in a slightly stronger position than Spain or Portugal because its economy is expected to grow by
0.9% this year and 1.0% next year. In addition, its budget is not as far out of whack, with the deficit this
year expected to equal 5.4% of GDP.
 Breathing Deep
4.10 CONTINUING LEARNING CENTRES
Take informed decisions:

After the boom, where does growth come from now?

Spain and other countries on Europe’s financially stricken fringe are groping
for a new basis from economic growth to put people to work and pay down
crushing deficits and debts. The question is especially urgent in countries with
the eurozone’s messiest public finances: Spain, Portugal, Ireland, and Greece.
Headlines have focused on Europe’s government finance crisis and the troubles
in Greece, where heavy debt equal to 123% of the entire economy fuels fears
of default and drives up borrowing costs. High debt levels there and in Portugal
and Ireland have undermined the euro and threatened other indebted
governments with similar troubles. Spain, with an unemployment rate of 19%, has less debt but a big
deficit and a shaky growth outlook.

Their governments are slashing spending and raising taxes. But ultimately, to pay down those debts, erase
the deficits and end the debt crisis, more growth will be needed. The job of finding growth will be even
harder than usual because governments are being pushed by the European Union to cut spending and raise
taxes to pay down debt, removing stimulus from government spending. And because they use the euro
these countries can no longer devalue their currencies, a quick safety valve in times past.

Europe’s core, Germany and France, know the way already. They have large, well established industrial
sectors making high-value goods for export: industrial equipment maker Siemens AG and aerospace firm
EADS NV, automakers Volkswagen AG, Porsche, BMW, Renault SA, and Peugeot Citroen.
Governments on the periphery, by contrast, are suddenly having to take up proposals to make their
economies more productive. Those include sending more people to college and cutting the red tape that
makes businesses take investment elsewhere issues forgotten during the boom.

Answers are slow in coming. Some of these adjustments will be sort of longer term in nature. For some
economies there won’t be any quick fixes. The Irish government’s strategy is to create high-tech hubs
boosted by alliances with universities and low tax rates. Greece is aiming for a three-pronged approach,
focusing investment in renewable energy sources and attracting investment by simplifying the country’s
notorious bureaucracy. It also focuses on boosting shipping and tourism, two major sectors for Greece.

Portugal’s Socialist government that took power in 2005 is pushing for modernisation and innovation -
developing renewable energy, electric cars, a national fibre optic network, and getting more students
enrolled at university. It also plans a new Lisbon airport and bullet train to Spain.

In Spain, the Socialist government of Prime Minister Jose Luis Rodriguez Zapatero has proposed a wide-
ranging Sustainable Economy Law designed to wean the country off construction. Among a slew of other
measures, it would provide loans and clear away red tape for people hoping to start up businesses and
provide bigger tax breaks for research and development.

But critics have called it a vague grab bag that fails to address critical issues such as improving education
to turn out world-class graduates more suited for innovation and loosening up the labour market to
encourage business to hire. IE Business School’s Pampillon said this kind of reform should have been
done back when times were good, but governments basking in tax revenue and relatively low
unemployment could not be bothered.
 Breathing Deep
4.11 Global OUTLOOK
Take notice from global events:

China’s hidden debt risks 2012 crisis

China’s hidden borrowing may push government debt to 96% of GDP next
year, increasing the risk of a financial crisis in the world’s third-biggest
economy. Professor Victor Shih a political economist at Northwestern
University, who spent months researching borrowing transactions by about
8,000 local-government entities said, “The worst case is a pretty large-scale
financial crisis around 2012”.

The slowdown would last at least two years and maybe longer. Surging
borrowing by local-government entities, uncounted in official estimates of
China’s debt-to-GDP ratio, is the key reason for Shih’s concern. A debt-fuelled
bubble in China may trigger a regional recession. Hedge-fund manager James
Chanos has predicted a Chinese slump after excessive property investment.

By Shih’s count, China’s debt may reach 39.838 trillion yuan ($5.8 trillion) next year. Chinese officials
allowed lending to explode from late 2008 to fight off the effects of the global financial crisis. In 2009,
new loans rose to a record 9.59 trillion yuan ($1.4 trillion).

Asset Bubbles: Now, amid the risks of asset bubbles, soured loans and resurgent inflation, officials are
reining in credit growth. One focus of concern is lending to the investment companies set up by local
governments to circumvent regulations that prevent them borrowing directly. Shih estimates that, already,
borrowing by such entities may result in bad loans of up to 3 trillion yuan ($439 billion).

China’s banking regulator has ordered lenders to review loans granted to local governments’ financing
vehicles and ensure they can be repaid. The China Banking Regulatory Commission is concerned that a
few cities and counties may face very large repayment pressures in coming years because of debt ratios
already exceeding 400%. The ratio is of year-end outstanding debt to annual disposable fiscal income.

‘Wave’ of Bad Loans: Local-government entities may have had a total of 11.429 trillion yuan in
outstanding debt by the end of last year, according to Shih. They have agreed credit lines with banks for
an additional 12.767 trillion yuan. A crackdown on local-government borrowing could trigger a “gigantic
wave” of bad loans as projects are left without funding, while a failure to rein in lending could lead to
inflation of over 15% by 2012. Either situation could trigger bank runs and a crisis as people lose
confidence in the financial system.

China’s banking regulator is concerned that some local governments’ financing vehicles have used loans
to pay taxes or buy property or shares, used money for purposes not approved by banks, or put cash into
projects with no capital, cash flow or guarantees. The regulator has urged banks to stop lending to projects
that are only guaranteed by local governments and wants loans to industries with overcapacity to be
repaid as soon as possible, the person said.

Shih arrived at his debt estimate after sifting through reports from more than 1,000 sources including
regulatory filings, bond rating agencies, local-government Web sites and newspapers. Besides adding
local-government debt, he included bad loans in state-owned banks and liabilities held by development
banks, asset-management companies and the Ministry of Railways.
 Breathing Deep
4.12 ISSUES OF THE PRESENT
Freedom to get & fail in the system of free enterprise
Time to Take On China's Currency Manipulations: Paul Krugman

Tensions are rising over Chinese economic policy, and rightly so: China’s
policy of keeping its currency, the renminbi, undervalued has become a
significant drag on global economic recovery. Something must be done.
To give you a sense of the problem: Widespread complaints that China
was manipulating its currency – selling renminbi and buying foreign
currencies, so as to keep the renminbi weak and China’s exports
artificially competitive – began around 2003. At that point China was
adding about $10 billion a month to its reserves, and in 2003 it ran an
overall surplus on its current account – a broad measure of the trade balance – of $46 billion. Today,
China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. The International
Monetary Fund expects China to have a 2010 current surplus of more than $450 billion – 10 times the
2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.

And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are
stuck in a liquidity trap – deeply depressed, but unable to generate a recovery by cutting interest rates
because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in
effect imposing an anti-stimulus on these economies, which they can’t offset.

So how should we respond? First of all, the US Treasury Department must stop fudging and obfuscating.
Twice a year, by law, Treasury must issue a report identifying nations that “manipulate the rate of
exchange between their currency and the United States dollar for purposes of preventing effective balance
of payments adjustments or gaining unfair competitive advantage in international trade.” The law’s intent
is clear: the report should be a factual determination, not a policy statement.

Will the next report, due April 15, continue this tradition? Stay tuned. If Treasury does find Chinese
currency manipulation, then what? Here, we have to get past a common misunderstanding: the view that
the Chinese have us over a barrel, because we don’t dare provoke China into dumping its dollar assets.
It’s true that if China dumped its US assets the value of the dollar would fall against other major
currencies, such as the euro. But that would be a good thing for the United States, since it would make our
goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for
China, which would suffer large losses on its dollar holdings. In short, right now America has China over
a barrel, not the other way around. So we have no reason to fear China. But what should we do?

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with
China for years, as its surplus ballooned, and gotten nowhere: recently Wen Jiabao, the Chinese prime
minister, declared – absurdly – that his nation’s currency is not undervalued. And Wen accused other
nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of
increasing their own exports.” But if sweet reason won’t work, what’s the alternative?

In 1971, the US dealt with a similar but much less severe problem of foreign undervaluation by imposing
a temporary 10% surcharge on imports, which was removed a few months later after Germany, Japan and
other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its
policies unless faced with the threat of similar action – except that this time the surcharge would have to
be much larger, say 25%. I don’t propose this turn to policy hardball lightly. But Chinese currency policy
is adding materially to the world’s economic problems at a time when those problems are already very
severe. It’s time to take a stand.
 Breathing Deep
5.0 BANKING SECTOR
New Banks, Old Lessons

Banking is a licensed activity the world over with regulators free to decide who is ‘fit and
proper’. Even in lightly regulated markets like the US, the entry of industrial houses in
banking business is frowned upon. The best institutional safeguard is to leave decision-
making to a competent panel with members of proven integrity. Ever since finance minister,
Pranab Mukherjee announced in his Budget speech that the RBI might be open to granting
banking licences to new private sector players, markets have been agog with excitement. Yet it is not as
though the FM’s statement per se signals any change in status quo. The RBI has never formally declared
it will not entertain fresh applications for banks licences. Nor has it ever suggested there would be any
dilution of its existing criteria on the subject.

On the contrary! As the RBI’s Deputy Governor was quick to clarify in a press conference soon after the
Budget, ‘The basic principles of ownership and governance remain unchanged. They are sacrosanct. All
the principles of ownership and governance will be taken into account while evolving the new
guidelines’. She also repeated a phrase, beloved of banking sector regulators the world over in the context
of ownership and control of banks: ‘fit and proper’.

The reality is banking is a licensed activity everywhere in the world. Even in a lightly regulated market
like the US neither GE nor Wal-mart has been given a branch banking licence. And it is not for want of
trying! Indeed one of the key tenets of the RBI’s policy that it shares with many other regulators is that
new banks should not be promoted by large industrial houses. While individual companies, directly or
indirectly connected with large industrial houses, may be permitted to take a stake up to a maximum of
10%, they will not be allowed controlling interest in the bank. There is a reason for this. Past experience,
not only in India but also elsewhere, shows that when industrial houses control banks the outcome is
never a happy one from the public perspective.

True the RBI does have safeguards like the 10% ceiling on voting rights, group exposure, concentration
ratios and so on. But as the controversy over the Tayals of Bank of Rajasthan using front companies to
transfer shares shows, subterfuges are possible, especially in the Indian context where governance
structures are weak and benami companies not an exception. So there is no case for re-visiting the ban
on banks being owned directly or indirectly by industrial houses. The same would apply to non-bank
finance companies controlled directly or indirectly by corporates.

Of course the RBI would also need to lay down more objective criteria such as the minimum capital,
promoter’s share etc. But while doing so it will need to keep in mind the objectives underlying the issue
of fresh licences. The Budget speech suggests there are two: One to ensure the banking system grows in
size and sophistication to meet the needs of a modern society; and two, to extend the geographical
coverage of banks and improve access to banking services. The first is tenable, the second is not. Private
sector banks, as experience has shown, go where the money is and unfortunately, this is not in the rural,
unbanked areas of Jharkhand or Chhattisgarh.

Clearly the only case for having more private sector banks is that they bring in more competition and
ensure access to better and more sophisticated banking products. The question is how can the licencing
authority ensure it strikes the right balance so that it is seen as the best judge rather than as opaque and
arbitrary? It’s not going to be easy, given the stakes involved and the kind of furious lobbying that will
inevitably follow the Budget announcement. The best institutional safeguard would be to make matters as
transparent as possible and then entrust decision making to a committee comprising competent
professionals of proven integrity.
 Breathing Deep

RBI increases repo, reverse repo rate by 25 bps

The RBI on 19th March 2010 raised its key short-term lending and
borrowing rates by 25 basis points each as part of its tight money policy to
combat inflation, which the government feels is a cause of concern. The
repo and reverse rate (short-term rates at which RBI lends and borrows
from banks) were hiked to 5% and 3.5% respectively and could make
banks commercial lending dearer.

”These measures should anchor inflationary expectations and contain inflation going forward," the RBI
said a month ahead of the announcement of its annual monetary policy on April 20 for 2010-11. Headline
Wholesale Price Index (WPI) inflation on year- on-year basis at 9.9 per cent in February 2010 has
exceeded out baseline projection of 8.5 per cent for end March 2010", the RBI said justifying its decision
to hike key rates ahead of its monetary policy.

As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will
not be affected", RBI said. The decision to tighten monetary policy follows inflation surpassing the RBI's
March-end projection of 8.5% and the government's recent decision to hike prices of petrol and diesel.
Besides raising the excise duty by 2 per cent to 10 per cent, the government also increased duties on
crude, petrol and diesel which saw the petrol and diesel prices going up by over Rs 2.50 per litre.

Rising commodity and energy prices are exerting pressure on overall inflation, it said, adding "the
acceleration in the process of non-food manufactured goods and fuel items in recent months has been of
particular concern". More importantly, the rate of increase in prices of non-food manufactured goods has
accelerated quite sharply ... taken together, these factors heightened the risks of supply-side pressures
translating into generalised inflationary process", it said. RBI also expressed the fear that rising industrial
growth could add to further inflationary pressure in the coming days.

RBI further said that even as food prices, which soared to around 20% in December, have started
moderating "they remain elevated". The food inflation for the week ending March 6 declined to 16.3%.
RBI has also expressed concern over food inflation spilling over to non-food manufactured goods.

Lenders expect interest rates to rise, though moderately, following the RBI's move. However, many
bankers said they will assess market conditions, before taking any such decision. ICICI Bank MD and
CEO Chanda Kochhar said, “"We need to wait and see the credit offtake and systemic liquidity to assess
the medium term impact on lending and borrowing rates." Several banks, including major players like
ICICI Bank, HDFC, and Bank of India, have already raised deposit rates which will increase the cost of
funds and have implications for the lending rates.

The apex bank started reversing its soft monetary policy from its October 2009 policy when it raised the
statutory liquidity ratio or the portion of deposits that banks keep in government bonds, gold and cash, by
one percentage points to 25 per cent, besides discontinuing with temporary fund augmenting scheme for
mutual funds. Following up on the October move, in its third quarterly policy on January 29, RBI asked
banks to keep more cash with the central bank. It did it so by raising the cash reserve ratio by 0.75
percentage points to 5.75 per cent.

Earlier, RBI had been easing money supply for the economy, hit by deepening global financial crisis from
the middle of September 2008.
 Breathing Deep
6.0 TAX UPDATES
Rights issues, share sale may face tax hurdle

Companies going for rights issues, share sale to strategic investors, or

stock rejig among group firms may face new hurdles if the taxman
chooses to strictly interpret a new provision introduced last year.
According to the changed tax code, individuals and companies receiving
securities at a price less than the `fair value’ of the stock will be asked to
pay tax on the difference.

Tax experts fear that the income-tax department may extend this rule to
bring transactions like rights issues, preferential allotment to financial
investors or JV partners, and transfer of a holding to another group
subsidiary into the tax net.

Parts of the new tax provision came into effect from October 1, ‘09, though subsequently the scope was
extended in this year’s budget. But if the government does not spell out the details, it can lead to endless
litigation. For instance, `fair value’ has to be defined... Further, a rights issue is always at a discount to the
market price, and in this case is the market price the fair value? In the absence of clarity, corporates
should be careful while passing a rights issue, so that they don’t come under the tax ambit.

Rights issue, bonus issue, preferential allotment will all be strictly speaking covered. However, this might
be stretching the law to an illogical extension. And while the receiver of shares will be taxed based on the
current fair market value (FMV), he or she will not get any adjustment for any future drop in the FMV.

What's worrying many business groups is the difficulty they will face in corporate restructuring.
Companies sell holdings or assets to group firms to attract private equity investors. From now on
corporates will have to watch out whether such transactions are happening at the fair value. Also, transfer
of shares between an Indian company and its wholly-owned subsidiary at less than the FMV may be taxed
in the hands of the subsidiary.

This is extending transfer pricing to domestic companies. All this will make corporate restructuring more
difficult. In most countries, there is an exemption for transfer of shares within the group. This also goes
against the basic tenet of taxation where only real income and not notional income should be taxed.

While the valuation norms are still to be announced, we feel there will be a lot of hardship if the taxpayers
have to justify that every transaction is at the FMV. It's a provision where the tax net can be spread
depending on how strictly one interprets it:

• The contribution of assets by partners to a firm will be hit, and the firm will have to offer deemed
income to tax;

• Foreign venture capital investors with ratchet rights will also be impacted; while pricing guidelines
don't apply to them but they may have to pay tax on notional income;

• Buyback of shares may also be covered.

 Breathing Deep
7.0 INFLATION
Inflation Rises To 16-Month High

Annual inflation shot up to a 16-month high of 9.89% in February 2010 due to

higher prices of fuels and manufactured goods. The recent rate has been due to
the announcement of the excise duty on motor fuels and the rising food prices.
The rise in inflation was broad based with non-food items such as cement, metals
and machinery becoming costlier over the month after manufacturers raised
prices to absorb rising input costs. Although the RBI has started tightening the
policy from January onwards by announcing a 75 basis point hike in cash reserve
ratio, it need to look at harsher measures to tame spiralling inflation.

If prices of non-food items continued to rise in the calendar second half of the year, an aggressive
tightening of the monetary policy stance and a hard landing scenario may become a reality which will
make the 8%-8.5% growth for the year a dream.

The finance minister, Mr Pranab Mukherjee, on 15th March 2010 exuded confidence that the economy
will soon return to 9-10 per cent growth, but said that double-digit inflation and excessive borrowing were
major challenges. “We shall have to move towards the betterment, towards the development and 9-10%
growth is achievable. It is not a pipe dream,” he said while winding up the discussion on the General
Budget in the Rajya Sabha. At the same time within the framework, it is possible to control inflation to
ensure that it does not eat up the benefits of growth. “Benefit of growth is necessary, price control is
necessary, fiscal consolidation is necessary,” he added.

On high inflation, the minister said it was mainly due to a low base. Last year during these months,
inflation was in negative zone and the impact of low base may remain for few more months till May/June
this year. “I will not be surprised if it (inflation) reaches double digit in March,” he said.

C. Rangarajan, chairman of prime minister's economic advisory council, expressed concern over rising
inflation and said, "It is a very uncomfortable level of inflation. We should do everything we can to
contain it before it reaches the double digit level. But I do expect that as the food prices rose very sharply
last year because of the downside expectations caused by the deficient rainfall, I believe that the
expectations of that type can be reversed if the Rabi output is good." He added that the numbers shot up
due to higher fuel prices. The inflation rate has turned out to be much higher than expected but it also
carries the impact of the recent rise in petroleum prices.

On whether the government would look at further rolling back some of the stimulus measures to curb
inflation, Mr Rangarajan said, "I think the Budget has been recently presented. It has tried to work out a
balance between the need for fiscal consolidation and the need for maintaining stimulus. For the present,
we will have to watch the behaviour of prices for few more weeks and see whether the food prices decline
happens as a consequence of better expectations of Rabi output."

Earlier, speaking on the sidelines of a conference on the global financial system organised by Madras
University's commerce department, he said the recent reduction in CRR, repo and reverse repo rates by
the RBI are steps in the right direction. Also, that the stance of the monetary policy must be to contain to
the price increase within reasonable limits even as support is provided to facilitate growth. "Sharp rise in
food prices over the year has compelled the Reserve Bank to raise the CRR by 75 basis points. Further
action will depend on the pick up in credit, the liquidity conditions and the pressure on prices," he said.
 Breathing Deep
8.1 MISCELLANEOUS UPDATES
Foreign funds may hike India allocation

Portfolio investors are positive on the India structural story. Foreign fund
managers from GIC, Boston-based Mass Financial, Janus, T Rowe Price,
Boston-based Wellington Management, Singapore-based Aberdeen Asset
Management and Fidelity, which were recently in India, have indicated that they
are looking for the right opportunities to match their India allocation.

Many have gone back to say that they are considering raising their India
allocation, said a senior strategist at the India arm of a foreign brokerage. However, how soon this will
translate into incremental flows will be difficult to say, he added.

The big fear so far had been that if the US raised interest rates, money would flow out of emerging
markets, including India. After the Federal Reserve statement on keeping interest rates low, this is
unlikely and viewed as a definite positive for fund inflows.

While most of these funds have been invested in India, with sufficiently large India portfolios, a few
names such as that of the US-based pension fund TIAA-CREF are also doing the rounds. TIAA-CREF
has been invested in India for more than a decade. The fund is said to be taking a relook at India.

However, equity analysts are concerned that a rise in interest rates by the Reserve Bank of India (RBI) to
contain inflationary expectations could act as a dampener and lead to some of these funds adopting a wait-
and-see attitude. Also, with a large tranche of Greece’s debt across various maturities coming up for
expiry in April, Europe still remains a concern.

“We are very bullish on India over the medium-to-long term. While we are currently overweight on India,
we may consider raising India allocations over the year, depending on how the next few months play out,”
said Sam Mahtani, director, emerging market equities, at the London-based F&C Asset Management.
“Our key high conviction stock ideas include Jindal Steel, Ranbaxy and Axis Bank,’’ he added.

F&C has a $ 2.5-billion emerging market portfolio, with India’s share of the pie being $350 million.
While the India portfolio is a diversified one, the four key themes include pharma, IT, financial services,
and metals and mining.

Foreign institutional investors, or FIIs, have been net buyers of more than $3.2 billion of Indian stocks as
on March 22. On a net basis bought $3 billion of shares in March alone. India has a 0.96% weightage in
the overall MSCI (World) universe compared to China, which has a 2.26% weightage. The MSCI India
market cap is $233 billion vis-à-vis India’s market cap, which stands at $1.3 trillion. Interestingly, most
portfolio investors are underweight on China.

The overall MSCI (World) universe on February 26, 2010, stood at $24.1 trillion, with 87.3% of it being
the MSCI developed world and 12.7% the MSCI emerging world. The stance of institutional investors
over the past few months has been one of cautious optimism. After the Federal Open Market Committee
(FOMC) meeting this month, investors have moved from being risk-averse to a more neutral zone on
emerging markets and India.

The perception is that while global liquidity will continue to determine future flows, India is holding out
much better than the fundamentals warrant. Currently, most FIIs are marginally overweight on India.
 Breathing Deep
8.2 INSURANCE SECTOR
Regulate selling of insurance policies by banks

A proposal to allow banks to sell policies of several life insurance

companies that was under consideration of the insurance regulator
appears to have reached a stalemate.

Insurers, promoted by banking groups like SBI and ICICI Bank, feel that their group banks should be
captive to them whereas other banks should have the freedom to distribute their products.

Banks that have entered into corporate agencies with insurers but have no equity relationship with them
such as Citibank want the freedom to sell products of other companies as well. Present regulations allow
banks to sell products of a single company.

Those in favour of captives say that an open architecture would result in banks playing one insurer against
the other for higher commissions. Those in favour of an open architecture say that a captive bank deprives
the banks customers of choice and also increases the risk for the life insurance company.

Deeper relationships

Limra — an international association of life insurance companies — had undertaken a survey of

bancassurance in Asia in 2009. According to the report, banks in Asia should consider the organisational
relationship with the insurer. Insurers should have a deeper relationship with banks for the distribution
arrangement to be successful. The report said the pure distributor model for bancassurance may not
always be the best because of the low integration between the insurer and bank.

Two to tango

The industry is trying to influence regulation on the basis of what suits companies best. The truth is that
neither RBI nor IRDA has really seen it from the perspective of the buyer. One pointer to this is the fact
that not a single insurer or bank has been penalised for mis-selling when even the regulators acknowledge
that there has been mis-selling. The scope for mis-selling by banks is enormous. Banks have been lured
into distribution by insurance companies who pointed out that as against the 2-3% loan spreads they make
on deposits, banks would gain over 20% by way of commission on the premium they bring in.

There are also a number of issues that both RBI and IRDA need to address. Many banks have an
overriding commission structure where both the bank and the official making the sale get a share of the
commission. This is despite overriding commissions being banned by the regulator. The regulators also
need to have different regulations for banks that bundle insurance with savings and loan products, banks
that sell under group insurance policies and banks that sell through wealth managers.

The processes in both the industries are so different that the insurance regulator alone cannot address this
issue. It is important for RBI and IRDA to jointly come up with regulations for bank distribution of
insurance products. This is also in the best interest of the industry. If the business grows and mis-selling
continues there is a possibility that the regulators may have to clamp down completely and close down
this channel of distribution.
 Breathing Deep
9.1 KNOWLEDGE RESOURCE
Buffett turns recession chaos to gold mine…

America’s most famous investor and Berkshire Hathaway CEO Warren E.

Buffett says his companies benefited from ‘climate of fear’, using the last
18 months to scoop up a string of assets and strengthen his firm.

Buffett struck a confident note in his annual letter to the shareholders of his
holding company, as he described in characteristically colourful terms how
his businesses had largely ridden out the calamity of the financial crisis.

Changing fortunes

The tone of the letter contrasted sharply with Buffett’s report last year, in which he took himself to task
for the firm’s decline in book value, only the second such decline since he took control in 1965. This
time, he described how he had used the last 18 months to scoop up a string of assets – a buying spree that
culminated at the end of last year with the agreement to buy the Burlington Northern Santa Fe Railway,
his biggest bet yet.

Buffett wrote that his company had net income of $ 8.1-billion (around Rs 37422 crore) last year, or about
$ 5,200 a share, 61% higher than in 2008. The company also reported a 19.8% rise in book value. The
crisis of 2007-08 led to the company’s first operating loss in the first quarter of last year, raising questions
about Buffett’s exposure to consumer spending and the housing market. The company recovered strongly
later in the year, however, helped by the rebound in the stock market, which strengthened his derivatives
holdings. In his letter, which accompanied the company’s annual report, Buffett laid out in detail how
many of his holdings still depended on the vagaries of housing demand and consumer spending. But
shares of the company, which peaked late in 2007 at around $148,220 and fell to lows of around $73,195,
have since rallied to close at $119,800.

“We’ve put a lot of money to work during the chaos of the last two years,” he wrote. “It’s been an ideal
period for investors: a climate of fear is their best friend.”

He also admitted mistakes of his own, saying he had closed a troubled credit card business, which had
been his idea, and had given too much time to turn around the NetJets Inc. business, long a burden. But he
dwelt also on the lucrative positions he took in a string of companies over the last year and a half, pouring
$15.5 billion into shares of companies such as Goldman Sachs Group Inc., General Electric Co. and Wm.
Wrigley Jr Co. Wishing he had taken greater advantage of the opportunities offered, he said, “When it’s
raining gold, reach for a bucket, not a thimble.”

Burlington Northern Santa Fe Corp. was Buffett’s biggest purchase to date. Addressing that company’s
65,000 shareholders, he offered them a primer in his investment rules. But he warned all shareholders that
the bigger size of Berkshire Hathaway would probably mean slower growth in the future. ”Huge sums
forge their own anchor and our future advantage, if any, will be a small fraction of our historical edge.”

Closing the letter, Buffett, ever the cheeky salesman, invited shareholders to his company’s annual
meeting on 1 May in Omaha—promising to play table tennis for spectators and urging them to buy goods
and services from his companies, and ending, ”P.S. Come by rail.”
 Breathing Deep
9.2 KNOWLEDGE RESOURCE
Credit Score

Imagine a situation where you have identified a house you like to buy. You
walk into a bank; provide some identification and the front-office executive
offers you a special discounted rate based on your credit score thrown up
by the bank’s computer. Not just that, the bank also feeds in details of the
property that you wish to buy and tells you whether the seller has a loan
outstanding against it or not. A combination of events are taking place that
will propel growth in retail loans to the level of developed markets by
reducing bad loans and improved accuracy in pricing.

At one end, a host of new credit information companies (CICs) are coming
up to provide banks with a comprehensive database of borrowers’ track
record. At the other end, the government is promoting institutions like the
Central Mortgage Registry, which will ensure that no two borrowers in the
country will be able to raise institutional loans against the same asset. Helping link the borrowers to their
credit histories will be the Unique Identification Authority of India (UIDAI) with its social security-like
number, which has received a government support of Rs 1,900 crore in the recent Budget.

Recently, the RBI gave operating licence to Experian Credit Information Company, which plans to roll
out its products over the next few months. Experian is the first credit information company to receive
operating licence after the Credit Information Companies (Regulation) Act was passed in May 2005.

Earlier in 2009 the central bank had given in-principle approvals to two companies – Equifax Credit
Information Services and High Mark Credit Information Services. Both are expected to get full-fledged
operational licences before the end of FY10. The competition in this nascent sector is set to hot up as the
new entrants enter the fray till now monopolised by Credit Information Bureau of India (Cibil), which
came into existence bore the CIC Act was passed.

CICs maintain a centralised database on borrowers and rate their creditworthiness based on the
information on their existing liabilities and past repayment record. The scoring is based on the analysis of
the information provided by banks, which have already extended credit facilities to the borrowers. If a
borrower goes to multiple lenders, then new lenders will benefit from these scores while making a lending
decision and pricing the loan appropriately.

The success of the model is based on information sharing between members – NBFCs and banks. While
Cibil enjoys a patronage of 200 credit grantors as members and has a database of about 1.5 million credit
accounts, Experian has already obtained commitments from 39 lenders, even before starting full
operations. Though the CIC Act has similar provisions for telecom and insurance companies, these are yet
to take off commercially.

Each player has his own strategy to tackle competition. Cibil, which set shop in 2004, is aware of the
challenges that it will face as more companies enter the market. Arun Thukral, managing director of Cibil
says “We welcome competition as it would eventually boost credit penetration in the country and bring
financial discipline among individuals. We will continue to make investments in information technology
infrastructure and offer innovative risk management products to the banking industry.”
 Breathing Deep

Phil Nolan, managing director of Experian Credit Information Company of India says, "We have to
differentiate our offering from that of Cibil. We understand the market and products better as we are twice
the size of our nearest competitor globally”. Experian plans to outsource all its data processing work to its
data centre in the UK, which it says is cost-effective. This UK-headquartered, $3.9-billion CIC has
presence in 69 countries.

The US-headquartered Equifax, which too has a sizeable global presence, is expected to set up shop soon
here. Equifax India head Samir Bhatia says, “Globally, Equifax has over 800 different products in its
bouquet. Over the medium term, we plan to introduce some of the most relevant products in the Indian
market,” “Our foremost priority will be to offer our clients products such as credit information reports,
scores and analytics services. We will also focus on identity and collection management areas. We are
also investing to bring in high-end technology to enable our customers superior and easy access.”

The reason why none of the companies are particularly perturbed by competition is the size of the market.
As of now, data is available only for 15 lakh borrower accounts, that too mainly from large cities. But
CICs are talking of covering Tier-I and Tier-II cities. Some, like Experian, are also in talks with micro-
finance companies in order to enter the rural market.

As for banks, such reports will help them arrive at a more realistic lending decision which, in turn, will
help them in reducing their non-performing assets (NPAs). However, this comfort comes with a cost.
Every report obtained from a CIC attracts a fee. For lenders to refer to more than one credit information
agency, it is incumbent upon the agencies to reduce their fees for such credit reports. Eventually, it will be
the accuracy of the credit report, besides pricing, based on the information provided by banks that will
hold the key. The competition may force CICs to ensure this. Cross-checking the customer’s data from
two different bureaus may put more confidence in the minds of the appraising officials about the true state
of affairs of the applicants’ current borrowing record.
 Breathing Deep

It’s not pink, STUPID!

www.mi7safe.org

Alka Agarwal
Managing Trustee Mi7

Financial Literacy Mission

A crash course of financial literacy

Missions Seven Charitable Trust

120/714, Lajpat Nagar, Kanpur - 208005
Phone 0512-2295545, 9450156303, 9336114780

E-mail at: safe@mi7safe.org

Safe Financial Advisor Practice Journal: April 2010: Volume 41 > Breathing Deep